Coalition governments have outperformed single party rule

TCA Sharad Raghavan in The Print

The perception that coalition governments are prone to going slow on reforms and see slower economic growth is not borne out by the data, an analysis by ThePrint has shown.

In fact, gross domestic product (GDP) in aggregate and within key sectors of the economy averaged faster growth during the coalition government periods of 1990-2014 than in the stable, single-party-majority periods that preceded or followed this phase.

Further, analysis shows that this coalition phase also saw a number of reforms that spanned sectors and that had profound impacts on the economic progress of the country.


 

The issue of coalition versus single-party-led governments has again come to the fore since the Bharatiya Janata Party — which formed the majority in the Lok Sabha from 2014 to 2024 — failed to reach the majority mark in the 2024 Lok Sabha elections. With 240 seats, the BJP will need to rely on a coalition with its National Democratic Alliance (NDA) partners to form the government.

Following these results, a few ratings agencies issued comments about how a coalition government would result in delays in key reforms.

Christian de Guzman, Senior Vice-President at Moody’s Ratings, for example, said that the NDA’s “relatively slim margin of victory, as well as the BJP’s loss of its outright majority in parliament, may delay more far-reaching economic and fiscal reforms”.

Fitch, for its part, said that the return of Prime Minister Narendra Modi with a weakened majority “could pose challenges for the more ambitious elements of the government’s reform agenda”.

The analysis of the coalition period in India’s history, however, shows these fears may be unfounded.


Also read: Adani Group sees Rs 3.6 lakh cr wiped out from market cap on counting day as BJP faces poll setback

Stronger economic growth

India saw its first phase of political stability at the Centre — defined as a single party forming the majority — between 1952 and 1989, when the Congress itself formed the government for around 90 percent of this period.

This phase, however, saw India’s GDP growing at a compounded average rate of growth (CAGR) of just 4 percent — derisively called the ‘Hindu rate of growth’. The CAGR is the rate at which the economy would have to grow every year since 1952 to reach the level it was at in 1989.

The next phase, of coalition governments, spanned the period 1989 to 2014. This 25-year period saw as many as eight prime ministers (counting Atal Bihari Vajpayee twice for his two separate terms), and as many governments coming to power. Each was formed on the basis of a coalition.

This shaky phase at the Centre, however, saw GDP growth accelerate to 5.8 percent compounded annually. Further, a sectoral breakup also shows that this faster growth was spread across key sectors of the economy rather than being driven by just a few.

The agriculture sector and mining sectors, for example, grew an average of 2.7 percent during the first stable phase, and accelerated to 3 percent during the coalition phase. Similarly, the industrial sector — comprising manufacturing, construction, and utilities — saw growth speeding up from 5.3 percent to 6.4 percent over these two periods.

The key services sectors such as trade, hotels, transport, communication, financing, real estate, professional services, and public administration all saw growth quicken during the coalition period.

Growth slows again, dragged by pandemic

The next phase of stability came with the historic victory of the BJP in 2014, having secured a single-party majority with 282 seats in the Lok Sabha. It returned to power in 2019 with an even larger majority of 303 seats.

This decade, however, saw average growth slowing to 5.1 percent, although this was heavily influenced by the 5.8 percent contraction in GDP in the COVID-19 pandemic-impacted year of 2020-21. That said, the first period of stability also saw such an outlier year, when GDP contracted 5.2 percent in 1979-80.

Apart from agriculture, which continued to accelerate under the Modi government, all other sectors of the economy saw slower average growth in the 2014-24 period than in the preceding 25 years.
Coalitions have been reforms-focused too

The coalition government under Narasimha Rao during the period from 1991 to 1996 is remembered primarily for the scope of economic reforms implemented during its tenure.

These include the dismantling of the ‘licence raj’, the opening up of the economy to the private sector and global investment and competition, and providing banks the freedom to determine their own interest rates, among other wide-reaching reforms.

