India’s Growing
Black Economy: Some Key Aspects
Arun Kumar
CESP, SSS, JNU
India’s black economy is roughly
estimated to be 50% of GDP, generating $600 billion annually. It is so
extensive because it is generated in every area of economic activity: the
public and the private sectors, i.e. everyone down the line from the Prime
Ministers, Chief Ministers, top industrialists, army men, judges, bureaucrats,
lawyers, teachers and so on.
A recent report estimates that since independence, more than $460 billion has been lost due to
flight of capital. This is much larger than India’s foreign debt or the Aid it received. A
country already short of capital has been exporting this commodity on a large
scale. Taking the opportunity cost is also taken into account, the figure runs
into a few trillions. If this amount had been invested in the country, say, in
rural areas that are woefully short of basic infrastructure, such as water,
sanitation or electricity, living conditions could have been far better.
Alternatively, investment in industry would have made industrialization,
technology and productivity far more advanced than at present.
All-Pervasive Impact of the Black Economy
Black economy leads to policy
failure. There is a vast difference between policies on paper and how they are
actually implemented. Whether it is environmental regulation or industrial
location or urban zoning or traffic lights, all laws are routinely violated. No
wonder that at a low level of per capita income, India has some of the worst
air and water pollution in the world. Due to insanitary conditions and water
pollution, most people suffer from poor health resulting in low labour
productivity. Literacy levels are low because money destined for constructing
schools is often siphoned off and teachers not appointed. Even in the fifth
grade, children are found to have acquired so few skills that they are
condemned to work at low levels of productivity and remain poor for the rest of
their lives.
The black economy results in revenue
loss of about 20% GDP, at current rates of taxes. In comparison, the fiscal
deficit is currently around 10% GDP. Without the black economy, there would
have been a surplus in the budget and much greater investments in
infrastructure and poverty removal. With less corruption, the effectiveness of
these expenditures would have been greater. The revenue deficit underlying the
fiscal deficit and rising debt in the budget would have been wiped out, meaning
that the fiscal health of the government would now be better.
The flight of capital associated
with the black economy is the main cause of the BOP problems that have plagued
the Indian economy for much of the time since independence. It takes place
through under- and over-invoicing of foreign trade, transfer pricing and havala
(parallel banking). Much of this is managed through shell companies set up in
tax havens (77 at current count) to launder the money siphoned out of the
country.
Due to fraud, there is rampant insider trading in
the stock markets which makes them unreliable and unstable. The Harshad Mehta Scam in 1992 was estimated by the Jankiraman
Committee to be upward of Rs.3,000 crores. Between 1991 and 1999 about 2,500 new companies floated in the stock
markets disappeared with public money, which scared off retail investors.
The Growing Size of the Black Economy
The size of the black economy is
given relative to the white economy and expressed as a per cent of the GDP. It
has been estimated to have increased from around 4% in 1955 to 7% in 1970 to
20% in 1980 to 35% in 1990 and 50% currently. Illegality in the country has
clearly been growing. More and more scams are surfacing and the sums involved
are increasing exponentially. The latest scam to make the headlines was the
allocation of frequencies in 2008 for the start of the 2G services. According
to the government auditors (CAG), the loss to the exchequer could be as much as
$35 billion, much larger than the earlier estimate of $10 billion, and may turn
out to be the largest scam globally.
While the number of scams emerging into public gaze
was just a handful between 1950 and 1980, this increased to 13 in the eighties
and 26 between 1991 and 1996. Between 2005 and 2008 it increased yet again, to
150 Prior to 1980 the biggest scam involving the then PM Rajiv Gandhi was
of Rs.64 crore. In contrast, there were 13 scams involving more than Rs.1000
crores in the nineties, and now the amounts run into tens of thousands of
crores. The numbers and the
per scam average amount involved have increased exponentially.
If, currently, illegality is
associated with 50% of the economic activity, it has to be systematic and
systemic. Systems are set up to bribe politicians and bureaucrats, for
adulteration of food, for producing spurious medicines, for not declaring the
full output produced so that profits are generated off the balance sheet and so
on. It doesn’t just occur sporadically - it is 24/7.
