PM Modi, Nehruvian Economic Policies Aren’t Going to Get Us Anywhere

narendra_modi
This is something that we should have written on a while back, but as they say it is better late than never.

In the annual budget of the government of India, presented earlier this month, the finance minister Arun Jaitley raised custom duties on a whole host of products. In his speech, Jaitley made it clear that this wasn’t a one-off thing, but a change in policy direction.

As he said: “In this budget, I am making a calibrated departure from the underlying policy in the last two decades, wherein the trend largely was to reduce the customs duty. There is substantial potential for domestic value addition in certain sectors, like food processing, electronics, auto components, footwear and furniture. To further incentivise the domestic value addition and Make in India in some such sectors, I propose to increase customs duty on certain items. I propose to increase customs duty on mobile phones from 15% to 20%, on some of their parts and accessories to 15% and on certain parts of TVs to 15%. This measure will promote creation of more jobs in the country.”

The customs duty has been raised on around 45 products. The maximum increase was in case of cranberry juice from 10% to 50%. (All you cranberry juice drinkers out there, maybe it is time to start appreciating the taste of chilled filtered water with a dash of lemon in it).

The idea as Jaitley explained is to create jobs within the country. With increased custom duties, imported goods will become expensive. This will make domestic goods competitive. As people buy more and more of domestic goods, the companies producing goods in India will do well. Once they do well, they will expand and create jobs in the process. Alternatively, because imports will become uncompetitive, the domestic companies can continue operating, and jobs can thus be saved. QED.

The problem with this argument is that it stinks of Nehruvian era economic policies, in particular import substitution, which was the norm in independent India, up until the economic reforms of 1991. Import substitution as a policy was introduced by Jawahar Lal Nehru and carried forward by Indira Gandhi, two individuals, the Bhartiya Janata Party keeps blaming for everything that is wrong in this country (even though we are four years into the term). At its simplest level, import substitution is basically an economic policy which promotes domestic production at the cost of imports. And it is an economic policy, which doesn’t work.

As the French economist Jean Tirole writes in Economics for the Common Good: “In economic matters too, first impressions can mislead us. We look at the direct effect of an economic policy, which is easy to understand, and we stop there. Most of the time we are not aware of the indirect effects. We do not understand the problem in its entirety. Yet secondary or indirect effects can easily make a well-intentioned policy toxic.”

What does Tirole mean here? Another French economist Frédéric Bastiat explains what secondary or indirect effects are, through the broken window fallacy.

Bastiat basically talks about a shopkeeper’s careless son breaking a pane of a glass window. He then goes on to say that those present would say: “It is an ill wind that blows nobody good. Everybody must live, and what would become of glaziers if panes of glass were never broken.

The point being that if windows weren’t broken, how would those repairing windows, the glaziers that is, ever make a living. This seems like a fair question to ask, but things aren’t as simple as that.

As Bastiat writes in Essays on Political Economy: “This form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.”

Bastiat then goes on to explain what exactly he means by this. Let’s say replacing the pane of the broken window costs 6 francs. This is the amount that the shopkeeper pays the glazier. If the shopkeeper’s son would not have broken the window there was no way that the glazier could have earned these six francs.

As Bastiat puts it: “The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.” This leads us to conclude that breaking windows is a good thing because it leads to money circulating and those who repair broken windows doing well in the process.

Nevertheless, this is just one side of the argument. As Bastiat writes: “It is not seen that our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps have replaced his old shoes, or added a book to his library. In short, he would have employed his six francs in some way which this accident prevented.”

How does this apply in the case of the Narendra Modi government increasing custom duties on a whole host of products? The seen effect of this, as already explained above, is that domestic Indian companies can compete with cheaper imports because of the custom duties being increased. This is likely to create jobs and if not, it is at least likely to save jobs. This is the first order effect or the seen effect.

What is the second order effect or the unseen effect? It is well worth remembering here that consumers only have so much money to spend. If cheaper imports no longer remain cheaper because of an increase in custom duties, the consumers have to pay a higher price for the goods made by domestic companies. Once this happens, they are likely to cut their spending on some other front.

