New Delhi: Kaushik Basu took over as India’s 14th chief economic advisor this month. In doing so, Basu made a transition from the world of academia and research into policy making at a critical juncture. In a recent conversation with Mint, Basu spoke about the current state of the economy, reforms and even his plans for Indian art. Edited excerpts:

Markets focus: Kaushik Basu. Ramesh Pathania / Mint

India is one of the most challenging economies in the world because its status is not settled in either direction. It is not an economy that is stagnant and hopeless; it is not an economy which is unquestionably headed to a seat among the world’s most developed and prosperous nations. It is really at the crossroads. It has a huge potential but also the risk of not realizing this potential. It has performed phenomenally well in some sectors, whereas there are some sectors that remain moribund. For me, joining government at this critical juncture is extremely exciting. We have to work and plan intelligently to make sure that India can take its place among the developed nations within a few decades. With some shrewd policy initiatives India can be, I believe, among the finest-performing and fastest-growing economies in the world. I hope to play a part in that.

When you said crossroads there is a doubt that the potential can be belied, there are downside risks.

There are downside risks. India has had high growth from 1994, when it hit a 7% per annum growth rate for three consecutive years; it slowed down a little after 1997 because of the spillover effects of the Asian crisis. Before the recession of 2008, India’s growth was hovering around 9% per annum for four years. This is remarkable performance. Yet, one has to remember that we do not as yet have the history of sustained growth of the kind China has had. China has done well continuously from 1978. We need to consolidate and take this performance further before we acquire some kind of insurance against downside risk. We must not forget that we still have widespread poverty in our country. The opening up of the economy is relatively recent for India. It happened in the last 10-15 years. India has handled the world very well, but the tide can turn against us. Once you’ve opened up sufficiently and you’re exposed to the globe, you have to be prepared to take fluctuations. This must not be construed as reason not to globalize. Enduring perpetual poverty in order to ensure that we do not face fluctuations is not wise strategy.

On food price inflation what do you think are the reasons? Is it a supply side constraint or is there something structural underlying this?

I believe this is not an inflation caused by our monetary or fiscal policies, since there is little evidence of bloated aggregate demand. That has happened in the past, that has happened in many countries. But right now in India it is a very sector-specific inflation that is taking place. Some people would even resist the term inflation. It is a relative price correction taking place. What’s the cause? Once it is so sector-specific, one suspects there are microeconomic factors at work. It is in part caused by the success of government in reaching out to the poor. For the poor, food constitutes the dominant item of expenditure. So if you are handing out money to the poor, food is the sector in which the demand is going to revise most sharply. This skewed inflation may therefore not be totally unconnected to the special efforts that have been made to reach the poor—I’m thinking of the employment guarantee programme and related policies which are causing a spike in the sector. Along with this, since we have just seen a very bad year in terms of droughts, this is leading to the anticipation of a decline in food production. This in turn is giving rise to a certain amount of speculative behaviour, whereby food is being stocked and this is pushing up prices further. Nevertheless, no matter how one describes this ‘inflation’, it is reason for great concern, since India is a poor country with lots of vulnerable people.

What should be the ideal public policy response?

A certain amount of price fluctuations are a part of economic life. There is no way to cut these out altogether. The main aim of policy must be to provide some protection to the poorest. I do not share the conservative opinion that India can’t afford to spend large sums of money on the poor. India can afford and India ought to. The challenge is to do this in intelligent, incentive-compatible ways.

You have talked about effects of bureaucracy and how it is an area that needs reform. What is it that you have in mind?

