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We are starting with the second chapter of the economic survey as the first chapter contains a mixture from all the chapters. Now we will finish each of the individual chapters and will come back to first for a better revision.

CHAPTER 02 The Economic Vision for Precocious, Cleavaged India

Introduction

  • The economic vision animating Indian policy can be divided into two phases.
    • First came nearly half a century of socialism, where the guiding principles were economic nationalism and protectionism. During those years, the public sector occupied the commanding heights and the government intruded into even the most micro-decisions of private firms:
    • This framework was rejected after 1991 But even now it remains unclear as to what has replaced it.
    • Next, India has replaced its erstwhile socialist vision with something resembling the “Washington Consensus”:
      • open trade,
      • open capital, and
      • reliance on the private sector – essentially the same development model that has been tried and proven successful in most countries of Eastern Asia
    • Every successive government have initiated reforms in line with the above consensus. The result of all these reforms over the past 25 years has been a remarkable transformation of India from a largely closed and listless economy to the open and thriving economy that we see today.
  • Three Measurable but qualitative aspect of Indian Economy due to these Reforms
    • (* An Economical Contradiction of India* A fundamental truth of geography is that large countries tend to trade less than small countries. Being large makes the benefits of trading with the outside world very low relative to trading within the country. The opposite is true for small countries: lacking an internal market, their benefits of trading with the world are relatively large and hence they tend to have higher trade-to-GDP ratios  India is “above the line”, in Figure 1(a), Figure 1(b) meaning that it trades far more than would be expected for a country of its size – a stark turnaround from the pre-1991 situation when India was an under trader.)
    • India’s capital inflows were normal during the period in comparison with emerging countries. In fact, in the most recent year, FDI is running at an annual rate of $75 billion, which is not far short of the amounts that China was receiving at the height of its growth boom in the mid-2000s.
    • Though India is accused of a larger Government, figures shows that the government expenditure is in line with the development of the country
  • This achievement is particularly remarkable because it has been achieved under a fully democratic political system.

II. The road to Be Traversed

In what ways is India different?

  • Three lingering features capture the doubt that it has not yet traversed the distance toward some vague and unspecifiable end-point that could be described as desirable or optimal.
    • First, there has been a hesitancy to embrace the private sector and to unambiguously protect property rights, combined with continued reliance on the state to undertake activities that are more appropriately left to the private sector
    • Second, state capacity has remained weak, as can be seen from poor delivery of essential services
    • Third, redistribution has been simultaneously extensive and inefficient

1. Ambivalence about private sector and property rights

  • The symptoms of this ambivalence toward the private sector manifest in multiple ways.
    • The most well-known example is the difficulty of privatising public enterprises, even for firms where economists have made strong arguments that they belong in the private sector.
  • Beyond a reluctance to privatise, the ambivalence towards the private sector is manifest in many other ways. The agriculture sector is entwined in regulation, a living legacy of the era of socialism.
    • While progress has been made in the last two years, producers in many states are still required by the Agricultural Produce Marketing Act to sell only to specified middlemen in authorised markets (mandis).
    • And when this system nonetheless generates price increases deemed to be excessive, the Essential Commodities Act is invoked to impose stock limits and controls on the trade that are typically pro cyclical, thereby exacerbating the problem.
    • Read APMC Chapter in 2014-15 Economic survey and Agriculture More from less chapter in Economic Survey 2015-16 Read Here
  • A similar legacy from the past circumscribes property rights.
    • During the socialist era, the 44th Amendment removed Articles 19 (1) (f) and Article 31  and replaced them with Article 300-A, thereby downgrading property to that of a “legal right”
    • The ramifications of this decision continue to be felt to this day, in such issues as retrospective taxation.
    • Evidently, it seems politically difficult to uphold a widely shared—and judicially endorsed—principle against expropriation and retroactivity because of the fear of being seen as favouring the private sector, especially the foreign private sector. 
  • The twin balance sheet problem—in the corporate and banking sectors ( Read Chapter From Economic Survey 2015-16 Click Here) 
    • It remains a millstone around the economy’s neck, casting a pall over private investment and hence aggregate growth.
    • This problem has not been resolved in the many years since it emerged in 2010 is the political difficulty in being seen as favouring the private sector, a problem which will necessarily arise in cases where some private sector debts have to be forgiven.

