Democracy Lab

India's Missing Ingredients

Indian growth is slowing. But there are two key reforms that will help.

Using its obligations to the IMF as political cover, India's government kickstarted the long-delayed process of liberalizing the economy back in 1991. The reforms -- and the economy -- have largely been a good news story ever since. Indeed, with growth averaging seven percent annually until the worldwide financial crisis in 2007, there was even talk that India would give China a run for its money as an emerging market powerhouse. But lost somehow in the tide of enthusiasm was the reality that two key IMF-prescribed reforms -- fundamental changes in labor and tax laws -- were left incomplete.

It's become increasingly evident by now that the bloom is off the rose. Last year, India recorded the lowest growth rate in a decade (4.9 percent). The Kelkar report on fiscal consolidation also warned of adverse consequences in light of the widening fiscal deficit (6.1 percent of GDP in 2012-13). While the failure to complete the reforms explains in part why growth has slowed to a shuffle (by Asian standards, anyway) it also represents an opportunity: Finishing the job now would sweep away a variety of barriers to business development, helping to pull the economy out of its slumping trajectory. The big question is whether the changes are possible in the teeth of rising inflation, massive corruption scandals, and populist blowback led by opportunistic politicians.

In a large fractious democracy like India, reforms are always difficult to pass. And arguably more difficult than usual given current political circumstances: India is ruled by the Congress party-led coalition, United Progressive Alliance (UPA), that has been forced to include innumerable parties that oppose reform in order to stay in power. It doesn't help, of course, that few in the UPA leadership have the motivation or communication skills to sell the benefits of reforms to a skeptical public.

But I get ahead of myself. Since the 1991 reforms, national income has quadrupled but employment rates have stagnated. While growth has reduced poverty and added tens of millions to the middle class, a shockingly high portion of working age adults are either unemployed or underemployed in low-productivity tasks. That's in large part because India's labor laws are complex and highly restrictive.

The Industrial Disputes Act, adopted in the wake of independence by India's Fabian socialist leaders, dictates what employers can and cannot do, which can be summarized as "very little." Among other provisions, businesses employing more than 100 can't hire or lay off workers without government permission. Thus taking on workers means you probably have to keep them unless you go bankrupt -- a very good reason to make do with as little labor as possible.

By the same token, the tax laws are far from business-friendly. Rates are high and provisions are complicated enough to puzzle the lawyers in Bleak House, a reality that gives businesses incentives to develop convoluted avoidance strategies or simply to bribe the tax man. At the beginning of its second term in 2009, the current government promised to lower the corporate tax rate from 30 percent to 25 percent. However, the initiative is stalled in Parliament. Today the World Bank ranks India 152 out of 185 countries on tax practices in its Ease of Doing Business Index.  

By no coincidence, a shocking 90 percent (not a misprint) of the Indian work force is employed in the informal sector, where labor laws are largely irrelevant and taxes can be easily evaded. But this flexibility comes at a high cost to both employers and employees who face, among other problems, the loss of social safety nets. Informal-sector workers also miss out on government training schemes that could increase their productivity and wages. Plainly, the government should be using labor and tax reform to coax as many informal businesses as possible into the formal sector and encouraging the growth of businesses to more efficient scale. The World Bank's 2013 World Development Report, which focuses on labor issues, surveyed businesses in 102 countries, finding (among other things) that larger firms are likely to be more productive and thus to pay more, innovate more and compete in export markets.

But deregulation is still a hard sell in India. The loudest voices in opposition are those with a vested interest in business-as-usual -- trade unions protecting job security in the formal sector, legal businesses avoiding competition from new entrants, corrupt bureaucrats preying on the informal sector. And advocates of reform have struggled to make the case for changes that will add considerable risk as well as opportunity to the lives of most.

This struggle is a familiar one. In most political systems, small groups with focused, clearly defined interests can typically veto change that would serve the majority. What's more, myopia all too often trumps long term thinking. In India, after all, even privileged insiders have much to gain from rapid, sustained growth. If you doubt it, compare Indians' wages to those of South Koreans, who were among the least productive workers on earth in the 1960s.

