Dr. P.V. Viswanath



Economics/Finance on the Web
Student Interest

  > Home >  

India's Economic Development -- Thoughts based on Arvind Panagariya's India: The Emerging Giant

  • Early Years (1951-1965)
  • Phase II: 1965-81
  • Phase III: 1981-88
  • Phase IV: 1988 onwards

Early Years (1951-65):

An important objective of Nehru’s based on India’s experience with imperialism and colonialism was independence from foreign control.  This meant that he was not willing to allow foreign firms to control strategic sectors, like heavy industry.  On the other hand, the resources of India’s private firms were insufficient.  As a result, a large role for the public sector was unavoidable. 
On the other hand, the heavy industry sector, being capital intensive, was unlikely to generate adequate employment opportunities.  As a result, production of consumer goods was left to the household sector.  This was also consistent with the desires of the Gandhian groups, which emphasized village-level self-reliance.

The direct resources of the government, through taxation and internal and external borrowing were not large enough; as a result, the government decided to allocate the output of certain commodities at prices below what the market could fetch.  For agricultural goods, this was also in keeping with the desires of the government to satisfy basic needs of the population at reasonable prices.

The desire for economic independence, which he saw as being key to political independence also meant that he wanted domestic production to replace imports. In the earlier years, this was not necessarily seen as erecting trade barriers. However, the focus on domestic needs meant that India did not produce goods that were desired by foreign markets or at a price that was attractive to them. As a result, with a fixed exchange rate, foreign exchange budgeting had to be introduced. The rupee could also not be allowed to depreciate, since this would have made desired imports costlier, and in any case, the higher costs of domestic goods were not the only barrier to successful exports. Once foreign exchange budgeting and non-market methods of restricting access to foreign exchange had been adopted, it was necessary to become very specific in what goods could be imported and how much. This also meant that industrial licensing had to be introduced, since the required capital goods were not available domestically. While licensing was not onerous in the beginning, starting with phase II, it became more and more of a binding constraint on production.

According to Panagariya (p. 32), this policy framework a) greatly underestimated the benefits of foreign trade via specialization in products of comparative advantage; exploitation of scale economies; transfer of technology embodied in goods; and enhanced competition; b) overestimated the ability of the government to efficiently coordinate the various parts of the economy. While the econmoy was smaller, this was more feasible, but as it grew larger, the diseconomies of management grew exponentially. If the government had understood that its ability to reproduce decentralizsed decisions of the market in a complex economy was very limit3ed, it would have relied more heavily on market-based instrucments to achieve the desired allocation of resources.

Nehru did not emphasize agriculture very much. Strategy in agriculture relied on the institutional model (i.e. land reforms and farm and service cooperatives), rather than on the technocratic model. Price incentives were not considered important, because farmers were seen to be unresponsive to prices. Land reforms languished because the states were not cooperative and because political pressures were strong. Growth in food output was slow.

Nevertheless, these problems and issues only affected the economy with a lag. As a result, the GDP grew at a decent average rate of 4.1% per annum.

Phase II: 1965-81

Towards the end of the previous phase and the beginning of this phase, the economy was hit by a multitude of shocks. In 1962, the country had to fight a difficult war with China. In 1965, there was a war with Pakistan, followed by another war in 1971, preceded by a huge influx of refugees. In 1965-67, there were two consecutive years of drought, as well as in 1971-73. In October 1973, there was a massive oil price shock, which affected the entire world.

From 1955 onwards, until 1973, the US provided food aid to India under PL-480. These were crucial especially during the years of drought. Following these years, the US forced India to devalue the rupee, promising continued financial aid through the World Bank. However, this was not forthcoming, partly because of the US tilt towards Pakistan. The causes of the devaluation are explained by Devika Johri and Mark Miller as being primarily inflation and the continued trade and fiscal deficits. The low rate of internal savings meant that the government had to borrow from the Reserve Bank of India to maintain its fiscal deficits. This increased the money supply and increased inflation.

