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Article Excerpt
In this issue ...
Breathless accounts of India's emergence as an economic colossus raise as many questions as answers for Canada. Is the enthusiasms about India warranted? Where does the Canadian beaver fit in with the Indian elephant? The author provides a realistic assessment of what's really going on in India, and the policy implications for Canada.
The Study in Brief
India is a land of contrasts. Indian information technology (IT) services firms are globally competitive but many manufacturers still seek protection from foreign competitors. Economic growth rates are speeding up but trade is still a small share of the world total. Logistics infrastructure is abysmal. India has the most mature and diverse financial system in the emerging market economies and many excellent universities, but the government seeks to create 100 million industrial jobs in this decade to provide employment for its 400-million-strong work force, many of whom are still illiterate.
As serious attempts are made to tackle its weaknesses and build on its strengths, India is broadening its economic reforms and establishing itself as a high-growth emerging market. Canada should be moving more quickly to deepen the bilateral economic relationship. Two-way merchandise trade flows are small. But mutual interest is growing to provide services, both directly to each other and from platforms in both countries, to serve larger regional and global markets.
While Canada's economic future will be determined mainly by its proximity to the United States, more could be made of the bilateral relationship with India. The two countries share many of the same institutions and language of commerce because of their common colonial heritage. There is a sizeable Indian diaspora in Canada. Business ties will continue to grow, but incrementally, unless governments facilitate this mutual interest.
They should consider negotiating a bilateral free trade a agreement--either in service or across the Board. Canadian interest would likely focus on greater across-the-board access for Foreign Direct Investment (FDI) in India, while Indians would likely push for liberalization of cross-border services provision and the movement of people. India has developed a mechanism, the Joint Study Group, for evaluating the net benefits of FTAs with other potential partners; the two countries should also tale this step.
Canadians are used to hearing breathless accounts of India's potential as an economic colossus which, though a distant market, is liberalizing its trade and investment regimes and opening to foreigners. Its IT software sector has made spectacular progress in penetrating international markets. India has the world's second-largest population and has recently embarked on talks to deepen its economic relationship with China, which has the world's largest population. Both are intent on deepening their integration with their Asian neighbors and navigating their own dynamic relationships with the United States.
Canada's economic future is largely determined by its proximity to the United States, the world's largest and richest economy. So where does the Canadian beaver fit with the Indian elephant? Is the enthusiasm about India warranted? Indicators of two-way trade and foreign direct investment (FDI) show the bilateral economic relationship to be miniscule, dwarfed by our economic interdependence with the United States. What is the basis for this mutual indifference? Can it and should it be changed?
In this Commentary I address these questions. The most obvious part of an answer to the last question is that the balance of global economic power is shifting to Asia from North America and Europe, and so our attention should also shift to the potential opportunities there as the breathless accounts suggest. But it is not that simple. In the next section, I examine India in the world economy, highlighting the continued ambivalence among powerful interest groups towards market forces and the protection of manufacturing and certain service sectors from competition. Both contrast sharply with the dynamic, increasingly globalized IT and business services sectors. In the third section on India's economic prospects it becomes apparent that the bright prospects for IT services exports and vibrant capital markets are offset by deeply entrenched labour-market inflexibilities and declining public institutions.
The last two sections examine the economic links between Canada and India and their implications for business and public policy. The fact that the two countries share the same institutions and language of commerce because of their common colonial heritage suggests that more could be made of the bilateral economic relationship. While merchandise trade is small, there is growing mutual interest in providing services, both directly to each other and from platforms in both countries to serve larger regional or global markets. Growth in such ties will be incremental unless governments facilitate this mutual interest with a strategic initiative to negotiate a bilateral free-trade agreement (FTA), either in services or across the board. An FTA in services is suggested as a start.
