The reforms of 1991 were designed for a different technological frontier than what faces India in 2021.
This article is part of the series 30 Years After: Review and Renew the Reforms Agenda.
Thirty years after India unleashed its reforms process, it is still incomplete. The reforms of 1991—which have continued, intermittently and gradually, in the years since—have succeeded in vastly increasing India’s national income and its people’s prosperity. By all reasonable measures, poverty has been reduced equally dramatically. Yet, there is little doubt that, even by the standards planned in 1991, much remains to be done.
The reforms of 1991 were designed for a different technological frontier than what faces India in 2021. Theories of development at that point centred purely on support for increasing the size of the formal industrial sector. In the decades immediately following liberalisation, however, India’s economic trajectory took an unexpected direction. Beginning in the late 1990s and the early 2000s, the share of industry in gross domestic product declined, and the services sector became the engine of growth. Before the pandemic, in 2019, the contribution of industry to GDP, in fact, hit a two decade low.
Beginning in the late 1990s and the early 2000s, the share of industry in gross domestic product declined, and the services sector became the engine of growth.
This might be for several reasons. It is possible to consider that the original 1991 reforms were meant to energise the sectors associated with the “second industrial revolution”— technologically advanced production at scale in sectors such as steel, chemicals and so on. Yet it was the sectors of the “third industrial revolution”—information technology enabled services, finance, and trade—that expanded employment and added value. The shift in the technological frontier, enabled by the growth of information and communication technologies, determined the nature of Indian growth, not the reforms process directly. This is not to say that the reforms were not a necessary component in whatever success India achieved in terms of growth, merely that they did not direct it. The 1991 reforms had several components. The first major changes, in the summer of 1991 itself, was the depreciation of the rupee—which eventually led to India’s currency being allowed to float freely—and industrial delicensing. Later on in the 1990s, foreign trade was also liberalised.
The removal of a peg for the rupee not only took pressure off India’s balance of payments—the immediate provocation for the reforms—it was also supposed to allow Indian products to become more competitive in the export market, since when a national currency loses value, the relative price of that country’s products decreases as compared to its competitors’ products. Information technology exports became a key foreign exchange earner thanks to this dynamic, amongst others. Industrial delicensing was supposed to free up companies in other sectors to take advantage of this possibility, and open foreign trade would force them to be more competitive.
The first major changes, in the summer of 1991 itself, was the depreciation of the rupee—which eventually led to India’s currency being allowed to float freely—and industrial delicensing.
Yet, there were crucial aspects to the broader 1991 plan that were not carried out fully. For example, comprehensive reform of both direct and indirect taxes was postponed. Indirect taxes were not given a more rational basis until the introduction of the goods and services tax in the last decade. A direct tax code is yet to be passed. Without tax clarity, the risks associated with production in India have continued to weigh down on its competitiveness. Nor was full reform of “factor markets” carried out; what economists call the “factors of production”, i.e., land, labour and capital—the building blocks of the production process. If you have a free market for what companies produce, you need to have a free market for what they have to buy in order to produce. If Indian companies that are dependent on restrictive markets for labour, capital, natural resources and land are forced to compete on equal terms with companies from abroad that have no such constraints, then Indian companies will be rendered even more uncompetitive. This is one reason why Indian de-industrialisation began to accelerate in the late 1990s. Reform of factor markets is, indeed, politically difficult. Yet with every passing year the political barriers become less stringent, and the need for these reforms becomes more urgent.
If Indian companies that are dependent on restrictive markets for labour, capital, natural resources and land are forced to compete on equal terms with companies from abroad that have no such constraints, then Indian companies will be rendered even more uncompetitive.
The inability to carry out reforms to factor markets is, in fact, an additional reason why it was the sectors of the third industrial revolution, and not the second, which drove Indian growth in subsequent years. Many of those sectors—IT, for example—benefited from being so new that there were no restrictive regulations that could potentially limit their growth. Many also did not need resources or land at the level that legacy sectors did. They could, thus, ignore the unreformed nature of factor markets and nevertheless manage to grow.
