indian model of economic development

8/8/2019 indian model of economic development

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I n d i a n M o d e l O f E c o n o m i c D e v e l o p m e n t P a g e | 2

Abstract

This research paper will tell u about the Economic model of Indian growth. We have chosen five

models and evaluate then that what are the factors which are a hindrances in the path of success.

What are the factors and how we can learn from those problems? How Indian economy moved

from a socialist economy and where it is standing right now. What steps their finance minister

took in order to manage the obstacles.

The economic development of India was dominated by socialist-influenced policies, state-owned

sectors, and red tape & extensive regulations, collectively known as "License Raj". It led the

country and its economy isolated from the world economy. However the scenario started

changing from the mid-1980s, when India began opening up its market slowly through economic

liberalization. The policy played a huge impact on the economic development of India. The

Indian economic development got a boost through its economic reform in 1991 and again

through its renewal in the 2000s. Since then, the face of economic development of India has

changed completely.

The economic reform of 1991 played a pivotal role in the economic development of India.

Reaping its benefit, the growth of the country reached around 7.5% in the late 2000s. It is also

expected to double the average income within a decade. According to the analysts, if India can

push more fundamental market reforms, it will be able to sustain the rate and can even achieve

the government's target of 10% by 2011


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Acknowledgement

I would like to given my first priority toAlmighty Allah, who is the Greatest Creator of universe,

Most Merciful and Omniscient. He is only alone and has no relationship with others. He has own

opinion to do everything. He blessed and inspired me with his compassionate to complete my

research work satisfactory for which I am humblest thankful to God and worship Him.

I also my gratitude with heart and soul to myHoly Prophet(P.B.U.H), the most exalted. He gave

the Islamic constitution to the Muslim to live according to the Islamic rules.

I offer my heartiest gratitude to my honorable teacherDr. Aslam


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D

escription of Background

For half a century before independence, the Indian economy was stagnant. Between 1900 and

1950, economic growth averaged o.8 percent a year -- exactly the same rate as population

growth, resulting in no increase in per capita income. In the first decades after independence,


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economic growth picked up, averaging 3.5 percent from 1950 to 1980. But population growth

accelerated as well. The net effect on per capita income was an average annual increase of just

1.3percent.

Indians mournfully called this "the Hindu rate of growth." Of course, it had nothing to do with

Hinduism and everything to do with the Fabian socialist policies of Prime Minister Jawaharlal

Nehru and his imperious daughter, Prime Minister Indira Gandhi, who oversaw India's darkest

economic decades. Father and daughter shackled the energies of the Indian people under a mixed

economy that combined the worst features of capitalism and socialism. Their model was inward-

looking and import- substituting rather than outward-looking and export-promoting and it denied

India a share in the prosperity that a massive expansion in global trade brought in the post-World

War II era. (Average per capita growth for the developing world as a whole was almost 3 percent

from 1950 to 1980, more than double India's rate) Nehru set up an inefficient and monopolistic

public sector, overregulated private enterprise with the most stringent price and production

controls in the world, and discouraged foreign investment -- thereby causing India to lose out on

the benefits of both foreign technology and foreign competition. His approach also pampered

organized labor to the point of significantly lowering productivity and ignored the education of

India's children.

But even this system could have delivered more had it been better implemented. It did not have

to degenerate into a "license-permit-quota raj," as Chakravarthi Rajagopalachari first put it in the

late 1950s. Although Indians blame ideology (and sometimes democracy) for their failings, the

truth is that a mundane inability to implement policy -- reflecting a bias for thought and against

action -- may have been even more damaging.


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In The 1980s, The Government's Attitude

In the 1980s, the government's attitude toward the private sector began to change, thanks in part

to the underappreciated efforts of Prime Minister Rajiv Gandhi. Modest liberal reforms --

especially lowering marginal tax rates and tariffs and giving some leeway to manufacturers --

spurred an increase in growth to 5.6 percent. But the policies of the 1980s were also profligate

and brought India to the point of fiscal crisis by the start of the 1990s. Fortunately, that crisis

triggered the critical reforms of 1991, which finally allowed India's integration into the global

economy -- and laid the groundwork for the high growth of today. The chief architect of those

reforms was the finance minister, Manmohan Singh, who is now prime minister. He lowered

tariffs and other trade barriers, scrapped industrial licensing, reduced tax rates, devalued the

rupee, opened India to foreign investment, and rolled back currency controls. Many of these

measures were gradual, but they signaled a decisive break with India's dirigiste past. The

economy returned the favor immediately: growth rose, inflation plummeted, and exports and

currency reserves shot up.

To appreciate the magnitude of the change after 1980, recall that the West's Industrial Revolution

took place in the context of 3 percent GDP growth and 1.1 percent per capita income growth. If


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India's economy were still growing at the pre-1980 level, then its per capita income would reach

present U.S. levels only by 2250; but if it continues to grow at the post-1980 average, it will

reach that level by 2066 -- a gain of 184 years.

India has improved its competitiveness considerably since 1991: there has been a

telecommunications revolution, interest rates have come down, capital is plentiful (although risk-

averse managers of state- owned banks still refuse to lend to small entrepreneurs), highways and

ports have improved, and real estate markets are becoming transparent. More than 100 Indian

companies now have a market capitalization of over a billion dollars, and some of these --

including Bharat Forge, Jet Airways, Infosys Technologies, Reliance Info comm., Tata Motors,

and Wipro Technologies -- are likely to become competitive global brands soon. Foreigners have

invested in over 1,000 Indian companies via the stock market. Of the Fortune 500 companies,

125 now have research and development bases in India -- a testament to its human capital. And

high-tech manufacturing has taken off. All these changes have disciplined the banking sector.

Bad loans now account for less than 2 percent of all loans (compared to 20 percent in China),

even though none of India's shoddy state-owned banks has so far been privatized.

For now, growth is being driven by services and domestic consumption. Consumption accounts

for 64 percent of India's GDP, compared to 58 percent for Europe, 55 percent for Japan, and 42

percent for China. That consumption might be a virtue embarrasses many Indians, with their

ascetic streak, but, as the economist Stephen Roach of Morgan Stanley puts it, "India's


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consumption-led approach to growth may be better balanced than the resource-mobilization

model of China."

