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Literary Review
Taking stock of reforms
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Economic Policy Reforms, a collection of papers on India's economic reforms since 1991, presented at a conference at Stanford University, reviewed by KALYANJIT ROY CHOUDHURY.
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THE book under review is a collection of papers on India's economic reforms since 1991, presented at a conference at the Stanford University Center for Research on Economic Development and Policy Reforms, held in May 2000. The participants were economists, policy makers (including bureaucrats), businessmen and academicians. The range of topics on which papers were presented at the three-day conference included important areas of economic reforms (past, present and future) like fiscal situation, globalisation, information technology, small scale industries, educational policies, regional variation in performances and the new business environment. Besides being an important contributor in many of the discussions that followed for three days at the Stanford Center, Anne Krueger has written the introduction, giving the readers an aerial view of the contents and themes of the papers included in this edited volume. Out of the nine papers included in this volume, Anne Krueger has contributed two significant papers — one on "The Indian Economy in the Global Context" (co-authored by Sajjid Chinoy) and the second one (the concluding paper in the book) on the "Priorities for Further Reforms".
The book has a foreword by the U.S. ex-secretary of state, George P. Shultz, who highlights the nature of the Indian economy prior to its opening up, in the following words: "in a country with the second largest population in the world, and the largest democracy in the world as measured by numbers of people, the economy was becoming less and less important to the world. India's rate of growth in real per capita income remained stubbornly low, at around 1.5 to 2.0 per cent per annum, while its share of world trade fell from 1.8 per cent in the early 1950s (a share larger than Japan's) to 0.6 per cent by the late 1970s (a share smaller than Algeria's). Although progress was made in reducing poverty, 330 million people, more than half of the population, were still living in desperate poverty in 1974. By 1999, the record was better but, even so, estimates are that about 270 millions people, over one-fourth of the population, live in poverty. Thus, the pressing need to bring better living standards, increased literacy, and improved health to this enormous population make this economic performance very disappointing... When crisis struck in the early 1990s, the Indian government began to reform its economic policies. Protection was reduced; quantitative restrictions on trade were dismantled; the financial sector was partially liberalised. Private economic activity was permitted in a number of areas previously reserved to the public sector and the extent of controls was reduced... The resulting acceleration of economic growth in India during the 1990s, reaching an average level of almost seven per cent per annum in the latter part of the decade, was not surprising, but was surely gratifying. All friends of India, students of India, and potential investors in India are watching the current pace of reforms with cautious hope. What should we expect in the future? ... If the essays in this volume can better inform the international community of scholars and policy makers of the progress India has made, as well as the problems still to be confronted, they will have made an immense contribution. Even more, if they can help improve the basis on which future policy reforms are made and strengthen economic performance, then India and all its partners and friends around the world will benefit. Then cautious hope can give way to confident optimism."
The papers that follow in the volume, have all, without any exception, contributed towards spreading the same kind of message as that given in the above quotation. Let me start with Anne Krueger and Sajjid Chinoy — "Indian Economy in Global Context". They concentrate on three vital areas where reforms have either been inadequate or could not make much impact, till the date of the conference. In fact, these have become in the new millennium, the main thrust areas of faster growth in India. The areas are: infrastructure, labour laws and public sector enterprises. In a very comprehensive analysis of the genesis of the reform measures, the authors have touched upon every aspect of economic life, where earlier economic policies have made little or no impact, and their subsequent post-reforms achievements. Their real contribution lies in focussing and emphasising the areas where even after 10 years of reforms, nothing significant could be achieved, and hence ought to constitute the new thrust in policy reforms. The first is infrastructure — it includes power, telecommunications, railways, roads and ports. By all standards and indicators, India's performance in this sector is highly inadequate, particularly relative to the achievements of East and South East Asian countries. With growth potential expanding in the economy as a whole, infrastructure inadequacies would act as a brake on the path to realising the potentials in the rest of the economy. This is what the authors have to say: "In 1999, the World Economic Forum (1999) asked businessmen to rank countries according to the adequacy of their overall infrastructure and of its various segments. Altogether, fifty-nine countries were ranked. Of those fifty-nine, India was ranked fifty-fifth in terms of the "adequacy of overall infrastructure", and fiftieth in importance accorded to infrastructure by the government. For individual components of infrastructure, only railroads fared significantly better, where India was ranked twenty-eighth of fifty-nine. For adequacy and efficiency of road infrastructure (fifty-fifth), port facility (fifty-third), telecommunication (fifty-first), and air transport (forty-fifth), India was ranked well down the scale." Even to this date, nothing significant has been achieved in most of the infrastructure sectors, though some progress has been made in the telecommunication sector and may be in express highways (roads). Power sector and ports remain as gloomy as before.
