INB 311
India and China
Dr. Lairson
9/9/14
Ideas, interests, and the tipping point: Economic change in India
Rahul Mukherji
Major questions:
 Why and how did India engage in economic reform in 1991 and not
earlier?
 How did this model of state-led, import-substituting
industrialization become transformed into an economic order that
stressed deregulation and globalization?
 Why did India make changes to its established economic policies as
a result of the 1991 events?
What are the special features of the India Case?
 India’s transition to globalization and deregulation is a saga of a
government promoting institutions that facilitated competitive
markets within a democratic polity while powerful social actors
opposed these changes.
 The literature on developmental states had not been optimistic about
India’s growth potential, because the country did not possess the
wherewithal of a ‘hard state’ with an authoritarian leadership that
could deal decisively with powerful social actors (Evans, 1995;
Chhibber, 2003; Kohli, 2004).
 India was characterized as a relatively soft state where the dominant
political coalition of industrialists, farmers, and the powerful
professional middle class was deeply interested in perpetuating a
state- led, import-substituting model of development.
Why did India choose reform in 1991 and not in 1966
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The answer to this puzzle lies in the way that ideas about
deregulation and globalization evolved within the Indian state –
especially among the country’s technocrats, who were evaluating
the results of different developmental outcomes. The gradual
evolution of liberal ideas and policies brought India to a tipping
point in 1991, when a balance of payments crisis provided an
excellent window of opportunity for India’s distinguished
technocrats and economists to deal decisively with parts of the
dominant electoral coalition at the time of a foreign exchange shock.
The tipping point constituted a moment when economic ideas and
policies that had been evolving since the mid-1970s had begun
undermining state-led import substitution quite significantly.
Comparing the 1966 and 1991 decisions:
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1966: When Indian politicians and technocrats were unconvinced
about the need for globalization and deregulation in the 1960s, they
only made a tactical retreat toward reform, then perpetuated the
country’s most stringently autarkic institutions after 1969.
 During the country’s balance of payments shock of 1991, on the
other hand, technocrats were convinced about the need for a more
liberal approach after having experimented gradual policy change
during the 1980s. Consequently, they exploited India’s dependence
on the IMF to deal with parts of the country’s dominant electoral
coalition, making virtue of the necessity of an IMF loan and its
attendant conditions. Had the technocrats dithered or been
unconvinced about the fruits of internal and external deregulation
during the 1991 crisis, the Indian story would likely have played out
very differently.
 Moreover, the 1991 reforms were a home-grown initiative rather
than an IMF-driven approach, at a time when the IMF seemed
concerned about the political durability of economic reforms in a
democratic polity such as India.
Were the 1991 decisions a result of capture or pressure from business elites in
India?
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Did the business class or the middle class capture the state and force
it to deregulate and globalize economic policy (Pederson, 2000;
Kohli, 2012)? This paper clearly demonstrates that Indian industry
was comfortable with gradual internal deregulation, but did not
push towards either promoting substantial internal competition or
global competitiveness. The captains of Indian industry were
comfortable deriving monopoly rents from the country’s over-
regulated economy. The state had to persuade parts of
professional Indian industry in 1991, and nudge them towards
accepting deregulation and globalization when they were hesitant
to do so. Therefore the reforms of 1991 cannot be derived from
what has been termed as the ‘pro-business’ orientation of the
government in the 1980s (Kohli, 2012). Indian industry acquiesced
to the government in 1991 when it had few options, as it was
heavily dependent on the IMF for financing the imports that
sustained the import-substitution industrialization system in
India.
The 1966 crisis:
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In spite of a very severe foreign exchange crisis brought on by increasing defense
spending from the 1962 war with China and the 1965 war with Pakistan, and the
role of foreign exchange in obtaining critically needed food imports, the Indian
government in 1966 resisted the broad policy demands of the US and the World
Bank.
The US pushed India toward substantial deregulation and adoption of a policy of
export promotion,
The World Bank agreed, pushing India to
o devaluation of the rupee; (2) the removal of direct controls on
the importation of intermediate goods; (3) population control;
and (4) increased investment in agriculture.
The Indian government at the time – under Indira Gandhi – had a strong preference for
socialist-communist positions. These included self-reliance and hostility to global
capitalism. This led to substantial resistance to policies preferred by the US and WB
from many parts of the Congress Party. Import dependent businesses also opposed the
devaluation.
Devaluation was done out of necessity but nothing else – indeed India became more
regulatory in the years after and its economy less effective.
