Industrial Development and the Licence Raj

Licence Raj in India: Origin and Legal Basis

Licences, Quotas and Permits: The Three Controls of the Licence Raj

Industrial licensing is the requirement that a business obtain the government's permission before it sets up, enlarges or changes a factory. The licence raj added quotas on output, permits for raw materials and imports, limits on big business houses and tight control of foreign exchange.

The words licence, quota and permit each describe a different control. A licence was permission to set up or expand a unit. A quota was the fixed upper limit of production that the licence allowed. A permit was the permission needed to obtain raw materials and other supplies. Together they gave the system its other names, the Permit Raj and the Quota-Permit-Licence Raj.

The label was intended as a criticism. It echoes the term British Raj, and Rajagopalachari believed that the system carried the potential for corruption and economic stagnation. Official inquiries later found that it favoured established business houses.

The state was also a producer in its own right. In this mixed economy the government owned and ran heavy industry while the private sector worked under licences. The two must be studied together. The public sector explains how the state held the commanding heights, and the licences explain how it controlled the rest.

Industries (Development and Regulation) Act 1951 and the 1956 Resolution

The legal basis was the Industries (Development and Regulation) Act of 1951, which imposed licensing on the industries it listed. The Act stands at entry 88 of the Ninth Schedule of the Constitution, and Article 31B provides that Acts in that Schedule are not to be treated as void for taking away the rights in Part III. The Act gave legal force to the mixed economy that India chose after independence.

The Industrial Policy Resolution of 30 October 1956 then fixed the division of labour between state and private firms. It classified industries into three schedules. Schedule A listed 17 industries reserved for the Centre. Schedule B listed 12 industries in which the state would take the initiative and private firms could supplement its efforts. Schedule C covered every other industry, open to private enterprise but subject to licensing and regulation under the 1951 Act. Schedule A included defence production, metallurgy, mining and transport.

The Resolution made compulsory licensing the settled pattern. All Schedule B industries and a number of Schedule C industries came under it. It also committed the state to set up new public enterprises in backward regions and gave emphasis to small industries.

Why India Chose Controls: Planning, Heavy Industry and Self-Reliance

At independence Indian industrialists did not have the capital for the ventures that the economy needed, and the market was not large enough to encourage major projects even for those who had the money. For these reasons governments had to play an extensive role in promoting industry.

The Second Five Year Plan, based on the ideas of P. C. Mahalanobis, gave the strategy its shape. It prioritised state-led heavy industry, and its investment programme depended on imported capital goods and technology. India's plans pursued four goals, namely growth, modernisation, self-reliance and equity. Self-reliance meant avoiding imports of goods that could be produced at home, because people who had recently won freedom feared that dependence on foreign food, technology and capital could make the country's sovereignty vulnerable.

The plan's ambitions outran its resources, and foreign exchange reserves were depleted. A balance of payments crisis in 1956 and 1957 made the government more concerned with allocating foreign exchange carefully across sectors.

Industrial leaders were not simply opponents of the system. The Bombay Plan of 1944, drafted by J. R. D. Tata, G. D. Birla and other industrialists, called for state investment in heavy industry and for controls on imports.

Industrial Licensing System: How Permission Worked

What Needed a Licence: Starting, Expanding and Siting a Unit

Licensing aimed to keep production from exceeding what the economy required, so a licence to expand was given only if officials were convinced that a larger quantity of goods was needed.

Licences governed more than the start of a unit. They set its location, product mix and maximum capacity, and up to 80 government agencies had to grant approval before a private company could produce a good.

The location of industry was also regulated. It was easier to obtain a licence for a unit in an economically backward area, and such units were given tax benefits and electricity at a lower tariff. The purpose was regional equality.

Quotas and permits operated alongside the licence, and import licences added a further requirement. The economist Anne Krueger estimated the rents from import licences at about 7 per cent of India's national income in 1964, which shows how much a licence was worth to its holder.

Licensing Distortions: Queues, Pre-emption and Concentration

In practice the system did not work as intended. Industrialists spent more time seeking licences and lobbying ministries than thinking about how to improve their products, and the long wait for approval became a cost of doing business.

A large industrialist could obtain a licence not to start a new firm but to prevent competitors from starting one. Official inquiries made the same point. The R. K. Hazari report of 1967 and the S. Dutt Committee of 1969 found that large groups had obtained a disproportionate share of licences, sometimes applying for capacity only to keep rivals out. Older and well-established industrial houses could also hamper newer ones through trade practices that forced them to agree to sell-outs and takeovers.

