India’s Development Challenges Higher School of Economics April 1, 2008

India – Economic Indicators

Context: Achievements and Challenges  India’s economic success: sustained rapid growth rates, sustained rapid growth rates, expansion of exports, expansion of exports, emergence of new industries, emergence of new industries, leader in some high tech fields, leader in some high tech fields, Avoided macro/financial crisis Avoided macro/financial crisis Has India poised as a global super power of the 21 st century

India is now a star—but experience shows stars generally fall to earth Change in growth rate, decade to decade (in percent per annum) Growth slowdown of previous decade’s stars versus other countries Top ten growth performers of previous decade All others 70s vs. 60s s vs. 70s s vs. 80s Notes: Negative is a slowing in growth. Source:

Regional variation in poverty in India—poorest places are at African levels, richest near upper middle income

The lagging states failed to accelerate Main issue is that while the middle income states accelerated in the 1990s over 1980s, lower income states did not

Lagging sector: slow structural transformation in Agricultural Sector  Ag GDP has declined to 24% in 2003/04  …but 58% of labor force still employed in agriculture, higher in poorest states  Extremely low labor productivity (closely linked to rural poverty) Source: Census 2001, CSO

Major Causes  Over-regulation of markets continue  Unbalanced composition of public expenditures Rising subsidies Rising subsidies Distorts incentives (water intensive foodgrains in water scarce areas)Distorts incentives (water intensive foodgrains in water scarce areas) Leading to natural resource degradationLeading to natural resource degradation Crowding out productivity- enhancing investments Crowding out productivity- enhancing investments direct impact on agric. growthdirect impact on agric. growth indirect impact on private investments, e.g. R&D, roads > diversificationindirect impact on private investments, e.g. R&D, roads > diversification Inadequate O&M Inadequate O&M Recurrent expenditures going to salaries  deterioration of irrigations, weak cost effectiveness of research and extensionRecurrent expenditures going to salaries  deterioration of irrigations, weak cost effectiveness of research and extension India Public Ag Investments and Subsidies as % of GDP Note: Ag subsidies include GOI foodgrain and fertilizer subsidies, state government power and irrigation subsidies Source: Min.of Agriculture, Acharya and Jogi 2004

Binding constraint I: Economic Infrastructure—falling further behind China Biases growth towards services: “infrastructure camels” Supply chain manufacturing— India as an export platform hindered the most Not “need to invest X billion” but “fix the institutions that fix the pipes”

Binding Constraint II: Fiscal Deficit Debt is high Deficit is high Interest payments are large

Sustaining and Equalizing Growth: Labor Laws  For every one person in organized private sector there are four unemployed.  The hollow middle: the proportion of small firms ten times as high in India as Korea (40% vs. 4%)  Employment elasticity of manufacturing output growth was negative.

Sustaining and Equalizing Growth : Financial sector  Reforms have gone much further in some sectors than others  Access of new firms to debt finance is still limited and limiting—but more ‘old style’ directed credit is not the solution  Micro-finance can be part of the solution, when integrated with more broad based empowerment.

Conclusions  India has achieved much in a decade of transformation  The agenda for sustainability remains daunting: infrastructure, fiscal consolidation, financial system reform, labor regulation  Combining reforms with attention to inclusiveness will be key to find the consensus required to carry this ambitious agenda forward