This article, extrapolating our key findings from a recent Centre for New Economics Studies (CNES) research analysis, involves a detailed analysis of India’s growth trajectory over the last three decades comparing its growth trends with other industrially developed economies across sectors like manufacturing, services, banking, etc., and with other like-minded group of nations.
Providing a background context is vital in shaping the design and framework of any comparative analysis. The absurdity of designing/making growth-centered economic comparisons must also be noted.
For example, this year, Bangladesh’s per capita income overtook India’s, in terms of size. But also India overtook the United Kingdom to become the fifth-largest economy in the world.
How do we make sense of both these facts? Let’s see.
Any critical macro-performance analysis for the Indian economy, since the 1990s, contains two distinct analytical parts.
For a simplistic version of growth composition, it is oft pertinent to look at the nation’s macro-growth scenario from an income-side approach and an expenditure-side approach. There are issues with these approaches, but it is important, directionally, to get a sense of what the numbers say.
When we look at the income components of the Indian GDP, we see that the service sector has observed the maximum growth since the 1990s, with the rate being as high as 15% by 2020. We have seen more organised (better-paying) employment and investment opportunities created in the sector, alongside direct and indirect foreign investment.
Spatially, this explains the anchored rise of urban-based growth witnessed through the exponential rise of cities (and migration to them) in India’s growth story ex-post 1990s.
On the other hand, we see agriculture and the manufacturing sector performance declines in terms of both size and growth rate. There is a negative growth rate in the manufacturing and agriculture sector (the rate here is -1.5%) highlighting how these components have shrunk overall as parts of the GDP. This trend is divergent from what ‘structural transformation theory’ (i.e. discussing growth transition from agriculture to manufacturing to services argues for any nation’s trajectory from one stage of development to another) says. Generally, when countries rapidly grow, we do see a movement away from agriculture as the sole driver of income in the nation, which is visible from these graphs.
Now, on the expenditure side: the two components to observe performance for include: a) Government Spending and b) Net exports. Both have not seen major changes as being part of the GDP over time (this could be because their sectional growth is directly proportional in magnitude as well to the GDP).
We do however observe high volatility in net exports over time, and the trade deficit has only worsened from 2002 to 2012 (meaning we are importing way more than what we are exporting). This is still the case (read here for more on India’s trade dynamics).
Let’s situate these sectoral trends in India by comparing them to other countries. This should provide context for the way in which we understand which sectors have contributed to India’s growth, and how we can understand what drives certain sectors to perform better than others, both in the Indian context and abroad.
Epochal comparison: Part I
While it is debatable to argue what the 5th largest economy tag means for India, according to IMF estimates, India’s performance outlook is often compared, quite loosely though with nations such as the US, China, Germany, and Japan, despite the fact, that each of these nations has done much better than India in improving the quality of lives of their citizenry and are much ‘developed’ on the human capability enhancement frontier, as Martha Nussbaum, Amartya Sen would argue.
To provide some further context for this argument, we compare India and other countries from a sectoral perspective while aiming to disaggregate the reasons for the differences between the growth trajectory of India and other countries.
When we look at like-minded countries, in terms of per capita income and stage of development, India’s performance outlook appears in a slightly different context – data on per capita GDP suggests that countries such as Vietnam, Philippines and Indonesia have clearly outperformed India in terms of per capita growth comparisons.
The ‘manufacturing’ conundrum
To understand what has really contributed to India’s urban-biased service-led growth model, it is necessary to observe all sectors one at a time. Diving deep into the manufacturing sector growth story for other industrial nations like Australia, China, Germany, the UK, and India, we see that Germany and China have the largest share of GDP contributed by manufacturing.
We see that manufacturing growth as a contributor to a nation’s overall GDP growth has been declining at similar rates for all countries as they progress towards a global economy which is built largely on Services and Informational Technology. India’s case can be categorised more as a classic example of a nation experiencing premature deindustrialisation, as elucidated here.
China’s case for much of the 1990s and early 2000s was unique though. It has seen the largest contribution to its GDP from manufacturing-led growth, with 30% of its GDP derived from that sector alone, also allowing China to export more manufactured goods than any other nation in the recent past (Vietnam and Bangladesh don’t come anywhere near the Chinese volume).
A key indicator for capital-invested growth
A factor which plays an important factor within the manufacturing sector is how much a country is spending on fixed capital, say in driving infrastructural growth, which ultimately helps bring more private investment into a sector/nation.
