Dispatch #62: Why liberal democracy is needed for India's economic development?
This is the transcript of Dr Raghuram Rajan's lecture at the 5th AIPC National Conclave in Chhattisgarh
What I want to talk about today is something that's on all our minds, which is what is happening to liberal democracy in this country and whether is it really that necessary for Indian development. I will argue it is. We absolutely must strengthen it but the reason I thought this would be an interesting topic of discussion is there is a feeling among some quarters in India today that democracy holds back Indian growth and India needs strong even authoritarian leadership with few checks and balances on it
to grow and we seem to be drifting in this direction. I believe this argument is totally wrong it is based on an outdated model of development that emphasizes goods and capital, not people and ideas.Â
I argue that the recent underperformance of our country in terms of economic growth and it has been happening for some time certainly seems to indicate the path we're going on needs rethinking. I will make the argument that in fact, our future lies in strengthening our liberal democracy and its institutions not weakening them. And this is, in fact, essential for our growth now, of course, many other reasons why we must confront and defeat majoritarian authoritarianism for one any attempt to make second-class citizens of a large minority will divide the country and create internal resentment in this age of geopolitical turmoil. It will also weaken us and make us vulnerable to foreign meddling. We only have to look south to Sri Lanka to see the consequences when a country's politicians try to deflect from their inability to create jobs by attacking a minority. It doesn't lead anywhere good.
Of course, there's a moral reason to have a just liberal democratic society. It's what enables each and every one of our citizens to flourish socially and politically. Now I must emphasize before I get into the meat of my talk that liberalism is not anti-religion. The sense of every major religion is to seek out that which is good in everyone. In many ways that is also the essence of liberal democracy. Now with that as a preamble let me talk about the economic rationale for why we need a liberal argumentative democracy.Â
Start first with where we are. India is rebounding today through the consequences of the war in Ukraine. The inflation and the rising interest rates around the world are all casting a shadow now. Any growth that we have should be celebrated but we cannot ignore the fact that the rebound that we're having is from disastrous numbers posted in the last two fiscal years. India's poorest citizens and especially their children continue to suffer. And they've suffered during the pandemic. They continued to suffer during a k-shaped recovery that we're having. The scarring of India's low middle-class households and MSMEs will mean that domestic demand will remain subdued after an initial rebound so we need to figure out how to get growth up. Now I want to emphasize that India's slow growth is not all the fault of the pandemic. Our underperformance predates the pandemic for about a decade probably since the onset of the global financial crisis. We haven't been doing as well as we could. The key measure of this underperformance is our inability to create the good jobs that our youth need. Think for example of the protests that were triggered by the government's recently announced Agneepath scheme. This is suggestive of how hungry our youth are for jobs. Just a while ago you saw 12.5 million applicants for 35000 railway jobs
Now it's particularly worrisome that India has a scarcity of jobs. When so many of our women are not working outside the house. India's female labour force participation is amongst the lowest in the G-20 at 20.3% in 2019. In fact, we had only one country which was keeping pace with us, which was Saudi Arabia and now Saudi Arabia's female labour force participation is 33% so we are alone. Think how much richer India would be as a country and how much less frustrated our youth would be if there were good jobs for all.
So I want to ask a question. Where has India gone wrong? But before I try and answer it let me emphasize that there is much to praise about India's economic record in the two decades after the 1991 reforms initiated by Prime Minister Narasimha Rao and Dr Manmohan Singh. India had a 7% growth for 20 years. That's something very few large countries have achieved and even in the last decade of relatively slow growth, India has had notable successes. Remember, the Aadhaar scheme was conceived of by Nandan Nilekani and he added to it the other stack which has had multiple applications. Now, this was an early innovation of the UPA government and it's paying off today. Think about the universal payment interface that many of you have used or UPI. we have over 4 billion transactions a month now on UPI. We started UPI in 2016 when I was at the RBI. The equivalent FED now will start at the Federal Reserve only in 2023 UPI is now studied across the world by central banks intending to implement fast retail payments. The point I want to make is not so much that this is the one thing we've done. There are so many things we've done. But when India puts its mind to it, it is second to none. Examples of successes abound such as our farmers; ISRO, a fantastic organization which has put a satellite around mars; our various unicorns and our Thomas Cup badminton team. But we can't indulge only in chest-thumping if we don't assess our feelings critically. We will increase the chances of continuing to underperform. So in that spirit of constructive criticism let me ask if Indians and India have so much potential why are we faltering today? Why aren't we creating those jobs that we desperately need? So let's start by asking what worked for us in those two decades after liberalization when we grew so so wonderfully.
