Pro-crony policies: Poor lose, powerful gain

Pro-crony policies: Poor lose, powerful gain

India’s aspiration to become a $5 trillion economy depends critically on promoting “pro-business” policy that enhances market competition negating the “pro-crony” policies that favour powerful private interests, says the Economic Survey 2019-20. Such policies have robbed the people in road sector, particularly Pradhan Mantri Gram Sadak Yojana (PMGSY), natural resources allocation and banking through wilful default of over Rs 1.4 lakh crore.

India is a classic case of rise in pro-crony business policies, observes the survey, which hurts markets. It cites global evidence that political connections lead to rent extraction. A recent World Bank study of cronyism in Ukraine finds that the country would grow one to two per cent faster if all political connections were eliminated. The political connections help firms pay lower taxes and extract other favours in China, Thailand, Indonesia, Malaysia, Vietnam, the survey says.

It also blames the government intervention hurting the market’s capacity to generate wealth. Price regulation of drugs in 2013 increase drug prices and have done precious little to the high prices charged by hospitals. This pro-crony move is contrary to pro-business policies that increase competition, correct market failures or enforce business accountability, the survey says.

“Such policies may promote narrow business interests and may hurt social welfare because what crony businesses may want may be at odds with the same. For example, crony businesses may lobby the government to limit competition in their industry, restrict imports or competing goods or reduce regulatory oversight enhancing lobbying by crony groups to enhance their income and hurt market and welfare”.

The 1991 market “reforms” has caused more “creative destruction” as per the stock market trends, the survey analyses. “Before liberalisation, a Sensex firm was expected to stay in it for 60 years. It has decreased to 12 years post-1991”.

“Pro-crony has destroyed value in the economy”. It cites example of an equity index of politically connected firms. It outperformed the market by 7 per cent a year from 2007 to 2010, reflecting abnormal profits extracted at common citizen’s expense. The index, in contrast, underperforms by 7.5 per cent in 2011, “reflecting the inefficiency and value destruction inherent in such firms”. The Sensex, it observes, represents a process of creative destruction rather than dynamism. It is uncanny about galloping rises index during the recent years.

Pro-crony has hit the discretionary allocation of natural resources till 2011. “It led to rent-seeking by beneficiaries while competitive allocation of the resources post-2014 checked it” The survey finds the rise of the forces of creative destruction in the Indian economy leading to the rise of new sectors such as financial and information technology. Some of the recent UN reports have stated that financialisation and finance firms have grown with the fall in global economy.

The share market players need to understand that they cannot be long-term investors in a firm. These remain dominant for only one-fifth of the time than their pre-liberalisation firms did. New sectors are emerging and difference between the sizes of the largest and smallest firms are rapidly shrinking.

The survey finds that political clout and preferential allocation of contracts has paid in road construction in India since 2001. Lehne, Shaprio & Eynde (LHY) examined bidding data on 88,000 rural roads built under PMGSY and juxtaposed data with election results. It finds that after close election victories, contractors affiliated to the winning politicians are more likely to be awarded road projects.

A comparison with Census 2011 data finds that several village roads recorded complete in PMGSY monitoring data are missing from the Census, “suggesting that these roads were never actually built or completed”. Around 26 per cent of the roads listed as completed are missing from the Census data.

The LHY study finds that preferential allocation accounts for 497 missing roads that could have benefitted 8.6 lakh people. It indicates that politically influenced PMGSY projects lead to sub-optimal economic outcomes. Allocations that started with Rs 3000 crore in 2000 have swelled to Rs 80,250 crore in 2019-20.

The LHY finds irregularities in coal and other natural resource allocations to unlisted foreign individuals, domestic or foreign enterprises. It also detected evidence of one-time payments to directors like commissions, perquisites and consulting expenses through the discretionary allocations. Though the companies’ salary expenses do not rise, director commissions increase by 12 per cent, perquisites by 5.7 per cent and other consulting expenses by 7.6 per cent.

The market share of firms declined between 1993 and 2011. But the committee-based allocations saw windfall gain from discretionary allocation. The total firm incomes declined by 54.9 per cent, expenses came down by 58.7 per cent and profit after tax 37.8 per cent. Total assets reduced by 76.2 per cent, land and building reduced by 48.2 per cent and plant and machinery by 51.1 per cent.

The competitive auctions, however, do not decline. Overall the evidence suggests that discretionary allocations of natural resources by a committee provide avenues for rent-seeking. Similarly crony lending led to wilful default by many Indian firms causing a loss of Rs 1.4 lakh crore to the lenders. The Reserve Bank of India says that these firms do not repay despite having capacity to honour obligations. Every rupee lent to such firms causes erosion of wealth.

The value of pledged shares falls when the firm is in distress. As the promoters have no personal liability beyond their pledged shares, they care little. Any reduction in their wealth is offset by rents they already extracted. Even they are least bothered about losing control of the company as they have extracted rents before the share price collapse.

Another way is to give loans to related parties. These are secured for them and help the company go into losses. Had the money thus siphoned away stayed in the economy it could have doubled the allocation towards health, education, rural development or MGNREGA.

Such defaulters pledge almost 50 per cent of their shareholding to lenders (banks) whose actual value had eroded. The cost is borne by the public sector banks funded by the common man. The survey says that rich businesses that want to get richer use wilful default as an instrument to redistribute (steal) the wealth away from the poor.

In Indian scenario, adverse selection may force genuine borrowers to exit the market altogether, leaving cronies in the market and resulting in a market failure that slows economic growth, employment and wealth creation capacity.



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Pro-crony policies: Poor lose, powerful gain