Democracy and Capitalism: Reinforcing the complementary foundations of modern India

(first published on the now-defunct website, IndiaBanao!, on 2nd December 2008)

Democracy and Capitalism must reinforce each other in creating the bedrock of a robust Indian State. This might seem a trite truism, but our national commitment to Capitalism has been half-hearted at the best of times, while our commitment to Democracy is periodically questioned despite having been collectively reaffirmed after the traumatic challenge of the 1975-77 Emergency.

In fact, Capitalism and Democracy should be seen as complementary values that are strengthened only if both are robust. The global financial system now faces its most serious crisis of confidence in 80 years, partly because US democracy failed to play its role as an effective watch-dog and regulator of its capitalism. But the truly notable feature is that capitalism has delivered growing prosperity to a swelling proportion of the world without a systemic crisis during the intervening eight decades.

Only for a fifth of that 80-year period has India fully partaken of the fruits of that prosperity, while China has done so for about a third of that time. Those that embraced capitalism (and democracy) earlier – the US, Japan, Germany, and western Europe – were able to catch up with and surpass the originator of laisser-faire capitalism, Britain, by 1945. Even in pioneering Britain, however, capitalism and democracy had reinforced each other from the outset – in distinct contrast with Britain’s non-white colonies, where capitalism coexisted with autocracy, and so never developed the checks and balances that alone can allow capitalism to truly flower and deliver benefits to the broadest swathe of the populace.

Why capitalism’s foundations in India are shaky

From independence onwards, capitalism in India has been on shaky ground ideologically. History had a lot to do with this: having been colonized by one of the world’s first joint-stock companies (the British East India Co., which came to India ostensibly to trade but quickly built up huge armies and bureaucracies in order to reign over the country), our founding fathers had an ambivalent attitude, at best, to capitalism.

Over time, the Fabian Socialism of Nehru gained the ideological upper-hand over the pro-capitalist sentiments of such stalwarts of the right-wing of Congress as Sardar Patel and Rajaji. The ideological polarization globally at the end of World War II appeared to leave our leaders with two stark choices – either to pursue the Anglo-Saxon model of capitalism (then leavened by substantial public intervention in the heyday of Keynes in Britain and the New Deal in the US), or copy the model of the other victor of that war, the Soviet Union. In a rather muddled desire to pursue a “middle way”, Nehru welded a fundamentally Anglo-Saxon constitutional structure onto an essentially-Soviet model of economic planning with the “commanding heights” controlled by the government.

It should have been obvious that the constitutional arrangements would prove thoroughly incompatible with the economic objectives. The Independence generation was imbued with idealism and a sense of service, but they assumed away the importance of self-interest. While the constitution made the right to property a fundamental right (and the system of property rights is of course a bedrock of democratic capitalism), the Indian state kept chipping away at that right over time -- through land reforms in the 1950s that de-legitimized the property rights of agrarian landholders, and through bank nationalization in 1969 that made capital-allocation a hand-maiden of an intrusive state. An already-impoverished nation saw the gradual erosion of any motive for private capital to be harnessed for national development – as the State increasingly sought to “pre-empt” meager national savings for purposes of its choosing.

The ills of the resulting license-raj are too well-known to need recounting. Companies needed licenses to expand capacity, and even change their product mix – and a labyrinthine edifice of corruption emerged to regulate that process. The system rewarded rent-seeking rather than value-creation – and only a mighty balance of payments crisis (precipitated by the combination of a surge in oil prices and the loss in remittances from Kuwait and Iraq, plus the collapse of the Soviet ally that used to buy a fifth of India’s then-meagre exports) finally led Narasimha Rao to embrace an economic metamorphosis.

The apparatus of the license-raj, and the elaborate system of protection from imports (a peak import duty of 350%, plus outright bans on the import of 3000 consumer goods), were dismantled within a decade of the advent of the reform era in 1991. But the mental apparatus of “socialism” never quite left our political class – a substantial majority of which remains wedded to the “public sector”, of government-owned banks and lumbering, inefficient government-owned companies producing everything from bread and milk to steel, aluminium, electronic products and heavy machinery.

