Do Politics Actually Have Any Affect on India's Economy?

In a fevered election battle, India's top candidates are claiming that they -- and only they -- can get the faltering economy back on track. But the data shows they're missing the point.

As Indians head to the polls this week in the first stages of an epic five-week election process to determine the next prime minister of the world's largest democracy, the ruling Congress party and the opposition Bharatiya Janata Party (BJP) are clashing sharply over India's faltering economy. The country's GDP growth rate has slowed from 9 percent in 2010 to under 5 percent, and voters are deeply frustrated by rising inflation and corruption. Congress candidate Rahul Gandhi and BJP challenger Narendra Modi are battling over whose approach -- redistributing wealth or promoting economic liberalization and fiscal responsibility, respectively -- has done more for the majority of Indians.

The good news is that, for once, an election campaign in India, which normally focuses on the candidates' personalities and castes rather than their platforms, is taking the economy seriously. The bad news is that the debate is backward-looking, mired in misleading claims, and oblivious to India's place in the world. 

The truth is that India's economy tends to rise or fall with the global economy, not with the party in power. For virtually every five-year period since 1980, Indian GDP has grown at a rate about 1.5 percentage points faster than the emerging-world average. This is mainly because even after two strong decades of growth, India's per capita GDP is still only about $1,300 -- and it's always easier to grow fast from a low level. Over the course of the last three governments, one under the BJP and the last two under departing Congress Prime Minister Manmohan Singh, India's average annual GDP growth has ranked somewhere between 40th and 50th out of the roughly 150 countries in the emerging world, regardless of which party was in charge. 

The last BJP-led government took office in 1999 under Prime Minister Atal Bihari Vajpayee. He helped liberalize India's economy by selling stakes in state-owned companies and established a cap on the budget deficit, but his reforms had little impact on India's ranking in the developing world. Over the next five years, India posted average annual GDP growth of 5.8 percent, ranking 50th in the emerging world, and average annual inflation of 3.9 percent, ranking 70th. This record represented little change from the prior two decades, so it is hard to see why today it should provoke much criticism, or bragging.

When the Congress party and Singh replaced the BJP in 2004, India stayed on a similar course. After 2003, with international trade booming and easy money pouring out of central banks in the West, growth accelerated sharply across emerging countries. India's GDP grew at an average of 8 percent from 2004 to 2008, but its ranking barely improved: From 2004 to 2008, India clocked in at 39th in the emerging world for average GDP growth and 73rd for inflation. And now the BJP campaign is implying that these boom years under Singh grew out of the reforms completed by Vajpayee. Although these reforms played a role, the real story is that India was simply reveling in a global party.

As a result of the economic boom, Singh won a second term as prime minister in 2009, but global conditions were getting tougher. After 2008, when the tide of easy money dried up in the global financial crisis, India, like many emerging countries, unleashed a stimulus package to keep growth alive, spending heavily on measures like guaranteed wages and income supports for the poor. But even that could not prevent India from slowing along with the world economy. Over Singh's second term, India's average annual GDP growth rate slowed to 6.5 percent, but its ranking remained basically the same at 45th. Underneath the headline growth number, however, the economy is starting to show serious cracks, in the form of rising deficits and inflation.

As India ramped up government spending after 2008, it began to slip in the global rankings of countries based on the size of the government deficit, which has risen from 3.3 percent of GDP in 2007 to 5.8 percent on average since 2008. Congress officials defend their record of heavy spending on income support and welfare for the poor, but this spending has driven up inflation, which attacks the poor hardest. India's inflation rate has risen from 6.5 percent in Singh's first term to 10.5 percent in the second, while its inflation ranking has fallen from 73rd in the emerging world to 130th. Since Singh took office, the misery index -- the combination of the unemployment and inflation rates -- has risen from a low of 12 percent in 2005 to 20 percent.

To be sure, it is not only Congress that overlooks inflation. India is in the grip of a money illusion, imagining gains that are in fact symptoms of an inflationary economy. Daily headlines hype the "record highs" of the stock market, which Congress officials spin as a vote of confidence in India's economic fundamentals and which BJP officials spin as a rally, anticipating reforms under Modi. But both sides are ignoring that these highs are being reached in nominal, not real, terms -- the apparent peaks are not corrected for the rise in inflation or the fall of the rupee, which has dropped more than 25 percent against the dollar in the last three years. Thus corrected, the market is about 35 percent below the highs it achieved in early 2008. Since then, corporate earnings have been rising 10 percent a year in nominal terms -- which means they have gained roughly nothing when adjusted for inflation.

