—RSJ

In a year when countries as diverse as India, the United States, the United Kingdom, Russia, Taiwan, Pakistan and Palau go for their elections, it is tempting to go for an overarching theme for the year while looking ahead. Unfortunately, like these aforementioned elections and the many others that will see about 50 per cent of the human population exercise their democratic choice, there seems to be only a messy mix of political signals emerging from them. Illiberal forces are rising in some places, and autocrats are rubber-stamping their authority in others. Democracy is blooming afresh in a few, while the trends of deglobalisation and closed borders are resonating among others. Of course, there are the wars old and new and, maybe, a few more round the corner to complicate any attempt at a broad narrative for the world. To add to the woes of anyone trying to write a piece like this, the economic macros globally look volatile and inchoate. There is increasing talk of a soft landing of the US economy while the EU and the UK stare at another lost year. Depending on who you speak to, China has either put its economic issues behind it and is ready to charge back with its investment in future technologies like AI, EVs and hi-tech manufacturing, or it is at the “Japan moment” of the late 80s. Japan, on the other hand, is itself having a brief moment of revival, and no one knows if it will have legs or if it is yet another false dawn.

It is foolhardy to purvey macro forecasts in this environment. But then this newsletter won’t write itself. No? So, I guess the best course then is to make more specific predictions instead of taking big swings and hoping those come true while the macros swing wildly. This will also satisfy Pranay’s pet peeve about generic predictions that I mentioned in the last newsletter. So, let me get going with 10 somewhat specific predictions for next year.

* President Biden will decide sometime in early February that he cannot lead the Democratic Party to power in the 2024 elections. He will opt out of the race and give possibly the most well-backed Democrat, financially and otherwise, a really short window of four months to clinch the nomination. In a way, this will be the best option for his party. If he continued to run for the 2024 elections, it would have been apparent to many in the electorate that they are risking a President who won’t last the full term. If he had opted out earlier, the long-drawn primary process would have led to intense infighting among the many factions of the party, eventually leading to fratricide or a Trump-like populist to emerge perhaps. A narrow window will allow the Party to back an establishment figure and reduce the fraternal bloodletting. Who will emerge from this is anyone’s guess. But whoever it might be, if (and it is a big if) they have to come up against Trump, they will lose. To me, the only way Trump doesn’t become the next President is if he isn’t on the ballot. And the only way that looks possible is if he loses his legal battles. Otherwise, you will see a second Trump term which will be worse than the first one. 

* There’s way too much confidence about the Fed having piloted a ‘safe landing’ for the US economy despite the many odds that were stacked against it. I think this is fundamentally misplaced. The fiscal deficit is unsustainable, and much of the soft landing is thanks to it. The GDP growth has been supported by an almost doubling of the federal fiscal deficit. This won’t last. The higher rates that haven’t yet led to any real string of bankruptcies or asset bubble collapses will begin to make an impact. The geopolitical risks that have only been aggravated in the last 12 months and the increasing protectionism worldwide will make it difficult to sustain growth at 2023 levels. My view is that the real landing will be in 2024, and it won’t be soft.

* China will get more adventurous geopolitically as it weakens economically. Look, the property market crisis is real in China and given the influence it wields on its economy, it is difficult to see any return to the ‘normal’ 8 per cent growth anytime soon. The local government finances will worsen, and there is a real possibility of a few of them defaulting. There will be more fiscal support to prop up the numbers and more packages for sectors in stress. Foreign inflow will continue to be anaemic, though it won’t be negative, as it turned out late last year. The Chinese customers' long-awaited consumption spree isn’t coming in 2024. All in all, China will stutter while still wowing the world with its progress in tech.

* BJP will come back to power, but it will fall a bit short of 300 seats. This will surprise many, considering the continued electoral success of its machinery and all the Ram Mandir ballast it plans for itself from this month onwards. There are a couple of reasons for it, largely driven by electoral arithmetic across the states where it did very well in 2019 and where a repeat showing will be difficult. Also, the sense of complacency about winning it hands down will mean a letup in the door-to-door mobilisation model that it has perfected. All of this will mean a decline in 30-40 seats across the board. The new Modi cabinet will be a surprise with new Finance and Defence ministers and a whole host of new faces as it goes for a generational change in leadership.

* The somewhat surprising trend of record US deficit going hand-in-hand with the relatively strong showing of the dollar in the past two years will eventually come to a face-off. And my guess is 2024 is when the dollar will blink. As other emerging economies start to trade in currencies other than dollars - who wants to risk more exposure to the dollar? - and its economy doesn’t have a soft landing like I predict, US dollar will be hit. My guess is that 2024 will be the first year of a 3-4-year dollar down cycle. In the next year, I predict the dollar to fall by 10 per cent against most world currencies. This might not hold with India because we are a bit of a unique case. But a dollar slide looks inevitable to me.

* I had predicted a more aggressive anti-trust stance and significant moves against Big Tech by the FTC. It didn’t pan out. So, I will repeat the prediction. Lina Khan, the FTC Commissioner, has a nine-month window to go after them, after which it isn’t certain she will continue to be in her post. I predict a big scalp during this time, which will then be legally challenged. But expect a tough couple of quarters as she and her team do their best to leave a mark for the future.

* The Indian economy will continue its trend of surprising on the upside, though I think global headwinds will temper the overall growth. I expect a 6.5 per cent growth with the inflation at the 4.5 per cent mark through the year. The much-awaited capex cycle will not be broad-based and will show up in select sectors led by large Indian conglomerates or global platform players. I expect FII inflow to be among the lowest in many years in 2024, and much of the equity market will be buoyed by domestic fund inflow into the market. The Nifty will remain flat or be up 5 per cent because of global weakness and the relative overvaluation seen already.

* The Israel-Hamas war will end faster than people think. Maybe by April. Not because there will be some solution agreed between the parties. There’s nobody to fight any more in Giza. The Hezbollah won’t get involved, and the Houthi insurgency will be a mere storm in the teacup. On the other hand, the Ukraine war will continue with no real end in sight during the year. A Trump (or Republican government) in 2025 will likely stop funding the war, and that will pressure Ukraine to negotiate with Putin. But that’s for 2025.

* Two specific corporate predictions: One, AI will continue to impress us with its capabilities without making a dent on real business. So expect to be surprised by a best seller written by an unknown author that will later revealed to be an AI-trained algorithm. Or a music album, even. There will be many conferences and papers, but AI's wider impact will still be distant in 2025. Two, I think Novo Nordisk will be well on its way to becoming the most valued company in the world in 2024. It might become the most valued in Europe during the year itself as it will struggle to produce enough of its weight loss drugs to keep up with demand.

* I forecast one of two contentious pieces of legislation will come into play after the elections are over. We will see a real move on either the Uniform Civil Code or on one-nation one-election (ONOE) at the back end of the year. These are issues close to this government; they will get these going right after the elections.

That’s that, then. We will see how they go during the year.

India Policy Watch: The Services vs Manufacturing Debate

Insights on current policy issues in India

— Pranay Kotasthane

Breaking the Mould: Reimagining India's Economic Future, a book by economists Raghuram Rajan and Rohit Lamba, has started a much-needed discussion on India’s future growth trajectory.

The authors challenge the dominant narrative that India should imitate the manufacturing-led growth strategy followed by the East Asian countries. They instead point to India’s comparative advantage in low-end and high-end services, making a case for a policy reprioritisation to double down on these strengths. The book argues that replicating China's manufacturing success is neither possible nor desirable.

Not possible because manufacturing supply chains are shortening due to increased protectionism and higher rates of automation, making the conditions far more difficult than what China faced. Moreover, China hasn’t gone away; it remains a formidable competitor in manufacturing.

Replicating that success might not even be desirable, they contend, as the value added in a product’s manufacturing stage is dwarfed by the value captured in the upstream R&D stage and the downstream services (branding, marketing, content production, etc.) stage. And hence, they are against the kind of subsidies on offer for electronics and chip manufacturing assembly. The Micron chip assembly plant is a particular thorn in their eye because it will cost Indians $2 billion and produce a mere 5000 direct jobs with no R&D spillover.

They argue that services and Services for manufacturing are the sweet spot for India to focus on. The money splurged on manufacturing and assembly should be ploughed back into education and health, priming India’s human capital for global success.

In sharp contrast, international trade economist Devashish Mitra makes the case that low-end export-led manufacturing (such as in textile, apparel, and leather) is the only way out for India. In his book review for the Economic Times, Mitra writes:

“India is a labour-abundant economy. This abundance is in low-skilled labour, given that almost 80% of its working-age population does not have even a higher secondary education, with only an eighth of the working-age population having studied beyond high school. While India adds 8-10 million people to its labour force annually, roughly 2 million are college-educated or beyond. There is also a wide variation in the quality of degree programmes across India, most of which cannot impart marketable skills. Thus, high-skilled workers are scarce.Standard international trade theory tells us that an economy abundant in low-skilled labour, when open to international trade, will specialise in low-skilled labour-intensive production activities, which are the ones in which such a country has its inherent comparative advantage. Furthermore, India's technology-driven comparative advantage is also expected to be in low-end manufacturing activities, as those would be the ones in which India's productivity disadvantage relative to advanced economies would be the least, for example, textiles, apparel and footwear. Thus, high-skill specialisation for India, as envisioned by Rajan and Lamba, would have to defy standard international trade theory.”

Mitra also points out that the government should prioritise solving the unemployment problem, the only way around which is low-end manufacturing because IT and IT services have historically had comparatively low levels of employment growth.

Reading these two perspectives over the past few days has been rewarding. This is precisely the debate that needs the attention of our policymaking elite. At this stage, I have three initial observations.

One, the services vs manufacturing is a false binary. Both views are actually quite similar in their essence because they both advocate capitalising on India’s comparative advantages. That advantage lies in high-end services such as chip design and in low-end manufacturing such as textiles and footwear. There is no need to choose just one of them. Success in both areas needs the same ingredients—eliminate self-defeating policies, improve skilling, pass trade-friendly reforms, and invest in health and education.

Two, I feel the criticism of low-end chip and electronics assembly misses an important consideration. If chips are the building blocks of the Information Age, it makes sense for India to begin the journey at the lower end of the chip manufacturing supply chain and climb up that ladder over two decades or so.

Jobs generated per rupee of money spent is not the only criterion that should motivate economic decision-making. For example, India’s nuclear energy sector is not evaluated primarily on the number of jobs it creates. Similarly, the primary goal of building the intellectual and manufacturing capability for making chips is to reduce critical vulnerabilities in the future. India can pursue the twin goals of doubling down on comparative advantages and reducing vulnerabilities simultaneously. In any case, attracting a single 65-nanometre specialised fab (which would cost around ₹10,000 crores) doesn’t come at the expense of a better university education system. India can do both.

Third, the book brilliantly emphasises that the services sector needs a lot more policy focus. Trade economists propose that we are heading towards a future where manufacturing supply chains will become shorter (because of protectionism and China-related fears) while services supply chains will become longer (because of better technology). This implies that services as a percentage of global trade will only rise. When that happens, nation-states will start imposing trade barriers for services, too. So, the Indian government needs to champion trade frameworks that bring down services trade costs.

An analogous case is that of the Information Technology Agreement (ITA) of the WTO. Signed in the nineties, the ITA substantially brought down tariffs on information technology goods and their intermediate products. This move immensely benefited multinational companies and consumers worldwide, including in India. Similarly, it’s time for India to champion a Global Services Trade Agreement that lowers barriers that Indian service providers face in participating in global trade. It also becomes clear why data localisation policies that hamper services exports will have a disproportionately negative impact on India’s economic future.

Finally, do read both the book and Devashish Mitra’s paper linked in the HomeWork section. And yes, check out our Puliyabaazi with Rohit Lamba, which discusses some of these themes.

PolicyWTF: How Pro-Business Protectionism Hurts Indian Women

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

By now, it’s widely known that Bangladesh has eaten away at India’s share in textile and apparel exports. This industry is labour-intensive and employs a significant proportion of women in the formal labour force—46% of all Indian women in the manufacturing sector are employed by apparel and textile industries taken together. Hence, it’s important to diagnose the reason for India’s decline.

As with policy success, policy failure can also have multiple causes. Bangladeshi exports received preferential treatment in the West as part of the latter’s policy to help poorer countries. This is one important reason that helped Bangladesh. However, this reason alone doesn’t explain India's decline in fibre production.

It turns out that the reason is our favourite villain: pro-business protectionism. I learned about this causal linkage from an excellent 2022 paper, Reigniting the Manmade Clothing Sector in India, by Abhishek Anand and Naveen Joseph Thomas.

This is how I understood the story that Anand and Joseph narrate. India has been losing global market share in textiles and apparel since 2011 to Bangladesh and Vietnam. The global demand for artificial fabric-based cloth (such as polyester) is far higher than that for natural fabric-based cloth (such as cotton) for cost and durability reasons. Thus, India’s underperformance is largely due to a decline in its exports in the artificial fibre segment.

And why is that the case? The most important input for the polyester fabric is a chemical called Purified Terephthalic Acid (PTA). The villain enters the scene. In October 2013, the two major domestic producers of PTA (Reliance Industries Ltd. and Mitsubishi Chemical Corporation India Ltd.) petitioned the government to impose anti-dumping duties on imported PTA. The government agreed. The anti-dumping duties were supposed to remain in force for six months. But they were kept in force for over six years! To make matters worse, the government imposed additional import tariffs on PTA in 2018 as part of its atmanirbharta driveoverdrive.

This rise in PTA costs had a cascading effect on the downstream fibre-making and apparel industries, making their products costly even as Bangladesh continued enjoying preferential tariff treatment in the EU. Vietnam benefited from trade agreements with Australia, Canada, the EU, and also the RCEP. The productivity of India’s textile sector declined, and many potential jobs vanished in thin air, disproportionately impacting women.

There’s an even uglier face to this fiasco. While large sections of Indians lost out, the position of a select few protected businesses improved. Vertically integrated firms with a presence in the entire supply chain from PTA to polyester yarn, and finally, apparel, benefited immensely as their competitors had to pay higher rates for the imported PTA. Protected from the cost of imports due to their in-house PTA production capabilities, these companies cornered a bigger domestic market share. Notably, their lower productivity means that even these protected firms can’t compete in the global market.

This a canonical example of how pro-business policies hurt markets and people. Even though the government dropped the anti-dumping duties on PLA in 2020 and started a Production-linked Incentive (PLI) for textiles, it simultaneously increased import duties for the downstream polyester to now protect domestic yarn producers from foreign competition! Talk about learning from past mistakes. PolicyWTF indeed.

In any case, do read the entire paper. It’s written lucidly, without the jargon and the scary Greek alphabet.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Martin Wolf has an excellent column in the Financial Times on liberalism and its discontents. It cites the Inglehart-Welzel Cultural Map to argue that even if there is no ‘clash of civilisations’, there seems to be a ‘divergence of civilisations’ on freedom-related questions. As an aside, I observed that there is no data for India in the seventh round of the World Values Survey, which covers the period 2017-21. Does any reader know why? Is it a story similar to India pulling out of the PISA rankings?

* [Video] This is a good conversation on Devashish Mitra’s paper Manufacturing-fed, Export-led Growth for Gainful Employment and Skill Creation. The presentation has no scary equations, and the discussion is insightful.

— RSJ

Happy 2024, dear readers! 

We hope 2023 was good for all of you. If it wasn’t, we are glad that it’s behind you. We didn’t have too bad a 2023 ourselves. This newsletter went along swimmingly (or so we think) and we had our book ‘Missing in Action: Why You Should Care About Public Policy’ published on 23 January 2023.

Why haven’t you bought it yet?

Anyway, it seems to be doing well based on the modest expectations we had of it. I’m yet to see the pirated versions of it peddled at traffic signals. Heh, that will be the day. But then I see it on shelves of all decent bookstores and that’s quite reassuring. That apart, Pranay had another book (one productive chap, I tell you), When The Chips Are Down on semiconductor geopolitics which is an area that’s going to get more interesting and contentious in this decade. All in all, we ended up writing 44 editions during the year totaling up to over a hundred thousand words. A good year, I guess.

On to 2024 then. Like in the past, we will indulge ourselves a bit in the first edition of the year. First, looking back at our predictions for 2023 and seeing how badly off we were and then next week, I will be doing a bit of crystal ball gazing for 2024.

Before I bore you with that, let me share with you this wonderful excerpt from a paper I read recently. Titled ‘Enlightenment Ideals and Belief in Progress in the Run-up to the Industrial Revolution: A Textual Analysis’, it covers an area of eternal fascination for me - Enlightenment and its impact on Western Europe. 

Interesting conclusions and a must-read:

“The role of cultural attitudes—specifically, of Enlightenment ideals that had a progress oriented view of scientific and industrial pursuits—in Britain’s economic takeoff and industrialization has been emphasized by leading economic historians. Foremost amongst them is Joel Mokyr (2016), who states that the progress-oriented view of science promoted by great Enlightenment thinkers, such as Francis Bacon and Isaac Newton, among many others, was central to what would become the “Industrial Enlightenment,” and ultimately Britain’s Industrial Revolution. In this paper, we test these claims using quantitative data from 173,031 works printed in England in English between 1500 and 1900. 

A textual analysis resulted in three salient findings. First, there is little overlap in scientific and religious works in the period under study. This indicates that the “secularization” of science was entrenched from the beginning of the Enlightenment. Second, while scientific works did become more progress-oriented during the Enlightenment, this sentiment was mainly concentrated in the nexus of science and political economy. We interpret this to mean that it was the more pragmatic works of science—those that spoke to a broader political and economic audience, especially those literate artisans and craftsmen at the heart of Britain’s industrialization—that contained the cultural values cited as important for Britain’s economic rise. Third, while volumes at the science-political economy nexus were progress-oriented for the entire time period, this was especially true of volumes related to industrialization. Thus, we have unearthed some inaugural quantitative support for the idea that a cultural evolution in the attitudes towards the potential of science accounts in some part for the British Industrial Revolution and its economic takeoff.”

2023 Predictions Scorecard

I had 8 predictions across the global economy, Indian economy and Indian social and political order. So, this is how does the 2023 report card looks like.

Global Economy

This is what I had written:

#1 The trend of securing your supply chain for critical products will get stronger.

….but it is clear to most large economies that on issues that concern national security, it will be foolhardy to not plan for worst-case scenarios any longer. And national security could mean anything, really, but I can see on energy and key technology, nations will opt for more secure supply chains with watertight bilateral partnerships than be at the mercy of distributed, multilateral chains. I won’t go as far as calling it ‘de-globalisation’ yet, but this ‘gated globalisation’ is a trend that’s here to stay.

This is playing out but a bit slower than what I expected. Disentangling and building domestic capabilities isn’t easy. And it is costly. But through the year we had increasing curbs on what hi-tech (GPU chips, AI research) and defence companies domiciled in the West could export to China. At home, we continued the push on PLI on electronics and tech equipment with debates on how much value-added manufacturing is really coming through in these schemes. Also, interestingly, we are continuing down the path of decoupling from global ‘default platforms’ especially in financial services. The Rupay platform is continuing to get bigger with a specific push from the government to derisk payment infrastructure from global networks like Visa and Mastercard. Also, in a recent statement, the central bank has suggested building a homegrown Cloud Computing infrastructure that will be used on regulated entities in India so that they aren’t tied into global Cloud service providers. 

#2 The fears of elevated inflation and a recession in the US in 2023 are overblown. The recession is due, but it will come a bit later

My view is that as supply chain issues ease up with China opening up, energy demand going up and the US continuing to be at almost full employment, we might have a 2023 where for the most part, the US inflation will be higher than target, Fed will continue to remain hawkish, and the growth will hold up. This will mean the real risk of recession will be more toward the end of the year than now.

Turns out I was accurate. In fact, the US economy has held up even better than I expected. And the Fed almost softened their tone by their last meeting of the year.

#3 Big Tech will continue to be under the cosh

I half expect India to gradually move all payment and eCommerce arms of Big Tech into a structure that’s domestically controlled and owned in 2023. Third, FTC, with Hina Khan at the helm, will accelerate antitrust and competition law changes to reduce the dominance of Big Tech.

I think I got this right in a big way. Through the year, fintechs have offloaded ‘troublesome’ shareholders (read Chinese investors) and there is a real trend of what’s called ‘reverse flipping’ where unicorns that were domiciled outside of India for tax and regulatory reasons are coming back home. Reason? Well, if you ask them they will tell you because they believe in the India story. That’s very convenient. The real reason is domestic regulators are making it difficult for a non-domiciled company to get a full bite of the Indian apple. From data security and storage requirements to tax and fund transfer regulations, the entities that are essentially Indian but are registered outside India to avoid ‘regulatory inconvenience’ are now facing business inconvenience in following that model. Here’s more on this. 

Indian Economy

I think I wrote more about the Indian economy in 2023 than any previous year. Much of it was about my surprise, in a positive way, on how much better it was doing than my expectations. Now as I read what I had written at the start of 2023, I think I had somewhat forgotten during the year that I was quite optimistic about the economy at the start of the year. Here’s what I had written:

#1 Greater optimism

I am a bit more optimistic about the broader numbers than most, and I will explain why. I think GDP growth will come in around 6.5 per cent for FY24, and inflation will be around 5 per cent. We might see a couple of rate hikes in the next few months, taking the repo rate to 6.75 per cent, but that will be it. I see domestic consumption to remain strong and exports, in the light of the shift away from China, to be good for manufacturers, and how much ever I might struggle to get behind the PLI scheme, it will yield some short-term benefits. IT exports might be a dampener, but on balance, I see more upside to these predictions.

Couldn’t have gotten it more right. I think the growth for FY 24 might come in at 7 per cent. Repo ended up at 6.5 per cent and domestic consumption and manufacturing have stayed strong while IT exports have gone worse over the year. 

#2 Digitalisation: Wave 2

There will be a significant push on digitalisation in lending and eCommerce. The UPI infrastructure has revolutionised payments and, along with GST, has accelerated the formalisation of the economy..... Also, as I mentioned in an earlier point, doing this will also mean shifting the balance of power from Big Tech-owned entities to an open platform or domestically controlled entities. I sense a strong push in this direction in 2023.

This was a no-brainer, really. I expected a bit more traction on platforms like OCEN and ONDC which haven’t taken off yet. The digitisation of the financial services sector has made low-value credit much easier for people to access. And UPI and digital KYC have enabled that to an extent that unsecured individual lending saw its biggest year ever in 2023. In fact, by the end of the year, we saw the central bank intervening to increase risk weights on these advances for banks and NBFCs and trying to bring down growth rates. The risk of an asset bubble because of faster and easier access to credit seems to become real based on the data they were reading. 

#3 The expected capex cycle push from the government will not come.

There are a couple of reasons for it. First, this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency. The other reason for a muted capex spend is the likely belief that the private sector credit capex cycle seems to be picking up. 

Got it mostly right except for the private sector capex cycle bit. That didn’t show up in 2023 as I was expecting. Government capex actually slowed as it kept its glide path to a 4 per cent union deficit by 2026. The efficiency improvement in tax collections and subsidy disbursement also helped in broadly sticking to the fiscal plan for the year. And as I expected, this government doesn’t need to loosen its purse strings in an election year. It has multiple other tools in its armoury to swing people’s opinion in favour of it.  

India: Political and Social

I had generally anticipated a more-of-the-same year despite some of the noise surrounding opposition efforts at the start of 2023. BJP with PM Modi at the helm, is possibly the most formidable political force in the world and it can turn its missteps too into its advantage. We saw this during the pandemic when its response was poor and too late. But that’s all water under the bridge now. It is also helped by a coincidence of circumstances where China has gone off-track and India is able to play its ‘swing power’ role to its fullest advantage in global geopolitics. All of this has meant it has a compelling domestic narrative to offer to the people of India rising in global prominence. This has tremendous capital at least among the middle class and the Hindi heartland. Back to what I wrote at the start of the year:

#1 More of the same

The expected consolidation of opposition forces to counter the BJP isn’t going to happen early enough for it to mount a credible challenge in 2024. There are eight state elections in 2023, and I suspect BJP will see reverses or very close fights in a couple of them where it is the incumbent (MP and Karnataka)....But it is hard to see opposition consolidation or a credible case that they can make to counter the electoral juggernaut of the BJP at this time. Congress, the other national party, isn’t capable of moving the masses either with its agenda or its leadership. The vacuum in national politics looks set to stay.

Ho hum. BJP lost Karnataka like I thought they would. MP was a surprise and it only shows how poorly Congress has performed through the year. Everything else is, as they say, same same.

#2 More Exit, Less Voice

I have made the point in the past about social fault lines tripping us up while we magically have a growth window that’s opened up for us again. This holds true. The space for opposition or dissent has shrunk; more importantly, even the fight for protecting or broadening that space has gone out....The state would be dependent on citizens if they value their loyalty and would then pursue a policy that listens to their voice. However, if the state doesn’t value it and the citizens know their voice won’t matter, the only option is to exit. For certain sections of our citizenry, they are possibly at this stage of engagement with the state. This scenario might not hurt the majority today, but we would do well to remember it has never been a good idea for the state to not value the loyalty of its citizenry in the long run. 

Nothing has changed on this. I guess this macro trend has only exacerbated in 2023.

So there I am with my report card. Not too bad, I guess though Pranay may again complain that these were quite generic and unless we make very specific predictions, it all seems to come true at the end of the year. Well, I will try to do that next week with my 2024 predictions. But don’t hold your breath on that, Pranay.  

A Framework A Week: Four Components of an Economic Strategy

Tools for thinking about public policy

— Pranay Kotasthane

Montek Singh Ahluwalia writes that any economic strategy has four components: slogans, targets, programmes, and policies.

Slogans refer to rhetoric employed by the government. Ahluwalia calls it the “front end” of economic strategy. Rhetoric is necessary in a representative democracy for communicating the government's position on an issue in a simple, catchy form without going into the details of the accompanying policy measures. Think Garibi Hataao, Shining India, Inclusive Growth, Sabka Saath Sabkaa Vikaas, and Minimum Government and Maximum Governance.

Targets are specific, measurable goals of an economic strategy. An example is the articulation that India will become a developed country by 2047. The World Bank comes up with a GDP per capita threshold for classifying an economy as a high-income one. So the target becomes a guiding light for policies and programmes and also serves as a tool for holding the government accountable.

Programmes refer to government-led measures involving public expenditure. Policies are government directives that allow or disallow specific economic activities. The difference can be understood using another popular three-fold classification which says that all governments do only three things — produce, finance, and regulate. This means programmes are government actions that involve producing or financing, while policies are about regulating. For example, bank recapitalisation is a programme where the government is financing public sector banks. In contrast, the Foreign Trade Policy 2023 lays down the rules that govern all exports and imports.

This four-fold classification is useful for policy analysts for two reasons. One, it doesn’t look at slogans cynically. Economic narratives are important. Slogans are often launchpads for powerful narratives.

Secondly, differentiating policies from programmes is crucial. The default government tendency is often to bat for government-run programmes. Think Production-linked Incentives (PLI) and export subsidies. There are enough and more programmes from the past to tinker with and regurgitate them into a new programme to “solve” the economic problems of the day. However, chronic economic problems might need a fundamental change in policies that cannot be fixed by programmes alone. India’s manufacturing underperformance is one such example. Though there have been many a programme for overcoming this challenge, the solution lies in changing trade, tax, labour, and doing business policies. Another example comes from the 1991 economic reforms. At the time, many politicians thought that India only needed a debt restructuring programme. However, the reformers successfully argued that India needed a change in tax, business, and investment policies; a new programme alone wasn’t good enough.

For an illustration of this framework, check this article by Montek Singh Ahluwalia on the problem with India’s public sector banks.

PolicyWTF: Screws are Strategic

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

The Department to Ground Foreign Trade, or less accurately, the Directorate General of Foreign Trade (DGFT), is a gift that keeps giving. Their latest policy move is to restrict the import of cheap screws so that India can become a self-reliant vishwaguru of screws. A screwpower, maybe?

In a notification issued on 3rd Jan, the DGFT banned the imports of screws priced lower than ₹129/kg. Indian manufacturers used to import these from France, China, Australia, Bangladesh, Brazil, and Belgium.

So, the government wants to do an import substitution of a humble product that costs ₹129 per kg and already has a diversified supply chain. If this isn’t ridiculous enough, think about the impact on Indian manufacturers who relied on these imports. They are the ones getting screwed here because they will end up paying more for the same product.

Long-time readers might experience déjà vu as there was a similar policy restricting the imports of mosquito electronic racquets in 2020, to which RSJ had paid proper obeisance in edition #129.

In other news, one of the issues blocking the India-UK FTA is that Indian EV car manufacturers don’t want the high import duties to be dropped. Currently, electric cars priced above $40000 are slapped with a 100 per cent import duty, while those below $40000 are levied a 70 per cent duty. Domestic manufacturers argue that a reduction in import duty will stall the sunrise industry.

These two stories in recent months illustrate the slippery slope of industrial policy in low state capacity conditions. A domestic subsidy for manufacturers can still be justified because every other country is doing that. It’s become an entry pass of sorts to play the manufacturing game. But to couple domestic production subsidies with import restrictions makes these policies scarily close to the import substitution regime in the pre-1991 era.

Every government makes mistakes. However, low state capacity results in governments repeating the mistakes of the past as there is no institutional memory. We seem to be reaching that point with India’s industrial policies.

This observation also stands empirically. Check out the New Industrial Policy Observatory (NIPO) released by the IMF (hat-tip to Niranjan Rajadhyaksha for sharing the accompanying paper on X). The database classifies industrial policy actions over the last few years into eight categories: export barriers, import barriers, domestic subsidies, export incentives, FDI measures, Public procurement measures, Localisation content measures, and miscellaneous. This is by far the most detailed database of industrial policy measures I’ve seen—a fantastic tool for scholars working in economic policy.

Now here’s my initial analysis looking at the data for India in NIPO. Of the 195 industrial policy measures that India has taken, 55 are distortionary trade measures, illustrating that we are repeating import substitution ideas of the past. There’s more to this. In the database, one can also classify industrial policies sectorwise. Here again, we see that import tariffs feature across most sectors.

Such mindless import substitution will lead to export contraction, as Indian companies become uncompetitive and bow out of international competition. We have seen this movie before.

P.S.: Look at this chart of trade as a per cent of GDP for the world’s five largest economies. Trade is a higher proportion of India’s GDP than is the case for Japan and China. It’s been that way for the last ten years. Trade is far more important to India than we realise.

HomeWork

Reading and listening recommendations on public policy matters

* [Book] Vivekananda: The Philosopher of Freedom is a thoroughly enjoyable, myth-busting biography.

* [Blogpost] This post has a mind map of market failures and corresponding government interventions. A boon for anyone interested in public policy.

* [Podcast] Listen in to a Puliyabaazi with economist Rohit Lamba on India’s future economic trajectories. This is a fun episode.

* [Paper] A useful take on Foreign Trade Policy 2023 in Economic and Political Weekly.

Insights on current policy issues in India

— Pranay Kotasthane

In the previous edition, I asked you to name your favourite sports policy to date. I don’t have a great answer myself. Nevertheless, my candidate would be liberalising FDI in retail.

When posed with such questions, we often get anchored to the way governments are organised. The best sports policy can only be made by the sports ministry; the best education policy can only be made by the education ministry, and so on. These answers assume that the public policy system is a linear, deterministic system with a small number of variables and negligible overlap across ministries.

But as we discussed in edition #213, it is useful to characterise public policy as a complex system. Such a system is greater than the sum of its parts and these parts interact and share information with each other. Complex systems display non-linear behaviour as small actions can have large effects while large actions can have small effects. As a result, decomposing the system into its constituent parts, and analysing them separately often results in inaccurate analysis.

Deploying the complexity lens makes us think beyond narrow sectoral policies. In the case of sports, it means we can think beyond the obvious candidates such as Target Olympic Podium Scheme (TOPS), Fit India, or Khelo India. As an amateur sports enthusiast, I contend that liberalising FDI in retail had a disproportionately positive impact on sports in India because that policy led to the world’s largest sporting retailer setting up shop in India.

Until fifteen years ago, buying sports equipment was not very different from purchasing soap at a kirana store. The options were limited and the buying experience was consistently disappointing. Moreover, equipment of only the most popular sports found space in the retail storefront.

All that changed with the entry of the French sports retailer, Decathlon; first in the cash-and-carry segment starting in 2009 and as a single-brand retailer in 2013 after the FDI policy allowed 100% FDI in single-brand retail. Decathlon has given the Indian sports enthusiast a choice and a range of sporting equipment that my 20-year-old self would find unimaginable. Allowing FDI in e-commerce was the next step jump, making these sports equipment accessible to people outside Tier-I cities.

I wish we had a real study of the consumer surplus generated by FDI liberalisation. Nevertheless, this example shows how sector-agnostic liberalisation can have a major impact. Ten years after the entry of Decathlon, further liberalisation of multi-brand retail is needed to bring more competitors into the sector, benefiting Indians at large.

Of course, no one policy can solve all problems. All success is multi-causal, especially in a complex system like public policy. But my aim here was to make you think beyond ministry turfs when approaching questions of this nature.

India Policy Watch #2: Holiday Reading

Insights on current policy issues in India

— Pranay Kotasthane

The year-end holidays are approaching. So what’s the best way to spend the holidays? Reading, of course. This time around, I want to recommend some classic reports that tried to diagnose India’s condition. Initial conditions matter a lot in a complex system, hence I’ve picked out reports that give a fair account of the problems that India inherited in various domains around the time of independence.

* Economy: Milton Friedman visited India twice in the 1950s and wrote two stunning articles on “Indian Economic Planning” and “A Memorandum to the Government of India 1955”. His diagnosis rings true even today. Centre for Civil Society has compiled the essays into a book.

* Public Policy and Administration: Paul Appleby’s Public Administration in India-Report of a Survey was an important report where the American consultant tries to diagnose problems with India’s public administration. The report is available on the Internet Archive.

* Science Policy: AV Hill was called by the British government in 1943 to advise on the organisation of scientific and industrial research in India. Some of our over-centralised scientific establishment cut off from the university ecosystem can be traced back to this influential report.

* Politics: It’s amazing how Ambedkar’s diagnosis is accurate in so many areas simultaneously. In Thoughts on Linguistic States, he identifies “one language, one state” and “one state, one language” as the two different approaches for state creation. His election manifesto for the Scheduled Castes Federation from 1951 identifies problems with India’s economy, foreign policy, and society. On the emotional issue of partition, he displays an amazing clarity of thought and analysis. With the benefit of hindsight, we can say that his analysis foresaw events and phenomena other leaders of his generation couldn’t.

Enjoy reading! And share your thoughts on these reports with us.

HomeWork

Reading and listening recommendations on public policy matters

* [Paper] The 2023 RBI CD Deshmukh Memorial Lecture (there’s also an equally excellent NCAER CD Deshmukh Memorial Lecture Series) by Arvind Panagariya argues that India could become the second-largest economy, surpassing the US, 50 years from now. You might well disagree with the conclusion, as do I, but the paper’s worth a read.

* [Article] It takes earth-moving prowess to enjoy a monopoly and yet run into a loss. No surprise that only governments are capable of such feats. Shekhar Gupta masterfully narrates how the Delhi Development Authority has an unsold inventory exceeding ₹18000 crore in value, despite the monopoly power it has enjoyed since 1957.

* [Podcast] The always wonderful Rest is History podcast has a seven-part series on the JFK assassination that you mustn’t miss. I was hooked.

* [News] The union government has banned onion exports now. Controls on exports of non-basmati rice and wheat are already in place. Expect more controls until the 2024 elections. With interventions like these, there’s little hope for agriculture to become a normal area of economic activity.

India Policy Watch: In Search Of Growth

Current policy issues in India

— RSJ

A quick macro update. The RBI’s Monetary Policy Committee (MPC) met this week and, as was widely expected, kept the repo rate unchanged at 6.5 per cent for the fifth consecutive time. The Governor gave the usual explanation of global political risk, higher volatility in global financial markets, and continued inflationary expectations as the reason for keeping the policy stance unchanged as ‘withdrawal of accommodation’. And the Governor was quite clear that there is no ‘inadvertent’ signalling to the market that it has actually moved to a ‘neutral’ stance with its prolonged pause on rate hikes:

“Reaching 4 per cent (inflation target) should not just be a one-off event. It has to be durably 4 per cent and the MPC should have confidence that 4 per cent has now become durable.

We are very careful in our communication. There is no inadvertence in any of our communication. So, if somebody is assuming that it is a signal to move towards a neutral stance, I think it would be incorrect.”

Well, that takes care of any possibility of a rate cut before next year's elections. And what’s the need, really? Between now and the elections, there’s always an inflation risk on vegetable and food prices. Also, while crude oil price has been on a downward trend during this year which has helped on the inflation front, there’s no guarantee how that will trend given the global geopolitical situation remains uncertain. Most importantly, what’s the need to signal any rate cut when the GDP growth numbers are coming in significantly above even RBI’s somewhat optimistic forecasts at the start of the year? Q2 GDP grew at 7.6 percent, almost a full percentage point above estimates, leading the central bank to up its full-year forecast to 7 per cent. All good news so far. Further, the RBI note had this optimistic comment for the near term:

“The healthy twin balance sheets of banks and corporates, high capacity utilisation, continuing business optimism and the government’s thrust on infrastructure spending should propel private sector capex.” 

Well, you can go back to the past six quarters, and you will find similar sentiments about an impending private sector capex boom from both the government and the private sector. But it is turning out to be a bit of a mirage. While both the corporate and bank balance sheets are the healthiest they have been in the past two decades, there is a continued ‘wait and watch’ approach on capex, which has mystified most observers. While the consumption growth remains robust, there are early signs that this lag in private capex is beginning to slow down corporate revenue growth. From the Business Standard:

“.... the slowdown in corporate revenue growth over the last one year has begun to reflect in India Inc’s capital expenditure as there is a close correlation between growth in net sales and investment in fixed assets. The net sales of 725 companies, excluding BFSI and state-run oil & gas firms, were up 4.2 per cent year-on-year (Y-o-Y) in H1FY24 – the lowest half-yearly increase in the last three years and down sharply from 12.2 per cent growth in the second half of FY23 and 31.3 per cent growth in the first half of FY23.”

As if on cue, the Chief Economic Advisor (CEA), picked the issue of sluggish private capex at a CII event this week. Instead of the expected anodyne address at events of this nature, he made some very insightful points. First, he correctly pointed out that to expect consumption to continue to drive GDP growth while private capex sits out for as long as it has defies logic. Consumption, as we have pointed out more than a few times here, is the residual factor. And that’s exactly the point the CEA made (again quoting the Business Standard):

“Waiting for demand to arise before they start investing will actually delay the onset of such demand conditions happening, because usually consumption has to be the residual. Investment leads to employment, which leads to income generation and which in turn creates consumption and then the savings are recycled back into the investment. So the more the corporate sector delays its investment, this virtuous cycle will not materialise.”

Then he mused on what might be holding the private sector back despite strong balance sheets, robust GDP growth and a general sense of global optimism about India’s prospects:

“So what is holding it (corporates) back? It is easy to say that there is general demand uncertainty. Post Covid, recovery has started. But one thing we have to remember is that this decade is going to be the decade of uncertainty, whether we like it or not. So for us to wait for the uncertainties to abate or recede, [its] like waiting for the waves to subside before taking a dip in the ocean. That is not going to happen.”

I won’t be surprised if there will be more plain-speaking to corporate India coming in the next few quarters on private capex from the government—three reasons for that. 

First, the government has pushed its capex targets in the last two budgets and, somewhat surprisingly, kept pace with them. The public capex has grown at a CAGR of over 30 per cent in the last three years. It is now about 3.3 percent of GDP as opposed to the 1.5 per cent it used to be pre-pandemic. The government has found resources to fund this capex by trimming subsidies following the pandemic and by the continued growth in tax collections because of the efficiencies brought in with GST and the rapid digitalisation of the financial system. However, given the fiscal deficit constraints, this public capex growth will be difficult to sustain at this clip. Couple that with the recent data that shows household savings at a multi-decade low of 5.1 per cent of GDP, there is no other lever of growth to pull except private capex.  

Second, given global uncertainty and the ‘higher for longer’ expectations in developed economies, the annual FDI flows have been the lowest in this fiscal year than at anytime in the past decade. The venture money in the form of investments by VCs and PEs has also dried up with a general ‘funding winter’ that has left all but a few startups untouched. While there’s stronger global demand for the MSME sector that’s visible across the board, it will start hitting the wall of lack of funds in the near term unless large capex projects take off and the general sentiment of investment picks up in the private sector, which then lifts all boats. 

Third, this government is instinctively fiscally conservative and likes to stick to its targets. It has set a target to reduce the fiscal deficit by 1.5 per cent of GDP in the next two years. That apart, the imminent inclusion in global bond indices will also mean a greater level of scrutiny of public accounts. The government would like to project an image of fiscal prudence to boost confidence of investors. So, I don’t see a continued heavy lifting through public capex as has happened in the past couple of years.

Which then brings us back to private capex and that question of what’s stopping it from taking off. I think CEA has a point on the general aversion of the corporates to any kind of uncertainty which has continued for so long that it seems like despite all the talk, they are unable to take the final leap in making that investment. Will this go away in due course? I guess it is possible that the Lok Sabha elections may be the final trigger which may kickstart the process.

But that apart I think there are two other points that remain unaddressed. One, the promoters are yet to come to terms with the new regime of greater scrutiny by banks when they borrow, an insolvency process where they can lose control of their companies and the limited degrees of freedom to do the kind of ‘excesses’ they did in the past in the garb of capex. These ‘reforms’, while good for the economy as a whole, haven't been fully assimilated in the minds of Indian promoters. The better-governed promoters will start taking the leap, and others will reluctantly come along after appreciating this is the only way things are going to get done from here on. Two, while there have been good steps to improve the ease of business, there is a huge opportunity to push for more fundamental factor market reforms to improve risk-taking and bring in a new generation of entrepreneurs in sectors beyond services. Possibly, this should be the big agenda if the inevitable third term materialises in May 2024. Private capex is the big lever still waiting to be pulled. 

Growth cannot come out of thin air, after all.

Numbers that Ought to Matter: In the ongoing Parliamentary session, the Ministry of Health and Family Welfare answered a question on the number of medical colleges and MBBS seats in India. There are 706 medical colleges in India, admitting 1,08,848 MBBS students annually. Over the last ten years, the number of MBBS seats in India has more than doubled (there were 51,348 seats on offer in 2014). However, the total number of seats on offer is quite low despite India now having the largest number of medical colleges in the world. On average, each medical college has just 154 seats. By 2020, China had 420 colleges offering 286,000 seats (i.e. 680 seats per college). Government policy should focus on helping existing colleges scale up. For more context, read edition #159.

Also, do check the new Rajya Sabha and Lok Sabha websites. They are useful data sources. Navigating the questions and government responses is much easier now. However, a lot of data remains locked in PDF files. That’s for another day.

A related project idea: Someone should parse the “Question Subject” field and classify it into meaningful categories. Maybe AI tools can help here. This data could be a proxy for the subjects that India cares most about. The next step would be to track if the subjects inviting the most questions successfully influence government policy. Any takers?

A Framework A Week: A Taxonomy of Defence Innovation

Tools for thinking about public policy

— Pranay Kotasthane

On November 30th, the Defence Ministry approved IAF’s capital acquisition proposal for 97 Tejas Mk1A aircraft. This move signals a major shift — India’s armed forces have accepted the Tejas platform as a replacement for their inventory of old and outdated, mostly Russian, aircraft.

This news item got me thinking about the process of defence innovation. What are the factors governing defence innovation? How are these factors related to each other? Why do some countries do better on this front than others? A search for answers to these questions led me to an excellent framework by Tai Ming Cheung in the Journal of Strategic Studies.

Instead of identifying a simplistic policy answer, Cheung looks at defence innovation as a system composed of several interrelated factors, as shown in the chart below.

In Cheung’s classification, there are seven types of factors:

* Catalytic factors are exogenous inputs that disrupt the defence innovation system. Examples include external threats, top-level leadership support, and revolutionary breakthrough opportunities.

* Contextual factors account for all path-dependent variables such as historical legacy, level of development, market size, etc.

* Input factors are the ingredients of defence innovation. Examples include Foreign Technology Transfers, budget allocations, human capital quality, and Civil–Military Integration.

* Organisational factors refer to the capabilities and mandates of organisations set up to deliver defence products.

* Institutional factors refer to shared norms, plans, strategies, intellectual property protection, and government-market relations.

* Networks and sub-systems include formal and informal networks linking various sub-systems.

* Output factors shape the final products coming out of the system. Examples include sales, marketing, commercialisation, and maintenance.

This approach allows the author to create a typology of defence innovation regimes, wherein specific pathways within the chart get amplified. Two such types relevant to India are incremental and rapidly catching-up regimes.

In incremental catch-up regimes, catalytic factors don’t play a significant role. Such countries produce incremental improvements by parsing input factors such as technology transfers through organisational factors (military and state agencies) and institutional factors (plans, strategies, and norms). The paper identifies India as a prominent example of this regime. Cheung illustrates the model as follows.

Rapidly Catching-up Regimes are underdeveloped defence innovation systems pushed by catalytic factors towards increased resource allocations and a strong research and development sub-system. Cheung classifies North Korea and China in this category. This model is illustrated in the chart below.

Readers should check the full paper and other regime types based on this framework. But the relevant question for us is this: has India transitioned from an incremental catch-up regime to a rapidly catching-up one?

There are some positive signs. Catalytic factors are playing a far bigger role now than in the past. This is mainly because China’s aggression and Pakistan’s relative decline have led to a new emphasis on the defence innovation system. The PM’s recent sortie in the Tejas illustrates that another catalytic factor—“top-level leadership support”—now has a more prominent role. There is also more focus on civil-military integration, diffusion networks, and technology development than in the past. And given that India enjoys a positive relationship with the US, the possibilities of “Foreign technology transfers” (a crucial input factor) are substantially higher than in the past.

The weakness is in the organisational realm. That part of the system is still governed largely by state-run entities with low technology absorption capabilities and fewer incentives for efficient production. The capabilities of universities and laboratories are also quite limited. The procurement system, classified as a network and sub-systems factor, is another weak link that discourages innovation while protecting inefficient government-run firms.

My subjective assessment using this framework is that India is catching up faster than before. It doesn’t seem to be “rapidly” catching up, though. Further, the more radical pathways, which lead to rapid breakthroughs in defence innovation systems, remain out of reach.

Whatever your assessment, Tai Ming Cheung’s framework is useful and helps clear many cobwebs of defence innovation.

HomeWork

Reading and listening recommendations on public policy matters

* [Question] What, according to you, is the Indian government’s best sports policy to date? Please drop a comment with your reasoning. We will put across your views and ours in an upcoming edition.

* [Podcast] The latest Puliyabaazi discusses the politics of polarisation. Gaurav Sood, a political scientist who has worked on this topic for over a decade, gives a detailed account of the psychological underpinnings of polarisation.

* [Article] This article on industrial policy challenges some of our Bayesian priors. More importantly, it links to many recent papers showcasing empirical research on industrial policy measures.

* [Article] A good article explaining how DARPA functions.

Insights on issues relevant to India

— RSJ

For nearly a month now, some of India's top wrestlers, who between them have earned over 25 medals in various global competitions, have been protesting against the conduct of the Wrestling Federation of India (WFI) chief and BJP MP Brij Bhushan Singh. This is not an ordinary protest. The allegations in the FIR against Singh are quite serious, including a couple of instances of demanding sexual favours as a quid pro quo for professional assistance, about 15 incidents of sexual harassment and stories of inappropriate touching, and molestation of minor girls. You would imagine this would be some kind of an open-and-shut case. 

I mean, here are a few women wrestlers who have everything to lose here by taking a stand against their own federation and the government. They aren’t superstar cricketers with financial security and access to media. They don’t have multi-million and multi-year sponsorship deals or lucrative post-retirement commentary gigs waiting for them. Their sport is everything to them, and they are willing to risk that one thing they have loved doing all their lives. These are girls who have come up the hard way in a society that doesn’t prize either women or sports and especially women in sports. They have persevered despite the odds against them because that’s what athletes do. So, the least you would have thought is that while the police investigations and the judicial process is going on, or, as we like to say in India, as the law takes its own course, the government should ask the WFI chief to step down temporarily. Surprisingly though, this doesn't seem to be a priority for the government. Instead, it appears they would rather suppress these voices than address their concerns. So, last week while you had saturation coverage on various channels about the inauguration of the new parliament building, these athletes were being roughed up and assaulted at the site of protest. There was barely any TV media there.

As they say, there are always two Indias at work. 

It is tempting to zoom out a bit and say that this story, in many ways, reflects the current state of Indian politics and society. It is not there yet. But there is a pattern in how we are dealing with protests and dissent that merits a deeper look. Before I go there, let me count the number of ways we have got this thing wrong. 

Firstly, for decades, we have managed sports and their governing bodies in India in the most unprofessional way possible. These positions have often been given to politicians as small consolation prizes to run their minor fiefdoms. Corruption, nepotism and high-handedness of officials have come along with this. Read any autobiography of an athlete in India and you will be struck by the remarkable apathy and neglect they had to overcome from their own sporting federation to succeed. As major sports events like the Olympics or Asian Games approach, there's often a question of why our sporting performance doesn't reflect our population size and recent prosperity. This story never gets old. While we have seen some improvement in the last decade, we remain an underperforming nation in sports. One fundamental issue to address is improving sports administration by involving experts with experience in either playing the sport, managing large organizations, or possessing a proven visionary track record. Indian tennis is a prime example where one family has presided over its administration for over half a century. We have only gotten worse in tennis, with almost no one ranked anywhere in the top 1000 in the world. Similar fiefdoms exist in other sports like boxing, shooting and even cricket. 

Despite the efforts of some public-spirited lawyers and a few interventions by the Supreme Court to set things right, things have remained the same. There was some hope when this government came to power that there would be much-needed reforms in sports administration, especially in those early days. However, once you have the keys to the power of the state, it is difficult to resist its benefits. The result is a disheartening situation where politicians with limited understanding or passion for sports lead the federations. We are back to the bad old days now. 

Secondly, we seem to be undoing all the progress we have made in addressing sexual harassment allegations in the workplace. There are POSH committees that are legally mandated in organisations and a framework that allows for a safe and secure environment for women at work. In India, the foundation for this framework was based on the Vishaka guidelines set nearly 25 years ago. In cases like this, the employer (in this case, the sports ministry) should form a committee with an independent chair who investigate these allegations and arrive at their conclusions. And it is usual that during such an investigation, it would be appropriate for the accused to step aside for a free and fair process. However, none of this process has been followed. Neither the WFI nor the Indian Olympic Association (IOA) have even acknowledged taking up these allegations. In fact, P.T. Usha, the current chief of IOA and a track legend initially dismissed them as false and an attempt to tarnish our nation's image. We are back in the territory of ghar ki izzat, and the patriarchal attitudes where raising such concerns are seen as bringing dishonour to one's family or damaging a country's reputation. It is concerning that even government officials are not adhering to their own established guidelines.

The response to the protests by both the sporting fraternity and the general public has been surprising. Despite the police manhandling of these athletes, very few voices have come out in support of them, with notable exceptions like Abhinav Bindra and Sania Mirza. Even their anodyne statements hoping that the athletes are given their due and that proper investigations take place seems like an act of courage. The 1983 cricket World Cup winning team, too, came out with a statement expressing anguish at the treatment of the athletes and hoping for a resolution. I’m not sure what resolution they are expecting in a case that should be picked up by the police and investigated with rigour. Quite disconcertingly, although to the surprise of no one, the usual set of partisans and news anchors have questioned the motives behind these protests. The usual whataboutery season is on in the TV debates, and the WhatsApp universities are busy generating content blaming the victims or distracting us with Rahul Gandhi’s US visit. It is a textbook case of a society losing its moral compass today while romanticising its glorious past and its superiority as a civilisation. 

In a society where many underprivileged children pursue sports as a means to improve their lives, the exploitation by administrators and coaches within the system should be a matter of great concern. Despite this reality, political affiliations and a belief that our leader can do no wrong is now trumping reason. We now have a situation where there are people questioning the legal process put in place for sexual harassment complaints that apparently favour the woman victims’ rights to fight their case. This mindset risks undoing the progress made towards providing safe working environments for women. We are happy to go down the path of victim blaming and gaslighting than hold men in power accountable. This in a country where crime against women is still among the highest in the world and that has one of the lowest female participation rates in labor worldwide. 

So, why is the government reluctant to act against Singh? Based on the track record of how it has handled previous protests, there are three possible explanations for this behaviour. 

One, this administration perceives admitting a mistake as a sign of weakness. They would rather make incorrect decisions than appear weak in any way. We have made this point earlier. This is the basis of its electoral appeal. That it can do no wrong. Accepting that the protesters are right will dent its strong government image. Two, there is the electoral angle to this, given we are less than a year away from the Lok Sabha polls. Brij Bhushan Singh's influence in the Ayodhya-Gonda region cannot be ignored. He or his family members have won elections there for over three decades, regardless of their party affiliation. His ability to switch allegiances while maintaining electoral success suggests a ground network that doesn’t depend on a party for success. While the BJP is on a strong wicket for winning 2024, it doesn’t want to risk failure, especially in U.P. This calculus might still turn if the recent mobilisation of the local Jat communities and Khap panchayats to support the wrestlers becomes stronger. This shift may transform the protest into something more politically relevant, as it happened with the farmer protests. I don’t think I had imagined a day when the Khap panchayats would be seen as advocates of women’s rights. But we are there. The third explanation lies in the ruling party's deeper understanding of social undercurrents, which they believe represent the silent majority's views. This covers issues like women's liberation and how India has imitated Western liberal guidelines that aren’t compatible with our civilisational values. They would like to believe that a sizable portion of Indian society may support a pause on liberal issues especially relating to women’s freedom. I’m not very sure if this is an accurate assessment, but it doesn’t hurt to be politically ambiguous on this. 

At a broader level, this is also about how we see protest or dissent in these times. It is intriguing how easily people trust the state despite the weight of history against it while distrusting the protesters who have a grouse against the powerful. This is an odd inversion that seems to have arisen because our collective sense of self-worth and pride are now closely intertwined with our perception of how well the state performs. So, questioning its actions or motives can be seen as an attack on the collective self-worth.

It is an almost perfect trick. 

India Policy Watch #2: Beyond Isomorphic Mimicry 

Insights on burning policy issues in India

— Pranay Kotasthane

“South Korea became a manufacturing and technological superpower riding on industrial policies that backed chaebols (large domestic business conglomerates), so why shouldn’t India do this too?”

“Technological upgradation of Chinese companies happened because of the Party-state’s policies of Forced Technological Transfer, also known as ‘trade-markets-for-tech (TMFT)’. India should adopt this approach as well.”

“France has banned short-haul flights to counter climate change. India should follow this lead and impose green taxes on air travel if not a full ban.”

“Amsterdam has bicycle tracks and Bogota has Bus Rapid Tranist (BRT); so should Bengaluru.”

I’m pretty sure you have come across similar arguments. Not just people outside the government, policymakers and career analysts can also be found making arguments of this nature. Now, it’s easy to ridicule these points of view as “isomorphic mimicry”, what Andrews, Pritchett, and Woolcock define as:

the tendency of governments to mimic other governments’ successes, replicating processes, systems, and even products of the ‘best practice’ examples… a key technique of successful failure that perpetuates capability traps in development.

My instinctive response to such arguments is similar. However, I now think that we need to go one step beyond and ask, “why are we prone to committing isomorphic mimicry? What makes us seek refuge in it?” This post is an attempt to answer these questions.

The fundamental reason behind such arguments is a mental model that imagines public policy as a deterministic process where heroic policies can quick-solution us out of trouble. It is this assumption that we must rethink in order to avoid isomorphic mimicry. Here’s why.

To begin with, we need dollops of humility. Forget quick-solutions, we don’t even know all the variables that impact major public policy processes.

Observe, for instance, the question of economic growth. In edition #52, RSJ explained how there’s no single answer as to why countries experience a period of rapid economic growth. At best, we can identify clusters of factors such as economic freedom, political freedom or institutions, geography, and investment in human and physical capital.

So is the case with innovation. Over the last few months, I tried to understand the reasons behind China’s strides in innovation and technology upgradation. The more I read about it, the more it became clear that forced technology transfer, IP theft, or industrial policy alone cannot explain the transformation. At best, I could come up with the explanation that China's innovation is a combination of fundamental factors and proximate factors. The fundamental factors were: a Capable Workforce, Technology Transfers, and State Focus on Innovation. The proximate factors such as Forced Technology Transfer, IP Theft, Specific Government Policies, and Selective Protectionism have, at best, played a cameo role.

So is the case with urbanisation. We have some good hypotheses about why certain sectors spatially organise into concentrated clusters, but we don’t know for sure what would it take to make a successful new city. We can identify some fundamentals, but it’s difficult to create a pathway.

These three examples illustrate the need to adopt a different mental model to think about public policy. One such frame is complexity theory. Over the last two decades, there have been several attempts to think about public policy as a complex system. Public Policy scholar Paul Cairney explains the attributes of complex systems in these words:

* A complex system is greater than the sum of its parts; those parts are interdependent – elements interact with each other, share information and combine to produce systemic behaviour.

* Some attempts to influence complex systems are dampened (negative feedback) while others are amplified (positive feedback). Small actions can have large effects and large actions can have small effects.

* Complex systems are particularly sensitive to initial conditions that produce a long-term momentum or ‘path dependence’.

* They exhibit ‘emergence’, or behaviour that results from the interaction between elements at a local level rather than central direction.

* They may contain ‘strange attractors’ or demonstrate extended regularities of behaviour which may be interrupted by short bursts of change. [From Paul Cairney’s post on his ever-excellent blog]

When applied to public policy, this complex system mental model gives us a few axioms.

Policy Ingredients, not Policy Recipes

The complex system lens shows us that it is futile to obsess about deriving policies using “best practices” from another country or city. It is far more important to think about preparing the initial conditions that could trigger emergent behaviour towards the desired policy goal. A government shouldn’t be designing a perfect quick solution to a chronic problem, but creating conditions in which different competing solutions can emerge. In a sense, governments need to put together all the essential ingredients that go into achieving a policy goal rather than create an award-winning policy recipe.

This line of thinking explains national innovation. There's no one blueprint to be found for innovation success. Countries have followed different pathways. But we know that ingredients such as reasonably high levels of human capabilities and infrastructure and strong connections with global science and technology ecosystems are common fundamental factors in innovation success.

Another example comes from economic policy. Pro-market policies are about putting together key ingredients for growth take-off, while pro-business policies are equivalents of step-by-step recipes handed down to you. I used to think that finance ministers claiming “the fundamentals of our economy are strong” was a cleverly-worded evasion. But the lens of complexity would suggest that fundamentals are exactly what the government should focus on.

The Idea of Probabilistic Success

The lens of complexity implies that governments are not as effective in achieving our goals. The best case is when governments have prepared all initial conditions for take off. But that’s no guarantee for success. In the Indian context, this thinking should give us a pause before we airdrop governments as a troubleshooter for all our problems.

The Merits of Decentralisation

In a complex system, it’s beneficial to give agency to organisations so that they can learn from their experience and change tack in response to on-ground conditions. In this sense, complexity theory is a reaffirmation of Hayek’s insight in The Use of Knowledge in Society. Individuals and, by extension, markets are in a better position to experiment and display different emergent behaviours than centrally engineered solutions from the top.

Hope, not Analysis-paralysis

Complexity can at once be liberating and shackling. The insight that there are no perfect policy recipes can drive us into an analysis-paralysis mode, leading to dejection and disillusionment. But the knowledge that given the right conditions, emergent behaviour can spring up unexpectedly gives a reason for hope and provides a new meaning to the shloka, “Karmanye Vadhikaraste ma phaleshu kadhachana” (perform your duty but do not expect the fruits of your labour).

P.S: The complexity theory mental model holds promise in public policy, but at present, there are far more questions than there are answers.

India Policy Watch #3: Why this Kolaveri with Assembly?

Insights on burning policy issues in India

— Pranay Kotasthane

I like the richness of the debate on the production-linked incentive scheme (PLI) for electronics manufacturing. Last week, economist and former RBI governor Raghuram Rajan questioned the government’s self-congratulatory messages on mobile exports using these words:

“.. it turns out that very little apart from assembly is done in India, though manufacturers claim that they intend to do so in the future. So, India imports much of what goes into the mobile phone, and when we correct for that, it is very hard to maintain that net exports have gone up.”

Some of you readers might recollect that we have regularly critiqued the electronics PLI since its inception. Our first post about it was written in November 2020. So, it shouldn’t surprise you that we agree with this recommendation:

The government should undertake a detailed assessment on how many PLI jobs have been created, the cost to the country per job, and why the PLI doesn’t appear to have worked so far before extending it to other sectors.

That said, I have several questions about the analysis.

First, I was surprised that one of the criticisms in the note is that “it is entirely possible that we have become more dependent on imports during the PLI scheme” on account of increased imports of mobile phone components for assembly in India.

It is well-known that imports of sub-components will keep increasing as we scale up assembly in India for a few years until local substitutes come up, as they did in China and Vietnam. Moreover, as we wrote in edition #185, China and Viet Nam witnessed a decrease in the domestic value added per unit of demand when they began assembling mobile phones. Companies preferred to import components, assemble, and then export them. Only after their electronics exports had achieved global scale did the two countries target local content addition.

And hence, we shouldn’t expect quick gains in the Indian case as well. Only after the assembly in India achieves some scale will local suppliers come up. In the Apple ecosystem, for instance, the Final Assembly Testing and Packaging (FATP) units run by the likes of Foxconn are the key nodes. Once they take root, it’s in their self-interest to develop a local supplier ecosystem to meet the unsparing demands of their product launch cycle.

Curiously, a terrible way for governments to reduce the import of components is to raise import tariffs further, a solution that the authors of the note would vehemently disapprove of.

Second, the note proposes that India should make its own chips. Manufacturing chips will help reduce the import bill, and that’s where the government’s semiconductor strategy comes in. However, the path to making a complicated leading-edge processor chip will perhaps take two decades. And to get there, the government would, in turn, need more PLIs and upfront capital investment in fabs. In fact, we should expect higher chip imports from China over the next decade until we have a semblance of chip manufacturing done here. Importing cheap chips from China is not a vulnerability.

In sum, I don’t see a rise in imports of components as an indication of the failure of the PLI, just as I don’t interpret the rise in mobile phone exports alone as an unqualified success.

HomeWork

Reading and listening recommendations on public policy matters

* [Chapter] Don’t miss this chapter on isomorphic mimicry. An old classic.

* [Podcast] On Puliyabaazi, MR Madhavan of PRS Legislative Research discusses all things Parliament. The part where we discuss the impending Lok Sabha constituency delimitation threw up a few interesting alternatives.

* [Blog] Paul Cairney’s long-running blog Politics & Public Policy is a must-subscribe.

Insights on issues relevant to India

— RSJ

Late on Friday this week, the RBI issued a circular withdrawing the circulation of ₹2000 denomination banknotes. The RBI clarified that these notes would continue to serve as legal tender, so this isn’t another demonetisation. Here’s the Indian Express reporting:

THE RESERVE Bank of India (RBI) Friday announced the withdrawal of its highest value currency note, Rs 2,000, from circulation, adding that the notes will continue to be legal tender. It said the existing Rs 2,000 notes can be deposited or exchanged in banks until September 30, but set a limit of “Rs 20,000 at a time”.

“In order to ensure operational convenience and to avoid disruption of regular activities of bank branches, exchange of Rs 2,000 banknotes can be made up to a limit of Rs 20,000 at a time, at any bank starting from May 23,” it said.

“To complete the exercise in a time-bound manner and to provide adequate time to the members of the public, all banks shall provide deposit and/ or exchange facility for Rs 2,000 banknotes until September 30, 2023,” the RBI said.

The RBI circular and the press note also attempt to make a convincing, logical case for this decision. There appear to be three reasons for doing this.

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One, the ₹2000 denomination notes seem to have served their useful purpose. They were introduced in November 2016 when the legal tender status of existing ₹500 and ₹1000 banknotes in circulation were withdrawn. Looking back, it appears these were introduced to help re-monetise the economy really quickly, which was under the stress of not having adequate new legal tender banknotes. According to the RBI, after this task of re-monetising was completed, the printing of new ₹2000 banknotes was stopped in 2018-19. Therefore, after 5 years of not printing any new notes, this looks like the right time to take them out of circulation completely.

Two, since most of the ₹2000 denomination notes were issued prior to 2017, they have apparently completed the typical lifespan of a banknote which is between 4-5 years. In an ideal system, most of these old notes should have come back to the RBI by now. Further, these notes are not seen to be used for transactions anymore. They seem to be just sitting somewhere out there. So, in pursuance of the ‘clean note policy’, the best course of action is to withdraw them from circulation. 

Lastly, there was also an allusion to the ₹2000 notes being often found by various investigative agencies in their haul of black money or frauds. So, somewhere there is a view that withdrawing these notes would smoke these fraudsters out, who are sitting on piles of this unaccounted-for cash.

Now, as students of public policy, we must assess this measure based on its intended objectives, the likely costs of doing it and the unintended consequences that are likely to arise. The first reason—that the ₹2000 banknotes have served their purpose, so it is time we take them out—can be scrutinised further.

I don’t think it was made clear when they were introduced back in November 2016 that the only reason for doing it was to re-monetise the economy quickly. There’s a bit of retrofitting of logic here. Also, the decision to stop printing new ₹2000 notes in 2018-19 has meant the total circulation of these notes has been on a decline. In the last four years, the total value of the ₹2000 notes in circulation has gone down from ₹6.5 trillion (over 30 per cent of notes in circulation by value) to about ₹3.6 trillion (about 10 per cent of total circulation by value). I guess, left to itself, we might have had this number slide to a smaller number, say below, ₹1 trillion in the next 3 years. The same point is relevant for the ‘clean note policy’ since these notes would have eventually come back if they were not being used for transactions and were already at the end of their lifetime. So, the question is, did we need to accelerate something that would have followed a natural path to the policy objective that’s desired? Would another three years of these notes in circulation have been detrimental to some policy objective? It is not clear. What’s clear is there will be another season of ordinary citizens queuing up in front of bank branches that will begin on Monday.

It might be argued that there won’t be any panic because the regulator has made it clear that these notes will continue to be legal tender. But who will receive these notes for any transactions starting today? These notes are as good as useless, and for anyone who uses them for transactions or has stored them for any legal purpose, the only way is to get them exchanged for those notes that are both legal and usable. There’s always a sense of schadenfreude among the middle class that it is the rich who will suffer. As was seen during the demonetisation exercise, the poor suffer equally, if not more. The cost of the logistics of sending all ₹2000 notes back from ATMs and branches to the RBI, replacing them with notes of other denominations, the extra hours spent by people exchanging their notes in batches of ₹20,000 and the additional measures to be taken to check for the provenance of the money that will come into the banking system and the risk of frauds during this process are all additional costs to the system. There should be a more compelling upside to these costs except to argue that these notes have served their purpose.

Lastly, on high denomination notes abetting corruption and fraud, there’s some data from experiences in other countries that suggest this. However, experience in India has shown after the initial ‘disruption’, the system finds a new equilibrium, and things continue as usual. The idea that demonetisation would aid the digital economy and will bring down cash in circulation was compelling at that time. But as seen, over time, cash in the economy continued to rise despite a significant ramp-up in digital transactions, which might have happened anyway because of UPI. There are more fundamental reasons for corruption that need to be addressed than making a case for smaller denomination notes. Anyway, the corruption argument never gets old in India, where everyone assumes that, barring them, everyone else around is corrupt. So, the usual arguments have started surfacing on social media that this will impact a small minority of people, and they anyway need to answer why they were hoarding these high denomination notes. And, there’s the political masterstroke argument which suggests this will derail the fundraising ability of the opposition in this election year. I’m not sure if that’s supported by data because we had the unusual scenario of almost 100 per cent of the invalidated denomination notes during demonetisation eventually returning to the RBI. Nobody was wiser when that happened. The only upside at the end of this exercise will possibly be with banks that will have a temporary increase in their deposits. The scramble for deposits that was on because of shrinking liquidity will abate for some time. That will possibly help them support loan growth that was dependent on deposit mobilisation. That might not be a bad outcome, but it is a torturous way to get there. But then we like convolutions.