Price controls were meant to give the public cheaper goods. The central subsidies that kept those prices low were paid to the licensed private companies, so the controls served the firms as much as the poor.

Public Sector Undertakings and the Steel Plants

Public Sector Undertakings: Roles in the Plan Era

The public sector was the other arm of the system. Because private industrialists lacked capital and the market was small, the state took responsibility for heavy and basic industries. Public sector undertakings were regarded as the principal instrument for raising savings and growth, and the classification of industries in 1956 had an in-built bias in favour of government-owned companies.

Nehru called such enterprises the temples of modern India. The Rourkela steel project, announced in 1953, was presented as one of them, meant to speed up industrialisation, end economic stagnation and create employment. The Centre's public sector kept growing until 1991, partly through units taken over in the nationalisation drives between 1960 and 1980.

State enterprises were also tools of regional policy. Rourkela was chosen in part because the Odisha government wanted investment in the Sundargarh district, then considered one of the most backward regions, with a mostly tribal population.

Nationalisation widened the state's reach. In 1969 the major private commercial banks were nationalised, in the same year as the MRTP Act.

Bhilai, Rourkela, Durgapur and Bokaro: The Public Steel Plants

Steel was the leading public sector industry. The Second Plan era raised integrated steel plants at Bhilai, Durgapur and Rourkela with the help of the Soviet Union, the United Kingdom and West Germany respectively. Private steel was older, since two well-managed iron and steel firms already existed before the plan era, one at Jamshedpur and the other at Burnpur, near Asansol in Bengal, but the large new capacity of the plan period was public.

The institutional arrangements developed in stages. Hindustan Steel Limited was set up on 19 January 1954, initially to manage only the Rourkela plant, and from April 1957 it supervised Bhilai and Durgapur as well. A separate company, Bokaro Steel Limited, was incorporated on 29 January 1964 to build the fourth plant. The Steel Authority of India Limited, SAIL, was established on 24 January 1973 as a holding company for the public steel plants. In 1978 SAIL was restructured to function as an operating company.

Losses, Monopolies and Ratna Status: Judging the Public Sector

The case against the public sector grew with time. State enterprises continued to supply goods and services, often as monopolies, long after it was clear that private firms could provide them too. Telecommunication is the standard example: Even in the late 1990s consumers had to wait a long time for a telephone connection.

Modern Bread, a bread-making firm, is a commonly cited example of the state undertaking work that the private sector could do, and it was later sold to the private sector. After four decades of planned development no distinction had been made between what only the public sector can do and what the private sector can also do. The government also ran hotels, an activity the private sector manages well.

Many public firms incurred huge losses but continued to operate, because a government undertaking is hard to close. Some had been private firms on the verge of closure that were nationalised to protect workers' jobs. Defenders argue that public firms should be judged by their contribution to welfare, not only by their profits.

Later reforms graded enterprises by the autonomy they were given. Profitable enterprises were declared Maharatna, Navratna or Miniratna, which gave them greater financial, managerial and operational autonomy. SAIL is among the Maharatna enterprises.

MRTP Act 1969 and FERA 1973: The Second Wave of Controls

MRTP Act 1969: Curbing Concentration of Economic Power

The Monopolies and Restrictive Trade Practices Act, 1969, was a response to the outcomes of the licensing system itself. The Act followed the inquiries of 1967 and 1969 and received the President's assent on 27 December 1969. Its purpose was to check the concentration of economic power and monopolistic practices. The Monopolies and Restrictive Trade Practices Commission was constituted in 1970 to deal with prohibited and restricted trade practices.

The Act's main instrument was a test of size. Firms with assets of ₹20 crore or more had to obtain the government's permission before any expansion, new venture or takeover of another firm, and they came to be known as MRTP companies. The limit was raised to ₹100 crore in 1985, because it was hindering these companies, which could neither add capacity nor invest in technological upgrading.

The 1991 industrial policy removed the asset limits. The Competition Act, 2002, replaced the MRTP Act, and the Competition Commission of India was established under it. The older Act was repealed with effect from 1 September 2009.

FERA 1973: Foreign Exchange Regulation and Foreign Firms

The Foreign Exchange Regulation Act of 1973, known as FERA, was the principal control over external transactions. Foreign exchange was a scarce commodity, and FERA proceeded on the presumption that all foreign exchange earned by Indian residents rightfully belonged to the government and had to be surrendered to the Reserve Bank of India. It prohibited all transactions that the Reserve Bank did not permit, and it came into force on 1 January 1974.

