Nitin Desai: Unleashing entrepreneurship

The UPA government needs to do more to fulfil the promise to unleash entrepreneurship.

The Common Minimum Programme of the UPA government is nearing the end of its second year. This will undoubtedly invite assessments as to whether the government has passed the test of "collective maximum performance", an alternative reading of the letters CMP given at the end of the Programme.

The government has clearly done a lot to implement the social agenda promised in the CMP. It has made a useful start on the infrastructure agenda, but only a start, not the rapid sprint that we need. But has it done enough to fulfil the promise "to unleash the creative energies of our entrepreneurs, businessmen, scientists, engineers and all other professionals and productive forces of society." How many leashes have been removed over the past two years?

When it comes to the restraints on the direction of investment, not much has been done. It is true that the big tasks of delicensing were done some time back. But there are other areas crying for further reform.

The CMP promised to expand competition in the financial sector. A few steps have been taken to remove restraints in banking, insurance, and, in the latest Budget, for mutual funds. The regime for foreign institutional investors has been implemented liberally and a host of private equity and venture funds have come to India. But more needs to be done to level the playing field so that domestic asset managers and financial service providers are not stopped from doing what their foreign counterparts are allowed to do. This is necessary to develop the depth and breadth of the Indian capital market and facilitate the market financing of large lumpy projects and technology ventures.

Another area which needs to be revisited is the small industry reservation. When trade policy is liberalised so that foreign suppliers can enter domestic markets for all products, including those reserved for small industries, it makes no sense whatever to continue with restrictions on domestic investment. In effect what we have done is not to protect small industry but to vacate a market for easy access by China and other mass producers. When we go to the market today we do not buy Aligarh locks. We end up buying Chinese locks, which are manufactured on a large scale, something that we stop Indian industry from doing.

The finance minister made a beginning in the latest Budget. So dereservation is presumably consistent with the CMP, which talks mainly of promotional support for household, artisanal and small industries. Household and artisanal industries will occupy niche markets because of consumer preferences, the making of fine saris being a typical example.

Small industry reservation applies to standard industrial products and is an unreasonable restraint on trade in a liberalised trading environment. Much of the benefit of this restraint accrues to enterprises which are small only in the eyes of the regulators. They are in effect substantial capitalist enterprises which earn rents from the controls on competition enforced by the reservation policy. They are sometimes employment-intensive because of the exemptions given under labour laws rather than because of product reservations. There is no serious distributive justification for continuing with the reservation policy and a sound economic rationale for getting rid of it altogether.

Fiscal complexity is another leash on entrepreneurship and competition that needs to be removed. The trend towards the simplification of the indirect tax regime is a crucial component of this effort. Fewer rates and fewer exemptions are the key. However, the latest Budget is a mixed story on this. It has promised a goods and services tax by 2010 and towards that end adjusted the general rate of customs duty and the service tax. But it also contains a slew of special interest provisions and rate differentiation which moves in the reverse direction.

The Budget, for the first time, presents some figures for the cost of tax exemptions. Excluding export-linked drawbacks the cost of these exemptions at Rs 158,661 crore is more or less the same as the entire fiscal deficit. The big chunk is the customs duty exemptions. Here the case is not for revenue recovery but to translate the amount into a more generalised tariff reduction instead of the present game of special interest winners and losers.

The CMP is committed to the goal of raising the tax-GDP ratio and to simplification. Clearly, much more needs to be done in the direction of rationalisation of rates and exemptions so that the fiscal policy regime confronting industry is stable, predictable and less subject to discretionary decisions about classification or eligibility for exemptions.

The Industrial Disputes Act and the restraints on hiring and firing are often mentioned as restraints on entrepreneurship. But modifications in this are not likely and the CMP promises only a "dialogue with industry and trade unions on this issue before coming up with specific proposals".

The actual record of employment and wage growth suggests that some labour rationalisation has taken place. From 1990 to 1997 organised sector employment increased but since then it has fallen both in the public and the private sectors till 2003. This is despite 50 per cent growth in manufacturing and services production over these six years. In fact the competitive restructuring of Indian industry since 1997 is one of the success stories of reform. Public sector restructuring has not proceeded as well but the public sector wage bill as a proportion of gross national income has also fallen from 2.2 per cent to 1.7 per cent.

The real focus of labour law reform must be to fulfil the CMP promise that "labour laws other than the Industrial Disputes Act that create an Inspector Raj will be reexamined and procedures harmonised and streamlined". This is yet another leash that has yet to be removed.

There are many other areas of entrepreneurial restraint. Some are justified on health, environmental or social grounds. But in all cases the real problem is the persistence of discretionary powers that create space for corruption and intimidation by low and high functionaries.

Entrepreneurship unleashed means the freedom to use capital, labour and technology for meeting rising demands in the market place. But it also means a level playing field so that profitability does not depend on regulatory rents. The UPA government has barely begun the task of moving towards a non-discriminatory and transparent policy regime for industry and services. If it does so, there is enough talent in this country for the 8-10 per cent growth rate that we seek.