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Economy Sep 21, 2012

If these are economic reforms, I'm Amitabh Bachchan

By R Jagannathan

Anyone who's never tasted butter will be glad to accept margarine as the real thing. This is the case with reforms and the UPA government. Having never seen real reforms for more than eight years, everyone has forgotten what real reforms are all about - changing the game, not the player uniforms. The recent burst of "reforms" are actually little more than palliatives - however welcome they are as a signal of change.

Ask yourself:

How is raising diesel prices to prevent bankrupting the oil companies reform? This is like saying sending a heart patient to the ICU is a sign of rude good health.

How is the sale of public sector shares - without any impact on the management - economic reform? Is selling your silver to feed your family a sign of terrific intelligence? It is a mere survival tactic.

Have they missed the reform bus? Reuters

How is permitting FDI in aviation and big retail reform? Investment was always open to domestic investors; even foreign investors could invest in both sectors with conditions. What has really changed is that foreign airlines can now invest in aviation (earlier, only non-airline companies could). This change is thus about eliminating a stupid rule imposed by crony capitalism earlier.

As for retailing, foreign companies were permitted to invest in the back-end even earlier. They were barred only from the front end. If the main benefits of big retail are supposed to come from back-end ops (cold chains, wholesale trade, reduction of middlemen, etc), but this option was always available to the Wal-Marts of the world. So putting a Wal-Mart board on the storefront is reform? Of course, this will make them invest more, but one can only call this incremental reform, not Big Bang Reform.

Now consider what the pink press considers "more" reforms. This morning's Business Standard informs us breathlessly that there are "no signs of reforms abating", and adds that "the government is set to go ahead with its reform agenda - be it restructuring of loans to state electricity boards or a hike in the cap on FDI in the insurance sector...".

So rescuing bankrupt power distribution companies (losses: more than Rs 2,00,000 crore) with even more grants and loans is reform? And allowing foreign insurance companies to invest more is big reform. The first step is unavoidable, since you can't allow the power sector to collapse. The second measure is again incrementalism is at work. Both are needed, but hardly anything to throw a party over.

The Economic Times runs a reforms story under the ecstatic headline: "Govt's only Answer to Bandh: More Reforms." The paper says: "PM Manmohan Singh is expected to underscore the return to muscular governance when he addresses the nation on Friday to explain the economic rationale behind the government's decisions to hike fuel prices and allow foreign supermarkets into the country."

The reforms ET talks about are raising the price of sugar for below-poverty line (BPL) families by Rs 3 a kg and allowing FDI in pharmaceuticals. So raising sugar prices from Rs 13.50 to Rs 16.50 a kg when the factory price is Rs 39 is reform. The word is incrementalism again.

"Muscular governance" is not a phrase that anyone would associate with the UPA for the last eight years, and if the PM wants to explain the "economic rationale" of his recent decisions, the most obvious question to ask will be: who ran the economy into the ditch that we need all these "reforms" now?

Pratap Bhanu Mehta is trenchant in his criticism of the Congress' new-found enthusiasm for reform and the trap it has set for itself. Writing in The Indian Express, he says:

The fact that these reforms are coming after four years of colossal mismanagement is making the reform narrative problematic. Admittedly, there was a global financial crisis that required a different policy response. But politically it is not easy for the government, after running all fiscal responsibility into the ground for four years, and after stoking structural inflation, to turn back and accuse opponents of being populist. The crisis narrative is a double-edged sword: it makes the case for reform compelling. But it also exposes the complicity and opportunism of government.

Moreover, the reforms now being thought of have little to do with the kind of things India nearly needs. A reform can be defined as something that will fundamentally change the game, improving economic efficiencies, improving governance and the delivery of government services, enhancing the autonomy of economic agents (companies, job-seekers), and reducing wastage in administration - among many other things.

Loosening up FDI in this sector or that will also contribute to such efficiencies, but they are simply not game-changers.

