economic-survey-vol-1-chapter-3-pro-business-versus-pro-crony

The aspiration of the Indian economy to reach the milestone of  $5 trillion, depends critically on Promoting Pro-business policies that wean away from Pro-crony policies.

$5 trillion Economy

Parameters for Analysis

The case for Pro-Business Policies

The case against Pro Crony Policies

Characteristics

  • Firms Compete on a level playing field.
  • Resource allocation in the economy is efficient.
  • Citizen welfare is maximized.
  • Some incumbent Firms receive preferential treatment.
  • Resource allocation in the economy may not be efficient.
  • Citizens welfare may not be maximized.

Impact 

On Businesses

  • The market undergoes creative destruction and brings in diversity. 
  • Creative Destruction: A process of industrial mutation that continuously revolutionizes the economic structure from within. It keeps on destroying the old one, at the same time creating a new one.
  • Free flow of new ideas, technologies and processes like Financial and Information technology.
  • It brings dynamism to the marketplace that keeps firms on their toes.
  • Builds confidence of Policy Makers.
  • Example: The economic events since 1991 provide powerful evidence. The creative destruction has increased in a significant manner after reform.
  • The liberalization of the Indian economy in 1991 unleashed competitive markets and enabled the forces of creative destruction, generating benefits that we still witness today. 
  • Pro-crony policies such as discretionary allocation of natural resources till 2011 led to rent-seeking by beneficiaries while competitive allocation of the same post-2014 ended such rent extraction.

On Society

  • Unleash the power of competitive markets to generate wealth.
  • Competitive prices for consumers.

On Businesses

  •  It may favor specific private interests, especially powerful incumbents.
  • It does not necessarily foster competitive markets.
  • There exists the danger of regulatory capture by private interests.
  • The crony firms become uncompetitive, nonperforming in the long run.
  • They are at the risk of becoming wilful defaulters and in turn increase the cost of borrowing.
  • For example, an equity index of connected firms significantly outperformed the market by 7 percent a year from 2007 to 2010, that reflects abnormal profits extracted at the expense of common citizens. 
  • In contrast, the index underperformed the market by 7.5 percent from 2011, reflecting the inefficiency and value destruction inherent in such firms.
  • Crony lending that led to wilful default, wherein promoters collectively siphoned off wealth from banks, led to losses that dwarf subsidies for rural development.
 

On Society

  • Business-Politics nexus that may hamper policymaking.
  • Rent-seeking by inefficient firms at the expense of genuine businesses and citizens who are not receiving any preferential treatment.
  • Transfer of wealth from competitive to non-competitive firms exacerbates income inequality in the economy.

 

Global Studies related to the impact of Pro-Crony Policies

Several global studies reinforce the relationship between such connections and rent-seeking activities when institutional checks and balances are weak.

A recent World Bank study of cronyism in Ukraine finds 

  • That the country would grow 1 to 2 percent faster if all political connections were eliminated.
  • Politically connected firms in Ukraine account for over 20 percent of the total turnover of all Ukrainian companies.

 The study finds some of the traits of these politically connected firms 

  • These are larger than non-connected peers
  • Pay lower effective tax rates
  • These are less productive in terms of total factor productivity (TFP)
  • These are less profitable and also grow slower 

The same findings are reinforced in Asian Economies too such as China, Thailand, Vietnam, Malaysia.

Conclusion

  •  Reforms aimed in the direction of Pro-business policies which furthers the eventual goal of maximizing social welfare are welcome.
  • For example, those that make it easy to start a business, register property, enforce contracts, obtain credit, bid for natural resources, get permits, and resolve insolvency help firms to function effectively and thereby enable competitive markets. 
  •  However, catering to the needs of crony businesses alone without regard for other businesses and the remaining stakeholders in the economy may end up benefiting the preferentially treated firms at the expense of other firms, market efficiency, and social welfare.

Also readGrowth Rebounding To 6% - Economic Survey

Summary Of Economic Survey 2019-20 Volume 1