How can imports benefit the Indian economy
Liberalization of India
India has effectively decoupled itself from the world market for decades. Its share in world trade has steadily decreased since independence. The focus was on domestic economic development, emphasis was placed on import substitution and exports were neglected. After a balance of payments crisis in 1991, the Indian government initiated a dramatic turnaround in economic policy. For the historian this means an epoch-making decision, the prerequisites and consequences of which are worth investigating, even if the archives do not yet provide any information. Dietmar Rothermund has devoted himself to this task and in a first report after a research stay in India explains the background to the reform policy of the Indian government. This project fits in well with the new focus at the South Asia Institute.
Under British colonial rule, India was subject to the forces of the world market, albeit on terms dictated by the colonial rulers. These worshiped the principles of free trade as long as they were not threatened by competition themselves, after which they switched to a regime of protective tariffs, which was riddled with tariff preferences for British goods. Indian nationalists recognized the negative effects of this regime and called for undiminished protectionism in favor of the local industry. This was only enforced in independent India, whereby in addition to prohibitive protective tariffs, import bans on certain goods were also issued. In addition, during the Second World War the colonial government had set up an instrument of intervention to guarantee the food supply and to buy up Indian industrial products for the needs of the army. These instruments were adopted by India's first Prime Minister Jawaharlal Nehru in order to implement his planned economy ideas. The Indian industrialists, who had made profits through the forced war economy, had already presented a plan for the post-war period in 1944, which recommended a "mixed economy" in which the taxpayer could raise the capital for heavy industry while the private sector devoted itself to the consumer goods industry accepted, which promised a quick return. In this sense, there was a symbiosis of private and state economy. Competition was eliminated by a licensing system because Nehru believed that only rich countries could afford competition, while India had to carefully manage its scarce resources. The administrative apparatus that was taken over by the colonial government, but now staffed with Indian officials, was very happy to take on this task, which brought it additional power. The result was a stable system that guaranteed slow but steady growth. The Indian economist Raj Krishna coined the winged word of the "Hindu rate of growth", the Hindu growth rate, of 3.5 percent per year, which with a population growth of two percent meant around 1.5 percent growth in per capita income per year .
If India had been able to finance its industrialization itself, it would not have been necessary to give up the domestically oriented, planned economy regime, but the import of urgently needed capital goods required foreign exchange, as did the import of oil, which increased rapidly with the progress of industrialization. India had its own oil reserves, but these were only slowly being developed, which in turn required the import of appropriate equipment. India's trade balance was therefore mostly negative. The balance of payments could only be balanced through development aid, loans or the export of labor.
In the early years of industrialization, the suppliers of capital goods were the ardent advocates of government development aid; they by no means pressured India to abolish the planned economy regime that secured them good contracts. As oil imports became more and more expensive, India was able to offset its balance of payments through remittances from the Indian labor force, which poured into the Gulf countries in large numbers. At the same time, the petrodollars that were pumped into the world credit cycle enabled commercial lending on favorable terms, which also lured India into the debt trap. But another factor covered India's need for foreign currency: The foreign Indians parked their money in India, where they collect high interest rates and could withdraw their money at any time because the government guaranteed convertibility.
Already in the 1980s under Indira and Rajiv Gandhi there was a gradual correction of course. It became increasingly clear that India was falling more and more behind in the world context, while elsewhere the "little tigers" made great leaps forward. But instead of first promoting internal competition and removing bureaucratic obstacles, the path of least resistance was taken and the protective walls were dismantled. Economists may argue that this is in fact the most rapid advances made. But imports in India now increased and brought the government in unimagined customs revenues. Since such income exclusively benefits the federal government, this strengthened its financial position vis-à-vis the federal states and at the same time allowed it to inflate the public sector further. The number of people employed in the public sector grew from 15 to 19 million between 1981 and 1991, while the number of people in employment in the private sector only rose from 7.4 to 7.6 million. In addition, of the employees in the public sector, only ten percent work in industry (manufacturing), but 60 percent in the private sector. This means that the inflation of the state sector primarily benefited the service sector, that is to say in plain English: more administrators, bouncers, messengers and so on.
