Doing Business versus the real Business Environment in Indian States

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Sabyasachi Kar and Spandan Roy

The World Bank’s Doing Business (DB) rankings for 2019 are out and India has again made a jump to 77th position from 100th in 2018, which too was 30 notches up from 130th in 2017. These rankings are based on the country’s performance in several areas, like starting a business, getting construction permits, getting electricity, contract enforcement, etc.—fields where India has traditionally done very poorly, resulting in its global rankings hovering around the 130s during the last decade. This had prompted the current government to initiate a slew of business-friendly institutional reforms including, “Make In India”, simplification of tax procedures, bankruptcy laws and so on. However, in reality, DB reports do not provide a dependable assessment of a country’s business environment, a point made by a study published in 2015 by Mary Hallward-Driemeier of the World Bank and Lant Pritchett of Harvard University. This study compares the DB reports, which are based on interviews and questionnaires administered to local domain experts, with the World Bank’s Enterprise Surveys (ES), which are based on a sample of firms in each country. It shows that the two reports have very different answers for similar questions on the business environment. For example, according to the DB report, it took about 180 days to get a construction permit in India in 2014, but the ES data shows that during that same year, some firms needed only one day while others needed up to 365 days to get the same permit, with the average being 33 days. This shows that the de jure rules of businesses that are captured by the DB reports and the de facto reality reflected by the ES reports differ significantly.

Several studies have been undertaken in India to throw more light on this issue, leading to more information on some of the broad trends in the country’s business environment. However, these studies fail to provide a deeper understanding of its causes due to the lack of a conceptual framework to analyze these trends. What should such a conceptual framework look like? In a recent book coauthored by one of us (The Political Economy of India’s Growth Episodes) we argue that the business environment in any developing country like India results from the nature of deals that are struck between the state and the business leaders.  Here, the state includes both the political and the bureaucratic class. These deals between the state and select business entities explain why, for example, it takes some firms in India only one day to get a construction permit while it takes other firms around one year. This framework should lead to two clear questions that any study on this issue should focus on: (i) what are the underlying social, economic or political characteristics of a state (be it the Central or the state government) that would encourage it to provide better deals to the bulk of the private sector firms and (ii) what are the strategies firms undertake in order to ensure that the political class offers them more business-friendly deals.

Under the international pressure of doing well in the DB reports, the Narendra Modi led-NDA government in India has attempted to clear up regulatory red-tape and putting in new policies and effective systems in place. However, policy decisions made in New Delhi are not necessarily implemented with the same zeal in the Indian states, where most of the implementation of policies take place. In a recent paper co-authored by one of us (Unmaking “Make in India”: Weak governance, good deals and their economic impact by Rajesh Raj S.N., Kunal Sen and Sabyasachi Kar), we show how de-facto norms determine the business environment in Indian states, rather than de-jure rules. In Bihar, “the 10th percentile set of firms reports obtaining an operating license in one day, while 90th percentile set of firms reports obtaining a license in 90 days”. This wide variance in firms’ within-state experiences makes it clear that a company’s regulatory experience is a product of its deal-making ability.

Most interestingly, this paper shows that firms in states with weaker capacity and poorer governance, are able to secure better deals. This clearly shows that for an average firm in India, good business environment is the outcome of regulatory failure rather than a more efficient regulatory process. Some would argue that this is fine since this is a form of corruption that enables higher growth. Unfortunately, the study finds that even that is not true as in most states, good deals go to the least productive firms. This jeopardizes the healthy growth in the Indian manufacturing scenario as the most unproductive firms are able to undercut and outcompete more productive firms by manipulating the regulatory environment. Moreover, such regulatory capture also creates structural disincentives for improving the governance capability of these state governments. This perpetuates a vicious cycle of poor governance in Indian states and unproductive growth in the Indian business sector.

Dr. Sabyasachi Kar is a Professor at the Institute of Economic Growth, University of Delhi, India, and Spandan Roy is Senior Field Investigator, Institute of Economic Growth. Email: skar_ieg@yahoo.com

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