Mahoshada

It should be noted at the outset that the title used for this article, “Catch an elephant by its ears” has been borrowed from a recent article by D.N. Patodia in the Hindustan Times (1st February. Data for India’s economy are drawn from this article.). Mr Patodia makes a strong argument that India must act quickly if it wants to take full advantage of the economic reforms that have been introduced. As he looks at the challenges facing his country, it is easy to see that there are many strong similarities with the economic challenges currently facing Sri Lanka. Given the dramatic improvements in India’s economic performance over the last decade, it makes sense to see what insights can be gained to shed more light on the best way forward for this country’s economic development.

It does not matter where good ideas come from. No country or individual ever progressed very far by ignoring good ideas no matter from where they originated.

Since far reaching economic reforms began to be introduced in India in 1991, the growth rate has increased from 5 percent to 8 percent. The savings rate has increased substantially and the equity market has also grown very quickly while strengthening its institutional foundation. International trade has grown rapidly and foreign reserves have skyrocketed, from $1.1 billion in 1991 to $137 billion today. And overall, as Mr Patodia points out: “In this new environment of economic freedom, the private sector has emerged as the prime mover of growth.”

Growth Mainly in Industrial and Urban Centres
Like Sri Lanka, India’s economic growth has been somewhat faster in the industrial and services sector, mainly concentrated in urban areas; in Sri Lanka the faster growing sectors have tended to be located in the Western Province. In contrast, agriculture, infrastructure and the rural economy – all closely related – have not grown as fast, for a variety of reasons.

India’s rural population faces extremely difficult living conditions where 220 million people live below the poverty line and half of all children are malnourished. While a large share of those people living in poverty in Sri Lanka are located in rural areas, it would appear that the extent of this challenge, in relative terms, may not be quite as great as in India.

Should we aim for strictly balanced economic growth? Whenever the fact that the industrial and services sectors are growing faster than agriculture is presented by politicians or officials as a critical national problem, implicitly they have in their minds the notion that all sectors should be growing at more or less the same speed. This proposition is rarely mentioned explicitly because it clearly makes little or no sense. Nowhere in the world has any country grown and developed in this way. Why should anyone expect all sectors to grow at the same rate? For example, in virtually all developed countries, the share of agriculture in the economy has steadily fallen as average incomes have increased.

Indeed, the essence of economic development is to transform the economy, moving from activities where productivity and incomes are low to activities where productivity and therefore incomes are much higher. As economic development proceeds, low paying labour intensive jobs, such as tea plucking and garment stitching, will become less and less viable because higher income opportunities will become more available.

The real challenge facing both India and Sri Lanka in this regard is not that agriculture and the rural economies are not growing as fast as the urban centered industrial and services sectors. The real challenge is that there remain substantial impediments limiting the scope of people living in rural areas from fully participating in the more dynamic economic sectors, notably the lack of alternative employment opportunities.

Low Productivity in Agriculture
Mr Patodia reports that the growth in Indian agricultural output has slowed to an average of 2 percent; falling to an even lower rate in 2004-05, to 1.1 percent. And while agriculture accounts for 21 percent of GDP, it also supports 50 percent of India’s population. This provides a clear picture of just how low agricultural productivity is relative to the rest of the economy. In the amount of time it takes for a person working in agriculture to produce Rs 42 in value added, an average person working in the more productive sectors will produce Rs 158 value added, or nearly four times as much.

The situation is not quite so bad here, where agriculture contributes 17.9 percent of GDP and provides employment for 34.1 percent of the working population. This means that in Sri Lanka, in the amount of time it takes for a person working in agriculture to produce Rs 52 of value added, someone working in elsewhere in the economy will, on average, produce Rs 125, or a bit more than twice as much.

While the productivity gap between agriculture and the rest of the economy is not as great in Sri Lanka as it is in India, it is still very large. And it is this gap that largely explains why incomes in rural areas remain far lower than in the more developed urban areas. Incomes reflect productivity and productivity is much lower in agriculture.

