The Elephant That Became a Tiger: 20 Years of Economic Reform in India, Cato Development Policy Analysis No. 13

8/6/2019 The Elephant That Became a Tiger: 20 Years of Economic Reform in India, Cato Development Policy Analysis No. 13

1/16

the cato institute

1000 Massachusetts Avenue, N.W., Washington, D.C., 20001-5403

www.cato.org

Phone (202) 842-0200 Fax (202) 842-3490

j u l y 2 0 , 2 0 1 1 n o . 1 3

The Elephant That Became a Tiger20 Years of Economic Reform in India

by Swaminathan S. Anklesaria Aiyar

Aforeign exchange crisis in 1991 induced India toabandon decades of inward-looking socialismand adopt economic reforms that have convert-

ed the once-lumbering elephant into the latest Asian

tiger. Indias gross domestic product (GDP) growth ratehas averaged over 8 percent in the last decade, and percapita income has shot up from $300 to $1,700 in twodecades. India is reaping a big demographic dividendjust as China starts aging, so India could overtake Chinain growth in the next decade.

When the reforms began in 1991, critics claimed thatIndia would suffer a lost decade of growth as in Africancountries that supposedly followed the World Bank-IMFmodel in the 1980s. They warned that opening up would al-low multinationals to crush Indian companies, while fiscalstringency would strangle social spending and safety nets,

hitting poor people and regions. All of these dire predictionsproved wrong. Indian businesses more than held their own,and many became multinationals themselves. Booming

revenue from fast growth has financed record governmentspending on social sectors and safety nets, even if these ar-eas are still dogged by massive corruption and waste. Stillpoverty is down from 45.3 percent in fiscal year 1994 to 32

percent in fiscal year 2010, and the literacy rate is up from52.2 percent to 74 percent in two decades, Indias fastest improvement ever. Several of the poorest states have doubledor tripled their growth rates since 2004, and their wage rateshave risen by over 50 percent in the last three years.

However, India continues to be hampered by poorbusiness conditions and misgovernance. Almost a quarter of Indian districts have recorded some sort of Maoistviolence, and corruption is a major issue. India ranks verylow on ease-ofdoing-business indicators. Rigid laborlaws prevent Indian companies from setting up large factories for labor-intensive exports, as in China. Both gover-

nance and economic reforms are needed, but progress onthe former lags far behind, is thus more urgent, and canhelp sustain and promote economic reform.

Swaminathan Aiyar is a research fellow at the Cato Institutes Center for Global Liberty and Prosperity and has been editor of Indias two biggestfinancial dailies, the Economic Times and Financial Express.

Executive Summary


2/16

2

Poverty didnot fall at all

in the threedecades after

independence.

Introduction

Faced with a foreign exchange crisis in1991, India embarked on gradual, erratic,but persistent economic reforms that in two

decades transformed its living standards andplace in the world. In 1991 India was viewedglobally as a bottomless pit for foreign aid,periodically hit by food and foreign ex-change crises and hamstrung by an immenseweb of controls imposed in the holy name ofsocialism and then used by politicians to linetheir pockets and build patronage networks.Early that year, The Economist magazine car-ried a survey on India titled The Caged Ti-ger, which concluded sorrowfully that Indiawould remain trapped in its cage, unable

to join other Asian tigers that had becomemiracle economies.1 Many analysts sawIndia as a lumbering elephant, in stark con-trast to the Chinese tiger.

Twenty years later, the Indian elephanthas indeed morphed into a tiger. It averaged8.5 percent growth in the last decade and survived the Great Recession of 200709 withonly minor bumps before returning to 8.5percent growth in 201011 (see Table 1).2 Itsper capita income has shot up from $300 in1991 to almost $1,700 today, and its GDP this

year will exceed $2 trillion3 in nominal termsand maybe $4.5 trillion in PPP (purchasingpower parity) terms, which would make it thethird-largest economy in the world after theUnited States and China. It is hailed todayas a potential superpower and has been pro-posed by the United States for a permanentseat on the United Nations Security Council.Political analysts see it as perhaps the only

credible Asian check on Chinese hegemonyin the 21st century. Many analysts (includingGoldman Sachs, who coined the term BRICsto mean Brazil, Russia, India, and China) pre-dict that India will soon overtake China as

the fastest-growing economy in the world.4

Nevertheless the unfinished reform agen-da remains huge. TheDoing Business report ofthe World Bank ranks India at just 134th of183 countries in ease of doing business.5 In-dia ranks only 121st in the United NationsHuman Development Index, and its nutri-tional indicators are among the worst in theworld.6 A quarter of the countrys districtssuffer from some sort of Maoist insurrec-tion. India needs major economic and governance reforms in the years to come.

A Brief History of20 Years of Reform

After independence in 1947, India followed a socialist pattern of development,emphasizing self-sufficiency and public-sector dominance. It was inward lookingand skeptical of markets and internationaltrade. In the 1970s, marginal income taxrates went as high as 97.75 percent, on top of

which a wealth tax of up to 3.5 percent waslevied to promote the garibi hatao (abolishpoverty) policies of Indira Gandhi. Yet pov-erty did not fall at all in the three decadesafter independence, and GDP growth aver-aged just 3.5 percent per year (the so-calledHindu Rate of growth), just half of whathad been achieved by Asian tigers with out-ward-looking, market-friendly policies.

Table 1

Indias GDP Growth Accelerates

GDP growth %

195080 3.5

198092 5.5

19922003 6.0

200310 8.5

Source: Calculated from tables in Government of India, Economic Survey 201011, http://indiabudget.nic.in/es20

10-11/estat1.pdf.


3/16

3

There was noRonald Reaganor MargaretThatcher inIndia: reformwas a verypragmaticprocess.

Some economic liberalization plus run-away public spending helped accelerateGDP growth to 5.5 percent in the 1980s. Butthis was based on unsustainable borrowing,and it ended in tears when India ran out of

foreign exchange in 1991. Rajiv Gandhi waswidely expected to win the general electionin June 1991 but was assassinated by a SriLankan terrorist. No party won an absolutemajority in that election, and the CongressParty formed a fragile minority governmentheaded by a political lightweight, Narasim-ha Rao.

