This is the second part of posts on my evolving thoughts on the Indian economic prospects. In the first part early this week on India's economic prospects, I had blogged about the expectations about the future trajectory of economic growth. In the spirit of being cautious and perhaps undertaking a pre-mortem, this post will focus on some emerging trends in the quality of economic growth.
While I believe that India appears best positioned among all major economies to ride out the impending recession in the developed economies, question marks hang over the quality of its longer-term growth trajectory. Fundamentally, even with a 6% growth, what is the likelihood that it would be broad-based than skewed? Will the rising tide lift all the boats?
Let me illustrate the point with one data point. The trends on two and four-wheeler sales in India over the 2010-22 period reveal some interesting insights, especially in the sharp divergence post-pandemic.
There are perhaps some unique factors that would have impacted automobile sales - the demand shock due to Covid 19 and supply shock due to the Ukraine invasion, the high petrol prices since July 2021, and the introduction of Euro VI emission standards from April 2020. But it can be argued that the divergence since the outbreak of the pandemic is sharp. And more worryingly are the trends in both two and four wheeler sales.
This finding supports the K-shaped recovery arguments, which state that the formal economy used the pandemic to retrench labour and increase productivity, whereas the informal economy bore the brunt and is struggling to recover. Reinforcing the view, the sales of three-wheelers (a lower income transport) has followed two-wheelers in declining whereas those of commercial vehicles has mirrored four-wheelers.
I'm less concerned about the short-term K-shape, but more about the long-term possibilities. The disturbing fact is the longer-term crawl of the sales of four-wheelers, a definitive marker of middle-class growth. It's today at the same level as it was six years back, and has moved in a small band. And has been so since at least 2005. At a decadal CAGR of 1.88%, four wheeler sales defy the double-digit growth expectations from a burgeoning consumption class. Even with the two-wheelers, its fastest growth phase from 2010-11 to 2018-19 equated to a CAGR of 7.97%, with that for the period till 2021-22 being just 1.23%.
Consider other high frequency indicators - steel, cement, and electricity consumption. Their CAGR for the decade from 2010-11 to 2020-21 were 3.7%, 2.77%, and 4.23% respectively. Excluding Covid (till 2018-19), the numbers are only slightly better - 4.65%, 4.58%, and 5.3%. These numbers don't point to an economy growing from a low-base and broad-based economic growth, where demand ought to double every few years. This is one more reason to recalibrate growth expectations.
One or two sets of data is not sufficient to extrapolate and draw conclusions on a general economic trend. But much the same applies to several other sectors which are good proxies of economic health. The most important is the apparent decoupling of the fortunes of the formal and informal economies, and the respective fortunes of those working in them. It may no longer be the case that the rising tide is lifting all the boats. It appears that not only is the formal sector racing ahead much faster than the informal sector, but the informal sector (or at least major parts of it) may be stagnating.
Any economic growth process will involve the transition from formal to informal, and the associated productivity improvements. But I think there are two reasons why the transition happening in the Indian economy may be worrying. One, the transition is being forced, explicitly targeting the informal sector. Fundamental structural transitions have a dynamic, and expediting them without providing sufficient buffers or cushions and also sufficient time for adjustments to happen can entail prohibitive collateral damage. After all, there are only so many Rs 100 and above haircuts (approximately the minimum price that a formalised haircutter would have to charge in a typical Indian city) that the Indian economy can support. As we wrote here, the informal to formal transitions happen less by way of the informal becoming formal but by way of the informal gradually shrinking and being displaced by the formal as the economy grows and new jobs are created.
Second, the technology drivers of this transition may be disproportionately destructive of jobs. The vast and rapidly emerging eco-system of digital technologies is the case in point. Besides the nature of the formal jobs being created in the service sector gig economy are not the sort of good jobs that have historically supported vibrant middle class growth in today's richer countries. If manufacturing is becoming less labour intensive and services not creating good jobs, then what would be the driver of good job creation required to grow the consumption class? This is not a uniquely Indian problem, but one which casts its shadow on the world economy at large. Its impact on India, given the stage of its economic growth and size of its population, will be disproportionately higher.
There is another problem about the formal and informal sector's fates - the critical role of governments in the latter's fortunes. Given its sheer size, India's formal sector is large enough to sustain high enough growth rates. This segment of the economy can support (at least for some more years) healthy growth rates in residential property, vehicles, consumer durables, private sector credit flows, and so on, thereby giving the impression of an economy in the pink of health. Further, central and state governments in India, by and large, have become conscious enough to not come in the way of their growth.
In contrast, the informal sector remains entrapped in the mai-baap sarkar world (in fact, may have become more so), where they are acutely dependent on the government for everything from education to health care, water supply to electricity, and PDS rations to cash transfers. This dependence on government creates a big problem. While the government's several recent initiatives have significantly addressed problems of access to various public goods and services, their quality remains a matter of concern, thereby detracting from realisation of the desired outcomes from their use. For example, only those with good skills can access good jobs, and good skills is a function of good quality education. This draws attention to the weakness of state capability, a problem which even if recognised can only be fixed through a long drawn effort.
Given all this, there is the danger of the Indian economy settling into a two-part equilibrium. The first part will be world-class with productivity standards matching those in the developed world. As the analysts at Marcellus Investment Managers have written, India has a disproportionately large share of listed companies with high returns on capital employed apart from an unhealthy and excessive concentration of business revenues and profits. The corporate deleveraging and bank assets clean up of the last decade mean that Indian companies and banks are in good health, ready for a new investment cycle. The Production Linked Investment (PLI) scheme may have done enough, if not by the volume of subsidies but at least by kindling animal spirits in the business environment, to finally integrate India firmly into the global supply chains. The stock markets reflect this and are perhaps on a sustainable upswing. Those working in this world have high and growing salaries and can aspire to enjoy world-class lifestyles. While the relative share of this part will be very small, it will be large enough in absolute numbers to be comparable to a larger European country, and therefore enough by itself to sustain a reasonable growth rate.
In contrast, the second part could consist of an informal economy stagnating in productivity. In the absence of broad-based economic growth, the trappings of formalisation will only make the regulatory and other compliance costs higher, thereby driving up prices and also reduce the demand for their goods and services without anything happening at similarly expedited pace to boost the demand. The biggest problem will be the entry barriers for those in this segment to migrate to the formal economy, starting with human capacity development related barriers. Access to good quality education and opportunities of good jobs could remain elusive for the vast majority of those inhabiting the informal sector.
This is, as prefaced, a pre-mortem of a possibility which should be acknowledged and taken into account in policy making.
I can think of at least two broad requirements to avoid this dual-economy trap. One, the economic growth going forward has to become more broad-based and inclusive, and policies will therefore have to target the quality of economic growth. In particular, we have to prioritise good jobs creation (say, focus on components and ancillaries to large scale manufacturing more than even getting the big contract manufacturers). Two, this would require the state to enhance its capabilities to improve the quality of delivery of public goods and services that are critical to also enable access to opportunities.
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