Not doing business in India

Since much of his work on “technology shocks” really centres around what happens in and to a typical firm in an economy, when he met President A P J Abdul Kalam last week, one of Nobel laureate Finn E Kydland’s first questions was how long it took to start a business in India.

Between seven and 14 days was the President’s reply, Kydland reported. Going by most global standards, that’s pretty good. Except, it actually takes 89 days to get all clearances to start a business—since the President’s expertise is science, not red-tape, he can be forgiven for getting this answer wrong.

Confronted by the real figure, and others such as the fact that it takes 10 years to close down the same business and 425 days to enforce a contract, Kydland said this was a classic case of policy limiting a firm’s ability to deliver “technology shocks”—along with Edward C Prescott, Kydland won last year’s economics Nobel for showing how technology shocks rather than conventional demand-side explanations were what really drove businesscycles in the world.

How important this is can be judged from the fact that barely 24 hours after Kydland spoke of this, the IMF’s first deputy managing director Anne Krueger spoke of the same thing, of how it took 89 days to register a business in India, as compared to a mere two in Australia.

Krueger didn’t delve on the other statistics, but one look at her and it was obvious what she felt about them.

Looked at another way, what these numbers are really saying is that no matter how much FDI the country is able to attract, local investment, especially that by small and medium enterprises, is always going to be constrained—after all, if it takes 89 days to register a firm, and another 425 more to enforce a contract, after which you get just around 12.5 per cent of what is due to you, and if God forbid your business doesn’t work out, another 10 years to close it down, who’s going to want to invest in any business?

What’s frightening is the impact of all this on India’s GDP.

Clearly it’s difficult to measure the impact of this since there is always investment that is taking place, but the World Bank, which has compiled all these figures through exhaustive surveys in various countries across the globe (including nine states in the case of India), attempts a few exercises.

For one, it quotes T N Srinivasan’s figures to say the ratio of private sector business or corporate investment (as opposed to total private sector investment) to GDP has consistently been falling from 9.9 per cent in 1994-95 to 4.9 per cent in 2001-02—in other words, the fact that the poor investment climate is restraining investments can be seen from this, even if only partially.

Having got sample data from 40 cities within 12 of India’s 14 largest states, the Bank then supplements this with Annual Survey of Industries datasets to draw up a fuller picture for each state for things like labour and total factor productivity—total factor productivity in high-growth states, for instance, is more than 2.5 times that in the lower-growth states.

What it then finds is truly amazing. The model shows that labour productivity falls by almost 28 percentage points when firms have to draw double the share of power from their own gensets.

While larger industry associations typically tend to go on about the impact of labour laws that don’t allow hire and fire, it appears the impact of this is much less serious.

If companies had double their current overstaffing, the model shows, their labour productivity would fall by only three percentage points—in other words, companies have by and large found a way around the rigid labour laws.

What they haven’t found their way around, however, is the time/money taken up by complex tax administration including customs formalities. If the number of firms serious dissatisfied with tax administration doubled, labour productivity would go down 10 percentage points.

All told, the Bank’s model shows that if the power problem is resolved to the point industries don’t need their own generators, labour productivity would rise more than 80 per cent in high-cost cities. Reforms in tax/customs administration would raise labour productivity another 60 per cent.

While it is true that the last 15 years of reforms have cut red tape to a large extent —the number of annual factory inspections has come down from 11.7 in 2000 to 7.4 in 2003, for instance—things still remain abysmal, and this is why India’s policy of gradual reform (even more gradual now that “caring” governance is the motto of the day!) simply isn’t going to deliver.

Early figures given out by the government report a huge improvement in the finances of state electricity boards (SEBs), which is vital if the power situation is to improve consistently.

While these numbers have to be viewed with a bit of caution since SEBs’ reporting of facts appears to have a logic of their own, what’s important is that after five years of very generous central assistance to reduce losses, SEB losses are still around Rs 20,000 crore a year.

And while it is true the government has been promising a slew of tax reforms and simplification of procedures a la Kelkar, this column reported last week how the Supreme Court had to come down on taxmen who simply refuse to give up their powers of harassment.

How Mr Chidambaram plans to tackle this, of course, will become evident in a few weeks from now.