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India needs to open up economy further for sustained growth

Nirupam Bajpai

Part I: Ten years of reforms: The unfinished agenda

Privatisation of India's state-owned enterprises is critical. Many of the state-owned enterprises are inefficient and loss-making firms.

These firms tend to be protected by grants of state monopoly, especially in areas of finance, such as commercial banking and insurance, and infrastructure, in areas such as telecommunications, port facilities, and road building.

An end to the state monopolisation of these sectors is crucial to permit new, privately owned firms to introduce competition and higher productivity into these sectors.

Privatisation of these enterprises is also desirable in most cases, since the government has no particular comparative advantage in running these enterprises, and may severe disadvantages (especially the politicisation of key investment and employment decisions of the enterprises).

Reforms to further opening up of the economy to trade and foreign direct investment are crucial if India is to sustain high rates of economic growth.

India's average tariff rate of 27 per cent vastly exceeds the average tariff rates of the other economies. India also displays continuing high barriers to foreign direct investment in contrast to most of the ASEAN (Association of South-East Asian Nations) economies.

While it is true that not all of East Asia relied heavily on foreign direct investment to achieve rapid growth: Japan and Korea are the two main exceptions.

But most of the region, especially in South-East Asia, has relied heavily on FDI, and the East Asian countries tend to have much simpler rules for FDI approvals than are now in place in India.

Expeditious translation of approved FDI proposals into actual investment require more transparent sectoral policies, bidding and selection procedures, and a drastic reduction in time-consuming redtapism.

A recent study of 1,099 manufacturing companies, spread across ten large states in India found that firms in India spent close to 16 per cent of management time in dealing with government and other sundry officials as against 9 per cent in China, 8.3 per cent in the transition economies of Eastern Europe and just 4.3 per cent in Latin America.

The states are becoming increasingly interested in attracting both domestic and foreign investment and should expedite their decision-making processes, especially for provision of land, electricity, water and other infrastructural services to investors.

Infrastructural projects on which survey and project work has already been done could be offered to prospective investors.

If India has to become an attractive destination for FDI and a major platform for labour-intensive manufacturing exports, reforms in India's labour laws and exit policies are extremely essential.

China's experience suggests that while workers in the Chinese state sector are accorded generous job guarantees, workers in the non-state sector do not receive guaranteed employment.

By contrast, in India, workers in both the public and the private sector, once employed, cannot be laid off without governmental permission.

As a result of liberal hiring and firing policies in China, there has been rapid growth of employment, since firms can hire workers without fear of being stuck with unwanted labour in the future due to restrictions on dismissals.

Formal sector employment in China has increased dramatically, from 95 million in 1978 to 158.5 million in 2000.

India, by contrast, has experienced a mere increase from 22.9 million in 1978 to 27.9 million in 2000, of which 19.3 million are employed in the public sector.

Remarkably, a mere 4.6 per cent of India's working age population of around 600 million is employed in the formal sector.

Similarly, reform to put in place an exit policy for firms is significant in the Indian context. An exit policy needs to be formulated such that firms can enter and exit freely from the market.

While the policy should recognise the need and potential merit of certain safeguards, if wrongly designed and/or poorly enforced it would turn into a barrier that may adversely affect health of the firms.

India has so far made little progress in commercialising the key infrastructural sectors. In power, for example, most electricity continues to be a public-sector monopoly, run by state electricity boards.

The SEBs are responsible for generating and distributing power, setting tariffs, and collecting revenues. Almost all of the SEBs make losses and some are even unable to pay for coal or the power they purchase.

This is due to the fact that SEBs implement social subsidy policies of state governments leading to inefficient patterns of energy consumption, and even to non-recovery of their own costs. Also, there is considerable theft of power from the distribution networks.

SEBs had accumulated dues of Rs 414 billion, with interest amounting to Rs 157 billion, as of February 2001.

Tariff reform, i.e. higher prices actually collected on electricity use, is the first order of business. Privatisation of power generation, and the conversion of SEBs from electricity providers to market regulators would come next.

