Terms of Trade | What ails competitive capitalism in India

Viral Acharya's new paper, which is likely to create a big debate, suggests that the monopolistic practices of a few firms are contributing to inflation.

In a paper which is likely to create a big debate in India, New York University professor and former deputy governor of the RBI, Viral Acharya has argued that India needs to do five things to exploit its true economic potential. They are, in Acharya’s order, reducing tariffs, curtailing the power of the biggest business houses in India, getting the bankruptcy code on track, aggressively following the FRBM and inflation targeting mandate in India and investing more in education and skilling.

Acharya, essentially speaking, is arguing that the state enforces greater discipline on capital to get rid of economic inefficiencies. (Mint File Photo)

The last three of these recommendations are likely to be less controversial, at least in principle, among mainstream economists. Acharya is not the first big economist to ask for a reduction in tariffs, especially because they hurt Indian exports by driving up the prices of imported inputs. Arvind Panagariya and Arvind Subramanian, both of whom have worked with the current government in the past, have made these arguments in the last couple of years.

What Acharya brings to the table for the first time

What really sets apart Acharya’s paper is the claim that monopolistic practices driven by the rising economic power of India’s biggest business groups have led to a rise in core inflation and the government ought to crack down on this increasing concentration.

At the theoretical level, increasing monopolization always leads to a fall in what is described as consumer surplus in microeconomics. This happens because a monopolist likes to (and can) set his price at a level which is significantly higher than his marginal cost. While India is not a case of textbook monopoly, there is no reason to believe that markets dominated by a handful of players (whether in India or outside) do not see monopolistic practices of setting prices higher than they should be. If business concentration in India has indeed increased in the recent past, then it is likely that it is acting as a source of inflation.

To be sure, Acharya’s claims are pretty recent and it is unlikely that they will be taken without any criticism. The criticism, when it comes, is more likely to question Acharya’s empirical findings – they are based on an analysis of the CMIE’s Prowess database – and argue that the causal link is not strong enough and the period of study (his analysis ends in 2021) is insufficient. A concrete rejection or acceptance of Acharya’s claims will require an econometric examination of his data work which is beyond the scope of journalistic work. What this week’s column intends to do is take Acharya’s claims at face value and situate them in India’s broader political economy landscape.

What is missing in Acharya’s paper: Interaction between business and politics

In an ideal world, as Acharya argues, governments should be going around breaking monopolies everywhere. While the record on this is not exactly great under capitalism at large, let us keep our discussion focused on India.

What is the defining feature of India’s political economy? While India is on its way to becoming the third largest economy in the world very soon, per capita incomes continue to be very low. The best example of economic precarity of an overwhelming number of Indians was seen during the pandemic when the government announced free food grains for 800 million people and enjoyed large political dividends out of the policy. This large-scale deprivation notwithstanding, elections have become an extremely expensive affair in India, with some studies suggesting that Indian elections are now the most expensive in the world.

What is the source of political finance in India? The bulk of the political funding in India actually comes from rich businessmen.

The basic question to ask is why does big business fund political parties in India? While a lot of people might find this unpalatable, political funding by big business is driven more by a quid pro quo arrangement (it could be perfectly legal) rather than ideological affinity, even though the latter is not an insignificant factor. This quid pro quo has been evolving in independent India’s political economy journey over the last 75 years.

The evolution of business-politics relations in pre-reform India

Indian big business wanted the Indian state to furnish two things for it when the country got independence: protect it from (much stronger) foreign competitors and take the lead in creating a capitalist base in India. Our domestic businesses did not have adequate capital to furnish the latter task at the time of independence. The famous Bombay Plan document is a testimony to these expectations.

The more corrosive quid pro quo between the Congress – it was symptomatic of the political ruling class – and the rural propertied classes was the mutual compromise to derail any radical land redistribution which has had long-term adverse consequences for agricultural productivity and by extension mass demand. The rural propertied classes contributed not just money but also muscle to the Congress’s political campaign.

Once India’s post-independence economic strategy fell between the two stools of placating the modern and pervasive rural propertied classes, the state’s economic contract with capital degenerated into a rent-seeking bargain where political finance was the tool to get the ruling party (or sometimes just the bureaucracy) to sanction scarce economic resources such as foreign exchange and imported inputs necessary for production in India’s permit-raj era. Those who excelled in this bargain accumulated wealth at a phenomenal pace. Others found it next to impossible to do business.