India's Entrepreneur-Driven Growth And China's State-Centered Model

The contrast between India's entrepreneur-driven growth and China's state-centered model is

stark. China's success is largely based on exports by state enterprises or foreign companies.

Beijing remains highly suspicious of entrepreneurs. Only 10 percent of credit goes to the private

sector in China, even though the private sector employs 40 percent of the Chinese work force. In

India, entrepreneurs get more than 80 percent of all loans. Whereas Jet Airways, in operation

since 1993, has become the undisputed leader of India's skies, China's first private airline, Okay

Airways, started flying only in February 2005.

What has been peculiar about India's development so far is that high growth has not been

accompanied by a labor-intensive industrial revolution that could transform the lives of the tens

of millions of Indians still trapped in rural poverty. Many Indians watch mesmerized as China

seems to create an endless flow of low-end manufacturing jobs by exporting goods such as toys

and clothes and as their better- educated compatriots export knowledge services to the rest of the

world. They wonder fearfully if India is going to skip an industrial revolution altogether,

jumping straight from an agricultural economy to a service economy. Economies in the rest of

the world evolved from agriculture to industry to services. India appears to have a weak middle

step. Services now account for more than 50 percent of India's GDP, whereas agriculture's share

is 22 percent, and industry's share is only 27 percent (versus 46 percent in China). And within

industry, India's strength is high-tech, high-skilled manufacturing.


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Even the most fervent advocates of service-based growth do not question the desirability of

creating more manufacturing jobs. The failure of India to achieve a broad industrial

transformation stems in part from bad policies. After India's independence, Nehru attempted a

state- directed industrial revolution. Since he did not trust the private sector, he tried to replace

the entrepreneur with the government -- and predictably failed. He shackled private enterprise

with byzantine controls and denied autonomy to the public sector. Perhaps the most egregious

policy was reserving around 800 industries, designated "small-scale industries" (SSI), for tiny

companies that were unable to compete against the large firms of competitor nations. Large firms

were barred from making products such as pencils, boot polish, candles, shoes, garments, and

toys -- all the products that helped East Asia create millions of jobs. Even since 1991, Indian

governments have been afraid to touch this "SSI holy cow" for fear of a backlash from the SSI

lobby. Fortunately, that lobby has turned out to be mostly a phantom -- little more than the

bureaucrats who kept scaring politicians by warning of a backlash. Over the past five years, the

government has been pruning the list of protected industries incrementally with no adverse

reaction.

In the short term, the best way for India to improve the lot of the rural poor might be to promote

a second green revolution. Unlike in manufacturing, India has a competitive advantage in

agriculture, with plenty of arable land, sunshine, and water. To achieve such a change, however,

India would need to shift its focus from peasant farming to agribusiness and encourage private

capital to move from urban to rural areas. It would need to lift onerous distribution controls,


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I n d i a n M o d e l O f E c o n o m i c D e v e l o p m e n t P a g e |

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allow large retailers to contract directly with farmers, invest in irrigation, and permit the

consolidation of fragmented holdings.

Indian entrepreneurs also still face a range of obstacles, many of them the result of lingering bad

policies. Electric power is less reliable and more expensive in India than in competitor nations.

Checkpoints keep trucks waiting for hours. Taxes and import duties have come down, but the

cascading effect of indirect taxes will continue to burden Indian manufacturers until a uniform

goods-and-services tax is implemented. Stringent labor laws continue to deter entrepreneurs from

hiring workers. The "license raj" may be gone, but an "inspector raj" is alive and well; the

"midnight knock" from an excise, customs, labor, or factory inspector still haunts the smaller

entrepreneur. Some of these problems will hopefully diminish with the planned designation of

new "economic zones," which promise a reduced regulatory burden.

Economic history teaches that the Industrial Revolution as it was experienced by the West was

usually led by one industry. It was textile exports in the United Kingdom, railways in the United

States. India, too, may have found the engine that could fuel its takeoff and transform its

economy: providing white-collar services that are outsourced by companies in the rest of the

world. Software and business-process outsourcing exports have grown from practically nothing

to $20 billion and are expected to reach $35 billion by 2008. The constraining factor is likely to

be not demand but the ability of India's educational system to produce enough quality English-

speaking graduates.


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High-Tech Manufacturing

Meanwhile, high-tech manufacturing, a sector where India is already demonstrating considerable

strength, will also begin to expand. Perhaps in a decade, the distinction between China as "the

world's workshop" and India as "the world's back office" will slowly fade as India's

manufacturing and China's services catch up.

It is an amazing spectacle to see prosperity beginning to spread in today's India even in the

presence of appalling governance. In the midst of a booming private economy, Indians despair

over the lack of the simplest public goods. It used to be the opposite: during India's socialist

days, Indians worried about economic growth but were proud of their world-class judiciary,

bureaucracy, and police force. But now, the old centralized bureaucratic Indian state is in steady

decline. Where it is desperately needed -- in providing basic education, health care, and drinking

water -- it has performed appallingly. Where it is not needed, it has only started to give up its

habit of stifling private enterprise.

Labor laws, for example, still make it almost impossible to lay off a worker -- as the infamous

case of Uttam Nakate illustrates. In early 1984, Nakate was found at 11:40 AM sleeping soundly

on the floor of the factory in Pune where he worked. His employer let him off with a warning.

But he was caught napping again and again. On the fourth occasion, the factory began

disciplinary proceedings against him, and after five months of hearings, he was found guilty and

sacked. But Nakate went to a labor court and pleaded that he was a victim of an unfair trade

practice. The court agreed and forced the factory to take him back and pay him 50 percent of his


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lost wages. Only 17 years later, after appeals to the Bombay High Court and the national

Supreme Court, did the factory finally win the right to fire an employee who had repeatedly been

caught sleeping on the job.

Although the world has just discovered it, India's economic success is far from new. After three

post independence decades of meager progress, the country's economy grew at 6 percent a year

from 1980 to 2002 and at 7.5 percent a year from 2002 to 2006 -- making it one of the world's

best-performing economies for a quarter century. In the past two decades, the size of the middle

class has quadrupled (to almost 250 million people), and 1 percent of the country's poor have

crossed the poverty line every year. At the same time, population growth has slowed from the

historic rate of 2.2 percent a year to 1.7 percent today -- meaning that growth has brought large

per capita income gains, from $1,178 to $3,051 (in terms of purchasing-power parity) since

1980. India is now the world's fourth-largest economy. Soon it will surpass Japan to become the

third-largest.

