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Sunday, 6 April 2014

The Case for Free Markets in India: Part 1. Introduction

The Case for Free Markets in India

Part 1. Introduction

Written by Dr. Seshadri Kumar, 06 April, 2014

Copyright © Dr. Seshadri Kumar.  All Rights Reserved.

For other articles by Dr. Seshadri Kumar, please visit http://www.leftbrainwave.com

Disclaimer: All the opinions expressed in this article are the opinions of Dr. Seshadri Kumar alone and should not be construed to mean the opinions of any other person or organization, unless explicitly stated otherwise in the article.

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Abstract

Socialism, India’s current economic system, has failed India in its 67 years of independent existence.  India must rapidly move towards free-market systems in every aspect of its economy to avoid sliding into a disastrous abyss.  I present the evidence for these assertions in the form of a 12-part series.

In this first part, that sets the stage, I discuss the economic choices followed by India since independence, and what they imply for the direction in which the economy is being shepherded in.  In subsequent parts I will discuss the real impact of this direction on different sectors of the economy and explain why this direction is injurious to the long-term prosperity of India.

Executive Summary

India is currently reeling from some of the worst economic shocks in recent years, and people are desperate for things to improve.  Things have not yet hit rock bottom, but there is every danger of that happening unless rapid course correction is made.  The economic policies of the last 67 years, and particularly of the last five years, have taken a huge toll on the country and its productive energies.

The 2014 Indian general elections are about to begin, and a new government will most likely take over after May 16th, when counting ends for the world’s largest democratic exercise.  The politicians who will govern India after May 2014 have some tough economic choices to make.

Do they want to go back to the socialism that kept India from growing for 50 years and still prevent it from reaching its true potential, or do they want to go with market-based, industry-friendly policy that can take India to double-digit growth and great prosperity?  People, and particularly leaders, need to understand that those are key issues facing India today. 

To change course, they must be convinced that the policies of the past are a mistake.  It is my hope that this document will help them see that and decide on better courses of action than have been taken in the past.

To realize this, Indians need to understand what their economic choices are.  Rather than present a theoretical exercise on whether market economics or socialism is better for India, I propose to deal with the results.  We have the results from 67 years of a socialist economy, and we can readily determine how that has worked out for us by looking at the results.  With a view to understanding the impact of socialism on the Indian economy, I analyze ten key sectors:

1.       Roads and Highways
2.      Hospitals
3.      Power Generation and Electric Supply
4.      Water Supply
5.      Telecommunications
6.      Railways
7.      Public Transport
8.     Defence
9.      Agriculture and Food Sufficiency
10.  Education

Each of these sectors is analyzed in detail, and the consequences of government mismanagement of these areas are shown, and suggestions are given as to how the state of affairs can be remedied.

The conclusion from analyzing these metrics is that India needs to move rapidly towards a system in which the government is either absent or is minimally present in each of these areas.

The analysis presented here is apolitical; the focus is on the economic systems that India must adopt.  Political parties are mentioned only in the context of their support for certain policies.  A certain criticism of the incumbent Congress Party is inevitable, as they have held power for most of India’s independent history since 1947, and therefore must necessarily shoulder most of the blame for the shortcomings of the economic models they have followed.

Introduction

India celebrated its 67’s birthday on August 15, 2013, with some rather sobering reminders: the Indian rupee was at its lowest-ever level with respect to the dollar; current foreign exchange reserves were only 6-7 months worth; foreign investment in India was fast drying up; corruption was all-pervasive after the last few years in which no sector has been spared, from mining to telecommunications to sports; Goldman Sachs had recently downgraded Indian stocks to underweight, joining Fitch and Standard and Poor in doing the same; foreign companies viewed the Indian government as arbitrary and unreliable after the Vodafone saga, where the government tried to change/interpret the law retroactively in order to make Vodafone liable for taxes payable to the Indian government in the Hutchinson Essar-Vodafone telecommunications deal; the country’s GDP growth rate had slipped from near 9% a few years ago to below 5%; India’s current account deficit was at a very high level, of nearly 5% of GDP; inflation was seemingly out of control, with onions selling at nearly Rs. 80 a kilogram; Indian industrial magnates had stopped new projects in India and were moving abroad for business expansion; and many high-profile industrial projects had been stopped dead in their tracks owing to problems in land acquisition and protests from villagers.

The government seemed rather stunned by the state of affairs, and was trying to fight fires by emergency measures.  Recognizing that such a low level of foreign exchange reserves is dangerous, the government tried to bar imports of gold (India is the largest importer of gold in the world) and tried to control spending of foreign exchange by individuals and corporates, a move that could backfire as it could further decelerate economic growth for Indian companies by denying them growth opportunities overseas after souring the economic climate within India.

