Narendra Modi’s great leap forward

As the disruption caused by the demonetisation effect continues unabated, government spokespersons have been pointing out that such a massive exercise is bound to cause some disruption. They are absolutely right.

For what Prime Minister Narendra Modi is trying to do, through the demonetisation exercise, through the Benami Property law and by pushing through the Goods and Services Tax (GST), is nothing short of a revolution. And, as Mao said long ago, “A revolution is not a dinner party, or writing an essay, or painting a picture, or doing embroidery; it cannot be so refined, so leisurely and gentle, so temperate, kind, courteous, restrained and magnanimous.” What he meant was you can’t make an omelette without breaking eggs.

Why call it a revolution? Simply put, if the reforms being forced through now are successful, they would change the face of the Indian economy. I am not talking here of mere GDP growth, but of a fundamental structural change. It is Modi’s Great Leap Forward.

Consider the current state of the Indian economy. It consists of a vast informal sector of petty producers, peasants and small farmers, with a thin creamy layer of large-scale, organized, modern enterprises on top. Most of the employment is in the informal sector, although the organized sector contributes about three-fifths of the country’s GDP. That’s because we have a huge sea of small-scale micro enterprises mired in very low levels of productivity, with very few chances of growth. Study after study has confirmed this characteristic of the Indian economy.

Indeed, the objective of economic policy is to expand the formal sector while contracting the informal one. But that is easier said than done. Instead, jobs for the masses have been mainly in the construction sector, where too productivity is very low. It is imperative therefore to expand the formal sector, which alone will result in higher productivity growth.

The political consensus so far has always been to try and expand the formal sector while at the same time providing support to the masses dependent on the informal sector. That was behind the reservations for small-scale industry in an earlier era. Although those reservations have vanished, the establishment turned a blind eye to the tax evasion rampant in the sector and its use as a means of laundering black money. The result was protection for petty production. To be sure, these protections have been slowly and steadily whittled down, but the tax evasion has continued. It has been a major fetter to the development of a modern capitalist economy.

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Many units in the informal sector survive because they do not pay taxes. They conduct most of their business in cash. This is true not just for small repair shops and kirana stores but also for larger enterprises, including many small-scale manufacturing establishments. This cost advantage also helps these units compete effectively against their larger and more efficient counterparts in the organized sector, who not only pay taxes but have to comply with a plethora of rules and regulations. In fact, many brokerage reports have pointed out that the introduction of the Goods and Services Tax will be a big help to companies in the formal sector, as they will be able to take away market share from the unorganized sector.

The demonetisation impact will be felt most acutely in the informal economy, which relies more on cash payments. This short-run impact, however, will be overshadowed by the long-run effect, which will see its share of the economy shrink rapidly, as the state rams through its vision of a cashless economy and forces them to pay taxes. Many units in the informal sector are likely to fail as a result. The hope is that the process will lay the base for the growth of a modern, capitalist state, instead of the ramshackle Third World petty production-cum-islands of modern industry model we see now. It will speed up the process of accumulation and will ensure the state has more resources at its command. Normally, the transition to a more formal economy would be slow and steady, taking many years. But Modi is speeding up the process. Like Mao, he probably feels:

‘So many deeds cry out to be done

And always urgently

The world rolls on

Time presses.

Ten thousand years are too long

Seize the day, seize the hour!’

What he is attempting is nothing less than a wholesale transfer of resources from the informal to the formal sector.

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There is no guarantee, of course, that Modi will succeed. Such an exercise has no precedent. There will be enormous disruption in the informal economy and even if jobs are immediately available as the formal sector expands, employment intensity is much lower in the formal sector. Unemployment is therefore likely to be a big problem, the more so because the construction sector, which has been the source of jobs for the masses, is likely to feel the heat from the government’s measures, simply because it is a big generator of black money. The process of dragging millions of people in the informal sector, kicking and screaming, into the twenty-first century will be a gargantuan task. Modi will have to buffer the pain by providing sops to the masses and by expanding public works. Lower interest rates will also help.

Even so, the endeavour is fraught with great risks, exacerbated by the unsettled global environment. The original Great Leap Forward, after all, was an unmitigated disaster. But perhaps Modi believes, like Mao,:

“There is great disorder under heaven; the situation is excellent.”

Manas Chakravarty looks at trends and issues in the financial markets.