eep-why policy and antecedents of economic reforms-2015

8/9/2019 EEP-Why Policy and Antecedents of Economic Reforms-2015

1/27

Economic Environment andPolicy

What is the course

about?

EEP-Antecedents to Economic Reform 1


2/27

The Focus Provide an understanding of the emerging

economic and policy environment in India The discussion essentially covers the post-reform

(1991) period The antecedents of economic reform provide the

contet to the policy analysis Trace changes in different policy domains in the

post-1991 period and identify emerging policychallenges

The coverage of policies is not comprehensiveenough!!

EEP-Antecedents to Economic Reform "


3/27

Broad Approach Indian situation analy#ed in the contet of

$onceptual underpinnings of mar%et and government(regulatory) failures

Eperience of East Asian economies (&here feasi'le)

egin &ith the analysis of the 199-91 crisis toeplore earlier conditions and policy paradigms Identify %ey policy distortions in different policy domains *iscuss changes envisaged in each policy domain and the

associated issues and challenges Eplore through the course ho& these distortions

have 'een addressed in the post 1991 period andho& a fe& ne& ones may 'e emerging

EEP-Antecedents to Economic Reform +


4/27

A Caveat India is a comple economy, society and polity The compleity is significantly higher as the nation is large

and diverse and &ent (going) through five transformationssimultaneously (uha, "11) .ational (colony to an independent state) *emocratic (political participation of &omen, castes/) Industrial (movement a&ay from agriculture) 0r'ani#ation (villages to to&ns) ocial (rights of su'ordinate groups)

2ost other economies &ent through these transformationssequentially (0, Europe, $hina/)

The course focuses largely on the 3economic4 dimensionsand therefore remains inade5uate to provide a 3complete4picture



5/27

Why Regulate?Market Failures

Regulation

Introducing Key Concepts and Providing the Context for Policy

Intervention



6/27


Why regulate and ho!? 2ar%et failures (discussed in Economic Analysis)

need to 'e corrected through regulation and policyintervention to enhance social &elfare

Endo&ment failures (another type o mar%et failure)

may also re5uire state intervention ut there can 'e government and regulatory

failures as &ell resulting in a variety of distortions Policy challenge ho& to regulate to avoid 'oth

%inds of failures:


7/27

EEP-Antecedents to Economic Reform ;

Market Failure "ccurs i# 2ar%ets, especially future mar%ets, do not eist

Imperfections in access to information Information asymmetry Imperfections in foresight a'out the future Eternalities - positive or negative (private and social

costs


8/27

EEP-Antecedents to Economic Reform @

Regulation$ Response tomarket #ailure or regulatorycapture? Regulation a response to pu'lic (consumer:) demand inthe presence of mar%et failures: Industries regulated in the a'sence of mar%et failures and firms

support ?hy: Regulation a response to industry4s demand (capture of

legislators): Industry (regulated) captures the regulatory agency (capture of

regulators) ut some regulations not supported 'y industry> ?hy:

oth types of empirical situations eist Regulation supplied in response to the demands of interest

groups acting to maimi#e utility


9/27


Endo!ment Failure AnotherType o# Market Failure? $onventional perspective is restrictive as

endo&ment failures can 'e critical Efficiency (maimi#ation of surplus) vs> e5uality

Etant distri'ution of endo&ments important 'ut ignored

in neo-classical perspective ?ho gets property rights: (Role of policy:) *istri'ution of surplus 'et&een 3consumers4 and

3producers4 important for policy (dynamic efficiency) 2ar%et errors commission omission

*istort mar%ets perpetuate crisis 2a%e participation in mar%ets disadvantageous for certain

sections through terms of trade shifts Reduction in &age-food price ratio during droughts is often

accompanied 'y no or slo& rene&al


10/27


A %i&erent Perspective''' 2ar%et errors commission omission>>

.ot create conditions (endo&ments) that ma%e mar%ettransactions advantageous

Perpetuate regular deprivation due to a'sence static efficiency 2aimi#ation of surpluses over time

Role of eternalities = investments in endo&ments andincentives for savings and investment = are important *istri'ution of surplus Endogenous gro&th theories emphasi#e on the role of

human capital in increasing returns to investment


11/27


Market Failures and

Regulation$ CurrentConsensus oth government mar%et failures eist

$hoice not 'et&een mar%ets or intervention 'ut 5uality ofintervention ?hen, &here and ho& to intervene:*isciplining function of mar%et competition useful forlearning and efficiency

Performance of mar%ets can 'e improved through a varietyof regulations including appropriate legal and property rightsystems

overnment may lac% capacity or coherence forappropriate action

Biscal pressures and informational pro'lems Crgani#ational vacuum in the government often does not

provide the re5uisite autonomy incentives Regulatory capture possi'ilities eist $ompetition among interest groups may vitiate policy

choices


12/27

EEP-Antecedents to Economic Reform 1"

