How Strong Really is India’s Economy?

By Mihir Khanna

India’s rapid economic rise has made headlines in The Economist, which refers to India as a rising economic power. Steady growth is evident in India’s 6-7% annual GDP growth, booming digital industry, and increasing FDI interest. However, economic news can be misleading. Growth theories explain that without a strong structural foundation, growth can become cyclical. This essay discusses the article’s claims concerning the main principles of growth theory: the Solow Model, the convergence hypothesis, and the institutional framework. This essay argues that as India demonstrates promise, its ability to sustain itself needs long-term solutions to productivity gaps, demographic shifts, inclusive growth, and development.

India’s modern growth trend depends mainly on higher expenditure on public projects and accumulation of capital, which is the premise of the Solow Growth Model. The capital stock increases when infrastructure grows through investment and capital inflows. However, the low total productivity factor (TFP), declining returns on capital, and depreciation might constrict the long-run increase in output. India’s average TFP growth per annum since 2010 is 1.2%, far below China’s 2.1 % rate during its peak. India’s low TFP growth rate is indicative of the fact that the country’s growth could be capital-oriented instead of productivity-driven. According to the Solow Model with technological progress, an economy will eventually converge to a balanced path where output per worker, capital per worker, and the labor-technology ratio will grow at a constant rate. In a steady state, the TFP and human capital will also determine output per worker. Hence, without subsequent enhancements in TFP and human capital, India is likely to converge to a lower steady-state income than other productive countries.

Furthermore, as per the convergence hypothesis, developing nations like India (GDP per capita approximately $2,500) have the capabilities to grow using established technologies adopted from developed economies. But the convergence process is based on efficient institutions and policies, which allow economies to catch up. Vietnam’s export performance and institutional strength have increased to a point where it is also growing at a similar rate to India. Yet, India’s manufacturing sector is lagging, forming only 14% of GDP, which is much below the productivity levels and importance of similar economies like China and Vietnam.

Moreover, to formalize India’s economy and industrial competitiveness, the article states that measures like GST, digital payments, and production-linked incentives (PLI) have been implemented. However, their enduring success is constrained by the weaknesses of India’s institutions. The growth of the inclusive institutions that are central to sustained growth yet are underdeveloped in India. Despite Aadhaar and UPI facilities, bureaucratic bottlenecks and regulatory opacity remain. Due to these inefficiencies, the cost of transactions increases, and foreign investments are discouraged; therefore, this hampers the real effects of the reforms. India’s improvement in ease of doing business, recorded by The Economist, fails to account for the major complexities entrepreneurs face on the ground. Innovation and risk-taking, according to endogenous growth theory, are essential, but flawed institutions make them impossible. Therefore, promising macroeconomic measures can be jeopardized by micro-institutional inefficiencies that the article briefly mentions.

Institutional weaknesses also constrain the benefits of foreign investment. In 2022-23, FDI reached $84 billion, benefiting manufacturing and technological progress. However, inflows can be volatile, such as when they fell by 16% in 2023 amid tightening global monetary policies, reflecting India’s vulnerability to external economic shocks. A weak domestic research and development investment reflects this: South Korea and Taiwan used FDI and aggressive R&D investment (3-4% of GDP) to foster innovation, while India allocates just 0.7% of GDP to R&D, which limits its endogenous growth and technological progress.

Another weakness is India’s falling domestic consumption, which accounts for about 60% of GDP. The article ignores important facts like rural consumption in 2023 grew only 1.5%, and household savings fell to 5.1% of GDP (a 30-year record low). These signals indicate financial stress and stagnation in middle-class families’ incomes, which hinders long-term sustainable growth. Hence, if India continues to focus on investment and neglect consumer demand, it is at risk of creating underutilized production capacity and increasing inequality.

Moreover, India’s demographic shifts (driven by increasing youth) create urgent demands for investment. More than 50% of the population is below 30, offering significant economic benefits if substantial education, jobs, and healthcare are provided. The average years of schooling is still fewer than 6.5, significantly below the OECD average (12 years), and youth unemployment crosses 20%. Unless India strengthens its public investment in rural education and skilling, India’s demographic advantage may lead to socio-economic inequalities rather than long-term economic benefits.

In conclusion, the facts in the article about India’s economic growth are correct. India is the 4th largest economy globally and is becoming more important in global politics and trade. However, a critical examination through macroeconomic theory lenses demonstrates that high growth does not necessarily mean high development levels. This surge in growth is not sufficient to deal with inefficiencies, external shocks, and promote endogenous growth, hence, India needs to reinforce its institutions and institutional frameworks, as elaborated in the essay.

Article Link:
“How Strong Is India’s Economy?” The Economist, 25 Apr. 2024, www.economist.com/leaders/2024/04/25/how-strong-is-indias-economy.

References for Stylized Facts and Cross-Country Statistics:

• The Economist. “How Strong Is India’s Economy?” The Economist, 25 Apr. 2024, www.economist.com/leaders/2024/04/25/how-strong-is-indias-economy
  
  

• World Bank. Vietnam Overview. 2023, www.worldbank.org/en/country/vietnam/overview
  
  

• International Monetary Fund. World Economic Outlook Data. 2023, www.imf.org/en/Data
  
  

• Government of India. Production Linked Incentive (PLI) Scheme Portal. 2023.
  
  

• Unique Identification Authority of India (UIDAI). Aadhaar Dashboard. www.uidai.gov.in
  
  

• World Bank. Doing Business 2020. www.doingbusiness.org
  
  

• Ministry of Commerce and Industry, Government of India. FDI Statistics. 2023.
  
  

• United Nations Conference on Trade and Development (UNCTAD). World Investment Report 2023.
  
  

• UNESCO Institute for Statistics. Research and Development Expenditure. 2023, http://uis.unesco.org
  
  

• Reserve Bank of India (RBI). Household Financial Savings Report. 2023.
  
  

• United Nations Development Programme (UNDP). Human Development Report 2023. hdr.undp.org
  
  

• Centre for Monitoring Indian Economy (CMIE). Unemployment Survey Data. 2023, https://unemploymentinindia.cmie.com
  
  

Mihir Khanna is currently a student at Ashoka University, majoring in Economics and Finance, with a minor in Environmental Studies and a concentration in Entrepreneurship. His academic interests span a wide range of disciplines, and he especially enjoys writing on themes such as sports, public policy, current affairs, economics, finance, and emerging markets, with a strong emphasis on stakeholder impact.

With a passion for data analysis and data-driven storytelling, Mihir has explored the intersection of numbers and narratives through multiple internships at renowned firms like Deloitte and ICICI Wealth Management (Private Banking and Securities). These experiences have helped sharpen his analytical abilities, deepen his understanding of financial systems, and enhance his ability to communicate complex ideas effectively.

This article co-authored by Jahaan Nichani.