Do Economic Reforms Hurt the Poor?: The Case of India

Pandit Jawaharlal Nehru, the first and a charismatic Prime Minister of independent India, believed that the state only could decide what is best for the nation. Hence, setting up massive public sector units to let them acquire commanding heights of the Indian economy remained his priority. Those gradually became inefficient, cradles of wastage and corruption, and caged in the “tiger” of private and creative energy and initiatives for many years. Nehru had no faith in the private entrepreneurs.

By cautiously integrating into the world economy, once India broke free from this stifling era in 1991 and allowed for greater private participation and for more domestic and international competitions, the “tiger’’ seems to have been uncaged. As a result, the notorious never-changing average Hindu growth rate of 3 %-- a term satirically coined by the famous Indian economist Prof. Krishna Raj, with which India grew in her first 40 years, for the first time started to rise to eventually reach an average of about 6.5 % in the last decade. The “tiger” seems to be roaring with all its might, yet in cautious measures and with gradualism, taking India into the 21st century with reforms that can be termed as her ‘second independence’ – from the clutches of the ‘License Raj,’ while also not allowing the newfound enthusiasm to let it lapse into financial crises that the other East Asian Tigers recently had been mired with.

However, do these reforms actually help the poor? Or do they make the rich richer, and the poor poorer? Experiences of those sub-national states in India, which hadn’t been doing well before, suggest otherwise. So do the tales of Soviet Russia and the East European transition economies. They all point towards one crucial question: are reforms anti-poor?

A critical analysis of this question will lead to a clearer understanding of the issue. Since India actually started reforming, the number of people living below the poverty line has been declining by roughly one percent per year. This implies that as many as 200 million people have escaped from the clutches of poverty in the past two decades. The reforms are actually the best bet for poverty reduction. They are aimed at building an open, competitive and productive economy, which will grow faster, create more jobs, and in time, wipe out poverty. An 8% GDP growth rate for over 5 years might make the top 10% richer by 100 times, but if it also enables 100 million people to rise above the poverty line, is it a gamble we will be unwilling to take? The answer is no. Reforms don’t hurt the poor. Scrapping licensing has hurt the corrupt bureaucrat and the bribe-giving businessman. Privatizing public sector units have hurt the overpaid underperforming worker, who is now expected to deliver. The opening up of the economy has hurt those Indian companies who are unreceptive and unwilling to change and compete. Labour reforms do not actually hurt the poor; the United States and United Kingdom, countries having the most flexible labour markets on earth, have actually witnessed a remarkable decline in activities falling under the category of ‘trade unionism’.

For long, economists in India have argued that subsidies don’t really benefit those at the bottom of the pyramid. They actually are gobbled up by the rich agriculturalists and those who have connections inside the corridors of power. The subsidies actually distort the price mechanism and misallocate society’s scarce resources. Hence, scrapping of subsidies don’t really damage the poor.

Markets are not inherently ‘good’ or ‘bad’. What is important is to understand the conditions under which they fail, or display inefficiency. They fail not because they are unresponsive to price changes, but due to lack of incentives, and improper information. There are two ways through which the poor will rise. One is through rapid economic growth, and this only the market can deliver. It is a wonder that the Government in India still needs to be reminded of this simple yet powerful truth, and has to be persuaded to keep out of production of goods and services. The State has to play the role of an enabler, and not a commander.

But it is through the second way that the poor will truly rise. The Government must invest, and invest heavily, in education, health and key infrastructure. It must empower the poor, and ‘expand their capabilities’, to quote Prof. Amartya Sen, so that they have more choices. As our economy has transformed over the years, our understanding of how to tackle poverty has also metamorphosed. In the 1950s and 60s, we focused on land reforms and land ceilings, and to some extent succeeded. But then, the overwhelming reality that redistributive measures hurt the very class that controls the system, and that in a democracy, there is a limit to radical measures, dawned upon us. Then, in the 70s and 80s, the romantic notion of wiping out poverty through employment guarantee fascinated the entire nation. The very idea of creating durable economic and social assets and eliminating poverty simultaneously was too tempting. We spent a monumental amount of money, and that turned out to be a monumental failure. Because of the Government’s faulty deliverance mechanism, the poor came face-to-face with very few tangible benefits, and most of the money was drained out in paying for administrative costs and in ‘leakages’. Also, so much stress was laid on equality of income that the country’s policy makers forgot the salience of equality of opportunity. Equality of income, which anyhow is a utopian concept, was sought to be brought about by the Government not by making the poor richer, but the rich poorer.

Only after the economic reforms of 1991, a general consensus emerged that the Government must limit itself to toning up primary education facilities, healthcare systems, and infrastructure. This coupled with rapid economic growth (for which we must reform), and improved governance at the grassroots level, will bring down poverty at an unprecedented rate. As per Prof. Sen, development is all about enlargement of opportunities for the individuals in society. Investing in education, health and infrastructure will lead to an expansion of their capabilities – by increasing their freedom to pursue what they value.

