Illustration by Stephen Cheetham

India’s Unfinished Journey to Economic Success

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Dec. 21 (Bloomberg) -- Even if the latest reforms succeed, India will need to do much more to acquire the efficiency, infrastructure, foreign direct investment, free markets and deregulated, corruption-free orientation that will allow the country to move from 5 percent annual real growth to higher sustainable gains.

Land reform is required not only to allow foreign supermarkets to become established but also to make it easier for manufacturers to set up factories. A national sales tax would encourage intra-Indian trade by replacing the tangle of state levies. For now, state governments distrust the central administration to give them their fair share of the proceeds.

Corruption needs to be reduced by shifting away from a system in which politicians allocate public goods and where many feel entitled to enjoy the lifestyle of the very rich. India inherited its bureaucratic system from the British and added corruption to the formula.

The “Licence Raj” system has been weakened since 1991, but is far from dead. Deregulating the distribution of coal would be a big plus. The government could begin by breaking up or selling Coal India Ltd., a huge and inefficient state monopoly.

Financial Markets

Financial-market development would be aided by easing the requirement that banks and other financial institutions hold large quantities of government securities -- a rule that has kept the private-sector credit and corporate-bond markets relatively small. Also, reducing government’s control over three-quarters of India’s banks would make capital allocation more market-driven and efficient.

Many Indians have strong entrepreneurial inclinations. The growth that could be produced by shifting economic power from politicians to entrepreneurs would be vital to reducing high poverty rates and corruption. Small- and medium-sized businesses are the largest nonfarm employers and account for 45 percent of manufacturing output. They add about 3.3 million workers annually. That’s still well below the 13 million new labor-force entrants each year.

Corruption, a byzantine bureaucracy and poor infrastructure impede entrepreneurs. In recent years, China has added annually about 10 times more power to its electric grid than India. The government’s reluctance to enact land reform and other spurs to agribusiness, as well as barriers to intrastate trade, inhibit entrepreneurial opportunities and rural productivity growth. And 80 percent of entrepreneurs, according to a survey, say that corruption is increasing, a reasonable assumption as economic expansion creates more opportunities for graft.

Furthermore, a culture that penalizes risk taking is an obstacle to new ventures. Indian business is concentrated among long-existing and well-connected conglomerates with close ties to the government, much like the state-owned enterprises in China and the chaebols in South Korea. No significant Indian government-owned business has been privatized in years.

Compared with the U.S., U.K., Germany and even China, India leads the pack in terms of business-startup costs and is only topped by China in the time it takes to establish a business. According to the World Bank, India ranked 132nd out of 185 countries in a study on the ease of doing business, behind Russia (112th) and Brazil (130th); China was 91st.

Many enterprises reduce the cost of bureaucracy and taxes by operating off the books. A landmark study in the mid-1950s found that the underground economy accounted for 4 percent to 5 percent of Indian gross domestic product. That share rose to 40 percent in 1996, and to 50 percent a decade later.

Education Deficit

Education also ranks high among India’s long-term challenges. About 97 percent of children enter school, but more than half drop out before completing high school. The literacy rate of 63 percent in 2006 -- the latest available data --though an improvement from 52 percent in 1991, is only higher than Pakistan’s 2009 rate of 55 percent among major countries. School enrollment is the lowest, in high school and college, among the so-called BRIC nations: Brazil, Russia, India and China.

Even more of a problem is the quality of public education. Business executives complain about the overbearing bureaucracy in highly regulated schools, and the emphasis on rote learning rather than critical thinking and comprehension.

An Indian call center found that it could hire only three of every 100 applicants because so few high-school and college graduates could communicate effectively in English and had basic reading comprehension skills. Students in India’s engineering colleges now number 1.5 million, compared with 390,000 in 2000. Yet 75 percent of technical graduates and more than 85 percent of general grads can’t pass the tests for jobs in India’s information-technology industry, call centers and other high-growth global sectors. These businesses directly employ only 2.5 million Indians and are constrained from more rapid growth by shortages of adequately prepared workers.

Major Indian outsourcing companies such as Tata Consultancy Services and Wipro Ltd. are increasing the length of training programs to bring newly hired graduates up to speed. Both companies made on-site evaluations of India’s 3,000 engineering schools. Tata says 300 students made the cut; Wipro said 100 did. Only two Indian universities rank in the world’s top 500, compared with 22 in China, two in Russia, six in Brazil and 154 in the U.S.