Using Gross Fixed Capital Formation (GFCF) as an indicator, we analyse how spending on fixed capital changed between 2000 and 2021 for developed countries. Higher GFCF as a percentage of GDP suggests greater investments in areas of infrastructure.
Except China and India, investments in fixed capital in all other developed economies declined over the last two decades. The timeline also matters. Stages of industrialisation were different, timeline-wise, for early industrialisers like the UK, Germany, Australia, the US and Japan.
Still, the decline of each of these nations’ manufacturing growth combined with a fall in gross fixed capital formation (as % of GDP) explains why each of the nations has pivoted to globalise their manufacturing supply chains, for cost-benefit reasons, to nations like China and India.
China, the second largest economy in the world, significantly increased their investments in fixed capital formation to allow greater growth of infra-based private investment. India has been slow in that regard.
Financial sector: Domestic credit to private sector
An important factor within the financial sector is how much money is raised within the economy as part of a new credit and investment cycle. A major source for raising capital is ‘credit’ and ‘debt’. When more money is credited in the economy, the investment levels increase as well. For our analysis, we used Domestic Credit, which refers to financial resources provided to the private sector in terms of loans, non-equity securities, etc.
As evident from above, this is one sector in which India has particularly performed poorly compared to other developed countries. On one hand, domestic credit to GDP in countries like the US and China exceeded the 180% mark whereas India’s domestic credit to GDP has been stagnant at around 50% for the last decade.
This suggests that compared to developed economies, not enough credit-based borrowing leading up to more private investment for expanding production capacity has been seen in India. This (the lack of credit-enabled domestic private investment) can also be cited as one of the key reasons why India’s growth has remained at sub-par or sub-optimal levels for much of the last decade (from 2012-13 onwards).
Foreign direct investment
When domestic private investment is low, the policy tends to pivot more towards attracting foreign capital to meet the overall saving-investment gap. Foreign direct investments are a net inflow of inward direct investments made by non-resident investors. In the last two decades, only India, China and Japan saw a net (positive) growth in the volume of FDI net (in)flows. FDI in most other developed countries like the US has fallen considerably, catalysed by low-domestic interest rates.
FDI’s contribution to India’s GDP increased by nearly 2.3%, whereas other developed countries experienced a decline in FDIs. This suggests India’s presence as a potentially ‘hot market’ for foreign institutional investment and direct investment for foreign investors. Our over-optimistic stock market trends indicate this ‘bullish’ trend too.
Trade and net export
India’s total exports in September 2022 are estimated to be $61.10 billion and total imports of $76.26 billion have led to a negative trade balance of (-) $15.16 billion. Its trade growth has been around -8.75% compared to a world negative trade growth of -3.91%. Historical context is important in understanding current trends.
Net exports present a measure of the revenue generated from exports minus the expenditure on imported goods. For a long time now, India’s net importer position has widened its trade deficit vis-à-vis other countries.
Most of the other comparable economies have experienced net positive exports, suggesting more trade is augmenting their economy, not deducting from it. Countries like South Korea and China in the emerging market spectrums too even managed to significantly increase their net exports, which have positively led to expansive growth possibilities. More details on India’s foreign policy outlook on trade and its trade-centred relationship with partner nations are analysed here in detail.
The service sector is one of India’s largest and most important sectors, from a growth perspective. Understanding the specific impact of the service sector requires looking at both: the ‘value added’ by the services sector in % GDP terms and in ‘absolute terms’.
Looking at the ‘value added’ by services in absolute terms allows us to contextualise the growth of services in the presence of rapid GDP growth, and then comparison across countries becomes far more detailed.
If we look at it in ‘absolute terms’, the picture above is clear: India’s absolute value added from services has grown far faster than countries such as the UK, Japan, Korea, etc.
This is where the context of GDP becomes important – the above graph tends to subsume the effect of GDP growth and so differences in GDP growth between countries seem like they are differences in the impact of various services sectors, when they may not necessarily. We need to therefore look at ‘services’ as a percentage of GDP (see figure below).
Here, the story is quite different.
India’s no longer soaring above all other countries. In fact, India is decidedly average, lowest in terms of ‘value added’ by services as a % of GDP in 2021, outpaced by China somewhere in 2013. This tells us that, as mentioned earlier, the ‘absolute value added’ of services for India has more to do with India’s rapid GDP growth, rather than witnessing a proportionate increase in the performance of the services sector. In short, a lot more needs to be done in expanding the contribution of services, across groups, to India’s potential GDP growth.
