CHAPTER 1

Indian Economy: Nature and Structure

This chapter first explains the nature and anatomy, or structure, of the Indian economy to provide readers with an overview and then moves on to the concept of economic reforms to help understand the nature of changes that accompany economic development.

Nature and Structure of the Indian economy: At the time of India’s independence in 1947 the economy was predominantly agrarian. The majority of the population was engaged in agriculture, and most of those people were very poor, surviving by cropping their own small plots or supplying labor to other farms. Landownership, land rental, and sharecropping rights were complex, involving layers of intermediaries. The structural economic problems inherited at independence were exacerbated by the costs associated with the partition of British India, which had resulted in about 12 to 14 million refugees fleeing past each other across the new borders between India and Pakistan. The settlement of refugees was a considerable financial strain.1 On the morrow of independence the following were the salient features of the Indian economy:

1. Low per capita income
2. Low productivity and excessive dependence on agriculture
3. Demographic features: high rate of growth of population and low level of human development
4. Continuance of poverty, unemployment, and underemployment
5. Low rate of capital formation due to low savings rate
6. Inequality in the distribution of income and wealth
7. Technical backwardness
8. Insufficiency of natural resources
9. Lack of infrastructure
10. Dualistic nature of the economy (features of a modern economy existed alongside the traditional)
11. Lack of entrepreneurship
12. Market imperfections
13. Corruption, malpractices, and bureaucratic control
14. Inadequate development of economic organizations
15. Dominance of unorganized sector

In 2017, agriculture, with its allied sectors, was the largest source of livelihood in India. Seventy percent of the country’s rural households still depend primarily on agriculture for their livelihood, with 82 percent of farmers being small and marginal.2 But with time the share of agriculture is decreasing and the share of the service sector is increasing. India’s diverse economy encompasses traditional village farming, modern agriculture, handicrafts, a wide range of modern industries, and a multitude of services. Services are the major source of economic growth, accounting for more than half of India’s output with less than one-third of its labor force. The sector that carries out all activity through a system and follows the law of the land is called the organized sector. The informal, or unorganized, economy is largely rural and encompasses farming, fishing, forestry, and cottage industries. It also includes petty vendors and some small-scale mechanized industries in both rural and urban areas. The sectors that evade most of the laws and don’t follow the system come under the unorganized sector. Compared with developed countries like United States, Japan, Germany, France, United Kingdom, Canada which were having higher rates of both savings and investment ranging from 20 to 28% on an average during 1960s,3 the Indian economy has a lower level of both the investment and the savings rate ranging from 10 to 14% on an average during the same period.4

Postindependence plans, objectives, and policy framework—­deliberate efforts toward economic development: Since independence India has been a mixed economy, where the public sector coexists with the private sector. Companies that are run and financed by the government constitute the public sector. India’s large public sectors were responsible for providing employment and revenue to the economy. India’s leaders who introduced the five-year plans agreed that strong economic growth and measures to increase incomes and consumption among the poorest groups were necessary goals for the new nation. The planners wanted domination of the public sector in the growth of the economy. The private sector would play a complementary role. This thinking dominated the planning process from 1950 to 1990. This thinking had several positive aspects as well as negative. Government was assigned an important role in this process, and since 1951 a series of five-year plans have guided the country’s economic development. In the period right after independence the Indian entrepreneur was not cash rich, so the government had to start creating big public sector enterprises. Companies that are run and financed by private individuals constitute the private sector. Although there was considerable growth, the long-term rates of growth were less positive than desired. Such a rate of growth, of around 3.5 percent, was termed the “Hindu rate of growth.”

During the early phase of economic planning, in 1950s, a large number of basic industries that produced capital equipment (machine tools, industrial machinery, process plant equipment, construction and mining equipment, electrical equipment, textile machinery, printing and packaging machinery, etc.) and useful raw materials were set up, making the country’s industrial structure quite strong. Social overhead capital, which broadly includes transport facilities, irrigation systems, energy production, educational system and organization, and health facilities, has registered promising development and created favorable conditions for growth and also for better living. The infrastructure sector has grown in terms of both capacity and modernization. The railways route length and road network in 2019 constitutes one of the largest in the world. India has also seen growth in life expectancy and literacy rates up to 2019, but education and health services have not expanded at the desired rate.

