24 July 2016 marked 25 years of liberalisation of the Indian economy. In this article, Parikshit Ghosh, Associate Professor of Economics at Delhi School of Economics, contends that liberalisation did not mean the State should wither away and let markets rule the roost; it redefined complementary roles for the State and markets, making each more important than before.
On 24 July 1991, Prime Minister Narasimha Rao announced the end of the license-permit Raj and Finance Minister Manmohan Singh presented a historic budget that rolled out economic liberalisation in India. We have now arrived at the 25th anniversary of that watershed moment.
Young people today have no memory of a time when footwear meant Bata shoes and Ambassadors roamed the earth. Two decades later, notes Rana Dasgupta, the roar of Ferrari engines – rich kids racing around Lutyens Delhi after midnight – kept Manmohan Singh tossing and turning in his bed. Liberalisation woke up a slumbering economy; its consumerist thunder also kept its chief architect awake at night.
To many, 1991 was simply a second freedom movement to liberate us from the nanny State. To others, it was a surrender to capitalist greed and the Washington consensus. These simplistic thumbnails do not capture the spirit of the new economy launched under Narasimha Rao’s minority government, which showed a boldness and vision that subsequent governments with larger mandates have failed to reproduce. Liberalisation did not merely diminish the importance of the State; it gave it a far more profound role whose challenges it is struggling to meet to this day.
Missing the manufacturing bus
People often talk about how the task of reforms was left unfinished. India still ranks a dismal 130th globally in the ease-of-doing-business. Its restrictive labour laws make exit difficult and hence entry unattractive for businesses, discouraging growth of the formal sector and large-scale enterprises. The government stubbornly holds on to poorly managed public sector companies like Air India and BSNL, whose losses are a drain on the exchequer and which have outlasted their utility thanks to a thriving private sector in the airline and telecom industry.
The major disappointment of the post-liberalisation era cannot be blamed entirely on these unfinished reforms. The big failure is our inability to launch a manufacturing boom, which is the only known path to development and higher living standards for the masses anywhere in the world. Growth in all sectors picked up after 1991, but the share of manufacturing in GDP (Gross Domestic Product) continues to hover around 15%, no higher than what it was before liberalisation. This figure is more than 30% for many of the Asian tigers – China, Korea and Thailand. Job growth in the formal manufacturing sector has been minimal, so our demographic dividend may turn into a curse.
Bottleneck in human capital
Manufacturing failed to really take off due to several bottlenecks, including infrastructure, skills and quality control. This is where the State’s dismal failure to do its job comes into sharp focus. Infrastructure spending as a percentage of GDP has been going up steadily under both UPA (United Progressive Alliance) and NDA (National Democratic Alliance) regimes, so there is some hope that we will be able to get over our crippling power shortages, poor connectivity and clogged ports. The prospect of creating the human capital that forms the backbone of any prosperous economy seems much more distant.
ASER reports reveal that although school enrolment is now very high, an alarming fraction of children in the country are not even learning the three R’s properly. Malnutrition is still widespread – 39% of children are stunted and 31% of adult women suffer from low BMI (Body Mass Index). The problem is not merely that public health, education and sanitation are underfunded – they are – but there is massive organisational failure in providing these services. Government schools and health clinics are riddled with absenteeism and demotivated staff – studies show the private sector can produce roughly the same results with less qualified personnel and at a fraction of the cost.
The poor state of public health and education in India has inevitably led to a flight towards market alternatives. The proportion of rural children enrolled in private schools has now crossed 30%, up from 19% only a decade ago. Private expenditure on healthcare is 70% of total health expenditure, whereas for the world as a whole, private spending only accounts for 40% of the total. Looking at this trend, it may be tempting to suggest that the State should give up on direct provision and enable private solutions through school vouchers and public insurance for private care like the American model. That will be ill-advised for a number of reasons.
It is difficult to find an example of a single developed country, which reached prosperity without substantial public investment in quality healthcare and education. The American healthcare system is an exception but so are its problems. Given our poor financial inclusion, cash aid can only go so far and the problem of affordability will affect a large section of the population under a purely private system. Also, the public sector in education and health sets a benchmark, which private providers have to beat in order to attract customers. Failing public schools and hospitals set the bar low and pull down quality in the private sector, except at the very high end.
The state has not been blind to the problem of malnutrition in the post-liberalisation era – we now spend close to 1.5% of GDP on food subsidies, midday meals and nutritional assistance for pregnant women. There is mounting evidence, however, that the number one problem may not be calorie intake but poor sanitation and widespread open defecation. The conclusion is inescapable that robust growth still awaits a solid platform of schools, hospitals, roads, toilets and sewage systems. Liberalisation unleashed India’s entrepreneurial energies. In doing so, it has vastly magnified the State’s responsibility to supply it with a healthy and productive workforce.
Managing the fallout of growth and privatisation
A second reason the State’s role has become very important is that rapid growth produces stresses and conflicts that only smart and vigilant governments can diffuse. One example of this is the conflict over land acquisition that erupted all over the country in the last decade. It threatens to stall the very success – industrialisation and urbanisation – that created it. Another example is the fumes of growth – massive air pollution and congestion that are choking our cities. Ironically, governance in these areas can be effective if it relies on some tricks of the market – for example, using auction-based methods to determine land value or employing congestion pricing to control traffic volume. Our governments have either been indifferent or responded with unimaginative and bureaucratic solutions.
Even in the matter of creating a greater role for the private sector, one must not forget the lessons of the Soviet Union, where the collapse of communism quickly led to crony capitalism and a race to strip off public assets. Opening up the mining and infrastructure sectors to private capital made it possible to get around the chronic funding crunch and inefficiency of the public sector. It also created the mega scandals that sank the UPA. More than a decade after admitting private players into the utility sector, our governments are still floundering on how to regulate the discoms or how to price the gas that Reliance pumps. Productive privatisation must rely on sensible and transparent mechanisms to avoid corruption and inefficiency. PPP and other models make heavy demands on the State’s regulatory knowledge and capacity.
One final reason liberalisation underscores the need for State capacity is the political pressure it has created for redistribution. The defeat of NDA’s India Shining campaign in 2004 made it amply clear that a strategy for some sort of inclusive growth is necessary for political survival in an era when the economy is not merely chugging along. We now have a dizzying array of schemes to complement trickle-down – distortionary and money guzzling subsidies, a leaky PDS, a corruption-ridden MNREGA (Mahatma Gandhi National Rural Employment Guarantee Act), income support for farmers, and even direct cash transfers. To simplify, rationalise and improve, rather than abandon, this vast machinery for income redistribution, has become a major challenge for governments.
Liberalisation did not mean the State should wither away and let markets rule the roost. That simplistic, oppositional view lies in the domain of ideologues. Liberalisation redefined complementary roles for the State and markets, making each more important than before. Once capitalism came of age in India, government needed to create the human capital necessary for growth, soften the blows of creative destruction, install a sensible regulatory framework, protect the environment and find smart ways of redistribution to make growth inclusive.
The history of liberalisation, in the first 25 years, is a story of half-fulfilled promises. The State abdicated critical responsibilities, but not in the sense of the antediluvian critics, who insist that 1991 was a historic mistake. It was not. But for the next 25 years to be more fruitful, the State needs to roll up its sleeve rather than sit back and let markets sort everything out.
A version of this article has previously appeared in The Quint: http://www.thequint.com/india/2016/07/24/the-misunderstood-role-of-the-state-25-years-since-1991-economic-reforms-liberalisation-manmohan-singh