Why Crony Capitalism will not deliver the economic growth India needs.

[This essay may also be at the TheWire.in, read here.]

There has always been a fallacious assumption held by the Indian economic right-wing (ERW) that the model best suited to promote growth is the so-called “tooth and claw” capitalism, where the state allows a clutch of tycoons to capture the commanding heights of the economy in order to facilitate rapid accumulation of capital.

The “evidence” often cited in this regard is the “robber baron” era of the Wild West in the US, when a host of railroads, banks, and other services were built by legendary tycoons. If this results in a rise in inequality, and pauperisation of the poor to begin with, then it is a necessary price to be paid for rapid growth, goes their argument.

Why then does liberalism favour market-based capitalism, with and free and rule-based competition, and that jealously guards against the creation of monopolies? Surely both can’t be right. By and large, the ERW ignores such questions and prefers to conflate crony or robber baron capitalism with an economic system based on free and competitive markets. Yet, both are as different as chalk and cheese.

Modi has largely followed the crony capitalism model in his seven years in office, while GDP growth has continued to tank since the high of 2017. Can this model deliver the growth rate that India needs to break out from the ranks of lower-income groups? And how is Modi’s model different from the one that Jawaharlal Nehru followed after Independence? Or the one followed by P.V. Narasimha Rao and Manmohan Singh after the economic reforms of the early 90s?

Our per capita GDP today is barely $2,136. India ranks 144th out of 194 countries in global rankings, its per capita GDP is only 40% of the average world per capita GDP. Our per Capita GDP is 60 times lower than the richest country and eight times higher than the poorest.  

Can Modi’s crony capitalism deliver the growth we need to break out of the low-income that traps some 400 million of our people? Mind you, India’s dollar GDP, at $2.66 trillion, is marginally ahead of France and ranks 6th largest in the world. However, the global GDP is currently $86 trillion and India’s GDP is only a measly 3% of that.

However, even with a mere 3% of global GDP, India’s right-wing elites want to strut on the global stage as Vishwagurus, who can teach the world how to run it. This huge chasm between India’s actual capacities and the ambitions of its right-wing elites can do lasting damage to the country’s growth prospects, and the welfare of its poor, as we shall see. It is the vaulting ambitions of our elites, and their total contempt for the poor, that explains the economic model that Modi has chosen. It is another matter that the elite’s ambition has never been matched by our tycoon’s ability to compete with the best in global markets, even as they seek sheltered markets at home, to India’s overall detriment.

Limits on growth

As I argued in an earlier essay, a gross savings rate of 30%, given an incremental capital output ratio (ICOR) of 5, can at best produce a real GDP growth of 6% per annum, which is what I call the alpha growth rate. There is a beta component to the growth rate, as we are witnessing now, when a temporary higher growth rate is possible, because, in an earlier period, the economy tanked due to the abrupt shutdown, followed by a recovery now underway. However, such beta fluctuations in output are unsustainable, and over the long term, given a savings rate of 30%, and ICOR of 5, the maximum that is possible is 6%.  

You can circumvent this natural limit in a variety of ways, for instance, by stepping up savings through higher levels of employment – our labour participation rate is below 40% – so that you have more people earning and saving. Or you can go for higher export-led growth financed by foreign direct investment (FDI). However, Modi’s crony capitalist model merely seeks to corner all the possible domestic savings, and more, as capital for top tycoons.

A small group of top businessmen seeking easy profits have no incentive to compete in global markets when a sheltered home market is available, thanks to Modi. So the model, dependent on the same 30% of gross domestic savings, will never generate overall GDP growth of more than 6%. What it does is to increase the crony’s share of asset growth, as they corner more of the savings in the system, to the detriment of other entrepreneurs. We can see that process underway in the phenomenal increase in the share of wealth and assets of the top two tycoons, even as overall growth has tanked.

There is far too much wishful thinking among Modi’s supporters, that somehow “non-linear” growth will help the economy break out of the constraints imposed by a savings rate of 30% and ICOR of 5. No such miracles await us. Digitisation of the payments system, while very visible, at best can provide a 0.1 to 0.15% boost to the economy. After all, what can it do except reduce the currency printing expenses of the RBI, which in any case are a minuscule portion of the GDP?

Similarly, a lot of hype is attached to unicorns. A study reported in the pink papers showed that Indian unicorns will at best add 0.25% incremental growth to the GDP, because they are mere digital platforms, not integrated into the real economy, or the payment and financial systems as Alibaba et al were, thereby reducing their potential to spark off chain growth fueled by both easy credit and the in-house payment history which made credit for consumer goods easy to retail. We, in typical Indian fashion, have ruled out such synergies ab initio. The wizards in RBI will never free credit and payment systems from their iron grip come what may. Without such freedom, easy consumer credit with moderate risk that fueled China’s consumer boom will remain out of reach.

Modi’s model is premised on the politics and economics of exclusion. At the top of the pyramid, Modi’s model seeks to exclude all but the favoured businessmen from the public trough. At the bottom of the income pyramid, it simply asks the people to fend for themselves as best they can, while squeezing hard the lower half of the income pyramid through indirect taxes, to provide direct tax cuts to corporates, along with copious “production-linked-incentives”, that are nothing but outright subsidies. The fact that Modi adjusts the indirect tax rates between budgets by increasing GST and duties at will, keeps the burgeoning level of indirect taxation under the radar.

The politics of exclusion goes deeper. Our approach to reforms has always been elite-centric and top-down. Thus, even the liberalisation reforms focused on freeing industry and firms from licensing and controls but did little to include the lower-income groups in the process. Instead, for them, the focus was on the elimination of subsidies; necessary perhaps, but hardly inclusive. This resulted in a rather poor understanding and appreciation of reforms among the laity, severely limiting political support for them, with disastrous results as we can see today.

