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Two Years Of Modi Govt | Relationship Capitalism Revisited

While overall trade performance has been weak, Modi's government has pushed for increase in FDI as a remedy to all of India's macro-economic woes

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In a book written in 2004, Raghuram Rajan and Luigi Zingales explained how free markets- perhaps the most beneficial economic institution known to humankind-rest often on fragile political foundations. The book, Saving Capitalism from the Capitalists, argues how bureaucrats and politicians who make decisions guide the invisible hand of the market. In the first few decades after World War II, state managed competition, which Rajan and Zingales referred to as "relationship capitalism", seemed to work quite well in continental Europe and Japan.

In a politically stable environment, both continental Europe and Japan experienced high rates of growth under a state-managed competitive system. However, as explained by Rajan & Zingales in their book, growth in these economies during the postwar decades concealed three serious problems: i) the relationship system failed to encourage innovation across major sectors driving production; ii) with the market suppressed, there was no allocative mechanism for monopoly profits to be adequately distributed; and c) the system failed to acknowledge constructive destruction where the sick, government-controlled/owned units could die out to give way to new/sunrise industries.

In the last two years, Modi's government seems to have taken similar steps to "manage" capitalistic forces through a number of reforms and policy initiatives- to mixed results (under the stated expectation of launching measures such as the Clean India campaign, the Smart Cities proposal, the Skill India initiative etc.-highlighted below). Though most policy initiatives have relevance, the journey from policy proposal to implementation seems misplaced due to the limited (cap)abilities of Indian states; lacking both the political will and financial resources to implement some of these policy initiatives to fruition.

In this article, I analyze Modi government's economic performance since the time it came to power, by examining the evidence on India's level of integration with the rest of the world which has been the topmost focus of the government's economic agenda (evident from an analysis on trends in FDI-foreign direct investment and OFDI-outward foreign direct investment). I also highlight the outdated approach taken by the pre-existing neo-liberal view on FDI as an "inclusive" determinant to increasing economic growth.

The Foreign Direct Investment Push
While overall trade performance has been weak, Modi's government has pushed for increase in FDI as a remedy to all of India's macro-economic woes. With an objective to increase this form of investment, the Make in India program, launched in September 2014, has resulted in a number of foreign enterprises investing in sectors such as defense manufacturing, automobiles, aviation, media and entertainment, electronic systems, bio-technology, food processing, and mining.
Over the last two years, there has been more than 48 percent growth in FDI equity inflows and 37 percent in overall FDI inflows. This is pleasant news considering the fact that level of foreign direct investment was at its lowest in February 2014 (as shown in Figure 1).

This has largely been made possible by a string of policy measures enacted to ease regulatory and procedural formalities in setting up and running a business. The improvement in ease of doing business has been complimented by an array of policy initiatives as exemplified by Skill India, Digital India, Start-Up India, Smart Cities, Atal Mission for Rejuvenation & Urban Transformation (AMRUT), to name a few. These initiatives have aimed to lay the foundation for the next wave of investment and growth through a massive infrastructure push.

One of the key challenges for the government in the near future will be to ensure that real wages (urban and rural) across sectors (especially manufacturing) grow in correspondence to the growth levels. Lessons from the economic history of East Asian economies like Japan and China show how a state-led development model in a relationship capitalistic set up may lead to the formation of an export-led manufacturing bubble in the long run.

The Increasing Outward Foreign Direct Investment (OFDI) Trend
India's big businesses as well as small- and medium-scale enterprises have received continuous support from government-controlled finance plans. However, if we observe the domestic industrial performance levels and the business confidence index, performance seems to be quite weak or underutilized due to both internal and external (what I call as endogenous and exogenous) factors.

While India continues to attract foreign investment into critical sectors, its own businesses are stagnating in their domestic performance and looking for opportunities to invest abroad/off-shore. This perceptible shift in Overseas Foreign Direct Investment (OFDI) and Overseas Investment Destination (ODI) in the last few years is an interesting trend and can be explained by a delay in the implementation of key government reforms, weak global commodity prices, low international aggregate demand for Indian goods etc.

