“When I was growing up in the 1980s, getting a telephone was difficult. The state had a monopoly over the telecom industry, and one could be on a waiting list for a telephone for years…. Today, I can go get myself a phone in 20 minutes.”
A friend of mine, a senior civil servant in the Indian government, told me an interesting story a few months ago. He had been given charge of a public sector unit (PSU) that was making losses. After much hard work, he managed to turn it around. Then he went to the minister in charge and told him that the PSU had just turned a profit. The minister gave him a worried look, leaned forward, and said:

“I think we should keep quiet about this.”

The minister, you see, wasn’t sure if making a profit was an honourable thing to do.

This is not an atypical anecdote. Decades ago, India’s first prime minister, Jawaharlal Nehru, told the industrialist JRD Tata, “Never speak to me of profit. It is a dirty word.”

There has been much talk in the last few years of how India is an emerging economic giant. Despite all the hype, India is a poor country, with hundreds of millions of people living lives of desperate poverty. The biggest cause is this widespread attitude towards profit and free enterprise. It hobbled India’s progress for decades after it became an independent country, and has slowly been changing over the last decade-and-a-half. But not enough.

The Mistrust of Profit

‘Free’ India’s early leaders distrusted profit and free enterprise. They fought long, courageous battles to gain political freedom for their countrymen, but did not have quite the same respect for economic freedom.

India’s history of colonialism was one reason for this. Trade brought imperialism to India. First, the East India Company arrived, ostensibly as peaceful traders. Then, with just a flip of the page in a book of history, the British took over. After a long and bloody freedom struggle, who could blame Indians for being distrustful of trade?

Also, culturally, traders were never given too much respect within India. One illustration of this—though not an explanation—is the caste system: priests (Brahmins) and warriors (Kshatriyas) were higher in the hierarchy than traders (Vaishyas). Even if the intellectuals of the freedom movement hated the caste system, the attitude towards trade that it illustrated persisted among the general public. Trade was grudgingly accepted, but not respected.

For more on spontaneous order, see “The Tradition of Spontaneous Order,” by Norman Barry, and “Rinkonomics: A Window on Spontaneous Order,” by Daniel B. Klein, on Econlib. For more on the mutual gains from trade, see the readings at Benefits of Trade and Comparative Advantage.

Some of the truths of economics happen to be unintuitive—spontaneous order, for example, or the almost banal fact that trade leads to mutual benefit. This was especially so in the context of those times. As Gurcharan Das wrote in India Unbound:

In a society steeped in feudal traditions and generations of economic stagnation, it is difficult to think of positive-sum results. Everyone is programmed to think that “my success can only come at the expense of your failure,” and “I can only get more land by taking it from you.” The government is “mother and father,” protecting me from my rapacious brother.

India’s first prime minister also mattered. As independence loomed, there were many candidates for that post, such as Sardar Vallabhbhai Patel, who was sympathetic towards capitalism, or C Rajagopalachari, a rare believer in free markets. But, with a little help from the influential Mahatma Gandhi, Jawaharlal Nehru got the job.

Modern Temples and False Gods

Fabian Socialism is discussed in Fabian Essays in Socialism, George Bernard Shaw and H. G. Wilshire, eds., and “John Stuart Mill: Traditional and Revisionist Interpretations,” by John N. Gray, on Econlib.

Nehru’s ideas about economics were shaped substantially by Fabian Socialism, which he came in contact with during his student days in England. He was also drawn to Communist ideals. He visited the Soviet Union in 1927, and wrote a travelogue of his trip that, in the words of historian Ramachandra Guha, was “unfailingly gushing.” As Guha wrote in his book, India After Gandhi:

It was, above all, the Soviet economic system that most appealed to Nehru. As a progressive intellectual of his time, he thought state ownership more just than private property, state planning more efficient than the market.

Nehru’s intentions were good, but his attitude was condescending. He did not believe that the ingenuity and hard work of millions of free Indians would be enough to take them towards prosperity—the state had to do it for them. Unlike the Soviet Union, he did not envisage state ownership of all resources, but supported a “mixed economy.”

