India is failing at creative destruction

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New Delhi | Published: June 27, 2018 4:46:01 AM

Supporting development of private sector initiatives in training and skilling ought to be an urgent focus of government policy, rather than trying to create an overall taxonomy of jobs and skills.

Cooperation between the Centre and the states will only go so far in such circumstances. In some areas, such as the financial sector, the Centre itself needs to do more.

In my last column (goo.gl/uCB3Q9), I began discussing what might lie ahead for India as it approaches the next general election. Major themes that are crucial for understanding the nation’s trajectory are the vertical relationships of governance in a federal system, and the boundaries between government and the private sector. On the first of these, India remains over-centralised. Local governments, in particular, still lack adequate funds and institutional capacity to provide the necessary public services to their constituents. For that matter, while the states have seen their budget constraints relaxed by the last Finance Commission, they, too, lack capacity in other dimensions: for example, their budgeting and accounting systems are typically inadequate for the scope of their responsibilities. Cooperation between the Centre and the states will only go so far in such circumstances. In some areas, such as the financial sector, the Centre itself needs to do more.

On the second theme, the boundary between the public and private sectors, there is surprisingly, still, much work to be done. In my last column, I mentioned the problems of the banking sector: these are the worst in public sector banks, and some judicious increase in private sector bank entry could help relax some financing constraints and improve efficiency. Of course, this has to be accompanied by effective regulation. Increasing household financial savings ought to be a major policy goal, but, the greatest payoffs may come from expanding non-bank channels of finance for firms. Here, too, the private sector has to play a leading role. The recent failure of the privatisation of Air India illustrates the difficulties the government faces in shrinking its participation in certain areas of the economy. Privatisation has continually lagged behind promises, and only the political leadership can make it work, by pushing on the bureaucrats who are charged with implementation.

Ultimately, poorly performing public sector enterprises are symptomatic of a deeper problem with the functioning of India’s economy. Entry and exit are stifled for private sector firms in India, though not to the same extent as in the public sector. The result is a failure of the “creative destruction” that Joseph Schumpeter argued is what drives growth. The issues here involve not just bankruptcy reform, but financial sector reform in general, as well as labour law reform. Again, successive governments in India have struggled to translate intentions into action.

One could argue that economies, such as Japan, succeeded without too much entry and exit, instead having business groups (similar to the Indian case) which innovated and built new product capabilities. They also fostered the development of their own supply chains of smaller firms, supporting these suppliers as well as squeezing them, as suited their needs. In the Indian context, these issues relate to an academic discussion some time ago, about whether India’s economic reforms have been “pro-business” or “pro-market.” Perhaps, the answer is “some of each,” with “pro-business” shading into the problem of crony capitalism. There is surprisingly little empirical research on questions of industrial dynamics and growth in the Indian context, but, my conjecture is that India’s economic growth would be higher with more competition and greater flexibility—the world is not what it was when Japan, or later, South Korea, began their economic ascent. One also has to acknowledge the importance of exporting and the competitive discipline it imposes, when thinking about these questions for India.

Thinking about labour law reform in the context of industrial dynamics can also be useful. The scarcity of “good” jobs in India—ones with relatively higher wages—has made job security paramount, especially at the lower end of the industrial skill spectrum. The government has yet to come up with creative and efficient ways of providing enough insurance for workers (more health insurance or even a universal basic income could help in this regard) so that there can be more flexibility in matching workers and firms. The other piece of this problem is skilling. India has failed to develop vocational training in a myriad of areas, and, as I claimed in my last column, government efforts are still inadequate. Supporting development of private sector initiatives in training ought to be an urgent focus of government policy, rather than trying to create an overall taxonomy of jobs and skills. Private sector firms should be working with other private sector firms to have their training needs met. The government can regulate by stamping out fraud, but, marketplace reputations can achieve much in ensuring quality.

All of this is not to say that the government should be absent. Even in the freewheeling capitalism of the United States, some of the best vocational education comes through community colleges, funded by state government taxes, and offering subsidised courses in a range of academic and vocational areas. And, private sector providers in the US can be deceptive and of poor quality. But, in many cases, India’s starting point is skewed toward an atrophied private sector.

The approach I am advocating here is in tune with goals of doing better in ways that show up in the World Bank’s “Ease of Doing Business” rankings, but, it focuses on specific growth constraints and how to overcome them. If financial capital and human capital are binding constraints for the kind of industrial dynamics that will support double digit growth, then policies should be squarely focused on how to remove those constraints as quickly and efficiently as possible.


The author is Professor of economics University of California, Santa Cruz

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