If India wants a meaningful place in the Asian Century it must act big and act now

The twenty-first century is widely referred to as ’the Asian Century’. Less obvious, however, is the place for India in the economically resurgent Asia. Can India be harness its demographic and democratic dividends to drive the growth and rise to the prominence? Or will it be mired in mercantilist protectionism, poor infrastructure and low human capital and thus, lurk in the ‘middle’?

The developments in India in the first fifteen years of the new millennia fail to offer a convincing answer.

India’s miraculous growth began in early 1990s after the sweeping economic reforms transformed the Soviet-style central planning economy into a market based liberal economy. The reform, led by economist-turned-politician, Dr. Manmohan Singh, then finance minister, entailed floating the currency, eliminating production and import controls and opening up the country to foreign investments among others. The result was immediate and phenomenal.

For the next two decades, the Indian economy grew at 7-8 percent on average and quadrupled per-capita income from US $262 in 1990 to more than US $1180 in 2010. Subsequently, India became a third largest economy in Asia and tenth largest in the world. However, the growth rate has slowed in recent years.

While some believe that the slow growth is due to the bleak global demand after global financial crisis and that India would regain the momentum, others (see here and here) flag policy gridlock as major barrier to the economic growth and doubt India can grow at pre-crisis pace. The skeptics are even pointing to the risk that the country may face ‘middle-income trap’.

India graduated to a lower middle-income country in 2010 and it may be too early to presume that the country would fall into the trap but there are some plausible issues to be concerned about.

As Arvind Panagariya, current chief economic advisor to the Indian government, notes, reform in the 1990s was an important milestone but was it was insufficient as a policy measure to turn Indian economy into a modern globalised economy.

Unlike in China, the reform didn’t focus on creating large manufacturing base and on formalising the country’s vast informal service sector. While a few more educated people were working in mushrooming IT firms and service industries, the majority were stuck in less productive agriculture fields and traditional factories.

Moreover, India kept many tariff and non-tariff barriers intact and prevented foreign investment in many key sectors like telecommunication, retail and aviation for long. The reform fell short of ameliorating the notorious labour and the land-acquisition laws. As a result, the country couldn’t fully obtain the benefits of integration into the global value chain.

Although the long stint of growth concealed the problem, rampant corruption, suboptimal infrastructure and bureaucratic red tape worsened over the years. On the top, complacent Indian policymakers not only failed to make any notable reform during those years, they aggravated the situation with contradictory and inimical policy measures. Its tax row with some multinational companies (here and here) is just one example.

Taking all together, structural bottlenecks explain half of the India’s growth misery.

To get back on track, India needs another wave of holistic reforms that would redress the structural cracks in the economy. Specifically, it should embrace deeper trade integration so that it can acquire much needed capital and catch-up with technology frontier. Moreover, the country should cleanup bureaucracy, strengthen inclusive institutions, and loosen the rule for input consumption.

With these policy reforms, coupled with young and low-cost labour force, India can even replace China as the world’s manufacturing centre and clear the path for continuing growth.

But the story doesn’t end here.

The growth generated through structural transformation would merely bring ‘episodic growth’ that would last for a short to medium term. It may take the country from lower-end of middle income to the higher-end. But for a sustained long-term growth, a prerequisite to become a high-income economy, the country needs to operate closer to the global technological frontier.

A common denominator among today’s developed countries is that they invariably facilitate innovation and offer knowledge-based produce. They have been able to determine the global technology frontier. Advanced countries design and deliver most of the new product and services that world today consumes from new gadgets to financial services to agricultural technology. For that, the countries invest heavily in human capital—on providing quality education to people and in keeping them healthy.

India, on the other hand, fails measurably in those respects. The country lags far behind average middle-income countries in creating human capital thanks to the poor education and healthcare provisions. The eminent economist and Nobel laureate, Amartya Sen, views India as ‘the only country trying to become a global economic power with an uneducated and unhealthy labour force’.

The basic tenet here is, the underdeveloped human capital will cripple Indian economy in form of low productivity and inability to innovate, both so vital for a country’s economic growth in modern times. Highly educated people with the ability to create high-value technology-driven products that match with the sophisticated consumer demand are the fundamental determinants of the economic growth.

The recent attempt by the new government to revamp the outmoded economic policies is welcoming news. If successfully implemented, these reforms will restart the high-growth momentum. However, India should be mindful of longer-term prospects for the economy, which again requires improving the country’s healthcare system and enhancing the quality of education at all level. Undoubtedly, it is an enormous challenge for the country of 1.3 billion populace and should be supported by other institutional reforms. However, if India wants to ensure a meaningful place in the Asian Century, it must act big, and act now.

