FIN 680D/ FIN 360AMAR 680V/ MAR 356E/ INB 670C India: Economic Overview P.V. Viswanath
Economic History: 1950-1990 • Post-independence India had a mixed economy, i.e. including both private and public sectors. The reasons for a strong public sector were: • Greate inequality in income distribution – doubts as to the viability of free markets • Free trade would probably have led to exploitation by stronger foreign countries • Exports were seen as a drain of resources from the country.
Post-independence economy • Foreign Investment was seen as foreign domination. • The quickest path to economic development was seen to be rapid industrialization, which would probably not happen without government intervention • Capital goods and heavy industry were seen as particularly needed. • Planning was needed to ensure industrial growth and the concomitant agricultural and service growth, as well as employment growth
Objectives • The broad objectives were: • Rapid growth in production with a view to achieving a higher level of national and per-capita income. • Full employment • Reduction of inequalities in income and wealth • Socialistic pattern of society with a democratic framework, based on equality and justice and absence of exploitation.
Policy Measures for Industrial Development • Trade and Regulatory Regimes designed to shield industrial producers from competition • High tariffs • Industrial licensing of production and investment • Monopoly and Restrictive Trade Practices (MRTP) Act • Foreign Exchange Regulation Act (FERA) • Export Restrictions
Industrial Policy • Directed allocation of subsidized credit through the commercial and developmental banking system • Administered interest rates and financial institutions required to lend for specific purposes at the administered rates. • Fixed, overvalued exchange rates; this ensured cheap imports for the government.
Industrial & Agricultural Policy • Price control for many products • Rigid labor laws that made it difficult to lay off workers. • Direct public investment in industrial activities. • Management of the agricultural sector to ensure reasonable supplies of food grains, edible oils, sugar and cotton to the domestic market.
Agricultural Policy • Procurement prices were fixed, which , in times of surplus, worked as a minimum support price. • At times of deficit, the government mandatorily procured a part of the grain at the procurement price and distributed it to poorer people through ration shops. • Fertilizer, irrigation, power and credit were subsidised for the agricultural sector.
Agricultural and Fiscal Policy • The need to mop up excess production led to trade restrictions. • Quantitative restrictions on exports and imports, through licensing • Canalization – the use of a single parastatal for imports and exports; the use of minimum export prices. • High income tax rates
Social Policies • Higher education was emphasized (IITs and IIMs) • Growth-oriented strategy as a means of mitigating poverty and unemployment. • However, structural inequalities in land ownership, availability of water, access to credit etc. led to growth without income and employment growth for poorer people.
Social Policies • Land reform (at least in some states) • Alleviation of poverty through special programs and policies, such as asset creation programs, employment generation programs, minimum needs programs. • Intervention programs to solve the problems of malnutrition and hunger.
Did the policies work? Industry • Industry grew 6% p.a. between 1951 and 1989 • There was little competition; hence there was little R&D. • The capital-input ratio went up considerably; total factor productivity dropped. Capacity utilization fell. • Deeply entrenched interest groups.
Agricultural Progress • Between 1950 and 1980, food grain production increased by 2.8% p.a., due primarily to productivity gains and multiple cropping. • But, investment growth slowed. • R&D suffered, development of irrigation lagged behind plan targets. • There was a substantial rise in subsidies for food and fertilizer and for credit, water and electricity. • India became self-reliant, but at great cost.
Social Progress • From 1970-88, the proportion of population below poverty dropped from 46.17% to 37.76% in urban areas and from 58.75% to 48.69% in rural areas. • Average life expectancy improved from 32.1 in 1950-51 to 58.7 in 1990-91. The death rate dropped from 27.4 to 12.5 during the same period. • Literacy was 52.2% in 1990-91 compared to 18.33% in 1950-51. • But compared to other developing countries, this was not good.
The crisis and the change • A massive rise in the government deficit spilled over to the current account deficit because it was financed by external debt. • External shocks, such as increased oil prices, decreased access to concessionary loans from abroad • Structural rigidities in the Indian economy made Indian products non-competitive, globally.
The solution • A twofold solution: • Make the economic structure more competitive • Contain the government deficit • Effects: • Structural Change and • Fiscal stabilization.
