India's Weak State Will Not Overhaul China

Op-ed in the Financial Times

August 16, 2010

As India enters its 64th year since independence, its economic dynamism presents a paradox. On most measures of market friendliness, it lags behind Latin America and even sub-Saharan Africa. It is still more closed to trade and foreign capital than most other countries; still hampered by extensive controls on economic activity, including onerous labor laws; and still dominated by a large public sector. In short, it should be growing at 5 percent, not 8.5 percent, a year.

... [W]hile policymakers have done the minimum to start growth, growth itself is now the driver of change and is begetting more growth.

Long-run growth depends on the quality of supporting public institutions. True, the India of today is less of a regulatory nightmare than before the opening-up in 1991. Some institutions-those that hold elections, preserve financial stability, and regulate telecommunications, for example-have worked well. But these exceptions apart, the state is weak and fraying. Policy reforms do not deserve the spectacular acceleration in growth that the economy has delivered.

Part of the problem is that Indian politics is getting progressively criminalized. The writ of the state does not run in nearly a quarter of its territory, with much of that area afflicted by violent insurrections. Corruption is endemic. And while India's high growth should have led to low debt, fiscal populism has ensured that India's public finances are almost as wobbly as those in the debt-addled industrial countries.

Such is the crisis that it seems increasingly possible the Commonwealth games-supposedly a cause for celebrating the rise of a new India-will be scaled down or not held at all. New facilities, including stadiums, remain unfinished. Cost overruns are astronomical and graft rampant. The obvious contrast with China's 2008 Olympics will illustrate all too starkly the core weakness of Indian governance.

This weakness is the result of a mix of gradual deterioration over time (most obviously in the political arena) with growing demands on the state. But it leaves a puzzle: Why is India growing so quickly? Conventional explanations focus on elite education and a dynamic information technology sector. These have played an important role in kick-starting growth but are too small in size and too narrow in the benefits they generate to sustain growth in such a large economy. The real explanation may be that, while policymakers have done the minimum to start growth, growth itself is now the driver of change and is begetting more growth.

This dynamic works through three channels. First, growth for three decades has widened entrepreneurship, and made the pursuit of money-making respectable. India, in the words of political scientist Devesh Kapur, is now a new nation of hustlers, constantly searching for economic opportunities-including ways of circumventing onerous rules-that, in turn, keep the growth engine purring along.

The second route comes as rising demand allows the private to replace the public sector. Consider education. Development economists have long bemoaned the Indian government's failure to supply good schools. But growth has changed the picture dramatically, largely because it has increased the returns from, and hence the demand for, education. Just look at private schools mushrooming in rural India because of teacher absenteeism in public schools or companies creating training centers to build skills in the cities because institutions of higher education are in shambles.

Finally, competition between India's states has also helped. The Nano, an iconic attempt to produce a reasonably priced car for India's mass market, is a good example. Regulations stopped its manufacturer, the Tata group, starting a factory in West Bengal. In the India of old, this would have killed the project. But now the state of Gujarat, which is a rare model of good economic governance, has taken the project instead.

Even just a few Gujarats should be enough to gradually force other state governments to change policies, while strong growth will also force the wider state to respond-even if weakly and intermittently. A not totally dysfunctional state combined with a new and no-holds-barred spirit of hustling, mean India's economic hopes are unlikely to come unstuck. Yet the Indian state will seldom be ahead of the curve in initiating or galvanizing wider economic change. And that bottleneck will make Chinese-type growth rates elusive.