360° Analysis

Liberalizing India’s Economy Is Critical for Global Stability

As China becomes an increasingly unreliable trading partner, India can step up if it makes the right reforms and adopts prescient policies.
India, India news, news on India, Indian economy, liberal economy, liberalization, Indian economic growth, South Asia, Asia news, Surya Kanegaonkar

© Mazur Travel / Shutterstock

September 07, 2021 13:11 EDT

The COVID-19 pandemic is increasing inequality globally and even advanced economies have not been spared. Before the pandemic began in 2020, inequality was on the rise. Decades of globalization, loose monetary policy and the rise of oligopolies have contributed to this phenomenon. In many ways, globalization has kept inflation down. When Walmart imports Chinese goods, Americans get more for less.

China can manufacture cheaply because labor costs are low. The Chinese Communist Party (CCP) also runs an authoritarian regime. The regime has repressive land and labor laws with scant regard for human rights. Legally, the CCP owns all the land in China and can appropriate any property it wants. Similarly, workers have little recourse to courts and sometimes work in slave-like conditions.

360° Context: The State of the Indian Republic


A rising China is challenging the postwar global order. Democracies, including the United States, are finding it difficult to meet the challenge for two reasons. First, loose monetary policies in recent years have brought back the specter of inflation. Second, no economy other than China’s can meet the supply needs of advanced economies. From laptops to toys, most goods are made in China.

Labor arbitrage has defined globalization from its early years. Companies set up factories where wages tend to be lower. This increases revenues and profits, making consumers and shareholders happy. Given rising inflationary expectations, advanced economies need labor arbitrage to keep costs of goods down. At the same time, these democratic societies want to decouple their supply chain from China.

With the size of its young workforce, India has a unique opportunity to become the new workshop of the world and emerge as a stabilizing global force in a multipolar world. To grasp this historic opportunity, it has to liberalize its economy wisely.

The Legacy of the Past

India could do well to heed the lessons of the past. The Soviet Union, Western Europe and the US emerged as strong economies after World War II by leveraging their manufacturing base. The war economy had led to a relentless focus on infrastructure, mass production and industrialization. In the case of Western Europe, the Marshall Plan helped put shattered economies back on track.

Over time, these advanced economies deindustrialized and production started shifting to emerging economies. China’s rapprochement with the US allowed it to enter the postwar Western economic system. Reforms in 1978 were critical to its success. The fall of the Soviet Union in 1991 created a brave new world where companies chased cheap production. China, with its size, scale and speedy centralized decision-making, emerged as the big winner.

As production moved to China, workers lost jobs in advanced economies and other industries did not emerge to retrain and employ them. The Rust Belt in the US has become a synonym for down-at-heel places left behind by globalization. Even as workers grew poorer, shareholders grew wealthier, exacerbating inequality.

Today, the United States finds itself in a complicated position with China. On the one hand, the Middle Kingdom steals intellectual property, transgresses international law and challenges the US. On the other hand, it supplies American consumers with cheap goods they need. America’s economic stimulus during the pandemic has, in fact, reinforced the country’s dependency on China. So, Washington cannot hold China’s feet to the fire and penalize its bad behavior. Beijing follows its policy of pinpricks short of outright conflict.

The US dollar is the reserve currency of the world. Since the days of Alan Greenspan, the Federal Reserve has followed a loose monetary policy. After the 2007-08 financial crisis, the US adopted the Japanese playbook from the 1990s and introduced quantitative easing. In practice, this means buying treasury and even corporate bonds to release money into the economy after interest rates touch zero. Such increased liquidity in the US has led to bloated company valuations and allowed the likes of Amazon or Uber to expand their operations. The cost of capital has been so low that profitability in the short or even medium run matters little.

Loose monetary policy has enabled the US to counter China’s state-subsidized companies to some degree. Yet both policies have distorted the market. The US can only continue with loose monetary policy as long as inflation is low. Should inflation rise, interest rates would also have to rise. This might trigger a stock market collapse, increase the cost of capital for its companies and weaken the global dominance of the US economy.

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To persist with its economic model and simultaneously contain China, the US needs to curb inflation. This is only possible by shifting some if not all production away from China. Mexico, Vietnam and Bangladesh are possible alternatives. Mexico has a major drug, violence and governance problem. Vietnam and Bangladesh benefit from huge Chinese investment. Therefore, they might not be the best hedge for securing supply chains from the Middle Kingdom, especially if the companies manufacturing in these countries are Chinese.

As a vibrant democracy with a formidable military, India offers the US and the West a unique hedge against China. For geopolitical reasons alone, manufacturing in India makes sense. However, doing business in the country continues to be difficult because of red tape, corruption, erratic policymaking, a colonial bureaucracy with a socialistic culture and more.