I would say at least three things. First, we enabled our people with capabilities and empowered them to seek out better futures; we trusted our people. Second, we freed up their access to opportunities and third, we governed with a dynamic and sensitive touch with an openness to criticism and a willingness to learn and correct course. Think for example about the things that went right in the decade of the 1990s and the 2000s. what few people realize is that we simply did not just tear down the licensed permit raj in those years between 1990 and 2010, we nearly doubled the years of schooling in our population from 3.6 years on average to 6.6 years and since then we've made some progress more so amongst men than amongst women. Of course, the steady liberalization of tariffs and regulations did make it easier for businesses to grow and it allowed our better-educated workers to get good jobs. Infrastructure investment helped Prime Minister Vajpayee's Golden Quadrilateral Highway building program opened up India. Further, the UPA’s Gram Sadak Yojana and many such yojanas, including in Chattisgarh opened and connected India. And as many of you know, once you have a paved road connecting a village to the rest of India it does wonders for the village economy overnight. You see dairy and poultry farming taking off because milk, eggs and chicken can be transported to markets. Shops start stocking the latest goods. You see phones coming about, you see SIM cards, you essentially see commerce taking over the village development occurs before your eyes as people take charge. Our citizens' control over the government was further strengthened by the implementation of Panchayati Raj and the UPA’s Right to Information Act.
And importantly government tried to reduce the extent to which the economy was controlled from the top. Instead, it tried to energize people from the bottom. We moved to let the energy of the people and competition between businesses decide rather than deciding from the top which industries and industrialists were to be favoured. Now, this led to 7% growth over two decades but this is the past. What are we doing now I think it's important to understand what the current government is trying to do at least as far as its vision on growth goals.
Now I would argue its vision centres around the term Atma Nirbhar or self-reliance. Now to the extent, it emphasizes better connectivity, better logistics, and better roads and devotes more resources to it. In some ways, this seems a continuation of the past reform decades and that is good. But in many ways when you look at what Atma Nirbharta is trying to achieve, it takes us back to an earlier and failed past where we focused on physical capital, not human capital. On protection and subsidies not on liberalization. On choosing favourites to win and not letting the most capable succeed. It also means that we have a misplaced sense of priorities. What do I mean by that? Think about what we're not spending money on today. There is a tragedy overtaking our school children, especially the poorer ones. Many not having been to school for two years are dropping out of school. Their human capital which is their and our most important asset in coming years is something that we're neglecting. We're failing them by not devoting enough resources to remedial education. Perhaps the central government thinks state governments will take care of children certainly. Education is also a state subject indeed. The state I work with Tamilnadu has come up with an innovative scheme, Illam Thedi Kalvi, to hire 1.75 lakh, local workers, to offer children remedial learning and draw them back to school in Tamil Nadu which has one of the better education systems in the country. Workers discovered that over 5 lakh children had dropped out and these are now being coaxed back. Now if Tamil Nadu has this problem think how much worse the problem is across the country. Why aren't we doing more to focus on our children? Why aren't we spending more on our children? And given that states are strapped for finance the centre should be providing more resources for this. So the question we have to ask is what is the centre devoting its money to?
