Why Modi failed to transform the economy

In May 2014, Narendra Modi swept into power on the promise of transforming the economy through decisive governance. Since then, he has been vocal, travelled the world, announced a stream of programmes, one notably called ‘Make in India’, and shown himself to be no different from India’s run-of-the-mill politicians in resorting to new welfare schemes. But his government has had little success in transforming the economy, an outcome signalled by the symbolic dismantling of the Planning Commission and its replacement by the Niti Aayog.

He came promising better infrastructure and more jobs. As far as infrastructure is concerned, it is difficult to see a dent having been made in a country severely short of it. As for jobs created, the government’s claims of success have been contested by independent economists, who have offered alternative estimates. But nowhere is the government’s failure more evident than in the investment figures. For much of this government’s tenure, private investment as a share of the economy has declined. It is lower now, at the very end of its term, than it was at its beginning.

The conclusion is inescapable that Modi’s economic policy has failed to inspire the confidence of India’s private sector. Private investment is based on the expectation of profit, which itself is based on the anticipated performance of the economy. By this logic, India’s private sector has not been bullish on the policies of the Modi government. On the other hand, the government has been successful in garnering record foreign direct investment (FDI), but this is so small a share of total investment in India that it has not made much of a difference to the economy.

Why has Modi failed to make a significant difference to the economy? The reason is not far to seek. Economic policy since 2014 has proved to be remarkably tame. For an aggressively nationalistic politician, Modi chose the ‘Washington Consensus’ to guide his government’s economic policies. The Washington Consensus refers to a set of economic doctrines adopted as universally valid by the World Bank and the IMF in the mid-90s, a time of rapid globalisation and, following the collapse of the Soviet Union, extreme belief in the transformative power of markets. Among its central tenets were a reduced role for the State, macroeconomic stability defined by low budget deficits and stable inflation, unrestricted cross border capital flows and privatisation of state enterprises.

In its economic policies, the Modi government has attempted to follow this model. It has succeeded in lowering the deficit and in maintaining low inflation, though possibly at the cost of growth. Its USP, however, has been to ease the doing of business, which relates to the interface of private enterprise with the State. That is evident in the country’s progress on the ease-of-doing-business ranking of the World Bank. Though a construct that has attracted controversy, India moving 50 places in the country table for this index points to an improvement of the economy’s supply side, at least for the manufacturing sector.

But, clearly, the problem is not on the supply side. Declining investment slows demand growth, which has a depressing effect on the economy and feeds back into private investment. This appears to have been missed by the government and its advisers who have remained attached to a view of the investment climate that focuses exclusively on the supply side.

It is not as if there were no economic policy options in this situation. The response of government at a time of sliding private investment ought to be the expansion of public investment. India is extremely short of effective public capital. The construction of roads and bridges would not only have buoyed demand in the short run, it would also have created enabling conditions for growth. However, a conservative government was unwilling to expand public spending on capital formation. Only ideological commitment can account for a commitment to shrinking the government in an economy with the infrastructure deficit statistics of India. Public spending in relation to the size of the economy is lower here than in several OECD countries.

Finally, there was Modi’s spectacular faux pas. Termed ‘demonetisation’, it involved first sucking out and then replacing around 85% of the currency in circulation, ostensibly to flush out ‘black money’. A contraction in certain sectors of the economy followed immediately, and GDP growth rate has not yet recovered. The growth rate of the economy may well have declined for reasons other than demonetisation, too, but the separate impact of demonetisation is evident in the contraction that followed in manufacturing.

The Modi government has made a fetish of ‘less cash’, valourising demonetisation for having nudged the economy in that direction. However, economics does not predict that moving to an electronic payments mechanism can be a substitute for the far harder task of increasing labour productivity, which alone can raise living standards. Overall, this government appears to have mistaken the architecture of an economy for its sinews, leave alone its driving force.

The Modi government’s failure to transform the economy points to where exactly action is now needed. Even as the sector supports the largest section of the population, agriculture has received scant attention from this government. Low agricultural income per capita depresses the rest of the economy. To spread prosperity in India an agricultural revival is necessary. Some clues on how to achieve this exist.

In the five years from 2003, Indian agriculture recorded its fastest ever growth, and the economy was particularly buoyant. We now know what contributed to this spurt. Loan waivers and raising minimum support prices were not part of the policy package, public investment was. Political parties aspiring to the reigns of the country following the Lok Sabha elections may want to bear this in mind if they intend to make a difference.

(The writer is Professor of Economics, Ashoka University, Sonipat)