On Sep 6,2001, a team from the consulting firm McKinsey
unveiled a road map to spur India's growth to 10%. At the end of the 2
hour presentation Prime Minister Vajpayee is said to have sighed:
"But how is all this to be put through our polity?"
That difficulty may be the only one that stands between
India's present 5% growth and the tantalising 10%, that is said to be a
panacea for all of India's social ills. There is nothing calamitous in the
McKinsey prescription save in the eyes of those who see doom in letting in
global winds of change.
Investment vs. productivity:
The McKinsey study is insightful in how, far from having
to attract over 10 times the direct investment that India does now, the
climb from 5% to 10% can be achieved by consciously tweaking the system to
Now, productivity has to understood outside of the
picture that first pops up in our minds. Most of us imagine it as a
measure of work done in a unit of time. Yes, it is that but on a far wider
canvas than the man-machine-conveyor belt image that we see.
Productivity is about putting in place systems that
enable maximum yields from a given investment. Take the Indian power
sector. Growing energy needs can be met in two ways: 1- by searching for
the impossible dollars to create new facilities in the moribund state
system or 2- by privatising to plug thefts, subsidies and waste, which
will first yield more power and next attract fresh investments. Again
productivity oriented reforms, is about simplifying tax and excise tariffs
that enhance compliance and competition.
The current focus on productivity as a driver for growth
has largely been due to the work of Stanford professor Paul Romer.
Classically, economists have considered land, labour and capital as being
in lock-step with growth numbers. Then came the insight of Robert Solow
who proposed that technical advances will get economies to start jogging.
Finally comes Romer's assertion that focus on productivity will in fact
cause economies to sprint.
When awareness, laws, enforcement, education and business
climate of a country are conducive to competition and productivity, things
automatically perk up: investment follows, infrastructure is created ,
global competitiveness is enhanced and steady growth is achieved. [India
is well placed in the competitiveness race. See a related
article in this site on the work of Jeffrey Sachs and Michael Porter.]
In fact the opposite is the case when mere investment is
used to drive growth. This leads to over creation of capacity and supply
and is hard to sustain. Paul Krugman predicted for this reason, that the
heady growth rates of Asian Tigers would not last. His hunch was that
investment driven growth cannot last unless backed by deep and wide
reforms. Now Gordon Chang is
prophesying the " Coming Collapse of China" for this and other
The McKinsey promise:
Convinced of the primacy of productivity in driving
growth the McKinsey Global Institute began a series of studies that
covered 13 economies, among them Brazil, Korea and Germany. The studies
were overseen by hard headed economists. The conclusions were
unmistakable: productivity and efficient markets yield more growth than
capital alone can.
Armed with this knowledge, McKinsey turned to India. A
study was undertaken by Amadeo M. Di Ludovico, William W. Lewis, Vincent
Palmade and Shirish Sankhe, with inputs from India's econo-crats Montek
Singh Ahluwalia and Rakesh Mohan. [A
summary and the full report may be accessed from this link. Registration
required.]. It was this study which McKinsey presented to India's
According to the study a growth of more than 4% is denied
to India by just three barriers: distortions in product-markets [2.3%],
distortions in land-markets [1.3%] and state ownership of business [0.7%].
The study says these can be corrected by 13 initiatives. It asserts that
what inhibits growth is not lack of capital or poor infrastructure. Indeed
these will follow automatically as soon as distortions are removed.
If the 13 steps are taken, McKinsey promises a dream
scenario: GDP growth rate will hit 10%; economy will touch $1.1 trillion;
75 million jobs will be created outside agriculture; fiscal deficit will
fall from 10 to 6%; and Indians will live in a prosperous economy. In how
many years? Three, says McKinsey.
Let us consider Mckinsey's arguments.
The three barriers:
In the Indian product markets the following anomalies
reign: unfairness and ambiguity [as in telecom license fees], poor
enforcement [as in electricity revenue collections], reservations for
small scale sectors [ which stymy scaling potential as in the garment
industry], restricted entry to foreign investments [as in retailing] and
continued system of licensing [as for instance in the dairy industry, due
to pressure from the co-operatives sector].
McKinsey hold out the success of the Indian auto industry
following India's open door policy there: old clunky models died, better
and cheaper cars arrived and employment soared 11% in the 8 years
Turning to land related issues McKinsey says, when seen
in relation to GDP the cost of land per square meter in Indian metros is
about 11 times that in Tokyo, 8 times that in Singapore and 16 times that
in bustling Sydney. But why? Supply of land for development is way behind
demand. Again, why? McKinsey says land records and delays in legal
processes have tied up large tracts of land. Lacking clear titles, it is
difficult to offer them as collateral for funding. Add to that high
registration charges, poor tenancy laws and inflexible zoning and you have
blocked opportunities waiting in construction and retailing industries
which are the greatest potential employers outside agriculture.
The third barrier is government ownership of business.
McKinsey proves that the Indian worker is not naturally unproductive.
Labour productivity in state units as against similar units in the private
sectors are as follows: 3:27 in dairy; 10:20 in power generation; 0.5:3 in
power transmission; 10:55 in banking and 25:76 in telecom. McKinsey says,
"electricity boards lose a staggering 30 to 40 percent of their
power, mostly to theft. By comparison, best-practice private power
distributors lose only around 10 percent, mostly for technical
If the facts presented are compelling, the steps
suggested for sweeping away all these ills are audaciously simple, given
The 13 steps and life thereafter:
Here they are in McKinsey's own words:
1 Completely eliminate the reservation of products for
small-scale industry; start with 68 sectors accounting for 80 percent of
output of reserved sectors
2 Equalize sales taxes and excise duties for all
categories of players in each sector and strengthen enforcement
3 Establish an effective regulatory framework and strong
4 Remove all licensing and quasi-licensing restrictions
that limit the number of players in affected industries
5 Reduce import duties on all goods to the levels of
Southeast Asian countries (10 percent) over five years
6 Remove the ban on foreign direct investment in the
retail sector and allow unrestricted foreign direct investment in all
7 Resolve unclear real-estate titles by setting up
fast-track courts to settle disputes, computerizing land records, freeing
all property from constraints on sale, and removing limits on property
8 Raise property taxes and user charges for municipal
services and cut stamp duties (tax on property transactions) to promote
the development of residential and commercial land and to increase the
land markets liquidity
9 Reform tenancy laws to allow rents to move to market
10 Privatize the electricity sector and all companies
owned by the central and state governments; in the electricity sector,
start by privatizing distribution; in all other sectors, first privatize
the largest companies
11 Reform labor laws by repealing section 5-B of the
Industrial Disputes Act, by introducing standard retrenchment-compensation
norms and by allowing full flexibility in the use of contract labor
12 Transfer the management of the existing transport
infrastructure to the private sector; contract out the construction and
management of new infrastructure to it
13 Strengthen extension services to help farmers improve
This may generate political discomfort but how illogical
or inhuman are these suggestions? Indians must reflect that though we are
now cruising at about 5% growth, for the 40 years till 1990 we grew at the
derisive 'Hindu rate of growth' of 2.5%. [--by the way, that was a mocking phrase coined in a period when 'secularists' --and not Hindus-- were running a state controlled, socialist economy; the result of their endeavours was conveniently rubbished as 'Hindu'.] How did we get here?
Economists agree India has attracted little foreign investment. So, how
did India double its growth in 10 years? Obviously even the half hearted
lunges at piece-meal reforms in 90s have worked. Yes there was the noise
and heat of debates and protests, but we did it.
We can, yet again.