Wednesday, August 02, 2006

On the workings of the Indian Economy

Nitin Pai points out that India is still a difficult place to do business. (Worse than Iraq, though?!)

The New Economist links to a World Bank working paper by by Franklin Allen, Rajesh Chakrabarti, Sankar De, Jun Qian and Meijun Qianon on "Financing Firms in India. "

Our evidence, including results based on a survey of small- and medium-scale private firms, shows that alternative financing channels provide the most important source of funds. We also find that informal governance mechanisms, such as those based on reputation, trust and relationships, are more important than formal mechanisms (e.g., courts) in resolving disputes, overcoming corruption and supporting growth.

This is typical of extremely immature market economies.
Now, how do businesses survive the corruption?

Perhaps one of the most effective solutions for corruption for firms in this sector is the common goal of sharing high prospective profits. This common goal can align interests of the investors and government officials with entrepreneurs and managers to overcome numerous obstacles.

Another potential effective solution for corruption is competition among local governments/ bureaucrats from different regions within the same country. Entrepreneurs can move from region to region to find the most supportive government officials for their private firms, which in turn motivates officials to lend "helping hands" rather than "grabbing hands," or else there will be an outflow of profitable private businesses from the region. This remedy should be typically available in a big country with multiple regions like India.

This is an interesting variant of Mancur Olson's "grabbing hand" theory of Government. Because the businesses can choose the "bandit" (the regional governments) they are subject to, the Bandits' rapacity is constrained.


gaddeswarup said...

I do not understand this post. where is the second quote and suggestion from? Can you explain a bit more this suggestion or give a reference; I am extremely naive on economic matters. Just trying to learn. Thanks.

Rajeev Ramachandran said...

Hi Swarup.
This may help:
See especially the bit about his last book.

gaddeswarup said...

Thanks. I think that I see the gist of what you said. Regards,