One of the big items on the centre's agenda in terms of funding is called Production Linked Incentives which are subsidies to the big manufacturing industry. So let's look at the PLI scheme and ask what exactly does it do and why I say it is a reversion to the past rather than forward-thinking. Now giving credit to the government. it is very much worried about jobs and that's why it's trying to energize manufacturing in the country. The scheme, it has in mind is PLI. Now clearly if you think about what PLI does it basically argues that our industry is uncompetitive, and our manufacturing cannot compete with the world. On the Ministry of Electronics website, it says we can't compete because of a lack of adequate infrastructure, because we have inadequate availability of power, limited design capabilities, not enough focus on R&D by industry and inadequate worker skills. There are all these problems. Therefore what do we do? How do we get manufacturing?Â
We offer tariff protection and subsidies. We raise the tariffs on manufactured goods so that our domestic manufacturers have protection and offer them subsidies so we can get more manufacturers to come to India and produce. So, for example, take cell phones. In 2017 the tariffs on cell phone imports were raised from 10% to 20% which gave manufacturers a 20% margin over the world. In addition in 2020, the PLI scheme was implemented which gives 6% of the cell phones’ invoiced price as a subsidy to the manufacturer. Remember the value added to a cell phone is about 20 to 25% of the cell phone. So you add essentially a 6% margin to producers who are actually producing 20 to 25% of that value. In other words, the profit margin they get is about a quarter to one-third of the value added. Given all this, in addition, states are offering power subsidies, and land subsidies capital expenditure subsidies to get manufacturers coming in. So cell phone manufacturers have a great deal which is why a number of them are willing to set up in India. The question you have to ask yourself is how sustainable is this. And who is paying for all this? Clearly because of tariffs consumers in India pay more than the international market price for cell phones. That of course becomes a direct profit to the manufacturers. I check the price of a popular cell phone which is available both in the US and India. It's priced at 43% more in India than it's priced in the US. That's the margin the manufacturer gets for producing it in India. Tells me the domestic citizen is paying a lot for the privilege of having cell phones manufactured in India.
In addition of course the taxpayers pay 6% in production subsidy for every cell phone produced in India and the state taxpayers pay for state subsidies. So no wonder foreign manufacturers are willing to flock in and of course, this may be worth it if a cell phone industry emerges in India which matches world costs. The key issue then for whether the PLI scheme succeeds or not is whether manufacturers become more efficient over time so India can remove the protection and subsidies. What does history tell us about this? Well, it tells us we tried something like this, before. It was called the license permit raj and it failed. Why did it fail? Because in the license permit raj there was no impetus for our industry to get efficient because protection never ended. Even that protection never ended they said we'll always get subsidies why become more efficient? Now in PLI, there is an ostensible end date when the subsidies end and hopefully at that time the tariff protection that they have will also end. These are hopes. But the real question you should ask is will they end?
In the meantime, the government has done little to remedy the deficiencies that render India uncompetitive. For example, increasing the skill base of the workers. So producers will not be competitive when PLI ends. Already firms are lobbying for PLI schemes to be extended to compensate for the pandemic period. And remember in a few years there will be a lot of Indian workers at risk when the subsidy scheme ends so the political temptation to end them will be considerable. That's one reason why I think the jury is still out on the PLI scheme. Will it make India a manufacturing giant or will it take us back to the license permit raj? It's quite possible it's the latter. The other problem however with schemes like the PLI schemes is in an attempt to get Indian manufacturing in certain areas they increase costs to other areas also. So, for example, there's a PLI scheme currently being contemplated for chip manufacturing in India. 10 billion dollars of subsidies for getting chip manufacturing into India. Now the problem of course is as the PLI scheme is implemented the cost of chips to other Indian manufacturers will go up. And those manufacturers now become less competitive. Think of car manufacturing. Lots of chips go into cars. If they have to pay 20%, 30% or 40% more for chips the cars that are produced in India become uncompetitive. Ultimately the entire economy becomes high cost and inefficient if you spread these costs to the economy. This was what we discovered during the license permit raj. We're trying that experiment again.
