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Arvind
Panagariya SCEPTICS remain
unconvinced that liberal trade and foreign investment policies have
resulted in a significant improvement in the performance of India’s
external sector. They argue that export growth during 1990s has not been
much higher than that achieved during 1980s when the level of protection
rivalled Mount Everest. They likewise argue that the response of foreign
investment to liberalisation has been less than overwhelming. Are the sceptics
right? The answer is a
qualified ‘no’. Evidence on the relative performance of the external
sector during 1980s and 1990s belies the sceptics. Exports of goods and
services grew at an annual rate 10.7 percent during 1990s compared with
only 7.4 percent during 1980s. Likewise, imports grew at 9.7 percent
during 1990s but only 5.9 percent during 1980s. The annual growth rate of
exports as well as imports has, thus, risen by 3.3 percentage points. This rise has
manifested itself in a significant increase in the imports-to-GDP and
exports-to-GDP ratios. On the export side, the ratio approximately doubled
from 7.3 percent to 14 percent between 1990 and 2000 and on the imports
side it jumped from 9.9 percent to 16.6 percent. The overall trade to GDP
ratio has thus gone up from 17.2 percent in 1990 to 30.6 percent in 2000.
In contrast, the change in the trade-to-GDP ratio between 1980 and 1990
was tiny: from 15.2 percent to 17.2 percent. On the foreign
investment front, India has been receiving approximately $5 billion every
year since 1994-95 compared with just $0.1 billion during 1990-91. This
amount is split approximately equally between foreign direct investment (FDI)
and portfolio investment. There has also been a significant shift in the
remittances from abroad: from $2.1 billion in 1990 to $12.3 billion in
2000. While the basic claim
of the sceptics is thus readily refuted, it must be acknowledged that the
response of the external sector to liberal trade and investment policies
has been an order of magnitude weaker in India than China. Exports of goods and
services grew at annual rates of 12.9 and 15.2 percent during 1980s and
1990s respectively in China. Imports exhibited a similar performance.
Consequently, China’s total trade to GDP ratio rose from 18.9 percent in
1980 to 34 percent in 1990 and to 49.3 percent in 2000. On the foreign
investment front, differences are even starker. FDI into China has risen
from $.06 billion in 1980 to $3.49 billion in 1990 and then to a whopping
$42.10 billion in 2000. China was slower to open its market to portfolio
investment but once it did, inflows quickly surpassed those into India,
reaching $7.8 billion in 2000. Even if we allow for an upward bias in the
figures as suggested by some China specialists, there is little doubt that
foreign investment flows into China are several times those into India. While some
differences between the performances of India and China can be attributed
to the Chinese entrepreneurs in Hong Kong and Taiwan, who have been eager
to escape rising wages in their respective home economies by moving to
China, a more central explanation lies in the differences between the
compositions of GDPs in the two countries. Among developing
countries, India and other countries in South Asia are unique in having a
very large share of their GDPs in the mostly informal part of the services
sectors. Whereas in other countries, a decline in the share of agriculture
in GDP has been accompanied by a substantial expansion of industry in the
early stages of development, in India this has not happened. For example, in 1980,
the proportion of GDP originating in industry was 48.5 percent in China
but only 24.2 percent in India. Services, on the other hand, contributed
only 21.4 percent to GDP in China but as much as 37.2 percent in India. In
the following twenty years, despite considerable growth, the share of
industry did not rise in India. Instead, the entire decline in the share
of agriculture was absorbed by services. Though a similar process was
observed in China, the share of industry in GDP was already quite high
there. As a result, even in 2000, the share of services in GDP was 33.2
percent in China compared with 48.2 percent in India. Why does this matter?
Because typically, under liberal trade policies, developing countries are
much more likely to be able to expand exports and imports if a large
proportion of their output originates in industry. Not only is the scope
for expanding labour-intensive manufactures greater, a larger industrial
sector also requires imported inputs thereby offering greater scope for
the expansion of imports. In India, the response of imports has been just
as muted as that of exports. This is demonstrated by the fact that
recently RBI has had to purchase huge amounts of foreign exchange to keep
the rupee from appreciating. Imports have simply failed to absorb the
foreign exchange generated by even modest foreign investment flows and
remittances. This same factor is
also at work in explaining the relatively modest response of FDI to
liberal policies. Investment into industry, whether domestic or foreign,
has been sluggish. Foreign investors are hesitant to invest in the
industry for much the same reasons as domestic investors. At the same
time, the capacity of the formal services sector to absorb foreign
investment is limited. The information technology sector has shown
promise, but its base is still small. Moreover, this sector is more
intensive in skilled labour than physical capital. Therefore, the solution to both trade and FDI expansion in India lies in stimulating growth in industry. The necessary steps are now common knowledge: bring all tariffs down to 10 percent or less, abolish the small-scale industries reservation, institute an exit policy and bankruptcy laws and privatise all public sector undertakings. The real question is: Will the government act? Economic Times, May 22, 2002 |
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