“Way back in 1959, when Rajaji and I founded the Swatantra Party and pleaded for a market economy for India, it was considered politically foolhardy, if not downright foolish, for us to go against the then prevailing dogma of socialism. Nevertheless, we persisted because it was already apparent to some of us that the economic policies being followed by Pandit Nehru and his party based on the socialistic pattern of society would lead the country to bankruptcy. Our worst fears came true, for the socialistic pattern of society did lead to economic disaster and moral degradation."

Thus wrote the liberal politician Minoo Masani a few years before his death. The Swatantra Party he led used to argue not just against the economic inefficiencies of Indian socialism but also its debilitating effect on human values such as honesty. The web of discretionary controls that were needed to ensure state control over the economy fed corruption. The focus of business activity was gaming the system rather than building globally competitive enterprises.

The effect of the licence raj on honesty is now widely accepted. However, subsequent research by political economists has shown that the causality actually runs both ways. The heavy hand of regulation creates opportunities for corruption. Widespread corruption undermines the credibility of the market economy. Citizens then look to the government to regulate an oligarchic capitalism that is based on rent extraction.

These issues should resonate more than 25 years after India began its shift to a market economy—a programme that has achieved economic success but has, as yet, got little popular political support. As Rafael Di Tella and Robert Macculloch explained in their 2009 paper, Why Doesn’t Capitalism Flow To Poor Countries?: “Corruption reduces the public’s voluntary acceptance—the legitimacy—of a country’s commercial institutions and their desire for a system in which capitalists might flourish. Voters who perceive corruption then vote for more regulation as a way of punishing the capitalists, whom they see as undeserving. Moreover, they do so even if the increased regulation generates still more corruption, slower growth and other economic ‘bads’; they are willing to incur material costs to obtain outcomes that they see as more fair."

These ideas serve as a useful backdrop to examine some recent policy initiatives—demonetization, the push for digital payments, the transition to a goods and services tax (GST), the bankruptcy law and the new bunch of real estate regulations, for example. Each has the potential to reduce the opportunities for corruption. The early record is a mixed one. There is as yet only slim evidence to support the belief that demonetization has struck a body blow to corruption. The use of bankruptcy laws by lenders to go after influential corporate groups that have defaulted on their loan commitments offers hope for a more dynamic capitalist system in India. GST is still in its infancy, but the use of input credit taxes that will be reconciled through the GST computer network offers hope of eventually less tax evasion in the production process.

The Narendra Modi government often says it is fighting the overdue war against corruption. The anecdotal evidence is that high-level corruption has come down. The problem of retail corruption remains, and is at a deep level a challenge of institutional design. Changing the rules of the economic game is just one part of the challenge. The government system that works on discretionary power needs reform as well. Milan Vaishnav of the Carnegie Endowment for International Peace has eloquently shown in his recent book that voters have rational reasons to back criminal candidates, because the latter can use their muscle power to get access to under-provided public goods and welfare payments that are blocked by the broken government system. The same logic perhaps applies to corruption as well.

It is no secret that India is one of the most corrupt countries in the world. Each individual policy proposal to curb corruption is welcome. But what binds everything together is the broader need to shift from crony capitalism to a competitive market economy on the one hand, and from a government system rooted in political patronage to one based on rules rather than discretion on the other. These are issues worth pondering over as India completes 70 years as a free country later this month.

Will reducing and reforming the discretionary powers of the government help eliminate corruption? Tell us at views@livemint.com