Weak State, Strong Reforms? Globalization, Partisan Competition and The Paradox of India’s Economic Reform

Economic reform in India presents a paradox for theories of the politics of economic reform. Recent work concerning the impact of globalization on the politics of adjustment contends that globalization creates opportunity costs that motivate economic interest groups to pressure the state for reform. Yet in India, the impetus for reform has not come from economic interest groups. India=s state has played a key role in initiating the process with virtually no pressure from economic interests in society. Second, the literature on the politics of economic reform asserts that the economic reforms will advance furthest by strong states with cohesive party systems. Yet the impulse for reform was largely stifled under the apparently Astrong government@ of Rajiv Gandhi who won a mandate for change by leading the Congress party to victory in 415 of 541 seats in the lower house of parliament, the largest share of parliamentary seats in Indian history. In contrast, reform was more sustained under the Aweak@ minority government of P.V. Narasimha Rao after Rao was rescued from political obscurity in 1991 by a divided Congress party with only 226 of 501 parliamentary seats. Only a bit less perplexing is the limited progress achieved by the fractious center-left, thirteen party minority government that was known as the United Front from 1996-98.

This essay explains the paradox of India=s economic reform in an effort to advance broader theories of the politics of economic adjustment. It will use the Indian case to critically examine the contention developed in Keohane and Milner=s Internationalization and Domestic Politics that globalization creates opportunity costs that shape the domestic political process.() It will attempt to advance their analysis by showing that it inadequately conceptualizes the role of the state in the politics of reform. Globalization not only creates opportunity costs that motivate various economic sectors to press the state to implement economic reform, as they suggest. In many cases, it creates incentives for states themselves to initiate reforms even without pressures from groups in society. The sequencing of economic opening and globalization appears to affect the mechanism through which globalization shapes domestic politics. In countries whose opening to the international economy preceded globalization, interest groups benefitting from the opportunities presented by globalization are likely to be more prominent in promoting economic reform. In countries such as India, whose economies remained relatively closed, the economic interests benefitting most from globalization may not exist or may lack the power to promote economic reform. In such cases, political leaders are likely to play a more prominent role in initiating reform when globalization presents them with opportunities to advance the national interest and their own political positions.

If globalization alters the structure of incentives for domestic political actors, it still leaves considerable space for the agency of domestic politics. Stephan Haggard and Robert Kaufman’s impressive volume The Political Economy of Democratic Transitions helps us to arrive at a more balanced view of the role of domestic politics in the reform process. Haggard and Kaufman contend that centralized executive authority is important for initiating reforms while political parties play a key role in reform consolidation. They assert that fragmented and polarized party systems impede the consolidation of support for economic adjustment. The more fragmented the party system, the

more difficult it is to overcome the collective action problems that arise in organizing legislative support for the reforms. Reform will be more difficult in polarized systems, according to Haggard and Kaufman, because the polarization makes compromise more troublesome. Party systems where the opposition includes strong left, populist, and movement parties with sectarian loyalties and aspirations to political hegemony are especially problematic because these parties inflexibly obstruct economic reform.()

Examination of India=s economic reform suggests that rather than limiting our analysis to the degree of fragmentation and polarization of the party structure we should examine the Astructure of political opportunities@ associated with particular party systems.() If we conceptualize partisan politics as providing opportunities as well as impediments to reform, we find that the impact of party system fragmentation and polarization is contingent on the spatial positioning of the ruling party and its opposition. When the ruling party occupies a central position in the political spectrum, fragmentation may facilitate economic reform. However, analysis at the level of party system is insufficient for an adequately developed partisan theory of economic reform. Competition inside parties to secure party leadership also generates an important dynamic in the reform process.() Furthermore, the interaction between competition within and between parties shapes the politics of economic reform. To incorporate these points of analysis, I adapt Robert Putnam=s analytical framework to examine partisan competition as a two-level game.()

Recently, analysts have concentrated on political institutions as the central variable affecting the politics of economic reform; but institutions are not the only variables that affect the outcome of the collective action problems that impede reform. Issue structure, or the matrix of costs and benefits that a policy creates, is also as a key variable. I present an analytical framework for issue structure that helps to explain the politics of economic reform. Issue structure varies on a two dimensional field. One dimension is defined by the extent to which reform increases access to new resource flows. The relative strength of the opponents of reform is the second dimension of the model. Economic reforms that generate access to more resources and weaker political opposition will be easier to implement. This framework helps to explain the pattern of economic reforms that is likely to occur under different political regimes. Political regimes with fragmented and polarized party systems will still be able to implement reforms that increase resources and arouse little opposition. Indeed, the political leaders of fragmented party systems will be especially attracted to these reforms since increasing resources assists them in overcoming their collective actions problems. Political leaders in more cohesive systems will be able to undertake more ambitious reforms.

The analysis is organized as follows: I begin by examining the manner in which globalization has changed the matrix of rewards for economic policy alternatives. Next I outline the issue structure model. Then, I discuss the extent of India=s economic reforms. Finally, I examine the politics of India=s economic reform analyzing the dynamics of partisan competition as a two-level game.

Globalization and Economic Reform

Until recently, scholars have tended to identify the impact of globalization in terms of economic crisis rather than the longer-term changes effected by globalization. The preoccupation with economic crisis is understandable in light of the fact that the impetus for economic reforms came after the debt crisis and was frequently initiated at the behest of the IMF and World Bank. While the impetus for change given by crises is undisputable, exclusive preoccupation with them neglects the impetus for reform that internationalization generates by altering the payoffs for different economic policies.

Frieden and Rogowski=s contention that declining costs of international transactions shapes domestic politics by increasing opportunity costs that motivate the potential beneficiaries of globalization to promote reform provides a useful point of departure for understanding the impact of globalization on the politics of economic reform.() However, their reliance on Stolper-Samuelson and Ricardo-Viner models leads them to develop an explanation that seems inappropriate for India and many developing countries. For Frieden and Rogowski, globalization creates opportunity costs for societal interests which motivates them to pressure the state to implement reforms. In contrast to this Abottom-up@ approach, economic reform in India has been a predominantly Atop-down@ process in which the state initiated reforms without pressure from economic interests in society.

The surprising policy reversal of 1981 was the earliest manifestation of the impact of globalization on India=s economic policy. Following the second oil shock, India=s balance of payments position badly deteriorated. The current account deficit increased from $347 million C 0.3 percent of GDP C in 1978-79 to $3.5 billion C 2.0 percent of GDP C in 1981-82. At the same time that the oil shock hit, India suffered its worst drought since independence, and agricultural production dropped by 15.2 percent in 1979-80. Commodity shortages and higher oil prices led to inflation rates of 17 in 1979-80 and 18 percent in 1980-81. India=s fiscal deficit increased from 5.7 percent of GDP in 1978-79 to 8.1 percent in 1980-81.

