LICENSE RAJ: PLANNING A PLANNED ECONOMY FOR INDIA

In today’s world, it is no secret that corruption and nepotism in Government are rampant, and money laundering, cash-for-vote, and foreign bank accounts are so commonplace that it serves almost as an alternate source of funding for many Government officials. However, going back to the 1940’s, one of the major political changes taking place in the world was the independence of India. India had demanded Total Independence from the British, and India’s potential prime-minister Jawaharlal Nehru’s cabinet was deciding upon the choice of economy, appropriate for the newly independent country. Socialism in Russia, seemed to be failing, but Jawaharlal Nehru decided that India would remain Socialist economically, partly in order to protect domestic industries from foreign competition and partly to flood his foreign bank accounts with money. The buck however, did not stop there and Nehru demanded a planned economy, where all aspects of the economy were controlled by the government, in many cases, the amount of output a company must produce, or the amount of Backward Class ‘OBC’ students accepted by private universities.  This era of elaborate licenses and permits needed to run businesses, quotas and subsidies implemented on certain industries and goods, and the accompanying regulations and red tape came to be known as the License Quota Permit Raj or the License Raj. This was an era where growth of powerful industries and wealthy business houses became stagnant, and the economic growth of India jolted. Excessive government intervention and extreme regulation bred corruption, and bribery became an integral part of conducting business.

Historically, the License Raj lasted for 40 years, and I would like to discuss the impact on industrial growth during a specific time frame, and talk about two of the most important policies of the License Raj; the Quota in the Education segment and the diesel subsidy. In the paper, I will talk about how these policies, although designed to help the people of India, actually benefitted only the corrupt politicians and businessmen. I will begin with the quota imposed in educational institutions and the impacts of the same and then discuss the diesel subsidy which became the main cause for adulteration and price hikes in the petroleum and diesel industry.

            In India, the education system is extremely competitive and highly complex as well. However, when India gained independence, Hindus living in Pakistan, had decided to migrate to India. Since, partition was a sudden decision, Indians in Pakistan and Pakistanis in India had little time to wind up their belongings before migrating to the country of their choice. The situation post partition became chaotic and riots broke out in both countries. The result was

rich, aristocratic families on either side of the border became paupers when they were forced  to migrate to the other side of the border leaving them with nothing but food and a pair of clothes. Appalled by the situation, the government decided to impose a quota or reservation in the educational institutions

The figures shows the effects of a quota. When the quota was implemented the price of education  soared, and this pressured deserving students to come abroad for education.

During the discussion of its implementation, this quota was based upon social class, and in its early days it also included a quota for the poor and the economically disadvantaged. Although, when they were implemented, the condition set by the government was that with the efflux of time, they would gradually reduce the quota. As it turns out, they were never reduced. When the government, imposed the quota, the price of education went up and those in the ‘Backward Classes’ (minority community) got admitted into a university based on the quota requirement. However, as I mentioned above, this bred corruption. With the price of education higher, those who could not be a part of the quota were at a loss. This is because, in India, the number of good universities compared to the number of students competing is extremely less. However, with a higher price being charged for education, those students belonging to wealthy families could afford the higher tuition. Also, those students who couldn’t qualify for a particular university’s admission requirements, could still pay donations to corrupt officials and university trustees and a higher tuition and get a prestigious seat, which ideally belonged to a student who had more merits in comparison but less than the regular students on account of social or economical disadvantages. The result, commencement of a self-devastating system. Students who got admitted through the quota, were neither qualified nor interested in education, but got certificates and guaranteed jobs, only because of their social status. On the other side of the scale, those who did not belong to the quota, were also unqualified but could get admissions because they could afford higher tuitions and paid huge donations to the universities. What happened, in turn, was a natural byproduct. As more students utilized the quotas, the more competitive the system became and the price of education soared high. Thus the number of seats available for average student belonging to middle income families greatly reduced marring the progress of the nation’s steadily growing middle class. Eventually, those who couldn’t afford the donations and high tuition, turned their attention abroad. The benefits of studying abroad were very similar, and the cost and pressure were really low and admission was guaranteed. Over the years, the population of Indian students in abroad increased rapidly and private institutions in India, suffered with heavy quotas but extremely poor talent.

