Atanu Dey (AD): Prof Bardhan, what are your views on where India is going in terms of liberalizing its economy and what policies India should be looking at?
Pranab Bardhan (PB): Liberalization, particularly deregulation, has been going on for some time, more than 20 years. Then in the 1990s, further deregulation, including tax reform, financial reforms, and importantly considerable international trade policy reform took place although much more needs to be done.
Different levels of progress have been achieved in various areas. For example, in privatization, while the progress has not been negligible, it has been relatively slow compared to deregulation and trade reform.
AD: What are the road blocks to privatization?
PB: I think that the general population is not very supportive of privatization. Whether their view is right or wrong we can come to later. There is a general opposition as suggested by data. The Centre for the Study of Developing Societies conducted an opinion poll using a fairly large sample after the 2004 elections. The results were published in the Economic and Political Weekly. The questions were about economic reform, about reduction in the size of government and about privatization. An overwhelming majority of the people was against these reforms.
Now why were they against? I am sure that some of them do not fully understand what is meant by economic reform. Our leaders have not done a good job of explaining what economic reform is. But there is also fear that reduction in the size of government, and privatization will mean that lot of people would lose their jobs.
Now some people will lose their jobs as the public sector is bloated with too many people. But that is not the full explanation because only a tiny percentage of the general population would get a government job. The majority of our people drop out of school by grade eight and, therefore, they are not even eligible for many of those jobs. It is more a general anxiety. Even if they are ineligible, their concern is for their future generation.
The other attraction of a government job is life-long job security. So, they look up to it and so even if the majority will not get a government job, it is something to aspire for.
AD: So, who is responsible for explaining to the general population what reform is all about? The political leaders certainly don’t have an interest or incentives to explain that a smaller government is a better government since they are part of the government. Is it our schools, or is it the press?
PB: Certainly the press has a major responsibility. However, those politicians who are genuinely interested in reform have a duty to explain that reform is not just about cutting the size of the government, it’s about improving the quality of government. There are also other aspects. Let me give you an example.
In that survey, an overwhelming majority of the respondents claim that reforms either help only the rich or reforms don’t help anyone. Now, those politicians who favour reform have to explain that while some reforms help the rich, there are reforms that directly help the poor and, therefore, reduce poverty, not just through higher economic growth. Here’s an example.
Small producers and small sellers are always harassed by lower level bureaucrats and police officers. The police collect bribes from small vendors, for instance. So, people should be told that reform does not just mean trade reforms, exchange rate reform, and things like that. Reform includes what I call ‘governance reform’ and which is not being carried out in India. Reform in this context means the police and corrupt inspectors have less opportunity to harass you. Because of fewer regulations, you have less need to kowtow to government officers.
Similarly, another serious issue needs to be explained. Reform sometimes means reducing subsidies on government provided services. Whenever the government attempts to reduce the subsidy on water or electricity, there is an immediate protest by the people. But if the leader then says, “while we will raise prices, at the same time, we will guarantee reliable supply.”
Because at the moment, you do pay a low price but get erratic supply. The thing is to make a credible commitment as a package, not just raising the price. In fact, they could say that three months from now, the price will be raised but in the meanwhile we will already guarantee reliable supply. Poor people are willing to pay for reliable supply. Their worry is that the prices will go up but they will continue to get the same poor quality service. This needs to be explained to the people by those politicians who favour reduced subsidy.
AD: So, there is an issue of communications and more specifically communicating credible commitments?
PB: In general, the way economists and the financial press think about economic reform is in terms of reducing controls and regulations, and which I think is a step in the right direction. But while price reform, reduced regulation and control, are necessary, they have to be part of a larger package. That package should include matters that poor people care about. One aspect I have already referred to as governance reform. There are many other aspects, such as the reform of judiciary, police, bureaucracy, etc.
Related to governance, while the government should reduce its profile in some things it used to control very heavily, that does not mean that the government does not have an important role for the poor. Social service delivery, education, health, child nutrition, drinking water, irrigation water—all these services, the government has to be involved. That is the role of the government, to provide public goods and services.
The problem is the government is in too many things in India and does most things badly. So, its role has to be reduced in some areas but in others, it has to more effectively deliver those services.
Let’s take the example of education. It is not just a matter of increasing funding. It may be necessary to give teachers a higher salary but that is not enough. Surveys have indicated that half the time either the teachers do not come to school, or even if they are there, they are not teaching. Again, the government stresses access to school. In some remote and tribal areas, access to school is critical. But you have to think beyond access and consider the quality of service.
AD: Surveys have indicated that the poor are sending their children to private schools.
