India is at a crossroads in its path to economic success. Of course, this is a statement that seems appropriate every few years, but perhaps there is a more fundamental choice now than any that has been faced since the late 1980s. That period saw an economic crisis that involved external pressures and domestic political flux. Together, they led to the beginning of the period of ‘reform’, which continues in its own way. Great progress has occurred, but nowhere near the examples that made up the ‘East Asian Miracle’, and India is not even close to the income levels where a ‘middle-income trap’ is supposed to hold countries back.
In my last column, I pointed to work by Sajid Chinoy and Toshi Jain, which shows that total factor productivity growth (TFPG) has slowed, a sign of lack of enough innovation. TFPG is related to tangible characteristics of the economy: public investment, openness to trade and effective financial intermediation. Fixing financial intermediation is urgent, and requires a big push in cleaning up existing messes, plus enabling new technologies and platforms to develop and be deployed quickly. Public investment is a no-brainer: it has many champions, and just needs an urgent financial restructuring—selling unproductive state-owned assets to finance it. Trade openness is less well understood, or even accepted, because it is not as simple as it used to be, and has to be part of a much broader package of openness.
Economists’ arguments for trade openness used to be based on classical theories of comparative advantage and static gains from trade. On this basis, one can easily argue for countries like India to produce and export labour-intensive products such as leather goods and garments. Considerations of growth and innovation complicate matters, in terms of the theoretical case for trade openness. An enormous practical complication is the rise of global value chains (GVCs) or global production networks (GPNs)—the first term emphasises the outcomes (value addition) and the second the mechanisms (essentially, complex supply chains).
On top of this, there are the benefits of spillovers when a country is integrated into GVCs/GPNs. Swati Mehta, whose work on India’s innovation system I mentioned in my last column, in newer research, has shown the value of GVCs for innovation, through backward linkages. The rise of India’s auto components industry is an example of such linkages. In East Asia, South Korea benefited from Japan and China from Taiwan (indirectly) in similar ways.
This model of trade openness also requires openness to foreign investment, especially in the form of FDI by multinationals that dominate GPNs. India is making progress in recognising and encouraging this avenue for integration and growth, though perhaps not enough. And it is failing in recognising the importance of openness to people and ideas.
In 18th century Europe, pure mathematicians exchanged ideas across borders, and moved among patrons in different nations. Their discoveries and conceptual tools helped pave the way for modern applied science—physics, chemistry and engineering. Inventors also sought support wherever they could find it. By contrast, 14th century China, then the world’s technology leader, closed itself off to the outside, including the world of new ideas and innovation.
India is a more recent example of this kind of disastrous closing off. In his book, ‘Locked in Place’, sociologist Vivek Chibber argued that “insufficient state capacity (for rapid industrialisation) stemmed mainly from Indian industrialists’ massive campaign, in the years after Independence, against a strong developmental state.” In independent India’s 75th year, a repeat of this process, abetted by an ideology of ‘self-reliance’ and cultural nationalism, is a real danger. This is why India is at a major crossroads.
As noted, the policy solution for India is not just passive opening up, by lowering trade barriers, though that is necessary too. Indian policymakers have to embrace a confident approach to integration into the global economy, including the GPNs and multinationals that govern them. Infrastructure and education are vital parts of this mix, as is making sure that the masses have decent food and shelter. Inclusive growth is sustainable growth, as many large companies will recognise, if they are nudged towards that conclusion.
As India emerges from the pandemic, with its demographic dividend still available to be cashed in, and with MNCs and their host governments looking for strategic reconfigurations of GVCs to provide resilience in the face of pandemics and the rise of China, India’s government cannot afford to take the wrong path.
The author is professor of Economics, University of California, Santa Cruz