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Growing economy: What's India's missing link?

Last updated on: January 10, 2011 15:32 IST

Growing economy: What's India's missing link?

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Parthasarathi Shome

India's growth surge has been phenomenal. Growth reached 9.5 per cent in 2005-06 and 2006-07, and 9.2 per cent in 2007-08.

Subsequently, the global financial crisis dampened growth to 6.7 per cent in 2008-09 and 7.4 per cent in 2009-10, but it is likely to pick up according to independent projectors.

What lay behind growth of the Indian economy?

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Image: India's manufacturing sector booms.
Photographs: Danish Siddiqui/Reuters.
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1. Was it neo-classical a la Robert M Solow and T W Swan, who emphasised the role of savings - translated into investment - in economic growth?

2. Was it demand-driven a la John Maynard Keynes, where an x amount of expenditure, even if not backed by savings, would lead to a multiple yx of income?

3. Was it economic growth and rising incomes that triggered both savings and investment, in line with Arthur W Lewis' capitalist surplus concept?

4. Or was it technological innovation that shifted up the growth path trajectory and endogenised technical change, as economists such as Paul Romer have hypothesised?

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Image: Indian economy booms.
Photographs: Reuters.
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Growing economy: What's India's missing link?

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Link 1. What stands out most is India's savings trajectory (Figure). Gross domestic savings rose from 10.3 per cent of GDP in 1950-55 to 36.4 per cent in 2006-07.

This success is revealed even in international comparisons where India is shadowed only by China (at over 50 per cent). Look at three components of savings. Specific policies facilitated growth in household savings.

Population per bank branch fell from 90,000 in mid-1950s to 14,000 by early 1990s. Also reflecting active interest rate and anti-inflation policies, household financial savings rose from 1.6 per cent of GDP to 10.6 per cent during this period.

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Image: India's savings rate.

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Growth in private corporate savings then became the front-runner, its share rising from 70 per cent of total savings in the first part of this decade to 85 per cent in the second part.

Public sector savings languished, however, declining from 1.7 per cent in 1950-55 to -0.6 per cent in 2003-04. Dissavings first appeared in 1998-99 as the public sector failed to meet its own revenue expenditure.

Subsequent discipline under the 2003 FRBM Act that enabled public savings to reach 5 per cent of GDP by 2007-08 was lost to fiscal relaxation. It fell to 1.4 per cent in 2008-09.

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Image: Corporate savings rise.

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That scenario changed with a setback in public sector productivity. From around the mid-1980s, public investment declined and private investment grew in terms of GDP (Figure).

A resurgent phenomenon of the 2000s, however, is a reversal of that process with a rise in public investment at the cost of household and corporate segments. Given low public sector productivity, this manner of crowding out is not justifiable.

When the private sector is capable of undertaking mega projects and is willing to do so, what is needed is an accommodative environment created by the government to enable private investment in infrastructure and large industry, protecting only the core strategic sector in its own brief.

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Image: Public investment declined and private investment grew.

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Accommodation is not tax incentives but removing non-tax barriers that comprise the real stumbling blocks for efficient allocation of resources between public and private sectors as well as for quantum of private sector resources that large businesses - foreign and domestic MNCs - are willing to invest.

The private sector does vie for incentives not only on a large scale as reflected in both our income tax and indirect tax structures such as the SEZ Act but also for minuscule relative advantages over perceived competitors.

But this behaviour would tend to dissipate once a non-tax level-playing field begins to appear on the scene.

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Image: India gets more funds.
Photographs: Reuters.
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Link 3. The overall high savings-high investment economy has generated high growth. India has generated the largest international marketplace and has experienced the largest expansion in the taxpayer base from 15 million to over 30 million between 1995 and 2008.

Growth has also produced robust capital accumulation as the country's middle classes as well as corporate sector activity and investment have grown.

Economists have found growth as the causal factor in India's capital accumulation.

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Image: High savings-high investment economy.

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Link 4. The role of technology seems below potential in generating India's growth. Apart from advanced economies, middle income countries are investing heavily in R&D. India's figures are inadequate.

We emulate techniques of production and service generation but linger in productive primary research. No great economy is generated or sustained without innovation and invention, and embedding them in the growth process. This is India's missing link!

We are well poised for further savings generation.

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Image: India needs to innovate to grow.
Photographs: Reuters.
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Our demographic projections reveal, up to 2045, the 25-59 age group of income earners will increase though our younger cohorts will diminish and retirees will increase (Figure).

Thus, for the next 30-35 years, our savings and investment will increase further, have positive ramifications for economic growth, and vice versa. However, we need to innovate and take technology forward.

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Image: Demographic projections.

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The public sector to step back once again and stop crowding out the private sector. We should eradicate custom-tailored tax incentives and create a level-playing field for all productive activity.

We will then surely witness a resurge in economic growth and in tax revenue with which we might address our deep challenges in income distribution and poverty.

(The views expressed are exclusively the author's *Chandra, R and R Sandilands, "Does Investment Cause Growth? India 1950-96", University of Strathclyde working paper, UK.)


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