I.
Accelerating and Sustaining Growth 1
Ending poverty in South Asia in one generation
requires faster growth. If growth can be accelerated
and sustained at 8 percent a year, and the past
response of poverty to growth is maintained, income
poverty in the subcontinent will fall to single-digits in
two decades.
Accelerating growth
Accelerating economic growth in South Asia from 6
percent to 8-10 percent a year will be difficult--but it is
possible, as East Asia has demonstrated. The difficulties
relative to East Asia are threefold: South Asia has lower
saving and investment rates and, in particular, huge
infrastructure deficits; distortions in labor markets; and
lower total factor productivity levels and growth rates.
Most South Asian countries have saving and
investment rates of about 25 percent of GDP or lower
(Figure 3). Meanwhile, from 1993-2002, China had
saving and investment rates of 39.8 percent and 42.3
percent respectively, and grew at 8.9 percent a year;
Korea’s income per capita increased 55 percent with
saving and investment rates of 32.3 and 34.4 percent
respectively.
Figure 3: GDP growth, saving and investment in South
and East Asia (1993-2002)
Percent Percent
8.9
40
6.2
30
5.0 5.3 5.2
20 3.5
4.4 4.4
2.7
10
0 0
Bangladesh India Nepal Pakistan Sri Lanka China
South Malaysia Thailand
Korea
Average annual gross savings/GDP (left scale)
Average annual gross fixed capital formation/GDP (left scale)
Average annual GDP growth rate (right scale)
Source: World Development Indicators
Perhaps the most vivid demonstration of South
Asia’s lower investment rate is the massive
infrastructure “deficit” that all South Asian countries
suffer from. In 1980, India had higher infrastructure
stocks than China, but China invested massively in
infrastructure, overtook India and is widening the gap.
To catch up to China’s present levels of infrastructure
per capita, India will have to invest 12.5 percent of GDP
per year until 2015--approximately four times what it is
currently investing.
There is no question that this infrastructure deficit is
impeding South Asia’s growth. Over a third of Indian
firms surveyed in the 2004 Investment Climate
Assessment cite infrastructure as a major or severe
obstacle to business expansion; in Bangladesh the figure
is 78 percent. Power is the most critical bottleneck, with
transportation a close second. In Bangladesh, firms
experience power outages and surges 250 days a year;
in Nepal, almost every day. As a result, about 40
percent of firms in India, Pakistan, Bangladesh, Sri
Lanka and Maldives have their own generators.
Businesses in Pakistan and India estimate they lose 5-8
percent a year in annual sales due to power problems.
South Asia is choking with poor quality roads,
inefficient ports, inadequate transport services. India
has practically no interstate expressways linking its
major economic centers and only 3,000 km of four-lane
highways. In the last 10 years China has built 25,000
km of four- to six-lane, access-controlled expressways.
The inefficiencies of Chittagong Port have given
Bangladesh all the characteristics of a land-locked
country. The second-largest rail network in the world,
Indian Railways is still burdened with congestion,
deteriorating quality of its rolling stock and huge
financial losses, even though recent financial results
have improved.
But the solution to South Asia’s infrastructure deficit
is not just to build new infrastructure--without changes
in the policy and institutional environment. For the
source of South Asia’s infrastructure problems is a
legacy of inefficient and inequitable policies that led to a
deterioration of existing infrastructure while making
participation in new infrastructure unattractive to the
private sector. The most important policy has been the
pricing of infrastructure services. Not only do
infrastructure subsidies use up scarce public resources,
10
but they diminish the end-user’s ability to hold the
8 service provider accountable. Because of under-pricing
of electricity, the Ceylon Electricity Board loses 50
6 million rupees--the cost of a rural hospital--every day.
India’s annual power sector losses amount to about 1.2
percent of GDP. These subsidies have led to over-
4
consumption of electricity, mostly by large farmers, and
2 depletion of groundwater resources. Financial
constraints have reduced spending on operations and
maintenance of the electricity grid, contributing further
to transmission losses. More importantly, these
subsidies and their associated impacts deter private
investors from participating in what would otherwise be
attractive ventures.
