Even Mr.Modi’s most ardent critics will acknowledge his immense enthusiasm and self-belief. But it is his misguided belief that he can somehow “fix” the economy that may be responsible for India’s current economic issues.
The economy is a complex, dynamic and fast evolving ecosystem with millions of stakeholders each with their unique set of needs. Knowledge about the resources available to meet these needs is dispersed in small, localized bytes throughout the economy and is continually changing. It is impossible for any government to aggregate this diverse information and engineer the economy. That’s why top-down efforts to improve economic outcomes invariably fail and end up damaging the economy. Demonetization is an excellent example of how governmental efforts to rearrange the economy caused more harm than good. So is GST, where the government’s desire to pick winners and losers by imposing different rates on products has caused significant economic damage.
So, while Mr. Modi might feel the urge to fix the economy, he would do best to leave it alone and let it evolve, adapt, and self-correct itself by responding to the forces of the free market. The more complex a system, the more likely it is that it can ONLY be developed spontaneously in a free market unencumbered by the state. Governments are too slow and cumbersome to keep up with the pace of change and disruption in today’s fast-changing world. The internet, probably the most complex of all networks, evolves spontaneously every second without any government to guide its development. No committee of bureaucrats would have the knowledge to run a complex system like UBER that handles millions of cars every minute all over the world, or a global information system like Google. The top 100 innovations of the 20th century resulted from the voluntary cooperation of people in free and open markets and not government efforts.
The state’s extensive control of life in India creates the belief that the government is required to design solutions to all problems. In reality, the best outcomes occur as a result of what economists call “spontaneous order”–that is as “the result of human actions, not of human design.”
Economic growth comes from innovations in the private sector. They are the players. The government is the umpire who ensures that everyone plays by a clear set of rules and no player cheats. These rules must be simple, unambiguous and enforced consistently so that one player is not favored over another. And to allow players to perform to their potential these rules must be kept to a minimum.
What can the Modi government do in its role as umpire to impact the economy?
- Simplify Tax Policy: Simple, fair and transparent tax rules improve compliance and increase revenue collection. There have already been 21 revisions in GST policy since its introduction. This reduces confidence in the rule, introduces needless uncertainty for businesses and hurts production and revenue collection. India could lead the world in tax simplification by replacing all existing direct and indirect taxes with a uniform GST of 10% on ALL goods and services consumed in India.
- Minimize Regulations: It takes 1 form and 1 day to launch a new business in New Zealand. In India, it requires 15 procedures and 26 days. With today’s technology, it can’t be that hard to register a new business. After all, if New Zealand can do it, so can India. The regulatory chaos in India appears to be deliberate because it facilitates rent-seeking and bribe collection. Mr. Modi can jump-start the economy tomorrow by ordering every government agency to eliminate all regulations that do not meet the twin objectives of citizen protection and ensuring equality of rights and opportunity.
- Improve Trust: Lack of trust adds considerable cost to doing business in India. The government can improve the economy by increasing the level of trust through a fair legal system with strong rules for property rights and contract law. Every player should know that contracts will be enforced and breaking rules and cheating will result in punishment. The government can encourage risk-taking and mitigate business uncertainty by creating separate courts with judges skilled in contract law to expedite the settlement of contractual disputes.
- Diversify sources of capital: Capital is the lifeblood of business. Indian businesses depend too heavily on state-run banks to provide capital. As a result, capital is both inaccessible and expensive. The government can help by minimizing its control over the banking system and encouraging the development of alternative sources of capital like corporate bonds, equity crowdfunding, peer-to-peer lending, and a stock market for startups.
- Accountability: Mr. Modi must remind all government employees that they work for the people and not the government. He can pass an executive order tomorrow that all future promotions in government will be based on citizen evaluation of services provided.
Mr. Modi would do well to remember what the 17th-century merchants told the French king when they were asked what the government could do to help– “ Laissez Faire” which translates to “ just let us be” is what they told the king. Mr. Modi can best help the economy by fixing India’s broken institutions and minimizing government interference in economic activity.