Tag: Arvind Panagariya | Page 2

8 February, 2016

Mr Jaitley’s Search for a One-Handed Economist

“Give me a one-handed economist,” quipped the American president Harry Truman, many years back. “All my economists say, ‘on the one hand…on the other’.”

The finance minister Arun Jaitley is currently probably going through the one-handed economist phase as well. There has been a huge debate going on, in the media, whether the government should relax the fiscal deficit target of 3.5% of gross domestic product for the next financial year i.e. 2016-2017, when it presents its budget later this month. Fiscal deficit is the difference between what a government earns and what it spends.

Economists, as usual, are divided on it. Some like the idea of government spending more in order to revive the slow economic growth (or so they like to believe). Others have been highlighting the negative consequences of the government spending more.

This has left Jaitley, who has no background in either finance or economics, and was a part-time politician and a full-time layer, until few years back, confused. As he recently said: “I’ve been consulting all shades of opinion. This is the first time I’ve come across people holding sharply divided views. Each one has a strong argument in his favour.”

The Chief Economic Adviser to the finance ministry, Arvind Subramanian, has been in favour of the government spending more. In the Mid-Year Economic Analysis released in December 2015, Subrmanian had suggested that in a scenario of lower than expected economic growth (as measured by the real/nominal GDP growth) “if the government sticks to the path for fiscal consolidation, that would further detract from demand.” Further, “consolidation of the magnitude contemplated by the government… could weaken a softening economy”. Fiscal consolidation is essentially the reduction of fiscal deficit.

The finance minister Arun Jaitley had talked about fiscal consolidation in the two budget speeches he has made till date in July 2014 and February 2015. In the first speech he said that the government is aiming to achieve a fiscal deficit target of 3% of gross domestic product(GDP) in 2016-2017.

In the speech he made in February 2015, he postponed this target by a year and said that the government will achieve a fiscal deficit of 3.5% of GDP in 2016-17; and 3% of GDP in 2017-18. Now there is pressure on the finance minister to abandon the fiscal deficit target of 3.5% of the GDP set for 2016-2017, from one set of economists and the industry.

The trouble is another set of economists does not agree with this. Economist Arvind Panagariya, who happens to be the vice chairman of the NITI Aayog said in January 2016: “I personally don’t think we should be tinkering with the deficit as a percentage of GDP.”
Raghuram Rajan, the governor of the Reserve Bank of India, has also been an advocate of the government sticking to a path of fiscal consolidation. He reiterated the same in a recent speech as well as the monetary policy statement released last week.

One of the interesting points that Rajan made was that India’s overall fiscal deficit position has deteriorated. As he said: “The consolidated fiscal deficit of the state and centre in India is by far the largest among countries we like to compare ourselves with; presently only Brazil, a country in difficulty, rivals us on this measure. According to IMF estimates (which is what the global investor sees), our consolidated fiscal deficit went up from 7 percent in 2014 to 7.2 percent in 2015. So we actually expanded the aggregate deficit in the last calendar year. With UDAY, the scheme to revive state power distribution companies, coming into operation in the next fiscal, it is unlikely that states will be shrinking their deficits, which puts pressure on the centre to adjust more.”

One reason why government’s numbers are different from IMF numbers is because the government of India under-declares its fiscal deficit. How does it do it? The government recognises the disinvestment of shares in public sector units as a revenue rather than as a financing item.

As economist Rajeev Malik of CLSA put it in a recent column in the Mint: “India tends to under-report its fiscal deficit because it counts divestment and other asset sales as revenue rather than a financing item, as is practised by the International Monetary Fund (IMF). Thus, the FY16 budget deficit target—adjusted for divestment—was actually 4.4% of GDP, not 3.9% as officially reported.”

“Rating agencies remain strangely silent on this self-serving approach,” Malik validly points out.

What complicates the situation further is that the government follows the cash accounting system and only acknowledges expenses once payment has been made. This has led to a situation where subsidy payments to Food Corporation of India(FCI) and fertilizer companies remain unpaid. The money has been spent by FCI and the fertilizer companies but remains unpaid by the government, and hence is not acknowledged as an expenditure.

The question is where does FCI get this money from? It borrows from the financial market. Why does the market lend money to FCI? It does that because it knows that it is effectively lending money to the Indian government. Hence, this subsidy expenditure has already been incurred by the government but has not been accounted for.