The other two areas highlighted by Krueger and Chinoy are "reforms of labour markets, increased efficiency and effectiveness of the commercial code and judicial system, and the restructuring of state owned enterprises". What exactly constitute labour markets reforms? Indian labour markets laws are outdated and regressive in nature, and encourages inefficiencies without at all increasing the workers well being. The important side effects of existing labour markets regulations are: "locking workers and employers into jobs (and thus reducing labour mobility to places where it earns the highest returns and discouraging employers from hiring additional workers), giving workers' union sufficient power, so that productivity has fallen (with random and unpredictable strikes), and discouraging the development of labour- intensive industries that might otherwise have a competitive advantage in export markets." Due to stringent labour laws, the growth of employment in the organised sectors of the economy has been highly inadequate, compared to the growth of employment in the unorganised and informal sectors of the economy. It is highly improbable that archaic labour laws will be changed in the near future (despite promises by the ruling parties), as all important political parties have labour unions of their own, who would always oppose any change in labour laws. The political leaderships must show guts and boldness, and must be willing to take political risk for the sake of better long-term achievements (but who cares for long run). In a large democracy, one cannot adopt policies followed in countries like South Korea, and Taiwan for disciplining labour.
The third area is the restructuring of public sector and sick industries. "Given the size of India's public sector enterprises, it is probable that there is room for a large improvement in the productivity and efficiency of the Indian economy if means can be found for improving the efficiency of the activities carried out by these enterprises. To be sure, some enterprises will simply, have to be closed down, as they simply be uneconomic. But for many others, there are doubtless significant opportunities for efficiency improvement with appropriate managers and incentives and with a relaxation of some of the restrictions (such as those on the employment of labour)". The Indian policy framers must take cognisance of the advice given by Krueger and Chinoy: opening the small scale sector to more competition; privatising all public sector enterprises that compete with either the other private sector firms or with imports (this will encompass a wide range of activities — from producing bread, to making steel and its associated products, to running hotels, to making watches and producing mineral water); and privatising natural monopolies (like telecommunication, oil and gas; transport including airlines; power and electricity — the entire infrastructure comes in this category). Though the sequencing of privatisation can be questioned in the Indian context, yet it cannot be denied that some achievements have been made since the year 2000. Disinvestment should ensure that government's ownership and control is reduced to zero, so that the PSEs go directly under complete private management and control, in order to maximise efficiency gains. The Minister for Disinvestment must be given the credit for some of the disinvestments that have taken place in the last few years. There is some logic in selling profit making public sector enterprises when the sun is still shining. Is there logic in buying loss-making enterprises? However, sick and loss-making enterprises can take a turnaround, when run by the private sector, with better management, better inputs used, and a reorganisation of production structure.
