Economic reforms: A retrospective view

The 25th anniversary of the 1991 reforms has occasioned a flood of retrospective assessments in the national media. This week’s column is devoted to elaborating some of the key messages and highlighting their implications for the future.

The general perception from all assessments is that the reforms have done well in stimulating growth, but less so in other respects. The acknowledgement that they have been good for growth is a huge change from 1991 when there were fears that the dismantling of government controls and greater reliance upon the private sector and market forces would be ruinous for the economy.

Since the Left were the most vociferous opponents, reformers can take comfort from the statement on NDTV by Sitaram Yechury, general secretary of the CPM (Communist Party of India-Marxist), when he said that of course if you judge only by gross domestic product (GDP), you can say the reforms succeeded. He was right to point out that GDP cannot be the only criterion, but the acknowledgement that reforms have helped growth is surely important. It has transformed India from a low-income economy at the start of the reforms to one at the lower end of what the World Bank calls the middle-income range. We are also currently the fastest growing emerging market country at a time when both the industrialized countries and the major emerging market countries have slowed down.

Another criticism in 1991 was that the opening of the economy to trade and capital flows would make us vulnerable externally, and the International Monetary Fund (IMF) loan would be a precursor to continuous recourse to IMF and extended submission to its intrusive conditionalities. This fear too was ill-founded. We went to IMF in 1981, and again in 1991, but we have not needed IMF since then.

We did experience external difficulties a few years ago when the current account deficit increased to almost 4% of GDP in 2012-13, actually worse than in 1990-91. The fiscal deficit had also worsened because of the fiscal stimulus. The “taper tantrum” triggered by Ben Bernanke’s statement in May 2013 that the Fed would taper off quantitative easing created great uncertainty about capital flows and the rupee came under severe pressure. From around ₹ 49 to a dollar in February 2012 it depreciated to ₹ 68 in August 2013. We were able to handle the crisis without having to call in IMF. A firm statement by finance minister P. Chidambaram that the fiscal deficit would be brought under control, combined with a flexible exchange rate which allowed the rupee to depreciate to some extent in the face of market pressure, all underpinned by the credibility provided by the large reserves, brought the situation to normal very quickly. This was achieved well before the fall in oil prices in the third quarter of 2014.

The decision in 1992 to open up to foreign institutional investment (FII) was much criticized at the time as making the country vulnerable to hot money flows. The fact is that while there was some outflow of FII money, it was for a brief period only, and was easily managed.

The impact of the reforms on the poor is obviously a critical factor in any retrospective assessment. Let us first consider what happened to poverty.

In the pre-reform period the percentage of the population below the poverty line (based on the Lakdawala committee estimates that were then used) increased marginally from 44.5% in 1983 to 45.3% in 1993-94 and the absolute number of the poor increased from 323 million to 404 million. In the immediate post-reform period 1993-94 to 2004-05, the percentage in poverty (using the latest Tendulkar committee estimates) declined, from 45.3% in 1993-94 to 37.2% in 2004-05. However, because population had increased, the absolute numbers increased marginally by 3.5 million. In more recent years, when growth accelerated sharply, the percentage of the population in poverty declined much faster than before from 37.2% in 2004-05 to 21.9% in 2011-12. For the first time ever, the absolute numbers declined by almost 140 million from 407 million in 2004-05 to 269 million in 2011-12.

This achievement is now internationally recognized, with the World Bank highlighting it as a major positive development in the fight against poverty globally. However, there is no doubt that the numbers in poverty are still too large. To have 269 million below the poverty line, and a very austere poverty line at that, is not something that should be seen as a victory. Nevertheless, we can say that if we can grow at 8% or so, and the growth is as inclusive as it has been in the recent past, we can expect to see poverty as now defined reduced to a truly marginal level in another 20 years. It is a different matter that by then our goalposts will have changed and government will have to meet higher expectations.

The real failure is perhaps less in reducing poverty defined in terms of consumption expenditures and more in the failure to deliver basic services such as education, health, clean drinking water and sanitation to the mass of our population. Access to these services is critical for human welfare. It is also critical for growth since they affect the productivity of the labour force and an unhealthy and inadequately educated/skilled workforce cannot sustain high growth.

In the case of education, we have achieved near universal enrolment in primary schools, but the quality of education provided is poor. The situation in healthcare is even less impressive because the roll-out of facilities, and especially their staffing, is much less widespread, especially in rural areas. Access to clean drinking water and sanitation, which is closely related to health, is a major problem. Although the percentage of the population said to have access to protected water sources has increased markedly, the quality of water, especially in rural areas, cannot be certified because it is not regularly tested. Open defecation is still practised by almost 50% of the population, much higher than in many other countries with lower per capita incomes. These shortcomings are all interconnected because poor sanitation and poor quality of drinking water leads to ill health and reduced learning outcomes.

