360° Analysis

India’s Economy Imperilled by Failure to Reform


July 18, 2011 18:15 EDT

Sasha Riser-Kositsky comments on the challenges that the Indian system poses to new firms trying to set up shop. A vast web of regulations and laws hamper rather than encourage the development of the country.

Out of 182 countries in the World Bank’s Ease of Doing Business Index, India ranked 134th in 2011. The ranking illustrates India’s immense challenges in productively absorbing its so called ‘demographic dividend’. While the government has made some strides since its initial liberalization in 1991, the pace of reform at the national level has shifted to a crawl over the last few years. The states that have forged ahead with their own reform measures have enjoyed sustained growth. With up to one million people entering the workforce every month for the next 20 years, India urgently needs to reform both its restrictive business regulations and the creaking ancillary infrastructure. Needless to say, the current business environment is terrible and retards economic growth making reform an urgent necessity.

A recent study by the Planning Commission found that the top three factors holding back the expansion of manufacturing were the cost of complying with licenses, the difficulty in obtaining environmental clearances and the constant battles to obtain land for new factories. New plants, on average, require 20 different clearances. It is easier to start a new business in Sudan than in India.

Any new venture in India faces an uphill battle to acquire land in order to open its doors for business. Acquiring land is difficult because of widespread corruption and lack of due process. The government’s track record in acquiring land is abysmal and it compensates the displaced terribly. This means that people are suspicious of land acquisition and oppose every new project because they see it as an excuse for expropriation. India’s farmers, peasants and forest-dwelling tribals have seen an estimated 20 to 60 million of their fellows displaced in the name of development since India’s independence and are loathe to join their number.

As popular protests against land acquisition have gathered strength, India’s government has dawdled while projects worth over $150 billion have been stalled for a decade. The need for land has stymied everything from factories to crucial infrastructure projects. After years of delay, the government has yet to near the completion of the dedicated railway freight corridors. Similarly, the national expressways project is nowhere near completion. Both projects are crucial for cutting down transit time between the ports and their hinterlands, and speed up economic growth. Another 285 infrastructure projects are delayed of which 139 have been pending for over two years. It is easier to get construction permits in the West Bank and Gaza than in India; the process on average takes at least 195 days and involves 37 separate forms. The government still follows the colonial Land Acquisition Act of 1894 at a time when India clearly requires a major overhaul of land acquisition policies. Reform legislation has been painfully pending since 2007.

Assuming a business finally acquires the land it needs, it must then seek permits from a notoriously incompetent and inefficient Ministry of Environment.  The ministry is known for holding up new projects all over the country and imposing ludicrous delays. While India should make every effort to protect its fragile environment, it has to ensure at the same time that it attains crucial national priorities. The country desperately needs infrastructure build-out at a time when the environment ministry seems to be making every effort to thwart its progress. While the power ministry scrambles to address persistent electricity shortages by encouraging new coal burning plants, the environment ministry has blocked the development of much of the country’s coal reserves, leading to ever rising shortages, spiraling prices and blackouts.

Unsurprisingly, the government’s ambitious new National Manufacturing Policy, which seeks to create 100 million new jobs and raise manufacturing to 25% of GDP by 2025, is currently stalled by the combined efforts of the labour and environment ministries. Ministerial intransigence in turn ensures the continued robustness of India’s vast informal sector.

Most new entrants to the job market have little hope of finding regular employment. Despite the landmark reforms in 1991, over 90% of working Indians work in the informal sector. These workers enjoy few if any benefits and even fewer legal protections. This condition contributes to the poor living conditions of hundreds of millions of Indians but is aided and abetted by government rules and regulations unreformed since the 1950s.

India’s archaic labour laws actively impede the growth of formal employment. Firms with 100 or more employees need to ask the government’s permission to downsize their payrolls. This permission is hard to get. A business-person seeking to close down an unprofitable unit must first seek the government’s approval. These rules are enough to make even the boldest entrepreneur think twice about starting a new business. Proposals to rationalize these rules have been stalled since 2002. It is, therefore, no surprise that India’s manufactures are concentrated in the highly mechanized production of high value goods despite having a huge pool of cheap labour. At a time when other countries in the region are seeing huge employment gains from a boom in low cost labour intensive manufacturing, India is still missing out on this opportunity.

After entrepreneurs have fought their way through the bureaucracy and acquired the necessary permits, permissions and stamps to start their business, they have little real hope of enforcing their contracts with suppliers and clients. It is easier to enforce a contract in Iraq and the Congo than in India. The World Bank data indicates that contract enforcement takes on average over 1,400 days and involves 46 different procedures. Cases languish up to 15 years before being heard by a court, a period which has been steadily increasing. With nearly 30 million pending cases across the country, there is little prospect of speeding up the judicial system despite the government’s annual noise about fixing the problem.

            Once a new business has finally managed to get started, it confronts India’s tangled tax codes. Efforts to transform India into a single national common market by replacing the current patchwork of federal and state indirect taxes with a single Goods and Services Tax have been stalled for the last four years, most recently in states controlled by opposition parties. Tax reforms will not be implemented until at least mid-2012. Businesses currently pay 63% of their profits as taxes in 56 different payments.

            The kinds of practical pro-growth reforms required to open India’s doors to business are not foreign inventions or impositions. All around the country states and cities have powerfully demonstrated the deep developmental benefits of improving their business environments. Kaushik Basu, a senior advisor to the Ministry of Finance, recently estimated that if the Ease of Doing Business Index was based off the best practices around the country, India’s ranking would advance from 134th to 79th, putting it on par with China. Over the last decade Gujarat has transformed itself into an industrial powerhouse and Uttarakhand has created thousands of jobs in new industrial parks by simply making it easier for businesses to function. The success of these states and others show just what Indian entrepreneurs can do when their governments work to encourage, not hinder their new enterprises.

            The need for reform at the national level is blatantly obvious. Technocratic elements in the government understand this well. The current Congress-led government, on the other hand, speaks the language of reform but is either unwilling or unable to muster the political will to do what needs to be done. Reeling from a series of high-level corruption scandals and engaged in an ugly fight with activists over the appropriate response, the government has little time for anything else. As the political divisions between the Congress and opposition BJP have deepened, both sides are steadfastly opposing the reforms proposed by the other – to the detriment of the country as a whole. Indians may well be forced to wait until after the 2014 elections for the reforms necessary to maintain their growth trajectory, something that the 50% of the Indian population that is under 25 can ill-afford.


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