22 December 2009

A Short Economic History of Modern India

Swaminathan Aiyar, in a brilliant article*, gives us a short economic history of modern India:

At last week's annual meeting of the World Bank and IMF, many speakers spoke of the need for governments to reduce controls and trade barriers and let entrepreneurs get on with the job. They also stressed the vital roles that governments did indeed need to perform: ensuring law and order, the enforcement of contracts, honest governance and the creation of basic infrastructure.

Dissenters will say this sounds suspiciously close to the formula of the British Raj. The result then was not prosperity but poverty and stagnation. Now that we are in our 50th anniversary year of independence, many people will ask: why did liberal economics prove an economic failure during the British Raj? And why should it be any more successful today?

Before the Industrial Revolution, India was the second biggest industrial power in the world (next only to China). When the British Raj ended in 1947, India was a poverty-stricken nation with minimal modern industry. Nationalist leaders like Jawaharlal Nehru blamed this decline on colonial exploitation. The British did not see it that way. They thought they had brought peace to a subcontinent that was earlier riven with constant war; had created political stability and rule of law where there had been neither; created an efficient and impartial civil service and judiciary; built one of the biggest railway networks in the world.

However, GDP growth in the first half of this century was barely 1% per year, just keeping pace with population growth. Food availability per capita declined. Indian artisans, who once dominated world industry, were decimated by the Industrial Revolution. And while in Europe the Industrial Revolution replaced handloom weavers with local textile mills, in India it replaced them largely with Lancashire textiles. Jawaharlal Nehru complained that this de-industrialisation halved India's urban population and forced once-prosperous industrial workers back to the land. He felt free trade was a British ploy to force its manufactures on India and prevent Indian industry from growing.

So after independence Nehru went for rapid industrialisation through import substitution and by taxing agriculture through adverse terms of trade. He felt agriculture lacked the potential to reduce poverty or increase employment and could only be a holding ground for surplus labour till industry provided additional jobs.

During the British Raj, India ran a persistent trade surplus. The ratio of India's exports to imports was 172.5% in 1840-69, 148% in 1870-1912, 133.4% in 1913-38. This persistent trade surplus, averaging 1.5% of GDP, was used to transfer wealth to Britain. So Nehru viewed export-orientation as a tool of colonial exploitation. He switched the emphasis from exports to import substitution. He viewed technical education as vital for industrialisation, but viewed primary education as less important and so did less for literacy than East Asian countries.

This strategy was initially hailed as a success. GDP growth rose to 3.5% per year, almost thrice the rate achieved in the last 50 years of the British Raj. Planning was high fashion at the time and Indian planning was at the very forefront of development economics. Only much later did East Asian countries demonstrate that 3.5% growth was slow, not fast, and that a different strategy – emphasising exports, agriculture and primary education and entrepreneurship – could produce much better results.

Nehru's biggest mistake related to agriculture. He failed to see, as Korea and Taiwan did, that with enough public investment and new technology, agriculture could be a dynamic sector that raised the living standards of the masses. The industrial sector was much too small to create much income or employment and so taxing agriculture to finance industrialisation did not reduce poverty in India during Nehru's rule or the Garibi Hatao phase of Indira Gandhi. It started declining only from the mid-1970s onwards, when the spread of the green revolution finally lowered real food prices and raised real rural wages. Higher rural incomes provided a firmer basis for rapid industrial growth than Nehru's earlier import substitution.

Nehru failed to see that the really big blow India suffered under the British was not in industry but agriculture. Ashok Desai estimates that grain yields in 1947 were one third of those in Mughal times. In the first half of this century, food production rose by only 0.5% per year, half the rate of population growth. This, not de-industrialisation, was the main cause of poverty in a country which was 85% rural.

The whole de-industrialisation thesis was flawed. Certainly the artisans of old suffered, but under the Raj a new breed of modern Indian entrepreneurs came up. The share of industry in India's GDP rose from 3.8 percent in 1913 to 7.5% by 1947 and the share of manufactures in India's exports rose from 22.4% in 1913 to 30% in the late 1930s. Modern industry employed fewer persons than the old artisan industry, but its output was more competitive.

Nehru's anti-export bias was mistaken. The British may have used trade exploitatively, but it had enormous possibilities with the end of empire. The East Asians saw this, but were regarded with contempt by Nehru as US puppets. They had the last laugh.

Let us return to where we started. Why did liberal economics and good governance not lead to prosperity during the British Raj? The main reasons are:
  • The British sadly neglected agriculture and rural infrastructure, far more so than industry.
  • The British Raj was racist, favouring British entrepreneurs and goods over Indian ones. This racism was probably important that the alleged lack of tariff encouragement to Indian manufacturers.
  • The British sadly neglected primary education and literacy. By contrast, East Asian countries had high levels of literacy by 1950.
  • The British used India's trade surpluses to remit capital to the UK instead of investing it in India's growth.
Today, all these conditions have changed. We now have a government that, however imperfectly, understands the importance of agriculture and rural development. It aims at improving the fortunes of Indians, not Englishmen. It has, imperfectly, improved primary education. In place of the colonial capital drain, there is now a large capital inflow that helps develop the economy. In these circumstances, a liberal economy and good governance can produce good results.

*"De-industrialisation Thesis Was Flawed", The Times of India (29 September 1996)

1 comment:

Deepak said...

Great article, Dheeru. Thanks for posting this. Reading this gives me hope.