The republic is at an economic crossroads

India will complete 75 years of its freedom on August 15 this year. This important milestone deserves a critical appraisal of the progress we have made as a nation. 

However, the larger framework that guided our nation-building project in the political, economic and social realms only came into being when we adopted our constitution on January 26, 1950. 

As India celebrates its 73rd Republic Day today, it is useful to take stock of the economic journey of the country.

What should be the guiding principle for such an exercise? The original preamble of the constitution – the 42nd amendment in 1976 inserted the word socialist in it – provides for an interesting tension in the economic trajectory of the republic. 

The constitution seeks to make India a sovereign republic, but also calls for ensuring social, economic and political justice. 

Sovereignty, when seen purely from an economic perspective, can be roughly described as growth in economic power of a country. This is best captured by GDP levels in the modern world.

But is growth a harbinger of equality?

Economists often argue that the two might actually be more congruent in the long-term. Simon Kuznets, the Nobel Prize winning American economist, is the most famous and influential proponent of this view. He theorized that inequality first increased and then decreased with increase in per capita incomes.

The experience of China seems to support Kuznets’ larger message. The Chinese state, although a communist dictatorship, has done well to achieve high economic growth and also achieved a sharp reduction in poverty in the past few decades.

Did too much democracy actually act as an impediment to economic growth in India? Does it continue to do so? 

The government being forced to repeal the farm laws due to persistent political protests (read democracy) last year can be held out as one such example by those who believe that those laws would have boosted farm incomes. 

After all, given India’s democratic framework, no government would like to sacrifice itself by pushing policies that have widespread political opposition.

The growth-equality tension is not the only one within the constitutional framework. 

The constitution envisions India as a union of states. Fiscal federalism is among the founding principles of the republic. Has the federal framework helped our economic journey in the past seven decades? Or, did it create more hurdles in the march to economic prosperity? What should be the way forward?

While the word socialism made a de-jure entry into the constitution during the infamous emergency, it is no secret that India’s economic policies, at least in the first few decades after independence were heavily influenced by the economics of the socialist countries.

From India’s Soviet Union inspired Five Year Plans – the constitution did not provide for a Planning Commission – to the commanding heights of the economy being an exclusive preserve of the state, India’s so-called mixed economy framework had a strong socialist flavour. 

Was this pro-state tilt in economic policy a costly mistake? Is it time to wind up the already reduced state presence in economic activities even more?

These are all questions that evoke strong and extremely polarized reactions in India’s public debates. The truth, as is often the case, lies not in a black and white approach to any of these questions. 

In fact, the experience of the past seven decades shows that when it comes to the economic well-being of the republic, the best foot forward must be decided by deliberating on the situation at hand, rather than blindly accepting or rejecting the policies of the past. This argument is best made by a set of examples.

Shunning the private sector, and shunning a part of the private sector, both have hurt growth

Were our founding fathers wrong in adopting a state-led, plan-based model of economic growth at the time of independence? That such a model was chosen may have to do with no other option being available. 

Private capital in India did not have the economic prowess to undertake large-scale economic activity after independence and in fact wanted to state to take up this job. 

The 1944 Bombay Plan document (it was a private proposal for economic development in post-independence India by some of the biggest industrialists of the time) is testimony to this fact.

However, what started as a state-led model of last resort ended up mutating into an economic system which created absurd controls on private sector activity that were counterproductive. Most of these fetters were dismantled when India unleashed large-scale economic reforms in 1991. Have reforms been unambiguously good for the cause of economic growth?

The answer would have been a big yes if we were asking this question a decade ago. However, a fall in compound annual growth rate (CAGR) of GDP in the past 10 years – this holds even if we exclude the pandemic year – shows that economic growth needs more than just reforms.

There is a widespread belief among independent economists today that the slowdown in economic growth in the second half of the last decade is the result of a policy induced squeeze on the informal sector in India. 

The larger message to be drawn from this trend is that while the pre-reform economic regime fell behind time in realizing the importance of private capital in India, the current regime may have faltered in trying to get ahead of time in wishing away the informal sector in the country.

State is not just about welfare, its economic footprint also brings a lot of positive externalities

The pandemic has taught even the most ardent free marketers the importance of welfare spending. 

In India, it brought to the fore the gross deficiencies in our public health system, as people struggled to access lifesaving medical care. Criticism of India’s poor track record in providing basic social services such as health and education to its people is not something new. 

For example, economist Amartya Sen has had a longstanding critique of India’s post-independence economic strategy being obsessed with physical production rather than human development.

Should the state then focus on just basic social services such as health and education? Has the time come for the state to finally withdraw from purely economic sectors such as banking? It has already withdrawn from the manufacturing economy to a large extent. The answer to this question must keep in mind among the most important and often under-appreciated concept in economics, that of externalities.

The state, when it enters an economic activity, does not just operate on a profit motive, and while not doing so, does a lot of work which strictly profit-driven firms would not do. 

The social capital which India’s public sector based industrial towns gave to the newly emerging middle class is one such positive externality.

Even today, the state’s presence is critical to realizing many of the ambitious inclusion programmes governments wants to pursue. For example, private sector banks – which are generally more profitable and efficient compared to their public sector counterparts – accounted for only 13 million out of the total 444 million beneficiaries of the government’s Jan Dhan Yojna, a no frills banking scheme. 

Would the scheme have been as successful had the public sector banks not taken this task on themselves, disregarding the profitability of the exercise? It will be naïve to think that state withdrawal from any critical sector will not unleash effects in the realm of externalities.

Political competition and the short-termism in the state’s economic approach

With political calculations driving economic decisions, long-term problems which involve taking on politically important communities have mostly been kicked down the road.

India’s half-hearted approach to land reforms immediately after independence was an outcome of the Congress’s dependence on local landowners for its political needs. 

A radical redistribution of land – even the US-led capitalist block promoted land reforms in some south-east Asian countries after the second world war – would have reduced economic inequality and given a boost to domestic demand. This is a reform that has lost its relevance today as landholdings have become extremely fragmented with time.

Similarly, a large number of problems – environmentally unsustainable farm practices, pending dues of electricity distribution companies and skewed procurement from just a few states are some – associated with the existing agricultural subsidy regime in India are rooted in the fact that almost all political parties promote such behaviour during local elections.

While the agriculture example is more relatable, political short-termism driving economic policy is a much larger problem for the Indian economy. 

The tendency to dilute environmental safeguards to expedite private investment, governments (especially at the state level) announcing a large number of cash-transfer schemes even as resource requirements on critical fronts are ignored, and the political temptation to use reservations as a silver bullet for all economic problems, are more such examples.

However, at a time when the Bharatiya Janata Party (BJP) as the new national political hegemon is seeking to squeeze regional political formations in state through the twin strategies of politically leveraging welfare schemes like never before and gaining an unprecedented lead in political funding (largely from big capital), such desperate attempts are only likely to increase. 

Given the increasing importance of spending by the states, this means a growing short-termism in resource allocation by the state.

It is in handling these three pitfalls – the state’s urge to dictate terms to the market, treating its own economic activities on par with the private sector and prioritizing short-term political gain over long-term interests, especially of sustainability – that the economic future of the Indian republic will depend.