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What it takes to end India's economic slowdown
By Raghuram Rajan |
May 7, 2013, Tuesday
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FOR country as poor as India, growth should be what Americans call a "no-brainer."
It is largely a matter of providing public goods: decent governance, security of life and property, and basic infrastructure like roads, bridges, ports, and power plants, as well as access to education and basic healthcare.
Unlike many equally poor countries, India already has a strong entrepreneurial class, a reasonably large and well-educated middle class, and a number of world-class corporations that can be enlisted in the effort to provide these public goods.
Why, then, has India's GDP growth slowed so much, from nearly 10 percent year on year in 2010-11 to 5 percent today?
I believe that two important factors have come into play in the last two years.
First, India probably was not prepared for its rapid growth in the years before the global financial crisis.
Land grabs
For example, new factories and mines require land. But land is often held by small farmers or inhabited by tribal groups, who have neither clear and clean title nor the information and capability to deal on equal terms with a developer or corporate acquirer.
Not surprisingly, farmers and tribal groups often felt exploited as savvy buyers purchased their land for a pittance and resold it for a fortune. And the compensation that poor farmers did receive did not go very far; having sold their primary means of earning income, they then faced a steep rise in the local cost of living, owing to development.
In short, strong growth tests economic institutions' capacity to cope, and India's were found lacking. Its land titling was fragmented, the laws governing land acquisition were archaic, and the process of rezoning land for industrial use was non-transparent.
The second reason for India's slowdown stems from the global financial crisis.
Many emerging markets that were growing strongly before the crisis responded by injecting substantial amounts of monetary and fiscal stimulus. For a while, as industrial countries recovered in 2010, this seemed like the right medicine. Emerging markets around the world enjoyed a spectacular recovery.
Investment
But, as industrial countries, beset by fiscal, sovereign-debt, and banking problems, slowed once again, the fix for emerging markets turned out to be only temporary.
To offset the collapse in demand from industrial countries, they had stimulated domestic demand.
But domestic demand did not call for the same goods, and the goods that were locally demanded were already in short supply before the crisis.
The net result was overheating - asset-price booms and inflation across the emerging world.
To revive growth in the short run, India must improve supply, which means shifting from consumption to investment.
In addition to more investment, India needs less consumption and higher savings. The government has taken a first step by tightening its own budget and spending less, especially on distortionary subsidies. Households also need stronger incentives to increase financial savings.
New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability.
If all goes well, India's economy should recover and return to its recent 8 percent average in the next couple of years.
Raghuram Rajan, professor of finance at the University of Chicago Booth School of Business and the chief economic adviser in India's finance ministry, is the author of "Fault Lines: How Hidden Fractures Still Threaten the World Economy. "Copyright: Project Syndicate, 2013.www.project-syndicate.org. Shanghai Daily condensed the article.
It is largely a matter of providing public goods: decent governance, security of life and property, and basic infrastructure like roads, bridges, ports, and power plants, as well as access to education and basic healthcare.
Unlike many equally poor countries, India already has a strong entrepreneurial class, a reasonably large and well-educated middle class, and a number of world-class corporations that can be enlisted in the effort to provide these public goods.
Why, then, has India's GDP growth slowed so much, from nearly 10 percent year on year in 2010-11 to 5 percent today?
I believe that two important factors have come into play in the last two years.
First, India probably was not prepared for its rapid growth in the years before the global financial crisis.
Land grabs
For example, new factories and mines require land. But land is often held by small farmers or inhabited by tribal groups, who have neither clear and clean title nor the information and capability to deal on equal terms with a developer or corporate acquirer.
Not surprisingly, farmers and tribal groups often felt exploited as savvy buyers purchased their land for a pittance and resold it for a fortune. And the compensation that poor farmers did receive did not go very far; having sold their primary means of earning income, they then faced a steep rise in the local cost of living, owing to development.
In short, strong growth tests economic institutions' capacity to cope, and India's were found lacking. Its land titling was fragmented, the laws governing land acquisition were archaic, and the process of rezoning land for industrial use was non-transparent.
The second reason for India's slowdown stems from the global financial crisis.
Many emerging markets that were growing strongly before the crisis responded by injecting substantial amounts of monetary and fiscal stimulus. For a while, as industrial countries recovered in 2010, this seemed like the right medicine. Emerging markets around the world enjoyed a spectacular recovery.
Investment
But, as industrial countries, beset by fiscal, sovereign-debt, and banking problems, slowed once again, the fix for emerging markets turned out to be only temporary.
To offset the collapse in demand from industrial countries, they had stimulated domestic demand.
But domestic demand did not call for the same goods, and the goods that were locally demanded were already in short supply before the crisis.
The net result was overheating - asset-price booms and inflation across the emerging world.
To revive growth in the short run, India must improve supply, which means shifting from consumption to investment.
In addition to more investment, India needs less consumption and higher savings. The government has taken a first step by tightening its own budget and spending less, especially on distortionary subsidies. Households also need stronger incentives to increase financial savings.
New fixed-income instruments, such as inflation-indexed bonds, will help. So will lower inflation, which raises real returns on bank deposits. Lower government spending, together with tight monetary policy, are contributing to greater price stability.
If all goes well, India's economy should recover and return to its recent 8 percent average in the next couple of years.
Raghuram Rajan, professor of finance at the University of Chicago Booth School of Business and the chief economic adviser in India's finance ministry, is the author of "Fault Lines: How Hidden Fractures Still Threaten the World Economy. "Copyright: Project Syndicate, 2013.www.project-syndicate.org. Shanghai Daily condensed the article.
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