China again is an example, where income inequality is still a major concern for policymakers, though the pace of poverty reduction has been remarkable. In this context, it is worth examining whether the liberalisation strategies of India have contributed to significant reduction in poverty uniformly across all its States.
Focus is on the pace of poverty reduction across Indian States and its determinants during 1993-2000. The pace of poverty reduction can measured by the average annual rate of reduction achieved in 25 Indian States from 1993-94 to 1999-2000. The analytical modeling framework followed is conceptualised in Figure 1. The analysis acknowledges the problems of endogeneity of variables used for such studies and therefore, uses the technique of three-stage least squares methods with appropriate set of instrumental variables. The results of this study have strong policy implications towards increasing the pace of poverty reduction.
Figure 1: Mechanisms of poverty reduction through government intervention, including economic liberalisation.
The analysis identifies industrialisation (measured by the share of industry in GDP) and deprived population (the share of the economically deprived population in a state’s total population), as two important factors directly speeding up the pace of poverty reduction.
Both State and Central governments in India undertake wide ranging welfare schemes to provide safety nets for the deprived population. The deprived population is proxied by the share of scheduled caste population, an Indian population grouping, across States. Welfare expenditures have spillover effects and the entire State benefits from such government interventions. States with a larger share of the deprived population receive a higher allocation of resources, and are thus able to reduce poverty faster through spillover effects. Other liberalisation strategies, such as improving infrastructure and access to education, influence industrialisation and contribute directly to increasing the pace of poverty reduction.
The importance of governments’ efforts in looking after the deprived populations and sustaining economic liberalisation for promoting industrialisation need not be overemphasised here.
The results reveal that FDI is attracted to States with higher levels of industrialisation, lower agricultural share in the economy, higher literacy rate, and better infrastructure. The results, however, indicate that FDI flows do not directly influence the pace of poverty reduction. This is an important finding from a policy perspective because FDI has been found to contribute to reducing poverty directly in countries like China. In the case of India, FDI, thus far, has not contributed significantly to poverty reduction directly, but it has influenced the structural changes in the economy, particularly with respect to promoting industry.
Why is this so?
Only a small percentage of FDI flows went into export-oriented industries and the bulk went into import-competing or non-traded industries in this period. India’s experience has been different from other developing countries, where FDI has generally been central to the establishment of export-oriented industries. Hence, it appears that increases in FDI lack the capacity to increase India’s labour intensive exports, which could generate the unskilled jobs most required to reduce poverty faster.
The conclusions for policy making in India are as follows.
First, the pace of poverty reduction can be increased by sustaining and fine-tuning economic liberalisation measures, particularly with respect to FDI approvals to facilitate greater access and participation by the unskilled sections of the labour force.
Second, it is imperative for both the Central and State governments to promote infrastructure development and education, which facilitate industrial growth and FDI growth.
Finally, governments need to promote agricultural growth through implementing technological measures, such as water management and promotion of different crop varietals; and through encouraging cooperative/corporate farming to combat the issue of land fragmentation.
Implementation of these policy recommendations will help to ensure that liberalisation plays its full role in poverty reduction throughout India.
Kaliappa Kalirajan is Professor of Economics in the Crawford School of Economics and Government at the Australian National University.
This article is based on a recently published paper in Asia – Pacific Economic Literature, entitled ‘Economic liberalisation strategies and poverty reduction across Indian states’.