View: Why Indian economy needs reforms, not stimulus
Sagging sectors of the economy should not expect bailouts from the government
A common tactic that large corporations in India have learnt to deploy effectively whenever they incur large losses is to impress upon the government that unless they are bailed out, the entire sector, even the whole economy, might run into deep trouble. I witnessed the use of this tactic first hand during my years at the Niti Aayog.
In 2015, a leading industrialist whom I had known for a long time came to see me and made this “too big to fail” argument to me. I smiled and told him, “I am afraid such fear mongering does not impress me.” The industrialist smiled back and said, “You are right [about fear mongering]. But when I make this argument to officials in ministries, it often produces the desired result.”
Unsurprisingly, now that the auto industry is experiencing a slump in sales, its captains can be seen making the “save us or else deluge” argument everywhere. For instance, appearing on a foreign television programme, the vice-president of sales at Suzuki Motorcycle India recently noted that commercial vehicles are the first indicator of the health of the economy and declared that their declining sales should be “a wake up call for … the government of the day”. On the same programme, the director general of Society of Indian Automobile Manufacturers (SIAM) opined, “Government has to come forward and help the industry” and that “We feel that a stimulus package is something that the government should really be looking at.”
It is nobody’s case that the government should never intervene to pull up a sagging economy. But such interventions should be the exception, not the rule. Creative destruction is an integral part of a dynamic economy. If the government implicitly underwrites the losses of private enterprises by offering stimulus any time they suffer large losses, it runs the risk of making them indistinguishable from the numerous inefficient, perpetually loss making public sector enterprises.
Profits and losses are key signals that guide investment flows in a market economy. Losses force entrepreneurs to work harder to innovate and cut costs. If they fail despite this because demand has shifted for good, it is time for them to move their investments to other, more profitable sectors. Government rescues that shortchange this process harm rather than benefit the economy.
In the specific case of the auto industry, the case for a government-led rescue is particularly dubious. It is an industry that has enjoyed absolute protection from foreign competition for the entire post-Independence era. Even when import liberalisation became ubiquitous in all sectors, this sector remained protected by an ultrahigh tariff wall. Today, custom duty is 60 per cent on cars costing less than $40,000, 100 per cent on more expensive cars and 125 per cent on used cars.
High tariff protection has allowed inefficient small auto plants to thrive in India at the cost of the customer. In many cases, she is paying one and a half times the price that the customer elsewhere in the world pays for the same car. If the industry thinks that it is fundamentally competitive and its present problems are temporary, it should use the huge profits it made over the last two decades to offer its own discounts to keep its sales going. Alternatively, if the problems are of a long-term nature reflecting its low productivity, it needs to restructure by closing inefficient plants. Profiting on the back of the taxpayer is not the answer.
Prima facie, it stands to reason that the industry’s problems are of a long-term nature. Had it been genuinely competitive, it could have easily made up for the temporary fall in the domestic demand by diverting sales to the vast export market, which was worth $740 billion in 2017. But with just 0.9 per cent share in this market, Indian auto industry has hardly proved its mettle in the world market.
Before rushing to a stimulus package, the government must ponder two important facts. First, loss making sectors always acquire a disproportionate voice in the media and have a vested interest in representing their plight as the plight of the entire economy. But this masks the reality of many sectors quietly operating profitably and growing healthily alongside. For instance, according to media reports, products such as smartphones, smart speakers, washing machines, refrigerators and air conditioners have seen their unit sales grow faster in the six months ending in June 2019 than the corresponding period in 2018.
Second, there are serious dilemmas in financing any stimulus package. If the government chooses to stay the course on its fiscal deficit target, it would be either diverting funds from more important expenditure items or sending its tax inspectors to extract yet more revenue from already overtaxed taxpayers. If it finances the stimulus by expanding its borrowing in the market, it would undermine yet further productive private investments in profitable sectors to reward inefficiency in the auto sector.
In the short run, India’s best bet is to let the interest rate and exchange rate do the work. In the longer run, we must accelerate structural reforms. Among these, reduction in government stake in listed public sector enterprises in which its current share is 65 per cent or less to 49 per cent should be at the top of the agenda.
(The writer is Professor of Economics at Columbia University)