India's democracy will make it a winner

The markets should focus not on short term politics but the medium term ahead, and on the past record of Congress

India or China, democracy or central control? Ever since the Chinese economic take-off, which began with the reforms of 1978, siren voices have advocated that it is easier to achieve economic growth in China than it is in India.

India or China, democracy or central control? Ever since the Chinese economic take-off, which began with the reforms of 1978, siren voices have advocated that it is easier to achieve economic growth in China than it is in India.

The argument is that, provided the government is sensitive to market signals, a top-down command economy can drive growth in a way that the more messy democratic system cannot do. Economic growth requires reforms which create many winners but also creates some losers. As a result, it is harder to maintain support for reforms in a democracy where the losers have a political voice than it is in an autocracy where they don't. So in the long run, China will beat India in the economic race.

It is a seductive argument and one that has, on the face of it, some merit. China has experienced straight-line growth since the early 1980s of around 8 per cent per annum. India, by contrast has had bursts of growth, but its economic reforms of the early 1980s faltered 10 years later and there was a financial crisis in 1991. There was then an austerity programme, followed by further reforms that together have led to more than a decade of very good economic performance.

But now the reformist BJP government has been thrown out and the financial markets have become panicky. Maybe voters don't like the consequences of economic growth, including rising inequality. In both China and in India the middle classes are vastly better off, but the new wealth has only tricked slowly down to the masses in the country. In China, where the wealth differentials are even greater than India, the authorities have managed to keep the lid on dissent. In India, the government loses power and to judge by the adverse reaction of the financial markets, the reform programme is threatened.

Mercifully for anyone who believes in democracy, things are not as bad as that. Indeed there are good grounds for thinking that, in the long run, the Indian economy may well perform as well as the Chinese one.

That, to be sure, is not what the financial markets seem to think. The Mumbai stock exchange fell by more than 11 per cent on Monday and while it recovered yesterday, confidence remains fragile. Are the markets wrong?

I think the best way to explain this negative reaction is to point to the long-established rule that all markets hate surprises and the election of a Congress government has been a huge surprise. Add in the fact that the new government has to be a coalition with the communists and that they have said they oppose further privatisation of the economy. Add in the further point that the stock exchanges had a huge upward run last year and were waiting for some excuse to fall - I was in Mumbai in January and the main question everyone asked was whether I thought there was a stock market bubble. The answer was pretty clear.

And, of course, the decision by Sonia Gandhi not to take on the job of prime minister ratchets the confusion a further few notches up the scale.

These are, however, very early days. Focus, instead, on the medium term ahead and the past record of Congress. Both the initial reforms of the 1980s and the more radical ones of 1992 were put in train by Congress. The BJP inherited a successful economy and then built on it. The heavy lifting had already been done.

The architect of the second round of reforms was the finance minister Manmohan Singh. I have never met him, but he is one of my heroes. His reform programme has probably brought more people from a state of poverty to a reasonable middle-class lifestyle in a decade than that of any other human being alive. It depends on the yardstick you choose, but perhaps 200 million people have seen a radical improvement in their lives during the last 12 years.

In 1991, the budget deficit was 8.5 per cent of GDP, the current account deficit was 3.5 per cent of GDP and the reserves covered only two weeks' imports. Then Manmohan Singh, newly-appointed as finance minister, made a famous speech in parliament in which he pointed out that the country had to think big. It could simply tighten its belt and inflict yet more misery on its people. Or it could do that, but also bring in market reforms that would unleash the renowned entrepreneurial spirit of its people.

That is exactly what happened. He quoted Victor Hugo: "No power on earth can stop an idea whose time has come." The idea was that India would become a major power in the world economy. And it was done by cutting regulation, bringing in more competition, simplifying the tax system and making risk-taking more attractive.

Congress was in power for five years, which gave time for the reforms to become embedded. The BJP carried on the reform programme, not always in the way that Manmohan Singh would have chosen - indeed he has been quite critical of them - but there was no significant reversal of policy. The "permit Raj" did not return.

The big question now is whether 12 years of reform have created a solid enough base to make India's boom secure. It is perfectly possible to make a mess of an inherently sound economy. It may turn out that there will be a period of weak, divided and divisive government. Combine that with some bad economic luck (the higher oil price does not help) and the country could slither back to a period of mediocre economic growth.

But I don't think so. For a start, economic success has created a sense of national self-confidence that in successful cities such as Mumbai and Bangalore is quite heady. The fruits of success are obvious, even if not yet sufficiently evenly shared: you see it in the variety of new cars on the streets, in the new boutiques and coffee bars, in the stylish clothing. I gather, too, that even the slums are visibly more prosperous.

Next, there has been considerable investment, both foreign and domestic, and that has created jobs. The business community is both a bigger segment of the economy and a globally more competitive one than it was a decade ago. This is not just traditional industries, such as textiles: the new industries are electronics, car components and the like. India, as a result, now has a trade surplus with China.

Further, there are the new industries that have been created, the high-tech ones we hear about in Britain. There have been a string of success stories in the southern cities of Hyderabad, Chennai (Madras), and, of course, Bangalore. As a percentage of the Indian economy, these are quite small, but they have demonstrated to other cities how they can build up employment and create success. The problem, as always, is pushing the wealth out and there will be a huge debate as to how best to do this. But I don't think many people at any level believe it is better not to generate the wealth in the first place.

Straight line economic development is not a natural condition. We should remember that here. The Chinese run for growth carries great risks, including running a banking system where nearly half the loans it makes cannot pay any interest. So expect bumps there, maybe quite soon. In India, there will be bumps ahead, maybe also quite soon. But the big lesson that big country has learnt in the last decade is that a democracy can be an economic success. Surely it will not want to unlearn that now.