The H.D. Deve Gowda-led coalition in 1996-97 saw then Finance Minister P. Chidambaram present what is now called the ‘dream budget’ in which he slashed the marginal income tax rate for individuals, cut corporate tax rates, reduced peak customs duties, and introduced the Voluntary Disclosure of Income Scheme (VDIS) aimed at curbing black money.

Next came the first government of the NDA under PM Atal Bihari Vajpayee, spanning 1999 to 2004. This government saw the groundwork laid for the ambitious golden quadrilateral highway project, the introduction of the National Telecom Policy, which ended government monopoly over the sector, raised foreign direct investment limits in banking and insurance, and put in place the Fiscal Responsibility and Budget Management Act, the provisions of which are largely followed even today.

The Congress-led United Progressive Alliance (UPA), in power from 2004 to 2014, rolled out the Value Added Tax (VAT) — the precursor to the Goods and Services Tax (GST) — across the country. The price of petrol was deregulated in 2010, allowing it to be linked to the market price of oil.

Several rights-based reforms were also introduced during this period, including the Right to Information (RTI), the Right to Food, and the Right to Education.

The Economist examines India's Economic Performance

 From The Economist

In the second week of 2024 business leaders descended on Gujarat, the home state of Narendra Modi, India’s prime minister. The occasion was the Vibrant Gujarat Global Summit, one of many gabfests at which India has courted global investors. “At a time when the world is surrounded by many uncertainties, India has emerged as a new ray of hope,” boasted Mr Modi at the event.

He is right. Although global growth is expected to slow from 2.6% last year to 2.4% in 2024, India appears to be booming. Its economy grew by 7.6% in the 12 months to the third quarter of 2023, beating nearly every forecast. Most economists expect an annual growth rate of 6% or more for the rest of this decade. Investors are seized by optimism.

The timing is good for Mr Modi. In April some 900m Indians will be eligible to vote in the largest election in world history. A big reason Mr Modi, who has been in office since 2014, is likely to win a third term is that many Indians think him a more competent manager of the world’s fifth-largest economy than they do any other candidate. Are they right?

To assess Mr Modi’s record The Economist has analysed India’s economic performance and the success of his biggest reforms. In many respects the picture is muddy—and not helped by sparse and poorly kept official data. Growth has outpaced that of most emerging economies, but India’s labour market remains weak and private-sector investment has disappointed. But that may be changing. Aided by Mr Modi’s reforms, India may be on the cusp of an investment boom that would pay off for years.

The headline growth figures reveal surprisingly little. India’s gdp per person, after adjusting for purchasing power, has grown at an average pace of 4.3% per year during Mr Modi’s decade in power. That is lower than the 6.2% achieved under Manmohan Singh, his predecessor, who also served for ten years.

image: the economist

But this slowdown was not Mr Modi’s doing: much of it is down to the bad hand he inherited. In the 2010s an infrastructure boom started to go sour. India faced what Arvind Subramanian, later a government adviser, has called a twin balance-sheet crisis, one that struck both banks and infrastructure firms. They were left loaded with bad debt, crimping investment for years afterwards. Mr Modi also took office at a time when global growth had slowed, scarred by the financial crisis of 2007-09. Then came the covid-19 pandemic. The difficult conditions meant average growth among 20 other large lower- and middle-income economies fell from 3.2% during Mr Singh’s time in office to 1.6% during Mr Modi’s. Compared with this group, India has continued to outperform (see chart 1).

Against such a turbulent backdrop, it is better to assess Mr Modi’s record by considering his stated economic objectives: to formalise the economy, improve the ease of doing business and boost manufacturing. On the first two, he has made progress. On the third, his results have so far been poor.

India’s economy has certainly become more formal under Mr Modi, albeit at a high cost. The idea has been to draw activity out of the shadow economy, which is dominated by small and inefficient firms that do not pay tax, and into the formal sphere of large, productive companies.

