India's future is bright, but its continued economic progress is not preordained. The challenge of sustaining growth that is equitable is formidable. Policies and institutions will have to play a key role if it wants to tap the opportunities associated with catching up with its Asian peers and harness globalization.
India's purchasing power parity-adjusted GDP per capita is almost half of China's and one-sixth of South Korea's. Labour productivity in China and Korea is 70% and 2000%, respectively, higher than in India. Under-five mortality rate in India is three times that of China and 14 times that of Korea. That's a sobering perspective.
In response to an average rate of growth of around 8% during 2003-2005, it has been argued that conditions are ripe to achieve 9-10% growth in the next few years. Achieving this in any single year is certainly possible. The question is whether this rate, a la China, can be maintained. This would require a significantly higher share of capital formation in GDP-about 40% against the current 26%. Employment growth at about 2.5% a year, significantly faster than in previous decades, would also be needed. Absorbing the extra investment would itself require substantial structural changes in the economy that are tough to envisage in the next five years. Thus, the challenge should not be underestimated.
A given amount of growth will have a bigger impact on poverty with lower initial levels of inequality and lower inequality increases. While education is a critical determinant of movements out of poverty, health-related shocks are prominent in pushing people into poverty. Poverty reduction will respond faster to economic growth when human development is high.
Nearly 50% of Asia's poor still reside in India. At a $1-a-day poverty line, 327 million live in chronic poverty. Using a $2-a-day poverty line raises the number of its poor to 830 million.
Rising income inequalities dampen the impact of growth on poverty. The Gini coefficient, a widely-used measure for inequality, has been rising since the early 1990s. While data issues have clouded the trends in inequality, a recent study that computes notionally comparable estimates of the Gini coefficient finds this has risen from 0.30 in 1993 to 0.34 in 2004. Inequality has increased between rural and urban areas and also within urban areas. Inequality across states is widening. More populous states, with rapidly growing population, such as Bihar, Madhya Pradesh and Uttar Pradesh, are getting left behind.
Social inequalities, which often trigger instability and crime, pose formidable challenges too. Primary school-aged children from poorer households are three times more likely to be out of school than those from richer households. Child mortality for the poor is three times higher than for the rich.
About 34% of India's 460-million labour force?is either unemployed or underemployed. By 2015, 90 million workers will be added to its labour force. Another 100 million will join between 2015 and 2030. About 250 million new jobs will be needed if full employment is to be achieved within a decade. Such a large pool of unproductive workers on the margins of poverty poses a clear and present danger to social and political stability. It also constitutes a tragic underutilization of resources. Failure to tackle the underemployment could yet turn a potential demographic dividend into a demographic curse. India's future prosperity depends on how it utilizes its most valuable resource-its people. If a large number of workers get left behind, the legitimacy of growth and, thereby, support for reforms needed to sustain catch-up and modernization could be threatened.
In addressing these challenges, India will need to exploit the opportunities offered by catching up with its peers, globalization and modernizing government. In catching up, a key will be labour productivity. Industrial productivity is currently three-and-a-half times that of agriculture. The corresponding number for services is over five. A movement of labour from agriculture to manufacturing and services at current levels of labour productivity will significantly raise total labour productivity. Also, there is considerable room within each sector for labour productivity levels to approach those already attained in China and Korea.
The share of manufacturing in both output and employment will need to rise. The potential of technological improvements and economies of scale are the greatest in manufacturing. The considerable infrastructural investment needed for the evolution of a modern manufacturing sector on a broad scale will, in turn, demand specialized services across a wide spectrum, triggering a virtuous cycle.
In all this, the forces of globalization -the deepening of economic linkages through freer movement of goods, services and capital, as well as through linked production networks-will be important. Ever bigger world markets generate increasing returns from trade and new opportunities for specialization. But deeper integration in the world economy brings discipline and reduces policy space. Greater mobility of international capital will mean less scope for macroeconomic policy autonomy. Already, global capital markets punish fiscal profligacy and monetary irresponsibility quickly. The rapid ascent of global value chains and production networks require the business and investment climate facing firms in India to be conducive in terms of infrastructure, incentives, institutions and information and at least on par with those of its Asian peers.
The strictures of global competition limit room for fiscal manoeuvre for a government caught in the double squeeze of being asked to do more to broaden the inclusiveness of growth with less scope for freedom of action. The government will have to find innovative solutions to meet the legitimate needs and aspirations of its citizens without jeopardizing fiscal discipline. It should limit itself to doing what the private sector would not otherwise do. But, there are important challenges that can't be effectively addressed by markets or the private sector. The case for state support for primary and secondary education and for basic health continues to be strong. Indian policymakers must be held accountable for ensuring appropriate outcomes and impacts. It will take determined and disciplined governments and a mature society to rise to the various challenges that India faces. But there is sound reason for optimism.