“I have a student called Suby Roy…”: Reflections on Frank Hahn (1925-2013), my master in economic theory

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1. “What was relatively weak at LSE was general economic theory. We were good at deriving the Best Linear Unbiased Estimator but left unsatisfied with our grasp of the theory of value that constituted the roots of our discipline. I managed a First and was admitted to Cambridge as a Research Student in 1976, where fortune had Frank Hahn choose me as a student. That at the outset was protection from the communist cabal that ran “development economics” with whom almost all the Indians ended up. I was wholly impecunious in my first year as a Research Student, and had to, for example, proof-read Arrow and Hahn’s General Competitive Analysis for its second edition to receive 50 pounds sterling from Hahn which kept me going for a short time. My exposure to Hahn’s subtle, refined and depthless thought as an economist of the first rank led to fascination and wonderment, and I read and re-read his “On the notion of equilibrium in economics”, “On the foundations of monetary theory”, “Keynesian economics and general equilibrium theory” and other clear-headed attempts to integrate the theory of value with the theory of money — a project Wicksell and Marshall had (perhaps wisely) not attempted and Keynes, Hicks and Patinkin had failed at.

 

 

Hahn insisted a central question was to ask how money, which is intrinsically worthless, can have any value, why anyone should want to hold it. The practical relevance of this question is manifest. India today in 2007 has an inconvertible currency, vast and growing public debt financed by money-creation, and more than two dozen fiscally irresponsible State governments without money-creating powers. While pondering, over the last decade, whether India’s governance could be made more responsible if States were given money-creating powers, I have constantly had Hahn’s seemingly abstruse question from decades ago in mind, as to why anyone will want to hold State currencies in India, as to whether the equilibrium price of those monies would be positive. (Lerner in fact gave an answer in 1945 when he suggested that any money would have value if its issuer agreed to collect liabilities in it — as a State collects taxes – and that may be the simplest road that bridges the real/monetary divide.)

 

 

Though we were never personal friends and I did not ingratiate myself with Hahn as did many others, my respect for him only grew when I saw how he had protected my inchoate classical liberal arguments for India from the most vicious attacks that they were open to from the communists. My doctoral thesis, initially titled “A monetary theory for India”, had to be altered due to paucity of monetary data at the time, as well as the fact India’s problems of political economy and allocation of real resources were more pressing, and so the thesis became “On liberty and economic growth: preface to a philosophy for India”. When no internal examiner could be found, the University of Cambridge, at Hahn’s insistence, showed its greatness by appointing two externals: C. J. Bliss at Oxford and T. W. Hutchison at Birmingham, former students of Hahn and Joan Robinson respectively. My thesis received the most rigorous and fairest imaginable evaluation from them…”

 

 

2. “Frank Hahn believed in throwing students in at the deep end — or so it seemed to me when, within weeks of my arrival at Cambridge as a 21 year old Research Student, he insisted I present my initial ideas on the foundations of monetary theory at his weekly seminar.

 

 

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I was petrified but somehow managed to give a half-decent lecture before a standing-room only audience in what used to be called the “Keynes Room” in the Cambridge Economics Department. (It helped that a few months earlier, as a final year undergraduate at the LSE, I had been required to give a lecture at ACL Day’s Seminar on international monetary economics. It is a practice I came to follow with my students in due course, as there may be no substitute in learning how to think while standing up.) I shall try to publish exactly what I said at my Hahn-seminar when I find the document; broadly, it had to do with the crucial problem Hahn had identified a dozen years earlier in Patinkin’s work by asking what was required for the price of money to be positive in a general equilibrium, i.e. why do people everywhere hold and use money when it is intrinsically worthless. Patinkin’s utility function had real money balances appearing along with other goods; Hahn’s “On Some Problems of Proving the Existence of an Equilibrium in a Monetary Economy” in Theory of Interest Rates (1965), was the decisive criticism of this, where he showed that Patinkin’s formulation could not ensure a non-zero price for money in equilibrium. Hence Patinkin’s was a model in which money might not be held and therefore failed a vital requirement of a monetary economy. The announcement of my seminar was scribbled by a young Cambridge lecturer named Oliver Hart, later a distinguished member of MIT and Harvard University.”

 

 

3.   Then there was Sraffa…I saw him many a time, in the Marshall Library… He would smile very broadly at me and without saying anything  indicate with his hand to invite me to his office.. I fled in some fear… It was very stupid of me of course… Joan Robinson cornered me once and took me into the office she shared with EAG… She came at me for an hour or so wishing to supervise me, I kept declining politely… saying I was with Frank Hahn and wished to work on money… “What does Frankie know about India?” she said… I said I did not know but he did know about monetary theory and that was what I needed for India;  I also said I did not think much about the Indian Marxists she had supervised… and mentioned a prominent name… she said about him, “Yes most of what he does can go straight into the dustbin”…

 

 

4.   “I had been attracted to Cambridge partly by its old reputation for philosophy, especially that of Wittgenstein. But I met no worthwhile philosophers there until a few months before I was to leave for the United States in 1980, when I chanced upon the work of Renford Bambrough. Hahn had challenged me with the question, “how are you so sure your value judgements promoting liberty blah-blah are better than those of Chenery and the development economists?” It was a question that led inevitably to ethics and its epistemology — when I chanced upon Bambrough’s work, and that of his philosophical master, John Wisdom, the immense expanse of metaphysics (or ontology) opened up as well. “Then felt I like some watcher of the skies, When a new planet swims into his ken; Or like stout Cortez when with eagle eyes, He star’d at the Pacific…””

 

 

5. “I went to Virginia because James M. Buchanan was there, and he, along with FA Hayek, were whom Hahn decided to write on my behalf. Hayek said he was too old to accept me but wrote me kind and generous letters praising and hence encouraging my inchoate liberal thoughts and arguments. Buchanan was welcoming and I learnt much from him and his colleagues about the realities of public finance and democratic politics, which I quickly applied in my work on India…” Hahn told me he did not know Buchanan but he did know Hayek well and that his wife Dorothy had been an original member of the Mont Pelerin Society in 1947 or 1948. Hence I am amused reading a prominent NYU “American Austrian” say about Frank’s passing “I do think economics would have been better off if the Arrow-Debreu-Hahn approach had not been taken so seriously by the profession. I think it turned out to be an intellectual straight-jacket that prevented the discussion of valuable outside-the-box ideas”, and am tempted to paraphrase the closing lines of Tractatus — “Whereof one cannot speak, thereof one must be silent/About what one can not speak, one must remain silent” — to read “Of that of which we are ignorant, we should at least try not to gas about…” Hahn and Hayek were friends, from when Hayek taught at the London School of Economics in Robbins’ seminar, and Hahn was Robbins’ doctoral student.

 

 

6. “The Hawaii project manuscript contained inter alia a memorandum by Milton Friedman done at the request of the Government of India in November 1955, which had been suppressed for 34 years until I published it in May 1989. Milton and Rose Friedman refer to this in their memoirs Two Lucky People (Chicago 1998). Peter Bauer had told me of the existence of Friedman’s document during my doctoral work at Cambridge under Frank Hahn in the late 1970s, as did N. Georgescu-Roegen in America. Those were years in which Brezhnev still ruled in the Kremlin, Gorbachev was yet to emerge, Indira Gandhi and her pro-Moscow advisers were ensconced in New Delhi, and not even the CIA had imagined the Berlin Wall would fall and the Cold War would be over within a decade. It was academic suicide at the time to argue in favour of classical liberal economics even in the West. As a 22-year-old Visiting Assistant Professor at the Delhi School of Economics in 1977, I was greeted with uproarious laughter of senior professors when I spoke of a possible free market in foreign exchange. Cambridge was a place where Indian economists went to study the exploitation of peasants in Indian agriculture before returning to their friends in the well-known bastions of such matters in Delhi and Calcutta. It was not a place where Indian (let alone Bengali) doctoral students in economics mentioned the unmentionable names of Hayek or Friedman or Buchanan, and insisted upon giving their works a hearing. My original doctoral topic in 1976 “A monetary theory for India” had to be altered not only due to paucity of monetary data at the time but because the problems of India’s political economy and allocation of resources in the real economy were far more pressing. The thesis that emerged in 1982 “On liberty and economic growth: preface to a philosophy for India” was a full frontal assault from the point of view of microeconomic theory on the “development planning” to which everyone routinely declared their fidelity, from New Delhi’s bureaucrats and Oxford’s “development” school to McNamara’s World Bank with its Indian staffers. Frank Hahn protected my inchoate liberal arguments for India; and when no internal examiner could be found, Cambridge showed its greatness by appointing two externals, Bliss at Oxford and Hutchison at Birmingham, both Cambridge men.”

 

 

7. “I have a student called Suby Roy…”  Frank sends me to America in 1980 to work with Jim Buchanan… One letter from him was all it took…

 

 

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And then five years later in 1985 he calls me “probably the outstanding young Hayekian”, says I had brought “a good knowledge of economics and of philosophy to bear on the literature on economic planning”, had “a good knowledge of economic theory” and that my “critique of Development Economics was powerful not only on methodological but also on economic theory grounds” — all that to me has been a special source of delight.

 

 

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We did not meet often after I left Cambridge but he wrote very kindly always, and finally said, hearing of my travails and troubles and adventures, “well you are having an interesting life…”…

 

 

In America, I once met Robert M Solow in a hotel elevator as we were on a  panel at a conference together; I  introduced myself as Hahn’s student… “Aren’t you lucky?” said Solow with a smile…and he was right… I was lucky…

 

 

I said of Milton Friedman that he had been “the greatest economist after John Maynard Keynes”;  Milton’s critic, Frank Hahn, may have been the greatest economic theorist of modern times.

 

 

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                                                                      Frank Hahn (1925-2013)

On the general theory of expertise in democracy: reflections on what emerges from the American “torture memos” today

Twenty years ago, I wrote in Philosophy of Economics (Routledge, London & New York, 1989) quoting from Solzhenitsyn’s experience:

“….the received theory of economic policy… must be silent about the appropriate role of the expert not only under conditions of tyranny (Solzhenitsyn: “The prison doctor was the interrogator’s and executioner’s right-hand man. The beaten prisoner would come to on the floor only to hear the doctor’s voice: ‘You can continue, the pulse is normal’” ); but also where the duly elected government of an open and democratic society proceeded to do things patently wrong or tyrannical (the imprisonment of the Japanese Americans). Hence Popper’s “paradox of democracy” and “tyranny of the majority”..… A theory of economic policy which both assumes a free and open society and bases itself upon a moral scepticism cannot have anything to say ultimately about the objective reasons why a free and open society may be preferred to an unfree or closed society, or about the good or bad outcomes that may be produced by the working of democratic processes…”

Today’s Washington Post reports:

“When the CIA began what it called an “increased pressure phase” with captured terrorism suspect Abu Zubaida in the summer of 2002, its first step was to limit the detainee’s human contact to just two people. One was the CIA interrogator, the other a psychologist. During the extraordinary weeks that followed, it was the psychologist who apparently played the more critical role. According to newly released Justice Department documents, the psychologist provided ideas, practical advice and even legal justification for interrogation methods that would break Abu Zubaida, physically and mentally. Extreme sleep deprivation, waterboarding, the use of insects to provoke fear — all were deemed acceptable, in part because the psychologist said so. “No severe mental pain or suffering would have been inflicted,” a Justice Department lawyer said in a 2002 memo explaining why waterboarding, or simulated drowning, should not be considered torture. The role of health professionals as described in the documents has prompted a renewed outcry from ethicists who say the conduct of psychologists and supervising physicians violated basic standards of their professions. Their names are among the few details censored in the long-concealed Bush administration memos released Thursday, but the documents show a steady stream of psychologists, physicians and other health officials who both kept detainees alive and actively participated in designing the interrogation program and monitoring its implementation. Their presence also enabled the government to argue that the interrogations did not include torture. Most of the psychologists were contract employees of the CIA, according to intelligence officials familiar with the program. “The health professionals involved in the CIA program broke the law and shame the bedrock ethical traditions of medicine and psychology,” said Frank Donaghue, chief executive of Physicians for Human Rights, an international advocacy group made up of physicians opposed to torture. “All psychologists and physicians found to be involved in the torture of detainees must lose their license and never be allowed to practice again.” The CIA declined to comment yesterday on the role played by health professionals in the agency’s self-described “enhanced interrogation program,” which operated from 2002 to 2006 in various secret prisons overseas. “The fact remains that CIA’s detention and interrogation effort was authorized and approved by our government,” CIA Director Leon Panetta said Thursday in a statement to employees. The Obama administration and its top intelligence leaders have banned harsh interrogations while also strongly opposing investigations or penalties for employees who were following their government’s orders. The CIA dispatched personnel from its office of medical services to each secret prison and evaluated medical professionals involved in interrogations “to make sure they could stand up, psychologically handle it,” according to a former CIA official. The alleged actions of medical professionals in the secret prisons are viewed as particularly troubling by an array of groups, including the American Medical Association and the International Committee of the Red Cross. AMA policies state that physicians “must not be present when torture is used or threatened.” The guidelines allow doctors to treat detainees only “if doing so is in their [detainees’] best interest” and not merely to monitor their health “so that torture can begin or continue.” The American Psychological Association has condemned any participation by its members in interrogations involving torture, but critics of the organization faulted it for failing to censure members involved in harsh interrogations. The ICRC, which conducted the first independent interviews of CIA detainees in 2006, said the prisoners were told they would not be killed during interrogations, though one was warned that he would be brought to “the verge of death and back again,” according to a confidential ICRC report leaked to the New York Review of Books last month. “The interrogation process is contrary to international law and the participation of health personnel in such a process is contrary to international standards of medical ethics,” the ICRC report concluded….” (emphasis added)

Twenty-five years ago, the draft-manuscript that became the book Philosophy of Economics got me into much trouble in American academia. As I have said elsewhere, a gang of “inert game theorists”, similar to many (often unemployable ex-mathematicians) who had come to and still dominate what passes for academic economics in many American and European universities, did not like at all what I was saying. A handful of eminent senior economists – Frank Hahn, T W Schultz, Milton Friedman, James M Buchanan, Sidney Alexander – defended my work and but for their support over the decade 1979-1989, my book would not have seen light of day.  Eventually, I have had to battle over years in the US federal courts over it – only to find myself having to battle bribery of court officers and the suborning of perjury by government legal officers  too! (And speaking of government-paid psychologists, I was even required at one point by my corrupt opponent to undergo tests for having had the temerity of being in court at all! Fortunately for me that particular psychologist declined to participate in the nefariousness of his employer!).

I find all this poignant today as Philosophy of Economics may have, among other things, described the general theoretical problem that has been brought to light today.  I was delighted to hear from a friend in 1993 that my book had been prescribed for a course at Yale Law School and was strewn all over an alley in the bookshop.

Separately, I am also delighted to find that a person pioneering the current work is a daughter of our present PM. I have been sharply critical of Dr Singh’s economics and politics, but I have also said I have had high personal regard for him ever since 1973 when he, as a friend of my father’s, visited our then-home in Paris to advise me before I embarked on my study of economics. My salute to the ACLU’s work in this – may it be an example in defeating cases of State-tyranny in India too.

Subroto Roy,

My American years Part One 1980-90: battles for academic integrity & freedom

On the Blacksburg campus February 1982, my second year in America.

I had come to Blacksburg in August 1980 thanks to a letter Professor Frank Hahn had written on my behalf to Professor James M Buchanan in January 1980.

I was in an “All But Dissertation” stage at Cambridge when I got to Blacksburg; I completed the thesis while teaching in Blacksburg, sent it from there in September 1981, and went back to Cambridge for the viva voce examination in January 1982.

Professor Buchanan and his colleagues were welcoming and I came to learn much from them about the realities of public finance and democratic politics, which I very soon applied to my work on India.

Jim Buchanan had a reputation for running very tough conferences of scholars. He invited me to one such in the Spring of 1981. We were made to work very hard indeed. One of the books prescribed is still with me, In Search of a Monetary Constitution, ed. Leland Yeager, Harvard 1962, and something I still recommend to anyone wishing to understand the classical liberal position on monetary policy. The week-long 1981 conference had one rest-day; it was spent in part at an excellent theatre in a small rural town outside Blacksburg. This photo is of Jim Buchanan on the left and Gordon Tullock on the right; in between them is Ken Minogue of the London School of Economics — who, as it happened, had been Tutor for Admissions when I became a freshman there seven years earlier.

(I must have learnt something from Jim Buchanan about running conferences because nine years later in May-June 1989 at the University of Hawaii, I made the participants of the India-perestroika and Pakistan-perestroika conferences work very hard too.)

My first rooms in America in 1980 were in the attic of 703 Gracelyn Court, where I paid $160 or $170 per month to my marvellous landlady Betty Tillman. There were many family occasions I enjoyed with her family downstairs, and her cakes, bakes and puddings all remain with me today.

A borrowed electric typewriter may be seen in the photo: the age of the personal computer was still a few years away. The Department had a stand-alone “AB-Dic” word-processor which we considered a marvel of technology; the Internet did not exist but there was some kind of Intranet between geeks in computer science and engineering departments at different universities.

It was at Gracelyn Court that this letter reached me addressed by FA Hayek himself.

Professor Buchanan had moved to Blacksburg from Charlottesville some years earlier with the Centre for Study of Public Choice that he had founded. The Centre came to be housed at the President’s House of Virginia Tech (presumably the University President himself had another residence).

I was initially a Visiting Research Associate at the Centre and at the same time a Visiting Assistant Professor in the Economics Department. I was very kindly given a magnificent office at the Centre, on the upper floor, perhaps the one on the upper right hand side in the picture. It was undoubtedly the finest room I have ever had as an office. I may have had it for a whole year, either 1980-81 or 1981-82. When Professor Buchanan and the Centre left for George Mason University in 1983, the mansion returned to being the University President’s House and my old office presumably became a fine bedroom again.

I spent the summer of 1983 at a long libertarian conference in the Palo Alto/Menlo Park area in California. This is a photo from a barbecue during the conference with Professor Jean Baechler from France on the left; Leonard Liggio, who (along with Walter Grinder) had organised the conference, is at the right.

The first draft of the book that became Philosophy of Economics was written (in long hand) during that summer of 1983 in Palo Alto/Menlo Park. The initial title was “Principia Economica”, and the initial contracted publisher, the University of Chicago Press, had that title on the contract.

My principal supporter at the University of Chicago was that great American Theodore W. Schultz, then aged 81,

to whom the Press had initially sent the manuscript for review and who had recommended its prompt publication. Professor Schultz later told me to my face better what my book was about than I had realised myself, namely, it was about economics as knowledge, the epistemology of economics.

My parents came from India to visit me in California, and here we are at Yosemite.

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Also to visit were Mr and Mrs Willis C Armstrong, our family friends who had known me from infancy. This is a photo of Bill and my mother on the left, and Louise and myself on the right, taken perhaps by my father. In the third week of January 1991, during the first Gulf War, Bill and I (acting on behalf of Rajiv Gandhi) came to form an extremely tenuous bridge between the US Administration and Saddam Hussain for about 24 hours, in an attempt to get a withdrawal of Iraq from Kuwait without further loss of life. In December 1991 I gave the widow of Rajiv Gandhi a small tape containing my long-distance phone conversations from America with Rajiv during that episode.

I had driven with my sheltie puppy from Blacksburg to Palo Alto  — through Tennessee, Arkansas, Oklahoma, Texas, New Mexico and Arizona; my parents and I now drove with him back to Blacksburg from California, through Nevada, Arizona, Colorado, Kansas, Missouri, Illinois, Indiana, Kentucky, West Virginia.  It may be a necessary though not sufficient condition to drive across America (or any other country) in order to understand it.

After a few days, we drove to New York via Pennsylvania where I became Visiting Assistant Professor in the Cornell Economics Department (on leave from being Assistant Professor at Virginia Tech). The few months at Cornell were noteworthy for the many long sessions I spent with Max Black. I shall add more about that here in due course. My parents returned to India (via Greece where my sister was) in the Autumn of 1983.

In May 1984, Indira Gandhi ruled in Delhi, and the ghost of Brezhnev was still fresh in Moscow. The era of Margaret Thatcher in Britain and Ronald Reagan in America was at its height. Pricing, Planning & Politics: A Study of Economic Distortions in India emerging from my doctoral thesis though written in Blacksburg and Ithaca in 1982-1983, came to be published by London’s Institute of Economic Affairs on May 29 as Occasional Paper No. 69, ISBN: 0-255 36169-6; its text is reproduced elsewhere here.

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It was the first critique after BR Shenoy of India’s Sovietesque economics since Jawaharlal Nehru’s time. The Times, London’s most eminent paper at the time, wrote its lead editorial comment about it on the day it was published, May 29 1984.

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It used to take several days for the library at Virginia Tech in Blacksburg to receive its copy of The Times of London and other British newspapers. I had not been told of the date of publication and did not know of what had happened in London on May 29 until perhaps June 2 — when a friend, Vasant Dave of a children’s charity, who was on campus, phoned me and congratulated me for being featured in The Times which he had just read in the University Library. “You mean they’ve reviewed it?” I asked him, “No, it’s the lead editorial.” “What?” I exclaimed. There was worse. Vasant was very soft-spoken and said “Yes, it’s titled ‘India’s Bad Example’” — which I misheard on the phone as “India’s Mad Example” 😀 Drat! I thought (or words to that effect), they must have lambasted me, as I rushed down to the Library to take a look.

The Times had said

“When Mr. Dennis Healey in the Commons recently stated that Hongkong, with one per cent of the population of India has twice India’s trade, he was making an important point about Hongkong but an equally important point about India. If Hongkong with one per cent of its population and less than 0.03 per cert of India’s land area (without even water as a natural resource) can so outpace India, there must be something terribly wrong with the way Indian governments have managed their affairs, and there is. A paper by an Indian economist published today (Pricing, Planning and Politics: A Study of Economic Distortions in India by Subroto Roy, IEA £1.80) shows how Asia’s largest democracy is gradually being stifled by the imposition of economic policies whose woeful effect and rhetorical unreality find their echo all over the Third World. As with many of Britain’s former imperial possessions, the rot set in long before independence. But as with most of the other former dependencies, the instrument of economic regulation and bureaucratic control set up by the British has been used decisively and expansively to consolidate a statist regime which inhibits free enterprise, minimizes economic success and consolidates the power of government in all spheres of the economy. We hear little of this side of things when India rattles the borrowing bowl or denigrates her creditors for want of further munificence. How could Indian officials explain their poor performance relative to Hongkong? Dr Roy has the answers for them. He lists the causes as a large and heavily subsidized public sector, labyrinthine control over private enterprise, forcibly depressed agricultural prices, massive import substitution, government monopoly of foreign exchange transactions, artificially overvalued currency and the extensive politicization of the labour market, not to mention the corruption which is an inevitable side effect of an economy which depends on the arbitrament of bureaucrats. The first Indian government under Nehru took its cue from Nehru’s admiration of the Soviet economy, which led him to believe that the only policy for India was socialism in which there would be “no private property except in a restricted sense and the replacement of the private profit system by a higher ideal of cooperative service.” Consequently, the Indian government has now either a full monopoly or is one of a few oligipolists in banking, insurance, railways, airlines, cement, steel, chemicals, fertilizers, ship-building, breweries, telephones and wrist-watches. No businessman can expand his operation while there is any surplus capacity anywhere in that sector. He needs government approval to modernize, alter his price-structure, or change his labour shift. It is not surprising that a recent study of those developing countries which account for most manufactured exports from the Third World shows that India’s share fell from 65 percent in 1953 to 10 per cent in 1973; nor, with the numerous restrictions on inter-state movement of grains, that India has over the years suffered more from an inability to cope with famine than during the Raj when famine drill was centrally organized and skillfully executed without restriction. Nehru’s attraction for the Soviet model has been inherited by his daughter, Mrs. Gandhi. Her policies have clearly positioned India more towards the Soviet Union than the West. The consequences of this, as Dr Roy states, is that a bias can be seen in “the antipathy and pessimism towards market institutions found among the urban public, and sympathy and optimism to be found for collectivist or statist ones.” All that India has to show for it is the delivery of thousands of tanks in exchange for bartered goods, and the erection of steel mills and other heavy industry which help to perpetuate the unfortunate obsession with industrial performance at the expense of agricultural growth and the relief of rural poverty.”…..

I felt this may have been intended to be laudatory but it was also inaccurate and had to be corrected. I replied dated June 4 which The Times published in their edition of June 16 1984:

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I was 29 when Pricing, Planning and Politics was published, I am 54 now. I do not agree with everything I said in it and find the tone a little puffed up as young men tend to be; it was also five years before my main “theoretical” work Philosophy of Economics would be published. My experience of life in the years since has also made me far less sanguine both about human nature and about America than I was then. But I am glad to find I am not embarrassed by what I said then, indeed I am pleased I said what I did in favour of classical liberalism and against statism and totalitarianism well before it became popular to do so after the Berlin Wall fell. (In India as elsewhere, former communist apparatchiks and fellow-travellers became pseudo-liberals overnight.)

The editorial itself may have been due to a conversation between Peter Bauer and William Rees-Mogg, so I later heard. The work sold 700 copies in its first month, a record for the publisher. The wife of one prominent Indian bureaucrat told me in Delhi in December 1988 it had affected her husband’s thinking drastically. A senior public finance economist told me he had been deputed at the Finance Ministry when the editorial appeared, and the Indian High Commission in London had urgently sent a copy of the editorial to the Ministry where it caused a stir. An IMF official told me years later that he saw the editorial on board a flight to India from the USA on the same day, and stopped in London to make a trip to the LSE’s bookshop to purchase a copy. Professor Jagdish Bhagwati of Columbia University had been a critic of aspects of Indian policy; he received a copy of the monograph in draft just before it was published and was kind enough to write I had “done an excellent job of setting out the problems afflicting our economic policies, unfortunately government-made problems!”  My great professor at Cambridge, Frank Hahn, would be kind enough to say that he thought my “critique of Development Economics was powerful not only on methodological but also on economic theory grounds” — something that has been a source of delight to me.

Siddhartha Shankar Ray told me when we first met that he had been in London when the editorial appeared and had seen it there; it affected his decision to introduce me to Rajiv Gandhi as warmly as he came to do a half dozen years later.

In the Autumn of 1984, I went, thanks to Edwin Feulner Jr of the Heritage Foundation,  to attend the Mont Pelerin Society Meetings being held at Cambridge (on “parole” from the US immigration authorities as my “green card” was being processed at the time). There I met for the first time Professor and Mrs Milton Friedman.

Milton Friedman’s November 1955 memorandum to the Government of India is referred to in my monograph as “unpublished” in note 1; when I met Milton and Rose, I gave them a copy of my monograph; and requested Milton for his unpublished document; when he returned to Stanford he sent to me in Blacksburg his original 1955-56 documents on Indian planning. I published the 1955 document for the first time in May 1989 during the University of Hawaii perestroika-for-India project I was then leading, it appeared later in the 1992 volume Foundations of India’s Political Economy: Towards an Agenda for the 1990s, edited by myself and WE James. (The results of the Hawaii project reached Rajiv Gandhi through my hand in September 1990, as told elsewhere here in “Rajiv Gandhi and the Origins of India’s 1991 Economic Reform”.) The 1956 document was published in November 2006 on the front page of The Statesman, the same day my obituary of Milton appeared in the inside pages.

Meanwhile, my main work within economic theory, the “Principia Economica” manuscript, was being read by the University of Chicago Press’s five or six anonymous referees. One of them pointed out my argument had been anticipated years earlier in the work of MIT’s Sidney Stuart Alexander. I had no idea of this and was surprised; of course I knew Professor Alexander’s work in balance of payments theory but not in this field. I went to visit Professor Alexander in Boston, where this photo came to be taken perhaps in late 1984:

Professor Alexander was extremely gracious, and immediately declared with great generosity that it was clear to him my arguments in “Principia Economica” had been developed entirely independently of his work. He had come at the problem from an American philosophical tradition of Dewey, I had done so from a British tradition of Wittgenstein. (CS Peirce was probably the bridge between the two.) He and I had arrived at some similar conclusions but we had done so completely independently.

Also, I was much honoured by this letter of May 1 1984 sent to Blacksburg by Professor Sir John Hicks (1904-1989), among the greatest of 20th Century economists at the time, where he acknowledged his departure in later life from the position he had taken in 1934 and 1939 on the foundations of demand theory.

He later sent me a copy of his Wealth and Welfare: Collected Essays on Economic Theory, Vol. I, MIT Press 1981, as a gift. The context of our correspondence had to do with my criticism of the young Hicks and support for the ghost of Alfred Marshall in an article “Considerations on Utility, Benevolence and Taxation” I was publishing in the journal History of Political Economy published then at Duke University. In Philosophy of Economics, I would come to say about Hicks’s letter to me “It may be a sign of the times that economists, great and small, rarely if ever disclaim their past opinions; it is therefore an especially splendid example to have a great economist like Hicks doing so in this matter.” It was reminiscent of Gottlob Frege’s response to Russell’s paradox; Philosophy of Economics described Frege’s “Letter to Russell”, 1902 (Heijenoort, From Frege to Gödel, pp. 126-128) as “a document which must remain one of the most noble in all of modern scholarship; a fact recorded in Russell’s letter to Heijenoort.”

In Blacksburg, by the Summer and Fall of 1984 I was under attack following the arrival of what I considered “a gang of inert game theorists” — my theoretical manuscript had blown a permanent hole through what passes by the name of “social choice theory”, and they did not like it. Nor did they like the fact that I seemed to them to be a “conservative”/classical liberal Indian and my applied work on India’s economy seemed to their academic agenda an irrelevance. This is myself at the height of that attack in January 1985:

Professor Schultz at the University of Chicago came to my rescue and at his recommendation I was appointed Visiting Associate Professor in the Economics Department at Brigham Young University in Provo, Utah.

I declined, without thanks, the offer of another year at Virginia Tech.

On my last day in Blacksburg, a graduate student whom I had helped when she had been assaulted by a senior professor, cooked a meal before I started the drive West across the country. This is a photo from that meal:

In Provo, I gratefully found refuge at the excellent Economics Department led at the time by Professor Larry Wimmer.

It was at Provo that I first had a personal computer on my desk (an IBM as may be seen) and what a delight that was (no matter the noises that it made).  I recall being struck by the fact a colleague possessed the incredible luxury of a portable personal computer (no one else did) which he could take home with him.   It looked like an enormous briefcase but was apparently the technology-leader at the time.  (Laptops seem not to have been invented as of 1985).

In October 1985, Professor Frank Hahn very kindly wrote to Larry Wimmer revising his 1980 opinion of my work now that the PhD was done, the India-work had led to The Times editorial and the theoretical work was proceeding well.

I had applied for a permanent position at the University of Hawaii, Manoa, and had been interviewed positively at the American Economic Association meetings (in New York) in December 1985 by the department chairman Professor Fred C. Hung. At Provo, Dr James Moncur of the Manoa Department was visiting. Jim became a friend and recommended me to his colleagues in Manoa.

Professor Hung appointed me to that department as a “senior” Assistant Professor on tenure-track beginning September 1986. I had bargained for a rank of “Associate Professor” but was told the advertisement did not allow it; instead I was assured of being an early candidate for promotion and tenure subject to my book “Principia Economica” being accepted for publication. (The contract with the University of Chicago Press had become frayed.)

Hawaii was simply a superb place (though expensive).

Professor James Buchanan won the Economics “Nobel” in 1986 and I was asked by the Manoa Department to help raise its profile by inviting him to deliver a set of lectures, which he did excellently well in March 1988 to the University as well as the Honolulu community at large. Here he is at my 850 sq ft small condominium at Punahou Towers, 1621 Dole Street:

In August 1988, my manuscript “Principia Economica” was finally accepted for publication by Routledge of London and New York under the title Philosophy of Economics: On the Scope of Reason In Economic Inquiry. The contract with University of Chicago Press had fallen through and the manuscript was being read by Yale University Press and a few others but Routledge came through with the first concrete offer. I was delighted and these photos were taken in the Economics Department at Manoa by a colleague in September 1988 as the publisher needed them.

Milton and Rose Friedman came to Honolulu on a private holiday perhaps in January 1989; they had years earlier spent a sabbatical year at the Department.

Here is a luncheon that was arranged in their honour. They had in the Fall of 1988 been on their famous visit to China, and as I recall that was the main subject of discussion on the occasion.

Milton phoned me in my Manoa office and invited me to meet him and Rose at their hotel for a chat; we had met first at the 1984 Mont Pelerin meetings and he wished to know me better. I was honoured and turned up dutifully and we talked for perhaps an hour. I recall making a strong recommendation that he write his memoirs, especially so that the rumours and innuendo surrounding eg the Chile episode could be cleared up; I also said a “Collected Works” would be a great idea; when Milton and Rose published their memoirs Two Lucky People (Chicago 1998) I wondered if my first suggestion had come to be taken; as to the second, he wrote to me years later saying he felt no Collected Works were necessary.

