A Response To Rahul Gandhi

The Government of India and supporters of the ruling Bharatiya Janata Party (BJP) have every reason to be pleased with the Op-Ed written by Congress vice-president Rahul Gandhi and published in Financial Times. He has missed an important opportunity to inform the readers and Indian voters that he is capable of, and is now ready to provide, better governance. Instead, he has reminded Indian voters that they were right to vote his party out of office in 2014 and may be right to keep it out of office again in 2019. The Op-Ed is an outcome of confused, convoluted and muddled thinking.

The first anniversary of the historic and unprecedented decision of the Government of India to demonetise two high denomination currency notes is an occasion to reflect on the nation’s economic governance priorities and show how that decision did not serve those priorities.

Even though the two high denominations (HD) that were demonetised constituted more than 85 per cent of the notes in circulation, India was not an outlier in that respect. China, Indonesia and Thailand had even higher portion of currency in circulation dominated by HD notes. Further, India experienced a big jump in the share of HD notes in circulation during the years 2000 to 2004 rather than from 2004 to 2014.

Further, shrouding the decision-making in secrecy indicated the moralistic nature of the decision which is highly problematic. Fighting and winning elections and running political parties require huge amounts of cash which are not sourced legally. Hence, a political party pursuing moral ends through economic policies is running a big credibility risk. The decision paid political dividends for the BJP but it caused economic damage. To paraphrase Nani Palkhivala, bad economics can be good politics temporarily but politics should be behind economic laws and not in front of it.

Black money is, relatively, more a reflection of tax laws, rules, rates and their administration than of intrinsic morality of the taxpayers. Hence, Gandhi could have usefully shown how he would have achieved the goals that the BJP government was pursuing through a tax system that would be simple, fair, consistent and transparent, and would feature reasonable rates administered on the basis of trust instead of mistrust. He could not say so because most of the tax policies and tax administration of the BJP government is inherited from the previous government led by his party.

Indeed, one of the disappointing features of this government is that it has not departed enough from the previous government. He can take credit for it because his jibe, suit boot ki sarkar has underpinned many acts of commission and omission by the BJP government.

Gandhi rues the impact of the government’s demonetisation on the country’s large rural poor and informal sector. The government will not have been unaware of it but it calculated that some of the demonetised HD notes would not be returned and, hence, could be cancelled. That would release the Reserve Bank of India from its liabilities on those notes, enabling it to pay a higher dividend to the government which could then be distributed to the poor. This potential Robin Hood action could not take place because the public managed to deposit almost all of the banned HD notes with banks.

That once again underscores the futility of running a police state than an enabling state. With the former, the government will effectively be engaged in a ‘cat and mouse’ game with the governed.

In truth, the outsized informal sector and the rural poor that operated on cash is an indictment of the policies that previous Congress governments had pursued since Independence and right up to 2014. Extensive and elaborate reservation of many items of production for the small scale sector created perverse incentives for enterprises to remain puny and to actively seek puny-ness.

The informal sector may be a source of employment but it is neither gainful employment nor productive employment. Most employees are unprotected and underpaid. They do not even have a written employment contract. Labour productivity is too low because the labour is unskilled and production is tiny. Capital productivity in informal and small enterprises is better than in large enterprises because they deploy too little of it. In absolute terms, their capital efficiency is not high enough to be a source of competitive advantage either to themselves or to the nation. Data show that “they (DO NOT) represent India’s innovative capabilities and (DO NOT) have the skills, knowledge and understanding to take on China’s manufacturing machine.”

China which, inexplicably, has taken up so much space in Gandhi’s polemical piece against the BJP government, exploited economies of scale far better than India did and created an economy that is at least four times as big as India’s. Its small-scale sector pays better wages than India’s small enterprises. Clearly, they are more innovative and productive than India’s small enterprises.

For the most part, India’s policy-making has been hobbled by the tyranny of small minds that have actively resisted scale and size. India’s policy bias against bigness has created a double whammy for the economy. It has kept enterprises small into eternity and favoured selective, politically connected big businesses. The bias against bigness and in favour of big businesses has turned the Indian economy into a unique Hotel California. It is difficult for enterprises to check in and, once checked in, it is impossible to check out. The unease of entry and exit has rendered the economy uncompetitive.

The romancing of poverty and small size by the Congress party has consigned India to a small and marginal role in the global economy. Gandhi’s article confirms that the infatuation is alive. He has wasted an opportunity to explain how he would liberate the economy from the burdens of these past economic mistakes committed by his party that continue under this government too.

The long-term benefits of demonetisation would surely exceed the costs if India used the exercise as a springboard to make formalisation attractive and viable for informal and small businesses. A policy package aimed at enhanced formalisation of the economy would include tax reforms – lower rates and better administration, fiscal and other measures to lower labour cost burden for businesses and better skilling of workers. Evidently, Gandhi is not thinking along these lines.

Gandhi blames the government for the introduction of a “flawed new tax” – the goods and services tax or GST. He is only partially correct for the GST Council featured representatives from all states including those ruled by his own party. As did the central government, they too were focused on revenues rather than seeing this tax reform as a launch pad for the economy to achieve greater economic activity and higher economic growth. The policy and political entrepreneurship missing in the design of the GST is absent in his critique too.

Gandhi deserves praise for two things. He has provided some mirth to his readers by blaming the government for ending the economic boom in the country. Surely, his government did not leave a booming economy for the BJP. He is misinformed. The Indian economy was damaged goods when the BJP came to power in 2014. Sharply weaker currency, bloated current account and fiscal deficits and persistent double-digit inflation are the hallmarks of a botched economy.

The economy enjoyed a boom between 2003 and 2008 thanks to benign global conditions and due to the lagged effects of the structural reforms including the building of infrastructure by the previous BJP government that was in office between 1998 and 2004. The coalition government that his party led from 2004 to 2009 ended it and replaced it with an unsustainable and overheated economy between 2009 and 2014 whose consequences India is still grappling with. Bloated debt and fractured balance sheets of the Indian corporate sector and the banking sector are two prominent examples of those consequences.

Two, he concedes that Modi rode to power on the anger created by joblessness – reflection of the disastrous economic management of the country by the government led by his party that ruled India from 2004 to 2014.

The BJP government has committed many mistakes. The most important of them is the failure to break free of the narrow and pro-poverty (distinct from pro-poor) mindset that the Congress has imbued the nation’s politics, bureaucracy and society with. Gandhi’s piece is a sad but important reminder that he is unlikely to embrace something more sensible by way of economic policies.

India’s ‘Ease of Doing Business’ ranking may have improved but it remains profoundly ill at ease with sound economic thinking. The Congress, including its vice-president, must take a large share of the blame for it.

One small suggestion for Gandhi: he can contribute to employment generation in India by hiring a ghost-writer who can write at least comprehensibly, if not sensibly.