Indian Economic History

The Beginning
• The civilization of the Indus River at Mohenjo-Daro
and Harappa arose at about 2500 BCE and ended
with apparent destruction about 1500 BCE.

• The layout of the cities in this civilization of 2500 B.C.

is surprisingly neat and orderly. The cities had not
only brick-lined streets but also a brick-lined sewer
system. The images below give some idea of the
surprising orderliness of the cities.
 The British Raj
• The British Empire had a tremendous impact
upon India. In fact, it created India. Had
Britain never come to India there would now
exist a number of separate states.
• In particular, the Dravidian language and
cultural areas would not be under the
domination of the Hindi-speaking population
of North India.
The Economic System of India

• Before the last decade, the 1990's, India was probably on the short list of
almost every economist outside of India of the countries with the worst
economic systems.
• India had and probably still has a parasitical class of politicians and
bureaucrats that micromanage the economy in the interests of their class.
• There has been some official allegiance to socialism with a goal of achieving
it through Stalinist central planning.
• The fact that the result has been some horrible mixture of state capitalism
and moribund corporatism is usually attributed to incompetence and
ineptitude on the part of the bureaucracy.
• The policies implemented by the Government of India before the last decade
were brilliant only in maintaining the power and influence of the
bureaucrats. Judged with respect to promoting the welfare of the Indian
people those policies were ridiculously bad, to the point of stupidity.

• The bureaucracy has been rather competent in generating excuses for the
failure of their policies.
• One of those excuses has been that there is a Hindu rate of growth that is
significantly lower than the rate of growth that other countries could achieve.
• Nehru chose the goal of economic self-sufficiency with economic development
to be achieved by central planning modeled on that of the Soviet Union.

• By cutting off imports India gave a protected market to domestic producers.

India got domestic production but it was production of low quality, obsolete
products. The policies stifled economic growth and India, with its high level
of population and poverty, could ill afford low rates of economic growth.
• The two makes of automobiles produced in India, copied from models of
the British Austin and Hillman of the 1950's, remained unchanged for
more than forty years.
• The planning and administration of the economic did not emerge full
blown.
• The first five year plan (1951-55) called for the planned development of
only a few industries, the ones that private industry had not developed for
one reason or another. In the first five year plan the other industries were
left to the market.
• The second five year plan (1956-1961), the product of P.C. Mahalanobis'
work, was more interventionist.
• It tried to implement the elements of British socialism and combine them
with the tenets of Mahatma Gandhi.
• It sought to eliminate the importation of consumer goods, particularly
luxuries, by means of high tariffs and low quotas or banning some items
altogether. The large enterprises in seventeen industries were
nationalized. License were required for starting new companies, for
producing new products or expanding production capacities. This is when
India got its License Raj, the bureaucratic control over the economy.
• Indian Government require businesses get bureaucratic
approval for expanding productive capacity,
• businesses had to have bureaucratic approval for laying
off workers and for shutting down. When a business was
losing money the Government would prevent them from
shutting down and to keep the business going would
provide assistance and subsidies.
• When a business was hopeless an owner might take
away, illegally, all the equipment that could be moved
and disappear themselves. In such cases the Government
would try to keep the business functioning by means of
subsidies to the employees.
• One can imagine how chaotic and unproductive a
business would be under such conditions
• Government planning also involved requiring businesses to produce in
particular areas, usually economically backward areas. It also might require
the production of certain goods such as cheap cloth for the poor.
• The Indian Economic Plans had to be financed and this often meant taking
resources away from agriculture and giving them to pet industries that were
not viable on there own.
• Ultimately this meant starving agriculture to feed inefficient industries the
Government favored. Such a program was not likely to alleviate poverty and
so in 1971, under Nehru's daughter, Indira Gandhi, the Government tried to
eliminate poverty by promoting small, labor intensive enterprises.
• The net effect of the Government programs was to take away resources from
agriculture in the countryside to give it to favored businesses in the cities.
• When the effects on agriculture and the countryside became significant the
plan added programs to help the countryside (labor intensive small
businesses) and programs to aid agriculture such as a fertilizer
subsidy.These programs to help agriculture and the countryside generally
came from resources which the Government took away from agriculture and
the countryside. The fertilizer subsidy may have been of greater benefit to
the wealthier farmers than to the poorer farmers
• India's output did grow but not as much as did that of
other countries in the region.
• The Government of India generally takes credit for
growth, but when India's performance is compared to
that of other countries one sees that the Government's
contribution to growth was negative. The following
shows the magnitude of the shortfall in growth that
India's oppressive system is responsible for.
Comparative Growth Rates
of Developing Economies Source: The Economist May 4, 1991, Survey page 7
Average Annual Rates 1960-88

