Industrial licensing and the permit-licence raj

Detail

1. What industrial licensing meant

• Industrial licensing means a firm needs government permission before it can start, expand, diversify or close an industrial unit.
• The legal base is the Industries (Development and Regulation) Act, 1951 (IDR Act), Act No. 65 of 1951. Under Section 11 of the Act, only the Central Government may set up a new industrial undertaking without a licence. Anyone else must get a licence issued by the Central Government [2].

• The detailed procedure was laid down in the Registration and Licensing of Industrial Undertakings Rules, 1952 [2].

• Even Schedule C firms (industries left open to the private sector under the Industrial Policy Resolution 1956) needed a licence to:

• start a new unit;
• expand output (produce more of the same good);

• diversify (produce a new variety of goods).

• The idea behind it: output should not go above what the planners thought "the economy required".

• A licence to expand came only if the government was convinced that more output was needed.
• So the state, not the market, decided how much of each good was made.

2. Licensing as a tool for regional equality

• Licensing for regional equality: licences were easier to get for units in backward areas.
• Such units also got tax benefits and cheaper electricity.

• The goal was to spread industry across regions instead of letting it crowd into a few cities.

• Freight equalisation policy (1952-1993): the government subsidised the transport of minerals such as coal and iron ore, so a factory anywhere in India paid the same price for them.

• How it worked against its own aim:
  • Before the policy, a steel plant near the mines in Jharkhand paid less for iron ore than a plant in Mumbai.
  • After the policy, both paid the same price, so the eastern plant lost its advantage.
  • Firms then chose sites near ports and markets, mostly in the west and south.
• Result: the mineral-rich eastern states (Bihar/Jharkhand, Odisha, West Bengal) lost their cost advantage and industrialised slowly.
• Simple example (illustrative numbers): suppose coal costs ₹1,000 a tonne at the mine and ₹400 a tonne to carry to a distant city. Without the policy, the mine-side factory pays ₹1,000 and the distant factory pays ₹1,400. With freight equalisation, both pay about the same price, so there is no reason left to build near the mine.

3. The wider control web

Licensing sat inside a larger system of controls.

Control	Year	What it did
Monopolies Inquiry Commission	1964-65	Found that economic power was concentrated in a few business houses
Hazari report	1967	Found that big houses were pre-empting licences (taking licences early to block others from entering)
Dutt Committee (Industrial Licensing Policy Inquiry Committee)	1969	Confirmed that the licensing system was being misused
MRTP Act (Monopolies and Restrictive Trade Practices Act)	1969	Limited the growth of large houses. Firms above set asset limits needed extra approval to expand
FERA (Foreign Exchange Regulation Act)	1973	Put strict controls on foreign exchange and on foreign firms
Price and distribution controls	1950s-80s	The government fixed prices and supply of cement, steel, sugar and other goods

• Pre-emption of licences: a big business takes a licence it does not plan to use, only so that no rival can get it.
• The first loosening came through Industrial Policy Statements:
• 1973: the joint sector, where the government and private firms own a unit together.
• 1977: District Industries Centres (DICs), which served small industry at district level, and more focus on small industry.
• 1980 and 1985: broad-banding, where one licence covered a group of related products, so a firm could shift output between them without a new licence. There was also partial delicensing.

4. What happened: the "permit licence raj"

• Licence Raj means heavy regulation of industry through strict permits to produce.
• How big firms misused it: big industrialists took licences to block competitors, not to build new units.
• Rent-seeking: firms spent time and money lobbying ministries to get permits, instead of improving their products. NCERT calls this the "permit licence raj".
• NCERT's chain of cause and effect:
• strict permits → few firms;
• few firms → little competition;
• little competition → little innovation, poor quality and high prices.

5. 1991 and after: licensing reduced to a small core

• The New Industrial Policy, 1991 abolished industrial licensing, except for a few hazardous or strategic products.

• The current list of industries needing a compulsory licence: under Notification S.O. 477(E) of 25 July 1991, only four industries need one [4]: 1. Cigars and cigarettes of tobacco and manufactured tobacco substitutes; 2. Electronic aerospace and defence equipment; 3. Industrial explosives; 4. Hazardous chemicals.

• Defence: the list of defence items that need a licence under the IDR Act and the Arms Act, 1959 has been cut down.

• DPIIT Press Note 1 (2019 Series), dated 01.01.2019, replaced Press Note 3 (2014 Series), dated 26.06.2014 [3].

• Parts and accessories used in defence do not need an industrial or arms licence unless they are named in the list [3][7].

• Online filing: applications for an Industrial Licence under the IDR Act and Arms Act can be made on an online portal run by DPIIT (Department for Promotion of Industry and Internal Trade) [7].