PB: Exactly. Because while government schools are relatively cheap, they don’t provide the service. So, the poor are paying out of their pockets to private schools because they get the service. All over India you see this happening.
There is an interesting example of a reversal of the trend of parents taking their kids to private schools. In Nagaland, the government around 2003 or so, made part of the teachers’ salaries dependent on the local village community organization.
AD: So, accountability was given to the local people.
PB: Yes, so there was an incentive for teachers to attend and they did. Parents who had taken their kids out of public schools brought them back. This reversal shows that creating simple incentives—the sort that to an economist would be obvious—as part of the governance reform that one needs to have.
Health is horrendous in India. In some health indicators, we are worse than Bangladesh. In infant and maternal mortality, child immunization, we are worse than Bangladesh. Not just that, we are worse off than sub-Saharan Africa in proportion of malnourished underweight children. I should emphasize that our growth is much higher than Bangladesh or sub-Saharan Africa.
AD: Something like 50% of children below the age of five are malnourished in India.
PB: While in sub-Saharan Africa, it is around 30%. So, health is in a dismal state. Now. health has two aspects in which governance reform is extremely important. One is the same as in education. You would find the health clinic locked on any random day. And even if it is open, perhaps the medicines are not available. The other issue is that people themselves don’t know what is good health care.
There is some evidence that they would often to go the local quack because he would give them a quick fix. You have fever and go to the public clinic. The doctor there—if he is good and is available—may say that you have the flu and that you just have to wait three days for it to run its course and there is nothing to be done. The person—and I have seen this myself in Delhi—loses faith in the doctor saying that the doctor is not giving them any medicines. The quack, on the other hand, gives them antibiotic which is totally unnecessary. Or sometimes give them a steroid injection, which makes them feel better immediately. This gives the impression that the private doctor is better. In this case, it is a matter of the consumer being not well-informed.
So, what is needed is an education and information campaign. In this regard, Kerala is ahead of many other parts of India. They have what is called the “People’s Science Movement.” They go from village to village giving people scientific information including how diseases happen, what is the nature of infection, etc.
First, information is extremely important. Second, Latin America is doing something that India should adopt. It started with Mexico and is now a huge programme in Brazil. The government gives money to the mother if the child is taken regularly to the health clinic and if the child goes to school. So, here is a case where you are giving the people an incentive to go to a public clinic or a school. This is what we call a “demand-side” intervention.
Here you don’t just make the supply—the clinic or the school—available, you make a contingent transfer to the consumer only if they use the service. These are simple reforms, which should be adopted.
AD:A few months ago I was invited by a colleague to attend a two-day debriefing session in Patna. It related to a week-long field visit that a particular foundation had undertaken to understand the ground reality in rural Bihar. My colleague related that during a visit to one ICDS (integrated child development services) they found that the only “service” the locals received was that the ICDS worker would show up at 11am and hand out one hard candy to each child. The peculiar thing was that the people were not willing to speak out against the lack of services that they were entitled to. He conjectured that to the people, he was an outsider and, however, badly the ICDS person was performing, she was an insider of sorts.
PB: Insiders matter. Reforms have to involve the local community. For instance, the information campaign has to be done by the local community, not by an outsider. That’s what happened with family planning. Local women were involved. The same thing is true about health and about education. The village panchayats have to be involved. The problem is that in some places like Bihar the panchayats don’t work. They have become conduits for money that comes from above, and they just misappropriate the money.
AD: So, it is plain rent-seeking.
PB: In that local context, it is rent-seeking. Unfortunately, the panchayat system is not working in many parts of India. The three or four states where it works to some extent are Kerala, Karnataka, West Bengal, and Madhya Pradesh (MP). In MP, it was working under Digvijay Singh but not so much now. In most parts of India, especially in Bihar and UP, the panchayats don’t work because they are captured by the strong-men of the villages. So, that is what I mean that the reforms that I am talking about has to include other parts.
AD: Here you are talking of institutional reforms.
PB: Yes. And that includes land reform. One reason why panchayats work better in West Bengal, Karnataka and Kerala than in Bihar and UP is they had some—not dramatic but some—land reform. In many cases the big landlords pack the panchayats with their relatives and misappropriate whatever money there is. In West Bengal, this may also happen but the people protest because there is some degree of village democracy.
These are issues that the poor are sensitive to. But if you just say trade reform, the poor have no clue. Same as with de-licensing. Very small producers don’t have to get licences anyway. They are more worried about the police or the inspector coming and harassing them.
AD: Now the need for liberalization arises from the fact the system is “illiberal”. The question then is, why did we have this illiberal regime in the first place?
