M1.

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Global and Indian
Economic History
Part - II

Dr. Arvind Subramanian

Chief Economic Adviser, Government of India

E-text
 Now we have to move on to Indian economic History. There is something very
special about the Indian development model. I'm going to argue in this session and come
back to it at the end the last session on this precocious development model. So if you really
want to understand the precocious development model you have to be here for all 14
modules. Okay? The first thing this chart shows percentages VS years that there is
democracy since independence, so zero means always a non democratic and one means
always democratic and we can see what was the level of income at independence. Now
notice all these countries. Graph shows firstly that India is one of the five countries that
have always been democratic since independence. And I think the useful fact for all of you
to remember is that we think that India is the only country to be democratic actually there
are four of the countries that have been democratic. In fact if you look at the chart closely
enough you will find that these are all at one and India is that a little bit less than one. Why?
The answer is “Emergency”, exactly! For two years India was not or whatever 20 months
India was not democratic so it doesn't quite get one. it's 98 or 99 percent so that's fact
number one, fact number two is that it's something that comes out that these other
countries so fact number one of the few countries always been democratic that's very
unique in history remember all these countries are here but what is really special about
India is that this was achieved despite starting at very low levels of income.

Other countries started it at higher levels of income. So in political science this a big
puzzle India one of few countries that were always democratic but what is really special is
that it sustained it at low levels of income. Even these countries they started off much richer
. so that's a political science mystery because usually you think that you have to have
higher levels of literacy, a less agrarian population and all of these. So this in some ways
the great Indian achievement being a democracy despite being at very low levels of
income.

In this one Asian country, one African country, two Caribbean countries and one a
Central American country. There's one fact about Costa Rica that all of you should know
which makes it a really interesting country, even more interesting than India in this one
respect and certainly much more interesting than Pakistan. We say that India managed to
keep the generals out of politics, Pakistan couldn't. but guess what! Costa Rica at
Independence said no army, no generals, so that's what's very interesting about Costa
Rica. it's kind of interesting factoid. The other thing that is very special about India is that it
has managed to maintain democracy .This a chart with GDP per capita at independence on
the x-axis and this a measure of ethnic fractionalization, that tells how divided is a society.
In fact the way you measure this to ask the question -that if you were to take any two
people from a country at random what is the probability that they will not be of the same
caste or religion or whatever .So there's a way of measuring this and it turns out that India
is one of the most fractionalized countries, because Indian historians have remarked on the
fact that in all societies have divisions religion language, culture ,gender, region etc. India is
unique in at least one dimension that is this caste dimension, of course very few other
countries have caste, so if you aggregate it all together you find that India is very cleavage.
a political scientists will tell you actually makes sustaining a democracy more difficult
because there many more differences in society and so you have to keep this in mind. This
something very special about India to have a democracy at low levels of income for very
long and that it did that under conditions of being very fractionalized society.

All societies need to make three big choices, “choice” number one, political I put that choice
with an inverted comma not because someone actually sits down and says we'll do this or
not but de facto that's what happens societies make choices the political choice democracy
or autocracy that's one choice. Then there's an economic choices markets or state and to
what extent and then of course social choices especially if you begin so fractionalized how
do you make sure that over time these divisions come down and are not exacerbated or
aggravated. Broadly you can say there are two ways of doing it - one is- do you actually
make growth inclusive or reduce this by providing opportunities to all by doing guarantees
i.e so and so is guaranteed so many seats in parliament, in jobs. what I call guarantees and
opportunities. This what India did in 1947 and subsequently in terms of these three choices
. to analytically tractable way of managing these kinds of things and then we can fit in all the
things under these three categories.

