Law and the Economy in a Young Democracy

India 1947 and Beyond

Tirthankar Roy, Anand V. Swamy

• Publisher: University of Chicago Press
• Year: 2022
• Print ISBN:
  9780226799001
• eBook ISBN:
  9780226799148
• Topic: Business
• Subtopic: Business General
• Index: Business

An essential history of India's economic growth since 1947, including the legal reforms that have shaped the country in the shadow of colonial rule.

Economists have long lamented how the inefficiency of India's legal system undermines the country's economic capacity. How has this come to be? The prevailing explanation is that the postcolonial legal system is understaffed and under-resourced, making adjudication and contract enforcement slow and costly.

Taking this as given, Law and the Economy in a Young Democracy examines the contents and historical antecedents of these laws, including how they have stifled economic development. Economists Roy and Swamy argue that legal evolution in independent India has been shaped by three factors: the desire to reduce inequality and poverty; the suspicion that market activity, both domestic and international, can be detrimental to these goals; and the strengthening of Indian democracy over time, giving voice to a growing fraction of society, including the poor.

Weaving the story of India's heralded economic transformation with its social and political history, Roy and Swamy show how inadequate legal infrastructure has been a key impediment to the country's economic growth during the last century. A stirring and authoritative history of a nation rife with contradictions, Law and the Economy in a Young Democracy is essential reading for anyone seeking to understand India's current crossroads—and the factors that may keep its dreams unrealized.

Chapter One

Introduction

Economic and social democracy cannot be in India merely the end products of industrial revolution; they must accompany it, keep pace with it and, what is more important, by releasing the initiative and energies of the people, be the very instruments that bring them about. — India, Planning Commission1

The Questions

It is widely agreed that it is difficult to “do business” in India. Buying a piece of land can be time consuming and complicated. A dispute with a buyer or creditor may take a long time to resolve. A permit required from a pollution control board may be slow in coming.2 These transactions can also potentially involve bribery. How has the situation come to this? In our previous book, Law and the Economy in Colonial India, we explored the colonial roots of this problem and told the story up to 1947. This book extends our analysis to roughly 2015. We begin below with some background before asking five specific questions, the answers to which constitute this book.

British colonial rule in India began with a series of alliances and conquests that the East India Company organized between 1757 and 1856. The Mutiny in the following year almost ended the rule. The Crown took over in 1858 and continued to govern India until 1947. The Company had effectively ceased to be a commercial body and became a partner of the parliament in running the empire from around 1800. The Indian empire emerged from a series of events, some of them unplanned, and in its final shape contained a little over half of the land area. Still, it was enormous in both geographical scale and population size. A tiny administration ruled over this vast empire.3

A central goal of colonial law, therefore, was to stabilize an insecure regime. Especially in rural India, the British colonial rule in India, or the Raj for short, was reluctant to undermine a very unequal status quo.4 At the same time, the law had to serve the Raj’s goals of facilitating trade and, so long as it did not hurt British interests, modestly facilitate Indian economic development. All this had to be done with limited resources.5 There was too much legislation in some areas, too little in others, and underinvestment in the legal infrastructure. Courts became slow and intimidating for the ordinary citizen. In some areas, such as eminent domain and control over forested areas, the colonial state assumed extraordinary power.6

The institutions of colonialism have continued to matter a great deal in independent India, as have the profound social inequalities of the late colonial period. However, postindependence there was a new trajectory. India became a democracy with universal adult franchise. The government was committed to promoting economic development and had the moral authority to act in ways British India would never have dared—for instance, it attempted to redistribute land to reduce inequality.7 In contrast with the Raj—which purported to favor free markets, open trade, and small government—the government of independent India was far more willing to intervene in markets and even to own and operate the “means of production.” It was also highly skeptical of the potential benefits of international trade and foreign investment.8 It eventually came to call itself socialist via a constitutional amendment in 1976.

This new trajectory itself, as well as the colonial legacy, later changed in two fundamental ways. First, from about 1980, Indian democracy became more substantive as the less privileged sections of society became more assertive and courts were more willing to challenge the government. Human rights lawyer Upendra Baxi wrote in 1985, “The Supreme Court of India is at long last becoming, after thirty-two years of the Republic, the Supreme Court for Indians.”9 Second, there was a fundamental change in economic policy after 1991. Frustrated by a long period of slow economic development, after 1991, India’s policy makers decided to “liberalize,” that is, reduce the role of government, allow freer markets and international trade, and welcome foreign investment.10