From 1986 onwards, I had been requested by the University of Hawaii to lead a project with William E James on the political economy of “South Asia” .I had said there was no such place, that “South Asia” was a US State Department abstraction but there were India and Pakistan and Sri Lanka and Bangladesh and Afghanistan etc. Sister projects on India and Pakistan had been sponsored by the University, and in 1989 important conferences had been planned by myself and James in May for India and in June for Pakistan.

I was determined to publish for the first time Milton’s 1955 memorandum on India which the Government of India had suppressed or ignored at the time. At the hotel-meeting, I told Milton that and requested him to come to the India-conference in May; Milton and Rose said they would think about it, and later confirmed he would come for the first two days.

This is a photo of the initial luncheon at the home of the University President on May 21 1989. Milton and India’s Ambassador to the USA at the time were both garlanded with Hawaiian leis. The first photo was one of a joke from Milton as I recall which had everyone laughing.

There was no equivalent photo of the distinguished scholars who gathered for the Pakistan conference a month later.

The reason was that from February 1989 onwards I had become the victim of a most vicious racist defamation, engineered within the Economics Department at Manoa by a senior professor as a way to derail me before my expected Promotion and Tenure application in the Fall. All my extra time went to battling that though somehow I managed to teach some monetary economics well enough in 1989-1990 for a Japanese student to insist on being photographed with me and the book we had studied.

I was being seen by two or three temporarily powerful characters on the Manoa campus as an Uppity Indian who must be brought down. This time I decided to fight back — and what a saga came to unfold! It took me into the United States District Court for the District of Hawaii and then the Ninth Circuit and upto the United States Supreme Court, not once but twice.

Milton Friedman and Theodore Schultz stood valiantly among my witnesses — first writing to the University’s authorities and later deposing in federal court.

Unfortunately, government lawyers, far from wanting to uphold and respect the laws of the United States, chose to deliberately violate them — compromising a judge, suborning demonstrable perjury and then brazenly purchasing my hired attorney (and getting caught doing it). Since September 2007, the State of Hawaii’s attorneys have been invited by me to return to the federal court and apologise for their unlawful behaviour as they are required by law to do.

They had not expected me to survive their illegalities but I did: I kept going.

Philosophy of Economics was published in London and New York in September 1989

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The hardback quickly sold out on its own steam and the book went into paperback in 1991, and I was delighted to learn from a friend that it had been prescribed for a course at Yale Law School and was strewn along an alley in the bookshop:

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The sister-volumes on India and Pakistan emerging from the University of Hawaii project led by myself and James were published in 1992 and 1993 in India, Pakistan, Britain and the United States.

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As described elsewhere, the manuscript of the India-volume contributed to the origins of India’s 1991 economic reform during my encounter with Rajiv Gandhi in his last months; the Pakistan-volume came to contribute to the origins of the Pakistan-India peace process. The Indian publisher who had promised paperback volumes of both books reneged under leftwing pressure in Delhi; he has since passed away and James and I still await the University of Hawaii’s permission to publish both volumes freely on the Internet as copyright rests with the University President.

In 2004 from Britain, I wrote to the 9/11 Commission stating that it was possible that had the vicious illegalities against me not occurred at Manoa starting in 1989, we may have gone on after India and Pakistan to study Afghanistan, and come up with a pre-emptive academic analysis a decade before September 11 2001.

To be continued in Part Two.

“A Dialogue in Macroeconomics” 1989 etc: sundry thoughts on US economic policy discourse

I have said here recently that some of the wisest advice President Obama or any leader anywhere can receive is that contained in Oliver Cromwell’s famous words “Think it possible you may be mistaken”.

This seems especially significant in context of new American macroeconomic and financial policies.  Mr Steve Clemons reports today there may be less intellectual diversity in the new President’s economic team than is possible or desirable; if so, conversation may become stifled and a greater propensity towards groupthink may arise, hence a greater likelihood of mistakes.

It is possible the directions that different people might like to see the conversation extended are different, and that would be a good sign of course!  For example, someone might think a Barro or a Mishkin could be the right addition of intellectual diversity, whereas others might suppose that to be the wrong direction towards more “market fundamentalism”.    But it would be a pity if the economic conversation within the new Administration came to be artificially or ideologically circumscribed in any direction.

Certainly I believe macroeconomic policy-discourse in the United States or elsewhere needs to proceed to a recognition of the existence of JM Keynes’s original concept of “involuntary unemployment” as well as to ask whether the actual unemployment happens to be or  not be of this sort.   (It may be “frictional” or “structural” or “voluntary” or “seasonal” etc, not the involuntary unemployment Keynes had meant.)  Furthermore, even if significant involuntary unemployment is identified, it needs to be asked whether government policy can be expected to improve or worsen outcomes.   The argument must be made either way, and, in John Wisdom’s phrase,  “Argument must be heard”.

“A Dialogue in Macroeconomics” which was Chapter 8 of my 1989 book Philosophy of Economics (Routledge,  Library of Congress HB 72.R69)  may provide some useful ballast.  The saga  that followed the  book’s publication left me unable to write about the US economy anymore, except briefly in 1992 and 1994-95 in Washington and New York, read only by a few friends.   Now in late 2008, I have published “October 1929? Not!” and “America’s divided economists” which may be of interest too, and which are republished below as well.

I have also added a couple of sundry points from an international perspective that I pointed to last September-October, namely

(i)  foreign central banks might have been left holding more bad US debt than might be remembered, and dollar depreciation and an American inflation seem to be inevitable over the next several years;

(ii) all those bad mortgages and foreclosures could vanish within a year or two by playing the demographic card and inviting in a few million new immigrants into the United States; restoring a worldwide idea of an American dream fueled by mass immigration may be the surest way for the American economy to restore itself.

Subroto Roy

I.

from Philosophy of Economics Routledge 1989

“Chapter 8.
A Dialogue in Macroeconomics

OUR next example is of quite a different sort, namely, the academic debate which has occurred in macroeconomics and monetary theory since Keynes’s General Theory of Employment, Interest and Money. This has of course received a great amount of attention, with innumerable commentaries having been written by many scores of protagonists and moderators around the world. Only a brief and highly simplified summary of these many conversations can be attempted here, within our limited objective of illustrating once more how it may be possible for critical discussion to be seen to proceed freely and yet objectively in economics. In the previous chapter we were fortunate to have had an actual conversation to consider; here our method shall have to be one of constructing a model of a conversation. In honour of Plato, we might name our conversants Athenian and Stranger.

ATHENIAN Tell me, have you perhaps been following the discussions among macroeconomists? I shall be interested to know what you take their present state to be.

STRANGER Indeed I have, though of course it is not possible or worthwhile to follow all of what has been said. But yes I have followed some of it, and certainly we can make it a topic of conversation.

ATHENIAN Please begin.

STRANGER Very well. Shall we do so in ‘36 with the publication of Keynes’s book? Rightly or wrongly, this must be considered a watershed in the history of modern economics, if only because most economists since have had either to admit its arguments in some measure or define and explain their disagreement. You’ll remember at one time it was said by many that Keynes had fathered a revolution in economic science.

ATHENIAN Except Chicago and the Austrians.

STRANGER Quite so. Now more recently a renewal of neoclassical thought has been under way, and many doubts have been raised about the keynesian consensus, so much so that some of the main questions of the thirties seem in modern form to continue to be at issue today.

ATHENIAN The more things change, the more they stay the same! But when you say Keynes has been a central figure, I take it you mean only that he has been among the most influential and most discussed and nothing more. It is not to preclude judgement on the merits of his book, which is itself of very uneven clarity. Besides there has been too much idolatry and hagiography.

STRANGER Yes, there is so often a rush to belief and worship. There may have been less if Keynes had survived longer. Yet I should say the broad aim of the work is not hard to see. Keynes himself clearly believes that he is starting a revolution — going so far as to suggest a comparison with contemporary physics. The first chapter says the book aims to provide a “general” theory, which will explain the traditional model as a “limiting” case. The second chapter says the theory of value has been hitherto concerned with the allocation of given resources between competing ends; Keynes is going to explain how the actual level of employment comes to be what it is.

ATHENIAN And so begs the question?

STRANGER Or does traditional theory? That seems to be at the heart of it.

ATHENIAN Go on.

STRANGER The theory will be of the short run in Marshall’s sense of taking capital as a fixed factor. Traditional theory is said to postulate about the labour market (i) that the real wage equals the marginal product of labour, so there is an assumption of profit maximization by competitive producers giving rise to a short run demand curve for labour; and (ii) that the utility of the wage at a given level of employment equals the marginal disutility of that amount of employment; i.e., the real wage is just sufficient to induce the volume of labour which is actually forthcoming. So it can account for unemployment due to temporary miscalculations, or intermittent demand, or the refusal or inability of labour to accept a job at a given wage due to legislation or social practices or collective bargaining or obstinacy, or merely a rational choice of leisure — i.e., it can account for frictional and voluntary unemployment but not for what Keynes wants to call involuntary unemployment. What it can suggest is either such things as improvements in foresight, information, organization and productivity, or a lowering of the real wage. But Keynes’s critique will not have to do with such causes of the contemporary unemployment; instead the population is said to be seldom “doing as much work as it would like to do on the basis of the current wage…. More labour would, as a rule, be forthcoming at the existing money wage if it were demanded.” But it is not being demanded, and it is not being demanded because there has been a shortfall of “effective demand”. That is why there is as much unemployment as there is.

ATHENIAN Or so Keynes claims. And he would take it the neoclassical view would be that it must be the real wage is too high; it is only because the real wage has not fallen by enough that unemployment continues.

STRANGER Right. To which there are two observations. The first has to do with the actual attitude of workers towards the money wage and the real wage respectively. The traditional supply function of labour is a function of the latter; Keynes claims that at least within a certain range it must be workers are concerned more with the former.

ATHENIAN How so?

STRANGER By the interesting and perhaps plausible claim that workers are found to withdraw labour if the money wage falls but do not seem to do the same if the price level rises. A real wage reduction caused by a fall in the money wage and the same real wage reduction caused by an increase in prices seem to have different effects on labour supply. “Whether logical or illogical, experience shows that this is how labour in fact behaves.” And he cites U. S. data for ‘32 to say labour did not refuse reductions in the money wage nor did the physical productivity of labour fall yet the real wage fell and unemployment continued. “Labour is not more truculent in the depression than in the boom — far from it.”

ATHENIAN And the second observation?

STRANGER This may be of more interest. “Classical theory assumes that it is always open to labour to reduce its real wage by accepting a reduction in its money wage… [it] presumes that labour itself is in a position to decide the real wage for which it works…” Keynes does not find a traditional explanation why prices tend to follow wages, and suggests it could be because the price level is being supposed to be determined by the money supply according to the quantity theory. Keynes wants to dispute the proposition “that the general level of real wages is directly determined by the character of the wage bargain…. For there may be no method available to labour as a whole whereby…. [it] can reduce its real wage to a given figure by making revised money bargains with the entrepreneurs.” Hence he arrives at his central definition of involuntary unemployment: if the real wage falls marginally as a consequence of the price level rising with the money wage constant, and there is greater employment demanded and supplied in consequence, the initial state was one of involuntary unemployment.

ATHENIAN You are saying then that Keynes’s intent is to establish the existence of involuntary unemployment?

STRANGER At least a major part of the intent yes. To make the concept meaningful, to argue that it refers to a logical possibility, and also that much of the actual unemployment of the time may be falling under it, and is a result of lack of “effective demand”.

ATHENIAN The neoclassicals have been said to be cavalier about fluctuations in economic activity, when in fact Wicksell and Marshall and Thornton, let alone Hawtrey or Hayek as Keynes’s own critics, certainly had profound enough theories of the cycle. Before we go further, I think we should remind ourselves of what they actually said.

STRANGER Very well.

ATHENIAN Would you agree that can be summarized, then as now, as the quantity theory of money married to the theory of general equilibrium?

STRANGER Though it may be better to speak of divorce perhaps rather than marriage, in view of the dichotomy.

ATHENIAN From Smith to Mill, political economists broadly agree the role of government should extend and be restricted to such activities as defence, civil protection, the rule of law, the provision of public goods, education, the encouragement of competition, and so on. The traditional agenda does not as a rule include direct activity to restrain or otherwise change the natural course of trade, production, or consumption, and certainly no theory of what today is called macroeconomic policy. Underlying it is a broad belief that the competitive pursuit of private welfare within the necessary and minimal framework of the institutions of government, will result in tolerable social outcomes, and any further activity may be counterproductive. The State is after all endogenous to the economy, without any resources to its own name.

STRANGER The minimal state, though not so minimal perhaps as we sometimes think.

ATHENIAN The main function of money is seen to be that of facilitating real transactions. Hence the main component of the demand for money is the transactions demand, and the broad objective of monetary policy is the maintenance of the stability of the price of money. But this is recognized to be something elusive in practice, and fluctuations in economic activity are expected to occur in spite of the best intentions of the monetary authorities.

STRANGER How so?

ATHENIAN Well we might imagine two or three distinct but related markets: one for real investment and savings determined by intertemporal preferences, resources, and technologies; one a market for investment and savings defined in terms of money; one a short term credit market. The market for real investment and savings is, as it were, unobservable to the naked eye. Yet it drives the second and third markets for nominal savings and investment in which we actually participate. Monetary equilibrium requires the observable money rates of interest to equal the unobservable real rate of return on the market for physical capital. In particular, the real or natural rate of interest determined in the equilibrium of the first market is not, and perhaps ultimately cannot be, affected by nominal or monetary disturbances in the second or third markets.

STRANGER Why call it “natural”?

ATHENIAN In the sense it is a function of the real data of intertemporal preferences, resources, and technologies being what they are. If these data changed it should be expected to change too. But given these data, it would be the rate at which intertemporal constrained maximizations by individual agents resulted in planned present consumption equaling planned present production at the same time as planned future consumption equaled planned future production.

STRANGER In other words, real planned savings equal real planned investment.

ATHENIAN Exactly. It is the real interest rate, or rather the whole structure of own-rates and cross-rates at various terms, which is the key price signal for macroeconomic equilibrium.

STRANGER “Natural” seems to me to carry a physiocratic connotation. A better nomenclature would replace it with something else — perhaps “equilibrium real rate” or just “walrasian” rate.

ATHENIAN Very well, though I for one do not bias myself against the physiocrats! Now consider how a simple business cycle might occur on wicksellian lines. From a position of full real and monetary equilibrium, an expansion of credit has its first effect on the banks, increasing reserves and inducing more lending for reserve/deposit ratios to be restored, and so lowering the loan rate. But customers are only able to perceive a lowering of this nominal rate of interest and cannot know the equilibrium real rate has not changed. As far as households know, the relative price of present consumption has fallen and there is an incentive for greater consumption and lesser savings. As far as businesses know, the relative price of the future good has risen, and there is an incentive for greater investment. Inventories are run down, and markets for both consumer goods and capital goods are stimulated and show signs of excess demand. But if there was a walrasian equilibrium initially, then the economy will now show signs of inflation; with a gold standard, there would be increased demand for imports and an external drain of reserves, and even perhaps an internal drain if there was a panic and a run on the banks. The loan rate will have to rise once more to reign in reserves, but if the rate is now raised too high relative to the still unchanged real rate, there would be the makings of a recession.

STRANGER Your point being that economists before Keynes had recognized the decentralized economy may be fluctuating continually.

ATHENIAN Surely they had done so quite fully. A first set of causes such as wars, disasters, discoveries and migrations would change the real data of the economy, while a second set would be monetary disturbances like the failure of the authorities to adequately follow the dictates of the real data of the economy, i.e., failure to observe the equilibrium real rate of interest. It may even be intrinsic to the problem that they must fail in the attempt to observe, let aside compute, the equilibrium real rate warranted at a given time by the structure of the real data.

STRANGER Hence the conclusion that they cannot hope to do better than establish a climate of monetary and fiscal stability, such as by declaring a long term policy and staying with it.

ATHENIAN Exactly. Private economic agents already face endemic uncertainty with respect to changes in the real data, and must be assumed to not want more added by government policy. You appear to have seen my point nicely.

STRANGER Very well. But you have jumped ahead as this kind of a conclusion sounds very modern to me. You made me stop all the way back at Keynes’s notion of effective demand!

ATHENIAN As I said, the more things change, the more they stay the same.

STRANGER Let us go back a little. I think we may be able to rejoin our initial route at a point which may bring us close to where we seem to have come by the route you have taken. Specifically suppose we go back to the question of the money wage and the real wage, and of the real wage being “too high”.

ATHENIAN That has been interpreted a number of ways, has it not?

STRANGER Yes it has. One would be to say Keynes was merely simple minded and assumed money illusion on the part of workers. Another would be to say Keynes assumed a short run context of fixed prices, so it would not make a difference whether labour happened to be concerned with changes in the real or the money wage. Yet a third would be to say Keynes, whether he realized it or not, had come upon a recondite truth about the sort of complex monetary economy in which we live — namely, that when transactions are quoted and made in a monetary economy, it may become difficult ipso facto for the walrasian equilibrium to be achieved. Even workers might fully recognize the real wage to be too high and be prepared to work more at a lower wage, but be unable to signal this willingness to potential employers.

ATHENIAN So involuntary unemployment becomes another sort of equilibrium outcome.

STRANGER Exactly. Not only of labour but of machines too, along with the unintended holding of inventories. It is as if firms would have sold what they had planned to if only workers had the income to buy it, which they would have done if only they had been able to sell as much labour they had planned to, which they would have done if only there had been an effective demand for it, which there would have been if firms had not cut back on production because they found themselves unable to sell what they had planned to sell. A kind of vicious circle, due to pessimistic and self-fulfilling expectations all around.

ATHENIAN An unhappy solution to a non-cooperative game you might say.

STRANGER Quite so. Keynes does not deny there may be a monetary route out of the impasse. A wage deflation would eventually lead to price deflation, raising the real value of money holdings, so via liquidity preference lead to an increased demand for bonds, raising their price and lowering money interest rates, which through the investment function would lead eventually to increased effective demand. But the fiscal route may be more direct and quicker in its effect on expectations. Trying to deflate across the board in the face of what seem to be excess supplies of goods and labour might be counterproductive, causing unexpected transfers from debtors to creditors and precipitating bankruptcies. Instead: “Government investment will break the vicious circle. If you can do that for a couple of years, it will have the effect, if my diagnosis is right, of restoring business profits more nearly to normal, and if that can be achieved then private enterprise will be revived. I believe you have first of all to do something to restore profits and then rely on private enterprise to carry the thing along….”

ATHENIAN A shot in the arm for enterprise in the hope of breaking the pessimism. But Keynes was hardly alone in such thinking.

STRANGER Quite true.

ATHENIAN And he certainly seemed to treat the opinions of others without due respect, which is to say he may have exaggerated the significance of his own. Hinting that he was the Einstein of economics set an especially bad example. Only the other day one eminence was comparing himself to Newton, and another was calling his friend Shakespeare. It will be Joyce and Pasternak next!

STRANGER Flattery and nepotism are common weaknesses, my friend. Like the rush to belief and worship.

ATHENIAN Besides you would have to assume the government to be outside the game, and only so being able to see the problem which private agents could not from inside the game. That may be too large an assumption, don’t you think?

STRANGER Yes it may. Yet it seems to me pump-priming was a possible solution being offered to a temporary problem. Many of the controversies may have come about because it became institutionalized, because discretionary fiscal policy became a permanent part of the government agenda.

ATHENIAN And a more direct route out was available too, was it not? With wealth placed in the consumption function directly, a deflation would increase the real value and affect effective demand directly. We would not have to wait for the roundabout effects through so-called liquidity preference.

STRANGER Which in a way brings us back to a central pillar of traditional theory: with given real data and given velocity of circulation, desired holding of real money balances will roughly be constant. In particular the demand for real money balances should not be seen as a function of the interest rate.

ATHENIAN The real rate or the monetary rate?

STRANGER For neoclassicals certainly the real; Keynes does not seem clear.

ATHENIAN There may lie a problem.

STRANGER The title of the book says “Employment, Interest, and Money”. No question employment is real and money is money — interest is the bridge. If you ask me to bet I would say Keynes’s agents make real responses to signals expressed as they must be in a large economy in monetary terms.

ATHENIAN Perhaps we ought to move on. Tell me, if you think Keynes’s book rightly or wrongly ranks as the most influential document of the last fifty years, would you agree it is Friedman’s address on the role of monetary policy which must rank second to it if not on a par with it?

STRANGER Certainly there can be few competitors.

ATHENIAN Well then, it appears to me the net effect of Friedman’s critique has been a restoration of the wicksellian theory and a banishment of the keynesian theory.

STRANGER Friedman of course makes his approach via a critique of the Phillips’ Curve.

ATHENIAN Yes, but it is Wicksell whom he acknowledges in advancing the notion of a natural rate of unemployment, one which has been “ground out by the walrasian system of general equilibrium equations” — in other words, one which happens to be consistent with the structure of the real data of the economy at a particular time.

STRANGER Though again we may as well speak of walrasian instead of natural.

ATHENIAN A monetary policy which tried to peg unemployment at lower than such a rate (if such a rate could be determined, which it cannot) is likely to be counterproductive. The initial effect of an expansionary policy on a walrasian equilibrium may be to increase real output. Workers assume the increase to reflect an increase in the unobservable real demand for their services, and hence they expect a higher real wage. Businesses see the same and assume it to reflect an increase in the unobservable real demand for their goods. But given there was no real excess demand in the first place for either labour or goods, the effect outside anything but the short run will be a return to the initial structure of real wages, and the temporary decline in unemployment is reversed to the walrasian rate at higher prices. If the government tries to maintain unemployment at less than the walrasian rate, it will have to concede — indeed it will have caused — accelerating inflation without any real fall in unemployment.

STRANGER And vice versa perhaps, so there would be a kind of knife-edge.

ATHENIAN Now your remark about Friedman making his approach via the Phillips Curve seems to me interesting. We may have been too hasty to make a comparison with the debate in the thirties. For the world suffers a very real and severe shock between Keynes’s book and the keynesian consensus, which is the Second World War itself.

STRANGER I am not sure I follow.

ATHENIAN Well think of the consensus afterwards on the need for macroeconomic policy — it is actually Tinbergen’s notion of a “policy-maker” which is married to what seems to be Phillips’s finding of a trade-off between inflation and unemployment. It becomes the role of the macroeconomist to advise the politician on how to minimize social disutility from inflation and unemployment subject to the Phillips Curve. Macroeconomics becomes a so-called “policy science”. Give your expert economist your social utility function, and he will tell you where to slide to on your Phillips Curve.

STRANGER The available instruments being money supply and tax rates. That is what I meant in saying Keynes’s idea became institutionalized.

ATHENIAN It seems to me this consensus is born out of the War.

STRANGER How so?

ATHENIAN Well just think of the structural problems of the time: demobilization of large armies, reconstruction, all the displaced peoples, and so on. What are democratic governments to do? Say to their voters, right, thank you very much, now could you please go home quietly? What could have been expected except an Employment Act? Governments were going to help their returning citizens find work, or at least it would have seemed irresponsible if they had not said they were going to.

STRANGER You are saying then that Friedman may have been arguing against a new orthodoxy, grown out of what might have been a sensible idea.

ATHENIAN Exactly. The world is a very different place now than in 1945, in ‘45 than in ‘33, in ‘33 than in 1914. Real shocks every time. It may be a grave mistake for us to look for a unique and universal theory which is supposed to explain all particular circumstances, all of history.

STRANGER Reminds me of the historical school.

ATHENIAN Why not? Again I hold no prejudice against them! Anyhow, consider that Lucas and others have followed Friedman to argue it is a mistake to formulate the problem as Tinbergen had done, with unemployment as a target in a social utility function along with inflation. If it ought to be assumed that people will not continually make the same mistakes in predicting policy, then a systematic employment policy is going to be discovered quickly enough and rendered either ineffective or counterproductive. This idea too has its origins in Wicksell. Examining an opinion that inflation might stimulate enterprise and free debtors, Wicksell says: “It need only be said that if this fall in the value of money is the result of our own deliberate policy, or indeed can be anticipated and foreseen, then these supposed beneficial effects will never occur, since the approaching rise in prices will be taken into account in all transactions by reasonably intelligent people.”

STRANGER Wicksell said that?

ATHENIAN Precisely that.

STRANGER It does sound very modern.

ATHENIAN Now Lucas speaks of how the advice that economists give should be limited only to “the well understood and empirically substantiated propositions of monetary economics, discouragingly modest as these may be.” What can we take him to mean? It seems to me he is sharing Friedman’s scepticism of the possibilities which had been claimed for macroeconomics by the keynesian consensus. And that surely has been a healthy scepticism, befitting good economists.

STRANGER As I said, there is so often a rush to belief.

ATHENIAN Which is really disastrous when combined with the craving for power.

STRANGER But the question remains, does it not, as to which propositions of monetary economics are to be considered “well understood and empirically substantiated”. I cannot help think the propositions taken to be well understood and empirically substantiated in Chicago may be very different from those taken to be well understood and empirically substantiated in Cambridge, or for that matter, those in the U. S. from those in Europe.

ATHENIAN I don’t see any difficulty in this. For first, it would have been granted there are propositions in economics which can be well understood and empirically substantiated. And that must be counted as progress! For something cannot be well understood if it cannot be understood at all, and where there is the possibility of understanding there must be the possibility of objective knowledge as well. And second, why should we not say the most appropriate task of economic theory or analytical economics is simply one of clarification and elucidation of the conceptual basis of economic thinking and expression? All theory ultimately is, or ought to be, “Critique of Language”. When we are faced with a particular and concrete problematic situation, the theorist is to whom we turn for conceptual guidance and criticism. If instead you take the role of the theorist to be one of searching the universe for grand and general and absolute and abstract truths, which need to be discovered before we can say anything about some concrete set of particulars, then it seems to me you will be either struck dumb by a total and debilitating scepticism or become very shrill in your dogmatism or alternate wildly between the two. To me it seems unimportant ultimately to whose flag one shows allegiance, or indeed that allegiance to any flag must be shown.

STRANGER It seems again I will not disagree. But you have sketched the critique of Friedman and Lucas and indeed the ghost of Wicksell addressed to the dogmas of the keynesian orthodoxy. And I have agreed with you this has been a healthy criticism of the sort we should expect economists to provide. But there has been serious question too of the framework used by Friedman and Lucas, hasn’t there? I am thinking especially of Tobin and Hahn.

ATHENIAN Tobin has done much to add clear and reasonable thinking about Keynes — his suggestion that a certain amount of inflation may be the only way to bring down real wages towards their walrasian rates in complex monetary economics is especially interesting; it shows how wide the common ground can be upon which the debate may occur. But you will have to tell me what Hahn’s criticisms have been. I have always found them too abstract and too caustic.

STRANGER That they tend to be, but don’t let that deter you. As I see it, Hahn argues somewhat as follows. We should grant Friedman and Lucas two important points: first, the government is itself a large economic agent whose actions and announced plans enter the calculations of private agents; secondly, erratic changes in monetary policy away from a steady k% rule may have perverse effects “by confusing signals of relative scarcity with those that arose from the monetary policy”. Also, we may accept that the assumptions sufficient for a full walrasian equilibrium with rational expectations suffice for the absence of any persistent involuntary unemployment by Keynes’s definition. But Hahn would say this may not be the relevant empirical description.

ATHENIAN In what way?

STRANGER Well for one thing the pricing axiom or the recontracting assumption of stability theory remains unexplained. It is possible traders will face quantity constraints, and this often seems so in markets for labour and credit. We may simply find prices not moving in the direction of excess demand even when a quantity constraint happens to be binding. The structure of wages may be “neither fixed, nor arbritrary, nor inflexible; it is what it is because given conjectures, no agent finds it advantageous to change it.” Moreover, it may not be plausible to suppose there will be convergence after arbitrary displacements back towards a stable equilibrium, because the conditions for stability are very stringent and uniqueness of equilibrium may also need to be postulated. Furthermore, it may be quite unsatisfactory to treat money in models which are isomorphic to the Arrow-Debreu model, because in such a world there is no logical use for money, so there must be some essential features of reality which have failed to be features of the model.

ATHENIAN You don’t think Patinkin’s integration was adequate?

STRANGER For many practical purposes perhaps, but certainly not to full logical satisfaction. If you put real money balances into the utility function and treat money just about like any other good, you have to be prepared to accept a possible equilibrium in which the price of money is zero. Lastly, if there are internal debts denominated in money as there are in fact, you may not assume equiproportional changes in all prices will not have real effects, unless you are prepared to assume away redistributions between creditors and debtors, which you can do only under another assumption that all households have parallel and linear Engel curves through the origin. Hahn’s line of argument is admittedly abstract, but you will have to admit it raises some fundamental questions.

ATHENIAN Another example we might say of the healthy scepticism of the theorist. It seems my turn to agree with you. But we can imagine replies too can we not?

STRANGER What do you have in mind?

ATHENIAN Well to argue there can be unemployment which is involuntary is not to have argued that an employment policy can be expected to remove it. This seems a premise and conclusion too frequently confounded by both keynesians and their critics, with disastrous consequences. Then, Buchanan would argue that a more thorough characterization needs to be given of the making of government policy, especially when it is proposed to supplant the market outcome. Policies are after all proposed, enacted, and put into effect by actual people — all of whom may need to be assumed to be pursuing private rewards as well in the course of their public duties. The relevant description for the economist needs to be one including this further fact that actual proposals of public policy can embody the private interests of the proposers too.

STRANGER Making it that much more difficult to determine what is in the public interest in a given case.

ATHENIAN Exactly. And so reinforcing the case for predictability and an orderliness in the framework of government.

STRANGER But we have been talking now for quite long enough my friend. I seem to feel a fear too that we have not gained anything at all in our discussions.

ATHENIAN Don’t be so pessimistic! Surely the point of reconstructing such conversations as we have done is not to hold absolutely to the matters raised in them. You and I after all have been making summary and highly simplified and unauthorized interpretations. I take the point of it to have been clarifying our thoughts, and perhaps to show ourselves how discussion can proceed between economists of different schools of thought. Arguments might come to a halt for any of a number of reasons, but they needn’t be supposed to have any logical or necessary end. Too often we let people retreat into different dogmatic positions, fostering the belief that each is starting from some set of absolute axioms ultimately irreconcilable with those of the other. We may need to keep insisting instead that the pursuit of knowledge and understanding is an open-ended activity with potentially indefinite limits. It yields conclusive results but has no absolute end. You or I might call a halt and retire from it, but that will not mean it cannot or will not continue without us.

STRANGER Perhaps so. But you are younger than I, and I have become tired by all these thrusts and parries. Besides, there has been the enjoyment of conversation itself.”

II

October 1929? Not!  by Subroto Roy / First published in Business Standard September 18, 2008

“Lehman Brothers filing for bankruptcy protection, Merrill Lynch taken over by Bank of America, Fannie Mae and Freddie Mac and now AIG being nationalised by the US Government, Bear Stearns getting a government bailout, many thousands of low-quality loans going bad … Does it all add up to an American financial crisis in the autumn of 2008 comparable to that in the autumn of 1929? Even Alan Greenspan himself has gone on record on TV saying it might.

But there are overriding differences. Most important, the American economy and the world economy are both incomparably larger today in the value of their capital stock, and there has also been enormous technological progress over eight decades. Accordingly, it would take a much vaster event than the present turbulence — say, something like an exchange of multiple nuclear warheads with Russia causing Manhattan and the City of London to be destroyed — before there was a return to something comparable to the 1929 Crash and the Great Depression that followed.

Besides, the roots of the crises are different. What happened back then? In 1922, the Genoa Currency Conference wanted to correct the main defect of the pre-1914 gold standard, which was freezing the price of gold while failing to stabilise the purchasing power of money. From 1922 until about 1927, Benjamin Strong of the Federal Reserve Bank of New York adopted price-stabilisation as the new American policy-objective. Britain was off the gold standard and the USA remained on it. The USA, as a major creditor nation, saw massive gold inflows which, by traditional gold standard principles, would have caused a massive inflation. Governor Strong invented the process of “sterilisation” of those gold inflows instead and thwarted the rise in domestic dollar prices of goods and services.

Strong’s death in 1928 threw the Federal Reserve System into conflict and intellectual confusion. Dollar stabilisation ended as a policy. Surplus bank money was created on the release of gold that had been previously sterilised.

The traditional balance between bulls and bears in the stock-market was upset. Normally, every seller of stock is a bear and every buyer a bull. Now, amateur investors appeared as bulls attracted by the sudden stock price rises, while bears, who sold securities, failed to place their money into deposit and were instead lured into lending it as call money to brokerages who then fuelled these speculative bulls. As of October 22, 1929 about $4 billion was the extent of such speculative lending when Chase National Bank’s customers called in their money.

