The Political Economy of India's Growth

Episodes
A Political Economy Reding of India's
Growth Experience
INTRODUCTION
This book attempts to explain India’s growth episodes—particularly the institutional arrangements and
political factors that gave rise to them.
The factors underlying high growth in India have been analysed by a number of influential studies:
The first view is that the policy regime—which was markedly pro-socialist, pro-poor and somewhat
anti-business during the sixties and seventies—turned pro-business by the early eighties. This
change was manifested mostly in terms of the preferential treatments and incentives that
established business houses received from the government rather than signifi cant changes in the
economic laws to bring about more competition.
The second view is that it is the economic reforms in the early nineties (with signifi cant relaxation
of some of the draconian laws affecting investments and imports) that led to overall lowering of
costs, increased productivity and resulted in higher growth rates in this period.
However, both of these approaches have stopped short of addressing a second and very crucial link in
the institutions and growth relationship, which is that growth outcomes also usually have feedback
effects on institutional arrangements.

Methodology: First identify distinct “episodes” of growth for the Indian economy and then analyse the
transitions from each of these growth episodes to the next.

A BRIEF DESCRIPTION OF POST-INDEPENDENCE GROWTH IN INDIA

The decadal average growth rates may consist of distinct periods of very successful growth and
periods of not-so-successful growth—and in some cases—even growth failures.
Clearly, using decadal averages as proxies for medium-term growth episodes is misleading as they fail
to capture this variability in growth dynamics.
In order to understand the genuine “booms and busts” in growth behaviour in these countries, the
methodological framework must consist of two parts.
The first part must define a methodology to identify all distinct growth episodes for a country.
The second part has to then explain the dynamics that leads a country to transition through each of
the growth episodes.

IDENTIFYING INDIAN GROWTH EPISODES

Methodology: ?
We identify three growth episodes for India which cover the period 1950 to 1992, 1993 to 2001 and
2002 to 2010, respectively.
The next step is to explain these growth episodes.

POLITICS, INSTITUTIONS AND GROWTH IN INDIA: VIEWS FROM THE PAST

Bardhan highlighted the fact that the distribution of political and economic power in a given society
influences the direction of policies and development in them.
Many other literatures also highlight these relation.
A Political Economy Theory of Growth
Episodes
INTRODUCTION:
A conceptual framework that related political econoy factors to transitions in growth episodes
(accelerations, maintenance or collapse).
Factors:
Deals Space (alternative informal institutional arrangements between the political and economic
elites)
Rent Space (rent-earning possibilities in the economy)
Political Space
Why was this approach needed: Because traditional explainations of long-run average growth rates
hide distinct medium-term episodes of successful growth and growth failures.
The crucial explanatory variable in our framework is the interaction between political and economic
elites, and the manner this interaction both drives growth and is shaped by the growth process.

Miracle Growth: >5% increase in per capita income

Stable Growth Regime: 0-5% increase in per capita income
Stagnant Growth Regime: 0% increase in per capita income
Growth Crisis: Average change in per capita income is negative

What we are interested in knowing: "An understanding of the factors that lead to growth acceleration—
that is, the transition from stagnation or crisis to stable growth or miracle growth—as well as the
factors that lead to the avoidance of growth collapses and the maintenance of positive growth– that is,
the ability of the country to stay in stable growth or miracle growth in period t+1 if it has experienced
the same in period t"
Also we should acknowledge that, "Igniting economic growth and sustaining it are somewhat different
enterprises. The former generally requires a limited range of (often unconventional) reforms that need
not overly tax the institutional capacity of the economy. The latter challenge is in many ways harder, as
it requires constructing a sound institutional underpinning to maintain productive dynamism and endow
the economy with resilience to shocks over the longer term.”
Therefore the question comes at:
(i) What are the institutional determinants of growth acceleration? and
(ii) How are they different from the institutional determinants of growth maintenance?

Analytical Tools
THE DEALS SPACE:
It captures the range of informal and personalized relationships that are observed between economic
actors and political elite in developing countries.
Key feature that distinguishes “developing” countries is the gap between the official, formal, legal, de
jure laws and regulations and what actually happens. The stated “rules of the game” have near-zero
predictive power for what will actually happen.

THE RENT SPACE

Captures the structure of economic opportunities in the economy.

Rentiers are the high-rent firms that sell their products abroad (natural resource-exporting);
Magicians are the exporters in competitive industries (apparel and electronics as well as tradable
service sectors such as information technology (IT);
Powerbrokers are the high rent firms that serve the domestic market (real estate, construction,
infrastructure, utilities and telecommunications); and
Workhorses are the firms in competitive industries that serve the domestic market (smallholder
agriculturists and the informal manufacturing and services sectors).

