India’s Modi Moment

May 26, 2014 --

One in every six people on the planet lives in India. At some point in the next 15 years, the country will pass China to become the world’s most populous nation. India has also passed Japan to become the world’s third largest economy, based on purchasing power parity exchange rates (according to a recent World Bank analysis, on which we commented here).

Despite its absolute size, in per person terms India’s economy is much smaller. Its per capita income last year (at market exchange rates) was only about $2,000: less than one-third China’s $7,000, and only about 4 percent of America’s $53,300. Thus the paradox of India’s economy: in some ways so important, yet in others so far behind. This paradox accords with the famous quote of Cambridge University economist Joan Robinson, “The frustrating thing about India is that whatever you can rightly say about India, the opposite is also true.”

One man now stands with great potential to sweep aside this paradox: Narendra Modi. In the country’s just-concluded national election, Indians handed Modi’s National Democratic Alliance a resounding parliamentary victory—the largest lower-house majority in 30 years. With such overwhelming support Modi, who is scheduled to be sworn in as prime minister today, has the potential to launch India on a much-needed new era of economic reform.

In the four decades following India achieving independence in 1947, the country struggled under the burden of highly protectionist and interventionist economic policies. For decades India’s economy grew at only about 3 percent per year; in per capita terms, annual growth was often well below 1 percent. Wise minds concluded that India was destined to always suffer this “Hindu rate of growth.”

Then came crisis. In 1991 a fiscal and currency crisis befell the country; to help stave off default, India was forced to ship 47 tons of gold to the Bank of England as collateral on a loan. Large loans were also required from the World Bank and International Monetary Fund, and as conditions for some of these loans Indian leaders initiated reforms to introduce more market forces—including more international market forces via, for example, trade liberalization. These reforms accelerated economic growth, to an average annual rate of about 7 percent over the next generation, driven by globally connected industries such as information-technology services.

But growth over the past three years has slowed sharply, to under 4.8 percent. A major reason for this deceleration has been a slackening of economic deregulation and reform. High-profile examples abound. Two years ago government leaders gave themselves authority to pursue retroactive tax claims against multinational companies going back to 1961—and thus have launched nasty disputes against firms including Vodafone and Microsoft. Similarly, in 2012 the government announced plans to permit inward foreign direct investment in general-merchandise retailing—but then reversed this decision in response to protests from local incumbents. In the World Bank’s annual rankings of how easy it is to do business in countries, India today scores 134th out of 189. In the sub-categories of “starting a business,” “dealing with construction permits,” and “enforcing contracts,” India ranks a woeful 179th, 182nd, and 186th, respectively.

The conditions underlying these rankings discourage foreign investment, stifle entrepreneurship, and more generally slow economic growth and its related expansion of opportunity and hope. A McKinsey analysis published earlier this year shows that 56 percent of India’s population—almost 700 million people—“lacked the means to meet essential needs.”

Recognizing the errors of his predecessors, Modi ran on a platform summarized as “less government and more governance.” He comes from the state of Gujarat, where during the decade in which he served as chief minister the economy expanded at an average annual rate of 10.3 percent. Thanks to Modi and others, during that time Gujarat curtailed or outright eliminated many of the country’s restrictive labor laws. Bringing these reforms to an entire country, says a new report from Goldman Sachs, could spur creation of as many as 40 million new manufacturing jobs over the next decade. Modi has also wisely said that a top priority will be upgrading the country’s creaky infrastructure of roads, ports, and the like. The slow pace at which people and products move around the country is a hidden tax on its growth.

A more prosperous India would benefit the hundreds of millions of Indians still struggling to escape the clutches of poverty. It would also be a shot in the arm for the global economy, for reasons including a rising middle class keen to consume the world’s branded goods and services. Prime Minister Modi has a rare opportunity to implement sweeping economic reforms. He needs to make the most of his moment.

Articles © 2014 Matthew Slaughter and Matthew Rees. All rights reserved.
Publication © 2014 Trustees of Dartmouth College. All rights reserved.