Book Review

Book Review by Dr. J. Dennis Rajakumar, ICFAI Business School, Bangalore: Book Reviewed: Nagaraj, R., Aspects of India’s Economic Growth and Reforms, New Delhi: Academic Foundation, 2006.

The book under review is a compilation of the works done by the author at the Mumbai-based Indira Gandhi Institute of Development Research (IGIDR) over a decade or so, on the impact of economic reforms in India Statistics used and policy implications drawn in these works make the volume particularly relevant to contemporary debates on drivers of India’s economic growth and what can be done to take it forward. Besides the introductory chapter, the volume is divided into three thematic sections. the first, “Macroeconomic Performance”, has three articles , “Industrial Growth” comprises of four papers, which discuss not only how industries in India have grown over the years and their structural changes, but also problems associated with industrial statistics. Part III “Some Aspects of Economic Policy” contains five papers. Of these, two examine performance of public sector, one looks into capital and another one on labor market related issues, and final one on FDI. Chapters are arranged in the chronological order in which they were published and so the review is done chapter by chapter. Chapter One examines if India’s economic growth had taken an upturn in the 1980s, as opposed to the hitherto view of ‘Hindu rate of growth’ of 3.5 percent. Using national income series (with base year 1980-81), it was found that the annual growth rate during 1980-81 to 1987-88 was 4.9 percent. Since a significant trend break was observed in 1979-80, it undermines the widely held proposition that Indian economy had constant growth rate over four decades since the early 1950s. Industrial sector’s growth accelerated at an unprecedented rate of 6.9 percent and similarly service sector grew at 6.3 percent in the 1980s. Though public spending increased since the late 1970s, overall growth rate did not get altered even after deducting ‘administration and defense’ from GDP. All these findings imply that the economy began to move into a higher growth trajectory since 1980. In Chapter 2, the author examines further the upturn in the growth rate and the effect of economic reforms ushered in 1991. The economy’s growth during 1991-92 to 1995-96 was 5.3 percent, which was lower than 5.9 percent recorded during 1985-86 to 1990-91. While the reform process did not affect public spending on health and education, defense spending decelerated. The gross fixed capital formation (GFCF) went down in public and household sectors; whereas that in private corporate sector showed a rise. Under reform period, total corporate GFCF grew at about 18 percent, whereas in registered manufacturing, its growth was in the order of 3 percent. Thus the author asserts “.. contrary to a priori expectation, structural adjustment seems to have propelled investment in non-traded goods sector” (p. 63). Financial sector reform had facilitated corporate sector to raise capital without much policy hindrances. However, according to the author, funds so raised were largely diverted to investment in real estate, inter-corporate investment, mergers & acquisitions, or trading in existing capital stock. As these assets could cause bubbles in the economy, the author says ”Such asset bubbles