So, both economic and political condi-tions were highly unfavorable. The SovietUnion was collapsing, making it clear thatmore socialism was not the answer. Mean-

while Deng Xiaoping had revolutionizedChina, showing that the market was the wayto go. And so, more in sorrow than ideologi-cal triumph, India turned away from social-ism to half-baked liberalism. There was noRonald Reagan or Margaret Thatcher in In-dia: reform was a very pragmatic process.

Opposition parties accused India of hav-ing sold out to the International MonetaryFund and swore to reverse the reforms whenthey came to power. But within two yearsthe reforms restored Indias finances, and

in the three years from 1994 to 1997 Indiaaveraged 7.5 percent GDP growth, a new re-cord. This was too successful to reverse, andso India continued down the reform patheven when other political combinationscame to power. The reform process was halt-ing, inconsistent, and sometimes partiallyreversed, yet the overall direction remainedunaltered. No party dared liberalize veryrestrictive labor laws, and so India failed tomake its mark in labor-intensive industries.But, to everybodys surprise, it emerged as

a major power in brain-intensive industriesranging from computer software and medi-cal tourism to auto exports and researchand development (R&D).

The Asian financial crisis of 199799 wasthe first test of the resilience of Indian re-forms. Growth took a hit, yetin part becauseit was a relatively closed economythe coun-

try survived without serious damage, withoutimposing new controls on capital inflows,and without having to go hat in hand to theIMF like so many other Asian neighbors. In-deed, this was the period when Indias com-

puter software industry rose to prominence,playing a leading role in developing softwareto thwart the so-called Y2K problem. Therecession of 2001 led to greater outsourcingof software and business services, and Indiabuilt on that opportunity. In the next decadeit marched up the value chain, moving steadi-ly into higher and higher levels of technology,proving that India had not just cheap laborbut world-class skills.

In 2000 India was seen as globally com-petitive in services but not industry, where

the Chinese juggernaut crushed all opposi-tion. Indias restrictive labor laws made itvirtually impossible to shed workers in anycompany with over 100 workers. Labor in-flexibility meant India could not followthe path set by the other Asian tigers, ofexport-led growth based on labor-intensiveindustries. Indian entrepreneurs were waryof setting up large labor-intensive factoriesfor exporting items like garments, and sosuffered the ignominy of being overtaken byBangladesh in this sector. But, after taking

time to adjust to liberalization and global-ization (which was opposed by an influen-tial quasi-protectionist section of industrycalled the Bombay Club), Indian industriesgreatly improved their productivity and inmany areas became globally competitive.

One measure of how far India has comeis that in 1991 Finance Minister ManmohanSinghs first budget brought the maximumimport duty downto a still whopping 150percent. Earlier it was as high as 300 percent.Today the standard import duty is down to

10 percent, and the effective rate for manyitems is around 7 percent, close to the aver-age for southeast Asian countries. Back in1991 more than 800 items were reserved forproduction by small-scale industries, andseveral more for the public sector. These res-ervations were whittled away gradually overmore than a decade. Controls on industrial


4/16

4

When Indiastarted down

this reformpath 20 yearsago, skeptics

abounded.

production, imports, technology, and for-eign exchange have been abolished or huge-ly relaxed.

The financial sector used to be a virtualgovernment monopoly but has now been lib-

eralized with the entry of several private andforeign players, though the sector remainsheavily regulated, and 70 percent of bank-ing is still in government hands. Foreign in-vestment has been liberalized in most areas,though much remains to be done in serviceindustries like retail, banking, and insurance.Privatization has been very limited, but pri-vate investment in infrastructure and otherareas previously reserved for the governmenthas transformed the country, especially intelecom.

When India started down this reformpath 20 years ago, skeptics abounded. Left-ist critics predicted that India was goingdown the World Bank-International Mon-etary Fund (IMF) path that had suppos-edly resulted in a lost decade of economicgrowth in Africa and Latin America in the1980s and warned that India would suffer asimilar fate. They predicted that opening upand cuts in import duties would cause mas-sive unemployment and de-industrialize In-dia. They warned that multinational giants

would rapidly take over the Indian economyand that Indian companies would go bust orbecome subservient underlings of foreigners.They also warned that the fiscal stringencyimposed by the IMF would strangle socialspending and safety nets, hitting the poor.

Every one of these dire predictions turnedout to be wrong. Far from suffering a lostdecade, India became a miracle economyaveraging 8.5 percent growth in the 2000s.Far from getting de-industrialized, Indianindustry rose to new heights with the aboli-

tion of controls, and many new Indian giantsemerged. A few Indian companies were indeedtaken over by multinational corporations,but most Indian companies comfortably heldtheir own, and dozens became multination-als in their own right, acquiring companiesacross the globe. Indeed, India began to rivalChina in making acquisitions abroad.

Far from suffering a fiscal squeeze onsocial spending, such spending rose to newheights, financed by booming revenues thataccompanied booming GDP growth. How-ever, failure to reform service delivery meant

that much of the additional revenue waswasted or diverted to the undeserving, whilecorruption flourished. Despite such waste,India enjoyed a record increase in literacy inthe two decades of reform, and poverty fellsubstantially. However, some social indica-tors did not improve quickly,7 and Indiasproportion of underweight childrena mea-sure of malnutritionwas the third-worst inthe world at 46.7 percent. This is one reasonIndia remained far down in the Human De-velopment Index of the United Nations.

Twenty years after reforms began, the In-dian public is angry at high corruption aris-ing out of crony capitalism, often a productof half-baked reform. Many analysts alsoworry that inequality is rising, the poor havenot benefited enough, and poor states aregetting left behind even as Maoist insurrec-tion in many states worsens. These criticismsare mostly exaggerated or plain wrong. Thereis plenty of evidence that poor people, statesand castes have benefited substantially. Butthe unfinished agenda remains large.

