Monday, 30th October 2017

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How to be a world leader

Coming out of the doldrums

By Writing on the wall: Ashok V. Desai
  • Published 8.11.16

The world has two big poor countries: China and India. Since World War II, they have had rulers focused on putting poverty behind and making their countries prosperous. Till the 1980s, neither had found the key to growth: China went through a long, painful ideological war; India's ambitious government had poor mastery of economics and kicked the economy into one crisis after another. When I was taken into that government in the early 1990s, I thought that the controls on India's external economic relations had to be removed if we were to avoid crises. That happened to some extent over the next few years. The economy was opened up, and we have not had an external crisis since 1991; even if the government tried today, it could not have one. But I was removed soon, and those who then ran the government did not find the key to steady, rapid growth. As a result, China grew enormously faster than India. In 1989, India's per capita income was $1100 and China's $900 at the same prices; India was 22 per cent richer. In 2015, the figures were $6265 and $13801; China was two-and-a-quarter times as rich as India. It saddened me, but at least I was relieved that I had no responsibility for our miserable performance.

Denis Medvedev was the World Bank's India economist for three years; he went back recently to become a lead economist in the Innovation and Entrepreneurship unit of the Trade and Competitiveness Global Practice. As a farewell gesture, he and his colleagues did a report claiming that it was now South Asia's turn to lead global growth, and proposing policies that would turn it into the next export powerhouse. It is a long time since someone had the vision and the insight to propose something ambitious for India. Medvedev's team covered South Asia; here I will confine myself to India.

Over the past two centuries, one country after another has grown rapidly by becoming the world leader in manufacturing: Britain, Germany, the United States of America, Japan, and most recently, China. But China is running out of surplus labour, its wage costs are rising, and it has made room for the next manufacturing powerhouse. It is India's turn.

India's share of world trade in 2010-14 was 1.5 per cent in goods and 3.2 per cent in services. It has diversified its markets since 2000, but it is still exporting the same old goods and services, and it is not exporting to richer markets.

It has to improve its export competitiveness; and the way to do so is to raise its total factor productivity. It has done so to some extent in the past quarter century, but most of its growth has come from greater inputs of labour and capital: its labour force has grown rapidly, and its investment ratio has been high. It continues to have a large share of its workers in agriculture; the potential for raising productivity by moving them into industry and services remains correspondingly high.

In an industrial country, labour supply is tight, and firms can expand only by attracting workers away from other firms. Hence workers move from firms with low labour productivity to firms where workers produce more. This tendency is weaker in India and China; because of labour surplus, even firms whose worker productivity is low can expand. Both countries could get considerable growth if the dispersion of productivity across firms came down. But small firms with low labour productivity - the ones we call SMEs in India - continue to proliferate; they dominated industry 20 years ago, and continue to do so. In the US, 40-year-old manufacturing plants are six to seven times as large as new plants in the same industry. Even in China they are two-and-a-half times as large. In India, they are hardly 40 per cent bigger. In other words, growth in India is accompanied by proliferation of firms; firms do not grow, and hence do not benefit from economies of scale.

India has a large agricultural sector; but its exports are small, and have diversified little from what they were two decades ago. Two sets of errors have crippled agricultural exports. One is the restraints on competition in the form of agricultural produce market committees; the government has not yet implemented the reforms required to stimulate competition. The other is the high level of agricultural protection, retained and reinforced after trade in industrial goods was substantially freed up; the import restrictions keep agriculture internationally uncompetitive. Minimum support prices artificially reinforce the effect of import restrictions.

Electronics industry tends to cluster. It requires skilled workers, who congregate around firms. So competitive electronic industries are geographically concentrated. Concentration is prevented in India by high real estate costs. They have much to do with obsolete real estate regulations which make transactions costly and time-consuming.

Customs clearance takes big firms two to 10 days and small firms two to three weeks. A container takes 11 days from Shanghai to Mumbai, and 20 days from Mumbai to Delhi. A quarter of the time spent by goods in transport goes into stoppages officially required at borders of states, cities and so on. The uncertainties thus introduced raise inventories by 27 per cent.

India is the world's second largest producer of cotton. It has a competitive yarn industry whose exports have made Bangladesh a major apparel exporter. But India has lost out in the apparel market. This is because it has higher import barriers on inputs; by securing the domestic market for its own producers, it has made them inefficient and incapable of competing internationally. India also comes out worse in buyers' perception of quality and timeliness compared to China and Vietnam.

Thus, Medvedev and his colleagues expect that China would price itself out of world markets, and that India could take its place and achieve high export-led growth. But to do so, India itself needs to become more competitive, and that requires dismantling of its import restrictions - not just the remaining quantitative ones, but informal ones inherent in its poor ports, airports and bureaucracy. India needs another surge of reforms; but it must be very different from past reforms. It must involve modernization of the government, and the final abandonment of the belief that protection of domestic industry is good for it.

We did considerable liberalization in the early 1990s; but as I found when I pushed reforms, they were adopted because of the external crisis. The bureaucrats' and politicians' penchant for protecting domestic industry and discriminating against external forces just went underground, and reappeared once the crisis was over. India's worst enemy is the narrow, irrational nationalism that pervades its ruling class; as long as it remains parochial, India will never become a world leader, however fast it grows. In spite of its conquest of world markets and its generosity towards other developing countries, China never became a world leader because it was too parochial to make friends internationally. India will get its chance in the next decade or two; but it too will fail for the same reason. The days of strutting and domination are gone; if they are to realize their world potential, Indians need to understand their neighbours and listen to them in their languages.