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The Chakravyuha Challenge of the Indian Economy

  • From socialism with restricted entry to “marketism” without exit
  • Impeded exit has substantial fiscal, economic, and political costs
    • The government’s initiatives including the new bankruptcy law, rehabilitation of stalled projects, proposed changes to the Prevention of Corruption Act as well as the broader JAM agenda hold the promise of facilitating exit, and providing a significant boost to long-run efficiency and growth
  • A market economy requires unrestricted entry of new firms, new ideas, and new technologies so that the forces of competition can guide capital and labour resources to their most productive and dynamic uses. But it also requires exit so that resources are forced or enticed away from inefficient and unsustainable uses.
  •  in a country as large and diverse as India, exit may not always be desirable.
  • But policy action is needed when the costs clearly outweigh the benefits, when the lack of exit generates externalities that hurt others—such as firms that have to compete with subsidised “sick” firms or taxpayers who have to pay for the corporate subsidies.
  • Chakravyuha challenge is more a feature of the relatively traditional sectors of the economy but is not restricted to the public sector—indeed, impeded exit in the private sector is becoming a major challenge.
  • In a normal economy, old firms would be the ones that were efficient, only then could they survive for that long and hence should be much bigger in size than new firms
  • But in India avg 40 year old firm is just 1.5 times larger than a new firm (8 times in US
    • Worst part is that a decade back they were 2.5 times larger i.e. inefficient firms are not allowed to exit and they remain small
 
  • costs of IMPeded exIt

  • The lack of exit creates at least three types of costs: fiscal, economic (or opportunity), and political
    • Fiscal costs:
      • Of course, inefficient firms are supported by explicit (bailouts) or implicit (free power, reduced tariff, interest subvention etc) government subsidies
      • High subsidies # high borrowings # high fiscal deficit # high debt # high interest cost
      • Add to this the tax revenue forgone, if efficient firms were allowed to take their place i.e. Double whammy(blow) of low tax and high subsidies
      • Exit is impeded often through government support of incumbent, mostly inefficient, firms.
      • This support—in the form of explicit subsidies (for example. bailouts) or implicit ones (tariffs, loans from state banks)—represents a cost to the economy.
    • Economic costs:
      • Economic losses result from resources and factors of production not being employed in their most productive uses.
      • In a capital scarce country such as India, misallocation of resources can have significant costs
      • stressed asset
    • Political costs:
      • lack of exit can also have considerable political costs for governments attempting to reform the economy.
      • benefits of impeded exit often flow to the rich and influential in the form of support for “sick” firms.
      • give the impression that governments favour large corporates, which politically limits the ability to undertake measures that will benefit the economy but might be seen as further benefitting business.
    • No sector illustrates the combination of fiscal, economic, and political costs more starkly than fertilizer
      • fiscal subsidies amount to 0.8percent of GDP, much of which leaks abroad or to non-agricultural uses, or goes to inefficient producers, or to firms given the exclusive privilege to impor
  • In India, the exit problem arises because of three types of reasons 
  • three I’s 
    •  Interests(vested interests) – Power of vested interests which is aggravated by certain imbalances or asymmetry
      • Concentrated producer interests (a few losers stand to lose by lot) v/s diffused consumer interests (individual benefit small but aggregate benefit large)
      • Concentrated interests have more voice, backed by financial power and often democratic political systems tend to give disproportional influence to them (vocal minority v/s silent majority)
      • In the case of administrative schemes, vested interests often create a market of their own, planning their actions to benefit from it: put differently, this is a case of supply creating its own demand
      • Bureaucratic inertia perpetuates persistence
      • 50 percent of schemes are 25 years old. extra vigilance is necessary to ensure that schemes remain relevant and useful over time. And vigilance should probably increase in proportion to the longevity. (for these reasons only concept of ZERO based budgeting was introduced)
    •  Institutions– Paradoxical situation of both weak and strong institutions delaying exit
      • Weak institutions –
        • Inability to punish willful defaulters (legitimacy of institutions itself is questioned)
        • Judiciary­ time and cost overrun
        • Debt recovery tribunal­ share of settled cases is small and declining (4 lakh crore locked up)
      • Strong institutions so called referee or vigilance institutions– CBI, CVC, CAG, Judiciary combined with the asymmetric incentives for bureaucrats that favours abundant caution and hence the status quo.
    •  Ideas/ ideology

      • Very difficult to phase out entitlements especially in a country with sizable poverty and inequality and one that is a democracy
      • The objective is often laudable but once the policies and programs have been set in place, they are very difficult to reverse
      • minimum support prices (MSPs) were envisioned as an insurance mechanism for farmers, but have become price floors instead, favouring some crops in some regions at the expense of other
    • How to address the problem?
      • addressing the Problem
        • Avoid exit through liberal entry:
          • promote competition via private sector entry rather than change ownership through privatization. Eg. BSNL, MTNL were not privatized but liberal entry to private telcos
          • Advantage­ It bypasses opposition from managers as well as labour interests.
        • Direct policy action:
          • new bankruptcy law that will significantly expedite exit
          •  exit problem in relation to public-private partnership projects requires the creation of alternative, albeit temporary, structures to be able to credibly allocate the burden of past failure.
          • The Kelkar Committee on “Revisiting and Revitalising the Public Private Partnership model of Infrastructure” has made recommendations on resolving legacy issues and key contractual features going forward. The Committee has recommended quick finalisation of principles of renegotiation to build in the flexibility while protecting authorities against the risk of moral hazard.
        • Technology and the JAM solution:
          • DBT in fertilizer and other input use can achieve targeting which allows the poor to be protected while allowing the underlying and persistent distortions to be removed.
          • Technology can help in two ways.
            • First, it brings down human discretion and the layers of intermediaries.
            • second, it breaks the old shackles and old ways of doing business.
        • Transparency:
          • It is increasingly clear that there is over-production of cereals, especially in some states
          •  minimum support prices to create incentives for producing
          • Reducing this over-production—a manifestation of this exit problem—is difficult. But one possible way of effecting change it to throw light on the costs of the status quo.
          • transparency about the real beneficiaries
        • Exit as an opportunity:
          •  resources earned from privatization could be earmarked for employee compensation and retraining.
          • such action can be converted into opportunities.
  • Box 2.2: Improving economic policy-making and implementation by getting public servants to decide without fear or favour
    •  problems with civil service decision-making stem from multiple sources.
      • here are gaps in capacity, training and specialised knowledge in dealing with certain kinds of economic issues.
      •  the increasing number and rigour of external oversight mechanisms may have unintended effects.
      •  external monitoring in the public sector tends to be skewed towards bad decisions that were taken rather than good decisions that were not taken (i.e. opportunities that were missed)
      • certain provisions of the anti-corruption law and the way they have been used in recent years.
      • Good public administration and sound policy making requires that public servants take decisions in public interest and, in particular, without ‘fear or favour’ (a phrase which finds place in the oath of office for ministers). There is a credible perception that well-intentioned but draconian legal provisions seeking to prevent decision making with favour, seem to be resulting in decision taking with fear.