India: An Economic Reform Case Study

A look at the work of Indian economist and student of Hayek, B R Shenoy...

"An Indian will, on average, be twice as well off as his grandfather; a Korean 32 times" said Robert Lucas in a 1985 paper titled On the Mechanics of Economic Development.

The Nobel laureate's figures were based on the 1960-1980 period when India's per capita income grew at 1.4% per year. In the period from 1992-2002, India's per capita income grew at 3.7%, and from 2003 to 2010 it grew 6.9% – at this rate an Indian too will be 32 times better off than his grandfather, writes Vipin Veetil for the Cobden Centre.

August 2011 marks two decades since a high level committee—Narasimham Committee—was setup by government of India to initiate financial sector reforms. The deregulation recommendation by the Narasimham Committee went a long way in improving capital market efficiency – a key ingredient of economic growth. Ideas of free market economics, however, were not new to India. Long before 1991, Prof B R Shenoy had fought a lonely battle to promote free-exchange.

Shenoy warned India about the consequences of "central planning" twenty years before Jagdish Bhagwati and T N Srinivasan told us – in their 1975 book Foreign Trade Regimes and Economic Development: India – "that India's foreign trade regime, in conjunction with domestic licensing policies in the industrial sector... impaired her economic performance". Shenoy was the only Indian economist to write a Note of Dissent to the 2nd Nehru-Mahalanobis Five Year Plan (similar to the Soviet Gosplan).

In the 1955 Note, Shenoy points out that the 2nd Plan "begins by prescribing the increase in national income which the Plan would set to achieve". In other words, the plan begins with a certain growth rate and then goes about figuring out how to gather necessary savings. Shenoy says "the availability of real resources must be assessed first and the investment plan must match it". This was at a time when Joan Robinson's view that "It is the rate of investment which governs the rate of saving, and not vice versa" was in fashion.

The government of India and its economic advisors chose to reject Shenoy's wise remarks. What followed was an unfortunate verification of Shenoy's theoretical vision. The average per capita income growth for the first five 5-year plan periods was a meager 1.5%. Joseph Schumpeter in his 1910 essay on Leon Walras says "It has become long since manifest who was being judged when the Academie des Sciences Morales et Politiques rejected his work". Perhaps the same can be said of the government of India's rejection of Shenoy.

"Is there some action a government of India could take that would lead the Indian economy to grow like Indonesia's or Egypt's?" asked Robert Lucas in the mid-80s. In 1991 the government of India took some such actions. And the debate turned ideological, especially with the IMF's condition-ridden package. Shenoy was the first economist of independent India to lucidly support free-market policies:

Efficient management of business and industrial concerns in a competitive market economy is a highly specialized function...best left to private entrepreneurs.

The reforms were greeted with skepticism at best and outright rejection at worst amongst India's intellectual class. Arun Ghosh—in an August 1992 Economic and Political Weekly article titledOne Year of Narasimha Rao Government: A Balance Sheet—declared "The Narasimha Rao government's economic policies have not brought any promise of harmony and progress to the Indian economy." Rather symbolically, the article was on the same page as an advertisement for the Hindi translation of a book titled The Russian Revolution by Rosa Luxemburg. Surprisingly, in the midst of the ideological battle of early 90s, Shenoy's ideas were not resurrected for intellectual support. S B Mehta wrote in 2001 of events a decade earlier:

the then Finance Minister was criticized by many that we were mortgaging our sovereignty to IMF. This author wrote to him that he should declare that we were following the policy that Shenoy hinted for twenty long years.... No politician or economist, however, uttered the name of Shenoy... Thus, it seems, we neglected the sound advice of Shenoy during his life-time [and also] when our policies leaned more towards free market.

With his 1931 article in the Quarterly Journal of Economics, Shenoy became the first Indian economist to publish in leading scholarly journal. However, Shenoy is not just a scholar of the past; his ideas are of great relevance today. Take the debate on corruption, for instance. In February 1975, Shenoy delivered a lecture in Ahmedabad putting forward the thesis that interventionism is the root cause of corruption. And data backs his claim: Transparency International's perception of corruption index and Heritage Foundation's economic freedom index are strongly correlated. The 10 least corrupt countries have an average economic freedom index rank of 11, while the average for 10 most corrupt countries is 163!

Shenoy chose to be "right in a minority of one". As India marks two decades of economic reforms, it is time classical liberals come forward to institutionalize B R Shenoy's ideas. They say that VKRK Rao, a prominent post-independence Indian economist, "strode like a Colossus over the Social Science disciplines". He established four institutions: the Delhi School of Economics, the Institute of Economic Growth, the Indian Council of Social Science Research, and the Institute for Social and Economic Change. Shenoy established none. The difference was at least partly because of their respective economic views. Rao was awarded his PhD in 1937 from Cambridge and was a student of Keynes. Shenoy was from the London School of Economics and was highly influenced by the then 'new' ideas of F A Hayek. Naturally the government of India loved Rao – a necessary prerequisite for establishing institutions in Gosplan India.

The first round of economic reforms was a matter of necessity, but India still ranks 124 in Heritage Foundation's 2011 Economic Freedom Index. Hopefully the much-needed second round of reforms will be a matter of choice. And a reform by choice will come only if India has institutions promoting ideas of B R Shenoy. In the long run, ideas must either take the form of institutions or die. And as to the question of where to begin, a chair at the Delhi School of Economics might be a good place.

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