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The Economic vision for precautious and cleavaged India

There is a pressure in India from some intellectual circles to change the approach towards development planning and become more pro market, pro private sector, private property and reduce excessive thrust on redistribution and “statist” intervention through subsidies and welfare programmes, because such elements in planning have been often populist, irrational, inefficient and unsustainable. This pro market and pro private sector approach also observes that India became a welfare democratic state prematurely without developing state capacities in infrastructure and social and economic overheads such as education and health. Therefore this school believes that there is a need to change the approach towards development planning.

To understand the vision for precautious and cleavaged India, it is apt to quote from economic survey: “Since about 1980, India’s growth performance has been robust, especially for a democracy. This has been backed up by policy reforms that have made India more open to flows of goods and capital and have reduced the size of the public sector, both in micro-efficiency and macro-fiscal terms. Yet, there are serious challenges that might impede further rapid progress which emanate in part from the fact that India started out as a poor democracy with deep social fissures (a “precocious, cleavaged” democracy). These long – standing challenges can be classified as an ambivalence about property rights and the private sector, deficiencies in state capacity, especially in delivering essential services, and inefficient redistribution. Meeting these challenges is not just a matter of overcoming vested interests; it may also require broader societal shifts in ideas and narratives.”

Main features of transition of the economic transformation of Indian economy

  • The result of economic reforms over the past 25 years (since 1991) has been a remarkable transformation of India from a largely closed and listless economy to the open and thriving economy that we see today. The country’s progress is not only qualitative. It is also measurable. Consider, for example, four standard measures: openness to trade; openness to foreign capital; the extent to which public sector enterprises dominate commercial activities; and the share of government expenditure in overall spending.
  • The Indian economy was growing at the so called “Hindu Rate of Growth (a term coined by prof. Raj Krishna to indicate a growth lower than 3.5 per cent) till1980.
  • The sixth Five Year Plan (1980-85) and seventh Five Year Plans freed India from low growth rate syndrome and GDP increased at the rate of 6 per cent per annum. Later, India recorded even a higher growth rate of about 8 per cent after embracing the New Economic Policy in 1991 based on three pillars of liberalization, privatization and globalization, especially during 2000- 2011 period.
  • This period saw a drastic fall in the rate of population growth from 2.4 per cent per annum in pre economic reform period to 1.6 per cent in 2011, leading to an increase of 4.5 per cent per annum in per capita income.
  • This in turn led to fall in the poverty ratio from about 50 per cent to 30 per cent in India. Despite all these positive developments in the GDP growth and living standard, Indian economy is still marked by poverty, inequality, unemployment and poor human development.
  • India has seen rapid increase in trade- GDP ratio, since 1991. India’s ratio has been rising sharply, particularly over the decade to 2012, when it doubled to 53 per cent; the recovery from the global financial crisis in 2008 was also swift. As a result, India’s ratio now surpasses China which is remarkable.
  • India’s FDI has risen sharply over time. In fact, in the most recent year, FDI is running at an annual rate of $75 billion, which is not far short of the amounts that China was receiving at the height of its growth boom in the mid-2000s.

India is now squarely in the middle of the emerging market pack. This is partly because India has allowed the private sector entry into, amongst others, civil aviation, telecommunications, and financial services. These have all served to reduce the share of the public sector even if there has not been much exit of the PSU enterprises themselves. Looking on to per capita expenditure in India as against per capita income it spends as much as can be expected given its level of development.

In sum, the standard measures suggest that India is now a “normal” emerging market, pursuing the standard development path. It is open to foreign trade and foreign capital, where the government is not overbearing, either in a micro, entrepreneurship sense or in a macro, fiscal sense. Taking a long view, and recognizing that India’s reforms actually started around 1980 (Rodrik and Subramanian, 2004), the first order fact is that India has grown at about 4.5 percent per capita for thirty seven years, an impressive achievement.

In what ways is India different?

Yet, there remains a niggling sense that India is not quite what it appears to be – that, despite all the data, it is not yet following the standard development model. Three lingering features capture the doubt that it has not yet traversed the distance toward some vague and unspecifiable end-point that could be described as desirable or optimal. First, there has been a hesitancy to embrace the private sector and to unambiguously protect property rights, combined with continued reliance on the state to undertake activities that are more appropriately left to the private sector (Kochhar et al. 2006).

