Election over, what now for India's economy?


Supporters of Hindu nationalist Narendra Modi, the prime ministerial candidate for India's main opposition Bharatiya Janata Party (BJP), cheer as Modi addresses a public meeting in Vadodara, in the western Indian state of Gujarat, May 16, 2014.

Article Highlights

  • India is still quasi-socialist and has not decided how to achieve economic reform.

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  • The new government must focus on domestic issues like land, labor and interstate reforms.

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  • If the new government can get the ball rolling, India can fulfill many lofty expectations.

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The Indian election is over. Does this mean Indian economic reform will restart?

There is no point expecting India to adopt an ideal economic reform program. The country is still full of quasi-socialists and has not made up its mind what it wants, much less how to achieve it. Nonetheless, the election offers a genuine opportunity to initiate high and sustained income growth.

The victorious Bharatiya Janata Party (BJP) seems to have realized that market-oriented reform is required for continued economic development. The question is whether its governing coalition will have the vision, courage, and political capacity to implement critical reforms, or will falter in favor of short-sighted populism.

The needed reforms are familiar to those who watch India: clearer rights to land, a freer labor market in manufacturing, and reduced barriers between Indian states. The most fundamental of these involves individuals and households: clear land rights.

Land ownership is the single biggest factor holding back Indian economic development. Land boundaries are unclear and rights attenuated, with individuals, local bodies, states, and the national government all making claims. A new land acquisition law enshrines collective ownership, denying a basic right to rural poor.

Because private ownership is limited, basic choices such as what crop to grow entail government action. As a result, food grain availability may actually be dropping. Distribution is a problem but so are yields, which are inferior across the board. Land rights would allow better farmers to easily buy land from worse farmers, boosting yields.

India suffers from mass poverty and rising inequality. China started its reform by granting a small measure of control to farmers, drastically increasing agricultural productivity and slashing poverty and inequality. Even modest steps toward clear private land ownership in India would enrich the poor far more effectively than handouts have.

The second most important change concerns firms, in particular their ability to fire workers in the manufacturing sector. This is indispensable if India is to employ its huge labor force.

There are 600 million people under the age of 25. It is therefore frightening that labor force participation seems to be falling, from about 61 percent in 2005 to below 56 percent now. India must be a job creation machine and manifestly is not. Demography could become a curse.

To create large numbers of jobs, manufacturing should imitate services. Manufacturing firms with more than 100 employees cannot close or sharply downsize without government permission. The services labor market is far less restricted, which has encouraged expansion and hiring. Unsurprisingly, many Indian services firms are globally competitive. If manufacturing can match this competitiveness, it can add 100 million jobs.

An end to restrictions on firing may need to occur state by state and with limitations for public enterprises. But, as with land rights, manufacturing liberalization will reduce poverty and inequality.

The third vital reform involves states. The walls between states undermine the idea that India has a true national economy.

Remarkably, states occasionally ban trade with each other. Regulatory and transit barriers inhibit agricultural output and contribute to wasted produce, even though malnutrition is still prevalent. There are clashing labor regulations. Workforce expansion could be much heavier in northern areas and, if migration is deterred, dangerous local unemployment may arise.

There is no national tax system; rather, mismatched taxes are imposed at state boundaries. There are multiple indirect taxes applied in each state and the kind of tax varies, as states chase revenue.

The most visible action to unify the economy would be a common Goods and Services Tax (GST). This would bring many advantages of scale a huge country is supposed to have. A simple and transparent GST would improve the competitiveness of Indian products internally - greater value to consumers - and externally.

Implementation of a common GST has gone nowhere for years. If a national GST is unworkable, the new government should start the process with those states willing to participate.

Trade and investment reforms may be conspicuous by their absence from the top three. They are secondary to successful development of a large economy. Foreign interests may even find they prefer a domestic emphasis - for example, being able to buy land is the single biggest obstacle to most investment.

In any case, India must address internal challenges first. And enhancing individual land rights, liberalizing manufacturing labor, and starting to unify the internal market already constitutes an daunting challenge. Fortunately, there is a silver lining to recent ineffective policy - only one area may be needed for a breakthrough.

The new government should pick the most feasible dimension on which to start. An advance in that area will bolster the national economy, bolstering productivity and growth and likely reducing inequality. This, in turn, will build support for reform in another area.

Such gains would not only be political. For example, a more unified internal market would boost the return to land ownership, making land rights even more rewarding for the poor. Reforms could feed off each other. If the new government can get the ball rolling, India can fulfill many lofty expectations.

Derek Scissors is Resident Scholar at the American Enterprise Institute and an adjunct professor at George Washington University.

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