Key Achievements of20 Years of Reform

The reforms have brought about far-reaching changes, many unanticipated. Thekey achievements of the last 20 years can besummed up as follows:

Rapid GDP growth of 8.5 percent inthe last decade has created expecta-

tions that India will overtake China ingrowth in the coming decade. Reformsbeing gradual and hesitant, they tooktime to have an impact. After threeyears of reform, GDP growth accelerat-ed to 7.5 percent per year from 199495to 199697. Then growth slowed downto an average of 5.5 percent per year


5/16

5

India became amiracle economyaveraging8.5 percentgrowth in the2000s.

because of the Asian financial crisis(199799), two major droughts (2000and 2002), and the recession of 2001.But after 2003 growth picked up sharp-ly and averaged almost 9.5 percent an-nually for three years from 200506through 200708. The Great Recession(200709) pulled growth down, but itwas a still impressive 6.8 percent in the

trough of 200809, followed by rapidrecovery to 8.0 percent and 8.5 per-cent in the next two years. The savingsrate shot up from 21.5 percent of GDPin 199192 to around 34 percent in201011 (see Table 2), enabling invest-ment to rise from 22.1 percent of GDPto around 37 percent. This high invest-ment level makes 89 percent growthsustainable. High domestic savingsmean India depends relatively little onforeign inflows and so is resilient in

times of financial crisis. Indias per capita income is up from

$300 in 1991 to an estimated $1,700today. This has not only directly raisedincomes and employment but yieldeda revenue bonanza that has financedhuge increases in social spending, anti-poverty programs and infrastructure.

Indias fast growth has not beenbased on using cheap labor for labor-intensive exports, the developmentpath taken by other Asian tigers in-

cluding China. Indias booming ex-ports are brain-intensive, not labor-intensive. This is a totally new develop-ment model unmatched by any otherdeveloping country. It means India iswell positioned to march up the valueladder. India is best known for its com-puter software exports, but this sector

accounts for no more than 2 percent ofGDP. Other services exports (legal, en-gineering, and medical services, R&D)have risen fast and exceeded $10 bil-lion in 201011. Exports of autos andengineering goods have soared, reflect-ing new skills in design and manu-facturing. India remains an economydriven mainly by domestic demand,

although the export share has risensubstantially.

India has become the world leader in frugal engineering, a concept that didnot exist a decade ago. Frugal engi-neering is the capacity to design andproduce goods that are not just 1015percent cheaper than in Western coun-tries but 5090 percent cheaper. TataMotors has produced the cheapest carin the world, the Nano, costing $2,500.Bajaj Auto is about to launch a rival

for $3,000 that gives 90 miles per U.S.gallon. Indias telecom industry is thecheapest in the world, with calls cost-ing just two cents per minute. NarayanHrudalaya and Aravind Netralaya arehospitals providing heart and eye sur-gery respectively at one-twentieth orless the cost of surgery in the West,one reason for the emergence of whatis called medical tourism.

China and some other Asian coun-tries stand accused of deliberately rig-

ging their currencies to undervaluedrates to run up large, mercantilisttrade surpluses. India has many capi-tal controls, and its central bank hasfor decades unofficially intervened inmarkets to keep the real effective ex-change rate at the 1993 level. This hastypically meant running a modest cur-

Table 2

Indias Savings Rate Rises Sharply

198081 199091 200001 201011

Savings rate/GDP, % 18.5 22.8 23.7 34

Source: Government of India,Economic Survey 201011, www.indiabudget.nic.in.


6/16

6

Indian companieshave become

multinationalcorporations intheir own right.

rent account deficit, not a mercantil-ist surplus. The central bank has nowstopped intervening, and Indias cur-rent account deficit in 201011 was2.8 percent of GDP, financed by capital

inflows.8

This is a healthier, more sus-tainable pattern of development thancheap-currency manipulation.

The Indian word jugaad has crept intomanagement literature. Farmers want-ing a vehicle got the idea of strappingan irrigation pump to a steel framewith four wheels, to create a function-ing vehicle called ajugaad. Subsequent-lyjugaad has come to mean, simply,innovation around obstacles of allsortsin designing, selling, managing,

and even surmounting governmentcontrols. Thus jugaad includes formsof crony capitalism and tax evasion noless than frugal engineering, so it is notuniformly a good thing. Theories havebeen floated that entrepreneurs whosucceeded in managing the politician-bureaucrat jungle of controls attainedsuch managerial skills that they cannow conquer global markets. Certainlysome businessmen who rose on the ba-sis of crony capitalism are today world

class, winning global contracts andrunning huge global businesses.

In 1991 many critics warned that In-dian companies would not be able tocompete globally, and so would eithergo bust or be taken over by multina-tional corporations. In fact Indiancompanies have not only held theirown but have become multinationalcorporations in their own right. In-deed, in outward-bound foreign directinvestment (FDI) as a proportion of

gross domestic product (GDP), India(0.9 percent) has beaten China (0.6 per-cent).9 The multinational firm ArcelorMittal, with roots in India, is now theworlds largest steel company. IndiasTata Steel has taken over and turnedaround Corus, an Anglo-Dutch com-pany six times its size. The Birla group

has taken over Novellis of Canada tobecome the sixth biggest aluminumcompany in the world. Tata Motorshas acquired and turned around JaguarLand Rover, an iconic company that

had run up huge losses under previousowners like BMW and Ford. Many topIndian software and pharmaceuticalcompanies have become multination-als through foreign acquisitions, andso have some auto parts companiesReliance Industries Ltd. has built theworlds largest oil refinery complexat Jamnagar, and its crack (spreadbetween crude and finished productprices) comfortably beats that of thebest Singapore refineries. Bharti Airtel

has taken over Zains telecom assets in14 African countries and aims to slashtelecom rates there toward Indian lev-els.10

Back in 1991 India was viewed as a bot-tomless pit for foreign aid. By globalstandards aid inflows into India stilllook large. In 200910 the aid inflowwas $5.9 billion, but this paled in com-parison with foreign investment (equi-ty plus portfolio inflows) of $51.2 bil-lion, commercial borrowings (which

were $68.2 billion gross and $10.4 bil-lion net) and remittances from over-seas Indians ($53.9 billion).11

Remittances remained stable throughthe Asian financial crisis and GreatRecession (200709) and have greatlyhelped counter the volatility of foreignportfolio capital in difficult times. In-dia has told smaller donors (like theScandinavian countries) that the gov-ernment will no longer accept aid fromthem, and they can give money direct-

ly to nongovernmental organizationsif they so please. India has stepped upborrowing from the World Bank, butthe share of soft loans in such borrow-ing has fallen from almost 100 per-cent in the 1970s to under 30 percenttoday. India itself has become a sub-stantial donor and recently granted a


7/16

7

Companieslike Intel andMicrosoft cameto India initially

for cheap laborbut now use it aa base for highskills.

$1 billion aid package to Bangladesh.Prime Minister Manmohan Singh an-nounced credits worth $5 billion toAfrican countries12 during his recenttour of the continent.