The notable thing about India's rise is not that it is new, but that its path has been unique. Rather

than adopting the classic Asian strategy -- exporting labor-intensive, low-priced manufactured

goods to the West -- India has relied on its domestic market more than exports, consumption

more than investment, services more than industry, and high-tech more than low-skilled

manufacturing. This approach has meant that the Indian economy has been mostly insulated from

global downturns, showing a degree of stability that is as impressive as the rate of its expansion.

The consumption-driven model is also more people-friendly than other development strategies.

As a result, inequality has increased much less in India than in other developing nations. (Its Gini


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index, a measure of income inequality on a scale of zero to 100, is 33, compared to 41 for the

United States, 45 for China, and 59 for Brazil.) Moreover, 30 to 40 percent of GDP growth is due

to rising productivity -- a true sign of an economy's health and progress -- rather than to increases

in the amount of capital or labor.

But what is most remarkable is that rather than rising with the help of the state, India is in many

ways rising despite the state. The entrepreneur is clearly at the center of India's success story.

India now boasts highly competitive private companies, a booming stock market, and a modern,

well-disciplined financial sector. And since 1991 especially, the Indian state has been gradually

moving out of the way - - not graciously, but kicked and dragged into implementing economic

reforms. It has lowered trade barriers and tax rates, broken state monopolies, unshackled

industry, encouraged competition, and opened up to the rest of the world. The pace has been

slow, but the reforms are starting to add up.

India is poised at a key moment in its history. Rapid growth will likely continue -- and even

accelerate. But India cannot take this for granted. Public debt is high, which discourages

investment in needed infrastructure. Overly strict labor laws, though they cover only 10 percent

of the work force, have the perverse effect of discouraging employers from hiring new workers.

The public sector, although much smaller than China's, is still too large and inefficient -- a major

drag on growth and employment and a burden for consumers. And although India is successfully

generating high-end, capital- and knowledge- intensive manufacturing, it has failed to create a

broad-based, labor- intensive industrial revolution -- meaning that gains in employment have not

been commensurate with overall growth. Its rural population, meanwhile, suffers from the


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consequences of state-induced production and distribution distortions in agriculture that result in

farmers' getting only 20 to 30 percent of the retail price of fruits and vegetables (versus the 40 to

50 percent farmers in the United States get).

India can take advantage of this moment to remove the remaining obstacles that have prevented

it from realizing its full potential. Or it can continue smugly along, confident that it will get there

eventually -- but 20 years late. The most difficult reforms are not yet done, and already there are

signs of complacency.


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Economic Models And Reasons Of Their Failure

Rostow's Stages Of Growth Theory

It assumes that every nation has an inherent tendency to aim for development and progressively

strive towards that goal. But there are no guidelines in this model on the motivational tool for a

progress goal development, to lead towards such take-off sages from under-developed to

development, and measure the development. Just after independence in 1947, India followed the

first Five Year Plan with emphasis on unilateral agricultural development, the Second Year Five

Year Plan with unilateral industrialization etc...with foreign assistance. Uni-directional

agriculture and industrialization without Domestic sources, as well as without equal updates in

Domestic Human and Technological infrastructure based on Rostow's theory, does not lead the

nation to an improved stage of development. Also the Productivity aspect of development was


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not taken into account by this model. In the Management decision for development, the influence

of intangible factors was never considered. These are the reason for the failure of this model in a

nation like India, which has a fairly high level of tangible wealth / intelligentsia as well as

intangible social and economic disparities.

Harrod-Domar Growth Model

It shows that in order to grow, economies must save and invest a certain portion of their GNP. If

more they can save and invest, the faster they grow. If we look at the relationship between

savings and economic growth in India, we find the paradox of high savings and low growth

despite preferential tax treatment to savings. It is because of the fact that Domestic Investments

from Domestic Savings (Exogenous component) is an one-sided guideline, without their proper

synchronization formula among them, and without reference to Domestic Human potential and

Technology (Endogenous component). Government decisions with reference to Socio-Economic

Development orientation, practical Productivity measures, as well as the influences of intangible

aspects are not a part of this model. These have resulted in a paradoxical situation in India

Structural Models (Primarily Lewis Model) Of Growth

this focuses on transfer of labor from agriculture, where there is surplus labor, to the modern

industrial sector where employment and productivity are expected to rise. This model considers

the possibility of the Endogenous component of Domestic Human potential transfers, without

any reference to the appropriate Domestic technology, and the need to synchronies them with

Human component. Also assumption on Productivity rise in this model is quantity oriented and

not Socio-Economic development oriented. Hence lob-sided Management decisions based on


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this model, without due consideration to the influence of intangible components, failed to bring-

in the expected development in India, having large resources and qualified/skilled surplus labor.

The International Dependence Model

This draws heavily from the Prebisch-Singer thesis that describes the existence of unequal

international power imbalances as the cause of under-development in developing countries.

Closure to developed international power and their market, truncates the development of a

nation, by not taking advantage of their Research and Development know-how, as well as the

production possibility of their needs at competitive domestic costs, prevailing due to lower level

of development. Hence, it is always wise to take advantage of international power and assistance

to start with, and progressively increase Domestic Investments from Domestic savings

(Exogenous component). Also simultaneous development of Domestic Human potential to suit

the Domestic Technology (latest Endogenous component from the international power

moderated to suit local needs), are not part of the Prebisch-Singer model. International influence

is an intangible component, and it should be utilized with proper precautions, with an eye on the

measurement of the Productivity of the nation, with reference to Socio-Economic development

units. The effect is that all the nationalized sectors as well as those in the exclusive control of the

government in India are progressively offered to private parties, including competitive bidders

from international locations.

Bottom Line

The central focus of the non-classical counter-revolution in favor of Supply-side Macro-

economics is that, under development results from too much state intervention by the Third

World governments. Reducing government controls and taxes are incentives for investment. But


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those who invest not necessarily follow the guidelines of exogenous rule of progressive

Domestic Investment from Domestic savings, and Endogenous rule of progressive Domestic

Technology with Domestic Human potential, and both their synchronization. Also these should

be backed with Socio-Economic development oriented Productivity approaches and

Management Decision should be oriented with due consideration for the intangible aspects.

