Economic Reform and the Rule of Law
(From the 75th anniversary edition of the Quarterly Bar Review of the Delhi High Court Bar Association, published in 2023.)
The Indian Republic will soon be 75 years old. Significant strides have been made since the Constitution was adopted, but much of India’s economic potential is yet to be realised. Indian entrepreneurship is held back by the ideologies and systems put into place by the state to control the economy after independence. With a demographic dividend, a growing start-up scene and global corporations looking to reduce their dependence on China, India could see a period of sustained high growth. To capitalise on this, India needs a new round of economic reforms founded on the principles of the rule of law and aimed towards maximising the economic freedom of market participants.
What is the rule of law?
Lord Bingham, one the most important judges of his generation in the UK, provided a succinct and comprehensive articulation in his 2011 classic, “The Rule of Law”[i]. For him, the rule of law comprised the following 8 principles.
· The law must be accessible intelligible, clear and predictable.
· Questions of legal right and liability should be resolved by application of the law and not the exercise of discretion.
· The laws of the land should apply equally to all, other than where objective differences justify differentiation.
· Public officials must exercise their powers in good faith, fairly and for the stated purpose, without exceeding the limits of such powers and not unreasonably.
· The law must afford adequate protection of fundamental human rights.
· Civil disputes should be resolved without prohibitive cost or inordinate delay.
· The adjudicative procedures provided by the state should be fair.
· The state must comply with its obligations in international law as in national law.
These principles apply not only to personal liberties and individual freedoms, but also to economic activity. Economic actors, including businesses and individuals, need to know what the law is. They need the law to be clear and relatively easy to understand and need to know that they can invest in accordance with predictable and durable rules. While state discretion cannot be eliminated, it must be limited, and its boundaries must be clear for businesses to understand. Such discretion must be exercised fairly and within the bounds originally contemplated. The legal system must resolve business disputes fairly and efficaciously. And finally, the state must stick to its promises.
Rule of law and the economy from independence to 1991
The relationship of the rule of law to the economy has been difficult. For over four decades, the post-colonial Indian economy was dominated by central planning, partly due to ideology and partly due to memories of scarcity during World War II. As a result, the state implicated itself in every aspect of economic activity, including production, distribution, sales and storage. This led to a tightly controlled and quite unfree system, based on industrial licensing, price controls, exchange control and import substitution.
Rohit De’s excellent “A People’s Constitution” evaluates the relationship between the state and the economy post-1950 in the context of India’s emergent constitutionalism.[ii] The requirements of a building a constitutional culture, which inevitably meant being concerned with the rule of law, often came into conflict with the post-colonial project of nation building and social justice, which interestingly also claimed their roots in the Constitution.
This meant that the post-colonial state had an uncomfortable relationship with individual property rights and was sceptical of free private enterprise. Violating laws dealing with the economy often had criminal consequences. These economic economic crimes were outside the scope of the criminal law and therefore not amenable to protections ordinarily afforded by criminal procedure and the state often sought, under these laws, to circumscribe key features of the rule of law for instance by shifting the burden of proof to the accused, providing for obligatory imprisonment for certain offences, confiscation of property, denying rights of appeal and summary trials.
It is true, as De argues, that this period also saw the development of the judicial review of state action, which is an essential feature of the rule of law.[iii] However, on balance, the rule of law found itself playing a back seat to the state’s desire to control the economy and this set the tone for the nature of the state’s relationship to the economy, that continues to the present day.
The 1991 reforms and beyond
While much has changed since, many features of the post-independence relationship between the state and the economy still guide the instincts of the state towards business. The 1991 reforms did much to dismantle the license raj by reducing or removing import tariffs, removing most import licensing and price and quantity controls and delicensing industrial production.[iv] Foreign investment, generally with prior approval, was permitted in several sectors. While the reforms did lead to some changes in the role of the state and the structure of markets, opening up was still selective and usually aimed at fulling instrumental objectives such as greater foreign direct investment, rather than aiming for deep economic freedom.
Reforms continued through the 1990s and 2000s, along the same lines. However, many features of the license-raj and the state’s mistrust of business still cast a long shadow. A comprehensive analysis of how this plays out is beyond the scope of this article but here are some examples.