The trouble is that this some other front on which consumers cut their spending, is not easily identifiable. Once consumers cut their spending on other fronts, some domestic businesses are not going to do well, and jobs will be lost there. The trouble is this is not something which is very obvious. It is an unseen effect.

If the consumers keep spending the same amount of money as before, they will end up cutting down on their savings, which isn’t necessarily a good thing. As Henry Hazlitt writes in Economics in One Lesson: “The fallacy… comes from noticing only the results that are immediately seen, and neglecting the results that are not seen.”

Another point that needs to be made here is that the domestic companies are organised well enough to lobby with the government. The end consumer never is.

Increasing customs duties is not a solution to creating jobs. For jobs to be created Indian firms need to be globally competitive. When companies produce for the global market, they need to compete with the best in the world. This automatically leads to a situation wherein the products which a company produces need to be globally competitive. On the other hand, when import substitution is the norm and companies need to produce just for the internal market, almost anything goes. This explains why the Indian corporate sector on the whole, has not been able to be competitive on the global front. It has still not been able to come out of the import substitution era. (We hope people do remember the Ambassador Car which had the same engine between 1944 and 1982.)

In order to be globally competitive, India needs to introduce a whole host of reforms, from labour law reforms to land reforms. It needs to start pricing electricity correctly. The governments need to control their fiscal deficits to ensure that they don’t push up interest rates in the long-term. Our education system needs a paradigm shift (We find this phrase absolutely cringeworthy, but nothing explains the situation better). The corporate bond market needs to function much better than it currently is. The number of inspectors that an average business needs to deal with has to come down. The paper work needs to be simplified. All these distortions in the system need to go.

Long story short—going back to Nehruvian economics is not going to do any good to the country. The sooner Narendra Modi understands this, the better it will be for India. India has suffered enough because of the mess initiated by the economic policies of Nehru and Indira Gandhi. And there is no point, going back to it.

The column originally appeared in Equitymaster on February 19, 2018.

How Business Funds Politics

indira-gandhi-ji

In the year 1969, Indira Gandhi split from the Congress party, to form her own Congress party. At that point of time, Gandhi was worried that the corporates would back the parties which opposed her.

Hence, she banned corporate donations to political parties. As Vijay Joshi writes in India’s Long Road—The Search for Prosperity: “One of the watershed moments in the history of corruption was the ban on corporate donations to political parties imposed by Mrs Indira Gandhi in 1969 because she was concerned about the money that would flow into the coffers of the right wing parties that opposed her.”

Of course, this did not stop corporates from donating money to political parties; it only drove them underground, into black money. This ban was lifted in 1985, after the assassination of Gandhi in October 1984. But the black money-non transparent nexus of businesses and politicians has continued since then.

There is very little direct evidence for this other than a few sting operations over the years where politicians have been caught on tape, asking for money. These sting operations have impacted the credibility of politicians across party lines.

Nevertheless, there is some very good research evidence to suggest that businesses do pay politicians before elections. In a paper titled Quid Pro Quo: Builders, Politicians, and Election Finance in India Devesh Kapur and Milan Vaishnav look at cement consumption of builders to show that builders make payments to politicians.

All construction requires cement. When it comes to cement demand, the real estate sector accounts for a major part of the demand in India. When the construction activity carried out by the real estate sector goes up, the demand for cement increases. If the real estate companies are key financiers of politicians, as they are assumed to be, then just before the elections, they will need money to finance the electoral campaign of politicians.

If the real estate companies pay the politicians, it would mean that they will lesser money to carry out their own activities. This would mean a slowdown in construction activity. And a slowdown in construction activity should lead to a fall in cement consumption.

Hence, cement consumption can be tracked to figure out whether real estate companies are actually financing politicians.  Kapur and Vaishnav looked at elections in seventeen Indian states between 1995 and 2010. They found a “contraction in cement consumption (representing a 12 to 15 percent decline) during the month of state assembly elections”. What this clearly tells us is that real estate companies do finance state level politicians, as is commonly inferred.

