Industrial Policy in Perspective

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Speech Delivered by R K Hazari at the Administrative Staff College of India, Hyderabad.

Once upon a time there was a feeling in this country that the wise people, who had either been elected to power or who were likely to be elected to power or those who had come into positions of authority and power by a process of careful selection and examination, were the best people equipped to decide upon the allocation of resources.  

The Fabian philosophy which formed the basis of much of our thinking, and even much of our political programming, made the basic assumption that one could not leave such an important matter as allocation of resources to the free play of market forces.  

There is, of course, no such thing as completely free play and no such thing as utterly free market forces, but even such as they were, they  had to be fully subordinated to careful allocation under socially authorised decisions of the people in power.   The generation to which I belong and an earlier generation were brought up on the intellectual cuisine of the London School of Economics and Cambridge and greatly influenced by the success during the thirties of the Soviet planning mechanism.     In simple terms, we were brought up to believe that policies should be at least regulatory.   Now, it follows from the definition of policy that it has to do something either inconsistent with or different from how things would be if left to themselves.   Otherwise, there would be no need for policy.   So policy involves some kind of intervention. Even non-intervention is a policy, just as indecision is also a decision. While thinking of a regulatory framework, the generation to which I belong was keenly aware of the traumatic experience of the twenties and thirties during which it was found that the gold standard did not work, imperialism had to change its stance, Russia demonstrated that planning could achieve a large number of social objectives which had not been achieved by the market economies, unemployment came to be regarded an unmitigated evil, and all civilised governments accepted the proposition that government had a lot to do with the creation and maintenance of employment. In this environment, the framework of the war economies between 1939 and 1945 and the subsequent efforts at reconstruction of Europe and Russia and China, all reinforced the belief that it was both desirable and feasible to have a large measure of intervention either by government authorities or by the duly constituted representatives of the community to achieve certain social objectives.

This whole spectrum of   ideas was markedly different from the ideas of liberalism that had prevailed through most of the 19th century and  in the early 20th century, when it was believed that the economy should be liberated from various kinds of trade prohibitions and internal and international barriers, restrictions on movement of personnel and of capital, etc.   In the 19th century, the idea was that the invisible hand of the market was more efficient, more effective, more conducive to progress and growth than the visible hand of the sovereign.   This liberalism came with a fair lot of philosophical baggage.   Just as Greek democracy was relevant only for citizens, not for slaves or women, who constituted the bulk of the population, similarly, most of these liberal ideas applied only to the masters of the world, mainly what are now considered the Western powers.   For colonial peoples, the philosophy was certainly talked about but with some concession to the need for protection, advocated by the Germans and the French, for whom many of our intellectuals had great admiration.   Dadabhai  Naoroji,  Gokhale and Ranade, who were our principal economic thinkers in the late 19th /early 20th century, believed in political liberalism, but not in full economic liberalism as it was advocated in England.   They wanted to protect the infant Indian industry against the competition offered by English goods,  and a certain degree of positive government intervention.

 In tracing the history of Industrial Policy, it is necessary to keep in mind that while there are certain important documents called Industrial Policy statements, a more comprehensive and realistic view requires allowance for the fact that policies can also be made from day to day by a series of actions and by regulations rather than by laws, by interpretation and implementation rather than by statements.

The earliest that I can trace back the recorded history of Industrial Policy is to the 1870’s, when it was called Stores Purchase Policy, beginning with the purchases by the railways, whether of coal or local minor engineering goods required for the construction and operations of railways or, if you like, such things as the purchase of paper and stationery.   By sheer force of circumstances, the railways required coal which could not be supplied from England, leave alone France, Belgium or Poland.   Therefore, coal mines had to be opened.   Similarly, the operation of the Post Office called for local purchases of such things as sealing wax, certain kinds of paper, bags of various sorts, and uniforms for the employees.   There were many letters exchanged between the Secretary of State’s office in London and the Government of India on such mundane issues. One can multiply these examples.   Much later, this kind of demand spilled over into the purchase of pig iron and steel rails.   It might interest you to know that the setting up of Tata Steel at Jamshedpur was initially made possible not only by Jamshedji’s  great enterprising ability but also by a firm order of 1 lakh tonnes of rails for the Indian railways.   That is how the plant was made feasible.   Later, the demand rose to 3 lakh tons and so forth and, accordingly, the size of the Tata Steel plant kept on expanding till, in the early 1950’s, it was the largest integrated steel plant in the British Commonwealth.

