Politicians are driven by short-term populism. India needs long-term structural reform. How do we bridge the gap?
In the wake of the jobs crisis the country is facing, the central government recently legislated a 10 percent employment reservation for economically weaker sections of society. The news illustrates an increasingly common pattern, wherein politicians opt for populist short-term solutions to fix problems that typically require more long-term thinking. Given the dire plight of farmers, loan waivers too have become a standard appeasement policy across parties. Economists have always decried such myopic thinking.
For politicians, it can be difficult to advance market-based supply-side legislation in democracies. Interventions that, for example, seek to enhance production by removing barriers to entry, promoting competition, or dismantling permits that hinder ease of doing business, face a number of political obstacles. The benefits of supply-based market reforms take time to materialise, while the costs are more immediate. The status quo also benefits specific interest groups who are politically powerful and able to resist change by lobbying to protect their interests. Ultimately, investing in long-term solutions is not aligned with a politicians’ short-term goal of being re-elected.
Loan waivers and job reservation quotas thus become the preferred policy choice and a de-facto equilibrium, appeasing both the voter and the politician. At the same time, staving off structural reforms can bring about economic crisis. Politicians have to face up to the onerous task of pushing forth these reforms to secure long term stable growth.
Get the Timing Right
How best can politicians sell much needed structural reforms? A 2010 OECD report, which studies the political economy of advancing product and labour market reforms in 20 stable democracies, holds important lessons for us. One important takeaway is to get the timing and pace of reforms right. Politicians are reluctant to implement reforms too close to elections, especially if they will tend to adversely impact their important constituencies. Thus, difficult reforms should be undertaken in the first year or two of being elected into office.
The Hartz reforms of Germany from 2002-2004, involving labour market reforms, is an interesting example. The Social Democratic Party of Germany, on being voted into power, immediately embarked on a path to push through labour reforms. It succeeded in advancing legislation to reduce unemployment benefits and increase incentives for the unemployed to find jobs.
Raghuram Rajan, former RBI governor, states that reforms should be undertaken during the recovery period from an economic downturn, as such periods usually secure buy-in from the public. He cites the cases of New Zealand and the United Kingdom, where a long period of low growth fostered support amongst the public for the need for implementing difficult policies. The Labour government in power in New Zealand in the 1980s pushed through deregulaton of the goods market, liberalised trade, cut tariffs and embarked on an ambitious privatisation programme. The pace of reforms is also key. In case of a lack of a stable electoral mandate, introducing gradual changes may work better than big-bang reforms.
Look After the Losers
Reforms tend to have benefits that are widely dispersed and costs that are concentrated on a few. A second strategy for increasing politically feasibility of structural reforms would be to adequately compensate the losers of a reform policy. This might include workers at risk of displacement, who tend to resist change. Compensation money can be generated directly from the beneficiaries of the reform. For example, when price-support mechanisms for the dairy industry in Australia were finally removed, farmers were provided with adequate compensation, financed from a levy on milk consumers. This reflected the reduction in the value of their dairy holdings and facilitated adjustment within the industry.
The GST reform undertaken by this government is a good example of how this strategy has been employed in India. States opposing the tax reform, fearing loss of revenue to their own coffers, were placated by the Centre’s decision to compensate them for their revenue loss. However, at times there could be a practical difficulty in implementing such compensation as it may not be clear ex-ante as to who the potential losers and beneficiaries of a reform are.
A third strategy would be effectively communicating the benefits of reforms through sound domestic institutions that actively engage all the relevant stakeholders. While undertaking structural reforms in 1990s, Australia successfully neutered the power of vested interests and built wider political support for its policies through the Productivity Commission and the Industry Commission. These Commissions carefully articulated the costs of protecting certain industries, subjected the arguments of vested interests to rigorous scrutiny, and informationally ambushed the government with recommendations for reform. Ultimately, the Commissions’ reports and processes also alerted the public to the costs of non-reform.
Finally, the presence of a strong and well-motivated political leadership is a pre-eminent requirement for pushing through difficult decisions. A strong political leader is able to build consensus within his government and effectively persuade the electorate of the gains of long-term structural reform. Although Prime Minister Modi is perceived as a strong and capable leader, he seems to have missed out on an opportunity to use his skills effectively. This is also the reason that this government is ultimately resorting to short-term populist measures to secure the next election.