The Act bore heavily on foreign companies. It required most foreign-owned firms to reduce their shareholding to 40 per cent, and IBM and Coca-Cola left India between 1977 and 1978 rather than comply. Experts called the Act draconian because it hampered the growth and modernisation of Indian industry, and the episode weighed against India when it later invited foreign direct investment.

FERA gave way to the Foreign Exchange Management Act, 1999, known as FEMA. The new Act was passed on 29 December 1999 and took effect on 1 June 2000. It turned foreign exchange offences into civil offences, and exchange was to be managed instead of regulated. Under FERA everything was prohibited unless specifically permitted. Under FEMA, current account transactions are permitted unless expressly prohibited, and capital account transactions are prohibited unless expressly permitted.

Industrial Policy Statements from 1969 to 1986: Tightening and Easing

Policy did not move in one direction after 1969. The statements of 1969 and 1973 tightened the system, while those of 1980 and 1985 to 1986 began to relax it.

The relaxations of the 1980s were partial. In 1985 the Rajiv Gandhi government delicensed a number of industries and allowed broad banding, which let firms switch between related products without new licences. These steps loosened the system but did not end it. The decisive break came only in 1991.

Small-Scale Industry Policy and Reservation

Karve Committee and the Case for Small Industry

Small industry was the third pillar of the system. The Village and Small-Scale Industries Committee of 1955, called the Karve Committee after its chairman D. G. Karve, noted the possibility of using small-scale industries for rural development. The Planning Commission appointed it after the formulation of the First Five Year Plan. It recommended that any development programme for small industry should be decentralised, should aim at gradual improvement in techniques without reducing job opportunities, should assure marketing through cooperatives and should offer positive promotional support.

A small-scale industry was defined by the maximum investment allowed on a unit's assets, a limit that was revised several times. In 1950 a small-scale unit was one that invested a maximum of ₹5 lakh. Small units were believed to use more labour for the same output than large ones and so to generate more employment.

The 1956 Resolution also stressed small industries and khadi and village industries. The 1977 Industrial Policy Statement added District Industries Centres to promote small and cottage industries on a mass scale.

Product Reservation: From 47 Items in 1967 to the Abid Hussain Committee

Small units could not compete with large factories, so the state protected them. Production of many products was reserved for the small-scale sector, with concessions such as lower excise duty and bank loans at lower interest. Reservation became effective in April 1967 with 47 items. The reserved list grew to its highest point of 873 items in the 1980s and then started declining, and at the end of 1996 it stood at 836 items.

Large firms were barred from expanding capacity in reserved products, and equity participation by large domestic companies and foreign investors in reserved lines was limited to 24 per cent.

The Expert Committee on Small Enterprises, chaired by Abid Hussain, submitted its report on 27 January 1997. It concluded that the reservation policy was serving no purpose in promoting the small-scale sector and recommended that reservation be abolished completely, not in phases, with transitional support for the affected units. The committee argued that reservation prevented successful units from growing and so acted as a dampener on entrepreneurship. It also pointed to product lines in which reservation had damaged export prospects, naming diesel engines, garment finishing, consumer electronics and leather products.

Many goods made by small-scale industries have since been dereserved, and the policy was largely dismantled in the 2000s.

Import Substitution and the Inward-Looking Trade Strategy

Import Substitution: Tariffs, Quotas and the Infant Industry Argument

Trade policy extended the licence raj to the external sector. In the first seven plans India followed an inward-looking strategy known as import substitution, which aimed at replacing imports with domestic production. Instead of importing vehicles made abroad, industries would be encouraged to produce them in India.

Protection took two forms. A tariff is a tax on imported goods; it makes them more expensive and discourages their use. A quota fixes the quantity of a good that can be imported. Both restrict imports and shield domestic firms from foreign competition.

The reasoning was the infant industry argument. Industries of developing countries could not compete with those of more developed economies, but if protected they would learn to compete in time. Planners also feared that foreign exchange would be spent on imports of luxury goods if imports were not restricted.

Protection allowed indigenous industries such as electronics and automobiles to grow, which they could not have done against imports. In that sense import substitution built real industrial capacity, but it came at a cost.

Costs of Protection: Captive Markets and Missing Exports

Protection from imports meant that Indian consumers had to buy whatever Indian producers made. The producers knew they had a captive market, so they had no incentive to improve quality. Competition from imports forces producers to be more efficient, and the control economy removed that pressure.

Serious thought was not given to promoting exports until the mid-1980s. India's share of world trade fell from 2 per cent in the 1950s to less than 0.5 per cent in the 1980s.

