Jagdish Bhagwati

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

narendra_modi
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

 

Jobs, jobs and more jobs is what India needs

jobs
Buried somewhere in the last financial year’s Economic Survey are some very disturbing data points, which the pink papers do not like to talk about. The usual news reports that you will read in the business newspapers published in the country are about professional colleges (MBA/Engineering) being flush with jobs.
None of the newspapers get into detail about how bad the overall job scenario in India is. The fact of the matter is that we just aren’t creating enough jobs for the youth who are entering the workforce every year.
The Economic Survey points out that between 1999-2000 and 2004-2005 the employment as measured by the usual status method increased from 398 million to 457.9 million. This was the period when the Bhartiya Janata Party led National Democratic Alliance was in power.
After this, the job growth just came to a complete standstill. Between 2004-2005 to 2009-2010, the employment increased by just 1.1 million to 459 million. The first term of the Congress led United Progressive Alliance was a period of jobless growth, despite the gross domestic product(GDP) registering solid growth. So, the size of the overall economy was growing but the jobs weren’t.
The situation improved over the next two years. Between 2009-2010 and 2011-2012, the number of employed individuals increased by 13.9 million to 472.9 million. Hence, the employment growth between 2004-2005 and 2011-2012 was at a minuscule 0.5% per year. In comparison, the employment growth was at 2.8% per year between 1999-2000 and 2004-2005.
Mihir S Sharma in Restart—The Last Chance for the Indian Economy looks at the data over a longer time frame and comes up with a similar conclusion: “In the years from 1972 to 1983—not celebrated as a time of overwhelming prosperity—the total number of jobs in the economy nevertheless grew by 2.3 percent a year. In the years between liberalization in 1991 and today, jobs have grown at an average of 1.6 percent a year.”
The trouble is that this is not enough. “13 million Indians will join the workforce every year from now on till 2030…But, if these young people have to absorbed, then jobs must grow at least 3 per cent a year—almost twice the rate at which they have since liberalization. This is simply not happening. In other words, one out of every two youngsters who starts looking for a job next year won’t find one,” writes Sharma.
What makes the scenario worse is that as per the last census nearly 47 million Indians under the age of 25 have been looking for a job, and not been able to find one.
So what is the way out? The Economic Survey provides what looks like an answer. As it points out: “The defining challenge in India today is that of generating employment and growth. Jobs are created by firms when firms invest and grow. Hence it is important to create an environment that is conducive for firms to invest…The ultimate goal of economic policy is to create a sustained renaissance of high growth in which hundreds of millions of good quality jobs are created. Good quality jobs are created by high productivity firms, so this agenda is critically about how firms are created, how firms grow, and how firms achieve high productivity.”
Theoretically the above paragraph makes perfect sense. But there are several problems with it. India grew at the rate of 7.4% per year between 2004-2005 and 2011-2012. Despite this the job growth came to a standstill. Between 1999-2000 and 2004-2005 the economic growth was around 6% per year. Nevertheless, jobs grew at a much faster rate than they grew between 2004-2005 and 2011-2012.
So, faster economic growth does not always create jobs. Further, the Economic Survey talks about highly productive firms creating quality jobs. The question is what portion of Indian firms are highly productive or want to achieve high productivity. A significant portion of big Indian firms are essentially run by crony capitalists who are more interested in short term gains rather than building a highly productive organization.
Then there is the question of labour laws as well. Sharma provides a comparison between Bangladesh and India, and how the countries stack up when it comes to their respective textile industries. As he writes: “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.
Why is there such a huge differential is a question worth asking? The answer lies in the surfeit of labour laws that firms in this country need to follow. And this ensures that most Indian textile firms start small and continue to remain small.
In their book India’s Tryst with Destiny, Jagdish Bhagwati and Arvind 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 employment in the apparel sector.
In fact, the Indian Constitution allows both the central as well as state governments to pass labour laws. This has led to a surfeit of labour laws. 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.”
What leads to further trouble is that these laws are not consistent with one another. This has led to a situation where “you cannot implement Indian labour laws 100 per cent without violating 20 per cent of them,” write Bhagwati and Panagariya.
This explains why Indian textile firms continue to remain small and not enough jobs are created in the process. 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, the textile sector is an excellent representation of the overall Indian business. Businesses which have less than 10 workers, employ more than 90% of India’s workers. What this clearly tells us is that the government of India needs to start simplifying its labour laws. At the same time this needs to trickle down to the level of state governments as well.
Sharma summarizes it best when he says: “[India] tried to protect workers instead of work; and it failed.” And that needs to change.

