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Indian Economic Reform

A Philosopher

Indian Economic Reform

A Philosopher’s Stone

Essays on Macroeconomic Policy and Growth in India

by Shankar Acharya; Oxford University Press, New Delhi, 2006; pp xii +233, Rs 550.


ndian economic policy has been for long a holy grail for Indian intellectuals of all persuasions. Since independence, a belief system overlaid by the shambolic thinking of the economists and the immediacy of access to power for politicians consisted of a few basic propositions. These included the ideas that India is bereft of an entrepreneurial class and dominated by traders with a short-term time-horizon; inelasticity of export growth leads to the duality of foreign exchange and domestic saving gaps; and deficit finance, a derivative from the Keynesian economics, is a resource which can be freely resorted to for financing economic development. This set of beliefs gave primacy to the statism, which guided Indian economic policy in the aftermath of independence in 1947. While this was sustained up to a point until 1960, mainly as a counterpoint to the decades of economic stagnation induced by a colonial power insensitive to domestic economy interests, it soon began to yield diminishing returns in terms of economic growth, efficiency of production and distributive justice. Only when the economy reached a cul-de-sac did policy-makers wake up to the imperative of emancipating the belief system from this tyranny of statism by the “encroachment of economic reform”, to use a felicitous phrase of the late professor J K Galbraith. It was, however, not easy to usher in alternative policies because of the vested interests in ideas, lust of power of the political class and the easy moolah gained by the private sector from the interventionist regime. Economic reform was therefore gradual, slow and faltering in the initial stages in the decade of the 1980s but taking a quantum jump from the beginning of 1990s.

The new turns and twists in economic policy were greeted with hostility by the intellectuals inebriated with the old brew of statism. First, they harked back to the east Asian countries particularly Korea which, from their perspective, accelerated their development by pursuing statist policies. Second, they predicted dire consequences of reform policies – a huge crisis in foreign exchange, worsening of poverty and rising inflation (for getting a flavour of this, read the issues of the Economic and Political Weekly in the first half of 1990s). However, they betrayed a lack of understanding of the dynamics of Korean development. The analogy was false. Korea’s approach to development was rooted in its institutions, history and genius, which enabled it to devise nonmarket institutions as complimentary and supportive to the market system [Dalla and Khatkhate1995].1 That the charisma of Korea and other east Asian countries as exemplars of statism evaporated after the financial crisis during the late 1990s is a different matter. As for the second, i e, a prediction of gloom and doom, time was cruel to them. India, far from languishing, is now on the cusp of a great and enduring economic transformation. Endemic foreign exchange crises have now become episodes in distant memory and the poor have not remained that poor.

Even when the winds have gone out of the sails of the sceptics of reforms, they are loath to give up their “never-say die” attitude towards statism.2 They have now

Economic and Political Weekly June 3, 2006 taken a different tack. Performance of the Indian economy during 1990s is not to be gloated over, they argue, as the real turning point in growth was during 1980-90 and not in the period beginning from 1991, when radical reforms were unleashed. This apart, it is even argued in all seriousness that a great structural change occurred in the period 1951-80 as it took India from economic stagnation to growth in a broader social transformation [Nayyar 2005].3 Taking the latter first, a comparison of the structural change in 1951-80 with the preindependence decades is both fatuous and facetious. During the later period there was no autonomous economic policy geared to the interests of a nation. The objective functions were different. It was a colonial policy, addressing the interests of the home country. Any policy, statist or otherwise, with India’s interests at the centre, would have achieved better results than under a colonial regime. The real question is whether the statist policies were superior to other alternatives but this question can never be answered for want of counterfactual evidence.

