Globalization, Growth and Welfare: India under Narsimha Rao & A B Vajpayee

Backdrop

   One of the first policy actions of the Aam Admi Party on forming the Delhi State government was to announce that it would try and rescind the decision of the previous Sheila Dixit government to allow FDI in Delhi’s retail sector.  The anti-FDI position of the left in BJP(or RSS) is very similar to that of the leftists in the Congress party even though they draw their inspiration from different sources.  There is therefore a danger that the manifestos of several parties may take an anti-FDI stand, and thus unnecessarily bind the next PM and the ruling coalition into policy positions they may regret.   It is therefore vital to understand how India has benefited from the opening and globalization of the Indian Economy since 1991.  The note shows how Globalization of the Indian economy, acceleration of economic growth and improvement in peoples Welfare have progressed in tandem during the tenures of both Shri Narsimha Rao and Shri Atal Bihari Vajpayee as Prime Ministers from 1991-2 to 2003-4.

Nineties Reforms

   The 1990s policy reforms consisted of three major elements- Domestic decontrol, Tax reforms and External opening and one smaller element- Public sector disinvestment.  Both the domestic and external liberalization focused on product and capital markets. On the product side, prices, production, investment, imports, exports and technology import were freed from controls.  Agricultural products were kept out of this agenda and remains largely so till today, at great cost to consumers and farmers.  Capital markets were also liberalized in a carefully phased manner to allow domestic companies to raise funds and for domestic and foreign savers to supply capital and innovative financial products. This was accompanied by a major effort to simplify Central government taxes (CIT, PIT, sales-excise-VAT, customs) by reducing exemptions & deductions and unifying and reducing rates. The Public Sector disinvestment was also intended to nudge the political owner (govt. departments) and the bureaucratic managers & employees to act more like private owners and managers.  The basic objective of this set of policy reforms was to improve the competitiveness of the product and capital markets and thus promote productivity and growth.  These reforms succeeded in promoting competition and opening, and raising the growth rate of the economy, resulting in a closing of the gap between the Indian per capita income and the World average.

Outcome: Opening & Competition

      India’s Imports rose from 8.3 per cent of GDP in 1990 before the Narsimha Rao reforms to 19.3 per cent in 2004, the last year of the NDA government. Part of this was a consequence of the rising World trade ratios. However the (negative) gap between the Indian and World Import-GDP ratio almost halved from 11.9 per cent to 7.3 per cent. India’s exports also rose from 6.9 per cent of GDP in 1990 to 15.3 per cent in 2004, closing the (negative) gap between Indian and World export-GDP ratio from 12.9 per cent to 9.3 per cent.    There was a corresponding opening of the Capital account and of technology imports as jointly captured by the inward Foreign Direct Investment (FDI). The ratio of net inward FDI to GDP increased eleven fold from a miniscule 0.07 in 1990 to 0.8 in 2004.  The ratio of Global FDI flows to World GDP however almost doubled from 0.93 to 1.66. Thus, India’s FDI-GDP ratio remained below the World FDI-GDP ratio by 0.86 per cent points.  Overall the opening of the Indian economy to international goods, services and capital improved competitiveness of the domestic producers and accelerated growth.

Growth and Welfare

      Indian Industry responded to the increased competitive pressure and opportunity for import of higher quality input, capital goods and technology by raising the rate of investment and productivity growth, particularly in the corporate sector and thus accelerating economic growth. The growth of per capita income at purchasing power parity accelerated to 4.3 per cent per annum during 1992 to 2004, up 1.4% point from an average 2.9 per cent per annum during 1981 to 1991. Though part (0.6% point)of this was due to an acceleration of World growth, Indian per capita income growth was faster than World average by 2.5% points during the Narsimha-Vajpayee period compared to the 1.7% point gap during 1981-1991 (Indira2-Rajiv). As a result of this growth acceleration, Indian per capita GDP at PPP rose from 18% of average World per capita GDP in 1990-1991 to 24% in 2004.

Lessons For Future

  The economic reforms of the 1990s were wider and deeper than those of the 1980s, overall as well as on the three major dimensions:[i]  Domestic decontrol, tax reform and external liberalization (opening and globalization). Consequently they resulted in a greater acceleration of economic growth relative to average World growth and a faster closing of the gap between the welfare of the average Indian and the average World inhabitant. We need to carry forward and complete the reforms in these three areas, including agriculture decontrol, further simplification of taxes and FDI in Defense, Insurance and Retail.   Reforms have been very limited and hesitant in one dimension, which has been shown to enhance productivity growth: Disinvestment and privatization of the Public sector, including Public sector Banks and Financial institutions, and de-monopolization of infrastructure enterprises.  This is partly due to inertia-the original objectives have long since become irrelevant and practiced only in the breach.  Land market reforms remain flawed and incomplete. Labor laws remain mired in an ideological swamp.[ii] These reforms could yield enormous dividends in terms of Welfare gains in the next two decades! We can only hope that the next government will have the understanding, will and political leadership to carry them out.