Mr Modi’s most controversial policy on this front has been demonetisation. In 2016 he banned the use of two large-value banknotes, accounting for 86% of rupees in circulation—surprising many even within his government. The stated aim was to render worthless the ill-gotten gains of the corrupt. But almost all the cash made its way into the banking system, suggesting that crooks had already gone cashless or laundered their money. Instead, the informal economy was crushed. Household investment and credit plunged, and growth was probably hurt. In private, even Mr Modi’s supporters in business do not mince words. “It was a disaster,” says one boss.

Demonetisation may have accelerated India’s digitisation nonetheless. The country’s digital public infrastructure now includes a universal identity scheme, a national payments system and a personal-data management system for things like tax documents. It was conceived by Mr Singh’s government, but much of it has been built under Mr Modi, who has shown the capacity of the Indian state to get big projects done. Most retail payments in cities are now digital, and most welfare transfers seamless, because Mr Modi gave almost all households bank accounts.

Those reforms made it easier for Mr Modi to ameliorate the poverty resulting from India’s disappointing job-creation record. Fearing that stubbornly low employment would stop living standards for the poorest from improving, the government now doles out welfare payments worth some 3% of gdp per year. Hundreds of government programmes send money directly to the bank accounts of the poor.

It is a big improvement on the old system, in which most welfare was distributed physically and, owing to corruption, often failed to reach its intended recipients. The poverty rate (the proportion of people living on less than $2.15 a day), has fallen from 19% in 2015 to 12% in 2021, according to the World Bank.

Digitisation has probably also drawn more economic activity into the formal sector. So has Mr Modi’s other signature economic policy: a national goods and services tax (gst), passed in 2017, which knitted together a patchwork of state levies across the country. The combination of homogenous payments and tax systems has brought India closer to a national single market than ever.

That has made doing business easier—Mr Modi’s second objective. gst has been a “game-changer”, says B. Santhanam, the regional boss of Saint-Gobain, a large French manufacturer with big investments in the southern state of Tamil Nadu. “The prime minister gets it,” adds another seasoned manufacturing executive, referring to the need to cut red tape. The government has also put serious money into physical infrastructure, such as roads and bridges. Public investment surged from around 3.5% of gdp in 2019 to nearly 4.5% in 2022 and 2023.

The results are now materialising. Mr Subramanian recently wrote that, as a share of gdp, in 2023 net revenues from the new tax regime exceeded those of the old system. This happened even as tax rates on many items fell. That more money is coming in despite lower rates suggests that the economy really is formalising.

Yet Mr Modi is not satisfied with merely formalising the economy. His third objective has been to industrialise it. In 2020 the government launched a subsidy scheme worth $26bn (1% of gdp) for products made in India. In 2021 it pledged $10bn for semiconductor companies to build plants domestically. One boss notes that Mr Modi personally takes the trouble to convince executives to invest, often in industries where they face little competition and so otherwise might not.

image: the economist

Some incentives could help new industries find their feet and show foreign bosses that India is open for business. In September Foxconn, Apple’s main supplier, said it would double its investments in India over the coming year. It currently makes some 10% of its iPhones there. Also in 2023 Micron, a chipmaker, began work on a $2.75bn plant in Gujarat that is expected to create some 5,000 jobs directly and 15,000 indirectly.

So far, however, these projects are too small to be economically significant. The value of manufactured exports as a share of gdp has stagnated at 5% over the past decade, and manufacturing’s share of the economy has fallen from about 18% under the previous government to 16%. And industrial policy is expensive. The government will bear 70% of the cost of the Micron plant—meaning it will pay nearly $100,000 per job. Tariffs are ticking up, on average, raising the cost of foreign inputs.

image: the economist

So what matters more: Mr Modi’s failures or his successes? As well as economic growth, it is worth looking at private-sector investment. It has been sluggish during Mr Modi’s time in office (see chart 2). But a boom may be coming. A recent report by Axis Bank, one of India’s largest lenders, argues that the private-investment cycle is likely to turn, thanks to healthy bank and corporate balance-sheets. Announcements of new investment projects by private corporations soared past $200bn in 2023, according to the Centre for Monitoring Indian Economy, a think-tank. That is the highest in a decade, and up 150% in nominal terms since 2019.

