Economy

Politics of Economic Reforms: Real Lessons from 1991

July 2021 marks the 30th anniversary of the economic liberalization in India. The liberalization began in 1991, with Dr. Manmohan Singh as the then-Finance Minister in the Congress-led coalition government headed by Mr. P.V. Narasimha Rao. Facing a severe balance of payment crisis and battling a situation where the country’s foreign exchange reserves had fallen to less than one billion dollars; an amount that was barely enough to last for 3 weeks of imports of essential goods. The then government decided to liberalize international trade, lower tariffs on imports, devalue the rupee and significantly dismantle the license and quota system that had hobbled most Indian industries. 

Much of the popular discussions commemorating the reforms of 1991 centered around the balance of payment crisis that triggered it, the economic reforms that followed, and the people who undertook them. What is usually lost is the political context that made the reforms possible, and sustained the economic trajectory over the next few decades. India has come a long way since then. In the 1980s, the economic growth rate averaged barely 5% per annum. In contrast, until a few years ago, India was seriously looking at the prospect of a double-digit growth rate.

The 1980s were politically volatile. There was ethnic violence in Assam. In Punjab, the Sikh militancy had boiled over, claiming the life of Prime Minister Indira Gandhi in October 1984. Thousands of innocent Sikhs lost their lives in the aftermath of the assassination, particularly in Delhi. Rajiv Gandhi had succeeded Indira Gandhi as the head of the Congress Party and a government with a massive electoral mandate. The hope he had initially inspired was lost, as Congress lost the general election in 1989. There was a political interregnum between 1989 and 1991 when the government was not led by the Congress party. As the decade came to a close, the country was sharply divided on the lines of caste and religion.

To keep the economy growing in the 1980s, the country borrowed heavily internally and externally. 1991 also saw the first Gulf War and a sharp rise in oil prices. By 1991 India was on the brink of default. 

In the middle of the economic crisis, a general election was called in the summer of 1991, just two years after the last one. During the election campaign, Rajiv Gandhi, the face of the Congress Party, was assassinated by Tamil militants from Sri Lanka. While Congress emerged as the largest party, it fell short of a simple majority in Parliament. 

Throughout the 1990s, only a handful of people realized the significance of economic liberalization that had happened in that 1991-93 period. Then the Congress lost the general election in 1996. The party not only disowned P.V. Narasimha Rao but also sought to distance itself from the legacy of economic liberalization in 1991. After another two years and two more prime ministers later, the Bharatiya Janata Party (BJP) emerged as the largest political party in Parliament after the 1998 general election, although well short of majority. Soon after the election, the coalition government led by A.B. Vajpayee, decided to set off a series of underground nuclear explosions in the desert of Rajasthan, to establish its nationalist credentials and formally declared India to be a nuclear power. A year later it went to war to expel Pakistani troops that had surreptitiously moved into the high mountains in the Kargil area of Kashmir. Not surprisingly, the popular discourse was not on the economy, but on the ethnic, caste and religious conflicts that were sprouting in different parts of the country.   

It was largely after his re-election in 1999, that the Vajpayee led coalition government resurrected the economic reforms agenda that claimed to continue on the path of P.V. Narasimha Rao and Manmohan Singh. This approach of change while claiming continuity, lowered the political temperature and drew many to relook and review the significance of economic liberalization in 1991 It was helped, in no small measure, by the visible changes in the economy and the increasing growth rate that set in by then. The India Shining campaign of the BJP in 2004 failed to get the BJP and Vajpayee re-elected, but the path of reforms came to be taken for granted came. For the first time, political parties tried to compete with each other over economic performance. Many had begun to believe that India's economic reforms were irreversible.

What makes the political context of economic reforms really interesting is between 1989-2014India had coalition governments at the national level, which were often large and unwieldy. The politics was factious and the wider society fractured along ethnic, linguistic, caste and religious lines. Yet, there remained a surprising degree of continuity in economic policies and the general thrust on reforms.

In retrospect, it seems; the politicians were forced to look for policies that improve economic performance only when they find that their own political survival is at stake. Throughout the first decade of the 21st century, in addition to the emotive social agendas, most major political leaders also competed on promises to deliver higher economic growth. This was something that was unheard of in India before the 1990s.

The real lesson from India’s economic reforms is that political competition creates the conditions where economic reforms become possible, which improves economic growth. Coalition politics requires negotiations that produce wider buy-in for reforms, while checking arbitrary use of political power that may put a coalition partner at a disadvantage. This is in sharp contrast to the popular belief that hard economic decisions can only be taken by a strong political leader, with a stable legislative majority. What this analysis suggests is that when political competition is high, the growth rate tends to move higher. It is needless to say that the economy is a very complex animal, and does not move on a linear trajectory, but the trend is clear (Fig 1). But what the graphs seem to suggest is that as political competition stabilizes, the economy tends to move into a higher gear. 

Well-intentioned autocrats are often cited as drivers of economic growth. A recent research paper by two Australian scholars, Stephanie Rizio and Ahmed Skali, examined this claim in a panel of 133 countries from 1858 to 2010. As compelling a narrative as it may be, the benevolent autocrat hypothesis simply did not stack up against the evidence.

Instead, markets function and participants flourish when trade is open and competition is intense, and regulations are light and predictable. Monopolies tend to capture the regulators and disrupt the efficiency of the market. India shows that the same is true in the political sphere. Political dominance is no assurance for economic reforms. Indeed, political dominance may make economic reforms redundant, since economic performance is no longer among the key determinants of electoral success. 

Contrary to popular belief, the lesson since 1991 is that competitive politics, even coalition governments, is more conducive to economic reforms by enabling competition in the economy, than politics dominated by one party.