As economist M Govinda Rao put it in a recent column in The Financial Express: “In fact, the cash accounting system hides the real fiscal deficit which is much higher as substantial subsidy payments to Food Corporation of India and fertiliser companies are yet to be disbursed.”

While Jaitley may keep debating whether or not to abandon the fiscal deficit target that he set previously, he needs to tell us clearly what is India’s real fiscal deficit. If that means that he doesn’t get around to meeting the target.

Getting back to Rajan, the RBI governor also raised the question, whether the extra economic growth that will come in because of the government abandoning its fiscal deficit target and spending more, be worth it.

As Rajan said: “Perhaps Brazil offers a salutary lesson. Only a few years ago, the world was applauding the country’s thriving democracy, its robust economic growth, and the enormous strides it was making in reducing inequality. It grew at 7.6 percent in 2010…Paradoxical as it may seem, Brazil tried to grow too fast. The 7.6 percent growth came on the back of substantial stimulus after the global financial crisis.”

In fact, India tried the same strategy in the aftermath of the financial crisis, with the government coming up with a substantial economic stimulus. While this lifted the economic growth for the next few years, it led to a huge increase in corporate debt and high inflation, the aftermaths of which the country is still facing.

The column originally appeared in the Vivek Kaul Diary on Equitymaster on February 8, 2016

10 September, 2015

Why India missed out on the industrial revolution and might miss it again

The Prime Minister Narendra Modi met representatives of Indian business on September 8, 2015. The Indian businessmen as usual asked for lower interest rates, weaker rupee and so on, to get economic growth going.

Modi on the other hand emphasized on job creation and the role the private sector could play in it. A report in the Mint newspaper points out that Modi also prodded the banks to help small and medium enterprises in the so-called informal sector as “they have great potential for generating new jobs”.

As I have mentioned in previous newsletters of The Daily Reckoning, creating new jobs should be a top priority of the Modi government. This is primarily because 13 million Indians are entering the workforce every year.

Also, as I have mentioned in the past, the only way countries have gone from being developing to being developed is by unleashing a manufacturing/industrial revolution. Despite having a huge labour force and initiating economic reforms in 1991, India has missed out on the manufacturing revolution.

Why is that the case? As Sanjeev Sanyal writes in The Indian Renaissance—India’s Rise After a Thousand Years of Decline: “The country [i.e. India] appears to have shifted from farming to services without having gone through an industrial stage. This not only goes against conventional wisdom but also the experience of other fast-growing Asian economies particularly China.”

China and other Asian countries (Japan, Taiwan, South Korea and countries of South East Asia) essentially followed an export oriented manufacturing strategy to create economic growth. They started with low-end exports and then gradually started going up the value chain. “These economies usually started out by scaling up low-skill exports like making ready-made garments, toys, cheap household items and so on. With time, they all move up the value chain as wages rise and their workforce become more skilled. Exports shift to things like high-end electronics and automobiles,” writes Sanyal. The services sector becomes a driver of growth only later.

In the Indian case, nothing like that happened. After the 1991 economic reforms, we moved on to exporting complex automobile parts and pharmaceuticals. We also exported information technology and became a global hub of the business process outsourcing industry. India also saw a huge expansion in banking, hotels, airlines, cable television, telecom and so on. None of this was low-end, like was the case of Asian countries as well as China. Hence, we jumped from farming to services, without going through an industrial/manufacturing stage.

And this jump from farming to services, without going through an industrial stage, is counter-intuitive. In fact, India should have latched on to a low end export oriented manufacturing strategy much before the 1991 reforms. But that did not happen.

In order to understand why, we need to go back in history and talk about a gentleman called Prasanta Chandra Mahalanobis. Mahalanobis founded the Indian Statistical Institute in two rooms at the Presidency College in Calcutta (now Kolkata) in the early 1930s. He became close to Jawahar Lal Nehru, the first Prime Minister of India, and was appointed as the Honorary Statistical Advisor to the government of India.

As Gurcharan Das writes in India Unbound –From Independence to the Global Information Age “His biggest contribution was the draft plan frame for the Second Five Year Plan…In it he put into practice the socialist ideas of investment in a large public sector (at the expense of the private sector), with emphasis on heavy industry (at the expense of consumer goods) and a focus on import substitution (at the expense of export promotion).”