certainly do not augur well for the economy’s real sector in the long run”. (p. 66). Removal of anti-export policy bias would have brought more resources into tradable goods sector, which should ideally give fillip to industrial sector. Contrary to such expected outcome, industrial sector did not grow in the 1990s as much as they did in the 1980s, with growth of unregistered manufacturing sector declining sharply from 7.6 percent in 1986-91 to 5.7 percent in 1992-96. Though the ratio of public sector expenditure to GDP had fallen during 1992-96, public sector’s contribution to the GDP rose by about 1.3 percentage points to 24.8 percent in 1992-95; with increased contribution from non-departmental enterprises. In Chapter 3, the author synthesizes the existing wisdom on political implications of a polarized society (that is, since 1991). It was found that the economy grew at about 5.7 percent throughout the 1980s and 1990s, with no significant trend break in the post 1991 period. In the 1990s, primary and tertiary (service) sector grew more or less at the same rate of the 1980s; whereas, secondary sector witnessed a modest slow down in the 1990s. For this observed growth to be virtuous its benefits should have percolated down – a phenomenon that economists often find difficult to capture. Given that poverty and unemployment are chronic pitfalls of Indian economy, virtuous growth in this context could be interpreted in terms of their reduction. Using head count ratio to capture the incidence of poverty, it was found that the number of poor began to fall down way back in 1973-74. The correlation between growth rate of per capita state incomes and change in poverty in these respective states was negative but not statistically significant. Both at the aggregate and state level, the virtuous relationship between growth and reduction in poverty did not hold good. Further, employment elasticity of output was found declining across major sectors over the years. There has been a rise in the casual wage employment. The ratio of rural to urban per capita incomes had come down in 1993-94 and the ratio of unorganized to organized domestic product also went down. In the corporate sector, share of wage income had dwindled with a simultaneous rise in the share of profit income. Thus, growth was not accompanied by any perceptible reduction in poverty or in unemployment. In other words, the economically better off section in the society benefited more under economic reforms. Given these evidences, the author concludes “If such an iniquitous growth process is not corrected – and corrected quickly – Indian society may have to pay a huge political price for it” (p. 106). Chapter 4 was written at a time when there was a serious concern amongst both the academia and the policy makers over industrial sector in India. The author used new series of NAS with base year 1980-81 and found that the growth rate of registered manufacturing was 7.6 percent during 1959-60 to 1965-66, which declined to 5.5 percent during 1966-67 to 1979-80. However, this sector regained its growth momentum in the 1980s recording growth of 10.4 percent. But unregistered manufacturing sector grew only at 5.3 percent. As unregistered sector had a share of about 2/5 of the total manufacturing sector, its performance dragged the overall growth of manufacturing to 8.3 percent. Contrary to the belief, Index of Industrial Production (IIP) did not result in the overestimation of growth rate. In Chapter 5, the author explains the phenomenal growth of manufacturing in the 1980s in terms of several hypotheses, which were earlier adduced to explain ‘industrial stagnation’ of the preceding decade. Those factors, found having a a positive impact on industrial growth, included the rate and composition of overall GFCF and public investment, developments in infrastructure industries, and inter-sectoral terms

of trade favoring non-agriculture since mid 1970s – can you rewrite this sentence? these variables responded favorably to several industrial and trade-related policy changes initiated in the 1980s. Agriculture linkage, seen in terms of a relationship between lagged agriculture growth and industrial growth, could not explain the growth. The disquieting trend in respect of growth of capital goods, along with basic goods like ‘iron and steel’, and the lackluster growth performance of non-food crops had, however, undermined the sustainability of industrial growth in the long run. Whether industrial sector retained its growth momentum on to the 1990s, when a series of policy reforms were carried out, is the central theme of Chapter 6. Of total manufacturing employment, registered sector had a share of one-fifth and one-third in terms of valued added, The remaining was accounted by unregistered sector. While registered sector was found to be a net importer, its unregistered counterpart accounted for the bulk of merchandise exports. As regards growth, manufacturing sector as a whole grew at a rate of 7.4 percent during1980-81 to 1990-91, and at 7.6 percent from 1991-92 to 1998-99; but the dummy test showed statistically significant slowdown during the latter period. Registered sector recorded a growth of 7.6 percent and 11.0 percent respectively during these two periods with no statistically significant change in the growth rate under reform period. It suggests that the slowdown in growth of manufacturing since 1991-92 had occurred in the unregistered sector. Further, regional disparity was observed in the industrial growth with low income groups like Bihar and UP not performing well, and erstwhile fast growing states like Punjab and Haryana witnessing significant slowdown. While fixed investment in registered sector grew, that in unregistered sector declined. Improvement in the investment of registered sector was seen as a direct consequence of improved business expectation under economic reforms, complimented by stock market boom in the mid 1990s, which eventually reduced cost of funds. As unregistered sector underlined India’s comparative advantage, given their labor intensive production and export orientation, the decline in its investment was ‘puzzling’ and attributed to financial sector reforms that reduced flow of credit to small scale industries. As opposed to the jobless growth of registered manufacturing in the 1980s, employment in the 1990s had indeed revived. However, unregistered sector recorded a steady fall in employment. In all, the poor performance of unregistered manufacturing in comparison with the registered sector, can be attributed to the adjustment process. It implied that unregistered manufacturing, seen as the vital segment of the economy, bore “the real brunt of adjustment in the organized sector – considering the close inter-firm linkages between the organized and unorganized sectors in the product and labor markets” (p. 190). In Chapter 7, the author notes that industrial growth momentum had tapered off since 1996-97 and attributes it to the lackluster agriculture performance and decline in public investment during the same period. While surge in industrial growth during 199293 to 1995-96 had provided convincing support to the proponents of economic reforms, the slowdown since then proved them wrong. It is not just policy changes per se, rather aggregate demand that mattered to lubricate industrial growth. Given the fact that nearly 3/5 of India’s workforce depended upon agriculture, a strong linkage between agriculture performance and industrial growth was postulated to exist. Moreover, citing evidences on “crowd in” effect of public investment, the author goes on to argue that, as a policy option, stepping up of public investment would not only provide stimulus for private

