Liberalization: where it has lead us and where it is headed

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Last updated: April 21, 2019

Since 1991, the Indian economy has been running under the mantra of “liberalization”. While there has been almost unanimous approval amongst the more affluent sections of the population for liberating the consumer goods sector from the “License Raj” of the previous decades, external liberalization has been subject to far more scrutiny, and has generated considerable controversy and debate.

The extent to which the economy should be decontrolled with respect to the international sector is not only of economic relevance but goes to the whole issue of national sovereignty and security. External LiberalizationWhereas domestic industrialists and investors come under the purview of national laws – and are therefore subject to a modicum of democratic control – that can rarely be said of foriegn investors. Numerous case studies from the experience of other developing countries show that the dependance on foriegn capital has invariably led to sacrificing national policy goals in favor of the demands and conditions of international lending agencies and other powerful agents of international finance coporations like credit rating companies, analysts for banks and mutual funds, and representatives of insurance companies.The examples from Mexico, and now from South East Asia all show that even before rapid economic growth can begin to trickle down to the poorest sections of the economy – the economies end up in debt traps, and then even those sections of the population that had benefitted from the process of external liberalization go through increasing hardship. External “Conditionalities”, Cutting Import Tarriffs As already mentioned, international lenders rarely lend without conditions.Pivotal to the issue of external liberalization has been the demand to lower import duties and this was one of the veiled “conditions” that the Congress Government of Mr Narasimha Rao accepted in 1991 when the IMF negotiated it’s loan package for India.

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Although this step was taken under “duress”, it was rationalized by the wealthiest sections of the Indian population as being necessary to introduce “competition” and “improve quality”. The spurt in the range and availability of consumer goods that followed seemed to justify this measure.But the masses whose incomes were being squeezed by limited employment opportunities and inflation were unimpressed by the new cars and refrigerators that were now available for purchase. And the increasing trade deficit also had it’s detractors. Responding to this pressure in 1996, sections of the UF campaigned vigorously against the negative effects of such unbridled external liberalization. But contrary to the UF’s pre-election pledges, the UF Finance Minister, Mr Chidambaram showed no compunctions in accelerating the process of external liberalization by drastically lowering import barriers.Whereas Mr Manmohan Singh of the Congress had pleaded that he was lowering customs duties as he was bound by WTO conditions – Mr Chidambaram made no such apologies and went far beyond even what was required under the WTO regimen. What had changed in a matter of five years is that a whole new class of businesses had emerged who had a vested interest in keeping import duties low.

From international lobbyists for the big multi-nationals to their domestic partners and agents – there was a chorus of voices in favor of cheap imports.Once the import of capital goods and raw materials had been eased in 1991, several Indian manufacturers slowly became dependant on either imported parts or machinery. Others were importing kits and assembling them for domestic sale. And some were importing finished goods for resale in the domestic market. Paying high salaries to financial officers and managerial staff , and to advertising and marketing specialists – they could count on the support of Indian professionals fluent in English looking for upward mobility.This made up the new “Import Lobby”.

For several years, local manufacturers had been complaining that the inverted duty structure favored imports over domestic value-addition because duties on finished goods were often less than duties on raw materials and components. Mr Chidambaram made things worse by lowering customs duties to the point where domestic excise duties and sales taxes exceeded corresponding import tarriffs. Thrilled by this unexpected windfall, the “Import Lobby” described the Chidambaram budget as a “dream budget”.

Unsurprisingly, this lead to a surge in imports that squeezed domestic producers and led to an industrial recession. Unmatched by a proportionate increase in exports, India’s trade balance has steadily worsened. Unlike Mr Chidambaram’s generosity towards foreign manufacturers – the richest trading nations have offered no such one-sided concessions to India’s manufacturers, and Indian exporters continue to face all manner of tarriff and non-tarriff barriers that prevent even high quality exports from India recording any significant gains.

Squeezing the Public Sector, Reducing Social SpendingAnother condition that international lenders often impose on developing nations is that they must stop supporting their public sector enterprises and allow private and external participation in key sectors of the economy. They also call for a reduction in social spending. These conditions are usually disguised as a matter of improved “efficiency” and controlling “unnecessary budget deficits”. This means that budgetary support for investment in key areas such as mining, power generation, railways and telecommunication has to be drastically curtailed.

Spending on affordable housing, health and education is also reduced.The “Import Lobby” is usually unperturbed by these cuts because they view these cuts as an opportunity to increase their imports. But the consequences for the rest of the population as a whole can be quite disastrous. With the government refusing to invest in these critical areas, crippling shortages develop in vital aspects of the infrastructure.

