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India Policy Forum 2010/11 – Volume 7: Editors’ Summary

Suman Bery, Barry P. Bosworth, and Arvind Panagariya


india policy forum 7

The seventh annual India Policy Forum conference convened in New Delhi from July 13-14. This seventh volume of the India Policy Forum, edited by Suman Bery, Barry Bosworth and Arvind Panagariya, cover economic growth, infrastructure, and politics in India. The editors’ summary appears below, and you can download a PDF version of the volume, or access individual articles by clicking on the following links:

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EDITORS’ SUMMARY

The India Policy Forum held its seventh conference on July 13 and 14,
2010 in New Delhi. This issue of the journal contains the papers and
the discussions presented at the conference, which cover a wide range of
issues. The first paper examines the services sector in India, evaluating its
growth and future prospects. The second paper looks at India’s corporate
sector, analyzing the profitability of firms in the wake of liberalization. The
third paper explores the reasons for the large time and cost overruns that
have been endemic to Indian infrastructure projects. The final two papers
focus on more political issues, looking at the impact of political reservations
used to increase women’s political voice, as well as the politics of intergovernmental
resource transfers.

Among fast-growing developing countries, India is distinctive for the
role of the service sector. Whereas many earlier rapidly growing economies
emphasized the export of labor-intensive manufactures, India’s recent growth
has relied to a greater extent on the expansion of services. Although there
are other emerging markets where the share of services in Gross Domestic
Product (GDP) exceeds the share of manufacturing, India stands out for
the dynamism of its service sector. Barry Eichengreen and Poonam Gupta
critically analyze this rapid service-sector growth in their paper “The Service
Sector as India’s Road to Economic Growth?”

Skeptics have raised doubts about both the quality and sustainability of the
increase in service-sector activity. They have observed that employment in
services is concentrated in the informal sector, personal services, and public
administration—activities with limited spillovers and relatively little scope
for productivity improvement. They downplay information technology and
communications-related employment on the grounds that these sectors are
small and use little unskilled and semi-skilled labor, the implication being
that a labor-abundant economy cannot rely on them to move people out of
low-productivity agriculture. Some argue that the rapid growth of service sector
employment simply reflects the outsourcing of activities previously
conducted in-house by manufacturing firms—in other words, that it is little
more than a relabeling of existing employment. They question whether shifting
labor from agriculture directly to services confers the same benefits in
terms of productivity growth and living standards as the more conventional
pattern of shifting labor from agriculture to manufacturing in the early stages
of economic development.

This paper evaluates these claims, coming up with an in-depth look at
the services sector in India. Eichengreen and Gupta find that the growth
of the sector has been unusually rapid, starting 15 years ago from a very
low level. The acceleration of service-sector growth is widespread across
activities, but the modern services such as business services, communication,
and banking are the fastest growing activities. Other rapidly growing service
sectors are hotels, restaurants, education, health, trade, and transport. Some
observers have dismissed the growth of modern services on the grounds
that these activities constitute only a small share of output and therefore
contribute only modestly to the growth of GDP. However, the results show
that the contribution of the category communication, business services, and
financial services has in fact risen to the point where this group contributes
more to growth of GDP than manufacturing. A slightly broader grouping
of communication, business services, financial services, education, health,
and hotels accounted for roughly half of total growth of the service sector
in 2000–08. These activities explain most of the post-1990 acceleration in
service sector growth.

Modern services have been the fastest growing in India and their takeoff
began at much lower incomes than in the Organisation for Economic
Co-operation and Development (OECD) countries. This, clearly, is a unique
aspect of the Indian growth experience. Furthermore, the expansion of the
modern service sector is not simply disguised manufacturing activity. Only
a relatively small fraction of the growth of demand for services reflects
outsourcing from manufacturing. Most production that does not go towards
exports, in fact, derives from fi nal demand at home. Thus, the growth of
service sector employment does more to add to total employment outside
agriculture than outsourcing arguments would lead one to expect.

Looking at the proximate determinants of services growth, Eichengreen
and Gupta show that tradable services have grown 4 percentage points a year
faster than nontradable services, other things equal. Services that have been
liberalized have also grown significantly faster than the average. Regulatory
change has been an important part of the story: where essentially all services
were heavily regulated in 1970, the majority have since been partially
or wholly deregulated. The services segments which were both liberalized
and tradable grew 7–8 percentage points higher than the control group
(nontradable/nonliberalized services). All this implies that policy makers
should continue to encourage exports of IT, communication, fi nancial, and
business services while also liberalizing activities like education, health care,
and retail trade, where regulation has inhibited the ability of producers to
meet domestic demand.