2. State capacity

  • A second distinctive feature of the Indian economic model is the weakness of state capacity, especially in delivering essential services such as health and education
  • Nearly all emerging markets started off with weak state capacity at independence. But as their economies developed and prospered, state capacity improved, often at an even faster rate than the overall economy.
  • In India, by contrast, this process has not occurred. The Indian state has low capacity, with high levels of corruption, clientelism, rules and red tape.
  • While competitive federalism has been a powerful agent of change in relation to attracting investment and talent (the Tata Nano car being the best example– Invitation to build the factory) it has been less evident in relation to essential service delivery.
    • There are exceptions such as the improvement of the PDS in Chhattisgarh and Bihar, the incentivizing of agriculture in Madhya Pradesh, the kerosene-free drive in Haryana, power sector reforms in Gujarat which improved delivery and cost-recovery and the efficiency of social programs in Tamil Nadu.
  • On health and education sector, in particular, there are insufficient instances of good models that can travel widely within India and are seen as attractive political opportunities.
  • At the level of the states, competitive populism (with few goods and services deemed unworthy of being handed out free) is more in evidence than competitive service delivery.
  • The weakness of state capacity has created another problem. Policy-making in certain areas has been heavily constrained, as a way of ensuring that decisions do not favour particular interests.
  • The result of reduced state capacity is twofold
    • First, there is now adherence to strict rules—for example, auctions of all public assets—that may not necessarily be optimal public policy.
      • Eg: judicially imposed requirement in telecommunications sector lead to serious issues.
      •  In some cases, it may be socially optimal to sell spectrum at lower than-auction prices because of the sizeable externalities stemming from the increased spread of telecommunications services.
      • But the understandable distrust of discretion means that methods other than auctions could be perceived as favouring particular parties
    • Second, there is abundant caution in bureaucratic decision-making, which favours the status quo.
      • it is well-known that senior managers in public sector banks are reluctant to take decisions to write down loans for fear of being seen as favouring corporate interests and hence becoming the target of the referee institutions, the so-called “4 Cs”: courts, CVC (Central Vigilance Commission), CBI (Central Bureau of Investigation) and CAG (Comptroller and Auditor General).
2. Inefficient Redistribution
  • Redistribution by the government is far from efficient in targeting the poor and welfare spending suffers from considerable misallocation and  suffer from the greatest shortfall of funds
  • Figure 7 show, the districts with the most poor (shaded in red in Figure 7 (a))
  • Economic Survey chapter 2 precocious
  • This leads to exclusion errors (the deserving poor not receiving benefits), inclusion errors (the non-poor receiving a large share of benefits) and leakages (with benefits being syphoned off due to corruption and inefficiency). 
  • Over the past two years, the government has made considerable progress toward reducing subsidies, especially related to petroleum products.  Not only have subsidies been eliminated in two out of four products, there is effectively a carbon tax, which is amongst the highest in the world
  • Issues with GST According to the Economic Survey
    • Even the design of the Goods and Services Tax (GST) reveals the underlying tensions. On the GST, the political pressures from the states to keep rates low and simple—resulting in an efficient and effective GST—were minimal.
    • Evidently, even a dream combination of being able to trumpet low taxes without suffering revenue losses was not considered politically attractive.

III. Possible Explanations

  • Central to understanding India’s economic vision is the fact that it has followed a unique pathway to economic success, what might be called “Precocious, Cleavaged India”.
  • Historically, economic success has followed one of two pathways.
  1. The path of Advanced Economies

    • Today’s advanced economies achieved their current status over two centuries in which economic and political development progressed slowly but steadily.
    • Today’s advanced economies didn’t provide universal franchise and Voting rights were narrow and restricted, to begin with, expanded slowly over time, a process that helped fiscal and economic development by limiting the initial demands on the state during the period when its capacity was weak
  1. East Asian Economies

    • The second set of accelerated economic successes mostly in East Asia began authoritarian, explicitly (Korea, China) or de facto (Singapore, Thailand, Taiwan), and gave way to political transformation only after a degree of economic success was achieved.
    • Explicit authoritarianism came in three flavours: military (Korea), party (China), or individual dictatorship (Indonesia)
  • India’s Case