The column appeared on www.equitymaster.com as a part of The Daily Reckoning on Feb 13, 2015

Note to Rahul: India sucks at producing rakhis and Ganeshas

rahul gandhi
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) 

Food Security – The biggest mistake India might have made till date

250px-Gandhisonia05052007Vivek Kaul 
Historians often ask counterfactual questions to figure out how history could have evolved differently. Ramachandra Guha asks and answers one such question in an essay titled A Short History of Congress Chamchagiri, which is a part of the book Patriots and Partisans.
In this essay Guha briefly discusses what would have happened if Lal Bahadur Shastri, the second prime minister of India, had lived a little longer. Shastri died on January 11, 1966, after serving as the prime minister for a little over 19 months.
The political future of India would have evolved very differently had Shashtri lived longer, feels Guha. As he writes “Had Shastri lived, Indira Gandhi may or may not have migrated to London. But even had she stayed in India, it is highly unlikely that she would have become prime minister. And it is certain that her son would have never have occupied or aspired to that office…Sanjay Gandhi and Rajiv Gandhi would almost certainly still be alive, and in private life. The former would be a (failed) entrepreneur, the latter a recently retired airline pilot with a passion for photography. Finally, had Shastri lived longer, Sonia Gandhi would still be a devoted and loving housewife, and Rahul Gandhi perhaps a middle-level manager in a private sector company.”
But that as we know was not to be. Last night, the Lok Sabha, worked overtime to pass Sonia Gandhi’s passion project, the Food Security Bill. India as a nation has made big mistakes on the economic and the financial front in the nearly 66 years that it has been independent, but the passage of the Food Security Bill, might turn out to be our biggest mistake till date.
The Food Security Bill guarantees 5 kg of rice, wheat and coarse cereals per month per individual at a fixed price of Rs 3, 2, 1, respectively, to nearly 67% of the population.
The government estimates suggest that food security will cost Rs 1,24,723 crore per year. But that is just one estimate. Andy Mukherjee, a columnist with Reuters, puts the cost at around $25 billion. The Commission for Agricultural Costs and Prices(CACP) of the Ministry of Agriculture in a research paper titled National Food Security Bill – Challenges and Optionsputs the cost of the food security scheme over a three year period at Rs 6,82,163 crore. During the first year the cost to the government has been estimated at Rs 2,41,263 crore.
Economist Surjit Bhalla in a column in The Indian Express put the cost of the bill at Rs 3,14,000 crore or around 3% of the gross domestic product (GDP). Ashok Kotwal, Milind Murugkar and Bharat Ramaswamichallenge Bhalla’s calculation in a column in The Financial Express and write “the food subsidy bill should…come to around 1.35% of GDP, which is still way less than the numbers he(i.e. Bhalla) put out.”
The trouble here is that by expressing the cost of food security in terms of percentage of GDP, we do not understand the seriousness of the situation that we are getting into. In order to properly understand the situation we need to express the cost of food security as a percentage of the total receipts(less borrowings) of the government. The receipts of the government for the year 2013-2014 are projected at Rs 11,22,799 crore.
The government’s estimated cost of food security comes at 11.10%(Rs 1,24,723 expressed as a % of Rs 11,22,799 crore) of the total receipts. The CACP’s estimated cost of food security comes at 21.5%(Rs 2,41,623 crore expressed as a % of Rs 11,22,799 crore) of the total receipts. Bhalla’s cost of food security comes at around 28% of the total receipts (Rs 3,14,000 crore expressed as a % of Rs 11,22,799 crore).
Once we express the cost of food security as a percentage of the total estimated receipts of the government, during the current financial year, we see how huge the cost of food security really is. This is something that doesn’t come out when the cost of food security is expressed as a percentage of GDP. In this case the estimated cost is in the range of 1-3% of GDP. But the government does not have the entire GDP to spend. It can only spend what it earns.
The interesting thing is that the cost of food security expressed as a percentage of total receipts of the government is likely to be even higher. This is primarily because the government’s collection of taxes has been slower than expected this year. The Controller General of Accounts has put out numbers to show precisely this. For the first three months of the financial year (i.e. the period between April 1, 2013 and June 30, 2013) only 11.1% of the total expected revenue receipts (the total tax and non tax revenue) for the year have been collected. When it comes to capital receipts(which does not include government borrowings) only 3.3% of the total expected amount for the year have been collected.
