The dark side of the moon: the Indian Economy

The Indian economy is characterized with a breakneck growth, leading outsourcing industry in the world and hundreds of millions of potential consumers demanding more comfort and class. The growth seen in the past 3-4 years is unprecedented and reason of envy for many countries. But now, after three years of near double-digit growth, signs of a potentially dangerous inflationary spiral are beginning to emerge. The economists were questioning the sustainability of growth for some time and it seems that they have won the first round. They are suggesting that India’s growth is not structural but cyclical in nature.

The Indian economy has recently been notching up some of the highest growth rates in the world but what is truly miraculous is the path that India has followed. This path is not followed by any other country in the world and no proven economic model can explain this. The India economy is based on domestic consumption rather than exports and it has a competitive advantage in services rather than in manufacturing. No country in the world has grown by expanding its services first and this is the reason why economists are worried.
A study was conducted in 2006 by IMF chief Mr. Raghuram Rajan and four other economists, titled ‘India’s Pattern of Development: What happened, what follows’. The most important finding of the study was that India has started behaving like the industrial countries at nearly quarter or 1/5th of their income levels. Moreover, India has skipped the manufacturing sector and moved directly to the services sector. This is in stark contrast to the path followed by the East Asian countries in 1960s and 1970s.

China was a late industrialized country like India and China is still promoting labour intensive industries and manufacturing. On the other hand, India has moved away from the labor intensive industries in the part 2 decades and is showing inclination towards skill intensive industries. The driving engine of Indian economy is services which contribute about 60% of the total GDP but only 25% of the population is dependent on the services. Agriculture sector contributes about 20% of the GDP and about 60% of the population depends directly or indirectly on it. There is mass unemployment or disguised unemployment in agriculture sector and that will eventually led to retardation in growth. Thus it is doubtful that the small base of services will eventually bring a structural change in the Indian economics without uplifting the primary sector. The historical evidences also suggest that all the industrialized countries have developed their agriculture sector first for long term sustainability of economic growth.

The East Asian economies followed an export led growth model that focused more on investment and export promotion whereas Indian economic growth is driven by domestic consumption growth. The huge middle class population of India has discovered a new appetite for consumption and India’s consumption as a percentage of GDP places it at second spot in the world after US.

Another exception that marks the India’s growth story is the low rate of savings (approximately 29% of GDP). Most of the developed countries and China (50% of GDP) had a higher rate of savings which they invested to generate more surplus.

The policy makers also need to realize that India needs to address some of the fundamental issues like bad infrastructure, primary education and health services in order to sustain the present growth rate. Over the years, government has realized the importance of world class infrastructure and is investing in projects like Golden Quadrilateral and developing Special Economic Zones (SEZ) but the outcomes of these investments is yet to be seen.
India has a huge working population and it is expected that India will have the largest working population in the world by 2040. But the fundamental question which remains unanswered is the relative and required skill level of the future work force. Since India is growing more in services sector which is skill intensive, skills and education of the workforce is a critical success factor. Even labor-intensive unskilled manufacturing requires a skilled supervisory and managerial force. Despite the large numbers of graduates emerging from universities in India, the number of graduates with the skills to work in industry or the service sector is relatively limited. With the immense demand for skilled workers in the export-oriented services industry, wages of skilled workers have been going up very fast. Given the extremely competitive situation in (typically tradable) labor-intensive industries, highly paid supervisory skilled workers are affordable only if they are used very economically relative to the use of unskilled labor–if, for example, firms have scale.

In summary, tremendous economic opportunities have been unleashed by the changes since the early 1980s. The changes include the move toward pro-business and pro-market economic policies and economic and political decentralization. However, pre-existing patterns of specialization in favor of skill-based production—have unleashed the gale winds of divergence, big time. India needs to bring reforms to invest in the primary sector and in primary education so as to develop the work force. Even if the needed reforms were to occur, there is a possibility that powerful forces emanating from the common market for resources could slow convergence. If they were to do so, India will have to brace itself for a lot of social churning as people move not just in search of jobs but also in search of acquiring the human capital to become employable. How India reacts to, and shapes, these forces may well be the biggest economic question India faces over the next few decade.

References

1.http://www.nytimes.com/2007/02/10/business/worldbusiness/10overheat.html?pagewanted=1&ei=5088&en=08a5a2259c138646&ex=1328763600&partner=rssnyt&emc=rss

2. www.imf.org/external/pubs/ft/wp/2006/wp0622.pdf

3. www.worldbank.org/mdf/mdf1/learn.htm

4. strategis.ic.gc.ca/epic/site/eas-aes.nsf/vwapj/op23e.pdf/$FILE/op23e.pdf

5. wbro.oxfordjournals.org/cgi/reprint/5/1/1.pdf

6. http://blogs.wsj.com/informedreader/2007/02/02/is-indias-economy-overheating/

7. http://economist.com/opinion/displayStory.cfm?Story_ID=E1_RGNJVPD

8. www.usindiafriendship.net/viewpoints1/Indias_Rising_Growth_Potential.pdf