Prior to 1981, India had always responded to balance of payments and fiscal crises with import controls and fiscal conservativism. In 1981, in contrast, it initiated a strategy of Aexpansionary adjustment@ which included increased investment in domestic oil production and infrastructure along with measures to increase exports. Initially, this strategy was funded by a $5.8 billion loan from the IMF. As the 1980s progressed, the government increasingly took advantage of India=s high credit rating to borrow from private commercial sources. Long-term debt to private creditors rose from $1.7 billion in 1980 to $22.8 billion in 1990. At the same time short-term debt rose $1.3 billion to $8.5 billion. India=s total debt jumped from $20.6 billion to $83.9 billion, later peaking at $101.5 billion in 1994. The Indian government=s resort to foreign finance during the 1980s, not only funded its current account deficits but also enabled it to run unprecedented fiscal deficits. Central government deficits grew from an average of 4.9 percent of GDP for the last five years of the 1970s to an average of 8.6 percent of GDP for the last half of the 1980s.

Like many developing countries, India began to take advantage of financial globalization long before it initiated economic liberalization. The impetus for economic liberalization came in part from the state=s inefficient use of international resources and the leverage that this gave to foreign creditors. Changes in the structure of international resource flows also promoted liberalization. TheAprivatization@ of international capital flows, in particular, the increasing importance of portfolio investment and foreign direct investment created incentives for market-based efforts to attract international resources.

In the last fifteen years, private international resource flows to developing countries have out paced the growth of official capital flows. (See Chart 1) In 1980, the net private resource flow to developing countries was $50 billion. By 1997, net private capital flows grew to $256 billion. During 1980-82, net private resource flows accounted for only 63 percent of the total net resource flows to developing countries. From 1995-97, they accounted for 84 percent of the total. Of private international capital flows, foreign portfolio equity, bonds, and foreign direct investment have grown the fastest. (See Chart 2) Portfolio investment to developing countries was negligible in the early 1980s. It increased to an annual average of $ 37 billion from 1995-97. Bond debt grew from an annual average of $2.4 billion 1980-82 to $54 billion in 1997. Corporate debt accounted for the fastest growing segment of total bond debt by far. It rose from $2.1 billion in 1991 to $36 billion in 1997. FDI became the largest single source of net resource flows to developing countries. It increased from $9.1 billion from 1980 to $120 billion from 1997.

India has taken measures to exploit these changes in international resource flows. Since 1991, reforms of regimes regulating FDI and foreign portfolio investment, have made substantial progress as measured by the increases that have occurred. (See chart 3) However, India has not made progress on all of the areas where globalization offers increased benefits. For instance, globalization enlarges the potential rewards for privatizing public sector enterprises since selling PSE=s to foreign capital potentially enhances foreign reserves, managerial expertise and technological know-how. Yet privatizing PSE=s to the point of transfering managerial control to foreign firms is nowhere on India=s political agenda. Similiarly, issues of joint ventures with foreign firms and lowering tariffs have become increasingly controversial in the past two years with the newly elected Bharatiya Janata Party offering a June 1998 budget that increases tariffs for the first time in since 1991. We must turn to the political process in order to explain these developments.

Issue Structure and the Politics of Economic Reform

Haggard and Kaufman emphasize fragmentation and polarization as the central variable explaining the ability of leaders to consolidate support for reform. They contend that by magnifying the conflicts among organized interests and exacerbating the collective action problem presented by building a coalition among political parties, fragmentation and polarization of the party system increase the costs of coordinating support for reforms. Yet coordination costs are not only a consequence of the fragmentation and polarization of the players of a game. They are also a function of the structure of the game. It is easier to achieve coordination in expanding-sum games than in zero-sum ones.

Different policies create disparate games. Each policy creates a matrix of costs and benefits for different actors. The consequences of party system fragmentation and polarization cannot be understood without reference to the the manner in which this matrix of expected payoffs structures the logic of coalition formation. The issue structure approach is similar to earlier arguments for Apolicy arenas,@ but it differs in that it does not share the optimism that issue structures can be reduced to a typology with a limited number of discrete categories. Rather it is based on the premise that particular policies create distinctive issue structures which can be located on the space created by two continuous dimensions.

Two features of an issue structure seem most important in determining whether a government will be able to build a coalition in support of a reform C the extent to which the reform enhances the resources available to the state and society and the relative strength of the reform=s opposition. By increasing scarce resources, some reform policies become very attractive to the leaders of developing states who hope that the infusion of new resources will bolster their positions by increasing state revenues and promoting economic growth. The infusion of resources will be especially attractive to leaders of fractious coalitions because it is likely to help maintain the coalition and Alubricate@ the policy process. States can increase the resources available to achieve public objectives by privatizing responsibilities for achieving them. Attracting foreign resources is often even more desirable since they can augment the resources of both private and public sectors. In addition, foreign resources may include advanced managerial and production technologies as well as financial resources. In sum, one dimension of issue structure that affects the incentives to reform is the extent to which a policy augments available resources either by enhancing domestic resource mobilization or attracting foreign resources.

A second dimension of issue structure that affects the politics of reform is the relative strength of opposition to the reform. The expected costs and benefits promotes the formation of coalitions of interests that support or oppose a reform. The relative strength of reform opposition refers to the balance of power between the opponents and supporters of a reform. At the extremes of the dimension are policies in which everybody loses and nobody benefits or where nobody loses and everybody benefits. Movement on this dimension is best conceptualized by drawing from James Q. Wilson=s classic typology. The relative strength of reform opposition is strongest where the costs of a policy are concentrated on a small number of powerful actors while the benefits are dispersed among a wide number of prospective beneficiaries who may not even exist yet. The relative strength of reform opposition declines as the balance shifts in favor of supporters of reform until we reach a point where the opponents of reform are dispersed and weak while the beneficiaries of reform are concentrated and strong.

Combining these dimensions produces a two-dimensional field that maps the issue structure of various reform policies. (See Chart 4) For instance, the issue structure of subsidy reform, where subsidy beneficiaries are concentrated and powerful is located in the upper left of chart. Similarly, labor reform that is detrimental to the interests of well organized trade unions occupying strategic economic sectors is also located in the upper left. In contrast, reforms to increase foreign investment in infrastructural projects enhance available resources and in capital scarce developing countries, the relative strength of opposition is likely to be weak. Reforms to increase foreign portfolio investment and reform equity markets occupy a similar position. The mapping of issue structure also helps us to understand how politics vary in what otherwise might be construed as a single policy arena. For instance, Indians make a revealing distinction between  Adisinvestment@ and Aprivatization.@ Disinvestment involves the sale of equity in public sector enterprises to foreign or domestic investors while the government retains managerial control.  APrivatization@ involves the transfer of managerial control in addition to the sale of equity. While disinvestment arouses little opposition, privatization incites vehement opposition from public sector trade, bureaucrats, and some politicians. Their divergent issue structures differentiates their politics and prospects for implementation. Mapping issue structures also helps to explain how the politics of issues can change. Policies promoting joint ventures with multinational corporations are likely to prove popular because they add financial, technological, and managerial resources. However, they will encounter growing opposition as they lead to foreign takeovers of domestic firms. Similarly, liberalization of trade policy can augment resources by reducing the price of imports, enhancing access to foreign technologies, and promoting exports. However, opposition is likely to increase when import liberalization leads to the displacement of domestic industry.

