India: Asia's Next Tiger?

Sunday, February 1, 1998

Introduction: Indian Expectations
India's fiftieth anniversary may be a time to critically review India's place in the world's strategic and economic calculations.1 The economic reforms of Prime Minister P.V. Narasimha Rao's government (1991–1996) have changed perceptions of India's economic prospectives and ended a long period of neglect by foreign investors. India is now viewed as one of the most promising of the world's emerging markets, if only the new government stays the course of reform.

Will India proceed steadily further down the road of liberalization? The new coalition government seems cautious, despite a consensus about the economic necessity of reform. But reform is not moving at a brisk pace because the coalition government cannot agree on concrete measures. Reform is being held up because India's deeply rooted democratic culture has dramatized the government's inability to ensure the equitable distribution of the benefits of liberalization. One difficulty that the government has had in making the reform process credible for its citizens is the endemic presence of corruption. Instead of eliminating corruption by trimming an intrusive and overgrown state, liberalization has, ironically, dramatized its prevalence.

Corruption distorts the private sector's response to the opportunities of the emerging liberal order. It underlies the breakdown of service delivery, the intensification of communal violence, the domination of the economy by the black market, and the government's inability to collect taxes effectively. The government's inability to implement basic programs has created a credibility deficit that has led former Prime Minister Inder K. Gujiral (1997) to state, publicly and bluntly, that "corruption is the biggest single impediment both in development and in the way of social programmes" (Far Eastern Economic Review, August 21, 1997, p. 42). Unable either to enforce the law or provide basic services, which have not been delivered despite numerous reforms and governments, what can be expected of government's efforts to direct liberalization to benefit all parties?

The liberal reforms introduced in 1991 were precipitated by crisis and enacted by decree. Reforms were undertaken because the funds needed from international donors to exit a severe macroeconomic crisis would not have been available any other way. Although they did not eliminate corruption, the reforms altered the policy matrix governing the country's trade and foreign investment regime by tearing down protective tariff walls and simplifying industrial licensing rules.2 These reforms are likely to seem easy compared to the reforms that lie ahead.3 Future economic liberalization will require a broader political base than the one currently in place.4 Reforming public sector enterprises by trimming employment, slashing wages, imposing hard budget constraints, closing plants, providing ailing firms with exit options, and tackling education, agriculture, and infrastructure will impinge on India's masses and therefore will require a broad political consensus, unlike the first wave of reform, which required limited popular awareness. Still the slim increase in foreign investment engendered a backlash by a range of highly mobilized interests. A well-publicized example of how reform can be politically contested when it is not institutionally secure occurred in 1996, when the new government in Maharashtra was reluctant to accept a deal with Enron that had been consummated by the previous state government. Needing foreign investment, the government had introduced liberal economic reform but bypassed necessary institutions or procedures (in this case, tender procedures) to ensure transparent, predictable, and accountable outcomes,5 thus arousing the suspicions of opposition parties even when evidence of malfeasance by government officials was absent.

Because political authority and the apparatus of the state are suspected of being linked with vested interests, liberal causes are prey to populist attack.6 If groups perceive that the regime cannot credibly commit to the implementation of policies designed to spur growth, they will prefer the status quo. Therefore, corruption must be addressed if reform is to be sustained and liberalization consolidated.

Politicians in India often derive political support from their ability to distribute spoils to their political supporters in lieu of broad services that target entire communities. Once elected, governing powers and the associated economic advantages are likely to be exercised as private rights. Since patronage, not policies, is delivered to pay off supporters, a crisis of governability is inevitable because politicians are unable to disperse spoils broadly enough to meet the demand. Narrow distribution causes resentment, a formula for constant conflict. Meanwhile, the government's general ability to provide basic services falters. When leaders cannot hope to deliver services or public goods such as appropriate policies, they focus on noneconomic issues--regionalism, communalism, nationalism--thus steering government further from the issues of sound economic policy.

A government willing to grapple with corruption by changing the system that nourishes it can dispel doubts that only the rich or insiders will benefit from reforms. The impetus for the 1996 political reversals of the Congress Party in national and local elections was corruption driven. An activist judiciary showed for the first time in the nation's history that politicians could be held accountable, and the voters responded to the courts' inspiration. India's progressive movement may have begun.

Rule Bound and Unaccountable: How Can It Be Both Ways?
At independence, elected officials as a whole depended on the expertise of the bureaucrats, their key source of policy advice, to govern and provide policy leadership. The political leaders, however, resented being dominated by a sophisticated elite corps of trained civil servants and attempted to assert the position they believed bestowed on them by the constitution's democratic mandate. Although the politicians were faced with a system of public administration over which they had little control, they eventually gained the upper hand by employing two mighty weapons, patronage and deinstitutionalization. The politicians gained an additional advantage from the civil service's inability to deliver services to the population effectively, thereby creating opportunities to defend the people against the bureaucrats. Helping constituents secure a contract, enroll in school, or enter the hospital were ways to win electoral support.7

The Indian bureaucracy was designed to be nonpolitical, with appointments and promotions based on merit. An independent civil service commission enforces the rules.8 The service worked by standardizing procedure down to every detail. The design quickly produced all of the known pathologies of excessive hierarchy, most notably an absence of accountability. The bureaucrat as master of red tape engendered the politician as fixer.

A stalemate occurred: the politicians resented the rigid rules and regulations, excessive formalism, and cautious "red tape" behavior of the bureaucracy; the administrators shouted political interference as the politicians intervened more. Although they accepted the supremacy of political leadership, bureaucrats openly blamed the ministers and political leaders for all the administration's ills, viewing the control of politicians as arbitrary and inferior to their status-based authority built on exclusion by educational attainment. The accountability of the civil service is to the politicians.

The conflict between bureaucratic and political forms of authority exists in any society. The source of the conflict is that bureaucracy, by its very nature, will seek to establish its professional authority through secrecy, keeping its knowledge and intentions from the purview of the noninitiated outsider. Bureaucracy welcomes poorly informed political interests and typically resists attempts by elected officials to gain knowledge by means of independent experts or interest-group collaboration.9

The incentives for bureaucrats to be distant and rule bound come from the same source. Because they control information, bureaucrats can screen out information not conducive to their own interests. They can produce information that suits them and then get their political sponsors to believe it. Politicians know this information is biased but do not have alternatives.

Politicians often get elected by promising to control the bureaucracy. The politicians justify their quest for greater authority on the grounds that the bureaucracy was never suited to its vast responsibilities; the bureaucrats' tendency to prioritize the enforcement of rules over the pursuit of outcomes gave the politicians a justification to manage government agencies directly.

Unfortunately, arbitrary disposition by bureaucrats was replaced by an equally arbitrary government by political chiefs. The politicians ended up accountable to a narrow constituency, offering political spoils rather than public goods such as a sound policy matrix, delivery of community services, or a neutral civil service.