Development Economics: The Journey So Far

Development Economics: The Journey So Far

Development studies is about finding solutions to the problems of poverty and destitution -- the conditions under which the vast majority of the world's population continues to live -- despite the promise of modern technology.
-- Prof. Dani Rodrik

The Economics of Development comprises of a study of the problems of developing nations. Though a relatively new field, it has emerged as one of the most complex and fascinating branches of Social Science.

The subject arose as a major discipline in the aftermath of the Second World War, as an answer to the desire for a clearer direction on how to achieve economic progress and prosperity, expressed by the newly independent nations of Asia, Africa and Latin America. A significant change that accompanied this rise was in the way the Western world addressed the poorer nations – from being ignominiously referred to as “backward” and “barbarous”, they started being called as “less developed” or “developing”. Apart from the above mentioned desire for progress, the realization amidst developed nations that poverty anywhere is a threat to prosperity everywhere served as a major fillip for the emergence of a comprehensive subject dealing with the problems of development.

What constitutes economic development? How can it be measured? These questions, at the outset, might seem trivial, but answers to these are revealing, and also a source of widespread debate. An increase in per capita GNP [the per head value of the goods and services produced by a country] has long been seen as the most powerful indicator of development. However, rising per capita income cannot be regarded as the end all of the process of development. This definition is subject to several flaws. Firstly, it does not take into account the distribution of income. An extremely affluent majority can propel the rise of the per capita income, while the vast majority may remain poor and deprived. Secondly, per capita income cannot be an indicator of well being. Two nations with equivalent figures for the same might, and do, differ markedly in various other parameters that are seen as central to the development of a nation, say, for example, the status of health of its citizens.

Economic Development v/s Economic Growth

Herein lies the distinction between economic growth and economic development. While the former refers to an increase in income levels, the latter is seen as a much broader concept, encompassing growth. It points to the increase in the well-being of the people. Now, what comprises well-being is a subjective question, and will differ from person to person. However, broadly, all of us will agree that in addition to rising income levels, educational attainment, good health care facilities, access to safe drinking water, sanitation, sound infrastructural facilities – all these, and much more, determine well-being. We can go on and add political freedom, law and order, human rights, time for leisure, etc. as additional factors that play a role. Thus, economic development can only be achieved when improvements are registered in all, or most of these.

Some economists suggest that growth is a primary concern of developed nations, while development is sought by developing nations. A better definition highlighting the difference between the two concepts was given by the famous Joseph Schumpeter, who said that economic development marks a decisive shift from one equilibrium level to another, while economic growth is marked by steady, continuous changes in the level of income over a long period of time.

However, many times, in our attempts to dismiss proponents of rising per capita GNP as the chief driver of economic development, we tend to misunderstand them. Consider the following statement made by Robert Lucas, in 1988:

By the problem of economic development, I mean simply the problem of accounting for the observed pattern, across countries and across time, in levels and rates of growth of per capita income. This may seem as too narrow a definition, and perhaps it is, but thinking about income patterns will increasingly involve us in thinking about many other aspects of societies too. So I would suggest that we withhold judgment on the scope of this definition until we get a clearer picture of where it leads us.

It might sound surprising but on the question of what constitutes economic development, there exists broad agreement. The advocates of the “per capita income” definition, never for once, see rise in levels of the same as the end, but instead, see it as the means to development. They suggest that in one way or the other, a rise in per capita GNP facilitates the achievement of the broad targets of development – good health care, high literacy, rising standards of living, etc. Thus, their attempt to classify per capita GNP as the main facilitator of the developmental process is only an endeavour to simplify things by bringing down the number of variables to be studied in correlation with development. This is critical, and a clear understanding of this would enable us to forego long held biases against the income approach.

The Varying Approaches to Economic Development

The leaders and policy makers of the newly independent nations of the 1940s and the 1950s had a strong mistrust against the markets, and believed that market failure is a recurring and inevitable event. Their strong prejudice against the market economy led them to establish state controlled economies, in which the production process was controlled by the Government. Private enterprise was curbed, and massive public sector units were setup. International trade, which later went on to script remarkable success stories in East Asia, was shunned. Export promotion gave way to import substitution. These policies stemmed not so much from economic analysis but from political ideologies. This was also the era when rising per capita GNP was seen as the end of the development process, rather than the means. Ragnar Nurkse’s Balanced Growth Model competed later on with Albert Hirschman’s Unbalanced Growth Theory. The Balanced Growth Model called for simultaneous development of all sectors of the economy, while Hirschman, in his theory, criticized this as utopian and called for concentration of the limited economic resources into developing specific sectors.

Hirschman’s theory merits greater attention. Since resources are limited, he called for investment in strategically selected sectors, ones that can lead to new investment opportunities, thus causing greater economic development. He believed that certain investments have the tendency to appropriate more external economies (created by past investments) than they actually create. He called them ‘convergent series of investments’. Vice-a-versa, investments that create more external economies than they actually appropriate were termed as ‘divergent series of investments’. Obviously, the focus, as per him, should be on investment of the second type. He favoured the creation of imbalances in the economy via two routes – the imbalance of Social Overhead Capital (SOC) or the imbalance of Directly Productive Activities (DPA).

