Tax cuts may be deemed politically necessary as the economy tanks. But they are a terrible idea given the enormous deficits the state is facing, and the investments it needs to make India competitive. (PTI) Tax cuts may be deemed politically necessary as the economy tanks. But they are a terrible idea given the enormous deficits the state is facing, and the investments it needs to make India competitive. (PTI)

The concern expressed by the GST Council, that the Centre may not be able to meet its GST distribution obligations to the states, should remind us of just how deep a hole the Indian economy has dug itself into. Just as a matter of policy, the Centre possibly reneging on its financial commitments to the states is a terrible idea for three reasons. First, the Indian government’s credibility on economic promises has been severely battered. But if the fiscal contract with the states is also no longer considered sacrosanct, then all credibility bets are off. If even Indian state governments cannot trust the Centre on a visible public and constitutional commitment, why should any investor?

Second, if the state finances suffer unexpected shortfalls, the impact on frontline delivery of services and growth will be severe. Third, in light of centralisation of power in our system that GST has already produced, expect even the fig leaf of cooperative federalism to turn quickly into federal anarchy. If there was ever a case for abiding by the dictum, pran jaye par vachan na jaye, the Centre’s contract with the states is the place to abide by it.

But this crisis also underscores the unreality of our reform discourse. We are like the person whose house has had its roof blown off by the storm, all the windows shattered, walls battered, most of the furniture inside destroyed, but thinks the most important thing to do right now is to paint the house. This is reflected in the obsession with “big bang reform.” India has just suffered two big bang reform shocks, demonetisation and GST. In one case, the logic was culpably ill-founded; in the other, the implementation a nightmare. It will require an unusual degree of masochism to trust another big bang reform founded in voodoo economics. Most of what passes off as big bang reform will do very little to revive growth. Intelligent privatisation of some PSUs may be a good thing. But it not the key to growth. Tax cuts may be deemed politically necessary as the economy tanks. But they are a terrible idea given the enormous deficits the state is facing, and the investments it needs to make India competitive.

Our reform imagination has to get out of the idea that it only means getting the state out of the way. Any economy that wants to be competitive should not obsess with methodologically useless indexes like the “Ease of Doing Business”. It should focus on how the state can actually make an economy competitive. All the elements that make an economy competitive, require the state to do things; not just get out of the way.

Competitive economies are founded on cheap energy, low logistics cost, high quality human capital, reliable regulation, sensible tax administration, liveable cities, high investment in research and development. In some ways, India is paying the price of underinvesting in most of these areas when the going was good. Ask one simple question. During our boom decade from 2000 to 2009, India could still not leverage growth to become a manufacturing export powerhouse. Why not? Because export powerhouses are not created by focussing only on tariffs, taxes and trade regulations. Nor does macroeconomic stability alone create competitive capabilities. Export power houses are created by investing in all the things listed above. So anyone who counsels that cutting back on public investment on these things is a good idea is going to make sure that India never becomes competitive.

But there is another lesson in this story. No economy got competitive by doing big bang reforms. The metaphor works if you have marginal tax rates of hundred per cent, or inordinately steep tariffs or runaway inflation. Beyond that, “big bang” is more excitement than substance. If the above story is right, what the state needs is an augmentation of capacities across the board. Take a non-controversial area. On some estimates, India’s logistics costs are almost 14 per cent of GDP compared to eight to 10 per cent for North America and Europe. We are not even competitive with them, let alone other low cost economies like Vietnam. What will fixing this take?

Lots of things, but primarily the right kinds of investment increasing the freight moving efficiency of the Indian Railways. But this is still less of a priority than it needs to be for the Railways. Similarly, in an era where industrial policy matters even more, our continued indifference to high quality education, or serious investment in R&D, will make us less competitive. Our energy costs are relatively high. Any “big bang reforms” that do not address these basic questions are completely beside the point.

The problem is that the state has depleted its capacities where it matters most. For one thing, its constant ability to create morally appalling distractions exerts economic costs. Think of a proposed nationwide NRC as the governance equivalent of demonetisation: Illusory gain but morally and practically high costs. The Modi government is often criticised for not having any adult economists in the room who can speak freely.

Education was never expected to be its strong point. Its alleged war on corruption, an elaborate smokescreen designed to shield plutocracy, made most regulatory systems worse. All this may be a problem. But its bigger problem is that it has seriously messed up in many areas where it was expected to be stronger: Logistics, energy, urbanisation, real estate. These are areas where it has neither ideas, nor execution capabilities. Senior figures in government used to tell us with glee that getting real estate prices to drastically crash would be the key to reviving the economy. The prices did not crash, but the sector stagnated anyway. The government is waking up to the problem, but it is hard to see the deep problems of the sector getting resolved without some form of “nationalising” stranded assets first. In short, all the kinds of reform we need require a credible and capable state.

There is an old saying that when there is a clamour that “something needs to be done,” something bad will be done. The real problem is not the absence of big bang reform. It is the misdiagnosis over what our priorities should be and where scarce governance resources need to be deployed. Investors are concluding that this is an unimaginative, incapable, unreliable, punitive economic regime. The only reform that will work is a drastic change in government functioning, if not a change in government itself.

This article first appeared in the print edition on December 5, 2019 under the title ‘The real big bang reform’. The writer is contributing editor, The Indian Express.

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