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5/16/11

"India’s Accidental Economic Formula"

Taj Mahal, Agra, India.Image via Wikipedia
What is holding India’s economy back?  It’s the restrictions that have survived from the days of Nehru’s infatuation with Soviet-style planning, the “maddening complexities” enforced by New Delhi’s entrenched bureaucracy.

Many had hoped that Prime Minister Manmohan Singh, given his solid reformist credentials, would push liberalization hard.  Yet he has presided over a weak government, stalling on promises of structural change in recent years.
Yet the economy is now in a “golden period.”  Estimates put the increase in gross domestic product for the year ended March 31 at a robust 8.6%.  Growth this year could be even better.
So why is the economy, in the absence of reform, doing so well?  New Delhi’s excessive fiscal and monetary stimulus is part of the answer, of course.
And another reason lies in the feebleness of Singh’s government.  The country’s constitution establishes a federalist system, so state governments can set their own course.  As an April 29 editorial in theWall Street Journal Asia points out, changes at lower levels of the political system are leading to a healthy competition for business and investment.
As the states try to outdo each other, India’s investment climate improves.  A joint report, “Economic Freedom of the States of India: 2011,” highlights the differences among the 20 largest of the Indian states.
The rankings have substantially changed in recent years, indicating a vibrant rivalry.  In the most recent report, Tamil Nadu, Gujarat, and Andhra Pradesh—in that order—were the top stars in economic freedom.  In the previous 2005 report, the list looked a lot different.  Only Tamil Nadu was in the top three then, with Madyha Pradesh and Himachal Pradesh as numbers two and three, respectively.
This now-intense rivalry could even end up moving New Delhi in the right direction.  Abheek Bhattacharya of the Wall Street Journal’s Asian paper noted that the strongest Indian states may end up pushing reform at the national level.  The states are essentially laboratories for nation-wide change, he observed in an interview on the John Batchelor Show last Wednesday.  And laggard states are realizing the need to catch up.  They are, he says, loosening restrictions and removing other impediments to growth.
The reform-from-below model, a direct result of India’s lively democracy, runs counter to accepted wisdom that authoritarianism is needed for economic development these days.  For instance, just about everyone agrees that strong central guidance has been the most important factor responsible for the spectacular rise of the Chinese economy.
Of course, the global narrative has been absolutely correct since 2008 in China, when that country’s growth has been driven by massive state investment.  In 2009, for instance, the country’s planners, either directly or indirectly through the state banks, poured about $1.1 trillion of stimulus into their then-$4.3 trillion economy.  Nobody, however, thinks Beijing’s spendathon is sustainable, especially now that China has built all the “ghost cities” it can afford and now that the country’s banks are burdened by trillions of yuan of questionable loans.
But the accepted narrative was not true before the global downturn, when Chinese growth was more in spite of national planning than because of it.  In reality, the country prospered primarily because of the creation and the development of the private sector, something that President Hu Jintao and predecessor Jiang Zemin were ambivalent about or hostile to.
Even Deng Xiaoping, the so-called architect of reform, succeeded because of defiance of his edicts by the Chinese people, both in the countryside and the city.  If there was one dynamic that existed from the end of 1978—the beginning of the reform era—until the middle of 2008—the beginning of the Great Recession—it is that the planners of the Communist Party have been trying to catch up with Chinese farmers and entrepreneurs as they sought to create their own livelihoods, independent of the mighty state.
There is no doubt that central guidance can jumpstart economic growth, something that has happened in both democratic and authoritarian societies.  Yet both India and China are beyond that stage.
And now, it looks like the Indians, mostly through good fortune, have ended up with a decentralized model of local competition that can continue growth over time, even if paralysis in New Delhi continues.  The Chinese top-down management of the economy—especially with Hu Jintao’s emphasis on renationalization—is a distant second choice for national development.
The vitality of competition will soon become evident as growth stalls in China and soars in India.
Follow me on Twitter @GordonGChang

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