Economic Lessons From the Raj

IT’S A SAD paradox of our history that national independence came with the loss of the economic freedom India enjoyed for a century-and-a-half under British rule. That may come as a surprise to Indians brought up on nationalist myths about colonial rule plundering India, de- industrialising its economy and draining off its wealth. More recent economic studies show that colonial India, well ahead of other developing countries, had built up a trading and industrial base that would have made it the envy of the Eastern Tiger economies, had Nehruvian socialism not cut it off from global markets after 1947.

Let’s take the myth of colonial plunder first. During the early phase of conquest, British generals and common soldiers undoubtedly acquired much war booty, then regarded as the legitimate spoils of victory. But their plunder was minimal compared with that of Indian contemporaries like the Marathas and Tipu Sultan or other foreign invaders from Iran and Afghanistan.

Much before the East India Company took over Bengal, the Marathas had ravaged the province with six plundering raids in the course of a decade, killing off hundreds of thousands and exacting huge sums in chauth from its Mughal Nawab, estimated at Rs 2.5 crore per annum in today’s money. It was these attacks and the inability of the feeble Mughal administration to resist them that led the Hindu business community, led by the powerful Jagat Seth banking house, to plot the British takeover of 1756-64.

Delhi was less fortunate than Bengal and suffered devastating invasions by Iran’s Nadir Shah, followed by the Afghan Ahmad Shah Abdali. According to contemporary estimates, Nadir Shah’s sack of Delhi in 1739 extracted in one month an estimated Rs 70 crore worth of plunder, many times anything creamed off by the Company Sahib during its most rapacious years in Bengal, and a blow from which the Mughal economy never recovered.

Myth number two is that India declined from being an economic superpower under the Mughals to a de-industrialised colonial wasteland. True, Mughal India in 1700 accounted for 25 per cent of world Gross Domestic Product, a statistic often misquoted to prove economic success, except when one remembers that India also had 25 per cent of the world’s population. Far more revealing are statistics of per capita GDP compiled by the Maddison Project, generally accepted as the most authoritative guide to global prosperity from ancient Roman times to the present.

The Maddison figures show that India’s per capita GDP was only half that of Britain’s in 1600, when the Mughal Empire was at its peak. Thereafter India witnessed steady economic decline, with its trade heavily dependent on textile exports increasingly unable to compete with cheaper European cloth. That’s because the Mughal economy offered neither incentives nor opportunity for labour-saving technological innovation. Eighty per cent of its territories were allocated to a rentier class of jagirdars, who creamed off any agricultural surplus for their own luxurious lifestyles. Because their tenure was restricted to a few years, they had no incentive to reinvest their rents in improved productivity. Capital costs were prohibitively high, with interest rates double the 6 per cent average in Britain and peaking as high as 40 per cent in pre-colonial Bengal.

That’s not the propaganda of colonial apologists but the judgement of eminent Indian historians as diverse as the Marxist Irfan Habib and the nationalist Tapan Raychaudhuri. ‘Not only was the Mughal state its own gravedigger,’ concluded Habib, ‘but no new order was or could be created by the forces ranged against it.’

Both Habib and Western economists like Angus Maddison have agreed that the Mughal land revenue system was far more exploitative than anything later devised by the Company Sahib or the Raj. It’s estimated that the Mughal elite creamed off an average 15 per cent of national income for its own consumption, compared with a mere 5 per cent by the British. Under the rapacious warlords who succeeded the Mughals, land revenue demands soared as high as 50 per cent of production to fund their local wars.

India in 1750, on the eve of the British conquest, had no scientific or technological research, no machinery, no mechanical tools. Its labour-intensive textiles were bound to suffer dramatically, whoever ruled, once cheaper European industrial goods captured their markets. This economic challenge coincided with a period of fierce regional wars, following the collapse of Mughal authority, which devastated both agriculture and manufacturing across vast swathes of the Subcontinent. It was a situation which left the European-ruled ports as the only safe havens for Indian commerce, prompting a migration of business communities like Marwaris from declining inland cities like Benares and Mathura to Calcutta, Madras and Bombay.

The first two decades of Company rule were undoubtedly a period when private trade carried on by its corrupt employees, in defiance of the Company’s own monopoly, damaged indigenous competitors. But the Company itself had no interest in such abuses, relying as it did on a steady supply of high quality Indian textiles that it could export to Europe. After 1773, when the British Parliament took direct oversight of the Company’s finances and administration, such privateering was firmly stamped out.

