devolution

Economic Slump: India’s Rickety Bridge Over Troubled Waters

Sustaining growth amidst a global economic slowdown would require tackling corruption.

Raghuram Rajan, the-then outgoing Governor of the Reserve Bank of India, in an exit interview he granted to Karan Thapar (‘To The Point’, YouTube, September 2, 2016), took satisfaction from the fact that India was “on a more sustainable growth path”.

The remark turned out to be premature. Less than two years later, starting the first quarter of FY 18/19, ominous signs of weaknesses started to emerge. GDP growth, which has been sliding continuously over six quarters, reached 4.5% per annum in the second quarter of FY 19/20. The slide may not be over yet.

If engineers inspecting a bridge find serious structural weaknesses, they can only conclude that the bridge is unsafe. But, their science cannot predict when the bridge will come down. Similarly, a detailed analysis of structural economic weaknesses cannot predict the timing of the next slump. Economists can at best be faulted for not being cognizant enough of the risks to the sustainability of growth.

The euphoria about India’s prospects following the economic reforms of 1991 is understandable. After all, growth had averaged just about 3.5% per annum in the pre-reform period. Moreover, the economy’s performance was more volatile with brief spurts in growth punctuated by painful crashes. The opening up of the economy through less state intervention not only ratcheted growth upwards to about 7% per annum on average, they came with far less volatility.

Also read: ‘Why Let a Good Crisis Go to Waste?’: What India Needs to Remember to Overcome its Economic Slump

According to the United Nations Development Programme (UNDP), some 271 million Indians were lifted out of poverty between 2005/06 and 2016/17. Reports issued by various large US multinational companies like Cisco, Citi and PwC held out the possibility that India would become the second-largest economy in the world after China and possibly an advanced country by 2050. The findings were reported by several major international and Indian newspapers.

Laudable as those achievements were, growth was not inclusive. While the top 1% of earners walked away with 22% of national income, the top 10% accounted for a whopping 56%. Had growth been inclusive, the resulting rise in incomes and opportunities would have been equitably shared by all income groups sharply reducing inequality over time. It is not surprising why attaining inclusive growth is far more difficult than boosting growth rates themselves.

Why India’s growth story is not sustainable

In a recent article (Why Let a Good Crisis Go to Waste? What India Needs to Remember to Overcome its Economic Slump, The Wire, November 20, 2019), I pointed out that corruption and poor governance have not only spawned rising income inequality but a host of other economic maladies as well. I was not trying to explain the downturn in terms of some recent developments like the collapse in consumption. Rather, I was referring to the structural weaknesses in the Indian economy as the genesis of India’s current economic predicament.

While it is possible for highly corrupt countries to register impressive rates of growth for a few years, widespread and entrenched corruption will thwart the sustainability of growth. Studies by the IMF and other international organisations point out a number of serious consequences of corruption.

First, corruption reduces the rate of growth. As a result, poverty in India could have been reduced at a faster pace were it not for corruption. The United Nations, based on data produced by the World Economic Forum, noted that the worldwide cost of corruption is at least 5% of global GDP.

Also read: The Short-Term and Long-Term Measures Needed to Reverse India’s Economic Slowdown

Second, as I noted earlier, weakly governed countries tend to invest far less in health and education than strongly-governed ones. Thus, when growth takes place, only the elites can take advantage of the expanded opportunities whereas the vast majority cannot qualify for well-paid jobs in the organised sector. They are left with little alternative but to eke out a living working in low-skill jobs in the informal sector. In short, countries with endemic corruption also tend to be highly unequal.

In fact, income inequality based on officially reported incomes collected through household income surveys significantly understate actual inequality. This is because the upper income groups, who are the main drivers of black money incomes and assets, understate their incomes in household surveys conducted by the government. If reported incomes were to include black money incomes generated from domestic and foreign assets, actual inequality would be worse than calculated inequality based on official income data.

Poverty in India could have been reduced at a faster pace were it not for corruption. Photo: rupixen/Unsplash

The greater actual inequality would have a larger destabilising effect than the measures available to economists would suggest. Assuming demonetisation left corruption intact, domestic black monies transferred abroad would return another day as inflows to drive up the stock market and other investments. Such round-tripping is often an elaborate scheme to launder dirty money.