Variation in issue structure is best understood as interacting with fragmentation/polarization of party systems. Economic reforms with issue structures that promote substantial resource flows and where the relative strength of opposition is weak are likely to be the easiest to implement. Reforms that generate little immediate resource flows and face relatively strong opposition will face more political barriers to successful implementation. However, the frontier of reform that a regime can implement is likely to be affected by the fragmentation/polarization of the party system. As its party system becomes more fragmented and polarized, a regime is likely to be confined to an inceasingly limited number of reforms located in the area in the lower right hand corner of Chart 4. As their party systems become more cohesive, regimes are likely to be able to pass reforms progressively closer to the upper left sector. This analytical framework offers a significant advantage. Because they limit the central variable of their analysis of political support to party system fragmentation and polarization, Haggard and Kaufman=s analytical framework does not allow us to explain variance across different policy domains. Mapping the issue structure associated with various reforms, helps us to explain how even states with very fragmented party systems can pass some reforms. It also helps to predict what new reforms states are likely to be able to implement as their party systems become less fragmented and polarized.

Comparing India=s Reforms Under Rajiv, Rao and the United Front

Examining the pattern of economic reform under three different regimes offers an initial test of our analytical framework. The hypotheses generated by the framework suggest that reforms that increase resource flows and arouse limited opposition should be easiest for each government to implement.  AStrong governments@ or governments formed by dominant ruling parties in cohesive party systems should be able to implement the broadest range of policies while Aweak governments@ or governments lacking dominant ruling parties and operating in fragmented and polarized party systems should be capable of implementing very limited reforms.

Rajiv Gandhi=s government (1984-89) must be considered extraordinarily strong by these standards. His Congress party was elected with 77 percent of the seats in the Lok Sabha, the largest share of parliamentary seats in Indian history. During Rajiv=s tenure in power there were only 1.7 Aeffective@ parties. If ever an Indian politician had a mandate for change it was Rajiv Gandhi, the representative of a new generation of Indians with a penchant for modern managerial techniques and a reputation that was untainted by corruption.

In contrast, P.V. Narasimha Rao=s government (1991-96) must be considered a weak government. Rao=s Congress won only 226 of 507 parliamentary seats in the elections in the 1991 elections which fragmented India=s party system so that it had 4.0 effective parties. By 1991, Hindu nationalism had become the most salient issue in national politics, polarizing the party system to unprecedented levels. The Bharatiya Janata Party (BJP) had ridden the wave of Hindu nationalism to become the country=s fastest growing party and the second largest in parliament while the adamantly secular Janata Dal and Communist Party of India (Marxist) ranked third and fourth respectively. Rao=s minority government was initially viewed as representing a continuation of an era of political instability, being the country=s fourth government in 32 months. Rao was the second choice of Congress power brokers. His fading political future and failing health (he had a quadruple coronary bypass surgery months before the election campaign) led him to retire into obscurity before the 1991 general elections. He was selected in large measure because his lack of an independent base of popular support. His total absence of personal charisma ensured in the eyes of many Congress leaders that he would be a transitional figure unlikely to threaten any of the party’s many factions. In light of these factors, the coordination problems confronting the Rao government were formidable. The time horizons of political leaders both within the Congress and its opposition should have been shorter. The credibility of the reforms should have been weaker.

These problems were even more serious under the United Front Government (1996-98). In the wake of the 1996 elections, party system fragmentation increased to 5.8 effective parties. A government was formed only after 13 parties controlling just 179 of the 545 seats in the Lok Sabha (the lower house of Parliament) coalesced into the United Front and reached an accommodation with the Congress party for the support of its 140 votes. The problems created by the fragmentation of the government coalition were exacerbated by the fact that Left parties controlling 40 of the UF seats decided to remain outside of the government while insisting on the formation of a UF Steering Committee with the veto power over all government decisions. Under these circumstances, we would expect reform to procede much further under Rajiv than under Rao or the UF.

Economic reform under Rajiv Gandhi=s Congress government (1985-89) had three primary objectives: 1) promote exports by lowering tariffs on capital goods to facilitate the modernization of Indian industry and by increasing incentives to export; 2) rationalize the tax system to provide greater incentives for growth; and 3) liberalize government regulation of private industry. Finance Minister V.P. Singh initiated the reforms in his 1985-86 budget speech, three months after the government came to power. He announced that quantitative controls on many varieties of industrial machinery were eliminated. Simultaneously, the government slashed customs duties on capital goods from 105 percent ad valorem to 45 percent. Customs for fertilizer projects were eliminated and duties on power projects were reduced to 25 percent. Export incentives were enhanced by exempting the first 50 percent of export profits from taxation. Export subsidies were increased, and the value of the rupee was tacitly allowed to decline against major currencies.

The government attempted to stimulate growth and reduce tax evasion by cutting income tax rates by 20 to 30 percent depending on the tax bracket. It increased the exemption limit from Rs 15,000 to Rs 18,000. The Estate duty was abolished, and the wealth tax was substantially cut. The government lowered the corporate tax rate from 57.5 percent to 52.5 percent. It raised the ceiling for exemptions from excise taxes for small-scale industry from Rs. 2.5 million to Rs. 7.5 million. Tax rates above this new ceiling were graduated for firms with turnover up to Rs. 15 million. In November of 1985, the government issued a long-term fiscal policy statement promising that rates of personal income tax and wealth tax would not be changed for five years.

The reforms attempted to improve the efficiency of Indian industry by reducing some of the government’s extensive regulation. Rajiv announced the elimination of the licensing of investment and production capacities in 27 major industries for firms whose assets were under the Monopolies and Restrictive Trade Practices Act (MRTP) threshold and had less than 40 percent foreign equity. Simultaneously, the Finance Minister declared that the asset threshold above which firms would be subject to MRTP regulations would be increased from Rs. 200 million to Rs. 1 billion. Later, in June, the government announced a new policy intended to revive the sagging fortunes of India’s textile industry. All restrictions on the capacity and production of the mill sector were removed. The government declared that it would no longer take over unprofitable enterprises, and it proposed a program to ease the transition for workers who lost their jobs because of the closure of their mill.

Opposition slowed the pace of India=s economic reforms after 1985, and Rajiv=s government was limited to introducing modest reform initiatives that engendered little opposition. It persisted in liberalizing the industrial licensing regime, by reducing the list of industries subject to licensing from 77 to 27 in 1988. It continued to augment export subsidies. In April 1988, it began to reform the country=s rapidly growing capital market by establishing the Stock Exchange Board of India (SEBI); however it did not give SEBI statuatory authority to levy sanctions. Finally, in March 1989, the government ended price controls for cement and aluminum.

In some respects, India=s economic performance under Rajiv Gandhi was commendable. From 1985-86 to 1989-90, India=s GDP grew at an annual average of 5.6 percent. The dollar value of exports increased 14 percent annually. Inflation remained quite manageable, averaging seven percent annually. The good performance, however, was not sustainable. India=s fiscal deficit averaged 10.1 percent of GDP. India=s current account deficit as a share of GDP expanded from an average 1.7 percent for the first half of the 1980s to 3.0 percent for the second half. India=s debt profile worsened substantially over the period. In absolute terms, its foreign debt doubled from $31 billion in 1984 to $64 billion in 1989 while its debt service ratio rose from 18 to 27 percent. At the time Rajiv Gandhi left office, India=s foreign reserves covered barely six weeks= imports. Ultimately, the macro economic policy mistakes of Rajiv Gandhi=s government played a major role in India=s 1991 economic crisis.