In fact, there is more evidence of businesses financing the electoral ambitions of politicians through black money. Sandip Sukhtankar looks at this phenomenon in a research paper titled Sweetening the Deal? Political Connections and Sugar Mills in India.

As he writes: “The cane price falls by approximately Rs 20 in politically controlled mills during election years. These drops translate to an economically significant drop in revenues of Rs 60 lakh (US$ 135,000) per election year per mill. Evidence suggests that the profit decline is not due to effects on mill operations, but rather due to appropriation of funds for electoral purposes… From the perspective of farmers, this fall in prices could represent either pure theft by mill chairmen, or indirect campaign contributions.”

Hence, sugar mill owners pay low prices to sugar cane farmers in an election year to be able to funnel more money into electoral campaigns of politicians.

So what is the way out of this? Companies are allowed to take tax credits for corporate donations i.e. they can make a deduction of the amount of political donation while calculating their taxable income. But this hasn’t’ helped. As Joshi writes: “Tax credits do not work because corporates prefer secrecy: they are risk-averse and fear reprisals from parties that win election for donations given to their opponents.”

And so the story continues!

The column originally appeared in the Bangalore Mirror on July 20, 2016

 

Big Govt is a Huge Negative for Economic Growth

nehru

These days, Jawaharlal Nehru, gets blamed for a lot of what is wrong with India. This includes the fact that many countries which attained independence around the same time as India did, grew much faster than India has.

The trouble is that this argument is not totally correct. These days Nehru tends to get blamed even for the economic mess created by his daughter Indira Gandhi. Between 1950-1965, the economic growth of India was 4.1% per year, on an average. Nehru was the prime minister between 1947 and 1964.

Between 1965 and 1981, the economic growth was 3.2% per year on an average. For most of this period, Indira Gandhi was the prime minister. As Arvind Panagariya writes in India—The Emerging Giant: “She [i.e. Indira Gandhi] nationalized the major banks, oil companies, and coal mines. She imposed tight restrictions on operations of foreign companies…She introduced tight ceilings on urban landholdings and effectively outlawed layoffs of workers…Many of the restrictions introduced during this era proved politically difficult to undo later, and some of them continue to harm growth today.”

All these things slowed down Indian economic growth considerably. As Rakesh Mohan and Muneesh Kapoor write in an IMF working paper titled Pressing the Indian Growth Accelerator: Policy Imperatives: “The slowdown in growth during the 1965-81 period, ‘the darkest in the post independence economic history of India’, can be attributed to the various restrictive policy actions put in place during this period that effectively closed the Indian economy and slowed down Indian economic growth, just when various East Asian countries were opening up and accelerating their growth.”

Long story short—as the government grew bigger, the economic growth of the country slowed down majorly. In fact, while the economic growth between 1965 and 1981, slowed down to 3.2% per year, the growth between 1965-1966 and 1974-1975 had been even slower at just 2.6%. This when the population growth was at 2.3%.

As Panagariya writes: “While the government understandably did not publicly acknowledge that it had gone too far in restricting industrial activity, it quietly began to ease up controls through administrative measures. These measures included capacity expansion, increase in the threshold level of investment below which no license was required, delicensing in selected sectors, and permission to change the product mix within existing authorised capacity.”

These changes started to happen in the mid-1970s and were expanded on between 1979 and 1984. The economic growth averaged at 4.8% per year between 1981-1982 and 1987-1988. Over the ten-year period of 1981-1990 it averaged at 5.4%.

The trouble was that in the second half of the 1980s, a good portion of the economic growth was financed by borrowing from abroad. This ultimately led to the economic crisis of 1991 and which finally led to economic reforms being initiated by the Narsimha Rao government with Manmohan Singh as the finance minister.