Second, state capacity has remained weak (Pritchett 2009), as can be seen from poor delivery of essential services (Rice and Patrick 2008).

And third, redistribution has been simultaneously extensive and inefficient (Kohli 2012). The symptoms of this ambivalence toward the private sector manifest in multiple ways. The most well-known example is the difficulty of privatizing public enterprises, even for firms where economists have made strong arguments that they belong in the private sector, for example aviation sector, banking sector, fertilizer sector, APMC (Agriculture produce market committee) etc, which despite loss making and inefficiency continue in public sector or government control.

Poor development of state capacity

Another distinctive feature of the Indian economic model is the weakness of state  capacity, especially in delivering essential services such as health and education (Mangla 2015; Deaton 2013). Of course, nearly all emerging markets started off with weak state capacity at independence. But as their economies developed and prospered, state capacity improved, often at an even faster rate than the overall economy. In India, by contrast, this process has not occurred. Fukuyama (2013) argues that the Indian state has low capacity, with high levels of corruption, clientelism, rules and red tape.

Puzzles related to competitive federalism and development model of India

The deepest puzzle here is the following: while competitive federalism has been a powerful agent of change in relation to attracting investment and talent (the Tata Nano car being the best example) it has been less evident in relation to essential service delivery. There have, of course, been important exceptions such as the improvement of the PDS in Chhattisgarh and Bihar, the incentivizing of agriculture in Madhya Pradesh, the kerosene-free drive in Haryana, power sector reforms in Gujarat which improved delivery and cost-recovery and the efficiency of social programs in Tamil Nadu. However, on health and education in particular, there are insufficient instances of good models that can travel widely within India and are seen as attractive political opportunities.

Aside from inhibiting service delivery, the weakness of state capacity has created another problem. Policy-making in certain areas has been heavily constrained, as a way of ensuring that decisions do not favour particular interests. The result is twofold. First, there is now adherence to strict rules—for example auctions of all public assets—that may not necessarily be optimal public policy. In telecommunications, the judicially imposed requirement for transparency and auctioning, while responding importantly and appropriately to the previous experience of corruption, has created a public policy dilemma. In some cases, it may be socially optimal to sell spectrum at lower than- auction prices because of the sizable externalities stemming from increased spread of telecommunications services. But the understandable distrust of discretion means that methods other than auctions could be perceived as favouring particular parties.

Second, there is abundant caution in bureaucratic decision-making, which favours the status quo. In the case of the twin balance sheet problem mentioned above, it is well-known that senior managers in public sector banks are reluctant to take decisions to write down loans for fear of being seen as favouring corporate interests and hence becoming the target of the referee institutions, the so-called “4 Cs”: courts, CVC (Central Vigilance Commission), CBI (Central Bureau of Investigation) and CAG (Comptroller and Auditor General). This encourages ever-greening of loans, thereby postponing a resolution of the problem.

Related to this is the third distinctive aspect of the Indian development model. All countries redistribute and must do so. The question is how effective this is and must be. Redistribution by the government on India is far from efficient in targeting the poor. If we evaluate we find that effectiveness of existing programs to help the poor, through subsidies and through government programs such as MGNREGS (Mahatma Gandhi Rural Employment Guarantee Scheme), SSA (Sarva Shiksha Abhiyaan), ICDS (Integrated Child Development Scheme), etc. It finds that welfare spending suffers from considerable misallocation. There are exclusion errors (the deserving poor not receiving benefits), inclusion errors (the non poor receiving a large share of benefits) and leakages (with benefits being siphoned off due to corruption and inefficiency) in these programmes.

India development model: A precocious, cleavaged democracy with poor state capacity, overemphasis on redistribution and doubt on private sector

 Central to understanding India’s economic vision is the fact that it has followed a unique pathway to economic success, what might be called “Precocious, Cleavaged India”. Historically, economic success has followed one of two pathways. Today’s advanced economies achieved their current status over two centuries in which economic and political development progressed slowly but steadily. They did not begin with universal franchise. Voting rights, narrow and restricted to begin with, expanded slowly over time, a process that helped fiscal and economic development by limiting the initial demands on the state during the period when its capacity was weak (Acemoglu and Robinson, 2013; North and Weingast 1989;Saint-Paul and Verdier 1993).