Myth number three is that our colonial rulers deliberately de-industrialised India by flooding it with machine-made British goods at the expense of Indian manufacturing. The Company certainly had no links with the satanic mills of Lancashire, nor any interest in selling their products. Its own trading interests lay in selling Indian goods to Europe, so it lobbied hard to lower British tariffs on them and also to raise protective Indian tariffs. That it failed to do so was a measure of the extent to which Europe’s Industrial Revolution was inevitably turning the economic tide against traditional cottage industries worldwide.

Even so, recent research has demonstrated that European industrial competition, though far from being a zero-sum game, created winners as well as losers. Cheaper factory-made British yarn may have hit Indian spinners but was a boon for weavers, who could now source cheaper supplies and produce a more competitive end-product. Although textile exports declined, domestic demand grew, with per capita cloth consumption increasing from 5.8 sq yards per year in 1750 to 7.4 sq yards in 1850. Handlooms held their own in the production of saris, but lost out to machine-made men’s clothing.

By the 1850s, a massive road-building programme by the East India Company had given Indian trade 2,600 km of newly metalled highways, including, of course, the Grand Trunk Road

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Far from being wiped out by colonial competition, actual numbers in the handloom sector remained stable throughout most of the colonial period, ending with the same number in 1947 as in 1750. Cheap yarn imports also freed weavers from being tied to regional spinning centres and enabled them to move closer to the ports, where they forged new links with mercantile houses, sowing the seeds of India’s own infant textile factories. India’s population increased from 170 million in 1750 to 425 million in 1947, a sure indicator of reduced famines and improved public health.

Myth number four is that imperial trade was a one-way flow, with cheap Indian raw materials extracted to supply British industry. The Raj created a Subcontinent-wide single market or customs union, which would have been the envy of the European Union today and which hugely expanded both internal and foreign trading opportunities for Indian merchants. By the 1850s, a massive road-building programme by the East India Company had given Indian trade 2,600 km of newly metalled highways, including, of course, the Grand Trunk Road. By 1913, India also had the world’s largest canal system and its fourth largest rail network.

This new transport revolution transformed agriculture and commerce by enormously speeding up flows of goods and price information. The railways lowered freight costs by as much as 90 per cent in the mid-19th century, compared with their predecessor, the bullock-cart. Based on the volume of freight traffic in 1900, the social savings brought by rail amounted to as much as Rs 1.2 billion or 9 per cent of national income. Detailed statistical studies at Cambridge University and the Massachusetts Institute of Technology (MIT) have demonstrated that railways raised real incomes by an average of 16 per cent in the districts they reached.

India’s foreign trade also benefitted from British command of the seas. Imperial naval protection helped Gujarati merchants like the Khojas trade with East Africa and the Gulf, establishing business networks that still survive. The other hugely lucrative opportunity for Indian merchants was the British-protected China trade in tea, cotton, indigo, jute and, notoriously, opium. The wealth from such commerce found its way into new banks and joint stock companies, established on the basis of newly introduced Western- style company law, and fed infant stock markets. The managing agency system, later reviled by Indian socialists, allowed scarce managerial skills to be pooled across companies, while protecting them from hostile takeovers.

From 1913 to 1938, Indian manufacturing output grew at an annual 5.6 per cent, well above the world average of 3.3 per cent and a growth rate we would welcome today

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By the 1850s, India’s own industrial revolution was taking off, fuelled by a virtuous economic circle of faster internal transport, increased commerce and agricultural productivity, rapidly expanding export markets and the resulting much-needed capital accumulation in an economy long starved of venture capital. Far from blaming colonialism, development economists now agree that India’s chronic capital shortage was largely due to geographical and climatic factors.

If globalisation is defined as the capacity to buy the knowledge, goods and services one needs in global markets, the British Empire led the modern world in the first great wave of globalisation in the 19th century. India was at its heart and a major beneficiary of the new openness and cosmopolitanism. The Empire offered free movement of capital and labour and relatively free trade in goods. A Bombay mill-owner could set up with borrowed British capital and the latest machinery and skilled foremen from Manchester. India’s first cotton mills opened in 1851, preceding Japan by 20 years and China by 40. They were soon beating Manchester at its own game, supplying 76 per cent of India’s textile demand by 1945.

