Urban labor markets and Economic Development

Urban labor markets are characterized by the spatial proximity of households and businesses, which offers
firms and workers advantages that lead to more efficient markets, enhanced productivity, and greater
economic success. Nevertheless, the nation's city, while generating a large proportion of the nation's
wealth, houses much of the nation's economic disadvantaged workers.

In every developed economy, cities are the center of economic activity and opportunity. They bring
together businesses, workers, and customers into close physical proximity, which offers firms and workers
advantages that lead to more efficient markets, enhanced productivity, and greater economic success.
These benefits come about in several ways. Large metropolitan areas allow firms and workers to specialize
in activities in which they hold a comparative advantage. By being close to suppliers and customers, firms
can build efficient supply networks that lower costs and enhance productivity. Also, dense, urban
environments enhance the flow of ideas and the transfer of technology through informational networks,
which create growth enhancing spillovers to firms. Workers also rely on informational networks to add to
their general knowledge, establish support groups, enhance job-related skills, and gain access to job
openings. Consequently, the physical and informational proximity of businesses and workers within
metropolitan areas yields the nation's most productive activities, spawns technological and organizational
innovations, and launches new business ventures.

For most urban residents, economic success is determined by the jobs and income generated by labor
markets. A labor market rewards those people with the appropriate skills, energy, and ideas. Acquisition of
these qualifications results from long-run decisions to invest in education and training, to choose work over
leisure, and to be networked with people who been successful. Labor markets also provide the signals and
incentives for individuals to make these decisions and to be in a position to take advantage of opportunities
when they arise. By offering the greatest opportunity for economic success, cities attract both the nation's
most talented and successful individuals and the most disadvantaged. While people of all skills are
important to generate the economic complementarities that enhance productivity, many of the least skilled
people do not find the success they had hoped for. Therefore, cities stand as a stark dichotomy of those
who have succeeded and those who have not. They generate a large proportion of the nation's wealth but
also house much of the nation's poverty and homelessness. Cities have always exhibited this stark
contrast between those who have achieved economic success and those who have not. The ancient Greek
philosopher Plato gave commentary to his times in observing that "there are two cities: One for the rich and
one for the poor" (The Republic). The ability of urban labor markets to improve the quality of life for all
groups of workers varies over time. In recent years, opportunities for economic advancement have
diminished. Real earnings growth has slowed to a paltry 0.9 percent during the last decade. Worse yet,
only those individuals with college degrees experienced improvements in real income; people with high
school degrees or less saw their real earnings decline.

The slowdown in earnings and the rise in income inequality have placed considerable stress on cities.
Many cities have been unable to make sufficient investments in physical and human capital required for
efficient markets and the easy flow of information. As the core structure of cities deteriorates and the
advantages of close proximity diminish, businesses and households have left inner cities for outlying areas.
This shift in location has left inner cities with fewer resources to devote to mounting social problems. This
shift has also helped to diminish the nation's capacity to spawn high-productivity, high-growth activities. For
individuals, these issues include slow wage growth, increased earnings inequality, persistent earnings gap
between whites and minorities, disparity in job opportunities and earnings between inner cities and
suburbs, the spatial mismatch of jobs, and the increased isolation of many inner city residents.

For the nation, the issues are the social fallout from growing income disparities and reduced income
mobility and the economy's diminished growth capacity as the physical and social infrastructure supporting
urban area markets deteriorates. It is appropriate for the federal government to create and carry out a
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national urban policy for two reasons. First, many of the issues listed above are related to the redistribution
of income, which is a traditional function of the federal government. Second, the close proximity of activities
within metropolitan areas generates externalities that contribute more than proportionately to growth and
that compound the many social problems facing cities. Therefore, to reflect the urban environment that
generates these economic and social trends, a national urban policy must incorporate these externalities.
The policy statement should emphasize the effect of physical and informational proximity on growth, the
benefits of efficient urban markets, and the importance of the access of workers to urban labor markets.
These characteristics distinguish a national urban policy from simply a national policy targeted at people
who happen to live in cities.

I Metropolitan Growth

The fiscal and social distress experienced by cities in recent years has been well documented. Yet, despite
increased concern about urban crime, congestion, air quality, and high housing prices, metropolitan areas
continue to grow and to offer their expanding populations greater job opportunities and higher income than
the declining nonmetropolitan areas. This ability to create relatively high paying jobs attests to the
advantages cities offer to firms through higher labor productivity and proximity to suppliers. The economic
performance of central cities and suburbs is strongly linked. Workers in both central cities and suburbs
benefit to a large extent from the growth of the entire region. In addition, job growth was markedly better for
metropolitan areas with smaller disparities between central city and suburban income. The linkages
between the two entities continue to strengthen as a greater percentage of holders of central city jobs
reside in the suburbs.

Even with these linkages, considerable disparity exists between central cities and outlying suburbs. The
median income of central city residents is 40 percent lower than that of suburban residents. Also, central
city residents are less educated and have a significantly higher unemployment rate than suburbanites. This
exodus from central cities and the persistent economic disparities heighten the physical and intellectual
barriers between central cities and suburbs.

Central cities have also experienced a shift in industrial composition from manufacturing to service jobs,
which has contributed significantly to the income differential between central cities and suburbs. The
decline in the percentage of manufacturing jobs has had a large effect on low-skilled workers. Factory jobs
traditionally offered low-skilled workers higher wages than they could find in other jobs. Metropolitan
manufacturing employment substantially impacts the employment and earnings of young men, with a high
school education or less.

II. Slow Earnings Growth and Rising Income Dispersion

The traditional role of cities as a place to seek job opportunities and achieve income advancement has
been eroded during the last two decades by historically low earnings growth for most groups of workers.
The less skilled workers have experienced a loss in real income, and consequently a decline in their living
standards. While city dwellers on average have fared better than the national average, their earnings have
followed the national trend of slower earnings growth. These trends stem from a complex assortment of
economic, demographic, and social forces. Many of the factors are symptomatic of urban problems.
Focusing on the more important factors offers perspective on how a national urban policy might prioritize
the host of problems facing urban labor markets.

Many economic factors are responsible for slower productivity growth, including a decline in worker skills,
lack of adequate investment in private and public capital, and decline in innovative activities. With cities
traditionally at the forefront of the nation's productivity gains, the slowdown draws attention to urban
concerns that may have contributed to this problem. Current urban problems of poor educational

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opportunities in inner cities, the movement of jobs away from the urban core, and the decline in investment
in urban infrastructure may have contributed to the productivity slowdown. Urban social issues, such as low
skills, lack of an adequate support structure, and lack of participation in the workforce, have also prevented
many urban workers from enjoying the benefits of productivity growth. Changes in social characteristics
also contributed to the change in household income. According to one study, social characteristics had an
even greater effect than economic factors. Ryscavage, Green and Welniak (1991) show that the decline in
married couple households as a percentage of all households and the increase in educational attainment
had large offsetting effects on household income. Of seven factors considered--age, race, type of
household, education, work experience and head of household, work experience of spouse, and industry of
household head--type of household and education registered the largest effects.

III. Minority Earnings Gap

One of the most troubling and persistent concerns in the performance of urban labor markets, and one that
a national urban policy must address, is the earnings gap.

IV. Lack of Economic Progress

For college graduates, changed occupational composition, shifts in industry demand, and growth in relative
supply are major contributors. For high school dropouts, the reduction in the real minimum wage lowers
earnings, and the increase in the proportion of people with criminal records are major causes of reduced
employment. The fall in employment is largely accounted for by a rise in the number of men who
experienced long spells of labor market inactivity, and not in more frequent spells. The increasing number
of working age males who are detached from the labor force has long-run economic and social
consequences. Without more frequent work experience, a growing portion of the work force loses valuable
job skills, which is detrimental to the national economy in wasting valuable labor resources as well as to
individuals who lose income. They also lose the job contacts necessary to retain employment or find better
job prospects. Nonparticipants in the labor market contribute to social problems. Those who are
unemployed and no longer actively look for employment are much less likely to marry and live with a
spouse than labor market participants.

V. Barriers to Economic Success

Urban workers benefit from metropolitan economic growth only if they have access to the urban labor
market. For minorities and low-skill workers, this access is impeded by physical barriers of spatial isolation
and intellectual barriers of poor education and inadequate support groups and referral networks. Therefore,
in designing a national urban policy, efforts should also be made to increase access to the urban labor
market. The shifting industrial mix of central cities and suburbs has left some groups of workers isolated
from decent-paying jobs. The movement of manufacturing jobs to the suburbs has made it increasingly
difficult for many inner city residents to finds jobs close by that offer the same wages as manufacturing
jobs. Various types of service jobs have concentrated in central cities, but either the pay is lower or the skill
requirements are higher than the qualifications of many residents.

