Route to Reform: Excerpts from Raghuram Rajan’s book The Third Pillar

Updated: March 03, 2019 6:58 AM

In these excerpts from his latest book, The Third Pillar, former RBI governor Raghuram Rajan talks of how India needs a more independent private sector, how the state can do more for its people by trying to do less, and how India is better positioned than China for growth.

This also means that when the party in power needs election financing, it only has to ask.

The State, Markets, and Democracy in India

India is therefore different from many of the developed countries we have seen earlier in that it was a democracy before it industrialised, before it had a strong state, and before it had an independent private sector or healthy markets. While democracy was apathetic initially, political decentralisation has revived political engagement, and has helped strengthen democratic institutions. It is hard to think of any system that would work in India other than democracy.

Given the multiplicity of languages (twenty-two major ones and over seven hundred dialects), religions (India has fewer Muslims than only Indonesia and Pakistan), castes, and ethnicities, India needs a system that allows grievances to be expressed through democratic protest and dialogue, rather than one that bottles them up so that they explode later. India’s raucous democracy alleviates pressures, and allows the country to be governed.
India’s problems stem from the other two pillars.

First, unlike the United States, where a still-independent private sector criticises government policy, including on social and political issues that are not directly related to their business, the Indian private sector—the market pillar—largely applauds all government policy.

A determined government, despite being ineffective in most areas that benefit the public, can still cow the private sector and the press with threats, or bribe them with credit or government contracts. Even decades after liberalisation began, there is still a sense among the public that the largest magnates have got where they are because of their ability to manipulate the system. The leaders of the party in power know the private sector’s poor reputation well. Since there is usually some past sin buried in a magnate’s past, as in China, which can be investigated and publicised if the magnate is uncooperative, very few are willing to speak out against the government of the day, let alone take steps to oppose it. This also means that when the party in power needs election financing, it only has to ask.

As a result, the opposition parties at the center find it harder to be heard, especially if the ruling party has a strong majority since both private-sector financing and press attention tend to dwindle after an election for fear of upsetting the government in power. This means the government’s deficiencies and authoritarian tendencies are primarily checked only by the judiciary, by democratic institutions like the Election Commission, and by governments at the state level run by opposition parties.

An interesting event brought home to me the lowly status of the private sector in government eyes in India. President Obama was visiting Delhi, and the entire Indian elite was invited to meet him at a reception in the Indian president’s house. True to form, the bureaucrats running the reception had identified everyone’s precise place in the political hierarchy, and lined them up to shake President Obama’s hand. It was a long line, starting with the Indian prime minister, the former prime minister, cabinet ministers, the leader of the opposition, military chiefs . . . retired dignitaries from the ruling party, ministers from various states . . . the Indian president’s grandson, serving bureaucrats . . . and at number eighty- three, the chairman of India’s largest private- sector group, accounting for over $100 billion in market value, followed by other tycoons and bankers. Admittedly, public service should be rewarded with higher status, to compensate for its lack of monetary rewards, but is not number eighty-three in the hierarchy for India’s top businessman alarmingly low? This is not to say that power and dependence flows only one way. Ironically, after they retire, many of the bureaucrats who preceded the tycoons in the line will be working for them.

This has to change. Elections are not enough, it is what happens between elections also that make for a vibrant democracy. If India is to bury the spectre of authoritarianism and cronyism, if Indian democracy is to be better informed and a stronger check on the state and corruption, India needs a more competitive, and thereby independent, private sector with higher public status. It needs many more small and medium enterprises to grow and flourish, providing competition to the established business houses.

