Lecture 20. INDIA: THE WORLD’S FASTEST GROWING ECONOMY Economics 1490 THE WORLD ECONOMY: GROWTH OR STAGNATION? with Professor Dale W. Jorgenson Lecture 20. INDIA: THE WORLD’S FASTEST GROWING ECONOMY November 7, 2017 Harvard University Department of Economics Fall 2017

THE WORLD ECONOMY: GROWTH OR STAGNATION? A. Comparing Economies B. U.S. Crisis and Recovery C. European Slowdown D. Asian Economic Miracles E. Sustainability of Economic Growth F. World Economic Outlook

D. ASIAN ECONOMIC MIRACLES 16. Is Asia’s Miracle a Myth?  17. Reviving Japanese Economic Growth 18. The Rise of Developing Asia 19. China: The World’s Largest Economy 20. India: The Most Rapidly Growing Economy

SUPPLEMENTARY READING: INDIA IMF (2017), India: 2017 Article IV Consultation, Washington, DC, International Monetary Fund, February. IMF (2017), India: Selected Issues, Washington, DC, International Monetary Fund, February. RBI (2017), Annual Report 2016-2017, Mumbai, Reserve Bank of India, August.

LIBERALIZATION OF THE INDIAN ECONOMY Liberalization of the Indian economy began in 1988, but led to a foreign exchange crisis and IMF program in 1991. Manmohan Singh was appointed Finance Minister in 1991 and continued through 1996. India grew at 5.08 percent per year from 1990-1995, 5.78 percent from 1995-2000, and 6.76 percent from 2000-2005. Singh became Prime Minister in 2004. Indian growth jumped to 8.10 percent from 2005-2010. In 1990 Indian per capita output was 3.14 (U.S. = 100.0 in 2000) by comparison with Chinese output for 2.78. By 2010 Indian per capita output was 8.12, but Chinese output was 17.22. Indian productivity increased from 21.96 (U.S. = 100.0 in 2000) in1990 to 31.91 in 2010; by comparison Chinese productivity jumped from 23.68 to 40.38 over this period.

MANMOHAN SINGH

BRIEF BIO: MANMOHAN SINGH Born: September 26, 1932, Gah, Punjab, British India (now in Pakistan). Education: Panjab University, Chandigarh, B.A. and M.A., Cambridge University, B.A., Oxford University, D. Phil. Professor of Economics, Cambridge University, 1963-5, 1969-71. Professor of International Trade, Delhi School of Economics. Governor, Reserve Bank of India, 1982-1985. Finance Minister, India, 1991-1996. Prime Minister, India, 2004-2014.

INDIA’S RESPONSE TO THE CRISIS Indian Exports Declined with the Collapse of Trade in 2008-9, But Recovered Quickly. India Had a Stimulus Plan in Place Before the Crisis The Central Government Ran a Large Deficit to Finance Measures Taken Before the 2009 Election The Deficit Was Increased by a Decline in Revenue After the Downturn in Exports

NARENDRA MODI

BRIEF BIO: NARENDRA MODI Born: September 17, 1950, Vadnagar, India.   Education: Delhi University, B.A., 1978, Gujarat University, M.A., 1983. Chief Minister of Gujarat, 2001-2014. Prime Minister, India, 2014-  

STRUCTURAL REFORMS NEEDED TO BOOST GROWTH AND EMPLOYMENT Greater Labor Market Flexibility and Product Market Competition Will Be Required to Create Employment and Increase Growth. Improve the Business Environment by Deregulating Product Markets and Strengthening Property Rights Improve Functioning of Public System for Food Procurement, Distribution and Storage. Introduce Efficient Pricing and Allocation of State Power and Natural Resources.

BUILDING A POLICY FRAMEWORK FOR SUSTAINED ECONOMIC GROWTH Create a National Market for Goods and Services. Privatize Public Enterprises and Deregulate Industrial Activity to Enhance Competition. Reform Monetary Policy and the Regulation of Financial Services. Reduce the Elaborate System of Employment Protections to Create Employment

MAINTAINING EXTERNAL STABILITY India’s External Position is Consistent with Fundamentals and Reserves Are Adequate. India Should Continue to Rely on Exchange Rate Flexibility As a Shock Absorber. India Faces a Challenge in Increasing Exports. New Opportunities May Be Created for Free Trade Agreements.

