Raghuram Rajan’s 10 Solutions to Get Economy Going Again

Summary: This one is for all of you, where are the solutions wallahs. Of course, I have offered many of the solutions that Rajan has offered in a column, but never put them together in one place.

One of the perils of writing on the Indian economy in the last six years has been the repeated comment from a few, don’t tell us about the problems, but give us the solutions. I mean how do you discuss solutions without highlighting problems. How do you come up with a prognosis without coming up with a diagnosis in the first place?

It’s not that one hasn’t highlighted solutions in what one has written over the years, but it’s just that where are the solutions wallahs, don’t seem to notice them. This belief that economics has solutions to everything (particularly among the non-economists, which means most of us), is very strong.

Over the years, I have come to believe that this is primarily because almost all of us are brought up writing exams where every question has an answer and every problem (in the mathematical sense of the term) has a solution. Life and economics don’t work like that. If everything had a solution, the word problem wouldn’t exist in the first place.

Nevertheless, this piece is all about solutions; things that the central government can do right now (and should have been doing by now) to get the economy going again. I have just finished reading Dr Raghuram Rajan’s piece on the Indian GDP (Gross Domestic Product) collapse. GDP is a measure of the economic size of a country.

Dr Rajan, who was the governor of the Reserve Bank of India (RBI), has offered many solutions. These are things that the government can do to get the economy going again. I have offered many of these solutions in my writing as well, though never gotten around to writing about all the solutions together at one place.

Let’s take a look at these solutions, one by one.

1) The government needs to expand its resource envelope in every way possible, Rajan writes. At the cost sounding like a broken record, it needs to sell its stakes in many public sector enterprises (how many times have I said this). In fact, in a sense it has already missed out on the current buoyant state of the stock market. The total amount of money collected through the disinvestment route during this financial year, remains close to zero.

Rajan also suggests that the government should be ready for on tap sale of its stakes in public sector enterprises, to take advantage of every period of market buoyancy.

2) Many public sector enterprises own land, in prime areas of India’s cities. And this land needs to be sold (Again, how many times have I suggested this). In fact, in a city like Ranchi, where I come from, the Heavy Engineering Corporation (a public sector enterprise) sits on acres and acres of government land. All this land across all these companies needs to be sold and money be raised. Of course, this isn’t going to happen overnight.

But that’s not the point here. If the government shows serious intent on this front by announcing a time-table to do this, as well as making preparations for the sale, this is something that the bond market will notice and be happy about.

3) Why is it important to keep the bond market happy? With tax collections collapsing by 30%, between April and July 2020 in comparison to the same period in 2019, it is but natural that the government will end up borrowing more. This is likely to push up the return (or the yield) that the market demands on the government borrowings, given that there is only so much financial savings going around. Other factors that will give confidence to the bond market is the publishing of the correct fiscal deficit numbers unlike the massaged numbers that are currently declared (well, well, well, I have been saying this for a couple of years now). Fiscal deficit is the difference between what a government earns and what it spends.

Another important reform suggested by Rajan is the setting up of an independent fiscal council, which can keep an eye on the deficit numbers (This is something that the former deputy governor of the RBI, Viral Acharya, has also been suggesting).

All in all, the government should seem like making serious moves towards restoring fiscal stability, which is currently lacking.

4) The world will recover faster than India, given that the covid-curve has been flattened across large parts of the world. Given this, economic demand in many of India’s bigger trading partners will recover faster than in India (Again, a point I made in a piece I wrote for the Mint on September 7, 2020). This means that faster exports growth can be a way for India to recover, suggests Rajan. But the trouble is that we are looking at import substitution as a policy more and more and imposing tariffs on imports. This raises the cost of inputs that go into goods that are ultimately exported.

Of course, the intermediary goods that go into the making of goods that are exported, can be produced in India, but this will happen at a higher price. Hence, this makes us uncompetitive at the global level (A point I made in a piece I wrote for the Mint in February). Also, reversing the entire import substitution bogey will mean going against the current atmanirbharta campaign, a very successful perception management campaign. (In economics, just because something sounds good, doesn’t mean it is necessarily good). Economics is not the only thing that any government is bothered about.

5) Rajan suggests that the focus on Mahamta Gandhi National Rural Employment Guarantee Scheme (MGNREGS) as a way of putting money directly into the hands of the poorest, should continue. If this means spending more money under the scheme, then so be it. (Okay, I had suggested this as far back as March in a piece I wrote for the Mint, even before the government had taken this route.)