The real game-changing reforms sometimes need even greater political will than the kinds of things announced on Big Bang Friday. Consider these reforms, some political, and others economic.

Deregulation and freedom to produce and prosper: India has simply too many regulations for business, and these are badly implemented. Whether it is starting a business or running it, there are simply too many clearances needed, and even after that there are the cohorts of corrupt officials to feed - from factory inspectors to labour inspectors to environment safety regulators to every other kind of regulator. Not to speak of excise officials and tax collectors of every kind.

Abolishing and simplifying most of these regulations and reining in the rent-seekers of the licence-permit raj will free Indian companies to compete, including the badly strangulated small and medium enterprises that create all the jobs. It is not the Tatas and Birlas and Ambanis who create lots of jobs, but the little guys setting up shop in places called industrial estates.

Creation of a single national market: In many agricultural commodities, states place their own restrictions on the movement of agri-produce by creating intermediaries like the Agricultural Produce Marketing Committees - where farmers are forced to sell their produce. This forces all sellers to compete on the same platform and reduces their bargaining power vis--vis middlemen. The APMCs also inhibit inter-state movement of agri-produce, and increase the prices for end-consumers. It is time to abolish them.

The goods and services tax (GST) - which will combine excise, service tax and state value-added taxes into one combined levy - will also create a single market, but it is the Centre that holds the key. The states, which will lose their revenue autonomy once GST comes into being, are holding out for assurances that their revenues won't fall once it happens. The Centre claims revenues will rise - but is not willing to bankroll states if it turns out to be wrong.

This reform is doable if the Centre merely promises to make good any state's projected revenue losses for, say, the next three years.

Labour reforms: The biggest barrier to the creation of more jobs in manufacturing and in the organised sector is India's labour law - which makes retrenchment very difficult. However, the net result is not that companies are not laying off employees, but they are not recruiting them in the numbers they can.

Big companies are simply substituting automation for labour (this is why the Tatas and Birlas create fewer jobs than the little guys in small factories and construction sites), and jobs growth is slowing. Most political parties, and especially the Left, are opposing labour reform on the assumption that easy retrenchment will be labour-unfriendly, but this is wrong. There is nothing which prevents the government from legislating good compensation and retraining for labour that needs to be retrenched.

The point is this: without the right to fire, with humane conditions attached, few employers would want to hire when business cycle conditions can improve or worsen in a volatile marketplace.

Bankruptcy law: India has a bankruptcy board - the Board for Industrial and Financial Reconstruction - but it is simply not as easy and effective as America's Chapter 11 bankruptcy law.

What applies to labour applies to capital too. If you cannot exit a company, few people would want to set up one too. India needs a dynamic bankruptcy law that allows failing companies to quickly seek protection from creditors, rework its loans and obligations, and then either emerge from bankruptcy or be sold to the highest bidder or closed down for good.

A good bankruptcy law is the key to creative destruction under capitalism.

Welfare reform: Governments - both at Centre and state - spends thousands of crores on welfare schemes and subsidies. Whether it is make-work schemes like NREGA, subsidised gas cylinders or cheap grain sold through the public distribution system, at least half the money spent goes into the wrong hands.

A proposal to give the poor cash subsidies, instead of subsidised food or kerosene, is the key to welfare reform. It will enable the state to ensure that money goes only to the poor (since they will be identified), ensure financial inclusion (since the poor will now have free banks accounts) and make the product markets function efficiently (Currently the government pays high prices for foodgrain, then sells it at subsidised prices to the alleged poor, and half the grain is sold in the market for profits to middlemen and shop owners. None of this can create a clean market for rice or wheat.

Subsidised kerosene is used to adulterate diesel, and subsidised cooking gas is sold to canteens and restaurants, and even taxis and steel welders. There are illegal profits to be had. Subsidised fertiliser is being overused, and farmland is being ruined - necessitating even more use of subsidised fertiliser to obtain the same output. A vicious circle is ever there was one.