Fortunately, the growth-induced pressures on
infrastructure, as well as the exceptionally favorable
results from reforms in some sectors such as
telecommunications, have created some momentum for
further reform and investment in infrastructure in South
Asia. Pakistan has successfully privatized the Karachi
and Faisalabad Electric Supply Companies. Building on
the success of its telecoms industry, India has
sufficiently reformed its ports and roads to attract about
$8 billion in public-private partnerships in its urban and
transport sectors.
There has not been even greater momentum
because infrastructure reforms are deeply political. In
India, state governments that reduce power subsidies to
farmers tend to lose elections to parties that promise to
restore free power. Attempts to rationalize the Ceylon
Electricity Board are resisted by trade unions that see it
 as the first step in the slippery slope towards
privatization and job losses. Plans to contract out water
services on a pilot basis in New Delhi--where, despite
plenty of supply (250 liters per capita per day), water is
available only a few hours a day--led to such strong
protests that the program was suspended. These
episodes are teaching policymakers and donors (some of
whom had taken a politically-blind approach to
infrastructure reform) that transparency and
consultations in reforms are essential, that stakeholders
should have confidence that their voices are heard and
that the design of reform options reflects what
consumers are looking for.
In addition to infrastructure, the high cost of
bureaucratic red-tape and regulations--the sure signs of
poor governance--impedes investment in South Asia.
More Indian firms rate these as constraints to growth
than they do infrastructure. In the ranking of all
countries in the world by “ease of doing business” in
Doing Business 2006, six East Asian countries are in the
top 30, but no South Asian country is. India ranks
116th out of 155. It takes about 71 days to start a
business in India. Firing a worker in Sri Lanka costs an
average of 75 weeks of salary. At the same time, South
Asian countries are lowering these costs. Pakistan was
one of the top ten global “reformers” last year. To the
extent that investors--especially foreign investors--use
changes in the costs of doing business as an indicator of
future profitability, South Asia stands to gain immensely
by concentrating on reforming these aspects of the
business environment.
On the savings side, while domestic savings rates in
South Asia are considerably lower than in East Asia, the
gap is narrowing in some countries, such as in India.
Both regions receive external financing, but the
composition is different. Whereas East Asia receives
larger amounts of foreign direct investment, South Asia
benefits from remittances from workers living abroad—
to the tune of $22 billion in 2004. Remittances have
enabled large numbers of families to escape poverty—
especially in Bangladesh, Nepal, Sri Lanka and parts of
southern India.
The second major determinant of growth is labor.
Overall labor force growth in South Asia (1.5-2 percent a
year) is comparable to East Asia. However, when you
compare the skill levels of the labor force, many South
Asian countries fall short. Only Sri Lanka, with its
historically high levels of education, has a labor force
whose skills match those of China and Thailand.
Growth is increasing demand for secondary
education in South Asia, and some innovations are
improving the quality of services (see Chapter III), but
the impact of these developments on growth will take
time. Restrictive labor market legislation that protects
jobs and not workers and therefore chokes off new jobs
is increasingly a binding constraint in South Asia
(Chapter II).
Figure 4: Sources of growth in South and East Asia (1960-2003)
Capital growth
Labor growth
Total Factor Productivity
3
2
1
0
Bangladesh Pakistan India East Asi
Source: World Development Indicators, Devarajan and
Nabi [2006].
Third, economic growth is the result not just of
growth in capital and labor, but also in “total factor
productivity (TFP)”, a catch-all term that includes both
increases in the efficiency with which capital and labor
are used, as well as improvements in technology. If
South Asia falls short of East-Asian investment levels
can it still reach 8-10 percent growth by accelerating
TFP growth?
The answer is both yes and no. Thanks to economic
reforms, especially trade reforms, South Asian countries
have improved the efficiency of their economies. Sri
Lanka began liberalizing its economy in the late 1970s;
India in the late 1980s, accelerating in the 1990s;
Pakistan, Bangladesh and Nepal in the 1990s. All these
countries experienced an increase in TFP growth, and in
TFP’s contribution to overall growth in the decade
following reform (Ahmed, 2006).
Nevertheless, South Asia’s TFP growth rate is still
lower than East Asia’s--and it may be difficult to narrow
the gap (Figure 4). First, unlike South Asia, East Asia’s
growth has been fueled by manufacturing, traditionally
the source of employment and technology growth.