Unless all these complex components are taken care, there cannot be any improvement in the

national Socio-Economic development. This is what is happening to India, even after 61 years of

Independence.

India Economic Policy

India Economic Policy plays a major role in determining various government actions on the

economic field. Depending on the India economic policy, the government of India initiates

various actions including preparing budget, setting interest rates etc. The economic policy also

influences the national ownership, labor market, and several other economic areas where

government intervention is required.

There are a number of internal factors like political beliefs and policies of the parties etc. that

play pivotal roles in determining the economic policy of India. Besides these, like all other

countries, Indian economic policy also gets influenced by various international institutions like

the World Bank and the International Monetary Fund (IMF) etc.


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The Economic Policy

The year 1991 was a significant one when it comes to Indian economic policy. The year saw a

major economic policy reform, which resulted in shifting the direction of India economic policy

from the post-independence era.

Indian Economic Policy Prior To 1991

Prior to 1991, the colonial experience and the Fabian-socialistic approach had a great influence

over India economic policy. The policy had got inclination towards protectionism, where

emphasis was given on industrialization, import substitution, business regulation, state

intervention in labor and financial markets, and central planning. The India economic policy

during that time had three basic features:

Autarchic trade policy

Extension of public sector

Direct, discretionary and quantitative controls on private sector

All the above three features interacted in both the institutional environment of functioning

markets as well as private ownership of means of production. It generated perverse incentives,

which resulted in economic growth of mere 3.5 percent per annum.

It was the first Prime Minister of India, Jawaharlal Nehru, along with noted statistician Prasanta


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Chandra Mahalanobis, who formulated and supervised economic policy of India after its

independence. The concept of Five-Year Plans came into existence, which were influenced by

the central planning in the Soviet Union. A number of industries were nationalized during the

mid-1950s, which include telecommunication, mining, steel, water, machine tools, electrical

plants, insurance and a few more. Setting up new businesses required elaborated licenses and

regulations. Red tapeism was also a part of it between 1947 and 1990.

The economic policy formulated by Nehru and Mahalanobis was based on direct and indirect

state intervention. Though they were quite optimistic about the success of their policy, economist

Milton Friedman later criticized their policy which concentrates on capital and technology-

intensive heavy industry as well as subsidizing manual, low-skill cottage industry at the same

time. According to Friedman, it would waste capital and labor and would slow down the growth

of small manufacturers.

Indian Economic Policy After 1991

India saw an economic policy reform in 1991. During the late 80s, government of India took

some bold decisions and started easing restrictions on capacity expansion, reduced corporate

taxes and removed price controls etc. These led to enhancement in growth rate, which in turn led

to high fiscal deficits and aggravating current account. Further, fall down of Soviet Union, which

was a major trading partner of India, and the first Gulf War which caused a sharp rise in the oil

prices, compelled India to face a major balance-of-payments crisis.

In this crucial juncture, the then Prime Minister Narasimha Rao and his Finance Minister


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Manmohan Singh initiated the economic liberalization, which changed the economic face of the

country. The reforms put an end to Red tapeism and also to several public monopolies. Foreign

direct investments in a number of sectors started pouring in.

During the last few years of economic reforms, India saw some important changes in the

liberalization and rationalization of:

Domestic And Foreign Investment Import And Export Trade Controls Tax Structure Public And Financial Activities

India Economic Development

Agriculture, services and manufacturing industries play a vital role in the development of the

Indian economy. The IT outsourcing, software and call center/ BPO industries, in particular,

have helped skyrocket Indias economic development in recent years.

Economic development in India still depends on the various sectors that constitute the Indian

economy agriculture, services and manufacturing industries.


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India is rated as one of the top economies in the world in terms of purchasing power parity (PPP)

of the gross domestic product (GDP) by leading financial entities of the world, such as the

International Monetary Fund, the World Bank, and the CIA (as referenced in the CIA World

Factbook).

As far as agriculture is concerned, India is the second largest in volume of output. Certain related

sectors of agriculture have played a major role in the development of the Indian economy by

providing employment to a number of people in the forestry, fishing and logging industries

In 2009, the agricultural sector contributed 17.5% to the entire GDP, and more than 50% of the

total labor force working in India is employed in the agricultural sector.

Production volume has gone up in Indian agriculture at a consistent rate since the 1950s. Much

of this improvement can be attributed to the five-year plans that were established for the

development of Indian agriculture. Developments in irrigation processes, as well as various

modern technologies used have contributed to the overall advancement of agricultural processes

Substantial amounts of research and development have been carried out in the agricultural space

in India by organizations such as the Indian Agricultural Research Institute, the Indian

Agricultural Research Statistics Institute and the Indian Council of Agricultural Research.

In the industrial arena, India is 14th in terms of volume of factory output. Various developmental

initiatives are also being carried out in the areas of gas, mining, electricity and quarrying. All

these sectors contribute significantly to the GDP, and provide jobs to Indias citizens.

India is regarded as the 15th best economy in terms of production in the services sector. A

sizeable amount of the Indian workforce is also employed by the service sector. In the ten-year


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period between 1990 and 2000, the rate of growth has been 7.5%, up from 4.5% during the 30-

year period from 1951 to 1980.

Verticals, such as information technology (IT), software development, call centers, IT

outsourcing, Business Process Outsourcing (BPO) and other IT-enabled services, have been the

biggest contributors in the services sector of the Indian economy.

An increasing number of Indian companies have emerged as leading global players. The

following Indian companies are part of the Forbes Global 2000 list for the year 2009:

Reliance Industries Limited (RIL)

State Bank of India (SBI)

Oil and Natural Gas Corporation (ONGC)

Steel Authority of India Limited (SAIL)

Reliance Communications

Larsen and Toubro Limited (L&T)

Bharat Petroleum Corporation Limited (BPCL)

Bharat Heavy Electricals Limited (BHEL)

HDFC Bank

Tata Consultancy Services (TCS)


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Economic Prospects for 2010

The global economy seems to be recovering after the recent economic shock. The Indian

economy, however, was hit in the latter part of the global recession and the real economic growth

witnessed a sharp fall, followed by lower exports, lower capital outflow and corporate

restructuring. It is expected that the global economies will continue to sustain in the short-term,

as the effect of stimulus programs is yet to bear fruit and tax cuts are working their way through

the system in 2010. Due to the strong position of liquidity in the market, large corporations now

have access to capital in the corporate credit markets.