In parallel, there was another interesting piece of policy-making going on. The TCS (tax collected at source) on international credit card spending outside of India. Earlier during the week, reports emerged that all such spends will now attract a TCS of 20 per cent which can then be recovered by individuals at the time of filing their annual return. The Indian Express on Tuesday reported:

THE CENTRAL Government, in consultation with the Reserve Bank of India, in a late night notification Tuesday amended rules under the Foreign Exchange Management Act, bringing in international credit card spends outside India under the Liberalised Remittance Scheme (LRS). As a consequence, the spending by international credit cards will also attract a higher rate of Tax Collected at Source (TCS) at 20 per cent effective July 1.

The notification brings transactions through credit cards outside India under the ambit of the LRS with immediate effect, which enables the higher levy of TCS, as announced in the Budget for 2022-23, from July 1. This is expected to help track high-value overseas transactions and will not apply on the payments for purchase of foreign goods/services from India.

Prior to this, the usage of an international credit card to make payments towards meeting expenses during a trip abroad was not covered under the LRS. The spendings through international credit cards were excluded from LRS by way of Rule 7 of the Foreign Exchange Management (Current Account Transaction) Rules, 2000. With the latest notification, Rule 7 has now been omitted, paving way for the inclusion of such spendings under LRS.

Now, what could be the reason for this? The Chief Economic Advisor in a column in the Indian Express gave an insight into the thinking:

It is a fact that remittances under LRS have increased multi-fold in the last few years, and as per data published by the Reserve Bank of India (RBI), LRS remittances which were Rs 0.9 trillion in FY2019, crossed Rs 2 trillion in FY2023. During FY2023, an interesting trend was noticed in the remittances for deposits, purchase of immovable property, investment in equity/debt, gifts/donations and travel. Remittances under these heads constituted almost 70 per cent of the total, representing a year-on-year growth of 74 per cent. Foreign travel alone was almost Rs 1.1 trillion in FY2023, a three-fold increase from the pre-Covid period. In all of these, payments made through credit cards are not reflected as such payments were not subject to the LRS limit. This is an anomaly that needed to be fixed anyway.

We are back to the old Indian argument. There are people who are spending money on their credit cards abroad that’s not captured in the LRS limit. We need to know who these people are and what is the amount they are spending. That’s fair. It is an information problem that needs to be solved. Find out who are the people spending this and add it back to their LRS eligibility. Better still, increase the LRS limit so that people can spend more freely. We aren’t in the 70s that we need to conserve foreign exchange through means that make the lives of ordinary citizens difficult. Why should a tax be applied to an information problem? And it is conceptually fine to say that this tax amount is only deposited with the government during the transaction and can be recovered at the time of filing the annual return. But there are way too many complications at an operational level, including upfront working capital costs.

The challenge of tracking international spending, separating corporate and individual purchases and optimising for the overall LRS limit, especially if people have kids studying abroad, will burden individuals. For card companies, it will mean helping customers track this, figuring out all sorts of exception scenarios when a customer cancels a foreign transaction on which a TCS has already been paid or where they default on payment but the card company has already deposited the TCS with the government. Instead of simplifying the tax structure and remittances, the attempt is to complicate things to catch hold of a few exceptions. And those who claim this impacts only 7 per cent of people who have a passport, I can only say why inconvenience even 1 per cent of citizens if there’s no compelling motive. 

Thankfully, some sense seems to have prevailed, and we had a clarification from the finance ministry on Friday. The ministry clarified:

Concerns have been raised about the applicability of Tax Collection at Source (TCS) to small transactions under the Liberalized Remittance Scheme (LRS) from July 1, 2023. To avoid any procedural ambiguity, it has been decided that any payments by an individual using their international Debit or Credit cards up to Rs 7 lakh per financial year will be excluded from the LRS limits and hence, will not attract any TCS.

Small mercies. But it still doesn’t fully do away with an unnecessary measure. 

India Policy Watch #2: Technological Learning is a Marathon, Not a Sprint

Insights on issues relevant to India

— Pranay Kotasthane

Electronics manufacturing is a hot topic nowadays, as it is being seen as a lead indicator of India’s improving manufacturing prowess. Not a week goes by without reports on this topic, ranging from the mobile exports clocked every quarter and the difficulties encountered by companies in localising production to the uptake of the Production-linked Incentives (PLI) scheme to encourage production.

Broadly speaking, the analyses can be classified into two simple categories: detractive (“hum se naa ho paayega” type) and presumptuous (“Hum jahan khade ho jaate hain line wahi se shuru hoti hain” type). I contend that both kinds of analyses make a common mistake: they don’t appreciate a concept of called technological learning. This leads them to reach similar conclusions, albeit through different perspectives.

Dodgson, a scholar of innovation, defines technological learning as “the ways firms build and supplement their knowledge-bases about technologies, products and processes, and develop and improve the use of the broad skills of their workforces”. The assumption is that firms build additional capabilities over time as and when they keep getting better at doing relatively simpler tasks, projects, and processes.

The detractors of India’s nascent electronics manufacturing are quick to point out that Indian manufacturers’ high failure rates are a clear indication that India cannot do large-scale manufacturing. For instance, the news report that iPhone casings produced at Tata’s Hosur plant had a 50 per cent failure rate, has become an oft-cited datapoint to downplay India’s manufacturing capabilities. While such critiques should not be dismissed lightly, it’s also important not to overreact. Electronics manufacturing in China faced pretty much the same challenges; in fact, Chinese manufacturers had far lower yields in the initial phases. Technological learning and upgradation happen over time; it is unrealistic to expect immediate success in this field.

On the other hand, fervent supporters believe that the Indian government can boost manufacturing output and export competitiveness merely by implementing industrial policies and import substitution measures. In this model, PLI schemes, higher import tariffs, and infant industry protection are necessary and sufficient conditions for building India’s electronics manufacturing sector. This line of thinking also ignores technological learning. Indian firms will have to begin with the assembly of imported components necessarily. In fact, we should be willing to digest a decrease in the domestic value added per unit of demand over the next few years, as was the case in China and Viet Nam. As Indian manufacturing achieves global scale, local content addition will increase by default, as firms seek to optimise costs, and employees go on to become local entrepreneurs. The hurry to localise domestic value addition runs at odds with exporting competitiveness, a point that the self-assured are ignoring.

And so, both viewpoints are misguided due to their disregard for the role of technological learning in manufacturing development. It is crucial to acknowledge that gaining proficiency in manufacturing takes time.

Naushad Forbes Business Standard article explains this process of learning took place in East Asia:

Firms like Samsung, Hyundai, LG, TSMC and Acer did not start as global brands. They began with outsourcing, as original equipment manufacturers or OEMs, building manufacturing operations of global scale. They used their demanding buyers as a source of technology that made them world-competitive. But they did not stop there. They invested in R&D, as process innovation, to make manufacturing more efficient. They then offered their buyers products with new and improved design, moving up the scale to own design and manufacture or ODM, claiming a piece of the innovation rents that came from better products.  This required them to invest in substantial product design capabilities, which over time completely outclassed and replaced the design capabilities of their buyers. And, finally, with world-competitive manufacturing and leading-edge product design in place, they made the shift to own brand manufacture or OBM, launching their own brands, going beyond their home market, spreading step by step into the world. This is the story of Samsung in microwaves and semiconductors, LG in TV sets, Hyundai in cars and excavators, TSMC in microprocessors, and Acer in laptops. This OEM to ODM to OBM story is one of continuous learning.

It’s crucial to bring technological learning back in conversations on India’s manufacturing.

P.S.: Earlier this week, the government announced another PLI scheme for "laptops, tablets, all-in-one PCs, servers etc.", with a budgetary outlay of ₹17000 crores over six years. If the government appreciated technological learning, it would accompany this PLI with a reduction in customs duties. Competitive exports need competitive imports of intermediate components and equipment.

Matsyanyaaya: Launch India-US Trade into Another Orbit

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Ahead of the Indian PM’s visit to the US next month, some of us at Takshashila propose an ambitious agenda on the trade front in this document—increase bilateral trade to $500 billion by 2030 and $1 Trillion by 2040.

Here’re the pathways to achieve this goal:

* Expand the existing US-India 2+28 ministerial dialogue: This dialogue currently comprises the Foreign and Defence ministers from both countries. However, to comprehensively address the intricacies of global trade relations, it would be beneficial to transition to a 3+3 format to include both nations' trade and commerce representatives.

* Capitalize on the role of states: The economic landscape in India is witnessing a shift towards the states. Various factors that significantly influence business operations, such as land acquisition and law and order, predominantly lie under the jurisdiction of individual states. Owing to India's vast size and diverse nature, different states have fostered their unique strengths and advantages. The trade relations between the two nations can be further enhanced through a partnership where groups of states engage in reciprocal visits each year, bolstering trade ties and fostering mutual growth.

* The Trade Policy Forum (TPF) must be held every year. It is the right cadence to ensure disciplined action and follow-through on ambitious goals. The institutional memory of the TPF will work to create continuity. The old adage "we overestimate what can be done in one year and underestimate what can be done in 5 or 10 years" is particularly applicable here.

* The organic growth in trade between companies on either side needs only the occasional enablement. Trade in technology services, pharmaceuticals, SaaS, industrial goods and many other sectors can continue. It will benefit from forums like the US-India Business Council (USIBC) that seek to remove frictions in the ordinary conduct of business and shine a light on some sticky areas.

* Create plurilateral trade partnerships. Until now, the US and India do not together find themselves in any regional trade partnership. The revived QUAD, with a heavy security focus, will be one such partnership with significant trade implications. The Indo-Pacific Economic Framework (IPEF) proposed this summer is a promising way to advance on a partnership, but the partnership details must be worked out. For the greater good, India and the US will have to work out sticking points in the data & privacy sections of the agreement. There appears to be significant mutual concurrence on tax, anti-corruption and clean energy, the other three pillars of the IPEF agreement.

* Trade in high-technology sectors would get a fillip from the two governments setting up specific framework agreements. The new US-India initiative on Critical and Emerging Technologies (iCET) is an example of a framework agreement that could kickstart interaction between government, industry and academia in areas such as artificial intelligence (AI), semiconductors, 5G/6G telecommunications, quantum computing, biotech, deep ocean and space technologies.

* In commercial and societal terms, the exchange of people will be the biggest binding factor between the two countries. In the short term, reciprocal visa access and availability should be addressed on a priority basis. In the longer term, both sides should work on Indians being separated from the general pool of "H1" applicants and in a category of their own. Additionally, the thresholds for each country employing citizens of the other should be brought down gradually.

[From Narayan Ramachandran et al., “Time to Launch the US-India Trade Relationship into Another Orbit,” Takshashila Policy Advisory 2023-02]

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Anupam Manur on the ₹2,000 note withdrawal in Moneycontrol — “Like a nightmare resulting from a traumatic experience for a person suffering from PTSD, demonetisation came back to haunt the collective consciousness of this country when the Reserve Bank of India (RBI) decided to recall the 2000 rupee note.”

* [Podcast] In the next Puliyabaazi, Devashish Dhar talks about cities, urbanisation, working in government, etc. Strongly recommend it to people considering public policy as a career option.

* [Articles 1, 2, & 3] Naushad Forbes’ series on private R&D and national innovation in Business Standard is a must-read for those interested in technology geopolitics and tech policy.

Reflections on global policy issues

— RSJ

This week, Donald Trump urged Republican lawmakers to let the U.S. default on its debt if the Democrats don’t agree on massive budget cuts. Trump likened the people running the U.S. treasury to ‘drunken sailors’, an epithet I can get behind. Default is not something Janet Yellen, the U.S. Treasury Secretary, can even begin to imagine. As CNBC reported, Yellen chose strong words to express her views if the debt ceiling was not raised by the House:

“The notion of defaulting on our debt is something that would so badly undermine the U.S. and global economy that I think it should be regarded by everyone as unthinkable,” she told reporters. “America should never default.”

When asked about steps the Biden administration could take in the wake of a default, Yellen emphasized that lawmakers must raise the debt ceiling.

“There is no good alternative that will save us from catastrophe. I don’t want to get into ranking which bad alternative is better than others, but the only reasonable thing is to raise the debt ceiling and to avoid the dreadful consequences that will come,” she told reporters, noting that defaulting on debt can be prevented.

There is more than a grain of truth there in some of her apparent hyperbole. The U.S. hegemony in the global financial system runs on trust that they won’t default on their debt. Take that trust out of the equation, and what have you got left? This is somewhat more salient in these times when there’s a talk of de-dollarisation going around. Russia and China have been keen to trade in their own currencies between themselves and other partners who are amenable to this idea. And they have found some traction in this idea from other countries who aren’t exactly bit players in the global economy. In March this year, the yuan overtook the dollar in being the predominant currency used for cross-border transactions in China.

Here’s a quick run-through of what different countries have been doing to reduce their dollar dependence. Russia and Saudi Arabia are using yuan to settle payments for gas and oil trade. Russia offloaded a lot of US dollars in its foreign reserves before the start of the war and replaced it with gold and yuan. It will possibly continue building yuan reserves in future. Brazil is already doing trade settlements in yuan and is also using the CIPS (China’s response to US-dominated SWIFT) for international financial messaging services. Argentina and Thailand seem to be also doing more of their trade with China in yuan. And I’m not including the likes of Pakistan, Bangladesh and other smaller economies that have politically or economically tied themselves up with China and are following suit. And a few weeks back, the French President, Emmanuel Macron, also raised the issue of strategic autonomy of the EU after his visit to Beijing. As Politico reported:

Macron also argued that Europe had increased its dependency on the U.S. for weapons and energy and must now focus on boosting European defense industries. He also suggested Europe should reduce its dependence on the “extraterritoriality of the U.S. dollar,” a key policy objective of both Moscow and Beijing. 

“If the tensions between the two superpowers heat up … we won’t have the time nor the resources to finance our strategic autonomy and we will become vassals,” he said.

You get the picture. This idea of de-dollarisation seems to be gaining traction. How real is this possibility? There are possibly three lenses to look at this issue, and we will cover them in this edition.

Why the recent hate for the dollar?

A useful area to start with is to understand where this desire to find alternatives to the dollar is emerging. I mean, it is obvious why Russia and China are doing it and the way the U.S. used its dominance over the financial system to shut out Russia. Companies were barred from trading with Russia, Russian banks couldn’t access SWIFT and networks like Visa and Mastercard stopped their operations. Russia got the message but so did other large economies that didn’t think of themselves firmly in the U.S. camp. ‘What if’ questions began circulating among policymakers there. What if, in future, a somewhat unpredictable U.S. president decides to do this to us? And once you start building these scenarios, you soon realise the extent of dependence the global financial system has on not just the dollar but, beyond it, to the infrastructure and rules of the game developed by the U.S. corporations. There’s been a measured retreat ever since.

In India, a visible example of this has been the push toward Rupay by the regulator and the government in lieu of Visa and Mastercard. But merely looking at the U.S. response to Russia as the reason would be missing the longer-term trend. In his book ‘Bucking the Buck’, Daniel McDowell shows data on the annual number of executive orders that instruct the US Treasury to enforce financial sanctions against specially designated nationals (SDNs). These were rarities in the 70s. By the early 2000s, such annual orders were in their low twenties and in the last few years, they have reached the three-figure mark. It is clear that the U.S. is using its enormous clout as the owner of the global reserve currency and financial infrastructure to punish those who fall out of line. This is war by other means. Interestingly, this ‘sanctions happy’ behaviour in the last decade coincided with a wave of populist leaders coming into power in many countries who would not like to be seen as weak or held to ransom by the U.S. This has meant these states have used strategic autonomy as a plank to pursue their interests to go around the U.S. built system. I don’t see this trend abating any time soon. The future U.S. administrations will continue to use financial coercion as a tool because it appears bloodless, and the larger economies will continue freeing themselves from this hegemony one system at a time. 

The tough and fortuitous road to becoming a reserve currency

But does that mean we will eventually end up with de-dollarisation? Well, there are two things to appreciate here. How does a currency become a reserve currency? How did the dollar become one? And once it does, what keeps it there? If you go back a little over a hundred years, most countries in the world pegged their currencies to gold as a means of facilitating cross-border trade and stabilising currencies. But during World War 1, it became difficult for these countries to fund their war expenses without printing paper money and devaluing their currencies. Britain continued adhering to the gold standard, but it was difficult for it to sustain its war efforts too. It had to borrow to run its expenses during and after WWI. Between the two wars, the U.S. became a huge exporter of goods and armament to the rest of the world, and it took the payment in gold. By the time World War 2 was ending, the U.S. had hoarded most of the world’s gold, which made going back to the gold standard impossible because other countries just didn’t have any gold. When the allied nations met at Bretton Woods to discuss the new financial world order after the war, it became quite clear that the only real option of managing a foreign exchange system was one that would have all other currencies pegged to the dollar, which would then be linked to gold. It is important to understand that there was no specific effort made to replace Pound as the international reserve currency. It just became inevitable, given the mix of circumstances.

Around the same time and for a decade after, the U.S. led the post-war reconstruction efforts in Western Europe and Japan, which gave it a political clout that was unmatched. This political dominance, along with the remnants of the Bretton Woods agreement, is what runs the global currency system in our times, though, in the 70s, the U.S. delinked the dollar from gold as well. That led to the floating exchange rates system that exists today and the dollarisation of the global economy. Over time countries learnt to accumulate their foreign exchange reserves in dollars by buying U.S. treasury bills. Together with the IMF and WB and the associated ecosystem that got built around the U.S. dollar, it became the force that it is today. Now for any currency to replace the U.S. dollar, it has to have the happy coincidence of being a dominant political and economic force, a lack of alternatives for the countries and an alternative to Bretton Wood (or a modification of the same) which can replace the current system. It is very difficult to imagine how something like this can happen unless there is a global crisis of a magnitude where a rebaselining of everything becomes the only way ahead. 

That brings us to the other point on what sustains the dollar as a reserve currency. There are multiple factors at play here. There are, of course, the network effects of the dollar being deeply embedded in so many commercial ecosystems that taking it out is rife with friction and pain. Also, the dollar is fully convertible, which makes it convenient for others to use it as a store of value. It has remained stable; its market is deep and liquid, enabling easy conversion of bonds to cash and vice versa; there exists a mature insurance market to cover currency risks and above all, we have an implicit guarantee that the U.S. will not default on its debt. This is a trust that has been built over the last eight decades because the world believes the U.S. will run a rule-based order with a strong legal framework to ensure no single person can override rules or conventions. 

Yawn when you hear Yuan as the next reserve currency

So, how does one see the efforts of China or Russia to wean themselves away from this dollar-dominated system? Will the yuan be able to replace the dollar ever? Apart from the points mentioned above, which led to the dollar being in a unique place in the world in the post-war days and which won’t repeat itself any time soon, there are other fundamental issues with the idea of the yuan as a reserve currency. To begin with, it isn’t convertible, and China runs a ‘closed’ capital account system. It is difficult to move money in and out of the country freely. You will need approvals. The opaque legal system, the authoritarian one-party (one-man) rule and the lack of depth in the yuan market mean it is impossible to imagine any prudent central bank risking its entire foreign exchange reserve in yuan. China could turn into an economic giant by exploiting a global trade order without adhering to its associated political expectations. But to think it could do the same in currency exchange order is a pipe dream. Even the numbers of the recent past bear this out. For all the talk of de-dollarisation, there has been a net sell-off of Chinese government bonds by private players in the last year. No one wants to sit on Chinese bonds if things go south in the global political economy. The central banks around the world who have wanted to diversify away from the dollar in their foreign exchange reserve don’t seem to have walked their talk. Even they have been net sellers of Chinese government bonds barring the initial days of the Ukraine war. Lastly, China is still struggling to raise consumption in its economy because, with a closed capital account and surplus capacity, it doesn’t know what to do with the surplus yuan. Without consumption going up, it will make things worse if it starts becoming a reserved or a semi-reserve currency for the world. 

The probability of de-dollarisation seems to be hugely exaggerated at this moment. The alternatives are worse, and for those who complain about the coercive nature of U.S. diplomacy because of their financial clout, wait till you have China with that power. You can check with Sri Lanka for how it feels to be under China’s thumb economically. Also, none of the hype around bitcoin, stablecoin or CBDC is ever going to materialise for them to replace the dollar. The recent events have shown the fairly flimsy ground on which the bitcoin exchanges (banks?) run. It is difficult to see the lack of trust to change in a hurry. But this also doesn’t mean the trend towards diversification of central banks’ reserves will buck soon. The gradual move towards reducing dependence on the dollar and its associated ecosystem will continue. Should the U.S. be worried about this? It shouldn’t, really. It draws enormous privilege for being the reserve currency of the world. It makes its job to borrow or access money very easy. And the fact that it is a safe haven means it benefits from every crisis. But it should also be clear that this privilege has hurt its ability to export because the dollar remains stronger than it should. This, in turn, has led to the financialisation of the U.S. economy, with the rich getting richer and an evisceration of the U.S. manufacturing capabilities. Reserve diversification won’t be such a bad thing for them. But that might mean a reduction of a few hundred basis points in what central banks hold globally in U.S. treasuries. 

That won’t de-dollarise the world. For that to happen, something catastrophic will need to happen. Maybe that’s why Yellen used that word about the possibility of the U.S. defaulting on its debt. That’s the kind of self-goal they must avoid.  

Matsyanyaaya: The Two Equilibria in India-US Relations

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

There has been a healthy debate over the last couple of weeks on the state of the India-US relationship. In a Foreign Affairs article, Ashley Tellis, a key figure in the 2005 civil nuclear deal, a well-known realist scholar, and a strong proponent of stronger India-US relations, cast some doubt on the burgeoning partnership. The article, provocatively titled ‘America’s bad bet on India’, concludes thus:

The United States should certainly help India to the degree compatible with American interests. But it should harbor no illusions that its support, no matter how generous, will entice India to join it in any military coalition against China. The relationship with India is fundamentally unlike those that the United States enjoys with its allies. The Biden administration should recognize this reality rather than try to alter it.

Tellis reasons that India wants a closer relationship with the US to increase its own national power, not to preserve the liberal international order or to collaborate on mutual defence against China. He further argues that the US ‘generosity’ towards India is unlikely to help achieve its strategic aim of securing meaningful military contributions from India to defeat any Chinese aggression in East Asia or the South China Sea.

As you would imagine, this article put the cat amongst the pigeons. However, I agree with the fundamental argument. Expectation setting is important, and it is true that India is unlikely to behave like a weaker ally; the US-India relationship will most certainly have some shades that the US-China relationship had between 1980 and 2005.

In what seems to be a rejoinder to this article, Ashok Malik—previously a policy advisor in the external affairs ministry—argues that fixating on India’s role in a hypothetical war on Taiwan is a wrong question to ask, an imagined roadblock that even the Biden administration isn’t overly concerned about. Instead, Malik lists the growing relationship in several domains to conclude that the two administrations are far more sanguine, having figured out an approach to work with each other despite key differences.

I agree with this view as well. There’s no doubt that the India-US relationship has grown across sectors despite fundamental differences during an ongoing war in Europe. It is easy to. observe the shift in India-US conversations at the policy execution levels. The talks are no longer about the whys but about the hows. Gone are the days when the India-US partnership conversations began with Pakistan and ended with Russia, with the two sides taking potshots at each other in between. The conversations are about debating realistic projects that India and the US could accomplish together in areas such as space, biotechnology, semiconductors, and defence.

How, then, can I agree with two seemingly opposing views? Because they aren’t mutually exclusive. The India-US relationship is so far behind the production possibility frontier on technology, trade and defence that there are enough low-hanging fruits to pick. And that’s exactly what we are seeing now. But if the US president were to change, or if there were to be an escalation around Taiwan, the India-US relationship would likely hit a ceiling that Tellis warns about.

In edition #165, I proposed a tri-axis framework to look at the India-US relationship: state-to-state relations, state-to-people relations, and people-to-people relations. There has never been a problem on the people-to-people axis. Like Mr Malik, I, too, think that state-to-state relations have turned a corner. However, it is the state-to-people axis which is the problematic axis. Many Indians still seem to harbour a deep frustration with the American State. On the other hand, many Americans also have doubts about the Indian State as a strategic actor.

Finally, it’s only the two administrations that can break this ceiling. The trade-offs aren’t easy, but they are real. Without the Indian government committing itself to do more to counter the Chinese military threat in the seas, the US is unlikely to transfer cutting-edge technologies. Likewise, unless the US quits its stubbornness to give more Indian products preferential access to its markets or delivers on the asymmetric promises under the technology and defence agreements, India is unlikely to revise its stance.

In other words, the stage is set for the Indian PM’s official state visit to the US next month.

India Policy Watch #1: Generalists vs General Equilibrium

Insights on issues relevant to India

— Pranay Kotasthane

Non-civil services folks who have worked in governments are almost always extremely insightful. Perhaps, their experience working with the bureaucracy gives them a filter to reject impractical ideas, while their breadth of knowledge allows them to take a long-term view of policy ideas. These "scholar-warriors" are often able to get to the root of issues.

One such person is Montek Singh Ahluwalia, who was a guest on this week's Ideas of India podcast. Among the many insights he delivers, one that switched a lightbulb on for me was the segment on "generalists vs specialists" in government. While this is an old debate, one that civil service "mains" exam takers would not so fondly recall, this conversation made me think somewhat differently.

Responding to a question on the HR problems in government, Ahluwalia says:

There’s big bias within the government against people wanting to specialize. The IAS’ view of itself is, it’s a generalist service. This I think is a bit of a colonial hangover. You come from England to rule the country; expertise is looked down upon. But in this day and age, we ought to be encouraging the people who are really into IT—there’s no point putting someone who’s really made up his mind that he wants to be in IT to have a stint in education and health and road transport and that sort of stuff.

At another point in the episode, he begins the journey of a policy reform as follows:

In the Indian system, and maybe it’s true in all systems, every area is assigned to a ministry, and changes of policy that belong (in a narrow sense) to that area are the responsibility of the ministry. There are two problems here. One is, the functioning of a system as a whole requires you to do more than just add up what needs to be done in each area, because you want to look at what the economist would call a general equilibrium approach. If you want to reach a particular result, you’ve got to do A over here, B over there, C over there.

I think there's a deeper insight at the intersection of these two dimensions. The “generalists vs specialists” debate masks another important dimension of effectiveness—whether the person approaches a problem with general equilibrium thinking or is limited to partial equilibrium analysis.

General equilibrium analysis takes into account the long-term interactions of a large number of economic agents. In mathematical terms, it is based on the assumption that several variables can change at once in response to a policy change. Partial equilibrium analysis, on the other hand, focuses narrowly on one sector and a handful of variables.

Ahluwalia explains that generalist civil service officers can default to partial equilibrium analysis because they are blinkered by their ministry mandates and interests. For example, few bureaucrats from the Ministry of Commerce will advocate that a unilateral lowering of tariffs will be beneficial to India, even though a general equilibrium analysis says so.

However, many specialists also fall into this same trap, albeit for different reasons. An urban planner is likely to hate mixed-use neighbourhoods, while an environmentalist might argue that all mining is evil. These partial equilibria arise from the failure to see the interlinkages across the economy, a crucial aspect of general equilibrium analysis.

So, irrespective of whether you are a generalist or a specialist, what matters is whether the bureaucrats are able to approach problems with a general equilibrium mindset. The current government mechanism to move career bureaucrats across ministries through deputations is probably a sub-optimal way to achieve competence in this dimension. The second mechanism is to have intra-ministerial committees or expert committees. Organisations such as the Planning Commission, Niti Aayog, or the PMO are supposed to bring in a general equilibrium mindset as well. The question is which of these bodies is best equipped to do this in this way. Probably, another way to push towards this equilibrium is to have economists and behavioural sociologists in many ministries so that their internal recommendations take a broader view beyond the self-protection of ministerial turfs.

PS: There’s a nice chapter on “Trace the general equilibrium effects” in In Service of the Republic by Shah & Kelkar.

HomeWork

Reading and listening recommendations on public policy matters

* A Twitter friend asked for book recommendations to understand post-independence Indian economic history. These are the ones that came to mind:

* India's Long Road: The Search for Prosperity by Vijay Joshi

* India: the Emerging Giant by Arvind Panagariya

* India's Tryst with Destiny by Arvind Panagariya and Jagdish Bhagwati

* Backstage: The Story Behind India’s High Growth Years by Montek Singh Ahluwalia &

* Changing India volume, this set is a compilation of Manmohan Singh’s papers (reading level: advanced)

* [Podcast] This Grand Tamasha episode is a great introduction to internal security in India, backed by the latest research and data on a crucial yet under-discussed topic.

* [Podcast] Should there be a caste census? Here’s a Puliyabaazi on this topic that’s sure to gain more traction as the national election draws near. We present two opposing perspectives, one by Yogendra Yadav and the other by Pratap Bhanu Mehta, before reaching our own divergent conclusions. Listen in and tell us what you think.

Reflections on global policy issues

— RSJ

A major state election (Karnataka) is coming up this week. But there’s hardly anything worth analysing. The Congress seemed to have a slight edge in the early opinion polls, but that’s wearing thin. The BJP, always with its ears to the ground, has cranked up its poll machinery in the last couple of weeks drawing upon the star power of the PM in the urban areas of the state. The friendly media houses have been mobilised to pick up ‘emotive’ issues that would tilt the scale in favour of the party in power. It is not too difficult to figure out what the average voter wants if you go by the opinion polls and surveys. But those substantive issues just don’t feature in the public discourse. If you read the papers or media reports on what’s being debated among parties in Karnataka, it is about who is a Hindu hater, who prostrates more often before deities and how going back to the OPS (old pension scheme) is such a wonderful idea. In the classical model of how representative democracy ought to work, the voters would have a limited view of how the world works, and it is the representative who owes the voters not only his labour but also his judgment on issues (to riff on Burke).

That seems to be inverted here. One set of representatives has, over the last few years, instituted all kinds of targeted laws - hijaab ban, anti-conversion laws, scrapping minority quotas and cow slaughter ban - in the hope that they will yield electoral gains. The other set is talking of another set of bans convenient to them and some really bad economic policies. We often say that this newsletter attempts to change the demand side of the political equation by making people more aware of public policies and demanding better from their representatives. What we have here is the public demanding the right kind of things (if opinion polls are to go by), but their representatives are keen on dragging them back to divisive emotive issues. The Karnataka election will be a good test of what prevails eventually. I can almost see the straight line from these polls to the general elections due almost exactly 12 months from now. We will all be debating similar trivial issues than what really should matter to India. For some reason, that doesn’t make for a good topic of debate. It makes any election analysis a waste of time, really. 

Switching gears, as I finished writing my last week’s edition on what the US Fed refuses to learn from the SVB collapse, another mid-sized US bank, the First Republic Bank (FRB), went down and was sold to J.P. Morgan, the ultimate backstop in the US financial system. No amount of assurance from FDIC to the depositors of the bank nor the combined infusion of capital about a month back from a consortium of big banks into FRB was enough to stanch the outflow of deposits. Soon the bank was insolvent, the shareholders and bondholders lost everything, and J.P. Morgan was given enough of a sweet deal to pick up the pieces. I’m sure the Fed will come out with another report on the FRB collapse where it will blame the management for not hedging its treasury risks and being lax in its risk practices. There will be a light rap to the supervisors and staff from Fed who monitored FRB, and that will be that. I hope there’s some more introspection by the Fed than that. Because as the shares of PacWest and Western Alliance have sunk over the last two days, it is clear that a number of mid-sized banks are going to collapse in slow-motion and end up in the lap of J.P. Morgan or FDIC very soon. The feeble Fed response was a 25 bps hike in rates last week with a strong indication that it will hit the pause button on hikes now. The question is if that’s enough to structurally save many of these banks.

I have argued for the past couple of months (just after the SVB collapse) that there are three problems for the Fed to contend with, and there are no real answers for them. It is Hail Mary time. Choose the best among the worst options and brace for the impact. I will lay out the three problems it faces before suggesting what looks like the best of the worst option that the Fed has chosen. 

First, the Fed continued raising interest rates to fight inflation without thinking through its impact on the banking system. This much is clear now. The surprises that have come up in the shape of SVB, Signature and FRB weren’t anticipated at all. As the interest rates rose, the value of the long-term assets held by banks has fallen while their liabilities, in the form of deposits, which tend to be shorter in term, haven’t fallen as much. The slowdown in the economy has meant there’s not enough demand for credit at elevated rates, which means banks continue to invest in long-term US treasury bills. Every time the rates go up, these held-to-maturity (HTM) assets take a notional mark-to-market loss. A recent report by the Hoover Institution suggests that at this moment, the US Banking system’s market value of assets is about $ 2 trillion below their book value. In an article on Yahoo Finance, Ambrose Evan-Pritchards writes:

The second and third biggest bank failures in US history have followed in quick succession. The US Treasury and Federal Reserve would like us to believe that they are “idiosyncratic”. That is a dangerous evasion.

Almost half of America’s 4,800 banks are already burning through their capital buffers. They may not have to mark all losses to market under US accounting rules but that does not make them solvent. Somebody will take those losses.

“It’s spooky. Thousands of banks are underwater,” said Professor Amit Seru, a banking expert at Stanford University. “Let’s not pretend that this is just about Silicon Valley Bank and First Republic. A lot of the US banking system is potentially insolvent.”

The second problem, which kind of starts giving this a contagion feel, is the state of the commercial property market in the US. Interest rates have moved up too fast, the slowdown is real with many large employers laying off people, so there’s no real need for commercial capacity, and the excess liquidity fuelled by the Fed during the pandemic meant additional capacity was built up cheaply, which now has no takers. What’s worse, the rapid increase in rates means that a lot of these loans that will come up for refinancing soon (at higher rates) will face defaults. The mid-sized regional banks have a sizable exposure to commercial real estate, with estimates that about two-thirds of all commercial property borrowing comes from them. From the same Yahoo Finance article:

Packages of commercial property loans (CMBS) are typically on short maturities and have to be refinanced every two to three years. Borrowing exploded during the pandemic when the Fed flooded the system with liquidity. That debt comes due in late 2023 and 2024.

Could the losses be as bad as the subprime crisis? Probably not. Capital Economics says the investment bubble in US residential property peaked at 6.5pc of GDP in 2007. The comparable figure for commercial property today is 2.6pc.

But the threat is not trivial either. US commercial property prices have so far fallen by just 4pc to 5pc. Capital Economics expects a peak to trough decline of 22pc. This will wreak further havoc on the loan portfolios of the regional banks that account for 70pc of all commercial property financing.

Estimates vary, but it is likely that even a 10-15 per cent increase in default rates on commercial property when the refinancing chickens come home to roost could mean about $ 100 billion in losses for banks. And these are real losses, not the notional variety sitting on the books. Will the regional banks be able to weather this? And what happens if 4-5 of them catch a cold together in this portfolio? The risk of contagion flowing up the banking food chain is real.

Lastly, the Fed, FDIC and the government took the extraordinary step of guaranteeing all deposits after the collapse of SVB to reassure depositors and not have further runs on mid-sized banks. But that didn’t stop the ever-increasing deposit erosion for FRB during April. People can do the math, and they realise there’s no way the government can fill a giant hole in case there’s a real deposit run. The FDIC, after all, has a little over $ 100 billion to act as insurance for such an eventuality. That’s loose change in the broader scheme of things. So, the depositors will flee the more you try and convince them all’s well. Plus, the blanket deposit backstop has meant there’s a moral hazard built right there for the management not to be too worried about the nature of deposits they bring or the risk of serious asset-liability mismatches. 

At the time of SVB collapse, I wrote in edition # 205:

I guess one way to look at this is if you let fiscal dominance become the central canon of how you manage your economic policy, you will eventually reach the same place as other economies (mostly developing) that have indulged in the same for years. The monetary authorities in the U.S. have been accommodating the fiscal profligacy of the treasury for years. This was accentuated during the pandemic. Trillions of dollars were pumped in to save the economy. I’m not sure how much the economy needed saving then. But that bill has come now. First in the shape of inflation, followed by rapid, unprecedented rate hikes and the inevitable accidents that are showing up now. Almost certainly, a recession will follow. Isomorphic mimicry of Latin American monetary policy indeed.

Now, back to Evans-Pritchard and his article in Yahoo Finance:

The root cause of this bond and banking crisis lies in the erratic behaviour and perverse incentives created by the Fed and the US Treasury over many years, culminating in the violent lurch from ultra-easy money to ultra-tight money now underway. They first created “interest rate risk” on a galactic scale: now they are detonating the delayed timebomb of their own creation.

Chris Whalen from Institutional Risk Analyst said we should be wary of a false narrative that pins all blame on miscreant banks. “The Fed’s excessive open market intervention from 2019 through 2022 was the primary cause of the failure of First Republic as well as Silicon Valley Bank,” he said.

Mr Whalen said US banks and bond investors (i.e. pension funds and insurance companies) are “holding the bag” on $5 trillion of implicit losses left by the final blow-off phase of the Fed’s QE experiment. “Since US banks only have about $2 trillion in tangible equity capital, we have a problem,” he said.

Going back to the original question I posed - what will Fed do given these problems on hand? I guess it has decided to choose what it thinks is the least worst option. It cannot let go of its fight against inflation. It has to find a way to avoid recession. So, all it can afford is a controlled banking crisis. An oxymoron if ever there was one. But that’s where we are headed, where we will see things unfold in a slow but almost predictable manner. The Fed will try and boost the banks’ capital in the meantime and hope the best of them brave through this without any risk of contagion. 

Anyway, in the worst case, there’s always Jamie Dimon and his chequebook.

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Numbers that Ought to Matter: In April 2023, the Union Health Minister reported that India has 108,000 MBBS seats in 660 colleges and 118,000 BSc nursing seats in approx 900 colleges. The total number of seats on offer is quite low, despite the large number of colleges. On average, each medical college has 163 seats, and each nursing college has just 131 seats. Government policy should focus on helping existing colleges increase their intake. For more context, read edition #159.

India Policy Watch #1: Coal is Out? Naah.

Insights on issues relevant to India

— Pranay Kotasthane

Earlier this week, I came across this Business Standard report:

“India plans to stop building new coal-fired power plants, apart from those already in the pipeline, by removing a key clause from the final draft of its National Electricity Policy (NEP), in a major boost to fight climate change, sources said.”

My prior assumption was that given coal-based power’s lower costs, India would construct many more coal-powered plants over the next two decades to meet a growing economy’s demand. Hence, this news item came as a bit of a surprise. So I went through the draft National Electricity Plan to understand the reasoning.

Before we dive in, some bureaucratic knots that need untangling. The cited “final draft” of the National Electricity Policy is nowhere to be found on the Ministry of Power website. But I could find an earlier draft on the IIT Kanpur’s Centre for Energy Regulation website! A Policy document such as this only lists the priorities and steers the sector. From it arises a Plan that’s to be released every five years by the Central Electricity Authority. The Plan document is the real deal as it does demand projections through an ‘Electric Power Survey’. It then presents the energy generation mix required to meet the projected demand scenarios. A part of this elusive plan document was released, after many delays, in September 2022. Some relevant insights from the plan:

* The current installed power capacity of ~400GW split looks as follows:

* By FY32, it is projected that India’s energy demand will be 2538 Billion Units, and peak power demand will be 363 GW, up from 1624 Billion Units and peak demand of 216 GW in FY23.

* Coal+Lignite accounted for 52.7% of total installed capacity in FY23.

* Using a planning tool that optimises for factors such as fuel availability, operational availability, and sustainability, the Plan throws up a required power generation capacity mix.

* After taking all these constraints into account, the Plan finds that by FY32, India would need an additional installed coal capacity of 42.6 GW in the base case scenario and 53.6 GW in the increased-demand scenario.

* Around 25.6 GW of capacity addition is already in various stages of execution.

Now, we come to the report claiming a ban on additional coal capacity addition beyond the current in-progress projects. It essentially means that to meet the projected demand, India will have to find other sources to compensate for coal. In the best case, an additional 17 GW capacity will have to be conjured up; and in the worst-case scenario, nearly 28 GW capacity will have to be compensated. This additional capacity goes beyond the planned additions in clean energy generation. That’s why I am sceptical about this news report. It’s unlikely that government will make a blanket commitment.

If we assume the report to be true, advancing the date of halting further coal power generation will require compensation by another reliable source to provide the base load. Only two options can be imagined with today’s technology — nuclear energy and Battery Energy Storage Systems (BESS).

Nuclear energy accounts for just 2 per cent of the total power generation mix today. The current plan already assumes a threefold increase in nuclear power capacity addition. For it to absorb the slack of stopping further coal addition, it has to reach six to eight times the current capacity.

Given that nuclear power generation faces the problem of high capital costs and invites protests, scaling it up is tough unless the Small Modular Reactor (SMR) technology breakthrough leads to mass adoption in India. Maybe for this reason, the government is “considering” overturning a ban on FDI in nuclear power. Expanding BESS capacity also depends on the ability to develop Lithium refining expertise and bring other options, such as Sodium-ion batteries, online.

So, stopping the building of new coal-fired power plants requires far too many other pieces of the puzzle to fall into place. Keep watching this space.

Tailpiece: check out this Puliyabaazi episode on the chemistry, geopolitics, and significance of Lithium-ion batteries.

India Policy Watch #2: Lessons from Apple’s India Journey Thus Far

Insights on issues relevant to India

— Pranay Kotasthane

Apple’s quarterly results are out. Its India revenue registered double-digit growth, prompting Tim Cook to make the now-commonplace “India is at a tipping point” statement. The last seven years have been stunning for Apple’s India business. From being shunned away by the government for their plan to import and sale of refurbished phones to becoming a poster child of electronics manufacturing in India, Apple’s India strategy has come a long way.

I’ve always wanted to know how Apple raised its India game and whether there are broader lessons for Indian public policy from this experience. So I was delighted to read Surajeet Das Gupta’s Business Standard article narrating Apple’s tryst with Indian public policy. Das Gupta identifies these milestones and speed-breakers:

* In 2016, after denying the import-refurbish-sell request, Apple was told to start manufacturing in India if it wanted to set up Apple-owned retail stores.

* In 2017, Apple put forward two pre-conditions for starting manufacturing in India:

* “15-year duty concessions (on capital equipment, components, consumables for smartphones).. and a reduction in customs duty on completely knocked down and semi-knocked down devices to be assembled in India.”

* relaxation of 30 per cent local sourcing directive for foreign direct investment (FDI) in single-brand retail stores.

* After both its asks were rejected, it set up an India team to work with the government and mobile phone industry associations.

* After three years of lobbying, the government relented by allowing the 30 per cent local norm to be met as an average for the first five-year period, not annually. Then the government agreed to qualify the value added by Apple’s contract manufacturers in India—regardless of the destination of these products—as “local sourcing”.

* The government allowed Apple to set up an online store before the physical store if it brought over $200 million FDI and extracted a commitment that the online store couldn’t get into heavy discounting.

* When PLI rules were modified to accommodate Samsung’s entry, Apple went along with the change.

* After the government made the entry of FDI from China in the Indian tech sector arduous due to the Galwan clash, Apple worked with the industry body to get 12 of its Chinese suppliers approved on the condition that they would enter into joint ventures with Indian partners who would have a majority stake. (We wrote about it in edition #199).

Take a breath. And it has only been seven years. There are three ways of interpreting this journey from a public policy perspective.

First, to the extent that the government has been able to capture Apple’s China manufacturing—even if in a really small way—its approach can be called a limited success. The government can rightfully claim that Apple’s supply chain has created over a lakh jobs in India. Grabbing some part of the manufacturing of the world’s biggest company has a signalling effect as well. It will also help Apple’s Indian partners upgrade technologically and raise their standards.

Second, Apple’s up-and-down journey also serves as a warning. If the world's most well-known company had to jump as many hoops, what chance does a smaller company have? How many other businesses will have the money and patience to set up India teams that negotiate with the government to remove roadblocks, one by one, calmly? And the approval of Apple’s Chinese suppliers shows that the government is comfortable making pro-business exemptions but is uncomfortable making pro-market relaxations. There’s a risk of going overboard with the “market access in return for manufacturing” approach.

A policy analyst must also pop the opportunity cost question. Could the government have spent precious state capacity elsewhere by following a general easing of these constraints? How many companies did India lose in the process of playing hardball with Apple? And what about the Indian consumers - what did they lose as a result of these overbearing conditions? These are tough questions to answer.

Third, this journey shows that technology policy is shaping up rather well in India. Industry associations and public advocacy departments of companies are now able to put forward their demands and grouses in front of governments in a far more transparent manner. Not just that, they are able to get governments to modify policies as well.

In my view, all three interpretations are simultaneously true. But this is just the beginning of India’s electronics manufacturing journey. The steps required to strengthen it might be drastically different from the approach required to start it.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Here’s a RestofWorld Q&A on the US-China chip war and its implications for India featuring one of us.

* [Story] FT has an excellent visual explainer on quantum computing this week.

* [Article] Niranjan Rajadhyaksha’s Mint column comparing Asian countries when their median age was 28 like India’s is today, is insightful.

Insights on issues relevant to India

— RSJ

A strange thing happens when you are away on a break. One week you are sitting and wondering how many different things you can write about because of the flurry of events around you. US banks getting into trouble, Rahul Gandhi being denied bail, more curbs on US companies doing business in China, frenetic moves in semiconductor politics - you get the picture. And then you take a break. And everything slows down. First Republic Bank doesn’t implode in a matter of hours like SVB. Instead, it drags its feet in a slow-motion death spiral. RBI pauses on its rate increases. Janet Yellen pulls back on US hostility towards China while cooing about how the two economies need one another. Things go to a standstill when you stop looking at the world with a weekly columnist’s gaze. It is like the vibe of a still summer day in India takes over everything. Nothing moves. Once back, what does one write about? Well, thematically, there isn’t any one thing that will do right now. So, I guess I will cover a few areas that could be of interest.

The big story out of India last week was that we might have overtaken China in the population sweepstakes. This was kind of inevitable, and a million people here or there doesn’t make a difference in the larger scheme of things. Yet, it is as good a moment as any to reflect on that elusive thing called the India opportunity. Now, we have devoted multiple editions to why having more people is a good thing. Somewhat to my relief, a lot of commentary in the last week has echoed this sentiment. There’s the usual comparison of the relatively younger demographics in India with that of China and the advantage of being more aligned geopolitically with the West. And, of course, the governments in India don’t do terribly arbitrary things like China did in the past couple of years to the tech sector. On this last point, I have my views, but we are using a really broad brush here, so I will let it pass. The general tone of these articles is that this is India’s opportunity to lose—a far cry from my school days when the population was seen as a problem. I have three points to make in this context which are a bit different from the usual view of what India should do not to let this opportunity slip.

First, there’s the usual prescription that India should industrialise faster to take advantage of this dividend and avoid the middle-income trap. My usual take on this is how well do we know why India couldn’t industrialise faster in the last 20 years when China took off. It is not like this is a fresh insight that wasn’t known to policymakers then. So, what gets in the way of India to industrialise? My short answer will always be the state. Despite all the hype around Make in India and the rising ease of doing business rankings, it is still quite difficult to start and run a business in India. The state is deeply entrenched in controlling capital in India, and it enjoys the arbitrary power that it has over them that it is impossible to change this with just better optics of ‘single window’, tax holidays or investment roadshows. In the last two decades, the state has retreated a bit in some areas, but paradoxically, with greater digitisation, it has more information and, therefore, greater power over industry.

My general contention is that the state can continue with its welfarism (or whatever else you may call it) on the social and political front, but for India to industrialise, the state has to retreat on the economic control it wields. This looks very difficult today because the state’s first goal is to perpetuate itself. It will require the PM to go back to some of his campaign promises of pre-2014 with real conviction. All Indian politicians of a certain vintage are instinctively socialist. And as the farm reforms saga showed, even a small vocal minority can derail a progressive reform. The other challenge has been the availability of capital for MSMEs to build their business and compete for global orders. For the most part, since 2009, we have had a twin balance sheet problem, and that has meant banks have been very choosy about whom to lend. Add to that the shallowness of the corporate bond market, and we end up having a manufacturing sector low on its ambitions. On this, we might be on a better footing now. Bank and corporate balance sheets are at their robust best, and the public digital infrastructure and GST network make it possible for better underwriting decisions using informational collateral. This is evident in the robust credit offtake reported in the MSME segment across the banking sector in the past year.

My view is we will industrialise a bit faster than in the past, but we are going to fall short of the expectations of the kind of industrialisation that’s expected for us to increase our per capita income from $2000 to $10,000 in the next 15 years. China traversed that exact journey between 2006-20, so it is possible. And it is possible to do it without making the same mistakes as China, where it went back on its decentralised model of growth that made regions and companies compete with one another to an overly centralised model now that will only hurt it further. We need a very specific retreat of the state from the economy with a regulatory framework that acts as an enabler rather than lording over it in a policing role. These seem to be difficult even for a PM and a party that’s hugely popular and has no immediate threat of losing power. We will therefore continue to do a respectable 7 per cent growth over the long run than a tearing 10+ per cent. It is what it is. 

This growth is good but not good enough to take care of the employment aspirations of the people. So, we will have to contend with high unemployment or underemployment for the foreseeable future. What will compound this is automation and the speed of AI adoption in the industry. One of the things to watch out for is the increasing sophistication of AI tools that could automate the services sector. The short-term evidence of generative AI tools like ChatGPT or Dall-e shows how quickly lower-skilled white-collar jobs could be automated. Also, these tools are now getting ‘consumerised’; that is the AI use cases are no longer restricted to a business-to-business context. This will increase the ability of the end users to use them for their needs directly. And that will reduce opportunities in the services sector, which has been the growth engine of the Indian economy in the post-liberalisation decades.

Separately, we have talked about the increasing market concentration among 4-5 corporate groups in India. This trend is only getting stronger, and I have explained in the previous edition how this is different from the ‘national champions’ model of the Asian tigers. Simply put, unlike them, these national champions aren’t using their monopoly to win in global markets. Concentration is a classic market failure that will eventually lead to higher prices and poor allocation of capital. There’s a good argument on this that’s been made, of late, on this by Viral Acharya. But it has gotten drowned in the usual nationalistic noise that any criticism of this government brings these days. The usual caution that would have come up at this stage would be about the social risks of a young and aspirational population being unemployed. As I travel across India, I find this risk to be somewhat overblown. The availability of cheap smartphones, cheaper data and a general increase in prosperity mean the youth is forever busy staring at their screens engaged in low-quality entertainment. We will continue to generate low-end services jobs to take care of the top tier of Indian society like the ‘home delivery of everything’ model has already shown us. This ‘yajman’ system of one rich Indian supporting ten others will be a feature of our economy.

Lastly, we must realise that the surplus labour and surplus savings (we are already getting there) that we will have will need to find their use outside of India. We will be one of the few countries in the world to have these together and almost no one will have our scale of surplus labour and savings. Free trade and open borders will therefore play to our advantage. It will be counterproductive to champion protectionism or any kind of swadeshi brand of politics. It will just be bad economics and blunt our edge in the global economy. 

There is no shortage of things to solve if we want to make use of the demographic dividend. I have read the usual lament on how we must improve the quality of our labour pool, upgrade our education system, improve infrastructure and bring women into the workforce - the list is long. I think these are downstream factors that will mostly get taken care of if the state makes it easier for the enterprises to do business. That retreat when the state has enjoyed having capital under its thumb for decades is mighty difficult. India will do well because there is an overlap of trends that favour it uniquely. The giant leap it so desires will need more than just this happy coincidence to come its way.  

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PolicWTF: Tariff ki Taareef Mein

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

We’ve cried ourselves hoarse that India’s position on international trade in electronics is self-defeating. The consensus in India is that high tariffs, heavy customs duties, and other such barriers are a crucial pre-condition for creating world-beating Indian electronics companies. Another edition of this series titled “Tariff ki Tareef Mein” played out last week.

On April 17, the World Trade Organisation (WTO) dispute settlement panel ruled that India’s imposition of tariffs on mobile phones and electronic components violates its commitment under the Information Technology Act (ITA). The ITA is a plurilateral agreement of the WTO in which the signatories committed to reducing all tariffs and taxes on Information and Communication Technologies (ICT) products. Europe, Japan, and Taiwan raised these disputes separately against India.

No surprise, the Indian government plans to challenge the ruling. In fact, government officials are signalling that the ruling won’t have any impact because the appellate body of the WTO doesn’t have enough judges to hear India’s position.

India’s formal defence is based on two arguments: one is technical, and the other is ideological.

The technical argument is that India signed the ITA in 1997 when mobile phones, chargers, and many of the now ubiquitous digital wonders hadn’t emerged. So, the recent tariffs on new products that came to life after 1997 do not violate India’s ITA commitments.

However, a deeper ideological argument underlies the technical argument. The Indian government strongly believes that signing the ITA led to the decline of its domestic electronics industry. And as a result, import tariffs are critical for maintaining the current uptick in domestic electronics production. The commerce ministry website pulls no punches when it says:

“India’s experience with the ITA has been most discouraging, which almost wiped out the IT industry from India. The real gainer from that agreement has been China which raised its global market share from 2% to 14% between 2000-2011.

In light of recent measures taken by the Government to build a sound manufacturing environment in the field of Electronics and Information Technology, this is the time for us to incubate our industry rather than expose it to undue pressures of competition. Accordingly and also keeping in view opinion of domestic IT industry, it has been decided not to participate in the ITA expansion negotiations for the time being.”

As this official position indicates, the government seems to have internalised that the ITA was the reason that India’s past attempts failed. (That line about incubating the industry rather than exposing it to “undue” pressures of competition transported me to the 1950s.)

There are at least three problems with this line of thinking.

One, it mistakes correlation for causation. It is true that Chinese companies decimated the domestic Indian manufacturers of cheap mobile phones by 2017. Indian domestic players couldn’t match the “features per unit price” that Chinese companies were able to offer. The import of cheaper phones back then benefited millions of Indian consumers. The reason that domestic players couldn’t compete wasn’t the ITA but that they had no competitive advantage. Their business model relied on rebranding older phones sourced from China. Zero tariffs under ITA, in fact, made it possible for these companies to import components cheaply and climb up the assembly value chain. But without any significant investment in R&D or industrial innovation, these “domestic” players were easily wiped off the market. This story isn’t unique to electronic products. Even in segments to which the ITA doesn’t apply, such as machine tools, textiles, or toys, Indian companies couldn’t stand international competition. Surely, the problem then lies in India’s large-scale manufacturing troubles and not in signing the ITA. The much-lampooned ease-of-doing business factors, such as poor infrastructure, byzantine labour and land regulations, and a complicated tax system, can explain why production in India remained a challenge across sectors.

Two, protecting domestic players will not produce world-beating champions. This is particularly true for electronics production, which relies heavily on cross-border flows of materials, machines, and humans. To export one type of electronic product, you need to import another type; atmanirbharta is impossible. By disregarding the ITA, products manufactured in India will not be able to compete in the international market. An analysis by the industry body of phone manufacturers shows that higher import tariffs have meant that a large portion of the money companies receives under PLI gets re-routed to pay these tariffs, ultimately making production cost-prohibitive. This is the reason why companies such as Apple have been trying to seek duty exemptions for some electronic components. It is also a major sticking point in the India-Taiwan Free Trade Agreement. A unilateral reduction in tariffs by following ITA is thus in India’s interest.

Three, India’s vehement dismissal of the ITA places it at a disadvantage in future negotiations. India has opted out of the ITA-2 negotiations that sought to expand the list of ICT products on which tariffs were to be reduced. As a big manufacturer, China was able to get favourable exemptions in these negotiations. Instead of reducing tariffs to zero immediately, it was able to extract waivers that give it a gentle gliding path towards zero tariffs. India has a similar opportunity today, given that it is far more integrated into the global supply chain for electronics due to the manufacturing presence of players such as Samsung and Apple. The geopolitical situation, too, is far more favourable. But India’s obstinate stance on the ITA makes the question of negotiating waivers a moot one.

China signed the ITA in 2003. By then, it already had a strong electronics assembly and manufacturing setup. The ITA supercharged its powers and helped it become a global provider of ICT goods. Twenty years later, India, too, has been able to kickstart electronics assembly. It’s now time to approach ITA more confidently instead of falling back to the tested-and-failed tropes of import substitution and infant industry protection.

A basic rule of strategy is not to spread too thin on many fronts simultaneously. India's trade strategy seems to ignore this maxim. If our chief adversary is China, it's better to settle trade disputes with the EU, UK, Japan, Taiwan, and the US with minimal friction. Instead, we continue to treat every tariff reduction as a bargaining chip. Missing the woods for the trees shouldn’t become India’s guiding principle in international trade.

Global Policy Watch: What Fed Learnt From SVB Failure

Reflection on global policy issues

— RSJ

On the face of it, quite a lot. A 118-page report.

As the Economic Times reports:

“The Federal Reserve issued a detailed and scathing assessment on Friday of its failure to identify problems and push for fixes at Silicon Valley Bank before the U.S. lender's collapse, and promised tougher supervision and stricter rules for banks.

In what Fed Vice Chair for Supervision Michael Barr called an "unflinching" review of the U.S. central bank's supervision of SVB, the Fed said its oversight of the Santa Clara, California-based bank was inadequate and that regulatory standards were too low.”

It is useful to understand what policy lessons are learnt by a regulator from a setback. SVB was a small bank (16th largest) but a fairly important player in the valley. And it went down in a heap within hours because of a run engineered by the enlightened VCs who asked their investee companies to pull out their deposits. I have covered the saga in a previous edition. 

In its report, the Fed has identified the reasons for the bank failure, which in hindsight, is clear to everyone now. It points to three broader issues:

“First, the combination of social media, a highly networked and concentrated depositor base, and technology may have fundamentally changed the speed of bank runs. Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding.

Second, as I have previously stated, a firm’s distress may have systemic consequences through contagion—where concerns about one firm spread to other firms—even if the firm is not extremely large, highly connected to other financial counterparties, or involved in critical financial services.

Third, this experience has emphasised why strong bank capital matters. While the proximate cause of SVB’s failure was a liquidity run, the underlying issue was concern about its solvency.”

All good, so far. And therefore, the question: So, what have they learnt from it? Well, the key “takeaways” summed up are here:

“1. Silicon Valley Bank’s board of directors and management failed to manage their risks.

2. Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.

3. When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.

4. The Board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.”

The Board and the management take a large portion of the blame. And then it appears like the Fed is holding itself accountable by calling out the weakness in supervisory standards. Till you read the fine print. It is largely throwing a small team of SVB-specific supervisors under the bus, thus making it sound like a specific instance of dereliction of duty. SVB failed because the Fed raised interest rates too quickly without asking what could be the possible risks of such a move. It didn’t do its homework for its actions on the banking system. And when it realised the likely vulnerabilities that it hadn’t anticipated, it went easy on the rate hikes than the hawkish stand it had taken only a week earlier. Had it been only an SVB-specific issue, what explains the slow unravelling of the First Republic Bank? 

It is one thing not to anticipate the unintended. It is another not to acknowledge it and search for lessons which won’t help you the next time around. Or maybe it knows what went wrong, and it is too proud to admit it went wrong. Either way, it comes out of this poorly. 

India Policy Watch #2: Devil and the Deep Sea

Insights on issues relevant to India

— Pranay Kotasthane

Over the last couple of weeks, the Congress’ new election slogan, “Jitni aabaadi, utna haq”, has caused quite a flutter. Bluntly speaking, it is a pre-election promise to expand reservations for Other Backward Classes (OBC).

We’ve seen this movie before. As was the case with the last election, it means that the grand narrative that’s been put forward to counter Hindutva majoritarianism is “backward” caste mobilisation. But this time around, the mobilisation comes with some clear demands: a caste census, an expansion of OBC reservation, and a dedicated ministry for the empowerment of OBCs.

In his characteristically edifying column, political scientist Pratap Bhanu Mehta explains why these three demands for caste mobilisation will not translate to social justice. Social justice needs good public institutions of education and inclusive economic growth, combined with strong affirmative action for the Dalits and some deeply marginalised sections of OBCs. Instead, political parties have reduced the logic of “social justice” to one and only one item: expansion of OBC reservation. In his words:

“The most important things that are required for social justice do not require caste data. Making quality education available to all, the creation of public goods in which all can participate, the design of welfare or other cash support schemes, the best mix of subsidies and income enhancing measures, and most importantly, an expanding economy that creates mobility do not require the framework of caste. The mistake of the social justice agenda was that it forgot Ambedkar’s lesson that to effectively attack caste you have to (for the most part) strongly but indirectly attack the range of material deprivations that make its logic so insidious. Second, we have to express the blunt truth on so much of what went under the name of social justice politics in North India.”

…

“In my years of dealing with higher education, it was rare to come across a social justice party that shed a single tear for the decimation of public education or the destruction of universities. But all their social justice outrage was focused on the one single point of reservations. So in Bihar you got the RJD that, for all its tapping into the politics of dignity, decimated the governance structures that could have empowered marginalised groups. In UP, under the garb of social justice agenda, we tolerated parties that had little interest in governing. What was called the deepening of democracy in North India did not lead to deepening of governance or inclusive growth.”

[The Indian Express, April 21]

As you would imagine, that article ruffled many a feather. Writing in the same newspaper, Manoj Kumar Jha (a Rajya Sabha member of RJD) and Ghazala Jamil mounted a defence with these words:

“The RJD and other opposition parties that he accuses of reducing social justice to distributing “government largesse based on officially reified caste identities” and “decimating public education and destructing universities” have, in fact, invested heavily in school education systems so that the marginalised sections can simply reach public universities. The quantum of ambition in Bihar’s youth for competitive exams for public jobs and their presence in all sectors of the private economy across India and abroad today is a testament to the massification of education, despite suffering from the effects of uneven development and the failure of cooperative federalism.” [The Indian Express, April 27]

To claim that RJD and opposition parties’ biggest success is increasing the “number of youth writing competitive exams for public jobs” proves Mehta’s point. With quotas as the primary instrument of action, government education institutions merely become vehicles to distribute positions along caste lines.

Of course, Mehta’s article is a lament that the opposition is using one form of majoritarianism to counter another form of majoritarianism. But those in favour are desperate to show that their project is morally superior. Both these views are somewhat orthogonal to how this issue will resonate with the electorate in 2024. As of now, we are stuck with the politics of religion versus the politics of caste.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Ajay Chibber’s take on fiscal decentralisation has useful comparisons:

“India’s share of sub-national (state plus local) spending at 60 per cent of total spend is quite high at its level of development. Other large federal states spend less. Brazil spends around 50 per cent at the sub-national level, Germany 46 per cent, the United States around 40 per cent, and Indonesia around 35 per cent. Only Canada and China spend more than 70 per cent at the sub-national level. …Going forward, where India must focus is the share of local government, which remains very small. India’s local government spend is less than 4 per cent of total government spending. This share is much smaller than in most advanced economies, but also much lower than in centralised authoritarian governments like China, where local government spending exceeds 50 per cent of total spending by government. China is an outlier in this, but in most advanced economies, the share is much higher than in India. The 28 countries in the EU spend 23.2 per cent at the local level, Canada 21 per cent, the US 29 per cent. In Latin America, local government spending is around 12.7 per cent and most analysts feel it should be much higher.” [Business Standard, April 20]

In this context, we earlier discussed a framework for decentralisation in edition #186.

* [Podcast] A Puliyabaazi on the population question. Is India really overpopulated?

* [Paper] The Information Technology Agreement, Manufacturing and Innovation – China’s and India’s Contrasting Experiences by Dieter Ernst is THE starting point to understand the debate on India’s protectionism in electronics.

*From the poem Opportunity by Raymond Garfield Dandridge

Insights on issues relevant to India

— RSJ

In one of the recent editions on the Hindenburg short-selling saga, I had written about how easily the Adani group had spread itself into a diverse range of sectors. The group was highly leveraged because it was so keen on getting into newer sectors and then winning bids in them with metronomic efficiency. Generally speaking, it is difficult to run a conglomerate of different businesses. You might argue that each business can be handled by a competent management team who will use the brand name and deep pockets of the parent group to build a solid business. But it is easier said than done. Capital allocation decisions, which lie at the heart of executing a business strategy, are difficult within a single line of business. They become hugely complicated within a conglomerate of businesses. Misallocation of capital, lack of focus and inability to stay competitive against smaller, nimbler players eventually follow. Soon, the businesses need to be hived off, and you find companies convincing would-be investors on how they are doing fewer things and doing them well instead of spreading themselves too thin. This is the usual cycle.

Yet, you see conglomerates appearing on the business landscape across countries. In some cases, these are businesses integrating vertically or finding interesting adjacencies in their business. This kind of makes sense in the Coase-ian “Nature of Firm” way. I mean, if the transaction costs of finding someone to do a particular work are higher than you doing it yourself, sure, go ahead and do it yourself. But beyond that, there should be no economic reason for having conglomerates. Unless you have one of these conditions in the economy: 

a) Cost of capital is high, and access to it is difficult. Newer players find it difficult to access capital to start new businesses while older, established players with free cash flow can muscle their way into unrelated but lucrative new sectors only because they have access to capital at a lower rate. 

b) The playing field isn’t level for newer players to make a dent. Through a mix of friendly regulations, ‘working’ the networks and M&A activities, the bigger players continue to have an advantage going into a new sector over smaller players who might have expertise in cracking those sectors open.

c) There’s relatively little ease of doing business in those sectors or in the evening overall. The established conglomerates with an army of people, lawyers and consultants can get started relatively faster and capture the market than new entrants. 

You don’t have to be a genius to see where the Indian policy-making framework is on the above conditions. There’s common and easy access to capital through a large number of PEs and VC funds but only for a particular kind of ‘flavour of the season’ variety. This also is getting difficult to access. The market for other forms of capital isn’t deep enough. In the same vein, long-term capital for greenfield projects where the credit risk has to be borne by the issuer isn’t available. There is always a whiff of regulatory capture especially in sectors where the government is closely involved bin decision making. Lastly, we might have moved up in the ‘ease of doing business’ rankings, but it isn’t clear yet how this has changed things on the ground. New businesses still find going tough for them.

All of the above means that in the past five years, we are reversing a trend seen since the ‘91 reforms. That of increasing salience of conglomerates in India. You don’t have to research too hard. Just take a look at any sector - already big or one that is emerging - you will have the same spectacle of a few large corporate groups getting themselves into all sorts of businesses, from defence to semiconductors or from airlines to carbonated soft drinks only because they believe they can take advantage of market distortions.

As if to illustrate this point further, here's news that’s only a day old. Here’s Moneycontrol  reporting:

“The shares of Mukesh Ambani-led Reliance Industries Ltd (RIL) rallied 3.5 percent in the morning trade on March 31 after the company said secured creditors, unsecured creditors and shareholders would meet on May 2 to approve the proposed demerger of Reliance Strategic Ventures.

After the approval, the unit, which is the financial services subsidiary of the oil-to-telecom conglomerate, would be renamed Jio Financial Services.

Benefits that shall accrue on the demerger of the financial services business will be the creation of an independent company focusing exclusively on financial services and exploring opportunities in the sector, the independent company can attract different sets of investors, strategic partners, lenders and other stakeholders having a specific interest in the financial services business, a financial services company can have a higher leverage (as compared to the Demerged Company) for its growth and, unlocking the value of the demerged undertaking for the shareholders of the demerged company, the conglomerate said in an exchange filing.”

This isn’t out of the ordinary. If you search for similar news items from the last five years, you will notice the same pattern of large conglomerates (usually the big 5) muscling into other or newer sectors because they think they have the capital and they will be able to manage the sector well. While one cannot blame these conglomerates for their ambitions, this trend suggests we might have tipped over from being pro-markets to pro-business.