Chase National had to follow their instructions, as did other New York banks. New York’s Stock Exchange could hardly respond to a demand for $4 billion at a short notice and collapsed. Within a year, production had fallen by 26 per cent, prices by 14 per cent, personal income by 14 per cent, and the Greatest Depression of recorded history was in progress — involuntary unemployment levels in America reaching 25 per cent.

That is not, by any reading, what we have today. Yes, there has been plenty of bad lending, plenty of duping shareholders and workers and plenty of excessive managerial payoffs. It will all take a large toll, and affect markets across the world.

But it will be a toll relative to our plush comfortable modern standards, not those of 1929-1933. In fact, modern decisionmakers have the obvious advantage that they can look back at history and know what is not to be done. The US and the world economy are resilient enough to ride over even the extra uncertainty arising from the ongoing presidential campaign, and then some.”


III

America’s divided economists by Subroto Roy First published in Business Standard October 26, 2008

“Future doctoral theses about the Great Tremor of 2008 will ask how it was that the Fed chief, who was an academic economist, came to back so wholeheartedly the proposals of the investment banker heading the US Treasury. If Herbert Hoover and FDR in the 1930s started something called fiscal policy for the first time, George W Bush’s lameduck year has marked the total subjugation of monetary policy.

In his 1945 classic, History of Banking Theory, the University of Chicago’s Lloyd Mints said: “No reorganisation of the Federal Reserve System, while preserving its independence from the Treasury, can offer a satisfactory agency for the implementation of monetary policy. The Reserve banks and their branches should be made agencies of the Treasury and all monetary powers delegated by Congress should be given to the Secretary of the Treasury…. It is not at all certain that Treasury control of the stock of money would always be reasonable… but Treasury influence cannot be excluded by the creation of a speciously independent monetary agency that cannot have adequate powers for the performance of its task…” Years later, Milton Friedman himself took a similar position suggesting legislation “to end the independence of the Fed by converting it into a bureau of the Treasury Department…”(see, for example, Essence of Friedman, p 416).

Ben Bernanke’s Fed has now ended any pretence of the monetary policy’s independence from the whims and exigencies of executive power. Yet Dr Bernanke’s fellow academic economists have been unanimous in advising caution, patience and more information and reflection upon the facts. The famous letter of 122 economists to the US Congress was a rare statement of sense and practical wisdom. It agreed the situation was difficult and needed bold action. But it said the Paulson-Bernanke plan was an unfair “subsidy to investors at taxpayers’ expense. Investors who took risks to earn profits must also bear the losses. Not every business failure carries systemic risk. The government can ensure a well-functioning financial industry, able to make new loans to creditworthy borrowers, without bailing out particular investors and institutions whose choices proved unwise.”

Besides, the plan was unclear and too far-reaching. “Neither the mission of the new agency nor its oversight are clear. If taxpayers are to buy illiquid and opaque assets from troubled sellers, the terms, occasions, and methods of such purchases must be crystal clear ahead of time and carefully monitored afterwards…. If the plan is enacted, its effects will be with us for a generation. For all their recent troubles, America’s dynamic and innovative private capital markets have brought the nation unparalleled prosperity. Fundamentally weakening those markets in order to calm short-run disruptions is desperately short-sighted.”

The House’s initial bipartisan “backbench revolt” against “The Emergency Economic Stabilisation Act of 2008” (ESSA) followed this academic argument and rejected the Bernanke Fed’s advice. Is there an “emergency”, and if so what is its precise nature? Is this “economic stabilisation”, and if so, how is it going to work? The onus has been on Dr Bernanke and his staff to argue both, not merely to assert them. Even if the House “held its nose” and passed the measure for now, the American electorate is angry and it is anybody’s guess how a new President and Congress will alter all this in a few months.

Several academic economists have argued for specific price-stabilisation of the housing market being the keystone of any large, expensive and risky government intervention. (John McCain has also placed this in the political discussion now.) Roughly speaking, the housing supply-curve has shifted so far to the right that collapsed housing prices need to be dragged back upward by force. Columbia Business School economists Glenn Hubbard and Chris Mayer, both former Bush Administration officials, have proposed allowing “all residential mortgages on primary residences to be refinanced into 30-year fixed-rate mortgages at 5.25 per cent…. close to where mortgage rates would be today with normally functioning mortgage markets….Lower interest rates will mean higher overall house prices…” Yale’s Jonathan Koppell and William Goetzmann have argued very similarly the Treasury “could offer to refinance all mortgages issued in the past five years with a fixed-rate, 30-year mortgage at 6 per cent. No credit scores, no questions asked; just pay off the principal of the existing mortgage with a government check. If monthly payments are still too high, homeowners could reduce their indebtedness in exchange for a share of the future price appreciation of the house. That is, the government would take an ownership interest in the house just as it would take an ownership interest in the financial institutions that would be bailed out under the Treasury’s plan.”

Beyond the short run, the US may play the demographic card by inviting in a few million new immigrants (if nativist feelings hostile to the outsider or newcomer can be controlled, especially in employment). Bad mortgages and foreclosures would vanish as people from around the world who long to live in America buy up all those empty houses and apartments, even in the most desolate or dismal locations. If the US’s housing supply curve has moved so far to the right that the equilibrium price has gone to near zero, the surest way to raise the equilibrium price would be by causing a new wave of immigration leading to a new demand curve arising at a higher level.

Such proposals seek to address the problem at its source. They might have been expected from the Fed’s economists. Instead, ESSA speaks of massive government purchase and control of bad assets “downriver”, without any attempt to face the problem at its source. This makes it merely wishful to think such assets can be sold for a profit at a later date so taxpayers will eventually gain. It is as likely as not the bad assets remain bad assets.

Indeed the University of Chicago’s Casey Mulligan has argued there is a financial crisis involving the banking sector but not an economic one: “We’re not entering a second Great Depression.” The marginal product of capital remains high and increasing “far above the historical average. The third-quarter earnings reports from some companies already suggest that America’s non-financial companies are still making plenty of money…. So, if you are not employed by the financial industry (94 per cent of you are not), don’t worry. The current unemployment rate of 6.1 per cent is not alarming, and we should reconsider whether it is worth it to spend $700 billion to bring it down to 5.9 per cent.”

Dr Bernanke has been a close student of A Monetary History of the United States in which Milton Friedman and Anna J Schwartz argued that the Fed inadvertently worsened the Great Contraction of 1929-1933 by not responding to Congress. Let not future historians find that the Fed, at the behest of the Treasury Secretary, worsened the Great Tremor of 2008 by bamboozling Congress into hasty action.”

IV

Would not a few million new immigrants solve America’s mortgage crisis?
October 10, 2008 — drsubrotoroy | Edit

America was at its best when it was open to mass immigration, and America is at its worst when it treats immigrants with racism and worse (for seeming “uppity”).

All those bad mortgages and foreclosures could vanish within a year or two by playing the demographic card and inviting in a few million new immigrants into the United States.  They would pour in from China, Vietnam, Thailand, Philippines, Indonesia, Mexico, South America,  South Africa, Nigeria, Egypt, Israel, Poland, Romania, Hungary, Belarus, Ukraine, Russia, Uzbekistan, Kazakhstan,  India, Sri Lanka, Bangladesh, and yes, Pakistan too, and more.  They would happily buy up all those empty houses and apartments, even in all those desolate  dismal locations.  If the USA’s housing supply curve has moved so far to the right that the equilibrium price has gone to near zero, the surest way to raise the equilibrium price would be by causing a  new wave of  immigration leading to a new demand curve arising at a higher level.   But yes, nativist feelings of racism towards the outsider or the newcomer would have to be controlled  especially in employment — racists after all are often rather “sub-prime” themselves and hence unable to accept characters who may be “prime” or at least less “sub-prime” from foreign immigrant communities.   Restoring a worldwide idea of an American dream fuelled by mass immigration may be the surest way for the American economy to restore itself.

V

122 Sensible American economists

September 26, 2008 — drsubrotoroy | Edit

“$700 billion comes to more than, uhhhm, $6,000 per income taxpayer in the USA.

I was glad to see the sensible letter of 122 American economists to US legislators regarding the Paulson-Bernanke plan to address America’s financial crisis.

Somehow, I have an inkling that foreign central banks have been left holding more bad US debt than might be remembered — which would explain the embarrassment of Messrs Paulson and Bernanke vis-a-vis their foreign counterparts… Dollar depreciation and an American inflation seem to be inevitable over the next several years.”

A Note on the Indian Policy Process

A Note on the Indian Policy Process
Subroto Roy

During the University of Hawaii perestroika-for-India project two decades ago, I had wished to attract Sukhamoy Chakravarty from Delhi. He very kindly met me on July 14 1987 and presented me his last personal signed copy of the famous RBI report his committee had chaired. He said he could not come to Hawaii because of ill health but he strongly recommended I take C. Rangarajan instead because, he said, Dr Rangarajan was the main author of the report. I met Dr Rangarajan in Kolkata at Jadavpur University where he was giving a speech in his role as President of the Indian Economic Society that year. Later in correspondence, he wrote to say he was over-committed but that if I took Amaresh Bagchi instead, he would help co-author Bagchi’s contribution to our project. So I commissioned Amaresh Bagchi, then Director of New Delhi’s National Institute of Public Finance and Policy.

In my next project-related visit to Delhi in December 1988, I met Amaresh Bagchi personally for the first time; he was about to retire or had already done so. He told me he knew my name from the fact the High Commission of India in London had sent the Finance Ministry in Delhi the May 29 1984 lead editorial of The Times of London on my work which had been very critical of Indian economic policy; Bagchi had been at the time in the Finance Ministry, and, as an old sarkari statist, had naturally taken exception to what I had said by way of liberal criticism. He wished to co-write his contribution for our Hawaii project with a young colleague of his; I declined permission for him to do that and told him our understanding was that Dr Rangarajan would be writing with him.

In any case, in May 1989, Amaresh was the first person to reach Honolulu in the team we had put together for the project, arriving early by several days. He was all alone and seemed miserable, so I took him to the supermarket and later invited him to dine with my small family at our home at Punahou Towers, 1621 Dole Street. It pleased him to eat some home-cooked Indian food, and he warmed slightly. He told me he had joined the Government as a bureaucrat in the income tax department and later acquired a doctoral degree in economics, though I did not get a sense that he was familiar with traditional public finance of the sort in Richard Musgrave’s classic textbook. I gifted him a copy of James Buchanan’s lectures that I had put together when Professor Buchanan had visited the University of Hawaii at my invitation in 1988 and which the University had then published with a preface by myself. He remarked he found it terrible that American supermarkets had all this canned pet food when the world was so hungry. Later I invited him to a larger dinner party again at my home before the conference began.

At the conference itself, I placed him next to Milton Friedman, which some said was a master-stroke. There was a long and somewhat heated interchange between him and TN Srinivasan, though not with Milton, as Milton was, as always, invariably polite, patient and clear-headed in argument for the two days that he stayed.

The chapter Amaresh Bagchi wrote for us in the book Foundations of India’s Political Economy, edited by myself and WE James, was useful as practically the only statement until that time on the fiscal-induced monetary weakness of India (that still continues today, indeed may have gotten worse since). It contributed to placing him in the policy-limelight in his post-retirement years. Dr Rangarajan was not a co-author after all but apparently contributed the most important paragraphs on the subject. (We have been trying for almost a year now to get the University of Hawaii to allow free republication of the book on the Internet; the original publisher, now dead, reneged on a promise to produce a paperback edition after there was leftist academic pressure on him in Delhi.)

I gave a copy of our book to Manmohan Singh when I met him and his senior aides in September 1993 in Washington at the Indian Ambassador’s Residence; I was introduced to Dr Singh by the then Ambassador of India SS Ray as the person on whose laptop computer the 1991 economic reform had been designed for Rajiv Gandhi during Rajiv’s last months, a statement accurate enough as has been told elsewhere. (Dr Singh had 20 years earlier kindly visited our then-home in Paris at 14 Rue Eugene Manuel at the invitation of my father who knew him, to advise me about economics just before I headed to the London School of Economics as an 18 year old freshman; but in 1993 both he and I had forgotten that earlier 1973 meeting.)

Today’s newspapers report Amaresh Bagchi’s passing and say that “When (Manmohan) Singh was finance minister in the early 1990s, Bagchi was one of his key advisers on fiscal policy”. Dr Singh has described Bagchi as “one of our most distinguished fiscal policy experts” and said “It is no exaggeration to state that Amaresh has been associated with almost every major fiscal policy reform in the past 30 years”.

I am afraid I disagree with the Prime Minister of India in that I do not see any “major fiscal policy reform” having taken place at all in India, just a lot of unsystematic tinkering here and there. The root cause has been the failure to face or want to comprehend the extremely dismal state of government and public sector accounts throughout the country. Without proper government accounting, there can be neither accountability nor any serious fiscal policy, and hence no serious monetary or macroeconomic policy either.

Introduction and Some Biography

My two main works, namely my book of 19 years ago Philosophy of Economics: On the Scope of Reason in Economic Inquiry (first published by Routledge, London & New York, 1989, 1991), and my monograph of 24 years ago Pricing, Planning and Politics: A Study of Economic Distortions in India (first published by the Institute of Economic Affairs, London, 1984) are both now republished here, each with a new preface. I have also published here for the first time the full story of my encounter with Rajiv Gandhi — an abbreviated version appeared in Freedom First in October 2001 which focussed on economic policy and deliberately excluded mention of my warnings about his vulnerability to assassination and my attempts in vain to get people around him to do something about it. I have also republished my three advisory memoranda to him between September 1990 and March 1991, which were first published in The Statesman‘s Editorial Page of July 31, August 1 and August 2 1991.

I have also published here now for the first time a public lecture I gave as the Wincott Visiting Professor of Economics at the University of Buckingham in 2004 titled “Science, Religion, Art and the Necessity of Freedom”. Also republished is “A General Theory of Globalization and Modern Terrorism” which was my keynote address to the Council of Asian Liberals and Democrats at their Manila meeting in November 2001; it appeared first in September 11 & Political Freedom: Asian Perspectives (eds. Smith, Gomez & Johannen) in Singapore in 2002.

I have also published for the first time my April 29 2000 address titled “Towards a Highly Transparent Monetary & Fiscal Framework for India’s Union and State Governments” to the Reserve Bank’s Annual “Conference of State Finance Secretaries”.

Also to be found in one place are my most recent signed writings since 2005 in The Statesman and elsewhere on India’s economy and foreign policy, Jammu & Kashmir, Pakistan, Afghanistan, China, Tibet, Taiwan, the United States, etc.

My political affiliation in India would be to a non-existent party — as may be seen from the article on a Liberal Party for India; and I trust it will be seen that I have dispensed criticism upon the present-day Congress Party, BJP/RSS and Communists equally harshly.

Readers are welcome to quote from my work under the normal “fair use” rule, but please quote me by name and indicate the place of original publication. Readers are also welcome to comment or correspond by email, though please try to introduce yourself.

The new preface of Philosophy of Economics is reproduced below as it is partly biographical.

“(Philosophy of Economics) germinated when I was 18 or 19 years of age in Paris, Helsinki and London, and it was first published when I was 34 in Honolulu. I came to economics from natural science (biology, chemistry, physics), not mathematics. It was inevitable I would be drawn to the beauty of philosophy as a theoretical discipline while being driven, as a post-Independence Indian, to economics as the practical discipline that might unlock secrets to India’s prosperity and progress. I belonged to an ancient family of political men, and my father, who had joined India’s new foreign service the year before I was born, inculcated in me as a boy an idea that I had “a mission” (though he later forgot he had done so).

I was fortunate to fail to enter Oxford’s PPE and instead go to the London School of Economics. LSE was at an intellectual peak in the early 1970s. DHN Johnson in international law, ACL Day in international monetary economics, Brian Griffiths vs Marcus Miller in monetary economics with everyone still in awe of Harry Johnson’s graduate lectures in macroeconomics, Ken Wallis, Graham Mizon, JJ Thomas, David Hendry in econometrics with the odd lecture by Durbin himself – I was exposed to a fully grown up intellectual seriousness from the day I arrived as an 18 year old. Michio Morishima as my professorial tutor told me frankly that, as an Indian, I would face less prejudice in Western academia than in the private sector, and said he was speaking from experience as a fellow-Asian. He turned out to be wrong but it was wise advice nevertheless, just as wise as his requiring pupils to read Hicks’ Value and Capital (which, in our undergraduate mythology, he himself had read inside a Japanese gunboat during war).

What was relatively weak at LSE was general economic theory. We were good at deriving the Best Linear Unbiased Estimator but left unsatisfied with our grasp of the theory of value that constituted the roots of our discipline. I managed a First and was admitted to Cambridge as a Research Student in 1976, where fortune had Frank Hahn choose me as a student. That at the outset was protection from the communist cabal that ran “development economics” with whom almost all the Indians ended up. I was wholly impecunious in my first year as a Research Student, and had to, for example, proof-read Arrow and Hahn’s General Competitive Analysis for its second edition to receive 50 pounds sterling from Hahn which kept me going for a short time. My exposure to Hahn’s subtle, refined and depthless thought as an economist of the first rank led to fascination and wonderment, and I read and re-read his “On the notion of equilibrium in economics”, “On the foundations of monetary theory”, “Keynesian economics and general equilibrium theory” and other clear-headed attempts to integrate the theory of value with the theory of money — a project Wicksell and Marshall had (perhaps wisely) not attempted and Keynes, Hicks and Patinkin had failed at.

Hahn insisted a central question was to ask how money, which is intrinsically worthless, can have any value, why anyone should want to hold it. The practical relevance of this question is manifest. India today in 2007 has an inconvertible currency, vast and growing public debt financed by money-creation, and more than two dozen fiscally irresponsible State governments without money-creating powers. While pondering, over the last decade, whether India’s governance could be made more responsible if States were given money-creating powers, I have constantly had Hahn’s seemingly abstruse question from decades ago in mind, as to why anyone will want to hold State currencies in India, as to whether the equilibrium price of those monies would be positive. (Lerner in fact gave an answer in 1945 when he suggested that any money would have value if its issuer agreed to collect liabilities in it — as a State collects taxes – and that may be the simplest road that bridges the real/monetary divide.)

Though we were never personal friends and I did not ingratiate myself with Hahn as did many others, my respect for him only grew when I saw how he had protected my inchoate classical liberal arguments for India from the most vicious attacks that they were open to from the communists. My doctoral thesis, initially titled “A monetary theory for India”, had to be altered due to paucity of monetary data at the time, as well as the fact India’s problems of political economy and allocation of real resources were more pressing, and so the thesis became “On liberty and economic growth: preface to a philosophy for India”. When no internal examiner could be found, the University of Cambridge, at Hahn’s insistence, showed its greatness by appointing two externals: C. J. Bliss at Oxford and T. W. Hutchison at Birmingham, former students of Hahn and Joan Robinson respectively. My thesis received the most rigorous and fairest imaginable evaluation from them.

I had been attracted to Cambridge partly by its old reputation for philosophy, especially that of Wittgenstein. But I met no worthwhile philosophers there until a few months before I was to leave for the United States in 1980, when I chanced upon the work of Renford Bambrough. Hahn had challenged me with the question, “how are you so sure your value judgements promoting liberty blah-blah are better than those of Chenery and the development economists?” It was a question that led inevitably to ethics and its epistemology — when I chanced upon Bambrough’s work, and that of his philosophical master, John Wisdom, the immense expanse of metaphysics (or ontology) opened up as well. “Then felt I like some watcher of the skies, When a new planet swims into his ken; Or like stout Cortez when with eagle eyes, He star’d at the Pacific…”

It has taken me more than a quarter century to traverse some of that expanse; when I returned to Britain in 2004 as the Wincott Visiting Professor of Economics at the University of Buckingham, I was very kindly allowed to deliver a public lecture, “Science, Religion, Art and the Necessity of Freedom”, wherein I repaid a few of my debts to the forgotten work of Bambrough and Wisdom — whom I extravagantly compared with the Bodhisattvas of Mahayana Buddhism, also saying that the trio of Wittgenstein, Wisdom and Bambrough were reminiscent of what Socrates, Plato and Aristotle might have been like.

I had written to Bambrough from within Cambridge expressing my delight at finding his works and saying these were immensely important to economics; he had invited me to his weekly discussion groups at St John’s College but I could not attend. Between 1979 and 1989 we corresponded while I worked in America on my application of his and Wisdom’s work to problems in economics. We met only once when I returned to Cambridge from Blacksburg for my doctoral viva voce examination in January 1982. Six years later in 1988 he said of my Philosophy of Economics, “The work is altogether well-written and admirably clear”, and on another occasion he said he was “extremely pleased” at the interest I had taken in his work. The original preface of Philosophy of Economics said he was not responsible for the use I had made of his writings, which I reiterated in the 2004 lecture. At our meeting, he offered to introduce me to Wisdom who had returned to Cambridge from Oregon but I was too scared and declined, something I have always regretted. It is only in the last few years that I have begun to grasp the immensity of Wisdom’s achievement in comprehending, explaining and extending the work of both Wittgenstein and Freud. His famous “Virginia Lectures” of 1957 were finally published by his admirers with his consent as Proof and Explanation just before his death in 1993. As for Bambrough, I believe he may have been or become the single greatest philosopher since Aristotle; he told me in correspondence there was an unfinished manuscript Principia Metaphysica (the prospectus of which appeared in Philosophy 1964), which unfortunately his family and successors knew nothing about; the fact he died almost in obscurity and was soon forgotten by his University speaks more about the contemporary state of academic philosophy than about him. (Similarly, the fact Hahn, Morishima and like others did not receive the so-called Economics “Nobel” says more about the award than it does about them.)

All I needed in 1980 was time and freedom to develop the contents of this book, and that I found in America — which I could not have done in either Britain or India. It would take eight or nine very strenuous years before the book could be written and published, mostly spent at Virginia Polytechnic Institute (1980-1985) and University of Hawaii (1986-1990) Economics Departments, with short interludes at Cornell (Fall 1983) and Brigham Young (1985-86). I went to Virginia because James M. Buchanan was there, and he, along with FA Hayek, were whom Hahn decided to write on my behalf. Hayek said he was too old to accept me but wrote me kind and generous letters praising and hence encouraging my inchoate liberal thoughts and arguments. Buchanan was welcoming and I learnt much from him and his colleagues about the realities of public finance and democratic politics, which I quickly applied in my work on India, published in 1984 in London as Pricing, Planning & Politics: A Study of Economic Distortions in India and republished elsewhere here. The visit to the Cornell Economics Department was really so I could talk to Max Black the philosopher, who represented a different line of Wittgenstein’s students, and Max and I became friends until his death in 1988.

Buchanan’s departure from Blacksburg led to a gang of inert “game theorists” to arrive, and I was immediately under attack – one senior man telling me I was free to criticise the “social choice” work of Amartya Sen (since he was Indian too) but I was definitely unfree to do the same of Sen’s mentor, Kenneth Arrow, who was Jewish! (Arrow was infinitely more gracious when he himself responded to my criticism.) On top of that arose a matter of a woman, fresh off the aeroplane from India, being assaulted by a senior professor, and when I stood for her against her assailant, my time in Blacksburg was definitely up.

The manuscript of this book was at the time under contract with University of Chicago Press, and, thanks to Mrs Harry Johnson there, I had come in contact with that great American, Theodore W. Schultz. Schultz, at age 81, told me better to my face what the book was about than I had realised myself, namely, it was about economics as knowledge — its subject-matter was the epistemology of economics. Schultz wrote letters all over America on my behalf (as did Milton Friedman at Stanford and Sidney Alexander of MIT, whom I had also met and become friends with), and I was able to first spend a happy year among the Mormons at Brigham Young, and then end up at the University of Hawaii where I was given responsibility for the main graduate course in macroeconomics. I taught Harry Johnson-level IS-LM theory and Friedman-Tobin macroeconomics and then the new “rational expectations” vs Keynesian material.

I was also offered a large University grant to work on “South Asia”, which led to the books Foundations of India’s Political Economy: Towards an Agenda for the 1990s, and Foundations of Pakistan’s Political Economy: Towards an Agenda for the 1990s, both created by myself and WE James, and which led to the origins of India’s 1991 economic reform and the India-Pakistan peace process as told elsewhere. Also, this book came to be accepted for publication by Routledge, as the first economics book in its famed International Library of Philosophy.

Just as I was set to be evaluated for promotion and tenure at the University of Hawaii, I became the victim of a most vicious racist defamation (and there was some connection with Blacksburg). Quite fed up with the sordidness of American academia as I had experienced it, I sued in the federal court, which consumed much of the next half dozen years as the case worked its way through the United States Supreme Court twice. Milton Friedman and Theodore W. Schultz stood as expert witnesses on my behalf but you would not have known it from the judge’s ruling. There had been not only demonstrable perjury and suborning of perjury by the State of Hawaii’s officers, there was also “after-discovered” evidence of bribery of court-officers in the US District Court for the District of Hawaii, and I had to return to India in 1996 quite exhausted to recuperate from the experience. “Solicitation of counsel, clerks or judges” is “embracery curialis”, recognized as extrinsic fraud and subversion of justice since Jepps 72 E R 924 (1611), “firmly established in English practice long before the foundation” of the USA, Hazel Atlas, 322 US 238 (1943). “Embracery is an offense striking at the very foundation of civil society” says Corpus Juris 20, 496. A court of equity has inherent power to investigate if a judgement has been obtained by fraud, and that is a power to unearth it effectively, since no fraud is more odious than one to subvert justice. Cases include when “by reason of something done by the successful party… there was in fact no adversary trial or decision of the issue in the case. Where the unsuccessful party has been prevented from exhibiting fully his case, by fraud or deception practised on him by his opponent, as…where an attorney fraudulently or without authority assumes to represent a party and connives at his defeat; or where the attorney regularly employed corruptly sells out his client’s interest to the other side ~ these, and similar cases which show that there has never been a real contest in the trial or hearing of the case, are reasons for which a new suit may be sustained to set aside and annul the former judgment or decree, and open the case for a new and a fair hearing….” (Hazel Atlas). There is no time-limit in United States federal law for rectification of fraud on the court of this sort, and I remain fully hopeful today of the working of American justice in the case.

The practical result was that this book was never able to be properly publicized among economists as it would have been had I become Professor of Economics at the University of Hawaii by 1992 as expected. The hardback sold out quickly on its own steam and went into paperback by 1991, and a friend told me it was being used for a course at Yale Law School. The reviews were mostly intelligent. Upon returning to Britain as the Wincott Visiting Professor in 2004, I found times had changed and so had Routledge who would not keep it in print let alone permit a second revised edition. But I am now free to republish the book as I please, and today in 2007, with the Internet growing to a maturity which allows the young geeks at WordPress.com to want to encourage blogging worldwide, I can think of no more apt place to reproduce the first edition of this book than here at my own blog http://www.independentindian.com.

This is not a second or revised edition, and it is unchanged in content except for this lengthy new preface made necessary by the adventures and dramas the book’s author found himself unwittingly part of since its first publication. I am 52 now and happy to say I endorse the book just as I had published it at 34, though I do find it a little impatient and too terse in a few places. The 1991 paperback corrected a few slight errors in the 1989 hardback, and has been used. I am planning an entirely new book which shall have its roots in this one though it will be mostly in philosophy and not economics — the outlines it may take may be seen in the 2004 public lecture I gave on the work of Bambrough and Wisdom mentioned above and published elsewhere; its main aim will be to uncover for new generations the immense worth there is in their work which is in danger of being lost.

At least two names failed to appear in the original list of acknowledgements. G. Bruce Chapman, now of the University of Toronto, and I talked much of serious ethics and political philosophy when I first arrived at Cambridge in 1976. And in 1980 in Blacksburg, Anil Lal, then a graduate student and house-painter, borrowed my copy of Bambrough’s work, read it, and later made a comment on the metaphysics of John Wisdom which allowed me to see things more clearly.

Ballygunge, Kolkata,
April 7 2007″

Fiscal Instability

Fiscal Instabilty

Interest payments quickly suck dry every year’s Budget. And rolling over old public debt means that Government Borrowing in fact much exceeds the Fiscal Deficit

by Subroto Roy

First published in The Sunday Statesman,

Editorial Page Special Article, 4 February 2007

While releasing Mr Chidambaram’s book some days ago, our PM said that as Narasimha Rao’s Finance Minister in 1991 he had caused “fiscal stabilization” of the country. Unfortunately, Dr Manmohan Singh may have been believing the flattery of his sycophants, since the facts point differently.

The Fiscal Deficit is new borrowing by Government added for a given year. In 1994-1995 for example, the Union Government’s expenditure net of operational and other income was some Rs 1,295 billion (1 billion = 100 crore). Rs. 674 billion was generated for the Union Government by taxation that year (Rs 184 billion from direct taxes, Rs 653 billion from indirect and miscellaneous taxes, less Rs 163 billion as the States’ share). The difference between Rs 1,295 billion and Rs. 674 billion, that is Rs. 621 billion had to be borrowed by the Government of India in the name of future unborn generations of Indian citizens. That was the “Fiscal Deficit” that year. If the stock of Public Debt already accumulated has been B,this Fiscal Deficit, C, adds to the interest burden that will be faced next year since interest will have to be then paid on B + C.

Interest payments on Government debt have dominated all public finance in recent decades, quickly sucking dry the budgets every year both of the Union and each of our more than two dozen States. Some Rs. 440 billion was paid by the Union Government as interest in 1994-1995, and this had risen to some Rs. 1,281 billion by 2003-2004. As a percentage of tax revenue, interest expenditure by the Government of India on its own debt rose from 40% in 1991 to 68% in 2004 ~ through the Finance Ministerships of Manmohan Singh, P Chidambaram, Yashwant Sinha and Jaswant Singh.

Financial control of India’s fiscal condition, and hence monetary expansion, vitally requires control of the growth of these kinds of dynamic processes and comprehension of their analytical underpinnings. Yet such understanding and control seem quite absent from all organs of our Government, including establishment economists and the docile financial press.

For example, contrary to the impression created by the Finance Ministry, RBI and Union Cabinet (whether of the UPA or NDA, while the Communists would only be worse), the Fiscal Deficit has been in fact very far from being all that the Government of India borrows from financial markets in a given year. The stock of Public Debt at any given moment consists of numerous debt-instruments of various sorts at different terms. Some fraction of these come to maturity every year and hence their principal amounts (not merely their interest) must be repaid by Government. What our Government has been doing routinely over decades is to roll over these debts, i.e. issue fresh public debt of the same amount as that being extinguished and more. For example, some Rs. 720 billion, Rs. 1,180 billion, Rs.1,330 billion and Rs. 1,390 billion were amounts spent in extinguishing maturing public debt in 1993, 1994, 1995 and 1996 respectively. No special taxes were raised in those years specifically for that purpose. Instead the Government merely issued additional new debt or “rolled over” or “converted” the old debt in the same amounts and more in the portfolios of the captive nationalized banking system (see graph).

Plainly, the Government of India’s actual “Borrowing Requirement”, as the difference between its Income and Expenditure, when accounted for properly, will be the sum of this rolled over old debt and the Fiscal Deficit (which is merely the additional borrowing required by a single year’s Budget). In other words, the Government’s Borrowing Requirement is the Fiscal Deficit plus the much larger amount required to annually roll over maturing debt. Because the latter expenditure does not appear at all in calculation of the Fiscal Deficit by the subterfuge of having been routinely rolled over every year, the actual difference between Government Expenditure and Income in India has been made to appear much smaller than it really is. Although neglected by the Cabinet, Finance Ministry, RBI and even (almost) the C&AG, the significance of this discrepancy in measurement will not be lost on anyone seriously concerned to address India’s fiscal and monetary problems.

On the expenditure side, Current Expenditure (anachronistically named “Revenue Expenditure” in India as it is supposed to be met by current revenue) meets recurrent liabilities from one budget-date to the next, like salaries of school-staff or coupon payments on Government debt.

Investment Expenditure “of a capital nature” is supposed to increase “concrete assets of a material and permanent character” like spending on a new public library, or reducing “recurring liabilities” by setting aside a sinking fund to reduce Government debt. Some public resources need to be spent to yield benefits or reduce costs not immediately but in the future. Besides roads, bridges and libraries, these may include less tangible investments too like ensuring proper working of law-courts or training police-officers and school-teachers.

Also, there has been large outright direct lending by the Government of India bypassing normal capital markets on the pattern of old Soviet “central planning”, whereby “credit” is disbursed to chosen recipients.

“Current”, “Investment” and “Loan” expenditure decisions of this kind are made on the same activities. For example, in 1994-1995, the Government of India spent Rs. 2.7 billion as “Loans for Power Projects” in addition to Rs. 9.8 billion under Current Expenditure on “Power” and Rs. 15.5 billion as Investment Expenditure on “Power Projects”. By 2003-2004, these had grown to Rs. 50.94 billion, Rs. 31.02 billion, Rs. 28.5 billion respectively. Yet the opaqueness of Government accounts, finances and economic decision-making today is such that nowhere will such data be found in one table giving a full picture of public expenditure on the Power sector as a whole. On the revenue side, Government’s “Current Income” includes direct and indirect taxes, operational income from public utilities (like railways or the post office), and dividends and profits from public assets. There has been a small “Investment Income” too received from sale of public assets like Maruti. Also, since loans are made directly, there has to be a category for their recovery.

