Despite the dismantling of the License Raj in the 1990s, interaction with government officials remains an important impediment to doing business in India. This column analyses the role of politics in determining which regions succeed and fail, and finds that MLAs from ruling parties make it easier for firms to do business in their constituencies. They do so not by providing public goods, but by helping firms clear bureaucratic hurdles that would otherwise hinder their operations.
India’s growth takeoff in the 1980s and 1990s was coincident with, and many would argue largely enabled by, the dismantling of the License Raj, the system of licenses, permits, quotas and tariffs that required businesses in almost all industrial sectors to receive explicit permission for operational changes.
A central challenge for firms under the License Raj was that they were subject to the whims of bureaucrats and politicians as the procedures involved were not very transparent. Moreover, they had little certainty over which permits and licenses would be granted and when. Tales abound of politically-connected firms using their influence to bypass regulations, have licenses denied to their competitors, and even to ensure national tariffs that benefitted their particular production technology.
The major liberalisation episodes of the 1980s and 1990s are widely described as eliminating the License Raj. Industries no longer need State permission to hire and fire workers, change their level of output, or add new products. In many sectors, the public debate has shifted to concern over whether firms are being given too free a hand in the new system.
Nevertheless, interactions with government officials remain an important impediment to doing business, at least according to the people running those businesses. The World Bank’s latest enterprise survey of local firms in India, conducted in 2014, asks managers and entrepreneurs about obstacles to doing business. The largest reported obstacle was corruption, with almost 50% more complaints than the next highest category, electricity supply.
Analysing the role of politics in determining which regions succeed and fail
My research with Sam Asher of the University of Oxford is focused on understanding the local determinants of growth and development: why are some parts of India doing so much better than others? What are the major impediments to employment growth and poverty reduction, and what do these say about the best investments that the government can make to facilitate development? Working with administrative data on individuals and businesses across India1, we investigate whether politics plays an important role in determining which regions succeed and fail (Asher and Novosad 2015).
We were interested in whether Members of Legislative Assembly (MLAs) who are part of a state ruling coalition are able to bring better socioeconomic outcomes to their constituencies. Research from many countries shows that political parties tend to favour the areas represented by their own members, whether to reward their supporters or make their candidates look competent (Burgess et al 2015, Dixit and Londregan 1998). We wanted to see whether MLAs from ruling political parties actually deliver better development outcomes, and if so by what mechanisms.
The challenge with testing this kind of theory is that political alignment may be correlated with unobservable factors that affect growth. For example, if a farmers´ party is in the majority, rural locations are more likely to be represented by ruling-coalition politicians. In such a case, we don´t want to argue that the difference between urban and rural growth is driven by politicians; clearly there are many unobservable variables that could bias our results.
We address this by assuming that when an election is very close, the winner is as good as randomly assigned. We then compare locations where ruling-coalition politicians narrowly won with locations where they narrowly lost.
We found that MLAs from ruling political parties do actually deliver better development outcomes to their constituencies: from 1990 to 2005, non-farm employment in ruling-coalition constituencies grew approximately 1% faster per year as compared to opposition constituencies. This adds up: it is equivalent to the difference in employment growth over this period between Bihar and Maharashtra.
Investors in the stock market appear to put weight on political connections as well. We looked at stock returns for firms headquartered in constituencies with close elections; when the coalition-aligned candidate was victorious, investors bid up the stock prices of these firms by 10-15%.
Voters value MLAs’ ability to influence public officials
What could be driving these effects? What are ruling coalition-aligned MLAs doing, that is so essential to the operations of firms in their constituencies and what can this tell us about the binding constraints faced by firms in India? This doesn’t look like selective spending on public goods or pork-barrel spending2. In fact, we found that ruling coalition-aligned MLAs do not affect the patterns of public sector employment, nor do they affect the construction of public goods like roads, schools and power lines.
This is perhaps not that surprising, given that the majority of MLAs’ time is not spent deliberating over laws in the state assembly. The average state assembly meets for only 40 days each year, and key political decisions are often taken by the executive. Recent qualitative work by Francesca Jensenius (2013) suggests that in their day-to-day lives, MLAs spend most of their time holding court in their constituencies, helping citizens get access to government services or deal with problems with government officials. The MLAs serve as middlemen between citizens and state officials, and their ability to influence ostensibly neutral public officials appears to be a key competency valued by voters. Maybe we shouldn’t be surprised that MLAs have power over bureaucrats: after all, research by Lakshmi Iyer and Anandi Mani (2012) shows that state politicians have significant control over the careers of those bureaucrats.
To test whether political control over the bureaucracy is driving our findings, we categorised firms according to whether they were in industries that typically reported being constrained by government regulation, or the implementation of regulation. We found that this set of firms was the most dependent on the party affiliation of local MLAs. In contrast, the growth of firms with high dependence on credit or public infrastructure did not seem to be disproportionately associated with party affiliation of local politicians.
Finally, we looked at the one sector for which we could find constituency-level data on bureaucratic outcomes: mining. We found that constituencies with ruling coalition-affiliated MLAs received more mining permits and licenses, and mining firms were granted larger areas. In an ideal world, mining licenses and permits would be reviewed neutrally, with an eye to promoting development and minimising environmental harm; when permits are granted on the basis of political connections, it is natural to worry that development and environment might not be taken seriously enough.
Businesses should not be subject to political discretion
A central argument for dismantling excessive regulation in developing countries is that it affords politicians and bureaucrats an undesirable influence on the success and failure of firms, putting them in a position that lends itself easily to corruption. India’s rapid recent growth suggests that the dismantling of the License Raj has brought significant dividends to India. Nevertheless, it appears that in the task of eliminating political discretion from the success and failure of individual enterprises, considerable work remains.
- Data sources: Population Census of India (1991, 2001), Economic Census of India (1990, 1998, 2005), stock prices of Indian firms 1990-2012 (Datastream, Compustat, Prowess), Election results (Election Commission of India), and World Bank Enterprise Surveys.
- Pork-barrel spending refers to a situation where politicians or governments use public funds to undertake projects that benefit a small select group of citizens in return for that group´s support or election campaign donations.
- Asher, S and P Novosad (2015), ‘Politics and Local Economic Growth: Evidence from India’.
- Burgess, Robin, Remi Jedwab, Edward Miguel, Ameet Morjaria and Gerard Padro i Miquel (2015), “The Value of Democracy: Evidence from Road Building in Kenya”, American Economic Review, Forthcoming.
- Dixit, Avinash and John Londregan (1996), “The Determinants of Success of Special Interests in Redistributive Politics”, The Journal of Politics, 58(4), 1132–1155.
- Iyer, Lakshmi and Anandi Mani (2012), “Traveling Agents: Political Change and Bureaucratic Turnover in India”, The Review of Economics and Statistics, 94(3), 723–739.
- Jensenius, F (2013), ‘Power, Performance and Bias: Evaluating the Electoral Quotas for Scheduled Castes in India’, Dissertation.