Under the Narasimha Rao government (1991-96), India moved from the brink of international default in 1991 to economic policies that appear to have placed the country on a trajectory of relatively rapid, sustainable growth. The reforms progressed furthest in the areas of opening up to foreign investment, reforming capital markets, deregulating domestic business, and reforming the trade regime. Rao=s government made much less progress in reducing the fiscal deficit, privatizing the public sector, and meeting the urgent need to increase investment in infrastructure.

Major reforms have occurred in India=s capital markets which have led to an influx of foreign portfolio investment In March 1992, the government abolished the Controller of Capital Issues which decided the prices and number of shares that firms could issue. With the passage of the SEBI Act of 1992 and the Security Laws (Amendment), SEBI was give legal authority to register and regulate all security market intermediaries. In November, 1992, India=s equity markets were opened up to investment by foreign institutional investors. Simultaneously, reforms made it easier for Indian firms to raise capital on international markets by issuing Global Depository Receipts (GDRs). In 1994, National Stock Exchange, a computer-based trading system went into operation. The NSE was used as an instrument to leverage reform of India=s other stock exchanges since its competition threatened to take their business. Within two years the NSE became India=s largest exchange.

Trade reform and changes in the regulation of foreign direct investment were introduced to open India to foreign trade while stabilizing its external deficit. Tariffs, under the Rao government, were reduced from an average of 85 percent to 25 percent, and quantitative controls have been rolled back. The rupee was made convertible on trade account. India=s economic opening has increased the ratio of foreign trade to GDP increasing from 14 percent in 1990-91 to 21 percent in 1995-96. Export growth averaged 19.7 percent annually from 1993-94 to 1995-96, and import growth had an annual average of 25.4 percent from 1994-95 to 1995-96.

Foreign direct investment was encouraged by increasing the maximum shares of foreign capital in joint ventures from 40 to 51 percent with 100 percent foreign equity permitted in priority sectors. Procedures for FDI approvals have been streamlined and in at least 35 industries approvals for projects within the limits for foreign participation is automatically approved. Total Foreign investment (including foreign direct investment, portfolio investment, and investment raised on international capital markets) grew from a minuscule US $158 million in 1991-92 to $4.7 billion in 1994-95 and$4.3 billion in 1995-96.

During 1991-92, the first year of Rao=s stabilization program, India=s economy grew only 0.9 percent. However, the trough was narrow, and growth increased to 5.3 percent in 1992-3, 6.2 percent 1993-4, 7.8 percent in 1994-5, and 7.2 percent in 1995-6. Industrial policy reforms stimulated an even more dramatic recovery in manufacturing. Industrial licensing was slashed as the number of industries licensed was reduced to 14, and industrial regulation was rationalized. After dropping to 0.6 percent in 1991-92, manufacturing grew by 4.2 percent in 1992-3 and averaged a 10.7 percent annual increase during the following four years while peaking at 13.6 percent in 1995-6.

India=s opening to the global economy was more sustainable than under Rajiv Gandhi. Coverage of imports by exports has improved from 53 percent at the beginning of the 1980s to 75 percent in 1990-91 to a peak of 95 percent in 1993-94 before declining to 88 percent in 1995-96. India’s current account deficit contracted from 3.7 percent of GDP in 1990-91 to 0.5 percent in 1994-95. With India=s rapid economic growth and subsequent increase in imports the ratio of current account deficit to GDP increased somewhat in the following two years. However, it remained quite manageable at 1.7 percent in 1995-96 and 1.4 percent of GDP in 1996-97. Foreign exchange reserves were only $1.1 billion in June 1991, covering less than two weeks of imports. They increased to $17.0 billion at the end of 1995-96.

Like the Rao government, the United Front advanced reforms intended to attract FDI and foreign portfolio investment. It also improved the functioning of equity markets, lowered customs duties, and rationalized its tax structure although it made little progress in other areas. The UF government endeavored to attract more FDI by raising the ceiling on foreign equity in nine industries — primary in infrastructure and metallurgy — from 51 to 74 percent in December 1996. It was also announced that foreign companies would be permitted to have 100 percent ownership in cases where a suitable Indian joint venture partner was not available provided that the foreign firm divest at least 26 percent of its equity in three to five years. The UF raised the maximum foreign equity for thirteen other industries from 51 to 100 percent for investments made by Non-Resident Indians (NRIs) and Aother Corporate Bodies@ in which NRI=s hold at least 60 percent equity. In pursuit of foreign capital, the UF increased the limit for the share of foreign portfolio equity in Indian firms from 24 to 30 percent, and it raised the ceiling on the equity share of a single FII from five to ten percent. In June 1996, guidelines for Euro-issues were liberalized to facilitate access for Indian companies wishing to raise GDRs or foreign currency convertible bonds for investment in infrastructure, and the permissible end-uses of funds obtained from GDRs and FCCBs were broadened. With the 1996-97 budget, the UF also promoted access to foreign technology by increasing the maximum for lump-sum royalty payments from Rs. 1 cr. To Rs. 7 crore.

The UF government took a series of measures to develop India=s equity markets and increase investor protection. The UF passed the Depositories Act, 1996 to enable the creation of the National Securities Depository Limited (NSDL) in November 1996. The NSDL was designed to modernize India=s antiquated settlement system, primarily by enabling dematerialized equity trading, a practice that has steadily expanded since its founding. Measures were taken to promote investor security by establishing a comprehensive system of margins, intra-day trading and exposure limits, capital adequacy norms for brokers, and trade/settlement guarantee funds for each exchange. Unlisted companies with a net profit in each of the last three years were given free access to the market. In November 1996, SEBI issued regulations on venture capital funds that allowed them to invest in unlisted companies, to finance turnaround companies and to provide loans. Finally, SEBI sponsored the Bhagwati Commission on corporate takeovers and on the basis of its recommendation modified the SEBI (Substantial Acquisitions of Shares and Take-overs) Regulations, 1994 to introduce new procedures that better protect the interests of minority shareholders and which facilitate hostile takeovers.

UF finance minister, P. Chidambaram=s Adream budget@ for 1997-98 brought substantial changes to India=s tax code as the finance minister slashed taxes in an effort to stimulate growth. The top marginal rate for income tax was reduced from 40 to 30 percent while the standard deduction was increased from Rs 15,000-18,000 to Rs 20,000. The top corporate tax rate was reduced from 40 to 35 percent for domestic firms and from 55 to 48 percent for foreign companies. Chidambaram also widened the tax base by requiring metropolitan city residents owning or leasing a motor vehicle, telephone, house or who have traveled abroad to file.

The UF continued to liberalize the trade regime. The 1996-97 budget lowered customs duties by an average of 8 percent. The 1997-98 budget reduced the peak duty form 50 to 40 percent. Duties on capital goods were lowered from 25 to 20 percent. Customs duties on a large number of inputs, raw materials, and intermediates were educed to improve the competitiveness of domestic producers especially in the power, chemicals, textile and informatic sectors. Non-tariff restriction on imports were also liberalized. 480 items were moved from the restricted list to Open General License in 1996-97. Another 128 items were freed in 1997-98.

The UF took a number of new initiatives to encourage more private investment infrastructure. It created an Infrastructure Development Finance Corporation to leverage private investment. On January 25, 1997 it also established the Telecom Regulatory Authority of India to improve the investment environment in the telecommunications sector.

