The rise and fall of Indian socialism: why India embraced economic reform.

When the Hindu radical Nathuram Godse murdered Mohandas Gandhi in 1948, he also killed the immediate prospects for a market-oriented Indian economy. Gandhi was sympathetic to village life and the entrepreneur, while his successor, Jawaharlal Nehru, was enamored with Soviet-style economic planning.

India became the poster child for post-World War II socialism in the Third World. Steel, mining, machine tools, water, telecommunications, insurance, and electrical plants, among other industries, were effectively nationalized in the mid-1950s as the Indian government seized the commanding heights of the economy.

Other industries were subjected to such onerous regulation that innovation came to a near standstill. The Industries Act of 1951 required all businesses to get a license from the government before they could launch, expand, or change their products. One of India's leading indigenous firms made 119 proposals to the government to start new businesses or expand existing ones, only to find them rejected by the bureaucracy.

The government imposed import tariffs to discourage international trade, and domestic businesses were prevented from opening foreign offices in a doomed attempt to build up domestic industries. Foreign investment was subject to stifling restrictions.

But the planners failed. Manufacturing never took off, and the economy meandered; India lagged behind all its trade-embracing contemporaries. Between 1950 and 1973, Japan's economy grew 10 times faster than India's. South Korea's economy grew five times faster. India's economy crawled along at 2 percent per year between 1973 and 1987, while China's growth lept to 8 percent and began matching rates for Hong Kong, Taiwan, and other Asian tigers. Even as that reality became clear as early as the late 1960s and early 1970s, India's policy makers refused to give up on economic planning. Experts and elected officials settled for what they called the "Hindu Rate of Growth," which, according to official figures, was sluggish at about 3 to 4 percent per year. That would be respectable for a developed country like the United States or Germany, since they start from a higher economic base. But for a country like India, it's abysmal.

Attitudes finally began to change in the 1980s, as India's persistent budget deficits forced austerity measures in the middle of the decade. A foreign exchange crisis in 1991 precipitated major shifts in public policy thinking. The government brought spending in line with revenues and moved away from fixed exchange rates, allowing the Indian currency to reflect world prices. (Fixing exchange rates at a government-determined price tended to overvalue the rupee on world markets, discouraging foreign investment.) The government began to open the door to foreign investment while Indian companies were allowed to borrow in foreign capital markets and invest abroad. Inflation was brought under control.

The new policies fostered a booming information technology industry, which grew to billion-dollar status in the mid-1990s and exceeded $6 billion in revenues by 2001. The technology sector didn't suffer from as many burdensome regulations as, say, steel and airlines. Nor did its success hinge on traditional utilities and basic infrastructure, depending more on new technology such as satellites. A 2004 World Bank report notes that "Services, the least regulated sector in the economy continue to be the strongest performer, while manufacturing, the most regulated sector, is the weakest."

At first, Indians were simply sub-contractors to more sophisticated multinational companies. Then Indian companies began to generate new technologies on their own as they tapped into the global marketplace. The software used to power Palm Pilots, for example, was developed by an Indian firm, not outsourced to technicians or programmers. Today 1,600 tech companies, including the billion-dollar multinationals Infosys and Wipro, export products and services from India's high-tech capital, Bangalore. U.S. companies with major Indian investments include Google, Yahoo, Microsoft, and Oracle. While I.T. exports led the industry's early growth, future growth is expected to be based on the expansion of the domestic economy.

With a billion people, India is bound to become a major consumer powerhouse. It may even outcompete China. "Culturally, India is much more attuned to free market ideas," says Barun Mitra, managing trustee of the New Delhi-based Liberty Institute. "India's social and institutional fabric is much more resilient than China's. The nationalized component of the Indian economy is relatively small. India's share of the workforce in any kind of public sector is barely 6 percent of the total workforce of 420 million."

Furthermore, India's regulatory apparatus was crafted from a kinder, gentler form of socialism. For one thing, more than 90 percent of its workforce is in the informal sector, largely untouched by the regulations perpetuated by the federal government in Delhi and the state and regional governments. Furthermore, India is a liberal democracy, bounded by a constitution and a broad-based cultural tolerance for different lifestyles and points of view. Those same factors--grassroots respect for trade, constitutional governance, and cultural tolerance of diversity--have contributed to the rise of another industry symbolic of a progressive, dynamic economy: film and entertainment. "Bollywood's" movie output rivals that of Hollywood and Hong Kong.

That's not to say there's no intolerance: A bloody war followed India's independence and partition in 1947, and serious tensions have persisted along religious, ethnic, class, and caste lines. But despite a population that is overwhelmingly Hindu, India's current president is a Muslim, and its current prime minister is a Sikh. Thirty thousand people died in the state of Punjab between 1980 and 1995 primarily because of conflict between Hindus and Sikhs. Yet Punjab is now peaceful, and is one of India's richest states.

"It is worth pointing out that there are 150 million Indians who profess the Muslim faith," Mitra observes. "Yet there is not one Indian Muslim who has been found to be involved with any of the international jihadi or terrorist groups. And I believe this is because of the sense of political participation that the Indian democratic process allows."

The key to further progress will be leveraging the country's comparative economic advantage in information technology and services. "India has many of the key ingredients for making this transition," notes a 2005 report from the World Bank Finance and Private Sector Development Unit. "It has a critical mass of skilled, English-speaking knowledge workers, especially in the sciences. It has a well-functioning democracy. Its domestic market is one of the world's largest. It has a large and impressive Diaspora, creating valuable knowledge linkages and networks."

As robust as India's growth is, it probably could do much better. It will take a continued commitment to open trade to achieve higher growth rates, and it's still unknown whether India has the political commitment to stay the course.

Samuel R. Staley ([e-mail]) is director of urban and land use policy at the Reason Foundation.