This belief was unshakeable despite the foolhardiness of demonetisation and shoddy implementation of the goods and services tax — two moves that wrecked the supply chain and hollowed out the economy. Even then, just before the Budget in July, the market hit an all-time high, as investors looked for a ground-breaking Budget. After all, Mr Modi had created history by winning a massive popular mandate for a second successive time and nothing stopped him from unleashing “big-bang reforms”.
The reality was different. Over the past few months, every economic indicator is flashing red. Rising unemployment, poor export growth, punitive taxes, tax terrorism, an imploding public sector, collapse in the GDP growth rate to 5 per cent (3.5 per cent according to the old calculations) in the first quarter, auto sales at a 20-year low, no manufacturing growth, and crisis in financial services and banking. All these added up to an alarming situation, which even die-hard fans of the government could not ignore. But just when all seemed lost, the government announced huge tax cuts and the belief in Mr Modi was restored. We are now expectantly waiting for the next round of big-bang reforms.
What could these reforms be? Economic success stories from around the world clearly tell us what works. Balanced, continuous, and equitable growth flows from higher productivity of land, labour, and capital. Experience from around the world shows that higher productivity can be delivered by two important engines: One, a true market economy, which offers both incentives and competition to economic agents. This leads to low and steady prices, which, in turn, boost consumption and investment; two, a regulatory, governance and justice system that encourages good guys and penalises the bad buys. There is no other proven method of durable economic progress. The much-hailed liberalisation of the early 1990s failed to fire either of the two engines, which is why we had corruption, bad loans, and inflation, from which the economy took a decade to recover. The later regimes made it worse by adding large doses of crony capitalism.
If the recent tax cuts flowed from a well-articulated overarching framework described above, it would have been transformative. There is no such framework. For the engine of incentives and competition to fire, we need ease of entry and exit for all businesses. We don’t have it. Dozens of permissions, some mindless, are required to start a business; running it involves large frictional costs, including bribes and extortion, and shutting it down is equally tough. Land acquisition remains a big thorny issue.
The governance, regulatory, and justice system is no better. The continuous failure of the central bank to supervise banks and finance companies, the bumbling of sectoral regulators across infrastructure, and the extortive attitude of revenue authorities are inimical to a market economy, leading to enormous waste of time and resources. The government is the largest litigant. Hidden from the public eye are ills of the tendering system for government projects, which leads to terrible productivity, enormous corruption, and decrepit public services.
Tax cuts did not flow from an overall plan to change this system. Welcome as they are, they are a knee-jerk action. The fact is, various markers of the economy today are worse than in late 2013, when a despondent India, tired of corruption, crony capitalism, and policy paralysis pinned its hopes and faith in Mr Modi. If the tax cuts were part of an economic philosophy, they would have been at least part of the last Budget. Indeed, the impact of the tax cuts, an afterthought, is so deep that it has turned the Budget upside down and there is no clarity on how it will boost demand through greater consumption.
The fact that the tax cuts were announced at the end of a series of six press conferences that started in late August, after the insipid and forgettable July Budget, shows that it was a panic reaction to the 3.5 per cent ... sorry, 5 per cent GDP growth. We can only hope that the government has finally “got it” and will stay focused on improving productivity, demand, and governance. If not, that extrapolation of the tax cuts to big-bang reforms will be a false expectation that will quickly peter out.