Even to understand economics you have to understand a little bit of history. There
are Individuals that made a big impact on early Indian development choices whether they
were economic political or social. In this beautiful picture, the two leaning in and listening in
to the father of the nation , makes me my hair stand on end . Obviously there are others like
Dr. Ambedkar also who had a big choice but in terms of economic certainly there were
these three big leaders and they had competing visions. Nehru wanted self-reliance,
industrialization and he believed in the government, the state the state will lead
industrialization Gandhi Ji of course had a completely different vision of self-reliance,
agriculture village communities but no industrialization and of course Sardar Vallabhbhai
Patel was much more pro agricultural, landlords pro-business, representing what today you
might say is the right side of the ideological spectrum, where there are more markets, more
agriculture. Nehru had the most dominant impact but the others too had an important
impact in some very important ways. In addition to individuals , the ideas determined what
choices we made and this very important to understand because today especially all of the
youngsters think- oh why did we do socialism? . bad choice .why did we do this? we forget
that these were choices made at a point of time in history and why these choices were
made. if you go back to 1947 at that point in time nineteen thirties have happened, forties
have happened. What happened in the 30’s and 40’s ? one we had for example the great
depression in the United States and after that to respond to that depression the Americans
built a welfare state . Similarly after 1945 Europe also follwed suit. The famous National
Health service was built in the United Kingdom where healthcare was provided by the state
free for everyone. So it was a general feeling where everyone believed that capitalism was
not working as it created the Great Depression and it didn't look after the poor . So it was
perceived to actually draw upon the state much more. That's one reason, second we forget
today we think about Putin's Russia or Gorbachev Russia in fact at that point the successful
societies were Japan and Russia. Russia at that point was very successful completely
socialist model of development so a small video clip. It became such legend which of
course was also very different and Nikita Khrushchev never told that he would bury
Americans In the early what he did say could be more closely translated as a promise that
communism will outlast capitalism. Nikita Khrushchev was before after Stalin and before
Brezhnev.He was the leader and came to the United Nations in 1954 and he's supposed to
have taken off his shoe and banged on the podium then and said “we will bury you” , some
people thought he referred to the nuclear bomb that he was going to unleash and it's not
the case as he actually meant that communism will outdo capitalism. But today it looks
ridiculous, but at that point in time it didn't ,because the Soviet Union was growing fairly
rapidly and it had built up a lot of industry and it was an example of fairly successful
industrialization at that point in time. That's the background the idealogical background
when India made some of these choices.

So then that was the kind of ideology from abroad there was an ideology at home
economic ideology in fact just before independence a bunch of Indian industrialists or
private sector people in Bombay created a document that they gave the government and it
was called the Bombay plan .In that they didn’t asked for more capitalism and less
government participation in industry type of model they however said the opposite, that they
want the government to lead industrialization and asked for barriers against goods coming
in imports, because they wanted to promote the domestic manufacturing sector. So it's a
combination of Nehru as an individual plus all these influences that actually determined
what model of development India finally ended up doing.

So next we go to the first choice and I want to talk about democracy versus
autocracy not in political terms but in economic terms. it is actually really important to
understand this from an economic point of view. If you go back to the 30’s and 40’s and
50’s when you look at economic thinking, development thinking. There were people who
said that the poor countries are poor because they don't have enough savings, so you need
more savings and that's what comes in finances investment. If you look at all the growth
models of Herod Omar, etc, in all this there are the constraint or savings. you increase
savings you increase investment, then economies grow . But then the question was -how
do you get these savings when you're very poor? how do you get savings? People when
they save less and they consume more, how do you get savings? it turns out that there was
an example of China and Russia who actually got these savings even at low levels of
income by doing what? they also extracted savings from agriculture essentially by being
ruthless and that is the sense in which autocracies they thought was better for long-run
growth because you could get the savings from agriculture to finance Investment. India on
the other hand our agricultural policies were constrained by the fact that we were
democracy and we were in decentralized democracy agriculture issues were state subjects.
The influence of Dr. Sardar Vallabhbhai Patel came in he also said you cannot tax
agricultural income in fact in our constitution the center cannot tax agricultural income and
that was a Sardar Vallabhbhai Patel’s legacy, so you cannot expropriate from agriculture
you can't even tax agriculture , the center is constrained as it's a state subject. so when you
get savings and that was the “cruel choice” that is you could either have freedom or you
could have growth that's the cruel choice that actually India was facing. supposed we're
faced by choosing our democracy and also the agricultural policies was such that we
couldn’t even do forcible land reform because that again would be undemocratic . so what
we had was voluntary land reform under Vinoba Bhave and of course it was all voluntary so
nothing much happened and so India was to low savings because of not being able to tax.
Today we have a strong powerful country we don't borrow from anywhere, we don't get
foreign aid but at that point in time because we didn't have savings, we got a lot of foreign
aid especially from the United States and a lot of it was in the form of food aid PL 480 and
at that point in time people this a very important historical fact that we were the darling of
western donors then in fact 25 percent of the plan was financed by foreign aid in the 1960’s
because they wanted democracy to succeed, they did not want China and Russia to
succeed. India is a model based on democratic values and west wanted it to succeed and
we used to get at least until the early 60’s lot of aid. Then of course things change very
dramatically in 66 when we had a major two consecutive famines, the geopolitics got much
more complicated. So what did India do ? what were the big choices that India made
between markets and the state? So the first thing we did was in the 1956 industrial policy
resolution, India decided to take control the state of the commanding heights but yet have a
mixed economy. So under this the Government will do all the important sectors like steel,
coal ,heavy industries. Because we still had democracy and we had a private sector unlike
Russia, we said the state won't do everything it will do many of the important things which
involved a lot of investment steel iron coal but other sectors we will leave to the private
sector and in some cases private sector and public sector could both be part of it. So that is
the first choice we made in terms of who will do what in the economy.

