Will India embrace capitalism before China is a democracy?

It is easy to be bullish about the future of India’s economy but doing generally requires a combination of distance and selective amnesia. From afar, India seems like a good fit for a success story of modern globalisation. 

After all, it has legal foundations based upon Anglo-Saxon traditions ensure that its democracy remains stable, and many Indians speak the dominant trading language. India also has a leg-up on one of two crucial preconditions for economic, which are an expanding workforce and capital accumulation as the basis of rising labor productivity. 

In demographic terms, India is expected to overtake China to have the largest population by 2025 or so. India’s birth rate is about 2.65 children per woman while China’s is 1.54. As such, China’s lower birth rate means that an aging population will depend upon a smaller working-age population. As it is, the proportion of China’s population of working age hit a peak of 73 per cent in 2010 while the ratio of India’s working population was 65 per cent in 2010, and continues to rise.

On these various terms, India could be the go-ahead winner in the global economic sweepstakes over all comers, including China. This is especially true since entrepreneurs drive India’s economic growth, while China’s economic model depends on state-centered spending and export-led growth.

Yet optimism about India often leads to grief and will do so as long as political actors and Indian intellectuals allow their distrust of market economies to hold back reform. Resistance to further economic liberalisation has deep roots that can be traced to the pre-Independence mischaracterisation of capitalism as the handmaiden of colonialism.

The origins of the socialist instincts that guide India’s political culture come from its modern founders. While Gandhi encouraged self-sufficiency and economic nationalism (swaraj), Nehru promoted a Soviet-style economy. And then Indira Gandhi oversaw modifications to the preamble to the Indian Constitution during the Emergency of the 1970s, proclaiming India to be a “sovereign, secular, socialist republic”. 

At the same time, an amended section in the Representation of Peoples Act required all recognised and registered parties to swear by this Preamble. Since all parties must support Socialism, it is impossible for parties to promote Classical Liberalism yet there are many that support Communism.

With an anti-capitalist mentality prevailing at the birth of modern India, it is deeply embedded in India’s political DNA. This is unfortunate since capital formation, as a prelude to increased productivity, would bring rising living standards to those condemned to the bottom of the economic pyramid.

This disdain for private capital undermines attempts at economic reform and contributed to the reversal on allowing foreign investment in retail sales to keep Wal-Mart and other large players out of India.

The current Prime Minister Manmohan Singh is credited for policy changes that removed some of the worst shackles on India’s economy in the early 1990s while finance minister. But Singh’s academic writing does not suggest he favored liberalizing the economy, and he had no plan until his boss, then-Prime Minister Rao, ordered him to come up with one. Unfortunately, many observers are misguided in thinking that an ardent economic reformer is guiding the government of India.

Whatever his bona fides, it turns out that the real power is presently wielded by the head of the dynasty-driven Congress Party, Sonia Gandhi. Her political views, including an antipathy to free markets, are akin to social democrats of her homeland, Italy.

As it is, actions and inactions of India’s political leaders created a climate of “regime uncertainty” that played a significant role in the collapse of the rupee in early 2012. Business investments always involve endogenous uncertainty arising from forecasting events in an unknowable future. But a lack of clarity about the impact of policies or the implementation of policy changes that have costly consequences introduces an avoidable, exogenous form of uncertainty.

As of June 2012, Indian politicians have shown few initiatives to fix the wide array of imbalances that are constraining economic growth. These include a high fiscal deficit, central bank policies that fuel increases in domestic prices and erode competitiveness along with a large external deficit and a slumping rupee.

Instead of addressing how to correct macroeconomic imbalances, the Indian Parliament is locked in debate over a “food security” bill to provide foodgrains at highly-subsidized prices. But the main question being discussed is whether it will cover 64 per cent or 80 per cent of the population. There is no apparent concern about the economic distortions such a programme might cause or how such spending will lead to higher deficits and debt.

India’s dreary past; hopeful present; brilliant future

At the beginning of the great European explorations of the world, India was home to a fabulous amount of wealth. Indeed, all the invading empires from the Mughals to the British became vastly rich. And the Maharajahs and Nawabs in far-flung Princely States scattered throughout India accumulated massive fortunes over many centuries.

The end of British colonialism left Indians with amazing opportunities and daunting challenges. Yet few other modern countries had so much promise at their birth.

India’s former colonial master left the new rulers of the world’s largest democracy with a modern physical infrastructure, including one of the best railway systems in the world. Of equal importance were well-developed “institutional” infrastructure, including a competent civil service and a judicial system guided by the rule of law.

But the post-Independence leaders soon squandered the birthright of their citizens. Soon after the British left, initiatives were introduced that gave birth to a Socialist state that soon had a tight grip around the throat of the economy. An important and pervasive aspect of these developments was the brainchild of PC Mahalanobis, the father of India’s Planning Commission.