Nehru not only created a vast public sector, but he also set in place entry barriers for private entrepreneurs in those fields. The complex web of government controls and regulations that resulted made entry into a market ruinously difficult, and expansion hard to achieve. Once the private sector was thus hobbled with this ‘License Raj,’ as Rajagopalachari called it, Nehru could point to its ‘failures’ and further justify the presence of government.

Existing big businesses supported this. They benefited by keeping competition out, and they could always get their way by bribing government officials in charge of licensing. As the government gained power, corruption naturally increased.

Many industries, such as airlines and insurance, were a monopoly, with the government being the only player. And where private sector companies were allowed to exist, like in steel and automobiles, the entry barriers were so high that there was virtually no competition.

In the absence of competition, there was no threat to the existence of public sector firms. There was no accountability, so inefficiency was not punished, and there were no incentives for efficiency. Labour unions became powerful, and wages were not dependent on performance. Decisions were not taken on the basis of market signals, which could safely be ignored, but on the basis of what special interest groups, such as labor unions and powerful politicians wanted—or on the basis of bribes paid.

Nehru once referred to public projects as “modern temples.” There is more truth to that than he intended. Nehru’s belief in central planning showcased a blind faith as startling as any religion. The state was conceived as a benevolent being that would display omniscience over every event in the economy, predict everyone’s needs, and ensure everyone’s welfare.

Thus, in Nehru’s time, a large, oppressive government replaced the British Raj that India’s freedom fighters had fought so hard to expel. But surely as the failure of such policies became apparent, the government would reverse course? One would have thought so, but it did not happen.

‘Indira is India’

Nehru’s failures when it came to India’s economy were understandable—his ideology was a product of the times. He was otherwise a great leader—he kept India united at a time when that did not seem inevitable, and he kept it secular and democratic. Those are great achievements. No such allowances can be made for his daughter, Indira Gandhi.

Indira became prime minister in 1966 after the sudden death of Nehru’s successor, Lal Bahadur Shastri. She wasn’t then a popular politician in her own right, and was propped up by a coterie of Congress Party insiders who thought she would be easy to control. As the 60s ended, she broke free of them, asserting her independence in a number of ways—one of which was by positioning herself as a socialist.

Indira embarked upon a series of programs that were supposed to help the poor, but which harmed them more than they helped. First, she nationalised all the big banks of the country. This was meant to give the poor, as well as the inhabitants of rural areas, access to credit that greedy capitalists allegedly denied them. In reality, vested interests ruled the process, and to get a loan, who you knew mattered more than credit-worthiness. Bad debts grew, making credit more expensive for the rest.

One populist measure was the ‘Loan Mela’, in which the bank would hand out loans in an assembly-line fashion to applicants, sometimes against livestock as collateral. There is an anecdote about how, in one village, a villager turned up with a cow and got a loan. Then he walked out, and another villager entered with the same cow. In this manner, an entire village got loans against the same bovine beast.

In his book, The Rise of India, Niranjan Rajadhyaksha wrote that in such loan melas “[d]ead relatives magically came to life for one day, collected their money, and went back to where they had come from.” The gods could not have better incentivised life after death.

This didn’t do wonders for the exchequer or the economy. But it made villagers happy, and it gave the government of the day the reputation for being ‘pro-poor’.

In a litany of ways, Indira hobbled India’s economy. In 1967, she restricted the production of a range of goods to small-scale industries, ostensibly to protect small manufacturers. This only served to restrict the growth of those industries, as companies in those areas could not expand beyond a point. In 1969, the Monopolies and Restrictive Trade Practices Act was brought into force, and became a roadblock to the expansion of businesses.

In 1973, the Foreign Exchange Regulation Act imposed controls on foreign exchange and imports. In 1976, the Urban Land Ceiling Act imposed controls on the ownership of land, which resulted in land markets being distorted. In 1976 and 1982, the Industrial Disputes Act was amended, bringing about labour laws that distorted labour markets, and prevented companies from growing.