The second thing was industrialization and I want to link this back to what I said
about savings ,so when Pandit Nehru called upon this statistician who created ISI Calcutta
Dr. Mahalanobis and said you do a development strategy for India. It's called the
Mahalanobis and that was incorporated in the second plan and lots of things about this are
very interesting but one of the big decision that were made in this plan was how much
should resources go into investment? remember if you don't have enough savings so you
won't get future growth so and how much resources go into consumption? and there was an
elaborate model with one critical parameter i.e . political . how much resources should we
put in investment in heavy goods or investment goods and investment in consumer goods.
Now if you put a lot of investment in consumer goods it will be consumed there won't be
savings, there won't be industrialization, but then if you don't put enough in this people can't
eat today so it became a choice between consumption today and consumption tomorrow
that was the “cruel choice” that led to this so apparently there was a lot of agony and the
model depended upon how much should the state invest in one set of industries as
opposed to another.
 Agriculture suffered injury in the only lining the share public resources devoted to
agriculture was not very high and so this was kind of very Nehruvian choice and remember
this therefore is a way of how they straddle this you cannot extract resources from
agriculture so what you do is that when the state invests money it puts less into agriculture
and more into industry and as a way of increasing savings and investment and that was
kind of the conceptual background to the plan. it was related to the political choices we
made so it was not kind of inconsistent but very coherent cogent kind of thinking, so we had
industrialization that was a choice lambda K equals 1 / 3 but the other choice was how
much do we allow foreign competition and how much do we promote our domestic sector
that's called import substituting industrialization because you want domestic production to
substitute for imports because you want to develop the local economy.