India’s Nehruvian past still hobbles the nation’s economy. The country adopted socialist command-and-control policies using a colonial-era bureaucracy that prevented the economy from achieving high economic growth. Manufacturing suffered the most. To start a factory, any entrepreneur needed multiple licenses that cost time, money and energy. Poor infrastructure made it difficult for manufacturers to compete with their East Asian counterparts. While wages were low in India, the cost of doing business made many manufacturers uncompetitive.

Acquiring land in India is still a challenge. The experience of the Tata group in Singur revealed both political and legal risks that still exist. Similarly, convoluted labor laws made hiring and firing onerous, rendering companies inflexible and unable to respond quickly to market demand. Liberalization in 1991 improved matters, but the state continues to choke the supply side of the Indian economy.

In the second half of the 1990s, liberalization lost momentum. Coalition governments supported by strong interest groups stalled reforms. In fact, India drifted back to left-leaning policies starting 2004 and this severely limited economic growth. For instance, many industrial and infrastructure projects were killed by ministers to protect the environment. India’s toxic legacy of Nehruvian socialism persisted in terms of continuing state intervention. The country never meaningfully transitioned from an agricultural to an industrial economy and still suffers from low productivity. This in turn has constrained consumption and slowed down growth.

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India’s much-heralded information technology sector only grew because it was new. The government did not exactly know what was going on and, as a result, there were fewer regulations to constrain this sector. Fewer regulations meant that the likes of Infosys and Wipro had greater autonomy in decision-making and fewer bribes to pay.

Reduce Red Tape

The first thing that India needs is an overhaul of its colonial-era bureaucracy that resolutely strives to occupy the commanding heights of the economy. It foists endless red tape on business, strangles entrepreneurship and takes too long to make most decisions. Government service is seen as lifelong employment. Once people become bureaucrats, they have little incentive to perform. Like their colonial predecessors, they lord over citizens instead of serving them. Rarely do they craft sensible policies. Even when a government comes up with a good policy, bureaucrats implement it poorly when they are not sabotaging it actively. This must change. Bureaucrats must be accountable to citizens. Performance-linked promotions and dismissal for underperformance are long overdue.

Over the years, politicians have tried to deliver benefits and services to citizens to win reelection. To get around a corrupt, colonial and dysfunctional bureaucracy, they instituted direct benefit transfers for welfare schemes, emulating other emerging economies like Brazil. This move is necessary but not sufficient. India needs sound economic policymaking directed by domain experts in each administrative department.

Only members of the Indian Administrative Service (IAS) occupy key positions in the finance ministry. Instead, India needs economists, chartered accountants, finance professionals and those with varied skill sets in this ministry. The treasuries of the US, Britain, Germany and almost every advanced economies have this diversity of talent in their upper echelons.

There is no reason why economic policymaking in 21st-century India should be monopolized by an archaic IAS. The government has made noise about the lateral entry of professionals into policymaking, but tangible results have been few and far between.

If the bureaucracy holds India back, so does the judiciary. Nearly 37 million cases are pending in the courts. It takes around six years for a case to be resolved in a subordinate court, over three years in the high courts and another three years in the supreme court. A case that goes all the way to the supreme court takes an average of 10 years to resolve. Many cases get stuck for 20 to 30 years or more.

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India needs to reform its judicial system if its economy is to thrive. Justice is invariably delayed, if not denied, and it also costs an arm and a leg. Not only does it add to transaction costs, but it also undermines business confidence. Virtual courts have already shown the way forward during the pandemic. A higher number of judges using both in-person and online technology could reduce the seemingly unending number of pending cases.

Create Efficient Markets

To improve labor productivity and consumption, the government must reduce inflation and improve purchasing power. For decades after independence in 1947, India was united politically but divided economically. Producers in one state could not sell in other states without paying taxes and, in some cases, bribes. In agricultural markets, they could not even sell in other districts. India’s new goods and services tax (GST) might be imperfect, but it has already made a difference. Even during a pandemic, interstate goods movement rose by 20% and menu costs, a term in economics used for the costs of adapting to changing prices or taxes, dropped because tax filings were done online.

The 2016 Insolvency and Bankruptcy Code has led to major efficiency gains. Now, lenders can recover their debt more speedily. Bankruptcy proceedings are now much simpler even if haircuts remain high. Unsurprisingly, India has risen in the World Bank Doing Business rankings from 130 in 2016 to 63 in 2020.

