An important economic lesson for India from the East India Company

When it comes to reading non-fiction nothing excites me more than reading books on economic history. Last month, I finished reading a fabulous book Why Nations Fail—The Origins of Power, Prosperity and Poverty by Daron Acemoglu and James A. Robinson.
The book has a few sections on India which make for a very interesting reading. It deals in some detail with the business model of the English East India Company.

Over the years, the English monarchy raised money in what could be called fairly innovative ways, at that point of time. One such way was by granting monopolies under the garb of developing national industry.

One such company, which was granted a monopoly, was the English East India Company that had been formed toward the last years of the rule of Queen Elizabeth I. On Decem­ber 31, 1600, the Queen granted the company the Royal Charter for a period of 15 years.

Interestingly, the English East India Company, which even had Elizabeth I as one of its shareholders, was the first limited liabil­ity company in the world. The liability of the shareholders of the company was limited to their investment in the company. If the company failed, the debts of the company would not be divided among the investors.

From its formation in 1600 and up until 1688 “the East India Company enjoyed a government-sanctioned monopoly over the trade with Asia”. As Acemoglu and Robinson write: “In 1688 some of the most significant imports into England were textiles from India, calicoes and muslins, which comprised about one-quarter of all textile imports. Also important were silks from China. Calicoes and silks were imported by the East India Company.” Calico is essentially a plain-woven textile made from unbleached and often not fully processed cotton. (Source:

India was the largest producer and exporter of textiles in the world at that point of time. “Indian calicoes and muslins flooded the European markets and were traded throughout Asia and even eastern Africa. The main agent that carried them to the British Isles was the English East India Company,” write the authors.

Things started to change in the late seventeenth century when the English textile producers started to grow bigger and became economically and politically more powerful. They wanted imports of cheap Indian textiles (calicoes) taxed or to even be banned. In fact, the wool industry managed to lobby the Parliament, which passed legislations in 1666 and 1678, making it illegal for an individual to be buried in anything other than a woollen shroud. This reduced competition that English textile producers faced from Asia in general and India in particular.

The lobbying continued and in 1701 the Parliament decreed: “All wrought silks, bengals and stuffs, mixed with silk or herba, of the manufacture of Persia, China, or East-India, all calicoes painted, dyed, printed, or stained there, which are or shall be imported into this kingdom, shall not be worn.”
This basically made it illegal in England to wear silks and calicoes produced in Asia. Nevertheless, it was still possible to import these textiles from India and other parts of Asia in order to re-export to other parts of the world.

This loophole (from the point of view of English textile manufactures) was finally plugged in. After December 25, 1722, it became unlawful “for any person or persons whatsoever to use or wear in Great Britain, in any garment or apparel whatsoever, any printed, painted, stained or dyed Calico.” This basically ensured that textile imports were no longer a competition for British manufacturers.

Further, the calicoes were the East India Company’s most profitable item of trade. It forced the company to change its business model as well. As Acemoglu and Robinson write: “In the eighteenth century, under the leadership of Robert Clive, the East India Company switched strategies and began to develop a continental empire…[It] first expanded in Bengal in the east…[It] looted local wealth.”

This had a huge impact on the Indian textile industry at that point of time. “This expansion [of East India Company] coincided with the massive contraction of the Indian textile industry, since, after all, there was no longer a market for these goods in Britain. The contraction went along with de-urbanization and increased poverty. It initiated a long-period of reversed development in India. Soon, instead of producing textiles, Indians were buying them from Britain and growing opium for the East India Company to sell in China,” write Acemoglu and Robinson.

So what is the relevance of this history in this day and age? The simple point is that it is very important for a country to make things if it wants to make economic progress or even stay at the level it currently is. Once the East India Company started getting into the empire building business, the Indian textile industry quickly collapsed. This collapse reversed economic development for a long time to come. And from making textiles for exports, we quickly moved on to producing opium.

In fact, as Cambridge University economist Ha-Joon Chang writes in Bad Samaritans—The Guilty Secrets of Rich Nations & the Threat to Global Prosperity: “History has repeatedly shown that the single most important thing that distinguishes rich countries from poor ones is basically their higher capabilities in manufacturing, where productivity is generally higher, and more importantly, where productivity tends to grow faster than agriculture and services.”

If this background is taken into account it becomes very clear as to how important the idea of “Make in India” really is. In fact, India’s trade with China clearly shows that enough is not being made in India.

As analyst Akhilesh Tilotia of Kotak Institutional Equities points out in a June 2015 report titled Making China make in India: “India’s trade deficit against China accounts for over a third of its trade deficit. India’s trade relationship with China is skewed significantly towards imports: 13% of all Indian imports are from China even as only 4% of Indian exports head to China.” Trade deficit is the difference between imports and exports.

In fact, as Tilotia writes this deficit would be a good starting point for ‘Make in India’. As he writes: “Of India’s imports from China over the past three years, more than half came from three categories: (1) electrical machinery and equipment, (2) nuclear reactors, boilers, machinery and mechanical appliances and (3) organic chemicals. Between these three heads, India imports more than US$30 bn of goods annually. The overall list makes for an impressive starting list for ‘Make in India’ though it is, of course, easier said than done.”

