The India Model

Gurcharan Das

From Foreign Affairs, July/August 2006

Summary:  After being shackled by the government for decades, India's economy has become one of the world's strongest. The country's unique development model -- relying on domestic consumption and high-tech services -- has brought a quarter century of record growth despite an incompetent and heavy-handed state. But for that growth to continue, the state must start modernizing along with Indian society.

GURCHARAN DAS is former CEO of Procter & Gamble India and the author of India Unbound: The Social and Economic Revolution From Independence to the Global Information Age.

AN ECONOMY UNSHACKLED

Although the world has just discovered it, India's economic success is far from new. After three postindependence decades of meager progress, the country's economy grew at 6 percent a year from 1980 to 2002 and at 7.5 percent a year from 2002 to 2006 -- making it one of the world's best-performing economies for a quarter century. In the past two decades, the size of the middle class has quadrupled (to almost 250 million people), and 1 percent of the country's poor have crossed the poverty line every year. At the same time, population growth has slowed from the historic rate of 2.2 percent a year to 1.7 percent today -- meaning that growth has brought large per capita income gains, from $1,178 to $3,051 (in terms of purchasing-power parity) since 1980. India is now the world's fourth-largest economy. Soon it will surpass Japan to become the third-largest.

The notable thing about India's rise is not that it is new, but that its path has been unique. Rather than adopting the classic Asian strategy -- exporting labor-intensive, low-priced manufactured goods to the West -- India has relied on its domestic market more than exports, consumption more than investment, services more than industry, and high-tech more than low-skilled manufacturing. This approach has meant that the Indian economy has been mostly insulated from global downturns, showing a degree of stability that is as impressive as the rate of its expansion. The consumption-driven model is also more people-friendly than other development strategies. As a result, inequality has increased much less in India than in other developing nations. (Its Gini index, a measure of income inequality on a scale of zero to 100, is 33, compared to 41 for the United States, 45 for China, and 59 for Brazil.) Moreover, 30 to 40 percent of GDP growth is due to rising productivity -- a true sign of an economy's health and progress -- rather than to increases in the amount of capital or labor.

But what is most remarkable is that rather than rising with the help of the state, India is in many ways rising despite the state. The entrepreneur is clearly at the center of India's success story. India now boasts highly competitive private companies, a booming stock market, and a modern, well-disciplined financial sector. And since 1991 especially, the Indian state has been gradually moving out of the way -- not graciously, but kicked and dragged into implementing economic reforms. It has lowered trade barriers and tax rates, broken state monopolies, unshackled industry, encouraged competition, and opened up to the rest of the world. The pace has been slow, but the reforms are starting to add up.

India is poised at a key moment in its history. Rapid growth will likely continue -- and even accelerate. But India cannot take this for granted. Public debt is high, which discourages investment in needed infrastructure. Overly strict labor laws, though they cover only 10 percent of the work force, have the perverse effect of discouraging employers from hiring new workers. The public sector, although much smaller than China's, is still too large and inefficient -- a major drag on growth and employment and a burden for consumers. And although India is successfully generating high-end, capital- and knowledge-intensive manufacturing, it has failed to create a broad-based, labor-intensive industrial revolution -- meaning that gains in employment have not been commensurate with overall growth. Its rural population, meanwhile, suffers from the consequences of state-induced production and distribution distortions in agriculture that result in farmers' getting only 20 to 30 percent of the retail price of fruits and vegetables (versus the 40 to 50 percent farmers in the United States get).

India can take advantage of this moment to remove the remaining obstacles that have prevented it from realizing its full potential. Or it can continue smugly along, confident that it will get there eventually -- but 20 years late. The most difficult reforms are not yet done, and already there are signs of complacency.

A 100-YEAR TALE

For half a century before independence, the Indian economy was stagnant. Between 1900 and 1950, economic growth averaged o.8 percent a year -- exactly the same rate as population growth, resulting in no increase in per capita income. In the first decades after independence, economic growth picked up, averaging 3.5 percent from 1950 to 1980. But population growth accelerated as well. The net effect on per capita income was an average annual increase of just 1.3 percent.

Indians mournfully called this "the Hindu rate of growth." Of course, it had nothing to do with Hinduism and everything to do with the Fabian socialist policies of Prime Minister Jawaharlal Nehru and his imperious daughter, Prime Minister Indira Gandhi, who oversaw India's darkest economic decades. Father and daughter shackled the energies of the Indian people under a mixed economy that combined the worst features of capitalism and socialism. Their model was inward-looking and import-substituting rather than outward-looking and export-promoting, and it denied India a share in the prosperity that a massive expansion in global trade brought in the post-World War II era. (Average per capita growth for the developing world as a whole was almost 3 percent from 1950 to 1980, more than double India's rate.) Nehru set up an inefficient and monopolistic public sector, overregulated private enterprise with the most stringent price and production controls in the world, and discouraged foreign investment -- thereby causing India to lose out on the benefits of both foreign technology and foreign competition. His approach also pampered organized labor to the point of significantly lowering productivity and ignored the education of India's children.