India: the next economic giant

Trade has dominated international policy discussion over the past week. The Australia-US Free Trade Agreement (FTA) has grabbed most of the headlines. And even as that debate was being wrapped up, attention was shifting to the prospect of another major FTA, this time with China. But while a focus on these two global heavyweights is perhaps inevitable, it is important to remember they are not the only game in town. In particular, the emergence of India as a growing force in the world economy, and as an increasingly important trading partner for Australia, is of great significance.

Not too long ago that would have seemed a strange assertion. After all, India spent much of its post-colonial history in determined retreat from the international economy. India was attracted by the apparent successes of Soviet-style planning and driven by a self-fulfilling pessimism about the prospects for export-led growth. Its development model in the years following independence was based upon public sector ownership of the economy’s commanding heights - and eventually many of its foothills - and a complex system of controls, licences and regulations known as the “licence Raj”. The result strangled the private sector and restricted India to a “Hindu rate of growth” of around 3½ per cent per annum.

Yet beginning in the 1980s, with a cautious shift to a more pro-business environment, and accelerating in the next decade after a financial crisis in 1991, Indian economic policy has taken a very different direction. A series of governments has liberalised domestic markets while at the same time seeking to re-engage with the global economy. True, the resulting reforms have been cautious, partial, and at times faltering. And Indian policymakers still have to grapple with a number of tough challenges, including fiscal fragility, inadequate infrastructure, and regional inequality. But reform has already delivered a transformation in economic prospects, turning India into one of the world’s fastest growing economies.

What has been particularly intriguing about this transformation is that it has taken a uniquely Indian path. Economic development in East Asia has tended to follow a fairly standard model, based upon the mass production of manufactured goods and a gradual move up the value chain. In contrast, India is making its mark in the global marketplace by exporting services, competing in areas that traditionally were thought to be the preserve of more developed economies.

India’s growth model rests on a marriage of technological progress in the telecommunications sector with a large supply of well-educated, English-speaking and relatively low-cost labour. This has already allowed India to grab market share in the information technology and business process outsourcing sectors. And in principle India now has the potential to be competitive across an even broader range of services.

The more successful India that is being forged by this model has the potential to reshape the global economy.

Perhaps most importantly, it will mean a higher standard of living for more than a billion Indians, about 17 per cent of the world’s population. And with an estimated one third of the world’s poorest people living on the subcontinent, a healthier Indian economy will have a significant effect on global poverty.

It should also be good news for the rest of the world. A stronger and more dynamic India means new markets for goods and services, and a new source of global demand. Moreover, India’s development model gives the international economy access to an enhanced supply of high quality, skilled workers. Over time this boost to the effective global stock of human capital should provide a spur to international productivity and hence to global growth prospects.

India’s rise will also bring with it adjustment strains for other countries. India’s growing presence in the market for services is leading to the birth of a truly global labour market, with all the challenges and opportunities that entails. Services now account for by far the largest share of output in developed economies. That means the eventual impact of India’s service revolution on patterns of employment and growth in the developed world could ultimately prove to be greater than that of East Asia’s manufacturing revolution.

At the same time, the growing importance of India, combined with an already powerful China, will accelerate the shift in the geographic distribution of economic power back towards Asia. This in turn has implications for the architecture of international economic diplomacy. Existing mechanisms for governing the world economy will either have to adapt to this changing balance of power, or else lose relevance.

Historically, India has been relatively neglected by an Australia focused more on the opportunities offered by East Asia. India’s emergence as a new economic power means that should now change. Australia’s prospects have repeatedly benefited from the rise of Asian economies, with Japan, South Korea and now China all providing an important economic stimulus. The birth of another Asian economic giant is the latest instalment in this good news story.