Re-igniting economic reforms in India: Three key principles

Economic Times, 23 July 2013

There is a remarkable loss of optimism in India today. For investment to take place, private decision makers have to feel confident on long time horizons. All too often, a bad faith principle is afoot: the private sector assumes that the government will do harmful things in the future. Addressing this requires deeper reform of laws and public bodies, around three key principles: restrict government meddling to market failures, the rule of law, and accountability of government agencies.

While the extent of engagement with government varies across fields, a substantial interface with government is a feature of most private firms. Hundreds of mis-steps in recent years have led to a great wave of mistrust about government. Whether it is tax authorities or RBI or SEBI or environmental regulation, the private sector has been burned over and over.

In earlier years, we used to worry about predictability and stability. It used to be argued that there are many plausible investment opportunities in India, but one needs to worry about how rules might change in the future and reduce the viability of these projects. Today we see a bad faith principle: It is assumed that when a government agency has powers, they will be used one day in the worst way possible.

In earlier years, it was felt that while the system is a bad one from the viewpoint of a law abiding business, it still worked for the seamy underside of Indian capitalism, for strongmen who would get things done. Private equity and foreign investors held their noses at the kinds of things that these strongmen did, but were comfortable that this would generate results. The corruption scandals of recent years have shattered this complacence. Today nobody is confident in their dealings with government, and financial investors particularly mistrust the strongman-entrepreneur who promises to get things done by hook or by crook. That the old messy ways do not work anymore is something to rejoice over. But in the meantime, investment is stalled while we wait for the new ways to fall into place.

We began on a journey towards a market economy in the late 1970s, and gained momentum in the early 1990s and then the late 1990s. That process seems to have run aground. We need to reinfuse that process with energy and clarity of purpose. Three big ideas stand out.

Focus government upon market failures
The first concerns the role of the State. What should government do? All too often, in India, government is a political animal responding to one pressure after another, meddling in the economy with unchecked powers. This meddling is creating acute political risk, and is entirely inappropriate for a mature market economy. We need to refocus government upon identifying and addressing market failures. Every proposal to meddle in the economy should satisfy this test: What's the market failure and how do you think this intervention will address it?

As an example, the civil aviation ministry wants to force private airlines to not hire foreign pilots. But what is the market failure here that requires intervention? In a transaction between consenting adults, why should the government get in the way? Laws and the governance ethos need to be recast around the phrase market failure, which falls into three headings: asymmetric information, externalities and market power. There is no fourth reason that is a legitimate excuse for government meddling.
The rule of law
At present, government agencies in India have sweeping powers and can attack anyone. This is inconsistent with the rule of law. The rule of law requires that precise powers be given to government agencies to pursue specific objectives. We will create legal certainty by a precise statement of objectives and powers in the drafting of laws. We must rewrite all laws that have vague objectives or vague powers.

Survey of India has attacked Google in court on the grounds that Google is in violation of a policy document of the Survey of India. However, policy documents are not laws and there is no crime if a private party has done something that is incompatible with an internal policy document. Alongside well written laws, we need to do much more on building high quality courts and judges, who will adjudicate disputes and hold the government under check.
Accountability of government agencies
As an example, RBI's recent actions attacking currency exchanges were primarily about grabbing turf at SEBI's expense. RBI is able to do such things as nobody knows what RBI is supposed to do and there is no mechanism for holding RBI accountable. This gives us an unaccountable bureaucracy with draconian powers: a recipe for political risk for all private parties. Strong accountability provisions need to be inserted into all laws, as has been done in the draft Indian Financial Code.

Back up to Ajay Shah's 2013 media page
Back up to Ajay Shah's home page