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Pete Klenow on India's surmountable development challenges

Stanford economist and Faculty Affiliate Pete Klenow uses microdata from firms to understand the underlying mechanisms behind economic growth in economies.

India’s population doubled over the last quarter of the 20th century and is projected to have 1.5 billion people within the next two decades. India is the world’s fastest growing major economy, with positive long-term projections, but the country's development is not without hindrances.

Stanford economist Pete Klenow, a faculty affiliate of the King Center, uses microdata from firms to understand the underlying mechanisms behind economic growth in economies like India’s.

For India’s development trajectory, inefficiency in firms is a major issue. Klenow’s research has shown that manufacturing plants in India grow about five times slower compared to those in the United States. In the U.S., a 40-year-old factory would typically be about seven times larger than one five years younger; in contrast, a 40 year old factory in India would only be twice as large. Another study by Klenow has calculated that the Indian manufacturing sector is only 40-60% as productive as in the U.S.

Pete Klenow
Pete Klenow

Klenow offers insight on some of the underlying mechanisms contributing to this pattern of inefficiency. The legal system, Klenow says, is a major factor, in part because it does not enforce property rights, a fact that poses a serious problem for managers looking to expand their businesses.

Additionally, Klenow points out, there is less accountability for employers and employees who may not act in the best interest of their companies. A common scenario includes a manager who wants to their business to expand, but is having trouble hiring workers because there is no legal basis to enforce their trustworthiness. As a result, the manager is either unable to expand his or her business, or ends up hiring family members -- individuals he or she can trust, but may not necessarily be the most skilled business partners.

Another factor that Klenow sees as impeding Indian firm efficiency is resource misallocation when referring to the flow of workers. Regulations on firing and hiring workers can block efficient utilization of skilled workers while restrictions on firing employees can drive managers to employ contract workers who are not protected by this regulation. As a result, employers often overlook skilled workers, stunting efficient investment in human capital.

Meanwhile, bureaucratically complicated permit laws make securing land a lengthy and frustrating experience, hindering business expansion.

When adding all the difficulties that manufacturing firms and other business encounter, India’s development faces an uphill battle. “I believe lack of development is like death by a thousand cuts,” said Klenow. “Lots of things add up -- market failure, government policies, and countless other reasons. Added up they amount to a big number. It can help you understand why you can’t just press a button and say ‘let’s develop.’”

Klenow believes there are a variety of factors that will determined the future of India’s development. Government policies will certainly play a role in improving firm efficiency. As previously mentioned, India’s legal system lacks accountability, so an intuitive place to start would be more effectively enforcing property rights that provide stability to firms. Other avenues of change could include improving infrastructure, land reforms, and allowing foreign investments to play a larger role. Prioritizing policies is a difficult process and even when there is sufficient information to indicate a course of action, mobilizing bureaucracies is arduous and lengthy.

“If these problems were easier to solve, they’d be solved,” Klenow says.

Yet, Klenow remains optimistic about India’s development. Recent economic reforms highlight India’s continual evolution, including a new reform on interstate taxes. India productivity growth has only gained momentum and shows no real signs of slowing down. So, will Indian firms be able to overcome current impediments? Klenow thinks so.

“It’s like tectonics plates: the pressure builds and builds, and then something finally gives.”