The 1956 policy referred to the government’s first industrial policy resolution adopted on 6 April 1948 and said:
Eight years have passed since this declaration on industrial policy. These eight years have witnessed many important changes and developments in India. The Constitution of India has been enacted, guaranteeing certain Fundamental Rights and enunciating Directive Principles of State Policy. Planning has proceeded on an organised basis, and the First Five Year Plan has recently been completed. Parliament has accepted the socialist pattern of society as the objective of social and economic policy. These important developments necessitate a fresh statement of industrial policy, more particularly as the Second Five Year Plan will soon be placed before the country. This policy must be governed by the principles laid down in the Constitution, the objective of socialism, and the experience gained during these years.
The Industrial Policy Resolution of 19566 was also categorical about the need to accelerate economic growth, speed up industrialization, develop heavy industries, expand the public sector and build up a large and cooperative sector. These objectives were considered paramount because they would help provide more employment, improve living standards and raise working conditions for the masses. Along with those objectives, there were the goals of reducing disparities in income and wealth, and preventing private monopolies and concentration of economic power in the hands of a small number of individuals.
The Industrial Policy Resolution said: ‘Accordingly, the State will progressively assume a predominant and direct responsibility for setting up new industrial undertakings and for developing transport facilities. It will also undertake State trading on an increasing scale.’ But this did not mean that the private sector was completely ruled out from playing any role in industrial development. The private sector would be given the opportunity to develop and expand itself in the context of the country’s expanding economy. But what would guide its growth was the principle of cooperation and need to allow the private sector to expand along cooperative lines. The private sector would, thus, play a secondary role that would be restricted only to supporting the government’s major economic initiatives to be undertaken in the public sector.
Keeping this perspective in mind, the Nehru government’s Industrial Policy Resolution classified industries into three broad categories—industries in the exclusive domain of the state; industries majorly run by the state, with the private sector playing a supportive role; and industries where most of the initiative had to be played by the private sector.
The Resolution made a special provision for small-scale sector units, which meant that the government would support these enterprises through differential taxation or by direct subsidies. The role of cottage and village and small-scale industries was recognized in ensuring speedy development of the national economy. By doing this, the government stayed true to its objective of striving to be both a welfare state on the one hand and a socialistic economy on the other.
For the public sector, Nehru wanted to decentralize wherever possible. He was also keen to ensure that the management in public sector stayed along business lines. Public enterprises were supposed to provide revenue for the State, which would also end up providing resources for further development.
‘But such enterprises may sometimes incur losses. Public enterprises have to be judged by their total results and in their working they should have the largest possible measure of freedom,’ the Resolution said. In other words, public-sector enterprises were to be given a special allowance if they incurred losses and a judgement call on them would be taken only after examining the pros and cons of their overall performance in terms of contributing to national economic development.
The same year of 1956 saw over 200 small insurance companies and provident societies being merged to give birth to a giant insurance entity called the Life Insurance Corporation of India. Lest the government’s role in trading would get diluted, the government set up the State Trading Corporation with the mandate of exporting and importing a host of select commodities. One of its key responsibilities was to trade with the centralized selling and purchasing behemoths in the Communist countries, including the Soviet Union, the largest of them. In the import of many items, the STC was given complete monopoly, as in the case of cement. State control and state ownership of economic activities were slowly spreading their tentacles.
The First Phase of Bank Nationalization
That was not all; the government had begun taking over key institutions and entrusted their management and ownership with itself. Already in 1949, it had set up a financial institution —Industrial Finance Corporation of India—to provide long-term financing of infrastructure projects. In 1955, the government nationalized the Imperial Bank of India and rechristened it the State Bank of India (SBI). Imperial Bank of India till then was India’s largest commercial bank, but its ownership was vested with private individuals. It was set up as a joint-stock company in 1921 and operated almost like British India’s central bank till the RBI came into being in 1935 to assume those functions.
Immediately after Independence, however, India’s first finance minister, R.K. Shanmukhan Chetty, had proposed the nationalization of the Imperial Bank of India, but the idea had few takers then and was opposed by none else than the then RBI Governor C.D. Deshmukh and industry leaders as well. Deshmukh had observed that if business and commerce were allowed to remain in the private sector, commercial banks, too, should be free to operate as private entities. However, within a few years, the mood changed. In November 1950, the Indian Parliament debated if the Imperial Bank of India needed to be nationalized so that more credit could be channelled to agriculture and cottage industries. But Deshmukh, who had by then become the finance minister, put his foot down.
