The coronavirus pandemic has not only left behind millions of dead, but also a trail of economic destruction throughout the world. India has suffered as well. The big question is:
Will the on-going economic pain persist through the next decade, or will a strong economic recovery offer hope of sunshine after the storm? Economic forecasting is always a fragile business, more so during events that the world has rarely faced before. What follows is an attempt to detect silver linings to the dark clouds that have dominated the scene since the pandemic began in China.
Let us first count the economic costs of the pandemic. The latest estimates suggest that the size of the Indian economy in the current financial year will be around the same as it was in 2019-20, or the last financial year before the pandemic struck. This means that the Indian economy has, in effect, stagnated for two years because of the pandemic shock.
These economic losses have been borne unequally in India as those living at the bottom of the pyramid have suffered significant income losses because they have either become unemployed or have seen their wages fall. At the same time, large enterprises in the organised sector have managed to weather the storm far better than smaller ones and have perhaps gained market share in some sectors. In sum, people who have been able to work from home have protected their incomes better than those who need to step out of the house to bring home money.
There is another way to look at the same facts. Let us assume that there had been no pandemic and the Indian economy had managed to grow at 6.5% a year in 2020-21 and 2021-22. Then, the size of our economy at the end of the current financial year would have been around $400 billion larger than it will be in reality. In other words, the permanent output loss because of the pandemic is huge – equal to the size of the economy in 1998. It may sound harsh, but one entire year of 1998-level output has disappeared down the sinkhole because of the pandemic.
Large shocks such as the one that the world is facing right now often have a lasting impact and their effects linger even after the rubble is cleared away. Let me give one example that is relevant to India. The ‘Spanish Flu’ ripped through the Indian countryside in 1918, killing an estimated 18 million people in undivided India. Two economic historians, Dave Donaldson and Daniel Keniston, have shown in recent work that the pandemic had a lasting impact.
In the districts where the death toll was very high, the survivors were left with additional agricultural land. This land was quickly put to use by the survivors. The resultant increase in incomes had an interesting consequence. The survivors invested in both ‘child quantity’ as well as ‘child quality’. In other words, they had more children and they also took better care of them. The two economists show that children born in these districts after the pandemic ended were taller and better educated than the children born before the pandemic.
These were big changes at the level of the household. There are examples from other countries of broader macroeconomic shifts. For example, the US economy had a great run in the decade after the end of World War I and the boom only ended with the stock market crash of 1929. Europe emerged from the destruction of World War II to experience at least 25 years of strong economic growth.
Economic theory tells us that economies grow from a combination of three sources – a growing labour force, a higher level of capital investments and increases in productivity. More specifically, economist Barry Eichengreen wrote in an essay published in July, 2020: ‘The crisis will influence potential growth through four channels, three negative and one positive. On the negative side, it will interrupt schooling, depress public investment and destroy global supply chains. Positively, by disrupting existing industries and activities, it will open up space for innovative new entrants, through the process that the early 20th century Austrian economist and social theorist Joseph Schumpeter referred to as “creative destruction”.’
It is worth asking whether these four channels are relevant to India as well, and especially whether three of them will have a negative impact and the fourth will have a positive one.
First, the pandemic is likely to disrupt the Indian education system for two years in a row. Millions of students will have had to make do with online instruction. It is quite likely that students who have access to good personal electronics as well as secure broadband connections will be able to learn enough. Evidence collected from across the country shows that children in poor households have struggled to keep up. The chances of an increase in school dropout levels cannot be ignored.
Even in colleges, students whose training depends on practical work may find themselves missing out on a key part of their professional education. India already suffers from a skills deficit. The quality of human capital is already a problem because of malnutrition, illiteracy and lack of new skills. The impact of the pandemic adds to the problem, even if we assume that the education system goes back to normal after the pandemic ends. These are important considerations for economic growth at a time when the Chinese population has peaked and India is the only comparable country that has a growing labour force.
Second, public finances have come under pressure because of the pandemic. The ratio of public debt to GDP for India is now estimated at around 90%, the highest in living memory. It is unlikely to come down significantly at least in the next five years. What this means in effect is that a large slice of domestic tax collections will have to be used to service the interest costs on the debt. This will weigh down on the annual government budget. The government will have relatively fewer resources available to spend on other items such as infrastructure.
This need not be a dead-end. The government has other options such as asset monetisation to raise resources. It can also ask the Reserve Bank of India to buy its bonds by printing new money. But all these options will have to be exercised in the shadow of a mountain of public debt. The complicated task for the government is to increase public spending right now to make up for the weak private sector demand in India while also withdrawing once corporate investment begins to pick up. The increase in capital stock over the next ten years will be a key factor, but for now, companies seem more comfortable deleveraging rather than increasing capacity.
Third, Eichengreen expects the disruption of global supply chains to be a negative for the global economy. But some economists in the Indian government expect it to be a positive for India. There are three possible reasons why global supply chains will begin to shift out of China in this decade. The Chinese themselves are trying to recalibrate their economy from cheap industrial goods to technology products. The growing geopolitical tensions with the US have led to growing restrictions on trade with China. The pandemic has exposed the risks of supply chain concentration in one country or one company; the organising principle of global production is expected to shift to the principle of resilience.
The Indian government has a clear focus on getting global supply chains into India. Some of the recent subsidies for domestic manufacturing are a step in that direction. However, the growing protectionist sentiment in India is at odds with becoming an important part of global supply chains, since the latter assumes that inputs can move across national borders with ease. The Apple iPhone has components from 43 countries that are assembled in large factories in China. High import tariffs will not make such a complex manufacturing system possible.
Fourth, disruptive innovation can unleash a new round of productivity growth. The impulses for such innovation can come from sources as diverse as the formalisation of the economy to meeting the growing challenge of climate change. A recent report by investment bank Credit Suisse says that India is the third-largest home to unicorns, or startups that have been valued at more than $1 billion. There are now 100 Indian unicorns with a combined valuation of $240 billion. The number of listed companies with a market capitalisation of more the $1 billion is 336. Most of the unlisted unicorns have been set up after 2005.
The growth of Indian unicorns suggests a deeper change as a new generation of Indian entrepreneurs drives growth. However, there is also the harsh reality of the crisis in the unorganised sector at one end of the spectrum, to the growth of domestic oligopolies at the other end. A surge in productivity can be sustained only with economic policies that encourage job creation in enterprises that are efficient rather than protected by the government – market capitalism rather than crony capitalism. The government itself will have to build infrastructure, maintain macroeconomic stability, build a social safety net and ensure that economic growth creates inclusive opportunities.
India was a poor country in 1991. It is a lower middle income country in 2021. Economic growth has to accelerate if we are to become a higher middle income country when the Republic turns a hundred. The pandemic has been a huge setback and a lot depends on how we negotiate the challenges through the rest of the decade. Neither empty optimism nor overpowering pessimism is warranted.
