|| Home || Site Directory || Feedback || Send This Story To Friends ||  Support GNI ||


McKinsey to India: "It's just 13 steps to good times."

It may be a tough-ask, but the McKinsey prescription is clarity all the way.

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 enhance productivity.

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 related reasons.

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 decision makers.

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 following 1992.

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 reasons".

If the facts presented are compelling, the steps suggested for sweeping away all these ills are audaciously simple, given political will.

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 regulatory bodies

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 sectors

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 ownership

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 levels 

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 their yield

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.