Instead, if a poor farmer gets his fertiliser subsidy paid in his account he will use fertiliser more efficiently (since he now has to pay the market price for it), and the fertiliser market itself will become more competitive as companies woo farmers to buy their brands.

Paying cash subsidies creates a consumer out of a welfare recipient - making him less of a supplicant for the state's favours.

The Unique ID Scheme would have been the perfect vehicle to identify and route cash subsidies to the deserving, but internal wrangling between the home ministry (over the creation of the National Population Register) and Nandan Nilekani's UID Authority of India over who will collect and issue unique IDs ended up with a split mandate - and needless delays in the creation of a unified national ID database.

This reform has been begging to be implemented ever since the UPA decided to make welfare its themesong.

Expenditure reforms: The Centre clearly needs to shift expenses away from consumption to capital spending. But in a situation of fiscal stress, even spending cuts end up chopping the wrong expenditures. This is because consumption expenditures (salaries, overheads, etc) are on autopilot, and capital spending (on machinery, fixed assets) is the only thing that is easy to cut. Net result: investment in capital goods suffers, while money is wasted on unproductive heads.

There are three ways to prevent this. One is to treat all spending as project spending where the administrative and capital costs are allocated upfront. Limits can also be set for administrative expenses as a share of project costs to keep them lean. Secondly, the finance ministry can stipulate that every new spending proposal from any ministry should be accompanied by its own means of financing. (Read our earlier post here).

For example, if the food ministry, under directions from Sonia Gandhi, wants to implement a Rs 1,30,000 crore Food Security Bill, it should ask for a specific food security cess on excise to fund that. Also, spending ministries have the option of funding a part of the social spends through voluntary contributions, too. The job of government is to enable worthwhile social spending, not do all of it itself.

The third expenditure reform is zero-base budgeting. Currently, a project started five years ago will continue to bleed the exchequer indefinitely merely because it remains unfinished, and even though it may no longer be needed. With zero-base budgeting, every project will be re-evaluated every year so that if its utility is gone, the government can cut its losses. As unneeded projects are scrapped, the budget deficit will get smaller.

Electoral reforms: State-funding of elections will reduce substantially the political need for slush funds and corruption. It can easily be funded by abolishing the MP Local Area Development Scheme (MPLADS), which gives each Member of Parliament Rs 5 crore every year to spend on his constituency.

But the big parties want to retain their financial advantage, by not reforming election funding. Congress, BJP, and the big regional parties have no interest in electoral reform since it will start closing out their ability to raise big money privately by doing secret deals with businessmen in areas which need government clearances - like allocation of coal blocks, spectrum, land or even environment.

The MPLADS scheme is also a way for party bosses to keep their own MPs in line by giving them a budget to spend on their constituencies. The MPs can use the money to favour themselves with construction contracts, among other things.

Public sector reform: Politicians like to use public sector companies under their ministries for private ends - fiddling with contracts, using their resources for private purposes, and misusing surpluses for bankrolling political subsidies (as ONGC subsidises the oil marketing companies), et al.

This is how Air India, the public sector oil companies, and the two telecom companies (BSNL and MTNL), among others, have been run into the ground. Dayanidhi Maran, when he was Communications Minister in UPA-1, is said to have used a private BSNL exchange to benefit his brother's company, Sun TV.

The key reform needed is to take public sector management out of the reach of ministers - something no coalition partner will currently allow - unless the lead party in the coalition sets an example and moves the public sector shareholdings to a separate holding trust or company or otherwise insulates public sector managements from political interference.

If the government wants to fix end-prices or subsidise them, it should indicate what subsidy it will pay to public sector companies (for, say, diesel or cooking gas or even power) and then allow them to decide whether it is worth it or not.

There can be many more such true reform ideas. This is what reform really ought to be about. Opening a FDI tap here or raising a diesel price there is not Reform with a capital "R'.

If these are Reforms, I'm Amitabh Bachchan.

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by R Jagannathan

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