Between 1968 and 2001, manufacturing value added
increased by a factor of 40, 27 and 17 in South Korea,
Malaysia and Thailand compared to a factor of 6 and 7 in
India and Pakistan, respectively. Secondly, inasmuch as
exports foster competitiveness and efficient use of
resources, South Asia’s export performance, although
improving, is still far below that of the successful East
Asian economies. The ratio of exports to GDP in
Pakistan, Bangladesh and India is considerably lower
than in Malaysia, Thailand and Korea (Figure 5); in fact
they are lower than these East Asian countries’ ratios in
the 1960s. Thirdly, a significant feature of the leading
East Asian economies such as China, Malaysia and
Thailand is the speed with which they have moved up
the technological frontier. Increasingly, their exports
consist of products embodying high technology. In India
and Pakistan, on the other hand, high technology
Percent of GDP
120
100 Malaysia
80
60
Thailand
40
Korea
20 Pakistan
Bangladesh
India
0
1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004
intensity products are still a small share of manufactured
exports. (Figure 6).
Source World Development Indicators
Figure 5: Merchandise Exports (% of GDP) in South and East Asia
Figure 6: Technology Intensity in Manufactured Exports
Percent
80
60
40
20
0
1981 2000 1981 2000
Resource based Low technology
Source: Lall [2003]
So how can South Asian countries accelerate TFP
growth in order to reach East-Asian levels of economic
growth? First and foremost, they can deepen and
broaden the economic policy reforms that have brought
them to this point. In many South Asian countries,
agricultural productivity is stagnating. Much of the
blame can be put on distortionary policies. In Sri Lanka,
an effort to introduce self-sufficiency in rice has
compelled farmers to specialize in paddy cultivation,
which is less profitable and more vulnerable to the
weather than other crops. In India, a plethora of
subsidies ranging from irrigation to fertilizer to power
has meant that there has been very little investment in
rural infrastructure, and agricultural productivity is
suffering.
Another recurring problem across the subcontinent
is the unusually low levels of tax revenues. In Pakistan,
the tax-to-GDP ratio has declined over time, and is now
at 9.1 percent. Bangladesh’s tax-to-GDP ratio is
similarly low. Sri Lanka’s tax revenues are barely
enough to cover the wage bill and interest payments.
Higher revenues are needed to finance priority public
spending, particularly in rural and urban infrastructure
and education and health, as well as to avoid the chronic
fiscal deficits that countries such as Sri Lanka and India
have experienced. True, some of the decline in
revenues is due to the tax-cutting policy reforms
undertaken in the 1980s and 1990s. But this is not a
reason to avoid introducing more efficient tax
instruments today.
Finally, state-owned enterprises continue to be a
drag on public finances and efficiency in several South
Asian countries. Several public-sector banks in
Bangladesh are running large losses. Yet privatization
has been elusive.
Pakistan
India
China
Malaysia
Thailand
1981 2000 1981 2000
Medium technology High technology
These three types of reforms--agricultural subsidies,
tax reform and privatization--are institutionally complex
and politically sensitive--which is probably why they
haven’t been undertaken so far. But South Asia’s recent
growth, as well as the greater openness to new ideas
that it has brought, provides the opportunity to
implement such second-generation reforms. Some
South Asian countries have seized this opportunity.
Pakistan has successfully privatized its banking sector.
Bangladesh has reduced agricultural subsidies
considerably (and invested much more in rural
infrastructure). And India is reforming its value added
tax system, which has already raised almost 2 percent
of GDP in additional revenues. If other South Asian
countries can learn from these examples, and their own
history, there is a good chance that the subcontinent will
see a second wave of reforms and an acceleration of its
TFP growth in the next decade.
South Asia is sitting on another gold mine of
growth—integration within the region. South Asia is the
least integrated region in the world. Starting from such
a low base, greater trade among South Asian countries
could have huge benefits to its people. Annual trade
between India and Pakistan is currently about $1 billion.
Estimates show that it could be as great as $9 billion.
Having enjoyed the gains from greater openness to the
world at large, the private sector in each South Asian
country can now benefit from trade with its neighbors.
Trade integration is only a small part of the gains
from regional cooperation. Cooperation on water, as
practiced by India and Pakistan on the Indus River
Basin, could confer enormous benefits to Bangladesh,
India and Nepal on the Ganges-Brahmaputra basin.
