India Forum
Paper Series
May 2011
Summary: Despite at least two
decades of reforms, the liber-
alization of India’s economy is
incomplete. This is primarily a
function of politics. Indian polit-
ical leaders have few incentives
to advance the reform agenda
given India’s high growth rate,
and instead prefer handouts in
the form of welfare schemes
and employment guarantees.
The ruling Congress Party is
inclined towards populism. The
realities of coalition politics
in both houses of parliament
further complicate reforms, as
they require concessions from
partners and, in some cases,
the opposition. While some
advances are being made, future
economic liberalization in India
will likely be hesitant, episodic,
and half-hearted.
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The Politics of India’s Unfinished
Economic Reforms
by Swaminathan S. Anklesaria Aiyar
Economic reform in India began hesi-
tantly in the 1980s and accelerated in
the 1990s. After a process of 20 to 30
years of liberalization, one might have
expected truly revolutionary changes
to India’s economic system. Yet the
Heritage Foundation’s 2011 Index of
Economic Freedom ranks India at just
124 of 183 countries and classifies it
as a “mostly unfree” state with a lower
than average score.
A separate study, Economic Freedom
of the World 2010, brought out annu-
ally by the Fraser Institute and allied
think tanks, places India at 87 out of
141 countries on economic freedoms.
In the 1980 edition of the same index,
India had been ranked as high as 57.
This apparent decline is not a result
of worsening freedoms: India’s score
on the index has improved from
5.41 to 6.51 on a scale of one to ten,
signifying an improvement. However,
other countries have liberalized much
faster than India in the interim period.
Interestingly, India does not rank
much lower than China (82), and
ranks much higher than its neighbors
Sri Lanka (111), Bangladesh (113),
Pakistan (118), and Nepal (125).
The Doing Business series of the Inter-
national Finance Corporation (IFC) at
the World Bank confirms the notion
of India being a generally unfriendly
environment for doing business.
Its 2011 report rated the country a
lowly 134 out of 183 countries. India
ranked close to the bottom in terms
of ease of starting a business (165),
getting construction permits (177),
and enforcing contracts (182). All of
these indices are clear demonstra-
tions of how India remains hobbled
by controls, corruption, the pathetic
delivery of public goods, and flawed
administrative and judicial systems.
While India has indeed been trans-
formed since 1991, the unfinished
reform agenda is massive.
In addition to various constraints on
doing business, corruption remains
another area of concern. It is currently
a hot topic in India, with an outraged
media revealing scam after scam, but
India may be experiencing more public
outrage rather than more corruption.
This is confirmed by the Corruption
Perception Index of Transparency
International, which ranks India 87 out
of 178 countries, behind China (78)
but well ahead of Bangladesh (134)
India Forum
Paper Series
India remains hobbled by
controls, corruption, the pathetic
delivery of public goods, and
flawed administrative and judicial
systems.
and Pakistan (143). India has slipped from 66th in 1998,
but in absolute terms, its corruption perception index has
improved from 2.9 to 3.3. This may be because corruption
has been abolished by deregulation in several areas – indus-
trial licenses, import licenses, monopolies clearance, and
foreign exchange permits – and this more than offsets rising
corruption in areas of political allocations, such as telecom-
munications, land acquisition, construction permits, and
infrastructure.
The Political Economy: Reforms, Handouts, and
Coalition Politics
Despite corruption and business constraints, India has
averaged 8.5 percent GDP growth in the last decade.
This reflects virtuous cycles created by economic reforms
over the last two decades, as well as a demographic divi-
dend. This has important implications for the political
economy. Having witnessed the benefits of miracle growth,
Indian politicians have little incentive to reduce corrup-
tion, misgovernance, or unwarranted economic controls.
Indian politicians, like their counterparts everywhere, want
to get re-elected, and while they may opt for reforms in
tough times, during an economic boom they prefer using
increases in revenue to shower handouts to constituents.
Handouts can range from employment programs and
subsidized grain to free electricity and canal water and
subsidized fuel and fertilizers for farmers. In some state
elections, political parties have promised voters bicycles,
color televisions, electric mixer-grinders, and even laptop
computers. Such handouts fritter away funds that could
better be better utilized building infrastructure, improving
governance – including establishing more courts and police
– and improving social services such as health and educa-
tion. Voters in poorer countries tend to have short time
2
horizons that favor immediate handouts over longer-term
reforms. So the political incentives for accelerating reforms
remain weak at present.
Coalition politics further hampers the reform agenda. The
governing United Progressive Alliance (UPA), led by the
Congress party, has lacked a majority in both houses of
parliament in both its first and second terms. In its first
term (2004-2009), the UPA survived only with outside
support from the Left Front, consisting of four communist
parties. This gave the Left a virtual veto on reforms. Several
reformist bills were introduced by the UPA — to allow
pension funds to invest in the stock market, to increase the
ceiling of foreign investment in insurance from 26 percent
to 49 percent, and to give investors in banks voting rights in
line with their shareholding — but the Left, dead set against
any financial liberalization or improved access to foreign
investment, blocked these bills. The Left also vetoed legis-
lation to end the public sector monopoly on coal mining.
And, of course, it demanded and got a huge increase in
social and rural spending programs. Of these, the most
useful was Bharat Nirman, which massively improved rural
infrastructure.
Having witnessed the benefits of
miracle growth, Indian politicians
have little incentive to reduce
corruption, misgovernance, or
unwarranted economic controls.