Now that too had some origins it didn't just come out of nowhere, it came out of
colonialism. a country that newly emerges from colonialism has seen kind of the worst
impact of foreign rule including foreign capital ,these guys came they extracted us .There
was a big debate and a very compelling work actually by Dadabhai Nauroji who said that
basically the Indian industry suffered especially, the textile sector suffered because of being
these people took our cotton and took it away and didn't allow our sector to develop. So that
was one background to this the second very respectable intellectual background to this -
Raul Prebisch and Hans Singer said if you do agriculture for example, agriculture prices
come down over time it's not a good thing to do therefore you have to do industry because
there you get better prices and the way to do it is by doing import substituting
industrialization. therefore very early on we basically had lots of restrictions on foreign
trade, foreign, exchange, foreign direct investment. we were what is called a very closed
economy, closed to foreign competition of all sorts and so we did more savings, we did
more industrialization, we did it more in the public sector, we did it through domestic rather
than competition so these were some of the big choices we made .we did most distinctive
thing what is called industrial licensing? So you have to listen to this very carefully, so
essentially what industrial licensing was ? domestic industrialists needed to get permission
before they could expand or even enter a market, remember that going back to this import
substitution i.e. limits on foreign trade this was today it seems a little bit crazy because
everyone is globalizing but actually it was very respectable then because most countries in
the world did it that, the most developing countries at that point especially in Latin America
Turkey even to some extent in East Asia they did the same thing they restricted foreign
competition, they didn't allow imports to come in and they didn't give access to foreign
exchange, they didn't allow foreign direct investment to come in. so it was very normal in
some sense historically to have done that , but what we did in addition to keeping out the
foreign guy but the domestic industrialists could undertake economic activity, if they got
permission from the government. This was something that was very distinctive about early
Indian choices. Now why that happened? I think that’s a question that we need to do much
more historical research on. But I think this was part of I would call this a little bit the
Gandhian legacy on Indian economic policy because Gandhi Ji wanted everything to be
small so there was a fear of people getting big both for political reasons or in a big people
too much money they will influence politics but also a genuine conceptual belief that India
should be made up of small actors, economic actors, political actors and so we had several
other things which actually favored the small and acted against the big and the rich.

We had something called the Monopolies and Restrictive Trade Practices Act, we
had labor laws for example which said if you have more than 100 people or later to 300
people you had to get permission from the government or if you wanted to fire people for
example. that too encouraged or discouraged firms from becoming too big . similarly and
then this sort of fairly unique to India in the 70’s we would identify products and say these
can only be done by the small scale sector. it began as ten products in the 70’s it went up
1,000 products around the late 90’s and then of course it was slowly disbanded but for a
large part of India's history we had these multiple things if you want to become big, you
have to get permission from government, you couldn't get big if you got big you paid
penalties and some of it was only forced only allowed for the small .so I call this a kind of
general equity phobia against size that we developed. Yes (question not audiable) the
question a very good question was the MRT P was not against big business per say but
only if they did certain kinds of things. What you are actually saying is how in fact
competition law works today? but at that point in time that's not how it works, if you are a
certain size there were many more just by virtue of being big you would have to get more
permission you couldn't do this you couldn’t do that just by virtue of being big . so that was
what all of this happened there were certain aspects of it which penalized becoming too big
and remember all of this then were combined with tax incentives that were given more for
being small and penalized you for becoming big so it's a whole conceptually it's a whole
apparatus in the thinking very consistent that favored this mode so I call this the Gandhian
overlay on Nehruvian fundamentally . so this a chart I'm going to use again and again and I
honestly think in my being chief economic adviser is there's one conceptual diagram that I
use a lot in thinking , I will show you this diagram over time . this a diagram of what we call
a small open economy. So this the supply curve, this the demand curve and this world
prices right. So if this economy is open this will be the domestic price, this will be dem and
this will be supply and this will be imports so this a basic simple open economy. Now
supposing you can think about import substitution as we put a tariff on foreign imports what
will happen is that domestic prices will go up, demand will come down, supply will go up
that's why it's protecting domestic because supply goes up from here to here this the impact
of import substitution and imports which were here so much come down to here. So this
import substituting industrialization this something that yeah only for the clarification
equation. I don't, okay good so I'm sorry I should have said this quantities on the horizontal
axis and prices on the vertical axis , this the world price but also the domestic price if you
have a tariff you have world price plus a tariff which gives you what the prices that domestic
producers in consumers face so that's simple way of thinking about this imports and imports
came down but here's the funny thing though that what India did with industrial licensing
was it said that no I will not even allow this to happen if you are here even becoming big I
will impose restrictions, so it is forcing domestic production putting restrictions on domestic
production and that is actually I can understand if you want to penalize the foreigner but this
was a way of penalizing domestic industry part of it was because you didn't want people to
become too big but very few countries actually did this because you can understand hitting
out at the foreigner but it's very difficult to understand taxing domestic industry and that's
why I call this import substitution and licensing with Indian characteristics there's something
that we did a very special.

