Economist and policymaker Arvind Panagariya, Chairman of the 16th Finance Commission, has documented the economic history of independent India’s first Prime Minister Jawaharlal Nehru’s era and its impact on subsequent policymaking. The book, The Nehru Development Model, states that Nehru’s policies stunted India’s economic potential, creating a socialist mindset that persisted long after the era and hampered growth until the liberalisation of the 1990s. Panagariya spoke with Business Today’s Siddharth Zarabi on what lessons are left to be learnt for India’s future economic journey. Edited excerpts:
Q: What remains to be dismantled of the Nehruvian era when it comes to economic policymaking in India?
A: A lot of what PM Nehru did has been dismantled… investment licensing, import licensing, and foreign exchange control… Those three have been largely dismantled, but there are things… [such as] the Industrial Disputes Act, which still needs to be replaced by the Code on Industrial Labour… But when I use the term Nehru era, one has to also include, at least for the purpose of this specific question, what followed Nehru? Because Nehru’s era did not end with Nehru…. [it] was followed by yet more socialism, what I call hard socialism, under his daughter Indira Gandhi. And a number of things that were done under Indira Gandhi still remain to be undone. These include the nationalisation of banks that was done in 1969. Coal mines were nationalised… oil industry was nationalised… And of course the influence of the Nehru era has even extended into the post-reform era whereby, during the UPA years, particularly UPA 2, 2009 to 2014, we saw a return of some of the Nehru-like measures, which included the very restrictive Land Acquisition Act and the Right to Education Act. There’s also retrospective taxation, which has not been undone…
Q: One of the points that you have made is on disinvestment—on the state getting out of the public sector. In the current political economy environment, what is to be done?
A: If anything, the state’s responsibilities have only increased… Education and health are two prime examples where the state is now invested far more heavily than it was during the Nehru era or even during the Indira Gandhi era. There are areas where clearly the state has to be deeply involved, like in defence. There again, one would like to see much larger expenditures going to defence than financial constraints have allowed so far. It is from that perspective that in some ways one can argue that for the state to come out of what it calls the non-strategic sectors now is yet more important.
Prime Minister [Narendra] Modi’s government has already stated its public enterprise policy under which it has identified four strategic sectors. The policy says that outside of these sectors, the state will relinquish production activity… that process has been a bit slow. Some privatisation has happened… but that process needs to gather more steam. And it also has to extend to the states… the process of disinvestment in the states has not even begun almost anywhere…
Q: In 1994 you wrote about how India was the new tiger on the block and that a 6-7% growth rate cannot be ruled out. Do you see all elements being in place to fully and finally break away from that era and take off in a newer direction at a newer rate of growth?
A: I am afraid this is a gradual process in a democratic system. The changing of minds is a very slow process. The natural flow is stacked against you for the reason that there exists what I call in the book ‘inheritance of ideas’; newer politicians inherit ideas from the old ones, new bureaucrats inherit ideas from the old bureaucrats… this generational change is difficult. [But] we have made a lot of progress.
When in 1994 I talked about a new tiger on the block… [and] 5-7% growth, we were on the defensive even talking about growth because it was not seen as something [that was needed]; redistribution was seen as what we needed…. Politically, I think it was only under Atal Bihari Vajpayee [who] as PM said that we need double-digit growth to combat India’s poverty. So that took time.
I think we have made a lot of progress but by no means [have] conquered the influence of the Nehru era. I think that’s going to remain [a] work in progress… At the state level, we are seeing a huge resurgence of giveaways… freebies. In almost every election, there is competition among parties to bring in more programmes of giveaways. And that ultimately impacts capital expenditure. State level capital expenditure has certainly been impacted by the promises of these giveaways… no matter which party wins, in the end we see these giveaways being added on to what already exists.
Q: Are cash transfers and giveaways becoming a concern for our long-term fiscal health? What can be done to correct course given that all the spending hinges on higher tax revenues?
A: Yes, there is some concern because if you look at the state level, you certainly see the impact on capital expenditures and there I think is largely the worry. I am personally not against cash transfers; frankly I was among the early ones [pitching for it]… going back to my first book, India: The Emerging Giant…
What is different now in these programmes is that these are not targeted transfers… we are identifying very large groups, all women, for example, and that is fiscally more demanding, even when you do transfers of `1,000 per month per person… Eventually, once we have acquired GDP in the range of $8-10 trillion, then we can afford those transfers. But in today’s time, capital expenditure is the need of the hour.
Q: There is a debate on the issue of slowing public capital expenditure and the need for much higher levels of private sector investment. Given the emerging international trade order, what does it mean for India’s economy in the short to medium term?
A: On private investment, I think we need a bit more clarity… If you look at total fixed investment as a proportion of GDP, that has steadily risen from what was about 28-29% immediately post-Covid… Today, it stands above 34%. This is the total investment. Now, certainly, the central government’s capital expenditure has been rising. But some of it is being neutralised by a corresponding small decline in state-level capital expenditures. So, the bulk of this increase from 29% to 34%-plus is coming from private sources… But at the end of the day, you cannot get away from looking at the total investment and that certainly as a proportion of the GDP has steadily risen. So, that is a correction that needs to happen in the media debates. This assertion of private investment being sluggish needs correction.
