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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Political Economy of Special Economic Zones: China vs India

Towhid Iqram Mahmood

IMG-3084According to the World Bank in 2008, a modern day Special Economic Zone (SEZ) typically includes a “geographically limited area, usually physically secured (fenced-in); single management/administration; eligibility for benefits based upon physical location within the zone; separate customs area (duty-free benefits) and streamlined procedures”. For that, practices related to business and trade differ from rest of the country and therefore, all units therein get special privileges. SEZs can generate both static and dynamic benefits. Static benefits include employment creation, export growth and rise in government revenues; whereas dynamic benefits include economic diversification, innovation and transfer of technology through Foreign Direct Investment (FDI) and skills upgrading. However, good governance, proper political and investment conditions for business and timely order of work is quintessential for a successful SEZ. The successes of SEZs in China made other South Asian countries like India to succumb to the Chinese SEZ model. The notwithstanding principles of this model resulted in a poor performance of India’s SEZs though.

In 2016, Chinese SEZs have contributed 22% of China’s GDP, 45% of total national FDI and 60% of exports. These SEZs have also increased the income of participating farmers by 30% and accelerated industrialization, agricultural modernization and urbanization. Whereas for India, SEZs contributed only 3.72% of GDP and 20% of exports. The most astounding fact is that only 223 are operational out of 420 approved SEZs. Furthermore, only 40% of the total lands acquired for SEZs are in use. Most of these lands were deliberately taken out from agricultural production to apt with quicker economic growth.

Chinese experience with SEZs has indicated a number of factors that contribute to their success and effective operation. For example, SEZs need to be linked to economic opening and capitalize on innovation, political stability, promote industrial expansion, building brands, incubating local ideas by integrating learning, bringing together resources and expertise from government, industry and research institutions to move into more advanced value chains etc.

The ease of doing business index by the World Bank shows fundamental differences in incubating businesses between China and India. One can argue that India started economic reforms and initiated SEZs much later than China. Although that is a very small fraction of caveat that India faces if not minimal. A few of the major reasons for slow growth of Indian SEZs are lack of diversification of products, unstable fiscal incentives due to changing regimes and their belligerence towards policies from previous regime, poor infrastructure, political patronage and delay in environmental clearance and approval by state governments.

However, the low performance of Indian SEZs can be looked at from a political economy perspective.  With better than ever infrastructure and geographically ideal position, China offers something more than that India could offer to the international market. We know that China is a one-party political system whereas India is a multiparty democracy. From the viewpoint of an investor, Chinese market is way more lucrative than India in terms of political stability and investment environment. Of course, it is not always true that an authoritarian system can incubate better economic system (take Idi Amin’s Uganda for example). However, China’s performance has assured investors to rely on its economic system ever since it has opened its door to a market economy. Thus, political stability along with better business environment helped China to attract the flood of foreign investment unanimously. In case of India, SEZ rules have been amended at least seven times since its initiation in 2010. These changes are concomitant with the caveats of regime changes that, in turn, changes most of the policies and acts because of internal rivalries between political parties. On top of it, as mentioned, bureaucratic complexity has made it more difficult for investors to easily start a business in India. Unjust land acquisition without feasibility studies raises questions. Perhaps, some of these are answered when some lands acquired for SEZs are sold at a higher-than-market rate by political activists.

Drawing from the discussion, it can be stated that undoubtedly political stability and understanding between political parties to ensure economic success for a country is the primary incentive for an SEZ’s success. Learning from SEZs in India, a lineation of rivalry between political parties in a multiparty democratic system is a must if we want to parallelly increase economic stability with the help of SEZs. To bolster effective SEZs, well monitoring of the mechanisms with inclusive functioning cannot be negated.

Towhid Iqram Mahmood, Senior Research Associate, SANEM

E-mail: towhid.iqram@gmail.com

First published in the Thinking Aloud, 1 November 2018