Last point. I said one of the things that our reform movement did was it created competition. It was no longer who you knew that determined how well you did, but what you produced and how efficiently you produced. With production-linked subsidies again the process about which industries get PLI is non-transparent and completely discretionary, leading to the possibility that taxpayer money goes to subsidize well-connected industrialists rather than sectors where India may have a natural advantage. So the broader point is that we are trying an experiment which failed, with some minor modifications which may be enough to make it work but really one should worry about the larger aim. Should India try and become a manufacturing powerhouse given how much protectionism there is today? On manufacturing and export-led growth put differently across the world you're seeing increasing protectionism because countries are simply unwilling to accept another China storming its way into their domestic markets. If India is to grow it has to become another China because that's the size of its workforce. And the West is not open to another China coming into their markets. So even if PLI is effective we become a manufacturing giant where are our markets going to be given the kind of protectionism that is emerging given that China already is there? So what should we do? How do we grow?
Given that growth is essential I would say let's go back to what worked and push it in new directions. What worked, put people first, help our people improve capabilities and empower them to seek out better futures, that's number one. Number two, increase their access to opportunities. Number three, govern with a dynamic and sensitive touch. Now, where does all this take us? I would argue that instead of manufacturing-led growth why not think of a new Indian way? Why not think of service-led growth? If India plays its cards right it doesn't need to emulate China it doesn't need to tread along the same path which is now as I argued blocked, it can leapfrog much of the manufacturing stage and go directly to services. Now let me explain in a little more detail. First, what do I mean by putting people first when I say people putting people first? India has to draw from every person that it has and in order to draw from every person that it has, it has to give everyone a fair chance starting from our biggest minority that is women and going on to religious minorities like Muslims and disadvantaged castes and tribes. But we know that a discriminatory society is not just immoral it's weak as I said earlier. But history also tells us that no minority, treated as second-class citizens, will stay docile in the face of oppressive behaviour by the majority. Equal treatment is not just appeasement it makes absolute sense. It is the right thing to do. It is also what will take our economy in the right direction. It will allow it to put its best foot forward.
Now, so the first element of putting people first is to treat people fairly, treat people equally. Second, because our fiscal resources are strained we must prioritize. So for example rather than spending 10 billion dollars on production-linked incentives to create chip factories with you know some small probability of succeeding. Today the US is spending 50 billion dollars, we have TSMC in Taiwan spending 30 billion on new factories. So there's a lot of spending on factories going on. Instead of us spending 10 billion dollars in starting from scratch without any assurance of success why not spend 10 billion dollars on 100 new universities or on 200 old universities, upgrading their talents, upgrading their labs or upgrading their facilities or on 2000 high schools? Today chip manufacturing is becoming a commodity business. Where there is value in chip design. By getting 100 new universities you get 10,000 new engineers. 10,000 chip engineers can do far more than one chip factory. In other words when we think about where we prioritize should we not spend money on people, on their capabilities, on ideas rather than on subsidizing some industrialists to try making chip factories? As we put people first, as we think about an agenda which increases their human capital we have to also ask why is it we haven't done so well in providing public goods to people. Why is it that our health care systems are deficient? Why is it that our schools are not stronger? I would argue that part of the reason is that people need more power in their hands to be able to affect the change.
