New Delhi’s recent actions suggest that it is getting serious about addressing structural bottlenecks to economic growth
The 18th century British writer, Samuel Johnson, is famously believed to have said: “Depend upon it, sir, when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully." A similar logic applies to the political economy of economic reform. Nothing concentrates the minds of policymakers and loosens perceived or actual political constraints on reform more than an incipient economic crisis.
Thus, in the case of India, 1991 is the classic example of far-reaching economic reforms being engendered by a macroeconomic (in particular, foreign exchange) crisis. The corollary is that good economic times induce an often unwarranted sense of insouciance among policymakers, who choose to defer politically difficult reforms for another day.
In India, the 10 years of the Congress-led United Progressive Alliance (UPA) government were marked by a failure to embark upon second-generation economic reforms and the crisis, such as it was, came too late to have an impact on economic policy—except that it helped the Narendra Modi-led Bharatiya Janata Party (BJP) sweep to power. By contrast, Modi’s first term in office saw some important (albeit, in some cases, incomplete or flawed) reforms—the monetary policy framework, the bankruptcy code and the goods and services tax (GST). The latter two, in particular, are in need of further reform if there is to be any prospect of their acting as enhancers rather than retarders of economic efficiency.
Modi’s first term in office also saw some notable missed opportunities in the realm of economic reforms, especially in factor markets. The ill-fated reform of the UPA’s land acquisition law, and a tentative and timid approach to labour market reform, have been much commented upon, including by this author, as was the government’s failure to restart the disinvestment agenda, which had been all but shelved by the UPA.
Some of this mixed experience may be attributed to a gradual, incremental approach to economic policy reform, as argued in the very first instalment of this column, while another contributing factor is surely the lack of a wholehearted embrace of liberal economics within the ranks of the BJP and its affiliated organizations. As has been argued by many, including your author, India has never really had a political mass in favour of economic reforms, and both major parties, the Congress and the BJP, have a centre-left orientation on economics despite some noted reformers in the ranks of both.
The start of Modi’s second term earlier this spring seemed to suggest a continuation of this gradualist approach. Despite coming back with an even bigger majority, and with much reduced opposition to the government’s legislative agenda in the Upper House of Parliament, the first Union budget of the new government was underwhelming, at best. However, darkening clouds on the economic horizon—apparent in tepid growth numbers and in a downward trend in other key indicators—seem to have given something of a new impetus to the government’s reform agenda.
Minister of finance Nirmala Sitharaman deserves considerable credit for making the case publicly for further reforms, and for quietly pushing them within the larger Modi ecosystem. Her bold decision to cut corporate income taxes was a promising start, as were recent announcements on jump-starting the disinvestment agenda.
India is by no means approaching an economic crisis as severe as 1991, but it is indisputable that a combination of demand-side (cyclical) and supply-side (structural) factors are weighing down on growth, employment and economic activity. The only debate is on parsing the contribution of cyclical as against structural factors, in which there is a range of opinion spanning the spectrum from arguing that India’s current woes are mostly cyclical (many of the government’s defenders) to the opposite view, that they are mostly structural (many of the government’s critics).
It is no secret that my view is that the burden falls on structural rather than cyclical factors in explaining the economic slowdown, and that the only remedy, therefore, is to re-energize the economic reforms agenda. Apologists for limited action on reforms tend to argue that the slowdown is cyclical and, therefore, standard Keynesian-style aggregate demand management policies (spend more, tax less) will suffice.
It appeared that the government hewed closely to the second view after its re-election earlier this year, judging from their apparent nonchalance on poor macroeconomic data. But more recent developments noted earlier suggest that they are taking more seriously the structural impediments to economic growth.
What needs to be done? First, after several false starts, the Modi government must convince investors and other observers that it is serious about disinvestment and outright privatization of public sector enterprises. This is a file to watch in the coming few weeks and months. Second, the government must grasp the nettle of labour market reforms. Consolidating many laws into just a few is a good start, and makes regulations function more efficiently, but this in itself does not constitute reform. Third, the fiscal deficit must be kept in check. This will involve pruning or even eliminating some schemes, and refraining from large new spending announcements. The corporate tax cuts, while welcome, are not a panacea, and they should be followed in short order by personal income tax cuts. Finally, the climate of doing business must be improved not just on paper but also in terms of the ground reality.