Power capacity will not be expanded until the SEBs are fundamentally overhauled or eliminated. Even private power projects currently are expected to sell their electricity to the SEBs as their only power purchaser, so that the bankability of private sector power projects depends fundamentally on the financial health of the SEBs.

There is no doubt that geography heavily influences economic performance. Both in China and to a lesser extent in India, the real economic success has come in the coastal provinces-states, which can take advantage of export-led growth.

In India, Tamil Nadu, Maharashtra and Gujarat have the potential to grow as the fastest growing Chinese coastal provinces of Fujian, Zhejiang and Jiangsu. GDP growth in the hinterland has lagged behind the coastal states by several percentage points per year.

There is a vast amount of economic reform that can be carried out to improve conditions in rural India, especially in the Gangetic valley. There is no reason for expensive and counter-productive charity for the northern states, and still less any case for holding back the fast-growing coastal regions.

Perhaps, the key step in the Gangetic plain is to improve the most basic infrastructure so that the vast rural populations can take part in more rapid national economic growth.

They will do so through increased exports to coastal states, and greatly improved productivity for local production.

The state governments need to adopt a strategy for rural India, in which there will be a reliable infrastructure supplied at commercial prices rather than given for free.

The government's commitment, both at the national and state level should be that every village will be assured at least clean water, a road to the regional market, reliable power, and minimal telephone service; but that every village will be responsible for covering the commercial costs of those services on a normal user-fee basis.

In particular, Bihar, UP, Orissa and Rajasthan are in dire need of reform. Bihar is the most underdeveloped state of India, perhaps, followed by Uttar Pradesh.

Ironically, of the ten Prime ministers that India has had since Independence, eight of them have come from UP and, in addition, of the 425 Members of Parliament in the Lok Sabha, 85 of them come from UP. Bihar accounts for 58 Members of Parliament, second highest after UP.

These states are land-locked and have very high birth and death rates, poverty ratios, illiteracy and maternal mortality, and infant mortality rates. These states also have very low rates of school enrolment and their per capita net state domestic product is among the lowest in the country.

As high as 42.6 per cent of Bihar's population and 31.1 per cent of UP's population was below the poverty line in 1999-00.

Sixteen per cent of India's population lives in UP, although the state accounts for only 7.5 per cent of the country's total area. In 2001, the state's population was placed at a 166 million.

If UP were to be a separate country, it would be the sixth most populous country in the world after China, India, United States, Indonesia and Brazil.

On the political front, while there seems to be some degree of consensus on the basic direction of reforms, however, there have been several instances when the political parties have supported reforms when in power, and opposed them, when in opposition.

Since 1991, every ruling party has supported reforms while the same party when in the opposition has tried to block them.

For instance, the Bharatiya Janata Party opposed the opening-up of the insurance industry when the Congress wanted to do so, and later the Congress opposed the same reform when the ruling BJP wanted to open-up the insurance industry.

Of course, the Congress agreed eventually and the insurance reforms went through. Similarly, the BJP had a tough time privatising a state-owned Aluminum firm, Balco, as the Congress opposed this move. Once again, even though the firm did get privatised, it was not until a Supreme Court judgment came through in favor of the government.

An important aspect of the unfinished agenda should therefore be wide dissemination of information and debate about the necessity of reforms, which should include a frank discussion on some its temporary negative consequences and ways of ameliorating their impact.

A decade of opening of the economy has produced new dynamism, most dramatically in the information technology sector, but in others as well.

The new technologies (especially information technology and biotechnology) give new opportunities for economic and social development.

The reforms implemented so far have helped India attain 5 plus per cent growth, however, should India be able to implement these remaining reforms and re-orient governmental spending away from inessential expenditures towards high priority areas of health and education and infrastructure development, then it is very likely to attain and sustain even higher rates of economic growth.

Nirupam Bajpai is a Development Advisor at the Center for International Development, Kennedy School of Government at Harvard University and the Director of the Harvard India Programme.

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