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Business News/ Politics / News/  The long road to breaking free
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The long road to breaking free

The promise of Independence was not just the end of colonial oppression, but also of the economic regeneration of India. How far have we walked down that path?

Illustration: JayachandranPremium
Illustration: Jayachandran

A few days before that momentous midnight hour in August 1947, Vallabhbhai Patel addressed a public meeting. A newspaper report from that day tells us that after explaining why Partition was painful but necessary, and calling on the princely states to join the new Union, Patel told the audience that ‘the main task ahead was the economic regeneration of India’.

Patel was voicing a view that was embedded in Indian nationalism from its earliest days. From the sharp critiques of colonial economic policy, to the Industrial Conferences that were held in parallel to the annual meetings of the Indian National Congress, to the sustained campaigns for the spread of technical education, to the success in negotiating for some element of fiscal autonomy after 1919, to the setting up of the Reserve Bank of India in 1935 — Indian nationalists had invested a lot of energy in economic issues.

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The transfer of power on 15 August 1947 provided them an opportunity to take action. It was not an easy situation. Economic output had stagnated for many decades, average incomes were miserably low, the new state was underfunded even compared to other former colonies, the food situation was dire, and there was a narrow industrial base concentrated around a few large cities. Most Indian leaders across the political spectrum— with MK Gandhi being the most significant dissenter—broadly agreed that breaking out of this trap would require rapid industrialisation led by the state.

The challenge was not just about increasing average incomes. The long march out of mass poverty involved profound changes in the structure of an economy. The Indian economy had to create opportunities for people to move from farms to factories/offices, from villages to cities, from household enterprises to formal enterprises. Each shift would enable labour to move from low productivity to high productivity activities, thus boosting incomes. That is what India has attempted over the past 75 years—with mixed results.

The initial record was impressive.

Economists have used statistical techniques to pinpoint 1950 as the first big structural break in India’s economic trajectory, with 1980 being the other. The economy accelerated after many decades of stagnant output. Economic growth averaged 4.2% a year between 1950 and 1965. Industrial output grew annually at 7.1%. The fact that industry grew faster than the rest of the economy meant that India began to reverse the deindustrialization that had begun in the last years of Mughal rule. Equally importantly, economist S Sivasubramonian showed in his monumental work on Indian economic growth in the 20th century that total factor productivity grew at 1.8% a year in the 15 years to 1965.

The elements of the classic Nehruvian growth strategy are well known: A focus on public sector investment rather than private sector investment, on capital and intermediate goods rather than consumer goods, and on the domestic market rather than foreign trade. There was more than just economics in play. The focus on building capacity in steel, machine tools and mining was an attempt to maintain strategic autonomy in the Cold War era—similar to why countries, including India, are today trying to build domestic capacity in semiconductors, electric batteries and telecom equipment, for example.

The drive to push up the investment rate while national savings were low meant that India had to battle periodic shortages of foreign exchange that were eased through foreign aid. Trying to earn foreign exchange from exports was not given enough attention, something that a young Manmohan Singh had pointed out in his PhD thesis written in the early 1960s.

Breaking the twin constraints of domestic savings and foreign exchange was a big concern in the development economics of the time. Interestingly, PC Mahalanobis believed that the public sector would soon be profitable enough to generate internal resources for the next wave of industrial investment. Oh, sweet innocence!

There were two other powerful critiques of the Nehruvian development strategy. The Mumbai economists CN Vakil and PR Brahmananda argued that India should invest more in agriculture and the production of consumer goods — or what they called wage goods.

The famous dissent of economist BR Shenoy provided four red flags. First, the heavy dependence on deficit financing to build industrial capacity would lead to balance of payments pressures. Second, the focus on capital goods rather than wage goods for mass consumption would be inflationary, as people employed in new industries would get money incomes but nothing to spend them on. Third, high taxation to finance the plans would weigh on citizens. Fourth, increasing government control of the economy would eventually harm Indian democracy.

Nehru died in 1964. During his regime, India had managed to build a diversified industrial base, albeit an inefficient one. A course correction of the sort that many East Asian countries made around the same time, from import substitution to export promotion, would have made a world of difference. That was not to be.

The short period when Lal Bahadur Shastri was prime minister offered hope of change. Shastri wanted more investment in agriculture to control rising food inflation. He saw that physical controls were creating artificial shortages and black markets; he preferred financial controls. And the failures of the public sector convinced him that the private sector should have a bigger role in the economy. One of the tantalizing questions in Indian economic history is whether India would have embraced liberal economic reforms 25 years before 1991, if Shastri’s tenure had not been cut short by his premature death.

Indira Gandhi began with a relatively liberal economic agenda, including devaluing the rupee as well as easing trade restrictions in response to balance of payments pressures. However, in response to the international geopolitical situation as well as domestic political calculations, she swung to the Left after 1969. The economy was choked with stringent licensing, credit rationing, import controls, as well as draconian laws such as the Monopolies and Restrictive Trade Practices Act and the Foreign Exchange Regulation Act. A series of exogenous shocks between 1965 and 1980 — wars, droughts and oil prices — further battered the economy.

