Strategic Consequences of India's Economic Perfomance

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EPW Special Article June 29, 2002
Strategic Consequences of India's Economic Performance
Economic performance and capability certainly constitute the foundation of national security and power for a developing nation like India. India has the military capability to defend her territorial integrity and security; however, it will have to sustain higher rates of economic growth to be able to alter the strategic balance in Asia, and globally, to her developmental advantage. Having said this, the author argues that it is not economic growth by itself that holds the key to India's global profile and power, but the nature of that growth process and the manner in which the economic challenges it faces today are addressed. The threat to what more recently has come to be defined as 'homeland security' is posed by social and economic backwardness, the inequalities and the political uncertainty this generates, and the quality of economic development.
Sanjaya Baru
At a time when the world was still coming to grips with the implications of the end of the cold war for the global balance of power, for the role and relevance of different nations in the emergent global system, and, before there was as yet any considered appreciation of the impact of the turnaround of the Indian economy on the global and Asian balance of power, one of Harvard’s most distinguished strategic thinkers made an interesting forecast about the nature of the post-cold war international system that resonates to this day among strategic policy analysts in India. Prefacing his study of western diplomacy with a reflection on the ‘New World Order’, Henry Kissinger (Diplomacy 1994), hypothesised that: The international system of the twenty-first century will be marked by a seeming contradiction: on the one hand, fragmentation; on the other, growing globalisation. On the level of the relations among states, the new order will be more like the European State system of the 18th and 19th centuries than the rigid patterns of the cold war. It will contain at least six major powers – the United States, Europe, China, Japan, Russia, and probably India – as well as a multiplicity of medium-sized and smaller countries (p 23). Admittedly, the US remains the dominant military power but it has come to accept the emergence of other centres of economic power. Reiterating his earlier formulation more recently Kissinger (2000) has again spoken of India’s ‘potential’ as a major power underscoring the importance of its economic performance. In 1994 India had neither convincingly demonstrated its ability to generate the kind of economic growth that it did in the period 1992-98, nor had it as yet declared itself a nuclear weapons power. Was Kissinger prescient in 1994 or was he drawing our attention to historical factors and underlying strengths in classifying India as a nation enroute to ‘major power’ status? As a student of power and realpolitik Kissinger may well have come to understand by then that not only was India capable of sustaining the acceleration of economic growth it had already initiated in the 1980s but that its economic policies would be marked by a greater degree of realism, as in fact was the case by then with respect to its foreign policy, a fact that Kissinger readily acknowledges. However, if Kissinger, like so many other analysts, continues to only see the ‘potential’ of an as yet unarticulated Indian power, the question is what must India do to translate that potential into reality? The analysts of power may suggest that notwithstanding India’s declared nuclear power status there is still a credibility and a capability gap that has to be bridged before India can truly be viewed as a military and nuclear power with relevance to the world beyond her immediate neighbourhood. Nothing can be more important in bridging this gap between ‘potential’ and reality, between promise and performance than the sustained growth of the Indian economy. Economic development and growth is fundamental to India’s re-emergence as a ‘Great Power’. If India succeeds in sustaining a high rate of economic growth and can generate the resources needed not only for its defence and security but to invest in human capabilities and well-being and ensure peace and security in its neighbourhood, Kissinger’s qualification can finally be dropped. Emerging Perceptions Whatever western, and in particular American, perceptions of India during the cold war, by the end of the 20th century two dominant factors seem to have shaped a new thinking about India in the western hemisphere: first, India’s economic performance in the last decade of the century and the shift in economic policy and thinking in India; and, second, India’s declared nuclear weapons status. Both these elements are factors endogenous to economic and political developments in India to which the US has had to respond. There are two other elements shaping US perceptions about India more recently, which are ‘exogenous’ to India but have a bearing on India-US relations. These are the rise of ‘jehadi’ terrorism in the Muslim world and China’s rising profile within Asia. Together, these factors, namely, India’s economic empowerment, her military and technological capability and her role as a liberal and secular democracy in the fight against sectarianism and terrorism will shape the bilateral relationship with the US and the western world in the 21st century and, in turn, this will define American perceptions of India’s global role in decades to come. The challenge for India is to be able to deal with each one of these elements: economic growth and development, national security, jehadi terrorism and China’s growing power and influence in a manner which will enhance national security and ensure national well-being in the foreseeable future. How India deals with each of these challenges will define the extent and nature of India’s power in the 21st Century and its national security. Economic Imperative In a recent classic, the Oxford historian, Neil Ferguson (2001)while rejecting themore simplistic recent theories of the economic foundation of national power, has argued: Tolstoy’s question was: ‘What is the power that moves nations?’ Substitute the word ‘mobilise’ and the question is perhaps easier to answer. Clearly, it is something more than purchasing power. Economic resources are important, of course, but they are not the sole determinant of power. A state’s means of destruction consist of more than the output of its steel industry. As we have seen, a state can defeat an economically superior foe if it has better strategic, operational and tactical ability. Nor is the effectiveness of military mobilisation sufficient. We also need to take into account a state’s financial sophistication: its ability to appropriate resources from taxpayers and to borrow from investors. And in major conflicts a state must also be able to mobilise civilians optimally. The right balance must be struck between the different sectors of the economy in order to maximise war-making resources without undermining domestic well-being. The quality of bureaucratic organisation in both the state and the private sector can therefore be as important as the quality of military organisation. (p 418) Ferguson draws attention to what he regards as the four key institutional pillars of financial strength, constituting the economic ‘square of power’, namely, a tax-collecting bureaucracy; a representative parliament; a national debt; and a central bank. Admittedly, Ferguson shies away from an economic deterministic theory of state power and says as much: No matter how efficient the tax system, no matter how representative the parliament, no matter how liquid the bond market and no matter how well managed the currency, in the end the legitimacy of a state is bound up with such intangibles as tradition (the memory of past benefits), charisma (the appeal of present leaders), popular belief (faith in future rewards, material and spiritual) and propaganda (the state’s use of available media to bolster all these). Though Carlyle feared that modernity would turn all human relations into economic relations, the true ‘homo economicus’– constantly aiming to maximise his utility with every transaction – remains a rarity, and to most of us rather a monstrous one. Every day, men and women subordinate their economic self-interest to some other motive, be it the urge to play, to idle, to copulate or to wreck (p 422). Thus, states can pursue power and increase their strategic relevance even without the economic wherewithal, but in the long run sustainable power is built on the foundations of sustainable development. For India, there is no doubt that the first and most important challenge is that of accelerating the rate of economic growth and development. Economic performance and capability certainly constitute the foundation of national security and power even more so for a developing nation like India. It will define the limits to military capability and alter the relationship between India and its neighbourhood, especially its two major adversaries, namely, China and Pakistan. India has the military capability to defend her territorial integrity and security, however, it will have to sustain higher rates of economic growth to be able to alter the strategic balance in Asia, and globally, to her developmental advantage. For this reason, her enemies will act to keep her economically weak.This only underscores the economic imperative and the strategic consequences of sustained economic development. In his masterly survey of the ‘potential and promise’ of Indian power, Stephen Cohen (2001) offers a balanced appreciation of both economic and military strengths in the making of a major power, posing the question: “Can India develop the technological, logistic, and military capacity to be more than a south Asian power in years to come?” However, Cohen focuses far too much on India’s military, diplomatic and political capabilities, treating economic capability only cursorily. Cohen correctly draws attention to the disjunction between the ‘worldview’ and ‘self-image’ of Indian elites, and India’s real capabilities. But in defining the latter he shows inadequate appreciation of the centrality of economic performance. A robust performance on the economic front is critical to the full realisation of India’s strategic potential and national security. The economic dimension was introduced more directly into the calculus of evolving strategic power equations in Asia in a RAND study (2000) that says that if India can sustain into the period 2000-15 the economic growth performance it recorded in 1992-98, then there would be a major re-ordering of Asian power equations. Following this argument, Ashley Tellis (2001) analysed the many strategic consequences of India’s improved economic performance. “The moral of the story”, says Tellis, is that “If India can sustain an average growth rate of even 5.5 per cent or thereabouts for the next two decades or so, it will become a significant actor on the Asian stage. If it can accelerate its growth rates to levels beyond this 5.5 per cent band, then its significance for Asian geopolitics only increases further.” Tellis then defines a new marker. “A realisation of a growth rate consistently 7 per cent or higher, an economic performance that inexorably transforms India into a great power, positions it as an effective pole in the Asian geopolitical balance, and compels international attention to itself as a strategic entity with continentwide significance.” (p 240) These ideas also find reflection in Teresita Schaffer’s Rising India and US Policy Options in Asia (CSIS, January 2002), in which the robustness of economic growth and governance are seen as key variables determining the nature of Indian power. Says Schaffer, “The extent of India’s rise as an economy and as an international actor will be determined primarily by factors internal to India. Two factors emerged as central drivers in our scenario analysis. The first is economic change, which will profoundly affect the political climate, the leadership contests, and India’s international behaviour…The second driver, … is the quality of political leadership,..” The idea that economic performance and capability is a necessary, though by no means a sufficient, foundation of political and diplomatic influence and military power is now widely acknowledged, more so after the implosion of the Soviet Union under the burden of its economic weightlessness, and the role that rapid economic development has played in China’s emergence as a major power. Having said this, it will be our contention that it is not economic growth in itself that holds the key to India’s global profile and power, its strategic role and relevance and its national security, but the nature of that growth process and the manner in which the economic challenges it faces today are addressed. By ‘nature’ we mean the distributional aspects of growth, the impact of growth on global competitiveness and integration with the global economy and the sectoral composition of that growth, that is the extent of industrialisation, and its fiscal sustainability. This is relevant because India’s bigger security challenge, in its journey to major power status, is largely internal both economic and political. The threat to, what more recently has come to be defined as ‘homeland security’, is posed by social and economic backwardness, the inequalities and the political uncertainty this generates, and the quality of economic development. India’s primary external security challenge, that posed by cross-border terrorism in the north-western region bordering Pakistan, cannot be addressed without dealing with its domestic counterpart which feeds on social and economic backwardness of minorities, and communal and caste tensions. Inegalitarian growth can only feed such threats to national security. Equally, economic backwardness holds the Indian economy back from competing globally and thereby limits the range of her global engagement. Sustained and sustainable economic growth and development are, therefore, the foundation of India’s power and security. IIndia’s Past Economic Performance and Contemporary Power If accelerated economic growth holds the key to realising India’s strategic potential, the question arises how has India done and what exactly is the gap between performance and potential. It is useful to acknowledge at this point that several factors, other than economic growth, contribute to India’s self-image as a major power: Her civilisational history, her contribution to religion and philosophy, her intellectual, especially scientific and mathematical achievements, her demographic size and composition, her geographical size and location, her military strength and capability. As John Garver (2001) notes in the opening line of his study of the rivalry between India and China “Two of the most brilliant civilisations yet produced by humanity, those of China and India, lie side by side on the continent of Eurasia. The peoples that have produced these civilisations are both rightly proud of their histories and achievements, and determined that their nations will play a major role in the modern world” (p.3). A recent statistical enterprise of the Organisation of Economic Cooperation and Development (OECD) captures this notion of historic potential through striking economic numbers. Angus Maddison’s (1998) study of China’s economic performance has thrown up a set of numbers on world income for the period 1700 – 1995 that draws attention to India’s and China’s dominant position in the world economy in the pre-industrial and pre-colonial era, and their more recent journey to regain this lost share. In 1700 China and India accounted for 45.7 per cent of world national income. (Table 1) By the end of the 19th century this share had fallen to 24.2 per cent and by the middle of the 20th Century to a lowly 9 per cent. The decline in the share of these two Asian giants in world income was matched by the dramatic increase in the share of the US and subsequently Japan. Europe saw its share increase to a peak of over 40 per cent by the end of the 19th century and a subsequent decline to levels enjoyed before the colonial era. These numbers feed the hubris of the Indian strategic and economic policy-making community that India is destined to regain its pre-eminent status as a major actor on the world stage. Equally, they draw attention to the centrality of economic performance in shaping a country’s strategic power and relevance. Table 1: Distribution of World Income: 1700-1995
1700 1820 1890 1952 1978 1995
China 23.1 32.4 13.2 5.2 5.0 10.9
India 22.6 15.7 11.0 3.8 3.4 4.6
Japan 4.5 3.0 2.5 3.4 7.7 8.4
Europe 23.3 26.6 40.3 29.7 27.9 23.8
US - 1.8 13.8 21.8 21.8 20.9
Russia 3.2 4.8 6.3 9.3 9.2 2.2
Source: Angus Maddison, Chinese Economic Performance in the Long Run, OECD, Paris, 1998
Admittedly, the dramatic story of the second half of the 20th century is China’s economic performance, though the jury is still out on the authenticity of the statistical claims. China set itself on a high growth trajectory before India and has succeeded in doubling its share of world income within a span of a quarter century, going up from 5.2 per cent in 1978 to 10.9 per cent in 1995. China’s economic growth performance parallels its emergence as a mercantilist trading power, with its share of world trade increasing from around 1 per cent in the late 1970s to 4.5 per cent in 2000. By contrast, India was a slow starter. However, there has been a consistent acceleration in India’s economic growth in the 20th century (Table 2). Table 2: Macroeconomic Trends in Indian Economy, 1900-2001
Trend Growth Rates of GDP by Sectors @
1900-01 to 1946-47 1950-51 to1959-60 1960-61 to 1969-70 1970-71 to 1979-80 1980-81 to 1989-90 1990-91 to 1999-00 1997-98 to 2001-02$

Primary 0.46 2.8 1.4 1.8 3.0 2.9 2.1
Secondary 1.82 6.1 5.4 4.7 6.9 7.2 4.5
Tertiary 1.65 4.0 4.5 4.5 6.4 7.7 7.8
Total GDP 1.05 3.7 3.3 3.5 5.4 6.2 5.4
Per Capita 0.22 1.8 1.0 1.2 3.1 4.3 -

Notes: Average annual growth rates of GDP based on end values, at 1938-39 prices.@ At 1948-49 prices; $ Ninth Five - Year Plan, 1997-2002.
Source: S. Sivasubramonian, The National Income of Indian in the Twentieth Century, Oxford, 2001
What exactly has been India’s more recent growth performance and what is the extent of the gap between performance and potential? While India has been slow to start, if a long view is taken of the growth process then we do see a steady acceleration of growth. After recording virtually no growth in the first half of the 20th century, the economy grew at an annual average rate of 3.5 per cent in 1950-80 and 5.4 per cent in 1980-90 and 6.2 per cent in 1990-2000. In the mid-1990s, 1992-98 the economy recorded over 7 per cent growth, however in 1998-2002 there has been a marginal deceleration, largely on account of slow industrial growth. This raises some questions about the medium- term growth potential. If the NBAR-CSIS view is accepted, then an average rate of growth of 5.8 per cent, which is the long-term rate registered during 1980-2002, is inadequate to enable India to not only deal with the challenge of development in a poor, populous country but also acquire the diplomatic and military profile of a major power. Indian planners recognise that the elimination of mass poverty and the challenge of human development can only be fully addressed if the economy delivers at least 7 per cent to 8 per cent growth over the next decade. Strategic analysts also believe that such a rate of growth of income is necessary for the government to raise the resources required for the modernisation of the conventional armed forces and the operationalisation of a command and control system relevant to a credible nuclear deterrent. Notwithstanding these caveats, the acceleration of growth over the past two decades has already had its strategic consequences. If there is further acceleration to a medium-term average of 7 per cent, then there will be further consequences. It is to these issues which we now turn. II Strategic Consequence of What Has Been Achieved India’s accelerated economic growth and, more importantly, the policy of trade and investment liberalisation has already impacted upon its political and diplomatic relations with nations near and far, ranging from the US and European Union to ASEAN and Taiwan. Nowhere is the impact more dramatic from a strategic perspective than on the relations with her two immediate neighbours and strategic competitors. India and Pakistan From the time of partition and independence, India’s immediate strategic challenge has been the relationship with Pakistan and, in turn, Pakistan’s relationship with the US and China. Pakistan’s relatively better economic performance in the period 1950 to 1980 only made matters difficult for India, notwithstanding the fact that Pakistan was defeated in every single battlefield confrontation with India. On its own India could have neutralised the Pakistan challenge, but big power support during the cold war and the relationship with China helped Pakistan neutralise India’s advantages to a considerable extent. While Pakistan’s nuclear capability has further reduced the structural imbalance between the two south Asian neighbours, the differential economic performance of the two neighbours has begun to turn the balance once again in India’s favour. Consider the fact that while in 1960-80 Pakistan’s GDP growth rate was closer to 6 per cent per annum compared to India’s 3.5 per cent, in the 1990s India’s growth rate was closer to 6 per cent while Pakistan’s had slipped to below 4 per cent per annum. This has had an impact on a variety of economic indicators. For example, India improved its ranking in the Human Development Index (HDI) (compile dannually by the United Nations Development Programme)while Pakistan’s ranking has actually slipped. India has moved up in the 1990s from being classified in the ‘low HDI’ category to the ‘medium HDI’ category. On another front, India has moved up from being classified as ‘moderately indebted country’ (external debt classification of the World Bank) to now being regarded a “low indebted” country. Pakistan, on the other hand, has experienced a