The Chakravyuha Challenge: Ease to enter, barriers to exit

Indian Economy making great strides in removing barriers to entry for firms, talent, and technology but less in relation to exit

The Economic Survey 2015-16 presented here today in the Parliament by the Union Finance Minister Shri Arun Jaitley invokes the legend of the Charkravyuha from the Mahabharata describing the ability to enter but not exit, with seriously adverse consequences. The Indian economy has made great strides in removing barriers to entry for firms, talent, and technology but less progress has been made in relation to exit. Thus, over the course of six decades, the Indian economy has moved from ‘socialism with limited entry to “marketism” without exit’.

 The Economic Survey 2015-16  states that the case studies suggest that the challenge is more a feature of the relatively traditional sectors of the economy. It is not restricted to the public sector but is increasingly being seen in the private sector. India seems to have a disproportionately large share of inefficient firms with very low productivity and with little exit.  This lack of exit generates externalities that hurt the economy.

Impeded exit has substantial fiscal, economic, and political costs.

• Fiscal Costs: Inefficient firms often require government support in the form of explicit subsidies (for example bailouts) or implicit subsidies (tariffs, loans from state banks).
• Economic Costs: Misallocation of scarce resources and factors of production in unproductive uses including overhang of stressed assets on corporate and bank balance sheets.
• Political costs: Government support to “sick” firms can give the impression that government favors large corporates, which politically limits its ability to undertake measures that will benefit the economy but might be seen as further benefitting businesses.

The Economic Survey analyses this exit problem with the help of the three I’s:

• Interests: The power of vested interests confers greater power on concentrated producer interests in relation to diffused consumer interests. As a result it becomes difficult to phase out schemes and they become instruments of granting favors. For example, 50 percent of Central Sector Schemes that were allocated money in the Union Budget 2015-16 were 25 years old. Thus, extra vigilance is required to ensure that schemes remain relevant and useful over time.
• Institutions: Weak institutions increase the time and financial costs of exit. For example, with rising non-performing assets, recourse to debt recovery tribunals (DRTs) has increased. The share of settled cases is becoming small and declining and the accumulated backlog of unsettled cases has increased manifold. Furthermore, inability to punish wilful defaulters questions the legitimacy of all institutions.

On the other hand, strong but inflexible institutions are unable to make risky decisions when departures from strict principles may be necessary for the economy.

• Ideas/Ideology: The founding ideology of state-led development and socialism makes it difficult to phase out entitlements even as those intended for the poor end up accruing to the relatively better off.

The Economic Survey 2015-16 suggests five possible ways to address this problem. The first is promoting competition via private sector entry rather than change of ownership from public to private. Secondly, direct policy action through better laws like the Insolvency and Bankruptcy Code 2015 will expedite exit. Also institutions need to be made stronger but flexible by empowering bureaucrats and reducing their vulnerability.  Thirdly, increase the use of technology to remove persistent distortions by bringing down human discretion and layers of intermediaries. The fourth is increasing transparency and highlighting social costs and benefits of various schemes and entitlements. Finally, showcasing exit as an opportunity towards a newer and better tomorrow.