A Thick, Liquid Market for Corruption: The Postings Merry-Go Round
The failure of the bureaucracy to deliver public services effectively was not anticipated in India's constitution. India's administrative institutions were designed to ensure sovereign commitment to democratically determined policy alternatives. The accountability of elected officials was flawed, despite the existence of a civil service commission grounded in the constitution; the prime minister can choose the civil service commissioner without legislative oversight.10 Laws prevent politically motivated promotions or dismissals but do not protect civil servants from being assigned arbitrarily, a major flaw. Where departments allocate licenses, subsidize goods, or raise money by black market sales (i.e., transport, public health, civil supplies, the development authority for land and projects), posts can command a good price.11 Power over postings, therefore, is a key to understanding corruption.

Determining the value of posts poses a significant barrier to politicians seeking to maximize the profits of the ability to control posts. To surmount this barrier, an implicit auction system has evolved that allows bureaucrats to bid for the most desirable "wet posts" from which the rupees flow. Because posts vary significantly in how much private benefit can be extracted, there is considerable competition among managers. The most corrupt managers have the money to compete for the most lucrative posts.

Efficient managers earn more than inefficient managers but not in the production of public goods. The system fosters innovation to improve the private yield on posts because ambitious bureaucrats must recoup their investment to acquire additional resources for subsequent auctions. There is little incentive to produce public output efficiently because job performance does not influence promotions; those are decided by seniority.

One of the great conundrum's of India's political evolution is why a highly elitist and centralized civil service was maintained in sharp conflict with the nation's democratic aspirations. (India's neighbors modified the practice and in some cases modified the elite character of service.) The answer is that a concentrated liquid market for the sale of posts throughout India exists in the centralized administrative service. Concentrating the bidders further maximizes the amount politicians can earn when they sell the posts. As in any auction market, the larger the number of buyers, the higher the asking price. An increase in the concentration of bidders heightens the value of the posts, especially when the bidders are insiders who know the value of the positions. Although politicians can gain considerable rewards from controlling the system of transfers, they have no direct knowledge about the value of a particular post or output in terms of bribes or kickbacks. As a result, politicians will allow the bureaucrats to compete by auctioning the posts in the districts to the highest bidder. The price offered by the seeker reveals the value of the post.12 To maximize the amount of revenue collected, these auctions are held frequently, hence the frequency of transfers.13 A centralized administrative service constitutes a concentrated liquid market for the sale of posts.

Although a symbiotic relationship exists between politicians and officials, it does not engender trust. Each group holds the other responsible for government's powerlessness to carry out meaningful public sector reform. Assigning blame, however, is meaningless. The pressure for transfers may come from the bottom or from the top. The culprit is the continuous expansion of new and attractive posts to which only bureaucrats may apply.

The evolution of the civil service demonstrates how institutions can be diverted from their intended usage by subtle shifts in the rules that govern them.14 Although merit recruitment and seniority promotions cannot be tampered with, discretion over postings allows politicians to circumvent the intent of the original design. Bureaucrats are shifted from post to post much more frequently than efficient job performance would justify.15 That excessive mobility adversely affects the capacity of the bureaucracy to provide leadership; continuity of expertise is disrupted, and motivation shifts from public to private goods production.

Highly placed politicians rarely discuss the motives for transfers; doing special favors for key constituencies can be kept secret, for no mechanism exists to ensure that reasons are given. No one knows whose interests are being served or why a particular posting has been made, meaning that civil servants do not influence decisions about postings in an organized manner.16

Competition over rewards and posts is intense, but the wrong kinds of output are maximized. Since a successful post holder is one who acquires funds to move to a more lucrative post, the individual must specialize in the private distribution of goods and services to maximize kickbacks and bribes. Thus, bureaucrats become specialists at mismanagement, working at cross- purposes with the laws and institutions they oversee.17

Defenders of the postings system view it as a way to punish incompetent subordinates. The mobility of bureaucrats is a bad practice only when it is conducted without any reference to serving the needs of constituents. Transfers are a poor surrogate for performance ratings and accountability for outputs. Panels made up of representatives of citizen and government interests would correct the arbitrary character of the present system. When the charge is to eliminate corrupt officials, remedies other than sending the problem to another locale are likely to be more effective.

Connection to a Larger System: Why an Inefficient System Persists
The solution to capricious transfers is neither difficult to conceive nor implement. Although periodic assessments to improve efficiency have included recommendations for major changes (Santhanam Committee, India, 1964), reform proposals have yet to be acted on. The attractiveness of the ad hoc criteria governing transfers can be easily curtailed, but, like many perverse practices, they are maintained. Why is nothing done? Why does a system so poorly designed to implement developmental goals persist?

The bureaucracy is reacting to what the system rewards. Even high standards for recruitment and clearly defined procedures can not ensure social output. The solution does not lie in human or material resources. Adding computers, hiring smarter people, or replacing corrupt with clean officials will not change the underlying fundamentals. In fact, the training facilities for senior bureaucrats at Musoorie are viewed as an exile from the real work of collecting bribes18 and are undervalued because promotions depend on seniority, not training. Better information, better systems, and better decision making do not fit the incentives of the decisive actors. To understand the motivational structure of the bureaucracy, we must understand how politicians get elected in India.

India's "Tammany Hall" System: "To the Victor, the Spoils"
India's large Congress Party dominated electoral competition during the first twenty years after independence. Created by India's founders, the Congress Party was built on principles of self-dependence, self-reliance, cooperation, nonviolence, communal cooperation, and participation from below. Its leaders were known to be uncorruptible; many had reputations for integrity backed by prison sentences served in the cause of national independence. Fifty years after independence, however, the party's prime minister was convicted of corruption and may go to jail. Most of the values his party has stood for are in disrepute. How has this come about?

Getting the message of policy results through to the large Indian franchise is difficult for any political party because of poor interregional communication and high levels of illiteracy. The Indian voter suffers from an extreme form of rational ignorance, in that he or she does not possess the resources to overcome communication, travel, and language barriers to gain knowledge about policy outcomes. In catering to voters that cannot distinguish macropolicy outcomes, politicians focus on particularistic goods targeted for a particular electorate. They are not motivated to champion the policies that affect broad groups or regions.19

A patronage network that spanned the entire nation was constructed by the Congress Party to overcome barriers to informed voting. The network was forged by empowering local brokers, or "big men," giving them access to governmental services controlled by the party20 in exchange for their local influence in gaining electoral support. Congress obtained its strength from a chain of individuals or brokers that stretched from village to state and eventually to the capital (Weiner 1957, 1967; Kohli 1990).21 Patron-client ties linked the Indian population to the national party system and to the system of rewards. These ties changed over time in part because of political competition. At independence, tradition helped define the expectations and rewards that linked hierarchically, vertically differentiated parties. The traditional power brokers acted as both agents of the center in the locality and agents of the locality in the center.

The traditional patronage chain began to weaken in the mid-1960s. The nationalist images that emerged from the independence movement controlled by the Congress Party were tarnished by numerous scandals involving the misuse of public trust. In addition, the party's association with the privileged elites nourished the cause of opposition parties who mobilized previously dormant sectors of the population. The mobilization intensified the competition for spoils as new group identities were forged to serve narrow social or political purposes. These new formulations of identity linked an individual or a group's membership in repressed social categories with the likelihood of receiving benefits from the state as a reward for political participation.22 The choice of identifying with a group was generally a political choice inspired by the possibility of receiving tangible benefits. The coalition that rules India today, with the particular exception of leftist parties, is a combination of small parties built on strong state-level ethnic bases. The Congress Party machine's domination of national politics was broken by its inability to deliver goods to the many newly mobilized sectors of the population. The first batch of leaders was separated from its clients by unbridgeable differences in education and wealth. Those leaders did not speak the same language as their clients and shared few moral bonds with them. Voters sought leaders who came from their own caste or subcaste, people more like themselves rather than from categorically different groups. Political competition encouraged the rise of a new set of leaders. Eventually the traditional power brokers were unable to distribute patronage widely enough to prevent the rise of alternative brokers serving more particularistic networks.