In each phase, existing law has been “sticky”—there is plenty of inertia—and legal change has often been contentious. The efforts to redistribute land from rich to poor in the first three decades after independence faced fierce resistance. These land reforms also added new restrictions on land sale and lease to an already opaque set of land rights. From the 1980s onward, protest movements challenged the state’s eminent domain rights, still largely based on a law passed in 1894. This led to conflict, a weakening of the eminent domain power via new legislation in 2013, and criticism of the law on the grounds that it swung the pendulum too far in the other direction.11 While the economic policy fundamentally changed after 1991, legal changes have lagged. For instance, it has been difficult to put in place a bankruptcy law that allows a firm to exit in an orderly way without too much loss of economic value. Some observers are optimistic that a 2016 legislation may finally address the problem.12 There is also still ambivalence regarding foreign investment, with foreign control viewed as a threat in some sectors of the economy. Even when laws have been aligned with international norms, the practice can remain at odds with them.13

Given this history, we organize the book around five questions. First, how have existing laws emerged? Are their roots in the colonial past, in developmental goals, in response to populist pressures, or in other factors? Second, laws were often framed with egalitarian objectives: did they meet them? Our third question requires some explanation. It seems self-evident that the legal environment must affect economic development. For instance, a farmer who does not have a secure title to his or her land may be unwilling to dig a well on it. But when there are many potential constraints, it is not always clear which one matters. For example, if the groundwater gets exhausted and no canal irrigation is available, there may be few investment opportunities available to the farmer. His insecure property right is not the binding constraint. In this spirit, Which laws constrained growth and when?14 The fourth question is perhaps the most relevant to policy. When a law constrains economic development, why isn’t it changed? What accounts for inertia? Our final question is, How much did case law and precedence, as opposed to legislation, matter to the evolution of law in postindependence India? Did case law act as a positive agent of change? Was it a constraint on needed reform? Was it relevant at all?

The Answers

Our answers to these questions will, we hope, be more meaningful to readers after we have discussed the relevant history and institutional detail. For now, we offer the following brief observations.

Regarding the origins of law, our answers are sector specific. Broadly speaking, the colonial inheritance has been “thick” and hard to let go in relation to land and natural resources. Developmental goals with an allegedly “socialist” tinge have played a large role in labor law and credit-related legislation. Company law has proved the most malleable in the liberalization era. Policy makers’ intuitions align with international practice, and they are explicitly targeting international recognition.15 We will, of course, have to nuance each of these claims as our discussion becomes more detailed.

On the question of equity, the law has rarely been effective unless backed by social movements of the poor. Where there is potential for mobilization, the passing of law can provide a focal point for social movements.16 We will discuss several examples of this, for instance, in the context of land redistribution and the rights of forest dwellers.

Has the law been a binding constraint on growth? We sense that until the 1990s, when Indian economic policy more broadly was not conducive to growth, the shortcomings of the law and the legal system were not hugely consequential. After economic policy became more market and private-sector friendly, economic growth has accelerated. More complex contracts need to be written and enforced. Natural resources have to change hands, going from (say) farmer to the industrialist. Now the legal constraint is more likely to bind. There is one partial exception. India has made considerable progress in clarifying company law and the rights of investors. This has been particularly relevant for facilitating the inflow of foreign funds into the stock market and also foreign direct investment.

When a legal constraint is binding, why is it difficult to change? This requires a longer discussion even in this introductory chapter. In enacting a body of law on (say) corporate governance, there isn’t a large body of potential losers from reform, and it will not cost the government too many votes. Therefore, once policy makers’ ideas change, legal change follows relatively easily (which does not mean it is easy). However, if the law pertains to (say) the terms on which an industrialist can acquire farmers’ lands, this is now a politically far more potent question. A wealthy corporation will have various resources at its disposal, including the ability to lobby or bribe, but the farmers are more numerous, and each one of them votes. In principle, the government can be a good-faith intermediary and work out satisfactory legislation that balances the interests of the parties. In practice, the weaker party in the transaction rarely trusts the implementing government agency, so it is difficult to design appropriate legislation. As we write, there are numerous and intractable conflicts over, for instance, land, forests, and the regulation of industrial relations.

Electoral politics also creates other perverse incentives. Governments tend to be highly sensitive to short-run growth, which has immediate electoral implications. Economic development in the long run is a lesser priority. Therefore, while rural credit markets might work better if farmers were (usually) held legally liable for their debts, large-scale debt waivers can be electorally beneficial.17 The short-term thinking of elected governments also probably explains why some of the most important environmental laws in India have not come from the legislatures but from the courts. Supreme Court judges are not up for election and can afford to think about notions like sustainable development or intergenerational equity. These are unaffordable luxuries for the politician seeking votes next year.

