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55374195-The-Politics-of-India-s-Unfinished-Economic-Reforms

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					India Forum
                                                             Paper Series
May 2011



 Summary: Despite at least two
                                       The Politics of India’s Unfinished
 decades of reforms, the liber-
 alization of India’s economy is
                                       Economic Reforms
 incomplete. This is primarily a
                                       by Swaminathan S. Anklesaria Aiyar
 function of politics. Indian polit-
 ical leaders have few incentives
 to advance the reform agenda
 given India’s high growth rate,
 and instead prefer handouts in
 the form of welfare schemes
                                       Economic reform in India began hesi-       The Doing Business series of the Inter-
 and employment guarantees.
 The ruling Congress Party is          tantly in the 1980s and accelerated in     national Finance Corporation (IFC) at
 inclined towards populism. The        the 1990s. After a process of 20 to 30     the World Bank confirms the notion
 realities of coalition politics       years of liberalization, one might have    of India being a generally unfriendly
 in both houses of parliament          expected truly revolutionary changes       environment for doing business.
 further complicate reforms, as        to India’s economic system. Yet the        Its 2011 report rated the country a
 they require concessions from         Heritage Foundation’s 2011 Index of        lowly 134 out of 183 countries. India
 partners and, in some cases,          Economic Freedom ranks India at just       ranked close to the bottom in terms
 the opposition. While some            124 of 183 countries and classifies it     of ease of starting a business (165),
 advances are being made, future       as a “mostly unfree” state with a lower    getting construction permits (177),
 economic liberalization in India      than average score.                        and enforcing contracts (182). All of
 will likely be hesitant, episodic,
                                                                                  these indices are clear demonstra-
 and half-hearted.                     A separate study, Economic Freedom         tions of how India remains hobbled
                                       of the World 2010, brought out annu-       by controls, corruption, the pathetic
                                       ally by the Fraser Institute and allied    delivery of public goods, and flawed
                                       think tanks, places India at 87 out of     administrative and judicial systems.
                                       141 countries on economic freedoms.        While India has indeed been trans-
                                       In the 1980 edition of the same index,     formed since 1991, the unfinished
                                       India had been ranked as high as 57.       reform agenda is massive.
                                       This apparent decline is not a result
                                       of worsening freedoms: India’s score       In addition to various constraints on
                                       on the index has improved from             doing business, corruption remains
                                       5.41 to 6.51 on a scale of one to ten,     another area of concern. It is currently
                                       signifying an improvement. However,        a hot topic in India, with an outraged
                                       other countries have liberalized much      media revealing scam after scam, but
                                       faster than India in the interim period.   India may be experiencing more public
                                       Interestingly, India does not rank         outrage rather than more corruption.
                                       much lower than China (82), and            This is confirmed by the Corruption
1744 R Street NW                       ranks much higher than its neighbors       Perception Index of Transparency
Washington, DC 20009                   Sri Lanka (111), Bangladesh (113),         International, which ranks India 87 out
T 1 202 683 2650                       Pakistan (118), and Nepal (125).           of 178 countries, behind China (78)
F 1 202 265 1662                                                                  but well ahead of Bangladesh (134)
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India remains hobbled by                                         horizons that favor immediate handouts over longer-term
                                                                 reforms. So the political incentives for accelerating reforms
                                                                 remain weak at present.
controls, corruption, the pathetic
                                                                 Coalition politics further hampers the reform agenda. The
delivery of public goods, and                                    governing United Progressive Alliance (UPA), led by the
                                                                 Congress party, has lacked a majority in both houses of
                                                                 parliament in both its first and second terms. In its first
flawed administrative and judicial                               term (2004-2009), the UPA survived only with outside
                                                                 support from the Left Front, consisting of four communist
systems.                                                         parties. This gave the Left a virtual veto on reforms. Several
                                                                 reformist bills were introduced by the UPA — to allow
and Pakistan (143). India has slipped from 66th in 1998,         pension funds to invest in the stock market, to increase the
but in absolute terms, its corruption perception index has       ceiling of foreign investment in insurance from 26 percent
improved from 2.9 to 3.3. This may be because corruption         to 49 percent, and to give investors in banks voting rights in
has been abolished by deregulation in several areas – indus-     line with their shareholding — but the Left, dead set against
trial licenses, import licenses, monopolies clearance, and       any financial liberalization or improved access to foreign
foreign exchange permits – and this more than offsets rising     investment, blocked these bills. The Left also vetoed legis-
corruption in areas of political allocations, such as telecom-   lation to end the public sector monopoly on coal mining.
munications, land acquisition, construction permits, and         And, of course, it demanded and got a huge increase in
infrastructure.                                                  social and rural spending programs. Of these, the most
                                                                 useful was Bharat Nirman, which massively improved rural
The Political Economy: Reforms, Handouts, and                    infrastructure.
Coalition Politics
Despite corruption and business constraints, India has
averaged 8.5 percent GDP growth in the last decade.
                                                                 Having witnessed the benefits of
This reflects virtuous cycles created by economic reforms
over the last two decades, as well as a demographic divi-        miracle growth, Indian politicians
dend. This has important implications for the political
economy. Having witnessed the benefits of miracle growth,        have little incentive to reduce
Indian politicians have little incentive to reduce corrup-
tion, misgovernance, or unwarranted economic controls.
Indian politicians, like their counterparts everywhere, want
                                                                 corruption, misgovernance, or
to get re-elected, and while they may opt for reforms in
tough times, during an economic boom they prefer using           unwarranted economic controls.
increases in revenue to shower handouts to constituents.
Handouts can range from employment programs and
subsidized grain to free electricity and canal water and         The 2009 election brought the UPA coalition back to power
subsidized fuel and fertilizers for farmers. In some state       with more seats, yet slightly short of a majority. No longer
elections, political parties have promised voters bicycles,      needing the support of the Left, it formed a government
color televisions, electric mixer-grinders, and even laptop      with the support of minor parties. But expectations that
computers. Such handouts fritter away funds that could           the second UPA government would surge forward with
better be better utilized building infrastructure, improving     reforms proved ill-founded. The reasons for this are several-
governance – including establishing more courts and police       fold. First, the leader of the Congress Party, Sonia Gandhi,
– and improving social services such as health and educa-        has demonstrated her preference for handouts. Along with
tion. Voters in poorer countries tend to have short time         many leaders of the Congress Party and members of the
                                                                 media, she believes that the UPA’s emphasis on welfare,

