Licence Raj · Lablypedia

Licence Raj was intended to protect Indian industry, promote economic self-reliance, and ensure regional equality. Up to 80 government agencies had to grant approval before a private company could produce something and, if granted, the government regulated the production. Economists including Jagdish Bhagwati, Padma Desai, and Anne Osborn Krueger have argued that the system misallocated resources, restricted competition, and created large rents for those who secured licences. Real economic growth during the era averaged about 3.5% a year, a record the economist Raj Krishna called the "Hindu rate of growth".

The term "Licence Raj" is a play on the "British Raj" which refers to the period of British rule in India. Chakravarti Rajagopalachari’s criticism of the Licence Raj stemmed from his opposition to strict government control and regulation of the economy. Rajagopalachari believed that the Licence Raj had the potential for political corruption and economic stagnation, and founded the Swatantra Party to oppose these practices. Reforms that began in 1991 have significantly reduced industrial licencing. Economists still debate how much of India's later growth acceleration should be attributed to dismantling the Licence Raj, and how much to changes that began in the 1980s.

Origins

Socialist influence and Nehru

Following the Russian Revolution, socialist thinkers in India began drawing parallels between the pre-revolution Russian proletariat and the Indian masses under colonial rule, seeing socialism as a way to empower poor Indian farmers. Following Indian independence, these socialist factions, most importantly Jawaharlal Nehru's conception of democratic socialism, influenced the policies of the Licence Raj.

Nehru studied at Trinity College, Cambridge, and was exposed to socialist ideas there. He also visited the Soviet Union in 1927, and this experience may have further influenced his views on socialism. Nehru described himself as a socialist, and in his 1936 address to the Indian National Congress at Lucknow, he identified socialism as the key to solving India's problems. In 1955, the Congress formally adopted a goal to establish a "socialist pattern of society" at its Avadi session.

However, Nehru's policies as Prime Minister were often more pragmatic than strictly socialist. He believed in a strong, centralised government and a planned economy, but also recognised the importance of private enterprise and the market in driving economic growth and development. Nehru also believed that protecting domestic industries would promote industrialisation and economic development in India, and he implemented several protectionist policies during his time in office.

He saw such government intervention as a way to modernise an economy which he regarded as impoverished by colonial rule. Unlike the Soviet Union, India retained a substantial private sector in its early decades: Nehru's government pursued a mixed economy, with strategic industries under state control and public sector corporations guiding investment.

The economic centralisation and controls required for the war effort during World War II helped create the bureaucratic and manufacturing infrastructure needed to implement Nehru's plans, and so, after independence and his election as prime minister, he could put his ideas into action. In his speech to the Constituent Assembly of India, he declared:

"The service of India means the service of the millions who suffer. It means the ending of poverty and ignorance and disease and inequality of opportunity."

Opposition and origin of the term

By the late 1950s, the Swatantra Party, the country's first classical liberal political party, had formed in opposition to Nehru's policies. This party argued economic policies were incompatible with democracy. In a memorandum to party officials, they claimed that "the best guarantee of speed in progress is a maximum of individual freedom and a minimum of governmental interference." They argued that Nehru's policies stifled individual initiative and freedom and slowed economic progress.

C. Rajagopalachari, one of the founders of the Swatantra Party, coined the term "Permit-Licence Raj" to encapsulate the party's frustrations with Nehru's policies, writing in his weekly Swarajya:

I want the corruptions of the Permit/Licence Raj to go... I want real, equal opportunities for all and no private monopolies created by the Permit/Licence Raj.

Opposition also came from within the economics profession. In 1955, the government convened a Panel of Economists to review the draft Second Five-Year Plan; of its 21 members, Bellikoth Raghunath Shenoy was the only one to dissent from the memorandum endorsing the plan. Shenoy objected to the plan's size and its reliance on deficit financing, which he warned would cause inflation, and opposed the general extension of state ownership and control over industry. Shenoy had attended Frederick Hayek's lectures in 1931, and his critique drew on the Austrian school's arguments against central planning.

