India’s Shift from Socialism to Capitalism in the 1990’s:
(“The Commanding Heights” – Chapter #8)
Present state of “Republic of India”:
 Population = 1,147,995,898 (17.2% of World
Population; over 3.75 times the population of the U.S.)
 Geographic Area = 1,269,345.60 (roughly 1/3 the area
of the U.S.)
 Population Density = 904.4 people per square mile
(U.S. is 81.8 people per square mile => India is over
10 times as densely populated)
 Life Expectancy at Birth: 69.25 years (up from 63.62
years in 2003)
 Per Capita GDP (PPP) = $2,932
 GDP Growth Rate = 7.4%
 Inflation Rate = 10.9%
 Unemployment Rate = 10.7%
 Gini-Coefficient = .37 (less than U.S. value of .45)
Overview of History of India:
“Company Rule in India” – India was essentially a
colony of the “British East India Company” from the late
1600’s through 1858
 British East India Company – an English
corporation founded in 1600, which would establish
trade routes between Great Britain, India, and China
 Primary goods traded: cotton, silk, indigo dye, tea,
opium, and saltpeter
 Over time, the BEIC “came to rule large swathes of
India, exercising military power and assuming
administrative functions, to the gradual exclusion of
its commercial pursuits.”
“British Raj” – India was a colony of the United Kingdom
from 1858 through 1947.
 Government of India Act of 1858 – act of the
parliament of the U.K. passed on 8/2/1858, dissolving
the British East India Company and transferring its
functions directly to the British Crown
 Ended “company rule” and ushered in the era of direct
colonization by the United Kingdom
 British Raj – a term used to refer to the period of
direct British rule of the Indian subcontinent from
1858 through 1947
Independence – British colonization of the Indian
subcontinent ended in 1947, with the establishment of two
separate independent countries:
i. the “Union of India” on 8/15/1947 (the primarily
Hindu regions of British India became the country of
India) and
ii. the “Dominion of Pakistan” on 8/14/1947 (the
primarily Muslim regions became the country of
Pakistan)
Two major leaders of Indian Independence Movement:
 Pandit Nehru – first Prime Minister of India (19471964); a member of India’s “Congress Party”
 Mahatma Gandhi – a major spiritual and political
leader in India during the first half of the 20th century
“Congress Party” (or “Indian National Congress”) – the
oldest surviving political organization in India; the party
played a major role in the Independence movement, and
has been the ruling party in most of the time since then
The Constitution of India – the supreme law of India
(drafted beginning in 1947, passed into law on 11/26/1949,
came into effect on 1/26/1950) which established India as a
“sovereign, socialist, secular, democratic republic.”
India’s continued commitment to democracy is one of the
great achievements of the second half of the 20th Century
 Free elections, independent judiciary, free press, and free
speech are in stark contrast to the political climates in the
region and the rest of the developing world at this time
Primary issues for India in the middle of the 20th Century:
Main Political Issue => Independence from Britain
Main Social Issue => extreme poverty in the country
India after Independence:
Gandhi’s economic vision: Self Sufficient Villages
 “Swadeshi” (or “self-reliance”), which focused on
home production of basic goods, a “spinning wheel in
every hut,” and self-sufficiency of every village.
 Strategies of included boycotting British goods, along
with the revival of domestic production of goods.
Nehru’s economic vision: Heavy Industry and Soviet Style
Central Planning
 Believed the road to prosperity and the elimination of
poverty was improved technology and heavy industry
 He valued Democracy, and was troubled by what
Communism did to individual freedoms
 Private property was acceptable, but was to be
subordinate to the state and the central planning of the
Indian Economy (i.e., people could own property, as
long as government could influence/control it’s use)
Economic Policies of Nehru and the “Congress Party”:
 Influenced by “Fabian Socialism” and “communist
planning,” Nehru and the Congress Party leaders
distrusted markets, and felt central planning, state
control, and government could best allocate resources
 India’s natural and economic resources were scarce =>
government needed to direct the resources (they could
not risk that their resources would “be frittered away
producing nonessentials such as lipstick”)
 Following the Soviet model, Government would focus
on heavy industry => mistake was that the focus was
simply on “investment itself,” and not on “productivity
of investment” and “value of what was produced.”