Physical distance is not the only barrier that prevents low-income inner city residents, from gaining access
to better-paying jobs. Intellectual barriers also play a major role. Intellectual barriers prevent people from
participating in the formal and informal information networks through which people learn about job
opportunities, are referred to employers, and gain appropriate role models and support groups. These
barriers stem in part from physical isolation, such as the increasing concentration of poverty. But they also
result from a growing gap in the ability of inner city residents to meet the skill requirements of the
workplace and to communicate and move comfortably within an increasingly sophisticated work
environment. While distances may become effectively shorter because of better transportation, intellectual

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barriers may continue to grow as businesses demand higher skills than many inner city workers can match.
The growing gap between skill requirements of the workplace and skills of inner city residents deters many
workers from participating in urban labor markets. Without appropriate skills and workplace know-how,
workers are shut out of many jobs, even entry-level ones.
The spatial separation of households with different income and educational levels is more pervasive than
simply between central cities and surrounding suburbs. Concentration of poverty, and thus the loss of
networks of families and friends with positive work experience, has occurred within central cities. Studies
have shown that low-income households have become increasing concentrated in central city
neighborhoods. Unfortunately, the tremendous increase in crime in inner city neighborhoods may
discourage the location of businesses, which reduces the number of jobs available to these residents.

VI. Policy Issues and Suggestions

An effective national urban policy must embody the unique characteristics of cities while addressing the
trends that pervade the national economy. The distinguishing features of cities include the spatial proximity
of businesses and households, the flow of information between these parties, and the linkages of markets
within urban areas. Consequently, government's role and the primary purpose of a national urban policy
should be to design programs that promote growth, internalize externalities, improve market efficiency, and
strive for a more acceptable income distribution. The slowdown in productivity growth has resulted in two
major national issues: sluggish real income growth and widening income dispersion. These trends directly
affect the welfare of urban workers and indirectly alter the structure of metropolitan areas by promoting
decentralization of businesses and households. Weakening the core structure of metropolitan areas may
diminish the economic advantages of cities. A national urban policy should address the underlying
economic and social causes of the productivity slowdown. Increased productivity is critical to boost
earnings and create additional employment opportunities. Long-term growth hinges on investment in
physical and human capital. Consequently, a national urban policy should include provisions to increase
the national savings rate and allocate resources to education, research and development, and a more
efficient flow of technological information. Cities are the obvious place for this investment, as they offer the
greatest return per dollar spent. However, in doing so, redistributing growth across metropolitan areas
through favorable tax incentives or government subsidies for selected areas should be minimized.

Efficient Urban Markets

Growth policies should also focus on increasing the efficiency of urban markets. Cities provide businesses
access to skilled labor, to supplier networks, to product markets, and to information. However, access has
been impeded by congestion, the decentralization of employment, and deficiency in skills of some workers.
Widening gaps between central cities and suburbs with respect to earnings, employment, and quality of life
have also reduced the efficiency of urban markets and has impeded overall growth. In addition, inner city
residents benefit from growth of the entire metropolitan economy, not only in the neighborhoods in which
they live. A national urban policy should include measures to narrow these disparities through promoting
the establishment of regional governments, sharing tax bases, and coordinating metropolitan provision of
government services. Urban externalities can be internalized by reducing fragmentation of metropolitan
area governments, which will enhance overall metropolitan growth. The benefits of the concentration of
economic activities in the urban core as well as the costs of supporting social problems of urban areas can
be shared throughout the metropolitan area. This would reduce the fiscal incentives to leave the inner cities
and help revitalize these areas.

Increase Access to Urban Labor Markets

Increased economic growth benefits only those people with access to urban labor markets. A growing
number of urban residents face physical and intellectual isolation from urban opportunities. Isolation

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deprives individuals of greater economic success and deprives the nation of potentially productive workers.
It also breeds behavior that is burdensome to society, such as welfare dependency, the breakdown of
support networks, the decline in traditional married-couple families, and involvement in criminal activity. A
national urban policy must address the disadvantages faced by minorities in qualifying for and obtaining
jobs and the disenfranchisement of low-income urban minorities. These programs should strive to get
people into jobs and keep them employed. Improving the quality of education and work-related training for
inner city residents will help to overcome intellectual barriers. Establishing support groups and supplying
appropriate role models through mentoring and employment advocacy programs will provide access to the
labor market and ensure that workers remain in the labor force. Providing more convenient and affordable
public transportation to people who must commute in directions and at times not typically served by mass
transit will increase access to jobs. In addition, setting up an electronic job placement system that offers
information on job seekers and job vacancies for the greater metropolitan region would give inner city
residents access to the broader labor market. Workers benefit from on-the-job learning and from
establishing a network and support system of economically successful people, which offer opportunities for
future advancement. Programs, such as wage supplements and public service employment, have proven
successful in getting disadvantaged workers into the workplace and on their way to more active
involvement in the labor force.

Economic Growth

Economic growth is the increase of per capita gross domestic product (GDP) or other measure of
aggregate income. It is often measured as the rate of change in real GDP. Economic growth refers only to
the quantity of goods and services produced.

Economic growth can be either positive or negative. Negative growth can be referred to by saying that the
economy is shrinking. Negative growth is associated with economic recession and economic depression.

In order to compare per capita income across multiple countries, the statistics may be quoted in a single
currency, based on either prevailing exchange rates or purchasing power parity. To compensate for
changes in the value of money (inflation or deflation) the GDP or GNP is usually given in "real" or inflation
adjusted, terms rather than the actual money figure compiled in a given year, which is called the nominal or
current figure.

Economists draw a distinction between short-term economic stabilization and long-term economic growth.
The topic of economic growth is primarily concerned with the long run. The short-run variation of economic
growth is termed the business cycle.

The long-run path of economic growth is one of the central questions of economics; despite some
problems of measurement, an increase in GDP of a country is generally taken as an increase in the
standard of living of its inhabitants. Over long periods of time, even small rates of annual growth can have
large effects through compounding (see exponential growth). A growth rate of 2.5% per annum will lead to
a doubling of GDP within 29 years, whilst a growth rate of 8% per annum (experienced by some Four
Asian Tigers) will lead to a doubling of GDP within 10 years. This exponential characteristic can exacerbate
differences across nations.

In 1377, the Arabian economic thinker Ibn Khaldun provided one of the earliest descriptions of economic
growth in his Muqaddimah (known as Prolegomena in the Western world):

"When civilization [population] increases, the available labor again increases. In turn, luxury again
increases in correspondence with the increasing profit, and the customs and needs of luxury increase.
Crafts are created to obtain luxury products. The value realized from them increases, and, as a result,
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profits are again multiplied in the town. Production there is thriving even more than before. And so it goes
with the second and third increase. All the additional labor serves luxury and wealth, in contrast to the
original labor that served the necessity of life."

In the early modern period, some people in Western European nations developed the idea that economies
could "grow", that is, produce a greater economic surplus which could be expended on something other
than mere subsistence. This surplus could then be used for consumption, warfare, or civic and religious
projects. The previous view was that only increasing either population or tax rates could generate more
surplus money for the Crown or country.

Later it was theorized that economic growth also corresponds to a process of continual rapid replacement
and reorganization of human activities facilitated by investment motivated to maximize returns. This
exponential evolution of our self-organized life-support and cultural systems is remarkably creative and
flexible, but highly unpredictable in many ways. As there are difficulties in modelling complex self-
organizing systems, various efforts to model the long term evolution of economies have produced mixed
results.

During much of the "Mercantilist" period, growth was seen as involving an increase in the total amount of
specie, which is circulating medium such as silver and gold, under the control of the state. This "Bullionist"
theory led to policies to force trade through a particular state, the acquisition of colonies to supply cheaper
raw materials which could then be manufactured and sold.

Later, such trade policies were justified instead simply in terms of promoting domestic trade and industry.
The post-Bullionist insight that it was the increasing capability of manufacturing which led to policies in the
18th century to encourage manufacturing in itself, and the formula of importing raw materials and exporting
finished goods. Under this system high tariffs were erected to allow manufacturers to establish "factories".
Local markets would then pay the fixed costs of capital growth, and then allow them to export abroad,
undercutting the prices of manufactured goods elsewhere. Once competition from abroad was removed,
prices could then be increased to recoup the costs of establishing the business.

Under this theory of growth, one policy attempted to foster growth was to grant monopolies, which would
give an incentive for an individual to exploit a market or resource, confident that he would make all of the
profits when all other extra-national competitors were driven out of business. The "Dutch East India
company" and the "British East India company" were examples of such state-granted trade monopolies.

In this period the view was that growth was gained through "advantageous" trade in which specie would
flow in to the country, but to trade with other nations on equal terms was disadvantageous. It should be
stressed that Mercantilism was not simply a matter of restricting trade. Within a country, it often meant
breaking down trade barriers, building new roads, and abolishing local toll booths, all of which expanded
markets. This corresponded to the centralization of power in the hands of the Crown (or "Absolutism"). This
process helped produce the modern nation-state in Western Europe.

Internationally, Mercantilism led to a contradiction: growth was gained through trade, but to trade with other
nations on equal terms was disadvantageous.

Classical growth theory

The modern conception of economic growth began with the critique of Mercantilism, especially by the
physiocrats and with the Scottish Enlightenment thinkers such as David Hume and Adam Smith, and the
foundation of the discipline of modern political economy. The theory of the physiocrats was that productive
capacity, itself, allowed for growth, and the improving and increasing capital to allow that capacity was "the
6
wealth of nations". Whereas they stressed the importance of agriculture and saw urban industry as
"sterile", Smith extended the notion that manufacturing was central to the entire economy.

David Ricardo argued that trade was a benefit to a country, because if one could buy a good more cheaply
from abroad, it meant that there was more profitable work to be done here. This theory of "comparative
advantage" would be the central basis for arguments in favor of free trade as an essential component of
growth.

