National Council of Applied Economic Research
Opinion: Sanjib Pohit
Informational asymmetry among consumers producers gives each economic agent an incentive to cheat.
The latest NCAER’s (National Council of Applied Economic Research) forecast has indicated that YoY growth will remain negative through Q2 Q3 and Q4 at -12.7% -8.6% and -6.2% respectively.
For the year as a whole 2020-21 GDP will decline by -12.6%. It is postulated that conventional fiscal and monetary policies alone will not be enough to get the economy out of its current crisis of unprecedented contraction combined with rising inflation. It is argued that wide ranging reforms no less ambitious than the reforms of 1991 is need of the hour. The economist argues that the most urgent component of such a reform package is the set of reforms to ensure the stability of the financial sector in India.
While there are merits in that argument for stability of the financial sector one cannot overlook a sector that has been practically untouched in the last three decades of economic reform. It is high time that our focus shifts to reform of the judiciary.
A salient feature of the 1991 reforms is the admission that the army of bureaucrats can not only fix the prices of each of the millions of commodities that people buy but also decide on what to produce and in what quantities. The invisible hand of market is more efficient to make this decision. This invisible hand (price adjustment) ensures economic equilibrium: what has been asked for is delivered to the economic agent that values it the most. The work of Arrow and Debreu established that free market countries are first and best.
However in the real world there is informational asymmetry among the economic players (consumers producers) and hence each economic agent has an incentive to cheat.
This brings us to the realm of contracts and contract enforcement. In essence there is need for a regulator to ensure that failure to honour contracts is costly for agents due to effective punishment rules. Thus strong legal institutions are required to ensure contract enforcements.
Merely having contracts will not work if the judiciary is too weak or slow to actually see if the contracts are being honoured in a time bound manner. Furthermore effective regulatory authorities as part of judiciary or as separate entities are also essential in a market economy to uphold the competitive spirit. Their role is also to restrict the vices of market economy such as cartelization and predatory policy so that all players play by the spirit of the game.
Of course where legal institutions are not that strong other important institutions exist which take its place. One such institution is that of ‘social norms’ where traders ensure honouring of contracts relying entirely on the social norms. Informal trade in South Asia in which India is a fulcrum is a perfect example of this kind of contract. However this social norm invariably led to black money/parallel economy which no government in power can overlook.
Three things are thus crucial for the market economy to function efficiently: transparency in information efficient dispute settlements and contract enforcement in a time-bound manner powered by an effective judiciary.
While the government has little role to play in transactions among players it plays an effective role by setting up efficient dispute settlement mechanisms so that the costs of transactions are minimal. The judiciary plays the overarching role in a market economy by enforcing contracts in the case of disputes through minimal costs.
Most of the market economies in the first world understand the importance of the judiciary for smooth functioning of the economy.
Consequently their expenditure on judiciary hovers above 0.1%. A small country like Israel spent nearly 0.8% of GDP on the same.
By contrast the average national spending on the judiciary in India in 2017-18 was 0.08% of the gross domestic product (GDP) according to the India Justice Report. Given the large size of the Indian population this definitely leads to a dysfunctional judiciary.
The recently released India Justice Report has concluded that inadequate allocations poor planning and under-utilisation of funds have impacted the ability of the justice system to address its capacity constraints and improve its functioning.
No state or union territory in India except Delhi spent even 1% of its budget on the judiciary between 2011-2012 and 2015-2016. Expectedly the budget constraints impinge on the core competencies of the judiciary legal aid police and prisons
The most critical of these constraints is the number of vacancies in core positions across the justice system. While judicial vacancies against sanctioned posts stood at 23.25% at all tiers the report pointed out that in 2016-17 high courts had a judge vacancy of 42% and subordinate courts of 23%.
The staff shortages obviously leads to delayed justice which effectively implies an inefficient dispute settlement mechanism. Thus the core element of a functional market economy is missing.
Of late the government has been very pro-active to ensure that India’s rank improves in the World Bank score-sheet on Ease of Doing Business. With some cosmetic changes in the rules India has been able to improve her ranking to some degree.
However without judicial reform the pace of delivery of the justice system or state of dispute settlement mechanism may not be improved.
Without this timely reform the establishment of sector specific regulatory authorities or revamping the capacity of the competition commission would serve no purpose.
(The author is a Professor at the National Council of Applied Economic Research. All views expressed here are personal and not necessarily those of The Lede’s.)