Reform in Asia. Edited by Philippa Dee. 90. Southeast Asia's Credit. Revolution. From moneylenders to microfinance. Aditya Goenka and David Henley ...
Economic Reform Processes in South Asia
While South Asia’s economic reform initiatives of the last two decades were often born in crisis, this alone does not account for their occurrence. This book looks at the processes and institutional arrangements behind these reforms, and analyses what lessons can be learnt about how South Asia can improve its policy efficiency. The book develops ideas about how to overcome the political restraints to reform by drawing on recent theories of political economy and policy learning. It tests these ideas against authoritative case studies of actual reform initiatives in South Asia, which illustrate processes and institutional arrangements that have helped South Asian governments to sustain reform efforts, even in the absence of a strong political base. This offers valuable lessons for the global economy as it moves into a phase of rebalancing, with the structural adjustments that this will require. The book goes on to identify weaknesses that could be addressed by South Asian national governments and regional forums. It is an important contribution to studies on South Asian politics and international political economy Philippa Dee is Adjunct Associate Professor at Crawford School of Economics and Government, Australian National University.
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Economic Reform Processes in South Asia Toward policy efficiency
Edited by Philippa Dee
First published 2012 by Routledge 2 Park Square, Milton Park, Abingdon, Oxon OX14 4RN Simultaneously published in the USA and Canada by Routledge 711 Third Avenue, New York, NY 10017 Routledge is an imprint of the Taylor & Francis Group, an informa business © 2012 for editorial selection and material, Philippa Dee; for individual chapters, the contributors The right of the editor to be identified as the author of the editorial material, and of the authors for their individual chapters, has been asserted in accordance with sections 77 and 78 of the Copyright, Designs and Patents Act 1988. All rights reserved. No part of this book may be reprinted or reproduced or utilized in any form or by any electronic, mechanical, or other means, now known or hereafter invented, including photocopying and recording, or in any information storage or retrieval system, without permission in writing from the publishers. Trademark notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation without intent to infringe. British Library Cataloguing in Publication Data A catalogue record for this book is available from the British Library Library of Congress Cataloging in Publication Data Dee, Philippa S. Economic reform processes in South Asia: toward policy efficiency / Philippa Dee. p. cm. Includes bibliographical references and index. 1. South Asia—Economic policy. 2. South Asia—Commercial policy. 3. Finance—Government policy—South Asia. I. Title. HC430.6.D43 2012 338.954–dc23 2011048073 ISBN: 978–0–415–52306–6 (hbk) ISBN: 978–0–203–11764–4 (ebk) Typeset in Times New Roman by Swales & Willis Ltd, Exeter, Devon
Contents
List of illustrations List of contributors Preface List of abbreviations 1 Toward a theory of policy efficiency
xiii xv xvii xix 1
PHILIPPA DEE
2 South Asia’s economic prospects from global rebalancing and integration
23
DIPAK DASGUPTA, NIHAL PITIGALA AND JULIEN GOURDON
3 Comparing structural reforms in India and Pakistan
43
ISHRAT HUSAIN AND RAJIV KUMAR
4 The process of banking sector reforms in India
61
RAJENDRA R. VAIDYA
5 Monitoring fiscal performance in India
86
D.K. SRIVASTAVA AND J.V.M. SARMA
6 Foreign direct investment in India: unfinished agenda
109
PRAVAKAR SAHOO
7 Policy efficiency of trade reforms in India
136
GEETHANJALI NATARAJ
8 Financial sector reforms in Pakistan ZAFAR MUEEN NASIR
154
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Contents
9 Sri Lanka’s economic reform process: progress and constraints
173
DUSHNI WEERAKOON
10 India–Pakistan trade: a roadmap for enhancing economic relations 191 MOHSIN S. KHAN
References Index
207 221
Illustrations
Figures 1.1 2.1 2.2 2.3 2.4 3.1 4.1 4.2 5.1 5.2 5.3 5.4 6.1 6.2 6.3 6.4 6.5 6.6
