Thoughts on economics and liberty

If only Anna could understand this simple 1975 lecture by B.R. Shenoy on the causes of corruption

Economic illiterates are running rampant in India. 

Although Anna Hazare (who only studied till class 7) developed the capacity to lead a major movement for reform in India, he has never understood the basics of economics.

Arvind Kejriwal, a graduate of IIT, has NO excuse, however, for his MAMMOTH ignorance of basic economics.

I suggest that these people try to read and understand this SIMPLE lecture by India's greatest economist, B.R. Shenoy. (Shenoy gave this lecture in February 1975 at the H A College of Commerce, Ahmedabad.)

If its leaders don't understand BASIC economics, India is doomed.

Economics of Corruption

In the outside world — unfortunately, not in India — there are two dis­tinct camps in economics: interventionists and non-interventionists. Communists represent the extreme case of interventionists. Interventionists of the socialist hue were in control when we came to direct our own economic-political affairs after Independence in 1947; and with the growth in economic chaos which attended the pursuit of socialist policies, communists have been on the ascendant through infiltration and the propagation of their theory which blames capitalism on the growing chaos. Their strategists argue that there is no hope whatever of any escape from the chaos other than via the adoption of communism.
 
There is little indication of any shift to non-interventionism among econ­omists in the academies, in government and its agencies, in business firms and in chambers of commerce. This applies, too, to publicists and intellec­tuals, though there is increasing recognition of the failure of socialist poli­cies. Strange as it may seem, the strongest opposition to a policy U-turn would be mounted by the chambers of commerce and industry.
 
It is not widely known in India that interventionism has invariably undermined the viability and progress of all breadline economies which adopted interventionist policies, and that no country, whether developed or underdeveloped, which entrusted the direction of its economic affairs to the price-market mechanism, has had anything but bumper returns. If we are to be saved from economic-political disaster, it is time that we aban­doned ideological predilections and subjected our policies to a basic trans­formation.
 
Both theory and experience have shown that corruption is among the inevitable by-products of the policy of interventionism. Corruption neces­sarily grows as these policies progress. Indian is a classic illustration of the functional link between corruption and interventionism.
 
Some people have stated that corrup­tion is an age-old institution in India, that it goes back to the Mughal days. We are told that, in the Punjab and else­where, when the income of a young offi­cial of marriageable age is considered by interested parties, due note is taken not only of his recorded income but also of the unrecorded — though nonethe­less real — income opportunities which his official position offers. Corruption certainly dates back to the Public Works Department of the British days.
 
We will not linger on this argument. Corruption and its ally inflation do not hurt us any less because they are old and universal ailments — they undermine character and mass well-being all the same. Our concern here is the effect of corruption on mass well-being. And this effect is considerable.
 
Corrupt payments financed by monopolies
Now, what is corruption? The corrupt incomes we are concerned with are illicit payments made to officials and politicians in power, or payments to party funds, for monopoly documents which bring windfall monopoly incomes. It is a matter of detail whether the payments are made directly, through intermediaries, or indirectly, as contributions to election funds or payments at fantastic rates for advertisements in the souvenirs issued on the occasion of party functions. Payments are made by the recipients of the monopoly documents to those who issue these documents, i.e., the officials who work under the general or specific directives of politicians in office.
 
It follows that corrupt payments are part of the monopoly gains. If monopolies did not exist, there would be no monopoly gains, and the ques­tion of this category of corruption does not arise. Monopoly gains are unearned windfalls, payments are made to gain those windfalls; and, look­ing at the phenomenon from the standpoint of accounts they debited, by the recipients of monopoly documents to the monopoly incomes. The net gain from the monopoly documents is the windfalls less the corrupt pay­ments made for acquiring the documents. The transactions being illicit are, of course, not recorded.
 
Corruption from import licensing
The most highly sought after monopoly instruments are import licenses, as the total amount of the windfalls they bring are enormous. Total imports in 1972-73 amounted to Rs 2,150 crore, of which Rs 780 crore (36.3 per cent) were on private account and Rs 1,370 crore (63.7 per cent) on government account.
 
