Central & South Asia

Five Urgent Economic Reforms for India

The COVID-19 crisis presents an opportunity to adopt new policies that leverage India’s domestic markets for industrialization, employment and growth.
By
India, India news, Indian news, Indian economy, India economy news, India COVID-19, India coronavirus economy, COVID-19 crisis, Manu Sharma, Atul Singh

© Gil C

May 05, 2020 19:11 EDT
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US President Donald Trump had already taken a sledgehammer to the export-led growth model. With the COVID-19 pandemic rousing primal passions, hitherto unfashionable ideas are emerging like Dracula from their grave. Protecting infant industries to improve future competitive advantage or strategic players for national security reasons are policies many are embracing with gusto again. Some might argue protectionism never really went out of fashion, citing Boeing and Airbus as classic examples, but now many governments are treating masks and ventilators as national priorities. Clearly, a new zeitgeist is underway.

Why Did the Indian Elephant Move Slowly?

Like all economic systems, the post-World War II Bretton Woods order had winners and losers. Some benefited more than others. The US gave countries that opposed the Soviet Union and helped bring the demise of the Red Empire access to its capital, markets and even technology. As a Soviet ally, India benefited from the communist giant’s munificence but, even so, it remained trapped in the Hindu rate of growth and lagged behind Asian tigers allied to the US.

When the Soviet Union collapsed in 1991, India faced a balance of payments crisis. It had to fly out its gold reserves to London to secure dollars to keep the country going. With its Soviet godfather dead, New Delhi had no option but to liberalize its economy, releasing the stranglehold its infamous bureaucrats had maintained since independence in 1947. This stranglehold is popularly known as the Licence-Permit-Quota Raj, which replaced the British Raj under India’s first prime minister, Jawaharlal Nehru.


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The Indian economy, long compared to a lumbering elephant, broke into a run once businesses did not have to propitiate bureaucrats to the same degree as before. In particular, the services sector boomed with jobs in IT outsourcing growing rapidly and bringing in valuable export earnings.

Unlike China, though, India did not build infrastructure, develop manufacturing, generate employment and deliver prosperity in its economy. Its growth spurt was good when compared to the pre-1991 era but paled in comparison to its East Asian peers, especially China. The fruits of growth in India were more unevenly distributed as well, which reflected in its poor performance on the human development index.

Analysts theorized profusely about India’s poor performance, blaming a range of factors from democracy to Hinduism. A few even criticized the British-created civil services, the holy cows of Indian society. While it is true that India’s colonial bureaucracy is inefficient and corrupt, its judiciary is equally detrimental to the economy.

Due to the glacial pace of hearings, it takes 1,445 days to enforce a contract, and India ranks a lowly 163 out of a total of 188 countries. Activist judges have further increased risk and uncertainty in the economy. Both domestic players and foreign companies dread the kiss of death by Indian courts.

Politicians in India do not escape blame. Most are poorly-educated and are prisoners of the Nehruvian mindset. Like politicians elsewhere, their focus is on the next election. In contrast to British or German politicians, they are not as focused on the economy. They lack policy chops and instead rely on bureaucrats who almost invariably do not have economic training or business experience. Rarely do India’s politicians seek impartial, honest advice.

Time for the Status Quo to Go

India’s economic policies have to change. The COVID-19 pandemic has caused the greatest crisis to the global economy since the Great Depression of 1929. With a population of more than 1.3 billion and still-widespread poverty, India has no choice but to act boldly and speedily. The authors propose that India adopts a five-prong policy to stimulate its economy.

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First, the country must promote industry and turn the “Make in India” initiative into a reality. In 2017, information and communications technology (ICT) goods comprised more than 9.7% of India’s imports and less than 0.9% of its exports. These ICT goods can and should be manufactured in India just as cars are. India must set up special manufacturing zones (SMZs) with liberal industrial permissions, land policy, transparent tax regimes and sovereign guarantees of policy stability.

There are numerous foreign companies who want access to Indian markets. India must welcome them with open arms on one condition: foreign players must manufacture domestically. This policy has already been tried in the car market, and players like Toyota, Honda, Suzuki, Kia and SAIC are manufacturing in the country. Companies in other sectors could do the same if India drafts a decent SMZ policy.

Of course, this policy would also be available to domestic firms. They could raise capital either domestically or through foreign capital markets. Theoretically, Indian players like Mahindra and Tata could export to developing countries around the world, especially in Africa, because conditions in these places are similar.

Some might ask how this policy is different from the Nehruvian model of import substitution. That policy protected the domestic industry, which was given a captive market to sell substandard goods, such as the legendary Ambassador car of Hindustan Motors. Domestic players never benchmarked their quality with their international peers and earned merry profits as crony capitalists, pleasing politicians and bureaucrats, not consumers who bought their products. This proposed policy welcomes every leading global player to manufacture high-quality products in India for the Indian consumer.