Hence, big heavy industry became the order of the day at the cost of small consumer goods. The alternative vision of encouraging the production of low-end consumer goods was put forward as well. As Das writes “It belonged to the Bombay [now Mumbai] economists CN Vakil and PR Brahmanand. It was neither glamourous nor as technically rigorous as Mahalnobis’s, but it was more suited to the underdeveloped Indian economy. Its starting point was that India lacked capital but had plenty of people…The thing to do was to put these people into productive work at the lowest capital cost.”

And how could this be done? “The Bombay economists suggested that we employ the surplus labour to produce “wage goods,” or simple consumer products – clothes, toys, shoes, snacks, radios, and bicycles. These low-capital, low-risk, business would attract loads of entrepreneurs, for they would yield quick output and rapid returns on investments. Labour would produce the goods it would eventually consume with the wages it earned in producing the goods,” writes Das.
Nevertheless, with the focus on the public sector, nothing like that happened.

But why did India miss out on a manufacturing/industrial revolution even after the process of liberalization started in 1991? India’s domestic savings through much of the 1990s stood at around 23% of the GDP. A major portion of these savings went into financing the government fiscal deficit. Given this, interest rates were high and “the country was forced to use capital sparingly,” writes Sanyal. Any industrial revolution needs a massive amount of capital, which wasn’t easily available in the Indian case.

Further, even with economic reforms many things on the ground did not change. As Sanyal writes: “The easing of big-picture impediments like industrial licensing and import tariffs did not get rid of the underlying framework of over-regulations, bureaucratic delays and erratic judicial enforcement. The country had built up a huge baggage off laws, by-laws and regulations at every layer of government during the half-century under socialism.” Much of this still remains to be dismantled.

Take the case of labour laws. There are more than fifty labour laws just at the central government level. As Jagdish Bhagwati and Arvind Panagariya write in India’s Tryst with Destiny: “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra (the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them.”

These laws prevent small Indian firms from growing bigger. They also prevent big Indian industrialists from entering sectors that can employ a huge amount of labour. Bhagwati and Panagariya recount a story told to them by the economist Ajay Shah. Shah, asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already backward integrated and made yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worthwhile only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”

If Narendra Modi wants Indian businesses to create jobs, he first needs to sort out the labour laws. And that will be easier said than done.

The column originally appeared on The Daily Reckoning on Sep 10, 2015

15 April, 2015

Indian firms are not creating enough jobs and the reason is restrictive labour laws

Vivek Kaul

Arvind Panagariya, the vice chairman of the NITI Ayog, recently said that Indian companies do not invest in industries which have the potential to employ a lot of people or what economists refer to as labour-intensive sectors. “Here is my charge to you: if I look around, none of you invest in industries, in sectors that would generate lots of employment; all of you just run away from hiring purpose,” Panagariya said.
Every month more than a million Indians are entering the workforce. As Panagariya put it: “Every year, 12 million enter the labour force. What is your plan for the country so that more people are employed? We really need to think. You know the ground conditions; why you are not investing in sectors which are more labour-intensive such as food processing, electronic assembly, leather products.”
The question that Panagariya was asking is why do Indian businesses shy away from investing in labour intensive sectors? This has led to a situation where the growth in labour force in India has been much faster than the rate at which jobs are being created.
As the latest Economic Survey points out: “Regardless of which data source is used, it seems clear that employment growth is lagging behind growth in the labour force. For example, according to the Census, between 2001 and 2011, labor force growth was 2.23 percent (male and female combined). This is lower than most estimates of employment growth in this decade of closer to 1.4 percent. Creating more rapid employment opportunities is clearly a major policy challenge.”
This slow growth in jobs has happened despite the Indian economy growing at a very fast rate for most of the period between 2001 and 2011. One obvious reason as Panagariya explained is the reluctance of Indian businesses to invest in sectors that are labour intensive. And there are reasons for the same.