Not surprisingly, thriving merchant communities strongly backed the Company during the 1857 revolt, and the smooth supply of crucial goods from the ports helped turn the tide against the rebels. According to economic historian Tirthankar Roy of the London School of Economics: ‘The Indian merchant saw the Raj to be a force working for the kind of capitalism in which they had built a stake, a better bet than the remnants of Mughal feudal warlords who led the other side.’ British Indian cities, thanks to public and private endowments, soon sported some of the world’s best municipal services and world-class educational and medical institutions.

Far from becoming a dumping ground for British products, India maintained a trade surplus with Britain throughout the colonial period, and export earnings paid for the services bought in from abroad by both public and private sectors. True, 19th century British governments at home and in India were committed to economic laissez faire and free trade and did little to protect indigenous industries. Nevertheless, young Indian industries like textiles and steel were given tariff protection during the world depression in the 1920s. From 1913 to 1938, Indian manufacturing output grew at an annual 5.6 per cent, well above the world average of 3.3 per cent and a growth rate we would welcome today.

From the 1920s, the colonial government made India’s railways buy their entire rail requirement from Tata Steel at Jamshedpur. By 1935, India produced 50 per cent of all the world’s steel made outside Europe, North America and Japan. Firms like Tata Steel profited enormously from government contracts during both World Wars; and these profits were ploughed into new industries like sugar and paper. Between 1850 and 1940, employment in Indian factories went from near zero to two million, while per capita output of industrial goods rose by one-third, hardly a mark of de-industrialisation. India’s per capita industrial output at independence was higher than anywhere else in Asia except Japan, and more than half its exports were manufactures, not raw materials.

Myth number five is that British governments, companies and officers drained off India’s wealth through foreign remittances of their ill-gotten gains. The actual fact is that by 1913, colonial India had attracted an enormous and very welcome injection of £380 million (£23 billion in today’s money) as inward investment by British capital. In the same year, the so-called ‘Home Charges’, the money remitted back to Britain by government and private transfers, amounted to the comparatively tiny sum of £11 million. Economists recognise that all foreign capital comes at a cost of foreign remittances. Calculated as an annual return on British investments in India, the Home Charges amounted to an average of only 3.4 per cent, a far lower return than British capital could have earned in world markets at the time. Amounting to an annual average of only 1.5 per cent of India’s national income, such remittances were hardly a drain of resources.

‘The so-called drain,’ writes Tirthankar Roy, to whose research I owe many of these figures, ‘was also a payment for skills, and it is impossible to imagine an economy short of skills dealing with the world without having to buy skills from abroad.’ Ironically, World War II allowed India to reverse the flow of remittances, with the imperial government paying New Delhi handsomely for the deployment of Indian troops abroad. The result was that at independence, the Reserve Bank of India held the enormous sterling balance of over £1 billion (£36 billion in today’s money), a golden handshake if ever there was one.

With governments now committed to freer enterprise, is the wheel turning full circle back to the economic openness of the colonial era? The dismantling of state controls still has a long way to go

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Myth number six is that major infrastructure developments like the railways were inspired by British commercial greed and fleeced India with extortionate royalties. Anyone who knows how difficult it remains for developing countries to secure infrastructure investment to this day can only marvel at the ability of the colonial state to do so. The Raj has been accused of guaranteeing private investors an excessive return of 5 per cent, which allowed them to inflate costs. What that overlooks is guarantees as high as 7 per cent in independent countries like Brazil and Argentina, which had equally challenging geographical terrain.

The average global lending rate at the time was 4.8 per cent, only slightly lower than the allegedly extortionate 5 per cent. After 1880, the Government of India guarantee fell to 3.5 per cent, and the Raj took advantage of cheaper credit to set up its own railways and buy out private operators. By the 1920s, India’s entire rail network was state-owned, a brilliant example of the public-private partnerships we aspire to today.

The British left us with a 5 per cent share of world GDP, not a measure of economic decline since the much quoted 25 per cent of Mughal India, but of how exponentially world GDP had expanded with industrialisation and globalisation. World trade had stagnated during the inter-war years, but was poised for a major take-off in the 1950s, and one which India might have led with its existing trading advantages.

