India's Foreign Policy : News, Views and Discussion

 
 

Why India is standing at a crossroads​

India is poised to become the world’s most important country in the medium term.

It has the largest population (which is still growing), and with a per capita GDP that is just one-quarter that of China’s, its economy has enormous scope for productivity gains.

Moreover, India’s military and geopolitical importance will only grow, and it is a vibrant democracy whose cultural diversity will generate soft
power to rival the United States and the United Kingdom.
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Narendra Modi has used local oligarchs to drive the Indian economy. AP

One must credit Indian Prime Minister Narendra Modi for implementing policies that have modernised India and supported its growth.
Specifically, he has made massive investments in the single market (including through demonetisation and a major tax reform) and infrastructure (not just roads, electricity, education, and sanitation, but also digital capacity).



These investments – together with industrial policies to accelerate manufacturing, a comparative advantage in tech and IT, and a customised digital-based welfare system – have led to robust economic performance following the COVID-19 slump.

Yet, the model that has driven India’s growth now threatens to constrain it.

The main risks to India’s development prospects are more micro and structural than macro or cyclical.

First, India has moved to an economic model where a few “national champions” – effectively large private oligopolistic conglomerates – control significant parts of the old economy. This resembles Indonesia under Suharto (1967-98), China under Hu Jintao (2002-12), or South Korea in the 1990s under its dominant chaebols.

In some ways, this concentration of economic power has served India well. Owing to superior financial management, the economy has grown fast, despite investment rates (as a share of GDP) that were much lower than China’s. The implication is that India’s investments have been much more efficient; indeed, many of India’s conglomerates boast world-class levels of productivity and competitiveness.

But the dark side of this system is that these conglomerates have been able to capture policymaking to benefit themselves. This has had two broad, harmful effects: it is stifling innovation and effectively killing early-stage start-ups and domestic entrants in key industries; and it is changing the government’s “Make in India” program into a counterproductive, protectionist scheme.

We may now be seeing these effects reflected in India’s potential growth, which seems to have declined rather than accelerated recently.

Just as the Asian Tigers did well in the 1980s and ’90s with a growth model based on gross exports of manufactured goods, India has done the same with exports of tech services. Make in India was intended to strengthen the economy’s tradable side by fostering the production of goods for export, not just for the Indian market.
The recent saga surrounding the Adani Group is a symptom of a trend that will eventually hurt India’s growth.
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Instead, India is moving towards more protectionist import-substitution and domestic production subsidisation (with nationalistic overtones), both of which insulate domestic industries and conglomerates from global competition.

Its tariff policies are preventing it from becoming more competitive in goods exports, and its resistance to joining regional trade agreements is hampering its full integration into global value and supply chains.

Another problem is that Make in India has evolved to support production in labour-intensive industries such as cars, tractors, locomotives, trains, and so forth.

While the labour intensity of production is an important factor in any labour-abundant country, India should be focusing on industries where it has a comparative advantage, such as tech and IT, artificial intelligence, business services, and fintech.

It needs fewer scooters, and more internet of things start-ups. Like many of the other successful Asian economies, policymakers should nurture these dynamic sectors by establishing special economic zones. Absent such changes, Make in India will continue to produce suboptimal results.

Finally, the recent saga surrounding the Adani Group is a symptom of a trend that will eventually hurt India’s growth.

It is possible that Adani’s rapid growth was enabled by a system in which the government tends to favour certain large conglomerates, and the latter benefits from such closeness while supporting policy goals.

Again, Modi’s policies have deservedly made him one of the most popular political leaders at home and in the world today. He and his advisers are not personally corrupt, and their Bharatiya Janata Party will justifiably win re-election in 2024 regardless of this scandal. But the optics of the Adani story are concerning.

There is a perception that the Adani Group may be, in part, helping to support the state political machinery and finance state and local projects that would otherwise go unfunded, given local fiscal and technocratic constraints. In this sense, the system may be akin to “pork barrel” politics in the US, where certain local projects get earmarked in a legal (if not entirely transparent) congressional vote-buying process.

Supposing that this interpretation is even partly correct, Indian authorities might reply that the system is “necessary” to accelerate infrastructure spending and economic development.

Even so, this practice would be toxic, and it would represent a wholly different flavour of realpolitik compared to, say, India’s vast purchases of Russian oil since the start of the Ukraine war.

While those shipments still account for less than one-third of India’s total energy purchases, they have come at a significant discount. Given per capita GDP of about $2500, it is understandable that India would avail itself of lower-cost energy. Complaints by Western countries that are 20 times richer are simply not credible.

While the scandal surrounding the Adani empire does not seem to extend beyond the conglomerate itself, the case does have macro implications for India’s institutional robustness and global investors’ perceptions of India.

The Asian financial crisis of the 1990s demonstrated that, over time, the partial capture of economic policy by crony capitalist conglomerates will hurt productivity growth by hampering competition, inhibiting Schumpeterian “creative destruction,” and increasing inequality.

It is thus in Modi’s long-term interest to ensure that India does not go down this path. India’s long-term success ultimately depends on whether it can foster and sustain a growth model that is competitive, dynamic, sustainable, inclusive, and fair.
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Why India is standing at a crossroads

India has done well using its big conglomerates as national champions. But that also brings traps that the country must avoid.
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