The Conte(t o#

Economic Re#orms in)ndia

Short, Medium & Long Term Dimensions ofthe Economic Crisis in 1991 and the ocus

of Structural !eform


13/27

EEP-Antecedents to Economic Reform 1+

Immediate Manifestations ofthe Crisis evere 'alance of payments (oP) pro'lems

Do& fore reserves (only enough for t&o &ee%s) .ear 'an%ruptcy to service eternal de't

igh rates of inflation

1+-16F Gan-GunH91 In late 19@s inflation &as high despite no eternalshoc%s (unli%e oil shoc% of 19;9-@1) Inade5uacy of food stoc%

*iverse eplanations of the crisis 'ut t&o stoodout and &ere acted upon Di'erali#ation of the 19@s, eternal shoc%s and financial

mismanagement &ere maor contri'utors in the shortand medium term

The %ey pro'lems related to long term policy distortions&hich re5uired structural reform


14/27


Short-term Dimensions of theCrisis (1989-91)

?orsening CP situation - Increase incurrent account deficits due to Do&ering trade 'alance (ro&th of imports

greater than that of eports in 199-91) Do&er inflo& of remittances (Invisi'les)

urpluses in invisi'le a


15/27


Short-Term Dimensions ofthe Crisis (1989-91)...

oP Pressures got intensified 'y ulf ?ar (Ball in remittances, increase in oil prices, maor

epense in rescue operations in the ulf) ?idening fiscal deficits spilled into higher prices and imports

and a drain on fore reserves *o&ngrading of IndiaHs credit rating

hort-Term E$s (1@ *ays) 'ecame un-availa'le to rollovershort-term de't due this do&n-grade

*ecline in investors confidence led to an outflo& of .on-resident Indian (.RI) deposits

Increase in rates of inflation after the ulf crisis (J17F insecond half of 1991) compounded oP pro'lems

A 17F appreciation of rupee during 19;9-@1 &hich hadadverse impact on eports Bore rate got corrected in 19@8 'ut &as pro'a'ly too late


16/27


Medium-Term Dimensions Developments in the 1980s

Patterns of Industrial Production Impressive gro&th in industrial production (@>7F) ro&th of consumer dura'les faster than consumer non-

dura'les and intermediates Import intensity of these goods &as high leading to fore outgo *emand for oil, fertili#er and defense added to import needs

tagnancy in indigenous oil production also led to more PCDimports Cil shoc% of 19;9-@1 added to the adverse impact

Eport orientation led to epansion of eports in import-

intensive areas leading to higher imports ro&th of Industrial production led 'y dura'les had a

narro& 'ase &ith limited eternalities The rich constituted the Khome mar%et4 &hich &as not

sustaina'le


17/27

EEP-Antecedents to Economic Reform 1;

Medium-Term Dimensions Developments in the

1980s…. Biscal Profligacy igh fiscal, revenue and moneti#ed deficits led to

increases in money supply and inflation *eficits also spilled into oP crisis

overnment reversed the policy of ensuring surplus in

revenue account to finance productive capital accountdeficit $apital a


18/27


19/27


Long-Term Dimensions Rethinking Development

Strategies 2aor long-term pro'lem &as a relatively lo& gro&thof national income (+>7 - 7F) Inade5uacy of savings for financing planned

investments - ecessive reliance on 'udgetaryresources led to large deficits

roadly, five types of pro'lems are identified Relative neglect of agriculture and rural development that

inhi'ited the gro&th of home mar%et *evelopment of inefficient, high cost, un-competitive

industrial structure erious infrastructure (transport, telecom, po&er, petroleum

products scarce) and human capital 'ottlenec%s ignificant financial capital constraints Eternal shoc%s


20/27

EEP-Antecedents to Economic Reform "

How to orret these fai!ures" Argument for Reforms

Larious policies contri'uted to these failures 'yintroducing micro-economic rigidities &hichresulted in several distortions

If these rigidities did not eist performance &ould

have 'een 'etter Rigidities did not allo& firms to ma%e rational

choices Policy reforms re5uired to reduce


21/27

EEP-Antecedents to Economic Reform "1

rigidities that

structural re#ormsaim to correct?

" Summary #These rigidities got $uilt o%er the years

ith the implementation of %arious policies'Many policies #e'g', those relating to e(it,la$our and agriculture) not included here'


22/27

EEP-Antecedents to Economic Reform ""

Industria! #o!i$ %ased&igidities

Policy did not encourage competition and contri'uted toinefficiencies through ureaucratic determination of plant capacity, product mi and

location through licensing regime 2ar%et forces more or less ignored (lac% of contesta'ility)

evere entry and eit 'arriers &ith licensing and other controls(e>g>, 2onopoly Restrictive Trade Practices Act - 2RTPA) Rent-see%ing through and lo''ying for licenses for capacities and

scarce materials as their ac5uisition provided monopoly po&er Trade in scarce materials 'ecame more lucrative than efficient

manufacturing (no 3contests4, or 3stic%4)