deterioration in its external debt profile during the 1990s and has had to seek debt rescheduling after coming close to default. These and similar divergent economic trends have encouraged strategic analysts to increasingly ‘de-hyphenate’ the two south Asian neighbours in any strategic assessment of the region. As early as in 1997 an analyst at the National Defence University, Washington, DC, (Clawson 1997) observed: The changed GDP ratios (between India and Pakistan) would have military implications. Given that India spends 2.5 per cent of its GDP on its military and that Pakistan’s economy is 19 per cent the size of India’s, Pakistan would have to spend 13 per cent of GDP to match the Indian military budget in absolute size. In fact, Pakistan cannot afford to spend that much. Pakistan can only afford military spending that is little more than half the size of India’s. That is, Pakistan can only afford to dedicate 6.5 per cent of its GDP to the military, because to do more would drain away the resources needed for the investment that sustains future growth. Already, Pakistan faces the same quandary as the former USSR: the military spending necessary to keep pace with the historic foe would drain off so many resources that the economy would fall further behind that of the adversary. The problem will get much worse (when)…Pakistan’s GDP slips relative to that of India. As India becomes richer, it will be able to afford to fund its military more generously. The ratio between the Pakistani military budget and that of India could easily become one to three, rather than one to two. At that point, it would become less and less plausible to see Pakistan as in any way comparable in national power to India. In short, the gap between Indian and Pakistani economic prospects could lead to a shift in the balance of power in the region. On present trends, India is likely to become the clearly pre-eminent regional power. Indeed, as the difference in economic growth rates becomes clearer, the trends in India’s favour will affect perceptions: India will be seen as the power of the future, and that will in turn multiply its power in the present. Given that economic trends have indeed moved in the expected direction, notwithstanding India’s recent growth deceleration, the ‘de-hyphenation’ of the two south Asian neighbours has already started. This has prompted Tellis to argue that: When the economic, political, and strategic fortunes of India and Pakistan are considered synoptically, the opposing trend lines appear in sharp relief. India’s grand strategic trajectory appears ascendant, while Pakistan, remaining trapped in the mire of stagnation, appears at risk of collapse. If these trend lines continue, the stage will be set for a consequential geopolitical transformation within south Asia itself. That is, India will steadily acquire the economic, political, and strategic capabilities that set it along the path to great-power status, thus enabling it to break out of the limiting confines of the Indian subcontinent (where it has been since at least 1962) and take its place as one of the major centres of power in Asia writ large (p 238). Even though Pakistan has tried to neutralise the impact of this differential economic performance by, one, going nuclear, and, two, imposing a non-conventional security threat on India, through what has come to be known as ‘cross-border’ terrorism, in the long run if Pakistan does not reverse the process of economic decline, it will be unable to continue to ‘hold India back’, one of its most persistently pursued strategic objectives. Indeed, in order to make economics work for it in a positive manner Pakistan will have to seek modus vivendi with India and normalise its political relations so that it can turn its attention to economic development. Their differential economic performance has already impacted upon the economic and business relations between developed industrial economies, including China, and the two south Asian neighbours. Neither the US nor China would like to hurt their business prospects in India. Indeed, China has in the past year delinked its growing business relationship with India from persisting differences on the political and diplomatic front. This partly explains China’s equivocal stance on an increasing number of India-Pakistan bilateral disputes like the Kargil war and the campaign against terrorism. Pakistan will also come under regional pressure from other south Asian countries to cooperate with India when they realise that Pakistan’s thwarting of the process of regional economic integration is hurting the region as a whole. India has already delinked the process of regional integration by pursuing bilateral liberal trade agreements with Sri Lanka, Nepal and Bangladesh. India’s desire to seek closer economic relations with its eastern neighbours, the members of ASEAN, along with some of the other south Asian countries like Sri Lanka and Bangladesh, will further reduce Pakistan’s economic relevance for south Asia. India’s Dialogue Partner status in ASEAN, its membership of the ASEAN regional Forum and the India-ASEAN summit scheduled for later this year suggest that ASEAN member countries, including Muslim-majority nations like Indonesia and Malaysia, have decided to place business above politics and religion and pursue closer relations with India. India’s ’Look East‘ Policy, its increasing strategic interaction with ASEAN, Australia and Japan and the attempts to create a new regional group around the Bay of Bengal, excluding Pakistan, symbolise a willingness on the part of India’s other neighbours to ‘de-hyphenate’ their relations in south Asia. This proces is largely driven by the emerging economic and business links between India and her wider ‘southern Asian’ neighbourhood. India and China For centuries India and China have been neighbours and at comparable levels of development. China moved ahead of India in the 18th century (Table 1), but slid back to level with it by the end of the 19th century. In the period 1950-80 the two economies remained at similar levels of development, even though China had started moving ahead of India by the early 1960s. When China launched the post-Mao modernisation programme it was already ahead of India on most economic and military indicators save one, namely, its extent of integration with the world economy. India and China had comparable levels of share of world trade, around 0.8 per cent each in the 1970s. The period 1980-2000 has made all the difference. China not only sustained a very high rate of growth compared to India during this period, even if China’s growth figures are vastly exaggerated, but more to the point China increased its share of world trade fourfold, to around 4.0 per cent by 2000, compared to India’s still lowly share of 0.7 per cent. China’s rapid economic growth, its emergence as a major trading nation and the phenomenal increase in foreign direct investment have combined to widen the gap between the strategic power and potential of the two Asian giants. China has used its economic and trading power to build strategic relationships with all major powers and, equally importantly, with each one of her Asian neighbours from the central Asian republics in the west to Japan and Korea in the east and ASEAN in the south. For India to be able to restore the balance within Asia it will not only have to pursue faster economic growth and domestic economic modernisation, but also