Perspectives on China and India: India's Rapid Economic Growth

November 12, 2012

B. Ravikumar, vice president in the St. Louis Fed's Research division, explains how reforms in India, including the privatization of industries such as telecommunications, have led to rapid economic growth. Expansion in the Indian services industry, such as the medical tourism sector, has also contributed to its rapid growth and exponentially boosted its per capita income prospects.

Presentation (PDF)


Cletus Coughlin: Okay. Thank you, YiLi. Our second featured speaker tonight is B. Ravikumar. Due to the challenges of pronouncing his first name, we just refer to him as Ravi. It's just much easier to do that rather than spending a half hour trying to pronounce his name correctly. While I characterized YiLi as an emerging distinguished scholar, I would characterize Ravi as a highly recognized, and I guess I would say an emerged distinguished scholar. Ravi is a vice president in our Research division. Before joining the Bank in 2011, he was a professor of economics at the University of Iowa. His current research focuses upon macroeconomics, international trade and economic development. He received his PhD in economics, also from the University of Iowa, and his masters of science in economics from Carnegie Mellon University. In addition, he has a master's in industrial engineering from the National Institute for Training in Industrial Engineering, a bachelor's in electrical engineering from the Indian Institute of Science and a bachelor's degree in physics from the University of Bombay. We often times joke that economics is not rocket science, but I would say that if we ever had to launch a rocket from the Fed here, I know where I'd turn first in terms of our staff. Anyway, it's all yours, Ravi.

B. Ravikumar: Thanks. Let me start with the basics so we have some time for Q&A. So most of you know India is a very ancient civilization. Depending on parts of India that you go to, you can see monuments from second century, third century or fourth century B.C. It's also a very diverse country. So on the Indian currency alone there are like 17 languages printed. So if you walk from one state to the next, if you go to the interior parts, you better know the language of that particular state otherwise you won't be able to communicate. It's sort of the equivalent of going from Missouri to Texas and not understanding what they have to say. But it's a bad example, I don't understand what they have to say anyway. It's the world's largest democracy, so it's a huge country. And the population, as Cletus mentioned earlier, is about four times that of the U.S., and the area is about 1/3 of the U.S. So imagine taking the eastern 1/3 of the U.S., start somewhere around Indiana, draw a vertical line, go all the way to the Atlantic Ocean. Imagine putting all the people in the U.S. in that area and then quadruple it. So now you're imagining how tight the space is in India.

So in terms of the economics, the reform started roughly around early 90s. So until then the reforms were all kind of piecemeal. So to give you an idea, the piecemeal reforms would be of the type, you're allowed to invest in producing t-shirts as long as the investment is less than $50,000. So in the next year they would say, okay, you're allowed to invest in shoes as long as that's less than $50,000. In the third year they would say, we upped the limits to 100,000 and so on. So in the early 90s they stopped with all these bits and pieces of reforms, and they went to what I would describe as a negative list. So the negative list basically says, well, if an industry is not on this list, you're free to do whatever you want. So they opened up the licensing procedures much more generally.

So I'm going to characterize the reforms in two broad categories. One I'm going to call inward competition, and the other I'm going to call outward competition. So by inward competition, I mean the sorts of examples that I gave you, the removal of licensing restrictions, and the second big one is privatization. So pretty much in the 70s everything was owned by the public sector. So as a result of the reform they started taking away the public sector monopoly over various things, and things became more and more a part of the private sector. And I'll have some examples of that as we go along in the talk.

On the outward competition, it opened up the international trade in a big way, both in terms of a free-floating rupee that competes in the foreign exchange market and also in terms of foreign investment that can be put into India. So previously the ownership of foreigners of various companies was restricted to particular limits, now all of those limits are slowly disappearing. So foreign investment is something that you can undertake very easily in India right now.

So here's an example of the privatization. So if you looked at the telecommunications industry—I'm going to pick on just the subscriber base in telephones—everything was a public sector. So if you looked in the 80s, there was no such thing like a private sector telephone operation possible. So in a matter of just 20 years it went from an entirely public sector monopoly operation to 80 percent private sector. So that's sort of the impact of the reform. In fact, if you looked at the cell phone industry, that would be more like above 90 percent right now. So the public sector is now part of the dying industry of the landlines, and the private sector has completely taken over the mushrooming industry of cell phones. And for an average person, this is a phenomenal improvement. So if you were to imagine yourselves kind of staying in the 80s, you literally had to wait for years in order to get a telephone. Now it's a matter of minutes. You can go get a cell phone from a shop, have a service, and you're off. And, of course, your cell phone can do a lot more than what a telephone used to do, but we'll come to that later.

