Prime Minister Narendra Modi salutes the national flag before addressing the nation on 68th Independence Day at the Red Fort on August 15, 2014 in New Delhi, India. (Mohd Zakir/Hindustan Times via Getty Images)
Snapshot
  • To make India a developed nation, we need a radical rethink of the role of government. Sadly, the chances of that happening are zero.

Indian budgets have long been prepared with what I would call mythical trade-offs — GDP growth vs inflation, growth vs equality, infrastructure creation vs deficits etc. But even a casual study of world history should tell readers that these are government-created myths and that most developed nations became so without any of these trade-offs. In other words, these are “third world fantasies” that have been propagated to perpetuate the state of developing economies. The subject of this article is not to explore who created these myths or why governments largely subscribe to these, but to point out the underlying issues and give a roadmap for India to become a truly developed nation.

I am using the term roadmap deliberately because these things cannot be done in a year or two. OK, not cannot, but will not. We do not have the political courage amongst the politicians nor the intellectual clarity amongst the policy makers. With a Ron Paul and a Jim Grant at the helm, we can complete this entire exercise even within one or two years. But returning to reality, even if Natrendra Modi can accomplish 50 per cent of what is outlined in his next five to six years (a very likely scenario for him to be at the helm for the period mentioned), he would indeed leave a lasting impression and could legitimately be proclaimed as the Lee Kuan Yew of India.

For the last 25 years, budgets have largely been tinkering at the margins. A fiscally conservative government, which is what one would have expected the BJP to be, merely slows down the increase in government expenditure. Deregulation happened in one significant step in 1991, but nothing of any substantive nature subsequently. Very rarely has any government attempted something that will dramatically transition India from a largely underdeveloped economy to even a moderately successful one.

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There is an economic truism that the more irrational a law or practice, the greater would the resistance to change, because of entrenched beneficiaries. So, this is a roadmap that would be filled with landmines and it would be easy to spread the message of an anti-people policy. After all, socialism is such an easy sell that even a mentally challenged person would buy the fantasy. Capitalism, on the other hand, places the onus of progress on the individual, devolves choices to the markets and limits the power of the government. And hence the need for very strong political courage and intellectual clarity.

I do not want to belittle the progress we have made since 1991, when we changed substantially from an abysmally closed and regulated system to one where we have pockets of a free market system. But despite the progress of the last 25 years, consider the totality of our living standards today.

• Almost 200 million of us do not have access to basic food and nutrition, even using a very basic calorie standard. If we were to use dietary standards acceptable in the developed world, practically 50 per cent of India would be considered starving.

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• Around 350 million are essentially illiterate. Of the so-called educated Indians graduating from universities, less than 25 per cent of even the technically qualified (such as in the disciplines of engineering, business management) are capable of joining the labour force in terms of their skill and competencies. It is not entirely uncommon to see fresh engineers working as cab drivers in the metros.

I could go on to paint a similar dismal pattern about housing, sanitation, access to a proper justice system, an effective police force etc. The larger point is that we are barely in the initial stages of progress and if we are to become a developed country, then economic reforms have to be taken to a different level altogether.

If Narendra Modi truly wants to make India a great country again, we have to solve all of the above problems and much more. And not with the approaches tried earlier. What we have attempted every time in the last 70 years of independence is to literally throw money at problems. Recession — create a fiscal stimulus; droughts — increase the allocation to the farm sector; lack of sanitation — create a Swachh Bharat fund; poor rates of literacy — add an education cess; black money problem — demonetise. Never have we even pondered for a minute if these actions/ allocations have any meaningful outcomes.

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As a country, we are more interested in being seen to be doing something, rather than thinking through the second and third order consequences of these superficial solutions.

Before I proceed any further, I would recommend the book Economics in One Lesson by Henry Hazlitt, one of the giants of the Austrian School of Economics. It’s a book written for a lay person to understand why the above listed solutions would have exactly the opposite effect of the stated or intended results.

Austrian economists have repeatedly pointed out that the only way to develop a prosperous as well as a just society is through the mechanism of limited government and sound money. What this would imply is a dramatic reduction in government involvement in economic activity, through downsizing, deregulation and deficits elimination. So the roadmap to high growth with low inflation is actually very straightforward. What is usually lacking in societies is the intellectual clarity and the political will — perhaps far more of the former than the latter. The sad part is that this clarity is missing even amongst the well-intentioned business leaders as well as the public at large.

