Economy Revitalising the Indian Economy

Focus

Pravin Krishna’s wish list of policy changes to revitalise the economy includes reforms to improve governance, decision-making processes and the financial health of the government, legislative changes to support investments, job creation and growth, and incentives at the microeconomic level to induce economy wide efficient outcomes, especially in the delivery of government services in the social sector

The dramatic slowdown of the Indian economy in the last years of the UPA government and the impressive single-party majority with which the Indian electorate voted the BJP into power, under the leadership of Narendra Modi, underscore both the need for urgent reforms to revitalise the economy, and the political feasibility of doing so now.

So what reforms does India need most urgently? Which of these reforms are most likely to yield growth dividends and lift hundreds of millions from grinding poverty? Sixty-five years after independence and despite a robust history of democratic governance throughout the post-independence period, this list of required reforms remains quite long. Antiquated, opaque and inefficient government policies and processes still pervade most spheres of economic activity. The corrosive effects of such a policy regime – the corruption, inequity and waste – are readily evident to all.

A wish list of policy changes to revitalise the economy would include reforms that improve governance and decision-making processes of the government at the central and state levels, and which improve the financial health of the government allowing it to undertake crucial ‘public good’ investments in the economy. Policy reforms and legislative changes that operate at a broad level to support investments, job creation and growth are badly needed as well. Finally, a number of changes are required to improve incentives at the microeconomic level to induce economy wide efficient outcomes, especially in the delivery of government services in the social sector.

An End to Policy Paralysis

‘Maximum governance with minimum government’ was one of PM Modi’s most cherished slogans during the election campaign. Indeed, the system, already weighed down by cumbersome inter-ministry approval processes was further impeded by the Group of Ministers (GoMs) and Empowered Group of Ministers (EGoMs) structures introduced by the UPA government. In addition, bureaucratic risk aversion, given the exposure to litigation and accusations of corruption following project approvals, led to the policy paralysis that became symbolic of the UPA. The early indications are that the Modi government has prioritised streamlining of the decision-making process. The GoMs and EGoMs have been abolished. The bureaucracy has been given assurances of support and backing from the PMO. A range of projects, which were previously held up, has been speedily cleared. These are very good signs and hold out the promise that the stagnation of the past will be replaced by an executive branch that is able to process governmental decisions in a transparent, consistent and decisive manner.

Consolidating Government Finances

Government finances are another important area in need of consolidation. Improvements may be achieved both by lowering expenditures and raising revenues. On the expenditure side, it is evident that a number of subsidies may be reduced, if not altogether eliminated, prime among them being the fertiliser and fuel subsidies, which account for about one half of the total subsidies.

Revenue may be increased by widening the tax net to include sources of income not currently covered by the system, and by bringing in individuals not previously identified as earning incomes. The tax system may also be simplified and rationalised through, inter alia, the implementation of the uniform Goods and Services Tax (GST), which will replace all indirect taxes implemented on goods and services by all states. The central government implementation of a uniform GST tax requires speedy resolution of negotiations between the centre and the states – and may require some initial outlays by the centre in favour of some states, but should result in revenue gains relatively soon.

Public sector disinvestments are also likely to generate huge revenue for the government. It must be conducted expeditiously, given the pressing expenditure needs.

A Boost to Manufacturing

How can the government stimulate economic growth and generate jobs necessary to employ the hundreds of millions of young India who will join the work force in the coming decade? India possesses an abundance of low-skill workers, and vast majority of them are employed in the agricultural sector. Indeed, more than half of the Indian labour force is engaged in the agricultural sector.

The expected trajectory for the evolution of the Indian economy involved the steady movement of rural workers out of the agricultural sector and into manufacturing. This was the path taken by many low-skill, labour-abundant countries along their growth path, China being the most notable recent example. Instead, the Indian manufacturing sector has not grown – it has stagnated at about 15 percent of GDP for the last couple of decades. Surprisingly, the economy has seen an expansion of the services sector, including that of high-tech services. While the impressive growth of the high-tech services sector has been justly celebrated, it must also be noted that expansion of services does not, in itself, offer a comprehensive path for Indian growth. The vast majority of workers in the agricultural sector do not have the skills necessary for employment in the services sector. An expansion of the manufacturing sector is necessary.

What policy changes could incentivise private sector investment and expansion of the manufacturing sector? To begin with, the regulatory framework that needs to be engaged in order to install capital and begin production is an extraordinarily cumbersome one. Land acquisition to locate projects is a major hurdle. Getting the necessary permits from the various ministries is highly challenging. Taxes relating to domestic and foreign investors appear to be variable and generate unnecessary uncertainty for investors. Retrospective taxation, as attempted recently in the Vodafone case, is nearly absurd; the new government would do well to reject this approach and clarify their own stance. Overall, the ease of starting and doing business in India is very low. What India needs is a simplified approval process (perhaps through the creation of a single window clearance mechanism) and a stable policy regime to support investment.

Infrastructural Investments and Labour Laws

Indian infrastructure clearly needs dramatic improvement. Our transportation network remains weak. The quality and coverage of our roads stand nowhere when compared to countries like China, as do our port facilities. Energy supply, a necessary input for production, remains low and variable. The need for infrastructural investments to support economic activity is thus obvious and should constitute a priority for the new government.

An additional factor that has been widely recognised as an impediment to the growth of the manufacturing sector is the highly restrictive set of labour laws that govern employment in India. The Industrial Disputes Act requires firms employing more than 50-100 workers to obtain the permission of the government in order to retrench or lay off workers. Since this permission is not easily forthcoming, it raises the effective cost of labour usage in production, and induces distortions in labour hiring. The Industrial Employment Act regulates the terms and conditions of work and applies to manufacturing firms employing over 10 workers. While no one would argue that we do not need to have worker protections in the law, it seems clear that Indian labour regulations, as they stand, often work against the interests of labour itself. For instance, if you make it difficult or impossible to fire workers, firms become reluctant to hire them, especially into formal jobs. This implies that we have a larger pool of informal ‘contract’ workers who don’t enjoy legal protections and job security that the law intended for them in the first place. Restrictive labour regulations can also induce firms to operate less than the optimum level, for example, by hiring fewer workers than they ideally need or by shifting to capital intensive manufacturing techniques, even if this is costly to do. Reforming labour laws, even if politically challenging, will yield especially high reward in the longer run.

Social Sector Reforms

Finally, the notorious weaknesses in the government’s delivery of social services are well-known. Health and education are important goals in themselves; they are also an important driver of economic growth. Government supplied health and education services are both inadequate in quantity and woefully lacking in quality. Regulatory and policy changes, with due attention paid to the incentives that shape the actions of individuals involved in service delivery (such as teachers and health care providers) are clearly required to generate better performance in the public sector. Equally, allowing the expansion of a private sector, which will competitively provide these services, is certain to yield better outcomes as well.

The reform challenges are many. The Modi government, with the overwhelming electoral mandate it received, has nevertheless gotten off to an exceedingly promising start. A continuation of this momentum is certain to restore very soon the near double-digit growth trajectory of the previous decade – but these changes will not have come a moment too soon for the young, the poor and the generations whose aspirations were smothered by the misguided policies of the past.

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Author

Pravin Krishna is Chung Ju Yung Distinguished Professor of International Economics and Co-Chair of the Bernard L Schwartz Globalisation Initiative at Johns Hopkins University. He is also a Research Associate at the National Bureau of Economic Research (NBER).

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Diplomatist Magazine was launched in October of 1996 as the signature magazine of L.B. Associates (Pvt) Ltd, a contract publishing house based in Noida, a satellite town of New Delhi, India, the National Capital.

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