India=s economic performance began to decline under the United Front. After peaking at 7.5 percent in 1996-97, GDP growth declined to five percent in 1997-98. Industrial production which had declined to 7.1 percent in 1996-97, continued to slump to an estimated an annual rate of 4.6 percent from April 1997 through February 1998. Export growth dropped from more than twenty percent to only 5.4 percent in 1996-97. It plummeted further to an estimated 2.6 percent for 1997-98. Despite declining exports, India=s current account deficit remained manageable at 1.0 percent of GDP in 1996-97 and 1.5 percent in 1997-98. One reason for India=s economic slump was the inadequacy of India=s infrastructure to sustain to rapid growth. The government=s efforts to restrain inflation through tight monetary policy and high interest rates created a credit squeeze that also curbed growth. More worrisome over the long-term is the continued high fiscal deficits. Under the UF government, the central government=s fiscal deficit rose from 5.2 percent in 1996-97 to an estimated 6.1 percent in 1997-98.

In sum, all three governments responded to the incentives for reform created by globalization, but the reforms under Rajiv Gandhi were much more limited than under Narasimha Rao (see Chart 5) even though, at least according to the conventional wisdom, political circumstances were much less conducive to reform under Rao. It is possible to argue that the economic crisis of 1991 catalyzed Rao=s reforms more than anything else. The crisis, did indeed play an important role. Yet something more than the crisis was at work since the reforms continued after the crisis was resolved. A crisis-based theory cannot not explain why the reforms – albeit it in a limited fashion – continued during the UF Government in times of relative prosperity and in difficult of political circumstances. To better understand these issues, we must analyze the dynamics of Indian politics.


Explaining the Paradox of India=s Economic Reform

We need a more fine grained analysis to explain the paradox of why India=s economic reforms were more substantial under Rao than Rajiv. Interest groups have rarely been a decisive factor in the formulation of Indian public policy, and the business community — the best organized social sector — was divided both organizationally and in their level of support for economic reform. It is possible to argue that by 1991 a bureaucratic Achange team@ favoring reform was assembled within the state, but in democratic states, Achange teams@ must be supported by political leaders if they are to have the authority to implement economic reform. Analyzing partisan competition among India=s political leaders provides an important contribution to explanations of India=s paradox of economic reform. To understand the dynamic of partisan competition we should conceptualize it as a two-level game in which competition within party organizations and competition between parties provide an important dynamic for the reform process.

The Dynamics of Intra-Party Competition

As the leader of the new generation of Indians that came of age in the post-Independence period, Rajiv Gandhi was confident that his electoral mandate would enable him to pursue a new set of policies to, as he brashly claimed, Abring India into the twenty-first century.@ Rajiv and his advisors failed to realize that his new policies had important political as well as economic consequences. By threatening to dismantle the regulation of business and streamline India’s mammoth public sector, Rajiv’s new economic policies also threatened to disrupt the modus operandi of patronage that, however economically inefficient, had enabled the Congress to retain control over the national government for all but three years since 1947. The Congress=s rural bases of support were particularly neglected by Rajiv’s reform initiatives. Other than the introduction of a modest crop insurance program, they reaped no benefits from Rajiv’s reforms. Since agricultural income was exempt from India’s income tax, farmers did not benefit from cuts in the income tax, yet they suffered from increased indirect taxes that raised consumer prices. Rajiv’s concessions to business and the middle classes along with his cosmopolitan personal background left the distinct impression that he had little empathy for the travails of rural life.

The most powerful opposition to Rajiv’s new economic policy came from within the Congress. The party’s disappointing showing in the March 1985 state legislative elections and parliamentary by-elections tarnished Rajiv’s image as a vote-getter. Opposition mounted when Rajiv presented an economic resolution to the Congress Working Committee (CWC) for its approval prior to the meeting in May 1985. The resolution concretized in the minds of many Congress leaders the idea that Rajiv was proposing an unacceptable break with the Congress party tradition. It omitted the ritual homage to socialism as well as any mention of anti-poverty programs. Furthermore, the resolution ominously contended, “In the process of development, the policy instruments relevant to one stage cannot be treated as permanently sacrosanct. Nor are they ends in themselves.” The ensuing protest was so strident that the original draft was substantially revised to reiterate its commitment to socialism and the past tenets of Congress economic policy.

This was the first of many concessions that Rajiv made to powerful interests within the Congress. At a time when privatization was sweeping through the world, Rajiv avoided any significant reform to make India’s immense public sector more efficient. While Indian industry favored rolling back government regulation, they opposed opening up the country to foreign competition. Rajiv obliged them by further deregulating domestic industry in 1988 and 1989 while reversing his efforts to open the Indian economy to international competition. Rajiv also took a series of measures to dispel his pro-rich image and build a rural base of support.

Why didn’t the ranks of the Congress rebel under Rao as it did under Rajiv? There was a peculiar strength in the Rao government’s weakness. Under Rajiv Gandhi, the Congress majority was large enough that dissidence did not threaten the party’s hold over the government. In contrast, Rao=s minority government had such a tenuous hold on power that even a few defections threatened to bring it down. Losing power would have spelled disaster for manyCongress members of parliament (MP=s). The party’s performance in the 1991 elections had been artificially enhanced by the sympathy vote that it had received following Rajiv Gandhi’s assassination. Observers estimate that the Congress picked up as many as forty parliamentary seats as a consequence. When not cultivating popular sympathy, the Congress’s main claim to support was that only it could provide stable and effective government. Should dissent within the Congress bring down the government, the party would have lost any basis to stake this claim.

Equally important were the changes that occurred in the composition of the Congress parliamentary party. The main bastion of the Congress’s political support has historically been in the “Hindi heartland” of north India; however in the 1989 elections, the Congress lost its much of its support in the Hindi heartland. Simultaneously, it performed extraordinarily well in the South. In the four southern seats of Andhra Pradesh, Karnataka, Tamil Nadu and Kerala, the party won 103 of 130 seats. These states accounted for 52 percent of the party’s total. The Congress’s performance declined slightly in the South in the 1991 elections, but it still won 87 of 129 seats, and the South remained by far the party’s largest regional base with 45 percent of its 199 seats. The Congress=s shifting base of political power was reflected in Narasimha Rao’s selection as Prime Minister since he was the senior-most Congress political leader from the South. Southern India had not produced a rival to Rao, and the support for the Prime Minister among the crucial parliamentary delegation from the South was initially unshakable. The shift in the Congress base of support simultaneously weakened the strength of potential rivals from northern India.

These advantages did not provide Rao with much security. The precariousness of Rao=s position was demonstrated by the fact that he distributed government portfolios to 57 MP=s. Opposition within the Cabinet and Congress parliamentary party obliged Rao to delay the announcement of his industrial policy in July 1991. M.L. Fotedar, Minister for Health and Family Welfare and Minister of State for Labor K. Ramamurthy opposed the new policy on the grounds that it broke with the Nehruvian tradition. Rao overcame their opposition by appointing an informal committee of cabinet ministers including Fotedar to review the policy. Fotedar and other opponents within the Congress acquiesced to the new policy after provisions to close down loss making public sector units were diluted, and Fotedar was authorized to write a preamble explaining how the new policy was a continuation of the Nehruvian tradition. Rao then succeeded in making the policy almost impossible to reverse by securing a vote of approval from his Cabinet and the CWC.

