20 Years of Economic Reform in India

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july 20, 2011



no. 13

The Elephant That Became a Tiger
20 Years of Economic Reform in India
by Swaminathan S. Anklesaria Aiyar

Executive Summary

A

foreign exchange crisis in 1991 induced India to abandon decades of inward-looking socialism and adopt economic reforms that have converted the once-lumbering elephant into the latest Asian tiger. India’s gross domestic product (GDP) growth rate has averaged over 8 percent in the last decade, and per capita income has shot up from $300 to $1,700 in two decades. India is reaping a big demographic dividend just as China starts aging, so India could overtake China in growth in the next decade. When the reforms began in 1991, critics claimed that India would suffer a “lost decade” of growth as in African countries that supposedly followed the World Bank-IMF model in the 1980s. They warned that opening up would allow multinationals to crush Indian companies, while fiscal stringency would strangle social spending and safety nets, hitting poor people and regions. All of these dire predictions proved wrong. Indian businesses more than held their own, and many became multinationals themselves. Booming

revenue from fast growth has financed record government spending on social sectors and safety nets, even if these areas are still dogged by massive corruption and waste. Still, poverty is down from 45.3 percent in fiscal year 1994 to 32 percent in fiscal year 2010, and the literacy rate is up from 52.2 percent to 74 percent in two decades, India’s fastest improvement ever. Several of the poorest states have doubled or tripled their growth rates since 2004, and their wage rates have risen by over 50 percent in the last three years. However, India continues to be hampered by poor business conditions and misgovernance. Almost a quarter of Indian districts have recorded some sort of Maoist violence, and corruption is a major issue. India ranks very low on ease-of–doing-business indicators. Rigid labor laws prevent Indian companies from setting up large factories for labor-intensive exports, as in China. Both governance and economic reforms are needed, but progress on the former lags far behind, is thus more urgent, and can help sustain and promote economic reform.

Swaminathan Aiyar is a research fellow at the Cato Institute’s Center for Global Liberty and Prosperity and has been editor of India’s two biggest financial dailies, the Economic Times and Financial Express. the cato institute 1000 Massachusetts Avenue, N.W., Washington, D.C., 20001-5403 www.cato.org Phone (202) 842-0200 Fax (202) 842-3490

Poverty did not fall at all in the three decades after independence.

Introduction
Faced with a foreign exchange crisis in 1991, India embarked on gradual, erratic, but persistent economic reforms that in two decades transformed its living standards and place in the world. In 1991 India was viewed globally as a bottomless pit for foreign aid, periodically hit by food and foreign exchange crises and hamstrung by an immense web of controls imposed in the holy name of socialism and then used by politicians to line their pockets and build patronage networks. Early that year, The Economist magazine carried a survey on India titled “The Caged Tiger,” which concluded sorrowfully that India would remain trapped in its cage, unable to join other Asian tigers that had become “miracle economies.”1 Many analysts saw India as a lumbering elephant, in stark contrast to the Chinese tiger. Twenty years later, the Indian elephant has indeed morphed into a tiger. It averaged 8.5 percent growth in the last decade and survived the Great Recession of 2007–09 with only minor bumps before returning to 8.5 percent growth in 2010–11 (see Table 1).2 Its per capita income has shot up from $300 in 1991 to almost $1,700 today, and its GDP this year will exceed $2 trillion3 in nominal terms and maybe $4.5 trillion in PPP (purchasing power parity) terms, which would make it the third-largest...
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