Order Before Peace
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Indian Prime Minister Narendra Modi came into government one year ago promising to increase India’s economic well-being. How has he done?
His government has certainly made progress. It has dropped the previous administration’s apparent assumption that sufficient growth will materialize out of thin air. Instead, it has tried to make it easier to do business, among other things, which will make for a somewhat more prosperous India.
However, the Modi administration is not following the best economic course. It has made choices that limit India’s ability to perform now and in the future. The government is thus helping India to do better but not helping it to do very well. This explains why many observers feel disappointed.
The path by which India can reach its full economic potential is difficult. It includes dealing with the contentious issue of private land rights, liberalizing the labor market, and creating a much less intrusive state in fiscal terms and otherwise. Defenders of the Modi government can certainly respond that such strong pro-market steps are politically unworkable.But if they are right, a high-middle-income India that is a true global economic power is off the table, indefinitely.
THE MODI PATH
In its first year, the government has both done some good things and benefited from some good fortune. The good fortune is most obvious in the case of falling global oil prices, which has reduced inflation pressure. The best example of good policy is the government’s attempt to greatly simplify India’s tax code and help unify the country’s domestic market with a single goods and services tax (GST).
Simplification is also the goal with respect to starting and operating a business. Modi and his staff have cut the number of government certifications required to do so and made it easier to apply for the remainder. They deserve credit for these policies and others, which will help India see more corporate investment and encourage solid headline GDP growth.
But Modi’s economic plans are fundamentally inadequate in multiple areas. Most prominent is the budget. Finance Minister Arun Jaitley is simultaneously anticipating GDP growth of over seven percent and rising and also budget deficits of over three percent of GDP. There’s no justification for chronic, large budget deficits in a period of what is claimed to be strong growth. Either GDP gains have not been especially helpful in boosting prosperity or the budget deficit represents excessive state intervention in the economy.
Or both could be true, where neither reflects well on the Modi government. An obsession with world-beating GDP growth has not served India well to date, previously helping to trigger a painful bout of inflation. Nor has the growth generated jobs at the rate needed as the demographic boom arrives. At least so far, GDP growth by itself is not bringing with it true economic health.
This may be because the state retains such a heavy hand. Budget deficits persist in part because mass subsidies are almost unchanged. Along the same lines, the Modi government still emphasizes state-driven infrastructure programs. “Smart cities” is the slogan, rather than “public-private partnerships,” but the record of the Indian government in leading infrastructure programs is still awful. Spending goals have been held over from the last government, and it is perhaps a blessing in disguise that there is not enough money available to meet them.
Even policies concerning the business environment are flawed. The 2013 Companies Act was passed under the previous government and has made the creation of new companies more difficult. In particular, it discourages the creation of new family-based firms, with more extensive licensing requirements and stronger penalties for failing to meet them. Amendments proposed by the current government will reduce the harm but not eliminate it. They certainly do not constitute a major step forward, one badly needed.
Progress in specific sectors has been sharply limited by the state’s continued domination. New bank licenses will have very little benefit because the bulk of lending must still go to sectors deemed important by the government. Although new banks will be profit-seeking, they will unavoidably also be quasi-state institutions. There are plans to have Coal India face its first competition from private miners. But there is no timetable for commercial mining to even start, much less reach a scale that can transform coal into a well-functioning industry and ease power shortages.
Progress toward solid GDP growth and a somewhat improved business environment are reasonable accomplishments for Modi’s first year. But further progress will be limited unless his administration changes course.
A BETTER PATH
It is worth recalling how much progress India needs to make. Although global rankings of personal income are difficult to gather, India is certainly not in the top 100 countries. It is behind Guatemala. It is well behind Tunisia. As government officials correctly say, to move up the ranks, India needs strong growth for a long time.
A more efficient state or improvements in the business environment won’t be enough. GDP growth that does not bring economic vibrancy won’t help. Instead, the keys to India becoming a prosperous and economically powerful country are full private ownership of land, a liberalized manufacturing labor market, and a shrinking state role in the form of fewer subsidies, the privatization of some banks, and improved bankruptcy law.
In rich countries, individual rights to land are clear and strong. In these countries as well, farmers are generally better off than the rest of the population. India badly wants to lift farmers out of poverty and later become a rich nation, but it is moving in the wrong direction on individual land rights. The 2013 Land Acquisition, Rehabilitation, and Resettlement Act was billed as protection for farmers, but that protection was granted by the state on the basis of collective land ownership. If anything, recent revisions introduced by Modi’s government move the country further away from personal land ownership. Modi’s Bharatiya Janata Party controls eight states, and there is no reason that it cannot launch programs to grant individuals and families full and permanent rights to land there.