Black money is mainly used to finance illegal and speculative transactions rather than boost productive investments in the official economy. In fact, while legitimate domestic investments have been on a declining trend, inflows of black money did nothing to help the economy. Regardless of how much black money was captured and surrendered to banks and how much could be traced to illegal activities, corruption cannot be curtailed without strengthening governance in all its aspects such as rule of law, effectiveness of regulatory oversight, quality and stability of politics, etc. To claim that demonetisation will curtail corruption is like putting on a winter jacket and expecting it to snow.

Third, wide-spread corruption leads to tax evasion by promoting a culture that tolerates the practice. The IMF finds that even among developed countries, strongly-governed ones collect about 4.5% of GDP more than relatively more corrupt ones. And that’s a lot of money the government could have used productively. The longer corruption rules, the more difficult it gets to dislodge it. In fact, as I have argued in my earlier article, corruption has restricted India’s fiscal space thereby significantly limiting the scope of a consumption-boosting targeted basic income.

Also read: India is Now in Classic Stagflation Territory

Fourth, corruption has reduced the effectiveness of government services through bribery, a reduction in compliance with government regulations, and the imposition of additional costs on investment projects. India’s “D” rated government effectiveness has led to a lack of public trust in officials and the quality of government services. This in turn promotes tax evasion because taxpayers do not feel that they are getting their money’s worth.

Fifth, researchers at the IMF found that child and infant mortality rates as well as the proportion of low-birthweight babies in countries with endemic corruption are much higher compared to countries where corruption is low. Moreover, school dropout rates are five times as high partly due to less effective government spending. The poor quality of public school education in India is consistent with these findings.

The deadweights of corruption, inequality, and environmental degradation would make it more difficult for India to deal with the crisis.

Finally, highly corrupt countries tend to be much more polluted than countries that are strongly governed. India is a perfect example of the nexus between rampant corruption and serious environmental degradation.

The tendency towards greater pollution is explained by the poor law and order, lack of environmental awareness, weak environmental regulations and their enforcement, bribery of regulatory officials, and a dearth of equipment and trained manpower to monitor compliance with regulations.

Hence, it is crucial to attain economic growth that is not only inclusive but environmentally sustainable as well. Inclusive policies by themselves cannot ensure that industries would comply with policies to protect the environment.

Sir Partha Dasgupta, Professor Emeritus at Cambridge University, finds that the fault lies in formulating economic policies which do not treat fresh water, clean air, and land as resources which could be depleted in the production process. Given that no country has an inexhaustible supply of these resources, there is a dire need for appropriate regulation, monitoring for compliance, and user fees to pay for clean-up and renewal. His work shows that environmental degradations will effectively derail economic growth if policies are not designed to take explicit account of these consequences.

Also read: GDP Data: Investment Growth at 19-Quarter Low Despite Modi Govt’s Stimulus Measures

This is not to suggest that growth strategies necessarily need to evolve from a low to a higher trajectory through reform before they can be inclusive as well as sustainable. Countries like Korea, Singapore, and Taiwan which made significantly larger investments in health and education were not only successful in ensuring more equitable outcomes and opportunities when growth occurred but have also avoided environmental degradation from limiting growth in the long run.

The primacy of volition

Even though structural issues are deeply embedded and take far longer to mitigate than counter-cyclical policies aimed at stimulating the economy, here too governments can do a lot more than pray.

Vito Tanzi, a fiscal expert and one-time director of the IMF’s fiscal affairs department, in an article on corruption around the world, opined that successful efforts against corruption typically begin with examples set by a country’s leadership. Top political leaders should not only provide the right example of honest living but should support stern legal action against corruption from any quarter regardless of political affiliations. If, on the other hand corrupt acts by friends, relatives, or political associates are condoned, then it would not be realistic to expect that public officials or indeed the country at large will behave honestly.

Also read: India’s Telecom Industry Is Being Cracked Like a Nut, but What Should the Centre Do?

The first step on the road to redemption is therefore the hardest one—leaders should set the right example, help support the appropriate laws, and implement a distinct plan for tackling corruption in all its manifestations. In short, the anti-corruption agenda must be strongly underwritten by the country’s leadership and the state governments as well. India needs to reduce corruption on a credible and sustained basis in order to better cushion the impact of difficult global economic conditions.

