Friday, January 2, 2015

The Failed Reforms - The design of regulators

Regulators have been an important part of the reforms of the 1990s. One of Manmohan Singh’s earliest acts was to transfer the regulation of stock markets from the finance ministry to Sebi. This regulator, which had been set up in 1987 but given nothing to do, was suddenly woken up from slumber and loaded with considerable responsibility. The insurance regulator was appointed long before there was anything to regulate. TRAI was set up when licences were given to private telecom operators. More recently, the CERC has been set up to regulate the power industry; and as if one is not enough, every state is being cajoled into setting one up.

However, there are other, older regulators; the only reason why they are not recognized as such is because the term did not exist then. Reserve Bank is the oldest regulator. Set up in 1934, it was explicitly set up to manage currency and regulate banks. Comptroller and Auditor General is also a regulator: he is supposed to keep government accounting straight.

These old regulators were set up before 1950; the new ones have come up after 1990. Why was there such a long drought in the creation of regulators? The reason is that the executive arm of the government came to be conceived as a super-regulator. Thus, industrial licensing was introduced in 1956; it could have been given to a regulator. Instead, a ministry administered it. Import licensing too could have been treated as a regulatory function; instead, it was given to a Chief Controller of Imports and Exports. In fact, what is called a regulator today was called a controller by the British: there was and is a Controller of Drugs; and the Controller of Capital Issues was meant to be a regulator.

Thus, both the British and the Congress socialists freely confused regulation and administration; but their reasons for doing so were very different.

The British political theory was and is that government is the application of law to administrative decisions.  The decisions may be numerous and repetitive, and may not therefore require such elaborate procedures as employed in courts; but they must be taken in the same fashion as a court would. They must apply the law fairly, without regard to whom it is being applied to. The theory is that Parliament lays down the law and the government only applies it. There are, of course, exceptions to this mechanical application of law. In foreign policy, for instance, a government pursues national interest, and gives little weight to justice or precedent. In immigration policy, governments blatantly discriminate against particular types of immigrants. Taxation is levied on principles that have only a tenuous basis in fairness. These are the areas that are decided on the basis of majority. A party gets to power by virtue of majority in parliament, and takes such arbitrary decisions as long as it holds majority. Thus one can imagine a variety of administrative decisions involving law and discretion in different proportions. The entirely discretionary decisions would be taken by or in the name of a minister; a controller would take the entirely mechanical decisions. Where the line was drawn was arbitrary; but whether a minister took a decision or a controller, it was supposed to be taken in a judicial spirit.

The Congress socialists, on the other hand, absorbed regulators into the government because they believed in revolutionary justice. They thought it fit to punish British industrialists because they were British, and later, the big business houses because they had backed the wrong side in the struggle between Indira Gandhi and the old Congressmen. They thought it fit to favour those born in scheduled castes and tribes because the higher castes had been unjust to them. They denied licences to established importers because they indulged in sinful importing without doing any virtuous manufacture. Revolutionary justice aims at correcting historical injustice. But those to whom history was unjust are long dead; the compensation and the retribution are visited upon quite another set of people. And the quantum of either bears no relation to the historical injustice. Hence revolutionary justice creates fresh grievances and discredits the government that dispenses it. Its revolutionary rule discredited the Congress; people did not trust it any more.

That is why the Congress started appointing regulators – to give new policies a semblance of independence and objectivity. But appointing a regulator is not enough; a regulator has to be independent and objective. For this, three things are necessary.

First, the task of a regulator must be clearly defined. Elsewhere, regulators are set up in industries where competition is inadequate, and are expected by law and custom to mimic competition. In India there is no general commitment to competition. This is why the courts have allowed DoT and MTNL to ride herd over TRAI, and why the overriding aim of the insurance commissioner is to push up premia, on the excuse that insurance companies should be solvent; the fact that high premia reduce competition and help the government companies is incidental.

Second, the authority of a regulator should be commensurate to the task. In India, there are too many regulators, and they have been set up without proper division of territory. Thus Reserve Bank and Sebi fight over who is to regulate bonds; DCA holds on to powers which it cannot properly use and which were best given to Sebi. Having separate SERCs from CERC is a sure way to conflicting decisions.

Third, a regulator comes into being because the government cannot be trusted to be fair or objective; it comes about as a compromise between the party in power and the opposition. It is the function of the opposition to ensure the independence of the regulator. The house committees of US Congress routinely hold discussions with the chiefs of regulatory organizations; in India, the government does not permit it, and Parliamentarians do not ask for it. They are more interested in what benefits them than in what befits the country.