Significant progressive changes have taken place in the banking and financial structure of India, and as a result of these, the importance of indigenous bankers and moneylenders has declined. With the nationalization of 14 banks in 1969, public sector banks (PSBs) radically changed their credit policy and made more funds available to priority sectors such as agriculture; micro, small, and medium enterprises (MSMEs); and transportation. The economy has progressed structurally in terms of the growth of capital goods industries, expansion of infrastructure, performance of the public sector, and so on. These factors, over the years, are believed to have created an element of dynamism in the country’s economy and one can now hopefully say that it would sustain development in the future.5 India’s industrial economy is gathering momentum on the back of improved output in the core sector industries—coal, crude oil, refining, steel, cement, natural gas, fertilizers, and electricity.

Postindependence, the rate of growth improved in the 1980s. The economy grew at an annual rate of 5.5 percent, or 3.3 percent on a per capita basis. Industry grew at an annual rate of 6.6 percent and agriculture at a rate of 3.6 percent. A high rate of investment was a major factor in improved economic growth. Investment increased from about 19 percent of the gross domestic product (GDP) in the early 1970s to nearly 25 percent in the early 1980s. India, however, required a higher rate of investment to attain higher economic growth.

India’s primary sector, including agriculture, forestry, fishing, mining, and quarrying, accounted for 32.8 percent of the GDP in FY 1991. In FY 1991, the contribution to the GDP by industry, including manufacturing, construction, and utilities, was 27.4 percent; services, including trade, transportation, communications, real estate and finance, and public and private sector services, contributed 39.8 percent. The steady increase in the proportion of services in the national economy reflects increased market-determined processes, such as the spread of rural banking, and government activities, such as defense spending.

Despite a sometimes disappointing rate of growth, the Indian economy was transformed between 1947 and the early 1990s. The number of kilowatt-hours of electricity generated, for example, increased more than fiftyfold. Steel production rose from 1.5 million tons a year to 14.7 million tons a year. The country produced space satellites and nuclear-power plants, and its scientists and engineers produced an atomic explosive device. Life expectancy increased from twenty-seven years to fifty-nine years. Although the population increased by 485 million between 1951 and 1991, the availability of food grains per capita rose from 395 grams per day in FY 1950 to 466 grams in FY 1992.5

However, considerable dualism remains in the Indian economy. The formal and informal sectors of the economy exist side by side. The informal economy is largely rural and encompasses farming, fishing, forestry, and cottage industries. The bulk of the population is employed in the informal economy. The formal economy consists of large units in the modern sector, such as manufacturing and mining, major financial and commercial businesses, and such public sector enterprises as railroads, telecommunications, utilities, and the government itself.6

Weaknesses of the economy

The greatest disappointment of economic development is the failure to reduce more substantially India’s widespread poverty. Studies have suggested that income distribution changed little between independence and the early 1990s, although it is possible that the poorer half of the population improved its position slightly. Farmers and other rural residents make up the large majority of India’s poor.

The bulk of the poor work, but low productivity and intermittent employment keep incomes low.

Housing and the ancillary utilities of sewer and water systems lag considerably behind the population’s needs. India’s cities have large shantytowns built of scrap or readily available natural materials erected on whatever space is available, including sidewalks. Such dwellings lack piped water, sewerage, and electricity. The government has attempted to build housing facilities and utilities for urban development, but the efforts have fallen far short of demand.7

Economic development going well beyond growth has been the principal agenda of each and all of the governments in India since it became independent. Many factors, including, in particular, the fact that India chose to follow a democratic political system and that the state was destined to play a vital role in the social, political, and economic development of the country, have been critical in shaping the state of the nation at different times. The country, unavoidably, went through phases of development, retardation, and crises from time to time, until 1991, when a totally new paradigm had to take over (Reddy 2016). By the early 1990s, economic changes led to the growth in the number of Indians with significant economic resources.8