THE POLITICAL SPACE

Refers to the balance or distribution of power between contending political elites and between elite and
non-elite, as well as the ideas or beliefs that political elite hold.
Horizontal power refers to whether there is concentration of power in one dominant political group
(who have the capability to resist any challenge to their control over political institutions) or whether
power is dispersed across several political groups jockeying for political control.
Weaker the concentration of horizontal power in the country, the more competitive the
settlement is.
Vertical power refers to the distribution of power among elites and non-elites (or neo-elites such as
the middle class).
Weaker concentration of vertical power implies greater strength of non-elites such as the
working class, peasants or neo-elites such as the middle class to resist institutional
arrangements that they see as corrupt or politically illegitimate.
The second element in the political space is the ideas and beliefs, which can be defined as the
“underlying interpretation (among elites) of how the world works, and the more specifi c question of the
range of possibilities for action that an individual or group recognizes”

TOWARDS A POLITICAL ECONOMY THEORY OF GROWTH EPISODES

Economic growth is likely to accelerate when there is a movement in the deals space from disordered
to ordered deal. Through “ordered deals”, the state can ensure that investors commit to the investment
decision and engage in production, so that rents can be generated through the production process.
Ordered deals environments are more likely to occur when cognitive maps of elites shift towards being
pro-business from being anti-business, as well as when political elites see an incentive to generate rents
for their own use (e.g. when the political space becomes more competitive, necessitating the extraction
of rents from business groups by political parties to fight more competitive elections).
Long-run productivity of the economy is determined by the “capabilities” of firms in the country to
produce a diverse array of products in the “product space”. Therefore the process of sustained growth
is the expansion of a country’s capabilities, which we can call the process of structural transformation.
Structural transformation is likely to occur with a movement in the deals space from closed ordered to
open ordered deals, or from disordered deals to open ordered deals. An ordered, even if, closed deals
environment, may be able to sustain growth for a considerable period. But for growth to be sustained
over the long run, the deals space must, while maintaining order, also become more open. This is
because openness in the deals space drives economic competition and facilitates new fi rm entry, which
leads to structural transformation as countries produce more complex products when resources shift
from low productivity sectors to high productivity sectors.

Positive feedback loops occur when the growth process leads to further opening up of the deals space
or more ordered deals while negative feedback loops occur when the growth process leads to a closing
down of the deals space or disordered deals.
If the growth acceleration episode is biased towards the Rentier and Powerbroker sectors (say, due to
a commodity price boom, or due to the high growth of non-tradable sectors such as infrastructure and
real estate), the economic feedback loop through the rents space could have a negative effect on the
deals environment, making it more closed.
On the other hand, a growth acceleration episode biased towards magician and workhorse sectors
(say, due to a rise in labour-intensive manufacturing or the emergence of high technology exporting
sectors) is more likely to lead to further opening of the deals space.

