Economic growth requires protection from expropriation of property by individuals, State

Reform was mostly the reduction of bureaucratic red tape of “licence raj”, making it easier for private players to enter and exit markets. This led to unprecedented economic growth, the creation of a middle class, and significant poverty reduction. These reforms got a further shot in the arm under Atal Bihari Vajpayee with the disinvestment drive. For example, the telecom and energy sectors that were plagued by shortages for decades were partially privatised and very soon turned a surplus, boosting the economy and laying the foundation for a “digital economy” in modern India. This was evidence that nationalisation and socialism were not the answers to India’s poverty and social problems.

The spectre of socialism and nationalisation, however, rose once again in 2012-13 when the then finance minister amended the Income Tax Act of 1961 with retrospective effect to undo the Supreme Court judgment in the Vodafone tax case. The FM articulated in an interview that the Supreme Court did this primarily due to their concern for its effect on foreign direct investment. The former FM, however, missed an important point: The primary issue was not whether FDI would be discouraged but, more fundamentally, whether private property is protected from expropriation by the state.

In a mature democracy, rights of an individual vis-à-vis the state are protected by an independent judiciary. This act of undoing a Supreme Court judgment was an assault on the individual right to private property. The Vodafone tax case went through the entire judicial process that is available to an ordinary citizen of the country. In its final verdict, the Court agreed that tax planning by the firm was legitimate and within the framework of the law.

The Court, while making a distinction between tax avoidance and tax evasion, made the following observation: “Every person is entitled so to arrange his affairs as to avoid taxation, but the arrangement must be real and genuine and not a sham or make-believe.” Even though it became evident that the existing Income tax Act of 1961 had a lacuna which needed to be fixed, and the sovereign had the right to do so, but to fix it retrospectively was deeply problematic. Applying the law prospectively would have been a reform but applying it retrospectively was to undermine the Court and was a blow to the independence of institutions that check the power of the state.

The second assault on private property came in quick succession in 2014, ironically from the Supreme Court itself, when it cancelled all the coal block allocations to the private sector from 1993 to 2012. In 2014, a public interest litigation was filed, questioning the arbitrary nature of coal block allocations to private players by the government. The Court accepted the petitioner’s plea and in one stroke cancelled all the coal block allocations from 1993 to 2012.

Unfortunately, the highest court did not take into consideration the property rights of various stake holders, such as creditors, investors, and shareholders of these companies for whom it would have been impossible to know whether the government’s coal allocations were arbitrary and therefore illegal. It is also important to remember that the share of the power sector in bank credit to industry was less than 1 per cent in 1998 and by 2014, it had grown to 20 per cent at more than Rs 5 lakh crore. It was evident that other stakeholders had significant exposure to this sector. Once again, the message was loud and clear that property rights of individuals are not well protected in India.

The coal allocation issue was not black and white, each case merited careful consideration by the Court in terms of its impact on various stakeholders who were not guilty of the crime committed by others. Perhaps, former US Supreme Court Justice Antonin Scalia was right when he wrote that “In the grand scheme of things, whether the right party won was secondary.

Famous old cases are famous, you see, not because they come out right, but because the rule of law they announced was the intelligent one. Common-law courts performed two functions: One was to apply the law to the facts, but the second function, and the more important one, was to make the law.” The law that got made that day was that individual property rights are not well protected in India.

There are important lessons to be learnt. In the last five years, several fiscal and monetary policy measures have been taken to arrest the decline in private investments. Long-term economic growth requires fundamental assurance to individuals that their private property is protected from expropriation by other individuals, the government and also the courts themselves. Large parts of the Indian economy remain informal — not due to tax rates or high cost of formalisation — but because of mistrust in institutions and fear of expropriation by them.

Democracy is expected to give us an edge over autocratic China in terms of privatisation and long-term growth. The enigma of our times is that China, with no tradition of free and fair elections and independent judiciary, has managed to provide economic freedom and protection to private property leading to unprecedented economic prosperity.

This article was first published on September 27, 2019 in the print edition under the title ‘Why property rights matter’. Kapoor is associate professor ISI Delhi, Ravi is research director, Brookings India.