The fact that the share of services has now converged more or less to the
international norm raises questions about whether it will continue growing
so rapidly. In particular, it will depend on the continued expansion of
modern services (business services, communication, and banking). But, in
addition, an important share of the growth will result from the application
of modern information technology to more traditional services (retail and
wholesale trade, transport and storage, public administration and defense).
This second aspect obviously has more positive implications for output than
for employment.

Finally, the authors find that the mix of skilled and unskilled labor in
manufacturing and services is increasingly similar. Thus it is no longer
obvious that manufacturing will need to be the main destination for the vast
majority of Indian labor moving out of agriculture, or that modern services
are a viable destination only for the highly skilled few. To the extent that
modern manufacturing and modern services are both constrained by the
availability of skilled labor, growth in both areas underscores the importance
for India of increasing investments in labor skills.

The paper concludes that sustaining economic growth and raising living
standards will require shifting labor out of agriculture into both manufacturing
and services, not just one or the other. The argument that India needs
to build up labor-intensive manufacturing and the argument that it should
exploit its comparative advantage in services are often posed in opposition
to one another. Eichengreen and Gupta argue that these two routes to economic
growth and higher incomes are in fact complements, not incompatible
alternatives.

Authors

In their paper “Sources of Corporate Profits in India: Business Dynamism
or Advantages of Entrenchment?” Ashoka Mody, Anusha Nath, and Michael
Walton ask whether the liberalization during the last two decades has led
to increased competition, characterized by innovation and growth, or to
profiteering through entrenchment and increased market power of the large
firms. While the authors consider various indicators of market structures,
the main focus of their analysis is the evolution of the profit rate at the firm
level in the wake of liberalization. The authors find that while liberalization
induced considerable new entry in the 1990s, that pattern did not continue
into the 2000s. On the whole, the major business houses and public sector
firms were able to maintain their dominance in terms of market share. 

The authors employ firm-level data from the Prowess database, which
provides detailed information on large- and medium-sized companies in
India. They focus on firms listed on the Bombay Stock Exchange. While
they present some trends for the period spanning 1989–2009, their core
econometric analysis covers the shorter period from 1993 to 2007, during
which the sample size increased from 1,000 to about 2,300 firms. Several
significant conclusions emerge from the authors’ discussion of corporate
and macroeconomic trends and their econometric analysis.

First, despite some deviations in the early years, they find a consistent
pattern that the corporate profit rate—measured as a return on assets—has
gone up and down in line with overall economic growth. Profit rates were
high in the early 1990s (with a median rate of 10–12 percent) when growth
accelerated and fell subsequently as GDP growth decelerated until around
2001 (reaching about 4 percent). The rates rose again (to about 8 percent in
2007–08) as growth in the Indian economy accelerated again.

Second, unless the expansion of the tradable sectors lagged behind the
growth in nontradable sectors—a possibility that cannot be ruled out—the
trade liberalization of the late 1980s did not have a major influence on
corporate profi ts. There is a striking similarity in the evolution of profitability
in the tradable and nontradable sectors, both moving in unison with
domestic growth. Tradable sectors enjoyed a somewhat higher profit rate
than nontradable sectors.

In contrast to trade liberalization, industrial deregulation was associated
with a more definite impact on profitability. Following deregulation around
1991, the number of firms increased in virtually all sectors. This increase was
associated with reduced market shares. The authors’ econometric analysis
suggests that smaller market shares, in turn, were associated with reduced
profitability. Thus, in the second half of the 1990s, slower GDP growth and
the scramble for market shares both contributed to driving down profit rates. 

The bulk of new entry, in terms of numbers, was of Indian stand-alone
firms, but both government-owned firms and business houses remain
dominant in terms of sales and asset shares. Indeed, the share of business
houses in the total sales rose slightly from 41 percent in 1989 to 42 percent
in 2008.

Firm profitability does show substantial year-to-year persistence, raising
the possibility of some market power. But the persistence declines when
profitability is averaged over longer periods (up to four years), implying that
some “super-normal” profits are whittled away over time. Also, more efficient
firms tend to have more persistent profits. Thus, some part of the persistence
reflects greater efficiency, although because of the overlap between efficient
and large firms, the possibility that market power may play a role in maintaining
the profit rate over time cannot be completely ruled out.

