The economy has struggled from the very start because of two early blunders. The first was the Congress party’s decision in 1955 to make the government the leading player in manufacturing. This was followed by its decision in 1970 to undertake massive welfare expenditure, thus shifting political focus from efficiency to equity. In fact, such control had been increased via the nationalisation of banks seven months earlier in July 1969 itself.
The second mistake flowed naturally from these two. To oversee the enormous government spending on industry and welfare, the bureaucracy took over the economy, making rules as it went along, without reference to anything other than the CYB (cover your backside) principle.
This is why Williamson and Alesina are so important. Mr Modi understands Williamson’s lesson instinctively because he knows it will make him popular as it makes things easier for businessmen. But he has so far shown no signs of acting on Alesina’s insight because he knows it will make him unpopular, namely, reduced government expenditure.
Modi and Williamson
Ever since 2014, Mr Modi has been trying to improve the “ease of doing business” in India. And in the last six years things have indeed improved. But not enough.
This is because the government, at the bureaucracy level, hasn’t really understood that it is the reason why it’s so hard to do business in India. And that’s because the babus have no idea of the insights offered by Oliver Williamson.
Williamson focused, amongst other things, on transactions costs in an economy. These are unconscionably high in India largely because of the bureaucracy which increases their number.
His starting point was the question that Ronald Coase, another Nobel winner, had asked in the 1950s: What’s the optimal number of transactions for a firm?
Williamson’s key insight was the cost of asymmetrical availability of information. “…when true underlying circumstances relevant to the transaction, or related set of transactions, are known to one or more parties but cannot be costlessly discerned by or displayed for others".
This is where the Indian bureaucracy comes in. It ignorantly imposes these costs not just on firms but on its employer, the government, also.
The Prime Minister therefore needs to ask the question Gabbar Singh asked: “Arrey o Babu, kitnay transactions hain re (How many transactions are there)?” If he can reduce these, efficiency will go up.
Modi, Alesina and Thomas Kuhn
If by following Williamson India can improve efficiency, by following Alesina it can improve equity. But there’s a cognition problem: Alesina’s conclusions run counter to received wisdom and like all good insights, they are also counter-intuitive.
In spite of his earlier work on inequality and growth Alesina showed, with all the data that was needed, that reduced government expenditure — except as relief during crises — actually led to better economic outcomes. But globally there are virtually no takers for this.
Alesina also showed how it is better to cut taxes to reflate the economy than to increase them to fund higher government expenditure.
Mr Modi who is in a tight spot fiscally, should pay heed if he wants to revive demand.
Meanwhile many economists with an eye on the main chance have chosen to encourage the politicians who are major beneficiaries of higher government expenditure.
These economists have ignored what they know: That all practitioners of bad policies look for intellectual validation.
India provides dozens of examples of this since 1971. The now defunct Planning Commission was, in fact, the maternity ward for these terrible ideas.
Thomas Kuhn was a philosopher who popularised the term “paradigm shift”. He wrote that “novelty emerges only with difficulty, manifested by resistance, against a background provided by expectation”.
He said there is always tension between the old and the new. This tension led to intellectual crises which were resolved in one of three following ways.
First, it was acknowledged that the existing body of knowledge was incapable of dealing with the crisis. Second, the crisis proved unsolvable and was stored for the future. Third, a new paradigm emerged, which, after the usual wrangle, replaced the older paradigm wholly.
The time has come for the last.