The alternatives to the Congress Party were generally not parties but patronage machines organized around personalities rather than issues.23 By 1967, the Congress Party had lost its majority. As the growth of the state crowded out other alternative economic activities,24 competition for access to resources led to political conflict because no party could meet the demands it mobilized.25 Thus spoils-based politics led to factionalism and political fragmentation, making it impossible for India's Congress Party to integrate the nation politically (Bueno de Mesquita 1978). The protectionist policies, demanded by decisive support groups, kept India out of the world economy, reducing the scale and scope of production in the private sector (Bardhan 1984).

How Patronage Works
Elected politicians hire a large number of rank-and-file political workers to get out the vote. These workers, in turn, build networks of personal relationships, obliging as many people as possible to vote. Local politicians are busy attending funeral, marriage, and birthday receptions. To ensure that these politicians will be remembered at election time, jobs and favors must be provided. Therefore, party workers are needed, and they need jobs (Weiner 1967, 464).26

Because of civil service rules that prevent firing government employees, each government increases its size and control over the economy. Those rules also make it difficult to dismiss the appointees of the previous government, increasing the frustration of politicians because they cannot control an important cause of inflation--inflated government payrolls.27

Service contracts for the government are another source of funds that enables politicians to purchase political support. To maximize these opportunities, politicians need information from bureaucrats about future construction sites, new factories, and public buildings. Control over the allocation of urban land is a key political resource. One of India's most famous corruption fighters, K. J. Alphons, describes the agency he works for, the Delhi Development Authority (DDA), as "the most corrupt institution in the country." Those who corrupt it, he adds, are "nearly all the top politicians in India." They help illegal builders grab DDA land to build houses and shops that are sold to unwitting buyers. Unauthorized buildings range from shanties to shopping centers for the middle class to the mansions of the rich, all established on government land under false pretenses with high-level political complicity. Moreover, Alphons reports, nothing gets built, legal or illegal, without a bribe (McDonald 1995, 78).

A politician from a ruling party in an appropriate political council is expected to command executive agencies to "do" things for his constituency (Weiner 1967, 464).28 It is common practice among property holders to negotiate the tax value of their land with the assessor to reduce its estimated value. Planned roads can be changed to avoid the property of the town elite. Money to speed up and improve the level of daily services (i.e., deliver letters or repair a broken line) comes as contributions from those concerned. "The repair person, of course, has options: a line may be repaired "immediately," "soon," or "in due course." The postal delivery person may deliver a letter after an announced "extra effort," "speedily," or "regularly," which generally means after some time (Schenk 1986, 117). Even such routine opportunities to collect bribes allow for networks of corruption to emerge, reverting to the politicians who control the postings. In this sense, even the most mundane corruption at the bottom--the venality of the official who sells postage stamps--is connected to the corruption at the top.29

From Personalization to Deinstitutionalization to Corruption
The character of public service changed dramatically when Indira Ghandi was leader of the Congress Party (1969–1984). In attempting to create a "committed" civil service, she initiated a process of deinstitutionalization that was to shift the locus of decision making from the bureaucrats to the politicians.30 With the goal of cleansing her party of loyalty to the old establishment, she made compatibility a key criteria for promotion and postings. She also introduced lateral positions in the Ministries of Commerce, Foreign Service, and Finance. As a result she was able to replace or circumvent those who would not do her bidding. A number of her appointments were open-minded reformers loyal to her, not to the system. Once the rules were bent and the institutional controls were removed to accommodate those "committed" to the poor, however, venal motives took over as personal aggrandizement replaced commitment and ideology.31

The evolution of the police and the educational services illustrates how the personalization of authority--achieved through deinstitutionalization--inevitably leads to venality. The police are particularly important because they can control access to the ballot box; therefore, chief ministers sometimes use the police force to extend personal political control.32 Police can help deliver votes as individual citizens depend on their services. Controlling police personnel administration is another way to make the force into a political tool, ensuring the protection of the party bosses, their cronies, and their constituents. With proper political support, anyone could pass the necessary police exams. What started as a strategy to enhance political control has had unanticipated and unfortunate consequences. An ill-trained, venal police force rarely provides the high standards of evidence needed to convict felons. Since fines and arrests can be lucrative sources of funds, venality eventually took over, and entire police stations were auctioned. Honest police have difficulty rising to the top since the posts are bought. Once interference evolved from political motivation to bribery, leaders could no longer depend on the police.33

Even the recruitment of teachers can become part of the spoils system. Highly decentralized school boards offer excellent patronage opportunities since teachers are paid by state governments. The political boss ends up hiring teachers who excel at political loyalty rather than teaching performance. Even the purchase of textbooks and supplies can be linked to the political boss who appoints purchasing agents. When teaching appointments are political, government inspectors (also political appointees) have no incentive to supervise teachers effectively; they may settle for collecting bribes from teachers who do not report to their classrooms but collect payments on the side for private lessons. Schools in rural districts are often empty as a result.34

In India, ideology--the appeal to equity--is used to support patronage, yet in the long run, ordinary citizens are the big losers because patronage politics interferes with social welfare in two principal ways. Political authority derived from disbursing patronage results in personalizing or deinstitutionalizing the system of service delivery. In this sense, political mobilization via patronage robs the state of its ability to solve problems in a rule-bound fashion. Leaders who come to office by virtue of their personal appeal are likely to rule by fiat rather than by means of rules and established procedures. Personalization of authority eventually ends in venality and the misuse of authority.

By far the most important conflict between patronage politics and development is the control of public services: police and fire services, street cleaning, and schools. Services that can be turned off selectively are more desirable than services that go to everyone. There would be no obligations on election day if the politicians provided services to everyone.

India's poor development performance is an economic outcome of a political dilemma. Personalization of authority erodes party discipline; as a result, voters do not have power over politicians. Patronage politics sustains personal power but robs politicians of power over the administrative machinery at every level of government. Moreover, growth rates do not reflect the poor delivery of public services that erodes the quality of life for all but the wealthiest of citizens.

Business and Political Patronage
Patronage-based politics engenders substantive regulation of economic activity and fiscal arbitrariness. Irregularities in the administration of justice, in administrative practice, and in taxation interfere with rational economic calculation, making it difficult for profit-making enterprises with heavy investment in fixed capital and a rational organization of labor to prosper. Government control over the commanding heights of the economy drove entrepreneurs seeking essential permits, licenses, and loans into the hands of politicians. Politicians, needing money, arranged for the delivery of licenses to businesspeople who, once having offered bribes, then depended on legal protection from the police and judicial authorities controlled by the politicians. For example, prosecutors are directly controlled by ministers and are not expected to follow an independent line; therefore, politicians may prevent investigations or block judicial authorities from taking action. Because the legal system is plagued with delays and filled with political appointees, business does not see the judiciary as offering much of a check on the politicians.35 It is widely believed that nobody with influence is convicted. Corruption, as the Indians often say, is built into the system.

