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Why India's new bankruptcy law is good for businesses

Do Not UseDo Not Use 12/05/2016 By Justin Rowlatt
India factory: The new law will ensure that now businesses will be able to be shut down and their creditors paid off much more quickly and easily © Getty Images The new law will ensure that now businesses will be able to be shut down and their creditors paid off much more quickly and easily

India's parliament on Wednesday passed the country's first national bankruptcy law. The finance ministry is calling it "the biggest economic reform" of Prime MInister Narendra Modi's government to date, the Financial Times agrees.

In this photograph taken on May 28, 2015, an Indian labourer uses a welding torch at a roadside metal shop in Mumbai. India's factory output rose to a four-month high in May on increased demand, a survey showed June 1, 2015, in a further boost for the economy after data showed it was outgrowing China.: The new law will ensure that now businesses will be able to be shut down and their creditors paid off much more quickly and easily © Getty Images The new law will ensure that now businesses will be able to be shut down and their creditors paid off much more quickly and easily

But I bet you are yawning and - if you've given it any thought at all - asking yourself why you should care.

Here's why: it may well help you get your next job.

Why? Well, we are used to hearing the success stories of business. But for every business that succeeds, many more fail.

Eight out of 10 entrepreneurs who start businesses fail within the first 18 months, according the financial data company Bloomberg. That's a staggering 80% failure rate.

What does that tell us?

First off that you should think very hard before you start a new business, but second - and more importantly - failure is central to the way capitalism works.

Economist Joseph Schumpeter called it "creative destruction" by which he meant the "process of industrial mutation that incessantly revolutionises the economic structure from within, incessantly destroying the old one, incessantly creating the new one".

That makes it sound very brutal, and that is because it is.

Just as in Charles Darwin's theory of evolution, it is only by being tested in the market that the winning companies are sifted out from the losers.

And winning companies make for successful economies.

Better debt recovery

Think of bankruptcy like plumbing, says the business consultant William Gamble. "It allows the market to flush away the inefficient businesses and reallocate capital to efficient businesses".

What India's new law aims to do is make the plumbing of the Indian economy much more efficient - something that could also usefully done for much of the nation's real plumbing.

Now businesses will be able to be shut down and their creditors paid off much more quickly and easily.

"Its (the law's) adoption is seen as a major breakthrough that will allow banks to recover their dues in a timely manner, says the Financial Times, "in contrast to the current system in which they often wage protracted legal battles in an attempt to recover what they are owned".

Just think for a moment what that means.

It means India's banks are much more likely to get their cash back which, in turn, means they will have more to lend out to promising entrepreneurs - but perhaps even more significantly, they're going be more likely to want to lend it out in the first place.

You only need to look at the statistics for debt recovery to see why lenders might be reluctant to dip into their pockets to fund new businesses at the moment.

Just 25% of Indian creditors get their money back when the average business goes bust, according to figures from the World Bank. Compare that with the average recovery rate of 77% for high-income nations (think Europe and the US).

If the new law addresses that yawning gap it will really help boost investment in new businesses.

I hope you've stopped yawning now.

Bankruptcy law is important because it ensures the efficient allocation of resources within an economy, and if India's is implemented well it should improve innovation and productivity.

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