The people of India, both lay and economist alike, were and are highly concerned with this state of affairs.  The government’s knee-jerk responses, such as restricting gold imports, or denying foreign exchange to individuals and corporates, not only will not solve the immediate problem (an indication of this is the fact that in spite of the government limiting the imports on gold, Indian people are buying even more gold, leading to a steep hike in the price of gold), but they miss the root of the problem, which is the economic system itself.  The fact is that India is still strongly wedded to an inefficient, leaky, and corrupt socialist system and, unless this is significantly dismantled and replaced by a true free-market system, prosperity will always remain an elusive dream for Indians.

Some of the woes I have listed above might be short-term, and the reader can be forgiven for thinking that I, too, am responding in a knee-jerk manner to macroeconomic fluctuations by condemning the entire economic system.  However, that is not my intention.  Therefore, condemn the current economic system of India I surely will, but not based on the woes that are currently afflicting the nation.  I view these woes as only symptomatic of a larger malaise affecting the nation.  To prove my hypothesis, I propose to look at the integrated effect of pursuing socialist policies for the last 67 years and show how those policies have ruined India and prevented it from rising to the ascendancy it richly qualifies for, when one considers the immense human capital present in this country.

The Socialist Economic Vision of the Congress Party

The ruling Congress party has strong socialist ties.  It was during the rule of the Congress party under Mrs. Indira Gandhi that the Indian Constitution was amended to describe India as a “socialist, secular republic.”  It was under Congress rule that India adopted what was popularly known as the “license Raj,” a term that connotes strong state control of all aspects of the economy.  The term “license Raj” arose from the fact that to conduct any economic activity, a large number of licenses and permits had to be obtained from a range of government offices and ministries; and even then, one could only produce what was allowed, where it was allowed, and how much was allowed by the government.  All this changed overnight when, at the point of a gun (metaphorically speaking), India was forced to liberalize its economy in 1992 under the prime ministership of PV Narasimha Rao of the Congress party.  However, the last 10 years of Congress rule have been marked by a strong move to return control of the economy to the state.

The alliance of the present Congress government and its allies, known as the United Progressive Alliance (UPA) that is governing the country today, is headed by Mrs. Sonia Gandhi.  Her son, Mr. Rahul Gandhi, is currently the second-most important person in the party and is the vice-president of the party.  It is instructive to understand the economic philosophy of the party by analyzing one of the rare instances that Mr. Gandhi spoke to a conference of business leaders, the Confederation of Indian Industry (CII), in April 2013.

I am reproducing below some extracts from this very important speech – a speech that gives clear insight into the thinking of Mr. Gandhi and the UPA (italics mine):

“What we have to do, what the government has to do, is: we have to improve the playing field and create an impartial, professional and rules-based governance system.  I’ve spoken to you about what we need to do to nurture this movement of people. I would also like to tell you about, what I feel, threatens this movement of people. What is it that we should worry about? What are the things that can go wrong? Lack of infrastructure is clearly one. Lack of knowledge infrastructure is another one. But for me the biggest danger is excluding of people. Excluding the poor, excluding the middle-class, excluding the tribals, the dalits and I’m going to tell you why.”

“Whenever we have not embraced the excluded – the poor, women, the minorities, the dalits, the tribals, we have fallen backwards.”

“What is the basic infrastructure? The basic infrastructure, as designed by the UPA, is the rights-based paradigm. Give everybody the basic minimum on a number of key ideas. Give them the basic minimum on the job front. Give them the basic minimum on the education front. Give them the basic minimum on information - which is what Nandan is doing. That is what we are trying to do with a rights-based approach.”

 “But the work our women do, the work millions of Indian women undertake every day, not poor ones, not rich ones, every single one of them. The work they do right now as we sitting here in this nice, AC hall: they are building not only our boats, they are the waves. And I for one will not speak of growth without speaking of them. Our economic vision must be about more than money. It must be about compassion. We must envision a future for India that leaves no man and no woman outside in the shadows.”

“Embracing the excluded is essential to the wealth of the nation. If we do not embrace them, we will all suffer. It’s very simple. In a democracy, the poor have a veto. And we have to carry the poor and the weak with us.”

Understanding the UPA’s Rights-Based Paradigm

What do all these words mean?  Let’s look at this carefully, understand the speech, and distil out its essence.  I have deliberately italicized important sentences in the extract above – let us focus on what those mean.