investment but also relieve infrastructure constraints. To quote, “.. it would perhaps not be incorrect to argue that in a poor and iniquitous, agrarian economy like ours public infrastructure investment contributes towards efficiency as well as equity” (p. 215). Motivated by the criticisms leveled against the role of public sector in India, in Chapter 8 and 9, the author analyzes performance of public sector enterprises. In particular, both officials and few pro-reform academic economists took a position that public sector drained the exchequer. As a panacea to reduce fiscal imbalances, they advocated a sharp reduction in the role of public sector. Based on analyses presented in these two chapters, the author convincingly proves these critics to be wrong. Not only non-departmental non-financial enterprises (mostly in manufacturing) did well in generating internal surplus to finance their investment activities, but they also increased their share in gross domestic savings. Their capacity utilization had also improved over the years. Of course, performance of administrative departments tells a different story. Share of wage income in the value added of non-department enterprises has gone down over the year, thus refuting the claim that “…workers and employees in public sector enterprises have been appropriating an ever increasing share of their output.” (p. 230). As the internal savings of these enterprises showed a rise, it was argued that better financial returns can be secured even “…within the framework of public ownership and control” – an argument which belies the stance of many on diluting of the public ownership. Findings of these chapters rekindle possibilities of hinging growth around the public sector. Chapter 10 deals with labor market rigidities. Earlier few studies observed a decline in the growth of employment in manufacturing sector and attributed it to labor market rigidities reflected in rising wage rate, unionization of the labor class, and inflexibility in hiring and firing of the labor. Contrary to these widely held propositions, it was found that earnings per worker and earnings per man-days had grown by about 3.2 percent and 1.6 percent respectively during the decade beginning from 1979-80. During the same period, the real per capita GDP increased by about 2.7 percent. The growth of earning per worker was observed to be “....above average increase in the number of days worked per worker” (p. 259), implying that industries just paid extra for the extra work and effort put in by workers. As increase in earnings per man-days was lower than the growth rate of real per capita income, the author contests the view that rise in wage rate caused decline in employment. Gleaning more evidences on unionization of workers such as man-days lost, union density, number of strikes, workers involved in industrial dispute and employment by factory size, it was shown that labor union did not gain any further strength, and so the author contests the view that policy-induced rigidities featured labor market. Decline in employment was found to be caused by a fast growth of less labor intensive industries, attempt by firms to intensively use existing labor, rising cost of capital that induced firms to shift production to unregistered sector and adjustment process reflecting in tendencies towards reorganization of the shop-floor workers, farming out production, using contract / part time labor for labor intensive services. As capital market received an overwhelming policy focus, the author explores in Chapter 11 if this market could contribute to the economy’s long-term development. A sharp rise in the resource mobilization through primary market was noticed – while debt instrument was used more in the 1980s, it was equity in the 1990s. Promoters’ stake also went up. Spurt in the market activities went hand in hand with relaxation or changes in