A fillip of sorts was given during the First World War [1914-1918], when, due to disruption of transport and communication, the Government of India was compelled to appoint a Munitions Board in 1916, which started procurement of material not so much for the war in Europe, as for the war in the Middle East:   anything in the Middle East was very sensitive for the British Empire in India.   As a historical footnote you might be interested to know that when, before the War , the Germans were extending the railway network into the Turkish Empire, they wanted to build it right upto Basra, at the head of the Persian Gulf.   The British Government intervened very actively to ensure that there was a break of railway gauge quite some distance before Basra, so that the railway line would not threaten the Indian Empire which, at that time, included Aden.   In response to enlightened Imperial interest, the British government felt that some purchases had to be made in India.   Some industry had, therefore, to be developed in India.   This became all the more necessary , again from the Imperial viewpoint, because if the Indian market had been kept totally free, in the traditional 19th century meaning of the term, the beneficiaries would have been not just British industry but also German industry and, later, also the Japanese.

Some of the development on the ground got dismantled after the First World War, when war demands disappeared.   In response partly to the Imperial interest, but also due to the strident demands made by Indian political leaders, a Fiscal Commission was appointed in 1924.   The burden of the Commission’s recommendations was that a limited degree of selective protection should be given to Indian industry against foreign competition, including British competition, but British goods were to get preferential treatment as part of the Imperial arrangements.   I deliberately refrain from getting into the textile question, because most students of history are familiar with it.   I wish only to point out to you that while the British were naturally eager to promote the interests of   Lancashire, they did not seriously attempt to throttle the Indian cotton mill industry.   First, it served their interest in terms of export of yarn to China and Japan from India.   Second, while Lancashire was important, so was the export of British mill machinery.

To cut a long story short, during the twenties and thirties, we had limited protection   (i)   for textiles more against Japan than against Britain;   (ii)   for iron and steel, more against Germany and Japan than against Britain   and   (iii) for sugar of which we were importing a lot from what was then called the Dutch East Indies, present day Indonesia, which led to a rapid growth of the sugar industry in UP and Bihar, where there was an urgent need to find a substitute for indigo, which had been replaced by synthetic dyes pioneered by Germany.

My biased view on the subject is that industrial policy since independence is essentially a continuance of these two strands of policies namely,  (i) Government purchases or public sector purchases or what you might in more sophisticated language call the investment or expenditure policy of the government under plan and non-plan outlays and (ii)   import substitution by protection or otherwise .   Much of Indian industrial history can be explained in terms of these two strands.   Nearly two-thirds of the orders placed on the engineering industry come directly or indirectly from the public sector.  Similarly, much of our growth has been determined by shutting out imports either by import licencing or by tariffs or by expanded or diversified production in one form or the other.   The third strand which has acquired significance since the mid-fifties is the setting up of the public sector. The public sector also is not an entirely new idea.   There were attempts at setting up of a few Government-owned and Government-managed industrial units in the 19th century, but most of these were closed down under instructions from London because they were inconsistent with government philosophy.   In any case, they were not large units.   The only large direct Government intervention which survived was in the form of certain railways.   Besides, due to various events after the First World War, the British-owned railways started passing under Government ownership.   But, as you are well aware, this was not uncommon even in those countries which had a fervent belief in private sector development:   even in the USA, where all the railways were privately owned and privately managed till a few years back, huge grants of land by public authorities and large financial assistance from various public agencies greatly facilitated railway development and assured its financial viability; these lands used to be resold to farmers in order to raise funds. Then, there were the princely states, in some of which industries were set up as a manifestation of the enlightened policy of the rulers. This was particularly marked in Hyderabad, Mysore, Baroda and in Saurashtra where many of the smaller prints set up a cotton mill each in the 1920’s and 30’s as a matter of prestige.   But these were all mere drops in the ocean:   anything done in India tends to be dwarfed by the sheer size of the country.

