If Narendra Modi ends up as the new prime minister of India, his reputation as an economic miracle worker will be put to a herculean test. As several news items make clear, the country’s economic problems go way beyond bureaucratic lassitude and policy indecisiveness to include major structural challenges. Unfortunately, Mr. Modi appears to believe that speedier decision-making is enough to pull India out of its doldrums. Speaking the other month at a seminar on economic policy, he exclaimed that “good governance is more potent than policies.”
One of the dominant narratives in recent decades has been about how the spectacular growth of an urban middle class in countries like China and India would reshape the global economic landscape. A 2007 report by the McKinsey Global Institute estimated that the size of the Indian middle class would swell to some 580 million people (41 percent of the population) by 2025. Similarly, a 2010 report by the Asian Development Bank reckoned that the middle class would grow to over 600 million by 2020, and to over 1 billion by 2030 – at which point, it would outnumber that in China.
Such mind-boggling numbers helped spawn the ubiquitously cited “BRICs” epic propagated by Goldman Sachs as well as Fareed Zakaria’s “Rise of the Rest” saga positing a “post-American” world. And as the 2008 global financial crisis unfolded, the U.S. National Intelligence Council concluded that growing prosperity in China and India had catalyzed a “global shift in relative wealth and economic power … [that] is without precedent in modern history.” There was even talk of “economic decoupling” – the notion that the Asian regional economy, with the two countries at its core, had achieved enough critical mass so it was no longer dependent upon developed markets in the West.
The sense that a new global order was dawning also led to a rash of high-level corporate redeployments. The head of the HSBC financial conglomerate relocated from London to Hong Kong, while Cisco Systems, one of Silicon Valley’s premier companies, decided to establish its eastern hemisphere headquarters in Bangalore.
But a series of reports in the Financial Times (here and here) this week argues that the growth of a solid middle class in Asia is less certain than widely assumed, since many who have risen out of poverty in recent decades could slide back into it during a prolonged period of slow growth. This point is buttressed by new data from the National Council for Applied Economic Research, a widely-respected institute in New Delhi. It finds that the annual income of the Indian middle class remains relatively low.(The ADB report cited above also made similar points.)
The International Monetary Fund warned last week that the world could face years of below-par growth, while some experts, like Ruchir Sharma (here and here), argue that developing economies like China and India are unlikely to achieve the high-flying growth rates they experienced in the last decade.
The Financial Times quotes Kaushik Basu, the World Bank’s chief economist and formerly the chief economic adviser to the Indian government, as saying that developing countries “need to do more, much more, in terms of structural reforms” in order to return to the kind of poverty-reduction gains seen in recent decades.
One fundamental reform India needs to carry through is the shifting of unskilled workers from the unproductive agricultural sector to labor-intensive manufacturing, something which should be a huge comparative advantage for the country. Another key is spurring the urbanization process, something which Mr. Modi has promised to do by building 100 new technologically-advanced cities and expanding existing metropolitan centers in smarter ways.
Goldman Sachs reckons in a new report that the urbanization rate in India was about 20 percent in 1980, a figure higher than that of China at the time. Since then, however, China’s rate has zoomed to over 50 percent, while India’s has only moved to just over 30 percent. The investment bank calculates that urbanization contributes 2-3 percentage points to GDP growth in China and believes that accelerated urbanization would add some 1.8 percentage points to Indian growth. Indeed, Foreign Policy magazine estimates that the top 35 metropolitan areas in China contributed just under half of its economic activity in 2013. Premier Li Keqiang, who calls urbanization a “huge engine” for growth, has just launched a high-profile effort to speed along the process. The Economist magazine figures that nearly 70 percent of the Chinese population will reside in urban areas by 2030.
But according to a new report in the Wall Street Journal, the urbanization process in India has stalled due to an array of factors, including the lack of manufacturing jobs, persistent high inflation, and populist social welfare programs that discourage the rural poor from moving to cities. A study released earlier this year by Crisil, a Mumbai-based company providing financial market intelligence, finds that some 37 million people exited the agricultural workforce in the 2005-2012 period, lured by better opportunities in the manufacturing and service sectors. But it estimates (here and here) that these sectors will create 25 percent fewer jobs in the 2012-2019 period, thus trapping many rural youth in a life of agrarian poverty. The marked economic slowdown in the past two years has already caused the rural labor pool to grow again and Crisil estimates that the under-employed agricultural workforce will expand by 12 million people in the 2012-2019 period.
The next prime minister will confront monumental economic challenges that cannot be resolved by greater injections of bureaucratic efficiency. We will soon see how ready the Indian political system is to accept this truth and bite the bullet of fundamental reform.