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Sustainable High Growth with Low Inflation

Deficits Elimination: As Peter Schiff would say, “The cost of government is not what it taxes, but what it spends”. Eliminate the fiscal deficits in sweeping steps from the current 3+ per cent to zero in three years by balancing the budgets. Then do the same for the state governments as well and get the government finances under accrual accounting.

The amount of capital that a reduction in government expenditure would free up for investments would be enormous. We would have a dramatic decline in interest rates, an upsurge in the value of the Indian rupee, and an unparalleled boom in the economy. We can really have all the growth in the world with even falling prices and never have to worry about inflation.

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What really happens when a government reduces its expenditure (whether social spending or infrastructure) is that this allocation of capital happens through the private sector. Not only will the project execution be far superior, but mistakes would be corrected faster, and funding get prioritised on the basis of the most attractive returns/ deserving ones. From decisions made on the basis of political expediency, it will be made by successful entrepreneurs based on capital raised in the market.

Deregulation: If taxes were the millstone against productivity, regulations were performing the job of delivering death through a thousand cuts with clinical efficiency. We have substituted an ineffective judicial system with a horrendous regulatory system that is choking entrepreneurship and rewarding crony capitalists. Most regulations really serve the purpose of limiting competition on behalf of the bigger well-established firms and very rarely serve consumer interests.

The best of regulations come from the marketplace and there really is very little need for the government to impose its judgement and wisdom on the markets. Even in terms of non-consumer issues such as labour laws, the markets enforce these standards in a far superior way. The best working conditions happened in the IT sector when employers used working conditions and employee satisfaction as a means of competitive advantage. That’s what eventually happens when markets are allowed to work.

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The philosophical guide to reforming government finances

Defining the destination is easy and it is the path that is difficult. When we decide to cut expenditures with a chainsaw, that is when the really critical and tough trade-off questions arise. I will provide some pointers and guidelines on some of the issues.

The Role of Governments in a Civil Society: The primary aim of the central government has to be just two functions — protection of private property and enforcement of contracts. This would imply the defence, police and justice system. Most of the other activities that the government has taken upon itself, from defining school syllabi, to textiles to railways, civil aviation, certifying movies etc are all pure market functions.

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It’s not that the central government has to hand over power to the markets overnight. Though that necessarily would not be a bad thing. But just devolve decision making to the state and local levels. At least there’s a good chance that some state government would see the benefits of a market economy and not insist on playing the role of adjudicator doling out carrots to their constituency. Let the states retain the benefits of a prospering economy and the ones falling behind would be forced to follow suit by the local population.

The Moral Case Against Freebies: Governments like to pretend that they are the equivalent of kings and that they can give something free to their citizens all the time. But the truth is that governments do not have any resources of their own and that they have to tax (or borrow, or worse, print) before they can give. What the average citizen doesn’t realise is that what a government gives with the right hand, it takes even more with the left hand through inflation.

But my main issue with subsidies is not how its funded or the mass leakages within the system it incentivises. It’s the very idea of servility and dependency that we create in the minds of the masses that look up to the government for everything.

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It’s this destruction of pride and the virtues of a self-reliant society that will take a long time to recover from.

The Vice of Equality: Election after election has been fought on the theme of the rich-poor divide and the promise of bridging the gap. The economic truism is that it is the very promise of inequality that is the basis for progress. One of the main reasons an entrepreneur works hard and spends sleepless nights is the promise of the reward he can enjoy were he to be successful. If everybody is going to be equal, or even almost equal, the most important incentive for innovation and progress would be taken away.

What citizens need is equity in the growth of an economy and not equality in outcomes. What a civilised society should aspire for is a basic level of facilities for the poor and that’s what the invisible hand of the free market automatically delivers in a prosperous society. Again, even a casual study will reveal that the rich-poor divide is the highest in centrally planned economies as opposed to the developed ones. So this topic of equality is really an election issue/ rallying cry for the communists and their solutions would really worsen the overall economy.

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Interference in Market Pricing and Voluntary Contracts: Whether it’s the case of a government ruling on fee structures that schools can charge, or governments deciding on the usage of genetically modified (GM) seeds, or the minimum support price (MSP) policies on foodgrains, or playing the role of pricing arbitrator on sugarcane — these are all Stone Age practices that stem from the belief that government knows best. Just allowing voluntary contracts between market players and the “invisible hand” of the markets would automatically lead to the most beneficial outcomes for everyone.