Coincidentally, as I was writing this, we had a paper authored by Viral Acharya (former Deputy Governor, RBI) on the opportunities and challenges for the Indian economy published by the Brookings Institution and being discussed in the media. Acharya has highlighted the concentration of power in Indian industry as a particularly worrying trend. He writes (I have paraphrased a bit):

“A striking feature of this rise in industrial concentration by private companies is that it is in part due to the growing footprint of “Big-5” industrial conglomerates, based on the overall share of assets in non-financial sectors in 2021. Data shows the following patterns.

First, until 2010, the Big-5 increased their footprint in more and more industrial sectors, broadening their reach to 40 NIC-2-digit non-financial sectors. After this breadth first strategy came the depth-next strategy. Starting in 2015, the Big-5 started acquiring larger and larger share within the sectors where they were present. In particular, their share in total assets of the non-financial sectors rose from 10% in 1991 to nearly 18% in 2021, whereas the share of the next big five (Big 6-10) business groups fell from 18% in 1992 to less than 9%. In other words, Big-5 grew not just at the expense of the smallest firms, but also of the next largest firms.

Next, this growth of Big-5 appears to be driven in part by their growing share of overall Mergers & Acquisitions (M&A) activity. Even though the aggregate number of M&A deals has dropped since 2011, the share of M&A deals by the Big-5 has doubled from under 3% in 2015 to 6% in 2021, without such an increase being seen in the next five biggest groups. Arguably, this growth has also been supported by a conscious industrial policy of creating “national champions” via preferential allocation of projects and in some cases regulatory agencies turning a blind eye to predatory pricing. Equally importantly, given the high tariffs, Big-5 groups do not have to compete with international peers in many sectors where they are present and derive most of their revenues domestically.”

Acharya then goes on to list the usual downstream problems of such an increase in market power concentration - inefficient allocation of capital, favouritism in project allocation, regulatory interference, related party transactions, over-leveraging while becoming too big to fail and crowding out new players.

But he also makes an important claim that this concentration of market power is one of the reasons for persistent core inflation. He concludes:

“In summary, creating national champions, which is considered by many as the industrial policy of “new India”, appears to be feeding directly into keeping prices at a high level, with the possibility that it is feeding “core” inflation’s persistent high level.”

I won’t go as far as Acharya yet on this thesis. As he admits, there’s more work that needs to be done here, but his conclusion on pricing remaining high because of industry concentration does pass the smell test. And it should concern policy makers. I know there are many who will ask what’s wrong in creating ‘national champions’ like the tiger economies did between the 70s-90s. But there are a few differences in our case. 

Firstly, the focus on creating national champions elsewhere was to choose specific sectors where they might have a comparative advantage, invest in them, especially on technology and then win in global markets through an export-oriented strategy. It is a somewhat flawed approach, but it still makes sense for a low-income economy to do this. But we aren’t really doing this in India. Our so-called national champions are focused on domestic markets where there’s no particular need to have them. In fact, there is only a monopoly risk here with the attendant problems of price cartelisation and poor customer service. Also, the limited focus on exports that these big five domestic players have as of now is largely linked to natural resources and not large-scale, job-creating manufacturing setups. It is unclear how the broader economy is benefitting from this apparent design.

Secondly, the successful national champion model in other economies didn’t need high import tariffs to support their ambitions like it is now the case in India. We have written about this many times in the past. Higher tariffs will reduce the competitiveness of the domestic players in those sectors to compete globally. It is counterintuitive to have a high tariff regime if you want to build national champions. After all, global markets are much larger than the domestic market, and that’s where these conglomerates must be competing.

Thirdly, what’s the government getting out of the apparent tilting, if it is intentional, of the playing field in favour of these players? If the idea is to have national champions despite the obvious flaws in this intent, it makes sense to have stakes in these ventures to participate in the value being created.

Lastly, the overall economy will benefit if the process of creating such champions leads to factor market reforms and real ease of doing business for other participants in the process. Else, the larger players will continue to get ahead not because of better products or innovation but simply because they know how to manage the system. In other words, it is the 1970s all over again with a tadka of markets.

It is difficult to see how we can trace our way back from this path, given the apparent lack of opposition and the already dominant position of these conglomerates in industry and media. Also, any walking back will require some bold antitrust kind of measures (it is what Acharya suggests) which is quite impossible in India. Possibly, the only medium-term scenario is these conglomerates start stepping on each other's toes as they continue to diversify their businesses and that competition alleviates the problems of concentration. But that might be too late in coming, or they might have a tacit understanding of the rules of the game in competing with one another. It will distort markets further. Maybe this is a tad alarmist, but it is important to acknowledge there’s way too much diversification among the top conglomerates in India and that’s always a sign of market distortion. 

India Policy Watch #2: We Need an Agnipath for India’s Diplomacy

Insights on issues relevant to India

— Pranay Kotasthane

In edition #198, I highlighted that at least three areas of the Indian executive need a quick state capacity boost. These were: the Ministry of External Affairs, Ministry of Electronics & Information Technology (MeitY), and economic regulatory bodies such as the Competition Commission of India (CCI).

Then I came across this tweet from the External Affairs Minister, which acted as a positive reinforcement for this line of thinking.

Managing these engagements in an unsettled world order needs an immediate boost in India’s foreign policy capacity. Solutions like incremental increases in the Indian Foreign Service (IFS), while required, will be too slow.

What we need today is a ‘surge hiring’ strategy. The external affairs ministry, in fact, was the first union ministry to experiment with a broader lateral entry for government officers in 2015. It also opened up positions in its policy planning and research division for people in academia and the private sector. However, these tentative trials seem to have lost steam. The underlying reason is the internal resistance from the foreign service officers, who see such attempts as a threat to their career progression.

The surge hiring strategy should try a different approach. It should attempt to hire a much larger number of people below ambassadorial positions. This way, the cadre protection impulse can be side-stepped. Instead of targeting joint secretary levels, two fellowships could be attempted: one for fresh graduates and another for young professionals working within and outside the government (thanks to Nitin Pai for this idea). Given the growing prominence of technology and economic issues as foreign policy domains, this approach would help build institutional knowledge within the ministry. More importantly, the surge should target staffing for the headquarter functions in Delhi for managing various engagements and new initiatives. Indian missions abroad can continue to be led by IFS officers.

Past attempts at lateral hiring were advertised as single posts in the unreserved category. By opening up a larger number of positions concurrently, the government could retain existing norms on reservations and quotas. Finally, the surge hiring strategy should have a sunset clause and a well-defined recruitment target. If it is conceptualised as a non-recurring measure keeping the current geopolitical situation in mind, it will resonate with the opposition and the parliament.

With the Agnipath experiment of the defence ministry, the idea of short-term employment within the government has gained some acceptability. It is no longer anathema to the government but an idea whose time has come. Without a surge in foreign policy capacity, we will only have great ideas but tardy implementation, resulting in a perennially underperforming foreign policy.

Matsyanyaaya: Reflections on the Quad

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Last week, I attended a US State Department sponsored programme that aims to invigorate think tank research on Quad collaboration in the four countries. As part of the first segment of this programme, five representatives from each country’s think tanks were hosted in the US. What follows are my reflections on the Quad as a geopolitical formation, based on what I saw in this programme.

* Quad ranks higher on the US foreign policy agenda than I had expected. My prior assumption was that given the multiple alliances that the US leads, a new, amorphous grouping such as the Quad wouldn’t rank high on its priority list. However, the interactions with the officials suggested a conscious effort to infuse energy into the Quad.

* The Quad is being positioned visibly and intentionally as a positive force that would bring benefits to the Indo-Pacific at large, rather than as an anti-China “alliance”. This is the reason why the interactions as part of the grouping have spawned into six leader-level working groups—on COVID-19 Response and Global Health Security, Climate, Critical and Emerging Technologies, Cyber, Space, and Infrastructure, and at least three initiatives—Indo-Pacific Partnership for Maritime Domain Awareness, Semiconductor Supply Chain Initiative, and the Quad Fellowship. The strategy, if there is one, seems to be to throw several balls up in the air, knowing fully well that some of them will get dropped, while others might be caught on their way back by all four countries, or only a subset amongst them.

* As the Quad is not a traditional security alliance, its success metric will also be different. Not all cooperation will be Quad-labelled, and some of it might come in bilateral or trilateral formats. So, the increased cooperation between Japan and Australia on defence ties, and between India and Australia on economic ties, are also indicators that the Quad is moving in the right direction.

* While the rationale for Quad collaboration in many areas is often “common interests” or “shared values”, an underrated frame is “mutual complementarities”. In many spheres, especially in technology, the Quad is an attractive forum for cooperation precisely because each country has complementary strengths.

* Positioning Quad as a force for good in the Indo-Pacific—rather than a geopolitical grouping against China— in many areas runs the obvious risk of underperformance and loss of credibility. In international affairs, efforts at providing benefits to another country are usually known by their failures more than their successes. For instance, in May 2021, the Quad Vaccine Partnership targeted the provision of 1 billion COVID-19 vaccines. Even though the four countries individually delivered 670 million doses, including 265 million doses in the Indo-Pacific, the demand for vaccines waned by the end of 2022. The dominant narrative was that the Vaccine Partnership had failed, even though it had made a significant contribution.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] We were on Shruti Rajagopalan’s excellent podcast Ideas of India to discuss our book and the Indian State’s many puzzles.

* [Podcast] A Puliyabaazi on citizencraft featuring Nitin Pai.

* [Paper] This paper by Isha Bhatnagar offers evidence that gender equitable preferences are rising in India. From the abstract:

Over more than a quarter-century period (1992–1993 to 2019–2021), I find a significant decline in son preference from 40 to 18 percent and an increase in gender-equitable preferences among most subpopulations. Multivariate analysis shows that for all survey years, education and frequent exposure to television significantly increased the odds of gender-equitable preferences. In the last decade, community norms supporting women's employment are also associated with gender-equitable preferences. In addition, decomposition analysis shows that compared to compositional change, social norm change accounts for two-thirds of the rise in gender-equitable preferences. These findings suggest that rising norms of gender equality have the potential to dismantle gender-biased preferences in India.

Insights on issues relevant to India

— RSJ

Regular readers might have noticed the absence of posts analysing the political economy and politics in general in our editions of late. This isn’t intentional. There’s not much to write about. There is a strange sense of stasis all around. Every move, every act is a chronicle of a future foretold. This inertness stems from a complete absence of ferment in the political landscape. The external factors that could impact politics, like the economy or national security, appear stable. And those directly in the fray have to contend with a political juggernaut backed by a fawning media that takes no prisoners. It is a complete mismatch. So, what can one write about except rallies, speeches and opinion polls

Into this state of ennui, this week walked the Court of chief judicial magistrate HH Verma, Surat. Here’s the Mint reporting on this:

“The Surat District Court sentenced Congress MP Rahul Gandhi to two years of imprisonment in the criminal defamation case filed against him over his alleged 'Modi surname' remark. The Congress leader was later granted bail by the court.

The court of Chief Judicial Magistrate HH Varma, which held Gandhi guilty under Indian Penal Code sections 499 and 500, also granted him bail and suspended the sentence for 30 days to allow him to appeal in a higher court, the Congress leader's lawyer Babu Mangukiya said.

The case was filed against Rahul Gandhi for his alleged “how come all the thieves have Modi as the common surname?" remarks on a complaint lodged by BJP MLA and former Gujarat minister Purnesh Modi. The Lok Sabha MP from Wayanad made the alleged remarks while addressing a rally at Kolar in Karnataka ahead of the 2019 Lok Sabha elections.”

In a remarkable feat of speed and agility, the Lok Sabha Secretariat disqualified Rahul Gandhi as a member of Lok Sabha the next day. As the Hindustan Times reported:

“Congress leader Rahul Gandhi has been disqualified as a member of Lok Sabha a day after the Surat court convicted him for two years in a defamation case. However, he was granted a 30-day bail in the case to allow him appeal in a higher court. 

The Lok Sabha secretariat said in a notification that he has been disqualified from the day of the conviction under the Constitution’s Article 102(1)(e) read with Section 8 of the Representation of the People Act.

As a next step, the Wayanad MP will have to appeal to the higher court seeking a stay on the conviction, in order to prevent the disqualification and the Congress said it will follow the procedure to move to a higher court.”

Look, there’s a tired old way of looking at all of this. And that’s what the discourse has been about this over the past few days. The opposition reminds us how there’s an undeclared emergency at this moment in India. Dissent is being suppressed, the slightest criticism of the PM or his party is seen as an affront to the nation, and the state machinery is fairly quick in settling scores on those not falling in line. There is also the eternal optimism of a certain section of the commentariat that suggests that Rahul Gandhi has rattled the BJP with his Bharat Jodo yatra. And this is the response to keep him in check. I’m sure there is an alternate universe where this is all true. But none among us is turning into Michelle Yeoh anytime soon to enter that multiverse.

As I have mentioned earlier, there’s still space for the opposition, as the response to the yatra shows. But Rahul Gandhi neither has the enterprise nor the ideas to turn that into electoral success. On the other hand, the BJP and its supporters initially argued that a sitting MP cannot make disrespectful remarks about the PM. Apparently, it is not done, especially when the PM is feted the world over for his leadership. Soon old videos popped up that showed we have a hoary tradition of calling our past PMs names. I’m old enough to remember the memorable rhyming metre of ‘gali gali mein shor hai, Rajiv Gandhi chor hai’ that rented the air in 1989 when I first followed a general election in my life. The tack changed. So, now you have the charge that Rahul Gandhi was denigrating an entire OBC community with that statement and triggering possible social unrest. This is a failure to understand syllogism 101. Even if one were to accept the dubious statement that ‘all thieves have Modi surnames’, it doesn’t follow that ‘all with Modi surnames are thieves’. The more nuanced lot is taking the line that it is the courts that are letting the law take its own course, and we shouldn’t read anything more into this. It is possible this is true, but we might again be talking of the multiverse here. Leaving that aside, we now have WhatsApp experts who look for a masterstroke in every decision of the ruling party now suggesting that this is a convoluted plan to give Rahul Gandhi a convenient leg up to be the face of the opposition in 2024 and then decimate him in the elections. If only there were a Nobel prize for politics… 

Beyond the noise, I see three overlapping patterns here, two of which have been strengthening over the past few years and one that is new.

First, there’s that interesting paradox of narrative domination that is at play here. The paradox is the more you start dominating the narrative and the media, the greater your anxiety about a single truth bomb bringing down your carefully constructed image. This is why there’s only a one-way ride to ever greater control of media and opposition voices. Once your ears get used to the perfect melody of your own symphony, the slightest variation seems terribly jarring. And so you overreact reflexively to the slightest provocation because, to your ears, it sounds big. Two things follow from here. Your reaction tends to get disproportionately bigger and harsher. And you create a chilling effect that shuts more people up further. This is all been in play in the last few years. The way to look at the Rahul Gandhi episode is to confirm the anxiety of narrative dominance and also to send out a message if there was any more needed, that no one can get away with direct criticism any more. This isn’t a new phenomenon in India, but the speed and the reach of social media make it a kind of dominance that will be difficult to upend, unlike in the past. 

Second, there’s always a desire to test how far charisma can stretch the ‘reality distortion field’ it creates among the collective who have subscribed to it. This is an ongoing natural process of those who have a hold on their ‘people’ to see how much more of a break from convention can they (the people) rationalise in their unqualified belief in the leader. It is a useful test of the relevance of charisma, and quite interestingly, the only way to build more charisma is to put it to test with more outrageous claims on people. The more you can get away with, the more your charisma. To quote Weber on charisma:

“Charisma knows only inner determination and inner restraint. The holder of charisma seizes the task that is adequate for him and demands obedience and a following by virtue of his mission. His success determines whether he finds them. His charismatic claim breaks down if his mission is not recognised by those to whom he feels he has been sent. If they recognise him, he is their master – so long as he knows how to maintain their recognition through ‘proving’ himself. But he does not derive his ‘right’ from their will, in the manner of an election. Rather the reverse holds: it is the duty of those to whom he addresses his mission to recognise him as their charismatically qualified leader.”   

This business of ‘proving’ himself becomes more difficult the longer you continue in office. Because there will be some dissatisfaction among your people on what goals you aren’t achieving. Some of this is evident in how a vocal minority (with Subramanium Swamy as some kind of a patron saint) seems to be disgruntled and pushing for more wins in the ideological and cultural wars. 

Lastly, I sense there’s a deliberate desire to take certain actions that will be picked up by western media who will bemoan the loss of liberal values in India. This will be a useful rallying point to build a narrative about how there’s still an anti-India global left that’s making a last attempt to sabotage a rising India. There’s nothing to suggest anyone is really worrying about a rising India till we hit some threshold of a middle-income economy with the accompanying economic and political heft. But who cares to test such grand conspiracy theories? It sounds right, and it fits the narrative that our greatest enemies are our own people who are in opposition and who, for power, will derail India. It looks like a winning narrative to me in the run-up to the elections. Also, I can see that there’s a desire to bring a raft of such ’western liberal’ values and set them up in a false confrontation with ‘civilisational’ values of India. And then use the inevitable electoral victory in 2024 to claim that the people of India have spoken and we don’t need the west to judge us using their discredited liberal values. We have our long dharmic history, and we will judge ourselves on its parameters. I have written about this point in the past using the examples of others who have tried to search for this civilisational counterpoint to western enlightenment, including Aurobindo, Kosambi, Vivekananda and Hazari Prasad Dwivedi. All of them ended up with some kind of ecclesiastical or spiritual quest instead of a tangible values doctrine that could guide political, economic or social actions.

I don’t think those who speak in such civilisational terms today have dived as deep as these scholars of the past have. Atleast I haven’t come across that kind of modern scholarship. My sense is their motivation is to continue to discredit western liberal thought for either political gains or to seek a kind of revanchist utopia with its foundations built on caste. In a way, I expect more of this desire to have an ideological battle in the run-up to 2024 and then claim a moral victory on the back of the electoral victory. I’m not sure this kind of false showdown has ever led to anything good as the experience of the 20th century or that of Turkey, Russia or China of late has shown. But there’s an appeal among the ideologically driven to go down that path. To pit the past against the future and hope we will discover the glory in the past to build a future that is better and different from the past. That we will be able to rise over this and get the best of the past and dream up a future that’s uniquely our own. This looks good on paper, but it gets muddied when put into action, as history has shown us over and over again. 

I will leave you with Kafka’s parable from Hannah Arendt’s 1961 book of essays, Between Past and Future:

“Kafka’s parable reads as follows:

He has two antagonists: the first presses him from behind, from the origin. The second blocks the road ahead. He gives battle to both. To be sure, the first supports him in his fight with the second, for he wants to push him forward, and in the same way the second supports him in his fight with the first, since he drives him back. But it is only theoretically so. For it is not only the two antagonists who are there, but he himself as well, and who really knows his intentions? His dream, though, is that some time in an unguarded moment – and this would require a night darker than any night has ever been yet – he will jump out of the fighting line and be promoted, on account of his experience in fighting, to the position of umpire over his antagonists in their fight with each other.”

That jumping out of the line happens only in dreams.    

PolicyWTF: Fretting Over Freights

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

The difference in the economic trajectories of southern and northern India is an endless fountain. Every person has a different causal story to explain how this economic divergence came into being. As you would expect, some narratives are more popular than others. Some South Indian exceptionalists claim that higher investments in education and health explain the difference. Some of them seek refuge in vague arguments about cultural superiority. The opposing side, in turn, blames repeated invasions and colonial policies such as the zamindari system.

It's tough to test some of these arguments. Some of them are biased intuitions masquerading as reasons. For some serious analytical work on this topic, I recommend this underrated book, The Paradox of India's North–South Divide, by Samuel Paul and Kala Sridhar. We had earlier discussed insights from this book in edition #148.

Among the reasons for the divergence is a policyWTF that makes a cameo appearance in policy conversations: the Freight Equalisation Scheme (FES). Introduced at the height of its socialist fantasies in 1956, FES was a union government policy for pursuing 'balanced industrial development' (Jan Tinbergen says hello). Under this policy, the government subsidised long-distance transport of key inputs such as iron, fertilizers, cement, and steel in the hope that companies in all states would access these inputs at the same costs. The story goes that FES was detrimental to the resource-rich eastern states of Bihar, MP, Odisha, and West Bengal. These states' manufacturing output in the early years of independence was higher than that of Gujarat, Tamil Nadu, and Punjab. But FES nullified their comparative advantage over time and contributed to the economic divergence.

Like other intuitions, this narrative, although compelling, needs a lot more evidence. I, for one, was biased against this explanation. I did not believe that a policy equalising freight transportation could have significant downstream effects that persist over time. And so, I have long been in search of studies that put the FES under the microscope. A recent paper Manufacturing Underdevelopment: India’s Freight Equalization Scheme, and the Long-run Effects of Distortions on the Geography of Production, by John Firth and Ernest Liu, is one such analysis that helps put FES into perspective. I summarise and annotate their findings below.

One, the study finds that the negative effect of FES exists for real. It did dampen the manufacturing prospects of resource-rich regions. The authors write:

We find evidence consistent with these claims: FES achieved exactly the opposite of its purported goal, exacerbating inequality between western India and the resource-rich east. Specifically, we show that FES led industries using the equalized iron and steel to move farther from the bases of raw materials production in eastern India.

Two, as a hat-tip to Hayek's warning against centralised design and price manipulation, the authors find evidence that FES had significant unintended consequences for downstream industries.

even small geographic distortions in input prices can help one region to nose ahead of another and exploit this advantage to steal industrial activity. Over the long term, this can result in substantial effects on the geographic distribution of production.

Three, the consequences of distortionary policies like FES are not immediately visible and hence might lead policymakers to underestimate the negative effects.

Our results show that the transition under FES was gradual. Even though the policy had little effect over its first 10 to 15 years, it led to steady movements of iron and steel using industries out of eastern India, and significant overall effects by the time FES reached its culmination in 1990.

Four, the repeal of FES in 1991 and complete abolition in 2001 had the opposite effect. Industries again went back to the resource-rich states, albeit this reversal was modulated by pre-existing input-output linkages that were built in the FES era.

We find in the case of FES, though, that repealing the policy led industry to move back toward the sources of iron and steel just as quickly as it left. Indeed, the results on implementation and repeal also complement one another, with the alignment between these results building confidence that, in both cases, the distortions related to FES cause industries to move across space in the manner described.

So, FES should be filed in the folder "Govenments are not omniscient". This experience should make us pause when governments make grand designs to interfere in markets. Good intentions are no guarantee for good policies.

Global Policy Watch: Dil Maange More than Moore

Insights on global policy issues relevant to India

— Pranay Kotasthane

Gordon Moore, the co-founder of Fairchild Semiconductor and Intel, died this week. His eponymous prediction, once a footnote in engineering textbooks, has now become commonplace. More so today, as semiconductors have become a test bed for industrial policy and a front for geopolitical confrontation between China and the US. So, let's discuss some less-known concepts about Moore's Law.

Moore's Law is actually an observation, a conjecture that has stayed true over the last 50 years. Gordon Moore, writing for the magazine Electronics in 1965, claimed that the number of transistors in the chips that Fairchild was making seemed to double every two years. He made this prediction when an IC contained 64 transistors. A testament to his foresight, an Apple A14 chip today has 134 million transistors per square millimetre.

There are several versions restating this prediction. More transistors per IC implies that the cost of implementing a functionality halves roughly every two years. That's the reason that the retail prices of electronic products fall rapidly even as newer products become faster and better.

Another variant of Moore's prediction has come to be known as Rock's Law. It states that the capital cost of a semiconductor chip fabrication plant doubles every four years, limiting the progression of Moore's law.

That Moore's prediction became a law is a testimony to human ingenuity and decentralised innovation. For decades, it has served as a pole star for the semiconductor industry. The "law" became a benchmark that focused efforts of the entire fraternity.

Several obituaries of Moore's Law have been written before. But every single time, it was defied, not just by technological improvements but also by economics. The comparative-advantage-based specialisation starting in the late 1980s was crucial for keeping Moore's Law alive. Companies kept becoming exceptionally excellent in one specific segment of the IC supply chain, leaving other parts to a different set of companies. The vertically integrated design model faded away in favour of a fabless-foundry-assembly model, unleashing unmatched creativity. This happened not because of some anti-trust regulation to break vertical integration but evolved organically as a result of market-based incentives. I wish people understood this aspect of Moore's Law better. It’s not just about technological progress.

I often wonder if this ethos of Moore's Law can be transported to other spheres. In recent times, Sam Altman of OpenAI makes a similar case:

The best way to increase societal wealth is to decrease the cost of goods, from food to video games. Technology will rapidly drive that decline in many categories. Consider the example of semiconductors and Moore’s Law: for decades, chips became twice as powerful for the same price about every two years... In the last couple of decades, costs in the US for TVs, computers, and entertainment have dropped. But other costs have risen significantly, most notably those for housing, healthcare, and higher education. Redistribution of wealth alone won’t work if these costs continue to soar...

“Moore’s Law for everything” should be the rallying cry of a generation whose members can’t afford what they want. It sounds utopian, but it’s something technology can deliver (and in some cases already has). Imagine a world where, for decades, everything–housing, education, food, clothing, etc.–became half as expensive every two years.

Moore's prediction was enabled by a combination of technological and economic factors. Can it become a guiding light for other fields? We hope so. Yeh Dil Maange More than Moore.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] On Persuasion: Yascha Mounk with Martin Wolf on the Crisis of Democratic Capitalism.

* [Book] Fabless: The Transformation of the Semiconductor Industry by Daniel Nenni is a good book to understand the industry.

Insights on global policy issues relevant to India

— RSJ

Where do I start this week? 

Maybe with a spot of self-promotion. Pranay and I were guests on the popular Hindi podcast Puliyaabazi. I have been a long-time fan, so it was nice to be a guest there. Pranay usually co-hosts this with Saurabh and Khyati, but this time, he was on the other side. I felt a bit like Uday Chopra, who is only in the film because he is the producer’s brother. Anyway, I think a good time was had by all as we covered a wide variety of topics - Enlightenment and why it didn’t happen in India (short answer: there wasn’t any need, really), why we write this newsletter (majboori) and the usual quota of Bastiat, Smith and Rorty (showing off).

Do listen if you have time (of course, you do).

Moving on. 

Here is a quick run-through of what’s gone on since my last post. Another US regional bank, Signature Bank, stared into the abyss with depositors making a run to withdraw their money as analysts looked around for large unrealised losses sitting on banks’ balance sheets. Fed officials spent their weekend hawking the other failed bank, Silicon Valley Bank (SVB), to potential buyers. But who in their right mind will buy out a troubled bank in these times? More so after all the trouble that the likes of JP Morgan Chase had buying out such banks during the financial crisis of 2009.

Running out of options, the Fed, the Treasury and the Federal Deposit Insurance Corporation (FDIC) announced an unprecedented bailout of all depositors of SVB and any other bank that will be in a similar hole in future. Simply put, FDIC will guarantee all deposits and not just those below $250,000 for which there’s insurance. To be sure, the equity shareholders and those holding unsecured corporate bonds won’t be bailed out. They will lose their shirts. So, this isn’t a repeat of the 2009 bailouts. The Fed then went a step further to address the root cause of the problem. Banks are sitting on huge held-to-maturity (HTM) losses on the securities they hold because the interest rates have moved too far up too quickly. And they have a liquidity issue if there are continued withdrawals from the depositors. If they sell their securities today to meet their commitments to give depositors their money when they ask for it, they will have to sell them at a loss. This substantial loss will mean they will need to raise capital from shareholders to keep themselves solvent as per Fed requirements. But who will give them money in this market? Uninsured depositors who play out this game-theory scenario in their minds will therefore withdraw more of their money. Ideally, if they play the scenario right as a collective, they shouldn’t. But as individuals, they will make a run on the bank. Soon, the bank will be in a death spiral, and this is what happened at SVB and Signature Banks. The last-minute solution devised by Fed was the creation of what’s termed the Bank Term Funding Program (BTFP). Here’s how Fed sees BTFP:

“The additional funding will be made available through the creation of a new Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution's need to quickly sell those securities in times of stress.

With approval of the Treasury Secretary, the Department of the Treasury will make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP. The Federal Reserve does not anticipate that it will be necessary to draw on these backstop funds.”

If you didn’t have any background to this situation and just read the above note from the Fed, you’d be forgiven if you thought here was a central bank of a developing world economy figuring out a short-term jugaad to solve a crisis at hand. But the Fed didn’t just stop here. After all, like the Queen in Through The Looking Glass, it can believe in six impossible things before breakfast. Leaving their struggles to find a buyer for Signature Bank behind, they put together a unique Barjatya style “hum saath saath hain” deal and nudged a number of banks to do their bit to shore up confidence in the banking system: (as CNBC reports)

“A group of financial institutions has agreed to deposit $30 billion in First Republic in what’s meant to be a sign of confidence in the banking system, the banks announced Thursday afternoon.Bank of America, Wells Fargo, Citigroup and JPMorgan Chase will contribute about $5 billion apiece, while Goldman Sachs and Morgan Stanley will deposit around $2.5 billion, the banks said in a news release. Truist, PNC, U.S. Bancorp, State Street and Bank of New York Mellon will deposit about $1 billion each.

“This action by America’s largest banks reflects their confidence in First Republic and in banks of all sizes, and it demonstrates their overall commitment to helping banks serve their customers and communities,” the group said in a statement.

“This show of support by a group of large banks is most welcome, and demonstrates the resilience of the banking system,” The Federal Reserve, Treasury Department, Federal Deposit Insurance Corporation and Office of the Comptroller of the Currency said in a joint statement.”

Remind me now, sometime in the past, I have accused Indian policymakers of what’s called isomorphic mimicry. It is a concept developed by Lant Pritchett et al to explain the tendency of governments to mimic other governments’ successes, replicating processes, systems, and even products of the “best practice” examples without actually developing the functionality of the institutions they are imitating. Policymaking in developing countries often falls prey to this. A good example of this is imitating the green energy policies implemented in Sweden (a $60,000 per capita economy) in India (a $2000 per capita economy) which has neither the state capacity to implement nor the public readiness to accept such policies. 

Why am I bringing up isomorphic mimicry here? Well, because I never imagined a day shall dawn when the US policymakers take a leaf out of what India did when faced with a crisis. What the Fed did to save Signature Bank is isomorphic mimicry flowing the other way. To refresh your memory, here’s a Business Standard report (Mar 13, 2020) on what the Finance Ministry and RBI did to save Yes Bank in 2020:

“Hours after the Cabinet approved reconstruction scheme for YES Bank, private lenders ICICI Bank, HDFC, Kotak Mahindra Bank and Axis Bank came to the cash-strapped bank's rescue. While the SBI had earlier announced its decision to purchase 49 per cent shares, both ICICI Bank and HDFC are set to invest Rs 1000 crore each with Axis Bank pouring Rs 600 crore to pick up 60 crore shares of the troubled lender and Kotak Mahindra infusing an equity capital of Rs 500 crore under the RBI's bailout plan.

The developments took place soon after Finance Minister Nirmala Sitharaman said that other investors were also being invited.”

I guess one way to look at this is if you let fiscal dominance become the central canon of how you manage your economic policy, you will eventually reach the same place as other economies (mostly developing) that have indulged in the same for years. The monetary authorities in the U.S. have been accommodating the fiscal profligacy of the treasury for years. This was accentuated during the pandemic. Trillions of dollars were pumped in to save the economy. I’m not sure how much the economy needed saving then. But that bill has come now. First in the shape of inflation, followed by rapid, unprecedented rate hikes and the inevitable accidents that are showing up now. Almost certainly, a recession will follow. Isomorphic mimicry of Latin American monetary policy indeed.

Anyway, that was not the only bailout of the week. We also had Credit Suisse almost going under in a bad case of deja vu to those who have seen 2009. Here’s CNBC on this:

“Credit Suisse announced it will be borrowing up to 50 billion Swiss francs ($53.68 billion) from the Swiss National Bank under a covered loan facility and a short-term liquidity facility.

The decision comes shortly after shares of the lender fell sharply Wednesday, hitting an all-time low for a second consecutive day after its top investor Saudi National Bank was quoted as saying it won’t be able to provide further assistance. The latest steps will “support Credit Suisse’s core businesses and clients as Credit Suisse takes the necessary steps to create a simpler and more focused bank built around client needs,” the company said in an announcement.

In addition, the bank is making a cash tender offer in relation to ten U.S. dollar denominated senior debt securities for an aggregate consideration of up to $2.5 billion – as well as a separate offer to four Euro denominated senior debt securities for up to an aggregate 500 million euros, the company said.”

What’s that word that starts with C and was used a lot during the pandemic? Well, that C word is knocking at the doors of global finance right now. It is not a contagion yet. But the odds of it happening have significantly gone up in the past week.

I will close this by covering the two discussion themes emerging from these events. 

First, what happens to the hawkish stance the Fed had taken a couple of weeks back on more rapid rate hikes in the light of inflation being sticky and inflation expectations being anchored? This, as I have written earlier, is of real interest to India and its policymaking stance. The Fed is in an absolute bind now before its meeting on Wednesday to take a call on rates. A rate hike in the current environment will make the weak banks look even more vulnerable despite the deposit backstop and the additional liquidity available from BTFP. And who knows what other accidents are lurking that will show up as the rates go higher? Does the Fed want to risk financial instability? On the other hand, inflation is real, and it is an election year. Runaway inflation will mean the eventual taming of it, and the recession that will follow will be hard and long. Who wants to preside over that? I see almost zero chance of a rate hike in this cycle. The Fed might wait till May to resume raising rates after it has weathered this risk of banking contagion and waiting for the April inflation data. But even then, the core problem remains. Further rate hikes will expose weak players, and that will mean we will have accidents. So long as they are small and contained, it is worth the risk of raising rates. But who can predict the nature of the accidents?

Second, there’s some kind of war that’s broken out on social media on who is responsible for the collapse of SVB and Signature. There are those who believe it is the Fed whose actions over the past three years are solely responsible for the situation we are in now. The crux of the argument is that the Fed forecasts the interest rate and then it sets the rate. Banks take bets on long-term securities based on these forecasts. This is called duration risk. If the Fed then sets the rate that’s so far removed from their own forecasts, what do poor treasury folks in Banks do? Plus, it is the Fed that has been making the rules since the GFC to direct a whole lot of bank liquidity into the purchase of long-term government bonds. The whole system is rigged by the Fed, and when things go wrong, it cannot pontificate on the risk management practices of banks. The counter to this is that the Fed only puts out an interest forecast based on the data (esp on inflation) that’s available. When the incoming data changes, its forecast changes. This deviation is in a narrow band in usual times. In unusual times like what we’ve been through in the past two years, you may have a bigger variance. Banks have multiple ways to hedge duration risks. Instead of looking at the Fed to apportion blame, one should look at how conveniently the depositors of SVB - the VCs, startups and other cool people - jumped ship at the first sign of trouble when they know such a collective deposit withdrawal will make the situation worse. It is incredibly stupid of this deposit base that prides itself on its ability to see further, take long-term bets and dimension risks better than others, that it could not have the patience to stand by a bank that has served them well. The problem of SVB bank, according to this lot, is they were over-reliant on a lopsided deposit base, and that deposit base acted most stupidly. 

I think both these debates are going to rage on for some time. The Fed has slipped down the path where it has allowed fiscal dominance to overrule prudent policymaking. It is quite difficult to retrieve ground from there unless you have a Fed Chair with the intellectual heft and drive to restore balance. Equally, asset liability matching (ALM) is a core responsibility of banks. They are supposed to diversify their base of customers, monitor duration risks, and stress-test their balance sheet. All the strutting around as a cool disruptive bank or hanging out with your clients should not distract you from that fundamental truth.

You take your eye off it, you veer off the road.    

Advertisement: Admissions to Takshashila’s Post-graduate Programme in Public Policy (PGP) are now open. This is a fantastic opportunity if you want to dive deep into public policy while pursuing your work responsibilities.

India Policy Watch: Milking Consumers and Producers, All at Once

Insights on burning policy issues in India

— Pranay Kotasthane

We harp on Hayek’s paper, The Use of Knowledge in Society, in this newsletter. Price is a vital signal, a decentralised coordination mechanism between producers and consumers. And so, when governments prohibit its functioning, bizarre things happen. Let’s analyse the consequences of price distortion using an ongoing situation — the milk shortage in Karnataka.

A bit of background to set things up. Milk is an ‘essential’ commodity. Its essentiality is not just a matter of fact or reason but also a carte blanche for Indian governments to regulate the production, supply, and distribution of any commodity that is classified as essential under the Essential Commodities Act (ECA), 1955. In practical terms, it means that the government fixes procurement prices, caps consumer prices, and often owns and runs everything that lies between these the producer and the consumer.

So is the case with milk in most states, including Karnataka. The Karnataka Milk Federation (KMF) is a dairy cooperative under the Department of Cooperation, Government of Karnataka. It procures nearly 50 per cent of all the milk that is produced in the state. It sells products under the brand name Nandini. Nearly 50 per cent of its consumption happens in the capital, Bengaluru.

Government ownership complicates and comicalises the situation in a way that can only be equalled by a Priyadarshan comic flick. See, for instance, what has happened due to a milk supply chain disruption over the last few weeks.

As the summer began early this year, the demand for milk rose sharply. A glass of majjige (buttermilk) or lassi is a wonderful refresher in the heat. Simultaneously, the supply drops in the summer months. Natural adaptation dictates that animals produce less milk than usual in the heat. A bout of lumpy skin disease has further exacerbated the gap between demand and supply this year.

For an ordinary product, a rise in prices would iron out this demand-supply gap quickly. With an increase in prices, consumers will rationalise consumption, while the producers will work harder to increase the supply. But when governments own the supply chain, price rises are defenestrated, and a chain of bizarre events emerges.

First, electoral concerns circle over pricing decisions like vultures. In this particular case, the government will not touch the price caps with a barge pole because the Karnataka elections are due in May. So the government tries to increase prices in a roundabout way: increase the maximum retail price (MRP) but offer a reduced quantity of milk for the same packet price.

Second, shortages abound. Since the administered price rises have not done enough to make the demand-supply gap go away, milk shortages have emerged. The rich can well afford to buy premium milk at higher prices from other suppliers. But for the poor, the milk packets disappear. Instead of paying a slightly higher price until the supply rises again, the less-privileged consumers are left only with an empty glass.

Third, the government resorts to blaming private businesses. Someone has to be blamed, and as so often happens in India, businesses get the flak. See this report in The Hindu, which casually places the blame on private players who are now willing to offer higher prices to the dairies and farmers. The report says:

“Private players purchasing milk from the retail market to sustain their businesses in milk products is said to be causing a disruption…

“He also said private dairies were procuring milk directly from farmers in rural areas by offering a higher price, thus reducing the union’s procurement.”

We should have been celebrating private players that are offering a better deal to farmers, given the scarcity. Instead, they have become villains.

And fourth, a quotidian issue becomes a front for inter-state tensions. The Karnataka government blames dairies in Maharashtra and Tamil Nadu for offering higher prices to farmers within Karnataka, while the Tamil Nadu government is blaming private companies from Andhra Pradesh!

Funny, the kinds of things that happen when the government enters and obstructs a control system called “prices”.

Even as this satire unfolds, the root cause of the milk shortages isn’t even being talked about. The Bangalore Milk Union president admitted that “many small milk producers have given up on rearing cows as it has become unsustainable”. Though he doesn’t mention the underlying reason for this change, the bans on cow slaughter and recent attacks on people transporting cattle surely have reduced the incentives for farmers from stepping into this minefield called milk production.

HomeWork

Reading and listening recommendations on public policy matters

* [Newsletter] Economic Forces is a must-read newsletter for all public policy enthusiasts.

* [Paper] This paper on the effect of a landmark policyWTF called the Freight Equalisation Scheme explains how good intentions can sometimes produce terrible policies.

Insights on global policy issues relevant to India

— RSJ

I must admit there are times when I have made a big deal about writing this newsletter. Not about the content, mind you. I’m not that vain yet. But the regularity of it all. Getting about 4000 words out between the two of us every week isn’t trivial stuff. But then there are weeks I ask myself if it is really a big deal. I mean, there are weeks when there’s so much happening in policy, politics and macro spheres that things just write themselves. I have been in what could be called writing self-help groups where people bemoan their writer’s blocks and the soul-crushing experience of staring at a blank word document with the cursor blinking. To them, I have two pieces of advice. Switch to writing on public policy. And don’t bother much about quality (speaking for me here, not what Pranay produces). 

Voila! You get something like 50% of this newsletter.

Anyway, coming back to this week. Sometime midweek, I thought it might be a good idea to write about the state of opposition in India in the light of Rahul Gandhi’s Bharat Jodo Yatra and his media engagements in Oxford. There’s always space for the opposition in India despite the brutal electoral majority of the party in power, as we have seen in the past. This was evident during the yatra. What is also evident now is that there’s a complete lack of understanding on the part of Rahul Gandhi on issues that can animate the electorate. So, he can only hope for the party in power to hit self-destruct mode to score an electoral victory. What’s worse is he has terrible ideas of his own and a tin ear for good advice. His acolytes defend him saying he’s sincere. I can only say when you combine sincerity with bad ideas, you get demonetisation and instant lockdowns. Back to the point. As I was thinking of writing about this, news came in of Manish Sisodia, the deputy CM of Delhi, being taken into custody by ED for what’s being called the liquor scam. Liquor policy in various Indian states is a gift that keeps giving. We love talking about it. What I also thought was admirable is the agile way the ED functions these days. Like some start-up in Koramangala. It is always hustling. 

These were the ideas I was toying with till a bank with a balance sheet size of US$ 200 billion (a tad smaller than HDFC Bank) collapsed in the US. And, so, served on a platter was another possible post on what could go wrong in the global economy. I’m afraid Rahul Gandhi, Sisodia, and liquor will have to wait for another day. I would like to discuss the aptly named Silicon Valley Bank (SVB) that has gone from boom to bust in less than two years.

Here’s what has happened since Thursday. WSJ reports:

“On Wednesday SVB said it had sold a large chunk of its securities, worth $21 billion at the time of sale, at a loss of about $1.8 billion after tax. The bank’s aim was to help it reset its interest earnings at today’s higher yields, and provide it with the balance-sheet flexibility to meet potential outflows and still fund new lending. It also set out to raise about $2.25 billion in capital.

Following that announcement on Wednesday evening, things seemed to get even worse for the bank. The share-sale announcement led the stock to crater in price, making it harder to raise capital and leading the bank to scuttle its share-sale plans, The Wall Street Journal has reported. And venture-capital firms reportedly began advising their portfolio companies to withdraw deposits from SVB.

On Thursday, customers tried to withdraw $42 billion of deposits—about a quarter of the bank’s total—according to a filing by California regulators. It ran out of cash.”

Looks like a good old run on the bank. The regulators had to step in. Again from WSJ:

“The Federal Deposit Insurance Corp. said it has taken control of the bank via a new entity it created called the Deposit Insurance National Bank of Santa Clara. All of the bank’s deposits have been transferred to the new bank, the regulator said.

Insured depositors will have access to their funds by Monday morning, the FDIC said. Depositors with funds exceeding insurance caps will get receivership certificates for their uninsured balances, meaning businesses with big deposits stuck at the bank are unlikely to get their money out soon.”

If you’ve been reading me over the past month, I have made three points. One, it is foolish to assume that the Fed will pause on rate hikes anytime soon. Inflation isn’t transitory in the US. And this was made clear this week when the Fed Chair, in his response to the questions from the Senate Committee on Banking, said that interest rate hikes are “likely to be higher than previously anticipated” and that because of it, the labour market is also likely to weaken in the near term. Like I have said before, it is best that markets, banks and companies plan for scenarios where the rate goes up to 7 per cent to stress test their models. This holds for India too.

Two, it is inevitable that a sharp rise like what we have seen in the past nine months will mean there will be ‘accidents’. We don’t know yet what their nature will be, but they will mostly emanate from private markets and the ‘new’ asset groups (like crypto, VC funded business models) where bubbles have built up.

Three, whatever accidents happen may not lead to a contagion. They will mostly singe private markets or those holding these new speculative assets.

In a way, what has happened with SVB this week bears my thesis out. 

So, what happened? And what does this mean?

During the pandemic, the US treasury pumped trillions of dollars to keep the economy afloat. But because of the pandemic, there was nothing to spend this money on. So, the money found its way into banks as deposits. The total deposits in US banks went up by $ 5.5 trillion, of which only about 15 per cent could be used to lend because of weak demand. So, what could Banks do? Well, like prudent entities, they parked this surplus in securities or kept it as cash. Now, when Banks buy securities, they are asked to take a call upfront on whether they plan to hold them to maturity. This decision then labels the securities as either held-to-maturity (HTM) or available-for-sale (AFS). Simply put, with an HTM security, the bank is declaring that it will hold, say, a US government 10-year bond till they mature (that is for ten years), while if it categorises another bond as AFS, it means it can sell them anytime in between.

Now, from a regulatory perspective, this plays out in different ways for a bank. An AFS security gives banks flexibility to sell a security if the world changes around them, while an HTM security allows banks to weather a fall in value because they aren’t marked to market (M2M). Therefore, they will remain on their balance sheet at amortised costs regardless. Banks don’t have to crystallise their losses on HTM portfolio because the expectation is that on the date of maturity, they will receive the full redemption value. However, if the bank sells anything out of its HTM portfolio, it has to reclassify the entire portfolio as AFS. In 2020, US banks had about 74 per cent of their portfolio in AFS securities. As things opened up after the pandemic and inflation started taking root, interest expectations rose. 

A small explainer will help the lay reader here. Others can skip ahead.

Bond prices are inversely related to interest rates. Suppose you bought a 1-year government bond of Rs. 100 with a coupon rate of 5 per cent. This means at the end of the tenure, the bond will fetch you Rs. 105 regardless of the bond's underlying market price. Assume the prevailing repo rate (benchmark interest rate) was 4 per cent. What this meant was you had an incentive to purchase this coupon that would give a little extra over the prevailing benchmark rate, and at the end of the year, you could redeem the bond and receive Rs.105. Because many people buy and sell government bonds, there is a market for them where they get traded. Now consider a scenario where in the middle of the year, the benchmark rate was increased to 10 per cent by the RBI. What if, for any reason, you want to sell your bond during this time? Nobody will buy your bond for Rs. 100 which is the price you bought it at. Why? Because it will fetch them only Rs. 105 (5 per cent return), while if they bought a fresh 1-year bond priced at Rs.100, they could get Rs. 110 (10 per cent return). But you’re desperate for money, so the best you can do is to offer your bond at Rs. 95.50 or so. Because then whoever buys it will get Rs.105 at the end of the year and will make an equivalent 10 per cent return. So, you take a loss of Rs.4.50 (or about 4.5 per cent) by pricing your Rs.100 bond at Rs.95.50. At an aggregate level, this is what happens in the market as the interest rates go up. The price of the bond falls. And conversely, if the rates fall, the bond price goes up. So, a Bank holding securities sits on a mark-to-market loss or profit depending on whether interest rates go up or down. 

As interest rates rose, the US banks that were sitting pretty with mark-to-market gains on their AFS portfolio started having losses emerge. Now you could keep taking mark-to-market hits every quarter, or you can reclassify the AFS to HTM, take a one-time loss upfront and move on. Because once you make it HTM, remember, you don’t have to account them as marked-to-market. And that’s what has been happening for most of 2022. Banks reclassified their AFS, and their share fell from 74 per cent in securities portfolio to a little less than 50 per cent. 

The Case of Silicon Valley Bank

Silicon Valley Bank (SVB) had an interesting time during the pandemic. It has, over the years, positioned itself as the bank for the valley ecosystem of startups, VCs and angels. The boom in VC funding since 2019 meant its deposit balance tripled to about $200 billion by March 2022. What’s more, a large part of it was demand deposits which don’t bear interest. As we have learnt now, its cost of deposits or the interest it paid its depositors on average was about 1.2 per cent. What does a bank do if it has so much money flowing in? It has to put the money to work. But SVB’s problem was there weren’t too many loan takers in its customer base since it catered to the valley ecosystem flush with funds. The real and safe option it had was to put money in securities. That’s exactly what it did. Around 12 months back, it had about $100 billion in HTM and another $25 billion in AFS through various securities like the US treasury bonds and mortgage-backed securities. 

That’s when the Fed's action on interest rates started. And it was rapid. This meant the price of those securities, especially the mortgage-backed lot, fell quickly. By September 2022, the unrealised losses on the portfolio had gone up to $16 billion, while the total common equity capital was $11.8 billion. Technically, the bank was insolvent. But these losses on the HTM portfolio don’t have to be recorded on the bank's books. What a Bank would do is wait for bonds to redeem, hope for interest rate hikes to pause, keep their depositors with them and see through this tough time. It was doing exactly that except for one more wrinkle. Its deposit portfolio was skewed to the fortunes of the valley. As funding dried up, the valley companies burned through their bank balances. This meant they were constantly withdrawing money. From $200 billion in March 2022, the deposits fell to $165 billion by last month. There was a serious danger of the bank not having liquidity to give depositors their money unless they restructured their balance sheet.

Endgame

This is what SVB set out to do last week. They sold $21 billion of AFS at a loss of $1.8 billion to have cash available to them. And to recover this loss, they planned to raise capital by issuing fresh equity. Tough to explain but still doable. As luck would have it, the same day, a crypto bank, Silvergate Capital, announced it was insolvent for pretty much the same reason, except that SVB had real cash deposits. The depositors lost their nerve. Large VCs called for their portfolio companies to take money out of SVB. In the good old days, this would have meant going to branches and asking for your money. It would take time. Today, it is just a few clicks on the mobile app, which is aimed to give you a frictionless experience. That lack of friction meant customers tried to withdraw $42 billion - about a quarter of its total deposits - in a single day. Most of the depositors at SVB had balances of more than $250,000, which is the threshold for deposits to be insured. This meant the demand for withdrawals was real. The bank ran out of cash. The CEO came to assure depositors that they needed to have patience and the bank was liquid. I might have told you before - the moment a bank has to tell its depositors that they are liquid, they won’t stay liquid any more.

What could the bank have done? Its HTM book could be sold. But selling a single bond there would have meant marking the whole portfolio to market. That would have been a huge loss, and the bank didn’t have the capital to absorb that. It could have borrowed funds, but that was coming at closer to 5 per cent, which was expensive. The only real thing it could have done was probably two years back. It could have diversified its depositors base, figured that its asset portfolio was too skewed to interest rate risk and reduced its balance sheet size. There are regulations on the nature of your deposits through what’s called Liquidity Coverage Ratio guidelines, but SVB was deemed too small for it. It is a lesson in policy making that what’s small or big is related to the broader macro context and cannot be fixed forever. This is what I meant when I said the scenarios that could unfold because of a rapid rise in rates are unknown to us. I mean, look at the percentage of unrealised losses to total equity among US banks. There are some vulnerable banks there. Is someone asking the same question in India? As I mentioned a couple of editions ago, it will be good for India to plan for a scenario where the Fed hikes the rate all the way to 7 per cent.

The Fed cannot anticipate the unintended consequences of its battle to tame inflation. At some level, I guess it doesn’t care as much. If there are weaker players who get sick on this ride up, so be it. The accidents are waiting to happen. We will be plain lucky if the contagion is contained to private markets because we believe the larger public markets and banks are better regulated. But you never know.   

Matsyanyaaya: The Indo-American Dance

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

There’s been a flurry of Indo-American diplomatic activity in recent weeks. The two National Security Advisors (NSA) held the inaugural meeting of the initiative on Critical and Emerging Technology (iCET) on Jan 31. Then there was the mid-February phone call between the Indian Prime Minister and the US President. In early March, the four foreign ministers of the Quad made it a point to turn up at a Raisina Dialogue panel. Most recently, the US Commerce Secretary Gina Raimondo was in Delhi, where she held meetings with the Finance, Education, External Affairs, Defence, Commerce, Electronics & IT ministers, and the NSA. The two commerce ministries also signed an MoU on Semiconductor Supply Chain and Innovation Partnership.

These are all significant shifts. Perhaps we can forgive Mr Singh’s Holi dance performance, where he appeared as anatopistic as Bharat Bhushan would have felt in a Karan Johar movie.

In edition #165, I analysed the India-US relationship using a tri-axis framework: state-to-state relations, state-to-people relations, and people-to-people relations. The people-to-people relationship never had a problem, to begin with, and state-to-state relations have never been better. Yet, surveys suggest that Indians continue to be circumspect of successive American governments.

Perhaps for a good reason. One can’t deny the US stance in the 1971 war, its continued support to Pakistan despite the latter’s anti-Indian projects, and its role in the multilateral export control regimes that held back India’s space and nuclear programmes.

These three reasons became the foundations on which the edifice of anti-Westernophobia was constructed. Like other ideologies, instances that reaffirmed the ideology got amplified and internalised, while instances that didn’t fit into the dominant narrative were discarded.

For example, consider an oft-repeated argument: a closer partnership with the US would imply that “India will be dragged into its wars.” The logic is as follows. The US, as a superpower, keeps overextending itself as it’s an integral part of its strategic doctrine to tackle the adversary before the threat reaches its shores. This means that partners have no choice but to fight these expensive and sometimes irrelevant wars. If they dare to strike a discordant tone, the US will use its immense power to punish them.

The problem with this story is that India’s own experience points out otherwise. India did face this question after the US misadventure in Iraq. By then, the relations were on an upswing. The Bush government wanted to hand over the post-war transition to a “coalition of the willing”, and India featured prominently in those plans. The Indian government considered this request at the highest levels and eventually chose not to intervene. Despite this refusal, the India-US relationship didn’t face a major bump. The two countries announced an initiative called the Next Steps in Strategic Partnership (NSSP) six months later. By 2005, the two countries had enough confidence to sign the monumental civil nuclear deal. So much for the concern over dragging India into American wars.

The civil nuclear deal provides another counter-point. A recent book by veteran journalist Seema Sirohi Friends with Benefits: The India-US Story, meticulously details the events and personalities involved from the American side. What struck me most was the efforts made by the Bush administration to align cognitive maps of domestic and international opponents, that too within a decade after the post-Pokhran economic sanctions had created a new low in the relationship. On the issue of getting the NSG waiver past six opposing countries, Sirohi writes:

“The Americans used every weapon in their diplomatic arsenal to persuade countries. At one point Mulford suggested sending a warning to Austria that Washington was ready to tell India to cancel all Austrian Airline flights. The British and the French, who were helping the US, would corner recalcitrant European ministers at every opportunity in different locations—including in opera houses and trains—to argue for the NSG waiver. In the end, all forty-five were persuaded. Many saw India as a responsible nuclear power with the potential to play an important role in world affairs.”

Now, none of this was out of benevolence. In fact, to use a construct applicable to human relations in state-to-state relations would be grossly inappropriate. To say that the US is hypocritical, unreliable, or benevolent makes no sense in an arena where national interests are supreme. Anthropomorphism in international relations is as sound as counting goals in a cricket match.

Rather, what this instance illustrates is the benefit of a closer India-US relationship. Having the world’s number one power on the same side can open doors that strategic autonomy can’t. To be sure, there will be costs. But, given that the interests of India and the US have never before converged as they have today, India’s mileage out of the relationship would likely be much higher. After all, Taiwan, Japan, South Korea, and even China gained power in no short measure due to the trade, technology, and human flows from the US. This is India’s opportunity to amass national power quickly.

PolicyWTF: Number Mirages

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Don’t let numbers fool you. This theme has spawned a new genre of books, starting with Darrell Huff’s 1954 classic How to Lie with Statistics. And yet, governments continue to insult our intelligence by using the same tropes repeatedly. What’s worse is that they often succeed.

So in this week’s policyWTF section, let’s look at some favourite number-chicanery tools used by Indian governments.

One: present a current figure as a multiple of its value from almost a decade ago.

Consider the news item from this week. “According to the National Statistical Office (NSO), the estimated annual per capita income at current prices for 2022-23 has doubled since the Narendra Modi-led NDA came to power in 2014-15”. Presented this way, the rise in national income sounds really, really impressive.

Now pause for a moment. Using the shorthand rule of 72 suggests that a figure increasing at roughly nine per cent annually doubles in eight years. Instead of putting out the 9 per cent annual growth, the government showed you national income as a multiple of its value eight years ago.

Two, present numbers at their nominal values in place of inflation-adjusted values.

Another common strategy to make small increases seem bigger is to compare numbers at current prices rather than constant prices. The national per capita income story from this week uses this second trick as well. Adjusting for inflation, the incomes have only risen by 35 per cent in the last eight years, which translates to a poor 3.8 per cent annually.

Instead of pointing out this abysmally low number, most news analyses went on a tangent to explain how the national per capita number is a mean value and doesn’t account for the variance in incomes (duh!). Soon it became a debate over growth versus income inequality. The government went scot-free.

Three, use a data point and its converse, both, to claim success.

Thanks to RSJ for pointing this one out. Take a recent example. Demand collapsed at the height of the pandemic, and so did imports. That led to India showing a current account surplus for a few quarters, a rare occurrence. The government celebrated this “achievement”, downplaying the worrying cause of the surplus. When the current deficit was back when the pandemic ended, that too was celebrated as an indicator of strong domestic demand and bounce back!

Four, spew out decontextualised metrics.

Using absolute numbers instead of per capita numbers is an old trick in the government. Most numbers related to the government are big. If I were to tell you that the Corporate Social Responsibility (CSR) Law (aka Mandatory Philanthropy) generated Rs 21,000 crores in a year, you might be impressed. But only if I were to tell you that this is less than half the amount the Union government spends on MGNREGS alone would you ask: are the compliance costs worth the benefits of the CSR law?

Five, compare budget estimates of the next financial year with budget estimates of the current financial year.

When budget documents are presented in the legislature, governments have revised estimates of the current year with them. An old trick is to compare the allocation of the next year with the older budget estimate in order to paint a better picture. For instance, the press release for the defence budget this year reads, “Defence gets Rs 5.94 lakh crore in Budget 2023-24, a jump of 13% over previous year”.

What’s left unsaid is that the increase over the revised estimates is a mere 1 per cent, that too in nominal terms. Accounting for inflation, the government will spend much less next year than it spent in the current fiscal year. The headline is perfectly accurate and perfectly misleading, both.

This list is nowhere near exhaustive yet. Are there other tricks you recollect?

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] A Puliyabaazi on India-US relations with Seema Sirohi

* [Book] A classic - FA Hayek’s The Fatal Conceit

* [Podcast] This Ideas of India episode is a treat for anyone interested in urban governance and planning.

* [Article] Shekhar Gupta’s take on India-US-Russia relations.

Insights on burning policy issues in India

— RSJ

Earlier this week, Pranay and I recorded an episode with Shruti Rajagopalan for her podcast Ideas of India. I have been following Shruti’s columns and the podcast for a while now, and I will recommend you subscribe to both her podcast and her newsletter. She’s always insightful, curious and uses first principles to probe issues. This means you cannot get away with the usual stock answers. One of the questions we discussed at length was why does the Indian electorate not prioritise growth while making their choices at polls. It is an interesting contention whose premise itself can be questioned. How can we conclude that they don’t? And then, if we assume for a moment they don’t, why do they not?

I won’t spoil your experience of listening to the episode by going into the details of what we discussed. But I will cover some ground in today’s edition on why it seems that people in India don’t care about economic growth. And as it often happens in life, this discussion happened in the same week when India published its GDP estimates for the quarter Oct-Dec, 2022. So what I will do today is cover the data released by the National Statistical Office (NSO), take a wider view of what’s happening with the economy and round it off with that question that Shruti asked.

Here’s the headline news on growth: From the ET:

“India’s gross domestic product (GDP) for the October-December quarter moderated to 4.4 per cent from 6.3 per cent in the previous quarter, data shared by the Ministry of Statistics and Programme Implementation showed on Tuesday. The GDP has now moderated from 13.5 per cent in the first quarter of FY23 largely due to pandemic-related statistical distortions.

Lower GDP growth can also be attributed to aggressive rate hikes by the Reserve Bank of India in order to tame the high inflation. In addition to these factors, the slowdown in exports and consumer demand has also contributed in bringing down the numbers. The dent in consumer demand can be linked with the bullish rate hikes by the central bank to bring down inflation in the past few months. Meanwhile, slowdown in external demand could be a consequence of the rate hikes by major central banks around the world.”

Apart from this, the NSO made revisions to the GDP numbers for FY 22, FY 21, FY 20 and to the first two quarters of this FY. Heh! I’m reminded of that famous quip by a former RBI Governor, ‘In other countries the future is uncertain, but in India even the past is uncertain’. 

The growth numbers came in as a negative surprise. What’s worse, manufacturing showed a contraction for the second quarter in a row. Not a great sign when the government has been pushing for companies to set up a base in India and eyeing that ‘China+1’ pie. 

The WSJ had a summary of the key signs of worry in the Indian economy:

“Weakness in private consumption stood out the most. India’s private consumer spending, which comprises about 60% of India’s gross domestic product, rose just 2.1% year over year, compared with an 8.8% increase in the September quarter. It was mainly hurt by higher interest rates and elevated inflation. Slower growth in rural spending after some pandemic-era subsidies were cut could have also played a role.

A closer look at other numbers in the GDP data also paints a worrisome picture. Import growth fell more sharply than export growth, again signalling weak domestic demand. And while fixed investment growth was a relative bright spot, it still slowed for the second quarter in a row.

Nomura economists Sonal Varma and Aurodeep Nandi think markets are still significantly underappreciating the risks to India’s growth. They say the country’s growth cycle has peaked, and a combination of weaker global growth and tight domestic and global financial conditions could spell further trouble for exports, investment and discretionary consumption.”

So, what should one make of this data? There’s clearly a moderation of growth. Some of it is expected because of the base effect of the pandemic years and the upward revision to growth done for the previous years. It is also true that global demand is weak, so exports will be sluggish for a while. On the other hand, manufacturing growth remaining weak despite all the PLI and ‘Make in India’ efforts should worry policymakers. Domestic consumption is starting to feel the impact of rate hikes, and the liquidity situation remains tight. Of course, the data can be spun the other way too. The NSO has maintained its 7 per cent growth forecast for the full year, which implies a 5.1 per cent growth in Q4. Inflation is subsiding, and it is likely that after the potential April rate hike, we will have a pause unless global factors come into play. Also, an expected good monsoon and China opening up post its Zero Covid madness will mean domestic and global demand will be back. So, it is all a mixed bag if you just go by quarterly numbers.

I thought it might make sense to look at the long-range data from NSO/CSO and other sources to reach better conclusions than merely reacting to quarter-on-quarter figures. Here’s what I learnt:

* The primary growth driver since 2015 (keeping the pandemic years aside) has been an increase in factor productivity. When compared to the previous decade, the contribution of capital to growth has come down. Simply put, while we have grown at a 6.5-7 per cent annual rate since 2015, which is similar to what we had between 2005-14, the composition of growth is different. We have become more productive, but we haven’t added new capacity to our economy as fast as we did earlier. The good news is factor productivity growth is difficult to achieve, and we have done that. All that talk of digital infrastructure seems to be working. Now, can we reverse capital formation? That’s the next point. 

* Will there be a long-delayed capex boom as has been promised by the government in the last two budgets? The debt to GDP has remained stagnant now for a decade. The total banking sector credit to GDP ratio has been range-bound between 50-55 per cent during this time. Why will it change now? First, the corporate debt to equity and debt to EBITDA are at their lowest right now in over 15 years. The demand for credit from corporates is linked more to the health of their balance sheet than their income statements. The Top 500 companies are sitting on the strongest balance sheets ever right now, and sometime soon, they will have to start believing in what they say at all these business conclaves about India’s time being now. Second, there is significant deleveraging in the banking system, and the leverage (assets/equity ratio) among banks is at a multi decade low. Combine this with a decade long real estate slump which is showing signs of turning despite higher interest rates, the mix is right for the capex cycle to start. 

* Lastly, there are two real risks facing the economy when you go beyond the immediate numbers. The debt to GDP numbers remain elevated at 85-90 per cent range, and the government continues to crowd out others in the debt market. There is some consolidation, as was seen in this budget, but the government has to stay on course to reduce the fiscal deficit and bring the debt-to-GDP ratio back to the 70 per cent handle. The other risk is on the balance of payments (BoP) which will remain in deficit for the foreseeable future. Exports have slowed, and the tightening of the rate differential between India and the US will lower the risk appetite which will impact capital inflow. A longer duration BoP deficit puts India at risk in case of an ‘accident’ in the global market.   

Anyway, you might think Q3 data or a longer-term view of the economy at the moment should trigger a debate on the economy in the media. That people on the street would be interested in knowing how the government would tackle this, and it should be an important discussion point in mainstream media. But there’s none of that anywhere. That leads me back to Shruti’s question on why economic growth is not a critical subject of public discourse in India. Pranay and I had three hypotheses for this.

First, it is not entirely true that growth isn’t a political issue in India. There’s been a steady rise in people’s expectations of economic growth from the government. State elections are fought on an economic plank more often than not. Almost every party speaks of ‘vikas’ without fail. Also, the fact that successive governments see the need to revise (or fudge) growth numbers suggest, in a perverse way, that they know people care about this stuff now.

Second, it is true that people in India still don’t correlate their immediate economic prospects with the policymaking of the government in power. The only economic indicator that bothers people and that they link back to the government is inflation. And that explains why governments tend to be sensitive to price rise data. Also, with the private sector becoming the primary source of new job creation, people tend to blame them for job creation or losses. The question of why the government doesn’t facilitate policies that help the private sector invest and create more jobs isn’t of immediate concern to people. 

Lastly, any discussion on economic growth in India devolves quite quickly to two notions that lots of Indians hold as true. One, we are gifted with the best resources and the best people, so we just have to announce to the world that our time has come, and they will flock to us. This has been exacerbated by a steady stream of global Indians doing well with leading global organisations. So, we think we have a birthright to be a vishwaguru. The WhatsApp forwards certainly don’t help in tempering this skewed notion. The problem is this image then confronts the reality of our performance - low per capita income, poor human development parameters, shoddy infrastructure and economic underperformance. This leads our people to the second notion. That the only reason we aren’t growing like we rightfully should is because there’s some mysterious force stopping us. And this something is easily spun in elections as some other group, some group of ‘them’ saboteurs derailing India versus the ‘us’ who are trying our best. Almost every growth discussion in India goes down this predictable path - start with asking what will spur more growth, refuse to engage with real issues like factor reforms, inefficient and large footprint of the state, complex tax structure etc., and, soon, come down to who or what forces are stopping us from growing? From there, the discussion is easier, politically speaking. Find the ‘other’. And damn them. This has been the script for over half a century now. As we speak today, the other is either some leftist, global cabal out to sabotage India’s inevitable rise or the minority community in India who don’t care about growth or progress. 

There is a likelihood that as income and awareness levels go up, people will draw the link between economic performance and governance and demand better. But this natural progression is up against a concerted narrative and a pliant media that isn’t interested in helping explain this link or asking the tough questions. So, we continue to have the spectacle of prime-time debates saturated with all sorts of non-issues on the day when GDP numbers are published.

It is easier to blame someone for a problem than to solve it. 

Addendum

— Pranay Kotasthane

It’s telling that there are very few recent papers that investigate the link between economic growth and electoral outcomes. But the few that I could find suggest the link between economic growth and political dividends is improving. A 2015 paper by Milan Vaishnav and Reedy Swanson tested this relationship in the period 1980-2012 for major state elections. In the aggregate, there was no statistically significant relationship between growth and electoral performance. But, the picture was different when they looked at just the recent twelve-year section of the study period (2000-2012). Incumbents were rewarded for higher growth, and the relationship held true after controlling for other factors. Contrary to popular belief, they found that inflation didn’t impact electoral outcomes, but economic growth did.

Another recent paper from 2019 by Bang & Mishra contends that sectoral growth matters more than aggregate growth. Specifically, the agricultural growth rate can propel electoral performance, while services sector growth has no such effect. The paper didn’t explain the methodology used, so we should interpret the results with caution.