A comparison explains why this mattered. The Four Asian Tigers, Hong Kong, Singapore, South Korea and Taiwan, have been characterised as using government intervention to facilitate export-oriented industrialisation. India's intervention protected its home market instead. Some economists still defend protection and argue that producers should be shielded for as long as rich nations shield theirs.

Balance Sheet of the Control Economy

Achievements: Diversification and a Larger Industrial Share

The control economy achieved substantial results. The share of industry in GDP rose from 13 per cent in 1950‑51 to 24.6 per cent in 1990‑91, and industry grew at about 6 per cent a year over the period. Indian industry, once restricted largely to cotton textiles and jute, became well diversified by 1990, largely because of the public sector.

Small-scale promotion gave people without the capital for large firms a way into business. Protection helped indigenous electronics and automobile industries to develop. The share of services also rose, to 40.5 per cent of GDP in 1990‑91.

The failures stood beside these gains. About 65 per cent of the population was still employed in agriculture in 1990, down only from 67.5 per cent in 1950. Many economists regard the failure of industry and services to absorb farm workers as an important failure of the policies followed from 1950 to 1990.

Hindu Rate of Growth: Meaning, Origin and the Debate

The Hindu rate of growth describes India's annual growth of about 3.5 per cent from the 1950s to the late 1970s. The phrase is credited to the economist Raj Krishna, and accounts place his first use anywhere from the mid-1970s to 1982. He used it as a polemical device to draw attention to a growth rate that stayed steady through changes in governments, wars, famines and other crises.

The verdict on the growth record is also contested. Jagdish Bhagwati and Padma Desai argued in 1970 that industrial policies and import controls produced inefficiencies and slowed growth. Pulapre Balakrishnan points out that GDP growth rose from under 0.9 per cent a year under colonial rule to 4.1 per cent in 1950 to 1964.

Growth moved above the 3.5 per cent mark in the 1980s, when the economy grew at over 5 per cent a year. Economists still debate how much of the later acceleration should be credited to dismantling the licence raj and how much to changes that began in the 1980s.

Why Indian Manufacturing Stayed Capital-Intensive

Causes: Strategy, Licensing, Reservation, Protection and Labour Rules

A labour-rich country would be expected to export labour-intensive goods, yet Indian manufacturing leaned towards capital-intensive output. The causes lie in the structure of the control economy.

• Strategy: The Second Plan prioritised state-led heavy industry, so capital goods, not light, labour-intensive manufacturing, stood at the core of growth.
• Licensing and size limits: Licences controlled capacity, location and product mix, and from 1969 firms above the MRTP asset limit needed approval to expand, which held back the fast-growing firms that export markets reward.
• Reservation: Reserving products for small units capped scale and technology. The Abid Hussain Committee found that reservation damaged exports in lines such as garment finishing and leather products.
• Protection: Import substitution gave producers a captive market, and serious thought was not given to exports until the mid-1980s.
• Labour regulation: Labour laws drove proprietors to keep work out of their own factories and contract it to numerous household enterprises equipped with primitive techniques, a barrier to technological development and to the growth of large labour-intensive firms.

The structure also failed to absorb the workers who stayed in agriculture, so industry never became the large employer that a labour-rich economy needed.

Measures for Labour-Intensive Manufacturing and Exports

Each cause has a matching measure. Replacing case-by-case permission with general rules removes the barriers of licensing and size limits. Licensing has been abolished for almost all industries since 1991, the MRTP asset limits were removed, and many goods once reserved for small units have been dereserved.

Openness to trade removes the protection that dulled export effort. The trade reforms aimed at dismantling quantitative restrictions on imports and exports, reducing tariff rates and removing licensing procedures for imports, and import licensing was abolished except for hazardous and environmentally sensitive industries.

Labour regulation has been consolidated: The 29 central laws have been merged into four Labour Codes that aim to simplify compliance and enhance labour market flexibility while keeping safeguards for wages, occupational safety and social security.

Skills and competitiveness are the final element. Government-led skilling initiatives aim at employability through industry-aligned training, and firms must be able to produce competitively before trade agreements can help them. Labour-intensive exports need scale, openness and competitiveness in place of permission and protection.

From Delicensing to Disinvestment: Unwinding the Licence Raj

Delicensing and the July 1991 Industrial Policy

The dismantling began in the 1980s and was largely accomplished in July 1991. By then India faced a balance of payments crisis with foreign exchange reserves sufficient for only a few weeks of imports, and it turned to the IMF and the World Bank. The new Statement on Industrial Policy abolished licensing for all but 18 industries, removed the asset limits of the MRTP Act and allowed automatic approval of foreign investment up to 51 per cent in high-priority industries.