During the period of post-war reconstruction and   planning, a number of amorphous ideas did float around, partly to take care of retrenched and demobilised war personnel, partly because some appreciation of the Indian contribution to the War effort had to be expressed, partly because we had accumulated large sterling balances and there had to be a programme for their gradual utilisation.   The thinking at that time comprised, on the one hand, the official ideas based upon war-time British experience and, on the other, there was the very significant contribution of intellectual input made by the Congress National Planning Committee, of which Jawharlal Nehru was Chairman and K.T. Shah the principal author.   There was also a People’s Plan prepared by M.N. Roy, a former distinguished colleague of Lenin and Trotsky ,and an Industrialists’ plan.   Regardless of the precise source, whether official, socialist or capitalist, there was a very large measure of agreement that (i) the government should be very active in economic activity by giving assistance as well as by participation in new industry; (ii) efficient allocation of resources for definite purposes required a measure of Government regulations and controls.   Please remember that, soon after independence, government was very small in relation to the over-all economy, and it was busy with the problems of Partition, Kashmir, threats of communal disturbances – and there were fears that the zamindars, the princes, the army, the civil service, the police, the whole inherited   Establishment, was a danger to the new set-up.   The new power structure felt itself threatened by the old power structure, but rather than seek to crush the latter, it sought to take the reins by persuasion and gentle pressure.   Government did not have the confidence to take on much direct activity  itself, but it had confidence enough – inspired by the inertia of inherited regulatory powers and contemporary wisdom – to continue with economic  controls, after a brief premature experiment with decontrol initiated during the last days of Gandhiji’s life. So price controls continued, capital issues control continued and because it was believed that new industrial units must be consistent with social priorities about location, investment pattern and direction, and so forth, an Industrial Control and Regulation Bill was formulated, later, this Bill became the Industries Development and Regulation Act, the change of name implying a more positive orientation of intentions to regulate private investment in order to make it consistent with social purposes, as interpreted by those exercising legitimate authority.   By and large, both the interpretation and the legitimacy commanded wide acceptance. Not much of a public sector was contemplated at that stage.   The emphasis was on regulated private investments.

 It was only in the mid-50’s that the idea of the public sector emerged as the main vehicle for positive allocation of resources and for the building up of an industrial base.   The half-million ton Rourkela steel plant as contemplated initially was merely a continuation of the old small public sector investment concept. Russian aid for Bhilai and heavy industry was a major catalyst for expanded horizons in steel and power.   The progress (albeit slow) of river valley projects (Bhakra-Nangal, DVC, Hirakud) led to greatly enlarged Government self-confidence.   Meanwhile, food shortage and liberal imports depleted the sterling balances, bringing about the first of a series of foreign exchange crises in 1958.   Far from causing nervousness, the crisis gave a boost to import substitution and and financed infrastructure development.   It also improved the social attractiveness of the Draft PIan frame produced by Mahalanobis, then Director of the Indian Statistical Institute.   This impressive theoretical framework offered the speeding up of growth to through heavy industry, and balancing the income thereby generated by getting consumer goods and employment from cottage and small industry, which were believed to be labour-intensive and capital-saving.   This frame¬work had many gaping holes, but it had the merit of being original as well as native, Leninist as well as Gandhian.   If the Russian economic revolution had proved, as Maurice Dobb said, that growth was limited not by pre-existing savings but promoted by newly created savings, then what Mahalanobis offered went much further:   the promise of more employment and consumer goods also at low cost.   The Draft Plan- frame was the first Economic Dharmasastra in Indian history.   True to tradition, it was elegant and attractive to intellectuals and rulers. Also true to tradition, its acceptance was selective and subject to as many exceptions as looked useful or materially necessary.   Philosophically, we appeared to synthesise Fabian, Leninist and Gandhian ideas!   One quasi-ideological fall-out of this view was reinforcement of the regulation of large industrial units in respect of their prices, output, employment, location, investment, capacity and what have you, all for one good cause or the other.   At the same time, demand was assured – till 1965 at any rate – by steep increases in government outlay, and near-elimination of competitive supplies.