It is important to remember that the Nehruvian policy of import substitution failed abysmally. Despite the Soviet Union selling oil at subsidized rates or giving it away through a barter system, the threat of a balance of payments crisis was never far away. India’s energy imports kept growing, but it was unable to manufacture anything cheap enough or of high-quality to compete globally. As a result, exports lagged behind imports. If global players manufacture in India, that would cut down imports and sharpen the domestic ability to compete in the global export market.

Second, India’s public sector is a sleeping giant that must be woken up. For decades, it has been used for patronage by politicians and bureaucrats. Officers of the heaven-born Indian Administrative Service (IAS) run businesses as diverse as Air India, the Food Corporation of India and Indian Tourism Development Corporation. They invariably have no industry expertise, guaranteed multi-decade careers and no penalty for failure. For example, Air India is in disarray, but no IAS officer who headed it has ever suffered any negative consequences. The same is true for every loss-making public sector unit that bleeds the taxpayer.

Many IAS officers like to compare themselves to American CEOs. They claim that the latter often lack industry expertise too. They forget that model has changed dramatically. Every internet giant is headed by CEOs who know their industry inside out. The days when Steve Jobs invited John Sculley of Pepsi fame to head Apple are long over. It is important to remember that, for all his success at Pepsi, Sculley nearly killed Apple. It was Jobs who revived Apple and made it the company it is today. Silicon Valley has not forgotten that bitter lesson.

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Privatizing the public sector is an option but must be used judiciously. In a country with a history of crony capitalism, there is a danger of selling the family silver at fire-sale prices. The disastrous privatization of the public sector in Russia is a warning to all former socialist countries, and India is no exception. Instead, professionalizing the public sector is the better policy choice. The Antrix Corporation, with its numerous successes in space technologies and services, is a shining exemplar for the rest of the public sector.

Managing directors like Rakesh Sashibhushan of Antrix and E. Sreedharan, the legendary engineer who built Konkan Railway and Delhi Metro, are the need of the hour. Top positions cannot be the birthright of IAS officers with no domain expertise. Instead, professional management with industry experience must run India’s public sector. Public sector boards must change too. They must have people with varied, relevant skill sets, not bureaucrats or politicians or sycophants looking for sinecures.

The State Must Serve, Not Rule

Third, stakeholders such as manufacturers, traders and professionals must have a right to redressal of grievance against the government. Currently, Indian bureaucrats are utterly unaccountable. They can and do change policies on whims with little due process or notice, causing carnage. A petty clerk can sit over a file forever, delaying a tax refund or project clearance. India’s British-designed bureaucracy is rentier in its DNA. It was supposed to suppress economic activity so that India would remain the supplier of raw materials and a market for British goods. That mentality persists and bureaucrats demand constant genuflection, if not outright bribes.

Furthermore, Indian bureaucrats wield far too much arbitrary power. Stakeholders can be falsely charged under confusing laws, indefinitely dragged to courts, lose their livelihood and perhaps lives with no accountability for the state or the wrongdoing bureaucrat. A doctor or accountant is liable for negligence under the law. The Indian bureaucrat is liable for nothing. Till today, the goods and services tax (GST) filing system remains glitchy. If a small trader’s tax was not refunded in time, turning his or her cash flow issue into a solvency one, then the official responsible for the delay must face some penalty.

In a system with interminable delays, every bureaucrat must have a time limit to make a decision. If she or he fails to make a decision, then the stakeholder’s file must be deemed automatically approved. At the same time, India needs fast-track, independent tribunals to speedily resolve stakeholder complaints. The “pocket veto” of bureaucrats in which they stymie economic activity by taking no action has to go. The state cannot penalize its citizens while its bureaucrats behave with impunity.

Fourth, Indian bureaucrats must no longer have the power to throttle supply-side activity. The default principle of the British-designed still-colonial state is that activities not explicitly permitted are often automatically deemed illegal. In much of the world, if an activity is not expressly forbidden by the law, the citizen has the freedom to engage in it. In India, an activity not expressly permitted by law or regulation can be shut down anytime. The fact it might be of much economic or social value, provide employment or essential services for a community is irrelevant. Fines, long-drawn inquiries and even closure are real consequences if even a petty bureaucrat takes umbrage.

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It is important to note that the British did not design such an oppressive bureaucracy for themselves. There is no British Administrative Service in the UK. The MI6, Scotland Yard, the British Treasury and the British Foreign and Commonwealth Office recruit horses for courses who are accountable for their performance. In contrast, Indian bureaucrats behave as rulers, not as public servants. In states such as Vietnam or Thailand that are not democracies like India, the default setting is different and labor, tax or environment regulators are not as powerful. This allows for greater entrepreneurial and economic activity.