Politicians may ask financial institutions to support existing management in the event of a takeover threat or when the firm lacks adequate collateral, which is a frequent occurrence.36 Because murky deals are best for generating unaccountable funds, an absence of adequate accounting occurs. Inadequate accounting makes it difficult for firms to verify their assets; hence corporations often find they require political backers to help get the credit they need from the state-run banking system.

Political parties could demand public contributions since companies are allowed to donate up to 5 percent of their net profits to political parties. The parties, however, prefer to collect money on the side so they do not seem beholden to business. In addition, shareholder endorsement of such expenditures would be necessary on the company side. As a result, company managers possess discretionary funds to obtain discretionary interventions; the shareholders and the citizens lose, but their voices cannot be heard. The system of corruption works so well that the World Economic Forum global competitiveness ranking of forty-nine countries ranks India forty-fifth in the honesty of government officials, forty-fourth in the effectiveness of laws to protect shareholders, forty-sixth in the ability of the board of directors to ensure corporate honesty, forty-fifth in the ability of the boards to protect shareholders' interests, and fortieth in tax evasion37 (India Today, November 30, 1996, p. 97).

Corruption persists because the benefits have been concentrated among a small group of political, bureaucratic, and business elites. The costs are diffused among citizens who lack the organization to impose an agenda for systemic reform. Although they can elect new faces, what India's voters need is a new system of accountable public administration.

Collaboration with Business
One key to East Asia's economic success was the corporate organization of industry, which helped individual firms raise money, limit individual deals or exceptions, impose unanimity in dealing with government, and provide leverage in dealing with government officials, thereby reducing the threat of sovereign transgression (Campos and Root 1996).38 The economic knowledge of economic interest groups is superior to that of the bureaucratic officials. Business interests cannot afford bad information because they face the consequences of such information in the form of economic loss. A bureaucrat can always hide behind the system and tax or use some other budget to cover for mistakes. Engaging business in policymaking was a distinctive feature of East Asia's most successful regimes--Japan, Korea, Singapore, Malaysia, and Taiwan. In sharp contrast to the experience of East Asia, India's system of bureaucratic decision making has benefitted only marginally from the ability to recruit interest groups made up of the economically and socially influential in advisory bodies, Corporate structures unifying interests across firms in the same industry, such as professional business associations, have been ineffective because private entrepreneurs transact business with the government on a personal basis.39 National economic councils work when all members of an industry or interest group are treated in the same way. Interests that depend on particularistic deal making are unlikely to develop habits of collective bargaining. The inability to put the concrete experiences of interest groups at the service of administrative rationality can be traced to patronage politics, which, as we have seen, favors isolated, atomized relationships and the exchange of favors in the form of access to loans, permits, exemptions, and tax loopholes.40 Dependence on the discretionary interventions of their political benefactors prevents firms from acting as a group to impose policy consistency on government. The expectation that rivals will also seek political favors intensifies the motivation to invest in political influence. Individual firms fear one another as much as they fear sovereign discretion (Kochanek 1974, 289).41 As a result, India's private sector had little direct influence on public policy until the 1980s and was unable to prevent or modify the introduction of a single major redistributive policy (Kochanek 1974). A leading specialist on Indian business organization asserts that "the business community in India is not a clearly articulated business class and is neither capable of acting as a unified lobby nor of pursuing a long term policy to achieve well-defined objectives. Business has neither the organization, coherence, nor power to act as an independent political force" (Kochanek 1987, 1283). Since industry cannot act as a group, the government does not bargain collectively with industry.42

India's Private Sector Adapts
Ideas regarding trade policy have changed radically in India since the early 1990s. The attractiveness of protectionist ideas has been corrected by experience and cross-country observation.43 India's planners and economists are unlikely to propose central planning again. Nevertheless, in 1997 the list of protected products still covered more than 2,700 items, the average import-weighted tariffs at 25 percent were well above East Asian averages, automatic business approvals were lacking in many sectors, the insurance sector was not open to foreign investment, and import controls on consumer durables were high. The demand for trade protection is still active because Indian firms developed structures and strategies for accomplishing goals domestically--coping with domestic political risks caused by weak policy credibility and arbitrary government discretion--which hinder their ability to compete internationally.

If the general governance structures in any society determine the strategies for organization and survival among firms, then it may seem curious that the adaptive strategies of firms in India are similar to those of China. Both Asian giants have small private sector firms because in both countries an absence of regulatory predictability and procedural transparency allows political risk to affect business calculations.44 In both countries, large-scale, hierarchically organized private commercial institutions, with centralized and standardized information gathering and processing and salaried managers, are undermined by the threat of sovereign transgression.

Sovereign transgressions can take many forms,45 the most obvious being outright expropriation, a risk faced by large firms in India during the 1970s. But other forms of sovereign transgression exist that make capital a liability of government. The risk of unpredictable regulatory behavior--when rules are interpreted according to the private interests of the regulator--is similar to the risk of seizure or confiscation. The most complained of sovereign transgression is an arbitrary tax apparatus. Doing business with the government or with government-owned entities is also a source of uncertainty because the government often fails to make good on debts to domestic companies.46 Ad hoc regulatory interventions, arbitrary tax collection agencies, and inflationary monetary policies are all forms of discretion at the disposal of government officials that can wipe out a firm's existing capital.47 Moreover, successful firms often have something to hide; it is hard to imagine how success could be achieved if serpentine rules had not been broken. This means managers in the private sector are continually subject to political manipulation.

A general source of manipulation is the political parties' need for funds. To fund politicians, companies must have on hand black money, accumulated through tax evasion or black market operations that circumvent government controls. A political party representative may ask for specific amounts under threat of raids by either the Revenue Intelligence or the enforcement director. During the 1970s, ministers were known to insinuate that a particular industry or trade might be nationalized, just to encourage the flow of contributions (Kochanek 1987, 1290–92).48 The threat of a raid by income tax authorities was supplemented by more-routine demands for payment by inspectors and licensing authorities and became part of the cost of doing business. Such costs arose unpredictably, however, and therefore could not be adjusted for in the firm's calculations.

India's fiscal system does not allow the residual income generated from property to be claimed predictably by its owners. Since tax raids arise at any time, even the most seemingly stable operations seek protection by adapting ownership and decision-making structures based on secrecy and idiosyncratic investment, production, and managerial systems. Information about assets and activities is hoarded, and accounting procedures and ownership structures are arcane (i.e., the books are cooked). The liabilities of firms are not publicly available, taxable assets are disguised, and the identity of investors and ownership structures is kept secret. Because symmetry of information is lacking, firms have incentives to behave opportunistically even toward their own stockholders.49 In fact, the Investor's Guide of India's Economic Times reports that "there is hardly a company that can resist the temptation or even the pressure to indulge in some amount of financial manipulation. The only difference is the degree to which accounts are played around with" (Grant's Asia Observer 1996). The need for secrecy, which generates high levels of firm-specific capital, is a rational risk, reducing responses to regulatory and fiscal uncertainty.

