Of India and skewed economic policy

Someone said the other day that India is becoming pro-business, instead of pro-markets.

When you think about it that is regrettably true. If business gains at the expense of other stake-holders (consumers, the tax department, farmers), economic benefits get captured by a small minority at the top of the pyramid.

Even without skewed policy, the benefits of reform will go in the initial stages to those who are better able to capitalise on the opportunities thrown up, creating new inequalities. If, on top of that, the system starts favouring a few producers over many more consumers and others, then system legitimacy becomes a casualty.

Whatever political saleability there is for reforms disappears as a result, and the clamour grows for subsidies, state hand-outs, protectionism, reservations and other distortions of the system - none of which is either pro-market or pro-business.

Every businessman knows, for instance, that the tax holidays available in Uttaranchal and Himachal Pradesh are patently indefensible; yet, as Rahul Bajaj more or less said the other day, you have to make irrational investment decisions and head for those states because the tax holiday is too attractive to resist - or because your competitor is making a beeline for it, and you cannot afford to be at a disadvantage. The loser is the exchequer.

Politically, the explosive issue is always land. If farmers find that their land is taken away from them at one price, and they are locked out of the huge increases in land value that go to a chosen few who are into real estate development (as with the special economic zones, which are the new flavour of the season), then the unequal capture of benefits will cause political tensions, especially when the government is seen to have had a hand in it.

Orissa has already witnessed rioting and lawlessness over land taken over and handed to industry on differential terms, and such episodes could be repeated elsewhere.

The key objective of tax reform, meanwhile, is to raise the tax-GDP ratio while keeping tax rates moderate, and to achieve this by expanding the base of the tax system. The tax-GDP ratio this year will be at a creditable level of over 11 per cent of GDP, but that is well short of what it should and could be (closer to 15 per cent).

One of the problems that has existed for many years now is that excise revenue growth is sluggish, and slower than the growth rate of industrial production. Clearly, the exemptions regime (which comes in the way of expanding the tax base) is proving counter-productive.

But more and more industries and activities are seeking, and often being given, concessional tax treatment - a trend that undercuts both the logic and the purpose of tax reform. The fallout will be the argument that moderate tax rates have not worked and should be given up for steeper gradation ("tax the rich").

At the same time, the government is not doing enough to make the system more market-oriented. The labour market remains distorted because of the excessive stress on the 10 per cent of the workforce that is in the organised sector; the market for an educated workforce is seeing huge price increases because of the failures of the education system; the land market remains hostage in many cities to land ceiling laws, which have not been abolished in even important states like Maharashtra; the debt market does not have the depth that it should have been given by now, and is in any case protective of the state-owned banks, which have a high cost structure - thereby hurting borrowers; the electricity market (which has the potential to force reform in this sector and encourage fresh investment) remains thin and is getting undercut by the electricity regulator; the currency market has just been made hostage to an illogical time schedule for capital account convertibility; and efficiency gains in trade (through the advent of a more organised retail market) are constrained by investment restrictions, thus denying benefits that would go primarily to consumers and (to a lesser degree) to producers.