The report of the Rural Banking Enquiry Committee, released during the same year, had added a new dimension to the debate over the ownership of the Imperial Bank of India. Its recommendation did not favour nationalization, but instead a reconstitution of its top management, an idea strongly resisted by those who were running the bank. A stalemate arose as the RBI and the Imperial Bank had failed to find a way out to resolve the tricky ownership question. Eventually, the report of the Rural Credit Survey Committee, finalized in the early months of 1953, recommended that the Imperial Bank of India needed to be brought under public ownership, a view that by now had the support of the then RBI governor Benegal Rama Rau. The Committee had recommended that bringing the Imperial Bank of India under public ownership should help the government entrust it with the responsibility for spreading banking facilities to the remoter regions of the country. To this end, the Committee recommended the formation of a new bank, to be called the State Bank of India, by amalgamating the Imperial Bank of India with the ten major banks associated with the former princely states. (The ten major state-associated banks were the State Bank of Saurashtra, Bank of Patiala, Bank of Bikaner, Bank of Jaipur, Bank of Rajasthan, Bank of Indore, Bank of Baroda, Bank of Mysore, Hyderabad State Bank and Travancore Bank.) The SBI was to be the principal instrument for extending modern banking to the rural areas, and of linking it with the needs of cooperative credit and marketing institutions.7
Rama Rau did not agree to the views of the Rural Credit Survey Committee on amalgamating the ten major banks with the bank that would be set up after nationalizing the Imperial Bank of India. He believed that it was not practical to integrate all these banks at the same time. In a seventeen-page note he sent to the finance minister, he said that the Imperial Bank should be first taken up for reconstitution, and later, similar arrangements could be worked out for other banks. The recommendations of the Committee were hotly debated by the management of the Imperial Bank, parliamentarians and the RBI management. With the RBI governor supporting the move to nationalize the Imperial Bank, Nehru decided to initiate the necessary changes in the legal framework. Deshmukh, who had earlier opposed nationalization of the banking industry, acceded to the idea of nationalizing the Imperial
Bank of India.
On 20 December 1954, Deshmukh released the report of the Rural Credit Survey Committee in Parliament and announced the government’s decision to accept its recommendation on bringing the Imperial Bank under public ownership as ‘the first step towards establishing an integrated commercial banking institution catering to the entire country. He also affirmed the government’s intention not to disturb other parts of the banking system which would continue to remain in private hands.’8 The government also imposed a condition that the state would at no time hold less than 55 per cent of the shares in the new bank. A legislative bill was moved in Parliament on 22 April 1955 to complete the process of nationalization and the bill was passed just after eight days on 30 April. When the SBI was born, the RBI held as much as 92 per cent of its shares; the remaining shares were held by private entities.
When the idea of nationalizing the Imperial Bank of India was mooted by Deshmukh, he had said that it was a decision based on economic, rather than doctrinaire, considerations. While moving the bill in Parliament, Minister of State for Revenue and Defence Expenditure A.C. Guha said the purpose of the new law was not just to take over the Imperial Bank, but to ‘recreate our rural life, to vitalize and strengthen our peasantry, and to rejuvenate . . . rural areas’. Industry leaders like Lala Shri Ram were upset and issued statements opposing the idea of the nationalization. But Nehru remained unmoved in his decision. Fourteen years later, his daughter, Indira Gandhi, would take a far bolder and bigger step by nationalizing fourteen leading private commercial banks operating at that time in the country.
The nationalization of the life insurance industry in 1956, referred to earlier, was also one of the outcomes of the Nehru government’s thinking on economic policy at that time. The Life Insurance Corporation of India absorbed as many as 154 Indian and sixteen foreign life insurers. In addition, it also absorbed seventy-five provident societies under its fold. The general insurance business, which provided insurance cover to various products and services, was allowed to remain in the private sector, although it was not clear why such an exclusion was made. Explaining the government’s logic behind nationalizing life insurance, Nehru told Parliament: ‘The nationalization of life insurance is an important step in our march towards a socialist society. Its objective will be to serve the individual as well as the state.’
A similar explanation was offered by the then finance minister C.D. Deshmukh when he piloted the legislative bill to nationalize the life insurance business in Parliament. Already, the government had created the Life Insurance Corporation of India after merging several small private-sector life insurance companies and bringing them under the ownership of the government. But now, Deshmukh was taking that process a step further. He said:
Insurance is an essential social service, which a welfare state must make available to its people and the State must assume responsibility for rendering this service once it cannot be provided in any other manner . . . With the profit motive eliminated, and the efficiency of service made the sole criterion under nationalization, it will be possible to spread the message of insurance as far wide as possible, reaching out beyond the more advanced urban areas and into hitherto neglected, namely, rural areas.
This was not the first time that such reasons would be cited in India to justify the nationalization of an economic activity. Similar arguments would be offered to justify the nationalization of banks thirteen years later and under a different prime minister and more pressing political circumstances.
The Second Five-Year Plan: A Shift in Focus
The Second Five-Year Plan departed from the approach of the First Five-Year Plan, which ended in 1956. Nehru gave it a different push. Prasanta Chandra Mahalanobis, an economist of repute and influence working with the ISI, was the moving spirit behind this plan. The plan focused on:
rapid industrialization by setting up basic and heavy industries,
a sizeable increase in national income to improve the standard of living,
a large expansion of employment opportunities, and
reduction of inequalities in income and wealth with a more even distribution of economic power.