One way of empowering people, is cash transfers to them, giving them the ability to command with the money in their hands; better services because now they can pay for it and they can ask people to provide those services. So cash transfers are one step in empowering people. Second is to decentralize government. Today when a teacher doesn't show up in a school in a village who do you complain to? The teacher is not employed by anybody who has power in the village. The teachers are employed at the state level and you have to go to the state capital to get redress. If instead there was decentralization, if each panchayat, each municipality had more power over the workers in that panchayat or municipality would there not be more local control and local responsibility from those functionaries? In other words, can we decentralise funds, functions and functionaries to the local area? Something the Congress started doing with Panchayati Raj in the late 1980s.But that experiment needs to be continued because at this point it is essential we have limited the amount of funds, functions and functionaries that are transferred to the local area. Third, if you want to empower people we also have to put much greater weight on individual rights and freedoms and push courts to enforce them. We have seen in many situations the weaponization of laws of draconian laws like UAPA and the sedition law. We have seen section 295a of the IPC being used to oppress certain communities and suppress free speech. Now, these laws if used well can help protect the public from criminals and terrorists. But if they're misused they protect the lazy, the incompetent and the corrupt government from the public or enable the government to hound those it does not like. We've seen both sides of it now I would argue that going forward if we want to put people first we want to give them the ability to protest against the ineffective government. We allow them to criticize a local government. We need to change these laws to amend them or repeal many of them so that people do not fear being put in jail just because they protest. We have to improve access to opportunities. There are so many ways we can improve access to opportunities once people have capabilities. Improving access to markets, to self-employment, to finance etc. On the agricultural side technology extension services, investment and marketing support. On the infrastructure side, we can build out much more infrastructure again. But one of the biggest problems in accessing opportunities is the difficulty of doing business. What are the real regulations that we have to adhere to? What are the inspectors we have to meet? What are the inspections we have to pass? And you know in much of this as you know there's also a certain amount of corruption. All these are things we need to work on in order to enable our people to create jobs for themselves; to create the kind of entrepreneurship that is very important going forward.
So that's the creating opportunity. We need a learning transparent government. In the path that we're trying to take, in this new path which tries to take us out from the tested manufacturing-led growth to something different, we need a government which is willing to experiment; which is willing to try things at a small scale and then roll it out more widely; which is willing to allow data to be gathered both on its successes and failures; which is willing to listen when it goes off track. Now, this requires therefore a government that is willing to take criticism. It requires a government that doesn't govern only from the centre from a small coterie which doesn't listen very widely instead decisions should be advised more widely by experts, by discussion in parliament, by debate more broadly otherwise we get very narrow decisions which don't have broad public support. Government should also not suppress unfavourable data. Today we have no idea what unemployment in India is because we have absolutely no survey which collects data on unemployment. We have no idea what the deaths from Covid-19 were. The broader point I'm trying to make is data, free speech, criticism, and debate, these are not inessential to the government. They're essential to good government because they allow us to find out what's going wrong. They allow us to change. Liberal democracy offers governments the best environment to learn and be more effective. This is something that all complex countries have discovered and are taking action on, strengthening their democracy rather than weakening it and that's the direction we should go.
Now let me end in the last three to five minutes. If we do all this, if we put people first we create opportunities for them, and we strengthen government by making it more sensitive and willing to adapt to the realities on the ground. Where should we go? How should we create these jobs now? We should certainly continue what we're doing- we're building our infrastructure, and we're trying to expand manufacturing. We shouldn't do it through subsidies but follow the old path of creating more competition, opening up the economy, and trying to encourage more growth in that way. But I also think that we have a new potential path which is focusing on service-led growth. Let me explain why the environment has changed to favour service exports. By the way today India exports 400 million in goods, and we export 250 million in services. We have a deficit in goods exports. We have a huge surplus on service exports. We have a comparative advantage in services. So the real question is if we're trying to put the emphasis where should we put the emphasis? On manufacturing goods or on services? And I would argue we can do it in services. Let me explain why the environment has changed. During the pandemic, it became easy to provide high-value-added services at a distance. If a consultant can work from home in Chicago to service clients in Austin can't she work from Hyderabad to service those clients in Austin? The market for services like