India’s structural challenges
India has gained more international media attention since prime minister Narendra Modi swept into power with a strong majority over a year ago. The victory of this reform-minded leader was expected to kick-start growth. With its large and young population, India no doubt has enormous potential; as China ages, India can emerge as the manufacturing hub of the world. And it is widely expected that India will be the world’s fastest-growing major economy.
However, optimism should be tempered with the knowledge that many of India’s biggest challenges have deep-rooted origins with no easy solutions. India is in need of sweeping reforms in order to realize the full power of its entrepreneurial talent and to make life easier for its poor and its middle class. This issue of Asia Insight seeks to outline the historical context that investors should have in order to hold a more comprehensive view of India’s efforts to reform its institutions. By “institutions” we are referring not only to government agencies but also to more abstract concepts such as employment policies and political representation.
The importance of inclusive institutions and economic growth
In the book “Why Nations Fail: The Origins of Power, Prosperity, and Poverty,” authors Daron Acemoglu and James Robinson discuss how inclusive institutions are crucial for sustained long-term economic growth. We identify inclusive institutions as having well-defined property ownership rights, flexible labor policies and all-encompassing political representation (where political leadership is representative of the overall population). These institutions allow entrepreneurial efforts to flourish, and for these efforts to be rewarded rather than expropriated by bureaucrats and politicians. In addition, the country’s institutions must allow new entrepreneurs to emerge over time, challenging and replacing the existing order.
Failure to develop such institutions tends to depress economic growth not necessarily over the short term but more over the long term. The lack of well-defined property ownership rights in India has led to innumerable delays in land acquisition by corporations. Similarly, rigid labor policies mean that companies are hesitant to hire workers as full-time employees. These labor laws impose restrictions on businesses that in most countries are left to the discretion of management. Paradoxically, instead of these labor laws protecting the workforce, they tend to push workers into informal employment with limited rights. And while India rightfully takes pride in its democracy, several regions still have high levels of illiteracy which cause truly representative governments in those regions to be lacking.