Industrial
Country GDP
Production

1960-1980 1980-1988 1960-1980 1980-1988

South Korea 15.2 12.6 8.8 10.1

Taiwan 12.8 7.2 9.6 7.4

Singapore 12.1 4.5 9.2 6.9

Hong Kong 10.3 7.5 9.9 7.4

Thailand 10.3 6.6 7.4 6.5

Indonesia 8.9 5.1 5.9 5.7

Pakistan 8.0 7.2 4.4 6.3

Malaysia 9.6* 6.1 7.9* 4.6

India 4.6 7.6 3.5 5.4

Bangladesh 6.1 4.9 5.8* 3.5

Sri Lanka 5.3 4.4 5.2 3.9

Mayanmar 4.2 7.3* 3.5 3.3*

* - 1970-1980
• With the top performers achieving a growth rate of industrial production
of about ten percent while India achieved a growth rate of only at most
about five percent the cost of the License Raj to India's growth rate was
about five percent, or half the rate of growth.
• One of the most wonderful things to happen to the world was the genetic
development of high-yielding grain varieties, the Green Revolution. This
development probably put an end to famine from natural causes.
• Between 1970 and 1989 agricultural production in India did grow but the
rate of increase was only 2.1 percent per year whereas over the same per
period the annual rates of growth of farm output in Indonesia, Malaysia,
the Philippines and Thailand were 3.7%, 4.7%, 3.6% and 4.5%,
respectively.
• Again the cost of the License Raj to growth in India was about half the
rate of growth. The cost of the License Raj more importantly is in the
slower pace of alleviating poverty.
 Other countries

• The success pattern of development in Taiwan and other

nations of Asia has involved cultivating export industries.
• In the case of Taiwan the first export industries were associated
with agriculture, such as processing sugar cane into sugar.
• Later light manufacturing emerged as economically viable.
• Generally the labor force for manufacturing came from the
surplus labor force in agriculture, often this was young women
from the countryside who moved to the cities to work in the
factories. Economically this was a transfer of labor from
agriculture where labor productivity was to low to higher
productivity occupations in manufacturing.
• The products that could be successfully produced by the
emerging manufacturing sector in Asian countries was
often not technologically sophisticated or prestigious.
• For example, one of the early successful export products of
South Korea was wigs made from human hair.
• But the successes in the low tech products led to successes
in more technically sophisticated products. One thing that
emerged out of the experiences of Japan, South Korea,
Taiwan, Hong Kong and Singapore is that it is difficult to
develop successful export industries without also
importing products.
• In contrast, India virtually shut off
imports with high tariffs, low quotas and
outright banning. The structure of
India's wall against trade is shown below
Type Regulation License?
Consumer Goods
Banned
Inessential
Consumer Goods
Permitted
Essential (Medicines)
Certification of Being
Capital Goods Essential
Permitted
Restricted Indigenous Angle Clearance
Capital Goods License
Open General Permitted No License Required
License
Intermediate Goods
Banned

Intermediate Goods Restricted License Required

Intermediate Goods Limited

License Required
Permissible
Intermediate Goods Open General No License Required
License
• In addition to rules concerning the imported goods there
are rules based upon the nature of the importer
• Imports are to be brought in only by the actual user where
is subject to bureaucratic definition.
• The Economist cites the case in which vehicle tires cannot be
imported by bus or trucking companies because only
vehicle manufacturers are deemed actual users.
• Some products whose importation is scheduled for
reduction can only be imported by certain government
agencies called canalizing agencies.
• In 1988, 40% of India's imports were of this canalized
variety. Another 12 percent were in the category of
restricted, 32 percent were limited permissible and only 16
percent fell into the category of Open General License
• Completely separate from the matter of the regulations on imports
is the matter of tariffs.
• That is to say, even if the importation of a product is approved the
tariff might be prohibitive. India in 1985 had the highest level of
tariffs in the world, as is shown in the following table.
Nominal Tariff Rates of Various Countries
As Percentage of Value, 1985