Blind faith to socialist ideology led many to overlook that extensive state controls and planning were holding back economic progress. In turn, India’s economy was suggested to be doomed to an unavoidably slow “Hindu rate of growth” as it the cause came from its dominant religious group.

This insult to one of the world’s richest religious cultures by blaming it for economic underperformance was not made by an outsider seeking to belittle India or Hinduism. Instead, the term is traced to an economist at the Delhi School of Economics, Raj Krishna to describe sluggish GDP growth of 3.5 per cent a year between the 1950s and the 1980s.

In all events, this reference distracted many outsiders from seeing that socialist ideology was what was ruining India’s economy.

For their part, Indian politicians are adept at deflecting blame for their own shortcomings. While they have tended to point to the size of the population as the source of most of its economic problems, it is hard to imagine a more misleading statement.

As it is, the human population is one of the most precious resources available to any country and inevitably is the source of many of the solutions to most problems. India’s extensive poverty in is not because there are too many Indians. It turns out that India’s population density is less than Holland or Japan or many other rich countries.

In fact, many Indians were and are so poor because of too many economic regulations and too many privileges provided to domestic elites by successive governments. Many of these interventions are entrenched and continue to interfere with formation of new businesses and new jobs.

Clearly, India recent flirtations with high economic growth are the result of a retreat of planning and deregulation rather than the demise of Hindu culture. But old habits are hard to shake. Indian bureaucrats still conjure up elaborate plans using sophisticated models even though most of investment is carried out by the private sector under the auspices of the Planning Commission.

The lesson of all this is that India’s citizens should understand that many of the economic problems they face are the result of failed political governance. The past few years of erratic policy decisions have frustrated investors and caused the shut down businesses or have dampened the rise of new businesses.

Slowdown in India’s stellar growth

From 2000 to 2010, India had a CAGR (compounded annual growth rate) of GDP of 7.5 per cent. And other economic indicators (eg, consumption of commodities, energy utilisation, trade surpluses) followed a similar trend.

But now there is evidence of the effects of “regime uncertainty” found in a reversed, downward trend in India’s economic growth. The official estimate of GDP growth in the last quarter (Q4) of 2011-12 was 5.3 per cent, down from estimated annual growth of 6.5 per cent, part of a continued downward trend. In Q1 of 2011-12 (April-June 2011), GDP growth was 8 per cent, dropping to 6.7 per cent in Q2 but fell further to 6.1 per cent in Q3.

Part of the story is that private final consumption expenditure fell from 59.5 per cent of GDP in Q1 of 2011-12 to 52.2 per cent in Q4. Meanwhile, government expenditure rose from 10.6 per cent to 11.4 per cent. With increased government spending funded by increased debt, higher borrowing costs pushed down investment (gross fixed-capital formation) from 33.9 per cent of GDP in Q1 to 30.9 per cent in Q4.

Mixed messages for foreign investors

First, the good news. The category of Qualified Foreign Investors has been expanded to include individuals, groups of individuals and investor associations. These can now invest directly in equities as well as Indian corporate debt.

Funds brought into India to purchase these instruments can remain in non-interest bearing account indefinitely. Before they had to invested within five days or be repatriated.

With the Indian rupee currently cheap, this might encourage increased capital inflows in the medium to long-term. However, Indian stocks remained a bit oversold and have been correcting downward for most of 2012.

Now, some of the bad news. The central government has broached the subject of a retroactive law to close gaps in the Income Tax Act that currently do not cover capital gains on some transactions. As far-fetched as this might sound, Indian authorities have enacted retrospective tax laws previously.

What is at stake is assessing taxes on companies with substantial business interests in India but that are registered abroad, allowing review of cases up to six years in the past. It would cover entities that sell all or part of their business interests in India to another firm by transferring ownership of an overseas holding company.

One target was Vodafone’s Netherlands subsidiary that purchased Hutchison’s Cayman Islands subsidiary to acquire interest in a mobile telephony company operating in India. While the Supreme Court dismissed these demands, the government has not given up on the idea and leaders of the opposition BJP (Bharatiya Janata Party) support the move.

Among other deals that could be affected are the acquisition by Kraft Foods of Cadbury India, SABMiller’s purchase of Fosters and Sanofi Aventis’s takeover of Shantha Biotech. Meanwhile, investors engaged in ordinary mergers and acquisitions face scrutiny of cabinet-level committees that make demands on top of those made by other state agencies.

India’s economy could benefit from risk management expertise and deep pockets of foreign-based insurance companies to aid in financing infrastructure spending. But a planned increase in the ceiling on foreign direct investment in the insurance sector from 26 per cent to 49 per cent was abandoned.

