Photo: PTI
Photo: PTI

State, market, institutions: Arvind Subramanian’s imprint on the Economic Survey

Much of the analytical heart of the new Economic Survey can be better understood through the twin challenges of state and entrepreneurial capacity

The new Economic Survey released on Friday has the clear imprint of Arvind Subramanian.

The chief economic adviser to the government has for long argued that the ability of a country to grow over the long run is critically determined by two factors: state capacity and entrepreneurial capacity. And he has also said that there is a fundamental asymmetry between the two. It is easier to create markets than it is to create state capacity—or prevent deterioration in the latter.

Once you look beyond the newsy economic forecasts, much of the analytical heart of the Economic Survey can be better understood through these twin challenges of state and entrepreneurial capacity. The economists in the finance ministry have offered several empirical insights on these issues—and more.

A useful starting point is the chart that shows how both India and China are outliers in terms of their institutional quality. India has far better institutions than can be explained by its level of economic development. China has far higher levels of economic development than can be explained by its institutions.

This was part of a devastating critique that Subramanian wrote on Why Nations Fail, the highly successful book written by economists Daron Acemoglu and James Robinson, which was itself based on their earlier work with Simon Johnson. What Subramanian showed in his simple chart was that the theory that institutions explain development is off the mark when the development experience of the two most populous countries is considered.

The Economic Survey suggests that these outliers will eventually revert to the mean. China will do so through slower growth combined with more democratization. India could do so in two ways. Either its economic growth will accelerate so that its income moves to a level that can be justified by its quality of institutions. Or it will face institutional decline to a level that its current low income levels would justify. There are no prizes for guessing which option would be better.

It is thus important in the long run that India builds its state capacity by halting institutional decline. Central to that challenge is to strengthen fiscal capacity—not only in terms of dry economic numbers such as the ratio of tax to gross domestic product but to cement a two-way political contract between the Indian state and citizens. There are currently only four direct taxpayers for every 100 voters. The Economic Survey says it should be closer to 23.

A lot of our present debates—from tax reforms to a new welfare state built on the JAM (Jan-Dhan Yojana; Aadhaar; Mobile) model – can be better understood against this background. Subramanian and his team have waded into controversial waters by saying that India is not an undertaxed or underspending economy once you control for its level of development. This fits into a separate argument made by economist Indira Rajaraman a few years ago that India has tried to build a redistributionist state too early in its development trajectory.

State capacity is important in tandem with entrepreneurial capacity. The Economic Survey says that India has moved from a system of socialism with limited entry to a market economy without exit—a catchy phrase that I first heard in the course of a long interview Subramanian gave to University of California economist Karthik Muralidharan in August 2015.

The Economic Survey uses the Mahabharata analogy of the chakravyuha. It is easier to enter than to exit. It then explains that many of the reform proposals of the government are meant to deal with this Abhimanyu problem, be it the new bankruptcy law, rehabilitation of stalled projects, the proposed changes in the anti-corruption law as well as the broader JAM agenda.

The possibilities of exit from various types of deadlocks could lead to greater efficiency of allocation in the Indian economy. (And it is especially good to see the finance ministry, in this chapter, pay passing homage to C. Rajagopalachari, who it describes as “India’s original economic liberal".)

The Economic Survey also links the problem of exit with the problem of institutions—and this implicitly connects the two grand themes of institutional capacity and entrepreneurial capacity. In a nuanced argument, the Economic Survey says that the problem of exit is paradoxical, since it “arises from a combination of both weak and strong institutions". The strong institutions in this case are the investigative institutions, or what Devesh Kapur of the University of Pennsylvania has called “referee institutions".

Most of these arguments are based on elaborate empirical work that is perhaps best read directly from the Economic Survey, one of the most ambitious in recent years. The broader political economy thrust of the report perhaps sits well with the early—but now forgotten—claim by Prime Minister Narendra Modi that what India needs is a combination of minimum government and maximum governance.

The Harvard economist Lant Pritchett has famously described India as a flailing state, a much harsher description than the old view of Swedish economist Gunnar Myrdal about India being a soft state.

Pritchett has been saying that India is “a nation-state in which the head, that is the elite institutions at the national (and in some states) level remain sound and functional but that this head is no longer reliably connected via nerves and sinews to its own limbs. In many parts of India in many sectors, the everyday actions of the field level agents of the state—policemen, engineers, teachers, health workers—are increasingly beyond the control of the administration at the national or state level".

The analytical focus on an Economic Survey is usually the result of two influences—the intellectual strengths of the chief economic adviser of the day as well as the economic situation.

For example, Kaushik Basu used his game theoretic insights to focus on incentive design at a time when the second Manmohan Singh government was focused on expanding the welfare system. It is in that sense that the new Economic Survey bears the imprint of Subramanian.

One common view among scholars is that India does better than China on entrepreneurial capacity while it is the other way round when it comes to state capacity. Their view is that India is held back by an ineffective state even as it needs to make life easier for entrepreneurs.

The analytical chapter in the new Economic Survey offers extensive data analysis to bolster some of these broader issues. It is a fine example of empirical political economy.

Niranjan Rajadhyaksha is executive editor of Mint.