A Very Short History of the Indian Economy

     A new account of India’s recent economic development (The Rise of India, by Niranjan Rajadhyaksha) begins by pointing out that the country was once a major global economic power and that, after a long period of decline, its share of world output began to increase only in the 1990s.  At that point, India began to take “the first tentative steps that could put it back on the long journey to prosperity.”² 

     For the first half of the last millennium, India had the largest share of income of any country in the world.  As recently as the 18th century, it accounted for nearly one-quarter of the world’s output.  India’s fabled wealth under the Mughal and Maratha dynasties attracted traders and conquerors from Europe and elsewhere. By the beginning of the 19th century, however, India’s share of the world economy began to decline—gradually at first, then more steeply; as other parts of the world surpassed India, its share of the global economy reached a low point of slightly more than 4 percent in the second half of the 20th century (see table below). 

India’s Share of the World Economy, 1000–2005

            Source: Angus Maddison in Rajadhyaksha, The Rise of India, p. 3; www.ggdc.net/maddison

     India has enjoyed some periods of prosperity in relatively recent times. According to Rajadhyaksha, in the last half of the 19th century the country experienced a period of rapid growth not unlike that of the present, based largely on the export of cotton and textiles as well as highly prized spices such as pepper, cinnamon, and saffron:

India was in the midst of the first wave of globalization. New technologies, falling transport costs and free capital flows were stringing together economies around the world. India, too, was breaking out of its old economic structure.  The Great Indian Peninsula Railway was built in 1863 to connect Bombay to the cotton-growing districts of the interior.  The first telegraph line between India and Europe was laid in 1866.  The Suez Canal was opened to traffic three years later.³    

     As a result of these favorable developments, industrial production in India grew at an average rate of 8.4 percent from 1861 to 1900.  Unfortunately, the era of open foreign trade did not last. In the early 20th century, countries around the world, including India, ignored the lessons of the past and began to erect barriers to foreign trade. By 1990, when India’s share of the global economy was barely above 4 percent, the country had established one of the most protected economies in the world.

     After India achieved independence in 1947, it chose to adopt economic policies that proved to be highly inefficient and failed to deliver robust economic growth:

India was a keen follower of the economic consensus of the 1950s, which held that national planning and protectionism were the way forward.  Suspicion of private enterprise, free markets, and foreign trade was endemic in the political class. … Domestic investment was shackled, foreign trade shriveled and foreign capital was kept out.  The domestic economy too was bound in a complex and bewildering web of controls. Entire industries were reserved to the public sector and the small-scale sector. Companies could not make things without a license from the government.  Despite rampant shortages, it was a crime to produce more than what you were allowed.

     As a result of these inefficiencies, the economy grew at less than 3 percent per year during the 1960s and 1970s. With the population increasing at 2 percent annually, there was little growth in individual income.  

     The situation improved somewhat in the succeeding decade. In 1980, the government of Indira Gandhi initiated an initial round of reforms that began to unshackle the economy, resulting in a growth rate of 5.8 percent during the 1980s.  Unfortunately, government expenditures increased at an even faster rate, and public debt grew rapidly.

     In 1991, with the country’s foreign currency reserves having fallen to less than $1 billion, the country faced serious financial problems. To avert a crisis, the new finance minister, Manmohan Singh, pushed through a series of far-reaching economic reforms that included lifting restrictions on foreign direct investment (FDI), simplifying the tax system, and abolishing much of the red tape (the “license raj”) that had impeded business. The economy revived, industry picked up, inflation was checked, and the stage was set for India’s current prosperity. The overall economy has grown at more than 8 percent per year for the past five years.  Whereas average income rose just 1.2 percent per year between 1950 and 1980, it has increased more than 4 percent per year since 1991.
 
     Today India’s economic potential seems almost limitless. A 2003 study by Goldman Sachs of the economic potential of Brazil, Russia, India, and China (the “BRIC” countries) predicted that India’s economy will be the third-largest in the world within 30 years, trailing only the United States and China (which is on the way to becoming the world’s largest economy).

     The same study concluded that although economic growth is expected to slow substantially in the other BRIC countries, as well as in the G6 countries, India “has the potential to show the fastest growth over the next 30 to 50 years [with] growth higher than 5% over the next 30 years and close to 5% as late as 2050” (see chart below).   India’s GDP is projected to reach $27.8 trillion by 2050—nearly 35 times larger than its current GDP.  The key factor that will allow India to continue to grow economically is that it is the only BRIC country whose population will continue to increase over the next half-century.

India versus China

     For many years, whenever India was discussed in a global context, it typically was “hyphenated” with Pakistan in terms of the potential for regional conflict.  Today, when India is discussed, it is most often linked with China, in terms of their rapid economic growth potential and seemingly unlimited potential.  The comparative strengths and weaknesses of these two these rapidly emerging Asian powers is a popular topic in discussions of global economic trends (see table below).

Source: China & India: A Visual Essay, Deutsche Bank Research, October 10, 2005; CIA World Factbook

 

     In many areas – including population, overall economic size, and per capita GDP – China still overshadows India. China also has a distinct advantage in terms of population literacy, female labor force participation, and technology infrastructure.  India, however, has a demographic advantage in the age of its population.  It also enjoys a robust democratic government that may provide a long-term advantage over China’s authoritarian system.

Education and Economic Growth

Education is one of four “core factors that can set the stage for economic growth,” according to the authors of the Goldman Sachs report on the prospects of the BRIC countries. (The other three core factors are macroeconomic stability, institutional capacity, and openness.)  The authors note that there is a positive correlation between the educational attainment of a country’s population and the growth rate of per capita GDP.  Studies have found that, on average, one additional year of schooling per child produces an increase of about 0.3 percent per year in annual growth rate over a period of 30 years.  Although rising educational levels have contributed to the economic vitality of the BRIC countries generally, the report’s authors conclude that, among these countries, “India receives low marks for educational indicators, particularly at the primary and secondary levels.”⁵

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