increase its share of world trade and widen its economic links with the Eurasian landmass as well as with the trans-Atlantic and Asia-Pacific economies. China has leveraged its economic power in the strategic arena in a variety of ways. At the time of the Asian economic crisis, it played a stabilising role thereby increasing its relevance and role in the region. This has helped impart momentum to projects like an Asian Monetary Fund, and the ASEAN-plus-3 group, which China has pursued. By investing in central Asian oil and gas projects and giving the latter access to the east and south-east Asian markets via land-based pipelines through China, its has been able to impact on energy security in the region as well as increase its economic influence in central Asia. Finally, China has emerged as a major market as well as a competitor for all east and south-east Asian economies. In short, it has increased its political influence both in south Asia and south-east Asia by leveraging its economic potential. Indeed, India-China relations have also improved in recent months riding on the back of increased trade and investment flows. China (including Hong Kong) has emerged as India’s second largest trade partner next only to the US. The strategic consequences of the economic competition with China are, therefore, fundamental to India’s future role within Asia and the global system. If India can sustain above average growth (over 7 per cent per annum in the next decade) and if China experiences a deceleration of growth, coupled with domestic political uncertainty, the widening gap between the two civilisational neighbours can be reversed to an extent. If not, China will emerge as the pre-eminent Asian power and force India into accepting its strategic leadership even within south Asia. The key to this strategic rivalry will be the relative economic performance of the two countries. The main strategic challenge for India in the medium term is, therefore, its relative economic performance vis-à-vis China. Tellis has summed this up admirably: They (Indian policy-makers) believe that the best antidote to the persisting competitive, and even threatening, dimensions of Chinese power is the complete and permanent revitalisation of the Indian economy. The pursuit of this objective implies that Indian security managers believe that the best insurance against assertive Chinese power lies not in participating in any evolving anti-China alliance but rather by emerging as a strong and independent power on China’s periphery… Within the subcontinental setting, India has focused entirely on economic renewal in order to secure the great power capabilities that eluded it during the cold war. (p 257) If India has to realise its power potential, it must address important challenges on the economic front with a direct bearing on her strategic capability. However, successive governments in India, at the centre and in the states, have not been able to devote single-minded attention to economic reforms. Political uncertainty, the vagaries of democratic politics and social tensions have constantly diverted governmental attention away from the economic reform programme. The two areas where the link between economic policy and performance and strategic capability and political influence are most direct are fiscal policy, which limits the economic power of the state, and trade policy, which defines the manner in which a country can utilise its economic power as an instrument of diplomacy, building relationships of inter-dependence between nations and shaping the institutions of multilateralism and the process of globalisation. IIIEconomic Impediments to National Security If India has to bridge the gap between performance and potential and leverage her economic size for strategic advantage then it must address at least two major economic policy challenges to make economic policy work more effectively to its strategic advantage. We are not considering here the larger challenge of human development and poverty eradication, which are obvious and manifest economic challenges facing India. The meaningful resolution of these constraints is fundamental to securing strategic capability commensurate with her economic size and civilisational attributes. However, here we consider two limited macroeconomic policy challenges whose resolution is of equal significance to India’s strategic capability. The term ‘strategic capability’ refers to the ability of a nation to deploy its economic, political, intellectual, cultural and military capability in the defenceof its national interest and the well-being of its people, and influence the course of events within its strategic environment. The Fiscal Empowerment of the State: In Ferguson’s model of strategic power, the ‘square of power’ as he dubs it comprises: the tax bureaucracy, the parliament, the national debt and the central bank. It is these four institutions of fiscal empowerment of the state which enable the projection of national power by creating the institutional framework for the mobilisation and deployment of financial resources. In Ferguson’s view, “(these) institutions that initially existed to serve the (British) state by financing war also fostered the development of the economy as a whole. Better secondary and higher education, the rule of law (especially with respect to property), the expansion of financial markets and the stabilisation of the credit system: these were vital institutional preconditions for the industrial revolution” (p17). Not surprisingly India inherited these British institutions of war financing and industrial development and managed to put them to good use in the post-independence period. The Indian finance ministry and the central bank by and large pursued a conservative policy of fiscal empowerment that enabled India to avoid many of the fiscal pitfalls of development, like hyperinflation, excessive external debt and exchange rate volatility, that marked the experience of many developing countries. As two distinguished analysts of Indian fiscal policy observed [Joshi and Little 1994] The British created in the Indian Civil Service a small, high-minded, highly elitist bureaucracy with a Gladstonian fiscal outlook; its successor, the Indian Administrative Service, preserved – at least initially – the same traditions… (p 8). The ‘fiscal conservatism’ of the civil service manifested itself in a low tolerance for inflation, in the search for exchange rate stability and in a dislike for high budgetary deficits. This paradigm, however, began to shift in the 1970s. Since then India has witnessed a deterioration in its fiscal profile. While this initially contributed to high inflation and high deficits, it finally precipitated a balance of payments crisis in 1990-91, with far-reaching consequences for Indian strategic policy. The1990s witnessed a gradual improvement in the external profile of the Indian economy. India’s current account deficit has been kept within the manageable limit of 1 per cent to 2 per cent of GDP. India’s external debt to GDP ratio has declined over the 1990s and the debt service ratio has improved as well. (Table 3) Table 3: External Debt Indicators
Year Debt Stock-GDP Ratio Debt-Service Ratio Debt-xports Ratio Short-Term Debt/total Debt Short-Term Debt/Foreign Currency reserves

1990-91 28.7 35.3 491.7 10.3 382.3
1995-96 27.1 24.3 295.7 5.2 28.5
1999-00 22.0 16.0 258.6 4.1 11.5
Source: Ministry of Finance, Government of India.
