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Pro-market Reforms and Growth

Arvind Panagariya

The embrace of pro-market reforms by the Marxist government of West Bengal notwithstanding, anti-reform scholars continue to express skepticism towards them.  Distinguished Princeton political scientist Atul Kohli has fired the latest shot on their behalf in an article in the Economic and Political Weekly (April 1 2006).

Virtually all skeptics rest their critique on a syllogism.  Their first premise is that the shift in the growth rate to six percent took place a decade before the 1991 reforms.  For example, Kohli opens with the assertion, “For the last quarter of a century India’s economy has grown at an average rate of nearly 6 per cent per annum.” The second premise of the critics is that the development strategy in the 1980s was “pro-business” rather than “pro-market”.  Both premises are deeply flawed.

To address the first premise, I report the growth rates of the GDP from 1979-80 to 1987-88 in Table 1.  For now, I deliberately suppress the years 1988-91.  To calculate the average rate from these annual rates, we must first decide the starting year.  India’s financial year begins on April 1 and ends on March 31.  Therefore, going purely by the calendar, we could begin on either April 1, 1980 or April 1, 1981.  April 1, 1980 fails an important economic test, however: it follows a year in which the GDP fell by 5.2 percent.  Therefore, the super-high growth rate of 7.7 percent in 1980-81 is spurious.  At the end of 1980-81, the real GDP was approximately the same as at the beginning of 1979-80. 

This suggests 1981-82 as the natural starting point for the 1980s.  Continuing to exclude the last three years of the decade for the moment, the average rate from 1981-82 to 1987-88 turns out to be 4.8 percent.  This is a far cry from the claims of 6 percent growth.

How do we then explain the pervasive impression among scholars that India grew nearly 6 percent per annum during the 1980s?  During the last three years of the 1980s—1988-89 to 1990-91—India grew a hefty 7.6 percent annually.  Once this super-high growth rate is added, the average growth rate from 1981-82 to 1990-91 works out to be 5.8 percent.  But this fact can hardly be used to support the claim that India’s growth rate had shifted to 6 percent at the beginning of the 1980s.

Some reform critics also cite econometric tests to bolster their case.  They report that these tests show a break in the growth rate series in the early 1980s and not in 1991 when the reforms began: ergo, the shift to the 6 percent growth rate was in the early 1980s and not 1991.  But again they unwittingly misrepresent the reality.  The econometric tests only tell us that starting in the early 1980s the growth rate was statistically significantly different from that during the prior three decades.  They do not tell us that the rate was 6 percent.

Based on the argument just outlined, I take the view that there was a modest shift from the 3.2 percent rate during 1965-81 to 4.8 percent during 1981-88.  This shift essentially represented a return (with a slight improvement) to the 4.1 percent rate that had already been achieved during 1951-65.  The shift to the more impressive rate of 6.1 percent was later, in the late 1980s.  The initial modest shift was consistent with the modest reforms in the late 1970s and the first half of the 1980s complemented by fiscal expansion and external borrowing throughout the 1980s. 

Accelerated fiscal expansion and external borrowing, complemented by much more significant Rajiv Gandhi era reforms, successfully raised the growth rate to 7.6 percent during 1988-91 but they also pushed the economy into the 1991 balance-of-payments crisis.  It is only because India responded to the crisis by continuous and systematic reforms in the 1990s that the growth rate of 6.1 percent could be sustained. 

What do we make of the distinction between “pro-market” and “pro-business” policies played up by Kohli?  Frankly, this author finds the distinction superfluous.  Kohli defines “pro-market” strategy as one that allows free play to markets to achieve efficient allocation of resources and promotes competition.  As for the “pro-business” strategy, he is less specific stating that it has ‘developed more via real world experience, especially from the rapid growth successes of some east Asian economies.’

But alas, outward orientation, timely depreciation to avoid overvaluation of the domestic currency, labor-market flexibilities, and license-free entry of new businesses and expansion of the existing ones, advocated by pro-market economists, were all integral part of the “real world experience” of the fast-growing economies of East Asia.  How can you be pro-business without giving free play to markets?  Surely, giving monopoly of the entire sectors (iron and steel, telecommunications equipment) to the government, as we did during the 1960s and 1970s, is not pro business. Likewise, creating private sector oligopolies through licensing (Ambassador and Fiat cars) may favor specific businesses but is not truly pro-business.

Even the claim made by some that liberalizing reforms in the 1980s were pro-business in the (alternative) sense that they favored the incumbent businesses by relaxing capacity expansion constraints rather than new entrants is not compelling.  Conceptually, either change is towards a more liberal regime and favored by pro-reform economists.  Factually, perhaps the most important industrial policy reform during the 1980s was the steady relaxation of the ceiling on license-free investment in fixed assets.  This ceiling was raised from 10 million rupees in 1973 to 50 million rupees in 1981 and 150 million rupees in 1989-90.  As it happens, the existing big players, namely, the companies falling under the Monopolies and Restrictive Trade Practices Act, were not permitted to avail of this provision.   

(The author is a professor at Columbia University.  This article draws on his book, India: An Emerging Giant, New York: Oxford University Press, forthcoming in 2007.)

Table 1: Annual Growth Rates of the GDP at Factor Cost During the 1980s



















 Economic Times June 28 2006