More than any other union government in the last 30 years, it is the BJP-led NDA government, which can take a strategic approach to the economy and pursue long-term objectives. It has unique political opportunity and capital. A strategic approach opens up more possibilities, because some problems cannot be solved by mere tactical measures. The Modi government needs a strategic approach on at least four fronts.
An ordered deals space
The government needs to create a growth-enabling interface between state and private capital.
In their recent book, Lant Pritchett, Kunal Sen and Eric Werker have developed a political economy model that explains why growth accelerates, sustains, or declines. They argue that in developing countries, governments typically do not apply the rules impersonally. Therefore, the rules in the books can hardly predict what will happen to specific firms; instead, deals – the “informal and personalised relationships between economic actors and political elites” – determine the business environment. This is why the “ease of doing business” rankings based on formal rules have almost no bearing on actual experience of firms.
This “deals space” may be ordered – those who strike them can count on the deals being honoured – or disordered. It may be open – people outside of the dominant elite can access them – or closed. To accelerate and sustain growth in India, the “deals space” should be both open and ordered. One explanation for India’s growth challenges is that the “deals space” has become disordered. This began with the cancellation of the spectrum licenses and coal block allocations, and has continued with decisions such as demonetisation.
In spite of the improvement in India’s ranking on the ease of doing business index, new project announcements by the private sector have not picked up, and in the first two quarters of this year, they were at a 15-year low.
As a cadre-based party with a mass following and a popular leader, the BJP can be less dependent on cronies. It can take funding from firms and their promoters without giving special favours in return. This means the BJP, if it so chooses, is in a position to open the “deals space”, allowing more and more people to participate.
Creating an ordered “deals space” will not be easy. Centralisation of power creates an illusion of order, but it presents its own set of risks. In a democratic system, promises made by a centralised authority will not last beyond the iron hold of that authority, which is bound to be temporary. A truly ordered “deals space” requires fairness of rules and integrity of institutions, in the absence of which, credible commitment is difficult. Therefore, an ordered “deals space” requires reforming the internal decision-making processes of the government.
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Light touch approach to economy
To grow, firms use their existing capabilities to improve the quality of their products, adapt their capabilities to gravitate towards more complex (and higher value) goods and services, and/or develop new capabilities that allow them to produce new goods and services. The government’s strategy must reflect the status of these capabilities.
Drawing on the work of economist Ricardo Hausmann and co-authors, the Narendra Modi government’s strategy for growth should be based on two considerations. First, whether the economy can use its existing capabilities to upgrade the quality of products that it already produces. Second, whether the economy can use its capabilities to easily move to new products.
Right now, India scores high on both these counts. In the foreseeable future, it can grow by improving the quality of existing products, because its technical capabilities are high relative to its income. And there are a number of products that it can produce by making minor adaptations to its capabilities. In sectors ranging from information technology to pharmaceuticals and automobiles, India can improve the efficiency, quality, and diversity of production without making big changes to capabilities. It is, therefore, all the more surprising that the economy is struggling to maintain growth.
In this context, a “light touch” approach is desirable. This is in contrast to the approach adopted by some other countries. For example, some countries need to push the technological frontier, while some others are compelled to make strategic bets on select sectors due to the lack of economic opportunities. In India, if the government plays an enabling role, firms will find opportunities to grow by making better and more complex products.
In India, the union government should mainly focus on broad, rather than sector-specific, measures. Government should look to support the economy by upgrading infrastructure, implementing regulatory reforms in factor markets (including regulation of technology), improving governance systems, restructuring taxes, improving tax administration, and so on. State and local governments may take a different, context-specific approach.
Light touch approaches are generally anathema to democracies because leaders want to be seen as actively solving problems. Government will, therefore, need to use its political capital to resist the demands for more activist approaches.
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Shift expectations from state
The government also needs a strategic approach to its role as a controller of resources. It owns many firms and other assets, and spends a lot of money.
Privatisation of certain public sector firms and infrastructure assets can improve economic productivity. However, this too must be embedded within a larger strategic approach to redefine the role of the state in the economy.
A coherent framework should include the deft use of political communication to gradually shift the expectations from the state. It must also involve a long-term plan for sectors where immediate privatisation is not feasible. In sectors such as banking, privatisation will increase fragility because many public sector banks rely on government support for building trust among depositors. There are no quick fixes here.
Besides privatisation, a strategic approach is also required in the domain of public expenditure, especially when it comes to expenditure that is difficult to restructure without a backlash (for example, subsidies). The objective of the government’s strategy should be to focus on the core functions of the state.
Fix measurement systems
The government needs a strategic approach to fixing the measurement of the economy. In recent years, serious doubts have been raised – from the likes of late T.N. Srinivasan to now Arvind Subramanian – about the validity of the estimates under India’s new GDP series. This, however, is only one part of the problem. Barring a few exceptions, India’s data systems need an overhaul. This is essential to help the private sector and government institutions (for example, the RBI) take sound decisions.
The inherent difficulty associated with addressing this problem is that any public admission of the predicament might increase economic uncertainty. In a democracy, the opposition can also make such an admission very expensive for the government. To mitigate this, the strategy should be implemented without much fanfare, allowing credibility to be built through future validation exercises by researchers and practitioners.
The economic slowdown has created the impulse to focus on economic issues. However, during a slowdown, leaders can easily lose sight of the big picture, and take decisions that do more harm than good to long-term growth prospects. They may be tempted to bend backwards to get a few large deals, instead of making the overall “deals space” open and ordered. They may pursue an activist industrial policy, in the hope of quick wins, instead of taking the light touch approach suitable for India. They may feel compelled to use public sector firms and government expenditure to boost short-term growth in a manner that harms the long-term growth prospects. And they may deny the problems of measurement in the economy by picking and choosing indicators to paint a positive picture or by acting suspiciously with inconvenient data.
Finally, the larger political context also matters for the success of any strategy. As economists Daron Acemoglu and James Robinson have argued, openness and inclusiveness of the political system are important for prosperity. Sooner or later, closed political systems falter in sustaining growth. Even the long period of high growth in China can be seen as partly a consequence of more open and inclusive political and economic institutions. If the BJP is serious about the country’s pursuit of prosperity, it will have to take inclusiveness and openness of political institutions more seriously.
Also read: Had flagged concerns about GDP estimates even when I was in govt, Arvind Subramanian says
The author is a Fellow at Carnegie India. Views are personal.
After today’s disappointing state election results, the ruling party will likely focus on the economy. There can be no other reason for such a precipitous decline in vote share in Haryana. Even Maharashtra has not lived up to its expectations.