Fourth, a regulator must not be beholden to the government. This is almost never true of Indian regulators. They are almost all civil servants, active or retired. Either way they have expectations of the government; they expect extensions or further plum jobs. In Britain, the power regulator is a professor of economics; in America, the chief of SEBI is a financier. Regulators must be expert, not red.

Finally, the regulator must have powers of instant punishment. The SEC in US is all the time debarring brokers from business, or fining financial agents for misdemeanour. In India, powers of punishment and deterrence are inadequate and often ill defined, and few regulators use the powers they have.

Before we set up any more regulators, we should set up a commission to deliberate on a general enabling law covering all regulators, which would give them authority, autonomy and clear objectives, govern the appointment of regulators, and give them protection from government. We have far too many regulators doing too little regulation; this is a clear sign that the government does not know what regulators are for.

The Failed Reforms - The administration of law and justice

All Indian governments work badly because their systems of management have not kept up with the size of their task. But the legal system is the least satisfactory part of them. The public impression is different; the public would give much higher marks to the judiciary than to the administration or the legislatures. That is for a number of reasons. First, the common man comes into infrequent contact with the law; his impression of it is based largely on what he reads or hears. Second, the literate man or woman comes into even less frequent contact with the law; those whom the law punishes are overwhelmingly less educated, and their experiences never reach the media. Third, the media give far more attention to the Supreme Court, and next to it, to the High Courts; whereas they are only the tip of the iceberg. The bulk of justice is delivered by lower courts, whose standards never come up for public scrutiny. Finally, the bulk of the media are passive purveyors of news, and regurgitate what is fed to them by the government and business; although the judicial system mostly functions openly, it does not feed the media, which in turn neglect it.

When people like us get exercised over the law, it is usually over delays. Actually, they are perhaps the most tractable problem. Lord Wolfe dealt with it in great detail in his report on British court procedures in 1996; it gives an excellent starting point for tackling the problem. To give just the major features of a solution, the case load of every court must be computerized, similar cases should be bunched and heard together, and the rule of priority – of hearing the oldest case first – applied. Justice Ahmadi cut down delays massively in the Supreme Court by computerizing the case load; the same can be done in every court. It will also transfer the power of scheduling cases from registrars to the chief justices. Second, judges must decide and stick to schedules of hearings for each case; the litigants’ and their lawyers’ wishes should not govern the course of litigation. Third, time limits must be set down for the length of pleadings. The US Supreme Court generally gives half an hour to counsel on each side. more reliance must be placed on written submissions and less on oral pleadings. Fourth, court fees in civil cases must be fixed as a high percentage of the amount awarded in the verdict. Finally, judges need to get more assistance, in the form of legal clerks, libraries, computerized databases etc.

Far more important than delays is the uncertain caliber of players. Lawyers earn far more than bureaucrats – including those in the law ministries – and judges; so those who have the choice would rather become lawyers, and the law ministries as well as the judicial service tend to receive more of those who would not be successful lawyers. That does not necessarily make them incompetent lawmakers; but they would be recruited from a wider field if their incomes were comparable to those of lawyers. For that reason, I think that judges’ salaries should be decoupled from those of the bureaucracy, and that courts should be financed from a certain proportional tax on the earnings of the lawyers that appear before them, such that judges’ incomes can be made comparable to those of lawyers. The law ministries should be manned by well known lawyers employed on fixed contract – rather as the advocates general and the attorney general are now – and should not have a permanent civil service at all. And finally, certain services in which law is important – for instance, the police service and the revenue services – should be manned by bureaucrats qualified in law, and their salaries related to that of the judicial service. They should invite penalties for misapplication of law. If, for instance, a police officer acts in disregard of the law, or a revenue officer makes levies that are overturned by two tiers of courts, they should face demotion.

So much for the caliber of the judicial and legal bureaucracy. But ultimately the law is made by legislators. One only has to visit any Indian legislature to see how few legislators are qualified to understand the laws they are making. Whenever legislation is being debated, attendance is less than 5 per cent of the strength of the house, and the speeches of those 5 per cent little reflect the legal implications of what they are discussing. This is a general problem with legislatures. After all, they are supposed to comprise the elected representatives of the people; skills or academic qualifications hardly come into the picture.

Countries try in different ways to make up for this lacuna. Much of the burden of legislation in the US is carried by the Senate, which has a fair proportion of lawyers and other qualified people. All the members of Congress get general allowances to engage staff and consult professionals. And finally, Congress has its own staff to formulate and vet laws, separately from the executive. In Britain, legislation goes through Select Committees, which comprise the more qualified and interested MPs, and which can engage and consult experts. Throughout the process of law-making, the MPs are helped by the Lord Chancellor’s office; although the Lord Chancellor himself is a politically appointed minister, he is almost always a lawyer, and has a qualified permanent staff of draftsmen. In India, the replacement of indifferent civil servants by lawyers taken on contract into the law ministry would help. But ultimately the solution is to elect some of the MPs on a new basis – either on the basis of a vote given to income tax payers in proportion to the tax they pay, or on the basis of minimum professional qualifications.

