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Shankar Acharya: Gandhian legacies

Indira Gandhi's economic choices four decades ago still hobble India. What will this government's structural legacy be?

Shankar Acharya 

December is the month when columnists tend to offer their forecasts for the new year ahead or review the year gone by. I will do both but over a much longer time frame than a year. As I ponder over the wreckage of our growth and development aspirations in the past two years, I am struck by the path-dependence of our economic policies and performance. That is, our economic ideas, policy choices and consequences from 40 years ago continue to constrain and influence our policies and performance today.

Hence the reference to legacies in the title. Indira Gandhi’s economic policies (1966-1984, with a three-year Janata interregnum) still exert powerful, usually negative, effects on current economic performance and policies. Similarly, looking ahead, I would venture to suggest that the policy omissions and commissions of the Gandhi-Singh government since 2004 will continue to constrain our developmental trajectory in the years ahead. Let me illustrate.

Consider the following three economic policies, whose consequences are still prominent in the Indian economic landscape. The nationalisations of banking and insurance were carried out in 1969 and 1970, motivated by a combination of pro-poor “socialist” ideology and hard-headed political calculus. More than 40 years later, despite liberalisation and reforms conducted over the past 20 years, 70 per cent of bank deposits lie with government-owned banks and the government-owned remains the dominant firm in the industry. While bank nationalisation undoubtedly accelerated the spread of bank branches in India and curtailed the unhealthy nexus between industrial houses and some erstwhile private banks, it also spawned some of the well-known deficiencies of These included the rise of a bureaucratic/departmental culture in banking, the proliferation of lending at the behest of political masters, frequent need for recapitalisation at taxpayers’ expense and the growth of new and unhealthy kinds of nexuses between politicians, bankers and industrialists. Hardly any independent financial expert would defend the current prominence of public sector banks in India today on the grounds of economic efficiency and financial prudence. Yet it persists. The new vested interests, coupled with residual political ideology, have successfully stymied all efforts since the late 1990s to reduce government ownership below 51 per cent.

Gandhian legaciesSecond, in 1967 the policy of small-scale industry (SSI) reservations was initiated (and strengthened in 1980). This shut out medium- and large-scale Indian firms from precisely those labour-intensive, manufactured products (garments, shoes, toys, sporting goods, small electrical appliances, etc) in which the East Asian tiger economies achieved their manufacturing-exports-led growth in the decades after 1970. It turned out that, as a general rule, India’s SSI units were too small and inefficient to realise the economies of scale and scope necessary to compete successfully in international markets. So, the SSI reservation policy seriously stunted the rise of an internationally competitive, labour-using manufacturing sector in India. Since the late 1990s, efforts to chip away gradually at this damaging, Gandhi-sponsored policy have met with success, but not before substantial harm had been inflicted on Indian industry’s capacity for growth, exports and employment.

Perhaps the most damaging of Indira Gandhi’s economic legacies was the severe tightening of labour laws carried out in the “Emergency year” of 1976 through the insertion of the restrictive chapter V(B) in the Industrial Disputes Act. In effect, this made it almost impossible for an industrial enterprise with more than 300 employees to either retrench its workforce or even close down without government permission, which was rarely given. The law was tightened further by lowering the threshold level of employees to 100 in 1982. The provisions essentially turned labour from a variable factor of production into a fixed one! The massive discouragement to fresh employment ensured that India’s organised sector employment (including nine million government administrative employees) stagnated at less than 30 million out of a total labour force of around 500 million. In 2010 organised manufacturing accounted for less than 1.5 per cent of the nation’s workforce!

In essence, such restrictive laws bought job security for a tiny fraction of the working class at the cost of condemning over 90 per cent of workers to casual/informal employment, with low earnings and negligible job security. By negating India’s comparative advantage in labour-intensive manufacturing, these laws helped ensure that India’s manufacturing sector stagnated at around 15-16 per cent of GDP, compared to over 30 per cent in China. Labour laws and SSI reservation policy were important factors explaining the absence of a large and growing class of factory workers in India, in strong contrast to East Asian nations where this category formed the core of a rising middle class. Today, as China grows rich (with average income more than triple India’s already), labour-intensive manufacturing is migrating to Vietnam, Cambodia and Bangladesh — but not India, where the employment crisis continues to build. The tragedy is that no major party supports labour law reform.

What might be some of the enduring new constraints on India’s economic development bequeathed by the nine years (and counting) of the Gandhi-Singh United Progressive Alliance government? First, the massive increase in subsidies, government wage-bill and entitlement programmes that occurred in 2008-09 converted a decent fiscal situation into a structural fiscal problem. Even by the government’s understated accounting, the combined (Centre and states) fiscal deficit jumped from four per cent of GDP in 2007-08 to 8.3 per cent in 2008-09, where it remained in 2011-12, with little prospect of any significant reduction this year or next. The costs in terms of higher inflation, higher interest rates, lower investment and growth and larger external deficits are likely to continue a good deal longer.

Second, prolonged, weak, diarchic governance has taken its toll on an already stressed government administrative machinery in ways that may be long-lasting, to the detriment of public policy. Weak governance has also allowed the proliferation of massive scams (such as in telecom, coal mining and land allocation), which have taken crony capitalism to new heights (or is it lows?) in India. Quite apart from the damage to the specific sectors, the tolerance of such nexuses for so long may have encouraged a persistent pattern of undesirable linkages between politicians, bureaucrats and business. Fourth, the greatly heightened dependence on imported energy and raw materials and a pattern of large external deficits have undoubtedly increased India’s vulnerability and reduced her economic security in ways that will challenge policy makers in the years ahead. Finally, and perhaps most significantly, the latter years of Gandhi-Singh rule may have inflicted lasting damage to India’s investment-growth potential for the foreseeable future.

The writer is Honorary Professor at Icrier and former Chief Economic Adviser to the Government of India Views are personal