The industries reserved for the public sector were also cut sharply. Today the only industries reserved for the public sector are a part of atomic energy generation and some core activities in railway transport. Industrial licensing survives only for a short list of categories, such as alcohol, tobacco products, industrial explosives and hazardous chemicals.

Reservation for the small-scale sector also began to give way, and in most industries the market was allowed to determine prices, as part of the wider 1991 economic reforms.

Disinvestment in India: From the 1991 Policy to a Department

Disinvestment means selling government equity in public sector enterprises. After 1991 the government began selling part of its equity in public enterprises, with the stated purpose of improving financial discipline and facilitating modernisation. The sales were also meant to bring private capital and managerial skill to the enterprises.

The administrative structure changed several times. In 1996 the government set up a Disinvestment Commission. On 10 December 1999 the commission was dissolved and a separate Department of Disinvestment was formed under the Ministry of Finance. In 2001 the department was upgraded to a full ministry. In 2004 the new government abolished the ministry and merged it into the finance ministry as an independent department.

Policy on control changed with governments. The National Democratic Alliance government of 1999 to 2004 classified public enterprises as strategic and non-strategic and used the word privatisation in place of disinvestment. The government that took office in 2004 discontinued the strategic sale policy, and minority stakes were auctioned in some public enterprises. Under the policy announced in November 2009, the government would retain at least 51 per cent of the equity and the management control in all cases of disinvestment.

National Investment Fund and DIPAM: Using the Proceeds

The government decided in January 2005 to constitute the National Investment Fund. Disinvestment proceeds were to be channelled into it, and it was to be maintained outside the Consolidated Fund of India. Its principal sum was to stay intact, and the fund was to be professionally managed by selected public sector mutual funds through their asset management companies. Of the fund's annual income, 75 per cent was to finance selected social sector schemes promoting education, health and employment, and the remaining 25 per cent was to meet the capital investment needs of profitable and revivable public sector undertakings.

The arrangement changed later. In January 2013 the government restructured the fund and decided that disinvestment proceeds from 2013‑14 would be credited to the existing Public Account under the head of the National Investment Fund, to remain there until withdrawn or invested for an approved purpose.

The Department of Disinvestment received its present name, the Department of Investment and Public Asset Management (DIPAM), on 14 April 2016. DIPAM deals with all matters relating to management of Central Government investments in equity, including disinvestment, and its work falls in three areas, namely strategic disinvestment, minority stake sales and capital restructuring. It is a department under the Ministry of Finance.

Legacy of the Licence Raj in Today's Industrial Policy

What Was Dismantled and What Remains

The same state that built Bhilai and Rourkela also made a generation of entrepreneurs depend on permission to grow, and both legacies are real.

Most of the system has been dismantled. Licensing is limited to a short list of categories, the MRTP Act has been repealed, FERA has been replaced by FEMA, and the industries reserved for the public sector are limited to part of atomic energy and some core activities of railway transport. The recent Labour Codes continue the same reform.

Sources

• NCERT: Class 11 Indian Economic Development, Chapter 2
• NCERT: Class 11 Indian Economic Development, Chapter 3
• Legislative Department, Government of India: The Constitution of India (Article 31B and the Ninth Schedule)
• Office of the Development Commissioner (MSME): Report of the Expert Committee on Small Enterprises (Abid Hussain Committee), 1997
• Department of Investment and Public Asset Management: About DIPAM
• Department of Investment and Public Asset Management: Strategic Disinvestment
• Ministry of Finance: Economic Survey 2025‑26
• Wikipedia: License Raj
• Wikipedia: Industrial Policy Resolution of 1956
• Wikipedia: Mahalanobis model
• Wikipedia: Second Five-Year Plan (India)
• Wikipedia: Public sector undertakings in India
• Wikipedia: Steel Authority of India
• Wikipedia: Bhilai Steel Plant
• Wikipedia: Rourkela Steel Plant
• Wikipedia: Durgapur Steel Plant
• Wikipedia: Bokaro Steel Plant
• Wikipedia: Foreign Exchange Regulation Act
• Wikipedia: Competition Act, 2002
• Wikipedia: Import substitution industrialization
• Wikipedia: Hindu rate of growth
• Wikipedia: Economic liberalisation in India
• Wikipedia: Disinvestment in India
• India Code: Monopolies and Restrictive Trade Practices Act, 1969
• India Code: Monopolies and Restrictive Trade Practices (Amendment) Act, 1985
• Wikipedia: IISCO Steel Plant
• UPSC: Civil Services Examination question papers