Reform space The growing role of emerging markets Share of India’s bilateral trade with China and the United States South Asia’s rising trade with East Asia Trade complementarity index with East Asia and Pacific Timing of delicensing in India 1980–97 Bank credit/GDP ratio Ratio of unsecured bank borrowings to total bank borrowings of largest 400 firms Revenue deficit relative to GDP of central and state governments Fiscal deficit relative to GDP of central and state governments Primary deficit relative to GDP of central and state governments Interest payments, pensions and capital expenditures as percentages of total expenditure: central and state governments combined FDI inflows into India Evolution of FDI policy in India FDI inflows into manufacturing and services Top ten sectors attracting highest FDI inflows (April 2000 to November 2009) Regional breakdown of FDI inflows Share of top investing countries in total FDI inflows 2000–8
3 25 26 30 32 50 64 67 88 88 89 95 112 114 117 118 118 119
Tables 1.1 2.1 2.2 2.3 3.1 4.1 4.2
Hypotheses about reform Revealed comparative advantage 2008 FDI inflows from East Asia Tariff rates in Asia 2007 List of industries never delicensed Bank group wise distribution of total credit outstanding Occupation wise distribution of bank credit in India
7 33 35 38 51 64 65
xiv 4.3 4.4 4.5 5.1 5.2 5.3 5.4 5.5 6.1 6.2 6.3 7.1 8.1 9.1 9.2 9.3 10.1 10.2 10.3 10.4
Illustrations, tables and box Distribution of bank credit in India according to population group Sector wise distribution of non-performing assets of banks in India Recovery of non-performing assets of banks in India through various channels Fiscal and primary deficits of central government relative to GDP at market prices: election years and others Fiscal and primary deficits of state governments relative to GDP at market prices: election years and others Decomposition of debt relative to GDP of central government Decomposition of debt relative to GDP of state governments Fiscal and revenue deficit of centre and states FDI inflows into selected countries 1995–2007 Indicators of business and macroeconomy 2007–8 Doing Business 2009 rank Tariff structure History of International Monetary Fund programmes in Pakistan since 1988 Selected economic indicators for Sri Lanka 1970–88 Selected economic indicators for Sri Lanka 1989–2008 Selected indicators of public sector employment India and Pakistan total trade with selected partners Gravity model estimates for merchandise trade specifying major customs unions and free trade agreements, 1976–2005 Actual-to-potential trade ratios for India, Pakistan and the world with selected trade partners by estimation period Barriers to trade between India and Pakistan
66 67 81 92 92 94 94 102 110 120 121 142 156 176 180 187 192 196 198 200
Box 6.1 Summary of major policies to attract FDI since 1991
113
Contributors
Dipak Dasgupta is Principal Economic Adviser at the Ministry of Finance, Government of India, and former Lead Economist for South Asia at the World Bank, Washington, DC. Philippa Dee is Adjunct Associate Professor at the Crawford School of Economics and Government, the Australian National University. Julien Gourdon is Economist at Centre d’Etudes Prospectives et d’Informations Internationales (CEPII) and former Economist at the World Bank, Washington, DC. Ishrat Husain is Dean and Director of the Institute of Business Administration, Karachi, and is a former Governor of Pakistan’s central bank. Mohsin S. Khan is Senior Fellow at the Peterson Institute for International Economics, Washington, DC, and is a former Director of the Middle East and Central Asia Department at the International Monetary Fund. Rajiv Kumar is Secretary General of the Federation of Indian Chambers of Commerce and Industry, New Delhi, and former Director and Chief Executive of the Indian Council of Research in International Economic Relations, New Delhi. Zafar Mueen Nasir is Chief of Research and Dean of Business Studies at the Pakistan Institute of Development Economics, Islamabad. Geethanjali Nataraj is Senior Economist at the National Council of Applied Economic Research, New Delhi. Nihal Pitigala is Consultant at the World Bank, Washington, DC. Pravakar Sahoo is Associate Professor at the Institute of Economic Growth, Delhi University. J.V.M. Sarma is Professor at the Department of Economics, University of Hyderabad. D.K. Srivastava is Professor and Director of the Madras School of Economics, Chennai.
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Contributors
Rajendra R. Vaidya is Associate Professor at the Indira Gandhi Institute of Development Research, Mumbai. Dushni Weerakoon is Deputy Director and Head of Macroeconomic Policy Research at the Institute of Policy Studies, Colombo.