Creative destruction and economic growth

Many economists view entrepreneurship as having a major influence on a society's rate of technological
progress and thus economic growth.[5] Joseph Schumpeter was a key figure in understanding the influence
of entrepreneurs on technological progress.[5] In Schumpeter's Capitalism, Socialism and Democracy,
published in 1942, an entrepreneur is a person who is willing and able to convert a new idea or invention
into a successful innovation. Entrepreneurship forces "creative destruction" across markets and industries,
simultaneously creating new products and business models. In this way, creative destruction is largely
responsible for the dynamism of industries and long-run economic growth. Former Federal Reserve
chairman Alan Greenspan has described the influence of creative destruction on economic growth as
follows: "Capitalism expands wealth primarily through creative destruction—the process by which the cash
flow from obsolescent, low-return capital is invested in high-return, cutting-edge technologies."

The neo-classical growth model

The notion of growth as increased stocks of capital goods (means of production) was codified as the
Solow-Swan Growth Model, which involved a series of equations which showed the relationship between
labor-time, capital goods, output, and investment. According to this view, the role of technological change
became crucial, even more important than the accumulation of capital. This model, developed by Robert
Solow[7] and Trevor Swan[8] in the 1950s, was the first attempt to model long-run growth analytically. This
model assumes that countries use their resources efficiently and that there are diminishing returns to
capital and labor increases. From these two premises, the neoclassical model makes three important
predictions. First, increasing capital relative to labor creates economic growth, since people can be more
productive given more capital. Second, poor countries with less capital per person will grow faster because
each investment in capital will produce a higher return than rich countries with ample capital. Third,
because of diminishing returns to capital, economies will eventually reach a point at which no new increase
in capital will create economic growth. This point is called a "steady state".

The model also notes that countries can overcome this steady state and continue growing by inventing
new technology. In the long run, output per capita depends on the rate of saving, but the rate of output
growth should be equal for any saving rate. In this model, the process by which countries continue growing
despite the diminishing returns is "exogenous" and represents the creation of new technology that allows
production with fewer resources. Technology improves, the steady state level of capital increases, and the
country invests and grows. The data does not support some of this model's predictions, in particular, that
all countries grow at the same rate in the long run, or that poorer countries should grow faster until they
reach their steady state. Also, the data suggests the world has slowly increased its rate of growth.

However modern economic research shows that the baseline version of the neoclassical model of
economic growth is not supported by the evidence. Calculations made by Solow claimed that the majority
of economic growth was due to technological progress rather than inputs of capital and labour. Recent
economic research has, however, found the calculations made to support this claim to be invalid as they do
not take into account changes in both investment and labour inputs. Dale Jorgenson, of Harvard University,
President of the American Economic Association in 2000, concludes that: ‘Griliches and I showed that
7
changes in the quality of capital and labor inputs and the quality of investment goods explained most of the
Solow residual. We estimated that capital and labor inputs accounted for 85 percent of growth during the
period 1945–1965, while only 15 percent could be attributed to productivity growth… This has precipitated
the sudden obsolescence of earlier productivity research employing the conventions of Kuznets and
Solow.’

Taking the G7 economies and the largest non-G7 economies, Jorgenson and Vu conclude: ‘the growth of
world output between input growth and productivity… input growth greatly predominated… Productivity
growth accounted for only one-fifth of the total during 1989-1995, while input growth accounted for almost
four-fifths. Similarly, input growth accounted for more than 70 percent of growth after 1995, while
productivity accounted for less than 30 percent.’

Regarding differences in output per capita Jorgenson and Vu conclude: ‘differences in per capita output
levels are primarily explained by differences in per capital input, rather than variations in productivity.’

Development economics

The latter half of the 20th century, with its global economy of a few very wealthy nations and many very
poor nations, led to the study of how the transition from subsistence and resource-based economies to
production and consumption based-economies occurred. This led to the field of development economics,
including the work of Nobel laureates Amartya Sen and Joseph Stiglitz. However this model of economic
development does not meet the demands of subaltern populations and has been severely criticized by later
theorists.

New growth theory

Growth theory advanced again with the theories of economist Paul Romer in the late 1980s and early
1990s. Other important new growth theorists include Robert E. Lucas and Robert J. Barro.

Unsatisfied with Solow's explanation, economists worked to "endogenize" technology in the 1980s. They
developed the endogenous growth theory that includes a mathematical explanation of technological
advancement. This model also incorporated a new concept of human capital, the skills and knowledge that
make workers productive. Unlike physical capital, human capital has increasing rates of return. Therefore,
overall there are constant returns to capital, and economies never reach a steady state. Growth does not
slow as capital accumulates, but the rate of growth depends on the types of capital a country invests in.
Research done in this area has focused on what increases human capital (e.g. education) or technological
change (e.g. innovation).

Recent empirical analyses suggest that differences in cognitive abilities, related to schooling and other
factors, can largely explain variations in growth rates across countries. Cognitive abilities comprise
intelligence and knowledge and are more important than education itself. Cognitive abilities are more
relevant than the classical growth factor "economic freedom". In comparison of low, mean and high ability
groups within societies the competence level of the high ability group is the most important, stimulating
through research and innovation economic growth and other favorable aspects of countries like
democracy.

Other theories

Theories of economic growth, the mechanisms that let it take place and its main determinants abound. One
popular theory in the 1970s for example was that of the "Big Push" which suggested that countries needed
to jump from one stage of development to another through a virtuous cycle in which large investments in
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infrastructure and education coupled to private investment would move the economy to a more productive
stage, breaking free from economic paradigms appropriate to a lower productivity stage.[16]

Analysis of recent economies' success shows a close correlation between growth and climate. It is possible
that there is absolutely no actual mechanism between the two, and the relation may be spurious. In early
human history, economic as well as cultural development was concentrated in warmer parts of the world,
like Egypt.

According to Acemoğlu, Johnson and Robinson, the positive correlation between high income and cold
climate is a by-product of history. Europeans adopted very different colonization policies in different
colonies, with different associated institutions. In places where these colonizers faced high mortality rates
(e.g., due to the presence of tropical diseases), they could not settle permanently, and they were thus more
likely to establish extractive institutions, which persisted after independence; in places where they could
settle permanently (e.g., those with temperate climates), they established institutions with this objective in
mind and modeled them after those in their European homelands. In these 'neo-Europes' better institutions
in turn produced better development outcomes. Thus, although other economists focus on the identity or
type of legal system of the colonizers to explain institutions, these authors look at the environmental
conditions in the colonies to explain institutions. For instance, former colonies have inherited corrupt
governments and geo-political boundaries (set by the colonizers) that are not properly placed regarding the
geographical locations of different ethnic groups, creating internal disputes and conflicts which in turn
hinder development. In another example, societies that emerged in colonies without solid native
populations established better property rights and incentives for long-term investment than those where
native populations were large.

Substantial academic literature and government strategies support the finance-led growth hypothesis,
based on an observation first made almost a century ago by Joseph Schumpeter that financial markets
significantly boost real economic growth and development. Schumpeter asserted that finance had a
positive impact on economic growth as a result of its effects on productivity growth and technological
change. (Schumpeter, Joseph A. “The theory of Economic Development”, 1912, translated by Redvers
Opie. Cambridge. MA: Harvard University Press, 1934). As early as 1989 the World Bank also endorsed
the view that financial deepening matters for economic growth “by improving the productivity of investment
(World Bank, World Development Report, Washington DC, 1989, 9. 30). A number of case studies on Asia
and Southern African countries show the positive nexus between development of financial intermediation
and economic growth.

Positive effects of economic growth

Income distribution

Economist Xavier Sala-i-Martin argues that global income inequality is diminishing, and the World Bank
argues that the rapid reduction in global poverty is in large part due to economic growth. The decline in
poverty has been the slowest where growth performance has been the worst (i.e. in Africa).

Quality of life

Happiness has been shown to increase with a higher GDP per capita, at least up to a level of $15,000 per
person.

Resource depletion

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Many earlier predictions of resource depletion, such as Thomas Malthus' 1798 predictions about
approaching famines in Europe, The Population Bomb (1968), Limits to Growth (1972), and the Simon–
Ehrlich wager (1980) have proven false, one reason being that advancements in technology and science
have continually allowed previously unavailable resources to be utilized more economically.

Economists theorize that economies are driven by new technology and ongoing improvements in
efficiency. In the book The Economic Growth Engine: How useful work creates material prosperity, 2009
Robert U. Ayres and Benjamin Warr present time series of the efficiency of primary energy (exergy)
conversion into useful work for the US, UK, Austria and Japan revealing dramatic improvements Ayres and
Warr, 2009. With useful work as a factor of production they are able to reproduce historical rates of
economic growth with considerable precision and without recourse to exogenous and unexplained
technological progress, thereby overcoming the major flaw of the Solow Theory of economic growth. With
regards ICT, we have faster computers today than a year ago, but not necessarily computers requiring
more natural resources to build.

Also, physical limits may be very large if considering all the minerals in the planet Earth or all possible
resources from space colonization, such as solar power satellites, asteroid mining, or a Dyson sphere. The
book Mining the Sky: Untold Riches from the Asteroids, Comets, and Planets provides an alternative
example of such arguments. However, depletion and declining production from old resources can
sometimes occur before new resources are ready to replace them. This is, in part, the logical basis of the
Peak Oil theory. Although individual oil wells and mines for other nonrenewable resources are often
depleted, the availability of these resources has generally risen and their prices have dropped over the
long-run.

