Credible commitment of the state to policies, deals or arrangements is an essential attribute of effective state-business relations. Investment decisions may have large sunk costs – that is, the costs of certain investments cannot be recovered in full if the investment decision turns out to be less profitable than anticipated (Pindyck 1991). The state needs to make a commitment that it will not change its policies, or renege on deals and arrangements; in order to incentivise entrepreneurs to make investment and production decisions (Rodrik 1991). If the state were not to uphold its announcements and promises, it is very likely that investors would not believe the state in the future, and investment would suffer (Bardhan 2005).
Credible commitment can be obtained through both formal and informal institutions. Formal institutions include properly enforced laws which prohibit the expropriation of private property without just cause, and well-functioning courts which protect firms if the state engages in predatory behaviour. Informal institutions are personalised relationships (“deals”) between the agents of the state and the business sector that are repeated over time (Hallward-Driemeier and Pritchett 2015). If these deals are “ordered” – that is, if deals negotiated between the state and business are reliably honoured – then informal institutions can provide the credible commitment necessary for investment to take place, even when formal institutions are missing or poorly functioning (Pritchett and Werker 2013, Sen 2013a).
The literature suggests that trust between the government and the private sector is an important contributing factor for the credibility of government actions and policies. While policies can be credible whether or not trust exists, policies and statements are more likely to be credible when there is prior trust (Rodrik 1997). Trust between business and government elites can reduce transaction costs and monitoring costs, diminish uncertainty, lengthen time horizons and increase investment (and policy fulfilment more generally) (Maxfield and Schneider 1997). Trust in state-business relations is an outcome of repeated interactions between bureaucrats and politicians on the one hand and private sector actors on the other, and can occur both through formal mechanisms (such as periodic meetings of a Joint Economic Council) and informal mechanisms (such as through networks of friendship and contacts that state and private actors may have).
Credible commitment in India’s economic success
In the 1960s and 1970s, the Indian government followed a command-and-control regime with the private sector that led to collusion and rent-seeking behaviour, and had significant negative impacts on India’s economic performance (Bhagwati 1993). There was an atmosphere of mutual distrust between the political and economic elites, along with a strong anti-business attitude of the government (Kohli 2007).
With a change of government in 1980 and the return of Indira Gandhi as Prime Minister, the promotion of economic growth became the focus of the government’s economic policy, leading to a growing alliance between the political and economic elites. As Kohli (2012: 30-31) notes: ‘just after coming to power in January 1980, […] Indira Gandhi let it be known that improving production was now her top priority. In meeting after meeting with private industrialists, she clarified that what the government was most interested in was production.’
Therefore, beginning in the 1980s, the Indian state clearly signalled to domestic capitalists its intention to commit credibly to an environment where private enterprise would be supported and growth-enhancing policies followed (De Long 2003, Rodrik and Subramanian 2004). This was reflected in changes in economic policies, such as the slow but steady liberalisation of import controls, especially on capital and intermediate goods.
The shift in the relationship between political and economic elites from one of mutual distrust to a more collaborative and synergistic relationship was further accentuated with the coming to power of Rajiv Gandhi in 1985. He took particular interest in modern sectors, such as information technology and engineering, and tried to bring in new economic elites, from these emerging sectors, into the relationship that the political elite had with the business sector.
In addition, with the rise of non-traditional business groups in southern and western India, there was a growing diversification of business ownership, leading to a broadening of the political connectivity of the business elite (Mehta and Walton 2014). Private investment increased significantly since the mid 1980s, especially in new sectors such as information technology and pharmaceuticals and, within a decade, India was one of the fastest growing countries in the world (Sen 2013b).
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