 The state would exclusively control some sectors of the
economy (the “Commanding Heights”), while in other
sectors existing private firms could remain (but the state
would take charge of any new undertakings)
 Created the “Planning Commission of India” which
formulates the “Five Year Plans” for India’s economy
 First “Five Year Plan” presented to Parliament in 1951:
 Focused resources on: irrigation & energy, agriculture
& community development, industry, social services,
and transportation & communications.
 Promoted a self-reliant, closed economy for India
 Greatly influenced by the ideas of Prof. P.C.
Mahalanobis of the Indian Statistical Institute
 “Mahalanobis Equation” expressed the entire Indian
economy in a single mathematical equation =>
planners tried to apply this theoretical representation
of the Indian economy to the real Indian economy
“Up the Marxist Mountain”: Economic system which
emerged in India had three self-defeating characteristics:
1. A Bias Toward State Ownership
2. The “Permit Raj”
3. A Rejection of International Commerce
1. Bias Toward State Ownership – increase in
government ownership and control in the economy,
reflecting what was described as the “Fabian’s measured
and slow paced ascent up the Marxist mountain.”
 Output of “public sector” increased from 8% of GDP
in 1960 to 26% of GDP by 1991.
 End of the 1980’s: 70% of all jobs were in state owned
enterprises in economy’s large “organized sector”
 Half of the 240 state-owned enterprises were
technically bankrupt => rather than letting them fail,
the government continued to operate these companies
 State owned companies operated in sheltered
markets, facing no competition => no incentive to
reduce costs or respond to customers’ desires; able
to continually incur losses without closing shop
 Example: “Hindustan Fertilizer Company” in 1991
- Factory constructed from 1971 to 1979, using
public funds to buy machinery from Germany,
Czechoslovakia, Poland, and several other
countries => different pieces of machinery did
not fit together and could therefore not be used
- For a dozen years nearly 1,200 employees
showed up to work every day
- No fertilizer produced for sale during the dozen
years when the plant was “open”
2. “Permit Raj” – complex system of licenses, controls,
regulation, and red-tape that influenced economic
decisions at all levels of production, investment, and
foreign trade in India’s private sector from 1947 to 1990.
 System operated by a maze of regulations, quotas &
tariffs, permits, and industrial licenses => businesses
found it nearly impossible to get anything done
 Everything needed “approval and a stamp”:
 If a firm wanted to make plastic pails instead of
plastic shovels, it needed government approval
 Any company worth over $20 million needed
government consent for all major actions (including
the membership of their Board of Directors)
 Experience of Narayana Murthy (founder and CEO
of Infosys, a successful Indian IT firm): it took 1224 months and 50 trips between Bangalore and
Delhi to get a license to import a computer worth
$1,500 (Bangalore and Delhi are 1,280 miles apart;
Atlanta and Denver are 1,204 miles apart)
 Nearly impossible to “work within the system” =>
people chose to “work outside the system” => high
levels of corruption; bribes became the norm
 In total, the system led to a distortion of or complete
elimination of incentives, risk taking, and
entrepreneurship
3. Rejection of International Commerce – a mindset of
“export pessimism” had settled over leaders in India,
leading the country to pursue “inward-looking trade
policies” intended to promote “self-sufficiency.”
