Friday, September 26, 2014

PM Modi’s Development Objectives & Reform Possibilities: Big Bang or Incremental?


     One year ago (13/9/2013), I wrote that, “India needs an alternative narrative of economic growth and welfare, that politically challenges the monopoly of the left intellectuals.[i]  I also indicated that BJP leader Modi may be the ‘non-intellectual leader who overthrows this monopoly and creates a new "governance and growth," "right of center" national narrative to compete with the "socialist ideology"? I went on to conclude that, “Shri Modi has a better than even chance of becoming the next Prime Minister of India and of changing the political narrative of National welfare, governance and growth.” Prime Minister Modi’s actions and his government’s performance to date strengthens my belief that he is indeed that leader.
      Several eminent economists and analysts have expressed their disappointment that Prime Minister Modi has not used his election mandate and his majority in the Lok Sabha to introduce “major” reform. I am not one of them because it has been clear to me for more than a year that, it is not his style. He is laser focused on the objectives and goals he has outlined, first in the BJP manifesto, then in the President’s address to the first session of the new Parliament and in subsequent speeches.  And he will make whatever policy & institutional changes that he is convinced are necessary to achieve them, no more and no less.

Likely Approach to Reforms

Given PM Modi’s personal experience and achievement in Gujrat, his first inclination is to improve governance, speed up decision making, make administration more effective, improve the functioning of Departmental Public Enterprises, Public sector Banks and Public sector units and he has started doing all this. But a second, perhaps equally important element of PM Modi’s approach is the understanding that  it is business that will create productive, self-sustaining jobs across the entire spectrum of skills( from unskilled to semi-skilled to highly skilled). Hence to be “pro-poor” is to be “pro-growth” (of economy and employment) and to be “pro-business” is consistent with being “pro-poor.”  Thus it is essential to cut through the jungle of laws, rules, regulations, procedures and controls, to make it easy to set up and run new (job creating) businesses. All business is welcome, domestic or foreign, if it “First Develops India(FDI)” and helps us to close the large economic and technological gap with China and the rest of the World.
  Are “big bang” reforms of the kind whose lack has been bemoaned even by political opponents, needed to achieve PM Modi’s objective of providing job opportunities for every youngster, making India a manufacturing hub and closing the economic & technological gap with the World?  That is the question that I believe the PM will seek an answer to over the next six months.  In my judgment, PM Modi will undertake those reforms that are essential for achieving these results, no more and no less. Thus the initial focus is likely to remain on governance and other incremental reforms that have been outlined in the PMs speeches. If and when the limitations of these improvements is apparent and the PM is convinced that major policy reforms are needed to achieve the objectives he has outlined, only then is he likely to undertake such policy reforms.  The opposite of the same coin is that he is unlikely to undertake (in his first term) any policy or institutional reforms that are either peripheral to his task or whose likely contribution to these objectives is uncertain.

Phasing and Timing

  What are these reforms and how should they be introduced?  My experience of Indian economic reforms from 1987 to 2009, shows that the cost-benefit calculus for any reform must account for the risk of a substantive political counter-reaction as part of the cost of reform. Operationally this means that reform objectives must be kept clearly in mind at all times, but the timing and phasing of their introduction must depend on this modified benefit-cost calculus. The pace of introduction must therefore be “with all deliberate speed” without either being politically foolhardy or being overwhelmed by so called “political compulsions”. Fortunately, PM Modi has demonstrated that he can communicate directly with the public to reduce the political risk and thus increase the benefit-cost ratio from reforms.

