March - 2006 - issue > In My View
Raghuram Rajan
Wednesday, March 1, 2006
Starting around 1980, the Indian economy became a veritable dynamo, posting an average growth of nearly 6 percent per year over the last twenty-five years. Despite the inevitable unfavorable comparisons with China, very few countries have grown so fast for such a prolonged period of time, or reduced poverty so sharply. We should indeed be proud of what India has achieved, and clearly, many of us are. There is a buzz today in India, a sense of limitless optimism. But is it justified?

To answer this question, let us start by asking how we got here. The best description of India’s path is really “constrained adaptation”. “Constrained” because of the numerous policies and regulations inflicted on us by an untrusting government and “adaptation” because Indians are by nature entrepreneurial. As a result, the law of unintended consequences was at work big time—what the policies produced was very different from what was intended.

What are the lessons we can draw from our past? First, our past policies, no matter how distorted, gave us a set of capabilities—in skilled manufacturing and in services. Our comparative advantage now lies in these areas. We should not sacrifice all this in a blind attempt to follow the Chinese path of unskilled, labor intensive manufacturing. No doubt, we need to improve the incentives for the creation of unskilled jobs—not just by getting rid of the archaic job protections of the past, even while building a genuine safety net for all workers but also by improving infrastructure, especially in laggard states and rural areas so these areas connect better to the larger economy. But we also need to create a greater supply of skilled workers by energizing higher education. We need 50 IITs, not 7. The government need not do this—it has, however, to clear the way for private enterprise to flourish.

Second, we should realize the government cannot simply legislate outcomes. People react to government policy, so what is intended and what materializes can be very different. Government has to focus on getting the incentives right, and thereby enlist the energy of the people in support of change, rather than force them to use their energy to outwit the government.

This mindset that believes in the extraordinary powers of the government is not entirely a relic of the past. If we suffer from a shortage of university teachers, it is better to examine why no one wants to teach—could the fact that teachers in top management schools earn less than fresh graduates be a factor—than to resort to the old command economy tactic of banning schools from expanding abroad.

Similarly, if the goal is to improve primary education, we should avoid the knee jerk reaction of throwing more resources at the problem. We should ask why on any given day in a government school, 25 percent of the teachers are playing truant, why at any given time only 45 percent of the teachers in a classroom are teaching, why the poor are willing to pay hundreds of rupees per month for a private school while avoiding the free government school across the street, and why a private school teacher shows up to teach as often as the government school teacher even though his pay is one fourth to one eight that of the latter’s. Government has to understand how to improve incentives better before throwing more resources at a problem.

Third, the overregulation of the past has bred public cynicism towards rules and towards government. In a market economy, however, trust in rules and public institutions are absolutely critical. Instead of government standing above the people, it has to be by the people, for the people, and of the people.

Even while paring down the role of government, we should make it more transparent, effective, and responsive to the needs of the people. We need to rebuild public trust in government.

If young people take more interest in the local government there is no doubt that the quality of our institutions will be forced to improve—the recent journalistic exposes of MPs accepting bribe, and the prompt salutary reaction by Parliament, are a case in point.

Finally, even though India is approaching growth rates of 8 percent, let us not think the struggle is over. Our current growth reflects what we did right in the past. To sustain growth rates of 8 percent, a lot of policies have to go right—at high speed, even a slight swerve can cause a major accident.

Moreover, capacity quickly gets exhausted at high growth rates. So despite the warm glow generated by reports like the famous Goldman Sachs BRIC report, let us treat straight-line extrapolations of current trends with the caution they deserve.

In sum, perhaps the defining metaphor for India today is churning, as entrenched interests lose power, as new jobs are created and old ones lost, as people move across states in search of better opportunities, as yesterday’s Bharat becomes today’s India, which becomes tomorrow’s Bharat again. Recall the story of the devas and asuras churning away as the ocean of milk frothed and foamed.

Out of the churning, first came poison, but further hard work yielded the divine nectar, amrita. Limitless optimism is justified, but hard work and churning lie ahead.

Raghuram Rajan is the Economic Counselor and Director of Research Department, International Monetary Fund (IMF), Washington.
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