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India’s Post-Liberalisation Blues 


Published with the kind permission of the author



In this paper I want to reflect on three major themes arising from recentIndian experience after its partial adoption of the classical liberal economicpackage in 1991. The first concerns new forms of rent seeking,which are to be found not only in India but also in China and Russiaafter they moved, however imperfectly, from the Plan to the Market. Thesecond concerns the rising tide of populism – reminiscent of the pastand current policies of many Latin American countries – and the dangersthis poses for sustainable growth in India. Finally, linking the two is thegeneral theme of the growth and dénouement of ‘entitlement economies’ –the social democratic ideal – in the fiscal and debt crises now envelopingEurope and the United States. These correspond to the following threesections of the paper. 

Post-liberalisation rent seeking 

There is a new form of rent seeking that has arisen in India, China andRussia, after their various degrees of movement from the Plan to theMarket. These economic liberalisations would have been expected tohave shown a decline in rent seeking. The daily revelation recently of variousscams suggests that rent seeking is alive and well in India. In fact oneof the puzzles about its economic liberalisation was how it could occur in a country that, for nearly four decades, had created an equilibrium state ofrent-seeking interests that had mired the economy in the dismal ‘Hindu’rate of growth. Many observers saw little hope of a seemingly dysfunctionalIndian democracy being able to deliver economic liberalisation. Inan important book, Rob Jenkins (1999) showed how the political players,particularly at the Centre, used both a rearrangement of the previousspoils system, and the various conflicts of interest within the numerousrent-seekers, to both institute and consolidate economic reforms. In termsof my predatory state model (Lal 2005, Ch. 13.2), the improved productivityof the economy resulting from economic liberalisation provided largerrents to the predators. They got an unchanged share of a larger pie. It isthese new forms of rent seeking that are the source of all these scams.But this raises its own puzzle: whereas the earlier pre-1991 form of rentseeking had led to growth rates wellbelow potential, the new forms ofrent seeking have been accompaniedby phenomenal growth rates.What explains these differences inoutcome, and is this new corruption likely to damage growth like the old?

To answer this question it is useful to outline the sources of economic‘rent’. Armen Alchian provides a succinct discussion in The New PalgraveDictionary of Economics. Economic ‘rent’ is the payment for any resource‘the supply of which is indestructible (maintainable for ever at no cost)and non-augmentable, and hence invariant to its price. In the jargon ofeconomics, the quantity of present and future supply is completely inelasticwith respect to price, a situation graphically represented by a verticalsupply line in the usual ‘Marshallian price-quantity graphs’. Land, distinguishedby its location, provides one such resource. As at all prices thesupply is constant, a tax on land rents does not affect any marginal decisionby economic agents, and hence does not affect economic efficiency. It isa lump sum tax. 

If in the future the aggregate supply of such indestructible resourcescan be increased in response to a higher price, even though the short-termsupply is inelastic, there would be ‘quasi rents’ accruing to the resource.An important form of ‘quasi rents’ are what Marshall called ‘compositequasi-rent’. ‘When two separately owned resources are so specific to eachother that the joint rent exceeds the sum of what each would receive if not used together, then that joint rent to the pair was called “composite quasirent”.’This is important when the ‘resources that have been made specificto each other in the sense that the service value of each depends on theother’s presence, the joint value of composite quasi-rent might becomethe object of attempted expropriation by one of the parties, especially bythe one owning the resource with controllable flow of high alternative usevalue’. Various institutional and contractual arrangements can be devisedfor the distribution of these ‘composite quasi-rents’. As with pure economicrent, given the short-term run inelasticity in the supply curve of atleast the specific resource that does not have ‘a controllable flow of highalternative use-value’, the ‘taxing’ of this specific resource will not affectthe efficiency of the economy. The arrangement for the division of the‘composite quasi-rents’ will represent a purely distributive outcome.

We can now see why the recent scams have not affected the productivityof the economy. Most of the scams involving pure ‘economic rent’, asin the allocation of housing perpetrated by the armed forces in the Adarshscandal, have no efficiency consequences. Though there may be sociallosses from the expenditures undertaken by ‘rent seekers’ to acquire theserents through political or administrative means.

