Former prime minister Manmohan Singh recently lambasted the government for its “all round mismanagement" of the economy and has blamed the economic slowdown on the “man-made blunders" of demonetization and a flawed implementation of the goods and services tax (GST). His final plea was for the government to reach out to sane voices.

If this criticism were from a less informed or credible source in the Opposition, one might have ignored it as political posturing, but Singh has accurately summed up the reality and the tragedy of the current economic slowdown. Alarming though it sounds, he recognizes the lack of economic thinking in the current government.

An example of the government’s economic ignorance is its position on the auto industry. Most auto manufacturers have recorded a major slump in sales. About a million workers directly and indirectly working in the auto industry have lost their jobs, and more layoffs are expected. The government’s response is to purchase vehicles for government use to boost demand. It is attempting to treat a symptom with no clue of the nature of the problem. What the government has failed to understand is that the problem is not unique to the auto sector. The slump in this sector is because domestic demand is depressed, thanks to demonetization and GST.

Parle-G, among the most recognizable brands in India, recorded a massive drop in sales recently. The company blames the 18% GST on biscuits and says it may have to lay off 8,000-10,000 workers. Coming from a company that has sold biscuits for 80 years, and for prices as low as 5 a pack, this is a signal of systemic and not sectoral drop in consumer spending.

The fundamental reason is that the Modi government has waged a war against the informal economy over the past five years. The Prime Minister and the government tend to conflate informality with corruption, and, in a misplaced effort to eliminate corruption, could end up killing the informal economy. Depending on how one defines it, more than 30% of the economy is completely informal, and perhaps 50% is quasi informal, and over two-thirds of the workforce is employed in informal enterprises. This makes the war on informality essentially a war on the economy. Demonetization is the best example and tragic consequence of this conflation.

Another example, GST, has brought back the licence raj in a new avatar—the tax raj. GST imposes criminal penalties for a sale without an invoice, or misuse of tax refunds, manipulation of tax credits, etc. In a country with an informal sector as large as India’s, and given high GST rates and complex compliance needs, the law effectively makes most businessmen criminals. Worse, the government seems to treat evaders like terrorists. Tax commissioners have wide powers to arrest people without registering an FIR or police complaint, and businessmen are left without the option of anticipatory bail. The government is enforcing the law to increase tax revenue, without realizing that it is killing the very activity that results in tax revenue.

India has such a vast informal sector not because Indians like to operate in the shadows, but because the cost of doing business by following all regulations is too high. Corruption is a consequence of the pernicious regulatory structure imposed by past socialist governments. Instead of removing regulatory burdens, the Modi government has been aiming the state’s regulatory apparatus at them. As a result, they cannot function, and the manufacturing sector, especially small and medium size firms, are in distress. The auto industry is not alone.

Since the auto industry is very visible and well organized, however, it can lobby the government for relief. The finance minister, whose understanding of economics is another matter, has said that the way forward is to provide sectoral relief. This will only increase cronyism and corruption instead of eliminating it.

While economists have repeatedly recommended simplifying the GST, the government’s solution is to change the rates for each sector on a case-by-case basis to stave off slumps or win elections. The consequence is that Parle-G biscuits, one of the country’s cheapest food items, is taxed at 18%, while gold and diamonds are taxed at 3% and 0.25%, respectively.

While there are many man-made blunders to unmake, there are a few steps the Modi government must take immediately. First, it needs to use this economic crisis to simplify the GST. The multiple rates, exceptions, cesses and surcharges need to be eliminated and replaced with one single GST rate across all goods and services, ideally below 15%. The GST compliance system needs a major rehaul, eliminating the need to file monthly returns. This will have a two-fold effect. The first is a major relief for the manufacturing and consumer goods sector, resulting in reduced prices to deal with the depressed demand. And, second, it will help recover the loss in business confidence.

Next, the government needs to announce real reforms, instead of sectoral freebies. The only way to end informality in the Indian economy is to make formal business operations cheaper. This requires a complete end to the inspector raj system and a simplification of regulations, starting with labour and land market rules. With these steps, there would be some hope that the Indian economy will recover over the next few years.

Shruti Rajagopalan is a senior research fellow with the Mercatus Center at George Mason University

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