"Finding the Will to Govern the Economy", 'The Hindu', August 25, 2012.

The Will to Govern the Economy

By Pulapre Balakrishnan


In less than half a decade the mood of India’s economic policy establishment has swung from hubris to dismay. The trumpeted arrival of double-digit growth did not materialize. Instead we face the prospect of sustained double-digit inflation. The polisariat, it appears, has run out of tricks. Any argument for greater global integration as the solution is unlikely to instill confidence at a time when the world economy is in the doldrums. Equally, the exhortation for “more reforms” is not likely to inspire the many when reforming is what the government has claimed to be doing for two decades by now. To be precise, reforms geared at greater integration with the rest of the world has been the lodestar of the reformer. Actually, the idea that mere integration with the rest of the world would per se raise the rate of growth of the economy never had much purchase with serious economists. While the argument that exporting is extremely important for India as it is highly dependent on imports is well taken, exports do not get promoted by merely lowering tariffs or signaling to multinationals that you’re ready for business.

                So does this mean that we should be reconciled to lower growth and higher inflation? Most certainly not. We have in India recently been witness to something akin to a secular epiphany in the collapse of the electricity grid serving over half the country. No more appropriate example is needed to show us what stands between us and prosperity. In a most immediate sense it is human negligence abetted by unaccountability. However, in a more general sense we might say that the event reveals that more than anything else it is the infrastructure deficit that is keeping us down. If lived experience of navigating the infrastructure in this country is not enough to convince that infrastructure is what it boils down to, we may turn east for confirmation. For over two decades China has dazzled the world with not just double-digit growth but trade surpluses that have been reproduced year after year. The foundation of this achievement is revealed by the quip “China’s competitive advantage lies in its infrastructure”. What has been left unsaid is that the competitive advantage enjoyed by its producers does not lie in low wages or the repression of unions by the communist party, though these are features of its political economy. After all, both North Korea and Zimbabwe are not exactly flourishing democracies. And if low wages could tilt the balance, India would be among the world’s great trading nations.

                What is significant to an understanding of the relationship between growth, the degree of openness to trade and economic policy is that our current account deficit today is greater than what it was in 1991. While there is no comparison between 2012 and 1991, principally because our reserves are over 250 times greater today, the yawning deficit shows that mere trade, or even industrial, policy reforms are insufficient to generate a rise in export growth. Also, a worsening balance of payments has its own negative consequences such as inflationary pressure via a depreciating exchange rate. Clearly the reforms that have aimed to integrate India with the rest of the world have not succeeded in making India’s exports more competitive. It is germane to the argument here that by now trade, measured as exports plus imports as a share of GDP, amount to more than half of GDP, a feature that the government’s Economic Survey of 2012 alludes to approvingly. This share is far greater than what it was in 1991, when the integration of India with the rest of the world was proferred as a panacea. And now, quite apart from the balance of payments, the growth rate itself has settled into levels not much greater than what was achieved in the late 80s. So why are we in this predicament? Why has growth slipped, and what do we need to do put it back up there again? For a start, the trade and industrial policy changes initiated in 1991 and classified as “reforms” barely measure up to a vision of the growth process. To the extent that quantification is meaningful in the context, they have addressed the problems of about a fifth of India’s economy. The vast, though not insurmountable challenge, of addressing the rest of it remains.

                The flaw in the strategy pursued by governments of differing hues since 1991 is that it has missed the woods for the trees. They have focused on what they consider the economy while ignoring the vital importance to sustained growth of the ecosystem of production. Originally conceived of in the quest to understand plant life, the idea of an ecosystem is fruitfully applied to an understanding of the economy. For the plant biologist it is the ecosystem that is the relevant unit for analysis even when s/he is interested in the development of the plants placed within it. In nature more generally the dynamics are determined through repeated interaction between the biotic and the abiotic components of the eco-system. Being the living and non-living components, respectively, they matter for one another. Plants need water and soil, and water and soil are held together by the vegetation. The parallels with the economy are not far to seek, the two components being the production units, whether farm or firm, and the terrain of production. This terrain is defined by the range of services so crucial for the economic unit to carry on production in an efficient manner. We may refer to them as producer services and they include both visible and invisible ones. A short list must contain power, transportation, roads, water and sanitation, waste management and management information systems. An unmistakable feature of the world economy is that globally these services are mostly provided by government. This is hardly so for ideological reasons. It springs from the reality that the private sector is either unwilling to bear the risk of investing large amounts in an uncertain activity or patient enough to accept too long a breakeven period. Along with the production units the arrangement for the provision of these producer services complete the ecosystem of production. The reliable existence of these services is at least as important for the economic progress of a country as smart entrepreneurs. It is easy to see that even the smartest entrepreneur will flounder if not supported by producer services. For the government to take the view that it has liberated the entrepreneur once it has set him loose from the Licence-Permit Raj is to duck its principal responsibility, which is to enable an entire eco-system. While it’s is not at all necessary to take a dogmatic view that the private sector ought to be kept out of the provision of these producer services it is certainly the case that right now in India this is largely the government’s responsibility. We can see this by evaluating the success of the much vaunted ‘PPP’ route to the creation of infrastructure. You would find that not very much has been created.   

                I have focused on the visible producer services, but the invisible ones are likely to be just as important. One that is egregious by it absence in India is advisory. The world over governments have taken it upon themselves to provide advice to entrepreneurs. An intuitive approach to the role of advice is to take cognizance of extension services in agriculture. Extension is the means whereby knowledge of advances in biology and demonstrated best practices in cultivation are taken from the laboratories and research stations to the farm. They have been fundamental to agricultural transformation worldwide and even in India during the Green Revolution. In India the rate of growth of public expenditure on extension has declined since 1991. Outside agriculture, small firms desperately require advice on emerging opportunities, marketing channels and sourcing of material. Private consulting firms do exist but are unaffordable to the small and medium enterprise sector which dominates India’s economy. This is why the world over local governments have departments for industrial promotion that supply these valuable services. Something of this sort was implicit in the plan of the Janata Government to set up the District Industries Centres, but it is not clear if they have been governed to perform.

                The call for “more reforms” is mystifying when it is not obfuscatory. It is not clear how pending legislation in the insurance, pension or retail-trade sector can address the deficit in producer services faced by India’s entrepreneurs.  Of course, some part of the solution to the electricity deficit does require reform, but this is not of the macroeconomic variety. However, this would have to be governance reform, involving the setting of targets, assigning of responsibility and the consequent seeking of accountability from public servants. The electricity segment is only an example; the entire public sector mandated to provide producer services is begging for this kind of attention. The relevance of improved governance for growth is revealed by the near perfect correlation between transmission and distribution losses and growth of the state domestic product that has been shown to exist by economists. So when India’s premier agencies such as the ministry of finance and its central bank state that there is little policy space they must refer to a very limited genre of policy, namely, the macroeconomic. Surely there is space yet for better governance. From the vantage point of producer services, improved governance is India’s golden goose. The question is whether the political class has what it takes to govern this space.