Global economic headwinds

In October, the IMF cut its forecast for this year’s global growth to 3.0% from 3.9% in January. Strong headwinds facing major economies such as geopolitical instability, business uncertainties, tariffs, and trade tensions, were responsible for the more somber outlook. The US Federal Reserve Bank began to cut its overnight lending rate to banks in July this year. The lending rate was lowered in three steps to a target range of 1.5 to 1.75% in October.

With the European Central Bank’s policy rate already in negative territory, the Federal Reserve’s rate cuts were accompanied by a significant decline in long-term bond yields. Stock markets are surging because of falling long-term interest rates and higher bond prices, not in spite of them.

Also read: The Dangers of Dismantling India’s Public Sector

The reason is investors have nowhere to place their funds to make a decent return other than in stock markets and other riskier investments, thereby driving their growth. So, there is no contradiction between weakening economies on the one hand and surging stock markets on the other.

While the easy money of central banks is meant to prop up slackening economic growth, the downside is that low interest rates are encouraging households to incur more debt and firms to take on greater financial risks. The corporate sector in India is carrying a heavy debt load and some may default on their loan repayments and fold, while others may require a rollover of debt or some sort of corporate debt restructuring.

Conclusion

We can expect the world economy to enter a protracted period of low growth, low demand, and low-inflation, its driving gear stuck in neutral. While well-heeled investors and pension funds around the world have earned handsome returns in the soaring stock markets and other riskier assets, these are dark waters.

The deadweights of corruption, inequality, and environmental degradation would make it more difficult for India to deal with the crisis and impose a heavy cost in terms of lost output, income, and jobs, along with an increasing risk of economic and political instability. These structural weaknesses need to be addressed on an urgent basis.

Dev Kar is Chief Economist Emeritus at Global Financial Integrity and a former Senior Economist at the International Monetary Fund. His book, India: Still A Shackled Giant, was released by Penguin Random House India in October 2019.

The Short-Term and Long-Term Measures Needed to Reverse India’s Economic Slowdown

The Narendra Modi government must rationally initiate these actions for reversing the slowdown instead of going after red herrings.

It is one thing to recognise that the Indian economy is slowing down, as the finance minister has done. It is another to know what needs to be done in the next few weeks, months and year to help reverse the slump.

In the government’s eyes, most challenges often appear binary. The problem is that their solutions fall in different shades of grey. In this case, it will require some unwinding of meaningless and self-defeating policies and a few positive interventions which will create a virtuous cycle of jobs, wages, investment and consumption.

In addition to this, the government will also have to initiate sensible policies which will spur growth and development when the economy eventually shows an uptick.

What is the big problem facing the Centre? It is the lack of employment and thereby lack of earning power of a large number of people that is the looming problem. This reality affects 60% to 70% of people, particularly in the rural areas which gets hit when the agriculture collapses and the network of the informal economy vanishes.

It is also a question of narratives. Economists with left leanings believe that the solution is more rural spending – more MNREGA, more food subsidies and more overall government intervention despite the fact that they are sub-optimal in delivery and that the Centre’s fiscal space is limited.

Also read: India is Now in Classic Stagflation Territory

If the government resorts to borrowing, it creates macro-economic instability apart from crowding out investment to private sector. Exhorting the government to put money in the pockets of India’s consumers, while understandable, may not be the best recipe because of pipeline losses, wrong nudges and suboptimal outcomes.

Contrary to this, more mainstream economists are batting for a reduction of tax rates, reduction in bank borrowing rates, RBI rate cuts and so on – as if all these transmit to higher investment. It is clear now that corporations sitting with money are not investing because the existing capacity utilisation is only 80% and they do not find any logic for further investment.

Both groups of economists cannot see beyond their blinkers. Intelligent taxation does not slow growth, judicious regulation does not stifle entrepreneurship and minimum wages do not destroy jobs. The Brooking Institute, and the Congressional Research Services, do not find any correlation between marginal tax rate and GDP growth and it is equally applicable to job growth, investors growth and productivity growth.

David Card and Alan Krueger’s landmark 1992 study has also shown that increase in the minimum wage can increase employment. Thus, it is time to unwind orthodoxy and try a heterodox approach.