The second of the feedback loops would be political in nature and would depend on the political space.
The direction and strength of the feedback loop would depend on how influential neo-elite groups such
as civil society, judiciary, the middle class and the media view the growth process, as well as how non-
elites mobilize themselves against elements of the growth process that they see as politically
illegitimate.
Stagnation and a Nascent Recovery: The
Growth Episodes of 1950-1992
The first growth episode, running from the fifties to 1992.
In terms of sectoral growth rates, investment rates and productivity growth, this long episode was
clearly characterized by economic stagnation till the seventies, with a nascent recovery in the last
decade, that is, the eighties.
In the political space, the chapter describes the evolution from a dominant party system—with the INC
under Jawaharlal Nehru—to weaker coalition governments, where the Congress party ruled with a
minority in parliament, supported by other parties. This period also saw increasing contestations in the
political space with the first non-Congress government running the country.
Relating these changes in the political space to the poor growth outcomes during this period. For most
of the episode, the predominant position of the Congress party coupled with its socialist ideology
resulted in institutional arrangements that are best described as disordered deals.
The disorder associated with this institutional arrangement led to low investment, productivity and
stagnation. During the last decade of the episode, as the political space became more competitive, the
political elite was forced to turn to the business elite for their support, and this led to more ordered
deals between them. Not surprisingly, this resulted in a recovery in investment and a nascent growth
during the eighties.
Onset of High Growth: The Growth
Episode of 1993–2001
The second growth episode that covered the period from 1993 to 2001.
It was the first episode that exhibited growth acceleration in India, with the average per capita growth
rate going up to 4.15 per cent, compared to 1.86 per cent in the previous episode.
In the political space, the change towards more contested elections increased during this period with
the emergence of a second major political party, the BJP.
However, the change in the political landscape that was most critical for the growth acceleration was
the continuation of the transformation in the ideology of the political elite from an anti-business to a
strongly pro-business approach.
This led to significant reforms in economic policies since 1993 under the Congress government of
Narasimha Rao.
Most significantly, this cognitive transformation cut across political parties, which meant that these
policies were not overturned even when the BJP came to power in 1998.
In terms of the institutional space, these policy changes—particularly in industrial licensing and in import
controls—reduced the role of the bureaucratic machinery in determining the outcome of deals, and this
removed a very important source of the disorder in the deal space that existed during the seventies and
early eighties.
The result was both more ordered and more open deals, which energized the magician and workhorse
sectors. As a result, investment and growth increased sharply during this period. Notably, due to the
open nature of the deals, the growth was substantially in less rent-thick sectors like manufacturing, IT
and hotels and restaurants.
Rapid Growth and Limited Structural
Transformation: The Growth Episode
of 2002–2010
The third growth episode of the Indian economy, running from 2002 to 2010.
It was also the second consecutive episode of growth acceleration, when average per capita growth
rates rose to 6.42 per cent per annum.
The sources of growth in this episode were significantly different from the previous one, with much of
the growth coming from rent-thick and natural resource based sectors such as large construction
projects and telecommunications.
Moreover within Industry, there was a similar shift towards natural resource based sectors. This was
also reflected in the rents space, where powerbrokers became much more significant and rentiers
appeared for the first time.
In the political space, this period is characterized by the rise of regional political parties and the resultant
fragmentation of the political space. As a result of the increased dependence of the major parties on
these regional parties, the characterization of the political space shifted from a two-party system to
two distinct power-sharing alliances, each consisting of one major party and a handful of regional
political partners.
These political changes coincided with closed deals becoming pervasive in the rent-thick sectors, with
a number of cases where there was illegal sharing of rents between business and political elites.
These cases of rent sharing were due to
(i) rent extraction by regional parties and
(ii) higher resource needs of political parties in order to compete in the fragmented political arena.
Together with the steady growth in the less rent- thick sector, this surge of closed deals in the rent-
thick sectors resulted in even higher investments and very high growth rates in these sectors and the
aggregate economy.
The Post-2010 Growth Slowdown
and a Debatable Partial Recovery
The Indian economy slowed down after 2010.
This slowdown has been particularly significant in rent-thick sectors that were characterized by closed
deals and crony-capitalism in the third episode.
This slowdown was due to negative feedback effects to closed deals that resulted in a disordered
deals environment, and hence a fall in investment and growth rates.
The new government has been partially successful in restoring an ordered deals environment and hence
growth, but political and reputational issues have delayed changes necessary for rapid growth.
Politics, Institutions, Episodes:
Concluding Observations
MEDIUM-TERM GROWTH RATES ARE VOLATILE AND EPISODIC
Rather than progressing at a steady rate, growth in developing countries is episodic, that is, phases of
high growth are followed by phases of slowdown, while phases of low growth are frequently followed
by acceleration.
The low growth during the first episode was followed by two episodes of acceleration and then, the
current phase seems to indicate a slowdown.
Conversely, the episodic nature of growth also shows that reaching a higher growth path is no
guarantee for remaining there indefinitely, if there are negative feedbacks emanating from the growth
process. Thus, even if countries have accelerated to higher growth rates, they have to ensure that such
negative feedback effects do not pull them down.

THE DEALS ENVIRONMENT IS A CRITICAL INSTITUTIONAL ARRANGEMENT THAT PLAYS A MAJOR

ROLE IN GROWTH EPISODES
We know that for long-run growth (as opposed to growth episodes) there is a consensus in the
academic literature that it is the quality of institutions that matter the most.
Institutional arrangements in developing countries are better described by the deals environment.
In India, during most of the first growth episode, there was a disordered deals environment and this led
to the poor Hindu rate of growth.
The deals environment started to get more ordered during the end of the first episode, and it
transitioned to an open ordered deals environment in the second growth episode. This transition
also led to a growth acceleration in the Indian economy.
The nature of the growth during this second episode, as well as certain external factors, opened up
the possibility of high-rent activities in some of the sectors. As a result, the economy again
transitioned institutionally to very closed ordered deals in the high-rent sectors in the third growth
episode. The combination of open ordered deals in the traditional sectors together with closed
ordered deals in the high-rent sectors accelerated growth even further in the third growth episode.
Finally, the corruption cases in these closed deals, and the resultant disquiet among the non-elites
and the pushback by legal institutions, all led to a loss of credibility of the deals towards the end of
the third episode. These resulted in a disordered deals environment after 2010–11, leading to a
slowdown in growth during the fourth growth episode.