Intermediate Capital Consumer Manufacturing

Country
Goods Goods Goods Goods

Hungary 14.2 15.0 22.6 20.9

Yugoslavia 18.0 20.7 20.0 19.0

Argentina 21.2 25.0 21.9 22.9

Morocco 21.6 18.1 43.0 27.3

Philippines 21.8 24.5 39.0 28.0

Mexico 25.5 23.5 32.2 24.7

Thailand 27.8 24.8 8.5 33.6

Turkey 29.4 54.9 55.3 37.1

Pakistan 75.0 73.8 127.3 89.8

China 78.9 62.5 130.7 91.2

Bangladesh 97.9 80.5 116.1 100.8

India 146.4 107.3 140.9 137.7

Source: World Bank, cited in The Economist May 4, 1991, Survey page9
• The end result is that India in 1988 had the lowest ratio of imports
to GDP of any country in the Asia and consequently also had a
comparably low ratio of exports to GDP.
• It is not impossible to expand exports without having a
corresponding expansion in imports but it is as a practical matter
difficult to do so.
• India's government, however, decided in the late 1980's to try to
promote exports without loosening its restrictions on imports.
• Exporters in India are given Import Replenishment Licenses which
can be used to buy imports. Profits on exports were made exempt
from the corporate profit tax.
• Because the loopholes created for export industries could be used
to avoid the taxes and restrictions on other parts of the economy
there are numerous rules and regulation to prevent the specieal
rules for exporters from being abused.
 The Effect of Protection on Enterprises and Industries

• There are some very interesting comparisons to be

made between the protected industries and the ones
that are not protected.
Comparison of High Protection and Low Protection
Manufacturing Industries in India, 1986
High Low
Protection Protection
Number of Sectors 21 30
Share of Labor Employed 18.5% 77.7%
Share of Value Added 39.0% 54.9%
Share of Capital
53.2 43.1
Employed
Capital per Worker 92,500 rupees 17,800 rupees
Average Wage 15830 rupees 9360 rupees
Energy Consumption 1.93 MWHr 1.13 MWHr
• The notable differences between the high protection and low
protection industries is that the average wage rate is almost 70
percent (69%) higher under high protection.
• One consequence of the higher wage rates is greater capital
intensity in the high protection industries and that did occur.
• The capital/labor ratio in the high protection industries is 5.2
times that in the low protection industries. As a result the high
tech industries, which produce 39 percent of the value-added only
employ 18.5 percent of the labor force.
• The protection system promoted the substitution capital for labor
in a country which has an abundant surplus of labor.
• The protection system promoted the substitution capital for labor
in a country which has an abundant surplus of labor.
 Public-Sector Enterprises