One of the barriers to true land reform nationwide is extremely slow progress on titling, which will take several decades to complete at the current pace. Titling should be a much higher priority for the central government and all state governments, yet it has not been addressed by the Modi administration. A more limited step, which would still be valuable to farmers, would be removing as many goods as possible from the purview of the Agricultural Produce Marketing Act, which places limits on where farmers can sell included goods. To its credit, the Modi government has suggested starting to do so. As with titling, however, progress on the ground is almost nonexistent.
For India to prosper, agriculture must become more efficient, with fewer farmers needed. The rest will then become workers, which, along with demographic expansion, will mean a flood of workers entering the urban labor force over the next decade or more. India needs to exhaust all options—manufacturing and services, domestic and foreign demand—to create jobs.
Under current conditions, firms won’t hire. Industrial companies with more than 100 permanent workers cannot downsize without the approval of government, which strongly discourages expanding past 100 workers. Existing labor laws essentially guarantee mass underemployment and an India that, unlike its neighbors in East Asia, cannot benefit from global demand for manufactured goods.
In this case, the Modi government is moving in the right direction, but far too slowly. The central government initially simplified implementation of labor laws, otherwise treating fundamental reform as a matter for the states. That won’t be adequate as India’s population expands; the longer labor reforms take, the more the boon turns to curse. More recently, New Delhi has taken a more active stance on labor, both in response to state policies and on its own. But its labor program must become much more aggressive, moving to actual legislation.
Under current conditions, firms won’t hire. Industrial companies with more than 100 permanent workers cannot downsize without the approval of government, which strongly discourages expanding past 100 workers.The government could also take steps that, although not individually as vital as land and labor reform, would together dramatically bolster investor confidence and improve productivity. It would improve the operation of the credit market to exempt more banks from onerous, “priority sector” lending requirements. Beyond that, along with ease of entry, a sound bankruptcy law is the key to an efficient corporate sector. Bankruptcy takes far too long in India, with the result that firms simply disappear, costing assets and harming workers. There is a Bankruptcy Law Reform Committee, but change must be truly pro-market, unlike the land and company laws.
The budget should be balanced during periods of rapid growth. Just as important is how the money is spent and raised. India has a vast array of subsidies, from cooking oil to petroleum. The subsidies are wasted in huge quantities, undermine competition, and promote corruption, since innovation and cost reduction are less attractive than seeking government funds. Reducing or suspending subsidies, only to have them return later—which may happen in the energy sector as global oil prices recover—has little value. Instead, some programs should be eliminated entirely and, hopefully, permanently.
On the revenue side, the government has started to do the right thing with the proposal for the GST. This will help unify the country economically, making it less dependent on global developments. But a new GST can be undermined if rates are set to benefit state coffers rather than economic development. A 27 percent rate that guarantees no revenue loss would strangle activity, not encourage it. GST can also be crippled if too many goods and services are left out, which some states and even some of Modi’s deputies have demanded. If the GST is flawed, it must only be the first step on the way to a sound one.
Modi’s defenders have claimed that it is politically infeasible to take the economic high road, pointing to the GST as an example. The GST has just this month been referred to a committee in the Upper House, yet another delay is raising still more questions about the final outcome. A good bankruptcy law is conceivable, but meaningful cuts in subsidies and labor market liberalization will be at least as difficult as the GST. And true private ownership of land seems almost unthinkable at present.
India is not in the process of lifting tens of millions of people out of rural poverty. It is not in the process of properly utilizing favorable demographics to become a global manufacturing powerhouse.
If fundamental reforms really are beyond New Delhi’s capabilities, though, India is in for a disappointing future. The gap between what should be done and what is being done by the present government is large. The fact that the Modi government’s economic policies are nonetheless an improvement over the previous government’s only highlights the challenges Modi faces, most of which are going unmet.
India is not in the process of lifting tens of millions of people out of rural poverty. It is not in the process of properly utilizing favorable demographics to become a global manufacturing powerhouse. It is not in the process of becoming upper middle income, much less rich. Although comparatively high GDP growth and breaking the top 100 in ease of doing business are nice goals, they are hardly transformative. The first year of the Modi government should reset many people’s expectations.