The labour laws in India remain very restrictive. In their book India’s Tryst with Destiny Jagdish Bhagwati and Panagariya recount a story told to them by the economist Ajay Shah. Shah, asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already backward integrated and made yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worth while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”
Labour comes under the concurrent list of the Indian constitution i.e. both central and state governments can make laws on it. This has led to a situation where there are a surfeit of labour laws which companies need to follow. As Bhagwati and Panagariya write: “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra (the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them.”
This explains why Indian businessmen stay away from labour-intensive businesses. It also explains why Indian businesses start small and continue to remain small. As Bhagwati and Panagariya point out: “As the firm size rises from six regular workers towards 100, at no point between these two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra cost of satisfying the laws”.
This means many firms that can grow bigger choose not to and in the process don’t create jobs that they would have otherwise. The textile sector is a very good example where most Indian firms continue to remain small. 92.4% of workers in this sector work with small firms which have forty-nine or less workers. Now compare this to China where large and medium firms make up around 87.7% of the employment in the apparel sector.
In fact, even Bangladesh has overtaken India in the textiles sector. As Mihir S. Sharma writes in Restart—The Last Chance for the Indian Economy: “Before the expansion of trade thanks to new international rules in the twenty-first century, India made $10 billion from textile exports, and Bangladesh $8 billion. Today India makes $12 billion—and Bangladesh $21 billion.”
So what happened here? The textile industry, explains Sharma, needs to turnaround big orders quickly and efficiently. “Really long assembly lines still matter in textiles: in some cases, 100 people can sequentially work to make a pair of trousers in least time. In Bangladesh, the average number of people in a factory is between 300 and 400; in the South Indian textiles hub of Tirupur, it’s around 50,” writes Sharma.
To allow Indian businesses to grow bigger, the government will have to prune down its long list of labour laws. But politically that remains a very difficult thing to do. Further, research shows that new and young businesses create the maximum jobs. As an OECD research paper points out: “SMEs (small and medium-sized enterprises) account for 60 to 70 per cent of jobs in most OECD countries, with a particularly large share in Italy and Japan, and a relatively smaller share in the United States. Throughout they also account for a disproportionately large share of new jobs, especially in those countries which have displayed a strong employment record, including the United States and the Netherlands. Some evidence points also to the importance of age, rather than size, in job creation: young firms generate more than their share of employment.”
This can only happen in India if the ease of doing business and starting a new business goes up in the years to come. To conclude, Mr Panagariya asked a question for which he already had the answer.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The article originally appeared on Firspost on April 15, 2015

20 August, 2014

Labour reforms: What Modi’s ‘Make in India’ call can learn from the Bolsheviks

Vivek Kaul

I was just joking to a friend during the course of a discussion in early August that soon we will start talking about the Rajasthan model of development. And that seems to have happened sooner than I had estimated.
The Business Standard in an editorial titled The Rajasthan Model today (August 19,2014) writes that Vasundra Raje, the chief minister of Rajasthan “is single-handedly creating a “Rajasthan model” of development.” This model, the paper goes on to write, differs from other models like the “Bihar model” and the “Gujarat model” in putting “liberal economic reform at the centre of the development strategy”.
Labour reforms are a key part of what seems to be emerging as the “Rajasthan model”. It is well worth mentioning here that the size of the organised work force in India is only around 15.8% of the total workforce (Source: What’s Holding Back India’s Labour Market Environment? Part 1, Morgan Stanley, August 12, 2014). And this work force which is highly unionised and tends to punch over its weight, has held back the growth of the Indian manufacturing sector.
Before we go any further let’s go back a little in history. Nicholas II, the last Tsar of Russia abdicated(i.e. relinquished) his throne in early 1917, after a massive revolt broke out. As Alan Beattie writes in False Economy—A Surprising Economic History of the World “Undermined by Russia’s dismal military failure on the Eastern Front of the First World War, the Tsar abdicated in February 1917 after a massive rolling revolt grew in Petrograd [known as St Petersburg till 1914, changed to Leningrad in 1924 and back to St Petersburg in 1991]…Starting with industrial workers, the rebellion then progressed to thousands of mutinying soldiers. This was a popular uprising but not a communist uprising.”
In fact, the communists were caught napping around the time of the popular uprising. “The ‘Bolshevik’ political grouping led by Vladimir Lenin and Leon Trotsky, which would eight months later take control of the country and become the Communist Party of the Soviet Union, was taken by surprise. Many of its key members were not even in Russia at the time, giving rise to the faintly comic spectacle of a bunch of revolutionaries hurrying home to catch up with a revolution,” writes Beattie.
Over and above that the Bolsheviks did not have support of people across the length and breadth of Russia. The Socialist Revolutionaries had that support. Nevertheless the Bolsheviks still managed to seize power. What worked in favour of the Bolsheviks was their “increasing control over Petrograd’s ‘soviet’, or workers’ organization, through the months that followed.”
As Beattie writes “They [i.e. the Bolsheviks] watched their rivals punch themselves out and exhaust local popular support by trying to run a provisional government after the February revolution. Amid mounting discontent with the [First World] war, which was still continuing, the Bolsheviks’ October revolution was a special forces assassination of a tottering government, not a pitched battle against the commanding heights of a functioning state.”
In fact, more people were accidentally killed when director Sergei Eisenstein was making a movie on the October revolution than were killed “during the event itself”. The Bolsheviks managed to punch way above their weight because their support was concentrated around Petrograd where the seat of power was, in comparison, the support of the Socialist Revolutionaries was spread across Russia’s vast interior. And given this, as Beattie writes “The Bolsheviks found it amazingly easy simply to dismiss the Constituent Assembly which was supposed to take power and in which the Socialist Revolutionaries had a clear majority, and take control themselves.”
The Indian labour market is similarly placed. The organised labour tends to punch above its weight like the Bolsheviks, primarily because labour laws are rigged in its favour. It is also unionised and the unions ensure that any prospect of labour reform which is beneficial to the overall labour force and not to organised labour, is vociferously opposed.

