Reforms: Clear the Clutter

The UPA government shows no interest in raising productivity or competition, and focuses instead on a clutter of conditions, quotas and permits to woo sundry vote banks.
September 16, 2013 • Commentary
This article appeared on The Times of India on September 15, 2013.

Economic reforms should be clear and simple, not cluttered with endless terms and conditions. This has long been forgotten by the UPA government, which tries desperately to ensure that any change satisfies several vote banks simultaneously, supposedly to ensure inclusion. This approach clutters even the most desirable changes (like the land acquisition bill) with loads of conditions, delays and red tape. A refreshing contrast comes from the new banking reforms of Raghuram Rajan, the new RBI Governor. He has decreed that any bank can now open a new branch without RBI clearance. Earlier, the RBI viewed every new bank branch as a special dispensation, to be approved only after long scrutiny. Indeed, the RBI once wanted to approve even individual ATMs, viewing these as bank branches of a sort! Rajan has jettisoned the approach of everything being forbidden till approved. By freeing banks to expand as required, subject only to the usual rules, he has produced clean, uncluttered liberalization.

Contrast this with the cluttered approach of Anand Sharma, supposedly one of the most market‐​friendly ministers in the Cabinet. He championed, and won Parliament’s approval, for 51% foreign direct investment in multibrand retail. He also got Cabinet approval for 100% FDI in single brand retail. He thought this should impress all foreign investors. In fact, one year after the supposedly revolutionary new multibrand policy, not a single dollar of FDI has yet come in (though Ikea and some others will hopefully come in soon).

The distinction the government makes between single brand retail and multi‐​brand retail does not exist in other countries. It has no business logic, and simply tries to buy off the vote bank of small shopkeepers. If FDI in retail is a good thing, it should be allowed without clutter. If it is a bad thing, it should be banned. Sharma justified the cluttering of FDI as an India‐​specific model. That’s precisely the problem: India specialises in clutter that more sensible countries avoid.

Sharma obliged foreign investors in multi‐​brand retail to source at least 30% of their products from small companies with less than $2million of fixed investment, and to invest at least half their initial investment in back‐​end infrastructure. This raised so many possible complications that it took a full year to clarify all issues. Ikea said it aimed to grow rapidly in India, so the industries it bought goods from would expand rapidly too, not remain small any more. After long agonized discussion, the government agreed to the expansion of supplier companies. It also agreed to limit the mandatory 50% spending on back‐​end infrastructure to the initial investment tranche of $100 million.

The question remains, why are we returning to the bad old policy of small scale industry reservations? The old reservations were initially created in the 1970s, and proved terrible. They created a perverse incentive to remain small instead of growing. Some entrepreneurs split factories into several bits, each of which stayed below the prescribed investment limit. Others leased machinery instead of owning it, to escape the investment limit. The policy was conceptually stupid because it made lack of growth and productivity virtues, not vices.

When reforms began in 1991, the small‐​scale lobby opposed de‐​reservation strongly. So, de‐​reservation was phased in very slowly, and was finally completed by 2005. Alas, the government has now brought it back — without any explanation for the reversal. The only logic seems to be vote bank politics.

The same vote bank approach has been carried further for procurement of goods and services by government departments and public sector undertakings. Since 2012, 20% of all procurement has been reserved for small and medium enterprises. Within that 20%, a sub‐​quota of 4% has been fixed for businesses owned by dalits and tribals. The next step will presumably be a quota for Muslims. Salman Khurshid will doubtless demand a sub‐​quota for Pasmandas (dalit converts to Islam). Jaganmohan Reddy will demand a quota for dalit Christians. Nitish Kumar will demand a quota for maha‐​dalits (the lowest of the scheduled castes). A quota for women will follow. The possibilities are endless.

There is a lobby for everything except productivity or competition, which are the mainsprings of higher incomes and lower prices. High productivity requires the ability of businesses to compete and grow without endless hassles and conditions. The UPA government shows no interest in raising productivity or competition, and focuses instead on a clutter of conditions, quotas and permits to woo sundry vote banks. This is a major reason for the economy’s downhill slide. Solution: more clear, uncluttered reforms of the kind Raghuram Rajan has just introduced.

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