After the first flurry in the early years of the Narasimha Rao government, the reform process has stalled. Even the modest reforms, mainly in the area of industrial licensing and trade policy have had a positive impact on the growth rate of the economy. But much more remains to be done in the areas of labour laws, imports of consumer goods, agricultural trade liberalisation, banking reforms and above all, in the removal of all those indirect and direct subsidies which continue to burden the national fisc. Not the least of these are the costs of keeping loss-making public enterprises and the sick industries from the private sector afloat. Is there any hope that these reforms will be undertaken by a fragile coalition government, some of whose partners have an ideological aversion to some of the needed reforms?
The results of a study of the economies of 21 developing countries from the 1950s to the late 80s that Hal Myint and I have recently published, provides some answers, and surprisingly some hope, though of an unconventional kind, which politicians and the bureaucrats serving them might find unpalatable. (D Lal and H Myint The Political Economy of Poverty, Equity and Growth OUP).
One of the major questions we sought to answer was when and why governments which had instituted dirigiste systems of economic controls most often in the 1950s changed their spots and liberalised their economies mostly in the 1980s. The general answer was that the liberalisation process was invariably associated with a fiscal crisis, a pattern which of course also fits the Indian reforms. But why should this be so?
The answer lies in recognising that all forms of dirigiste interventions (including direct taxes and subsidies) are part of a political game of redistribution. Their net effect is to create enhanced income streams for some groups which are paid for by direct or indirect exactions on others. Thus, trade protection enhances the incomes of domestic producers paid for by an indirect tax on consumers. The creation of these politically-determined entitlements to current and future income streams for various groups in the economy (the deserving poor, industrial labour, regional interests, infant, declining or sick industries) leads to the creation of specific politically-determined property rights. Economic liberalisation involves rescinding these rights, which is likely to be difficult particularly in a democracy.
However, the groups bearing the often implicit tax burden of financing these entitlements will at some stage strike back, through tax resistance, avoidance and evasion and the gradual but inevitable growth of the black economy. This shrinks the fiscal base of the government. Unwilling or unable to cut the politically- determined public expenditure entitlements, and with little hope of tax revenues rising with economic growth because the dirigiste system has damaged the growth mechanism the government finds that incipient or actual fiscal deficits become chronic.
There are only three ways of financing these deficits: domestic and/or foreign borrowing and levying the inflation tax. But these avenues of escape provide a temporary respite. Domestic borrowing crowds out domestic investment with deleterious effects on the growth rate and thence tax revenues; foreign lending can cease abruptly as the borrowed funds are most often used for public consumption rather than investment so that they do not lead to the rise in future incomes on which their repayment depends: recognising this foreign lenders take fright; the inflation tax also proves unviable as private agents will begin to take evasive action through a further expansion of the black economy and by substituting some indirect or direct form of foreign currency based assets for domestic money: the base for levying the inflation tax thus rapidly shrinks.
With taxes being evaded, with declining access to domestic and foreign credit, and with private agents taking evasive action to avoid the inflation tax, the government finds its fiscal control of the economy vanishing. It might not even be able to pay for its own functionaries to provide the classical public goods of law and order, defense and essential infrastructure. It is to deal with this very unMarxian withering away of the State that economic liberalisation is undertaken. For even a partial liberalisation by boosting output growth will improve the public finances, whilst the introduction of some fiscal and monetary rectitude will restore part of the previously vanishing tax base.
The Indian post-Independence history of economic repression and partial reform has followed this pattern, which has many historical antecedents. The most notable was the replacement of the mercantilist system by the liberal economic order in the 19th centurys great Age of Reform . As Hecksher showed in his monumental study, Mercantilism, the impetus for these reforms was the desire to regain control over ungovernable economies that the previous period of dirigiste controls had engendered much as in todays Third and Second Worlds. The trigger most often for the reform, or in some cases revolution was a chronic fiscal crisis. After all the French Revolution began when Louis XVI had to call the Estates-General to deal with his acute fiscal crisis.
In India, the Manmohan Singh-Narasimha Rao reforms however partial dealt with the immediate fiscal and balance of payments crises that had triggered them. But without a complete rescinding of the unviable politically-determined income entitlements that past dirigisme had created, they remained incomplete. Once again a chronic fiscal crisis is in the making. But as the above analysis shows, far from being a cause of despair, for reformers this provides a ray of hope. For it is only when such a macroeconomic crisis portends the unMarxian withering away of the State, will its functionaries undertake the next stage of reform.
(Deepak Lal is James S Coleman Professor of International Development Studies, Department of Economics, University of California)