There is no consistent evidence of a general influence of market concentration
on profitability: if anything, firms in less concentrated sectors have
slightly higher profit rates. The 2000s witnessed some reconcentration in
some sectors, affecting about a third of all the firms, but the profit behavior
of firms in re-concentrating sectors appears to be similar to that in the overall
sample. Firms with growing market shares do enjoy higher profitability, but
the pattern of results is more consistent with causality fl owing in the other
direction, that is, with the success of dynamism. In particular, this association
is at least as strong for small firms and for less concentrated industries. 

This said, following significant new entry and competition for market
shares in the first half of the 1990s, the pace of entry abruptly stalled in the
late 1990s, market shares stabilized, and concentration rates started to rise
again in some sectors. Thus, the findings are also consistent with the possibility
that the phase of competitive dynamism may be diminishing, with
incentives for the exercise of market power and investment in business–
government relationships being on the rise.

Finally, the authors’ econometric results show that the faster a firm grew,
the higher was its profitability. Supporting descriptive statistics add interesting
nuances to this finding. The gap in firms’ growth rates opened up in the
2000–07 period. During that period, the fast-growing firms opened up the
largest gap in profitability rates relative to the medium-growth firms. Slow
growing firms, typically much smaller in size, have had particularly low profit
rates and have actually been shrinking in terms of real sales. This suggests
that efficiency was rewarded: the dynamic medium-sized firms were able
to grow fast and garner sizeable profits, reinforcing their ability to grow.
The smallest firms fell increasingly behind. Thus, the shakeout resulted in
a potentially more efficient structure.

Greatly expanded level of infrastructure investment is critical to sustaining
Indian economic growth. During the last decade, an increasing volume of
funds has been allocated to building infrastructure, and successive governments
have accorded infrastructure a high priority. Nevertheless, delays and
cost overruns remain large and frequent. Moreover, owing to a paucity of
research on the subject, our understanding of the causes behind the cost and
time overruns and their remedies remains poor. These issues assume additional
importance in view of the recent changes in the official procurement
policy in infrastructure. The central government as well as state governments
are increasingly looking to private funding for infrastructure projects principally
through public–private partnerships (PPPs). Though a shortage of
funds within the government sector is largely responsible for this shift, there
is equally a belief that private-sector participation can reduce delays and cost
overruns. However, there is insufficient empirical work to either support or
repudiate this confidence in the superiority of the private sector.

In his paper “Determinants of Cost Overruns in Public Procurement of
Infrastructure: Roads and Railways,” Ram Singh provides a detailed analysis
of time and cost overruns in infrastructure projects in India using two large
datasets that contain information on the key dates for implementing and
completing projects and the difference between planned and actual costs.
The first dataset includes 934 infrastructure projects completed during April
1992–June 2009. The second dataset includes 195 road projects under the
supervision of the National Highways Authority of India (NHAI). The
analysis develops several hypotheses and subjects them to empirical testing.
Among other issues, the paper compares delays and cost overruns in PPPs
with traditionally funded projects.

A simple tabulation of the data shows large cost overruns, averaging
15 percent, and time delays of about 80 percent. However, the author also
finds that delays and cost overruns have declined over time. It is also evident
that time delays are the primary cause of cost overruns and that larger projects
lead to larger percentage cost overruns. Projects in sectors such as roads,
railways, urban development, civil aviation, shipping and ports, and power
have experienced much longer delays and higher cost overruns than those in
other sectors, but the author finds no evidence of any regional pattern of cost
overruns or delays. He suggests that incompleteness in the initial planning
and contracting is responsible for many of the cost overruns.

The study shows that the design of the contract has a significant bearing
on the level of delays. Traditional item-rate contracts provide little or no
incentives to avoid delays. In contrast, since a PPP allows contractors to
reap returns as soon as the project is complete, it creates a strong incentive
to complete the project at the earliest possible date. Moreover, by bundling
responsibility for maintenance with construction, the PPP also motivates
contractors to avoid compromising on quality. Somewhat surprisingly, PPP
projects experience higher cost overruns even though they have significantly
lower time delays. The author attributes the shorter time delays to the fact
that the project revenues do not begin until it is complete. The larger cost
overruns are more puzzling, but may reflect incentives to expand the scope
of the project.

Finally, according to the author, a comparison of road with railways sector
projects suggests that organizational factors also contribute to delays and cost
overruns. The author identifies three specific aspects. The railways sector is
slower during planning and contracting phases. Second, contract management
by the railways sector is poorer than by the roads sector. While the NHAI
awards most project works to a single contractor, the railways award different
works to different contractors. This results in poor project coordination. Third,
in the railways sector, projects are allocated funds only for the relevant fiscal
year and this is done in the second half of the year. The NHAI’s project
delivery mechanism is not subject to this constraint.

