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Unshackling the Old Economy

Arvind Panagariya

            Speaking to the U.S. Congress during his recent visit to the United States, Prime Minister Vajpayee noted, “In the last ten years, we have grown at 6.5 per cent per year: that puts India among the ten fastest growing economies of the world.”   He boldly went on to add, “We are determined to sustain the momentum of our economy: our aim is to double our per capita income in ten years -- and that means we must grow at 9 per cent a year.”

Vajpayee is to be applauded for setting ambitious goals for the nation he leads.  After all, no general ever won a war without being ambitious.

The bad news, however, is that the Prime Minister’s resolve is about to be tested.  Finance Minister Yashwant Sinha must soon present the second budget of the present government.  If he fails to announce bold new initiatives, the Prime Minister better shelve his goal of doubling India’s per-capita income in ten years.  If tough decisions are not taken in the first two years of the government’s tenure, they will not be taken in the last three.

            The list of potential reforms is too long to fit this column.  Therefore, let me focus on what I regard to be the most important area to stimulate growth: industry.  The major new stimulus to growth must come from further freeing up of the Old Economy, which lags behind the unfettered New Economy.

Prior to the July 1991 reforms, the conventional industry was shackled in five different dimensions: the heavy industry was a public monopoly, private industry in the organized sector was subject to strict investment licensing, most of the remaining sectors were reserved for small-scale enterprises, labour laws effectively prohibited exit of firms with 100 or more workers, and imports were subject to licensing and exceptionally high tariffs.

            The reforms during 1990s have unshackled the economy in some of these dimensions.  Thus, public monopoly has been abolished except in railways, investment licensing is a thing of the past, import licensing is essentially gone and tariffs have been substantially reduced.

Nevertheless, the process of freeing up the industry remains incomplete in key respects.  If we are to begin growing at 9 percent, immediate action is needed on at least four fronts.

First, our labour laws remain entirely untouched by reforms.  While the workers in the organized sector enjoy absolute protection from retrenchment, contract labour and other workers are under a perpetual threat of being laid off.  Both situations need to be remedied.

Without the reform of labour laws, we cannot take full advantage of the liberalization that has already taken place.  For instance, the Prime Minister recently ended the small-scale reservation for garments and hosiery making.  But potential large-scale manufacturers will still hesitate to enter so long as exit costs remain high.  Exit conditions have profound effect on entry decisions: not many enter the “no-exit” world of the Mafia voluntarily unless they expect to become the Don.

            Second, the process of industrial liberalization will remain incomplete without an end to the small-scale industries (SSI) reservation.  Several hundred key labour-intensive products continue to be reserved for manufacture by small-scale enterprises.  While economic assistance to small enterprises can be defended on income-distribution grounds, there is no rationale whatsoever for the ban on the entry of large-scale manufacturers in these products.  With import licensing virtually gone, our small enterprises must already compete against products manufactured by large-scale enterprises elsewhere in the world.  Why then deny our own large-scale enterprises the right to manufacture these same items?

            Three years ago, the government had appointed an Expert Committee on Small Enterprises.  Led by its dynamic chairman Abid Hussain, the committee recommended an immediate end to the SSI reservation.  The committee argued, “The reservation policy has provided an illusion to the government and the country that adequate protection/promotion was being provided to SSI.  It has actually done precious little for their promotion, and succeeded only in keeping out our large enterprises.”

The reservation policy has hampered the growth of important sectors like light engineering and food processing.  It has also stunted the exports of toys, textiles and leather: small enterprises are simply unable to supply large volumes of high-quality goods in time.  If we are to effectively compete with China in the world market, it is as important to unshackle the SSI sector from the reservation policy as it was to free the organized sector from licensing.

The third area that deserves immediate action is privatisation of public sector units (PSUs).  It may be argued that if private sector grows sufficiently rapidly, the relative importance of PSUs will automatically decline over time.  But the fact is that PSUs constitute a very large proportion of the industry.  We cannot afford to sacrifice their rapid growth and still grow at 9 percent per annum.  That means privatisation.

When pressed on slow progress on privatisation, the government has often taken a cover behind the argument that there is no consensus for it.  This is rather disingenuous.  Precisely what sections of the society oppose privatisation: the man in the city street or the farmer in the village?  Much of the opposition seems to be concentrated in the line ministries themselves, which stand to lose their enterprises without gaining the revenue from their sales, the workers who enjoy guaranteed high-wage jobs without having to work and the top civil servants who fear losing the perks that come with sitting on the boards of these enterprises.

Finally, any serious reform must carry forward trade liberalization.  Despite liberalization, our tariff rates remain among the highest in the world.  Without further tariff liberalization, the economy’s transformation into the producer of labour-intensive goods will remain incomplete.  Understandably, the government faces opposition to liberalization from the domestic industry, which seeks protection.  But good economics says that protection to the domestic industry should be provided through the exchange rate, not selective trade barriers.

Economic Times, January 31 2001