The 1991 crisis and decisions
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These events were affected by the gradual changes in ideas and policies after
1975 which reached a tipping point in 1991. These idea and policy changes were
supported by small changes in the preferences of the dominant governing
coalition – about 20% of the population.
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The politics of institutional change in India during non-crisis periods
demonstrates why parts of the country’s dominant political
coalition, such as the industrial class and the farmers, permitted
limited deregulation during the 1980s. The dominant coalition
comprising about 20 per cent of the population became quite
influential in the 1980s. Indian industrialists wanted the state to
protect their monopoly rights, lavish them with subsidies and also
impose fewer restrictions on them. Farmers demanded subsidies,
assured prices and cheap loans but were unwilling to be taxed.
The professional middle class sought cheap higher education,
better salaries and lower taxes. Those working for the government
enjoyed their regulatory powers. The economy was thus locked in
an equilibrium characterized by limited loosening of state controls
for domestic investors and protectionism
 The technocrats’ preparation for change during the 1980s was
essential, and the mood within the technocracy was quite different
in 1991 than it was in 1966. The gradual preparation for change since
the mid-1970s is critical for understanding the power of the tipping
point model for India. Indian technocrats’ preference for state-led
industrialization began to wane in the 1970s, owing to the country’s
dismal rates of economic growth at a time when various sections of
society were clamoring for more subsidies.
 The country’s technocrats began focusing on five policy issues: (1)
the management of publicly owned enterprises; (2) deregulation of
domestic investment; (3) import liberalization; (4) export promotion;
and (5) promoting foreign investment. Gradual industrial
deregulation became noticeable when Indira Gandhi became prime
minister for the second time in 1980. This process accelerated
gradually after 1984 when her son Rajiv Gandhi assumed
premiership and continued up until 1991.
1991 events
 In October 1990, the credit rating agency Moody’s downgraded
India’s credit rating, pointing to an unsustainable rise in the
country’s debt-service ratio, increased exposure to commercial
borrowing, the impact of the Gulf War, and a ballooning budget
deficit. Non-resident Indians began withdrawing their deposits and
India had to pledge gold in return for hard currency to import
essential items.
 India was two weeks away from a default on its debt payments
when P.V. Narasimha Rao was selected prime minister of India by
the ruling Congress Party, which had formed a coalition
government in June 1991. Only one month earlier, former PM Rajiv
Gandhi had been assassinated.
Many changes in the world had pushed Indian leaders in the dominant classes to rethink
their views:
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The collapse of the Soviet Union
Modest reform in the 1980s
Economic success in East Asia
A balance of payments crisis at this juncture necessitated a
fundamental reshaping of India’s economic and foreign policies.
Manmohan Singh, one India’s most experienced technocrat economists,
was chosen to deal with the crisis as finance minister. A group of Indian
economists with significant ties to global economic liberalism were deeply
involved in making policy. These leaders were determined to
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break the hold of “state-led autarkic industrialization.”
Curb government spending to support SOEs
Increase competition in the Indian economy
Expand foreign investment, but restrict this to FDI and NOT
portfolio investment or foreign debt
 Export promotion over import substitution
 Near elimination of industrial licensing
 Eliminate controls on production location and quantities for large
firms
Resistance to these policies was significant and from powerful sources, including the
Indian capitalists and most political parties. But the success of the policies in
increasing the rate of growth helped to convince some of the benefits of
globalization and liberalization.
However, policies providing subsidies and support to business and agriculture
continued and even expanded. This resulted in a large and persistent budget deficit
and exposed India to potential crisis. India had become very dependent on global
finance for its economic survival.
Explaining India’s policy changes:
We posit a theory of slow moving gradual ideational and policy change
based on the puzzles posed by previous policies and the international
demonstration effect of Asia. Slow economic growth till the mid-1970s, the
fiscal unsustainability of autarkic pro-business liberalization in the 1980s
and developments in Asia and Soviet Union pointed the policy elite
towards the need for embracing deregulation and globalization. This
ideational tip- ping point was the necessary condition that enabled
technocrats to exploit the balance of payments crisis in 1991 to produce
significant economic change in India. When Indian technocrats were not
prepared for economic policy changes that occurred during the 1960s, IMF
pressure was not able to bend the institutions and policies of import
substitution in India.
