Failure of 1991 reforms

1991 reforms: Weak balance sheet, found wanting on manufacturing and employment

Print edition : September 24, 2021

At the Tata Consultancy Services (TCS) campus in Siruseri near Chennai, a file picture. The software industry relied heavily on implicit and explicit state support for its development and expansion, by way of tax holidays and skilled labour from top-notch public institutions. Photo: Dhiraj Singh/Bloomberg

Contrary to popular perception, the economic reforms of 1991 were a dismal failure as they did not address chronic issues in the areas of manufacturing and employment, and the success stories credited to liberalisation were in fact a result of active state policy rather than state withdrawal.

There is a view popular among the elite and middle classes of India, which is constantly reinforced by articles and discussions in mainstream media, about the “before” and “after” of economic liberalisation. According to this, in the period between Independence and 1991, the Indian economy was desperate, depressed, shackled and constrained, with endless shortages, no economic opportunities and lack of availability of most consumer goods. All of this apparently changed completely with the onset of the liberalising economic reforms, which brought in faster growth, more access to a wider range of consumer goods, and more or less anything that is now seen as positive in the economy.

This view is as ridiculous as the one that claims that “nothing happened” and no progress was made in India for 70 years after Independence, until a particular party and leader came to power. Yet, it is surprising that those who see the absurdity of one position still cling faithfully to the other, when both are so obviously wrong.

India in 1991

When economic reforms were introduced in 1991, India was already a semi-industrialised economy with a significant degree of economic diversification compared to most other developing countries. Many of the much-vaunted “successes” of the past three decades, such as the rapid growth of the software industry or the global emergence of pharma companies that could make the cheapest drugs in the world, would not have been possible without public regulations and institutions that were nurtured by successive governments—from public sector manufacturing units to higher education institutions.

Of course, this is not to say that all was well with the Indian development project before 1991. Rather, it showed quite significant failures on many crucial fronts. But none of those failures have actually been remedied by economic liberalisation from the early 1990s; if anything, they have been further extended and accentuated. The reforms were supposed to address failures, such as low employment generation, insufficient economic diversification out of primary activities and low-paying services into higher-value-added manufacturing, the persistence of income and food poverty and the poor performance of human development indicators.

Yet, if anything, the progress on these fronts has slowed down or even reversed in the three decades of reforms. Even the limited structural transformation that had occurred by the 1990s has reversed in the most recent decade.

Also read: Neoliberalism: An era of growth sans justice

The immediate goals of the 1991 economic reforms were stabilisation and external adjustment, because the economy was then facing a severe balance of payments crisis that was met with a devaluation of the rupee in July 1991. But this was accompanied by other very significant changes, such as major trade liberalisation, which opened up imports of a range of goods and reduced export incentives, followed by deregulation of domestic investment, including financial investment, and eventually easing of restrictions on foreign capital to operate in the country.

These measures were based on the idea that removing restrictive regulations on international trade and controls on agents in different markets would force Indian producers to become more competitive and “efficient”. Meanwhile, providing incentives and concessions to large capital was expected to increase private investment. Opening up the financial sector was meant to enable domestic investment to increase well beyond the limits posed by domestic savings. Large corporate investment from within and outside the country was supposed to become the engine of growth, increasing employment especially in the formal sector, causing incomes to grow across the board through the “trickle down” effect, thereby improving both living standards and social indicators.

Pros and cons of deregulation

Some of the domestic deregulation was certainly necessary, for example in transport equipment and civil aviation, both of which experienced significant expansion and lower prices for consumers, as existing oligopolies were forced to compete with other local and global producers. But in many other sectors, deregulation and trade liberalisation had a dampening effect, as local enterprises found themselves unable to compete with cheaper or more aggressively marketed products of multinationals and other producers that benefited from economies of scale and public subsidies provided by their home governments.

The overall rate of growth did increase somewhat in the 1990s, and much more in the 2000s, when India was “discovered” as a favourable destination for global capital. Ironically, though, the sectoral successes of the 1990s that then spilled over into the 2000s were the result of quite specific industrial policies rather than blanket liberalisation.

The three striking successes were in the pharma, software and automobile industries, all of which became successful net exporters. However, none of them could have achieved success without active trade and industrial policies and implicit government support—so much so that the subsequent reduction of that support led to a decline in their fortunes.

The Indian pharma industry gained directly from the operations of the Indian Patents Act, 1960, which allowed only process patents for chemicals and pharmaceuticals. This enabled “reverse engineering” of drugs and created what became the cheapest and most effective drug industry in the world. However, once the effects of the World Trade Organisation’s (WTO) Trade-Related Aspects of Intellectual Property Rights (TRIPS) agreement (which required product patents on everything, including drugs) fully kicked in from 2005, this was no longer possible. Since then, domestic pharma industry has struggled and several of the more successful firms have simply been taken over by multinationals. Even worse, India has gone from being a major producer of bulk drugs to being heavily reliant on imports (primarily from China), after the public sector drug companies were starved of investment and allowed to stagnate and some of them were even closed down.