India has gradually liberalized its FDIrules but still has significant barriers(especially in agriculture, retail, and fi-nance) that have kept flows into Indiafar below flows into China. FDI peakedat $26 billion in 200910 and declinedto $19.4 billion the next year. However,most of the Fortune 500 companiesnow do business in India, especially inbusiness services, software, and R&D.Accenture and IBM have more employ-ees in India than in the United States.

Companies like Intel and Microsoftcame to India initially for cheap laborbut now use it as a base for high skills.India has become a global productionhub for Suzuki, Hyundai, Bosch, Ford, Abbot Labs, Daiichi Sankyo, Pfizer,and others. It has also become an im-portant R&D hub for many pharma-ceutical, software, and auto companies,with contract research and clinical tri-als costing far less in India than in theWest.

Indias stock markets were rightly viewedas snake pits back in 1991, with a hand-ful of brokers rigging prices, a plethoraof fake share certificates, and settlementperiods extended for months if it suitedbrokers. A major scandal in 1992 led to astock market overhaul, and India creat-ed a completely new electronic exchangewith no floor at all, the National StockExchange, long before London or NewYork did. This slashed costs and endedmost forms of rigging. Shares were de-

materialized and held in electronic formto end fake certificates. Settlement pe-riods were compressed dramatically toT+3 (payment three days after a trans-action), among the fastest rates in theworld. Indias stock markets have beentransformed to among the cleanest andmost efficient in Asia, which is why port-

folio flows into India have been amongthe highest in Asia, in contrast to thesluggishness of FDI. Equity inflowsinto India are untrammeled, but debtinflows are subject to stringent restric-

tions still, one reason why the corporatedebt market has not developed well. In many developing countries, a hand-

ful of crony capitalists have dominatedindustry thanks to political contacts,and India was no exception until 1991.But since then economic liberalizationhas facilitated the rise to the top of a vast array of new entrepreneurs. Thebest known are in software, but manyhave emerged in pharmaceuticals (SunPharma, Glenmark, Dr. Reddys Labs,

Ranbaxy) infrastructure (Adani, Lanco,GMR, GVK, IVRCL), telecom (BhartiAirtel), steel (Jindal, Bhushan), and fi-nance (ICICI Bank, HDFC Bank, AxisBank, Kotak Bank, Yes Bank). Some ofthe new businessmen (notably in realestate and infrastructure) are cronycapitalists, but others have risen entire-ly on merit. Many illustrious businesshouses of past decades have crashed(Hindustan Motors, Premier Automo-biles, JK Synthetics, DCM), indicating

that there is also room for creative de-struction in Indias economy. Of the30 companies constituting the Sensex(Indias equivalent of the Dow JonesIndex) in 1991, only nine are still in theSensex today, a business churn that in-dicates healthy competition.13 PrimeMinister Manmohan Singh has said ofthe new entrepreneurs These are notthe children of the wealthy. They arethe children of liberalization.14

India is currently reaping a demo-

graphic dividenda rising share ofworkers and falling share of depen-dents in the population. The westernand southern states adopted birthcontrol first and reaped a demograph-ic dividend from the 1980s onwards.The backward northern and centralstates are starting to do the same now.


8/16

8

Economicliberalization hasfacilitated the rise

to the top of avast array of new

entrepreneurs.

In the last decade, the number of chil-dren aged 06 years declined by 3.08percent for the first time since inde-pendence, with the sharpest declinesoccurring in poor, backward states.15

A recent paper by two IMF economists,Shekhar S. Aiyar and Ashoka Mody,16estimates that the demographic divi-dend may explain 40 percent of addi-tional GDP growth since 1980. Theyestimate the incremental growth at1.74 percent of GDP in the 2000s, andproject it at around 2 percent in thenext two decades before tailing off.China reaped its demographic divi-dend much earlier thanks to Maosone-child policy, but that is about to

end as the country starts aging. This isone reason why analysts like GoldmanSachs expect India to overtake Chinain GDP growth in the next decade.

How Reforms Benefitedthe Poorer Half

There has been widespread criticism thatthe reforms of the last 20 years have by-passed poor regions; have bypassed poor sec-

tions of the population like dalits (formerlycalled untouchables); that poor people havein desperation taken to Maoism, which nowaffects almost a quarter of all districts; andthat social and poverty indicators have notimproved fast enough. These criticisms aremostly exaggerations or falsehoods.

Poor regions. Many critics assert that poorregions have been bypassed by fast-growingGDP. For instance, James Lamont wrote anews story in the Financial Times headlinedHigh Growth Fails to Feed Indias Hun-

gry.17 This is false. The proportion of peopleclaiming to be hungry in some or all monthshas fallen from 17.3 percent in 1983 to 2.5percent in 200405. Six poor, backwardstates accounting for half of Indias popula-tionUttar Pradesh, Bihar, Madhya Pradesh,Orissa, Chhattisgarh, and Jharkhandhavegrown exceptionally fast in recent years,

many faster than the national average. In-dias western and southern states have his-torically been dynamos, with the northernand central ones lagging far behind. But inthe five years from 2004 to 2009, the mean

growth rate surged in the poor northern andcentral states (see Table 3)Bihar (12.4 per-cent), Chhattisgarh (9.7 percent), Jharkhand(8.5 percent), Madhya Pradesh (6.6 percent)Orissa (10.2 percent), and Uttar Pradesh (6.7percent).18

Critics have asked rhetorically, Whenwill growth trickle down to the poor re-gions? The question is meaningless in theIndian context. In some small mineral-richnations, income is concentrated in a fewhands, so mineral-based fast growth can by-

pass the bulk of the population. This is notpossible in a large, diversified country likeIndia with a relatively egalitarian Gini coef-ficient of 0.37 (this coefficient is a measureof income inequality, and ranges from 0 forcomplete equality to 1 for complete inequal-ity). Growth of 8.5 percent in such a countryis possible only if the bulk of the populationimproves its productivity, as is the case inIndia. This fast growth of poor states trick-led up to create record GDP growth at thenational level. India is mainly a case of trick-

le up, not trickle down, though of coursefast national growth also produced morerevenue that was shared with the states.

