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The Ideas India Must Shed



Is the decade-old Indian growth miracle over?

India's latest growth number of 5.3 percent for the first quarter of the current fiscal year prompts that worrying question. It falls short of two important benchmarks in India: It is 3 to 4 percentage points below the growth in China, and, critically, it is almost 4 percentage points lower than the nation's growth of 9 percent before the global financial crisis, which Indians have come to expect as the new norm or even entitlement for growth.  

But the latest growth number along with the decline of the rupee might just be the jolt this government needs to rouse itself out of its policy funk. The list of actions the government of Prime Minister Manmohan Singh must take is well known and has been touted ad nauseam by a variety of analysts.  But this Congress party-led government will take them only if it disenthralls itself from two assumptions that have underpinned its sins of omission and commission for three years.

The first assumption has been that fiscal populism is electorally popular. And second, that economic growth can be sustained on autopilot. Consider both.

When this government was reelected in 2009, it came to believe that fiscal populism, which meant emphasizing equity over growth, had been the key to its electoral success. It concluded that the massive program of rural employment guarantees delivered its election victories in certain key states. Accordingly, the subsidies continued—on fuels, power, food, and fertilizer—at the expense of fiscal consolidation.

Policymakers were aware of the risks for the economy and growth. But they complacently believed they could ignore this risk because of the second assumption that growth was on autopilot. In this view, not only did the economy not need any assistance from policy, it could even survive the corrosive effects of bouts of macroeconomic wobbliness, policy uncertainty, and creeping corruption.  

Recent events will force a rethinking of both these ideas. The government will have to reverse its fiscal populism for two reasons. The proximate one is simply the evidence. Current policies have contributed to a weakening macroeconomic situation, characterized by high deficits, high and stubborn inflation (averaging close to 8 to 9 percent for two years), and widening external deficits exceeding 3 percent of GDP. From a macroeconomic perspective, India is not on the brink of a full-blown crisis but is approaching amber territory.

But there is a deeper reason to reconsider its current macroeconomic stance. It is no secret that the advocates of equity (and fiscal populism) have the ear of this government's political leadership. But they have failed to grapple with the fundamental contradiction of their intellectual position. They seek to spread economic wealth and opportunity, which is a laudable objective. But their means—mobilizing the Indian state—are most unsuited to reaching that objective.  The Indian state is weak and in perilous decline. It is increasingly unable to deliver even basic services, and thus losing legitimacy, diminishes its chances to achieve sophisticated redistribution.

To be fair, the assumption that growth was on auto-pilot seemed warranted for a time. The Indian economy purred along for nearly ten years despite the lack of meaningful reforms, surviving even the global financial crisis without too much damage. In India it seemed that "growth begat growth," rather than "reform begetting growth."  

In these circumstances, the pressure to reform was slim. No country in the history of humanity has undertaken serious reforms while growing at 9 percent per annum. Europe and the United States have taken action only when close to the precipice. India has been no different, except that the precipice in India is a growth rate of 6 percent whereas for the advanced countries it is economic contraction and high unemployment.

The deceleration in economic growth will therefore shine the spotlight on the factors undermining India's long-run growth potential. Pre-1991, the economy was shackled by controls on a lot of economic activity and the ensuing reforms eliminated many of them. But in recent years the locus of corruption has shifted from the old controls, mostly in the manufacturing sector, to the government's allocation of scarce resources—land, coal and other mineral resources, and spectrum—which generate very large revenues. These revenues are called rents to reflect their scarcity value. Thus, India has gone from becoming a "permit-quota-license Raj" to what might be called a "Rents Raj," with profoundly adverse consequences for the growth potential of the economy, which I wrote about recently.

In some ways, the Indian economy needs all the bad news that it is getting—not just to spur action, but more fundamentally, to shake existing ideas and assumptions that have arguably been the biggest impediment to such action.

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