POLITICS PLAYS A SIGNIFICANT ROLE IN DETERMINING THE DEALS ENVIRONMENT

The nature of the deal contracts will depend on the political ideologies or compulsions faced by the
political elite.
In the fifties, sixties and seventies, the political ideology in many of the newly independent developing
countries were strongly socialistic and to a certain extent wary of capitalism. India was no exception to
this. As a result, the political elite were largely focused on economic development through the public
sector. Not surprisingly, the deals environment for the private sector during this fi rst episode was
disordered. However, the lack of growth in the economy made the ruling political elite increasingly
unpopular and they faced a political challenge from new political elite.
The new contestation in the political space forced the political elite to look for more resources and allies
in their quest to remain in power. This brought them closer to the capitalist class and as a result the
deals environment also turned more ordered. This change started towards the end of the fi rst episode,
although initially, it was closed and only for domestic capitalists. When this did not give robust growth
outcomes (with a few years of high growth during the second half of the eighties interspersed with
growth crashes including the crisis of 1991), the political elite chose to go even further, opening up the
deals world to international capital as well. This resulted in a much more open deals environment during
the second growth episode. As we have described above, the third growth episode saw the
institutional transition to closed deals environment in a number of high- rent sectors. This was, of
course, partly due to the nature of these sectors that required large-scale production. However, in
many of these cases, rents were transferred to the political elite leading to political corruption. There are
two political factors underlying this. The fi rst, of course, is the continuing increase in the cost of
political activities including the cost of fi ghting elections. The second is the rise in the power of the
regional political parties and their attempts at rent-seeking through these deals.
Finally, let us consider the disordered deals environment that seems to continue from 2010 to 2011
onwards. Not surprisingly, this environment was created when the ruling political group in power started
losing political support from the non-elites. Interestingly, even after an election and a change in
government, there seems to be no political settlement and only a weak ordered deals environment, due
to the lack of an acceptable “deal” between the major political parties.

POLITICS, INSTITUTIONS, EPISODES: LESSONS FROM SOME OTHER COUNTRIES

The underlying factors of episodic growth for other developing countries is similar to what we have
found in the Indian case—growth accelerations occur with a shift from disordered deals to close
ordered deals. Such accelerations in growth are typically followed by growth decelerations as the
process of growth (especially if it is biased towards rentier and powerbroker sectors) usually leads to
negative feedback effects to the deals space, leading to a disordering of closed ordered deals.
Economic growth in most developing country contexts remains episodic and prone to collapse, as
institutions do not evolve over the growth process, and in many instances, deteriorate.
The move from growth processes that rely on informal institutions (deals) to growth processes that rely
on formal institutions (rules) is not pre-determined, or linear. Shifts back and forth from good transitions
in growth to bad transitions in growth are common in developing countries with weak or poorly
enforced formal institutions such as India.
Thank You
- Onset of High Growth: The Growth
Episode of 1993–2001 -
EVOLUTION OF THE ECONOMY, 1993–2001
Due to Gulf War, there was widening current account deficit.
With the help of IMF, 'Industrial Policy Statement' was introduced in Parliament
Industrial licensing was abolished irrespective of the level of investment except for 16 industries
The number of industries reserved for the public sector presently was signifi cantly reduced
Import licensing was virtually abolished with respect to the imports of most machinery and equipment
and manufactured intermediate goods.
There were financial sector reforms with deregulation of the stock market and decontrols of interest
rates, macroeconomic stabilization with a reduction in the fi scal deficit and devaluation of the
exchange rate
The proximate cause of the acceleration in economic growth was a sharp increase in private investment
since the early 1990s that responded positively to economic reforms.
Overall, the 1993–2002 growth acceleration episode was characterized by strong growth in the private
sector, especially around manufacturing, IT, hotels and restaurants and communications.

EVOLUTION OF POLITICAL INSTITUTIONS, 1993–2001

The country moved to a competitive political settlement, with two or more political groups jockeying
for power.
Political elite held view that market-oriented economic policies are essential for India’s rapid economic
development was that economic reforms were not rolled back whenever a new government took
power. Thus, deals remained ordered.
The shift in the ideas and beliefs of political elite (and hence, in the political space) towards a more pro-
business orientation led to a growing diversification of business ownership.
Ex: Sun Pharma and Dr Reddy’s Laboratories in pharmaceuticals and Infosys and HCL in IT.
In the 1990s, state-business relations became more inclusive, as both new state actors and economic
elite came into the fray for the first time.

