Home / Opinion / Views /  Opinion | Steer clear of policy shocks to achieve economic goals

Will the Indian economy reach the $5 trillion mark by 2022 in line with the popular discourse, or is it just a mirage? Given that at present India is a $2.7 trillion economy (in 2010 constant US dollar terms), achieving that size would amount to almost doubling the current real gross domestic product (GDP). Even if the economy grows at 14-15% per year in real terms, it would require 4-5 years to achieve that size. Achieving such growth, however, would be a Herculean task, and the recession-like conditions only make it harder. The annual growth rate of real GDP at present is about 5%, amid a slowdown in consumption as well as investment, and an increase in unemployment. If this rate persists, it would take even longer—about 14 years—for the economy to reach the $5 trillion mark. How should policymakers respond to this unpleasant arithmetic?

The solution may lie in understanding the nature of business cycles in emerging markets such as India. Mark Aguiar and Gita Gopinath, in a seminal paper published in 2007, posit that for emerging market economies, the cycle is the trend. They argue that emerging economies experience frequent policy regime switches, leading to substantial volatility in trend growth. Think about the substantive policy changes that the Indian economy has experienced after Independence, in the form of government spending shocks, bank nationalization, trade policy changes following frequent balance-of-payments crises, liberalization, monetary policy shocks, and the more recent massive shocks of demonetization and the goods and services tax. All these shocks have had persistent effects on productivity. The economy’s productive capacity itself was affected, either negatively or positively for significant periods of time.

Contrast these with developed economies. There is a fair degree of stability in the policy environment that businesses and individuals face, making it easier for them to form expectations and take decisions. Cycles in output are caused by transitory shocks. Therefore, the business fluctuations in developed countries are transitory fluctuations around a stable trend, while fluctuations in emerging markets stem more from shocks to trend growth. If we follow Aguiar and Gopinath’s logic, the first thing that policymakers ought to do is avoid shocking the trend growth through abrupt and substantive policy changes.

We know there is a problem of tax evasion and informality, but there aren’t quick fixes. All developing countries have the same problem. Policy changes required to address this are a set of inclusive policies focused on the long-term that ensure entry into the formal sector for all. For example, policies that broaden access to education, healthcare, and credit markets, together with a strong social security system, could stem the flow of Indians to the informal sector. In addition, it is necessary to implement policy changes that reduce the cost of hiring labour for firms, and ensure cost efficiency through the removal of size restrictions on firms and the harmonization of labour laws, along with adequate unemployment insurance support. The question of optimal sequencing of such reforms will also have to be addressed if we are to avoid the risk of slipping back into the “cycle is the trend" world.

Sustained long-run growth requires simultaneous investment in physical and human capital. All developed countries have had at least 150 years of free public education by now. The benefits they are reaping today are the result of these investments that Indian policymakers continue to shy away from. There is no short cut. An educated workforce is the key to using physical capital efficiently and generating positive technology shocks. The government will have to build institutions that will incentivize an accumulation of these factors. That would mean actively discouraging discrimination based on religion, caste, gender and sexual orientation.

A massive increase in the legal infrastructure is needed to clear a substantial backlog of cases and ensure the swift resolution of new ones. Reforms will have to be undertaken to improve enforcement mechanisms for contracts. Recourse to legal support has to be equalized for different sections of society. Markets can work miracles, but without institutional support and redistribution of endowments, they will lead to further inequality and exclusion of the underprivileged.

All these are long-term reforms and may not bear immediate fruit. Are there any short-term remedies to get us out of an economic rut? Yes. There needs to be an urban counterpart to the National Rural Employment Guarantee Act. It would be a great way to create short-term employment and can be used to improve the availability, access and delivery of essential public goods and services. Investment in agricultural infrastructure to improve access to markets and cold storage across India is another reform that could fetch immediate gains. Increased spending on schooling, strengthening midday meal schemes, and greater access to healthcare could substantially ease the burden on unskilled and uneducated workers. Providing services will also generate jobs. These are real hard reforms that the state of Delhi undertook and reaped political rewards for. Whether the Centre will bite the bullet is a $5 trillion question.

Parag Waknis is associate professor of economics, School of Liberal Studies, Ambedkar University Delhi

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