Higher training costs are reducing the international competitiveness of India’s outsourcing industry, which contributes $69 billion annually to the economy and accounts for a quarter of exports. Furthermore, competition from other countries, such as the English-speaking Philippines, is increasing.

Tablet Computer

There is hope for Indian education, however. The new Right to Education law promises to lift quality by setting minimum standards for school buildings, playing fields and student-teacher ratios. Also, some wealthy Indians are endowing universities, financing higher salaries to attract good faculty, hiring Indian academics from abroad and promoting research, as well as teaching. In addition, the Indian government, in partnership with Canada’s DataWind Ltd., recently introduced a low-cost tablet computer to be sold to students for about $35, part of the government’s effort to leverage the Internet in education.

Income inequality has always been prevalent in India, and has been rising in recent years. McKinsey & Co. estimates that there are 2.5 million households making more than $34,000 per year, compared with 1 million in 2005. However, those on the bottom, with less than $3,000 a year, have increased to 111 million from 101 million in 2005.

India’s millennia-old caste system impedes social mobility and economic growth. Every Indian is the same before the law, though caste determines social status, who a person can marry and what his or her occupation will be.

When India moved toward capitalism in 1991, it set out to create equal opportunity for all, regardless of caste. The huge number of lower-caste Indians used their voting power to push the government to more than double the number of jobs and civil-service positions reserved for them.

Despite 20 years of efforts to break them down, caste influences play more of a role in wage inequality in India than do social hierarchies in Indonesia, Brazil and China. In 2010, median household income of high caste Indians was more than twice that of the low-caste Dalits. And the higher the caste, the more access there is to indoor plumbing, electricity and vaccinations for children, and the better the English skills and literacy rates for both sexes become.

Urbanization also remains a challenge for India. Subsidies and other government policies, at least until now, have encouraged rural life. There are now 377 million city dwellers, or 31 percent of the population, and that number is growing by about 5 million a year as migrants from the hinterland flock to the cities. That’s still a far cry from the situation in China, where 49 percent of the population was urban in 2010, even though migrants from rural areas are legally discouraged from moving to cities. With urbanization comes economic growth and rising incomes as better-paid, high-value-added city jobs replace farm work.

City Migration

Reducing subsidies for rural Indians could encourage them to move to cities, much as the Enclosure Acts in England in the 18th and 19th centuries pushed landless rural people into factory towns during the Industrial Revolution.

India’s rural subsidies might be better spent on social services such as old-age pensions and disability insurance, health care, unemployment benefits and training. India ranks last on the Organization for Economic Cooperation and Development’s list of public social expenditures as a share of GDP.

Although a smaller share of India’s GDP is produced by industry than in China, services account for 56 percent of the economy, compared with 43 percent in China. Services range from high-value-added segments such as information technology to restaurant dishwashers and rickshaw drivers, which on average have much lower productivity and wages than industry. The demand for goods is much more volatile than for services, especially in the export arena. So India’s more inward-looking stance and its orientation toward the production of services offer better protection than China and other goods-export-led nations, which are hurt by the global economic weakness and resulting depressed demand for goods.

Urbanization must be combined with deregulation, bureaucratic restraint, clean government and adequate infrastructure to result in high efficiency and rapid economic growth. And Indian infrastructure -- roads, railways and electric power -- needs a vast improvement, another long-run challenge.

India has limited natural resources, but a lack of local raw materials hasn’t restrained Japan’s growth. India also has to take care of its environment. Like other developing countries, India has major problems with air and water pollution. The Ganges River is sacred, though tanneries, paper mills and other industries dump untreated waste into it.

Indians have yet to acquire a sense of responsibility for their environment, their national treasures and public spaces. This may be due to an overreliance on government to fix things; a historic caste culture; the religious conviction that the present is unimportant; a sense of fatalism; and the pressures created by a huge population. And it simply may be part of the early stages of economic development.

Visiting India, I realized that this is a very old and deep culture that resists rapid change. After independence in 1947, these traits were reinforced by stifling bureaucracy, corruption, economy-distorting subsidies, veneration of rural life, Soviet-style central planning and an acceptance of slow growth.

It will be fascinating to see if India’s problems can be overcome and whether rapid and sustainable economic growth can be established in a robust democracy. I believe India will succeed in the long run.

(A. Gary Shilling is president of A. Gary Shilling & Co. and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” The opinions expressed are his own. This is the fifth in a five-part series. Read Part 1, Part 2, Part 3 and Part 4.)

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