            Even today, 65 years after India’s independence, students still get guaranteed admissions into universities based on their Social Class, despite the fact that most of them come from extremely prosperous families. With a fast-developing India, the quota has not been abolished; in fact, India’s Finance Minister proposed to increase this quota to a staggering 15%. With admissions getting more and more competitive, family wealth becomes a key factor for admissions, and with that the pressures on merit students increases, with very many students committing suicide despite getting in their high 90’s in grilling exams. Thinking about this in a long term, the country will end up with a middle class that will be under-qualified to run the country. Thus, when people think of an import quota, they generally think that domestic prices increase with a quota, and this helps the survival of domestic firms. However, the example above is one instance where, the implementation of a quota, led to a total disaster.   

 *Fig 1: Supply increases by an amount equal to that of the subsidy. Quantity increases and price falls benefitting consumer

A subsidy can be defined as a benefit by the government to groups or individuals usually in the form of cash payments or lower taxation. This benefit is usually provided by the government to remove some type of burden on the business, in order to incentivize firms to produce products. The way this works is, when the government provides benefits, the firms lower the price on their goods which may be done to provide cheaper goods for the population or may be done to help domestic industries sell at a lower price thereby protecting it from foreign competition. A once self-sustaining nation in terms of food, India, with a rapid explosion of population and migration saw its food reserves fast shrinking, and with higher demand the prices charged for these food products skyrocketed. The poor were unable to pay the prices, and this is when the government, subsidized food products like wheat, sugarcane and vegetable oil and other necessary products, thereby giving the poor an opportunity to purchase these goods at extremely low prices, through the government’s shops. The result, food and other basic necessities were available to the poor and the well-to-do families, and the farmers producing rice were not hurt by selling their crop for a really low price as they receive benefits from the government. One excellent example of such benefits was that, in recent years the government has abolished all income taxes for farmers to protect them from suffering the brunt of low prices. Subsidies, however, generally prove beneficial to the common people. Keeping this in mind, the government of India, also subsidizes diesel, CNG etc. as a whopping 92.3% of the transportation trucks in India run on diesel, and according to a 2010 survey of the cars manufactured in India, 67% of cars produced by Tata Motors, 83% of automobiles produced by Hindustan Motors, and all automobiles produced by Ferodia Motors utilize diesel for their engines. Since vehicles produced by Tata Motors are purchased by families for personal consumption, the government has subsidized diesel for all citizens for both commercial and personal consumption. As India is not endowed with rich deposits of crude oil, it imports crude oil from the Middle East nations, most prominently from Iran, and then sells it to Indian state-owned petroleum companies like Indian Oil Corporation or the Bharat Petroleum Companies Limited or Hindustan Petroleum Companies Limited and also privately owned corporations like Tata Petrodyne etc. which have units that chemically process the crude oil and convert it to diesel. This process is extremely expensive and owing to the costs and the available demand, most companies would want to steer clear of producing diesel. However, this is where the government intervenes by providing firms with a subsidy of Rs. 6.08 per litre of diesel, which on an annual basis costs the government Rs. 52,365 crores. Thus, going by the current price of diesel in Mumbai city, India, a litre of diesel costs consumers Rs. 45.99 with the government subsidy, and would cost them Rs. 51.07 on average, without the subsidy. Assuming a truck oil tank needs 400 litres of oil, the cost savings with the subsidy for one trip to the gas station would be Rs. 2032. However, due to corruption in India, the firms charge a higher price than that determined by the government, and so companies reap benefits from both the government and the consumers. This subsidy, therefore, incentivizes the firms to supply more diesel in the market shifting the supply to the right by an amount equal to that of the subsidy. This reduces the firm’s cost of chemically processing the diesel and they are willing to produce more at lower prices. This however, results in heavy consumption of diesel because of its lower price but it adversely affects the price of other petroleum products like CNG or petrol. Without any subsidy the price of petrol in Mumbai, is Rs. 70.65 per litre, with a very likely Rs. 8 price hike in the next year. Although the transportation industry is heavily dependent on diesel, a stumping majority of family cars have petroleum engines, and such price hikes make lives on the other side of the spectrum difficult.

