Internet-based services. Indian software engineers helped the world rise to
the Y2K challenge.
The image of India as a major provider of outsourcing was particularly
evident to Americans, who exaggeratedly viewed India as cutting a wide
swath through skilled U.S. white-collar jobs. But India's competitive incursion
has been modest to small, especially in proportion to its workforce of
nearly 450 million.
Total employment in India's information technology industry is currently
about 1.5 million, five times its level of 1999. Almost all the increase
is export related. Another 3 million jobs have apparently been created in
telecommunications, power, and construction as a consequence of the IT
surge. Directly and indirectly, that's barely 1 percent of total employment
in India. And that's the problem.
The IT industry and other services isolated in the major cities of Bangalore,
Delhi, and Mumbai have vaulted over the twentieth century into
the twenty-first. But as a government official complained to a BBC inter
*Nonetheless, India's tariffs are still double the average levels for Southeast Asian countries, increasing
the costs of materials consumed in production for export. India still comprises only
2.5 percent of global trade in goods and services. China accounts for 10.5 percent.
tProperty rights in India are significantly undermined by the cost of enforcing a contract. According
to the World Bank, it takes 425 to 1,165 days (depending on the state) to enforce a
contract in Indian courts. Nine-tenths of land in India is subject to disputes over ownership.
3/9
THE AGE OF TURBULENCE
viewer in early 2007, "Go out beyond the glitter of some of the cities and
you are back in the nineteenth century." For India to become the major
player in the international arena that it aspires to be; it will need to build
factories that entice a very large part of its agricultural workers to urban
enclaves to produce labor-intensive exports, the time-honored path of the
successful Asian Tigers and China.
Manufacturing in India, however, even high-tech, has been hobbled for
decades by job-destroying labor laws, a decrepit infrastructure that cannot
provide reliable electric power,* and roads and rails that inhibit movement
of manufactured parts and finished products between plants and markets.
Owing to costly labor laws that apply to establishments often or more employees,
more than 40 percent of employment in all manufacturing takes
place in firms employing five to nine workers. This compares with only
4 percent in Korea. Productivity in these small Indian firms is 20 percent or
less of that of large firms; the small firms evidently can't create the economies
of scale available to the larger firms. If mass manufacturing is ever to
close the gap in standards of living between India and China, the rival to
which it is so often compared, India will need to encourage agricultural labor
to migrate to the manufacturing sector in the cities. And to encourage
workers tied to the land to leave, manufacturing will have to become globally
competitive. That will require a major scrapping of the remaining parts
of the license raj. In play is the fate of the three-fifths of the Indian workforce
who toil inefficiently on farms. They need a dramatic change for the
better.
Rural India is mired in a level of poverty as bleak as anywhere in the
world outside of sub-Saharan Africa. Here is where a high concentration of
India's illiterate (two-fifths of the adult population) and most of the more
than 250 million Indians who live on less than $1 a day reside. Half of India's
homes have no electricity. Productivity on farms is only one-fourth of
what it is in nonfarm areas. Rice yields are half of what they are in Vietnam
and a third of what they are in China. India's cotton's comparative yields
are even worse. Wheat yields, which so benefited from the enhanced seed
of the green revolution of the 1970s, are still only three-fourths of China's.
*Many business establishments have installed their own small generators to ensure power.
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THE TIGERS AND THE ELEPHANT
Only in tea is India more productive than its Asian competitors. Moreover,
Indian road transport linking farms and cities is so inadequate that output
of perishable crops is largely restricted to on-farm consumption; a third of
crops is reported to rot en route to market.
Growth of agricultural productivity has slowed since the 1980s. Although
weather has been partly to blame, a highly subsidized government-
directed agriculture that prevents market forces from adjusting acreage
usage is the main culprit. The government in recent years has expended
more than 4 percent of GDP on subsidies, mainly on food and fertilizer,
while state subsidization of power and irrigation has added measurably
more. If farmworkers are encouraged to migrate to the more productive
cities, as has happened in China, a level of agricultural output that feeds 1.1
billion people must be maintained. India's ability to expand food imports
is limited. Farm productivity growth is thus the only viable way to maintain
food availability as manufacturing draws workers from rural India. Market
competition in agriculture is badly needed.
Martin Feldstein, the eminent Harvard economist, in a somewhat different
context, stressed an irony that is applicable to India's farm policy dilemma
in an essay in the Wall Street Journal (February 16, 2006): "Cellphone service
is widely available [in India] at low cost because it was regarded as a
luxury and therefore left to the market, while electricity is hard to obtain
because it has been regarded as a necessity and therefore managed by the
government."
Regrettably, the dismantling of large farm subsidies seems no more
likely in Delhi than it does in Paris or Washington. Long-term subsidies are
capitalized in the value of the land. The net beneficiaries of subsidies are
always those who own land when the subsidies are created. Future owners
pay for the expected continued subsidy flow in an elevated purchase price
of the land. They are not, in principle, net beneficiaries. To increase taxes on
farmlands—which, in effect, is what an uncompensated reduction in subsidies
does—is not taken lightly by farm owners. Some progress in trimming
these subsidies has been accomplished on the edges, but a frontal assault
will be difficult considering the leanings of the Congress Party and its
twenty-three coalition partners, including the Communists. Prime Minister
Singh is a highly reputable reform-oriented economist, but he does not
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THE AGE OF TURBULENCE
have the authoritarian clout that enabled Deng Xiaoping to start China's
agricultural reform in 1978. Indian democracy is up to this task. It needs
only to focus on the urgent needs of India's population. A very large dose
of deregulation and competition can spread India's IT revolution to the rest
of the country*
India's rapidly growing IT sector is largely the result of homegrown
software programmers and engineers. While Indian entrepreneurs are doing
exceptionally well in high-tech service, they are doing less well with high-
tech hardware, which suffers many of the shortcomings of Indian manufacturing
overall.