That brings me to the deficiencies in the state. The state, while retaining the power to be arbitrary on occasion, is still not very effective; it tries to do too much with too few resources. Fortunately, the Indian state is also trying to reform itself. It is trying to bring professional expertise in laterally, and it is trying to use information technology to streamline delivery of its services and its monetary transfers to the public. These are important steps, but India has some way to go, especially in withdrawing from activities the state has no business being in.
Perhaps an anecdote will make the point: When I worked for a while at the Indian Finance Ministry as the chief economic adviser, I was shocked by the heavy paper files that came across my desk—shocked first that we still used paper files in the twenty-first century, and second at the amount of back papers I had to read to understand the note tagged on to the front of each file that required my comments and signature. Once I commented and signed, of course, my comments would become required reading for the next recipient of the file.

As I complained about this to a veteran bureaucrat, he gave me a simple solution backed by impeccable logic and experience: ‘Spend the least time on the thickest files. They are issues going nowhere, which circulate back and forth across desks, with everyone wasting each other’s time by adding yet more comments. That is why they are so thick. Devote all your time to the thin files. Those are fresh issues where a cogent opinion may actually make things happen.’

He was right but there is a broader message here. India needs to drop the thick files, and focus more on the thin files. The state can do more by trying to do less.

Why India Has Not Done as Well as China

China and India used to be sleeping Asian giants, but China awoke first. They used to be equally poor, but now China has raced ahead. China’s initial advantages of a healthier and better educated workforce were perhaps more important in the early flush of liberalisation, and its lack of a competitive market or private property rights were not disadvantages—indeed, they allowed the state to push favoured industries.

Construction is probably the most important sector in the early phases of industrialisation. It is a sector that employs unskilled workers—and hence can absorb many that leave agriculture. It is also a sector that contributes to the growth of other sectors, as businesses spring up to make use of the infrastructure. For example, it is quite magical in India to see the economic growth of a village as a good all-weather road is built connecting it to the city. The road allows trucks to transport goods to the city quickly, so farmers undertake new activities like dairy and poultry farming and horticulture. As they get richer, shops selling packaged goods and clothes open up in the village. Soon a kiosk starts selling prepaid cell phone cards, and not too long afterward, the village gets its first bank branch. Construction thus multiplies jobs and facilitates development.

Perhaps the most obvious consequence of their starting conditions is that China has been able to expand its construction sector enormously, while India has been less successful. China has moved ahead because it has been able to fund construction projects with cheap credit, and land acquisition has not been problematic because all land belongs to the state. In India, by contrast, credit comes at market rates. More important, any new project requires a painful and long acquisition of the necessary land from owners. If land rights are not well established, it can take even longer. The time delay involved itself undermines the economics of the project. While the law permits forcible land acquisition for public projects like roads and airports, opposition politicians, sensing the political opportunity, are always willing to organize protests against these. India’s well-developed civil society, with each organisation fighting for a special cause, often joins in.

If the Indian state were effective, then these elements would provide an appropriate check on its power—indeed, Indian land acquisition laws are models of trying to balance the rights of the owner against the imperatives of development. The state, however, is ineffective, so land acquisition, and hence construction, is unduly delayed. India’s infrastructure projects are, for the most part, too little and too late. In the early stage of growth, China has had an advantage.

India needs to speed up land acquisition. It would be tempting but shortsighted to lighten protections for the land owner. That would only bring the politician in to agitate against acquisitions that are deemed arbitrary in the court of public opinion. Instead, India needs to make the land owner a partner in development by giving them back a share of the developed land, as some Indian states are doing successfully. It could also focus some of its limited state capacity on establishing clean property rights in land, thereby easing ownership and sale, while giving up other activities it does less well, such as running an airline or bank. If it does this, India has plenty of easy catch-up growth still ahead of it, building roads, ports, railways, airports, and housing. Moreover, if it continues improving the education of its youth—and the quality of their learning needs to be the focus going forward—it will have the low-cost labour and the infrastructure to establish a larger presence in manufacturing, to add to its capabilities in services. Given the right reforms, India can still grow strongly for a long while. And with its vibrant democracy, it is probably better positioned than China for growth once it closes in on the frontier. It needs to get there first, though.

Pages 272-276
Excerpted with permission
from HarperCollins

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