The Law Commission is quite wasted in the present context. It is generally headed by a retired judge of the Supreme Court and manned by equally venerable colleagues, it works on laws for years and years, and then its work is forgotten. It would be a great improvement if it were directly associated with Parliament, and had the power both to vet all legislation brought before Parliament and suo moto to take to Parliament any other legislation, including amendments to aged laws.

The Bharatiya Janata Party is keen on a review of the Constitution. The motives are infamous: some want to ensure that once it forms government, it should be impossible to vote the BJP out of power, whereas others want to disqualify Sonia Gandhi. But the idea is unexceptionable. Instead of targeting the Constitution straightaway, it would be advisable to set up four commissions to probe why the law functions so poorly in India, and how its functioning can be improved. One of the commissions would work on the Constitutions, another on legislatures, a third on the quality of the civil service, and a last one on judicial appointments and court procedures. The proceedings of the four commissions should feed into one another, to the benefit of them all. That is the way to develop a robust solution to our legal problems.

The Failed Reforms - Geographical ailments

Large states contain diverse populations and have trouble in integrating them, some more than others. The US has been the most successful; the USSR was such a failure that it split up. The US and Brazil are constructed of immigrant stock, which they have drawn from relative narrow confines of Europe, and on which they have imposed a single culture drawn from British and Portuguese roots respectively. China has similarly tried to integrate its several “nationalities” into the dominant Han culture. India is far less integrated than any other large nation. Its linguistic, religious and caste groups retain greater differentiation; the Indian fabric is woven distinctly looser.

It was first torn by linguistic tensions. Nehru was initially inclined to leave the states as the multilingual entities that had accidentally emerged under the British, and to use English as the binding medium. But the Samyukta Maharashtra agitation negated his plans. Finally the suicide of Potti Sriramulu forced the formation of linguistic states.

The linguistic states have been extremely unfair to tribes; in Gujarat, Madhya Pradesh, Bihar, Orissa, Andhra and West Bengal, the tribals have been largely excluded from power and reduced to serfdom. Those near the borders, however, were able to acquire arms and stage violent revolts. Agitations continue in Jharkhand and Telengana. The Bhils have forborn for long. But if the Bajrang Dal has its way in Gujarat, a Bhil revolt is inevitable.

The rulers’ formula has been to suppress these movements as long as possible, and when suppression no longer works, to concede a state. Mrs Gandhi conceded states to every major tribe in the northeast. (The Kashmiris, who are different enough from the Indian Bhadralok to constitute a tribe, came to India with their own state.) The central government gives these peripheral states liberal aid. An elite group intercepts much of it. Where that group distributes the aid wisely, it manages to keep peace in its state; where the rulers are too greedy as in Kashmir, insurgency resurfaces. In either case, the state remains undeveloped, and the gap between it and mainstream India progressively widens. This will also be the fate of any new states that the BJP may now choose to create, such as Jharkhand and Uttarakhand.
India has border problems and tribal problems; but since these peripheral populations are small, it has been possible to keep the problems from boiling over except in Kashmir. Still, the feeling of alienation and discrimination is very strong– even in Assam and Manipur, whose populations are better integrated into the mainstream. Tribals have been poorly served by the linguistic states, and every concentration of tribals is a powder keg.

But the problem they pose is trivial compared to the rift that has emerged in mainstream India. Even during the days of socialism, western India developed much faster than the rest; Gujarat, for instance, which was poorer than West Bengal at the time of independence, is vastly more prosperous today. But the schism began to widen much faster in the 1990s. Once industrial licensing was removed, even the industry that was forcibly located in the east did not have to go there; and with the liberalization of foreign trade, the maritime states did much better than the inland states.

Thus the geographical configuration of advanced and backward states is changing. Earlier, Gujarat and Maharashtra were way ahead in the west, and Punjab and Haryana were far ahead in the north. Now states are competing for investment. Of them, Karnataka has become the home of the new industries, and Tamil Nadu has pulled up after Jayalalitha left. Chandrababu Naidu may still manage to retrieve Andhra Pradesh. Rajasthan and Delhi also have attracted sizeable investment. But Madhya Pradesh, the north and the northeast have done miserably; their poor performance is beginning to show in deteriorating law and order, which will make them even less attractive for investment. It is no longer the cow belt vs the rest; it is more the maritime states vs the rest. If the rift continues to widen, it will tear India apart.

