To get rich before we get old, the pace of growth has to increase: Raghuram Rajan

Professor Rajan, India’s domestic economic scenario is the topic, but first, a question that has engaged economists’ minds in the past six months: the possible headwinds from the new protectionist mood in Washington, D.C. How would you see that impacting India’s economic prospects?

 It’s complex. Let’s start with why the US [United States] is moving in this direction. President Trump is not a fan of free trade. Since the 1980s, he has been pointing to initially Japan, then China, as taking jobs away from the US. He and his close advisers on trade see a current account deficit with any country as an indictment of that country’s trading practices and as evidence that they are exploiting the US. Some of this may be rhetoric to get better deals, but underlying what the US is doing is President Trump’s conviction that this is for the good. And he’s not the only protectionist in the world. We have our own homegrown protectionists in India and elsewhere.

The key question is: The US is the most powerful and one of the richest countries in the world. Is he undermining the basis of US prosperity and its dominance of the post-Second World War economic system with this view? I think we are turning the tables on what worked.

Apart from trying to level the playing field, there is a strong desire to generate revenues from trade tariffs. The “big beautiful bill” which passed recently is going to expand red ink in the US fiscal deficit as far as the eye can see. One of the offsets are the tariffs that the US proposes to collect. At the old level of tariffs, approximately 3 per cent, you collected very little. Already, with average tariffs at around 13 per cent, there’s substantial inflow of taxes on goods coming in. Higher tariffs imply more revenues for the US government.

The third element is an attempt to shift the balance of trade from China to friendlier countries, maybe even bring it onshore into the US. Most likely what will happen is (that) it will shift to another country which has similar capabilities as China—relatively cheap labour, good infrastructure, logistics. When you look at the deal with Vietnam, it’s supposed to be 20 per cent tariffs on Vietnam’s goods, but 40 per cent tariffs on any trans-shipments of Chinese goods via Vietnam. So there seems to be a third element, which is to cut China down to size.

Put all together, higher tariffs by the United States towards the rest of the world are here to stay. They’re not just a bargaining ploy, but they’re partly a bargaining ploy to get tariffs down in other countries.

As of now, it’s not having an impact on prices, so there’s no real public disquiet.

Well, it’s not had a huge impact, but when you parse the data carefully, you start seeing that in the areas that have been tariffed, there is faster growth in prices. Some exporters to the US would absorb some of the tariff increases initially (but) I can’t keep absorbing it. But at least initially, I don’t want to change prices because I don’t want to anger my customers. But you can already see in the last Consumer Price Index report that the tariffed sectors are showing higher price growth.

From India’s point of view, the tariffs are supposed to push us towards negotiating a free trade agreement with the United States. What are the risks and rewards you see there?

Let’s be clear that India adopted a policy of freer trade right from the liberalizations in the early 1990s. But we’ve been going back on that. It would be too much to say that the old licence permit raj is back, where the government decided which sectors you were free to enter. But the intervention is back, whether through subsidies today or through tariffs and production-linked incentives.

We put tariffs up on areas we want to encourage. But then we put up tariffs on intermediate goods in that sector also. Then people complain, Oh, I can’t make this effectively here because the intermediate goods are tariffed. And we go round and round on this. That creates enormous uncertainty for business.

Our big industrialists have a bad habit when they see competition—they try and kill it through various forms of regulation, which sometimes a friendly government is willing to impose. All these are practices that inhibit competition and hurt the Indian consumer. In the best interests of both our producers and consumers, having a transparent and level playing field where we invite foreign investors to produce in India, but give them the ability to compete with our producers on an even plane—I think that’s in our interest.

To the extent that this negotiation with the US can clear up some of these issues and make our industrial policy more credible and pro-competition, I think it’s in our own interest. Of course, there are sensitive areas in trade, for example, our milk sector. We have to be careful because you also want to look at the extent of subsidies in other countries and whether you’re suddenly going to get a whole lot of subsidised imports hurting our producers.

