The critical task is to bring States on board in supply-side reforms.
A recent festschrift for the Planning Commission Deputy Chairman, Mr Montek Singh Ahluwalia (Kochar, S. [Ed.], Policy-Making for Indian Planning, Academic Foundation: New Delhi), is an opportunity to reflect on Indian economic policy making.
Change is always difficult; guiding change even more so. Mr Ahluwalia was closely associated with the enormous changes India has gone through, having made major contributions to this process.
An individual’s contributions have inherent limitations. But when he or she helps reform the system — which Mr Ahluwalia has done — the contribution is magnified many times.
India requires mechanisms that moderate the flaws and bring out the best of both governments and the markets.
The book details many examples of such mechanisms. Take India’s public-private-partnership or PPP framework that Mr Ahluwalia helped craft and which recently received high marks from the Asian Development Bank.
But there is much more to be done, and there are enough insights from the book on India’s many continuing challenges that one can pick up.
There are many chapters, for instance, on how to improve the functioning of governments and various institutions. Two critical issues here are public service delivery and farm sector supply response, in both of which the contribution of State governments is vital.
INCENTIVES FOR STATES
The book has a chapter, giving the perspective from the States. States, for example, want to be consulted on any decision by the Centre that affects the pool of its revenues shareable with them. The Centre, could, however, defend itself by pointing out how difficult it is to get more than a certain number of States to agree to anything.
At the same time, non-discretionary mechanisms such as the Finance Commission’s incentive payments have improved the finances of States. Incentives work best when they are immune from political renegotiation.
The Planning Commission and the Central ministries, too, make large transfers to the States. A part of these could be conditional upon improved public services, thereby helping convergence among the States. There is one chapter giving the example of how the Self-Employed Women’s Association, an NGO, has increased returns to its producer-members and lowered prices to consumers by giving competition to middlemen.
Indeed, making a part of the Planning Commission’s allocation to States conditional upon reforming their Agricultural Produce Marketing Committee Acts, which favour entrenched mandi intermediaries, could induce more competition in agricultural marketing.
One can also link such transfers to the speed of implementation measured through e-tracking initiatives.
The book also has a chapter on Mr Ahluwalia’s early and influential work on Simon Kuznets’ famous ‘inverted U’ hypothesis — how inequality first rises with development.
Perhaps, this concern made him support the United Progressive Alliance government’s transfer schemes, although he did voice doubts about pushing more money down a leaky pipe.
But thankfully, a politically acceptable alternative has become available. And that is ‘active inclusion’, inclusion which creates conditions for the many to contribute to, and participate in, growth.
Government activism remains essential here, since there are externalities that limit private investment.
But the activism should lead to provision of better health and education facilities, infrastructure, and public services, thus increasing rewards to work.
Those State governments that are delivering this type of better governance are being re-elected. This active inclusion strategy has hence also become politically rewarding, while being uniquely suited to Indian catch-up growth and increasingly youthful demographic profile.
If the Centre’s initiatives improve governance, the voter would reward it as well.
FINANCE AND CRISES
Another chapter on financial crises points to the lessons that Latin America drew from repeated crises, one of which was to rely more on domestic credit. This has resonance for India today, as we struggle to finance high current account deficits (CAD) with fickle risk-on risk-off portfolio flows.
The chapter mentions active debates in the region on where exchange rates should be — how these suit different purposes at different levels.
There has been similar debate in India arising from the recent volatility seen in the rupee: Depreciation may well reduce the country’s current account deficit over the long term, but it would raise inflation in the immediate term.
Only a more appreciated currency may be consistent with the current pressures from higher average wage demands.
Mr Ahluwalia recognises the dangers of unbridled financial flows, in the current flawed international monetary system.
He even pointed to these during his tenure as head of the Independent Evaluation Office of the International Monetary Fund. In his view, it was India’s capital controls that saved it during the East Asian crisis of the later 1990s.
But in his current avatar, Mr Ahluwalia has pushed for more debt liberalisation, considering the sheer demands of financing India’s infrastructure investments.
If a trillion dollars are required for infrastructure financing, $250 billion can possibly come from foreign savings if the CAD is pegged at about 3 per cent.
But financing these CAD levels is proving difficult in the present context.
Policymakers in the Centre focused on more opening up, because this was something they could do without persuading the States to come along. But it was also required because India was too closed an economy.
But we have reached a stage when foreign inflows are also not coming in, because of domestic supply-side bottlenecks. So, the difficult task of motivating the States to improve the supply-side must receive priority today.
More domestic financing sources must be found through inclusion and improving the financial intermediation of household savings.
The Planning Commission is well placed to contribute to this.
Since Asia is a relatively high-growth region today with high savings rates as well, greater regional financial integration can perhaps be a possible source of stable finance.
That could also be a way of diversifying our opening-up strategy, even while avoiding Euro Zone-type problems.
(The author is Professor of Economics. IGIDR, Mumbai. firstname.lastname@example.org)