India's Economy
Brian Trumbore
President/Editor, StocksandNews.com

Gurcharan Das, the former CEO of Procter & Gamble India, has an essay in the July/August issue of Foreign Affairs that addresses India's economy.

While most investors have been focusing on growth here just in the past three or four years, India's economic growth rate was 6 percent a year from 1980 to 2002 and since then it's running at about a 7.5 percent clip. As a result, the middle class has quadrupled to about 250 million, while India's economy is now the 4th-largest in the world and will soon be third after passing Japan.

[Note: If you include the entire European Union as a single bloc, then it's U.S., EU, China, Japan and India?otherwise, it's U.S., China, Japan, India, Germany, United Kingdom, France, Italy, Brazil and Russia as the complete top ten. Source: CIA.gov]

However, it hasn't always been this good. Between 1900 and 1950 (India achieved its independence in 1947), growth was almost non-existent, just 0.8 percent a year. Then from 1950 to 1980 it averaged 3.5 percent, though due to exploding population growth, per capita income was rising at a pace less than half of that.

As Gurcharan Das notes, the three-decade period following independence was known as "the Hindu rate of growth," which had nothing to do with Hinduism but rather everything to do with the socialist policies of Prime Ministers Jawaharlal Nehru and Indira Gandhi, his daughter.

"Father and daughter shackled the energies of the Indian people under a mixed economy that combined the worst features of capitalism and socialism. Their model was inward-looking and import-substituting rather than outward-looking and export- promoting, and it denied India a share in the prosperity that a massive expansion in global trade brought in the post-World War II era?.

"Nehru set up an inefficient and monopolistic public sector, over-regulated private enterprise with the most stringent price and production controls in the world, and discouraged foreign investment - thereby causing India to lose out on the benefits of both foreign technology and foreign competition. His approach also pampered organized labor to the point of significantly lowering productivity and ignored the education of India's children."

But while Prime Minister Rajiv Gandhi instituted major economic reforms in the 1980s, changes that encouraged development of the private sector, it wasn't until 1991 that the groundwork for today's success was laid in the policies of the finance minister of that time, Manmohan Singh, who is today's prime minister.

"(Singh) lowered tariffs and other trade barriers?reduced tax rates, devalued the rupee, opened India to foreign investment, and rolled back currency controls."

Mr. Das notes a rather startling statistic related to how far India has come the past 25 years in particular.

"If India's economy were still growing at the pre-1980 level, then its per capita income would reach present U.S. levels only by 2250; but if it continues to grow at the post-1980 average, it will reach that level by 2066 - a gain of 184 years."

No doubt, India's progress hasn't been without its problems. There is still a bureaucracy to deal with, for example. And as Das writes, India cannot take its accelerating growth for granted.

"Public debt is high, which discourages investment in needed infrastructure?.And although India is successfully generating high-end, capital- and knowledge-intensive manufacturing, it has failed to create a broad-based, labor-intensive industrial revolution - meaning that gains in employment have not been commensurate with overall growth. Its rural population, meanwhile, suffers from the consequences of state-induced production and distribution distortions in agriculture that result in farmers' getting only 20 to 30 percent of the retail price of fruits and vegetables (versus the 40 to 50 percent farmers in the United States get)."

One sector that stands up well compared to China is banking. According to Das, "Bad loans now account for less than 2 percent of all loans (compared to 20 percent in China), even though none of India's shoddy state-owned banks has so far been privatized."

In India, consumption accounts for 64 percent of the economy (similar to the United States), versus just 42 for China. "That consumption might be a virtue embarrasses many Indians, with their ascetic streak," writes Das, "but, as the economist Stephen Roach of Morgan Stanley puts it, 'India's consumption-led approach to growth may be better balanced than the resource mobilization model of China.'"

One negative, though, is in the aforementioned lack of any real labor-intensive industrial growth, the kind that can more readily transform the lives of the tens of millions still living in poverty, particularly in the rural areas. So while China has created all manner of low-end manufacturing positions through its export sector, many in India are wondering if it can afford to essentially skip the industrial revolution phase as it seemingly moves from an agricultural economy right to a service oriented one. Das notes that "Economies in the rest of the world evolved from agriculture to industry to services."

"Economic history teaches that the Industrial Revolution as it was experienced by the West was usually led by one industry. It was textile exports in the United Kingdom, railways in the United States. India, too, may have found the engine that could fuel its takeoff and transform its economy: providing white- collar services that are outsourced by companies in the rest of the world. Software and business-process outsourcing exports have grown from practically nothing to $20 billion and are expected to reach $35 billion by 2008."

High-tech manufacturing should also continue to strengthen, though as India's wages rise we are already beginning to see a shift in some high-tech areas to other destinations such as Eastern Europe. [This is my opinion, not necessarily Gurcharan Das's.]

One institution in India that continues to be a huge drain, however, is the bureaucracy. Nehru touted it as a "steel frame" that guaranteed stability and continuity following British rule. But today's Indians "think of bureaucrats as self-serving, obstructive, and corrupt, protected by labor laws and lifetime contracts that render them completely unaccountable."

Mr. Das adds "The Indian bureaucracy is a haven of mental power. It still attracts many of the brightest students in the country, who are admitted on the basis of a difficult exam."

But the most damaging failure in India has to do with public education, despite some of the stories we hear in the U.S. on how India is churning out engineers. [I've noted some counter- arguments in my "Week in Review" column over the past year.]

Gurcharan Das writes:

"Consider one particularly telling statistic: according to a recent study by Harvard University's Michael Kremer, one out of four teachers in India's government elementary schools is absent and one out of two present is not teaching at any given time. Even as the famed Indian Institutes of Technology have acquired a global reputation, less than half of the children in fourth-level classes in Mumbai can do first-level math. It has gotten so bad that even poor Indians have begun to pull their kids out of government schools and enroll them in private schools, which charge $1 to $3 a month in fees and which are spreading rapidly in slums and villages across India."

While private school teacher salaries are considerably lower than public schools, the students perform far better. But as you can imagine, when you have a sprawling bureaucracy, the 'professionals' are not happy; i.e., in this instance the government is slamming the private school network.

Gurcharan Das:

"How does one explain the discrepancy between the government's supposed commitment to universal elementary education, health care, and sanitation and the fact that more and more people are embracing private solutions? One answer is that the Indian bureaucratic and political establishments are caught in a time warp, clinging to the belief that the state and the civil service must be relied on to meet people's needs. What they did not anticipate is that politicians in India's democracy would 'capture' the bureaucracy and use the system to create jobs and revenue for friends and supporters. The Indian state no longer generates public goods. Instead, it creates private benefits for those who control it."

Prime Minister Singh and his "dream team of reformers" face many challenges, including a resurgent Left that stands against reform and for the status quo. Singh's big challenge is to spread the wealth and ensure the rural areas see the same kinds of improvements most of the cities have witnessed.

And as Gurcharan Das concludes:

"(Indians will reach) greatness only when every Indian has access to a good school, a working health clinic, and clean drinking water. Fortunately, half of India's population is under 25 years old. Based on current trends, India should be able to absorb an increasing number of people into its labor force. And it will not have to worry about the problems of an aging population. This will translate into what economists call a 'demographic dividend,' which will help India reach a level of prosperity at which, for the first time in its history, a majority of its citizens will not have to worry about basic needs. Yet India cannot take its golden age of growth for granted. If it does not continue down its path of reform?then a critical opportunity will have been lost."

Wall Street History will return next week.

Brian Trumbore

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