CONSOLIDATING THE FISCAL POSITION Fiscal Consolidation Has Paused, But the Allocation of Government Expenditure Has Improved Achievement of Fiscal Targets Has Been Postponed, But Will Probably Be Reached. The Main Policy Objective Is to Implement the Goods and Services Tax in 2017.

THE GOODS AND SERVICES TAX The Goods and Services Tax is a Value Added Tax That Will Replace Indirect Taxes at the National and State Levels on April 1, 2017. Passage of the Tax at the National Level Required a Constitutional Amendment in 2016. Revenues Will be Shared between the National and State Governments. Exports will be Exempt from the Tax, While Imports Will be Subject to the Tax at the Same Rate as Domestically Produced Commodities.

FEDERAL RESERVE BANK OF INDIA ADOPTS FLEXIBLE INFLATION TARGETING A Monetary Policy Framework Agreement (MPFA) Was Signed between the RBI and the Government of India on February 20, 2015. The CPI Inflation Target Is Four Percent by the End of 2016-7. Monetary Policy Is Set by the Monetary Policy Board, According to the Amended RBI Act of May 14, 2016. The Policy Rate Was Reduced by 75 bps during 2015-6 and 25 bps during 2016-7.

BANKING AND FINANCIAL REGULATION IN INDIA Basel III Was Implemented by the Reserve Bank of India (RBI) for Banks in India on March 27, 2014. Commercial Banks are Regulated by the Department of Banking Regulation of RBI. Non-Banking Financial Intermediaries are Regulated by the Department of Non-Banking Supervision of RBI. The Financial Stability Unit of RBI Is Charged with Macro-Prudential Regulation of Financial Institutions. The RBI Is Committed to Harmonization of Prudential Regulation Across Various Segments of the Financial Sector.

DEMONETIZATION On November 8, 2016, Prime Minister Narendra Modi Announced that Large Bills, Rs500 and Rs1000, Comprising 86 Percent of Currency in Circulation in India, Were “Demonetized,” That Is, No Longer Legal Tender Except in Specified Circumstances. These Bills Were to Be Deposited in Banks by December 30 and Restrictions Were Placed on Cash Withdrawals. The Purpose of Demonetization Was Fourfold: Curb Corruption, Counterfeiting, Use of Currency to Finance Terrorist Activities, and the Accumulation of “Black Money” Generated by Income not Declared to the Tax Authorities. Demonetization Will Create Short-Term Costs and Long-Term Benefits. Short-Term Costs Are the Inconvenience, Even Hardship, Especially for Informal and Cash-Intensive Sectors. The Long-Term Benefits Are the Reduction of Corruption Concealed by Conducting Illegal Business Activities in Cash, Reduction of Counterfeiting by Introducing New Currency Less Subject to Counterfeiting, and Increasing the Cost of Cash Financing of Terrorist Activities. The Most Important Long-Term Effect Is a Sharp Reduction in Tax Evasion Which Will Make It Possible to Stimulate Economic Activities by Reducing Tax Rates. Much of the Short-Term Cost Has Already Taken Place. There Has Been a Modest Boost in Tax Revenues through Punitive Rates Paid on Cash Deposits That Had Not Previously Been Reported to the Tax Authorities. Lower Prices and Interest Rates Cushioned Some of the Short-Term Impact. The Impact of Demonetization Will Be Reinforced by Adoption of the Goods and Services Tax.

EFFICIENT REDISTRIBUTION India Devotes About Five Percent of Its GDP to Over 950 Central Government and Central Government-Supported Income Programs, Many of Which Are Not Properly Targeted to Support Groups Most in Need. From the Annual Survey: there may be valid reasons for the status quo but overall they indicate that the embrace of markets—even in the modest sense of avoiding intrusive intervention, protecting property rights, disposing of unviable public sector assets and exiting from areas of comparative nonadvantage, and allowing economic agents to face market prices—remains a work-in progress.. Universal Basic Income: The Ultimate Realization of Mahatma Gandhi’s Anti- Poverty Program: “Wipe a Tear from Every Eye.”