India’s executive technocratic team favoring globalization and deregulation in 1991 had to deal with the country’s politics. The paper
demonstrates the centrality of a crisis in negotiating far reaching
institutional change in a soft state with a powerful dominant coalition of
industrialists, farmers and professional middle class. The team had to
negotiate both with the IMF and domestic constituencies to chart a
politically and ideationally secure path towards a silent revolution. Indian
industry had to be nudged toward reform by the technocrats, and the IMF
needed to be convinced that areas of divergence between New Delhi and
Washington would not derail the reform program. In addition India would
not reform its labor laws or re- duce fertilizer subsidies, due to the political
power of organized labor and the farmer’s lobby, respectively. India’s
fiscal deficit was also allowed to grow after the first year of stabilization,
which was not in accordance with the IMF’s preferences.
Mukherji, R. (2009) ‘Interests, Wireless Technology and Institutional Change:
From Government Monopoly to Regulated Competition in Indian
Telecommunications’, The Journal of Asian Studies, 68(2): 491–517.
Mukherji, R. (2007) ‘Economic Transition in a Plural Polity: India’, in R. Mukherji
(eds) India’s Economic Transition, New Delhi: Oxford University Press, pp. 117–45.
Why has China grown so fast?
Mobilize capital and invest in market-enhancing infrastructure
How did the investment process work?
Lieberthal, Managing the China Challenge
How do we understand how the Chinese system works?
Using western or American assumptions about politics and economics
won’t work
All people want to be free and eliminate government restraints
All people hate the government and want it to go away
Government leaders only want to make more money for themselves
What kinds of ideas have Chinese developed to direct their efforts to respond to the
West after the 1840s?
Develop uniquely Chinese ideas and reject the West
Adopt western technology but reject western ideas
Adopt western ideas and technology completely – nothing Chinese is sacred
What are Chinese attitudes toward the West today?
Page 6
How Does China Work?
Chinese Communist Party – monopoly of political power
Party Congress
Central Committee
Politiburo
Standing Committee of Politiburo
Xi Jinping
General Secretary of the CCP and Chairman of the Central Military Commission
Li Keqiang
Premier and head of the State Council
Party and Government at all levels – the party-state
CCP
75 million
Leninist in origin and operation
Nomenklatura system – appointment of top leaders at next lower level
Important national policies
Policy and implementation
Centralized? Flexible? Totalitarian? Authoritarian?
What are the major themes and directions of Chinese policy today?
Achieve wealth and power, security and prominence for the nation
Pragmatism, trial and error, experimentation
1) Preservation of Communist Party rule at all costs
2) Expand and deepen the social safety net
3) Existing economic strategy – labor intensive, light manufacturing
based on FDI – must be changed to continue Chinese growth
4) Develop global technological leadership through indigenous
innovation such as green technologies
5) Expand modern urban areas inward
What are the specific actions China is taking?
Restructuring of the Chinese economy. The list is long and daunting:
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Agriculture
Local manufacturing TVEs
SOEs and restructuring
Accommodation of domestic private firms
Creating domestic markets and linking these markets to global
prices and markets
Integrating global firms into the Chinese economy
Shifting large labor pools into eastern SEZs for global production
Urbanization
o Reduce and eliminate the hukou system
Massive infrastructure investment on a national scale
Infrastructure upgrading for global production networks
Value chain upgrading
Global standards for Education and Human Resource upgrading
WTO accession changes to business practices and laws
Layers of the Chinese state
Center
Province
Municipality
County
Township
The “DEAL” that defines the relationships of the levels of the party-state
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Fundamentally hierarchical – above directs below but allows
considerable latitude to interpret specifics
Support initiative and even entrepreneurialism to achieve
broad policy goals
Leaders of the party-state at all levels have a direct stake in the
success of policy and economy
Advancement increases the benefits of the system to leaders
Local leaders make most appointments at their level
Local leaders control local banks, courts and administrative
agencies
Wide latitude to act entrepreneurially to achieve economic
growth
Large role for market forces that provide incentives,
information and constraints to entrepreneurs
Deep and complex party-state relations to firms at a micro and
local level: land, licenses, capital, regulations, purchasing
decisions, ownership
All business in China – foreign and domestic - is deeply
connected to the party-state
Success within the party-state is a result of developing leaders
who can creatively and effectively promote economic growth
at a micro-level
Demonstrated entrepreneurial talent is the criteria for
achievement and advancement in the party-state
Local official are deeply connected to the business enterprises
in their area, high significant autonomy and operate as active
and important partners in promoting business success
Consensus building across various lines of authority as
decision-making system: at least 2 key players required to
move an initiative forward
The CCP and the party-state is a dynamic, flexible, decentralized and
internally competitive organization
The party-state is organized to promote economic growth
Problems with the party-state system
Local protectionism
Fragments markets
Undermines achievement of economies of scale
Poor intellectual property protectionism
Long tradition of copying the best model
Knockoffs
Owners of best model want protection and profits
Dangers from fake drugs, milk
Corruption
Can corruption support economic growth?