Environmental impact

Those more optimistic about the environmental impacts of growth believe that, although localized
environmental effects may occur, large scale ecological effects are minor. The argument as stated by
commentators Julian Lincoln Simon states that if these global-scale ecological effects exist, human
ingenuity will find ways of adapting to them.

Negative effects of economic growth

A number of critical arguments have been raised against economic growth.

Growth 'to a point'

It may be that economic growth improves the quality of life up to a point, after which it doesn't improve the
quality of life, but rather obstructs sustainable living. Historically, sustained growth has reached its limits
(and turned to catastrophic decline) when perturbations to the environmental system last long enough to
destabilise the bases of a culture.

Consumerism

Growth may lead to consumerism by encouraging the creation of what some regard as artificial needs:
Industries cause consumers to develop new taste, and preferences for growth to occur. Consequently,
"wants are created, and consumers have become the servants, instead of the masters, of the economy."

Environmental impact

10
The 2007 United Nations GEO-4 report states that humans are living beyond their means. Humanity’s
environmental demand is purported to be 21.9 hectares per person while the Earth’s biological capacity is
purported to be 15.7 ha/person. This report reinstates the basic arguments and observations made by
Thomas Malthus in the early 19th century. Economic inequality has increased; the gap between the
poorest and richest countries in the world has been growing.

Some critics argue that a narrow view of economic growth, combined with globalization, is creating a
scenario where we could see a systemic collapse of our planet's natural resources. Other critics draw on
archaeology to cite examples of cultures they claim have disappeared because they grew beyond the
ability of their ecosystems to support them.[34] Concerns about possible negative effects of growth on the
environment and society led some to advocate lower levels of growth, from which comes the ideas of
uneconomic growth and de-growth, and Green parties which argue that economies are part of a global
society and a global ecology and cannot outstrip their natural growth without damaging them.

Canadian scientist, David Suzuki stated in the 1990s that ecologies can only sustain typically about 1.5-3%
new growth per year, and thus any requirement for greater returns from agriculture or forestry will
necessarily cannibalize the natural capital of soil or forest. Some think this argument can be applied even
to more developed economies.

Equitable growth

While acknowledging the central role economic growth can potentially play in human development, poverty
reduction and the achievement of the Millennium Development Goals, it is becoming widely understood
amongst the development community that special efforts must be made to ensure poorer sections of
society are able to participate in economic growth. For instance, with low inequality a country with a growth
rate of 2% per head and 40% of its population living in poverty, can halve poverty in ten years, but a
country with high inequality would take nearly 60 years to achieve the same reduction.[36] In the words of
the Secretary General of the United Nations Ban Ki-Moon:

"While economic growth is necessary, it is not sufficient for progress on reducing poverty."

Researchers at the Overseas Development Institute compares situations such as in Uganda, where during
a period of annual growth of 2.5% between 2000 and 2003, the percentage of people living in poverty
actually increased by 3.8%. The ODI thus emphasizes the need to ensure social protection is extended to
allow universal access and that policies are introduced to encourage the private sector to create new jobs
as the economy grows (as opposed to jobless growth) and seek to employ people from disadvantaged
groups.

Implications of global warming

Up to the present there are close correlations of economic growth with carbon dioxide emissions across
nations, although there is also a considerable divergence in carbon intensity (carbon emissions per GDP).
The Stern Review notes that the prediction that "under business as usual, global emissions will be
sufficient to propel greenhouse-gas concentrations to over 550ppm CO2e by 2050 and over 650-700ppm
by the end of this century is robust to a wide range of changes in model assumptions". The scientific
consensus is that planetary ecosystem functioning without incurring dangerous risks requires stabilization
at 450-550ppm.

As a consequence, growth oriented environmental economists propose massive government intervention

into switching sources of energy production, favouring wind, solar, hydroelectric and nuclear. This would
largely confine use of fossil fuels to either domestic cooking needs (such as for kerosene burners) or where
11
carbon capture and storage technology can be cost-effective and reliable. The Stern Review, published by
the United Kingdom Government in 2006, concluded that an investment of 1% of GDP per annum would
be sufficient to avoid the worst effects of climate change, and that failure to do so could risk global GDP
being 20% lower than it otherwise might be. Because carbon capture and storage is as yet widely
unproven, and its long term effectiveness (such as in containing carbon dioxide 'leaks') unknown, and
because of current costs of alternative fuels these policy responses largely rest on faith on technological
change.

On the other hand, Nigel Lawson claimed that people in a hundred years' time would be "seven times as
well off as we are today", therefore it is not reasonable to impose sacrifices on the "much poorer present
generation".

Indian Economy:

The economy of India is the eleventh largest economy in the world by nominal GDP and the fourth largest
by purchasing power parity (PPP). Following strong economic reforms from the socialist inspired economy
of a post-independence Indian nation, the country began to develop a fast-paced economic growth, as free
market principles were initiated in 1990 for international competition and foreign investment. India is an
emerging economic power with a very large pool of human and natural resources, and a growing large pool
of skilled professionals. According to the book 'Contours of the World Economy, 1-2030AD' by Angus
Maddison, India was the largest economy from the year 1 AD until the colonial period whereupon it was
taken over by other countries such as China and the U.K. Economists predict that by 2020, India will be
among the leading economies of the world. According to the BRIC report, published by Goldman Sachs,
India will be the second largest economy after China by 2043.

India was under social democratic-based policies from 1947 to 1991. The economy was characterised by
extensive regulation, protectionism, public ownership, pervasive corruption and slow growth. Since 1991,
continuing economic liberalisation has moved the country toward a market-based economy. A revival of
economic reforms and better economic policy in first decade of the 21st century accelerated India's
economic growth rate. In recent years, Indian cities have continued to liberalize business regulations. By
2008, India had established itself as the world's second-fastest growing major economy. However, the year
2009 saw a significant slowdown in India's GDP growth rate to 6.8% as well as the return of a large
projected fiscal deficit of 6.8% of GDP which would be among the highest in the world.

India's large service industry accounts for 55% of the country's Gross Domestic Product (GDP) while the
industrial and agricultural sector contribute 28% and 17% respectively. Agriculture is the predominant
occupation in India, accounting for about 52% of employment. The service sector makes up a further 34%,
and industrial sector around 14%. The labour force totals half a billion workers. Major agricultural products
include rice, wheat, oilseed, cotton, jute, tea, sugarcane, potatoes, cattle, water buffalo, sheep, goats,
poultry and fish. Major industries include telecommunications, textiles, chemicals, food processing, steel,
transportation equipment, cement, mining, petroleum, machinery, information technology enabled services
and pharmaceuticals.

India's per capita income (nominal) is $1,030, ranked 139th in the world, while its per capita (PPP) of
US$2,940 is ranked 128th. Previously a closed economy, India's trade has grown fast. India currently
accounts for 1.5% of World trade as of 2007 according to the WTO. According to the World Trade Statistics
of the WTO in 2006, India's total merchandise trade (counting exports and imports) was valued at $294
billion in 2006 and India's services trade inclusive of export and import was $143 billion. Thus, India's
global economic engagement in 2006 covering both merchandise and services trade was of the order of
$437 billion, up by a record 72% from a level of $253 billion in 2004. India's trade has reached a still
relatively moderate share 24% of GDP in 2006, up from 6% in 1985.
12
India's economic history can be broadly divided into three eras, beginning with the pre-colonial period
lasting up to the 18th century. The advent of British colonisation started the colonial period in the early 19th
century, which ended with independence in 1947. The third period stretches from independence in 1947
until now.

Pre-colonial

The citizens of the Indus Valley civilisation, a permanent settlement that flourished between 2800 BC and
1800 BC, practiced agriculture, domesticated animals, used uniform weights and measures, made tools
and weapons, and traded with other cities. Evidence of well planned streets, a drainage system and water
supply reveals their knowledge of urban planning, which included the world's first urban sanitation systems
and the existence of a form of municipal government.

The 1872 census revealed that 99.3% of the population of the region constituting present-day India
resided in villages, whose economies were largely isolated and self-sustaining, with agriculture the
predominant occupation. This satisfied the food requirements of the village and provided raw materials for
hand-based industries, such as textiles, food processing and crafts. Although many kingdoms and rulers
issued coins, barter was prevalent. Villages paid a portion of their agricultural produce as revenue to the
rulers, while its craftsmen received a part of the crops at harvest time for their services.

Religion, especially Hinduism, and the caste and the joint family systems, played an influential role in
shaping economic activities.[33] The caste system functioned much like medieval European guilds, ensuring
the division of labour, providing for the training of apprentices and, in some cases, allowing manufacturers
to achieve narrow specialization. For instance, in certain regions, producing each variety of cloth was the
specialty of a particular sub-caste.

Textiles such as muslin, Calicos, shawls, and agricultural products such as pepper, cinnamon, opium and
indigo were exported to Europe, the Middle East and South East Asia in return for gold and silver.