The other plank of argument that the Indian growth rate after the 1999 radical reforms was not as robust or striking as that during 1980-90 is also equally suspect, as well analysed by Shankar Acharya, the author of the book under review, Arvind Panagariya (2004) and Arvind Virmani (1997). Table 7.1 on page 208 of Acharya’s book, presents the average GDP growth during the sub-periods 1951-52 to 1980-81, 1981-82 to 1990-91 and 1992-93 to 1996-97, and 1997-98 to 2001-02. Add to these the growth rates during 2002-03 and 2003-04, and it is clear that the reform period of 1991 onwards has been quite spectacular. Acharya also nails down the error of choosing the first year of the postreform period by the critics, who insist that the post-reform period average growth rate is lower than that attained in the immediate pre-reform period. This criticism, Acharya shows, is sometimes compounded by the elementary error of including the crisis year of 1991-92 within the post-reform period. This clearly makes a difference since the average growth in the three years 1992-93 to 1994-95 was 4.9 per cent, as compared to only 3.9 per cent if 1991-92 is included in the post-reform period (p 28). Pangariya also makes the same point [Panagariya 2004].

Panagariya has reinforced Acharya’s insights as well as his statistical analysis by shining the spotlight on the higher variance of growth during the 1980s than during the 1990s – a period of high reform [Panagariya 2004]. This variance was due to the sources of the shift in the growth rate, particularly during the subperiod 1988-89 to 1990-91, when growth was 7-6 per cent largely because of substantial, though not systematic, economic reform. This phase was noted for policy reforms like import liberalisation, a wide array of export incentives, exchange rate changes, freeing up of several sectors from investment licensing, etc. However, there was a rather unconscionably high recourse to external and internal borrowing, which eventually hurt the liberalisation programme. So the average rate of growth during the pre-reform period of 1980-81 to 1990-91 was boosted by reform policies, raising both the variance as well as magnitude of the growth rate. This empirical evidence amply bears out that the rudiments of economic reforms were apparent during the pre-reform periods of 1980-81 to 1990-91 and therefore both the periods 1980-81 and 1990-91 and 1991-92 to date should be treated as one continuum, rather than treating them separately for assessing the impact of reforms (p 12) also [Panagariya 2004, Virmani 1997].

Judging by a criterion that is wider in significance than a mere growth rate in evaluating the impact of reforms is the change in total factor productivity (TFP) which rose from 5.3 during 1981-82 to 1990-91 to 6.5 during 1991-92 to 1999-2000 (Table 7, p 215). The direct linkage between TFP growth and policy reform draws additional and convincing support from Panagariya (2004).

Acharya has also effectively answered the critics of Indian reforms, who despite being defied by the evidence on growth and distribution still obsess that Indian reforms did not yield a favourable distributional outcome [Nayyar 2006]. As regards employment, “the Planning Commission’s estimates of annual increments in economy-wide employment indicate strong growth from a low of three million in the crisis year, 1991-92, to an average of six million in each of the next two years and then rising further to 7.2 million in 1994-95. Since labour is the principal asset possessed by the poor, this surge in employment opportunities is likely to be associated with a favourable trend in living standards and poverty” (p 42). Not only was unemployment on a downward trend, but real wages have tended to rise too. Though they first declined in the crisis years they “rose by 5.6 per cent in 1992-93 and by 3.6 per cent in 1993-94 as the economy recovered from this crisis in response to reform” (p 42).

Acharya’s employment data may be considered somewhat out of date. But his findings are amply fortified by the latest quinquennial National Sample Survey, scrutinised carefully by an economist, who is no enthusiast for economic reforms. During 1977-78 to 2000, his conclusions are:

These figures indicate that unemployment rates are relatively low, tend to be volatile but do not point to any secular deterioration… Of course, given that the size of the population and labour force are increasing, the absolute magnitude of unemployment and underemployment are higher now than 20-25 years ago. But there is no warrant for the concern that the situation is getting progressively worse… The fact is that rural employment opportunities have increased progressively and have been able to absorb practically all the entire increase in the labour force. Employment is also getting diversified … Taking a longer view we see a progressive decline in the overall labour force participation rates...This trend reflects the combined effect of changing age composition and… a progressive rise in the proportion of persons in these age groups attending education institutions… these figures should not be interpreted as a deterioration of the employment situation [Vaidyanathan 2005].