India in the World Economy
When British rule ended early in the post-war period the newly independent Indian government adopted a Soviet-style planned economy. Capitalism was tolerated but its individualist excesses were curbed through government oversight and controls. During most of the 1950-1970 period, India's economy was largely closed as it pursued growth and development on its own. With some exceptions, the period was one of indifferent economic growth, serious droughts, and crop failures. India muddled along during those years, depending heavily on a major trading relationship with the Soviet Union and, increasingly in the 1980s, on government stimulus to keep growth going. (1)
When the Soviet Union collapsed in 1990, India's main export market went with it and the country plunged into a balance-of-payments crisis the following year. At the time, Manmohan Singh, the current prime minister, was the finance minister who recognized a window of opportunity opening for market-oriented reforms. In July 1991, he introduced a number of policy changes in a budget that seemed radical at the time: liberalizing the trade regime by removing import controls, reducing customs duties and allowing more flexibility in the exchange rate regime. Licensing controls on private investment were abolished, taxes were cut and some public sector monopolies were dismantled. Since then, India's economic performance has improved dramatically (Table 1). On a purchasing power parity (PPP) basis, the economy has tripled in size.
But some major challenges persist. (2) One is fiscal deficits. Government borrowing crowds out private-sector borrowing and deficits hamstring publicly funded infrastructure modernization initiatives. India is similar to Canada in that it has a federal structure consisting of weak coalitions at the centre and strong states, many of which spend more than the revenues they take in. Total government deficits stretch back to the 1980s. India's public-sector debt, including the debt of public enterprises, reached 95 percent of GDP in March 2003, but has since begun to stabilize. Most of this debt is held by domestic financial institutions. One of the most intractable sources of spending growth is public sector salaries and, increasingly, pension liabilities; in many occupations average public-sector salaries exceed comparable private-sector pay by 2.3 times.
A second challenge is population growth. Since 1990, the population has grown at an annual rate of just under 2 percent, a rate that, if it were to continue, would double the 1990 population to 1.7 billion people by 2031. More than 70 percent of India's one billion people still live in the countryside; nearly a third still live in absolute poverty. The literacy rate of people over 15 years of age is only 61 percent (Table 2); female literacy and school enrolment rates are significantly lower than those for males. Child mortality has declined but is still high by international standards.
Nevertheless, the economy has opened up and trade and FDI flows have risen. But while India has shone in services trade and investment, it has lagged in merchandise trade. Two-way merchandise trade accounts for only about 20 percent of its GDP (Table 1). Goods exports account for only 9 percent of GDP, a ratio that has grown little in nearly 15 years. Even in markets like the global market for garments where it has comparative advantage, market share changed little over 20 years--the share was 4 percent in 1980 and 5 percent in 2000. (3) Lack of international competitiveness in these labor-intensive sectors can be attributed to the fact that India's manufacturing existed for many years behind a wall of protectionism that is part of the socialistic bureaucratic legacy of the past. While the "licence raj" (bureaucrats controlled licences to import and export) was largely dismantled in the 1990s, an "inspection raj" persists in many states, which continues to erect informal barriers to private businesses. Even so, India has developed expertise in some higher-value-added manufacturing where it is also an emerging international investor. This includes pharmaceuticals, biotech, oil and gas, and more recently, autos. (4)
In contrast to manufacturing, India's notable trade success lies in knowledge-based, particularly IT services, exports. It is a major exporter of commercial services (Figure 1) with software accounting for more than a third of the total earnings from services exports in 2001/02, followed by travel and tourism. Services imports are about 80 percent of its exports; half of these imports are transportation, travel and financial services. The list of private companies in the software sector is growing; the top 15 accounted for US$4 billion in exports in 2002/03 and have affiliates in 14 countries (Table 3).
[FIGURE 1 OMITTED]
What are some of the reasons for this success? Use of the English language and common law, and the supply of technically trained postsecondary graduates are an important part of the answer. But another is the perverse impact on entrepreneurs of India's regulatory thicket. Restrictions have protected goods production and trade but encouraged the IT revolution. In the 1970s, the Hindu nationalist BJP government required foreign multinationals to dilute their equity holdings in their Indian subsidiaries by selling shares to Indian investors. Rather than comply, IT companies like IBM left the country and created a vacuum that Indian firms moved to fill. Some of these firms also entered the IT sector in reaction to India's restrictive trade regime. Domestic entrepreneurs were prevented from importing and exporting computer hardware in the 1970s and 1980s. Some persisted and built hardware businesses anyway; others shifted their focus to software and what goes on inside computers, creating a "virtual" industry that was free of the regulatory and infrastructure obstacles obstructing merchandise trade.
Trade liberalization in 1991 made it attractive for foreign firms to return to India, where they concentrated on software development and call centers. Indian companies continued their hardware businesses built up since the 1970s but also increasingly turned to software. One firm's experience gives some insights into how the...
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