If genuine labour reform has to happen, it is this ability of the organised labour force to punch above its weight, that needs to be controlled. Let’s take the case of the Industrial Disputes Act 1947. According to this Act any factory employing more than 100 workers needs the permission of the state government, if it decides to lay off a worker. The permission to lay off employees if the situation demands so is difficult to get.
This has led to a situation where firms continue to remain small even when they have an opportunity to grow. It also explains why a country like Bangaldesh manages to export more apparel than India. Economist Arvind Panagariya in an open letter to Rahul Gandhi in November 2013 wrote that “India exported less apparel than much smaller Bangaldesh and less than one-tenth that by China.” Most Indian apparel firms start small and continue to remain small.
This leads to a situation where they cannot benefit from the economies of scale and hence, cannot compete in the export market. In their book India’s Tryst with Destiny, Jagdish Bhagwati and Panagariya point out that 92.4% of the workers in this sector work with small firms which have forty-nine or less workers. Now compare this to China where large and medium firms make up around 87.7% of the emplo
yment in the apparel sector.
Given this, the smallness of the Indian apparel sector, the economies of scale never come into play. As Panagariya wrote in the Business Standard recently “It is astonishing that Indian laws view a factory of 100 workers as a large, corporate firm. In the United States, any firm with fewer than 250 workers is classified as “small”, while a firm with 250 to 500 workers is classified as “medium”. Even the World Bank, a development institution, defines a firm with 50 to 300 workers as being of medium size, and not large.” This ensures that a firm that starts small, continues to remain small. And this ultimately has an impact on job creation. As Chetan Ahya and Upasana Chachra of Morgan Stanley point out in a research note titled What’s Holding Back India’s Labour Market Environment? Part 1 “All of these ultimately lead to lower job growth. Indeed, the manufacturing sector accounts for only 12.9% of GDP in India (2013) vs. 31.8% in China (as of 2011), 23.7% in Indonesia, 20.5% in the Philippines, and 14.8% in Brazil.”
History tells us that the creation of a strong and robust manufacturing sector is very important for robust economic growth. But in India’s case the system as it stands is rigged in favour of the incumbent large firms and organised labour.
The Industrial Disputes Act also requires the firm to take consent from the workers before modifying an existing job description. “This creates additional rigidities in the use of labour in response to changing market conditions,” write Ahya and Chachra.
Another tricky point is the fact that only 10% of the workforce is required to start a trade union. As the Trade Unions (Amendment) Act, 2001 points out “No trade union of workmen shall be registered unless at least 10% or 100, whichever is less, subject to a minimum of 7 workmen engaged or employed in the establishment or industry.”
This leads to a situation where there is “scope for multiple trade unions in a single factory”. As Ahya and Chachra point out in a note titled What’s Holding Back India’s Labour Market Environment? Part II dated August 18, 2014, “A company with 700 workers can have 70 trade unions. In most other countries, the requirements for minimum membership for trade unions to be recognized are higher than those in India, reducing the scope for multiplicity of unions.”
In Pakistan at least 20% of the workmen are required for the trade union to be registered. In Bangaldesh the number stands at 30%. Sri Lanka requires a minimum of seven employees for a trade union, but collective bargaining is only allowed if the trade union represents a minimum of 40% of the total employees.
Then there are multiplicity of laws to cope up with. This is primarily because labour law is a concurrent subject and both the central and state governments can legislate on it. As Ahya and Chachra point out “This has resulted in multiplicity of laws, at times with overlapping jurisdictions. Currently there are 44 central laws and about 160 state laws on the subject (ILO, 2013).” It is not rocket science to conclude that it is very difficult for any entrepreneur to follow all these laws. As Reuters columnist Andy Mukherjee wrote in a recent column “As a textile businessman recently tweeted, if small and mid-sized companies in India followed all existing rules, “your underwear will cost what your jeans cost today”.”
The Rajasthan government has begun chipping away at these laws. One of the changes proposed is that a firm needs to approach the state government when laying off workers only if it employes three hundred or more workers. These are state level changes being made to central government regulation, and hence, they need the assent of the president.
But Rajasthan is just a small part of the overall puzzle. Labour market reforms are needed at the central government level especially if Narendra Modi’s recent “Make in India” call needs to be taken seriously.
Currently, China accounts for 17.5% of the total global manufacturing exports. India in comparison stands only at 1.6%. Labour markets reforms at the central government level are needed if that number has to go up.