The 2009 election brought the UPA coalition back to power
with more seats, yet slightly short of a majority. No longer
needing the support of the Left, it formed a government
with the support of minor parties. But expectations that
the second UPA government would surge forward with
reforms proved ill-founded. The reasons for this are several-
fold. First, the leader of the Congress Party, Sonia Gandhi,
has demonstrated her preference for handouts. Along with
many leaders of the Congress Party and members of the
media, she believes that the UPA’s emphasis on welfare,
India Forum

Paper Series
particularly a massive rural employment guarantee scheme,
was a key reason for her electoral victory in 2009. However,
Limited co-operation between
the labor component of the employment guarantee scheme
comes to just 0.3 percent of GDP, and work under this political foes reflects the
scheme accounts for only 1 percent of total rural person-
days of work. It seems implausible, then, that this could institutional strength of democracy
have been the main reason for rural prosperity or the UPA’s
re-election. The truth may in fact be more prosaic. Three in India, and helps overcome some
new parties emerged in the 2009 election: Praja Rajyam in
Andhra Pradesh, a splinter group of the Shiv Sena headed
by Raj Thackeray in Maharashtra, and a new party in Tamil of the political hurdles to reform in
Nadu. The Congress was the incumbent in all three states,
and the new parties helped further split the anti-incumbent an era of permanent coalitions.
vote. This gave the Congress approximately 60 seats more
than it would have otherwise won in the 2009 general elec-
The Big Ticket: Tax Reforms and Concessions
tion. Beyond that, economic improvement may well have
BJP support is absolutely essential for the biggest reform bill
helped the Congress, but it remains unproven whether the
of all — a Constitutional amendment to abolish the current
credit for that goes to rapid growth or increased welfare
mélange of taxes levied by the central and state govern-
spending. However, most Congress stalwarts continue to
ments, and its replacement it by a Goods and Services Tax
believe that welfarism — not reform — wins votes.
(GST). This amendment, which would require a two-
thirds majority in both houses of parliament, could truly
modernize Indian tax administration, eliminating cascading
Expectations that the second UPA taxes and curbing tax evasion. The substance of this bill has
been hammered out by a committee of state finance minis-
government would surge forward ters over the last decade, including those of states governed
by the BJP and Left Front. But the BJP has recently raised
with reforms proved ill-founded. fresh objections of a political, rather than technical, nature.
It probably will not assent to the GST legislation until the
central government goes slow on the prosecution of BJP
politicians for the mass killing of Muslims in Gujarat in
The second UPA government also lacks a majority in the 2001. In this case, at least, political reform is complicated by
Rajya Sabha, the upper house of India’s parliament. It can the politics of religion.
try to make concessions to regional parties to secure their
The Congress has, it appears, been rewarded for its patience.
votes for controversial bills, but such support would be
The BJP has agreed to support a long-pending Pensions
unpredictable and unreliable. Finance Minister Pranab
Bill that will, among other things, allow private players into
Mukherjee believes that, in many cases, legislation can only
pension funds, which in turn will be allowed to invest in
proceed by evolving a multi-party consensus, which often
equities. In return, the Congress has agreed to postpone
means getting the support of the BJP, the main opposition
a bill creating an Academy of Scientific and Innovative
party. Securing BJP support has become so important that
Research, which the BJP objects to. This limited co-opera-
the Congress has often been willing to tolerate the BJPs
tion between political foes reflects the institutional strength
antics, such as blocking the entire winter session of Parlia-
of democracy in India, and helps overcome some of the
ment in 2010 over an investigation into a massive telecom
political hurdles to reform in an era of permanent coali-
scam. In theory, the Congress could have asked the Speaker
tions, in which no party can realistically win a majority in
to expel unruly BJP legislators and allow parliament to
parliament.
proceed, but it wilted out of a desire to secure BJP support
on some key bills.

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India Forum
Paper Series
Episodic and Half-Hearted Reforms
The bottom line is that future reform in India will be slow,
but all indications are that it will still move in the right
direction. Corruption has become a big issue thanks to the
recent wave of middle class outrage stoked by the media,
and it seems all parties may agree to legislation that limits
the scope for ministerial discretion in awarding government
contracts or selling government property. This will be a net
positive for economic reform.
Legislation is not necessary to
allow foreign direct investment in
the retail sector, or to liberalize
rigid labor laws that inhibit
the growth of labor-intensive
industries.
On the other hand, we should beware the interpretation
that the absence of a parliamentary majority for the UPA,
notably in the Rajya Sabha, is the only reason for the slow
pace of reforms. No new legislation, for example is required
to decontrol oil prices and fertilizer costs, remove subsi-
dies for electricity and water for farmers, or discipline
absent teachers and health workers. Similarly, legislation
is not necessary to allow foreign direct investment in the
retail sector, or to liberalize rigid labor laws that inhibit the
growth of labor-intensive industries. Yet this UPA govern-
ment has shown no inclination to move forward on any of
these issues. The Congress Party is, at its core, populist with
old socialist roots, and believes that wooing voters with
handouts is good electoral practice. Combined with the
realities of coalition politics, this means that future reform
in India will tend to be hesitant, episodic, and half-hearted.
About the Author
Swaminathan S. Anklesaria Aiyar is consulting editor of The Economic
Times in India, and a research fellow at the Global Prosperity Center of
the Cato Institute, Washington DC.
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