PB: The illiberal regime you are thinking of is this one about licences and restrictions and foreign exchange control and so on. If you look at the history, many of them were installed by the British government during the wartime, not the Indian government.
During that time, licences and permits were instituted because of scarcity of resources. Then came independence. But by that time, the bureaucratic vested interests had taken hold. Bureaucrats found that there was power in giving out licences. Then came the Left ideology that free market is bad for the poor and, therefore, the need to control. What kind of control?
The Left did not always suggest that all the restrictions were good for the poor. They supported restrictions of the following kind. For trade restrictions, they gave two reasons. (By the way, by the Left I do not mean just the left parties. I include the Congress under Nehru as well). Trade restriction was justified on what is called the “infant industry” argument. It went this way. India can produce some of these things efficiently but they need some breathing space to do so. This has worked sometimes but not in most cases.
An example of where it did work is auto parts and ancillary industries. Today India and China have international best practice in auto parts and they are exporting to the rest of the world. Reaching this position was not done over-night. Because of the restriction that in the manufacture of cars, auto parts could only be bought locally, the auto parts industry was protected. Here, is an example of where learning-by-doing infant industry argument worked.
But there are hundreds of other examples where it did not work and only sheltered inefficiency. So, it is very difficult to tell a priori where it will work.
AD: And where it does not work, the infant industry argument ends up becoming a geriatric protection business.
PB: In those cases where the infant industry protection was successful, what they did in places like South Korea, is they pursued it. But in those cases where it became clear that it was merely sheltering inefficient producers, they withdrew that protection. The problem in India is that once you start the protection, it is very difficult to remove it.
AD: So the problem is one of inability to make a credible commitment to removing the protection in case it does not work.
PB: Yes, so that is part of governance reform, the ability to make credible commitments. Anyway, the infant industry argument was very popular in India in general, not just with the left. But it was just one of two arguments. The other simple argument given was this. If trade were not restricted, the rich would buy fancy cars and other luxury goods. So, in the name of controlling luxury consumption you put severe tariffs on these products. But what they don’t realize is that high tariffs would—and this is simple economics—cause those goods to be produced at home and that too inefficiently.
AD: Which of course skews the terms of trade between rural and urban production.
PB: And you are not reducing the fancy consumption of the rich through trade restrictions, anyway. If you really want to reduce luxury consumption, the route is through high consumption taxes, or wealth tax or what have you. This was a wrong argument but this argument was used.
Naturally, I am not justifying but rather explaining why the illiberal system arose. There was bureaucratic inertia and then bureaucratic (and political) vested interests.
AD: But then what was the reason for production quotas? For example, the restriction on producing scooters. Sure, you are not allowed to import scooters but why isn’t anyone who is willing to produce them, allowed to do so?
PB: We had and still have small-scale reservations. The argument that was given—and this is another thing that went out of hand—was that they wanted to restrict the growth of monopolies. They were afraid that if they allowed somebody to become big then it would end up becoming a monopoly which would end up controlling the economy and buying up the politicians. The same argument is given against foreign investment.
The argument went that if we allow foreign investment to come, they will dominate the economy.
AD: In essence, that they will become the new “East India Company.”
PB: Yes. But it was not just foreign investment. Even domestic investment was feared. It was basically a fear of monopoly. But there are ways of controlling a monopoly, such as the anti-trust laws in the United States. Imposing quotas is a wrong way of doing it.
Their rationale was to help the small producers. In effect what happened was they gave incentives to small producers not to grow. One of the reasons we had low growth was because if you were a small producer, you were in the reserved sector. You had no incentive to grow because if you grow, you lose those advantages. So, there was a kind of built-in disincentive to grow.
AD: Why has privatization not proceeded much?
PB: The problem there is that as the unions in the public sector became strong. The richer the industry, particularly in the public sector, the more powerful are the unions. The most powerful unions are in the nationalized banks. I think what the unions try to do is share in the rents the business earns. Which may be a good thing. But the problem is in a country like India, the overwhelming majority of labour is not in unions.
AD: In India, about 93% of labour is in the unorganized sector.
PB: So, a few people sharing in the rents often means that other people are deprived of jobs. If there unionized jobs were not so heavily protected, other people could have come in. To some extent, the opposition of unions have prevented privatization.
AD: Which brings me back to the point we had discussed earlier: that people are not well informed about the consequences of market reforms. For example, I recall when the debate was about allowing the private sector entry into the telecommunications sector, the union was strongly against it. I stress that it was not about privatization. They were not selling the public sector incumbents. The union workers did not realize that if the private sector was allowed, the demand for workers would go up.
PB: I will give you an even more stupid policy that the unions followed. In the 1980s, the unions opposed computers. For years they opposed the computerization of banks. Now looking back I am sure that they realize that it was a stupid policy.
