The Constitution of Markets

Celebrating India’s 74th Republic Day, we wanted to take a brief look over the World’s largest democracy and how the drafting of the Constitution shaped the markets and economy we see today. 

The Constitution of India lays the foundation for the country’s political and economic systems and impacts the economy.

Federal Finance in India 

India is a federal country with the constitutional assignments of legislative and fiscal jurisdictions to Central, States and local governments. The latter was granted Constitutional status only in 1993 through the 73rd and 74th amendments to Indian Constitution and is yet to be properly integrated with the federation as it seriously lacks financial and administrative autonomy.

Article 280 of the Indian Constitution provides for the Finance Commission (FC) to be appointed every five years to recommend financial devolutions to States under various constitutional provisions. 

What is Constitutional Economics?

Constitutional Economics is a branch that focuses on the economic analysis of the constitutional law of a state. Constitutional economics principles are used to estimate how a country or political system will grow economically since a constitution limits what activities individuals and businesses can legally participate in. 

Traditionally, constitutional economics prefers a constitutional constraint legitimized by rule of law over economic constraint when public policy decisions are made. 

It was James Buchanan who developed the concept further and also won a Nobel for the theory. 

He was a constitutionalist who paid more attention to the rules of the game rather than individual policies that emerge from the inevitable compromises of everyday politics. 

If India did not have its Constitution adopted on 26 January 1950, what would have been the trajectory of Indian development?

Before the colonization, India had multiple kingdoms and the various rules and regulations which the kings and feudal lords in those kingdoms exercised, continued to shape administrative laws, property rights and social norms. The Constitution was a historical break from this traditionalism.

The constitution of India evolved in a very different historical context from the liberal constitutions of the West, which were written before it. The Western constitutions were framed on a conception of rule of law which ferociously guarded individual liberties and protected property rights. Framed in the backdrop of revolutions against the tyrannical rule, they were designed to put restraints on governments. Whereas the constitutions framed in the developing world, in countries like India, South Africa or Brazil became more than just a means to restrict governments. They were inspirational texts and vision documents, with a mandate to transform society and correct historical wrongs. The constitutional vision held by Jawaharlal Nehru, the first Prime Minister of India, viewed the objective of the Constitution as “the removal of all invidious social and customary barriers which come in the way of the full development of the individual as well as of any group”.

Coming back to Buchanan, the debate about the importance of rules and discretion in economic policy is an old one. 

Indian economic policy has been dominated by discretion rather than rules. The constituent assembly that debated the political constitution did not seem to have given too much thought to the economic rules of the game. It set up the Finance Commission that till today gives a formula on how tax revenues are to be shared by different levels of government. But the thrust of the debates seems to have been on economic outcomes rather than the rules that would bring us closer to those outcomes. 

An example to focus on is Fiscal Policy which is also run by the whims of the government of the day. Similarly, the Indian Central Bank has generally argued against either a formal inflation target or a money supply rule or an interest rate rule devised by John Taylor. Some of the most malign policies in the planning era—the introduction of ad hoc treasury bills that automatically monetized the budget deficit or the bizarre web of import controls that came up after the foreign exchange crisis of 1957—were a classic case of discretion run wild.

This is what Buchanan warned us about, does the government play by the rules? This is precisely why we need to pay attention to his wise advice on constitutional rules. 

Keeping Buchanan’s theory in mind, explore the Republic Day Special smallcases that have been part of history- and are still part of the economy.