One of the conditions the US has specified is better market access in agricultural produce and dairy. That’s obviously a red line for India. But turning to the problems the Indian economy currently faces. Is there jobless growth, informalisation of employment, too much dependence on low-value manufacturing and services? You wrote recently that high-value services might be the way forward for India. How do you see that playing out?

 Let me add one point about red lines. One should look for win-win situations in any negotiation. There may be areas in agriculture where we can work with the US to improve prospects for our own producers. We’re the world’s largest milk producer. Can we market some of our milk? Can they help value addition in milk products? Are there ways that we can engage them [the US] where we want help in agriculture? These are the places where we really could benefit.

On the broader issue of Indian growth, let’s start with obvious premises. We are in the midst of our population dividend when our dependency ratio is falling. More young people are entering the labour force. For India, as population growth is slowing, that dependency ratio is coming down, and we’re getting more people of working age. Many countries have grown very fast when that population dividend is realised. For India, that’s not happening. We’ve grown at 6, 6.5 per cent for the past 25, 30 years, which is hugely creditable. But we’re not taking off. We’re in low earth orbit.

To get rich before we get old—and we are growing older, you can see it in southern India, where fertility rates have fallen below the reproduction rate—the pace of growth has to increase. We cannot be satisfied with 6 or 6.5 per cent. We are the fastest-growing country in the G20, but we’re also the poorest country in the G20 on a per capita basis.

The key question is where is that growth going to come from? Manufacturing-led exports is much less of an answer today. Manufacturing has become much more automated. Even in assembly, where you think a lot of low-skilled workers can be used, you’re seeing the use of machines. What companies need is people who can tend the machines, repair the machines, rather than people who actually do the work that machines do.

Second, when you’re competing in manufacturing, you’re not competing with the US or Europe—rich country workers, where your low cost of labour is really a big advantage. You’re competing with Vietnam and China who also have low-cost labour but also good infrastructure.

Third, there’s manufacturing protectionism across the world because everybody wants their own little manufacturing industry. There’s no room for another China. And we are China’s size. We cannot expect that number of jobs in manufacturing.

Our point is you need to think on a multi-level platform. We do need exports: we are doing very well in high-skilled services. Today, we account for 4.5 per cent of global exports in services; manufacturing more like 1.5 per cent. But that can’t employ everyone.

We also need to think of getting all the jobs in manufacturing that we can, both to service the global economy and our domestic economy, which is now bigger than Japan. But we can also have a huge market for domestic services, which are more moderately skilled—truck driving, logistics, repair, carpentry, plumbing. We can create many more jobs, but for that we need skill building. Get a job wherever, create a job wherever you can. But don’t be focused on this idea that only in export-led manufacturing are there jobs, because that train has left the station.

You say [in your recent book co-authored with Rohit Lamba] that there’s controversy over whether India is de-industrializing, but that question may be superfluous since we should look at “de-industrialization not as a bug, but as a feature of our growth path”. Can you have high-value services growth without manufacturing value added? Our software industry is so exclusively export-focused that it has very little for the domestic market. Does that imbalance call for correction?

We shouldn’t see imports of information technology hardware as necessarily a problem. Yes, it’s an opportunity for us to produce our own hardware, but not by saying thou shalt buy only Indian, in which case you handicap the IT software industry. What you hope is that with large quantities they’re buying here, there is an Indian producer who has the capabilities. By all means, when they’re equally capable, we should choose Indian, but not impose a tax on the software exporters by increasing protection to hardware.

As far as Indian domestic use of software goes, Indians will find more need for that. The problem is demand, not that the IT exporters are unwilling to supply. I was talking to somebody who does healthcare in the US. He says Indian hospitals simply don’t want this. They don’t want to pay for it and they are not convinced this is going to add to efficiency. The bigger ones are coming around, but the smaller ones need to see this as part of their functioning.

Last point: maybe we need the hardware in order to do software. But it is not clear. Nvidia doesn’t produce any chips, but it designs them. Apple doesn’t produce any iPhones, but it designs them. In designing and in the intellectual property, you capture the higher end of the market. The best chip-making machines in the world are produced in Netherlands, which neither designs the chips nor produces them.

