The Indian Election and the Country’s Economic Future

Raghuram G. Rajan at Project Syndicate: There is a buzz in India today – a sense of limitless possibilities. India has just overtaken its former colonial master (the United Kingdom) to become the world’s fifth-largest economy. If it maintains its current growth rate of 6-7% per year, it will soon overtake stagnant Japan and Germany to take over third place.

But by 2050, India’s workforce will start shrinking, owing to demographic aging. Growth will slow. That means India has only a narrow window in which to grow rich before it grows old: with per capita income of just $2,500, the economy must grow by 9% per year for the next quarter-century. That is an extremely difficult task, and the current election may well determine whether it remains possible at all.

China Model

In pursuit of rapid growth, the Indian government intends to follow a tested road map: the same path that Japan took in the immediate postwar decades, and that China took after the death of Mao Zedong. During the first stage of the journey, labor flows out of the traditional agriculture sector as employment increases in low-skilled manufacturing – typically stitching garments or assembling components into electronic goods. This output is then exported to the developed world to capture the benefits of producing at scale.

Cheap labor helps compensate for a country’s other deficiencies, such as excessive bureaucracy, unreliable power (especially electricity), or poor roads. As firms profit from exports, they invest in equipment to make workers more productive; and as those workers are paid more, they can afford better schooling and health care for themselves and their children. Tax revenues also grow, providing the resources to upgrade the country’s infrastructure. The result is a virtuous cycle, because higher-skilled workers and better infrastructure enable firms to make more sophisticated, higher-value-added products. That is how China has moved from assembling components to producing world-leading electric vehicles in just four decades. Unfortunately, the same strategy is unlikely to work for India today.

More here.

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