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Comment on Srinivasan

Anne Krueger

October 12, 2005

As always, T. N. Srinivasan has provided an excellent analysis of the Indian economy’s

performance– this time of the role of ITES (information technology enabled services) in past

and prospective economic growth.

The analysis of the growth of the IT sector is masterly, and I have only a few comments

on it. I will then focus on the insights that

the experience of the IT sector provides for Indian

economic policy and growth more broadly.

Turning first to the IT sector, its performance has been spectacular by any standard –

especially in contrast to the rather sluggish performance of many

Indian economic activities.

But it should be quickly noted that there are several unique characteristics of the IT sector,

which may have enabled it to grow so rapidly. First and foremost, IT is less heavily

dependent on infrastructure than most industries are. TN notes that 25 different government

rules had to be changed or removed in order to set up the first earth station in Bangalore in

1986. But the fact is that the industry could rely on an earth link and avoid many of the

cumbersome aspects of Indian infrastructure: it hardly needed Indian roads or railroads,

telecommunications (as they then were) or Indian ports.

For many other industries, rules

would have had to be altered AND infrastructure and other bottlenecks removed. While the

IT sector had to live with the same constraints regarding other aspects of infrastructure as

other industries, the effect on their cost was arguably considerably less.

A significant feature of the IT sector is that most of the major firms have campuses in

Bangalore, or in the other cities cited by TN, and these campuses are virtually self-sufficient.

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They have their own generators and do not depend on public provision of power. Even

getting people to and from work is done by use of company-owned buses, rather than

reliance on public transportation.

Indeed, in Bangalore, some of the large firms are

concerned that they may be unable to sustain their rapid growth because as their employment

increases, road congestion will be too great to absorb additional buses!

The IT firms

perceive the need to fight with the local authorities for capacity expansion for virtually every

publicly-provided urban service for which private investment cannot substitute.

If infrastructure was less of a constraint for IT, there was another important factor. The

IT sector was “encouraged”, as T.N. notes, but mostly by removing the disadvantages that

other industries have. The sector was “discriminated for” in the sense that it did not suffer the

disadvantages the government imposes. For one thing, the industry was new, and in a sense

outran the government by growing rapidly before regulations could be put in place.

But, as TN also notes (all too modestly, since he had a significant role in it),

the

telecommunications reforms of the 1990s and later were highly significant. The IT sector

probably could not have grown as rapidly as it did in the absence of

those changes. One can

only wonder what industry or industries would experience comparably rapid growth if the

transport, or the labor market, or the power, bottlenecks and regulations were removed for

other sectors of the economy.

One final comment on the IT sector’s growth prospects. TN has a table on wage

differentials and notes that wages are very low by international standards. The relevant

comparison should, of course, be unit labor costs, and a comparison there would be highly

worthwhile. During the NAFTA debate in the early l990s, for example, much was made of

the fact that average factory wages in the U.S. were some ten times the average Mexican

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factory wage. But, once the calculation of unit labor costs was undertaken, it was found – not

surprisingly – that unit labor costs were quite similar, and indeed, several percent lower in

the U.S. than in Mexico!

Clearly, there is great scope for productivity improvement in India,

in IT and elsewhere, and that can enable rising wages and

sustained economic growth.

Moreover, one would have to guess that in many IT services (where the physical capital input

is very low), unit labor costs are significantly lower in India than in the major industrial

countries and that, for that reason, there is some scope for real compensation increases in

India in the context of rapid IT expansion.

But I want to focus on overall Indian growth. A first point relates to the excellent

Indian Institutes of Technology which have provided a steady flow of world class engineers

since they were first set up in the late 1950s. When they were established, it was in the belief

that India had a “shortage” of engineers. The number of student places in the Institutes was

determined by estimating the number of “needed” engineers and providing sufficient places

to generate the “needed” stock in a fairly short time.

Not surprisingly, before too long there was an excess supply of highly qualified engineers.

That is a partial explanation of the large diaspora of

Indian engineers to Silicon Valley and

elsewhere, as well as of the advantage

the IT sector had in recruiting its personnel. A strong

case can be made that India over-invested in higher education for engineers and that overall

growth may have been significantly more rapid had some of those resources been allocated to

increased

places in primary, secondary, and technical education.

This brings me to my second point. India remains a country with a very large quantity of

unskilled labor. No matter how successful the IT industry is, India is going to have to use its

abundant supply of unskilled labor more productively, and to provide primary and secondary

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education and training for an increasing fraction of its labor force.

To achieve rising living

standards, that will be essential, especially in light of the fact that India still has 70 percent of

its population located in rural areas.

To utilize its unskilled labor more productively, there are innumerable further policy

reforms that are needed. There are considerable labor market rigidities, which undoubtedly

serve as a disincentive for firms to hire unskilled labor: in the “organized sector”, as it is

called, firing workers is illegal (although some businesses have learned that if they do not

pay their electric bills, their electricity is shut off and they are forced to close, thus solving

their labor problems). There are requirements for training workers, for provision of housing

and other services. There was a “small scale reservation”

(SSR) policy, under which many

small, labor-intensive industries (over 800) were identified as eligible for privileges (such as

tax exemptions) provided that they did not grow large. These were activities such as candle-

making, radio assembly, and production of

batteries, and large firms were forbidden to enter

these activities. Interestingly, these industries, and exports from them,

grew much more

slowly than would have been expected.