We are a nation of some 1.4 billion, with very hard working and thrifty people. Our propensity to save is among the highest in the world. How then can we be short of capital to fund rapid industrialisation and the creation of new productive jobs? This is a little-understood conundrum that Sheilja Sharma and I tried to explain in two essays here and here.   

We used the Peruvian economist Hernando de Soto’s model to show how about a trillion dollars’ worth of wealth is locked up in slums [built up by years of genuine savings of the dwellers even if the initial land was grabbed] because we have failed to create a system to record such property, dematerialise it, and make the wealth locked in it fungible with capital, that owners can bring into the economy for alternative uses [as opposed to being limited to personal use.]

Such examples can be multiplied across the economy. Farmers’ land for instance is not fungible with capital because it is tied up in a bewildering number of land use restrictions, combined with prohibitions on sale to various categories of buyers. Instead of capital setting a person free to use in his enterprise, a farmer’s land ties him as a serf to the land, working for the state, for product prices that do not compensate him for even a fraction of the market value of land. The land so tied up as wasted capital could be another $1-2 trillion. The same can be said of housing property, acquired by the government under archaic rules, that lies wasted because it is unavailable for redevelopment even in metros like Mumbai and Kolkata. 

The point here is we lack neither savings nor wealth waiting to be converted into capital. What we lack are the administrative arrangements, a property system that efficiently records ownership of such properties and makes them sellable with minimum regulation. With block-ledger technology, all property can now be dematerialised safely. Cumbersome title deeds should be put away in government vaults for good.

The advantage with bottoms-up capitalism is that it directly benefits the poor, with no extra burden to society at large, and in their prosperity and wealth, comes support for economic reforms. Furthermore, such additional wealth and capital gives them a higher earnings capacity, puts more money in their hands to spend, increasing consumption manifold, thus actuating the quantum jump in growth that India is looking for. Since plumbing is right up Modi’s skill set, I wonder why he has not taken up reforms in this area at all. Instead, both his attempts at reforms in this area have aimed at grabbing farmers’ land cheaply from their owners. The three farm laws were a similar attempt.

It should be clear by now, to the meanest intellect in government, that Modi’s sheltering of domestic markets for select tycoons through protectionism will not only lock India out of any FTAs but also prevent a strategic partnership with the US that goes beyond token handouts. Being locked out of meaningful FTAs also means that India just cannot hope to attract the $250 billion in FDI that it needs to raise exports from $350 billion to $1 trillion that Modi has declared as his target. And with no substantial jump in labour-intensive exports, both GDP growth and new job creation will continue to languish at current dismal levels. MCP and Modi’s declared economic goals are incongruent.

India now needs an inclusive, bottom-up approach to reforms that clearly, and visibly, bring tangible rewards for the poor, as well as add to their capacity for enterprise and productivity. 

We should unfetter property from the existing archaic colonial system, and instate a new property system that delivers clear, marketable titles in Demat form to owners, both in terms of urban and rural property, as well as farmers’ land. 

It is time to free farmers and their lands from all controls. A certain acreage of land may be reserved for food production. All other lands should be set free of controls, and reserved land should be marked-to-market at a suitable rate, comparable to free land in districts nearby.  

Rent control laws need to be completely dismantled, and ownership restored to original owners or their heirs. These steps should be taken state by state, district by district, and not with a “one shoe fits all” model. Taking it district by district enables learning by experience and makes risks manageable.  Depending on experience and response, extend the reforms further. But the result should be clear marketable titles in Demat form.

This alone can take India’s gross domestic savings back to the 40-50% range that prevailed earlier. Enterprise at grassroots levels would create an upsurge in new firms, creating new jobs, that would further increase GDS, through an increase in labour participation rate (LPR). We should aim for going back to the 60% LPR that we had in the 1990s.

India’s top-down economic reforms brought many benefits but have now run out steam. Modi is desperately trying to flog a dead horse along the old Nehruvian model of squeezing the poor to create capital for the rich. The only difference between Nehru and Modi’s models is that Nehru kept such capital wrung out of the poor with the public sector, while Modi gives it to his chosen few. That by itself is not going to be sufficient to lift growth above 6% because these forced transfers of capital from the poor to the rich don’t by themselves create higher savings. They come out of the same 30% static kitty. It is simply robbing Peter to benefit Paul.

Coming back to tooth-and-claw capitalism, as Soto explains in his book, the great robber baron age of economic growth began because the US took time off to create a property system that worked, and not because the state-backed robber barons, as our ERW thinks. It was the success of the US in including the ordinary people in property and prosperity, that fueled the first economic boom. As Daron Acemoglu and James A. Robinson explain in their book Why Nations Fail, it is always more inclusion that creates more growth, never the other way around. The truth of this proposition should be familiar to anybody with the slightest familiarity with macroeconomics. Yet in politics, we forget this principle all the time.

The state is very poor at picking global champions. If MITI of Japan, or the Chaebols of South Korea, did well, it is because the state-backed firms that were already internationally competitive. Its role lay in helping them build scale. They did not support firms that sought sheltered markets at home to “create” capital before venturing abroad, because the absence of competition means you never learn to compete. Modi’s favoured businessmen are among those whose net export is virtually zero (not even Reliance on a net basis), have no global brands, and whose whole enterprise model is based on asset gathering to create monopolies in domestic markets. They will deliver good growth for themselves, but only because they impoverish many other firms and people.

Modi might consider the bottoms-up approach to economic reforms, if only because it will enable him to persist with his model for a while longer. Secondly, the bottom-up approach to reforms is a sure-fire winner politically, that will take the steam out of the opposition to reforms. With China under Xi faltering, this is a once in a generation opportunity to catch up with the rest of the world painlessly.

Sonali