A Passage to Prosperity
The right strategy for India is to walk on two legs: traditional labor-intensive industry and modern IT. Both legs need strengthening through further reforms; and four specific reforms are of special importance.
Having sustained 6% annual growth since the late 1980s, India is now regarded as an unequivocal economic success. Prime Minister Manmohan Singh, who visits the White House on Monday, initiated many of the key economic reforms during his tenure as the finance minister in the '90s. But his task remains incomplete. India continues to trail well behind China, which has been growing at the annual rate of 10% since 1981. From an equal level in 1980, per capita income in China today is more than twice India's. The proportion of the population below the poverty line has dropped below 5% in China compared with 26% in India.
Though trade has grown rapidly in both countries, it has grown far more rapidly in China. Exports of goods and services grew at the annual rate of 15.2% compared with 10.7% in India. By 2003, China's share in world exports hit a noticeable 5.8% while that of India remained virtually invisible at below 1%. Foreign direct investment (FDI) in India expanded manifold in the '90s over '80s, but it remained less than one-tenth the level achieved by China.
The single most important factor explaining these differences is the relatively poor performance of Indian industry. Whereas the share of industry in China's GDP rose from a high level of 42% in 1990 to 51% in 2000, it remained virtually stagnant in India. By contrast, Indian service grew rapidly, expanding its share from 41% in 1990 to 48% in 2000. This trend has continued in the last five years.
Industrial output is far more tradable than services. True, information technology services have a large traded component, but they are less than 2% of India's GDP. Therefore a low share of industry and slow growth in it translate into slow growth in trade. Moreover, in labor-abundant economies such as China and India, FDI is attracted principally to industry to take advantage of lower wages: A low share of industry means a lower level of FDI; and if the conditions for rapid industrial growth are lacking, growth in foreign investment will also be low.
What can India do to achieve the high level of growth and the low level of poverty achieved by China? Some argue that India can achieve this by specializing in services. If the bulk of the recent growth in services in India had been in formal services such as telecommunications and IT, this strategy would make eminently good sense. But these sectors are currently tiny, with distribution services, public administration, real estate, community services, and transport accounting for 70% of services. Moreover, 60% of India's workers earn their living from farming and cannot be drawn into formal services without being taken through 15 years of education.