Opinion | Peace, easy taxes, and decent administration of justice4 min read . Updated: 08 Jul 2019, 04:45 PM IST
India would do well to adopt the advice of Adam Smith on what makes an economy work and grow
Last week I was in Edinburgh, Scotland, when Nirmala Sitharaman presented the budget in Parliament. I woke up bright and early trying to stream her speech on my phone, waiting for actual budget allocations and fiscal implications. Instead, I learnt poetry as the finance minister quoted from Chanakya and Pisiranthaiyar.
As I walked around in Edinburgh later that day, visiting the statues and tombstones of the Scottish Enlightenment legends, Adam Smith and David Hume, Smith’s words came to mind: “Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things." It would do well for the Indian government to adopt this as its guiding principle.
As India grapples with lower growth rates and stagnating sectors in the economy, Smith’s insights might come in handy. In his treatise, An Inquiry Into The Nature And Causes Of The Wealth Of Nations, Smith does not begin with estimates or growth rates or global macroeconomic factors, but instead with the simple observation of labourers in a pin factory.
Smith ponders that if 10 workers were tasked with producing pins, but worked alone, they could scarcely produce 20 pins each, or 200 pins in all. Smith describes how the same 10 workers in a factory divide the various tasks of pin making: “One man draws out the wire, another straights it, a third cuts it, a fourth points it…" By the simple act of dividing the tasks, they are able to produce 48,000 pins a day. This 240-times increase in output is a result of division of labour. These gains are caused by savings in wasted motion switching from one task to another, the increased dexterity from learning, and innovations in tool design and use. For Smith, division of labour is at the heart of generating economic growth. If division of labour is the secret ingredient for growth, how can nations achieve it? Smith argued that “it is the power of exchanging that gives occasion to the division of labour". Specializing in one-tenth of the tasks of pin-making requires that one is able to trade the pins or revenues from the sale of pins for other goods. One cannot use the pins for all other needs in the absence of trade. In markets where there is little to no exchange, there will be no division of labour. As there is greater exchange in society, individuals are incentivized to participate in the division of labour and specialize.
Which raises the question: How does one increase division of labour? Smith’s most famous insight is that “the division of labour is limited by the extent of the market". The Indian government can take a number of policy steps to enable a larger market.
The first prescription is free trade, without barriers, tariffs or subsidies. Smith argued that global trade would deepen and strengthen the division of labour and specialization. At present, India is far from engaging in global free trade, though it has come a long way from its socialism of the 1960s and 70s. Instead of the current trend of retaliatory tariffs and protectionism, India would benefit from unilaterally removing subsidies to benefit its consumers, and also making its industries more specialized and competitive. Aside from global trade, India has lost a big chance in domestic trade as its domestic market is highly fractionalized. Partly to blame are internal tariffs and tax differentials. Though the goods and services tax regime has tried to create one single market, it has too many rates and classifications, state-level cesses and exemptions.
This fractionalization is also linked to Smith’s second observation on the importance of geography and transportation. Smith observed a higher degree of division of labour and specialization in port cities, and saw how they reduced the costs of trade and incentivized specialization. In India, fractionalization is partly due to a lack of transportation infrastructure. Indian ports have remained stagnant for the last 70 years and domestic waterways have not been improved to support goods trade. Roads and highways have seen a marked improvement, but it’s not nearly enough, not with so many checkpoints and barriers between states.
Third, trading with strangers requires trust among individuals and confidence in the dispensation of justice by the government. Individuals need to trust that the government will not expropriate their land and assets. Demonetization and retroactive taxation are excellent examples of predatory policies of past governments. To foster trust among individuals, everyone must have faith that the government will enforce contracts and prosecute theft, fraud, etc. Developing greater state capacity to dispense justice and maintain law and order will go a long way in fostering trust. Instead of new schemes and subsidies given to special interests, state resources are better spent creating a well-equipped justice system to enforce property rights and contracts.
India has an opportunity to create the single largest domestic market in the world and participate in global trade. Currently, this opportunity is unrealized as the Indian market is fragmented due to pernicious regulation, internal tax and tariff regimes, poor contract enforcement, and lack of infrastructure. To unleash growth, all it needs is “peace, easy taxes, and a tolerable administration of justice". I hope Indian economic policy sees fewer poets and more Adam Smith in the future.
Shruti Rajagopalan is an assistant professor of economics at Purchase College, State University of New York