It became virtually impossible to lay off employees, and unions became immensely powerful. Productivity went down, and companies had to comply with a vast number of regulations—especially if they were beyond a certain size. For example, firms employing more than 100 workers had to comply with so many regulations that most such firms either kept much of their workforce in the informal sector, or started five small plants instead of one big one, which prevented them from exploiting economies of scale.

The License Raj grew more complex, and tax rates went up, up, up—the peak income tax rate reached as high as 97.5%. While South-East Asia, once behind India economically, reformed and benefited economically, India continued growing at 3.5% per year, and its poverty remained intact.

All these measures could be explained as being good for the poor, who could not see their long term effects, and loved this charismatic woman who seemed to care so much for them. Her partymen were in thrall of her as well—a Congress president, DK Barooah, once famously said, “Indira is India and India is Indira.” No wonder India was in such a mess.

Besides snatching away the economic freedom of ordinary Indians, Indira also took away their political freedoms when she imposed an emergency in 1975. A country rose up in protest, and the emergency ended when she called elections in 1977, which resulted in her being out of power for three years. The common Indian protested when he lost the right to vote—but not the right to trade.

After Indira was assassinated in 1984, her son, Rajiv Gandhi, ascended to what had become a family throne. Rajiv was well-intentioned but naïve—he put together a few reforms in an ad-hoc manner, but if India was to become any more than a poor, third-world country, more was needed.

Opening Up

When I was growing up in the 1980s, getting a telephone was difficult. The state had a monopoly over the telecom industry, and one could be on a waiting list for a telephone for years. (Yes, years.) Businesses, which needed telephones to survive, often had to give “chai-paani” (tea and snacks, a euphemism for bribes) to get a connection.

Today, I can go get myself a phone in 20 minutes.

The telecom industry is just one illustration of how India has changed since 1991. Equally, there are many illustrations of how India has not changed. Let’s talk about the changes first.

At the start of the 1990s, India faced a balance of payments crisis. The Congress had won the 1991 elections as Rajiv was assassinated, and India’s prime minister was a compromise candidate named PV Narasimha Rao. At the time he took power, India’s foreign exchange reserves were worth two weeks of imports.

Rao and his finance minister, Manmohan Singh, called a meeting of opposition leaders. They were told how grave the situation was, and that there was hope in the form of a loan from the International Monetary Fund. But for the loan to be forthcoming, a series of economic reforms had to be carried out. The opposition had no choice but to agree. Suddenly, for just a while, politics ceased to be a factor in economic decision-making. And Rao and his team seized that opportunity.

Singh and the commerce minister, P Chidambaram, then rolled out a series of reforms. The rupee was devalued. Many industries that had earlier been monopolies were opened up to private entrepreneurs, such as airlines and telecommunications. Many licensing requirements that previously burdened businesses were dropped. Import quotas were removed and tarriffs were reduced. Foreign direct investment was allowed in many industries—and it rolled in, as foreign investors reacted with glee to the prospect of a market approaching a billion people.

It was as if, after decades of greeting the world with folded hands, India opened its arms and embraced the world.

Guha writes in India After Gandhi: “Between 1991 and 2000 the government approved more than 10,000 investment proposals by foreign companies…. Exports increased from 4.9 to 8.5 percent of GDP, imports from 7.9 to 11.6.”

To the West, India’s software industry was the most visible beneficiary. India’s software exports at the end of the 90s were 63 times what they were in 1990. But all across India, waves of entrepreneurship were unleashed. The economy began to grow faster and faster: It had grown at around 3.5 percent annually between 1950 and 1980, lifted slightly during the 80s, took off in the 90s, and reached 9.4 percent for 2006-07.

The middle-class burgeoned. So did the stock market. Someone who visited an Indian city in 1988, and then came again in 2008, would have trouble believing it was the same place. The signs of prosperity were everywhere: fancy cars filled the streets, and large malls dotted the cityscapes.

But there was another side to this story.

“Half Sub-Saharan Africa”

“Our vision of India,” the Nobel Prize-winning economist Amartya Sen said in a speech a couple of years ago, “cannot be one that is half California and half sub-Saharan Africa.”

