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The Rediff Pre-budget Special/Nirupam Bajpai, Jeffrey D Sachs

Thrust on liberal labour laws, exports, services and IT will make the difference

Part I: Lowering revenue deficit, subsidies hold key to fiscal consolidation

Part II: Benefit of privatisation: larger national savings

Part III: Wanted: tax reforms, higher allocations for health and education

We are of the view that India's growth strategy should focus heavily on exports. Export-led growth in services is one of the most interesting developments, and export-led growth in manufactures, the more traditional textiles and apparel, in electronics and other labor-intensive operations remains an area where India could do a lot more than in the past.

Therefore, it is essential that we look closely at India's export environment. We find that India's export environment suffers from several institutional weaknesses. India's labour laws, noted unfavorably in the 1999 Global Competitiveness Report, make it very costly to fire workers in enterprises of more than 100 workers.

The result is that formal-sector firms (those that are registered and that pay their taxes) are loath to take on new employment, and the vast majority of India's employment is informal, in small, tax-evading, inefficient enterprises.

Equally remarkably, India's legislation continues to restrict the entry of medium or large firms, or the growth of small firms into medium or large firms, in several areas of potential comparative advantage. Thus, garments, toys, shoes and leather products continue to be reserved, to a varying extent, for small-scale producers.

Such restrictions virtually assure China's dominance in these sectors compared with India. India's tax and tariff structures similarly remain anti-export biased. India's high overall tariff rates, especially tariffs on intermediate products that are used by exporters, impose a heavy indirect tax on export competitiveness.

Furthermore, the Union Budget for 1998-99 had imposed an additional non-modvatable levy of 8 per cent on imports, which was later reduced to 4 per cent. There are duty drawback systems to reduce this anti-export bias, but such programmes are administratively burdensome and often too costly to use effectively.

Finally, the regulatory attitude to foreign direct investors, who could be the fuel for India's export drive, continues to be ambivalent. The government promotes FDI on the one hand, but then maintains regulations against full foreign ownership, or insists on lengthy approval processes, on the other hand.

The development of industrial parks for exports should be greatly intensified and enhanced. Private developers need the freedom to acquire urban and semi-urban land to develop privately financed infrastructure in support of exports. The government must take urgent measures to reduce export costs, including private-sector provision of port services; zero tariff ratings on capital and intermediate goods imports used for export (based on an effective duty exemption scheme); enhance export-oriented infrastructure, especially roads to the airports, reliable power supply, and telecommunications facilities to support export zones.

As suggested by the Abid Hussain Committee, the reservation of labour-intensive sectors to small-scale enterprises should be scrapped. This will give India a chance to provide stiff international competition in labour-intensive exports to countries such as China. The government should actively encourage inward investment in export-oriented sectors, allowing 100 per cent foreign ownership without administrative interference, and with the provision of generous tax holidays as necessary to attract internationally mobile capital from other locations.

China has achieved a lot more in manufactured export production than India and for no particular reason. India has the resource base, it has the entrepreneurship, has the access to the sea coast, a vast labour force, it has everything that coastal China has had except the interest of government which neglected this for a long time and which even today under-emphasises the role of industrial facilities, underemphasises the role of infrastructure, of land area, of effective port facilities that one needs to be able to compete with China in this area. But it is, we believe, a place where one could find tens of millions of jobs over the next few years in real, significant foreign exchange earning private sector activity.

It is important to mention, in addition to labour-intensive manufacturing exports, India's clear and growing capacity in service-sector exports based on information technology. Here, as in labour-intensive exports, Indian government policy could do much more to spur export growth.

On the plus side has been the government's long-term commitment to the IITs. More recently, has been the government's support for Software Technology Parks (STPs), in Madras, Bangalore, Pune and other cities, which are the IT-industry equivalent of the EPZs in manufacturing industries.

There are serious negatives, however. The continuing state monopoly of VSNL in international telephony seriously raise the costs of telephone and IT services in India, and is doing considerable damage to India's international competitiveness in the IT sector.

India's telephone density is abysmally low, at around 1.3 per hundred in 1995, compared with around 62.6 per hundred in the United States. Charges for domestic long distance and international telephone calls in India are among the highest in the world, largely due to lack of competition. Physical infrastructure for data transmission within India (e.g. fibre optic cables) remains underdeveloped despite some recent progress.

India is becoming one of the most important players of the world in the IT sector and it is the fastest growing foreign exchange earner for India.

We believe that the government could do more for this industry, not through direct subsidies necessarily but actually through liberalisation of telecom, allowing for lower priced telecommunication services, by allowing new entry of major international players in telecom who would lay down a tremendous fibre optic network in India and increase the bandwidth available for Indian business and put India even more closely to the international scene.

We would like to see the government find some resources to support basic science and R&D in this sector to some extent because India has world-class engineers and scientists that have already brought India up in an important way in this sector and could keep India in the very forefront of this new technology.

To sum up, action is needed on several fronts. Some of the key areas requiring further reform to attain and sustain higher rates of GDP growth are: greater openness of the economy; dereservation of items from the reservation list of the small scale sector; deregulation of India's private sector, including liberalization of labor laws and exit policies; demonopolization of infrastructure; and decentralization of economic policy-making.

Fiscal deficit remains high. Ominously, the ratio of internal public debt to GDP has continued to rise, and the debt service burden has risen even faster because of rising interest rates. Quite evidently, expenditure reform has lagged behind tax reform. Hence, the expenditure-GDP ratio needs to be brought down considerably.

The composition of government spending is skewed towards unproductive, current expenditures and away from basic infrastructure as well as vitally needed spending on human resource development, especially in the areas of primary health and education.

Nirupam Bajpai is a Research Fellow at the Centre for International Development (CID) at Harvard University and the Director, India Program at CID. Jeffrey D Sachs is Director, Centre for International Development and Galen L. Stone Professor of International Trade at the Department of Economics, Harvard University.

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