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Why do we need sound institutions in India?

As per World Bank estimates India will be an economy with a GDP of 10 trillion dollars in the next 25 years. This is only possible if we have sound institutions.

Manoj Mathew

Creative Transformation and Economic Freedom

Capitalism refers to a system of innovation, wealth creation and social change. It’s a legal, social, economic and cultural system that economist Joseph Schumpeter called “creative destruction”, developed through the voluntary process of market exchange (Palmer, 2011), which later he referred to as creative transformation. India reluctantly moved to a free, open market economy from a closed, protected one with the economic reforms of 1991. India got exposed to free markets, but 30 years and Indians have still not learnt the creative value of economic freedom (Seetha, 2019). Economic freedom requires sound institutions.

Institutions are social and legal norms and rules

“Institutions are the rules of the game of a society, or, more formally, are the humanly devised constraints that structure human interaction. In consequence, they structure incentives in human exchange, whether political, social, or economic.” a definition by economist Douglass North. This definition helps us to understand constraints created by formal policies, informal rules and lack of enforcement mechanism, which does not allow India to benefit from the fruits of the capitalist system. (North, 1990)

The foundations of economic freedom are a personal choice, voluntary exchange, freedom to enter markets and compete, and security of the person and privately owned property (Gwartney, Lawson, Hall, & Murphy, 2021). This essay will reflect on the five key institutions in India that need to be strengthened: i) Private property Rights ii) Rule of Law iii) Free Exchange iii) Limited Government iv) Enforcement of Contracts.

i. Private Property Rights

The Forty-forth Constitution Amendment in 1978, the right to property ceased to be a fundamental right. This amendment, advanced the state to play a prominent role in deciding about the control over the use of the property, the right to take any benefit from the property, the right to transfer or sell the property and the right to exclude others from the property. The coercive state through land acquisition infringes private property. Protection of persons and their rightfully acquired property is a central element of both economic freedom and civil society. (Gwartney, Lawson, Hall, & Murphy, 2021). Property rights have shown their ability to nurture economic growth & social development, promote prosperity & innovation, and have shown across the world to be the most effective mechanism to guarantee civil rights & civil liberties. Private property rights protect individual liberty, the fundamental argument for a system of strong private property rights. So it’s important that property rights as fundamental rights be restored, to ensure that millions of peasants and tribals will be protected of life, liberty and livelihood.

ii. Rule of Law

The Rule of Law operates as a facilitator, structure, and dynamic stimulus for our economic system and society. It is a “purpose independent” system in which rules are ones that allow people to make choices within a shared framework that allows them to pursue their own goals. The idea of the Rule of Law is that there is a law above the state. It supports and constrains the government. In India, we have seen the effects of crony capitalism as narrow niches of private actors increasingly come to influence and even control governmental decision-making. India laws are outdated for the free market economy, it needs revision and repeal to the current times.

iii. Free Exchange

Indian markets are uncertain and create contradictions. Inflation in India affected poor people during the pandemic and the rich also are impacted by the high prices. The earned wages and savings disappear during inflation. India needs sound money to protect its private property rights. It becomes difficult for individuals to plan for the future and in-process impacts economic freedom. Governments should facilitate the free exchange, allow the right to gain credit, hire or work for whom you wish, or freely operate your business. (Gwartney, Lawson, Hall, & Murphy, 2021)

With high imports tariffs on wheat, sugar, and 47 tariffs prohibited for exports, 79 lines restricted is not a good sign of a free-market economy. World Trade Organisation (WTO) recently mentioned that “India continues to rely on trade policy instruments such as the tariff, export taxes, minimum import prices, import and export restrictions, and licensing…frequent changes are made to tariff rates and other trade policy instruments, which creates uncertainty for traders,” (Suneja, 2021). India’s state-controlled price transmits misleading information by an artificial, non-market price. India needs a free market system that is ruled entirely by demand and supply from buyers and sellers, with no or limited government regulations.

iv. Limited government

Political liberalism in Indian society is not directly encoded in the Indian constitution but nested in the relationship between state and society that has emerged through the governance and regulatory practices of the post-Independence Indian state (Krishnaswamy, 2019). We need to value the principle that people are responsible for their actions, so they have the liberty to make choices in their interest without the government. India needs to foster that people should also be held responsible for their bad choices and incentivised for the good choices.

v. Enforcement of Contract

India’s poor ranking in the enforcement of contracts in the Ease of Doing Business ranking speaks volumes of how our laws and judiciary fails miserably. Enforcement mechanisms are an integral part of the institutional framework of a society and can function fully. The role of the government should be restricted to enforcement of law and order and preservation of property rights, taking regulatory action against monopolies and reduction of externalities (Hayek, 1944). Institutions are effective when they are enforced, for this India need to update its contract laws. We need institutions that encourage and enforce the performance of contracts.


Capitalism considers Adam Smith’s idea of the “invisible hand” where self-interested individuals operate through a system of mutual interdependence. The institutions need to be strengthened and India needs a paradigm shift from the challenges of the caste system, which is deeply rooted in the hierarchy system, where Brahmins valued knowledge and power. Most see the pursuit of money as the low role of the Banias, the caste most closely associated with commerce (Sharma, 2019). The welfare state has created a democracy on entitlement as author Ruchir Sharma mentions “In India, everyone is a statist. The economic debate is about how the state can best help the poor, by developing roads and other infrastructure, by distributing welfare benefits, or a bit of everything”. Capitalism in India is a journey yet to unfold as institutions are clouded with socio-political and cultural constraints.


· Barnhizer, D. R., & Barnhizer, D. D. (2016). Political Economy, Capitalism and the Rule of Law. Cleveland State University.

· Gwartney, J., Lawson, R., Hall, J., & Murphy, R. (2021). Economic Freedom of the World-2021 Annual Report. Fraser Institute.

· Hayek, F. A. (1944). The Road to Serfdom. London: Routledge.

· Krishnaswamy, S. (2019). Is the Indian Constitution Liberal? In R. Meinardus, How Liberal is India (p. 61). New Delhi: Academic Foundation.

· North, D. C. (1990). Institutions, Institutional Change and Economic Performance. Cambridge University.

· Palmer, T. (2011). The Morality of Capitalism: What Your Professors Won't Tell You. Ottawa-Illinois: Jameson Books.

· Seetha. (2019). How Liberal is India. In R. Meinardus, How Liberal is India (p. 115). New Delhi: Academic Foundation.

· Sharma, R. (2019). Democracy on the Road. Penguin Random House India.

· Suneja, K. (2021, Jan 07). India’s export restrictions, import duties on farm goods, reforms come up in WTO review.

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