Modi’s Move: A Retrospective Study of the Background

There are two hypotheses concerning corruption in India: greasing the wheel and sanding the wheel. The proverbial wheel represents the Indian economy.  The idea is that India has dysfunctional institutions and an obdurate bureaucracy, so corruption works as the lubricant and helps things advance, thereby enhancing the economic performance of the country. ‘Sanding the wheel’ notion alludes to the detrimental effect of corruption on the economy.

Not surprisingly, many scholars have found empirical evidence in support of the ‘greasing the wheel’ hypothesis. It means that corruption in India does help in achieving higher economic efficiency. What it doesn’t mean is that corruption is good for the country. Corruption is good only in the absence of good institutions. To put it simply, the best is to have good institutions which work without corrupt practices. And, the second best option is to turn a blind eye to corruption if institutions are dysfunctional.

Improving institutions involves lengthy and costly political processes. There are always people who thrive on the current setup of institutions. Any change/attempt to change the setup brings stiff opposition from these people. Even the economic liberalization of 1991 which improved the economic health of the country manifold had to face opposition from different quarters.

Mr. Narendra Modi became the Prime Minister of India in June 2014. It is not wrong to say that development and curbing the use of black money were two of his most important poll planks. By 2014 the process of institutional reforms had slowed down. The Congress party which ushered the economic reforms found itself unable to carry out any more reforms. The growth rate had deteriorated. Corruption was rampant. Anna’s movement against corruption became a testimony of public anger against corruption. The people of India wanted development and wanted to be ridden of rampant corruption. They voted for Mr. Narendra Modi with great expectation that he would be able to fix the twin issues of development and black money.

What made corruption so rampant and growth rate so low in India? [Between 1960 and 1980, India had a very low growth rate: 1.5% on average, it was jokingly called the Hindu rate of growth.] Despite the availability of cheap factors of production such as land, labor, and minerals, businesses didn’t thrive in India. The system that we had in place was called the license and quota raj which was antithetical to domestic investment and inflow of foreign capital in productive sectors. The license and quota raj also promoted several corrupt practices. For example, it became almost a norm to pay a bribe to get a license to start a factory. These corrupt practices were largely supported by the use of black money. Narasimha Rao’s government (1991-96) dismantled the license-quota raj to a large extent. Unfortunately, the corrupt practices and use of black money didn’t go away; it not only remained rampant in the economy but also permeated to the lowest level.

To experience a high growth, the kind which the Indian public was expecting, the kind which South Korea and Singapore experienced, it became necessary to have fair, honest and efficient institutions which promote domestic investment and inflow of foreign capital. The presence of corrupt practices and black money has stifled the both. Black money cannot be reinvested back in the formal sectors. So, people invest their black money in land, real estate and gold which creates excess demand causing the rate of return to rise in these sectors. Increased rate of return attracts even those investors who have no black money. The presence of corrupt practices and black money distorts the business environment which decreases the inflow of foreign capital.

India lacks the political consensus for reforms. Only strong political leadership at the prime ministerial level in the presence of dire economic situation is able to force economic reforms in the country. The Modi government has been trying its  best to reignite the engine of growth. However for Modi, the political math: the number in Rajya Sabha (the upper house of the parliament) is not in  favor. The Modi government’s attempt to pass the land acquisition bill failed. The entrenched interest of organized labor resists any reform in labor laws. Fortunately enough, the parliament was able to pass the GST bill. The government is carrying out piecemeal reforms, but the country is not able to achieve the high growth rate that is expected of it. The government gets A for the effort but a mediocre B- for the result.

The question was how Modi could Trump this game? There are two main ways of treating a disease: one is described in Ayurveda and another is popular in Allopathy.  Ayurveda emphasizes treating the root cause and fixing the system while allopathy believes in curing the symptoms. More than a half-way through his tenure, Prime Minister Modi sees that time is running out. For one reason or the other, he is unable to follow Ayurveda and is not able to fix structural problems of the economy. What worried him the most was his inability to make any progress on the account of bringing back black money. His government needed to do something fast. He needed to do something out of ordinary. And, it seems that Mr. Modi has found that something extraordinary: an allopathic tool to tackle the twin political issues of growth and black money.

One must appreciate Mr. Modi, as this move is not only extraordinary but also risky. Fight against corruption and black money in India is considered a difficult proposition for the simple reason that almost all of us have some black money and/or have used corrupt practices for some short-term gains. We all talk about the need to curb corruption but none of us really want the complete elimination of black money and corrupt practices. After all, it helps us lubricate our inefficient institutions.

The short-term impact would be chaotic.  Modi will need his leadership skills to manage this transition. There is a high probability (>0.5) that this move may not achieve the desired result. If this happens, Modi will be remembered as one term prime minister who squandered his chances on a crazy idea. But, I still appreciate his gumption that he decided to handle the black money in this particular way. There is also a good probability (less than 0.5) that he would be able to get the desired result and reap the electoral benefit in the next election.