Although higher interest rates have sapped foreign direct investment in the past year, firms’ reported intentions to invest in India remain strong, as they seek to “de-risk” their exposure to China. There is some chance, then, that Mr Modi’s reforms will kick growth up a gear. If so, he will have earned his reputation as a successful economic manager.

The consequences of Mr Modi’s policies will take years to be felt in full. Just as an investment boom could vindicate his approach, his strategy of using welfare payments as a substitute for job creation could prove unsustainable. A failure to build local governments’ capacity to provide basic public services, such as education, may hinder growth. Subhash Chandra Garg, a former finance secretary under Mr Modi, worries that the government is too keen on “subsidies” and “freebies”, and that its “commitment to real reforms is no longer that strong.” And yet for all that, many Indians will go to the polls feeling cautiously optimistic about the economic changes that their prime minister has wrought.

Which economy did best in 2023?

 From The Economist

image: the economist/shutterstock

Dec 17th 2023

Almost everyone expected a global recession in 2023, as central bankers fought high inflation. They were wrong. Global gdp has probably grown by 3%. Job markets have held up. Inflation is on the way down. Stockmarkets have risen by 20%.

But this aggregate performance conceals wide variation. The Economist has compiled data on five economic and financial indicators—inflation, “inflation breadth”, gdp, jobs and stockmarket performance—for 35 mostly rich countries. We have ranked them according to how well they have done on these measures, creating an overall score for each. The table below shows the rankings, and some surprising results.

Top of the charts, for the second year running, is Greece—a remarkable result for an economy that was until recently a byword for mismanagement. Aside from South Korea, many of the other standout performers are in the Americas. The United States comes third. Canada and Chile are not far behind. Meanwhile, lots of the sluggards are in northern Europe, including Britain, Germany, Sweden and, bringing up the rear, Finland.

Tackling rising prices was the big challenge in 2023. Our first measure looks at “core” inflation, which excludes volatile components such as energy and food and is therefore a good indicator of underlying inflationary pressure. Japan and South Korea have kept a lid on prices. In Switzerland core prices rose by just 1.3% year on year. Elsewhere in Europe, though, many countries still face serious pressure. In Hungary core inflation is running at around 11% year on year. Finland is also struggling.

In most countries inflation is becoming less entrenched—as measured by “inflation breadth”, which calculates the share of the items in the consumer-price basket where prices are rising by more than 2% year on year. Central banks in places like Chile and South Korea increased interest rates aggressively in 2022, sooner than many others in the rich world, and now seem to be reaping the benefits. In South Korea inflation breadth has fallen from 73% to 60%. Central bankers in America and Canada, where inflation breadth has dropped even more sharply, can take some credit, too.

Our next two measures—growth in employment and gdp—hint at the extent to which economies are delivering for ordinary people. Nowhere fared spectacularly well in 2023. But only a small minority of countries saw gdp decline. Ireland was the worst performer, with a drop of 4.1% (take this with a pinch of salt: there are big problems with the measurement of Irish gdp). Britain and Germany also performed poorly. Germany is struggling with the fallout from an energy-price shock and rising competition from imported Chinese cars. Britain is still dealing with the consequences of Brexit.

America did well on both gdp and employment. It has benefited from record-high energy production as well as the effects of a generous fiscal stimulus implemented in 2020 and 2021. The world’s largest economy may have pulled up other countries. Canada’s employment has risen smartly. Notwithstanding its war with Hamas, Israel, which counts America as its largest trading partner, comes fourth in the overall ranking.