Indian Economy 2010

In order to sustain economic growth during the time of the worst recession, government

authorities in India have announced the stimulus packages to prop up economic growth. To

finance the stimulus packages, the Indian government has raised over $100 billion over the last

four quarters in a way to finance the stimulus package. The countrys public debt, according to

the RBI, has surged to over 50% of the total GDP and the RBI has started printing new currency

notes.

The India Model

Although the world has just discovered it, India's economic success is far from new. After three

post independence decades of meager progress, the country's economy grew at 6 percent a year

from 1980 to 2002 and at 7.5 percent a year from 2002 to 2006 -- making it one of the world's


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best-performing economies for a quarter century. In the past two decades, the size of the middle

class has quadrupled (to almost 250 million people), and 1 percent of the country's poor have

crossed the poverty line every year. At the same time, population growth has slowed from the

historic rate of 2.2 percent a year to 1.7 percent today -- meaning that growth has brought large

per capita income gains, from $1,178 to $3,051 (in terms of purchasing-power parity) since

1980. India is now the world's fourth-largest economy. Soon it will surpass Japan to become the

third-largest.

The notable thing about India's rise is not that it is new, but that its path has been unique. Rather

than adopting the classic Asian strategy -- exporting labor-intensive, low-priced manufactured

goods to the West -- India has relied on its domestic market more than exports, consumption

more than investment, services more than industry, and high-tech more than low-skilled

manufacturing. This approach has meant that the Indian economy has been mostly insulated from

global downturns, showing a degree of stability that is as impressive as the rate of its expansion.

The consumption-driven model is also more people-friendly than other development strategies.

As a result, inequality has increased much less in India than in other developing nations. (Its Gini

index, a measure of income inequality on a scale of zero to 100, is 33, compared to 41 for the

United States, 45 for China, and 59 for Brazil.) Moreover, 30 to 40 percent of GDP growth is due

to rising productivity -- a true sign of an economy's health and progress -- rather than to increases

in the amount of capital or labor.

But what is most remarkable is that rather than rising with the help of the state, India is in many

ways rising despite the state. The entrepreneur is clearly at the center of India's success story.


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India now boasts highly competitive private companies, a booming stock market, and a modern,

well-disciplined financial sector. And since 1991 especially, the Indian state has been gradually

moving out of the way - - not graciously, but kicked and dragged into implementing economic

reforms. It has lowered trade barriers and tax rates, broken state monopolies, unshackled

industry, encouraged competition, and opened up to the rest of the world. The pace has been

slow, but the reforms are starting to add up.

India is poised at a key moment in its history. Rapid growth will likely continue -- and even

accelerate. But India cannot take this for granted. Public debt is high, which discourages

investment in needed infrastructure. Overly strict labor laws, though they cover only 10 percent

of the work force, have the perverse effect of discouraging employers from hiring new workers.

The public sector, although much smaller than China's, is still too large and inefficient -- a major

drag on growth and employment and a burden for consumers. And although India is successfully

generating high-end, capital- and knowledge- intensive manufacturing, it has failed to create a

broad-based, labor- intensive industrial revolution -- meaning that gains in employment have not

been commensurate with overall growth. Its rural population, meanwhile, suffers from the

consequences of state-induced production and distribution distortions in agriculture that result in

farmers' getting only 20 to 30 percent of the retail price of fruits and vegetables (versus the 40 to

50 percent farmers in the United States get).

India can take advantage of this moment to remove the remaining obstacles that have prevented

it from realizing its full potential. Or it can continue smugly along, confident that it will get there

eventually -- but 20 years late. The most difficult reforms are not yet done, and already there are


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signs of complacency.

Economic Development In India: The Role Of Individual Enterprise,

(And Entrepreneurial Spirit)

The Indian economy provides a revealing contrast between how individuals react under a

government-controlled environment and how they respond to a market-based environment.

Evidence suggests that recent market reforms that encouraged individual enterprise have led to

higher economic growth in that country. India can generate additional economic growth by

fostering entrepreneurial activity within its borders. To pursue further the entrepreneurial

approach to economic growth, India must now provide opportunities for

(1) Education directed specifically at entrepreneurial skills,

(2) Financing of entrepreneurial efforts, and

(3) Networking among potential entrepreneurs and their experienced counterparts.

Further, although the Indian government should establish policies supportive of entrepreneurial

efforts, its role overall should be minimized so that the influence of the free market and

individual self-interest can be fully realized.


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Economic development, achieved largely through productivity growth, is very important to both

developed and developing nations. However, even though we know that higher productivity

leads to improved economic outcomes (for example, higher income, more choices to the

consumers, better quality products, etc.), there has been no consensus among researchers about

either the desired path of development or the role of state in economic development. Concerning

the path of development, that the appropriate strategy for any country depends not only on its

objective economic situation but also on its government policies and national views regarding

the appropriate role of the state. Regarding the appropriate role of the state, it seems that for

every argument in favor of a smaller government role one can find a counter argument in favor

of a more active government role.

The role of the state in economic development began to change dramatically with the advent of

the Industrial Revolution. In the West, the resulting industrialization and economic development

were based on the establishment of individual property rights that encouraged the growth of

private capital. Competition and individual enterprise thrive in this environment because

individuals pursue their self-interest of survival and wealth accumulation. The instinct to survive

under competitive pressures yields innovation and productivity increases, which eventually lead

to both increased profits for business and lower prices to consumers. However, the rise and

spread of capitalism led a number of thinkers to examine the consequences of the market-based

approach to development. Socialists argued that capitalism (or private ownership of capital) can

lead to greater inequalities of income and wealth, while developmental economists argued that

private decisions may not always lead to socially desirable outcomes (particularly) in the case of

market imperfections). Indeed, many policymakers at the time saw market failures as quite


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common and therefore assumed that only appropriate government interventions could guide an

economy to a path of sustained economic development

In the early 20th century, the former Soviet Union attempted a bold experiment of improving

individual well-being without sacrificing the objective of greater equality of income and wealth

through total ownership of capital by the government. Initially, the Soviet Government was able

to raise productivity through directed industrialization and, within a span of 25 years (by the end

of World War II), emerged as a superpower. It was around this time that a substantial number of

colonized nations were gaining their independence (for example, India, Pakistan and Burma).