Fortunately, during his brief tenure as “Disinvestment” Minister, Arun Shourie was able to demonstrate that every single public-sector company that he privatized was able to perform substantially better – both in terms of profitability (which benefited both the new shareholders, and the government as a minority shareholder) and in terms of worker-productivity and job-security, the combination of which delivered substantially better rewards to workers as well as owners, and ultimately to the nation (in the guise of better-functioning companies that were no longer a drain on the taxpayer, as they had been prior to privatization).

But merely the logic and rationality of raw evidence is never sufficient to convince our political class, and five years have since elapsed without an iota of progress on the path to privatization that Shourie had so clearly laid out. Politicians (and bureaucrats) have too much invested in the entitlements of the public sector (free seats on planes, trains; cars and drivers, and all the other petty services that government companies provide for ministers and babus, apart from the appurtenances of corruption). So our politicians continue to spout elaborate “ideological” justifications for the persistence of government ownership.

Had our founding fathers been a little more willing to consider other models, they may not have been so blinded by confusion. In Asia, Japan had demonstrated that a mixed-economy with a capitalist orientation could in fact deliver prosperity to a backward nation within a generation (although this was somewhat obscured by the ravages of war by 1945). Japan dismantled its own feudal structures in 1868-70, but compensated the old aristocracy in the form of government bonds (some of which were quickly devalued by high inflation in the subsequent decade) and stocks in the new government enterprises that kick-started Japan’s industrialization. Over time, these fungible stocks and bonds helped turn the old feudal caste of samurais and daimyos into the merchants of the sogo-sosha trading houses that came to dominate Asian commerce by the 1930s, and resumed doing so by 1955.

Unlike in Nehru’s India, Japan never abandoned the market-based allocation of resources and factors of production. Severe Soviet coercion could not adequately allocate capital, labour and resources – so it was hardly going to be possible for Nehru and Mahalanobis to do so in a non-coercive democratic era. Instead, India’s “socialism” led to the ossification of caste and class, the stultification of enterprise, and very modest economic growth between 1947 and 1980 (3.7% real GDP growth annually, albeit substantially better than under British rule, which saw 0.7% annual growth from 1900 to 1947). The reason we need to keep “reforming” parts of the economy even now is because the dead-weight of Soviet-style government-directed resource-allocation still afflicts important nooks and crannies of our system.

Demographics, and substantially-free resource allocation, have moved us to a much-faster growth path (6.7% annually for the past 10 years). But we still need to free up the vast public sector – NALCO, BHEL, NHPC, NTPC, SAIL, etc. plus SBI, LIC, UTI, etc. – that continues to distort the free market. Only then can the full promise of democratic capitalism be realized. Ironically, what Japan did in the 1880-1910 period – gradually shift most of its publicly-owned companies to private ownership – supposedly-communist China has done in the past two decades. Whether it is cars, steel, petrochemicals, semiconductors or consumer electronics, former state-owned companies are now in the vanguard of China’s capitalist transformation – and their embrace of capitalism is largely responsible for the consistently faster economic growth China has achieved than India. Ironically, democratic India’s tentative steps in the direction of unfettered industrial capitalism were nipped in the bud five years ago. In the agriculture sector, capitalism has never fully been allowed to exist, and our pension and provident fund systems remain in woeful need of private-sector efficiency in order to prepare us for the ageing of our population in thirty years time.

Reinforcing democracy as a handmaiden of capitalism

Unlike today’s Japan, however, China is not a democracy. Instead, China has achieved economic progress via a developmental state a la Japan and Germany before the Second World War – with the iron hand of autocracy committed to delivering steady prosperity that stifles the need for dissent. South Korea, Taiwan, Chile and Indonesia – among others – have demonstrated that this model ultimately faces a crisis of legitimacy when state-directed capitalism creates a large-enough middle class, or when a threshold level of per-capita income is achieved. Korea and Taiwan reached this limit in the late-1980s, Indonesia in 1998 – and China is about five years away from the threshold per-capita income levels of Korea and Taiwan in 1990.

