Macroeconomics

Boom and Bust: Institutional causes of India's growth slowdown in 2011

  • Blog Post Date 22 December, 2015
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Kunal Sen

University of Manchester

kunal.sen@manchester.ac.uk

The slowdown in India's growth in 2011 is generally attributed to the global financial crisis and domestic policy paralysis. In this article, Kunal Sen argues that the high growth rates in the 2000s were driven by 'closed deals' between the political and business elites. Mobilisation of the masses against corruption and actions by accountability institutions in 2011 disrupted this trend and halted the growth.



For much of the 1990s and 2000s, India was seen as the 'new kid on the block' among countries that were growth success stories. This narrative of India's emerging growth miracle came to a sudden stop in 2011, as growth slowed down considerably1. The conventional analysis of this phenomenon attributes the slowdown to a combination of external factors such as the global economic slowdown or internal factors such as a tight monetary policy or the 'policy paralysis' that befell the second term of the United Progressive Alliance (UPA) government (2009-2014). However these explanations are either inadequate or incomplete. For example, although the global slowdown and the resultant recessionary expectations are definitely important factors, the International Monetary Fund (IMF) finds that two-thirds of India's slowdown is due to internal problems such as policy paralysis, and not a worsening external environment or a tight monetary policy. The argument that policy paralysis was responsible for the growth slowdown is more plausible, but incomplete, as the paralysis of policy that occurred in the second term of the UPA government is seen as an unexpected external shock, rather than something that needs to be explained, and is an outcome of the growth process of previous years (Sen and Kar 2014).

Liberalisation and 'open ordered deals' in the 90s

India recorded the highest rates of growth in its history in the first decade of the 21st century, but the nature of growth in this period was very different from that of the earlier decade, which was a period of high growth as well. The personalised relationships (which led to 'deals') that had emerged between the political elite and key economic actors since the 1980s became relatively open (in that the deals were not restricted to a limited set of economic actors) in the 1990s with the increasing importance of regional business elites, and the entry of new private firms among modern sectors such an engineering, pharmaceuticals and information technology (IT). Moreover, the 'deals' were more 'ordered' (that is, economic actors were confident that the deals would be adhered to by the political elite), due to the industrial and trade reforms in 1991, resulting in removal of uncertainty related to granting of licences such that investment decisions of firms no longer depended on whims and fancies of individual bureaucrats.

The trade reforms and industry deregulation also led to significant entry of new firms and products at the industry level in the 1990s. In the 1990s, economic growth was mostly driven by the export-competitive sectors (such as IT and chemicals) and domestically-oriented relatively competitive service sectors such as hotels and restaurants.

Emergence of 'closed ordered deals' in the 2000s

The deals environment changed radically in the 2000s, becoming more exclusionary and not conducive to economic dynamism. This was most evident in the increasing level of 'crony capitalist' deals that political elites struck with economic elites in 'high-rent' natural resource sectors such as bauxite, coal, iron ore, manganese ore, and natural gas, at both national and regional levels. In various ore-rich states such as Jharkhand, Karnataka, Goa and Odisha, influential, politically-connected business elites systematically underpaid mining royalties to state agencies (along with extracting iron and bauxite in excess of the amounts stipulated by the leases that private mining firms held with state governments). In 2010, the Shah Commission constituted by the central government found evidence of enormous and large-scale multi-stage illegal mining of iron ore and manganese ore, along with collusion between ruling politicians at the state and national level and private mining firms. There were similar concerns in the allocation of licences for coal deposit blocks to private firms by the central government in the 2004–2011 period, which was done preferentially at lower-than-market rates, instead of a competitive bidding process, according to investigations on the nature of the allocation process by the Comptroller and Auditor General (CAG).

The existence of 'closed ordered deals' was not confined to natural resource sectors; it was also evident in infrastructure sectors such as telecommunications. The latter witnessed impressive growth in the 1990s, driven by high demand for mobile phones among a rapidly expanding middle class. In 2008, the Department of Telecommunications (DoT) decided to allocate second-generation (2G) spectrum licenses to mobile phone operators on a first come first served (FCFS) basis at a price significantly below the market price. Later investigation by the CAG found clear evidence of insider information being passed to selected private firms on the timing of the FCFS announcement, as well as of the very short time given to submit the applications. The CAG estimated the loss to the Indian exchequer due to the under-pricing of 2G licenses at over Rs. 176,000 crore (US$29.3bn approx.).