Unfortunately, during their time as colonies to the Western nations, these countries, for the most

part, had been deprived of the industrialization that had engulfed those same Western nations.

Based on the successful experience of the former Soviet Union, many economists and

policymakers concluded that, particularly in a poor country, planning was essential for the

efficient allocation of an economys resources

The history of U.S. business has shown how the pursuit of self-interest by individual economic

agents has led to benefits for the larger society. Consider the well-known example of Henry

Fords introduction of assembly line production. This technological advancement led to a

significant increase in productivity at Ford Motor Company. Indeed, despite paying higher wages

to his workers, Ford could still produce automobiles at a much lower cost and pass on part of that

lower cost to consumers in terms of lower prices.

The governments in these newly independent nations assumed a significant role in economic

development. They sought to quickly and substantially raise the standard of living through

directed and controlled economic development. Apart from everything else, these developing


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countries invested heavily in education to promote literacy and to ensure an adequate supply of

technical manpower to meet their growing needs. Further, these previously colonized nations did

not want to subject their poor and weak economies to international economic fluctuations and

thus sought to industrialize through import substituting industrialization, where imports were

expected to be increasingly replaced by domestic production.

In this paper we examine economic development in India, a former British colony that became

one of the most closed economies in the world, to contrast the roles of government intervention

and individual enterprise in that countrys economic growth. In particular, we demonstrate that,

given recent economic reforms in India, along with the evidence for the role that individual

enterprise can play in a countrys economic growth, the Indian government should devise

policies that rely more on individual enterprise, with its emphasis upon individual initiative and

self-interest, to spur economic development. Further, we describe the special role that can be

played in the economic development of India by a greater emphasis upon entrepreneurship.

The plan of the paper is as follows. Section I summarizes the strategy of economic development

and the overall economic environment that has prevailed in India since its independence from the

United Kingdom. Section II analyses the consequences of regulated economic development in

India, with particular emphasis on the implications of the microeconomic aspects of Indias

approach to its economic environment. Section III assesses the results of Indias economic

reforms since the countrys economic crisis of 1990, and highlights the role that individual

enterprise has played and can continue to play in that countrys economic fortunes.

Indias Strategy Of Economic Development


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Indias economic development strategy immediately after Independence was based primarily on

the Mahalanobis model, which gave preference to the investment goods industries sector, with

secondary importance accorded to the services and household goods sector For example, the

Mahalanobis model placed strong emphasis on mining and manufacturing (for the production of

capital goods) and infrastructural development (including electricity generation and

transportation). The model downplayed the role of the factory goods sector because it was more

capital intensive and therefore would not address the problem of high unemployment in India.

Any increase in planned investments in India required a higher level of savings than existed in

the country. Because of the low average incomes in India, the needed higher levels of savings

had to be generated mainly by restrictions on the growth of consumption expenditures.

Therefore, the Indian government implemented a progressive tax system not only to generate the

higher levels of savings but also to restrict increases in income and wealth inequalities. Among

other things, this strategy involved canalization of resources into their most productive uses.4

Investments were carried out both by the government and the private sector, with the government

investing in strategic sectors (such as national defense) and also those sectors in which private

capital would not be forthcoming because of lags or the size of investment required (such as

infrastructure). The private sector was required to contribute to Indias economic growth in ways

envisaged by the government planners. Not only did the government determine where businesses

could invest in terms of location, but it also identified what businesses could produce, what they

could sell, and what prices they could charge.

Thus the strategy of economic development in India meant

(1) Direct participation of the government in economic activities such as production and selling

and


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(2) Regulation of private sector economic activities through a complex system of controls.

In addition, the Indian economy was sheltered from foreign competition through use of both the

infant industry argument and a binding foreign exchange constraint. Imports were limited to

goods considered essential either to the development of the economy (such as raw materials and

machines) or to the maintenance of minimal living standards (such as crude oil and food items).

It was further decided that exports should play a limited role in economic development, thereby

minimizing the need to compete in the global market place. As a result, India became a relatively

closed economy, permitting only limited economic transactions with other countries. Domestic

producers were sheltered from foreign competition not only from abroad but also from within

India itself

The huge savings-investments gap could not be filled by the amount of foreign aid that was both

sought and available. Further, additional foreign investments (both direct and portfolio) were

never seriously considered as a way to close this savings-investment gap. Higher levels of

income and wealth were taxed at much higher rates relative to lower income and wealth Further

as, the marginal rate of taxation including a tax surcharge was93.5 per cent in early 1970s. In

India, this meant transfer of savings from the private to the public sector.

Over time, India created a large number of government institutions to meet the objective of

growth with equity. The size of the government grew substantially as it played an increasingly

larger role in the economy in such areas as investment, production, retailing, and regulation of

the private sector. For example, in the late1950s and 1960s, the government established public

sector enterprises in such areas as production and distribution of electricity, petroleum products,

steel, coal, and engineering goods. In the late 1960s, it nationalized the banking and insurance


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sectors. To alleviate the shortages of food and other agricultural outputs, it provided modern

agricultural inputs (for example farm machinery, irrigation, high yielding varieties of seeds,

chemical fertilizers) to farmers at highly subsidized prices (World Economic Indicators, 2001).

In 1970, to increase foreign exchange earnings, it designated exports as a priority sector for

active government help and established, among other things, a duty drawback system,

programmers of assistance for market development, and 100 per cent export-oriented entities to

help producers export (Government of India, 1984). Finally, from the late 1970s through the

mid-1980s, India liberalized imports such that those not subject to licensing as a proportion to

total imports grew from five per cent in 1980-1981 to about 30 per cent in1987-1988 However,

this partial removal of quantitative restrictions was accompanied by a steep rise in tariff rates.