The 1970s were a lost decade, with low growth and high inflation. However, there were two significant structural breakthroughs. First, the Green Revolution that began in the late 1960s helped India make a big dent in the food constraint. Second, the domestic savings constraint eased, perhaps helped by the spread of bank branches after nationalization. There were also the first signs of introspection on the nature of Indian economic policy in several official committee reports, though actual policy reforms were not yet on the horizon. The underrated budget speech by H M Patel in 1978, as finance minister of the short-lived Janata party government led by Morarji Desai, deserves more attention.

The first tentative economic reforms began after Indira Gandhi came back to power in 1980. Political scientist Atul Kohli has written of how she made her peace with Indian business houses. The licence raj was eased. Taxes were reduced. VP Singh presented a reformist budget in 1985, when Rajiv Gandhi was prime minister. Manmohan Singh helmed the seventh five-year plan. It focussed on technology, productivity and efficiency. The Reserve Bank of India allowed the rupee to gradually depreciate in a bid to promote exports.

The growth spurt in the 1980s was supported by a large increase in fiscal deficits as well as international borrowing. It was unsustainable. The road to the 1991 crisis lay ahead. The macroeconomic crisis—in the midst of political and social instability —was a turning point. The duo of PV Narasimha Rao and Manmohan Singh abolished industrial licensing, slashed import tariffs, opened up the financial sector, attracted foreign capital, fixed public finances and made the rupee convertible on the current account. In his landmark budget speech in July 1991, Manmohan Singh cogently argued that the balance of payments crisis was a symptom of a deeper malaise: macroeconomic imbalances, low productivity of public sector investments, loopholes in the tax system, indiscriminate protection that had weakened the incentive to export, lack of domestic competition, a weak financial system that was not allocating capital efficiently, lack of access to the latest technology, and much more. The great achievement of 1991 was not each reform in isolation, but the rollout of a comprehensive reform programme where different parts complemented each other.

The development state was replaced by the regulatory state. The government was no longer the main vehicle of investments. That job was handed over to the private sector, while new regulators were set up or empowered to ensure markets functioned well in a wide range of areas.

The reforms that followed in the decades ahead—fiscal laws, bankruptcy code, inflation targeting, for example—were all designed to strengthen the market economy. The goods and services tax (GST) introduced by the Narendra Modi government is both a grand federal bargain as well as an essential step in integrating the Indian market through national supply chains, or an internal free trade agreement. The infrastructure push that began with the Atal Bihari Vajpayee government, and that has picked up pace in recent years, will also help strengthen the common Indian market. Since 2018, India has had an odd combination of new restrictions on the trade account with greater openness on the capital account, exactly the opposite of what economists such as Jagdish Bhagwati have long argued for. India has to remain a trading nation if it is to prosper, and the recent spate of free trade agreements is hopefully a counter to any slide into renewed protectionism.

The economic journey of the past 75 years offers lessons for the future. Here are some of the salient challenges.

— Independent India began as a poor country that had barely seen any economic growth for several decades. It is now what the World Bank defines as a lower middle income country. That is an impressive transition. However, there are still large pockets of extreme poverty. And while economic growth over the past 75 years—and especially in recent decades— has helped bring down poverty, India has been a laggard in the development race as compared to more successful countries such as South Korea and China, which were at a similar level of development not too long ago.

— The process of development in most countries involves people moving from farms to factories. India has not been able to create enough quality jobs to absorb the millions who are leaving agriculture. So, too many people are struck in tiny informal enterprises that cannot be scaled up. The lack of quality jobs can be a political fault line in a country with growing aspirations, and successive governments have tried to paper over this fault line by increasing income support schemes that leave less money for growth-inducing public goods, merit subsidies and infrastructure.

— One way of looking at the Indian development journey over the past 75 years is in terms of breaking structural shackles to growth. India has broken free of three important constraints—the food constraint, the domestic savings constraint and the foreign exchange constraint. One major structural constraint that persists is energy. India is deficient in energy, and prone to economic stress whenever global energy prices rise. The planned switch to green energy in response to climate change offers a window of opportunity to break the energy constraint.

— The final question is one of political economy—will India resemble East Asia or Latin America? The countries in East Asia have managed to achieve inclusive growth through the creation of competitive enterprises as well as quality jobs for citizens. Public finances have been managed well. Latin America has tended to grow with wide income disparities, macroeconomic imbalances and social tensions. Where will India find itself in 2047? The answer is not yet clear.

The writer is CEO and senior fellow at Artha India Research Advisors, and a member of the academic advisory board of the Meghnad Desai Academy of Economics.

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Published: 15 Aug 2022, 12:12 AM IST
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