Order, order, order

The last 17 years of reforms have transformed India, but we still have a long way to go. There are different areas where reforms are still needed. As we approach the next general elections, it is pertinent that we take stock and identify 'second-generation reforms' that would have the highest multiplier effects.

So what are these second-generation reforms all about? The first 17 years were about withdrawing an overextended state. 'Liberalisation' and 'reform' meant the same thing in this stage. There is still some unfinished business from the first generation, but second-generation reforms are a fundamentally different set. They are about adjusting institutional arrangements in order to support the 'market-based' economic system that has emerged. This is about building a healthy relationship between the state and civil society in general, and the economic system in particular.

Perhaps the most important role that the post-liberalisation state fills is the provision of general governance. One need do no more than read Kautiya's Arthashastra or Adam Smith's Lectures on Jurisprudence to realise how much emphasis even the earliest economists placed on the state's role in ensuring general governance. The legal infrastructure is the key institutional framework through which the state provides general governance. The legal system includes both the rules of engagement (like laws and regulations), as well as the enforcement of these rules (like police and judiciary). This is especially important when economic resources are no longer being allocated by administrative diktat, but by a series of market contracts.

The legal system can be an agent of change in common-law countries like India. This is a role that is often ignored by economists because the legal system is seen as the blind and passive enforcement of a static body of rules. However, in the English common-law tradition (India firmly belongs to this camp), each judgment creates a precedent that can be used in future cases.

Time to take a hard look

As every Indian knows, two things are necessary for a good game of cricket—a set of consistent rules that are understood by everyone and even-handed enforcement (that is, good umpires). This is also true for the economic game. Unfortunately, the Indian legal system fails on both counts.

India has a very large body of laws and regulations. Given the federal constitutional arrangement, there are national-level laws, as well as state-level laws. In addition, there are a plethora of rules, regulations, orders and administrative instructions issued by various government bodies. Many of these laws were introduced in the 19th century and still provide the legal framework for activities that were never imagined at that time.

Furthermore, there is little internal harmony or consistency. Many laws contradict each other. Some areas are over-regulated, while others do not have meaningful laws. For instance, there are almost 50 labour-related laws just at the national level, together with associated rules and regulations. In addition, there are a plethora of state-level laws and administrative directives. On top of these, there are several other state and Central laws that indirectly affect labour, such as the Dangerous Machines (Regulations) Act 1983. Note that I am not commenting here on the content of these laws. That is a large area of debate in its own right. I am merely pointing out the sheer complexity of the legal framework related to the simple, routine act of employing workers.

Not surprisingly, such a confusing body of law makes it difficult for everyone to understand the rules of engagement. Even if people were diligently law-abiding, it would be virtually impossible for them to function without knowingly or unknowingly breaking some rule. Indeed, much of the call-centre outsourcing business is technically illegal, according to some state laws. In 2005, the Haryana Labour Ministry invoked Section 30 of the Punjab Shops and Commercial Establishments Act, 1958, to disallow women from working night shifts at call centres in Gurgaon.

Failure on most fronts

There are even greater problems with enforcement. The Indian judicial system is infamous for the very slow pace of processing even routine cases. As a result, there are over 25 million cases pending in the courts. This figure does not include the cases stuck in various tribunals and quasi-judicial bodies.

It is not just delays that are a concern, but also the systematic failure to deliver justice, especially in the criminal justice system. Two-thirds of jail inmates are under-trials being forced to live in jail, as they cannot afford bail or do not have the legal support to apply for it. Many of these prisoners have been in jail for years without coming to trial and some may have long exceeded the maximum sentences for their alleged crimes. Meanwhile, the judicial system seems unable to identify and punish genuine offenders. According to Bibek Debroy, the conviction rate is less than 5%!

Given all the issues discussed above, there is no doubt that the legal system needs to be reformed. However, this is even more relevant in post-liberalisation India, where we expect a market-based economic arrangement to bring prosperity to the country, particularly to the poorest sections of society. As pointed out by economists like Hernando de Soto, market-based systems work to reduce poverty only when there is an integrated formal system of enforcing contracts (particularly property rights).

Unfortunately, legal reform is usually seen as peripheral to the economic reforms process. In my view, however, this is probably the single most important area requiring attention, and it would have dramatic multiplier effects through the rest of the economy. The roles played by the Reserve Bank of India and Sebi in improving the functioning of the financial system in the last 10 years illustrates how a good set of rules and their even-handed enforcement can dramatically improve performance.

What makes this idea even more attractive is that it is unlikely to require a great deal of additional public expenditure. No formal estimates are available of how much money would be needed to set the judicial system right, but my guesstimate is that to stabilise the judicial backlog at current levels would need an additional allocation of about 0.12% of GDP worth of fixed investment and around 0.06% worth of annual recurring costs. Even if the actual amount is a multiple of this guesstimate, it would still be a very small amount of money compared to the likely systemic gains. Besides, it would probably pay for itself through increases in court fees and general tax collections.

October 15th, 2008

by sanjeev sanyal