Restoring the Indian Economic Miracle

Narendra Modi, then-Chief Minister of Gujarat, speaking at the World Economic Forum’s India Economic Summit 2008 in New Delhi, six years before being elected to the position of Prime Minister (© World Economic Forum, Flickr Commons, photo by Norbert Schiller)

Narendra Modi, then-Chief Minister of Gujarat, speaking at the World Economic Forum’s India Economic Summit 2008 in New Delhi, six years before being elected to the position of Prime Minister of India (© World Economic Forum, Flickr Commons, photo by Norbert Schiller)

In the early 1990s, India’s leaders made a bold decision to shift the country away from the statist economic and import substitution industrialization policies that had characterized the country’s post-independence years. They instead embraced core tenets of free and competitive markets, open and non-discriminatory trade, and openness to flows of goods, technology, capital, and people. This decision led directly to the so-called “Indian Economic Miracle,” in which India’s economy grew 40 percent faster per year in the two decades that followed the 1991 reforms than it did in the two decades preceding it. Unfortunately, over the past several years, Indian economic growth has stagnated as momentum for continued reforms has waned. By 2013, both Indian economic growth (currently at 4.4 percent) and productivity growth declined to decade-level lows—this even as the country contends with an annual $100 billion trade deficit and a looming “demographic dividend” that will see over 100 million citizens enter India’s workforce over the coming decade.

If India is to revitalize its economic growth and successfully address these daunting challenges, newly elected Prime Minister Narendra Modi must articulate a clear and coherent economic growth strategy. As The Information Technology and Innovation Foundation (ITIF) writes in The Indian Economy at a Crossroads, it should contain four key elements: embracing across-the-board productivity growth, improving India’s environment for doing business, investing in infrastructure, and seeking to attract—rather than compel—foreign direct investment (FDI).

Productivity growth, the increase in the amount of output produced per a given unit of labor or capital, is the most important measure and determinant of economic performance for any nation. Unfortunately, too many in India—policymakers, economists, and business leaders alike—fear that productivity growth costs, rather than creates, jobs. As the CEO of a major Indian manufacturing company told me at a conference in Goa in 2009, “India cannot afford productivity; we need the jobs.” While one need do no more than read Erik Brynjolfsson and Andrew McAfee’s new book, Race Against the Machine, to see that this debate rages in the United States as well, the reality is that the vast majority of scholarly evidence, including the Organization for Economic Cooperation and Development’s seminal report entitled Technology, Productivity and Job Creation, finds that productivity growth leads not to job loss but to employment creation in developed and developing nations alike over the long-term. As such, India’s faltering productivity levels—especially when compared to those of peer nations like China—are particularly concerning. For example, in 1970, India’s productivity levels were two-thirds greater than those of China. Four decades later, however, these numbers have plummeted to just one-third of China’s. Accordingly, Modi should make increasing Indian productivity across all sectors of the economy, not just in manufacturing but also in agriculture and services, a top priority. This is vital because, while some hope that manufacturing employment alone will provide the panacea India needs to address the demographic dividend, the reality is that India will need significant employment growth from agriculture and services sectors as well to generate much-needed employment. Modi could start by appointing a National Productivity Commission, as Australia has done, and by increasing incentives for businesses to invest in modernized capital equipment.

Modi’s next priority should be to broadly improve India’s environment for doing business, including by addressing the labyrinth of regulations that make India one of the world’s most difficult places for businesses. As I noted in a recent Forbes column, India ranks a lowly 119th on the Heritage Foundation’s Index of Economic Freedom and just 132nd on the World Bank’s Doing Business index. Moreover, as the OECD report Economic Policy Reforms: Going for Growth found, out of forty nations examined, India ranked thirty-third for having the most complex regulatory environment, recorded the  thirty-seventh most restrictive policies toward welcoming foreign direct investment (FDI), had the thirty-ninth most stringent protections for employment (for example, manufacturers employing more than one hundred workers must attain government approval to lay off just one employee), and posted the highest tariffs on trade. And as Gucharan Das points out in Reimagining India, “in a country where two out of five people are self-employed, it takes 34 days to start a business.”Modi could make tremendous strides by paring back the “license/inspector raj” that currently remains alive and well in India.

Modi’s agenda must also include dramatically improving India’s infrastructure, particularly in terms of regular electricity availability; semiconductor manufacturers simply will not build fabrication plants whilst rolling blackouts remain a threat. Improving India’s transportation infrastructure would also have a tremendous impact on both Indian quality of life and economic growth. Fully 30 percent of Indian agricultural production, for instance, never makes it out of the field and, of the remaining 70 percent that does, more than 50 percent is lost due to subpar transportation and storage technology. Not only is this a travesty in a country that accounts for one-quarter of the world’s malnourished population, but it costs tens of thousands their economic livelihoods as well.

This is precisely why India needs to embrace FDI, particularly in retail sectors where firms like Amazon and Walmart could provide improved logistics and distribution technologies. In this matter, India should also eschew local content requirements, such as the country’s Preferential Market Access policy in the information technology sector that would compel foreign firms to produce in India as a condition of market access. When it comes to FDI, India wins if it employs an attraction, rather than a compulsion, strategy—especially since many global corporations are actively seeking alternatives to investing in countries like China, which have increasingly embraced mercantilist practices.

To be sure, the above represents an aggressive economic agenda for a newly elected prime minister at the head of a nation with entrenched fiscal, demographic, institutional, and regulatory obstacles. But if Modi and India can embrace market-based competition among domestic and foreign competitors, achieve across-the-board productivity growth, and invest in the innovation potential of its own entrepreneurs and businesses, the country will be able to begin to achieve the economic and employment growth it seeks.

Stephen Ezell

Stephen Ezell is a Senior Analyst with the Information Technology and Innovation Foundation (ITIF), a Washington-DC based technology and economic policy think tank, where he focuses on science, technology, and innovation policy as well as international competitiveness, trade, and manufacturing issues. He is the co-author, with Dr. Robert Atkinson, of Innovation Economics: The Race for Global Advantage, published in 2012 by Yale University Press. Mr. Ezell holds a B.S. from the School of Foreign Service at Georgetown University, with an Honors Certificate from Georgetown’s Landegger International Business Diplomacy program.