Tuesday, March 27, 2007

Crony Capitalism in India? Take II

During his keynote address at the Steel Summit 2007 organised by the Ministry of Steel and the Confederation of Indian Industry (CII), our Prime Minister made some interesting observations:

A comment has been made recently that most of our business leaders who have become billionaires seem to be operating in either relatively protected business environments, in oligopolistic or monopolistic markets or are dealing in scarce resources. If this observation is true then someone could say that we are promoting crony capitalism. That certainly should not be the case. (full speech available at pib.nic.in)
Now, what exactly is crony capitalism? It is somewhat more complex than corruption, although that distinction is often not made. Let us start with none less than Gary Becker and Richard Posner:

Crony capitalism is a system where companies with close connections to the government gain economic power not by competing better, but by using the government to get favored and protected positions. These favors include monopolies over telecommunications, exclusive licenses to import different goods, and other sizeable economic advantages. Some cronyism is found in all countries, but Mexico and other Latin countries have often taken the influence of political connections to extremes.

Of course, much of the discourse on crony capitalism is associated with Asia (in particular in the wake of the Asian crisis) and Latin America. Paul Krugman has been one of the few US economists to talk about cronyism in the US. In 2003 he wrote in an NYT column entitled Who's Sordid Now?

Cronyism is an important factor in our Iraqi debacle. It's not just that reconstruction is much more expensive than it should be. The really important thing is that cronyism is warping policy: by treating contracts as prizes to be handed to their friends, administration officials are delaying Iraq's recovery, with potentially catastrophic consequences. ... It's rarely mentioned nowadays, but at the time of the Marshall Plan, Americans were very concerned about profiteering in the name of patriotism.. Iraq's reconstruction, by contrast, remains firmly under White House control. And this is an administration of, by and for crony capitalists.

While at the wake of the Asian crisis everyone was keen to show how the Korean miracle was really no miracle at all and the crisis was really an effect of the cronyism that went unnoticed until then, one critical question about the so-called "cronyism" went unanswered. It was raised by Alice Amsden in her pioneering work: why is that in South Korea, an extremely tight nexus between the state and business could bring about such tremendous increase in growth rates whereas everywhere else it has only resulted in the enrichment of a few at the cost of national development? Authors have offered many different answers. Amsden's own answer was that the South Korean state was able to get businesses to contribute to national development in exchange for the favours it granted them. Nothing as given for "free". I have argued in my book, Indian capitalism worked quite differently from Japanese of South Korean or Taiwanes capitalism. In these miracle economies, the focus of the state was on macro-economic growth and businesses were forces to operate in sectors, and with prices and costs where macro-economic growth would be maximized. The emphasis was not on corporate profits, but on maximizing revenue and productivity and capacity utilization. This focus away from profits and on growth was the most important thing the state could extract from business in exchange of all the resources it supplied. In India, and in most parts of the world, the state simply supplied subdized resources to its corporations and the corporations did what was in their interest: increase profits by whatever means possible, in most cases through practices through cartels, creating barriers to new competition and price manipulation. In East Asia, innovation and maximization of productivity were the only means to corporate growth (the data comparing profits in India and East Asia are quite illuminating, the methodological problems of comparing profitability not withstanding). Of course, the brunt of this was born by East Asian workers, who gain much by way of income, but lost a lot by way of rights and political freedoms.

In India, the state focused on creating many procedural and bureaucratic controls on business, which could all be bypassed if you were large enough a player but became insurmountable barriers for the small entrepreneur. This did little to create a synergy between corporate growth and profitability, macro-economic growth, productivity and innovation.

Globalization was supposed to cure these ills, by having the state withdraw from its regulatory role. Really, did it? Well, if Manmohan Singh is asking that question, then surely I cannot be blamed for being skeptical.