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Entitled to grow

Some types of populism may be more compatible with economic growth

Written by Dhiraj Nayyar | October 13, 2010 5:26:21 am

On almost every occasion that the states of India are ranked on the basis of economic parameters,Gujarat comes out on top. It was therefore somewhat surprising to see Tamil Nadu come out on top in the latest Economic Freedom Rankings for the States of India,2009 last week. Incredibly enough,the last set of economic freedom rankings in 2005,compiled by the Cato Institute and Indicus Analytics,had also put Tamil Nadu right on top of the pile,just ahead of Gujarat. That ranking is particularly significant because there is a strong link between liberal economic policies and high growth. And,Tamil Nadu’s growth performance in the last five to 10 years has indeed been in the top league among Indian states,as has Gujarat’s.

Notably,in the 2009 rankings,Andhra Pradesh ranks at number three in terms of economic freedom,up several rungs from its 2005 ranking. Again,there is a strong correlation between its ranking on this index and its remarkable growth in the last three years.

But what makes the findings on Tamil Nadu and Andhra counter-intuitive is that,unlike Gujarat,both these states have been more famous for their populist policies than liberal economic policies — one would normally put these two states at the top of a ranking based on populism! Tamil Nadu is,after all,a state in which the ruling party promised free television sets to all before the last assembly election and then proceeded to dole them out — that is populism at an extreme. It is the one state that has universalised the public distribution system (PDS),giving every resident access to cheap foodgrains,something that sensibly should be reserved for the poorest alone. And very few would associate either of the leaderships of the two major political parties,the DMK and the AIADMK,with transparency and accountability.

Andhra would also rank right up there on populism. The late Y.S. Rajasekhara Reddy,chief minister between 2004 and 2009,was inclined to dole out not just subsidised food,but also subsidised power,the latter being something more progressive states have long abandoned. And YSR,for all his strengths,wasn’t famous for transparency in running his government.

So,does this square up with the freedom rankings? It does,in a rather interesting way. When disaggregated into its component parts,the Economic Freedom Index is revealing. On the parameter of size of government (expenditures,tax revenues and state-owned enterprises),both Tamil Nadu and Andhra rank quite poorly; smaller governments get a higher ranking. The heavy spending on populist policies does,therefore,show them up on this parameter. However,on the other two parameters — property rights and security,and regulation of credit,labour and business — both states register excellent scores,enough in fact to neutralise the problems on the size of government parameter.

More than the size of government,it is the latter two parameters that have a direct bearing on the ease of doing business in the private sector. And in that lies the key lesson: some types of populism may be more compatible with the growth of enterprise and indeed economic growth; other types of populism can be more damaging.

What are the most damaging forms of populism then? The ones that most directly affect the ease of dong business. To name just a few: appropriation of private property rights,archaic labour laws,state support of strikes,physical threats to safety of business,withholding local licences and permissions,delays in court cases,excessive control on flow of credit to the private sector — basically policies that interfere with the functioning of market forces. Where Tamil Nadu and Andhra score impressively is in being liberal in precisely these policy areas,particularly in the last five years. That makes them attractive investment destinations,and investment spurs growth.

Ironically enough,at least some forms of the redistributive populism under the head of government spending can actually reinforce the growth driven by private investment. The Andhra government has spent heavily on capital investments,particularly in rural areas. Also,any government transfers to the people that ultimately boost consumption end up reinforcing growth. This was also a lesson learned from the period of the global slowdown when government-enabled rural spending across India helped in keeping growth resilient.

The states,of course,have a more stringent budget constraint than the Centre — their ability to borrow from sources other than the Centre is strictly limited and their ability to levy taxes,although greater than their ability to borrow,is also limited by their constitutional remit. This may actually be a good thing in a politics often driven by populism because it acts as a good check on what can otherwise degenerate into a careless and damaging tax-and-spend spree.

The policy path followed by Tamil Nadu and Andhra may be a more realistic role model for other states when compared with Gujarat. Gujarat has always been an atypical Indian state with its political economy,and as a consequence policies are heavily skewed in favour of private business interests — the state’s strong tradition of entrepreneurship and long history of industrialisation have ensured that. Most Indian states,however,grapple with a political economy that is usually split between attracting investment and growth on the one hand and satisfying populist demands on the other,just like Tamil Nadu and Andhra. These two southern states may now be shedding valuable light on how to marry these sometimes contradictory pulls.

There may be a valuable lesson in this for the UPA government at the Centre as well,whose recent economic policy thinking seems to be clearly tilted in the direction of populism — the National Advisory Council in particular is lending strong support to a universal PDS,as in Tamil Nadu. Such populism,if it is to be at all sustainable,must be accompanied with policy liberalisation in other spheres — labour laws,environment laws — so that growth remains on the fast-track.

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