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India Forum


Paper Series
particularly a massive rural employment guarantee scheme,
was a key reason for her electoral victory in 2009. However,
                                                                Limited co-operation between
the labor component of the employment guarantee scheme
comes to just 0.3 percent of GDP, and work under this           political foes reflects the
scheme accounts for only 1 percent of total rural person-
days of work. It seems implausible, then, that this could       institutional strength of democracy
have been the main reason for rural prosperity or the UPA’s
re-election. The truth may in fact be more prosaic. Three       in India, and helps overcome some
new parties emerged in the 2009 election: Praja Rajyam in
Andhra Pradesh, a splinter group of the Shiv Sena headed
by Raj Thackeray in Maharashtra, and a new party in Tamil       of the political hurdles to reform in
Nadu. The Congress was the incumbent in all three states,
and the new parties helped further split the anti-incumbent     an era of permanent coalitions.
vote. This gave the Congress approximately 60 seats more
than it would have otherwise won in the 2009 general elec-
                                                                The Big Ticket: Tax Reforms and Concessions
tion. Beyond that, economic improvement may well have
                                                                BJP support is absolutely essential for the biggest reform bill
helped the Congress, but it remains unproven whether the
                                                                of all — a Constitutional amendment to abolish the current
credit for that goes to rapid growth or increased welfare
                                                                mélange of taxes levied by the central and state govern-
spending. However, most Congress stalwarts continue to
                                                                ments, and its replacement it by a Goods and Services Tax
believe that welfarism — not reform — wins votes.
                                                                (GST). This amendment, which would require a two-
                                                                thirds majority in both houses of parliament, could truly
                                                                modernize Indian tax administration, eliminating cascading
Expectations that the second UPA                                taxes and curbing tax evasion. The substance of this bill has
                                                                been hammered out by a committee of state finance minis-
government would surge forward                                  ters over the last decade, including those of states governed
                                                                by the BJP and Left Front. But the BJP has recently raised
with reforms proved ill-founded.                                fresh objections of a political, rather than technical, nature.
                                                                It probably will not assent to the GST legislation until the
                                                                central government goes slow on the prosecution of BJP
                                                                politicians for the mass killing of Muslims in Gujarat in
The second UPA government also lacks a majority in the          2001. In this case, at least, political reform is complicated by
Rajya Sabha, the upper house of India’s parliament. It can      the politics of religion.
try to make concessions to regional parties to secure their
                                                                The Congress has, it appears, been rewarded for its patience.
votes for controversial bills, but such support would be
                                                                The BJP has agreed to support a long-pending Pensions
unpredictable and unreliable. Finance Minister Pranab
                                                                Bill that will, among other things, allow private players into
Mukherjee believes that, in many cases, legislation can only
                                                                pension funds, which in turn will be allowed to invest in
proceed by evolving a multi-party consensus, which often
                                                                equities. In return, the Congress has agreed to postpone
means getting the support of the BJP, the main opposition
                                                                a bill creating an Academy of Scientific and Innovative
party. Securing BJP support has become so important that
                                                                Research, which the BJP objects to. This limited co-opera-
the Congress has often been willing to tolerate the BJPs
                                                                tion between political foes reflects the institutional strength
antics, such as blocking the entire winter session of Parlia-
                                                                of democracy in India, and helps overcome some of the
ment in 2010 over an investigation into a massive telecom
                                                                political hurdles to reform in an era of permanent coali-
scam. In theory, the Congress could have asked the Speaker
                                                                tions, in which no party can realistically win a majority in
to expel unruly BJP legislators and allow parliament to
                                                                parliament.
proceed, but it wilted out of a desire to secure BJP support
on some key bills.