The UPA government’s latest report for 2000 and 2003 shows “that the employment growth in India has been a very high,

2.9 per cent per annum and almost triple the anaemic employment growth experienced between 1993 and 1991” [Bhalla 2006].

Acharya could have strengthened his defence of the impact of reform in regard to poverty reduction since 1991, by drawing on the papers at a workshop on ‘Poverty Measurement and Evaluation’ organised in India by the World Bank together with the Planning Commission. The consensus that emerged from the papers of participants of all ideological hues was that “India recorded one of the developing world’s fastest reductions in poverty during the 1990s. According to official estimates, poverty fell from 36 per cent of the population in 1993-94 to nearly 26 per cent at the end of the decade [EPW 2003]. Thus, the post-1991 reforms emphatically showed that the economic growth resulting from reforms was not separated from distributive outcomes.

Assessing the consequences of economic reforms by focusing only on the rate of growth reflects a myopic vision. Since 1991, there have been startling changes in the sphere of the financialisation of

Economic and Political Weekly June 3, 2006

saving-investment processes, structure of foreign trade and the balance of payments, the institutional basis of the macroeconomic policy, thereby giving a new tone and direction to monetary and exchange rate policies. Acharya’s narrative of the institutional and structural transformation is comprehensive, with insights and suretouch that can come only from his close involvement in policy-making and the grasp of political economy dynamics. Today, India has far more developed money and capital markets that are mobilising savings and mediating them to the most efficient use. All this is done with an appropriate incentive system in place and not with high-handed and discriminatory direct controls. Foreign trade was liberated from the shackles of bureaucratic whims and the results are there for all to see. Exports boomed and exploded the myth of export pessimism, imports increased but without encroaching on domestic industry producing similar products, the current account of the balance of payments remained in deficit, which was financed by the autonomous inflow of private non-debt capital inflows through foreign institutions. External debt indicators (as given in Table 4.4, Acharya 2005, p 139) turned extremely favourable. Thus, the total debt/GDP ratio declined from 28.7 per cent to 22.0 per cent between 1991 and 2000 and shortterm debt to foreign reserves from 382.1 per cent to11.5 per cent in the same period. With all this, the government, whether the present UPA or the NDA before it, managed the external sector with great skill and dexterity so that the balance of payments position was insulated from the vagaries of global capital flows. Thus, the structural change and turning point in India’s quest for development in the period 1991-2004 were far more significant and trail-blazing than any time in India’s chequered history.

Acharya captures all this in his narrative with scrupulous adherence to details and avoiding ideological postures. However, he should have analysed the balance of payment in a little more depth. It is true that there has been striking growth in invisibles in the balance of payments. However, it is difficult to know how much is invisibles earnings proper, and not capital inflows in the guise of invisibles, because of the way the current balance of payments are currently compiled. It is high time that the Reserve Bank shakes of its complacency and undertakes a thorough revamping of the balance of payments data and its integration with national income accounts.

Acharya has, while applauding the impact of the 1991 reforms, not underestimated the lack of governance, “We must never forget that the quality of economic outcomes depends crucially on the quality of economic laws and their administration (p 53). But the real question is how governance should be improved in future. The new “transaction cost political perspective” pioneered by Avinash Dixit (2004) implies that economic policy has to be negotiated at each stage – from formulation to implementation – with each concomitant cost being determined by the layers of institutions and procedures. Efforts to reduce these costs can be formidable when the work culture and ethos of existing institutions are at odds with the demands of economic development. The implications of the transaction cost theories are exceedingly well captured in Arun Shourie’s (2004) terse and episodic narrative of India’s transition from controlled to market economy. A similar view on governance, though articulated differently, is presented by Pranab Bardhan (2005), “Reforms would have been more popular if the authorities were equally and simultaneously concerned with reforms in the appalling governance structure in the delivery of basic social services for the future...It is anomalous to expect reform to be carried out by an administrative set up that for many years has functioned as an inert, heavy-handed, corrupt, overcentralised and uncoordinated monolith”. Governance in India is absent because of the fractured political process structure. Thus, any schemes delivering social and health services or rural employment, financed through pump-priming as advocated by some economists schooled in bastardised Keynesianism, would only end in more development with deception.

