Economic history: How the relationship between government and big business changed in India

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Coming on top of each other, the four seismic developments of the second half of the 1980s completed the alienation of the upper-caste Hindus from the Congress and the Janata Dal. But what gave staying power to this shift was a simultaneous, and sudden, rise of insecurity in the intermediate bourgeoisie that industrialisation within a closed, autarchic economy had created in the previous half century.
This had begun almost surreptitiously with the removal of several restrictions on imports in 1978 and a relaxation of India's industrial licensing laws in 1980 and 1981. But the pace of economic liberalisation had accelerated dramatically in 1985 after Rajiv Gandhi became the prime minister. In his first budget, presented in February 1985, the government abolished industrial licensing for about half of all industrial production. In the next few months, it also took a large number of controls on industrial modernisation off the rule book, reduced duties drastically on the import of capital goods, and eased the import of new technology.
This rapid shift away from the crippling controls of the previous three decades, and the consequent return of modern industry into the consumer goods sector, fulfilled the essential economic requirement for the development of the fascist impulse, for it turned the seemingly solid ground that near-total import control, and a chronically shortage-ridden market, had created for the small and medium sized, owner-managed enterprises into quicksand. The shock this gave to it was almost as great as the shock that the onset of the 1930s' Great Depression had given to the Mittelstand in Germany.
At first sight, India's industrial landscape in the 1980s and '90s did not look very different from that of other industrialised countries during the middle stages of their transformation into modern market economies. There was the same sprinkling of large, professionally managed, multi-product firms at the top of the hierarchy, followed by a body of medium and small enterprises that grew wider as their size became smaller.
But the similarity in the size distribution of industry was deceptive. For while in countries where the growth of capitalism had been unhindered, or actively encouraged by the state (as in the 'tiger' economies of East and Southeast Asia), the relationship between small and large industry had evolved naturally from competition to symbiosis. As technology progressed and the minimum scale of efficient production expanded, small industry turned increasingly from producing final goods sold directly to the consumers to providing components, ancillaries and specialised services for supply to the large industrial companies that produced and marketed the finished goods. In sharp contrast, the vast majority of small-scale producers in India continued to produce final goods for the market in direct competition with the now liberated large-scale enterprises till the very end of the twentieth century.
The reason for this 'arrested development' of capitalism was a singular, and in retrospect tragic, convergence of economic and political compulsions. Before 1957, the Indian government had followed a relatively open trade policy because it had accumulated large sterling balances during the Second World War, and therefore did not foresee the need to husband the use of foreign exchange. Its first Five Year Plan (1952–57), therefore, emphasised infrastructure, community development and agriculture, and left industrial development to the private sector.
Economic autarchy was ushered in by the Second Five Year Plan, which emphasised self-reliance and gave priority to the establishment of heavy industry. This would have required tighter controls on non-essential imports anyway, but what really brought about a sudden and complete ban on all non-essential imports was a severe foreign exchange crisis in 1957 when the government belatedly realised that it had exhausted its sterling balances and was not exporting enough to carry on with its earlier liberal import policies.
Since this crisis occurred before the World Bank had shifted its focus from European reconstruction to economic development in the Third World, and before the era of liberal US economic aid ushered in by President John F Kennedy, the government had no option but to pull down the shutters and ban virtually all but the most essential imports. The near-complete ban on the import of consumer goods that followed created the market space for the rapid rise of an intermediate industrial class in the country.
At that time, India produced very little for export except textiles, jute, tea and a few other simple manufactures. Everything from lead pencils to liquor was imported. Importers had seen the foreign exchange crunch coming at least a year before the government, and had spared no effort to corner as many import licences as possible. When the government lowered the boom, these licences began to change hands at fantastic premia. Premia of 1,000 and 1,200 per cent were not unknown.
Those with import licences received a windfall profit of staggering dimensions overnight. Denied future imports, many of them asked their suppliers to help them set up manufacturing units for what they had previously been importing. Most manufacturers obliged, and sent equipment, often second-hand machinery that was to have been phased out, and took equity shares in the enterprise in return. In this way, commercial capital was converted into industrial capital overnight, and a new class of small and medium-sized enterprises was created.
For the next ten years, hectic import substitution enabled industrial production to grow at an average of 9 per cent a year. By the time the foreign exchange crisis petered out, this new owner-manager class was firmly established and ready to make a bid for power. Its opportunity arose when Prime Minister Indira Gandhi abolished the privy purses of the princes and, in 1969, enacted the ban on company donations to political parties, described earlier, without creating an alternative mode of financing elections and electoral politics. Since political parties, including the Congress, still had to meet their expenses, they still needed large amounts of money, but now in cash. The intermediate class stepped into the breach and began to provide it.