Preface
While South Asia’s reform initiatives of the last two decades were often born in crisis, this alone does not account for their occurrence. This volume looks for processes and institutional arrangements that also ensured that reforms moved off the drawing board. South Asia provides a tough testing ground for hypotheses that were developed and tested in a companion volume on East Asia. This is because politics has often played a more complex and influential role over economic outcomes than in East Asia. The case studies in this volume illustrate processes and institutional arrangements that have helped South Asian governments to sustain reform efforts, even in the absence of a strong political base. This offers valuable lessons for the global economy as it moves into a phase of rebalancing, with the structural adjustments that this will require. The volume is the result of a five-year project organized within the Crawford School of Economics and Government at the Australian National University in collaboration with the South Asian Bureau of Economic Research (SABER) and the East Asian Bureau of Economic Research (EABER), jointly comprising 43 leading research institutes throughout Asia. It is an early research product of the newly created SABER, the South Asian network of research institutes. The project was funded under an Industry Linkage Grant through the Australian Research Council in partnership with the Australian Government via AusAID, the Australian government’s aid organization. The following South Asian institutions participated in the project: the Indian Council of Research in International Economic Relations, New Delhi; the National Council of Applied Economic Research, New Delhi; the Indira Gandhi Institute of Development Research, Mumbai; the Institute of Economic Growth, Delhi University; the Madras School of Economics, Chennai; the Department of Economics, the University of Hyderabad; the Institute of Business Administration, Karachi; the Pakistan Institute of Development Economics, Islamabad; the Institute of Policy Studies of Sri Lanka, Colombo; the Peterson Institute for International Economics, Washington, DC; the World Bank, Washington, DC; and the Australian National University. Both the project and the volume owe their existence to the vision of Professor Peter Drysdale in creating the South Asian Bureau of Economic Research, not only to examine South Asian economic issues, but also as a vehicle for South Asian–East Asian dialogue on global integration.
xviii Preface I would like to thank the attendees of the conferences in New Delhi and Canberra, which launched the project and refined the case studies. Special thanks are due to Suman Bery and his colleagues, who hosted the New Delhi conference at the National Council of Applied Economic Research, and to Peter Drysdale and the EABER–SABER team, who hosted the Canberra conference at the Crawford School. Finally, I would like to thank the case study authors for their efforts and enthusiasm for the project. Their close familiarity with the content of the reforms, and the processes that allowed them to come into being, has provided the fundamental insights of this project. Philippa Dee October 2011
Abbreviations
AFTA APT ASEAN ASEAN-6 ATM AVE BIMSTEC BJP BRICs CEIC CMAS DNA DOT EMCs EPZ EU EXIM FDI FTA G-7 GDP GNP GSDP GSP GST HS ICICI ICRIER IT JVP
Association of Southeast Asian Nations Free Trade Area Actual-to-potential trade Association of Southeast Asian Nations Association of Southeast Asian Nations plus Australia, China, India, Japan, Korea, New Zealand Automated teller machine Ad valorem equivalent Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation Bharatiya Janata Party Brazil, Russia, India, China A company providing macroeconomic, industrial and financial time series data Chile, Mexico, Australia, Singapore Deoxyribonucleic acid Department of Telecommunications Emerging market economies Export processing zone European Union Export import Foreign direct investment Free trade agreement Group of 7 industrialized countries Gross domestic product Gross national product Gross state domestic product Generalized System of Preferences Goods and services tax Harmonized Commodity Description and Coding System An Indian bank Indian Council for Research on International Economic Relations Information technology Janatha Vimukthi Peramuna
xx Abbreviations LTTE MFN NAFTA NGO OECD PDR PIIE PML POSCO PPP RCA Rs. SAARC SAFTA SAPTA SARFAESI SEZ SLFP TEWA ThFC TRIPS TwFC UNP VAT WTO
Liberation Tigers of Tamil Eelam Most-favoured nation North American Free Trade Agreement Non-government organization Organization for Economic Cooperation and Development People’s Democratic Republic Peterson Institute for International Economics Pakistan Muslim League Pohang Iron and Steel Company Pakistan People’s Party Revealed comparative advantage Rupees South Asian Association for Regional Cooperation South Asian Free Trade Area South Asian Preferential Trade Arrangement Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Special economic zone Sri Lanka Freedom Party Termination of Employment of Workmen (Special Provisions) Act Thirteenth Finance Commission Agreement on Trade Related Aspects of Intellectual Property Rights Twelfth Finance Commission United National Party Value-added tax World Trade Organization
1
