Archive for June 25th, 2007

Transforming India

June 25, 2007

That is the title of the paper written by Arvind Panagriya (AP) and the paper is very well written. The solutions are the same, it is the presentation of the paper which makes it stand out.He starts off the paper by dividing India’s growth pattern in 4 phases:

1951-65 :  4.1% 
1965-81: 3.2%
1981-88: 4.8%
1988-04: 6.1%

And during the last three years i.e. from Apr 2003 to Mar 2006 the average growth is 8.1% ( if you add the latest CSO estimate of 9.4% then in last 4 years the average has been 8.75%). The question is whether this increase in growth rate is a business cycle phenomenon (means temporary) or a shift in the long term growth rate (means permanent)? AP says he is more convinced that it is the latter. His reasons are:

  • Trade and foreign investment expansion and therefore integration into the world economy in the current phase has been much more rapid and deeper.
  • The exchange rate in the current phase has been either stable or has appreciated. This has meant a very rapid growth in the GDP in dollar terms when converted at the market exchange rate. Given very large stock of foreign exchange reserves of $165 billion on August 11, 2006, prospects of a large depreciation are extremely low. What this means is that the expansion in the dollar value of the GDP achieved will sustain itself.
  • After three consecutive years of 7 percent plus growth, the previous phase (1993-97) saw growth rate plummet to 4.8 percent in 1997- 98. The current phase has so far shown no sign of slowing down. According to all available projections, despite natural calamities and therefore very low agricultural growth, the GDP growth in 2006-07 is expected to hit the 8 percent mark.

I do not find the reasons very conclusive. Need to look at additional literature.Anyways, the growth story’s salient features are:

  • Despite the shift most of the employment is still in agriculture. In 1999-00, 
                                 Share in GDP        Share in Employment
    Agriculture                 25.3                              60.3
    Industrial                    19.5                              11.9
    Services                      65 .2                              27.8

Industrial includes Mfg., Mining and Electricity Sector. Mfg contributes 15% of GDP & 11.0% of employment. Services include Construction, Hotels, Transport, Financial Services and Social Services. In Services, Financial services contributes 13% to GDP but its share in employment is just 1.2%

  • So, the transition from agriculture to other sectors has been very low.
  • The most interesting table is on Page 20, which divides the employment % into organised and unorganised labour. It says that outside of agriculture, as much as 88 percent of the labor force continued to be in the informal sector in 1999-00 though the output generated there was only 44 percent. Within manufacturing, 94 the informal sector though only 39 percent of the manufacturing output originated there.

And then AP revisits (albeit in brief) India- China debate and says China liberalized much more than India did and hence has a different growth pattern. The reason why China grew faster was that it allowed manufacturing of unskilled labour-intensive products on a large scale and India limited their production by reserving these items for small-scale industry.

As most would know, India moved from agriculture led growth to services one where as most countries first move to manufacturing sector and then to services. The large-scale firms in India had a preference for capital intensive goods and did not want to move into unskilled labour-intensive sectors.  

Now, both services and industries require educated/skilled workforce and India lacks way behind on this front. Hence, initially, there is a need to move the surplus labour in agriculture to these low skilled jobs which the former can adapt to in a much more easy manner. The reforms so far have not been very friendly for such kind of production.

This is the basis of AP’s idea, which he very neatly summarizes as:  

Therefore, the challenge of transformation facing India is that of creating an environment that allows unskilled-labor-intensive manufacturing to grow rapidly and rise as a proportion of the GDP. On one hand, such growth would pull workers from agriculture into gainful employment more rapidly than is the case currently while on the other it will reduce the burden of labor on the land. Wage in agriculture would also rise faster than in the absence of rapid expansion of unskilled-labor-intensive manufacturing. Some have argued that the transformation to the modern economy need not require a switch to manufacturing. After all, according to the traditional growth pattern, once manufacturing reaches a certain stage, its share does decline and that of services rises. India could simply skip the transitional stage and directly jump to the final stage of specialization in the services sector.

The flaw in this argument, however, is that if the workers are to be employed in the formal-sector services, they must be given college education. But the vast majority of the farm workers that need to be moved into the formal sector of the economy lack even high school level education. Moreover, given the countrywide gross college enrollment ratio (the number of individuals in college as a proportion of the population in the 18 to 24 years age group) of 14 percent and relatively poor prospects for further expansion of higher education, prospects that a large proportion of the population can be imparted college education in the next two decades are extremely poor.

It makes some sense in another way. With increasing liberalisation, the sectors/industries that are out of favour would have large number of idle labour. Without jobs, this already constrained section would face enormous difficulties and hence resentment against government etc. Now, it is difficult for these people to move to high-specialised jobs right away and would need to earn a living first. These kinds of low skilled jobs would definitely help relocate this section of population. It looks like a good policy suggestion.

However, what would be needed to achieve growth in this sector- labour market reforms and infrastructure. 😦 Things never seem to end. 

Nevertheless, a very good paper with a very fresh perspective. A must read for new insights on Indian economy.

Assorted Links

June 25, 2007

1. Robert Barro says Bill Gates has done more for business world than he can do for philanthropy. Thanks to Greg Mankiw for the pointer.

2. Doha Round has collapsed. Comments from Dani Rodrik New Economist 

3. Myron Scholes (of Black-Scholes fame), seeking a licence  to advice Japanese Pension Funds. Thanks to Finance Professor for pointer.

4. Finance Professor points out to various links that talk about Bear Sterns bailing out its hedge funds.

5. A nice debate looking at reasons behind rise is US bond yields. Thanks to WSJ Blog

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