My own unsubstantiated assertion is that the period of fast growth was so short (2003-2008) that it doesn't register as a benchmark in voter decisions. Our reference points are far lower. Middling rates of economic growth without excess volatility are enough to convince us that we are going in the right direction. We might be subconsciously extrapolating this growth rate linearly, hence allowing other factors to outweigh our electoral decisions.

Regardless, we need a lot more empirical studies to decode this puzzle.

A Framework A Week: A Taxonomy of Policy Failures (and Policy Successes)

Tools for thinking about public policy

— Pranay Kotasthane

Policies can fail due to different reasons. These reasons and diagnostic tools are scattered across several editions of this newsletter. In this edition, I will compile these tools so that we have a single meta-framework for analysing policy failures.

The idea is that whenever you witness a policy failure, one of these menu items might help you diagnose it. A word of caution: this taxonomy is neither mutually exclusive (some failures might span multiple frameworks) nor collectively exhaustive (there definitely are other reasons I’ve not read yet). Nevertheless, it is a useful collection, I think.

Framework 1: The Programmatic - Political Axes

We discussed this framework in edition #147. It assesses policy success on two parameters - programmatic efficiency & effectiveness, and political coalition building & communication. The 2x2 matrix below presents four stylised scenarios.

The use of the “political work” axis highlights that judgments on policies are often subjective. They are “constructed” in our minds as much as they are outcomes of good craft work. That’s why narratives are crucial in policy-making.

Framework 2: A Fourfold Measure

Another framework that we covered in edition #147 builds on the previous framework and devises four parameters of success/failure in order to eliminate getting swayed by narratives alone.

Broadly speaking, Programmatic Assessment measures the Effectiveness and Efficiency of a policy. Process Assessment indicates Implementation Capability. Political Assessment measures narrative power.

Framework 3: Unpacking Success and Failures

Allan McConnell’s paper Policy Success, Policy Failure and Grey Areas In-Between, classifies policies along a spectrum in each of the first three dimensions from the previous framework. The spectrum has the following shades: outright success, resilient success, conflicted success, precarious success, and, finally, outright failure. For instance, here’s how this spectrum would look along the Political dimension.

This framework helps policy analysts identify contradictions between the different dimensions of policy failures. Some policies might be successful along one dimension but might fare poorly along another. McConnell identifies three typical contradictions:

* Successful Process vs Unsuccessful Programmes. These are policies which follow well-established methods of deliberation, such as parliamentary debates, standing committee suggestions, and excellent law drafting. And yet, they might fail as a programme, i.e. they do not achieve the stated goals, and their costs far exceed the benefits. I put policies such as Items Reserved for Manufacture Exclusively by the Smallscale Sector under this category.

* Successful Politics vs Unsuccessful Programmes. These are electorally popular policies that governments want to associate with long after their consequences have played out. Yet they fail to achieve the stated goals and impose far higher costs than intended benefits. Probably, the Bombay Rent Control Act and Corporate Social Responsibility Act fall into this category.

* Successful Programmes vs Unsuccessful Politics. Until about a year ago, I would have classified the Civil Services Pension Reform of 2004 as an outright success along all dimensions. But with five states having gone back on it already, it’s become a classic case of poor coalition-building.

There’s another common contradiction: Successful Programmes vs Temporal Failures. These are programmes that achieve short-term goals but lead to adverse unintended consequences in the long term. Minimum Support Prices policies for grains and the Bombay Prohibition Act fall under this category.

Framework 4: Outlays - Output - Outcomes

We discussed this framework in edition #98.

Inputs/Outlays refer to the resources provided to a scheme or project that the government runs. Outlays for a project is no guarantee for success. To measure success, policies or schemes need two other parameters: outputs and outcomes. Outputs refer to the direct and measurable product of program activities, often expressed in physical terms or units. Outcomes, on the other hand, are the long-term benefits that a project or intervention is designed to deliver.

…

This framework also yields a useful vocabulary for measuring success. We can assess policies in terms of its economy, efficiency, and effectiveness. Economy refers to inputs. It answers the question: are project inputs being purchased at the right price? Efficiency relates to outputs over inputs. It answers the question: what is the relationship between investment in inputs and the outputs that are produced? Effectiveness relates to outcomes over outputs. It answers the question: are outputs leading to the expected outcomes?

This framework can help disambiguate implementation failures from “theory of change” failures. Often, implementation failures are caused due to insufficient outlay allocation or corruption, which impedes the conversion of outlays into commensurate outputs.

In the case of “theory of change” failures, the assumed linkage between outcomes, outputs, and outlays is found to be incorrect. For example, the theory of change in education policies continues to be that more outlays on government schools and on teacher salaries will result in higher student enrollments, which would eventually lead to better learning outcomes. This linkage doesn’t hold strongly, as ASER surveys have shown year after year.

What we think of as implementation failures often turn out to be “theory of change” failures under the hood.

Framework 5: Violating the Tinbergen Rule

Editions #9 and #135 talk about this failure. The more the number of objectives that a policy or institution is supposed to achieve, the more likely it is to fail in achieving any of them. A classic case of failure is that of the traffic police in India — burdened with regulating traffic while its main function is enforcing adherence to traffic rules and regulations.

Policies that seek to achieve many goals should raise the alarm in an analyst’s mind.

Framework 6: Incentive Interference

The mother of all policy failures is, of course, ignoring people’s preferences and incentives. Bans, price caps, sticky subsidies, and high tax rates meddle with choices and preferences to such an extent that they are almost always counterproductive.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] It is easy to get swept away by the government’s rhetoric on industrial policy. So it was a relief to see the Minister of State in MeitY strike a cautionary note about PLI schemes in a Mint report:

“Think of PLI as the period during which we are transitioning from a less than fully competitive economy to a fully competitive manufacturing (economy). So the PLI will take care of that interim period. But the economy, the efficiency, the competitiveness, the skills, the logistics, costs, all of that will eventually kick in and make us competitive".

As we keep saying, PLI is probably a necessity in today’s geopolitical scenario, but it is hardly the solution to our economic woes. There was another article in the Financial Times on similar lines.

* [Podcast] Over at Puliyabaazi, we spoke with senior journalist Seema Sirohi, who has closely tracked the India-US relationship for over three decades. Her book Friends with Benefits: The India-US Story is a must-read for anyone interested in this subject.

* [Article] Check out S Dinakar’s Business Standard piece to know why the Russian crude oil discount is not reflecting in your petrol pump bill. It’s a classic case of government price-fixing, using a benchmark that saves government-owned refineries at the cost of consumers.

Insights on burning policy issues in India

— Pranay Kotasthane

(An edited version of this article was published in Hindustan Times on 13th Feb)

Another defence budget zoomed past us on Feb 1. Since then, analyses have focused on how the defence spending for the coming year departs from the last year. Some have waved a red flag as defence spending has fallen below 2 per cent of GDP for the first time in many years. On the other hand, the defence ministry’s post-budget press release emphasised a 44 per cent increase in operational spending, which is expected to “close critical gaps in the combat capabilities and equip the Forces in terms of ammunition, sustenance of weapons & assets, military reserves etc.” The ministry also highlighted that the capital outlay for modernisation and infrastructure development has risen by a seemingly handsome 57 per cent over the last five years. How, then, do we make sense of these conflicting narratives?

Comparing allocations with those in the previous year gives us a confusing picture. Every interest group can pull up a number from the budget to suit their pre-formed narrative. Taking a step back from these narratives, this article will show that this was another run-of-the-mill defence budget, just like the previous one was. Nothing in it indicates any significant change in the defence posture. Unlike Japan, which has announced a doubling of its military spending in the next five years, India’s approach is about gradually improving the operational efficiency of the armed forces.

Looking under the hood

This article looks at the defence expenditure over the last six budgets to make sense of the numbers. To put numbers into context, let’s use an earlier year (FY16). FY16 is a useful reference point as it predates two major developments: China’s visibly aggressive posture on the border and the budgetary commitments arising from the One Rank One Pension (OROP) scheme. Three observations follow from such an analysis.

One, not only has defence spending fallen as a proportion of GDP, but it has also fallen as a percentage of government expenditure. In other words, defence has slipped in priority relative to non-defence functions (Figure 1). 

Two, the China challenge hasn’t led to any spectacular change in the composition of defence expenditure. Defence spending can be divided into four major components: salaries, pensions, capital outlay, and others. As Figure 2 shows, capital outlay was being squeezed by rising pension expenditure over the last few years. For two consecutive years (FY19 and FY20), more money was spent on pensions than on capital acquisition and modernisation. The balance has now been marginally restored since FY21, after the Galwan crisis flared up.

Crucially, the rises in pension and capital expenditures have come at the cost of operational and maintenance expenditures, including ammunition stores (under the Others category). It is hence not surprising that the latest budget is trying to arrest this decline in combat capabilities.

Three, this period has been relatively better for the Indian Navy in terms of capital expenditure. Since the procurement of new platforms happens over multiple years, a temporal view is useful in analysing how capital outlay is split between the three armed forces. Figure 3 suggests that the big change in the last four years is in the capital outlay for the Indian Navy, with the FY24 figure having doubled in absolute terms since FY20.

The Big Picture

By connecting these dots over the last five years, the picture that emerges is this: the government seems confident that China can be handled without a substantial rise in defence expenditure.

The latest budget serves as a bellwether indicator for this claim. It was the first budget of the post-pandemic period, at a time when the economic prospects for India had improved considerably. The government achieved better-than-expected buoyancy in income taxes and GST in the current financial year, while the cooling of global fertilizer prices has led to a decline in the projected subsidy bill. Consequently, the government, for the first time in many years, had some fiscal room to play with. It has used that space to increase the overall capital outlay to Rs 10 lakh crore, almost three times the outlay in 2019-20. Despite this increase in the overall capital outlay, the defence budget resembles the middle overs of a one-day cricket match.

From a financial savings perspective, there have been just two important changes over this period in the defence domain. The first was the announcement of the Agnipath scheme. It might reduce the pension burden, but these savings will reflect only after a decade-and-a-half. Other proposals, such as theatre commands, haven’t come to fruition yet. The proposal to create a non-lapsable fund for modernisation — a proposal the union government gave an in-principle agreement way back in Feb 2021, still hasn’t found a mention in the latest budget.

Probably, the defence budget is the wrong place to infer India’s strategic posture against China. Perhaps, the government considers other tools of statecraft—diplomatic, economic, or non-conventional—more suitable for the purpose.

This point needs deeper reflection. The discussions over the roles of these tools of statecraft currently operate under mistaken assumptions. Attempts at getting India into an anti-China alliance are spurned at the altar of “strategic autonomy”. The opponents seem to assume that India only needs to equip its armed forces with greater firepower. For too long, many parliamentary standing committees and defence organisations have gone hoarse trying to convince the government that defence expenditure should be raised to 3 per cent of GDP. If anything, the change is in the opposite direction.

The defence budget trends are a reminder that the government does not prefer using the military instrument to outflank China. At best, it wants to equip the armed forces such that China’s incursions can be matched or repulsed. Given that there’s no significant increase in allocations for the Navy and the Air Force, it also means that the government is not considering an increased presence in the South China Sea. So, the military is being equipped to plug a vulnerability and not to gain an asymmetric political advantage over China.

This line of thinking probably makes sense. There’s no point in matching China’s defence spending dollar-for-dollar. After all, the Indian armed forces are more adept at fighting at high altitudes. But this line of thinking should also make it apparent that India must develop capabilities in domains other than those involving force to inflict pain on China.

The government should build a political consensus that closer relations with China’s adversaries are not a matter of choice but an imperative. That we need to double down on economic growth and technological upgrading if we are to constrain China’s hand in other domains. It also means that we shouldn’t be indiscriminately banning China’s investments in India; a better approach would be to make their companies in non-strategic domains more dependent on the Indian market. We will then have more tools in our kit to deploy if the situation on the border worsens. Each of these posture changes needs an updating of our priors and payoffs. For that to happen, it is necessary that the government comes clean about China’s incursions. Pretending that all’s well might give us false comfort, but they will also dissuade the strategic establishment from confronting the tough trade-offs in non-military domains. Without this pivot, we would merely rely on hope as a strategy.

India Policy Watch #2: Through The Looking Glass

Insights on burning policy issues in India

— RSJ

We talk about the arbitrary powers of the state on these pages often. Now, we cannot grudge the state's sovereignty because we have voluntarily handed it that power. One argument that follows from this is that such power is often prone to be used arbitrarily. And that’s a problem for the citizens. The typical solution we have offered on these pages over time is to restrict the domain of the state to a narrow set where it can make the maximum impact or to design its incentives in a way that makes the state act with accountability. Now, these are good design principles. We could use them to create structures and institutions that are strong and independent that could hold their own against any arbitrary use of power. 

But are these enough? A natural question that should follow is how do we know things are working in practice like they were meant to? How do we get authentic information about how the state is conducting itself? How do we confirm that it is not subverting the institutional design that is in place to control its powers?

These questions lead us to the other pillar of a well-functioning democracy - transparency. It is a topic we haven’t discussed enough on these pages. Transparency is a moral good, and it is vital for a healthy democracy. Darkness stunts democracy. It needs light to thrive. In the early part of the 20th century, the US Supreme Court judge Louis Brandeis famously remarked, “sunlight is the best disinfectant” while making a case for a transparency imperative. Or, if we were to go further back, Bentham, often credited to have done the most original thinking on transparency, summed it up with - the more strictly we are watched, the better we behave - a principle he put at the heart of his advocacy for an open government. 

So, what has triggered my early morning ruminations on transparency? Well, there are two reasons. 

Here’s one. The Indian Express reports:

“The Supreme Court said it did not want to accept in a “sealed cover” the Centre’s suggestions on who could be the members of a committee the court had proposed to assess the market regulatory framework and recommend measures, if any, to strengthen it in the wake of the Adani-Hindenburg affair. It refused to accept any suggestions on names from the petitioners as well.

Chief Justice of India DY Chandrachud, who headed a three-judge bench hearing a clutch of petitions on the Hindenburg Research report and its aftermath, told Solicitor General Tushar Mehta, the court wanted to maintain “full transparency”. The court would appoint a committee of its own that will promote a sense of confidence in the process, he said.”

CJI Chandrachud said, “We would rather not accept the sealed cover suggestions from you for this reason; in constituting a committee which we want to do, we want to maintain full transparency. The moment we accept a set of suggestions from you in a sealed cover, it means the other side is not seeing them. Even if we don’t accept your suggestions, they will not know which of your suggestions we have accepted and which we have not. Then there may be an impression that well, this is a government-appointed committee which the Supreme Court has accepted even if we have not accepted your suggestions. So, we want to maintain the fullest transparency in the interest of protecting the investors.”

Bravo. The Chief Justice was almost channelling Bentham there, who famously wrote, “secrecy, being an instrument of conspiracy, ought never to be the system of a regular government.” I mean, what even is a sealed cover in a matter that concerns millions of ordinary investors? Why should there be secrecy in the name of experts and their recommendations? A sealed cover is a strange invention. It gives the sheen of a fair and independent process to what is essentially a subversion of a democratic principle. It ranks up there among one of the great Indian coinages. The top spot, of course, is forever occupied by ‘mild lathicharge’. 

And now, onto the other reason for all this talk on transparency. This was the headline-grabbing news of this week in India - “Weeks after its documentary taken off, BBC gets I-T knock”. Here’s the Indian Express reporting on this with many quotes from “unnamed government sources”:

“The Income-Tax Department surveys at the premises of the British Broadcasting Corporation (BBC) in Delhi and Mumbai on Tuesday (February 14) were conducted in view of the BBC’s “deliberate non-compliance with the transfer pricing rules” and its “vast diversion of profits”, government sources said.

The surveys were looking into “manipulation of prices for unauthorized benefits, including tax advantages”, sources said.

The BBC has been “persistently and deliberately violative of transfer pricing rules, it has “deliberately diverted a significant amount of the profits”, and has not followed the “arm’s length arrangement” in the allocation of profit, the sources said.”

A very garrulous source there with a lot of information. I don’t want to ascribe motives to the tax raids yet. There’s enough in the timing of these ‘surveys’ to raise suspicions. The I-T department has been used to settle political and other scores for decades. It speaks poorly of our institutional strength and independence. But that’s not the issue we are discussing today. The question is about transparency. Does anyone know why the surveys were carried out? The sources have cleverly given some reasons, but what stops the department from giving an official reason for them? Is it because it is likely that if they give the official reason, there will be further questions on the arbitrary nature of the actions? So, it is best to share nothing officially, selectively leak information to the media to paint the BBC in poor light and get away with harassment that then sends a message across to other foreign media outlets. Because even based on the merits of what the sources have said, it is difficult to justify a two-day survey. To quote the same news report:

“Transfer pricing issues are very common for foreign companies but survey/search actions against them are not common. Assessment is usually opted for but is not the only route through which such cases can be approached. If tax officers want to do a survey/search, then transfer pricing issues can get covered.

However, it is an approval-driven process with prior approvals required within the tax department before carrying out survey action. They would be having some information against the company and there might be a history of non-compliance too,” a Delhi-based tax expert said.  A notice preferably is issued to a company in an assessment exercise by the tax authorities flouting transfer pricing rules before undertaking any such action, experts said."

It shouldn’t surprise anyone that political actors don’t like transparency. It adds to their burden of accountability and increases the political costs of any missteps, deliberate or otherwise. So, how should the citizens keep up the demand for transparency in a democratic setup? After all, for the citizens to be involved in the governance process, they must have access to the government's information, plans and intentions. Also, there is a line beyond which too much transparency could be counterproductive. Too much information, too early in the process, could mean stalling the plan as interest groups jump in and skew the decision-making process. I have outlined three frames that one could use to think about transparency in a democracy.

First, it is in the long-term interest of political parties to seek transparency in a democratic setup. For those in the opposition, it is about making the incumbent party in power more accountable. For the incumbent, too, there’s always the uncertainty about the future when they might not be in power. In such a scenario, it is better for them to have stronger laws on transparency for their own access to government information, which they can use to hold others accountable. A lack of certainty about future electoral prospects for any party is a feature of a good democracy. It is in this environment most transparency laws are made. In India, too, the RTI came about because of grassroots activism and a broad consensus among the political class led by the party in power then. However, it is important to note that the Overton window was right during that time when getting re-elected was an exception. It meant the political actors were keen to have access to information in future. In that sense, any period when transparency is suppressed in a democracy is a good surrogate for the power of the party in power. In India, the RTI laws allow for access to a significant amount of government information. The problem is that there is a gradual erosion of its ambit as the dominant political class comes to view it as an irritant. The only way to counter this is for the citizenry to continue using the RTI tool to its fullest extent. The more people know the tool's power, the harder it will be to blunt it. 

Second, it is important to devolve transparency to state and local governments. This is where the political uncertainty is still high in India, which means there’s an incentive for political actors to support transparency moves to guarantee their own access to information in future. This is also the space where petty corruption is still rampant. One of the challenges of RTI in India is that most of the activism here is focused on big-ticket issues. The opportunity to bring sunlight as a disinfectant and its payoffs are the highest at the local level of governance. Separately, there are also specific areas in the private sector that could do with improved transparency. This is tricky territory, and let me be very specific about this. There’s a significant amount of information that’s collected, often without explicit consent, from the citizens by the private sector, which is then monetised in various ways. The mechanism by which their information is used and the extent to which the private sector, especially the social media platforms,  benefits from it are not transparent to the citizens who are the customers. If your attention is being monetised through multiple trackers and personalised ads, it is only fair you must know the rules of the game and agree to play it. This is still a white space of policymaking in India.   

Lastly, the oft-cited risk of policy waters being muddied because of transparency, where various interest groups will lobby for their positions and slow down the decision-making process, is a bit misplaced. Those in favour of transparency do not argue for the innards of policymaking being put out for display. That process requires stakeholder mapping and seeking inputs in a way that’s been documented by various policy thinkers. We have written about the eight-step process of policymaking on these pages on multiple occasions. The issue of transparency is important in two areas. First, the implementation and measurement of a policy proposal. How did a policy fare compared to its promise? Were the public resources and efforts prudently used? Was there a clear understanding of why something failed? Access to this information is important for the public and experts outside the government to hold the government accountable and improve future decisions. Second, the size of the state in India often means it is the biggest, often the sole, customer in multiple sectors and its decision on setting the rules of games in these sectors, awarding contracts and its performance in managing its budget should be available for public scrutiny. Again, this doesn’t mean the government should vet its decisions at each stage with prevailing public opinion. Rather it must be able to explain its process and the rationale for decisions openly and transparently. 

The practice of sealed covers or I-T surveys and raids without a clear reason isn’t new to India. What’s new is the somewhat strange support for these actions by the mainstream media that are being fed by the ever-bizarre theories cooked by the partisans on social media. BBC isn’t doing a documentary on Gujarat because China is now funding it. Nor is there a leftist cabal that’s busy bringing Adani down one week and using BBC the next to show the government in a bad light. This playbook is reminiscent of the Indira era of the mid-70s, where in the name of national interest, we buried transparency and accountability. It took us decades to get out of that mire. Learning from history is free, but most of us fail the eventual test.

PolicyWTF: Casually Banning Films Committee, Reprise

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Last week, I came across an excellent report by Aroon Deep in The Hindu that explains how the Central Board for Film Certification (CBFC) is going way beyond its usual stance of “demanding” cuts of scenes showing sexual content, violence, or abusive language.

Instead, the CBFC now also has a perspective on dietary preferences (demanding that mention of “beef” be struck off), foreign policy (demanding that references to ex-KGB officers, China, and Pakistan be removed), and even corruption (how can a filmmaker dare depict a police officer accepting a bribe?).

Seriously, what an omniscient body.

Despite its activism, the Censor Board hasn’t impressed the extremists. One Hindu group leader has called for creating a ‘Dharma Censor Board’ “to review Bollywood films and keep a check on any anti-religious content or distortion of facts about Sanatan Dharma.” In his words:

“Our experts will see a film when it is released and if we find it suitable for people belonging to Sanatan Dharma, we will issue a certificate. At present, films passed by the censor board set up by the government have been found carrying scenes that hurt the sentiments of people. We have repeatedly asked for a religious person to be included in the censor board but this demand has not been accepted. This is why we had to constitute our own board.”

While it sounds absolutely absurd at face value, there is a liberal way out to assimilate this conservative critique. We covered it in edition #122, and I want to re-emphasise those points.

In 2016, my former colleagues Madhav, Adhip, Shikha, Siddarth, Devika and Guru wrote an interesting paper in which they recommended that film certification should be privatised.

Deploying the Banishing Bureaucracy framework, they wrote:

The CBFC be renamed the Indian Movie Authority (IMA) and that the primary purpose of the IMA would be to license and regulate private organisations called Independent Certifying Authorities (ICAs) which will then certify films.

So, the Hindu group can very well have its own ICA, which will rate the movie on its Sanatana Dharma compliance score. But…

The certificate granted by ICA will only restrict what age groups the film is appropriate for. This is the only form of pre-censorship that is necessary in today’s age as all other restrictions on film exhibition should be applied retrospectively. The choice of ICAs available for producers to approach will render the question of subjectivity moot as the producer can switch to another ICA if unsatisfied with the certificate. The IMA will set the guidelines for the ICAs to follow and will be the first point of appeal.

In other words, this solution reimagines the CBFC as a body that grants licenses to independent and private certification organisations called ICAs. These ICAs must adhere to certain threshold criteria set by the CBFC. Beyond these criteria, some ICAs may specialise themselves as being the sanskaari ones trigger-happy to award an “A” certification, while others may adopt a more liberal approach. In the authors’ words:

This will allow the marketplace of ideas to draw the lines of what kind of content is fit for what kind of audience with the government still being capable of stepping in to curb prurient sensibilities.

This solution has the added benefit of levelling the playing field between OTT content and films. Currently, the CBFC has no capacity to certify the content being churned out on tens of streaming services. By delegating this function to private ICAs, the government can ensure adherence to certification norms.

In essence, just as governments can often plug market failures, markets too can sometimes plug government failures. Reforming our ‘Censor Board’ requires giving markets a chance.

There’s much more detail in the paper about grievance redressal, certification guidelines, and appeals procedure. Read it here.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] Over at Puliyabaazi, we discuss technology geopolitics with Anirudh Suri, author of The Great Tech Game.

* [Paper] Laxman Kumar Behera’s take on the defence budget.

* [Paper] This paper has a fantastic framework for understanding policy failures and successes.

Insights on burning policy issues in India

— Pranay Kotasthane

As Wilson’s Matrix tells us, concentrated benefits (costs) trump diffused costs (benefits) on most occasions. Organising people around diffuse interests is difficult. As a political articulation of these voices is difficult, they are consigned to being a background hum in the cacophony of politics.

One such diffused interest group is the future generation. Apart from the common difficulty that all diffuse interest groups face, they face a small, little additional problem — they aren’t even in this world to be able to speak for themselves.

Hence, it shouldn’t come as a surprise that governments and societies shortchange future generations by borrowing more than their means for current consumption and passing this burden to the future generation.

India is no exception. Even today, the biggest expenditure item in the union budget is neither defence nor home affairs, but the interest paid by the union government to borrowers on past loans. We are paying for the profligacy of past and current governments. The chart below from this year’s budget tells us that roughly a fifth of the government’s total expenditure is being spent on interest payments.

As we keep living beyond our means, the portion of the future generation’s spending on interest payments keeps growing. This is what a real debt trap looks like.

Most governments run deficits, and so does India. But the quality of deficits matters. If governments borrow to finance physical and social infrastructure, the burden on future generations is mitigated to the extent that the outputs continue to be available to them.

But that’s not the case in India. The union government still runs a sizable revenue deficit, meaning that a portion of the borrowing is being used merely to keep the government running today. In other words, we snatch money from future generations to meet the demands of the current generation’s citizens.

In Studies in Indian Public Finance, Govinda Rao points out that while children in the age group of 0-14 constitute over 35 per cent of the population, investment in the two items that matter most for their capabilities—health and education—continues to be low.

This idea of sharing resources across generations is known as intergenerational equity. I prefer to call it intergenerational balance. A $2500 per capita income country with 20 per cent poverty must accord higher priority to improving the life chances of today’s citizens. Nevertheless, we must push governments to seek a balance between today’s consumption and tomorrow’s choices.

It is for this reason that state governments reshifting to the Old Pension Scheme is a wilful crime against future Indians. At a time when government employees already have better payscales than the median Indian, committing to an ever-growing pension liability is to rob money from the future for the benefit of a select few.

But then, matters of fiscal prudence are not politically savvy. No one ever voted for a government for its fiscal marksmanship. No politician ventures there unless specifically asked. For this reason, it was encouraging that the Prime Minister—at least rhetorically—made a case for intergenerational balance in the Parliament:

“You should not put burden on your children.  Borrowing for present day needs leaving the debt burden on future generations is a matter of serious concern...For the economic well being of the nation, states also have to take the path of discipline... Only then states will be able to benefit from development.”

There’s a lot more the union government could’ve done and can still do. Criticising state governments on the floor of the parliament won’t make the problem disappear. It’s important for the union government to explain to state governments the fiscal impact of such profligacy. Aligning their cognitive maps is important. Back in 2003, a coalition government was able to get states to commit to fiscal consolidation. There’s no reason why it can’t be done now. But it would require collaboration rather than confrontation between the union and the states.

There’s another area of public policy where thinking about intergenerational balance is crucial: governing the use of natural resources. What rules should govern the rate of extraction or utilisation of a limited natural resource is a question that all governments and societies must resolve.

Many States, including the Indian Republic, own forests, rivers, beaches, oceans, and minerals as a trustee, i.e. on behalf of current and future generations. This idea, known as the Public Trust Doctrine (PTD), requires that extraction of the natural resource should go hand in hand with investment in productive assets that can be used by future generations (Hartwick’s Rule). Norway’s Oil Fund is an oft-cited example of the Public Trust Doctrine in action.

Factoring in the opportunity cost incurred by future generations into the current price is a sound mechanism for the sustainable use of natural resources. The main obstacle is often that people might not agree to put any price tag on the natural resource. The resulting logjam harms the intergenerational balance.

Global Policy Watch: US Inflation and its Discontents

Global policy issues and their implication for India

— RSJ

One of the predictions, part of my usual beginning of the year edition, was that in 2023, US inflation would be stickier than most people have forecast, the growth would be stronger in the first half of the year, and employment would remain fairly high - and all of these would mean that Fed would continue to raise rates this year to fight inflation. The slowdown would come later, perhaps in 2024, and it would hurt more than most people imagine.

Well, here’s the latest inflation news from Reuters:

U.S. consumer spending increased by the most in nearly two years in January amid a surge in wage gains, while inflation accelerated, adding to financial market fears that the Federal Reserve could continue raising interest rates into summer.

The report from the Commerce Department on Friday was the latest indication that the economy was nowhere near a much-dreaded recession. It joined data earlier this month showing robust job growth in January and the lowest unemployment rate in more than 53 years.

“Clearly, tighter monetary policy has yet to fully impact consumers and shows that the Fed has more work to do in slowing down aggregate demand," said Jeffrey Roach, chief economist at LPL Financial in Charlotte, North Carolina. "This report all but insures the Fed will continue on its rate hiking campaign for a lot longer than markets anticipated just a few weeks ago.”

The Fed is expected to deliver two additional rate hikes of 25 basis points in March and May. Traders on Friday raised their bets for another increase in June. The U.S. central bank has raised its policy rate by 450 basis points since last March from near zero to a 4.50%-4.75% range.

This brings me back to a more specific prediction I have which might currently seem bizarre but isn’t outside of the realm of possibility. I suspect we might have the Fed hiking rates all the way to the 6.50%-7.00% range before they declare a win in the war against inflation. Inflation hurts the poor, and no political party likes it. An increase in prices takes wealth away from savers, and it erodes trust in the future for consumers. Price stability, therefore, is the primary role of a central bank. Given that growth hasn’t come off despite a 450 bps rise in rates and the blockbuster US employment numbers that came in last month, I don’t see what will stop the Fed from turning more hawkish in the coming months.

So, what does all of this mean for India? I will suggest the following.

Firstly, we can no longer work under the assumption that the Fed rate hike cycle is nearing its end, and we can therefore expect the rates to stabilise in India, too, after one more round of hikes. We must work out a scenario of what it means to live in a world where the US rates are at 7 per cent or more. The impact of it on the Rupee, our forex reserves and our growth if we continue to retain a differential between the two rates are all important factors to bear in mind. At this moment, we seem to have an uneasy and overwhelming consensus on how the macro will pan out. This recent inflation data from the US should make us pause and relook at our premises.

Secondly, the two variables that can mar India’s decade story are the fiscal deficit - among the highest in the world when you add the union and state numbers - and the current account deficit. It will be useful to stress test scenarios if we have US rates touching 7 per cent. Most global institutional investors have a fine disregard for these two metrics so far as they have built their models with US rates in the 5 per cent range.

Lastly, if there’s going to be an ‘accident’ because of this 7 per cent scenario coming to pass, it won’t be in the public market or a particular currency or sector. The banking sector is at the strongest it has ever been worldwide, and there are few asset bubbles in the conventional sectors. Of course, there are pockets of overvalued assets, especially in real estate sectors in Germany (and Western Europe in general), Canada and Australia. But it isn’t so large that it will create a domino. The likely accident could be in the private market, like the private equity space or in assets like crypto and private tech valuations. Thankfully, these won’t lead to contagion in the usual sense.

My sense is it will be useful for most macro models in India to recalibrate their assumptions to higher interest rates for 2023 and stress test the scenarios at 7 per cent and beyond levels. We might be lulled by the growth and employment numbers in the US, but the real pain could unfurl only in 2024 and beyond.

PolicyWTF: The Tyranny of Import Duties

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Exhibit 1

Apple phones are costly. But they are beyond costly in India, not because Tim Cook has it in for India, but because our government wants us to buy “Made in India” phones instead.

Imported smartphones attract a 20 per cent basic customs duty. In addition, there’s a social welfare surcharge of 10 per cent of the duty rate. Besides this 22 per cent customs duties, all phones attract a GST of 18 per cent (up from 12 per cent). This 18 per cent rate is applied to the phone cost inclusive of the customs duty. The cascading involved in this tax regime would make public finance specialists hopping mad, but then all is fair in love and atmanirbharta.

As you would anticipate, these high import duties have opened up a new market for smuggled smartphones, estimated to be in the range of ₹15,000 crores.

Apple phones made in India are also not spared. Under the Phased Manufacturing Programme (PMP), the government applies import duties on sub-components as well. The idea is to magically create a local supply chain. But what it ends up doing is increasing the cost of manufacturing in India, making products uncompetitive globally. We have written about this topic on many occasions before. I’ll just link them below for now.

But hey, not all’s lost. Realising that the PMP might be self-destructive, the latest budget has removed the customs duty on the import of certain parts, such as the camera lens. Small mercies.

More on this subject:

* #185 - No Exports without Imports

* #155 - The Problem with Protectionism

* #86 - Production Linked Incentives

Exhibit 2

The Podfather Amit Varma told me (he’d heard it from a friend) the reason behind most DSLR and action cameras’ 30-minute video recording limit is…. import duties!

Not a work of the Indian government, though. Apparently, the EU passed a rule in the nineties that imported video cameras would be subject to a customs duty, while still-cameras would not. A video camera was defined as one that could capture a continuous video of a length greater than 30 minutes at a high quality. And so, even as still cameras became more powerful, they continue to retain the 30-minute limit. Given that the EU was a big market, camera makers found it convenient to follow this restriction in all geographies. This Hacker News conversation has more information. Apparently, the EU disbanded this import duty in 2018. But the 30-minute restriction seems to have a hysteresis.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] In this Puliyabaazi episode, we explore the reasons behind China’s technological upgradation.

* [Paper] Rahul Basu of the Goa Foundation explains the Public Trust Doctrine in the context of mining in Goa.

* [Paper] To understand the evolution of the Public Trust Doctrine, read this paper.

मैं अकेला ही चला था जानिब-ए-मंज़िल मगर 

लोग साथ आते गए और कारवाँ बनता गया

I had set out on this journey all by myself

Others joined, and it turned into a caravan

India Policy Watch #1: Decoding Our Maladies

Insights on burning policy issues in India

— RSJ

Tell me the conspiracy theories a society is willing to believe in, and I will tell you about its maladies.

Truth is a contested notion in today’s world. Maybe it has always been. But there’s something clarifying about a conspiracy theory that no truth can match. It is not the conspiracy itself. That often crumbles under the lightest of burden of logic applied to it. The real deal is what prompts the need for the conspiracy. It stems from the irreconcilability of an often irrational belief that many hold with the reality of the world around them. The greater the chasm between the two, the weirder the conspiracy theory. And it is this chasm, this flight from reality, that a conspiracy theory is born to serve. By denying the facts that are around you and leaning on your own right to have an opinion, conspiracy theorists make it easier for you to dismiss inconvenient facts as mere opinions. Once you have painted facts as fabrications of another mind, you get the permission to have your own facts. That’s how conspiracy theory works.

So, why am I going on about conspiracy theories now? Well, here’s Mint:

In an article quoted by Hindi Daily, Amar Ujala, the RSS mouthpiece said that a group of Indians has created a negative narrative against Adani. The article pinned blame on an ‘Indian lobby which includes the country’s famous propaganda websites associated with leftist ideology'. 

Harping on an ideological and political warfare, the article further stated that this attack is very similar to how ‘anti-India’ George Soros ruined the Bank of England and the Bank of Thailand.

He claimed that this controversy did not start on January 25 after the Hinderburg report, but it already began in 2016-17 in Australia. 

According to the RSS mouthpiece, an Australian NGO called Bob Brown Foundation (BBF) manages an exclusive website only to defame Indian Industrialist Gautam Adani. 

Marking out NGOs and websites in India, the Amar Ujala article singled out an alleged contribution of Azim Premji's NGO to the Independent and Public-Spirited Media Foundation. The article alleged that left-minded media houses and NGOs were behind the sudden turmoil of the Adani Group.”

So there you have it. I suspect this thing isn’t going to die away soon. This is a useful pot to keep stirring. A few leaks about CBI or ED investigations every few months will give enough ammunition for future reports or allegations about the Adani group. Once you have brought in left-minded NGOs into the picture, there’s open season for all sorts of conspiracy theories to pop up in future. The speed of response to any future report will improve from here on. Soros is at it again with our leftists will be the first cry. I often wonder what a busy life that man must be leading.

Let us first get the theory out of the way. The short-seller interest in the Adani group of companies wasn’t because a five-member research group could dig out already existing information about it that could raise questions about stock manipulation and governance. No. It was because, and mark my words carefully now, a leftist cabal of anti-India forces led by a foundation run by India’s greatest philanthropist who happens to be Muslim. Their intention was to stop the apparently unstoppable rise of India by knocking the Adani group off their perch because, after all, the two are now inseparable.

When the stocks went up all these years, there was no conspiracy to suggest why they went up. It was all market. But not when they crashed. Also, what a convoluted and low-probability way to go about such an agenda. All these conspirators, after putting their minds together to find the best way to spread chaos in the financial system, came up with the bright idea that we must get Hindenburg to write a report. What are the odds that someone could predict the sequence of events after the report? That all of this was intended. Pretty low if you use your judgment.

This brings me to the earliest, and still the most cogent, criticism of conspiracy theories by my favourite thinker, Karl Popper. He coined a term to collectively describe this phenomenon: “The Conspiracy Theory of Society”. His point was simple. It comforts many people to believe that history is a product of intended actions by individuals or groups driven by certain beliefs or ideologies (or conspiracy theories). In my words, people believe in conspiracy theories because they aren’t Bayesian.

Anyway, he wrote:

“The conspiracy theory of society is just a version of… theism, of a belief in gods whose whims and wills rule everything…. The conspiracy theorists will believe that institutions can be understood completely as the result of conscious design; and as to collectives, he usually ascribes to them a kind of group-personality, treating them as conspiring agents, just as if they were individual men.”

So, there is a leftist cabal running across the world who are all working in tandem with such precision and impact that you wonder why they are not using such superpowers to actually rule the world. Why are they the underdogs? Popper had a counterintuitive answer for this too. The grand theories of this kind become real when the people who believe in them gain power. Because then any failing which is natural (or otherwise) during governance can be ascribed to a conspiracy. The mythical realm of the conspirators and their powers grows because those in power stoke them.

As Popper wrote:

"The conspiracy theory of society is very widespread, and has very little truth in it. Only when conspiracy theoreticians come into power does it become something like a theory that accounts for things which actually happen (a case of what I have called the ‘Oedipus Effect’). For example, when Hitler came into power, believing in the conspiracy myth of the Learned Elders of Zion, he tried to outdo their conspiracy with his own counter-conspiracy."

The problem with ascribing such wide-ranging power to a super-effective cabal is the old human problem of screwing up. Humans make mistakes, and they don’t anticipate the unintended. If the state with all its powers can fail in this, why shouldn’t a mysterious, underground group of conspirators? For Popper, if every event is due to intentional successful planning by conspirators, where does it account for human stupidity and their history of not translating intents to actions? Most of the consequences of our actions are not in our control, and the best-laid plans of men and mice often go awry, as the bard said. This is the strongest argument against any ‘conspiracy theory of society’. As he wrote:

“It is one of the striking things about social life that nothing ever comes off as intended. Things always turn out a little bit differently. We hardly ever produce in social life precisely the effect that we wish to produce, and we usually get things that we do not want into the bargain."

Anyway, that possibly explains why such theories are usually bunkum. Coming back to the point that I started out with - what does it tell us about our society when we have such conspiracy theories being spread around by mainstream and social media platforms? I have three opinions to offer here.

First, despite evidence of the past, we love personality cults. We believe in the idea of a man of destiny who will change our fortunes. So, it is easy for anyone to lead us on to the line that a charge against the Adani group is a charge against PM Modi, which is, therefore, a conspiracy to destabilise India. The logical improbability of this sequence comes up short against the irrational belief in the cult.

Second, there was always an underlying natural scepticism in Indian society about the wealthy and their ways. The usual lament that captured this was that line often used in Hindi films - “sab saale chor hain.” Like any strain of scepticism, it was both wrong and occasionally healthy for a society to harbour. What we have now is the willingness to abandon this sense of scepticism in favour of vishwaas. It would have been a welcome change had it been an abandoning of scepticism about the markets as against a particular group. But, alas, no one is cooking conspiracy theories to support freedom and markets.

Lastly, the ease with which the conspiracy theory could bring in a Muslim entrepreneur with an impeccable track record in business and possibly, one of India’s greatest philanthropists, tells you where the conspiracy theorists want you to be led. There’s not much to explain here. It is sad.

Like I said earlier, this is a pot that will keep getting stirred because it is a pot that will keep giving. You might ask how do you know that the conspiracy theorists aren’t right. Well, I don’t know, but it is good to retain scepticism on both views. I’m sure Popper would have had something to say here. In fact, he does:

“It is a great step forward to learn to be self-critical; to learn to think that the other fellow may be right - more right than ourselves. But there is a great danger involved in this… for it is more likely that both, we ourselves and the other fellow, are wrong.”

A free society is, by definition, a sceptical society.

India Policy Watch #2: Five Imperatives for the Future of Indian Public Policy

Insights on burning policy issues in India

— Pranay Kotasthane

In analysing emergent public policy developments every week, there’s a risk of losing sight of the big picture. So for our two-hundredth edition, I want to step back and reflect on what I feel are imperatives for Indian public policy going ahead. These, to me, are five goalposts we should not lose sight of.

One, The imperative of "societism" - We must restore the balance between the state, market, and society.

We are at a juncture where the weaknesses of all three agents of change are apparent. Society is increasingly majoritarian, the State’s internal balancing mechanisms are flailing, and market concentration across sectors is rising.

The Indian Republic was meant to be the primary vehicle of a social revolution. Seventy-five years later, its primacy has only been cemented. So much so that a large section of Indian society wants to deploy the same State apparatus for another social revolution — one whose goals are quite different.

The crucial point is that solutions to today’s social failures, such as affective polarisation and majoritarianism, must come from society. These aren’t market failures that the State can rectify or government failures that better bureaucratic design can fix.

We need to understand how to build social capital in the Information Age, where political leanings tend to predetermine social interactions. We must invest in new ways to build “bridging social capital” that brings people from different walks of life together. Just as Hindutva is a social movement, its response must also be many social movements.

Two, getting the Indian State to do fewer things and doing them well.

The paradox of the Indian State—as we have discussed many times in this newsletter—is that it’s too big and too small simultaneously. It’s omni-absent. It is big in terms of its ambition but small in terms of its competence.

The developmental departments of the governments are quite small and understaffed. The State’s performance on its core responsibilities—public services, law and order, primary health, or education—is consistently pathetic. So much so that most people have begun to think of the State as a means for other ends, such as pride, or for honouring their religious and linguistic asmita (identity).

We must go back to holding the State accountable for its core functions.

Three, the imperative of strengthening the Indian Republic

Far too often, we have allowed the Indian Republic to be sacrificed on the altar of democracy. It is the Indian Republic that prevents a majority from using its coercive power against individuals or groups with lesser power.

The Indian Republic prohibits the majority from running roughshod based on its numerical strength. In a Republic like India, the Constitution limits the power of governments and groups to protect an individual’s rights. It is the Republic that grants fundamental rights to individuals to live, work and even protest. Strengthening it is our only chance.

Four, the imperative of economic growth

Many of our problems will become less burdensome if we become richer. We must not forget that a GDP per capita of merely $2500 is our biggest national weakness. We cannot redistribute our way out of such a poor country — there just aren’t enough rich persons to redistribute from.

Global inequality is overwhelmingly between countries, not within countries. Inequality reduction is overwhelmingly a national task. And you cannot do redistribution if your income levels are low, as the size of the economic pie is too small to create a difference meaningfully. Rich country governments spend up to 40% of GDP precisely because they can collect higher revenues from a more affluent population, even at low tax rates.

Without economic growth, there can be no well-being, happiness, or sustainability.

Five: The Imperative of Hope

In today’s times, uncertainty engenders anxiety. Anxiety engenders distrust. And distrust engenders defeatism. And hence, we need hope to place us in the right frame of mind while confronting new challenges. We need to document government, society, and market successes. We must recognise that Indians have overcome seemingly insurmountable challenges several times in the past.

Matsyanyaaya: High-tech Geopolitics in the Post-pandemic World

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Here are four significant trends in high-tech geopolitics from my recent Takshashila Working Paper.

One, trade wars are likely to be tech wars at their core. Nuclear weapons make large-scale conventional conflict unlikely. Similarly, globalisation has made any large-scale economic decoupling unfeasible. But the backstops in the high-technology domain are not understood well enough. Moreover, the emphasis on the importance of high-technology to national power means that governments are willing to incur the costs of high-technology decoupling. This decoupling might happen at the level of materials, machines, humans, and ideas. The precise pathway will be technology-specific.

Two, aggressive national competition over high-technology might produce some non-linear breakthroughs this decade. The literature on national innovation suggests that a nation-state’s net negative balance of security concerns (termed ‘creative insecurity’) helps explain why only some nation-states choose to focus on innovation. Given that leading powers increasingly feel ‘creatively insecure’, national policies will focus on innovation more than before, sometimes at the expense of consumers and other policy priorities. Regardless, this situation sets the stage for some key breakthroughs. This is not unlike the Sputnik moment when a beachball-sized artificial satellite led to a drastic change in science and innovation policies in the US.

Three, there will be higher alignment between private high-technology players and their national governments. The position of Intel in China illustrates this change. Until as late as November 2021, Intel was deeply interested in China. A WSJ report showed that Intel is among the active investors in a Chinese Electronic Design Automation (EDA) firm. Another Bloomberg report pointed out that Intel wanted to build a fab in Chengdu. Both these stages of the semiconductor value chain are precisely where the US had planned to restrict Chinese access. But after the CHIPS Act was announced, Intel dropped its plans to start a new fab in China. Instead, it now plans to invest more in the US, even though making chips there is much costlier. These flips are likely to become more commonplace.

Four, we will likely encounter selective international cooperation on high-technology subject to geopolitical considerations. High-technology ecosystems are transnational; they rely on comparative advantages to accelerate innovation. To get ahead of each other, high-technology powers such as the US and China are likely to transfer technologies to their respective partners, provided these strengths are complementary. Such cooperation was recently seen in the AUKUS deal and then in the iCET announcement on GE jet engines.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] Over at Puliyabaazi, Pranay Lal gives a riveting account of India’s natural history

* [Paper] A useful conceptual framework of defence innovation

Insights on current policy issues in India

- RSJ

That was an eventful week in India. In the last edition I had written these lines on the ongoing Adani saga that have now come back to bite me:

“The FPO might struggle a bit to sail through. But that amount is a chump change for the group. A week or so of volatility, some questions from regulators, a few lawsuits, some strategically timed PR events and the group will be done with this kerfuffle by February. This is nothing more than a minor speed bump in its fortunes.”

Ooh. It didn’t turn out to be a minor kerfuffle. After the Adani Group came out with their 400+ page response to the Hindenburg report who then retorted with their characteristic bite, we witnessed a free fall in Adani stocks in the first few days of the week. The FPO barely saw any retail participation. A few anchor investors including an Abu Dhabi sovereign fund participated. And then at the eleventh hour we had family offices of prominent Indian industrial houses and few domestic institutional investors subscribe to it and the FPO just about sailed through. Social media was abuzz with either ‘see, this is the spirit of new India’ or ‘upar se call aaya hoga’ (they must have got a call from the top) kind of messages. But even this news didn’t mean much. The free fall continued that day. Eventually, the Group canceled the FPO and positioned itself as a martyr to the cause of investors who have stood by them over the years. Well, you live long and you get to see everything. There was further negative news for the group as the Dow Jones decided to remove Adani Enterprises, the flagship company of the group, from their sustainability index. A few global banks reported they wouldn’t accept Adani bonds as collaterals from their clients for margin trading. Only late on Friday, was there some good news coming in from the Group. They confirmed they kept their bond payout commitments and that all interest payments have been made till date. A couple of credit agencies, that prescient lot who you will remember didn’t have a clue till a day before the Lehman crisis that something was wrong, confirmed there’s no debt maturing among the group companies till 2025. Only then did the stocks find some respite.

So, you see not exactly what I had predicted. And so I’m somewhat less certain now if this will only just be a minor bump in the road for the group.

The other big event during the week was the Union budget that was presented on Feb 1. This was the last full budget to be presented before the 2024 general elections and there was an expectation that the government would tilt towards being more populist. Even here, I had made a prediction at the start of the year:

“..this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency."

Phew. On this I was right. The government cared more for its fiscal deficit trajectory than being populist. The surprising part, and the one I got wrong, was the significant capex push that is budgeted to grow 33 percent to Rs. 10 trillion in the coming year. Despite this, the government expects the deficit to be down to 5.9 percent in line with its three-year plan. How did it manage that? Well, forget populism, this government plans to cut down on subsidies and expenditures during a pre-election year. The subsidies budget is down 27 percent from Rs. 5.2 trillion to Rs. 3.7 trillion. At a macro level, this is an important message about its fiscal management philosophy. The infra push follows three themes that are all good in my opinion: a) internal connectivity through investments in railways, roads, airports and last mile connectivity; b)rural and low cost housing and c) decarbonisation to reduce dependence on fossil fuel and stay within range to the Paris commitment.

There wasn’t anything more to write home about. The market borrowing figure is big but in line with expectations. The numbers make sense and broadly stack up. It is good to see this happening and the legacy of being clever with them is now well past. There was the usual tinkering of the personal tax rates - the old switch and bait of give few visible breaks and take some concessions away in footnotes - and some tweaks on custom duties on dozens of items which we love doing all the time. The rest of the speech was spent on announcing the outlays for various sectors with some old and new scheme names. In a way, it was good to have a boring budget with capex focus. 

Anyway, the Adani story and the capex push in the budget sets up this piece nicely. I mean in normal times all the announcements about investment in infra and green economy would have been music to the ears of the Adani shareholders. There are three issues to discuss in this context. One, the usual, what does all of this mean for the Adani Group? Two, does this change the view of global investors about corporate India and its governance? How will that impact the ambitious capex push of this budget? Three, will this trigger a more fundamental look at how to invest in public infrastructure programs in India?

For the Adani group, the immediate issue is how to get out of this bad news cycle and find a patch of terra firma to plan their future. Last week I was certain that this would happen within a couple of weeks for them. Now I’m not so sure. The reason for this goes to the heart of corporate finance, the multiple players involved across the chain and their many interlinkages. It is not Dollars or Rupees which is the currency of corporate finance. It is that strange thing called trust. Someone wants to borrow money from you. Of course, you’re sceptical about their ability to repay. So they come back to you with data, track record, promises and commitments to convince you to trust them. You price your trust and give them the money. There’s nothing that you get in return for the money you have given. It’s all trust. This one transaction founded on trust then spawns hundreds of others. There’s some kind of alchemy at work where that single root branches out into millions of transactions based on parties trusting each other. Sometimes when you look at the complex web of financial relationships that span countries, currencies and time horizons, you forget how this complex megapolis with these towering skyscrapers and beautiful structures is founded on something as fragile and intangible as human integrity. Once that is tainted, even partly, the megapolis isn’t the same anymore. At the heart of it, the Adani Group has built maybe three core competencies. One, it wins more government tenders than others because they have the pulse for it. Not surprising because Adani after all anagrams to naadi (pulse in Hindi). He he, sorry about that. Two, it is a capital raising machine from banks and bond markets using the highly valued equity of its group companies as collateral. And three, unlike the previous infra players, it has, so far, broadly delivered on its projects. You might say the real test lies ahead because of how much it has taken on its plate. But it has a decent track record on delivery.

The key to all of these is its ability to raise capital and no matter what the ‘nation first’ brigade will tell you, a large part of this capital will need to come from outside India. And that capital flow will dry up a bit for the Group. Of course, there’s then apparent $ 2 trillion dry powder that’s available with the oil rich Gulf states who are always ready to come in to rescue. But even they might pause on their funding. That apart, the brazen ease with which the group wins projects might slow down a bit. The mainstream media might not highlight this but now that the light has been shone on its business practices, global media and investors will keep a tab on this. It might mean the law of averages catching up on its win rate. Lastly, the implementation track record that has been good so far might be under cloud if the funding environment becomes tighter or costlier, or both. A few well published delays and failures in completion of projects and the sheen of getting things done will wear off. Will they be able to complete their existing projects to build and maintain ports, roads, airports and more? So, there are more clouds on the horizon than anticipated in the early days of the report. The group is probably aware of the thin ice they are skating on now. Adani also anagrams to anadi (simpleton) but don’t got by that one. Expect some quick, big moves.

For the global investors, this is a moment to put the Indian model of economic development or nation-building as the government calls it in the context of what they have seen elsewhere. India does seem to present a tremendous opportunity in the light of China’s likely secular slowdown and lack of big opportunities elsewhere. So, they will keep a close eye on what is the India model of growth that emerges. So far, the model since 1991 has been to try a bit of everything - market, crony capitalism, socialistic redistribution and flailing in its own way managing them all. The current thinking, or maybe it is that Gujarat model, is to identify ‘national champions’ like Adani and bet on them to deliver. Indian elite take pain to explain that this is different from the Russian kleptocracy model. And it is true to a large extent. Indian business houses, unlike the Russian oligarchs, don’t squat on national resources like oil and gas, sell them abroad at a premium and then stash away their profits in tax havens outside. In fact, it is quite the reverse. Indian business houses raise funds from outside, leverage themselves to the hilt, deliver in India (or hope to) and make profits in India. The risk is largely external while the value creation is domestic. But this is a game where those taking the risk (largely external institutions) should be knowingly in on the game that their downside risk is protected because of the way capitalism works in India. Once that faith in the unique India model goes, they will go back to riding the high horse of governance or ESG and stay out of long term investments. This is something India can ill afford. This is its third attempt at ‘nation building’. So far, implementation has been its bug bear. It cannot come back in this new shape again. What will restore faith is not the usual demand to eliminate ‘national champions’ in favour of true market forces playing out in the nation-building space. That’s a pipe dream. The hope for foreign investors and fund houses is to have an honest attempt to set right the governance of ‘national champions’. Maybe build them like South Korea did with their chaebols. Let no one be too big to fail or too large to govern. Spread the spoils more evenly. Avoid getting into situations where an honest reckoning by domestic regulators and fund houses about such entities won’t be possible because too much is at stake. This doesn’t work well ever. A house of cards, no matter how high, is still a house of cards.

Lastly, how should we look at long term reform of the public infrastructure sector and investments in it? The simplest answer is to follow the first principles here. An open and transparent bidding process, a regulatory regime that’s focused on market failures of information asymmetry and market power and has the teeth to intervene, a clear roadmap for government investment plan and its ability to support private enterprise and a strong market linked mechanism to reward or punish performance. The problem is this will mean the state will have to voluntarily relinquish a lot of its arbitrary power that has brought us here in the first place. The real reform is not just in announcing a 33 percent jump in infra spending in the budget. It is about creating a rule-based mechanism that ensures there is delivery on these big plans that’s on time and continues uninterrupted. Adani is just a symptom of the problem of planning for infrastructure in India. What the symptom shows is the failure of imagination in revamping public policy here. I don’t often agree with Mihir Sharma but he makes a valid point in his Bloomberg piece:

“Nobody else in Modi’s India has this specific mixture of confidence in government support, ability to navigate byzantine regulations, and willingness to risk enormous sums of money. Some worry that Adani is too big to fail. He isn’t. But he may be too unique to fail. Wherever the money may have come from — public sector banks, pension funds, faceless pools of offshore capital — what matters for India’s growth is how productively it is spent. Effective oligarchs might be dangerous for a country and, if they’re corrupt, even more so — just ask Russia. Inept oligarchs are calamitous.

If Adani’s companies can deliver a fraction of what he has pledged, then perhaps, in time, they might even grow into the valuations they have already achieved on paper. If they fail, then a lot more goes down than his investors; Adani will take down India’s industrial policy with him.”

There is indeed a lot more at stake here than just the Adani empire.

Not(PolicyWTF): Chinese Companies Can Make in India - Conditions Apply

This section looks at surprisingly sane policies

- Pranay Kotasthane

An interesting recent development is the government’s change in stance on Chinese manufacturers of electronic components. Instead of an unsaid, outright ban on Chinese manufacturers, the government has now given a preliminary approval to 14 of Apple’s 17 Chinese suppliers to set up joint ventures in India.

This preliminary approval is just that — it comes with many conditions that do not apply to non-Chinese companies. For example, Chinese companies must compulsorily establish a joint venture with an Indian firm. Apparently, the latter also needs to have a controlling stake. Moreover, the FDI restrictions announced after the 2020 Galwan clashes are still in play, meaning that all these investments from China are still subject to receiving the appropriate government aashirwaad.

Back in 2020, we had written that tightening the FDI rules for all sectors is a policyWTF. Existing FDI rules back then already had restrictions on foreign investments in strategic sectors. To overlay this reasonable condition with a region-specific ban on investments across sectors didn’t make sense.

Given this backdrop, the small opening the government has now offered to Chinese suppliers of Apple is a positive course correction.

It’s a bitter pill to swallow, but there’s just no other way to achieve the stated goal of creating $300 billion in electronics manufacturing by 2026, with overseas sales of $120 billion, than to engage Chinese manufacturers. See what this excellent explainer by Surajeet Das Dupta says:

“Nearly 80 per cent of the global mobile device supply chain is in China and is run by Chinese companies. It has been built over the past 15-20 years because the biggest mobile device brands from Apple, Xiaomi, Vivo and Oppo have their production bases there. Suppliers in Vietnam or Thailand are also owned by Chinese companies — and the governments of those countries have gone out of their way to encourage them.” [Business Standard, Jan 29]

We have also written in the past that 64% of India’s chip imports come from China and Hong Kong. And this number will only increase over the next 7-8 years as India’s mobile manufacturing scales up. And that’s alright for now.

We must go beyond economic nationalism and come to a modus vivendi with China on the economic front. If Chinese companies are willing to invest in India in non-strategic products, we shouldn’t be turning our face away. That’s exactly what China did. It took investments from its richer and more capable adversaries—Japan, Taiwan, and the US—when it was the weaker power.

Deng Xiaoping, on his first visit to Japan after Mao’s death, famously said that the roles have now reversed — you are the teachers, and we are the students. While the India-China equation is quite different, we shouldn’t be afraid of exploiting Chinese investments to Make in India.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Tyler Cowen writes that the Industrial Policy of the Information Age will spur globalisation, not impede it.

* [Article] Indian nation-building, Modi and the Adani crisis: Adam Tooze has a thoughtful piece on the Adani episode.

It makes for a great gift too. Ship it to your friends. Here’s the helpful link.

Now curl up for a long Sunday edition.

India Policy Watch #1: The State and Capital

Insights on current policy issues in India

— RSJ

First, the good news. 

“India may have already surpassed China as the world’s most-populous nation in a milestone that adds urgency for Prime Minister Narendra Modi to create more jobs and ensure the country sustains its world-beating growth.

The South Asian nation’s population stood at 1.417 billion as of end 2022, according to estimates from the World Population Review, an independent organization focused on census and demographics.

That’s a little over 5 million more than the 1.412 billion reported by China Tuesday when authorities there announced the first decline since the 1960s.” (from Business Standard, 18 Jan)

We have argued for long on these pages that people are resources. They aren’t a problem. We have a governance problem if our default view of people is that they are a burden. We have a chapter in our book (HAVE YOU ORDERED YOUR COPY YET?) explaining why ‘aabadi isn’t barbaadi”. There’s an extract from that chapter in the next section of this edition. 

Here’s another news item that caught my attention this week:

“State-run Rashtriya Chemicals and Fertilizers Ltd (RCF) and National Fertilizers Ltd (NFL) plan to build five new factories to manufacture super-efficient nano-urea under a licence from IFFCO Ltd, a development that promises to ease India’s mounting fertilizer subsidy burden.

The two companies have signed arrangements with IFFCO, a producer in the cooperative sector which holds the patent for nano-urea, a person aware of the matter said on condition of anonymity. They will pay royalties to IFFCO for producing nano-urea, a nanotechnology-based product 100 times more efficient than conventional urea, which will shrink the quantity of fertilizer usage and thereby lower the subsidy burden. It also boosts nutrient availability, enhances productivity, helps soil health and reduces the carbon footprint in fertilizer production.”

(from Mint, 19 Jan)

It is useful to appreciate why policymakers and well-meaning thinkers over the ages have worried about population increase. One mental model we have is about the finiteness of resources available on earth to support human life (or life in general). There’s a biological load that the planet can support, and after this limit has been reached, we will face scarcity. Malthus, who was among the first to articulate this, put it simply - the growth of human population is exponential, while food and other resources needed to support life grow linearly. And unless wars, famines or other events correct this, we will hurtle towards a ‘Malthusian catastrophe’. He wrote about in the late 18th century with a warning that unless preventive checks on population are done at a policy level, the catastrophe might be upon us by the mid-19th century. Of course, we know it didn’t turn out that way. What happened then? It is difficult to prove this conclusively, but it is likely that spontaneous order worked. As demand increased, producers searched for additional resources like new arable land (maybe more colonialism), worked harder (two crop cycles instead of one) or became more productive through technology (early mechanisation of agriculture using tools of the industrial revolution). Yet, there was a lurking feeling through the late 19th and early 20th century that we might reach the limit of sustenance. 

Till Haber and Bosch did their thing.

Plants need nutrients, specifically N (Nitrogen), P (Phosphorus) and K (Potassium). NPK plus water and the sunlight is the only way to convert solar energy into food. Plants get these nutrients from the soil. When they die, they give them back to the soil. This is how life sustains itself. But this wasn’t enough to sustain a civilisation. We needed more plants, and soon we realised we had natural limits of these nutrients. Among them, Nitrogen was the most elusive. It is the most abundant element in the atmosphere, but it is available in an inert form. And it was almost impossible to isolate it. There were workarounds to this. Certain plants (like legumes) could ‘fix’ Nitrogen from the atmosphere. That is, their rhizomes could support bacteria that could convert the inert Nitrogen into ammonia that could then enrich the soil. Or, we found large guano deposits in Chile and Peru, which were rich in Nitrates, and we exported them worldwide. But these weren’t enough to sustain the ever-growing demand for food. Synthesising ammonia became one of the great scientific problems of the time.

In 1909, a German scientist, Fritz Haber, achieved this breakthrough in his lab. Soon, he and a BASF engineer, Bosch, translated this lab experiment into a commercial process. Ammonia could now be mass-produced. It was not the most efficient process because it required a lot of fuel. But, it revolutionised agriculture production around the world. It was possibly the single most important innovation of the 20th century that had no shortage of great ideas. Agriculture productivity grew between 3-5 times across most countries in that century, and it is safe to say urea and synthetic fertilisers were the single biggest reason for it. Haber-Bosch process is a wonderful example of human ingenuity where a technological breakthrough unlocked a new productivity frontier when we had thought we had reached its limit. 

But this came with costs. There’s no elegant way for plants to absorb Nitrogen from urea. It has to be spread on soil and then sprayed on leaves. About 30-40 per cent of it gets used at best. The rest is wasted. It leaches into groundwater and rivers and kills aquatic ecosystems. They eventually end up in our food and into us. The production of urea requires a huge amount of fossil fuel. Nitrous oxide, a greenhouse gas, is a byproduct of the Haber process. The environmental impact of synthetic fertilisers has begun to undermine their benefits. It is still a force of good but with an asterisk next to it.

In India, we have an additional burden of fertilisers. Fertilisers are expensive to manufacture. The input costs keep going up. A 45 kg bag of granulated urea costs about Rs. 4000 to manufacture. This is unaffordable for most Indian farmers, or so the government believes. So, it subsidises fertilisers. The farmer gets the same bag for Rs. 266. The government (and therefore the taxpayer) pays Rs. 3750 per bag for this subsidy to the fertilizer manufacturers. Put together, the annual fertiliser in India totals Rs. 2.5 lakh crores (trillion). It is not a small number. It is about half of our total healthcare spend. We, here, take a dim view of subsidies. Subsidies distort markets and create deadweight losses. The producers (often government entities in India) don’t have the incentive to be competitive. Private players don’t have an incentive to come in. They are delivered inefficiently and do not often reach the intended recipients. Then there are interest groups formed to perpetuate the subsidies because they benefit from them, and this leads to rent-seeking behaviour from the state. And, finally, all of this is funded by the State whose track record of using taxpayers’ money in the most effective manner is dismal. There’s no economic rationale to justify subsidy. Yet, once you have gotten this gravy train going, it is impossible to bring it to a halt. You can argue that India shouldn’t have so many marginal farmers in the first place who find urea prices impossible to afford. That getting these farmers out of agriculture is the only viable future for them. But there’s a human cost to pay in the short term to go down this path. There’s electoral cost too. So, we will continue down the path of ever-increasing fertiliser subsidies and dig ourselves into a deeper hole. And, we will have the union minister for fertilisers proudly claiming that we will have a 40 per cent increase in subsidies during this year.

That brings me back to the news item about nano urea. India is setting four new plants, apart from the one already in production, that will manufacture nano-urea under a licence from IFFCO Ltd. Nano urea seems like some miracle drug. On paper, if one were to believe the hype, it is 100 times more efficient than conventional urea, will boost crop productivity by 20 per cent, improve soil health and reduce carbon footprint. The patent is held by IFFCO based on the work done by a young Indian scientist, Ramesh Raliya, who returned from the US to set up Nano Biotechnology Research Centre with IFFCO. There have been some field pilots done, and based on that, the fertilisers ministry has decided to double down on production. I hope they have been scientifically rigorous on the tests and aren’t buying their own hype.

Let me take just take the claim that nano urea is super efficient by, say about 80 per cent (not some 99 per cent that the literature shows). What does it mean in terms of urea consumption? Liquid nano urea will replace the urea that’s spread on leaves and plants directly. It won’t possibly substitute the urea spread on the soil. I could be wrong here, but that’s my understanding reading through the patent that’s filed. If this were true and 50 per cent of urea is what’s sprayed directly on plants (which is where efficiency will be seen), we would see a net reduction of about 40 per cent of urea consumption.

Let’s keep it at this broad level. The total subsidy budget for next year is likely to be about Rs. 2.5 lakh crores. Urea accounts for about two-thirds of the total subsidy, which comes to about Rs 1.7 lakh crores. And we might eventually end up saving about 40 per cent of it. That’s a cool Rs 70,000 Crores. I mean, why build 5 factories? Build 50 and start exporting this. Besides the subsidy savings and the impact on the current account because of lower imports, there is all the positive impact on the environment and carbon footprint. It seems too good to be true.

But that’s what the Haber-Bosch process looked like when it was used commercially. “Bread from air” was how people saw it. Like they say, any sufficiently advanced technology is indistinguishable from magic. Well, I’m rooting for nano urea to live up to its hype. It will again show that the answer to our problems is not to go back on scientific progress and development. It is to find a forward-looking solution for the problems that’s brought upon us by the progress of the past. Science will ultimately solve the problems created by science.

Jan Nisar Akhtar (father of Javed Akhtar) wrote this line in a song from Chhoo Mantar (1956):

“Tumhi ne dard diya hai,

tumhi dawaa dena”

(God, it is you who has given me this pain, and it is you who must provide succour too).

Akhtar was talking about God. He might as well be talking about science.

An Excerpt from Missing in Action: Why Should You Care About Public Policy

— A chapter from our upcoming book that releases tomorrow

Chapter 25: Aabadi Isn’t Barbaadi

There was a time not so long ago when a population clock (counter) would play for a few ominous seconds on Doordarshan (DD). During the ‘80s, the State-run DD was the only channel in the country and right in the middle of a film or an episode of B.R. Chopra’s Mahabharat we would see the counter ticking away furiously, eighty-one crore Indians and counting. Thus sobered about the grim reality of our population, we would go back to the fifth day of the great war wondering about Abhimanyu. 

Over the years, governments of all hues have viewed our population as a problem. This is a view that most citizens also hold because this has been drummed into their heads. Population explosion or ‘janasankhya visphot’ is a hook on which Indians hang a lot of their problems. People are seen as hungry stomachs to feed rather than enterprising brains that can contribute to prosperity. From an economic perspective, population is a neutral variable. It can be good or bad depending on the context. We will examine it in the Indian context in this chapter.

