Raghuram Rajan: Why Liberal Democracy is Necessary for Indian Development


By Nayab Gauhar and Farhan Siddique

While addressing the students of Aligarh Muslim University at a Literary Festival on the topic “Why Liberal Democracy is Necessary for Indian Development” on 21 May, 2022, Dr. Raghuram Rajan said, “When it comes to spending priorities, should we spend on production linked subsidies to our biggest industries or make sure that kids go back to school? I would say the latter has more weight.”

According to Mr. Rajan, the recent surge in the argument that India needs an authoritarian regime with minimal checks and balances is blatantly misguided and wrong, as it is against the ethos of Indian society and is an outdated development model. To be fully developed and limitless, we have to rely on the institutions of our already existing liberal democratic institutions.

He agrees that India is the world’s fastest-growing economy today, but it mustn’t be ignored that the rebound is from the disastrous numbers of last fiscal year. Even with this strong growth, we are still significantly below where we were at pre-pandemic times. To substantiate this claim, Dr. Rajan cites data from JP Morgan which states that the real GDP of India is about 6 to 7% below the pre-pandemic trend line. In the West, many countries have caught up with their pre-pandemic trend line.

The distinguished economist pointed out that India’s slow growth is not because of the pandemic or the ongoing war in Ukraine; we have been underperforming our potential since the onset of the Global Financial Crisis. The key measure of this underperformance is our inability to create good jobs that people like us need. There are 12 million applicants for 35000 railway jobs, and this shows the level of scarcity of jobs that India is going through. As he says, “Our youth spend their best time sitting for government jobs exams until they become very old to sit.”

The most worrisome fact is that we have a scarcity of jobs even when so many of our women are not working outside the house. In India, female labor force participation is amongst the lowest in the G20. From 20.3% in 2019, the situation has only worsened. Our under-performance predates the pandemic.

Dr. Rajan also praises the fact that India has had some significant success regardless of the slow growth rates. For example, India is the largest two-wheeler manufacturer globally, exporting Classic Enfield to the land of Harley Davidson, i.e., the United States. In the financial sector, an application like Unified Payments Interface (UPI) digitizes everyone’s life. UPI is now studied worldwide by central banks intending to implement fast retail payments. This symbolizes that we can come up to the best in the world, especially our youth who knows no limits.

Now the question arises, why haven’t been able to provide jobs? Where have we gone wrong? It’s not the fault of our people, given the right environment is second to none in the world. It is a failure of imagination of our politics and leadership. What have worked for us in the past are well-thought-out frameworks or infrastructures that freed our people to utilize their creativity. For example, Prime Minister Vajpayee’s golden quadrilateral Highway building project opened and connected India.

On top of that, when we had the rural road projects of subsequent governments, they connected those highways to the interior of India; when the interior is connected it does wonders for development. This project is an example of creating a framework, in this case, physical infrastructure to connect the country, which brought change. So as a result, our economy improved tremendously, and all this led to a 7% average growth, something very few large countries have achieved. But fall in development over the last decade urges the need to go entirely in new directions. Time changed, and the situation changed, so the strategy also needs to be changed.

Speaking about the current government policy of being ‘Atmanirbhar’ (self-reliant), Dr. Rajan says, “In some ways, this is a continuation of what we used to do in the past. The model behind Atmanirbhar seems to be a reversion to a more distant and failed past where we focused on physical capital and goods and not human capital and services, on protection and subsidies and not on liberalization and competition.” To be Atmanirbhar, the government has introduced the Production Linked Incentive Scheme (PLI), which not only encourages foreign companies to find a workforce in the country and thereby generate employment, but also encourages domestic and local production to create micro jobs, just as China did after 1978.

But we have to understand the fact that although in 1995, India and China were neck to neck in per capita GDP, China being an authoritarian country grew at a tremendous pace by suppressing wages – consumption and limiting the returns on deposits to households by reducing the interest rate paid to them. These allowed the firms to make more profits while also allowing Chinese firms to get compensation for initial deficiencies which led to their growth over time. In the long run, China created an educated workforce and decent infrastructure which ultimately led China to grow fast and eventually reach the world level. He further states that India is trying to replicate China but India’s starting point is different. It is impossible and undesirable for India as a democracy to suppress wages or to keep household savings low.