Assessment of India's pre-colonial economy is mostly qualitative, owing to the lack of quantitative
information. One estimate puts the revenue of Akbar's Mughal Empire in 1600 at £17.5 million, in contrast
with the total revenue of Great Britain in 1800, which totalled £16 million. India, by the time of the arrival of
the British, was a largely traditional agrarian economy with a dominant subsistence sector dependent on
primitive technology. It existed alongside a competitively developed network of commerce, manufacturing
and credit. After the decline of the Mughals, western, central and parts of south and north India were
integrated and administered by the Maratha Empire. The Maratha Empire's budget in 1740s, at its peak,
was 100 million. After the loss at Panipat, the Maratha Empire disintegrated into confederate states of
Gwalior, Baroda, Indore, Jhansi, Nagpur, Pune and Kolhapur. Gwalior state had a budget of 30 million.
However, at this time, British East India company entered the Indian political theatre. Until 1857, when
India was firmly under the British crown, the country remained in a state of political instability due to
internecine wars and conflicts

Colonial

An aerial view of Calcutta Port taken in 1945. Calcutta, which was the economic hub of British India, saw
increased industrial activity during World War II.

Company rule in India brought a major change in the taxation environment from revenue taxes to property
taxes, resulting in mass impoverishment and destitution of majority of farmers and led to numerous
famines. The economic policies of the British Raj effectively bankrupted India's large handicrafts industry
and caused a massive drain of India's resources. Indian Nationalists employed the successful Swadeshi
13
movement, as strategy to diminish British economic superiority by boycotting British products and the
reviving the market for domestic-made products and production techniques. India had become a strong
market for superior finished European goods. This was because of vast gains made by the Industrial
revolution in Europe, the effects of which was deprived to Colonial India.

The Nationalists had hoped to revive the domestic industries that were badly effected by policies
implemented by British Raj which had made them uncompetitive to British made goods.

An estimate by Cambridge University historian Angus Maddison reveals that "India's share of the world
income fell from 22.6% in 1700, comparable to Europe's share of 23.3%, to a low of 3.8% in 1952". It also
created an institutional environment that, on paper, guaranteed property rights among the colonizers,
encouraged free trade, and created a single currency with fixed exchange rates, standardized weights and
measures, capital markets. It also established a well developed system of railways and telegraphs, a civil
service that aimed to be free from political interference, a common-law and an adversarial legal system.
India's colonisation by the British coincided with major changes in the world economy—industrialisation,
and significant growth in production and trade. However, at the end of colonial rule, India inherited an
economy that was one of the poorest in the developing world, with industrial development stalled,
agriculture unable to feed a rapidly growing population, India had one of the world's lowest life
expectancies, and low rates for literacy.

The impact of the British rule on India's economy is a controversial topic. Leaders of the Indian
independence movement, and left-nationalist economic historians have blamed colonial rule for the dismal
state of India's economy in its aftermath and that financial strength required for Industrial development in
Europe was derived from the wealth taken from Colonies in Asia and Africa. At the same time right-wing
historians have countered that India's low economic performance was due to various sectors being in a
state of growth and decline due to changes brought in by colonialism and a world that was moving towards
industrialization and economic integration.

Independence to 1947

Compare India (orange) with South Korea (yellow). Both started from about the same income level in 1950.
The graph shows GDP per capita of South Asian economies and South Korea as a percent of the
American GDP per capita.

Indian economic policy after independence was influenced by the colonial experience (which was seen by
Indian leaders as exploitative in nature) and by those leaders' exposure to Fabian socialism. Policy tended
towards protectionism, with a strong emphasis on import substitution, industrialization, state intervention in
labour and financial markets, a large public sector, business regulation, and central planning. Five-Year
Plans of India resembled central planning in the Soviet Union. Steel, mining, machine tools, water,
telecommunications, insurance, and electrical plants, among other industries, were effectively nationalized
in the mid-1950s. Capitalism and Private enterprise did not exist before 1991. Elaborate licences,
regulations and the accompanying red tape, commonly referred to as Licence Raj, were required to set up
business in India between 1947 and 1990.

Jawaharlal Nehru, the first prime minister, along with the statistician Prasanta Chandra Mahalanobis,
carried on by Indira Gandhi formulated and oversaw economic policy. They expected favorable outcomes
from this strategy, because it involved both public and private sectors and was based on direct and indirect
state intervention, rather than the more extreme Soviet-style central command system. The policy of
concentrating simultaneously on capital- and technology-intensive heavy industry and subsidizing manual,
low-skill cottage industries was criticized by economist Milton Friedman, who thought it would waste capital
and labour, and retard the development of small manufacturers. The rate from 1947–80 was derisively
14
referred to as the Hindu rate of growth, because of the unfavourable comparison with growth rates in other
Asian countries, especially the "East Asian Tigers".

The Rockefeller Foundation's research in high-yielding varieties of seeds, their introduction after 1965 and
the increased use of fertilizers and irrigation are known collectively as the Green Revolution in India, which
provided the increase in production needed to make India self-sufficient in food grains, thus improving
agriculture in India. Famine in India, once accepted as inevitable, has not returned since independence.

Since 1991

In the late 80s, the government led by Rajiv Gandhi eased restrictions on capacity expansion for
incumbents, removed price controls and reduced corporate taxes. While this increased the rate of growth,
it also led to high fiscal deficits and a worsening current account. The collapse of the Soviet Union, which
was India's major trading partner, and the first Gulf War, which caused a spike in oil prices, caused a major
balance-of-payments crisis for India, which found itself facing the prospect of defaulting on its loans. India
asked for a $1.8 billion bailout loan from IMF, which in return demanded reforms.

An industrial zone near Mumbai, India.

In response, Prime Minister Narasimha Rao along with his finance minister and current Prime Minister of
India Dr. Manmohan Singh initiated the economic liberalization of 1991. The reforms did away with the
Licence Raj (investment, industrial and import licensing) and ended many public monopolies, allowing
automatic approval of foreign direct investment in many sectors. Since then, the overall direction of
liberalisation has remained the same, irrespective of the ruling party, although no party has tried to take on
powerful lobbies such as the trade unions and farmers, or contentious issues such as reforming labour
laws and reducing agricultural subsidies. Since 1990 India has a free-market economy and emerged as
one of the fastest-growing economies in the developing world; during this period, the economy has grown
constantly, but with a few major setbacks. This has been accompanied by increases in life expectancy,
literacy rates and food security.

While the credit rating of India was hit by its nuclear tests in 1998, it has been raised to investment level in
2007 by S&P and Moody's. In 2003, Goldman Sachs predicted that India's GDP in current prices will
overtake France and Italy by 2020, Germany, UK and Russia by 2025 and Japan by 2035. By 2035, it was
projected to be the third largest economy of the world, behind US and China. India is often seen by most
economists as a rising economic superpower and is believed to play a major role in the global economy in
the 21st century. In 2009 India purchased 200 Tons of Gold for $6.7 billion from IMF as a total role reversal
from 1991.

Sectors

Industry and services

India has one of the world's fastest growing automobile industries. Shown here is the Tata Motors' Nano,
the world's cheapest car.

Industry accounts for 28% of the GDP and employ 14% of the total workforce. However, about one-third of
the industrial labour force is engaged in simple household manufacturing only. In absolute terms, India is
16th in the world in terms of nominal factory output.

Economic reforms brought foreign competition, led to privatisation of certain public sector industries,
opened up sectors hitherto reserved for the public sector and led to an expansion in the production of fast-
15
moving consumer goods. Post-liberalisation, the Indian private sector, which was usually run by oligopolies
of old family firms and required political connections to prosper was faced with foreign competition,
including the threat of cheaper Chinese imports. It has since handled the change by squeezing costs,
revamping management, focusing on designing new products and relying on low labour costs and
technology.

Textile manufacturing is the second largest source for employment after agriculture and accounts for 26%
of manufacturing output. Ludhiana produces 90% of woolens in India and is also known as the Manchester
of India. Tirupur has gained universal recognition as the leading source of hosiery, knitted garments,
casual wear and sportswear. Dharavi slum in Mumbai has gained fame for leather products. Tata Motors'
Nano attempts to be the world's cheapest car.

India is fifteenth in services output. It provides employment to 23% of work force, and it is growing fast,
growth rate 7.5% in 1991–2000 up from 4.5% in 1951–80. It has the largest share in the GDP, accounting
for 55% in 2007 up from 15% in 1950.

Business services (information technology, information technology enabled services, business process
outsourcing) are among the fastest growing sectors contributing to one third of the total output of services
in 2000. The growth in the IT sector is attributed to increased specialization, and an availability of a large
pool of low cost, but highly skilled, educated and fluent English-speaking workers, on the supply side,
matched on the demand side by an increased demand from foreign consumers interested in India's service
exports, or those looking to outsource their operations. The share of India's IT industry to the country's
GDP increased from 4.8 % in 2005-06 to 7% in 2008. In 2009, seven Indian firms were listed among the
top 15 technology outsourcing companies in the world. In March 2009, annual revenues from outsourcing
operations in India amounted to US$60 billion and this is expected to increase to US$225 billion by 2020.

Organized retail such supermarkets accounts for 24% of the market as of 2008. Regulations prevent most
foreign investment in retailing. Moreover, over thirty regulations such as "signboard licences" and "anti-
hoarding measures" may have to be complied before a store can open doors. There are taxes for moving
goods to states, from states, and even within states. Tourism in India is relatively undeveloped, but growing
at double digits. Some hospitals woo medical tourism.

Agriculture

Farmers work inside a rice field in Andhra Pradesh. India is the second largest producer of rice in the world
after China and Andhra Pradesh is the 2nd largest rice producing state in India with West Bengal being the
largest.