In fact, economic growth since then has been higher than 5% in almost all years. Next month, it will be 25 years since India saw the first wave of economic reforms. And 25 years after economic reforms were first initiated one lesson that we can draw is that big government hurts economic growth.

As the National Manufacturing Policy of 2011 pointed out: “On an average, a manufacturing unit needs to comply with nearly 70 laws and regulations. Apart from facing multiple inspections, these units have to file sometime as many as 100 returns in a year. This kind of compliance burden puts-off young entrepreneurs and they are not willing to take up an entrepreneurial role. As a result, a large number of people who could have been self employed and would contribute to further employment and enhance economic activity, end up accepting jobs much below their potential.”

This is something that needs to be corrected. The Modi government has taken a few steps on this front, but a lot more needs to be done to unravel the big government that India inherited from Indira Gandhi. This is necessary for job-creating economic growth to happen.

(Vivek Kaul is the author of the Easy Money trilogy. He can be reached at [email protected])

The column originally appeared on Bangalore Mirror on June 15, 2016

Time to change your jingle: Rahul Gandhi’s garibi hatao rhetoric is like the Nirma ad

Vivek Kaul 

Guess who’s back, guess who’s back?
Guess who’s back, guess who’s back?
Guess who’s back, guess who’s back?
Guess who’s back? – 
Lines from Without Me by rapper Eminem 

Rahul Gandhi is back. The vice-president of the Congress party is back to India after a 57 day sabbatical. Depending on which political gossip columnist you believe he was holidaying either in South East Asia or in Italy. A news-report also suggests that he was meditating in Burma. But all that doesn’t really matter.
While Rahul was away the Congress politicians put on a brave front. They told the nation that the Gandhi family scion was taking a break and figuring out what to do next. Among many such statements that were made the best one came from Mukul Sangma, the chief minister of Meghalaya. Sangma compared Rahul’s sabbatical (or disappearance, depends on how you look at it) to that of Alfred the Great, who ruled Wessex, an anglo-Saxon kingdom in the South of Great Britain, between 871 and 899 AD.
After a defeat at the hands of the Viking armies, Alfred retreated and came back strongly to win the subsequent war. Sangma compared Rahul’s sabbatical to that of Alfred the Great, 
when he told The Indian Express: “There are certain strategies, some secret plans that leaders always have. If you read stories, read history, Alfred the Great, after he lost the battle, he needed to plan, think and ideate and come up with another formula to defeat the enemy.”
Sangma suggested that Rahul was doing the same. The Congress party 
spokesperson Randeep Surjewala suggested the same when he said: “I don’t know where he is but I know he is not on a holiday. He has taken time off to reflect on how to strengthen the Congress. I see it as an extremely mature step.”
Companies these days regularly go on off-sites, at least once a year, to think and ideate, and to figure out the way forward. While no one quite goes on a two month off-site, but let’s not nitpick here. So Rahul’s sabbatical was along similar lines. Fair enough.
The question is what has he come up with at the end of the sabbatical? From what was visible in his speech to farmers at the 
Ramlila Maidan in New Delhi yesterday, Rahul hasn’t come up with anything new. In fact, he has gone back to the garibi hatao rhetoric of his grandmother Indira Gandhi.
Sample some of the things that Rahul said in his speech yesterday.

Today when farmers go to sleep, they dont know what is going to happen when they wake up the next morning.” 

We increased the MSP of wheat from Rs 540 to Rs 1400.” 

Opposition asked us where will the money come for your loan waiver. Our govt waived Rs 70,000 crore of farmer loans.” 

The MSP[minimum support price] has not changed, no benefit to farmers.”

