Dear Chairperson, fellow IIM alumni, and dear friends:
Thanks very much to the organizers and Mr. Tharman Shanmugharatnam for inviting me to this global meet, the first of its kind. I hope there will be many more to come.
In my talk this morning, I want to focus on why India slowed and how we can revive growth. But I also want to talk about a larger theme: how India’s story, which is being written even as we speak, is unique – of a large country growing out of poverty through free enterprise even while being fully democratic. If this story concludes happily, and I have every confidence it will, it offers an example for many poor countries around the world of how growth and democracy can be mutually supportive rather than antagonistic. But let me start first with why we have slowed.
Why India Slowed
For a country as poor as India, and we are still a poor country, growth should be what Americans call a “no-brainer.” It is largely a matter of providing public goods: decent governance, security of life and property, and basic infrastructure like roads, bridges, ports, and power, as well as access to education and basic health care. We then let the entrepreneurial ones amongst us drive growth.
And, unlike many equally poor countries, India already has a very strong entrepreneurial class, a reasonably large and well-educated middle class, and a number of world-class corporations that can be enlisted in the effort to provide these public goods.
Why then has India slowed so much, from nearly 10% growth in 2010-11 to the 5% today? Was the near 8% growth in the decade from 2002 to 2012 an aberration? I will argue the answer is no.
There are two important reasons that have come together in the last two years for why India slowed.
India grew fast in the years before the global financial crisis. We were probably not fully prepared for that growth. For example, new factories and mines need land. But land is often held by small farmers or inhabited by tribals, who neither have clear and clean title to the land, nor the information or capabilities to deal on equal terms with a developer or corporate acquirer.
Not surprisingly, farmers and tribals often felt unfairly treated as savvy buyers purchased their land for a pittance, later reselling it for a fortune. And having lost their primary means of livelihood, the compensation the poor farmer got did not last long as development pushed up the local cost of living.
The point is strong growth tests the capacity of institutions to cope. And India’s economic institutions were found lacking. Our land titling was fragmented, the laws governing land acquisition archaic, and the process of rezoning land for industrial use non-transparent.
India is a vibrant democracy, and as the economic system failed the economically weak, the political system tried to compensate. Unlike in some other developing economies where the rights of the farmer or the tribal have never stood in the way of development, in India politicians and NGOs took up their cause. Land acquisition became progressively more difficult.
A similar story repeated elsewhere. For example, the government’s inability to allocate resources such as mining rights or spectrum in a transparent way led the courts to intervene and demand change. And as the bureaucracy got hauled up by the courts, it saw very limited upside from taking decisions and many downsides. Given India has a plethora of rules, the absence of a helping hand from the bureaucracy to navigate them, to grant the required permissions and clearances, was problematic.
So the first reason for slowing growth is that India’s economic institutions could not cope with strong growth, and its political checks and balances started kicking in to prevent further damage.
The second reason has to do with the global financial crisis. As it hit, India, as did other emerging markets, experienced an abrupt fall in growth. And encouraged by the IMF and the G-20, many emerging markets, which were growing strongly before the crisis, injected substantial amounts of monetary and fiscal stimulus. For a while, as industrial countries recovered in 2010, it looked like this was the right medicine. Emerging markets around the world enjoyed a spectacular recovery.
But as industrial countries, beset by fiscal, sovereign debt, and banking problems, slowed once again after the first flush of recovery, emerging markets found they had tackled the wrong problem. To replace the collapsed demand from industrial countries they had stimulated domestic demand. But domestic demand did not fall on the same goods that the industrial world had demanded. And the goods that were locally demanded were already in short supply before the crisis. The net result was overheating – asset price booms and inflation across the emerging world.
In India, matters were exacerbated by the fact that investments slowed as the political reaction I described earlier emerged to oppose unbridled investment and development. The resulting supply constraints further exacerbated inflation. So even as growth slowed, the central bank raised interest rates so as to rebalance demand and the available supply, and the economy slowed further.
The picture thus far seems gloomy. But in a vibrant democracy like ours, adversity creates the search for responses, and eventually solutions.
So how do we re-energize growth? In the short run, we have to improve supply, which means moving away from consumption to investment. And we have to do it by creating new transparent institutions and processes that will limit adverse political reaction.
Using these institutions, we have to fix the problems in the coal and gas sectors, for without energy, we do not have power, and without power, we do not have growth. The issues here are not insurmountable but they need steady and determined effort. Importantly, if we can provide coal and gas supplies to the power projects on the verge of completion, India could have plentiful power and much stronger growth in the coming years.
