The Indian Economy Blog

December 6, 2005

Why We Reformed What We Did

Filed under: Economic History,Regulatory reforms,Trade — Ravikiran Rao @ 1:20 pm

It is a rare occurrence when someone agrees with me, so I might as well record it when it happens. Ramnath and I have managed to agree that privatization is not the most important reform measure. We also managed to agree on which one it would be. We both say that product market liberalization is the most important reform measure that we can undertake. For those who haven’t kept pace with the jargon, “Product Market Liberalization” in India means removing the restriction that some goods can only be produced by small scale units. There are around 700 of them, and this restriction is the single biggest roadblock that is stopping us from becoming a manufacturing powerhouse.

So Ramnath wants to know why the government is focusing on privatization rather than the other more important things. I know the answer to this, and I am afraid that the answer makes me very sad, because I’ve known this answer for more than 10 years, and it is high time it turned out to be wrong.

We are privatizing because, believe it or not, it is an easier reform measure to undertake than the more important ones.

It has always been like this. Among the first things that the government did was to reform the stock and currency markets, relax the complex industrial licensing laws and abolish import licensing.

What was common to the three? Well, all three were easy to accomplish for one reason or the other, the most important reason being that they have powerful interests in favour and none or weak ones against. No one was really against stock and currency market reforms, while many people were in favour. Most industrialists were in favour of abolishing those industrial licenses, and only bureaucrats would have been against. Given the circumstances at that time, the bureaucrats didn’t have much opportunity to make a stand.

As for import licensing, note that consumer goods are still heavily restricted. There is no economic rationale for that whatsoever. It just so happens that industrialists want to import raw materials, but don’t want customers to import finished goods, so that’s how things are.

There is also another thing that is common to them. They end up favouring foreigners over Indians. It wasn’t by design, mind you. It just happened that way because of the dynamics of the decisions. It is easier to just remove import restrictions than it is to remove the complex set of restrictions on Indian firms. Reforming the stock market and easing FII restrictions meant that foreign money could come in freely, but where could it go? Not into a manufacturing plant in the hinterland, because it was still difficult to set up one, so it went into software companies in the big cities, where the restrictions where minimal.

So that is how we got here. I’m afraid the performance of everyone involved in the process has been nothing short of disgraceful. Everyone supports reforms, but someone opposes every single reform measure.

Remember the Bombay club? They were for the reforms before they were against it. When the reforms started to pinch them, they decided that freeing up imports and easing FDI was not such a good idea after all.

Remember when the BJP used to be a pro-reform party? That was when it was making the eminently sensible complaint that we are going in for external liberalization before we liberalize internally. But when they came to power, they discovered that internal liberalization would mean that their unions and their small businesses would get hurt. Then it realised that internal liberalization was not such a good idea after all.

Also remember when Ford, GM etc. were such champions of free trade when they wanted to get in? But when it came to allowing import of second-hand cars, they suddenly turned into environmentalists. They decided that free trade wasn’t such a good idea after all.

Everyone, everyone has been behaving shamefully about the whole thing.

If a dispassionate observer had seen the reform measures that were being undertaken at that time, he would have predicted exactly what has happened since then. In fact, many did. The gradual, step-by-step opening was supposed to be a good thing from the point of view of eminent caution. It was supposed to be a continual experiment, the results of which would help us to take further steps. If this experiment succeeded, the argument went, we would feel more confident, and it would be politically more acceptable to take those steps.

As an experiment it has succeeded spectacularly. Where we reformed, we did well. We reformed the stock market, and the stock market is doing well. We allowed foreign investment and foreign investment flowed in. We liberalized the telecoms sector and now the poor have mobile phones.

Where we did not reform, we are doing badly. We did not liberalize the labour market and so organized sector unemployment is still high. We did not dereserve the small-scale sector and we are still lagging in manufacturing. We haven’t touched agriculture and farmers are still committing suicides.

This is as perfect a controlled experiment as you can ever get in the social sciences. If you want to test out the efficacy of a drug, you split a population into two, give one of them the drug and the other a placebo. If the group that receives the drug improves and the control group that received the placebo does not improve, we know that the drug makes a difference.

