Nobel laureate Amartya Sen — who is not a free-market liberal — has spoken on how contemporary India needs a right-wing political party that is both secular and committed to an open economy. This is a good time to go back to the issue, for two reasons. First, we have seen how economic reforms were blocked by the Left to begin with and have now been hijacked by the crony capitalism of the Samajwadi Party. Second, modern India’s only stab at a successful liberal party started in August 1959; the Swatantra Party would have entered its 50th year this month, if it had survived as a national political force.
Countries with low levels of trust and high levels of corruption tend to be more wary of free market capitalism
Fifteen years of high growth, thanks to economic reforms, should have created a strong political base for liberal party. It hasn’t. I am often surprised at how even people who have benefited from economic reforms still believe that the government should control prices to beat inflation or that companies are making too much profit at the cost of society. Is it any wonder that no party is ready to face the electorate with a free market agenda?
The interesting question is why this happens. The answer involves more than political failure. The nature of Indian society and capitalism are also part of the answer.
An interesting new research paper by Philippe Aghion of Harvard University, Yann Algan of the Paris School of Economics, Pierre Cahuc of the Ecole Polytechnique and Andrei Schleifer of Harvard University offers one set of clues. They have mapped the relationship between demands for regulation in a country and the level of distrust between its citizens.
What these four economists show from their study of rich nations is that people ask for more government regulation when they do not trust their fellow citizens. They have used a concept that has attracted a lot of attention over the past decade and more — social capital. Any economy needs physical capital (tools), financial capital (money) and human capital (skills) to grow. It also needs social capital (trust). Economist Kenneth Arrow once said that virtually “every commercial transaction has within itself an element of trust, certainly any transaction conducted over a period of time. It can be plausibly argued that much of economic backwardness in the world can be explained by the lack of mutual confidence.”
Aghion and his three fellow authors show in their July paper, Regulation and Distrust, that countries with low levels of trust in other persons, companies and political institutions are more likely to have more regulations on economic activity. But this regulation leads to low growth and corruption, as we know from our own experience of the licence permit raj. “What is perhaps most interesting about this finding…is that distrust generates demand for regulation even when people realize that the government is corrupt and ineffective; they prefer state control to unbridled production by uncivil firms,” say the economists.
The way companies earn profits does affect the popularity of capitalism. In a paper published in 2006, Rafael Di Tella of Harvard Business School and Robert MacCulloch of Imperial College ask: Why Doesn’t Capitalism Flow to Poor Countries? They say the most important factor is corruption, which cuts into the “moral legitimacy of capitalism”. Di Tella and MacCulloch add: “Existence of corrupt entrepreneurs hurts good entrepreneurs by reducing the general appeal of capitalism.”
These two pieces of research show that the popularity of a free market political party will depend on both the level of trust in a country and whether profits come from competitive markets or oligopolies protected by the state.
Economic historian Douglass C. North and his colleagues have given us what they call a conceptual framework to interpret human history. They say that societies emerge as “limited access orders”. Here, the political system is used to limit economic participation and impose social order. The lack of economic competition leads to excess profits that are used to limit violence and maintain political stability.
North says that some societies later evolve into “open access” orders. Here, there are few restrictions on economic and political participation, which is another way of saying that these societies have open economies and open political systems. Order is maintained through the competitive process.
There is a famous story about Margaret Thatcher. Soon after she became head of the Conservative Party in the UK, she is said to have reached into her briefcase and pulled out a copy of F.A. Hayek’s Constitution of Liberty, a book that explains with great clarity why liberal systems lead to freedom and prosperity. Interrupting the speaker, she is said to have banged the book down on the table and said: “This is what we believe.”
Is there any Indian politician who has similar convictions — and the guts to make them public?
Your comments are welcome at cafeeconomics@livemint.com