Tuesday, March 21, 2006

Microeconomic policy reforms needed in India

Much policy reform debate in India is often focused on the BIG issues like macro-stability, privatization and capital markets. These are only the tip of the iceberg of desirable policy reforms. The real action of enabling markets is often at the microeconomic policy level.

The report Industry level analysis: the way to identify the binding constraints to economic growth by Vincent Palmade captures this succintly. Their abstract runs as below.
There are many economic diagnostic tools available which are trying to identify the constraints to economic growth in a given country. Unfortunately these tools tend to provide inconclusive and often conflicting answers as to what the most important constraints are. Even more worrisome, they tend to overlook the many industry specific policy and enforcement issues which, collectively, have been found to be the most important constraints to economic growth. This is the key finding from more than ten years of economic research by the McKinsey Global Institute (MGI). The MGI country studies have been uniquely based on the in-depth analysis of a representative sample of industries where clear causality links could be established between factors in the firms’ external environment and their behavior, in particular through the analysis of competitive dynamics. They showed in details how industry specific policy and enforcement issues were the main constraints to private investment and fair competition – the two drivers of productivity and thus economic growth. This finding implies that governments and international financial institutions should rely much more on in-depth industry level analysis to uncover product market competition issues and set reform priorities. These analyses should include the often overlooked but critically important domestic service sectors such as retail and housing construction.
They point out much-needed reforms in these arenas in order to jumpstart product market competition. Non-tariff trade barriers; Licensing restrictions; Price/ Product restrictions; Inadequate regulations of quasi-natural monopolicies and social sectors; Land market issues and the Unequal enforcement/informality trap. The last one is especially relevant for the distortions it introduces in markets to the disadvantage of both informal and formal enterprises: underdeveloped informal enterprises and absence of fair competitive field.

Once you start talking of microeconomic policy reforms, you cannot ignore legal reforms in the economic arena. There are studies in selected sectors in India which show that 20% of the selling price is incurred as additional transaction costs imposed by legal and infrastructural ones. Of course the true cost is what they deter in the long-term. For a rare study of much-needed legal reforms in India do read Bibek Debroy's Reforming the Legal System. He argues that market-oriented reforms cannot succeed without legal reforms and points out glaring loopholes in a host of laws. His analysis clearly brings out a paradox afflicting India: over-legislation and under-governance. The last 16 pages in fact are a list of laws that show how over-regulated is India. For a more fundamental understanding of legal reforms this post of mine may be helpful.

Both studies are recommended for their high IP (Insight/Pages) ratio!

Cross-posted on the Indian Economy blog.

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