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June - July 2005

Business Forum

India in a Globalising World

Montek S Ahluwalia, Deputy Chairman, Planning Commission India

(Extracts from his 27th Jawaharlal Nehru Memorial Lecture
given at Chatham House, London 20th April 2005)

India in a globalising world may appear at first glance to be an odd choice for a lecture in Jawaharlal Nehru’s memory. Globalisation as we know it today did not exist when Jawaharlal Nehru was Prime Minister and some would say it h as elements somewhat alien to his world view. Nehru’s politically formative years, between the two World Wars, were marked by a significant reversal of globalisation and a shrinking of world trade as the major industrialised countries resorted to protectionism to maintain domestic employment. This was also a period when the autarkic Soviet Union appeared to be gaining ground while the market economies were struggling to manage their economic problems.

There are two reasons why I feel my choice of subject is appropriate. First, globalisation is a contemporary reality and presents India and other developing countries with new challenges, which call for new responses. Nehru always recognised that India’s future would pose new challenges which would need a fresh approach. He said in his speech on the eve of India’s Independence: "The past clings on to us still in some measure and we have to do much before we redeem the pledges we have so often taken. Yet the turning-point is past, and history begins anew for us, the history which we shall live and act and others will write about."

Nehru was firm on basic principles and fundamental values – secularism, democracy, modernisation, development with social justice – but he was not one to be tied down by dogma to particular instrumentalities. Second, Panditji was a committed internationalist and he believed that independent India must participate fully in the world community. Given the reality of globalisation, I have no doubt that he would have wanted India to be in the forefront of a globalising world. As a man with a deeply scientific bent of mind would have wanted us to adopt the policies most likely to achieve our economic and social objectives, learning from the experience of others where relevant. For all these reasons, there can be no better way to honour his memory than a discussion of how India must deal with these challenges.

The problems posed by globalisation have been much discussed in recent years and perceptions about globalisation have changed greatly in this period. The early 1990s were in some respects the years of uncritical enthusiasm about globalisation especially in the West. The collapse of communism in Russia and Eastern Europe, and the enthusiastic conversion of these counties to market economics, created an environment of triumphalist optimism which was reflected in Francis Fukoyama’s premature pronouncement of "the end of historty". Many in the industrialised world advocated a drastic reduction in the role of the state and freeing of markets – domestic and external, including liberalisation of capital markets – as a tested formula for development. It was felt that countries only had themselves to blame if they failed to follow this simple recipe.

Experience did not validate this simplistic view. In some of the emerging market countries, especially in Africa and Latin America, it became evident that economic reforms did not always lead to rapid growth. The liberalisation of capital markets also proved to be a source of problems in certain circumstances as several emerging market countries experienced severe financial crises from which recovery proved to be a prolonged process, and where the poor were often the worst hit.

The industrialised economies also saw growing opposition to globalisation arising primarily from fears of lost job opportunities. Careful research repeatedly established that these losses had more to do with technological changes than competition from cheap imports, but public perception remained otherwise, and protectionist fears fanned anti-globalisation sentiments.

It is in this background that India, functioning as an open democracy, has been charting her course in globalising world. Politicians of all political parties in India know that globalisation is a reality. Many of them also know that all countries that have grown rapidly have done so by exploiting opportunities in world markets and this can only be done if the economy is globally competitive. The challenge lies in adopting policies that make the economy globally competitive while simultaneously managing the fears about globalisation and also countering negative fallout as and when they arise.

There are two types of concerns about globalisation. First, there is apprehension that globalisation, and especially the policies of openness associated with it, may lead to adverse effect on GDP growth. Second, there are concerns that even if aggregate growth is not adversely affected, indeed even if it increases, globalisation may have severely disruptive distributional affects hurting the economic interests of particular groups, sectors or regions causing a loss of income and an increase in poverty.

India’s growth record during the period of globalisation has been much better than it was in the 60s and 70s, when economic growth slowed down to 3.5% per year. Growth accelerated to around 5.7% per year in the 80s and 90s; and the economy is currently growing at about 6.5%. The present government has targeted a growth rate of between 7 & 8% for the near future. Since population growth has slowed down from 2% prior to 1990 to around 1.6% at present, the acceleration in the growth of per capita incomes is obviously much greater.

