India's Economic Reforms: Dismantling the Machine for Going Backwards

Jagdish Bhagwati
India at fifty remains an enigma. Its huge incoherences invite the witticism that, in India, anything and its opposite are true, m consonance with the ancient metaphysics of India: what is, is not. V S Naipaul's conversion from an exasperated critic in An Area of Darkness (1964) to an admiring celebrant in India: A Million Mutinies Now (1990) is thus to be seen, not merely as a personal journey from the shock of first recognition to the fuller understanding that time brings, but also as his confrontation with the diversity that India maddeningly presents. India's politics and economics underline these contrasts, showing India to be both a success and a failure. The politics, for all its shortcomings, has been an extraordinary success. Now that democracy has spread so widely, it is all too easy to forget that, almost uniquely among the newly liberated nations that entered the second half of this century, India managed to remain democratic, despite its multitude of religions and languages and the tragic and inflammatory legacy of the turbulent Partition. The misguided descent into Emergency Rule by Prime Minister Indira Gandhi and its resounding rejection soon thereafter at the polls left Indians even more wedded to the institutions that define the democratic process. The politics of democracy is rarely as neat as that of authoritarian regimes. But the noise of democracy that bothers the rulers further east is wrongly mistaken for chaos. Instead, it has been the safety valve of articulated dissent that has held the country together. But if India's democratic success has made her the unique example for the theorists of democracy today to understand, her economics has been a dis appointment. To put it plainly, it has been a dis aster. More than a generation has been lost to policies that produced low growth rates, leaving the economy in a state of technological backwardness, low per-capita income, high, illiteracy, and massive poverty. India had been marked out in the 1950s as the developing country most likely to succeed economically, with its uncommon assets in entrepreneurship (that, at its apex, boasted the Tatas, who gave India its first steel plant at Jamshedpur a commercial success
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This paper by Jagdish Bhagwati presents a critical appraisal of India's economic strategy over the last five decades. According to Bhagwati, while India's democratic success has been outstanding, her economics has been a big disappointment leaving the economy in a state of economic backwardness. By 80s/ India's economic failure became a classic case study to lean what not to do. Recent reforms, which signal the final discrediting of the failed ideas/ have started dismantling the past policies that crippled India's performance. However/ Bhagwati feels that the prospects for a complete transition still remain problematic partly on account of the politics of coalitions at the centre and partly because the dissent from the supporters of India's earlier policies may create confusion and delays. Jagdish Bhagwati is Arthur Lehman Professor of Economics at Columbia University, USA.
Reproduced with permission from the Times Literary Supplement, August 8, 1997.

without the subventions that would corrupt the economy after independence), political leadership (whose pride was Jawarharlal Nehru) and bureaucracy (with its legendary Indian Civil Service). By the 1980s, however, India's failure had made it the classic case to study to lean what not to do. The success stories turned out to be small nations in the Far East, characterized by sustained two-digit growth rates (compared with India's average around 3.5 per cent over three decades), high levels of literacy that grew in turn with the economy, rising wages, and pheno-menally low levels of poverty.

of new technology, even as the stagnant export earnings, a result of India's import-substitution strategy, blocked the absorption of new technologies embodied in imported capital equipment. While India, like the Soviet Union, could produce concentrated attacks on specific technological tasks of immense intricacy, such as picking up nodules from the ocean floor and going into space, the overall state of her technology in economic activity remained abysmal, again like the Soviet Union's. The licensing system also rapidly degenerated into a "permit Raj," which, by creating a complex web of bureaucratic permissions and sanctions, killed off the possibility of entrepreneurial efficiency and innovation, and produced irresistible incentives for the corruption that would become a new but endemic feature of the political scene. Public enterprises also began to make losses, and their deleterious effects went deeper. These enterprises became so dominant, as indeed was planned, that their inefficiency spilled over into other industries; and their losses made them a drain on the budget, adding fuel to the deficit that would grow in the 1980s to the point where it led to the balance-of-payments crisis that threatened bankruptcy in early 1991 and led India finally to begin the reforms. What led India down this r oad? Some of the ideas came, as many have remarked, from the politics of Harold Laski at the London School of Economics, and from the economics of Joan Robinson et al. at Cambridge. But it must also be said that, if the seeds were planted in England, there was substantial, home-grown culpability on the part of India's economists. Faced by the mounting evidence of the bankruptcy of India's policies, the economists generally dug in their heels, often exercising their theoretical talents to rationalize what was nonsensical. It has been well said that any elementary mistake in economics can be turned into a profound truth by ingeniously making the right assumptions to deduce what you want; and thus India suffered the tyranny of anticipated consequences from the wrong premises. Thus, when the losses made by public enterprises became obvious, the economist Amartya Sen, then at the Delhi School of Economics, wrote saying how economic theory showed that losses could be socially profitable. Indeed, that is true. But the problem was that social profit had little to do with why the losses were being made. Capital-intensive white elephants in the public sector were supported on the basis of models that deduced that this choice of techniques would yield a higher savings rate and hence higher

