Why cronyism peaked during UPA, and why it may now be in remission

Crony capitalism is much in the news these days. Not just because of Arvind Kejriwal’s diatribes against Modi, the Adanis and the Ambanis, but because the global financial crisis of 2008 brought capitalism into disrepute when million-dollar bankers were shown to be raking it in even as millions of ordinary people were losing jobs and livelihoods. Wall Street had pushed Main Street to the Wall.

In its 15 March issue, The Economist has even built a crony capitalist index which shows India improving its position from No 6 to No 9 - which means we are less crony capitalist now than before (2014 against 2007). Among the 23 developed and developing economies the magazine chose to rank, Hong Kong and Russia are the toppers (which means cronies run the show there), while the US comes in at No 17, China at No 19 and Japan and Germany at No 21 and 23. This makes Germany least prone to crony capitalism.

However, these are crude measures, resulting from The Economist’s methodology which links cronyism to wealth extraction from sectors that are “vulnerable to monopoly, or that involve licensing, or heavy state involvement.” These sectors include rent-seeking ones like mining, infrastructure, ports and airports, real estate, construction and utilities. Banks, too, since they are systemically too important to fail - and hence vulnerable to state intervention and bailouts. In all these sectors, wealth creators need government support and regulatory indulgence to charge as high rates as possible from users for their services. In other words, these sectors lend themselves naturally to bribery and cronyism.

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What’s interesting is that India’s rank has improved, and this suggests that much of the current hand-wringing over cronyism may be over a phenomenon that may be on the wane.

Is crony capitalism really waning in India? On the face of it, this may not appear true, given the huge corporate scams that have been tumbling out of the closet over the last few years: 2G, Coalgate, iron ore mining, Sahara, Satyam, etc.

However, there is a good reason why scams and cronyism have peaked together under UPA - and may now be on the wane. The reason is socialism: crony capitalism is the result of allowing bureaucrats and ministers to decide what the markets should. It also is indicative of the failure of transparent and effective regulation resulting from a weak state that is unable to make its writ run. In this scenario, businessmen will make efforts to “capture” regulators and influence policies using administrative weakness to their advantage.

Under UPA-1 and UPA-2, the reach of the state was extended enormously in the name of the poor, giving scope to every two-bit businessman to make money using central and state connections.

Crony capitalism needs two conditions to succeed: a state that tries to do too many things and exceeds its management capabilities, and a state that is politically too weak to assert itself against powerful businessmen. This is why when growth peaked during UPA-1 and the first half of UPA-2, we saw the flowering of scams.

The following are the India-specific reasons for the rise of crony capitalism, and why it may be about to start withering - gradually.

#1: The rise and fall of state control. Before 1991, India was a poor socialist state. The state was inherently suspicious of markets and business, and controlled everything: production, prices, imports, lending rates, everything. This situation ensured that only businessmen who were cronies of the Congress party could flourish. Between 1947 and the mid-1980s, few big industrialists went out of business, and the rest continued to either survive or flourish using connections.

After 1991, when the markets were opened up, suddenly we started seeing businesses disappearing. Do you hear very often today of the Mafatlals, or the Thapars, or the Walchands? Beyond Kumar Birla, how many of the other Birlas are worth remembering today? They still exist, but they operate at the margin.

In fact, in the 1980s and 1990s, Dhirubhai Ambani - everyone’s first name in crony capitalism - was the one (ironically) busting the cronies. The Bombay stock market was run by a few Marwari firms; Dhirubhai busted the cartel and democratised the equity cult. His methods weren’t kosher, but this is what he achieved.

Today, a similar thing is happening where even the Ambanis and other big businesses are under threat.

Reason: the boom-boom years of UPA-1 growth created new capitalists in the states. With states becoming the new political power centres, state capitalists began busting the older cronies. Ever ask yourself why it is the Mittals who rule telecom, why two Andhra business houses run the country’s biggest airports, and why the Adanis matter more than some others in Gujarat?

State-level businesses are bubbling up to the top, challenging the old Delhi-based crony order. Crony capitalism at the centre has been under attack from state-level cronies. The 2G scam happened because telecom suddenly became a state subject - owned by Tamil Nadu politicians. It has ended because this now threatens other telecom players.