India ranks second worldwide in farm output. Agriculture and allied sectors like forestry, logging and fishing
accounted for 17% of the GDP in 2009, employed 52% of the total workforce and despite a steady decline
of its share in the GDP, is still the largest economic sector and plays a significant role in the overall socio-
economic development of India. Yields per unit area of all crops have grown since 1950, due to the special
emphasis placed on agriculture in the five-year plans and steady improvements in irrigation, technology,
application of modern agricultural practices and provision of agricultural credit and subsidies since Green
revolution in India. However, international comparisons reveal the average yield in India is generally 30%
to 50% of the highest average yield in the world.

Paddy fields at Kanyakumari district in Tamil Nadu

16
India is the largest producer in the world of milk, cashew nuts, coconuts, tea, ginger, turmeric and black
pepper. It also has the world's largest cattle population: 193 million. It is the second largest producer of
wheat, rice, sugar, cotton, silk, peanuts and inland fish. It is the third largest producer of tobacco. India is
the largest fruit producer, accounting for 10% of the world fruit production. It is the leading producer of
bananas, sapotas and mangoes.

India is the second largest producer and the largest consumer of silk in the world, with the majority of the
77 million kg (2005) production taking place in Karnataka State, particularly in Mysore and the North
Bangalore regions of Muddenahalli, Kanivenarayanapura, and Doddaballapura, the upcoming sites of a
INR 700 million "Silk City".

Banking and finance

The Indian money market is classified into: the organised sector (comprising private, public and foreign
owned commercial banks and cooperative banks, together known as scheduled banks); and the
unorganised sector (comprising individual or family owned indigenous bankers or money lenders and non-
banking financial companies (NBFCs)). The unorganised sector and microcredit are still preferred over
traditional banks in rural and sub-urban areas, especially for non-productive purposes, like ceremonies and
short duration loans.

Mumbai is the financial and commercial capital of India. Shown here is the World Trade Centre of Mumbai

Prime Minister Indira Gandhi nationalised 14 banks in 1969, followed by six others in 1980, and made it
mandatory for banks to provide 40% of their net credit to priority sectors like agriculture, small-scale
industry, retail trade, small businesses, etc. to ensure that the banks fulfill their social and developmental
goals. Since then, the number of bank branches has increased from 10,120 in 1969 to 98,910 in 2003 and
the population covered by a branch decreased from 63,800 to 15,000 during the same period. The total
deposits increased 32.6 times between 1971 to 1991 compared to 7 times between 1951 to 1971. Despite
an increase of rural branches, from 1,860 or 22% of the total number of branches in 1969 to 32,270 or
48%, only 32,270 out of 5 lakh (500,000) villages are covered by a scheduled bank.

The public sector banks hold over 75% of total assets of the banking industry, with the private and foreign
banks holding 18.2% and 6.5% respectively. Since liberalisation, the government has approved significant
banking reforms. While some of these relate to nationalised banks (like encouraging mergers, reducing
government interference and increasing profitability and competitiveness), other reforms have opened up
the banking and insurance sectors to private and foreign players.

More than half of personal savings are invested in physical assets such as land, houses, cattle, and gold.
Indian has the highest saving rate in the world at 36 percent.

Natural resources

India has the world's fifth largest wind power industry, with an installed wind power capacity of 9,587 MW.
Shown here is a wind farm in Muppandal, Tamil Nadu.

India's total cultivable area is 1,269,219 km² (56.78% of total land area), which is decreasing due to
constant pressure from an ever growing population and increased urbanisation. India has a total water
surface area of 314,400 km² and receives an average annual rainfall of 1,100 mm. Irrigation accounts for
92% of the water utilisation, and comprised 380 km² in 1974, and is expected to rise to 1,050 km² by 2025,
with the balance accounted for by industrial and domestic consumers. India's inland water resources
comprising rivers, canals, ponds and lakes and marine resources comprising the east and west coasts of
17
the Indian ocean and other gulfs and bays provide employment to nearly 6 million people in the fisheries
sector. In 2008, India had the world's third largest fishing industry.[88]

India's major mineral resources include coal, iron, manganese, mica, bauxite, titanium, chromite, limestone
and thorium. India meets most of its domestic energy demand through its 92 billion tonnes of coal reserves
(about 10% of world's coal reserves).[89]

India's huge thorium reserves — about 25% of world's reserves — is expected to fuel the country's
ambitious nuclear energy program in the long-run. India's dwindling uranium reserves stagnated the growth
of nuclear energy in the country for many years.[90] However, the Indo-US nuclear deal has paved the way
for India to import uranium from other countries.[91] India is also believed to be rich in certain renewable
sources of energy with significant future potential such as solar, wind and biofuels (jatropha, sugarcane).

Petroleum and Natural gas

ONGC platform at Mumbai High in the Arabian Sea. As of 2010, India is the world's fifth largest consumer
of oil.

India's oil reserves, found in Mumbai High, parts of Gujarat, Rajasthan and eastern Assam, meet 25% of
the country's domestic oil demand. India's total proven oil reserves stand at 11 billion barrels, of which
Mumbai High is believed to hold 6.1 billion barrels and Mangala Area in Rajasthan an additional 3.6 billion
barrels.

In 2009, India imported 2.56 million barrels of oil per day, making it one of largest buyers of crude oil in the
world. The petroleum industry in India mostly consists of public sector companies such as Oil and Natural
Gas Corporation (ONGC), Hindustan Petroleum Corporation Limited (HPCL) and Indian Oil Corporation
Limited (IOCL). There are some major private Indian companies in oil sector such as Reliance Industries
Limited (RIL) which operates the world's largest oil refining complex.

Pharmaceuticals

India has a self reliant Pharmaceuticals industry. The majority of its medical consumables are produced
domestically. Pharmaceutical Industry in India is dotted with companies like Ranbaxy Pharmaceutical, Dr.
Reddy's Laboratories, Cipla which have created a niche for themselves at world level. India including
China, Brazil, Turkey, Mexico, Russia and South Korea are called “pharmerging” countries.

Today, India is an exporter to countries like the United States and Russia. In terms of the global market,
India currently holds a modest 1-2% share, but it has been growing at approximately 10% per year. India is
unable to capture much of the value as most of the innovation taking place is by non-Indian firms. They are
developing products in their own R&D centres or outsourcing to Indian engineering services firms and
getting the stuff manufactured at either their own factories or through contract manufacturing, as in
pharmaceuticals.

External trade and investment

Global trade relations

In March 2008, India's annual imports and exports stood at US$236 and US$155.5 billion respectively.
Shown here is the cargo of a container ship being unloaded at the Jawaharlal Nehru Port, Navi Mumbai.

18
India's economy is mostly dependent on its large internal market with external trade accounting for just
20% of the country's GDP. In 2008, India accounted for 1.45% of global merchandise trade and 2.8% of
global commercial services export. Until the liberalization of 1991, India was largely and intentionally
isolated from the world markets, to protect its economy and to achieve self-reliance. Foreign trade was
subject to import tariffs, export taxes and quantitative restrictions, while foreign direct investment (FDI) was
restricted by upper-limit equity participation, restrictions on technology transfer, export obligations and
government approvals; these approvals were needed for nearly 60% of new FDI in the industrial sector.
The restrictions ensured that FDI averaged only around US$200 million annually between 1985 and 1991;
a large percentage of the capital flows consisted of foreign aid, commercial borrowing and deposits of non-
resident Indians. India's exports were stagnant for the first 15 years after independence, due to the
predominance of tea, jute and cotton manufactures, demand for which was generally inelastic. Imports in
the same period consisted predominantly of machinery, equipment and raw materials, due to nascent
industrialization.

Since liberalization, the value of India's international trade has become more broad-based and has risen to
63,080,109 crores in 2003–04 from 1,250 crores in 1950–51. India's major trading partners are China,
the US, the UAE, the UK, Japan and the EU. The exports during April 2007 were $12.31 billion up by 16%
and import were $17.68 billion with an increase of 18.06% over the previous year. In 2006-07, major export
commodities included engineering goods, petroleum products, chemicals and pharmaceuticals, gems and
jewellery, textiles and garments, agricultural products, iron ore and other minerals. Major import
commodities included crude oil and related products, machinery, electronic goods, gold and silver.

India is a founding-member of General Agreement on Tariffs and Trade (GATT) since 1947 and its
successor, the WTO. While participating actively in its general council meetings, India has been crucial in
voicing the concerns of the developing world. For instance, India has continued its opposition to the
inclusion of such matters as labour and environment issues and other non-tariff barriers into the WTO
policies.

Balance of payments

Cumulative Current Account Balance 1980-2008 based on the IMF data

Since independence, India's balance of payments on its current account has been negative. Since
liberalisation in the 1990s (precipitated by a balance of payment crisis), India's exports have been
consistently rising, covering 80.3% of its imports in 2002–03, up from 66.2% in 1990–91. India's growing oil
import bill is seen as the main driver behind the large current account deficit. In 2007-08, India imported
120.1 million tonnes of crude oil, more than 3/4th of the domestic demand, at a cost of $61.72 billion.

Although India is still a net importer, since 1996–97 its overall balance of payments (i.e., including the
capital account balance) has been positive, largely on account of increased foreign direct investment and
deposits from non-resident Indians; until this time, the overall balance was only occasionally positive on
account of external assistance and commercial borrowings. As a result, India's foreign currency reserves
stood at $285 billion in 2008.