As Atul Singh and Manu Sharma explained in an article on Fair Observer in 2018, non-performing assets of Indian banks have led to a financial crisis. The government could do well to adopt some if not all the reforms the authors suggested. Given rising inflationary pressures because of rising oil prices, India’s central bank can no longer cut rates. So, the government has to be creative in tackling its banking issues and free up liquidity for Indian businesses with great potential to grow. Banks burnt by poor lending in the past and fearful of corruption charges as well must discover the judgment and appetite to lend to deserving businesses in a fast-growing economy that needs credit for capital formation.

A little-noticed need of the Indian economy is to strengthen its own credit rating systems and agencies. Capital flows are aided by accurate corporate and political risk assessment. The US enjoys a global comparative advantage in attracting investments thanks to the big three homegrown agencies: S&P, Moody’s and Fitch. These agencies tend to fall short in their India assessment. The standards they set give American companies an advantage over Indian ones.

Therefore, both the private sector and the government must strengthen Indian rating agencies such as CRISIL and ICRA. These agencies are improving continuously. They now have access to increased digital high-frequency data, which they can interpret in the domestic context. As a result, Indian agencies can benchmark corporate or sovereign risk better than their American counterparts for domestic markets. A better benchmarking of risk is likely to deepen the bond market and cause a multiplier effect by enabling companies to raise money for increased capital expenditure.

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For decades, India followed a socialist model of agriculture, doling out large unsustainable subsidies. As Singh and Sharma explained in a separate article, the Soviet model was the inspiration for the Indian one. Indian agriculture denuded groundwater, emptied government coffers and lowered farm productivity. The current reforms allow farmers to grow what they want and sell wherever they want to bypass parasitic middlemen. The new legislation emulates the US farm bills and promises to boost agricultural production, lower inflation and increase exports. This legislation might also lower rural hunger and improve India’s human capital in the long term.

India has to transition hundreds of millions from agriculture to industry. Currently, 58% of the country’s population is dependent on agriculture and contributes just 20% to gross domestic product (GDP). All advanced and industrialized economies have a much lower percentage of their populations engaged in agriculture. In the US, the figure is 1.3% and in Vietnam, 43% work in agriculture. The last time the US had 50% of its population engaged in agriculture was in 1870.

Improve Infrastructure

To facilitate movement from agriculture to industry, India must invest in infrastructure and urbanization. For decades, its infrastructure has been woefully inadequate. Indian cities are known to be chaotic and do not provide basic services to their citizens. Recently, India launched a $1.9-trillion National Infrastructure Pipeline that is engaged in a rollout of road, rail, seaport and airports to connect centers of manufacturing with points of export. This focus on infrastructure has to be consistent and relentless.

India could emulate Chinese cities like Chongqing and Shenzhen that could be home to industry and hubs of trade, both domestic and international. Projects like the smart city in Dholera, 80 kilometers from Gujarat’s capital of Ahmedabad, are the way forward. Similarly, the new Production Linked Incentive scheme is the sort of policy India needs. The Tatas are setting up a plant to manufacture lithium-ion batteries under this scheme. Not only could Indian industry meet the needs of a fast-growing market, but it could also be a source of cheap imports for many other countries.

India must not only focus on metropolises, but also smaller cities and towns where the cost of living is lower. Digitalization of work will allow people to stay in such urban areas. Of course, they will need investment and organization for which India must tap capital and talent not only nationally but internationally. For instance, pension funds in North America and Europe are seeking growth to meet their increasing liabilities. If India could get its act together, investment into Indian markets could be significant.

A key part of infrastructure that needs reform in a low energy consumption society is the power sector. Gujarat’s growth is underpinned by increased production and improved distribution of electricity. The rest of the country must emulate this westernmost state and Gujarat itself must bring in further reforms. Renewable energy sources such as gas, solar, wind and hydro must grow further. A nationwide energy market would bring in efficiency gains and boost growth.

A focus on renewable energy also brings risks and opportunities. Currently, China controls critical metals and rare earths required in electric vehicle and battery manufacturing. Beijing has an effective monopoly over 80% of the world’s cobalt, 50% of lithium, 85% of rare earth oxides and 90% of rare earth metals. A decarbonized future cannot be intrinsically linked to an authoritarian state that has a history of not playing by free market rules.

India’s $1.1-billion “Deep Ocean Mission” offers a unique opportunity for the country to provide energy security to democratic nations in North America, Europe and elsewhere. As they transition to clean technologies, India can provide a safer, more reliable and benign alternative to an increasingly belligerent China.

In 2021, India has a historic opportunity to enter a new economic arc. The global conditions could not be more favorable. Advanced economies are looking to decouple from China without triggering inflation. India is the only country with the size and the scale to be an alternative. Its large youth population and rising middle class are powerful tailwinds for high economic growth. Indeed, India owes it not only to its citizens, but also to the rest of the world to get its act together and become a force for global stability at a time of much volatility and uncertainty.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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