• Locational policy remains: the 1991 policy kept some rules on where units may be located. These rules sit alongside the licences still needed under the IDR Act [6].
• MRTP was replaced by competition law:
• Policy moved away from curbing monopolies, meaning limiting firm size, and towards promoting competition, meaning punishing unfair conduct. So the MRTP Act was repealed [6].
• The Competition Act, 2002 was passed in the Winter Session ending 20 December 2002. It was notified as Act No. 12 of 2003 [6].
• Its aims are to prevent practices that harm competition, to promote and sustain competition, to protect consumers, and to ensure freedom of trade [6].
• Key difference: the MRTP Act was built for the pre-reform economy. The Competition Act is built for the post-reform economy [6].

6. From rent-seeking to crony capitalism

• Crony capitalism is an economy where business success depends on ties with officials, through permits, contracts and subsidies, rather than on fair competition.

• The licence raj was an early form of this. Later, discretionary allocation of natural resources raised the same problem. Discretionary allocation means officials choose who gets a resource, without an open auction.

• The courts struck down discretionary allocation:

• 2G spectrum licences were cancelled in 2012;
• coal blocks were cancelled in 2014;

• both judgments pushed allocation towards auctions, where the highest bidder wins in an open and transparent process.

• Economic Survey 2019-20, Chapter 3 ("Pro-Business, Creative Destruction and Wealth Creation"):

• It says that India's goal of a $5 trillion economy depends on "pro-business" policy that uses competitive markets to create wealth. It also depends on moving away from "pro-crony" policy that favours particular private interests, especially powerful incumbents (firms already established in the market) [5].
• It argues that the churn, meaning old firms leaving and new firms entering, in a healthy pro-business system creates more wealth than a static pro-crony system [5].
• Creative destruction: new and better firms replace old and weaker ones.

• International evidence it cites: a World Bank study on Ukraine found the economy would grow 1 to 2 per cent faster if all political connections were removed [5].

• Pro-market versus pro-business policy (Rajan-Zingales):

• Pro-market policy creates a level playing field and competition for all firms.
• Pro-business policy (in this older sense) hands favours to particular incumbent firms.
• Watch the wording: the Economic Survey 2019-20 uses "pro-business" in the good, pro-competition sense and "pro-crony" for the bad sense. Rajan-Zingales use "pro-market" for good and "pro-business" for bad.

Prelims Hooks

• IDR Act, 1951 (Act No. 65 of 1951) is the law behind industrial licensing. Section 11 requires a Central Government licence for any new industrial undertaking [2].
• Compulsory licensing today covers four industries: tobacco cigars and cigarettes, electronic aerospace and defence equipment, industrial explosives, and hazardous chemicals. The basis is Notification 477(E), 25 July 1991 [4].
• Freight equalisation policy (1952-1993) hurt the mineral-rich eastern states. It did not help them.
• Match the committee to its finding: Monopolies Inquiry Commission (1964-65) → concentration of economic power; Hazari (1967) → pre-emption of licences; Dutt Committee (1969) → confirmed misuse.
• MRTP Act (1969) was replaced by the Competition Act, 2002, notified as Act No. 12 of 2003 [6]. FERA (1973) was the foreign-exchange control law.
• Broad-banding (1980s) = one licence covering related products. District Industries Centres = Industrial Policy Statement 1977. Joint sector = 1973.
• Which licensing trap is real? Before 1991, even Schedule C firms needed a licence to expand or diversify, not only to start a unit.
• Terms trap: in Rajan-Zingales, "pro-business" is the bad option. In the Economic Survey 2019-20, "pro-crony" is the bad option [5].
• Court cancellations: 2G spectrum in 2012, coal blocks in 2014. Both led to auctions.

Mains Points

• Licensing hurt the goals it was meant to serve:
• It was meant to steer scarce resources and spread industry evenly.
• Instead, it led to pre-emption of licences, rent-seeking and little innovation.
• Freight equalisation made the regional imbalance worse.

• This is a case study of government failure, useful for GS-III answers on liberalisation.

• Moving from controlling firm size to regulating firm conduct (MRTP → Competition Act, 2002, with the CCI as regulator) shows the shift from a license-permit state to a regulatory state [6]. Licensing now survives only where there is a clear safety or security reason, such as explosives, hazardous chemicals and defence [4][3].

• Cronyism outlived the licence raj:
• The discretionary allocation behind the 2G and coal cases repeated the old licence-raj problem.

• The fixes are auctions, transparent rules and a strong competition regulator. Their aim is pro-business, not pro-crony, policy [5].

• Policy link: easier defence licensing and online filing [3][7] support Make in India and Atmanirbhar Bharat in defence manufacturing. This shows how deregulation fits with strategic self-reliance.