You cannot take the drug’s lack of effect on the control group to claim that it isn’t effective, can you? But that is exactly what I’ve been hearing for the past ten years that I’ve been following this debate. It is bad enough that we are conducting this cruel experiment – where the rich and the middle-class are administered the medication while the poor are given the placebo. What is worse is that we’ve been ignoring the results of those experiments on the ground that the supporters of these experiments wear supercilious smiles on their faces.

Let’s at least stop pretending that this is an experiment. It is not. No one is going to get persuaded by the results of these experiments, because no one cares for the results. No one is going to change his stance about any reform measure, because no one is honest about it being an experiment.

We get the reforms that the government can get away with. If anyone tried to liberalize the product market, they’d face the unions, the “small scale” industrialists, the communist parties in a shameful alliance with them, and the conscience of an entire nation that still feels guilty about abandoning Gandhianism.

If anyone tried to reform the crazy labour laws, they’d have to face the might of the entire unionized labour force.

If we sell off bits of PSUs, the communists would still oppose it, but the idea was that the opposition would be less as the workers’ jobs wouldn’t be immediately threatened. So selling off the PSUs was thought to be an easier bet than the other, more important reforms. But that was before Prakash Karat came and decided to take a principled stand instead of a self-interested one.

I am not very optimistic about the reforms. They aren’t going to move forward unless the economy gets into another crisis, and the way we are going, there isn’t much chance of that. It’s a pity about all those poor people though.


  1. Excellent post, Ravikiran.
    I think in general, people tend to filter the information and evidence they receive with their preconcieved prejudices. They tend to accept evidence that supports their views and ignore evidence that contradicts it. So it is apparent that you will never persuade them of another view. The only hope is that the people with the socialist mindset are from the Nehru/Gandhi generation and will eventually retire or die.

    But I am curious about this. How is it that there is still a Communist Party in India? The CP went bondi almost everywhere on Earth. There disappeared in Eastern Europe where they were dominant for generations. The Communists killed more people and ruined more lives than anyone – even the Nazis – during the 20th century. How can anyone take a Communist seriously in the 21st?

    Comment by Michael H. — December 7, 2005 @ 1:53 am

  2. Nice post. I think most people who visit this blog can empathize with your frustration. I think of the reforms that began in the 1990′s as the beginning of a race. While, we the reforms might be hapazard and very very slow, they are slowly changing the mentality of the country. You have the likes of Infosys and Wipro that have worked hard to prevent the unionization of their industry. You have the cheif minister of West Bengal declaring the IT industry as a public utility, preventing strikes. At the same time, everytime a PSU is privatized, those who are trying their best to reverse reforms grow slightly weaker. Indians who demand reform will eventually hit a critical mass, the question is will this happen before India’s demographics become unfavorable.

    Comment by Patel — December 7, 2005 @ 3:00 am

  3. nice posts. i agree with most of the things you haev written.

    Now this may sound like nitpicking, but its more like a question

    “Everyone, everyone has been behaving shamefully about the whole thing.”

    Do you think firms have been behaving shamefully, or do you think thats a reasoable thing to do if you are working for a firm and your objective is to maximise profits. As long as lobbying is not illegal, lobbying for certain things, is it shameful?

    Should the onus be on the government or should the firms take certain responsibility thinking about the long term effect of a closed or planned economy?

    Comment by ik — December 7, 2005 @ 4:02 am

  4. Ravikiran,

    As others have noted, good post – especially the second half where you talk about the reforms process being akin to a controlled experiment. I am not old enough to have followed the debate since the 1991s and I don’t know if people explicitly talked about reforming in specific areas to see if it was beneficial – that’s just BS. Government plucked the low-hanging fruits – pareto optimality before marshall optimality and all that.

    But IMO, you have painted a simplistic picture in

    We did not liberalize the labour market and so organized sector unemployment is still high. We did not dereserve the small-scale sector and we are still lagging in manufacturing.

    1. I remember reading in Business India (or was it Business today) that labour laws are routinely flouted and the companies hiring and firing decisions went ahead irrespective of the labour laws. The reason for the decline in organized sector employment was due to the type of industries in which organized sector grew – only skilled workers were needed.