Policy Reform Menu

 In my view the following reforms, can restore and sustain growth at 8% for several decades:[ii]
  1)      Macro Pivot:[iii] Scale back government consumption expenditures including subsidies and transfers, to bring Revenue deficit to zero in three years and Fiscal deficits to zero in five years. This will reduce government debt, the Current account deficit and foreign indebtedness and raise the national saving rate, allowing RBI to ease monetary policy and stimulate investment and consumer durable demand without fear of increasing Non Performing Assets or inflation. A UID linked mobile payment system provides the most effective means for delivering cash to all those who need & deserve public welfare support. Competitive auction of all natural resources will reduce corruption and raise more revenues. It is hoped that the Expenditure Reforms Commission will spell out a road map for improving the revenue & fiscal deficits.
  2)      Public sector: Close loss making units and reduce shareholding in profit making ones. Sell those units in industries that are inherently competitive (e.g. steel, airlines, power/ railway equipment, hotels, machinery; banks, insurance).[iv] This will stimulate a surge in manufacturing productivity (as in 1990s).  Use the proceeds of Public sector bank (PSB) share sale to recapitalize them and thus lift constraint on bank lending.[v]  Use PSU share sales to expand the fund for Govt. investment in Public goods infrastructure like highways, seaways, higher speed rail lines, MRTS & sewage collection & disposal networks.
  3)      Environment Protection has become a big bottleneck to investment because of its sweeping authority and expansive mandate.  A professional, technocratic, ‘environment protection agency (EPA)’ should be set up to deal with all types of environmental pollution (water, air, land; chemical, nuclear). The EPA should set standards for different forms of pollution and have the authority to impose penalties for violation of norms.  The environment ministry should have no discretion on application of these norms and standards.  The Supreme Court’s Green Bench, the only court of appeal, must be strengthened to ensure expeditious disposal.  An organization similar to the EPA, should be considered for dealing with ecological issues (forest, wetlands, coast, river basins, mountains).  Ecological issues must be defined and circumscribed much more carefully to eliminate endless governmental reviews and scope for corruption.
  4)       Land Acquisition Relief and Rehabilitation Act. The extremely laudable objective of fairness in compulsory acquisition of land has been converted into an expansive ecological and social agenda. Purely private voluntary land transactions must be removed completely from the ambit of this law and the enormous bureaucratization of rules and procedures rolled back. In addition the process & procedures for changing land use must be made transparent. The concerned minister has already initiated discussion with States, who are now becoming aware of the threats to growth that the law poses. This discussion needs to be carried through to changes in the Act.
5)      Institutional Reform: Fundamental political/electoral, police, judicial, legal and bureaucratic reform to address the issue of pervasive, systemic corruption and restore good governance on a sustainable basis.[vi]  Public safety & security is the right of all citizens as is “equality before law.” In the long term, the “rule of law” is critical to sustaining growth in a democratic open society. With good governance, we can even dream of welfare catch up with China! The e-governance and digital India initiatives can help in reducing corruption as will competitive auction of all natural resources. The law minister has already announced that many outdated laws will be repealed and more will be considered from repeal, amalgamation & simplification. The PM has also announced his support for measures to reduce the presence of criminals in legislatures. Tentative announcements on judicial and police reform need to be pursued more vigorously.
  6)      Infrastructure:  Break up government monopoly in coal and infrastructure sectors and introduce competition.  Convert the Indian Railways, Ports and Airports into publicly owned Ltd companies and set up professional independent regulatory structure to oversee free entry & benchmark competition in these sectors.  Enforce open access in electricity distribution & transmission & separate farm feeders for irrigation. The Digital India mission will be facilitated, particularly in rural areas, by “open access” to telecom land lines and electricity wires. This will set of a cycle of self-sustaining infrastructure growth and productivity improvement. The Coal nationalization act must be amended to allow private entry into coal mining. Coal India should be re-divided into 4-5 companies that compete with each other & shareholding reduced to 49%(to start with).
  7)      Labor Laws, rules & procedures: A reform of labor laws can play an important role in the success of “Make in India” campaign and is critical for generation of better quality jobs for unskilled & semi-skilled youth.  Exit clauses (5-6) in labor law can be repealed, with existing employees in organized sector grand fathered. Allow private competition in Employee State insurance (ESI), Employee Provident Fund (EPF) and other monopoly social welfare schemes for employees.[vii] Reform “Contract labor Act” to make it easier for labor contracting firms to comply with labor laws and increase provision of contract labor to industry. The already initiated reform Apprenticeship Act, to encourage training, instead of hindering it, is a good step.
  8)      Agricultural Policy: [viii]  Halt procurement price led inflation and massive overstocking of wheat and rice, repeal Agricultural Produce Marketing Act and Essential Commodities Act. Remove all policy restrictions on FDI in food retail.  Replace the policy of Ad hoc agricultural import-export bans by import-export tariff bands that offer transparent protection within limits. Re-establish scientific approach to GM crop trials and introduction of GM crops. These & related reforms will reduce Indian food inflation to the much lower levels prevailing globally, and thus help control overall inflation. They will also incentivize farmers to raise productivity and farm profitability.
  9)      Education:[ix] Research has shown that the private non-profit (NPO) sector provides education of quality equal on average to that of the public sector, but at 1/3rd the cost. By requiring the NPOs to double or triple the salaries of teachers, RTE Act will drive them out & do incalculable damage to the cause of education. These clauses need to be dropped. The “license-permit raj” control system in education, needs to be replaced by a modern system of performance/quality rating and transparent accounting/financial disclosure, that allows students-parents to judge for themselves the quality & cost of education in different schools & colleges.


 The above menu of policy reforms is not cast in stone. As the economy recovers, other policy changes may need to be added to the list and perhaps some removed. The history of economic growth shows, that sustaining fast growth is much more difficult than raising it from a slower level.[x] Many countries have raised growth to higher levels for short periods, few have sustained it for long enough period to move from Low income levels to high income (or even upper-middle income) levels. Success has usually come to those who have a non-ideological, pragmatic approach to economic development, growth and welfare, and have pursued these objectives with determination.[xi]  Successful countries are those who respond to shocks and challenges as they arise instead of ignoring them or allowing them to fester.

[ii] First presented in  and Arvind Virmani, “National Reform Agenda For Growth and Welfare,: Policy Paper No WsPp1/2014, January 2014. .
[v] A recent  calculation shows that the market value of the 23 largest PSBs (excluding SBI) is less than the market value of one private bank. Thus a large portion of the national debt could be eliminated by selling these 23 PSBs. All those who are declared eligible for bank licenses by the RBI could be authorized to bid for controlling shares in a competitive auction of the smaller, less profitable PSBs (with 51% minimum govt. holding deleted). Govt. would also sell 25% of its shares in the other 23 PSBs (reducing it from 51% to 26%) so as to capitalize them.
[vii] The New Pension Scheme (NPS) for government employees already allows private management of these funds.
[ix]  “Sustaining Employment and Equitable Growth:  Policies For Structural Transformation Of The Indian Economy,” Working Paper No. 3/2006-PC, Planning Commission, March 2006.
[x] “Accelerating And Sustaining Growth:  Economic and Political Lessons,”  IMF Working Paper No. WP/12/185, July 2012. [ ].
[xi] or Arvind Virmani, “Sustaining Fast Growth In India: Economic and Political Economy Lessons,” Working Paper No. WsWp 3/2012, June 2012 [ ].

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