Economic Survey 2016-17: Chapter-2: Economic Vision For Precocious, Cleavaged India

“Democracy” has allowed India to show a robust performance in economic growth yet, there are  serious challenges that underline the poor democracy with deep social fissures in the country. Due to these challenges, the economic survey calls India a precocious, cleavaged democracy. As highlighted in chapter-1, these long-standing challenges include: ambivalence about property rights and the private sector; deficiencies in state capacity, especially in delivering essential services, and inefficient redistribution.

From Socialism to something like a Washington Consensus

After independence, socialism remained the economic vision for India for around half a century, marked by economic nationalism and protectionism, dominance of public sector and government monopoly, and its interference in private firms and their investment, production and trade.

This came to an end in 1991 with the advent of liberalization, privatisation and globalization in 1991. What followed was an economic vision that resembled the so called “Washington Census” i.e. open trade, open capital, and reliance on the private sector. This development model has been successful in several countries in Eastern Asia.

Reforms of 25 years and transformation of India

Due to continuous reforms in last 25 years, there has been a remarkable transformation of India from a closed economy to an open and thriving economy with respect to several standard measures such as openness to trade, openness to foreign capital, share of government expenditure in overall spending etc.

• With respect to openness to trade, the fundamental fact is that geographically larger countries tend to trade less with other countries mainly because of presence of large internal markets in them. India also follows this principle but overall India’s trade is much larger than what one of would expect of its geographical size. In last 25 years, India’s trade GDP ratio has shown steep rise and it has become larger than China and United States. {note that India’s trade-GDP ratio has been around 55-58% in recent years}.
• With respect to the openness to foreign capital, the survey says that despite significant capital controls, India’s net inflow of foreign capital has been quite normal and is comparable to other emerging economies. India’s FDI has risen sharply over the time and in most recent year, India received FDI of USD 75 Billion which is not very short of China.
• With respect to the share of government expenditure in overall spending, the survey says that when we compare the size of the government expenditure to GDP ratio, India’s share is much larger than other countries with similar development levels.

In summary, these reforms have allowed Indian economy to grow significantly and the survey pats the country on its back for remarkable development on these three standard measures. This growth has been particularly remarkable because it has been achieved in a fully democratic political system.

Challenges that make India a “precocious, cleavaged democracy”

Despite of being a successful democracy and a achieving a remarkable growth, the country has not been able to reach an optimal development model. There may be numerous reasons but survey has particularly highlighted three reasons – (1) the country is still not able to embrace the private sector and protect the property rights. There is still over-reliance on state for the activities that could be left for private sector (2) the state capacity to deliver the essential services has been week (3)  extensive but inefficient redistribution {of income}.

Ambivalence towards private sector and property rights

Though ambivalence towards private sector is everywhere because of the intrinsic paradox – the profit maximization aim of private sector does not match with social concerns of government. However, this ambivalence is greater in India, if we compare attitudes to the private sector in India with other countries. This ambivalence manifests in several forms, for example:

• It is difficult to privatise the public sector enterprises even if there are strong arguments for the same. This is evident in civil aviation sector, banking & finance sector. We have still to wait for the day when our airlines are “world class”.
• In farming sector, the requirement to sell the produce only via APMC is archaic. It distorts the prices against the favour of both producers and consumers; and when the prices rise much far, the Essential Commodities Act is invoked to impose stock limits etc.
• With respect to property rights, these rights were initially included as Fundamental Right {Article 19 (1) (f)} but later were converted to ordinary legal right {Article 300-A} via 44th amendment. But this downgrade of rights to property has resulted into the “retrospective taxation’ problem and is lingering around even today {survey say so, I think they overlooked the circumstances in which the 44th amendment was enacted}. This was evident in a number of recent cases such as those involving Vodafone and Monsanto. This is further aggravated by the Twin Balance Sheet Problem – in corporate and in banking sector {discussed later}.

Weak state capacity to deliver the essential services

Almost all emerging economies started as weak states at the time of their independence. However, as their economies developed, the state capacity also improved. Unfortunately, this did not happen in India. Indian state has low capacity and high level of corruption, clientalism, rules and red tape. The survey says that while competitive federalism in the country has been a powerful agent of change with respect to attracting investment and talent, it has failed to improve essential services delivery with few exceptions such as improved PDS of Chhattisgarh, incentivasation of agriculture in Madhya Pradesh, power sector reforms of Gujarat, and improved delivery of social services in Tamil Nadu etc. As far as delivery of health and educational services is concerned, the competitive federalism has not been able to bring much changes.

The weakness of state capacity has not only resulted in inhibition of service delivery but also heavy constraints in policy making. Since the policy making needs to be such a way that it does not result in vested interests, there is an adherence to strict rules which may sometimes not be optimal public policy {example- auction of public assets}. For example, the transparent spectrum auction may be a socially optimal policy, but it has undermined the other methods than auction. This apart, there is too much caution in bureaucratic decision making, which actually favours status quo. For example, senior managers of banks fear in writing down the loans for the fear of being seen as favouring corporate interests; and becoming targets of 4Cs viz. courts, CVC, CBI and CAG. What happens due to this is “evergreening of loans” and postponing the solution of the problems.

Extensive but Inefficient Redistribution

In India, the redistribution is not efficient with respect to targeting the poor. The welfare schemes suffer not only from shortfall of funds but also from misallocation. This results in exclusion errors {deserving poor are excluded}, inclusion errors {non-poor receiving benefits} and leakages. The government has tried to solve the leakage problem via subsidy reforms and use of technology.

Explaining the precocious, cleavaged democracy

The survey tries to explain why India is a precocious, cleavaged democracy while comparing it with other democracies. It says that at the time of independence, India was a highly poor society and also a highly socially cleavaged society in terms of languages, castes, religions, regions, gender and classes. Further, the founders of India took the country on path of socialism whereby the wanted to build the country by developing industry under state’s control. Obviously, embracing private sector in such circumstances was not possible.