On trade, I think there is clearly a looming challenge because President Trump is going to return on January 20 and he has certainly said that he is going to demand reciprocity in trade policy; and he has explicitly singled out two or three of these countries: Canada, Mexico and China. In that singling out, we have been spared so far, but he has also mentioned India in the context of reciprocity… So that is going to be a challenge. I’m not sure in what way we would handle this. Personally, to minimise the disruption in trade flows in both directions, we ought to negotiate and see where we can give concessions and where we can get concessions from the US. That would be a lot better than letting the US raise its tariffs on our goods and then us reacting by raising tariffs on what we import from the US…
In the long run, the US wants to get away from China, India wants to get away from China. If both countries want to get away from China, they have no choice but to be closer to each other… I hope that both on the US and Indian sides, cooler minds prevail, and we negotiate tariffs down.
Q: Where do we stand in our progress towards a primarily outward-oriented market economy? How much more time and effort are required?
A: Reforms are an ongoing process… We often focus on the 1991 episode and celebrate that as the big-bang reform, but the fact of the matter is that in the overall scheme of things, it is hardly a big-bang reform… we were already moving in that direction of ending investment licensing and import licensing. What we did in 1991 was to end investment licensing, but even then, it was not a complete end, because small-scale industry (SSI) reservation had still not been touched… approximately 850 products, mostly labour-intensive ones, had remained off limits to larger enterprises… and that process of liberalising the SSI took us close to another 15 years. It was by 2005 that most of the products were removed and open to large-scale manufacturing. About 20-odd products were finally eliminated and the list was eliminated in 2015 by the Modi government. I mentioned this history to indicate that the process of liberalisation in a democratic system is inevitably slower. It involves a lot of consensus building. So it’s still work in progress.
Our share in the world’s merchandise exports is less than 2%; services it’s closer to 4%, but even in merchandise we have to get to at least 4% in the next 8-10 years, if not sooner. Because compare that to China, which has about 13-14% share in merchandise exports. And it is the merchandise exports market that is large, $25 trillion, versus services, which is about $7 trillion. That is also part of the work in progress. [In] our education sector, reforms are required, particularly in higher education. We are still operating under the 1956 University Grants Commission Act that needs to be replaced… that is the nature of the reform process and you cannot do it in one go… We have tried to do that with the Insolvency and Bankruptcy Code, and some of the other laws as well… we will also need to do something eventually about the Land Acquisition Act that has made building of infrastructure incredibly costly…
Q: Is there merit in the criticism that wealth is being concentrated in the private sector elite?
A: If the critics provide a road map on how this can be done better, without adversely impacting the growth process and therefore also our ability to do the redistribution… then I am all for it. But the critics never offer an alternative road map. My choice then is to have greater equality, but levelling down the rich to achieve that equality… then I’m not so sure that that’s a good idea. What is often forgotten in the context of the targeting of the billionaires by the critics… is that by and large, the wealth of the billionaires does not end up in ostentatious consumption, but instead is invested. And these are smart entrepreneurs who hopefully would invest their wealth in a very highly productive manner.
Think of the alternative. Suppose we were to tax away a lot of this wealth and this wealth comes back into the hands of the government. What will happen? Very likely a large part of it will go into the current expenditures, what was investment will turn into current expenditure. And even what gets invested will probably not get invested in projects that will yield very high rate of return…
This is not an endorsement of inequality. But it is simply asking a question, ‘Is there a better road? Can we continue to have very equitable redistribution and continue to grow at 7%-plus, which is our ambition?’ And I don’t see a pathway to it… When there is wealth creation, it does lead to some accumulation of wealth. Because those who create wealth, even if they keep 4-5% for themselves, it quickly produces billionaires. Likewise, growth also tends to concentrate in certain areas, geographically.
So, you will also see regional inequality rise… Urban versus rural, because growth by nature will concentrate in urban areas and if it does not, then even if it starts in the rural areas, eventually those areas will become urban… A good example is Shenzhen, which in 1980 used to be just a bunch of fishing villages. Today, it is one of the most vibrant, urbanised spots on the face of the earth. You’d say a lot of people who are in Shenzhen today probably migrated from rural areas. So, they’ve shared in that prosperity… As long as this inequality is also accompanied by lifting up everybody, particularly the bottom 30%, then it becomes a little more acceptable. The alternative is leaving everybody poor…
Q: How significant is it for the GST council to address some pending issues in the existing framework given the regressive nature of indirect taxes?
A: There are two issues I would address. One is that my general approach, which may be a bit out of sync with most, [is] that I wish we would not use the tax policy as an instrument of promoting equality… income taxation… progressive taxation is well-accepted. But indirect taxation is a little different. I lean very heavily on expenditure policy.
We are going to look at how to do the job of income redistribution, make your taxation efficient, so that the production activity is facilitated by a transparent, efficient taxation, and get the revenues and do the redistribution, which we are doing on a fairly substantial scale. It’s a difficult political ask, but as an economist, I would move away from making indirect taxation an instrument of income distribution. That’s my first point. The second on GST is that this was a very difficult reform… A big part of that reform is the fact that there is only one tax on any given product… What more remains to be done? We need to build some consensus towards bringing the number of tax rates down. Many economists would argue that a single rate GST would be the most desirable. I think, politically, that is a challenge. But we should certainly strive towards two non-zero tax rates. Long ago, I wrote an article in one of the leading journals about uniform tariffs… And politically, what that means is that lobbying completely disappears… It is also generally more efficient than what we end up with… A similar argument does apply to GST; if you commit to one or at most two rates, then a lot of both criticisms as well as lobbying that goes on for a higher or lower tax rate can be more or less eliminated. So, that is something we, the GST Council, will have to deal with over time.
But as I said, this was a very difficult reform and things are happening in stages… Revenue-wise, GST is yielding solid amount of revenue; the buoyancy is also good. I think the next steps hopefully will come in a logical sequence saying that we will get fewer tax rates.
