The past couple of months have seen a resurgence of growth optimism about the Indian economy. In the short-run of the current fiscal year this is entirely justified by the exceptionally strong monsoon (following on the mini-drought of 2002-03), a mild cyclical upturn in industry and steady growth in services.
The Indian economy could well grow at 7 per cent or higher in 2003-04. But the growth optimism seems to extend well beyond the present year. A growing number of writers (including Vijay Kelkar and N K Singh) have emphasised the potential of some medium and long-term drivers of growth.
In particular, they have pointed to the 'demographic dividend' generated by India's relatively youthful population swelling the ranks of the labour force in the coming decades and reducing the dependency ratio of children plus senior citizens.
Long-term optimism has also been fed by the recent Goldman Sachs study (Dreaming with BRICs), which projects the rising global economic role of Brazil, Russia, India and China in the next half century. Is such optimism justified? Are we really on a growth escalator which will lift India to the front rank of global economic powers in the next three or four decades?
In some ways the BRICs projections are most alluring from an Indian perspective. The study notes "India has the potential to show the fastest growth over the next 30 and 50 years". What is really seductive is that the projections appear so modest and reasonable.
India is seen to grow at about 6 per cent per year between now and 2040 and then slow down gradually to 5 per cent by 2050. None of the wishful 8 per cent of the Tenth Plan is invoked. And yet, even with such 'modest' growth, India attains today's Korean (RoK) standards of living by 2042 and Italy's (almost) by 2050.
In terms of GDP in US dollars the Indian economy would overtake UK in 20 years and Japan in 30 years! Such is the power of compound interest and a large base population. This is heady stuff. Should we just book our seat and enjoy the ride to nirvana? But perhaps we need to take a closer look first. What's driving this stellar long-term performance?
The 'demographic dividend' seems to be a large part of this captivating tale. To quote: "Demographics play an important role in the way the world will change…With the only population out of the BRICs that continues to grow throughout the next 50 years, India has the potential to raise its US dollar income per capita to 35 times current levels". That's an increase of 3500 per cent!
What is this magic potion of 'demo-div'? It's part of the larger story of the 'demographic transition', which runs roughly as follows. In undeveloped economies both birth rates and death rates are high and, as a result, the population is static and poor. With development come advances in public health and disease control, which bring down the death rate.
Since, initially, the birth rate stays high, population grows apace and, after a 10-15 year lag, so does the labour force. As development proceeds and technology improves, living standards rise and families prefer fewer children. Increasingly they acquire the means to execute such aspirations.
In short, the birth rate also starts to decline, leading to lower population growth. That, in turn, reduces labour force growth. That is the demographic transition of a society from high rates of birth and death to low ones.
Towards the last third of this story comes a phase (of several decades) when labour force growth is high (because of earlier births) but the proportion of dependent children is low (because of reduced birth rates).
These are the decades when the economy has the highest proportion of its population in the working age (15-60) and offers the maximum potential for productive employment and growth. That's the demographic dividend.
Note one absolutely crucial point. The 'demo-div' is all about the supply of labour. Nothing is said about demand. Therein lies the catch. The additional labour supply offers the potential for employment and growth.
In a well-functioning economy with competitive product and factor markets labour demand would match supply and lead to more jobs and output. But there is no guarantee of such a happy outcome. It all depends on how well the economy is run; in particular, how well labour markets work. Let's return to the reality of India.
Between 1993-94 and 1999-2000 the economy grew at over 6.5 per cent per year. But, according to the Tenth Plan, employment grew only 1 per cent per annum! This was a period when labour force was growing at over 2 per cent a year and there was plenty of backlog of under-employment and unemployment.
Quite clearly, labour demand was growing far slower than labour supply. The labour market was far from perfect. There were many reasons. An important one is our rigid labour laws, which effectively convert labour from a variable to a fixed factor of production. Employers have every reason to avoid hiring new workers knowing it is almost impossible to lay off workers in a downturn.
In sharp contrast, firms in China employ millions of new workers each year knowing that they can be laid off if business conditions worsen. Of course, with capital surging in to avail of cheap, productive labour the downturn never comes!
Another crucial point is that India's demographic trajectory is an average of the demographic paths of its constituent states. From around 1970, the fertility story has diverged considerably across states. For various reasons (including female education, gender parity, and improving incomes) Kerala led the way with rapid decline in fertility, followed by Tamil Nadu and other southern states and, subsequently, other states.
By 1995, fertility rates (average live births per woman) in Kerala and Tamil Nadu had dropped below replacement level (2.1), other southern states and Maharashtra had fertility levels below 3, another group of states had fertility levels between 3 and 4, while the BIMARU states (undivided) and Haryana still had rates above 4.
In a recent EPW paper Leela and Pravin Visaria have presented long-term population projections for these three groups of states. These are shown in the table along with data on recent per capita incomes and state GDP growth. What do the data show?
First, the four BIMARU states have low per capita incomes (averaging below Rs 10,000 per year) compared to the five low-fertility leaders in the demographic transition, which average over Rs 18,000.
Second, the BIMARU economies have grown at only 4.6 per cent over the last decade compared to the 6.3 per cent clocked by the low-fertility states. The disparity is greater in terms of per capita income growth since population in BIMARU states has grown faster.
Third, precisely because the BIMARU states are laggards in the demographic transition, they will see the highest relative and absolute expansion in population and labour force between now and 2051. Their share of India's population will rise from 41per cent to 48 per cent, since nearly 60 per cent of India's population increment will be concentrated in these four states.
In a nutshell, the 'demo-div' of a transitional labour supply bulge will be focussed on four populous, poor, slow-growing northern states, with weak infrastructure, education systems and governance. The chances of translating this potential of additional labour supply into a reality of employment and high growth appear slim.
Returning to the BRICs study, the authors tested their projection model by running it 'backwards' for the period 1960-2000 for 11 countries. The 'predictions' were excellent -- except for India, where the model 'predicted' growth of 7.5 per cent but the actual outcome was 4.5 per cent! Perhaps we shouldn't yet bank on this escalator to nirvana? The author is a professor at ICRIER and former Chief Economic Adviser to the Government of India. The views expressed are strictly personal