The article originally appeared on www.Firstbiz.com on August 20, 2014
(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

19 November, 2013

Note to Rahul: India sucks at producing rakhis and Ganeshas

Vivek Kaul

Economist Arvind Panagariya has written an open letter to Rahul Gandhi, on the edit page of today’s edition of The Times of India. In this piece Panagariya answers Gandhi’s query to Indian industrialists, as to why India has to import ganeshas and rakhis from China and can’t produce them on its own.
Panagariya’s answer is very simple. India sucks at labour intensive manufacturing. As he writes “our top industry leaders are very comfortable doing what they do: invest in highly capital-intensive sectors such as automobiles, auto parts, two wheelers, engineering goods and chemicals or in skilled-labour-intensive goods such as software, telecommunications, pharmaceuticals and finance. The vast labour force of the nation stares them in the face but they look the other way.”
This is the major reason as to why India cannot compete with China in manufacturing rakhis and ganeshas. But some historical context also needs to be built in, in order to completely appreciate India’s lack of competitiveness on this front.
Prasanta Chandra Mahalanobis founded the Indian Statistical Institute in two rooms at the Presidency College in Calcutta (now Kolkata) in the early 1930s. He became close to Jawahar Lal Nehru, the first prime minister of India, and was appointed as the Honorary Statistical Advisor to the government of India.
As Gurcharan Das writes in India Unbound –From Independence to the Global Information Age “Mahalanobis had a profound effect on Nehru’s thinking, although he held no offcial position. His title, “Honorary Statistical Advisor to the Government of India,” certainly did not reflect the extent of his influence. His biggest contribution was the draft plan frame for the Second Five Year Plan…In it he put into practice the socialist ideas of investment in a large public sector (at the expense of the private sector), with emphasis on heavy industry (at the expense of consumer goods) and a focus on import substitution(at the expense of export promotion).”
Hence, big heavy industry became the order of the day at the cost of small consumer goods. The alternative vision of encouraging the production of consumer goods was put forward as well. As Das writes “It belonged to the Bombay (now Mumbai) economists CN Vakil and PR Brahmanand. It was neither glamourous nor as technically rigorous as Mahalnobis’s, but it was more suited to the underdeveloped Indian economy. Its starting point was that India lacked capital but had plenty of people…The thing to do was to put these people into productive work at the lowest capital cost. The Bombay economists suggested that we employ the surplus labour to produce “wage goods,” or simple consumer products – clothes, toys, shoes, snacks, radios, and bicycles. These low-capital, low-risk, business would attract loads of entreprenurs, for they would yield quick output and rapid returns on investments. Labour would produce the goods it would eventually consume with the wages it earned in producing the goods.”
But Mahalanobis’s vision of an industrialisted India sounded a lot sexier to the politicians led by Nehru who ran this country and hence, won in the end.
The Indian industrialists had done their cause no good by drafting and accepting the Bombay Plan in 1944. “In 1944, India’s leading capitalists had come together in Bombay and crystalllized their vision for a modern, independent India. They inclued the giants of Indian business – JRD Tata, GD Birla, Lala Shri Ram, Kasturbhai Lallabhai, Purshotamdas Thakurdas, AD Shroff and John Mathai – they produced what came to be known as the Bombay Plan,” writes Das.
The Bombay Plan put forward the idea of rapid and self reliant industrialisation of business in India. At the same time the businesses were willing to accept “import limitations on the freedom of private enterprise”. “Even more disastrous was their acceptance of a vast area of state control – in fixing prices, limiting dividends, controlling foregin trade and foreign exchange, in licensing production, and in allocating capital goods and distributing consumer goods. Without realising it, the Indian capitalists had dug their graves,” writes Das.
