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India’s Transformation After gaining independence from Britain in 1947, India adopted a democratic system of government. The economic system that developed in India after 1947 was a mixed economy characterized by a large number of state-owned enterprises, centralized planning, and subsidies. This system constrained the growth of the private sector. Private companies could expand only with government permission. It could take years to get permission to diversify into a new product. Much of heavy industry, such as auto, chemical, and steel production, was reserved for state-owned enterprises. Production quotas and high tariffs on imports also stunted the development of a healthy private sector, as did labor laws that made it difficult to fire employees. By the early 1990s, it was clear that this system was incapable of delivering the kind of economic progress that many Southeastern Asian nations had started to enjoy. In 1994, India’s economy was still smaller than Belgium’s, despite having a population of 950 million. Its GDP per capita was a paltry $310; less than half the population could read; only 6 million had access to telephones; only 14 percent had access to clean sanitation; the World Bank estimated that some 40 percent of the world’s desperately poor lived in India; and only 2.3 percent of the population had a household income in excess of $2,484. The lack of progress led the government to embark on an ambitious economic reform program. Starting in 1991, much of the industrial licensing system was dismantled, and several areas once closed to the private sector were opened, including electricity generation, parts of the oil industry, steelmaking, air transport, and some areas of the telecommunications industry. Investment by foreign enterprises— formerly allowed only grudgingly and subject to arbitrary ceilings, was suddenly welcomed. Approval was made automatic for foreign equity stakes of up to 51 percent in an Indian enterprise, and 100 percent foreign ownership was allowed under certain circumstances. Raw materials and many industrial goods could be freely imported and the maximum tariff that could be levied on imports was reduced from 400 percent to 65 percent. The top income tax rate was also reduced, and corporate tax fell from 57.5 percent to 46 percent in 1994, and then to 35 percent in 1997. The government also announced plans to start privatizing India’s state-owned businesses, some 40 percent of which were losing money in the early 1990s. Judged by some measures, the response to these economic reforms has been impressive. The economy expanded at an annual rate of about 6.3 percent from 1994 to 2004, and then accelerated to 9 percent per annum during 2005–2008. Foreign investment, a key indicator of how attractive foreign companies thought the Indian economy was, jumped from $150 million in 1991 to $36.7 billion in 2008. Some economic sectors have done particularly well, such as the information technology sector where India has emerged as a vibrant global center for software development with sales of $50 billion in 2007 (about 5.4 percent of GDP) up from just $150 million in 1990. In pharmaceuticals too, Indian companies are emerging as credible players on the global marketplace, primarily by selling low-cost, generic versions of drugs that have come off patent in the developed world. However, the country still has a long way to go. Attempts to further reduce import tariffs have been stalled by political opposition from employers, employees, and politicians, who fear that if barriers come down, a flood of inexpensive Chinese products will enter India. The privatization program continues to hit speed bumps—the latest in September 2003 when the Indian Supreme Court ruled that the government could not privatize two state-owned oil companies without explicit approval from the parliament. State owned firms still account for 38 percent of national output in the nonfarm sector, yet India’s private firms are 30–40 percent more productive than their state-owned enterprises. There has also been strong resistance to reforming many of India’s laws that make it difficult for private business to operate efficiently. For example, labor laws make it almost impossible for firms with more than 100 employees to fire workers, creating a disincentive for entrepreneurs to grow their enterprises beyond 100 employees. Other laws mandate that certain products can be manufactured only by small companies, effectively making it impossible for companies in these industries to attain the scale required to compete internationally.

Case Discussion Questions

A. What kind of economic system did India operate under during 1947 to 1990? What kind of system is it moving toward today? What are the impediments to completing this transformation?

B. How might widespread public ownership of businesses and extensive government regulations have impacted (1) the efficiency of state and private businesses, and (2) the rate of new business formation in India during the 1947–1990 time frame? How do you think these factors affected the rate of economic growth in India during this time frame?

C. How would privatization, deregulation, and the removal of barriers to foreign direct investment affect the efficiency of business, new business formation, and the rate of economic growth in India during the post-1990 time period?

D. India now has pockets of strengths in key high technology industries such as software and pharmaceuticals. Why do you think India is developing strength in these areas? How might success in these industries help to generate growth in the other sectors of the Indian economy?

E. Given what is now occurring in the Indian economy, do you think the country represents an attractive target for inward investment by foreign multinationals selling consumer products? Why?