The 'premium' that a license fetches continues to be enormous. In the case of copper, the market price is over 3.5 times the landed cost. The con­trolled price (which is based on the landed cost) is Rs 10,000 per ton, the market price Rs 36,000 per ton. The price of copper import licenses would therefore be of an order of 2.5 times the face value of the licenses. The prices of or 'premiums' on import licenses may vary from 30 to 35 per cent to five times or more of the landed costs. This means that, on an average, imports worth Rs 10crore bring windfall profits ranging from Rs 3 to Rs 50 crore, depending on the commodity. At an average premium of 75 per cent, the monopoly gain from private sector imports alone will amount to an annu­al order of Rs 585 crore.
 
IT IS NOT AS IF nationalisation of imports eliminates the windfalls and the corruption. So long as the windfalls obtain, corruption will go with it. Nationalisation may shift the recipients of the corrupt payments. If the cor­rupt among the officials and politicians controlling the operation of the State Trading Corporation (STC) are no longer in a position to claim the payments, corruption may change form. The windfalls may get absorbed in over-staffing, raw material leakages (which are but a variant of corruption) or production inefficiencies:
 
As a rule, licenses are non-transferable, so transactions in the market for import licenses are not legal. The Alladin's lamp of import licensing pro­duces fortunes as though from nowhere for a large community of importers and dealers in import licenses. The cost of production of import licenses being zero, the premiums they fetch are windfalls, and when to the gains from private sector imports are added the gains from the nationalised import trade, the total amount of the windfall gains may be of an order of Rs 1,600 crore annually.
 
Unearned monopoly gains on so large a scale cannot be wholly retained by the recipients of the import licenses. The inevitable competition to acquire the import licenses would necessarily bring a share to those respon­sible for issuing the licenses — the administrators and the politicians. As a practical matter, there is nothing that anyone can do to prevent this.
 
If Mr Afrom among those responsible for the issue of the import licens­es is beyond corruption, the only outcome will be that Mr A will forgo his share of the corrupt payments. Possibly, the shares of B,C,D and the rest who collaborate in the issue of the licenses, would go up. The chances are that these others would conspire to have Mr A transferred to another department, in order to make things safe for them. The possibility of the entire body of people, including politicians, responsible for the issue of import licenses being beyond corruption is too unreal to merit any analyti­cal notice.
 
Corruption from public sector contracts
Import licenses are not the only goldmine of corruption. Government contracts and contracts in public sector undertakings are among the other doc­uments in great demand for the fabulous incomes which they yield. When Rs 100 crore is accounted to have been 'invested' in public sector projects, the whole of it does not go into the projects concerned. At some places, the amount actually invested would be at 60 per cent, others at 80 per cent.
 
What happens to the balance? The balance is the windfall of the contrac­tor. For the same reason that the windfalls from import licenses cannot be all kept by the recipients of these licenses, the windfalls from public sector contracts cannot be all retained by the contractors. They have to share a part with the persons whose responsibility it is to accept and issue these con­tracts. Contractors have to make corrupt payment to the administrators, engineers and politicians concerned before they may get the  contracts,
 
What are the amounts involved? The RBI Report on Currency and Finance for 1973-74 places total public sector plan outlays in 1972-73 at Rs 3,960 crore. If contractors have to distribute 10 per cent of these amounts to get the contracts, the total corrupt payments under this head are of the order of Rs 400 crore. If they have to distribute 15 per cent, corrupt payments in 1972-73 were of the order of Rs 600 crore.
 
Corruption from smuggling and other illicit transactions
To this must be added corrupt payments on account of:
  1. Other control measures — every control creates monopolies, and payments are demanded and made for acquiring the monopolies concerned
  2. International trade — smuggling in gold, watches, radios, razor blades, cloth, art-silk yarn and other such goods, and smuggling out silver, rice and the like
  3. Internal trade — smuggling, mainly of rice and wheat, from the sur plus to the deficit state and urban areas
  4. Various administrative services, hurdles or penalties — petty or large bribes paid for pushing files and to the income-tax, customs and police officials.
By the very nature of things, the total amounts of the corrupt payments are not known or ascertainable, even their orders of magnitude. The actual amounts in each corrupt deal can be known only to the two parties to the deal and the intermediaries. But, quite obviously, the totals would not be tens of crores of rupees but several hundreds of crores of rupees.
 
