The Hindu Business Line : Looking at long-run economic growth

The current focus on annual and even quarterly growth rates diverts attention from the longer-run processes of change in the India economy. In this edition of Macroscan, C. P. Chandrasekhar and Jayati Ghosh take a look at a long er time period to understand the basic forces behind growth and stagnation.

IT HAS now become fashionable — possibly for political/electoral reasons — to be obsessed with the latest growth estimates for the year, or even the quarter, as projected by the Quick Estimates of national income of the CSO. But these estimates tell us relatively little about the real patterns of growth and change in the economy. They are also projections which are usually modified substantially when the `revised' estimates are declared, and altered even further by the time the `final' estimates are published.

In any case, these annual fluctuations may even conceal more long-run changes in the economy. One of the more important questions thrown up by looking at long run growth is: What caused the shift from the so-called "Hindu rate of growth" of economic activity, of around 3.5 per cent per annum, to the higher rates of around 5.6 per cent per annum from the 1980s onwards?

That such a shift definitely occurred, somewhere from the late 1970s, is evident from Table 1, which provides decadal rates of growth since the early 1950s. The table presents compound rates of growth for the average of three-year periods mentioned, for gross domestic product (GDP) and per capita net national product (NNP) at constant 1993-94 prices. It is evident that real GDP growth rates increased to a higher level in the latter two decades. Increases in per capita income were even more marked because of the fall in the rate of population growth.

As Table 2 shows, this has been associated with some amount of structural change, although perhaps not as much as might be expected. Investment rates have increased over time, which is only to be expected in a developing economy achieving higher rates of per capita income, but the rate of increase actually slowed down;, until the last decade there was almost no change in the investment rate.

Meanwhile, the share of agriculture in GDP has fallen along predictable lines in the course of development, but there has been little increase in the share of the secondary sector, which has not changed at all since the early 1990s. Rather, the share of the tertiary sector has increased dramatically to the point where it now accounts for around half of the national income.

Such change in output shares has not been accompanied by commensurate changes in the distribution of the workforce. The proportion of all workers engaged in agriculture as the main occupation has remained stubbornly above 60 per cent, despite the collapse in agricultural employment generation of the most recent decade. It is intriguing that the higher rates of investment have not generated more expansion of industry, but have instead been associated with an apparent explosion in services, which constitutes a very heterogenous category.

The past three decades in the Indian economy deserve more careful scrutiny. By the early 1970s, the crisis of the dirigiste state was already apparent, and there were various pressures building upon the import-substituting strategy of the earlier decades. The oil shock of 1973 added to domestic inflationary pressures to create the dramatic increases in prices of the period 1973-75, which was also a time of much enhanced socio-political unrest in the country.

Chart 1 indicates the price volatility in the early 1970s, which has not been experienced with such intensity in any later period. It also shows that the reduced rates of inflation were a feature of the 1980s as much as the most recent decade. This is noteworthy because worldwide rates of inflation were not as low in the 1980s as they were in the 1990s, and so the control over inflation essentially reflected changes in the Indian economy. So what enabled the recovery and growth of the 1980s, and what allowed the model of public sector-led expansion to continue for some more time without generating higher inflation? One important reason was of course the import liberalisation which began for a range of intermediate goods and components from the early 1980s, and was intensified in the mid-1980s, and allowed the economic expansion to occur without higher inflation.

Chart 2 suggests that a role could also have been played by the inter-sectoral terms of trade. The first half of the 1970s marked a peak in terms of the relative price of agricultural goods, but after 1977, and through to around 1985, such a tendency was effectively contained and the domestic terms of trade were generally favourable for industrial expansion.

In turn, this pattern of the terms of trade can be partly explained by the fact that world agricultural prices were declining over the 1980s. But what was more significant was that growth after 1980 in the Indian economy generated much less employment than before, and therefore implied much less demand for food than would have been the case with more employment-intensive expansion.

Thereafter, from the mid-1980s, it is worth noting that for about a decade Indian agriculturalists were relatively protected from the international movement of terms of trade against primary products. The liberalisation of imported manufactured goods that started from the 1980s also played a role in ensuring that terms of trade did not move against agriculture from the mid-1980s. The domestic relative prices continued to be favourable for cultivators until the late 1990s, when trade liberalisation exposed farmers to declining world prices.

In the first two decades after Independence, a leading role in economic growth was played by public investment, which had strong positive linkages with private investment in both agriculture and industry. Chart 3 shows that public investment as a share of GDP continued to increase over much of the 1980s (although it peaked in 1986-87), and this no doubt acted as a positive stimulus to private investment over this period. However, after 1987, public and private investment trends diverged quite sharply. Public investment declined quite sharply as a share of GDP, falling back to the levels of the early 1970s, while private investment continued to increase, such that aggregate investment rates remained broadly stable.

Some observers have interpreted such a tendency to mean that Indian entrepreneurs have broken out of state dependence, and that economic liberalisation has created a surge of animal spirits such that private investment no longer requires state activity to be buoyant. The combination of deregulation and trade liberalisation, according to this view, has created a virtuous pattern of growth whereby the state can reduce its expenditure and allow private investors to fill the gap in investment.

There is no doubt that the process of import liberalisation (which really began in the 1980s and was accelerated in the 1990s) did lead to some increase in manufacturing activity in particular, as the pent-up demand for a range of consumer goods was sought to be met through increased import-intensive production. However, this really reflected a once-for-all increase in the domestic market, which tapered off over time, especially because it did not involve large increases in employment in these sectors.

However, just looking at public investment alone may give a misleading sense of the full nature of the fiscal stimulus, especially in the 1980s. Government expenditure of all kinds has played a crucial role in generating more employment and, therefore, more direct and indirect demand for private activity. These linkage and multiplier effects were especially strong in the period from 1975 to 1986. Chart 4 indicates that this was a period of very large increases in the share of total government expenditure (minus interest payments from which it is assumed that the marginal propensity to consume is low) to GDP. This was clearly the basis for the high growth rates observed in the 1980s, since the positive effects of such expenditure operate immediately as well as with a time lag.

Chart 4 suggests that this positive fiscal stimulus declined after 1986. Interestingly, in the period after 1993, this was not because total government expenditure came down, but simply because interest payments tended to occupy a greater and greater share of it. While the tax-to-GDP ratios did increase between the early 1970s and the mid-1980s, this increase for both Central and State governments taken together was only around 3 percentage points of GDP (from an average of 11.4 per cent of GDP in 1970-74 to 15.8 per cent in 1985-89). Meanwhile the increase in total expenditure (minus interest payments) was by as much as 10 per cent of GDP over this period. Therefore, much of the public expenditure of the 1980s was debt-financed.

In the 1990s, while the proportion of state expenditure to GDP decreased, economic liberalisation measures such as reduced import tariffs and domestic duty rates, caused the total tax-GDP ratio to decline to 14.8 per cent by the turn of the decade. Further, in the early 1990s, financial liberalisation measures significantly increased the cost of government borrowing, such that total interest payments of Central and State governments became ever more significant, and accounted for as much 7.3 per cent of GDP on average by the turn of the decade.

However, though the fiscal stimulus declined after 1986, it was still quite significant, above 26 per cent of GDP, until the mid-1990s. The tapering off of growth rates in the latter part of the 1990s (from a compound rate of 5.8 per cent per annum in 1989-91 to 1995-97 to a lower rate of 4.6 per cent in 1995-97 to 2000-02) can be seen in this context.