Due to the global late-2000s recession, both Indian exports and imports declined by 29.2% and 39.2%
respectively in June 2009. The steep decline was because countries hit hardest by the global recession,
such as United States and members of the European Union, account for more than 60% of Indian exports.
However, since the decline in imports was much sharper compared to the decline in exports, India's trade
deficit reduced to 252.5 billion rupee.

19
 India's reliance on external assistance and commercial borrowings has decreased since 1991–92, and
since 2002–03, it has gradually been repaying these debts. Declining interest rates and reduced
borrowings decreased India's debt service ratio to 4.5% in 2007. In India, External Commercial Borrowings
(ECBs) are being permitted by the Government for providing an additional source of funds to Indian
corporates. The Ministry of Finance monitors and regulates these borrowings (ECBs) through ECB policy
guidelines.

Foreign direct investment in India

As the fourth-largest economy in the world in PPP terms, India is a preferred destination for foreign direct
investments (FDI); India has strengths in telecommunication, information technology and other significant
areas such as auto components, chemicals, apparels, pharmaceuticals, and jewellery. Despite a surge in
foreign investments, rigid FDI policies resulted in a significant hindrance. However, due to some positive
economic reforms aimed at deregulating the economy and stimulating foreign investment, India has
positioned itself as one of the front-runners of the rapidly growing Asia Pacific Region. India has a large
pool of skilled managerial and technical expertise. The size of the middle-class population stands at 300
million and represents a growing consumer market.

The inordinately high investment from Mauritius is due to routing of international funds through the country
given significant capital gains tax advantages; double taxation is avoided due to a tax treaty between India
and Mauritius, and Mauriitus is a capital gains tax haven, effectively creating a zero-taxation FDI channel.

India's recently liberalized FDI policy (2005) allows up to a 100% FDI stake in ventures. Industrial policy
reforms have substantially reduced industrial licensing requirements, removed restrictions on expansion
and facilitated easy access to foreign technology and foreign direct investment FDI. The upward moving
growth curve of the real-estate sector owes some credit to a booming economy and liberalized FDI regime.
In March 2005, the government amended the rules to allow 100 per cent FDI in the construction business.
This automatic route has been permitted in townships, housing, built-up infrastructure and construction
development projects including housing, commercial premises, hotels, resorts, hospitals, educational
institutions, recreational facilities, and city- and regional-level infrastructure.

A number of changes were approved on the FDI policy to remove the caps in most sectors. Fields which
require relaxation in FDI restrictions include civil aviation, construction development, industrial parks,
petroleum and natural gas, commodity exchanges, credit-information services and mining. But this still
leaves an unfinished agenda of permitting greater foreign investment in politically sensitive areas such as
insurance and retailing. FDI inflows into India reached a record $19.5 billion in fiscal year 2006-07 (April–
March), according to the government's Secretariat for Industrial Assistance. This was more than double the
total of US$7.8bn in the previous fiscal year. The FDI inflow for 2007-08 has been reported as $24 billion
and for 2008-09, it is expected to be above $35 billion. A critical factor in determining India's continued
economic growth and realizing the potential to be an economic superpower is going to depend on how the
government can create incentives for FDI flow across a large number of sectors in India.

Currency

The RBI headquarters in Mumbai

The Indian rupee is the only legal tender accepted in India. The exchange rate as on 23 March 2010 is
45.40 INR the USD, 61.45 to a EUR, and 68.19 to a GBP. The Indian rupee is accepted as legal tender in
the neighboring Nepal and Bhutan, both of which peg their currency to that of the Indian rupee. The rupee
is divided into 100 paise. The highest-denomination banknote is the 1,000 rupee note; the lowest-

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denomination coin in circulation is the 25 paise coin (it earlier had 1, 2, 5, 10 and 20 paise coins which
have been discontinued by the Reserve Bank of India).

The Rupee hit a record low during early 2009 on account of global recession. However, due to a strong
domestic market, India managed to bounce back sooner than the western countries. Since September
2009 there has been a constant appreciation in Rupee versus most Tier 1 currencies. On 11 January 2010
Rupee went as high as 45.50 to a United states dollar and on 10 January 2010 as high as Rupee 73.93 to
a British Pound. A rising rupee also prompted Government of India to buy 200 tonnes of Gold from IMF.

The RBI, the country's central bank was established on 1 April 1935. It serves as the nation's monetary
authority, regulator and supervisor of the financial system, manager of exchange control and as an issuer
of currency. The RBI is governed by a central board, headed by a governor who is appointed by the
Central government of India.

Income and consumption

Percentage of population living under the poverty line of $1 (PPP) a day, currently 356.35 rupees a month
in rural areas (around $7.4 a month).

As of 2005:

• 85.7% of the population lives on less than $2.50 (PPP) a day, down from 92.5% in 1981. This is
much higher than the 80.5% in Sub-Saharan Africa. 75.6% of the population lives on less than $2 a
day (PPP), which is around 20 rupees or $0.5 a day in nominal terms.
• It was down from 86.6%, but is still even more than the 73.0% in Sub-Saharan Africa . 24.3% of the
population earned less than $1 (PPP, around $0.25 in nominal terms) a day in 2005, down from
42.1% in 1981.
• 41.6% of its population is living below the new international poverty line of $1.25 (PPP) per day,
down from 59.8% in 1981. The World Bank further estimates that a third of the global poor now
reside in India.

Housing is modest. According to Times of India, "a majority of Indians have per capita space equivalent to
or less than a 10 feet x 10 feet room for their living, sleeping, cooking, washing and toilet needs." and "one
in every three urban Indians lives in homes too cramped to exceed even the minimum requirements of a
prison cell in the US." The average is 103 sq ft (9.6 m2) per person in rural areas and 117 sq ft (10.9 m2)
per person in urban areas.

Around half of Indian children are malnourished. The proportion of underweight children is nearly double
that of Sub-Saharan Africa. However, India has not had famines since the Green Revolution in the early
1970s. While poverty in India has reduced significantly, official figures estimate that 27.5% of Indians still
lived below the national poverty line of $1 (PPP, around 10 rupees in nominal terms) a day in 2004-2005. A
2007 report by the state-run National Commission for Enterprises in the Unorganised Sector (NCEUS)
found that 65% of Indians, or 750 million people, lived on less than 20 rupees per daywith most working in
"informal labour sector with no job or social security, living in abject poverty."

Since the early 1950s, successive governments have implemented various schemes, under planning, to
alleviate poverty, that have met with partial success. All these programmes have relied upon the strategies
of the Food for work programme and National Rural Employment Programme of the 1980s, which
attempted to use the unemployed to generate productive assets and build rural infrastructure. In August
2005, the Indian parliament passed the Rural Employment Guarantee Bill, the largest programme of this
type in terms of cost and coverage, which promises 100 days of minimum wage employment to every rural
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household in all the India's 600 districts. The question of whether economic reforms have reduced poverty
or not has fuelled debates without generating any clear cut answers and has also put political pressure on
further economic reforms, especially those involving the downsizing of labour and cutting agricultural
subsidies. Recent statistics in 2010 point out that the number of high income households has crossed
lower income households.

Employment

Agricultural and allied sectors accounted for about 60% of the total workforce in 2003 same as in 1993–94.
While agriculture has faced stagnation in growth, services have seen a steady growth. Of the total
workforce, 8% is in the organised sector, two-thirds of which are in the public sector. The NSSO survey
estimated that in 1999–2000, 106 million, nearly 10% of the population were unemployed and the overall
unemployment rate was 7.3%, with rural areas doing marginally better (7.2%) than urban areas (7.7%).
India's labor force is growing by 2.5% annually, but employment only at 2.3% a year.

Official unemployment exceeds 9%. Regulation and other obstacles have discouraged the emergence of
formal businesses and jobs. Almost 30% of workers are casual workers who work only when they are able
to get jobs and remain unpaid for the rest of the time Only 10% of the workforce is in regular employment.
India's labor regulations are heavy even by developing country standards and analysts have urged the
government to abolish them.

Unemployment in India is characterized by chronic or disguised unemployment. Government schemes that

target eradication of both poverty and unemployment (which in recent decades has sent millions of poor
and unskilled people into urban areas in search of livelihoods) attempt to solve the problem, by providing
financial assistance for setting up businesses, skill honing, setting up public sector enterprises,
reservations in governments, etc. The decreased role of the public sector after liberalization has further
underlined the need for focusing on better education and has also put political pressure on further reforms.

Child labor is a complex problem that is basically rooted in poverty. The Indian government is implementing
the world's largest child labor elimination program, with primary education targeted for ~250 million.
Numerous non-governmental and voluntary organizations are also involved. Special investigation cells
have been set up in states to enforce existing laws banning employment of children (under 14) in
hazardous industries. The allocation of the Government of India for the eradication of child labor was $10
million in 1995-96 and $16 million in 1996-97. The allocation for 2007 is $21 million. In 2006, remittances
from Indian migrants overseas made up $27 billion or about 3% of India's GDP.

Economic trends

India's 300 million strong middle-class population is growing at an annual rate of 5%. Shown here is a
residential area in Mumbai.

