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Fallacies in liberalisation policies

Consider the consequence of the reliance on external capital to promote India's development. Consider the recent Finance Ministry directive to the Central Board of Direct Taxes that any capital routed via Mauritius (even though not originating in Mauriti us) would enjoy total exemption from direct taxation on its earnings in India. The above merely illustrates how we are becoming prisoners of our erroneous policies, says

Arun Ghosh.

THE liberalisation and globalisation policies pursued by the Government are predicated upon a number of assumptions with regard to the behaviour of `economic agents' which are not sustainable. It is possible to identify five important assumptions which a re wrong. Let us take a quick look at these assumptions.

First, it is firmly believed that privatisation would promote efficiency. Ergo, it is assumed that even in areas where there are `natural monopolies', private monopolies are preferable to public monopolies with, perhaps, a `regulator' thrown in. Why else has it been suggested that the Department of Telecommunications (DoT) be corporatised, as a preliminary to its privatisation; and that the DoT be split into the Department of Telecom Services (DTS) and the DoT, with the former being sub-divided into the DTS and the Department of Telecom Operations (DTO), with no function for the former? Forget the freebies promised to all the telecom employees to overcome their opposition to the move.

That private monopolies are not necessarily more `efficient' than public monopolies has been the bitter experience of the people of the UK where, under Mrs. Margaret Thatcher, `utilities' such as water and power supply were `unbundled' and privatised. Ov er the years, the quality of services declined; the prices charged have risen significantly; and the citizens' long-term interests sacrificed. The profitability criterion rules out investments with a long gestation period, even with a low discount rate.

There are other problems. Take the example of the Enron power project. In itself, it is an `efficient' unit of production. Yet, Enron has made for `systemic inefficiency' in the Maharashtra power supply grid because -- as a result of the availability of Enron power -- the Maharashtra State Electricity Board is now forced to cut power offtake from Tata Electric Power (which is much cheaper than the Enron power), and close down its own thermal power generation units with costs around a fourth of Enron pow er.

The second fallacy goes like this: Since the marginal rate of saving of the rich is much higher than that of the poor, some inequalities in the distribution of income are inevitable in the early stages of the development process. Did not Simon Kuznets' e mpirical findings regarding the `inverted U-shaped curve' of income distribution in the industrially developed countries prove that these `inequalities' were temporary? Unfortunately, Kuznets' hypothesis is not borne out by the story of development, post -Second World War, either in the Newly Emerging Countries or in mainland China. Rapid development in the post-War world was been spurred by egalitarian policies. Indeed, in countries where the income distribution has not been egalitarian, even GDP growth has not been sustained, pace the Latin American countries.

The above does not necessarily argue against the process of `liberalisation', though it has implications that will be clear later. Let us move on to the third assumption behind current economic policies. Given the choice between an `employment-oriented p attern' of development and a pattern based on `free trade' and `globalisation,' it is assumed that the latter is likely to be more attuned to `welfare maximisation', and, therefore, better attuned to making for rapid economic development of the country.

During 1991-2000, India's GDP grew more than 6 per cent annually, a far higher decadal growth rate than ever witnessed. Yet, all available evidence point to two starkly uncomfortable facts: First, while up until 1993-94, there was a steady reduction in t he percentage of people below the poverty line, thereafter, the available evidence point to a sharp reversal of this trend. Second, there was a steep increase in the crime rate, perhaps due to an increasing number of people unable to make a living.

Two facts stand out. First, since July 1991, the government's focus has been on the liberalisation of trade and exchanges; on a `market-driven' consumer-friendly pattern of development; on reliance on private capital, especially external capital providin g the thrust for development rather than on the earlier focus on public investment; and on an employment-intensive pattern of development.

As seen above, the overall GDP growth rate has certainly gone up. Yet, even if we discount the Thin Sample estimate of `rural poverty' in January-June 1998 as afflicting 45 per cent of the rural population (compared to 37 per cent in 1993-94), the eviden ce is most disturbing. Much as we may welcome our new-found `individual freedom', the evidence available is not such as can be cited to indicate `welfare maximisation' in India during the 1990s.

The fourth fallacy is the assumption that foreign direct investments can help the country develop, including even `infrastructure'. This is a claim dear to all neoclassical economists. The brief problem herein is that FDI is likely to flow only to those countries where the expected profits exceed the return that funds can earn in the home country. Yet, it is well known that because of the problem of `externalities', the productivity of new investment in developing countries generally must remain low.

The point may be briefly elaborated. Even Adam Smith -- the original champion of free enterprise and a free-market system -- urged that one of the principal duties of the Sovereign or the Commonwealth was ``that of erecting and maintaining those public i nstitutions and those public works which, though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay any individual or small number of individuals...''

External capital can be expected to flow in only if the profitability of investment is higher than what capital can earn at home. That stands to reason. Indeed, it is for this reason that the Government has had to offer `guarantees' of (quite high) minim um profits to external capital, merely to attract FDI.

Yet, FDI inflows against guaranteed returns is obviously counterproductive. In fact, FDI then takes the shape of high-cost loans. And, to the extent that the guaranteed profit is higher than the increased productivity ushered in by the FDI, such external capital can be serviced only by squeezing the already low domestic savings of the host country. And, if that is true of the FDI, it is much more so with respect to portfolio and other short-term capital which merely acquire existing assets rather than c reating new ones. (FDI allowed to come in via `acquisitions' is of the same genre.)

The fifth fallacy in the present economic policy framework of the Government relates to the paeans being sung to the benefits of `integration' of India's financial services with global finance, already largely (though not yet wholly) achieved. This is so ught to be justified as essential for attracting larger volumes of FDI. The hypothesis is wrong. China attracts large volumes of FDI, yet, the Chinese financial system remains insulated from global finance. China does not allow any inflow of short-term c apital. Indeed, even for FDI, to this day, all proposals are individually screened; and the FDI is allowed entry only if the proposal fits in with China's long-term plans, and further subject to specific conditions.

Briefly consider the consequence of the reliance on external capital to promote India's development. Consider the recent Finance Ministry directive to the Central Board of Direct Taxes that any capital routed via Mauritius (even though not originating in Mauritius) would enjoy total exemption from direct taxation on its earnings in India. The above is merely an example, yet it illustrates how we are becoming prisoners of our erroneous policies.

In contrast, Dr. Mahathir Mohamad pulled Malaysia back from the hole it was in, in 1999, when the rest of the world predicted doom not only for the Malaysian economy, but also for him, when he clamped down strict capital account controls in Malaysia.