A much quoted recent study by Goldman Sachs identified Brazil, Russia, India and China as the set of large emerging market countries projected to grow rapidly over the next 30 years. Within the group, India’s potential growth rate was projected to be the fastest – around 8% per year – faster even than Chin. According to this study, by 2040 India will become the third largest economy after the USA and China.

Economics tells us that per capita income in an economy depends upon resource availability, i.e. capital, labour, the quality of human capital, the level of technology and the set of policies and economic institutions which determine the efficiency with which the resources are used. In an open economy it is particularly important for the policies to be such that the country can take full advantage of the opportunities provided by interaction with the rest of the world and this aspect has become especially important in a globalising world, where technology has created new opportunities for trade and other interaction which simply did not exist earlier. Looking at these determinants, I have no doubt that India is well position to accelerate from its present 6.5% growth to around 8% in the near future

Let me first comment on the issue of availability of capital. This depends upon the rate of investment, which in turn is determined by the rate of savings. India’s domestic savings rates are very respectable at 24% of GDP, gradually rising because of the change in the age composition of the population. Public Savings is negative; and that is a weak spot. In a globalising world, domestic savings can be supplemented by investment flows from abroad. India has only recently begun to attract foreign investment and there is considerable scope for expanding these flows. The government has set the target of raising foreign investment from its present $5billion of FDI to $15billion (three times). The present government is actively seeking to remove policy impediments to such flows and has already taken some steps in this area. With continuing improvement in domestic savings, and an increase in FDI from under 1% of GDP to say 2.5%, India can achieve the higher rates of investment needed to sustain 8% growth.

The other major determinant of growth prospects is the quality of human capital which refers to both the availability of skilled manpower and also entrepreneurial ability. India has a large pool of technical and higher skilled manpower, reflecting long established socio-cultural biases in favour of education and also the emphasis placed on higher education almost immediately after independence. The country produces about 400,000 graduates in engineering and technology annually and while quality varies, the best institutions such as the Indian Institutes of Technology and the Indian Institutes of Management, are truly world class. Familiarity with English has proved to be another important advantage. These considerations make India a potentially competitive base for investors looking for high level skills at a fraction of the cost in the industrialised world. However, the picture is much less encouraging when it comes to basic education of the labour force. We lag behind in adult literacy and years of schooling. This needs priority attention.

One of India’s major strengths is a long established tradition of private enterprise which flourished even in the period when economic policy strongly favoured the public sector. In those years, Indian entrepreneurs operated in a domestic market where government control limited domestic competition and high protective barriers insulated them from foreign competition. This was not an environment that encouraged entrepreneurship. Industry profited more from its ability to manage the bureaucracy and obtain discretionary benefits of one kind or the other. There has been a major change in the business environment in the past two decades thanks to economic reforms and this has had a powerful impact on the private sector. Indian firms have reoriented themselves to deal with both domestic and foreign competition and many have begun to establish subsidiaries abroad to compete more effectively in a globalised world. Earlier fears that lowering of tariff barriers would swamp Indian industry have been dissipated. Some of the best Indian firms have begun to globalise and have even listed on foreign stock exchanges. They now have substantial foreign institutional stakeholders, who are an important force pushing for greater transparency and better corporate governance.

In recent years, scholars have placed a great deal of emphasis on the role of institutions as distinct from policies in achieving high rates of growth. The relevant institutions in this context are commercial and legal institutions such as the existence of an independent judiciary and the rule of law, the prevalence of acceptable accounting standards, corporate governance practices and stock exchange practices. In a globalising world, these institutional characteristics, sometimes called "soft infrastructure" to distinguish it from the traditional "hard infrastructure" of roads, ports, railways, etc. are an important positive factor, especially for attracting foreign investment. India is well positioned in these areas with institutions patterned on those in the industrialised countries. Their functioning needs to be improved but the basic structures are in place and they are increasingly being benchmarked against best practices internationally.

Finally, economic policies play a central role in determining growth prospects. Their role has probably been exaggerated by economists in relation to the role of institutions, but this is principally because policies can be changed over relatively shorter periods while institutions take much longer to create and to mature. India has seen major improvements in this area as a consequence of a process of economic reforms over the past two decades consciously aimed at helping India to perform more effectively in a globalising world.

