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By Vivek H. Dehejia
The gloss is coming off the India story. Recent weeks have seen downgraded growth forecasts, rising inflationary pressure, poor job creation numbers, a faltering stock market and an erratic trajectory in inbound foreign investment. These developments, coupled with the signal failure to deliver on any of its promised “second generation” economic reforms, are leading many commentators to point to a state of “policy paralysis” in the current government.
With a growth rate of national income stuck at around 8.5 per cent, the much-vaunted plan of achieving double-digit growth rates in the coming few years has been unceremoniously shelved. This means that rather than it taking 7 years for income to double, it will instead take 9 years, which in turn implies that achieving rich country income levels is pushed back another generation or more. Endemic poverty and social deprivation will haunt another generation. This could have been avoided, had the growth momentum been maintained.
Where did things go wrong? Unusually for a developing country, India emerged as a fully-fledged democracy at the moment it came into being as an independent, post-colonial nation state. It therefore faced the daunting challenge of mobilising resources for development that could be marshaled by decree in a totalitarian state such as China’s. Indeed, for decades, the conventional wisdom was that India’s fractious democracy was holding back its economic development, and that, distasteful though it might have been to western liberal tastes, the Chinese model was the only sure route to prosperity.
In their drive to prove that India’s democracy could do as well as China’s autocracy, most commentators failed to remark that Indian growth, since the economy was liberalized in 1991, had hardly been exceptional.
The India boosters also missed the striking empirical regularity that shows that most episodes of rapid growth throughout history have fizzled out after a decade or two, when countries get out of poverty and approach middle income status, what economists have dubbed the “middle income trap”.
The reason seems to be a political economy configuration that gets stuck in a “rent-seeking” mode but fails to graduate to a “rent-creating” one. The electorally decisive “median voter” is stuck at an income level that prevents a coalition of middle and upper income voters from pushing for further reform, and the politics of redistribution trump the politics of growth. To many, it would appear that India has already achieved this unenviable scenario, in which the government’s flagship economic schemes are centred on entitlements such as the right to food, education, or to work and not, for instance, on reforming arcane labour laws.
Of course, the middle income trap is not necessarily inescapable, and some countries, notably in East Asia, have left it. What would it take for India to follow them?
A politically durable consensus must be forged around economic reform; henceforth, it must not occur merely in response to a crisis, as in 1991, or by stealth, as has happened, intermittently, since. The problem is not a lack of understanding by ruling politicians of what needs to be done. But they have failed to show us how our recalcitrant democracy can be goaded onto that path.
The most important aspect will be to redefine the concept of “inclusive development”, moving it away from today’s model of redistribution substituting for growth, to a mode of growth with redistribution. The process of replacing inefficient subsidies with direct cash transfers to the poor, already afoot, ought to be accelerated. Labour law reform may be coupled with the establishment of a social security system, which provides a safety net to those who may lose their job in a more flexible labour market. And, crucially, the nexus between big business and big government must be broken, so that the average voter realises that true economic freedom empowers him.
India cannot wait much longer to return to the high road of economic development, and avoid the quicksand of the middle income trap that beckons today.
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