The latest quarterly figures show growth stalled in the five to 5.5 per cent range. The rest of the world, barring China, is not doing so great either, with perhaps worse to come. But then again, they do not have the stubborn inflation we have.
Looking back, could the seeds of the present growth slowdown and the persistent inflation be traced back to design defects in the big reform package of 1991? The answer is yes.
There were three very serious defects in the design of the 1991 reforms. The process of correcting two of these was started over the period 1999-2001, but one remains uncorrected to this day.
Trade was liberalised in 1991, and inward capital flows facilitated, to resolve the external payments crisis. The current account was further liberalised over time to enable discovery of the true external price of the rupee. With abolition of licensing for industrial entry, the product market reform required to reap the rewards of trade liberalisation was thought to have been completed.
Astonishingly, no attempt was made to reform the markets for labour and land, two key inputs without which no production is possible. Economists call these inputs factors of production. Just as industrial licensing was a policy wedge in product markets, restricting and hindering entry, there were a host of policy wedges in place in the markets for labour and land which obstructed the free movement of labour and land between alternative uses. This was a fundamental defect of the 1991 package, since the word reform, as economists understand the term, is about freeing factors of production to flow into their most efficient uses. Only thus does the economic engine become reformed, in the sense of using its factor endowment to the greatest advantage.
Why was no attention directed towards reforming factor markets? The reason of course was that labour and land are on either the concurrent or state lists of functions in the Constitution. And the principal feature of the 1991 package was that it was done at the national level without any attempt to involve state governments as partners in the reform process. In part this may have been because of the powerful opposition to reform from many quarters at the time, who saw the decline in the external price of the rupee as a sell-out to foreign interests. The response to this, instead of taking states on board, was to do reform by stealth, so that issues like factor market reform which required state co-operation remained unaddressed.
The constrictions imposed by labour laws in India are well known, and have been dealt with repeatedly by many economists. Although some states have on their own moved part-way towards making the labour market more flexible, and therefore more labour friendly, we continue to have corporate enterprises shying away from formal hiring, and relying on contract labour which falls outside the purview of labour regulation. The net result has been to make labour far worse off than if contractual hiring were made permissible, with equal pay for equal work, and health and retirement benefits. Periodic episodes of violence against factory managers indicate the pent-up rage on the shop floor. Industrial workers, far from being happy with unreformed labour markets, are extremely angry.
Still worse was the failure to do anything to reform the market for land. Transfer of agricultural land to non-agricultural uses is on the state list of the Constitution. Some states have done more to facilitate this than others, in such a way as not to harm the interests of people selling land. In states which did not, there have been episodes of violence. I have written earlier on how land sale should be structured (“Wanted: new financial instruments”, Business Standard, May 29, 2012), so I will focus here on why we need facilitation of transfer, even of fertile land, to other uses.
A case will illustrate the point. In a fertile agricultural stretch on the Karnataka-Andhra border, irrigated by a rain-fed tank, the switch several decades ago to horticultural crops for the urban market made the area so prosperous that demand grew for a bus depot to facilitate transport of produce. Because of the absence of any template for valuation and sale of privately owned agricultural land, the tank was drained to make way for the bus depot. Production continued for a while with pumped up groundwater, the water table fell, and now the area is a wasteland. The youth in the area who could have been prosperous farmers are embittered casual labourers in nearby factories.
Failure to reform the land market, and the resulting concealment of land transactions actually taking place, causally underpins today’s food price inflation, stalled growth, and land scams. It underlies the power crisis too, since land acquisition for coal mining has no clearly defined platform on which each case can be valued and negotiated.
Trade theory in economics is predicated on the assumption of perfect factor markets. The intellectual fathers of reform in India failed to see the disconnect between that assumption and Indian markets for labour and land, which are beyond Byzantine in their complexity. Even reputed Indian institutions desirous of complying with labour laws find them so complex and intrusive that they know themselves to be in violation of one or other of the laws prevalent in the states in which they operate.
The land acquisition Bill should have been shepherded through an inter-state platform akin to that formed for the VAT, where the raucous disagreements that will greet it in Parliament could have been played out behind closed doors. It would then have been politically honed to a form that would have had easier passage in Parliament.
Going forward, states need to brought on board to unlock the India growth story. State (and central) laws inhibiting the free and fair functioning of land and labour markets have to be reformed, if we want to release supply-side brakes on growth and bring down inflation.
The writer is a retired professor of economics