What this means is that the government during the first three months of the financial year has not been able to collect as much money as it had expected to. This means that the cost of food security will form a higher proportion of the total government receipts than the numbers currently tell us. And that is just one problem.
It is also worth remembering that the government estimate of the cost of food security at Rs 1,24,723 crore is very optimistic. The CACP points out that this estimate does not take into account “additional expenditure (that) is needed for the envisaged administrative set up, scaling up of operations, enhancement of production, investments for storage, movement, processing and market infrastructure etc.”
Food security will also mean a higher expenditure for the government in the days to come. A higher expenditure will mean a higher fiscal deficit. Fiscal deficit is defined as the difference between what a government earns and what it spends.
The question is how will this higher expenditure be financed? Given that the economy is in a breakdown mode, higher taxes are not the answer. The government will have to finance food security through higher borrowing.
Higher government borrowing by the government as this writer has often explained in the past crowds out private borrowing. The private sector (be it banks or companies) in order to compete with the government for savings will have to offer higher interest rates. This means that the era of high interest rates will continue, which will not be good for economic growth.
Also, it is important to remember that the food security scheme is an open ended scheme. As Nitin Pai, Director of The Takshashila Institution, writes in a column “The scheme is open-ended: there’s no expiry date, no sunset clause. It covers around two-thirds of the population—even those who are not really needy. This means that the outlays will have to increase as the population grows.”
This might also lead to the government printing money to finance the scheme. It was and remains easy for the government to obtain money by printing it rather than taxing its citizens. F P Powers aptly put it when he said that money printing would always be “the first device thought of by a finance minister when a large quantity of money has to be raised at once”. History is full of such examples.
Money printing will lead to higher inflation. Prices will rise due to other reasons as well. Every year, the government declares a minimum support price (MSP) on rice and wheat. At this price, it buys grains from farmers. This grain is then distributed to those entitled to it under the various programmes of the government.
The grain to be distributed under the food security programme will also be procured in a similar way. But this may have other unintended consequences which the government is not taking into account. As the CACP points out “Assured procurement gives an incentive for farmers to produce cereals rather than diversify the production-basket…Vegetable production too may be affected – pushing food inflation further.”
And this will hit the very people food security is expected to benefit. A discussion paper titled Taming Food Inflation in India released by CACP in April 2013 points out the same. “Food inflation in India has been a major challenge to policy makers, more so during recent years when it has averaged 10% during 2008-09 to December 2012. Given that an average household in India still spends almost half of its expenditure on food, and poor around 60 percent (NSSO, 2011), and that poor cannot easily hedge against inflation, high food inflation inflicts a strong ‘hidden tax’ on the poor…In the last five years, post 2008, food inflation contributed to over 41% to the overall inflation in the country.”
Higher food prices will mean higher inflation and this in turn will mean lower savings, as people will end up spending a higher proportion of their income to meet their expenses. This will lead to people spending a lower amount of money on consuming good and services and thus economic growth will slowdown further. It might not be surprising to see economic growth go below the 5% level.
Lower savings will also have an impact on the current account deficit. As Atish Ghosh and Uma Ramakrishnan point out in an article on the IMF website “The current account can also be expressed as the difference between national (both public and private) savings and investment. A current account deficit may therefore reflect a low level of national savings relative to investment.” If India does not save enough, it means it will have to borrow capital from abroad. And when these foreign borrowings need to be repaid, dollars will need to be bought. This will put pressure on the rupee and lead to its depreciation against the dollar.