Pronounced pro-la'our stance restricted &or%force rationali#ation u'sidi#ed ailing small scale industry (I) Employment vs> efficiency politically employment concerns critical Policy needs to enhance eport contri'ution of I ignored

Inhi'ited economies of scale through licensing and reservation forI (certain sectors reserved for the small firms)


23/27

EEP-Antecedents to Economic Reform "+

THE INDUSTRIAL CONTROL SYSTEM

The establishment and operation of an industrial enterprise in India has required

approval from the Central Government at almost every step. Before making an

investment, an entrepreneur has to obtain approval in principle from the Ministry of Industry. The granting of this approval results in the issuance of a etter of Intent

!"I#. $rmed %ith this "I, the entrepreneur can then tie up other requirements for

setting up the pro&ect. If he needs to import a capital good, he must obtain a capital

goods import license from the Chief Controller of Imports ' ()ports !CCI'(#, in the

Ministry of Commerce. The approval for the import, ho%ever, is given by a committee

set up in the Ministry of Industry. If there is also a need for a foreign collaboration

agreement, the entrepreneur has to obtain a specific approval for this, an *.C. approval,

from a committee chaired by the *inance +ecretary, but serviced by the Ministry of

Industry. In order to raise funds for the pro&ect, if an entrepreneur %ants to go to the

capital market, he needs separate approval from the Controller of Capital Issues in the

Ministry of *inance. *or imports of ra% material and components, separate licenses

have to be obtained on an annual basis from the CCI'(. In each case, an essentiality

and indigenous nonavailability clearance has to be given by the technical %ing of the

Ministry of Industry, the irectorate General of Technical evelopment. "nce

everything is tied up and the unit is about to go into production, the entrepreneur has to

go back to the Ministry of Industry for an Industrial icense. !Mohan and $ggar%al,

-/#


24/27


Trade #o!i$ %ased

&igidities igh import tariffs meant lo& imports 'ased competition An anti-eport 'ias &hich 'lunted eport rivalry and the

associated spillover 'enefits from eports This 'ias &as reinforced 'y

$ur'ed imports via tariffs and 5uantitative controls as a part of

import-su'stitution strategy> This led to reduction in eternalcompetitive pressures and increases in input costs, especially ofeporta'les

Boreign echange policy &ith over-valued rupee made Indianeports non-competitive

lac% (*aala) mar%et emerged (0 M 7 'illion transactions

estimated for 199) and capital flight too% place (a'out Rs",8, crores stashed a&ay 'y Indians in &iss an%s!) Rent see%ing possi'ilities &ere high &ith multiple tariff rates,

5uotas and comple eemptions Inverted tariff structures (lo&er tariffs on final products and higher

tariffs on inputs) created 'iases against local production as &ell as

eports


25/27


#u'!i Setor #o!i$ %ased&igidities

Pervasiveness of the pu'lic sector in heavy industryand infrastructure Reservation for the pu'lic sector created entry 'arriers Inefficiencies in P0s led to higher input costs &ith significant

adverse effects for the rest of the economy through a variety

of input-output lin%ages Infrastructure 'ottlenec%s &ere particularly severe

Inefficiencies along &ith soft 'udget constraints meantlo& rates of return and no surpluses for reinvestment

Provided monopoly po&er to P0s in industries &hich

&ere reserved .o incentives or pressures to 'e efficient ?ith significant trade 'arriers these inefficiencies got

transmitted to other firms and sectors (esp> non-trada'les)


26/27


oreign Inestment #o!i$%ased &igidities

evere restrictions on portfolio and direct investment ectors of entry as &ell as etent of e5uity controlled .o threat of potential foreign competition Potential of technology flo&s through B*I restricted

Tight controls on technology transfer, licensing,international mar%eting ('rand) etc> Dicense fees, royalty rates and sectors &here foreign

technology can 'e licensed &as controlled

$ontrols on foreign technology 'ased entry 'y local producers

reduced these competitive pressures too Internationally efficient scales of production could not

'e achieved


27/27

EEP-Antecedents to Economic Reform ";

inania! Setor #o!i$ %ased&igidities

$ompared to industrial sic%ness, financial sector sic%ness has amore severe impact through the multiplier effects, &hich aremore &idespread for the latter

$apital constraints 'y Ncro&ding outN of private sector anddiminished 'an% profits 'y Administered interest rates (mar%et forces ignored)

*irected NPolicy DoansN to agriculture and small industry (O 6Fof deposits) and government (DR O +8F of deposits) ureaucrat determined pricing in securities mar%et The amount of money that could 'e raised from the e5uity mar%et

&as also decided 'y the government Interestingly, many policies adopted 'y India &ere similar to

those used in East Asia 'ut could not ensure contesta'ility andavoid rent see%ing

The ne economic policy #+E) post 1991 as e(pected toremo%e these and other micro-economic rigidities so that firmscould ma.e rational choices #crisis as not only a short term phenomenon, the roots lay in long term)

eep-why policy and antecedents of economic reforms-2015

Documents