Reforms in India: Democracy's drawbacks

An excellent article. Very blunt and beats around no bushes. Expands on the term "India has a democratic govt and communist economy".
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Sustained growth in India would be all the more impressive if the government could pass its reforms. But the road is blocked by politics.

Out of this IT infrastructure has grown a huge business in “outsourcing” almost any business process that can be performed remotely, from answering a call in a help centre to interpreting an X-ray. The largest outsourcing firm relaunched itself in September as Genpact, partially disguising its origins as the Indian back-office of General Electric, and expects to exceed $1 billion in annual sales by 2008.
These service businesses have thrived because they have capitalised on India's strengths—computer skills, fluency in English—and are not hostage to its weaknesses. Yet those weaknesses are all too obvious, and are the reason why India on many counts still lags behind its neighbour-rival, China. India has lousy infrastructure, bumbling and burdensome regulation and restrictive labour laws. And economic reform now appears to have stalled in political recriminations.

Last year's election gave no party a clear majority. A delicate arrangement allowed Manmohan Singh, of the left-of-centre Congress party, to take office as prime minister, while a committee was set up to negotiate policy between Congress and its coalition partners (together called the United Progressive Alliance or UPA) on the one side, and the Left Front of Communists and other left-wing parties on the other. The committee, however, has not managed to meet since June, though on October 26th there were rumours that it was about to. Meanwhile, the Communists—without whom the coalition has no majority in Parliament—are getting truculent. They staged a four-month boycott of the co-ordination committee to press their policies and then, in concert with the trade unions, called a one-day general strike on September 29th. It was ignored in many places, but the banks, along with the Communist stronghold of Kolkata (Calcutta), were paralysed.

When Mr Singh was finance minister, in the 1990s, it was he who pushed through the measures that kick-started reform in India. Without the support of the Left Front, however, he can do nothing more. His most significant legislative achievement to date has been a law that guarantees 100 days' employment to every household in India's 200 poorest districts. Though the Left Front loves it, many economists reckon that much of the money—as much as 1% of GDP, by some estimates—will be wasted or stolen.

The Left Front, which draws most of its support from organised labour, does not greatly care. Its eyes are on state elections due next year in West Bengal (whose capital is Kolkata) and Kerala, the two biggest states where the Communists are strong. Those who are losing out from unreformed labour laws are hundreds of millions of people now marginally employed in the countryside. These people need jobs in manufacturing if India is to improve its record on poverty, as well as growth. Jobs could be found in the labour-hungry textile industry, especially now that, with the ending of the developed world's protectionist Multi-Fibre Arrangement, India's textile exports are booming. As it is, a jobless boom is going on in manufacturing, which is growing at 7% annually, but without increasing employment.

Touches of xenophobia
India's antiquated laws are not only preventing it from exploiting the textile boom as successfully as China (whose textile businesses are so successful that they provoke retaliation). They are also pushing it far behind China in terms of foreign direct investment. FDI has been the most important driver of China's growth, not just because of the money involved (more than $60 billion last year) but also because of the technology, expertise, marketing relationships and much else that this money represents. India's showing has been far less impressive: about an eleventh of China's haul last year (see chart 3).

One chief reason for the discrepancy is that India imposes caps on FDI in a host of economically important, or politically sensitive, sectors: insurance, aviation, coal-mining, media and much else. Chief among these is retailing. Though franchise operations are allowed, foreign direct ownership is banned, which explains why even Delhi's smartest shopping areas are scruffy and chaotic places with limited stock.


Mr Singh's government would like to raise the caps, and had some success at first. It proposed in February, for example, that the cap for telecoms investment should be lifted from 49% to 74%, and this has just, at last, been approved. But the Left Front is violently opposed to any tinkering with the rules for FDI in retailing. Its leaders appear to accept that the advent of, say, Wal-Mart would generate many jobs, since much of what the company sold would be domestically produced (Wal-Mart spends $15 billion a year in China). But they worry that millions of small retailers would be put out of work. For those who want to move out of farm work, a small shop is often their first choice.

Mr Singh remains optimistic, but on slender grounds. With the Left Front so adamant, nothing is likely to happen. And the same is true of privatisation, or its younger sibling, disinvestment, the selling of minority stakes in state-controlled companies. From the very start of its tenure, the government was forced by the Left Front to agree not to privatise nine so-called “crown jewels”, or leading state-owned companies. But the Left has taken advantage of its position to go beyond what was originally agreed. When, in June, the government announced plans to sell a 10% stake in Bharat Heavy Electricals, an engineering firm, the Left Front vigorously objected. Although the sale does not require legislation, and so could be enacted by the minority government, the government shows no stomach for doing so.

Another disappointment—though the word is perhaps inappropriate, since no one ever expected a Congress government to have the necessary courage—is the failure even to attempt to do anything about the mountain of subsidies that distort the Indian economy. Often badly targeted, benefiting middle-class people more than the poorest, they consume a shocking 14-15% of GDP.

Worst of all, Indian politics may actually be retreating to its bureaucratic past. Take oil pricing, a complex statist rigmarole that had been moving from the hands of government to those of a regulator. Under Mr Singh, price decisions are again being taken by the government.

The prime minister's instincts are sometimes depressingly bureaucratic. Faced with obvious and longstanding problems, he commissions a study on them. The latest strategy document appeared in September from a specially convened National Manufacturing Competitiveness Council. It listed the most pernicious difficulties for manufacturers: power shortages, taxes and the “inspector raj”. No one was surprised by these, or felt much hope they would be fixed.

Removing the brake
It may seem odd, if reform is so important, that the economy is doing so well without it. There are a number of reasons. The biggest is that the Indian economy is so strong, structurally and cyclically, that it can ride out a period of wobbly policy. India's young population gives it a fast-growing workforce and a declining proportion of dependants. Over the next few decades, that will be good for savings and investment. Industry, meanwhile, has recovered from a splurge of over-investment in the mid-1990s. It has improved efficiency and is now both reaping the benefits and investing again in new capacity.