Similarly, the scams involving the allocation of the 2G spectrum, thevarious mining-related scams, and those involving infrastructure projectslike roads, all relate to the distribution of ‘composite quasi rents’. Thesewill again affect the distribution of income but have no effect on the productiveefficiency of the economy, again with the proviso of the considerationof the social losses involved with the expenditure on ‘rent seeking’.

There is a third category of rents: ‘monopoly rent’. These are createdby artificial restrictions on other potential competitors in order to favoursome economic agents. The Indian licence-permit raj (during the ‘planning’era), with its import quotas, industrial licensing, price controls, etc.,created these ‘monopoly rents’. As the government interventions creatingthese rents affect the marginal decisions of consumers and producers, theylead to substantial efficiency losses, in addition to any of the deadweightlosses associated with the ‘rent seeking’. They are equivalent to the levyingof distortionary taxes cum subsidies, unlike the lump sum taxation associated with various forms of rent seeking to obtain pure ‘economic’ or‘composite quasi’ rents.

Economic liberalisation in former highly controlled economies likeIndia (but also China and Russia) reduces or eliminates these monopolyrents. With the boost given to economy-wide productivity by the liberalisation,the value of ‘economic’ and ‘composite quasi’ rents will rise. Thisallows the polity to substitute an even more highly valued source of rentsto compensate the losers from the abolition of monopoly rents, but withoutany damage to the productive efficiency of the economy. This explainsthe paradox that post-liberalisation rent seeking has been accompanied byhigh growth rates in these predatory states, and an increase in the rentsgarnered, while the pre-liberalisation rent seeking had led to growth rateswell below their potential.

There is, however, one continuing major source of ‘monopoly rents’.These are the colonial labour laws creating ‘monopoly rents’ for the smallaristocracy of organised labour. By limiting entry and exit, and artificiallyraising the price of India’s most abundant resource, they have damagedlabour intensive industrialisation in India. This situation will be madeworse by the minimum wage and other purported labour rights beingimplemented in the unorganised sector. Much worse, the proposal tointroduce minimum wages in the Rural Employment Guarantee Schemewill remove the main reason for the efficiency of this poverty-redressingpolicy: self-targeting. Though the immorality of rent seeking associatedwith pure ‘economic’ and ‘composite quasi’ rents may be reprehensible,it is less damaging to growth than the continuing ‘monopoly rents’ generatedin the labour market.

The wages of populism 

One of the surprises in the comparative study of 21 developing countriesin The Political Economy of Poverty, Equity and Growth, which I co-directedwith Hla Myint for the World Bank (Lal & Myint 1996), was that two ofour largest countries – Brazil and Mexico – which had had nearly threedecades of spectacular growth, suffered prolonged ‘growth collapses’ inthe 1980s. Thus, from 1950–1980, Brazil’s GDP grew at 6.8% and Mexico’s at 6.4% p.a., as compared with Korea’s at 7.4% p.a. This was followed by‘growth collapses’, with Brazil’s GDP growth rate falling to 2.4%, Mexico’sto 1.0%, and per capita growth rates declining to –0.1% in Brazil and –1.2%in Mexico between 1980 and 1987 (see Maddison & Associates 1992). Thelessons they provide for India’s current political economy, as a corrective tothe hubris flowing from recent Indian growth performance, is the subjectof this section.

In both the Brazilian and Mexican cases, the proximate cause of thegrowth collapse was severe macroeconomic imbalances leading to hyperinflationand debt crises. But, the deeper causes were numerous microeconomicdistortions and unsustainable fiscal expenditures on politicallydetermined income streams.