I feel bureaucracy is a bit like infrastructure. If you improve infrastructure in the country, you can sit back and let ordinary citizens with enterprise and ideas take the economy forward. Likewise, with bureaucracy and governance. We of course need them. However, if the structure of bureaucracy can be made efficient, with red tape cut down, it is like having better roads and good water supply. It enables ordinary citizens to be more effective and enterprising and generate greater productivity. Some claim that the economies which flourish have very few laws. That is not true. All modern market economies need a huge number of laws and regulations. Successful nations are ones where, despite the large body of laws, the bureaucracy runs efficiently. This is quite evident in most industrialized nations. In the case of India we need to streamline the functioning of the bureaucracy so that the sorts of things needed for enterprise to flourish and individuals to be more productive are cleared quickly. Thus we need contracts to be enforced, and enforced quickly; firms waiting to set up a new venture should get their permits cleared..or not cleared…quickly; bankrupt firms wanting to close down should be enabled to do so quickly. You still have to go through the procedures, but you need to speed this up. Let’s say we can make the bureaucracy more efficient by 10%, so it takes 10% less time for each of its current activities. This can have a magical effect on the economy. It is like raising the water table in the country by a couple of inches. It will feed efficiency and life into the entire economy.

This also feeds into labour market regulations. You have in the past made the point that rigid labour laws in India keep down the wage rate.

I believe that with an intelligent amendment of our labor laws—most of which are a legacy of British rule—which result in greater flexibility of contracts, there can be a large increase in the demand for labour. And as demand goes up, wage rates will rise. And I would welcome this natural rise in wages and the accompanying increase in the demand for labor. I am aware that this is a very sensitive topic in India. There are people who believe that any flexibility in labor market regulation can only hurt workers. All I can say is that I do not share this faith in the colonial legacy of our labor laws. But India is a mature democracy. What we need to do is to discuss and debate this topic instead of hushing it up and pushing it under the carpet or making a hasty amendment because some economist believes in it. If after the discussion, the consensus is to do nothing, I will be fine with that. My own interest in labor market reform is solely because I want workers to do better. Usually when people think of helping workers they think of conferring new legislative rights on them, but there is another force, arguably even more potent, which works through natural market processes and can make them better off. This happens when a regulatory framework is provided in which the demand for labor goes up. When firms and people want more labour, the demand for labour goes up and workers are able to demand a better deal for themselves. Very often in our thinking we miss out on the fact that the biggest benefits for workers can come from firms competing with one another to reach out for more labour. So that’s really the kind of change I would like to see happen in the economy where in the end it is the workers who will be better off.

This is happening in new service sectors such as IT (information technology).

It is happening in the IT sector and this is good. But India’s labour intensive manufacturing sector remains too small for a country of our size. Some argue that these kinds of changes are not too important because India’s organized manufacturing sector—where most of our labor laws apply—is too small. This misses the point that one of the reasons the manufacturing sector is small is because it is hemmed in by our ill-conceived, colonial-period laws.

You are an economist who lays a lot of importance on social and political process. What do you see as you come in?

The reason why I am a great optimist for India is that the growth that has taken place, and the development process in general, has been a bottom-up one; there are lots of natural forces at work that nurture this growth. The Indian state is not as overpowering as states in some other countries. This has the advantage of empowering our civil society and this has played a large enabling role for the economy. At the same time there is the risk of political dissension because large segments of the population are too poor to partake in the development that is taking place. Our ultimate success will depend on how we handle this problem. You want people to feel a part of this large process that is India. No one should feel excluded. But this is of course easier said than done. We need intelligent policies to reach out to all segments of society and bring more and more into that network of markets and trade.

On the same subject, going to the Tendulkar panel recommendations, there is a paradigm shift on criteria used. Implicit in this is aspirations and there is an inherent desire to recognize the deliverables are through the market too. Do you agree there is a shift happening?

There is a shift and shift of focus is needed. After all poverty is many different things. It’s not just by plain simple consumption to meet some minimal calorific needs. However, what one needs to be careful about when one changes a definition, is to remember that the new poverty figures represent not a new reality but a new way of looking at the same reality. In the case of Tendulkar’s work, his new measure of poverty does not mean that poverty in India has risen but it simply urges us to look at poverty differently. His way of looking does suggest a special role of markets and social norms. It reminds us that you can’t reach out to such a huge population as ours just by the state doling things out. If the state could do so, that would be well and good. But this is an impossible task for the state. So, again, you would have to use an intelligent mix of the state and markets to work in the interest of this segment.

When you picked the inflection point of economic growth which happened in the 70s, you identified nationalization of banks as a contributing factor to it. Now, we have the state-owned banking system, which seems to have been picked for driving financial inclusion. In this context, do you feel some kind of loosening of state control is required? What sort of financial sector reform are you looking at?