Rahul Gandhi (and the UPA he heads) believes in a rights-based paradigm.  The UPA does not want to leave anyone behind.  They understand that there are problems in the country – deficits, if you will – in infrastructure, education, nutrition, etc.  And how do they propose to solve these problems?  By using a “rights-based” approach.  What is this rights-based approach he is talking about?

Well, it is already in evidence in India.  Mr. Gandhi is talking about policies that the UPA has already implemented in UPA I & II and is continuing to implement. 

1.       One specific example is the Mahatma Gandhi National Rural Employment Guarantee Act (MNREGA), which is a “Right to Employment,” guaranteeing people in rural areas a right to an income, whether or not something productive is achieved with that income.  The point of the MNREGA (in practice) is not so much that useful work is done as it is to give a free handout to rural people in an attempt to directly alleviate poverty.  Given that poverty leads to immeasurable suffering, the aim is certainly noble.

2.      Another example of the “rights-based” approach is the Right to Education – the idea that every school should provide quality education to every child in the nation, so that no child is left behind.  Again, a noble idea and, in theory, what this should guarantee is a well-educated and literate population, which is highly desirable.

3.      A third example is the national mid-day meal scheme, which provides free, nutritious meals to children as an incentive for parents to send their children to school.  Again, a very good idea in principle.  The midday meal, ideally, saves money for the parents, compensates for the child not being used as a bread-winner, and provides a fundamental right – education – to children.

4.      Another, more recent example is the Food Security Bill, which is designed to provide free food to hundreds of millions (about 67% of the population) so that their basic nutritional needs can be met.  This seems like a highly desirable aim, considering that much of the country does not get proper nutrition.

Other rights-based schemes one could envision in a UPA-III would be

1.       The right to housing – after all, food, clothing, and shelter are defined as the necessities of life – in which each person of the republic is guaranteed free housing or housing at highly subsidized rates.  This would again be a noble endeavour – for who would want to see our fellow citizens suffer without a roof over their heads, whether in the monsoons, in the heat of Indian summers, or in the cold of North Indian winters?  (Note: when I wrote the draft of this article, this was just a hypothetical scheme I thought of by extrapolating the existing welfare schemes in operation.  However, I was surprised in February 2014 to see that the Congress party indeed has plans to implement exactly such as scheme if it comes to power again, which it calls the Right to Homestead Bill.)

2.      The right to free medical care.  Again, it is heart-breaking to see poor people suffer because they cannot afford medical care.  A government-funded program that would provide free medical care to all people below a certain income would guarantee that no one would suffer.  Of course, this is already present in large measure due to the existence of government hospitals, in which healthcare is practically free, but government hospitals are still too few and there are not enough of them for every Indian.  A tenfold expansion would be well-advised if no one is to be left behind.  (Note: Again, in the time that it has taken me to polish and finish this article, the Congress has, as in the case of the Homestead bill, promised to, in fact, enact a free healthcare bill if elected to power in 2014.)

3.      The right to free mobile telephony.  One can argue that in the modern age, being without a mobile telephone puts people at a serious disadvantage.  People may not be able to hail emergency services when a calamity occurs, or when a pregnancy is due, when a crime is committed, or when a serious health crisis such as a heart attack happens.  The resulting delay could mean the difference between life and death.  Providing everyone below a certain income (the richer people can, of course, afford to buy theirs with their own money) with a basic, no-frills mobile telephone will level the playing field for all Indians.

4.      The right to free computers and internet connections.  In this knowledge economy, not having a computer is being seriously crippled.  If someone has a school-going child at home and the child does not have a computer with an internet connection, he or she will be definitely backward compared to children from affluent families who have computers and internet connections.  The resulting disadvantage will put him or her in a backward state for his or her entire life and prevent him or her from ever raising his or her status in life. 
To a large extent, this is not a hypothetical scheme I am proposing – the government has already gone down this path with the development of the Akash tablet PC, which is to be distributed at very low prices to poor kids.  What would be a good idea to complement the distribution of Akash tablets would be free BSNL connections to all poor families so that their children could take advantage of the information superhighway.

One can go on and on, but I think you get the general idea of the rights-based paradigm.

What Could be Wrong with The UPA’s Vision?

On the surface of it, it is hard to come up with an objection to any one of these schemes.  After all, they speak to basic issues that we would all agree affect all of us.  None of us, except the most hard-hearted, would wish for someone to die because they had chest pains and did not have a mobile phone to call the ambulance; or want a pregnant mother to not get immediate medical care when she needed it; or see a brilliant child who might be the next Ramanujam end up washing dishes because he did not have access to a computer or textbooks; or want children to miss school because they couldn’t afford to feed themselves.
So why would I object to any of these ideas?

