Online Extra: Spreading India's Uneven Wealth

To U.N. economist Santosh Mehrotra, the biggest challenge for the new ruling party will be lifting 650 million Indians living in poverty

To many investors, the shocking election upset in India, where a coalition led by Sonia Gandhi's Congress Party ousted the ruling Bharatiya Janata Party, means the nation's reforms and stunning economic growth are now in jeopardy. But many economists have a more optimistic view. They argue that India's economic boom wasn't sustainable over the long term because it revolved too heavily around the technology sector and the middle and upper classes.

Santosh Mehrotra, an Indian-born economist with the U.N. Development Program (UNDP), subscribes to this view, and he's elated that India will be led by Prime Minister Manmohan Singh, a former Finance Minister who is regarded as the godfather of Indian economic reform. One of the chief authors of the UNDP's annual Human Development Report, Mehrotra argues that for India to achieve the kind of high, long-term growth that China has enjoyed, the benefits must spread to the 650 million Indians living in the impoverished countryside. He says this will require a much heavier emphasis on areas such as primary education, health care, and rural infrastructure.

Mehrota recently discussed what India must do to tackle the "unfinished agenda" of attacking mass poverty with BusinessWeek Senior International News Editor Pete Engardio. Following are edited excerpts of their conversation:

Q: What's your reaction to Manmohan Singh becoming Prime Minister?


It's about the best thing that could happen for the country. He has said all the right things. He is absolutely the right man for this type of job. The question is whether his hands will be tied by politicians.

Q: Why does India need a new economic strategy?


What has happened is that the economy as a whole has grown 6.2% annually since 1990. But clearly what matters is the nature of the growth. The gap between rich and poor has grown in both rural and urban areas. So has the gap between urban and rural areas, and so have the gaps among different states. This is the fundamental problem the economy is facing.

The growth has been based on information technology, manufacturing, and services. The problem is that 65% of India's population depends on agriculture, which has grown by only 2% annually over the past decade. The import important thing in rural areas is to generate jobs. The manufacturing growth has been jobless because it is based on capital-intensive investment to mostly produce durables such as cars, washing machines, and dishwashers. And there is rising overcapacity now in manufacturing -- utilization is 81% -- so there is only so much more the economy can keep growing this way.

There are six or seven things that would reduce poverty and lay the ground to sustain the growth we have seen since the 1990s.

Q: You mention agriculture. Hasn't India had a Green Revolution in recent decades?


There has been a Green Revolution in India, especially in places like the Punjab, Haryana, and West UP, where there has been a dramatic increase in agricultural income. So India has plenty of food. Plenty of food grains are publicly financed and publicly warehoused.

Yet, India has 223 million hungry people, which we define as consuming less than 1,960 calories a day. This is out of 800 million people in the world who are hungry. In fact, there are more hungry people in India than in all of Africa, where there are 183 million. Between 1990 and 2000, the number of hungry people in the world actually fell. This was entirely due to China, where 80 million people escaped hunger. The number did not decline in India.

Q: How can this be?


One problem is that the government's public-distribution system is a sham. India is producing, but it doesn't mean people are getting the food. Another big reason is that prices are high. The government owns warehouses and buys food from rich farmers. But the prices it pays are higher than the market price. The main reason it buys at high prices is the farm lobby.

The government policies are supposed to cover economic costs such as land and fertilizer, but on top of this the government pays a bonus. And government purchasing prices have been rising.

Q: Why aren't these policies helping poor farmers as well?


Most of the massive state subsidies go to big farmers. However, only 25% of cultivated land is irrigated. So most farmers depend on the monsoon. This simply will not do. There must be wider investment in quality irrigation. To generate jobs, there must be an increase in output and more food processing and services in the agriculture sector, such as distribution and warehousing.

Q: India has a reputation for a highly educated workforce. But illiteracy remains high. How big is the problem?


