India's Next Challenge

After the election surprise, can India keep charting its own unique path to prosperity?

The most consequential event in this week’s news is without a doubt India’s elections — yes, more than the European Central Bank’s rate cut or the surprisingly strong US jobs report.

India’s elections are a remarkable logistical feat: over 640 million people voted (out of 970 million eligible voters) during about six weeks. Voting ended on June 1 and the initial results were announced on June 4. Democracy at work, with impressive orderly efficiency.

And democracy delivered a surprise, as PM Modi’s BJP fell short of expectations and failed to reach an outright majority. Modi will get a third five-year term, but this time at the helm of a coalition government.

Media across the world cheered the result. Predictably, because they have treated Modi like an outcast since he was first elected in 2014. I have argued in a past blog that India under Modi has been held to an unfair double-standard. Partly because Modi hails from what the majority in the media regards as the wrong side of the political spectrum, and partly because the British press can never hide its visceral resentment at India’s success. 

Indian voters have spoken, and hopefully those who had been warning of an “authoritarian turn” in India will now calm down. 

The election result, however, might complicate India’s economic outlook. 

Stronger growth

India’s economic growth enjoyed a strong acceleration over the last 30 years, sparked by a first round of market reforms in 1991. You can see the accelerating trend in this first chart: GDP growth per capita (so as to abstract from the impact of population growth) as a 3-year average to smooth out annual fluctuations.

Source: IMF

The acceleration is even clearer in the next chart, which takes average per capita GDP growth over four distinct periods: before the 1991 reforms; after the reforms and before the current government came to power (1992-2013); the first six years with Modi as PM (2014-2019) and the post-pandemic period (2021-2023). 

Source: IMF

Simply cutting out the 2020 pandemic year, when per capita GDP contracted by nearly 7%, exaggerates a bit the strength of the last three years, as robust 2021 growth was partly a rebound effect, but the upward trend is clear. 

Faster growth has yielded major benefits. By 2023 employment had rebounded above pre-pandemic levels, and the last several years have registered a rise in labor force participation and a marked decline in unemployment, as shown by this chart, taken from the December 2023 IMF Staff Report:

Source: IMF India Staff Report, December 2023

Discontent with unemployment and inflation (running just under 5%) are said to have played a role in the election outcome, but the progress made is undeniable.

And a massive poverty reduction

One of the best things about strong economic growth is how quickly it reduces poverty: a recent Brookings paper notes that India has now virtually eliminated extreme poverty ($1.9 per day on purchasing power parity), with the Headcount Poverty Ratio falling from about 12% in 2011-12 to just 2% in 2022-23. Poverty as defined by a $3.2 per day on purchasing power parity has fallen from about 54% to just over 20% over the same period. 

Source: Brookings

The IMF estimates that India has lifted over 400 million people out of poverty since 2005. The Brookings authors point out that the statistics do not take into account the additional support that poor households receive in free food distributed to two-thirds of India’s population. This represents the continuation of a long ongoing improvement: extreme poverty has been in continuous decline from about 50% at the time of the 1991 reforms. 

Over the same period India has also secured a significant reduction in both urban and rural inequality, always according to Brookings (1).

Charting its own path

India’s impressive progress has been powered by a three-pillar strategy:

• Market reforms, which accelerated in recent years with moves to cut bureaucratic red tape and improve the business climate, often leveraging India’s digital strategy, as well as significant labor market reforms.

• The launch of a best-in-class digital infrastructure, starting with the biometric digital identity system Aadhaar in 2009, as I detailed in a previous post. 

• A decisive and well-structured effort by the Modi administration to address basic needs of the population — including constructing toilets and broadening access to cleaner cooking fuel, electricity and piped water — and to bolster traditional infrastructure.

With this three-pronged strategy, India has charted its own unique path, very unlike other emerging markets. As it scaled back the importance of agriculture, it has increasingly turned to services, rather than low-cost manufacturing. India’s growth is powered more by capital investment and productivity gains rather than being labor-driven — which makes India’s model closer to that of advanced economies. 

This model, however, has not sufficed to create a large enough number of well paying jobs, which India needs to bolster its middle class and gradually work its way up the middle income ranks (it currently qualifies a lower-middle income country) and eventually out of the middle income trap. Over half of India’s workforce is still in agriculture, construction and trade, sectors characterized by low wages and low productivity. 

To get a quick sense of the limits of this growth strategy, consider the extent to which India has fallen behind China: in 1990, India and China accounted for nearly equal shares of global GDP; today China accounts for one-fifth of the global economy, more than twice India’s share.

Source: IMF

The consensus is that India needs to bolster its manufacturing sector; but here it faces a double challenge: First, the bulk of India’s workforce is still low-skilled, unprepared for the opportunities offered by the manufacturing sector. Second, global manufacturing has become a much tougher game, with advanced economies trying to reshore production and digital innovation bringing continuous disruption and the threat of automation.  

The next challenge

Now India has a major opportunity: with a first-rate public digital infrastructure, a tradition of software excellence and outstanding STEM education in its elite academic institutions, India could make fast inroads in developing a stronger and competitive manufacturing industry through the rapid deployment of digital-industrial technologies. 

To get there, though, India has its work cut out: First, it needs to foster a greater shift of its labor force towards manufacturing; this will require faster implementation of the latest labor market reforms, up-skilling, steps to raise female labor force participation as well as land reform. India also needs further liberalization to encourage firms to scale, and it should continue its efforts to bolster traditional infrastructure — efforts that in the last several years have enjoyed an important acceleration. 

The election result complicates the picture. While the BJP’s allies seem to support Modi’s economic agenda, coalition governments require compromises and are less conducive to ambitious reforms. And the Congress Party, the main opposition force, gained a significant increase in support after running a campaign of populist socialist measures — to the point that the Wall Street Journal wondered if an unlikely Congress victory might send India the way of Venezuela…

A best case scenario is that a BJP-led coalition government will maintain momentum on crucial economic reforms, buttressing them with additional measures to further reduce poverty. This would help India maintain a strong pace of growth, which is the best way to address the population’s desire for more and better jobs and higher living standard. And if India manages to carve out a greater role in advanced manufacturing, this could make strong growth long-lasting and offer a more reliable path to the upper middle-income ranks. In this scenario, India would continue to successfully chart its own unique path to economic development

Backsliding on reforms would instead slow the country’s economic progress. That would be a shame, given India’s impressive progress so far and the substantial opportunity — and need — for further fast economic advancement. 

Anyone who wants a stronger global economy should hope that India’s success story will continue.

Opening photo credit: Unsplash+

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(1) One caveat: India’s statistics could still do with some improvement, which leaves an extra margin of uncertainty on some of these numbers. For example, the World Bank  still shows extreme poverty at close to 9% in 2021, though the Brookings author argue that the WB is relying on flawed data in this case. WB data though also show a major decline in poverty over the past three decades.