By far the largest amounts of the corrupt payments would be from import licenses, public sector contracts, and smuggling.
 
Any administration exposed to these Himalayan corruption potentiali­ties would succumb to the temptation. With so much money to be had, even the German civil service, reputed for its integrity and efficiency, may fall a victim.
 
If I may quote notorious smuggler Haji Mastan Mirza's statement: "Smuggled goods do not rain from the heavens, they move on roads." They cannot move so freely without the active co-operation of the officers of the various customs and excise departments.
 
Eradicating corruption
How can corruption be prevented when an import license — a piece of paper which costs nothing but the signature of the concerned official to produce — authorising the import of, say, copper worth Rs 5 crore fetches in the market over Rs 12 crore?
 
Competition for the document would neces­sarily bring into being corrupt payments. Schemes to prevent this are not worth a moment's notice. The various reform schemes will only shift the parties receiving the corrupt payments. Corruption will continue. If, for instance, the issue of import licenses is entrusted to an independent board of men of the highest integrity, corrupt activity will move from the government departments concerned to the independent Board and its staff.
 
The only hope of eradication of corruption on the current scale is a com­plete U-turn in our policies — abolition of import control and exchange restrictions, a drastic scaling down of public sector outlays, auctioning away to the highest bidders in the private sector the existing public sector undertakings, removal of the system of permits, licenses and quotas as Professor Erhard did in Germany and limiting government activities to their natural sphere.
 
There is, however, little hope of any U-turn in our policies. Prime min­ister Indira Gandhi, addressing a public meeting at Mangalore on 11 January 1975, declared that she would not budge from her party's policies merely for political exigency. She added, "We have not done it and we will not do it. We feel strongly about our policies and we are not going to listen to anybody." Corruption being a by-product of the prevailing policies, this means that corruption will continue; this will not only undermine national character but also economic growth and social progress.
 
Black market incomes
Import licenses, government contracts and other instruments of statist con­trol over the economy yield phenomenal illicit incomes to the recipients of these instruments. Their total magnitude can be placed at an order of Rs 750 crore annually. The largest bulk of it — of an order of Rs 460 crore — ensued from the traffic in import licenses; an order of Rs 260 crore from contracts in public sector undertakings and other programs of 'development', and the rest from price controls, permits and concessions.
 
This phenomenon adds unduly to the undeclared cash transactions in the economy as distinguished from transactions paid for by cheque. First,the recipient of an import license who has incurred illicit payments for acquiring it cannot enter these payments in his books. But being part of his costs, he has somehow to recover the amount  from      the sales of the goods imported against the license; he arranges to get some of his receipts in unaccounted form, i.e. cash. This may take the form of fictitious inter-sales to non-existent parties or receipts of payments partly in cash and partly by cheque, the receipt being made out only for the latter.
 

Secondly, being illicit earnings, they cannot be entered in the books or figure in the income-tax returns. The earnings must be held in cash — not as deposits with a bank — and payments from them, whether for consumption or for invest-merit, must be in cash.
The amount of the black incomes being so considerable, the attendant necessity for cash transactions has, in recent years, altered the currency component of the Indian monetary circulation. The amount of currency with the public has risen relatively to the amount of bank money. In 1951¬52, the amount of currency with the public represented 69.5 per cent of the total monetary circulation. Since then the industrial sector of the economy, where the banking habits of the people are better developed than in the rural sector, has expanded by 92 per cent, or at an annual rate of 9.2 per cent.

ORDINARILY, THIS SHOULD have led to an increase in the ratio of bank money — cheque currency — to the total monetary circulation. Yet, it is the currency part of the monetary circulation that has gone up; the latter has fluctuated upward with the intensification of statist economic policies, the ratio of currency to the total money at the close of 1961-62 being 73.2 per cent. The currency part of the circulation has grown to meet the pronounced increase in black market transactions.
The annual accruals of illicit incomes are much more than the annual average increase (Rs 470 crore) in the Indian national income of the decade ending 1960-61. If such large incomes were to remain permanently illicit, their cumulative effect might soon become intolerable, through black market transactions growing in extent and volume. But 'black' incomes are being continually converted into 'white incomes. We may briefly recall some of the devices though which this is effected.
Probably the most common device — because it is the simplest to operate — is to understate domestic expenditures. If a black marketeer's household expenditure is Rs 3,000 per month, it may be shown in the books as, say, Rs 1,000 per month. This would permit monthly overdrafts on black incomes of Rs 2,000 to meet household expenditures. Equivalent open incomes being thereby left unspent, they take the place of the black incomes utilised for household expenditure: we have here a case of the conversion of black earnings into white. But the amounts that may be transferred into white incomes in this manner are limited by the magnitude of domestic expenditure, and one would have to wait for a long time to transform large amounts of black money.
 