The Underlying Cause: The Growing Triad
This is only possible if those in
charge of rule implementation are party to black income generation. These
people connive in the persistence of illegality and share the extra profits
generated. A Triad exists between the corrupt businessmen, corrupt politicians
and the corrupt government machinery. The last consists of the police, the
bureaucrats and the judiciary. Often, now, either the businessman or the
politician has a criminal record and this has led to growing criminalization in
society. This nexus is so powerful that a financially honest PM voluntarily
tolerates the corruption all around them in order to survive. He or she thus becomes a convenient source of
credibility for a corrupt system.
The Triad is mutually convenient to all. The businessman is
able to influence policy and protect his ill-gotten profits. The other two need
the businessman to invest their funds and launder them. Most politicians have
at least one businessman close to them who provides such services. The media is
increasingly a party to some of these illegalities. There
is manipulation of the laws and cases are stuck in the Courts, where there is a
backlog of about 27 million cases. Many cases have dragged on for 10 to 30
years. MCD stated in Delhi High Court in 2002 that not a single honest engineer
is left in the Public Works Department. Commissioners of Income Tax polled in
1983 said that 95% of their department was corrupt. Police in Delhi and Mumbai
are found to extort money every week from the various illegalities they
encourage, and the money goes straight to the top.
The Transparency International India 2005 Report estimates
the monetary value of petty corruption in 11 basic services provided by the
government (e.g. education, healthcare, judiciary, police) to be around Rs.21,000
crore (US$ 4.8 billion). As surveys are notoriously inaccurate in India
these statistics were most likely underestimated. The value could be higher by
about 50% by now.
Impact on Inequality and Growth Rates
The black economy is concentrated
in the hands of, at most, 3% of the population (Kumar, 1999). Yes, there is
petty corruption - but this is insignificant compared to the huge earnings of
these elite few. In 1995, the ratio of incomes between the top 3% and the
bottom 40% was 12:1 in the white economy, but became 57:1 when including the
black economy. Nowadays, the disparities are much worse. In a vast and poor
population of 1.15 billion, there are 35 million, the size of a European
nation, who are well-off and can afford luxuries.
The black economy tends to generate
activities that result in social waste. Roads are constructed poorly so that
they break down and have to be repaired, and more money earned by the corrupt,
doctors prescribe tests that are not needed and so on. Inefficiencies like
these set back development. India has been losing an estimated 5% rate of
growth for the last three decades. Its rate of growth could thus have been 9%
in the seventies and 13% now, if not for the black economy. The per capita
income could have been about $6,000 and it would have been the second largest
economy in the world. Growth
rates and employment generation in the economy are below its potential. Funds
destined for poverty alleviation schemes, education and health are diverted,
leading to policy failure.
Policy Response and Failure
Over the last 60 years, countless committees and commissions
have examined different aspects of the problem, the most well known being the
Wanchoo Committee and the NIPFP Report. Thousands of suggestions have been
made. Hundreds of them have been implemented but the size of the black economy
still continues to grow. The highest marginal tax rate has come down from 97.5%
in 1971 to 30% today. Controls and regulations have decreased substantially
since 1991 with MRTP, licensing and FERA gone and small scale reservation
reduced.
Voluntary Disclosure Schemes have been floated 6 times but
the CAG report stated that it has made people habitual tax offenders.
Computerization of tax accounts and allotment of PAN numbers have been implemented
by the Tax Department. But the black economy continues to grow, since none of
the steps taken touch the underlying cause, the Triad.
The Triad has power and is not interested in checking the
black economy. Well-intentioned measures only serve to complicate the laws
enabling the black economy to grow faster. Human ingenuity can always find ways
of circumventing laws, and the Indian elite are, basically, feudal and think it
is their right to violate laws to gain advantage.
Despite the reduction in tax
rates and removal of controls like MRTP, FERA, licensing and easing of
reservations for small scale after 1991 the size of the black economy has not
decreased. The Triad has grown stronger and forms of making black incomes have
changed accordingly.
The Right to Information act,
introduced in 2005, is merely being subverted by tying it up in knots. Yet this
can be a game changer; laws against money laundering and private sector
corruption are being strengthened or conceived. However, these will be mainly
decorative since the policy makers (politicians and executive) use the havala
channels and know who is involved. Action is needed, not new laws.
Conclusion
The black economy underlies the
major macroeconomic problems faced by India - fiscal crisis, inflation and BOP
problems. The micro and the sectoral problems of the economy - education,
health and infrastructure - also relate to the black economy. It results in the
weakening of democracy. If not checked, India’s growth story could become a
thing of the past.
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