Despite recent progress in India toward the social inclusion and empowerment
of women, their presence in the country’s state and national lawmaking
bodies remains low, raising concerns about how well women’s interests are
represented. Previous empirical evidence has substantiated these concerns:
women have different policy preferences than men, and elected leaders tend
to implement policies in line with their own personal policy preferences,
regardless of earlier campaign promises. These arguments provide an important
motivation for gender-based affirmative-action policies.

In order to increase women’s political voice, the Indian government
amended its constitution in 1993, devolving significant decision-making
powers to village-level councils called Gram Panchayats (GPs) and requiring
a randomly selected third of all members and leaders (Pradhans) of
these councils to be reserved for women. Most recently, in 2010, the upper
house of the Indian parliament passed a bill applying similar reservation
requirements to the state and national levels of government in the face of
considerable resistance and skepticism. Despite the widespread adoption
of such gender-reservation policies, several concerns about their effectiveness
remain. First, little will change if husbands of female leaders elected
to reserved seats lead by proxy, and second, reservation could leave fewer
seats to be contested among other disadvantaged groups for which reservations
were not established, such as India’s Muslims.

Using new data spanning 11 Indian states, the paper by Lori Beaman,
Esther Duflo, Rohini Pande, and Petia Topalova, “Political Reservation
and Substantive Representation: Evidence from Indian Village Councils,”
assesses the impact of introducing political reservation in India’s GPs, with
particular attention to the aforementioned concerns. In conducting their
study, the authors collect GP meeting data across fi ve economically and
socially heterogeneous states, obtain data on public-good provision from
a nationwide survey, and conduct their own survey of 165 GPs within the
Birbhum district of West Bengal.

The study examines the effect of reservations in local village councils; the
results are likely to be applicable to similar provisions within higher levels of
government because the electoral process is the same, voter participation is
high, and political parties invest significant resources in elections across all
levels of government. Furthermore, by exploiting the random assignment of
GP gender reservations, the authors are able to ensure that observed effects
can be attributed to political reservations, rather than other factors, such
as social attitudes toward women and local demand for public goods. The
expansive data and novel study design allow the authors to shed light on
three distinct elements of the debate on gender reservations in policymaking:
politician selection, citizen participation in politics, and policymaking. 

First, the authors assess the degree to which reservation affects politician
selection. Encouragingly, they fi nd no evidence that reservation for women
has caused the crowding-out of other politically underrepresented social
groups. Evidence does suggest, however, that women elected to reserved
seats are less experienced and more likely to enlist their husband’s help
in carrying out their duties as Pradhan. Nevertheless, two years into their
tenure, female Pradhans from reserved GPs claim they are as comfortable
and effective in their roles as their counterparts in nonreserved seats.

The study also reveals the causal mechanisms through which issues
important to women might receive insufficient attention in local government.
The authors hypothesize that underinvestment in what they determine
are “female-friendly” issues occurs because male leaders either possess
entirely different preferences, or discriminate against the viewpoints of the
opposite gender, regardless of whether or not their preferences diverge. The
study revealed that neither is the case. Leaders in reserved GPs are neither
more likely to react positively to a female-friendly issue, nor more likely to
respond favorably to the inquiry of a female participant in Village Council
(Gram Sabha or GS) meetings. On the contrary, women in both reserved
and nonreserved GPs were found to receive more constructive responses in
these meetings then men. This suggests that the problem lies not in unsympathetic
leadership, but in a lack of female constituent participation in the
political process that would voice women’s policy concerns. Accordingly,
the study also examines the effect of gender reservation on female participation
in politics. Reservation does have a positive effect on whether women
participate at all in the GS meeting, and the degree to which they remain
engaged throughout the meeting. Therefore, inasmuch as electing women to
Pradhan seats continues to encourage the participation of women in GS
meetings, the reservations will continue to prove effective.