Maoist travails. Many critics think slowgrowth and lack of development have led tothe rise of Maoist insurrection in some poorstates. However, insurrection in India is cor-related closely with ethnic and religious divi-sions, not with poverty or deprivation. From1978 to 1993 Punjab, Indias richest statehad an insurrection led by the richest com-munity (Jat Sikhs), while the poorest (Mazh-

bi Sikhs) remained loyal to India. Kashmirhas the lowest poverty rate of all states, yet ithas suffered insurrection by Kashmiri Mus-lims wanting independence, with a death tollof approximately 70,000 since 1988. In As-sam a secessionist insurrection has been ledby upper-caste Hindus, mainly against poorBengali immigrants. Maoist violence has


9/16

9

India is mainly acase of trickle upnot trickle down

been concentrated in tribal areas of centralIndia and is best seen as ethnic conflict be-tween tribesmen and nontribesmen (thoughpoverty adds fuel to ethnic tensions).19 Thepoor states with the most Maoist violence(Bihar, Orissa, Jharkhand, and Chhattisgarh)have recorded exceptionally fast growth in

GDP and in literacy. Industrial growth hasaveraged an impressive 15 percent in Orissa, Jharkhand, and Chhattisgarh, and is basednot simply on mining (which can deprivetribesmen of their land) but on manufactur-ing.20

Dalits, the poorest of the poor. Critics be-lieve that the economic liberalization hasbenefited just a small elite and left behindthe poor, especially the lowest Hindu casteofdalits. Their condition is worst in north-ern states like Uttar Pradesh, Indias biggest

state, with almost 200 million people. But arecent authoritative survey21 in two districtsof Uttar Pradesh revealed striking improve-ments in living standards ofdalits in the lasttwo decades. Television ownership was upfrom zero to 45 percent; cellphone owner-ship up from zero to 36 percent; two-wheel-er ownership (of motorcycles, scooters, and

mopeds) up from zero to 12.3 percent; chil-dren eating yesterdays leftovers down from95.9 percent to 16.2 percent.

Even more striking was the improve-ment in dalits status. Cases where dalits wereseated separately at weddings were downfrom 77.3 percent to 8.9 percent; cases of

non-dalits accepting food and drink at dalita house up from 8.9 percent to 77.3 percent;halwaha (bonded labour) incidence downfrom 32 percent to 1 percent; dalits usingcars for wedding parties up from 33 percentto almost 100 percent; the dalit proportionrunning their own businesses up from 6 per-cent to 37 percent; and proportion workingas agricultural laborers down from 46.1 per-cent to 20.5 percent. The dalits themselvessay the improvement in status matters morethan income improvement. Some dalits have

become millionaire businessmen, and havealso established a Dalit Chamber of Com-merce and Industry.22Dalits are still at thebottom of the income and social ladders,but they have gained substantially in the re-form era.

Literacy. Literacy is a problem of thepoor, not the elite, so it is heartening that in

Table 3

GDP Growth Accelerates in Poor States

Mean % growth 200004 Mean % growth 200409

Bihar 4.5 12.4

Chhattisgarh 6.1 9.7

Jharkhand 1.9 8.5

Madhya Pradesh 1.9 6.6

Orissa 4.8 10.2

Uttar Pradesh 3.3 6.7

All India 5.6 8.5

Source: Calculated from data from Central Statistical Organisation, www.mospi.nic.in.

Table 4

Literacy Rate Accelerates

195051 196061 197071 198081 199091 200001 201011

Overall Literacy 18.3 28.3 34.4 43.6 52.2 64.8 74.0

Source: Government of India, Census of India 2011, www.Censusindia.gov.in.


10/16

10

Insurrectionin India is

correlated closelywith ethnic

and religiousdivisions, not

with poverty ordeprivation.

the two decades since 1991, Indias literacyrate has shot up by a record 21.83 percent-age points to 74.04 percent (see Table 4). Inthe earlier two decades, it rose only 17.8 per-centage points. This figure would be evenless if we adjusted for the fact that before1991 the literacy rate referred to people aged5 and above, and from 1991 onward referredto people aged 7 and above.

In the last decade, the improvement inall-India literacy (9.7 percentage points) was vastly exceeded by several poor backward

statesBihar (16.82), Uttar Pradesh (11.45),Orissa (10.37), and Jharkhand (16.07). Fe-male literacy improved even more dramati-cally, by 11.8 percentage points across India,and at still higher rates in Bihar (20.2), UttarPradesh (17.1), Orissa (13.9), and Jharkhand(15.3).23

Poverty. The poverty headcount ratio,calculated from data from the NationalSample Survey Office (NSSO), has declinedfrom 45.3 percent in 199394 to 32 percentin 200910 (see Table 5).

Some will say this is not fast enough.However, NSSO surveys now capture only43 percent of consumption measured byGDP data against 87 percent in the 1970s.24Poor people may understate their living stan-dards for fear of losing benefits targeted atthe poor. Hence the poverty headcount ratiomay actually be much lower than suggested

by the official data. The proportion of peoplesaying they have been hungry in some or allmonths has declined sharply in the pooreststates and has fallen overall from 17.3 per-cent in 1983 to 2.5 percent in 200405 (seeTable 6).25

Booming revenues in the reform era haveenabled the central and state governmentsto greatly increase outlays on subsidies andemployment programs aimed at the poorThese programs are notorious for fraud andleakages, but nevertheless something is get-

ting through. However, casual labor wageshave risen with fast growth, and labor short-ages are being felt everywhere, even in agri-cultural and construction labor (tradition-ally viewed as unskilled labor). Agriculturalwages in the 35 months to December 2010were up by 106.5 percent and 84.4 percentrespectively in rich agricultural states like Andhra Pradesh and Punjab, and were upsharply even in poor states that normallysuffer outmigration, such as Bihar (58.3 per-cent), Orissa (62.9 percent), Uttar Pradesh

(62.4 percent) and Madhya Pradesh (56.2percent).26 Rapid growth has done more tocombat poverty than welfare schemes.27

The Unfinished Agenda

Even after two decades of reform, a large

Table 5

Poverty Rates Decline

199394 200405 200910

Poverty ratio, % 45.3 37.2 32.0

Source: Government of India,Economic Survey 2011, indiabudget.nic.in; PTI news item inBusiness World, Apri20, 2011.

Table 6

Fewer Households Report Any Hunger in Last 12 Months

1983 199394 19992000 200405

Hunger ratio, % 17.3 5.2 3.6 2.5

Source: Angus Deaton and Jean Dreze, Food and Nutrition in India: Facts and Interpretations, Economic and

Political Weekly (India), February 14, 2009.