The supposed ills of a large population have an outsized influence on our policymaking. The near-death experience in the mid-60s when we were in danger of being a global basket case casts its long shadow on our thinking. The idea that the human population would outpace farm productivity leading to hunger, pestilence and deaths has been debunked over the years. The role of human capital, institutions and ideas on productivity have been established by economists like Solow and Romer. Yet we persist with the Malthusian notion. 

As Julian Simon argued in his 1981 book The Ultimate Resource, we are an intelligent race who innovate in the face of scarcity. Human ingenuity is the ultimate resource that can make other resources plentiful. More humans lead to more ideas, bigger markets, larger infrastructure spending and, paradoxically, higher prices for scarce resources, which leads to conservation or search for replacement products. There is empirical evidence to support this has been good for the world over the last century.

Pitted against Simon was Paul Ehrlich whose 1968 book The Population Bomb was a stronger and more logical update of the Malthusian argument for a different era. Ehrlich believed human exploitation of resources would make them scarcer and costlier until we ran out of them. Famously, in 1980, Ehrlich and Simon placed a bet on the future prices of five metals ten years later. Here’s Ronald Bailey in his book The End of Doom (Thomas Dunne, 2015) about the bet:

In October 1980, Ehrlich and Simon drew up a futures contract obligating Simon to sell Ehrlich the same quantities that could be purchased for $1,000 of five metals (copper, chromium, nickel, tin, and tungsten) ten years later at inflation‐​adjusted 1980 prices. If the combined prices rose above $1,000, Simon would pay the difference. If they fell below $1,000, Ehrlich would pay Simon the difference. Ehrlich mailed Simon a check for $576.07 in October 1990. There was no note in the letter. The price of the basket of metals chosen by Ehrlich and his cohorts had fallen by more than 50 percent. The cornucopian Simon won.

Population isn’t a problem. The ability to tap human capital to produce ‘catch-up’ growth and ‘cutting-edge’ growth is the issue in India. We have failed to create institutions or policy frameworks that enable the ultimate resource. As Nitin Pai, director of the Takshashila Institution, a think tank, puts it eloquently: under-governance, and not overpopulation, is India’s problem.

To say that our public institutions have the capacity to handle only so large a population is not an argument to reduce the population. It is an argument to enlarge the capacity of our public institutions. Like Procustes, we cannot chop off the legs of sleepers who were too tall to sleep on his bed. We need longer beds. Enlarging capacity is about better ideas, better technology, better people and more people engaged in governance. It is wholly wrong to attribute our failure to scale up governance to keep pace with population growth to ‘overpopulation’. (Source)

Nevertheless, we continue to blame our population. Several prime ministers in the past have failed to appreciate this and PM Modi, in his address to the nation on 15 August 2019, followed the same line. This sentiment is shared by large sections of our society too. It’s not difficult to find Malthusians opposing migration on the grounds that there are just way too many people in their city.

We will get older before getting richer. That is the plain truth. At a mere $2000 per capita income, we are sliding below-replacement fertility rate in most of the states. This is a bigger problem than our imagined overpopulation. In 2040, we will be an old, low-income country lacking a social security net. At this time, the only moral imperative is income growth. Everything else pales in comparison. But we continue with false trade-offs between growth and other higher-order virtues—equity, environment and national pride. This is not to argue that these aren’t important. But we should consider our priorities as a $2000 per capita income economy. Not what we imagine ourselves to be.

….

Not(PolicyWTF): Pausing Before Preaching

This section looks at surprisingly sane policies

- Pranay Kotasthane

Our judiciary sometimes behaves like a panchayat. Some court orders preach so much that they resemble WhatsApp rants by your neighbourhood uncle. Then there’s also a tendency to succumb to the performative pressure in today’s times, where every decision needs to take a moralising tone rather than confront tough trade-offs.

However, the judiciary surpassed itself on at least two occasions in the last two weeks, and it deserves all the appreciation for it.

The first instance was its Jan 10 order on a petition demanding an urgent Supreme Court hearing on the Joshimath land subsidence issue. Taking a pragmatic stance on the issue, the Chief Justice of India deferred the hearing by a week on the grounds that:

"Everything which is important in the country need not come to us. There are democratically elected institutions to see this. They can deal with what falls under their control. We'll keep it on 16th” (LiveLaw)

In normal circumstances, the Court would have gone on a “development vs environment” tirade, which would have helped none. For acknowledging that it cannot—and doesn’t need to—solve everything wrong, the Supreme Court deserves praise.

On Jan 16th, the Supreme Court stuck to its guns, explaining that it could not intervene since the Uttarakhand High Court was already considering the issue.

"You don't want to use this issue for social media sound bytes. From the order of the High Court, it seems that the issues raised are in an IA before the High Court. Over and above if you have any other issues, we can give you liberty to approach the High Court with them. (LiveLaw).

It’s rare when institutions resist the temptation to expand their scope, and for this reason, the Supreme Court’s order stood out.

The second reason was, of course, the Supreme Court Collegium’s decision to respond publicly to the union government’s objections regarding certain appointments.

The objections by the union government were comical and sad at the same time.

In one instance, the government opposed the appointment because of the person’s sexual orientation and because he had a Swiss partner. Laughably, the sole premise of the union government’s opposition to the current method of appointments is that it lacks “transparency, objectivity, and social diversity”.

In another instance, the union government didn’t like that a candidate shared an article criticising the PM. The government isn’t even pretending that the judiciary needs to align with the government’s views. In the third instance, the union government didn’t like the fact that the candidate was “highly opinionated and selectively critical on social media.” Note the importance given to the candidates’ social media profiles.

We’ll see more chapters of this stand-off between the judiciary and the executive soon. But for now, the judiciary’s forthright stance against the government’s ludicrous objections deserves praise.

India Policy Watch #2: Another Impossible Trinity

Insights on current policy issues in India

— Pranay Kotasthane

The “impossible trinity” or the “policy trilemma” is a useful thinking aid. The framework is represented a choice among three favourable options, only two of which are possible at the same time. There’s nothing scientific about it, but it can help shed light on the trade-offs involved.

For instance, living in many Indian cities can be represented as a trilemma between these three parameters:

* A decent standard of living: means that a median resident can afford a dignified dwelling, can commute without fearing death or disability, and can breathe non-hazardous air most of the time.

* Economic dynamism: means that the place offers a wide range of economic opportunities at all income levels. &

* Individual liberty: means that a place allows an individual to be herself, where community beliefs do not suppress individual initiative, preferences, and expressions.

Some intentionally broad generalisations follow from this characterisation. Most of our smaller towns offer a reasonable standard of living but no economic dynamism and little individual liberty. Places like Goa and perhaps cities in Kerala offer a decent standard of living and individual liberty but far fewer economic opportunities. Cities such as Mumbai, Delhi, and Bengaluru offer economic dynamism and higher individual liberty but come at the expense of losing a decent standard of living. Finally, there are cities in Gujarat which might offer you economic dynamism and a reasonable standard of living, but then you might have to eat meat sheepishly and consume alcohol surreptitiously.

Does this trilemma make sense to you? And are there places that have resolved this impossible trinity?

HomeWork

Reading and listening recommendations on public policy matters

* [Paper] This USIP paper explains the methods used in judicial appointments as a trade-off between independence and accountability rather well.

* [Book] Another edition compiling lessons from policy successes, this time from the Nordic countries.

* [Paper] Smriti Parsheera’s paper on the governance of Digital Public Infrastructure in India is essential reading for anyone interested in technology policy. A critique by Rahul Matthan is here.

—RSJ

As promised last week, let’s get going with some predictions for 2023. Pranay likes to keep them very specific (for a good reason), while I get away with broad bets.

Global Economy

The problem with predicting anything on how things will unfold globally is the random big event that upends all forecasts. This has happened in the last three years. The impact of the pandemic waves and the Ukraine war is yet to play out fully. By themselves, it makes for difficult terrain for forecasts. I’m hoping we don’t have another such event during the year.  

#1 The trend of securing your supply chain for critical products will get stronger.

Look, it is difficult to disentangle from the globally integrated supply chains that have been a feature of the economic model since the end of the Cold War. But it is clear to most large economies that on issues that concern national security, it will be foolhardy to not plan for worst-case scenarios any longer. And national security could mean anything, really, but I can see on energy and key technology, nations will opt for more secure supply chains with watertight bilateral partnerships than be at the mercy of distributed, multilateral chains. I won’t go as far as calling it ‘de-globalisation’ yet, but this ‘gated globalisation’ is a trend that’s here to stay. What this will mean in concrete terms is there will be a gathering of pace on bilateral treaties among larger economies on these issues that reduces dependence on China or Russia. For India, there are a couple of issues here. How to continue to balance the purchase of oil from Russia for its energy security without inviting sanctions from the west? It has managed this well in the last year. The other issue is to find alternatives to Russian hardware for its defence machinery without rubbing it the wrong way. We have batted for free trades on these pages for a long time. So, it is concerning to see this retreat, but history has shown over time, geopolitics trumps geoeconomics. 

#2 The fears of elevated inflation and a recession in the US in 2023 are overblown. The recession is due, but it will come a bit later

I have made the point here earlier too. The Fed has gone overboard on inflation targeting with more rate cuts than necessary and not waiting for their impact to come through. The moderation of inflation in the past few months (though at 3.6 per cent, it is still higher than the target) suggests that the Fed has been partly successful and it should continue to remain hawkish. I am not so sure. It takes time for rate hikes to start impacting demand, and my suspicion is that the current moderation in inflation was due in any case. The impact on rate hikes on subduing demand and growth is yet to play out. My view is that as supply chain issues ease up with China opening up, energy demand going up and the US continuing to be at almost full employment, we might have a 2023 where for the most part, the US inflation will be higher than target, Fed will continue to remain hawkish, and the growth will hold up. This will mean the real risk of recession will be more toward the end of the year than now. 

#3 Big Tech will continue to be under the cosh 

Three problems look to exacerbate in the tech space in 2023. First, the valuation of ad-driven economic models and the insane optimism about the distributed ledger, crypto, DAO or independent sovereigns (yeah, remember that) will abate. A lot of value has been destroyed in the last year (esp in public markets), and I still think there’s more to go in the private market valuations. This correction will weigh on markets, fund raises and investments into startups. Second, global markets will shrink for Big Tech as more countries will place restrictions on how deep they will allow them to own commerce or payment infrastructure. I half expect India to gradually move all payment and eCommerce arms of Big Tech into a structure that’s domestically controlled and owned in 2023. Third, FTC, with Hina Khan at the helm, will accelerate antitrust and competition law changes to reduce the dominance of Big Tech. Some of these measures will be significant overreach in my opinion, but I see more executive orders in this space. Conversely, I see significant hype building up on AI platforms during the year. Like every hype cycle we will have people going overboard on AI, but I think this is one trend where in the classic sense, we might be overestimating the impact in the near term and underestimating it in the long term. AI will eventually get us a driverless car, but it will get to the mediocre creator economy faster. The jobs under immediate threat aren’t that of cab drivers and factory workers. The average copywriter, reporter and illustrator are in greater peril. It will be interesting to see how these groups who have a greater share of voice in the media will tackle the threat of AI in 2023. 

Indian Economy

#1 Greater optimism

I am a bit more optimistic about the broader numbers than most, and I will explain why. I think GDP growth will come in around 6.5 per cent for FY24, and inflation will be around 5 per cent. We might see a couple of rate hikes in the next few months, taking the repo rate to 6.75 per cent, but that will be it. I see even a small possibility of a rate hike cut in the later part of the year to spur growth with an eye on Lok Sabha elections in May ‘24. We have corporate balance sheets that are strong, banks across the board are well provided for, and inflation hasn’t gone out of control. I see domestic consumption to remain strong and exports, in the light of the shift away from China, to be good for manufacturers, and how much ever I might struggle to get behind the PLI scheme, it will yield some short-term benefits. IT exports might be a dampener, but on balance, I see more upside to these predictions. Of course, the risks are another global one-off event, oil prices going up and restrictions on accessing Russian oil and a bad monsoon. But those aside, I foresee India standing out as an outperformer thanks in no part to many cards falling into place for it often without its own efforts. But then why look the gift horse in the mouth?

#2 Digitalisation: Wave 2

There will be a significant push on digitalisation in lending and eCommerce. The UPI infrastructure has revolutionised payments and, along with GST, has accelerated the formalisation of the economy. The benefits of these have so far been more skewed towards the government in terms of tax collections. I think we will see a focused push for the next round of benefits with platforms like OCEN (lending) and ONDC (eCommerce). The data that’s available because of the digital rails, the account aggregator framework that’s live now with banks and the groundwork done in getting small suppliers onboard on ONDC - these prerequisites are now available for the next order benefits of digitalisation for customers. Also, as I mentioned in an earlier point, doing this will also mean shifting the balance of power from Big Tech-owned entities to an open platform or domestically controlled entities. I sense a strong push in this direction in 2023.

#3 The expected capex cycle push from the government will not come.

There are a couple of reasons for it. First, this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency. The other reason for a muted capex spend is the likely belief that the private sector credit capex cycle seems to be picking up. These are early days for it, but the data for the past two quarters shows an uptick in corporate credit pickup and an increase in interest costs in the balance sheet. The benefits of the corporate tax cut in 2019 are now seen in strong corporate profits in FY23 for most sectors. That, plus the belief that the rate cycle has almost peaked, could mean the private capex cycle could strengthen during the year. I expect the MSME sector to gain from strength to strength on the back of China+1, PLI-like schemes and easier access to credit because banks are in better shape. MSME is the story of the next decade.

India Political and Social

#1 More of the same

The expected consolidation of opposition forces to counter the BJP isn’t going to happen early enough for it to mount a credible challenge in 2024. There are eight state elections in 2023, and I suspect BJP will see reverses or very close fights in a couple of them where it is the incumbent (MP and Karnataka). But LS elections aren’t any longer an agglomeration of many smaller elections like they used to be pre-2014. So, I don’t see an upheaval in national politics in 2023 that will make a meaningful dent in 2024. This is a pity because we have reached a stage of single-party dominance of polity and media, which isn’t healthy for democracy in the medium term. But it is hard to see opposition consolidation or a credible case that they can make to counter the electoral juggernaut of the BJP at this time. Congress, the other national party, isn’t capable of moving the masses either with its agenda or its leadership. The vacuum in national politics looks set to stay.

#2 More Exit, Less Voice

I have made the point in the past about social fault lines tripping us up while we magically have a growth window that’s opened up for us again. This holds true. The space for opposition or dissent has shrunk; more importantly, even the fight for protecting or broadening that space has gone out. As Hirshman (in Exit, Voice and Loyalty) asked in the context of the relationship between the state and its citizens: the citizen has the choice to either voice their disapproval when dissatisfied or exit from the state. The state would be dependent on citizens if they value their loyalty and would then pursue a policy that listens to their voice. However, if the state doesn’t value it and the citizens know their voice won’t matter, the only option is to exit. For certain sections of our citizenry, we are possibly at this stage of engagement with the state. This scenario might not hurt the majority today, but we would do well to remember it has never been a good idea for the state to not value the loyalty of its citizenry in the long run. 

An Excerpt from Missing in Action: Why Should You Care About Public Policy

— A chapter from our upcoming book that releases on 23rd January

Chapter 11: When the State Owns What’s Yours

A typical scene in those old Bollywood films with a rural setting was that of the zamindar standing with his ‘not-so- smart’ (naalayak) offspring on the terrace of their haveli and telling him:

Yahan se jahaan tak tumhari nazar jaati hai, woh saari zameen hamari hai![All the land that you can see from here belongs to us.]

In reality, the only zamindar who can make such a claim in modern India is the Indian State.

A fundamental concept underlying economic reasoning and public policy is the property rights system. To an Indian, the phrase ‘right to property’ conjures up the image of a rapacious zamindar exploiting peasants. This narrative has fostered a zero-sum perception—owning property is assumed to have occurred in the context of the violation of someone else’s human rights. This perception has, in turn, meant that the enforcement of property rights has always been weak in India. Once a fundamental right, the right to property under the Indian Constitution was deprecated to a constitutional right by the 44th amendment. Now the State can go about violating an individual’s right over their property, as long as it can couch this takeover is being done under vaguely defined ‘public interest’.

Why Is a Functional Property Rights System Necessary?

A property right is an exclusive authority to determine how a resource is used. This applies not just to land but to any physical or intellectual property such as your phone, your water bottle, or your innovation. Such a right can be held by a person, a group of persons, or the State.

When this exclusive authority over someone’s resources is protected—by the State or society—the owners can be confident of deploying and improving the quality of their owned resource instead of spending their energy in feverishly protecting the resource from being stolen by another entity. Moreover, giving an exclusive authority to someone to enjoy the use of a resource changes the nature of competition itself, bringing it into the realm of social acceptability. For example, without property rights, entities might compete over a common resource by resorting to means such as intimidation, denial, and distancing. But once it is demonstrated that the authority over a resource will be protected, competition shifts to owners improving their offering to win more buyers. Finally, a strong property rights system also enables the exchange and sharing of resources, as resource owners can be confident that their ultimate ownership is secure.

Now this sounds quite theoretical and straight out of an economic reasoning textbook, which this book is not. So, to understand how pivotal the concept of a well-functioning property rights system is, we turn to an Indian story of violation of these rights. By understanding what happens when property rights are denied, we might better appreciate their importance.

Daastaan-e-Sandalwood

The story of sandalwood production in India is as intriguing as it is frustrating. The wood is used for its timber. The oil extracted from its roots is used in perfumes, incense, soaps, and medicines. In India, sandalwood has a special religious significance as well.

As hopeful consumers, many of you would have heard about the astronomical costs of this wood. Many of you would have also heard about brigands such as Veerappan who gained Robinhood status by smuggling sandalwood. Some of you might have been duped into buying ordinary scented wood being passed off as sandalwood. But few of us realize that the strand that connects these stories is misguided State action.

Generally, the price of a commodity is indicative of its natural scarcity, but that’s not the case here. Nearly 90 per cent of the world’s sandalwood resources are available in the three Indian states of Karnataka, Tamil Nadu, and Kerala. And yet, the production of sandalwood in India has declined sharply. In 1965–70, annual production stood at 4000 tonnes. By 1999–2000, it had decreased by half. And by 2019, it had become just 200 tonnes. Other countries supplied a total of 400 tonnes in the same year, while the total global demand is estimated to be nearly 6000 tonnes a year. This massive demand–supply gap has made sandalwood so costly that it is often referred to as ‘red gold’.

The drastic fall in sandalwood supply from India can be explained by a long history of denial of property rights. In fact, State interference in growing, producing, and selling sandalwood has a history of nearly 230 years in India. Here’s how the story goes.

Sandalwood was in huge demand even during colonial times, especially in China. The East India Company— never one to miss a trading opportunity—aimed to exploit the resources in southern India and export them to China. The problem was that much of the sandalwood-growing area fell under the kingdom of Mysore, led by Tipu Sultan. Recognizing the commercial value of this resource, Tipu Sultan forbade his subjects from trading in the wood with the Britishers in 1786. To take this idea further, he decreed sandal as a ‘royal tree’, monopolizing sandalwood trade in 1792. Thus began, out of good intentions, the story of sandalwood’s decline.

Eventually, this sandalwood trade blockade became one of the primary causes of the Anglo-Mysore Wars. Once the Britishers took control, they were only happy to continue the sandalwood trade monopoly. The conception of sandalwood as a source of government revenue strengthened. Fast forward to Independence and we see that such was the lure of the scented wood that subsequent Indian governments followed the same policy of denying property rights to sandalwood growers. Even when the tree was located on private land, it belonged to the state government, and the owner of the land was required to make a declaration of the number of trees on his land. The forest officer could enter any private land and cut the trees and the range forest officer was supposed to give 75 per cent of the value as decided by the officer. Landholders were to be held responsible for damage or theft of any tree even though they had no exclusive authority over it. Violators could be imprisoned and fined. Further, in Karnataka and Tamil Nadu, it was necessary to get a licence to store, sell, and process sandalwood. Possession of sandalwood in excess of twenty kilograms was made an offence.

Unsurprisingly, the complete disregard for property rights meant that no one was interested in growing sandalwood on their land. It became a liability to be gotten rid of rather than an asset to be invested in. After all, who would want to be accountable for a resource whose fruits of labour they cannot enjoy?

The result was a steep fall in production. But the story didn’t end there. Given that the demand for wood was still high, a thriving black market emerged. With supply from cultivators choked off by government policy, smuggling the wood growing in government-controlled forests became a lucrative opportunity. Such were the profits to be made that the government could not protect sandalwood smuggling from these forests. When governments created armies of forest guards and personnel to ‘protect’ the forests, many forest staff colluded with smugglers, further causing the depletion of the resource. Eventually, this smuggling business paved the way for the likes of Veerappan, who moved away from the riskier ‘business’ of killing elephants to the far-more profitable sandalwood smuggling.

After decades of this failed policy of denying property rights, governments recognized their mistake in 2001, when the Karnataka government allowed private players to grow and own sandalwood. Tamil Nadu followed suit in 2002. But this recognition of exclusive authority remains incomplete. The government continued to monopolize demand, which meant that farmers could only sell the sandalwood back to the government. Realizing that this was still a major stumbling block, the Karnataka government further liberalized sandalwood policy in 2009. Now, the growers could sell their wood directly to semi-government corporations such as Karnataka State Handicrafts Development Corporation (KSHDC) and Karnataka Soaps and Detergents Limited (KSDL). Apparently, KSDL offers a non-negotiable sum of Rs 3500 per kg of sandalwood. The company then turns around and sells the product for nearly Rs 16,000. Even today, farmers are not free to sell to other private players or export their produce.

Meanwhile, Australia, which had its own native sandalwood, shifted to the Indian variant in 1998, introduced genetically engineered high-yield varieties, and beat India at its own game. So much so that India now imports Australian sandalwood for the sandalwood oil industry!

The Takeaway

The sad sandalwood story illustrates that denial of property rights took away a shot at prosperity for thousands of ordinary farmers. One of the key components of liberty is economic freedom. Denial of this core freedom to individuals by the State or the society is a cruel act that perpetuates poverty. The State shouldn’t be let off easily when it abridges this basic right.

The hope is that learning from the mistakes of previous generations, many states in India have now adopted liberal policies for sandalwood production. This shouldn’t be seen as isolated policy reform. The principle that needs to be internalized is that the State should focus on the protection of property rights of individuals instead of usurping them.

India Policy Watch: The Old Debate about Colonial Rule in India

Insights on current policy issues in India

— Pranay Kotasthane

Earlier in the month, I chanced upon this Al Jazeera article, in which two historians have a new data point to illustrate the damage inflicted by British colonial rule on India. They find that “Britain’s exploitative policies were associated with approximately 100 million excess deaths during the 1881-1920 period.”

Claims of this nature keep surfacing fairly regularly in our public discourse. In recent times, a reason has been the recurring debate in current-day Britain over the legacy of the British Empire. Even as that country is a much smaller power today and one that continues to be outpaced by other competitors, there is understandably a tendency to indulge in colonial nostalgia. From a realist perspective, the colonial period was indeed Britain’s moment of glory.

In response to this colonial nostalgia, Marxist scholars keep reminding us of numbers and narratives to explain how British rule was ruthless, inhuman, and detrimental to India.

Another reason the debate finds a fresh lease of life is that Indian nationalists of various hues resurface the sone ki chidiya narrative — that India was rich and wealthy before the Britishers came here; it was only the British rule that impoverished us. Some even talk about reparations as a way to address—even if to a small extent—the problematic legacy of colonialism. Shashi Tharoor’s 2017 book Inglorious Empire: What the British Did to India falls under this category. I, too, have caught myself resorting to this trope in casual conversations — the causal chain of reasoning for many of India’s problems intuitively ends up with British Rule.

We now know that these extreme claims are not all accurate. For instance, consider the economic deprivation argument. The oft-repeated claim is that India made up a quarter of the world’s GDP before the Britishers set foot here, and by the time they left, India made up just 4 per cent of the world GDP, a sure sign of loot, plunder, and deliberate deprivation. But now we know better. India’s GDP per capita in 1500 was still $500 (in constant 1900 dollars), far below that of contemporary powers such as China ($600) and Europe ($800). In the pre-industrialised world, GDP was a simple function of the population, as there were minor differences in productivity. We comprised 25 per cent of the world GDP only because India was one political populous unit, not because we were rich. The industrial revolution brought in a step-jump in productivity in Europe, and the divergence in incomes became a giant gap by the 1900s. While it might well be true that some part of the divergence resulted from British policies in India, the contribution of the intellectual, industrial, and social revolutions in Western Europe played a much bigger part in accelerating growth there. Moreover, we also know that the period between 1870 and 1913 saw the fastest growth in pre-independence India.

On the other hand, economic historians such as Tirthankar Roy have repeatedly highlighted that the economic consequences of colonial rule are, at best mixed. His two books on the Economic History of India, covering the periods 1707-1857 and 1857-1947, authoritatively demonstrate three points. One, the Britishers could sweep across the subcontinent because many sections of Indians found them to be the best among all available alternatives. Two, British rule did bring in some benefits as well. Regardless of intentions, policies such as a consolidated tax system and Railways did have positive consequences. And three, it is difficult to estimate if famines and loot were substantially higher in the British era than in the past because comparable data for the latter simply doesn’t exist.

From a consequentialist lens, none of these counterarguments should surprise us. As we know, even the worst of social experiments do have some positives, and even the most well-intentioned policies also make some people worse off. Just like COVID-19 also had some small unexpected positive changes, British rule too had some positive outcomes.

Despite these counter-arguments, the simpler stories that suggest “British plunder doomed India” are likely to stay dominant. That’s because historical accuracy is not the most important consideration while discussing colonialism. Modern Indian nationalism grew out of the shared anti-colonial experience, and putting the blame on the “conniving” Britishers was important for forging unity amongst Indians. So, this narrative is really about nation-building rather than deepening our historical understanding.

In today’s times, the argument for reparations seems anachronistic. India is a bigger (definitely not richer) economy than the UK today. The UK PM himself is of Indian origin. The future prospects of India are far brighter than that of the UK. Given how far India has already come, these reparations arguments do not make any sense beyond an ointment for our emotional wounds.

In fact, doubling down on this colonial loot argument can be counter-productive. India needs the West’s help to increase its own national power vis-a-vis China. Just as China benefited from movements of goods, services, labour and capital from the West, we need them too. The more we keep harking back to emotional arguments against colonialism, the more difficult it becomes to adjust to the reality that the West remains indispensable for India.

People's intentions in the past matter very little for future policymaking.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] This Mint article captures the main fallacy behind the sone ki chidiya narrative.

* [Article] A good summary of Tirthankar Roy’s two books on the economic history of India.

Others might begin the new year with resolutions, but we prefer excuses. Last year, we wrote only 42 editions. There was much to do in the remaining ten weeks. There was the Football World Cup, a few time-offs, a couple of vacations, and of course, a lapdog ate our laptops. If these honourable reasons weren’t enough, we add another: we wrote a book!

Our book Missing in Action: Why You Should Care About Public Policy will be published on 23 January 2023. Like this newsletter, it is a 'pop' public policy book in which we explain concepts through stories rooted in the Indian context.

We couldn’t have asked for a more helpful and encouraging team than our friends at Penguin India, who got us over the line and in time for a Republic Day release. The book is ready for pre-order now. You will have to excuse us for a bit of promotion that we will do over the next month or so on these pages. 

So what’s the book about?

At the heart of the book is our belief in the core objective of public policy. It should increase the welfare of the citizens. Like the verse from Bhagavad Gita goes:

अनन्याश्चिन्तयन्तो मां ये जनाः पर्युपासते।तेषां नित्याभियुक्तानां योगक्षेमं वहाम्यहम्।।9.22।।

That word - Yogakshema - to preserve the prosperity and welfare of citizens is what public policy should be about. 

We write this newsletter with the hope that it will, in its small way, move the needle on discourse. The book is a logical extension of this hope. Hope, as Andy Dufresne taught us, ‘is a good thing; maybe the best of things’.

We are hopeful about the future of India, but not in a misguided nationalistic way. We believe we can make an impact, however small, on the demand side of the policy equation. That making people aware of policy choices and helping them anticipate the unintended will lead to a change in the supply side of politics. There are two preconditions for this to happen, which we assume hold true. One, people have time and mental space available for discussions that matter to their lives. Two, a belief we can arrive at what’s good for us through those debates and discussions.

In the book, we have taken the citizens as the point of reference and elaborated on their interactions with the state, the market and the society. Think of the book as a primer to understanding the fundamentals that underpin these interactions. We cover why we need a state or the markets, what is the role of society and how the three interplay among them. We go back to the foundational texts on political philosophy and economy in the book to explain the core concepts of public policy but in what we hope is an accessible fashion. We have tried to avoid jargon and approached all topics using first principles. Like the 16th century Bhakti poet, Nabha Dasa, who compiled the life of every saint from time immemorial in Bhaktamala, wrote:

"Jaat na puchhie saadhu ki, poochh leejie gyan,

mol karo kirpan ka, padi rahne do mian"

("Do not ask for the antecedents of a learned saint. Only seek their wisdom. The true worth is what’s within us and not what you see from outside.")

We have been ecumenical in our approach in this book.

The other thing you might find interesting in the book is our focus on finding examples in the Indian context to illuminate a point or to make a case for our arguments. This will contextualise a lot of the discussions in the book to our immediate environment, and we hope it will make our reasoning clearer to our readers. Further, we have tried to keep ourselves free of dogma in the book. We have strong faith in markets, but we understand their limitations and the critical role of the state and society. We have been open to knowledge from all sources and have challenged our premises and priors before stating our point of view. Lastly, the tone of the book is conversational, and it is filled with some of our usual groan-inducing Bollywood references. 

Special thanks to all of you for reading us and engaging with us. Without your encouragement, we wouldn’t have attempted a book. And now that we have said such good things go buy the book!

Truth be told, we are a tad nervous about how the book will be received. We hope you will enjoy reading it and recommending it to others. Show it some love, friends and order it now. 

Thanks

Pranay & RSJ

India Policy Watch: How Did I Do On My Predictions For 2022?

— RSJ 

Each year I start with a prediction post. But before I get down to my predictions for 2023 (which I will in the next edition), there’s the unfinished business of how I fared on the predictions that I made in 2022. So, here’s a look back at the year through the lens of my predictions at the start of the year.

Economy - Prediction #1 

This is what I wrote:

“we will be in the 5-5.5 per cent growth range (if you take the base of FY 21). Inflation (CPI) will be around 5 per cent with an occasional jump to 6 per cent during the year despite threatening to go out of control. Maybe three interest rate hikes (a total of 75 bps) during the year will keep a lid on it. Public markets will moderate a bit (around 10 percent upside).... China won’t attract it (foreign capital) as it will continue to go down the path of self-reliance and its notion of an equal society.”

Result: No one could see the Ukraine war coming back when I made the predictions. Notwithstanding that, I think I got the growth and the inflation prediction in the ballpark. The war threw the interest hike prediction off totally. Instead of a 75 bps hike over the year, we got a 225 bps increase. I think, on balance, the Indian economy did quite well in 2022, given the headwinds. Domestic consumption was strong; we weathered the peaking of oil and commodity rates quite well, the twin balance sheet problem is now behind us, and by the end of the year, we saw private Capex growing. Not a bad state of affairs. I would have taken this happily at the start of the year. 

Overall, I’d give a 6/10 on this prediction.

Economy - Prediction #2

“There won’t be much to write about reforms. Some attempts at piecemeal MSP reforms will be attempted to make up for the repealed farm laws. The National Monetisation Pipeline will get going but the progress will be modest. A couple of more disinvestment proposals of PSUs (including banks) will be taken up. But this will be for raising revenues rather than a planned strategy to make PSUs market competitive. The LIC IPO will just go over the line and that will be the big event to showcase reforms.”

Result: Got that pretty much spot on. Maybe an 8/10.

Politics - Prediction #1 & 2

Here’s what I wrote:

“BJP election machine will continue its winning run barring the odd defeats in Punjab and Goa. The big prize, UP, will be fought hard but BJP will win a safe majority. The bahujan vote of the depleted BSP will shift to it more than to SP and that will make all the difference.”

“There will be a split in the Congress. The party in its current form is untenable and beyond a point, there will be nothing to lose for those who split it. The key question is who will lead it - those who have a political base and think Congress leadership is a liability that cannot be carried along any further, or those without a political base but with strong ideological opposition to the BJP. My guess is it will be the latter. In any case, it won’t make much of a difference.”

Result: Punjab went the way I had guessed. Goa was close. Congress didn’t split but it lost senior leaders like Capt. Amarinder Singh and Ghulam Nabi Azad among others. And despite the Bharat Jodo Yatra, which has only been in the news because people cannot believe Rahul Gandhi has sustained it for so long, I don’t think Congress improved its election prospects dramatically this year.

Society - Prediction #1

“Expect love jihad and anti-conversion laws in various states, some kind of population control bill, a revival of CAA and a push for a uniform civil code during the year. There’s that early 20th century Europe playbook of stoking demographic anxiety that plays on a threat to the survival of a civilisation or a way of living. The pitch will be queered on this. Indian society is a fertile ground for it. This land can be shown to its people as a palimpsest. But it can, perhaps more easily, be shown as a glorious, ancient civilisation that’s been asphyxiated for centuries by ‘outsiders’. A true revival of it requires setting the past records straight and the right demographic arithmetic.”

Result: Well, there was the usual noise around a lot of these issues but, thankfully, we had a somewhat muted year on legislating these. This didn’t mean that the media mouthpieces and influential voices within and outside the government went slow on stirring the pot on these topics. We have reached a point where turning back on these issues will be difficult. It remains the one faultline that can derail our economic prospects that look surprisingly good at this moment. I will give myself a 7/10 as much as I want to score a zero here.   

Society - Prediction #2

“Politics is driven by the idea of having an enemy; the other. For much of the last decade, this was the left-liberal cabal (Lutyens, Khan market, NYT, Soros, Amnesty etc). Even when much of news and propaganda came to be dominated by the right-wing, there was a strawman of this all-powerful cabal of anti-nationals that was kept alive because the notion of an enemy is critical. But once you have decimated it, what do you do? You look for the enemy within.”

Result: I will be the first to admit that I am still amazed at how this prediction isn’t yet true. There are still imaginary left cabals to be fought against. It is a measure of both the enterprise of the propaganda machinery and the gullibility of ordinary voters that we are still drinking up all the kool-aid that we are being served on how anti-India interests are still the ‘establishment’ in India and globally. There's still a long way to go before finding the enemy within your camp to fight. I will give a 5/10 on this. 

Miscellaneous - Prediction #1

“There will be serious big tech regulations that will come into play in America. Others will follow suit. India will have a version of this along with dollops of atmanirbharta. This will mean some tough days for big consumer tech giants in India.”

Result: Some big tech regulations have come into play in the US, and the collapse of FTX will lead to further clamping down. India came down heavily on Chinese apps and made life difficult for consumer-facing tech giants like Amazon, Meta and Alphabet. I expect this to continue. I guess a 7/10 on here will be about right. 

Miscellaneous - Prediction #2

“China will struggle for growth. Demographics, debt and delusion have come together in China in a way that will make it difficult for it to sustain growth. China-Russia relationship will get stronger with their support for each other and for other authoritarian regimes around the world.”

Result: Even without the Ukraine war, I thought this was how it was going to play out. It only became stronger with the war. I think I got a 9/10 there. 

Miscellaneous - Prediction #3

“Meta, Crypto, Decentralisation, NFT (and everything else pumped up by the Valley tech bros) will see their hype abate (about 25-30 percent drop in asset value). When John Terry starts buying Bored Ape NFTs, you know the whole thing has jumped the shark. About time too.”

Result: I should have followed my gut more and doubled down on this last year. I could sense a big correction, and a large-ish collapse was in the offing in this space. But I stopped short of calling a mini meltdown in this space. But that’s how it turned out by the end of the year. An 8/10 here.

So, there we are with how I fared on last year’s predictions. I will come back next week with a few specific and somewhat contrarian predictions for 2023. 

Not(PolicyWTF): Making Education Profitable

This section looks at surprisingly sane policies

- Pranay Kotasthane

The University Grants Commission (UGC) released draft regulations earlier this week, permitting foreign universities to set up Indian campuses. While the draft needs some much-needed improvements, this reform is in the right direction. For the moment, keep the programmatic part of the policy aside. It’s the politics of this move that caught my attention.

Ritika Chopra in the Indian Express reminds us that the first such attempt was made in 1995. Another one in 2005-06 never made it past the cabinet. Then in 2010, the UPA government brought in another bill. The Foreign Educational Institutions (Regulation of Entry and Operations) Bill, 2010 was introduced in the Lok Sabha, a Standing Committee gave some suggestions, the government sat on it for three years, and it was tabled again in 2013. By 2014, the UPA was voted out, and the bill lapsed.

It’s interesting to observe how the Overton Window has changed on this issue. The 2010 bill was far less radical than the draft UGC regulations being proposed now. That bill disallowed foreign universities from repatriating any money abroad, it mandated that interested entities have a corpus fund of at least Rs 50 crores, and it allowed only entities that had operated for at least 20 years. Despite these unreasonable restrictions, the Left and the BJP still found the bill too permissive and buried it.

The Left had a far greater influence on the matter as it was a part of the ruling coalition. I went back to check the best form of arguments put forward by the Left. True to form, they argued that this bill would encourage “commercialisation” of education. The CPM said it would open the ‘floodgates for weakening and dismantling the public education system in higher education. And India could be atmanirbhar in developing a higher education system; we need no help from anyone.

Shouldn’t we reflect on how much this ideological opposition cost us? What was the number of people who went ahead to get quality education in other countries, including in risky countries like Ukraine and Kazakhstan? Blocking foreign educational institutes for equity reasons is akin to banning people from eating Sushi just because India still has a large poor population. Forget the fact that a former General Secretary of the CPM is himself an alumnus of a British university.

The BJP’s objection predictably was that the courses offered could ‘adversely affect the sovereignty and integrity of India’. That insecurity hasn’t subsided, and the new draft regulations have an explicit clause forbidding such courses.

We can interpret the new draft regulations as an example of the Overton Window stretching on this issue. On some counts, it has extended the boundaries of freedom by allowing people to have more options within India while allowing foreign universities to repatriate money back home. It’s a hesitant acknowledgement that profit-making in education is not bad. On the other hand, the Window has also stretched toward “lesser freedom” with clauses banning certain types of courses, effectively implying that non-controversial “technology” universities might receive preference over liberal arts universities.

Real-life policymaking is often a search for the second-best option. So I’ll take the door left ajar, rather than it remaining closed altogether.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] Some predictions for 2023 by the Puliyabaazi team

* [Book] Optimally Irrational: Good Reasons Why We Behave The Way We Do is promising.

* [Article] Many editions ago, we wrote about the EU ban on chargers, warning that it could come to India as well. That ban is here though, and we again reiterate why it is counterproductive.

Happy holiday season, everyone!

India Policy Watch: Digital Rupee (e₹-R) Is In Town

Insights on current policy issues in India

— RSJ

The RBI launched the first pilot for the retail digital Rupee this week. It is now among the select list of central banks that’s got a CBDC pilot going.

The RBI press release covers the plan for the pilot:

* The pilot would cover select locations in closed user group (CUG) comprising participating customers and merchants. The e₹-R would be in the form of a digital token that represents legal tender. It would be issued in the same denominations that paper currency and coins are currently issued. It would be distributed through intermediaries, i.e., banks. Users will be able to transact with e₹-R through a digital wallet offered by the participating banks and stored on mobile phones / devices. Transactions can be both Person to Person (P2P) and Person to Merchant (P2M). Payments to merchants can be made using QR codes displayed at merchant locations. The e₹-R would offer features of physical cash like trust, safety and settlement finality. As in the case of cash, it will not earn any interest and can be converted to other forms of money, like deposits with banks.

* The pilot will test the robustness of the entire process of digital rupee creation, distribution and retail usage in real time. Different features and applications of the e₹-R token and architecture will be tested in future pilots, based on the learnings from this pilot.

The obvious question that comes up is how’s a digital currency different from a transaction on UPI. The RBI Governor got into the explanation mode on this at the press meet.

Separately, in an earlier concept note, the RBI had outlined the two different types of CBDC it would pilot as part of this process:

Based on the usage and the functions performed by the CBDC and considering the different levels of accessibility, CBDC can be demarcated into two broad types viz. general purpose (retail) (CBDC-R) and wholesale (CBDC-W).

CBDC-R is potentially available for use by all private sector, non-financial consumers and businesses. In contrast, wholesale CBDCs are designed for restricted access by financial institutions. CBDC-W could be used for improving the efficiency of interbank payments or securities settlement, as seen in Project Jasper (Canada) and Ubin (Singapore). Central banks interested in addressing financial inclusion are expected to consider issuing CBDC-R.

Further, CBDC–W has the potential to transform the settlement systems for financial transactions undertaken by banks in the G-Sec Segment, Inter-bank market and capital market more efficient and secure in terms of operational costs, use of collateral and liquiditymanagement. Further, this would also provide coincident benefits such as avoidance of settlement guarantee infrastructure or the need for collateral to mitigate settlement risk.

About 18 months back, in edition #122, I wrote a fairly detailed piece about CBDC in the context of China running a pilot for digital Yuan. It will be useful to bring that piece up to contextualise the RBI CBDC pilot.

What’s Money?

As we have written in an earlier post, money performs three roles for us: it is a store of value, it is a medium of exchange, and it is a unit of measure. Through it, we save for the future, pay for goods and services and measure the value of very different things using a common unit. These roles mean anything that aspires to be a currency (the usable form of money) should have a relatively stable value over time and should be widely acknowledged as a store of value and unit of account among people. If it does so, the network effect takes over after a while, and it becomes a widely used currency.

Throughout history, a key feature of a sovereign state was its control over the supply and circulation of money that’s used within its boundaries. The royal mints, after all, have been around for more than two thousand years. As modern nation-states emerged through the 19th and 20th centuries and as global trade increased, central banks emerged to manage the monetary system and provide financial stability.

There are three forms of money in any modern economy:

* Banknotes: These are physical paper currency notes issued by the central bank that we all use in our everyday lives. This is a direct promise by the central bank to pay the note holder a specified sum of money. This promise is printed on all currency notes.

* Bank Deposits: Ordinary people and businesses don’t hoard banknotes to conduct their business. They deposit their money in commercial banks. These deposits are stored in electronic form by these banks. The banks offer two services to their customers. They convert these deposits to central bank money in the form of banknotes when you demand it at an ATM and they offer to transfer your money to someone else through a payment system that exists between banks. Unlike banknotes, your deposits aren’t risk-free. They aren’t backed by any sovereign guarantee. A bank will be able to convert your money into banknotes only if it is solvent and can honour its commitments. We have seen instances of a bank failing to do so in India (Yes Bank, PMC etc.).

* Central Bank Reserves (“reserves”): Commercial banks have their own accounts with the central bank where they deposit their funds. These deposits are used by banks to pay each other to settle transactions between them. The reserves are the other form of central bank money apart from banknotes. These are risk-free and therefore used for settlements among commercial banks.

Where does CBDC then fit in?

Simply put, a CBDC is a digital form of a banknote issued by the central bank. Now you might think we already use a lot of digital money these days. Yes, there’s money we move electronically or digitally between banks, wallets or while using credit/debit cards in today’s world. But that’s only the digital transfer of money within the financial system. There’s no real money moving. The underlying asset is still the central bank money in the form of reserves that’s available in the accounts that commercial banks have with the central bank. This is what gets settled between the commercial banks after the transaction.

This is an important distinction. We don’t move central bank money electronically. But CBDC would actually allow ordinary citizens to directly deal with central bank money. It will be an alternative to banknotes. And it will be digital.

CBDC: The Time Is Now

So, why are central banks interested in CBDC now?

There are multiple reasons.

One, cryptocurrency that’s backed by some kind of a stable asset (also called ‘stablecoin’) can be a real threat as an alternative to a sovereign currency. Stablecoins are private money instruments that can be used for transactions like payments with greater efficiency and with better functionality. For instance, the current payment and settlement system for credit cards in most parts of the world has the merchant getting money in their bank accounts 2-3 days after the transaction is done at their shops. A digital currency can do it instantly. For a central bank, there could be no greater threat to its ability to manage the monetary system than a private currency that’s in circulation outside its control.

Two, in most countries, there’s an overwhelming dependency on the electronic payment systems for all kinds of transactions. As more business shifts online and electronic payment becomes the default option, this is a serious vulnerability that’s open to hackers and the enemy states to exploit. A CBDC offers an alternative system that’s outside the payment and settlement network among commercial banks. It will improve the resilience of the payment system.

Three, central banks need to offer a currency solution for the digital economy that matches any form of digital currency that could be offered by private players. Despite the digitisation of finance and the prevalence of digital wallets in the world today, there’s still significant ‘friction’ in financial transactions all around us. You pay your electricity bill electronically by receiving the bill, then opening an app and paying for it. Not directly from your electric meter in a programmed manner. That’s just an example of friction. There are many other innovations waiting to be unleashed with a digital currency. Central banks need to provide a platform for such innovations within an ecosystem that they control. CBDC offers that option.

Lastly, digital money will reduce transmission loss both ways. Taxes can be deducted ‘at source’ because there will be traceability of all transactions done using CBDC. It will also allow central banks and the governments to bypass the commercial banks and deliver central bank money in a targeted fashion to citizens and households without any friction. The transmission of interest rates to citizens for which central banks depend on commercial banks could now be done directly.

While these are the benefits of a digital currency, there are other macroeconomic consequences including the loss of relevance of bank deposits that we have with our banks. Some of these may seem speculative at the moment but these are factors to consider as things move forward. A CBDC that offers interest will mean we could have a direct deposit account with the central bank. This will also mean a move away from deposits in banks to CBDC with the central bank. Also, the nature of a bank ‘run’ will change. Today a bank ‘run’ means a rapid withdrawal of banknotes from a bank by its depositors who are unsure of the solvency of the bank. This takes time and is limited by the amount of money available in ATMs. In a CBDC world, the ‘runs’ will be really quick and only constrained by the amount of CBDC issued by the central banks. Depositors will replace their deposits with CBDC pronto.

This secular move away from deposits could increase the cost of funds of commercial banks. They will have to depend on other sources of funds than the low-cost deposits that customers deposit every month in the form of salaries to them. A reduction in deposits will reduce the availability of credit in the system. This will have a repercussion on the wider economy. It will also mean greater demand for reserves from the central bank by the commercial banks to provide credit to their customers. Central banks will increase their reserves and their balance sheets will become bigger. These are among many potential scenarios that could unfold. These are early days and it will be interesting to track the iterations of the pilots that the RBI will do as it appreciates the use cases, the design features and the policy issues involved.

This is an interesting space to watch. India’s track record on building national digital infrastructure in payments is second to none. It might be the one place where the promise of CBDC could turn into reality.

A Framework a Week: China’s Predicament

Tools for thinking public policy

— Pranay Kotasthane

A couple of weeks back, I had linked out to a CSEP paper by Amb. Shivshankar Menon. Titled Internal Drivers of China’s External Behaviour, he explains the domestic imperatives that are likely to modify China’s external behaviour.

In that paper, one #lightbulb framework explains the novelty of the situation that China finds itself in. Here’s the text from the paper:

Today, China faces an unprecedented situation at home and abroad and is therefore reacting in new ways. China is more powerful than ever before but is also more dependent on the world. This is an unprecedented combination, not known in Chinese history—not in the Han when she had to ‘buy’ off the Xiongnu by marrying Han princesses off to steppe leaders; nor in the Song when she was one and sometimes the weakest power in a world of equals; nor in the high Qing when she was powerful but independent of the external world, as the Qian Long emperor reminded George III in writing. [Internal Drivers of China’s External Behaviour, CSEP Working Paper, Shivshankar Menon ].

We can interpret this insight visually in this 2x2 framework.

The implication is that China finds itself in an unfamiliar position today and as a result, will act externally in new ways altogether. The high power-high dependence combination helps explain China’s belligerence in the Himalayas and the South China Sea.

It also explains the drive towards self-reliance in technology domains. The high-dependence on adversaries acts as a motivation, and high domestic power gives China the confidence (over-confidence?) to do it all domestically. Observe China’s response to the US export controls on its semiconductor industry. I expected a definitive retaliation after the 20th Party Congress had reaffirmed Xi’s control. But that hasn’t happened. It only makes sense if China’s political establishment is confident of overcoming the dependence in due course while taking advantage of it to bolster present capabilities.

Advertisement: Takshashila is now accepting applications for the next cohort of GCPP. Apply now. If you like reading this newsletter, you will find the course enriching.

PolicyWTF: Emigration Embargoes

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Rina Agarwala has an excellent article in The Monkey Cage, highlighting the restrictions preventing the less-educated, poor Indians from emigrating easily.

“Under India’s 1983 Emigration Act, poor emigrants have to hire a government-certified recruiter, fill out piles of government paperwork, pay huge fines and hope for government approval. Unlike Ramdas Sunak’s experience in the 1830s, they usually emigrate without family members on temporary visas, working under difficult conditions for little pay under the control of their foreign employer.

Although these emigrants send home the largest share of India’s massive remittances — an estimated $100 billion in 2022, and which have saved India through multiple financial crises and cover 40 percent of the basic needs for millions of poor households — they receive little acknowledgment or support from the Indian government.

Educated emigrants, by contrast, are free to leave India as they please. Since the 1980s, the Indian government has offered them awards and special financing options for savings accounts, investments and bonds within India. The government has also encouraged their temporary return to India with business partnerships and high-level positions within the Indian government. Receiving countries are also more likely to welcome educated Indians than poor immigrants. [Is the new U.K. prime minister a paragon of immigrant success?, Rina Agarwala, Washington Post]

It is indeed quite disturbing how the emigration policy came to be this way. There are good intentions behind it, of course. The government’s rationale is that these entry barriers are meant to check human trafficking. That’s why the restrictions on less-educated women are even more stringent than those for men. Check this out:

The Emigration Act (1983) states that persons of working age who have not completed schooling up to the tenth standard are issued an ECR (Emigration Clearance Required) passport. The remaining population is eligible for an ECNR (Emigration Clearance Not Required) passport. When men having ECR passports plan to emigrate for work, they need to obtain an “Emigration Clearance” from the office of the Protector of Emigrants (PoE) before travelling to certain countries (currently, 18 in total). What’s even more egregious is that a woman of age less than thirty with an ECR passport is completely banned from getting emigration clearance for all kind of employment in any ECR country.

But the anticipated unintended result is that it blocks off opportunities for people who probably would improve their life outcomes the most by emigrating.

I’ll leave you with a link to edition #15, in which we write about this policyWTF and solutions to improve the situation.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] Our Puliyabaazi on public libraries received a lot of listener interest. What do you make of it?

* [Book] Global Value Chains and the Missing Links: Cases from Indian Industry by Saon Ray and Smita Miglani is a must-read to understand India’s prospects in different sectors, given the shifting geopolitics and geoeconomics.

* [Podcast] Math with CCP Characteristics.

Insights on current policy issues in India

— RSJ

Many moons ago I sat down for lunch with someone who is often referred to in the media as a ‘doyen of the industry’. Among other things, I asked him the single most important advice he would give to anyone who is at the start of their career. I didn’t have any burning desire to succeed in the corporate rat race. So, I wasn’t looking for a life-changing insight. I asked it because custom demanded you ask such questions of doyens like him over a meal. Also, even back then I was aware that I should fill my pitaara with such stories because sometime in future I could use them to make myself appear interesting. Anyway, he squinted at me and with something that appeared close to conviction told me, “always defer gratification”. I nodded and pronged a moody forkful of Aglio e Olio. Instant gratification.

Over the years I have come to appreciate that piece of advice. Running a successful business over the long term is all about how well you trade off short-term gains with doing what’s right for long-term sustainability. The odds are stacked against you because most of your shareholders, the analysts and the media are measuring you on quarterly performance. You can put out a convincing long-term story that will deliver a big, deferred outcome but how can anyone be sure you’re headed that way? Any short-term wobble can have people question you. It is tough to live a life of deferred gratification. I haven’t followed it to any meaningful extent in my life. Nor do I think even the doyen has done so since that meeting. But having understood how difficult deferring gratification could be, I appreciate how important it is for long-term success in any field of human endeavour. And, of course, that includes public policy in case you are wondering why am I channelling my inner Deepak Chopra and inflicting random truisms on you. 

OPS versus NPS

This problem of grasping short-term gains while jeopardising the long-term has been running on my mind for the past few months as I see the spectre of the Old Pension Scheme (OPS) returning as a key election promise in the manifestos of Congress and AAP in state elections. There are two issues that I have been thinking about. First, what drives a political party to make a bonfire of the future for a questionable short-term electoral gain? And I’m picking on the OPS issue and these two parties only to illustrate this point. Every party in India has done this in the past. The abandoning of the farm laws was an instance of this. So, the question is what prompts a political party to do this and, importantly, why does the average voter get seduced by this? The other question is what can be done to change the incentives of the parties to do this? In other words, how can we make sure political parties learn to defer gratification? 

But before I get into them, let me give you a short overview of what’s happening with the demand for OPS and the problem with states returning to it while abandoning the New pension Scheme (NPS). The Congress governments in Rajasthan and Chhattisgarh have already gone back to OPS and it has promised the same in its manifesto in Himachal and Gujarat. Not to be outdone, AAP plans to return to OPS in Punjab and might make it a plank in Gujarat. Nothing catches the imagination of our politicians like a bad economic idea, so we now have the Bharatiya Mazdoor Sangh, the RSS-affiliated trade union wing of the ruling BJP, demanding the same from the FM. As Business Standard reports:

“National General Secretary of BMS, Ravindra Himte told IANS that during the meeting with Sitharaman, the organisation has urged the Finance Minister to restore the old pension system, increase the amount of minimum pension from Rs 1,000 to Rs 5,000 and to provide better health facilities to retired people under the Ayushman Bharat scheme.

The BMS has also urged the Finance Minister to strengthen the social security scheme for workers and to take various other steps to protect the interests of the weaker section of the society.”

For context, there are nine state elections scheduled for 2023. Pension of state government workers is a state subject. They can claim they have the mandate of the people to change this if they win using this as one of their key poll planks. 

Pension is a way to provide social security to workers following their retirement. A simple way to design a pension scheme is for an organisation to promise workers: upon retirement, we will continue paying, say 50 per cent, of your last drawn salary till you die.

This is simple and intuitive. The worker has served the organisation for long and you reciprocate that loyalty by taking care of them after retirement. A few years of this scheme and you will soon have a reasonable request from the retired workers. The pension provided isn’t keeping up with the inflation. The last drawn wage about a decade back is hardly worth anything now and a pension indexed to that is unfair to the worker. What do you do as a welfare-minded employer? You offer to index the wage to the revised pay scale that’s prevalent now. So, the pension drawn by a worker is no longer 50 per cent of their wage when they were last working in the organisation. It is now 50 per cent of the wage of anyone doing the same job now to keep up with inflation. 

This is all good though a bit onerous. However, if you fast-forward this by a couple of decades, you will reach an uncomfortable scenario. The number of people who have retired from the organisation is now, say, equal to the number of people who are currently working. Those who have retired are drawing a pension that’s 50 per cent of the existing pay scale. Simply put, if the total wages paid to working employees is Rs. 100, the pension paid to retired employees is Rs. 50. A third of the total wage bill is allocated to pension. Another decade and you might have two-thirds of the wage bill being taken up by pension. This is a problem in many ways.

First, the working employee is continuing to take additional burden to pay for the ever-increasing number of retired employees. The incentive to be productive for the current employee keeps going down when they know the lion’s share of any productivity gain will go to the retired pool. The organization continues to be weighed down by the pension bill. It finds it difficult to attract new talent because it cannot match market wage rates offered by newer companies that don’t have such a pension bill. It also cannot invest in new products and innovations because the pension bill keeps rising. Unless the employer is the State, in which case, it can print money, increase its debt and keep paying for pension, there’s really only one end state to this. The organization will go bankrupt because of its pension burden. This is not a hypothetical scenario. A whole generation of great American companies went down this path including the giant automakers of Detroit. The OPS that is being revived in many states in India is exactly this scheme. 

In 2004, the Union government introduced a New Pension Scheme (NPS) to avoid exactly this fate. The NPS model is quite simple. It is what is called a defined contribution model. The worker sets aside a small percentage of their salary every year towards a pension fund. The government matches that amount by making its own contribution from its coffers. This means there’s an additional wage burden for the government during that year. This amount goes into a pension fund which is managed by professional fund houses regulated by the PFRDA. The fund houses have fairly rigid investment rules that prohibit them from investing in speculative assets. This ‘accumulation phase’ continues till the employee retires. At the time of retirement, there’s a nice little corpus that’s built up. The employee can then take out, say 40 per cent of the corpus for their immediate need, the remaining amount moves into an annuity product where a fixed amount is paid out every year like a salary.

Over the years the NPS scheme has been taken up by all Union government employees and gradually all state governments adopted it too. The professional fund houses that manage the NPS funds report annualised returns that have always been better than the Provident Fund (managed by the government) returns or even the best of mutual fund managers. And the first generation of retirees who use the NPS can vouch that the annuity they get has kept pace with inflation without having to wage-index their pension to the revised pay scale. This a beautiful solution that frees up the government from having a pension burden on its balance sheet after the retirement of the worker. No longer are current employees paying for the pension of the previous generation. In fact, we have often quoted the transition to NPS as one of the more successful public policy examples in India.

Now, we want to undo it. There’s really never been a clamour for OPS. But if you go around telling retired or near-to-retirement employees that we will give you a higher-paying pension scheme by taking you back to OPS, you might find some traction. Even if the numbers don’t bear you out. Few voters will ask you how will you foot the bill. If the current and future employees don’t see that eventually, they will be paying for this largesse, you might be able to convince every working employee that this will work better for them. I don’t think we are there yet but I never bet against the popularity of a bad economic policy. They have tremendous seductive appeal. 

The Difficulty In Choosing Deferred Gratification

This is just another example where there are short-term pains in implementing a policy that will yield outsized long-term benefits. We could do that by implementing the NPS in 2004. Now, we are on the reverse. We want to implement a policy that might have short-term gains for a few but huge long-term costs for everyone. There are other similar policy questions in a democracy. How should we think about climate change? Should we take costly actions now by punishing polluting industries and impacting job creation while waiting for the benefits of these actions to pan out over decades? Or, how about increasing taxes today to rebuild roads and public infrastructure that will benefit society thirty years later? How should a political party think about these issues when their incentive is to win elections that happen every four or five years? Are democracies doomed to pick policies that are good in the short run but damaging in the long term because of this flaw?

This intertemporal trade-off between maximizing societal welfare now and investing for the future is a vexing issue for political parties in a democracy. What I want to do is to understand the reasons for this trade-off being skewed in favour of short-term value maximisation and see if there’s a way to engineer a choice architecture for the public that redresses it. I can think of four reasons why the skew exists.

Firstly, there’s the commitment problem among political parties. People are never convinced that a political party will stay the course on a particular policy. This is borne out of experience. Parties are less guided by economic ideology these days. The same set of politicians who might advocate a higher tax today and ask you to tighten your belts may change their tune tomorrow when they sense a change in the air. Also, politicians aren’t permanent. There is turnover among them within a party itself. And the newer set might renege on previous commitments. So, for the citizens, paying short-term costs because you believe in the political commitment of a party now is fraught with risks.

Secondly, forecasting is difficult. There’s the fog of uncertainty and lack of adequate information to accurately predict these benefits. It is easier for a voter to use past performance as a guide to the future than predict it based on the impact of a new policy. The average voter anyway has only limited cognitive mind space for public policy. They might be able to think only about present outcomes with some clarity. This encourages politicians to think of policies that are typically myopic. Further, this information challenge means even if voters and the government say they care about the future, their actions will continue to be shortsighted. Separately, even those who are trained in public policy to think about the intertemporal trade-off can struggle to make accurate assumptions about the future. We live in a world that’s more volatile and ambiguous than before. To predict the future and the societal context that will emerge then is a risky proposition. For the policymaker, it is optimal to maximise a more certain near-term than go out on a limb for the distant future. 

Thirdly, we have the old problem of concentrated benefits and diffused costs. It is natural for a smaller group for whom the benefits of a policy are concentrated to organise themselves and demand its implementation. The converse of this is also true. Any policy action where the short-term costs are to be borne by a small but organised group while the benefits will emerge over time for the wider society will get scuttled by this group. The repeal of the farm laws was an example of this. Even if the short-term pain and the long-term gains both accrue to this small group, they will oppose it. Because a better alternative for them is to redistribute the short-term pain to everyone while securing the long-term benefits for themselves. Or, to continue with the status quo.

Finally, we have the problem of political parties that have either run out of ideas or who want to make a dent in new electoral terrain. To them getting a foothold through the aid of a myopic policy is worth the price. After all, they have many other policies that are better for society, which they might rationalise. Or, it is a question of survival and how does long-term matter if you will cease to exist then. This is what explains the actions of AAP and Congress on OPS. 

Is There A Way Out?

So how does a policymaker counter these? I have a few suggestions, some of which might seem Machiavellian.

First, there are ways to take the sting out of short-term costs. A deft policymaker can obfuscate some of the costs by making their calculations more complex (say, in the design of an auction or a tax) that is difficult for the voter to understand. The idea is to reduce the overt display of the cost to be paid in the short-term. The other option is to impose the short-term costs in a phased manner or in specific cohorts (‘grandfathering’ certain beneficiaries for some time). There is a whole field of behavioural economics that can be used to nudge the voter towards a certain action like loss avoidance. The other way to do this is to diffuse the responsibility of who is imposing the short-term costs among many agents of the state including the government, independent regulators, corporates, local bodies or international treaties. This fragmentation of power and diffusion of the blame can make it easier to take difficult calls. They can take the sting out of the costs to be paid for future benefits. 

Second, there are ways in which the long-term gains can be crystallised into something more tangible in the present. There are ways in which some of the future payoffs can be advanced through well-choreographed pilots. This is particularly true for infrastructure investments where the example of a few recent successes can be talked up and few well-timed benefits early on in the investment process can convince the citizens of the long-term benefits. The other way to think about it is to play up the huge long-term consequences of not acting now with any small evidence in the present being used to project a terrible future. This is how climate change activists are playing the game today where any minor aberration in weather patterns anywhere in the world is used to proclaim ‘climate change is real’. You might disagree with them on principle but their approach to building public support is right. 

Third, we come to making political commitments sticky for the future so that voters are more willing to support taking short-term pain. The way to go about is to make any reversal of course difficult by making a policy difficult to dismantle. This can be achieved by placing exit barriers while implementing a policy that could include multiple players and steps whose consent would be needed to roll back a policy. They could have veto powers to stop such rollbacks. The more the institutional fragmentation, the higher the barrier to exit. Other means could be adopted too like making an amendment to the law or constitution or setting up a new independent authority to institutionalise a policy. By having such players whose incentives are aligned with long-term benefits promised in the policy, one can create a significant hurdle. The costs of reneging on a commitment go up significantly. 

Lastly, how do we counter the small but organised interests that might scuttle a policy because they don’t want to take the short-term pain? In most cases, the problem here is how do we mobilise the larger group for whom the benefits are diffused and in the long-term to counter the smaller but highly motivated group? One of the ways to think about this is to choose a smaller subset from the larger group whose benefits (or costs in case the policy isn’t chosen) might have greater salience for the group. For instance, talking about children and the future of our planet makes it easier to focus on the costs of not making climate change investments today. The ability to show with clarity that the redistribution of benefits of a policy that imposes costs on current beneficiaries and favours a future group is crucial in winning the battle of minds. The benefits are often spoken in abstract terms over a larger group than making it very specific for a focused smaller group. If that’s done well, you get a countervailing force against the small, organised group that wants to retain the status quo.

The intertemporal policy choice is crucial to ensure democracies don’t lapse into the most shortsighted policy recommendations because that’s what gets instant mass approval. The wise man who told me to ‘always defer gratification’ gave me the best career advice. Unfortunately, he didn’t tell me how to do it. I suspect he didn’t know it too.

Because it is tough.   

For more on the Pension issue, check these editions:

* Pension Tension in edition #174

* Pension Troubles are Back in edition#162

* A Framework a Week: Understanding Cognitive Maps in edition #62

Thanks for reading Anticipating the Unintended! Subscribe for free to receive new posts and support our work.

India Policy Watch #2: The Cats See Through the Monkey’s Trick

Insights on domestic policy issues

— Pranay Kotasthane

In edition #131, I wrote that India’s fiscal federalism resembles the monkey and the two cats fable. While states fight amongst each other to corner a higher share of the total money devolved to them, the Union government can go scot-free even as it appropriates nearly 60 per cent of the divisible pool resources, raises new cesses, and uses a part of these funds to run its own centrally sponsored schemes. This focus on horizontal devolution (the formula used for sharing resources between states) masks the far more serious problems of vertical devolution (how money is split between the Union government and all states as a whole).

Given this starting point, one news item from the past week caught my attention. State Finance Ministers (FMs) in the pre-budget consultation meeting with the Union FM highlighted the problems with the vertical devolution regime. Their criticisms and suggestions can be summarised as follows:

* Increase states’ share in goods and services tax (GST) to 60 per cent from 50 per cent at present.

* Merge cesses and surcharges with the existing taxes so that states are not deprived of their share, and

* Rationalise the expenditure under centrally sponsored schemes. The Tamil Nadu FM said that "All states, irrespective of political parties, expressed a common theme -- states' fiscal autonomy is greatly constrained by the extent of centrally sponsored schemes, by the extent of changing ratios of funding of such schemes”.

Let’s focus on the first suggestion, which seems to be a reform pathway for India’s fiscal federalism. What should we make of it?

First up, a clarification. The 50 per cent share that the state FMs highlighted refers to the rate of taxation and not the share of total GST collections. If you check any bill, the GST is split equally into two halves — SGST (which remains with the states) and IGST (which goes into the total divisible pool to be split between Union and state governments). Since 42 per cent of IGST is again devolved to states using the Finance Commission formula for vertical devolution, states already get about 70 per cent of the total GST collections. If the proposed change were to be made, the states’ share in GST will further rise to 76.8 per cent, according to former J&K Finance Minister Haseeb Drabu.

Keeping this important clarification aside, the suggestion to increase the share of SGST by 10 per cent is excellent. As I have argued earlier, any fiscal reform that increases general purpose transfers to states increases their autonomy and allows them to decide their own priorities. In a country where the GSDP per capita of the richest state (Goa) is nearly ten times that of the poorest (Bihar), one-size-fits-all schemes run from Delhi can hardly be expected to be effective.

However, the proposed reform in its current form will be dead on arrival. There’s nothing in it that would motivate the Union government to change its stance, and nor are states promising anything at their end in return. With some conditionalities, this reform can be made to work in the overall interest of citizens.

One, states should commit to sharing a fixed percentage of their increased SGST share with local governments. State governments cannot always play victims. They are simultaneously culpable in strangling the finances of local governments. An increase in the SGST share can act as a useful incentive mechanism to fix this crucial flaw in our fiscal federalism.

Two, states should commit to a fixed increase in capital expenditure. The increased fiscal space can easily be frittered away by states. Three states switching back to the costly Old Pension System that burdens future generations is a case in point. Hence, an increase in the states’ GST share should be made conditional on improving the quality of expenditure.

Three, the increased SGST share should be accompanied by a sunsetting of centrally sponsored schemes. This will create fiscal space for the Union government to focus on higher-level functions: defence, trade, manufacturing competitiveness, higher education, and R&D. Admittedly, this change would be the toughest part of the bargain. The Union government runs so many centrally sponsored schemes precisely because it is politically beneficial for parties to portray that our day-to-day requirements are solved directly only by the largesse of the occupant of the 7, Lok Kalyan Marg. A move away from this low-level equilibrium would need immense political capital.

