India’s new economic reforms and challenges ahead

November 24, 2020 6:31 AM

New economic reforms barely scratch the surface of what needs to be done to sustain growth that can lift millions out of poverty

After a record slide of 23.9% in the June quarter, the year-on-year contraction in real GDP narrowed to 7.5% in the second quarter of this fiscal.

By Nirvikar Singh

India is in a crisis, with the pandemic battering an already weak economy. The national government has struggled, both in terms of managing the pandemic and in trying to rescue the economy. The crisis and the urgency it has created has, however, led to the beginning of a new set of economic reforms. These reforms aim to address obstacles to growth that have persisted through the three decades since India shifted its basic stance towards economic policymaking.

In an earlier column, I commented on the reforms in agricultural markets and marketing, which have the potential to improve efficiency in agricultural markets, and perhaps even help farmers earn more as a result. As farmers’ responses suggest, these benefits are not guaranteed, and the government should consider additional reforms that focus on production, risk mitigation, and ensuring competition by buyers and intermediaries. Improvements in credit access for farmers would also help. An additional possibility is reform of the PDS, along with better incentives for farmers to shift into higher-value crops. This would reduce the damage to the environment that the current narrowly-designed PDS creates in states like Punjab, as a recent detailed analysis by Naresh Devineni, Shama Perveen and Upmanu Lall suggest.

The central government also passed a series of labour law reforms that are designed to streamline the regulation of labour. Like the agricultural reform bills, the urgency of action has led to a lack of prior debate and new laws don’t seem to be entirely well thought out. Many details are left out of the laws and left up to future executive actions. The reforms aim to continue to provide needed protections for labour while increasing flexibility for employers. Still, there are some valid concerns about adequate safety and health protections for labour under the new legal framework, and the dilution of collective bargaining power for labour. Another issue is the lack of employment protection, and here one has to be agnostic since the difficulty of firing industrial labour in India has been a major barrier to hiring.

Of course, flexibility in hiring and firing is not going to be sufficient to improve anaemic employment growth. In addition to other kinds of incentives for industrial growth, one hopes that the government will make a serious attempt to collaborate with industry and figure out how to improve the skills of India’s workforce, in both depth and breadth. One of the challenges is that so much employment is in smaller firms, which do not have the resources to provide training for workers. By contrast, India’s software firms had sufficient scale (and high enough profit margins) to train their workers who, even as graduates of engineering colleges, did not have the specific skills or quality of training needed.

Perhaps the most central example of the new set of economic reforms is the production-linked incentive (PLI) scheme for 10 sectors, ranging across a variety of products and technologies. The essential idea is to reward growth in sales, and this is certainly better than policies that encourage firms to stay small, as did the notorious Small Scale Reservation schemes of the past. The latest PLI policy follows on an earlier announcement for some electronics manufactures. Encouraging rapid growth with simple and direct monetary incentives seems especially attractive as the economy seeks to recover from the pandemic. But here, too, the government may need to fill out its policy package in a more careful manner.

Sustained growth in manufacturing will come from good physical infrastructure, efficient regulation, building a reputation, developing customer and supplier linkages, and so on. A more rational and trade-friendly tariff structure will also help. The best investment will be attracted by an environment that includes all of the above. As noted earlier, access to labour with the appropriate skills, or the existence of local organisations that can impart these skills, is also an important component of sustained manufacturing growth. The poor performance of India’s manufacturing sector is caused by multiple deficiencies in the preconditions for productive investment and growth.

The PLI schemes are useful to signal government support and to jumpstart the economy in sectors that are viewed as having potential for growth or that have strategic importance, but they will ultimately be a drop in the bucket compared to what is needed. And, on top of everything else, broad-based manufacturing growth will still require cleaning up and reforming the financial sector. In any domestic ecosystem of manufacturing, access to credit and capital will have to be smooth and efficient. India’s financial system has been prone to financial capital being allocated inefficiently, or even just stolen.

Companies such as Apple or Reliance may be able to rely solely on their own funds, but a successful economy will require a much better functioning financial sector than the one India has. Innovations based on digital technology provide some hope for improving the financing of India’s firms, but regulation will have to catch up quickly and make sure that this can happen without introducing new kinds of risk.

In the final analysis, the new set of economic reforms being introduced with urgency by India’s national government is barely scratching the surface of what needs to be done for the economy to sustain growth at rates that will once again start lifting millions out of poverty

(Author is Professor of Economics, University of California, Santa Cruz. Views are personal)

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