Entrepreneurship needs simple, stable rules
The Narendra Modi government has been big on changing the rhetoric around business and profit. Recognizing that the government cannot generate sufficient employment for the country, and the slowing down of private investment, the government launched the Startup India campaign in January 2016 to support entrepreneurship in the country. And 9 November is now being celebrated as National Entrepreneurship Day.
While the recognition of the importance of entrepreneurship is a welcome step, the government seems to have missed the underlying reason why most people don’t pursue entrepreneurship in the first place.
Promoting entrepreneurship is, at its heart, a problem of reallocating talent towards entrepreneurial ventures. This is a challenge, given the perception associated with being an entrepreneur. Only 44.4% of Indians believe that entrepreneurship is a good career option, ranking 57 out of the 65 countries surveyed by the Global Entrepreneurship Monitor in 2016. This perception is a rational response to the experience of the middle class when it comes to starting a business, whether directly or indirectly through anecdotal evidence.
At the same time, joining the Indian bureaucracy has been one of the most sought after career choices. This is also easy to explain because it is the bureaucrat who gives entrepreneurs permissions, verifies the sundry list of documents or decides on tenders worth crores, if not hundreds of crores. It is no secret that a job in the civil services guarantees stability with more than its fair share of perks, legitimate and illegitimate. The attraction of the administrative services is borne out by the tripling of the number of applicants for Union Public Service Commission (UPSC) prelims in the last decade, from 380,000 in 2006 to 1.14 million in 2016—with even graduates from Indian Institutes of Technology (IITs) and India’s best liberal arts colleges applying for these positions.
Talent goes into activities which have the highest private returns, not necessarily the highest social returns. While a competent bureaucracy is important to the smooth functioning of the government, it is ultimately the private sector that drives economic growth. The challenge for the government is to redirect the energy of our society from unproductive (and destructive) activities towards arbitrage, innovation and other socially beneficial behaviour.
Entrepreneurs employ their local knowledge about the problems, scarcities and preferences of people around them. Different entrepreneurs pursue different ideas to solve those problems and competition ensures that scarce capital is allocated to the most productive ones. This process not only satisfies consumers wants, it also produces socially useful knowledge that motivates new investments and ensures jobs and growth.
An important reason why the present reforms might not immediately transform into action is the role played by informal rules or norms. The classic problem of institutional change is how changing the formal rules of the economy plays out when the new rules are in conflict with the underlying norms. The farther the new rules deviate from the norms,the more enforcement costs increase. Informal norms may be influenced in the long run by the formal institutional framework. However, they almost always take priority in the short run. This is where the difficulty with culture lies: It is fundamental to the success of reforms but it is difficult to change and affect.
Even if the formal rules invert the power dynamic between the bureaucrat and the entrepreneur—making procedures straightforward for the latter and giving the officer less discretionary power—it will take some time for the expectations of the parties to change. For credible changes, the government has to persevere with reforms, and simplify rules for the entrepreneur.
Sadly, the attempts to increase entrepreneurship have not been helped by some of the recent actions of the present government. First, the goods and services tax’s (GST’s) implementation has been poor. It has increased the costs of compliance, changing the number of tax filings from four to 12, and there has been pervasive confusion about the tax rates on different products. Second, entrepreneurship invariably involves speculation regarding the open-ended future. The role of the government is to provide a regime of stable rules and ensure predictable changes in policy. But the government has historically struggled to keep interest groups at bay while forming its policies. Since GST rates have been changing, it has created room for businessmen to lobby the government and for the government to pander to vote banks. The tax reduction last month on Gujarati khakra is a case in point. Changing tax rates have also made it difficult to enter into long-term contracts as many exporters who had entered contracts at pre-GST rates have had to bear heavy losses with an increase in their tax burden.
Some economists argue that the differential allocation of talent is one of the reasons why England had the Industrial Revolution in the 18th century but France did not. Historically in India, government service and the attendant “power” was the main aspiration for a majority of the people. The tide has been changing in the previous decade with increasing entrepreneurial activity; the number of new tech start-ups increased from 480 in 2010 to 800 in 2015. If entrepreneurship has to be encouraged holistically, the solution lies in changing the pay-offs for productive work relative to unproductive activities. The government must empower the entrepreneur over the bureaucrat; it is the rules framework that needs to change for India to have more entrepreneurs.
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