The BJP is, in a sense, the only nationalist party today; as such, it has an approach to these problems. Its answer is Sanskritization. Its politicians take oath in Parliament in Sanskrit, and speak only in pidgin Sanskrit. I see the Prime Minister’s east-west and north-south highways as another attempt to unify India. Forcible cultural homogenization has been tried elsewhere. It succeeded in China; but the sinification of China took centuries, if not millennia, and nowadays, proselytizers such as the Hindu joint family do not get even decades to accomplish their work. It failed in the Soviet Union with dire results; today the nationalities unified centuries ago by the Czars are separate, but have inherited economies that cannot survive separately. It worked in the US and Brazil, but these nations have been artificially forged out of settlers by selective immigration and unilingual schooling.

It would be far less wasteful of national energies, far less divisive, far less violent, to preserve and encourage the diversity that we have in India. The present states have failed to serve the geographical minorities; we should have far more states – 50 or 100. The smaller the states, the more interdependent they will be. A state should consist of a large town surrounded by its hinterland; every city in India should become a state. In the process, suppressed languages and tribes will find new expression.

All barriers that obstruct the movement of goods and people between such states should be banned, including differences in commodity taxation, different regimes for alcohol, sugar or cigarettes, and roadside checkposts. In particular, no state should be allowed to impose the language of instruction within its boundaries; any minority should have the right to be educated in the language of its choice, including Japanese or Swahili.

The growing rift between the maritime states and the inland states is due to excessively high transport costs. Today it is cheaper to import granite into Bombay from Italy rather than from Rajasthan, or to import wheat for southern millers than to bring it from Punjab. Removal of state-imposed barriers will bring down transport costs. But to reduce them significantly, two things are necessary. First, railways should be taken out of the hands of ministers like Jaffer Sharief, Ram Vilas Paswan or Mamata Banerjee, and privatized, and three-quarters of its work force should be given a VRS. Railways need massive investment to move larger volumes of goods, and they will attract it only if their flab is cut and they are made profitable. Second, the existing roads should be repaired, widened, straightened out, and fenced to keep out jaywalkers, cattle and buffalo carts. Highways are just like railway tracks; they serve much better if access to them is restricted. And finally, all agricultural price support should be removed, especially support for wheat, rice and cane prices; if the north and the east produce these more cheaply, they will sell more of them to the south and the rest of the world.

The Failed Reforms - Reforming government enterprises

The bureaucracy defeated the reforms of the 1990s. By the bureaucracy I do not mean, not the Indian Administrative Service, but the 4 million minions who run the machinery at the centre, in the states, in municipalities and in public enterprises. Of this bureaucracy, the majority is today employed by productive enterprises, both departmental and corporate. Those are the ones I want to deal with in this article.

But that was only the latest and most famous instance; the bureaucracy has won many more battles. The biggest is the one over telecommunications. As telephone users will testify, low-level corruption is rampant in the telephone services. The earnings of corruption would disappear if there were competition; so the Department of Telecommunications and its daughters have fought a dirty battle to prevent competitors from emerging, and when they emerged, from succeeding. When the politicians decided to introduce private operators, the DoT ensured that their number would be the smallest possible. Then the DoT enlisted MPs – including those of BJP – to argue that the interest of the government lay in extracting the highest licensing fees from private operators – which meant from their customers. They extracted such a high price that it took the operators five years of politicking, at who knows what price, to have the regime changed to revenue sharing. And even then the DoT fought in courts till the end. It defied with impunity the one institution that could have ensured a level playing, namely Telecommunications Regulatory Authority of India. Any bureaucracy that wants to protect its turf has much to learn from DoT.

In 1992, when Manmohan Singh decided to license new banks, bank staff and workmen organized lightning strikes. They never go on a protracted strike, for that might invite retaliation. They always strike one or two days at a time; that way they maximize incovenience to the public at minimum cost to themselves. Thanks to their pressure, Reserve Bank issued only a handful of new bank licences, many of them to institutions within the government family; it just filed the rest of the applications, and continues to sit on them till now. This sequence is about to be repeated in insurance. After deliberating for seven years, the government piloted a bill making it possible to introduce private competitors in insurance. Immediately the staff of LIC and GIC threatened to go on strike. To pacify them and protect their portly employers, the BJP government has ensured that foreign insurance companies, the only companies with any experience, can have only a 26 per cent stake in Indian companies; they will each have an inexperienced Indian gatekeeper to usher them in and share in their profits, exactly as in telecommunications. And the insurance regulator will do the rest: he will keep up the premiums so that LIC and GIC may not be hurt too much, and he will limit the number of new competitors to the minimum.