Things to be done in short term

If in the short term, the country is looking for a centre of gravity for addressing the slowdown, a good starting point would be urban affordable housing, social housing and infrastructure. House building activity provides employment in numbers and its transmission effect to small towns and villages is both quick and good. If this perks up, there will be an increase in the demand for steel and cement and this will start a virtuous cycle.

The Centre has already initiated some action on affordable housing. The challenge is scaling it up; co-opting states and municipalities and having them use state resources for social housing. The government can give tax breaks and smoothen investment in this sector. Infrastructural development in the PPP framework gives positive spin offs too.

The banking sector, which is not lending for a variety of reasons, can be pushed to give loans to this sector, if necessary with higher collateral insistence.

Secondly, infrastructure investment should be stepped up, particularly in those sub-sectors which can create jobs. Roads, water-shed development, logistics chains such as warehouses, cold storage, grading and sorting facilities will not only give succour to agriculture and rural sector but also mitigate rural stress. Revitalisation of PPPs with appropriate and enforceable risk allocation will be helpful here. However, resources need to be allocated carefully to avoid investment on vanity projects such as rebuilding a new parliament, secretariat, statues and projects for earning political brownie points.

Also read: GDP Data: Investment Growth at 19-Quarter Low Despite Modi Govt’s Stimulus Measures

Thirdly, India has a comparative advantage in abundant supply of labour. The country will have to switch to large scale labour intensive industries and should specialise in their production and exports. Textiles, apparels, leather, handlooms and handicrafts should be focused for jumpstart the exports. This will bring down the trade deficit too. These sectors should be given cluster support, technology support and tax breaks for five years.

Lastly, government investment is important in the production side of the economy. Investment by the government becomes difficult when too many schemes and too much of subsidy transfer is taking place. The Centre must rework all the subsidy schemes and cut down its expenditure.

This can be helped through the stake sales in PSUs and monetisation of their land.

Medium and long-term interventions

Investment in the medium-term can be sought to be augmented by giving a sharp impetus to small scale manufacturing. People who are seeking to leave low productivity agriculture – those who are unemployed or under-employed – should be given technical training and be encouraged to set up businesses. Large industries can access bond markets but SMEs require banking support for sure. Even though higher collaterals are required, if should be insisted upon but funds should flow rather than being subordinated to the loans to large industries.

The time has come for reforms in land and labour. Labour reform is required for enabling large scale employment, doing away with mandated responsibility for paying workers even if the unit is not working. Emergency-era incorporations of Part V of ID Act must be taken care of now. Similarly, a richer variety of contracts with benefits of social security for workers is required for longer employment. Cleaner titles of land, simultaneous land transfer along with registration, technology based mapping and quicker land subdivision are required for enabling long-term lease of land and ease doing business in agriculture & construction.

On the credit front, many say that the five-year period between 2013 and 2018 was the failed clean-up stage for the banking sector. A reasonable inference is that the time is now ripe to bring down the government’s stake below 50% in state-run lenders in order to distance the Centre from banking.

Thirdly, subsidies for energy, water and fertilisers has distorted production. Progressively there subsidies are to be withdrawn to have climate-sensitive agriculture and free crop choice. In any case these subsidies have given largely to bigger farmers. Instead of these subsidies, a DBT transfer to the farmers will take away the likely opposition to the withdrawal of these benefits.

Also read: As GDP Growth Slips, Opposition, BJP Allies Attack Govt Over Slowdown

Fourthly, skilling in India is a huge problem. While millions wait for jobs, industries have huge gaps in manpower as the skill sets are not available. All the industries should be mandated to take in large numbers of apprentices, even if means the government pays part of the internship payment. This will mitigate problems of skilling. The government has initiated a huge skill development programme but its results have not solved the underlying problem. Ramping up apprenticeship for many may hold the answer to this intractable problem.

Lastly, with the Finance Commission’s award being round the corner, it is an opportune moment to insist on conditionalities to be complied with by the states as a condition precedent to devolution.

The Narendra Modi government, which has shown resoluteness in so many instances, can be expected rationally to initiate these actions for reversing the slowdown – if only it recognises it rather than going after red herrings.

Satya Mohanty is a former secretary to Govt of India and is currently Adjunct Professor of Economics in JMI, New Delhi.