South Asia is also a unique case of one of the energy-
thirstiest countries in the world, India, sharing common
borders with energy-surplus countries such as
Bangladesh and Nepal—with no trade in energy between
them. Domestic reforms of the energy sectors in each
country could pave the way for market-based energy
trade, creating a win-win situation for all parties, as is
happening between Bhutan and India. Finally, and
perhaps most importantly, greater cross-border
cooperation in South Asia can reduce border tensions.
The benefits from such a change will dwarf all those
discussed above.
Sustaining growth
Even if South Asia achieves 8-10 percent growth,
sustaining it will be a challenge, given a number of
ticking time-bombs lurking in the background. Three
risks stand out.
Water. Pakistan and northern India have been
described as among the most “water-stressed” areas in
the world. Partly due to pricing policies that encouraged
overuse, and partly due to hydrological and weather
conditions, these areas, whose economies are
dependent on irrigated agriculture, risk a severe water
shortage at some point in the next 50 years. Some
recent estimates for Andhra Pradesh show that global
climate change, through its effect on droughts, could
reduce future agricultural output and hence GDP by up
to 3 percent. A major water crisis could undermine
many of the economic gains accumulated over the
years.
HIV/AIDS. Although the HIV-prevalence rate is less
than one percent, HIV/AIDS poses an economic
development risk to South Asia. There is a possibility of
the epidemic spreading from localized groups, such as
intravenous drug users or sex workers, to the general
population. Furthermore, the syndromes of denial and
stigma, which contributed to the spread of HIV/AIDS in
other regions, are deeply rooted in South Asia. And the
economic and human costs of a generalized epidemic
can be devastating. A recent study shows that an
uncontrolled epidemic could reduce India’s growth rate
by one percentage point (NCAER [2006]). When the
human costs of the disease to the victims and their
families are included, the economic impact of the
epidemic could be much worse.
Conflict. Perhaps the most vivid set of risks facing
the subcontinent is the number of simmering and full-
blown conflicts. Sri Lanka, Afghanistan and Nepal have
all experienced long-term civil conflicts in the last two
decades. The costs of Sri Lanka’s 20-year civil war have
been put at 2-3 percentage points of growth a year.
The region also faces numerous low-level conflicts that
could flare up into a major disaster. Skirmishes on the
border between Pakistan and India are one example; the
Naxalite movement in India, which is prominent in one-
quarter of the country’s districts, is another. And the
July 2006 railway bombings in Mumbai were a reminder
that terrorism has a foothold in the subcontinent.
These three risks are real, and if realized, they
could seriously undermine the gains in economic welfare
that South Asia has achieved over the past two decades.
But there are two reasons to be optimistic. First, South
Asia has faced a number of adverse shocks in the past
five years, and managed to sustain growth. The increase
in oil prices has had only a mild impact on growth—
mainly because governments took the politically-difficult
decisions to pass on most of the price increases to
consumers, especially in Pakistan and India. Just in the
past two years, the region has also been hit with a
series of natural disasters—floods in Bangladesh, a
tsunami in Maldives, Sri Lanka and south India, and an
earthquake in Pakistan—but the economies of these
countries have rebounded within a year or two. The
resilience of the South Asian people to these disasters
has been remarkable.
Secondly, the fact that the ticking time-bombs are
already being discussed and debated in South Asia is a
good sign. Partly as a result of the greater openness
that is following rapid economic growth, South Asians
are willing to confront these problems, and put in place
mechanisms to reduce their adverse consequences long
before the shock actually hits. Pakistan is planning
major dam projects to conserve and store water in the
Indus valley. The Government of Andhra Pradesh is
already developing a plan for adaptation to climate
change. India has a major campaign, headed by the
Prime Minister, to prevent the spread of HIV/AIDS, as
well as provide anti-retroviral treatment to a large
number of HIV-positive people.
The distinguishing and common characteristic of
South Asian countries is their recent, rapid economic
growth. Can this growth be increased to 8-10 percent
and sustained? The challenge is daunting. But growth
itself gives South Asia an extra edge in accelerating
growth. The challenge of going from four decades of 3
percent growth to 6 percent must have seemed daunting
20 years ago. That South Asian countries met this
challenge is the reason and the inspiration for the belief
that they will also achieve the reality of a subcontinent
free of poverty.
1
This chapter draws on Devarajan and Nabi [2006], World Bank [India Development Policy Review, 2006]. Doing Business in South Asia,
and various Investment Climate Assessments.