Transcript Economic Reform in a Federal Setting

Indian Economic Policy Making:
Successes and Challenges
Indira Rajaraman
IGIDR Silver Jubilee Conference on
Development: Successes and Challenges
Mumbai
3 December 2012
Did Design Defects in the 1991
Reform Package Carry the Seeds of
Today’s Growth Slowdown?
2
Revisiting reforms of 1991
• Product markets reformed (policy wedges
eliminated; price discovery enabled –
principally, the price of the rupee)
• BUT
• Factor markets (land, labour) not reformed!
• This made the design of the 1991 reform
package fundamentally defective, since reform
is centrally about freeing factors to flow into
their most productive uses
3
Why were factor markets neglected?
• Reason (not amounting to justification):
– land and labour are on the concurrent or state lists of
the Constitution
– fiscal wedges in the land market (stamp duty on
transfer of land) are in the state fiscal domain
• Failure to shepherd factor market reform by
states in concert led to sharp regional variations
in the benefits of reform
– Research focus has mostly focused on variation across
states in labour market reform (Petia Topalova, AEJ
Applied, Oct 2010) but the far greater problem today
is the unreformed market for land
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Today…
• These factor markets remain hugely imperfect
and remain the sources of today’s
– supply constraints; resulting inflation; political
scams
– failure of trickle down since growth benefits
accrued as abnormally high rents to owners of
scarce, highly priced, land
• The intellectual fathers of the 1991 package
quite simply failed to take into account the
requirements of reform in a federal setting
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Second core deficiency of the 1991
reform package
• In the national financial accounting structure
before 1999-2000, small savings were routed
through the national exchequer, and routinely
on-lent to states by jurisdiction (uncapped)
• There was state pressure for high deposit
rates on small savings, raising the floor of the
interest rate structure, because onlending
rates were unrelated to deposit rates
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Finally corrected in 1999-2000
• The creation of the NSSF in the Public Account
in 1999-2000 linked on-lending to deposit
rates, and so eliminated the pressure for high
deposit rates
• This gradually brought down the cost of credit
and led to the growth spurt after 2003
• BUT credit continues to remain grotesquely
costly for those outside the formal financial
system
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Third core deficiency of the 1991
reform package
• Fiscal consequences of trade liberalisation
neglected
– The need for compensating revenue not foreseen
(my paper in Global Policy, September 2012)
• The Centre’s gross tax revenue remained:
– below 10 percent of GDP during 1992-2006
– below 9 percent of GDP during 1998-2003
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Growth cost of third deficiency
• Foregone public investment at both Central
and state levels
– Despite that, PMGSY started in 2000, a far-seeing
public investment initiative by the Central
government, for last mile connectivity
• Finally, over 2000-01, moves initiated towards
tax revenue enhancement at the Centre; and
at the level of states (VAT finally in place by
2005)
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Conclusions
• Growth has stalled in India because of three
major defects in the 1991 reform package, which
overlooked the need:
– To facilitate factor flows
– To bring down the cost of credit (until accounting
correction in 1999-2000 brought down the interest
rate floor)
– For compensating revenue from loss of trade tax
revenue (until ~2000-01)
• The first defect remains uncorrected: factor
markets (land, labour) remain hugely obstructed
• Credit remains very costly for those outside the
formal financial system
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