    2. SSI reservation is not the only reason. There are many industries which are now not reserved for SSIs but they haven’t grown either. It has more to do with lack of power, roads and appropriately skilled workforce.

    One nitpick. You have neglected to mention the power sector where attempted reforms were unsuccessful and actually counterproductive to the whole reforms process.

    Comment by Eswaran — December 7, 2005 @ 6:15 am

  5. Good Post. Regarding people/companies trying to manipulate things according to their needs is plain capitalism. The problem does not lie with capitalists but partial/swayable politicians. Everyone of course will try to get things the way it favord them the most. It is the duty of the government to control this behavior and implement policies for general good.

    Regarding reform pace, I think the so-called easy reforms do matter. It is all about inhibitions. Once the first road-block is removed you can move to the second one. Unfortunately in India there are too many of them. Governments are trying to go step by step rather than straight away trying to blast through. For example, communists now agree to partial sale of PSU’s because it is better for them. Once this step is completed, the next steps can be taken to further reform PSU’s. Or I hope so. Compromise is part of the game. It is better to work in realities rather than say have a dictatorial government to push through all the hard reforms without care for anyone.

    Comment by Arun Puri — December 7, 2005 @ 6:43 am

  6. [...] the conscience of an entire nation that still feels guilty about abandoning Gandhianism. [IEB] The most pernicious manifestation of stealth-mode reforms is the monstrosit [...]

    Pingback by The Acorn » All the reforms the government can get away with — December 7, 2005 @ 7:50 am

  7. Ravikiran,

    I did not understand what you meant by the following:

    It is bad enough that we are conducting this cruel experiment – where the rich and the middle-class are administered the medication while the poor are given the placebo.

    Secondly, you have a hypothesis that lack of “product market liberalization” is the single biggest obstacle to growth of manufacturing sector in India. What data and information would you need to support this hypothesis?


    You are curious about the existence of a Communist Party in India. As a matter of fact there are several communist parties in India. Communists in India, at least after their mistake of not participating in Quit India movement recognized that the only way by which they will be able to sustain is through participation in democratic political process. The communist state government of Kerala became the first democratically elected communist government ever. Communists in India today are more like the democratic socialists of Europe, but a little bit more to the left. While they will never be able to form a national government, Communists in India will probably continue to maintain a small but significant presence.

    Comment by Anup — December 7, 2005 @ 8:42 am

  8. Best post I’ve ever read here. Sums everything up perfectly.

    Comment by AK — December 7, 2005 @ 9:33 am

  9. Anup, it is from a McKinsey study. Ramnath’s comment here might help you find it. I am sorry I cannot give a more precise reference, as I had read it in hardcopy long time back.

    Comment by Ravikiran Rao — December 7, 2005 @ 10:14 am

  10. Ravikiran,

    I mentioned in my earlier comment about reading an article (actually in Businessworld) about why the real role labour laws play in organized sector jobs. Here is the article. Asking for labour law reform is barking up the wrong tree.

    Comment by Eswaran — December 7, 2005 @ 10:48 am

  11. Anup, I think it should be clear that I was following the analogy of the controlled experiment… The poor formed the control group (no reforms) and we were the subjects of the experiment. Or was it something else that was not clear?

    Arun, you continue to think that the communists actually care about the results of the experiment.

    Comment by Ravikiran Rao — December 7, 2005 @ 11:07 am

  12. [...] our reform processes are not helping us enough. Ravikiran helps us understand better "why we reformed what we did" that dispels any such misgivin [...]

    Pingback by DesiPundit » Reforming Reform — December 7, 2005 @ 11:10 am

  13. Eswaran, I agree that it is BS. People did say that gradualism was a good idea, but they were either fooling themselves or fooling others. Those who were against the reforms used this as a way to stall or slow down the reforms. Those who were in favour used the argument to console themselves that there was actually a sensible argument for what we ended up doing.

