The hammer (but not the sickle!)

In the world at large, there are some countries that do well economically and some that fare miserably. Many fall into the middling, mediocre lot. But no matter what the category is, it is a fact that all economies suffer from distortions—what economists would call market imperfections—of some kind or other that pull down the performance. For example, in India, distortions at the social level like our rigid caste system or norms that prevent large sections of women from entering the job market have historically inhibited growth in the economy.

In this article, I’ll take a cursory look at economic distortions that affect the way wealth is created and distributed, and then exercise the writer’s prerogative to draw a sweeping conclusion. Distortions, in this context, may be understood as those entrenched practices or ways of doing things that prevent the economy from attaining its full potential with the given resources.

In truth, this wisdom is not just about economics but about life in general. You may be poor but even with your current earnings you can do a much better job of providing for your family if you are willing to change your ways, say, give up on alcohol. You child may not be a bright student but if only you could persuade him to cut down on distractions and focus more on studies, you know he would score much better in his exams. Incidentally, the impetus for economic reforms springs from a realization that even without throwing in more money, and merely by getting rid of distortions, an economy can deliver substantially better results.

Even as distortions persist in an economy and become impediments to growth, there will always be a section of the people who profit from them, in other words, earn “rent” from it. Rent, in economics, is the income paid to a factor of production in excess of its opportunity cost. Typically, it arises out of exclusivity, and this exclusivity can be either natural or contrived. For example, the high wages paid in the government sector to workers doing low end jobs is a form of rent while collective bargaining by powerful unions is rent-seeking behaviour.

And so, in a country where the banking system has limited reach, money lenders would gain. In a place where the infrastructure for supply of drinking water is poor, there will be a thriving community of traders who bring water in tankers or sell it in bottles. And where the electricity supply is erratic, a whole industry develops around generators, inverters, UPS, voltage stabilisers etc. To the extent that they all fulfil a need arising from the inability of the economic system to fully perform its functions, it is perfectly in order.

The problem arises when they become focal points for successful opposition to efforts aimed at tackling those weaknesses in the system on which their livelihood depends. This would give birth to a new distortion. Indeed, prevailing distortions in an economy are not always of historic origin that emerged years ago and that we are now compelled to live with. As a matter of fact, new ones are created all the time. Like when a new technology threatens redundancy for some sectors of the economy and the government steps in to protect those at risk. This compels the economy to carry on with the burden of a sub-optimal technology with lasting consequences for efficiency.

India did not permit FDI in the retail sector for long fearing the impact on the local kirana stores. It’s been pointed out that India has a hugely inefficient retail sector with high levels of wastage of perishables and very high mark-up in prices from the time goods leave the producers to when they reach the consumer. A large format retailer sourcing directly from the producer and who also sells directly to the consumer would make sense. And yet, thanks to our statist mindset that delights in telling businessmen what is permissible and what is not, we’ll live with this inefficiency for some more time.

Similarly, decades of socialist oversight have so distorted the labour market that the overwhelming majority of our workforce—well over 90%—toil in the unorganised sector with little or no benefits. The tiny minority who gained an early entry into the organised sector, the entrenched labour aristocracy, have done very well for themselves and their unions are now the main stumbling blocks to much-needed labour law reforms.

It follows therefore that what we call economic or structural reforms is nothing but the practical process of removing the distortions that have taken hold in the economy. It also follows that the starting point for any serious effort in this direction would be pain. This is the pain felt by that section which was so far profiting from the distortions and are now deprived of their easy pickings. Experience would suggest that such groups are rarely anything more than a minority. But quite often they are organised and have a voice louder than their numbers.

Moreover, economies where poverty and backwardness go back over many years are likely to have many such distortions often feeding on each other. In this scenario, it can happen that while the different groups profiting from the various distortions individually remain in a minority, collectively, their numbers can add up to a majority and more. And typically, such countries would present the greatest obstacles to economic reforms. Since almost everyone gets to dip a finger in the pie, the minimum consensus for change of any sort is sorely missing.

In a country where everyone gets to take advantage of a prevailing atmosphere of lawlessness, it can be taken for granted that support for enforcing law and order will be minimal. That everyone suffers in some way or the other from the lawlessness will probably not make a difference. For instance, many of our otherwise law-abiding (and reform-minded) citizens would perhaps feel uneasy about reforms in the electricity sector with the unwelcome prospect of accurate metering. And that is why, even when economic reforms make perfect sense, it is always difficult to get it started. And when the process finally begins in earnest, it is always a soft target for the “anti” propaganda.

I once saw an east European film on television in the days when Doordarshan was the only channel available and they had this wonderful late night series of off-beat international cinema. It opens with an unkempt, elderly man with a flowing white beard living in seclusion in the woods. I gathered he was a doctor who had fallen out of favour with society for some reason I could not make out. On this day, he is approached by a man who brings his young son along.

The boy is crippled in one leg and has not walked since a childhood accident. We see the “doctor” examining the boy and telling the father that he can be cured by an operation on the knee. The father agrees, perhaps because he was his last hope, and we see the boy lying on a makeshift table, his eyes trustingly following the doctor as he goes about preparing for the operation. The doctor is now ready. What follows is a moment I shall never forget. As the camera closes in on him, I see him positioning a hammer, yes, a hammer, over the boy’s kneecap. “DON’T!” I remember screaming to myself. “He is a quack!”

As it turned out, he was a brilliant doctor who knew exactly what he was doing. After the accident, the bones in the boy’s knee had healed improperly and fused into each other haphazardly. By bringing down the hammer on it, the existing improper alignments were first dislodged and in the operation that followed, he ensured that it would set again the right and proper way. Needless to add, the boy was able to walk again.

I know the director of the film would not have had this in mind. The fact is, I see a metaphor for how distortions in an economy often need to be undone with the shattering impact of a hammer so that a crippled economy can be made to walk again. One day, who knows, it may even sprint.

That’s why in a country where the established wisdom says “reforms with a human face”, I say, “bring on the hammer.”

(Author’s note: If you liked this post, you may also like to take a look at my earlier posts on CRI, mostly with an economics theme, available here.)