Initial Reforms • Trade policy reforms have done away with most quantitative restrictions and reduced tariff levels • Industrial policy has removed barriers to entry and limits on growth in the size of firms • Regimes for foreign investment and foreign technology have been liberalized considerably • Domestic tax structure has been rationalized. • The financial sector is being deregulated.
Second-generation reforms • Privatization of public sector undertakings • Very slow, but steady. BHEL • Exit policy for labor • Reforms of the agricultural sector • Reforms of the state government
Growth in Industrial Production Atul Kohli, “Politics of Economic Growth in India, 1980-2005,” Economic and Political Weekly, April 2006, pp. 1251-1259 and 1361-1370
Changes post-1991 • Disparity in growth across states • Move towards service sector • Lack of industrial growth • Income inequalities • High poverty in the rural sector – farmer suicides • Continued casteism, gender inequality, communal unrest
Microfinance • Lack of rural development was thought to be due to lack of production assets and credit. • The government introduced easy credit programs through Regional Rural Banks. • These banks improved access to credit of better-off farmers, but failed to reach the vast numbers of landless people, microentrepreneurs, agricultural labourers and illiterate women. • Cheap credit skewed development to richer farmers.
Microfinance • Early Rural Credit programs failed because: • procedures of rural banks were unduly complicated and costly • the sole emphasis on production loans was ill-guided • the poor were able to save, but had no opportunity of depositing their savings • transaction costs were prohibitive • financial products were unsuitable
Microfinance in India • National Bank for Agriculture and Rural Development (NABARD) concluded from a study that: • Microfinance programs have to be savings-led, not credit-driven. • The poor have to have a say in their design. • The NABARD program with the help of the RBI based itself on the work of self-help groups (SHGs).
SHGs • SHGs are successful because they are self-directed, • largely homogeneous in terms of caste and activity, • build a common fund from very small regular savings and interest income • lend to their members for periods of 1-3 months at an interest rate of 2-3% per month.
SHG Banking • The NABARD program piggy-backs on the work of established SHGs by providing them refinance. • This program works because India already has in place a network of rural banks. • By March 2005 SHG banking reached 1.6 million savings-based groups with 24 million members, covering over 120 million people from the lowest strata of the rural population. • The program is in the hands of local agencies, driven by local SHG ownership.
Microfinance • Why does it work? • Incentives • Group Monitoring
Economic Discrimination • Two theories of employee discrimination: • Statistical Discrimination – desired characteristics are more prevalent in the sought-after group. Hence employees belonging to this group are preferred. • A recent study concluded that SC/ST graduates of the 2006 IIM-Ahmedabad batch got jobs with lower pay offers. • The study found that after adjusting for weaker academic performance, there was no discrimination.
Economic Discrimination • Preference-Based Discrimination (Becker) • If employers prefer to associate with employees of a certain background, then that characteristic will be priced – employees of the favored group will be preferred even if there is no difference on efficiency grounds. • This may be changed by advertising, marketing and misconceived associations between group affiliation and economic performance.
Capital Account Convertibility • CAC based on the theory that capital will flow from high capital-endowment countries to low capital-endowment countries, from low-return-to-capital countries to high-return-to-capital countries. • But CAC often led to movement of capital from developing countries to developed countries. • One reason is information asymmetry problems in developing countries combined with contract enforcement difficulties.
Capital Account Convertibility • Preconditions: • Low governmental fiscal deficit as a proportion of revenues • Contract enforcement • Line of credit
Shareholder Dispersion: Why? • Helps stock market liquidity • Which, in turn, helps market efficiency and • Information aggregation • Prevents control of government by corporate sector, leading to subversion of political system. • From the firm’s point of view, IPOs directed to shareholders at large, rather than Financial Institutions will keep the cost of capital lower. This will ensure economic efficiency.
Shareholder Dispersion: Why not? • Agency costs • Leads to divergence between managerial goals and shareholder goals • Reduced investment in monitoring of managers • Inefficient investment • Need strong market for corporate control and well-regulated securities market to offset this. • Empirically, dispersed share-ownership is a characteristic of developed economies.
Shareholder Dispersion: The facts • As of end Mar 2007, promoters held 54.94% of total shares, individuals held 13.78% and institutional holdings accounted for 14.64%