The short time horizon of elected governments may also explain the extraordinary persistence of a problem that has been acknowledged since independence: understaffing and inadequate expenditure on legal infrastructure. A simple measure of the underinvestment is the number of judges as a ratio of the population. This, the top Indian judiciary thinks, should be fifty per million. In fact it is a little over one per million, one of the smallest proportions among common law countries. Measured by the average duration of cases or the number of outstanding cases at any time, the Indian legal system is a monstrously inefficient institution. In June 2018, eight million civil cases were pending in Indian courts. On average, each case had been pending for about five to six years. In about 9% of the total pending, cases were waiting for a conclusion for more than ten years.18 Between 1968 and 2018, pending civil cases as a proportion of the population increased from 177 to 1,298 per million. There is now a substantial literature using econometric methods that demonstrates the adverse effect of court congestion.19

There is a consensus that India needs more investment in its legal infrastructure. However, the benefit of investment in legal infrastructure will probably be seen long after the next election, and even then, voters may not be able to identify the cause. The expansion of the number of courts is not a catchy campaign slogan! It is no surprise that it gets low priority.

We should note, in fairness, that the pressures of democratic politics have also led to legal changes that have removed constraints on economic development. For instance, until 2006, a forest dweller in possession of a small patch of land most probably did not have title to it. The Forest Rights Act of 2006, pushed by protest movements and NGOs, gave him or her title and the motivation to increase productivity.20

To understand why growth-constraining law remains law in place, it is important to recognize that even after 1991, there are three dimensions in which even India’s policy-making elites remain skeptical of markets. The first has to do with the fear that if the poor are permitted to sell or lease their assets, they will be cheated. This anxiety goes back to the late nineteenth century when laws were passed preventing tribals from transferring their land to nontribals.21 Laws like this have not merely been retained, they have been expanded in independent India. The Forest Rights Act of 2006 acknowledged the property rights of a small owner but forbade him or her to sell the right. A historic 2014 legislation that recognizes the rights of an urban street vendor to operate in a particular location also prohibits him or her to sell that right. Economic theory tells us that restrictions like this lead to misallocation of resources. However, the intuition that the poor will be exploited if the assets become transferable runs deep. The corruption and delay in India’s legal system make this intuition plausible.

A second and related reason why Indians tolerate market restrictions is that income growth is not the only goal, and income stability matters a great deal. As we will see, India has in place laws that make it hard for firms above a certain size to retrench workers, potentially discouraging hiring. Despite decades of consensus among policy makers on the need for reform, it has not occurred. One of the reasons for this is that in India’s “dualistic” economy, a factory worker’s earnings are much larger than his or her alternative in the informal sector. A worker who is fired will experience a dramatic fall in living standards. This is distress that even tough-minded policy makers are reluctant to impose, and at least to date, reform of labor law has been half-hearted (but see the postscript to chap. 6).22

Finally, there is a fear of foreign ownership, especially in areas like the media and intellectual property. This is partly the legacy of antipathy toward colonial rule, but it also follows from the sense that powerful international players don’t always play fair. The Bhopal gas disaster of 1984, which killed over fifteen hundred people and harmed many more, is Exhibit A for this argument. There are also some notorious instances where multinational corporations have tried to patent medicines or rice varieties indigenous to India.23 In the media industry, incumbents gain from politicians’ anxiety over foreign ownership of news production. Therefore, even as Indian law becomes more open to the global players, in practice they can face obstacles.

What role, if any, did case law play in the dynamics outlined? Did it play an independent role in shaping laws? Was that role positive or constructive? We do refer to a few specific cases as “landmark” or “historic,” but only a few of them. It is safe to say that overall, the judges followed the political trend that legislation ruled, and the courts played a broadly passive role. But there are important exceptions to this rule. One exception is the Supreme Court in the last thirty-odd years when, in cases concerning fundamental rights, constitutional law, and public interest, the decisions did set precedence. In specific types of disputes, again, case law did matter. Three come to mind. First, in the case of land law, courts often sided with the landowners. Second, on environmental law, the state abdicated its responsi...

Table of contents

• Cover
• Title Page
• Copyright Page
• Dedication
• Contents
• List of Illustrations
• chapter 1.   Introduction
• chapter 2.   Land Rights: Equity versus Transferability?
• chapter 3.   Rural Credit: Overreliance on Law
• chapter 4.   Democratic Rights and the Limits of Eminent Domain
• chapter 5.   Environmental Law: Judiciary Takes Center Stage
• chapter 6.   Law in a Labor-Surplus Economy
• chapter 7.   Politicians’ Burden? The Evolution of Company Law
• chapter 8.   Globalization with a Nationalist Face: Mergers, Acquisitions, and Intellectual Property
• chapter 9.   Property: Equity versus Religious Norms
• chapter 10.   Conclusion
• Acknowledgments
• Notes
• Bibliography
• Index