Note, too, that luring businesses into the formal sector would broaden the tax base, generating revenue that could be used to extend the social safety net beyond the 8 to 9 percent of the workforce that is currently covered. Today, about 4 percent of Indians pay 70 percent of the total tax in India. Friendlier labor laws combined with tax reform could undoubtedly increase the tax-to-GDP ratio.

The stakes in the battle to complete the reforms sooner rather than later will be particularly high in the coming decade. As India's birth rate falls and life expectancy stabilizes, the portion of the population that is of working age will grow. This will yield what economists call a "demographic dividend" -- a period in which the burden of supporting the dependent young and old will be relatively light, leaving more income to plow back into investment.

But there's an obvious catch: To harness the dividend, jobs will have to be created to accommodate the seven million workers added annually to the workforce. The UPA introduced the New Manufacturing Policy to this end, aimed at increasing the share of manufacturing in GDP from a strikingly low 16 percent (the figure is above 45 percent in China) to 25 percent and to add 100 million jobs by 2022. This is a classic case of putting the cart before the horse -- those jobs won't be created if tough labor restrictions remain in place. An analysis by CRISIL, an Indian consulting group, concludes that, without major reforms, the share of manufacturing in GDP will only reach 17 percent.

One strategy for disarming popular opposition for further reform is to try it in individual states that are more receptive. India's 28 states, which have widely diverse political and economic cultures, could serve as mini-laboratories to test what works and to make a case for reforms accordingly. There's already some evidence of the benefits of reduced labor regulation from interstate comparisons. A 2012 survey by the Indian government's labor bureau concluded that "some of the states having pro-labor rights policies have not performed well in terms of unemployment rate."

That said, the best of worlds would still be one in which labor and tax reform law were fast-tracked. But is that world possible? The state of Indian politics offers little room for optimism. Consider, for example, the fate of the initiative for opening Indian retailing to foreign direct investment by big-box establishments like Walmart and Tesco that could dramatically cut consumer costs.

When Prime Minister Manmohan Singh introduced the foreign direct investment (FDI) initiative in 2011, nobody was surprised when parties of the left denounced it. What was dismaying, though, was the opposition of the Bharatiya Janata Party (BJP), the leading right-wing opposition party. It had championed FDI when it was in power in 2004, but apparently couldn't resist the chance to attack the government in a moment of vulnerability. The government did prevail -- but only after a year of delay. And the battle, needless to say, bodes ill for passage of even more controversial -- but necessary -- labor law reform.

In September 2010 The Economist predicted that the Indian economy would soon outshine China's, considering its advantages in "democracy" and "demography." Two years later it seems that, once again, Indian politicians have snatched defeat from the jaws of victory. A billion people are worse off for their incompetence and venality. It would be a shame if India had to wait for another crisis and another intervention by the IMF to unleash reforms when we already know what needs to be fixed.    

Photo by SAM PANTHAKY/AFP/GettyImages

Argument

An Idea Whose Time Has Come

It's not just Obama -- the entire world is ready to get serious about climate change. 

Before President Obama vowed to address climate change in his inaugural address, U.S. climate policy was so dead in people's minds that skeptics of global warming had crept, unmolested, into the mainstream. Not only do important Republicans still question the merits of climate science and the wisdom of a U.S. climate policy, but terms like "environmental alarmism" and climate "propaganda" are now apparently part of the centrist vernacular. The recession, one might be tempted to conclude, killed climate policy for good.

But Obama's speech, in which he promised to lead the transition to sustainable energy, was not the first indication that progress can be made on climate policy. While a comprehensive federal response to global warming may yet be out of reach, a number of states and localities are taking action independently -- as is much of the rest of the world. Moreover, the president's nomination of Sen. John Kerry (D-MA) as the next secretary of state elevates a staunch advocate of climate policy at the same time as a growing list of American allies are looking for increased cooperation on that front.

Officials around the globe are exploring the future of sustainability, especially in massive megacities, giving the United States a unique chance to engage. The European Union, Canada, and Australia are moving forward with major carbon-saving initiatives. Even China, is aggressively seeking reductions in carbon and oil imports with mammoth investments in renewable energy, restrictions on car purchases and use, incentives for electric vehicles, and even pilot carbon trading programs.  

In the coming years, then, the United States may well be able to capitalize on these diverse efforts to marshal support for coordinated measures to slow climate change. The trick, as international relations scholar David Victor has noted, may be to limit ambition and start with realistic goals that can build credibility.

