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Three decades on, India is again at crossroad

One of the great paradoxes is that Indian industry is capital intensive despite the country having surplus labour. Job creation in industry has been weaker than expected. Art: The Dismantled Wheel by Prabhakar Pachpute, 2020  (Courtesy: Prabhakar Pachpute/Experimenter)Premium
One of the great paradoxes is that Indian industry is capital intensive despite the country having surplus labour. Job creation in industry has been weaker than expected. Art: The Dismantled Wheel by Prabhakar Pachpute, 2020 (Courtesy: Prabhakar Pachpute/Experimenter)

India needs to help create 100,000 competitive small enterprises over the next 10 years if it hopes to create 100 million well-paying jobs by 2030

Vishwanath Pratap Singh visited Kuala Lumpur in June 1990 as the Indian prime minister. He was surprised with the economic progress he saw around. Malaysia was one of the handful of Asian countries that had engineered an economic miracle by the 1980s, as it harnessed domestic capabilities to build an export engine that pulled people out of poverty. The average Malaysian was better off in 1990 than the average Indian is today.

Singh later asked Montek Singh Ahluwalia, who was then working in the Prime Minister’s Office, to write a policy note on the steps India needed to take to emulate what so many other countries to the east of our borders had done. The result was the “M-Document" that brought together the thinking of economic reformers who had begun to make an impact within the Indian government over the previous decade.

This anecdote is part of the folklore of the 1991 economic reforms, introduced by the duo of then prime minister P.V. Narasimha Rao and finance minister Manmohan Singh when India was on the brink of an international default. It is also strikingly similar to the epiphany Deng Xiaoping had—and the lessons he took back to China—at the end of his Asian tour in 1978, soon after he had consolidated his power following the death of Mao Zedong. China embarked on its new economic strategy soon afterwards. The Asian model was worth emulating.

In the neighbourhood
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In the neighbourhood

The role of the twin epiphanies should not be exaggerated. Large countries do not change their economic course only because of what their leaders see on a foreign visit. However, the Asian story cannot be ignored either. It tells us that economic success is not just about accelerating the rate of economic growth on a sustained basis; it is also about structural transformation of the economy.

The process of structural economic transformation is built around three interlinked transitions—from farm to factory, from informal to formal enterprises, from villages to cities. Each of these transitions provide opportunities for people to shift from low-productivity to high-productivity activities, with access to financial capital, labour markets and commercial networks. Several Asian countries—from Japan in the 1950s to China in the 2000s—successfully made these transitions.

In his landmark 1992 budget speech, Manmohan Singh was clearly referring to the Asian success stories when he said: “We … embarked on a medium-term programme of structural reform, including new initiatives in trade policy and industrial policy aimed at improving the efficiency, productivity and international competitiveness of the Indian industry. Our longer-term objective is to evolve a pattern of production that is labour intensive and generates larger employment opportunities in productive higher-income jobs, and reduces the disparities in income and wealth between rural and urban areas."

It will soon be 30 years since the economic reforms of 1991. Much of the debate over this period has focused on the second of the two themes mentioned above—the reduction in poverty as a result of higher average incomes. India has done reasonably well on the first front. The size of the Indian economy has increased from $274 billion in 1991 to $2.87 trillion in 2019. Average incomes have increased from $308 to $2,097 over the same period. The World Bank now defines India as a lower middle-income country.

Much of this is known. However, far less attention has been drawn to the equally important first theme—the structural transformation of the Indian economy. Have there been enough opportunities for Indians to move out of their traditional occupations, which are also often linked to caste hierarchies? A December 2019 story in the Plain Facts section of this newspaper used data from the India Human Development Survey to show that social mobility is still very weak in India: There is only a one in three chances that a son born to a farmer or farm worker or construction worker moves to a different occupation.

Indians have begun exiting the overcrowded agriculture sector in recent decades. The proportion of the Indian labour force employed in agriculture has come down sharply over the past three decades—from 62.56% in 1991 to 42.39% in 2020, according to estimates from the International Labour Organization.

Yet the Indian farm continues to shrink in size, as farming families divide land because of the lack of economic opportunities elsewhere. The average Indian farm is now just over one hectare in size. It was around 1.4 hectares in 1995, a little after the 1991 economic reforms. Indian agriculture has a problem of scale.

That is why job creation outside farming matters. Where have these sectoral migrants been absorbed? The proportion of the Indian labour force in industry climbed from 15.72% in 1991 to 25.57% in 2020. Industry in this context includes manufacturing, construction, mining and public utilities. Services sector employment rose from 21.72% in 1991 to 32.04% in 2019. The bottom line is that a fifth of the labour force has moved out of agriculture since 1991, a sign of structural transformation in progress.

