Policy reversals and private investment

Business Standard, 2 September 2024

Does an environment with more policy reversals fuel policy risk and inhibit private investment? The flourishing of the market economy does not require autocratic control with a strong government that periodically releases irreversible decisions. The important thing is getting to good policies, and dispersion of power is a means to that end. There are pathways to do policy in ways which induce less policy risk. While there will always be the tactical detail of day to day policy decisions, policy coherence and strategic thinking in policy helps reduce policy risk. The animal spirits of the private sector matter, and these are shaped by the strategic view of improvements in the Indian state.

Economic growth is forged in conventional private investments in physical capacity (e.g. increases in the fixed assets as seen in annual reports) and in private investments in obtaining higher productivity. These investments are risky and are greatly influenced by the stance of the state. Do the recent policy reversals have an adverse impact on perceived policy risk and thus on private investment? It is unlikely.

Difficult negotiations between multiple political parties, that lead to twists and turns in policy, are not inconsistent with economic success. The advanced economies of the world are vastly successful in economic terms (e.g. the US per capita GDP is about 10 times bigger than that in India), and all advanced economies are liberal democracies where power is vigorously contested, and there is a day to day evolution of policy decisions reflecting the tug and pull of rival interests and views.

Some people in the world of business have a simplistic conception of power. There is a desire for powerful CEOs that swiftly make deals with powerful politicians and thunder on into their great journeys. This conception is just a caricature. All governments are complex creatures. In a good country, there is little role for deal making. When investments have time horizons of 20 to 40 years, making deals with the current ruling party does not reduce risk. When private persons gauge policy risk, they think about institutions, processes and the policy strategy that will be in play for 20 to 40 years.

The plot line in a democracy will always have many twists and turns. There is nothing wrong with reversals; what matters is getting to good outcomes. For example, the outcome on the broadcast bill was pretty good, the outcome on the NPS was not.

What is the policy process that creates lower policy risk and better outcomes? The recipe is well known in India. Government organisations require deep roots in knowledge, partnerships with knowledge organisations, and deep engagement with the private sector. A robust public domain literature on each field is required, with insights and debates on rival policy pathways. Expert committees help sift through the debate and create greater intellectual consensus on the shortlist of what's worth considering. Genuine consultation helps identify flaws in draft documents and improve them. Good ministers challenge their joint secretaries, asking for sophisticated responses to a few opeds of the day. Parliamentary standing committees generally improve bills.

When this kind of process is used, e.g. in the journey up to the NPS in 2002, the range of policy possibilities is well known, documents emanating from the government are of higher quality, there are fewer surprises and better outcomes. Reversals are not important; what is important are the processes of deliberation and thought, and the extent to which they yield good outcomes.

Governments are vast organisations where decisions are made at thousands of places. This raises the problem of policy coherence. Left to itself, decisions made in different places lack harmony, or even conflict with each other. When these heterogeneous actions are seen by private persons, it is confusing and exacerbates policy risk. Policy coherence comes from principles, from ideas, from philosophy. As an example, through much of the 1991-2011 period, there was an intellectual consensus on the reforms that were being taken. These ideas percolated through the Indian state, and thousands of autonomous decision makers started applying them in ways that were internally consistent. The changed behaviour at thousands of decision makers in the Indian state persuaded private persons that reforms were underway.

The phrase `animal spirits' is applied to the leap of faith that goes into private decisions to invest, and the optimism of the periods of investment booms and high growth. While it is tempting to resort to propaganda in trying to induce animal spirits, this is not effective. Claims of progress and alternative facts do not persuade. Only policy progress helps address the caution of the private sector.

Out of the hundreds of policy problems of the Indian state, only a few can be solved in a few years. State capability does not always go up, and when it does, the gains are slow. How, then, have investment booms arisen? We should not think in terms of a sequence where the state gets fixed and then an investment boom follows. Animal spirits that engender private investment are not about some idealised state capability or policy mix. It is about optimism about movement towards a more perfect state capability and policy mix.

Animal spirits are made of four components:

  1. The leadership needs to put forth a coherent strategy for making progress, where reformers dedicate themselves to the trio of problems : of reducing central planning, improving rule of law, and creating state capability.
  2. In addition to these documents, a down payment of tangible progress in some areas with respected teams and successful actions is required. Most of the Indian state worked poorly through the boom of 1991-2011, but progress did take place in some areas. In a few areas, the state needs to walk the talk.
  3. As most of the Indian state is malfunctioning, private persons repeatedly run into difficulties. They need confidence that they will get access to policy makers and important problems will be solved.
  4. Animal spirits are also shaped by the overall levels of conflict and toxicity in the society. When there is harmony and optimism in the overall culture, this helps foster animal spirits. When the broader culture is infused with anger and violence, it becomes harder for private persons to make the leap of faith that is required in investing.

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