“One must not take from the real needs of the people for the imaginary needs of the state”, said Montesquieu; while De Marco in the same vein said “the greatest satisfaction of collective needs” has to be sought by “the least possible waste of private wealth”. Even Mao Zedong reportedly said: “Thrift should be the guiding principle of our government expenditure”. The C&AG requires Government determine “how little money it need take out of the pockets of the taxpayers in order to maintain its necessary activities at the proper standard of efficiency”.

Yet India’s top politicians and bureaucrats spend wildly ~ driven by the organised special interest groups on whom they depend, while ostentatiously consuming public time, space and resources themselves “quite uselessly in the pleasurable business of inflating the ego” (Veblen).

For Government to do what it need not or should not do contributes to its failure to do what it must. Thus we have armies of indolent soldiers, policemen and bureaucrats and piles of rotting supplies in government warehouses while there are queues outside hospitals, schools, courts etc.

Parliament and State Legislatures need to first ask of an annual budget whether it is efficient: “Is expenditure being allocated to enhance the public interest to the greatest extent possible, and if not, how may it be made to do so?” National welfare overall should increase the same whichever public good or service the final million of public rupees has been spent on.

Fundamentally, government finance requires scientific honesty, especially by way of clear rigorous accounting and audit of uses and origins of public resources. That scientific honesty is what we have not had at Union or State level for more than half a century.

Towards a Highly Transparent Fiscal & Monetary Framework for India’s Union & State Governments (29 April 2000)

Towards a Highly Transparent Fiscal & Monetary Framework for India’s Union & State Governments

An address by Dr Subroto Roy to

the Conference of State Finance Secretaries, Reserve Bank of India,  Mumbai, 29 April 2000.

It is a great privilege to speak to this distinguished gathering of Finance Secretaries and economic policy-makers here at the Reserve Bank today. I should like to begin by thanking the Hon’ble Governor Dr Bimal Jalan and the Hon’ble Deputy Governor Dr YV Reddy for their kind invitation for me to do so. I should also like to record here my gratitude to their eminent predecessor, the Hon’ble Governor of Andhra Pradesh, Dr C Rangarajan, for his encouragement of my thinking on these subjects over several years.

My aim will be to share with you and seek your help with my continuing and very incomplete efforts at trying to comprehend as clearly as possible the major public financial flows taking place between the Union of India and each of its constituent States. I plan to show you by the end of this discussion how all the information presently contained in the budgets of the Union and State Governments of India, may be usefully transformed one-to-one into a fresh modern format consistent with the best international practices of government accounting and public budgeting.

I do not use the term “Central Government”, because it is a somewhat sinister anachronism left over from British times. When we were not a free nation, there was indeed a Central Government in New Delhi which took its orders from London and gave orders to its peripheral Provinces as well as to the British “Residents” parked beside the thrones of those who were called “Indian Princes”.

Free India has been a Union of States. There is a Government of the whole Union and there is a Government of each State. The Union is the sovereign and the sole international power, while the States, as political subdivisions of the Union, also possess certain sub-sovereign powers; as indeed do their own subdivisions like zilla parishads, municipalities and other local bodies in smaller measure.

Our 15 large States, which account for 97% of the population of the country, have an average of something like 61 million citizens each, which is vastly more than most countries of the world. In size of population at least, we are like 15 Frances or 15 Britains put together. The Indian Republic is unique or sui generis in that there has never been in history any attempt at federalism or democracy with such sheer large numbers of people involved.

In such a framework the citizen is supposed to feel a voter and a taxpayer at different levels, owing loyalty and taxes to both the national unit and the subdivisions in which he or she resides. In exchange, government at different levels is expected to provide citizens with public goods and services in appropriate measure. The problem of optimal fiscal decentralisation in India as elsewhere is one of allocating to each level of government the power to tax and responsibility to provide, public goods and services most appropriate to that level of government given the availability of information of resources and citizens’ preferences.

In parallel, a problem of optimal monetary decentralisation may be identified as that of allocating between an autonomous Central Bank and its regional or even State-level affiliates or subsidiaries, the power to finance through money-creation the deficits, if any, of the Union and State Governments respectively. It is not impossible to imagine a world in which individual State deficits did not flow into the Union deficit as a matter of course, but instead were intended to be financed more or less independently of the Union budget from a single-window source. There would be a clear conceptual independence between the Union and State levels of public action in the country. In such a world, the Union Government might approach a constitutionally autonomous national-level Central Bank to finance its deficit, while individual State Governments did something analogous with respect to autonomous regional or even State-level Central Banks which would be affiliates or subsidiaries of the national Central Bank.

This is similar to the intended model of the United States Federal Reserve System when it started 90 years ago, though it has not worked like that, in part because of the rapid rise to domination by the New York Federal Reserve relative to the other 11 regional Federal Reserve Banks.

A more radical monetary step would be to contemplate a “Reverse Euro” model by which a national currency issued by the national-level Central Bank acts in parallel with a number of regional or State-level currencies with full convertibility and floating exchange-rates guaranteed between all of them in a world of unhindered mobility of goods and factors.

However, these are very incomplete and theoretical thoughts which perhaps deserve to be shelved for the time being.[1] What necessitates this kind of discussion is after all not something theoretical but rather the practical ground realities of our country’s fiscal and monetary position, something of which this audience will be far better aware than am I.

Economic and political analysis suggests that managing a process of public financial decision-making requires a coincidence of the people who have the best information with the people who have the authority to act. In other words, decision-makers need to have relevant, reliable and timely information made available to them, and then they need to be considered accountable for the decisions made on that basis.

In a democracy like ours, the locus of economic policy decision-making must be Parliament and the State legislatures. Academics, civil servants, journalists, special interest groups, this or that business or industrial lobbyist or foreign management consultant can all have their say — but consensus on the direction and nature of economic policy, if it is to be genuine, has to ultimately emerge out of the legislative process on the basis of reasonable, well-informed discussion and debate, given full relevant timely information. The proper source of all economic policy decisions and initiatives is Parliament, the State legislatures and local government bodies — not this or that lobby or interest-group which may be vocal or powerful enough to be heard at a given time in New Delhi or some State capital-city.

Our 1950 Constitution was a marvellous document in its time and it has worked tolerably well. It defined the functions of government in India in accordance with the main parameters of normative public finance.

Economics ascribed a quite extensive traditional role to Government, the most important functions being collective and individual security, followed by all activities which in the words of Adam Smith,

 “though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay the expence to any individual or small number of individuals, and which it, therefore, cannot be expected that any individual or small number of individuals should erect or maintain.” (Wealth of Nations, V.i.c., 1776)

Our 1950 Constitution defined the Union’s responsibilities to be

External Security;

Foreign Relations & Trade;

Supreme Court & Domestic Security;

Debt Service, Foreign & Domestic;

National Infrastructure;

Communications & Broadcasting;

Atomic Energy;

Public Sector Industries;

Banking; Currency & Finance;

Archives; Surveys & National Institutions;

National Universities;

National Civil Services & Administration.

Each State’s responsibilities were

High Courts & Lower Judiciary;

Police; Civil Order; Prisons;

Water; Sanitation; Health;

State Debt Service;

Intra-State Infrastructure & Communications;

Local Government;

Liquor & Other Public Sector Industries; Trade; Local Banking & Finance;

Land; Agriculture; Animal Husbandry;

Libraries, Museums, Monuments;

State Civil Service & Administration.

Some duties were supposed to be shared by the Union with each State, including

Criminal Law;

Civil & Family Law, Contracts & Torts;

Forests & Environmental Protection;

Unemployment & Refugee Relief;

Electricity;

Education.

But the authors of the 1950 Constitution could not have envisaged the nature of present problems, or foreseen in those early years what we would have become like today. Our fiscal system has become such that a few clauses may have led to an impossibly complex centralization of fiscal power and information. Not only did the 1950 Constitution identify agendas of the Union and State Governments, it also dictated the procedure of decision-making and it is this which may have become intractable over 50 years. Under Article 280, a Finance Commission is appointed every five years whose task is to try to efficiently and equitably allot tax revenues collected by the Union downwards to the States and laterally between the States. Members of Finance Commissions have been elder statesmen of high reputation and integrity, yet the practical impossibility of their task has made their actions seem to all observers to be clouded in mystery and perhaps muddle. As one recent member, Justice Qureshi, has candidly stated

 “it is humanly impossible for a person to understand the problems of the Centre and the 25 States and take a decision thereon within such a short time” (Ninth Finance Commission, Issues and Recommendations, p.350).

No matter how competent or well-meaning a Finance Commission’s members may be, their purpose may be stymied by the overload of information and overcentralisation of authority that has come to take place. As a result, it may have been inevitable that Government has ended up doing what it need not have done at the expense concomitantly of failing to do what only Government could or must have done.

The present situation is such that, despite the best efforts of the Reserve Bank and other Government agencies, there may be a gross lack of timely, relevant and reliable information reaching all decision-makers including the ordinary citizen, who as voter and taxpayer is the cornerstone of the fiscal system. My own inquiry started when Mr. Hubert Neiss, then Central Asia Director at the IMF, hired me as a consultant in December 1992. He told me the IMF was naturally concerned about India’s national budget deficit, but no one seemed to quite know how this related precisely to the budgets of the different States whose deficits seemed to be flowing into it. By its terms of reference, the IMF could not inquire into India’s States’ budgets and I did not do so in my work with them, but the import of his question remained in my thinking. Later I found similar questions being asked at the World Bank. I do not think it a great secret to state that there may be a great deal of simple puzzlement about the workings of our fiscal and monetary system on the part of observers and decision-makers who may be concerned about India’s fiscal position.

Among both public decision-makers and ordinary citizens right across the length and breadth of our country, a severe and widespread lack of information about and comprehension of India’s basic fiscal and monetary facts seems to exist. This in itself may be a cause of fiscal problems as citizens may not be adequately aware of the link between making their demands for public goods and services on the one hand, and the necessity of finding the resources to fund these goods and services on the other.

In any ultimate analysis, resources for public goods and services in an economy can be found only by diverting the real resources of individual citizens towards public uses. Other than printing fiat money, a national Government can only either tax those citizens who are present today in the population, or, borrow from the capital stock on behalf of unborn generations of future citizens.

West Europe and America are heirs to a long history of political development; yet even there, as Professor James Buchanan has often observed, the idea until has not been grasped until recently that benefits from use of public goods and services are supposed to accrue to citizens from whom resources have been raised. Until the 19th Century,

 “government outlay was frequently considered “unproductive”, and there was, by implicit assumption, no return of services to the citizens who were taxed. In a political regime that devotes the bulk of government outlay to the maintenance expenses of a single sovereign, or even of an elite, there is no demonstrable return flow of services to the taxpayers…. Tax principles were discussed as if, once collected, revenues were removed forever from the economy; taxpayers, both individually and in the aggregate, were held to suffer real income loss” (James M. Buchanan, The Demand and Supply of Public Goods, Rand 1968, p. 167).

According to Buchanan, such an undemocratic fiscal model was transformed in the work of the great Swedish economist Knut Wicksell and others by introducing the key assumption of fiscal democracy, namely, that

 “those who bear the costs of public services are also the beneficiaries in democratic structures”

Conversely, we may say those who demand public goods and services in a fiscal democracy should also expect to pay for them in real resources. If citizens are aware of taxes only as a burden and come to feel they receive little or nothing from Governments in return, there is a loss of incentive to pay taxes or to stand up and be counted as proud citizens of the country. There is an incentive instead to evade taxes or to flee the country or to cynically believe everything to be corrupt. On the other hand, if citizens demand public goods and services without expecting to contribute resources for their production, this amounts to being no more than a demand to be a free-rider on the general budget.

In our country, we may have been seeing both phenomena. On one hand, there is, rightly or wrongly, a tremendous public cynicism present almost everywhere with respect to expecting effective provision of public goods and services. On the other hand, the idea that the beneficiaries of public goods and services must also, sooner or later, come to bear the costs in terms of taxed resources is far from established so our politics come to often be unreasonable and irresponsible.

Reliable and comprehensible information about the system as a whole and about the contents of public budgets is thus vital for a fiscal democracy to function. In ancient Athens it was said:

 “Here each individual is interested not only in his own affairs but in the affairs of the State as well; even those who are mostly occupied with their own business are extremely well-informed on general politics — this is a peculiarity of ours: we do not say that a man who has no interest in politics is a man who minds his own business; we say that he has no business here at all.” Pericles (Funeral Oration, Thucydides, The Pelopennesian War)

That was the criterion that Pericles defined for ancient Athenian democracy, and I see no reason why in the 21st Century it cannot be met in modern India’s democracy.

This finally brings me to the positive contribution I have promised to make. The aim my attempt to redesign the Union and State’s budgets utilising precisely the same data as available has been to make the fiscal position of all public entities accessible to any interested citizen.

We do not have to say that every Indian citizen, or even every literate and numerate citizen of our country, has to be able to understand the intricacies of the public budgets of his or her State and the Union. But if information is available such that anyone who understands the finances of his own family or his own business enterprise is also reasonably able to understand the public budget then a standard of maximum feasible transparency would have been defined and met.

I have relied on the international normative model developed by our own countryman, Mr. A. Premchand, who retired from the IMF a few years ago, as described in his outstanding book Effective Government Accounting (IMF 1995), where he showed applications for e.g. the USA, New Zealand and Switzerland. What I have done – or rather did in 1997/1998, with the help of a research assistant and a student – is apply that to all of our States and the Union too.[2] What will be seen by way of differences with the present methodology is that there is essentially an Operating Statement, a Financial Statement and a Cash Flow Statement offered for each State and the Union. The financial position and gross fiscal deficit definition emerge rather neatly from this – while there the rather confusing “Development/Non-development” and “Planning/Non-Planning” distinctions have been done away with.

The exercise points to the foundations of a new and fresh federal framework for our Republic. A central new fact of modern India is that many, perhaps most, of our States have developed what is effectively a bipolar division in their legislatures. Voters have also increasingly started to judge Governments not by the personalities they contain but rather by their performance on the job, and, at election-time, have begun to frequently enough shown one side the door in the hope the other side may do better. In such circumstances, there seems no reason in principle why an entity as large as the average State of modern India today cannot be entrusted to legislate and administer a modern tax-system, based especially on the income-tax, and especially taxing income from all sources including agriculture. In a fresh and modern federalism, an elected State Government would have appropriate economic powers to run its own affairs, and be mainly accountable to the legislature whose confidence it requires, and ultimately to voters below.

From an efficiency standpoint, we should want a framework in which repercussions of political turmoil or bad financial management by a State Government to not spill into other States or flow into the Union Government’s own problems of deficit financing. With free mobility of goods and factors throughout the Union, citizens faced with a poorly performing State Government could seek to vote it out of office, or may of course “vote with their feet” by moving their capital or resources to another part of the country. In short, State Governments will be held responsible by their electorates for their expenditures on public goods and services, while having the main powers of domestic taxation in the economy, especially taxes on income from all sources including agriculture.

At the same time, diverse as India is, we are not 15 or 25 separate republics federated together but rather one country all of whose peoples are united by a common geography and a common experience of history. From an equity and indeed national standpoint, we may also want a system which also firmly established that the National Parliament would have to determine how much each citizen should be taxed for the Union to provide public goods and services for the country as a whole, as well as what transfers ought to be made between the States via the Union in the interests of equity given differences in initial resource-endowments between them.

Here again an American example may be useful. As is well-known, the 50 United States each have their own Constitutions governing most intra-State political matters, yet all being inferior in authority to the 1789 Constitution of the United States as duly amended. In India, an author as early as 1888 recommended popular Constitutions for India’s States on the grounds

“where there are no popular constitutions, the personal character of the ruler becomes a most important factor in the government… evils are inherent in every government where autocracy is not tempered by a free constitution.”[3]

We could ask if a better institutional arrangement may occur by each State of India electing its own Constitutional Convention subject naturally to the supervision of the National Parliament and the obvious provision that all State Constitutions be inferior in authority to the Constitution of the Union of India.[4] These documents would then furnish the major sets of rules to govern intra-State political and fiscal decision-making more efficiently. An additional modern reason can be given from the work of Professor James M. Buchanan, namely, that fiscal constitutionalism, and perhaps only fiscal constitutionalism, allows over-riding to take place of the interests of competing power-groups.[5]

State-level Constitutional Conventions in India would provide an opportunity for a realistic assessment to be made by State-level legislators and citizens of the fiscal positions of their own States. Greater recognition and understanding of the plain facts and the desired relationships between income and expenditures, public benefits and public costs, would likely improve the quality of public decision-making at State-levels, sending public resources from destinations which are socially worthless towards destinations which are socially worthwhile. It bears repeating the average size of a large State of India is 61 million people, and almost all existing political Constitutions around the globe furnish rules for far smaller populations than that.

Thank you for your patience. Jai Hind.

[1] Monetary Federalism at Work: F. A. Hayek more than anyone else taught us that relative prices are signals or guides to economic activity — summarizing in a single statistic information about the resources, constraints, expectations and ambitions of market participants. An exchange-rate between two currencies is also a relative price, conveying information about relative market opinions regarding the issuers of the two currencies. Suppose we had two States of India in the fresh kind of federal framework outlined above, which were identical in all respects except one had a larger deficit and so a larger nominal money supply growth. Would that mean the first currency must depreciate relative to the second? Not necessarily; it is not the size of indebtedness that matters but rather the quality of public investment decisions, to which borrowed money has been put. Thus we come to the crux: Suppose we have two States which are identical in all respects except one: State X is found to have an efficient Government, i.e. one which has made relatively good quality public investment decisions, and State Y is found to have one which has made relatively bad quality public investment decisions. In the present amalgamated model of Indian federal finance, no objective distinction can be made between the two, and efficient State Governments are surreptitiously compelled to end up subsidising inefficient ones. In a differentiated federal framework for India, as the different information about the two State Governments comes to be discovered, the X currency will tend to appreciate as resources move towards it while the Y will tend to depreciate as resources move away from it. In an amalgamated model, efficient State Governments lose incentives to remain efficient, while in a differentiated model, inefficient State Governments will gain an incentive not to be inefficient. The present amalgamated situation is such that inefficient States – and this may include not only the State Government but also the State Legislature and the State electorate itself – receive no fiscal incentive to improve themselves. In a differentiated framework, the same inefficient State would face a tangible, visible loss of reserves or depreciation of its currency relative to other States on account of its inefficiency, and thereby have some incentive to mend its ways. I call the proposal given here a “Reverse Euro” model because Europe appears to be moving from differentiated currencies and money supplies to an amalgamated currency and money supply, while the argument given here for India is in the opposite direction. Professor Milton Friedman of the Hoover Institution at Stanford, has had the kindness, at the age of 88, to send me a brilliant and forceful critique of my Reverse Euro idea for India when I requested his comment. Since he is the founder of the flexible exchange-rate system and he has found it too radical, I have shelved it for the time being.

[2] The assistance of Dola Dasgupta and K. Shanmugam is recorded with gratitude.

[3] Surendranath Roy, A History of the Native States of India, Vol I. Gwalior, Calcutta & London: Thacker 1888.

[4] Large amounts of legal and constitutional precedent have built up on issues of a regional or local nature: whether a State legislature should be unicameral or bicameral, what should be its procedures, what days should be State holidays but need not be national holidays, on tenancy, rent control, school standards, health standards and so on ad infinitum. All this body of explicit and implicit local rules and conventions may be duly collected and placed in State-level Constitutions.

[5] James M. Buchanan, Limits to Liberty, Texas, 1978.

A major expansion and reorganization of the judiciary would have to accompany the sort of basic constitutional reform outlined above. Union and State judiciaries would need to be more clearly demarcated, and rules established for review of State-level decisions by Union courts of law. It is common knowledge the judiciary in India is in a state of organizational overload at the point of collapse and dysfunction. An expansion and reorganization of the judiciary to match new Union-State constitutional relations will likely improve efficiency, and therefore welfare levels of citizens.

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Rajiv Gandhi and the Origins of India’s 1991 Economic Reform

Rajiv Gandhi and the Origins of India’s 1991 Economic Reform

Subroto Roy

Author’s Note May 2008: The family of Rajiv Gandhi received a copy of this when it was first written in July 2005. An earlier abbreviated version “Encounter with Rajiv Gandhi: On the Origins of India’s 1991 Economic Reform” was published in October 2001 in Freedom First, Bombay, a journal founded by the late Minoo Masani and now edited by S V Raju. A copy of that article was received by all Congress MPs of the 13th Lok Sabha. In May 2002, the Congress Party passed an official resolution stating Rajiv Gandhi and not Narasimha Rao or Manmohan Singh was to be credited with having originated the 1991 economic reforms. This article has now been published in print in The Statesman Festival Volume, October 2007.  It may be profitably followed by “The Dream Team: A Critique”, “Solving Kashmir”, “Law, Justice & J&K”, “What to tell Musharraf”, “India’s Macroeconomics”, “Fiscal Instability”, “India’s Trade and Payments”, “Fallacious Finance”, “Against Quackery”, etc. My original advisory memoranda to Rajiv in 1990-1991 were published in The Statesman’s Editorial Pages July 31-August 2 1991, and now have been republished elsewhere here as well. See too https://independentindian.com/thoughts-words-deeds-my-work-1973-2010/rajiv-gandhi-and-the-origins-of-indias-1991-economic-reform/did-jagdish-bhagwati-originate-pioneer-intellectually-father-indias-1991-economic-reform-did-manmohan-singh-or-did-i-through-my-e/  https://independentindian.com/2014/08/07/haksar-manmohan-and-sonia/

I met Rajiv Gandhi for the first time on 18th September 1990 thanks to an introduction by S. S. Ray (see “I’m on my way out”: Siddhartha Shankar Ray (1920-2010)… | Independent Indian: Work & Life of Professor Subroto Roy) We met a half dozen or so times until his assassination in May 1991. Yet our encounter was intense and consequential, and resulted directly in the change of the Congress Party’s economic thinking prior to the 1991 elections. I had with me results of an interdisciplinary “perestroika-for-India” project I had led at the University of Hawaii since 1986. This manuscript (later published by Sage as Foundations of India’s Political Economy: Towards an Agenda for the 1990s edited by myself and W. E. James) was given by me to Rajiv, then Leader of the Opposition, and was instrumental in the change of thinking that took place. In interests of fairness, I tried to get the work to V. P. Singh too because he was Prime Minister, but a key aide of his showed no interest in receiving it.

The Hawaii project manuscript contained inter alia a memorandum by Milton Friedman done at the request of the Government of India in November 1955, which had been suppressed for 34 years until I published it in May 1989. Milton and Rose Friedman refer to this in their memoirs Two Lucky People (Chicago 1998). Peter Bauer had told me of the existence of Friedman’s document during my doctoral work at Cambridge under Frank Hahn in the late 1970s, as did N. Georgescu-Roegen in America. Those were years in which Brezhnev still ruled in the Kremlin, Gorbachev was yet to emerge, Indira Gandhi and her pro-Moscow advisers were ensconced in New Delhi, and not even the CIA had imagined the Berlin Wall would fall and the Cold War would be over within a decade. It was academic suicide at the time to argue in favour of classical liberal economics even in the West. As a 22-year-old Visiting Assistant Professor at the Delhi School of Economics in 1977, I was greeted with uproarious laughter of senior professors when I spoke of a possible free market in foreign exchange. Cambridge was a place where Indian economists went to study the exploitation of peasants in Indian agriculture before returning to their friends in the well-known bastions of such matters in Delhi and Calcutta. It was not a place where Indian (let alone Bengali) doctoral students in economics mentioned the unmentionable names of Hayek or Friedman or Buchanan, and insisted upon giving their works a hearing.

My original doctoral topic in 1976 “A monetary theory for India” had to be altered not only due to paucity of monetary data at the time but because the problems of India’s political economy and allocation of resources in the real economy were far more pressing. The thesis that emerged in 1982 “On liberty and economic growth: preface to a philosophy for India” was a full frontal assault from the point of view of microeconomic theory on the “development planning” to which everyone routinely declared their fidelity, from New Delhi’s bureaucrats and Oxford’s “development” school to McNamara’s World Bank with its Indian staffers.

Frank Hahn protected my inchoate liberal arguments for India; and when no internal examiner could be found, Cambridge showed its greatness by appointing two externals, Bliss at Oxford and Hutchison at Birmingham, both Cambridge men. “Economic Theory and Development Economics” was presented to the American Economic Association in December 1982 in company of Solow, Chenery and other eminences, and then Pricing, Planning and Politics: A Study of Economic Distortions in India published by London’s Institute of Economic Affairs, provoking the lead editorial of The Times on May 29 1984. The Indian High Commission sent the editorial to the Finance Ministry where it caused a stir as the first classical liberal attack on post-Mahalonobis Indian economic thought since B. R. Shenoy’s original criticism decades earlier. The “perestroika-for-India” project was to follow at Hawaii starting in 1986. New Delhi was represented at the project’s conference held between May 22-27 1989 by the accredited Ambassador of India to the USA, the accredited Consul General of India to San Francisco, and by the founder-director of ICRIER (see photo).

friedman-et-al-at-uh-india-conf-19891

All this I brought into that first meeting with Rajiv Gandhi on September 18 1990. That first day he came to the door to greet me. He was a handsome tall man with the most charming smile and manner, seemed pleased to see me and put me at ease at once. I gave him my books as well as the manuscript of the “perestroika for India” project. He gave me a celebratory volume that had just been published to mark his grandfather’s centenary. He began by talking about how important he felt panchayati raj was, and said he had been on the verge of passing major legislation on it but then lost the election. He asked me if I could spend some time thinking about it, and that he would get the papers sent to me. I said I would and remarked panchayati raj might be seen as decentralized provision of public goods, and gave the economist’s definition of public goods as those essential for the functioning of the market economy, like the Rule of Law, roads, fresh water, and sanitation, but which were unlikely to appear through competitive forces.

I distinguished between federal, state and local levels and said many of the most significant public goods were best provided locally. Rajiv had not heard the term “public goods” before, and he beamed a smile and his eyes lit up as he voiced the words slowly, seeming to like the concept immensely. It occurred to me he had been by choice a pilot of commercial aircraft. Now he seemed intrigued to find there could be systematic ways of thinking about navigating a country’s governance by common pursuit of reasonable judgement. I said the public sector’s wastefulness had drained scarce resources that should have gone instead to provide public goods. Since the public sector was owned by the public, it could be privatised by giving away its shares to the public, preferably to panchayats of the poorest villages. The shares would become tradable, drawing out black money, and inducing a historic redistribution of wealth while at the same time achieving greater efficiency by transferring the public sector to private hands. Rajiv seemed to like that idea too, and said he tried to follow a maxim of Indira Gandhi’s that every policy should be seen in terms of how it affected the common man. I wryly said the common man often spent away his money on alcohol, to which he said at once it might be better to think of the common woman instead. (This remark of Rajiv’s may have influenced the “aam admi” slogan of the 2004 election, as all Congress Lok Sabha MPs of the previous Parliament came to receive a previous version of the present narrative.)

Our project had identified the Congress’s lack of internal elections as a problem; when I raised it, Rajiv spoke of how he, as Congress President, had been trying to tackle the issue of bogus electoral rolls. I said the judiciary seemed to be in a mess due to the backlog of cases; many of which seemed related to land or rent control, and it may be risky to move towards a free economy without a properly functioning judicial system or at least a viable system of contractual enforcement. I said a lot of problems which should be handled by the law in the courts in India were instead getting politicised and decided on the streets. Rajiv had seen the problems of the judiciary and said he had good relations with the Chief Justice’s office, which could be put to use to improve the working of the judiciary.

The project had worked on Pakistan as well, and I went on to say we should solve the problem with Pakistan in a definitive manner. Rajiv spoke of how close his government had been in 1988 to a mutual withdrawal from Siachen. But Zia-ul-Haq was then killed and it became more difficult to implement the same thing with Benazir Bhutto, because, he said, as a democrat, she was playing to anti-Indian sentiments while he had found it somewhat easier to deal with the military. I pressed him on the long-term future relationship between the countries and he agreed a common market was the only real long-term solution. I wondered if he could find himself in a position to make a bold move like offering to go to Pakistan and addressing their Parliament to break the impasse. He did not say anything but seemed to think about the idea. Rajiv mentioned a recent Time magazine cover of Indian naval potential, which had caused an excessive stir in Delhi. He then talked about his visit to China, which seemed to him an important step towards normalization. He said he had not seen (or been shown) any absolute poverty in China of the sort we have in India. He talked about the Gulf situation, saying he did not disagree with the embargo of Iraq except he wished the ships enforcing the embargo had been under the U.N. flag. The meeting seemed to go on and on, and I was embarrassed at perhaps having taken too much time and that he was being too polite to get me to go. V. George had interrupted with news that Sheila Dixit (as I recall) had just been arrested by the U. P. Government, and there were evidently people waiting. Just before we finally stood up I expressed a hope that he was looking to the future of India with an eye to a modern political and economic agenda for the next election, rather than getting bogged down with domestic political events of the moment. That was the kind of hopefulness that had attracted many of my generation in 1985. I said I would happily work in any way to help define a long-term agenda. His eyes lit up and as we shook hands to say goodbye, he said he would be in touch with me again.

The next day I was called and asked to stay in Delhi for a few days, as Mr. Gandhi wanted me to meet some people. I was not told whom I was to meet but that there would be a meeting on Monday, 24th September. On Saturday, the Monday meeting was postponed to Tuesday because one of the persons had not been able to get a flight into Delhi. I pressed to know what was going on, and was told I was to meet former army chief K.V. Krishna Rao, former foreign secretary M. K. Rasgotra, V. Krishnamurty and Sam Pitroda.

The group met for the first time on September 25 in the afternoon. Rasgotra did not arrive. Krishna Rao, Pitroda, Krishnamurty and I gathered in the waiting room next to George’s office. The three of them knew each other but none knew me and I was happy enough to be ignored. It seemed mysterious while we were gathering, especially when the tall well-dressed General arrived, since none of us knew why we had been called by Rajiv, and the General remarked to the others he had responded at once to the call to his home but could not get a flight into Delhi for a day.

Rajiv’s residence as Leader of the Opposition had a vast splendid meeting room, lined with high bookshelves on one or two walls, a large handsome desk on one side, two spacious comfortable sofa sets arranged in squares, and a long conference table with leather chairs occupying most of the rest of the room. The entrance to it was via a small 10 ft by 10 ft air-conditioned anteroom, where George sat, with a fax machine, typewriters and a shredding machine, plus several telephones, and a used copy of parliamentary procedures on the shelf. Getting to George’s office was the final step before reaching Rajiv. There were several chairs facing George, and almost every prospective interviewee, no matter how senior or self-important, had to move from one chair to the next, while making small talk with George, as the appointment with Rajiv drew near. Opening into George’s office was a larger and shabbier waiting room, which is where we sat, which was not air-conditioned, and which opened to the outside of the building where a plainclothes policeman sometimes stood around with a walkie-talkie. There were large photographs of Mahatma Gandhi, Nehru and Indira Gandhi on the wall, and a modern print also hung incongruously. A dozen or more plastic chairs lined the walls. There were faded torn issues of a few old magazines on the plastic coffee-table, and on one occasion there was a television playing the new sporadic domestic cable news and weather information for the entertainment of the many visitors waiting. Via this waiting room went the vast majority of people who were to meet Rajiv in his office. To reach the waiting room, one had to walk a hundred yards along a path lined by splendid high hedges from the initial reception desk at the rear-gate, manned by Congress Seva Dal volunteers in khadi wearing Gandhi-caps. These persons were in touch with George’s office by telephone, and would check with George or his assistant Balasubramaniam before sending a visitor along. The visitor would then pass through a metal-detector manned by a couple of policemen. If someone’s face came to be known and had been cleared once, or if someone acted to the policemen like a sufficiently important political personage, such a person seemed to be waved through. Outside, the front-entrance of the premises were closed unless extremely important people were entering or exiting, while at the rear-entrance there were usually two or three jeeps and several plainclothes policemen, who might or might not challenge the prospective visitor with a kind of “Who goes there?” attitude before the visitor reached the Seva Dal reception desk. The whole arrangement struck me from the first as insecure and inefficient, open to penetration by professional assassins or a terrorist squad, let aside insiders in the way Indira Gandhi had been assassinated. I could not imagine counter-terrorist commandos would suddenly appear from the high hedges in the event of an emergency.