The software industry is often presented as the iconic example of the success of the economic liberalisation strategy. Yet, this industry too relied heavily on implicit and explicit state support for its initial development and subsequent expansion. The technical education provided by the Indian Institutes of Technology and similar public institutions proved to be a major source of supply of the necessary skilled labour (and even of the initial entrepreneurs).

Success with state support

The industry benefited from major fiscal incentives, most of all the tax holidays on profits that were introduced in 1999 and continued for two decades. Obviously, this was a critical element that enabled low pricing of its export services; since the end of that period of windfall tax breaks, the industry’s growth has decelerated.

Also read: ‘A corporate-communal nexus has emerged’: Sitaram Yechury

Another aspect critical to its performance was the Indian government’s conscious decision to promote the domestic software industry at the expense of the nascent computer hardware industry (unlike China, which initially did the opposite). As a result of this strategy, import tariffs on hardware were lowered, effectively destroying the possibilities for a vibrant domestic computer industry. This has become a concern in recent years as more and more software comes embedded in hardware (whether in computers or tablets or mobile phones), which means that Indian companies can only compete for specific bespoke software services and business process outsourcing even within India—to the point that the country may soon become a net importer of software services.

The automobile sector expanded rapidly once the licencing constraints on other producers were removed and foreign investment into the sector was encouraged. But in the 1990s, this liberalisation of investment rules was accompanied by active industrial policy in the form of gradually increasing domestic content requirements, which forced the foreign companies investing in India to get a higher proportion of their inputs from domestic suppliers. This enabled the creation of a flourishing automobile ancillary industry and created industrial hubs of automobile and parts production in several regions.

Once again, the WTO’s Agreement on Trade-Related Investment Measures (TRIMS) agreement effectively constrained this policy, but fortunately this was only from 2005, after these industries had already emerged and developed to the point that they were competitive.

Other industries that did not get similar advantages did not do so well; many of them, especially small and medium-sized enterprises, could not cope with the competition from imports, especially as infrastructure constraints continued to loom large. The public investment that could have provided the necessary infrastructure was not forthcoming, since the government continued to believe that private investment would take up the slack, especially through “public-private partnerships” that effectively made taxpayers take on all the risks of investment. And while large players were given both freedom and various concessions, the “licence raj” continued to plague small and micro enterprises, adding to their costs and reducing their financial viability.

Contrary to the grandiose claims and expectations of liberalisers, manufacturing in India, especially labour-intensive manufacturing, simply did not take off after liberalisation. The share of manufacturing in the country’s gross domestic product (GDP) fluctuated around low levels of 15-18 per cent throughout the period between 1980 and 2010. Thereafter, it fell even further, despite the declared “Make in India” strategy of the current government. It has plummeted to only 12-13 per cent of the GDP in the past two years, according to World Bank data.

Victims of reforms

Agriculture also suffered because of the neoliberal reforms, not only because it was neglected by successive Central governments until the mid-2000s, but because the large majority of small-holder farmers in India were exposed to the vagaries of very volatile global prices and competition from heavily subsidised northern agribusinesses.

The reforms have threatened both food security and the viability of cultivation, which still accounts for around half of the recognised workforce. The latest attempts to increase corporate power in agriculture through the three farm laws brought in last year would be the final nail in the coffin for Indian farmers, although the continuing protests against these laws may have kept their implementation on hold, at least for the present.

Meanwhile, the period of economic boom in the 2000s, essentially between 2002 and 2012, was very much also the result of active state policy rather than state withdrawal. Since the idea was to provide incentives to large private capital, state policy let them grab resources (everything from land to forests to minerals to water to spectrum) and despoil nature. The policy also involved privatising of utilities and public services that are best delivered by public agencies and providing continuous and increasing tax benefits to large corporations.

Also read: P. Chidambaram: ‘Now, cronyism is a bitter fact’

Predictably, this led to massive increases in inequality and fiscal constraints upon the state, which could not meet its obligation to provide essential public services, such as nutrition, health and education, to its people. Worryingly, this uneven and unequal growth also caused substantial environmental damage, and ecological and climate changes are now affecting not just economic activity but even human existence.

Possibly the most significant failed promise of the economic liberalisation has been the dismal performance of employment. This was poor even during the so-called boom phase of the economy: formal jobs barely grew, informal employment continued to predominate among workers, and women’s workforce participation collapsed to unbelievably low levels despite supposedly rapid economic growth.

In the 2010s, matters deteriorated further as declining investment and new tendencies towards automation further eroded job opportunities. The pandemic has brought about catastrophic changes in the labour market, with a significant number of job losses and substantially lower incomes even for those who do still have employment.

So, the balance sheet for the period of economic reforms does not look too good. There is reason to believe that it is one of the basic reasons why India has struggled to deal with a public health crisis like the pandemic. Given all this, the widespread perception that these reforms were a major success remains a mystery.

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