At About 5–6%, Economy Won’t Collapse But It Won’t Generate Enough Jobs: Montek Singh Ahluwalia

There was a time in the 1990s when India aimed at attaining double-digit growth following the liberalisation of economy. Between 1979 and 2018, China grew at an average rate of 9.5%, whereas India remained at just about 6% to 7%. What were the shortcomings for India?

I do not think we ever formally targeted 10% growth. That was talked about, but the formal target was maybe 8.5% or 9%. We got close to that for some years. Then it tailed off.

I think our governments—and this is true of all governments—have often identified the weaknesses correctly, but they have not done enough to remedy the situation.

China achieved very high growth because it was able to achieve exceptional levels of investment and, even more importantly, ensure much better implementation than anyone expected. In India, being a democracy and highly diverse country, speedy implementation is not easy. Vested interests can mobilise opposition to policies that otherwise make eminent sense economically. This is the real challenge before the political leadership—how to mobilise support and deal with vested interests The 1991 reforms dismantled a long-established control system and successfully overcame vested interests in many areas. We need similar watershed reform events.

The Modi government fast-paced reforms with the Insolvency and Bankruptcy Code (IBC), the goods and services tax (GST) regime and even the controversial demonetisation came fast. Economist Vijay Kelkar once wrote that GST regime will add 2% to India’s GDP, but that has not happened yet.

Let me first comment on the specific reforms you have mentioned. Demonetisation was certainly swift, but I would not call it a reform. Most analysts think that it did not achieve any of the stated objectives.

The GST is different. It is a very important reform. The United Progressive Alliance (UPA) tried for several years to get it through Parliament but met with opposition from the Bharatiya Janata Party. The latter deserves credit that once in power, it got it done quickly.

There are two reasons why it has not yet produced the extra 2% growth that people expected. First, the GST we have introduced is very different from the ideal value added tax that has generated large revenue gains in many countries. The critical requirement is that (a) the coverage should be very wide, with only a few exemptions and (b) there should be only one or two rates. Our GST has exempted a very large number of items, kept some important items out of the GST (petroleum products, electricity and alcohol and real estate development) and, to top it all, had five rates! Many experts have pointed this out, and the GST Council must act. Perhaps the Central government should take a lead and bring out a policy paper for wider discussion and build public support for it.

The GST was also supposed to stimulate efficiency. Important gains have been made here. Multiple taxes levelled earlier have been combined into one GST rate. The fact that each product has only one tax, no matter where it is produced, creates a unified market. Imports pay the same rate of GST as domestic products, which levels the playing field. And, we no longer see long lines of trucks at state borders.

However, there was a great deal of confusion initially. Many producers complained that it was not easy to operate the system and even now small-scale units complain. Some of these are just teething problems, which have been experienced all over the world when a basic change like this one is made. In our case, the teething had barely ended when we ran into the pandemic, when growth collapsed. Perhaps, the post-pandemic period will show a positive effect on growth provided the tax structure issues are addressed.

The IBC is also an important initiative of the Modi government. Again, the pandemic led to a weakening of intent in enforcing it. I hope that as normalcy returns, we will iron out the problems and give this legislation some teeth. Once again vested interests have gamed the system to reduce its effectiveness. It is vital to strengthen the system and create an atmosphere in which those who borrow from banks are incentivised to repay. Let us see if the amendments proposed achieve this.

More generally, I think we should move away from taking satisfaction at multipole reforms being attempted in every area. We do need to reform virtually everything if we want to modernise, but all these reforms will take time. At any given time, there are perhaps a handful of structural reforms that should occupy the attention of government. We should give them priority and get them done in good time.

Are there areas where you feel we need to rethink what we are doing?

I think that we really need to assess the danger of being pushed back to protectionism. The 1991 reforms initiated the process of reducing import duties to levels prevailing in other comparable developing countries. This was followed by several successive governments, including the National Democratic Alliance government under Atal Behari Vajpayee. India did well as a result, with an improvement in the export to GDP ratio and an increase in the world market share. Unfortunately, this process has been reversed in the past few years and import duties have been raised over a wide range of products. Arvind Panagariya, who was the first vice chairman of the NITI Aayog, has said in a recent article that this was a mistake. He also said that it has been done based on no analysis.

