Growing the Pie in India

Why Growth Matters

Title: Why Growth Matters: How Economic Growth in India Reduced Poverty and the Lessons for Other Developing Countries
Author: Jagdish Bhagwati and Arvind Panagariya
Publish Date: 2013
Publisher / Edition: Public Affairs

“Redistribution, as distinct from growth, cannot be the answer to removing poverty. In countries such as India, China, and Brazil, the large numbers of poor mean that redistribution will do little and that, too, will not be sustainable. … The pie has to grow; growth is a necessity.” So Jagdish Bhagwati and Arvind Panagariya begin their analysis on ‘Why Growth Matters’ and the lessons India and other developing countries can learn from Indian successes, failures, and missed opportunities for economic growth.

Drawing on their previous scholarship defending the economic liberalization in India through the 1991 reforms, the authors delve into the types of reforms that India needs to pursue. They argue that Indian poverty is a result of bottlenecks caused by institutional failure of the socialist regime and that state shackles controlling markets should be removed to increase economic growth and reduce poverty. Their main idea is that first and foremost India needs pro-market reforms, which are necessary for the ‘pie’ to grow, followed by a second set of pro-welfare reforms that redistribute the bigger ‘pie’ efficiently.

In the context of the ongoing Bhagwati-Sen debate on Indian economic policy, this book is a compelling argument against Sen and his supporters, who want to extend welfare and entitlement based schemes in India to improve human capabilities. Bhagwati and Panagariya explain that pursuing these entitlement schemes before or to the exclusion of pro-market growth-enhancing reforms is placing the cart before the horse. They argue that reforms enhancing economic growth directly pull the poor out of poverty by providing opportunities for gainful employment. Further, these reforms increase state revenues to make a second set of welfare programs fiscally feasible. So, the authors detail Track I reforms aimed at “accelerating and sustaining growth” and Track II reforms to make “redistributive programs more effective.” The book is almost a manual for Indian policymakers.

The book is divided into three parts. In the first part, the authors debunk many myths prevalent in the debates and rhetoric used in Indian policy. They de-romanticize the haloed socialism of the early post-independence decades and provide data on how licensing and price controls steeped Indians in poverty. They take on the sentiment, widely believed by Indians, that the 1991 reforms in India only benefited the rich and hurt the poor and provide compelling arguments and data to show that removing controls on markets and reducing trade barriers has alleviated poverty. This part of the book sets the tone well, and before proposing specific reforms, the authors establish that pro-market reforms from 1991 did, in fact, help reduce poverty in India.

In the second part of the book, the authors argue that even though the 1991 reforms led India to an annual growth of 8.5% for almost a decade, there is still immense unexploited potential for further growth. The Indian economy still has low labor productivity and pursuing further reforms will pull the poor away from the low productivity, low wage agricultural sector. The main areas the authors identify for reforms are land, labor, and higher education in India.

Their message is clear. First, India should move to a regime where property rights are stable and protected, and individual contracts are enforced. Second, existing paternalistic legislation attempting to protect workers, farmers, students, etc. have actually harmed the intended beneficiaries and therefore, the focus must shift from intentions to incentives.

According to the authors, an important area of pending reform is the myriad labor regime comprising fifty-two federal labor laws and 150 state level labor laws to govern the Indian workforce. Complicated labor regulations, which make it difficult for firms to hire and fire workers, have led entrepreneurs to substitute away from labor-intensive toward capital-intensive technology, and also created a large informal sector. While recommending a complete revamping and simplifying of Indian labor law, the authors recommend immediate amendment and repeal of the most damaging clauses of the Industrial Disputes Act, 1950.

Next, the authors focus their attention to land in India. Property rights, or the lack thereof, are a complex and entangled web in India, and the authors steer clear of the bigger constitutional issues and focus on the colonial Land Acquisition Act, 1894 and its more recent counterpart passed in 2013, which allow for state takings for private use. The state routinely takes land using eminent domain; paying compensation much lower than market price to later give the land to private developers at a low price. With India’s policy to develop Special Economic Zones, farmers are routinely deprived of their property rights. To strengthen property rights in general, and specifically in the context of farmers’ livelihoods that depend on agricultural land, the authors recommend market transactions, instead of land acquisition by the state prone to interest group capture.