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Features

Central planning

A key characteristic of the Licence Raj was a Planning Commission that centrally administered the economy of the country. Like a command economy, India had Five-Year Plans on the lines of the five-year plans in the Soviet Union. However, unlike Soviet Union, private sector also played a significant role. The Planning Commission was set up in 1950 to survey the available resources in the country and formulate plans to raise the standard of living.

Planning Commission enacted the First Five Year Plan in 1951, aimed at developing the agricultural sector amid severe food shortages and an influx of refugees from the Partition, and that plan led to a 4% increase in GDP, higher than the projected 2%. Nehru's government hoped to build on the success of the First Five Year Plan with their more ambitious Second Five Year Plan aimed at continuing agricultural and infrastructure investment while developing heavy industry and increasing employment. But this plan failed to reach its goal of 5% growth and the heavy spending in the plan depleted the country's foreign currency reserves as the country did not have sufficient domestic resources to fund these projects and therefore had to rely on imported capital and technology.

Industrial licencing

Another main characteristic of the Licence Raj was heavy regulation on industry. Legislation to regulate industry started with the Industrial Development Regulation Act of 1951, which laid out licensing restrictions on industries it designated as Schedule I which included industrial machinery, telecommunications, and chemical manufacturing. Next, the Industrial Policy Resolution of 1956 extended these restrictions by designating certain industries known as Schedule A to be exclusively under state control, and certain other industries under Schedule B to be majority state-owned. Industries in Schedule A included defence production, metallurgy, mining, and transportation.

Banking

During the 1960s, the Indian banking sector came under criticism for being controlled by a few big industrialists in large cities, and thus failing to meet the needs of rural Indians and small-scale industry. In response, the government of Indira Gandhi began pursuing "social control" of banking institutions, with Deputy Prime Minister Morarji Desai spearheading the Banking Laws (Amendment) Bill in 1968 to regulate the commercial banks' leadership. The bill stipulated that at least 51% of the directors should not be directly connected monopolies and big business, that industrialist chairmen had to be replaced by professional bankers, and that banks could not form relationships with companies tied to their own directors. Additionally, Desai forged the National Credit Council (NCC) to regulate credit allocations in order to bring more credit to rural areas and small industry. However, many of these changes were rendered moot when Indira Gandhi decided to fully nationalise 14 major banks in 1969, with 6 additional banks coming under state control in 1980.

Capital controls, foreign investment and trade

Indian capital controls started as wartime restrictions imposed by the British on cross-border transactions during World War II, eventually growing into a complex framework of restrictions on the current account and capital account. After independence the Indian government introduced restrictions on the flow of foreign exchange reserves, and following a balance of payments crisis from 1956 to 1957, the government became more concerned with carefully allocating foreign exchange between different sectors of the economy. After a failed attempt at liberalisation in 1966, the Foreign Investments Board was established in 1968 to scrutinise companies investing in India with more than 40% foreign equity participation. Foreign investment that did not involve technology transfers was severely restricted, and foreign collaboration with local companies was conditioned on export quotas. This tight control over foreign investment became a core part of a broader policy of import substitution industrialisation, the belief that countries like India needed to rely on internal markets for development, not international trade. To achieve this goal, the Indian government erected strict import restrictions and a complex system of tariffs that featured high rates which varied by industry.

Fall of the Licence Raj and Rise of Compliance Raj

The Licence Raj system was in place for four decades. Many members of the Congress, including Prime Minister P.V. Narasimha Rao and Finance Minister Manmohan Singh, were strong supporters of liberalisation and played key roles in implementing these changes. In 1991, Prime Minister Narasimha Rao, who was also the Minister of Industries, initiated a policy of liberalisation in India. This policy aimed to reduce government intervention in the economy and promote market-based solutions to economic problems.

