A short history of the Indian economy


“…because nothing, ultimately, is more important for economic growth than having a well-educated and healthy labour force (ask Chinese, Japanese, Koreans and other Asians, and they will tell you). That is the biggest lesson of East Asian development that India has missed.” – Amartya Sen

This brief history of the Indian economy will start from the time of Independence in 1947. After more than a century of colonial rule in India, suddenly the new government with Jawaharlal Nehru as prime minister, had to create concepts how to rule a country as diverse as India. He decided to combine the positive experiences, made during the British Raj, with his own fabian socialist beliefs. Resulting from this, the policies that were about to come were mainly copies of soviet socialistic and economic policies. This included protectionism, import substitution, a large public sector, industrialization, state intervention in labor and financial markets and rigid business regulations. Because this worry-plate was way to extensive, the first Indian government decided to focus on substitution. The believed that after Independence the most effective way to boost the economy was to focus on the own, national market rather than allowing any international interference. In fact, with a regulated, fixed currency and high taxes on imports, international organizations were scared away. Furthermore, the Nehru government decided that the scope of investment must be determined by the state and not by the market. In line with these policy changes they nationalized the key industries, such as power, water and telecommunication and established a system of centralized planning, the so-called “License Raj”. The idea behind that was, that the government was handing out licenses in order to control prizes, products, investment, expansion plans and the sources of capital. But this concept backfired pretty quickly. The number of licenses was limited and hence powerful monopolies in steel, mining, power and telecommunication established and eradicated all sprouting businesses within the country. From this followed, that with red tape business owners were trying to get these permissions. That was when corruption and bureaucracy started flourishing and permeating all layers of the Indian political system.


These policies had to have consequences at some point and when they came down on India, they hit them hard. The problem was, that the ban of foreign investment and nationalization of industries had brought very slow growth in annual income (3.5%), in fact, it was the slowest among the Asian countries. Furthermore, the GDP growth rate was similar to 0-1%. In the 70’s-80’s this led to a disastrous financial crisis throughout the subcontinent. The government called it problems in “balancing the payments”, but in reality the country’s economy was nearly bankrupt, no financial institution was willing to give any further credits and the foreign exchange reserves were less than the value of a three weeks’ import. That was when the International Monetary Fund (IMF) stepped in to help the Indian government to bring the economy back on track. As a collateral, the government had to pay 67 tons of gold to London&Bernes, the Indian Rupee was deregulated from $1=17INR to $1=45INR and further the country had to undergo rigid economic reforms, dictated by the IMF. This reforms included:

  • Opening of the markets to foreign investment
  • Doing away with the “License Raj”
  • Automatic approval to Foreign Direct Investment to promote foreign trade
  • Deregulation of the business markets
  • Reformation of the capital markets
  • Privatization of inefficient government institutions
  • End to monopolies

The liberalization of the Indian economy through these reforms was extremely successful. The foreign investment increased from $132 million to $5.3 billion in 2004, as well as the GDP which grew from 1% to 5.3% in (with lots of up’s and down’s) in 2008. The privatization of the infrastructure sector, such as civil aviation and telecommunication, has been very successful and further IT and Service industries started shooting through the roof. For instance, by 2004 approximately 300 million people belonged to the lower middle-class in India, 1/3 of them emerged from poverty, if the economy would have been growing at the same rate until 2025, economists estimated that the majority of the poor would be uplifted to the lower middle-class. But unfortunately since recent years the economy is slowing down rapidly to a GDP growth rate of only 4.5% in 2013. But when observing the structure and distribution of labor within the Indian economy, the decline is not that surprising anymore:

  1. Industry sector
    adds to GDP: 27% ; employs 17% of the labor force
  2. Service sector (IT, ITES, BOP)
    adds to GDP: 56%; employs 23% of the labor force
  3. Agriculture sector
    adds to GDP: 17%; employs 60% of the labor force


Technical universities are sprouting behind every corner in India, but the fact that IT and ITES only contributes 1% to the GDP of India emphasizes that there are lots of other job professions and sectors that should be supported by the government and international organizations.
Regarding agriculture, the government pays large subsidies but these block investment which would be desperately needed in order to advance the productivity of the famers. As seen in the figure above, the agriculture sector has an over-supply of labor, but is suffering from underemployment due to job scarcity. Furthermore, the state intervention in labor, capital and land as well as bureaucratic overregulation qualifies the economic behavior of the farmers and increased the costs, price risk and uncertainty. At the tip of this rather depriving environment for farmers is the inefficient infrastructure, as in electricity, water, health care, education and transportation. If a future government intends to turn the economy around, this may be the construction to start with.


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