The application of this technique to marriage expenditures and to the costs of buildings and equipment might enable larger sums to be redeemed from the black label. One is often struck by the comparatively low declared costs of impressive residential structures put up by businessmen and cor­rupt state officials. The explanation frequently is that a house costing, say, Rs 150,000 is accounted to have cost but Rs 60,000; the balance represents payments from black income. This is a case of Rs 90,000 of black money being baptised into white money, through the former now becoming an openly marketable asset — a residential building.
 
Considerable amounts of illicit earnings may be converted into white with the collusion of bullion dealers. An individual Bulchand with illicit earnings ofRs 200,000 may engage in a fictitious 'sale' of 'ancestral jewelry' of this value to a bullion dealer, Chimanlal. Chimanlal will then make an entry in his books of purchase of Rs 200,000 of jewelry from Bulchand and of payment to the latter of Rs 200,000, thereby converting black funds into white. He can now deposit the amount in a bank, entering it in his books as the proceeds of the sale of inherited jewelry.
 
But the transaction presents a problem to Chimanlal, the bullion dealer. His accounts will show a purchase of non-existent jewelry. The security of his position from the clutches of income-tax authorities requires that the 'purchase' must be balanced by equivalent 'sales'. To make the fiction real­istic, Chimanlal gets the jewelry 'melted' at a refinery or goldsmith, the costs of such melting being duly entered in the books of Chimanlal and of the refinery or goldsmith, this operation calling for collusion of the latter. Having 'melted' the jewelry into bullion, Chimanlal straightens out the position in his books by showing in it 'sales' of bullion to numerous benarni parties (fictitious individuals). Once the purchase is cancelled by such sales, Chimanlal's position is well fortified.
 
For the services thus rendered by Chimanlal to Bulchand, the former charges the latter a commission at the market rates for such services, the current rates being placed at 8 to 10 per cent of the sums involved. This covers the payments for 'melting' the jewelry paid to the refinery or the goldsmith.
 
SINCE HOUSE CONSTRUCTION cannot go beyond needs and 'ancestral jewelry' may have limits, black-marketers may resort to other techniques of changing the label of their earnings. One such is to 'purchase' the business losses of individuals. This is a rather complicated operation and needs clarification. A businessman Premchand, who has suffered a business loss of Rs 200,000 may 'sell' this loss to another businessman Mansukhlal, who has black money for conversion into white. Premchand would then make after-the-event entries in his books to show that the losses suffered by him represented the balancing profits of Mansukhlal; the relative transaction being stated to have been effected with the latter. This fiction would enable Mansukhlal to bring out his black funds into the open, as they would be now declared as business profits. Forward transactions, especially on the stock exchange, are rather easily amenable to the application of this tech­nique. It is believed to be in vogue extensively, the transactions being put through specialist brokers and go-betweens who have come into existence to meet the large demand for such services.
 
Considerable demand exists, too, for the concealment of open incomes, the chief motivation behind this being tax evasion, as the tax rates on the upper income slabs are exorbitant. We have developed police-proof techniques to bring this about — these latter are generally the reverse of the techniques for converting black money into white. They include overstatement of domestic and marriage expenditure and of cost of buildings and equipment, and 'purchase' of business profits.
 
With two decades of experience behind us, the needs of the black mar­ket have been by now well institutionalised. As has been aptly remarked by one writer, the black market sector of the Indian economy today is well past the take-off stage of development. The phenomenon is revolting to the national conscience, and there is no remedy to it other than to strike at its roots — abandonment of the policies of statism. So long as statist policies remain, corruption too will remain.
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Sanjeev Sabhlok

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