In the third part of the book, the authors detail Track II reforms focusing on welfare and entitlement schemes. The ongoing Sen-Bhagwati debate is centered on the question of pro-welfare versus pro-market reforms. The debate became larger than merely the views of the two economists, and critics have attacked Bhagwati’s arguments made in favor of economic growth as “anti-poor.” In part three, Bhagwati and Panagariya shatter this myth and make arguments for inclusive growth. But they analyze the incentives created by the current welfare and entitlement schemes and propose reforms to increase efficiency in public delivery systems.

The authors focus on the National Rural Employment Guarantee scheme (NREGA), the Food Security scheme, and the public school system as important areas of reform, because these schemes are pan India and together they account for the largest proportion of government spending on welfare. In dealing with these, the authors argue in favor of reforming public delivery of services and goods to best align incentives and reduce graft.

The overall theme of track II reforms is simple: reduce state paternalism that has historically created perverse incentives and harmed the poor, and ensure greater choice in decision-making in the hands of the beneficiaries of the welfare schemes. The authors recommend reforms to ensure incentives are better aligned, thereby reducing leakage and graft in the system. Instead of the NREGA scheme, which employs labor in low quality public works, the authors propose direct cash transfers to the poor to reduce distortions in the market, and eliminate middlemen. In the case of the food security scheme, run by the inefficient public distribution system that provides poor quality food grain, 70% of the outlays are leaked before they reach the intended beneficiaries. The authors, once again, recommend direct cash transfers to poor households instead of providing poor quality food grains. The Indian elementary public education system is completely defunct. Despite the “right” to education, poor households choose expensive private schools over the barely functioning free state schools. Once again, the authors recommend simplifying the myriad rules applicable to private schools and de-licensing private schools to fill the gaps in public education through competition.

In Why Growth Matters, the authors make an elegant and powerful argument: that growth reduces poverty directly by pulling the poor into gainful employment, and indirectly through additional revenue which enables the financing of redistributive programs principally aimed at the poor. The book is very successful in making clear and compelling arguments to reform specific sectors like labor, land, infrastructure, unemployment, food redistribution, and education in order to have the largest impact. The authors target the legislation and regulation that distort Indian markets and identify sectors, which will have the most impact in improving the lives of the poor. Their point is simple, it is not the intentions, but the incentives created by the institutional system that matter for economic outcomes, and therefore the institutional regime in India must be reformed.

Bhagwati and Panagariya understand the problem of political capture and rent seeking in India, and their proposed reforms in various sectors attempt to alleviate this very problem. This is unsurprising since Bhagwati, with Anne Krueger and Gordon Tullock, pioneered the research on rent seeking activities in India. However, the authors do not discuss the potential for political capture and the accompanied rent seeking while transitioning from one institutional system to another with wide scale reforms. The transition experience of the Soviet economies has shown the problems with political capture of the reform process, and the authors do not suggest ways to ensure that the reform process is not compromised in India. This is an important aspect, crucial for the success of the reforms proposed in the book, which has been overlooked by the authors. Due to recent high profile scandals of regulatory capture and corruption, Indians are increasingly disillusioned with the political system and the current government. Success of and support for the wide scale reforms proposed by the authors is contingent on how resistant it is, to interest group capture.

While this is beyond the scope of the book and the authors’ main argument, to ensure the success of Track I and Track II reforms, India needs constitutional reforms, an area overlooked in the book. The Track I reforms proposed by the authors, requires less government regulation, delivery of public goods, and maintenance of the rule of law through enforcement of property rights (fundamental rights) in the Indian Constitution. Track II reforms proposing more efficient welfare schemes are essentially reforms in the area of positive rights or entitlements outlined in the Directive Principles of State Policy in the Indian Constitution. India has had much constitutional turmoil with over 95 formal amendments to its constitution. The right to private property has ceased to be a fundamental right, and all individual rights are subject to the Directive Principles of State Policy with the Twenty Fifth Amendment to the Constitution. The authors do not pay much attention to the constitutional reform that must accompany or in some cases precede the economic reforms proposed in the book. The authors clearly argue that Track I must take precedence over, and not be to the exclusion of, Track II reforms. However, in the current constitutional regime in India, property rights are secondary to economic welfare rights. Therefore, some constitutional reform will also be necessary to support the legal reforms proposed in Why Growth Matters.