On that Tuesday when Rajiv finally called in our group, we entered hesitantly not knowing quite what the meeting was going to be about. Rajiv introduced me to the others and then spoke of why he had gathered us together. He wanted us to come up with proposals and recommendations for the direction the country should take on an assumption the Congress Party was returned to power in the near future. He said it would help him to have an outside view from specialists who were not party functionaries, though the others obviously had been closely involved with Congress governments before. Rajiv said we were being asked to write a draft of what may enter the manifesto for the next election, which we should assume to be forthcoming by April 1991. I asked what might have become of the “perestroika” manuscript I had given him at our previous meeting. He said he had gotten it copied and bound, and that along with my 1984 monograph, it had been circulated among a few of his party colleagues who included P. Chidambaram and Mani Shankar Aiyar.

The initial meeting left us breathless and excited. Yet within a few days, the others became extremely tied up for personal causes, and I found myself alone in getting on with doing what we had been explicitly asked to do. I felt I should get done what I could in the time I had while keeping the others informed. Rajiv had said to me at our first meeting that he felt the Congress was ready for elections. This did not seem to me to be really the case. He actually seemed very isolated in his office, with George seeming to be his conduit to the outside world. I decided to start by trying to write a definite set of general principles that could guide and inform thought about the direction of policy. I spent the evening of October 26 in the offices at Rajiv’s residence, preparing an economic policy memorandum on a portable Toshiba computer of his, the first laptop I ever used. After Rajiv’s assassination, this was part of what was published in The Statesmen’s center pages July 31-August 2, 1991.

Rajiv read the work and met me on October 30 or 31, even though he was down badly with a sore throat after his sadbhavana travels around the country; he looked odd clad in khadi with a muffler and gym shoes. He said he liked very much what I had written and had given it to be read by younger Congress leaders who would discuss it for the manifesto, for an election he again said, he expected early in 1991. I said I was grateful for his kind words and inquired whom he had shown the work to. This time he said Chidambaram and also mentioned another name that made me wince. In December 1990, I was back in Hawaii when I was called on the phone to ask whether I could come to Delhi. With the rise of Chandrashekhar as Prime Minister, Rajiv had called a meeting of the group. But I could not go.

In January 1991, the Gulf War brought an odd twist to my interaction with Rajiv. On January 15, the UN deadline for the withdrawal of Iraq from Kuwait passed without Iraqi compliance, and American-led forces started the heavy aerial bombardment of Iraq. The American media had built up the impending war as one of utter devastation and mass killing, especially when the American infantry became engaged. Estimated casualties on the American side alone were being wildly exaggerated by the number of “body-bags” being ordered by the Pentagon. An even larger conflagration was being imagined if Israel entered the fighting, while Saddam Hussein had vowed to set fire to Kuwait’s oil-fields before retreating. I like everyone else erroneously believed the media’s hyperbole about the impending regional catastrophe. On January 16, just after the bombing of Iraq had begun, I called an American family friend who had retired from a senior foreign policy role and who had known me from when I was an infant. In informal conversation, I mentioned to him that since other channels had by then become closed, an informal channel might be attempted via India, specifically via Rajiv who was still Leader of the Opposition but on whom the Chandrashekhar Government depended. The sole aim would be to compel an immediate Iraqi withdrawal without further loss of life. What transpired over the next few days was that a proposal to that effect was communicated at Rajiv’s decision to a high level of the Iraqis on the one hand, and evidently received their assent, while at the same time, it was mentioned to the authorities on the American side. But nothing came of it. Rajiv initiated a correspondence with Chandrashekhar beginning January 19, demanding a coherent formulation of Indian policy in the Gulf war, and faxed me copies of this. By February 8, the Times of India led by saying Rajiv’s stand “on the Gulf War demonstrates both his experience and perspicacity … in consonance with an enlightened vision of national interest”, and urged Rajiv to “give the nation some respite from [the] non-government” of Chandrashekhar. I taped my phone conversations with Rajiv during the Gulf War because notes could not be taken at the necessary speed; in late December 1991, I was to give his widow a copy of the tape for her personal record.

I returned to Delhi on Monday, March 18, 1991 as new elections had been announced. Rasgotra said I should be in touch with Krishna Rao, and the next day March 19 Krishna Rao met me for several hours. I told him what I thought were the roots and results of the Gulf war. He in turn generously told me what had happened while I had been away. He said the group had met Rajiv in December with the proposal that Rajiv better organize his time by having an “office manager” of larger political stature than George. The name of a UP Congressman of integrity had been put forward, but nothing had come of it. Rajiv had been advised to keep Chandrashekhar in power through the autumn of 1991, as Chandrashekhar was doing Rajiv’s work for him of sidelining V. P. Singh. The idea was to cooperate with Chandrashekhar until he could be pushed up to the Presidency when that fell vacant. Rajiv had been advised not to work in a Chandrashekhar cabinet, though in my opinion, had we been like the Scandinavians, it was not impossible for a former prime minister to enter another cabinet on the right terms in the national interest of providing stable government, which was imperative at the time. Things seem to have slipped out of control when Chandrashekhar resigned. At that point, Rajiv called the group together and instructed them to write a draft of the manifesto for the impending elections. I had advised readiness back in September but the lack of organization had prevented much tangible progress at the time. Our group was to now report to a political manifesto-committee of three senior party leaders who would report to Rajiv. They were Narasimha Rao, Pranab Mukherjee and Madhavsingh Solanki. Krishna Rao liased with Narasimha Rao, Krishnamurty with Mukherjee, Pitroda with Solanki. While Rajiv would obviously lead a new Congress Government, Mukherjee was the presumptive Finance Minister, while Narasimha Rao and Solanki would have major portfolios though Narasimha Rao was expected to retire before too long.

Krishna Rao said I should be in touch with Krishnamurty who was preparing the economic chapters of the draft of the manifesto. Krishnamurty told me he had brought in A. M. Khusro to the group, and there would be a 5 p.m. meeting at Khusro’s office at the Aga Khan Foundation. I arrived early and was delighted to meet Khusro, and he seemed pleased to meet me. Khusro seemed excited by my view that India and Pakistan were spending excessively on defence against each other, which resonated with his own ideas, and he remarked the fiscal disarray in India and Pakistan could start to be set right by mutually agreed cuts in military spending. (Khusro was eventually to accompany Prime Minister Vajpayee to Lahore in 1999).

Krishnamurty had prepared a draft dated March 18 of several pages of the economic aspects of the manifesto. After our discussions, Krishnamurty was hospitable enough to open the draft to improvement. That evening, the 19th, I worked through the night and the next morning to get by noon copies of a revised version with all the members of the group. At 4 p.m. on the 20th there was a meeting at Andhra Bhavan of the whole group except Pitroda, which went on until the night. The next day the 21st , Krishnamurty, Khusro and I met again at Andhra Bhavan for a few hours on the economic aspects of the draft. Then in mid-afternoon I went to Rasgotra’s home to work with him and Krishna Rao. They wanted me to produce the economic draft which they could then integrate as they wished into the material they were dictating to a typist. I offered instead to absorb their material directly on to my laptop computer where the economic draft was. Rasgotra was reluctant to let go control, and eventually I gave in and said I would get them a hard copy of the economic draft, which they then planned to re-draft via a stenographer on a typewriter. At this, Rasgotra gave in and agreed to my solution. So the work began and the three of us continued until late.

That night Krishna Rao dropped me at Tughlak Road where I used to stay with friends. In the car I told him, as he was a military man with heavy security cover for himself as a former Governor of J&K, that it seemed to me Rajiv’s security was being unprofessionally handled, that he was vulnerable to a professional assassin. Krishna Rao asked me if I had seen anything specific by way of vulnerability. With John Kennedy and De Gaulle in mind, I said I feared Rajiv was open to a long-distance sniper, especially when he was on his campaign trips around the country.

This was one of several attempts I made since October 1990 to convey my clear impression to whomever I thought might have an effect that Rajiv seemed to me extremely vulnerable. Rajiv had been on sadhbhavana journeys, back and forth into and out of Delhi. I had heard he was fed up with his security apparatus, and I was not surprised given it seemed at the time rather bureaucratized. It would not have been appropriate for me to tell him directly that he seemed to me to be vulnerable, since I was a newcomer and a complete amateur about security issues, and besides if he agreed he might seem to himself to be cowardly or have to get even closer to his security apparatus. Instead I pressed the subject relentlessly with whomever I could. I suggested specifically two things: (a) that the system in place at Rajiv’s residence and on his itineraries be tested, preferably by some internationally recognized specialists in counter-terrorism; (b) that Rajiv be encouraged to announce a shadow-cabinet. The first would increase the cost of terrorism, the second would reduce the potential political benefit expected by terrorists out to kill him. On the former, it was pleaded that security was a matter being run by the V. P. Singh and then Chandrashekhar Governments at the time. On the latter, it was said that appointing a shadow cabinet might give the appointees the wrong idea, and lead to a challenge to Rajiv’s leadership. This seemed to me wrong, as there was nothing to fear from healthy internal contests for power so long as they were conducted in a structured democratic framework. I pressed to know how public Rajiv’s itinerary was when he travelled. I was told it was known to everyone and that was the only way it could be since Rajiv wanted to be close to the people waiting to see him and had been criticized for being too aloof. This seemed to me totally wrong and I suggested that if Rajiv wanted to be seen as meeting the crowds waiting for him then that should be done by planning to make random stops on the road that his entourage would take. This would at least add some confusion to the planning of potential terrorists out to kill him. When I pressed relentlessly, it was said I should probably speak to “Madame”, i.e. to Mrs. Rajiv Gandhi. That seemed to me highly inappropriate, as I could not be said to be known to her and I should not want to unduly concern her in the event it was I who was completely wrong in my assessment of the danger. The response that it was not in Congress’s hands, that it was the responsibility of the V. P. Singh and later the Chandrashekhar Governments, seemed to me completely irrelevant since Congress in its own interests had a grave responsibility to protect Rajiv Gandhi irrespective of what the Government’s security people were doing or not doing. Rajiv was at the apex of the power structure of the party, and a key symbol of secularism and progress for the entire country. Losing him would be quite irreparable to the party and the country. It shocked me that the assumption was not being made that there were almost certainly professional killers actively out to kill Rajiv Gandhi — this loving family man and hapless pilot of India’s ship of state who did not seem to have wished to make enemies among India’s terrorists but whom the fates had conspired to make a target. The most bizarre and frustrating response I got from several respondents was that I should not mention the matter at all as otherwise the threat would become enlarged and the prospect made more likely! This I later realized was a primitive superstitious response of the same sort as wearing amulets and believing in Ptolemaic astrological charts that assume the Sun goes around the Earth — centuries after Kepler and Copernicus. Perhaps the entry of scientific causality and rationality is where we must begin in the reform of India’s governance and economy. What was especially repugnant after Rajiv’s assassination was to hear it said by his enemies that it marked an end to “dynastic” politics in India. This struck me as being devoid of all sense because the unanswerable reason for protecting Rajiv Gandhi was that we in India, if we are to have any pretensions at all to being a civilized and open democratic society, cannot tolerate terrorism and assassination as means of political change. Either we are constitutional democrats willing to fight for the privileges of a liberal social order, or ours is truly a primitive and savage anarchy concealed beneath a veneer of fake Westernization.

The next day, Friday March 22, I worked from dawn to get the penultimate draft to Krishna Rao before noon as planned the night before. Rasgotra arrived shortly, and the three of us worked until evening to finish the job. I left for an hour to print out copies for a meeting of the entire group, where the draft we were going to submit would come to be decided. When I got back I found Rasgotra had launched an extended and quite unexpected attack on what had been written on economic policy. Would someone like Manmohan Singh, Rasgotra wanted to know, agree with all this talk we were putting in about liberalization and industrial efficiency? I replied I did not know what Manmohan Singh’s response would be but I knew he had been in Africa heading something called the South-South Commission for Julius Nyrere of Tanzania. I said what was needed was a clear forceful statement designed to restore India’s credit-worthiness, and the confidence of international markets. I said that the sort of thing we should aim for was to make clear, e.g. to the IMF’s man in Delhi when that person read the manifesto, that the Congress Party at least knew its economics and was planning to make bold new steps in the direction of progress. I had argued the night before with Rasgotra that on foreign policy we should “go bilateral” with good strong ties with individual countries, and drop all the multilateral hogwash. But I did not wish to enter into a fight on foreign policy which he was writing, so long as the economic policy was left the way we said. Krishnamurty, Khusro and Pitroda came to my defence saying the draft we had done greatly improved on the March 18 draft. For a bare half hour or so with all of us present, the draft was agreed upon. Later that night at Andhra Bhavan, I gave Krishna Rao the final copy of the draft manifesto which he was going to give Narasimha Rao the next day, and sent a copy to Krishnamurty who was liaising with Pranab Mukherjee. Pitroda got a copy on a floppy disc the next day for Solanki.

In its constructive aspects, the March 22 1991 draft of the Congress manifesto went as follows with regard to economic policy: “CHAPTER V AGENDA FOR ECONOMIC ACTION 1. Control of Inflation …. The Congress believes the inflation and price-rise of essential commodities… is a grave macroeconomic problem facing the country today. It has hit worst the poorest and weakest sections of our people and those with fixed incomes like pensioners. The Congress will give highest priority to maintaining the prices of essential commodities, increasing their production and supply using all appropriate economic instruments. 2. Macroeconomic Policy Framework To control inflation of the general price-level, the Congress will provide a predictable long-term policy framework. The average Indian household and business will not have their lives and plans disrupted by sudden changes in economic policy. Coherent monetary policy measures will be defined as called for by the Report of Experts of the Reserve Bank of India in 1985. The Long-Term Fiscal Policy introduced by the Congress Government of 1984-1989 will be revived. Medium and long-term export-import policies will be defined. The basis for a strong India must be a strong economy. The Congress believes a high rate of real growth is essential for securing a strong national defence, social justice and equity, and a civilized standard of living for all. As the party of self-reliance, Congress believes resources for growth must be generated from within our own economy. This means all wasteful and unproductive Government spending has to be cut, and resources transferred from areas of low priority to areas of high national priority. Subsidies have to be rationalized and reduced, and productivity of investments already made has to be improved. The widening gap between revenue receipts and revenue expenditure must be corrected through fiscal discipline, and the growing national debt brought under control as a matter of high priority. These policies in a consistent framework will create the environment for the freeing of the rupee in due course, making it a hard currency of the world of which our nation can be proud. Public resources are not unlimited. These have to be allocated to high priority areas like essential public services, poverty-reduction, strategic sectors, and protection of the interests of the weaker sections of society. Government has to leave to the initiative and enterprise of the people what can be best done by themselves. Government can now progressively vacate some areas of activity to the private, cooperative and non-government sectors. Black money in the parallel economy has become the plague of our economic and political system. This endangers the social and moral fabric of our nation. Artificial price controls, excessive licensing, capacity restrictions, outmoded laws on rent control and urban ceiling, and many other outdated rules and regulations have contributed to pushing many honest citizens into dishonest practices. The Congress will tackle the problem of black money at its roots by attacking all outmoded and retrograde controls, and simplifying procedures in all economic spheres. At the same time, the tax-base of the economy must be increased via simplification and rationalization of tax-rates and coverage, user-fees for public goods, and reduction of taxes wherever possible to improve incentives and stimulate growth. 3. Panchayati Raj India’s farmers and khet mazdoors are the backbone of our economy. Economic development is meaningless until their villages provide them a wholesome rural life. The Congress will revitalize Panchayat Raj institutions to decentralize decision-making, so development can truly benefit local people most effectively. 4. Rural Development Basic economic infrastructure like roads, communications, fresh drinking water, and primary health and education for our children must reach all our villages. The Congress believes such a policy will also relieve pressures from migration on our towns and cities…… Through the Green Revolution which the Congress pioneered over 25 years, our farmers have prospered. Now our larger farmers must volunteer to contribute more to the national endeavour, and hence to greater equity and overall economic development. Equity demands land revenue should be mildly graduated so that small farmers holding less than one acre pay less land revenue per acre…. 9. Education and Health The long-run prosperity of our nation depends on the general state of education, health and well-being of our people. Small families give themselves more choice and control over their own lives. Improving female literacy, promoting the welfare of nursing mothers and reducing infant mortality will have a direct bearing on reducing the birth-rate and improving the health and quality of all our people. Primary and secondary education has high social returns and is the best way in the long-run for achievement of real equality. Efforts will be made to reduce the cost of education for the needy through concessional supply of books and other study materials, scholarships and assistance for transportation and residential facilities. The Congress Party pledges to dedicate itself to promoting education, especially in rural areas and especially for girls and the weaker sections of society. The next Congress Government will prepare and launch a 10-year programme for introduction of free and compulsory primary education for all children of school age. It will continue to emphasize vocational bias in education, integrating it closely with employment opportunities…. 11. Industrial Efficiency Our industrial base in the private and public sectors are the core of our economy. What we have achieved until today has been creditable, and we are self-reliant in many areas. Now the time has come for industry to provide more efficiency and better service and product-quality for the Indian consumer. The public sector has helped the Indian economy since Independence and many national goals have been achieved. Now it has become imperative that the management of public sector units is made effective, and their productivity increased. Major steps must be taken for greater accountability and market-orientation. Failure to do this will make our country lose more and more in the international economy. Budgetary support will be given only for public sector units in the core and infrastructure sectors. Emphasis will be on improving performance and productivity of existing investments, not on creating added organizations or over manning. Units not in the core sector will be privatised gradually. Even in core sectors like Telecommunications, Power, Steel and Coal, incremental needs can be taken care of by the private sector. The Government-Enterprise interface must be properly defined in a White Paper. The Congress believes privatisation must distribute the profits equitably among the people of India. In order to make our public enterprises truly public, it is essential that the shares of many such enterprises are widely held by the members of the general public and workers. Congress pledges to allot a proportion of such shares to the rural Panchayats and Nagarpalikas. This will enhance their asset-base and yield income for their development activities, as well as improve income-distribution. 12. Investment and Trade Indian industry, Government and professional managers are now experienced enough to deal with foreign companies on an equal footing, and channel direct foreign investment in desired directions. Foreign companies often bring access to advanced technological know-how, without which the nation cannot advance. The Congress Government will formulate a pragmatic policy channelling foreign investment into areas important to the national interest. Every effort must be made also to encourage Indians who are outside India to invest in the industry, trade and real estate of their homeland. Because of the protected and inflationary domestic market, Indian industry has become complacent and the incentive for industrial exports has been weakened. When all production is comfortably absorbed at home, Indian industry makes the effort to venture into exports only as a last resort. This must change. A Congress Government will liberalize and deregulate industry to make it competitive and export-oriented, keeping in mind always the interests of the Indian consumer in commercial policy. Export-oriented and predictable commercial policies will be encouraged. Existing procedural constraints and bottlenecks will be removed. Quotas and tariffs will be rationalized. Thrust areas for export-development will be identified and monitored. Efforts will be made to develop a South Asian Community. Trade and economic cooperation among South Asian countries must be increased and simplified.”

This March 22 1991 draft of the Congress’s intended economic policies got circulated and discussed, and from it rumours and opinions appeared that Congress was planning to launch a major economic reform in India. Economic Times said the manifesto “is especially notable for its economic agenda” and Business Standard said “if party manifestos decide election battles” Congress must be “considered home and dry”. A senior IMF official told me three years later the manifesto had indeed seemed a radical and bold move in the direction of progress, which had been exactly our intended effect. When I met Manmohan Singh at the residence of S. S. Ray in September 1993 in Washington, Ray told him and his senior aides the Congress manifesto had been written on my computer. Manmohan Singh smiled and said that when Arjun Singh and other senior members of the Congress had challenged him in the cabinet, he had pointed to the manifesto. Yet, oddly enough, while the March 22 draft got discussed and circulated, and the Indian economic reform since July 1991 corresponded in fundamental ways to its contents as reproduced above, the actual published Congress manifesto in April 1991 was as tepid and rhetorical as usual, as if some party hack had before publication put in the usual nonsense about e.g. bringing down inflation via price-controls. Certainly the published manifesto was wholly undistinguished in its economic aspects, and had nothing in it to correspond to the bold change of attitude towards economic policy that actually came to be signalled by the 1991 Government.

On March 23, our group was to meet Rajiv at noon. There was to be an event in the inner lawns of Rajiv’s residence in the morning, where he would launch Krishna Rao’s book on India’s security. Krishna Rao had expressly asked me to come but I had to wait outside the building patiently, not knowing if it was a mistake or if it was deliberate. This was politics after all, and I had ruffled feathers during my short time there. While I waited, Rajiv was speaking to a farmers’ rally being held at grounds adjoining his residence, and there appeared to be thousands of country folk who had gathered to hear him. When it was over, Rajiv, smiling nervously and looking extremely uncomfortable, was hoisted atop people’s shoulders and carried back to the residence by his audience. As I watched, my spine ran cold at the thought that any killer could have assassinated him with ease in that boisterous crowd, right there in the middle of Delhi outside his own residence. It was as if plans for his security had been drawn up without any strategic thinking underlying them.

Krishna Rao arrived and graciously took me inside for his book launch. The event was attended by the Congress’s top brass, including Narasimha Rao whom I met for the first time, as well as foreign military attaches and officers of the Indian armed forces. The attaché of one great power went about shaking hands and handing out his business card to everyone. I stood aside and watched. Delhi felt to me that day like a sieve, as if little could be done without knowledge of the embassies. One side wanted to sell arms, aircraft or ships, while the other wanted trips abroad or jobs or green cards or whatever for their children. And I thought Islamabad would be worse — could India and Pakistan make peace in this fetid ether?

Proceedings began when Rajiv arrived. This elite audience mobbed him just as the farmers had mobbed him earlier. He saw me and beamed a smile in recognition, and I smiled back but made no attempt to draw near him in the crush. He gave a short very apt speech on the role the United Nations might have in the new post-Gulf War world. Then he launched the book, and left for an investiture at Rashtrapati Bhavan. We waited for our meeting with him, which finally happened in the afternoon. Rajiv was plainly at the point of exhaustion and still hard-pressed for time. He seemed pleased to see me and apologized for not talking in the morning. Regarding the March 22 draft, he said he had not read it but that he would be doing so. He said he expected the central focus of the manifesto to be on economic reform, and an economic point of view in foreign policy, and in addition an emphasis on justice and the law courts. I remembered our September 18 conversation and had tried to put in justice and the courts into our draft but had been over-ruled by others. I now said the social returns of investment in the judiciary were high but was drowned out again. Rajiv was clearly agitated that day by the BJP and blurted out he did not really feel he understood what on earth they were on about. He said about his own family, “We’re not religious or anything like that, we don’t pray every day.” I felt again what I had felt before, that here was a tragic hero of India who had not really wished to be more than a happy family man until he reluctantly was made into a national leader against his will. We were with him for an hour or so. As we were leaving, he said quickly at the end of the meeting he wished to see me on my own and would be arranging a meeting. One of our group was staying back to ask him a favour. Just before we left, I managed to say to him what I felt was imperative: “The Iraq situation isn’t as it seems, it’s a lot deeper than it’s been made out to be.” He looked at me with a serious look and said “Yes I know, I know.” It was decided Pitroda would be in touch with each of us in the next 24 hours. During this time Narasimha Rao’s manifesto committee would read the draft and any questions they had would be sent to us. We were supposed to be on call for 24 hours. The call never came. Given the near total lack of system and organization I had seen over the months, I was not surprised. Krishna Rao and I waited another 48 hours, and then each of us left Delhi. Before going I dropped by to see Krishnamurty, and we talked at length. He talked especially about the lack of the idea of teamwork in India. Krishnamurty said he had read everything I had written for the group and learned a lot. I said that managing the economic reform would be a critical job and the difference between success and failure was thin.

I got the afternoon train to Calcutta and before long left for America to bring my son home for his summer holidays with me. In Singapore, the news suddenly said Rajiv Gandhi had been killed. All India wept. What killed him was not merely a singular act of criminal terrorism, but the system of humbug, incompetence and sycophancy that surrounds politics in India and elsewhere. I was numbed by rage and sorrow, and did not return to Delhi. Eleven years later, on 25 May 2002, press reports said “P. V. Narasimha Rao and Manmohan Singh lost their place in Congress history as architects of economic reforms as the Congress High command sponsored an amendment to a resolution that had laid credit at the duo’s door. The motion was moved by…. Digvijay Singh asserting that the reforms were a brainchild of the late Rajiv Gandhi and that the Rao-Singh combine had simply nudged the process forward.” Rajiv’s years in Government, like those of Indira Gandhi, were in fact marked by profligacy and the resource cost of poor macroeconomic policy since bank-nationalisation may be as high as Rs. 125 trillion measured in 1994 rupees. Certainly though it was Rajiv Gandhi as Leader of the Opposition in his last months who was the principal architect of the economic reform that came to begin after his passing.

My response to The Times’ editorial of May 29 1984

In August 1980, I went to Blacksburg in Virginia from Cambridge to work with James M. Buchanan’s Center for Study of Public Choice and to be Visiting Assistant Professor and later Assistant Professor at the Economics Department. When The Times editorial appeared in London on May 29 1984, I did not come to know of it for several days until foreign newspapers reached the Virginia Tech library and a friend phoned me with having seen it there. The Times (then under the editorship of Charles Douglas-Home) had been laudatory but also inaccurate as to what I did or did not have to say. My letter dated June 16 1984 corrected what was said about my work. The editorial is republished elsewhere here.

Pricing, Planning & Politics: A Study of Economic Distortions in India (1984)

Pricing, Planning & Politics: A Study of Economic Distortions in India Subroto Roy

First published on May 29 1984 as Occasional Paper No. 69 of the Institute of Economic Affairs, London

Preface March 2007

A quarter century has passed since my 1982 doctoral thesis at Cambridge University under Frank Hahn, examined by Christopher Bliss and Terence Hutchison, and titled “On liberty and economic growth: preface to a philosophy for India.” I wrote what follows shortly afterwards in Blacksburg, Virginia, and Ithaca, New York, and it was published on May 29 1984 in London by the Institute of Economic Affairs as Occasional Paper No. 69, ISBN: 0-255 36169-6. The day it was published it turned out to be the subject of the main editorial of The Times, then London’s leading newspaper. (I learnt later this had been due to Peter Bauer, and also that 700 copies sold in the first month, a record for the publisher.) The Times editorial though laudatory was misleading, and I had to clarify the contents of the monograph in a letter published on June 16 1984; both documents are available elsewhere at this site.

This work was the first explicit critique of post-Mahalanobis Indian economic thought from a classical liberal perspective since B. R. Shenoy’s initial criticism decades previously. I was 29 when it was published, I am 52 now. I do not agree with everything I wrote back then and find the tone a little puffed up as young men tend to be; it was five years before publication of my main “theoretical” work Philosophy of Economics: On the Scope of Reason in Economic Inquiry (Routledge: London & New York, 1989, also now republished here). My experience of life in the years since has also made me far less sanguine both about human nature and about America than I was then. But I am glad to find I am not embarrassed by what I said as a young man, indeed I am pleased I said what I did in favour of classical liberalism and against statism and totalitarianism well before it became popular to do so after the Berlin Wall fell. (In India as elsewhere, former communist apparatchiks and fellow-travellers became pseudo-liberals overnight.)

The famous November 1955 Milton Friedman memorandum is referred to herein for the first time as “unpublished” in note 1; I was to meet Milton and Rose Friedman at the Mont Pelerin Society meetings held at Cambridge later that year, where I gave them a copy of this monograph; when Milton returned to Stanford he sent to me in Blacksburg his original 1955-56 documents on Indian planning. I published the 1955 document for the first time in May 1989 during the University of Hawaii perestroika-for-India project that I was then leading, it appeared later in the 1992 volume Foundations of India’s Political Economy: Towards an Agenda for the 1990s, edited by myself and WE James. The results of the Hawaii project reached Rajiv Gandhi through my hand in September 1990, as told elsewhere in “Rajiv Gandhi and the Origins of India’s 1991 Economic Reform”. The 1956 document was published in November 2006 on the front page of The Statesman, on the same day my obituary of Milton appeared in the inside pages (both are republished here too).

It is apparent from this monograph that I knew almost nothing then about Pakistan or Islam; that has changed as may be seen especially from the other book I created with WE James at the University of Hawaii, Foundations of Pakistan’s Political Economy: Towards an Agenda for the 1990s, as well as my more recent work on Pakistan and Islam. It is of course impossible to understand India without understanding Pakistan and vice versa.

In general, this monograph had to do with India’s microeconomics and theory of value and resource allocation while my latest work – “India’s Macroeconomics”, “Fiscal Instability”, “India’s Trade and Payments”, “Our Policy Process”, “Fallacious Finance”, “The Dream Team: A Critique” . “Against Quackery”, “Growth & Government Delusion” etc – has to do with India’s macroeconomics and monetary and fiscal theory and policy. Part of the criticism of “distorted incentives” prevailing in Indira Gandhi’s India may still be relevant to India today, while the discussion of ethnic problems, agriculture, the “public choice” factors that stymie Indian progress, misgovernance etc will almost certainly be found so.

Pricing, Planning and Politics:

A Study of Economic Distortions in India

First published on May 29 1984 as Occasional Paper No. 69 of the Institute of Economic Affairs, London

“The economic laws which operate in India are the same as in other countries of the world; the causes which lead to wealth among other nations lead to prosperity in India; the causes which impoverish other nations impoverish the people of India. Therefore, the line of enquiry which the economist will pursue in respect of India is the same which he adopts in inquiring into the wealth or poverty of other nations.” Romesh Chunder Dutt, 1906, The Economic History of India

“Satyameva Jayathe” (“Let truth be victorious”), Motto of the Indian Republic

I. INTRODUCTION

IN THE last 15 years, considerable evidence has accumulated to suggest that the most important policies pursued by successive governments of independent India have not been conducive to economic development, and have indeed gone against some of the most basic lessons that political economy has to offer. Forewarnings of the present predicament of India had come from a few economists in the late 1950s and early 1960s, but their arguments were either ignored or maligned as dogmatic and motivated by`ideology’.[1] My thesis in this Occasional Paper will be that, if the basic and commonsensical lessons of political economy had been acknowledged early on in the history of the Indian Republic, we might have found today a much more prosperous economy and a much healthier body politic than is the case.

To argue this, it is first necessary to describe an economy where the pursuit of the individual good by rational agents is conducted within some set of orderly political institutions which is conducive to both civil peace and sustained mass prosperity. Accordingly, Part I of this short Paper begins by describing the broad and familiar features of what may be called a neo-classical or liberal model, and then proceeds briefly to contrast it with a model in which individual incentives and public institutions have been distorted from their efficient characterizations.

The practical question that arises is: Where in practice have independent India’s policies led most conspicuously to distorted incentives and institutions? This will be the subject of Part III. Part II places the discussion in context by briefly describing a few relevant aspects of the political history of the Indian Republic.

I have argued elsewhere that every normative proposal for action is, in principle, open to question and criticism on the logical and factual grounds upon which it is founded. Whenever two people disagree about what ought to be done, it will be found either that at least one of them has made a mistake of logic or that they are also in disagreement about the facts of the case.[2] In Part IV, a tentative manifesto for political and economic reform in India is proposed, and I hope these proposals too will be subjected to critical scrutiny on the positive grounds upon which I shall seek to establish them.

Part I: Theory

2. EFFICIENT INCENTIVES AND INSTITUTIONS

A `FACT’ may be understood as the opposite of that which could have been the case but is not. A basic fact of the study of men and society – one which was acknowledged first by Aristotle and then, very importantly, by Adam Smith, and which has been emphasized in modern times by Friedrich Hayek – is that, while we are able to study and speak of the nature of human decision and action in general terms, we do not and cannot have a knowledge of how particular actions are moved by particular causes and circumstances.[3]

We might certainly know, for instance, that every household in an economy views some horizons, wants to fulfill some aspirations, and faces some constraints. But if we were asked to specify what all these characteristics happened to be as a matter of fact at any one moment, we would certainly not be able to do so. Men are concerned almost wholly with (and are experts at) living their own lives as best they can – foraging for food, shelter and work, celebrating weddings and births, rearing children, and mourning deaths. For the most part, they are neither interested in, nor competent at judging, what others happen to be doing in their private lives. Neither benevolence nor envy extends much beyond a man’s immediate vicinity, and, certainly, neither can extend to people he does not know or come to know of in the course of a lifetime.

This fact is also acknowledged in modern microeconomics, when it is said that, for the individual agent to be able to make decisions and act upon them, it is sufficient for him to know (besides his own desires, abilities and constraints) only of the relative prices prevailing locally of the goods and skills he wishes to trade.`Efficient incentive’ defined We might then provisionally define an `efficient incentive’ as a set of relative prices and wages such that, when economic agents act upon them, three conditions are fulfilled:(i) the difference between the total demand for and the total supply of every good and skill is zero; (ii) every consumer succeeds in trading the amounts of different goods that he desires, and so obtains the highest utility he can within the constraint of his budget; (iii) every private enterprise maximizes the difference between its total revenues and total costs, that is, its profits. [4]

Rational action, however, occurs within a particular institutional context. Which action is rational and which is not will depend on what institutions there are and how well or poorly they function. As both classical liberals and Marxists argue, the neo-Walrasian tradition in modern economics – as exemplified by the Arrow-Debreu model – is practically devoid of any explicit institutional description, and so may best be regarded as a useful but grossly incomplete metaphor in the economist’s inquiry.