It has become dangerously clichéd in recent years to speak of “two Indias.” (There are obviously as many Indias as there are Indians, but what good is nuance when it comes to rhetoric?) But it is undeniable that much of India has not been touched by the economic reforms. Some states, like Bihar, remain desperately impoverished, and tens of millions of people in the country still lack access to clean drinking water, and basic healthcare, and primary education.

This is not a failure of reforms. It is a failure of governance. In all the areas where the state remains paramount, it remains dysfunctional. It is a sign that the economy needs to be liberalized more, not less.

In recent years, the most common image used to depict the plight of the Indian poor is that of a farmer committing suicide—a worryingly common occurrence. And indeed, it is a failure of India that 60 percent of India depends on agriculture for a living—in most developed countries, that figure is closer to 5 percent. This is despite India achieving an agricultural surplus long ago, which should, in the normal course of things, have triggered an industrial revolution.

No such industrial revolution took place because of the many restrictions on business. Some of those have been removed—many other haven’t. Starting a business is still a nightmarish process: In their 2005 book, Law, Liberty and Livelihood, Parth Shah and Naveen Mandava wrote: “Entrepreneurs can expect to go through 11 steps to launch a business over 89 days on average.” (In Australia, it takes two days.)

In many areas where the license raj has been removed, a related inspector raj remains, and rent-seekers abound. India ranked 115 in the 2008 Index of Economic Freedom, which explains why it never became a manufacturing superpower. It still has draconian labour laws. Many industries are still restricted to small scale units.

What’s more, there are a variety of laws across India that prevent agricultural land from being sold for non-agricultural purposes. Farmers are not allowed to sell their produce beyond a restricted area, and price controls are rampant. Not only are farmers kept poor, but they are virtually trapped in their professions because alternative sources of employment haven’t been allowed to spring up.

India’s greatest failures have been in providing education and building infrastructure. A maze of licenses and regulations provides a tough entry barrier for would-be entrepreneurs, and government schools are dysfunctional. As any visitor to India’s big, gleaming cities would notice, infrastructure is in a mess, with inadequate roads and, barring Mumbai, insufficient water and electric supply.

Wherever the government has allowed competition and free markets, consumers have benefited—the telecom and airlines industries are obvious examples. But in the most crucial areas of our lives, the government refuses to let the private sector in.

Alas, there is also no political momentum for change. Manmohan Singh, the architect of the 1991 reforms, is the prime minister, but he heads a coalition government supported by the communists, who veto all significant reforms. His own party leader, Rajiv Gandhi’s widow Sonia, tilts towards the left—she once famously sent Manmohan a letter saying that foreign investment in retail might harm small retailers, and should therefore be reconsidered. She championed the National Rural Employment Guarantee Scheme, a wasteful public spending scheme that has since been found to be rife with corruption—and has since been expanded.

There is no Indian political party that supports free markets on principle. The middle classes who have benefited from the reforms aren’t politically influential enough to press for reforms, and are happy enough just going about their own lives. And for the poor, it remains an article of faith that wherever there is a problem, the government will solve it—even when the problem is government itself. Patronage remains the oxygen of Indian politics, and most politics in India is identity politics.

The reforms that were carried out in the heady days following 1991 were mainly low-hanging fruit—they didn’t have powerful interest groups ranged against them. The ones that are left—such as labour law reform or product market liberalisation—will be far harder to carry out. At the moment, there doesn’t seem to be the will to see them through. India’s economy might well keep growing at a healthy annual rate, but lifting all its people out of poverty is surely a moral imperative of any government.

The best way to achieve that, oddly enough, is by getting out of the way.

Further Reading

India Unbound, by Gurcharan Das. At amazon.

India After Gandhi, by Ramachandra Guha. At amazon.

The Rise of India, by Niranjan Rajadhyaksha. At amazon.

The Indian Economy: Problems and Prospects, by Bimal Jalan. At amazon.

Law, Liberty and Livelihood, Parth Shah and Naveen Mandava, eds. At amazon.


*Amit Varma, the winner of the 2007 Bastiat Prize for Journalism, blogs at India Uncut.