India’s elections: A scorecard of Modinomics and what’s needed to escape the low-middle income trap

Indians are going to the polls to evaluate whether they will have more of Modinomics, and so it seems appropriate to evaluate Prime Minister Narendra Modi’s economic performance since coming to power in 2014. On the one hand, in the last few years, India has experienced the fastest growth among major Asian countries, on the other, job creation has been underwhelming. In fact, India’s absor ptive capacity for the country’s growing supply of labor remains weak and so does its ability to build the necessary infrastructure . This remains a key problem as its working population is expected to e xpand rapidly , so much so that India needs to create at least 11 million jobs per year in the next decade. As it is , India has a low labor participation rate – only 54% versus China’s 68% according to ILO estimates . Worse still, within the Indian employment population, 82% of jobs are in informal sectors, meaning most have vulnerable employment with economic low output, versus China’s less than 60%. Moreover, India’s investment in infrastructure has stagnated in less than 10% of GDP.   In this note, we take a deep dive into whether the Modi government has delivered on these promises since coming t o power in 2014. We assessed Modi’s pledges on three key factors of production: labor, capital and productivity. Whether it is demonetization, GST or FDI liberalization, m ost progress is made on capital while it remains very limited on labor reform or generally increase in total factor productivity. All in all, it seems clear that the reform agenda has not helped generate enough jobs to absorb India’s excess labor.   If the progress of the Modi government, albeit positive, is not enough to help India escape the low middle income trap (GDP per capital of USD2,015 versus China’s USD8,827), then what is required? A number of issues seem crucial. First, India needs more inward FDI into the manufacturing sector as well as a higher savings rate. We use China in the early 2000s as an example of what is needed for India. India currently attracts only 0.6% of GDP in manufacturing FDI versus China’s 2.5% of its own GDP in the early 2000s. In other words, manufacturing FDI was 9.5% of fixed asset investment (FAI) for China versus India’s 2% of FAI. This is particularly surprising since China’s overall FAI is larger than that of India as a percentage of GDP. In addition to needing about 2% of GDP more in FDI, India needs to also increase its savings rate to be able to fund much-needed infrastructure development , as well as to increase FAI more generally .   In short, the Modi government has made positive progress, particular ly pertaining to capital, but such improvement is very short of the bold reforms needed to take India beyond the low - middle income trap. This is especially true for labor-related reforms and more generally those enhancing total factor productivity. Should India attract 2% of manufacturing FDI, then it will be able to close its financing gap ( with a current account deficit of 2.4% of GDP in 2018). This would make India much less vulnerable to volatility of capital flows. Beyond this, it also needs to raise its domes tic savings rate to increase infrastructure investment .