While the external financial profile of the economy has improved, there has been a deterioration of the government’s fiscal profile. The tax to GDP ratio has declined from over 11 per cent in the 1980s to around 9 per cent by the end of the 1990s. The combined fiscal deficit of the central and state governments remains at around 10 per cent of GDP after a decade of fiscal correction. The persistence of the fiscal problem prompted the Reserve Bank of India to urge the government to fiscally ‘empower’ itself through a Fiscal Responsibility Act which seeks to place mandatory legislative curbs on the fiscal and revenue deficits of the central government. From a national security perspective, sound macroeconomic management entails: – Elimination of the revenue deficit, a manageable fiscal deficit, elimination of wasteful subsidies not targeted to the poor;– Low and manageable current account deficit;– Low internal and external debt, low short-term debt in overall external debt;– Profit-generation by public enterprises; privatisation of non-strategic public enterprises;– Self-financing public utilities like power, irrigation water and public transport;–An increase in the tax/GDP ratio to levels reached by rapidly industrialising developing countries of around 15 per cent of GDP from the current low of 9 per cent of GDP. The medium term fiscal threats facing the economy arise from an inability to finance essential development expenditure and the inability to ensure a truly efficient financial system. Productive investment is being held back by the inability to reduce unproductive subsidies, mobilise adequate direct tax revenues and generate returns to existing public investment. These systemic weaknesses increase the vulnerability to external economic pressures, especially from multilateral and bilateral aid agencies and donors. In making the transition to ‘major power’ status India will have to find the resources for national defence and military capacity building. Higher economic growth as well as political and military strength cannot be achieved without a major programme of fiscal regeneration at both the state and central levels. In the 1980s growth acceleration was fuelled by fiscal profligacy and imprudence which in turn contributed to the balance of payments crisis in 1990-91. The non-sustainability of such fiscal expansion is demonstrated by the sustained increase in interest payments from 2.2 per cent of GDP in the early 1980s to 4.7 per cent of GDP by the late 1990s. The increasing pre-emption of public finances by non-productive interest payments and subsidies has left little for productive investment, on the one hand, and for defence, on the other. Unless the growth process is fiscally sustainable, India will not be able to translate her economic gains into military and strategic capability. Table 4: Structure of Central Government Expenditure(percentages)
Item 1980-85 1985-90 1990-95 1995-00 2001-02 2002-03
Non-plan expenditure 59.90 65.52 71.02 75.00 73.00 72.33
Interest payments 13.07 16.52 24.59 30.00 29.00 28.60
Defence 16.72 16.35 14.70 15.00 15.60 15.80
Subsidies 8.35 9.52 9.86 8.50 8.40 9.70
Police 1.24 1.35 1.65 2.00 2.00 2.03
Pensions 1.60 2.04 2.25 3.40 4.00 3.67
Loans and advances to States and Union Territories 2.86 6.03 5.31 6.80 - -
Grants to states and UT 2.58 2.76 2.52 2.40 4.66 4.67
Other non-plan expn 13.48 10.95 10.14 9.00 - -
Plan expenditure 40.10 34.48 28.98 25.00 27.00 27.67
Total 100 100 100 100 100 100

Source: Economic Survey, Ministry of Finance, Government of India.
Fiscal Empowerment and Public Investment In the current phase of privatisation inadequate attention is being paid to necessary public investment and to making existing public investment more productive. This will remain a challenge even after all public enterprises have been privatised. There are at least two areas in which public investment will remain relevant and important: one, social and economic infrastructure; two, defence and strategic industries (including aerospace, space, shipbuilding and nuclear energy). The central and state governments will have to find the financial resources for increased investment in health, education, urban services and utilities. There are also important governance issues in each of these areas. Fiscal empowerment is both a function of revenue mobilisation and improved productivity and profitability of public investment. This is a necessary pre-condition of accelerated economic growth of 7.0 per cent and above. The experience of China once again suggests that even as the space for private enterprise and market forces is increased, public investment must not only continue but must become increasingly productive if economic growth is to translate into strategic capability. Fiscal Empowerment and Defence Spending India’s national security concerns, especially arising out of jehadi terrorism, and her long-term nuclear capability building will undoubtedly impose a financial burden on the government. Equally, the acceleration of economic growth will increase concerns about the security of energy supplies. This will also require India to bolster her strategic capability within the Indian Ocean region. India is a modest spender on defence and the “guns vs butter” issue has never been a major point of political contention. A Regional Security Assessment by Jane’s Information Group (1997) observed: “India’s defence spending remains modest compared to other countries with major security concerns.” Through the 1990s India’s defex has remained in step with world averages, at around 2.5 per cent of national income, compared to over 5.0 per cent for Pakistan and China. In the last two years, after the Kargil war, there has been a step increase in defence spending but this remains below the peak of 3.5 per cent of GDP reached in the mid-1980s. India’s frontline role in the campaign against terrorism will imply that the government will have to find the resources for defence and national security. The burden of this effort is directly related to economic growth and the fiscal empowerment of the government. The relationship between economic performance and strategic capability is direct in this case. In a large continental economy like India public investment in strategic industries has economic externalities going beyond power projection. India’s investment in defence related industries, as indeed in the case of the US and China, has helped develop domestic technical capabilities with spin off benefits for the civilian sector. The fiscal pressures on the defence budget have in fact meant a reduction in capital expenditure, hurting the development of domestic scientific and technical capabilities, which in turn hurt economic development. The ‘fiscal empowerment’ of the state is, therefore, a vital step in the realisation of the economic potential, which in turn will enable India to bridge the gap between her current strategic capability and her potential as a major power. Globalisation and Trade Diplomacy It is not a coincidence that the turn in India’s external economic policies after 1991 coincided with the end of the Cold War. The re-engagement of the global economy, in particular re-building economic relations with the US, on the one hand, and with the wider Asian neighbourhood, on the other, have been important planks of India’s economic policy in the 1990s. The strategic consequence of this new policy of outward-orientation is obvious. Among developing countries India was late in shifting gears from inward-oriented industrial development to outward-oriented development. The end of the Cold War, coinciding with a balance of payments crisis in 1990-91, forced the pace of this change. Table 6: Trends in Combined Fiscal Deficit and Contingent Liabilities of Central and State Governments(As Percentage of GDP)
Year Gross Fiscal deficit Government Guarantees
1990-91 9.4 -
1995-96 6.5 9.9
1999-00 9.4 10.7
2000-01 10.0 -

Source: Annual Report, Reserve Bank of India.