Opposition within the Congress to Rao=s efforts to reduce fertilizer subsidies was more powerful. Fertilizer subsidies had grown from 3.4 billion rupees in fiscal year 1978-79 to 44 billion in 1990-91. On July 24, 1991 Finance Minister Manmohan Singh announced that he would increase the price of fertilizers by 40 percent in order to reduce the subsidy by 18 billion rupees. The ill-timed announcement came just before planting time for the major agricultural season and caused large demonstrations by irate farmers. The protests generated widespread concern among Congress MP=s who feared a backlash from the rural sector which included seventy percent of the country=s electorate. Forty Congress MP=s signed a Farmers= Parliamentary Memorandum criticizing the price increases. Their opposition was so strident that Manmohan Singh offered his resignation at a meeting of the Congress parliamentary party. After refusing to accept Singh=s resignation, Rao formed an ad hoc committee of key Congress leaders to consider the matter. The committee concluded that the government had to reverse the measure if it was to survive, but Manmohan Singh refused to restore the subsidy completely. A compromise was struck according to which the price increase was reduced from 40 percent to 30 percent, and small farmers were exempted from the price increase. For the cost of 8.6 billion rupees, the politically deft compromise stilled the farmer protests and restored peace within the Congress. The episode, however, illustrated Rao=s vulnerability to pressure from within his party.

Rao continued to face opposition in the Congress, especially from Arjun Singh, the most prominent Congress MP from northern India. Singh attempted to rally support within the Congress by making public statements defending Aover four decades of planning and the policies pursued by us,@ and he expressed concern for the impact of the economic reforms on the Acommon man.@ In the months before the budget session of parliament, Rao and Manmohan Singh took measures to limit opposition to economic reform within the Party. They began to meet with Congress MP=s to discuss their economic policies as part of their preparation for the new budget to be discussed in March. On January 27, Rao convened a joint meeting of the Congress Parliamentary Party and All India Congress Committee (AICC) officers to discuss his programs. In response to criticisms that his economic reforms imposed sacrifices upon the poor, Rao announced that would take measures to protect the poor through the Public Distribution System (PDS) C a network of ration shops distributing basic necessities at subsidized prices. On January 30, he convened a special meeting on the PDS to explore new initiatives. Although there were rumblings of dissent, the Congress MP=s stuck together and supported the passage of the new budget.

By the end of 1993, just as Rao was consolidating his control over his party and finally achieving a majority for his government in parliament government, the pace of his reforms decelerated. Rao=s position in the two-level game of partisan competition helps to explain this puzzle. When Rao established control over the party, the Congress became a Acharismatic party@ without a charismatic leader. Indira Gandhi and Rajiv Gandhi had already centralized power within the Congress party organization, making the success of the party dependent on the popular appeal of its national leader. Rao centralized power even further after the Tirupati AIIC meeting in the spring of 1992. The Congress party=s culture of obsequiousness toward its leader and its centralized party finances facilitated Rao=s efforts. However, under the Congress system, the party supremo must prove his muster in electoral competition. In India=s federal political system, elections for state legislative provide a proving ground for the leader=s vote-getting abilities. Here, Rao’s soporific speech-making, unimaginative campaigns, and poor discretion proved major liabilities. From 1993-1996, the Congress lost eight of 12 state legislative elections. The electoral defeats diminished Rao=s power within the party even as he was increasing his formal authority. Dissidents, arguing that economic reform was an electoral liability pressured Rao to dilute the reform program. Ultimately, the anti-reform faction split the party in May 1995. Then, in a dispute over electoral alliances, the local party organization in the southern state of Tamil Nadu left the party. Weakened by these splits and a series of corruption scandals that implicated many of the its top leaders, the Congress lost the May 1996 parliamentary elections after an inept campaign.

At the same time partisan competition within the Congress was shaping the politics of economic reform, politics within its two main rivals also had an impact. The alliance between the National Front (NF) and the Left Front (LF) was shaky due to the LF=s disdain for the NF=s emphasis on reservations for backward castes and its turbulent factionalism. The NF, itself, was in disarray. Two regional parties, the DMK and the Assom Gana Parishad left the Front while N.T. Rama Rao, the architect of NF, publicly expressed his dissatisfaction with it and threatened to leave. In the wake of its poor performance in the 1991 parliamentary elections, the NF=s largest party, the Janata Dal (JD) faced widespread unrest within the party. Party stalwarts including: Biju Patnaik, Ramakrishna Hegde, George Fernandes all complained about the ineffectiveness of the party organization. Party president V.P. Singh=s stock reached a nadir after the party=s poor showing in the general elections and the November by-elections. Ajit Singh, son of former Prime Minister Charan Singh, attempted to persuade to V.P. Singh that the JD should ally with the Congress. When his plan was rejected, Ajit=s followers split the JD in the vital state of Uttar Pradesh (U.P.). After months of vituperative infighting, V.P. Singh expelled Ajit from the party on December 26, 1991. He expelled three more MP=s who were followers of Ajit on January 4, 1992. Ajit=s hope that other disgruntled JD leaders would follow him were belied. Outmaneuvered by V.P. Singh, he remained in a political netherworld, not belonging to any political party, until he joined the Congress in December 1993. Ajit Singh=s defection made it clear that before being able to entertain hopes of success in new elections, the JD needed confront the erosion of its popular support and the dissent among the party=s leadership.

The BJP also faced serious internal divisions. One BJP faction under the leadership of party president Murli Manohar Joshi was identified with hard line religious militant groups like the Vishwa Hindu Parishad and the Bajrang Dal while another faction, led by L.K. Advani, the BJP=s parliamentary leader, though not above exploiting Hindu nationalism, favored cultivating support by showing that they could provide responsible government. Joshi was identified with the BJP=s traditional forward caste base. Advani, at this particular juncture, proposed to expand the party=s support by attracting the country=s backward caste communities.

The state of U.P. was a strategic battlefield for the rivalry. It was in U.P. that Hindu militants were conducting demonstrations to remove the Babri Masjid from what they considered to be the site of the Hindu God Ram=s birthplace. It was also in U. P. that Advani succeeded in getting his protégé Kalyan Singh, a backward caste leader, elected as Chief Minister of the BJP state government. As head of the UP government, Kalyan Singh had the difficult task of maintaining law and order while appeasing the increasingly unruly militants. Singh=s position was particularly precarious because he faced a dissident forward caste faction that resented his selection as Chief Minister and was attempting to mobilize disgruntled members of the Legislative Assembly to overthrow him. The tensions came to a head on October 31, 1991 when militants stormed the Masjid, damaged portions of its outer wall, and hoisted a Hindu flag on one of the mosque=s domes. When Kalyan Singh=s government arrested some of the militants, it came under attack from the militant leaders. The tensions were alleviated only after the Rashtriya Swayamsevak Sangh (RSS), the fundamentalist organization that founded the BJP, organized a three day meeting to conciliate Singh and the militants. The debilitating divisions within the BJP continued through December 1992 when Hindu militants stormed and destroyed the Babri Masjid. Prime Minister P.V. Narasimha Rao responded by dismissing the BJP governments in U.P. and the other three states where they had come to power.

