The year 2009 should be
something of a landmark for the Indian economy. It marks
three completed decades of renunciation from the Hindu
growth rate. In the 1980s and the 1990s, the Indian
economy grew by about 6 percent. In the decade just
ending, this figure climbed to over 7 per cent. Per
capita growth rate in this decade is about 5-5.25 per
cent compared to about 3.50 percent in the previous two
decades.
Three completed decades of solid, steadily-improving
economic performance is cause for considerable cheer. No reasonably-sized
democracy in the history of humanity has posted such growth rates for so long
while remaining democratic. (The “reasonably-sized” qualifier is necessary
because Botswana and Mauritius have been uninterrupted democracies and done even
better than India in growth terms).
Impressive as India’s achievement is, it falls far short of China’s. The two
countries left the blocks at roughly the same time — the late 1970s — but China
went on to grow at more than 10 per cent a year for 30 years, which no country —
democracy or otherwise — has matched, ever.
But this gap cannot be bridged for some considerable time. It is not that India
lags China in its embrace of markets or in the entrepreneurial capacity of its
private sector. It is simply that there is no contest in that other key
determinant of long-run growth: state capacity and effectiveness. India’s
rickety and fraying public institutions are no match for that deadly combination
of the Chinese Communist Party and military in providing the basic services —
order, stability, health, education, and water — that are essential for and
complement the functioning of markets. Mao’s legacy has proven more durable and
more effective than Nehru’s in the economic sphere. The Chairman trumped the
Pandit.
It is not that India’s institutions are uniformly bad. They can organise
elections for 700 million people (every five years), the census for 1.2 billion
people (every 10 years), and the Kumbh mela for about 70 million people (every
12 years). But they have a miserable record of providing health, water and
education for its poorer citizens on a daily basis. And the truth is, we have
little clue as to how to reform our public institutions — civil service, police,
judiciary etc — to deliver these basic services.
There is a fundamental asymmetry between state capacity and markets. The dirty
secret is that it is easier to create markets than it is to create state
capacity or to prevent its deterioration. Creating markets is a lot about
letting go, establishing a reasonable policy framework, and allowing the natural
hustling instinct to take over. Hustling is the natural state, and as Devesh
Kapur of the University of Pennsylvania has argued, India has become a nation of
“hustlers”.
In contrast, building state capacity involves overcoming collective-action
problems, mediating conflict between different groups, creating accountability
mechanisms, and contending with the deep imprints of history. Building public
institutions is, to borrow from Max Weber, like the “slow boring of hard
boards”.
In assessing the likelihood of India moving to the Chinese growth trajectory,
policy analysts tend to focus on policy reforms that will improve the
environment for the private sector. But the preceding analysis of the deeper
determinants of China’s and India’s growth record suggests that improvements in
state capacity may well be as important. But is there any credible effort to
improve state capacity?
Indirectly, yes, and that effort is the implementation of the GST being overseen
by the 13th Finance Commission under Vijay Kelkar. This is a major “reform”
initiative and has the potential to be a game-changer for the Indian economy
going forward. Why so?
The obvious appeal of the GST initiative is two-fold. It would vastly simplify
and rationalise the tax system in India in a self-policing manner that would
minimise leakages. Second, the rationalisation across states would also go
towards making India more of a common market, facilitating the easy, unhindered
mobility of goods and services, and less a collection of barrier-ridden states
that it currently is. The value of creating a common market will rise
dramatically when the India of 28 states becomes an India of say 35 or 40
states, as seems likely.
But the tax reform’s more important contributions may well be in relation to
strengthening state capacity. One of the key functions of the state is being
able to respond to macroeconomic crises. The wherewithal for effective response
is a sound public sector balance sheet. China has emerged from the recent crisis
economically stronger than many industrial countries because of its low
indebtedness while going into the crisis which allowed it to mount a strong
fiscal action during the crisis. India’s public finances, in contrast, are
wobbly. The GST, by widening and creating buoyancy in the tax base, would
provide the best hope for India to bring down its deficit and indebtedness to
more reasonable levels. Of course, that outcome cannot be guaranteed. Higher
taxes could be spent rather than used to pay down debt. But with the GST, there
is at least a credible tax and revenue handle to reverse fiscal course.
The deeper, if more abstract, point about the GST and tax reforms relates to
taxes and institutional development. Taxation is a glue that binds citizens and
states to create civic engagement and productive two-way interaction. Because
governments need to tax, they have an incentive to facilitate wealth creation
(which provides the tax base) and hence to guarantee rule of law, protect
property rights, and ensure sanctity of contracts. And because citizens are
taxed, they have an incentive to hold governments accountable for the promises
they make.
It is, of course, debatable whether taxation-as-glue works better in the form of
income taxes and direct fees or in the form of indirect taxes such as a GST. But
in a poor country, the vast majority of the population will remain outside the
net of income taxes for some considerable time. Until then, indirect taxes such
as the GST, inequitable though they may be, will be important, even essential,
in creating the civic connection between the state and its citizens.
Heading into 2010, the world is looking anxiously for new liberalisation
initiatives by India to move it to the 9-10 per cent growth trajectory. Tax
reforms may not be sexy. They may not even be liberalisation as conventionally
understood. But if the essentials of GST reform can be implemented in enough
states with a modicum of effectiveness in 2010, prospects for India’s
institutional development and hence long-run growth would be considerably
strengthened.