• In addition to over-regulating the private sector the Government of

India has created socialist enterprises directly.
• The Government nationalized heavy industry (the commanding
heights of the economy) and built new state-owned enterprises, SOE's.
• The evidence that SOE's were inefficient was abundantly clear before
the bureaucracy created their new ones.
• These SOE's are generally more costly to build than privately built
plants. In the case of steel plants the SOE's cost 30 to 40 percent more.
• The excess capital cost should be met out of the return
on the capital for the plant but that is not likely to occur
since, according to a study by the Bureau of Industrial
Costs and Prices, the average rate of return on capital
in SOE's is just 1.5 percent.
• The management problems that afflict most SOE's are:
– excessive over-staffing
– under utilization of capacity
– excessive inventories
– poor management of materials
– obsolete technology
– inadequate maintenance
– wrong selection of products
• Large firms in certain industries, called core industries, have to abide
by the Monopolies and Restrictive Trade Practices Act, (MRTP).
• Despite the name the effect of the MRTP tends to restrict competition
and protect the monopoly of the firms which are already in an
industry.
• The worst monopolies are state monopolies and the MRTP does not
apply to them and nothing restricts their practices.
• The Government of India has a policy of reserving certain products
for "small" companies.
• In the late 1970's there were 800 products reserved for such
companies.
• A small company was defined as one having plant and equipment of
value less than a specified figure.
• Although such companies were small compared to the giants of
industries the amount of wealth involved in the ownership of such
companies was large compared to the average wealth of the general
population of India.
• The License Raj provided protection for a class of quite well-to-do
Indians, a class ideally suited to dealing with and sharing rents with
the members of the License Raj.
• Since the net effect of Indian Government policies are
negative and upwards of two thirds of the economy is
in agriculture the policies are a terrible tax on the poor.
• Rather than abandon the policies the government and
bureaucracy added another layer of policies to try to
ameliorate the impact of the other policies.
• The Government created irrigation projects and
fertilizer subsidies for agriculture. In addition there is
a roadbuilding program for the rural areas.
• The bureaucracy also created a system of transfer
payments for the rural poor which in its typical fashion
called rural development.
• In the support of the Indian Government for education
the class interest of the government and bureaucracy
can be clearly seen.
• The level of education which is most generously
supported is higher education rather than elementary
education.
• But it is generally the children of the well-to-do who
attend colleges and universities. Thus the support of
higher education is, in effect, a subsidy for the well-to-
do families.
• It is a transfer of income from the poor to the middle
and upper classes, the classes which dominate the
government and bureaucracy.
 Economic reforms under Rajiv Gandhi
• Rajiv came into power as the Prime Minister of India in 1984.
• Rajiv called for a tax reform which cut the income and corporate tax
rates. As a result of the lower tax rates tax evasion was reduced and
the lower tax rates brought in 40 percent more revenue.
• He reduced the restrictions on the economy. He modified definitions so
that the limitation imposed by "small company" policy were lessened.
• Some industries were removed from coverage by the MRTP Act. He
created broadbanding in the matter of licensing. Broadbanding meant
that a license for version of a product would serve to allow production
of a closely related version of the same product rather than requiring a
new license for the new version.
 The Crisis of 1991

• Statistics bear testimony to the fact that the genesis of the economic crisis in
India, which surfaced in 1991, lies in the large and persistent macroeconomic
imbalances that developed over the 1980s.
• Large fiscal deficits emerged as a result of mounting government expenditures,
particularly during the second half of the 80s.
• These fiscal deficits led to high levels of borrowing by the government from
the Reserve Bank of India.
• Also, because of the dynamic interrelationship between the fiscal and trade
deficits, the former resulted in large current account deficits in the balance-of-
payments.
• In order to meet these deficits, large external commercial borrowings were
undertaken which in turn aggravated the problem of external indebtedness.
• An unprecedented balance-of-payments crisis emerged in early 1991. The current
account deficit doubled from an annual average of $2.3 billion or 1.3 percent of
GDP during the first half of the 1980s, to an annual average of $5.5 billion or 2.2
percent of GDP during the second half of the 1980’s.
• The balance-of-payments came under severe strain from one liquidity crisis
experienced in mid-January 1991 to another in late June 1991. On both occasions,
the foreign exchange reserves dropped significantly and the government had to
resort to measures, such as using its stocks of gold to obtain foreign exchange
India had begun to prepare to mortgage their gold savings with the Bank of
England to obtain the cash reserves needed to run the country
• utilization of special facilities of the IMF, and also emergency bilateral assistance
from Japan and Germany among others.
• Having resorted to these measures, the government was able to avoid a default in
terms of meeting its debt service obligations and financing of imports.
• Subsequently, the government embarked upon a comprehensive program of
economic reforms.
 Latin America

• Brazil : Brazil once was plagued by chronic inflation

which turned into hyperinflation. The source of this
inflation was the expansion of the money supply. The
government financed its operation and its development
projects not out of taxes or borrowing funds but by
simply creating money.
Price Levels in Brazil, 1980 to 1997
Year Consumer Price Index
1980 4
1981 8
1982 16
1983 38
1984 111
1985 362
1986 895
1987 2,940
1988 21,435
1989 328,113
1990 100,000,000
1991 500,000,000
1992 5,600,000,000
1993 113,600,000,000
1994 2,472,400,000,000
1995 4,104,400,000,000
1996 4,751,200,000,000
1997 5,080,300,000,000
• Similar policies also lead to hyperinflation in
countries such as Chile, Argentina, Peru and
Bolivia.
• Thankfully India didn’t share the same problem
with these countries as the RBI followed better
money management.