The institutions most relevant to economic activity are those of government. We might therefore add a fourth condition to characterize an efficient economy, namely, that government institutions work in such a way as to allocate tax revenues towards providing public goods in the amounts desired by citizens. This must be an institutional assumption implicit in the general equilibrium construction, without which it would be impossible to see the sense of that model.

The question that follows is how we are to ascertain the composition of the set of public goods to be provided. As is commonly known, this seems to confront the economist with numerous conceptual and practical problems. I propose here to circumvent all the typical difficulties of how to discover and combine individual preferences for public goods, or how to prevent free-riders, and to take a somewhat different route.

Functions of civil government: protection, public goods, education

To answer the question `What should be public goods first and foremost? I suggest we look for the kind of answer Adam Smith or Jeremy Bentham or J. S. Mill might have given to a related but different question : `What should be the functions of government in a large civil society, regardless of whether or not it is constituted democratically?’ This was the relevant question before the modern era of mass democracy. And it is still interesting because, first, it probably remains the appropriate question for the many countries today which either do not have democratic governments or do not have long histories of democracy, and, secondly, because the kinds of answer given by classical authors were very similar to those we might expect from individual citizens in modern democracies as well.

The most important practical functions of civil government include defence against external aggression, the dispensing of civil and criminal justice, the protection of life, property and trade – broadly, the Rule of Law – and the pursuit of a judicious foreign policy. All are different aspects of the same broad objective of ensuring the survival of the community and the security of individual life.

Yet no pretext has been more common than that an imminent danger to the security of the community requires the government to take despotic measures. The guarantee by a civil government of the freedom of inquiry, discourse, criticism, and historical research should take precedence, therefore, even over ensuring security and survival, for it is probably the only final check there can be on whether what a government says is or is not in fact the case. Where this freedom is forcibly denied, or where it exists but people are too apathetic, ignorant or busy with their daily lives to exercise it, public life soon becomes self deceptive and absurd, with propaganda taking the place of discourse, and pretensions and appearances diverging more and more from attainments and reality. Wherever the questions `What is true?’ or `What is the case?’ are not asked frequently enough, there will be fewer and fewer correct answers as to what the case happens to be.[5]
After collective and individual security, the functions of government include the building of dams, embankments, bridges and canals, the provision of roads and fresh water, and so on – activities which, as Adam Smith put it, “. . . though they may be in the highest degree advantageous to a great society, are, however, of such a nature that the profit could never repay the expence to any individual or small number of individuals, and which it, therefore, cannot be expected that any individual or small number of individuals should erect or maintain.” [6]

Each may be more or less a “pure” public good in the modern sense :“that each individual’s consumption of such a good leads to no subtraction from any other individual’s consumption of that good”.[7]

Such a list could be extended to include activities as diverse as: the prevention of soil erosion; the public finance of school education, and’ of measures of basic public health such as vaccinations against contagious diseases; the issuing of currency; sewage disposal; population censuses; the standardization of weights and measures; and so on. It is unnecessary to be more specific here since some people will find even this list controversial. Dogmatists will deny the need for free inquiry; pacifists will dispute that defence is a public good; communists will protest against the public protection of private property; `anarcho-capitalists’ will contest the public dispensation of justice; and so on. To these critics, I would offer merely the following short and incomplete reply.

First, a sound argument can be made that what functions civil government should have can be ascertained, without prejudice, by reasonable citizens, though which particular functions these are may well vary according to circumstances. Secondly, if we could spend time in thoughtful and leisured conversation with every citizen of a large community, it might be predicted – as a matter of cold, empirical fact – that practically everyone would agree with the suggestion that the first destinations of tax revenues should indeed be activities like defence, civil protection and the Rule of Law, the provision of roads, and so on. If such a prediction is correct, my thesis is plainly much more democratic than it might appear to modern economists, though I shall later claim that an objective defence of democratic institutions can be made on quite different grounds as well.

If there is a clear family resemblance between classical liberal authors – from Smith and Mill through to Hayek, Robbins, Friedman, Buchanan, Bauer and many others – it has to do, not so much with the denunciation of government activity in the market-place, as with the recognition of the existence of certain duties of government outside it, the fulfillment of which are indispensable to civil life, let alone the pursuit of economic prosperity. Their protest is at the high opportunity cost of the alternatives foregone.

This raises the question of how we might tell whether government is working well or badly in a particular country at a particular time, or, generally, how we might tell whether different public goods are provided in too small or large amounts. For present purposes it will again be sufficient to suggest a very rough and common sense way of proceeding: let us look first, and think second.

For example, the Iran-Iraq war has clearly been a perfect public bad as far as the ordinary citizenry in either country are concerned. Similarly, if there happen to be millions of cases queuing outside the courts waiting to be heard, or if crime is rampant and police protection ineffective, that may constitute prima facie evidence that too few public resources have been devoted to civil order and justice. Or, if heavy rainfall annually causes landslides in the hills and floods in the plains, devastating crops and leaving innumerable citizens destitute, that also might prompt us to ask whether sufficient public resources have gone towards precautions against such havoc. And so on.[8]

Which goods happen to be public goods depends on the circumstances and the level of government being discussed. For similar circumstances and levels, similar goods will most likely be public goods in different countries. The state ordinarily consists not only of the national government but also of several provincial governments and a myriad of local governments. In particular, a premise of the liberal state would be that public goods should in fact be provided by various levels of government, financed through taxes paid respectively at those levels. The citizen is a taxpayer at a variety of levels, and accordingly public goods are due to be provided at a variety of levels. Just as the national government may not usurp the power to tax for, or spend money on, a public good which is best provided by a provincial government to the citizens of a province, so a provincial government may not tax for, or spend on, a public good best provided by a local government to the citizens of a locality.

The broad principle involved has two aspects: first, a recognition that knowledge of particular circumstances – and hence the ability to act – is infinitesimally dispersed within a population; and, secondly, as direct and visible a matching as possible of the benefits a citizen receives from a particular public good with the taxes he pays towards it, thereby perhaps reducing his incentive to be a free rider on the contributions of others.8Uncertainty and ignoranceProvisionally, therefore, efficient incentives may be thought to consist of a set of market-clearing relative prices and wages, occurring within an institutional context in which the basic and indispensable functions of government have been adequately performed at a variety of appropriate levels.

Such a definition would still be seriously incomplete in one major respect. For we must now recognise: (i) that history is unique and irretrievable, that the present consists only of the fleeting moment, and that the future, by its very nature, cannot be fully known; (ii) that such a thing as human freedom exists; and (iii) that, as a consequence, uncertainty and ignorance are ubiquitous.

Some of the uncertainty derives from the unfolding of natural events (like the rains) over which man has little or no control. The rest derives from the fact that the individual is a free agent who is affected by the actions of others but who cannot predict those actions completely because they too are free agents like himself. Game theory would have had no appeal for the economist if the existence of human freedom had not been a fact. It is this which makes it impossible to read everything in another person’s mind and thus makes it impossible to predict everything he might do. The lasting contribution of Keynesian economics could be its emphasis that such uncertainty and ignorance are important to the economist’s inquiry.

Mathematical economists have been saying for several years that what is required if we are to be realistic are models which reflect the sequential character of actual decision-making and account for the past being immutable and the future uncertain.[9] However, they have proceeded to write even more complex mathematics than we already have – disregarding Aristotle’s advice not to seek more precision from the subject of an inquiry than it may be capable of yielding.[10] My question is the more mundane one of what becomes of the classical liberals’ concept of efficient incentives and institutions in a dynamic world. I shall answer it too in a pedestrian way.

The single overwhelming reason why uncertainty and ignorance are relevant to the economist’s descriptions is that they make real the possibility of mistakes by economic agents. To extend the previous discussion to a dynamic context, what we can do is to ask which institutions are most likely to reduce or mitigate the social consequences of mistaken decisions, whether made by private agents or by those in public office. And it is here that the classical liberals advocate two important institutional features: competition and the decentralisation of decision-making.

The major value of democratic institutions over authoritarian ones is that they encourage these two principles to be put into effect. Because, in a large economy, particular knowledge is infinitesimally dispersed, it may be better for adjustments to a multitude of variables to be made continuously in response to changing circumstances by a vast number of small economic agents, rather than for adjustments to a few variables to be made at political intervals by a small group of very powerful agents. The concentration of power to make major decisions among a few fallible men is a much more ominous prospect than the distribution of power in small amounts among a large number of fallible men. It is much more dangerous for a monopoly of ideas to be claimed about where the political good of a country lies than for there to be free and open competition among such ideas at the bar of reason.

D. H. Robertson put it well when he warned “that all the eggs should not be in the same basket – that in this highly uncertain world the fortunes of a whole trade, or a whole area, should not depend on the foresight and judgement of a single centre of decision”.[11] The presumption in favour of democratic institutions is that they reduce the potential damage from wrong political decisions damage which can be rationally expected in an uncertain world.[12] Elections, in the liberal understanding, are then not so much the means to promote the interests of one’s confederates as to remove from office without bloodshed rulers who fail to do what they are entrusted with, and to replace them by those from whom better is expected. Economic efficiency in an uncertain worldThe economic notion of efficient incentives is also modified by uncertainty and ignorance. In the theory, a set of prices is market clearing only relative to unchanging preferences, resources and technologies. In a dynamic world, however, demand and supply functions are themselves changing and the notion of efficient incentives must accordingly be adapted to one in which relative prices move in the direction of the excess demand: that is, if the parameters change so that the total demand for a good or skill comes to exceed the total supply, we should want to see its relative price rising (and, conversely, if total supply exceeds total demand, we should want to see its relative price falling). During such a process of adjustment, many people may suffer very considerable hardship – something which reasonable Keynesians do well to emphasise.

If changing preferences, resources or technologies cause the demand for a product to diminish, we should want to see the firms which manufacture it either entering different markets, or improving its quality by technological innovation, or lowering prices. Similarly, we should want to see workers in these firms whether blue- or white-collar – who have skills specific to a product whose price is falling either increasing their productivity or retraining themselves in different skills more specific to the manufacture of goods whose prices are rising. Numerous enterprises can go bankrupt, and numerous workers can find themselves unable to sell the skills they possess, if they fail to adapt quickly enough to changing market conditions. The more specialised the product and the more specific the skill, the more hardship there may be. There could well be orthodox Keynesian consequences whereby laid-off workers reduce their consumption expenditures and firms on the verge of bankruptcy reduce their investment expenditures, leading to lower incomes for others, and thus to lower expenditures by them too, and so on. An anti-Keynesian who denied the existence of such hardship would be closed to the facts. He might also not be doing his own theory justice: for it is not unreasonable to argue that, while adjustments are inevitable in an uncertain world, the classical response of prices moving in the direction of excess demand probably minimises the hardship in the transition from one equilibrium to the next.

In a dynamic world, therefore, in which supply and demand functions are shifting continually and unpredictably (though probably incrementally, and not drastically), efficient incentives are better thought of as relative prices which are not stagnant but which are moving – and moving quickly – in the direction of excess demand. It should, in general, be continually profitable at the margin for firms and workers to be innovating technologically and improving productivity. As everyone knows from experience, the principle goad to such activity is fair and free competition. If a job or contract is sought badly enough, and if better quality or lower price are known to be the only criteria of selection, the expected outcome is a differentiation and improvement by competitors of the individual quality or price of what is sold.

In broad summary, the liberal understanding of how material well-being can be improved rests on the assumption that the basic functions of civil government are performed satisfactorily. Government provides the backdrop of civil order and protection necessary for private citizens freely and fairly to conduct their own lives and their transactions with one another. It is a theory which acknowledges a fundamental fact in the study of society, namely, that the individual household : (a) most commonly defines its own horizons; (b) knows the particular opportunities available to it to produce, trade and consume; (c) recognises the particular constraints which prevent it from doing all that it may desire; and(d) perceives how these opportunities and constraints may be changing. Where, as in the liberal picture, there are large numbers of producers and consumers, sellers and buyers – each family acting more or less independently – the efforts of one family do not directly make for other than its own success, while at the same time the repercussions of its mistakes are felt by itself and do not reverberate throughout the whole community. Such has been, as I see it, the American secret to mass prosperity.

3. DISTORTED INCENTIVES AND INSTITUTIONS

DISTORTED INCENTIVES are the logical opposites of efficient ones. Relative prices and wages send distorted signals to individual economic agents when they do not move in the direction of excess demand, so that there is no general tendency for markets to clear. A long-run or endemic excess demand for a good reveals itself in rationing, queueing and black markets. The price at which trade nominally takes place is too low and shows no tendency to move upwards.

Conversely, in a product market, a long-run or endemic excess supply reveals itself in surpluses and spoilages. In a labour market, it reveals itself, on the one hand, in armies of tenured employees who have no incentive to improve productivity, and, on the other hand, in lines of involuntarily or disguised unemployed who cannot sell all the skill they possess and have to settle for selling their less-specialised ones. The price at which trade nominally takes place is too high and shows no tendency to move downwards. In practical terms, firms do not find it profitable to be continually entering new markets or improving quality or enhancing technology or reducing price in order to attract and retain customers. Farmers in particular may face output and input prices which make technological improvements unprofitable.

In politics, distorted incentives are ones which make it profitable for politicians and government officials to be corruptible and taxpayers to be evasive. Because corruption is not penalised and honesty not rewarded, the pursuit of private interest may make it rational to be corrupt and irrational to be honest.

Individualism and statism

A neo-classical economic model like the one outlined above presupposes among citizens a political attitude of individualism. This may be defined as a condition in which citizens have the idea (a) that it is the individual household itself which is principally responsible for improvements in its own well-being, and (b) that government merely “is, or ought to be, instituted for the common benefit, protection and security of the people …”, and that government officials are merely the citizens’ “trustees and servants, and at all times amenable to them.” [13]

Its logical opposite may be called an attitude of statism – defined as prevailing when various classes of citizens have the idea that it is government which is and should be principally responsible for improvements in individual and public well-being. A good sense in which `power’ can be defined in political and economic contexts is as “the capacity to restrict the choices open to other men”.[14] An attitude of statism entails a willingness, or at least an acquiescence, on the part of citizens to relinquish to those in government, with little or no questioning, the power to make decisions which may affect their lives intimately. At the same time, responsibility for relapses or lack of progress in individual well-being is also thought to be the consequence of governmental and not private decision-making. Whereas individualism is a self-assertive attitude, statism is a self abnegating one. For those in government to have a statist mentality is the same as saying they are paternalistic, that is, making the presumption that the citizen is often incapable of judging for himself what is for his own good.

The suggestion that government should have the principal responsibility for improvements in individual and collective economic well-being – in the sense that the collectivity can and should satisfy the material aspirations of every individual – appears straightaway to be self contradictory. An individual can have enough difficulty trying to articulate his own horizons, aspirations and constraints, let alone trying to do the same for others. For a politician (or economist) to claim (or imply) not only that he knows(or can know) the relevant characteristics of everyone at once, but also that he knows how to ameliorate the condition of humanity at a stroke, as if by magic, would have been considered ridiculous in more candid times than ours. If we understand `collective effort’ to mean the sum of individual labours engaged in a common pursuit or endeavour, then for the collectivity to try materially to satisfy every individual would amount to imposing a duty on everyone to try materially to satisfy everyone else – an absurd state of affairs, flying in the face of the fact that most people most of the time do not wish to, or cannot, cope with much else except their private lives.

Exhorting government directly to improve the material wellbeing of `the people’ cannot mean what it seems to because it cannot refer to literally all the people but only to some of them perhaps only a majority, or only the well-organised. That the state is endogenous to the polity implies that no government has resources of its own out of which to disburse the amounts a politician may promise or an economist recommend. To fulfil new promises, given an initial condition of budgetary equilibrium, a government is only able either to print more fiat money or to tax the resources of individual citizens more heavily. Leaving aside the first alternative, fulfillment of the exhortation amounts to using public institutions to transfer resources from some people in order to keep promises made to others.

When the attitude spreads that, in politics, one man’s gain is another man’s loss, and where political control is to be had by winning majorities in elections, the citizen comes to face a perverse incentive to try to coalesce with more and more others in the hope of capturing the public revenues in his favour – instead of thinking critically about the nature of the political good as the institutions of democracy require him to. Political power becomes less dispersed, and the size of the polity diminishes in the sense that it comes to have fewer and fewer constituent agents, each of which is a larger and larger coalition of like-minded confederates intent on acquiring control for its own benefit.

Perhaps the worst consequence of a general attitude of statism, however, is that the basic, commonsensical functions of government are obscured, ignored, and neglected. Instead of requiring politicians and government officials to fulfill these functions, a citizenry allows its public agents to become brokers and entrepreneurs – trading not only in the products of government controlled industries but also in an array of positions of power and privilege, all in the name of directing a common endeavour to help the poor. The state places itself at every profitable opportunity between private citizens who might otherwise have conducted their transactions themselves perfectly well. The result is that governments do, or try to do, what either does not need to be done or ought not to be done by government, while they neglect that which only governments can do and which therefore they ought to be doing.

Part II: History

4. INDIVIDUALISM AND STATISM IN INDIA

AN ATTITUDE of statism has probably been present in India since Mughal times at least. If anything, it spread during the British period since the raison d’être of British rule in India would have vanished without paternalism (as in the course of time it did) and the existence of British rule was the raison d’être of the nationalist movement. Paternalism towards India was espoused even by those Englishmen known for their liberal views at home. Thomas Macaulay, for instance, declared to the House of Commons in 1833: “It may be that the public mind of India may expand under our system till it has outgrown that system; that by good government we may educate our subjects into a capacity for better government; that having become instructed in European knowledge, they may, in some future stage, demand European institutions. Whether such a day will ever come I know not. But never will I attempt to avert or retard it. Whenever it comes, it will be the proudest day in English history.”[15]

Less than a hundred years later, in 1930-31, the Indian National Congress – to the considerable chagrin of the British Government – resolved to bring about an independent India in which every citizen would have the right to free speech, to profess and practise his faith freely, and to move and practise his profession anywhere in the country. There would be universal adult suffrage and no-one would be unjustly deprived of his liberty or have his property entered, sequestered or confiscated. In particular, all citizens in the future republic would be `equal before the law, irrespective of religion, caste, creed or sex’, and no disability would attach`to any citizen by reason of his or her religion, caste, creed or sex, in regard to public employment, office of power or honour, and in the exercise of any trade or calling’.[16]

These resolutions were made in the thick of the battle for independence, and underscored the fundamental argument of the nationalists that, in spite of the infinitely diverse characteristics of the inhabitants of the sub-continent, a free and secular India was possible in which all would be ruled by a common law. That argument had been in contradistinction to the frequent taunt from British Conservatives that an
India without Britain would disintegrate in internecine bloodshed, and also to the later `two nations’ theory of the Muslim League which led eventually to the creation of
Pakistan. With the departure of the British and the Pakistanis, in 1950 the Constitution of the first Indian Republic was finally able to bring into force the idea of secularity which had inspired the nationalist cause. Thus, among the Fundamental Rights established by the Constitution, Article 14 provided that the state `shall not deny to any person equality before the law or the equal protection of the laws within the territory of
India’. Articles 15.1, 15.2, 16.1, 16.2 and 29.2 went on to prohibit discrimination on the arbitrary grounds of religion, race, caste, sex or place of birth in matters of public employment or access to publicly-funded education.

The century between Macaulay and the resolutions for independence was by far the most important to the country’s intellectual history since earliest antiquity. While it took its turbulent course, long severed since the time of the early Greeks – came to be re-established. The common interest and the common contribution became one of admiring and learning from Europe and from India’s own past what there was to be admired and learnt, whilst forsaking and resisting what was self contradictory or base. The maxim for a century might have been : learn the good and let the evil be buried in history. As Tagore wrote :`The lamp of Europe is still burning; we must rekindle our old and extinguished lamp at that flame and start again on the road of time. We must fulfill the purpose of our connection with the English. This is the task we face in the building up of a great India.’[17]

The ideal aspired to was swaraj, or `self rule’. It literally meant not only a government of India by Indians accountable to Indians, but also the governance of the individual by himself. Not only was the country to be sovereign vis-à-vis other states; its individual citizens were to be free vis-à-vis each other and equal before its laws. Swaraj meant, in other words, a condition of political autonomy where the citizen constrained his own free actions so as not to harm others, and where the Rule of Law would protect him when he acted autonomously and resist him when he did not. Given a backdrop of civil order, the infinite number of ways to individual happiness and prosperity in an infinitely diverse sub-continent could then be pursued. Statism all pervading

An attitude of statism, however, has pervaded all public discourse in independent India, and has been reinforced by the social and economic policies pursued by successive governments.

In the first place, a ghost from earlier controversies with the British was to remain in the 1950 Constitution. Immediately after the provisions establishing equality before the law and equality of opportunity in public employment and publicly funded education, the following caveats appeared. Article 15.3 said that the state could make “any special provision for women and children”; and then, of more significance, Article 15.4 allowed the state to make “any special provisions for the advancement of any socially and educationally backward classes of citizens or for the Scheduled Castes and the Scheduled Tribes”.

Article 16.4 allowed it to make “any provision for the reservation of appointments or posts in favour of any backward class of citizens which, in the opinion of the State, is not adequately represented in the services under the State.” Lastly, Article 335 said that “the claims of the members of the Scheduled Castes and the Scheduled Tribes shall be taken into consideration, consistently with the maintenance of efficiency of administration, in the making of appointments to services and posts [under the State] . . .” Who was to decide who was `backward’ and who was not, or which group was to be `scheduled’ and which not? Article 341.1 said that `The President may . . . by public notification specify the castes, races or tribes which shall for the purposes of this Constitution be deemed to be Scheduled Castes’, and Article 341.2 added that `Parliament may by law include in or exclude from the list of Scheduled Castes specified under 341.1 any caste, race or tribe or part of or any group within any caste, race or tribe . . .’ Articles 342.1 and 342.2 said the same for the Scheduled Tribes.

Subsequently, two Presidential Orders named no fewer than 1,181 different groups in the country as `Scheduled Castes’ and more than 583 other groups as `Scheduled Tribes’. Roughly a sixth of the population thus came to be termed `backward’ by executive decree and were segregated by statute from the rest of the citizenry.

The direct precursor of these provisions was the `Communal Award’ by the British Government in 1932, who had taken it to be their duty “to safeguard what we believe to be the right of Depressed Classes to a fair proportion in Legislatures ”.[18] (`Depressed Classes’ was the official name for those misleadingly called `untouchables’ outside the Hindu fold.)

The complex customs of the Hindus call for endogamy and commensality among members of the same caste, thus making anyone outside a caste somewhat `untouchable’ for its members. In marriage and dining habits, many orthodox Hindus would hold foreigners, Muslims, and even Hindus of other castes at the same distance as those formally classified as `Depressed Classes’. Indeed, non-Hindus in India -including the British often maintained social protocols that were equally as strict.

No serious Indian historian would doubt that members of the `Depressed Classes’ had been oppressed and had suffered countless indignities throughout Indian history at the hands of so-called`caste Hindus’. At various times, persecution had led to mass conversions to the more secular faiths. But the ancient wrongs of the Hindu practices had to do not so much with the lack of physical contact in personal life which the word `untouchability’ connotes for Indian society has always consisted of a myriad of voluntarily segregated groups – but rather with open and obvious inequities such as the denial of equal access to temples, public wells, baths and schools.

Gandhi, who by his personal example probably did more for the cause of the `Depressed Classes’ than anyone else, protested against the Communal Award with one of his most famous fasts. Privately, he suspected that `…the communal question [was] being brought deliberately to the forefront and magnified by the government because they did not intend to part with power’.[19] Publicly, he argued that the pernicious consequence would be a further exacerbation of the apartheid under which the `Depressed Classes’ had suffered for so long, when the important thing was for their right to be within the Hindu fold to be acknowledged by `caste’ Hindus.[20]

The Fundamental Rights in the 1950 Constitution establishing the equality of all citizens before the law evidently had the 1930-31 resolutions as their precursors; while Article17 – which specifically declared `untouchability’ to be `abolished’ and its practice `forbidden’ – was part of Gandhi’s legacy, placing those who had for centuries been denigrated and persecuted on exactly the same footing in the eyes of the laws of the Republic as their denigrators and persecutors. The subsequent clauses authorizing the state to discriminate in favour of `Scheduled Castes’, and allowing it to define by executive decree who was to be so called, were evidently the remnants of the Communal Award of 1932. Discrimination by the state was initially to last for a period of 10 years only. It has, however, been extended three times -for another 10 years on each occasion – and so continues to the present day. We shall examine a few of the consequences in Part III.‘A socialistic pattern of society’As for economic policy, while the original 1950 Constitution had ambiguously stated certain ends – such as that government was `to strive to promote the welfare of the people’ – it made no mention at all of any specific economic institutions, statist or liberal, which the new Republic was to nurture as means towards those ends. In spite of this omission, successive governments have explicitly avowed their espousal of` socialism’ as the means to the good and prosperous society.

For instance, a “socialistic pattern of society where the principal means of production are under social ownership or control” was declared to be a national objective at the ruling Congress Party’s convention in 1955; and, in 1976, the notorious 42nd Amendment purported to change the very description of the country in the preamble to the original Constitution from the sober `Sovereign, Democratic Republic’ to the awkward `Sovereign, Secular, Socialist Democratic Republic’. It is an open and important issue of constitutional practice whether a temporary majoritarian government can change the legal description of a republic so fundamentally that it necessarily begs every question now and in the future about the efficacy of socialism as the route to mass prosperity.[21]

Even so, `socialism’ is a vague and equivocal word, meaning different things to different people. Briefly, what happened in the Indian context seems to have been that the Nationalist Government explicitly took upon itself the responsibility of becoming the prime mover of the economic growth of the country. This was in addition to its other fundamental and urgent political responsibilities at the time, namely, to establish peace and civil order in the aftermath of a bloody partition, re-settle several million destitute refugees, integrate into the Republic the numerous principalities and fiefdoms run by the princes and potentates, re-draw provincial boundaries on a sensible linguistic criterion, and generally educate people about their rights and responsibilities as individual citizens in a new and democratic republic.

In a poor country which had just ended a long period of alien rule, it was understandable, if in advisable, that a nationalist government led by cultured, educated men among unlettered masses should take upon itself the responsibility for economic growth. Part of the nationalists’ critique of British rule had been precisely that it had worked to the considerable detriment of the Indian economy. And, certainly, whatever the exact calculation of the benefits and costs of the British presence in India, while there had been obvious benefits, there had also been obvious costs such as iniquitous taxes and overt racial discrimination in employment. [22]Thus, when the nationalists practically swore themselves to provide better government for the economy, it was certainly a very praiseworthy aim; 1947 would indeed be the year of India’s `tryst with destiny’.

Better government not necessarily more government
What the Nehru Government came to believe, however, was that better government for the economy necessarily meant more government activity in the economy. A similar nationalist government led by cultured, educated men among an unlettered public had chosen differently in 1776 at Philadelphia, but the times and circumstances were very different. The Indian nationalists, and most especially Prime Minister Nehru, had just witnessed what they took to be, on the one hand, the collapse of the market economy in the Great Depression and, on the other, the rapid growth to greatness of Bolshevik Russia. In his presidential address to the Congress in 1936, for instance, Nehru spoke of the immediate past in these terms: `Everywhere conflicts grew, and a great depression overwhelmed the world and there was a progressive deterioration, everywhere except in the wide flung Soviet territories of the USSR, where, in marked contrast with the rest of the world, astonishing progress was made in every direction . . .’ Thus, it seemed to him, there was`. . . no way of ending the poverty, the vast unemployment, the degradation, and the subjection of the Indian people except through Socialism”. Socialism meant, inter alia, ` the ending of private property, except in a restricted sense, and ttte repla emenr of the ,private profit system by a higher ideal of co-operative service. It means ultimately a change in our instincts and habits and desires. In short, it means a new civilisation, radically different from the present capitalist order. Some glimpse we can have of this new civilisation in the territories of the USSR. Much has happened there which has pained me greatly and with which I disagree, but I look upon that great and fascinating unfolding of anew order and a new civilisation as the most promising feature of our dismal age. If the future is full of hope it is largely because of Soviet Russia and what it has done, and I am convinced that, if some world catastrophe does not intervene, this new civilisation will spread to other lands and put an end to the wars and conflicts on which capitalism feeds’.[23]
Equally as certain and deep as his admiration for the liberal values of the West was Nehru’s evident misunderstanding of the causes and consequences of Stalin’s Russia. The political and economic history of India in the past 30 years cannot be understood without regard to her most powerful leader’s ambivalence about the nature of the political and economic good.
By the mid-1950s, many of India’s other prominent statesmen had died or retired from public life, and there was hardly a public figure of’ stature left (with the exception of Rajagopalachari) to challenge Nehru’s socialist vision of the country’s future. Moreover, men who were ostensibly `expert economists’, but whose writings revealed no knowledge of prices or markets or the concept of feasibility, were encouraged to endorse and embellish this vision, which they did without hesitation in the secure knowledge that they were shielded from critics by the intellectual patronage of a charismatic and elected leader.[24]
The choice between alternative models of mass economic prosperity must have seemed quite clear at the time. The cold fact did not, however, vanish that one of the oldest objective lessons of political economy has been that more government is not necessarily better government. It is to the consequences of ignoring this lesson that we now turn.

Part III: Practice
ECONOMIC POLICIES IN INDEPENDENT INDIA

INDIA TODAY is a bizarre maze of distorted incentives, which I (and no doubt others) have found very difficult to untangle and understand. I shall, however, list and discuss the most significant of them as methodically as I can.

(i) Industry
The Indian Government has declared a large `public sector’ in commerce and industry to be a national objective. Towards this end, it has therefore progressively acquired numerous enterprises, large and small, so that it now has either a full monopoly in an industry or is one of a few oligopolists. These industries range from banking, insurance, railways, airlines, cement, steel, chemicals, fertilisers and ship-building to making beer, soft drinks, telephones and wrist-watches. There are no explicit penalties for indefinite loss-making; indeed, bankrupt private enterprises have often been nationalised to serve politicians’ ends. And, certainly, there has been no general rule of marginal-cost pricing. In public utilities, like electricity generation and distribution or city buses and trams, prices appear to be well below marginal cost, leading to severe rationing and queueing. Sudden stoppages of electricity for hours at a time and monumental congestion on buses and trams have become endemic facts of life for millions of urban Indians.
At the same time, private industry in India has been made to face labyrinthine controls. The government has continually exhorted private firms to work in the `national interest’ – which means accepting the constraints of centralised planning. It has left no doubt that, while there is a `role’ for the min the growth of the economy, they exist at the sufferance of government and had better realise it, otherwise the dark forces of revolution which have so far been kept at bay will inevitably sweep them away altogether, as happened in Russia and China.
The constraints imposed on the operation of a private business are legion, and would make a businessman from the West or Far East reach for a psychiatrist or a pistol. An entrepreneur may not enter numerous industries without government approval of the `technical’ viability of his project; once it is approved, he cannot find credit except from a government bank; and he cannot buy raw materials and machinery of the highest quality at the lowest price since, if they are produced in India, he will be denied a licence to import better and/or cheaper foreign substitutes. The onus is on him to satisfy the government that no production occurs within India of the input he requires; only then will an import licence conceivably be granted, subject to periodic review by the government. He may be compelled to export a specified proportion of his output as a condition for the renewal of his import licence, which therefore places him at a disadvantage with foreign buyers who, of course, are aware of this restraint. He may be unable to compete internationally because the rupee is priced above its likely equilibrium and some of the inputs he uses are high-cost, low-quality domestic substitutes. As a result, he may be compelled practically to dump his output abroad at whatever price it will fetch.

The entrepreneur’s factory may be subject to random cuts in electricity for hours at a time. He may require government approval before he can increase his fixed capacity, modernise his plant, change a product-line, or even change the number of labour shifts. He may face minimum-wage and stringent unfair dismissal laws on the one hand, and price controls on the other. If he fails to meet credit obligations to the nationalised banks, he may be penalised by the appointment of one or more government directors to his board – a form of `creeping’ nationalisation. Further, he may be subjected to a constant threat of full nationalisation as and when the government decides that his industry should be in the public sector in the interests of national planning.[25]

The consequence of all these controls has been a monumental distortion of incentives away from encouraging private firms to try to attract customers by improving technology and quality or reducing prices towards encouraging them to concentrate on `rent-seeking’, in the term made familiar by Professors Gordon Tullock and James Buchanan.[26]

As Anne Krueger says in her excellent study of the automobile ancillary industry, the very notion of entrepreneurial efficiency changes in such circumstances: `Under conditions in India, the most important problem confronting entrepreneurs is that of assuring that production will continue. The combined effects of import licensing and investment licensing give virtually every firm a monopoly or quasi-monopoly position. The entrepreneur who is most successful in getting licences of greater value and/or in getting licences more quickly than his fellow producers will have higher profits. `The producer who does not compete successfully for licences cannot produce at all, no matter how skilled he is in achieving engineering efficiency, unless he enters the “open market” and pays a premium to the successful licence applicant for some materials . . . Successful entrepreneurs are therefore those who are best at obtaining the greatest number of licences most expeditiously . . .’ [27]

Moreover, firms which are low-cost and efficient (in the free market sense) and which are successful at rent-seeking as high-cost, inefficient firms may still not be able to compete the latter out of business because government will not usually allow a particular firm to expand – regardless of its efficiency – if there is excess capacity in the industry of which it is a part. High-cost firms can thereby rationally count on staying in business simply by maintaining significant excess capacity.