While most of the earlier Indian investment went to resource rich-countries such as Australia, United Arab Estimates, and Sudan earlier, the trend over the last two years points to a big push towards countries providing higher tax benefits such as Mauritius, Singapore, the Netherlands, and the British Virgin Islands. Most Indian firms have invested there through Mergers and Acquisitions (M&As) transactions, where the expectation is that these companies will get access to better technologies and more extensive markets, which will enable them to cater to a global consumer base.

The Mirage of "Inclusive Economic Growth"

The over reliance on FDI as a remedy to all investment and financial woes is largely driven by the neoliberal framework of the 1960s, the Solow model. Economists and policymakers insouciantly use the word 'inclusive growth' in penning down the objectives and rationale for every policy and reform measure across all planning reports and policy documents.

In a paper written in 2012, Indira Hirway, provides some useful empirical evidence from South Asia-including India in debunking the myths attached with the 'inclusive' theoretical application of neo-liberalist version of economic growth. Hirway explains how in spite of the adoption of pro-market policies in most of the South Asian countries, the level of income inequalities continue to widen in most of these countries.

Out of the fourteen Asian countries for which sufficient data is available, inequality has increased in eleven countries-Sri Lanka, China, Cambodia, India, Indonesia and Nepal. Malaysia and Thailand were the only two countries where inequalities decreased at the margin. In the case of India, the Gini coefficient (a useful parameter for measuring income inequality) has increased from 0.44 to 0.47 during the last decade.

The issue with the Indian case has primarily been with the implementation of Track II reforms where in spite of higher, sustained economic growth levels from early 2000s, the level of public spending on education and healthcare has remained drastically low (less than 3 per cent and 2 per cent of the GDP respectively till now).

In the field of employment and labour, recent trends in the global labour market observed by scholars indicate a poor performance in generating productive employment with 'decent work' conditions. In India, the unemployment rate increased from 1.96 per cent in 1993-94 to 2.2 per cent in 1999-2000, to 2.37 per cent in 2004-05 and to 2.06 per cent in 2009-10.

The evidence in support of FDI causing local level job creation, technological development and back-end infrastructural development in India is weak (excluding the case of the capital goods segment since the early 1990s). Thus, policymakers must guard against over-dependence on foreign borrowing and investment as a sustainable measure to increasing economic growth.

The Challenges Ahead

The tardy fate of the Goods & Services Tax (GST) bill, bankruptcy reform bill, and the Companies Amendment Bill echo the Modi government's political failure in passing key reform bills. In a recent article, I've discussed how this political limitation has arisen due to institutional challenges (present at the legislative, executive, and judicial level).

These are primarily responsible in reducing the domestic investment levels and negatively impacting local business confidence levels in spite of the projection of a progressive economic regime in power. There is also a degree of over-centralization associated with the Prime Minister's Office (PMO), which appears more presidential (as in the American political machinery) than federalist, which is germane to the Indian political economy framework. The over-centralized approach has made state level implementation of key reforms a challenge.

In the years to come, it remains to be seen if the Indian economy on a whole continues to perform better under Modi and whether the government can gradually make an effort to move away from the relationship capitalistic system in letting the markets freely compete across sectors and if improved coordination can be established with the states on areas of policy implementation? It would be prudent for the government to focus more on promoting greater economic and financial freedom to states and local level political institutions.

The current government must also do away with its obsession with increasing FDI as an answer to all its economic/financial woes and prioritize more on economic development by focusing on Track II reforms by enhancing access to quality education (at a primary level) and primary healthcare as the foremost means for communities/societies to get the opportunity to develop. The focus on driving greater investment from/to abroad must be complimented by socially investing the physical capital for long term returns accrued in forms of human & knowledge capital.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Deepanshu Mohan

The author is Visiting Professor, Department of Economics, Carleton University

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