To make this idea palatable, a move to the 60:40 sharing can be made optional. Only states that agree to the above three conditions can transition to the new regime. The rest can continue to be stuck with the older compromise. In sum, the proposed reform merits serious discussion.

Advertisement: Here’s an awesome opportunity for mid-career professionals who missed out on learning the liberal arts.

Global Policy Watch: Myth-busting Reservations About Global Supply Chains

Insights on global issues relevant to India

— Pranay Kotasthane

Geopolitics is trumping geoeconomics the world over. The good old days when international trade was unapologetically perceived as a positive-sum game are past us. Countries are pursuing expensive industrial policies across sectors, by labelling everything from the display screen of your phone to the apps on it as “strategic”. In this worldview, one constant villain is Global Supply Chains (GSCs). The dominant narrative seems to be that shorter and more domestic GSCs are more reliable, and hence government intervention to snip these GSCs is desirable.

But what does the evidence suggest? A few recent papers inject some sense into the ongoing debate. In this section, I will summarise key insights from them, and link out to more readings on GSCs.

The one economist to read on GSCs is Richard Baldwin. His 2012 paper Global supply chains: why they emerged, why they matter, and where they are going covers the foundational concepts lucidly. It delivers one insight after another, busting many myths in the process. Sample this:

“Globalisation is often viewed as driven by the gradual lowering of natural and man-made trade costs. This is a serious misunderstanding.

Globalisation has been driven by advances in two very different types of ‘connective’ technologies: transportation and transmission.” …

In Baldwin’s view, the first unbundling of globalisation was made possible by steam and made profitable by scale economies and comparative-advantage-led separation. The second unbundling was made possible by information communication technologies and made profitable by wage differences.

There’s a lot more in the paper that I’m still processing. Do give it a read.

Meanwhile, his latest paper with Rebecca Freeman investigates if the current structure of GSCs is too “risky”. They acknowledge that the recent challenges—COVID-19, climate change and geopolitical tussles—are of a global scale and will likely reshape GSCs.

They add that all firms make a risk-reward trade-off. Recent events have already driven firms to invest more in building resilience. Thus, there are just two cases where a government intervention makes sense. First, when the social evaluation of this trade-off puts greater stress on the “risk” compared to the firm’s evaluation of this trade-off, there’s a case for market failure. The higher the gap between these two perceptions, the higher the likelihood of government intervention. From an Indian perspective, China’s recent actions have widened this gap.

Second, the complexity of GSCs might make firms (especially the smaller ones) underestimate the true risks involved. This lack of information can be another justification for government action in the form of mapping and making this information public.

On the issue of which interventions might actually reshape GSCs, they suggest:

Locational equilibriums are unlikely to shift unless firms perceive a permanent shock and governments commit to substantial, long-term production subsidies (as with agriculture), massive regulation (as in banking), or massive state-lead interventions (as in defense).

Policies on essential medical supplies and semiconductors may well prove to be more durable and effective given their critical nature. Arguments that these sectors are part of today’s national defense, broadly defined, are more credible, and thus more likely to endure long enough to reshape production structures.

Going beyond government interventions, they identify a trend that’s of importance to us in India. Given the improvements in industrial automation and AI, future manufacturing GVCs might become shorter. At the same time, future services GVCs might become longer and more widespread, given the multilateral agreements on services trade, which are far less protectionist than those in manufacturing trade.

From an Indian perspective, these propositions mean that India (or any other country) is not likely to displace China in the manufacturing of goods which are not considered “strategic”. Instead, it is automation that’s more likely to reduce other countries’ dependence on China. On the other hand, India’s opportunity lies in the services trade. Policies such as data localisation or restrictions on human capital movements will only dampen India’s chances.

Perhaps, the far more important lesson from the US export controls on China is not that the US might do something similar to India, but how difficult it is to displace a country of China’s size once it’s embedded itself in GVCs. India’s strategy should therefore be to embed itself in services GVCs.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] DO NOT MISS this Puliyabaazi with Ajay Shah in Hindi/English on state capacity and public policy. While you are there, subscribe to our channel :).

* [Report] The State of State Finances report by Saket Surya and Tushar Chakrabarty of PRS is useful reference material for anyone interested in contemporary Indian public policy.

* [Twitter Thread] For a simple explanation of the central issue in India’s fiscal federalism, read Pranay’s thread.

* [Explainer] This Trade Deficit-101 is worth your time. It asks: What is a trade deficit and how does it affect the economy?

Insights on domestic policy issues

— Pranay Kotasthane

Public policy is all around us; observing the same public space over time can reveal much about public policy, implementation, and state capacity. So, I’ll try something different today. I will narrate the story of a parking policy reform, which I’ve observed closely over the last couple of years. In it are lessons for government contracting, deployment of technology, and public choice. Drop a reply if this story resonates with you or if you have other such anecdata in mind.

The Pre-reform Situation

MG Road is a busy thoroughfare in Bengaluru’s Central Business District. Well-known shops, pubs, restaurants, and offices line the road. As you can imagine, many office-goers and business owners commute to MG Road and park their vehicles next to the curb. On weekdays, finding a vacant parking space after 9 am is a sure-shot sign of divine intervention.

Even though curbside parking is not chargeable nominally, scarcity causes Coasian transfers to originate. An informal cohort of unauthorised Parking Marshalls emerges. These marshalls help vehicle users negotiate parking in return for a fee. After multiple complaints about this “rent-seeking”, the city government puts up free parking boards and demarcates parking bays for two-wheelers and four-wheelers.

A reduction in the real price of parking leads to increased demand. Office-goers rush towards the city centre earlier than usual. The threshold beyond which parking became an ordeal moves up to 8.30 am, after which people have to park about half a kilometre away in a designated paid parking. And since the Traffic Police have no capacity to enforce parking rules except once in a moon, you would usually encounter double-parked vehicles on MG Road, usually cabs. Some shops even employ valets to double-park customers’ cars, which are slid into vacant parking slots as soon as they become available. The motorable road width decreases because of these double-parked vehicles. It is quite a chaos.

The Smart Parking Reform

The paid parking reform had been mooted on several occasions but wasn’t politically palatable. Finally, the city government bit the bullet after the first COVID-19 wave. BBMP —the city municipal corporation—realised that its tax revenue sources had thinned. And with an ongoing hoarding ban and a newly launched GST, revenue generation options had narrowed further. That’s when the Overton Window for paid parking opened up.

Given the lack of state capacity, BBMP doesn’t usually do parking enforcement itself. So it enters into a public-private partnership in which one company Central Parking Services (CPS), is granted a contract for parking on ten major roads in the city’s Central Business District for ten years. Reports suggest that BBMP expected Rs 31.56 crore annually through this arrangement.

To prevent corruption, BBMP employs technology. Curbside parking spots are clearly marked and numbered. Sensors are installed on each slot to identify the presence or absence of a vehicle. Customers can book a parking slot on arrival via an app and pay seamlessly through UPI/card/or wallet. Parking kiosks are also installed on footpaths for people who don’t have the phone app. To encourage digital payments, cash payments are made costlier by 16.6%, i.e., Rs 30 in cash grants parking permission for 50 minutes, while the same amount paid digitally allows you to book a parking slot for 60 minutes. For a detailed account, see this Deccan Herald report.

To help people transition, parking charges are waived for the first week of operations. Thereafter, cars have to pay Rs 30 per hour.

Now, guess what would have happened? Can you anticipate the unintended consequences?

Post-reform observations

Pricing a resource according to its scarcity leads to a more efficient resource allocation. We saw that scarcity principle play out here. Soon enough, you could find a parking slot at any time of the day. The contractor employed several uniformed parking marshalls to prevent double-parking and unauthorised use. The same road you saw above now started looking as below:

The story doesn’t end here, though. It’s not as if parking requirements are this elastic in the central business district, and it’s not as if the city has reliable public transport options.

What really happened was the displacement of parked vehicles from MG Road to a nearby residential road and a parallel thoroughfare. To avoid paying the parking fee, people started parking vehicles on other roads, sometimes right under “No Parking” signs. These infractions were uncommon earlier as these roads were patrolled by traffic police vehicles. But with the enforcement contracted out to a company in the surrounding area, perhaps the incentive for the Traffic Police to patrol the area decreased, as public choice theory would predict. And so, while the parking situation on MG Road improved, other neighbouring roads became free parking lots, causing congestion and unchecked traffic rule violations.

As for MG Road, the “smart” parking didn’t remain smart for long. The sensors for most parking slots stopped working soon. The app and the kiosks showed a parking slot as" “empty” if you parked a vehicle there. At other times, it showed unpaid bills of previous customers. On one occasion, the app asked me to pay a parking fee of Rs 18,290!

Despite repeated calls to the grievance contact number, the contractor didn’t seem to be interested in getting these fixed. The profit motive would have suggested that the company would aggressively keep all sensors active, but that’s not how it played out.

As public choice theory would predict, corruption didn’t go away. The situation was much better than in the past. Nevertheless, since the sensors weren’t working, the Parking Marshalls sensed an opportunity. The system allowed them to reset or extend the parking time limits at the kiosks. Some of them started striking side deals with regular commuters. The parking marshalls also enjoyed discretion in enforcing steep fines for overparking. Since there was no robust check to track fines, they could strike a deal with the customer instead of registering an official fine.

Zooming Out

The marginal benefits of the parking policy reform are greater than the marginal costs; hence, it should continue. But it is still a work in progress. Contracting out doesn’t obviate the need for enforcement entirely. My anecdata reiterates one important lesson in public policy: better contracting or procurement also requires state capacity. Without having built that muscle, contractors can easily take governments for a ride. As Chitgupi, Gorsi, and Thomas write in their LeapJournal article titled Learning by doing and public procurement in India:

Procurement is an expertise. No government organisation can sporadically do this well. It is an expertise which can be built, albeit over many years. In any government organisation, people and processes can be organised to focus on this expertise, and to devote time and effort on the entire pipeline of government contracting. The process of developing this capability can be accelerated by bringing in people with this specialised expertise. Strengthening the entire life cycle is required to successfully spend budget amounts. But this is only the beginning of success in procurement where government can contract to deliver quality projects efficiently, on time and at low cost.

Applications for the re-awesomed Post-Graduate Programme in Public Policy are now open. Check details here.

Global Policy Watch: End Game

Insights on global policy issues

— RSJ

Some recent inflation prints from the US and other developed markets suggest the central banks are winning the fight. In India, too, the inflation expectations are getting less hawkish. Is this true, or is there more to this? 

A bit of a diversion here. A few editions ago, I pointed out how the ECLGS scheme launched during the pandemic to support the MSME sector had worked out well in India. The sovereign promised the banks they would guarantee the loans they disburse as part of this scheme. The banks could continue to use their underwriting norms without making them too stringent because of overthinking the negative impact of the pandemic on these businesses. The bank could, therefore, support these businesses, and as it has turned out, that’s all that was needed to keep this sector above water. The government didn’t have to dole out loans themselves, and the banks did what they do well, namely, underwrite, disburse and collect. Net result: the system NPAs for this scheme will end up in the 3-4 per cent range in line with this kind of portfolio in normal times.

I bring this up because while writing about this last month, I thought it would be useful to check if other governments went down this path during COVID-19. It turns out yes, they did. Most of western Europe did the same. Over 60 per cent of new loans in France were guaranteed by the sovereign. In Germany, it was over 40 per cent, and now they have come up with a fresh scheme to stave off the energy crisis emerging from the Ukraine conflict. In Italy, not only were fresh loans state-backed, but they also rolled over older credit to these new schemes. This seems to be becoming a thing.

Governments seem to have hit upon this nice little trick where they don’t have to raise debt or taxes to manage a crisis. They simply need to offer credit guarantee through banks. It will sit on their books as a contingent liability and won’t show up in debt ratios. Nobody gets hurt. Neat.

So, why did I bring this up while talking about inflation? Since the global financial crisis (GFC) of 2009, the debt-to-GDP ratios in the developed economies have only moved one way. Up. Then we had the pandemic in 2020. Governments threw more money at the problem. The result is we have debt-to-GDP ratios upwards of 250 per cent in most OECD countries now. Two problems have arisen because of this.

One, this indiscriminate money supply plus some supply chain constraints have meant inflation has hit multi-decade highs. Notwithstanding all modern monetary theory hypotheses that were in vogue a couple of years back, it turns out that more M4 money in the system will lead to higher inflation. And inflation hurts the poor most. Second, the system is vulnerable to collapsing at such debt-to-GDP ratios with the smallest of shocks going forward. I mean, how long can you keep kicking the can down the road?

So, the inevitable has happened over the past six months. Central banks have raised interest rates in a dramatic manner to tame inflation. This seems to be working, as the slowing of headline inflation number suggests. But I am not sure about it. Most of the recent reduction comes from the fall in prices of the more volatile commodities. In fact, the ‘sticky’ part of the consumption basket seems to be still in inflationary mode. Also, the rising rates have killed growth in most developed economies. They are in a recession. And while the employment data suggests that jobs are being added, if you look closely, the worm is beginning to turn. The slowdown across sectors will mean layoffs, consolidation and a reduction in capital expenditure. The employment rate will soon start falling. 

With that backdrop, what are the choices available to a government? I see a likely scenario that brings these various tugs and pulls together for a short-term fix that might appeal to them. I will elaborate below.

Now that inflation has touched multi-decade highs, and we are at that point in the rate hike cycle where we have pretty much killed growth in the short term, there isn’t more elbow room to increase rates. Inflation may subside a bit as supply constraints reduce, and maybe the war in Ukraine ends. But this is an opportune time for governments to reset inflation expectations upwards among its people.

If you were running an inflation targeting model with a two per cent threshold (like in the US), it is somewhat easier now to raise it to 4-6 per cent without much furore. If you were running it at a 4-6 per cent range (like in India), you could reset it to 6-8 per cent. The Overton window is available for this. I think the governments will willingly take it. A slightly higher inflation expectation, without it becoming runaway, will allow central banks to pause raising the rate. It will also increase nominal GDP. This is important because a two per cent upward reset of the inflation target will lead to a corresponding increase in the nominal GDP. And increasing nominal GDP through higher inflation is the easiest way to reduce debt to GDP in the system for a government. Cutting costs and tightening the belt are all difficult ways of balancing the budget. Nobody wants to do that. In the past, letting inflation run high was unacceptable to any incumbent government. But the way the cards have fallen in the last six months, the governments can get away by citing forces beyond their control. I think no government will look this gift horse in the mouth. They will reset inflation targets. Now doing this means what’s called financial repression. That is, the savers will lose because their savings will be undercut by inflation in future. So, this will have to be done gradually. But I see this level of financial repression as inevitable. 

The success of credit guarantee schemes opens another front for governments. As I mentioned, the governments will do more of this because why not? So, in some sense, you will see a capture of private credit by government-directed guarantee schemes. It won’t be as much in India, but I see it quite likely in the developed economies. So, it is likely that while the economy will head to a recession, private banks will continue to supply credit because of these sovereign guarantees. There’s a likelihood that bond traders will take a dim view of this and push up yields significantly. But there are multiple tools with the government to force pension and insurance companies to buy government bonds. This will rise. Yield curve management isn’t a big deal anyway if central banks decide to do it. So, no fear on that front too. This will mean we could have continued credit expansion backed by the government in the near future without the fear of a rating downgrade. If you combine that with the developed economies bringing manufacturing back from China into their own countries, we could have a capex-led boom beginning soon after we have brought inflation into the new target limit. 

Of course, I’m not saying I support this kind of state intervention that pushes credit in the areas it wants to focus on instead of the market allocating capital in the most efficient way. In the long run, the state will make the wrong choices driven by its political objectives. But we will have to wait for the cycle of boom to first play out before that kind of bust unfolds. This might take a decade or maybe more. I am, therefore, sceptical of those who suggest a deep recession or stagflation is around the corner for the global economy. There will be a short recession, but other options are available for the state to manage this and push a real reckoning into the future.

Stagflation might be the end game, but that end is not nigh.   

HomeWork

* [Paper] Internal Drivers of China’s External Behaviour by Amb Shivshankar Menon is really helpful in understanding China’s recent actions. This line in the paper struck me (There’s a useful 2x2 matrix in it):

“Today, China faces an unprecedented situation at home and abroad and is therefore reacting in new ways. China is more powerful than ever before but is also more dependent on the world. This is an unprecedented combination, not known in Chinese history—not in the Han when she had to ‘buy’ off the Xiongnu by marrying Han princesses off to steppe leaders; nor in the Song when she was one and sometimes the weakest power in a world of equals; nor in the high Qing when she was powerful but independent of the external world, as the Qian Long emperor reminded George III in writing.”

* [Book] The High Costs of Free Parking by Donald Shoup is essential reading on parking policy.

* [Paper] Which social welfare policies should the Indian government prioritise? This paper does a cost-benefit analysis to answer this important question.

Insights on global policy issues

— RSJ

One of the great problems of policy, or even philosophy, is who should own things that are or that behave like public utilities. For instance, who should own news broadcasting services? Suppose you prepare a case study explaining what’s news broadcasting, the perils that someone abuses such a service to spread fake news and propaganda, and the damage they do to society. Now hand over this case to a bunch of well-meaning people and ask them: how would they frame a policy on ownership of such a service? What do you think the answer will be?

I don’t have any empirical evidence to back this, but I think in most scenarios, you will find a group of well-meaning people supporting some kind of ownership by the state or a distributed set of individuals. They might suggest a set of tightly regulated norms on what should be broadcast, and they could also throw in a stringent penalty regime for violations. It is unlikely that any group will come up with the answer that it should be owned by a megalomaniac rich man who believes in free speech, flips the bird to regulators on most occasions and has a penchant for poop emojis. A public utility cannot be left to such unstable people regardless of their genius, is what most would say. 

Twitter is the equivalent of a global public square where news stories are broken, and opinions and trends are generated. Should it be owned widely by the public with a governing board that regulates the platform, its content and its algorithm? Or should it be owned by the state, which can run it like a public utility without a profit motive? Or should Elon Musk own it? 

What do you think?

Twitter Is Different

Before I venture to write about the options, it will be useful to lay out the unique character of Twitter as a platform. During the week, I reached out to Amit Varma (doesn’t need an introduction to readers here), who always has a clear-eyed view of things, to understand what he makes of the happenings at Twitter. His views helped me articulate my thoughts better. Read his insightful piece on Twitter here.

First, unlike broadcasting services of the past, Twitter is exceptionally quick because it is a hyperconnected network of people. Events unfold in real-time on it, and trends catch on fast. Mobilisation on Twitter is faster than the speed of response of any state. It plays an outsized role in shaping the discourse because speed is a feature in today’s age.

Two, the incentive architecture of Twitter is designed to reward extreme positions. The ‘retweet’ or ‘quote’ button, the notion of having ‘followers’ and the constraint of the 280 characters all mean there’s more purchase for broad generalisations, provocative positions and performative behaviour to pander to your own tribe.

Three, Twitter is a monopoly in a very unique sense. Granted, there are other platforms that take a share of our attention, but there’s only one platform that richly rewards us for our attention with the dopamine hit in the manner Twitter does. Social media platforms tend to be ‘winner takes all’ plays because, as a user, once you build a certain kind of network and reach that’s unique to that platform, there’s little incentive to start building it all over again for the same benefits in another. The switching costs are just too high. 

#OwningTwitter

Think of these features of a broadcasting service together - hyperconnected and quick, rewarding fringe behaviour and a natural monopoly. How should we think about its ownership? Now look at the three options of its ownership - a) the state (or a group of states), b) a widely-held listed public company or c) a Musk-like figure. One way to think through this is to understand the natural incentives of these respective owners, how they will use the platform to achieve those and what will be the net societal outcomes of those actions. 

Take the state first. All good intentions aside, as we have demonstrated over and over again on these pages, the primary incentive of the state is to perpetuate itself. Or, the party that runs the state to continue being in power forever. While to many in India who are brought up to think of the state as the mai-baap, it seems like a fair arbiter of how a public utility should be managed, the evidence all around us should go against that intuition. A public utility like Twitter controlled by a state that’s benign and fair can be a tremendous aid for the welfare of the community. But in public policy, you must consider the ‘corner cases’. You must ask, what if a utility like Twitter is in the hands of the politician you dislike the most? Will they be fair and benign? And then think about ownership and governance of such a utility and its consequences. So, the argument that a global public square like Twitter should be owned by a state or a group of states and managed like a global public good appears pious and workable on paper but is fraught with the risk of a bad faith actor with sovereign power taking it over. That will mean only one kind of fringe taking over. Bad things will follow.  

Next, let’s consider the ownership by a publicly held company which is how Twitter used to be till Musk bought it out. The management of such a company is the shareholders' agent, and its incentives are aligned with what’s best for the shareholders. The management, therefore, works to maximise shareholder returns which get tracked every quarter based on the company's performance. Regardless of how visionary the management team is, they are toast if they do not deliver every quarter. There’s no avoiding short-termism here. What’s the incentive for any manager to fundamentally retool this company, take short-term hits for many quarters and live in the hope that the strategy will pay off in the long term? Nada. Shunya. Nobody has seen the long-term, and the shareholders have other places to invest than to wait for so long.

Twitter has dug itself into a hole where outrage and fringe positions bring in engagement, and that engagement is monetised for advertisers. Even if you had an enlightened management team that knew the damage this ad-dependent business model was doing to society, it would find it impossible to junk the model and change the engines mid-air, so to speak. Because any change in course will need to be dramatic, meaning significant short-term pain. That would understandably test the time and patience of the shareholders. You would need a Steve Jobs-like reality-distortion capability to convince them otherwise. There aren’t many Steve Jobs around to run a public company as professional CEOs. The best that Twitter, in its public company avatar, could do is to be managed efficiently. That’s it. That efficiency on its current model however would mean it would only get better in coarsening our discourse and widening cultural chasms. I think this is what is called irony.

Lastly, let’s consider the option of a Musk-like figure buying out Twitter and doing what he pleases with it. What happens here? While it was somewhat easier to appreciate the incentives that drive the state or the shareholders of a public company, we can only speculate on Musk’s incentives. There’s no academic research done (yet) on Musk’s behaviour and actions. So, we can only think in terms of scenarios here. 

Scenario 1 is what I call the ‘Matt Levine view of Musk’. Levine is a modern-day Plato. The most lucid interpreter of capital and economy in the world today. His newsletter is quite simply the best chronicle of our times. And it’s free. What a legend! He has built a theory of Musk’s purchase of Twitter in many delightful editions. In this theory, to Musk, Twitter is a video game he loves. Ordinary people, like you and me, play a game, get addicted to it and then, over a period of time, get bored with it. We start hating a feature, or a new upgrade isn’t to our liking, or we see too many people playing it. Whatever. We move on.

But Musk is not any of us. He’s the world’s richest man. He is also the world’s most addicted user of Twitter. He loves to troll people there, responds with poop emojis to the tweets of others and originates many meme cycles. He’s the shahenshah of all Twitter super users. So he buys up the video game company. Now he can play around with features as he fancies so that he can continue to enjoy the game. He placed a bid for it that was high. Then as the tech stocks and the markets crashed, that bid looked worse. Like any rational actor, he tried to get a better deal by threatening to pull out of the deal. Eventually, he bought it because a) he always wanted to buy it or b) maybe, because legally, he couldn’t opt out of it. Whatever. It is his now. 

Is there a reason to believe this theory of Levine? The answer is yes. Musk is rich enough to throw $44 billion for his favourite toy. In any case, he’s not paying everything from his own pocket. Maybe about half of the $44 billion. Nothing in how Musk has used Twitter so far suggests he has any great vision for the platform. In fact, he enjoys and leverages all the toxic features of the platform. Musk will play with this for some more time, and during that time, he will keep it running with some mix of charisma and his unique gift to meme-ify things. He will then hand it over to a sucker and walk out with a tidy profit. Twitter will then collapse in a heap. Or maybe it will collapse under his watch itself. An expensive way to amuse himself? Sure. But does he care? Either way, he’d have had his fun. That was his only incentive. 

Scenario 2 is the alternative that I want you to consider. I don’t necessarily believe in it, but it has equal merit to exist as the Levine scenario. Think of it as the RSJ scenario.

For a moment, consider that Musk is an incredibly rich man because he makes things that people pay a nice premium to own. In short, he’s not a Sam Bankman-Fried. His businesses that are live offer genuine products with real software running within. People die if he gets them wrong. He has often mentioned in his interviews (listen to him speaking to Lex Fridman or Seth Rogen) that his primary concern is the survival of the human race. Therefore his preoccupation with autonomous cars, clean energy and finding an alternative to Earth as a home for our species. He doesn’t think about them like a scientist. He isn’t interested in the theory beyond a point. He wants to build products that will use science to solve these problems. He’s an innovator. In this scenario, he views Twitter in its current form as a net negative for the race. He sees it going only from bad to worse. It is worth his time and money to intervene. To innovate. This is hard work. Remember, he doesn’t need to work for a single day in his life. He can donate a tiny fraction of his wealth to build museums and libraries and earn all the praise and fame for posterity. 

His problem is there won’t be any posterity. 

He isn’t interested in delaying the inevitable. He wants to build an alternative for the inevitable. He doesn’t want to tweak Twitter for it to be a net positive. He is certain it won’t help. The old Twitter has to be changed at its foundation. That’s why he is at the Twitter HQ working long hours (and occasionally tweeting). This is a different frame to look through. If you consider this scenario, Musk’s incentives are to build a platform for good that doesn’t have to cater to extreme positions for engagement and ad revenues. He has no short-term pressure to show better numbers, no shareholders to answer to, and no sword hanging over his head to show instant results. He is his own man. He will change Twitter for it to be a force of good at his own pace and time. $44 Billion is important even for as rich a man as he is. He could have put it anywhere to make more wealth. He’s sinking it into a platform he thinks can do enormous good for humanity if it is changed. That’s the only incentive that matters to him. 

Now consider how things will play out if you take the Levine and RSJ scenarios together. In both, Musk will behave based on his incentives. One of the two results is only possible then. Twitter will die in short order or turn itself around and be a force of good. In either case, we will be better off from where we are now with Twitter. 

Stacking It All Up

So, let me summarise this ownership and consequences thing here. 

a) The state(s) could own Twitter, and their incentive will mean they will weaponise it further to perpetuate themselves. This will be bad for everyone. It will be worse than where we are today. 

b) Or Twitter could continue being a widely-held public limited company with incentives that will dig a deeper hole for itself. It will mean ever-spiralling toxicity forever. Again a worse outcome. 

c) Or, Twitter could be owned by someone like Musk. Here, it will either die quickly or become a force for good. Either scenario will be an improvement on Twitter in its current form. 

Which ownership option from among the three would you choose?    

Applications for the re-awesomed Post-Graduate Programme in Public Policy are now open. Check details here.

Matsyanyaaya: Managing China the Aussie Way

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Anthony Albanese, the new Australian PM, had a tough couple of days this week. Asked about Taiwan’s candidature for the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) — a regional trade pact of 11 countries — he said, “The CPTPP is a relationship between nation-states which are recognised”. Since the statement came just three days after Albanese met Xi Jinping, it ruffled quite a few feathers. Did the statement mean Australia was trying to build bridges with China again? Was Australia changing its position concerning Taiwan as a result?

In any case, the Australian government swung into action, clarifying that Canberra remains open to Taiwan joining the CPTPP. Albanese, too issued an explanation:

“Our position has not changed. We will deal with applications that are dealt with by consensus for economies applying to join the CPTPP. At the moment, they’re dealt with one at a time.”

So, it’s pretty likely that the Australian PM misspoke. There doesn’t seem to be any change in the Australian position on Taiwan or China. However, this incident provides a window into the debate in Australia on its China policy.

Australia, in recent years, has been the most vocal opponent of Chinese expansionism and authoritarianism. The surfacing of a case of Chinese interference in Australian domestic polity in 2017 was an inflexion point in Australia’s China policy. Since then, it has actively tried to counter China’s aggression unilaterally and balance China’s power multilaterally. It is also the most enthusiastic participant of Quad 2.0. There is a bipartisan consensus that Australia needs to partner with the US and other powers to counter China, even if it means significant economic setbacks.

And yet, there are some in Australia who oppose this consensus. Hugh White is one of them. In a recent Quarterly Essay, White opposes Australia’s current China policy. He locates his opposition in realism and not idealism or liberalism. Some of his arguments echo the voices in India who are opposed to a closer collaboration with the West. For this reason, it’s worth studying it in some detail. Here’s my summary of the essay.

Background

Hugh White is a well-known Australian professor of strategic studies. He wrote Australia’s Defence White Paper 2000. A constant theme in his writings has been that Australia should not overly rely on the US. It should instead learn to co-exist with a powerful China by drawing a few red lines. Essentially, he makes what we know in India as the “strategic autonomy” argument.

TL;DRWhite argues that the US will “abandon” Australia as the costs to the US for meaningfully challenging China in East Asia are far higher than the benefits. The stakes for the US are far lower, unlike in Europe. In contrast, the stakes for China are much higher, and it will be willing to sacrifice a lot more to oust the US. Australia must therefore chart an independent strategy towards China, India, and Indonesia.

Highlights from White’s Essay

* White admits that his view is out of the Overton Window. Both the Liberal and Labour parties of today consider China the paramount strategic threat and consider the alliance with the US vital.

* He says Australian leaders thought they could “swing” between the US and China until 2017. They underestimated China’s “ambition to push America our of East Asia and take its place as a leading regional power”.

* Three factors led to Australia becoming the most strident anti-China country in the region within three years: Trump’s China position, Xi Jinping’s grip on power in Beijing and evidence of repression, and Malcolm Turnbull’s premiership.

* He takes Obama’s China policy to the cleaners when he says:

“They were deeply committed to the idea of preserving US primacy in Asia… but were reluctant to acknowledge, address and accept the costs and risks of doing so against a rival as formidable as China was turning out to be. They were in denial.”

* The US, under Trump, declared China to be its rival for Asia but didn’t do anything material. There was no significant increase in military capability in the Western Pacific and no enhancement of diplomatic or economic heft in the region.

* Biden’s policy that “America only reform at home to triumph abroad is deeply delusional. It is a delusion based on exceptionalism.” However, just as economic productivity and population made America a great power earlier, the same forces are now working for China. The exceptionalism mindset implies that the US doesn’t have to make any hard choices or sacrifices to defeat China.

* Both the Democrats and Republicans agree that America’s policies abroad shouldn’t cost voters at home. And so, no American leader will compete effectively with China.

* White then goes on to analyse all the reasons why the US might want to confront China in East Asia and counters each of them. He reasons that the US forsakes isolationism only when there’s a power strong enough to dominate the entire Eurasian continent. In the current scenario, China is nowhere near subjugating other Eurasian powers such as Russia, Europe, and India. For this reason, the US would be disinclined to commit its resources against China.

* On the dimensions of a possible US-China conflict, White says that the US cannot match China’s economic dynamism, its proximity, and the opportunities it offers. And the failed Trans-Pacific Partnership talks show that the US is not even trying. He trashes the diplomatic counter —the Quad — as a talk shop. He then says that the most important dimension is the military, as both sides explicitly threaten war if the other makes a wrong move.

* Since China’s stakes are higher, it would be willing to go to any length over questions such as a war over Taiwan. The US won’t. Taiwan should be left for China.

* He assumes a multipolar order is likely, where India, China, Europe, and Russia will have their spheres of influence. And so, he regrets that:

“Instead of helping America to manage the strategic transition in Asia wisely, we are encouraging Washington to confront Beijing in a contest it cannot win”.

* Australia must chart an independent policy towards India, Japan, and Indonesia.

* Finally, he believes that China will not necessarily be a ruthless and bitter enemy with which Australia cannot do business. It is possible but unlikely.

What’s the Takeaway?

White represents a view that’s politically out-of-fashion in Australia. Yet, it is an analysis founded on realism. But some of his underlying assumptions are contestable. For one, Biden’s current policies on China (like the semiconductor export controls) indicate that the US is willing to incur costs on its own companies and citizens to counter China. While it is true that the US cannot decouple from China in most fields, there is definitely a willingness to counter China in economic areas that the US considers core to its national security interests. This is a significant commitment that the Biden administration has made. It doesn’t seem like the US will give China a walkover in East Asia.

Secondly, it is unclear how a shaky outreach to China will be better for Australia than one in which China’s powers are restrained because of a partnership with the US. If the US does back out from the region, it would indeed make sense for Australia and others to make peace with China — even if it is on the latter’s terms. But we are far away from that happening.

Thirdly, the fact that White’s view is not acceptable to both political formations in Australia is proof of Xi Jinping’s failed foreign policies. China is the most important trade partner for perhaps every country in its neighbourhood, and yet it has managed to put itself into a situation where many of these trade partners have reached a domestic consensus on standing up to China politically.

Fourthly, I agree with White that the US does need to demonstrate its commitment to the Quad and IPEF quickly. If the US cannot commit itself to a trade arrangement with China’s adversaries, its effectiveness as the paramount power in East Asia will decline. Countries will start cutting their own deals with China.

And finally, India’s position in this game differs from Australia's. While it is tempting to draw lessons for India from White’s fear of depending on the US, that would be to miss a fundamental determinant of international relations: power. To the extent that the future prospects of a country of India’s size keep growing, we need not fear about the loss of “strategic autonomy”. India’s engagement with the US will be very different from the Australia-US partnership.

And so, it doesn’t look like Australia is changing its position on China after all. But there are no finalities in international relations. This space is worth watching.

Not(PolicyWTF): A Perfect Takeoff

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

This week marked a milestone for India’s space sector. Hyderabad-based Skyroot Aerospace successfully launched India’s first privately developed rocket into space. There’s a lot left to be accomplished, but today is a good day to reflect on a rather-interesting story of policy reform.

Aap Chronology Samajhiye…

Until 2020, the space sector was effectively a government monopoly. Yes, a few private companies developed satellites or supplied materials and equipment to ISRO, but more ambitious projects were out-of-bounds for private companies. In this sector, liberalisation seemed particularly challenging because the government umpire and player — ISRO — was doing a far better job than other public sector organisations. So why reform something that’s not broken? Why invest political capital in liberalisation and not double ISRO’s budget instead? That would have been the starting position for politicians and bureaucrats.

Many papers arguing for the liberalisation of the sector had been written earlier. As late as Jan 2020, there was no indication that a big reform was on the government agenda. My Takshashila colleagues had also put out a policy brief proposing a policy and regulatory structure to develop India's nascent private space sector.

And then, the COVID-19 pandemic began. The horrendous lockdown was announced in March. The future looked scary. On 5th May, the border clashes in Ladakh began. On June 15th, the Galwan clash claimed the life of 20 Indian soldiers (and an unknown number of Chinese soldiers). The satellite imagery displayed in the public domain came from constellations of private companies in the West. And on June 24th, the union cabinet “approved” private sector participation in space activities.

These connections are merely speculations, as we have no idea about the internal decision-making process of the government. Nevertheless, a few things are instructive.

The government was searching for success in various domains after the botched lockdown. As for the space sector, the government could well have chosen a “big bang” reform to double the ISRO budget to improve India’s presence in the space domain. The PM would have announced it on Twitter, and people would have cheered. Crucially though, the government had other policy solutions to choose from when the crisis hit. And it is praiseworthy that the government chose the option to liberalise rather than expand ISRO’s mandate. By 2021, the government also had de-regulated geospatial information collection and dissemination. And by 2022, the first private-sector rocket had been launched.

A lot more remains to be done in this sector. The role of ISRO and the new regulatory body needs clarification. But the key lesson for policy analysts is to be ready with well-articulated solutions before a crisis hits. While the crisis provided urgency, it could have also made the situation worse had the liberalisation option not been internalised by policy entrepreneurs in the government.

Congratulations to SkyRoot. And thanks to the government for getting out of the way.

HomeWork

Reading and listening recommendations on public policy matters

* [Newsletter] "What do Joe Biden's harsh Chinese chip controls mean for India?" Rohan Venkataramakrishnan and Pranay discuss this question in Rohan’s excellent India Inside Out newsletter.

* [Paper] Internal Drivers of China’s External Behaviour by Shivshankar Menon is a must-read.

* [Article] Nitin Pai explains why the opening up of India’s space sector is a big reform.

* [Podcast] On Puliyabaazi, historian Aashique Ahmed Iqbal gives an account of aviation in India.

Insights on global issues relevant to India

— RSJ

One of our favourite topics to talk about around here is regulations. We aren’t dogmatic about things. But the one principle that comes close to being a dogma for us is our belief in spontaneous order. The world is a complex interplay of many economic and social networks. Don’t try to force an order on it. Let the spontaneous, uncoordinated actions of the millions run their course. Some order will emerge from it. There might be occasional ‘disorder’ but inbuilt into such systems is an autocorrecting mechanism which will kick in. This is better than some powerful entity (like the State) trying to force order because it thinks it knows best. No one really can be a Laplace’s demon. The top-down forcing of an order will make things worse. 

That said, we aren’t libertarians by any stretch. The State must intervene when there’s a market failure. And more than any other sector, I believe financial services need regulation because of two obvious market failures endemic to them.

One, there’s a serious information asymmetry between the supplier of these products and services, and their customers. The products get more complex over time as suppliers look for additional arbitrage to make higher income, and customers can only understand so much of what’s often non-intuitive. I mean, compounding as a concept is a leap for most people; figuring out more complex instruments ain’t going to be easy. Two, the market power and dominance gets built up really fast in this sector. With it comes the risk of a contagion or the spectre of ‘too big to fail’. All of these leads to misallocating of capital that’s worse than most state interventions. So, I tend to look at financial regulations somewhat more benignly than, say, regulating cattle transportation. 

Having got that preamble out of the way, here’s a news item that many of you might have seen last week:

“The founder of the world’s second-largest cryptocurrency exchange, FTX, has apologised for his company’s near-collapse this week, saying he “fucked up” in his calculations and in his communications during the crisis.

Due to “poor internal labelling of bank-related accounts”, he said he “was substantially off” in his calculations of the sums that the exchange had lent out to users to let them make leveraged bets – borrowing money to trade with, magnifying potential gains and losses…

The sudden collapse in value was prompted by leaked documents which implied that Alameda Research, a hedge fund tightly intertwined with FTX through its common owner, Bankman-Fried, was, in effect, insolvent….

The leaks about Alameda turned into a crisis for FTX when Binance, the largest cryptocurrency exchange, announced it would sell its own major stake in FTX. The fire sale that followed crashed the token's value far below the $22 floor that FTX had committed to support and prompted the equivalent of a bank run at FTX itself as customers raced to withdraw their deposits faster than the exchange could process them.”

It wouldn’t be out of place to say there’s a lot to unpack there. But is there really? I have held a general theory about fintechs for a while. There are three sources of value in fintechs as I have seen them. 

One, they build slick, frictionless journeys that make buying financial products easier and more intuitive. Traditional players either don’t think this way or their legacy systems just don’t allow them to create such convenience. This focus on customer journey is good and somewhat sustainable in sectors where customers value speed and efficiency over risk management. Now ‘friction’ isn’t great in most cases but it has a few benefits. It slows things for you to pause and reconsider. In financial services, some friction is necessary to protect the customer. Not all of them have the ability to manage speed and the attendant risks that come with such lack of fiction. Anyway, frictionless works in sectors that have savvy customers. The best examples of such disruption have been new-age retail brokers like Robinhood, or closer home, Zerodha. There isn’t a lot more there in terms of product innovation or better management of risk that are traditional sources of value. It is all about convenience. Of course, such simplification and gamification - like, animated confetti floating all around when you make an options trade - runs the risk of drawing customers who don’t have the financial nous or the appetite for such risky products. And those accidents happen. But you could still argue there’s some tangible value fintechs have created in forcing everyone to rethink customer journeys in the industry. Is that sustainable, and does it warrant a huge valuation? Not quite. But at least you’ve got a real reason for customers coming to you. 

The second source of value - risk arbitrage - is of a more dubious kind. Traditional finance is built like it wants to reject customers. You must know your customers well, assess their risk profile, check for the suitability of the product and then offer them your product. At least, that’s what is expected. And for the risk appetite you decide on, the regulator will ask you to maintain capital so that you don’t ever have to turn your pockets inside out, tilt your head to the side and tell your customers you have no money. If you slack off on this, you might get away for a short while, but the chickens come home to roost fairly quickly. You have stringent disclosure norms, so there’s nowhere to hide when things go wrong. This means traditional finance does the equivalent of an airport strip search for every customer while taking them on. Sure it inconveniences 99.99999% of the customers but there’s no point taking that infinitesimally small risk by going around and trying to avoid it.

Now, this isn’t exactly how most fintech models operate. There’s greater value in getting truckloads of customers in really fast, offering them discounts because no one is asking you to make profits and creating a Bezos-like ‘flywheel’. This model militates against prudent risk management practices. The many lending apps that promise loans in seconds, the entire Buy Now Pay Later (BNPL) craze that swept through in the last few years and the many variants of such models are good examples of this mindless model. The only good news is that such models are up against fundamental economic sense. The risk starts to bite soon, and there’s nowhere to hide. The dismal performance of such fintechs once they’ve gone public should surprise no one. The only way out is by going back to the harsh reality of doing business in finance - manage your risk. 

And that brings us to the third, perhaps the rarest, source of value among fintechs - product innovation. This is rare because of two reasons. Firstly, traditional finance is innovative enough. This might seem surprising, but I guess a charge that’s laid on banks is that in the last thirty years they’ve innovated too much. It led to what’s often called the financialisation of the economy. In fact, one of the lessons from the global financial crisis (GFC) for the regulators was to clamp down on innovation to reduce the possibility of toxic products. So, there’s not been any dearth of innovative thinking in traditional finance.

Secondly, real product innovation is hard work. It requires deep knowledge of the domain and an understanding of the customer to arrive at one. Now, there aren’t more than a handful of fintech models that truly qualify as innovative, or to apply that much-abused term, disruptive. And if we have true product disruption, then there will be an information asymmetry-driven market failure deeper than usual. I mean if people don’t understand the run-of-the-mill financial products well now, what are the odds they will appreciate a real disruption? What this means is that ‘disruptive’ regulations will have to be applied to address the disruptive model in play. Importantly, the timing has to be right. Apply them too early, and you won’t have the disruption that’s useful in the long run. Go too easy on them, and you might create a beast that will be difficult to tame when things go wrong. 

Crypto(currency) is a real product disruption by this definition. We have covered it in a few previous editions (here, here, and here). The promise of a decentralised monetary system that isn’t ‘repressed’ by central banks worldwide has its own appeal. Not to me, but there are all kinds of people in this world.

And FTX was (as I write this I hear it has filed for bankruptcy) a fine example of the possibilities of this disruption. It was the second-largest crypto exchange in the world. You could open an account with it and transfer some money to it to buy any bitcoin. And they would hold it for you. When you want to liquidate the bitcoin for money, they will do so. They will charge you a small transaction fee for their troubles. That’s it. Not much of a business model till you start complicating things. Bitcoin isn’t exactly a stable asset. Its price fluctuates quite wildly. Now to some, this is a problem, but to people in financial services, this is an opportunity. So FTX started offering other services. You could borrow money from them to buy more bitcoins, or they could offer you bitcoins for money if that’s what you wanted (maybe you wanted to short bitcoins). Soon, it was no longer just an exchange or securities brokerage business. It was doing (margin) lending and taking risks on its books. It also started issuing tokens (think of it as its own kind of currency) that it offered to people to lend against. One of the things about finance is that there’s no real product that’s shipped from factories. People can make up products on the fly if they spot an opportunity to arbitrage time or risk appetites. So things get out of hand in terms of complexity soon. With FTX that’s what happened. You are lending and borrowing across time and risk horizons and you don’t know whether you can have your assets and liabilities match over the medium term in all likely scenarios. This can get messy in a traditional bank with all the bells and whistles of risk management and treasury teams monitoring this daily. In a fintech start-up that has some opaque tech platform with limited supervision and scenarios planned, it can be quite catastrophic.

In FTX’s case, they had the added complexity of having their own tokens, which they were accepting as collaterals against loans. So FTX had loaned a load of its customer assets to another of its company (Alameda) in return for its own tokens. The value of the tokens was based on FTX’s value. But FTX was also sitting on a load of them as collaterals.  If the value of the tokens fell, FTX would be impacted because it held a lot of them. If FTX got impacted, the tokens would fall further because that’s what the intrinsic value of the token was. If you are a token owner worried about the token crashing, you would take out your money asap. And if everyone thought like you, as they will, you will have a run on the bank (or the exchange). It was tailor-made for a death spiral. All it needed was a spark which was provided by its friendly rival Binance who tweeted one fine day about what it thought of FTX’s tokens. 

FTX, which was valued at $ 32 billion about a month back has filed for bankruptcy. Its investors (like PE giant Sequoia) have marked their investment value down to zero. Some customers will almost lose all their money here. There are counterparties involved, so we will know the full extent of its collapse after a while. The details that have emerged since about how FTX was governed are hilarious. There’s no other way to put it. There were only three members on its board. Two executives, including the founder and a lawyer based in a tax haven. No equity investor had a presence there. There was hardly an Asset-Liability Management (ALM) committee or a model. The founder’s partner ran the finance function. The whole thing ran on the back of an engineering team that built the platform with hardly any supervision on what was coded. The founder tweeted that there may have been a ‘labelling’ error in one of its fields and that could’ve led people to believe it had a liquidity problem. I used to make such excuses for MS Excel errors at the turn of the millennium when I was wet behind the ears analyst working for peanuts. For all the talk of software eating the world and decentralised platforms disrupting governments, it would be good to begin by acknowledging that the generations that have gone before us building what they built were no fools. In financial services, regulations are often a feature, not a bug. Thinking people don’t get it because they don’t understand disruption has no basis. It is hubris, and that leads to a fall. That’s the only lesson of history. 

India Policy Watch: Don’t Choke Cheap Chips from China

Insights on domestic policy issues

— Pranay Kotasthane

A lot has been said about India’s dependence on chip imports. Especially on chips coming from our long-term strategic adversary, China. And yet, I haven’t come across an analysis to understand the composition, size, and trends in this particular item of trade. So, I decided to investigate it further using the Department of Commerce’s Trade Statistics portal.

Chips (or Integrated Circuits) are India’s eighth-biggest import item by value. Energy imports — petroleum, petroleum gas, and coal rank above it. So do gold and diamond. The other items we import more than chips are products made using them — computers (including laptops, desktops, printers. etc.) and telephones (including mobiles, modems, etc.).

Now, let’s look at the chip imports from China. Considering PRC and Hong Kong as one political unit, India imports 64% of its ICs by value from China. Over the last five years, imports from PRC have increased seven-fold. Check this chart below to see the various kinds of ICs that come to India from China.

While this chart may look alarming, it can be misleading in many ways.

One, the absolute increase in chip imports from China follows the overall trend of increasing chip imports to India. Total chip imports to India have also increased sevenfold over the last five years. India is importing many more chips from all countries, including China.

And this is a good thing. It’s positive because it indicates that a lot more electronic device assembly is happening in India. A country will import chips — not finished electronic goods — in large quantities, only if it has a downstream domestic equipment manufacturing ecosystem. As even more Samsung, Apple, or Redmi devices get assembled in India, we should expect chip imports to India to rise for at least another decade in the best-case scenario, by which time we could have a semblance of chip manufacturing done here.

Two, chips imported from China are not necessarily Chinese chips. For one, it is likely that they are just assembled in China. Chip assembly is a labour-intensive process that is outsourced to other companies. China is a much bigger player in outsourced assembly and packaging of chips, than in fabrication. So, it’s quite likely that a die (an unpackaged chip) travels from Taiwan or Japan to China, gets packaged and finds its way into India. Secondly, even when chips are fabricated and packaged within China, a portion of it is done by foreign companies with facilities in China (such as Samsung, UMC, SK Hynix, etc.).

And three, its a fool’s errand to think we will ever be in a situation when no chips are imported. If India’s own chip assembly and packaging takes off, import of unpackaged chips will rise substantially. ICs are in fact the biggest import category by value even for Taiwan, the semiconductor superpower. It’s a folly to look at the entire semiconductor supply chain through a “national security first” lens. Cross-border movements of chips are desirable and inevitable.

To mitigate risks, what can be done is to diversify the source of India’s chip imports. And this is where the US export controls on China might have some effect. Though these export controls target only specific high-end chips, Chinese fabs will increasingly be pressed into meeting its domestic demands. Moreover, the confusion over further decoupling means that equipment makers will look at a China-free supply chain.

So, a significant portion of our chips are indeed imported from China. And yes, importing cheap chips from China is alright.

Applications for the re-awesomed Post-Graduate Programme in Public Policy are now open. Check details here.

Global Policy Watch #2: Seasonal Bird Migrations

Insights on global issues relevant to India

— Pranay Kotasthane

Exactly three years ago, I created an account on Mastodon, a decentralised social media platform that aimed to challenge Twitter. But the network effect pull of Twitter was just too strong though. I didn’t post a word on Mastodon, and as usual, forgot my login password.

But with the new Twitter boss taking sudden—and some inexplicable—decisions, another round of en-masse flight to Mastodon has begun. The 2019 en masse migration was India-centred, after Twitter blocked the account of a well-known Supreme Court lawyer. This time however, the migrants are from across the world. It’s the kind of natural experiment that social scientists turn into papers and books. I’m trying to be more active this time around, and observing how this new digital community takes shape. Having spent a few days, here’s what I have noticed.

One, the importance of the “other” doesn’t disappear. Most of the posts in my corner of Mastodon are self-referential. They are criticisms of Twitter and Elon Musk, and explanations for why Mastodon is better. Many early movers detest Big Tech, Capitalism, and such like; some are in love with “-isms” from the left-liberal political network. Beyond a point, the utility of Twitter as the “other” will decline, and I wonder what would it be replaced by. Finding the “other” is a core aspect of human behaviour. While the federated nature of the platform allows people to block people or communities (servers) easily to prevent confrontations between two ideologically distinct communities, I doubt it is powerful enough to overcome human desire for dissing an out-group to build in-group solidarity.

Two, if this is Web3, it feels a lot like Web1. This is a Web3 avataar minus the blockchain, bitcoin, and virtual reality. Not everyone across the world is in one town square. You need to know the coordinates of another person to be able to talk to them. In essence, it’s a lot like Web1. Many old-time internet citizens are celebrating this freedom from the powerful intermediary-controlled Web2. However, most users who were born into the Web2 might find this retro version inexplicable. For that generation, open social media platforms were never about “healthy discussions”, as the Web1 folks like to remind. Open social media was always something more instrumental—for a job, to access instant news, or to build an online persona. For discussions with friends, people used encrypted peer-to-peer platforms. So, it will be interesting to see how this generation of people finds a platform where non-virality is a feature and not a bug.

Three, there’s a large-numbers paradox at play. The initial few days on it have been quite good in this respect — the users seem to be warm, friendly, and welcoming. As long as it remains a small, elite group of people with similar worldviews, it might survive. But if it does get popular, and more people from various ideologies and with differing motivations join in, it is could again become just as vicious yet attractive medium like Twitter. While the architecture is aimed at preventing the slide into another big, loud, and heated forum, human predilections are the biggest bottleneck.

In any case, I’m going to observe this new experiment for some more weeks at the very least. I’m on Mastodon at pranaykotas@mastodon.social. Connect with me there if you are in another corner of the fediverse. Let’s see how far this experiment takes us.

HomeWork

Reading and listening recommendations on public policy matters

* [Book] The Aeroplane and the Making of Modern India by historian Aashique Ahmed Iqbal explores the link between technology and sovereignty.

* [Podcast] Michael Munger and Ross Roberts discuss a topic that’s on all governments’ mind - Industrial Policy - on EconTalk.

Insights on domestic policy issues

— RSJ

Sometime last week, this newsletter marked three years of its existence. A blink of an eye in the larger scheme of things. Yet, it feels nice to have reached this milestone. Consistency might be the virtue of an ass, but it is a virtue nevertheless. In these three years, we have stayed somewhat true to our purpose in every edition we have sent out. We have analysed policies intending to anticipate their unintended consequences. We have debated about what’s good in the long term for India since we care for it. And we have tried to influence or perhaps shape the demand side of the political equation by increasing awareness about public policy among our readers. This is a marathon, and we are in it for the long run. No effort is too small. We cannot thank you enough for the generosity of your time in reading us. 

Anyway, returning to one of the things we care for deeply. India’s future prospects. No amount of thinking about it could have brought us to the conclusion that Arvind Kejriwal reached last week about this vexing issue. The leader of AAP addressed a press conference where he asked the PM for a critical policy intervention:

"I appeal to PM Modi that the Indian currency has the picture of Gandhi ji on one side, it should remain like that. But on the other side, there should be a picture of Ganesh ji and Laxmi ji. We need efforts to make the Indian economy stronger, but we also need the blessings of gods and goddesses," he said.

While Laxmi is the goddess of prosperity, Lord Ganesh is believed to solve all our 'vighnas' (problems), Kejriwal said.

"We are not asking for printing fresh currency, but all the new currency that gets printed, this should be implemented. Eventually, the circulation of these notes will increase," he said.

As the yesteryear villain Ajit (“the loin”) would say: smart boy.

Soon another AAP leader, Atishi, took the battle to the BJP camp:

“BJP leaders can hate Mr. Kejriwal but why hate Hindu deities Lakshmi and Ganesh? Do you not want the blessings of our gods to be with the people of the country? I humbly request leaders of the BJP not to oppose this noble proposal. It is not just a proposal from Arvind Kejriwal, but is the proposal of 130-crore citizens of this country.”

I don’t remember when I (among them aforementioned 130-crore citizenry) signed up for this proposal, as Atishi suggested. There’s something to be said about how times change people. A person whose last name ‘Marlena’ was derived from her family’s belief in the Marxist-Leninist strand of godless communism is now asking for deities to be put on currency notes as a policy measure. I guess this is how things roll in politics.

Keeping an open mind, I looked around for evidence correlating having Lakshmi Ji and Ganesh Ji on currency notes with economic growth anywhere in the world. I didn’t make much headway. No developed nation has ever had them on its notes. Indonesia did issue 20,000 Rupiah notes from 1998-2005 with Ganesh Ji on them, but it was discontinued in 2008. The Indonesian economic growth during those intervening years was nothing to write about. I also came across a few Devdutt Pattnaik videos on Lakshmi Ji and yajman and how the yajman must make sure she doesn’t leave them. Very compelling stuff. Considering he was with the Future group during those days and it has since gone into bankruptcy, I’m not sure it helped much there too. The bottom line, there isn’t a lot of academic literature out there to help with the Kejriwal thesis.

The AAP move has spawned numerous opinion pieces, of course. Some have accused them of soft Hindutva (a unique Indian term like ‘mild lathicharge’) and being a ‘B team’ of the BJP. Others have lamented the loss of idealism in politics. And then some think it is the pragmatic way for Kejriwal to turn the tables on the BJP and nothing more should be read into it. Well, who knows? I think it is helpful to examine this in the context of public choice theory. There are three conclusions one can draw from this, which I will elaborate here.

Firstly, we must acknowledge that any political system, particularly a democracy, rewards a politician who appears to be doing the right things. Now, what’s the ‘right thing’ is defined by the moral standards prevailing at a particular time in that society. Most politicians will try to do what is considered good by the people. But moral standards aren’t constant. They change with time. An astute politician, therefore, needs to be morally flexible to change according to what’s considered good at a point in time in society. Moral rigidity might be good for philosophers and idealists but not for politicians. There’s no incentive for a politician to question the prevailing moral standards. A rare politician who does that is playing a high stake game. They often lose. And a politician who loses is worthless.

The conventional moral standard prevailing now in India allows Kejriwal to make a statement like this. Anyone in India can now position their bad-faith actions or beliefs in a way that they fit this conventional standard. Politicians are power-hungry. Their incentives are aligned that way. A singular pursuit of these incentives separates a good politician from the bad one. It makes them sociopaths, but that’s an unfortunate side effect they learn to live with over time. The question in India today shouldn’t be why Kejriwal is making such bizarre demands. The real question is what does it say about our society that politicians can make such demands in the garb of what is good or right for the society. 

Secondly, there’s this belief that democracy, with its periodic elections, changes in the mood of the people and a system of checks and balances can temper this power lust of the politicians and channel it for the good of society. In this view, Kejriwal (or any another politician, really) is making these statements to do well in some elections (Gujarat?), but once he’s in power, his true moral self will be back, and that will be good for the society. He’s got to play the game, you see.

There are two problems I see with this thesis. One, it assumes that the conventional moral standards of society are permanent and any number of such statements don’t change them. Once the gains from such a statement are realised, society, like some kind of a memory foam, will remember its original shape and go back to demanding what’s right for it. This is optimistic and isn’t borne out by history.

Two, it also assumes that a politician who gets positive returns from this approach will not continue doing so in an ever-spiraling escalation down this path. That will be an illogical option for any power-hungry politician who doesn’t like to lose. He would like to keep doing more of the same if the returns don’t diminish. This isn’t about what’s right. It is about ensuring he gets the power to do what he thinks is right in the larger scheme of things. Politicians are plain old opportunists. This is why I don’t understand how any logical mind can have ‘tribal loyalty’ to a particular political party.

Thirdly, some of you may ask this. On the one hand, we advocate free markets, where we believe that individual incentives come together spontaneously for everyone to benefit. On the other, I’m making a case that in the political marketplace, individual incentives don’t work for the overall good. How do I square this? Well, for one, there is a fundamental difference between a businessman (to use a gendered term) and a politician. The businessman has the belief and the incentives (long and short term) to maximise profit. He might couch it with good intentions in his public statements because of his bias for social desirability. This bias won’t change his actions, though, because he’s a rational actor. He might say something against his conviction but he will do exactly what will maximise his incentives. In the case of a politician, this might play out differently. The social desirability bias can, and often does, change their immediate actions in a manner that’s different from their long-term incentives. Not only will he speak against his conviction to be more accepted, he might also act in the same manner. The Kejriwal statement is a good example of this. Also, history has shown that voters are different from consumers. Voters get swayed by emotions, tribal loyalties, affiliations and demagoguery. Consumers might be swayed temporarily, but soon rationality takes over. A good example of this distinction is evident in the film business in India. Over the past few years, the incentive to make films that portray some glorious Hindu heritage without historical basis was quite high. This led to a steady pipeline of films with ever-increasing religious jingoism and ramping up of Hindu ethno-nationalist pride. Yet, within a relatively short period, the consumers have seen through this ‘formula’, and the recent box office rejection of these films bears testimony to this. Free markets have corrections built in because the assumption of rational actors largely holds. That doesn’t work for the political marketplace.

At a broader political level, Kejriwal’s statement is an interesting reflection of how the political class is reading society now. Conceptually, there are two possible approaches to contend with the formidable politics of Hindutva. One option is to counter it with the diversity of thoughts and iconographies within Hinduism to deny a monolithic, Abrahamic version of the religion that Hindutva desires to apply to all its adherents. This diversity or internal divisions that often cancelled each other out in electoral politics was considered a societal default position. There wasn’t much to do to change it, except to get the electoral arithmetic right and capture power. That default is changed now and you could try to bring that back. That’s one play in the current political landscape. The other option is to join the Hindutva politics bandwagon, raise new issues, however bizarre and peddle those optics to the public. The goal isn’t to outdo the original Hindutva masters. Pursuing that would be folly. The idea is to make the Hindutva plank par for the electoral course in a manner that voters no longer find it necessary enough to make it a part of their voting calculus. If everyone is on to it, it no longer is a differentiator. It is clear now that the political class is giving up on the first option. There will be greater convergence on the second option. The underlying belief among them seems to be that one can retrace the steps back after having used the second option opportunistically. That’s what those supporting Kejriwal believe. I’m not so sanguine.   

Postscript: Pratap Bhanu Mehta articulates the fundamental fallacy of an either/or formulation in making these choices in his excellent column in the Indian Express: ‘Why it’s wrong to say that Hinduism is a product of colonialism’. He writes:

If the Hindutva project is to homogenise and centralise Hinduism, the answer to that cannot be the historically ill-founded and philosophically inept strategy of denying the historical existence of Hinduism altogether. Or worse, to imagine that pre-modern Hinduism is simply an endless proliferation of sects, walled up, with few interconnections and not dependent on a shared cosmology, social system, or even intellectual concerns. It is to reduce Hinduism to simply an aesthetic heteroglossia, and not take seriously any of its imaginative constructions, intellectual endeavours or practices. If Hindutva uses identity to erase diversity, it is also important to avoid the opposite fallacy: To use diversity to deny the fact that the diverse parts may also be parasitic on referencing a larger whole, and common canons of contestation.    

India Policy Watch #2: The Tyranny of Context in Electoral Systems

Insights on domestic policy issues

— Pranay Kotasthane

Israel voted for the fifth time in four years earlier this week. The former PM Benjamin Netanyahu is set to come back once the arduous coalition-building talks reach another precarious consensus. Opinion pieces routinely refer to this process of coalition stitching in Israel as “horse-trading”. Meanwhile, the vote share of the extreme right-wing party Religious Zionists has more than doubled, and they will now demand their pound of flesh in the government formation talks.

One aspect of the Israeli political system should interest many Indians. Unlike India, Israel follows the List Proportional Representation (PR) system. This system optimises for the proportional conversion of vote share into equivalent seat share. People vote for a party, not a candidate. All parties with a vote count above a minimum threshold (3.25% currently) are sure to have their representatives in the Knesset.

India follows the First Past the Post (FPTP) system. Voters vote for a candidate. The one who polls the most votes wins. The parties fielding the losing candidates get zero seats, even if they poll just one vote lesser than the winning candidate’s party in every constituency. The disproportionality between the vote share and seat share is a feature of this system, not a bug. So a party with a 30 per cent vote share might be able to win a majority of seats and form a government.

Now, one is sure to come across this statement in casual conversations about elections in India: “the root cause of unfair electoral representation is that India follows the primitive FPTP. We should instead move on to a ‘fairer’ Proportional Representation (PR) system, one in which the legislature represents the true vote shares.”

But the lived experiences of Israel’s (and earlier, Italy’s) PR system show it’s riddled with problems too. In this article, I explain why PR is an overrated solution to India’s problems with electoral representation.

Issue 1: The Purpose of an Electoral System

A PR system can be perfectly representative and yet utterly dysfunctional. The proponents of the PR system are right when they say that it is fairer than FPTP in translating vote shares into seat shares. By design, it will have another positive effect of having representation of many more political parties in the legislature.

At the same time, another inescapable feature of the PR system is post-election coalition-building, in which many fringe parties hold all the aces. Israel’s recent electoral struggles are a case in point. Many smaller extremist parties are openly demanding specific ministerial posts as a precondition for their support to Netanyahu. In a democracy that is 120 times bigger than Israel, this problem of unstable and unworkable coalitions could get amplified. A government would be formed by a coalition of 20-30 parties, and the smaller partners will have disproportional leverage. Fewer governments will complete their full term. Israel has had 25 elections to the Knesset thus far, and only on nine occasions has the government completed or come closer to completing the four-year term.

Confronting the trade-off between fairness in translating vote shares to seat shares and effectiveness in creating governments that can perform is inevitable. And I’m not sure if the PR system in India can strike the right balance.

I spoke with a friend who understands India’s polity much better than me. In his view, the fundamental goal of an electoral system is not necessarily proportional representation but to render a government legitimate. And on that count, Indian governments elected using the FPTP system have been broadly accepted by the Indian electorate after the elections. The current government is testing the limits of this acceptance, but its legitimacy to govern is not under serious question yet.

Issue 2: The Party vs the Legislator

In a PR system, the legislator is virtually a rubber stamp, as candidates vote for parties, not specific candidates. The political party is at the front and centre of the system, unlike in an FPTP system where people vote for individuals to represent them.

In the Indian context, political parties are an already unhealthily powerful institution which has accreted more power through instruments such as the anti-defection law and opaque electoral bonds. Switching to a PR system would break even the modicum of connection between legislators and the electorate.

Issue 3: The Fringe as the Centre

In a divided polity such as India’s, successful political parties have no option but to cater to a broad section of the electorate to win the 30-40 per cent vote share. In a PR system, parties have no incentive to appeal to a broad section of the electorate. As long as they can win the votes of a narrow group, they are assured of seats, which would be enough to make them “king-makers”. Moreover, as the Israel experience has repeatedly shown, a PR system can legitimise small, extremist parties, a result India definitely doesn’t need at this time.

These three issues highlight that the PR system might make us worse off. Of course, this debate between PR and FPTP is not new. Some countries, such as Germany, have tried a mixed-member system in which voters cast one vote for their legislator (who has to qualify through FPTP) and another for a party list (which then translates to seats on a proportional basis). But one thing’s for sure. Every alternative is path-dependent and not without drawbacks.

The unthinking support for shifting to PR at the margins is a specific case of a general phenomenon I call the ‘tyranny of context’. The existing familiar system appears unworkable in this phenomenon because we know its pitfalls too well. On the other hand, a reform from another context appears attractive because we don’t understand it at all.

Changing to a PR system is unlikely to result in better governance outcomes. On some parameters, it might make things worse. Ambedkar had famously warned:

“However good a Constitution may be, if those who are implementing it are not good, it will prove to be bad. However bad a Constitution may be, if those implementing it are good, it will prove to be good.”

What he said of the Constitution also seems to apply to the electoral system. It’s better to look for solutions within the constraints of the FPTP system, perhaps. What do you reckon?

PolicyWTF: Abnormal Bovine Movement

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

This headline in the Deccan Herald caught my attention:

Online pass permit to be mandatory for cattle transport in Karnataka: The new cattle pass permit system will include transport certificate, ownership document and veterinary first-aid equipment.

Let that sink in. If you own a cow and want to transport it to another place 15 km or more away, you need to first get appropriate blessings from the Animal Husbandry Veterinary Services Department manifested as an online cattle pass permit. Never to miss a revenue opportunity, the owner of the transporting vehicle also has to pay a fee to obtain the permit. Plus GST.

There’s a backstory to these absurd rules. In January 2021, the state government passed the Karnataka Prevention of Slaughter and Preservation of Cattle Act, imposing a blanket ban on cattle slaughter. One of the sections of the Act prohibited the transport of cattle for slaughter. But, of course, cattle need to be transported for reasons other than slaughter. And hence, the online permit will now ascertain that the movement is for a bonafide reason.

That Act also gives the Police the power to search and seize if they have reason to believe any violations have occurred. It would be funny if it weren’t so tragic that precious state capacity is being expended on bovine transport controls in one of the country's best states.

HomeWork

Reading and listening recommendations on public policy matters

* [Knowledge Base] The Ace Electoral Knowledge Network has a good overview of all electoral systems, their weaknesses, and their strengths.

* [Podcast] In the next Puliyabaazi, Sumit Kumar of Bakarmax webcomic discusses the state of Indian comics and animation.

* [Podcast] Anita Anand and William Darlymple’s Empire presents familiar stories of colonialism in a new light.

* [Report] Why do Indian Founders in the Space Industry start their start-ups abroad? The reasons equally apply to start-ups in other deep tech sectors.

Global Policy Watch: When Traditional Institutions Work  

Insights on topical policy issues in India

— RSJ

King Charles III was coronated last week. I saw the pictures of the event, and if you did not know the history of the British monarchy, the whole thing looked like a Monty Python sketch on a Nolan-esque budget. The King wore a costume that might have appeared outdated even in the 12th century when the Westminster Hall was built. The political class in their finery bowed, the aristocracy in splendid robes kept a stiff upper lip, the media continually upped the circus quotient for public consumption, and the Yeomen of the Guard marched in precise steps while some grand music (Handel?) played on. It was all pomp and circumstance (Elgar would have approved).I watched this with mild bemusement. I mean, here’s King Charles III, a man who is reputed to speak to his plants, iron his shoelaces, show strange interest in red squirrels and, who often, rails against scientific revolution and the modern economy. What a strange man to ascend the throne of a nation vastly different from him. He must have found the quaintness of the pageantry to his taste. On the other hand, I’m sure he would have some time during the ceremony contemplated the history of the other Charles (Charlies?), who might have ascended the throne with similar accompanying pageantry.

