In a recent column for the Project Syndicate, renowned political economist Dani Rodrik made a strong argument for countries to cautiously defend economic populism (in certain cases) where restraints imposed on domestic economic policies may be seen to be desirable while being contrary to the impositions drawn from global trade and investment laws.
Albeit the rise of political populism (argued by Rodrik) can unquestionably in almost all cases be recognised as a menace – impinging significant costs to areas of institutional autonomy, democratic freedom of states and non-state actors (including the independence of civil society and media); a certain degree of economic populism practiced in the interests of a country’s own citizens may merit some more thought from a public policy perspective.
If we look at the nature of investment flows in India, recent policies enticing foreign investors to increase volumes of foreign investment (into the country) as against pushing for greater domestic private investment can be cited as just one case where one may recognise how a certain economic restraint (i.e. towards foreign investment) may help with India’s own macroeconomic fundamentals.
The obsession with drawing Foreign Direct Investment (FDI) & Foreign Institutional Investment (FIIs) across sectors sans a growth in domestic private investment opportunities, poses long term risks in sustaining capital flows within (and from) the economy.
In this regard, the upcoming Budget offers the current government an opportunity to practice a certain degree of (restrained) economic populism in pushing for domestic private investment through the budgetary tools available and reduce an increasing dependence on foreign capital for sustaining growth capacities.
The Domestic Private Investment Scenario
The growth in India’s gross capital formation (in annual percentage terms – Figure 1) has been sharply falling due to low domestic private investment levels across sectors (argued here). Post 2014, since the current government came in power at the Union level, the macro-economic problem persisted pushing the government to look for more foreign (direct) investment opportunities across services and manufacturing (through schemes like Make in India and disinvestment). Recently, the decision to allow 100 percent FDI in single-brand retail (through Automatic Route) is a step made in the same direction.
As Figure 2 illustrates, FDI levels in India (as % of GDP) have increased significantly since 2012. Though, the conventional wisdom on the effectiveness of FDI (Foreign Direct Investment) per se, on creating higher investment opportunities for the domestic economy (i.e. in terms of job creation, higher income), has presented mixed evidence. The inflow of FDI (within India) is largely regionalised in its nature and factors like market size, quality of labour involved (in the business activity) and infrastructural development plays a key role in driving investment and its impact on social and economic development indicators.
In India’s own growth story (since the late 1980s), the performance in its overall production capacities have rather been directly proportional to the amount of capital accumulated through its domestic private sector across sectors (and not foreign capital alone) and the ease of domestic credit provided by banks to private enterprises. In Figure 1, we can also see this for the periods between 2000-2007 and 2009-2011 when the average growth rate was around 7-8 percent and capital formation growth was averaged between 15-20 percent. Similarly, Figure 3 (below) gives us an idea on the growth of domestic credit provided to the private sector (as a percentage value from the total GDP).
At the same time, the demand for loans (from the private enterprises) declined during the same period which triggered spill-over effects on growth of employment opportunities and (stagnation of) wage levels across services and manufacturing.
Cometh 1 February 2018, the annual statement of financial outlays presented by the finance minister offers a vital opportunity for addressing some of the above concerns responsible for the ailing domestic private sector investment levels (across sectors).
A few areas of policy focus (outlined in the Budget) may help:
- Reduction in Corporate Income Tax Levels: With the GST implemented in 2017 and now gradually improving the indirect tax compliance mechanism for firms (across sectors), a next move to reduce corporate income tax i.e. visible in form of a high average statutory tax rate of 34.47 percent may infuse some confidence amongst domestic industrial actors. A lower (corporate) tax rate without exemptions will allow a more equal tax incidence framework across businesses. Currently, the service sector has an effective tax rate of 30.3 percent compared to 25.9 percent for the manufacturing sector. A lowering of tax rate to say 25 percent (from the current 34.47 percent), sectors such as the financial institutions, electronics, food processing may benefit more.
- Easing Domestic Credit to Private Sector Enterprises: Given the magnitude of the current NPA crisis and efforts taken to address it, easing domestic credit facilities (through public sector banks) will be a challenge for the government in 2018. The annual budget presentation exercise however, is more about creating and managing expectations for the year to come and targeted tax based incentives to drive domestic private sector investment in small and medium scale industrial activities (including textiles, food processing etc) may help.
- Greater Spending on Agri-Business Research: The stagnation seen in the performance of the agri-business sector and the farm employment levels has triggered a lot of chatter in recent months. While the government’s narrow response so far has been to facilitate loan waivers (through state governments) and introduce reforms in agricultural marketing with limited local impact, public investments and a higher spending for farm education, research and extension will be seen as a positive move (in the short and long term).
Macroeconomic populism exercised in these regards may help the government not only gain political points that it may seek with this year’s budget (given the 2019 Lok Sabha elections) but more importantly use this opportunity to allow some structural problems to be addressed at the same time. While we should constantly be cautious and wary of (political) populism that stifles “political pluralism” and “liberal democratic values”, economic populism may occasionally be seen to be necessary.