Prime Minister Narendra Modi’s new government will face challenges on the economic front. Growth is slowing down, exports are not doing well, corporate earnings are not robust, and tax targets have not been met.
While direct transfers may assuage resentment for a short duration, they are not long-term solutions for India. The long-term solution is sustained economic growth which pulls the population out of poverty.
The reform agenda requires a change in the philosophy of the role of the state and markets in the economy. Issues such as jobs, investment, credit, farm incomes and exports need to be addressed. But this should not be done in a piecemeal way. The state needs to regulate markets, to enable them to work more effectively, rather than replace markets.
Liberalise factor markets
The last three decades of growth have come from the ‘small’ and ‘shallow’ liberalisation that was done in the 1990s. Today, the steam from these reforms is running out. The reforms were in product markets, in international trade and investments. This allowed India to export services and gain some foreign investment.
However, in the broader economic picture, the reforms were small — limited to trade and manufacturing. Factor markets such as land, labour and capital were not liberalised.
The reforms resulted in growth in sectors which did not employ large numbers, used highly paid workers, were capital intensive and depended on export markets. India’s labour intensive small-scale sectors were not given any ‘freedoms’.
Even in terms of sectors, India’s biggest employer, agriculture, lost out. Draconian laws like the Essential Commodities act, agricultural land ceiling laws and agricultural market committee laws are still on the statute books, shackle farmers to unproductive farms and prevent them from participating in free markets.
The 1991 reforms were also ‘shallow’. There were no substantive legislative policy changes. For example, the root of most ‘licence and permit raj’ powers lies in the Industries (Development Regulation) Act, 1951. This gives the government broad powers to prevent setting up industries, control prices of products, and a host of other restrictions. It was under this legislation that the government would pass draconian ‘Control Orders’. This law gave birth to the Cement Control Order, which limited the number of cement bags one could buy to build one’s home, and the Aluminium Control Order, which banned the use of aluminium for canned drinks.
Sadly, post-1991, only the Control Orders were withdrawn. The overall legislation is still in force, and the government may, in principle, bring back the pre-liberalisation ‘licence raj’ at any time. Similarly, while foreign investments have been liberalised, the legislation governing foreign investments, The Foreign Exchange Management Act, 1999, bans all cross-border capital flows unless permitted by the central bank.
The retreat of the state from market activities has been incomplete. In telecom, existing PSUs were allowed to function while new licences were given to the private sector. The state stood back as the private sector took over the process of bringing efficiency and quality and lowering prices. However, in contrast, the banking sector continues to be plagued by government ownership and the problems it brings with it. One could argue that the state has worked actively to prevent the growth of private sector banks by withholding licences and creating an unequal playing field which prefers government banks.
Deeper reforms across sectors
The reforms of the 1990s can take us only so far. While there have been substantial changes in India’s legal system like the electronic securities trading system, a modern competition law, shift to value-added taxes, a new bankruptcy code and setting up of an inflation target, the state is yet to remove ‘restrictions’ on citizens in the economic field. This requires the state to rewrite laws in major areas of the economy: Labour, land, agricultural markets, industrial licensing and finance.
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Land regulation
Before GST, Indian businesses faced multiple taxes from various authorities. Land regulation in India faces a similar problem.
The severe restrictions on agricultural land in terms of land ceiling, leasing, and use have locked farmers into unviable agricultural practices. Land ceiling depresses prices and prevents farmers from exiting agriculture. Leasing restrictions have the same effect. Land use restrictions prevent farmers from doing any other activity and retard support services to agriculture like warehousing and processing.
While land is a state subject, the government will have to address it to improve farmer incomes. Just like the urban land ceiling laws were withdrawn in the mid-2000s with leadership from the central government, it is time to repeal the agricultural land ceiling laws.
Agricultural markets
Participating in national and international markets is the cornerstone of creating wealth. The 1990s reforms allowed Indian businesses to participate in global markets. India’s software industry is an example of the success of globalisation for India. Similarly, GST removes barriers to intra-India trade and will have positive outcomes for Indian industry.
However, Indian agricultural markets are crippled by APMC laws and restrictions placed by the Essential Commodities Act. As long as these laws exist, India will not gain a national market in agricultural goods. The government has tried to bypass the problem through the E-National Agricultural Market programme. It does not seem to be generating the volumes expected of a country like India.
Industrial restrictions
As long as legislation like the 1956 industries regulation law and many others like it remain on the statute books, India is at risk of reverting to command and control economic systems. Such laws hang like the sword of Damocles over every business in India. This encourages short-term business policies at the expense of long-term business strategies. If there is no guarantee that a favourable policy will be there next year, why should a business make long-term investments?
Finance
While some movement has been made in the financial sector, the basic structure of Indian finance is still plagued with an “everything-banned-until-permitted” approach, combined with regulatory failures in consumer protection.
In finance, the legal response has been only to emergencies without rethinking the first principles of regulation. The disturbing regularity with which the financial sector faces a crisis every few years is symptomatic of structural problems in regulation which have not been addressed. This includes retreating from the banking sector and changing the philosophy of regulation.
A new approach to regulation
For the next three decades of economic growth, the state has to withdraw from prohibiting citizens from carrying out mutually-beneficial transactions of their own free will. Farmers need the freedom to sell their produce to whomever they want, or even exit farming by selling their land. Labourers and firms need the freedom to draw up employment contracts that are acceptable to both of them, instead of being jacketed into labour laws. Financial firms need the freedom to write credit default swaps to protect investors from IL&FS-like default situations.
This freedom will need ‘protection’ from the government. Protecting the freedom of citizens to carry out legitimate business is no mean task. It will require the Indian regulatory and bureaucratic philosophy to change. Instead of pursuing the goal of price control and production control, they have to move towards contract enforcement and consumer protection.
India has to de-emphasise controlling the price of drugs and re-emphasise ensuring the quality of drugs. It has to stop worrying about the exchange rate and worry about preventing corporate frauds like IL&FS.
Ila Patnaik is an economist and a professor at the National Institute of Public Finance and Policy.
Shubho Roy is a consultant at NIPFP.
Views are personal.
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Interesting article. That said, shouldn’t judicial reforms be as important? The fear of delayed justice harms the investment confidence of both domestic and foreign players. Has the impact of a slow judiciary on our economic growth been studied?
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