Now this where we come to guarantees versus opportunities social choices and the
point that was made earlier the neglect of basic education was apparent from day one. If
you look at what happened in India over time we invested not enough in human capital. but
the basic point was that basic education remained a state subject until 1976 and there's a
very lovely book by Myron Whiner, it's called the child in India and talks about how the child
was neglected because basic education was neglected. Shared to primary education
declined from 56 percent in the early 50’s to 30 percent so this was another aspect of you
know so when we talk about social if you think that to get inclusive growth you need to
invest in human capital but unfortunately this never happened.

Now the interesting politics of this again I'm not making a political statement I'm
making a description the interesting politics was people always ask well why didn't the early
rulers like Nehru why didn't he emphasize basic education? to which again not justifying his
answer was that look basic education was a state subject it was not a central subject, so
then the debate now is well formally that was true but could he nevertheless have done
more on that using his political power and so on so that's where the debate is. last two three
years labor reform is both a state and a central subject ,now the government has decided
that this will do labor reform we left more to the states to do something like that happened
on basic education in India. so in terms of the early charges in terms of inclusiveness,
opportunities and inclusiveness there was a major choice which had consequences later on
in terms of educational outcomes in India.

So the final thing I would say is that also in terms of opportunities versus guarantees
I think because of all these historical issues that we had with cast especially and the whole
debate between Gandhi and Ambedkar ,on how to go about this, we settled finally for a
guarantees and we have reservation that began as twenty two and a half percent and after
Mandel it's become close to fifty percent also there are guaranteed seats in the legislators
and now of course we have this in the third tier as well.

So India in some sense chose inclusiveness . education was a bit neglected

because of the choices made on education also because inclusiveness was to some extent
affected by the fact that we didn't focus on agriculture because agriculture had most of the
people and we chose in terms of how we get inclusiveness by guaranteeing things
guaranteeing outcomes for certain communities and so these were the broad choices that
India made.
 Name the five or six big things that influenced Indian economic policy? I have a
question I think that distinction between guarantee an opportunity over say is little broad, I
think sometimes a captivating opportunity .I think that's a very good point you could say that
this guarantee is itself a form of opportunity right but then the question is that is it broad-
based or narrow focus and we can get into those distinctions. but I think there is no where
as hard and fast as this suggests. I think we should emphasize that these were guaranties
given to political minorities, it is actually the formation of nation and three communities we
are talking about in 1920’s. I want to make a distinction between political guarantees and
economic guarantees, these were economic guarantees and these were political
guarantees but you're absolutely right, it was part of redressing historical social inequities
but also furthering the political formation of the political state in India and that's a very fair
point.

So far what I've been saying applied from say 1947 to 1991 again ,I myself have
done a lot of work on anytime we draw these hard and fast distinctions , actually it
happened in 85, 86 but take this as broad time and get into the details certainly afterwards.
the big bang reforms happened, macroeconomic stabilization, exchange rate, we opened
up the economy and we dismantled industrial licensing and those of you who want to read a
more kind of accessible narrative which you could give to your students as reading
Vanessa Tupper his recent book called “the half line “ I think goes through how what
decisions were made and how they were made so it's very interesting so if you have
students who are interested in reading and politics in addition that would be a good way of
introducing the 1991 reforms to them because a part of the thing I want to do here is –
maybe recommend things that will be good for your students to read as well and not just
talk about what is being said here.

I was just thinking about it this morning or yesterday, what were the five or six big
economic decisions that were made and maybe you could organize your classroom
teaching if you don't like this structure you could organize it around the five or six big events
in economic history.

I think certainly the second five-year plan was a big conceptual thing. the Industrial
Policy Resolution which did the commanding heights was another one the industrial
licensing was another big event. one of the thing is Bank nationalization in 1969, that also
had a big impact on subsequent Indian economic development and of course the 1991 big-
bang reforms so again apart from what you're saying about the economy I think what I want
to convey is how do you teach this to your students, you can teach this in terms of
conceptual analytical categories or you could choose if you wanted to say okay five or six
depending upon how much time you want it to spend, these would be alternative ways of
doing it.