Towards an Indian growth model

The lasting contribution of Arvind Panagariya’s new book on the Nehru Development Model is likely to be the drawing out of the consequences of choices made including the inevitable corroding of institutions with persistent effects.

Past distortions

The bureaucratic structure set up for planning, forex allocation, industrial licensing, resulted in the infamous license-permit raj and created severe distortions.

There is also the point that choices made were inappropriate for the structure of the economy. A labour surplus economy needed labour intensive industry to create jobs, but scarce resources were tied-up in heavy industry.

Consumer goods were reserved for cottage industry without the capital to develop scale and become export competitive. The absence of mass jobs reduced incentives for and investment in primary education. Government sponsored higher education was for the elite.

In the OUP Handbook on the economy I edited I had developed the SIIO paradigm — of structure and ideas becoming engraved in institutions and affecting outcomes.

There were other causal factors that affected institutions apart from the mismatch of ideas to structure: Planning came on top of British centralism and a federal structure leading to overlap in decision-making, obstruction and delays. Ensuring uniform public goods, the original mandate of finance commissions (FCs), was also diluted in order to raise resources for planning.

Local autonomy is essential for public goods. Delivery should be near users and accountable to them. Democracy with a rare full franchise should have led to broad-based economic empowerment, but our structure enabled political use of caste, community and poverty to create vote banks. Decentralization of funds and functionaries to the 3rd tier was limited.

As Chairman of 16th FC, Panagariya has a unique opportunity, following on his analysis, to increase decentralisation and re-establish the constitutional hierarchy among institutions. Forward-looking inducements can help restrict state borrowing to investment and development expenditures that enhance growth. Revenue deficit grants could be given to cover only such expenditures.

The role of markets

The book suggests that a lack of support for markets is the other lasting fallout of Nehruvian socialism. But except for a few ideologues, no one is in favour of government allocation. The difficulty is to change institutions designed to control activity.

Decision by committees also makes India slow moving. A decisive leader enables faster change. We are benefitting from that. But there is support for a greater role for markets across the political spectrum. This is also pushed now by more voter awareness and pressure for delivery of public goods. In elections the development and infrastructure plank has done better than the freebie model. Doles are not sufficient for rising aspirations.

It is ironical that an economy that had once been a hub of global trade was closed because of openness to international ideas of the time such as import substitution for development, a government led big push.

These were inappropriate for India’s structure, but there was hardly any opposition from economists, foreign or domestic. There tends to be herding among economists — it is safer to follow academically or politically fashionable ideas.

That is why it is good to have local schools, who may be more aware of domestic conditions and resist dominant ideologies. The Bombay school was a rare nay sayer to the Nehru model — pointing to the importance of developing the wage goods sector in Indian conditions. Our relative neglect of agriculture has often led to inflation that stalled growth.

Moreover, extreme pro-market positions are also dangerous. There was strong international pressure for full capital account liberalisation.

Our gradualism, reserve buffers and prudential regulation has helped us to navigate the many global shocks of the liberalisation period. Post-pandemic also there was intense analyst pressure for monetary policy to follow the Fed, but our degrees of freedom, partly due to the absence of full capital account convertibility, helped give us a robust recovery.

At last there was attention to a major wage good — food and the impact of food prices on inflation.

India’s growth model

So what is India’s growth model? The same issues seem to be debated today. There are those who believe only exports can create enough jobs, but others say that given the international situation we need to focus on domestic demand.

Some think we have missed the manufacturing bus and should specialise in service exports that have worked well for us. Others think high-tech manufacturing is the way. But neither that nor services create mass jobs.

Given our diversity and the size of our population an extreme solution is unlikely to work for us. Domestic as well as global demand under competitive openness will add to the diversity that has helped us survive global shocks.

Services, manufacturing as well as agriculture are all delivering. The middle ground allows a thousand initiatives to bloom. Today, capital is not a constraint. There is enough to allow both MSMEs and high tech industry to grow and compete internationally with incentive-compatible policy help.

Apart from competitive openness, productivity is the other vital ingredient that was neglected in the earlier debate. It is the factor that can ensure domestic demand rises by enough to create more jobs, inclusion and demand for education. Technology such as AI, if used well, can raise lower level productivity and suits the age profile of our workers. Public goods also raise productivity. Communication technology is improving governance and coordination in delivery, although rationalising institutions remains work in progress.

The government tries to do enough on the supply-side to relieve bottlenecks and allow growth to continue. This is essential and can slowly raise potential growth, but if macroeconomic smoothing is neglected growth becomes volatile, given the shocks we face, reducing average growth. The post-pandemic experience shows we have the space for counter-cyclical policy.

After independence India suffered from a fixed exchange rate and lost competitiveness. A full float, given global risk led capital flow surges, will be equally harmful. International and market-led pressures for this must be resisted. Excess volatility helps markets make money but hurts the real sector.

Our post-liberalisation policy of building buffers and intervening to reduce excess volatility and real misalignment, while allowing the nominal rate to be market-determined, works well. Given our dependence on oil imports we cannot afford excess depreciation and given our current account deficit we cannot afford excess appreciation.

The writer is Emeritus Professor, IGIDR. The article develops comments made as a discussant for Dr. Panagariya’s lecture at IGIDR

Published on June 2, 2025

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