We need better coordination and implementation within government to ensure that projects, once started, will be finished on time. That will also give more impetus for new projects to start. The Cabinet Committee on Investment has been set up to remove the governmental impediments to large projects. It has already cleared $ 14 billion worth of projects in its first 3 meetings, and the hope is that the pace of clearance will accelerate.
In addition to more investment, we need less consumption and more saving. The government has taken a first step by tightening its own budget, and spending less, especially on distortionary subsidies. Households also need to be incentivized to increase financial savings. Lower inflation, which raises real returns on bank deposits and other fixed income instruments, will help here.
If all goes well, India should recover from its growth slowdown and go back to its recent 8 percent average in the next couple of years. Enormous new projects are on the anvil to sustain this growth.
As just one example of what is likely, the Delhi Mumbai Industrial Corridor, a project with Japanese collaboration entailing over $ 90 billion in investment, will link Delhi to Mumbai’s ports, covering an overall length of 1483 km and passing through six States.
This project will have nine mega industrial zones, high speed freight lines, three ports, six airports, a six-lane intersection-free expressway connecting the country’s political and financial capitals, and a 4000 MW power plant. We have already seen a significant boost to economic activity as India built out the Golden Quadrilateral highway system, the boost to jobs and growth from the Delhi Mumbai Industrial Corridor can only be imagined.
Moreover, the institutional change we are undertaking – greater transparency in the allocation of contracts, for example – will create a level playing field for Indians and foreigners alike. That will spur growth.
So as the Prime Minister said in a speech on Wednesday, we should not be overly gloomy on the Indian economy. Fluctuating waves of sentiment have historically washed against the economy even while it chugs along at a steady pace. We should pay heed to sentiment but not be overwhelmed by it.
Free Enterprise and Democracy
But a growth recovery still leaves an important question. How do we achieve a stable balance between economics and politics, between free enterprise and democracy? After all, central to India’s unique growth story is that it is trying to rely on the private sector to lift India out of poverty even while giving its citizens full democratic rights.
There is indeed a fundamental commonality between democracy and free enterprise. Both guarantee participation to all, but neither guarantees power or success. Instead, political and economic entrepreneurs try to persuade the public that their product is the best one, and it is collective choice, whether by the electorate or the marketplace, which determines success. And when they outlive their welcome, democracies and markets are ruthless in ejecting incumbents.
These similarities are, of course, accompanied by considerable differences. After all, in aggregating choices, democracy treats individuals as equal, with every adult getting an equal vote, whereas the free enterprise system empowers individuals based on how much income they generate and how much property they own.
There is therefore an inherent tension between systems: the less-well-off majority could vote to dispossess the rich and successful. And the rich, through their money power, could try to erode the political rights of the voter. Indeed, there is a delicate balance between democracy and free enterprise, which if upset, could destroy both.
What preserves that balance across the world? One reason that the median voter rationally agrees to protect the property of the rich may be that she sees the rich as more efficient managers of that property. So, to the extent that the rich are self-made, and have come out winners in a competitive, fair, and transparent market, society may be better off allowing them to own and manage wealth, while taking a reasonable share as taxes.
The more, however, that the rich are seen as idle, incompetent, or crooked, the more the median voter should be willing to vote for tough regulations and punitive taxes on them.
In today’s Russia, for example, property rights do not enjoy widespread popular support, because so many of the country’s fabulously wealthy oligarchs are seen as having acquired their wealth through dubious means. They grew rich because they managed the system, not because they managed their businesses well. When the government goes after a rich oil tycoon like Mikhail Khodorkovsky, few voices are raised in protest.
And, as the rich kowtow to the authorities to protect their wealth, a strong check on official arbitrariness disappears. Government is free to become more autocratic.
In contrast, under conditions of fair transparent competition, the process of creative destruction tends to pull down badly managed wealth, replacing it with new and dynamic wealth. Great inequality, built up over generations, does not become a source of great popular resentment. On the contrary, everyone can dream that they, too, will become rich, and they support the system that allows them the opportunity.
So one condition for the free enterprise system to have democratic support is that it be seen as competitive and efficient, allocating rewards to the bright and capable, rather than just the well-connected.
A second condition is that most people should believe they have a reasonable shot at success in the free market. This is not a given, especially in a poor country like India.
A poor child growing up in an Indian village with bad nutrition, indifferent teachers, and limited access to the kind of learning opportunities available in modern cities, starts adult life with very little chance of being successful in the vibrant economy India has.