However, the impact that this had was that with diesel being subsidized, and the amount of cars being run on petrol being used more and more, the people of India were required to pay more for petrol and demand increased even at higher prices. 

 

This was one of the most unusual changes seen in the demand for a product, that despite higher prices, the demand not only for petrol, but the demand for cars that ran on petrol also saw a tremendous rise. The graph above shows the rise in prices of petroleum over the years, and also shows the corresponding rise in demand for petrol and petroleum operated cars. This, in economics, is sometimes referred to as the dual-role of prices and is derived from the common wisdom – the more sugar you add, the sweeter it gets and you get what you pay for. What happened, during this time frame was interesting because, people’s demand for higher priced petrol and more expensive petrol cars, proved that this was a direct effect for the proposition that consumers perceive high prices to be associated with higher quality. Looking at a graph of where consumption of diesel is coming from, it is pretty clear that automobiles constitute a rather large fraction, about 15%. However, in metropolitan areas, where petrol consuming BMW cars, have a six-month waiting, the government is coming to a conclusion that diesel operated cars are fast becoming obsolete and that the government might save a lot of money by discontinuing the subsidizing of diesel on personal consumption. As mentioned above, discontinuing the subsidy on 15% of the diesel usage, the government can save annually save Rs. 7,800 crores which can certainly be used to regulate the cost of petrol, or can be used to make LPG gas cylinders less expensive, so even the poor can afford to cook using LPG. 

A look at the graph to the left sparks a question in one’s mind, as to why did India subsidize diesel and not petroleum, after all, the use of diesel in agricultural equipments and mining equipments, was not nearly as high as it is today? The most important reason is corruption. The Indian business fraternity during its early years of independence contained only a few big names, most of them large business houses, like the Bajaj family, the Tata family and most importantly, the Birla family. During the early days of free India, only two companies produced all the automobiles that ran on Indian roads, the autos and trucks built by Bajaj Auto, and the infamous Ambassador car manufactured by the Hindustan Motors of the Birla family. Both families were known for their extremely influential political connections and very close ties with Mahatma Gandhi and Mr. Nehru. During the early years of independence, there was a lot of pressure from foreign companies to establish manufacturing in India. This would significantly impact automobile manufacturers in India, who had little technological power. The License Raj provided an opportunity to the Birla family to maintain their monopoly by producing diesel operated cars thereby beating foreign competition and with a diesel subsidy, the public chose diesel vehicles, keeping the Hindustan Motors profitable, and maintaining a monopoly allowing them to thwart any entry in the market. The result? For an odd 25-30 years, Hindustan Motors produced the same car, the Ambassador, to the public, and in the 30 year span, the car had little improvement in technology. With no investment in technology and production facilities, the company became extremely profitable, earning revenues of Rs. 1200 Crores year over year, becoming India’s largest conglomerate. Slowly and steadily, as Indian people began importing foreign cars, the Ambassador lost its market share, yet again through bribery they eventually got a government contract, where all government vehicles, were Ambassadors and I believe, India is the only country, where a car with no demand in the market, can survive for a record 60 years without any change in the design. Although, its hard to put a number to the loss, many economists and Finance ministers widely believed that the License Raj cost the industry over Rs. 24 lakh crores (which turns out to roughly $ 115000000000000 ) that could have been used for the betterment of the people.

Jawaharlal Nehru, once said, being skeptical of Capitalism:

“The forces in a capitalist society, if left unchecked, tend to make the rich richer and the poor poorer.”

However, a planned economy under the control of a greedy gerontocracy is even more volatile and tends to create more inequality. The checks and balances, after all, are held by the corrupt who only turn a blind eye and deaf ear to corruption. Every economy needs to be regulated by those who are outside the circle of influence.