IV

One of the chronic hang-overs of Fabian philosophy was  that the prices of essential goods and services like  steel, cloth, cement, electricity and of railway fares and freights should be kept down.   This was meant to ensure that the general price level would thereby be kept down.   It was also believed that in the course of development, these commodities and services would tend to receive a disproportionate benefit of newly generated demand and their producers would therefore make excess profits.   In order to prevent them from doing so, and to conserve resources for investment either in production of these commodities or for investment elsewhere, the resources should it was believed  be canalised through official funds or similar means rather than be left in the hands of the producers themselves.   In other words, the consumer of these essential goods and services was not to pay directly for their growth and development; that was supposed to be a charge upon the national economy as a whole.    This idea has a curious history which is worth dwelling upon.   You might recall that in medieval Western Europe, if your travelled on a road ( or turnpike as it was called in England) you paid a toll.   You used a certain service and you paid for it on the spot.   Then, as an integral part of 19th century liberalism, all these tolls and local charges cane to be deemed as interference with trade and with the free movement of goods, human beings and   services. Most of these tolls and charges were, therefore, abolished to free the domestic economies from restrictions.    The theoretical basis of this abolition was admirably summed up in a famous article in 1926 by Hotelling. His theorem was fundamental to welfare economics till the late 1950’s.

This theorem demonstrated that if, for instance, you have a bridge and a charge is levied for its direct use, the welfare of all its users and of the entire society would be greatly reduced because of that charge. The argument was that the fixed cost of providing the bridge was a historical bygone, while the marginal cost of providing the bridge service was nil.    Since maximisation of welfare required that price be equal to marginal cost, the price should be nil.   The fixed cost would either have been recovered from a previous generation or could be recovered from present and future generations by means of a direct tax which, by definition, could not be shifted and which would not disturb the equality of price and marginal cost.   This theorem was advanced in the heyday of pre-Keynesian economics but its influence on economic thinking and price policy in a welfare state survived long thereafter – ultimately to undermine the economic foundations of all welfare states, but that is a different story.

The 1950’s was the first decade in many centuries when there was positive growth in the economy.   Only the sky appeared the limit -though food and foreign exchange were scarce towards the end, and there were nagging doubts about the increase in the concentration of economic power in the hands of capitalists.

Troubles with China cropped up in 1959 and came to a head in 1962.   Our defence expenditure, which had come down to about 2 1/2% of national income, started rising; till it reached nearly 6% in 1965/66.   This stiff rise ate into the development effort.   From 1962 onwards, there was a marked deterioration in the political climate. Politicians set about their factional games in anticipation of Nehru’s death and collecting funds from dubious sources.   Money used to be collected by politicians before also, but it used to be for a cause or a party, not for private purposes.   Politics came to be rapidly monetized thereafter especially in the seventies.   Simultaneously, however, strong feelings were built up against the further expansion of large private business units and groups and policies were framed for imposing a variety of further controls over their expansion as well as current operations. Meanwhile, in the mid-sixties, Lal Bahadur  Shastri’s disenchantment with planning, the Indo-Pakistan war, subsequent devaluation of the rupee and near-famine conditions led to abandonment of planning, except in name and ritual, with lasting deleterious effect on advance action in respect of railways, power and steel.   Fortunately, the momentum built up in agricultural research, and extension produced a green revolution in some parts of the country.   This positive development helped reinforce    a shift of political power from the urban to the rural elite.

