There is an always an eternal debate about the policies a country should implement in order to inspire economic growth. The questions asked are is it better for a government to intervene and choose which industries to develop, or should it allow the private sector to decide what to produce? We heard many success stories of countries that had followed industrial policies, such as the Asian tigers in the 1960s and 1990s, but there are also stories of failure, such as India in the decades prior to the 1990s. What led to the economic miracle in India during the 1990s is the question?
The Indian government sought to encourage industrialization by directing investment toward the production of capital goods and by restricting imports. At the same time, it tried to help its poorest citizens, who lived in villages, due to which the return on capital in the public sector during the 1980s was only 1.5%. The private sector, after Independence suffered under other restrictions, including the following:
- Import restrictions that did not permit the free exchange of goods and knowledge.
- Anti-trust laws that did not allow businesses to grow.
- Public monopolies that operated very inefficiently.
- The License Raj, which complicated the process of opening new businesses
So, it is not surprising that GDP per capita grew only at an annual rate of only 3.5% in the years prior to the 1980s. Considering, how poor India was, even in the following decade, the GDP per capita was only $447 in 1985, the growth rates were also alarming. They were not high enough to lift the population out of poverty. Like many other countries that were unable to produce enough to finance their government projects through taxation, India financed itself with public debt. In 1991, the public debt reached $70 billion and India was on the verge of declaring bankruptcy. To avoid this disastrous last resort, India was forced to take immediate action to fix the problem.
In 1991, the Indian government broke with industrial policy, which had failed. In a surprising 180-degree twist, the new policies encouraged business activity, stimulated growth in the private sector, and revived international trade.
Some of the most important measures included:
- Eliminating the industrial license requirement for most sectors;
- Removing limits on capital accumulation;
- Eliminating licenses for importing the majority of goods;
- Reducing tariffs.
- Opening the private sector to many activities that had previously been reserved for the public sector.
- Reducing requirements for bank reserves and restrictions on interest rates.
- Eliminating restrictions on foreign investment.
Liberalization achieved the desired results, as reflected by the following data:
- GDP per capita grew at an annual rate of 6 % in the 1990s, driven by the service sector, which would come to represent 53.5 %of GDP by 1999.
- Exports grew at an annual rate of 17.3 % during the 1990s, in large part because of a boom in the software sector.
- India’s score on the Fraser Institute’s Index of Economic Freedom rose from 4.8 in 1990 to 6.2 in 2000, reflecting remarkable improvements in the freedom to trade internationally.
- Although the economy grew after liberalization, one could argue that this is a coincidence and that the growth was really a belated effect of the previous industrial policies. It could also be argued that economic growth would have occurred even without any policy changes.