(ii) Foreign trade
The Government of India has always claimed that foreign exchange is a `scarce’ resource which must be rationed by fiat in the national interest. The total foreign-exchange revenue (at an exchange rate which was fixed until 1971 and has since been on a managed `peg’) has been allocated in the following order of priorities: first, to meet foreign debt repayments and government expenditures in the conduct of foreign policy, such as the maintenance of embassies (G1); secondly, to pay for imports of defence equipment, food, fertilisers and petroleum (G2); thirdly, to meet ear-marked payments for the imported inputs of public sector industries so that they may achieve projected production targets (G3); fourthly, to pay for the imported inputs of private sector firms which are
successful in obtaining import licences (P1); and, lastly, to satisfy the demands of the public at large for purposes such as travel abroad (P2).
Foreign exchange is `scarce’ in India, or elsewhere, in precisely the same sense that rice or petrol or cloth is scarce. Just as there exists some positive price for rice, petrol or cloth which, at any moment, will match total supplies with total demands, so there exists some positive price for rupees relative to dollars which, at any moment, will match the transaction and asset demands of Indians for dollars with the transaction and asset demands of foreigners for rupees. Underlying that market-clearing price would be (a) the demands of Indians for foreign goods whose f.o.b. prices were lower than those of domestic substitutes, and, similarly, the demands of foreigners for goods in which India has had a comparative advantage; and (b) the expectations of Indians and foreigners about the future purchasing power of the rupee relative to the dollar, using as a proxy, say, the difference between interest rates in India and abroad.

A free market in foreign exchange would first have encouraged India’s traditional exports, like jute manufactures and textiles, and then (if the positive theory of international trade is broadly correct)progressively encouraged the export of other non traditional goods which used India’s relatively inexpensive labour relatively intensively and thereby enabled Indian entrepreneurs to compete successfully in foreign markets. At the same time, capital flows into and out of India would have given the monetary authorities an incentive to keep domestic interest rates in line with the real opportunity cost of forgoing consumption in favour of savings.

Thus, the case against a free market in foreign exchange has always been, to say the least, far from obvious.[28] But even if, for the sake of argument, we accept the presumed superiority of rationing, the elementary theory of optimisation which underlies the so-called theory of `planning’ dictates that the government should allocate dollars between alternative uses such that the marginal dollar yields the same increase in social utility in any use. The Indian Government, however, appears to have allocated foreign exchange simply on the basis of giving a higher priority to its own foreign expenditures (categories Gl, G2 and G3) than to private foreign expenditures (categories Pl and P2). That is to say, regardless of how much social utility might have been derived from a particular increase in private-sector imports, it would not be considered until after the government had met all its own expenditures abroad.[29]
Jagdish Bhagwati and T. N. Srinivasan put it as follows : `The allocation of foreign exchange among alternative claimants and users in a direct control system . . .would presumably be with reference to a well-defined set of principles and criteria based on a system of priorities. In point of fact, however, there seem to have been few such criteria, if any, followed in practice.’[30]
With respect to imported inputs for private- and public-sector industries, a rule of `essentiality’ (that is, the input must be technically `essential’ to the production process) and a rule of `indigenous availability’(that is, there must be absolutely no domestically-produced physical substitutes, regardless of cost and quality)seem to have been followed. But, as Bhagwati and Srinivasan report, `. . . the sheer weight of numbers made any meaningful listing of priorities extremely difficult. The problem was Orwellian: all industries had priority and how was each sponsoring authority to argue that some industries had more priority than others? It is not surprising, therefore, that the agencies involved in determining allocations by industry fell back on vague notions of “fairness”, implying pro rata allocations with reference to capacity installed or employment, or shares defined by past import allocations or similar rules of thumb’. [31]

Clearly, in abjuring the free market and claiming a monopoly over foreign-exchange transactions, government planners have accepted certain premises as unquestionable: (a) that government sponsored industrialisation is the best means to mass prosperity; (b) that a policy of indefinite import-substitution is the best means to industrialisation; and (c) that such a policy requires all foreign expenditures by government to take precedence over all private foreign expenditures. The trade and foreign-exchange policies pursued cannot be understood except by reference to domestic economic policies and, in particular, to the view held about the proper functions of government in and out of the market-place.

In addition to a plethora of controls, tariffs and outright bans on imports, there have been erratic policies, subsidising the export of `new’, non-traditional manufactures like engineering goods, and taxing- and even banning – the export of goods in which India has traditionally enjoyed a comparative advantage.[32]

Moreover, the rupee has been continuously over-valued. From 1949 to 1959, the official exchange rate of Rs. 4.76 to the US dollar was, on average, 12..3 percent above the black-market rate, a figure which rose to 61 per cent between 1960 and 1965. From 1966 to 1970, the devalued official rate of Rs. 7.50 to the dollar was above the black-market rate by an average of 47.6 per cent, while from 1971 onwards the managed-peg rate has been above the black-market rate by an average of 24.3 per cent.[33]

Simple economics suggests that a free-market equilibrium rate would be somewhere between the black-market and official rates. An official exchange rate for the rupee fixed above that warranted by underlying relative demands for Indian and foreign goods, as well as by relative degrees of confidence in the rupee and the dollar, subsidises imports at the expense of exports. By discriminating in favour of its own foreign expenditures and against those of the private sector, the government has been the principal beneficiary of an over-valued rupee. If capital-intensive goods are the main imports and labour-intensive ones the main exports, an over-valued rupee further distorts incentives so as to favour the use of capital-intensive production processes over labour intensive ones – in a country with a demonstrable abundance of relatively inexpensive labour!
With an eye to India, Krueger has argued the general issue in these terms:`Subsidies can make any industry an export industry, even one that would not produce at all in an efficient allocation. Similarly, taxes can be levied on an industry that has comparative advantage which will penalize it enough to render domestic production entirely unprofitable. When taxes and subsidies are used, therefore, it is possible not only to distort the structure of production, but to distort it so much that the “wrong” commodities are exported.”[34]

The Indian Government’s planners have had the idea of forcibly effecting a reversal in the comparative advantage of the country, as if by magic overnight. The hope might have been that a forced pace of industrialisation would somehow allow economies of scale to be reaped and thus soon make Indian industrial goods competitive enough in international markets to be the country’s principal source of foreign exchange, displacing traditional manufactures like jute and textiles. In practice, however, as the evidence given by Bela Balassa
and other economists demonstrates, such a policy has not succeeded to date and is most unlikely ever to do so.
India’s import bill has risen continuously, most drastically after the 1973-74 quadrupling of petroleum prices; non-traditional manufactures have hardly been able to compete successfully in foreign markets; and the traditional exports of jute and textiles have suffered very severe setbacks. Balassa contrasts the consequences of the freer, outward-looking trade policies of South Korea, Singapore and Taiwan with those of the inward-looking, controlled regime of India as part of a study of 11 countries(including Argentina, Brazil, Colombia, Mexico, Chile, Israel and Yugoslavia) which, along with Hong Kong, account for most of the manufactured exports of developing countries. India’s share of the total manufactured exports of these countries has fallen steadily from 65.4 per cent in 1953 to 50.7 per cent in1960, to 31.2 per
cent in 1966 and to a mere 10.3 per cent in 1973. The proportion exported of India’s total manufactured output fell from 9.7 per cent in 1960 to 9.4 per cent in 1966 and to 8.6 per cent in1973. In contrast, during the same two periods, the proportion of manufactured output exported rose from1 to 14 to 41 per cent in South Korea, from 11 to 20 to 43 per cent in Singapore, and from 9 to 19 to 50 per cent in Taiwan.[35]
Balassa cogently argues that the adverse effects of a sudden change in external factors, such as the quadrupling of petroleum prices in 1973-74 or the 1974-75 Western recession, were absorbed much more easily by developing countries with large foreign-trade sectors than by those like India with relatively small ones: `Outward orientation is associated with high export and import shares that permit reduction in non-essential imports without serious adverse effects on the functioning of the economy. By contrast, continued inward orientation involves limiting imports to an unavoidable minimum, so that any further reduction will impose a considerable cost in terms of growth. Furthermore, the greater flexibility of the national economies of countries pursuing an outward-oriented strategy, under which firms learn to live with foreign competition, makes it possible to change the product composition of exports in response to changes in world market conditions, whereas inward orientation entails establishing a more rigid economic structure.’[36]
In other words, if imports are both high in total value and diverse in composition, a rise in the relative price of a particular import for which home demand is relatively inelastic (like petroleum and its products) can be accommodated by a substitution of expenditure towards it and away from inessential imports for which demand is relatively elastic. A similar argument had typically been advanced by advocates of import-substitution when they maintained that the exports of a small country should be diverse and not concentrated on only a few goods since a decline in world prices would otherwise lead to serious falls in export revenues. This suggests that both critics and advocates of import substitution might agree that, for a country which is a price-taker in world markets, the encouragement of a large foreign-trade sector is a way of diversifying the risk of adverse effects from changes in world prices. The question remains as to whether the positive theory of trade is correct in saying that the encouragement of comparative advantage is superior to import-substitution as a means of achieving a large foreign sector. From the contrasting experiences of, say, South Korea on the one hand and India on the other, the answer seems overwhelmingly to be that it is.

(iii) Agriculture
The Indian Government has instituted a multiple-pricing system for the major food-grains, especially rice and wheat. Farmers are compelled to sell a specified fraction of their output to the government, at a price fixed by the government which is significantly lower than that warranted by underlying supply and demand conditions. Farmers may sell the remainder of their output freely. The quantities the government acquires in this way, plus any it imports (imports being subsidised by the over-valuation of the exchange rate), are sold by ration at lower than free-market prices in the so-called `fair-price’ shops – which happen to be mainly in urban areas. Urban consumers may purchase part of their requirements from such shops and the remainder on the open market at higher prices. Astute middle-class urban housewives know that rationed grain is often of poorer quality than that sold on the open market. Accordingly, the former often constitutes part of the wages of the domestic servants of the urban household, while the family consumes the latter. Insofar as this is true, it suggests that farmers distinguish quality much better than do government officials, and that they use this advantage somewhat to partition their output into low- and high-quality, selling the first under compulsion to the government and the second on the open market.
While such is the general food policy of India, the compulsory procurement of grains and their distribution to the ration-shops is implemented by individual State governments and not by the Union Government. There have usually been numerous restrictions on inter-State movements of grain, so the States do not form a full customs union; instead, the Union Government tries to be a central clearing-house, matching the desired imports of one State with the desired exports of another.[37]

Economic effects of ban on futures contracts
Furthermore, futures contracts in grains have been banned by law, in the belief that futures trading is conducive to speculation and that speculation is undesirable. A futures contract in grain consists simply of a promise by a seller to deliver an amount of grain to a buyer at some specified date in the future in return for payment at a price agreed today. The seller’s incentive to enter into the contract is the guarantee of a certain sale, and the availability of funds now; the buyer’s incentive is the guarantee of a certain price for future deliveries. The contract may be entered into because buyer and seller have different expectations about what the spot price will be in the future. The buyer minimises his expected costs and the seller maximises his expected revenues; both are able to balance their budgets inter-temporally. Even if they have the same expectations about future spot prices, buyer and seller may still find it mutually profitable to enter into a futures contract as a way of insuring against risk. Forbidding such contracts by decree thus forces more risk onto both buyer and seller than they would normally be prepared to carry, and also induces them to balance their accounts in each period rather than it inter-temporally. Alternative kinds of credit markets become it relatively more lucrative, with the potential seller and buyer of futures wheat respectively borrowing and lending more than they would otherwise have done.[38]
The government has also expressed its determination to keep prices in ration-shops low. It has accordingly stockpiled large inventories of grain, apparently regardless of the costs of storage and spoilage or the alternative of holding larger foreign-exchange reserves to permit increased imports when necessary.

The ostensible, declared objective of all such policies has been to ensure that the poor do not suffer severe adverse income effects from sudden rises in the price of food resulting (it has been thought) from the contingencies of rainfall and the actions of speculative traders. It is, however, an open secret that the policies have really been a means of (a) taxing farmers, who pay a smaller percentage of their income in direct and indirect taxes than do urban dwellers, and (b) subsidising urban consumers, who broadly comprise the industrial working class and the middle in classes.
At the same time, however, the government and its advisers — after the considerable hesitation recorded by David Hopper [39]- have also accepted that the best long-run prospects for increasing agricultural productivity lie in modernising traditional farming techniques. Given the outstanding results of the Green Revolution in wheat, they could hardly have arrived at any other conclusion. The problem from the government’s point of view has been, as a sympathetic economist puts it “…how to procure a sufficient quantity of food grains at reasonable prices without jeopardising the farmers’ incentives to produce more”.[40]

Thus, while taxing farmers de facto on their output, on the one hand, the government has tried, on the other, to promote the use of modern inputs by subsidizing them both directly and through low-interest loans from the banks for such investment.
Distortions of incentives in agriculture
The distortions of efficient incentives caused by such policies are not difficult to see. First, the low output prices of wheat and rice have, in effect, been discriminatory taxes on wheat. As Edward Schuh remarks, these discourage the production of `. . . the very crops that policy-makers believe the vulnerable groups should have greater access to . . .’[41]

Vasant Sukhatme and Theodore Schultz have argued that, even between wheat and rice, there has been severe discrimination in favour of the former. At the official over-valued exchange rate, the price of domestic wheat has been significantly higher than imported, while at open-market rates for the rupee, the domestic price approximated the import price. For rice, however, the domestic price has been consistently below the import price. Sukhatme estimated that the dead weight loss in welfare from the under pricing of rice amounted to 8.5 per cent of total agricultural income in 1967-68 and to 2.2 per cent in 1970-71. He also calculated effective rates of protection, which were strongly negative for rice whether at official or open-market exchange rates and positive for wheat at the official exchange rate. Both he and Schultz conclude that the discrimination against rice has been a major factor in explaining the absence of a Green Revolution in rice on the scale of that in wheat.[42]
Secondly, the main beneficiaries of government subsidies for modern inputs have evidently been not the many small farmers but the fewer relatively large ones. As Gilbert Brown reports :`Large-scale farmers buy most subsidised inputs. Poorer farmers usually lack the money to buy adequate amounts of fertiliser and pesticides, and are commonly unable to get credit except at near-prohibitive rates of often 60% to 100% per year. Even in countries with subsidised bank credit for agriculture, rich farmers get most of the credit because of legal or administrative restrictions and/ or through open or disguised bribery. Credit and subsidy programmes for tractors, tube wells and other fixed investments also go mostly to the largest and richest farmers . . .Water is also a subsidised input . . . The farmers who receive this subsidised water generally have substantially higher incomes (because of the water) than farmers without access to public irrigation. Thus, claims that water should be subsidised to help small farmers misses the point that most farmers with irrigation have higher incomes than those who do not.’[43]
Brown argues that subsidies for inputs have been made necessary only to offset the forced depression of output prices. Moreover, the social benefit from subsidising inputs is limited to when the input is first introduced: ‘Once the benefits and technique of using the input are widely known, however, the continuation of such subsidies serves largely to increase the benefit-cost ratio of using the input . . .’.
Whether it is better to continue with artificially low input and output prices or to adjust towards a free market in both must take into account that the subsidies have encouraged more capital-intensity in production, and also that the `. . . low prices of certain inputs, particularly water, are often associated with widespread waste and inefficient use of the resource’.[44]
Thirdly, the farmer who is too small to find investment in storage facilities profitable may also consider it not worth his while to hold any of his output for sale on the open market. He will then sell it all to the government – at a below-market price.
A general conclusion would seem to be that, if the combined effect of input subsidies and forced grain sales to government has been a net subsidy to agriculture, then it has been a progressive subsidy; whereas if the combined effect has been a net tax on agriculture, then it has been a regressive tax. The Marxists may be quite right to protest that what gains there have been in agriculture have accrued to the relatively larger farmers, while smaller peasants and farmers are becoming landless labourers in growing numbers as a result of bankruptcy (that is, there has been increasing `rural proletarianisation’, to use the Marxists’ picturesque phrase). But if this is true, the cause can be traced unambiguously to the Indian Government’s belief – vociferously shared by the Marxists – that the way towards the declared objective of helping the poor is by extensive interference in the price system. Besides, the industrial working class demonstrably benefits from low food prices, so the honest Marxist must face up to being torn by divided loyalties between the rural and the urban proletariats.

Srinivasan put it as follows in a 1974 survey article :`The public distribution system with respect to foodgrains . . . operated to the benefit of all those living in metropolitan cities and other large urban concentrations while all others, including rich and poor in relatively small urban and almost all rural areas, did not benefit at all. When one recalls that the rural population includes the most abject among the poor, namely landless workers, the inequity of the system becomes glaring. And in urban areas, the existence of the system and the fact that the ration is often inadequate provides incentives for a household to falsify the data on its size and age composition given to the rationing authorities, as well as to create bogus or ghost ration-cards, not to speak of the corruption of the personnel manning the rationing administration.’[45]

The history of the extensive control of agriculture – which has included a partial government monopsony, forcibly-depressed output prices, inter-State restrictions on grain movements, and urban ration-shops – can be traced to the last years of British rule, as an attempt to bolster the popularity of the imperial regime. [46] The continuation and reinforcement of statism in agriculture in independent India has evidently rested on certain premises, namely, that the private market would be grossly inefficient and would be dominated by a few traders continually reaping large speculative profits, with both the small farmer and the ordinary consumer suffering in consequence.

Uma Lele’s fine study of the private grain trade, however, shows the real picture to be quite different. She found that the trade was highly competitive, that individual traders were rational agents (given the constraints of technology and government policy), that location price differences closely reflected transport costs, and that temporal price differences closely reflected storage costs. She argued that, while there was considerable scope for government activity, it should be in the form, not of interfering in the competitive market, but rather of encouraging the market to work – by, for example, disseminating relevant information such as crop forecasts, standardising weights and measures, constructing or improving roads and encouraging efficiency in the market for the transport of grain, etc.[47]

The evident neglect of such findings as these, and the continued application of policies inimical to competition and the free market, suggest that successive governments of independent India have been hardly more concerned for the rural poor – whether as farmer or consumer – and hardly less concerned with bolstering their popularity in the urban areas than were the British.

(iv) Employment
An obvious consequence of the economic policies described above has been the distortion of the individual citizen’s calculation of the expected benefits and costs of living and working in urban areas compared with the rural countryside. The forced depression of output prices in agriculture and the plethora of foreign-trade policies which discriminate against agriculture certainly seem to have artificially depressed the expected incomes of farmers. At the same time, a large `public sector’ in industry, plus the array of foreign-trade policies which have protected private industry, plus the indirect subsidisation of food sold in urban ration-shops certainly seem to have artificially raised expected urban incomes. Predictably, the reaction has been a vast and continuing net migration from the villages to the towns and cities, even after adjusting for the seasonal nature of agriculture. This drift has been the subject of much inquiry and discussion by development economists.[48] I propose to set it aside and examine instead a different aspect of employment policy which has not received nearly as much attention, namely, the consequences of putting into effect the clauses in the 1950 Indian Constitution mentioned above which authorised discrimination in employment and public education in favour of the `Scheduled’ castes and tribes, as well as other policies which discriminate on grounds of ethnic origin.

The consequences have been similar in several respects to those in America of `affirmative action’ towards so-called `racial minorities’, and it will be useful to draw out the analogy a little. As Thomas Sowell has cogently argued in recent years, the racial composition of contemporary American society is a complex mosaic, and no-one can say with certainty how it has come to be what it is today. In such circumstances, for the government to try to isolate a single contingent characteristic like `race’, partition society on the basis of census data according to this characteristic, and then construct public policies accordingly, is to introduce an enormous arbitrariness into economic life. By merely defining a group by reference to a single contingent characteristic, which all its members seem to possess, the intrinsic complexity of the individual person is lost or overlooked. Two members of the same race may be very different from each other in every relevant characteristic (income, education, political preference, and so on), and indeed resemble members of other races more closely in them. A policy which introduces a citizen’s race as a relevant factor in the assignment of jobs or college places partitions the citizenry into vague groups : members of groups who are very different from members of other groups in characteristics other than race rarely competing with each other anyway, while the burden and beneficence of the state’s policies fall on members of groups who are not very different from members of other groups in characteristics other than race: `. . . costs are borne disproportionately by those members of the general population who meet those standards with the least margin and are therefore most likely to be the ones displaced to make room for minority applicants. Those who meet the standards by the widest margin are not directly affected – that is, pay no costs. They are hired, admitted or promoted as if blacks did not exist. People from families with the most general ability to pay also have the most ability to pay for the kind of education and training that makes such performance possible. The costs of special standards are paid by those who do not. Among the black population, those most likely to benefit from the lower standards are those closest to meeting the normal standards. It is essentially an implicit transfer of wealth among people least different in non-racial characteristics. For the white population it is a regressively graduated tax in kind, imposed on those who are rising but not on those already on top.’[49]
At the same time, there is, in effect, a progressively graduated subsidy for members of the `minority’ group in favour of those who are already closest to meeting the general standards. Those in the mainstream of each group are largely unaffected; it is at the margins of competition that the bitterness caused by such policies will be felt and will manifest itself. It would seem that the situation in India – where the racial mosaic is if anything more complex than in America – is somewhat analogous. In recent years there has been civil tension and violence in the streets as poor Muslims, `caste’ Hindus, Sikhs and others have protested at being edged out of jobs and promotions by equally poor, or wealthier, members of the `Scheduled Castes’. In March-April 1981, for instance, there was widespread civil tension and violence in Gujarat over the reservation of places in the State’s medical colleges. A quarter of these places were statutorily reserved for members of the `Scheduled Castes’, with any not taken up by qualified candidates from these groups accruing to them in the future, thereby rapidly excluding from general competition as many as half the total number of places.[50]

The cruel paradox is that, while the position of many members (perhaps the vast majority) of the `Scheduled Castes’ vis-à-vis `caste’ Hindus remains one of degradation and persecution – quite regardless of the constitutional guarantees of equality in the eyes of the law – the relatively few who have succeeded in taking advantage of the discriminatory statutes have aroused the indignation of those who have not -causing even more animosity towards the `Scheduled Castes’ in general. One commentator observes the emergence of a `new elite’ among the `Scheduled Castes’ which `ceases to identify with its caste brethren’; while, at the same time, the law on equality `is so widely flouted precisely because the Scheduled Castes have not the means or courage to seek its protection . . .’ He concludes :`Contrived gestures such as are now popular will either not benefit [the Scheduled Castes] . . . or will do so only by further lowering already deplorable academic and administrative standards’. [51]
Moreover, when all government posts are advertised with a caveat that 10 or 15 per cent of themare reserved for members of the `Scheduled Castes’ and `Scheduled Tribes’, there is a considerable incentive for people to persuade Parliament to declare them as being such. And that also has happened. Discrimination in employment on the ground of caste has not been the only kind of discrimination practised by the Indian state. In what may be the most thorough study currently available on the origins, consequences and legal history of official discrimination in India, Weiner, Katzenstein and Rao have described the plethora of policies pursued by the central and state governments which have used not caste but ethnic origin as a criterion for public employment (with the private sector also often being `encouraged’ to follow suit) :`Preferences are given to those who belong to the “local” community, with “local” understood as referring to the numerically dominant linguistic group in the locality.’ [52] The authors conclude that what is emerging in India is`. . . a government-regulated labour market in which various ethnic groups are given a reserved share of that market. Competition for employment is thus not among all Indians, but within specified linguistic, caste, and tribal groups.`. . . various ethnic groups, therefore, fight politically for a share of that labour market. The major political struggles are often over who should get reservations, how the boundaries of the ethnic groups should be defined, and how large their share should be. There are also political struggles over whether there should be reservations in both education and employment, in private as well as in public employment, and in promotions as well as hiring. The preferential policies themselves have thus stimulated various ethnic groups to assert their “rights” to reservations.’[53]

It is not difficult to understand the general economic argument against discrimination on grounds such as caste or ethnic origin. If a private employer indulges a personal preference to hire only people of an kind A when there are more able or better qualified candidates of other ethnic kinds B, C, D, . . . ,available, and if the product of his firm is subject to competition in the market from other enterprises which do not discriminate on criteria which are irrelevant to economic efficiency, we may confidently expect the discriminating employer’s product to become uncompetitive and his profits to fall. The best and most obvious example of this would be in the professional sports industry in the USA : a `whites-only’ basketball or football team would be immediately vanquished on the games-field into bankruptcy. If government pursues employment policies which discriminate according to economically irrational criteria such as caste or ethnic origin, or if it forces all private firms to do likewise, there will certainly be inefficiency resulting in a loss of real aggregate output in the economy. In the terms of modern economics, a vector of total outputs which would be feasible given the parameters of the economy, and which would leave everyone either better off or at least no worse off, would not be achieved. In sum, the consequence of direct and widespread government interference in the labour market in India appears to have been, not only a disregard for the principle of equality before the law for every citizen (in a nascent republic of immensely diverse peoples), but also a loss of real output and an enormous `politicisation’ of economic life whereby individual success becomes increasingly tied to political power and increasingly removed from personal merit, enterprise and effort. In addition, the composition of occupations in the economy has been indirectly distorted by the set of industrial, agricultural and foreign-trade policies pursued by successive governments.

6. THE MALFUNCTIONING OF GOVERNMENT

IT MIGHT be thought that a large and flabby `public sector’ in industry and commerce, labyrinthine controls on private industry, a government monopoly of foreign-exchange dealings, the overvaluation of the currency, indefinite import-substitution, forcibly depressed output and input prices in agriculture, enormous politicization of the labour market, disregard for equality before the law, and distortion of the composition of occupations would constitute a sufficient catalogue of symptoms of grave illness in the political economy of a nation. Sadly, however, there are in modern India other symptoms too which I can mention only briefly here.
An opinion frequently encountered among urban Indians (as well as among the majority of Western development economists) is that government control over the size of the population is a necessary condition for economic development, and indeed that it is the failure of government to do this that has dissipated the economic growth that would otherwise have resulted from the economic policies pursued. The urban Indian witnesses the hovels and shanty-towns inhabited by migrant families from the countryside attracted by the policies discussed previously, and he experiences the resulting congestion. So does the Western development economist when he ventures out of his hotel into the city streets. Very often, that is his only personal experience of the legendary `poor masses’ of India. It is understandable that such princely discomfiture should lead him to the opinion that the poor are mindless in their breeding habits and that they must be persuaded, bullied or compelled to change. If this opinion were true, it would seem to point to a neat and simple solution to many of the woes of poor countries, and India in particular. But if the opinion is false and yet widely believed, it would cause governments to be, as it were, barking up the wrong tree.
It is, however, far from established, and certainly not at all obvious, that demographic control is either necessary or desirable in India or elsewhere. In the first place, when the rate of infant mortality is known and experienced by rural people to be high, there will be mare births than there would have been otherwise. Secondly, it is perfectly clear that children are an investment good in traditional societies such as those of rural India. Even young children are a source of family income, either directly by working outside the home or indirectly by working at domestic chores and thereby releasing adult members of the family for outside work. For a child to be absent from primary school or to drop out within a few years is not necessarily truancy; it may be the outcome of a rational economic calculation about where his time may be better spent towards increasing the household’s income. Furthermore, in traditional societies adult children are the principal source of support for elderly and retired parents.
To know of the existence of artificial measures of contraception certainly enlarges the alternatives open to a couple. Assuming that such knowledge is not in itself a cause of unhappiness (as it can be if there are conflicting religious commitments), a couple may certainly be better off with that knowledge because of their ability to control the number and timing of their children. The couple might also have fewer children – though there is no necessary or causal connection between a knowledge of contraception and the number of children born to a couple. Rational calculation may produce the same number of children as the caprice of nature, the implication being that in general there is no causal connection between the availability of contraceptives and the rate of growth of the population. The value of a public policy which encourages the use of artificial contraception is not so much that it reduces the number of births as that it may allow couples more control over their own lives. Whether or not artificial contraception should be publicly subsidised is quite another question.
The Indian Government has expended considerable resources in propagating and subsidizing artificial birth control. The results appear to have been, at best, indifferent (coupled as birth control has been with indirect incentives for large families and, at worst, cruel – as when frenetic zeal spilled over into demands for, and the implementation of, compulsory sterilisation. For this author, however, the important consideration would seem to be not so much the exact costs and benefits of the demographic policies pursued as the critical acknowledgement that they have little or nothing to do with the fundamental causes of mass economic development.[54]
It remains a stark paradox that, with a general literacy rate of perhaps 30 per cent [NB: In 2007, this has grown to 73% for males and 48% for females] India still produces the third largest absolute number of science and engineering graduates in the world. This reflects the lopsidedness of the educational system, continued from British times, in which higher education is enormously subsidised relative to primary education. In addition, entry into the civil services requires a college or university education, which in turn requires a good private secondary school education, which in turn requires a good preparatory school education. Strenuously competing to enter prep. school, with the help of outside tutoring, is the unhappy fate of many a five- or six-year-old in the towns and cities, followed by strenuous competition in secondary school, college and university, and finally at the doorstep of government (or a foreign university).
A job in government – any job in government – has carried prestige since Mughal times. In addition to the prestige and the obvious benefits of tenure where ether `decent’ jobs are scarce, there has been in recent times the inner satisfaction from a belief that a person can truly do his best for his country only by being in government. Tens of thousands of youths spend significant personal resources (such as whole years in cramming schools) to compete for a few annual openings in government. It is only to be expected that the competent, ambitious, patriotic youth who succeeds will mature into a respected mandarin with an unshakeable conviction in the good his government has done for the masses, and in the further good yet in prospect.
Failure to anticipate monsoon damage and disarray of the judicial system
The most serious examples of the malfunctioning of civil government in India are probably the failure to take feasible public precautions against the monsoons and the disarray of the judicial system. Official estimates, for instance, of the damage caused by flooding to homes, crops and public utilities in a few weeks of July-August 1981 alone amounted to over Rs 1 billion, with 10.8 million people `affected’, 35,000 head of cattle lost, and 195,000 homes damaged. The full magnitude of the devastation which annually visits vast areas can be understood perhaps only by those in rural India, although the towns and cities also regularly suffer considerable chaos. [55] [NB 2007: Monsoon prediction appears far better today than it was when these words were written.]
As for the disarray of the judicial system, The Statesman lamented in July 1980:`The simplest matter takes an inordinate amount of time, remedies seldom being available to those without means or influence. Of the more than 16,000 cases pending in the Supreme Court, about 5,000 were introduced more than five years ago; while nearly 16,000 of the backlog of more than 600,000 cases in our high courts have been hanging fire for over a decade. Allahabad is the worst offender but there are about 75,000 uncleared cases in the Calcutta High Court in addition to well over a million in West Bengal’s lower courts.”[56] Such a state of affairs has been caused not only by lazy and corrupt policemen, court clerks and lawyers, but also by the paucity of judges and magistrates. In addition, however,`. . . a vast volume of laws provokes endless litigation as much because of poor drafting which leads to disputes over interpretation as because they appear to violate particular rights and privileges. Land legislation offers an example of radical zeal running away with legal good sense, giving rise to thousands of suits against the Government . . .’ [57] When governments determinedly do what they need not or should not do, it may be expected that they will fail to do what civil government positively should be doing. In a sentence, that has been the tragedy of modern India.

Part IV : Reform
A LIBERAL AGENDA

IT WILL by now have become evident to the reader from the descriptions and arguments given above that, in the judgement of the present author, only a set of radical changes in policy can put the Indian economy on a path to higher mass prosperity within a free and healthy body politic. I shall therefore put forward a tentative manifesto for reform, adding some predictions about which classes of citizens would be most likely to support or oppose a particular proposal. The scope and intention of such a manifesto should be made clear at the outset. As Aristotle taught, a set of actions which are the means towards certain ends may themselves be the ends towards which other prior means have to be taken.[58]
The ultimate ends of economic advice in India are to seek to bring about mass prosperity under conditions of individual freedom. The proposals I which follow are to be construed as means towards those ultimate ends. But they also constitute a set of intermediate ends, and their implementation would require further judgement about the best means towards achieving them. In economic policy, for instance, a firm but gradual phasing-in over a period of three or four years may be the best way to minimise the hardships entailed by the adjustment. For reasons which will become clear, however, I shall not here try to answer the question as to how the proposals might best be implemented.