Charles I was beheaded for treason by the parliament led by Oliver Cromwell at Whitehall, not too far away from where Charles III was seated. The second King Charles led a charmed life with childhood exile, a triumphant return to the restoration of monarchy, and finally, a long suspension of parliament in the last years of his rule marking his legacy.

Uneasy may not lie the head that wears the crown these days (there’s really no day job here), but Charles III cannot be too careful about the institution that he represents. The institution is in a perilous state, and he’s seen by many as an oddity unfit for the role. The commonwealth states don’t have any time for the monarchy. The link to the colonial past is no longer about nostalgia. That’s been erased and replaced with an indifference bordering on disdain for monarchy and its role during the excesses of colonialism. Among the young in Britain, the support for the monarchy is on the wane. Only 33 per cent in the age group of 18-24 support monarchy today compared to the 59 per cent who did a decade back. Some feel with the passing of Queen Elizabeth II, the institution of the monarchy will struggle to remain relevant or to serve its vital role of being the ceremonial head of the state. An elected president could do it better. I mean, what’s the point of monarchy barring providing grist to the paparazzi mill, occasional photo shoots with visiting heads of state and announcing a few royal honours every year? Why spend enormous money and effort propping up an archaic and undemocratic institution? Why have a democratic constitution and then have a hereditary basis for choosing the head of the state? Isn’t that a traditional and conservative imposition on the people?I have more than one reason to support such traditionalism in a democratic polity.Firstly, people need symbols and customs that represent continuity with their past. This assurance that you are part of an unbroken chain that holds all that’s good and great about your culture gives meaning to many people's lives. That it extends beyond the personal (faith and family) to the political in how you organise your community and run your nation makes it both an anchor to hold a society steady and an escape valve that lets off any built-up steam of anger. Old institutions build up their influence over the ages. This is how they become easier to follow at any given time. This is a vital capability to preserve in any democracy.Writing in the mid-1860s, Walter Bagehot, the editor of the Economist then, made an insightful observation of how to create and nurture a good Constitution that will clarify this capability further:

In ..constitutions there are two parts (not indeed separable with microscopic accuracy, for the genius of great affairs abhors nicety of division) first, those which excite and preserve the reverence of the population — the dignified parts, if I may so call them; and next, the efficient parts — those by which it, in fact, works and rules. There are two great objects which every constitution must attain to be successful, which every old and celebrated one must have wonderfully achieved every constitution must first gain authority, and then use authority, it must first win the loyalty and confidence of mankind, and there employ that homage in the work of government.There are indeed practical men who reject the dignified parts of government. They say, we want only to attain results, to do business: a constitution is a collection of political means for political ends, and if you admit that any part of a constitution does no business, or that a simpler machine would do equally well what it does, you admit that this part of the constitution, however dignified or awful it may be, is nevertheless in truth useless. And other reasoners, who distrust this bare philosophy, have propounded subtle arguments to prove that these dignified parts of old governments are cardinal components of the essential apparatus, great pivots of substantial utility; and so they manufactured fallacies which the plainer school have well exposed. But both schools are in error. The dignified parts of government are those which bring it force which attract its motive power. The efficient parts only employ that power. The comely parts of a government have need, for they are those upon which its vital strength depends. They may not do any thing definite that a simpler polity would not do better; but they are the preliminaries, the needful prerequisites of all work. They raise the army, though they do not win the battle.

Secondly, in this age of polarisation and tribal loyalties trumping reason, the idea of an apolitical sovereign reigning as the head of state is appealing. There’s a hope there that such a sovereign might not help rally people toward a populist cause but could perhaps hold them back from falling prey to raw emotions and passions. This moral authority, however undeserved, can constrain any political movement that threatens to derail democracy in the name of populism or majoritarianism. There’s an additional element to the exercise of undemocratic sovereign power. When things are going good, the checks and balances of power between the legislature, executive and judiciary work effectively. There are debates and consultations before a consensus on the way ahead is arrived. But in times of crisis and exigencies, there’s a need for an additional reserve of power or authority that can supersede or expedite the usual decision-making process of a democracy by imposing its will. A constitutional monarchy run on a parliamentary system has that reserve. A presidential style of government lacks this and runs the risk of not being agile enough to counter such exigencies.

Like Bagehot put it:

“at a quick crisis, the time when a sovereign power is most needed, you cannot find the supreme people. There is no elastic element, every thing is rigid, specified, dated. Come what may, you can quicken nothing and retard nothing. You have bespoken your government in advance, and whether it suits you or not, whether it works well or works ill, whether it is what you want or not, by law you must keep it.”

Lastly, a functioning and aware monarchy helps assuage the deeply embedded anxieties about identity in society while gradually accepting the inevitable change that times bring with it. One of the things that the British monarchy, with Queen Elizabeth II at the helm, did well was to stand for what was to be British in times of tremendous upheaval. She was resolutely Christian, proud of the empire, rarely apologetic about its excesses, devoted to her duty as the unelected sovereign and funny in a very British way. Each of these was (and is) a fault line in a society wanting to modernise and cast away the sins of its past. She carried them along because maybe she understood the importance of being a gradualist. Or it is likely the legacy of the institution guided her to be one.

It is strange, but the monarchy, the most top-down of the institutions, perhaps has been the bulwark against any hastily concocted plans of a top-down imposed change in societies. I went back to some of the early speeches of Queen Elizabeth II to see if she always knew this was what she had to contend with being a modern constitutional monarch. It could be her speech writers who saw this, or it could be her imprint on them, but her early speeches give a sense of her awareness about this. In her coronation day address, she said:

The ceremonies you have seen today are ancient, and some of their origins are veiled in the mists of the past. But their spirit and their meaning shine through the ages never, perhaps, more brightly than now. I have in sincerity pledged myself to your service, as so many of you are pledged to mine.Therefore I am sure that this, my Coronation, is not the symbol of a power and a splendour that are gone but a declaration of our hopes for the future, and for the years I may, by God's Grace and Mercy, be given to reign and serve you as your Queen.Parliamentary institutions, with their free speech and respect for the rights of minorities, and the inspiration of a broad tolerance in thought and expression - all this we conceive to be a precious part of our way of life and outlook.

During recent centuries, this message has been sustained and invigorated by the immense contribution, in language, literature, and action, of the nations of our Commonwealth overseas. It gives expression, as I pray it always will, to living principles, as sacred to the Crown and Monarchy as to its many Parliaments and Peoples. I ask you now to cherish them - and practise them too; then we can go forward together in peace, seeking justice and freedom for all men.

Listen, much of this can seem like pompous drivel to the more cynical among us. But it is uplifting and meaningful to a lot more. There’s a lot worse that was being said—then and now—to people from positions of authority. I’d rather have thousand-year-old institutions rooted in modern or outdated traditions speak uplifting drivel like this. People should get more of this.It applies to India too.

Matsyanyaaya: The Chips are Down for Russia's Defence Companies

Big fish eating small fish = Foreign Policy in action

— Abhiram Manchi & Pranay Kotasthane

(An edited version of this post first appeared in the Times of India’s September 23 edition)

Russia is considered a dependable defence partner to India, and rightly so. An underlying assumption is that Russia will continue to be a reliable supplier even in the future. But this assumption fails to consider that Russia’s defence production capabilities will continue to decline well after the ongoing war in Ukraine ends. Here’s why.

Consider these telltale signs first. Russia has delayed the delivery of two Talwar-class stealth frigates for up to six months. There are also short-term delays in the supply of S-400 Triumf missile systems and spares for Kilo-class submarines, MiG-29 fighters and Kamov Mi-17 military transport helicopters. These setbacks shouldn’t be dismissed as routine. They indicate a deeper problem: Russia’s inability to access semiconductor chips for defence platforms going ahead.

Ukraine put out an alleged shopping list of semiconductors, connectors, transformers, etc., that Russia is desperate to purchase. Politico, a US-based media company, divided this list into three parts Critical, Important, and Not-so-important. The Critical list has some chips of basic complexity, such as connectors, and memory chips, besides digital signal processors and Field Programmable Gate Arrays (FPGAs), which fall slightly higher in the complexity grade. There are no cutting-edge chips on the list. These items are pretty standard and can be manufactured on a large scale in most cases. This surprising lack of complexity in Russian equipment has also surprised the US. There have been claims that college students majoring in electrical engineering could reverse engineer and build most of the electronics used. Also, there have been instances of Russian-guided missiles missing their mark purely due to the old versions of navigation systems.

When Russia invaded Ukraine in late February, the US quickly banned selling semiconductors used in defence systems to Russia. The new controls target chips, encryption software, lasers and sensors, etc., for Russia’s defence industry. The other three pillars of the semiconductor industry, i.e. Taiwan, South Korea and Japan, also banned the export of items through the export control list provided by the US. These controls essentially mean that none of the high-end chips will be available for use by Russia. Russia also does not have the infrastructure to manufacture these chips domestically. Only two Russian companies, Angstrem-T and Mikron Group, are reported to have elementary production-grade chip manufacturing capabilities.

As a result, Russia is feeling the pinch. It is running low on hypersonic weapons because of the unavailability of microchips. Examination of the remnants of the missiles Russia launched on Ukraine showed the usage of older technology parts with elementary GPS systems. Sometimes Russia even used chips taken out of dishwashers and refrigerators.

This puts India in a precarious position. India is the largest importer of Russian weaponry in the world. Even after the ongoing war ends, it is unlikely that the West will remove these high-tech sanctions. With these constraints to negotiate, Russia could proceed in two ways, neither of which augurs well for India.

As seen in most weapons in Ukraine, Russia could use chips from western manufacturers by indirectly sourcing them. It is tough to track chips once they leave the foundry, as there may be multiple unregulated second-hand markets for them. There are also third-party firms sourcing chips and then directly selling them to Russia. While Russia has been a reliable defence partner of India, it would prefer to replenish its declining stocks of chips before considering India’s requirements. From the Indian perspective, even if Russia does continue the supplies, India has to think twice before using chips obtained from these dark markets.

The other option for Russia’s defence industry is to approach China and obtain the chips from them. While this may work for Russia and be advantageous for China to have Russia in their debt, India has to be wary of these Chinese chips entering into the defence equipment being sent to India. Do we want Chinese chips in our missiles and submarines?

Whatever the option Russia opts for, India must prepare for a sharp drop in Russia’s ability to deliver on defence purchase orders. Their technology is dated, and the chips would come from the black market or China. There will also be delays and cost overruns, with supply chains disrupted, financial systems in tatters and Russian manufacturers closing shop. India will now also face issues with its exports to other countries, a case being the partnership with Russia to work on assault rifle export.

Given the reality of Russia’s defence sector, India must diversify its weaponry in the short term and focus on local manufacturing over the long term. Regardless of Russia’s intentions, its capability to meet India’s defence needs has taken a big hit. India must utilise partnerships with the US, Japan, Australia, France, and Israel to secure defence equipment and chip supplies. 

India Policy Watch #1: India’s Semiconductor Policies v2.0

Insights on burning policy issues in India

— Pranay Kotasthane

Earlier this week, the Union Cabinet approved modifications to three of the four schemes introduced in December 2021 for developing a domestic semiconductor ecosystem. Several news websites have claimed that with the government “sweetening the deal”, investments in this sector will be more forthcoming. I agree, but not without some fundamental reservations. Here’s why.

Semiconductor Fabs

To attract chip manufacturing companies, the original programme promised up to 50% upfront financial support for leading-edge nodes (28 nanometres and below). The promised fiscal support for trailing-edge nodes employing older technologies dropped commensurately, going down to 30% for a fab that produces chips at the 45-65 nanometre nodes. (The node size is a rough measure for the size of a building block in a chip. The smaller that number, the more building blocks that can be packed in the same area resulting in higher performance).

Under the new scheme, the government promises upfront fiscal support of 50% for all node sizes. The change reflects two realities. First, trailing-edge fabs are crucial for India. The demand for older node sizes will not disappear anytime soon. Future applications such as 5G radios and electric vehicles will continue to require manufacturing at these nodes. Most current defence applications also require trailing-edge chips.

Second, many countries are wooing the leading-edge node foundries with much larger incentive packages. Companies such as TSMC are being courted by all major powers, and it’s unlikely they will pick India for the most-advanced nodes. India’s chances are better for securing older technologies.

Display Fabs

Most display panel manufacturers are located in East Asia — companies from China, Taiwan, South Korea, and Japan dominate this industry. The scheme was designed with the explicit aim of import substitution. The original scheme promised up to 50% upfront financial support subject to a cap of ₹12,000 crores. As part of the changes, this upper cap has been struck off.

To me, this scheme didn’t make sense even when it was announced. I have four reasons for the scepticism.

* Even during the high peak of supply chain disruptions during COVID-19, there was no shortage of display panels, indicating that there are no constraints to increasing production, as is the case for chips. (The only shortage related to displays was for the driver chip, not the panels by themselves).

* Apart from China and Taiwan, South Korea and Japan have leadership in specific segments of displays. So we aren’t dependent on one vulnerable source, as in the case of chips.

* Import dependence on China won’t go away. Even if these fabs manufacture displays in India, the input materials will have to be imported from elsewhere. So the bottlenecks will shift but don’t disappear.

* The industry is moving to newer technologies apart from LCDs and AMOLEDs. Samsung is focusing on Quantum-dot displays instead of LCDs. The scheme might be able to get old-tech here, but for newer technologies, imports might continue.

Thus, to spend ₹12000 crores for a product in the pursuit of a failed notion of import substitution doesn't justify the opportunity costs. Moreover, removing the upper cap after Vedanta-Foxconn got into this game raises concerns about rent-seeking — the tendency of businesses to distort policies to serve their own interests.

Assembly, Test, Packaging Units, and Specialised Low-volume Fabs

For assembly, test and packaging firms, & compound fabs, the promised financial support has increased substantially, from 30% to 50%. More importantly, the original scheme allowed disbursal once a facility had begun production. Under the modified scheme, the financial support will be upfront. Prepaid, not postpaid.

These changes again warrant scrutiny. Is it another case of rent-seeking?

At the margin, I am okay with the changes in this segment. India has a potential advantage because of the need for a large, mid-level trained workforce for this segment of the supply chain, in comparison to conventional semiconductor fabs.

Semiconductor Design

Surprisingly, there were no modifications in the one area where India does have a comparative advantage - semiconductor design and design services. The capital requirement for this segment is at least two orders of magnitude lower than the first three segments. And yet, the response to the scheme for encouraging design firms seems less than lukewarm. We propose two changes in the policy for that segment in an article for Hindustan Times earlier this month:

* To receive deployment-linked incentives under the current scheme, a design firm has to be registered in India with a 50% local stake. That clause could be watered down. Companies should qualify as long as the workforce is majorly Indian and the development happens here.

* Reducing tariff and non-tariff barriers are also crucial for India’s semiconductor design companies to increase operations in India.

On both these counts, the status quo prevails.

To summarise, the modifications reflect the government’s seriousness in attracting investment in this sector. Through these changes, the government is acknowledging that India must start its chip manufacturing journey at the lower end and climb its way up. Getting good at this game takes a couple of decades. At the same time, a thin line separates responsive government policies from regulatory capture by businesses. All industrial policies run this risk, and we need to be vigilant.

India Policy Watch #2: Six Essential Questions in Indian Public Finance

Insights on burning policy issues in India

— Pranay Kotasthane

Longtime readers might recall what I say about public finance: it is an underrated discipline that offers insights across all public policy domains. Many good public finance textbooks exist, but there are few books which explain the subject in the Indian context. Luckily, we now have a book which does that — M Govinda Rao’s Studies in Indian Public Finance (SIPF).

To make it easier for all readers, I have a book essay that distills the insights from the book as answers to six questions of contemporary relevance. They are:

* What do we know about the quantity and quality of India’s public expenditure?

* Should India reintroduce wealth and inheritance taxes?

* Is an imperfect Goods and Services Tax better than no GST?

* What is the single-largest expenditure item in the union government budget?

* What ails Indian Fiscal Federalism? and

* How many centrally sponsored schemes should the union government run?

To know how the book answers these questions, read my Indian Public Policy Review essay here. And if you are serious about learning public policy, the book is unmissable.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] Who should pay for the UPI? We have a fun Puliyabaazi on this topic.

* [Post] Big Think’s Progress Issue is a must-read, especially Hannah Ritchie’s essay An End to Doomerism.

* [Blog] Morgan Housel on Three Big Things: The Most Important Forces Shaping the World

* [Paper] Down with Legalese. In this paper, authors confirm that “Poor writing, not specialised concepts, drives processing difficulty in legal language”

Insights on topical policy issues in India

— Pranay Kotasthane

The human-made floods in some parts of Bengaluru generated much furore. Writing about it in our previous edition, RSJ remarked:

The way the political economy is structured right now, it is difficult to see how there will be enough devolution of power and finances to a city. A big city most often is a bankrupt political orphan in India. It doesn’t look like changing any time soon.

I share his anguish. However, I remain hopeful because there are many global examples of cities first committing themselves to and then rescuing themselves from the tyranny of half-hearted decentralisation.

Decentralisation: Take 1

The term decentralisation is a catch-all term in public policy. There was a time when it was touted as the solution to all ills. But many PhD dissertations, journal papers, and World Bank projects later, we understand it better now. Throwing some light on this concept can help us put a finger on what’s exactly wrong with Indian cities.

Let’s begin by understanding the three forms of decentralisation — deconcentration, delegation, and devolution. Deconcentration is the simplest form of decentralisation. As the name suggests, it means decentralising functions and responsibilities. For example, if you can submit a passport application in Mysuru instead of having to come to the state capital, this function can be said to have been deconcentrated. The various government branch offices and grievance centre kiosks are examples of deconcentration.

Delegation means that specific functions are carried out by another organisation or the government nearest to the citizen on behalf of the more distant government. In the Indian case, the plethora of state public sector enterprises (SPSEs) for public transport, power distribution, and water distribution are examples of delegation. For example, BESCOM is a Government of Karnataka company tasked with the responsibility of supplying electricity to the state capital.

Devolution is the most comprehensive form of decentralisation. Devolved units hold defined spheres of autonomous action. Policy implementation and authority shift to the government nearer to the citizen. This typically means having elections at the subnational level. For example, Indian states are devolved units with clearly defined responsibilities, and tax revenue handles in the Constitution.

With these definitions at hand, we have one way to diagnose the dismal performance of our city governments: the Union-State government relationship is characterised by devolution, while the State-local government relation is characterised by delegation and deconcentration.

Elections do take place at local government levels. After the 74th Amendment in 1992, some more functions were devolved to urban local bodies. And yet, they hardly enjoy autonomy and authority in any defined sphere. State governments tightly control resources, personnel and plans, treating local governments as deconcentrated implementing agencies.

Decentralisation: Take 2

There’s another way to see the Indian experience in light of decentralisation theories. Decentralisation can happen along three dimensions — political, administrative, and fiscal. These dimensions are further characterised by four factors: authority, autonomy, accountability, and capacity. The USAID Democratic Decentralisation Programming Handbook has a helpful framework that combines these three dimensions and four characteristics. In the chart below, here’s how I think India’s urban governments fare on the twelve parameters at their intersection.

My crude classification into three categories is subjective and based on my understanding of local government public finances. Even so, this framework can offer valuable insights into India’s urban governments. First, they are characterised by poor capacity across all three dimensions of decentralisation. Hardly surprising. But here’s something more interesting: urban governments in India do pretty okay on administrative decentralisation, not so well along the political dimension, but score a big zero on the fiscal dimension.

Devesh Kapur writes, “At the heart of state-building is a fiscal story”. And so, it’s not unexpected that the sorry state of fiscal decentralisation is a powerful reason behind the abject failure of our urban governments.

The Way Ahead

And so, to fix our cities, we need energy and focus on improving along the fiscal decentralisation dimension. And how exactly do we get there? In this talk below, organised by the Bengaluru Navanirmana Party, I propose a few ideas for the Bengaluru government:

* “Wherever possible, charge”: underpricing leads to overconsumption. Cities ought to get better at generating non-tax revenues.

* Strengthen the State Finance Commissions. It’s amazing how bad they are, despite the example of the stellar performance of Union Finance Commissions. Untied grants through the state finance commissions are imperative for devolving critical political and administrative functions to urban local governments.

* Rent out property owned by city governments.

* Simplify laws for regulating businesses in the city so that trade license fees can go up.

* Capitalise on the property tax potential.

India Policy Watch #2: This Moment is Precious 

Insights on topical policy issues in India

— RSJ

The more perceptive among you, dear readers, might have espied a certain pattern in my posts over the past six months. On the one hand, my tone has been steadily bullish on the medium-term prospects of the Indian economy. Almost four months back, in edition #168, I concluded that the then-nascent Ukraine war and the inflation roiling the developed world have put India in a sweet spot among global economies. I wrote:

“I’m not often optimistic on these pages. But the way the stars have aligned themselves, India does have an opportunity to revive its economy in a manner that can sustain itself for long.”

Then in edition #182 (Aisa Mauka Phir Kahan Milega?), I sort of doubled down on this:

“For India, all of this is a golden opportunity. China will remain busy with these transitions that it has wrought upon itself. The jury is still out on whether it will have a soft landing on them. Global businesses that started seeking more resilient and cost-effective alternatives to China during COVID-19, are now convinced that they must employ a ‘China + 1’ model to safeguard their long-term interests. There are only that many economies that have the labour pool, capital and a business environment that can take advantage of this shift away from China, however gradual.

There is a high likelihood of a golden decade ahead for MSMEs in India if it plays its cards right.”

In the past couple of weeks, there has been a flurry of reports from global research firms echoing the same sentiments. IMF, usually the last to know what’s happening around the world, also seems to have cottoned on to this trend. This week its chief Kristalina Georgieva said that “despite global uncertainty and headwinds, India continues to be a bright spot in the global economy.”

The proximate reasons are evident all around. Domestic demand is strong, inflation isn’t the runaway kind, the bank balance sheets are stronger and cleaner than ever, and we seem to be seeing off the peak of the commodity cycle.

The other large emerging markets have their own troubles. South America is in the throes of one of its ‘how to shoot yourselves in the foot’ scenarios. Brazil is going through its most fractious election campaign ever, with the hard-left rhetoric of Lula seemingly ahead of Bolsonaro. That’s been enough for Bolsonaro to again take a leaf out of Trump’s playbook and raise doubts about the integrity of the electoral process. Venezuela has a Hugo Chavez bhakt running against a populist ‘outsider’ who wants to upend the system and start fresh. Turkey has an autocrat who turns macroeconomic theory on its head in running its economy. South Africa is muddling through, and Russia is mostly an international pariah at the moment. Indonesia and smaller economies like Vietnam and Laos are possibly the only emerging markets that can claim to be in a similar zone as India. There’s no competition, really.On the other hand, I have called out India’s remarkable ability to lose its way because of either overconfidence or distracting itself with a ‘zero return’ nationalist agenda of aatmanirbharta or some random ‘One Country - One X’ ideology. Like I wrote in edition #182:

“…not overdoing aatmanirbhar Bharat beyond the rhetoric and remaining an open and liberal democracy that convinces others that it will have sufficient checks and balances to not lose its way. These are the basic block and tackle moves to capitalise on the opportunity.

Because the only lesson to learn from a possible China misstep is that overdetermined leadership and top-down economic thinking eventually fail.”

It becomes challenging to plan for India's long-term prospects because of this dichotomy of being bullish on its economy while being worried about social harmony. I mean, one day, you applaud the entrepreneurial spirit taking root in small-town India and the other day, you hear another state enacting some love jihad law.

It is like that E. B. White quote:

“I arise in the morning torn between a desire to improve the world and a desire to savour the world. This makes it hard to plan the day.”

Anyway, for the sceptics on either side, I will try to go beyond the evidence that people are good at avoiding. There are structural reasons why both these arguments about India hold.Let’s tackle the issue of why India is in this sweet spot.Firstly, in the past few years, there’s been a retreat from globalisation, or hyper globalisation , as Dani Rodrik would put it. This was somewhat inevitable if you go by Rodrik’s trilemma: it is impossible to enjoy the fruits of integrating with a hyper-globalised economy, national sovereignty and being a democracy simultaneously, because only two of these things can be achieved at any one time. Rodrik believes that eventually, most large economies will choose national sovereignty and democracy and retreat from globalisation. This has come to a pass all over the world now. India, which has always been somewhat ambivalent about globalisation, now finds it doesn’t stick out because of this stance. This retreat has meant that any economy with a large domestic market is at a relative advantage. Through a fortuitous mix of demographic dividend and periodic fiscal stimulation, domestic demand in India is going strong. This will attract capital flow into the economy.Secondly, the widespread adoption of digital means for production and distribution has meant the traditional constraints of infrastructure and labour laws aren’t as binding as before. The national digital infrastructure in India (JAM, FASTag, UPI, etc.) is among the best in the world, and there’s evidence now that they are improving domestic efficiencies across multiple sectors. Even surface transport, railways and ports have improved substantially in the last few years. These are nowhere near world-class, but the improvement is sufficient to reduce service costs across industries. Also, while ‘retail’ corruption remains an issue in India, even the most prominent critic of the current government will admit that large-scale institutional corruption is a thing of the past. There are allegations of crony capitalism which might come back to bite in future, but for now, India provides as good a level playing field as any other emerging market.Thirdly, the aftermath of the pandemic has been surprisingly benign for India. The extended credit scheme for small businesses, free food distributed through PDS for BPL families and the restrain shown in keeping the fiscal deficit in check appear to have paid off. The national-level vaccination drive has all but erased the memory of those traumatic days of the second wave. Contrast that with China’s botched vaccination policy that is still hurting its economy.

I will confess I didn’t see this scenario unfolding. Even the Ukraine war and the rise in oil price has been managed well. In continuing to buy oil from Russia (now in INR) and allying with the US on Quad, India seems to have manoeuvred the geopolitical storm well. Despite strong misgivings in some quarters (with good reasons), the key institutions (central bank, market regulators) have stayed objective and independent in their policy thinking. The bar on strong and independent institutions in emerging markets is set really low, and India seems to be scaling it easily. Finally, the freedom to raise or issue debt in its own currency, the inflating away of debt that’s happening now and the flexibility of the labour market, all mean India isn’t in any near-term danger of stagflation that’s spooking the west.Many of the above factors can be credited to the sound policy measures taken over the past two decades. And, there’s, of course, the good fortune of being in the right time at the right place.All good.

So, why do I harp on the risks of social harmony and overdetermined leadership? Well, the history of many emerging countries is replete with such moments of opportunity in their history. Barring a few exceptions, most have failed to capitalise on them. They didn’t get their economics wrong. Most often, they failed on political and social fronts.It turns out that being a functional, liberal democracy does improve your odds of getting this right. However, in most cases of failure, countries turned more illiberal, assuming it won’t hurt them. Curbing freedom of expression, compromising judicial integrity, restricting voting rights of minorities and abusing coercive power of the State are classic moves here. This is abetted by creating an ‘us’ versus ‘them’ construct that takes over everything. The blame for any shortcoming can be laid at the doors of ‘them’, who typically include the old elites, intellectuals and some hapless minorities. Once this template is set, the divisiveness in the society between ‘them’ and ‘us’ is played up at every opportunity. The pitch is queered further by the revisionist history project to redress past wrongs, the mindless glorification of the nation, a continuous search for enemies among the ‘them’ and escalating levels of punishment for any deviation from the norm. The middle continues to shrink, and debates and compromises become rare. Everything is maximal. Many people think these moves won’t hurt the economy because in markets, as the Indian aphorism goes, ‘paisa bolta hai (money talks)’. This is both a flawed understanding of economics and a complete disregard for history. A society that loses its middle ground makes terrible choices. And that shows up in the economy.We have a tremendous economic opportunity because of the way cards have fallen in our favour. And we are making the classic mistakes in potentially fomenting social trouble and losing the opportunity again. I don’t understand why it is difficult to hold these two ideas together in our brains and find a way forward.There’s a possibility that this dichotomy could be solved if there were public discussions on these issues together. But it is rare to find that kind of a platform where a dispassionate and constructive discussion about India’s future is possible. Those who believe in the ‘sweet spot’ thesis have very little inclination or a sense of historical perspective to appreciate the existential risks of social disharmony. They are happy nodding off to ‘this is India’s time’ lullaby. While the others who bemoan the loss of what’s often called the idea of India cannot believe India could be, by design or happenstance, sitting on a golden opportunity under this regime. There must be a catch somewhere and they spend inordinate amount of time looking for it.

It reflects the barren intellectual landscape prevalent in India that we cannot acknowledge and debate these in good faith. You can only be monotheistic. There can only be one truth. Those who reject it are enemies.

It’s a pity really.

India Policy Watch #3: The Nature of Competitive Federalism in India

Insights on topical policy issues in India

— Pranay Kotasthane

It’s rare for semiconductors, federalism, and favouritism to appear in the same story. But the last week did blow up a political storm that combined the three. Vedanta-Foxconn signed a much-publicised Memorandum of Understanding (MoU) for a display and semiconductor fab with the Government of Gujarat. All was good. but then came the news that the consortium turned down the Maharashtra government’s reportedly superior offer, leading to accusations of the Union government having a hand in favouring Gujarat.

Keeping regional and partisan politics aside, how should we parse this news? Are there frameworks to help us appreciate such events?

At first, it appears encouraging that states are vying to kick off advanced manufacturing. It seems to be a perfect illustration of the merits of what is known as Competitive Federalism. States compete for investments, woo investors, and the best one “wins” the prize. Didn’t the Prime Minister say in his independence day speech that "it is the need of the hour that besides cooperative federalism, we need cooperative competitive federalism. We need competition in development”?

To answer these questions, it is worthwhile to understand the “competitive federalism” rubric. This term gained prominence in public finance literature after a 1987 paper by Albert Breton titled Towards a Theory of Competitive Federalism. Crucially, he identified two preconditions for competitive federalism to be efficient.

The first condition is competitive equality. This condition is similar to the logic behind affirmative action for individuals from disadvantaged communities. Healthy competition between states requires not just good umpiring but also progressive rule-making, one that does not put some states at a permanent disadvantage. In Breton’s words:

“horizontal competition does not require that all competing units be of equal size any more than efficient competition in markets requires that firms be of equal size. But it must be that the large units are not in a position to continually dominate, coerce, and in other ways prevent the smaller units from making independent autonomous decisions; nor are they in a position to inflict "disproportionate" damage on them. The smaller units must be able to compete with the strong on an equal footing.

… A capacity to compete is more than a capacity to talk; it is also, and radically, a capacity to exert a real influence on decisions. That is the real meaning underlying the notion of "monitored" competition.”

Breton identified that the responsibility for ensuring competitive equality lies squarely with the union government. In his view, two monitoring mechanisms available with the central governments are: intergovernmental grants that offset the disadvantages of certain states, and a “Council of States” that can genuinely give “salience to the provincial dimensions of public policies”.

The second condition is cost-benefit appropriability. As Breton puts it:

“In competing to attract businesses to its jurisdiction, either by supplying particularly attractive local public goods, such as theatre, concerts, or dance, by offering tax advantages, or by buying part of the output of the sought-after enterprises, the government of a province should not be able to shift the burden of the offered amenities to the citizens of other jurisdictions.”

In other words, states should be regulated by a hard budget constraint, i.e. the consequences of breaching spending limits should be significant. A moral hazard develops if states assess that the central government will bail them out in case of fiscal failure. When the budget constraints on states are of a “soft” nature, they will continue to borrow or widen their deficits, confident that other state and union governments will come to the rescue. Competitive federalism under such conditions would not be efficient.

A third precondition, proposed by M Govinda Rao, is that there should be no impediments to the unrestricted mobility of factors and products across the country.

This discussion of competitive federalism suggests that not all competitive federalism is good. It needs guardrails to deliver results. And the Indian experience with competitive federalism has been suboptimal as governments have violated all three preconditions to varying degrees.

As a result, we are stuck in a low-level equilibrium. States compete, but on issues such as wasteful subsidies on private goods, welfare schemes, and salary structures for government employees. And when they do compete to attract investments, they do so based on spectacular tax and non-tax waivers rather than on promises of better business and law and order environments.

To make India’s competitive federalism deliver, we need reforms along three dimensions:

* Reforms to ensure that states face a hard budget constraint. An independent fiscal council that ex-ante evaluates the costs of government proposals can help. Consider the fact that both Maharashtra and Gujarat allegedly promised subsidies worth Rs 40000 crores and Rs 28000 crores, respectively, without public scrutiny of the costs and benefits of the project. An independent fiscal council would come of use here by conducting an independent financial evaluation of such policies before they receive the final approval. A stricter Fiscal Responsibility and Budget Management Act can also help here.

* Reforms to improve competitive equality. Designing intergovernmental transfers that actually help bridge the gap between states will create a level playing field. Moreover, an institution that allows states and union governments to bargain and negotiate, like the one proposed by the 14th Finance Commission, might also contain unhealthy competition.

* And most importantly, a union government that acts as an unbiased umpire is crucial for competitive federalism to succeed.

Without some reforms along these lines, we will continue to see competitive federalism of the more harmful kind.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Raghuram Rajan’s note questioning the underlying assumptions of Production Linked Incentives.

* [Paper] Fiscal Decentralisation in Indian Federalism by M Govinda Rao explains India’s experience with fiscal devolution.

* [Report] The USAID Democratic Decentralisation Programming Handbook is a fantastic starting point for understanding decentralisation.

* From Alexis De Tocqueville’s magisterial Democracy in America, in which he writes: “the federal system was created with the intention of combining the different advantages which result from the magnitude and the littleness of nations; and a glance at the United States of America discovers the advantages which they have derived from its adoption”.

Global policy issues and their implication for India

— RSJ

There is an energy crisis in Europe. Russia announced this week that it won’t resume supplying gas to Europe via the Nord Stream 1 pipeline until the west lifts the sanctions over its invasion of Ukraine. Till last year, Russia accounted for about 45 percent of the EU's total gas imports. About a third of it flowed through Nord Stream 1. A few months back Russia halted supply via Nord Stream citing maintenance concerns. At least there was a pretense. Now the gloves are off. The weaponising of energy is complete. That apart you may have heard of this being the hottest summer in Europe in living memory. The rivers have run dry and hydel power generation is at an all-time low. The crisis is real. 

How bad is it? Well, if you go by estimates an average European household might end up spending over €500/month by March next year on their energy bill. This number was around  €160-170 /month a year back. This will mean an aggregated annual increase in energy spends in EU of about €2 tn. To put this in perspective, the total GDP of the member states is around €14 tn. No economy can take such a price surge in its stride, more so, when the inflation is already running at a multi-decadal high. Typically, they could do a few things to manage this. One option is to cap the prices of imported gas from Russia. The other is for the governments to absorb these price increases and lighten the burden for the people. The last option is to reduce demand by imposing rationing measures on people. The long term option is to move to renewables but that’s not going to help anyone during this winter.  

The idea of capping imported gas prices seems the easiest. Of course, price caps distort markets and will lead to other unintended consequences but you have to choose the lesser devil in scenarios like these. Except any price cap on Russian gas will mean you will have to deal with the wrath of Putin. On Wednesday, he gave EU leaders a peek into how he sees any attempt by the EU to impose a price cap. As CNBC reported:

Responding to EU proposals to implement price caps on Russian energy imports, Putin told business leaders in Vladivostok that Russia could yet decide to rip up existing supply contracts.

“Will there be any political decisions that contradict the contracts? Yes, we just won’t fulfill them. We will not supply anything at all if it contradicts our interests,” Putin said at the Eastern Economic Forum in Russia’s far east.

“We will not supply gas, oil, coal, heating oil — we will not supply anything.”

“We would only have one thing left to do: as in the famous Russian fairy tale, we would let the wolf’s tail freeze. Freeze, freeze, the wolf's tail,” he said.

Hmm. So, what’s this famous Russian fairy tale about a tail? The good, ol’ Pravda came to the rescue here:

In the tale, the cunning fox made the stupid wolf catch fish in the frozen river by putting his tail into an ice hole. The fox would hop around the desperate and hungry wolf saying "freeze, freeze, the wolf's tail" until the ice hole froze trapping the wolf in the ice. Men from the village then came and beat the wolf for all the bad things that he had done to them in summer. The wolf struggled and escaped, but his tail was left in the frozen ice hole.

I read that a few times to get my head around the fairy tale. It didn’t make any sense given the context. I guess Putin wanted to give some folksy spin to his threat of freezing Europe this winter. Maybe Russians enjoyed that. Anyway, the upshot of this threat was visible in the meeting of the EU ministers on Friday that was convened to discuss the energy crisis. The ministers deferred the proposal to cap price agreeing that it needed more work and deliberation. Also, there was no real proposal to force a reduction in demand among the member countries. There is a voluntary pledge of cutting it by 15 percent but that might neither be enforced nor be adequate. I guess the price surge, if allowed, will eventually bring down the demand but which politician will want that scenario to be played out? That leaves the option of a combination of rationing for industries (less politically sensitive) and government subsidies to manage the pain for people. That’s what different governments have been doing. France, as NYT reports, has asked businesses to appoint an ‘ambassador of energy sobriety’ while spending over €26 billion since the Ukraine war to keep gas prices in check.

Further:

Germany, Europe’s biggest user of Russian gas, reversed plans on Monday to shut down two of its three remaining nuclear power plants by the end of the year, and on Sunday announced a $65 billion aid package to ease the burden of high energy costs on citizens. Italy is looking to Algeria as a potential new supplier of natural gas to replace Russian fuel. In Spain, the government has begun a huge effort to improve energy efficiency in buildings and in industry.

Also, it is not as if the utility companies are making money hand over fist at this time. All utilities companies use derivatives available on utility exchanges to protect themselves from price swings. Typically, they lock in a price for the future to guard themselves against price falling. When prices surge, like they have now, they cannot cancel these derivatives and this leads to huge losses at least on paper. Eventually, if the prices remain elevated and the derivatives contracts run out (usually 6-9 months), the utilities will make a windfall. But till then the exchanges are at risk that the utilities will not be able to honour their derivatives contracts. So, the exchanges will demand that utilities give them cash collaterals for such an eventuality. What could be the size of such collaterals put together? A reasonable estimate is about €1.5 trillion. There is no way that utilities are sitting on that kind of working capital to stump up this collateral. For the markets to function efficiently and to avoid a Lehmann-like contagion, some solution has to be found. One is to cap the price and prevent further paper losses. But Putin has closed that option. Eventually, the governments will have to step in as the back stop. There’s a lot of heavy lifting the governments have to do. It will further raise their debt burden that’s already at their peak after the spending spree during the pandemic. The taxpayers will have to foot the bill; one way or the other. 

I don’t know about you but it doesn’t seem to me there are any good options left for Europe in the short run. Some kind of a structural solution can be worked out where the tariff deficit is allowed to be spread over a longer term, thus allowing the utility companies to securitize these future revenues. It is easier said than done though. The other scenario is for EU members to agree on price caps, Putin’s wrath notwithstanding. This will happen because humouring Putin isn’t a long term solution. That apart, there could be some forcible demand reduction, then a hope for a milder than usual winter and a scenario where there’s an increase in supply from the Middle-East and the US because of the likely move away to Russian oil and gas by China and India. A combination of all of these could help Europe tide this crisis over. It isn’t going to be easy at all.

Europe’s winter of discontent has begun. And it could be a long one. 

Meanwhile, Europe isn’t alone in the energy crisis.

Here’s the Washington Post on China:

Amid the most intense global heat wave in decades, China experienced another electricity crisis this summer. Ten months after surging coal prices drove widespread curbs on power consumption, parts of central and eastern China had to ration power after months of drought and scorching heat.

This year’s heat wave across central and eastern China ran for more than 70 days, the country’s longest stretch since such record keeping began in 1961. Rainfall dropped more than 45 percent across the Yangtze River basin, which supplies water to more than 400 million people.

Supply constraints, in turn, forced severe restrictions on power use in Sichuan and other provinces that tap into Sichuan’s power. Sichuan authorities imposed comprehensive restrictions on industrial power consumption starting Aug. 15, while neighboring Chongqing, a provincial-level municipality with a population of 32 million, introduced similar cuts two days later. Additional restrictions for commercial spaces and households meant limited access to cooling, even when daytime highs exceeded 100 degrees Fahrenheit.

And China’s short term response won’t be music to the ears of the climate warriors:

Authorities are likely to respond by expanding their alternatives to hydropower. This may well include building more coal-fired power plants, which are responsible for roughly 40 percent of China’s carbon emissions. The 2021 crisis saw the same response; provincial coal-fired power plant approvals rose almost 50 percent year on year in the first half of 2022 as the central leadership stressed the importance of “energy security.”

Thankfully, India has seen through its summer months before the global energy crisis has come to a head. The global demand for coal has surged as countries have been forced to hark back to thermal power plants to meet their energy needs. Almost 70 percent of electricity generation in India is from thermal power plants. The domestic supply of coal isn’t going to be enough and Indian companies will need to stockpile more for future security. This is an area to keep an eye on while looking at the macroeconomic indicators for India that otherwise look benign in a troubled world.  

Not(PolicyWTF): No Exports Without Imports

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

If one were to make a word cloud of our editions, the term “import substitution” would appear right in the centre, in angry red colour. On many occasions, we have highlighted that high import tariffs and Production Linked incentives (PLIs) are at cross purposes. The tariffs end up increasing input costs to such an extent that it negates the monetary benefits of PLI schemes. The result is that manufacturing in India remains as uncompetitive as it was earlier, despite the government providing significant financial incentives.

Given our abhorrence for higher tariff barriers, it was a welcome surprise that the Minister of State for Electronics and Information Technology released an excellent report on August 29th, which has empirical evidence on the importance of trade for creating a domestic electronics industry.

The report, titled Globalise to Localise: Exporting at Scale and Deepening the Ecosystem are Vital to Higher Domestic Value Addition in Electronics, is written by trade economists from Indian Council for Research on International Economic Relations (ICRIER). It makes a crucial point that should interest anyone interested in Indian public policy: India must first globalise and only then localise if it aspires to be a global production and export hub for electronics. I guess this recommendation would hold to a large extent in other sectors as well.

But let’s get back to electronics. The report highlights that both Viet Nam and India exported the same value of electronics items in 2010. But by 2020, Viet Nam’s electronics exports had become seven times that of India’s. What just happened?

The report argues that the reason could be the difference in trade strategies followed by Viet Nam and China on one hand, and by India on the other. The difference is this. Indian governments have pursued a strategy of simultaneously increasing electronics exports and boosting domestic value addition per unit of total demand. For increasing exports, governments used tax rebates and built special economic zones. For boosting domestic value addition, governments deployed higher custom duties for components, and local sourcing norms for public procurement.

In contrast, both Viet Nam and China focused on growing their exports at scale first. At first, this led to a decrease in the domestic value added per unit of demand. This is because companies preferred to import components, assemble, and then export them. Only after electronics exports had achieved global scale did the two countries target local content addition. That too, through instruments such as sourcing fairs and technology upgradation programmes, instead of erecting trade barriers. Over time, not only did the exports continue growing, but also a competitive components industry mushroomed.

Hence the report suggests that India too should first globalise and then localise. The comparative analysis in the paper is illuminating. I’ll leave you with the recommendations chart, which has specific ideas for putting this strategy into effect.

From a political economy viewpoint, it’s interesting that the electronics ministry unveiled this report. I hope that it suggests that the government is willing to reconsider its strategy of high custom duties for domestic value addition. To become a global manufacturing hub, we need to internalise that import substitution is self-defeating.

PS: This report’s analysis also makes for an excellent public policy teaching resource.

India Policy Watch: Kaun Kitne Paani Mein?

Insights on topical policy issues in India

— RSJ

This week Bangalore had rains.

Tip tip barsaa paani.

And paani ne aag lagaa di.

Pictures of streets of Bangalore looking like a river in spate with high-end luxury cars drowning in them made the rounds. The poor took the usual brunt. The familiar lament of lack of urban planning, the venality of municipal corporations in big cities and the apathy of citizens soon followed. Such flooding is a common phenomenon now even in cities that don’t have a history of heavy rainfall. Over the past few years, there have been similar pictures from Chennai, Hyderabad and Pune.  

There are four factors at play here.

First, there’s climate change. It could mean different things to different people. But let’s accept short bursts of intense and often unseasonal rainfall is a thing now in many parts of India and the world. It didn’t happen this often in the past. So, expect flooding when you get more than 150 mm of rainfall in under 3 hours in a densely populated urban landscape like it happened in Bangalore this week..

Second, urbanisation is good for India and it will only gather more pace. Cities provide network benefits, greater opportunities and they help diffuse historical identities that get in the way of social mobility. New cities or satellite towns cannot be planned and developed top down like many policy makers think when they announce such plans. So, there’s no point arguing for reducing the burden of a large city by proposing a plan to ‘develop’ new cities. A city emerges organically on the back of the millions of individual transactions that continue growing because of network effects. You cannot control them though you can anticipate their growth and plan to manage it. That planning is totally absent in India. The numerous cases of lake beds and natural reservoirs being usurped for construction, the lack of any thinking about the topography of a location and the flow of water in it before allowing for buildings to come up and consistent reduction in green cover - all of these mean there’s nowhere for water to go except flood homes and then stand still till it is pumped out.

That brings me to the third point. The way the political economy is structured right now, it is difficult to see how there will be enough devolution of power and finances to a city. A big city most often is a bankrupt political orphan in India. It doesn’t look like changing any time soon.

And lastly, you have to ask how long will citizens remain stoic and manage their lives through these great difficulties? Should we beware the fury of the patient?

Among these four, I don’t foresee any correction of course for the first three factors. They will continue in the same vein. That leaves only the citizen. She will have no choice but to accept these as inevitable and then find private solutions to what are public problems. These solutions will tend to be locally optimal but suboptimal for the whole. The numerous gated communities that try doing this are examples of this. You can live in a gated republic and keep the state away. But nature is a different ballgame. It doesn’t care for your gates. Things will only get worse for citizens.

Will there be a tipping point, I often ask myself? I don’t think so. People will grin and bear it. And then forget it.

Resilience of the people is the timeless safeguard against a revolution. 

Matsyanyaaya: Chip Trouble

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

In a Politico article earlier this week, the authors explain Russia's desperate attempts to get hold of some pretty basic integrated circuits (chips) for military equipment. This news comes closely after the delays in delivering frigates to Indian Navy. The Indian government would do well to keep a close eye on these developments.

Regardless of Russia's intent, its defence production competence has been set back many years because of the coordinates sanctions. This means India should develop contingency plans for all pending military platform deliveries from Russia.

Russia doesn't have reliable semiconductor manufacturing facilities of its own. We should expect that it will try to get hold of these legacy-node chips through the black market. We should also expect that some Chinese foundries like SMIC might come to Russia's rescue. In either case, it has the same lesson for India - Russia's ability to deliver secure military platforms to India has taken a big hit. We should seek other alternatives.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] This post by Hannah Ritchie on effective but counter-intuitive ideas on climate change action is gold.

* [Book] This excellent book, Global Value Chains and the Missing Links Cases from Indian Industry by Saon Ray and Smita Miglani

* [Article] S Vishwanath has the most informative article on the Bengaluru floods.

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

In the past, we have discussed many government plans of the “One Nation, One X” kind. Still, I must confess. Of all things that can substitute the letter X, “fertiliser” was beyond my thinking horizon. Limited thinking wasn’t a problem for the government, which has:

“decided to implement One Nation One Fertiliser by introducing single brand name and the logo under fertiliser subsidy scheme namely Pradhan Mantri Bhartiya Janurvarak Pariyojana (PMBJP).”

While you decipher what this order means, a short detour about the abbreviation PMBJP is in order. Its usage suggests something profound — the government is finally running out of acronyms! I claim so because there’s an existing scheme with the same abbreviation in the very same ministry — the older Pradhan Mantri Bhartiya Janaushadhi Pariyojana (PMBJP), run by the Department of Pharmaceuticals since 2008. Perhaps the reason for repeating this abbreviation is apparent — it comprises both the ruling party and the party leader. To make matters more confusing, this scheme has been hailed as “the call of #NewIndia which will take our nation to greater heights” by a politician whose name also abbreviates to BJP.

The new PMBJP seems utterly bizarre at first. Why would the government want all companies—government-run or private—to sell their products under a single brand name of ‘Bharat’? Why would a government order go to such lengths to specify that “Two-thirds of the area on the top half of a fertiliser bag will be used for the official branding and logo of the PMBJP while a fertiliser firm can use the rest one-third area for its own logo and branding as well as printing other information relating to the product”?

If you dig deeper, the bizarreness gets replaced by a sense of rejection. The diktat to dissolve the value of all fertiliser brands only takes the veneer off the sham called a market for fertilisers. Here’s how.

The fertiliser sector is insanely regulated even by Indian standards. It all began with good intentions. One of the components of the Green Revolution was to subsidise agricultural inputs. And so, a fertiliser subsidy was introduced. The government fixed the retail price of urea fertiliser considerably below the market price to encourage its usage.

This difference between the market and administered prices was called “fertiliser subsidy”. The government paid off the difference to fertiliser companies with taxpayers’ money. Simultaneously, the government started running fertiliser plants to increase supply. Combined with the Minimum Support Price (MSP) mechanism guaranteeing procurement of certain grains, these measures worked to the extent that Punjab, Haryana, and a handful of other states were able to increase grain production rapidly. The fears of India’s dangerous “population bomb” subsided.

But as you might anticipate, interfering with prices had unintended consequences. An overuse of subsidised fertilisers led to a decline in soil quality. An artificially low price also led to the diversion of urea for non-agricultural uses. Urea is a versatile material used in textiles, paint, explosives, and medicinal sectors. Naturally, people purchased cheap fertilisers from retail shops and diverted them to these industries.

The government then introduced the Fertiliser (Movement Control) Order, 1973. Fertiliser couldn’t be sold across states within India without the ministry's permission. Instead, state-level fertiliser requirements were aggregated at the union ministry level, and each state had its quota “allocated” from in-state and select out-of-state fertiliser manufacturing facilities. And, of course, there were the usual export restrictions until recently.

Essentially, there’s no such thing as a market for fertilisers. Just as MSP effectively turned farmers into government employees, the fertiliser subsidy turned manufacturers into satellite government agencies meant for supplying fertilisers.

Meanwhile, the fertiliser subsidy bill kept rising. It is now the union government’s second-largest explicit subsidy, behind only food. For reference, India spent more on fertiliser subsidy last year than it did on defence capital expenditure. This year, higher international prices due to the Ukraine war mean that the government’s fertiliser subsidy bill will shoot up further. And so, the government decided: if we’re going to pay Rs 2 lakh crore to our fertiliser contractors (companies) annually, why not claim the full credit for it? And that’s how we got the One Nation, One Fertiliser scheme. While the name might seem bizarre, it is just the high point of continued government interference in this sector.

We can anticipate the unintended consequences. Fertiliser companies—now unable to differentiate their products—will be further disincentivised from improving or innovating. With the PMBJP branding at the front and centre of every fertiliser bag, the endowment effect of the subsidy will grow stronger. It’s now explicit that the government supplies fertilisers to farmers, not companies. Which government will now take the risk of being seen as anti-farmer by reducing this subsidy bill?

A better alternative would’ve been to eliminate all complex controls over the fertiliser sector and increase the amount provided as income support to farmers under the PM-KISAN scheme instead. A subsidy to fertiliser manufacturers made sense in the 1960s due to food shortage. It continued to make some sense until there was no way to identify farmers. But now, with an income support scheme already identifying farmers via Aadhaar, it is unconscionable to direct taxpayer money for another subsidy programme. We are stuck in a low-level equilibrium that just keeps getting worse.

Global Policy Watch #1: Karza Maaf Karo

Global issues and their implications for India

— RSJ

The wonderful thing about bad ideas is how so many politicians find them good. Good ideas must go through the steeplechase of policy proposals, committees and reports. Then they run the marathon to solicit bipartisan political support and public acceptance. And, if they are lucky, they make the finish line alive. No such test of endurance for bad ideas. They fly past these hurdles flipping the bird to them. Time and place don’t matter. Bad ideas are welcome. Everything, everywhere, all at once.

The immediate cause for that short ode to bad ideas is the announcement by the Biden administration this week of a student loan forgiveness programme. If you missed the news, here’s a summary from New York Times:

“President Biden announced a plan on Wednesday to wipe out significant amounts of student loan debt for tens of millions of Americans, saying he would cancel $10,000 in debt for those earning less than $125,000 per year and $20,000 for those who had received Pell grants for low-income families.

Students who received Pell grants will be eligible for $20,000 in debt forgiveness on their loans. About 60 percent of borrowers have received Pell grants, and the majority come from families making less than $30,000 a year. The Education Department estimates that 27 million borrowers will qualify for up to $20,000 in relief.

Millions of other borrowers will be eligible for $10,000 in debt relief, as long as they earn less than $125,000 a year or are in households earning less than $250,000.”

Good Intentions

What will this cost the exchequer? There is a wonderful report on this by the Penn Wharton Budget Model team at the University of Pennsylvania. It has a detailed analysis of the impact of the announcement. I will leave you with the summary:

“President Biden’s new student loan forgiveness plan includes three major components. We estimate that debt cancellation alone will cost up to $519 billion, with about 75% of the benefit accruing to households making $88,000 or less. Loan forbearance will cost another $16 billion. The new income-driven repayment (IDR) program would cost another $70 billion, increasing the total plan cost to $605 billion under strict “static” assumptions. However, depending on future IDR program details to be released and potential behavioral (i.e., “non-static”) changes, total plan costs could exceed $1 trillion.”

All right. $605 billion under static assumptions and $1 trillion based on future behaviour changes. I will bet this will easily go north of that number because such announcements change the credit culture of a society. We, Indians, know it. So, apart from the $1.9 trillion that Biden announced early last year as part of the COVID-19 relief and build back better package, we have another trillion of stimulus being given back to largely the top two quintiles of the US households. A trillion here, a trillion there, and pretty soon we are talking about real money, to misquote that famous quip by Senator Dirksen. 

Of course, there are these pious reasons for this policy from the White House press release:

“Since 1980, the total cost of both four-year public and four-year private college has nearly tripled, even after accounting for inflation. Federal support has not kept up: Pell Grants once covered nearly 80 percent of the cost of a four-year public college degree for students from working families, but now only cover a third. According to a Department of Education analysis, the typical undergraduate student with loans now graduates with nearly $25,000 in debt.

The skyrocketing cumulative federal student loan debt—$1.6 trillion and rising for more than 45 million borrowers—is a significant burden on America’s middle class. Middle-class borrowers struggle with high monthly payments and ballooning balances that make it harder for them to build wealth, like buying homes, putting away money for retirement, and starting small businesses.

For the most vulnerable borrowers, the effects of debt are even more crushing. Nearly one-third of borrowers have debt but no degree…”

A college education is a passport to higher income and better life in the US. It is the single most significant determinant of social mobility. Two data points from this Pew report puts this in context.

First, in 2021, full-time workers ages 22 to 27 who held a bachelor’s degree, but no further education, made a median annual wage of $52,000, compared with $30,000 for full-time workers of the same age with a high school diploma and no degree.

Second, households headed by a first-generation college graduate – that is, someone who has completed at least a bachelor’s degree but does not have a parent with a college degree – had a median annual income of $99,600 in 2019, compared with $135,800 for households headed by those with at least one parent who graduated from college. The median wealth of households headed by first-generation college graduates ($152,000) also trailed that of households headed by someone with a parent who graduated from college ($244,500).

A college education helps you earn more. And if you have two generations of college education in your family, you’re made. This should be a sufficient incentive for people to take the risk of a college loan and graduate because it does make a difference. Also, the so-called debt burden as a percentage of income is disproportionately high among people who take student loans but don’t graduate. About 40 per cent of students who take loans never graduate. They find it difficult to shrug off the burden throughout their lives. 

Unintended Consequences

When you look at the data together, you should reach the following conclusions:

* A college education is an expensive affair in the US. The universities have gotten richer over the years, with their trust funds rivalling many private fund houses. The universities seem to have kept the supply limited. The demand has kept soaring, and the somewhat easy availability of credit has meant college fees have grown faster than inflation. The nature of regulations and a stranglehold on accreditation by universities have meant no meaningful disruption in the college education space. A few attempts were made during the pandemic with digital courses, unbundling of the university stack and income share agreement models of funding college education, but they seem to have lost steam once the world got back to normalcy. The universities can continue to retain their oligopoly and set their own prices without real fear of disruption.

* Then there is a question of alignment of incentives between the borrower and the lender. A college education is the most critical factor for higher income in US society. For the average student, the risk of taking a loan is worth it. Also, taking a loan and not completing college has terrible consequences. This is not some kind of design flaw that’s increasing inequity. It is how it should be. 

* Lastly, the US university system is the best in the world for a reason. It is difficult to get in. You pay a premium for the degree, that money allows the universities to hire and retain faculty who then tend to be of high quality, and it funds research that pushes the boundary of human knowledge. 

The debt forgiveness program of the Biden administration doesn’t solve the fundamental issue of high college fees. Neither does it strengthen the alignment of incentives between the lender and borrower. In fact, an announcement like this will possibly spur more college applications in future in anticipation of future relief packages like this. That will raise the demand for college seats and increase tuition fees further. 

Worse, as many have already pointed out, such relief packages have a moral hazard built in. We have written about this in the context of farm loan waivers in India. There are two problems here. When you waive the loans, what do you tell those repaying their debts regularly at great costs to themselves? That they were stupid to do so? Secondly, you have set a precedent for future packages like this. Once that mindset sets in, more borrowers will be taking loans and defaulting because they know the government will bail them out. Mihir Sharma has drawn exactly this parallel with the Indian case in his Bloomberg column this week. He writes:

“But the consequence of loan waivers, as they are called in India, have not been at all positive for farmers. Economists have noted that the waivers have encouraged farmers to take on more credit than is justified by their productivity, saddling them with more debt. This cycle of forgiveness and indebtedness reduces the overall flow of agricultural credit, while privileging the minority of borrowers willing and able to game the system. Over the years, multiple cycles of debt forgiveness have not improved household savings, investment or credit flow.

…

In other words, once you announce a loan waiver program, the incentives of borrowers and politicians change to make both future defaults and future forgiveness more likely. In the US, it’s entirely likely that future administrations will succumb to demands to extend bailouts to those with private loans, for example, or to raise the cap to something more like $50,000 per person.”

The other problem is inflation. The consequences of mindless packages since the beginning of the pandemic are there for all to see. The US inflation is at a 40-year high. This relief package will put more money in the hands of the middle class that is already using its excess savings built up during the pandemic to drive up prices. The Fed has been pushing up interest rates to tame inflation. There’s a serious possibility of a recession and debt defaults among the most vulnerable borrowers because of rising rates. More importantly, if the market starts believing that the government doesn’t care about inflation, then high inflation expectations will lead to a real increase in prices. Inflation is expectation driven. It is a self-fulfilling prophecy. That’s why the Fed is careful about its words and why analysts spend so much time parsing its statement. Who in their right mind would want to do this now and set such expectations?

The inflation point is particularly important to the rest of the world and to India. Otherwise, who cares what student loan policies are pursued by the Biden administration? Unfortunately, US inflation, interest rates and growth matter to us, as we have already seen in the past few quarters. This bonfire of good economic thinking will singe us. 

But the persistence and universality of bad ideas cannot be easily fought. There are always short-term reasons to contend with and, of course, elections to be won. Biden’s move is to shore up his popularity among the youth and possibly give Democrats a fighting chance in the mid-terms. These don’t turn out well. But who cares about the future? 

India Policy Watch: The Elements of Revdi Culture

Insights on burning policy issues in India

— Pranay Kotasthane

The PM’s revdi culture remark castigating state governments for distributing freebies has been widely debated over the last month. Everyone and their uncles have dipped their toes in the discourse stream. Those on the left have tried hard to prove that freebies are, in fact, desirable social sector spending. Those aligned with the government have highlighted the fiscal imprudence of state governments handing out laptops, TVs, and mixer grinders before elections.

My only advice is to read more public finance specialists on this issue and fewer political scientists. What classifies as a subsidy or freebie? Which level of government is guilty of doling out freebies indiscriminately? The discipline of public finance has a lot to offer on such questions. The landmark paper on subsidies in India is by M Govinda Rao and Sudipto Mundle in 1991, in which they devised a subsidy classification. They neatly define a subsidy as:

the difference between the cost of delivering various publicly provided goods or services and the recoveries arising from such deliveries.

Based on this broad definition, we can classify subsidies along two axes: the nature of the good or service subsidised (merit vs non-merit) and whether they are recognised as subsidies in government accounts (implicit vs explicit). The chart below is my representation of subsidies at the intersection of these two axes.

Of the four categories of subsidies, we can now define freebies as non-merit goods which are explicitly or implicitly subsidised by the government. The bone of contention here is the “meritorious” nature of goods. The above paper takes a liberal approach and classifies any good with positive benefits to people beyond the recipient as a merit good.

This classification now allows us to understand freebies' volume and nature better. The 1991 paper found that Indian governments were collectively spending almost 15 per cent of GDP on subsidies.

Continuing this line of inquiry, Mundle and Sikdar find that the total volume of subsidies had fallen to 10 per cent of GDP by 2015-16. The union government only accounted for 30 per cent of this subsidy bill. State governments accounted for the remaining ~7 per cent of GDP spent on subsidies. Crucially, states subsidised both merit and non-merit goods/services. Since social services like health and education are the primary domain of states according to the constitution, they end up spending ~3 per cent of GDP on such merit goods. The remaining 4 per cent of GDP was spent on non-merit goods.

So, the PM’s statement is not incorrect. Both state and union governments have to set their house in order, but on freebies, the state governments have a lot more work to do.

The punchline from Sudipto Mundle’s article in Indian Express is vital gyaan for anyone working in Indian public policy:

.. four “merit” subsidies account for only a third of total subsidies. Thus, two-thirds of total subsidies, about 6 per cent of GDP, are unwarranted freebies which should be eliminated. .. if central and state governments could step beyond their business as usual budgets and take bold measures to phase out these unwarranted freebies, along with much of the tax exemptions and concessions, which amount to about 5 per cent of GDP, that would free up huge fiscal space. This would enable a massive reduction in the combined fiscal deficit of the Centre and the states, while at the same time stepping up required expenditure on education, health and infrastructure. The myth of restricted fiscal space simply reflects the missing appetite for deep fiscal reforms which could radically change the structure of central and state government finances.”

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Global Policy Watch #2: Falling In Love With “Your” Politician

Global issues and their implications for India

— RSJ

Taking the cue from the loan forgiveness piece, the question often asked is why do politicians behave the way they do when it is evident that the long-term consequences of their actions will be bad? Like I mentioned a few weeks back, I have been reading an anthology of essays by Bryan Caplan titled - “How Evil Are Politicians?: Essays on Demagoguery”. Caplan introduces the notion of power-hunger in one of the essays and how rational politicians continue to raise it and then try their best to satiate it. 

Caplan writes:

“In Public Choice, also known as “economics of politics,” we usually assume that politicians are motivated not by greed, but by power-hunger.  Of course, we rarely utter the word “power-hunger.”  Instead, we call it “vote maximization,” just as we call greed “profit maximization.”  But when Public Choice pictures politicians, it pictures humans filled with lust for power.

Is this a reasonable picture of politicians’ psyches?  Absolutely.  That politicians crave power is as undeniable as that businesspeople crave profits.”

Then he argues that democracy and its check and balances might blunt this naked pursuit of power, but that is never enough. He writes:

“Under democracy, politicians are less candid about their motives; they need us to like them, and power-hunger is not likeable.  But given its ubiquity throughout most of political history, can we really believe that the motive of power-hunger is no longer paramount? 

Once you thank the stars you aren’t ruled by Louis XIV or Lenin, a grim truth remains: democracy gives power-hungry politicians far worse incentives than the market gives greedy businesspeople.  Above all, voters – unlike consumers – have no incentive to be rational, spurring power-hungry politicians to preach and practice endless demagoguery.  It’s gotten worse lately, but it’s always been terrible.  Democracy hasn’t turned politicians into decent human beings; it’s only gilded their age-old power lust with altruistic hypocrisy.”

So, what’s the solution?

Eternal vigilance. And not to be enamoured by any politician and their promises of making your nation great again or reclaiming your deserved vishwaguru status. That’s easier said than done in these days of tribal loyalties and mass disinformation. Bad policies have a lot going for them. 

HomeWork

Reading and listening recommendations on public policy matters

* [Post] Pakistan is facing a terrible flood event. And the political debate there is not very different from the one we have whenever there's a drought or flood in India. The linked post discusses how causal stories are deployed for telling disparate political stories about such events.

* [Article] Ritesh Rautela and Anurodh Giri have a good take on India’s fertiliser subsidy program for nextbillion.

* [1, 2] The two-part article on Subsidies, merit goods, and fiscal space is well worth a read.

Global issues and their implications for India

— RSJ

In a few editions in the past, we have alluded to structural challenges in the Chinese economy and the window of opportunity that it presents India. I thought it would be useful to take a more comprehensive view of this. 

China reported a GDP growth of 0.4 per cent in the quarter that ended in June 2022. China's National Bureau of Statistics (NBS) isn’t known for its allegiance to truth. It is safe to assume the real GDP would have shrunk in the quarter. The daft ‘zero Covid’ policy led to total lockdowns in major cities during the quarter. The government crackdown on the real estate sector has meant that investment in the sector fell sharply. These contributed to the slowdown. Two other data points are interesting to note. The unemployment rate among the youth aged between 16-24 was at an all-time high of about 20 per cent. Also, retail sales continued to be weak at about 2.7 per cent, much below the 5 per cent forecast. Domestic consumption, the great desire of Chinese policymakers, remained sluggish. The spokesperson for the NBS put up a brave face while spinning these numbers as short-term bumps on the road. He raised the possibility of global stagflation and its negative impact on China to possibly justify weak numbers in the future. 

But is this slowdown just a blip in the impressive rise of China in the past three decades? I’m not sure. There are three transitions underway in China right now. It is difficult for nations to pull off any one of these in normal times. To attempt three simultaneously is ambitious. It is most likely to fail. Anyway, back to these transitions.

* The first transition started a few years back. This was forced on it because economics doesn’t bow to the party's diktats. China is finding it difficult to transition from a manufacturing-heavy, investment-led economic model to a consumption-driven one. This couldn’t be avoided. There would always be a limit to the world’s capacity to absorb China’s imports. Also, as China grew richer, it knew its low-cost edge in manufacturing would wither away. So after a few years of structural overinvestment in building capacity - the bridges to nowhere, the ghost cities, empty airports and other excesses - it had to pivot to a consumption-driven economy. It did try to delay the inevitable transition by aiming to export this overcapacity through its belt and road initiative. But after the initial hoopla, most countries have come to see it as what it is. A debt trap. So, this transition was necessary to move away from growth predicated on size and scale of investment to a more sustainable model of higher quality. But this is proving to be difficult. The history of unproductive investments has led to a debt build-up in the system (the debt to GDP ratio in China is over 300 per cent) and a drag on productivity that will continue for a long time. The state-owned enterprises (SOEs) that led this investment-driven growth are in a debt trap, and many continue to stay afloat by evergreening their loans. New productive investments have suffered because of this. People aren’t sure of their future, so instead of consumption, there’s an increase in domestic savings. Also, the pandemic and the recent lockdowns haven’t helped consumption growth. This is going to be a long, painful road.

* The second transition has been brought upon it because of its confidence in creating a ‘patterned’ society based on a premeditated design of the society. The prime example of ignoring spontaneous order was its plan to control the population through a one-child policy. China is now past the peak of its demographic dividend. The Labour force in China peaked in 2015 at around 800 million. It has now shrunk to 783 million, almost what it was in 2010. In the next 15 years, this is projected to go down to about 650 million. The stupid notion of the population as a liability has meant a rapidly shrinking and ageing workforce. The government has now reversed the one-child policy with a two-child policy without learning that such top-down interventions worsen things. Other similar ideas like patterned migration from villages to specific cities, controlling information flow for its citizens and taking some lofty top-down emission targets that have contributed to a serious energy crisis right now will also turn out the same way. The fault isn’t in their stars but in their ideology.  