These strategies have a negative effect on productivity. The need to secure property rights by making them impenetrable to the outside prevents the development of a liquid market for those rights. Unreliable information concerning the assets and liabilities of individual firms limits the market for claims on their liabilities or assets. By delaying the evolution toward professionally managed, rationally structured administrative hierarchies, secrecy further disrupts efficiency.

When formal alliances between firms are uncertain, intermarriage remains a more effective way to seal business deals than contracts. As a result, India's private sector organizations are dominated by family business, and firms remain small despite the availability of technical expertise and skilled labor. The family holding company is the preferred method of concentration, as its opaque accountability is best suited to cope with the risk of government opportunism.50 The separation of management from ownership, which underlies the international dominance of German, Japanese, and American firms,51 is not possible when whimsical government intervention makes property rights uncertain.

Capricious interventions by the government motivate firms to develop idiosyncratic forms of institutional capital; heavy investment in political corruption compounds uncertainty by intensifying the risk of the repudiation of agreements when the government changes hands. Rival political parties may require that deals consummated under a previous government be reexamined. When elections determine the status of property rights, political risk escalates to the level of that under a dictatorship. Contracts, which depend on the previous leader's discretion, can easily be annulled by a successor.

High information costs, asymmetric information, and collusion are part of the strategic calculation of individuals and firms faced with great uncertainty. The sources of that uncertainty--weak policy credibility and excessive government discretion--must be removed before entrepreneurial structures can flourish. As a result, economic actors have good reason to fear the violation of economic rights by those exercising political power. To overcome the uncertainty, private firms in India are driven to demand protectionism and monopoly profits.

Since liberalization, business has benefitted from meaningful consultations. The need to give gifts to bureaucrats while negotiating a deal is now less important; as business becomes more educated, each side is more likely to view the other as equal. The trading class is beginning to break out of its family culture. Nevertheless, the past still weighs heavily on the structure and behavior of business interests.

Business Reputation and Liberalism
Business in India has a bad name because business leaders have been forced for decades to skirt legislation that made ordinary business behavior illegal. To avoid restrictive legislation, businesses use political connections to corner industrial licenses, employ import licenses to make quick profits, hold money abroad for business expenses, gain advantages by bribing officials, avoid taxation by earning unaccounted money, and pocket excise duties by claiming production in low-tax, high-cost regions while production occurs in high-tax, low-cost locations. Overpricing goods bought by government departments and sharing the profits as kickbacks with purchasing agents is widely practiced. To avoid taxes, wholesalers often pay for advertising, adding the cost to the price passed on to the retailer. Stealing electricity or diverting production to the underground economy is rampant, and all contribute to an image of a socially irresponsible private sector.52

Turning the spotlight on corporate fraud and corruption will not help, nor will popular support for economic reform increase when the country's business leaders go to jail. Unhappily, governments that behave as predators foster private sectors that routinely break the law to do business. The murky reputation of business, gained after years of adaptation to laws that made ordinary business activities criminal, must be amended, or popular opinion will see no difference between business and criminality. Without governance reform, liberalization looks like giving the rich a green light to get away with anything.

The Cost of Corruption
Is corruption inherent in developing countries' administrations? The international development community has long treated the link between corruption and underdevelopment with indifference. Since international development agencies did not make assistance conditional on integrity, notoriously corrupt governments received development assistance with hardly any reference to the widespread misuse of public funds. How did rampant abuse of public resources avoid disclosure, analysis, and response for so long?

Even economists provided scientific support for ignoring corruption by elaborating a number of reasons why corruption does little economic harm during development. Corruption may even be a good thing, we are told, when it lubricates unwieldy administrative machinery that might otherwise grind to a halt. Indifference was also justified on grounds that no evidence existed that corruption was a quantitatively significant component of gross domestic product. This brand of developmental stoicism drew on Karl Marx's observation that the early stages of capital accumulation thrive on inequality and are inherently unjust. Even Marx's capitalist critics were willing to accept the bitter pill: no corruption, no development. The issue for the development community was to get countries to proclaim adherence to the right policies (i.e., liberalism), regardless of whether or not it was politically sustainable. Condoning corruption in high places has not made it go away but has eroded national morale while providing a justification to those who practice it.

Stoicism was reinforced by East Asia's prosperity, proof that dirty practices do not prevent growth. The generalization about East Asia is inaccurate: the high performers--Singapore, Korea, Taiwan, Hong Kong, and Japan--aggressively tackled bureaucratic corruption before undertaking economic reform as a way to establish the credibility of government in the eyes of their citizens (Root 1996).

Above all, economists and donor organizations acted on the belief that corruption is a political problem53 and that the cure is liberalization. They proposed eliminating corruption by cutting red tape and simplifying procedures to narrow the opportunities for petty graft. Trade liberalization, they conclude, will wipe out the opportunities for big-time graft characterized by collusive arrangements between large firms and government.

The cure has been disappointing. Consider South Asia, India, Pakistan, Bangladesh, and Sri Lanka, where no national government has been reelected successively during the 1990s, the decade of economic liberalization, because none has been able to control corruption. Contrary to the claim of apologists that corruption is a Western invention, poor voters in those countries attempt to throw out those politicians who practice it. Pakistan's Benazir Bhutto was deposed twice as a result of charges of corruption. The new prime minister, Nawaz Shariff, who was deposed earlier on charges of corruption, has made corruption a principal target for reform. India's Congress Party was undone on charges of corruption; Prime Minister Rao has already been convicted, and many of his top cabinet members are facing criminal investigations. Sri Lanka's Chandrika Bandaranaike Kumaratunga (People's Alliance Party) made corruption a cornerstone of her successful upset during the electoral process of the rule of the United National Party. In Bangladesh the Awami League ousted the rival Bangladesh Nationalist Party on the grounds that party members had abused public trust while in power. The elections on the Asian subcontinent are unambiguous; corruption scandals erode popular support for government, cost politicians their jobs, and produce political crises.

Less obvious are the ways political corruption inevitably slows productivity growth by making economic liberalism unsustainable in the following ways (economists take note):

  1. Corruption erodes the capacity of the government to provide basic public service delivery. Instead of public goods, such as an effective policy matrix, corrupt systems focus on the use of public authority to create private goods for regime supporters. This undermines the credibility of the government and weakens the consensus for long-term support of liberal reforms.
  2. While closing older avenues for kickbacks, liberalization can open new opportunities, like privatization deals, for corruption.
  3. Corruption distorts the decision making of both the public and the private sectors. Officials will work at cross-purposes with the institutions they represent, keep supplies and permits scarce, and use opaque regulations to create insecurity in order to maximize their profitable interventions. Similarly, firms must adapt management structures that maximize secrecy and idiosyncratic forms of ownership to prevent manipulation by politicians and to cope with unpredictable government bureaucracies. Business often succeeds at outwitting the regulators but at the expense of transparent practices that encourage long-term business confidence.
  4. Excessive regulation causes profit-seeking firms to break the law. Assaults on illegally accumulated wealth subject business to persistent political uncertainty, and denies business public support or a continuous, open role in policy making. To surmount regulatory uncertainty, business relies on strong personal relationships with politicians. Deals that depend on the right connections, however, can be overturned when a new government appears.
  5. In a democracy, corruption is difficult to hide; instead, it is publicly debated, discussed, and examined. Opposition parties can cite the corruption of the previous government to gain political advantage.54 When government changes hands, contracts consummated under one government may be reconsidered. Consequently, property rights are no more secure in democracies of South Asia than in autocracies where the rule of law does not apply and leaders can confiscate the property of citizens at will. Knowing that contracts may not be honored when the government changes, investors entertain long-term investment reluctantly and often require government subsidies or guarantees of monopoly to offset the risk. Government must stay involved in managing the economy to subsidize the large capital expenditures that may be subject to political risk, further crowding out the private sector.