There was no strong national leadership, no strong national political party, but a large defence expenditure.   Bank nationalisation and the victory of 1971 generated a great euphoria, underwritten by large food stocks  though food imports continued. Privy purses of former princely rulers were abolished by executive fiat after legislative effort was frustrated.   Political and economic power became more broad-based, and many new elements secured entry into the power structure.   The transition appeared smooth.  Radicalism   (with competitive populism thrown in) appeared to do no damage, partly because of the green revolution, partly because bank funds were deployed more widely than ever before, more rural based politicians and white and blue collar workers/ acquired explicit muscle.   Industries did not come to a standstill;   far from it.   Controls over the large units and groups created difficulties and caused delays, but small industrial units grew rapidly, and a lot of new industrialists came up who, it was believed, might not have grown to prominence, if the large houses had been allowed full sway. It took some time for the negative side to loom large.   The new elements that came to power, together with their apna aadmis, were neither familiar with nor did they care for what was essentially Victorian political values.   The standards and norms of public conduct changed quite rapidly.   Inflation undermined the middle class, which is the principal instrument of a welfare state – and of a bureaucratic-controlled economy.   Nearly every segment of the political spectrum sought to misuse power for personal or factional gains   – and, for that purpose, to abuse the police and administrative apparatus, followed logically by abuse of the instruments of economic and fiscal control to subserve partisan ends and display of arbitrary power.   Smuggling diversified and became rampant.  Avoidance or evasion of income tax, which is, a small part of total revenue , proliferated into avoidance or evasion of excise and sales taxes which are quantitatively far more significant. Price controls, MRTP, FERA, Company Law, the working of banks and financial institutions all these have got tied in knots, firstly because regulation has become so wide and deep that it had lost its purpose, secondly it is widely believed to be a device for abuse, and third, given ‘socialist’ objectives, each round of de-regulation involves circuitous navigation by politicians, administrators and businessmen.   To make things worse or at least more complicated, the performance of the public sector has been, on the whole, uninspiring, often disappointing.   The abuses and failures are no longer, as the Italians say, mere apertura; they are wide – open doors.    There has been, consequently, an undermining of the power of the State as also of the legitimacy of State controls.

I have deliberately spent some time on this question of ideas and legitimacy which I think are fundamental.   Everything else is a matter of operational detail.   The laws that regulate the economy, the parliamentary and executive controls that exist over the public sector, all these form part of this legitimacy of control. The private sector is accountable for its performance not only to the owners but also to the controllers representing  the public at large.   The public sector is run by professionals, not by owners, who are required to maintain certain standards of accountability.   Where have we gone wrong and how?   It is no use  blaming the politicians alone, because most of us are parties to what has happened.   Who puts the politician in power?   We do.    Where and which controls have gone wrong?

What are we seeking to control and for what purpose?   As in any particular firm, so for the country as a whole, there has to be a statement of objectives and a certain clarity of objectives, in the light of which you can conceptualise a control mechanism.   Nobody in his senses puts across the argument that there should be no controls at all.   All of us want traffic controls.   We want certain environmental controls.   We do need town planning.   We do need some controls over educational standards. All these are universally acceptable as necessary for the implementation of social objectives.   You are familiar with the ABC concept of inventory control, namely, that 80% of the total value would probably be in 9 to 10 items, maybe in only 4 items.   For a control system, therefore, one has to concentrate on the few items which account for the bulk of the value.   This elementary basis of a control system has, unfortunately, not  informed the controls that we have  had.    Take investment control.   All we need to do is   only to control the bulky investments, not all investments. About half of the new investment outside agriculture is in the public sector, for which the kinds of control that are required are different. For the rest, is it necessary to have all the present far-ranging controls? What I had suggested in my licensing report of 1967 was that you take the area or the projects that account for two-thirds of the total investment, and delete the rest from licensing.

We have sought to control capacity.   Capacity is an undefinable concept.   We all know that.   Once licensing is done in terms of capacity, everybody has a certain theoretical capacity and since licences are issued in a bunch, there is pre-emption of capacity by those who are quicker on their toes,   whether they are in the  private sector or in the public sector.   When the relative commodity will be produced in what quantity is a different matter.   The basic question is : are we seeking to have a monopolistic economy or a competitive economy? Licensing is a way of conferring monopoly of one sort or the other.   If we seek to have pressure of competition to reduce costs rather than the pressure of parlimentary enquiries and issue of directives or circulars, then regulation of capacity by itself has no meaning.