11/16

11

Dalits are stillat the bottomof the incomeand socialladders, butthey have gainedsubstantially inthe reform era.

unfinished agenda of economic reform re-mains, as does an even larger unfinishedagenda for governance reform.

Economic freedom and doing business. TheHeritage Foundations 2011 Index of Eco-

nomic Freedom ranks India at just 124th of183 countries.28 The Fraser Institutes 2010 Economic Freedom of the World report ranksIndia a bit better at 87th of 141 countries.29TheDoing Business report of the World Bankplaces India at just 134th of 183 countries,showing it has a long way to go before it canbe called business-friendly. India comes closeto the global bottom in ease of starting abusiness (165th), getting construction per-mits (177th), and enforcement of contracts(182nd).30 This reflects controls, red tape,

and delay (mostly at the state governmentlevel), even after significant liberalization bythe federal government.31 India holds theworld record for legal case backlogs (31.5million) which will take 320 years to clearaccording to Andhra Pradesh High Courtjudge V.V. Rao.32 Indian states are beginningto improve business conditions but have along way to go. Meanwhile the federal gov-ernment continues with significant curbson investment in infrastructure, natural re-sources, the financial sector, education, and

retail. Strict controls on land ownershipand the movement of goods thwart agricul-tural growth. Rigid labor laws have not beenamended at all and prevent India from mov-ing into labor-intensive industries that couldemploy millions.

Social spending and waste. Social spend-ing has boomed along with the economy.Innovations in the reform era include a ru-ral employment guarantee program; a forth-coming Food Security Act to greatly expandsubsidized food for the poor; an expanded

Education for All scheme along with a Rightto Education Act; a rural health mission;special programs for rural infrastructure andurban problems; and schemes targeted atpoorer sections, castes, and religious groups.Social spending broadly defined rose from5.49 percent of GDP in 200506 to 7.27 per-cent in 200910.33 However, these schemes

are dogged by corruption, waste, and leak-ages on a monumental scale. Supposedlyfree government schools and health centersbarely function, so poor people increasinglyswitch to paid private schools and doctors.34

Powerful trade unions ensure that thereis no accountability from teachers, healthworkers, and other deliverers of governmentservices; absenteeism is rampant and bribesare constantly demanded for supposedly freeservices. Major administrative reforms areneeded to change incentives and make ser-vice providers accountable to the people theyserve.

Nutrition. India has some of the worstnutritional indicators in the world. Anemiaaffects over 80 percent of the population in

several states. Child malnutrition, measuredby low weight for age, affects 46.7 percent ofall Indian children, worse than in any Afri-can country. A family health survey suggestsvirtually no improvement in child malnutri-tion between 199899 and 200506, despiterapid GDP growth. However, data from theNational Nutritional Monitoring Boardshow some improvement. By global stan-dards Indian children suffer from stunting,low weight, and wasting. The puzzle is thatmalnutrition and anemia affect high income

groups too. Calorie intake is falling despiterising incomepoor people want to switchto superior, tasty foods rather than get morecalories out of basic foods. Nutrition is abigger problem than hunger, so nutritionaleducation and fortification of food with vi-tamins, iron, and iodine are on the futureagenda.35

Skill shortages. Every sector in India (in-cluding farming and construction) com-plains today of a labor shortage, but thebiggest bottlenecks are in skilled labor. The

government school system is deplorable, andmillions leave school functionally illiterate.Both government and private colleges arehighly unsatisfactory in both quality andquantity. India needs a huge improvementin education and vocational training if it isto fully harness its demographic dividend. Voucher programs can give parents the


12/16

12

India is called amiracle economy,

but the realmiracle is how

it grows despitesuch a flawed

institutional base.

choice of sending kids to private schools andcolleges. The government should allow for-profit schools (currently banned) as well aseasy entry of foreign universities into India.

Law, order, and justice. The police and

courts have a terrible record and are seenas founts of corruption and injustice. Casesdrag on for decades, and many criminals dieof old age before being convicted beyond allappeals. Indias court case backlog guaran-tees that many legal controversies will neverbe settled at all. India has 14,576 judges asagainst approved and budgeted posts of17,641. This works out to 10.5 judges permillion population, against the Indian Su-preme Courts suggested norm of 50 permillion.36 India has less than one policeman

per thousand people against the United Na-tions standard of 2.2.37

Politicians misuse powers of arrest andprosecution to protect wrongdoers in theirown ranks and to target opposition groups.Vast areas of rural India have very few police,courts, or forms of administrative redress,and poor people complain that the few ruralpolice are bought off by richer landownersand traders. This is one reason why Maoistshave come up in remote areasthey holdcourts and implement instant rough justice,

filling a void created by state absence.In enforcement of contract, India ranks a

shocking 182nd of 183 countries accordingto the World Bank. Its called a miracle econ-omy, but the real miracle is how it managesto grow fast despite such a flawed institu-tional base. A saving grace is that while civilcases go on forever, Indian courts are speedyand effective in checking arbitrary actionsby the government, and this is highly valuedby all businesses including foreign ones.

Corruption. This is the hottest political

topic in India today. After decades of in-creasing criminality and corruption in poli-tics and the bureaucracy, public anger overcorruption has exploded. This is a struc-tural shift linked to the rise of an assertivemiddle class, exemplified and amplified bytelevision channels. Politics is widely seenas business, and politicians as millionaires,

and this is now affecting politics where ithurtsin election results. That is a hopefulsign.

Most surveys show that people think cor-ruption is getting worse, with the biggest

culprits being politicians, the police, andbureaucrats, in that order. However, it seemspossible that India is experiencing morepublic outrage rather than more corruption,as suggested by the Corruption PerceptionIndex of Transparency International. Thisranks India 87th out of 178 countries, be-hind China (78th) but well ahead of Bangla-desh (134th) and Pakistan (143rd).38 Indiahas actually improved its score slightly overthe years, from 2.7 out of 10 in 2002 to 3.3in 2010. This may be because corruption has

been abolished by deregulation in severalareas (industrial licenses, import licenses,monopolies clearance, foreign exchange per-mits), and this tends to offset rising corrup-tion in areas of political allocations (naturalresources, real estate, and government con-tracts). However, rising corruption in thesethree areas has been so brazen as to makepoliticians richer and the public angrier thanever before, stoking criticism that liberaliza-tion amounts to a ploy to enrich politiciansand business cronies alike. Not everyone rec-

ognizes the problem as one of insufficientliberalization that leaves too much space forpolitical discretion and favoritism.