6) While, MGNREGS takes care of the lack of economic activity in rural areas, the urban areas get left out under the scheme. Hence, the government should be making more efforts to put money into the hands of the urban poor, suggests Rajan.
One of the things that the government has done is to put Rs 1,500 over a period three months into female Jan Dhan accounts. This cost the government around Rs 31,000 crore. I think it is time to put money into male Jan Dhan accounts as well (Again, I have been saying this for months now). This will take care of the urban poor to some extent. I know this isn’t the perfect solution because proper targeting will continue to remain a problem, but it is better than doing nothing.

7) Rajan further suggests that the government and public sector enterprises should clear their dues as fast as possible. This will put more money into the economy and particularly into the hands of corporations and help them survive. (Something I had said in March). A newsreport in The Financial Express today points out that the total amount of money owed by the central government and the public sector enterprises, amounts to Rs 9.5 lakh crore, or a little under a third of the Rs 30.4 lakh crore that the central government plans to spend this year. Of the Rs 9.5 lakh crore, Rs 2.5 lakh crore is owed to the Food Corporation of India (FCI). The remaining Rs 7 lakh crore is a large amount on its own. Even if a portion of this is cleared, the economy will get some sort of a stimulus.

As far as a real stimulus goes, focusing on physical infrastructure is the need of the hour, leading to creation of demand for everything from steel to cement. One area that can really get the Indian economy going again is real estate. I have discussed this so many times before. But for that to happen, so many other things need to happen, including many of the current real estate firms going bust and banks losing a lot of money. Creative destruction needs to be unleashed. Of course, the deep state of Indian real estate is not ready for something like this and will not let it happen.

8) Rajan also suggests that firms below a certain size could be rebated the income tax and the goods and services tax, they paid last year (if not the whole amount, but at least a part of it). This could be an easy and direct way of helping smaller businesses, which have faced the brunt of the pandemic all across the world. (Okay, I haven’t suggested anything like this anywhere, from what I remember).

9) Rajan recommends that public sector banks need to be properly recapitalised as the extent of losses due to covid are recognised. I feel that if the government doesn’t have the money to do so, then it needs to let these banks raise money from the market and in the process, the government should be okay with the idea of diluting its stake. (I have written a book on this )

10) And finally, as the moratorium on repaying loans taken from banks and non-banking finance companies has come to an end, there are bound to be defaults. Here, the government should have a variety of structures in place to deal with the emanating problems, and not have a one size fits all approach. Also, in my opinion, dilution of the entire insolvency and the bankruptcy process, is really not the right way to go forward.

So, to all the where are the solutions wallahs, these were 10 solutions that Dr Raghuram Rajan has offered to the government (Actually, there are more solutions in the piece he has written, but I have stopped at ten. Some of these solutions are about land reforms, labour reforms, genuine ease of doing business reforms, etc., to improve India’s competitiveness, which keep getting made endlessly over and over again). Rajan has also said that the time to do these things is now and not wait for things to get worse.

In my writing over the last few months, I have recommended eight or nine of these solutions as well, though never put all these solutions at one place. One important solution that I think needs to be quickly implemented, is a reduction of the goods and services tax on two-wheelers.

The trouble is that most of these solutions need money to start with. And for that the government needs to come out of its comfort zone and start raising money in ways that it has never done before (like selling land). Also, all reforms need intent and communication clarity to be able to explain these things to the junta at large. Plus, they may not lead to electoral gains immediately, something like a focus on an actor’s suicide may.

You see the government just doesn’t have the incentives to do the right things.

PS: I sincerely hope this should satisfy the appetite of all the where are the solutions wallahs, out there.

Is Narendra Modi ready for the creative destruction that Start-Up India will unleash?

In their brilliant book, Why Nations Fail: The Origins of Power, Prosperity and Poverty, Daron Acemoglu and James A Robinson recount a story from ancient Rome that is relevant even today: “During the reign of the emperor Tiberius, a man invented unbreakable glass and went to the emperor anticipating that he would get a great reward.” Tiberius ruled between 14 AD and 37 AD.

