The Indian economy is yet to fully escape the state’s shackles

There are many reasons for this. Independent India was born as a poor country with universal adult franchise. Most developed democracies widened the right to vote only after getting rich.

Capitalism works best when the institutional structures of a developed economy ensure equality of opportunity, fair competition and a hefty price for violating rules.

For capitalism to work for a large majority of people, you need institutions to encode and enforce the rules, and prosperity to fund the welfare payments required to uplift specific disadvantaged segments of the population.

Also read: The eastern states have a big role in India's development aim

Given the imperatives of a large and poor electorate, if a political economy becomes redistributive too early, then the wealth pie and institutions do not grow large and robust enough for the job.

Since Independence, India’s quandary has been just this. While nearly 400 million people have been elevated from abject poverty, any surplus has been distributed even before widespread prosperity could emerge.

This column, the sixth in the series on the ‘quantity to quality’ reforms required for India to achieve upper-income status, tackles the pervasive but hard-to-grasp issue of statism. For decades, governments on both sides of the political aisle in India have harboured a deep suspicion of the private sector.

This suspicion runs so deep and nuanced that an intricate framework of rules amounting to a ‘chastity belt’ has left even well-meaning companies exhausted with compliance requirements.

The unfortunate flip side of the coin is that to escape this dirigiste system, a few companies appear to have curried favour with rent-seekers in the Central and state governments, leading to suspicions and allegations of crony-capitalism.

The Indian political economy, at the central and state levels, has time and again reached for interventionist solutions rather than structural reforms.

The only major exception was in 1991-92, when with our economic back against the proverbial balance-of-payments wall, India enacted a series of liberalizing reforms that generally unshackled the economy by delicensing industry and slashing customs tariffs, among other major moves, in particular.

Also read: This elephant in the Indian economy’s room needs attention: Inequality

Despite that, reforms in the areas of foreign direct investment (FDI), disinvestment and factor markets in need of structural changes were halting and painfully gradual. Even when the going was good, 20 years ago, India’s approach to free trade was ambivalent; we wanted it to be ‘free’ on the other side but subsidized (and sometimes low quality) on ours.

The still-pervasive caste system has only compounded this problem. Even though labour mobility, particularly for urban jobs, has mitigated the problem a little bit, the societal misallocation of resources and attendant low productivity that results are contributors to mistrust of a meritocratic capitalist system.

Unfortunately, the distribution of learning, opportunity, production, capital and credit still functions in a manner that is discriminatory of certain castes.

One academic study has shown that if the borrowing capacity of firms owned by lower-ranked castes are set equal to their higher-caste counterparts, direct labour productivity would rise by nearly 6% and additionally total factor productivity (TFP) by 3.1%.

India’s approach to rule-making has also crossed a tipping point. Rules are stacked upon rules, so much so that “master circulars" have to be issued to make some semblance of sense. Agencies enforce not only these ‘de jure’ elements but also a set of ‘de facto’ edicts that arise from a paternalistic and anti-fraud mindset.

For some reason, our authorities are unable to prosecute specific wrongdoers. We operate in a paraphrased version of an old adage: criminal conduct is by a few firms, but the compliance cost is socialized for everyone to bear.

India’s hope of becoming an upper middle-income country cannot be realized in this environment of statism, because it will fail the cause of deepening prosperity throughout the population. Intricate rule-based regulation must give way to framework regulation.

There will be fewer red lines to monitor, fewer frivolous reasons to threaten company officials with jail, and fewer line items of cost for compliance, all of which will flow to the improvement of productivity at the micro-level and prosperity at the macro one.

Also read: Crack the employment paradox to avoid a middle-income trap

The state must more specifically and convincingly prosecute wrong doers, but enable and encourage those that follow the law. Agencies must clearly separate their regulatory, development and implementation functions. Ideally, most of them would give up their implementation function to the private sector.

Of course, some amount of welfarism is still required, but that can be done in a fair and targeted manner.

The state has a very important role to play as a standards setter and enabler of fair competition.

If the state were to function as an enlightened referee, rather than as umpire, player and promotion board, then individual actors would innovate and contribute much more to an economy that could underpin an inclusive and prosperous country.

P.S: “This disposition to admire, and almost worship, the rich and the powerful, and to despise, or at least, to neglect persons of mean condition, is the great and most universal cause of corruption of our moral sentiments," said Adam Smith in his book, ‘The Theory of Moral Sentiments.’