(a) Effects of foreign policy on the domestic economy
It will be useful to begin with a short and very incomplete consideration of foreign policy insofar as it may bear upon domestic economic policies. It is a settled fact of international politics that, while there is no obvious connection between a nation’s economic and political institutions and the choice of strategic allies it faces, people’s subjective perceptions and opinions of the social arrangements in a foreign country can be deeply influenced by whether that country is seen as a potential ally or adversary. A related and equally settled fact is that war, or the fear of war, can make for the most incongruous of bed-fellows. In contemporary India, it is quite evident that the antipathy and pessimism towards market institutions found among the urban public, and the sympathy and optimism to be found for collectivist or statist ones, has been caused to a very significant extent by the perception that the United States is relatively hostile towards India while the Soviet Union is relatively friendly. This was not always so. The official affection between the United States and India in the early years of the Republic was grounded in sincerity and goodwill. The roots of its demise are probably to be found in the split between the Soviet Union and China in the late 1950s which, in a short period of time, made the latter a valuable strategically for the United States against the former. By the early 1970s, the spectre of a joint military threat to India from a totalitarian China and a militarist Pakistan – and especially a threat which it was perceived democratic America would do little or nothing to thwart – made it prudent for democratic India to become the virtual ally of totalitarian Russia.
Such a configuration on the international chess-board need not have been detrimental to India’s economic development. It is possible to imagine a liberal state allied to a totalitarian one for strategic reasons, yet maintaining liberal economic policies domestically and internationally. In practice[58], however, the extent of `economic collaboration’, bilateral trading arrangements, `joint ventures’, barter agreements, `cultural exchanges’, and the like into which the Indian Government has entered with the Soviet bloc, appears significantly to exceed what it has achieved with the Western powers. In particular, Soviet arms have in recent years been purchased more often and then manufactured under licence. This too need not have been economically detrimental if the Soviet products had in practice been competitive on international markets in terms of price and quality. As is common knowledge, however, this is often not so. It therefore appears that part of the price India has had to pay for the strategic support of the Soviet Union has been the foisting on her of low-quality, high-priced Soviet goods, whether arms or steel mills or technical know-how. At the same time, for reasons which are partly historical and partly related to these considerations, direct foreign investment by private Western firms has been treated with, at best, coolness and, at worst, open hostility.

A change in India’s foreign policy
If the economic liberalisation that will be proposed here for India is to be effective, a truly independent yet prudent foreign policy may be required to accompany it. A change in the present strategic configuration – in which the United States is perceived in India to be virtually the ally of both China and Pakistan, while India is perceived in the United States to be virtually the ally of the Soviet Union – is unlikely until and unless the United States finds it in her best interests in the region to distance herself from China and Pakistan, which is unlikely to happen without a rapprochement between the Soviet Union and China. A drastic alternative way for India to reduce her dependence upon the Soviet Union would be the kind of divorce Egypt effected some years ago, followed by an alliance with the Western powers. This might, however, undermine once more the independence of foreign policy and be perceived in India as a move from the devil to the deep sea. The prudent remaining alternative would appear to be an earnest and vigorous pursuit of serious no-war pacts with Pakistan and China, combined with an appropriately small independent nuclear deterrent. It seems to the author that the reasons which commend this course are closely analogous to those offered by the present American and British governments for pursuing serious no-war negotiations with the Soviet bloc whilst simultaneously improving the Western nuclear deterrent.
(b) Liberalisation of foreign trade
Not only would the truly independent foreign policy proposed in the preceding paragraph allow India to distance herself from the Soviet Union; it would probably also prompt the Western powers to end the intergovernmental transfers which go by the name of `foreign aid’. For reasons that Peter Bauer has emphasised over many years, an end to such transfers might be a boon in disguise for India.[59] In particular, it would require the government to seek to balance the foreign-exchange accounts without becoming obligated to the Western powers, and this in turn would require a major economic transformation from a closed and protectionist economy to an open one which harnessed India’s comparative advantages.
An initial liberalisation of foreign trade, involving a transition from quotas to tariffs, would probably be supported by private industry as a whole. It would, however, be opposed by incumbent politicians and government officials since it would dissipate the rents they receive under the closed regime. A subsequent reduction in tariffs, a withdrawal of export subsidies, and the free floating of the rupee would be opposed by those private firms (and their labour unions) which would be uncompetitive internationally – probably those in `non-traditional’ industries. The measures would, however, be supported by ordinary consumers, by private firms in traditional industries like jute manufactures and textiles, and particularly by farmers.
Once private industry became subject to the strict discipline of international competition again, there would be no reason whatsoever for government-imposed internal controls which were not conducive to free and fair competition among firms for the consumer’s rupee. The repeal of the plethora of licensing policies would dissipate the large rents attached to the controls under the present regime. Since these rents are paid by private industry and received, directly or indirectly, by incumbent politicians and government officials, the former could be expected to welcome repeal and the latter to oppose it vigorously.

(c) Privatisation of `public-sector’ industries
At the same time, for the so-called `public-sector’ industries to face international competition, when they are currently monopolists or oligopolists, would demand such an improvement in economic discipline as probably to require the shares of most of them to be sold on the open market, with marginal-cost pricing imposed on the remainder. There is no economic reason why the Government of India shouldbe engaged in commercial or merchant banking and insurance, or in industries from steel, machine-tools, ship-building and fertilisers to wrist-watches, hotels and beer. Nor is there any cogent reason why it should be a major producer, let alone a monopolist, in the road, rail, air and sea transport industries. Large-scale privatisation would be supported by private citizens in general, and would also draw out the reputedly vast private funds which circulate in the untaxable underground economy. But such measures would probably be opposed vigorously by the government officials who currently manage these industries, aswell as by the public-sector labour unions.

(d) Free-market pricing in agriculture
With the repudiation of the mistaken premise that government sponsored industrialisation is the best means to mass economic development, the free-market pricing of agricultural outputs and the removal of all controls that are not conducive to free competition among farmers should follow. This would be welcomed by all farmers and perhaps by the rural population in general. It could also be expected to provide much encouragement to the technological transformation of traditional agriculture. The abolition of ration-shops in urban areas would be opposed by the industrial working class, by the urban middle classes in general, and by government officials and employees engaged in the present regime of public distribution. Further, farmers, especially relatively large ones, might be expected to oppose the concomitant free-market pricing of agricultural inputs, including credit and fertilisers, as would those government employees presently charged with distributing these inputs.
The ending of the distortions in agricultural output and input prices would establish a conclusive case for uniform systems of taxation in the economy, and especially for income from agriculture to be treated on a par with income from other occupations. These systems could locally include direct subsidies to those (whether in rural or urban areas) who are unable to provide any income for themselves, such as the insane and the severely disabled – all of whom are currently cared for, if at all, by private charity, and none of whom, strangely enough, appears to enter the moral calculations of socialist and Marxist economists.

(e) Tax revenues for public goods
The first and most important destination of tax revenues, whether raised centrally, provincially or locally, must be the provision of public goods – central, provincial and local. In an earlier section, we have seen what kinds of goods these should be. Among the most urgent in India are more effective precautions against the monsoons and improvements in the efficiency of the systems of civil and criminal justice. The former might include measures to prevent soil erosion and the building of better dams, embankments, canals and roads. Such programmes would be likely to command practically unanimous support in the localities in which they were implemented.
Reforms of the judicial system might include raising the salaries of judges and policemen, as well as the penalties for their misconduct; improving the training and morale of the police, with the object of increasing public confidence in them (especially in the villages); and expanding the number of courts, at least temporarily until the monumental backlog of cases has been reduced and brought under control. A general reduction in the political and administrative direction of economic life would lead to fewer lawsuits being brought against the government itself, and thus provide further relief for the judiciary. Widespread prison reform may also be required if the reports are true that a large proportion of those held prisoner for a number of years have yet to be brought to trial, and that potential prosecution witnesses, if they are poor and uneducated, are themselves sometimes kept in jail until a case comes to court. Such reforms would command the support of everyone except criminals, capricious litigants and corrupt or incompetent members of the police and judiciary, none of which groups, it must be supposed, comprises apolitical constituency.

Together with improvements in the system of justice, the principle of equality before the law would have to be taken seriously. This would require the dispensation of justice by the state to be, as it were, a process blind to the infinitely diverse caste and ethnic characteristics of the citizenry, which in turn would imply the repeal of all laws – whether central, provincial or local – permitting governmental authorities to discriminate in favour of a particular politically-specified caste or ethnic group. Merely to have written `equality before the law’ into the Constitution without really believing it either possible or desirable is to allow the mutual caste and ethnic bigotry of private citizens to be exploited for political ends. That innumerable members of a caste, or religious or ethnic community have suffered at the hands of another, and that members of the `Scheduled Castes’ in particular have been victims of enormous cruelty, should not prevent acknowledgement of the sober fact that the past is irretrievable, or that it is similar cruelty in the present and future against any citizen at the hands of any other, or the state, that the declaration of Fundamental Rights was intended to prevent.

(f) Other reforms
Other proposals could also be suggested : the introduction of vouchers for primary and secondary education; a serious assessment of the benefits from and costs of subsidies to higher education; an end to the government monopoly of radio and television; a revision of government pay-scales to make them competitive with the private sector, together with equivalent reductions in non pecuniary benefits; a decentralisation of public spending decisions from New Delhi to the State capitals and from there to the districts; and so on. However, it is hardly necessary to go further, since even a limited liberal agenda would appear doomed to be still-born.
Incumbent politicians, government officials, and the public sector unions in general would vigorously oppose any reduction in government intervention in the economy for fear of losing the rents and sinecures of the status quo. Indeed, professional politicians in general could be expected to be averse to any lessening of the politicisation of economic life.
In other countries, a political party proposing such a reduction in government intervention would usually enjoy the backing of private industry. In India, however, private industry in general would probably see it in its own interest to support only the reduction of internal controls, whilst vigorously opposing reductions in the neo-mercantilist external controls. In July 1981, for example, I asked a prominent industrialist to imagine first a free-market regime at home : `That would be very welcome indeed’, he replied enthusiastically. I then asked him to imagine a policy of free trade : `That would wipe us out’, he replied gravely. His answers indicate very well what is perhaps the single most important feature of the equilibrium that has emerged in India: by accepting without significant protest the constraints and costs imposed upon it by the government and its `planners’, the private corporate sector has traded the freedom of enterprise for mercantilist monopoly profits in the home market.
When Indian Marxists rail about collusion between the `national bourgeoisie’ (that is, the governmental class) and the `comprador bourgeoisie’ (that is, the private sector), they make a cogent point as old as Adam Smith’s critique of mercantilism.[60] But, again, they fail to see that the fortunes of the industrial working-class have also risen with those of the private and public industries that have gained from the present regime. Moreover, a large proportion of industrial workers and blue-collar government employees are migrants with families left behind in rural areas; these rural families might also oppose reductions in the transfers currently received by their migrant relatives. Finally, while joining other farmers in welcoming a free market in grain, the politically influential larger farmers could be expected to oppose the direct taxation of agricultural incomes and the elimination of subsidies for inputs.

Who is left who would gain from the kinds of reforms proposed here? Only the ordinary citizen qua consumer, the rural poor and the residuum of severely disabled citizens unable to create any income for themselves. None of these has been or is likely to become an effective political force.

India’s `unhappy equilibrium’
The economy of the first Indian Republic has tended towards a broad and increasingly unhappy equilibrium. Distortions of efficient relative prices and wages lead to both substitution and income effects. Those who lose from one distortion rationally seek another from which they may gain; those who lose from the second seek a third; and so on ad infinitum until a maze of distorted incentives are in place and a60Adam Smith, host of income transfers are in progress – sometimes offsetting losses, sometimes not. Tullock has emphasised that the problem is not only that there are dead-weight losses in welfare, but also that people are led `. . . to employ resources in attempting to obtain or prevent such transfers.’[61] In modern India, the waste of productive resources put to the pursuit of such transfers has been incalculable. The reforms pro-posed here would cut through the maze of distorted incentives and institutions all at once – for which very reason it seems unlikely they can come to be implemented.

The economic significance of a political attitude of individualism is that it clearly recognises the relationship between individual effort and reward, and the relationship between cause and consequence generally. An attitude of statism obscures or obliterates this relationship. In republican India, statism has pervaded all public discourse and prompted most public policy. Successive groups of politicians and government officials seem never to have recognised the fundamental nature of those functions of government which are the indispensable prerequisites of civil peace and mass prosperity. Nor have they understood that it is no part of government’s agenda to be the driving force to mass prosperity, and that this can come (if it will) only from innumerable individual efforts in the pursuit of private rewards. This is not at all to say that those in government have been ill-intentioned. On the contrary, they may have sincerely sought the public good whilst introducing a Leviathan government into the market-place and neglecting the proper duties of government outside it. As Bauer has remarked in a related context :`Their financial benefits may appear to be fortuitous, as if Adam Smith’s invisible hand were to work in reverse, so that those who sought the public good achieve what was no part of their intention, namely personal prosperity.’[62] It is indeed possible that the basic fact of human nature that individual households every where ordinarily know most about, and are only concerned with, their own well-being has never been acknowledged in modern India. The simple secret of a stable and prosperous polity is to create institutions which harness the universal pursuit of individual self interest, and not ones which pretend that men are selfless saints. A polity where this fact is acknowledged would not have to depend for the viability of its institutions on mere exhortation, as the institutions of the Indian Republic seem perpetually fated to do, even while the competitive pursuit of self interest is everywhere manifest.

The logic of economic reasoning and the adducement of economic evidence have in the past had little effect in India because the distribution of gains and losses from the policies pursued has been closely matched by the distribution of effective political power. This distribution seems most likely to continue, and so the prospects of significant and sustained endogenous reform seem, to this author at least, very small. Changes in external constraints seem to be the only likely source of a major disturbance to the equilibrium, and there can be no guarantee that the results will be for the better. This is a sad and troubling conclusion to come to, for a citizen of India or anyone else who has loved the country. It places this author in the paradoxical position of believing his arguments to be broadly correct – while hoping they are not.

ENDNOTES (The original monograph in 1984 had footnotes, which have had to be transformed since pages, in this new HTML age, no longer have to be linear as in a book nor have to be turned in order to be read).

[1] The early studies notably include: B. R. Shenoy, `A note of dissent’, Papers relating to the formulation of the Second Five-Year Plan, Government of India Planning Commission, Delhi, 1955; Indian Planning and Economic Development, Asia Publishing, Bombay, 1963, especially pp. 17-53; P. T. Bauer, Indian Economic Policy and Development, George Allen & Unwin, London, 1961; M. Friedman, unpublished memorandum to the Government of India, November 1955 (referred to in Bauer, op. cit., p. 59 ff.); and, some years later, Sudha Shenoy, India : Progress or Poverty?, Research Monograph 27, Institute of Economic Affairs, London, 1971. Some of the most relevant contemporary studies are: B. Balassa, `Reforming the system of incentives in World Development, 3 (1975), pp. 365-82; `Export incentives and export performance in developing countries: a comparative analysis’, Weltwirtschaftliches Archiv, 114 (1978), pp. 24-61; The process of industrial development and alternative development strategies, Essays in International Finance No. 141, Princeton University, 1980; J. N. Bhagwati & P. Desai, India: Planning for Industrialisation, OECD, Paris : Oxford University Press, 1970; `Socialism and Indian Economic Policy’, World Development, 3 (1975), pp. 213-21; J. N. Bhagwati & T. N. Srinivasan, Foreign-trade Regimes and Economic Development: India, National Bureau of Economic Research, New York, 1975; Anne O. Krueger, `Indian planning experience’, in T. Morgan et al. (eds.), Readings in Economic Development, Wadsworth, California, 1963, pp. 403-20; `The political economy of the rent-American Economic Review, 64 (June 1974); The Benefits and Costs of Import-Substitution in India : a Microeconomic Study, University of Minnesota Press, Minneapolis, 1975; Growth, distortions and patterns of trade among many countries, Studies in International Finance, Princeton University, 1977; Uma Lele, Food grain marketing in India : private performance and public policy, Cornell University Press, Ithaca, 1971; T. W. Schultz (ed.), Distortions in agricultural incentives, Indiana University Press, Bloomington, 1978; V. Sukhatme, “The utilization of high-yielding rice and wheat varieties in India: an economic assessment”, University of Chicago PhD thesis, 1977.

[2] S. Roy, “On liberty and economic growth: preface to a philosophy for India”, University of Cambridge PhD thesis, 1982a, Chapters I and II; “Knowledge and freedom in economic theory: Parts I and II”, Centre for Study of Public Choice, Virginia Tech, working papers, 1982b. My epistemological arguments have closely followed those of Renford Bambrough, Moral Scepticism and Moral Knowledge, Routledge and Kegan Paul, London, 1979.

[3] Aristotle, Ethica Nicomachea, in Richard McKeon (ed.), The Basic Works of Aristotle, Random House, New York, 1941. We read: `. . . the whole account of matters of conduct must be given in outline and not precisely, as we said at the very beginning that the accounts we demand must be in accordance with the subject matter; matters concerned with conduct and questions of what is good for us have no fixity, any more than matters of health. The general account being of this nature, this account of particular cases is yet more lacking in exactness; for they do not fall under any art or precept but the agents themselves must in each case consider what is appropriate to the occasion, as happens also in the art of medicine or of navigation.’ (1,104a2-a9.)`. . . we do not deliberate even about all human affairs; for instance, no Spartan deliberates about the best constitution for the Scythians. For none of these things can be brought about by our own efforts. We deliberate about things that are in our power and can be done.’ (1,112a28-30.) Adam Smith, An Inquiry into the Nature and Causes of the Wealth of Nations(1776), eds. R. H. Campbell et al., Liberty Classics, Indianapolis, 1981. We read: `What is the species of domestick industry which his capital can employ, and of which the produce is likely to be of the greatest value, every individual, it is evident, can, in hislocal situation, judge much better than any statesman or lawgiver can do for him.’ (Book IV. ii. 10, p. 456.) In modern times, Friedrich Hayek has always kept this fact in the foreground of his thinking. In his Individualism and Economic Order, Routledge and Kegan Paul, London, 1949, we read, for example, of `. . . the constitutional limitation of man’s knowledge and interests, the fact the he cannot know more than a tiny part of the whole of society and that therefore all that can enter into his motives are the immediate effects which his actions will have in the sphere he knows . . .’ (p. 14.) The individual agent has a `special knowledge of circumstances of the; thus `. . . practically every individual has some advantage over all others because he possesses unique information of which beneficial use might be made, but of which use can be made only if the decisions depending on it are left to him or are made with his active co-operation.’ (p. 80.)

[4] The mathematical economist will recognise these three conditions as the characteristics which define a multi-market general equilibrium in the Arrow-Debreu model: Gerard Debreu, Theory of Value, Yale University Press, New Haven, 1959; K. J. Arrow and F. H. Hahn, General Competitive Analysis, Oliver and Boyd, Edinburgh, 1971.

[5] This argument is discussed further in Roy (1982a), pp. 96-107, pp. 133-43.

[6] Adam Smith, op. cit., Book V. i. c., p. 723.

[7] P. A. Samuelson, `A pure theory of public expenditures’, Review of Economics & Statistics, 36, 1954,reprinted in K. J. Arrow & T. Scitovsky (eds.), Readings in Welfare Economics, R. D. Irwin, Homewood, Ill., 1969.

[8] The idea I have in the background is of some implicit public goods function endorsed more or less unanimously by citizens – but not necessarily by those with political power – with commonsense dictating the elements it should contain. Thus Let U = U (π1, π2 , …, πn) be such a function with δU/δπi > 0, δ2U/δπi2 < 0 i=1,2,…,n, where πi = 1,2,…n, is a lateral index of a public good or service like defence, civil protection, roads, dams, or the finance of basic education. Each of these is “produced” by an expenditure of public resources: πi = πi (τi ), δπi/δτi > 0, δ2πi /δτi2 < 0 i=1,2,…,k, Σ i=1,2,…,n τi = τ* where τ* is the total level of public resources available (whether by taxation or borrowing). An efficient condition, i.e., one in which given public resources are efficiently allocated among alternative public goods or services, would be δU/δπi/ δπi/δτi = δU/δπj / δπj/δτj for every i,j = 1,2,. .,n. So, if the marginal tax-rupee was put towards the production of any public good, the increase in social utility should be the same; otherwise we would find an excess supply of some public goods (e.g. bureaucrats) and an excess demand for others (e.g. courts, dams, police protection, etc.).

[9] Two examples are F. H. Hahn, On the notion of equilibrium in economics : an inaugural lecture, Cambridge University Press, Cambridge, 1973, and J. M. Grandmont, “Temporary general equilibrium theory : a survey”, Econometrica, vol. 46, 1977.

[10] Aristotle, op. cit., 1,094b12-1,094b27

[11] D. H. Robertson, `The Economic Outlook’, in his Utility and All That, Allen & Unwin, London, 1952, pp.51-52.

[12] Karl Popper made a similar point in The Open Society and its Enemies, Princeton University Press, Princeton, 1950, when he suggested that Plato’s question `who should rule?’ should be discarded for the question:`How can we so organise political institutions that bad or incompetent rulers can be prevented from doing too muchdamage?’ (p. 120). There is relevant discussion by Renford Bambrough in `Plato’s modern friends and enemies’, Philosophy, 37, 1962, reprinted in R.Bambrough (ed.), Plato, Popper and Politics : some contributions to a modern controversy, Barnes and Noble, New York, 1967. I have discussed the relationship of expertise to democracy in Roy (1982a), pp 80-95.

[13] Virginia Bill of Rights, 1776, in The Constitution of the United States, ed. E. C. Smith, Barnes & Noble, New York, 1979, p. 21.

[14] P. T. Bauer, Dissent on Development, Harvard University Press, Cambridge, Mass., 1971, p. 72, n. 2. The term `statism’ suggested itself to the author after he read M. R. Masani, “Post-Sanjay outlook: where salvation does not lie” The Statesman, 9 July 1980.

[15]G. M. Young (ed.), Macaulay: Prose and Poetry, London: Macmillan, 1952, p. 718. Some 20 years later, in Considerations on Representative Government, ed. H. B. Acton (London: J. M. Dent), J. S. Mill claimed that rule by`a superior people . . . is often of the greatest advantage to a people, carrying them rapidly through several stages of progress’ (Ch. IV, p. 224). Ironically, a few years ago a distinguished retired member of the Indian civil service (who happens to be a recipient of the Lenin Peace Prize) used very similar words in a newspaper article – in defence of the Soviet occupation of Afghanistan!

[16] Resolution of the Indian National Congress, August 1931, reprinted in B. N. Pandey (ed.), The IndianNationalist Movement : 1885-1947, Macmillan, London, 1979, p. 67.

[17] S. Radhakrishnan, The philosophy of Rabindranath Tagore, Macmillan, London, 1918, p. 232. For an excellent account of the intercourse between ancient India and ancient Greece, H. G. Rawlinson, `Early contacts between India and Europe’, in A. L. Basham (ed.), A Cultural History of India, Clarendon Press, Oxford, 1975. For excellent accounts of the growth of liberalism in India in the l9th and carly 20th centuries : Anil Seal, The Emergence of Indian Nationalism : Competition and Collaboration in the later l9th Century, Cambridge University Press, Cambridge, 1971, Chs. 1, 3-6; J. R. McLane, Indian Nationalism and the Early Congress, Princeton University Press, Princeton, 1977; Gordon Johnson, Provincial Politicsand Indian Nationalism,Cambridge University Press, Cambridge, 1973, Ch. 1.

[18] Ramsay Macdonald’s letter to M. K. Gandhi, 8 September 1932, reprinted in Pandey (ed.), op. cit., p. 74.

[19] Devdas Gandhi’s letter to Jawaharlal Nehru, 2 October 1931, reprinted in Pandey (ed.), op. cit., p. 71

[20] Gandhi’s protest succeeded to the extent that the Award itself was superseded; and in unusual, euphoric displays of fraternity, `caste’ Hindus threw open temples to members of the `Depressed Classes’ and embraced them with
garlands. The compromise Pact which replaced the Communal Award removed separate electorates but still guaranteed special political representation for some years following the agreement. For an account of Gandhi’ s position on the Communal Award, Judith M. Brown, Gandhi and Civil Disobedience, Cambridge University Press, Cambridge, 1977, pp. 313-21.

[21] For an eminent lawyer’s commentary, N. A. Palkhivala, The Light of the Constitution, Forum of Free Enterprise, Bombay, 1976.

[22] There is reason to think the Mughals before the British had done no better and had probably done much worse. T. Raychaudhuri, `The State and the Economy: the Mughal Empire’, in T. Raychaudhuri & I. Habib (eds.), The Cambridge Economic History of India, vol. I, Cambridge University Press, Cambridge, 1982.

[23] V. B. Singh (ed.), Nehru on Socialism, Government of India, Ministry of Information and Broadcasting, Publications Division, Delhi, 1977, pp. 56-57, 67.

[24] `Draft recommendations for the formulation of the Second Five Year Mahalanobis;`The Second Five-Year Plan – A tentative framework’, drafted by the economic ministries; and a `Memorandum’ written by a panel of prominent Indian economists – all contained in Papers relating to the formulation of the SecondFive Year Plan, Government of India: Planning Commission, 1955 – were the principal influences on the actual Second Plan. No significant understanding of markets, prices or the concept of feasibility is evident on the part of any of the authors. Shenoy’s lonely dissent has already been noted (note 1).

[25] The best descriptions of Indian industrial policy are still to be found in Bhagwati and Desai (1970), op. cit. Also C. Wadhwa, `New Industrial Licensing Policy: An Appraisal’, in C. Wadhwa (ed.), Some problems of India’seconomic policy, Tata-McGraw Hill, Delhi, 1977, pp. 290-324.

[26] Gordon Tullock is generally credited with introducing the notion of rent-seeking in `The welfare costs of tariffs, monopolies and theft’, Western Economic, Journal, 5 (June 1967), while Krueger (1974), op. cit., introduced the term itself. The collection edited by J. M. Buchanan et al., Toward a theory of the rent-seeking society, Texas A&M Press, College Station, 1980, contains reprints of both papers as well as other studies.

[27] Krueger (1975), op. cit., p. 108 ff.

[28] The classic argument for a free market is in M. Friedman, `The case for flexible exchange rates’, in his Essays in Positive Economics, University of Chicago Press, Chicago, 1953, pp. 157-203. Also V. S. Vartikar,Commercial policy and economic development in India, Praeger, New York, 1969, based on his PhD at Wayne State University; and D. Lal, A liberal international economic order : the international monetary system and economic development, Essays in International Finance No. 139, Princeton University, October 1980.

[29] An additive sub-utility function might be defined within each set of categories UG= ∑ ai vi (Gi) a1 ≥ a2 ≥ a3, ∑ ai= 1UP= ∑ bj wj (Pj) b1 ≥ b2 ∑ bj= 1where the vi (.) and the wj (.) are further sub-utility functions defined on each category, etc. None of these has ever been spelt out by the Indian Government and certainly no amount of UP has seemed substitutable for an iota of UG.

[30] Bhagwati and Srinivasan, op. cit., p. 38.

[31] Ibid.,p. 38

[32] In 1980, for example, exports of pig-iron and of sheep- and goat-meat were banned; an export duty on jute manufactures was imposed on 18 February and lifted on 8 September. (Annual Report on Exchange Controls, International Monetary Fund, 1981, pp. 205-13.) The Import and Export Policy (April 1982, March 1983)announced by the Commerce Ministry reported the banning of exports of cane, paraffin wax, mustard and rape-seedoil, and `certain
wild-life items’, including lizards and robins. An embargo on the export of CTC (cut, tear and curl) tea was announced by the Ministry of Commerce on 24December 1983. CTC is high-quality tea which accounts for about three-quarters of India’s tea exports. The ban followed a doubling of domestic prices over the previous year, compulsory registration of tea dealers holding more than 1,000 kg. to prevent hoarding, and agreement by manufacturers to reduce their profit margins and cut prices ofpackaged tea by about 20 per cent (Financial Times, 14 December 1983). The Indian Government apparently feared that the supply of tea for the domestic market was going to run out (The Times, 5 January 1984). The effect of thesemeasures is artificially to depress prices in the domestic market whilst raising them overseas (The Economist, 14 January 1984).

[33] Pick’s Currency Year-book, various editions

[34] Krueger (1977), op. cit., pp. 27-28.

[35] Balassa (1978), op. cit., p. 39; Balassa (1980), op. cit., p. 16.

[36] Ibid.,p. 22.

[37] Short surveys of the relevant practices can be found in Lele, op. cit.,Appendix 1, pp. 225-37, and Sukhatme, op. cit., pp. 29-37. Also Gilbert Brown, `Agricultural pricing policies in developing countries’, and G. E.Schuh, `Approaches to “basic needs” and to “equity” that distort incentives in agriculture’, in Schultz (ed.), op. cit.,pp. 84-113 and pp. 307-27 respectively.

[38] Theoretical economists have long recognised that a fundamental flaw in, for example, the Arrow-Debreu model is its assumption that all conceivable futures contracts are practicable. The longest futures price actually quoted at
the Chicago Board of Trade, however, would be for silver, at about two years; for grains, the longest would be only about three months. Since the natural market outcome is a far-cry from the theory, the Indian Government’s fears about the effects of speculation appear to be much exaggerated. To see the risk-dispersing character of a futures contract, let us suppose that both buyer and seller place a probability of one-half on prices being either in 8 or 2; if they are risk-averse, they may prefer to trade at a certain futures price of 5 now, rather than wait for the future to unfold.

[39] David Hopper, `Distortions of agricultural development resulting from Government prohibitions,’ Schultz (ed.), op. cit., p. 69 ff.

[40] K. Prasad, `Foodgrains policy 1966-1976′, in Wadhwa (ed.), op. cit., p.479.

[41] Schultz (ed.), op. cit., p. 309.

[42] Sukhatme, op. cit., pp. 74-86; T. W. Schultz, `On the economics and politics of agriculture’, in Schultz(ed.), op. cit., p. 15 ff.

[43] Schultz (ed.), op. cit., pp. 92-93.

[44] Ibid.,p. 95.

[45] T. N. Srinivasan, `Income Distribution: A survey of policy-aspects’, in Wadhwa (ed.), op. cit., p. 265. That the small farmer may not find it profitable to invest in storage, and that (if it has been taxed) agriculture has been taxed regressively, are also remarked upon by Srinivasan.

[46] Lele, op. cit., p. 2, where reference is made to Sir Henry Knight, Food Administration in India, Stanford University Press, Stanford, 1954.

[47] Lele, op. cit., pp. 214-24

[48] For example, M. Todaro, `A model of labor migration and urban unemployment in less developed countries’, American Economic Review, March 1969, 59, pp. 138-48; J. P. Harris & M. Todaro, `Migration,unemployment and development: a two-sector analysis’, American Economic Review, March 1970 60, pp. 126-42.The best paper known to the author is by Jerome Rothenberg, `On the economics of internal migration’, Working Paper No. 189, Dept. of Economics, MIT, July 1976.

[49] Thomas Sowell, Knowledge and Decisions, Basic Books, New York, 1980, pp. 268-69.

[50] `The logic of protection’, The Statesman, Editorial, 19 March 1981; also the Editorial, `Danger of caste ethnic

[51] S. K. Datta Ray, `Backlash to protection: fancy gifts ignore real reform’, The Statesman Weekly, 21 March 1981.

[52]M. Weiner, M. F. Katzenstein, K.V.N. Rao, India’s preferential policies : migrants, the middle classes and ethnic equality, University of Chicago Press, Chicago, 1981, pp. 16-17.

[53] Ibid. p. 5

[54] P. T. Bauer, `Population explosion: myths and realities’, in Equality, the Third World and Economic Delusion, Harvard University Press, Cambridge, Mass., 1981, pp. 42-65, contains some of the clearest arguments known to the author about this question; also M. Weiner, India at the Polls : the Parliamentary Election of 1977, American Enterprise Institute, Washington DC, 1978, pp. 35-39.

[55] 10 8 million people affected by floods’, The Statesman Weekly, 22 August 1981; also `Down the drain’, Editorial in The Statesman, 8 July 1981.

[56] Justice with speed’, Editorial in The Statesman, Calcutta and New Delhi, 21 July, 1980

[57] Aristotle, op. cit., 1,094a1-1, 094b11.

[58] There are few thorough studies known to the author that are relevant. One such is Asha L. Dattar, India’s Economic Relations with the USSR and Eastern Europe 1953-1969, Cambridge University Press, Cambridge, 1972.

[59] Bauer (1981) op. cit. Chapters 5 & 6.

[60]. Adam Smith op cit Book IV; also B. Baysinger et al.,`Mercantilism as a rent-seeking society’, in Buchanan et al (eds) op. cit. pp. 235-68.

[61] G. Tullock in Buchanan et al. (eds.), op. cit., p. 48.

[62] Bauer (1981), op. cit., p. 144.