For these reasons, an analysis of the structural change in the Indian economy can give a completely wrong impression. If one refers to the proportions of the primary, secondary and tertiary sectors, the picture emerges of a well-developing “modern” economy that quickly follows the development path known from all industrialized countries. The share of the primary sector (agriculture) in the national product shrank from around 60 to 33 percent between 1950 and 1990, the share of the secondary sector (industry) rose from 15 to around 27 percent and that of the tertiary sector from around 30 to 40 percent. But if one takes into account that around 60 percent of the workforce is still employed in agriculture, one notices the blatant discrepancy between the regrettably low productivity in agriculture and the comparatively high productivity in industry. The service sector, which plays a leading role in the modern industrialized countries but offers a wealth of different jobs outside of the public service, is largely controlled by the state in India. The tariff revenues enabled the government to leave everything as it was, and even to add to the old mistakes. However, further “progress” in this direction was slowed down by a political crisis that escalated into a balance of payments crisis.
After gaining independence, the National Congress that had emerged from the struggle for freedom had become a state-sponsoring and state-sponsored party. The majority vote in India worked in favor of the Congress Party, as left and right opposition always beat each other out of the field. Only in 1977 was there a combination of oppositional forces and Indira Gandhi was defeated. But these forces soon fell out again, and Indira Gandhi came to power again in 1980. After she was murdered in 1984, her son Rajiv won the quick elections with a large sympathy bonus. In the five years of his reign he lost this sympathy. It turned out that he could not cope with the "side entry" into Indian politics. Again there was a combination of oppositional forces. Their efforts were enough to defeat Rajiv Gandhi in 1989, but not to form a government that could find a majority in parliament. Tolerated minority governments, which were very limited in their ability to act, now dominated the field. The political instability lowered India's creditworthiness, and the Gulf War also inflicted severe damage on India because the Indians working in Kuwait had to be evacuated in a flash and their remittances could no longer be expected.
In a conversation with Indira Gandhi in 1981, when I asked whether she was afraid that an unexpected crisis in the Gulf region could hit India hard, she replied: “The Arabs need us” and thus wiped all concerns off the table. Nine years later the question became very topical, and India was indeed hard hit. As India drifted towards national bankruptcy, the foreign Indians also withdrew their funds, making the balance of payments crisis inevitable.
In India, at the time the crisis was worsening, the election campaign was in full swing. Rajiv Gandhi was assassinated in the middle of the election campaign in May. Once again, his party probably benefited from a sympathy bonus. The Congress Party only narrowly missed the majority and had to form a minority government again, but tolerating it was unproblematic because at that time no one could be interested in new elections. The new Prime Minister P.V. Narasimha Rao, so to speak, fled to the front and opted for a liberalization program that completely corresponded to the ideas of the World Bank and the World Monetary Fund. He appointed Dr. Manmohan Singh as Minister of Finance, who himself was a World Bank official. Singh guaranteed that India would meet the requirements that these institutions place on large-scale loans. In this case, these conditions were not even mentioned. India should not lose face, and the reputation of the finance minister ensured that the usual conditions were met. He promptly devalued the currency by 18 percent and vigorously campaigned for a reduction in the budget deficit. Since India had regained its creditworthiness in this way, the funds of the foreign Indians also flowed back to India, which soon had considerable foreign currency reserves at its disposal, but it did not rest on this cushion. The government, so to speak, took advantage of the crisis to take measures that had previously lacked political courage. Foreign entrepreneurs were allowed to acquire majority shares in Indian companies, and possibly even to own them in full. The privatization of public sector companies was promoted. The state budget was balanced as much as possible, and the grip on the treasury of the state-owned Reserve Bank of India was reduced, because this grip inevitably meant cranking the money press and thus fueling inflation.
Unfortunately, the skid marks caused by this financial policy soon became apparent. The federal government cut its transfer payments to the federal states and also called on them to cut their expenditure in line with budgetary discipline. They did that too, but not in the areas in which it was necessary (administrative expenses, civil servants' apparatus), but in those in which it was most easily possible (education, health care, social benefits). There were also slowdowns in investment, and Indian industry experienced a certain recession from 1991 to 1993, which it escaped fairly quickly. Only the expected foreign direct investment has not yet flowed into the country to the expected extent, but speculative investors (for example American pension funds, which have to invest billions of euros at low prices) pushed into the Indian stock market. This resulted in dependencies that dwarfed those of foreign Indians. The money from smaller overseas investors, which would make the stock market more stable, simply cannot handle the antediluvian, nationalized Indian banking system. This can only be remedied by rapid privatization and modernization of these banks.