Finally, the study takes advantage of new data to elucidate earlier claims
regarding the effects of political reservations on allocations of public goods.
A first dataset, much broader in geographic scope than that of previous
studies, confirms earlier findings that female Pradhans elected to reserved
seats deliver more drinking water infrastructure, sanitation, and roads than
their nonreserved counterparts. However, in exploiting the richer cross-time
variation of a second dataset, the study reveals that reservations have a much
broader impact across sectors than previously thought. The data from the
Birbhum region of West Bengal allow the authors to compare public goods
allocation patterns between newly reserved GPs, GPs reserved twice in a
row, and GPs that are currently unreserved but were reserved before. These
new data indicate that, while continuing to push drinking water investments,
women elected in the second term under a reserved seat also invest more
in “male issues” such as school repair, health center repair, and irrigation
facilities. These investment patterns are found to be enduring, as even male
Pradhans elected to previously reserved seats continue to invest in female friendly
issues, after female reservation for their GP has expired.

Taken together, the findings of the study provide important insights into
how leaders in reserved seats are elected, affect policymaking, and actual
policy outcomes. While women elected in reserved GPs do differ from their
male counterparts in their experience as leaders, they are able to increase
female participation in the political process and make different policy decisions.
The basic structure of India’s fiscal federalism was in place within
fi ve years of the country’s independence on August 15, 1947. The division
of expenditure responsibilities and sources of revenue across units of the
federation as well as the institutions for allocating resources between levels
of government gave substantial discretion to the central government, thereby
concentrating economic and political power at the federal level. The design
was understandable in light of the perceived need to combat incipient
forces of separatism and the economic logic of planned development. This
framework for fiscal federalism has been remarkably stable, however, even
as the fears of separatism faded, political power dispersed and new parties
representing state interests gained representation at all levels of government,
and markets replaced planners in directing investment.

In their paper “Inelastic Institutions: Political Change and Intergovernmental
Transfer Oversight in Post-Independence India,” T.N. Srinivasan
and Jessica Seddon Wallack examine the persistence, and in some cases
strengthening, of centralizing features in India’s fiscal federalism, which is
a surprising exception to the general trend toward decentralization that other
analysts of India’s political economy have described.

The paper focuses in particular on the two institutions—the Finance
Commission (FC) and the Planning Commission (PC)—that oversee the
bulk of intergovernmental resource transfers. The FC, a constitutional
body designed to be independent of both Center and state constitutionally
defined jurisdictions, was created to ensure that states had predictable and
stable resources and autonomy in their use. In practice, the FC has played
a limited role relative to its constitutional potential. Many have argued that
it has unique constitutional authority to oversee intergovernmental revenue
transfers, but a substantial portion of these transfers are determined and
allocated through the PC instead.

The PC, an entity created by a cabinet resolution and hence a part of the
constitutional sphere of the Center, was to advise the Center on planning
and plans for national development. In contrast to the FC, the PC has in
fact played a much larger role in allocating transfers than advising would
necessarily imply. As a transfer mechanism, it facilitates Central government
oversight of states’ development policies and has ample scope for
Central government discretion in transfers. The centralizing aspects of this
arrangement have been highlighted in various high-profile public discussions
questioning the division of responsibilities between the FC and the PC as well
as the various mechanisms for transfers by the PC. Yet, little has changed in
terms of the institutional oversight over resource flows.

The authors explore various explanations for the persistence of these
centralizing features and conclude that the most likely explanation lies in the
barriers that India’s federal institutions pose to collective action by states.
State leaders have ample political reasons to seek greater control over their
finances and in fact do appear to care about the centralizing implications of
the fiscal federal framework. However, they are divided both by design—state
boundaries were in many cases drawn on the basis of linguistic or cultural
differences—as well as by the economic reality of diverging fortunes and
varying dependence on transfers.

India’s institutions also offer no authoritative forum for states and Central
government to discuss federal arrangements and propose alternatives. The
available arenas for intergovernmental discussions are either toothless or
have structures that create incentives for individualist behavior. The Union
Parliament, for example, would be able to effect changes to the federal
structure through instruments available to it under the constitution or through
constitutional amendments if needed. However, the parliamentary system
also gives those state parties that are part of the government a vested interest
in preserving the status quo.

Srinivasan and Wallack’s analysis implies that there will be limited
change in the intergovernmental transfer system, a conclusion that they
find worrisome for India’s ability to adjust economically and politically to
changing circumstances. Not only does conventional public finance theory
favor decentralization of decision making with respect to the financing and
provision of public goods and services, especially in heterogeneous societies,
but “voices from below” are increasingly valuable as an information
source about what is needed in a fast-changing world. They argue that India’s
record of government performance also suggests a dearth of accountability,
and that real decentralization of roles and responsibilities—not delegated
expenditure duties—can be more effective in creating stronger performance
incentives.

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