There were four reasons why a 'closed-deals' environment emerged in the early 2000s. First, with increased demand for minerals originating from China, increasing profits could be made in natural resource sectors, and there were clear incentives for political elites to preferentially allocate these licenses to selected economic elites on terms that were not transparent, or the most economically competitive, in return for extra-legal monetary rewards. Secondly, as rapid economic growth spurred an increase in demand for the services of infrastructural sectors such as telecommunications as well as real estate, political elites entered into rent-sharing arrangements with business groups that were awarded contracts to operate in these sectors. Thirdly, with the growing importance of regional political elites in the coalition governments of the 2000s, 'closed deals' between these elites and powerful economic interests both at the national and regional levels become more prevalent in the 2000s. Finally, election campaigns became increasingly expensive and the growing reliance on informal private funding meant that parties and politicians raised funds from businesses informally in return for discretionary contracts and regulatory favours (Gowda and Sridharan 2012).

Different patterns of growth in 90s and 2000s

Corresponding to the 'closed-deals' environment, there was a different pattern of growth in the 2000s relative to the earlier decade. Natural resource sectors became increasingly important in India's export basket, and sectors such as construction in India's economic growth. There was also a decline in India's product complexity in exports, after a period of sustained improvement in the 1990s, suggesting structural retrogression of the tradable sector, and there was strong growth in 'high-rent' non-tradable sectors such as real estate and telecommunications (Nagaraj 2013).

Shift back to 'disordered deals'

There were two negative feedback loops from the 'closed ordered deals' environment in India to the institutional environment during the 2000s that ultimately disrupted this orderliness post-2010 and turned it into a 'disordered deals' environment, where economic actors could no longer trust the political elites to deliver on the deals. The first negative feedback loop was through the mobilisation of the non-elites against both forced land acquisition and corruption. There were strong social and political movements of the masses against the attempts by the political elite in states such as Odisha and West Bengal to obtain land through extra-legal and often coercive means for mining or for providing land to large business groups to set up manufacturing plants. The second negative feedback loop on the institutional environment worked through the coming together of the accountability institutions - the CAG, the Central Bureau of Investigation (CBI) and the judiciary. Important examples of this are the Supreme Court of India banning iron ore exports, and the CAG investigating corruption in the allocation of 2G and coal block licenses. These again eroded the deals environment by raising the possibility of all deals being challenged and scrutinised legally, thus pushing the economy back to a 'disordered deals' world - paradoxically by the action of formal accountability structures.

All these developments made the 'closed-deals' environment unsustainable, towards the end of the first decade of the 21st century. In addition, with increasing uncertainty over the nature of deals, and as the ruling party at the centre lacked the authority to credibly commit to new deals in the face of both popular and legal challenges, deals became increasingly disordered as well.

As media accounts of corruption around the 'closed-deals' environment became widespread, there was growing popular discontent at the flagrantly excessive levels of rents shared between political and economic elites in these deals. Thus, the policy paralysis in the central government that one observed since 2010 was simply an outward manifestation of a 'closed-deals' environment falling apart. The 'disordered-deals' environment that emerged from 2010 was the principal reason for the slowdown in economic growth, as investor confidence in the ability of the ruling political elite to offer credible deals to them fell.

How can growth be revived?

To revive economic growth in India, more than infrastructure spending or economic reforms, it is necessary to return to the 'ordered open deals' environment observed in the 1990s. For this to happen, economic elites such as business groups should see an interest in moving from closed to open deals, as the rents available from closed deals diminish over time with more transparency in the allocation of licences in infrastructure sectors, and the end of the commodity price boom. At the same time, there must be a recognition among accountability groups such as the professional middle class and civil society actors that ordered deals between the State and the business sector are essential for economic growth to return as long as these deals do not lead to outright corruption or to the exploitation of socially marginalised groups such as tribal populations. Only if all important actors — the private sector, the political class, bureaucracy, media, judiciary, civil society and the middle class — can find a 'realistic middle ground' in the deals environment will economic growth return to India and be sustained.

Notes:

  1. The average rate of GDP (Gross Domestic Product) growth in the 1990s and the first decade of the 21st century was 7%, slowing to less than 5% in 2011-2014,

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