Then, there is the question of location.   When the IDRA Act was put on the statute book, policy for location was supposed to be one of its most important aspects.   Now, in many ways, the location of public sector units does take some care of overall locational policy.   Ideally, railway and power expansion should take care of locational policy.   If, on the other hand, you magnify the issue  to the other extreme you get the passion for no-industry districts. If you wish to untie the knots to which I referred earlier, you can keep on giving exemptions for Jammu & Kashmir, or Sikkim or no-industry districts or backward districts and so forth.   I am not objecting to this new passion.   What I am questioning, is the basis of the distribution of the cake over the country.   When you locate in Jammu and Kashmir or Sikkim, there are high costs of transportation, power and so forth. Obviously, every district does not have a sound case for industrial location.   Some districts do not even have water and many are not on the railway   or power map.   Rural electrification   has already undermined the economics of the power system.   If we are going to multiply these examples, are we in  pursuit of economic policy or distribution of largesse? These are high-cost  ideas.   Similarly, when we go in for import substitution, regardless of comparative costs, that also leads to high costs.   When instead of licensing  three or four economical units in a particular industry, we license twenty to please a larger number, these lead to high costs – and indefinitely high costs.

A short while back, I briefly explained the Hotelling theorem for pricing.  New economic thinking has now moved towards the other extreme.   It is believed that pricing of essential commodities should not only cover the full cost of production but also (i) provide for financing of growth, and what is more (ii) have a tax element so as to provide resources for growth elsewhere too. In other words, Items like electricity, petroleum, steel and cement should have a large tax element, apart from being subject to a pricing formula which covers full costs and also leaves a margin for re-investment of earnings.   What is increasingly being questioned in economic theory is whether price control is at all an economically efficient element of growth policy.   This is a far cry from the thinking of thirty to fifty years back since then it has been found that price regulation is at best a cost plus formula, which militates against reduction of costs.   Over time you get low productivity, obsolete technology and   uneconomical units.

Let me take financing briefly.   Whether in respect of banks or term-lending institutions, the ideas on control that came up in the late sixties and early seventies assumed that partisan politics would be kept out;   this was a brave assumption, which has not been borne out  by actual events, Second, these ideas assumed that the public sector must occupy the commanding heights of the economy which, in turn, assumed that the public sector would yield the expected results – better than unregulated private activity. Third, I was one of those whole   believed that credit and institutional controls would largely replace industrial licencing, and controls on  production and prices; this did not happen.   The new controls merely got added to the old controls.

Talking further about commanding heights or command performance, government alone now absorbs about 30% of national expenditure, a very large part of it in the form of administration, security or defence. Imagine the impact that this large chunk would have made had this expenditure been incurred on creating a genuine productive demand for goods and services.   Furthermore, the real value of public sector capital formation tended to stagnate for more than a decade after 1966 – even though, for statistical purposes, one-half of draught relief was included in capital formation.   While the public sector as a whole keeps on drawing more from national income, its contribution to further real capital formation and income generation has been disappointing.   Take import substitution, which has been so important an element of our industrial policy.   Most of the scope for import substitution was exhausted by the early seventies, with the exception of petroleum and petroleum associated products.   High costs and low productivity have meant that income generation and re-investment have been” depressed.   Finally the ” achievement” of a much higher capital-output ratio  offset the advantages that could have accrued from the impressive increase in the ratio of savings to national income.

What I have sought to emphasise above has, no doubt, been accompanied by a tremendous upgradation of skills, and of managerial capabilities.   There has also been a great building up of our educational capabilities, notwithstanding all the criticism of the system that one encounters.   Individually many of us can stand up to our competitors anywhere in the world;   it is as a totality or as a team that we get into  or cause  trouble.  

Finally, before I end, let me emphasise that such of our industrial growth as has been on a competitive basis, was based on cheap materials – not so much on cheap labour.   Indian materials are no longer cheap.   Our electricity is expensive when we get it.   Our steel is more expensive than international steel.   Now that we have a large debt burden, which we have to meet eventually out of exports, it stands to reason that we should be very much concerned about our material as well as labour costs and that in future industrial policy should be far more concerned with productivity, than with the distribution of the cake.

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