 India attempted to protect its domestic manufacturing
industries via “Import Substitution” policies
 Rejected foreign trade and investment => excluded
themselves from the “emerging global economy”
 India fell behind technologically => technology frozen
at 1950’s/1960’s level for several decades
These characteristics of the economic system led to:
i. Shortages of goods in many markets
ii. Consumers having access to only low quality goods
at relatively high prices
Example: Automotive Industry
 Late 1940’s: Toyota started producing passenger cars
in Japan and Hindustan Motors began producing the
Ambassador car in India
 50 years later, Toyota was producing roughly
5,000,000 cars per year, while Hindustan Motors was
producing about 18,000 Ambassadors per year, still of
basically the same original model
 consumers often had to wait for 15 years to be able to
purchase a new Ambassador in India
Overall, the Indian economy was stagnant throughout much
of the 20th century => it was said (apologetically) that India
was consigned to a slower, “Hindu Rate of Growth”
“Poor performance” is especially noticeable in comparison
to the “Asian Tigers” and “New Tigers” which emerged
during the second half of the 20th Century
 India and South Korea had been at the same economic
level in 1960 => current levels of GDP per capita
(PPP): $2,700 in India versus $24,600 in South Korea
Drastic differences between India and the “Tigers”
regarding International Trade
 “Tigers”: “outward looking,” “export led growth”
approach => allowed for the realization of benefits of
international trade
 India: “inward looking,” “isolationist,” “import
substitution” approach => prevented the realization of
benefits of international trade
 Comparison of exports to (the fairly wealthy) OECD
(“Organization for Economic Cooperation and
Development”) countries at this time:
 India exported $9 billion worth of goods to OECD
countries
 South Korea exported $41 billion worth of goods to
OECD countires
 But India’s population is 20 times that of South
Korea’s!
Economic Reforms under Prime Minister Rao:
 Collapse of Soviet Union in 1991 sent shock waves
through the world and particularly India
 notion of “central planning” was shattered => the end
of a “role model” for India
 the collapse of India’s largest trading partner
 Decades of “Planning” and “Isolationism” had made
India’s economy stagnant, inefficient, and indebted
 India would begin a process of moving away from a
planned economy and toward a market economy during
the time when P.V. Narasimha Rao was Prime Minister
(from 1991 to 1996).
 Many of the reforms implemented in India were done so
under the guidance of two individuals:
Manmohan Singh – economist who served as Finance
Minister under Prime Minister Rao from 1991-1996, and
is currently the Prime Minister of India (since 2004);
played a central role in instituting economic reform
under Prime Minister Rao, with a focus on
macroeconomic issues
Palaniappan Chidambaram – lawyer and businessman
who served as Minister of State in the Indian Ministry of
Commerce under Prime Minister Rao from 1991-1992
and 1995-1996, and is currently Finance Minister of
India under Prime Minister Singh (since 2004); played a
central role in reforming trade policy and reducing
license/permits (i.e., deconstructing the Permit Raj)
 In 1991, India faced an impending economic disaster:
government was borrowing and accumulating large
debts; economic growth was virtually zero; foreign
investors were pulling money out of India
 India was on the verge of a financial and economic
collapse – Manmohan Singh observed that India was “at
the edge of a precipice” and there was “no time to
lose”…“the room to maneuver, to live on borrowed
money or time, does not exist.”
In a matter of weeks in 1991, Rao’s government (guided by
Singh and Chidambaram) instituted numerous reforms:
 Cut subsidies for domestic products and for exports
 Reduced tariffs and trade barriers
 Eliminated licenses for 80% of industry
 Eliminated requirements for big firms to get advanced
government approval to expand or diversify operations
 Reopened the door to foreign investment
 Began a process of “Disinvestment” (the term for
“Privatization” in India, whereby the government sold
some of its shares in government owned enterprises)
Singh noted: “…we got government off the backs of the
people of India, particularly of the backs of India’s
entrepreneurs. We introduced more competition, to release
the innovative spirits which were always there in India.
The economy turned around much sooner and much more
deeply than I had anticipated. The economy was growing
at a rate of 7% per annum, so our critics were completely
silenced.”
“Sunset of the Permit Raj”:
Indian economy has been radically transformed since 1991:
 License and approvals required under Permit Raj have
been mostly eliminated
 Quantitative restrictions on imports of goods and
agricultural products have been entirely removed
 Foreign trade has opened up => imports of $268.4
billion (ranked 13th) and exports of $164.3 billion
(ranked 21st) in 2010
 Foreign investment has opened up
 Corruption has been reduced
Experience of Narayana Murthy illustrates differences in
environment before/after the “sunset of the Permit Raj”:
 Recall, prior to the reforms it took 12-24 months and
50 trips between Bangalore and Delhi to import a
computer worth $1,500
 Murthy notes: “Ever since 1991, there has not been a
single instance when I went to Delhi for any license
for any business of Infosys. Today I can import a
computer worth millions of dollars” without having to
see a single bureaucrat or apply for any license.
