Governance 2.0

Indian Express, 7th November 2012

The idea of economic reform in India has largely been seen as the reduction of restrictions imposed by the government on economic activity - it must go beyond this narrow scope. The next wave of reforms needs to focus on governance. The lack of transparency in the government's functioning at present is increasingly unacceptable.

In its recent approach paper, the Financial Sector Legislative Reform Commission (FSLRC) outlined recommendations to bring about an improvement in governance, with a focus on financial sector regulation. These proposals hold lessons for the ways in which the government functions in other sectors as well.

Many government tasks can be outsourced to external agencies. This is motivated by two considerations: political independence and functional autonomy. The Election Commission should not care about pleasing the ruling party, so it should be politically independent. Tax administration should not be used by the ruling party to harass rivals and obtain election funding. Thus, tax administration should be politically independent. In finance, functions such as regulation and supervision should be immune to political pressure, much like tax administration should be distanced from politics. In addition, monetary policy should not be influenced by or subject to election cycles, which makes a case for the political independence of the RBI.

The second kind of autonomy is functional. This is rooted in problems that arise from the outdated ways in which the Indian government operates. It is difficult to construct competent and professional structures within the government, given the weaknesses of human resource processes, cumbersome procurement policies, etc. If bodies external to the government are freed from the strictures that depress its productivity, superior outcomes can be attained. Bodies outside the government can aspire to the professionalism, specialised staff capability and efficiency of the private sector once they are free to deviate from government processes.

These two reasons make a compelling case for political independence and functional autonomy in many situations. But we have to be mindful about accountability. When power is given to unelected officials working in agencies external to the government, what is the mechanism by which accountability can be ensured? Why will these officials pursue the public interest? Will they not, instead, pursue their own interests? In recent decades, we have watched agencies external to the government fail to cater to the interests of the people. They tend to do things that are convenient for existing officials, reduce the work of the agency and increase discretionary power. They also avoid taking responsibility.

It is important to consider the independence of these agencies, but it is essential that questions of accountability also be included in the discussion. A government agency is only well structured when it has the right blend of independence and accountability. Enshrining independence mechanisms in the law must go along with enshrining accountability mechanisms in the law.

The FSLRC has laid out four paths to accountability. The first is clarity of purpose. Poorly specified goals give officials a free hand to pursue their pet projects. So, laws must set down specific objectives and powers.

These goals must not be internally contradictory. For example, the Insurance Regulatory and Development Authority was given the job of regulating insurance companies and of developing the market for insurance. When it supported the unhealthy sales practices of insurance companies with the sale of unit-linked insurance plans, it could claim that it was sacrificing the regulation objective in favour of the development objective. The RBI is able to argue that it failed on inflation control because it has been holding interest rates low in order to pursue other goals, such as preventing exchange rate fluctuations, obtaining low-cost financing for public debt, preventing banks from failing, etc. Each department or agency must have clarity of purpose and not suffer from inherent conflicts of interest.

The second area of concern is the rule-making process. Parliament delegates the writing of rules to regulators, an enormously powerful tool to hand unelected officials. While it is valuable to have officials with professional expertise, we should be mindful of the extent to which unelected officials can pursue their own interests. Hence, the delegation of rule-making powers must be accompanied by an elaborate array of checks and balances in the rule-making process. Regulators must be made to demonstrate that the gains to society from a proposed rule exceed the costs of complying with restrictions. Draft rules must be released to the public and specific responses must be released for every comment. There should be convenient forums for appeal, where rules are subject to judicial scrutiny.

The third area of concern is the rule of law. India's economic policy today has seen numerous failures in that respect, partly due to the socialist policies of the past. There is a need to strip regulatory agencies of arbitrary power. Laws should be known before an action is taken; laws should be applied uniformly; when a law is invoked, it should be accompanied by the rationale employed for its use; and specialised courts for appeal should be available.

The fourth element of accountability is reporting. Once an agency has been properly structured and its objectives have been clearly defined, it should be asked to report on the extent to which it has met these objectives and how it will do better in the future. For instance, a government agency set up for the specialised purpose of addressing consumer complaints in finance must document the case backlog and the extent to which its orders were upheld on appeal, survey evidence about the satisfaction of citizens who filed a complaint, and report the cost of the process as seen by individuals, the compliance cost imposed on firms, etc. Annual reports today are filled with general platitudes about the economy, and reporting must shift away from that to include specific outcomes that the agency was mandated to achieve.

This approach to improved governance emphasises transparency, consultation and rule of law. The application of this approach in the financial sector and beyond will lay the foundation for improved public administration in India.