One way to see how India is doing in comparison to some other significant Asian economies is to compare the structure of the economy today with that of its regional peers when they were at a similar level of development. India had an average income of $2,000 in 2019, the year before the recession induced by the pandemic. South Korea was at a similar level in 1983, Thailand in 1992, China in 2006, Indonesia in 2007 and Vietnam in 2012. Bangladesh had a per capita income of a little less than $2,000 in 2019.

The table shows that India is broadly comparable to these Asian countries when they were at a similar level of economic development. It is worth pointing out that urbanization levels across countries are not strictly comparable because each nation uses a different way to define a city, and India is far more urbanized than our official statistics show.

However, there are some major challenges as well. Much of the industrial work that Indians who have exited farming have got is not productive enough to pay them good wages. The reason: They have not moved from farming to modern factories or modern offices, but are finding work in stunted enterprises that act more as social shock absorbers rather than engines of income growth.

The average Indian enterprise is tiny. Only one in every 50 enterprises hires more than 10 employees. An average enterprise has only 2.24 employees. This is in sharp contrast to the situation in China, where people leaving farms have been absorbed into large enterprises that often have links to global supply chains. In a study done for NITI Aayog, researchers at IDFC Institute pointed out that most workers in India are employed by firms with less than eight people while most workers in China are employed by firms with 51-2,000 people.

India needs to create 100,000 competitive small and medium enterprises over the next 10 years, each employing about 500 people, if it hopes to create 100 million well-paying jobs by 2030. The proliferation of tiny enterprises will not do the trick.

India is at the crossroads right now. Thirty years after it reintegrated with the world economy, it is a lower middle-income country that has sustained its economic momentum for three decades, one of the few countries to do so. It has covered around a third of the long journey towards an economy freed of mass poverty. The biggest economic challenge over the next 10 years is to meet the aspirations of a young population through the creation of jobs with decent wages. The record has been a mixed one till now.

The biggest public policy challenge in the coming years will thus be robust job creation through the growth of modern enterprises. It does not help that the organized sector which is better placed to create high-quality jobs has shown a marked preference for machinery over men in recent decades.

One of the great paradoxes is that the Indian industry is capital intensive despite the country having surplus labour. Economists have pointed out the capital intensity of Indian manufacturing has been steadily rising since 1980, for a range of reasons, from labour market regulations to infrastructure bottlenecks. The result is that job creation in the industry has been weaker than expected.

Job creation is the best way to guarantee inclusive growth. The inability to do so since 1991 has meant that the Indian state has come under pressure to use its fiscal resources to buy social stability, through programmes such as the Mahatma Gandhi National Rural Employment Guarantee Scheme or the Pradhan Mantri Kisan Samman Nidhi.

Such income support programmes leave less money aside for the provision of public goods or the building of infrastructure. The inability to provide quality jobs in modern enterprises in effect means that the Indian state has been forced to move from a development role to a compensatory role, not exactly the best option for a country at our level of development.

The task ahead is thus to double down on the goal Singh spoke about in his 1992 speech—to emulate what other countries to the east of our borders have managed. The Asian success stories have many common themes. The more orthodox economists stress on their export orientation, high levels of domestic savings, a liberal import regime, competitive exchange rates and macroeconomic stability. The heterodox economists point to successful industrial policy, subsidies to select sectors, preferential credit allocation and administrative guidance. What both agree on is that these countries pursued export promotion rather than import substitution, and invested heavily in human capital.

The 1991 reforms were a decisive turn away from import substitution in a protected domestic market. India reintegrated into the world economy. Import tariffs have been going up over the past few years. Industrial policy is making a comeback through incentives to specific sectors that have been identified by the government. Prime Minister Narendra Modi has maintained strategic ambiguity about what he means by atmanirbhar, but some of his ministers have been talking about the importance of import substitution.

India is unlikely to slide back into a 1970s-style interventionist economy. Yet the decision to bank on the $3-trillion domestic economy rather than the $85-trillion global economy could be a strategic mistake—especially at a time when international discomfort with Chinese aggression has hastened the shift of global supply chains from that country.

One insight from trade economics is that an import tax is in effect an export tax. India’s own pre-1991 record shows that protectionism does not help build a competitive industrial sector. The lessons from Asia are still key.

Niranjan Rajadhyaksha is a member of the academic board of the Meghnad Desai Academy of Economics.

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