Policy changes for a brighter future

It is clear that there is much more that can be done to open up India’s economy. Looking at the World Bank “Doing Business” report for 2012, India was 132nd out of 183 countries, up slightly from the previous year. This ranking speaks of the time, cost and minimum capital requirement to start a business as well as the difficulty for hiring and firing workers. Opening a business in India takes an average of 12 steps and requires 29 days while official fees and fees for legal or professional services cost about 47 per cent of per capita income.

Further evidence of India’s lackluster commitment to markets is its ranking as 94th of 142 countries in the “Economic Freedom of the World 2011” report of the Fraser Institute. The impact of policies on blocking private business initiatives is also indicated by the “Capital Access Index 2009” constructed by the Milken Institute that India moved from 47th to 44th of 122 countries. The CAI evaluates domestic capital markets on the premise that access to financial markets is the key to long-term growth and to reducing poverty and income gaps.

Indian entrepreneurs face obstacles that are the lingering result of bad policy choices of the past. Electric power is unreliable and expensive due to public-sector controls.

Goods moving between Indian states are held up at internal border checkpoints. While taxes and import duties are lower, Indian manufacturers face the burden of coping with many indirect taxes due to a lack of a uniform goods-and-services tax.

Then there is the problem of expensive subsidy and entitlement programs. Reduction or elimination of these could release funds for needed improvements in physical infrastructure that could be carried out with private-sector partners.

Despite a target for limiting fiscal deficits to 3 per cent of GDP, subsidies for food and energy will push the combined deficits of state and central governments beyond that goal. In turn, high fiscal deficits will eventually push up consumer prices as well as interest rates.

There must be convincing steps towards reducing the general government deficit that currently exceeds 10 per cent of GDP. Fiscal consolidation has been an elusive goal with little more than promises to curb public-sector spending by reducing or removing subsidies on fuels or reining in entitlement costs. Instead of offering credible reductions in government expenditures, the focus is on raising revenues using regressive measures or asset sales to curb the fiscal deficit.

Besides inefficient subsidies, there are massive entitlement programs. For example, the National Rural Employment Guarantee Act guaranteed 100 days of employment to adults of rural households to carry out unskilled work at the minimum daily wage. The outlay for NREGA was about $8 billion in fiscal year 2010-11.

Finally, India’s tax code needs to be overhauled by closing loopholes for specific industries along with implementing a uniform goods and services tax. Despite having developed a direct tax code and GST have been prepared, the government has never delivered.

Politics as the main obstacle for India’s prosperity

With global macroeconomic factors being unstable over the past few years and with volatility expected to intensify, domestic economic reform becomes more necessary. And so this raises big questions concerning the role of the Indian state in the economic future of the country.

Should the Indian state continue to refrain from economic liberalisation? Should it remain a vehicle for political parties to seek power to be uses for their own narrow ends? This approach will weaken and undermine the legitimacy of India’s democracy while doing little to alleviate the condition of poverty that afflicts so many.

Or should the Indian state of the future be a mechanism to protect the freedoms and rights of individuals living under a general law with shared allegiance to a secular state? Continued economic reform can allow Indians to benefit from the genius, initiative and entrepreneurial skills evident in so many of those that left to create wealth elsewhere.

While liberalisation towards free markets might allow shared prosperity, continuing a nascent welfare state with more regulations is likely to bring lower economic growth. Unfortunately, most of India’s politicians eschew free markets; limited government and deregulation while wholeheartedly embracing interventionist government.

The above remarks have refrained from making endless comparisons of India with China, as many curious outsiders are wont to make. As a remedy to this, perhaps it is appropriate to end with a query concerning the future of these two large and important countries.

The question is this: Will India embrace capitalism before China embraces democracy?


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Christopher Lingle

Christopher is a Visiting Professor of Economics at Universidad Francisco Marroquín in Guatemala, Adjunct Scholar at the Centre for Independent Studies (Sydney), Research Scholar at the Centre for Civil Society (New Delhi), and Member of the Academic Advisory Council of the Globalization Institute (Brussels). His research interests are in the areas of Political Economy and International Economics with a focus on emerging market economies and public policy reform in Europe, East Asia, Latin America and Southern Africa. He earned a doctorate in economics from the University of Georgia in 1977. 

Dr. Christopher Lingle
Universidad Francisco Marroquín

T: +1 310-706-7473
E: [email protected]   
W: http://naturalorder.ufm.edu/ 


Universidad Francisco Marroquín

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Universidad Francisco Marroquín

T: +1 310-706-7473
E: [email protected]   
W: http://naturalorder.ufm.edu/