The second set of accelerated economic successes mostly in East Asia began authoritarian, explicitly (Korea, China) or de facto (Singapore, Thailand, Taiwan), and gave way to political transformation only after a degree of economic success was achieved. Explicit authoritarianism came in three flavours: military (Korea), party (China), or individual dictatorship (Indonesia).

India, on the other hand, has attempted economic development while also granting universal franchise from the very beginning.  India, at independence, was a very poor democracy. In the figure, India is close to the bottom, indicating that it was the poorest democracy – in fact, one of the poorest nations, regardless of political system, with a per capita GDP of just $617 measured in purchasing power parity prices (PPP -1990 prices, Maddison).

At the same time, India was also a highly cleavaged society. Historians have remarked how it has many more axes of cleavage than other countries: language and scripts, religion, region, caste, gender, and class (Guha 2016). Measured by ethno –linguistic fractionalization alone, India is similar to other countries (Easterly and Levine, 1997).But if caste is also taken into account (based on Banerjee and Somanathan, 2007), India stands out.

A precocious, cleavaged democracy that starts out poor will almost certainly distrust the private sector. Reinforcing this notion was the prevailing intellectual zeitgeist of socialism. The founders of India wanted to “build the country” by developing industry that would make India economically, as well as politically, independent. The private sector had conspicuously failed to do this under colonial rule, not only in India but in every other newly independent nation, giving rise to severe doubts as to whether it could ever do so. In contrast, the example of the Soviet Union, which had transformed itself from an agricultural nation to an industrial powerhouse in a few short decades, suggested that rapid development was indeed possible, if the state would only take control of the commanding heights of the economy and direct resources into priority areas.  Another important implication of India’s precocious, cleavaged democracy is that India had to redistribute early in the development process, when its state capacity was particularly weak sense of how challenged Indian state capacity was in a comparative sense. It compares the income levels of different countries that had to spend what India does today, in percent of GDP. Typically, this occurred fairly late in the development process, when these countries had built up state capacity. For example, South Korea spent at a per capita GDP level of close to $20,000 what India spends today at a per capita GDP level of $5,000. Finally, given the pressing need to redistribute, India did not invest sufficiently in human capital – for instance, public spending on health was an unusually low 0.22 per cent of the GDP in 1950-51 (MoHFW, Government of India, 2005). This has risen to a little over 1 per cent today, but well below the world average of 5.99 per cent (World Bank, 2014). All this explains why such policy endeavors and interventions began. But this cannot fully explain why such inefficient redistribution persists because, after all, other countries have graduated toward less inefficient forms of redistribution.

Problems that need to be addressed

A partial explanation is the difficulty of exit. Exit is difficult everywhere but it can be especially difficult in a poor, cleavaged democracy dominated by vested interests, weak institutions and an ideology that favours redistribution over investments.Second, there is abundant caution in bureaucratic decision-making, which favours the status quo. In the case of the twin balance sheet problem mentioned above, it is well-known that senior managers in public sector banks are reluctant to take decisions to write down loans for fear of being seen as favouring corporate interests and hence becoming the target of the referee institutions, the so-called “4 Cs”: courts, CVC (Central Vigilance Commission), CBI (Central Bureau of Investigation) and CAG (Comptroller and Auditor General). This encourages ever-greening of loans, thereby postponing a resolution of the problem.

Thus, today India’s approach needs to mark a shift and allow private sector to play more important role. India also needs to shift public spending from consumption to investment.  Redistribution by the government is far from efficient in targeting the poor. Another important implication of India’s precocious, cleavaged democracy is that India had to redistribute early in the development process, when its state capacity was particularly weak. Thus today redistribution policy needs to evaluate the outcomes against allocations and then reject or rationalize such public expenditure and decide to continue them or stop them. It is also important to find out wrong exclusions and inclusions to better target the poor and deprived sections of the society through JAM trinity. Subsidies to the rich and inefficient sectors need to be done away with. Free lunches should be stopped and non-merit subsidies cross subsidization etc. in electricity and irrigation sector need to be stopped. All this would free capital to spend on infrastructure and durable assets to provide employment and promote trade and commerce and industrialization.

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