Presentation of the OECD Economic Survey of India 2007, by Angel Gurría, OECD Secretary-General
New Delhi, Tuesday 9 October 2007
Dear Dr. Ahluwalia and guests,
I am honoured to address this distinguished audience and to share the platform with Dr. Subba Rao. I would also like to thank the Academic Foundation for their efforts in publishing a version of this Economic Survey for the Indian market.
This is in fact a very special occasion for me and for the OECD. I am visiting this country after having received the mandate from our 30 members to engage more closely with India. The presentation of the first OECD Economic Survey of India is a strong indication of how useful this cooperation can be. For the last four decades, the OECD has been advising its member countries on the best policy options to promote economic development. We are glad to share this knowledge with you, but also to learn from your experiences.
Engaging with India as well as with Brazil, China, Indonesia and South Africa is also a clear sign of a changing OECD, which is working to become a hub for dialogue on global issues.
This Economic Survey presents an overview of economic policies in India and proposes a number of reforms. It is the result of extensive discussions between the staff of the OECD and a wide range of experts in India both in the central and state governments and in the private sector. It has also benefited from an exchange of views between officials from India and our member governments. This is one of the strengths of the OECD. It provides a forum where public policies can be compared, based on the shared experience of our 30 democracies.
India’s success over the past two decades has relied on a series of reforms in the domestic market which have involved a greater role for the private sector and a reduction of the role of the state in economic affairs. These reforms have addressed a broad range of areas. Government control over business investment has been terminated; entry barriers to most industries have been lowered or eliminated; income tax rates have been reduced and public intervention in most forms of foreign trade has been ended, with tariffs being lowered markedly. Financial markets have been improved and the macro-economic environment made more stable.
Such changes have allowed India to benefit from globalisation. The share of exports in GDP has risen dramatically, almost tripling in the past two decades. India is now well-known for its growth in IT services exports. More recently, it has benefited from the outsourcing of business processes. The pace of change in these sectors has gained substantial momentum in the past few years. We estimate that in 2006, India was the fourth largest exporter of IT and IT enabled services, up from 16th place as recently as 2003.
The outcome of these reforms has been that growth has accelerated markedly and has reached 9%. More importantly, it would seem that real incomes can now rise by at least 7% annually on a sustainable basis, enough to double real incomes in a decade and put India on the path to convergence with the more advanced economies. This shows how sound policies and courageous reforms can change the economic prospects for millions.
Developments in India are today far more sensitive to movements in the world economy. Two decades ago, India’s policies were inward-looking and designed to avoid imports which were seen simply as a drain on foreign exchange, rather than as a source of competition and beneficial change. Today, foreign exchange is no longer a constraint and India’s exports of services exceed all but 8 OECD member countries, while imports were larger than all but 12 OECD countries in 2006.
With this background, it is clear to us that undertaking a series of economic reforms would allow India to reach a sustainable growth rate of 10%. I will focus on just four: improving the business environment; infrastructure; public finances and labour market reform. The OECD Survey covers many more subjects and I invite you to consult it for more detailed information.
The reform of the business environment is an area in which the central and some of the state governments have been making progress. The requirement of government permission for new investment was eliminated and the policy of restricting the manufacture of certain products to very small scale firms has been significantly reduced and will soon be phased out. In addition, a number of states have recently introduced legislation to improve the efficiency of the civil service.
Many of the policy initiatives in this field, such as the introduction of one-stop shops and the Right to Information Act, are only a few years old and it is too early to tell if they are having the desired impact. If these efforts are successful, they will help reduce the duality between the formal and informal sectors, broaden the tax base and level the playing field for doing business in India. In short, they will increase India’s growth potential.
There is still, however, a long way to go. Despite recent improvements, the time required to start a business is excessively long. This might be indicative of more widespread problems in government administration, which deter firms’ entry into established markets and thus discourage competition and innovation. The key in this area is to link reform to reengineering administrative processes from the ground up. Working within the existing framework will only produce limited results. The introduction of a centralised unit within government to undertake regulatory impact analyses of existing and proposed laws would be a good step in the right direction. A new bankruptcy law is also needed so that resources can move more effectively from one area of activity to another with less of a role for the courts.
The second policy area I would like to focus on is infrastructure. With economic expansion, the demand for infrastructure is growing rapidly. Given fiscal constraints, the government is turning more and more to private sector provision. In some infrastructure sectors the introduction of regulation allowing private sector competition has proved enormously successful. India’s fast growing wireless telephone sector is the third largest in the world and a leading example of how the private sector can quickly deploy infrastructure when regulation encourages competition. Besides a dramatic increase in capacity, the price of telecoms services in India has dropped from one of the highest in the world to being comparable to those in developed countries today. Because of increased competition, telecoms services have become affordable for an increasing number of people.
Civil aviation and toll roads are two other examples of successful reforms. In other infrastructure sectors, however, the picture is more mixed. Over the past four years, the government has been gradually implementing a new policy for the electricity sector. But progress at the state level has been uneven. Cross subsidies are still extreme. While the price of electricity for households and agriculture are among the lowest in the world, the price for industry is one of the highest.
Reductions in losses in transmission and distribution have been disappointing in several states. Distribution companies are, on average, paid for only 60% of the electricity generated. The central government could consider ways of encouraging the privatisation of state electricity companies once conditions for competitive markets have been established. In any case, even if such companies remain in the public sector, there is ample room for efficiency improvements.
The third area that I would like to address is fiscal policy. A faster growth rate will require more investment, and that will need more domestic savings if expansion is not to end in higher inflation and an unsustainable current account deficit. Fiscal policy needs to ensure that the government adds to savings, contrary to what has happened in the past. Already, the central and state governments are budgeting for a combined fiscal deficit of just over 5% of GDP, substantially below the near 10% deficits at the beginning of this decade.
