Tuesday, August 12, 2008

F.A. Hayek’s Dreaming of Swatantra

Dreaming of Swatantra

Modern India's only stab at a successful liberal party started in
August 1959; the Swatantra Party would have entered its 50th year this
month, if it had survived as a national political force

Cafe Economics | Niranjan Rajadhyaksha

Nobel laureate Amartya Sen — who is not a free-market liberal — has
spoken on how contemporary India needs a right-wing political party
that is both secular and committed to an open economy. This is a good
time to go back to the issue, for two reasons. First, we have seen how
economic reforms were blocked by the Left to begin with and have now
been hijacked by the crony capitalism of the Samajwadi Party. Second,
modern India's only stab at a successful liberal party started in
August 1959; the Swatantra Party would have entered its 50th year this
month, if it had survived as a national political force.

Countries with low levels of trust and high levels of corruption tend
to be more wary of free market capitalism Fifteen years of high
growth, thanks to economic reforms, should have created a strong
political base for liberal party. It hasn't. I am often surprised at
how even people who have benefited from economic reforms still believe
that the government should control prices to beat inflation or that
companies are making too much profit at the cost of society. Is it any
wonder that no party is ready to face the electorate with a free
market agenda?

The interesting question is why this happens. The answer involves more
than political failure. The nature of Indian society and capitalism
are also part of the answer.

An interesting new research paper by Philippe Aghion of Harvard
University, Yann Algan of the Paris School of Economics, Pierre Cahuc
of the Ecole Polytechnique and Andrei Schleifer of Harvard University
offers one set of clues. They have mapped the relationship between
demands for regulation in a country and the level of distrust between
its citizens.

What these four economists show from their study of rich nations is
that people ask for more government regulation when they do not trust
their fellow citizens. They have used a concept that has attracted a
lot of attention over the past decade and more — social capital. Any
economy needs physical capital (tools), financial capital (money) and
human capital (skills) to grow. It also needs social capital (trust).
Economist Kenneth Arrow once said that virtually "every commercial
transaction has within itself an element of trust, certainly any
transaction conducted over a period of time. It can be plausibly
argued that much of economic backwardness in the world can be
explained by the lack of mutual confidence."

Aghion and his three fellow authors show in their July paper,
Regulation and Distrust, that countries with low levels of trust in
other persons, companies and political institutions are more likely to
have more regulations on economic activity. But this regulation leads
to low growth and corruption, as we know from our own experience of
the licence permit raj. "What is perhaps most interesting about this
finding…is that distrust generates demand for regulation even when
people realize that the government is corrupt and ineffective; they
prefer state control to unbridled production by uncivil firms," say
the economists.

The way companies earn profits does affect the popularity of
capitalism. In a paper published in 2006, Rafael Di Tella of Harvard
Business School and Robert MacCulloch of Imperial College ask: Why
Doesn't Capitalism Flow to Poor Countries? They say the most important
factor is corruption, which cuts into the "moral legitimacy of
capitalism". Di Tella and MacCulloch add: "Existence of corrupt
entrepreneurs hurts good entrepreneurs by reducing the general appeal
of capitalism."

These two pieces of research show that the popularity of a free market
political party will depend on both the level of trust in a country
and whether profits come from competitive markets or oligopolies
protected by the state.

Economic historian Douglass C. North and his colleagues have given us
what they call a conceptual framework to interpret human history. They
say that societies emerge as "limited access orders". Here, the
political system is used to limit economic participation and impose
social order. The lack of economic competition leads to excess profits
that are used to limit violence and maintain political stability.

North says that some societies later evolve into "open access" orders.
Here, there are few restrictions on economic and political
participation, which is another way of saying that these societies
have open economies and open political systems. Order is maintained
through the competitive process.

There is a famous story about Margaret Thatcher. Soon after she became
head of the Conservative Party in the UK, she is said to have reached
into her briefcase and pulled out a copy of F.A. Hayek's Constitution
of Liberty, a book that explains with great clarity why liberal
systems lead to freedom and prosperity. Interrupting the speaker, she
is said to have banged the book down on the table and said: "This is
what we believe."

Is there any Indian politician who has similar convictions — and the
guts to make them public?

Your comments are welcome at cafeeconomics@livemint.com

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