In a little over 30 days from now we will have a new government. Most people expect the NDA led by the BJP to form it. But elections can spring surprises.
Regardless of which set of political parties forms the next government, as far as the economy is concerned, it will have to fashion a new approach. India has actually done this every 12-15 years or so in the past.
Thus in the first 15 years from 1952 to 1967 it focused on investment-led growth. Then it stopped because it ran out of money. That caused a lot of hardship.
So from 1971 to 1985 it focused on distribution via a whole host of welfare measures. That slowed down growth.
By 1984 these policies had run their course, and the new government that came to power in December that year reverted to private investment-led growth. It financed the expenditure via deficit financing.
The crucial mistake it made then, however, was to not open up the Indian economy to external competition and markets, which is what China was doing. This error was corrected in 1991.
These policies were diligently followed for the next two decades and worked wonders for expanding output. But after 2014 a new set of policies has made the economy less open. This has resulted in India not attaining its potential output levels.
The proof of this lies in the negative change in occupational structure. Fewer people are working in the formal sector than ought to be for an economy of India’s size.
It’s these policies that the next government will have to rethink. The short point is that the Indian economy needs a sharp kick in its pants. Protectionism has made it complacent.
The savings rate
India saves far less in financial assets than it can. Even after allowing for problems of classification, and the stout defences being mounted by the government, the fact remains: without a much higher savings rate, say, around 40 per cent, investment will fall short of the required levels. This is not rocket science.
But instead of encouraging savings in financial assets successive governments have treated them very badly. That’s why it must be an absolute priority of the next government to design policies — and more importantly, practices — that don’t penalise savers.
This ‘gotcha’ practice has resulted in people hiding their savings and/or not fully declaring their incomes. The thing, however, is governments can’t tell people to be self-employed, as this one has been urging and then punish them for being so. But this is exactly what has been happening since the infamous budget of 1957.
If someone saves some money and derives some income from that saving, the government taxes it at the same rate as normal income. This being so why would people not put their money where the government can’t see it and get a higher return?
What is truly remarkable is that despite such active discouragement by the government people manage to save around 20 per cent. Imagine what would happen if incomes from savings were fully exempted from tax.
The short point is this: Indians without government pensions place a high premium on converting a portion of their current incomes into a stream of future incomes. Why place so many roadblocks before them?
Investment holds the key
All governments know this but all politicians choose to disregard what they know. When was the last time you heard a politician talk about investment?
No, what the government makes is not investment. It incurs expenditure. The two are not the same because spending taxpayers money without returns isn’t investment. It is mere expenditure.
Savings and returns both require positive returns and India has stifled returns for 60 years now. Returns should be based on economic and commercial efficiency, not what the bureaucracy thinks they should be.
This is critically important because thanks to the Left virus, successive Indian governments have chosen to conflate high returns with undeserved profits.
What we have had, therefore, is a consensus that if governments take away half your income via a combination of direct and indirect taxes, it is okay.
Well, it’s not because this Mughal rate of extraction makes the rulers very well off and others poor. It also deters savings and thus investment and hence growth.
And here’s the paradox. The BJP wants to remove all symbols of Mughal rule. But it is happy to retain its worst aspect: high taxes. Chanakya would have disapproved strongly.