It has long been said, only half in jest, that India needs a crisis in order to reform," T N Ninan wrote recently in the editorial "Oh for a crisis!" (August 3).
Indeed, the failure of our planned economy in delivering growth and reducing poverty had been evident to all except its most diehard adherents for a decade or more before 1991, yet it took a macroeconomic crisis for us to jettison the worst excesses of the licence-permit raj.
The idea that it takes a crisis before governments will take unpopular decisions sounds intuitive and may well be right. Yet, it stands on relatively recent foundations within "positive political economy" - that field of study that attempts to explain not what governments ought to do (we have conventional economists at hand to do that) but how they actually behave.
ALSO READ: Oh for a crisis!
The question is: if economic reform is, indeed, good economics, shouldn't it also be good politics? By definition, good economic policies should benefit the majority of citizens and, if citizens understand these benefits, surely they should support them?
When, then, is reform so difficult politically?
Academic research starting in the early 1990s helped us make sense of this puzzle. The crucial insight is that even good economic policy reforms bring distributional impacts that will harm some while they benefit others. The potential losers, then, have an incentive to block a reform that is good for the economy as a whole. This problem becomes important if they're also politically powerful and so can "veto" a reform - unless they are somehow "bribed" or cajoled into accepting it.
Click here to connect with us on WhatsApp
Alberto Alesina and Allan Drazen ("Why are Stabilizations Delayed?", American Economic Review, December 1991) conceive of the political battle over reform as a "war of attrition" between groups, each of which wants to shift the burden to its rival. In their theoretical framework, reform only happens when one group eventually finds the stalemate too costly and concedes, handing victory to its rival and allowing reform to occur.
The most important implication of the Alesina-Drazen paper is that reforms are more likely to be delayed, the greater the degree of political fragmentation and the lower the degree of social cohesion - both of which make it likely that some groups will bear a heavy and disproportionate burden of the costs of reform. That is why it may take a macroeconomic crisis - such as we experienced in 1991 - to free the hands of would-be economic reformers who until then have been stymied by powerful and entrenched interests who stand to lose.
By contrast, Raquel Fernandez and Dani Rodrik ("Resistance to Reform: Status Quo Bias in the Presence of Individual-Specific Uncertainty", American Economic Review, December 1991) focus on the possibility that there's uncertainty about the identity of winners and losers in advance of a reform. In their framework, even though the majority of citizens would support reform, ex post facto, they may opposite it, ex ante since they fear being on the losing side.
This is an appealing explanation of why there is much resistance to reform, before it occurs, and an unexpected degree of support for reform, and consensus around reformist policies, after the fact. The Indian experience of 1991 and afterwards seems broadly consistent with the Fernandez-Rodrik story.
If distributional conflict helps explain why reform is difficult, what advice would one give to a policymaker who wishes to push reform? My own research ("Will Gradualism Work When Shock Therapy Doesn't?", Economics and Politics, March 2003), and that of other scholars, has made the case for a gradualist track toward reform, in preference to the "shock therapy" approach advocated, most notably, by Jeffrey Sachs.
Gradualism, I argue, tempers the adverse effects of a major economic transformation on those who stand to be hurt, and makes it more likely that reformers will win the day. By contrast, a premature "shock" reform will alienate many, and, even if initially successful, stands to be reversed, as indeed has occurred in Russia.
As it happens, India's reforms starting in 1991, while bold by our standards, have indeed been careful and calibrated as compared to those unleashed elsewhere - the state, indeed, never fully receded from the "commanding heights" of the economy, which remains at the core of our current economic difficulties.
At the root of all such theories is the notion that inter-group distributional conflict, as filtered through political institutions, is central to explaining why good economic reforms often prove politically difficult.
Most recently, Rodrik ("Ideas and Interests in Political Economy", Harvard Kennedy School working paper, April 2013) has made the case that, as a consequence of this fixation on interests and institutions, the role of ideas has been underappreciated by scholars of political economy.
He argues that crises may provide an occasion to rethink existing policy, both because they may discredit entrenched interests but also because policymakers may be open to trying something different. "The need for a new narrative is greater, and so is the willingness to experiment," as Rodrik puts it.
This is a sobering observation as India stands, yet again, on the brink of a possible economic crisis.
The writer is an economics professor at Carleton University in Ottawa, Canada, and is co-author of Indianomix: Making Sense of Modern India (Random House India, 2012)
Marginalia makes research from the academic world accessible to all our readers
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
