What are the economic ideas of Arvind Panagariya, the vice chairman of NITI Aayog? In a speech in February last year he had expressed rather radical ideas of reform. Will they be too hot for the PM? This is first part of a multi-part series
Prime Minister Narendra Modi dismissed the Planning Commission and set up the National Institution for Transforming India (NITI) Aayog. As expected, Modi appointed his long-time supporter, economist and professor Arvind Panagariya as the vice chairman of NITI Aayog. Pangariya, as an economist is known for his radical views on reforms, and it would be interesting to see, if PM Modi subscribes to his views and actually carries out the NITI Aayog vice chairman’s suggestions. What are his thoughts?
For this, let us turn to CD Deshmukh Memorial Lecture 'A Reform Agenda for India's New Government' on 11 February 2014. That lecture is fairly exhaustive and is almost a blue print for reforms and growth. Pangariya outlined a strategy of reforms along two tracks, one of faster, employment intensive growth and second, expanded and more effective social spending. Here are his thoughts on some of the main issues facing India today. Especially, for manufacturing sector, Panagariya has suggested reforms in labour laws, red tape, inspector Raj and exit policy for industrialists.
The experience of virtually all miracle economies around the world, such as South Korea, Taiwan and Singapore in the 1960s and 1970s and China more recently, has been that fast growth in manufactures leads to economic transformation. This process also leads to rapid urbanization and modernization. In India, this process has not worked. The share of manufacturing in GDP has hardly budged since 1990–91.
The organized sector, consisting of firms with 10 or more workers, employs less than 5% of all workers. The only way to create good jobs for the vast and rapidly rising workforce is to create the enabling environment for the growth of employment-intensive manufacturing. How can this be done? Reforms are required on several fronts:
Improved infrastructure including roads, railways, ports and electricity is essential for manufacturing growth. Because profit margins per worker are low in sectors where labour costs are 80% or more of the total costs, it is important that transportation and electricity are available to entrepreneurs at competitive rates. I will return shortly to the subject of infrastructure in greater detail.
2 Labour market flexibility
Myriad labours laws—52 of them at the Centre and three times those in the states—drive our entrepreneurs away from employment intensive manufacturing sectors and also encourage them to opt for capital-intensive technologies in whatever manufacturing they do. Where a machine can do the job, they prefer not to employ workers. While we must protect the interest of our workers when employed, we also need to create millions of jobs for those toiling in the informal sector or who are without any job at all. Therefore, we must think of creative ways to introduce greater labour-market flexibility such that the interests of workers already employed and those seeking good jobs are balanced. Recognizing that labour is a concurrent subject in our Constitution, one way to do this is to give powers to states to amend central legislation. With 28 states (soon to be 29) in India, this could provide healthy competition as well as greater experimentation.
Apprenticeship is a very important vehicle for skill creation. Yet, India has only 300,000 apprentices compared with 10 million in Japan. As Manish Sabharwal has written in a number of articles, the existing relevant legislation, the Apprenticeship Act of 1961, is highly constraining. It treats apprenticeship as employment and an associated stipend as salary, with all attendant regulations also applying to apprenticeships. Depending on the trade, the duration for apprenticeship can vary from three months to three years but the current legislation does not give this flexibility. A relatively uncontroversial reform of the Act can lead to a manifold expansion of apprentices. Many skills are learned on the job, so that an expansion of apprentices can serve to stimulate manufacturing and greatly improve the employability of the individuals receiving apprenticeships.
4. Land acquisition
According to the best available reports, land acquisition came to a standstill the day the new Land Acquisition Act became a reality. A quick reform of this Act will be absolutely essential for the new government. Land being central to all activities including infrastructure, housing, manufacturing and services, a land acquisition law that is fair to those whose land is acquired but that also allows land acquisition at a reasonable price is critical to all economic transformation.
There is no doubt that excesses had routinely happened under the antiquated 1894 Act that the new Act has replaced. But the 45 pages worth of regulations that the buyer acquiring land must satisfy make land acquisition for building even rural roads prohibitively expensive and long drawn. Once again, with land being a concurrent subject, the next government should consider allowing states greater flexibility in bringing about their own legislation to suit their local conditions. As mentioned, I shall return to this legislative decentralization in greater detail towards the end of the lecture.
5. Red tape and the Inspector Raj
Red tape and the Inspector Raj remain major sources of costs and corruption facing small and medium firms. Larger firms are able to absorb these costs more easily. The next government must endeavour every way it can to cut this red tape and Inspector Raj to help small and medium size firms—if China can do it, so can we.
6. Exit policy
Winding up business when losses persist year after year remains an arduous task in India. The average time to complete closure of a firm under the current Board of Industrial and Financial Restructuring (BIFR) and Sick Industrial Companies Act exceeds 15 years. When exit is costly, businesses hesitate to take what is normal risk in other countries. They enter only those businesses where the chance of failure is near zero. They are particularly hesitant to enter employment-intensive sectors where political pressure against closure in order to preserve jobs is intense.
We need an exit policy that protects the interests of workers by ensuring adequate compensation upon exit, but also allows firms to close down transparently and within a reasonable time if they are incurring losses year after year.
Genuine privatization involving transfer of ownership rather than just disinvestment to raise government revenues, which had gathered some momentum under the National Democratic Alliance (NDA), has been at a standstill during the last ten years under the United Progressive Alliance (UPA) government.
Public sector units (PSUs) for which privatization involved the sale of majority stakes, and therefore resulted in the transfer of management and control to private hands, have exhibited vastly superior performance compared to PSUs for which such a transfer did not take place.
To quote Gupta (p. 143), “Compared to partially privatized firms, sales and returns to sales increase by an average of 23% and 21%, respectively, when firms sell majority equity stakes and transfer management control to private owners. Moreover, the sale of majority equity stakes is not accompanied by layoffs. In fact, employment appears to increase significantly following privatization.”
These are important gains suggesting that further privatization could make a significant contribution to manufacturing growth. According to Gupta (2012), even after the NDA privatizations, Central government-owned PSUs alone accounted for 11% of GDP in 2005. Therefore, there is considerable scope for the privatization of PSUs.
8. Manufacturing hubs and industrial zones
While the Central and state governments can facilitate the creation of manufacturing hubs through the provision of infrastructure in specified zones, without appropriate policy reforms they will not fulfil their most important objective of creating good jobs for the low skilled. For example, creating new cities with such hubs under the auspices of the Delhi-Mumbai Industrial Corridor project is an excellent initiative, but their potential to create good jobs will be determined by the overall policy regime.
Without reform of labour and land markets, the hubs will remain homes to highly capital-intensive industries and mainly remain the vehicle for obtaining tax breaks that typically accompany such initiatives.