Strategies for development - I

By Nirupam Bajpai

IN HIS address to the nation from the ramparts of the Red Fort, the Prime Minister, Mr. Atal Behari Vajpayee, announced on August 15, 2000, that the Government had set a target of doubling India's per capita income by 2010. This is an ambitious target, but certainly achievable. For this, India needs growth in GDP per capita of 7 per cent a year over the next ten years. And to achieve this growth rate on a sustained basis, India needs a well-focussed growth strategy. While India made substantial progress in market reforms during 1991-2000, much remains to be accomplished in the months and years ahead.

Economic growth is primarily based on three main factors: (1) accumulation of the factors of production, including both human and physical capital; (2) efficient allocation of resources within the economy; and (3) improvements in technology over time. In current economic jargon, the poorer countries can expect to ``converge'' with the richer countries in per capita income levels. Convergence occurs mainly because of the first and third factors in growth. But convergence can be achieved only when there are effective economic and governmental institutions supporting rapid capital accumulation, efficient allocation of resources, and rapid diffusion of technology from the more advanced economies.

Perhaps the most critical feature of fast-growing economies has been the rapid rise of manufacturing exports. This has been supported by trade policies that have allowed manufacturing exporters to operate at (nearly) world prices, both for inputs of capital and intermediate goods, and for the sale on world markets. All fast-growing economies, for example, avoid trade policies that undermine the capacity of manufacturing exporters to obtain necessary inputs at world prices, or that penalise exporters through heavy taxation (effective taxation of exports can arise through: tariffs and quotas on inputs, inconvertibility of the currency, state monopolisation of exports on unfavourable terms for exporters, or explicit taxation of exports).

The exact form of the trading regime has differed across countries, but the following elements have been common features in most of the fast-growing economies: (1) convertibility of currency for current account transactions; (2) zero or low tariffs (and the absence of licensing) for capital goods and intermediate inputs, and modest tariffs for most consumer goods; (3) implicit or explicit subsidisation of exports; and (4) other institutions supportive of manufacturing exports (e.g. export processing zones, state guarantees on export credits). High growth economies have been quite open to trade both for imports and exports, especially in comparison with other developing countries. Industrial policies, where they exist, have supported manufacturers not mainly through the protection of the home market, but through the subsidisation of export activities.

Openness, and the orientation to manufacturing exports, has made several contributions to growth. First, it has helped ensure the efficient allocation of resources, through specialisation, comparative advantage, and dynamic learning by doing. Second, openness has promoted domestic competition by limiting the market power of domestic firms, and by providing a rigorous international yardstick of performance. Third, openness has promoted the rapid accumulation of capital through foreign borrowing and foreign direct investment, which is then serviced by the rapid expansion of exports. Fourth, openness has promoted the rapid improvement of technology through the import of foreign technologies. Technology may be imported directly through merchandise trade (e.g. in the form of machinery embodying a new technology), or it may come via FDI. In either case, openness has greatly enhanced the domestic economy's awareness of, and access to, technological advances in the rest of the world.

India's average tariff rate of 27 per cent vastly exceeds the average tariff rates of the other economies. India also displays continuing high barriers to FDI in contrast to most of the fast- growing Asian economies. It is true that not all of East Asia relied heavily on FDI to achieve rapid growth: Japan and Korea are the two main exceptions. But most of the region, especially in South East Asia, has relied heavily on FDI, and the East Asian countries tend to have much simpler rules for FDI approvals than are now in place in India.

Common features, such as currency convertibility, moderate tariffs, strong private sector orientation - rather than specific industrial policies - are behind the widespread successes in the fast growing economies. While high performing economies have differed widely in the scope and ambition of industrial policy, a few institutions of industrial policy have been widely applied, and deserve a sympathetic look. Most importantly, virtually all of the East Asian countries have used export-processing zones (EPZs) or other special economic zones (SEZs), to help attract foreign investment and to initiate the process of manufacturing export-led growth.

These zones have not aimed to pick ``winners'' in the classic sense of industrial policy. Rather, they have attempted to carve out a geographical zone in which export-businesses can conduct profitable activities, exempt from costly regulations, tax laws, and labour standards that apply within the country. More generally, the relatively successful industrial policies have had a few common characteristics: (1) they have aimed to promote exports, rather than to protect the domestic market; (2) they have provided subsidies on the basis of successful performance (e.g. the growth of exports) rather than to cover losses; and (3) they have been temporary rather than permanent subsidies (e.g. a five-year tax holiday for new export firms).

The Chinese experience could hold lessons for India. While the non-state Chinese economy operates without many of the legal underpinnings of a more advanced market economy, it is at least subject to strong market forces, international trade, and low taxation that are the hallmarks of the fast-growing market economies. Despite appearances, India is probably less market oriented than China at this point, though China's state sector is somewhat larger than India's. Measured by output, the share of state-owned enterprises (SOEs) in the Chinese economy has declined, from 75 per cent in the late 1970s to about 28 per cent in 1999, but SOEs still account for some 44 per cent of the economy's urban employment, and for as much as 70 per cent of Government revenues. Virtually all of China's heavy industry is in the hands of SOEs, which use up most of China's stock of capital, but more importantly produce little in return.

In China, the non-state sector is relatively unconstrained by Government regulation while in India, the non-state sector or the private sector continues to be tied down by extensive regulations that hinder dynamic development. Deregulation of India's private sector is the key if India is to attain and sustain high rates of economic growth. The Government of India announced two major reform initiatives in the budget for 2001/02. These are de- reservation of 14 products having export potential, such as leather, toys and shoes from the list of products reserved for the small-scale industry and reform of labour laws, that is, the Industrial Disputes Act. It remains to be seen, however, whether the Government is successful in implementing them.

(The writer is a Research Fellow at the Center for International Development, Kennedy School of Government, Harvard University, and the Director of the Harvard India Program)

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