The Politics of India’s Unfinished Economic Reforms
by Swaminathan S. Anklesaria Aiyar
Summary: Despite at least two decades of reforms, the liberalization of India’s economy is incomplete. This is primarily a function of politics. Indian political leaders have few incentives to advance the reform agenda given India’s high growth rate, and instead prefer handouts in the form of welfare schemes and employment guarantees. The ruling Congress Party is inclined towards populism. The realities of coalition politics in both houses of parliament further complicate reforms, as they require concessions from partners and, in some cases, the opposition. While some advances are being made, future economic liberalization in India will likely be hesitant, episodic, and half-hearted.
Economic reform in India began hesitantly in the 1980s and accelerated in the 1990s. After a process of 20 to 30 years of liberalization, one might have expected truly revolutionary changes to India’s economic system. Yet the Heritage Foundation’s 2011 Index of Economic Freedom ranks India at just 124 of 183 countries and classifies it as a “mostly unfree” state with a lower than average score. A separate study, Economic Freedom of the World 2010, brought out annually by the Fraser Institute and allied think tanks, places India at 87 out of 141 countries on economic freedoms. In the 1980 edition of the same index, India had been ranked as high as 57. This apparent decline is not a result of worsening freedoms: India’s score on the index has improved from 5.41 to 6.51 on a scale of one to ten, signifying an improvement. However, other countries have liberalized much faster than India in the interim period. Interestingly, India does not rank much lower than China (82), and ranks much higher than its neighbors Sri Lanka (111), Bangladesh (113), Pakistan (118), and Nepal (125).
The Doing Business series of the International Finance Corporation (IFC) at the World Bank confirms the notion of India being a generally unfriendly environment for doing business. Its 2011 report rated the country a lowly 134 out of 183 countries. India ranked close to the bottom in terms of ease of starting a business (165), getting construction permits (177), and enforcing contracts (182). All of these indices are clear demonstrations of how India remains hobbled by controls, corruption, the pathetic delivery of public goods, and flawed administrative and judicial systems. While India has indeed been transformed since 1991, the unfinished reform agenda is massive. In addition to various constraints on doing business, corruption remains another area of concern. It is currently a hot topic in India, with an outraged media revealing scam after scam, but India may be experiencing more public outrage rather than more corruption. This is confirmed by the Corruption Perception Index of Transparency International, which ranks India 87 out of 178 countries, behind China (78) but well ahead of Bangladesh (134)
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India remains hobbled by controls, corruption, the pathetic delivery of public goods, and flawed administrative and judicial systems.
and Pakistan (143). India has slipped from 66th in 1998, but in absolute terms, its corruption perception index has improved from 2.9 to 3.3. This may be because corruption has been abolished by deregulation in several areas – industrial licenses, import licenses, monopolies clearance, and foreign exchange permits – and this more than offsets rising corruption in areas of political allocations, such as telecommunications, land acquisition, construction permits, and infrastructure. The Political Economy: Reforms, Handouts, and Coalition Politics Despite corruption and business constraints, India has averaged 8.5 percent GDP growth in the last decade. This reflects virtuous cycles created by economic reforms over the last two decades, as well as a demographic dividend. This has important implications for the political economy. Having witnessed the benefits of miracle growth, Indian politicians have little incentive to reduce corruption, misgovernance, or unwarranted economic controls. Indian politicians, like their counterparts everywhere, want to get re-elected, and while they may opt for reforms in tough times, during an economic boom they prefer using increases in revenue to shower handouts to constituents. Handouts can range from employment programs and subsidized grain to free electricity and canal water and subsidized fuel and fertilizers for farmers. In some state elections, political parties have promised voters bicycles, color televisions, electric mixer-grinders, and even laptop computers. Such handouts fritter away funds that could better be better utilized building infrastructure, improving governance – including establishing more courts and police – and improving social services such as health and education. Voters in poorer countries tend to have short time horizons that favor immediate handouts over longer-term reforms. So the political incentives for accelerating reforms remain weak at present. Coalition politics further hampers the reform agenda. The governing United Progressive Alliance (UPA), led by the Congress party, has lacked a majority in both houses of parliament in both its first and second terms. In its first term (2004-2009), the UPA survived only with outside support from the Left Front, consisting of four communist parties. This gave the Left a virtual veto on reforms. Several reformist bills were introduced by the UPA — to allow pension funds to invest in the stock market, to increase the ceiling of foreign investment in insurance from 26 percent to 49 percent, and to give investors in banks voting rights in line with their shareholding — but the Left, dead set against any financial liberalization or improved access to foreign investment, blocked these bills. The Left also vetoed legislation to end the public sector monopoly on coal mining. And, of course, it demanded and got a huge increase in social and rural spending programs. Of these, the most useful was Bharat Nirman, which massively improved rural infrastructure.
Having witnessed the benefits of miracle growth, Indian politicians have little incentive to reduce corruption, misgovernance, or unwarranted economic controls.
