The Telegraph
Tuesday , August 19 , 2014
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- The prime minister has many ideas, some good, some less so

The prime minister’s Independence Day speech was refreshing. He spoke fluently and extempore; he was full of ideas. Some were good, others not quite. The government’s actions affect millions; if it makes mistakes, millions suffer the consequences. Hence it is necessary to identify mistakes before they are made; inaction is better than wrong action. I shall take up some of the prime minister’s ideas, and suggest how he could do better.

The prime minister wants to replace the Planning Commission with something else. Five-year plans are too mechanical. The government has a one-year plan, which is the budget. But it is necessary for governments to look further ahead than a year, since many projects take longer. The Planning Commission had three basic functions. One was to allocate money between the plans of various ministries. Another was to look five years ahead. The third was to allocate Central funds between states. The first can be done by the finance ministry. Fixed five-year plans are a bad idea; but the government should have a rolling plan for up to a dozen years. On the third, the prime minister is discontented with the Planning Commission, having been the chief minister of a state. But a joint institution of the Centre and the states would be a bad idea. Historically, the Indian Constitution created a strong Centre. It is useful in international relations. But we have another arbitrator between the Centre and the states, namely the quinquennial finance commissions. They are small and unbureaucratic, and work fast. The prime minister should think of a permanent or more active finance commission, or give the function to the finance ministry.

The prime minister is keen on manufacture. The world’s leading nations — Britain in the 19th century, the United States of America in the 20th century, Germany and Japan after World War II, China in the past quarter century — have been industry leaders. India tried hard to encourage industry by discriminating against imports after Independence. That policy failed; after the 1991 reforms, India dismantled it. India’s failure in industry rankles many. But as long as workers are moving into more productive activities, it does not matter what those activities are; information technology was not manufacturing, but India did well out of it. It is worth asking what obstructs productive activity. Answers have been available from Transparency International and other bodies for years; the government should look at them and start removing the obstructions they pointed out.

The most obvious obstructions arise from trade policy, foreign investment policy and visa policy. The prime minister has promised a major liberalization of foreign investment policy: any foreigner would be allowed to make anything he likes in India. That is not enough. The three policies are interrelated and must be liberalized together. Foreign investors would like to bring foreign managers and technicians; they would want that dismantling of the human movement licensing policies of the commerce ministry and the external affairs ministry.

Foreign investment is regulated by the ministry of commerce and industry as well as the Securities and Exchange Board of India. They do not talk to each other. They have divided up the work; the industry ministry deals with foreign direct investment and Sebi with portfolio investment. This distinction is outdated; a direct investor may use minor investors to reinforce control, and minor investors may come together to take control. Sebi has become huge and bureaucratic, and its rules are so complicated that even it does not always understand them. The entire regulation structure in this area needs to be refashioned and simplified.

To do so, the prime minister must ask himself: is he serious about easing entry of foreign investors? If he is, he will have to ask himself: what difference does it make whether investment — ownership — is Indian or foreign? No one says it in so many words, but policy in this area has been designed to serve the interests of Indian industrialists, who were once called managing agents and are today called promoters. They aim to control companies with minimum investment; that is why they want controls on outsiders’ investment in their companies. These controls are in their interest, not in the national interest. In general, a more active market in control of companies will improve management.

Foreign investment has another angle: it can affect the balance of payments. There are simple ways of taking care of this; Raghuram Rajan will tell the prime minister how to do it. In general, liberalization of FDI is a good idea; but the prime minister must liberalize trade policy and visa policy at the same time.

Trade policy was radically liberalized in 2000, but it left behind the negative list of goods that the commerce ministry continues to treasure. The controls bring in the customs department of the finance ministry, which used to compete with the chief control of imports and exports to be the government’s most corrupt and lucrative department. The CCIE was abolished in the reforms of the early 1990s; but customs and the commerce ministry continue to be powerful obstacles; they make India an unattractive country to trade with.

If the prime minister tries to liberalize trade, the bureaucrats and politicians will ask him whether he is prepared to sacrifice food security. This is a red herring. India should, of course, be able to feed itself; it is a large food consumer, and if it runs short of food, it can have difficulty in importing it. But there is no such risk. India is producing more of wheat and rice than it can eat, and stocking so much that it is rotting. Import liberalization would require some finesse, but it can be done in such a way that India will not become dependent on imports. In fact, it is one of the world’s top two rice exporters; if it liberalizes trade in food, it can become a dominant player in the world foodgrain market.

This will require two major reforms in food policy. First, subsidies to the poor should not be tied to their buying grains in ration shops; they should be given cash subsidies instead. Second, the government should buy just enough foodgrains to insure against serious shortages. It should renew its foodgrain stocks every year — in other words, sell off old stocks and buy new stocks throughout the year.

Let me come back to the prime minister’s objective — making India a world industrial power. India’s biggest attraction is its low wages. The wages will rise if manufacturing expands and creates more employment. And the wages will buy more if food prices are lower. The government should dismantle controls — agricultural price support and excessive foodgrain purchase — that keep food prices high.

His fellow politicians will tell him that if he does that, more farmers will kill themselves. Farmer suicides are not due to low prices; they are due to uneconomically tiny farms and excessive borrowing. The solution is non-agricultural employment — which manufacturing can create. But it also requires labour mobility; the biggest obstacle to it is rural migrants’ difficulty in getting homes in towns. That is where the prime minister’s smart towns can help. He has so many ideas that one column is insufficient to chase them.