India now stands at the cusp of the fourth industrial revolution (4IR). Yet, in fact, just as India lives in several centuries at once, it is also an economy with sectors from all four industrial revolutions at once. It has a vast number of small factories that use basic technology—the first industrial revolution. It has world class companies in steel, automobiles, and petrochemicals—the second industrial revolution. It is a global leader in software, and telecommunications has been the backbone of recent growth—the third industrial revolution. And it has to prepare for automation and digitalisation, the harbingers of the fourth industrial revolution.
Can a reform programme be, in fact, designed that manages to energise all these revolutions at once? For that is the task it faces.
The first duty must be to complete the reforms of 1991. Direct taxes—corporate income tax, securities taxes, personal income taxes—must be overhauled, as envisaged in the 1990s. There has been some movement towards factor market reforms in recent years, and that movement must speed up. Labour codes have been introduced, but they stop short of full flexibility. A combination of a more effective social security net and a more flexible labour market must be the priority. Land reforms—allowing, for example, agricultural land to be freely bought and sold so as end the domination of the land market by middlemen and government bureaucrats—must happen. Governments may prefer to create their own land banks and to push forced land acquisition, but a proper land market is far more efficient. And, finally, the stranglehold of public sector banks on capital must end, for they have repeatedly demonstrated their tendency to distort the market that companies face for capital, and, thus, have caused repeated bad loan crises. A start towards more flexible capital markets has been made by the introduction of the insolvency and bankruptcy law. But, in spite of the new bankruptcy code’s successes, it also faces major problems—the lack of capacity in the judicial system being one of them. Although bankruptcy in India is now supposed to be a time-bound process, the deadlines built into the law are regularly breached.
The stranglehold of public sector banks on capital must end, for they have repeatedly demonstrated their tendency to distort the market that companies face for capital, and, thus, have caused repeated bad loan crises.
The second duty is one that, in fact, can be understood from the constraints facing sectors relevant to both the second and third industrial revolutions in India: The shortage of skills. For a labour surplus country, it is depressing that employers—whether at an automobile factory or at an information technology firm—will complain that labour of the requisite skill is either unavailable or expensive. Skilling of India’s population is a prerequisite for taking advantage of the fourth industrial revolution as well, given that productivity per worker has to be so much higher in many 4IR sectors. Together with skilling goes the ability to support individuals who need to shift careers, shift locations, shift education levels—or who are facing catastrophic circumstances whether related to personal health crises or broader events like the pandemic. A proper welfare system allows for risk-taking by workers and entrepreneurs, particularly crucial for the fast-developing landscape of the fourth industrial revolution.
And the third pillar of 4IR reforms must be to the Indian state. Administrative reforms are long overdue. While major efforts have been made towards increasing the ease of doing business, it is still too easy for bureaucrats or judges to revisit, reinterpret, or renege on contracts. Both independent regulators and the judicial system have to be strengthened and provided more capacity. Dispute resolution must be the core competence of the state. Speedy and fair dispute resolution is a prerequisite for the risk-taking that will allow the fourth industrial revolution to take hold in the fertile soil of the Indian economy. Without more capacity in various branches of the state—including the fourth, regulatory, branch—even well-meaning reforms like the bankruptcy law have a tendency to founder.
Speedy and fair dispute resolution is a prerequisite for the risk-taking that will allow the fourth industrial revolution to take hold in the fertile soil of the Indian economy.
On the 30th anniversary of the beginning of India’s reform process, it is important that the right lessons are learned from the experience of the past three decades. First, incomplete reforms will only work imperfectly. Second, reforms cannot direct or steer the Indian economy, they can only create an enabling environment for Indian workers and entrepreneurs. It is Indian enterprise, broadly defined, that will determine the future sources of Indian growth. The state must not try and pick the sectors it will support on the assumption it knows where growth will come from. Did the reformers of 1991 predict that IT, finance, trade and telecommunications would drive Indian growth for the next decades? They did not, and they could not. Today’s reformers similarly have no special insight into how the forces underlying the fourth industrial revolution will play out. Their duty is to ensure that Indian companies can discover those forces and adapt to take advantage of them.
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Mihir Swarup Sharma is the Director Centre for Economy and Growth Programme at the Observer Research Foundation. He was trained as an economist and political scientist ...
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