Owing to the scarcity of resources, Governments can invest in either SOC or DPAs, not both simultaneously. SOC are basic services like education, health, communications, transportation, power, etc. without which productive activities cannot function. It creates external economies, while DPAs appropriate them. A large investment in SOC will facilitate and encourage private investment in DPAs. For example, cheaper power supply will lead to setting up of small industries. This is called unbalancing the economy with SOC. The economy can be unbalanced with DPAs also. If DPA investment is undertaken first, shortages of SOC are likely to raise production costs. Mounting political pressure will then lead to greater investment in SOC.

The late 1960s and 1970s witnessed a direct focus on eradication of poverty and inequality. The very meaning of development was questioned. The term acquired the meaning that it carries today, and became much wider scope than just augmentation of incomes. Industrial development gave way to focus on rural development, which fascinated most economists. Growth, most of them felt, was having only a ‘trickle-down effect’, and thus intensive approaches to eliminate poverty started being undertaken. Growth was important, but with a sense of redistributive justice. Meeting the basic human needs was also a primary concern of the economists of this generation. The long neglected human resources also found a place for themselves vis-à-vis the development of physical capital.

However, in the 1970s and 1980s, as planned economies started to fail miserably, hope gave way to despair. Corrupt rent-seeking Governments gave no incentives to the public sector units to perform, which, devoid of a competitive market, became cradles of corruption and hallmarks of inefficiency. As the world realized that protected economies, where free enterprise was anathema, were fast moving towards complete failure, the resurgence of neoclassicism was imminent. The ‘modern neo-classicists’ once again emphasized the supremacy of the market, and emphasized the need for laissez-faire. They argued that markets are not inherently ‘good’ or ‘bad’. What is important is to understand the conditions under which they fail, or display inefficiency. They fail not because they are unresponsive to price changes, but due to lack of incentives, and improper information. This was a path breaking concept, and marked the evolution of the theories of incentives and incomplete information. Economists of the likes of Nobel Laureate Joseph Stiglitz and Hal R. Varian became champions of these branches.

Privatization, globalization, disinvestment – these have become the new mantras of economics. Countries have started reforming, and have taken steps towards cleaning up the cobwebs of the past. The East Asian economies took the lead in this process. China followed in the late 70s, and India caught up, albeit after a major economic crisis, in 1991. Inward-looking policies highlighting import substitution were replaced by the dynamic mechanisms of export promotion. Disagreements over the pace and sequencing of reform are aplenty. The ‘East Asian Tigers’ reformed with great zeal, but were in a hurry, which led to considerable successes, but also to the major economic crisis of 1997. India took gradual and cautious steps, which was frustrating, but enabled it to come out unscathed from the 1997 crisis. These cautious measures towards reforms have the stamp of approval of influential men of the likes of Dani Rodrik and Joseph Stiglitz, who have studied the progress of the ‘transition economies’. The failure of Soviet Russia and the East European economies have added considerable fuel to the fire. However, the general commitment towards the very process of reforms remains strong, and the motives and vision of reforms are seldom questioned.

‘Development as Freedom’, and Cause for Hope

Development can be seen as a process of expanding the real freedoms that people enjoy.
-- Amartya Sen

Nobel Laureate Amartya Sen has, through his immensely powerful persuasive skills, put the philosophical notion of human capabilities at the centre of public policy debates. As per Sen, development is all about enlargement of opportunities for the individuals in society. This implies an expansion of their capabilities – by increasing their freedom to pursue what they value. Capability expansion is all about increasing choices as far as how to lead one’s life is concerned. Development involves removal of all sources of unfreedom – economic, social, political, etc. Thus, expansion of freedom and eradication of barriers to the same are both the ends and the means of the developmental process. A society can be termed as ‘developed’ in the real sense, only when its citizens have multiple choices, and are free to exercise their judgment about what choice to make.

Sen’s insights can be regarded as a logical culmination of the process that was going on since the origin of the subject in the 1940s. From rising incomes, to increase in well-being, to expansion of freedom and capabilities – the journey of development has been an eventful one. At present, we have the best chance of fulfilling our long cherished dreams of a world free of poverty, ignorance and hunger. China is taking giant strides towards achieving economic prosperity. India is fast catching up. This accounts for 1/3rd of the world’s population. Latin America and Eastern Europe have problems, but genuine attempts are being made in these parts to solve them. The major concern today is Africa. Unlike other developing nations, this ‘hopeless continent’ has actually seen a rise in the absolute number of people living below the poverty line in the last decade. Corrupt and unaccountable Governments are seen as the major cause of this, and the worry that without good governance, development simply cannot be ushered in, is genuine. However, the recently concluded G-8 Summit in Gleneagles, where the world’s richest nations announced a major and long due debt relief package for the continent, and the World Bank’s latest initiative to transform Africa into a ‘Continent of Hope’, are steps in the right direction. If these efforts continue to be undertaken with utmost sincerity, Africa will slowly, but definitively, inch towards the path to prosperity.

The world has entered the new millennium on the brink of the greatest and most significant transformation in history. Who knows, a poverty/ignorance/hunger free world might become a reality in our lifetimes. Till then, the holy fingers are crossed.