Recent Economic Development: Bangalore – “India’s
Silicon Valley”…
Bangalore (current population of roughly 6,200,000,
making it the 3rd largest city in India) “symbolize India’s
new engagement with the world economy.”
 Emergence of Bangalore as a technology center resulted
from a combination of “vision, good public investment,
and the supportive policies of the government,” along
with the “overall economic liberalization of the 1990’s.”
 Planning under Prime Minister Pandit Nehru established
Bangalore as the center of India’s electronics and
military research industries
 Nehru’s emphasis on “education” and “research and
development” are illustrated by the establishment of the
“Indian Institute of Technology” in 1952 (provides
students with a demanding education and produces some
of the world’s brightest scientists and engineers)
 India’s investment in education paid off, providing the
country with world class professionals in the ever
important field of information technology
 Foreign enterprises noticed the “human capital rich labor
force” => attracted investment by high-tech foreign firms
 In 1985 “Texas Instruments” became the first foreign
high-tech firm to invest in Bangalore
 Other foreign, high-tech firms followed, attracted by
well-educated, English speaking labor force
 Another advantage: because of the 9-to-12 hour time
difference, a U.S. company with an office in Bangalore
could easily provide customers with 24 hour customer
support
 Led to Bangalore becoming a major center of “back
office services” (i.e., work involving billing, debt
collection, personnel records, etc.)
 Success of Bangalore:
 India’s software exports have recently grown by 50%
per year
 Broadly defined, Information Technology now
accounts for almost 3% of India’s total GDP
Experiences of Bangalore provide a lesson in how a
developing economy can succeed in the global economy:
 Chidambaram: “The lesson to be learned there is, the less
the regulation, the further the government is away from
business, the better it is for business.”
 Bangalore’s success “demonstrates what can happen
when a government invests in its human resources,
creates the right business environment, and trusts that the
business sense and entrepreneurial spirit of the people
will lead to spectacular results.”
 Clear pattern for the “role of the state” in regards to
promoting economic growth and development: “Invest in
human resources, create a favorable environment for
entrepreneurship, and let the markets do their work – the
rest will follow.”
Very solid recent Economic Growth…
Year
2003
2004
2005
2006
Growth Rate
4.3%
8.3%
6.2%
8.4%
Year
2007
2008
2009
2010
Growth Rate
9.2%
9.0%
7.4%
7.4%
This growth has led to higher overall standards of living in
India, evidenced by increases in Per Capita GDP
 Real Per Capita GDP more than doubled from $862.68
in 1991 to $1,705.72 in 2003
 From 2003 to 2009, it increased by an additional
71.9% to $2,932.49
The “Indian Elephant”? India has not emerged like a
“dragon” (like China) or a “Tiger” (like South Korea,
Taiwan, or Thailand)
 Perhaps the best zoological allusion is an “Elephant” –
“slow to rise and get up to speed, but, once in motion,
fast and steady, moving through thicket after thicket”
But, poverty is clearly still a pressing issue…
 As of 2005, 41.6% of the population is living in
“extreme poverty” (i.e., less than $1 per day)
 Bangalore illustrates the vast differences in living
standards that remain: the city is “an enclave amid an
ocean of poverty and illiteracy. Domino’s Pizza outlets,
golf courses, state-of-the-art gyms, and elite school
graduates armed with the latest in mobile technology
stand in stark contrast to the surrounding countryside,
where the average Indian still washes his clothes in a
nearby creek and has never made a telephone call.”
 But, the “lessons of Bangalore” suggest a way to reduce
overall poverty and bring about more widely shared
prosperity, specifically a further
- increased reliance on free market institutions,
- elimination of bureaucratic red-tape and corruption,
- integration into the world economy
 That is: “Invest in human resources, create a favorable
environment for entrepreneurship, and let the markets
do their work – the rest will follow.”