Chapter two is on "India's Fiscal Situation" by T.N. Srinivasan. That India's macro economy performed extremely well in the last two decades prior to the new millennium has been well documented now. It also experienced the most expansionary role by the government, causing current account receipts to fall below the current expenditures. The consequence has been an increase in both internal and external debts to finance fiscal imbalances. Fiscal prudence was replaced by fiscal profligacy. An important point is that real imbalances turned out to be much more than what government budget would actually reveal. "The reason is that the rates of interest, at which the government appropriated a large share of the loanable resources of the banking system through statutory liquidity ratio (38.5 per cent maximum) and cash reserve ratio (15 per cent maximum) were administratively set below what would have been market clearing levels. Also, at least in the early years, external borrowing was largely on concessional terms from multilateral lending institutions and from bi-lateral government to government external aid transactions. As the 1980s wore on, the government also resorted to borrowing from abroad on commercial terms, from both the capital market and non-resident Indians." A large component of gross fiscal deficit has been financed by monetisation, through the sale of ad hoc treasury bills to the R.B.I. This put tremendous pressure on domestic inflationary situation and on exports potential externally. Thus began the crisis of 1991. The expansionary fiscal regime-led high economic growth could not be sustained any more. Hence began the reforms of economic policies of the government of India. Fiscal situation became unsustainable without policy changes. Srinivasan found the state finances more precarious than central government finances. With a shrinking revenue resource base and expanding expenditures on account of large responsibilities assigned to the states in important sectors like "education, health, irrigation, and other investment in agricultural development", in the absence of adequate transfers from the centre (already estranged in huge fiscal deficit) the states have been running into unsustainable fiscal imbalances. The poorer the state, the more is the estrangement, despite the centre's supposedly caring role of redistributive transfers to these states.
An important side effect of this is the diversion of state resources from investment to current expenditure, and by defaulting on payment to central public sector enterprises (like Coal India and NTPC). Incorrect user charges and pricing policies of goods and facilities provided by the states have been the contributory factors in the mess-up of state finances. As Srinivasan says, "both for sending the appropriate signals to users and for raising resources for investment, states will have to address pricing issues with respect to electricity, irrigation, water, education, and goods and services provided by the government." About the genesis of the problem, this is what the author says: "under the present system, the states have established a large infrastructure and spent on social services, including many populist programs without adequate financing through taxes or recovery of costs from users of state provided goods and services. In the context of electoral politics as practiced in India, populism is attractive to politicians of all shades."
What is the way out from this long-drawn impasse? Indeed a valuable pragmatic suggestion from the author — "there is a lot to be said for the view that the centre's roles should be confined to national defence, external relations, the maintenance of a common currency and of national networks of communication and transport, and the assurance that there is a single (that is, national) common market. To this I would also add a relatively circumscribed role of redistribution across states. All other activities could be left to the states. Such a step would approximate the market preserving federalism (MPF) of Weingast (1995). Under MPF, the central government would ensure that goods and factors are mobile across states, limited revenue sharing exists among levels of government, and access to capital markets is limited for all levels of government. Under these assumptions, the ability of any level of government to tax and spend unwisely would be severely limited, since factors would flee any state that did so. However, adhering to other requirements of MPF in the absence of mobility of factors across states might accentuate the existing interstate disparities in income and poverty as well as lower public expenditures on rural development and poverty alleviation. Alternatively, it might encourage states to compete to provide an environment that is most conducive to economic and social development. I am optimistic that the latter situation would occur and that interstate competition in tax rates and in the provision and pricing of infrastructure services will in fact be a race to the top rather than a race to the bottom." The paper by Srinivasan received valuable comments from Shankar Acharya, Kenneth Kletzer and N.K. Singh.
The next paper is by Montek Singh Ahluwalia on "State Level Performance Under Economic Reforms in India". He provides valuable insights into the interstate differentials in growth performance since 1991. Some of his findings are as follows: (i) Post-1991, there is no evidence that richer states have got richer. In fact, the two richest states, Punjab and Haryana, actually dipped below the national average; (ii) Maharashtra and Gujarat achieved the fastest rates of growth in terms of per capita Gross State Domestic Product (GSDP); (iii) Some of the poorer states have improved their positions (Rajasthan in particular, though Bihar, Orissa and Uttar Pradesh have remained poor despite positive growth rates); (iv) The middle income states of West Bengal, Tamil Nadu, Kerala, and Karnataka, showed improved performance. Their per capita GSDP have grown faster since 1991, with West Bengal's performance relatively better.