The process of economic reforms began in the mid-1980s, following a recognition that India’s performance in the 60s and 70s was below its potential, and that other countries were forging ahead. Rajiv Gandhi was the Prime Minister at the time, and he was keenly aware that East Asian countries were outpacing India. He initiated a restructuring of economic policies towards the industrial sector by liberalising the earlier excessive government controls on private investment, encouraging Indian private companies to expand in scale and induct contemporary technology, and also encouraging foreign investment as a mechanism for technology injection. He was personally convinced of the importance of telecommunications and encouraged the development of computer usage and the software industry, decisions which paid rich dividends ten years later, when India emerged as the most globally competitive emerging market country in software and IT services.

Economic reforms were intensified in the 90s following a serious balance of payments crisis in 1991. The present Prime Minister, Dr. Manmohan Singh, was the Finance Minister at the time, and was the architect of those reforms. The internal liberalisation begun in the 80s was carried further, and was combined with a gradual process of external liberalisation, including lowering of import duties, removal of quantitative restrictions on imports and a major liberalisation of foreign direct investment. The 90s also saw the start of a process of financial reforms aimed at introducing greater competition and tightening prudential norms in the banking sector, stock exchanges and capital market institutions and the insurance sector.

India’s reforms were gradualist in pace. This gradualism is a consequence of the compulsions of India’s highly pluralist and participative democracy. It has the obvious disadvantage that the benefits of reforms take time to surface and this sometimes tries the patience of our friends from around the world. But it has the advantage that it builds a broad consensus in favour of the reforms being attempted thereby giving them greater political sustainability.

The response of the economy to the gradualist reforms provides good reasons for being optimistic about India’s growth prospects in a globalised world. The reforms of the 1980s produced a distinct improvement in economic performance as the growth rate of GDP, which had earlier averaged only around 3.5% accelerated to 5.7% per year. This was not only better than in earlier years, it was also much better than growth rats in Latin America and Africa in the 80s. However, it was far below growth rates achieved in China, which grew at about 8.5% in the 80s, or even Malaysia and Thailand, which grew at 6% and 7.4% respectively.

The intensification of reforms after 1991, including especially the external liberalisation, was expected to push the economy to a distinctly higher growth path. It appeared to do so initially, as GDP growth averaged 7.5% per year between 1993-94 and 1996-97; and India appeared ready to transit to a faster rate of growth but this did not happen. Growth slowed down in the second half of the 1990s and the average growth rate for the 1990s was not very different from that in the 1980s. More recently the growth rate has accelerated to around 6.5%.

There has been much discussion in India on why the reforms of the 1990s did not produce significantly faster growth than observed in the 80s. Some critics have even questioned whether the deepening of the reforms of the 1990s, including especially the liberalisation of trade policy and foreign investment, were at all necessary. In my view the reforms initiated in the 1990s were indeed essential.

The reforms of the 80s had initiated the process of internal liberalisation but they did not address the issue of international competitiveness, which required liberalisation of trade policy and foreign investment. As a result, there was not enough improvement in export competitiveness in the 1980s. The balance of payments remained under pressure and the economy resorted to external borrowing, leading inevitably to a deterioration of external debt ratios. Not surprisingly, a loss of confidence in 1990 precipitated a reversal of debt flows and produced a crisis.

The reforms of the 1990s sought to correct this weakness and they did succeed in this objective. India’s export share in world trade increased from 0.5 % in 1990 to 0.8% in 2002. This figure is modest but I should add that it does not include earnings from exports software and earnings from business process outsourcing, which have become very important in recent years and could not have emerged without the liberalisation of the 1990s. Higher export earnings were supplemented by larger flows of foreign direct investment and investments by foreign institutional investors (FIIs) in the stock market. The inflow from these sources was around $7billion until 2003-2004 when it shot up to $11.6 billion mainly because of FII inflows.

The disappearance of the "foreign exchange constraint" emboldened successive governments to orchestrate a reduction in import duties, albeit at a very gradual pace. There was a brief reversal in the late 1990s, followed by a continuation of the process after 2000. Indian import duties are still too high – nearly three times higher than in China – but the government is committed to bringing them down to levels comparable to East Asia and reductions were implemented in each of the two budgets presented by the present government. Interestingly, Indian industry is no longer alarmed at the prospect. On the contrary, representative industry organisations have publicly recommended a gradual process of duty reduction.

The question why the reforms of the 1990s did not lead to significantly higher rates of growth of GDP remains important. I believe it is not because the reforms were ill conceived but because they were incomplete, especially in one respect which is critical for global competitiveness and that is the provision of infrastructure.

The full version of this article is available in the print edition.

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