India, along with the rest of the world, is on the brink of a new year. It certainly feels like 2016 has been an unusually tumultuous year, more for politics than the economic crisis that marked 2008. Brexit, the election of Trump, conflict in Syria, and the human displacement and terrorism radiating out of that conflict have both reflected and created further unease. India, in comparison, has seemed relatively quiescent, despite increasing tension with its neighbour to the west. The most momentous event of 2016 was ostensibly an economic one, rather than political, namely, demonetisation.
However, it seems to me that the driver of the demonetisation policy and its timing was a political calculation. I realize it is impossible to verify this claim. But it is certainly true that election finance is a major locus of unaccounted cash transfers. Milan Vaishnav, of the Carnegie Endowment for International Peace, has written perceptively on the problems of India’s current system of campaign financing. He does not make as categorical a claim as I did in my last column, but he has written that (on.ft.com/2go13Hj), “Indeed, it is hardly a coincidence that Modi’s manoeuvre comes just months before state polls in Punjab and Uttar Pradesh.” He goes on to suggest that demonetisation will not be a long-term solution, and proposes institutional reforms.
There are two general themes here, both of which underlie my worry that India is on the brink, not just of a new year, but also of another lost opportunity to add to the many that have marked its seven decades of Independence. As many have recognised, India’s potential demographic dividend will become a demographic disaster if the country does not fashion a path of sustained growth approaching double-digits in percentage terms: this is why I think India is on the brink of a crisis. The first general theme is that India is large and heterogeneous, and its governance requires a balancing of many sub-national interests and claims, and negotiating trade-offs of decentralisation and centralisation. The second theme is partly related to the first, the manner of governance, in terms of its institutions at every level, from the Centre down to the village. Here, the balancing and trade-offs occur between politics and administration, rules and discretion, and responsiveness and commitment.
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Over a decade ago, M Govinda Rao and I attempted to analyse the different dimensions of the Political Economy of Federalism in India—the title of our co-authored book. Much has changed since then, with the abolition of the Planning Commission, greater devolution of funds to the states (by the 14th Finance Commission, where Dr. Rao was a key member), and slow but perceptible progress in some aspects of local governance. But the key political structures of federalism are the same, and governance of the country still involves the Centre working with the states in myriad ways. The role of the Rajya Sabha has been crucial in the tenure of the current government, and has heightened the importance of state assembly elections, particularly in large states such as Uttar Pradesh.
This is where Milan Vaishnav’s analysis is very relevant—are there institutions that can reduce the direct and indirect economic costs, and improve political outcomes, of a country that has many thousands of governments at multiple levels? One can also ask how tax and transfer systems can be improved further, how problems of “multiple vetoes” (Pranab Bardhan’s evocative labelling) can be overcome to achieve forward progress, and so on. All large federations or quasi-federations face similar challenges, including China, Russia and the United States. If I am correct, demonetisation was a poor-quality intervention in dealing with the ongoing challenges of federal governance, in contrast to the systematic, if long and difficult, effort of the Goods and Services Tax.
The second theme, of institutional quality in governance, is something I have written on in multiple previous columns (most recently, goo.gl/Yy7nwj). If India is to sustain rapid long-run growth, it needs better institutions of governance. How ministries are structured internally, the thinness of technical talent, the career incentives of civil servants, and the certainty and transparency of rules and procedures all need attention for improvement. The conceptualisation and implementation of demonetisation both illustrated the worst tendencies of Indian governance traditions, harking back to Indira Gandhi, and perhaps even the British Viceroys and Mughal emperors. I realise that the spin now is on how demonetisation has jump started digital payments, with a tripling of such transactions, but I have already argued that these gains will be ephemeral without planned, sustained investment in digital infrastructure and the human capital to support it.
Demonetisation has not been what I would call courageous, nor is it despotic, but it illustrates the weaknesses of India’s governance institutions, both in terms of federal structures and political competition, and in terms of quality of day-today governance and policymaking. Unless these weaknesses are addressed, the growth that India needs to step back from the brink of heightened internal social conflict will remain elusive.
The author is professor of economics, University of California, Santa Cruz