Let fiscal federalism and economic freedom drive prosperity in times of a trade war
- Today’s trade war mustn’t distract India from pursuing a clear domestic agenda for economic success. Here’s a thought experiment of an autarkic model that’ll help clarify what we should do.
Imagine there was no other country but India. The subcontinent was all the landmass that there was on the planet, with oceans all around. And all 1.5 billion people in the world were Indians. The Indian national economy would be the global economy. There would be no such things as international trade, foreign investment and immigration. The Indian economy would be an autarchy. By definition, it would be self-sufficient.
Now think how such an economy could also be prosperous. The immediate order of business—as Bhishma teaches us in the Mahabharata’s Shanti Parva—would be to establish the rule of law, protect property rights, govern justly and ensure that people live peaceful lives where they can enjoy the fruits of their labour.
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The next task would be to ensure economic integration of the vast subcontinent, where goods, services, people, ideas and capital can move freely from one place to another.
Now that basic political and economic integration has been achieved, let us look at economic policy. What will we do for energy? There is very little oil we can pump out of the ground. There are no foreign countries that we can buy it from.
So we will have to rely on solar, wind and hydro-electric sources. We will have to use the coal that we have and invest in nuclear power plants. This might not cover all our requirements. So we will have to economize on the use of energy. Electricity cannot be provided free of cost to anyone, not even farmers.
That brings us to food. Without petroleum imports, we will have to figure out how to make fertilizer. In addition to chemical methods, closed loop biological methods that convert human and animal waste into manure will be an obvious choice. Farmers will have to change their cropping patterns and farming methods.
Indeed, because electricity will not be free, it will no longer be possible to pump out ground water and use it to grow crops inappropriate to those soil conditions. Indian farmers will no longer grow water-intensive crops in water-deficient areas on the back of subsidized electricity. Many farmers will have to change their farming methods. Quite a number of them will have to stop farming and find other livelihoods. India will have to enable this transition.
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The idea that people are better off doing what they can do more efficiently is called ‘comparative advantage.’ It is the single biggest idea that can make our self-sufficient closed economy a prosperous one. When people, firms and regions do what they are most efficient at doing, they specialize and become more productive. They then trade with others who are better at other things. Some places specialize in software technology, some in manufacturing, some in agricultural products, some in tourism, and so on. Indeed, comparative advantage is not an imposition. People specialize because they have reasons and the freedom to do so.
By extension, we can see that prosperity requires the political system to be federal. States and regions should have the autonomy to engage in activities of their choice. The Union government can through the Finance Commission ensure that all citizens get enough resources for there to be broad parity. However, it should not use fiscal policy to determine the pattern of economic activity. It shouldn’t be in the business of choosing who produces what, where and at what prices. Indeed, a self-sufficient India cannot be prosperous without political and fiscal federalism, all the way down to the level of local governments.
There is nowhere to import technology from. So a lot of public investment will have to go into scientific research and development (R&D) as well as education. Again, comparative advantage suggests that the government should finance firms and institutions that can do this efficiently, without insisting that those doing state-funded R&D also be government employees.
The backbone of the economy will need a financial system that can gather savings and surplus capital and put it into the hands of those who can make the best use of it.
I could go on, but the upshot is that if you want India to be self-sufficient and prosperous, the government’s economic role must shrink and change. It should abandon striving for ‘even development’ and stop trying to redistribute money and economic activity.
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Let’s bring this thought experiment to an end. Even as you worry about tariffs and trade wars, note that a lot of what we must do to be prosperous is a matter of domestic policy. Of course, international trade is very desirable. It will make us more prosperous, faster and at lower cost. It will open up wider possibilities.
We should hope that a mindless trade war doesn’t start (or at least ends quickly). India is a big country with a diverse geography and a large as well as young population. Our domestic economy is capable of weathering this storm. It is a good time to break down the constraints we have imposed on ourselves and unleash the awesome energy of the national economy.
The author is co-founder and director of The Takshashila Institution, an independent centre for research and education in public policy.
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