The Dynamics of Inter-Party Competition

The dynamics of competition among Indian parties played and important if neglected role in advancing the reform process. India=s party system had been transformed from a cohesive one dominated by the Congress under Rajiv Gandhi to a highly fragmented and polarized one at the time of Rao=s ascendance to power. Despite these apparently unfavorable conditions, competition among India=s parties actually facilitated reform.

After Rao ascended to power in June 1991, no party wanted to be seen as destabilizing his government at a time of economic crisis since it was widely agreed that the public wished to give the government time to address the nation=s economic problems. In these circumstances, opposition parties introduced Acut motions@ into parliament to provide the opportunity for debate on specific budgetary provisions that they anticipated would be unpopular and undesirable. After giving the government a rhetorical lambasting in parliamentary debate, the opposition never united to pass their motions for fear of bringing down the minority government.

The opposition parties wished to avoid elections for other tactical reasons. Indian election campaigns are expensive. The parties had just completed two campaigns in less than twenty months. They needed time to refill their campaign coffers. In addition, each party needed time to increase their popular support if they were to improve their position after the indecisive 1991 elections. The opposition anticipated that the Congress would be compelled to implement austerity measures that would erode its support. Why not give it some time to dig its own grave? Contrary to expectations, the Congress grew more popular as it implemented its early reforms. This was dramatized by the November 1991 by-elections, in which the Congress won eight of fifteen parliamentary seats with Prime Minister Narasimha Rao winning by the extraordinary margin of 580,000 votes. Congress=s popularity continued to grow. An opinion poll in April 1992 showed that if elections were held in that month, the Congress would gain 45 seats in the Lok Sabhagiving it 290 of 545 seats.

The efforts of the Congress to reform the economy were facilitated by the party=s central position in the political spectrum. From his party=s position in the center, P.V. Narasimha Rao was able to pursue a Apolitics of consensus@ to appeal to his opponents on both sides and defuse any impetus for opposition unity. An important element in Rao=s strategy was his willingness to consult with his opponents. On the left, JD leader V.P. Singh urged, AThere should be dialogue between the government, industry, labor, and the political parties. There need not be conflict.@ Rao=s Finance Minister Manmohan Singh not only consulted with V.P. Singh and other leaders on the Left, he identified his reforms to the reforms proposed by Singh=s government in 1990. In addition, he used Montek Singh Ahluwalia and Rakesh Mohan C bureaucrats prominent in V.P. Singh=s government C to formulate and sell the reforms.

While placating the left, Narasimha Rao began a subtle courtship dance with the BJP. Shortly after coming to power, Rao succeeded in gaining the BJP=s support for the Congress candidate for speaker of the Lok Sabha in return for his pledge to support a BJP candidate for deputy speaker. After Bajrang Dal C a militant Hindu youth group affiliated with the BJP — activists stormed the Babri Masjid, Rao responded in a restrained matter even though the incident might have been used as a pretext to dismiss the BJP government in U.P. Shortly thereafter, in November 1991, Bhaorao Deoras, a central committee member of the RSS and younger brother of RSS chief Balasaheb Deoras, met with Narasimha Rao to propose an alliance between the Congress and the BJP. By spring of 1992, BJP leader L.K. Advani was quoted as saying AThe days of anti-Congressism are over.@ Advani meant that the long-standing animosities between the BJP and the Congress had terminated with the end of the Nehru-Gandhi dynasty. Now, the BJP, realizing that the Congress was in need of support to pass its budget and remain in power, hoped to ally with the Congress. In doing so, the BJP hoped to increase its acceptance in India=s political mainstream.

The centrality of Congress=s ideological position also turned the ideological polarization of India=s political parties into a factor promoting economic reform. The end of the Nehru-Gandhi family dynasty extinguished the political antipathies that united the opposition against the Congress. While the Congress=s Asoft@ Hindu nationalism made it an acceptable ally to the BJP, its Nehruvian tradition made it an acceptable ally to much of the Left. At the same time, the BJP=s hindu nationalism was as much an anathema to India=s Left as the Left=s secularism was to the BJP. The efforts by V.P. Singh=s government in 1990 to appeal to backward castes by implementing the Mandal Commission=s recommendation for an affirmative action program reserving about a quarter of all central government jobs for the backward classes was especially objectionable to the BJP since the measure competed with the BJP=s efforts to incorporate the backward castes into its Hindu alliance. The ideological polarization within the opposition prevented an alliance against the Congress, highlighting the fact that the dynamics of economic reform are often affected by unrelated issues.

Partisan competition is multidimensional. While the polarization of BJP and the Left on issues of secularism and affirmative action prevented their cooperation, the parties= positions on economic policy were not that different. The BJP=s 1991 election manifesto enunciated a position favoring in favor of economic reforms that was even stronger than that of the Congress. When the Congress announced its economic reforms in July 1991, LK Advani, declared, AThe BJP is happy to note that the statement on Industrial policy conforms to the approach which the BJP has been advocating.@ On the left, although the JD criticized the reforms, its leader V.P. Singh was one of the early architects of the Congress liberalization policies. Under his leadership, the National Front government took some mild measures to liberalize the economy during its eleven month tenure in power in 1989-90. The economic program it advocated in its 1991 election manifesto included a number of pro-liberalization measures. Perhaps the most vehement opponent of the reform program was the CPI(M). It accused the Congress of selling out to the IMF. Its opposition to the reforms was muted by its eagerness to avoid toppling the Congress government and the fact that the CPI(M) provincial government in its bastion of West Bengal was implementing similar reforms at the state level.

Why were the differences between India=s parties diminishing on economic issues at the same time that they were increasing on issues such as secularism? The shifts in views on economic policy were in part a response to the incentives created by globalization. The decline in the transaction costs of trade and capital flows motivated policy-makers to take advantage of the opportunities to promote economic dynamism through accessing international capital flows and promoting trade. In addition, the demise of the Soviet Union discredited state-socialism as an alternative to market-based capitalism. India=s federal system also increased support for reform. Capital shortages and harder budget constraints have placed limited the ability of the leaders of India=s state governments to use populist measures to mobilize support. These leaders are under increasing pressure to compete for private capital and improve the efficiency of government expenditures. The experience of political state-level policy-makers has moderated the resistance to reform in opposition parties where state-level leaders are especially influential. Finally, India=s business associations, especially the Confederation of Indian Industries, have helped to reduce opposition to economic reform through their efforts to lobby members of parliament and prominent bureaucrats.

The United Front and the Politics of Economic Reform

Although conflict within the UF=s largest party, the Janata Dal was a factor in the ouster of the United Front, the extreme fragmentation that produced the 13 party front made intra-party conflict much less important than conflict between the constituent parties of the minority government and their supporters outside the government. The necessity of sustaining the support of the CPI(M) and its allies whose 40 MPs remained outside the government but a member of the UF Steering Committee and the Congress party whose 140 MPs supported the UF from outside the government and the steering committee, produced two strategies that ultimately failed to sustain the UF. The leader of the government could align with the Left parties at the cost of attenuating support from the centrist parties, especially the Congress, as did the UF=s first Prime Minister, H.K. Deve Gowda. This strategy resulted in the Congress withdrawing its support from Deve Gowda=s UF government on April 11, 1997 after only ten months in power. The second strategy was to secure the support of the Congress at the expense of the left parties. This strategy was followed by the UF=s second prime minister, I.K. Gujral. It destabilized the government because the Left parties fomented division in the UF and made the compromises necessary for keeping the UF in power impossible. The Gujral government fell in on November 28, 1997 after only seven months.

