Edited and Footnotes by Jason Samuel

We recently discussed how liberalization and ensuing economic freedom brought riches to India.1 This would certainly rise the question if liberalization was a good thing, why did we act like a socialist economy? Were we misguided?

14 commercial banks nationalized in 1969

To understand this, we need to go back to the original system, commonly known as License Raj. It was a system in which, the government-controlled many key industries, and had control over the producers and what they could produce. In this system, both the public sector and private sector coexisted in some sectors, while the government had a monopoly in a few critical industries.

The Government of India post-independence executed the License Raj over a series of steps.

Government monopolies were established in the weapons, atomic energy, railroads, mining, iron & steel industries, aircraft, manufacturing, shipbuilding, and telecommunications equipment sectors according to the Industrial Policy Resolution of 1948.
The Industrial Policy Resolution of 1956 added an additional 12 industries to the list of those under the government's purview.
Life insurance was nationalized in 1956.
Large commercial banks were nationalized in 1969.
The Monopolies and Restrictive Trade Practices Act of 1970 was created to give the government greater information about the organization and financial status of all businesses with assets over INR 20 Crore (approximately USD 2.5 Million in today’s exchange rate) and to bolster the licensing system. This was done to reduce the concentration of private economic power and impose restrictions on commercial activities deemed to be against the public interest.
The General Insurance industry was nationalized in 1973
Over time, the federal and state governments established organizations and businesses involved in finance, trading, the exploitation of minerals, manufacturing, utilities, and transportation, including Hindustan Insecticides, Ashoka Hotel Corporation, Tyre Corporation of India, Air India, GAIL, SAIL, ONGC, etc.

To know why the system of license raj was adopted, we need to see it in the historical context. During the second world war, India fought for British Empire. As part of the war efforts, the Government of India enacted laws to control Indian industries to aid the war effort. Although India got independent in 1947, many of the acts and frameworks still remained in place. During the British raj, India was primarily used for resource extraction and as a market for final goods. A large part of manufacturing happened in the British Isles.2

When we got independent, we lost access to manufacturing capacity, as depending on Britain would result only in imports. The founders of the nation were greatly influenced by the rise of Soviet Russia. Soviet Russia arose in a similar situation. After the Second world-war ravaged ‘Agrarian’ Russia, the Soviets rebuilt the economy by improving its industrial capacity and human resources.3 This formed the motivation to continue the wartime controls into a system that enabled the government to dictate the direction of the economy.

The Indian government came up with five-year plans inspired by Soviet Russia. The nation decided on a few key sectors every 5 years to focus on and develop them. For example, the first five-year plan was devised in 1951. It focussed on rebuilding primary sectors that suffered from partition and independence. The GDP growth rate exceeded expectations. It helped to establish the base for future economic growth. The logic behind the plan was that India lacked capital and funding just after independence. Subsequent five-year plans focussed on other sectors, but they never satisfied the projected growth numbers.

License raj was characterized by the need for a license or permit for numerous business activities and production quotas. Starting a business, expanding production, or even closing down a business required various approvals. The government had these measures in place to prevent the formation of private monopolies. In reality, they had the opposite effect.

Some of the important measures that were taken during the License Raj are as follows:

In order to launch new companies, create new goods, or increase production capabilities, licenses were necessary.
Government consent was required from businesses before they could lay off employees or shut shop.
High tariffs, low import quotas, and outright import bans on specific products all but completely stop imports. For instance, in 1960, the import tax on automobiles was approximately 125%.
The highest tariff rate in the world in 1985 was found in India. The nominal tariff rates expressed as a percentage of value in 1985 were: 146.4 percent for intermediate products, 107.3 percent for capital goods, 140.9 percent for consumer goods, and 137.7 percent for manufactured goods.
The Indian government nationalized heavy industry, the foundation of the economy, overregulated the private sector and established new state-owned enterprises (SOEs) in industries as diverse as jute mills, hotels, and steel factories.

This strong bureaucratic red tape ensured that only big organizations can survive these regulations, leading to few big companies dominating every industry. To promote the domestic production of goods and services, the country imposed very high customs on imports. In the early days, they even had an import quota for each good. Some goods were allowed to be imported only by the government. This was known as the import substitution policy.

This policy had 2 effects.

It shielded Indian industry from foreign competition- making them inefficient
It stifled domestic production of complex goods as input goods can’t be imported that easily.

This has created a huge drag on the economy. As India lacked energy resources like Crude oil, India always depended on imports for its energy needs. As license raj gained steam, the exports of India started to become increasingly uncompetitive due to high costs and lack of the latest technology. This created an imbalance in trade.