Toward a theory of policy efficiency Philippa Dee
Introduction If South Asia is to survive and prosper in the ‘new normal’ global economic environment, its behind-the-border domestic reforms will be even more important than before. But these reforms are much more difficult and complex than initial market opening (Soesastro 2010). So it is timely to ask what lessons can be learned about how to ‘get the job done’. The focus of this book is on the processes and institutional arrangements that will help. In other words, it is about policy efficiency, a concept that is given a formal definition shortly. While the focus of the book is not primarily on the content of the reforms, their further necessity is undeniable. As Dasgupta et al. observe (Chapter 2), recovery from the global financial crisis in 2008–9 will involve a fundamental restructuring of the global economy. Under the ‘new normal’, the developed countries of Europe and North America will save more, spend less and grow more slowly. Their demand patterns will not provide the same impetus for export growth for South Asia and other developing regions, except perhaps in services. Global recovery will instead be led by emerging markets. This means that the South Asian region will have to look East. It will also have to look internally for sources of growth. A ‘look East’ strategy can take advantage of South Asia’s comparative advantage (relative to East Asia) in food, organic and inorganic materials, textiles, metal products and labour-intensive manufactures such as apparel, footwear, parts and jewellery, as well as in services. But if South Asia is to link into East Asia’s existing production networks, it will have to significantly improve its transport and logistics services. Currently, the quality of these services is better than in some of the new low-income members of the Association of Southeast Asian Nations (ASEAN), but significantly poorer than in China or some of the original ASEAN members. It will also have to lower border trade barriers that remain well above those in East Asia, despite past reforms. Looking internally will involve boosting intra-regional trade, as well as cultivating the large internal markets in the region. The uncharacteristically low levels of intra-regional trade currently are an indication of significant economic and political barriers – the region has one of the most fragmented markets in the world. Converting internal and regional markets into sources of growth will require
2
P. Dee
tackling the physical, logistical and regulatory barriers to the movement of goods and services both within and between South Asian economies. Under the ‘new normal’, South Asia will have to intensify its efforts at behindthe-border domestic reforms. But these are difficult. So what institutional mechanisms can the region use to make the job easier, and to improve the success rate?
Defining policy efficiency As used here, the concept of policy efficiency applies to the policy-making process. Policy efficiency ensures that difficult but worthwhile reforms are identified, prioritized, initiated, implemented and sustained. While it may be true that some reforms will generate larger economy-wide benefits than others, the concept of policy efficiency is not primarily about picking which ones are better. It is about ensuring that at last some worthwhile reforms are actually adopted, rather than staying on the economist’s drawing board. The concept of policy efficiency goes beyond economic ‘business as usual’. Economists normally operate as policy draftspeople. They design policies that, according to theory and past evidence, will lead to improvements in economic well-being. They may identify which policies will generate larger net gains than others. They may also identify and rank possible adjustment costs. But implementation is not normally their concern. Implementation itself is left to politicians and bureaucrats. The study of which policies get adopted and which stay on the drawing board is left to political scientists. The concept of policy efficiency also goes beyond political economy ‘business as usual’. Studies of political economy will explain whether a policy is adopted or not as the outcome of a balance of interests – one group of voters versus another, politicians versus voters, politicians versus lobby groups, politicians versus bureaucrats, and so on. But the process is normally static. Each group’s interests remain fixed, and there is no scope for learning, or for groups to change their minds about their policy priorities. The concept of policy efficiency is related to the concept of ‘political will’. Some definitions of political will are tautological – political will is what it takes to get a policy adopted, and if it is not adopted, this shows that political will is lacking. Other definitions of political will describe the environment in which policies are actually adopted. For example, Andrews (2008) talks about ‘reform space’ as an environment in which there is an acceptance of the need for reform, and the authority and ability to carry it out (see Figure 1.1). Policy efficiency is about the cultivation of political will. It is about institutional mechanisms that help to create acceptance of the need for reform, that provide the authority for reformers to do their job, and that provide a learning environment where ability can be developed.