Infrastructure. A major barrier to growthin the coming years will be insufficient in-frastructure, and this is connected with cor-ruption. Roads, power, ports, railways, andtelecom are all connected with the three topareas of corruptionnatural resources, landand government contracts. Private coal min-ing is still not permitted save for captive in-dustrial consumption. No agricultural land

can be converted into nonagricultural landfor industry or services without govern-ment permission, which provides huge kick-back opportunities. India needs more opentransparent procedures and the abolition ofpolitical discretion in these areas, not just toprovide cleaner government but to acceler-ate infrastructure provision, too.


13/16

13

Criminals in politics. In the 2009 elections,150 of 542 seats were won by politicians withcriminal records, including cases of murder,rape, and theft. This was up from 128 suchpoliticians in the 2004 elections.39 The situ-

ation is about as bad in the state legislatures.The inability of courts to convict people be-yond appeals means thugs can use moneyand muscle with impunity. This translatesinto a deplorable form of political clout,and so the thugs are wooed by political par-ties and join politics to stall cases they face.This deterioration of political morality isintimately linked with the rise of big-ticketcorruption and of the public anger againstit. Possible reforms include independentinstitutions (like the proposed Lokpal, an

ombudsman with teeth) to investigate cor-ruption by ministers and top politicians.Another proposal is to decree legal seniorityfor all cases against elected legislators. Oncethugs find that getting elected expeditesrather than stalls their criminal trials, theywill lose interest in joining politics, whichwill automatically become cleaner.40

Conclusion:Governance Reforms

Are Key Today

Indias unfinished reform agenda in-cludes two main areas: economic reformand governance reform. Of the two, gov-ernance reform lags far behind and is thusmore important. After all, economic reformhas already been deep enough to produce8.5 percent growth and give India miracle-economy status, but the same cannot be saidfor governance. Indeed, the real miracle is

that India has grown so fast despite so muchmisgovernance.

Whereas economic reform can improvegovernance in key areas, good governance isdesirable in itself and it is an essential ingre-dient for faster economic growth. Free com-petition and a level playing field for businessare not possible without decent governance.

Reform of the police-judicial system will notjust improve crime detection and redress ofgrievances, it will also improve contract en-forcement and protection of property rights.If land, mineral licenses, and the telecom

spectrum are auctioned transparently andnot handed out to favored parties, that willnot only check corruption but will also helpmake productivity more important thanpolitical connections, an essential condi-tion for dynamic competition. Eliminatingcorruption from government contracts willmean not only cleaner politics and adminis-tration but more bidders for every contract,reducing costs and speeding up projects.Eliminating criminals from politics will not just signal that crooks and cronies cannot

gain immunity by joining politics, but willreduce a significant cause of corruption andrent-seeking and can thus help create freermarkets and increased competition. That isthe way India needs to go.

Notes1. Clive Crook, The Caged Tiger, The Econo-mist, May 4, 1991.

2. Indias fiscal year runs from April 1 toMarch 31. FY 2011, for example, is often referredto as 201011.

3. Government of India, The Economic Survey201011, www.indiabudget.nic.in. This puts GDPat current market prices at Rs 79 trillion in 201011. With expected nominal growth of 15 percentthis year, GDP should exceed Rs 90 trillion orUS$2 trillion.

4. Goldman Sachs, Dreaming with theBRICS: The Path to 2050, Global Economics Pa-

per 99, 2003, http://www2.goldmansachs.com/ideas/brics/book/99-dreaming.pdf.

5. World Bank/International Finance Corpo-ration, Doing Business 2011 (Washington: WorldBank, 2010).

6. United Nations Development Programme, 2010 Human Development Report (New York:Oxford University Press, 2010).

7. Angus Deaton and Jean Dreze, Food andNutrition in India: Facts and Interpretations,


14/16

14

Economic and Political Weekly (India), February14, 2009. The authors show that the mean bodymass index in India is 20.5, the fourth lowest inthe world, and below the sub-Saharan Africanaverage of 21.9.

8. Economic Advisory Council to the Prime

Minister, Economic Outlook for 2010/11 NewDelhi, July 2010.

9. Aditya Matoo and Arvind Subramanian,India and Bretton Woods II, Economic and Po-litical Weekly, November 8, 2008.

10. Swaminathan S. A. Aiyar, Indias GlobalImage Is Driven by Private Initiatives, The Timesof India, January 9, 2011.

11. Government of India,Economic Survey 201011, pp. A73 and A75, February 2011.

12. Reuters Africa, India Says to Offer $5 bln

for Africa Development, May 24, 2011.

13. Swaminathan S. A. Aiyar, Indian BusinessIs Not a Small Crony Club, Times of India, June5, 2011.

14. Swaminathan S. A. Aiyar, Escape from the Benevolent Zookeepers, (New Delhi: Times GroupBooks, 2009), p.15.

15. Census Commissioner of India, Census of In-dia 2011.

16. Shekhar S. Aiyar and Ashoka Mody, TheDemographic Dividend: Evidence from the Indi-an States, IMF Working Paper 11/38, February,2011.

17. James Lamont, High Growth Fails to FeedIndias Hungry, Financial Times (London), De-cember 22, 2010.

18. Government of India. Figures calculated byauthor from data of Central Statistical Organ-isation, 2011, www.mospi.nic.in.

19. Swaminathan S. A. Aiyar, Truth about Dis-parities and Violence, Times of India, June 3, 2007.

20. Indicus Analytics, Manufractured Growth,Business Standard, April 28, 2011.

21. Devesh Kapur et al., Rethinking Inequal-ity: Dalits in Uttar Pradesh in the Reform Era,

Economic and Political Weekly (Mumbai), August28,2010.

22. Rama Lakshmi, New Millionaires Hope toServe as Role Models for Indias Lower Castes,Washington Post, April 14, 2011.

23. Census Commissioner of India, Census ofIndia 2011.

24. Surjit Bhalla,The New Hindu Constant,The Indian Express, April 23, 2011.

25. Deaton and Dreze.

26. Swaminathan S. A. Aiyar, Wage BoomProves Inclusive Growth, Economic Times, July 72011.

27. The Surge in Wages,Business Standard, May25, 2011.

28. Terry Miller and Kim R. Holmes, 2011 Index of Economic Freedom (Washington: HeritageFoundation, 2011).

29. James Gwartney, Joshua Hall, and RobertLawson, Economic Freedom of the World: 2010 Annual Report(Vancouver: Fraser Institute, 2010).

