From Financial Express, October 30, 2012

Signs of hope for India’s economy

The latest World Bank report on the ease of doing business in 185 economies provides a mixed picture of India, but with some glimmers of hope. India’s overall rank based on a composite index has not changed from last year. It remains at 132, still firmly in the third division of the ease-of-doing-business league. But since most countries are making improvements on this front, India’s stasis in the relative rankings is consistent with some absolute improvements.

Since 2005, the greatest percentage improvements — measured in terms of distance from the global best-practice frontier—in India’s standing in various dimensions of doing business have come in getting credit, dealing with construction permits, and procedures for starting a business. But it still ranks 173rd in starting a business, and 182nd in dealing with construction permits. To the extent that what matters are the levels of various hurdles to doing business, absolute improvements are good. But low rankings matter wherever global competitiveness is an issue.

Comparisons in rankings and levels of barriers across developing countries for different aspects of doing business do not reveal any obvious patterns, or necessarily a tight link between ease of doing business and growth performance. Where India ranks close to dead last, however, is in enforcing contracts, and the major contributor to that ranking is the length of time taken. This suggests that the state of India’s judicial system, particularly with respect to contractual disputes, is a major weak spot for its business environment.

Fixing the judicial system requires a concerted effort by the central government. It has been weakly on the reform agenda, but without making much headway. The sad part of this is that the resources needed to reduce judicial delays in India are probably a fraction of those being thrown by the government at other areas of the economy.

In other cases, there is more hope, because positive change can come at the state level. A recent story in the Washington Post, by Simon Denyer, rediscovers the possibility that, despite the central government’s difficulties in moving economic reforms forward, individual states have considerable leeway to progress, and have been doing so. Arvind Panagariya, quoted in the story, reminds us that decentralisation of economic control was a major theme of the 1991 reforms—he himself is working on a major study assessing the comparative performance of India’s states. Ajay Shah, in the same newspaper story, notes the competition for investment among some states, but also the slow diffusion of lessons on best practices in governance.

Part of the problem is that even when one gets down to the state government level, decision-making is top-heavy. How a state does seems to depend on who is at the top, and discussions of good and bad performance focus on personalities, whether it is Narendra Modi, Jayalalitha, Nitish Kumar, Chandrababu Naidu, or Prakash Singh Badal. Anecdotes abound about the way in which state leaders shape the culture of administration, and set the tone for how civil servants (the elite Indian Administrative Service in particular) carry out their duties.

Of course, leadership matters, but governance at the state level can display over-centralisation, just as at the national level. Ajay Shah notes the need to devolve power to city governments, in the Washington Post story. The 74th amendment set the stage for this 20 years ago, but actual progress has been limited. One of the key problems is the lack of political autonomy, with state-level politicians and bureaucrats able to interfere too much at the local level. Another is a lack of funds.

To some extent, the lack of funds is endogenous—with local politicians finding it easier to rely on trickle-down transfers, however small and unreliable, rather than making effective decisions on taxing at the local level. The urban property tax, in particular, has been eroded by corruption in the real estate market and in local tax administration. The national and state governments need to make a concerted effort to improve the design and administration of urban property taxes, while giving cities more leeway in setting rates—as well as allowing them to piggyback on a future GST—as I argued in my last column.

As I argued earlier, getting the states to decentralise to the local level will require giving them more autonomy and revenue authority. States are exercising de facto autonomy in competing for investment, and that can be good for improving conditions for doing business, but it is important that this not lead to competitive reductions in tax effort, with the expectation that the national government will cover the gap. As the government sets up the 14th Finance Commission, rethinking the inter-governmental transfer mechanism in concert with reconfiguring tax authorities should be an important part of the commission’s mandate. The goal should be to improve marginal incentives for revenue collection at all sub-national levels of government.