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A version of this article appeared on the editorial page of the Times of India on 20th February 2014, under the banner, “Don’t Close Down, Open Up.”  http://timesofindia.indiatimes.com/home/opinion/edit-page/Globalisation-during-Narasimha-Rao-and-Vajpayee-years-was-good-for-growth-and-welfare/articleshow/30689500.cms

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[i] See for instance, Arvind Virmani, “Policy Regimes, Growth and Poverty in India: Lessons of Government Failure and Entrepreneurial Success!, Working Paper No. 170, ICRIER, October 2005.           http://www.icrier.org/page.asp?MenuID=24&SubCatId=175&SubSubCatId=233 or other references  at https://sites.google.com/site/drarvindvirmani/growth

[ii] See Arvind Virmani, "Reform Agenda for Growth and Welfare," Policy Paper No. 1/2014, New Delhi, January 2014; at https://sites.google.com/site/drarvindvirmani/policy-papers or “Reforms for Policy and Growth” at http://dravirmani.blogspot.in/2013/12/reforms-2014-19-for-employment-and.html for further details.

Defence FDI or Imports?

    For 60 years we have been striving to become self sufficient in Defense production with minor success.  Unlike in consumer products where "self sufficiency" is an illusion if not a delusion, "self sufficiency" has real substance in the case of defense production.  One of our cherished and oft proclaimed foreign policy goals is, "strategic autonomy in decision making".  The more we are dependent on imported equipment and ammunition the less strategic autonomy we have in general and particularly in a hot war.

   Given the nature and structure of our economy the simplest and most effective way to achieve self sufficiency in defense is to allow our private sector to produce and sell any and every defense item and to allow up to 100% Foreign direct investment (FDI).  But won't that make us 100% dependent on foreigners?  Well ask yourself the following question. Do you prefer the current situation in which many systems, sub-systems and parts are imported 100% or a new system that is produced in India with 100% FDI.  In the case of import of defense equipment we are completely dependent on others at a time of potential or actual conflict to replace any losses.  In FDI case we have the option to a much greater extent to ramp up production.  Further the transfer of technology is much deeper and more meaningful with FDI as there will be numerous Indians working at different levels of the company who will get hands on experience of the technology, production techniques, sources of supply of components etc.. Over time the technology defuses from the company to other domesic company through mobility of employees and access to better components and parts that the FDI company uses.  This means a deeper and more thorough transfer of technology than any purchase of blueprints can accomplish, particularly if the technology is highly sophisticated.  The technology of defense systems is highly interconnected web of technologies, sub-systems and components that is completely missed by an importer even a sophisticated one such as the defence department.

   To get the maximum benifits from a new policy of up to 100% FDI, I would reccomend the following structure of FDI to be implemented by an FIPB type Defense technology board:

(a) Up to 100% FDI in 1st generation high tech defense technologies (such as those being currently incorporated in the US on its ‘under-development’ defense aircraft & space craft, warships, armored fighting vehicles, missiles and smart bombs).
(b) Up to 74% FDI 2nd generation defense technologies (such as those already incorporated in the advanced Western countries’ frontline, ‘in-service’ fighters, bombers, warships, tanks, arms and ammunition).
(c) Up to 51% FDI in 3rd generation and dual use technologies for (defense) items requiring an industrial license for production by the private sector. This allows the Indian company to be a subsidiary of the home country company and will facilitate transfer of technology that the home country doesn’t allow to be sold to other countries’ companies.

(d) Up to 49% FDI on automatic route.  As Government is the sole buyer of defense equipment and also controls exports of defense equipment, most of these are likely to be in the form of JVs with an Indian private or public sector partner having 51% equity.
     The board would determine the sophistication of the technology and specify the level of FDI accordingly.  Both the domestic private sector and the domestic public sector would be open to participate in joint ventures, depending primarily on the preference of the FDI partner supplying the sophisticated technology.

     One would expect rational FDI investors to prefer private Indian companies for investment in parts components and smaller sub-systems but to hedge their bets vis-a-vis complete system and large sub-system by involving the public sector, as this is more likely to bring in demand from the government.  Public sector units would still be free to produce any item themselves if the can develop or acquire the technology.  The defense technology board can always take suitable account of this when actual cases start coming before it

    The time for introduction of such a policy is particularly apt., given that the USA is now willing to supply the most sophisticated technologies to India, and US companies would be eager to exploit this opportunity given the poor state of Developed country finances and demand for defense products.  The companies form other countries are in a similar position and would be equally eager to compete with the US in participating in this long term opportunity.