TCS Daily

Critical Choices for India

By Edward M. Graham - June 1, 2004 12:00 AM

During the past weeks, India has come up with more surprises than a fun house at a carnival.

First, on May 12, India's voters elected not to return the Bharatiya Janata Party (BJP, commonly termed the "Hindu Nationalist" Party) to power, in spite of the fact that the BJP had presided over the fastest economic growth in Indian history. Many of those who voted for the Congress Party, which emerged the overall winner of the elections, apparently thought that they were voting for Sonia Gandhi to become the new prime minister. Mrs. Gandhi is the matriarch of the Nehru family that has produced three Indian prime ministers (Jawaharlal Nehru, India's first prime minister following independence, his daughter Indira Gandhi, and her son Rajiv Gandhi, husband of Sonia; both Gandhis were assassinated in office). The leanings of most such voters tends to be "populist" and, indeed, some commentators interpreted the loss by the BJP as a repudiation of the market-oriented economic reforms carried out by the BJP (but see below). The highly state-oriented, interventionist economic policy implemented by India from independence until the early 1990s was initiated by Jawaharlal Nehru and continued by both his daughter and grandson when each was prime minister. Thus, many voters might have thought they were voting for a return to these policies, still associated with Nehru and his family in the minds of many Indians.

But whether Sonia Gandhi would return India to Nehru's economic policies soon became moot. On May 19, Mrs. Gandhi, under pressure from her own family and from Indian Hindu nationalists who insisted that a foreign-born prime minister would be unacceptable (Sonia Gandhi is a native of Italy), indicated that she would not accept the position of prime minister. Her wish rather was that this position be given to Manmohan Singh, finance minister during the last period the Congress Party held power (1991-96). Singh, a Sikh, became prime minister two days later, the first non-Hindu to hold India's highest office. More important, he is the most free-market-oriented person ever to lead this very important country. The Mumbai stock market fell by the largest amount in its history on May 17, apparently anticipating that Mrs. Gandhi would become prime minister. But, on the announcement that the job would go to Mr. Singh instead, the stock market recovered most of its losses.

Indeed, the reforms many Indian voters apparently associated with the BJP were actually begun under Singh's direction when he had been finance minister under Prime Minister P. V. N. Rao during the early 1990s. A former academic with a Ph.D. in economics, Singh's philosophy of government has been that government should not attempt to do those things it cannot do well, especially in the economic sphere. And, in India in 1991, the government indeed was attempting to do a lot of such things not very well. Fortuitously, a balance of payments crisis requiring IMF intervention in that year gave Singh an opportunity to implement his philosophy aggressively. Thus, under Singh's direction, India began to dismantle state planning, remove restrictions on imports and foreign direct investment, deregulate, and privatize state assets. One consequence was that economic growth in India rose to 5.6% during the Rao/Singh years, following two decades of near stagnation.

The Congress Party lost power in elections of 1996, and the coalition government that then governed India for two years generally continued the reforms started by Singh. Then, when the BJP gained power in 1998, the reforms continued. But, in fact, over the six years of BJP rule, the pace of reform has slowed significantly. Thus, although in this month's election the BJP was portrayed as "market-oriented, it has been overall a considerably less aggressive agent of reform than the Congress Party under Rao and Singh or even the coalition government that followed them. Indeed, on a number of important fronts -- e.g., privatization and deregulation -- the BJP has arguably backtracked. For example, in recent years privatization has been limited to the selling of minority shares in profitable state-owned firms. Moreover, in certain important areas ripe for reform -- e.g., enforcement of intellectual property rights (which is notoriously lax in India; see below) -- such reform has not really gotten off the ground.

In spite of this, economic growth rose under the BJP to over 6% per annum, the main reason why most forecasters expected it to be returned to power in the elections just held. Given this, the return to power of Singh is a surprise that neither India nor indeed the world has yet fully digested.

A Mandate for Change?