Thus, corruption is a political problem that has far-reaching economic consequences: opportunities are lost, innovation is deferred, entrepreneurialism and investment are aborted. When citizens perceive that government cannot credibly commit to the implementation of policies designed to increase economic growth, government loses support, reelection becomes improbable, and questions may even arise concerning the durability of the political system.55 Thus, the uncertainty resulting from corruption scandals cannot be captured in strictly quantitative terms as a percentage of output. Corruption violates the credibility of the liberalization process and prevents the establishment of a credible policy environment, crucial to the success of economic reform.
India's success at unifying a diverse secular state through democratic means is one of the great political achievements of the twentieth century. Information disclosure, an important component of any functioning democracy, will enhance economic performance just as it makes corruption difficult to hide. Indeed, corruption is one of India's most contentious political liabilities, causing successive governments to fail. The worst sins of India's political class eventually come to light, and the voters have responded by making politicians pay, unlike Indonesia or China. Once transparency is adopted by India's political parties, India may once again march ahead of its rivals and become a model for Asia.

The demand for more-transparent public policies and procedures may emerge from various sources. New industries, particularly high-tech ones, are forming outside of official regulation, producing new sources of wealth that the government cannot easily subvert and new independent spokespeople for governance reform. Citizen groups in general and the business community specifically are gaining organizational capacity and associational skills that may enhance their ability to monitor government services. A growing middle class may demand positions in government based on professional competencies. Accountable politics and civil administration may arise in response to the growing demand of these groups. However, India's path from patronage politics may face a new obstacle. New political contestants may use corruption to create a power base among the poor.

1 The author would like to gratefully acknowledge the comments and Suggestions of Muzzaffer Ahmad, Bruce Bueno de Mesquita, Joyce Cerwin, Amanda Morgan, Nahalel Nellis, Nancy Overholt, and Henry Rowen.

2 The reforms included an initial devaluation of the rupee and subsequent market determination of the exchange rate; abolition of import licensing with the important exceptions of restrictions on imports of manufactured consumer goods and on foreign trade in agriculture; convertibility (with some notable exceptions) of the rupee on the current account; reduction in the number of tariff lines as well as tariff rates; reduction in excise duties on a number of commodities. For a detailed account, see T. N. Srinivasan (1996, 14–15).

3 The long list of needed reforms includes amending the labor laws, closing the fifty-eight public sector enterprises that are chronically ill and trimming the rest, closing loss-making bank branches, privatizing the insurance sector, reducing the number of public sector employees, increasing oil prices, imposing user fees for public utilities, and allowing 100 percent foreign ownership of business ventures.

4 The reforms included simultaneous stabilization and structural adjustment, which threatened to reduce aggregate demand, increase interest rates, and reduce public investment in infrastructure.

5 In retrospect, many believe that the fast-track deals inviting foreign investment presented scope for cost padding and favoritism. In the absence of competitive bidding, accusations of corruption were inevitable, especially when there was political advantage to be had from such claims.

6 Populist pressures deriled the reforms attempted by Rajiv Gandhi in 1985 after only six months. The party could not find support to liberalize. Rajiv Gandhi concluded a new moral center was needed; trust was absent. While giving a speech celebrating the 100th anniversary of the Congress Party, he bluntly asserted that "millions of ordinary Congress workers are handicapped, for on their backs ride the brokers of power and influence, who dispense patronage to convert a mass movement into a feudal oligarchy--corruption is not only tolerated but regarded as a hallmark of leadership" (Kholi 1990, 5). It is widely acknowledged that corruption is worse now than when he made this statement.

7 Patronage started early but was not initially contested because the status of early politicians was beyond reproach.

8 The Civil Service Commission is a statutory-constitutional body; however, lines of authority do end in the hands of the politicians. The commission reports to the prime minister and presents an annual report to Parliament. The prime minister appoints the commission and can appoint people it controls. Guarantees of autonomy are weaker than in the United States; parliamentary hearings to oversee appointments do not exist in India. Provincial civil service commissions operate in a similar manner. When different parties exist between the state and center, problems will develop as central government can tell local seekers that there are no postings available.

9 The Indian bureaucracy was initially reluctant to accept input from organized groups representing business interests.

10 Although the civil service is grounded in the constitution, accountability is ultimately to the politicians. The prime minister appoints the commissioner without the constraint of congressional hearings, as in the U.S. system.

11 In Rajastan during one year, forty thousand transfer orders were carried out in the education department alone. Fees help explain this merry-go-round. Each transfer cost its bearer 1,000 to 3,000 rupees. The post of a superintendent engineer went for 50,000 rupees (Zwart 1994, 81).

12 Police stations are repeatedly auctioned; officers of rank bid for the rights based on corruption prospects. As a result, honest officers have limited hopes of rising to the top.

13 Not all posts are for sale and not all careers are made through graft. Many situations exist in which the bidding is based on technical competence, making it possible for highly motivated and competent individuals to rise in the system and serve at the highest levels. They too must labor with the overall breakdown of integrity at lower levels of service and perhaps can ultimately be counted on to support reform from inside.

14 In the early 1980s, transfer policies laid down norms calling for postings of three years, but numerous independent studies reveal that this has not been followed. One study shows that 80 percent of India Administrative Service officers held posts for less than two years, and a majority stayed for less than one year; only 20 percent stayed for two or more years (Potter 1986, 218).

15 The transferring authority is accountable for transfer decisions only to the immediate officer; no justification for one assignment rather than another need be given to anyone else. Who the transfer officer is depends on the rank of the transferee and on the distance of transfer. Procedures do not exist by which individuals are entitled to be consulted or even to express their preferences. No reasons need be given and no appeal procedure is available (Wade 1985).

16 Just as the political influence of business in India is exercised in a particularistic manner, in this arena too group representation of interests is not encouraged.

17 (Wade 1985, 485.) Canal managers are under pressure to behave almost exactly contrary to the ostensible objectives of their job: instead of reducing water uncertainty, they artificially increase it if they wish to maximize bribe revenue; instead of maintaining the canals in good condition, they leave large stretches of canal unmaintained to save maintenance funds for other uses. Agricultural officers are under pressure, if they wish to have congenial postings, to adulterate the special inputs they are in charge of, so as to sell the balance on the black market, and to approve the substandard seeds or fertilizers of private dealers.

18 Forced to live on their official salaries, many bureaucrats complain they cannot make ends meet while dispatched for training.