However, the pace of liberalization slowed down after 1993. The time when the favor of the crisis spurred the courage to act was over. State elections indicated that the electorate had noticed the skid marks, but not yet the advantages that the new economic policy brought with it. The government was afraid of its own courage, which can already be seen in a remarkable linguistic rule: the word liberalization was avoided as much as possible and only economic reforms were spoken of. All sorts of populist measures were taken that were poorly thought out and coordinated. It was all about impressing the voters. But the failure of the Congress party in the May 1996 elections shows that this goal has obviously not been achieved. The new government will now have time after the elections to resume the reform course, and it will benefit from the fact that no party is fundamentally opposed to this course. From the leaders of the right-wing Bharatiya Janata Party to Jyoti Basu, the communist prime minister of Bengal, all political forces are in favor of liberalization. However, as is well known, the devil is in the detail, which is why we would like to conclude here with a few problems that await a solution.
The reform policy to date has largely been limited to macroeconomic decisions that were undoubtedly urgently needed, but will not have sufficient effect without appropriate institutional reforms. Only a few questions should be mentioned here which concern the attitude of the state towards the agricultural market, the labor market and the fight against poverty. The intervention of the state in the agricultural market had taken on almost absurd features, which cannot easily be corrected because the peasants defend the absurdities in question in the interests of safeguarding the vested interests. About a sixth of the entire grain harvest is bought up by the state every year, then hoarded, so to speak, in the public interest, and finally distributed over 400,000 “fair price shops”. The state procurement price is often higher than the market price. In this way, the farmers have a sales guarantee, not at low prices, but at maximum prices. The "hoarding" is costly, the stored grain is eaten to a large extent by rats, but is also embezzled by employees of the relevant state storage company (Food Corporation of India). The "fair price shops" are supposed to give the grain to the poor at cheap prices, but it is difficult to effectively deny the wealthy access to these shops. Since the government did not want to abolish the system with the stroke of a pen, it let the prices in the "fair price shops" rise until they almost reached the market price, thus the demand decreased and the government is now sitting on a monstrous stockpile of about 36 Million tons of grain. Even if you only sold a fraction of it on the world market, it would be completely ruined. India needs a supply of around ten million tons for times of emergency, and the advice of the World Bank and the International Monetary Fund to build up a cash reserve instead, with which the grain could be procured on the world market, should rather not be followed. Zimbabwe has had bad experiences with this recently. But the existing system in India urgently needs to be reformed.
Labor market policy is also in need of reform. Her goal so far was to keep every job, even if it turns out to be completely unproductive. Many entrepreneurs have left their "sick industries" in the lap of the government, which continues to operate them at a loss. The private entrepreneurs have reacted to this labor market policy by employing as few workers as possible and preferring to buy expensive machines that save jobs. This is completely inappropriate behavior for India, but for the entrepreneurs it is perfectly rational under the circumstances. Another reaction to the labor market policy is the outsourcing of production to suppliers in the “unorganized” sector, that is, small businesses with fewer than ten workers that can be laid off without difficulty. These micro-enterprises also do not have a works council and are largely beyond state control. Here there are downright early capitalist conditions, but this mode of production naturally contradicts the rule that larger companies can produce more cheaply through large numbers. Institutional conditions distort the market, but the “disorganized” sector is thriving. It was thought that, in the wake of liberalization, the workforce would increase in the organized sector and decrease in the unorganized sector, but the opposite is true. As long as liberalization does not fully penetrate the labor market, it cannot be expected otherwise.
The main problems arise with government measures to reduce poverty. The poor are mostly in agriculture (landless farm workers) or in the “unorganized” sector, or they are simply unemployed. It is almost impossible to record their number even approximately correctly. The debates about the proportion of the population living below the poverty line are mostly mirror-fencing. The government claims it is only 19 percent of the population. Critics put the number far higher. In addition, the poverty line in India is drawn according to criteria of food intake, other basic needs such as clothing and housing are largely neglected. If you were to include them, around 50 percent would surely live below the poverty line. The government is fighting poverty primarily through job creation schemes, on which vast sums of money have been spent. Critics emphasize that a maximum of 15 percent of these amounts actually reach the poor and complain that the work done usually does not add value, but is useless. It is better, therefore, to provide the poor with money directly. A new National Social Assistance Scheme provides direct social assistance to the elderly, the sick, needy mothers and families whose only working member has died. This could prove to be a promising approach, especially if the distribution is done through local self-governing bodies. So far, the government has hardly given any thought to how social assistance can be sensibly designed and coordinated. Programs were mostly announced ad hoc and inadequately carried out, but the money definitely got among the people, if not among the poor people. The doctrine that the best way to fight poverty is still to promote economic growth is certainly correct, but social corrections are necessary because the gains in prosperity in the course of liberalization are concentrated in the hands of the already privileged classes.
Prof. Dr. Dietmar Rothermund, South Asia Institute, History Department, Im Neuenheimer Feld 330, 69120 Heidelberg,
Telephone (06221) 54 89 09
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