The New Cold War
America, China, and the Echoes of History
Early in the morning of August 15, India’s Independence Day, Narendra Modi, the country’s prime minister, delivered a forceful extemporaneous speech, calling for national unity in fighting poverty, improving sanitation, and protecting women from sexual violence. There was one area in which the speech fell short, though: economics. Contrary to Modi’s campaign promises, his address included barely any pro-market content.
It is, of course, too early to grade “Modinomics.” It would be unreasonable to expect the new prime minister to have already enacted profound reform. And members of his Bharatiya Janata Party (BJP) have, in less prominent venues, spoken about the need for policy change, typically emphasizing the importance of improving the business climate and curbing bureaucracy.
Without deeper reforms, however, these would be only modest improvements. To be successful, Modi must do much more. His party campaigned on inaugurating an era of pro-market policies after years of mismanagement under the Congress party. India does need fundamental change: its rural land rights system is a mess, its manufacturing has been strangled by labor market restrictions, and its states are poorly integrated. But, so far, the new government has squandered major opportunities to establish its economic vision: in the new budget unveiled in early July; at the World Trade Organization (WTO) talks in late July, and at the Independence Day speech.
Worse, the government has not created its own opportunities to launch a reform platform by scheduling a major event or speech around it. It is beginning to seem that Modi the campaigner is distinct from Modi the prime minister, and that perhaps he and his staff do not intend to make a decisive shift to greater market competition and, ultimately, greater prosperity.
A fair assessment of Modi and his government depends in large part on what the public expects of the new team. Does India need only to reduce corruption and become more business-friendly? Or does it require more sweeping reforms? If it is the former, Modi is on track. Effective anti-corruption and pro-business measures are challenging but feasible, and the process has at least started. If one expects the latter, though, the benchmarks for success are considerably higher.
From that perspective, the new government’s first substantial act, the unveiling of the budget, was a letdown. Defenders of the budget say it was not the right forum to present an economic manifesto. Instead, they argue, the document rightly focused on small-scale, targeted reforms, including advancing infrastructure projects and allowing greater foreign ownership of defense and insurance ventures. Although some changes were welcome, most of the budget was business as usual, including spending on statues, memorials, and heritage sites; setting up committees; and handing out benefits to farmers. The budget promised lower inflation and higher growth, but did not indicate how these would come about.
Criticized for the budget, the BJP responded by emphasizing the business climate. This has gone beyond vague promises to "cut red tape” and the like. For example, Modi’s stance against retrospective taxation, the levying of surprise taxes on firms years after the transactions took place and initial taxes were paid, is qualified but still constitutes an improvement. And the Agriculture Produce Marketing Committee Act aims to allow farmers to sell freely, rather than being forced to go through middlemen, which will both boost farmers’ profits and cut food prices.
But other BJP material is all too familiar. Just as the Congress party pledged, the BJP too claims that GDP growth will soon accelerate. GDP is an accounting device, not a magic elixir, and what matters most is how to make it grow faster. Congress tried to achieve faster growth through infrastructure spending, and the new government has suggested something similar. But the public-private partnership approach has largely failed and Modi’s government cannot afford to be the lead investor. New Delhi has invited foreign investment in railways and other sectors, but without major internal reform, it will receive far less funding than hoped.
To truly jumpstart infrastructure development, India will have to address land ownership. The BJP has indicated that it wants to revise the 2013 Land Acquisition Act, which was so badly flawed that some Congress-run states wanted to change the bill within six months of implementation.
But Modi’s proposal to address the problem by simply making it easier to acquire land misses the point. The problem is not just that it is hard for governments and corporations to buy land, but that many lack full land ownership rights, especially the poor.
The rights of many individuals to own land are limited, and the boundaries of their land are unclear. Landowners should know exactly what they hold and be able to sell it, if they wish, at market prices. At the moment, the state can simply decide that it wants a parcel of land, pick what it believes is a fair price for it, and then compel a sale. So no individual fully owns land. For the poor, this means what is often their only asset is fundamentally insecure.
The Congress government perpetuated this situation, likely because it did not trust the free market. But Modi professes to be different. The BJP has made the bold claim that a pro-business government is also pro-poor. The best way to prove that would be to give the rural poor well-defined land rights.