The raging election debate over the economy is new and healthy, but it would be far more useful if it were less backward-looking. It is hard to understand why Modi and Gandhi are spending so much time defending the mediocre records of governments in which neither played a decisive part. Instead, they should be shifting their sights to the future.

The genuine Asian miracle economies, like Japan, South Korea, and China, were rising manufacturing powers that maintained decades-long runs of unusually rapid growth with low inflation, even when the world economy was struggling. As yet, no Indian party has achieved that feat. The question Gandhi and Modi should be answering is not what their predecessors did for the economy, but what they can do to make India a real miracle.

A version of this article originally appeared on the Times of India’s website on April 4, 2014. Republished with permission.

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Democracy Lab

Why India Is Overdue for Economic Reform

If Narendra Modi wins, India's leftists will have no one to blame but themselves.

From April 7 to May 12, India will conduct the most critical election in the 67 years since it gained independence from Britain. It is, in essence, a referendum on the development paradigm set by India's first prime minister, Jawaharlal Nehru, which offered India democratic political rights -- while sharply curtailing its economic freedoms.

Hindu nationalist Narendra Modi has taken a hefty lead in the polls by effectively reversing this formula and vowing not to let India's messy democracy stand in the way of a business- and infrastructure-focused economic liberalization. Modi is an authoritarian figure with no clear plan to back his pledges beyond his personal charisma. Should he win, India's leftist intellectuals, who've only offered failed socialist solutions to address the soaring economic aspiration of Indians, will bear much of the blame. (In the photo above, a supporter wears a Modi mask while handing out campaign fliers outside his apartment buliding.)

Nehru turned to Fabian socialism, which relies on central planning rather than the spontaneous activity of individual entrepreneurs, to achieve his development goals. This backfired. As economist Arvind Virmani notes, when India achieved independence in 1947, the real income of the average Indian was 25 percent that of the average inhabitant of the world. Three decades later, it had dropped to 14.5 percent. This gap only began to close around the 1990s when, confronted with a humiliating debt crisis, India jettisoned the more irrational aspects of Nehruvian socialism, especially its ridiculous "License Raj," which required businesses to obtain government permission before moving equipment within their own factories, changing their product mix, or even traveling abroad for a conference.

These reforms produced a decade of explosive growth, lifting 300 million from poverty. It also made India the IT hub of the world leading to heady talk about "Brand India," the notion that just as India had come to define the global standard in quality programming, so it would in other aspects of its culture.

Given such spectacular results, the next round of liberalization should haven been a no-brainer when India's economy took a nosedive about five years ago. In the West, there is a great deal of disagreement among technocrats about how best to jumpstart growth -- whether to use stimulus spending or resort to austerity measures. In India, however, there is near unanimous agreement because there are so many low-hanging policy reforms still to be plucked. One core reform would be eliminating India's rigid labor laws that forbid money-losing factories with more than 100 workers to shut down. This has asphyxiated India's manufacturing sector, forcing many of the 15 million Indians who enter the workforce every year into low-wage agricultural or menial jobs.

Instead, the ruling Congress Party, which has been controlled by the Nehru dynasty since its inception, has ignored the technocratic consensus for further reform. It has taken inspiration from the National Advisory Council that Sonia Gandhi, the Congress Party head and the Italian widow of former Prime Minister Rajiv Gandhi, has stacked with like-minded NGO activists (essentially community organizers) and leftist intellectuals. Most of them oppose India's turn to "neoliberalism" and privatization and believe that the old recipe of "social spending" and industry mandates is the answer to poverty. Congress has followed this advice with a vengeance for the last 10 years, granting massive new entitlements for subsidized grains in the name of "food security" to 67 percent of the population, and guaranteeing a minimum income to all rural families. It also implemented the Right to Education Act that requires private schools to set aside 25 percent of their seats for the poor and lower castes.

Rahul Gandhi, Sonia's blunderbuss son who is Congress's undeclared candidate for prime minister, has made such "rights," rather than reform, the cornerstone of his campaign. In the past, this would have generated a voting bonanza. Not this time. A recent Pew Research poll found that 70 percent Indians are dissatisfied with the direction of the country. And with good reason. Such schemes won't even offset the double-digit inflation that has been playing havoc with household budgets. More importantly, they betray a complete tin ear, offering a mere subsistence existence when, thanks to the brief experience of real growth, people want something approaching dignified living.