There is another factor that can put pressure on the rupee. In a particular year when the government is not able to procure enough rice or wheat to fulfil its obligations under right to food security, it will have to import these grains. But that is easier said than done, specially in case of rice. “Rice is a very thinly traded commodity, with only about 7 per cent of world production being traded and five countries cornering three-fourths of the rice exports. The thinness and concentration of world rice markets imply that changes in production or consumption in major rice-trading countries have an amplified effect on world prices,” a CACP research paper points out. And buying rice or wheat internationally will mean paying in dollars. This will lead to increased demand for dollars and pressure on the rupee.
The weakest point of the right to food security is that it will use the extremely “leaky” public distribution system to distribute food grains. As Jagdish Bhagwati and Arvind Panagariya write in India’s Tryst With Destiny – Debunking Myths That Undermine Progress and Addressing New Challenges “A recent study by Jha and Ramaswami estimates that in 2004-05, 70 per cent of the poor received no grain through the pubic distribution system while 70 per cent of those who did receive it were non-poor. They also estimate that as much as 55 per cent of the grain supplied through the public distribution system leaked out along the distribution chain, with only 45 per cent actually sold to beneficiaries through fair-price shops. The share of food subsidy received by the poor turned out to be astonishingly low 10.5 per cent.”
Estimates made by CACP suggest that the public distribution system has a leakage of 40.4%. “In 2009-10, 25.3 million tonnes was received by the people under PDS while the offtake by states was 42.4 million tonnes- indicating a leakage of 40.4 percent,” a CACP research paper points out.
Bhagwati and Panagariya also point out that with the subsidy on rice being the highest, the demand for rice will be the highest and the government distribution system will fail to procure enough rice. As they write “recognising that the absolute subsidy per kilogram is the largest in rice, the eligible households would stand to maximize the implicit transfer to them by buying rice and no other grain from the public distribution system. By reselling rice in the private market, they would be able to convert this maximized in-kind subsidy into cash…Of course, with all eligible households buying rice for their entire permitted quotas, the government distribution system will simply fail to procure enough rice.”
The jhollawallas’ big plan for financing the food security scheme comes from the revenue foregone number put out by the Finance Ministry. This is essentially tax that could have been collected but was foregone due to various exemptions and incentives. The Finance Ministry put this number at Rs 480,000 crore for 2010-2011 and Rs 530,000 crore for 2011-2012. Now only if these taxes could be collected food security could be easily financed the jhollawallas feel.
But this number is a huge overestimation given that a lot of revenue foregone is difficult to capture. As Amartya Sen, the big inspiration for the jhollawallasput it in a column in The Hindu in January 2012 “This is, of course, a big overestimation of revenue that can be actually obtained (or saved), since many of the revenues allegedly forgone would be difficult to capture — and so I am not accepting that rosy evaluation.”
Also, it is worth remembering something that finance minister P Chidambaram pointed out in his budget speech. “There are 42,800 persons – let me repeat, only 42,800 persons – who admitted to a taxable income exceeding Rs 1 crore per year,” Chidambaram said.
So Indians do not like to pay tax. And just because a tax is implemented does not mean that they will pay up. This is an after effect of marginal income tax rates touching a high of 97% during the rule of Indira Gandhi. A huge amount of the economy has since moved to black, where transactions happen but are never recorded.To conclude, the basic point is that food security will turn out to be a fairly expensive proposition for India. But then Sonia Gandhi believes in it and so do other parties which have voted for it.
With this Congress has firmly gone back to the garibi hatao politics of Indira Gandhi. And that is not surprising given the huge influence Indira Gandhi has had on Sonia.
As Tavleen Singh puts it in Durbar “When she (i.e. Sonia) refused to become Congress president on the night Rajiv died, it was probably because she knew that if she took the job, she would be quickly exposed. In her year of semi-retirement she learned to speak Hindi well enough to read out a speech written in Roman script, and studied carefully the politics of her mother-in-law. There were rumours that she watched videos of the late prime minister Indira Gandhi so she could learn to imitate her mannerisms.”
Other than imitating the mannerisms of Indira Gandhi, Sonia has also ended up imitating her politics and her economics. Now only if Lal Bahadur Shastri had lived a few years more…
The article originally appeared on www.firstpost.com on August 27, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 
 

Political suicide: Why UPA took so long to bite the bullet on reforms

State-of-Reform-twitter4
Vivek Kaul
 
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)