In addition to the process described above, fragmentation of politics which almost coincided with the atrophying of the utopia around the planning model also gave birth to a political economy at the regional level where even the local elite evolved their own rent-seeking models in exchange for political funding of regional parties or regional level leaders in national parties. This arrangement, more than anything else, compromised India’s delivery mechanism for both social and physical infrastructure.

How reforms changed this bargain

The nature of the political economy bargain changed once the economic reforms of 1991 did away with most of the restrictions on capitalist activity for (first) domestic and (gradually) foreign capital. While a detailed analysis of the political economy of 1991 reforms is too vast to be covered in passing, a competition to usurp scarce natural resources on favourable terms (for capital) and financial resources (which allowed massive investments with very little promoter skin in the game) became the characteristic feature of this bargain in the first two decades of the reform era. While the infrastructure and credit boom did deliver high growth for the Indian economy, it left a significant amount of political and financial stress in the system in the form of corruption allegations and pile up of bad loans. It was the undoing of this economic model which generated the economic anger which brought down the Congress-led United Progressive Alliance (UPA) government in 2014.

To be sure, the reform period also saw the growth of many over-the-board businesses that lobbied for industry-wise rather than industrialist-wise benefits. The evolution of NASSCOM which lobbies for India’s IT firms is among the biggest examples of this.

How Narendra Modi has changed this bargain

There is a widespread agreement among analysts that one of the biggest reasons for the popularity of Narendra Modi is his ability to deliver on the low-hanging fruits of first-generation problems by streamlining delivery, plugging leakages through the JAM framework, scaling up infrastructure projects and then exploiting all of them boost his political capital.

There is also a big-business bias, although the policy nudge towards tilting the scales in favour of big business is not just an infrastructure phenomenon. The entire formalization push in the economy has had the same effect in all sectors of the economy.

While technology has played a role here, what is often underestimated is the political gamble Modi and the BJP have taken by alienating the rent-seeking arrangement between capital and politicians at the local level. Today’s BJP has pre-empted this political finance damage by rewriting the rules of the game to allow big business to make non-transparent but legitimate funding to political parties via electoral bonds. The difference it has brought is far from insignificant. Earlier a big business group making donations to a political party had to do it in (unaccounted) cash to keep it under the radar, but now it can do so legitimately via electoral bonds. Any analysis of how electoral bonds have changed the business-politics bargain in India remains impossible because the information on exact donors and recipients is not available. What we do know is that the money donated has been significant and the BJP now outspends its political competitors by a distance.

When seen in this backdrop, it will not be very off the mark to argue that state facilitation of business concentration is the new bargain between capital and politics in today’s India. This is mutually beneficial because it has allowed the BJP to develop a centralized political narrative around the Prime Minister’s unprecedented capacity to deliver and big capital can increase its business by usurping what was earlier in the informal sector. Acharya’s claim of rising business concentration leading to inflation, even if true, is only a side effect rather than an intended effect of this policy.

Can there be political traction for Acharya’s prescriptions?

This is the part most people will find provocative. Acharya, essentially speaking, is arguing that the state enforces greater discipline on capital to get rid of economic inefficiencies. This is not a new argument at all and the history of Asian success and failure stories – this column has referred to Joe Studwell’s book How Asia Works more than once – is a testimony to the importance of the State’s ability to impose discipline on capital for a successful economic transformation. However, what is also a fact is that most of Asia’s successful economic transformation took place in societies which had far less democratic (if not outright dictatorships) competition than India has had and continues to have.

A fiercely competitive polity which has a fundamental asymmetry between the providers of democratic legitimacy (almost a billion poor voters) and the political finance needed to run the machinery to achieve this legitimacy is very unlikely to see such a disciplining exercise by the state. Herein lies the fundamental political economy contradiction in building a capitalism which is committed to Schumpeter’s idea of creative destruction in letter and spirit.

Every Friday, HT’s data and political economy editor, Roshan Kishore, combines his commitment to data and passion for qualitative analysis in a column for HT Premium, Terms of Trade. With a focus on one big number and one big issue, he will go behind the headlines to ask a question and address political economy issues and social puzzles facing contemporary India.

The views expressed are personal