Thursday, March 23, 2023
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After Lok Sabha polls, new govt must be wary of big-bang ideas that lead to bad outcomes

From bank nationalisation to demonetisation, the Indian state has often rushed into things it has not been able to handle well.

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After the mammoth seven-phase Lok Sabha elections, India will transition from the poetry of campaigning to the prose of performance.

Contestation is intense in this election, and the incoming government – irrespective of its composition – will be under pressure to perform. Hopefully, economic reform will be a priority.

Experience tells us that just getting the state out of economy’s way by lowering entry barriers and opening markets is not enough. The government must make deeper institutional changes in the way it defines and performs its functions.

For instance, increasing competition in banking is not just about giving more licenses; India needs to strengthen its regulatory system, build a specialised bankruptcy regime for banks, and address the problems created by government ownership of banks. Reforms should now be about reorienting the state towards its basic functions and performing them well.

Arguably, given where we are, the basic state functions are: public goods’ provision (law and order, contract enforcement, fiscal and monetary stabilisation, public health, defence and foreign policy), providing basic education to all, competition regulation and consumer protection regulation in markets for important goods and services, environmental regulation, ensuring supply of basic infrastructure and utilities, disaster relief, alleviation of poverty, and financing fundamental research.

When today’s developed countries were at our stage of development, the state performed even fewer functions. In India, the ideological shift towards expanding the role of the state has ignored the constraints of state capacity and resource availability. These acute constraints hamper the performance of state’s functions.

At the same time, capacity and resources are used for extraneous functions – for example, large amounts of resources are with government enterprises in sectors where government ownership is not necessary, like pharmaceuticals, engineering, mining, oil marketing, hotels, shipping among others.

Also read: Modi’s inability to transform economy isn’t a personal failing, it’s a structural problem

Ideological shifts needed

Two ideological shifts can lead to reforming the state’s role in the economy.

First, the state needs to shun the paradoxical approach of finetuning the markets towards pre-conceived outcomes, while focusing primarily on inputs with regard to its own functions.

The state performs many of its basic functions poorly. On learning outcomes, our students perform worse than students in most countries. Reasonable public safety eludes large parts of the country, including the national capital. Contract enforcement is extremely difficult, according to the East of Doing Business index.

These are foundational issues. But the state’s emphasis continues to be on inputs, allowing it to evade accountability for actual outcomes. Perhaps this continued failure, which generates a sense of dissatisfaction with the state, partially explains the strong anti-incumbency in our elections.

Well-functioning markets require certain inputs from the state – efficient regulation, exit mechanism for bankruptcy, supply of infrastructure, and contract enforcement.

Instead of focusing on getting these right, the state often seeks to command market outcomes. In banking, even while competition remains low and barriers to innovation remain high, the state directs banks to open accounts and give loans to identified categories of borrowers.

We need the state’s focus to shift from outcomes to inputs when it comes to markets, and from inputs to outcomes for services the state is supposed to provide.

Second, state intervention in the economy must be based on rules and reason. By occupying a controlling position in the economy, the state acquired habits of capricious decision-making. This culture also prevails in some of the independent regulators like the RBI. The state must intervene in the economy based on pre-defined rules. And, it must explain the intervention by providing an analysis of the expected impact of its decisions, by consulting stakeholders and publishing reports on performance.

Also read: Maximum schemes, minimum welfare: How the Modi govt fell into the same trap as UPA

Enchantment with statism

Such reforms are difficult because they reduce arbitrary powers and limit the state’s pretence of omnipotence. They are made more difficult because of a persistent temptation of statism in the name of unorthodox or out-of-the-box ideas. Many of these ideas are borrowed from very different contexts, and peddled without a proper understanding of our constraints. Here are three ideas that have recently gained momentum, but lack adequate appreciation of India’s constraints.

First, the increasing protectionism and the proposals for an industrial policy that picks winners are again privileging the idea of state-directed growth and employment. These paths have been successfully taken in countries with high state capacity and relatively authoritarian regimes. We have to consider paths consistent with our democratic values and state capacity constraints. Our past should caution us – India’s experience with protectionism and industrial policy has not been good.

Second, there are calls for a minimum or basic income to achieve better redistribution by both the Narendra Modi government and the opposition Congress party. While some modest version could work as a substitute for the “subsidy state”, the fact is that only so much redistribution is possible in a country with a per capita income of Rs 1.25 lakh per year. Further, the economic costs of higher taxation and the crowding out effect of more government borrowing could harm the foundations of private sector growth. Unfortunately, in some quarters, the idea is being coupled with calls to relax fiscal discipline when, after more than a decade, India is finally returning to normative deficit level.

Third, to protect the right to data privacy, which was recently endorsed by the Supreme Court, the Justice Srikrishna Committee has recommended a law that would equip an authority with draconian powers, including the power to monitor the data economy and to pursue imprisonment for those in violation. The expansive list of proposed rights and regulatory powers is mostly copied from other countries. There is little documentation of actual harms that justify such a law in India.

This globalist approach is leading to arbitrary elevation of certain values, and the absolutist claims over“rights” are making utilitarian and pragmatic compromises appear morally wrong. We may never know whether this is consistent with the general will. There is almost no acknowledgment of the enormous capacity challenges in implementing such a law, and the risks of such draconian powers. Mere copying of laws will not lead to the desired outcomes.

Also read: State regulation in India – the art of rolling over rather than rolling back

These examples suggest that the temptation for statism runs across much of our political-ideological spectrum. These ideas are not inherently bad, but with our constraints, they can lead to bad outcomes.

Somehow, the myriad failures of the state have not sobered us to the realities of messianic policy wonkery. From bank nationalisation to demonetisation, the Indian state has often rushed into things it has not been able to handle well.

We should surely consider unorthodox ideas that help perform the basic state functions (for example, new learning methods in schools) and adapt to the new challenges to these functions (for instance, emerging technological challenges to law and order). But we should be wary of ideas that go beyond these functions. And we should always ask for analysis that shows a plausible path from ideas to outcomes, because that path is narrowed by our constraints.

We have got the basics of electoral democracy right. Now, we need to get the basics right in other domains as well. Our newly elected leaders must have the wisdom and the courage to focus much more on the basics than on the so-called “transformational” ideas.

The author is a Fellow at Carnegie India.

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  1. Very difficult to undo a bad decision after it has been taken. The banks were nationalised in 1969. No succeeding government has made a serious effort to undo it. Mainly because it is fun to have control over such a vast pool of captive savings which have not many safe alternative outlets. Partly also because it would be seen as going against the interests of the poor. 2. Demonetisation is in a league of its own.

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