SCEPTICS remain unconvinced that liberal trade and foreign investment policies have resulted in a significant improvement in the performance of India's external sector.They argue that export growth during 1990s has not been much higher than that achieved during 1980s when the level of protection rivalled Mount Everest. They likewise argue that the response of foreign investment to liberalisation has been less than overwhelming.Are the sceptics right? The answer is a qualified 'no'. Evidence on the relative performance of the external sector during 1980s and 1990s belies the sceptics.
Exports of goods and services grew at an annual rate 10.7 per cent during 1990s compared with only 7.4 per cent during 1980s. Likewise, imports grew at 9.7 per cent during 1990s but only 5.9 per cent during 1980s.The annual growth rate of exports as well as imports has, thus, risen by 3.3 percentage points. This rise has manifested itself in a significant increase in the imports-to-GDP and exports-to-GDP ratios.On the export side, the ratio approximately doubled from 7.3 per cent to 14 per cent between 1990 and 2000 and on the imports side it jumped from 9.9 per cent to 16.6 per cent.The overall trade to GDP ratio has thus gone up from 17.2 per cent in 1990 to 30.6 per cent in 2000. In contrast, the change in the trade-to-GDP ratio between 1980 and 1990 was tiny: from 15.2 per cent to 17.2 per cent. On the foreign investment front, India has been receiving approximately $5 billion every year since 1994-95 compared with just $0.1 billion during 1990-91.This amount is split approximately equally between foreign direct investment (FDI) and portfolio investment. There has also been a significant shift in the remittances from abroad: from $2.1 billion in 1990 to $12.3 billion in 2000.While the basic claim of the sceptics is thus readily refuted, it must be acknowledged that the response of the external sector to liberal trade and investment policies has been an order of magnitude weaker in India than China.
Exports of goods and services grew at annual rates of 12.9 and 15.2 per cent during 1980s and 1990s respectively in China. Imports exhibited a similar performance. Consequently, China's total trade to GDP ratio rose from 18.9 per cent in 1980 to 34 per cent in 1990 and to 49.3 per cent in 2000.On the foreign investment front, differences are even starker. FDI into China has risen from $.06 billion in 1980 to $3.49 billion in 1990 and then to a whopping $42.10 billion in 2000.China was slower to open its market to portfolio investment but once it did, inflows quickly surpassed those into India, reaching $7.8 billion in 2000. Even if we allow for an upward bias in the figures as suggested by some China specialists, there is little doubt that foreign investment flows into China are several times those into India.While some differences between the performances of India and China can be attributed to the Chinese entrepreneurs in Hong Kong and Taiwan, who have been eager to escape rising wages in their respective home economies by moving to China, a more central explanation lies in the differences between the compositions of GDPs in the two countries. Among developing countries, India is unique in having a very large share of its GDP in the mostly informal part of the services sector.
Whereas in other countries, a decline in the share of agriculture in GDP has been accompanied by a substantial expansion of industry in the early stages of development, in India this has not happened.For example, in 1980, the proportion of GDP originating in industry was 48.5 per cent in China but only 24.2 per cent in India. Services, on the other hand, contributed only 21.4 per cent to GDP in China but as much as 37.2 per cent in India. In the following twenty years, despite considerable growth, the share of industry did not rise in India. Instead, the entire decline in the share of agriculture was absorbed by services.Though a similar process was observed in China, the share of industry in GDP was already quite high there. As a result, even in 2000, the share of services in GDP was 33.2 per cent in China compared with 48.2 per cent in India.Why does this matter? Because typically, under liberal trade policies, developing countries are much more likely to be able to expand exports and imports if a large proportion of their output originates in industry.
Not only is the scope for expanding labour-intensive manufactures greater, a larger industrial sector also requires imported inputs thereby offering greater scope for the expansion of imports. In India, the response of imports has been just as muted as that of exports.This is demonstrated by the fact that recently RBI has had to purchase huge amounts of foreign exchange to keep the rupee from appreciating. Imports have simply failed to absorb the foreign exchange generated by even modest foreign investment flows and remittances.This same factor is also at work in explaining the relatively modest response of FDI to liberal policies. Investment into industry, whether domestic or foreign, has been sluggish.Foreign investors are hesitant to invest in the industry for much the same reasons as domestic investors. At the same time, the capacity of the formal services sector to absorb foreign investment is limited. The information technology sector has shown promise, but its base is still small. Moreover, this sector is more intensive in skilled labour than physical capital.Therefore, the solution to both trade and FDI expansion in India lies in stimulating growth in industry. The necessary steps are now common knowledge: bring all tariffs down to 10 per cent or less, abolish the small-scale industries reservation, institute an exit policy and bankruptcy laws and privatise all public sector undertakings. The real question is: Will the government act?
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