What did the License Raj do to economic growth in India?

A decision to plan raises an immediate practical question: how do you enforce the plan? If the state decides how much steel India needs, how much food, how many factories — it needs a mechanism to ensure that private businesses actually produce those things, in those quantities, in those locations. That mechanism was the License Raj.

The logic was straightforward. If a business could produce whatever it wanted, in whatever quantity, the plan would be meaningless. So, every significant business decision required government permission — a license. Starting a factory. Expanding its capacity. Importing machinery. Entering a new industry. Hiring beyond a certain size. Even letting workers go. The license was not a formality. It specified exactly what you could make, how much, and where. Deviate from it and you were operating illegally.

To understand what this meant in practice, imagine we want to start a food brand in 1975. We have a recipe, a small factory in mind, and customers we know will buy. We submit our application for an industrial license. We wait months, sometimes years. We are told our proposed capacity exceeds what the government has decided the market needs. We appeal. We wait again. We hire someone who knows someone in the ministry. Eventually, perhaps, we get our license, for half the capacity we asked for, with conditions attached. And that is before we apply separately for an import license to bring in the equipment, navigate the labour laws that make hiring and firing nearly impossible, and deal with the inspector who arrives periodically to ensure we are not producing one unit more than our license permits.

If you are thinking that sounds like a lot of hassle, then you are right. And this kind of hassle produced two consequences that compounded into each other.

The first was the death of entrepreneurship. The system did not reward the best idea or the most efficient producer. It rewarded whoever could navigate the bureaucracy. Those who could not, the ones that lacked the connections, the time, or the willingness to pay — simply did not start. A generation of Indian entrepreneurial energy either gave up or left the country.

The second was the capture of the system by incumbents. A license, once granted, was a moat. Existing producers could lobby officials to deny licenses to competitors who might undercut them. The License Raj turned large industrial houses into political operators. Their advantage was not better products or lower prices — it was access. Planning, designed to direct capital toward national priorities, ended up protecting incumbents from competition.

The consumer-facing cost was most visible in telephones. In 1991, India had roughly 5 million telephone connections for a population of 850 million. Getting a line meant joining a waiting list that stretched, in many cities, to five years. The state monopoly had not built enough capacity, and no private provider was permitted to fill the gap. The telephone — a basic tool of commerce and communication — had been rationed by the plan.

Across the economy, the result was what economists called the Hindu rate of growth — India’s sluggish pace of around 3.5% a year through the decades the License Raj operated. South Korea, industrializing at the same time, grew at more than twice that pace. The gap compounded for four decades. By 1991 the average South Korean earned several times more than the average Indian - something that in 1950, would have seemed impossible.

It’s important to note that licenses themselves were not designed to achieve rent seeking. They were the tools through which central planning was made operational. To understand how and why licenses would lead to rent seeking I would recommend you read the FAQs on public choice theory.