30. World Bank/International Finance Corporation.

31. For a review of the diverse levels of economic freedom among the Indian states, see BibekDebroy, Laveesh Bhandari, and Swaminathan

Aiyar, Economic Freedom of the States of India 2011(New Delhi: Friedrich Naumann Stiftung andCato Institute, 2011).

32. Courts Will Take 320 Years to Clear Back-log Cases: Justice Rao, Times of India, March 62010.

33. Government of India,Economic Survey 201011, Table 12.4, February 2011, p. 204.

34. For an account of the growth of privateschools for the poor in India and other poorcountries, see James Tooley, The Beautiful Tree(Washington: Cato Institute, 2009).

35. Deaton and Dreze.

36. Courts Will Take 320 Years to Clear Back-log Cases.

37. Harnessing Technology, Defence Service

Alert, New Delhi, May 25, 2011.38. Transparency International, Corruption Perceptions Index 2010, transparency.org.

39. More Criminals in 15th Lok Sabha ThanLast,Mumbai Mirror, May 18, 2009.

40. Swaminathan S. A. Aiyar, Ten Command-ments for Dr. Singh, Times of India, June 102010.


15/16

STUDIES IN THE CATO INSTITUTE

DEVELOPMENT POLICY ANALYSIS SERIES

12. The State of Liberal Democracy in Africa: Resurgence or Retreat? by TonyLeon (April 26, 2010)

11. Reflections on Communism Twenty Years after the Fall of the Berlin Wallby Paul Hollander (November 2, 2009)

10. An International Monetary Fund Currency to Rival the Dollar? WhySpecial Drawing Rights Cant Play That Role by Swaminathan S. Anklesaria

Aiyar (July 7, 2009)

9. The False Promise of Gleneagles: Misguided Priorities at the Heart of theNew Push for African Development by Marian L. Tupy (April 24, 2009)

8. El Salvador: A Central American Tiger? by Juan Carlos Hidalgo (March 9,2009)

7. The Benefits of Port Liberalization: A Case Study from India bySwaminathan S. Anklesaria Aiyar (December 3, 2008)

6. Zimbabwe: From Hyperinflation to Growth by Steve H. Hanke (June 25,2008)

5. A Decade of Suffering in Zimbabwe: Economic Collapse and PoliticalRepression under Robert Mugabe by David Coltart (March 24, 2008)

4. Fifteen Years of Transformation in the Post-Communist World by OlehHavrylyshyn (November 7, 2007)

3. Securing Land Rights for Chinese Farmers: A Leap Forward for Stabilityand Growth by Zhu Keliang and Roy Prosterman (October 15, 2007)

2. Corruption, Mismanagement, and Abuse of Power in Hugo ChvezsVenezuela by Gustavo Coronel (November 27, 2006)

1. The Rise of Populist Parties in Central Europe: Big Government,

Corruption, and the Threat to Liberalism by Marian L. Tupy (November 8,2006)


16/16

Anne ApplebAumWAshington post

gurchArAn DAsFormerceo, procter& gAmble, inDiA

ArnolD hArbergeruniversityoF cAliForniAAt los Angeles

FreD hugolDmAn sAchs, AsiA

peDro-pAblo KuczynsKiFormerprime ministeroF peru

DeepAK lAluniversityoF cAliForniAAt los Angeles

JospierAFormerministeroF lAborAnDsociAl security, chile

T

he Center for Global Liberty and Prosperity was established to promote

a better understanding around the world of the benefits of market-liberal solutions to some of the most pressing problems faced by develop-

ing nations. In particular, the center seeks to advance policies that protect hu-

man rights, extend the range of personal choice, and support the central role of

economic freedom in ending poverty. Scholars in the center address a range o

economic development issues, including economic growth, international finan

cial crises, the informal economy, policy reform, the effectiveness of official aid

agencies, public pension privatization, the transition from socialism to the mar

ket, and globalization.

For more information on the Center for Global Liberty and Prosperity,visit www.cato.org/economicliberty/.

Nothing in this Development Policy Analysis should be construed as necessarily reflectingthe views of the Center for Global Liberty and Prosperity or the Cato Institute or as an attempt to aid or hinder the passage of any bill before Congress. Contact the Cato Institute forreprint permission. Additional copies of Development Policy Analyses are $6 each ($3 for fivor more). To order, call toll free (800) 767-1241 or write to the Cato Institute, 1000 Massachusetts Avenue, N.W., Washington, D.C., 20001; phone (202) 842-0200; or fax (202) 842-3490

OtherStudieSOndevelOpmentfrOmtheCatO inStitute

BOardOfadviSerS

Why Is Africa Poor? by Greg Mills, Development Policy Briefing Paper no. 6 (December 6, 2010)

Freedom and Exchange in Communist Cuba by Yoani Snchez, Development Policy Briefing Paperno. 5 (June 16, 2010)

The State of Liberal Democracy in Africa: Resurgence or Retreat? by Tony Leon, Development Policy

Analysis no. 12 (April 26, 2010)

Reflections on Communism Twenty Years after the Fall of the Berlin Wall by Paul Hollander, Devel-opment Policy Analysis no. 11 (November 2, 2009)

Socialism Kills: The Human Cost of Delayed Economic Reform in India by Swaminathan S.Anklesaria Aiyar, Development Policy Briefing Paper no. 4 (October 21, 2009)

An International Monetary Fund Currency to Rival the Dollar? Why Special Drawing Rights CantPlay That Role by Swaminathan S. Anklesaria Aiyar, Development Policy Analysis no. 10(July 7, 2009)

The False Promise of Gleneagles: Misguided Priorities at the Heart of the New Push for

African Development by Marian L. Tupy, Development Policy Analysis no. 9 (April 24, 2009)

El Salvador: A Central American Tiger? by Juan Carlos Hidalgo, Development Policy Analysisno. 8 (March 9, 2009)

Documents

The Elephant That Became a Tiger: 20 Years of Economic Reform in India, Cato Development Policy Analysis No. 13