India will never face the gigantic crisis of legitimacy that felled Suharto, Pinochet, or the successors of Park Chung-hee (Chun Doo-hwan) and Chiang Kai-shek (his son Chiang Ching-kuo). The daily aggravations of relatively slow democratic governance are infinitely preferable to the massive upheavals (thousands of deaths, massive repression, economic crises lasting several years) that usually accompany the fall of long-standing dictatorships. Smooth political transitions are a precious gift of our successful democracy that we should be very grateful for (and proud of).

Democracy confers other benefits in the long term, including creativity and enterprise far beyond what autocracies like China can achieve. In China (as in Japan before WWII), large formerly state-owned enterprises are typically at the vanguard of the economy – but rarely are they real fonts of entrepreneurship. In post-1991 India, by contrast, entrepreneurship has had a true flowering: not only did companies like Infosys, Wipro, Satyam, Suzlon, Biocon, etc., emerge from minuscule beginnings, but many of the grand old companies of India remade themselves from rent-seeking entities of the License era into enterprising risk-takers ready to take on massively heightened competition at home and also remake themselves into global players within specific niches.

Thus the Tata group made Tata Steel (which used to be dwarfed by SAIL in the Indian market) into the fifth largest steel manufacturer in the world (through acquisitions made possible by spectacular cost savings in the Indian operation, their expansion to Asia through Natsteel, and the eventual purchase of Corus), grew TCS into a world-class software producer, and Tata Motor into a successful maker of small cars and medium-size trucks (some of them made in Korea) as well as owner of a couple of luxury marques known around the world. The AV Birla group became a global player in key commodities like aluminium, carbon black, copper, cement and textiles – but faced Indian competition in the metals space from the enterprising upstart Vedanta / Sterlite (which capitalized on privatizations -- at home with Hindusthan Zinc and BALCO, and abroad through its superbly-timed purchase of the copper mines of Zambia).

All these corporate groups were beneficiaries of the freedom and creativity that is possible in a democracy. Ironically, however, the moral foundations of our democracy itself have increasingly been undermined over the past two decades. The quality of political leadership has deteriorated, our morality appears to have plunged as materialism merged smoothly with corruption, and the perception has grown that the political class is concerned merely with personal gain even at the expense of the broad national interest.

Middle-class Indians bemoan the limitations of democracy, and increasingly yearn for tougher governance.

Strong, effective rule and an unyielding commitment to the national interest, however, are not necessarily incompatible with democracy. In fact, in successful democracies like Japan, the US and the UK, democracy coexists with effective enforcement of the law (often unobtrusively, as with Japan’s police, which presides in the friendliest way over a virtually crime-free society). Our democracy increasingly gives more and more rights to criminals and terrorists – without understanding that the concomitant result is the abridgement of the rights of the vast majority. Sectional political interests increasingly interfere with – and thoroughly undermine – the autonomy of the Institutions of governance. Ultimately, this erosion of morality will begin to eat into the vitals of our vibrant economy – as the terrorists of 26/11 so vividly illustrated in Mumbai last week.

To truly make democracy the handmaiden of a more robust capitalism, we need to seize back our institutions and create an iron core of laws that assure the relative autonomy of key institutions. The Supreme Court and Election Commission have relative autonomy – partly because their tenure cannot really be interfered-with significantly by politicians. (There has recently been an attempt to inject partisanship into the Election Commission, which we must monitor and counter at all costs). Other key institutions must also be freed from political interference, including the Reserve Bank of India (by ensuring that the Governor appointment is undertaken via a more bipartisan process), and key national-security posts (including NSA and chiefs of IB and RAW, who must all be subject to closer parliamentary scrutiny – in camera, where necessary). From the top, this relative autonomy must also begin to filter down to the grassroots, with the police in particular given genuine relative autonomy (freedom from political interference) after their pay-scales and service conditions are improved dramatically to ensure that they inspire fear at least among the criminals and terrorists rather than being seen as simply harassing private citizens. Only with the restoration of the genuine autonomy of our institutions can we be sure that the gains of our capitalist revolution of the past two decades will not go up quickly in the smouldering smoke from the fires that consumed south Mumbai last week, and could spread much wider if we remain careless about our precious civilisational heritage of tolerance leavened with morality.