Liberalisation 2.0

Indian Express, 2 August 2011

The liberalisation ushered in by the Congress government twenty years ago opened up enormous new opportunities. It removed the restrictions placed on markets and trade that had been imposed during the socialist era. Getting the government out of meddling in the economy was valuable, and a lot more needs to be done in that spirit. However, the looming challenge that India now needs to confront is not that of mere deregulation, but that of building the legal and institutional infrastructure for a market economy.

From the late 1970s onwards, the simple policy strategy of getting government out of the economy induced a growth acceleration. We moved from the `Hindu' rate of growth of 3.5 per cent up to a trend growth of 7.5 per cent. Removing restrictions on entrepreneurs, and connecting up to globalisation, in an economy with centuries of experience with trade and commerce and cross-border business, saw economic activity revive across millions of firms.

Much remains to be done in clearing the thicket of laws and government agencies that mindlessly interfere in the economy. But no market economy operates in a vacuum. The market economy involves a major role for the government at two levels.

The first issue is that of public goods. Every firm requires that underlying infrastructure: of safety of life and property, contract enforcement and a sound judiciary. India is failing on all three counts. Tearing the thicket of regulation will not solve this problem. These basic public goods require a pro-active approach on the part of government. It involves building systems, procedures, staff, agencies. Our long socialist detour took the focus of the top leadership away from the core issues of law and order and courts. The political class has been more interested in building and running welfare programs.

The least corrupt part of the economy that has come about through trade reforms is the tradeables sector. Here, every firm in operation is competing with global providers. Each firm is likely to export, or global competition will drive it out of business. These firms function in a globally competitive environment. But they require the government to provide public goods. A country where women are not safe in the night shift is a country where BPO exports will be hobbled. Our failures on the basic task of government - law and order, judiciary -- are hobbling the market economy in otherwise simple areas. Similarly, our ability to increase export earnings, and generate employment for crores of low skill workers, has been hobbled by our labour laws.

The troublesome part of the economy is in the fields with a government interface. This includes problems such as land and mining, regulated industries such as infrastructure and finance, and fields such as health and education where there is extensive meddling by the government. These fields have shaped up as a problem zone. As Indian GDP has grown, the stakes in these fields have amplified a hundred-fold. Global competition does not act as a check which cleans up the sector, as is the case with tradeables.

To some extent, the problems of these fields can be diminished by mere deregulation. Almost everything that the government is doing in the field of education needs to be simply stopped; the resulting education sector would be healthier and cleaner. Similarly, finance can be converted from non-tradeable to tradeable by removing capital controls. These policy directions are worth pursuing. But there will always remain a large swathe of the economy where there is a strong government interface. These areas have become the cess pool of the economy.

Alongside the deregulation agenda in these fields, then, is the positive agenda of constructing sophisticated institutions. As an example, SEBI needs to have top quality legal foundations; the recruitment process that chooses the leadership team of 20 key people at SEBI needs to be of top quality; SEBI needs the ability to honestly investigate wrong-doing and write tough orders that inflict pain on powerful people. Across the board in the Indian State, today, such capable institutions are lacking.

When we get our act together in sectors with a government interface, we will spur the tradeables sector. As an example, when we get away from our mistakes in financial policy, tradeables firms will get cheaper financial services, which will spur job creation in tradeables. Similarly, when we do better on electricity policy, tradeables firms will get cheaper and more reliable electricity, which will spur job creation in tradeables. Governance thus hits the tradeables sector in two ways: directly (through police, courts and labour law) and indirectly (when the industries with a high government interface perform better).

The contrast between India's performance on growth and India's performance on the quality of institutions is striking. India ranks among the fastest growing countries in the world. But, as the Wall Street Journal recently commented, on Transparency International's Corruption Perception Index, India ranks 87 and lies between Malawi and Djibouti. Similarly, on the World Bank's measurement of the ease of doing business, India ranks a dismal 134 out of 183 countries. For some years, we used to be complacent in India, thinking that when we start from such a low base, mere deregulation is enough to deliver rapid growth, without paying attention to institutional quality. The wake-up call of 2010 and 2011 is that such complacence is unwarranted. Our institutional failings are now visibly hitting our growth.

However, political consensus to bring about fundamental change in the role of the state in a way that reduces rents for the political classes is not simple. The failure to reform the institutional structure is now finding a solution by bringing in the Lokpal bill meant to address check the corruption this system creates. This will try to address the symptoms and not the disease.

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