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Greater Economic Freedom Can Fuel India's Economic Growth

14/01/2015 12:00 AM IST | Updated 15/07/2016 8:24 AM IST
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Co-authored by Natasha Srdoc, co-founder, International Leaders Summit and Becky Norton Dunlop, vice president, The Heritage Foundation and former director of the White House Cabinet Office, President Ronald Reagan. 

Traveling through India in December 2014, we met with entrepreneurs of new start-ups, established business leaders, young professionals, state government cabinet ministers, university professors, faculty, students and citizens. What they all have in common is hope for India's future. In facing major obstacles, they unanimously raised concerns about a dysfunctional infrastructure, bureaucracy, red tape, and widespread corruption. 

 

Bangalore's success as India's Silicon Valley and home to innovative companies such as Biocon (Asia's largest biotechnology company with a market value of $1.4b), defies the obstacles to doing business in India. Reverse brain drain attests to the high growth expectations for the immediate future. Left largely unregulated, Bangalore's IT business thrived and gave birth to world known companies such as Infosys and Wipro. Infosys ranked as the 18th-largest IT services provider globally by HfS Research in 2013 and among the top-20 of the world's most innovative companies in 2012 by Forbes magazine. Wipro's market capitalization, approximately $20.8 billion as of March 2014, makes it the seventh-largest IT services company in the world. Bangalore exemplifies human and intellectual capital, entrepreneurial and innovative spirit with thousands of highly-educated Indians flocking to the city every year.

 

Prime Minister Narendra Modi's articulated priorities of economic growth and good governance struck a chord with India's voters in last year's elections. With 10- to 15-million people entering the job market every year, India's government must act fast to remove barriers to new job creation and create an environment conducive to dynamic economic growth. 

 

Decades of experience and research in economic development and transition economies provide a clear template of principles needed to achieve higher levels of economic growth. The Heritage Foundation/The Wall Street Journal's Index of Economic Freedom classifies these principles in four broad categories over which governments typically exercise some policy control: rule of law, government size, regulatory efficiency and open markets. These categories incorporate 10 specific components of economic freedom.

 

India's government must protect private property rights - real and intellectual. Individuals and businesses have to rely on the protection of property rights, enforcement of contracts and an independent and effective judiciary to plan their economic activity with certainty. Government transparency and accountability should serve as mechanisms to combat corruption. Greater freedom from corruption will reduce the costs of doing business in India. 

 

In order to increase its fiscal freedom and competitiveness, India should reduce the top marginal income tax rate as well as its corporate tax rate. The 32 percent corporate tax rate discourages foreign direct investment. Privatizing state-owned enterprises in steel,  rail and the energy sector (including coal and oil companies) and eliminating wasteful subsidy programs will both reduce government spending and increase economic freedom. Legislation initiating this process needs to be presented urgently to demonstrate the government's commitment. The Modi government's first full budget to be submitted in February should incorporate these reforms.

 

To increase business freedom, India's government needs to reduce the time, number of procedures and costs of starting a business and obtaining construction and other necessary licenses. The government has announced a goal of cutting the average time it takes to start a business to one day - a very positive development. 

Streamlining the tedious license approvals and reducing the time needed to enforce contracts have to be among the top priorities to improve business environment. In enforcing contracts, India ranks 186 out of 189 countries in the World Bank's Doing Business 2015 report. In reviewing the report, India can follow the example of a number of countries that have made enforcing contracts easier, timely, less costly and more transparent by introducing an electronic filing system, enabling electronic submission, registration, service notification and access to court documents. India also should significantly reduce the number of procedures - now totaling 27 - currently needed to obtain construction permits and make the permits  available at a minimum cost to investors. The current process takes on average over 162 days to complete - a wholly unnecessary delay.

People should be free to change jobs as they wish. Entrepreneurs and companies should be free to employ as many employees as they need for as long as they require. All these will achieve greater labor freedom. To increase monetary freedom, an independent central bank should keep the inflation rate at a low level. Meanwhile, prices should be determined by the demand and supply in the market. India's government should stay clear of controlling the price of any goods or services.

 

India needs to open its markets to free flow of goods, services and capital. Increasing trade freedom, by reducing tariffs and non-tariff barriers, will benefit India's citizens and companies by lowering the price of imported goods and services for consumption and industrial input. 

India should also increase investment freedom. Investment capital should be free to flow to and out of India, should be treated equally, whether it is domestic or foreign, should flow to any sector of industry and can be used to purchase real estate. Profits should be repatriated freely and without exchange controls. Finally, India would increase its financial freedom by privatizing state-owned banks, opening its financial markets to foreign investors and eliminating government interference in the allocation of credit.  

 

A better tax system is a top reform priority mentioned by Modi. Meeting India's infrastructure needs is estimated to require $1 trillion, to be funded by a combination of government spending and foreign direct investment. India can augment both financial sources  - tax revenues and FDI - by implementing a flat tax. A lower flat tax rate on personal and corporate income provides incentives to work, save and invest, increases economic activity, improves tax collection, attracts FDI and leads to higher levels of economic growth, which in turn fuels greater tax revenues. Broadening the tax base by eliminating tax exemptions and various loopholes, while at the same time reducing the tax rate, has enabled governments to collect the same tax revenues or even more in just one year after the implementation. Transition economies which introduced the flat tax managed to collect additional tax revenues from previously undeclared economic activities which surfaced from the informal sector. The single flat tax rate makes it simple to file taxes, eliminates bureaucracy and red tape, and reduces corruption. 

 

India's political realities will be driven by its economic realities. Modi envisions transforming India's economy in just 10 years. To accomplish that, his government needs to ride the wave of optimism among Indian citizens, create an environment for faster economic growth, and, provide good governance, which can be measured in time for the next parliamentary elections. 

India's citizens have demonstrated their readiness to embrace opportunity for all and favoritism for none. India's government received a mandate to make it happen.

Co-authored by Natasha Srdoc, co-founder, International Leaders Summit and Becky Norton Dunlop, vice president, The Heritage Foundation and former director of the White House Cabinet Office, President Ronald Reagan. 

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