The Congress led United Progressive Alliance (UPA) government has been talking about economic reforms over the last two months. This after more or less ignoring them since May 2004, when they first came to power.
The rupee’s rapid depreciation against the dollar which started towards the end of May 2013, and which could lead to a serious economic crisis, has forced the government to get a tad serious on the reform front.
The recent Indian experience is no different from how things have happened all over the world. It takes an economic crisis or the possibility of one happening, to get economic reforms going, more often than not.
Nevertheless, the question is why wait till things turn really bad and then start implementing economic reforms? As Alberta Alesina and Allan Drazen ask in a research paper titled Why are Stabilizations Delayed? “Countries often follow policies for extended periods of time which are recognized to be infeasible in the long run. For instance, large deficits implying an explosive path of government debt and accelerating inflation are allowed to continue even though it is apparent that such deficits will have to be eliminated sooner or later. A puzzling question is why these countries do not stabilize immediately, once it becomes apparent that current policies are unsustainable and a that change in policy will have to be adopted eventually.”
The government expenditure in India has exploded over the last few years and more than doubled(gone up by 133%) to Rs 16,65,297 crore between 2007-2008 and 2013-2014. An increase in expenditure has also led to an increase in the fiscal deficit or the difference between what the government earns and what it spends. The fiscal deficit between 2007-2008 and 2013-2014 has gone up by 327.4% to Rs 5,42,499 crore.
It was only recently that the government started taking steps to control the fiscal deficit by trying to control the subsidy it offers on cooking gas, petrol and diesel.
A similar thing has happened on the current account deficit front. The current account deficit(CAD) for the period of 12 months ending March 31, 2013, was at 4.8% of the GDP or $87.8 billion. The CAD is the difference between total value of imports and the sum of the total value of its exports and net foreign remittances.
The level of the CAD at 4.8% of GDP was much higher than the comfortable level of around 3% of GDP. It did not reach such a high level overnight. In fact warnings were made as early 2010 on the mess India would end up in because of the high CAD. And that’s precisely what has happened over the last few months. A high CAD has led to a shortage of dollars, which in turn has led to the depreciation of the rupee against the dollar.
But it was only very recently that the government started to make serious efforts on this front to ensure that the dollars kept coming in. One such move was to increase the allowed level of foreign direct investment(FDI) into a host of business sectors.
What India has seen over the last few months is minor economic reform at best and that too has happened because of the ‘possibility’ of an economic crisis. “The fact that broad-ranging, fundamental economic reform is difficult is attested to by the simple observation that it is quite rare,” writes Val Koromzay in a paper titled Some Reflections on the Political Economy of Reform.
There are many reasons for economic reforms being as rare as they are. Lets look at some reasons which are valid in the Indian context.
A major reason is the fact that politicians do not see beyond their terms. As Dennis Arroyo writes in a research paper titled The Political Economy of Successful Reform: Asian Stratagems “A politician elected to a 3-year term may know that proposed reforms may bear fruit in 8 years. So why scuttle re-election by inflicting temporary economic pain? They would rather optimize over the short term. The benefits of reform do not ripen fast enough to fit the political cycle.”
Lets take the case of allowing FDI in multi-brand foreign retailing (in simple English allow Wal-Marts of the world to operate in India), a decision which was hanging for more than a decade. When FDI was finally allowed into multi-brand retailing in September 2012, it came with too many terms and conditions attached to it. Some of these conditions were done away with recently.
The benefits that India is likely to get in the form of better supply chains, elimination of middle-men, lesser wastage of food, greater consumer choice etc, will not happen overnight. Meanwhile, the government would have to face the heat from opposition parties, traders, and even the press. This largely explains why the Congress led UPA government took a long time to bite the bullet on this front. If the government had made this decision after being re-elected in 2009, the benefits of this reform would have started to become visible by now. As Arroyo puts it “The conventional wisdom is that politicians should use the early honeymoon period to embark on the difficult reforms. The latter will yield fruit by the end of their terms, just in time for the campaign period for reelection. Surprisingly, reform governments do not often take advantage of this window.”
