Sunday, April 29, 2007

The economy's next two decades

If you want to do something for yourself read this!

WHAT DO the next two decades hold for India? `Feel good' seems to be the current answer. However, why should recent success translate into permanently higher rates of growth of output in the future? Are there structural reasons to believe that India is indeed on a permanently higher growth path?There is a good underlying reasons for expecting India's output to grow at close to 7 per cent a year, which implies a per capita output growth of about 5.5 per cent a year. At this rate, the income of the average Indian would increase eight-fold over a 40-year period compared with the four-fold increase that current growth rates would deliver.

This optimistic forecast is based on three key features of the Indian economy: productivity, demographics, and institutions.

(1)Productivity
A key aspect of India's recent performance has been the high contribution of productivity — about 60 per cent — to overall growth, a performance that has only been surpassed by China. Recent productivity performance can be expected to continue in the future, and even accelerate, because of the improved prospects for reforms. There is a greater sense than in the past that reforms are delivering tangible results, with the telecommunications revolution being perhaps the best example of benefits flowing to a large cross-section of the population.

(2)Demographics
Over the next 20 years, India's dependency rate will decline sharply as its labour force grows faster than population. Declining dependency can be expected to raise domestic savings rates by up to 12-15 percentage points. Provided the opportunities for the private sector continue to expand, increased savings can finance more rapid capital accumulation, contributing to an acceleration in output.

(3)Quality of Institutions (India's underrated strength)
Experience around the world increasingly points to the importance of institutions that affect the rule of law and protection of property rights and opportunities for participation as a key determinant of long-run development.But India is far from reaping the benefits of its institutional quality. India's per capita income should be about 4-5 times what it currently is. In other words, India, having done the really hard work of building good economic and political institutions failed until the 1980s, to take advantage of it. Contrast this, for example, with China which has grown extremely rapidly in the last quarter century, but which faces the inordinate challenge of large-scale institutional transformation.

But will India's institutions hold up in the future? Three encouraging trends can be discerned. First and foremost, there has been a sharp rise in transparency: public institutions have been exposed to the glare of public scrutiny thanks to the explosion in the quantity and quality of the media. From Godhra to Tehelka, it seems that not much can elude the prying eyes of the press or television. While the accountability of public officials and institutions may not have increased commensurate with the increase in transparency, the disconnect between the two can only narrow in the long run.

Second, a vibrantly assertive civil society, becoming one of the new and key meta-institutions, has been one of the positive developments in the last few decades. Indian civil society has taken on at least two roles: a direct one, in delivering development outcomes and indirect one by striving to hold public institutions accountable.

Third, policy liberalisation will progressively erode the license-quota-permit raj as a source of corruption and patronage that has had such a corrosive effect on public institutions.

What then are the downside risks to this optimistic outlook? One disturbing trend in the last two decades of rapid growth has been the growing disparity in economic performance between states. States that were rich in 1980 have grown faster than States that were poor, accentuating existing inequalities. Peninsular India has been growing more rapidly than the hinterland BIMARU states.

While the disparity between States is a cause for concern it is also the consequence of a very powerful positive dynamic in India: namely, the competition among States to improve institutions and policies — a kind of "race to the top" — as a means of attracting increased amounts of foreign and domestic capital. For these reasons, it is possible that the divergence is self-limiting — States left behind will be under pressure to follow the demonstration effect of the more successful states.

Perhaps a more worrying disparity is between skill levels, with new technologies creating large wedges between a small proportion of highly-skilled (typically urban) people and a vast majority of less-skilled (typically rural). Certain metropolises are already witnessing the phenomenon of islands of dollar-salaried populations embarrassingly embedded in a sea of ordinariness or even poverty. Managing this disparity will be one of the major challenges for India in the years ahead. Success in this effort will depend to a large extent on what we(the authors mentioned below) referred to earlier as the joker in the pack — the progress that India will make in improving basic education.

The Nobel winner, Amartya Sen, has drawn attention to the disappointing post-Independence performance of the Indian state in delivering education, reflected in very slow improvements in literacy rates. While the supply of educational services by the state was inadequate, Prof. Sen raised the puzzle as to why there was not greater demand for education and hence greater pressure on the state to meet this demand. One answer to this puzzle is that the private returns to literacy and basic education must have been low.

This state of affairs may be changing now. There is evidence that the increasing opportunities that are spurring economic growth — related to the IT-explosion — contribute to raising these returns, leading to a greater demand for educational services — public and private — and hence in educational outcomes. Anecdotal evidence for this comes from the mushrooming of English-language schools in backward States such as Bihar and the agricultural hinterland of Punjab. To be sure, increased demand will relate in the first instance to the acquisition of specific skills (such as fluency in English and computer proficiency). Over time, however, this demand could percolate down the hierarchy of skill, improving basic educational outcomes. But this is more hope than firm prediction, and on realizing this hope will hinge how fast and broad-based will be India's future economic growth.

So what lessons do we learn for the future from studying India's recent economic history? It seems more clear now that economic development results from the interaction of growth triggers with the right fundamentals that allow the triggers to be exploited. In the conventional view of the Indian development process, there was a long and dark period — the period of controls and import substitution — followed by the burst of sunlight and reforms since 1991. The boom in the IT-sector first awakened observers to the fact that the dark age was not all dark, that important cumulative elements (the fundamentals) were being built up that yielded rewards with a lag, and that these fundamentals were as important as the triggers that sparked the IT boom. In this case, the fundamentals were the pools of skilled human capital built through the technology, management, and research institutes — a sort of import substitution effort in skilled human capital development — that were integral to the Nehruvian vision.

Nevertheless, the Nehruvian economic legacy went beyond the technical institutions: it consisted of the meta-institutions of democracy, rule of law, free press, and technocratic bureaucracy that recent research shows are crucial to economic development. To be sure, these meta-institutions have been buffeted and weakened by the vicissitudes of vested interests, time, and politics. Since the 1980s, the shackles on the private sector have been slowly removed, and the appropriate triggers are now in place. The house that Nehru and others painstakingly built before and immediately after Independence, wobbles and all, is now well poised to seize the newly-created opportunities.

Source : Excerpts from The Hindu
Source Writers : Dani Rodrik & Arvind Subramanian

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