Ever since India's economic reforms of the 1990s, factories like this one have been at full capacity. However, the Indian economy still faces many challenges ahead as more reforms are needed in order to sustain fast-paced economic growth.

Most headlines featuring India today focus on its impressive economic growth, outsourcing, and impact on information technology globally. Multinational firms eye the country’s growing, confident middle class with enormous interest, while its demographics, with a growing work force, seem favorable to continued economic dynamism. "India shining" became the slogan of the Bharatiya Janata Party (BJP), headlining the ruling coalition in the 2004 parliamentary elections. Dig deeper, though, and the numbers on basic health, nutrition, and education still leave much to be desired. According to Devesh Kapur in his article "India’s Promise" in a recent Harvard Magazine article, governance – including law and order, provision of basic needs in health and education, and overall fiscal management – continues to be one of India’s greatest weaknesses, despite the resilience of its democratic system. Symptoms of governance failure include an increase in grassroots insurrections in several Indian states and voter dissatisfaction. In 2004, the BJP-led coalition lost over a quarter of its parliamentary seats and the chance to govern India, despite India’s economic progress under the coalition. The Indian National Congress party, leader of the successor coalition government, has since struggled to find a policy orientation that provides greater inclusiveness in economic development.

Unfortunately, much of the political and policy debate in India is mired in rhetoric and outmoded theoretical constructs, and lacks empirical analysis. The political left rails against globalization in general, while economic reform proposals often lack coherence and consistency. The diversity of the country, the complexity of the political and economic issues, and resistance from the beneficiaries of the status quo all make progress difficult. Nevertheless, if one assesses India’s experiences over the last six decades, particularly the struggle for reform in the last two, lessons emerge that point the way forward. If India is to emerge as a prosperous and stable nation, it must (1) understand the role of the market and reflect this in policy, (2) make the government more focused as well as more effective in its focus, and (3) reform governance so it can enable citizens to make their representatives more accountable.

The role of the market

From 1947 through the 1970s, the perceived vagaries of capitalism and the inequities of imperialism shaped India’s post-independence policy stance towards the market. The government was to occupy the “commanding heights” of the economy, managing basic heavy industries and finance in order to make the requisite big push towards development. This strategy had some initial success, creating industries and infrastructure from the ground up, and perhaps contributed to political and social stability. However, gradually the words of James Madison, writing in The Federalist Papers in 1788, became more and more salient: “men are not angels,” even within government. India’s government increasingly encroached into the marketplace for less than noble reasons (i.e., the patronage and corruption that accompanied controlling or usurping market-based economic activity), and the “license-permit-quota raj” strangled private enterprise.

Economic reform in the last twenty-odd years has meant removing a web of controls on international trade and domestic corporate investment. The success of India’s information technology firms, operating below the radar of government controls, has become an exemplar of what Indian entrepreneurs can accomplish when given half a chance. Unfortunately, a myriad of unnecessary controls persist, often at the state level. Small and medium enterprises, as well as the agricultural sector, continue to be constrained by restrictions on investment, production decisions, and domestic trade. Part of the problem is that it is difficult to leave things to market forces without having the adequate laws, rules, institutions, and safety nets in place. Nevertheless, the dynamics of the market still need to be fully accepted in India, as the country needs even faster industrial growth if it is to absorb all the young people that will enter the labor market as well as those left unemployed from India’s days of slow growth. The path of economic liberalization has a long way to go, even as governance needs to improve by removing government participation from the business of running airlines, hotels, and other non-core activities, thereby focusing more explicitly on the proper roles of government.

Government as referee

The pre-democratic model of government was that of the “big man” or “chief,” (terms used by Jared Diamond in his 1997 book Gun, Germs and Steel: The Fates of Human Societies), and India’s democratic veneer has not altered this view of government, which still remains as the figurative mother and father – the “mai-baap sarkaar.” This attitude pervades the bureaucracy and the political class, preventing constituents from fully enforcing electoral accountability. In particular, it still influences government regulation of the market economy. Committees on private and foreign investment in higher education, capital account convertibility, telecommunications and other areas where the government needs to set the rules for market players continue to be pervaded by the “father knows best” attitude. Instead, the government needs to recognize that the “children” (whether companies or citizens) are grown up and need a different kind of support.

Progress has been made in areas such as financial and telecommunications regulation, two parts of the economy that have done very well. However, these and other sectors (particularly electric power) need continued development of modern, arm’s-length regulatory institutions in order to nurture a competitive environment and reduce politicization of economic decision-making. In order to create a level competitive field in all industries, competition policy remain to be overhauled and needs to replace paternalistic ex ante controls with transparent rules, monitoring, and sanctions for violations. More broadly, in addition to its deeper social and ethical purposes, the entire legal system needs additional resources and institutional reforms to allow it to serve its role as a referee in the market. Necessary reforms include procedural streamlining, greater transparency, and improved education and training.

Government as facilitator

It is well recognized, in India as much as internationally, that the market cannot do everything that a nation and society needs. Primary education, public health, child nutrition, and other related areas are where the government has a clear and necessary role. Although there has been progress, it is hardly enough and the government continues to perform extremely poorly. According to the United Nations Development Programme, India’s Human Development Index in 2006 ranked it 126th out of 177 countries with some particularly underdeveloped regions. For example, poverty rates in the state of Bihar are 60 percent above the national average and infant mortality rates in Madhya Pradesh and Orissa are almost double the national average. Part of the problem is a lack of focus – essentially an attempt by the government to do too many things. This dissipation became worse over the past several decades, and is only now gradually improving. Interest group capture worsens the problem, with state and national governments competing to dole out massive subsidies and plain give-aways to garner political support. Even initial successes, such as publicly funded higher education, are eroding as funding is stretched thinner and thinner. Another problem is the lack of incentives among frontline government service providers, such as teachers and health providers.