Designing India’s reform agenda

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March 24, 2021 5:15 AM

Land and labour reforms are important, so one can’t fault successive governments for trying to tackle these. But, the binding constraints on the growth of industry in India seem to lie elsewhere

The problem of Indian industry is that of small and medium firms—they face difficulties in getting launched, in surviving, and in growing.The problem of Indian industry is that of small and medium firms—they face difficulties in getting launched, in surviving, and in growing.

In some respects, India’s government is following a bolder reform agenda than ever before. On the input side, reforms in land and labour markets are making progress, in different ways. In terms of sectors of the economy, the government has pushed its Make in India agenda for industry, albeit supported by a somewhat backward-looking trade regime of higher tariffs. It has focused on the technological frontier with its Digital India initiative, and encouraged foreign direct investment, which can bring in knowhow as well as financial capital. It has normalised privatisation of public sector firms that have subpar performance. All this is good.

But, as I argued in my last column, the agricultural market reforms illustrate a weakness in the reform process at this stage, in terms of prioritisation, or sequencing, or bundling various reforms, or some combination of these three dimensions of policy design. In the case of agriculture, I have argued that fixing the national public food procurement system, which is wasteful and leading to environmental damage, should have been prioritised instead, and done in a way that would be more humane, and simultaneously more politically palatable.

And this should have been combined with tackling weaknesses in the overall agricultural production system, including a deterioration of agricultural extension, inadequate access to credit for many farmers, and lack of non-politicised safety nets such as crop insurance (as opposed to loan waivers and other ex post relief schemes).

More broadly, what agriculture needs most of all is employment generation outside agriculture. In other words, agricultural reforms should not be tackled in isolation. This brings us back, as it always does, to the failure of India’s manufacturing sector to take off, and to do so in a manner that generates large numbers of new jobs, rather than just being capital intensive. This is still India’s first-order economic policy challenge. Reforms in land and labour markets are important, so one cannot fault successive governments for trying to tackle these difficult issues. But one might argue that the binding constraints on the growth of industry in India are elsewhere.

Here, one must draw another lesson from the agricultural marketing reforms, and how they have been perceived. A major concern for many stakeholders has been that these reforms would lead to the extension of corporate power, especially of just one or two conglomerates, backed by fortunes that are impressive even by global standards. Purely in terms of economic theory and empirical analysis from other countries, we know that if an industry or sector is dominated by two or three large firms, the outcomes are skewed in favour of those large players, at the expense of other participants.

And this is aside from the political clout that giant companies may exert to amplify their power—this can be seen around the world, to varying degrees. When the success of corporate giants or conglomerates depends on competing globally, that can help, but when they control large domestic markets, the situation is least satisfactory.

The problem of Indian industry is that of small and medium firms—they face difficulties in getting launched, in surviving, and in growing. What is needed to change this situation is relaxing constraints in access to finance, and to certain kinds of skilled labour. Labour market reforms will not solve the latter problem. Large firms can take the best workers, and can afford to train them if needed.

But small firms cannot bear those expenses, or if they do, are at much greater risk of losing their investments when workers take better opportunities. India’s public education system is woefully inadequate for India’s workforce needs, and this ought to be a first-order reform priority.

Access to finance is also desperately constrained for small and medium firms. There are additional challenges here, since the danger of money being stolen or misallocated is high – India’s current problems are largely due to the poor quality of its institutions of financial intermediation. Interestingly, this failure has strengthened the power of larger firms, which squeeze their smaller suppliers. In a different context, it also skews the distribution of incomes associated with agricultural production.

Building a more effective and equitable system of financial intermediation for all kinds of productive activity (presumably with specialised players for different sectors), seems to be such an important and basic need for the economy. So one wonders why it is not receiving more attention, and is not progressing faster, especially since digital technology has enabled approaches that would have been impossible or prohibitively costly in the past. There is an interesting connection to the previous issue as well—many of those employed in the financial sector need to have their skills upgraded, but do not have the opportunity to do so.

The political barriers to providing employment-relevant skills to a much greater fraction of India’s population, and creating a strong system of financial intermediation, seem harder to identify than what we see with unions opposing labour market reforms, or farmers worried about losing their land. It seems unlikely that large corporates would be obstacles. Is it, therefore, a failure to analyse what the economy needs to grow rapidly? To do a proper cost-benefit analysis? To understand what it takes to run a business, and what the greatest obstacles are to do that successfully? India’s reform agenda should be designed to answer questions like these.

Professor of Economics University of California, Santa Cruz

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