AD: Do you recall what was the position of the communist parties?
PB: Both the CPI and CPI(M) were against computerization.
AD: It would be interesting to go and talk to A.B. Bardhan about it now.
PB: That is a Luddite attitude: machines will take away jobs and therefore should be opposed. Of course, machines take away jobs. But new jobs are created. Having said this, let me say something in defense of unionized workers.
Suppose you are in a good unionized job. What is your major anxiety? That you are going to lose the job. In other countries, particularly in Europe and to some extent in the US, you have something to fall back upon. You have some sort of safety net. Problem is that we don’t have that. I call it “social vertigo.”
You are in this job, staring at the edge. That makes you fight tooth and nail against computerization, for example. If there were even a minimal safety net, you would be less opposed to liberalization, less opposed to globalization. This is not just in India.
Why is it that Scandinavian workers are less opposed to globalization than in the US. In Scandinavian countries, the unions are much stronger. Why is it then that the Swedish workers are much more pro-globalization as opposed to the American workers? Because the Swedish safety net is much stronger. Their safety net includes job training and comprehensive health insurance and they know that they can depend on it. It is not entirely problem free but you are less anxious.
It is anxiety that is important. It is so because if five people lose jobs, 500 people become anxious. So, it is anxiety that is behind this opposition. I think one should try to understand the workers’ point of view when there is this vertigo. This means reforms have to be a package deal.
Politicians and economists who are in favour of reform usually say that labour laws have to be reformed. At the moment, it is very difficult to sack somebody. I also think that labour laws have to be much more flexible. But it cannot just be a one-sided deal. So, if the government takes the position that labour laws should allow the hiring and firing of workers, then it has to be combined with a comprehensive safety net.
AD: But we cannot afford a comprehensive safety net.
PB: However, you can do it in stages. First, you can do it with organized labour because it is just 7% of the total, as you just pointed out. Start with that and then slowly expand it. Then you will see resistance to reform go down. Otherwise there is a stalemate. The unions will not allow labour law reforms.
Our labour laws of course hurt the non-unionized workers. Once a business hires a worker, it cannot fire him or her. So, that business is reluctant to hire and uses more capital intensive technology unnecessarily. That ends up hurting un-organized labour as they end up not getting those jobs. The other thing is that our labour laws are hurting unionized workers as well.
There are parts of our labour laws that people don’t talk about which are effectively anti-labour though they do not look like it. Let me cite an example.
In our labour laws, any seven people can form a union. That has been there for a very long time. People should protest against it. Why? Two things happen. First, union movement becomes fragmented. Anyone can start a union. In fact, employers in order to undercut the workers, get their chamchas to start a union. It fragments the unions. Also, we don’t have majority unions, secret ballot unions. Most of the world has that but we don’t. Extreme fragmentation makes labour weak, not strong. So, it is labour which should argue against these laws. This has to be explained to them.
AD: On a different matter, liberalization could account for part of our current growth. So, what exactly is the reason that India is growing now? What happened?
PB: Well, it started in the 1980s itself, not in the 1990s. I think there are a lot of things happening. Certainly in the corporate sector, de-licensing and deregulation have played important invigorating roles. It unleashed energies that were controlled before. Moreover, those controls helped big firms. The Birlas and the Tatas did not have trouble getting licences. The middle level was hurt. By middle I don’t just mean in the national corporate ladder but also regional capital.
If you look at the top 50 or 100 businesses today, there are many companies which were not there 20 or 30 years ago. So, in a sense, the corporate sector has been opened up so that lots of middle-level firms are entering. That has increased competition and led to the unleashing of entrepreneurial energies. The other thing is that many corporations that were not sure that they would be able to compete with foreign firms are becoming more confident. In some cases, they are unable but in some others they are able to compete. But that is all in the corporate sector.
AD: So is India’s growth of 8% or 9% in the recent past—is it all driven by corporate growth?
PB: Actually I haven’t seen any good explanation for it and I don’t fully understand it. Let me give you an example. The service sector is the leading sector in India, unlike in China where manufacturing is the leading sector. Now, when you and I talk about the service sector growth, we mean telecommunications, software, business process outsourcing, finance, etc. Yet, if you breakdown the service sector into sub-sectors, you will find that two-thirds of the services is in the informal sector.
AD: You mean the small middle-men and traders.
PB: Exactly. Say a little tea shop is part of that informal service sector. So, the part that I don’t understand is: how can the service sector lead in an economy where two-thirds of the service sector is in the informal sector? They are tiny enterprises which are below the reform radar. So, when someone says to me that reform is the cause I don’t believe it because two-thirds of it is below the policy radar. Something else is going on and I haven’t seen a full explanation.