We bear these excesses in silence lest we might be victimized. But the cost is enormous. Government enterprises have high costs both because they use more resources than necessary to produce whatever they do, and because their employees cost more than their value in a competitive market. Although the top salaries in government enterprises are below those in the private sector, the average wages are considerably higher than in comparable jobs in the private sector.

The standard solution offered to the tyranny of public enterprises is to privatize them. But this has proved virtually impossible in India, for three reasons. First, the opposition of employees. They find their present condition enviable – they have lifetime jobs with no obligation to deliver. They prevent any adverse change in it. Second, the absence of a market for public enterprises. Many of them could fetch very high prices – provided their fat could be removed. It is a matter of religious faith with our politicians that no one should be dismissed; so no one can be removed, and the value in the enterprises cannot be unlocked. Even if it could, our labour laws would make it very expensive to persuade surplus staff to leave. The government has chosen the worst alternative of voluntary separations; these are not only expensive, but they get rid of precisely the best employees, who have the greatest value to the enterprise. And finally, the nexus between bureaucrats and politicians. The big corporations – for instance the DoT, or the oil corporations – can easily befriend 50 or 100 MPs, and use them to block any changes they do not like. Unless we clean up politics, we can never clean up the bureaucracy.

Employees are a liability to a greater or lesser extent in all government enterprises; if they are to be privatized, this liability must be taken off their books. If the BJP is serious about privatization, it would have to separate the enterprises to be sold from the employees. For each enterprise it should pass a privatization bill. It would stipulate that the enterprise would be sold without its employees. Those employees whom the buyer retains beyond one year would get no compensation; in that year they would be expected to work out employment conditions with the new owner, or leave and be compensated. The compensation should be such that it would give the younger employees enough time to seek new careers, and old employees enough to retire on – it would vary between a year’s and eight years’ wages. The enterprise would go to the highest bidder, who would be free to strip it and sell it off piece by piece if he wants. Most would be kept as going enterprises, but by allowing them to be stripped, the government would be maximizing their sale value, and hence the difference between it and the liability to workers.

This is the way to remove the millstone of manpower from the neck of a potential buyer of a government enterprise. But there is one more millstone in the case of government financial enterprises, such as the financial institutions and banks – namely, bad debts. The principle to follow in their case is the same as in the case of employees; they should be taken off the institutions books before selling them. But whereas employee compensation can be laid down in advance, the value of bad debts cannot: it depends partly on the effort made to collect them. The buyer should be given some time – a year to three years after purchase – to ascertain the quality of loans. The price of the bank should be fixed at the end of the period, and the value of the assets found bad by the buyer should be deducted from it.

In every case, the object should be to maximize the sale value of the enterprise. That sale value depends on what the buyer can do with it; hence the aim should be to remove the constraints on what he can do. Unwilling labour and bad debts are the major such constraints; but there may be others. Whatever they are, the government must unbundled the enterprises and remove their historical encumbrances, so that their essential value can be realized.

The Failed Reforms - Reforming the bureaucracy

In the last article I mentioned the uneasy relationship between the BJP ministers and the civil servants. This goes back to the root of our administrative system. In all countries other than the United States, the bureaucracy came before representatives of the people. All organized states right into the eighteenth century were monarchies. Monarchs needed a bureaucracy to collect taxes, to fight wars and to maintain order; but they did not need democracy. Democracy was forced upon them; and even then, the first parliaments represented particularly influential subjects, such as army commanders, landlords and merchants. These parliaments were consultative, not decision-making bodies. They enabled the monarchs to judge the degree of support or resistance their plans might face, and sometimes let some people let off steam.

That system was first overturned in the United States, where the settlers said that they could not be taxed by the British king without being represented, and won the point. So it came about that the representatives wrote into the  US Constitution that they would approve most administrative decisions, and not only be consulted. That is how they approve appointments of senior civil servants, import restrictions, health care regulations, treaties with foreign countries, etc etc.

India inherited the British system, in which the Viceroy in Council decided everything. It was a monarchical – a viceregal - system. The British had envisaged only a consultative role for elected representatives; and they represented influential subjects, such as property holders, rather than “the people”. So when popular government was elected after independence, the politician ministers had little to do. Nehru used habitually to deal with secretaries of ministries instead of ministers, and to admonish ministers who “interfered” in the administration. That was the administration to which Appleby  gave such high marks in the early 1950s.

That is all past now. Today, ministers routinely manipulate the appointments and transfer of civil servants, and thereby control them. They have thereby created a docile and compliant civil service. One of my most vivid impressions of my time in the government is how civil servants sat watching their minister in meetings, guessing what the minister wanted, not uttering a word until they knew the minister’s mind, working out how each minister could be handled. Most ministers had simple agendas: for instance, “Push up agricultural support prices,” or “Get the central government to take over the bankrupt mills nationalized by the Maharashtra government,” or “Make the banks give loans to Jat farmers”, or “Give favourites licences to set up petrol pumps”. The civil servants satisfied the ministers’ agenda and made them happy; in return, the ministers let the civil servants run their rackets. Both exploited and cheated the people.