I realise that other countries—notably the United States—have raised import duties also. But we have to realise that our duties are quite high anyway. If you listen to every industrialist, you would find that they want a higher duty on what they produce and a lower duty or whatever they import to produce it! We should have a considered approach to duty changes. As a general rule, we should go back to the original objective of aligning our duties with those of other developing countries.

Certainly, duty inversions should be corrected. But this should not mean that if the input duty is too high, you raise the output duty. I think the correct way to deal with duty inversions is to lower the input duty so that it is not higher than the output duty.

I hope the government spells out the principles it wants to follow in adjusting duties.

India wants to become a developed nation by 2047, for which, as per the definition of the World Bank, the per capita income will have to be above $12,535. Where can we reach by 2047?

As far as our growth potential is concerned, it is not some predestined number. It depends upon whether we can adopt the policies needed to maximise our growth potential, taking account of new challenges, like climate change. Personally, I think we can grow at 7% to 7.5% for the next two decades but only if we implement appropriate policies. With population likely to grow at an average rate of about 0.6% per year between now and 2050, a GDP growth of 7.5% translates into a per capita growth rate of around 6.9%. At this rate, our per capita GDP which is $2,100 today will become just under $12,000 by 2047. That is just below what the World Bank calls “developed” economy levels.

If we do not make the reforms needed, we will just be growing at about 5% to 6%. The economy will not collapse, but we will not generate the employment we desperately need to give our younger generation satisfying jobs.

Are we in danger of being caught in that middle-income trap?

The middle-income trap concept is based on a notion that a low-income country can grow rapidly for a while because there are low-hanging fruits. The 1991 reforms were that kind of low-hanging fruit. “Low-hanging” does not mean “easy”. It was difficult to get the 1991 reforms done, but it was obvious what we had to do, which was getting rid of excessive administrative controls. Once a country gets into the middle-income range, it becomes more complex, and a new kind of constraints becomes relevant. If you are going to have foreigners coming in and investing big sums of money, they want to have a legal process that is transparent and speedy. These types of reforms take more time and the effectiveness of legal reforms depends upon how the system works in practice. Look at how the IBC got caught up in problems.

Human capital is another major constraint. We are talking about digitalisation and we have done a good job on Aadhaar, the JAM trinity—an abbreviation for jan-dhan, Aadhaar and mobile—India stack and UPI. But we need a workforce which is much more educated to take advantage of digitalisation. The threat of climate change calls for a major energy transition, and we need skilled people who can handle the new technology. These are more complex issues. It is very easy to abolish import controls: you just have to take the political courage and do it. But how to get a good training system is not a matter of just abolishing something. You have to create a good training system and many different models, etc. You have to build institutions, many of which have to be built at state levels.

As Indian companies become big, consumers will start questioning whether their interests are being protected. Institutions like the Competition Commission of India become more important. In order to create confidence in these regulators, they have to be staffed with high-quality people, and they have to be independent of the government. In certain cases, for example the Securities and Exchange Board of India, we have done a good job, and investors internationally have confidence in it as a regulator. We need to develop the same kind of confidence in the telecom regulator and the Competition Commission of India, the power regulator, etc. This is a big task.

You say that getting to 7% to 7.5% growth is difficult, but does this mean 5% to 6% growth is what is possible with Adam Smith’s invisible hand for Indian economy?

I think 5% to 6% growth is what is possible without too much radical reform, but even that will require a macroeconomic balance. In other words, assured macro balance and a private sector-led economy will deliver 5% to 6% [growth]. But if we lose macro balance, all bets are off. In a relatively open economy, with significant private capital flows, loss of macro balance can provoke a crisis very quickly. I am also assuming that the economic policy will not swerve back to public sector playing a larger role in production. The government has a very important role to play but not in producing things which can be produced by the private sector. If we make that mistake again, we cannot be sure of even 5% to 6%.