Evidence tells us, unequivocally, that sustained economic growth is the best bet for poverty alleviation. But scepticism about growth remains embedded in our discourse. In this episode, FED Director Rahul Ahluwalia talks to one of India’s most-renowned economists, first Vice-Chair of the NITI Aayog and Chair of the 16th Finance Commission, Dr. Arvind Panagariya. They discuss Dr. Panagariya’s personal journey and perspectives on growth that still shape India’s intellectual discourse and policymaking.
RA: Everyone knows Dr. Arvind Panagariya, the economist. But I want to talk about Dr. Arvind Panagariya, the person. So tell us a bit about your formative years, what inspired you to get into economics? What were the views and events around the world that shaped your thinking, especially on the topic that you have been such a strident champion of, which is economic growth?
Dr. AP: I’m from a generation when parents used to be very influential in your life. My father had this plan for his three sons – one was to be an engineer, another a doctor, and the third a civil servant. I was supposed to be the civil servant. My father had a very good idea about what would be important in the life of a civil servant, and he felt that economy policy would be central. So I got a Masters in economics to prepare for the civil services, but was simultaneously also applying to universities abroad, and I got admitted to Princeton with full financial aid. However, I wasn’t very confident of clearing the civil services interview because I had studied in a Hindi-medium school till Class 10! Somehow, I managed to convince my father and came to America where I enrolled in Princeton.
On how my perspective about growth took shape: Part of it was because in America, as opposed to UK or India, there was a bent in favour of free markets. Although, when you come from India – I arrived in 1974 – you come with a lot of intellectual baggage and are defensive about protectionist policies. So it takes a while for one’s thought process to evolve, it was only by the 80s it was very clear to me that liberalisation was required but I remember being sceptical about whether it will happen. I thought India’s bureaucrats won’t allow it to happen. When liberalisation happened, I was one of the early champions, but of course, in my own evolution, a big influence was Jagdish Bhagwati, who stood for growth. He became my mentor even though I was never his student. He was very kind to younger scholars generally.
RA: The intellectual climate today is again challenging economic growth? What is, in your mind, the simplest logic for why we need growth?
Dr. AP: It’s ironic that, if you’re from India, the evidence stares you in the face – what lack of growth did to us, and yet, the ideas of socialism are so firmly embedded in a large part of the intellectual class. Nehru himself wasn’t sceptical of growth. In Discovery of India, he wrote that the country was so poor that the only thing you could redistribute was poverty. So he wanted growth! It’s just that the policies he adopted failed to deliver growth. And then Mrs. Gandhi was even more firmly committed to redistribution, to the point of being sceptical of growth.
What we know is, in the end, we made a big dent in poverty only after growth began to happen. Beginning in early 2000s is the key turning point in India’s growth story when, for the first time, the economy grows at practically 8% And it continues for at least for 5-6 years. This is the period that I studied very extensively, because India is a contentious country. When I showed that poverty fell, people said ‘Oh, but you know, this is not helping the Dalits, and this is not helping the tribals’, and so forth. I did all the numbers myself actually, and whether you look at scheduled castes, scheduled tribes, Muslims, any kind of grouping. There was not a single group, which did not benefit from growth. That really, in some ways, I think, doing those numbers, and seeing that the pattern was so strong, really convinced me.
RA: So you’re very clearly making the point that unlike the mainstream narrative, post liberalisation growth was quite inclusive?
Dr. AP: Yes, but the way I would put it is during the Nehru era, we did not have inclusion in the growth process itself. Because we gave no capital to the workforce; all capital was given to steel mills and heavy industry, where very few workers were employed. So, our process was very different from countries like South Korea, Taiwan and China, where capital was spread to these workers through labour-intensive industries. There was no skill upgradation in India, as opposed to these other countries, where skills continued to improve over time as the country became more capital abundant and incomes rose. That process did not happen in India; it has still not happened, because we’ve not been using our most abundant resource which is labour.
When liberalisation happened, the service sector was fully freed. Nothing in services was subject to something like the small-scale industries reservation we had in manufacturing. Labour laws have still not been reformed and the most constraining ones, like the Industrial Disputes Act, apply exclusively to factory manufacturing.
That is why we’re not at a 10% growth rate.
RA: How would you explain the importance of trade and how central it is to growth for a low per-capita country like India?
Dr. AP: It is incredibly central. Simplest way to think about it is, suppose we forget about international trade and become a closed economy. Then you can grow only as fast as your demand grows. But your demand will grow only as fast as the economy is growing. And you know that initially, the growth rate is not going to be high. That’s a vicious circle right there.
RA: And we practically were a closed economy at one point, so, you can just take that growth rate and extrapolate from it…
Dr. AP: The only way to break that circle is to go to the global markets, where the demand is massive, right. And therefore, certain sectors can grow as rapidly as they want or as rapidly as they can. Then there are other associated factors, which is that innovation is taking place in the world economy; minds are at work around the world. But all these innovations were happening outside India. So how would India access that technology? Most of these technologies are embedded in machines. So, you must be able to import these machines to access the latest technology. And to get to a position where you can import, you must export because you cannot import without exporting. So, once again, you get back to the idea that trade is central.