As long as the ministers have the powers of appointment and transfer of civil servants, you cannot get a clean civil service without a clean political system; that is why I devoted the last article to the cleaning up of politics. But clean politicians by themselves will not lead to a clean bureaucracy; for that a number of other things are necessary: exit of the state from commercial activity, rule of law instead of rule of functionaries, a reward system for bureaucrats based on honesty and competence instead of pliability, and easy entry and exit from the civil service based on performance.

The government needs to go out of commercial activity – production and trading – because law, in the sense of rules based on some concept of justice, is inapplicable there. In these activities, competition is good for consumers. In competition, some businesses will prosper, some will suffer; some people will get jobs, some will lose them; some will get orders, other will not. These decisions will be driven by costs and profits. If ideas of justice derived from government are applied to competing businesses, weird results follow. The solution is not to let government businesses flout rules of justice derived from administration; it is for government not to be in business at all. I shall elaborate this further in the next article.

The function of law is to constrain the executive: to limit its discretion and compel it to serve the guiding principles of the state. But language is a highly flexible instrument; it can be used to create discretion as much as to restrain it. In the British system that we follow, the bureaucracy has considerable power to create law; typically, the legislature passes only an enabling law, leaving it to the government to make “rules”. This power is systematically misused; the bureaucracy makes masses of rules that are vague, non-transparent, and inconsistent with the guiding principles, and uses them to harass the people. These rules are tabled in legislatures, but politicians are too ill educated to read them, let alone understand them. In France, the judiciary is closely woven into the bureaucracy, and participates in the formulation of rules, which thus have a strong judicial basis. In the US, Congressmen are backed by strong secretariats, and many, especially in the Senate, are highly trained; they write into laws much that in India would go into rules. In India, the legislatures are incompetent for vetting the rules, or even the laws; we need judicial commissions to go through all laws and rules, make them transparent and consistent with the principles of justice, publish them, and weed out junk. Legislation should be initiated by these judicial commissions, and should go to legislatures only for approval.

The British gave permanent jobs to civil servants in the expectation that they would thus be made less susceptible to politicians’ whims. But politicians have found in promotions and transfers the whip to bend the bureaucracy to their will. In the process they have destroyed the bureaucracy as an organization; its command consists of sycophants, and its troops are ill trained. If this is to be changed, the government’s labour force needs to be tailored to the work done, and its choice, promotion and dismissal need to be related to performance. The present non-gazetted staff should be replaced by young persons under the age of 30 who would serve on short-term, non-renewable contracts, the present gazetted staff or senior officers should be replaced by people selected by examination from the non-gazetted staff on renewable contracts of 5-10 years, and the present records need to be completely computerized. With these changes, it would be possible to get rid of babus before they become corrupt or useless, the number of superior officers can be cut down to the work to be done, and the work itself considerably cut down once files are abolished. Movement of files is an extremely poor way of administration; it immobilizes information in nonretrievable forms and makes it unavailable to most people who need it most of the time. Private businesses are rapidly moving from paper-based systems to intranets and electronic information systems. So are many governments. For India, which boasts of a world class IT industry, the changeover should be particularly easy.

The Failed Reforms - Reforming the political establishment

The last BJP government handled the civil service with great lack of success. It came to power with considerable sympathy within the civil service; it has more or less won over the middle class, of which the civil service was a part. But the relations between ministers and senior civil servants deteriorated rapidly, and the politicians handled the conflicts crudely; in the end, the average civil servant was no fonder of the BJP ministers than of their predecessors. Instances of conflicts are well known. In the Bhagwat case, George Fernandes was at least guilty of overreaction, and the suspicion that he acted out of unhealthy political considerations was never removed. Ram Jethmalani’s conflict with his secretary was largely the result of his intemperate behaviour. And the removal of Vijay Kelkar, soon after he delivered a first-class budget, remains an unexplained mystery.

With the wilful changes in secretaries, the BJP has brought to the centre a practice which was confined to the states till recently. There the chief minister moves about civil servants as he likes. The practice is a bit more orderly in better run states like Gujarat and Maharashtra, whereas arbitrariness rules the roost in the northern states. The manipulation of civil servants’ careers to make them malleable is bad for both politics and administration. Politically, it concentrates power in the chief minister and his favourites. As a result, too many people want to become chief ministers; the Congress at one time ran a game of musical chairs in the states to accommodate aspirants. Still, not every one can be accommodated; so ambitious politicians split away from the major parties; this is how the welter of parties has been created. Thus the roots of political instability are to be found in the fact that politicians exercise powers that are not theirs by manipulating civil servants’ appointment. Some chief ministers buy stability by decentralizing the power to move civil servants; in MP, for instance, even MLAs have the power to select district collectors. This only results in collectors who do not administer, but instead concentrate on pleasing politicians.