Concept of economic reform: In any discussion on economic reforms, there ought to be three strands: (i) Why were reforms necessary, and what was wrong with the earlier system? (ii) What reforms have been introduced? (iii) What remains to be done? The new economic policy, also known as economic reforms, is a set of policies and administrative procedures introduced in July 1991 to bring about changes in the economic direction of the country. Economic reforms were intended to enable Indian industry to develop an outward orientation, and to allow freer play to market forces. Economic reforms placed overwhelming reliance on private initiative and enterprise. There are essentially two aspects to economic reform, related to internal and external economic policies. Each, in turn, has two aspects. In internal policymaking, one aspect is debureaucratization and easing of controls; the other pertains to privatization of public enterprises following the neoliberal philosophy of laissez-faire and reliance on the market for all investment decisions, with minimum government intervention in the economy.

The policy has two major components: stabilization and structural reforms. The stabilization part has three components: (i) management of balance of payments, (ii) control of inflation, and (iii) fiscal correction. The structural reforms part has seven components: (i) exchange rate adjustment, (ii) liberalization of imports, (iii) rationalization of tariff structure, (iv) delicensing/removal of licensing restrictions, (v) financial sector reforms, (vi) disinvestments of public sector shares, and (vii) foreign direct investment.

Though these policies and procedures have a macroeconomic thrust, their impact on micro-level economic activities cannot be ignored. From this point of view, the policy of economic reforms will have repercussions on the entire gamut of economic development. Let us understand the reasons behind the introduction of economic reforms in 1991. There were several, and they are as follows:

1. Eliminating quantitative restrictions on exports and imports
2. Bringing down and rationalizing tariffs, eliminating export subsidies, so that trade policy is neutral
3. Eliminating overvaluation in exchange rates and making the exchange rate market determined
4. Reforming the public sector through disinvestments and reducing public sector monopolies and introducing greater competition
5. Reforming the monetary policy and transiting to market-determined interest rates, reforming the financial sector
6. Bringing down budgetary deficits, targeting government subsidies better, and reforming the tax structure so that indirect taxes become more transparent; simultaneously, bringing down rates of direct taxation, while broadening the base
7. In industry, removing barriers to entry and exit
8. Reforming the agricultural sector by making output and input prices market determined
9. Targeting government expenditure on primary health, primary education
10. Introducing social safety nets as protection against the effects of structural adjustments
11. Developing economic and social infrastructure

In the wake of economic reforms three terms are frequently used: liberalization (or deregulation), privatization, globalization (LPG). Liberalization describes the process of removing rules imposed by government that limit the economic freedom of individuals. Privatization means removing the state and its agents from economic activities and letting these be undertaken by private individuals. Globalization, however, has a much broader connotation; indeed, it has become a buzzword for many different phenomena. A comprehensive definition would define globalization as the process of increasing both the scope and the actual incidence of interaction between people from all parts of the globe.

Economic reform provides fillip to structural change: Due to the balance of payments crisis seen in the wake of the Gulf War, the 1990s saw structural changes in the Indian economy and the entry of both the private sector and the foreign sector. Greater participation was ensured, and today, barring the nuclear sector and railway operations, all areas are open to private and foreign investment and companies. This has also changed the government’s approach to the development of various sectors. The government has recognized the efficiency of the private sector in execution by partnering with it on various development projects in the infrastructure sector. This has been done through public private partnership (PPP).

The trade policy too complemented the industrial policy, and the first seven five-year plans (1951 to 1985) wanted import substitution. The planners, however, never seriously considered providing an impetus to exports. But, since the mid-80s, economists have been in favor of privatization of nonstrategic public enterprises and fully opening the economy to private and foreign industries. Owning to this, it was felt that there is a need for a new economic policy, and this policy was introduced in 1991.