EVOLUTION OF DEALS, 1993–2001

Shift to ordered deals by the late 1980s and a more collaborative relationship between the state and
business with an attitudinal change from being anti-business to being pro-business on the part of the
Indian ruling elite.
The gradual shift to ordered deals which occurred in the 1980s and was consolidated in the 1990s with
changes in the “micro-environment” for deals through industrial and import quota delicensing was the
key contributing factor for the increase in private corporate investment.

The shift from disordered to ordered deals is particularly important for the private sector to incur the
large fi xed costs necessary to invest in machines. The rapid increase in the investment rate in
equipment was the primary proximate cause for the growth acceleration episode of 1993–2002

Thus, in the 1993–2002 growth acceleration phase, economic growth was mostly driven by magicians
(IT and chemicals) and workhorses (hotels and restaurants). Such a growth strategy that was driven by
magicians and workhorses should have led to a further opening up of the deals space.
Rapid Growth and Limited Structural
Transformation: The Growth Episode
of 2002–2010
INTRODUCTION

THE EVOLUTION OF THE ECONOMY, 2002–2010

Overall, the growth acceleration of 2002–2010 was driven primarily by non-tradable sectors such as
construction and communications as well as tradable services such as IT.

Another important feature of the 2002–2010 growth episode was a shift in industrial structure towards
natural resource-using sectors (Table 5.2). It is evident that the average shares of food, beverages and
tobacco, textiles and apparel and machinery (which would be the sectors where magician and
workhorse firms would be more likely to be found) in total manufacturing real gross value added have
declined in the period 2002–2010.

The Rentier, Magician, Powebroker and Workhorse Sectors

Structural Transformation

THE EVOLUTION OF POLITICAL INSTITUTIONS, 2002–2010

The regional parties became important components of the ruling coalition in the 2000s and exerted a
signifi cant influence on what the main ruling party.
Given the veto power exerted by numerically small but powerful groups of politicians in regional parties
that comprised ruling coalitions in the 2000s, the deals that economic elite have had to strike with
political elite increasingly accommodated the interests of these parties, with implications for both the
“ordered” nature of these deals as well as their “open-ness”

THE EVOLUTION OF DEALS, 2002–2010

There was a shift in the deals environment in this period from relatively open to much more closed deals.
This was most evident in the increasing level of “crony capitalist” deals that political elite struck with
economic elite in “ high-rent” natural resource sectors such as bauxite, coal, iron ore and natural gas, as
well as telecommunications at both national and regional levels.
Reasons:
A sharp increase in the price of several minerals in the early to mid- 2000s. clear incentives for
political elite to preferentially allocate these licences to selected economic elites on terms that were
not transparent, or the most economically competitive, in return for extra-legal monetary rewards.
Secondly, as rapid economic growth in the previous growth episode spurred an increase in demand
for the services of infrastructural sectors such as telecommunications (naturally oligopolistic and
characteristically high-rent), political elite entered into rent-sharing arrangements with business
groups that were awarded contracts to operate in these sectors.
Thirdly, with the increased fractionalization of the political system at the national level, and the
growing importance of regional political elites in the coalition governments of the 2000s, “closed
deals” between these elites and powerful economic interests both at the national and at the
regional levels become more prevalent in the post-2002 period. This was accentuated by the rapid
turnover of governments and closely contested elections, both at the national and regional levels,
which led to a shortening of the time horizon of political elites, who were more interested in fi nding
ways to extract rents to fi nance elections that they would have to fi ght in the immediate future
Reforms in Indian election expenditure laws in 1975 and 2003 put the expenditures of party and
supporters of individual candidates outside the purview of the expenditure limits on these
candidates and banned corporate donations. These led to increased informal fi nancing of election
campaigns and a greater reliance on informal deals to finance costly election campaign in return for
discretionary contracts and regulatory favours.
The Post-2010 Growth Slowdown
and a Debatable Partial Recovery
INTRODUCTION

There are three important conclusions that can be drawn from this table. The fi rst is that most of the
sectors seem to have slowed down after 2010–11, whether we take the data based on old or new defi
nition of GDP. The second and even more important conclusion is that those sectors that were
particularly identifi ed with closed deals that led to rent-seeking and corruption, including mining,
construction (particularly large construction projects) and communication (with the spectrum-based
scams), have shown a large fall in growth rates compared to the average growth rates during the
previous growth episode. Thirdly, the banking sector, that lent to many of the high-growth sectors in
the previous episode, suddenly found their balance sheets under stress due to the overall slowdown in
the economy, and according to data based on the new defi nition, this sector has also slowed down
signifi cantly.

INSTITUTIONAL ARRANGEMENTS AND THE POLITICAL ECONOMY, 2011–2016