Friday, May 21, 2004

Elections 2004 And Economic Reforms

The PM designate (of India) has in his statement outlined the objectives of his government. At the risk of simplification we can say that there are two objectives. One is the emphasis on the income and welfare of the poor, the farmers and workers. The other is to make this to make India a prominent power so as the 21st century is an “Indian century.” To put it in economics lingo, the objective is to accelerate Growth, employment generation and poverty reduction. The PM designate has also emphasised that neither he nor his party have an ideological approach to meeting these objectives. In other words the method adopted for achieving these objectives will be pragmatic. Whatever works (policy, programs) to achieve these objectives will be adopted, whatever is ineffective or inefficient in meeting these objectives will be abandoned. In a way this can be read as the common mans definition of reforms.
The markets have been worried about what will happen to economic reforms generally and in particular to “Privatisation” and “ Labour reforms” under a Congress led government. Let us start with the facts. On privatisation the Congress party manifesto is quite explicit about not privatising profit making PSUs. It is pertinent to ask how many such units were privatised in the past 5 years. The answer is about five. About two years ago it looked like privatisation of PSUs was about to take off. Within a couple of months thereafter the exercise had crashed under the determined opposition of Shri Ram Naik, the SJM, the RSS and others. In the most negative scenario in which no profit making PSUs are privatised in the next five years a change from five to zero is not earth shaking. Further, won’t privatisation of 6-10 loss-making PSUs be as good for the economy as that of 5 profit making ones? In any case much of the action in the last few months of 2003-4, which had enthused the equity market, was in terms of sale of shares of profit making companies to the public. There does not seem to be any convincing reason why the public should not hold more shares in public sector units managed by the government.
A few years ago the Finance Minister’s budget speech talked about reforming the labour laws to impart greater flexibility to the labour market. Despite sporadic discussion and a number of GOMs on the issue no central laws, rule or regulation has been changed pursuant to this announcement. Thus even in the most negative scenario in which no further action is taken for labour reform, the actual policy change will be ‘no less than’ it was during the last 5 years.
What about reforms more generally? With Dr. Manmohan Singh as the (likely) Finance Minister, the quality of reforms is likely to improve. What do we mean by the quality of reform? As shown in a recent ICRIER paper (WP #121) on the link between policy reform and institutional reform successful policy reform requires good analysis to identify the critical bottlenecks to higher growth and poverty reduction, innovative design of policy taking account of socio-political constraints and supportive institutional changes. These steps improve the efficiency and sustainability of reforms. This is what one would expect to happen under the experienced economic leadership of Dr Manmohan Singh fully supported by the Prime Minister. The experience of a breakthrough in the growth of manufacturing sector during 1994-5 to 1996-7 (ICRIER WP #122) also gives room for optimism that it can both be recreated and sustained given the accumulated experience.
Expectations play a very important role in the modern economy. This situation is quite different from what it was twenty years ago and is radically different from what it was 50 years ago. By the nature of capital (stream of output for many years in the future) investment has to be forward looking. Therefore an entrepreneur or investor has to gaze into the future and form expectations about what will happen to the market for its product etc. As the financial sector intermediates between savers and investors it is the fulcrum around which these expectations operate. With the widening of markets for saving, investment and the growth of the financial sector, and the increasing diversity of markets and products, the importance of expectations has increased over time. Both domestic and global politics influence expectations about the economy. There is therefore a link between political developments and financial markets through expectations. In a period of transition from one government to another, such as the present, when hard facts about the new government are scarce, speculation plays a much greater role than at normal times. Thus great care needs to be exercised in making statements about policy and programs that will effect investment decisions. These speculative elements will gradually die down as the new government ministers take charge and the policy of the new government gets defined. Reform actions will then have a greater role in determining expectations and financial market developments. I have no doubt that reforms will continue (at least) at a pace that maintains the 5.8% per annum growth rate that has prevailed for the last 24 years, the 8th highest in the World (ICRIER WP #122). This has reduced the poverty rate from about 55% of the population (end-1970s) to 26% (1999-2000). Faster growth and poverty reduction may, however, require accelerated reform.

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