This active and dominant participation by the government in economic activities resulted in the

creation of a protected, highly-regulated, public sector-dominated economic environment. Along

with this government domination of the economy, India soon faced not only some major

problems in its overall approach to development, particularly in the area of industrialization, but

also a dramatic increase in corruption in its economy. Finally, like any other growing economy,

the Indian economy faced a number of serious sectoral imbalances, with shortages in some

sectors and surpluses in others. These consequences of Indias government-controlled economy

are discussed in depth in the next section.

The Consequences Of Indias Regulated Economic Development

Indias environment of regulated economic development led to the formulation of policies that

were concerned with both macroeconomic and microeconomic aspects. Whereas much attention

in the literature has been devoted to the macroeconomic issues, we focus primarily on the

microeconomic aspects of Indian economic policies. In particular, we examine how individuals


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guided by their self-interests of survival and wealth accumulation will act in a regulated

environment, which in fact discourages the pursuit of those self-interests. To do so, we describe

the consequences of Indias use of price ceilings, in which prices are set below their equilibrium

level to make products and services affordable to relatively poorer sections of the society.

How price ceilings can influence a nations economy. Specifically, when prices are kept

artificially low, demand outstrips supply. To alleviate the resulting shortage of products and

services, the government can either help to increase the supply or help to decrease demand for

those products and services. Considering the supply side options first, the government had the

following choices:

(1) Increase the price of the product;

(2) Subsidize production of existing suppliers so they will produce and sell more;

(3) Encourage new businesses to enter the line of production and selling; or

(4) Permit imports to reduce or eliminate the shortage.

In India, none of these options was seen as satisfactory. First, the government certainly did not

wish to increase prices, because price ceilings appealed to a majority of the vote bank. Second,

although the government did subsidize production in several sectors considered essential, the

resulting increased production was not sufficient to eliminate the large shortages. Third, the

government decided to restrict rather than increase the entry of new producers under the pretext

of directing scarce resources into their efficient uses. Finally, it allowed only limited recourse to

imports, in order to protect Indian producers, unless the shortage reached a stage of crisis. The

overall result was that inadequate amounts of products and services were supplied to the market.


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In contrast to the supply side options just considered, if the government had decided instead to

limit demand, it could have done so by increasing taxes or by regulating the level of demand

itself, usually by restricting how much an individual or a family could consume. To ensure the

availability of the scarce products and services to Indian consumers, albeit at less than desired

levels, the Indian government in fact resorted to large-scale rationing. This rationing was

undertaken by government agencies themselves or by licensed private retailers. As might be

expected, the rationing regulations required those licensed private retailers to follow government

stipulations in their sale of the scarce products and services. The policy of price ceilings, along

with the quantitative restrictions on production and consumption, led to an economic

environment ripe for corruption. Specifically, because of the general scarcity of products and

services, individuals competed to receive the privilege of economic rights to produce or

consume. The implementing authority responsible for allocating these economic rights

politicians, government officials and businesses enjoyed monopoly power in this situation and,

as might be expected, was susceptible to bribes and other illegal favors. The result was an

informal and illegal market in which the desired economic rights could be traded. Also, the lure

of higher profits led producers and sellers

(1) To have little concern for quality such that many deliberately produced and sold inferior

quality products, and

(2) To resort to the creation of artificial shortages by not releasing to the market all of the

products that were available for selling

Corruption as the use of public office for private gain, in which an official entrusted with the

responsibility for certain public duties engages in malfeasance for personal enrichment that is not


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easy to monitor. He says that corruption has multiple effects on economic development. For

example, it diminishes the efficiency of economic transactions, because corrupt officials will

delay or otherwise obstruct those transactions until they receive their expected favors. Also, the

payment of a bribe to receive an investment license tends to reduce the incentive to invest.

Honest investors will see the futility of competing with dishonest investors who are guaranteed,

through their bribes, to receive the privilege of investment rights

. To fully understand the widespread nature of the corruption that existed in India at this time, it

is necessary to consider the roles played by the many participants. For example, business people

bribed government officials not only for the right to enter a particular line of business, but also to

prevent others from entering that same line of business. Government officials made payoffs to

politicians to receive the premium government positions that would allow them to easily contact

businesses to seek illegal income and wealth. Indeed, as Wade indicates, those officials could

earn far more through bribes and other corrupt behavior than they could earn in salary.

Consumers bribed government officials, politicians, and business people to receive a particular

amount of a scarce good or a higher quality version of the good. Even individuals and

organizations outside India took part in the corruption.

Some bribed both officials and politicians, particularly those connected with the revenue and

police departments, to smuggle scarce goods into India at a high profit.

The complex system of government controls, including price ceilings, along with the resultant

corruption, meant that decision making was arbitrary and the transactions non-transparent. The

result was an increase in transaction costs. For example, businesses had to spend more to stay

connected with appropriate government officials and politicians. And consumers, in addition to


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waiting in line to purchase needed products and services, also made illegal payments for what

they should have received at a reasonable price in the first place. It has already been explained

how Indias government grew in size as it played an increasing role in controlling the economy.

It grew even further in trying to be appropriately vigilant in dealing with the increased corruption

among government officials, businesses, and other participants.

Price controls were only one example of the regulated economic environment. Another example

of a harmful policy was the control of ownership of private capital (both income and wealth) by

Indian nationals in India and also by foreign nationals doing business in India. Such policies,

coupled with high individual and corporate income tax rates and high customs and excise duties,

led to outcomes similar to those resulting from price ceilings namely, increased corruption and

higher transaction costs.

Conclusion

This has shown how individuals guided by their self-interests, will act in a regulated

environment. Government controls based on arbitrary and ad hoc administrative decisions lead

not only to greater concealed income and wealth but also to diminished productivity, particularly

due to the resulting higher transaction costs.

Economic Reforms: The Mixed Results For India

Due to government intervention, particularly the high levels of government subsidies, it was

clear by 1990 that India was living beyond its means. The result was a severe payments crisis in

which, for the first time, the government physically transported gold overseas to prevent


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defaulting on foreign commitments. To meet its immediate balance of payments crisis, India also

entered into a structural loan adjustment agreement with the International Monetary Fund (IMF).