What is common to all these statements? That India is a poor country. And that the Indian farmer is poor. And that he needs to survive only on doles given by the government. And that the Congress led United Progressive Alliance was excellent in giving out doles. And that the Narendra Modi led Bhartiya Janata Party is not doing the same thing.
This has been the Congress party rhetoric since Indira Gandhi took over the party in the late 1960s. And truth be said it worked beautifully for decades. But isn’t working any more. Why is that? One reason lies in the fact that agriculture contributes 18% of the country’s GDP while it employs almost around 50%(or more depending on which estimate you believe in) of its workforce. What this shows is that agriculture is not remunerative enough given that there are too many people dependant on it. It is also known that only 17% of farmers survive on income totally from agriculture. The rest do other things as well to make money.
Hence, truth be told India has many more farmers than it needs. People need to be moved away from agriculture. And that in turn means we need to create more jobs in other sectors. And that is clearly not happening. This is something that 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.”
As per the Census the employment growth between 2001 and 2011 was at 1.8%. It was at 2.5% between 1991 and 2001. The Labour Bureau suggests that the employment growth between 2011-12 and 2013-2014 was at 1%.
The Congress led UPA was in power between May 2004 and May 2014. And it clearly did a lousy job of creating jobs. In fact, data from the last census tells us that nearly 4.7 crore Indians under the age of 25 are looking for jobs, but have not been able to find one. Who is responsible for this?
Once we take all this information into account, what it clearly tells us is that the garibi hatao rhetoric and the policies that have emanated from it, haven’t really worked.
It is time for the Congress(and all other political parties) to do this country a favour and move on from it. It is time to think jobs. But Rahul Gandhi is still stuck up garibi hatao. This even after taking a two month sabbatical.
In that sense, the Congress party is a bit like the Nirma washing powder advertisement, which worked beautifully for a long period of time. In all these years the ad has basically stayed the same. (I have watched it since television first came to Ranchi in 1984). But Nirma is no longer the company it used to be. And the same is true for the Congress.
It is time for both to change their jingle. 

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

The column originally appeared on Firstpost on Apr 20, 2015 

The new Janata Party will be a challenge for Modi in Bihar

Vivek Kaul

The year was 1977. The emergency had just ended. The opposition leaders who had been imprisoned during the course of the emergency had just released. They were holding a massive rally at the Ram Lila maidan.
It was a rainy day in Delhi and well past 9.30pm by the time Atal Bihari Vajpayee rose to speak. He was the star speaker for the evening and the people who had turned up at the rally had stayed back just to hear him.
To the shouts of “
Indira Gandhi murdabad, Atal Bihari zindabad,” Vajpayee started his speech with a couplet:
Baad muddat ke mile hain deewane,
Kehne sunne ko bahut hain afsane,
Khuli hawa mein zara saans to le lein,
kab tak rahegi aazadi kaun jaane.”

(It has been an age since we whom they call mad have had the courage to meet,
There are tales to tell and tales to hear,
But first let us breathe deeply of the free air,
For we know not how long our freedom will last). (Source: Tavleen Singh’s
Durbar)

