Structural Change in Indian Economy – Part 3

In the early stages of economic development, many countries followed a two-sector growth model. In this model, the industrial sector was considered the main engine of growth. Resources such as labour and raw materials were shifted from agriculture to industry, often with strong support from the government. This idea was supported by economists like Lewis.

However, economist Kuznets pointed out that growth in agriculture is very important before such a shift can happen successfully. Agriculture must first become more productive so that it can generate surplus output. This surplus can then support industrial development by providing food, labour, and savings for investment.

To promote industrial growth, many countries adopted certain policies. These included:

• Encouraging import substitution industrialization (producing goods domestically instead of importing them)
• Giving favourable conditions to manufacturing through trade policies
• Ensuring easy availability of foreign exchange
• Providing high protection to industries (like tariffs and subsidies)
• Keeping low protection for agriculture
• Imposing taxes on agricultural income

As a result of these policies, the share of agriculture in national income and employment started declining, which was seen as a natural part of economic development. However, many economists later criticized this approach because it led to neglect of the agricultural sector.

Over time, economists realized that agriculture and industry are interdependent. Agriculture plays a crucial role in supporting overall economic growth, and ignoring it can harm long-term development.

India’s Experience

India, being a largely agricultural economy, followed a closed and inward-looking economic policy until the early 1990s. By 1991, it became clear that:

• Import substitution policies
• Overvalued exchange rates
• Government controls

had limited business decisions and created a high-cost industrial system that could not compete globally.

As a result, India introduced the New Economic Policy in 1991, which focused on:

• External reforms: Changes in trade, exchange rates, and foreign investment
• Internal reforms: Changes in industrial policy, pricing, distribution, and financial systems

In 1995, India joined the World Trade Organization (WTO), showing its commitment to globalization and faster economic growth.

Role of Productivity

Economic growth is closely linked to productivity growth. Productivity means producing more output with the same or fewer inputs. It is important because:

• It increases real income and living standards
• It supports long-term growth

Simply increasing inputs like labour and capital is not enough because of the law of diminishing returns. Therefore, improving productivity is essential for sustained growth.

Rise of the Service Sector

While studying economic development, economists also observed the rise of the tertiary (services) sector in developed countries.

Economists like Fisher and Clark explained that:

• Demand for agricultural goods grows slowly
• Demand for manufactured goods grows faster
• Demand for services grows even faster as income increases

This leads to a gradual shift from agriculture → industry → services as an economy develops. However, this shift usually happens only after agriculture and industry become sufficiently developed.

Link Between Industry and Services

There is a strong and positive relationship between the manufacturing sector and the services sector. As industries grow:

• Demand increases for services like transport, banking, trade, hotels, education, and healthcare
• These services, in turn, improve the productivity of industries

At the same time:

• The service sector depends on manufactured goods (machines, equipment, etc.)

This creates a two-way relationship (bidirectional link) between manufacturing and services, where both sectors support and grow with each other.

With rising income levels, the demand for services increases rapidly due to their high income elasticity. This strengthens the connection between the two sectors, especially in advanced stages of development.