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Incomplete Capitalism Holds India Back: K.V. Subramanian

K.V. Subramanian, India’s executive director at the International Monetary Fund and former chief economic adviser to the Central government, minces no words while pointing to flaws in the economic policy of pre-Narendra Modi era. However, he is optimistic about India’s growth potential amid the global slowdown and attributes the country’s stability in face of the challenges brought about by Covid-19 to its refusal to imitate others economies. In an interview with Kamalika Ghosh, he recounts the hits and misses of incumbent and earlier governments during India’s economic journey since independence

Photo: Suresh K. Pandey

Why has India, unlike China, failed to grow in double digits over the last 30 years of liberalisation?

Liberalisation opened the products markets to competition. But we did not open the factor markets for labour, capital, power, logistics and overall economies of scale in our firms. As a result, we exposed our firms to competition but did not enact the economic policy that equips them to compete with the world. Neither did we undertake labour reforms nor we cleaned up the banking sector. Equity markets did develop well, but we undertook no reforms to enhance the quality of debt capital, especially bank capital in our country. In the power sector, we continued cross-subsidising and therefore power remained costly for our manufacturing firms. We did not do enough in building physical infrastructure, like highways, roads, ports, airports, etc., and therefore the logistics costs that our firms faced remained high. And we pursued an economic policy that perversely encouraged the phenomenon of dwarfism. When firms are small, their average costs are high. When you add up all these costs of capital, labour, power, logistics and diseconomies of scale, each one being about 10% to 15% higher than Chinese firms, the cumulative cost for Indian firms was about double that of Chinese firms.

In contrast, not only did China get all these things right but it also made space for state-sponsored capitalism, where it actively subsidised its firms. Chinese firms’ costs were thus far lower than those of Indian firms. They could spread their cheap products to the entire world even while making profits. So, China had state-sponsored capitalism while India had incomplete capitalism.

Until 2014, we did not venture into opening our factor markets to competition. Despite all these disadvantages, if India has grown at an average of 7% plus, that is testimony to the quality of India’s entrepreneurs and the work ethics of our working class.

Does India have the potential to grow at 10% plus?

Undoubtedly, but with a caveat. I think the role of economic policy in removing frictions in the economy is extremely critical. We have to unwind so much of the damage that has been created by Nehruvian socialism. For instance, if you look at the power sector, the banking sector, the logistics sector, infrastructure and the labour market, the inefficiencies in these are all because of the faulty economic policies that were pursued.  

Economic policy is not rocket science. All it needs is careful thinking and good intent. Broadly, if we leave out a couple of exceptions like liberalisation and the reforms by the Vajpayee government, what good has economic policy served in India? As I said, it is not rocket science that public goods need to be created, infrastructure needs to be built and education and healthcare need to be fostered.

If the economic policy identifies frictions in the economy and goes about removing them carefully and diligently, as the government has been doing in recent times, there is no reason why we cannot hit double-digit growth. Reforms must continue to be focused on the factor markets. It is the factor market that will enable the manufacturing sector growth and create jobs for the large section of the middle part of the pyramid, thereby encouraging consumption, and move the “virtuous cycle” faster to create widespread prosperity. 

How do you think reforms like demonetisation, goods and services tax and digitisation have added to the growth rate of the India economy?

When I took over as the chief economic adviser in December 2018, I was handed an economy that was slowing down. People were speculating that there is a structural change in our growth trajectory. As we demonstrated with rigorous evidence in the 2019–20 Economic Survey, the entire overhang was because of the financial sector problems. The growth slowdown was because of financial sector problems and not because of demonetisation or GST.

What we did during the Covid-19 pandemic contributes to the India story, going forward. In my memory, it was the first time India had the courage and the self-confidence to do what was right and not just mimic the advanced economies. The advanced economies pursued profligate fiscal policy. In contrast, India recognised early on that Covid-19 would be a huge supply-side shock. Let me contrast our economic policy during Covid-19 to what India implemented during the [2007-2008] global financial crisis, where the government then delivered inflation in the double digits for 18 consecutive months. Note that this high inflationary environment was without any supply-side issues at that time. In fact, inflation peaked at 18% in one of those 18 months. Had we copy-pasted what the rest of the world did during Covid-19 or what India had implemented during the global financial crisis, we would have been staring at 20% inflation for two years.

People need to understand why we had to strike a balance between demand and supply. It was important to take into account that Covid-19 was a supply-side shock. We entered Covid-19 with sovereign ratings agencies lowering their economic outlook on India when we were just one notch above non-investment grade. If we had gone and spent profligately like we did during the 2008 crisis or how other advanced economies did during Covid-19, we would have possibly been staring at a sovereign rating downgrade. And a downgrade would have meant that we would have not been investment grade anymore, resulting in huge capital flight.

See the outcome now—while advanced economies are facing 2.5 to four times their historical level of inflation, our inflation is less than our historical average of 7%. That combined with this year’s growth prospect of 7% and similar growth prospects going forward, should make it clear to people as to who is all talk and who walks the talk on good economics.

Are we on the right path as far as reforms are concerned? What should the government do to achieve its potential rate of growth? 

I have no doubt in my mind that we are actually on the right path. But in terms of economic growth and policy, I am an impatient person. For instance, on privatisation, while we have done Air India privatisation, I think we need to do more. Many years back, the Union cabinet had already approved 40-odd companies for privatisation. Yet, we have done only one privatisation—Air India. There is a strong need for a push on this.

We need to do more on ease of doing business. We have been handed out a lot of overhangs, both from the socialist era and the 2004–14 period when a lot of good work done on reforms side was undone. We need to move faster on compliance, and this part is not as much on the Central government as it is on state governments. State governments need to understand that to do economic good for their people, they have to focus on reforms. And there cannot be a better example of that than Gujarat. Many [state] governments often fear that if they reform, they cannot come back to power. But I think that the majority with which the Gujarat government has come back to power shows that if you deliver value to the people in the form of economic prosperity, voters recognise such work. Even Madhya Pradesh is an example that if you deliver economic prosperity to the people, they will recognise that.