This canard, which is floated sometimes, that you need the manufacturing in order to do the associated services, is not necessarily true. In many areas it’s not. In a global world where communication is so easy, you can figure out what the manufacturers want very quickly.

 Is this transition going to be affected through impersonal market forces or do you need strategic investment? Do you, as the World Bank often says, just need to get the incentives right for the miracle to follow?

You need action on a number of fronts. We need strategic investment in capabilities, not in the government saying thou shall invest in this sector or that. I don’t think we have the capacity in our bureaucracy to really say, this is where you should invest.

If we want to use our research and development funds in an intelligent way, it’s not a bad idea to say, “Where is the world heading? Where do we have some advantages?” Can we identify a few thrust areas where we will fund R&D? Both by universities but also by businesses, because intellectual property is really important. I’m not averse to choosing a few thrust areas because you can’t do everything. But we should focus on improving capabilities—strengthen the quality of our schools, our universities. You have to have a few national labs where you’ve got state-of-the-art equipment where you can actually be competitive. You can’t have every university with a state-of-the-art lab.

Upskilling both across the board, not just at the very top, but also lower down—carpentry, plumbing. Tamil Nadu has this Naan Mudhalvan scheme. We should find out what works because there’s a lot of skilling schemes which go nowhere.

The government has been focused on creating physical capital infrastructure—roads, airports. That’s a good thing. We have to be careful not to overbuild. There’s a temptation when you build: every small town wants a metro. That’s overbuilding, and those will be white elephants. But building infrastructure is the second aspect, including cheap green power. We can’t afford very dirty power for too long.

I would focus more on creating frameworks. Making industry more certain about what’s coming—not constantly changing the rules, but also offering a broad vision of what we want to be developed by 2047. The government’s role is to create support systems and infrastructure that can allow businesses to take advantage.

We have established that the private sector is reasonably capable. We don’t have to occupy the commanding heights of the economy as in Nehruvian times, but the private sector needs more competition. Too many of our large businesses throttle competition in their industries. We have to be more alert to creating the competitive framework, some of which can be done by bringing in foreign direct investment.

You wrote Fault Lines in 2010 about the global meltdown of 2008. You identified three factors: widening trade imbalances, sharpening economic inequality in the United States, and financial deregulation with inconsistent standards being enforced by different countries. Have those conditions changed for the better?

 Not really. On financial regulation, we have a better handle on the banks. But the other two have gotten worse because the public’s attitude towards trade has become much more negative. Trade is exploitative rather than beneficial. And the perception of inequality, if not the reality, has also increased—that some people, the elite, are benefiting while the rest of us languish based on elite policies such as free trade.

The problem is the corrective is much harder, which is really improving access, expanding access to the broader masses. Instead, the approach seems to be let’s punish the bad guys—which for trade means every foreigner and for inequality means let’s punish the universities. As opposed a levelling up, we’re levelling down. Unfortunately, global economics is moving in that direction.

Even on regulation, when we have moved far away enough from a crisis, we stop paying attention to potential risks. Banks aren’t taking the risk directly, they’re taking risks indirectly. Banks are engaged in providing lines of credit to private credit issuers. It’s very true of India also that non-banking financial companies aren’t completely independent. They get their financing from the banks. When we say the NBFCs [non-bank financial companies] are taking the risk, the banks aren’t; we ignore the fact that it’s coming back through the back door onto banks.

Are there concerns about financial stability in India? RBI is increasingly funding the government budget deficit through its surpluses. Are we sufficiently equipped for potential instability?

 The RBI’s equity comes from holding foreign currency reserves, which when the rupee depreciates are higher in rupee terms. When the rupee depreciates, the RBI becomes wealthier because of holding foreign exchange reserves. The government naturally sees the wealth of the RBI as something that belongs to the people and has been pressurizing the RBI to pay out more in dividends.

