Column : India really is a supply side story

Written by Michael Walton | Michael Walton | Updated: Jul 15 2009, 03:37am hrs
Economic spirits are up in India, notwithstanding budget-related disappointment. Growth has been impressively resilient despite the global crisis. Stock exchanges are signaling recovering profit expectations.

But excessive optimism would be premature. The short-term story is primarily about demand. Supply-side constraints are daunting for the medium and long term.

The short-term resilience has been a welcome surprise. I earlier thought the economy would be hard hit by falls in exports and investment, as international demand fell, expectations dropped and international credit for firms dried up. All of this happened. But the combination of monetary easing and a substantial additional fiscal stimulussome 3% of GDP relative to the previous yearsubstantially offset this. The fiscal stimulus was partly fortuitous: it helps to have a crisis after an election budget, even more after a big government pay increase. The fact that NREG was up and running (at least reasonably well) meant the government could put more resources in precisely the kind of automatic, contracyclical, poverty-focused expansion that such insurance mechanisms should have. Many measures got money into private hands quickly.

So, the short-run looks good, and growth momentum may follow. But short-run resilience was not a consequence of decoupling, and the global economy is not out of the woods. If international recovery stalls, there is precious little fiscal room left .

But the big questions lie in tackling supply-side constraints. There are salutary lessons from international experience. Analysts of the Emerging Market Forum highlighted a common pattern: most countries have periods of decent growth and then get stuck in a middle income trapBrazil, Mexico and the Philippines are typical; Korea is an exception. China is too early to tell.

Why is sustaining rapid growth so hard Fundamentally, this requires an evolving policy and institutional basis that supports productivity growth. Institutional design is complex and transplanting institutions from other countries generally fails. Furthermore, the kind of institutional change needed frequently involves working against entrenched interests. This is the link with structures of inequality: those benefiting from the existing system will resist change, even if change is good for long-run prosperity.

This applies to the full range of areas: from the judiciary to urban management and education. Take just two areas: rural productivity and infrastructure.

Rural productivity is no longer a dominant influence on aggregate growth, but remains massively important to the wellbeing of most Indians. All the East Asian successes had rapid rural productivity growth as a central element. Yet in India, there has been a long-term shift in budgets away from support for innovation and investment to subsidies. Many subsidies exacerbate the time-bomb of water management, a reflection of an immense collective action failure combined with lack of credibility of governments to effect genuine reform. Yet, politicians still promise more subsidies to shore up the rural support base.

Infrastructure is thick with opportunity for extracting rents and corruption. Private sector involvement is surely part of the solutionboth on grounds of finance and efficiency. If designed well, private involvement can be better for equity than distorted and captured public systems. But this requires a whole range of institutions from high-powered regulators and concession-managers to effective courts and mechanisms to manage resettlement and disputes. Private involvement was supposed to solve Latin Americas infrastructure deficit in the 1990s. A fair bit of infrastructure got built. But outside telecomsrelatively easy because competition is possibleand outside Chilea small country with an unusually strong rule of law traditionthe push to private involvement signally failed. Corruption was a big issue. Im sure private involvement is needed, but it requires careful institutional underpinning.

So, what does this add up to First, the restoration of rapid growth is quite likely in the next year or so, but this is a poor predictor of longer-term growth. Second, sustaining rapid growth will require continuous institutional evolution in multiple areas, and this is both a political economy and a technical issue. Third, the corporate sector can be part of the problemresisting desirable institutional changeor part of the solution if it acts in the longer-term collective interests of the sector. And fourth, if political capital means the space to tackle tough issues with a medium-term orientation, this government will need to carefully marshal and use it.

The author is at the Harvard Kennedy School, the Institute of Social & Economic Change and the Centre for Policy Research