You might think that the American stockmarket, filled with firms poised to benefit from the revolution in artificial intelligence, would have done well. In fact, adjusted for inflation it is a middling performer. The Australian stockmarket, filled with commodities firms managing a comedown from high prices in 2022, underperformed. Share prices in Finland have slumped. Japan’s firms, by contrast, are experiencing something of a renaissance. The country’s stockmarket is one of the best performers this year, rising in real terms by nearly 20%.

But for glorious equity returns, look thousands of miles west—to Greece. There the real value of the stockmarket has increased by over 40%. Investors have looked afresh at Greek companies as the government implements a series of pro-market reforms. Although the country is still a lot poorer than it was before its almighty bust in the early 2010s, in a recent statement the imf, once Greece’s nemesis, praised “the digital transformation of the economy” and “increasing market competition”. While underperforming Finns can console themselves this Christmas by drowning their sorrows in their underwear (or getting päntsdrunk, as it is known locally), the rest of the world should raise a glass of ouzo to this most unlikely of champions. 

Economics Essay 78: Ownership and Control of Firms

Discuss how the divorce of ownership from control may affect both the conduct and performance of firms.

Key terms:

1. Divorce of ownership from control: This refers to a situation in which the individuals who own a company (shareholders) are not the same individuals who manage and control the company's day-to-day operations (managers). In many large corporations, shareholders are dispersed and have limited influence over the decision-making process, while managers make strategic and operational decisions.

2. Conduct of firms: The conduct of firms refers to how firms behave in terms of their strategic choices, pricing decisions, production methods, investment decisions, and interactions with competitors. It encompasses the actions taken by managers to maximize the firm's objectives, such as profit maximization or market share expansion.

3. Performance of firms: The performance of firms refers to the outcomes achieved by firms, such as profitability, efficiency, market share, innovation, and customer satisfaction. It reflects the extent to which a firm is successful in achieving its objectives and delivering value to its stakeholders.

The divorce of ownership from control can have significant implications for the conduct and performance of firms:

1. Conduct of firms:

   • Agency problems: The separation of ownership and control creates agency problems, as managers may prioritize their own interests over those of the shareholders. Managers may engage in self-serving behaviors, pursue personal goals, or make decisions that do not align with shareholders' interests.
   • Risk-taking behavior: Managers may be more inclined to take excessive risks when their personal wealth is not fully tied to the company's performance. They may pursue ambitious projects or make risky investments that could negatively impact the firm's financial stability.
   • Managerial discretion: Managers, in the absence of close monitoring by shareholders, have more discretion in decision-making. They can shape the firm's strategies, set executive compensation, and determine resource allocation. This discretion can influence the firm's conduct, including its competitive behavior and investment choices.

2. Performance of firms:

   • Shareholder value: The divorce of ownership from control can result in a divergence between the interests of shareholders and managers. This misalignment can lead to suboptimal firm performance and a failure to maximize shareholder value.
   • Managerial incentives: Managers may prioritize goals other than profit maximization, such as personal reputation, job security, or firm growth. This may lead to decisions that do not optimize the firm's financial performance or long-term sustainability.
   • Accountability and monitoring: Without effective oversight and monitoring by shareholders, managers may face less accountability for their decisions and actions. This can impact the firm's performance by reducing the incentives for managers to perform at their best or make efficient use of resources.

It is worth noting that the impact of the divorce of ownership from control can vary across firms and industries. Some firms may implement governance mechanisms, such as independent boards of directors or performance-based compensation, to align the interests of managers with shareholders and mitigate the negative effects. Additionally, the extent to which the separation affects conduct and performance depends on factors such as the degree of competition, market conditions, industry regulations, and the specific managerial practices implemented within the firm.

Overall, the divorce of ownership from control can introduce agency problems and influence the behavior and performance of firms. Addressing these challenges through effective governance mechanisms and aligning the interests of managers with those of shareholders is crucial for maintaining sound conduct and improving firm performance.