    • India, on the other hand, has attempted economic development while also granting universal franchise from the very beginning.
    • Even rarer, India, at independence, was a very poor democracy.
    • in fact, one of the poorest nations, regardless of political system, with a per capita GDP of just $617 measured in purchasing power parity prices of 1990
    • At the same time, India was also a highly cleavaged society.
      • Historians have remarked how it has many more axes of cleavage than other countries: language and scripts, religion, region, caste, gender, and class
      • Measured by ethno–linguistic fictionalisation alone, India is similar to other countries (Easterly and Levine, 1997) But if caste is also taken into account India stands out. In Figure 9, India is a clear outlier in the north-west corner of the plot, indicating both high levels of poverty and deep social fissures
      • Economic survey Chapter 2 precocius
  • A precocious, cleavaged democracy that starts out poor will almost certainly distrust the private sector.
  • Reinforcing this notion was the prevailing intellectual zeitgeist of socialism. The founders of India wanted to “build the country” by developing the industry that would make India economically, as well as politically, independent.
  • The private sector had conspicuously failed to do this under colonial rule, not only in India but in every other newly independent nation, giving rise to severe doubts as to whether it could ever do so.
    • In contrast, the example of the Soviet Union, which had transformed itself from an agricultural nation to an industrial powerhouse in a few short decades, suggested that rapid development was indeed possible if the state would only take control of the commanding heights of the economy and direct resources into priority areas.
    • Of course, while India adopted planning and a large role for the state sector, it never abolished the private sector, unlike the Soviet Union. Instead, it tried to control private businesses through licensing and permits. Paradoxically, however, this only further discredited the private sector, because the more the state imposed controls, the more the private sector incumbents were seen as thriving because of the controls, earning society’s opprobrium in the process.
  • Another important implication of India’s precocious, cleavaged democracy is that India had to redistribute early in the development process when its state capacity was particularly weak.
    • For example, South Korea spent at a per capita GDP level of close to $20,000 what India spends today at a per capita GDP level of $5,000.
  • Finally, given the pressing need to redistribute, India did not invest sufficiently in human capital – for instance, public spending on health was an unusually low 0.22 percent of the GDP in 1950-51 (MoHFW, Government of India, 2005).
  • This has risen to a little over 1 per cent today, but well below the world average of 5.99 percent (World Bank, 2014).
  • A poor country with weak state capacity like India when confronted with the pressure to redistribute had necessarily to redistribute inefficiently, using blunt and leaky instruments.
  • All this explains why such policy interventions began. But this cannot fully explain why such inefficient redistribution persists because, after all, other countries have graduated toward less inefficient forms of redistribution
  • A partial explanation is the difficulty of exit. Exit is difficult everywhere but it can be especially difficult in a poor, cleavaged democracy dominated by vested interests, weak institutions and an ideology that favours redistribution over investments
  • (discussed in detail in Chapter 2 of the Economic Survey 2015-16, Volume I Read here)
  • The history of Europe and the US suggests that typically, states provide essential services (physical security, health, education, infrastructure, etc.) first before they take on their redistribution role. That sequencing is not accidental. Unless the middle class in society perceives that it derives some benefits from the state, it will be unwilling to finance redistribution. In other words, the legitimacy to redistribute is earned through a demonstrated record of effectiveness in delivering essential services.
  • A corollary is that if the state’s role is predominantly redistribution, the middle class will seek to exit from the state
    • So, a precocious cleavaged democracy is almost destined to succumb to this pathology. One sign of exit is fewer taxpayers. This is abundantly evident in India.
    • By reducing the pressure on the state, middle-class exit will shrivel it, eroding its legitimacy further, leading to more exit and
    • A state that is forced into inefficient redistribution, risks being trapped in a self-sustaining spiral of inefficient redistribution, reduced legitimacy, reduced resources, poor human capital investments, weak capacity and so on

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IV. Conclusion

  • India has come a long way in terms of economic performance and reforms. But there is still a journey ahead to achieve both dynamism and social justice.
  • The experience, thus far, of demonetization is instructive.
  • In one perspective, demonetisation has been a re distributive device to transfer illicit wealth from the rich to the rest, via the government. In the short run at least, the costs are being borne to a great extent by those in the informal/cash-intensive sectors that tend to be less well-off than the rich. In one sense, this could be thought of as inefficient redistribution. So, if, subsidies have been an inefficient way of redistributing toward the poor, demonetisation could be seen as an inefficient way of redistributing away from the rich.