On the trade side, so the trade was kind of miniscule in terms of India with the rest of the world. From something like 5 to 10 percent in the 80s, it's moved up to half of GDP by 2010. Which is sort of a big deal when it comes to thinking about productivity and all other issues economists think about. Now we have to compete with foreigners, and the fact that it has risen to 50 percent of GDP is sort of a good sign on the productivity. Of course, this can improve a lot more, but this is how much trade reforms have changed the interaction of India with the outside world.

Now, we've been talking a lot about growth, and Cletus mentioned what's happened over the last 500 years. YiLi mentioned something about China's growth rate. So one thing that I want to reiterate about what it means for an average person when you see numbers like per capita income growing. So if you could sustain a per capita income growth rate of roughly 2 percent per year, which is the U.S. history over the last 150 years, and imagine a generation—a generation is roughly, what, 35 years long—so at the rate of 2 percent per year, the average person in a generation would make twice as much income as the average person in the previous generation. So the income is double for the average person every generation at the rate of 2 percent. Now, if you upped that to 8 percent per year or 6 percent per year, that's a phenomenal increase in income. So the average person in the next generation would be eight times as well off as the previous generation.

So to give you an idea, it's like your children making eight times as much as you are, if you can sustain a growth rate of 6 percent. So changes in the growth rate if you can sustain them have phenomenal impact economically. It can lift not only millions of people out of poverty, but the standard of living every generation is improving dramatically at that particular growth rate. So Cletus mentioned the industrial revolution. If we were growing at the rate pre-industrial revolution, we would have been barely doubling our income today. It would have taken 700 years for the average person to double their income. So that's how much growth rates have changed in terms of standards of living.

So here's a picture of what the differences in growth rates are. This is a peculiar picture. So the way I have drawn it is, imagine for a minute that U.S. and India started out at the same point in 1988 which was roughly the start of the reforms. And then plot what happened to the U.S. based on the growth rates of the U.S. and plot what happened to India based on the growth rates of India, and you can see the differences in growth rates. So during the middle of the last decade, the per capita income growth rate in India around 2005 was something like 8 percent. Around the same time, the US growth rate was 1 percent. And we will sort of see what the impact of those differences are in terms of where the growth rate comes from. But this sort of growth rate is what's going to help you catch up to the U.S.

So in 1988 if you measured how big was the U.S. per capita income relative to India per capita income—that is, what is the average person in the U.S. making relative to the average person in India—the answer would have been the U.S. is like 23 times as rich. The average person is 23 times as rich. Now, thanks to the growth rates of the Indian economy, that gap is kind of closing. Now the average person in the U.S. is only about 12 times as rich as the one in India. Now, of course, to close this gap further, you have to be able to sustain this growth rate for longer and longer periods of time.

So one question that naturally comes up is, okay, these economies are growing, where does all this growth manifest itself? So typically you can think of lots of ways that growth manifests itself, and YiLi gave you some examples. You sort of see more construction, the housing prices are going up, people are going to more schools and savings is higher, and so on and so forth. And I'm going to plot you a slightly different picture.

This is in terms of Indian spending abroad and the foreigners spending in India. This is kind of a consumption good. So you see this in growing tourism. The reason I picked this particular plot is on the receipt side, a big growing industry is what's known as medical tourism. So there is a lot of activity in terms of high healthcare cost countries trying to get their surgeries done in India. So a cardiac surgery for instance in the U.S. would be 10 times as expensive as exactly the same thing done in India. Of course, of the money that you save, you can tour India. So normally you have access to things that you don't normally have access to in the U.S., right? So you can see the Taj Mahal, so it's something that you won't have easy access to sitting here. So the medical tourism is a big growing industry right now.

This also manifests itself in some unusual transitions. So to give you a contrast, if I were to ask an average economist who works on development and asked the question, what would contribute to economy's transitioning from a low state of development to a high state of development, which industry would grow the fastest? The typical example is manufacturing. It's always been a transition from agriculture to manufacturing. And India is unusual in many ways, and this is one of the unusual ways. Bulk of the growth in India has been happening as a result of growth in the service sector. The medical tourism is one such example. So medical services are growing, tourist services are growing, so the service is what's contributing heavily into the economy.

So you might think, okay, all this growth rate, what exactly is the size of the Indian economy? So I want you to take a guess. So how big is the Indian economy if I were to measure total GDP of India and I want to compare the total GDP to that of Japan, Germany, United Kingdom plus France? So would you say India is bigger than, which one of them? All of them. That's pretty good. So the correct answer is actually four. So half of you picked the right answer. It is bigger than all of them this date. So to give you the numbers, it's about 4.7 trillion in India right now, the total size of the economy measured in common terms. So Japan would be the next biggest compared to India, and then even U.K. and France put together doesn't add up to the Indian economy size. So the size of the Indian economy is going to kind of play a role to think about sort of the future potential of India. I'll come to that in a minute.

This popular lecture series addresses key issues and provides the opportunity to ask questions of Fed experts. Views expressed are not necessarily those of the St. Louis Fed or Federal Reserve System.

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