Genesis of India’s Economic Reforms

All our present day politicians, especially the ones belonging to the ruling group, endorse the policies of economic reforms with some differences on the details. But no body has really bothered to articulate as to why reforms have become necessary after fifty years since India’s independence: what went wrong with the economy in the last fifty years; and who was responsible for it. When pressed hard, such questions are parried by putting blame on the policies of the previous governments. Thus, Narasimha Rao in 1991 put the blame on the policies of the V.P.Singh’s government for the economic mess that he inherited. V.P.Singh proposed to reform the License Raj built by his predecessors by instituting the policies of delicensing, decontrol and deregulation. Rajiv Gandhi projected himself as a modern messiah wanting to lead the country into twenty first century by introducing computers and communications technologies and tools in India without any reference to the policies pursued by h is mother for about twenty years of her rule. Indira Gandhi, in turn, blamed the short-lived Janata government for the economic woes of India. Of course, most of the time she blamed the wicked West or the nefarious North for discriminating against the poor South and forcing unfavourable terms of trade and denying modern technology to fiercely independent countries like India. All this is politics of getting power and remaining in power. The real malaise has to be traced to the faulty philosophy and unsound economic strategy for development adopted by our leaders in the mid-fifties through the framework of five year plans.

I recall that I was a student of M.A. (Economics) at Gujarat University School of Social Sciences, Ahmedabad in 1956. Professor B.R. Shenoy was the director of this newly established institute. E was an eminent economist and an able administrator. Also he was a prominent member of the panel of economists appointed by the government to prepare draft outline of India’s Second Five Year Plan for the period 1956-57 to 1961-62. He became best known for his ‘Note of dissent’ on approach to Second Five Year Plan adopted by the government on recommendation of the majority of the economists on the panel led by P.C. Mahalanobis, the chief architect and the author of the Second Five Year Plan. It is this strategy which has formed the foundation of the economic policies of the last forty years wh8ich has led to the present dismal situation. The objections raised by Professor Shenoy forty years ago have been prophetic. Many of the current reforms are based on the alternative approach suggested by Prof. Shenoy to what he regarded as ‘planification’ of Indian economy. It may therefore be relevant to look at some of the points of dissent recorded by Prof. Shenoy at that time.

Prof. Shenoy objected to the technique of planning based on first fixing the targets and then looked for resources to fulfil those targets. He believed that such a technique could work in a totalitarian state with full control and ownership of all resources by the State, but not in a democratic State where people had freedom to choose how and where to use their resources. He felt that in such a situation either the targets will remain unfulfilled or the State will have to resort to large scale intervention in the economy to channelize the resources in desired quantities and desired directions through quotas, controls, licences, regulations, administrative orders, etc. up to a point when the economic democracy could be seriously impaired. Besides, he feared, such a situation will make the State – meaning politicians and bureaucrats wielding the State power – very powerful; an ugly nexus will develop between politicians and the bureaucrats, it will give rise to rampant corruption among people wielding excessive power and influence peddling will become order of the day. The present day situation demonstrates that Prof. Shenoy’s fears were well founded. Further, Prof. Shenoy believed that no amount of judicial activism or strengthening of the investigative agencies could cure the corruption. His prescription was to adopt the systems approach, that is, to have a system which does not give too much power and thereby opportunities for corruption to the State organs, viz. bureaucracy and the ruling political party. Even if it is to use a well-worn cliché, he firmly believed that the best government was the one which governed the least. Therefore, he believed that Market and the Price mechanism based on inter-action between Demand and Supply, though not a perfect tool was the best instrument to turn to for allocation of resources. He believed that the effort of the State should be to make this mechanism work as smoothly and competitively as possible.

Second, Prof. Shenoy objected to the heavy dose of deficit financing envisaged in the Second Five Year Plan to supplement the level of investment and raise it above and beyond the level of savings available during the plan period. Prof. Shenoy believed that printing of currency or credit creation could not generate real resources and therefore could not be substitute for real capital formation. He firmly believed that deficit financing would only make the real resources dearer and generate inflation which would hurt the weakest sections of the society most. He contrasted the situation of the developed countries from that of the developing countries. The situation of the developed countries was marked by lack of aggregate demand or under-utilization of available resources leading to perpetual recession sought to be remedied by various measures including pump priming. The situation of developing countries was marked by scarcity of resources and scarcity of savings constantly pulling the investment down. This, he argued could not be remedied by pump priming and could only lead to rampant, at times even hyper inflation. There was also a moral argument against deficit financing. He believed that just as a household or an individual had to earn his income to be able to spend and was not at liberty to print money to finance his day today expenses, the State should also not be at liberty to create money. Prof. Shenoy was also concerned about the growing government expenditure by resorting to borrowing and increasing the public debt. Such a situation was all right for a short period of time. But perpetually growing public debt was a sign of bankruptcy of the government and a policy of pushing the burden o the succeeding generation. Prof. Shenoy was opposed to the amendment of article 285(3) of the Constitution to permit taxation by the State of articles essential to the life of Community. As feared by him, India entered an era of double digit annual inflation starting with the 2^nd fifth year plan period.

Prof. Shenoy objected to the higher priority and higher investment outlays given to the heavy industries and relatively lower priority and smaller outlays for agriculture. The intention was to set in motion the process of converting India from an agricultural to an industrial country. Prof. Sehnoy argued that amelioration of poverty and raising of standards of living of the people of India – and majority of them – over 70 per cent lived in rural India – was more important than setting up heavy industries whose capital requirement was much higher, employment potential was much smaller and gestation period was much longer. Further, he argued, that some of the wealthiest countries in the world like USA, Canada, New Zealand, etc. remained primarily agricultural economies for a long time before embarking on a programme of industrialization. He recommended larger outlays for development of rural India in areas like rural literacy, rural health, housing, irrigation, rural transport, rural communication, rural electrification, improvement of farming techniques, better seeds, better fertilizers, etc. Or else, he feared, rural-urban gap will widen, rural unemployment will increase, driving villagers to the urban centres given rise to urban congestion and overall deterioration in the quality of life in both the villages and urban India. Exactly that is what has happened. How prophetic was the prognosis of Prof. Shenoy!