Consents: While industrial licensing is largely a thing of the past, a number of permissions are still required to carry out many business activities. For instance, in 2016, the Brihanmumbai Municipal Corporation announced that it had reduced the approvals to set up 38 different businesses from 72 to 51.[v] Opening a restaurant in Delhi as of 2020, required submitting 45 documents and obtaining 26 licenses.[vi]
Compliance: “Jailed for Doing Business”, a monograph by ORF and Teamlease RegTech, claims that there are there are 1,536 laws that govern doing business in India.[vii] These laws contain the requirement for 69,233 compliances. And these compliances need to be communicated to the governments through 6,618 annual filings. An MSME with more than 150 employees faces between 500 and 900 compliances.
Criminality: Many economic laws still have criminal consequences – 26,134 of them, to be precise. ORF-Teamlease point out that of India’s 843 economic legislations, rules and regulations, 37.7 percent carry imprisonment as penalties. Many of these criminal consequences relate to procedural failures, including mistakes in submitting information or delayed filings. [viii] A deeper analysis of these laws shows significant disproportionality between the severity of the non-compliance and the extent of imprisonment.
The heavy burden of compliance, combined with criminal consequence of failing to do so, has at least two negative consequences. This incentivises rent-seeking behaviour from state agencies and dissuades many potential entrepreneurs from taking the plunge to start a business.
Contracts: An important area of economic activity in India involves private parties contracting with [ix]the state. These contracts are often poorly drafted with inefficient risk allocation. This leads to problems in contract management and frequent disputes. For instance, the National Highways Authority of India accounts for almost 40% of the cases that the Union Government is party to in the Delhi High Court.[x] State bodies routinely deny valid contractual claims[xi], rarely settle disputes and tend to carry on litigation till all appeals have been exhausted, regardless of the merits of the case.
Confidence: The reputation of the Indian state and confidence in the Indian economy was deeply bruised by the Vodafone and Cairn retrospective taxation cases[xii]. These matters came just as India was clawing back its reputation as a safe place to do business following the Enron debacle. This behaviour continues. A little over a year ago, the Punjab government passed a law cancelling the tariff clauses in validly signed power purchase agreements.[xiii]
So, when commentators speak of the need for second generation economic reforms,[xiv] we must think hard about the principles on which this second round of reforms should be based. The phrase coined by the Prime Minister, “Minimum Government, Maximum Governance,” is surely shorthand for greater economic freedom, together with clear and simple laws to govern economic activity. This view reflects the spirit of this quote attributed to Friedrich Hayek: “Under the Rule of Law…the individual is free to pursue his personal ends and desires, certain that the powers of government will not be used deliberately to frustrate his efforts.” This requires building trust between the state, the law and business. And the way to do this is by looking at economic reform with a rule of law perspective.
Valuing the rule of law
The rule of law is not just a good to have. It is no surprise to see that in the World Justice Project’s Rule of Law Index, countries that perform best on rule of law are also amongst the most prosperous in the world.[xv] While some countries may bristle at their position on such indices, investors often pay attention.
This index drills down on two indicators which relate more closely to the economy, regulatory enforcement[xvi] and civil justice[xvii] and the same pattern is observed. The World Economic Forum Index of Global Competitiveness also show a reasonable degree of overlap between competitiveness and the Rule of Law.[xviii] The Heritage Foundation curates an Index of Economic Freedom.[xix] Again, there’s high correlation between a country’s ranking on this index compared with its economic performance. The now discontinued World Bank Doing Business Report used to compare business regulation in almost 200 economies, ranking countries’ performance in several indicators such as starting a business, construction permits, property registration, contract enforcement and tax administration, amongst others.[xx] India, unfortunately, does not fare well in any of these indices.
A recent report attempted to evaluate the economic value of English law to the UK economy.[xxi] This is interesting because the UK is considered to be a jurisdiction in which the rule of law is respected. This report is based on the principle that economic value is created by “gains from trade”. For transactions to take place, there must be trust between the parties and confidence in the outcomes if the parties do not stick to their bargain. This confidence comes not only from the reputation of the contracting counterparty but also faith in the underlying institutional environment. Uncertainty causes risk and risks lead to higher transaction costs as parties put a price to such risks. This also means that fewer transactions are likely to occur.
