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Interview with Vijay Kelkar & Ajay Shah: ‘The middle-income trap can happen here’

In our book, our big ideas are related to Mahatma Gandhi’s ideal world which is an “ordered anarchy”, where the people shape their destiny, where the people don't look to the government to reshape their world.

Written by Udit Misra |
Updated: December 17, 2019 5:22:01 am
Vijay Kelkar and Ajay Shah. (Express photo by Tashi Tobgyal)

In their recently released book, titled “In service of the republic”, Vijay Kelkar (former chairman of the 13th Finance Commission) and Ajay Shah (Professor at National Institute of Public Finance and Policy) lay out the reasons why India lost its growth momentum after 2011. The book also outlines how India can become a liberal democracy because if individual freedoms are not respected and state coercion not contained, even high growth will not be enough. UDIT MISRA caught up with the authors to speak in detail.

You start off the book by saying that the book would try to answer why the reforms introduced from 1977 onwards delivered success during the 1991-2011 period, but faltered thereafter. So what was the essential reason?

Vijay Kelkar: Simply put, under-developed institutions; weak institutional capacity.

Ajay Shah: Where did we go wrong? We had a slogan of becoming a market economy, of fostering economic freedom, of obtaining the economic dynamism that goes with these. But we did not think through what should be the role of the government in a market economy. It is not a matter of simple deregulation, of shutting down government intervention, as there are market failures in a market economy. There is actually a role for the state. We didn’t do enough in thinking through the role of the state, on the problems of state capacity, on how to obtain competence in government organisations. And we failed to recognise the dangers of state power, of state coercion. How do you protect the private sector from state coercion? We didn’t agree on an intellectual framework, and we did not build the institutional capacity to protect private persons in a market economy.

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VK: We never got rid of mai-baap sarkaar, the paternalism. The notion is that state is the march of god on earth. Right from the start, Mahatma Gandhi did not believe in this, but we slipped into the notion of state benevolence.

AS: In our book, our big ideas are related to Mahatma Gandhi’s ideal world which is an “ordered anarchy”, where the people shape their destiny, where the people don’t look to the government to reshape their world.

 Given this argument against too much state intervention and not understanding the role of the state in a market economy, how do you look at the current growth deceleration in India, which has now gone from being the fastest-growing major economy to a major cause of concern in just 3-4 years? Was this expected? Are these the makings of India falling in the middle-income trap that you mention in the book?

VK: We should not look at the 8 years after 2011. Changes in trend growth are long slow phenomena. Right from independence, our dream was that India should become a prosperous liberal democracy. But there are many instances in the international experience where this has not happened. That (middle-income trap) can happen here and that is why we started thinking about it. The most important word in this book is the “republic”: there is an intimate connection between the objective of liberal democracy and the objective of a prosperous market economy. We have been thinking for over a decade now how India can grow sustainably, how sound GDP growth can be sustained for 30 years. Our dream is to help India attain its rightful place in the world and the global economy.

AS: I want to say this in historical sequence. I was very excited about what was happening in India from 1991 onwards. But by 2006, 2007, which were the go-go years for the economy, I was starting to get extremely nervous about the decline in institutions. I was seeing vast sums of money being used by private persons to subvert state institutions. And I had a feeling that this would go badly. You cannot have functioning capitalism without capabilities in state institutions. It took some time for the data to fall into place, but now the picture has become clear that 2011 was the year when that boom ended. In one data series after another, be it the growth rates of automobile industry or nominal private investments, there is a clear break and deceleration after 2011. So there was the 1991 to 2011 period and then there are the following eight years. The heart of this story is one of institutional decline. The reason why we had all the problems in infrastructure and PPPs (public-private partnerships) etc. was that we did not have the commensurate capacity in the departments of governments, in the regulators, in the courts. Our errors in financial policy meant there was no bond market, so infrastructure debt was loaded into banks, and that ran into trouble. And so on, in one area after another, these failures came about, and they have all added up. Mobilising capital and labour and translating into GDP growth is not something trivial and obvious. The truth is that we have vastly underutilised our labour, and the access to capital in the global financial system. This happened because our institutions created an environment where private persons lost heart in investing, in using these readily available factors of production.

Vijay Kelkar (right), former chairman of the 13th Finance Commission, and Ajay Shah — Professor at National Institute of Public Finance and Policy.

What are the things that changed since 2011 which stand out in your mind?