    I did not talk of the power sector, but if I had, I’d have said the same things. They privatised generation, but not distribution – again, because, you know, we need to be cautious about reforming and all. So when the reforms went awry because of the bankruptcy of the distcos, people started arguing that the reforms had failed.

    ik, it goes back to the old argument about petrol pump owners. Just because it is in their interest to kill IOC officials, it doesn’t mean that they should do it. Saying that they have an incentive to do it doesn’t mean that it is right to do so. Given that we think that it is wrong to do so, we libertarians say that we should have legal disincentives against doing so. In short, no, I don’t think that lobbying should be illegal. But yes, we should reduce the powers of the government so much that the scope for lobbying is reduced.

    Michael, I share your bewilderment. The reason we still have communist parties is that we did not actually adopt communism. We adopted a mixed economy. That enabled the people to say “We have failed to achieve socialism” rather than “Socialism has been tried and failed”.

    Comment by Ravikiran Rao — December 7, 2005 @ 11:25 am

  14. Incidentally, Eswaran, my comment addressed to you was a response to your first comment. I hadn’t seen your second comment about labour laws.

    Frankly, that article you’ve linked to is a horrible one. I don’t know which idiot wrote that article, but I’ve just read his paragraph about the decline of employment in the 80s not being a result of labour laws and… I can’t find a way to make a polite comment about that.

    Comment by Ravikiran Rao — December 7, 2005 @ 11:34 am

  15. “Remember the Bombay club? They were for the reforms before they were against it.

    Remember when the BJP used to be a pro-reform party?

    Also remember when Ford, GM etc. were such champions of free trade when they wanted to get in? But when it came to allowing import of second-hand cars, they suddenly turned into environmentalists.”

    We can add the half hearted laws trying to restrict the migration of call centres from developed to developing nations. And if we sit down and do a proper study we may find many such incidents of pro-reformers turning anti-reformers when it suites them.

    Remember that economic decisions are not just about economics but also, a lot about power and politics?

    Comment by mridula — December 7, 2005 @ 11:48 am

  16. I was just thinking the other day on how any change in India that would benefit the common man or the country at large generally came about only after a crisis.

    The tragedy, as usual is that lobbies exist only for specific interest groups, and not for the consumer.

    Comment by Prasanna — December 7, 2005 @ 2:19 pm

  17. The real problem is the carefully cultivated and promoted leftist hysteria against privatisation. A simple slogan – “privatisation is bad’ – repeated endlessly would make any ill informed worker think it dangerous. Painting a dark, gloomy future with no jobs, the rich growing richer, and the poor growing even poorer would naturally scare the daylights out of them. It is simpler to understand. Benefits of liberalization are not.

    This is also the reason why the communists are so fanatically opposed to the US and most of the west. In the west, they see a theory that is radically opposed to theirs. And yet, the theory is working, making the western countries richer, providing more employment and better standards of living. The western system has the potential of uprooting the communist ideology even here and so is a clear danger.

    But western prosperity cannot be denied, and so the fight is taken to another frontier – if only to serve as a distraction. So the communists shriek against ties with the US calling them imperialists and every other pre-independence and cold war adjective they can lay their hands on. The western countries become raiding and pillaging monsters while the Communists forget China’s own sordid history.

    We’ve allowed the unions to grow, be controlled by communist, left centric or even right wing parties. That is the major reason why even right wing parties drag their heels on liberalisation. Look at what we have now: the politically controlled monolithic unions, egged on by opposition to privatisation now well beyond the control of the parent parties, have actually managed to paint the mother political parties red. Why? because parties need votes. These votes come from the hundreds of thousands of unionised workers. And the workers are against privatisation.

    Regarding Michael’s comment, The reason why communist parties still exist in India is because the largest party in the country, the Congress, still has leftist tendencies despite having some excellent pro reform thinkers. Nehru was a socialist and the party still believes in following his ideology despite him being proved wrong. That is partly due to a fundamental flaw in the culture of the party. Since there is no real democracy within the party (like most others) the top levels of the hierarchy tend to choose ground level leaders who fall in sync with high command’s thought processes. And so the disease continues.

    So Congress sees nothing wrong in alliances with the communists. Apart from that, the only real power the leftists have is in West Bengal and Kerala, two of India’s worse off states.

    We are just being weighed down by the baggage of 40 years of so-called socialism that encouraged unions and their inherent dangers. Expecting it to go away so soon would be unrealistic. Thats the price we are paying for being a democracy. I’ve got much more to say but this has become an enormous comment already and so I will stop ;-).