In the time to come all the major opposition parties came together and formed the Janata Party. This was the only way they could take on Indira Gandhi by ensuring that their votes did not split. The party won 295 seats in the Lok Sabha elections that followed and thus came to power. The largest number of 93 MPs were of the Jana Sangha (now the Bhartiya Janata Party) origin. Forty four MPs came from the Congress (O) party. Seventy one MPs came from Charan Singh’s Bhartiya Lok Dal. Jagjivan Ram’s Congress for Democracy brought in 28 MPs.
A large number of the Lok Sabha seats that the party won was limited to North India, given that the southern part of the country hadn’t really felt the ill-effects of the emergency implemented by Indira Gandhi as much as the north India had. Given this, Indira Gandhi’s Congress still managed to win 154 seats though they were wiped out in Uttar Pradesh with both Indira and her son Sanjay losing elections.
If one leaves out the Jana Sangha from this, the other parties were what we would call socialists, in the Indian sense of the term.
Nearly four decades later some of these socialists who were a part of the Janata Party have decided to come together again. This time to take on Narendra Modi. The parties which are merging together are Mulayam Singh Yadav’s Samajwadi Party, Lalu Prasad Yadav’s Rashtriya Janata Dal, Nitish Kumar’s Janata Dal(United) Indian National Lok Dal of Om Prakash Chauthala, Janata Dal(Secular) of HD Deve Gowda and Kamal Morarka’s Samajwadi Janata Party.
Mulayam Singh Yadav has been announced as the head of the party in Parliament, though its name and symbol haven’t been decided as yet. The Times of India reports that the party is likely to be called Samajwadi Janata Dal with the cycle as its symbol (which is the current symbol of the Samajwadi party).
So how strong a challenge is this new party going to be to Narendra Modi? Will it be as strong as the Janata Party was to Indira Gandhi? The first thing we need to understand is that the party has been formed when the next Lok Sabha election is still four years away.
After the merger, the party will have 15 members in the Lok Sabha, which is minuscule to the 295 members that the Janata Party had. In the Rajya Sabha the party will have 30 members. In that sense, the party will provide very little challenge to Narendra Modi.
Further, the support of all the parties which are coming together is heavily localized. Samajwadi Party is strong in Uttar Pradesh. The Indian National Lok Dal is strong in Haryana and Dev Gowda’s Janata Dal(Secular) is strong in parts of Karanatka. Hence, to that extent no consolidation of votes can be expected against Narendra Modi.
The only exception to this is Bihar. In Bihar, both Lalu’s Rashtriya Janata Dal(RJD) and Nitish’s Janata Dal (United)(JD(U)) are on a strong wicket. Data from the election commission shows that the combine of Bhartiya Janata Party (BJP) and Ram Vilas Paswan’s Lok Janshakti Party(LJP) got 35.8% of the votes polled during the Lok Sabha elections last year.
The RJD and the Congress Party which fought the elections together got 20.1% and 8.4% of the votes respectively. The Janata Dal(United) which fought the elections separately got 15.8% of the votes. Hence, the vote percentage of JD(U) + RJD matches that of the BJP + LJP. Further, RJD+JD(U)+Congress got more votes than BJP + LJP. Nevertheless, since RJD+ Congress and JD(U) were not in alliance, these votes did not translate into Lok Sabha seats.
Things changed in the by-elections to 10 assembly seats that happened in August 2014. In these elections the JD(U) came together with the RJD+Congress and took on BJP+LJP. The data from the election commission shows that the RJD+Congress+JD(U) got 45.6% of the total votes polled. The BJP+LJP got 37.9% of the votes polled. Given that, this time JD(U) was not fighting the elections separately, the votes polled translated into assembly seats as well, unlike the Lok Sabha polls. The RJD+ Congress+ JD(U) got six out of the ten assembly seats.
Hence, in Bihar, given the way the caste combinations work, the new Janata Party can be a potent force to take on Modi. The trouble is that Lalu and Nitish, despite the claims that they make in public these days, do not get along with each other.
Nitish became the Chief Minister of Bihar in 2005, more than three decades after he entered politics in the early 1970s. And for the first half of his political career, he propped up Lalu Prasad Yadav even though he knew that Lalu wasn’t fit to govern. Journalist Sankarshan Thakur puts this question to Nitish in his book Single Man: “Why did you promote Laloo Yadav so actively in your early years?” he asked.
And surprisingly, Nitish gave an honest answer. As Thakur writes “’But where was there ever even the question of promoting Laloo Yadav?’ he mumbled…’We always knew what quality of man he was, utterly unfit to govern, totally lacking vision or focus.”
So why then did Nitish decide to support him? “There wasn’t any other choice at that time,’ Nitish countered…’We came from a certain kind of politics. Backward communities had to be given prime space and Laloo belonged to the most powerful section of Backwards, politically and numerically.”
And this logic still continues to remain valid. The next assembly elections in Bihar are scheduled for later this year is in November 2015. And the chief minister’s post will be a bone of contention between Lalu and Nitish. It remains to be seen whether the new party will be able to survive this.
In other states the new party may be able to cause some damage to Modi only if it comes together with the Congress. To conclude, the biggest challenge for the party will be to survive till the next Lok Sabha elections in 2019.

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

The article originally appeared on Firstpost on April 16, 2015