In the revised 2007 figures, based on increased and sustaining growth, more inflows into foreign direct
investment, Goldman Sachs predicts that "from 2007 to 2020, India’s GDP per capita in US$ terms will
quadruple", and that the Indian economy will surpass the United States (in US$) by 2043. In spite of the
high growth rate, the report stated that India would continue to remain a low-income country for decades to
come but could be a "motor for the world economy" if it fulfills its growth potential. Goldman Sachs has
outlined 10 things that it needs to do in order to achieve its potential and grow 40 times by 2050. These are

1. Improve Governance
2. Raise Educational Achievement
3. Increase Quality and Quantity of Universities
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 4. Control Inflation
5. Introduce a Credible Fiscal Policy
6. Liberalize Financial Markets
7. Increase Trade with Neighbours
8. Increase Agricultural Productivity
9. Improve Infrastructure
10. Improve Environmental Quality.

Issues

Agriculture

Slow agricultural growth is a concern for policymakers as some two-thirds of India’s people depend on rural
employment for a living. Current agricultural practices are neither economically nor environmentally
sustainable and India's yields for many agricultural commodities are low. Poorly maintained irrigation
systems and almost universal lack of good extension services are among the factors responsible. Farmers'
access to markets is hampered by poor roads, rudimentary market infrastructure, and excessive regulation.

– World Bank: "India Country Overview 2008"

The low productivity in India is a result of the following factors:

• According to "India: Priorities for Agriculture and Rural Development" by World Bank, India's large
agricultural subsidies are hampering productivity-enhancing investment. Overregulation of
agriculture has increased costs, price risks and uncertainty. Government interventions in labor, land,
and credit markets are hurting the market. Infrastructure and services are inadequate.[150]
• Illiteracy, slow progress in implementing land reforms and inadequate or inefficient finance and
marketing services for farm produce.
• The average size of land holdings is very small (less than 20,000 m²) and is subject to
fragmentation, due to land ceiling acts and in some cases, family disputes. Such small holdings are
often over-manned, resulting in disguised unemployment and low productivity of labour.
• Adoption of modern agricultural practices and use of technology is inadequate, hampered by
ignorance of such practices, high costs and impracticality in the case of small land holdings.
• World Bank says that the allocation of water is inefficient, unsustainable and inequitable. The
irrigation infrastructure is deteriorating. Irrigation facilities are inadequate, as revealed by the fact
that only 52.6% of the land was irrigated in 2003–04, which result in farmers still being dependent
on rainfall, specifically the Monsoon season. A good monsoon results in a robust growth for the
economy as a whole, while a poor monsoon leads to a sluggish growth. Farm credit is regulated by
NABARD, which is the statutory apex agent for rural development in the subcontinent.

India has many farm insurance companies that insure fruit, rice and rubber farmers in the event of natural
disasters or catastrophic crop failure, under the supervision of the Ministry of Agriculture. One notable
company that provides all of these insurance policies is Agriculture Insurance Company of India and it
alone insures almost 20 million farmers.

India's population is growing faster than its ability to produce rice and wheat. The most important structural
reform for self-sufficiency is the ITC Limited plan to connect 20,000 villages to the Internet by 2013. This
will provide farmers with up to date crop prices for the first time, which should minimise losses incurred
from neighbouring producers selling early and in turn facilitate investment in rural areas.

Corruption
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Corruption has been one of the pervasive problems affecting India. The economic reforms of 1991 reduced
the red tape, bureaucracy and the Licence Raj that had strangled private enterprise and was blamed by
Chakravarthi Rajagopalachari for the corruption and inefficiencies. Yet, a 2005 study by Transparency
International (TI) India found that more than half of those surveyed had firsthand experience of paying
bribe or peddling influence to get a job done in a public office.

The Right to Information Act (2005) and equivalent acts in the Indian states, that require government
officials to furnish information requested by citizens or face punitive action, computerisation of services and
various central and state government acts that established vigilance commissions have considerably
reduced corruption or at least have opened up avenues to redress grievances. The 2009 report by
Transparency International ranks India at 84th place and states that significant improvements were made
by India in reducing corruption.

Government

The number of people employed in non-agricultural occupations in the public and private sectors. Totals
are rounded. Private sector data relates to non-agriculture establishments with 10 or more employees.

The current government has concluded that most spending fails to reach its intended recipients. Lant
Pritchett calls India's public sector "one of the world's top ten biggest problems — of the order of AIDS and
climate change".The Economist's 2008 article about the Indian civil service stated that the Indian central
government employs around 3 million people, including "vast armies of paper-shuffling peons".

At local level, administration can be worse. It is not unheard of that a majority of a state's assembly seats
can be held by convicted criminals. One study found that 25% of public sector teachers and 40% of public
sector medical workers could not be found at the workplace. India's absence rates are one of the worst in
the world.

Education

India has made huge progress in terms of increasing primary education attendance rate and expanding
literacy to approximately two thirds of the population. The right to education at elementary level has been
made one of the fundamental rights under the Eighty-Sixth Amendment of 2002. However, the literacy rate
of 65% is still lower than the worldwide average and the country suffers from a high dropout rate.

Infrastructure

In the past, development of infrastructure was completely in the hands of the public sector and was
plagued by corruption, bureaucratic inefficiencies, urban-bias and an inability to scale investment. India's
low spending on power, construction, transportation, telecommunications and real estate, at $31 billion or
6% of GDP in 2002 had prevented India from sustaining higher growth rates. This has prompted the
government to partially open up infrastructure to the private sector allowing foreign investment which has
helped in a sustained growth rate of close to 9% for the past six quarters.

Some 600 million Indians have no means of electricity at all. While 80% of Indian villages have at least an
electricity line, just 44% of rural households have access to electricity. According to a sample of 97,882
households in 2002, electricity was the main source of lighting for 53% of rural households compared to
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36% in 1993. Some half of the electricity is stolen, compared with 3% in China. The stolen electricity
amounts to 1.5% of GDP. Almost all of the electricity in India is produced by the public sector. Power
outages are common. Many buy their own power generators to ensure electricity supply. As of 2005 the
electricity production was at 661.6 billion kWh with oil production standing at 785,000 bbl/day. In 2007,
electricity demand exceeded supply by 15%.Multi Commodity Exchange has tried to get a permit to offer
electricity future markets.

India has the world's third largest road network in the world. Container traffic is growing at 15% a year.
Some 60% of India’s container traffic is handled by the Jawaharlal Nehru Port Trust in Navi Mumbai.
Internet use is rare; there were only 7.57 million broadband lines in India in November 2009, however it is
still growing at slower rate and is expected to boom after the launch of 3G and wimax services. Most
urban cities have good water supply water 24 hours a day, while some smaller cities face water shortages
in summer season. A World Bank report says it is an institutional problem in water agencies, or "how the
agency is embedded in the relationships between politics and the citizens who are the consumers."

Labour laws

India’s labor regulations — among the most restrictive and complex in the world — have constrained the
growth of the formal manufacturing sector where these laws have their widest application. Better designed
labor regulations can attract more labor- intensive investment and create jobs for India’s unemployed
millions and those trapped in poor quality jobs. Given the country’s momentum of growth, the window of
opportunity must not be lost for improving the job prospects for the 80 million new entrants who are
expected to join the work force over the next decade.– World Bank: India Country Overview 2008.

India's restrictive labor regulations hamper the large-scale creation of formal industrial jobs.

India ranked 133th on the Ease of Doing Business Index 2010, behind countries such as China (89th),
Pakistan (85th), and Nigeria (125th). The Constitution provides protection of child labor, slavery, equality of
opportunities and forced labor etc. in form of fundamental rights, but the implementation of provisions cited
is a matter of concern.

Economic disparities

Lagging states need to bring more jobs to their people by creating an attractive investment destination.
Reforming cumbersome regulatory procedures, improving rural connectivity, establishing law and order,
creating a stable platform for natural resource investment that balances business interests with social
concerns, and providing rural finance are important.

– World Bank: India Country Overview 2008

Slums next to high-rise commercial buildings in Kaloor, Kochi. Hundreds of people, mostly comprising
migrant labourers who come to the city seeking job prospects, reside in such shabby areas.

One of the critical problems facing India's economy is the sharp and growing regional variations among
India's different states and territories in terms of per capita income, poverty, availability of infrastructure and
socio-economic development. Six low-income states - Bihar, Chhattisgarh, Jharkhand, Madhya Pradesh,
Orissa and Uttar Pradesh - are home to more than one third of India's population.

Between 1999 and 2008, the annualized growth rates for Maharashtra (9%), Gujarat (8.8%), Haryana
(8.7%), or Delhi (7.4%) were much higher than for Bihar (5.1%), Uttar Pradesh (4.4%), or Madhya Pradesh

25
(3.5%). However, In 2009-10, Bihar witnessed a growth of about 12.6%, and ended up becoming the
'fastest growing state' , followed by Gujarat with a growth of 11.3%.

Poverty rates in rural Orissa (43%) and rural Bihar (40%) are some of the worst in the world. On the other
hand, rural Haryana (5.7%) and rural Punjab (2.4%) compare well with middle-income countriesThe five-
year plans have attempted to reduce regional disparities by encouraging industrial development in the
interior regions, but industries still tend to concentrate around urban areas and port cities After
liberalization, the more advanced states are better placed to benefit from them, with infrastructure like well
developed ports, urbanisation and an educated and skilled workforce which attract manufacturing and
service sectors. The union and state governments of backward regions are trying to reduce the disparities
by offering tax holidays, cheap land, etc., and focusing more on sectors like tourism, which although being
geographically and historically determined, can become a source of growth and is faster to develop than
other sectors.

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