policies. A shift away from internal sources to external sources of funds was noticed; and within external sources the role of fresh issue of capital assumed significance since the early 1980s. For this market to contribute to economic growth, primary issues should be highly correlated with capital formation. Rate of growth of capital issues and corporate capital formation was found to be positively correlated only till 1980, since when the correlation became negative. Surprisingly, corporate profitability had gone down in the 1980s. And so, the author concludes “..with capital market growth, an increasing share of loanable funds have accrued to a sector that contributed relatively les to output growth and that did not improve its investment rate either” (p. 297) The last Chapter 12 examines various interesting issues associated with the much debated role of FDI in India and its oft-repeated comparison with China. Inflow of FDI had increased over the years during 1992-2000, the United States accounted for the larger share (about 20%) followed by Mauritius (about 12%), the sector ‘power and fuel’ attracted nearly 1/4 of the total approved FDI, nearly 70 percent of FDI were concentrated in investments exceeding Rs. 100 crore, Maharashtra attracted bulk of inflow (about 17%) followed by Delhi (about 13%), and the actual-to-approval ratio went up over the years. Route wise, the proportion through FIPB route (meant for larger projects) declined over the years, via RBI (meant for medium and smaller projects) retained ‘modest flow’, via NRI declined sharply, and via ‘share acquisition and ADR/GDR’ went up prominently in the second half of the 1990s. In particular, there have been more mergers and acquisitions by FDI firms and many of them got de-listed from Indian bourses. On an average, India received about 2.2 percent of world FDI in 1997, up from 0.5 percent in 1992. India faired poorly in comparison with China in respect of attracting FDI. The possibility of underestimating inflow of FDI into India was highlighted due to the definitional inconsistencies in Indian case. Around 40 to 50 percent of inward FDI into China was ‘recycled domestic savings’ (round tripping), and bulk of them landed in those areas, like real estate, and so represented speculative capital. On the beneficial impact on India, FDI firms were able to bring about ‘greater choice and quality improvement – a desirable outcome for customers’ (p. 322), and indirectly created competition in domestic market. Arguing that India has a labor-based advantage and so had greater potential to attract more FDI, the author, as a policy option, calls for allowing FDI “..mainly in manufacturing to acquire technology, and to establish international trading channels for promoting labor-intensive exports.” (p. 332). That is, he sees merit in encouraging FDI the China way - to ‘augment domestic capability’ and to gain foreign market access for ‘labor intensive manufactures’. As a coda, it is customary for reviewers to pinpoint certain flaws in the work reviewed; these flaws are generally observed at the level of problem formulation, in the data and techniques used, and in the inferences drawn. While measuring profitability of PSEs (p.232), the author used the ratio of gross profit to capital employed. Such measure is far from satisfactory because gross profit is expressed in current price whereas a major portion of capital employed is expressed as per their book values. Thus, one is likely to notice tendencies of rising profitability. However, other evidences on PSEs performance go a long way in supporting the authors’ conclusion drawn otherwise. Notwithstanding this, every article included in the volume are highly worth reading, to come to grips with various aspects of problems confronting the Indian economy.

Perhaps, soundness of the analysis can be viewed against the objective of the volume. As the author notes in ‘Introduction’, the prime motivation to write these papers was his “.. desire to carefully examine some of the widely held propositions on the aggregate and sectoral economic performance, premises of a few reform measures and the outcome of some aspects of the economic reforms initiated in the 1990s.” (p. 19) Viewed against this, content of the volume can provide appropriate guideposts to policy makers to take Indian economy forward. While presenting the volume, the author asks a fundamental question: “Can India hope to catch up with East Asia ..China, with more thoroughgoing (or deepening of) economic reforms, as many have advocated? Or do we need to alter the course of the economic policy?” (p. 26). After reading it, one is inclined to believe that, if statistics are used effectively in the way the author does and implications are drawn keeping in view long term objective, India could pursue economic policies of its own and forge ahead of others not only in this region but globally.