The change in the financial patrons of the Congress party did not take long to get reflected in economic policy. Professionally managed businesses found it far more difficult to give unaccounted donations. When they said so, they were told openly by party treasurers and fundraisers to find ways of doing so 'or else…'. The relationship between government and big business therefore, changed overnight from one of cosy co-operation to one of barely concealed hostility.
The businessmen who found no difficulty in giving cash were the owner-managers of small enterprises and traders. This class led an insecure existence at the best of times. Its control over the market was virtually non-existent; its access to bank finance at reasonable rates of interest was limited; its dependence upon the government for infrastructure – power, water, communications and transport – was total. Consequently, its 'transaction costs' (the bribes it had to pay) were higher. It lived in mortal dread of any policy change that would enable modern enterprise to enter the fields it had chalked out for itself. Mrs Gandhi's ban on company donations to political parties, and its consequent need for clandestine donations, gave it the opportunity to convert its growing economic power into political power. Within a decade, the Congress had transformed itself from being an ally of modern, large-scale industry into an ally of this new, intermediate bourgeoisie.
Between 1970 and 1973, the Indira Gandhi government passed a spate of laws that cut all remaining links with big business, and turned India into an inward-looking siege economy. A Monopolies and Restrictive Trade Practices Act defined monopoly companies as those with total assets of more than $7 million and those that controlled more than one-third of the market for a product. An Industrial Licensing Policy amendment act barred 'big business' from investing in any but the core sector, ie, basic metals, heavy engineering and chemicals industries. It permitted even this only when they could further prove that the proposed investment would not make them a monopolist.
By an amendment to the Foreign Exchange Regulation Act, the government also banned foreign investment except in 100 per cent export-oriented ventures. Its most draconian enactment was a 'conversion clause' that permitted investment banks to convert 40 per cent of their loans to any company into equity shares, at their discretion. Since the promoters seldom owned more than a third of the equity capital of the company, and since all the three institutional investors in the country – the Industrial Development Bank of India, the Industrial Finance Corporation and the Life Insurance Corporation – were almost wholly owned by the state, the conversion clause became a way to nationalise private concerns by the back door.
This sowed an enormous fear of growth itself in large industrial enterprises, which was heightened when these institutional investors began to convert the loans they had given to the most successful enterprises into equity instead of those given to struggling companies to keep them afloat. Not surprisingly, the conversion clause put an end to new large-scale investment by private companies for more than a decade.
As if all this did not give sufficient protection to small-scale industry, the government also explicitly reserved more and more products for manufacture exclusively by it. The number of such products rose from an already high 177 in 1972 to 837 in 1983. So comprehensive was this list that it virtually blocked any large company from entering the consumer goods sector. From garments to electrical goods, to transistor radios and household appliances, virtually every Fast Moving Consumer Good (FMCG) was reserved for the small-scale sector. Thus, in the mid-eighties, this 'intermediate' manufacturing sector had 853,000 industrial units, produced 5,000 consumer products, employed 9.6 million workers and, including the output of the public sector, accounted for over 40 per cent of total industrial output.
By 1984, therefore, the structure of Indian industry bore a remarkable resemblance to that of Germany at the end of the 1920s when the Great Depression began, and of Iran in the 1960s and '70s. In the 1980s, India had entered the middle stages of transformation into an industrialised economy. It had the same overt hostility towards big business; the same handful of favoured cronies among such businessmen; the same elaborate regime of controls to curb the growth of big professionally managed concerns; the same xenophobia towards foreign businesses; the same autarchic determination to be self-reliant at any cost; the same benevolent attitude towards small enterprise; and the same elaborate structure of party middlemen to 'fix things' with the government, that Germany had had in the 1930s and Iran in the 1970s.
While this 'intermediate class' was protected from competition by the Congress, and could rely on it to pass and maintain laws that would curb the growth of the large industrial houses and keep foreign investors out, it had no need to look for another patron. Thus, Hindu nationalism remained without the third essential ingredient that had been responsible for the rise of fascism in Europe. Paradoxically, that ingredient was provided by the success of Rajiv Gandhi's partial liberalisation in 1985. This led to a burst of investment in industry that pushed manufacturing growth up from 4.9 per cent between 1980 and 1984 to 10.4 per cent between 1985 and 1990.5 The rapid growth of income, and consumer demand, that resulted from this jump in production softened the impact of the initial economic liberalization upon the intermediate stratum of manufacturers. But this proved a temporary reprieve.
Rajiv had lifted controls only upon the domestic market and left India's highly overvalued exchange rate untouched. This kept Indian manufacturers out of the world market and ensured that little of the jump in production went into exports. The vast bulk – nine tenths or more – went into satisfying the pent-up demand of a growing middle class within the country and pre-empted the further expansion of the small-scale enterprises. Almost overnight, therefore, the intermediate class lost a large part of the comforting, secure 'economy of permanent shortages' that Mrs Indira Gandhi had created for it between 1970 and 1973.
But that was only the first blow.