It was an ambitious document at the time. It aimed at increasing the country’s national income by 25 per cent in five years. The fuel for this rise in national income was to have come from a healthy dose of investments—the Second Five-Year Plan had projected an increase in the investment rate from 7 per cent of the GDP in 1956 to 11 per cent by 1961. It assumed that the rate of population growth would remain at 1.3 per cent and the capital–output ratio would be 2.3:1. The Plan relied a lot on heavy investments in the capital goods sector that yielded output over a longer period of time.
Overall investments in the Second Five-Year Plan at Rs 6,750 crore more than doubled from what it was in the First Five-Year Plan. The private sector’s share in the total investments went up marginally to 46 per cent, compared to a share of 43 per cent in the First Five-Year Plan. But the most important shift in the Second Five-Year Plan was noticeable in the allocations of public investments in the industrial sector, aimed at rapid industrialization. In sharp contrast, the First Five-Year Plan focused on improving the capacity and infrastructure in the agriculture sector.
As the roll-out of the Second Five-Year Plan began, problems over its implementation began to surface. Food output had seen a smart recovery in the last two years of the First Five-Year Plan, thanks to good rains and a bountiful harvest. However, food production saw a decline during the period of the Second Five-Year Plan, resulting in a sharp rise in food prices. Inflation got worse because of the deficit financing that the government had resorted to. The cost estimates for all the heavy industrial projects that had been planned went awry.
The Second Five-Year Plan was also dependent a lot on large-scale imports to sustain the industrialization drive, but that led to a foreign- exchange shortage, dealing a blow to a Plan that was dependent on imports. It was soon clear that the investment allocations made for setting up the projects were not adequate and the government had to consider revising the size of the Plan. The projects were split into two categories—core projects, for which resources were prioritized, and other projects, which were placed on hold pending availability of funds. Inflation rising by 30 per cent during the five years of the Second Five-Year Plan was politically a big blow to the Nehru government; inflation was much less during the First Five-Year Plan. The growth target, at 4.3 per cent, was close to the target of 4.5 per cent. By that measure, the Second Five-Year Plan was not a complete failure.
The Mahalanobis model, which was expected to move the trajectory of the Indian economy to a new plane, failed to achieve the projected goal. Instead, the Indian economy was troubled by a set of problems that would continue to bedevil it for the next few decades.
The Chinks and Disrupters
Nehru will certainly be counted as one of the main disrupters who pushed India towards statism. He left nobody in doubt that he would advocate a policy of planned economic development. Leading lights of Indian industry at that time, including G.D. Birla and J.R.D. Tata, were not in favour of an economic policy that appeared to have been influenced by the model that Soviet economist Grigory Feldman had created for the planning exercise in the Soviet Union. But more than Indian industry leaders, the person who cast a more powerful influence on Nehru was Mahalanobis, who had set up the Indian Statistical Institute (ISI) and became a key adviser to the government. The close relationship between Nehru and Mahalanobis has few parallels in the history of economic policymaking in any country. A popularly elected leader was completely in thrall to an economist and the model of economic development he was propagating. In a rare display of how beholden Nehru was to the ideas of Mahalanobis, the prime minister visited the ISI campus in Calcutta (as Kolkata was known then) to inaugurate a new discipline of studies relating to planning for national development.
On 3 November 1954, Nehru was seated on the dais of the function organized at the ISI camp
us and Mahalanobis held forth on the rationale and virtues of the model of economic development that would eventually underpin the Second Five-Year Plan that would be launched two years later. In that sense, Mahalanobis was as responsible for the disruption caused to India’s economic development pattern as Nehru. Indeed, given Mahalanobis’ central role in the formulation of the Second Five-Year Plan, he would be arguably a bigger disrupter than even Nehru.
The central message of the Mahalanobis model was to encourage investments within the country with the setting up of capital goods industries. This, as Mahalanobis said at the Calcutta campus of the ISI, would build the country’s indigenous capacity to produce more capital goods, which in the process would boost investment and growth.
The consequences of Mahalanobis and his ideas endured for several decades in the sphere of economic policymaking in independent India. Barring a short period when Lal Bahadur Shastri as prime minister made an unsuccessful attempt at making an about turn on economic policymaking, statism as espoused by Mahalanobis continued for several years even after the underwhelming outcomes of the Second Five-Year Plan.
Indeed, the drive towards statism got a leg up in the succeeding years. For instance, it took almost seven decades before the Planning Commission was wound up and the model of planned development abandoned—by the government led by Narendra Modi in 2015. The roots of industrial licensing grew so strong that it took about four decades and a major economic crisis to force a major dilution in the licensing regime, dismantling the monopoly of the state sector in many areas of economic activity and removing licensing controls in most sectors. If it took about a decade for the Mahalanobis model to grow roots in Nehru’s government, its gradual phaseout happened over more than two and a half decades after the country was hit by an unprecedented balance-of-payments crisis and fiscal indiscipline.
The Rise of Goliath Page 7
