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Vivek Dehejia: When good politics is bad economics

Those who blame politicians for stalling economic reforms must keep in mind the limits of democratic governance

Vivek Dehejia 

As the fiasco unfolding over foreign direct investment (FDI) in retail in India amply attests, good economics is often bad politics. This is a fundamental tenet of political economy, which is a field of study that lies at the intersection of economics and political science. However, it is often forgotten by conventional economists, who excoriate politicians for failing to enact much-needed economic reforms. If it were that easy, of course, politicians would have carried out reforms — a rather basic observation that escapes most technically-minded economists. What makes the current scenario interesting is a bold and apparently principled decision by the government being quickly reversed in light of its political calculus, as is the decision by the principal Opposition to oppose it on self-evidently opportunistic grounds.

In general, efficiency-enhancing economic reforms are politically difficult because they carry distributional consequences. An economy as a whole will gain, for instance, from a move towards free trade, but workers and firms in import-competing sectors stand to be hurt, and will protest. Politicians, in turn, will weigh the likely electoral gains and losses, which may not tally perfectly with the corresponding economic ledger.

The current events amply illustrate these arguments. Democratically-elected governments in Greece and Italy have fallen, and replaced by technocratic administrations charged with implementing vitally-needed reforms to stave off financial crisis and save the euro zone from imploding.

The very fact that the proposed measures – ranging from spending cuts to curbing the privileges of powerful vested interests – proved impossible for elected governments to enact, with bankruptcy staring them in the face, starkly illustrates the limitations that democracy places on economic reform.

The difference in China and India’s economic performance is another perfect illustration. After a promising start, economic reform in India has faltered, and growth has started to taper off. If even a year ago, foreign and domestic analysts were predicting that India would overtake China – in terms of growth rate, if not income level – the barrier of double-digit growth now seems all but impossible to breach.

Indian commentators blame “policy paralysis”, a euphemistic turn of phrase for the government’s evident lack of interest in pushing files ranging from privatisation of loss-making state-owned enterprises to unshackling rigid labour laws that retard the growth of a large, export-oriented manufacturing sector. The emphasis, rather, is on rolling out large, entitlement-based social programmes, such as the rural employment guarantee scheme.

The knee-jerk reaction among economists and a certain category of political analysts is to castigate politicians who put redistribution ahead of growth. They point to the success of the East Asian “tigers” in earlier decades, and China today, as exemplary instances of well-honed policies that have delivered rapid and sustained economic advance.

Yet they forget, in what might be termed wilful amnesia, that all of these instances of economic liberalisation took place under non-democratic political systems. During the period of rapid growth, South Korea, Taiwan, and Singapore were virtual one-party states; Hong Kong was a British colony; and Chile was ruled by a brutal and blood-soaked military dictatorship. And China today embodies the very opposite of an open and pluralistic society.

These days, of course, it is no longer army generals with medals and epaulettes, but Ivy League-trained bankers in bespoke business suits, who engineer bloodless coups. And their international backers are no longer the Central Intelligence Agency, but the International Monetary Fund. But whether sporting navy white or Savile Row pinstripe, the architects of economic reform, now as then, often do so from outside the political mainstream.

The corollary is that that the inertia of democratic polities – what political economy terms “status quo bias” – implies that sweeping economic reforms invariably occur in an ambiente of crisis. This was true of India’s first wave of liberalisation, following a foreign exchange crisis, in 1991, and, obviously, is true of Greece and Italy today.

Some observers, usually economists and policy analysts, lament the constraints that democracy places on economic policy, especially in the context of developing economies — they rue the impossibility of achieving Chinese-style rates of economic growth without embracing Chinese-style totalitarianism. Democracy, on this view, is like a sticky accelerator, which prevents the economic engine from racing ahead at full speed.

This is the wrong lesson to draw. Far from being a “constraint”, democracy is integral to a civilised society. It is, in other words, inherently woven into the fabric of a society worth living in, not merely an instrumental component that may be disconnected when it becomes a nuisance.

Hopefully, those who criticise India’s recent lacklustre economic performance, or who are cheering on the unelected administrators at the helm in Greece or Italy, will keep this in mind. The moment democracy appears inconvenient or irrelevant to some, it is incumbent upon the rest of us to speak most vociferously in its defence.

The author is an economics professor at Carleton University in Ottawa, Canada. You can follow him on Twitter @vdehejia 

First Published: Sat, December 17 2011. 00:40 IST
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