The Poverty Miracle: Three decades of market-based reforms have dramatically reduced poverty and expanded India's middle class. But the business climate remains uneven.

AuthorRees, Matthew

What has been the most consequential change to the global economy during the past thirty years? While there are many potential candidates--such as the collapse of Communism and the growth of the capital markets--history will show that one change outflanks them all: poverty reduction. Approximately 1.5 billion people have escaped extreme poverty since 1990. The combination of the speed with which this occurred, and the number of people who benefited, is without precedent in human history.

But how did it happen?

It's standard practice for development economists to say that every country has a unique set of conditions, and thus policies that reduce poverty in one country won't necessarily do the same in another country. This idea overlooks that while the most successful anti-poverty policies have differed, the principles underpinning those policies have been remarkably similar: reduced state intervention in the economy and a greater reliance on market forces.

Consider the findings of the independent Commission on Growth and Development, chaired by Nobel laureate economist Michael Spence. In 2008, it identified five factors that had contributed to strong and prolonged growth in seventeen developing countries. Three of the factors were relatively agnostic on the scope of government: macroeconomic stability, high rates of saving and investment, and good governance. But the other two factors were decidedly not agnostic. Critical to long-term economic expansion in these countries, said the Commission, was that they "fully exploited the world economy" and "let markets allocate resources."

China was one of countries studied by Spence's commission, and the country's achievements have been breathtaking, with approximately 700 million people moving into the middle class since the country's economic reforms (many of them market-based) started in 1979. But if China was the valedictorian in the school of poverty reduction, India has been the salutatorian, with hundreds of millions of people escaping a life of penury over the past three decades. And the country's experience reinforces the central role played by markets in enabling people to realize higher living standards.

One person with an acute understanding of how economic reform leads to higher living standards is Chandrababu Naidu, who served as chief minister of Andhra Pradesh, a state in south-central India, from 1995-2004. Naidu was the architect of reforms and initiatives that transformed Hyderabad (the state's biggest city at the time) from a somewhat sleepy municipality into a dynamic metropolis that has attracted large investments from many of the world's most respected technology companies. During a November 2019 interview with me, in the city of Amaravati, Naidu was crystal clear about what's needed to help the poor: "Without private investment and without job creation, you cannot eradicate poverty."

Hyderabad (the subject of a future TIE article) is an emblem of India's economic progress over the past thirty years--a period during which India's economic growth rate dramatically increased relative to the decades following independence, resulting in a six-fold rise in incomes. Fundamental to that expansion, says Columbia University economist Arvind Panagariya, has been "removing the heavy hand of government and relying much more on the invisible hand of the market."

Valuable lessons can be learned from India's decades-long experience as it moved from government domination of the economy to market-based reforms that unleashed prosperity. To fully appreciate what India has achieved, it helps to understand the country's economic journey.

INDIA IN THE PAST

The land mass that is today's India was once a global economic colossus, accounting for nearly 25 percent of global economic output in the late 1600s. But in the centuries that followed, many other countries grew wealthier, while India became poorer. Colonial misrule by the British was fundamental to the economic decline--per capita income rose less than 20 percent from 1900 to 1947 --and the experience of opening the country to the East India Company cast business and globalization in a harsh light. "India's most significant experience with entrepreneurship was a country captured by a business" is the apt summation by Infosys co-founder Nandan Nilekani. By the time the last British vessel set sail from Mumbai in 1947, India's share of the global economy had fallen to just 4 percent.

The country's first post-independence prime minister, Jawaharlal Nehru, was emblematic of a political class enamored with the Soviet Union and scarred by the colonial experience. The policies that came out of this toxic environment were previewed by Nehru in a book he wrote the year before India achieved freedom. The goal, he said, was "the attainment, as far as possible, of national self-sufficiency." Closing the borders to trade was the one (admittedly blunt) way to ensure that India's experience with colonialism would not be repeated. And limiting trade advanced Nehru's vision of the world, which he branded "scientific socialism." He cautioned that he and his colleagues were not opposed to international trade, but "we were anxious to avoid being drawn into the whirlpool of economic imperialism."

The British had imposed import and export controls starting in 1940, and while there was some liberalization after independence, the controls were resurrected following extreme foreign exchange volatility in 1956-1957 (triggered in part by the Suez crisis). For much of the next thirty-plus years, India's policymakers pursued policies that were a central planner's dream. Imports were severely restricted. Several major industries--from banking to mining--were nationalized. Companies with more than 300 employees needed state approval before making layoffs (a threshold later lowered to 100 employees). Foreign direct investment was all but prohibited, and companies that did succeed in navigating the complex regulatory terrain were required to relinquish 60 percent of their local equity to Indian shareholders. Individual income taxes, while only paid by a small segment of the population, could be as high as 97.5 percent.

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