These observations have important implications for the state level poverty incidence. With a state's growth performance being the most important factor in poverty reduction (besides poverty alleviation programmes), economic analysis must concentrate on determinants of growth at the state level. Of course, T.N. Srinivasan's suggestion for a market preserving federalism, by providing factor (labour) mobility, can make some dent in poverty reduction of the states through "factor remittances" even if growth is inadequate. However, as Ahluwalia says "it certainly cannot substitute for acceleration of growth of the domestic economy in these states." The growth of GSDP can be explained by three factors, the level of investment in states, the quality of human resources and the quality of infrastructure. Though economic reforms in various segments of the economy have not affected all states equally, yet no state could be affected adversely. The three factors mentioned above are hence crucial in appropriating the gains from liberalisation. Compared to the phase of state-led investment determination, "with liberalisation of investment control and much stronger pressure of competition, especially competition from imports, investment size began to be determined on economic grounds, and location was also determined to a much greater extent by economic considerations. It is very likely that in practice this led to a reallocation of investment in favour of states perceived as having better infrastructure facilities, better labour skills and work culture, and a more investor-friendly environment. The resulting reallocation of investment in the better-performing states, and a consequent increase in their growth rate, with a corresponding reduction in investment in less well endowed or well governed states and a deceleration in their growth."
As with other papers to follow, Ahluwalia's analysis of what must be done to lift the growth states is quite exhaustive. A whole gamut of policies, affecting the three crucial determinants of state level growth, have been considered. Some state chief ministers ought to go through Ahluwalia's paper very intensively. Vested interests and corruption are two big obstacles in the way of implementing Ahluwalia's prescriptions, particularly with respect to states' finances.
The next chapter is by Naushad Forbes on "Doing Business in India — What has Liberalization Changed". He analyses how and whether the economic and business environments have changed since 1991. Forbes gives some amusing aspects of India's contradiction-ridden economy. One such is the following: "The Talcher unit of Fertilizer Corporation of India, the state owned fertiliser factory, recently celebrated its silver jubilee. It has yet to produce its first kilogram of fertilizer. A few years ago, its workers went on strike (one wonders from what), demanding higher wages. The government that put through the 1991-93 reforms gave in to the demand." Or consider the following: "A visit to the finance ministry convinces one that the Indian bureaucrat is being cast in a new mould, that of a market-oriented individual with an international outlook. One remains convinced until one visits certain other ministries and meets bureaucrats who, one suspects, have not yet had the end of the cold war brought to their attention."
Forbes brings out in a very emphatic manner the positive effects of reforms on the industrial structure, with firms trying to be innovative in a competitive setting. Commenting on the qualitative change from the pre-1991 period of inward looking policies, Forbes says, "what is clear is that the criteria for success in Indian industry have changed from capturing industrial licenses through acquaintance with Rajiv Gandhi, bribes for bureaucrats, or liaison men in Delhi. Today, success increasingly comes from making a better product more efficiently than anyone else, as it does in most of the world, Indian industry is becoming normal".
The readers would find the list of winners and losers among Indian firms and MNCs in this new competitive framework, as given in table 4.7, highly illuminating and educative. Forbes thinks that the worst period for Indian consumers is over. For 40-odd years they have suffered due to government's protectionist policies. From "worst development records in Asia" to making Indian firms "tigers and not pussy cats", is what liberalisation can do to the Indian economy a la Forbes. A very well documental piece.
The next paper is on the Indian software industry, and is titled "Bangalore — The Silicon Valley of Asia", by Anna Lee Saxenian. She concentrates on the development of software industry in the post-liberalisation period, where the success rate has been phenomenal. She finds that in India, the IT hardware industry could not grow due to the inward looking policies of the government. She gives credit to Rajiv Gandhi for ushering the IT revolution in India, for his emphasis on "electronics, software, telecommunication, and other emerging industries". It was during his regime that software was recognised as an "industry", "making it eligible for an investment allowance and other incentives. The policy also lowered import duties on software and personal computers (PCs) and permitted the import of computers in exchange for software exports at a special low duty".
Saxenian's paper ought to be read in conjunction with the follow-up comments by Narayana-Murthi and Sandeep Raju, and that by Ashok Desai. Together, they cover the entire gamut of India's software industry. The next phase of industrial revolution in India will the combination of software-telecom-infrastructure-education-hardware. Can such a development produce the necessary trickle-down and spread effects, so vital for the survival of the new-found panacea for growth? Can the growth of service industry alone lift the economy to the self-sustaining stage, and subsequently to the next higher stage of matured mass consumption? Not really, if more than half the population is by-passed by the new growth process.
