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Use your head

When it comes to economic policy, one size does not fit all. One has to temper theory and statistics with commonsense and intelligence. Kaushik Basu writes.

india Updated: Sep 25, 2009 23:28 IST

In designing and thinking about policy to promote economic development, it is a handicap not to know the fundamental causes of economic growth. The only greater handicap is to believe that one knows the fundamental causes of economic growth. It is, of course, useful to be acquainted with the theory and to be familiar with the statistics. But in the end there is no substitute for commonsense. When confronted with an uncomfortable fact, people wed strongly to some preconceived theory or tend to distort the fact to fit the theory, whereas the correct course of action is to re-examine the theory one began with and reshape it to be able to take account of the facts.

Asia is the best place for checking this out. Over centuries this was a region that slumbered. First, it was Japan that woke up; by the late 1960s Singapore, Korea, Taiwan and Hong Kong were growing at a rapid clip; by the 1980s, Asia began to change truly when China began growing consistently at rates till then believed to be impossible for a nation as large as China. Then, by the mid-90s, India, for long wedded to a mediocre 3 per cent GDP growth rate, suddenly broke ranks from many other developing nations in Africa, Asia and Latin America and also its own past and began surging ahead. Over the five years, 2003-08, India’s GDP growth rate has averaged just short of 9 per cent per annum.

If one carefully looks at these countries’ growth histories, what becomes evident is that no existing theory really fits them all. Do a counter-factual experiment. Assume that China has the political and institutional system and the structure of governance that it actually has, but that its economic record happens to be dismal. Suppose it has a growth rate that averages 2 or 3 per cent per annum, every now and then its economy falters and actually shrinks, its unemployment is large, and its head-count ratio of poverty is high and unchanging. Most ‘experts’ would say that this is exactly what is to be expected; that with its big and commanding government, the exercise of ‘party power’ over commerce — and the use of controls to regulate the movement of labour — it is not surprising that China’s economy is doing so badly. Hence, the fact that China has done phenomenally well in terms of growth poses a major intellectual challenge for mainstream economics.

If one turned to India’s experience, certainly up to the end of the 1980s, it would appear the opposite. The bulk of India’s production has been in private hands. In terms of the share of GDP emanating from the private sector, India looks rather similar to South Korea. The history of entrepreneurship in India goes back easily a couple of centuries. India has had a thriving and deep market for stocks and shares. In large parts of the nation, the hand of government has been weak if not non-existent.

In fact some parts of India are among the most ‘marketised’ economies of the world. You can buy virtually anything, from college degrees, driving licences and medical certificates for good health. As I have written elsewhere, many years ago in Delhi, outside the office for obtaining driving licenses, a “doctor” offered me a certificate for good eyesight, adding kindly, “irrespective of the condition of your eyes.” When some Western economists explained India’s economic sluggishness by “the fact” that India was a socialist economy, they were distorting the facts to fit their theory.

From these above examples we cannot jump to the conclusion that we should have a large government, with commanding control over the entire economy since this strategy seems to have succeeded in China. The counter-example is provided by Russia, which attempted much the same policy. After a short period of rapid growth, the policy backfired. Also, in the case of India, carefully-planned market liberalisation seems to have paid off (though we still have great distances to go).

All this goes to show that, when it comes to national economic policy, one size does not fit all. One has to temper theory and statistics with commonsense and intuitive intelligence.

For India, this is a time of great opportunity, and the possibility of India out-performing China is no longer the impossibility that it once seemed. Instead of basing our policies on some grand theory of growth, we must work on the “small things”. We need to work on increasing government efficiency. India takes too long to clear the permits needed for an entrepreneur to start a business, it takes too many days to enforce a contract when one party reneges and it takes us longer than virtually any other country to allow a firm that has gone bankrupt to close down.

This does not happen because of any individual’s fault but because of the rules and regulations that history has handed down to us. To be able to cut down on these inefficiencies is to allow enterprise to flourish. It is important for government to work on this. This should be viewed as much as an investment as building bridges and roads.

While working on making it easier for business and enterprise to flourish, the State needs to work on directly alleviating poverty. If a large segment of the population feels disenfranchised from the growth process, it is unlikely that a country can grow and prosper. We need to invest in rural infrastructure and provide direct support to the poor.

But these are merely a few examples of the nooks and crannies of the economy into which we have to look and make changes in order to seize the moment and enable the benefits of development spread through the entire nation.

Kaushik Basu is Professor of Economics and Chairman, Department of Economics, Cornell University