India has the largest number of illiterates in the world, larger than the total population of 1947. China had a literacy rate of 65% in 1980. Now its literacy rate is about 85%. But India's literacy rate today is still at 65%. Over the 1990s, India spent about 3% to 4% of GDP on education. This has not risen.

You don't get sustained high economic growth rates unless you have the human capital upon which to build it. Education has a revolutionary effect on a society. Within a generation, you can transform a society.

Q: Why hasn't India accomplished more in this area?


Low education spending by the government is one problem. Another is that spending has been consistently skewed toward higher education, rather than primary education. From 1950 through 1990, 30% of public education spending has gone to higher education. Government policy had a lot to do with it. From 1952-57, government spending was remarkably high on primary education. But in the second plan (1957-62), capital-intensive industry was emphasized, so this required demand for higher education -- sciences, doctors, engineers, etc. After 1990, there was a shift to elementary education, and higher education fell to 10% of education spending.

But higher education remains heavily subsidized. It costs about 125,000 rupees to send a student to an Indian Institute of Technology, but even after big tuition increases, the average student pays only about 36,000 rupees. Meanwhile, while millions of children of school age have no proper school to go to.

Q: How is India different than, say, the East Asia Tigers?


In South Korea, 70% of public-education investment in the 1950s was in elementary education. Then it focused on secondary. Almost all higher-education students went to private schools, which paid for themselves. In India, most higher institutions are public financed and subsidized. Not surprisingly, only 50% of public-education spending goes to grades one through eight.

Q: What are the problems beyond insufficient spending?


Another problem is that 97% of primary-education spending goes to teachers' salaries, leaving little left over for other things, like books and schools. That's largely because of highly unionized teachers, who make sure they have high salaries. Also, teachers have political power because they are guaranteed seats in the assembly. In many villages, teachers are the highest-paid people. They often are the few who own cars. On top of this, a huge number of teachers don't even come to teach.

As a result, there has been a big increase in private education at all levels. But many of the poor can't afford that.

Q: Are there other differences between India and the Asia Tigers?


Another is land reform. The major reason poverty declined so quickly in East Asia is that land reform often began in the 1950s. Korea carried out massive land reform in the first 10-15 years after independence. So did Taiwan. As a result, there was greater initial equality in society. When the state made investments in services and education, therefore, people could take advantage of the opportunities provided by the markets. In India, and in South Asia generally, that level of reform never took place. Agricultural growth has also been consistently slower in India than in most East Asian countries.

Q: How about availability of electrical power?


That is a major, major problem. You can't have good irrigation without electricity. Almost all of India's 500,000 villages have electricity. But it does not reach most rural homes or farms. The shortage of power also is the most serious bottleneck in releasing the energy of the manufacturing sector.

The relatively well-off farmers and the vast majority of small industries have the wherewithal for their own diesel generators. Even in major cities, you get used to having power cuts several hours a day -- especially during the summer monsoon. So the majority of shops and homes, even in New Delhi, have diesel generators. Imagine how this raises the costs for industry, retailers, and farmers.

Q: Much of India also lacks enough water. What are the main reasons?


One of the great achievements of India since the '80s is that 90% of population has access to safe water. But that doesn't mean water is running into their homes. Even in Delhi, people get access to the tap only two times a day. If you don't fill up your jug or water tank, you don't get water. In the rural areas if you are well-off, you build a well. But that costs a lot of money.

Also look at sanitation. It's appalling. You would expect that in urban areas the situation is better. But in 2000, only 61% of urban people have access to improved sanitation. In urban China it's 69%. India is very densely populated. In Africa, there are 23 people per square kilometer. India has 230. If people are going to the toilet on the street, or sleep along railway lines, you can imagine the health impact.

Q: Speaking of health, in what kind of shape is public health care?