In India, even as sections of the upper middle class have relished the rapid growth in the consumer goods industry, all sections of the population have been highly frustrated with the state of the infrastructure in the country.Unaware of the naunces surounding the situation, many think that it is a problem of public sector inefficiency and join in the demands for delicensing and private participation in key sectors of the economy. And so the international dictum of “letting the private sector step in” is accepted at face value. But belying expectations, very little private investment actually materializes in these areas, and when it does, it comes at a heavy price. International companies insist on all manner of tax breaks like extended tax holidays, subsidized land, and “counter-guarantees” before they invest.

Even though such concessions go against the spirit of “free market economics” that the international lending agencies trumpet, these concessions are treated as inevitable. Costs escalate in spite of all these hidden concessions. For instance, all the power projects that are demanding counter guarantees will generate electricity at almost double the cost of a BHEL built plant in spite of various concessions that should have reduced the cost-basis of these projects.

Another borrowing condition is “open” and “transparent” bidding for infrastructure projects. On the surface, these terms do not seem at all objectionable.But in the implementation, it can turn out that these are just more code words favoring the MNCs. For instance, in the name of “openness” and “transparency”, India’s telecom sector was opened to international bidding. But the tender requirements were framed in a manner that no domestic company could ever win a contract without tying up with an international telecom giant. With the public clamoring for faster telephone connections – this crafty move drew little attention.

But even after winning the licenses to provide new phone connections – most international companies stayed away.So the vast majority of the public’s telephone requirements continue to be met by the Public Sector companies that are under-funded on the assumption that private industry will be picking up the slack. In 1996, it appeared as if the UF was becoming aware of this situation, and some critics of the Congress rallied around it, hoping for change. In their 1996 election campaigns, sections of the UF argued vigorously for the re-invigoration of the public sector and pointed to how internationally successful public sector enterprises like BHEL and ONGC had been deliberately prevented from making new investments and bidding on new contracts.They exposed how public sector companies were being privatized at a fraction of their market value – and that the auctions were being deliberately rigged. But, after taking office – the UF, rather than correct these policies, further aggravated Roughly five years ago, I gave up practicing law, which I had been doing for seventeen years, and decided to make a career of investing in India. I wanted to have fun, make money, and do some good for India, in that order.

The results so far are a little unclear.I definitely am having fun; I won’t know if I am making money until some of our investments mature; and if I make money, I will do some good for India, because I will help create well-paying and productive jobs, which India needs perhaps more than anything else. I sometimes wonder what made me think that investing in India would be a good thing to do? Why is India as a destination for venture capital attractive or not attractive? Why did I choose to stake my professional future on India? And what are the prospects for economic growth in India? Below are thoughts on my personal perspective of that issue.My perspective on India and investing is not all positive, but it is an effort to tell the truth as I see it.

Many of the less positive aspects concern the role of the Indian government and its proper role in the development of technology companies in India. That’s why I have subtitled my paper, “What’s a nice government to do? ” To those in the audience who are part of that government, I extend my apologies in advance for anything unpleasant they read below. I first went to India in 1994 to work on a project to build a large electric power generating station.The project is sponsored by Enron and is the largest foreign investment in India’s history. In India, I was astonished by the opportunities I saw. It seemed that there were dozens of products and businesses that simply were not available or were available only in sub-standard form, which could be profitably supplied. I also saw enormous human resources that were not being used to their full potential. I still believe that is the case, but I see now much more clearly than I did then some of the problems that exist.

First, I have learned that many good products cannot be marketed profitably in India because the number of people who can afford them is too small. I tend now to focus less on Indian markets and more on the human resources India has to offer the rest of the world that have more value outside India then they do in India. I also have had some experiences dealing with various arms of the Indian government that have been less than edifying. In preparing for this paper, I tried to distill my thoughts and experiences about India and its prospects as a destination for venture capital and its prospects for economic growth in the near term.I came up with three rather simple points. India has one great strength, one great weakness, and one great hope.

Its great strength is its people; its great weakness is its government; its great hope is the Internet. First, India’s great strength is its people. India has one billion of them, which is a number that is almost beyond the ability of our minds to conceive. The quantity and quality of the human resources of India are, in my view, at least as good as those anywhere in the world. And vast numbers of them speak English, which is a great advantage in the world’s markets.

The quality of the human resources available in India may seem obvious to those in this room, but let me take a two-minute tour of Indian history to illustrate this just a bit. Four thousand five hundred years ago, the Indus valley was one of only four places in the world-the other three being Mesopotamia, China and Egypt-where there was what we consider civilization, complete with plumbing superior to that of many Indian villages today, sophisticated mathematical knowledge, and active trade relations with the other centers.For centuries beginning roughly 600 B. C. , India was the mother lode of philosophical and mathematical thought for many other peoples. To take some examples, its philosophical and religious tradition informed the teachings of Buddha.

