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Moving the behemoth

India?s growth acceleration is now visible to all. The key challenge is to make it sustainable. This requires invigoration of reforms.

india Updated: Oct 18, 2006 00:11 IST

India’s growth acceleration is now visible to all. The key challenge is to make it sustainable. This requires invigoration of reforms. For this, the Prime Minister and Finance Minister have recently called for ‘political space’.  But we also need a sound strategy to generate political support to intensify the reforms. At this stage of the political cycle, legal reforms will not only generate a large political consensus but will be quick-yielding in terms of accelerating growth and making it more inclusive.

India still has infrastructural weaknesses such as potholed roads, power brown-outs and over-crowded trains that had plagued it in the pre-liberalisation era. Yet, there is no doubt that many parts of the economy have been completely transformed in the last 15 years. Why have some segments changed so dramatically while others have languished? In order to understand the phenomenon, it is instructive to look at those areas that have been at the forefront of the country’s new success.

India’s financial markets have been dramatically transformed over the last decade. Not so long ago, these markets were bogged down by illiquid instruments, opaque practices and frequent financial scandals. In contrast, the country’s capital markets are now considered to be among the most transparent and well-regulated in the world. This improvement has been rewarded with sharply higher asset prices and improved liquidity.

What caused this change? In a word — governance. This term relates to both the quality of ‘rules’  that govern market participants as well as the ‘enforcement’ of the rules. In the case of India’s financial markets, the change has been made possible because of improved governance by the relevant institutions — Sebi, Reserve Bank of India, NSE and so on. In turn, this has had huge multiplier effects on the economy as a whole through improvements in resource allocation, corporate governance and returns to investors.

However, this same principle applies to the economic system in general. Good governance is a precondition for success, especially in a liberalised economy where markets are harnessed to promote better allocation of resources and equitable outcomes. Legal infrastructure is the key institutional framework through which the State provides good governance. The legal system incorporates both the rules of engagement (laws and regulations) as well as the enforcement of these rules via the police and the judiciary.

Furthermore, it should be recognised that the legal infrastructure can be an agent of change in common-law countries like India. This is a role that is most often ignored by economists because the legal system is seen merely as the blind and passive enforcement of a static body of rules. However, in the British common-law tradition — India firmly belongs to this camp — each judgment creates a precedent that can be used in future cases. In other words, a good judicial system can be an active agent of change,  rather than just a passive enforcer.

As every Indian knows, two things are necessary for a good game of cricket — a set of consistent rules that are understood by everyone, and even-handed enforcement, viz. good umpires. This is also true for the economic game. Unfortunately, the Indian legal system fails on both counts.

India has a very large body of laws and regulations — national laws, state laws, municipal laws and administrative directives, among many others. Unfortunately, there is little harmony, consistency or inter-linkage of the laws. Many laws date back to the 19th century and still provide the legal framework for activities that were never imagined at that time. Some areas are absurdly over-regulated while others do not have meaningful laws.

For instance, there are almost 50 labour-related laws at the national-level alone, together with associated rules and regulations. In addition to these central labour laws, there is a plethora of state-level laws and administrative directives. On top of these, there are several state and central laws that indirectly affect labour. The content of these laws is, of course, another matter — a large area of debate in its own right. But this is a pointer to the sheer complexity of the legal framework related to the simple, routine act of employing workers.

Not surprisingly, such a confusing body of law makes it difficult for everyone to understand the rules of engagement. Even if a person were diligently law-abiding, it would be virtually impossible for that person to function without knowingly or unknowingly breaking some rule or the other. Indeed, much of the booming call-centre outsourcing business is technically illegal, according to some state laws. In 2005, the Labour Ministry of the Haryana government invoked Section 30 of the Punjab Shops and Commercial Establishments Act, 1958, to disallow women from working night-shifts at call-centres in Gurgaon.

There are even greater problems with enforcement. The Indian judicial system is infamous for the slow pace of processing even the most routine of cases. As a result, there are over 25 million cases pending in the courts. This does not include the large number of cases stuck in various tribunals and quasi-judicial bodies.

It is not just delays that are a concern but also the systematic failure to deliver justice, especially in the criminal justice system. It is common knowledge that two-thirds of jail inmates are undertrials who are being forced to live in jail as they cannot afford bail or do not have the legal support to apply for it. Many of these prisoners have been in jail for years without coming to trial — some have long exceeded the maximum sentences for their alleged crimes. At the same time, the judicial system seems unable to identify and punish genuine offenders. The conviction rate, apparently, is less than 5 per cent.

Given all these issues, it should be no surprise that one should wish for reforms in the legal system. Unfortunately, legal reform is usually seen as peripheral to the economic reform process.

However, it is the single-most important reform initiative for improving governance. This is the one thing that will have a dramatic multiplier effect through the entire economy. Of particular interest is the possibility of using the judicial system, combined with the Right to Information Act, to improve the provision of public goods and services.

What makes it even more attractive is that it is unlikely to require a great deal of additional public expenditure. A large proportion of cases involve the government on both sides — these should simply be resolved internally through administrative measures. For the rest, efficiency can be drastically improved by increased investment in this sector. No formal estimates are available of how much money is required to set the judicial system right. But preliminary estimates suggest that to stabilise the judicial backlog at current levels together with significant quality improvements, an additional allocation of about Rs 4,000 crore fixed investment and around Rs 2,000 crore as annual recurring costs will be required.

The potential gains to the economy will be multiples of these expenditures. Finally, perhaps, the most important reason for focusing on legal reforms at this stage is that these can receive bipartisan support as everyone gains from them. There are no losers here and the results will be quick.

Vijay Kelkar is Chairman, India Development Foundation, New Delhi, and former Finance Secretary, Government of India. Sanjeev Sanyal is Adjunct Fellow, Institute of Policy Studies, Singapore. These are personal views of the authors.

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