When Narendra Modi took office in May 2014, India was at a turning point. Growth had dropped to 5.9 percent after almost a decade of 8 percent annual growth. Inflation jumped to 9 percent while current account and fiscal deficits ballooned. Amid the economic uncertainty, many public and private projects stalled.
Modi acted quickly to kick-start the economy and fix some of the mistakes made in the previous decade. He introduced a goods and services tax to replace a plethora of taxes levied by the central and state governments. He went after corruption in a bold way, demonetizing 1,000 and 500 rupee notes. He introduced the insolvency and bankruptcy act which offered a one-stop solution for what was a cumbersome and lengthy process. He also initiated wide-ranging reforms of the country’s education system including an overhaul of funding and a mandate that schools display learning goals. And he launched the “Clean India” campaign against open defecation, which upped the percentage of rural households with toilets from 37 percent to 77 percent. India’s GDP is now roughly at the level China was in 2000.
Yet significant challenges remain. Speaking at the Nand and Jeet Khemka Distinguished Speakers Forum, Arvind Panagariya, the Jagdish Bhagwati Professor of Indian Political Economy at Columbia University, put India’s development in perspective. It’s useful, he said, to compare India to its next-nearest neighbor in population, China. China sustained impressive growth (over 7 percent for more than two decades) due in large part to two strategies with which India has struggled: urbanization and scale.
The City Solution
Approximately 35 percent of India’s population lives in urban areas, compared to 54 percent in China. This is important because “as economists, we tend to think urbanization will lead to economic growth,” said Amit Khandelwal, director of the Chazen Institute and moderator for the talk. Economists often point to urbanization as a marker of development because it ushers in higher wages.
“That is the transition that has not happened,” Panagariya said. The slow rate of urbanization is a symptom of deeper structural issues, he added.
“On the urban side, we are not creating good jobs fast enough to pull the work force out of agriculture and into industry and service. A large workforce remains informal and underemployed,” he said. On the rural side, policies to create more minimum-wage employment in rural areas have discouraged people from leaving.
India has also not done a great job managing its cities, said Panagariya. For instance, China has excelled at creating new cities and housing for migrants. In India, slums spring up because migrants need a place to stay.
Small Businesses Stay Small
India’s second big economic problem is one of scale, he said. China is home to factories with tens of thousands of workers that feed a booming export business. In India, by contrast, “anything we do, we do on a very small scale” which leads to an inability to conquer global markets, he noted. While Indian software and pharmaceutical firms have succeeded in building large operations, industries such as apparel, electronics, and auto manufacturing have not. “Large companies in those industries have maybe 2,000 employees,” he said.
The gap is particularly noteworthy in apparel. China exports $170 billion in garments while India exports $18-$19 billion. Bangladesh, a much smaller country, bypassed India in garment exports years ago and now exports about $27 billion a year. Even Vietnam has surpassed India.
Labor laws and land acquisition laws are part of the reason. Some of India’s strict labor laws controlling hiring practices, safety, and compensation make it difficult to grow the formal employment sector. But Panagariya also noted a “Brahamian” attitude among entrepreneurs that limits their ambition to build largescale operations.
This is not to say that India hasn’t made efforts to develop industry and support startups. India’s commerce ministry and other government entities launched the Startup India program in 2016 with initiatives to fund new companies, extend income tax exemptions, push for female entrepeneurship, and protect intellectual property. India is also home to a growing number innovation labs and incubators.
For India to continue its trajectory, it needs to create more nonfarm jobs, said Panagariya. Its future lies with urbanization — either encouraging people to move to urban areas or building up rural areas into small townships and then cities, he said, citing Shenzhen, China, as an example. “That’s the kind of thing you need to start engineering.”