The Unassuming Economist

This material first appeared on Noahpinion:

I really believe that Indian industrialization is one of the most important stories in the world today. The fate of over a billion people — most of them still pretty poor — hinges crucially on the question of whether the world’s most populous nation can lift itself out of poverty by its bootstraps, as China has done, and as Vietnam is now in the process of doing.

Instead of writing another post about Indian industrialization, I thought I’d solicit a guest post from Karan Bhasin, who knows a lot about the subject. Karan is a doctoral candidate at University at Albany, SUNY, whose research has documented India’s recent progress in reducing poverty. He’s joined in this post by Prakash Loungani, the Director of the M.S. in Applied Economics program at Johns Hopkins University, who teaches a course on economic growth with Karan. Together, they explain the next steps they think India needs to take in order to supercharge its industrial development.

In February 2023, Noah posed an important question: can India industrialize? The question has been on the minds of Indian economic policymakers since its independence in 1947. Recent attempts at industrializing include Modi Government’s “Make in India” program and the liberal use of industrial policy for sectors such as electronics, semiconductors among others. However, the emphasis on industrial development is not new—India’s second Five-Year Plan in 1956 had already identified rapid industrialization as a key strategy for poverty alleviation.

In the 1950s, India had its own version of the Western Solow growth model—this was the P.C. Mahalanobis growth model, which emphasized the role of investment in capital goods (heavy industry) to drive long-term economic growth. It argued that a country should prioritize investment in industries that produce capital goods (like machinery and equipment) to increase its capacity to produce all types of goods, including consumer goods, in the future. The capital allocation decisions undertaken by India on the basis of the Mahalanobis Model yielded a growth rate of 4.3 percent, encouragingly close to the government’s target of 4.5 percent for 1956-61. This contributed to a growing sense of confidence in the ‘planned approach’ as an effective way to achieve industrialization. The confidence was, however, short-lived as growth started to falter during the Third Five-Year Plan. Indian policymakers started to recognize the need for reforms in their approach, particularly as many East Asian economies had successfully transformed their economies and were rapidly industrializing. These economies had embraced international trade, liberal domestic economy and limited the state to important areas such as rule of law, education and healthcare services etc. To emulate at the success of these “Miracle Economies” – Indian economic policymakers embarked on similar reforms in 1991. The objective behind these reforms was to fundamentally reorient the Indian economy from a planned economy to a market economy, hoping at such reforms would help India rapidly industrialize and move to a higher growth path.

The 1991 reforms were successful in in many respects, but the success came with an Indian accent. Unlike East Asian peers, which first industrialized before pivoting towards services, India achieved success in export of high-value services even as it struggled with exports of labor-intensive products. Figure 1 illustrates that the share of manufacturing in India’s GDP has remained relatively flat, even as the services sector expanded significantly from 40% to 60% between 1980 and 2024. India is, therefore, paradoxically, a large labor-surplus economy which but struggles with labor-intensive production but instead specializes in production of high-value services (and also goods such as pharmaceuticals and more recently electronics).

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