This improvement is the result of the progressive adoption of fiscal responsibility legislation across the country. Long-term growth prospects would be bolstered by continuing the current fiscal consolidation and by extending the Fiscal Responsibility and Budget Management Act for the next five years. This will free up resources for growth in private investment. It will also show resolve and provide a very visible sign of fiscal discipline to the markets.
But more is needed than simply reducing deficits. The efficiency of public spending has to be improved. This is a challenge that all OECD members share. In the case of India, the survey suggests that the government spends four rupees to deliver one rupee of food and fuel subsidies to the poorest. At the same time, existing tax breaks need to be reviewed in order to increase revenues or perhaps to lower direct tax rates. Furthermore, the efficiency of spending in the area of public education has to be upgraded to respond to the increasing demands for skilled human capital. These are just a few examples to illustrate a broader point.
Finally, I come to labour market policy. A key feature of the Indian labour market is that only 15% of the labour force has regular employment contracts and of those, only about one fourth(4%) are in firms of the so called “Organised Sector”. Employment growth has been substantial in India over the past decade. Most of these new jobs, however, have been created in the informal sector of the economy, which is largely free of the restrictive regulation that governs formal-sector employment. The problem with informal sector jobs, however, is that they are unproductive and poorly paid. In fact, the productivity of formal sector firms is 13 times greater than that of firms in the unorganised sector of the economy. The reason is that the regulations that apply to the “Organised Sector” are more rigid in India than in most OECD countries, especially those related to collective dismissals. On the other hand, the employment rules governing temporary contracts are similar to those found in the OECD area. Thus, large firms bound by these labour laws have been hiring staff on temporary contracts and not recruiting regular employees when people leave. This highlights the fact that restrictive employment regulation in the formal sector acts as a major handbrake on growth in this sector.
Creating more formal sector jobs is an important key to future economic growth. The significant barriers to employment in this sector need to be lowered. This would involve redesigning and updating the whole approach to employment protection, particularly the most restrictive provisions dealing with prior government approval for collective dismissals. To make such a move feasible, however, it may need to be accompanied by an increase in the statutory payment for redundancies.
Another possible way of reforming the labour laws would be to give the state governments more jurisdictions in this area. The responsibility for labour laws is currently shared between the central and state governments, and there are significant differences in the extent to which labour market reforms have been introduced across states. We have found that states that have gone further in reforming labour laws have more labour mobility in comparison to the more restrictive states. This results in a better matching of people to jobs and increases overall employment, productivity and innovation. Granting more labour market flexibility to state governments would allow reform-minded states to move more quickly in this area and act as important demonstration cases.
To move forward on the path of reform, India can look at international experiences, but it also can rely on its own achievements so far.
Indeed, there are many examples of successful reform in this country, and this is a message I want to underline. Telecommunications, airline and IT services are illustrative of what could happen if constraints on the economy were lifted. The interesting question is whether this could be repeated in the manufacturing sector. Although performance has been improving this decade, the surprising feature of the Indian economy has been the relatively mediocre development of the manufacturing sector, despite the underlying advantage of low labour costs.
Faced with difficulties in introducing reform at the national level, the government has decided to establish a large number of special economic zones, and these may represent a way to accelerate the integration of the Indian manufacturing sector into the world economy. They have been designed to free businesses from a number of the constraints they face in the area of labour laws, administrative procedures and the provision of infrastructure. It is also true that companies in these zones will benefit from extensive tax incentives that could divert activity from the rest of the country.
Thus, it might be better to implement reforms nationwide, like having a lower national corporate tax rate.
Overall, while a long-term development strategy should not depend on SEZs, these can perform a useful short-term role in overcoming drawbacks and showcasing the positive impact of a number of economic reforms in a real life setting.
One of the features of this Survey that may interest India relates to the process of economic reform of other OECD countries. Change can sometimes be challenging, and there are some good examples of how countries have successfully introduced programmes of structural change that have boosted their economic growth.
Two examples spring to mind: Australia and Ireland. In Australia, tariffs were high but the sheltered industries were not creating jobs. Tariff reduction was painful, but the industries most directly affected managed to adapt to a new environment. Agriculture was sheltered by policies that protected regional markets, but when barriers were removed, productivity increased. Just as important, significant labour market reforms were introduced. While some groups lost out in the short-term, employment and GDP growth have picked up since. It took them 10 years to review the whole existing legislation to make sure it was conducive to more open competition. But, by all accounts, it added substantially to their GDP per capita.
In Ireland, growth has been based on a set of policy reforms that provide the right context for business development: attracting foreign investment through a competitive tax environment, improving educational standards, allowing a flexible labour market, and ensuring a more stable macro-economic context through a major programme of fiscal consolidation. People are now talking about the “Irish tiger”.
Not all OECD member countries have advanced at the same pace. The challenges in implementing reforms are different depending on the context. But the fundamental factors underlying economic growth are strikingly similar in many countries, notwithstanding obvious differences in size and economic standing. Sharing worldwide experiences and benchmarking national policies against best practices within the OECD framework may help garner acceptance for the reform process in India. Sometimes the so called “political economy of reform” becomes more complex than the design of the reforms themselves.
With this first Economic Survey we have gained a better understanding of India’s great achievements, as well as the challenges it faces. We hope it will contribute to the policy debate for achieving sustainable and sustained high levels of economic growth and that the experiences of OECD member countries will be useful for you. We don’t come here to tell you things about India that you know better than us, but rather to exchange information about what other countries are doing, how you compare with them, and how the remarkable progress achieved so far can be strengthened .It has certainly been an enriching experience for us, and I am confident that our future cooperation will be equally fruitful.
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Official Visit of the Secretary-General to India (8-9 October 2007)