The 2009 election brought the UPA coalition back to power with more seats, yet slightly short of a majority. No longer needing the support of the Left, it formed a government with the support of minor parties. But expectations that the second UPA government would surge forward with reforms proved ill-founded. The reasons for this are severalfold. First, the leader of the Congress Party, Sonia Gandhi, has demonstrated her preference for handouts. Along with many leaders of the Congress Party and members of the media, she believes that the UPA’s emphasis on welfare,
particularly a massive rural employment guarantee scheme, was a key reason for her electoral victory in 2009. However, the labor component of the employment guarantee scheme comes to just 0.3 percent of GDP, and work under this scheme accounts for only 1 percent of total rural persondays of work. It seems implausible, then, that this could have been the main reason for rural prosperity or the UPA’s re-election. The truth may in fact be more prosaic. Three new parties emerged in the 2009 election: Praja Rajyam in Andhra Pradesh, a splinter group of the Shiv Sena headed by Raj Thackeray in Maharashtra, and a new party in Tamil Nadu. The Congress was the incumbent in all three states, and the new parties helped further split the anti-incumbent vote. This gave the Congress approximately 60 seats more than it would have otherwise won in the 2009 general election. Beyond that, economic improvement may well have helped the Congress, but it remains unproven whether the credit for that goes to rapid growth or increased welfare spending. However, most Congress stalwarts continue to believe that welfarism — not reform — wins votes.
Limited co-operation between political foes reflects the institutional strength of democracy in India, and helps overcome some of the political hurdles to reform in an era of permanent coalitions.
The Big Ticket: Tax Reforms and Concessions BJP support is absolutely essential for the biggest reform bill of all — a Constitutional amendment to abolish the current mélange of taxes levied by the central and state governments, and its replacement it by a Goods and Services Tax (GST). This amendment, which would require a twothirds majority in both houses of parliament, could truly modernize Indian tax administration, eliminating cascading taxes and curbing tax evasion. The substance of this bill has been hammered out by a committee of state finance ministers over the last decade, including those of states governed by the BJP and Left Front. But the BJP has recently raised fresh objections of a political, rather than technical, nature. It probably will not assent to the GST legislation until the central government goes slow on the prosecution of BJP politicians for the mass killing of Muslims in Gujarat in 2001. In this case, at least, political reform is complicated by the politics of religion. The Congress has, it appears, been rewarded for its patience. The BJP has agreed to support a long-pending Pensions Bill that will, among other things, allow private players into pension funds, which in turn will be allowed to invest in equities. In return, the Congress has agreed to postpone a bill creating an Academy of Scientific and Innovative Research, which the BJP objects to. This limited co-operation between political foes reflects the institutional strength of democracy in India, and helps overcome some of the political hurdles to reform in an era of permanent coalitions, in which no party can realistically win a majority in parliament.
Expectations that the second UPA government would surge forward with reforms proved ill-founded.
The second UPA government also lacks a majority in the Rajya Sabha, the upper house of India’s parliament. It can try to make concessions to regional parties to secure their votes for controversial bills, but such support would be unpredictable and unreliable. Finance Minister Pranab Mukherjee believes that, in many cases, legislation can only proceed by evolving a multi-party consensus, which often means getting the support of the BJP, the main opposition party. Securing BJP support has become so important that the Congress has often been willing to tolerate the BJPs antics, such as blocking the entire winter session of Parliament in 2010 over an investigation into a massive telecom scam. In theory, the Congress could have asked the Speaker to expel unruly BJP legislators and allow parliament to proceed, but it wilted out of a desire to secure BJP support on some key bills.
Episodic and Half-Hearted Reforms The bottom line is that future reform in India will be slow, but all indications are that it will still move in the right direction. Corruption has become a big issue thanks to the recent wave of middle class outrage stoked by the media, and it seems all parties may agree to legislation that limits the scope for ministerial discretion in awarding government contracts or selling government property. This will be a net positive for economic reform.
About the Author
Swaminathan S. Anklesaria Aiyar is consulting editor of The Economic Times in India, and a research fellow at the Global Prosperity Center of the Cato Institute, Washington DC.
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Legislation is not necessary to allow foreign direct investment in the retail sector, or to liberalize rigid labor laws that inhibit the growth of labor-intensive industries.
On the other hand, we should beware the interpretation that the absence of a parliamentary majority for the UPA, notably in the Rajya Sabha, is the only reason for the slow pace of reforms. No new legislation, for example is required to decontrol oil prices and fertilizer costs, remove subsidies for electricity and water for farmers, or discipline absent teachers and health workers. Similarly, legislation is not necessary to allow foreign direct investment in the retail sector, or to liberalize rigid labor laws that inhibit the growth of labor-intensive industries. Yet this UPA government has shown no inclination to move forward on any of these issues. The Congress Party is, at its core, populist with old socialist roots, and believes that wooing voters with handouts is good electoral practice. Combined with the realities of coalition politics, this means that future reform in India will tend to be hesitant, episodic, and half-hearted.
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