We begin with Mexico. It had followed a policy of relatively balanceddevelopment with macroeconomic prudence until about 1970. Thischanged with the 1968 suppression of the protest movement before theOlympic Games. Luis Echeverria assumed the Presidency in 1970, andannounced his new policy of ‘shared development’ – reminiscent ofIndira Gandhi’s ‘garibi hatao’ (‘remove poverty’) slogan of the 1970s andthe current Congress Party-led United Progressive Alliance’s slogan ofdevelopment for the ‘aam admi’ (‘common man’) – in contrast with the‘stabilising development’ economic policy since 1958. Echieverra thoughtthat, even though poverty had declined as a result of the rise of per capitaincomes in the 1960s, the stubborn inequalities in income distributioncould be tackled by increasing public expenditure and expanding thepublic sector. This led in the short term to mounting inflationary pressures,a rising current account deficit, an overvalued exchange rate andincreased foreign borrowing. The hitherto conservative Bank of Mexico‘became a printing press to finance rising budget deficits and public sectorenterprises’ (Maddison & Associates 1992, p. 133). Echieverra’s aim toimprove income distribution was belied as ‘the 1977 family expenditureand income survey showed no noticeable improvement over conditionsexisting in 1973, in 1963, and as far back as 1950’ (Maddison & Associates1992, p. 135). The discovery of large oil deposits in 1972–73 provided atemporary bailout. But Echieverra’s successor, Lopez Portillo, took theoil price rise of 1978 as a permanent rise in Mexican income and began afurther expansion of Echiverra’s populist economic policies. A mild boomresulted, fuelled in part by foreign borrowing based on the new-found oil reserves. When oil prices collapsed with Volcker’s tightening of USmonetary policy, the unsustainability of the Echieverra–Lopez Portillopopulist policies of dessarrollo compartido were exposed, as the macroeconomicimbalances they had created led to the debt crisis of 1982, and theMexican ‘growth collapse’.

There are eerie similarities with India’s current economic policies.Believing that, because of its ‘demographic dividend’, India is now ona permanent 9% growth path, a vast network of fiscal entitlements havebeen enacted, and are planned from the burgeoning tax revenues that areassumed to automatically accrue. If these assumptions are belied becauseof terms of trade shocks related to the currently projected trends in worldfood and oil prices, India might – like Mexico – find that these politicallydetermined entitlements become unsustainable. Moreover, as Surjit Bhallahas documented, the ‘leakage’ from these entitlement schemes remains asgreat as Rajiv Gandhi’s 1980s estimate: that only 15% of the expenditurereaches the poor. Much faith is put in the IT giant INFOSYS’s former bossNilkani’s government-sponsored electronic ID cards, for accessing entitlements.But this may be premature, given the ‘arms race’ that is likely todevelop with the counterfeiters. Nor do I believe – despite the rhetoric– that there is a demand for ‘equality of outcomes’ as opposed to ‘equalityof opportunity’ in the Indian polity. As discussed in my UnintendedConsequences (Lal 1998), there is aprofound difference in the cosmologicalbeliefs of the Semitic egalitarianreligions and the hierarchical‘religions’ of Asia. It is this profoundcultural misunderstanding ofthe Nehruvian wing of Macaulay’schildren3that accounts for their current endorsement of the populist policiesthat could lead, as in Mexico, to a growth collapse.

The lessons from Brazil, and its growth collapse, for India are somewhatdifferent. In a 1970s study of effective protection in Brazilian industry, JoelBergsman was puzzled that Brazil could produce highly capital-intensiveprivate jets competitively (at ‘world prices’) when labour-intensive industrieslike textiles required heavy protection to be sustained domesticallyagainst imports. The Lal–Myint comparative study, by distinguishingbetween the different development paths of countries with abundantlabour and scarce land (including natural resources), and those that wereland abundant but labour scarce, argued that, as the wage levels in thelatter would necessarily be higher compared to their labour-abundantcousins, their comparative advantage would necessarily lie in the capitalintensiveend of the manufacturing sector. As capital was also scarce inthese land-abundant developing countries, with growing labour forcesthey would, over time, be forced on to a lower wage path, if capital did notgrow as fast as population. To prevent this politically disastrous outcome,and to validate the high-wage capital-intensive development path, theyneeded to see the capital stock growing faster than the population. Asdomestic savings were insufficient, they sought to garner forced savingsthrough inflation, supplemented by foreign borrowing to continue thehigh wage development path. These countries are thus likely to indulgein ‘big pushes’ of investment based on foreign borrowing and inflation.