The Licence Raj was believed by some to be hindering economic growth and preventing the Indian economy from reaching its full potential. This belief was based on the idea that the government's heavy intervention in the market was stifling economic activity and hampering the ability of the economy to grow and develop.

Liberalisation resulted in substantial growth in the Indian economy, which continues today. The Licence Raj is considered to have been significantly reduced in 1991 when India had only two weeks of foreign reserves left. In return for an IMF bailout, India transferred gold bullion to London as collateral, devalued the rupee and accepted economic reforms. The federal government, with Manmohan Singh as finance minister, reduced licensing regulations; lowered tariffs, duties and taxes and opened up to international trade and investment.

The reform policies introduced after 1991 removed many economic restrictions. Industrial licensing was abolished for almost all product categories, except for alcohol, tobacco, hazardous chemicals, industrial explosives, electronics, aerospace and pharmaceuticals.

Arguing that the Planning Commission had outlived its utility, the Modi government disbanded it in 2014. On 6 August 2014, the Indian Parliament raised the limit on foreign direct investment in the defence sector to 49% and removed the limit for certain classes of infrastructure projects: high speed railways, including construction, operation and maintenance of high-speed train projects; suburban corridor projects through PPP; dedicated freight lines; rolling stock including train sets; locomotives manufacturing and maintenance facilities; railway electrification and signalling systems; freight and passenger terminals; infrastructure in industrial parks pertaining to railway lines and mass rapid transport systems.

However, Indian labour laws continue to protect workers in the formal sector from being laid off by employers and place significant restrictions on the ability of businesses to reduce their workforce without incurring significant costs and burdens. This is viewed by some as a barrier to economic growth and development as it may create a disincentive for businesses to hire workers and can make it difficult for them to respond to changing market conditions or economic challenges.

Economic impact

The fall of the Licence Raj and the implementation of economic liberalisation policies have contributed to increased regional inequality in India. Some experts argue that these policies benefited certain regions of the country, such as the major cities and industrial centers, at the expense of others, leading to a widening gap between rural and urban areas.

It has contributed to mass migration from rural areas to cities, as people sought to take advantage of new economic opportunities and improved living standards in urban areas. This mass migration can place a burden on cities, as they may struggle to accommodate the influx of new residents and provide them with adequate housing, education, and other basic services. Slums in India are a common sight in many cities and are often found in areas that are vulnerable to flooding or other natural disasters. They are often home to marginalised communities, including migrant workers, informal sector workers, and other groups that may be excluded from mainstream society.

The scaling back of public sector enterprises may also have led to a reduction in the ability of the government to direct investment and resources towards priority areas and to protect the interests of workers, minorities and other stakeholders.

One consequence of the Licence Raj was that it benefited large corporations at the expense of smaller businesses. Because large corporations were often better able to navigate the complex bureaucracy of the Licence Raj and secure the necessary licences, they were able to dominate many sectors of the economy. This made it difficult for small businesses to compete, and contributed to a concentration of economic power in the hands of a few large corporations.

Another criticism of the licensing system in India was that it was prone to corruption, as businesses and individuals had to navigate a complex bureaucracy in order to obtain licences and permissions, and may have had to pay bribes or engage in other forms of corruption in order to obtain the necessary approvals.This corruption was fuelled by a broader environment of corruption in India, which was characterised by a lack of transparency and accountability in the government, a weak legal system, and a culture of corruption that had been allowed to persist for many years.

Legacy

Although industrial licencing was largely abolished, many regulatory controls continue to remain in place. Although some states have adopted a more flexible approach to labour laws, it remains heavily regulated. A 2002 study by the Observer Research Foundation and TeamLease, a staffing firm, found that Indian businesses face over 69,000 compliance requirements annually across more than 1500 laws at the central and state levels. Commentators, including Raghuram Rajan, have dubbed continued restrictions on Indian businesses as "inspector raj," or "regulatory cholesterol."