The column originally appeared on The Daily Reckoning on Sep 4, 2015

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)

Kaala Dhandha Gore Log – Why politicians are not serious about black money

kaala dhandhaVivek Kaul

Sometime in the mid 1980s, I vaguely remember spending a few days with my family, in one of the many small coal producing towns that dot what is now known as the state of Jharkhand. As was common in those days, we had hired a VCR and had decided to go on a movie watching spree.
One of the movies on the list was
Kaala Dhandha Gore Log. The movie was directed by Sanjay Khan. That is the only bit about it that I still remember. I don’t know why, but I found the title of the movie very fascinating and was really looking forward to watching it.
But the adults in the family threw a spanner in the works and banned us “kids” from watching the movie, without really going into the reasons for it. Around three decades later I can speculate as to why we weren’t allowed to watch the movie.
I guess the movie must have had a few scenes with the heroine mouthing the most famous cliché of the eighties,“
mujhe bhagwan ke liye chhod do,” or it must have had songs we now call “item numbers”.
Those were days when cable television hadn’t come to India (that would happen only in late 1991, early 1992). Middle class India still hadn’t discovered
The Bold and the Beautiful or Santa Barbara for that matter, two shows that went a long way in Indian parents becoming a lot more liberal in deciding what their kids could watch on television.
For some reason the title of the movie has always stayed in my mind, and I have speculated now and then, on its possible storyline. As the title of the movie suggests, the story could possibly be about businesses run by white people (meaning foreigners) which throw up black money.
Three decades later, reel life seems to have turned into real life. There is a great belief in this country that all of the black money generated over the years is now with foreigners. It has been transferred into foreign banks operating out of tax havens. The prime minister Narendra Modi has promised to get the money back.
In an earlier piece I had explained why getting this money back is not a feasible proposition, even though it might sound possible. And a better thing to do would be to simply concentrate on unearthing all the black money that is there in the country. I had also said that a lot of black money which has gone abroad over the years is possibly now being round-tripped to India, given that the chances of earning a good return are better in India.
Nevertheless, there are two questions that arise here? First, why has the black money problem been allowed to become so huge? Second, will the politicians choose to do anything about it? Let me answer the second question first.
Political analyst Mohan Guruswamy shared some very interesting data
in a recent column in The Asian Age. Between 2004-05 and 2011-12, national political parties collected Rs 435.87 crore as donations. Of this the Bhartiya Janata Party received Rs 192.47 crore from 1,334 donors and the Congress Rs 172.25 crore from 418 donors.
Corporates made 87% of these donations. Interestingly, over and above this, the parties received donations from unknown contributors as well. The Congress party received a total of Rs 1,185 crore in three financial years (2007-08, 2008-09, 2009-10) and the BJP received around Rs 600 crore during the same period.
It is worth remembering that in the period between 2004-05 and 2011-12, there were two Lok Sabha elections and many elections to state assemblies. It doesn’t take rocket science to come to the conclusion that the amount of donations declared by the political parties were clearly not enough to fight so many elections.
In fact, a study carried out by Centre for Media Studies in March earlier this year estimated that around Rs 30,000 crore would be spent during the 16
th Lok Sabha elections which happened in April and May 2014. Of this total, the government would spend around Rs 7,000-8,000 crore to conduct the elections through the Election Commission and the home ministry.
The remaining amounts would be spent by the candidates contesting the elections and the political parties they belonged to. Candidates standing for Lok Sabha elections are allowed to spend only Rs 70 lakhs for fighting an election in bigger states. For other states, the amount varies from anywhere between Rs 22 lakh to Rs 54 lakh.
These amounts are peanuts when it comes to fighting elections. Even candidates from major political parties fighting state level elections spend more money than this. Candidates stay within these limits officially, but political parties spend much more money outside the set limits, during the course of campaigning.
What this tells us clearly is that political parties have got access to funding beyond what they have declared in the public domain. This money that comes to them is black money. This black money can possibly be the money that politicians have accumulated through corruption or money handed over by crony capitalists looking at possible favours in the days to come.
Hence, a crackdown on black money within the country would lead to the major source of funding for political parties and politicians being impacted. Guruswamy put it very aptly in his column when he said “
Their own taps will run dry.”
Now, let me try and answer the first question, which was that
why has the black money problem been allowed to become so huge? Why has it been left unattended for so many decades? As Daron Acemoglue and James A Robinson write in Why Nations Fail—The Origins of Power, Prosperity and Poverty “Political institutions determine economic institutions…Extractive political institutions concentrate power in the hands of a narrow elite and place few constraints on the exercise of power. Economic institutions are then often structured by this elite to extract resources from the rest of the society. Extractive institutions thus naturally accompany extractive political institutions. In fact, they must inherently depend on extractive political institutions for their survival.”
So what does this mean in the Indian context? It means that the Income Tax department, which is supposed to be unearthing the black money in this country, is corrupt because the politicians running this country are corrupt. The way the economic incentives of politicians have evolved has led to a situation wherein they simply cannot become active in cracking down on black money.
It explains why only 3.5 crore individuals out of a population of 120 crore pay income tax in this country.
To conclude, the question worth asking is, what will it take for politicians of this country get serious about unearthing black money?

The column originally appeared on on Nov 14, 2014