Brazil has periodically followed this route. An innovative package,which included widespread wage indexation and relatively conservativemacroeconomic policies, was initiated by Roberto Campos as planningminister, and Octavio Gouveia de Bulhos as finance minister in CasteloBranco’s 1967 administration. The ‘big push’ initiated by Delfin Netto in1979, after the second oil shock, sabotaged this strategy. The terms of tradeshock was accommodated by changing the indexation formula to currentrather than forecast inflation and higher adjustments for lower-paid workers.The resulting macroeconomic imbalances led to the Brazilian growthcollapse of the 1980s.

India’s similarity with Brazil is not in its factor endowments. Rather,because of labour laws going back to the Raj, India has created an artificialindustrial sector reminiscent of Brazil. India too has high-tech, capitalintensiveindustries, which can be internationally competitive given theartificially inflated wages in the organised sector. Meanwhile the labourintensiveunorganised sector languishes, as it cannot grow to a sufficient scale (as in China) if it is to avoid these labour laws. This is going to makea mockery of India’s projected ‘demographic dividend’ as the millions ofill-educated youth flood the unorganised sector. Meanwhile palliativeslike wage indexation, which are now being introduced for the ‘poor’, could– as in Brazil – lead to serious macroeconomic imbalances, making themunsustainable in the face of likely future terms of trade shocks.

For all these reasons, India today needs urgently to rescind its colonialeralabour laws and reappraise its populist economic path. For the wagesof populism as in Mexico or Brazil are likely to turn its much hyped ‘economicmiracle’ into a ‘growth collapse’.

The entitlement economies 

When I went up to Oxford in October 1960, I took a slow boat fromBombay on which were a number of young Australians, also going toBritish universities. One memory stands out. It was the amazement of theyoung Australians at the ‘cradle to grave’ welfare state that they had readBritain had set up, with bipartisan support.

As the dust settles on the first year of the new Con–Lib UK government,the dénouement of this major trend in the subsequent history ofBritain is now apparent. The expansion of the welfare state, and itscomplications, particularly during the last 13 years of Labour rule, hasled to the creation of a broken society with a large underclass: work-shy,feckless, sometimes criminal and entirely dependent on public handouts.Successive governments trying to massage the unemployment figures colludedwith work-shy ‘able-bodied’ claimants, putting them on incapacitybenefits. These 2.6 million, costing about 12.6 billion pounds a year ‘onthe sick’, are either a sad indictment of the state of the nation’s healthunder its self-proclaimed national treasure, the NHS, or else the currentsystem of subsidising unemployment, while creating disincentives for thisunderclass to work, is to blame.

There are now 250,000 households where no one has ever worked.There are nearly 100,000 households receiving benefits that are morethan the average wage. Someone on benefits who decides to work facesa marginal tax rate of 90%. They prefer to remain unemployed on benefits,while joining the black economy if they want to work. It is thefiscal crisis accompanying the vast expansion of a dysfunctional welfare state that is leading the coalition to consider, and hopefully undertake, itsradical overhaul – something even the Iron Lady shied away from. Thisdénouement (and the even more drastic one facing the Club Med countriesof the Eurozone) should give the social democrats in the Indian coalitiongovernment, seeking to establish a European-style welfare state, cause topause.

This reflects the well-documented dynamics of the creation of anentitlement society and its effects (see Lal 1993; Lal & Myint 1996). Aswith medical experiments, these dynamics are best seen in microcosm inthe small, natural resource-rich open economies of the Third World, likeJamaica, Sri Lanka, Tanzania or Peru. Reliant on commodity exports fortheir prosperity, they are subject to the volatility of their terms of tradelinked to the cycles in world commodity prices. The export sectors alsoprovide the main source of public revenues, which also then fluctuate withworld commodity prices. During the boom, with public coffers flush, ‘rentseekers’ flock to obtain politically determined entitlements. Governmentskeen to expand their clientele find it expedient to succumb. With theturn in the commodity cycle, expenditures inflexible because of the entitlementsgranted in the boom, and revenues falling, there is an actual orincipient fiscal crisis.