However, India remains on the margins of the process of globalisation, still accounting for a mere 0.7 per cent of world trade, compared to China’s share of over 4.0 per cent, and with as yet modest foreign direct investment inflows (See Table 6). This compares with a 2 per cent share of world trade that India had in the 1950s compared to China’s share at that time of less than 1 per cent. China has used a ‘mercantilist trade policy’, based on a cheap currency, as a strategic instrument of international engagement, which India is yet to even begin doing. As a result of its overall trade expansion, China is today a larger trade partner of every single country in Asia, with the exception of Nepal and Sri Lanka, than India. Her increased penetration of Asian and western markets has given China a strategic profile which India has yet to acquire. The arena of trade diplomacy, now including the World Trade Organisation, will play an increasingly important role in shaping the external profile of China and India and their bilateral relationship. Interestingly, ‘Greater China’, that is the People’s Republic and Hong Kong taken together, has emerged as India’s second largest export destination next only to the United States. The US market accounts for around 22 per cent of India’s exports followed by China and Hong Kong with a combined share of over 8 per cent. Countries like the UK, Germany and Japan have a share of around 5 per cent each. India’s trade with China is likely to increase in the near term with both countries using business to build a bridge over troubled political waters. India’s tariffs remain high by Asian standards, though they are set on a downward course, and the weakness of trade-related infrastructure hurts the competitiveness of Indian exports and adds to import cost. Altogether this is an area for further reform. If India sustains 6.0 per cent and above growth it will be able to secure a larger share of world trade. This will alter the strategic equations within south Asia and impact on India’s relations with other Asian nations. India has been able to improve her trade relations with Sri Lanka, Nepal and Bangladesh, even as Pakistan has continued to drag its feet in the creation of a South Asian Free Trade Area (SAFTA). India has pursued a dual track policy of seeking improved bilateral trade relations with major trading partners, particularly the US, ASEAN and some of her immediate neighbours; on the one hand, while maintaining an aggressive stance in multilateral trade negotiations. However, there is much ground waiting to be covered both in terms of policy and infrastructure building if India has to match China’s trade power in the region. Interestingly, China has emerged as India’s second largest trade partner (PRC and Hong Kong taken together), next only to the US (if European Union is not viewed as a single entity) India and China are seeking to use trade and business relations as a means of improving their bilateral relations, even as differences on the delineation of their common border are kept on the backburner. China’s willingness to allow trade relations to improve, even as political differences remain, is exerting pressure on Pakistan to similarly enable progress on the business front and not make this hostage to differences on Kashmir. China’s membership of the WTO poses a major diplomatic challenge for India both at the regional and multilateral level. Further, China’s aggressive campaign for an Asian Free Trade Area (AFTA) and an Asian currency unit will exert pressure on India. Increasing India’s trade competitiveness will, therefore, remain a strategic policy challenge with far-reaching consequences for how India can translate her improved economic performance into a foreign policy asset. As a traditional trading nation with historic trading relations with all of Asia, India can make external trade relations work as an effective instrument of international engagement by creating relationships of mutual inter-dependence with key countries. India’s growing trade relations with some member countries of ASEAN have helped strengthen the political relationship with the regional grouping. Sub-regional preferential trading arrangements and joint infrastructure projects have also gathered momentum around the rim of the Bay of Bengal. New trading opportunities will come India’s way, as it becomes more hospitable to FDI and foreign trade. How effectively India can do this will depend on the pace of domestic economic reform. However, the relatively low share of world trade and domestic fears regarding the competitiveness of Indian manufacturing exports have made India a defensive player in multilateral trade negotiations, as most recently exemplified at the Doha Ministerial Meeting of the World Trade Organisation. A steady acceleration of exports and perhaps the recent success in information technology and software services exports will help change attitudes and policies that in turn will enable India to regain her share of world trade and income. While domestic industry remains wary of globalisation, as in most countries, India has the potential of making globalisation work for it in a more positive way than would be the case with many other developing countries. The large and diverse Indian ‘diaspora’ has emerged as a new network of overseas business and can, as in the case of China, work to India’s advantage in the global economy. If domestic policies are more attuned to external trade and capital flows in general they will also enable India to tap the resources of the ‘people of Indian origin’ worldwide. V Economy and Power: 4-D Challenge A strategy of ‘inward-oriented’ industrialisation and the political choices India made during the Cold War reduced India’s global economic and strategic engagement during the half century after Independence. However, the steady acceleration of economic growth in the last two decades and the shift in economic policy towards a more open, outward-oriented economy in the 1990s has helped India seek new relationships of economic engagement with her neighbours in Asia as well as with major powers. Two unrelated but parallel events have propelled this process in the 1990s: first, the end of the Cold War; and, second, the IT and software ‘revolution’ at home. These events have enabled India to impart a strategic relevance to her economic policies. Table 6: changing Profile of Foreign Trade
Period Foreign Trade as a Percentage of GDP share of India's in World Exports (per cent)