I have argued that the first steep rise in India’s savings and investment rate, which occurred in the 1970s and in turn contributed to the nation’s higher growth rate, was caused by the bank nationalization in 1969 and the decree issued to open up branches in rural areas. But a policy that works at one time need not work at another. Only ideologues believe otherwise. I do believe that some state action is needed to encourage financial inclusion but this has to also be combined with financial sector reforms, which can energise our markets, from banking to finance, in general.

Your faith in market is one of the things being questioned after the meltdown. Are you revisiting it?

I don’t have to revise my opinion because I never thought of the market as a mechanism which can deliver everything. So the fact that it has malfunctioned and failed to deliver does not require any alteration in my view. My position is that for a big economy it is impossible for the state to deliver everything and market forces cannot be ignored but are vehicles of progress that we need to utilize to our advantage. You have to intelligently use markets. And markets — with the state laying down the parameters within which markets function — can deliver a lot. In fact at this stage it is not clear to me that we have any viable alternative.

In the Indian context when it comes to entitlement, a subject you have worked on, what are your thoughts?

I have written on and talked in terms of rights quite a bit. Rights are important. But on the other hand it is easy to fall into the trap of announcing one right after another and feeling smug that you have achieved something fundamental. I would be careful not to over use the method of rights. Further, most rights come with a corresponding obligation on the part of the state and also other citizens. We must take this seriously instead of multiplying the rights and leaving them to live by their violation.

What are your views on deficits?

On this my position is close to the line taken by the finance ministry and the finance minister, in particular. This is pretty much in accord with the global opinion--when you are in recession you have to use a fiscal stimulus. This is a policy which comes down to us from the time of Keynes. At the same time, you have to keep in mind that this is one of those instruments which you can use only for short durations, rather like antibiotics. How short the duration should be will depend on the way the economy is functioning. But deficits are something which, to me, is not anathema. Its just that when you begin to fold back the stimulus there will be some hardships, some withdrawal symptoms that you have to deal with.

Strategic mix: Basu says that for a big economy, it is impossible for the state to deliver everything and market forces cannot be ignored. Ramesh Pathania / Mint

To look at creativity in a population as a sign of a nation’s potential is what I was talking about. Contemporary Chinese art is extra-ordinarily good and creative. To me, that is a signal. Though China is a hugely state-controlled society, there must be a flourishing creativity in the population which you see from China’s art. In the case of India, because India is in many ways a more open, flexible, also anarchic society, that you don’t really don’t have search too hard to find creativity. Yet, creativity can and needs to be nurtured. I take a lot of interest in contemporary art movements. I believe that India’s art needs nurture and with a little bit of that the nation can give rise to a flourishing of art talent that will make the global art market sit up. On this, I plan to float some ideas once the rush of the Budget is behind us. I will, at some point, bring in ideas about how the government can take a first few steps to get the art market going.

What about education where you clearly dissented (Basu was a member of the Yash Pal committee on Higher Education, 2009)?

I have had my fill of this so let me give this question a pass. I don’t want to avoid this topic—India’s higher education in which I have spent the bulk of my career is too close to my heart for that. But my suggestions for this are now all in public space. I will be happy to work on reviving India’s higher education system should I be given the opportunity.

Going back to your current job, what made you consider and accept it? It is a dramatic shift.

It was not an easy decision, since I loved my life of research and teaching and Cornell took good care to leave me free to pursue these with abandon. I have to admit, silly though this may sound, I come to this job with a bit of a missionary zeal to do something valuable for India. I felt that if any government was going to be daring and allow for major progressive changes it is probably this government. There are individuals here. I am thinking of the people at the top like the prime minister, the finance minister. There are people here who have foresight and want change. I was also personally at a stage where I thought that since I had done copious amounts of writing which no one listens to, this may be a good opportunity to goad people to actually do things. Minimally this is an exciting time for me to try to make important changes. I have come with a fixed duration job—it is a two year term. All I can say is that I will give this job the best that I can.