THEY DON’T WORK. 

And TODAY’S INDIA, 67 years after independence, is THE EVIDENCE.

The policies that the UPA is pursuing and is talking of continuing to pursue have been followed in India earlier.  In fact, ever since independence, India has followed these kinds of policies.  And their kind has a name.  It is called socialism. 

Our first prime minister, Jawaharlal Nehru, was enamoured of what he saw in the former Soviet Union before independence, and decided that he would commit India to similar policies as the USSR had implemented, so that India could also be a superpower like the USSR.  And thus began the cycle of five-year plans, a standard feature of socialist, planned economies.

Socialism did not work for India in the 45 years from 1947-1992.  In 1992, facing a balance of payments crisis, and under pressure from the IMF and World Bank, Prime Minister PV Narasimha Rao directed Finance Minister Manmohan Singh to liberalize the Indian economy.  Liberalization of the economy meant that the vise-like grip of the state on all aspects of the economy had to be loosened and the private sector was encouraged to play a larger role in the economy.  This led to a boom in the private sector in India. 

Figure 1 shows how the Gross Fixed Capital Formation (GFCF), a measure of new investment in the economy in the form of fixed assets, has varied over the years (measured as a percentage of GDP).  The graph shows two curves: one showing how much the total GFCF was as a percentage of GDP; and another showing how much the contribution of the private sector was.  This was obtained from World Bank data.  Clearly, both have risen over the years, which is to be expected as the economy has been growing.  There is a disturbing decrease in GFCF, both public and private, since 2007, that is a sign of a troubled economy.  More specifically, it is a sign of stagnation in an economy that still has a lot of room to develop.

Figure 1. Variation in Gross Fixed Capital Formation Over the Years

What is more illuminating is to see what percentage of the total GFCF is contributed by private investment, and Figure 2 shows this percentage. From a value of 60% in 1992, at the start of liberalization, this rose to nearly 76% by 2004.  Since then there has been no rise in the relative role of private investment.  For instance, in the 5 years of 1999-2004, the relative percentage of new fixed capital investment contributed by the private sector rose from 71.4% to 75.9%.  What this means is that 75.9% of all new fixed capital investment that happened in 2004 was contributed by the private sector, as opposed to only 60% in 1992.  This rise in the role of the private sector has led to remarkable increases in the standard of living of the ordinary Indian.  In the 8 years from 2004-2012, the private sector's percentage in the GFCF has actually dropped from 75.9% to 74.9%. 

Figure 2. Percentage of Private Gross Fixed Capital Formation Over the Years

It is important to understand that even though the GFCF tells us that 75% of all NEW fixed capital investment comes from the private sector, the 45 years of 1947-92 have left us with a huge base of government investment in industry.  India’s economy is still heavily dominated by the government.  To really significantly lower the role of government in the economy, two things need to be done: aggressive disinvestment of government assets, such as coal mines, ports, steel plants, oil refineries, and the like; and increasing the percentage of private GFCF much beyond even the current value of 75%.  However, for the past 10 years this has been stagnant, as can be seen in Figure 2.

The present UPA government (2004-2014) appears to have had a serious rethink on the role of the private industry.  Several of the initiatives discussed earlier seem to be targeted to increase the role of the state in the economy rather than decrease it.  For instance, the Food Security Bill that was passed in 2013 stipulates that 67% of all grain production will be purchased by the government at fixed prices, thus almost eliminating the role of the market.  Essentially, the focus appears to be to reverse the trend of privatization that was the hallmark of the economic policies of governments from 1992 to 2004, by now greatly enhancing the role of the government. 

How salutary is this proposed change to the Indian economy?  That is the question this series of articles attempts to answer.  To know the answer to this question, all we need to do is look at the present, and see what the net effect of big government in the economy from 1947 to the present has been on India’s economy.

To do this, I present, in a sequence of articles, detailed analyses for 10 different sectors that are vital to the health of the country and its prosperity, and show how socialism has adversely affected the state of each of these aspects of India’s economy:

1.       Roads and Highways
2.      Hospitals
3.      Power Generation and Electric Supply
4.      Water Supply
5.      Telecommunications
6.      Railways
7.      Public Transport
8.     Defence
9.      Agriculture and Food Sufficiency
10.  Education

And, finally, I sum up the ideas discussed in this series in a concluding article.

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