India’s GDP growth rate slowed down to 5 per cent in Q1 of FY20 and is expected to be around 6 per cent or below in this financial year. As former Reserve Bank of India governor Y V Reddy mentioned recently, a combination of cyclical and structural factors have been responsible for the slowdown. One example is the auto sector. There seems to be a collapse of aggregate demand in the economy. Global uncertainties have added to the problem. In the last few weeks, the government has announced several measures to improve both consumption and investment in different sectors and for the economy as a whole. The announcement of reduction in corporate tax rates announced on Friday may help in reviving the sentiments of the private sector but the tax revenue may also decline and put pressure on fiscal deficit. These stimulus and structural measures and monetary policy may help reviving the economy to some extent in the near future. But, these measures alone may not help in getting higher growth. The Chief Economic Advisor also mentions that we need long-term structural reforms for investment-led growth. Among other things, we need to focus on three structural issues: Physical infrastructure development, raising human capital and revival of rural economy for a long-term growth of 7 to 8 per cent and attaining $5 trillion economy by 2024.
In a recent book Dani Rodrik et al discuss two challenges faced by countries like India. The “structural change challenge” is focused on moving resources from traditional low-productivity activities into modern, more productive industries or activities. The “fundamentals challenge” relates to development of broad capabilities such as infrastructure and human capital. We can’t have higher growth without tackling this fundamental challenge.
Generally, it is said that we need three things for higher growth. These are infrastructure, infrastructure and infrastructure. This will help both cyclical and structural factors. Late I G Patel indicated in the early 2000s that we should aim only for 6 per cent GDP growth till we improve infrastructure. Hope we have not come back to I G Patel growth rate of 6 per cent or below in the medium term. In one of his speeches, Y V Reddy also mentioned that infrastructure could be a constraint for higher growth. A lot of progress has been made in all infrastructure sectors. However, almost all indicators score poorly if one looks at India’s urban and rural infrastructure particularly compared with South East Asian countries and China.
However, in the present context, some kind of pump priming from the government is necessary to take care of both cyclical and structural factors. This can be done without compromising much on fiscal deficit targets. Disinvestment, reducing non-merit subsidies, removing exemptions, increasing tax base and shifting from revenue to capital expenditures are some of the measures for raising government investment. The government seems to be fast tracking public capex, encouraging public sector enterprises (PSEs) to invest more and trying to clear the pending bills for the corporate sector and MSMEs. The announcement of Rs 100 lakh crore over five years for infrastructure by the government is an important measure. However, details on how to get finance, the roles of public and private investment, the contract structures like PPPs are not clear. The Vijay Kelkar committee’s recommendation on PPPs would be useful. The private sector’s role is equally important. Spending on infrastructure will have multiplier effects in the overall economy including stimulating private investment, aggregate demand and jobs. In fact, construction sector was an important source of job creation during 2004-05 to 2011-12. This sector has to be revived in order to create growth and employment.
NSS employment data shows that the shares of agriculture, industry and services in total employment were 44 per cent, 25 per cent and 31 per cent respectively in 2017-18. But, the share of manufacturing employment was only 12 per cent in total employment. There is a need for rise in infrastructure investment, structural reforms in land acquisition and a favourable exchange rate for exports to revive the manufacturing sector, which showed a 0.6 per cent growth in Q1 of this fiscal.
The second structural issue is raising human capital for higher growth. Health and education achievements are essential for human capital. Yet the country’s progress on both these aspects leaves much to be desired. We also have great quality dichotomy in both these sectors. There are islands of excellence that can compete internationally in education while vast majority of them churn masses of children with poor learning achievement and unemployable graduates. One has to fix this dichotomy in heath and education. Few years back, the Deputy Prime Minister of Singapore cautioned about school education in India. He said: “Schools are the biggest crisis in India today and have been for a long time. Schools are the biggest gap between India and East Asia. And it is a crisis that cannot be justified.” Skill deficiency of workers is well known. The Niti Aayog says that only 2.3 per cent of Indian workers have formal skill training compared to 70 to 80 per cent in other countries. Promotion of technology and knowledge economy will add to growth. One can’t have a “demographic dividend” for growth with low human capital. In order to have structural change from agriculture to non-agriculture and from the unorganised sector to the organised sector, education and skill development are needed. Women’s labour participation rates have been low and declining. Raising women’s human capital and participation rates can improve economic growth. We may also not achieve high human capital and productivity with 40 per cent of our children suffering from malnutrition.
Lastly, we can’t expect demand to increase as 70 per cent of our population lives in rural areas and has stagnant incomes and wages. There is a need for revival of the rural economy with infrastructure investment and structural reforms. Agricultural marketing reforms should be a priority. For better price discovery, agriculture has to go beyond farming and develop value chains comprising farming, wholesaling, warehousing, logistics, processing and retailing. Agricultural exports should be promoted with various policies. Similarly, rural infrastructure and water management are other priorities. Stimulus and structural reforms can raise farmers’ prices and wages and rise in demand for manufacturing and services.
Both immediate and long-term structural reforms are needed to achieve higher economic growth. Physical infrastructure development, tackling Dani Rodrik’s fundamental challenge of raising human capital and stimulus and reforms in rural economy are needed to achieve a sustainable 7 per cent to 8 per cent growth. The Centre has to work closely with states similar to GST council for achieving higher growth. The massive mandate of the new government will help such coordination.
This article first appeared in the print edition on September 21, 2019 under the title ‘Fix the fundamentals first’. The writer is Director and Vice Chancellor, IGIDR, Mumbai.