The next essay, on the small-scale industries in India by Rakesh Mohan is a path-breaking piece. The greatest harm to the process of industrialisation in India has been caused by the government's reservation policy. In the name of employment, equity, balanced regional development, dispersion of technology, non-inflationary effects, and what not, small-scale enterprises were given protection and all kinds of subsidised inputs as well as fiscal benefits. What has been the end result? Disaster; well, if you cannot believe, the readers are advised to go through the 90-odd pages (inclusive of four page comments by Roger G. Noll) of Rakesh Mohan's paper. Small-scale sector has been the focus of the next round of reforms, which has already begun — the dereservation.
The next two papers are on education, an area much neglected so far. However, it is the most crucial sector on which IT and its complementary areas are dependent on, for their continuous success. As Anne Krueger says, "Evidence that increased educational attainments are a necessary condition for higher wage incomes for much of the labour force is by now widely accepted... it is widely recognised that the quality and quantity of Indian educational opportunities, especially at the primary and secondary level, must be improved. However, there are significant questions as to what are the most effective measures to improve the educational attainments of young people in India".
On education, the first essay is by Anjini Kochar entitled "Emerging Challenges for Indian Education Policy". She approaches the problem from the supply side, analysing the relationship between quality of public schools and school enrolment. In the Indian situation, the growth and functioning of private schools have been hampered by government regulations. Hence, an area of future reforms lies in school education sector. Schooling inequality, when added to the general inequality, may endanger the entire growth momentum unleashed by the new economic policy of 1991. It is of course, difficult to measure schooling quality, even the observable aspect of it, in the absence of data. School education being mainly a state subject, government expenditure on primary and secondary education varies widely among the states. What must be encouraged is the growth of private schooling in India, and this requires less regulation by the government. Kochar says, "Many argue against the growth of the private sector on the grounds that it would increase schooling inequality. However, there is little evidence on this issue; an increase in the supply of private schools may very well reduce school fees, making such schools more affordable to poorer households. The evidence suggests that even poor households are currently incurring significant schooling expenses, frequently in the form of fees for private tutoring. The willingness to pay for quality teaching suggests that poor households would take advantage of good quality private schools, should they become available."
The second essay on education is by Andrew D. Foster and Mark Rosenzweig, on "Does Economic Growth Increase the Demand for Schools? Evidence from Rural India, 1960-99." Testing the hypothesis about the relationship between economic growth and demand for schooling in 240 villages across India, the authors find that a significant positive correlation does exist. Implying higher (lower) growth increases (decreases) demand for schooling. In a dynamic setting the returns to schooling increases. Surprisingly, wealth effect does not necessarily produce a higher demand for schooling. Agricultural productivity has a favourable impact on both school enrolment and school construction. In a knowledge-based economic development, human capital and skill formation at various tiers of society would be essential for sustaining the process of development. Investment in education in general, and in particular school education would play a vital role in the next round of development. But it is difficult to accept "freeing up the market restrictions" as the right approach. Given India's vast size of population, an optimal mix of private and public is what is desirable. But that requires a good quality government and governance.
At the end, we are back to Anna Krueger for the last paper in the book — "Priorities for Further Reforms". Of all the points she touches upon, taking cue from the presentation of the various participants in the Stanford conference, the most relevant ones are on centre-state relationship, the financial sector reforms and the labour market reforms. It is hoped that the book under review must have already made a far reaching impact on those who matter in the context of guiding India's planned economic development, in a mixed economy cum federal democratic polity. Others outside that framework are either victims or beneficiaries of what these gentlemen/ women do, in regulating-steering-guiding the Indian economy.
Economic Policy Reforms and the Indian Economy, edited by Anne O. Krueger, OUP, 2002, hardback, p.377, Rs. 595.
Kalyanjit Roy Choudhury is Head, Department of Economics, St. Stephen's College, Delhi.
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