How the success of 1991 reforms arrested India’s development

This July marks the 25th anniversary of the most momentous set of economic reforms the Indian state ever undertook since Nehru and PC Mahalanobis’s Second Five Year Plan commissioned in 1956.

When Narasimha Rao formed his minority government in June 1991, with Manmohan Singh as his finance minister, so chronic was India’s balance of payment crisis that the Reserve Bank of India had foreign exchange for only two weeks’ worth of imports, when three months’ worth is considered safe.

This crisis was not sudden. Irresponsible external borrowings under governments led by both Rajiv Gandhi and VP Singh had already put pressure on the reserves from 1985-onwards, while exports remained non-competitive because of higher effective exchange rate. What made matters worse was the Gulf War of August 1990, which led to a trebling of oil prices, cessation of exports to Iraq and Kuwait and stoppage of remittances from Indian workers in Kuwait. Because of political uncertainty, Indians living abroad withdrew around $900 million worth of their money from Indian banks between April and June 1991.

What followed was – in retrospect – a series of very drastic steps to end industrial licensing, liberalise trade and embark on a risky devaluation of the rupee.

The legacy of these reforms has, on the whole, been unambiguously positive. The 25 years between 1991 to 2016 have seen Indian GDP increase almost eight-fold, with the economy generating enough savings and investment to ensure an annual average growth rate of almost 5%. The most positive effect of delicensing and trade liberalisation is evident in the telecom, electronics and fast moving consumer good sectors where improvements have benefitted society at large. Where landline phone connections took years to get, the country now boasts of over a billion mobile phones.

Making in India

But structural problems remain in the economy. A quarter of a century of deregulation has provided little boost to manufacturing. Unlike almost any significant growth story of the past 200 years, India’s story is not based on manufacturing exports. According to last month’s data, exports have declined consecutively for straight 18 months, at a time when developed Western markets are showing significant signs of recovery. The formerly great industrial cities of North India like Kanpur and Patiala lie deindustrialised – their manufacturing shifted to China. With an annual import bill reaching $40 billion, the electronics segment is set to become the new oil unless radical steps are taken to induce manufacturing at home.

There is general agreement that rigid labour laws and cumbersome land acquisition structures, where badly needed reforms did not take place, do much to hamper industry. But those are not the only problems.

Getting industry ready to export is similar to making your child ready for the job market. You need to invest in her, and let her learn first before subjecting her to the cut-throat competition in the job market. Success in manufacturing requires patient capital, growth of ecosystems of suppliers and consumers, production know-how and scale. All these are very gradual processes that take time to institutionalise. Which is why biased intervention in trade and industry by the government is almost a necessary condition for a successful large-scale manufacturing economy to take off in a developing country, as noted before by this writer here, here and here.

The past 25 years are perhaps testament to this. While trade liberalisation has given us access to latest electronics, much of the value is imported from East Asia. China, on the other hand, used the unprecedented opening of global trade borders of these 25 years to actively promote its domestic industries. From steel and solar panels to textiles and technology, China has ruthlessly subsidised and assisted its domestic producers to conquer world markets. As Britain’s active monopolisation of capital in India during the Raj and the United States’ use of high tariffs to protect its heavy industry from German and British competition before World War I make evident, such “cheating” has been a part and parcel of most development strategies of the past 200 years.

The worst legacy of the 1991 reforms is that their (very limited) success has made ideas promoting aggressive state intervention in the private industry and international trade unfashionable.

State intervention

Every effort by the state to regulate or actively interfere in industry is greeted by hesitant appraisal while every move to liberalise – the recent opening of aviation and defence sectors to foreign direct investment being a case in point – is celebrated. Little thought is given to what China, Korea and other other countries in East Asians, whom we have been desperately trying to emulate, actually did. For instance, if we were to realise that foreign investment played little role in increasing investment in both Korean and Chinese economic history, and was mostly used for the purposes of “spill-over” effects like transfer of technology and latest management techniques, then much of the intellectual edifice behind praising brownfield FDI-liberalisation would come into question.

In the mainstream discourse, all economic failures are ascribed to the inability of the government to pursue “structural reforms” hard enough – which almost always implies the failure to further privatise, liberalise and deregulate. Why are exports declining? Because India does not rank high enough on the Ease of Doing Business index. But a logical follow-up would ask: Why is China the largest exporter in the world despite ranking only 84 in the same index. For those marketing Goods and Services Tax as the silver bullet must wonder why the world’s greatest industrial success story never bothered with one.

With grossly inadequate job growth, stuttering manufacturing and poor performance in health, education, sanitation and urban planning, India needs an effective state more than anything else. Yet, our legacy of substandard state intervention prior to 1991, which throttled entrepreneurship, coddled big business and warped India in its own time frame, ensures that we remain confined to curiously unreasoned ideas such as “minimum government, maximum governance”. Instead of getting state intervention right, we run away from the idea of state intervention.

What we need is a state that prioritises rationalisation, effectiveness and “getting things done” over political operation and procedure, and that manipulates all instruments of policy available to it – yes it includes trade and licensing – to aggressively nurture a manufacturing sector to take on the world and provide high investment and employment at home.

But with a commentariat that is largely committed to the fantasies of free trade, and globalisation, and the overwhelmingly presence of Ivy League economists at the top institutions of economic management – almost all of whom are schooled solely in neoclassical doctrines – is a real change likely? Don’t bet on it.

Akshat Khandelwal is a writer and entrepreneur based out of Delhi. His twitter handle is @akshat_khan. He can be contacted at 124.akshat@gmail.com.