Modi Turns to the Supply Side; The Indian leader’s plan to boost growth and contain inflation

Modi Turns to the Supply Side

The Indian leader’s plan to boost growth and contain inflation.

Updated June 10, 2014 6:25 p.m. ET

Indian President Pranab Mukherjee presented the new government’s policy address Monday on behalf of incoming Prime Minister Narendra Modi, as prescribed by the British tradition for opening parliament. While the occasion favors pomp over substance, the speech confirmed that India may be at a historic turning point: Mr. Modi is suggesting that he wants to lead nothing less than a supply-side revolution.

The Indian economy is stuck in stagflation, with growth running below 5% and inflation around 10%. That reflects disincentives to invest, barriers to hiring and regulatory bottlenecks. Rising prices are the result of too much money chasing too few goods, so removing obstacles to producing more goods is the best solution.

One of the chief obstacles to is India’s unpredictable and capricious tax system. The last government tried to confiscate profits by making new tax regulations retroactive, which tanked domestic and foreign investment. Monday’s speech promised “rationalization and simplification of the tax regime to make it non-adversarial and conducive to investment, enterprise and growth.”

Deregulation is another key plank of supply-side reform. Mr. Modi has already unveiled plans to streamline the bureaucracy and merge ministries that compete to protect their power over industry. Under his administration, the Environment Ministry will presumably speed up clearances for new factories.

That still leaves the Land Acquisition Act that makes siting factories difficult, and the Industrial Disputes Act that makes it almost impossible for companies with more than 100 employees to lay off workers.

In the countryside too, government policies hurt productivity. Subsidies and make-work schemes discourage farmers from concentrating on maximizing yields. Under the Agriculture Produce Marketing Committee Act, they are required to sell produce to monopolistic middlemen. As a result, much of India’s harvest rots before it gets to consumers, further driving up food prices. Monday’s speech promised that “existing cooperative sector laws will be reviewed to remove anomalies and lacunae.”

So far India has failed to compete with China or even Bangladesh in low-skilled manufacturing industries such as textiles and electronics assembly. These are the first rungs on the ladder of global trade, and the only way India can create enough jobs for the roughly 12 million young people who enter the labor force every year.

International companies that source sweaters and disc drives have certain minimum requirements that India doesn’t meet, such as a stable power supply and the roads and ports to move products. Reliable electricity grids and efficient ports can only be created with private investment, and the government needs to streamline clearances. But such projects also require the soft infrastructure of well-designed and enforced laws, so contractors and customers honor their contracts.

Embracing foreign investment and free trade is the natural extension of a supply-side philosophy, since foreign competition will spur Indian companies to become more productive. While Mr. Modi hasn’t articulated a trade-liberalization agenda, becoming part of global supply chains will create incentives to reduce import barriers.

Also crucial is reducing corruption that deters investment and saps economic vitality. As well as reducing bureaucrats’ discretion, Mr. Modi is proposing more transparent and competitive methods for awarding government contracts.

All of these measures will help companies concentrate on increasing production instead of overcoming government obstacles. Mr. Modi may not call his reforms a supply-side revolution, but they reprise a proven formula to rejuvenate economies stuck in stagflation.