The problem with paying it out in dividends is if there’s a huge dividend payout, it changes the fiscal balance for that year. At some point with low inflation, the rupee is going to stop depreciating so much and the RBI is not going to have this easy source of wealth to pay out to the government.

From a financial risk perspective, we always have to be vigilant. The recent episode with Jane Street and SEBI is quite important because some of these hedge funds have made tens of billions of dollars, taking the other side to some of our youth who are speculating in options markets. We really need to be more careful about allowing low-income or moderate-income youth into markets where it becomes more like a lottery or gambling rather than real investing.

The SEBI document is quite detailed (on Jane Street), and I commend SEBI on doing what it did. Accusations of market manipulation are very serious, and we should take action if it turns out to be supported by the courts.

 You’ve advocated that decentralized administrative processes would be best suited for India’s challenges. You’ve spoken in your book, The Third Pillar, about how the community gets little attention as a pillar (of governance) compared to the state and the market. Do you see this principle as applicable in India, given it’s not quite harmonious at the grassroots?

 I think it’s extremely important and the time has come where we should do more of it. There were big debates between Ambedkar and Gandhi about decentralization. The village was the den of inequity—local elites kept out lower castes and it was terrible. Gandhi’s sense was self-governance should be pushed down to the village level.

Both leaders have some merit to their arguments, but it is possible now, given the social development we’ve had, to decentralise more. It doesn’t mean that you decentralise to the village and just let go. Keeping the democratic processes running in the village is important, but empowerment is also very important.

The village community can see when the funds transmitted from the State government or Central government are misspent or line the pockets of the village elite. So long as you preserve some element of democratic response there, then they feel they have control. If the panchayat head can be thrown out for not distributing the Pradhan Mantri Awas Yojana funds properly or for not ensuring the school teacher shows up on time in the village school. Today, they have no ability to rectify those because decisions are taken far away at the district headquarters or state headquarters or even in Delhi.

Ambedkar was against decentralization, but now the time has come for much more decentralization. We started with the Panchayati Raj constitutional amendments, but it really has stopped at the State level. We haven’t allowed decentralization to go forth into the district, municipality, and village levels because the state doesn’t want to give up power. State after state should give more power to the municipalities, to the villages. That will both enhance commitment to democracy but also allow for better governance.

Final question about accessing authentic data. Is this government engaged in a war against data to ensure there’s no comparability with earlier data, so that every assessment of where we are going starts de novo from 2014?

 I don’t know that there is a war against data, but yes, the suppression of certain surveys which send a message that the government doesn’t necessarily like. And the constant changing and fiddling of underlying parameters and the ways we conduct surveys.

As a country which is modernizing very fast, we need all the data that we can get, but we also need data to understand what is working amongst government programmes and what is not. There is an accusation of fire and forget with government campaigns. We announce a campaign, but never actually determine whether it’s working. It becomes an announcement rather than effective rollout.

Almost surely, every government programme should have attached to it an evaluation process by which data is collected. If you start a programme, it doesn’t work, close it down or change it. But don’t say that you’re infallible and everything you do must work and that nobody should challenge it.

The government doesn’t understand that suppressing data is to its own detriment. When you don’t know how the production-linked incentive scheme works, it’s terrible. Yes, you can crow from the rooftops, but nobody is going to believe you. And you also make bad decisions. You need data, but also give it to your critics. Your critics are sometimes your best friends because they will identify what’s going wrong and then you can make the changes and then get credit for it.

Something like the argument for press freedom—the way the press is manipulated to ensure only good news goes out doesn’t help governance.

It doesn’t. But the problem is that the big lie tends to pervade societies which dominate the press. They can send a narrative, and a lot of people don’t question that narrative. Eventually, when they see that day-to-day life is very different from the narrative being portrayed, they turn, but it takes a long time.

You can see the attraction of trying to dominate the press and sending only feel-good news out. But for the public to understand that this is really mass manipulation takes a long time. And that’s where the attraction of this process is. That’s where we as Indians should fight it.