What are the prospects of substantially increasing agricultural productivity and thereby increasing rural incomes? The reality is that even if extensive economic reforms were to be introduced, productivity in agriculture can be expected to grow only slowly. An in-depth report on India by the McKinsey Global Institute estimated that even if all policy and regulatory barriers were removed, the maximum growth in agricultural productivity for the foreseeable future would be no more than 5 percent annually. That is better than current performance, but still far behind the other faster growing sectors.

Major improvements in sectoral performance will come about in the long term only when average wages in the country are substantially higher and jobs are created for a large proportion of those now engaged in agriculture. When wages are higher, it will become economically viable to invest in mechanization that will greatly increase productivity. But as McKinsey found in Thailand, substantial mechanization only began to take place when the average wage was some four times higher than the current average wage rate in India.

There is no reason to believe that the prospects for increasing productivity in the agricultural sector in Sri Lanka are any better than they are in India. Agriculture cannot provide an adequate living for half of India’s population any more than it can for one-third of Sri Lanka’s population. The challenge for both countries is to ensure a rapidly growing economy that will generate sufficient numbers of new non-agricultural jobs so that people can move from poverty by earning a decent living.

Insufficient Investment in Infrastructure
India, like Sri Lanka, needs substantial increases in key infrastructure facilities if economic performance is to be improved. India’s current power generation of 125,000 MW is estimated to be 47 percent less than what is required. Inadequate and deteriorating roads are a major problem throughout that country. And their port facilities are both highly inefficient and below the required capacity. Mr Patodia argues that the current (2003) investment in infrastructure of $21 billion, or 3.5 percent of GDP, is far too small to meet the rapidly growing needs. He suggests that investment on the order of $100 million, or nearly 500 percent higher, is required.

There should be no question in anyone’s mind that the poor state of infrastructure in this country is an important deterrent to increased economic growth and development. It is often cited as a key problem, as in the Global Competitiveness Report 2004-2005 published by the World Economic Forum. In their survey, inadequate infrastructure was the fourth most problematic factor in doing business in Sri Lanka, following (i) political instability; (ii) government instability; and (iii) restrictive labour regulations. And while there have been ample financial resources for much increased investment in roads, power generation and other areas, no government has been able to get very far with the urgently needed investments.

Poor Fiscal Management
Mr Patodia argues that India’s fiscal management has been “very poor”, with large and persistent government budget deficits that are not economically sustainable and that draw resources away from much needed and more productive investments. He also points out that India’s Fiscal Responsibility and Budget Management Act was introduced to resolve this problem. By law, their revenue deficit should be eliminated by 2007-08 – a goal that will almost certainly not be met.

Sri Lanka too has a dismal record of incurring unsustainably high budget deficits year after year, draining much needed resources from more productive uses. And Sri Lanka too enacted its own Fiscal Responsibility Act in 2002 with the intention of legally compelling the government of the day to substantially reduce the deficit. Like India, it seems that there is little chance that the mandated targets will be met.

Mr Patodia also points to a number of areas where the Indian government is wasting the money that it does have” “A major part of subsidies are wrongly directed that don’t reach the beneficiaries. Free power and water do not benefit poor farmers. Subsidies … are freely misused.”

In addition, he is concerned about the excessive size of the Indian government, which has 19 million government employees – one for every 50 citizens. Of course, Sri Lanka with 1,094,415 public sector employees (2004) has a proportionally much larger public sector to support – one for approximately every 18 citizens. In other words, on a per capita basis, Sri Lanka’s public service is 170 percent larger than India’s. In both countries, large and unproductive public sectors constitute a significant diversion of available resources away from more productive uses.

More Reforms Required
Both countries could come up with a list of important changes needed to strengthen economic performance. In India this list would include, for example, labour reforms, improvements in the justice system and extensive regulatory reforms. As Mr Patodia aptly puts it: “Reforms and policy modifications needed to sustain and accelerate our growth have been recommended and placed before the government from time to time. But decisions are delayed and implementation is too slow. If growth has to accelerate, we have to act and act fast. Given these reforms India can achieve a steady growth rate of 10 percent. The world is anxious to invest in our development and the next decade will be crucial for India to emerge as [an] economic powerhouse of the 21st century.”

Much the same could be said for Sri Lanka.