Granting proper land rights is an enormous undertaking, likely to take many years. But without it, India can never be rich. Here, China is instructive. In 1978, a desperately poor China granted limited land rights to farmers. The result: a massive increase in agricultural productivity that ended malnutrition and permitted Chinese farmers to move to cities and work in manufacturing, creating an economic miracle. In fact, from eighteenth-century Britain onward, advanced economies have boasted the strongest private land rights of the day. On this issue, Modi has the chance to mark himself as transformative -- or fail to.
To increase investment and employment, the new government must also reform the labor market. Indeed, restrictive labor laws have robbed India of its chance to become a manufacturing powerhouse.
It is well understood that India’s demographic explosion has already started: Some 200 million people will reach working age over the next two decades. These prospective workers could be an enormous boon, but right now, they are set to become an enormous burden. The percentage of working-age people participating in the labor force has slowly declined, from roughly 60 percent in 2004 to 56 percent in 2012. It is no good to talk of low unemployment if India’s huge working-age population cannot even join the labor force. Rapid job growth in the first half of the last decade has given way to weaker gains, due chiefly to weakness in manufacturing employment.
What is less understood is that demographic expansions end. Then the huge mass of new workers becomes a huge mass of people increasingly dependent on others. This phenomenon is sharper in developing countries with lower life expectancy and India ranks last in life expectancy, by a good margin, among the world’s largest economies. Every month, a bit of the demographic dividend slips away.
India must take advantage of its young population while it can. The manufacturing sector must absorb tens of millions more workers, impossible under current laws. Under today’s regulations, for example, manufacturing firms with more than 100 employees must seek government permission to fire employees, making firms unwilling to hire and expand.
For now, New Delhi seems to have largely punted the issue to the states. But the scope of India’s demographic expansion makes waiting for states insufficient. This is exactly the kind of political challenge Modi was elected to surmount: The central government must devise and strongly support a clear set of labor law reforms. In particular, large manufacturers must be allowed to lay off workers more freely. This process will take time and needs to be started now.
A NEW INDIA
If the labor market can be transformed, improving India’s standing with its foreign partners will become vital. The two issues are natural complements: To fruitfully employ the huge working-age population, firms based in India must be able to sell internationally. India’s share of world trade is currently two percent and led by imports, not exports. For the sake of employment, Indian exports must soar.
However, the same foreign partners to whom Modi has offered a new India recently saw the old India at the WTO. In a troubling move this July, New Delhi blocked the long-sought WTO agreement on trade facilitation -- all because it wanted greater concessions in agriculture subsidies. In 2008, the Congress government also disrupted the WTO Doha Round. These repeated attempts to stifle WTO talks indicate that India is still looking backward at agriculture when it needs to look forward to manufacturing. If Modi does not change course, India could be undercut by high-standard, regional agreements that exclude it.
Trade facilitation is not just an international problem, it is also a domestic one. Economic barriers between states undermine the existence of a true national economy. The BJP has switched to endorsing a unified Goods and Services Tax (GST), which would replace the many state tax schemes with a single, national one -- helping to create an integrated Indian market. But Modi has provided few details as to how he will overcome the states’ concerns about revenue sharing. Factions within some Indian states, such as West Bengal and Tamil Nadu, see a single GST as risky, arguing instead for local trade barriers.
Even if tax reform is successful, there remain harmful inter-state regulatory barriers, for instance concerning registration requirements, inspections, and the power of states to halt cross-border trade without giving just cause. Modi should follow a specific GST proposal with a framework for regulatory harmonization.
As with the budget, the Modi administration quickly defended the Independence Day speech as not the right forum to disclose reforms. This is getting old. If scheduled events are not the right opportunity, it is past time to create one.
To be sure, Modi’s record in Gujarat provides considerable reassurance that the business climate will improve over time. But India as a whole cannot rise to prosperity purely due to an improved business climate. Modinomics, if it is to be successful, must be far more sweeping.
Otherwise Modi need only look east, to his Japanese counterpart Shinzo Abe, to glimpse his future. Abe charged into office in late-2012, promising a reinvigorated economy. But his administration ultimately waffled on structural reforms, leading to no economic breakout. Now Abe is considerably less popular, and belated calls for stronger reforms may be too little, too late.
It is far too early to say that Modi is another Abe. But it is not too early to expect a real economic reform plan, instead of tentative statements that seem like fodder for the next poll. Modi’s government faces a marathon task. It makes no sense to start the race at a crawl.