The imports were rising faster compared to the exports. In a normal economy, these import bills would be paid by private companies that can rise money in various ways. In India’s case, many of those companies were publicly owned. Thus these became the liabilities of the government of India. In addition to this, the Indian government was constantly running a fiscal deficit that was financed by foreign loans. All these factors led to the balance of payments crisis in 1991 and subsequent liberalization.4

Many scholars today argue that license raj was a bad idea that held back the Indian economy for decades. On the flip side, the protectionist policies enabled the growth of domestic industrial capacity in various sectors. How can we judge this situation? Are there any precedents? Incidentally, there are many. There are 2 main examples, the US and Great Britain.

While our history books told the Indian side of colonialism story, the British side of things was quite different. Britain implemented near free trade policy in its colonies. In many colonies, they taxed exports heavily. In their homeland, they followed a reverse approach. They imposed very high customs on all imported goods except raw materials. Exports were highly encouraged. This led to Britain becoming the workshop for British Empire.

The import taxes ensured that British industries had the time to develop themselves to compete on a world stage. Thus Britain used protectionist policies to jump-start its own industrial power.

While the US is a country that is a strong advocate of free trade today, it was not always the case. When the original US colonies were founded by the British, they followed policies similar to what they implemented in India. They encouraged primary sectors like agriculture and mining to grow while they curbed Industrialisation through high domestic and export taxes. This ensured that the US can’t be independent of Britain despite its rich natural resources.

Just after American independence in 1776, Alexander Hamilton released a report on the need for protectionist policies to develop American industries to become independent of other global powers. In subsequent years, this protectionism was implemented in various forms. This ensured the growth of American industries.

The two world wars helped to push these industries to innovate and achieve the technical dominance we see today. Only after the second world war, the US decided to follow free trade policy. This ended protectionism in most sectors of the economy except a few critical sectors.

Does this mean the protectionist policy is a super effective answer to developing underdeveloped nations? The answer is no.

The solution is more complicated. While Russia flourished in recent years from import substitution, the African countries suffered from similar policies. The difference lies in the capabilities of the nation.

In the US, India, the UK, and Russia, the problem of lack of industries was not due to a lack of skill. It was due to a lack of policy support and money. The workers were skillful but didn’t get a chance or incentive to work for local industries. When protectionism was implemented, they had the right conditions to use their skills to add value to the economy.

The case of African countries was the quite opposite. During colonialism, the colonists controlled the flow of labor and skills in Africa. The local population never had a chance to upskill themselves. In Sharp contrast, Indians were upskilled to help manage the Indian empire during colonial days. For example, when the import substitution policy was implemented in Tanzania, there were only 2 qualified engineers to handle the whole industry.5 This resulted in nations suffering despite nationalizing the profits of previous private companies that dominated the market. This serves as an example that; mere protectionist policies and money can’t solve an economy’s problem.

Now that we know the context, it's hard to argue that the license raj was a big mistake. Nearly all modern countries have undergone a phase of protectionism that helped to develop their industries to global standards. In modern times, many economists argue for a free trade policy without considering the specific context of each country’s past and abilities.

These were the comparative growth rates of developing Economies during the impact of the License Raj.

Source: License Raj | India Before 1991 (indiabefore91.in)

Thus, it is unfair to compare our story with other countries having different conditions to say, we were better or worse in our decisions. In real life, economics is never about just supply and demand, it also encompasses the people element. How well the people are equipped to handle the opportunities would decide the success of any policy.

1

#05 The Dangerous Dance - An Introduction to India's romance with famed International policies.

2

The economic de-industrialization of India was introduced by Sir Willian Bentink who acted as the Governor-General of India between 1833-35. This policy impacted the cotton industry of India heavily which is also noted by Karl Marx in his book Das Kapital. Please note however that - the actual period of Economic de-industrialization of India by the British started in 1757 till our Independence in 1947.

Suggested reading: Deindustrialization in 18th and 19th Century India: Mughal Decline, Climate Shocks, and British Industrial Ascent by David Clingingsmith and Jeffrey G. Williamson - Read/Download link here.

3

The Soviet economic reform post second world war rapidly experimented with big changes happening during the 60s. However, the major changes are Kosygin/Liberman reform, a set of planned changes in the economy of the USSR in the years 1965, 1973, and 1979.

Suggested reading: An Economic History of the USSR, 1917-1991 by Alexander Nove.

4

The problem actually started in 1985. India was facing twin deficits in both trade balance and a huge fiscal deficit. India had a rupee exchange in trade with USSR and the collapse of the Soviet Bloc massively endangered it. The Gulf war by the end of 1990 basically sealed the fate where India’s foreign exchange reserves barely financed three weeks’ worth of inputs.

5

Tanzania took a series of bold steps to liberalize trade after its economy deteriorated during the 1970s and the early 1980s. Read Tanzania’s Experience with Trade Liberalization and what other developing countries can take as important wisdom here.

The Sheep Code

#06 Re-Examining the License Raj