Now it could be that the manufacturing sector which formerly used to do in-house services are now out-sourcing those services and some small enterprises are getting those sub-contracts. Say the gardening of a large firm is now subcontracted out to a small firm. I don’t think this is a full explanation but I feel that maybe some outsourcing is happening by the other sectors.
Another part of the explanation could be that even the lower middle class are using more services than before. I have heard examples such as even poor people hire private tutors for children. Similarly lots of low middle class people go on pilgrimage which essentially boosts the tourism services industry. So, there is probably some increase in demand for services from the population at large but I need to see some data on this.
AD: I’d like to touch upon a different topic. The growth is leading to an increase in inequality. Is that a matter of concern?
PB: It is certainly a matter of concern, if not for any other reason, for political reasons. If others are making money and I am not, I get disgruntled. And if I am the majority, then high growth and the reforms are not sustainable. Because sometimes there could be sometimes foolish opposition. I mentioned before that sometimes people are not fully informed. So, there is backtracking of reforms. And during election time, politicians don’t talk about reform.
I think going back to credible commitments: it has to be a package deal. I think you have to have pro-poor redistributive policies. I think the right to information act and the National Rural Employment Guarantee Act are steps in the right direction. There are many problems in the way they have been legislated and implemented. But the poor have to be told that these are the things that are being done for them, there are the ways that reform will help them, and there are the ways in which reform may not help them immediately but it is part of a package.
AD: Underlying all this, I think that education is very critical. Why is that sector not being liberalized?
PB: We should distinguish between lower level education—the primary and secondary—and higher education. The lower level primarily affects the poor. I generally agree with the claim that the government should be involved with the funding of the lower level education but should not necessarily be involved in the provisioning. That distinction is not understood by the people and therefore is an information issue. They think that if the government were to withdraw from it, government cannot fund it. The next step is the proposal to give people vouchers which they can use at private schools. But the problem is that vouchers work where there are lots of competing schools. In many villages, however, within 20 or 30 miles there is no competition.
AD: So, vouchers can work in urban areas where there is competition. In rural areas, we need a different solution.
PB: Exactly. The other point is that even in urban areas, the evidence is not so far conclusively in favour of vouchers. The only developing country experience that has been studied is in Chile. What they found is that it sorts the people but in general it does not improve average test scores. But that is just one test case.
Anyway, I would in general support that government should be in the business of funding but not necessarily providing education except in those cases where there is no competition.
AD:Now let’s talk about tertiary education. Should the government get out of it and if so, will it?
PB: I want the government to get out of tertiary education except in the matter of funding some basic research. At the moment the higher education has too little autonomy, and too much interference by the government. The problem is—and this goes for the lower level as well—that the teachers’ unions are firmly against reduction of government role. And that may be the reason that the ministry of human resources is so unproductively interventionist in higher education. As fewer people are involved, that barrier may be broken. But when it is, we still need effective regulation, which at the moment is often missing in the case of private colleges run commercially by politicians or their family.
AD: Finally the last question. What is your prognosis of the Indian economy? Are you optimistic? Cautiously optimistic?
PB: I am cautiously optimistic. Somehow I don’t think 10% growth is sustainable. Perhaps 7% is. But to me these growth rates don’t mean much. I want to know how the income of the bottom half of the economy is growing. At the moment, it is not growing at that rate. So, if you can get the income of bottom 50% growing at 5% or 6% on a sustained basis, that would be good. But the problem is that the bottom half is largely in the agricultural sector. The agricultural sector growth is declining. I am less optimistic here. Unless something is done in the agricultural sector and in the rural industrialization sector, the incomes of the bottom half cannot grow at the 5-6% needed.
Our rural infrastructure—roads, power, irrigation—those are declining. We need a huge amount of public and private investment in rural infrastructure, and more importantly, we need better governance in managing the infrastructure.
AD: I feel that we have to reduce the amount of labour in agriculture. So, that means we have to aid the transition of a large number of people from agriculture to non-agriculture.
PB: What we need is rural industrialization. Chinese growth is impressive mainly here and it relieved people from low-productivity agriculture. I think India has not done well in rural industrialization.
AD: I am going to ask a difficult question. Suppose there is one policy reform that you could push through, what would it be? I know that one reform alone cannot make a difference but still what would be a key reform which would enable other reforms to take hold?
PB: I think it would lie in the area of governance: social service delivery reform. Because if you can do that, the poor will support you in your other reforms.
AD: Thank you, Prof Bardhan. I appreciate the time you have taken in talking to me.