On the other side, the practice of moving about civil servants at will brings to the top civil servants whose only qualification is malleability; they command no respect in the bureaucratic hierarchy, and hence cannot be effective. The point of having a hierarchy is to make large numbers of employees subject to commands from the top; but where the top officials do not command respect or authority, the hierarchy does not function. The objectives of such a bureaucrat become schizophrenic: he wants to last out his time without getting into trouble, and tries to use the time for personal advantage. Thus malleable civil servants are more often corrupt and cautious. Politicians’ selection of civil servants for senior posts, and their interference in selection and promotion processes, have been the major causes of administrative deterioration.

One only has to apply this to the police to see why law and order is so unsatisfactory. The BJP got enormous bad publicity for attacks on Christians. Its involvement in many of the events is unclear and doubtful. But the fact is that the police in India today are virtually incapable of catching criminals and taking their prosecution to the correct conclusion. Vast amounts of criminal litigation go on with very little result. The bending of the police to politicians’ will has destroyed their effectiveness.

The same goes for the developmental bureaucracy; whether it be in education, health care, transport or energy, the government achieves so little development with so much expenditure. Large parts of the bureaucracy are driven by short-term, personal objectives; and the politicians who control or influence appointments to critical posts often share in their spoils. The result is that much development expenditure disappears in the enrichment of contractors, bureaucrats and politicians; little is actually translated into real development.

This was a bit less true of the central government than of state governments. The last BJP government brought the centre slightly closer to the abysmal state practice. If it is interested in good government, and in being reelected for good government, it should be thinking of reforms in two directions – political and bureaucratic. Of the two, political reform must come first, for without honest politicians, an honest bureaucracy is impossible, and without competent politicians, bureaucrats cannot be controlled.

If politics is to be cleaned up, two things are necessary. First, the parties must be so well funded that they can employ politicians; and second, the only way to success for politicians should be through a rise up party bureaucracies. In India, parties have so little money that they pay their employees a pittance; at election time they hunt around for candidates who can win – and those are politicians who have money or muscle of their own. In this way, corrupt politicians dominate parties.

Most politicians become rich by misusing state power. The point of privatization and liberalization is reduce opportunities for such self-enrichment. But generally, politicians cannot be corrupt on their own; they need the cooperation of bureaucrats, who share in the booty. Their resistance has defeated reforms in India; before reforms can come, a way must be found to strengthen parties vis-à-vis politicians, and to strengthen party finances.

I believe the way to do this is to go over to proportional representation based on the list system. This arrangement confines competition to parties; individuals cannot win unless they get into the list put up by a party. Proportional representation is supposed to be less conducive to the emergence of majorities in legislatures than our present first-past-the-post system. But the present system has in fact failed for over a decade to produce decisive majorities; in our circumstances, proportional representation will not produce less decisive results. And proportional representation can be made to produce decisive results by putting a cut-off point below which parties would get no seats. It is 5 per cent of the vote in Germany; the higher it is fixed, the greater the likelihood of a decisive majority. If the threshold is 1/3, there will be at most two parties; if it is ½, there will be only one party.

Reform of the electoral system will go far towards solving the funding problem. For people give money to parties that have a chance of winning. But if that is not enough, parties should be funded out of state funds in proportion to their votes. The funding should be generous enough to enable them to maintain bureaucratic establishments down to the district level at all times.

The greatest benefit of PR is that it will bring up politicians who have a nationwide or statewide reputation. At present a politician has to have a hold on a single constituency to become a player – just pour state resources into the constituency, or get jobs for his constituents. This is how a Laloo or a Jayalalitha gets elected, which is the first step to becoming a leader. PR would devalue money and patronage, and favour ideology and achievement . 

The Failed Reforms - External Economic Policy

To recall what I wrote last week on foreign policy, economic policy must govern foreign policy, its aim should be to increase flows of foreign trade and investment, especially with neighbouring countries, and we should stop being touchy, ill-manned and ill-tempered in our relations with other countries and interfering in matters that do not concern us. Today I want to spell out what this means in terms of external economic policy.

Foreign trade is the way to expand the market available to Indian goods beyond the Indian market. The world market is about thirty times as large as the Indian market; if India can produce anything more cheaply than others, exports can give it a far larger market than home sales. It is with exports that country after country has transformed itself and become a world power – Holland, Britain, Germany, Japan, and most recently, China. It is India’s general failure as an exporter that has set it back.

