‘Legacy of bad, socialist habits hampering India from realising its potential’

In the annual ranking of Index of Economic Freedom, released in Hong Kong on Wednesday, India crawled in at a lowly 124th rank, well below economic ‘giants’ like Malta (ranked 57) and Tonga (118), but still 11 rungs above China (135).

A joint project of The Heritage Foundation and The Wall Street Journal, the index ranks countries on a 1-100 scale on the basis of 10 measures that evaluate openness, the rule of law and competitiveness.

India’s lowly ranking does little justice to its potential to be perhaps “the leading economy in the world at some point,” notes Terry Miller, director of the Center for International Trade and Economics at the Foundation, who co-authored the report.

In an interview to DNA in Hong Kong, Miller, a former diplomat, argues that simplifying the regulatory environment and ensuring greater transparency would boost economic freedoms in India — and prosperity. Excerpts:

How does India fare in this year’s ranking?
There was a slight improvement in India’s score, and that’s always good to see; India is 25th in the region now, but its overall rank — 124th — is not really what you would expect from an economy that has the potential to do so much more than the Indian economy has done.

There’s a historical legacy of socialism in India that put the economy on some bad paths and held back development substantially.

Now many of those bad policies have been changed in some way, and you have governments that are somewhat more forward-looking than they might have been in the past. But there are still a lot of habits there and a lot of things to overcome.

It’s an economy that is so diverse and with such a large population in widely varying levels — even within India you have different States with different levels of development and different kinds of economic policies.

India is one of those places that’s so big and complex that it’s very hard to compare adequately with any other country.

For the purposes of this ranking, on what indices did it do well, and where did it slip up?
The things that leap out right now are the low score on property rights… And these are unusually low for a former British colony. We find that many of the former British colonies, of which the US is one, score very highly on property rights and rule of law.

It’s a British legacy, but somehow it has not taken hold in India in the same way. On investment freedom and financial freedom too, India scores far below the world average. These are relatively easy for governments to adjust; sometimes it might be hard politically, but the policy measures are very straightforward: you either strain and keep out investment or you open yourself up to investment and make the regulatory process much more transparent.

For a country like India, transparency would be one of the most important things to strive for. India is a democracy, with a big educated — and highly vocal — population speaking up for their rights. If it can work on increasing the transparency in government decision-making processes, I’d be very confident that the Indian people would help encourage the government get the policies right.

How do you account for the jump in labour freedom?
We use data collected by the World Bank on an annual basis for its Doing Business Report. Based on the data that was reported by the Indian government to the World Bank, the labour regulatory environment appears to be evolving very rapidly.

We’re looking at things like hire-and-fire policies, and minimum wage; this is really a numerical calculation… This looks very positive.

What is the biggest drag on economic freedoms in India?
Where do I begin? Take business freedom: India scores just 36.9  — that means if you’re a potential entrepreneur you really have to jump through hoops to get the approvals to start your business; everytime you have a procedure and have to interact with the government, that’s an opportunity for graft and corruption - and that shows up in the corruption score as well. These are inter-related.

Many countries around the world have taken really strong efforts to cut back on the number of processes it takes to start a business; it’s easier to start businesses, and some of them have one-stop shops, where you have to go to just one place and interact with just one bureaucrat and it gets all the approvals you need to open a business.

In India, obviously you’re going to have some federal regulation, and some State and local regulations. So, it’s going to be a bit more complex than it is in some countries. I don’t think you can overcome all of that, but anything you can do to reduce the number of steps is going to make it easier to create those jobs that you’re going to need to keep the economy growing.

Is it your case that India needs ‘big bang’ reforms?
India probably needs to concentrate on getting the regulatory environment right. I think you had a bad one for a long time, and that’s evolving now, but it’s a complex environment, and anything that can be done to simplify the regulatory environment and make it more transparent would go a long way.

India likes to compare itself with China. How does it fare relative to China on the economic freedom index?
 Well, India is about 10 places ahead of China in the rankings, but I don’t think that’s good enough for an economy like India’s. India is a far more democratic; people enjoy far more political freedom than people in China, and there’s really no excuse for India to lag behind on any of those indicators of economic freedom.