    Comment by Alok Patel — December 7, 2005 @ 3:27 pm

  18. That was when it was making the eminently sensible complaint that we are going in for external liberalization before we liberalize internally. But when they came to power, they discovered that internal liberalization would mean that their unions and their small businesses would get hurt. Then it realised that internal liberalization was not such a good idea after all.

    Error in an otherwise sound argument. The NDA government’s lasting contribution in the area of economic reform is the privatization of state-owned enterprises, carried out in the teeth of opposition from not only the usual suspects such as the Left and the unions but from within the government and even the courts. Shourie — with backing from Vajpayee — fobbed off the goon-like tactics of Ajit Jogi in the sale of Balco. More than a dozen companies were successfully sold and many more were lined up to be sold before the government was voted out of power. It was the supreme court — not the unions — that stopped him from pulling off what could have been the biggest privatization success story: the sale of HPCL.

    Privatization has been a very contentious issue in most every country bitten by the socialist bug in the last century. In Europe, a political party’s willingness to privatize state enterprises has been used as the barometer of its commitment to free markets. No wonder the first thing that the corrupt bunch that is ruling us has done after coming to power was to put an end to strategic sale of public sector companies.

    Comment by RR — December 7, 2005 @ 8:25 pm

  19. Ravikiran,

    Are you talking about India: The Growth Imperative? I have only glanced at the report, but the report follows classic McKinsey style of benchmarking, interviewing and extrapolating rather than fundamental macroeconomic modelling. The report has several good suggestions, but I would take their numbers of a healthy dose of skepticism. The McKinsey report is clearly biased against the so called “Transition sector” of the economy where most of the Indian population is currently employed. These are mostly mom and pop operations widely recognised as the best generators of employment albeit at a lower wage than the “modern sector”. Finally, the reserved portion of the small scale industries accounts only for 30% of the total SSI sector.

    About the Placebo for poor comment: There is no doubt that the economic reforms since 1991 have benefitted the well educated middle and upper class. That does not mean that the poor were placed on a pacebo. In some cases people benefitted from the reforms, and in many cases have lost big time. Ditributional impacts of the reform process are felt by the poor people. They may not understand the economic jargon, but they sure do vote.

    Comment by Anup — December 7, 2005 @ 9:52 pm

  20. Prakash Karat is supposed to have just said he is NOT “not-in-favour” of privatizing profit making psus. Make of that what you will.

    If business journos are reading this blog, maybe someone will go and ask the Karat couple and their ilk to start creating jobs before they can comment on how the jobs created should be sustained.No one has the right to demand employement as far i know !

    They crib about FDI in retail but go to a big bazaar and its primarily manned by young men and women from non upper / middle class backgrounds. A casual conversation while waiting in long qs reveals that most of these kids are from families of laid off mill workers, have just about completed their 12th in local language schools , know some english or are currently going to english speaking classes to improve their english and pitching in to help run their homes. some are children of mom and pop store ownders whose shops have closed and while they may have been compelled to get a job, the inherent business savvy has propelled them rather quickly in a retail setup besides of course bringing better money than they could ever have earnt.
    if in the bargain , they are able to go up the managerial chain then we have created and sustained jobs.

    Regrettably, some of our politicians will only look at the glitzy facade of the malls without peeking at the economy they propel.


    Comment by Ila Bhat — December 7, 2005 @ 9:54 pm

  21. I saw reference to this post on other blogs and saw high praise. I have to say I am disappointed with the posting.

    Beyond the quibble on if the reforms are a cruel experiment that the GOI is playing on poor people while allowing the rich and middle class to prosper (even if you can decide it is an experiment or not, the thesis sounds pretty socialist, or class-based, to me). And apparently cell-phone use by poor, mentioned prior, doesn’t count.

    Just because it is easy it does not mean it is wrong. Privatization (and trade, licensing, and financial sector reforms) started 15 years ago and is still done yet. The farm, SSI, and reforms that impact manufacturing are not happening not because of opposition from the rich and middle-class (I doubt they care who makes their chappales and weaves those baskets) nor by the poor (who usually don’t have any say in anything anyway). Even if the communists weren’t there (they are now mostly stalling the reforms that started a decade ago), there would no reform to improve manufacturing.

