Reservations have improved productivity in higher-level jobs

Written by Sarika Malhotra | Sarika Malhotra | Updated: Jun 17 2012, 06:37am hrs
Even as demographics matter to the pace and process of economic growth, the key policy question is whether health and education allocations by the government will grow in tandem to transform Indias youth into productive employment, says Chetan Ghate. He is currently serving as RBI chair professor of macroeconomics at ICRIER, on leave from the planning unit of the Indian Statistical Institute, where he is associate professor. In his latest edited work, The Oxford Handbook of the Indian Economy, Ghate dwells on an array of key issues confronting the Indian economy. The volume features research by leading scholars and economists, like Rajat Achaarya, Pranab Bardhan, David Bloom, Gautam Bose, Willem Buiter, Priya Shyamsunder and Nirvikar Singh. Ghate tells Sarika Malhotra that understanding Indias dualistic development process and the emergence of the Indian economic miracle are crucial in tackling the obstacles India faces in transforming itself into a modern 21st-century economy.

Does the economic history of colonial India have useful lessons for post-colonial development in India Do the prepositions of the past shed light on the present

Per-capita incomes between 1914-1947 grew at close to 0%. Despite low average growth rates, colonial India was hardly the example of a failure. It had strong property rights, a literate elite and a bureaucratic tradition on which a stable democracy could be built. Modern industrialisation, which began in the 1850s gave India a head start in activities that promised to raise living standards. India also had no shortage of entrepreneurs.

The first globalisation (1857-1920), buttressed by colonial rule, induced agricultural transformation. This helped create the urban industrial giants of Bombay and Calcutta. Work in the volume suggests these were not small gains, and produced rich returns in post-colonial times. But the gains were restricted to a few industries, a few cities and a few districts. Prosperous regions were also endowed with water, good land and market access. All this takes us to the issue of the fundamental causes of Indian economic growth. Geography and geography-based factors had an important bearing on post-colonial growth. Institutions mattered. Cities were also, and continue to be, important engines of economic growth. This is because the process of growth in developing countries is fundamentally a process of migration from rural districts to metropolitan centres.

It has been pointed out that the pre-1991 growth rate should be taken as the new growth rate for India. Do you agree

No, I dont think we will settle into the pre-1991 growth rate. The Indian economy has almost quadrupled in size since 1991, growing at close to an average of 7%. Savings and investment rates are higher at around 32% of GDP. The demographics of a young population offer a distinct growth advantage. Productivity has also increased. In terms of factor accumulation, sustaining growth is feasible. The current global downturn notwithstanding, trade will continue to serve as an engine of growth in the years to come. Our share of the worlds merchandise exports has risen from 0.5% in 1993 to 1.5% in 2010. Interestingly, in 1953, it was 1.3%.

India has withstood the trade and financial shocks of the financial crisis of 2008 reasonably well. But there are challenges. Although the transition from low to middle income can be managed by countries if they have the right incentives and basic human development, the transition from middle income requires a capacity to innovate. We dont want to miss the boat here. Rising inequality in India may also create more political demand for redistribution. If redistribution takes the form of better infrastructure, better schools and better public health, this will further help growth. If it takes the form of unproductive subsidies, then a higher investment-GDP ratio will be required to offset the drag on growth. So the composition of government spending matters. The key question is whether Indias domestic political economy will allow 8-9% growth. We have to look at inclusive growth in a more dynamic sense: how a more equitable distribution of income now feeds into future growth. Redistribution through public infrastructure is better for growth and equality.

Whats your opinion about public sector reservations and their impact on productivity

This is an open research question. Productivity measures are constrained by data availability. Productivity gains could be realised through general productivity gains from greater workforce diversity, or there could be more efficiency in supervision of lower-level workers by their own social groups, or it could be that there is a higher intrinsic motivation to prove critics of reservations wrong. Our volume cites some research into the impact of job reservations on workers productivity in the Indian railways and finds that reservations have improved productivity, especially for higher-level jobs.

Given Indias vast population and the mass of unskilled workers, what measures should be taken to boost Indian manufacturing

An acceleration in growth in manufacturing employment has eluded India. What is the binding constraint Is it uncertainty in the policy climate or labour laws or something else The evidence in our volume suggests that labour laws, poor infrastructure and financing constraints are the main reasons behind the lacklustre performance of manufacturing in India. Policy needs be directed to alleviate these constraints. Indian states with relatively inflexible labour regulations have experienced slower growth in labour intensive industries and slower employment growth. Capital intensity in Indian manufacturing is far higher than what Indias factor endowments predict. Factor market imperfections further raise the capital intensity of manufacturing. India isnt gaining from its labour advantage. A lot of this has to do with the current policy mix in manufacturing. And political leadership matters.

Economy and higher education must not be viewed merely in relation to Indias own past, but also relative to its neighbourhood and the world. How would you place India in this context

In contrast to Indias record in primary and secondary education, which floundered after independence, the building of high quality research institutes (like the School of Technology and Computer Science, the Indian Institute of Science and the Indian Statistical Institute) was one of the great success stories of Nehruvian socialism. Very few countries at Indias level of development have institutes of higher research training of such calibre. Outside these institutions and a few others, however, the quality of graduate education is poor. The new private higher education institutions are basically teaching shops. Our volume suggests that worldwide, there is little evidence that supports the success of a for-profit model in building higher education.

Do you think it is important to address financial frictions for a comprehensive monetary policy

It is well-known that monetary policy has smaller effects on output and prices in emerging and developing economies. In India, shortcomings of transmission further arise because of an underdeveloped financial system and the problem of credit rationing by formal sector banks. Financial activity is segmented between a formal sector that primarily serves large enterprises and an informal sector that provides a majority of financing to SMEs. A key area of research is to understand the allocational effects of interest shocks, and how formal and informal finance influence monetary policy. Answers to these questions will shed light on how monetary policy will be made into a more effective tool in the future.

Do you see capital flows as a self-inflicted pain

It is true that there are dangers of aggregate risk of volatile capital flows, which affect the volatility of non-traded goods and asset prices in the recipient country. Developing countries also run large budget deficits, and have financial repression. This volume suggests these characteristics raise the risks of opening up to capital flows. Until a couple of years ago, unbridled capital flows had led to an appreciation of the nominal exchange rate. But capital flows are prone to reversals. How you deal with this volatility is a key question. Are their advantages to capital controls Maybe in the short run. The experience through the financial crisis, where the Asian countries that had some measure of controls were not as affected as the rest, has also reinforced this message.

Exchange rate volatility may constrain realisation of economic growth. Is an in-depth examination of exports and exchange rate volatility overdue

Indias trade deficit widened considerably during April-February 2011-2012 compared with the corresponding period of the previous year. Notwithstanding the rupee depreciation, trade deficit widened, primarily due to a slowdown in global demand and the relatively price inelastic nature of some of Indias exports. Indias trade deficit will probably remain high in the near future. The rupee has also weakened as a result of the volatile capital flows. We show that in the post-reform period, nominal exchange rate volatility has dropped to 5.35 (1991-2010) from 6.74 (1950-1991). Nominal exchange rate has also turned counter-cyclical in the post-reform period. From an acyclical relation in the pre-reform period, the post-reform period shows that the exchange rate goes up in bad times and moves down in good times. Drawing a modern macro model to understand the stylised facts of the Indian business cycle, and to what extent the changing stylised facts of this cycle are driven by structural changes caused by liberalisation policy, good luck and better monetary policy, is an exciting research project.

The Oxford Handbook of the Indian Economy

Chetan Ghate

Oxford University Press

(Hardcover)

Rs. 4,995