Narendra Modi, the chief minister of Gujarat who represents the opposition Bharatiya Janata Party, has achieved cult status by forging a rhetoric that shrewdly gives voice to such aspirations. His stump speeches promise growth or development and jobs, especially for young people. In every other way, he is a highly flawed candidate -- and not only because he is a megalomaniac who holds multiple, simultaneous rallies across the state, "attending" each one using 3-D holographic technology, as if to suggest his omnipotence.

For starters, there is the infamous 2002 pogrom in Gujarat that prompted the United States to blacklist him for a visa. For several days, his party goons roamed the streets freely, rampaging and killing close to 2,000 Muslims. Although the Supreme Court "exonerated" Modi, India's Human Rights commission characterized the response to the bloodletting as a "comprehensive failure" -- a damning charge for a man who is parading his bona fides as a "great administrator" who will improve law and order and root out corruption in India. What's more, far from apologizing and assuring Muslims that their right to practice their faith will be safe under him, when recently asked if he feels regret over the massacre, he said he did, just like he would if his driver ran over a puppy. Meanwhile, he repeatedly derides the constitution for its special accommodations for the religious minorities that some of the ardent Hindus in his base despise.

Equally troubling, his tenure as chief minister has been marred with extra-judicial killings in staged encounters with alleged Muslim terrorists. His administration has also been trying to fend off "Stalk-Gate"-- a scandal involving the use of the state police to stalk a young woman. Also troubling for civil libertarians, he shows little compunction about banning books that irritate Hindus or harassing independent-minded writers. All of this has prompted India's pre-eminent historian, Ramachandra Guha, no hyperventilating left-winger, to condemn Modi's incipient "fascism."

But such accusations simply roll off the backs of fed up Indians who see Modi as a tough, smart, and incorruptible administrator with a track record of success in turning a resource-poor state like Gujarat into an economic powerhouse. Gujarat's record is, indeed, impressive. It contains only 5 percent of India's population but accounts for 25 percent of its exports. But there are arguably other states -- Harayana, Mahrastra, Andhra Pradesh -- with better growth records, suggesting that Modi's real gift is political marketing.

Such marketing can win elections. But transforming the national economy is another matter given the yawning gap between Modi's lofty rhetoric and his actual policy proposals. He pledges to make India an Asian Tiger like Hong Kong with a "minimal government but maximal governance" approach -- a revolutionary formulation in India. But Modi "strongly opposed" Congress's attempt to open India's primitive retail sector to big-box stores like Walmart. Why? Because mom-and-pop businesses, his core base, didn't want the competition. More remarkably, he supported Congress's entitlement schemes, even criticizing the Food Security Act for not offering large enough subsidies.

Most disappointing, however, is his economic plan, which, as an Economic Times writer declared, has "no new ideas." It included vague promises to slash or scrap income, sales, and excise taxes, although his party has since backtracked, and says nothing about reforming India's labor or other sectors. Instead, it is heavy on Big Government infrastructure projects. Some are sorely needed, but many -- such as building "smart cities" and "bullet trains going in four directions" -- are patently absurd and calculated mainly to appeal to India's chauvinistic desire to keep up with China. "The only thing one can say for certain about Modi is that he won't harass businesses as much as other contenders," says First Post's Dhiraj Nayyar, one of India's smartest young commentators.

That Indians seem ready to risk political repression for vague promises of an economic transformation shows just how desperate they are to improve their living standards. This suggests that Nobel laureate Milton Friedman was right that political freedom requires a foundation of wealth that only economic freedom can generate. (The Heritage Foundation ranks India 120th among 165 countries in its economic freedom index, putting it in the group of "mostly unfree" countries.) Political liberties are a luxury that people care about more when they have fuller bellies. Richer people have more means of resistance and become costlier to oppress.

Nehru's intellectual heirs have failed to comprehend this, and ultimately, this has paved the way for a demagogue like Modi. Amartaya Sen, the Nobel Prize winning economist and the darling of India's intellectual left, belatedly admitted as much, noting recently that India badly needs a "clear-headed, pro-market, pro-business party that does not depend on religious politics."

The challenge for India's leftist establishment will be to turn the Modi administration into such an entity should he be elected. This will mean allowing the technocratic consensus for reform to proceed unmolested. The left needs to do some soul searching and recognize that its remedies simply can't fulfill the economic aspirations of Indians. Modi is far less likely to act on his anti-pluralistic, socially regressive tendencies if he can actually deliver the growth he's been promising. Otherwise, he'll be tempted to play his Hindu nationalist card. Should that happen, India might end up with the worst of both worlds -- poverty and repression -- and Modi won't be the only one to blame.