A country will be able to export only if it imports; countries export value added, not goods or services. A free import regime is good for exports. It is also good for consumers. Some producers, those who are afraid of foreign competition, will think otherwise; and they will always find politicians whom they can bribe to take their side. This is the BJP’s greatest economic weakness. It is close to industrialists, and in its one year’s rule, it has yielded repeatedly to pressure from high-cost producers for protection.

Commodity-wise protection is wrong: it favours some commodities against others, some producers against others, and producers against consumers; it is the outcome of an unholy alliance between certain producers and certain politicians. There will be times when protection to producers must be increased, for instance when the majority of them are in trouble. But such protection should be extended in such a way that it does not favour one producer against another. There are only two ways of doing it: either by putting a uniform import duty on all imports, or by devaluing the currency.

Import duties discriminate against value-added exports. They raise the cost of imports above what producers in countries with lower duties pay, and handicap our exporters against their competitors in other countries. Our import duties have always been high; despite the considerable reduction in the 1990s, they continue to be high. This is why the range of India’s exports has remained so narrow despite import liberalization. Gems remain our largest export because their value is high and difficult to estimate, so underinvoicing and overinvoicing are easy. Textiles are exported because export restrictions keep domestic cotton cheap. Most other exports are made out of indigenous inputs; true value-added exports are small. China, whose exports were no higher than ours 20 years ago, exports six times as much as us today; it exports the widest range of consumer goods to industrial countries. The reason is that it imports raw materials, adds value to them and exports them.

To make this possible, we have various arrangements like advance licensing, duty drawback and the passbook scheme. But they have done little to diversify exports. They are available only to exporters of goods whose input-output norms have been worked out by the DGFT and approved by the Customs. The rigmarole of doing so is just too great for exporters of new goods. And the corruption in the two departments hampers exports of even those goods with approved input-output norms. Today, these two departments are the biggest obstacle to exports.

This is why I advocate that import duties should be brought down to zero; if there are no import duties, no duty drawback will be necessary. To make duty reductions painless, the rupee should be devalued at the same time. This was the device tried in the early 1990s; it doubled exports. It can be tried again with even greater results. The finance minister should over the next three years reduce the maximum import duty to 30, 20 and 10 per cent respectively, and adjust the exchange rate so as to protect industry. Import licensing has to be dismantled by 2001 anyway; and if the maximum duty is reduced to 10 per cent or less, advance licensing will become largely unnecessary.

Another vexatious barrier to trade is the multiplication of import and excise duties. For instance, if a product bears an import duty of 40 per cent and an excise duty of 40 per cent, its imports are taxed at the rate of 98 per cent. This multiplication is quite unnecessary; it is far simpler to simply add the two duties to 80 per cent.

Another matter on which the BJP and Indian industrialists have conspired together is foreign direct investment; under their dual influence, the policy on foreign investment has become so arbitrary and complicated that direct investment is negligible. After the reforms of 1991, Indian industrialists had rushed abroad welcoming foreign investors. But they wanted foreign companies to come in as partners. But earlier, foreign companies preferred joint ventures because it was easier to get industrial licences for them than for subsidiaries, and because import licensing made producing in India full of indigenization hassles best left to Indian partners. With the removal of industrial and import licensing, foreign companies no longer need gatekeepers, and prefer to set up subsidiaries. Under the influence of the erstwhile gatekeepers, the BJP has instituted a highly non-transparent policy to make foreign investors take on Indian partners.

Foreign subsidiaries do not only create competition for domestic producers; they also create jobs for Indian workers, and markets for Indian suppliers. Not all Indian producers are afraid of foreign competition; there are some, like Reliance and Telco, who welcome it. But there are terrified producers and they have political influence; the workers and the suppliers do not come into existence  and cannot have political influence unless the subsidiaries are allowed.
It is unrealistic to ignore the domestic producers’ influence; at the same time, to give them veto over the entry of foreign competitors would be arbitrary and against consumer interest. What is needed is a transparent policy devoid of ministerial discretion. A number of alternatives are available; they are not mutually exclusive.

One is to make foreign companies announce their intention to set up a subsidiary, and to allow them to do so three years after the announcement. In this way, their Indian competitors will have three years to prepare for the competition. The other is to let them set up subsidiaries as companies registered in India with a minimum 40 per cent of the capital held by Indian investors or by mutual funds investing in such subsidiaries; that will give Indians a share in their success – or failure. A third alternative is to exempt such subsidiaries from restrictions provided that at least 40 per cent of the capital is held by nonresident Indians. These are not the only options; the BJP can work out its own. The important thing is to remove discretion and arbitrariness from its policies, for it can only bring the party a bad name.