Also, technological diffusion can happen through products. You bring in laptops and reverse engineer, we did that in pharmaceutical – how exactly did we build the pharmaceuticals industry? It was because India’s patent protection was very weak. So, we did not protect the products in pharmaceuticals, we protected only the process. If you could vary the process a little bit by introducing some sort of ingredients that were inactive, it was a different process. And then the pharmaceutical industry could do well by reverse engineering. So, India, even today has access to the cheapest medicines around the world. So that helps, and of course, there is also the force of competition. When you see somebody doing better than you, you say, well, why am I innately any worse than those guys, so you work harder when you compete with the best in the world, you are inspired to work harder; that also makes you better and improves your productivity. There are several reasons why being open to the global markets helps you grow faster.
RA: What really helps ground this and I’ve heard you give this powerful example so many times of the apparel industry. Where the Indian domestic market is only $55 billion and growing at 2-3 percentage points, but global imports are worth $500 billion. And so, you will often mention how large that is.
Dr. AP: So, take the broader comparison. We in India think that we are a large economy, which we are, the fifth largest in a global context. It’s a large economy and it will be third largest very soon. So certainly, it is not a small economy. However, having said that, let us say, you know, by 2022 to 2023 figures 3.4 trillion, maybe with the current year ending by the end of 2024, we’ll be 3.7-3.8 trillion. But that’s our GDP! Now, if you look at the export market alone, the total export market, in the year 2022 was $25 trillion. And this was just the export market for goods. Then there is services, which is another 7 trillion in the year 2022. So here, you’re talking about a $32 trillion world market, which is roughly 10 times India’s GDP. So that’s a very large market to operate in. Even if we can capture the entire global market for a few products, that’s it! We don’t have to do anything else. That really is the China’s story, that it acquired a very large share in certain products. And that is what has really, given China such a large boost, you know, for three to four decades it grew 10% a year
RA: Your point that we should force firms to compete because that improves productivity and that’s where growth comes from – globally and not just in India, we’re again seeing a return of this debate on protectionism and import substitution. So from a global and historical perspective, instead of trying to get into a more controversial national perspective, what is your perspective on these debates? Can we really point to industrial policy and protectionism as a successful source of competitive advantage for countries?
Dr. AP: In 2019, I published this very thick book: “Free Trade And Prosperity“. And I looked at all the successful countries such as Hong Kong, Singapore, Taiwan, South Korea, China, and India, and these are the six successful high growth examples. And my conclusion was very clear that, in the end, countries that have been open are the ones that have grown rapidly.
Historically, this temptation to return to import substitution does arise in other countries, India is not unique. And a good example of that is South Korea. South Korea had the history of being very open and from 1963 to 1973, it was a full decade during which South Korea grew with relatively neutral incentives. If I remember the numbers correctly, it started off with exports, having an export-GDP ratio of 5%. By 1973, it had grown to over 20% Korea was also running a large trade deficit. So, the import-GDP ratio, at around 25%, maybe a little more. What happens is I think, when you get there, there is a temptation to think that the imports that are coming could be produced domestically. Then, of course, “smart” economists always come in to make the infant industry argument. So that temptation is added by intellectuals too.
So this happened, the whole heavy and chemical industry drive that South Korea went through, starting in 1973. was exactly that – industrial targeting. But if you look at the growth figures during this period, growth declined by about two percentage points or less. And they ealised it quickly by 1979 and exited the industrial policy. Eventually the growth rate picked up again. By early 1980s, Korea returned to the growth path, and then grew for a whole decade at 8%-9%. But in India, the intellectual support for industrial policy and import substitution remains strong. And there are hardly any champions of an outward export-focussed orientation. I fear that for India, exiting this new phase of import substitution is going to be a challenge.
RA: It’s interesting. I know of South Korea only through your work. It is not discussed broadly that industrial policy is a drag they and how countries have grown in spite of their industrial policies, not because of them. Even for Japan, their industrial ministry tried to block Sony, Mitsubishi, and Honda, from procuring transistor technology from the US and Honda from entering the automobile market. So again, some of these champions succeeded in spite of the government intervention. Lastly, in your view, what could Indian states be doing to be more export oriented?
States need to recognize that, ultimately, for them to succeed, they need to achieve this transformation of bringing workers into gainful employment. And that, of course, means, creating a favourable environment for labour intensive industries. I think that to me is the single most important policy objective that states ought to be pursuing, particularly the larger states agriculture still dominates very heavily. I mean, Bihar clearly is one case in point but UP as well. And to do that, I have championed, creating special zones. Because reform at the national level and everywhere has been a challenge. But I think states could take a bit of initiative.
The present central government, I think, is very indulgent in these matters, and so, if the states were to bring in legislation, which would create a legal environment in which such special zones, which should be large, you know, you can’t do this for a few 100, a few 1000 hectares, you have to go 200 to 300 square kilometre kind of areas in which substantial economic activity can take place, and basically, the administrator of that zone ought to have the near full authority to change the rules. I think that could really do wonders and change the ethos in favour of employment intensive industries.