Hence, the government became the mai baap sarkar which gave out licenses for everything. And the Indian businessman if he had to survive had to become a crony capitalist to get these licenses. This was initiated during the regime of Jawahar Lal Nehru and perfected during the rule of his daughter Indira Gandhi.
The orientation of the Indian government was towards setting up big industries. What they did not want to set up themselves, they would give licenses to the private sector. And in order to get licenses a businessman had to be close to the government.
This ensured that both the government as well as the private sector set up and continue to set up capital intensive businesses. This is reflected in the slow growth of the number of workers working in private sector etablishemnts with ten or more people. As Jagdish Bhagwati and Arvind Panagariya write in their book India’s Tryst with Destiny – Debunking Myths that Undermine Progress and Addressing New Challenges. “The number of workers in all private-sector establishments with ten or more workers rose from 7.7 million in 1990-91 to just 9.8 million in 2007-2008. Employment in private- sector manufacturing establishments of ten workers or more, however, rose from 4.5 million to only 5 million over the same period. This small change has taken place against the backdrop of a much larger number of more than 10 million workers joining the workforce every year.”
Hence, an average Indian business starts off small and continues to want to remain small. “An astonishing 84 per cent of the workers in all manufacturing in India were employed in firms with forty-nine or less workers in 2005. Large firms, defined as those employing 200 or more workers, accounted for only 10.5 percent of manufacturing workforce. In contrast, small- and large-scale firms employed 25 and 52 per cent of the workers respectively in China in the same year,” write Bhagwati and Panagariya.
What is true about manufacturing as a whole is also true about apparels in particular, a very high labour intensive sector. Nearly 92.4% of the workers in this sector, work with small firms which have 49 or less workers. In comparison, large and medium firms make up around 87.7% of the employment in the apparel sector in China.
The labour intensive firms in China ensure that they have huge economies of scale. This drives down costs and explains to a large extent why India imports ganesha idols and rakhis from China. Everyone wants a good deal. And China is the country providing the good deals and not India.
A major reason for Indian firms choosing to remain small is the fact that the country has too many labour laws. Since labour is under the Concurrent list of the Indian constitution, both the state government as well as the central government can formulate laws on it. As Bhagwati and Panagariya point out “The ministry of labour lists as many as fifty-two independent Central government Acts in the area of labour. According to Amit Mitra(the finance minister of West Bengal and a former business lobbyist), there exist another 150 state-level laws in India. This count places the total number of labour laws in India at approximately 200. Compounding the confusion created by this multitude of laws is the fact that they are not entirely consistent with one another, leading a wit to remark that you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them.”
This explains to a large extent why Indian businesses do not like to become labour intensive and choose to stay small. The costs of following these laws are huge. As Bhagwati and Panagariya write “As the firm size rises from six regular workers towards 100, at no point between these two thresholds is the saving in manufacturing costs sufficiently large to pay for the extra cost of satisfying the laws.”
In fact, Bhagwati and Panagariya narrate an interesting anecdote told to them by economist Ajay Shah. Shah, it seems asked a leading Indian industrialist about why he did not enter the apparel sector, given that he was already making yarn and cloth. “The industrialist replied that with the low profit margins in apparel, this would be worth while only if he operated on the scale of 100,000 workers. But this would not be practical in view of India’s restrictive labour laws.”
This is the answer to Rahul Gandhi’s question of why India imports rakhis and ganeshas from China. Like is the case with almost every big problem in this country, even this is a problem created by his ancestors.

The article originally appeared on www.firstpost.com on November 18, 2013

(Vivek Kaul is a writer. He tweets @kaul_vivek)