A certain amount of inequality in circumstances is inevitable, and even useful, but too much and it breeds resentment of the free enterprise system. Why would the poor vote for expanding free enterprise, for more good jobs in finance and other services, when they know they simply are not good enough to get one themselves? Why not instead vote for the traditional politician who promises patronage, and sometimes even delivers on it.
In sum, to obtain democratic support, the free enterprise system has to be seen as following fair rules of the game – competition is essential. Also, most players should also believe they have the basic capabilities to have a reasonable chance of bettering themselves – meaning growth should be inclusive. If rewards are excessively skewed, and few feel they have a chance of getting them, the system loses democratic legitimacy.
The government has to play a delicate role here. It has to make the system fair, both in appearance and actuality. And it also has to ensure that the broad mass of people have the wherewithal to participate initially on equal terms.
It should not, however, go further and determine winners and losers in the economic system, for that would make the political vote dominant over the economic vote. Equally, it cannot let money power buy votes for that would make democracy a sham.
A number of outcomes are possible if the government fails this task. One is corporatist capture, where entrenched incumbents such as industrialists or trade unions skew the system further in favor of themselves. This has been Mexico’s plight, though the government of President Pena has decided to take on the corporatist interests by cutting the telecom barons down to size and arresting the head of the teachers’ union.
A second is soak the rich or socialist policies where entrepreneurs are labeled parasitic exploiters, and the public votes to tax them heavily. France is currently in the midst of implementing these policies and discovering how costly they are as the industrialists leave.
A third is competitive populism, where the dominant elite tries to buy off those falling behind with sops such as cheap credit or free consumer goods. The United States before the recent crisis could well have been accused of encouraging cheap housing finance so as to assuage the anger of the middle class, which was experiencing stagnant incomes.
When carried to an extreme, corporatist policies lead to fascism, socialist policies to communism, and competitive populism to economic crisis and chaos.
How it will play out in India
All three outcomes are possible in India today. However, I feel confident we will do much better, finding a mutually reinforcing equilibrium between democracy and free enterprise.
We are improving competition through greater transparency, by opening up the economy further to foreign investment, to trade – I should mention that the sum of Indian exports and imports to GDP is now nearly 50% -- and by empowering a Competition Commission, which is starting to ask the right questions even off the government.
We are also working to make growth more inclusive. In doing so, we ought to agree that:
A good job is the best form of inclusion. Rather than assuming the poor need an increasing array of handouts, they should be empowered to equip themselves and their children to become effective contributors to the economy.
Where the poor need help, they should get targeted cash transfers, which they can spend on the education, food, or healthcare they want, whether from a private provider or a government provider. Better they make choices than have the choices of some remote government or civil society thrust on them.
We must also remember that the line between equipping the poor to get decent jobs and populist vote-buying is a thin one, and governments must be careful not to cross it.
To raise resources for such spending, the rich must play their part. The government must broaden the tax base, both by finding and penalizing tax evaders and also giving them incentives to declare their income by increasing the status associated with legitimacy.
The government has to also become more transparent and responsive to the people. Fortunately, information technology can help tremendously, by giving people more of a sense of what their due is, and making clear which part of the government is proving wasteful, corrupt, or a bottle neck.
If we take such reasonable and feasible steps, therefore, I am confident Indian free enterprise and democracy will reinforce each other. A self-assured India, brimming with ideas and energy, can play an enormously beneficial role in the world. We will offer an alternative view of development, one combining free enterprise with democracy, bringing together cutting edge innovative companies with bottom-of-the pyramid services. We could teach both the West and the rest, even while learning from them, as we did in the historic past when we were a global broker of ideas. We could be a voice for good in the international arena.
I think people like you have an enormous role to play, not just in business and finance, but in shaping India’s engagement with ideas and with the world. It is important that you step up your contribution quickly.
India will become a superpower due to the size of its population, long before its citizens grow rich. Without a world view, a view formed through informed and reasoned debate amongst those who think deeply about these issues, India’s interaction with the world may be purely reactive, guided by the politics of the moment and the unthinking traditions of the past.
That will be dangerous, especially because the powers India will deal with will have far more sophisticated reasoning guiding their actions. India must draw on its best minds across the world, and I hope you will be willing to give back if asked.
Let me conclude. I have not spoken about entrepreneurship or Jugaad or frugal engineering or all those important innovations emerging in Indian business today. I wanted to focus on a broader theme, one that still raises more questions in my mind than answers – the links between our growth and our democracy. I would, of course, be happy to answer any questions of yours that I have an answer to.