This is met, in successive cycles, by ratcheting up export taxes.Eventually this rising tax burden on the productive sector leads to a permanentfall in output and revenues, and a full-blown fiscal crisis. This issought to be met by borrowing (usually from abroad). When its limits arereached, as lenders react to the fall in output by taking fright, the monetaryspigots are turned on to raise the inflation tax. As the inflation taxrises, the populace escapes it, by limiting holdings of domestic money, andthe revenues from the inflation tax actually start declining. The governmentis then faced with a fiscal-cum-debt-cum-foreign exchange-cuminflationarycrisis.

Often in this downward spiral, the government finds its revenues insufficientto even pay its functionaries providing public goods, like the police,defence and utilities. It seems to be faced with the un-Marxian ‘witheringaway of the state’. It is only when they are staring at such an abyssthat governments undertake the rescinding of the politically determinedentitlements to income streams, which are the ultimate cause of the multifacetedcrisis they face.

The origins of the recent global financial crisis in the US, as in the1980s Latin American debt crisis, lay in unsustainable entitlements – inthe US case in housing, health and social security (see Lal 2010a, 2010b;Reinhart & Rogoff 2009; Rajan 2010). The US is still a long way fromthe final dénouement of these entitlement crises. But as the current travailsof California show, it is not unimaginable, and the current debt crises inGreece, Ireland and Portugal, and the incipient ones in the UK and otherEuropean welfare states, show that, once the primrose path of the entitlementeconomy is trodden, it is politically very difficult to get off until closeto the abyss.

What, then, of the emerging Asian powers that, in the future, couldconceivably challenge the US? China under Mao had, in keeping with itsCommunist ideology, sought to create the ultimate entitlement economy.The recognition of its economic failure with Deng Tsiao Ping’s economicliberalisation programme in the late 1980s, also led to smashing of the ‘ironrice bowl’, and the creation of the freest labour market in the world. Beingonce bitten, twice shy, the Chinese remain reluctant to create a new entitlementeconomy, despite the advice from many welfare state proponentsfrom the West, who want China to raise domestic consumption by expandingentitlements. Instead, the Chinese are rightly following the classicalliberal advice of raising the demand for labour in productive enterprises,which, by raising labour incomes (unlike entitlements), ensures sustainablealleviation of poverty. Its future prospects, however, are clouded byits increasing adherence to the state-led capitalist model since Tiananmenlabelled ‘the Beijing Consensus’ (see Huang 2008, 2011).

India, by contrast, which seemed to have turned its back on Nehruviandirigisme, with the liberalisation following the economic crisis that itspast dirigisme had caused, appears to have begun to seriously tread theprimrose path of the entitlement economy. After the 2004 elections, theeconomic reformers responsible for the 1991 liberalisation, who once againcame to power, were forced to trim their sails by their Communist coalitionpartners, particularly in rescinding the colonial labour laws that stillhamper the labour-intensive industrialisation that India needs to alleviate  its ancient poverty. With the Congress Party’s victory in the 2009 electionand the decimation of its previous Communist allies, it seemed thatthe government could now speak with a unified voice and undertake theso-called second generation economic reforms. Instead, the reformers areagain being hamstrung. The dirigiste Opposition is now present withinthe Congress, particularly in the wholly constitutionally unaccountableNational Advisory Council set up by the latest Nehru–Gandhi dynast,Sonia Gandhi, who is the President of the Congress Party but not thePrime Minister. A vast expansion of the entitlement economy and the‘quotacracy’5 has begun, under the aegis of a leader who in effect wieldspower without responsibility. Though – as in the small, boom-time,resource-rich open economies – these may seem to be easily financed bythe rapid growth the initial economic liberalisation of 1991 has engendered,the damage they can do to India’s productive potential, oncethis primrose path is trodden, makes me wonder about India’s ability toachieve the high potential growth rates and the concomitant great powerstatus it craves. It might find, like Argentina in the early part of the 20thcentury, that its seemingly unstoppable economic rise, to rival the US orChina, turns to ashes.