Buddhism, of course, became the most influential philosophic and religious tradition of Asia. The system of numbering we use today came from India, although we call it “Arabic” because it came to Renaissance Italy via the Arabs of North Africa. It includes the crucial concept of a space holder-in other words, zero.This concept allows vastly more complex and useful calculations to be performed than could be performed with the Roman numbering system used in Europe previously. In the centuries after its introduction, it revolutionized European science and ultimately led to, among other things, the base-2 system that is the foundation of the digital computer. In our more immediate history, the twentieth century has been a century full of revolutions and revolutionaries.

Arguably the greatest of them were Gandhi, Nehru, Patel, Ambedkar and their colleagues.These leaders not only freed India from foreign oppression, they also established a genuine democracy, complete with a free press, a real legal system, and extensive personal freedom. To appreciate what this means, one can compare them with some of the other successful revolutionaries of this century, such as Lenin, Mao, Pol Pot or Ho Chi Minh. Each of them established authoritarian governments that tortured, murdered and brutalized huge numbers of their own people. Nothing of the sort happened in India.The quality of the human resources of India is well illustrated by one startling fact: according to a recent survey, Indians who have emigrated to the US have an average income higher than that of any other American ethnic group.

Besides its human resources, India has some other advantages from an investor’s perspective and from the perspective of economic development. Most importantly, it is stable politically. India has been a multi-party democracy since its independence in 1947, with only a short interruption during the 1970s.In 1996, the voters turned the Congress Party, which had governed India for all but two brief periods since 1947, out of office. There were no talk of annulling the elections and no rumblings from the military.

India also has certain other fundamentals that contribute to political stability and the protection of investors: a free press, reasonably good accounting standards, and an independent judiciary. The judicial system, although slow and archaic, offers meaningful protection to foreign investors from arbitrary action by politicians, as the recent scandals involving the retail outlets of KFC (Kentucky Fried Chicken) has shown.After local officials closed two KFC outlets on blatantly phony health grounds, they were opened again under court injunctions against the local officials. That sort of protection is not something available to investors in Russia, China or most other emerging markets. Given the human and educational resources of India, given its relative political stability, given its well-developed legal system, all fundamental prerequisites to the building of wealth, why does India remain so poor?And why is there so little venture capital investment? Why has the poverty become worse since independence, at least in comparison to the rest of the world? And why do Indians who emigrate do so much better on the average than those who stay in India? To get a sense of India’s poverty, the average per capita wealth in the US and Europe during the 50s was 6 times that of the average per capita wealth in India, taking into account purchasing power differences of the currencies; by 1990 it was 12 times.As for the venture capital, according to estimates published a couple of years ago in the Asian Venture Capital Journal, the pool of venture capital in India-specific funds is the lowest in Asia except for Pakistan.

It is the lowest on a per-capita basis-which one might expect-but it is also lowest as a percentage of gross domestic product, which one would not. The answer to all these questions, which are related, is not hard to find. In three words: “the Indian government.

” This is India’s great weakness.It consumes vast economic resources that could be more profitably employed elsewhere and inhibits the efficient application of resources in the private sector. There is a saying that the British introduced bureaucracy to India, but the Indians perfected it.

As I’m sure many of you know, “red tape” is still in use-literally. It is cloth tape that wraps the files circulating endlessly within the various ministries. In fact, that’s where the expression “red tape” comes from; it’s not from sticky tape. Horror stories of foreign investors caught in the tentacles of the Indian bureaucracy and Indian politics are legion and legendary.I saw the consequences first-hand on the Enron project which was delayed and subjected to enormous additional expense-hundreds of millions of dollars-by the government of Maharashtra, essentially for political reasons. This is frustrating to me personally, but it is the least of the ways in which the government interferes in the Indian economy to its detriment.

India’s government is a powerful drag on India’s economy. In fact, it’s more than that. The past policies of the Indian government-Swadeshi socialism-constitute a human tragedy of immense proportions.In the last one hundred years, the economic growth produced by the relatively free markets of Canada, the US, Europe and Japan has brought previously unimaginable wealth to the average citizen. In the last thirty years, more and more countries have participated and generally have grown economically in rough proportion to the extent they have freed their markets.

India has largely failed to participate in this process of building wealth since independence, because of the Swadeshi socialist path its government chose. Two generations of Indians-hundreds of millions of people-have been condemned to a life of poverty because of it.

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