Discarding the Failed Ideas

If we celebrate India's economy today, the cause is not India's achievements; for there are too few. Rather, it is India's recent reforms, demanded unsuccessfully by some of us over a quarter of a century ago, that have begun to undo the policies that crippled her performance. India has regressed to the early 1950s, when her promise, not her performance, earned plaudits; the difference is that where India then was in the lead, now it is catching up. At the moment, we do not know whether the reforms will succeed, or whether India will lapse into its old, sluggish pattern of reforms begun but stalled. If this question is to be answered plausibly, then we must understand why India failed in the first place. The most dramatic source of change, much as in Tony Blair's Labour Party, has been the final discrediting of the failed ideas. India's economic strategy rested on four principal errors: that the external environment for increased exports was bleak, this "export pessimism" justifying an inward-looking import-substitution strategy; that, even if greater exploitation of the global economy were possible, it was a peril, not an opportunity; that massive state intervention was necessary, using an extensive licensing system, to guide and monitor production, trade and investment decisions throughout the economy; and that. while nationalizations were to be generally avoided, investments in public enterprises should steadily expand in successive five-year plans, eventually yielding a dominant state ownership of the means of production in a Fabian crawl. Each of these premises turned out to be wrong-headed and fatal to India's economic health. As the East Asia experience would prove beyond doubt, export pessimism was a badly mistaken view. The fear of the world economy, moreover, leading to a hostile view of inward foreign investment, reduced it in the end to a trickle, blocking off this route to absorption
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growth: a conclusion that would now sound laughable, had its consequences not been so tragic. When export pessimism was being successfully challenged in the 1960s by perceptive economists such as Manmohan Singh, who would usher in the reforms in 1991, creating the possibility that India could have escaped its self-imposed strait-jacket of bad policies a lot sooner, the development economists in India were busy building variants of models prescribing "optimal" choice of industries and techniques on the assumption that the economy was closed or had an insuperable export constraint. Economists drawing attention to the absurdities of the licensing system, and its costs, were dismissed by invoking the non sequitur that since markets were not perfect, they did not matter, and claiming that a reduced role for industrial policy was therefore reactionary rubbish. This is now well understood. The reforms have dismantled much, but by no means all, of this remarkable machine for producing backwardness. Industrial and trade controls are greatly diminished, foreign investment is being wooed and even attracted, the growth rate has picked up. Privatization remains on the shelf, though many areas, reserved earlier for the public sector, have been opened up to private entry and competition, even from foreign investors.

Minister, Palaniappan Chidambaram, an impassioned reformer in the earlier government of P V Narasimha Rao, has been reduced to offering popular tax cuts as a way of demonstrating his commitment to reforms, when, in fact, taxes had already been substantially reduced earlier and new reductions are likely to exacerbate the budget deficits that pose a danger to the economy's macroeconomic stability, and hence to the entire reform process. Among economists, the old supporters of India's mistaken policies have been largely reduced to prudent silence on the reforms. But their dissent now takes the form of indirection: the obsession with the economic reforms is to be deplored, the economists Jean Dreze and Amartya Sen have recently written, because it "crowds out the time that is left to discuss the abysmal situation of basic education and elementary health care...(and) other issues that have a crucial bearing on the well-being and freedom of the population." The implied notion that reforms are only tangential to the provision of social opportunity to India's masses is a strange throwback to the obscurantism that shielded the inefficient policies from the brunt of early criticisms. Growth, which reforms would enhance, is not a passive "trickle-down" strategy; rather, it is a radical "pullup" strategy for removing India's poverty. There is enough evidence now that it works; India's problem has been that there has not been enough growth. Then again, the financing of schools and health programmes requires money which only an expanding economy and revenues can provide. In seeking to undercut the reforms, in the name of poverty and social opportunity, these economists can be justly charged with defeating the very social purposes that they espouse.

Prospects for Complete Transition

The enthusiasm for reforms, even impatience with their slow course, is often manifest on the ground. Naipaul's mutineers are keen to enjoy their new economic freedoms and to expand them. No political party can expect to gain votes on a platform that promises to reverse the reforms; at least, they act as if this were so. This should translate into some forward momentum. But the prospects for a complete transition remain problematic, for several reasons. Indian politics has become, more than ever, coalitional at the centre. The current United Front government has managed better than expected, but there is no doubt that the reform process has slowed down. The new Finance

Vol. 23, No. 1, January - March 1998