Could railways have done more to aid economic development in India?

Indian Railways celebrated its 160^th-anniversary last month. This column argues that while railways played a large economic role in British India, it is likely they could have done more to aid economic growth and development in the country.

Between 1850 and India’s independence in 1947, railways were the most important infrastructure development in the country. In terms of the economy, railways played a major role in integrating markets and increasing trade. In terms of politics, railways shaped the finances of the colonial government and the Princely States. Indian political institutions influenced railway ownership and policy, which in turn influenced railway performance. As the 20^th century progressed, railways became a force for independence and democracy.

While the Government of India had a strong influence on railways from the beginning, the government’s role increased over time. Railways were partially nationalised between 1880 and 1908 as the Government of India assumed a majority ownership stake in most of the main trunk lines. Complete nationalisation occurred between 1924 and 1947 as the colonial government assumed full control over operations.

Dividend guarantees were a key feature of the early era of private ownership before 1880. The British companies that built and operated the early railways were guaranteed a 5% return on their capital investment¹. Guarantees were costly because they dulled incentives to lower operational costs, but it is likely they encouraged rapid railway development. The only alternative was large scale government ownership and investment, which was unlikely given India’s fiscal development around that time.

Economic role in British India

The performance of Indian railways can be classified into two periods: pre-1920 and post-1920. There was a trend to higher output, productivity, and profits between 1850 and 1919. The rate of total factor productivity growth, which is the difference between output growth and average of input growth, was similar to more advanced countries. But after 1920 there was a leveling off in productivity, and an increase in fares. The low productivity often associated with Indian railways began in the second quarter of the 20^th century.

Traffic developed slowly in the first decade of railway operations, but the subsequent increase in traffic was large, surprising even official estimates. In the absence of comparable alternatives, Indians used railways to transport goods and people. The key questions are whether the introduction of railways increased market integration and price convergence, and also whether railways substantially increased income.

Railways and prices

A large body of research has examined the effects of railways on price convergence. Hurd (1975) compared average prices and variation in prices across railway and non-railways districts. In railway districts, prices were less dispersed and closer to the average as compared to non-railway districts. McAlpin (1974) found that prices of both food and non-food crops converged as railway development expanded. However, Andrabi and Kuehlwein (2010) imply that railways can explain only 20% of the overall 60% decrease in cross-district price dispersion between the 1860s and 1900s. They conclude that the effects of railways on market integration are over-stated. Meanwhile, in an innovative study, Donaldson (2012) shows that inter-district price differences in salt are equal to trade costs because salt is produced in only one district and consumed in many other districts. He then measures trade costs and finds the arrival of railways significantly reduced trade costs, and that railroads significantly increased trade flows.

The different conclusions partly stem from the commodity being studied. Grain was a more important good than salt in terms of total value, but it was not always traded between regions even after railways entered. The conclusions may also differ because there is a missing variable in both analyses, which is the freight rate charged by railways in each market. Data from the Administration Reports show that freight rates differed across commodities, with special rates sometimes being offered on grain or coal. More research is needed to understand how railways influenced markets, incorporating the role of freight rates and different goods and inputs used in production.

Railways and incomes

Historians have long argued that national income would have been far smaller in most countries if railways had never been introduced. Hurd (1983) was the first to make a social savings calculation for Indian railways. He assumed that without railways, freight rates would have been between 80 and 90% higher, based on the observed differences between rail freight rates and those for bullock carts during the mid 19^th century. Using the volume of freight traffic in 1900, Hurd estimated the social savings to be Rs.1.2 billion or 9% of national income. The estimated social savings of railways are large considering real GDP increased by around 50% from 1870 to 1913.

Why did railways have a relatively large impact in India?

We think there are two reasons. First, railways were far superior to the existing transport technology in India. Bullock carts were not an effective alternative to railways and India did not have an extensive inland waterway network. Second, Indian railways experienced high levels of total-factor productivity growth after they were constructed. The social savings of any technological innovation is partly due to improvements in efficiency after the original breakthrough. According to our estimates the high level of railway productivity growth accounts for over 13% of all national income per capita growth from 1874 to 1912 (Bogart and Chaudhary, 2013).

The social savings methodology provides a powerful and simple tool, but it has some problems. First, it is not clear what the price of road or water transport would have been in the absence of railways. Congestion would have increased on roads and rivers with the increased traffic volume. The cost of using alternative transport modes is arguably underestimated in most cases as a result. Second, the social savings calculation omits spillovers or indirect effects. In theory, railways should increase demand for iron and steel and increase competition in manufacturing. They also contribute to agglomeration of economic activity, like the emergence of cities.

In spite of these critiques, there are reasons to doubt the importance of spillovers in the Indian case. Most iron and steel imports came from Britain and thus there was limited scope for increase in demand due to railways. The manufacturing sector was small as well, so the effect of railways on competition in manufacturing was relatively weak. Indian cities also remained quite small well into the 20th century.

Indian Railways could have done more

It appears that railways’ primary impact in the Indian economy was to increase inter-regional and international trade. But this raises a different question. Why didn’t railways do more, such as spurring a higher rate of economic growth? Some scholars blame colonial policy. The Indian government paid a lot of attention to profits, and freight rates were perhaps not set at the socially optimal level. There is also criticism that passenger services were given insufficient attention. Fares were quite high considering income levels in India. For example, Thomas Robertson, a contemporary critic of Indian railways, argued in 1903 that Indian fares and rates should be one-sixth of English fares, when in fact they averaged between one-third to two-third. Ultimately, it seems the railways could have done more to aid Indian economic development by setting ‘developmental’ fares and freight charges.

This column has been reprinted with permission from India at LSE (http://blogs.lse.ac.uk/indiaatlse/)

Notes:

Private British companies constructed the initial railway lines in India and a majority of the capital was raised in Britain