Tackling slowdown institutionally: Look to institutions rather than individuals to solve problems

Cross the river, observed Deng Xiaoping, by feeling the stones. The current Union government may do well to heed this advice, as it struggles to tackle a serious slowdown in the economy and gets ready to present the Union Budget for 2020.

This slowdown is both structural and cyclical in nature. To the extent that it is cyclical, the economy will bounce back sooner or later. In fact, some green shoots of recovery are already visible. However, to the extent that it is structural, the road ahead to reverse it would, indeed, be steep. This is because it primarily relates to the poor institutional capacity in our country that has been deteriorating for the last 40 years. In fact, the lack of such capacity has created a trust deficit between the citizens and the government.

This has resulted in all-round poor governance that has impacted the economy. Following opaque processes, bureaucrats exercise vast discretionary powers, and are often governed by poor accountability standards. Since they are under no obligation to consult people for their decisions—and the knowledge and information base they rely upon is often dubious—it is not surprising that they get things wrong. Yet all these limitations have not deterred them from stepping in, even though governmental intervention is often costly and ineffective. Vijay Kelkar and Ajay Shah, in their latest book ‘In Service of the Republic’, have pointed out that a public outlay of Rs 1 ends up costing Rs 3 to the Indian society.

The country may have moved up from 142nd rank to 63rd in the the World Bank’s Ease of Doing Business rankings between 2014 and now (the current government undoubtedly needs to be given credit for this achievement), but its rank continues to be poor in respect of certain key parameters that really matter—enforcement of contracts (163), ease in paying taxes (115), starting a business (136), etc. Even today, people shudder to get involved in litigation or deal with departments like Income Tax, police or the Enforcement Directorate because cases take years to reach closure.

This institutional weakness is what really holds the country back from realising its full growth potential as a nation. The obvious solution, of course, lies in strengthening institutions. This is essential because otherwise the country runs the risk of falling into a middle-income trap. Only four countries—South Korea, Taiwan, Singapore and Israel—have been able to escape this trap. All four invested heavily in institution building. India has a long way to go before it joins the ranks of these countries. Its per capita income of $2,172 makes it a low-middle-income country; this must increase about six times to $12,056 before it can be classified as a high-income country.

The steps required to do this are not likely to be popular either with politicians or bureaucrats. The government must continue to focus on its sovereign functions, i.e. maintaining law and order, ensuring settlement of disputes, collecting taxes, managing the defence of the realm, conducting foreign policy, and ensuring the stability of the currency. Outside of these areas, it must explore other options, before it decides to intervene.

And when it does, it must limit its intervention to the bare minimum and confine itself to situations where markets cannot function or have failed to perform—or when a negotiated solution cannot be found. Rather than further empowering bureaucrats, the government should consider reducing their powers and check arbitrary exercise of power.

In the long run, we must prepare for a 50-year marathon. The country must look to institutions rather than individuals to solve problems. As a people, we are, at times, guilty of having developed highly romantic and idealistic notions of people who perform public service. We have to realise that public servants are ordinary human beings who act according to their self-interest. Power should, thus, be vested in teams rather than individuals, and concentration of power should be avoided.

Finally, we must bear in mind that whether we talk about ordinary citizens or officials, people respond better to incentives than coercion. Change the incentives and you change behaviour. When kerosene is cheap and petrol dearer, it is naïve to think that people will not adulterate petrol with kerosene. The future challenge for policymakers would be to devise simple rules that incentivise good behaviour and punish bad behaviour.

Good policymaking will have to be a slow affair, feeling the pebbles at the bottom of the water, one step at a time. Applied to GST, this would mean widening the coverage of the tax by reducing exemptions; and simplifying the levy, by reducing the number of rates, to one or two. Had the government heeded to this advice, it may not have enacted CAA so hastily.

The author is former chief commissioner of Income Tax

Source: Financial Express