Acharya’s essays, though familiar to the readers of the EPW, educe consistency in analytic presentation, concision in thought process, as well as the author’s concordant relationship with some of the ablest economic policy-makers in the paradigm-shifting epoch of India’s economic history.




1 Critics who often cited Joan Robinson in support of their advocacy of statism conveniently develop amnesia about what she said in her three lectures on her visit to China in the 1950s. These “were remarkable in that they contain a skeleton outline of the policies the Chinese authorities are implementing now – a pragmatic, gradualist, trial and error, mix of the market, openness and central control [Harcourt 2005: 25].

2 There is a variant of the 1980-90 turning point view, profounded by David Rodrik and Arvind Subramanian (2005) and Atul Kohli (2006). They attribute it to the pro-business policies of the government. However, the difference between pro-business and pro-market economic policies is one of degree and not substance, as both sets of policies place a premium on profits as incentive, which the market also ensures.

3 It is high time that the statists wake up to learn from the famous communist historian Eric Hobsbawm who showed rare intellectual courage to jettison his long-held dogma, when faced with the uncontestable reality. “The end of official Marxism of the USSR” he told Jaques Attali, an international banker in a debate “has liberated Marx from the public identification with Leninism in theory, and with the Leninist regime in practice... the globalised capital world that emerged in the 1990s was in some ways uncannily like the world Marx predicted in 1948 in the communist manifesto...Paradoxically, it was the capitalists who rediscovered Marx, more than others”, ‘The New Globalisation Guru’, New Statesman, March 13, 2006.


Bardhan, P (2005): ‘Nature of Opposition to Economic Reforms in India’, Economic and Political Weekly, November 26.

Bhalla, Surjit (2006): ‘It Does Not Matter RIP: Reform, Ideology, Politics’, Business Standard, April 6.

Dixit, A (2004): Lawlessness and Economics, Princeton University Press, NJ.

Dalla, I and Khatkhate, D (1995): ‘Regulated Deregulation of the Financial System in Korea’, World Bank Discussion Papers, 292, Washington, DC.

Economic and Political Weekly (2003): ‘Poverty Measurement, Monitoring and Evaluation in India: An Overview’, January 25.

Harcourt, G C (2005): ‘Joan Robinson and Her Circle’ in Bill Gabson (ed), Joan Robinson’s

Economics: A Centennial Celebration, Edward Elgar, Cheltenham, UK.

Kohli, A (2006): ‘Politics of Economic Growth in India, 1980-2005, Part I and II’, Economic and Political Weekly, April 1 and 8.

Nayyar, D (2006): ‘Economic Growth in Independent India: Lumbering Elephant or Running Tiger?’, Economic and Political Weekly, April 15.

Panagariya, Arvind (2004): ‘Growth and Reform During 1980s and 1990s’, Economic and Political Weekly, June 19.

Rodrik, D and A Subramanian (2005): ‘From Hindu Growth to Productivity Surge: The Mystery of the Indian Growth Transition’, IMF Staff Papers, Vol 52, Number 2.

Shourie, A (2004): Governance and the Sclerosis That Has Set In, ASA/Rupa, New Delhi.

Vaidyanathan, A (2005): Employment Guarantee and Decentralisation’, Economic and Political Weekly, April 16.

Virmani, Arvind (1997): ‘Economic Development and Transition in India’, papers presented at the Tokyo Dialogue on Alternatives to the World Bank, IMF Approaches to Reforms and Growth, Economic Planning Agency, Tokyo, Japan, November 7.

Economic and Political Weekly June 3, 2006

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