VK: I want to be careful in emphasising long delays between cause and effect. If the data on outcomes, such as private investment, show deterioration from 2011 onwards, this is surely caused by many policy actions of the preceding many years. We should not look for a sharp event in 2011 that triggered off the decline.

One basic barrier that has emerged is the lack of trust in the government by the business decision-makers because the government is going back on contracts. A key trigger was retrospective taxation. But it didn’t end there: after that, the government of India and state governments have gone back on many contracts. In a market economy, the sanctity of contracts is the most important thing. Today, if I were a private person, I cannot take certain decisions because I do not know whether the government will honor their end of the bargain, or not. A case in point in how Chief Minister of Andhra Pradesh has canceled all contracts with foreign companies. Data would show that in the pending cases, 50% of the litigants are government and its agencies. This has created a complete indeterminacy.

 What has prompted repeated governments to intervene so often? Is it is a reflection of widening inequalities, or people’s lack of trust in the market providing the solutions?

AS: This book is not so much about here and now, rather the last 40 years and the next 40 years. With the benefit of hindsight, in the period after 1991, we the economists, the intellectual community, did not do enough in terms of thinking more deeply about the role of the state and the role of the market, understanding market failure, building a legal framework to bring in more checks and balances in the system. For example, the SEBI Act was repeatedly amended during the 90s, but in those years we had little clarity about the difficulties of checks and balances in an agency, of firmly placing such an agency in a rule of law arrangement. These weaknesses of the analysis of that period are now coming back to bite us.

You have talked about Mark 1 strategy, which was developed by Nehru-Mahalanobis etc. Mark 2 was the conceptual approach of J Bhagwati, T N Srinivasan and Manmohan Singh etc. In the book, you say, constitutes an effort to find the Mark 3 framework. What is that?

AS: What Mark 3 needs to do is to build an economic policy framework in the context of the republic where freedom is respected, where officials do not have arbitrary powers, where there are checks and balances and the coercive power of the state is brought under control. That will be the kind of atmosphere in which private persons will gain confidence, will trust and will come back to invest in India and building India – not just by putting their money but also their life. Only when millions of people feel the excitement of being in India, are suffused with enthusiasm to build the republic, will India stand on its feet, become prosperous and become a wonderful liberal democracy. These things don’t happen by themselves. In the 90s we did a lot of slogans and high philosophy about the market economy, but very little of the gritty detailed work that is needed to address market failures. We thought that by saying that we are not doing central planning now, it would go away. The license-permit-raid raj did not go away: it morphed into arbitrary powers, in meddling and raiding by many bureaucracies around the country.

But how will Mark 3 happen? The long-standing appeal – that some strong leader will come and solve all problems – endures.

Mark 1 or 2 or 3 are projects of ideas, they are intellectual constructs. Every great liberal democracy is the product of intellectual ferment. Don’t see Nehru in isolation. Nehru alone did not create Nehruvian socialism; there was an entire intellectual community that thought it through. Similarly, Manmohan Singh’s Ph.D. thesis in 1964 questioned export pessimism – that was intellectual innovation of the highest order, and was a key building block of the Mark 2 framework. Over the years, those ideas became mainstream. This book is our contribution into the larger process of thinking through the Mark 3 framework.

VK: We should not be gloomy. India has been through a great ferment two times before. There were twenty years of thinking and debate that led up to Mark 1 by Nehru and others. Similarly, there were twenty years of thinking and debate that led up to Mark 2 from 1991 onwards. Look back at a person like Atal Bihari Vajpayee. He was a liberal by instinct and had a remarkable intuition about what was right for India’s long term future, he was able to channel the knowledge of that time into very good actions. We have to build knowledge through a process of debate and research; the good ideas will find their way into action.

 But Vajpayee was the product of the coalition government era. And didn’t we, for the longest time since economic liberalisation, see coalitions as weak and inhibiting the reforms agenda.

VK: By now the evidence is beginning to pile up that dispersed power works better. We have often found that Parliamentary Standing Committees work better when there is a fractured Lok Sabha and Rajya Sabha – that is when there is a negotiation between multiple parties, there is a give and take, and this improves a Bill. It is a very old principle, that liberal democracy is all about dispersion of power. So we should resist this Chinese Communist Party-type idea that some strongman will push through something. Our highest aspiration should be for mutual respect and debate and negotiation between many political parties that represent the diverse interests of the people of India.

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