Don't take growth for granted

Financial Express, 14 August 2010

From pessimism to exuberance

When Indian socialism was constructed in the 1960s and 1970s, it induced widespread pessimism about the possibility of breaking out of the Hindu Growth Rate of 3.5 per cent. The events of the late 1970s and early 1980s gave the first break, to growth of 5.5 per cent. The events of the early 1990s gave the second break, to growth of 7.5 per cent. Today, India is holding an enviable track record, where GDP expanded by six times in the last 30 years: an average growth rate of 6.17 per cent.

The growth pessimism of the 1970s has been replaced by a sense of entitlement to high growth. Starting with Goldman Sachs, many people have got used to doing linear extrapolation, thinking that there is a boundless future of high growth. Most of us are pretty certain that in the next 30 years, GDP will grow between 6 to 8 per cent, thus rising by between 6x and 10x.

The happy destination is not destiny

The global experience over the last 200 years does not support such extrapolation. The growth experience of countries holds many surprises. Sometimes, a country which used to have low growth shifts into high gear (e.g. India). At other times, a country which used to have high growth shifts into low gear (e.g. Japan). Growth is much more complicated than counting labour and capital.

Alongside economic growth is the political system. The Indian elite has long been certain that in time, India will evolve into a political system of US or UK quality. There has been a sense of inevitability about this destination, of a high quality political system. While this might indeed come about, the experience of the last 200 years is not encouraging. Italy and Japan do not yet have a good political system, and as recently as 1982, Spain had an attempted coup. The US and the UK stand out as exceptions rather than the rule.

The goal of the Indian development project over the next 30 years is that of getting a 6x to 10x enlargement of GDP and emerging with a UK- or US-quality political system. India has a crack at achieving these remarkable things. But this is not a certainty and history encourages considerable caution.

What might go wrong along the way?

Exuberant spending, or the Greece problem
Thirty years of high growth has given politicians a sense that public money is there for the spending. The hard won lessons of fiscal prudence, which were starting to take root in the 1990s and early 2000s, have been abandoned by the UPA. Many a country has come apart when large spending programs were not supported by commensurate tax revenues, particularly in downturns. The political stress associated with these spending programs is the highest when they are entitlements (such as NREG or RTE) as opposed to discretionary (such as building highways).
Corruption, or the Russia problem
When the license-permit raj was eased, we expected corruption in India to decline. And indeed, in fields with a low government interface, it has. But every functioning market economy requires a complex government interface in many fields. Regulation is a feature of a vast swathe of the economy, ranging from health/safety/environmental regulation which influences a large number of firms, to much more detailed regulatory interfaces in finance and infrastructure. India's nascent capitalism is characterised by firms vigorously pursuing profits. All too often, these firms have low ethical standards; it seems that corruption has gotten worse over the last decade. Under normal notions of competition in the market economy, the most efficient firms get to the top. In parts of the economy afflicted with corruption, the most rotten firms get to the top.
The political system, or the Italy problem
It is our cherished belief that in 30 years, as prosperity seeps in, we will get to a US- or UK-quality political system. But there are formidable hurdles along the way. We start with a weak hand of cards in having a fairly badly drafted Constitution. The fledgling capitalism that has been unleashed by economic reforms is interacting with the political system in dangerous ways. There is not even one state in India where governance and politics is working well. First-past-the-post elections have given incentives to political parties to find a loyal base of roughly 25% of voters, and not reach out to the middle through policies which benefit all. The foundations of civilisation -- courts, human rights and freedom of speech -- are malfunctioning.
State capacity, or Lant Pritchett's `Flailing State' problem
The Commonwealth Games are a salutory reminder of the incompetence of the Indian State. We are a $1.2 trillion GDP, but we do not have the commensurate State capability for addressing sophisticated questions. Each year of high GDP growth is increasing the gap between requirements and capabilities. Countries experiencing high GDP growth require a rapid pace of surgery of the instruments of State, more than that required under low GDP growth: India has to do much better at institutional reform than OECD countries.

Will the Indian development project succeed? It could, but we cannot assume that it will. We have a lot going for us, but we have to keep our eyes on the above four balls in order to make it work.

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