1985-86 10.99 0.5
1990-91 13.32 0.5
1995-96 19.28 0.6
2000-01 21.80 0.7

Source: Medium Term Export Strategy, 2002-07 Ministry of Commerce, India
India’s sustained economic growth within the framework of an open economy and the new capabilities in information technology have helped create new relationships of economic inter-dependence with other growing economies, especially in North America, east and south-east Asia and Europe. India’s economic performance in the 1990s has helped redefine her political relations with such diverse nations as theUS, China, Korea, Israel, Russia, Singapore, Thailand, Australia, European Union and her own neighbours. More to the point, it has helped India graduate from the so-called ‘south Asian’ box, into a ‘southern Asian’ power, with economic and strategic links spreading from the energy rich west Asia to the growing markets of east Asia. To sustain this growth process, however, India will have to ensure the security of energy supplies and access to foreign markets. Together these needs will continue to give an economic edge to India’s external relations, with its own strategic implications. The importance of IT and software in India’s growth process has contributed to a strengthening of India’s links with the ‘Anglo-Saxon’ world, namely the US, Canada, UK, and Australia, which are the largest markets for Indian software service personnel. Equally, it is helping in redefining India’s relations with China and Japan. The growing importance of each of these relationships is altering India’s erstwhile global profile as a poor, developing country in south Asia hobbled by an irritant called Pakistan. However, to be able to make a decisive break from the past and from the constraints imposed by Pakistan’s diabolic agenda of keeping her boxed in the confines of south Asia and held back by divisive social tensions, India will have to move faster on the path of economic modernisation and improved human development. If it falters on this economic front, its wider political quest will be impaired. It is on the foundation of sustained economic growth that India will be able to address what can be dubbed the 4-D challenge of development, defence, diplomacy and the diaspora. Economic development within the framework of a ‘decentralised democracy’ (the two other ‘Ds) is the biggest challenge facing India. India’s ‘strategic capability’ would be seriously impaired by the prevalence of mass poverty, high illiteracy and economic backwardness. The growth process of the past two decades has enabled India to address many of the challenges of development. The poverty rate has gone down from 50 per cent in the 1970s to below 30 per cent in the 1990s, the literacy rate has gone up to over 60 per cent, and per capita income growth of over 4 per cent per annum in the 1990s has been the highest in living memory. This has enabled India to move up the HDI ladder from being classified under ‘low HDI’ to now being classified as ‘medium HDI’. The second challenge of defence is critical to India’s national integrity and development as it is to ensuring peace and stability in the wider southern Asian region, as events of the past few months have dramatically shown. India’s ability to play the role of a regional peace keeper and stabiliser, ensuring the security of the Indian Ocean and the free flow of energy from the region to the global markets beyond, policing piracy on the high seas and facing the threat of non-state actors and terrorist organisation critically depends on her ability to generate the resources required for the requisite defence capability. India is currently agonising on the question whether it can afford to buy an aircraft carrier from Russia. Many countries in the region would like India to be more pro-active in dealing with piracy on the high seas and the US, Australia and Japan have welcomed India’s active participation in Indian Ocean security. However, India will not be able to take on this role which today others would like it to, unless it can generate the fiscal resources required. This is a function both of the “fiscal empowerment of the state” and of generating tradable products and services to raise the hard currency resources required. The third challenge of diplomacy is even more directly related to economic performance because international relations have increasingly come to be shaped by economic relations. The phenomenon of globalisation, the growing importance of regional economic groups and free trade associations and China’s aggressive mercantilism have all given an edge to economic diplomacy which India can not effectively deploy unless it emerges a larger trading nation and a more open economy. To enable this, without hurting domestic business interests, India will have to sustain a higher rate of economic growth. India has set itself the target of doubling its share of world exports in the next five years. It is also pursuing closer economic relations with the wider southern Asian neighbourhood and with Africa, Latin America and Russia, part from the continuing economic relationship with the US, India’s largest trade partner, and the EU. Finally, in making globalisation work for India, it can make productive use of the diverse and talented community of ‘people of Indian origin’ worldwide, of over 25 million, the so-called Indian ‘Diaspora’. This community has emerged as an important strategic asset in India’s relations with the US, and the Anglo-Saxon world as a whole, as well as with south-east Asia. However, India’s ability to draw on the skills and capital of this community will depend to a large extent on its domestic economic performance and the opportunities for business it throws up at home. Clearly then, it is India’s economic performance which will shape the manner in which each of these strategic assets can be deployed in the projection of Indian power and influence worldwide. The sustained, if gradual, acceleration of economic growth and its translation in to all-round development, defence capability, diplomatic influence and the process of globalisation, mediated by the Diaspora, will shape the nature and extent of India’s strategic capability. [This paper was read at the Economics and National Security Seminar, John M Olin Institute of Strategic Studies, Weatherhead Centre for International Affairs, Harvard University, Cambridge M A, USA, April 11, 2002. 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