The question now is whether Singh will be able to resume the aggressive pace of reform that he oversaw during the early 1990s. Although the Congress Party holds the largest number of seats in the lower house of India's parliament (as in the UK, the lower house holds most power), it does not have a majority and hence must work with other parties. The largest party supporting the Congress Party, and with which the Congress Party must work, is the Communist Party of India (CPI). Surprisingly, and in spite of some unsettling rhetoric of CPI leaders, this is unlikely to be a major obstacle to reform. In fact, the CPI was an active part of the coalition government of 1996-98, and the CPI did not oppose continuation of market-oriented reforms at that time. Moreover, the government of the state of West Bengal has been under Communist Party control since 1977. But, in that state, the government has closed loss-making state-owned enterprises, has banned strikes in the important information technology sector, and has aggressively encouraged inward foreign investment. Thus, arguably the only major difference between the Communists and Singh with respect to economic policy is that the Communists remain ideologically opposed to privatization of state assets. Even here, in practice, they are unlikely to attempt to block renewed privatization.

Potentially more problematic for Singh will be whether he really has a mandate for reform from smaller coalition partners and even from within his own Congress Party. As already suggested, many of India's voters apparently thought that they were voting for a return to the more populist policies of an earlier era in India. These voters largely come from that segment, a very large one, of the Indian population that has yet to benefit from India's recent growth. In fact, this failure of growth to benefit a huge segment of India's population suggests that even more reform is badly needed, e.g., of labor laws meant to protect Indian workers and their jobs but which in fact create huge disincentives for firms in India to hire new workers. Such reform would almost surely benefit India's poor, including by facilitating much needed migration of Indian peasants from the rural to urban sectors, but it will be fought fiercely by labor unions and other entrenched constituencies that are core supporters of the Congress Party.

The IP Sector

Singh's work is cut out for him. Although much progress has been made since 1991 in making India's economy more market-driven and less state-driven, a lot still needs doing. One clear area is in intellectual property rights protection. This protection in India remains very lax. This is especially true with regard to the intellectual property of foreigners, where this laxity has been a major deterrent to much needed foreign direct investment in India. Defenders of the status quo in India nonetheless point to the putative success of India's pharmaceutical sector, where local firms have become adept at "reverse-engineering" drugs developed (and patented) outside India and producing "generic" versions of these drugs that are often sold below the price of the patented drugs. While it is true that some Indian pharmaceutical firms have by this means become large and profitable enterprises, these firms fall far short of being world-class. This is true in spite of the fact that these firms often employ very talented technical staff. These firms are stuck in the position of being second-class imitators, ones that produce only products that have been innovated elsewhere, and where the Indian imitations are often of questionable quality. Moreover, deterred by lack of intellectual property protection, no foreign-owned pharmaceutical firms operate in India, and thus India is deprived of the leading-edge technology that such firms could bring to this sector.

The pharmaceutical sector contrasts sharply with the burgeoning information technology sector in which foreign firms have invested in India on a large-scale, spawning in the process world-class local firms that operate side-by-side with foreign-owned ones. In this sector, intellectual property rights have been de facto respected in spite of lack of an effective policy by the government to provide such protection. One reason would seem to be that IT-sector firms in India, whether under foreign or local control, recognize that respect for intellectual property is in everyone's self interest. Also, in this sector, intellectual property more often takes the form of trade secrets than of formal patents, and trade secrets are harder to penetrate by rival firms than patented technology. The consequence is that the Indian IT sector is world-class whereas the pharmaceutical sector is not.

My own guess is that India could develop a world-class pharmaceutical sector, and indeed world-class firms in other high technology sectors, if effective policies to protect intellectual property rights could be implemented there. India's population includes large numbers of well-educated scientists and engineers, and thus availability of trained technical personnel is not a constraint on Indian development as it is in most developing nations. Rather, Indian failure fully to capitalize on these human assets, apart from the information technology sector, is the result of bad policy. My further guess is that Prime Minister Singh well understands this. But whether he is able to bring about the needed reform in the face of entrenched interests seeking to maintain the status quo has yet to be determined. During his tenure as finance minister, Singh's task was largely to identify those reforms that needed to be done urgently, where he could count upon the political finesse of then-Prime Minister Rao to get the reform accepted within India's convoluted political power structure. Now, Singh will be called upon to provide political leadership as well as technical prowess. India's continued rise will depend upon his succeeding at both.

The author is Senior Fellow, Institute for International Economics.


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