India has the potential in terms of resources and population to be a leading — perhaps the leading — economy in the world at some point. All these restraints that the government has put in place in the past - the Five Year Plans and the incessant idea of state control in every aspect of economic activity - is clearly coming off in India, but as it does, you could have a clear understanding; there’s a compact between citizens and government about the appropriate level of government involvement.

That evolves in every country, and is not going to be necessarily the same in every country. That’s a dialogue that’s going on in India, but perhaps needs to be intensified a bit. The faster you come to a clear understanding of what the role of government is and the limits of that role are, the entrepreneurs and business people and citizens will have a clearer idea of where they can act to get the thing going.

The fastest growing economies today — India, China, Brazil and so on — are all ranked below 100 in your economic freedom index. What does that say? Is economic freedom redundant for headline GDP growth?

They’re all growing from very low levels; that’s a big part of that. You can grow at very high levels for a short period of time based on improvements in one area or the other, but to sustain that over time, you’re going to need broad-based economic freedom throughout society. I won’t pretend that we have a perfect measurement of economic freedom: we measure what we can get consistent data on from around 180 countries.

So there are always other factors at play in these economies, but I think when you look at countries like Brazil or India, you’re going to be able to identify what has changed, where have the policies changed that have allowed us to get these high growth rates. Is all of society enjoying these growth rates?

In China, there are very high growth rates in some provinces, but also very low growth rates in others. There’s a huge disparity. That’s true in India as well. What can we do in India, where you still have a serious poverty problem, to get the lowest levels of society going?

That’s not going to come as a result of government handouts; it’s going to come as a result of education and infrastructure, and land and property rights for people.

Is there a correlation — positive or inverse — between democracy and economic freedom?
There’s a very strong positive correlation between democracy — as measured by the Economist Intelligence Unit — and economic freedom. So democracies have higher economic freedom, and countries with higher economic freedom also tend to have higher levels of democracy.

Which is the chicken, which is the egg?
I don’t know. People argue both sides of it: there are those who say that democracy has a positive impact on economic freedom, and others — like me — believe that if you give people freedom, they have the wherewithal to defend their political and civil rights as well. So there’s a positive impact both ways. It’s a feedback loop; it’s positive from both sides.

To the extent that the 2007-08 financial crisis is attributed to excessive deregulation in financial markets, is there cause for reflection on whether too much freedom might be a bad thing?
I don’t think that at all.

I would challenge the assertion that it is the deregulation of the market that led to the financial crisis. We know that certainly wasn’t the case in the US, where we can identify specific regulatory interventions in our housing markets, and in our financial markets, that led to the creation of a housing bubble that was at the root of the financial crisis. It came about because of government regulation, not because of the absence of that.

Markets are remarkably self-adjusting; they adjust very quickly and to the appropriate level. Economic development happens when you get the prices right — whether it’s the price for investment, labour or goods and services. It’s the market that determines what the real price is.

If government comes in and intervenes and moves that price somewhere else, it’s going to create a shortage if the government sets the price too high, or a bubble if it sets the price too low. The US government came in and set the price for housing mortgages too low with its intervention, and we got a housing bubble as a result. That was unsustainable, and it collapsed, and we got into the situation we are in now.

You say the markets are efficient. But a professor in Queensland, who has written a book called Zombie Economics, argues that the Efficient Markets Hypothesis has been demonstrably disproved and that theories like ‘trickle down economics’ are zombie ideas floating around…
I don’t agree with that at all. I think that among countries around the world, those that let the market work in a truly open way…  There aren’t very many true free markets around the world anywhere; even in the countries that enjoy the highest levels of economic freedom like Hong Kong or the US, we have massive amounts of government intervention in the markets.

I think the professor would be right if he would say ‘there aren’t really any free markets out there’. But if his assertion is that free markets don’t work as well as the more controlled market, I would challenge that very strongly.