Conclusion 1: When capitalists attack each other by using political clout, they neutralise their collective crony power. This, coupled with the rise of citizen concerns about big scams (the Anna movement, the entry of courts into economic decision-making), is leading to a sharp decline in crony power.

#2: Why cronyism spiked during UPA rule. Between 1991 and 2004, despite poor regulation and cronyism, the broad trajectory was that of a state trying to reduce its role in economic affairs. First, many state enterprises were listed on the stock markets; then, banks were freed to charge interest rates according to market demand; private enterprise got a huge leg-up to enter businesses it couldn’t earlier. The NDA government even started privatising state concerns and put restraints on its own spending by legislating the Fiscal Responsibility and Budget Management Act.

But UPA-1 reversed all that with its social spending agenda, driven by rights and entitlements. When the state expands, cronyism automatically expands since businessmen will flock where there is money, and UPA was sitting next to the spigot just when the economy was spewing cash. Under both P Chidambaram and Pranab Mukherjee, the FRBM Act was relaxed and the government borrowed like crazy and doled out subsidies. This could have been financed by raising tax revenues, but UPA went the other way and dished out goodies at low cost (2G) or even free (Coalgate), and state-level satraps in Karnataka (before and during BS Yeddyurappa’s regime), Jharkhand, Goa and Odisha helped businessmen loot their mines.

All the rights mandated by UPA - education, food, etc - will lead to more corruption and more cronyism unless these are reversed by the next government. The only natural limit to this abuse is the state’s physical recourse-raising power - and we are probably reaching that limit.

A second reason why cronyism spiked during UPA rule was the weakness of government. The division of power from responsibility - between Sonia and Manmohan - ensured that even the PM would not stop cronyism when he saw it happening.

Conclusion 2: A weak state encourages more cronyism, especially when it extends the state’s realm of operation. Unless the state contracts, cronyism will continue expanding. A strong, but small, state can focus on levelling the playing field by reducing its own discretionary power - which lies at the heart of cronyism.

#3: The gap between economic and political reforms. The third reason why we have seen a spike in cronyism over the last 10 years is that the political and legal reforms needed to support the economic reforms of 1991 have not come at all.

A competition and open economy needs a strong and open state supported by a strong legal and judicial system. Political funding has to be transparent and clean. But in India, after the initial shock of the opening up in 1991, politicians failed to follow through on their side. They merely saw economic reforms as a different way of making money and funding re-election.

So instead of making money from licensing, they moved to other areas of rent-seeking that fast economic growth enabled: real estate, sale of licences utilising finite resources (spectrum, coal, iron ore), arbitrary regulation, etc.

Conclusion 3: An unreformed political and legal system will ensure that no wrongdoing will be punished, increasing the incentives for graft. This is the kernel of an idea that we should thank Arvind Kejriwal for, but he shows no interest in carrying this forward for now.

#4: From the commanding heights to the depths. As UPA-1 stopped the idea of privatisation of public sector enterprises, the monopoly rents collected in these enterprises became another cause for cronyism. The government owned most of the big banks - and bank cash was used to fund cronies in fields as diverse as aviation, infrastructure and telecoms. Public sector cash surpluses in the oil and coal companies were used to dole out subsidies - thus destroying competition in these sectors at home.

UPA has emptied public sector coffers to finance its re-election, and in the oil sector alone subsidy payments are in the region of Rs 8,00,000 crore. National wealth has been destroyed at an alarming rate.

This emptying of coffers is bringing up the endgame in cronyism. The state does not have the resources to extend itself, and it will have to sell, privatise or close down its public sector enterprises to stay afloat. Banks, sinking under a flood of bad loans, are in no mood to oblige even the finance ministry, which has no cash to recapitalise them.

Tentative Conclusion 4: State bankruptcy is ensuring that cronies cannot be supported any more. Rather, the state has to be bailed out by successful businesses built genuine value creation. Only they can generate the tax resources needed for the state to grow. The state will use its remaining rent-creating powers to raise more revenues - as we saw in the recent spectrum auctions and the plans to auction coal blocks. The state cannot afford to finance endless cronyism.

Cronyism is in remission - at least for now.