The United States should begin by creating international partnerships on low-carbon transport fuels, which have the potential to eliminate 2.6 gigatons of carbon by 2035 through efficiency gains and fuel switching, according to the International Energy Agency. Alternative fuels not only help reduce greenhouse gas emissions, they also enhance global energy security and lessen the burden of high oil bills around the world. For these reasons, many countries are converting vehicles to run on natural gas, while many others are beginning to invest in electric vehicles, biofuels, and even hydrogen fuel cell technology. Countries with important vehicle-exporting industries -- including Japan, China, the European Union, and Brazil -- are taking an especially strong interest in alternatives to petroleum.

Given this nearly-universal interest in alternative fuels, it may be possible to agree on global testing protocols for vehicle efficiency and life-cycle -- steps that would go a long way toward creating global performance standards. The United States could further advance global dialogue by addressing low-hanging fruit such as methane flaring, land use, and deforestation -- starting within its own borders. By starting small and sidestepping controversial issues like universal carbon caps, the United States might find that significant progress is within reach.

The fact that the United States is embarking on an oil and gas renaissance should not hamper such efforts. Australia, for example, adopted rigorous climate change policies despite a recent natural gas boom of its own. It instituted a carbon tax that applies to oil and gas development, and is now phasing in a cap-and-trade system that will link up to the European Union and perhaps California, which itself launched a cap-and-trade program in 2012. Canada, the world's 5th-largest energy producer, also passed laws to phase out coal plants and institute a carbon tax in both British Columbia and Alberta; Quebec is launching a cap and trade program that links with California.

Nor should the patchwork nature of these initiatives be taken as an argument against U.S. participation. The future of greenhouse gas diplomacy will inevitably rest with an amalgamation of governments, non-governmental organizations, and private actors responding to both emerging technology opportunities and public sentiment. Already, major oil companies like ExxonMobil, Chevron, and Shell are taking concrete steps at introducing carbon management targets and practices, and most are quietly factoring in the future price of carbon in their long-range strategic planning. Investor Warren Buffet, who previously bought oil and gas pipelines and railroads, just placed a $2.5 billion bet on solar energy.

Even companies investing in the controversial Canadian oil sands are working to reduce emissions by improving energy efficiency, using low-carbon fuels for processing and transport, and even capturing and sequestering carbon. In our private discussions with oil executives, virtually all have acknowledged that climate policies -- such as cap and trade and California's low-carbon fuel standard -- are inevitable in the long run. In some cases, such policies could benefit the companies themselves, even beyond energy efficiency savings. As Carbontracker.org, a website dedicated to aligning capital market and climate change objectives, has rightly pointed out, mining and resource companies that book long-range reserves often have assets on their balance sheets that will never be commercialized, meaning that their shares are overvalued. These companies, which make investment decisions on a 20-year time horizon, will become increasingly eager to formalize climate policies to reduce risk and uncertainty and maintain value for shareholders.

The prospect of environmental activists and policymakers blocking -- or even delaying -- multi-billion-dollar investments in Arctic or other complex pre-salt deep sea resources that might take 15-plus years to bring on line could be disastrous for these companies. Should tighter restrictions on carbon be instituted in the next two decades, returns might be higher on investments in low-carbon natural gas and other cleaner alternatives. Shell's current predicament is a case in point: Should it sink even more dollars into technically and politically troubled offshore exploration in Alaska, or should it focus future spending on unconventional natural gas production and transportation in the lower 48 states?

In January 2012, the chairman of state oil behemoth Saudi Aramco went on record saying, "Greenhouse gas emissions and global warming are among humanity's most pressing concerns. Societal expectations on climate change are real, and our industry is expected to take a leadership role." If the world's oil superpower is willing to accept responsibility, certainly the United States can afford to take a more forward diplomatic stance. By starting with programs that revolve around transportation and standards like those underway in California, the United States might find it can build trust and the will for progress on the global climate change agenda. The Obama administration can leverage emerging successes at the state and local level into a credible global dialogue on climate and transportation policy. That would elevate the standing of the United States to a position of global environmental leadership -- and allow the president to make good on the promise he laid out in his inaugural address.

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