Understanding political economy for India’s future growth

By: | Published: January 26, 2019 12:18 AM

Decentralisation needs to extend to India’s cities, which also need better governance, and which will be the focal points for future economic growth.

But the delivery on those promises may not have been enough to persuade voters to give as strong a mandate this time around.

Economists and political scientists have developed reasonably good understandings of how politics and economics interact in abstract, and in the case of specific countries. A basic principle of the different explanations is that societal groups and the institutions within which they function create trade-offs between competition for a nation’s current output (especially the surplus, or “economic rents”) and efforts to expand that output, that is economic growth. That growth creates more economic rents down the road, but economic and political institutions may not allow that to be done in the best way possible.

In particular, I would argue (1) India is too economically centralised for a successful growth acceleration, and (2) institutional capacity, both in terms of public finances and the human capital to manage them, needs to be strengthened at the level of the states, which can be better at serving their constituents in many dimensions than can a distant national government. A subtler argument that also fits in the trade-off framework is the tendency for economic policy thinking to be tilted towards public sector action rather than strengthening the private sector, which will ultimately deliver the growth and jobs that India’s citizens need. In my previous columns, I described this tilt in terms of a lack of sufficient attention to “industrial dynamics”.

This goes well beyond just trying to score better on the World Bank’s Ease of Doing Business, though performing better there is certainly an indicator of movement in the right direction. There is also the complication that the private sector can be part of the problem, when capitalists focus on capturing economic rents (or even theft), with the connivance of politicians.

Of course, India is not doing too badly at present, and one should recognise that good performance. Its neighbour, Pakistan, for example, is an example of much more suboptimal economic performance, which can be traced to the economic rent-capture and rent-protection of narrow elites that dominate societal institutions. This needs to be kept in mind as the spectacle of campaigning for India’s national elections unfolds. The country’s heterogeneity and diversity make the quest for ruling at the Centre a complicated one, involving multiple regional political groupings, shifting alliances, and large sums of money, much of it from uncertain sources.

It seems to me that the state of play right now is complicated. Five years ago, the challengers could point to disappointing economic performance, some evidence of paralysis in policymaking, and instances of corruption in a ruling coalition that seemed to have run out of steam in its second term. Promises of better governance and better economic performance won the day, leading to the first single party majority in many years. But the delivery on those promises may not have been enough to persuade voters to give as strong a mandate this time around.

One way to understand events in India is in terms of an imbalance between political and economic decentralisation. The structure of Parliament, in which the composition of the Rajya Sabha reflects political control at the level of the states, and the states are large, heterogeneous and, sometimes, distant from the Centre, means that any party or coalition of parties has to work hard to secure a national majority. This was apparent throughout the tenure of the current government, when much attention was paid to multiple, asynchronous state assembly elections, distorting national policies and taking away attention from national governance. This was not the only problem, of course: non-economic factors, such as an aggressive ideology of cultural nationalism have also been at odds with the kind of good governance that would promote the best possible economic outcomes. This ideology also conflicts with the reality of a diverse nation, and sometimes with realistic visions of progress (instead of fantasies about the past).

Economic decentralisation will not alleviate the political difficulty of stitching together a coherent national coalition for governance, nor change the direct political influence of the states through the Rajya Sabha. But it will improve economic performance, if done correctly, with capacity building and greater autonomy over funds. Ideally, this decentralisation needs to extend to India’s cities, which also need better governance, and which will be the focal points for future economic growth. This is an arena in which cooperative federalism between the Centre and states can truly matter, beyond being a nice sounding phrase.

In past five years, we have seen some economic policy decisions at the Centre that continued a quarter century of reforms to improve the functioning of government in various spheres, such as taxation, the bankruptcy code, and rules on foreign direct investment. In other areas, there is still much to be done. And in the case of India’s central bank and its money, there have been some retrograde steps. In the short term, we will see some attempts to stimulate the economy and make voters feel better about the ruling party. That is to be expected, and is not too harmful. The real questions are whether economic strategy for the long-term can survive damaging political compulsions, what institutional changes can be made that reduce the chances of such damage, and which politicians—if any—understand the need to make those changes.

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