19 Voting in India does not seem to reflect awareness of major issues and/or the intention to maintain or to change specific policies--that is, contrary to the description sometimes made of voters in America, Indian voters do not vote in expectation of certain policy outcomes (Meyer 1989, 1121). Weiner explains that "for the bulk of the Indian population there is a greater concern for the position which each group has in relation to every other group than for India's economic position vis-à-vis other countries" (Weiner 1967, 465). This arithmetic is "almost everywhere and for almost everyone, that the quest for power, rather than the desire to implement programs, led to the formation and the dissolution of the coalition ministries" (Bueno de Mesquita 1975, 88).

20 Because the Congress Party controlled much of that sprawling governmental structure, the party elite could readily channel those economic resources to build and sustain political support. The economic development implications of using scarce economic resources for political ends or, for that matter, of adapting to local power structures and thus foregoing any reforms that might adversely affect the influential "big men" probably were negative. Nevertheless, those strategies were political in motivation and, when judged by political criteria, were quite successful. They helped the Congress Party build and sustain a sprawling network of supporters across India (Kohli 1990, 186).

21 This chain linked the party's national leaders with landowning members of the local elite who derived their legitimacy from an association with the nationalist symbols of the Congress Party and, "more important, by cultivating their image of being problem-solvers within the local community. Although their organization for problem-solving was like machine politics anywhere, the use of public resources at the discretion of the local elite had not yet come to be viewed as corrupt and self-seeking behavior." The so-called big men "received political offices or access to governmental resources in return for using their local influence to mobilize electoral support for Congress. That chain of important individuals stretching from village to state and eventually to the national capital, welded by bonds of patronage, was one central feature of Congress's success until the 1960s" (Kohli 1990, 186). But patronage created expectations of resource allotments that could not be satisfied. Bueno de Mesquita provides evidence that India did not progress under the Congress Party rule from being an "uneasy amalgamation of interests" to becoming a politically integrated nation" (Bueno de Mesquita 1978, 279). One reason that the Congress Party failed "in its efforts to integrate India's population into a single political framework"(287) was its reliance on locally based patronage networks.

22 The term demand groups is used by Lloyd Rudolph and Susanne Rudolph (In Pursuit of Lakshmi: The Political Economy of the Indian State [Chicago: University of Chicago Press, 1987]).

23 "Since 1951 India has had over 100 political parties, most growing out of the will of a handful of people with only a local base. Others were confined to a linguistic region and only a few were organized across state boundaries. There have been thousands of individual defections, dozens of party splits and mergers, and frequent electoral alliances" (Meyer 1989, 1113)."Discontented castes or factions are often geographically confined, making it difficult for opposition parties to unify a broad coalition of discontent. Congress deals with discontent on a piecemeal basis; although it opposes casteism and communalism its local calculations usually employ ethnic arithmetic" (Weiner 1967, 475).

24 "Public sector industry has absorbed 55% of the planned investment and controls 70% of fixed assets. The share of the public sector has increased from 10% of the gross domestic product in 1960 to 15% in 1970 to 21% in 1980" (The Economist [London], January 8, 1983, p. 64, cited in Kochanek 1987, 1281).

25 The relative size of the Indian public/government sector at independence in 1947 dramatically increased from 7.6 percent to 24.9 percent of GDP, its share in the net domestic product (NDP) increased from 7.5 to 24.9 percent and in final consumption expenditure from 8.2 to 15.6 percent. Its share of gross domestic capital formation, as a proportion of GDP, rose from 10.2 percent in 1950–51 to 24.6 percent in 1990–91. But in gross domestic savings, its share decreased from 17.2 to 4 percent. Jagdish Bhagwati (1995, 6) attributes the dramatic decrease in governmental savings to the unprecedented increase in the 1980s of budgetary expenditure on defense, governmental wages and salaries, and subsidies.

The 244 economic enterprises of the central government alone, excluding the railways and the utilities, employed as many as 2.3 million workers in 1990 (Bhagwati, 63). The public sector enterprises in manufacturing, mining, construction, transport, communications, banking, and insurance provided nearly 70 percent of the 26 million jobs in the large-scale "organized" sector in 1989 (Baghwati, 64). In the steel industry, all steel production in 1950–51 was centralized in the private sector, but in 1991–92, 85 percent of aggregate steel output came from the public sector. However, despite the growth of the steel industry in the public sector, the country still had to import steel worth over 2,000 crores every year (Prasad, 2).

During the 1950–1991 period, combined public finances (revenues and expenditures ) of the center, states, and union territories rose 218-fold. Tax revenue as a percentage of GNP rose from 6–7 percent to 17–18 percent, and expenditure a percentage of GNP rose from 9.4 percent to 43.7 percent. The state of Indian public finances had reached crisis proportions by the end of the 1980s. The public debt–to-GNP ratio increased through the 1980s, jumping drastically towards the end of the decade to nearly 60 percent, a near doubling of the ratio in 1980 (Bhagwati, 66).

26 Weiner writes, "Economists have been irritated by the Indian penchant for focusing on investment rather than production targets, but the main point here is that the volume of government investment and the increasing size of the government payroll have been important factors in the strength of the local Congress party organization" (Weiner 1967, 464).

27 In already industrial nations, loss of control over the macroeconomy makes patronage essential for politicians to win voter support.

28 According to Weiner, "The local Congress party aids its membership and its supporters in the countryside in their efforts to influence tax enforcement, to get the necessary permits for the purchase of cement, fertilizers, and other commodities, and to influence local administration in its appointment and myriad other activities" (Weiner 1967, 464).

29 The Santhanam Report in 1964 confirmed this observation (Government of India 1964).

30 Indira Gandhi gave her justification on November 16, 1969, when she publicly criticized the civil bureaucracy as the "stumbling block" in the way of the country's progress (Bhambhri 1972, 23). At the time, the idea was widely expressed by Congress leadership that the Indian Administrative Service (IAS), with its orthodox and conservative leadership and upper-class prejudices, would not promote social and economic change along socialist lines. An administrative cadre "committed" to the cause was urgently requested.

31 Mrs. Gandhi attempted to strengthen her position by undermining the security and durability of chief ministers. She promoted factionalism in the Congress-ruled states to make herself indispensable as mediator. She allowed no state chief minister to develop a local power base. The overall cohesion and stability of the party were weakened as she catapulted chief ministers who enjoyed a limited local power base into national politics. Some of her ministers were not even members of the state legislatures they were requested to pilot. She kept chief ministers in constant flux to make sure that none could dispense with her patronage. Factional leaders were given preference over those chief ministers who seemed secure on their own. The result was loyalty to the leader at the expense of party coherence. The same logic of patronage pervaded the entire system of administration. Loyalty to the leader overrode all other principles of management (Dua 1985).

32 The police captain is a key patronage position. The local political boss requires a loyal chief of police since the police decide which laws to enforce and which public to serve. A captain enjoying the support of the political boss has many opportunities to exploit and little to fear. Political control over the police is rarely exercised at the local level; rather, the key appointments rest with the political leadership of the state.

33 Special police forces can be created through executive orders of government.

34 By changing the system of accountability, one can change the outcomes. In Kerala, pay and supervision are overseen by village legal institutions rather than by the states. Literacy rates are significantly above national averages as one generation of literate villagers demands the same opportunities for its children.