The curious case of ‘India vs China’ comparisons
In 1990, India’s current GDP was greater than that of China.
In the next three decades, China didn’t just surpass India, it went on to become the second-largest economy in the world while driving more people out of poverty than any other nation on earth.
It is still intriguing (and fascinating for development studies scholars) to analyse how China experienced a ‘quicker’ path to economic prosperity while maintaining a higher level of economic growth rate than India.
The sector that played a major role here, no doubt, is the better performance of the Chinese manufacturing sector. It also allowed a large chunk of the underutilised workforce from rural provinces to be absorbed by the expanding manufacturing sector base.
In 2021, the manufacturing sector in China contributed 26.3% to its economy, which is roughly double what it contributed in the context of the Indian economy.
To figure out the causes for this major difference, we observed both countries in terms of their performance of indicators like GFCF and domestic credit provided to the economy. From 1990, China consistently had roughly 4 times of domestic credit to its GDP compared to India.
Private investment drove manufacturing growth in China while in India, even though FDI flows increased, overall domestic private investment levels have remained significantly sub-par. MSMEs and small-scale firms remained ‘small’ and ‘medium’ scale in the absence of ‘domestic credit’ and/or supply of cheap loanable funds from the organised banking sector.
Greater levels of credit mean more loans have been made available to the domestic private sector in China. Yes, in a publicly regulated banking space, there are problems of high indebtedness, on the discretionary power of providing loans to company ‘A’ against another, and of public-private corruption in China but the net effects of overall credit-fueled growth engineered its ‘epochal’ rise.
This is also evident as China’s growth rate in GFCF over the last 30 years is substantially more than India’s.
Over the last 30 years, China managed to increase its investment in fixed capital by 5 times of India. This investment resulted in production on a larger scale, and it is here that China’s manufacturing sector ended up contributing almost double what it contributes to the Indian economy.
However, a greater production level would be of less use if they aren’t efficiently allocated in both domestic and international markets. Since China has a reputation for cheap exports, it’s important to signify the difference between China’s and India’s export trends.
Our team also used the Economic Complexity Index, which takes data on exports and ranks countries based on the diversity and ubiquity of the products in their export basket. Hence a country which has a more diverse basket and exports to a greater number of countries is ranked higher. For research, we compared how India and China’s ranks changed over the last two decades.
From the graph above, we notice that post-2000, the economic gap between India and China consistently increased. With China ranking in the top 20, it suggests that China is exporting a more diverse product basket and is exporting to a greater number of countries as well. However, India failed to keep up with China and substantially fell behind it on the index. This suggests that China’s export levels and export revenue substantially increased, leading to higher growth.
However, greater export revenue does not mean greater value added to GDP (as we have argued before). Import expenses also need to be accounted for, and in many cases, countries have a deficit in their net exports.
For this, one needs to compare how net exports as a percentage of the GDP fared for both countries over the last three decades.
Except for one year, China consistently had positive net exports vis-à-vis India.
Interestingly, cheap labour is a factor which is commonly associated with China and India’s manufacturing sector. While India has had access to cheap labour, in a labour surplus economy, it could not tap into the potential for expanding its manufacturing competitiveness as much as China did.
From our research, we could conclusively say that most of India’s rapid growth is due to an increase in ‘absolute value’ added by the service sector of the country.
In real terms, and on per capita income, we are not only way behind but it seems like a redundant (or even pointless) exercise drawing a comparison between the ‘top 4’ (largest growing nations in size) and India, when the aggregate growth composition and its implications for average income distribution, wage growth, quality of life, access to basic amenities and welfare, between India and other (compared) nations, remains so stark.
Yes, in terms of sectoral context, services are where our strength lies but most of the ‘value added’ is disproportionally constrained to capital-intensive, urban-based service-based sectors where ‘value added’ growth is becoming increasingly limited for India as compared to other nations. There is potential but a lot more needs to be done by policy to realise this potential.
More importantly, the big elephant in the room is the inability of India’s growth position to sufficiently create good jobs with better wages for a largely young demographic working-age population base. There is a need for immediate policy-level interventions that catalyze short-medium-long term implications to both, acknowledge and address evident fault lines in India’s fractured growth pole, sooner than later.
Deepanshu Mohan is associate professor of economics and director, Centre for New Economics Studies (CNES), Jindal School of Liberal Arts and Humanities, OP Jindal Global University. Aniruddh Bhaskaran, Hemang Sharma, Soumya Marri, Malhaar Kasodekar are all members of the CNES InfoSphere team and working as research analysts with CNES.