( This article was first published on South Asia @ LSE Blog here. The feature picture credit Flickr/Michael Foley/CC BY-NC-ND 2.0)

AIIB to unlock South Asia economic potential

South Asia’s economic potential has long been constrained by low levels of economic integration. Despite being closely linked geographically, culturally and historically, intra-regional trade is very low. A major problem has, of course, been political difficulties within and between South Asian countries. But an important, and overlooked, barrier to greater economic integration is the poor quality and inadequate investment in infrastructure in the region. The newly established Asian Infrastructure Investment Bank (AIIB) can play a pivotal role in fixing this problem.

For a long time, infrastructure bottlenecks have been recognised as a barrier to regional trade and economic integration. Access to infrastructure in South Asian countries is limited and the quality of available infrastructure is also poor. In Bangladesh, for example, only 39 per cent of the rural population has access to road transportation. India has the second largest road and rail network in the world, but half of these roads are not paved and cannot be used in all seasons. Despite huge potential in electricity generation, people in the region consume less than 655 kilowatts per capita in intermittent electricity supply in 2012, which is less than one fifth of that in East Asia.

The situation for cross-border infrastructure is even less encouraging. A telephone call from Nepal to India is more expensive than calling to the United States or Europe. Cargo trucks waiting 3–5 days at the border for clearance from customs is normal. Despite sharing a nearly 3000 kilometre-long land border, shipping between India and Pakistan has to go via Dubai. As a result, the cost of trading across borders in South Asia is prohibitively high.

According to the World Bank, South Asia has nearly US$2.6 trillion in shared GDP. While overall trade flows are growing, intra-regional trade among countries is still less than 5 per cent of total trade. This is far less than that within ASEAN (25 per cent) or NAFTA (58 per cent).

Despite this, investment in in-country and cross-border infrastructure has been inadequate over the years. This has created a huge infrastructure investment gap in the region with supply trailing far below demand.

It is estimated that South Asian countries need to invest around 7.6 per cent of GDP in infrastructure per year if they are to achieve economic growth of 7.5 per cent. This amounts to an annual capital investment of US$88 billion in new investment and in maintaining existing capital stock. Currently, actual average investment in infrastructure is around US$28 billion per annum — the lowest in the world, excepting sub-Saharan Africa.

The South Asian Association for Regional Cooperation (SAARC) — which is comprised of Afghanistan, Bhutan, Bangladesh, India, Pakistan, Maldives, Nepal and Sri Lanka — made an attempt to narrow the investment gap recently. For a decade, SAARC negotiated a free-trade agreement called the South Asian Free Trade Agreement (SAFTA). Coming into effect in 2006, SAFTA aims to facilitate the ‘development of communication systems and transport infrastructure’ to facilitate intra-regional trade. Still, the pace of infrastructural reform envisioned by the agreement has been slow.

Other similar initiatives include the establishment of the South Asian Development Fund (SADF) in 1996. Later reworked as the SAARC Development Fund (SDF), its aim is to act as an umbrella funding mechanism for all regional development projects, including infrastructure. But with capital of only US$300 million, the SDF has been unable to go beyond funding some social projects. The idea of setting-up a South Asian Development Bank (SDB), led by India, has also been proposed to provide low-cost funding to member countries for infrastructure projects. But this idea has never taken-off.

There have been some unilateral efforts to improve infrastructure. India, for example, has pledged to invest US$138 billion in railways alone in the next five years. It has also been experimenting with the creation of a ‘National Investment in Infrastructure Fund’.

On the bilateral front, projects like the Central Asia–South Asia Electricity Transmission Project, the Nepal–India Regional Trade and Transport Project, and the Bangladesh–Bhutan–India–Nepal (BBIN) initiatives are currently underway with support from multilateral organisations like the World Bank and the Asian Development Bank (ADB). Still, there are no major cross-country highway or railway projects currently underway.

With this backdrop, the creation of the AIIB has come at the right time. The bank was established with an explicit objective to provide financing for developmental infrastructure like roads, railways, sea and airports, and power generation plants to facilitate greater economic integration in the Asia Pacific.

Although US$100 billion in paid-up capital may not look like much in comparison to the investment demand, the AIIB can play a key role in complementing the work of traditional multilateral lenders like the ADB and the International Finance Corporation.

The AIIB is also expected to have a longer term investment horizon, recognising the fact that returns to infrastructure spending in developing countries can be slow and sometimes low. If the AIIB can also shorten the loan assessment and approval procedures, South Asia could see an investment boom.

The involvement of the AIIB in South Asia will be welcome news for the region. Six out of the eight countries in South Asia (the exceptions are Afghanistan and Bhutan) are founding members of the Bank. India, which was recently elected as a member of the board of the bank, is also likely to prefer the AIIB — with its multi-nation oversight — rather than a situation where China acts alone in what India considers its backyard. With mutual trust and support, the AIIB can help South Asia realise its shared dream of greater economic prosperity.

( This article was first published on East Asia Forum here.)