With this overview of changes that took place between 1947 and 1990, one would have an understanding of the progress that led to the strengthening of the Indian economy. Apart from the growth in quantitative terms, there have been significant changes in India’s economic structure since independence. The structural change has been very slow, but it has virtually given a fillip to the traditional and stagnant economy. After the economic reforms of 1991, the Indian economy became one of the most promising developing economies of the world. The strategy paper of the National Institution for Transforming India (NITI Aayog) says that India is on the cusp of a major transformation and change has been in the making (NITI Aayog 2018b)

The economy is moving out of the negative legacies of the past. To meet the rising aspirations of the young population, however, India needs to achieve and sustain a high rate of GDP growth for the next three decades, ending 2050. There will be several milestones in this long and arduous journey. The direct implication of ensuring rapid growth with inclusion is that policymaking will have to be rooted in Indian ground realities and emphasize the welfare of all in both design and implementation.

Policymaking needs a balanced approach: With this approach in view from 2019 onward, the broad direction of macro policies in India is moving toward more accommodation. The triggers are both political and economic. Social welfare commitments—health care, pension for the unorganized sector—will likely incur higher expenses in the coming years. Accommodative macro policies do not necessarily imply imprudence. If growth is weak, then countercyclical macro policies are essential (Varma and Nandi 2019).

The more funds are diverted to subsidy, the less investment in productivity enhancing social and physical infrastructure. Of course, there is a need for subsidy, to help the poor break out of poverty, but it must be sparingly used, and intelligently. India must prioritize growth and marshal resources to that end. India must shun a political economy of competitive populism that sees redistribution as the way out of poverty.9 Within the economic sphere, what India still needs is careful rethinking of the balances and boundaries between public and private; centralized and decentralized; economics and politics; and rich, poor, and middle (Singh 2019b). “Three decades after the unveiling of economic reforms of 1991, India’s mainstream political parties are increasingly speaking the same language on welfare. The new political positioning in contrast to the earlier belief was that growth is the best antidote to poverty.” The kind of competing welfarism that was reflected during the 2019 general election is certain to dismay sections of economic policymakers, industry, and investors. “But it is also a signpost of India’s political economy at work and a reflection of the sobering fact that irrespective of the color and stability of the regime, the direction of reform hinges on political will” yet, it is also true that in the postreforms period, no government has reversed any major policy pursued by a previous regime, thus providing a measure of comfort to business and industry. “Well-meaning policies aimed at welfare maximization or redistribution are bound to succeed only when the state has both fiscal and implementation capacity. It is all very well to say that growth will lift all boats, but ultimately, politics is the art of the possible.”10

Endnotes

1. 1. Structure of the Economy: Independence to 1979 http://countrystudies.us/india/93.htm (accessed January 25, 2020)
2. 2. FAO in India: India at a glance http://www.fao.org/india/fao-in-india/india-at-a-glance/en/ (accessed January 25, 2020)
3. 3. Source: OECD, Annual National Accounts. http://www.oecd.org/economy/monetary/34305161.pdf
4. 4. Source: https://www.encyclopedia.com/international/encyclopedias-almanacs-transcripts-and-maps/saving-and-investment-trends-1950
5. 5. YourArticleLibrary. n.d. “4 Significant Structural Changes in India’s Economic Structure Since Independence.” http://www.yourarticlelibrary.com/economics/4-significant-structural-changes-in-indias-economic-structure-since-independence/2754, (accessed September 27, 2019).
6. 6. India Economy Growth: A study on the economic growth of India https://www.indianchild.com/india_economy_growth.htm (accessed January 25, 2020)
7. 7. Structure of the Economy: Independence to 1979 http://countrystudies.us/india/93.htm (accessed January 25, 2020)
8. 8. U.S. Library of Congress. n.d. “Structure of the Economy.” http://countrystudies.us/india/93.htm (accessed September 27, 2019).
9. 9. The Economic Times. February 3, 2019. “Shun a Handouts Political Economy,” Editorial Comment. https://economictimes.indiatimes.com/blogs/et-editorials/shun-a-handouts-political-economy/, (accessed September 28, 2019).
10. 10. The Indian Express. February 4, 2019. “Old, New Welfare,” ­Editorial Comment. https://indianexpress.com/article/opinion/editorials/budget-2019-mgnrega-allocation-bjp-congress-modi-old-new-welfare-5567321/, (accessed September 28, 2019).