1

Small-scale firms cannot be expected to have the

resources or the capacity to develop international markets. While enterprising businessmen

were able to have many “companies” owned by various relatives side by side in one building,

and thus circumvent the small-scale requirement to some extent, it was still a major barrier

and disincentive to expansion and exporting.

1

See Mohan, Rakesh, 2002. “Small-Scale Industry Policy in India: A Critical Evaluation”,

pp 213-267 in Anne O. Krueger, editor, Economic Policy Reforms and the Indian Economy,

University of Chicago Press, 2002.

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Ironically, when China began its rapid industrial expansion, based largely on unskilled

labor-intensive goods, Chinese firms were able to penetrate the Indian market in many of the

SSR industries.

In the past several years, the Government of India has begun to remove

industries from the

SSR list, but there still remain about 350 reserved industries.

I have already noted the poor quality of Indian infrastructure. It would probably be

absolutely insane to plan a business without including provision for the costs of generators.

And transport costs are high; port delays are long; airplane scheduling and services, though

greatly improved in recent years, are still in excess demand.

2

And, while the Government of India has invested in education, there are many problems.

Teachers aren’t in school; they are absent and tutoring for higher pay than they could obtain

in the schools (but still collecting their pay from the school). In a recent survey, the state with

the lowest rate of teacher absenteeism, Maharashtra, had an absentee rate of 15 percent. In

some states, it was more than 40 percent. With rates such as those, of course, parents may

decide that they will have the child work at home, or in the field, since even if the child goes

to school, he may simply have to return home.

3

The litany of ills could continue, but I will stop after mentioning two more. The first is

the regulatory environment which still exists (despite improvements) that is surely a major

2

See Forbes, Naushad, 2002. “”Doing Business in India: What has Liberalization

Changed?”, pp 129-167 in Anne O. Krueger, editor, Economic Policy Reforms and the

Indian Economy, University of Chicago Press, 2002.

3

See Kremer, Michael et al, 2004: “Teacher Absence in India : A Snapshot” in Journal of the

European Economic Association, Volume 3, Nos 2-3, April-May 2005.

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productivity-reducing block for most private sector activities.

4

Bureaucratic red-tape and

delays constitute a major obstacle and deterrent to efficient production and expansion.

5

The second is the very large fiscal deficit of the general government (almost 10 percent of

GDP in 2004) with India’s debt-to-GDP ratio already above 80 percent.

Yet the fiscal deficit must be addressed at the same time as the GOI finds means for

improving infrastructure. That is in part because much of the existing pattern of expenditures

is inefficient, with untargeted subsidies intended to benefit the poor going largely to the rich,

and the need for thorough-going tax reforms.

6

In my judgment, India has tremendous growth potential. Reforms have proceeded,

albeit much more slowly than might have been desirable to attain significantly higher growth

rates. They have been undertaken in a

functioning democracy, which is certainly a huge plus

for India. But much more is needed by way of reform, and soon. While the IT sector will

surely continue to contribute to growth, as TN has indicated,

it cannot absorb the greater part

of India’s abundant labor force. IT can increase growth somewhat over the coming decades,

but the rapid increase India needs will depend on the success of other reforms.

Certainly, Indian economic prospects for the coming decade or two are brighter than they

were around 1990. A growth rate of around 6 percent

is probably sustainable if reforms

continue at their present rate. But with more reforms, the 8 or 9 percent growth that India

4

See World Bank: Doing Business in 2006, page 129. World Bank & IFC, 2006.

5

See Shourie, Arun, Governance and the sclerosis that has set in, ASA Publications, New

Delhi, 2004.

6

See Srinivasan, T.N: Eight Lectures on Indian Economic Reforms, New Delhi, Oxford

University Press, 2000.

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needs would become attainable. The IT sector’s development is not only a major success

story, but it is also an indication of what could be achieved.

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References

Forbes, Naushad, 2002. “”Doing Business in India: What has Liberalization Changed?”, pp

129-167 in Anne O. Krueger, editor, Economic Policy Reforms and the Indian Economy,

University of Chicago Press, 2002.

Kremer, Michael, Nazmul Chaudhury, F. Halsey Rogers, Karthik Muralidharan and Jeffrey

Hammer. “Teacher Absence in India : A Snapshot” in Journal of the European Economic

Association, Volume 3, Nos 2-3, April-May 2005.

Mohan, Rakesh, 2002. “Small-Scale Industry Policy in India: A Critical Evaluation”, pp 213-

267 in Anne O. Krueger, editor, Economic Policy Reforms and the Indian Economy,

University of Chicago Press, 2002.

Shourie, Arun, Governance and the sclerosis that has set in, ASA Publications, New Delhi,

2004.

Srinivasan, T.N: Eight Lectures on Indian Economic Reforms, New Delhi, Oxford University

Press, 2000.

World Bank: Doing Business in 2006, page 129. World Bank & IFC, 2006.