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Paper Series
Episodic and Half-Hearted Reforms
The bottom line is that future reform in India will be slow,        About the Author
but all indications are that it will still move in the right        Swaminathan S. Anklesaria Aiyar is consulting editor of The Economic
direction. Corruption has become a big issue thanks to the          Times in India, and a research fellow at the Global Prosperity Center of
recent wave of middle class outrage stoked by the media,            the Cato Institute, Washington DC.
and it seems all parties may agree to legislation that limits
the scope for ministerial discretion in awarding government         About India Forum
contracts or selling government property. This will be a net
positive for economic reform.                                       India Forum — an initiative of the German Marshall Fund, Legatum
                                                                    Institute and Sweden’s Ministry for Foreign Affairs — convenes poli-
                                                                    cymakers, intellectuals, journalists, and businesspeople from Europe,
Legislation is not necessary to                                     the United States, and India twice a year to discuss shared challenges
                                                                    and facilitate cooperation and coordination. For more information on

allow foreign direct investment in                                  India Forum, go to www.gmfus.org/cs/asia/india_forum.

                                                                    About GMF
the retail sector, or to liberalize
                                                                    The German Marshall Fund of the United States (GMF) is a non-

rigid labor laws that inhibit                                       partisan American public policy and grantmaking institution dedi-
                                                                    cated to promoting better understanding and cooperation between

the growth of labor-intensive
                                                                    North America and Europe on transatlantic and global issues. GMF
                                                                    does this by supporting individuals and institutions working in the
                                                                    transatlantic sphere, by convening leaders and members of the policy
industries.                                                         and business communities, by contributing research and analysis
                                                                    on transatlantic topics, and by providing exchange opportunities to
                                                                    foster renewed commitment to the transatlantic relationship. In ad-
On the other hand, we should beware the interpretation              dition, GMF supports a number of initiatives to strengthen democra-
that the absence of a parliamentary majority for the UPA,           cies. Founded in 1972 through a gift from Germany as a permanent
notably in the Rajya Sabha, is the only reason for the slow         memorial to Marshall Plan assistance, GMF maintains a strong
pace of reforms. No new legislation, for example is required        presence on both sides of the Atlantic. In addition to its headquarters
to decontrol oil prices and fertilizer costs, remove subsi-         in Washington, DC, GMF has six offices in Europe: Berlin, Paris,
dies for electricity and water for farmers, or discipline           Brussels, Belgrade, Ankara, and Bucharest. GMF also has smaller
absent teachers and health workers. Similarly, legislation          representations in Bratislava, Turin, and Stockholm.
is not necessary to allow foreign direct investment in the
retail sector, or to liberalize rigid labor laws that inhibit the
growth of labor-intensive industries. Yet this UPA govern-
ment has shown no inclination to move forward on any of
these issues. The Congress Party is, at its core, populist with
old socialist roots, and believes that wooing voters with
handouts is good electoral practice. Combined with the
realities of coalition politics, this means that future reform
in India will tend to be hesitant, episodic, and half-hearted.




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posted:5/18/2011
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