India Used to be Socialist. What Happened?
Nehru
At its founding, India’s architects designed a centrally-planned economy. For decades, the government operated most financial institutions, and manufacturing conglomerates, with heavy protectionism, a focus on import substitution industrialization, and micro-managing the private sector.
In 1969, J. R. D. Tata described doing business in India as “I cannot decide how much to borrow, what shares to issue, at what price, what wages and bonus to pay, and what dividend to give. I even need the government's permission for the salary I pay to a senior executive.”
India’s inward-obsessed domestic policy was driven by a desire for economic independence to solidify political independence. Many post-independence Indian thinkers thought free trade with the West would only restore the exploitation of Indian workers by the British that they had just fought so hard to end. “India's share of global trade fell steadily from 2.2 percent at independence to 0.45 percent in 1985, and that was hailed as a policy triumph by Indian socialists,” economist S. S. A. Aiyar writes.
However, by the 1980s it was obvious to the Indira Gandhi government that the country was far behind its peers; often treated as an economic equivalent of Pakistan despite having 8 times the population. The Gandhi administration eased regulations and investment controls, which caused an economic boon from 1988 to 1991.
By 1991, the government was confronted with a near-empty currency reserve. Since India’s rupee was pegged to a basket of currencies of trading partners, the government often had to deploy reserves quickly to keep the peg stable. The 1991 global oil crisis, initiated by Saddam Hussein’s invasion of Kuwait, caused import bills to skyrocket, wiping the RBI’s reserves. Newly elected Prime Minister P. V. Narasimha Rao, and his finance minister (and future Prime Minister) Manmohan Singh, worked to quickly liberalize the economy to jumpstart growth.
Rao and Singh
Rao administration policies include ending the License Raj by removing licensing restrictions for all industries except 18 related to security, social, safety, or environmental concerns. To attract foreign investment, it allowed automatic approval for investments up to 51% foreign ownership, enabling foreign companies to bring in modern technology. It also eliminated the need for government approval of foreign technology agreements. Additionally, it aimed to break public sector monopolies by selling shares of public companies and limiting public sector growth to essential infrastructure, minerals, and defense. Finally, it abolished the MRTP rule, which automatically put large companies under government supervision.
After the 1991-1993 liberalization reforms, India experienced massive economic growth, lifting 139 million out of extreme poverty in two decades. From 1993 to 2005, GDP growth averaged 6 percent.
As a way to test if the economic improvements were due to liberalization or just the 90s global economic boon, we can compare India’s growth to a control group of “synthetic India” composed of countries nearby India (like Pakistan and Bangladesh) that did not implement the same liberalization measures. We find that India’s actual growth far surpassed neighbors after the ‘90s liberalization efforts.