35 Lower-court judges, prosecutors, and police are widely suspected of corruption, and in the higher courts legal delays are endemic. Even if the Supreme Court ensures prosecution, it could take decades and achieves little, so that probity even where it tends to be concentrated rarely provides results.

36 All major banks and insurance companies were nationalized in 1969, and these accounted for more than 90 percent of the financial sector's assets by the early 1990s. Although the public sector banks have succeeded in mobilizing savings, extending banking to rural areas, and directing credit to "priority" sectors, the subsidies and defaults have become so rare that the policy of subsidized and directed credit has become unsustainable. The net worth of the banking sector has been eroded. (Srinivasan 1996.)

37 Based on a survey of two thousand business executives from forty-nine countries.

38 A corporatist agreement raised the costs to government of predictable future policies.

39 In 1964 this weakness was recognized by a national committee set up to investigate corruption. The Santhanam Committee "agreed with the view that association of recognised bodies of commerce in decision-making can greatly reduce issue of licenses to spurious firms who have no standing in a particular commercial activity or industry. This is so because those in the field would know the bonafides of a firm in that field while it is possible that a supervisor or inspector of the government can be duped by the false credentials of a bogus firm. Again, licenses should not be issued to those firms who are not admitted to a particular trade guild or chamber of commerce. Another step to curb corruption would be for the government to enter into direct negotiations with business organizations (Gopinath 1982). The report took notice of frequent unrecorded meetings between executives of commercial firms and senior government officials.

40 For example, during the 1950s and 1960s, important business houses had reportedly "captured" certain members of Parliament. "Members of the FICCI are generally understood to have well-established contacts with the Congress hierarchy, with bribes being passed under the table to party coffers in exchange for political favors. Most business houses, moreover, maintain 'liaison offices' in New Delhi that wine, dine, and probably bribe bureaucrats and senior politicians to facilitate licensing and access to other resources the government controls" (Kohli 1990, 325–26).

41 Kochanek reports that "because business firms in India do not trust each other, they are unwilling to disclose their affairs to business associations. . . . They must, therefore, maintain their own liaison with government." This generally includes a listening post in Delhi to keep track of deals offered to rivals (Kochanek 1974, 289).

42 The Associated Chambers of Commerce and Industry (ACCI) tend to represent foreign multinationals and the more managerial firms of Bombay led by Tatas. The Federation of Indian Chambers of Commerce and Industry (FICCI) is dominated by the Marwari firms that moved from trade to industry in the last half of the nineteenth century. The Federation of Associations of Small Industries of India (FASH) represents the small-scale sector. These three organizations often have sharply divergent views and are unable to generate a homogeneous perspective or to articulate a consistent set of interests or values.

43 Observation of China's rapid growth converted the Indian planning commission to the advantages of openness.

44 Political risk affects the informational structure of Indian firms in ways that are different from China. In India, matters of fiscal policy are open to public debate, but the risk of expropriation or discretionary application of regulations exists despite the rule of law.

45 Even India's largest private conglomeration has faced the threat of public bashing. Indira Gandhi's George Fernandez, a prominent labor leader and Minister of Industry, threatened to break up the big private holdings, such as the Birlas, and talked of nationalizing India's most successful steel firm, Tata Iron and Steel Company (TISCO) (Waterbury 1993, 58).

46 One problem of doing business with government-owned entities is that they seem more solvent than in fact they are. Major discrepancies are known to arise in the accounts of public sector firms that are notorious for being able to avoid the annual scrutiny of auditors; however, deregulation compels government firms to show a profit. India's central bank, the Reserve Bank of India, has been ineffectual in monitoring the activities of the banks under its supervision. The inspectors are highly competent, but their reports are submitted to a superior who is not subjected to outside accountability. Sensitive information can often be withheld since everything is secret. Often the directors of the central bank have conflicting interests, as they also serve as directors of the private banks they oversee. All this means that firms never know where they stand when they deal with the government (Grant's Asia Observer 1996, 9).

47 Government can randomly change prices of price-controlled products to penalize or favor particular interests. For example, in 1989, a private firm that had just completed a new vitamin C production line became obsolete when the government cut the vitamin's price.

48 Incidence of nationalization of foreign investment was a worldwide phenomenon, not unique to India, that peaked around 1975, vanishing in the early 1980s (Kobrin 1984).

49 Laws protecting shareholders of Indian companies lack teeth. Regulatory bodies rarely play the role of watchdogs. The staff of the Securities and Exchange Commission is inadequate and undertrained. Few are lawyers. When investigative agencies are weak and understaffed, corporate fraud cannot be effectively prosecuted. Companies cannot be expected to provide realistic information to oversight boards when the books are cooked to avoid restrictive laws (India Today, November 30, 1996, 105).

50 A distinctive feature of the private corporate sector of India is the dominant position enjoyed by a relatively small number of large, family-controlled business houses. The top thirty-seven houses were drawn predominantly from families who belonged to the major traditional trading communities of India (Kochanek 1987, 1281). In the family holding company, the majority of shares are owned by the family; only with great difficulty can shareholders monitor firm performance.

51 See Fukuyama (1995) for a discussion of the commonalties in firm organization of the world's industrial leaders.

52 It is widely believed that India's business elite lacks ideological legitimacy in a society that traditionally views the profit motive and private gain as antisocial. A similar traditional bias existed among the "Confucian" societies of East Asia that have prospered dramatically since 1960. It seems more likely that India's socialist economic legislation, by making normal economic calculations illegal, turned profit-seeking businesspeople into quasi criminals.

53 Which is why multilateral organizations, citing their apolitical charters, have been reluctant to get involved, leaving the study to the category of anecdote. Moreover, the donor organizations kept mum for fear of encouraging a moral outrage on the part of donor nations, and many leaders in the development field argued that corruption reflects Western values.

54 For example, much of the opposition campaign in India's 1989 national election was based on Rajiv Gandhi's alleged involvement in a scandal that involved kickbacks on a government contract (Bofors) and on the Congress charge that the opposition leader, V. P. Singh, had a large secret bank account in the Caribbean.

55 Traditionally in the economic literature, uncertainty has not been viewed as a powerful explanatory factor in neoclassical investment and growth models, which rarely analyzed the impact of volatility on economic activity. However, recent empirical studies indicate that volatility can adversely restrict investment. Ramey and Ramey (1995) demonstrated a strong negative correlation between volatility in real gross domestic product and the average rate of growth using cross-country evidence. Others have found a negative relationship between various volatility measures and private investment (Aizenman and Marion [1993] Hausmann and Gavin [1995]). Alesina et al. (1992) identified adverse growth effects of political instability in developing countries after controlling for other variables. Aizenman has argued that underinvestment will occur in the absence of a commitment mechanism ensuring no future tax. For example, populist political pressures have created volatility in India by weakening institutional commitment mechanisms. Investment subsidies needed to overcome policy uncertainty are made unsustainable through these pressures. The Enron controversy discussed earlier revealed that considerable political gain can be obtained by overlooking why investors might want to charge a risk premium to enter a market that has experienced considerable policy uncertainty. Renegotiation in turn created additional policy uncertainty.