A few numbers are useful to put in perspective the development challenge that India faces today. India’s current gross domestic product (GDP) is around $2.5 trillion while its GDP per person is $2,000. With an annual population growth of 1.1 per cent and aggregate GDP growth of 6.6 per cent, India’s per person GDP is currently growing at 5.5 per cent annually. At these growth rates, India’s per person GDP would be around $19,000 in 2060.
To put this scenario in perspective, Greece’s per person GDP today is around $20,000. Even if India manages to sustain an average growth rate of 7 per cent for the next 41 years, India’s per person GDP would still be barely above the current per person GDP of Greece. And, Greece isn’t exactly a development role model.
The uncertainties around these scenarios are also huge. If the average aggregate growth rate drops to 5.6 per cent, India’s per person GDP in 2060 would be around $12,000, which is only slightly above the per person GDP in China today. This is the risk inherent in India slipping even slightly from its current growth path and the scale of its development challenge.
Development is a challenge globally, not just in India. The per person GDP of the richest 5 per cent of countries in the world is over 50 times larger than the per person GDP of the poorest 5 per cent. What explains such large disparities across countries?
Output is produced by combining labour of different skill types, land, capital, energy and public infrastructure. Combining these inputs also requires entrepreneurship and management. For example, at the level of the firm, managers who are better at matching the skills of individual workers to tasks are able to generate higher revenues. This applies at the level of the country as well. It is the unmeasured X-factor that is commonly referred to as productivity.
A number of researchers have found that measured inputs account for at most half of the per person difference in output across countries. The remaining output gap is due to differences in productivity levels across countries. For some reason, the same measured inputs produce much more output in the richer countries, relative to poorer nations.
What is the secret sauce that richer countries use which makes them so productive? There are a few suspects. The first is clearly the policy environment in the country. Economies that encourage capital and labour to easily move across firms, sectors and countries towards their most productive use tend to be more productive. Economies where such mobility is restricted have more misallocation of labour and capital. There are many examples of these: Historians working as bankers, capital stuck in loss-making firms that cannot shut down due to exit policies and limited technology inflows due to import restrictions.
A second reason for differences in productivity across countries is the quality of institutions. The types of contracts that individuals and businesses are willing to sign depend hugely on things like the rule of law, the nature of laws, enforcement of contracts and property rights, reliability of public data and information, the independence of agencies that oversee law enforcement and dissemination of public information.
How does this apply to India? Clearly, there are many impediments to the supply of inputs. Businesses need land to build factories, and foreign partners for the latest technologies. Factories are needed to absorb the labour that India has. A large fraction of this labour is currently stuck in extremely distressed conditions in agriculture because not enough jobs are being created in other sectors. Moreover, current labour laws make large scale hiring costly for firms. Addressing these require reforms to India’s existing land acquisition and labour policies.
Businesses also need capital which they acquire from financial markets. This requires a healthy credit culture wherein debts are repaid, insolvencies are dealt with in a quick and orderly way, and banks are free to lend to the most productive borrower. Our banking sector is mostly state controlled. Banks face myriad constraints on lending due to targets for priority sector lending, statutory liquidity ratio and informal pressures on directed lending. Repeated loan waivers have vitiated the credit culture making it harder for banks to recover loans. The introduction of the insolvency and bankruptcy code has been an excellent initiative but resolutions under it are still slow. All of this bids up the cost of funds for private businesses. Financial sector reforms, including bank privatisation, are clearly needed.
More generally, private businesses, locally and globally, need to feel that India is business friendly — its industrial and trade policies are not subject to sudden reversals, enforcement agencies are independent, public data is reliable, and the country values domain specialists in overseeing its market infrastructure. This is about generating confidence in the institutional structure of India to encourage greater investment and newer technology inflows through foreign direct investment.
As we saw above, relatively small changes in performance can induce wide divergence in potential outcomes over a sustained period. Forty years is the working life of a whole generation. The period from 1950 to 1990 already saw a generation barely experiencing any growth in incomes. India cannot let that happen again. Development is a long game. India needs to act now and stay the course.
The writer is director, Centre for Advanced Financial Research and Learning, Mumbai and professor of economics at the University of British Columbia (views are personal)
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