INDIAN INDEPENDENCE NEED not have meant the end of the open economy under which colonial India had prospered. The new state might have focused on sectors such as educational infrastructure, which the Raj had neglected, while allowing private enterprise to do the rest. Instead we moved towards a flabby imitation of Soviet-style state planning.

The rot began during World War II, with increased wartime state regulation by the Raj. Then came the Bombay Plan of 1944, which reflected an alliance of big industrialists and nationalists to promote industrialisation with protectionist policies at the expense of foreign trade. The Congress came to power with a long-held distrust of India’s traders, dating back to the Swadeshi Movement’s boycott of foreign goods.

Each successive Five-Year-Plan took the process further, severely damaging not only trade but industry too. Macroeconomic stability was compromised, because of the decline of exports needed to finance imports for heavy industry; and the vast foreign currency reserves left by the Raj rapidly evaporated. The Licence Raj that followed is a familiar story, leading to the collapse of previously thriving industries like textiles, which were then nationalised and run as a huge drain on the taxpayer. Private banks were increasingly undermined by political pressures for uneconomic lending and eventually nationalised in 1969, a blow from which Indian banking has not yet recovered, with severe consequences for our capacity to finance new investment.

Average Indian tariffs of 100 per cent were the highest in the developing world and no lower for industrial imports, thereby inflating the price of final products. A high export tax and an overvalued exchange rate hit traditional exports like tea, which fell from over 20 per cent of total exports in 1947 to 10 per cent by the late 1960s. The export of agricultural goods was banned. Indian annual per capita income growth from 1950 to 1980 dropped well below the world average growth at 1.5 per cent, and poverty increased in both absolute and relative numbers.

Government attempts to protect the consumer were an abysmal failure. The new State Trading Corporation was a disaster, packed with bureaucrats who knew nothing about trade. Price controls on essential goods just led to intense and corrupt political lobbying.

Foreign companies were a favourite target for Nehruvian socialism. Tax incentives to foreign staff were abolished and foreign shareholding reduced to a maximum of 40 per cent. Valuable foreign capital fled to more welcoming climes. Foreign Direct Investment, which had been 10 per cent of Indian capital stock pre-World War II, dropped to a mere 2 per cent soon after independence.

Ironically, the main beneficiaries of Congress socialism were the flabby, big business houses which benefitted from protectionism and became adept at buying up politicians and bureaucrats. ‘Its major failure,’ writes Tirthankar Roy about Nehruvian planning, ‘was to imagine that the state could substitute for the world economy. Discouragement to openness led to an unravelling of not only protectionist industrialisation, but industrialisation itself.’

That was the situation in 1959 when C Rajagopalachari (Rajaji) and my father, Minoo Masani, founded the Swatantra Party, India’s first and only attempt at a secular, free enterprise-oriented political party. It was an uphill task, because businessmen who funded the Congress were reluctant to win the opprobrium of backing a party which openly espoused their interests. Nehru himself berated JRD Tata for making a modest donation to Swatantra. JRD replied that Tata was giving Swatantra less than half what it paid Congress, to which Nehru scowled and made no reply.

Swatantra, despite the odds, did well in both the 1962 and 1967 General Elections, rapidly expanding to become the largest opposition party in the Lok Sabha. My father functioned for several years as Leader of the Opposition, in which capacity he led the annual debate on the Union Budget. I remember his budget speeches as a devastating critique of two decades of creeping socialism that had corroded the foundations of the Indian economy. His alternative was a mix of Western free enterprise and the Gandhian concept of minimum government, with the state confining itself to infrastructure and leaving private enterprise free to do the rest. The Swatantra alternative died in Indira Gandhi’s 1971 landslide, but surfaced again in the Congress-led economic liberalisation of the 1990s.

With governments now committed to freer enterprise, is the wheel turning full circle back to the economic openness of the colonial era? The dismantling of state controls still has a long way to go; and Messrs Modi and Jaitley could certainly take lessons from the Raj in how to attract foreign capital for India’s infrastructure projects, lagging so far behind China’s. Some analysts have heralded the arrival of a new kind of cosmopolitan capitalism, led by technocrats rather than traditional business families, focussing on information technology and epitomised by firms like Infosys, Tata Consultancy Services and Wipro. But the jury is still out on whether their success can translate to the more capital-intensive world of manufacturing.

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About The Author

Zareer Masani

Zareer Masani is a London-based historian and broadcaster. He is the author of Macaulay: Pioneer of India’s Modernization

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