Lessons From Kenya’s Experiment With Transfer of Power and Resources

The Kenyan example illustrates the importance of constitutional guarantees for devolution. But it also shows that devolution is no magic bullet for the problems of corruption and ethnic politics.

Kenyans rally for a new constitution in 2010. The constitution guaranteed shared power and resources for 47 county governments. Credit: Reuters

Kenya is three years into a bold experiment of transferring real power and resources from the national government to its 47 counties. It’s an experiment marked by vicious turf wars between national and county governments and between county governments and the Senate. And, as Michelle D’Arcy, co-author of “Devolution and Corruption in Kenya: Everyone’s Turn to Eat?” observes, devolution has come at the price of decentralising corruption. She was interviewed by The Conversation’s Regional Editor East Africa, Julius Maina.

What is devolution?

Devolution is the transfer of authority, resources and personnel from the national to the sub-national level. As a more comprehensive form of decentralisation it always involves a form of power-sharing between central and sub-national government. So it has been used to try to protect minorities, ensure fair distribution of resources and diffuse conflict.

Although decentralisation has often been proposed as a solution to a range of problems facing developing countries, and African countries in particular, there have been few examples of success. Most African countries have introduced some form of decentralisation. Few have achieved a meaningful transfer of power as central governments have been reluctant to transfer resources and authority, and local elites have co-opted the process.

Any examples to illustrate the failure to achieve meaningful transfer of power?

Uganda is often mentioned as an example of a country that initially achieved a meaningful degree of decentralisation during the first years of Yoweri Museveni’s rule. It was then in his political interests to strengthen local government and build his support base. But more recently Uganda has experienced recentralisation.

The critical point in speaking about decentralisation in the African context is that there is no ideal scenario. Donors, and particularly the World Bank, have held out decentralisation as an idealised set of political reforms that will bring greater democracy and development. But we do not have concrete evidence of this and statistical studies have yet to find clear effects of decentralisation on human development outcomes.

Why did Kenya choose devolution?

Devolution was a key part of the political settlement that emerged after the post-election violence in 2007-08 . It was seen as a solution to the underlying pathologies of Kenyan politics. The over-centralisation of the state had allowed certain ethnic groups to dominate. It led to inequitable resource distribution. It resulted in politicising ethnicity in ways that fuelled violence and a political culture of “our turn to eat”.

In which important ways is Kenya’s system different from or similar to other devolved systems?

The design of devolution in Kenya mirrors the original federal constitution (majimbo) that was in place after independence. But it devolves power to smaller units – counties, rather than provinces.

It goes beyond most decentralisation reforms in other African countries in two main respects. First, it transfers considerable powers and resources. Second, it guarantees these constitutionally, rather than just through easily-amended legislation.

What have been the most important impacts from the devolved system of government?

The most important achievement so far is the degree to which it has been implemented. In most cases where decentralisation reforms have been introduced, central governments have successfully diluted reforms so that meaningful power and resources are not transferred to local governments.

The representatives of the new county governments in Kenya, particularly the governors, have worked effectively together to ensure that devolution has been implemented. It has also ensured that a significant proportion of the national budget has been transferred.

What has been the downside?

The downside so far has been the replication in county governments of many of the pathologies we have traditionally seen in central government in Kenya. There have been allegations of corruption and the misuse of funds on, for example, foreign trips for members of county assemblies. There’s also evidence in some counties of ethnic bias in the hiring of county public services.

In this sense, devolution has not marked a change in how politics operates in Kenya, only in the level on which it operates.

What aspects should African countries seeking to adopt the development model mimic?

The Kenyan example illustrates the importance of constitutional guarantees for local government. Central governments rarely have incentives to implement devolution, so local governments need constitutional protection and mechanisms to resist recentralisation. However, it also illustrates how devolution is not a silver bullet solution to the problems of corruption and ethnic politics.

What important lessons have been learnt from the Kenyan experience?

The Kenyan case shows the trade-offs that are intrinsic to the process of political reform. Devolution has in many ways been implemented because it has been seen as “everyone’s turn to eat”, meaning that there is a broad-based constituency ready to fight for its implementation.

The implementation of devolution has come at the price of decentralising corruption. However, this may, at this, stage be a price worth paying as the implementation of devolution is a significant achievement. It may be the first necessary step towards more meaningful and inclusive development in Kenya.

This article was originally published on The Conversation. Read the original article.