Health spending is just 0.9% of GDP. In China, health expenditure is 2% -- yet China has a much higher life expectancy and lower infant mortality so its needs are less. In most of the West, public health spending is about 4% to 5% of GDP. Some of India's statistics are terrible. Only 43% of Indians are born under some kind of medical care. The rest are born in their houses, usually without trained care.

Q: What's the problem?


It's not that India has no clinics. Every district of 2 million has clinics, a primary health center, and a hospital. But often the doctors and nurses are not there, and often there are no medicines. That's because there's no money. These are structural problems that the state must deal with.

For example, the HIV/AIDs epidemic is growing. The government is taking notice now, but there are structural problems in delivering care. It is interesting that Indian companies are making generic anti-retroviral drugs available in Africa, and are even threatening transnationals, but the Indian government has no money to buy anti-retroviral drugs.

In 1993, after it was approached by the government, Cipla offered to supply AZT for just $2 a day. But the government couldn't afford it. Just now, in the last six months, the government has been negotiating with three or four big manufacturers to buy anti-retroviral drugs in bulk and supply them to patients.

Q: India will need a lot of money to address some of these problems. What is the shape of government finances?


The big question is, how will all of these investments be financed? The ratio of tax revenue to gross domestic product is 40% in most rich countries. In India, it's 10%. Public expenditure is 18% to 19% of GDP, which leaves a budget deficit of nearly 10% -- half by the central government, half by the states. You have a real serious public-finance problem.

Q: How can the deficit be reduced?


One way is to cut wasteful spending. Defense is a major budget item, so peace with Pakistan could help. But much of the deficit also is driven by massive subsidies to producers. The major source is services provided to factories and big farmers for which costs are never recovered. The rate that many of them pay for power is often very low, so that's an implicit subsidy.

There also are implicit subsidies in irrigation. Canals are dug and managed by the government, but few of the costs are recovered. There also is a fertilizer subsidized, plus the high procurement prices we talked about.

Q: Why then is tax revenue so low?


In the '90s, [the ratio of] taxes to GDP was just 8% to 9%. There's a huge, massive black economy. Only 1% of population pays direct tax. Most revenues are indirect, such as excise duties, customs, and a trade tax. Now the government wants to implement a value-added tax, which has been talked about for many years. A VAT has been successful in most countries where it has been used. That will be one great day and huge victory if the VAT is actually implemented.

Q: Considering all these problems, you say you are an optimist. Why?


Well, there are very serious reasons to be pessimistic. But there are two possible hopeful signs under current the government. One, Congress has learned, having been out of power in the center, that they need to deliver more than they ever delivered before.

They also have been taking a heavy drubbing in the state elections. This was not a vote for Congress. The electorate has decided it will throw out whichever government that does not deliver. Only reason the chief minister of Madhya Pradesh state stayed as long as he did was that he delivered on education and health, so he stayed nine years. But he still was thrown out.

Second, of all political parties, the two Communist parties (which have 63 legislative seats and was an ally with Congress in the elections) has been the most morally upright. They have delivered in West Bengal and delivered in Kerala, where they have been in power. West Bengal has had a Communist party elected six times over 25 years. It is probably one of the few elected Communist parties in world.

In Kerala, for 50 years government has alternated between Congress and the communists. There is such competitive rivalry that no matter which party formed the government, they had no choice but to follow pro-poor policies in Kerala. In the 1990s, Kerala achieved a high record in education and health. In the early decades, high unionization led to a lot of strikes deindustrialization. But that whole scenario has changed dramatically. In the '90s, there has been high income growth, big drops in poverty, and a construction boom. There also now is an IT industry.

Q: Many analysts fear that India's economy will slow due to the transfer of power and the new policies. Are you worried?


If you get a slightly lower growth rate in the short run, the gains could be that this growth will be more sustainable and there will be a changing pattern of production. There's no reason that this could not mean that growth in the future will be much higher than now. But if India doesn't achieve more balanced growth now, it may become another Brazil, with rich regions but the majority living in poverty.

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