Liberalization meets investment climate: The case of India

The last three decades have witnessed a departure from the model of planned industrialization that dominated development policy in the post-war period. The emphasis on planning as a means of engendering development has been replaced by an emphasis on liberalization and competition. In their quest for growth many developing countries have abandoned central planning, dismantled government controls over industry, and liberalized trade. This shift from government control to the promotion of competition represents a key paradigm shift in development policy over the past fifty years.

A parallel shift has been the growing focus on institutional factors as a key driver of economic growth. This reflects a heightened awareness that the state of political, legal and social institutions surrounding economic production fundamentally affect the investment and growth prospects of countries.

An important question to pose is whether the impact of liberalization (in the form, for example, of dismantling planning controls or liberalizing trade) on economic performance is mediated (that is is magnified or dampened) by the domestic policies and institutions which determine investment climate in a country or region. This question does not focus on the direct effect of either liberalization or investment climate on economic performance, but rather on whether liberalization and investment climate are complements or substitutes when present together. If they do interact in a meaningful manner then the domestic institutional and policy reforms may play a central role in determining whether a country or region benefits from or is harmed by liberalization. This approach, in effect, brings the spotlight back onto local policy and institutional reforms as determinants of the impact of liberalization reforms on economic outcomes. Indeed the strong interest shown by policy makers in improving their investment climate indicators can be understood as an attempt to ensure that they benefit, in a relative sense, from the liberalization process.

There is, as yet, very little work at the intersection between liberalization and investment climate. This project fills this gap by exploiting state-industry panels in India to examine whether the domestic institutional context in which liberalization takes place affects post-liberalization industrial performance. Concretely the research question we want to address is whether the business environment in a particular state is an important determinant of whether industries in that state benefit or are harmed by trade liberalization or delicensing. Using industry panels in this way combined with data on the business environment will be valuable as it will allow us to build up a picture of which elements of the institutional environment are central to engendering growth following a liberalization episode. This is turn will suggest concrete avenue for domestic institutional and policy reforms.

A paper has been published (see Output below) which looks at the interaction between delicensing and labour regulations in the Indian states. The paper attracted a lot of academic and policy attention as it makes point that there are, within the same country, losers and winners from nationwide liberalization experiments. The fact that whether state labour regulation was pro-worker or pro-employer affected the impact of liberalization in the form of delicensing or trade liberalization was particularly topical as it made it clear that state level institutions and policies had a central bearing on whether they benefit from or are harmed by liberalization.

Future work will focus on looking at a broader set of investment climate indicators for Indian states in order to build up a more complete picture of which elements of investment climate are crucial in terms of post-liberalization industrial growth.