Indian bureaucrats constantly argue that changing the default setting is a prelude to chaos. They need onerous laws to avoid a humongous country like India from descending into disorder. The reality is that small businesses are increasingly crushed by compliance requirements of innumerable regulations. If a trader fails to clarify, say, subclause three of clause 30 on the 10th page, then she or he can spend eternity running from pillar to post. The government has to simplify forms and stop interfering in economic activity if it wants income, jobs and growth to increase.

Victorian Moralizing Costs Too Much

Finally, India must discard its Victorian attitudes toward “sin” industries and rationalize its policies toward them. The country faces a massive economic crisis. In particular, state governments may run out of cash. Many of them derive a significant percentage of their revenues from taxing liquor or tobacco and running lotteries. Yet both central and state follow moralizing, inconsistent and incoherent policies for these “sin” industries that do not make any sense at all.

While known carcinogens like khaini — the Indian version of fermented, dried tobacco — can be sold freely, too many relatively innocuous activities are either illegal or under restrictive regulations. One of the authors experienced the folly of prohibition as a young officer in Nagaland. Even pastors preaching temperance drank clandestinely as did police officers seizing liquor, making bootlegging the biggest industry in this American Baptist state. This caused a massive loss of revenue to Nagaland while fostering a culture of all-pervasive corruption. Other states have similarly impractical holier-than-thou policies.

Similarly, many Indian states take a strong stance against so-called sinful activities such as betting and live entertainment. As a result, these activities are pushed into the black economy. This benefits criminal rackets and deprives states of revenues, increasing the tax burden on more socially desirable activities. Puritanism in India has perverse consequences. A more mature approach that formalizes and taxes “sin” industries instead of driving them underground will boost the Indian economy immensely. India can take inspiration from its past. The Khajuraho Temples still draw in tourists and continue to benefit the local economy centuries after their construction.

It is an open secret that Indians flock to casinos in Singapore and Macau. India could allow casinos in coastal areas or islands to keep precious capital home and boost tax revenues. Goa already allows for gambling in circuitous ways. A rational policy toward gambling and betting is long overdue.

Question 1: Can These Policies Work?

For all its faults, India is a large economy and has established some domestic market institutions. Unlike the 1950s or even the 1960s, the country is not facing the same existential questions. At that time, India suffered from food insecurity, lacked capital and had a lingering suspicion of corporations, which was only natural given its colonization by the British East India Company.

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These policies are not advocating autarky like the Nehruvian model. They are not advocating East Asian-style export-led growth. That ship has sailed. The World Trade Organization (WTO) estimates that trade could fall by as much as 32% in 2020 thanks to COVID-19. Therefore, domestic industrialization through domestic players, foreign capital and foreign direct investment is the way forward.

Question 2: Will They Work?

In the pre-pandemic world, India could not compete with Japan, South Korea, China and other Asian economies. These countries had mastered the manufacturing game with scale, technology and supply chain linkages in their favor. Furthermore, the WTO rules did not allow India to support domestic industry. The free trade agreements India signed over the years also opened up markets to foreign players, decimating domestic rivals.

COVID-19 has fundamentally changed the rules of the game. Trump had already initiated a trade war against China. Now, other countries are turning away from the haloed principles of free trade, which was never truly free in the first place. Trade deals have always been a product of torturous negotiations, and Indian bureaucrats with little domain expertise or legal training have negotiated poor deals for the country. Feckless political leadership did not help either.

The post-pandemic world will give India a historic opportunity to reset the clock. Already, it has walked out of negotiations for the Regional Comprehensive Economic Partnership (RCEP), a trade bloc largely of East and Southeast Asian nations. Now, the RCEP wants India back at the table. This demonstrates that companies in these nations want access to Indian markets. Instead of signing yet another FTA, India must play hardball and welcome these companies to manufacture their wares within Indian shores. If it does so, there is no reason why this domestic industrialization will not work.

Question 3: Are They Worth Undertaking?

With a broken financial sector, comatose private sector and clueless governance of the economy, India could experience mass suffering and political turmoil. The government has shown much political will on issues like Article 370 in Kashmir that have plagued the nation since 1947. It is time for it to show similar will in the economic realm and implement long-overdue structural reforms that include changing the toxic nature of its colonial state.

The services sector is at a saturation point. Agriculture remains stagnant and industry has been hit hard. India desperately needs a new growth engine. If India boosts domestic manufacturing, reforms its underperforming public sector, gives stakeholders the right to redress their grievances against the state, takes away supply-side constraints and rationalizes policy on “sin industries,” it could enter a multi-decade growth spurt as in 1991. Then, as now, India could put a crisis to good use and improve the living standards of millions. Surely, that is worth undertaking.

*[A full copy of the memo the authors have sent the Indian Prime Minister’s Office can be found here.]

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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