The divisiveness of the UF coalition frustrated reform initiatives on many pressing issues. The most serious omissions were related to the fiscal deficit. Less than three weeks after assuming office, UF finance minister P. Chidambaram, issued guidelines for expenditure management for central government ministries according to which each ministry was asked to formulate plans to implement maximum feasible manpower reductions as quickly as possible. Chidambaram was quickly pressured to withdraw the guidelines when confronted with vehement opposition from public sector unions and the Left parties within the UF. The finance minister=s efforts to reduce government subsidies of petroleum products by raising prices were also reversed. Left party opposition obliged the finance minister to reduce a 30 percent price increase for diesel to 15 percent. The UF government was obliged to ignore the recommendations and ultimately curtail the powers of its own Disinvestment Commission that it constituted to expedite the sale of equity in public sector enterprises because of opposition from the Left parties. Perhaps most damaging was the UF government=s action on the recommendations of the Fifth Pay Commission. The commission suggested a package including pay increases to central government personnel valued at no less than 1.6 percent of India=s GDP in the first year and a thirty percent reduction of personnel to be achieved through attrition over the next ten years. Faced with the possibility of massive strikes by public sector unions who were supported by the UF=s Left parties, the UF Government decided to implement the pay increases while forgoing the personnel cutbacks.

The frustration of reforms under the UF should not obscure the reforms were implemented under by UF. As we have seen, the UF government implemented substantial measures to attract foreign capital, liberalize the trade regime, and reform the country=s equity markets. In fact, the UF=s reforms went much further than those under Rajiv Gandhi despite its much less favorable political circumstances position. The progress on these fronts attests tocumulative nature of India=s reforms and the impact of globalization=s incentives for reform on even the most fragmented political systems.

Conclusion: Integrating International Structure with Domestic Political Agency

By creating opportunities to attract foreign capital and secure the benefits of trade, globalization generates an incentive structure that motivates economic reforms regardless of domestic political conditions. The opportunities presented by globalization shape the patterns of economic reform by rewarding some policy adjustments more than in others. The dramatic increase in international private capital flows increases rewards for countries who can attract foreign investment through appealing policies and institutions or by permitting domestic firms to raise capital on international markets. World trade is growing faster than domestic economies, and globalization creates incentives to promote exports and curtail restrictions on imports, especially those containing technologies and materials facilitating exports. Globalization has a more ambiguous impact on areas like fiscal and social welfare policy. In these policy domains, domestic political variables are likely to be more salient.

The argument rejects Samuelson-Stolper and Ricardo-Viner while critically affirming Friedan and Rogowski. Specifically, globalization creates incentives for economic reform, but those incentives are not limited to economic interests in the private sector. Globalization also motivates states and politicians to promote economic reform. The more internationalization lags behind globalization, the more the impetus for economic reform has come through the state. In such cases, partisan politics and matrix of costs and benefits created by public policy will play important roles in the process of redefining economic interests.

Partisan competition also shapes economic reform. Haggard and Kaufman have helped us better understand the agency of politics by focusing on the party system and arguing for the importance of fragmentation and polarization as important variables determining whether support for reforms will be consolidated. This essay has advanced their analysis in two ways. First, it has shown that there are conditions in which fragmentation and polarization facilitate adjustment. Economic reform under Narasimha Rao was promoted because his ruling Congress party occupied the center of the political spectrum. When the ruling party occupies the center, fragmentation and polarization can impede the coordination of parties= opposition to economic reforms. Second, this essay has extended Haggard and Kaufman=s analysis by demonstrating the insightfulness of conceptualizing partisan competition as a two-level game. Application of two-level model has illuminated the importance of competition inside parties. It is only by examining intra-party competition that we can explain why the impetus for reform under Rajiv Gandhi=s strong government was stifled. Second, interaction between intra- and inter-party competition is an important dynamic shaping the politics of reform. In particular, the poor showing of the Congress under Rajiv and Rao in state-level elections weakened their position in the Congress and made it more difficult for them to overcome the opponents of reform in the party.

A comprehensive understanding of the political dynamics of economic reform must analyze the interaction of international structure with domestic politics. Changes in the international economy — the growth of international trade and the globalization and privatization of finance — offer state leaders the opportunity to increase national resources. Combining the dimensions of increased resource flows and the relative strength of reform opposition into an issue structure model moves beyond Haggard and Kaufman=s analysis because it helps to explain the pattern of economic reforms that is likely to develop. Even the most fragmented and polarized party systems are likely to implement reforms that increase economic resources at little political cost, as the case of India demonstrates. In fact, such reforms are especially attractive to leaders of fragmented and polarized party systems since they offer an important means for alleviating the acute collective action problems that they confront. As ruling parties and party systems become more cohesive, the frontier of viable reforms will move to include reforms that arouse more opposition and add fewer resources.

Are the parties in India=s fragmented system selecting reforms that are easy to implement while postponing the more difficult ones, or will their reforms cumulate into a fundamental adjustment of the economy? At a time when analysts better understand the limitations of Abig bang@ approaches to structural adjustment, we need to develop more insight into the sequencing that will be an essential part of more gradual approaches. Here, I refer to the political as well as the economic logic of sequencing. The logic of political sequencing will be especially important for countries undertaking reforms with fragmented party systems since they are unlikely to be able to initiate radical reforms. This essay suggests a possible political logic for sequencing structural adjustment. Reforms might move from policies that increase resource flows and engender little opposition to ones that are were initially more contested. As they implement the reforms necessary to attract foreign and domestic resources from the private sector, politicians gradually strengthen the supporters of reform at the expense of its opponents. Business makes commitments to exports, joint ventures, and international capital markets that increase their support for reform. States become committed to international resource flows in order to promote growth and increase revenues. The increasing importance of private sector resources means that market institutions become more central to the economy while market displacing interventions become more counterproductive. This sequencing logic seems to roughly characterize economic reform in large countries such as Brazil, China, and India with variations for disparate local circumstances. It may be less appropriate for countries that are less attractive to foreign resource flows. True, attracting the more volatile forms of foreign capital may lead to economic crisis. However, these crises seem best resolved by more, not less, reforms. This logic also says little about the consequences of the reforms for social equity. That depends on the way politics structures the use of the incoming resources and the capacity of different segments of society to absorb them.

The political logic is not irreversible. Although the domestic preference structure may become progressively more supportive of reform, politics is multi-dimensional and the opponents of reform may gain power through their appeal in other issue domains. They will nevertheless have to balance the costs of reversing economic reforms with the benefits accrued outside that domain. On June 1, 1998, India=s new Hindu nationalist government announced a budget that included an eight percent across the board increase in tariffs to Alevel the playing field@ of competition between Indian and foreign business. On June 12, it sliced the increase in half after Indian business demanded that the tariffs be rolled back.