The question is why is the Congress led UPA government so gung-ho now about allowing multi-brand foreign retailing now, given that its benefits are not going to become visible any time soon? One obvious explanation is that India needs dollars that the foreign companies are likely to bring in, if and when they decide to invest in India.
Then again, this is not going to happen overnight. Koromzay has a better explanation for this sudden commitment of the Congress led UPA government to encourage FDI in multi-brand retailing. As he puts it “There is, I think, a definite role for suicide in politics. When a government reaches the point in a reform process where the prospects for re-election become dim, one has much less to lose by continuing with the reform. Politics is a repeated game, and the political parties (if not, usually, their leaders) will be back to fight another election.”
Then there is also the political cost of reform. Take the case of various subsidies that the Congress led UPA government has been doling out over the years. While it is important to cut down these subsidies, it is easier said than done. As William Tompson and Robert Price write in an OECD study titled The Political Economy of Reform “Fiscal reforms in particular often impose risky political costs (Sobel 1998). They entail raising taxes, cutting program budgets, privatizing state enterprises, downsizing the civil service, removing subsidies on sensitive goods, and reallocating funds from one region to another. There will be winners and losers, but it is difficult to pinpoint who are the net gainers a priori. The people feel this short-term pain and ignore the long-term gain.”
It is also important that politicians pitching for reforms effectively communicate their benefits. As Tompson and Price point out “ The importance of meaningful mandates makes effective communication all the more important. Major reforms have usually been accompanied by consistent coordinated efforts to persuade voters and stakeholders of the need for reform and, in particular, to communicate the costs of non-reform.”
Now when was the last time you saw an Indian politician try and explain the benefits of economic reform to the citizens of this country? As economist Vivek Dehejia told me in an interview that I did for the Daily News and Analysis in August 2012, “What makes reforms more difficult now is what I call the original sin of 1991. What happened from 1991 and thereon was reform by stealth. There was never an attempt made to sort of articulate to the Indian voter why are we doing this? What is the sort of the intellectual or the real rationale for this? Why is it that we must open up?”
It is also important that politicians present a united front on the reform front. As Tompson and Price write “The cohesion of the government is also critical. If the government undertaking a reform initiative is not united around the policy, it will send out mixed messages, and opponents will exploit its divisions; defeat is usually the result.” Given that India has had coalition governments since 1996 total ‘cohesion’ has gone missing from its governments, making it all the more difficult to push through economic reform.
What makes reforms further difficult is the fact that there is a section of the population that benefits if the situation continues to be as it is. Take the case of labour law reforms in India. India has too many labour laws which have held back the growth of labour-intensive manufacturing business. Jagdish Bhagwati and Arvind Panagariya in their book India’s Tryst with Destiny estimate that there are as many as 52 independent Central government Acts in the area of labour. Over and above this there are some 150 state level labour laws in India.
And this has held back the growth of firms because the extra costs of satisfying labour laws are so huge that the firms choose to stay small. But the moment there is any talk of labour laws being reformed there are protests from labour unions and political parties (to which the labour unions are affiliated).
Bhagwati and Panagariya estimate that India has nearly 47 crore workers. And of this less than a crore (98 lakh to be precise) were employed in private sector establishments with more than 10 workers in 2007-08. And it is in the interest of these workers and the political parties their unions are affiliated to, that the status quo continues. As Koromzay puts it “reducing rents in the interest of greater efficiency is a task that can be counted on to evoke the opposition of those whose rents are at risk.”
Given these reasons economic reforms are rare and are only pushed through when a country is facing an economic crisis or is likely to face one. India is in a similar situation right now.
Disclosure: The idea for this article came from Vivek Dehejia’s column Why are Reforms Difficult?published in the Business Standard.
This article originally appeared on www.firstpost.com on August 8,2013
(Vivek Kaul is a writer. He tweets @kaul_vivek)