IMF: India faces "the gale winds of divergence, big time"

Can India reform? Well, it is starting to. Over at the Indian Economy Blog, meanwhile, Amitabh Arora asks What Holds Back Reform in India – Ideas, Interest Groups or Ineptitude? (Hat tip: PSD Blog)

But for another perspective on this debate, a new paper by IMF Director of Research and colleagues is well worth reading. Raghuram Rajan, along with IMF economists Kalpana Kochhar, Utsav Kumar, Arvind Subramanian, and Ioannis Tokatlidis, gave a paper last Friday on India's pattern of development: what happened, what follows (PDF). It first examines India’s pattern of development circa 1980 "on the grounds that a snap shot at this point represents the legacy bequeathed by India’s unique and much-commented upon development strategy". It then looks at the shift to greater market reliance between 1980 and 2001. "We then use this post-1980s experience as a basis to speculate about the future." The main story is one of growth divergence between India's states:

The impact of the pre-1980s policies combined with decentralization has meant that Indian states are more responsible for their economic fortunes, which in turn has led to sharp divergences in their growth rates. With the caveat that Indian states are enormously large entities and are internally very diverse, it would appear that the fast growing peninsular states are starting to resemble more developed countries in their specialization, while the slow growing hinterland states, with still rapidly growing, less well-educated, populations ..may not have the capability to emulate them.

India’s fast growing states have managed to avoid the traditional pattern of specialisation in labour intensive industries one might expect in a low-income economy. They are more like the industralised countries:

...they appear to have skipped directly to specialization in skill intensive industries (within manufacturing) or to services where they appear to have a comparative advantage (at least vis a vis other poor countries).

But the authors are less optimistic about the hinterland's prospects. The authors suggest we can expect continued divergence in growth rates between states - in part because the fast-growing states will "suck the more mobile skilled labor from the slow moving states". But also in part because of the rigidities, poor infrastructure and lack of reform in the hinterland. As they put it:

...the needed improvement in governance, business climate as well as physical infrastructure may simply not be forthcoming in the laggard states.

...It may well be that these hinterland states (as well as backward areas in the fast-growing states) will have to follow a more traditional path of growth, focusing on labor intensive manufacture. But they have not thus far. That they have not could be because further reform is needed - in particular, more flexible labor laws and an improvement of infrastructure, especially vis a vis the states in the hinterland so that these industries can be internationally cost-competitive - to revitalize labor intensive manufacturing.

They also point out that "even if serious reforms were undertaken in the laggard states, competition from the more advanced states will not make it easy for them to grow." In summary, the authors argue that "changes since the early 1980s ..have unleashed the gale winds of divergence, big time":

A unitary India, centralized politically and uniformly mediocre in economic performance has given way to multiple Indias with performance more related to the capabilities of individual states and the opportunities they create. The fast-growing states have fallen into patterns of production that are more similar to the industrial countries than to the fast growing East Asian economies. Ideally, the slow-growing states would reform - improve governance, infrastructure, and labor laws—and utilize their vast pools of underutilized low-cost labor to attract investment and create jobs in labor-intensive manufacturing and thereby catch-up with the leading states in India. In this scenario, the pattern of convergence that we saw in the post-war period between industrial countries and the East Asian economies would play itself out within India in the future.

However, even if these reforms were to occur, there is a possibility that powerful forces emanating from the common market for resources could slow convergence. If they were to do so, India will have to brace itself for a lot of social churning as people move not just in search of jobs but also in search of acquiring the human capital to become employable. How India reacts to, and shapes, these forces may well be the biggest economic question India faces over the next few decades.

P.S. The paper was given on November 18 to Carnegie-Rochester Conference on Public Policy on International Trade and Globalization in Pittsburgh.

Comments

[Patel]

The removal of Laloo Prasad's RJD from Bihar will hopefully help slow down the "gale winds of divergence"

[Vijay Dandapani]

Divergence is not necessarily bad and culture beyond the usual suspects of bad labor laws, infrastructure and governance surely plays a role.

Secondly, looking at pre-'80 India and using the Armed and Civil Services as a proxy for the economy of the future may show some insights on how the churning anticipated by the authors may in fact be something India deals easily with. Both services reflected the relative ease with which mobility was attained. When Gujarat and Punjab both embrace labor law changes that rquire self-certification in factories for compliance with the law but one requires a random 1% of the sample set to be tested while the other - Punjab requires every factory to be tested for compliance, the outcome is not hard to predict - Gujarati factories and its labor market are going to thrive free of the oppressive (and likely corrupt) inspector.

Also, another aspect that may have influenced the early move out from manufacturing from the advanced states is labor productivity. A look at productivity levels for those states in relation to industrial countries for an explanation of $3K versus the normal $12K per capita decline in manufacturing could be interesting.

[Aditya]

A Poet's View

Some of our best thinkers say that India had better change her ways if she is to keep up with her more disciplined cousin, China. In this widely accepted worldview, China and the US are global bookends, and India must slip between these two giants, on the bookshelf of economics - and progress.

But India could be quirky enough to opt for her own bookshelf – not by design, but by habit. I know this is true for people like you and me, and for many others who came from “there”.

"There" may be a place outside the group, from where rogue chromosomes join the spiral, and evolve a new global being that confounds the sum of its parts.

My intuition tells me that there’s value in India’s hidden suspicion, self-doubt and insecurity – in and her craving for a different kind of change.

India may well be the shy teenager who opts out of must-attend parties, chooses grunge over high-fashion, and spends nostalgic nights in an untidy room. From this mess could emerge new voices, new metaphors and new ways of living – and working.

Ready or not, India is large enough that when she finds her voice, the world will listen. For, are today's rich cousins the ones to beat - or the are they Sirens who whisper, "Walk the other way"?

India’s trendsetters sit atop a mountain of everyday Indians, whose lives don’t make the MTV cut. Do you find yourself drawn into their eyes, drawn into worlds that your words cannot touch? Will they save their India for a different tomorrow?

Yes, there’s hope in the air, and money to be made, and the nation is abuzz with expectations. It happened in Japan, and now the Japanese wear suits and skirts and sing Elvis songs in karaoke bars, and soon the Chinese will follow. Somewhere under the Benettons lurk ancient Asian souls, not trusting the past, half sure about the present, and coy about the future.

It’s not a bad way to be, if their newborns should arrive with visions yet unborn. Into Asia’s iconic void, they could sow the seeds of tomorrow, brought forth from worlds beyond our graves. Perhaps the plan is larger than our theories can fathom. Perhaps the plan is to be slightly lost, so that we can stumble into who we are. And we can find our own way home.

Thanks for indulging this poet ...