consulting, legal and financial advisory, education and telemedicine are ripe for globalization and unlike goods, services delivered online cannot be stopped at a physical border. Furthermore, when we talk about protectionism the biggest suppliers of services in the world are the US and Europe and therefore it is not in the interest to be overly protectionist, to erect barriers to services in fact it is in their interest to be more open. Second India has a key asset in providing services- its liberal democracy. Think for example when you provide medical services one of the biggest elements of medical services is data and data privacy. The patient on the other side doesn't want her data to be just spread around without any notion of privacy. She also doesn't want your government to be looking at her data. Her government doesn't want you to be looking at her data. So if you want to provide medical services across the border one of the things you have to assure the other side is you will have strict controls on the data. You will protect that data, the data will stay within the provider and it will even be protected from your own government. What countries can give better assurance of this kind of data protection? Typically transparent tolerant democracies are governed by the rule of law. So if for example, we can convince other countries that our own government cannot see our data without going through the course. Our own firms can be sued in court if they spread the data around. We have a much better chance of getting into data-intensive services something that a country like China cannot get into because there are no checks and balances on the Chinese government. The US today will not allow China to provide financial services in the US, in fact, a number of Congress people in the US are saying we should put restrictions on Tik-Tok because it gathers up so much data. When data is the new oil think about countries that have a much greater ability to commit that the data will stay private. Those countries will have an advantage in providing services. Add to that the fact that India is already known for providing services across the world. Our software engineers have done wonders for us. And a final reason for why focusing on services rather than manufacturing is the world is growing green. Services are expanding, manufacturing cannot expand at that pace because it's impossible for the world to grow its consumption of goods as it did in the past. More of the consumption will increasingly consist of services. Why don't we focus more on spreading services across the world?
So what does this mean in terms and this is where I'll end, what does it mean in terms of what we need to do? Well certainly we need to improve the capabilities of our people but we also need to for example when we're talking about telemedicine we need Indian degrees to be recognized across the world. We need therefore the process by which Indian doctors get qualified in the US; to be made it easier; those Indian doctors shouldn't have to travel there, and exams are offered across the world so that Indian doctors can qualify. Similarly in terms of insurance, one of the biggest things in medicine is that national insurance typically pays for medical services, we need the national health system of the US, of the UK to pay for Indian doctors. We need Medicaid to pay for Indian doctors. For that our government has to take it up with those countries and say we want to do this and it'll be good for you because we will be providing medical services taking some of the burdens of your overclocked medical services. If we could take some of the pressure off that by providing medical services from India that would be good. But for that, we need to negotiate with them. The broader point is instead of just focusing on manufacturing if we start moving to services and think about what our service providers need for us to open up the doors to them across the world.
Now the last question you're going to ask is is this going to provide enough jobs? Yes, it can provide jobs to doctors. Yes, you can provide jobs to our well-educated young people who become consultants or lawyers. What about aam-janta? Is it going to provide jobs for them? Well first typically any high-level job in India creates five or six more jobs because there are people who help those doctors, nurses, assistants, clerks etc., there are lots of jobs of that kind created so that's one. Second those jobs themselves as they provide incomes allow those households to educate their children and the leap forward for the next generation of children is tremendous. So the point I'm trying to make is we need to create jobs of any kind with reasonable incomes and then use education, use good health care to elevate that next generation so that in 20 years they leapfrog their parents and we get a far stronger, far richer, far better economy.
 So let me end by saying we need an Indian growth path that draws on the capability of Indians and builds on India's historic culture of tolerance and respect for all. It's a growth path that builds on India's liberalism. On our ability to debate, to criticize, to essentially argue with one another. I think this will improve the quality of India's governance but more important it will make India trusted by citizens elsewhere in the world. In other words, I am suggesting that India can become a Vishwa Guru not just based on the basis of ideas of the past but because it has a new vision of green, inclusive, local-led growth and development and based primarily on services rather than manufacturing. And it persuades the rest of the world that this works by essentially doing it. This path will not be easy given the current ruling ideology but I think it can be a manifesto for change. Now, this is our 75th year of Independence, let me end by saying I believe India's best days are still ahead but we really have to work to make it so. I think we can but that work has to start now.
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