Improving performance in these areas should be a priority for governments for the next 10 years. Additional financial resources will be needed, but there is also the problem of the institutional capacity to spend money well. A basic problem is that the institutions for delivery and the personnel in these areas are all under the control of state governments. It can be argued that accountability must therefore lie with states. However, the central government also has a role to play.

One area where the centre can help is in learning from independent reporting systems. Scholastic achievement as measured by official data based on percentages of marks obtained in school exams differ widely from the findings of the Annual Status of Education Report produced by the non-government organization Pratham. Some years ago, the Organisation for Economic Co-operation and Development-sponsored Programme for International Student Assessment (PISA) survey, which is conducted in several countries, was conducted in India for the first time on a pilot basis. It showed that the levels achieved by students from two relatively advanced states (Tamil Nadu and Himachal Pradesh) ranked at the very bottom of developing countries! The human resource development ministry discontinued the survey arguing that it was unreliable because the tests did not allow adequately for country-specific circumstances.

Lant Pritchett, a professor at Harvard University, has pointed out that India’s top 100,000 students compare with the best anywhere, but quality collapses beyond this thin layer. Rapid growth cannot be achieved on the basis of a thin layer of excellence. It has to be based on a much broader level of quality, and our public educational system is very far from getting there. However, unless there is agreement that a problem exists, we cannot expect a solution. A systematic resort to PISA type testing in all states, after allowing for cultural differences which could skew results, is essential to form an independent opinion on the quality of outcomes. There is considerable evidence from other countries that once the problem is identified and accepted, corrective steps do help.

Perhaps the greatest unhappiness about the reforms is because the growth process they have produced has not yielded a sufficient expansion of job opportunities, and the opportunities created are of poor quality. They may be good enough to pull people above the poverty line, as when agricultural labour moves into higher paid but informal jobs in construction, and the resulting tightening of the agricultural labour market, with some help from Mahatma Gandhi National Rural Employment Guarantee Act, raises rural wages for those who stay behind. However, these jobs will not meet the aspirations of younger people who are no longer looking at being pushed above the poverty line, or even being assured that they will not fall back into poverty. They are looking for ways of getting on a trajectory that assures a transition to a sustainable middle-class existence.

Rapid growth is certainly necessary for this outcome, but it is not enough. It must be accompanied by growth in more labour-intensive sectors. Small and medium manufacturing units are a part of the solution because they are typically more labour using. However, the objective must be to create an environment in which even large units in labour-intensive sectors can do well, even as smaller units in the same sectors expand in size. Policies that discriminate against organized sector units in favour of unorganized sector production, for example, modern retail formats, need to be reviewed because they discourage the expansion of the organized labour force.

Some of what is needed has been on the reform agenda for some time and is uncontroversial, though complex. This includes the provision of good quality infrastructure to all parts of the country, building an efficient banking system and the related set of financial sector reforms, including the new bankruptcy code and its supporting infrastructure, ease of doing business, etc.

Some of what is necessary is controversial, notably labour reform. Leaving it to state governments could help, but it is important to be sure that states implement the right kind of reforms. For example, simply increasing the cut-off level of employment at which the Industrial Disputes Act will apply from 100 employees at present to 300, may not be the best way of providing labour flexibility. It certainly gives owners who employ between 100 and 300 workers more flexibility, but it exempts them from all provisions, including those relating to safety. What we need is flexibility of the right kind, available to firms employing many more workers.

A common worry of many people is that the reforms have increased the level of corruption. The fact is that the elimination of industrial licensing and import licensing eliminated corruption and cronyism from areas where it was once widespread. Where scams are alleged today are the areas that were not reformed, notably allocation of spectrum, mining rights and land. Land is a state subject. In the case of mining rights and spectrum a decision was taken in United Progressive Alliance (UPA)-II that all future allocations would be by auction. In these areas there should be no problems in future and very successful spectrum auctions were conducted under UPA-II and this is continuing under the present regime.

The central message coming out of the anniversary celebrations is that the reforms did well in many fields, but not as well as might have been hoped in some important areas. We have to renew our efforts in what remains undone. Meanwhile, an economy that has moved into middle income status is bound to face new challenges. If we don’t respond, we run the risk of getting stuck in what has been called the “middle income trap”. The lesson is clear: we need more reforms and not less, but as the economy becomes more complex, the reforms have to be much more carefully designed.

Montek Singh Ahluwalia was the deputy chairman of the erstwhile Planning Commission.