Finance minister Arun Jaitley just spent a week in the US, and half this time was in Silicon Valley and its environs. Perhaps this is indicative of the importance of innovation, even over money (New York) and political power (Washington DC), the other two loci of the minister’s visit. Even before the visit, his forthcoming interaction with the luminaries of The Indus Entrepreneurs (TiE) garnered attention, with those innovators of Indian origin lauding the progress and mindset of the current Indian government, but also raising continued concerns about bureaucratic unpredictability, ambiguous tax policy and generally high costs of doing business in India.
Knowing this in advance, even before meeting with TiE, the finance minister addressed these concerns in a lecture at Stanford University which I attended, on “India’s Economic Future”. Exuding reassurance and erudition, in just over half-an-hour, the minister spoke about reducing regional inequalities, improving implementation of infrastructure projects, dealing with political obstacles, reducing and rationalising subsidies, increasing financial access, smoothing land acquisition, and other specific reform areas, as raising transparency and reducing bureaucratic discretion—in tax policy, but also contracts, natural resource allocation, and other areas—the main concern of the entrepreneurs. Of course, many of these improvements started under earlier governments, but others have involved policy or attitude reversals under the new leadership. The minister expressed what sometimes gets forgotten: India has a greater consensus and momentum for economic reform and progress than ever before.
All this is to the good. But the challenge India faces may be greater than its leaders realise, or at least admit publicly. The anaemic global growth environment and the urgency of dealing with the country’s demographic bulge among those reaching working age represent a situation that may require a much faster pace of change. The finance minister spoke of moving from expectations of 6-8% growth, to the higher range of 8-10%, but India may need growth even greater than bare double digits to avoid social problems. Early in his remarks, the minister noted how some of the so-called BIMARU states have shown the capacity to shake off that appellation, and described the Centre’s own plans of channelling funds from auctioning off rights to mineral resources into resource-rich states with large tribal populations that have been left behind in the growth process. It is well known that these states have also been the locus of insurgency and social unrest. The possibility, of course, is that insufficient growth will lead to similar unrest, not in regions and among people outside the mainstream economy, but in the heart of India’s cities and towns.
Underlying the issue of sufficiently high growth is also the problem of employment creation. India’s past growth acceleration was associated with a low employment elasticity—the growth rate of output was not matched by the growth rate of employment. Part of the problem is certainly the country’s labour laws, but the problem is made much worse by the lack of human capital—a large portion of India’s potential workforce lacks appropriate education, training or skills. There is no substitute for good education. Indeed, research suggests that the success of Indian immigrants to America is largely driven by their relatively high levels of education—much greater than any other group in the country.
Another issue that also deserves urgent attention is financial sector reform. The minister mentioned bankruptcy law reform, and streamlining of arbitration law and methods of resolving disputes over public contracts. He also outlined a massive plan for recapitalising public sector banks. Perhaps most encouraging was an emphasis on restructuring the management of these banks, separating the CEO and chairman positions, and opening up executive positions to outsiders. Indeed, if all of the public sector in India could be made more professional and less subject to political influence, the gains would be substantial. My sense, however, is that business finance in India needs more sweeping, fundamental reform. Small and medium businesses in India not only have problems raising or borrowing funds for investment, but they suffer daily from being squeezed in their short-term capital management by the policies of large firms, which habitually delay, and sometimes default on, payments to smaller suppliers. A secondary market for short-term finance, as RBI has proposed, will help, but there also needs to be a change in a culture and legal framework which protects large, politically influential firms from respecting contracts with smaller upstream firms.
The case of financial sector reform illustrates an ongoing challenge of India’s economic reform process. In some ways, the finance minister’s scope in his talk was too broad. If he could have articulated a comprehensive set of rapid financial sector reforms that would spur commercial investment at all levels and thereby accelerate new business creation, that might have created more conviction about a bright economic future for India than a talk that touched on everything from tribals to toilets. At every level of India’s governance, there are too few specialists to create and implement detailed institutional reforms. Fixing that shortage is also a matter of urgency.
The author is professor of economics, University of California, Santa Cruz