Indian economic policy has not allowed firms to be created and to grow and prosper at the levels required for adequate job creation.
Inclusive and sustained economic development requires creating good jobs. Creating good jobs requires having more firms in operation, and these firms being more productive. Having more firms and more productive firms requires increases or improvements in physical capital, embodied human capital, disembodied knowledge, and physical and institutional infrastructure. It sounds simple. Some economies have implemented this chain with astonishing success over the past few decades. What is holding India back? How is the development mantra to be translated into actions in the Indian context?
Even relatively high growth in India has not generated enough good jobs.
Indian economic policy has not allowed firms to be created and to grow and prosper at the levels required for adequate job creation. Policy deficiencies include restrictive labour laws, but also inefficiencies in access by firms to financing, land, electricity, transport, and so on. Furthermore, firms have been restricted in shutting down (related to those restrictive labour laws), which inhibits new entry as well. Indian policy has also made it difficult to provide high quality education at all levels, from preschool to graduate school. The constraints here have included high costs and poor incentives for education delivery by existing institutions, as well as restrictions on entry or on operations by new providers. So the growth of human capital has been unnecessarily stunted. Similar issues exist in the provision of other inputs that matter for firms to be productive.
Stepping back from these specifics, what is the institutional failure, or mechanism failure? After all, a democracy is supposed to be responsive to the wishes of its citizens, and India’s citizens clearly have an enormous unmet demand for economic growth and good jobs. India has been improving the functioning of some markets, but not enough, and not always the ones that matter the most. What is holding things back is the quality of the institutions that govern the market. In the introduction to their 2017 edited volume, Rethinking Public Institutions in India, Devesh Kapur, Pratap Bhanu Mehta and Milan Vaishnav contended that “improving the capacity of India’s public institutions is the single biggest challenge that India faces in the twenty-first century.” In this context, capacity includes quality and quantity of personnel, quality and clarity of laws and regulations and their enforcement, ability to manage horizontal and vertical coordination dilemmas, and external and internal accountability.
Indeed, weaknesses along these dimensions in public institutions often permit similar weaknesses to persist in private sector organisations, so that the link between the productivity of firms and their growth or survival is weak or broken.
Democracy, in the form of elections, does not guarantee that public institutions will be reformed. Douglas North, John Wallis and Barry Weingast describe a common situation for developing countries such as India as a limited access order (LAO), which ‘manages the problem of violence by forming a dominant coalition that limits access to valuable resources—land, labour and capital—or access to and control of valuable activities—such as trade, worship and education—to elite groups.’ India’s failures in ‘state capacity,’ or more specifically, in increasing the quality and availability of the inputs needed for productive activity, can be thought of as the typical situation of a limited access order. In such cases, it is a struggle to alter the social equilibrium.
Decentralisation and transparency can help the process of change, by enhancing competition among the components of the ruling coalition, but India’s decentralisation has remained very limited. Devices such as Coastal Economic Zones can allow for a very special kind of decentralisation that does not threaten the ruling elite, and these can make them politically more feasible than true decentralisation of governance. This reasoning was the obvious driver in the case of authoritarian China, but the logic also applies to democratic India, where participants in government focus on creating and capturing economic rents for themselves.
A few years ago, Pallavi Roy provided a perceptive analysis of the experience of Maharashtra and West Bengal as examples of evolving LAOs. The Maharashtra case was particularly interesting, because it described how control of growing and refining sugar by the political elite in that state allowed them to provide space for industrialists to invest and prosper, at least relatively to the rest of the country.
West Bengal, on the other hand, saw a different type of LAO, based on control of agriculture and stifling of industry. It would be interesting to think about states such as Gujarat, Tamil Nadu and Andhra Pradesh (pre-split) in terms of their LAO structures and trajectories. Punjab and Haryana provide a very obvious comparison pair as well. The goal of such a conceptual and empirical exercise is to step back from chronicling the deficits of the inputs that firms need, and the deficits of public institutional capacity, to understand why these situations persist, and what might be amenable to destabilisation and positive change. One can think about the massive problems of India’s banking sector, the persistence of inefficient state enterprises, and the way in which political and electoral coalitions are formed in terms of the compulsions of a LAO. And maybe that can lead to a strategy for true “reform” that is more than just “liberalisation.”
Professor of Economics University of California, Santa Cruz. Views are personal