Legendary financier George Soros has suggested that we may be seeing not only the end of a period of especially rapid global growth (a 25-year “financial bubble”), but also the demise of a post-World War II (WW II) “super boom”. This view happens to be consistent with economist Nikolai Kondratiev’s theory of 60-year-long waves. Without buying into the background reasoning, one can still speculate on the consequences for the Indian economy of a major global downturn.
Given the gloomy global picture, and the sharp rise in India’s inflation, should one be pessimistic about India’s growth prospects? The last few years, when sustained 10% growth seemed within reach, could have been just an aberration of favorable global conditions. A decades-long slowdown across the world will be very different in its impacts from recent crises, where recovery, with some exceptions, was rapid and robust.
How can India’s growth story survive? While openness to international trade will continue to be better than the old autarkic regime, export-led growth may not be the driver of overall growth, as it was for East Asia in the 1960s, or China now. Even growth in services exports will be affected by a global slowdown. So, battles over the right exchange rate for exporters may be of second-order importance. Inflation, too, provided it does not get out of control (not much more than 10%), is not necessarily bad for growth, though it distorts economic decisions and hurts the poor. South Korea grew at “miracle” rates with relatively high inflation in the 1960s and 1970s, though it ultimately benefited from bringing down inflation rates. Access to foreign capital, too, may not be critical to continued high growth: Studies suggest that not all kinds of foreign capital accelerate growth.
I would argue that India can sustain high growth, whatever happens, by paying attention to growth fundamentals. Growth is driven by investment in physical, human and knowledge capital. India’s growth acceleration has been associated with significantly higher rates of domestic saving and investment. Removing industrial controls, reforming the tax system and developing the domestic financial sector have all contributed to raising savings and investment. The good news is that there is enormous scope to realize further efficiencies in institutions for allocating capital, as well as in implementing capital projects. By continuing with financial sector reform, as detailed in the Percy Mistry and Raghuram Rajan committee reports, and removing infrastructure constraints, policymakers can boost growth even in the face of a global slowdown.
India’s economy has also benefited from the better use of human capital, made possible by domestic and international liberalization, and by technological change. Yet, this has been achieved with a very narrow base — there has been trivial progress in expanding the supply of human capital in India. The pursuit of advanced education abroad, which has increased, can only make a small dent in the country’s needs. There is a huge opportunity to expand domestic supply by allowing foreign direct investment (FDI) in higher education. Petty politics and an ideology of insecurity have prevented this from happening. Simple demographics — the aging of the rich world — will drive FDI in this sector if policymakers allow it.
India also remains woefully behind the world technology frontier. Industrial productivity is still very low by best-practice benchmarks. Creating a policy climate for innovation, and even more so for adaptation of existing technologies to Indian conditions, provides the third enormous opportunity for India. In the first century after the Industrial Revolution, growth rates were much lower than those achieved after WW II. Part of the reason lies in the accumulation of a stock of knowledge capital, which accelerates innovation, increases imitation opportunities for latecomers, and allows leapfrogging. The situation is even more favorable now than it was for 1960s’ East Asian industrializers. India can grow rapidly by technological catching up, along with investing in physical and human capital.
Where will the profits come from to drive the process, if not growing global markets? India’s size and demographics have the potential to create a significant domestic middle class, just as it happened in Japan. Middle-class habits of saving and consumption can be particularly favorable to economic growth. India’s domestic market potential is even more than Japan’s was in the past. International openness still matters, of course, for competition, innovation and scale efficiencies.
Much of what I have written here about drivers of growth is no different from India’s development strategy of the 1950s. International openness and a market and enterprise orientation are the key differences, and are critical. India can do more than survive a global crisis: The right policies can put it on a bulletproof growth path.