INDIAN ECONOMIC POLICY: SUMMARY The Goods and Services Tax Will Contribute to the Creation of National Markets for Goods and Services. National Markets for Goods and Services Can Be Made More Competitive by Privatization of Public Enterprises and Deregulation of Industrial Activities. Flexible Inflation Targeting and a Unified System of Financial Regulation Will Strengthen the Financial Sector. The Great Challenge That Remains is to Develop Labor Markets That Will Create Employment and Sustain Economic Growth.

THE SOURCES OF ECONOMIC GROWTH Comparisons among Regions and Countries Sources of Growth in Capital Input Information Technology and Non-Information Technology Labor Input and Labor Quality Total Factor Productivity

MODEL OF PRODUCTION: Production Possibility Frontier where: I - Investment C – Consumption K – Capital L – Labor A - Total Factor Productivity (TFP)

MAJOR TRENDS IN THE WORLD ECONOMY The Growth of the World Economy Has Accelerated Since 1995 and Become Much More Turbulent. The Balance of the World Economy Is Shifting from the Advanced Economies of the G7 to the Emerging Economies of Asia, Especially China and India. The Transformation of the World Economy has Led to a New World Order, Led by China, the U.S., India, and Japan.

ECONOMIC PERFORMANCE OF THE WORLD ECONOMY Average annual growth rates, weighted by the income share.

ECONOMIC PERFORMANCE OF CHINA AND INDIA Sources of Chinese Economic Growth Sources of Indian Economic Growth Average annual growth rates, weighted by the income share.

PROJECTING THE GROWTH OF THE WORLD ECONOMY Future Demography: Population Projections for the World Economy Are Available from the United Nations. Labor Input Growth Includes the Growth of the Labor Force and Growth of Labor Quality Due to Changes in Composition by Age, Gender, and Educational Attainment. Future Productivity: Productivity Projections for the World Economy Can Be Derived from Past Trends in the Development of Information Technology and Non-Information Technology. Future Output and Capital Input: We Derive Output and Capital Input Projections from Future Trends in Demography and Productivity. Future Productivity Growth Is the Main Source of the Substantial Uncertainty in These Projections.

SOURCES OF AVERAGE LABOR PRODUCTIVITY GROWTH where:   y = Y/H - Output per Hour Worked (ALP).   k = K/H - Capital Input per Hour Worked. CAPITAL DEEPENING: growth of capital input per hour worked, weighted by the share of capital. LABOR QUALITY GROWTH: growth of labor input per hour worked, weighted by the share of labor. TOTAL FACTOR PRODUCTIVITY

RANGE OF WORLD OUTPUT PROJECTIONS Annual percentage growth rates

OUTLOOK FOR THE WORLD ECONOMY The Growth of the World Economy Has Accelerated since 1990 and This Acceleration Will Continue for 2015-2025. Average Labor Productivity Growth for the World Economy in 2015-2025 Will Slow Relative to 2005-2015. Growth of Hours World for the World Economy in 2015-2025 Will Accelerate Relative to 2005-2015. Future World Economic Growth Will Be Subject to Substantial Uncertainty.

RANGE OF OUTPUT PROJECTIONS FOR CHINA AND INDIA Chinese Output Projections Indian Output Projections Annual percentage growth rates

OUTLOOK FOR CHINA AND INDIA Future Chinese Economic Growth: Our Projection Is for a Substantial Slowdown from Nine Percent Growth for the Past Decade, 2005-2015, to a Sustainable Growth Rate of Five Percent for the Next Decade, 2015-2025. This Is Well Below Official Chinese Projections. The Major Downside Risk for the Chinese Economy Is for Financial Distress Due to Unmanageable Levels of Debt. The Upside Potential of the Official Projections Would Require Major Financial and Fiscal Reforms Yet to Be Undertaken. Future Growth of the Indian Economy: Our Projection Is a More Modest Slowdown from the Growth of the Past Decade, Almost 7.5 Percent Annually, to a More Sustainable 6.5 Percent Annually in the Coming Decade. The Downside Risk for the Indian Economy Is Failure to Restore Fiscal Balance and Maintain Control of Inflation. The Upside Potential of India’s Favorable Demographic Trends Depends on Labor Market Reform and Greatly Increased Integration with the World Economy.