The manufacturing-for-export model that India urgently needs to embrace
has an impressive record of success elsewhere in Asia. It is a model
that employs in mass urban manufacturing centers low-wage rural workers
with some education. A critical ingredient has been foreign direct investment
(FDI) embodying advanced technologies and attracted by laws (often
newly drawn) protecting property rights. With the demise of central planning,
this model has spread across the developing world, especially China.
But clearly the license raj has discouraged foreign direct investment.
India received $7 billion in FDI in 2005, a sum dwarfed by China's $72 billion.
India's cumulative stock of FDI at 6 percent of GDP at the end of
2005 compares with 9 percent for Pakistan, 14 percent for China, and 61
percent for Vietnam. The reason FDI has lagged badly in India is perhaps
no better illustrated than by India's unwillingness to fully embrace market
forces. That is all too evident in India's often statist response to economic
problems. Faced with rising food inflation in early 2007, the response
was not to allow rising prices to prompt an increase in supply, but to ban
wheat exports for the rest of the year and suspend futures trading to "curb
speculation"—the very market forces that the Indian economy needs to
break the stranglehold of bureaucracy.
*Growth in India's industrial production has accelerated since 2004, but the nation still lags
behind China's growth in services and especially industrial production.
322
SIXTEEN
RUSSIA'S SHARP ELBOWS
T
T
o say I was startled doesn't do the moment justice. Vladimir Putin's
chief economic adviser, Andrei Illarionov, approached me after a
U.S.-Russia bilateral meeting at the International Monetary Fund in
October 2004 and asked, "The next time you are in Moscow, would you be
willing to meet with me and some of my friends to discuss Ayn Rand?" For
Rand, the uncompromising defender of laissez-faire capitalism and fiery foe
of Communism, to have penetrated the cloistered enclave of Russian intel
lectual leadership was to me mind-boggling. Putin certainly must have been
familiar with Illarionov's staunch defense of free competitive markets when
he hired him. Was Illarionov thus a window into the policy inclinations of
Putin? Was the culture under which all Russians were raised being shed
that quickly? It seemed incredible that Putin, this former member of the
KGB, could have developed so un-Soviet a perspective in so short a time.
The reality, obviously, is far more complex. When Putin was appointed
acting president by Boris Yeltsin at the end of 1999, he capped an astonishing
rise through the ranks that had started only four years earlier when he
began working in Moscow as a presidential adviser. He was named deputy
head of presidential administration in 1997 and came to the attention of
THE AGE OF TURBULENCE
the world in 1998 when, as head of the Federal Security Service, he ordered
Russian troops into Chechnya. His presidency was embraced by reformers,
who felt confident he would promote continued evolution to a
market economy. From the start, Putin expressed support for such reforms,
although he argued that they must work in concert with "Russia's realities,"
including the tradition of a paternalistic state.
Within two years, Putin, along with Illarionov, pushed through the Duma
an aggressive agenda of tax reform, deregulation, and some privatization of
land, with the clear goal of steering Russia into the global economy.
But after this promising embrace of capitalism, Putin began to backtrack
toward authoritarianism. Apparently, he feared that Russia would
become subject to market forces over which he had no control. In particular,
the oligarchs—business opportunists who had laid claim to much of
Russia's productive wealth through special loans-for-shares deals with the
Kremlin during the 1990s—were seen as using their riches to subvert his
regime. As a consequence, starting in 2003, a different economic strategy
began to emerge. Through selective enforcement of new and existing
laws, Putin wrenched control of myriad energy assets back into the Kremlin's
orbit. The key driver of Russian economic growth—oil and gas—is
becoming increasingly nationalized in Russian government-owned or government-
controlled monopolies like Gazprom, which dominates natural
gas, and Rosneft, which dominates oil. Mikhail Khodorkovsky, the founder
of Yukos Oil, was jailed and stripped of his assets, which Rosneft then
swallowed.
I do not pretend to know whether Khodorkovsky was guilty of the
crimes with which he was charged. But the stark shift from the Kremlin's
earlier market liberalism clearly disillusioned Illarionov, and he was soon
publicly criticizing his boss. He openly called the retroactive tax claim on
Yukos's assets and the scarcely hidden financial manipulations in favor of
Rosneft the "swindle of the year."
Given Putin's KGB roots and his upbringing in a collectivized society,
it is unlikely that he has a deep understanding of how free markets work.
But his choice of Illarionov as chief economic adviser had to mean he had
been attracted by the evident successes of capitalism in fostering high stan
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RUSSIA'S SHARP ELBOWS
dards of living. Ultimately, however, Putin may have found himself more
threatened by the seeming anarchy of Yeltsin's capitalism than inspired by
the stabilizing force of Adam Smith's invisible hand. Then again, I doubt
that Adam Smith was the primary issue on Putin's mind. His seizure of
Russia's oil and gas wealth, and his ham-handed cutoff of natural gas to
Ukraine and Western Europe for two days in January 2006 were most likely
aimed at restoring Russia's international relevance.
What is remarkable in all this is that it took so long for Illarionov to be
demoted. Eventually he was relieved of his role as presidential representative
to the G8 heads of government, and in 2005 he resigned, stating that
Russia was no longer a free country. But Illarionov's extended Kremlin ten-
tire may reflect a grudging attraction by Putin to the capitalist paradigm.
Putin's ambivalence about retreating fully from Yeltsin's democracy surfaced
in a revealing exchange with former Soviet leader Mikhail Gorbachev,
who described it in a 2006 radio interview. Gorbachev quoted President
Putin as saying that "the influence of mafia groups and other such elements
is so strong that elections become buyer-seller situations." This was bad,