The government started to get out of business's way in the 1980s and, especially, after a balance-of-payments crisis in 1991. At that point Mr Singh, as finance minister, was given the freedom to bring in reforms by an unexpectedly brave prime minister, Narasimha Rao. Since then, government has been unable to put an absolute crimp on growth. Many important reforms—especially trade liberalisation, but also the dismantling of the “licence raj” of bureaucratic obstacles to enterprise—are well in train and not in reverse.

Too many are still losing out
Almost every budget since 1991, including this year's, has cut import tariffs and freed more industries from “reservation” for small firms, a big hindrance to competitiveness in businesses that might benefit from economies of scale. This year, moreover, saw the introduction of one long-planned reform, a standardised value-added tax imposed at state level. Typically, politics meant that not all states fell into line, and implementation has been patchy. Yet the tax may eventually not only bring new fiscal stability, but also reduce the burden of cascading excise and sales taxes that is one of the biggest handicaps facing manufacturers. Modest, piecemeal reform, in other words, is not quite dead.

The government's priorities—investment in infrastructure, agriculture, basic education and primary health care—are also right, given that the big macroeconomic stuff was mostly done in the 1990s. But they all need money, and that requires fixing the budget. India's fiscal deficit is now 8% or so of GDP if both state and central governments are counted—an improvement after six years of double-digit deficits, but still too high. Public finances have been in a mess for so long that it seems almost impolite in government circles to mention them.

The deficit, which goes largely on interest payments (40% of recurrent spending), defence, subsidies and civil-service wages and pensions, leaves little room for big capital investments. Some new airports, ports and roads are being built, and the “Golden Quadrilateral” highway, linking India's four biggest cities, is being expanded to six lanes. But Mr Singh wants a good deal more. Improving India's infrastructure, he says, is his top priority. Hence his government's zeal for “public-private partnerships” to finance and construct it.

A standard concession agreement is to be produced soon, modelled on successes with toll roads, where concessionaires have put in competitive bids for government grants. For some projects, the government does not need parliamentary approval and can proceed anyway. Other projects, however, such as airports, will run into objections from the left. It is therefore hard to see these partnerships making much of a dent in what Montek Singh Ahluwalia, the prime minister's chief planner, calls India's “infrastructure deficit”.

Might the left-wing parties ever become less obstreperous, and realise that reforms like these are of benefit to all Indians? It is possible. Jairam Ramesh, a Congress member of parliament who played a big role in writing the “common minimum programme” that defines relations between the UPA and the Left Front, floats the interesting theory that, now that Congress has enacted the Employment Guarantee Act that the Left was so keen on, the Left may prove a little keener on asset sales. They would, after all, be a way of paying for all those jobs.

From the Left Front come faint signs of accommodation. Prakash Karat, the general secretary of the CPI (M), the most important party within the group, is, like Mr Ramesh, adamant that full-scale privatisation of profitable public enterprises is not on the agenda. But he says the party is “ready for a discussion” on how to raise resources for spending on the poor.

Among the most eloquent advocates of a re-think is, in fact, a senior Communist, Buddhadeb Bhattacharjee, chief minister of West Bengal, a state of 82m people run for 28 years by the Communists and their allies. On September 30th, the day after Communist-affiliated trade unions had brought his capital, Kolkata to a halt, he could scarcely conceal his exasperation. He told The Economist that the trade unions—and many of his party comrades—had become “one-dimensional”, representing only the interests of the 30m or so workers in India's “organised” sector.

Mr Bhattarcharjee concedes that some of his colleagues in Delhi do not seem to grasp that economic reform could benefit a much bigger number of workers than those who belong to unions. If they do, they perhaps see political benefits in ignoring it. But “Here, we are running a government. We have to fulfil the aspirations of the people.” To that end, he is trying to turn Kolkata into a hub for the information-technology industry by declaring it a “public utility” where strikes are banned, and has started going abroad to bang the drum for inward investment.

Jobs for the poor
Such enthusiasm may start to shift the political balance back towards reform, but it looks unlikely. For the foreseeable future, both left-wing intransigence and lack of decent infrastructure—in particular, a chronic shortage of electricity—will constrain India's growth. An average annual rate of 6-7%, as in the past decade, does not seem a tall order. But a gear-shift to a durable growth rate of 8-10% still seems out of reach.

Without it, that burgeoning workforce may seem less of an advantage. Shankar Acharya, a former government economist now at a Delhi think-tank, worries that between now and 2051 nearly 60% of India's population increase will come from four “populous, poor, slow-growing northern states with weak infrastructure, education systems and governance”.

China has sucked surplus agricultural labour into factories by the tens of millions. India's manufacturing industries, by contrast, have progressed by becoming more productive. They are still not a big source of rural employment. As a good liberal economist, Mr Singh says he does not believe in having an “industrial policy” or picking favourites. Create decent infrastructure, and industry will come—and he sees huge potential, as do many others, in food-processing. His finance minister has spoken of 12m new jobs in the textile sector alone in the next five years.

They are sorely needed. India's information-technology firms are world-beaters, but the entire IT and office-service industry employs only about 1m people. None of the Asian tigers, not even Singapore, managed its rapid climb into the ranks of middle-income and rich countries without a boom in export-oriented manufacturing. India is unlikely to be different.

When he speaks of following the “Chinese model”, Mr Singh seems to admit this. But it remains sadly true that the free market that has helped the tigers so much often works better in Communist China than in India—not least thanks to India's own democratically elected Communist politicians.

http://economist.com/displaystory.cfm?story_id=5081267