Why India Is the Fastest-Growing Economy on the Planet

One of the world’s foremost economists suggests which catalysts propelled India out of desperate poverty – and predicts how the subcontinent will turn its sprint into a marathon.

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After years of trailing in China’s shadow, India last year galloped ahead to become the fastest growing major economy on the planet. Its GDP crossed the 2015 finish line at a 7.6 percent expansion rate, according to the World Bank.

Dale Jorgenson, the Samuel W. Morris University Professor at Harvard University, wanted to know just what India did in recent years to goose its economy. Beyond wishy-washy, paragraph-long truisms that academics, politicians and laypeople have credited with economic growth, he sought some quantifiable metrics.

In his new book, The World Economy: Growth or Stagnation? (2016, Cambridge University Press), he and his coauthors examined 40 countries throughout the world. To determine which factors contributed most to growth, they weighed each of the five KLEMS components: Capital (which uses the K), Labor, Energy, Materials, and Services Purchased.

As Jorgenson explained at a recent event sponsored by the Chazen Institute and the Raj Center for Indian Economic Policies, the KLEMS data revealed a somewhat startling pattern. “Our findings contradict conventional wisdom that productivity leads to growth,” he said. Instead, “we determined that a sharp acceleration in investment made up the predominant source of growth in the world economy,” led by the emerging markets of China and India.

At the lecture he also posed, and answered, two related questions: “Will India’s growth spurt continue?” and “Has India established a framework to sustain economic performance?”

India in Context

Globally, the KLEMS analysis shows a pronounced economic leap forward around 1995, when annual growth topped 4 percent. Although global growth slowed to around 3.5 percent between 2005 and 2015, in large part a result of the Great Recession, China and India forged ahead, thanks to a series of reforms in both countries, observed Jorgenson.

In both countries, money made all the difference. The investment stream was kick-started by a series of systemic reforms that began in China in 1978, as Deng Xiaoping opened up the country to foreign investors and allowed entrepreneurs to start businesses, and in India during the early 1990s, as the IMF called for the country to reduce import tariffs and taxes, deregulate markets, and allow greater foreign investment. Both implementation of those reforms and subsequent investment flows came more gradually to India, helping explain why its growth lagged China’s.

Now that India’s reforms have begun to catch up, Jorgenson credited the relative youth of the Indian population for recent gains. “India’s more favorable demography pushes up the hours worked and productivity components,” he said. “Those factors have led to India overtaking China” in the race to the world’s fastest growing economy.

How India Can Sustain Growth

What’s ahead? By all measures, productivity growth is set to slow from what many observers consider an overheated pace. That will likely cut global GDP growth from 3.7 percent currently to about 3.2 percent annually. (A best-case scenario is 4.5 percent and worst case is 2.4 percent). And China will do well to maintain a 5 percent annual pace over the next decade. Jorgenson pointed to the growing Sino debt burden, which could threaten China’s financial system, and the country’s aging population as drags on growth.

In contrast, India’s growth trajectory will continue, predicted Jorgenson, but at a slower, albeit more sustainable rate of about 6.5 percent annually through 2024, about a percentage point below its 2004-2014 pace. Although productivity growth in India will slow (as in the rest of the world), hours worked will continue to climb at a significantly faster rate than elsewhere as India finds jobs for its youthful populace. The all-important capital stream will persist, supporting India’s infrastructure and businesses, but don’t expect large increases in this department. “Investment in India has reached a plateau,” he indicated.

India does not have to grapple with the same problems that could sideline China. Instead, its downside risks include the failure to restore fiscal balance and maintain control of inflation, said Jorgenson. Reasons for optimism include serious labor market reforms under discussion and possible acceleration of India into the global economy.

What must India do to assure favorable conditions? Jorgenson suggested four policies:

  • Create a national market for goods and services. India currently is a loose affiliation of states with a tax system that discourages commerce across state borders, much like “Europe before the EU,” said Jorgenson, who added, “Every major country in the world – except India and the United States – has a VAT.” Despite obstacles, Jorgenson suspects India is already on the road to developing a single marketplace. Pending legislation regarding a national goods and services tax, replacing the Byzantine maze currently in place, could go a long way to creating a market that would be among the largest in the world.

  • Privatize public enterprises and deregulate industries to enhance competition. This process was begun in 1991 but stalled shortly thereafter. Much remains to be done, said Jorgenson, but serious efforts are underway to discard red tape, and talk has begun about some privatizations.

  • Reform monetary policy and the regulation of financial services. Jorgenson praised India’s moves to make the Reserve Bank of India more independent of political control and said its more flexible policies regarding inflation has lowered interest rates. He also credited acceptance of the Basel III accords in 2014, which required banks to hold meaningful reserves, with putting India’s financial system on a much sounder footing.

  • Reduce the elaborate system of employment protections to encourage job creation. Social programs and restrictions on businesses remain among the biggest challenges to business and labor productivity advances, said Jorgenson. India appears to be acknowledging the need for employment reforms, but much remains to be done in this regard, he said. “Efficient labor markets will be essential for realizing the benefits of favorable developments in India’s demography.”

Jorgenson considers himself an India optimist. His 6.5 percent growth predictions for India assume political and economic reforms will continue, largely because the populace recognizes progress has already occurred and is motivated to build on the reforms. Between 2008 and 2011 (the most recent data cited), the World Bank calculated India to be No. 1 in the world in liberating people from extreme poverty. As far as more than a billion people are concerned, India’s efforts are achieving “the great escape,” Jorgenson said.

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