The period 2000-2010 was a golden period, one of rapid services-led
economic growth in India; the economy grew at an average annual rate of
7.2 per cent, and around 63 per cent of this growth came from growth of
services. This experience gave rise to a number of hubristic beliefs:
that India has inherent strengths in services; that the rapid services-led growth resulted from India's success in exporting skill-intensive services; and that manufacturing-led
growth at early stages of development is an obsolete idea. These
beliefs have served to create a perception that rapid services-led
growth will continue, that India has arrived, having leapfrogged over a
phase of manufacturing-led growth. Though growth has since dwindled, the
perception survives. It is widely believed that the growth slowdown
currently being experienced is temporary and that rapid services-led
growth will return soon.
Yet a factual scrutiny shows the beliefs to be little more than wishful
thinking. The services-led growth, by generating high-wage non-manual
jobs for the educated, has been of immense benefit to the middle
classes. The end of this pattern of growth naturally appears as a
dreadful prospect to them. This at bottom is the reason why the beliefs
survive. Their survival, however, will bring much harm; for, it will
prompt India's policy makers to keep knocking on locked doors.
India's services-led growth does not reflect certain inherent strengths
of Indians; it has been the result of past policies. Ironically, it was
the Mahalanobis strategy of industrialisation that built some of the
pre-conditions for services-led growth. The core of that strategy - the
promotion of heavy industries producing capital (e.g., machines) and
intermediate (e.g., steel) goods - called for strategic priority to be
accorded to tertiary education, cheap capital and the public sector. So,
many resources went into building of institutions of tertiary education
and to subsidisation of students in these institutions, even while
primary and secondary education remained neglected. Capital too was
subsidised in a variety of ways (cheap credit, low import duties,
overvalued exchange rate). These policies made both skilled labour and
capital relatively cheap. On the other hand, labour regulations,
introduced with the good intention of ensuring a decent livelihood for
workers in the modern part of the economy, had the effect of making
unskilled/low-skilled labour relatively expensive. This is how the
organised segment of India's economy came to acquire comparative
advantage in the production of capital- and skill-intensive goods and
services.
Alongside, there were other policies that favoured services and
disadvantaged manufacturing. Services have been much more lightly taxed
than manufacturing. Inadequate attention to physical infrastructure
(roads, railways, ports, airports) has constrained manufacturing far
more than services. Trade and foreign investment regimes have been made
more favourable for services than for manufacturing. These policies and
policy biases explain India's premature services-led growth.
It is simply not true that this growth was triggered and sustained by the growth of services exports.
Services-led growth actually began in the early 1980s (when exports
were insignificant) and not in the late 1990s (when exports were
significant and growing). To be sure, the growth of services exports
contributed to accelerated growth of services during 2000-2010. But even
in this period, growth of exports was far less significant a
contributor to services growth than growth of domestic demand; a simple
growth accounting exercise shows that growth of services exports
accounted for only 13 per cent of services growth while growth of
domestic demand accounted for 78 per cent (growth of services inputs
into agriculture and industry accounting for the rest). The share of
services exports (in value added terms) in services output has never
been large; even at its peak in 2009, it was only 12 per cent and the
average for the period was 8 per cent. Growth of software exports, it is
true, has been very impressive, but software output has been and
remains a minuscule part of services output. The rapid growth of
services was supported by rapid growth of domestic demand.
Given India's low per capita income, the fact of rapid growth of
services being supported by rapid growth of domestic demand appears
rather puzzling. But some plausible explanations are available.
Technological change and product innovations in transport and
communication seem to have increased the share of expenditure on these
services for all income groups. And rapid skill-intensive growth seems
to have fed on itself; it enabled public expenditure and hence public
services to grow and it caused a shift in private expenditure in favour
of services by increasing income inequality.
Has India really leapfrogged over a phase of manufacturing-led growth?
One cannot help wondering why India should have this unique privilege.
Historically, the developed countries of today went through a long
period of manufacturing-led growth before entering a phase of
services-led growth. The emerging economies of today, other than India,
have all experienced manufacturing-led growth.
Rapid services-led growth over a fairly long period in a low-income
economy such as India is indeed without precedent. But it does not mean
that India has leapfrogged over a phase of manufacturing-led growth. In
fact, services-led growth has already reached a dead-end and the growth
slowdown reflects this. The balance of payments difficulties that India
faces today are a consequence of the services-led growth of yesterday.
That pattern of growth resulted in a growing anomaly between domestic
absorption - the consumption and investment of citizens and government -
and domestic production (GDP).
Rough calculations show that the share of goods in domestic absorption
was 75 per cent in 2000 and 67 per cent in 2010. On the other hand, the
share of goods in domestic production was 51 per cent and 43 per cent in
those two years respectively. High and growing net imports of goods
were thus needed to meet the requirements of domestic absorption. Net
exports of services have never been, and can never be, adequate to
finance more than a small fraction of the required imports of goods. In
2010, for example, net exports of services could conceivably have
financed at most 30 per cent of the net merchandise imports.
The currently high level of current account deficit, which reached 4.3
per cent of GDP in 2012 and still remains around that level, reflects
the anomaly between domestic absorption and domestic production
generated by a long period of services-led growth. This level of current
account deficit is not sustainable and that is fundamentally why
services-led growth is not sustainable either. Resumption of high growth
now requires accelerated growth of production and export of goods,
particularly of manufactures. India has not leapfrogged over a phase of
manufacturing-led growth; it stands at the beginning of such a phase.
The sooner India's policy makers recognise this, the better. For,
serious reorientation of a whole range of policies - public investment,
foreign trade, subsidisation of capital and skilled labour, and labour
regulations - is required to boost development of physical
infrastructure, to facilitate exports of manufactures and to increase
relative prices of capital and skilled labour vis-à-vis
unskilled/low-skilled labour.
