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He is the Chief Economic Advisor to the Government of India, Ministry of Finance, and C. Marks Professor of Economics at Cornell University. An outsider to the government machinery, Kaushik Basu talks about his frustrations, the changes needed to labor laws and the lessons to learn from our neighbors.

Entrepreneur (E): Our smaller home-grown industries have been hammered by cheaper Chinese products, while countries like Bangladesh are competing with our textile sector. What is the issue here and what do we do about it?
Kaushik Basu (KB): The most important ingredient for success in the sectors where we face competition from Bangladesh, Vietnam and China is infrastructure—both hard and soft. By hard infrastructure I mean the usual—ports, roads, rails and steady power supply. By soft infrastructure I mean the efficacy of the bureaucratic machinery—the customs work and the various permits one needs to send goods abroad. Delays in these can destroy the prospects of exports.

Export, as a sector, is very punctuality-dependent; this is especially true for textiles and apparel. The other factor that has hurt our manufacturing exports sector is our labor laws and, more importantly, the culture and norms they have spawned. They have disadvantaged our manufacturing sector and prevented it from reaping the full advantages of the economies of scale.

Actually it is the small to mid-sized firms that have been most adversely affected by these laws. Many of them do not apply to very small firms, so they are not affected by them; and the really big corporations have the money power to iron out the hurdles.

Ironically, it is the workers—in both the informal and formal sectors—who have lost out the most because of these laws. The laws have contributed to keeping the demand for labor low and, as a consequence, wages have remained low. It is trade unions that should be demanding more flexible labor laws. The rupee exchange rate also has played a role in restraining our exports sector.

E: Is the cluster development program really working?
KB: Cluster development is important to get some of the advantages of returns of scale. When you have several operations taking place in one area and infrastructure can be shared between different units, there can be large dividends. I do not think we have done well in this regard and I cannot give a one-line answer as to why we have not done well.

Bangladesh should be a good lesson for us since we have inherited similar histories. We have come out of similar colonial pasts and certainly sectors like textiles have done much better in Bangladesh. India still has some distance to go on this front.

E: So, are our policies lost?
KB: No. India has been doing very well in recent times. My frustration is that we can do even better if we can make some more reforms. A lot of our administrative systems were inherited from the colonial period, and we have not been dynamic enough to change with the times. Even the British have changed and updated most of these systems.

E: What are the challenges emanating from the WTO? Are Indian entrepreneurs geared up for the challenges?
KB: The ostensible aim of the WTO is to create a flat world, one in which there are minimal barriers to trade. I believe India is ready for such a flat earth. For Indian entrepreneurs, the aim must be to steadily improve corporate governance and to be relentless in quality control.

E: Are our tariffs and rates in sync with the world? If not, shouldn’t we bring them down?
KB: Our tariffs and duties are pretty competitive and comparable with the rest of the world. They were dramatically misaligned back in 1991, but since then there has been a steady move to lower the rates and make sure that India is not an outlier. There is still some distance to go on some fronts, but overall we are in sync with the world.

E: ‘Too much money, too few deals’ highlights the excess capital chasing Indian startups, and the lack of fundable deals. How do you deal with a situation like this?
KB: Capital for startups and even expansions continue to be limited in India. One particular route for raising money—to wit, the bond market—has been particularly deficient. Aggregate outstanding corporate bonds as a percentage of GDP constitute less than four in India. The same statistic for South Korea is 62 and for Malaysia it is 37. Our corporations and entrepreneurs will get a leg-up if we energize our bond market.

One fundamental prerequisite for transactions that take place over long tracts of time—such as bonds and mortgages—is an effective and quick contractual system.

Those who renege on contracts should be quickly brought to justice. If the state and judiciary are able to ensure just this, many different kinds of markets, including the bond market, would get a big boost.

E: Tax breaks and subsidies are some of the incentives the government doles out for the small businesses sector. Are there any other methods to spur entrepreneurs to greater heights?
KB: I am not in favor of using special tax breaks and subsidies to encourage different sectors. Taxes should, as much as possible, be the same across products and sectors. It is much better to help small entrepreneurs by increasing the efficacy of the bureaucratic machinery and by making our labor laws more flexible.

Let me stress that the growth of the small labor-intensive manufacturing sector is crucial for India. That is the best employment program that we can think of.
But we now know from experience—or at least I hope that we do—that we cannot achieve this through dicta and law. Rather, the government’s aim has to be to create an enabling ethos—by way of good infrastructure and effective contract enforcement—and this sector, which has the benefit of several natural advantages, will take off.

E: Is the availability of collateral-free loans an issue? What can be done about this? What pitfalls do we need to avoid?
KB: Collateral-free loans become possible only when the state—the one organization in modern society with the monopoly of violence, as Max Weber put it—is willing to use its powers of punishment to enforce contracts. In the absence of this, lenders will seek collateral; there is no escape from this.

©Entrepreneur June 2010

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Chief Economic Advisor, Cornell University, Government of India, Kaushik Basu, Ministry of Finance