    These reforms are not happening because of the socialist mindset of Indian political parties (egged on by NGOs). They wrongly presume that SSI and its workers need shelter. So they rather spend 100 crores on job program hand outs (how is that for a cruel experiment on middle-class tax paying school teacher) instead of enabling unskilled and semi-skilled job creation through manufacturing reforms. There is nothing new about it. It is part of easy solutions package that Indian political parties put forth – just like job and education reservation everywhere to every little group as the cure to solve the age old issues of discrimination and social immobility.

    The reforms will happen – probably too slow to help another generation of poor people. If I had my way, I would turn back the clock on all economic laws and constitutional amendments enacted since dear Indira started the great GOI grand thief of Indian private property since 1968. How’s that for a wholesome reform package?

    Please don’t bring Gandhi into this – he is long forgotten soul for most Indians and irrelevant for this topic.

    Comment by Chandra Dulam — December 8, 2005 @ 11:12 pm

  22. I’ve already said that nobody is blameless in the matter. I’ve blamed a long list of people. I could have added the “Government and NGOs” to the list and it would still be incomplete.

    I’ve also already said that noboday actually designed it as an experiment. It happened that way because of the dynamics of the decisions. Are you saying that just mentioning classes of people puts me in the socialist camp?

    I am not opposing privatization. In fact I would dance with joy if the government sold off or shut down every one of its PSUs, including the railways. Failing that, I will be happy with whatever reforms I can get. I just wanted to disabuse people of the notion that there was some grand design behind the sequence of reforms.

    And as for Gandhiji, I offer you a bet. If the government whispers something about dereserving SSIs, the op-ed pages and the letters to the editor pages will be filled with critical articles and most of them will invoke Gandhiji.

    Comment by Ravikiran Rao — December 9, 2005 @ 11:05 am

  23. “Remember when the BJP used to be a pro-reform party?”

    This is the bullshit which most of the self proclaimed libertarians use. BJP was never a pro-reform party till it was forced to take the stand after they got power. Even their 1998 manifesto was full of criticism about reforms. Mind it, the very first budget by Yashwant Sinha was not so “pro-reform”. It was a budget made to satisfy RSS bigwigs. Eventually they settled down to realize that reforms are the way to go and then tried to hijack the results of liberalization with their India shining campaign. I am seeing this many of the “libertarian Indians”. They seem to think that BJP was the reason why India is on the reform process and the current state of Indian economy. In fact, the revese is the case. BJP and communists are the reasons why Rajiv’s half hearted reform efforts failed. BJP joined hands with communists in opposing Manmohan Singh’s reform process. Their election manifesto before they got power in 1998 was anti-reform. The economic wing of the socially right BJP, RSS etc is Swadeshi Jagran Manch. This is a bullshit propaganda that BJP was pro-reforms party. Also I don’t understand how many of the supposedly libertarians support a morally authoritarian socially right wing party like BJP. I see this as a case of hypocrisy.

    Comment by Krish — December 18, 2005 @ 5:12 am

  24. Also remember who kicked out Enron from Maharasthra.

    Comment by Krish — December 18, 2005 @ 5:12 am

  25. [...] does it not go far enough, but that it’s not likely to go much further, in his post Why we reformed what we did.” An excerpt: The gradual, step-by-step openin [...]

    Pingback by Unjustly » What’s wrong with our reform process? — February 7, 2006 @ 8:24 pm

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  27. I currently live and work in Gurgaon the “satellite” or whatever of Delhi. The govt. is making teh poor poorer is very obvious to someone living here more so than in any Indian city or town I have seen.

    1) No public transport.vs. Car majors opening plants and more there.
    The poor have to walk in the South even villages don’t force this on their citizens. The rest of us drive around.

    2) Major freeway construction vs poor quality of internal roads.

    3) Malls malls everywhere vs. Local shops losing middle class customers plus worsening roads and transport making them unaccessible. While creating higher expectations. Dangerous.

    Comment by Sridhar Jagannathan — December 3, 2006 @ 5:55 pm

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