However, one condition of this loan required India to undertake economic reforms to move from

a centrally-planned development strategy to one based on market-based resource allocations. As

a result, the government of India undertook a package of economic reforms between 1991 and

1993, with the intent of placing the market in place of government controls as the prime mover in

the economic development process.

As one might expect, macroeconomic policy played a major role in Indias economic progress in

the 1990s. For example, Indias devaluation of the rupee and its decision to increase the level of

allowable foreign investment helped it to make considerable economic progress. Indias policy

of selective capital account liberalization helped it to achieve important economic objectives

(and still avoided the crises faced by the East Asian countries) highlights the important role

played by Indias prudent management of exchange rate policy and its tight monetary policy the

privatization of the public sector enterprises and the gradual dismantling of the government

planning process in favor of market forces.

Overall, there can be no doubt that the reforms implemented since 1991 have led to considerable

economic progress in India. For example, from1992-1993 through 2000-2001, economic growth

averaged an unprecedented6.3 per cent per year Further, as indicates, the rate of inflation and the

fiscal deficit have both decreased substantially. He also says that Indias improved exchange rate

management has restored the confidence of foreign investors, which in turn has led to improved

financing of the current account deficit and higher levels of foreign exchange reserves.


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However, even though India has made substantial economic progress in recent years, it still has

several areas in need of major market-based reforms. Below, we identify three examples from

Indias economy that reveal a restriction of the pursuit of individual self-interest and a diversion

of resources away from their most efficient use. The first example concerns the obstacle still

presented by the Indian tax system, the second highlights the inefficiencies of the Indian civil

service, and the third describes the need for further land reform in India.

A study undertaken by McKinsey Global Institute found that the Indian product markets are still

over-regulated; government still owns about 43 per cent of total capital stock; and the real estate

market is still substantially distorted. This study concluded that this over-regulation is still the

major barrier to economic growth in India

Spite of recent tax reforms in India, the present tax system still works against the individual self-

interest to survive and accumulate wealth and, as a result, still leads to the hiding of income,

wealth and expenditures. Indeed, whereas in the United States and the Republic of Korea, the

highest tax rate applies to an income level of $250,000 and $66,000, respectively, in India that

same tax rate applies to an income of only $3,400. Simply reforming its tax system to bring it in

line with comparable nations should yield several substantial benefits to the Indian economy.

The Indian civil service provides attractive career choices for young job seekers due mainly to

the excellent job security, non-monetary compensation, and opportunities for influence available

in those careers. For example, despite minimal salaries for individuals holding top-tier positions

in such areas as administration, police, revenue and railways,

These civil servants are entitled to high job security and heavily subsidized housing, transport,

medical services, telephone privileges, and at times domestic help. We believe that the policies


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underlying compensation to government employees should be reformed such that they are based

primarily on market principles. The advantages of doing so include eliminating departments

known for corrupt practices, making explicit the true cost of a government employees

performance, and giving government employees a good sense of their market worth.

. Finally, considerable reform is needed in the Indian real estate sector. A large proportion of the

land is owned by the government, and any land made available for private use is governed by

archaic ownership, zoning, tenancy, and rent laws. Further, this government control of land has

reduced the amount of land available for trading purposes. The result is that Indian land prices

are the highest among all Asian nations relative to average income

Most of the illegal income is concealed by people at higher income brackets trying to avoid

paying higher taxes. Consider the following illustration: suppose the extent of unreported income

is100 per cent of reported income. Since the tax on income, profits, and capital gains was about

three per cent of GDP, we can assume that unreported income, once reported, should yield at

least three per cent of GDP (or around $13.42 billion in 1999). This total should be enough to

cover more than67 per cent of the overall budget deficit of the Indian Central Government

(World Economic Indicators, 2001).

The starting salaries for these positions are in the range of $1,800 to $2,200 per year, with the

highest salary at about $10,000 per year.


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Further, the officially assessed values of real estate are low, while the true market price is very

high.8 This situation leads, among other things, to higher levels of corruption as individuals use

real estate as a major hiding place for investments of illegally acquired income

Examples such as these indicate that there are still a large number of areas where the individual

self-interests of survival and wealth accumulation are not respected. In the next section, we

examine how one fairly new approach to microeconomic policy the encouragement of

entrepreneurship can help India to continue its recent economic growth.

The Role Of Entrepreneurship In Indias Future Economic Development

The progress of Indian economic development from 1947 to the present provides further

evidence that individuals do respond to incentives in their pursuit of self-survival and

accumulation of wealth. Further, the nature of this response depends on the economic climate,

particularly the role of the government. Indias economy struggled as long as it was based in a

system of government regulation with little interaction with economic forces outside the country.

The economic reforms of the early 1990s set the stage for substantial improvements in the Indian

economy. As was stated earlier, Indias economy grew at an average of 6.3 per cent from 1992-

1993 to 2000-2001 Further, its rate of inflation and fiscal deficit both decreased substantially.

Improved exchange rate management led to improved financing of the current account deficit

and higher foreign exchange reserves. Finally, Indias GDP and per capita income both increased

substantially from 1990-1991 to 1998-1999. India can do more, however, to further advance its

economic development. Indeed, one of the more recent microeconomic approaches to economic

growth is the promotion of entrepreneurial activities. Entrepreneurial efforts have been found to

generate a wide range of economic benefits, including new businesses, new jobs, innovative


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products and services, and increased wealth for future community investment . The following

narrative explains in considerable depth how entrepreneurial activities have succeeded in several

countries and how it can now be used to further Indias economic development. It is entirely

possible that the officially assessed value may be 5 to 10 per cent of the actual market price of

the dwelling of the plot of land.

Following an extensive study of entrepreneurship in 21 countries, Reynolds, Hay, Bygrave,

Camp and Autio (2000) concluded that successful entrepreneurial activity is strongly associated

with economic growth. Their research was subsumed under the Global Entrepreneurship

Monitor (GEM), a joint research initiative conducted by Babson College and London Business

School and supported by the Kauffman Center for Entrepreneurial Leadership. Their findings,

based on surveys of the adult population of each country, in-depth interviews of experts on

entrepreneurship in each country, and the use of standardized national data, supported their

conceptual model depicting the role of the entrepreneurial process in a countrys economic

development


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indian model of economic development

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