For every market inefficiency that we observe (for example, most private colleges in Tamil Nadu were started by bootleggers and politicians), there would be a less observable government regulation that caused it. Our system never allowed genuine academicians to get into this arena and instead of trying to change the regulatory landscape, we are intent on fixing the fee structure by government fiat.

Imagine the scenario we would have if governments had insisted that software companies could not recruit more than 500 people (due to the undue bargaining power it would give to the large employer over the employee — or for any of those logical sounding and yet, inane reasons). This is what we have done in agriculture through absurd land, labour and other laws that have pretty much strangulated the sector beyond redemption.

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We cannot solve this by spending more money on water infrastructure or greater subsidies or mandated technology transfers from Israel. It has to only come from repealing laws that would allow greater flow of private capital and technology to this sector.

Consider the rank absurdity of some of our flagship schemes — like MNREGA. The Indian government is actually paying our rural population not to work. Forget the attitude of servility and lack of self-respect that we are building in our population, we are actually diverting scarce resources away from productive activities. Don’t blame the implementation, as there’s no conceivable way for a government to direct resources towards economic activities, especially at a very local level. If somebody had deliberately wanted to destroy Indian agriculture, they couldn’t have come up with a more ingenious plan.

If ever there was a sector that is in crying need of complete deregulation, it is the agricultural sector and that’s where most of government meddling has happened over the decades. We shouldn’t be surprised with the consequences of rural poverty and farmer suicides. It is a very logical outcome of our regulatory system and very little to do with inadequacy of capital.

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The Case Against Subsidies: We cannot be running a society wherein a majority of the society comprises beneficiaries of government largesse. Especially the ones aimed at age 16 and above. We have to identify a targeted subsidy mechanism intended at the real needy — perhaps no more than 5 per cent of the population. Even this should really be seen as a transition mechanism because of the expectations that have been built up over the decades. Robbing Peter to pay Paul is hardly an ethical activity, though it fits in very well with the practice of democratic politics.

Government-sponsored healthcare and education are not necessarily the signs of a developed economy. In fact, as the US economy will demonstrate in the next few years, these are the means of converting a developed industrialised society into a basket case.

Complete Elimination of Income Tax and Corporate Tax: The moral case against the income tax is perhaps the strongest. As Ron Paul would argue, this assumes that the government owns the lives and labour of its citizens. With multinational corporations becoming the norm, the corporate tax also leads to all sorts of cross-border manipulations with litigations. We can easily substitute this with excise, GST and of course, a dramatic reduction in government expenditure.

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By no means is this a complete set or even an easy-to-implement set of guidelines. But this ought to be the philosophical basis for decision making. If we insist on governments micro-managing contracts, subsidising all sorts of activities and incentivising sloth, it’s hard to make a case that India will be a developed nation even in the next 100 years.

A Bridge Too Wide?

Having said all this, we do live in the age of democratic politics where a privilege, once granted, is hard to take away. One of the best ways to reach the destination would be to maintain the basic social services on education, health etc. at current levels of expenditures and allow growing revenues to bridge the gap. The rising levels of prosperity coming from a growing economy would automatically eliminate the need for some of the above services, as citizens would gravitate towards better and private solutions, even if it means paying from their pocket.

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However, the cultural change needed in the minds of our people can only come from elimination of schemes like MNREGA. It’s impossible when on the one hand, the government treats people like beggars, handing them free money, colour televisions, bus passes and pressure cookers, while on the other hand, the market expects them to have the responsibility of developing the skills needed and taking pride in their work.

The connection between inculcating self-respect and rejecting government doles is not far-fetched at all. The Swiss rejected the concept of a basic income for all (a fairly good $2,500 per month) by an overwhelming majority of 77 per cent, while I would find even educated Indians toiling to get a free bus pass worth a few hundred rupees. Perhaps it’s a bridge too wide, especially when we do not even realise that we have to cross it. And governments thrive on the existence of an attitude of servility.

What are the chances that Modi would proceed in this direction? Practically zero. In the last few years, the reforms that we have seen are of the marginal variety and not on the scale that are adequate to face the challenges ahead. A pity in some sense, as Modi represents India’s best hope for a giant leap.

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