Prof. Shenoy disagreed with the primacy given to the development of the public sector in the Second Five year Plan. In that context, he was very critical of the Industrial Policy Resolution for 1956 stipulating that development of heavy industries, basic and key industries would be largely in the public sector in the future. By definition, key industries comprised of defence, atomic energy, fundamental scientific research and other industries of strategic importance. Basic industries comprised of steel, power, transport, communications, mining, oil, petro-chemicals, etc. Strangely, Prof. Shenoy pointed out that agriculture was not included in the category of basic industry, although food was a very basic item required for human existence. The reasoning of the planners for putting public sector in commanding position was two-fold. First, it was believed that primacy of the public sector meant giving greater socialist character to the economy which was the avowed goal enunciated by the ruling Congress party at its previous session at Avadi in 1955. It was decided at this session to give socialist pattern of society. Second, the planners or at least majority of them believed that the large amount of capital required for development of basic and key industries would not be available from private sector and hence imperative for the public sector to take that responsibility. Prof. Shenoy faulted them on both these counts. He argued that it was only in theory that public ownership meant socialism. In practice, it meant more power to the politicians and bureaucrats controlling the industries in the public sector giving them greater opportunities to misuse that power and lead to corruption. Furthermore, Prof. Shenoy felt that lack of profit incentive and lack of professional management will make these enterprises inefficient, wasteful and loss making propositions. Again, after more than forty years of working of the public sector it has been amply demonstrated how prophetic the prognosis of Prof. Shenoy is. What is more, it has reduced the private sector or whatever is left of it after forty years totally dependent on the government for protection. Its entrepreneurial ability and competitive character has been seriously sapped by the government oriented politico-economic culture created over all these years.

The draft outline of the Second Five Year endorsed nationalization as a desirable policy in principle. The only reason why it did not prescribe nationalization in one stroke was the fear of non-availability of the trained cadres to manage nationalized enterprises. Prof. Shenoy observed in his Note of Dissent that he was in principle opposed to the policy of nationalization for the same reasons which he had outlined for his opposition to establishment of public sector for management of key and basic industries. Thus, ideological bias was very strong on both sides.

Prof. Shenoy was opposed to the instituting of the exchange controls. It was for the same reasons that he outlined against all other controls. He believed that exchange controls will lead to corruption, malpractices and lot of inconvenience to importers and exporters and general public in need of foreign exchange for travel, education, etc. Instead, he advocated free convertibility of Indian rupee, keeping down the inflation by curtailing deficit financing and proper management of money supply in the system. He was opposed to the idea of import sub-situation as, he believed, it would lead to blockage of technology and foster high cost-low quality indigenous goods and sheltering an uncompetitive sector of economy. He was in favour of boosting exports, especially of agricultural goods, in which he thought India had tremendous potential. He was opposed to providing any subsidies but was in favour of allowing import of all necessary inputs to make exports competitive internationally. In fact, it is not without significance that forty years too late his prescription seems to be finding favour with our present day reformers, of course, without giving credit to Prof. Shenoy or faulting their predecessors for adopting an intrinsically wrong policy. The experience of the most of the developing countries that have succeeded in graduating from developing to the developed country status I the last forty years or even less, has demonstrated that export-led growth is the key to success. And providing competitive environments for the export industries is a sine qua non for this purpose. The examples are countries like South Korea, Taiwan, Hong Kong, Singapore and now Malaysia and Indonesia.

It is very clear from the above that the root cause of non-development in the last forty years and the present day malaise requiring reforms lies in the faulty strategy of planning and erroneous policies regarding the role of the State (what Prof. Shenoy has regarded as Statism) followed over all these years. Unfortunately, brilliant visionary like Prof. Shenoy was in the minority of one at that time. The mainstream economists were all in favour of the Mahalanobis model of planning. This was understandable in the context of the national and international situation prevailing at that time. Planning was in fashion in those days. USSR and China – the leaders in planned economies were regarded as progressive and successful countries in achieving rapid growth through planning. This judgement was mainly based on false statistics of achievements by these countries. Even in the West, there was a fascination for planning or some form of State intervention for economic growth. Various growth models propounded by the development economists endorsed planning and State intervention for rapid economic development of the newly independent countries of the so called Third World. International institutions like the World Bank and International Monetary Fund were in favour of target fixing and resource allocation through planning. Fabian socialism was in fashion in the post-war Europe and the UK Indian leaders like Nehru and Krishna Menon were greatly influenced by the political thought of those times. Their eagerness to combine socialism with democracy was at the back of their minds in preparing the blueprint of the Second Five Year Plan.

Clearly history has proved them wrong. China has failed in its Great Leap and Maoist revolution. It has ushered in the market economy era without much ado and called it four modernizations. It has given up Maoism without denouncing Mao. Soviet Union collapsed under the weight of its own inefficiency and drag. They have abandoned Marxism-Leninism without denouncing Marx and Lenin. In India the present day rulers are doing similar thing. They are slowly but certainly moving away from Mahalanobis-Nehruvian mould without denouncing Nehruvian Legacy. As a result, their approach seems to be half hearted and inclined to tinkering with the problem than coming to grips with the fundamental policy problems.