Economic opening, starting in 1991, may have created wealth in India. But it hasn’t created a political constituency for reform.

The Indian government’s annual budget statement later this month will mark close to 20 years since India finally turned its back on most of the economic policies that had placed it on the edge of an abyss in the early months of 1991.

The dramatic liberalization of that year and further policy changes by governments in the late 1990s were a smashing success in some ways—India has a far more stable economy and is far more prosperous than before. But the failure to push reforms over the past six years, along with the shortcomings of past reforms, tell us a lot about why liberal economic policies have little political resonance in India.

Say what you will about the quality of reforms, India has come a long way since 1991. Back then a profligate government, an uncompetitive and heavily protected economy, high tax rates, an overvalued exchange rate, and sudden capital flight had brought India within 15 days of an embarrassing default on its international loans. In response, the government cut tariffs, did away with industrial licensing and opened the economy up to foreign investment. Though New Delhi is battling similar problems today—a large budget deficit and a wide current account deficit, for instance—the Indian economy is on a much firmer footing thanks to the discipline imposed by those reforms.

These reforms are paying off not only at a macro level but also for individual poor households. Average dollar incomes have more than tripled since 1991. Diets have improved and more proteins are being consumed. School enrollment has soared. Human development indicators increased more in the first decade of the current century than they did in the 1990s. The demand for basic consumer goods is rising. Mobile phones, watches and ceiling fans are common possessions in poor communities.

Yet the so-called 1991 Big Bang, and the reform process since then, left a lot undone. In the past few years especially, the Congress Party-led government of Prime Minister Manmohan Singh, the finance minister who helped introduce many of the most dramatic reforms from 1991-93, has lost its nerve for liberalization. Several important second-generation reforms, like the introduction of a unified goods and services tax that will finally stop distorting the tax incentives of producers, have not progressed since the Congress came to power in 2004.

More importantly, Mr. Singh has done nothing to liberalize India’s labor laws, the key impediment to job creation. A plethora of labor legislation enacted since India’s independence in 1947 makes it very difficult for firms to hire and fire people as they wish. Laws to protect existing workers have kept new workers out of jobs. Because of these laws, manufacturing firms have preferred to substitute otherwise cheap labor with capital. So even when India’s companies grow, they aren’t taking its workforce along.

Meanwhile, the government still struggles to provide basic public services. India is terrible at making sure its citizens have the opportunity to go to schools or hospitals, or even have drinking water. In some cases, it can’t even promise law and order. These problems add an edge to the old complaint that the Indian state does too much in the economy and too little in governance. So reordering priorities should involve further economic reforms on the one hand and governance reforms on the other.

The major problem now is that these earlier reform failures are creating political conditions where it may be harder to push forward with more liberalization. India’s biggest political-economy puzzle, and also one of its most serious challenges, is that earlier reforms have not created an effective political constituency for further reform. Voters consistently reward candidates promising greater welfare benefits or government intervention in the economy.

Why reformers don’t win votes is clearest in the labor market. Even if the potential reform constituency now has phones and consumer goods, it doesn’t have steady employment. Manish Sabharwal of staffing firm Teamlease Services points out that one number has stayed constant despite all the positive change in India over the past two decades: 93% of working-age Indians, estimated now at 500 million, continue to work informally—outside of the organized sector and without proper labor contracts.

This lack of modern employment opportunities, coupled with poor public services, has denied millions the upward mobility that was seen in most other Asian countries. Unemployed or underemployed Indians, still living an abject life without much dignity, look at the hype surrounding the Big Bang and wonder what was in it for them.

This disconnect between rising aspirations and the inability to meet those hopes quickly enough gives rise to a fault line in Indian politics. Politicians happily exploit it: Rather than summoning the will to push through reforms that would address the roots of the problem, it’s easier to pitch illiberal spending and subsidies as an easy “fix.”

This explains measures that already have moved India backward from its reform progress, including entitlements proposed by Mr. Singh himself despite his reform leadership in the early 1990s. The most obvious example is the rural employment guarantee scheme his government started in 2005, essentially paying the rural poor to work whether or not any actual work existed for them to do.

In 2010, the government passed the Right to Education Act, which empowers public teachers without caring for student enrollment and retention. And for the past two years, it’s been contemplating a right to food act that would dramatically expand the current food subsidy regime, which already costs 500 billion rupees ($11 billion) a year. Expansions of all these programs depend on a thin tax base that could stretch state finances to the breaking point.

Will the new entitlement state affect India’s post-liberalization story? The first decade after 1991 saw growing personal consumption as more Indians put the raw struggle for survival behind them. The second decade saw families invest in the future by raising their spending of services such as education and health. The third decade is now upon us. If India can’t overcome the current political inertia surrounding reform, this decade won’t see the positive strides the last two saw.

Of course, there is the possibility that the widening arc of prosperity will encourage voters to look beyond entitlements—to seek leaders who deliver more secure futures through expanded opportunities and better infrastructure. This has already started happening at the state level. Last November voters in Bihar, one of India’s most backward states, re-elected Nitish Kumar, a leader who had reformed governance and who had managed to woo investors. In Gujarat, Narendra Modi’s solid economic credentials have translated into political gains.

If this keeps up, national-level politics could change too. But for the moment, India still is waiting for national-level politicians who understand the importance of pushing forward with a second generation of reforms.

Source: The Wall Street Journal

–  Niranjan Rajadhyaksha, Managing Editor, Mint