This anticipation of a reward came from the fact that the Roman state did encourage new inventions. Nevertheless, this did not happen and the man was in for a surprise. As Acemoglu and Robinson recount: “He demonstrated his invention, and Tiberius asked him if he had told anyone else about it. When the man replied no, Tiberius had the man dragged away and killed, ‘lest gold be reduced to the value of mud’.”

A similar story comes from the era of Elizabeth I, who ruled England and Ireland from 1558 to 1603. William Lee made a knitting machine in 1589 and approached the Queen for a patent, so that others would not copy his invention and he could cash in on it.

The Queen refused to grant him a patent and told him: “Thou aimest high, Master Lee. Consider thou what the invention could do to my poor subjects. It would assuredly bring them to ruin by depriving them of employment, thus making them beggars.”

Lee went to France and was refused a patent there as well. Back in England, James I (Elizabeth’s successor) also refused to give a patent to Lee’s knitting machine.

By now, dear reader, you must be wondering why I am telling these historical tales, particularly given the headline suggests this is a column on Prime Minister Narendra Modi. Allow me to explain.

In the Independence Day speech Modi gave a few days back, he initiated a new call: “Start-Up India, Stand-Up India”. Whether this was just another marketing slogan Modi and his backroom boys are so good at coming up with, will only become clear in the time to come. But the idea, as Modi explained during the speech, is that each of the 1.25 lakh bank branches all across India “should encourage at least one Dalit or Adivasi entrepreneur, and at least one woman entrepreneur”.

On the face of it, like most of Modi’s big ideas, this makes tremendous sense. Around 13 million Indians enter the workforce every year, and it is start-ups that have the potential to generate the huge number of jobs that India needs to create for its burgeoning workforce.

The trouble is that start-ups also challenge the existing way of doing things and lead to what economists call creative destruction.

Creative destruction was a term coined and defined by Austrian-American economist Joseph Schumpeter in Capitalism, Socialism and Democracy as the “process of industrial mutation that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one”.

This process of “industrial mutation” challenges the existing paradigm, and it is messy, causing reluctance among governments and politicians to accept the new inventions, discoveries and ideas of start-ups.

Here’s Acemoglu and Robinson again: “For sustained economic growth we need new technologies, new ways of doing things, and more often than not they will come from newcomers such as Lee [in today’s terminology essentially start-ups]. It may make society prosperous, but the process of creative destruction that it initiates threatens the livelihood of those who work with old technologies, such as hand-knitters who would have found themselves unemployed by Lee’s technology.”

The point is that if Modi’s “Start-Up India, Stand-Up India” call is more than a marketing slogan, it has the potential for widespread creative destruction, and this will challenge the incumbents and their way of doing things.

Obviously, the incumbents will try to do everything to stop their businesses from becoming irrelevant…including trying to get politicians on their side.
Take the case of what has happened around the entire issue of “net-neutrality, which the mobile phone companies have opposed tooth and nail because it would make substantial portion of their business model irrelevant.

Or take the case how life is being made difficult for taxi-cab operators like Ola and Uber who’ve challenged the existing paradigm. As Acemoglu and Robinson write: The elite, when their political power is threatened, form a more formidable barrier to innovation. The fact that they have much to lose from creative destruction means not only that they will not be the ones introducing new innovations but also that they will often resist and try to stop such innovations. Thus society needs newcomers to introduce most radical innovations.”

If “Start-Up India, Stand-Up India” goes beyond just being a marketing slogan, a whole host of existing businesses will feel threatened, and will approach the government for relief. Given the close relationship most governments share with existing businesses, they are more than likely to oblige.

Acemglou and Robinson offer the example of manufacturers of woollen textiles in England who, when faced with fierce competition from imported textiles, “lobbied Parliament to pass legislation in 1666 and 1678 that would make it illegal for someone to be buried in anything other than woollen shroud’.

If the creative destruction of “Start-Up India, Stand-Up India” is indeed unleashed, Modi and his government will have to resist the temptations of doing similar things. However, India is ranked 158th among 189 countries worldwide, and last among the eight South Asian countries (Afghanistan, Sri Lanka, Pakistan, Maldives, Bangladesh, Nepal, Bhutan and India) in the World Bank’s annual Ease of Doing Business Rankings.

Before we see creative destruction in India…before Modi is even in a position to grant protections to fading industries…the ease of doing business in India must improve.

I remain sceptical.

(The column originally appeared in The Daily Reckoning on August 19, 2015)