After at least a month of wrenching uncertainty about the complexion of the new Union government, the people of India voted decisively. The result was an anticlimax: Fears of a muddled verdict were swept aside and one coalition, the United Progressive Alliance (UPA), has been given a clear mandate to govern. The question now is, what should it do with its victory and what will it do?
In that sense, the coming years will have the appearance of a laboratory experiment. The UPA has been in power for the past five years, will be so for the next five (barring the exceptional, of course). In these years, the coalition dumped economic reforms and imbibed populism. It served India badly, even if it had a role in securing a victory.
Now, of course, the UPA has no crutches to cope with. For the Left is gone and the “numbers” are decisive in their own right. This is the first time since 1991 that the road to reforms is not obstructed by electoral concerns. As a result, the UPA should waste no time: It should quickly initiate reforms that have the potential to shift the growth gears of India. Moving the country from 7%-plus annual growth to the 9% trajectory requires three things.
Illustration: Jayachandran / Mint
One, India needs to abandon its framework of labour laws. Freeing the labour market by permitting companies to hire and fire workers at will, especially in the small and medium enterprises (SME) sector, has the potential to ignite growth. The timing for this is propitious: As the world enters a weakening phase of recession, India can work hard to make inroads into global markets.
Labour market flexibility is one condition that can give India a cost advantage that countries such as China, Bangladesh and Vietnam possess.
Labour market flexibility, however, has more to it than mere cost competitiveness. It will open the doors for job creation—something that can be a powerful engine of progress, if implemented. The political returns to such a move should not be underestimated.
Two, the country badly needs to move towards a rule-based fiscal and monetary policy mix. The absence of such a rule-based system has ensured that the fruits of liberalizing foreign trade and product markets have not been reaped. A rule-based system will also complement labour market reforms. Until now, the government’s fiscal policy interventions have been ad hoc and are usually in the wrong direction, leading to inflationary situations. As a result, when it comes to firefighting, monetary policy has the potential to kill growth.
Once all markets have been liberalized, it becomes all the more important to follow a rule-based system. Interest rate fluctuations, to give one example, have the ability to kill SMEs: No amount of labour reforms can keep them alive in adverse economic conditions created by a bad monetary-fiscal policy mix.
How should the government proceed in this direction? As a first step, the Union government can go back to the discipline of the Fiscal Responsibility and Budget Management Act. The more difficult task will be that of convincing other political parties about the need and utility of policy continuity on this front. If the UPA can move along these lines, the chances that the next government will follow suit will increase dramatically. The success of such a rule-based platform can ensure this.
Once these reforms are initiated, an economic transition can begin. One may say that that is what has been happening for the last 18 years, isn’t that sufficient time to move towards open markets? The answer is yes only in a partial sense: For in the absence of labour market flexibility, no transition to an open economy is complete.
Which brings us to the most important part of these reforms: the creation of a social security net during the transition. The UPA does not have to begin creating a safety net de novo. It already has a template in the form of the National Rural Employment Guarantee Scheme (NREGS). Turning NREGS in that direction, however, will require extensive rejigging. But that may be worth a try. The government can also try out new innovations, such as direct cash transfers to the needy. That has the potential to save administrative costs and also control corruption associated with programmes such as NREGS. This, however, will be a big challenge.
Will the UPA execute these reforms? It is a hard question to answer. If one looks at the necessary conditions for these reforms, one can say yes. But a necessary condition is not the same as a sufficient condition. That sufficiency has to come from the political leadership. That is a big imponderable.
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