The Paradox of Institutions in India

by Arvind Subramanian, Peterson Institute for International Economics

Op-ed in Business Standard, New Delhi
April 16, 2007

© Business Standard


The tepid-to-torrid transformation in India’s economic growth since 1980 is a big story of recent times. But how are India’s institutions faring in the light of this transformation?

While the popular perception in India is one of institutional decline, caution is warranted, in part because India’s sheer size and heterogeneity defy easy attempts at generalization. As Joan Robinson famously noted everything and its opposite are guaranteed to be true in India.

To be sure, not all signs point to institutional decline. Certain referee institutions, especially the Supreme Court, the Election Commission, and the Presidency have witnessed rejuvenation. Further, some of the new institutions such as TRAI, SEBI, and IDRA have performed very respectably, especially considering the novelty of the terrain they have had to navigate. The RBI’s record in maintaining price stability has been exemplary.

But concerns endure about key institutions--politics, judiciary, bureaucracy, and police—that are vital for a market-based economy to flourish. Law and order is a serious concern, as one in every four districts is home to armed insurgent activity. In state courts, there is a growing backlog of unresolved cases. Weak delivery of essential public services, especially in health, education, and water, is endemic. An illustrative statistic is provided by the tripling of losses in electricity transmission and distribution to 27 percent between 1971 and the early 2000s, reflecting weak governance at the state level.

Overall, the accountability of core public institutions, especially the political process, tends to be weak and episodic. Democracy does allow a blunt form of accountability—removing incumbents from electoral office—to be exercised at election time. But accountability as threaded into the fabric of daily life remains elusive.

We see rapid economic growth alongside institutional stagnation. This juxtaposition leads to two paradoxes. First, why has growth been accelerating despite institutional stagnation? The second, and deeper, paradox is the mirror image of the first: why, despite 25 years of rapid growth, have institutions not improved perceptibly? Consider each in turn.

The conventional view now is that growth owes to the policy reforms begun in the early 1980s which reined in the over-regulating, out-of-control state, thereby unleashing the energy of the private sector. But this cannot be a sufficient explanation, and an international comparison illustrates why. Like India, many countries in Latin America and sub-Saharan Africa have also implemented policy reforms, sometimes broader and deeper than those in India. Yet the growth response in these countries has been feeble compared to India’s. What explains this contrast? One answer is that India’s institutions, built up through the decades preceding independence, created the conditions for the rapid growth, so that even the relatively modest policy reforms favoring the private sector was an adequate trigger. Our legacy was so good as to provide India with considerable institutional slack. But are we fast using up this slack?

This question naturally leads to the second paradox. As countries grow, political and economic institutions tend to improve. As people become richer, they demand more from their public institutions—better public services, more security and law and order, and greater political participation. But in India, average incomes have risen fourfold and yet institutions may not have improved. Why?

Indeed, this puzzle deepens because over this period India has witnessed a number of developments that should have improved institutions: greater transparency with the explosion in the quality and quantity of the media; the progressive dismantling of the license-quota-permit raj which fostered corruption and patronage; the rise of civil society as a vibrantly assertive presence, striving to hold public institutions and officials accountable; and the unleashing of the dynamic of competition between states, allowing citizens in lagging states to question why they cannot expect the same standards of public institutions and public service delivery as in the more progressive states.

There are many possible explanations to this puzzle. Although growth has accelerated and poverty has declined substantially, divergences have also increased. Some regions and groups have partaken only minimally, if at all, of the fruits of economic growth. It is no coincidence that Naxalite activity is strongest in the tribal belt spread across central and eastern India, feeding on the fertile climate of alienation and disenfranchisement.

Unequal growth also has subtler effects on institutions. If growth is more concentrated at the upper ends of the income spectrum, there is the distinct possibility of “exit”: the rich and influential opt out of the public system, turning to the private sector for essential services, instead of lending their voices to calls for improvement. Examples of such opting out include gated communities with private policing and households with private power generators.

Another contributing factor is the increasing inability of the public sector to attract talent. This too has deeper causes, but clearly one of them is the very rise of the private sector. The unprecedented level of remuneration that the new economy is showering on skilled people is skewing the allocation of talent away from public institutions.

What do these two paradoxes imply for a future reform agenda? Indian policy makers are being nagged to refurbish India’s creaking infrastructure, reform its stifling labor laws, and lift barriers to foreign investment. Underlying these calls is the view that the public sector is the problem and the private sector the solution, and that the policy challenge ahead calls for merely rolling back the frontiers of the state and allowing greater freedom for the private sector. This view is understandable given India’s dirigiste past; it is also constructive because it allows for new private-sector-based solutions to be explored and found in areas such as basic and higher education that have hitherto been the public sector’s exclusive responsibility; but it is also incomplete because it fails to recognize the limits to private sector action. Yes, India needs less government but it also needs much better government in key areas.

Neglecting institutional reform is tempting because institutions are notoriously difficult to change. How does one even think of reforming the Indian bureaucracy or police or judiciary? A starting point has to be the recognition that allowing institutional decline could well come back to haunt even the private sector, whose fortunes depend crucially on effective public institutions. Rehabilitating the institutions bequeathed by Mahatma Gandhi, Pandit Nehru and others, and not just finding creative ways of working around them, should consume the energies of Midnight’s grandchildren.

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