Achieving policy efficiency Achieving policy efficiency means that reforms will move off the drawing board to be implemented and sustained over time. Understanding what it takes to achieve
Toward a theory of policy efficiency 3 Isthereacceptance: Oftheneedforchangeandreform? Ofthespecificreformidea? Ofthemonetarycostsofreform? Ofthesocialcostsforreformers? Doembeddedincentivemechanismsfacilitateorhinder acceptance,especiallywhentransitioningfromoldtonew? Isthereauthority? Doeslegislationallowpeopletochallengethestatusquo andinitiatereform? Doformalorganizationalstructuresandrulesallow reformerstodowhatisneeded? Doinformalorganizationalnormsallowreformerstodo whatisneeded? Isthereability? Arethereenoughpeople,withappropriateskills,to conceptualiseandimplementthereform? Aretheretheappropriateinformationsourcestohelp conceptualize,plan,implementandinstitutionalizethe reform?
Acceptance
Authority
Ability
Reformspace,attheintersectionofA,A,A, determineshowmuchcanbeachieved
Figure 1.1 Reform space. Source: Adapted from Andrews (2008).
policy efficiency means understanding first what gets in the way of better policies being adopted. An earlier volume (Dee 2010) started with the following taxonomy of what gets in the way of better policies being adopted. • • •
Governments do not know what is policy ‘best’ or ‘better’ practice, or lack the capacity to implement it. Governments know what is ‘better’ practice, but face political resistance from vested interests. Governments do not want ‘better’ policy, because they rely on the rents from current policies for political funding purposes.
Thus the key problems were seen essentially as two-fold – ignorance, or vested interests (including those inside government). Thus policy efficiency could be promoted by institutional arrangements that helped to overcome these two problems. The earlier volume argued that in both cases, there was a useful role for policy reviews, and hence for institutions that could undertake them. If the problem was one of identifying better policies, then the policy reviews could provide a technical solution – they could review current policy settings and identify better options. But if the problem was managing vested interests (including those within government), then policy reviews would be a strategy rather than a technical solution. They would provide ammunition with which to manage vested interests and build a coalition in favour of reform, although there would be no guarantee that the reviews would be decisive in any particular instance. Over time, however, they could help influence the terms of the debate.
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P. Dee
Policy reviews as a technical solution For policy reviews to make a useful contribution to identifying better policy options, they need to be done early in the policy development process, before positions become locked in. Ideally, a policy review would involve a sequential process of specifying the policy problem and the desired objectives, assessing a range of options, evaluating the effects of each option on all stakeholders, recommending the best option, or else explaining why some other option is preferred, and outlining a strategy to implement the preferred option and then review its operation, thus providing an ex post check on policy performance. Ideally, the policy review process would also involve a great deal of consultation. This could take place at the beginning, as the review panel or agency started to develop its ideas. It could also take place after full analysis and an outline of possible policy solutions (including perhaps a preferred solution). This consultation would help the review agency to identify all the costs and benefits to each stakeholder, and equally provide an opportunity for the review panel to explain its proposed solution to stakeholders. Obviously the policy development process does not always work in an orderly fashion. Instead, policy-making may result from crisis, from political imperatives for quick action, or from deals with particular interest groups. Decisions may be made without prior policy review, without input from stakeholders, and with little public scrutiny, if at all, until after the decision is made. The earlier volume contained case studies of policy-making in the East Asian region. These showed that no country always had an orderly policy development process. But many countries had at least some of the institutional elements that allowed for prior policy review and consultation. Policy reviews to help manage vested interests The opportunity provided by policy reviews for transparent consultation is the key to their strategic role in managing vested interests. Policy reviews can help deal with vested interests in a number of ways. • •
•
Policy reviews can help set the agenda – policy change will not happen if nobody talks about it. Reviews can also set the parameters of the debate. They can establish analytical frameworks within which to examine the costs and benefits of various policy settings to all stakeholders. These analytical frameworks can make it much harder to ignore the interests of particular stakeholders, particularly those, such as consumers, who may not be well-organized or are less able to represent themselves. A policy review process can help to depoliticize a debate. And most governments will find it in their own interests on occasion to take the heat off an issue by referring it for independent, objective study.