Investment and infrastructure bias – local officials love new roads, buildings,
fancy bridges
Misallocates investment
Lack of central government control
Environmental protection
Lack of an effective social safety net
Retirement
Health care
Major challenges to the Chinese system
Political coherence – Bo Xilai
Managing the effects of rapid change
Resource shortages and environmental destruction
Water – 38, 40
The United States as supporter of or opponent of China’s growth?
China must manage its relationship to the US and Europe to preserve a
favorable international environment.
Economic outcomes in China are a result of a relationship among the party state,
state and private (domestic and foreign) firms and domestic and global market
forces.
Structure and Operation of the Party-State System
The basic arrangement of General Secretary as most powerful actor combined with
a top governmental official as chief executive (premier, governor, mayor, county
head) operates throughout the nation at all levels.
A system of ranks defines the power relationships among the various units of the
party-state – including party, government, SOE, media organization, publishing
company, school, research institute, hospital, museum. These ranks are not
published but are not secret.
Units cannot issue orders to another unit at the same or higher rank.
There are unusual ranks that affect power relationships:
 Provinces have the same rank as ministries in Beijing, which means
ministers cannot issue order to provinces.
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Only the Communist Party – which stands above the highest
governmental body, the State Council - can command the military.
The Minister of Defense does not command the military.
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Many large SOEs have the same rank as ministries and many others
have a higher rank than the government of their city
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In addition to the system of ranks, the effect of reforms has been to
empower territorial governments to control their own specialized
agencies. Occasionally, the central government has altered this
relationship when excessive localism has developed.
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It is very important to ascertain the nature of the power relationship:
leadership relationship (lingdao quanxi) versus professional
relationship (yewu guanxi).
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The outcomes of the system are a product of the relationships among
the division of labor system, the ranking system and the
leadership/professional system.
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Not all decision at the national level have the same operational
implications:
o Orders – must be implemented precisely
o Instructions – develop a plan that considers local
considerations
o Circulars – the issue is of concern but do not require
operational decisions
o Opinions – suggest thinking at the top but without decision
The consequence of the system of ranks, in combination with the various layers of
government and party, results in a substantial distribution and even fragmentation
of power in China. The system of power in China is far less centralized than most
westerners realize.
Local officials have considerable leeway on many issues of national policy as along
as they do not directly contradict this policy. Policy is stated and defined in general
terms and can be implemented based on local conditions.
This means decisions on substantial business operations require a consensus across
different jurisdictions and no one person can command such a consensus. Higherlevel official typically expect lower levels to work out a decision. This can frequently
mean a determined opponent can veto a decision.
Laws and regulations can vary considerably across different jurisdictions. Decision
latitude for one level is a negotiated arrangement with the next highest level. There
is a lot of play in the system.
Lieberthal provides advice to TNCs operating in China.
Government relations are a strategic issue in China.
Governments at all levels must be seen as differentiated and complex
Understand the complex network of government-business relations - 107
Products that qualify for indigenous innovation: mean and effect of the
catalogue
How Chinese reach conclusions about dealings with foreigners – 64
Understand the policy directions of the nation and make proposals that conform to
these directions
Develop plans to take advantage of the urbanization of 2nd and 3rd tier cities
Local market research
Chinese market is highly segmented
Expect much lower price points for products
Good enough products
Decentralize product development to local units
What are the political risks associated with China?
Will the CCP be overthrown?
What is the nature of political unrest in China?
How does the Chinese government affect the choices on FDI?
Can foreign firms participate in the creation of regulations that affect their
operations?
Disputes in China are negotiated and are not settled in a rules-based or laws-based
setting. 85-86
Resolve versus win
Costs of going to court to enforce contracts against firms with important
political supporters
What are the political risks associated with making corrupt payments?
Milkmaids
Foreign corrupts practices
Reputation for operating without corruption
Effects of US-China relations
Tiananmen Square consequences
Trade conflict on solar power panels
Managing issues of product safety and quality across supply chains
Ethical choices – 93-95
Cyber risks
Taxis in Shanghai – microphones
Large and sophisticated systems of penetrating corporate information
systems