The ensuing domestic instability led to political unrest and ended in Prime Minister Indira Gandhi opposing the economic liberalization championed by her opponents. Continued central planning and restricted foreign investment and restricted imports of consumer goods, coupled with protection for local industries meant that local producers who obtained import licenses managed to benefit from monopolistic rents (Monopolies Enquiry Commission, 1964). Over time, the licensing procedures also lead to corruption, which also ended in profits for a smaller number of business houses. These windfalls then led to control of large firms through the Monopolies and Restrictive Trade Practices Act (MRTP) in 1969. These were accompanied by tighter restrictions on foreign investment and foreign firms (to prevent outflow of foreign exchange due to remittances of dividends, profits and royalties), as embodied in the Foreign Exchange Regulation Act (FERA) of 1973, and tightened licensing regulations through the Industr4ial Licensing Policy of 1970. The MRTP act put further restrictions on the growth of large firms and reserved further sectors for small-scale industries. However, this led to two sorts of inefficiencies. First of all, scale economies were lost; second, smaller firms did not have the resources or the know-how for many kinds of advanced investments.

The rentier profits of the large business houses along with the political influence of the trade unions led to increased labor protection. While profitable business may have been willing to go along with calls for greater restrictions on firms' abilities to retrench workers (1976 amendment to the Industrial Disputes Act of 1947), such legislation drove entrepreneurs away from labor-intensive to capital-intensive methods. Furthermore, it drove industry from the formal sector to the unorganized, informal sector. To this day, the unorganized sector represents most of the employment in India.

Mrs. Gandhi also nationalized most of the private banks in 1969. The insurance sector had already been nationalized in 1956. This led to tremendous inefficiency in the financial sector, but helped the government in the financial repression that was necessary to fund the public sector. The average rate of GDP growth in this period was only 3.2%.

Phase III: 1981-1988:

Following Mrs. Indira Gandhi's return to the prime ministership in 1977, and the second oil price shock in 1979 (following the fall of the Shah in 1979), the government retreated from the restrictive regime that Mrs. Gandhi herself had put in place. This liberalization took place, both in industrial licensing and in import restrictions, as well as on the MRTP front. Average GDP growth was 4.8% during this period.

Phase IV: 1988 onwards:

GDP at factor prices grew at the rates of 10.5, 6.7 and 5.6% in the fiscal years 1988-91 respectively. Growth was spread across all sectors, 7% in agriculture, 9.1% in industry and 7.1% in services. Private investment rose during these years from 10.2% of GDP in 1986-87 to 13.9% in 1990-91. This was accompanied by strong imports, which led to large current account deficits (from around 1.5% of GDP in the early 1980s to 3.4% in 1990-91. This was financed by external loans of shorter maturities, which led to fiscal deficits, as well; in 1990-91, the fiscal deficit was 10.4% of GDP from around 8% in the first half of the 1980s. All of this led to steep declines in foreign exchange reserves. In 1990-91, there was only 1 month's worth of imports in foreign exchange reserves.

This scenario accelerated industrial reforms. Industrial licensing is pretty much a story of the past. THe provisions relating to merger, amalgamation and takeover in the MRTP Act have been repealed. FDI is prohibited only in retail trading, atomic energy and the gambling business, as well as restricted in a handful of other industries, notably insurance, defense, public sector refineries, air transport services and news publishing.. Import licensing has also pretty much been abolished. The result has been an increase in the proportion of total trade (exports plus imports of goods and services) to GDP from 15.9% in 1990-91 to 43.1 in 2005-6.

The structure of the economy has changed dramatically, as seen in the table below (Source: Table 3, Components of Gross Domestic Product, Handbook of Statistics on the Indian Economy):

Year Agriculture and Allied Industries Manufacturing Services
1952-53 55 11 10 34
1964-65 47 15 13 38
1980-81 38 17 14 45
1987-88 32 19 15 49
2004-5 19 20 15 60
2010-11 14 20 16 66

The charts below indicate the developments in the Indian economy over time:


1952-53 to 2010-11
Source: Table 1, Handbook of Statistics on the Indian Economy, RBI website

per capita NNP

1952-53 to 2010-11
Source: Table 1, Handbook of Statistics on the Indian Economy, RBI website


GDP recent

Source: Table 1, Handbook of Statistics on the Indian Economy, RBI website

per capita NNP recent

Source: Table 1, Handbook of Statistics on the Indian Economy, RBI website