On the other hand, a legal system which performs well on rule of law leads to higher predictability and confidence for transactions to take place. Easily understood rules are provided and contracts are enforced quickly and fairly. Ultimately, this results in greater transaction volumes and value creation.
The law and its enforcement, that is the rule of law, is a critical part of the plumbing through which these transactions flow. The study argues that the widespread use of English law in contracting for global transactions comes from the high level of certainty and predictability English provides and confidence in underlying institutional framework.
This faith in English law in turn leads to the greater use of legal services within the UK for international transactions. The use of legal services by international businesses generates significant value for the UK - the UK legal services sector alone generated a trade surplus of £5.9bn in 2019.[xxii]
This is the direction in which India needs to head, by altering the architecture of economic laws and regulation to embody the rule of law as enunciated by Lord Bingham. While short-term incentives and limited reform can bring some immediate benefits, deep and sustained gains will require a fundamental commitment to making the laws governing the economy be fair, clear, predictable, transparent and responsive.
[i] Bingham, Tom. The Rule of Law. Penguin Books, 2011.
[ii] De, R. (2018). A People’s Constitution: The Everyday Life of Law in the Indian Republic. Princeton University Press. https://doi.org/10.2307/j.ctv346n37
[iii] Ibid, p118, p121
[iv] See for instance, Mohan, R. (2018). India Transformed: Twenty-Five Years of Economic Reforms. Washington: Brookings Institution Press and Rajagopalan, Shruti, The 1991 Reforms and the Quest for Economic Freedom in India (December 14, 2021). Capitalism & Society, Volume 15, Issue 1 (2021), Available atSSRN: https://ssrn.com/abstract=3985599
[v] https://www.business-standard.com/article/pti-stories/bmc-brings-down-number-of-permissions-needed- to-start-biz-116022601270_1.html
[vi] https://economictimes.indiatimes.com/small-biz/sme-sector/more-documents-needed-to-open-a- restaurant-than-to-buy-a-pistol-says-economic-survey-2019-20/articleshow/73799670.cms
[vii] https://www.orfonline.org/wp-content/uploads/2022/02/ORF_Monograph_JailedForDoingBusiness_Final- New-11Feb.pdf
[viii] There have been reports of the Cabinet approving a law to decriminalise what are termed as “minor crimes” by businesses in India. This is a good idea. https://www.businessworld.in/article/Cabinet-Approves-Bill-To- Decriminalise-Minor-Offences-Of-Businesses/17-12-2022-458464/
[ix] https://www.bqprime.com/business/what-happened-to-the-spv-model-in-ppp-projects
[x] https://blog.theleapjournal.org/2022/07/identifying-roadblocks-in-highway.html
[xi] Akshay Jaitly & Ajay Shah, 2021. "The lowest hanging fruit on the coconut tree: India's climate transition through the price system in the power sector," Working Papers 9, xKDR.
[xii] https://www.internationaltaxreview.com/article/2a6a9ipgp0eg9m706twjk/cairn-and-vodafone-pursue- talks-to-settle-indian-tax-claims
[xiii] https://www.bqprime.com/opinion/punjab-ppa-bill-indian-power-sectors-vodafone-moment
[xiv] https://www.orfonline.org/research/economic-reforms-2-0-recommendations-for-a-new-economic-agenda- for-india/
[xv] https://worldjusticeproject.org/rule-of-law-index/global/2022/
[xvi] https://worldjusticeproject.org/rule-of-law-index/global/2022/Regulatory%20Enforcement/
[xvii] https://worldjusticeproject.org/rule-of-law-index/global/2022/Civil%20Justice/
[xviii] https://www3.weforum.org/docs/WEF_TheGlobalCompetitivenessReport2019.pdf
[xix] https://www.heritage.org/index/ranking
[xx] https://openknowledge.worldbank.org/bitstream/handle/10986/32436/9781464814402.pdf
[xxi] https://legaluk.org/wp-content/uploads/2021/09/The-value-of-English-law-to-the-UK-economy.pdf
[xxii] TheCityUK (2020), ‘Legal excellence, internationally renowned UK legal services 2020’, November.