So, what is the Indian government doing?

The Indian government is devolving resources on tariffs and subsidies to promote manufacturing. When tariffs are imposed on imported products, that gives domestic production protection by sort of making any imports more costly and offering production subsidies for large manufacturers so not only they are protected by higher tariffs but also get government money if industries produce domestically. The motive of tariffs and subsidies is to make domestic manufacturers efficient. The cost of them is endured by citizens i.e., us, but history tells different stories, taking an example of Ambassador cars, as they were manufactured in India for 40 years without any change on subsidies. Still, it remained inefficient. That is what happens when we protect industries but also subsidize them.

Another hindrance is that those industries that get subsidies are not ready to forego protection. Furthermore, once you start putting tariffs on imports, it becomes a tax on exports, and we are continuously putting more and more tariffs on imports. Which industries will get production linked subsidies is totally non-transparent and entirely discretionary. Every budget, the government decides which new industry will get subsidies, and there is no partial process. Moreover, this constant demand for protection by industry tends to increase, to balance that the government vary tariffs, and there is no certainty over cost, which further hinders the global manufacturer. The problem is that eventually, the taxpayer money goes to subsidize our most prominent and well-connected firms, the Ambanis, Adanis and Tatas, rather than the sector where India may have a natural advantage.

What should be done by the Government? As per Dr. Rajan, we should continue building infrastructure, making the production and business environment more liberal, and encouraging manufacturers to seek out new global markets. Still, we should not do it through protective tariffs and subsidies. By fixing our deficiencies, saved resources should go to the making of schools and colleges, which will be a direct investment in human capital. Dr. Rajan emphasizes that instead of subsidizing industries by allocating 13 billion dollars through the PLI scheme, we should subsidize education which will give us far better output. Due to the pandemic, poor children have been out of school for two years, and most of them have already forgotten what they have studied earlier, which brought them back to ground zero. There is no ongoing program to rescue this lost generation. By investing in humans, we can create an educated population, which will improve the quality of workers, making the business environment easier for people to start a business.

We should shift our focus to services from manufacturing. To substantiate this point, Dr. Rajan said, “Instead of subsidizing 10 billion dollars for chip manufacturing we should reallocate that to maybe 200 first-class universities or 2000 or maybe more high-quality high schools. We would not get chip manufacturing, but we would get chip design and much of the value in the world is now in those high skill services such as chip design rather than in manufacturing. So even our spending priority needs to be rethought.”

Services are something which physical borders cannot stop. A person sitting in Bangalore can provide her service to someone in Chicago, and it can be of any kind, be it legal assistance, finance, education, IT services, consulting, telemedicine, etcetera. But the critical element in providing these services is shared values and trust, especially around the data that are harvested. This automatically puts authoritarian countries like China and Russia at a disadvantage, as people are afraid to share their data across borders, especially with people from authoritarian countries as they or their government can snoop their data to blackmail the beneficiary. But when the provider comes from a liberal democracy where the rule of law prevails, the beneficiary does not hold any kind of fear and accept services. Having a liberal democracy is already an advantage for India in providing services to the world.

All we have to do is prioritize our spending on service sectors, which will lead to the creation of skilled jobs that further provide three to four less-skilled jobs, which will benefit our economy. Choosing this path will make us the first nation to transit directly to services without going fully through manufacturing: “Premature deindustrialization will not be a bug for India but a feature for our growth path.”

If India has to escalate into the economic world, we need our government to be pragmatic, transparent, decentralized, open to criticism, and carry everyone – be it women, the biggest religious minorities i.e., Muslims or any other socially backward class of our society. If other democracy is our target market, we cannot be seen as creating second class citizens of our minorities. So, if we allow our democracy to crumble in majoritarianism or authoritarianism, then our economic future and our soul as a nation and place among other democratic nations will be jeopardized. Democracy is not something nice to have but it is central to everything.

Nayab Gauhar and Farhan Siddique are students of Law at Aligarh Muslim University.


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