* The final transition is the more perplexing one. This was articulated in a speech by Xi Jinping on August 17, 2021, where he introduced the notion of ‘common prosperity.’ This marked the most cogent articulation of Xi’s shift towards greater ideological rigidity. The days of economic growth based on ideological compromises were coming to an end. As Xi mentioned, ‘common prosperity is the essential requirement of socialism and an important feature of Chinese-style modernization’ and China ‘must resolutely prevent polarization, promote common wealth, and achieve social harmony and stability.’ The crackdown on the consumer tech sector (virtually destroying Jac Ma’s empire) and the ‘three red lines’ drawn for the real estate sector, that has disproportionate weight on its economy, should be viewed in this backdrop. It is unclear whether this is a real commitment to ideology or a way to consolidate his position as dictator-for-life by appealing to the masses. But Xi has doubled down on this, as seen by his remarks at the World Economic Forum:

"We will first make the pie bigger and then divide it properly through reasonable institutional arrangements. As a rising tide lifts all boats, everyone will get a fair share from development, and development gains will benefit all our people in a more substantial and equitable way,"

In my (very broad) view, Xi has concluded that China might have peaked in economic growth. You start talking about redistribution and ‘dividing it properly’ when you know the pie won’t grow at the same rate as it was earlier. Importantly, I also suspect this is the reason why Xi is acting like a bully in the neighbourhood. If you know you have hit the peak of your geopolitical and geoeconomic leverage, you will be foolish to let the moment pass without maximising your gains.

Some might argue furnishing other economic data that this ‘peaking’ theory isn’t true. China is still a global manufacturing engine. Its trade surplus has ballooned in the past year suggesting the world is hungrier for its goods. And so on. There’s this insightful column by Michael Pettis in FT that I will quote, which puts in perspective the record trade surpluses that China has been notching up in recent months while making these three transitions together.

Pettis writes:

Contrary to what many assume, the country’s burgeoning trade surplus is not a symptom of manufacturing prowess, nor is it evidence of a culture of thrift. It is instead a consequence of the great difficulty China has had in rebalancing its domestic economy and reining in its soaring debt. This is because the very conditions that explain stagnant domestic consumption also explain the rapid growth in Chinese exports relative to imports.

Beijing has known the solution to this problem for years. In order to control soaring debt and the non-productive investment it funds, it had to rebalance the distribution of income by enough that growth would be driven mainly by rising consumption, as is the case in most other economies. But this requires a politically-difficult restructuring of the economy in which a larger share of total income — as much as 10-15 percentage points of GDP — is transferred from local governments to Chinese households.

This is why the trade surplus matters. In recent years, Beijing has tried to slow the growth in debt by reducing non-productive investment in property and infrastructure. This year, as we saw with Evergrande, Beijing came down hard on the property sector.

If a rising share of China’s total income had been going to ordinary households, the resulting reduction in investment by property developers could have been balanced by a rise in consumption. But that’s not what’s happened. In the past two years, partly as a consequence of the Covid pandemic, growth in wages has actually lagged behind growth in GDP. The share Chinese workers have received of what they produce has declined rather than increased, and with it so has the share they are able to consume.

Rising exports are usually a good thing, but for countries like China, rising trade surpluses are not. In this case they are symptoms of deep and persistent imbalances in the domestic distribution of income. Until the country is able to reverse these imbalances, something which has proven politically very difficult, these large surpluses are just the obverse of attempts by Beijing to control debt, and so they will persist.

For India, all of this is a golden opportunity. China will remain busy with these transitions that it has wrought upon itself. The jury is still out on whether it will have a soft landing on them. Global businesses that started seeking more resilient and cost-effective alternatives to China during COVID-19, are now convinced that they must employ a ‘China + 1’ model to safeguard their long-term interests. There are only that many economies that have the labour pool, capital and a business environment that can take advantage of this shift away from China, however gradual. To me, it might be faster than what we all anticipate. And it will pass India by if it doesn’t stay alert to its possibilities.

There is a high likelihood of a golden decade ahead for MSMEs in India if it plays its cards right. A long overdue factor market reforms (possible at the state level), kickstarting a government capex cycle that will instil confidence in the private sector to follow suit, not overdoing aatmanirbhar Bharat beyond the rhetoric and remaining an open and liberal democracy that convinces others that it will have sufficient checks and balances to not lose its way. These are the basic block and tackle moves to capitalise on the opportunity.

Because the only lesson to learn from a possible China misstep is that overdetermined leadership and top-down economic thinking eventually fail.

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India Policy Watch #1: A Potent Cocktail

Insights on burning policy issues in India

— Pranay Kotasthane

The ongoing political saga in Delhi over a new (now suspended) excise policy is a heady cocktail for policy analysts. The cocktail’s components include a tussle over alcohol licenses, Maximum Retail Price (MRP), privatisation, regulation, allegations of corruption, rent-seeking, and political contestation.

The political motivations behind the current actions are quite clear. But it might be useful to look at the under-discussed policy aspects of the debate. Useful, because it’s not the last time we have seen a stand-off on alcohol policy.

The underlying motivation for the Delhi Excise Policy 2021-22 is to increase government revenue. Although we know that the best way to do that is lower the tax rate and broaden the base, India’s poor economic performance over the last decade has made it politically risky to bring additional people under the tax net. Hence, states are opting for the easier—and counterproductive—option instead: raise tax rates.

With the GST taking away the power to raise tax rates on most items unilaterally, state governments are exploring other options. One lucrative option is liquor excise. The Indian State heavily regulates the production, sale, and consumption of alcohol. Streamlining the licensing policies for the production and sale of alcohol can generate non-tax revenue, while higher overboard consumption can result in an increase in tax revenue (excise duty). One reform, two revenue handles. This is why the Aam Aadmi Party (AAP) governments in Delhi and Punjab have set their eyes on this sector. Moreover, raising the fees on government-provided private goods doesn’t fit its existing political persona.

To be fair, the Delhi Excise Policy 2021-22 is fairly progressive. It states that the policy's objectives are to augment the state excise duty revenue, simplify liquor pricing, prevent duty evasion, and transform the liquor trade commensurate with Delhi’s position as a city of global importance.

To achieve these objectives, the policy aims to award new licenses for alcohol sale, dividing the city into 32 zones, with a fixed number of shops allowed per zone. It aims to end government-run booze shops, distributing those licenses to private players instead. To foster competition, it allows shops to offer discounts below the Maximum Retail Price (MRP), permits shops to stay open till 3 am, and authorises bars to serve alcohol in licensed open spaces.

A report in the Business Standard captured the view of a craft beer brand as follows:

“The new excise policy is facing teething issues like any other but we find the policy very good since there is now a lot more opportunity to showcase our brand. Earlier, stores were dingy with no proper brand display, but now the stores have a mandated minimum floor area and are women-friendly. This helps with visibility of our brand.”

There were quite a few initial hiccups. Some dealers started giving deep discounts to capture the market. That led the government to change the no-MRP policy to a “discount only up to 25% of MRP” policy. After that, retailers started offering “buy one bottle, get another free”. And hence, big dealers could attract more customers, while the smaller ones were finding it difficult to compete. Some licenses didn’t attract any buyers at all. These seem to be transient-state shocks. The steady-state promised to be much better.

Alas.

Reforming a tightly regulated policy area in which powerful rent-seekers have flourished for decades is not easy. The old status quo has powerful defenders. Like many other reforms, the benefits are widely dispersed while the costs are concentrated. And so, many existing licensees have ganged up on the government. We can be sure that some of these licensees also have political connections, which they have used to oppose the policy. There is also the additional issue specific to alcohol — any policy that is seen to liberalise its sale becomes an easy target for conservative moralisers. Further, the Delhi government made a mistake by pausing the policy implementation amidst the criticism.

Then came the political pushback. Despite the government’s revenue increasing by 27 per cent after the policy was put in place, some notional revenue loss of the “2G spectrum allocation” vintage has surfaced. There are also charges of favouritism and corruption in the allocation of new licenses, an issue so sensational that it requires the combined might of the Central Bureau of Investigation (CBI) and the Enforcement Directorate. (Sarcasm is intended.)

Many state governments must be eying this Delhi experiment with excise policy reform. Moreover, this case illustrates the difficulty in reforming sub-optimal licensing arrangements. As for the Delhi government, are they reaping what they sowed in the name of anti-corruption?

Global Policy Watch #2: Xi Jinping’s Thoughts

Global issues and their implications for India

— RSJ

Talking of China (and I’m intruding into Pranay’s area of expertise), I came across this wonderful blog, globalinequality by Branko Milanovic. In his latest post, he writes about what he learnt from reading a translated version of the book, ' Anecdotes and Sayings of Xi Jinping’.

Milanovic writes:

The undisputable emphasis in the “Chinese” part of the book is on the matters of governance. By giving numerous examples from Chinese history of rulers and their aides who cared about people’s welfare, lived modestly (“One should be the first when taking care of state affairs, the last when taking care of personal affairs”), strove to improve themselves morally and educationally, Xi proposes a theory of governance that is based on virtue of rulers and results achieved, not procedure. While Western theories emphasize the procedural aspect (how is one selected to be the ruler, is it by a well-established democratic process or not), Xi’s concern is with the results. The tacit premise is not to discuss how one is selected to rule….The success is defined in terms of improvement in the well-being and happiness of people whom they govern.

…In all cases of a good rule, there is the emphasis on individual characteristics of rulers. What is required, they (the editors) write, is “morality inside and virtue outside”; what is sought is the rule of virtue, and by virtue.  

But how to bring about such a rule? Obviously, by having moral rulers. Hence--the reader begins to realize--Xi’s ideological campaign: if Confucian-cum-Communist  ideology is disregarded and everything is simply esteemed in terms of money and economic success, there cannot be a moral and virtuous rule.

The key question, unanswered in the book, then becomes: is it possible to achieve an educational and moral “rejuvenation” under the current “normal” conditions of capitalism where money-making is held by the majority of the population to be the highest objective revealing also one’s individual worth?

Xi is fighting against the spirit of the times, and while his struggle may be driven by a genuine desire to create a morally superior China, the odds of succeeding in this endeavor are, I am afraid, not particularly high. 

This is, to put it mildly, a brilliant summary of the ideological battle Xi has picked up and his odds of winning it. I tend to agree with its conclusion.   

India Policy Watch #2: Value Addition, Not Import Substitution

Insights on burning policy issues in India

— Pranay Kotasthane

“Import Substitution” is still in vogue. One would have thought that the unsuccessful pursuit of this goal since independence would’ve discredited it. That doesn’t seem to be the case.

Every few weeks, we come across policies targeting import substitution, implicitly if not explicitly. Just a few days back came the rumour that the government plans to ban Chinese phones priced under Rs 12,000 in order to give a leg up to domestic champions. Thankfully, unnamed sources in the government have denied this story for now.

Even so, import tariff hikes and industrial policies continue to chase the illusory target of import substitution. Some policies for display fabs and drones explicitly mention import substitution as the target. Of late, this idea has morphed into targets for maximising value addition per unit of exports.

Now, readers of this newsletter know what we think of this idea. In edition #161, we had warned that Atmanirbhar Bharat is approaching a wrong turn. We have also cautioned against the proliferation of Production Linked Incentives (PLIs) beyond a few critical sectors.

I will make the case against import substitution in this edition using another example. Look at the chart below, which shows the import profile of a country for the year 2020. This country’s largest import by value is Integrated Circuits (chips) at 18.8%. The total import bill is $259 billion. Can you guess the country?

If you need a hint, here’s one: as exports rise, imports also rise. The world’s top two exporters are China and the US. And the world’s top two importers are also the US and China.

The answer is neither the US nor China. India can be ruled out because we know that our biggest import is crude oil. Here’s another hint. Look at this country’s export profile for the same year. Its biggest export is again integrated circuits, at 36.9% out of a total exported value of $374 billion.

Do you have an answer now? The right answer might surprise you. This is the typical year-wise trade profile of a country that is acclaimed as the world’s semiconductor superpower: Taiwan!

We forget that despite its unmatched prowess in contracted chip manufacturing, Taiwan is not even close to being self-sufficient. Some Taiwanese companies import chips, do value addition through packaging and testing, and then export the final commodity. A portion of the imported chips goes into the machines that are used to manufacture chips by the famed Taiwanese chip foundries. The fundamental message is that imports are critical to exports, even in sophisticated economies.

PLI scheme began with the aim of promoting India’s exports. But my sense is that import substitution has displaced exports as the primary goal. How else does one explain the simultaneous increase in import tariffs and a phased manufacturing programme (PMP) that aims to increase tariffs on imported components?

Atmanirbhar Bharat needs to return to its goal of creating competitive manufacturing capabilities in India by allowing companies to start, grow, and close with considerably less bureaucratic friction. Shielding domestic component makers from international competition on the one hand, and subsidising end-equipment manufacturers on the other will end up helping neither. Equipment manufacturers will merely make expensive, poor-quality products. Some others will use the production subsidies to import components at higher prices, with no net benefit to them or the consumers.

As RSJ writes in the first section, this decade is India’s to lose. Imports aren’t evil. Target value maximisation, not import substitution. Counterproductive policies targeting import substitution won’t help.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Why the MRP should be abolished. A 2015 article by Anupam Manur remains relevant.

* [Paper] PIIE has a good paper with a framework to analyse the world’s dependence on China for strategic minerals.

* [Book] Scarcity: Why Having Too Little Means So Much by Sendhil Mullainathan and Eldar Shafir is a useful read.

- Pranay Kotasthane and RSJ

This newsletter can often seem pessimistic about India. That isn’t true, though. Every year, on Independence Day, we remind ourselves and our readers why we write this newsletter. This is how we ended the Independence Day edition of 2020:

“What we have achieved so far is precious. That’s worth reminding ourselves today. We will go back to writing future editions lamenting our state of affairs.

We will do so because we know it’s worth it.”  

This year we thought it would be fun (?) to run through every year since 1947 and ask ourselves what happened in the year that had long-term repercussions for our nation. This kind of thing runs a serious risk. It can get tedious and all too familiar. Most of us know the landmark events of recent history and what they meant for the nation. 

Maybe. Maybe not. 

We’ve given an honest try (of over 8000 words) to see if there’s a different way of looking at these familiar events and their impact on us. Here we go.

1947 - 1960: Sense Of A Beginning 

1947

Perhaps the most significant “What, if?” question for independent India surfaced on 17th August 1947 when the Radcliffe Line was announced. The partition of the Indian subcontinent has cast a long shadow. What if it had never happened? What if Nehru-Jinnah-Gandhi were able to strike a modus vivendi within a one-federation framework? These questions surface every year around independence.

The indelible human tragedy of the partition aside, would an Akhand Bharat have served its citizens better? We don’t think so. We agree with Ambedkar’s assessment of this question. In Pakistan or the Partition of India, he approaches the question with detachment and realism, concluding that the forces of “communal malaise” had progressed to such an extent that resisting a political division would have led to a civil war, making everyone worse off. The partition must have been handled better without the accompanying humanitarian disaster. But on the whole, the partition was inevitable by 1947.

“That the Muslim case for Pakistan is founded on sentiment is far from being a matter of weakness; it is really its strong point. It does not need deep understanding of politics to know that the workability of a constitution is not a matter of theory. It is a matter of sentiment. A constitution, like clothes, must suit as well as please. If a constitution does not please, then however perfect it may be, it will not work. To have a constitution which runs counter to the strong sentiments of a determined section is to court disaster if not to invite rebellion.” [Read the entire book here]

1948

What if Mahatma Gandhi wasn’t killed that year? How would the course of our history change? Gandhi spoke like an idealist and worked like a realist. He was possibly the most aware of the gap between the lofty ideals of our constitution and the reality of the Indian minds then. He knew the adoption of the constitution was only half the work done. He’d likely have devoted the rest of his life to building a liberal India at the grassroots level. His death pushed a particular stream of right-wing Hindu consciousness underground. We still carry the burden of that unfinished work.

1949

The Constituent Assembly met for the first time in December 1946. By November 26th 1949, this assembly adopted a constitution for India. Even a half-constructed flyover in Koramangala has taken us five years. For more context, Pakistan’s Constituent Assembly began work on 10th August 1947, and their first constitution came into force in March 1956, only to be abrogated two years later. India’s founding fathers and mothers were acutely aware that they were elite, unelected, and unrepresentative of the median Indian. They dared to imagine a new nation-state while grappling with that period's harsh economic, social, and political realities. Their work should inspire us to strengthen, improve, and rebuild—but never to give up on—the Republic of India.

For more, check out the miracle that is India’s Constitution in our Republic Day 2021 special edition.

1950

We have written about our Constitution a number of times. It is an inspiring and audacious document in its ambition to shape a modern nation. It has its flaws. Some consider it too liberal; others think it makes the State overbearing. Some find it too long; others feel it comes up short. This may all be true. However, there is no doubt our constitution has strengthened our democracy, protected the weak and continues to act as a tool for social change. It is our North Star. And a damn good one at that. 

1951

Few post-independence institutions have stood the test of time as the Finance Commission (FC), first established in 1951. In federal systems, horizontal and vertical imbalances in revenue generation and expenditure functions are commonplace. Closing the gap requires an impartial institution that is well-regarded by various levels of government and the people. The Finance Commission is that institution.

It’s not as if it didn’t face any challenges. As a constitutional body established under article 280 of the Constitution, it was sidelined by an extra-constitutional and powerful Planning Commission until 2014. But we have had 15 FCs in total, and each key tax revenue-sharing recommendation has become government policy.

1952

Our Constitution adopted a universal adult franchise as the basis for elections. Every citizen was to be part of the democratic project. There was to be no bar on age, sex, caste or education. And this was to be done in one of the most unequal societies in the world. The ambition was breathtaking. To put this in context, women were allowed to vote in Switzerland only in 1971. Not only did we aim for this, but we also moved heaven and earth to achieve it in 1952. In his book India After Gandhi, Ram Guha describes the efforts of the government officials led by the first Election Commissioner, Sukumar Sen, to reach the last man or woman for their ballot. The elites may lament vote bank politics or cash for votes scams and question the wisdom of universal franchise. But we shouldn’t have had it any other way. And, for the record, our people have voted with remarkable sophistication in our short independent history. 

1953 

For a new nation-state, the Republic of India punched above its weight in bringing hostilities on the Korean peninsula to an end. Not only did the Indian government’s work shape the Armistice Agreement, but it also chaired a Neutral Nations Repatriation Commission (NNRC) that was set up to decide the future of nearly 20,000 prisoners of war from both sides. This experience during the Cold War strengthened India’s advocacy of the Non-Aligned Movement (NAM).  

1954

Article 25 guaranteed the freedom of conscience and the freedom to profess, practice, and propagate religion to all citizens. But how does one define a religious practice? And can a practice under the garb of religion breach the boundary of individual rights or public morality? This is a familiar conflict zone in secular States and would inevitably show up in India because everything in India can be construed as a religious practice. Like Ambedkar said during the constituent assembly debates:

“The religious conceptions in this country are so vast that they cover every aspect of life from birth to death…there is nothing extraordinary in saying that we ought to strive hereafter to limit the definition of religion in such a manner that we shall not extend it beyond beliefs and such rituals as may be connected with ceremonials which are essentially religious..."

In 1954, the Supreme Court gave a landmark judgment on what constitutes a religious practice in what’s known as the Shirur Math case. It held that the term religion would cover all practices integral to that religion. Further, the Court will determine what practice will be deemed essential with reference to doctrines within that religion itself.

This test of ‘essentiality’ in religion has kept the public, the legislature and the courts busy since (entry of women in Sabarimala, headscarf in Islam, to name two). The outcome has bent towards individual liberty in most contexts, but the ambiguity in the definition of essential means it could go the other way too.

1955

Another wild "What, if” moment that we like to recall relates to Milton Friedman’s visit to the Indian finance ministry in 1955. What shape would India’s economy have taken had his seminal document “A Memorandum to the Government of India 1955” been heeded?

In this note, Friedman gets to the root of India’s macroeconomic problems—an overburdened investment policy, restrictive policies towards the private sector, erratic monetary policy, and a counterproductive exchange control regime. Being bullish about India’s prospects was courageous when most observers wrote epitaphs about the grand Indian experiment. But Friedman was hopeful and critical both.

The Indian government, for its part, was humble enough to seek the advice of foreigners from opposing schools of thought. At the same time, it was too enamoured by the Soviet command and control model. In fact, many items from Friedman’s note can be repurposed as economic reforms even today.

Here’re our points from Friedman’s note.

1956

The idea of One Nation, One ‘X’ (language, election, song, tax, choose any other) is both powerful and seductive. It is not new, however. Back in the 50s, there was a view that we must not strengthen any identity that divides us. So when the question of reorganisation of the colonial provinces into new states came up, an argument was made that it must be done on factors other than language. Nehru, ever the modernist, thought the creation of language-based states would lead us down the path of ethnic strife. The example of nation-states in Europe built on language in the 19th century and the two devastating world wars thereafter were too recent then. So, he demurred.

Agitation, hunger strikes and deaths followed before we chose language as the primary basis for reorganising the states. It was perhaps the best decision taken by us in the 50s. As the years since have shown, only a polity assured of its heritage and identity will voluntarily accept diversity. The melding of our diversity into a single identity cannot be a top-down imposition. We should never forget this.

1957

India’s economic strategy of state-led industrialisation through deficit financing in pursuit of import substitution took off with the Second Five-Year Plan. Heavy industries needed imported machinery, inflating India’s import bill. Since the exchange rate was pegged to the British pound, it meant that Indian exports became pricier. This imbalance between rising imports and flagging exports was financed by running down the foreign exchange reserves.

By 1957, India witnessed its first foreign exchange crisis. This event had a significant effect on India’s economy. Instead of devaluing the rupee, the government opted for foreign exchange budgeting - every investment in a project needed government approval for the foreign exchange required to buy foreign inputs. The immediate crisis in 1957 led to controls that worsened India’s economic prospects over the next 35 years.

1958

The government nationalised all insurance companies a couple of years earlier. India hadn’t gotten into a socialist hell yet, so this was a bit of a surprise. The proximate cause was a fraud that few private life insurers had committed by misusing the policyholders’ funds to help their industrialist friends. A run-of-the-mill white-collar crime that should have been dealt with by the criminal justice system. But the government viewed it as a market failure and moved to nationalise the entire industry. It would take another 45 years for private players to come back to insurance. Insurance penetration in India meanwhile remained among the lowest in the world.  Also, in 1958, Feroze Gandhi took to the floor of Lok Sabha to expose how LIC, the state insurer, had diverted its funds to help Haridas Mundhra, a Calcutta-based businessman. The same crime that private insurers had done.

The government would repeat this pattern of getting involved where there was no market failure. The outcomes would inevitably turn out to be worse. Seven decades later, we remain instinctively socialist and wary of capital. Our first reaction to something as trifling as a surge price by Ola or a service charge levied by restaurants is to ask the State to interfere.

1959

“The longest guest of the Indian government”, the 14th Dalai Lama pre-empted the Chinese government’s plans for his arrest and escaped to India. Not only did India provide asylum, but it also became home to more than a hundred thousand Tibetans. Because of the bold move by the Indian government in 1959, the Central Tibetan Administration continues its struggle as a Nation and a State in search of regaining control over their Country to this day. This event also changed India-China relations for the decades to come.

1960

Search as hard as we might; we hardly got anything worth discussing for this year. Maybe we were all sitting smugly waiting for an avalanche of crisis to come our way. Steel plants, dams and other heavy industries were being opened. The budget outlay for agriculture was reduced. We were talking big on the international stage about peace and non-alignment. But if you had looked closer, things were turning pear-shaped. The many dreams of our independence were turning sour.

The 60s: Souring Of The Dream

1961

The Indian Army marched into Goa in December 1961. The 450-year Portuguese colonial rule ended, and the last colonial vestige in India was eliminated. It took this long because Portugal’s dictator Antonio Salazar stuck to his guns on controlling Portuguese colonies in the subcontinent, unlike the British and the French. Portugal’s membership in NATO further made it difficult for the Indian government to repeat the operations in Hyderabad and Junagadh. Nevertheless, that moment eventually arrived in 1961. 

This was also the year when India’s first indigenous aircraft, the HAL HF-24 Marut, took its first flight. Made in Bengaluru by German designer Kurt Tank, the aircraft was one of the first fighter jets made outside the developed world. The aircraft served well in the war that came a decade later. It never lived up to its promises, but it became a matter of immense pride and confidence for a young nation-state.

1962

Among the lowest points in the history of independent India. We’ve written about our relationship with China many times in the past editions. The 1962 war left a deep impact on our psyche. We didn’t recover for the rest of the decade. The only good thing out of it was the tempering of idealism in our approach to international relations. That we take a more realist stance these days owes its origins to the ‘betrayal’ of 1962.

1963

ISRO launched the first sounding rocket in November 1963. Over the years, this modest beginning blossomed into a programme with multiple launch vehicles. The satellite programmes also took off a few years later, making India a mighty player in the space sector. 

1964

If you told anyone alive in 1964 that less than 60 years later, Nehru would be blamed for all that was wrong with India by a substantial segment of its population, they would have laughed you out of the room. But here we are in 2022, and there’s never a day that passes without a WhatsApp forward that talks about Nehru’s faults. It seems inevitable that by the time we celebrate the centenary of our independence, he would be a borderline reviled figure in our history. But that would be an aberration. In the long arc of history, he will find his due as a flawed idealist who laid the foundation of modern India. 1964 was the end of an era.

1965

As the day when Hindi would become the sole official language of the Indian Union approached, the anti-Hindi agitation in the Madras presidency morphed into riots. Many people died in the protests, and it led to the current equilibrium on language policy. The “one State, one language” project moved to the back burner, even as Hindi became an important link language across the country. The lesson was the same as in the case of the 1956 states reorganisation: melding our diversity into a single identity cannot be a top-down imposition.

1966

The two wars in the decade's first half, the inefficient allocation of capital driven by the second and third five-year plans, and the consecutive monsoon failure meant India was on the brink in 1966. The overnight devaluation of the Rupee by over 50 per cent, the timely help with food grains from the US and some providence pulled us back from it. The green revolution followed, and we have remained self-sufficient in food since.

The experience of being on the brink taught us nothing. We still believe in the Pigouvian theory of market failure, where government policies are expected to deliver optimality.  Strangely, the idea that we reform only in crisis has only strengthened. There cannot be worse ways to change oneself than under the shadow of a crisis. But we have made a virtue out of it.

1967

This was the year when the Green Revolution took baby steps, and the Ehlrichian prediction about India’s impending doom was put to rest. But it was also the year when the Indian government made a self-goal by adopting a policy called items reserved for manufacture exclusively by the small-scale sector. By reserving whole product lines for manufacturing by small industries, this policy kept Indian firms small and uncompetitive. And like all bad ideas, it had a long life. The last 20 items on this list were removed only in April 2015. We wrote about this policy here. 

1968

In the past 75 years, we have reserved some of our worst public policies for the education sector. We have an inverted pyramid. A handful of tertiary educational institutions produce world-class graduates at the top. On the other end, we have a total failure to provide quality primary education to the masses. It is not because of a lack of intent. The National Education Policy (NEP) that first came up in 1968 is full of ideas, philosophy and a desire to take a long-term view about education in India. But it was unmoored from the economic or social reality of the nation. We often say here that we shouldn’t judge a policy based on its intentions. That there’s no such thing as a good policy but bad implementation because thinking about what can work is part of policy itself. NEP is Exhibit A in favour of this argument.

1969 

The nationalisation of 14 private-sector banks was a terrible assault on economic freedom under the garb of serving the public interest. The sudden announcement of a change in ownership of these banks was challenged in the courts, but the government managed to thwart it with an ordinance. 

Fifty years later, we still have low credit uptake even as governments continue to recapitalise loss-making banks with taxpayer money.

1970

The dominant economic thinking at the beginning of the 70s in India placed the State at the centre of everything. But that wasn’t how the world was moving. There was a serious re-examination of the relationship between the State and the market happening elsewhere. The eventual shift to a deregulated, small government economic model would happen by the decade's end. This shift mostly passed India by. But there were a few voices who questioned the state orthodoxy and, in some ways, sowed the intellectual seeds for liberalisation in future. In 1970, Jagdish Bhagwati and Padma Desai published their monograph, India: Planning for Industrialisation, which argued that our economic policies since independence had crippled us. It showed with data how central planning, import substitution, public sector-led industrial policy and license raj have failed. But it found no takers. In fact, we doubled down on these failed policies for the rest of the decade. It was a tragedy foretold. What if someone had gone against the consensus and paid attention to that paper? That dissent could perhaps have been the greatest service to the nation. It is useful to remember this today when any scepticism about government policies is met with scorn. Dissent is good. The feeblest of the voice might just be right.

The 70s: Losing The Plot

1971

Kissinger visited China in July 1971 via Pakistan. Responding to the changing world order, India and the USSR signed an Indo–Soviet Treaty of Peace, Friendship and Cooperation in August of that year. India had become an ally of the USSR. Four months later, the India-Pakistan war pitted India and the USSR against Pakistan, China, and the US. The Indian strategic community came to internalise USSR as a super-reliable partner and the West as a supporter of India’s foes. It took another three decades, and the collapse of the USSR, for a change in this thinking. Even today, Russia finds massive support in the Indian strategic establishment. We had problematised this love for Russia here. 

1972

India won the 1972 war with Pakistan and liberated Bangladesh. India’s unilateral action stopped a humanitarian disaster. The victory was decisive, and the two parties met in Simla to agree on the way forward. This should have been a slam dunk for India in resolving festering issues on the international boundary, Kashmir and the role of the third parties. But international diplomacy is a two-level game, and Bhutto played that to his advantage. We explained this in edition 30. We paid a high price for giving away that win to Bhutto.

1973

The Kesavananda Bharti verdict of the Supreme Court rescued the Republic of India from a rampaging authoritarian. The basic structure doctrine found a nice balance to resolve the tension between constitutional immutability and legislative authority to amend the constitution. Bibhu Pani discussed this case in more detail here. 

1974

You are the State. Here are your crimes. You force import substitution, you regulate the currency, you misallocate capital, you let the public sector and a handful of licensed private players produce inferior quality products at a high cost, you raise the marginal tax rate at the highest level to 97 per cent, you run a large current account deficit, and you cannot control Rupee depreciation.

Result?

People find illegal ways to bring in foreign goods, currency and gold. And so was born the villain of every urban Bollywood film of the 70s. And a career option for a capitalist-minded kid like me. The Smuggler.

But the State isn’t the criminal here. The smuggler is. And the State responded with a draconian law to beat all others. An act the knowledge of whose expanded form would serve kids well in those school quizzes of the 80s. COFEPOSA — The Conservation of Foreign Exchange and Prevention of Smuggling Act. A predatory state's defining feature is how it forces ordinary citizens to do unlawful activities. COFEPOSA was the mother of such laws. It has spawned many children. 

1975

This blank editorial by the Indian Express says it all.

1976

We view our population as a core problem. The politicians, the public servants and the ordinary citizens share this view. We don’t want to acknowledge our governance deficit. Calling population a problem allows us to shirk the responsibility of running a functioning State. We have written about the flaw in thinking about the population as a problem on many occasions.

How far could we go to control the population? Well, in 1976, during the peak of the Emergency, the State decided to sterilise male citizens against their wishes. This madness ended when the Emergency was lifted. But even today calls for population control keep coming back. 

1977

The first non-Congress union government was an important milestone for the Indian Republic. While Morarji Desai’s government did reverse the worst excesses of the Emergency rule, its economic policies were less successful. This period went on to witness a demonetisation in search of black money (2016 from the future says Hi!), and the same old counter-productive policies in search of self-reliance.

1978

Despite all available evidence that statist socialism was an abject failure, the Janata government that came to power decided to double down on it. One of the great ideas of the time was to force MNCs to reduce their stake in their Indian subsidiaries to below 40 per cent. A handful agreed, but the large corporations quit India. One of those who left was IBM in 1978. The many existing installations of IBM computers needed services and maintenance.

In a delightful case of unintended consequences, this led to the nationalisation of IBM’s services division (later called CMC). Domestic companies started to serve this niche. Soon there were the likes of Infosys, Wipro and HCL building a business on this. CMC provided a good training ground for young engineers. And so, the Indian IT services industry got underway. It would change the lives of educated Indians forever.

1979

In a classic case of violating the Tinbergen rule, the Mandal Commission recommended that the reservation policy should be used to address relative deprivation. While the earlier reservations for oppressed castes stood on firm ground as a means for addressing unconscionable historical wrongs, the Mandal Commission stretched the logic too far. Its recommendation would eventually make reservation policy the go-to solution for any group that could flex its political muscles. We wrote about it here. 

1980

After ditching the Janata experiment and running out of ideas to keep Jan Sangh going, the BJP was formed. It wasn’t a momentous political occasion of any sort then. A party constitution that aimed for Gandhian socialism and offered vague promises of a uniform civil code and nationalism didn’t excite many. Everything else that would propel the party in later years was to be opportunistic add-ons to the ideology. The founding leaders, Advani and Vajpayee, would have been shocked if you told them what the party would be like, four decades later.

The 80s: A Million Mutinies Now

1981

This year witnessed a gradual shift away from doctrinaire socialism in economic policymaking. “The Indira Gandhi government lifted restrictions on the expansion of production, permitted new private borrowing abroad, and continued the liberalisation of import controls,” wrote Walter Anderson. The government also “allowed” some price rises, leading to increased production of key input materials. The government also permitted foreign companies to compete in drilling rights in India. All in all, a year that witnessed changes for the better. 

1982

The great textile strike of Bombay in 1982 was inevitable. The trade unions had gotten so powerful that there was a competitive race to the bottom on who could be more militant. Datta Samant emerged intent on breaking the monopoly of RMMS on the city's workers. And he did this with ever spiralling demands from mill owners in a sector that was already bloated with overheads and facing competition from far eastern economies. There was no way to meet these demands. The owners locked the mills and left. Never to come back. The old, abandoned mills remained. The workers remained. Without jobs, without prospects and with kids who grew up angry and unemployed. The rise of Shiv Sena, political goondaism and a malevolent form of underworld followed. Bombay changed forever. It was all inevitable.

1983

The Nellie massacre in Assam and the Dhilwan bus massacre in Punjab represent the year 1983. Things seemed really dark back then. It seemed that the doomsayers would be proved right about India. Eventually, though, the Indian Republic prevailed. 

1984

Her Sikh bodyguards assassinated India Gandhi. The botched Punjab policy of the previous five years came a full circle with it. An unforgivable backlash against innocent Sikhs followed. A month later, deadly gas leaked out of a Union Carbide factory in Bhopal, killing and paralysing thousands. 1984 will rank among the worst years of our republic. There were two silver linings in retrospect. One, we would learn to manage secessionist movements better from the harrowing Punjab experience. Two, had Indira continued, would we have had 1991? Our guess is no.

1985

This was an eventful year in retrospect. Texas Instruments set up shop in Bangalore. It was to begin one of modern India’s true success stories on the world stage. 

This was also the year when the Anti-defection law transformed the relationship between the voter and her representative. Political parties became all-powerful, and people’s representatives were reduced to political party agents. We have written about this changing dynamic here. 

This was also the year when the then commerce minister, VP Singh, visited Malaysia. The visit was significant for India because it served as a reference point for Singh when he visited that country again in 1990, now as the Prime minister. Surprised by Malaysia’s transformation in five years, he asked his team to prepare a strategy paper for economic reforms. This culminated in the “M” document, which became a blueprint for reforms when the time for the idea eventually came in 1991.

1986

Who is a citizen of India?  This vexing question roiled Assam in the early 80s. The student union protests against the widespread immigration of Bangladeshis turned violent, and things had turned ugly by 1985. The Assam accord of 1985 sought to settle the state's outstanding issues,, including deporting those who arrived after 1971 and a promise to amend the Citizenship Act. The amended Citizenship Act of 1986 restricted the citizenship of India to those born before 1987 only if either of their parents were born in India. That meant children of couples who were illegal immigrants couldn’t be citizens of India simply by virtue of their birth in India. That was that, or so we thought.

But once you’ve amended the definition of who can be a citizen of India, you have let the genie out. The events of 2019 will attest to that.

1987

Rajiv Gandhi’s ill-fated attempt to replicate Indira Gandhi’s success through military intervention in another country began in 1987. In contrast to the 1971 involvement, where Indian forces had the mass support of the local populace, the Indian Peacekeeping Force (IPKF) got itself embroiled in a bitter Sri Lankan civil war. Not only did this involvement end in a failure, it eventually led to Rajiv Gandhi’s brutal murder in a terrorist attack. The policy lesson internalised by the strategic community was that India must stay far away from developing and deploying forces overseas.

1988

Most government communication is propaganda in disguise. However, there are those rare occasions when government messaging transcends the ordinary. In 1988, we saw that rare bird during the peak era of a single government channel running on millions of black and white TV sets across India. A government ad that meant something to all of us and that would remain with us forever. Mile Sur Mera Tumhara got everything right - the song, the singers, the storyline and that ineffable thing called the idea of India. No jingoism, no chest beating about being the best country in the world and no soppy sentimentalism. Just a simple message - we might all sing our own tunes, but we are better together. This is a timeless truth. No nation in history has become better by muting the voice of a section of their own people. 

Mile Sur Mera Tumhara, Toh Sur Bane Hamara, indeed.  

1989

1989 will be remembered as the year when the Indian government capitulated to the demands of Kashmiri terrorists in the Rubaiya Sayeed abduction case. It would spark off a series of kidnappings and act as a shot in the arm of radicals. 

1990

VP Singh dusted off the decade-long copy of the Mandal Commission report and decided to implement it. This wasn’t an ideological revolution. It was naked political opportunism. However, three decades later, the dual impact of economic reforms and social engineering has increased social mobility than ever before. Merit is still a matter of debate in India. But two generations of affirmative action in many of the progressive states have shown the fears of merit being compromised were overblown. The task is far from finished, but Mandal showed that sometimes you need a big bang to get things going, even if your intentions were flawed.

1990 also saw the exodus of Kashmiri Pandits (KPs) from the valley. A tragedy that would bookend a decade of strife and violence in India. The only lesson one should draw from the sad plight of KPs is that the State and the people must protect minority rights. We’re not sure that’s what we have taken away from it. And that’s sad.

The 90s: Correcting The Course

1991

With the benefit of hindsight, the 1991 economic reforms seem inevitable. But things could well have been different. In the minority government, powerful voices advocated in favour of debt restructuring instead of wholesale reforms. In the end, the narrative that these changes were merely a continuation—and not abandonment—of Nehru and Indira Gandhi’s vision for India carried the day. This political chicanery deserves some credit for transforming the life of a billion Indians. 

1992

Harshad Mehta scammed the stock markets. It wasn’t a huge scam. Nor did it hurt the ordinary Indians. Fewer than 1% invested in markets back then. Yet, the scam did something important. It set in motion a series of reforms that made our capital markets stronger and safer for ordinary investors. Notably, over the years, Mehta came to be seen as some kind of robber baron figure. Capitalism needed an anti-hero to catch the imagination of people. Someone who could reprise in the 90s the Bachchan-esque angry young man roles of the 70s. Mehta might not have been that figure exactly, but he helped a generation transition to the idea that greed could indeed be good.

Also, Babri Masjid was brought down by a mob of kar sevaks in 1992. It will remain a watershed moment in our history. The Supreme Court judgement of 2019 might be the final judicial word on it. But we will carry the scars for a long time.

1993

The tremors of the demolition of the Babri Masjid were felt in 1993. Twelve bombs went off in Bombay on one fateful day. The involvement of the city’s mafia groups was established. The tragic event finally led to the government rescuing the city from the underworld. Not to forget, the Bombay underworld directly resulted from government policies such as prohibition and gold controls. 

1994

One of the great acts of perversion in our democracy was the blatant abuse of Section 356 of the constitution that allowed the union to dismiss a state government at the slightest pretext. Indira Gandhi turned this into an art form. S. R. Bommai, whose government in Karnataka was dismissed in this manner in 1988, took his case up to the Supreme Court. In 1994, the court delivered a verdict that laid out the guidelines to prevent the abuse of Section 356. It is one of the landmark judgments of the court and restored some parity in Union and state relationship.

Article 356 has been used sparingly since. We are a better democracy because of it.

1995

India joined the WTO, and the first-ever mobile phone call was made this year. But 1995 will forever be remembered as the year when Ganesha idols started drinking milk. This event was a precursor to the many memes, information cascades, and social proofs that have become routine in the information age. 

1996

Union budgets in India are occasions for dramatic policy announcements. It is a mystery why a regular exercise of presenting the government's accounts should become a policy event. But that’s the way we roll. In 1996 and 1997, P. Chidambaram presented them as the FM of a weak ragtag coalition called the United Front. But he presented two budgets for the ages. The rationalisation of income tax slabs and the deregulation of interest rates created a credit culture that led to the eventual consumption boom in the next decade. We still carry that consumption momentum.

1997

The creation of the Telecom Regulatory Authority of India (TRAI) is an important public policy milestone for India. By no means perfect, the setting up of TRAI helped overturn a norm where government departments were both players and umpires. TRAI made the separation of “steering” and “rowing” functions a new normal. That template has been copied in several sectors thereafter, most recently in the liberalisation of the space sector.

 1998

India did Pokhran 2, which gave it the capability to build thermonuclear weapons. We faced sanctions and global condemnation. But the growing economy and a sizeable middle class meant those were soon forgotten. Economic might can let you get away with a lot. We have seen it happen to us, but it is a lesson we don’t understand fully.

Also, in 1998, Sonia Gandhi jumped into active politics. The Congress that was ambling towards some sort of internal democracy decided to jettison it all and threw its weight behind the dynasty. It worked out for them for a decade or so. But where are they now? Here’s a question. What if Sonia didn’t join politics then? Congress might have split. But who knows, maybe those splinters might have coalesced in the future with a leader chosen by the workers. And we would have had a proper opposition today with a credible leader.

1999

This was a landmark year for public policy. For the first time, a union government-run company was privatised wholly. We wrote about the three narratives of disinvestment here.

2000

We have a weak, extended and over-centralised state. And to go with it, we have large, unwieldy states and districts that make the devolution of power difficult. In 2000, we created three new states to facilitate administrative convenience. On balance, it has worked well. Despite the evidence, we have managed to create only one more state since. The formation of Telangana was such a political disaster that it will take a long time before we make the right policy move of having smaller states. It is a pity.

The 2000s: The Best Of Times

2001

Not only was the Agra Summit between Musharraf and Vajpayee a dud, but it was followed by a terrorist attack on the Indian parliament. It confirmed a pattern: PM-level bilateral meetings made the Pakistani military-jihadi complex jittery, and it invariably managed to spike such moves with terrorist attacks. 

2002

There was Godhra and the riots that followed. What else is there to say?

2003

The Fiscal Responsibility and Budget Management (FRBM) Act and the Civil Services Pension Reform are two policy successes with many lessons for future policymakers. We have discussed these on many occasions. 

2004

The NDA government called for an early election, confident about its prospects. India Shining, its campaign about how good things were, wasn’t too far from the truth. It is how many of us felt during that time. The NDA government had sustained the reform momentum of the 90s with some of the best minds running the key departments. Its loss was unexpected. Chandrababu Naidu, a politician who fashioned himself like a CEO, was taken to the cleaners in Andhra Pradesh. Apparently, economic reforms didn’t get you votes. The real India living in villages was angry at being left out. That was the lesson for politicians from 2004. Or, so we were told.

Such broad narratives with minimal factual analysis backing them have flourished in the public policy space. There is no basis for them. The loss of NDA in 2004 came down to two states. Anti-incumbency in Andhra Pradesh where a resurgent Congress under YS Reddy beat TDP, a constituent of NDA. TDP lost by similar margins (in vote share %) across the state in all demographics in both rural and urban areas. There was no rural uprising against Naidu because of his tech-savvy, urban reformist image. Naidu lost because the other party ran a better campaign. Nothing else. The other mistake of the NDA was in choosing to partner with the ruling AIADMK in Tamil Nadu (TN) over DMK. TN was famous for not giving split verdicts. It swung to extremes between these two parties in every election. And that’s what happened as AIADMK drew a blank.

Yet, the false lesson of 2004 has played on the minds of politicians since. We haven’t gotten back on track on reforms in the true sense. 

2005

The Right to Information Act and the National Rural Employment Guarantee Act came into force in 2005. The “right to X” model of governance took root.

2006

In March 2006, George W Bush visited India and signed the Civil Nuclear Cooperation Agreement with Manmohan Singh. From facing sanctions in 1998 for Pokhran 2 to the 123 Agreement, this was a victory for Indian diplomacy and its rising status in the world. You would think this would have had bipartisan support among the political class in India. Well, the Left that was part of UPA and the BJP that worked on the deal when it was in power, opposed it. Many shenanigans later, the deal was passed in the parliament in 2008. It is often said there’s no real ideological divide among parties in India. This view can be contested on various grounds. But events like the opposition to the nuclear deal make you wonder if there are genuine ideological positions on key policy issues in India. Many sound policy decisions are opposed merely for the sake of it. Ideology doesn’t figure anywhere. 

2007

It was the year when the Left parties were out-lefted. In Singur and Nandigram, protests erupted over land acquisition for industrial projects. The crucible of the resulting violence created a new political force. As for the investment, the capital took a flight to other places. The tax on capital ended up being a tax on labour. Businesses stayed away from West Bengal. The citadel of Left turned into its mausoleum.

2008

Puja Mehra in her book The Lost Decade traces the origin of India losing its way following the global financial crisis to the Mumbai terror attack of 2008. Shivraj Patil, the home minister, quit following the attack and Chidambaram was shifted from finance to fill in. For reasons unknown, Pranab Mukherjee, a politician steeped in the 70s-style-Indira-Gandhi socialism, was made the FM. Mehra makes a compelling case of how that one decision stalled reforms, increased deficit and led to runaway inflation over the next three years. Till Chidambaram was brought back to get the house in order, it was too late, and we were halfway into a lost decade. It is remarkable how bad policies always seem easy to implement while good policies take ages to get off the blocks.

2009

The Unique Identification Authority of India (UIDAI) was established in January 2009 to architect a unique digital identity for persons in a country where low rates of death and birth registrations made fake and duplicate identities a means for corruption and denial of service. Under the Modi government, the digital identity — Aadhaar — became the fulcrum of several government services. 

This project also set the stage for later projects such as the Unified Payments Interface (UPI) and Abha (Health ID).

2010

There’s petty corruption everywhere in India. It is pervasive. Not surprisingly, it is one political issue leading to mass movements in India. The anti-corruption mood gripped India in 2010 on the back of the 2G spectrum scam, where the chief accountant of the government claimed a notional loss of about Rs. 1.8 trillion to the exchequer. Auctioning of natural resources wasn’t exactly a transparent process then. It was evident there was a scam in the allotment of the 2G spectrum. But the 1.8 trillion number was a wild exaggeration that anyone with a semblance of business understanding could see through. It didn’t matter. That number caught the imagination. UPA 2 never recovered from it. More importantly, the auction policy for resources was distorted forever. We still suffer the consequences.

The 2010s: Missed Opportunity

2011

India’s last case of wild poliovirus was detected in 2011. Until about the early 1990s, an average of 500 to 1000 children got paralysed daily in India. The original target for eradication was the year 2000. Nevertheless, we got there eleven years later.

India’s pulse polio campaign has since become a source of confidence for public policy execution in India. We internalised the lesson that the Indian government can sometimes deliver through mission mode projects.

 2012

If you cannot solve a vexing public policy issue, turn it into a Right. It won’t work, but it will seem like you’ve done everything. After years of trying to get the national education policy right, the government decided it was best to make education a fundamental right in the Constitution. Maybe that will make the problem go away. A decade later, nothing has changed, but we have an additional right to feel good about.

2013

This year saw the emergence of AAP as a political force via the anti-corruption movement. AAP combines the classic elements of what makes a political party successful in India - statist instincts, focus on aam aadmi issues, populism and ideological flexibility. Importantly, it is good at telling its own version of some future utopia rather than questioning the utopia of others. 

2014

The BJP came to power with many promises; the most alluring of them was ‘minimum government, maximum governance’. Over the past eight years it has claimed success in meeting many of its promises, but even its ardent supporters won’t claim any success on minimum government. In fact, it has gone the other way. That a party with an immensely popular PM, election machinery that rivals the best in the world, and virtually no opposition cannot shake us off our instinctive belief in the State's power never ceases to surprise us.

2015

The murder of a person by a mob on the charges of eating beef was the first clear indication of the upsurge of a new violent, majoritarian polity. It was also one of the early incidents in India of radically networked communities using social media for self-organisation. 

Meanwhile, 2015 also witnessed the signing of a landmark boundary agreement between India and Bangladesh, which ended the abomination called the third-order enclave. The two States exchanged land peacefully, upholding the principle that citizen well-being trumps hardline interpretations of territorial integrity.

 2016

There will be many case studies written in future about demonetisation. Each one of them will end with a single conclusion. Public policy requires discussion and consensus, not stealth and surprise. We hope we have learnt our lesson from it.

2017

Until 2017, many in India still held the hope of a modus vivendi with China. Some others were enamoured by the Chinese model of governance. However, the Doklam crisis in 2017, and the Galwan clashes in 2020, changed all that. Through this miscalculation, China alienated a full generation of Indians, led to better India-US relations, and energised India to shift focus away from merely managing a weak Pakistan, and toward raising its game for competing with a stronger adversary. For this reason, we wrote a thank you note to Xi Jinping here. 

2018

It took years of efforts by the LGBTQ community to get Section 377 scrapped. In 2018, they partially won when the Supreme Court diluted Section 377 to exclude all kinds of adult consensual sexual behaviour. The community could now claim equal constitutional status as others. There’s still some distance to go for the State to acknowledge non-heterosexual unions and provide for other civil rights to the community. But the gradual acceptance of the community because of decriminalisation is a sign that our society doesn’t need moral policing or lectures to judge what’s good for it.

2019

The J&K Reorganisation Act changed the long-standing political status quo in Kashmir. Three years on, the return to political normalcy and full statehood still awaits. While a response by Pakistan was expected, it was China that fomented trouble in Ladakh, leading to the border clashes in 2020. 

2020

We have written multiple pieces on farm laws in the past year. The repeal of these laws, which were fundamentally sound because of a vocal minority, is the story of public policy in India. Good policies are scuttled because of the absence of consultation, an unclear narrative, opportunistic politicking or plain old hubris. We write this newsletter in the hope of changing this. 

2021

The second wave of the COVID-19 pandemic left behind many bereaved families. People are still trying to pick up the pieces. The sadness was also interrupted by frustration because of the delays in getting the vaccination programme going. India benefited immensely from domestic vaccine manufacturing capability in the private sector. Despite many twists and turns in vaccine pricing and procurements, the year ended with over 1 billion administered doses. In challenging times, the Indian State, markets, and society did come together to fight the pandemic. 

So, here we are. In the 75th independent year of this beautiful, fascinating and often exasperating nation. We are a work in progress. We might walk slowly, but we must not walk backwards. May we all live in a happy, prosperous and equal society.

Thanks for reading Anticipating the Unintended! Subscribe for free to receive new posts and support our work.

Insights on burning policy issues in India

— RSJ

I have been following the case of Mohammed Zubair, the co-founder of the fact-checking site Alt News with interest. He was granted interim bail by the Supreme Court a couple of weeks back. You can read more about the story here. I border on free speech absolutism, so my opinion on this case, as with many other similar cases in India, is simple. No one should be jailed for any speech unless they are violating Mill’s harm principle.

In his essay On Liberty, Mill wrote:

“That principle is, that the sole end for which mankind is warranted, individually or collectively, in interfering with the liberty of action of any of their number, is self-protection. That the only purpose for which power can be rightfully exercised over any member of a civilized community, against his will, is to prevent harm to others. His own good, either physical or moral, is not a sufficient warrant.”

But free speech is not the only reason I have brought up the case of Mohammed Zubair here. The case illustrates a point I have made before in this newsletter: while countering lies with fact checks is a noble, worthwhile endeavour, it means nothing in an environment where people are intoxicated with half-truths and grand illusions about a ‘real’ past or an ‘imagined’ future.

A few years back, I came across this wonderful essay ‘Monopolize the Pretty Lies’ by Bryan Caplan. While I understood it back then, reading it again now is insightful.

Caplan writes:

What then is the primary purpose of censorship?  It’s not to suppress the truth – which has little mass appeal anyway.  The primary purpose of censorship is to monopolize the pretty lies.  Only the powers-that-be can freely make absurdly self-aggrandizing claims. 

Human beings like to say – and think – whatever superficially sounds good.  Strict censorship allows rulers to exploit this deep mental flaw.  If no one else can make absurd lies, a trite slogan like, “Let’s unite to fight for a fantastic future!” carries great force.  Truthful critics would have to make crowd-displeasing objections like, “Maybe competition will bring us a brighter future than unity,” “Who exactly are we fighting?,” or “Precisely how fantastic of a future are we talking about?”  A rather flaccid bid for power!  Existing rulers tremble far more when rebels bellow, “Join us to fight for a fantastic future!”

This is why I think this case won’t go anywhere. It will fizzle out here because fact-checkers don’t really matter. What will matter is if there is a counter-narrative based on dubious claims of an equally fantastic future. It explains why AAP is seen as a credible threat by the BJP.

Caplan ends his essay with a rather pessimistic view of free speech:

Doesn’t this imply that free speech is overrated?  Yes; I’ve said so before.  While I’d like to believe that free speech leads naturally to the triumph of truth, I see little sign of this.  Instead, politics looks to me like a Great Liars’ War.  Viable politicians defy literal truth in virtually every sentence.  They defy it with hyperbole.  They defy it with overconfidence.  They defy it with wishful thinking.  Dictators try to make One Big Political Lie mandatory.  Free speech lets a Thousand Political Lies Bloom.

Yes, freedom of speech lets me make these dour observations without fear. I’m grateful for that.  Yet outside my Bubble, dour observations fall on deaf ears.  Psychologically normal humans crave pretty lies, so the Great Liars’ War never ends.

I guess once you’ve gotten into the chakravyuha of the Mahabharata of lies, there’s no way of getting out. You will only find an avalanche of prettier lies from all sides engulfing you in future. 

India Policy Watch #2: Nature Of Representation

Insights on burning policy issues in India

— RSJ

Droupadi Murmu, the NDA presidential nominee, was elected as the 15th President of India a couple of weeks back. Murmu, a tribal leader from Mayurbhanj, Odisha, had earlier served as the governor of Jharkhand. That a woman from a historically marginalised section of the society now occupies the highest constitutional post is a moment to celebrate in the 75th year of Indian independence. It shows a kind of deepening of democracy. This is because we associate democracy with representation. It was no surprise therefore that a lot of opinion pieces reflected this sentiment while talking about her. 

Here’s Aditi Narayani Paswan writing for the Indian Express:

“Droupadi Murmu is not just a source of inspiration for us; her life and struggle, determination and success in the face of great odds represent the hope and promise of New India.

Under the leadership of Prime Minister Narendra Modi, Indian democracy has become more representative and inclusive. The BJP represents the New India of prosperity, equality and socio-economic mobility, reflecting the true embodiment of samajik samarasta (social harmony). A tribal woman succeeding a Dalit to the highest constitutional post of the nation is a remarkable testimony to the deepening roots of Indian democracy.”

And here’s a piece in Outlook:

“What is really significant for us to understand here is that Murmu’s victory is not merely the victory of a specific party to power. Rather its implications can be drawn deep down to the very philosophy of what India as an independent nation has been striving to practically achieve. Whether or not her victory can bring goals of that philosophy to fruition is a matter of time to tell. But at the moment, from the point of view of a modern, multicultural, multi-ethnic nation-state, Murmu’s victory is the victory of representation.”

Origin Story

Since we are all talking about the victory of representation, I thought it would be useful to go deeper into the idea itself. What does representation mean in a democracy? How useful is it? Does an increasing emphasis on identity in society mean a greater opportunity for democracies to be truly representative? Is there such a thing as too much representation?

To understand this, we will go back to the modern conception of the state and, therefore, to Hobbes. There are good reasons to go back to ancient history and the Roman republic or the Roman empire while talking about representation. But the political theory of the time concerned itself with the question of who was fit to rule us from among the people who should be ruling us. It didn’t answer the question of how we find who was fit to rule us. The process didn’t matter much then. So, we start with Hobbes again. This is a familiar territory for this newsletter so forgive me for going over it again.

For Hobbes, human life in the state of nature is ‘solitary, poor, nasty, brutish and short’. We would be a ‘fractious multitude’ forever at war with each other for scarce resources because there would be no powerful force to keep us in order. The solution, Hobbes wrote, was for people to come together to form a pact, let’s call it the ‘commonwealth’, where they voluntarily give up some of their freedoms to a powerful entity called the ‘sovereign’ in exchange for protection against the violence that’s inevitable in the state of nature. So that’s how the State worked. There were the multitudes, a notion of the commonwealth, and then there was the sovereign. The sovereign was all-powerful but ruled because of the legitimacy of the commonwealth. If the sovereign itself became brutish, the multitudes might dismantle the commonwealth and look for another. Hobbes didn’t care much about how to search for the sovereign. It could be through a parliament, or it could be a monarch; it didn’t matter so long as it had absolute power to maintain order which was in turn voluntarily offered to them by the people. 

The enlightenment thinkers who followed Hobbes concerned themselves with two big ideas. One was individual liberty and how it should be protected and championed in the face of a powerful sovereign. The other was the separation of the ‘church’ from the State or how to ensure the sovereign doesn’t bow down to another power in the name of God. The revolutions and political reforms in the late 18th century Europe and North America were a result of the excesses of the sovereign and the propagation of these ideas within those societies. The primacy of individual liberty, the weakening of monarchy and the separation of the church led to the evolution of the modern, representative democracy where the people chose who would lead them. The people would be sovereign through the mode of representation. A system of checks and balances between the legislature, executive and judiciary would limit the concentration of power in any one person. This became the democratic model to emulate. 

The Problem Of Representation

The problem of representation wasn’t too difficult to solve in the early days of democracy. There was no universal suffrage, people lived in villages over generations, their representatives knew their issues well, and the people chose someone who presented the best option to address their concerns. There was very little information asymmetry. This model started fraying with increasing industrialisation and deepening of capitalism leading to greater social and geographic mobility. Cities with diverse populations, new professions, break down of the feudal structure in the countryside and universal suffrage followed. This meant it was difficult for any representative to know their people as well as before. Even the people couldn’t keep pace with all the information around them.

Like Walter Lippman would write, there was a world outside, and there was a picture of it inside our heads. We make our decisions based on this picture which is a second-hand view of the world because we cannot see all of the world. Because of this, we search for an authentic messenger who can explain the real world to us. The elites use the media to present themselves as the authentic messengers and shape public opinion. It is this elite then who influence representation for the public. Once this model got established, we saw the elites dominate representation in democracies for most of the 20th century. This wheel turned in the last decade when the excesses of the financial system, the concentration of the benefits of globalisation, the proliferation of media and greater disparity in opportunities led to a populist backlash against the elites.

The Three Narratives

There are now three competing narratives on representation today. The first is the old Burkean point on the role of a representative of people. His speech to the electors of Bristol in 1774 is a classic on the role of a representative:

“Certainly, gentlemen, it ought to be the happiness and glory of a representative to live in the strictest union, the closest correspondence, and the most unreserved communication with his constituents. Their wishes ought to have great weight with him; their opinion, high respect; their business, unremitted attention. It is his duty to sacrifice his repose, his pleasures, his satisfactions, to theirs; and above all, ever, and in all cases, to prefer their interest to his own. But his unbiased opinion, his mature judgment, his enlightened conscience, he ought not to sacrifice to you, to any man, or to any set of men living. These he does not derive from your pleasure; no, nor from the law and the constitution. They are a trust from Providence, for the abuse of which he is deeply answerable. 

Your representative owes you, not his industry only, but his judgment; and he betrays, instead of serving you, if he sacrifices it to your opinion.”

This is the model of an independent representative with a mind of his own. They work with autonomy using their judgment to do what they think is best for their people.

The second narrative is about the representative being either an expert or who will rely on experts for finding the best answers to the concerns of the public. This narrative strengthens when a nation is in crisis because of a war, economic failure or an emergency (health or environment, for instance). These don’t last long, and an expert eventually falls out of favour unless they reinvent themselves. 

The last narrative is that of a representative who is like you and me, the proverbial US politician who you could have a chat with over a beer. This is the literal interpretation of representation where fealty to someone is drawn because of how closely they resemble us. In a world where every expertise can be questioned, where independent thinking is viewed with suspicion, and tribal loyalty is the highest virtue, this literal view of representation is the strongest. 

Of course, this isn’t to say that these narratives of representation cannot come together in the shape of a single person who could satisfy all of them. But that looks increasingly rare around the world these days. What’s easier is for a representative to fashion themselves in closer affiliation to a particular identity among the people and use that to come to power. Over-indexing on any one of these narratives and choosing representatives on that basis is bad for democracy. It weakens the state.

It is something we must keep in mind while celebrating representation.  

Matsyanyaaya: A New East Asian Transition

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

This week’s news was dominated by the Speaker of the United States House of Representatives, Nancy Pelosi’s visit to Taiwan. If you weren’t sleeping under a rock, you would have already read many views, claims, blames, and counter-claims around this event. Here’s another one, but from an Indian realist perspective.

The dominant narrative sees this visit as another episode of the ongoing US-China great power rivalry. In this narrative, Taiwan by itself, is secondary. All that matters is to place the blame either on China or the US for the escalations. One framing is that this visit was unnecessary, provocative, and irresponsible. The argument goes that the US has worsened the security situation of China’s neighbours by inviting the latter’s aggression. The opposite framing suggests that the blame rests solely on China’s expansionist tendencies over the last five years. China’s response of activating a military response ahead of the upcoming 20th National Congress of the Chinese Communist Party only shows what this event is really about.

Both frames of the dominant narrative are missing a crucial element: the choices of the Taiwanese people. The great power rivalry framing often ignores that other nation-states also have the agency to make their sovereign choices, even if doing so sometimes involves playing one great power against another.

Ukraine’s case is similar. Some people blame NATO’s expansion on Russia’s borders, while others point out that an invasion has no justification (I share this view). But we forget that most Ukrainians themselves want to move away from Russia and get closer to the West. Any final analysis needs to take this factor into account. My colleague Nitin Pai made a critical argument in early March:

““NATO/EU shouldn’t have expanded” is an insult to the agency of countries that have willingly exercised their choice to join. Accepting their sovereign decisions is also realism. Pretty silly to call yourself a ‘realist’ while pretending sovereign states don’t exist/lack agency.”

So is the case with Taiwan. Some analysts are stuck in the old times, believing that Taiwan is China’s “internal issue”. They haven’t been paying enough attention to Taiwan’s domestic polity.

The Taiwanese “nation”—the imagined community in Benedict Anderson’s conception— has been carefully constructed over the last few years. Democracy, freedom, and deep connections with the broader world are key foundations of Taiwanese nationalism. This kind of nationalism is antithetical to the mainland’s nationalism.

The two consecutive electoral victories of the ruling party—Tsai Ing-wen’s DPP—is a sign that this Taiwanese identity has taken shape. The DPP defeated the grand old Guomindang, a party that has been soft on China.

This is what Taiwan’s foreign minister, Joseph Wu said in a BBC interview a couple of days ago:

"We want to maintain the status quo, which is that Taiwan has no jurisdiction over mainland China and the People's Republic of China (CCP) has no jurisdiction over Taiwan. That is the reality… On the index of freedom Taiwan is ranked number one, on economic freedom Taiwan is also at the top. Taiwanese people enjoy democracy, freedom and the value of human rights, that put Taiwan in the democratic world…. We have the will and the capability. We need other countries to provide Taiwan with defensive articles, but defending Taiwan is our responsibility, we are not asking other countries to sacrifice their lives to protect Taiwan."

Read the lines again. They are definitely not about a small internal issue or a minor historical, ideological tussle.

What About Pelosi’s Visit

Having understood the categorical shift in Taiwan’s politics, we can better understand Ms Pelosi’s visit. The Taiwanese government knew what they were getting into. Taiwan orchestrated the visit precisely to clarify to the world that its differences with China are irreconcilable. Even the Guomindang came out in support of the visit. Having been under the threat of a mainland invasion for over 73 years, the Taiwanese know China’s intentions and actions better than most others.

The visit, by itself, was just symbolic. It didn’t involve a leader from the Biden administration. Moreover, both Pelosi and the Biden administration made it clear that they are not reversing the “One China” principle. It was China that raised the stakes. China could’ve opted to let it pass by with a strong statement alone. But it chose to ratchet tensions, hoping that this tried-and-tested strategy would stare down Taiwan.

But that was not to be. Taiwan and Pelosi called China’s bluff. And when that happened, China began conducting massive military drills, fired missiles and withdrew from important dialogue forums with the US. All this in response to just a symbolic visit by a legislators’ group! Just like the unsportsmanlike kid who walks away with his bat, ball and wickets after being adjudged out. (I know I’m breaking my injunction against anthropomorphising international relations.)

How Should We in India Process This?

Thus far, we have opted for our favourite position of taking a stance by not taking a stance. Foreign ministers of the US, Australia, and Japan jointly condemned China’s launch of missiles. The fourth Quad member was conspicuous by its absence.

From an Indian perspective, Taiwan standing up to China’s expansionism is encouraging. India is familiar with China’s tantrums over visits by foreign diplomats. On every occasion a US Ambassador to India visits Arunachal Pradesh, the Chinese government gets riled up. Pelosi’s visit should be seen in the same context. China’s unreasonable demands and the disproportionate escalation when the demands aren’t heeded, deserve strong criticism short of any change in the “One China” formulation. At the same time, India should close the long-pending free-trade agreement with Taiwan. Its strategic value far outweighs the benefits of haggling over import duties.

These words from Joseph Wu serve as a useful reminder to India and Indians:

“Look at their[China’s] behaviour over Hong Kong, or claiming the East China Sea and the South China Sea. It is the typical expansionism of an authoritarian state.. Countries in this region need to watch out for what China is trying to do. Taiwan is not going to be the last piece in Chinese dream of expansionism.”

Want to find out more about India and Taiwan?

Start with this Puliyabaazi episode we recorded with Sana Hashmi, an Indian scholar of East Asian international relations (it’s in Hinglish).

Earlier this year, Sana also anchored a comprehensive policy report analysing the India-Taiwan partnership for the Taiwan Asia Exchange Foundation. The report has twenty chapters on various facets of the relationship. I have co-written a chapter on semiconductors, while my colleague Shambhavi has a chapter on bilateral cooperation to tackle future pandemics.

Finally, my colleagues have analysed a few cross-strait scenarios from an Indian national interest perspective in an excellent Takshashila Intelligence Estimate.

Course Advertisement: Admissions for the Sept 2022 cohort of Takshashila’s Graduate Certificate in Public Policy programme are now open! Visit this link to apply.

HomeWork

Reading and listening recommendations on public policy matters

* [Blog] If you are interested in the semiconductor angle in the Taiwan-PRC tensions, we have a post on it in our High-tech Geopolitics newsletter.

* [Book] Deng Xiaoping and the Transformation of China by Ezra Vogel is necessary reading to understand China better.

* [Tweet thread] Common mistakes we make in pronouncing Chinese names.

Insights on burning policy issues from an Indian lens

— RSJ

Who do you think has a better long-term view of the world? An administration struggling to control inflation and rising oil prices, one that’s facing midterm elections with the lowest approval ratings, or large institutional investors projected to own about 20 per cent of all US listed companies by 2028?

I don’t know.

I mean, it is conventional wisdom that all that the likes of Blackrock, Vanguard and State Street care about is making profits on their investments. On the other hand, the government is expected to take long-term decisions in the interest of society. But when you own 20 per cent of everything, I would suspect you will conclude there’s no other way to maximise profits except trying to do good for everyone. I mean, there won’t be a lot of arbitrage left anymore in choosing specific industries or sectors. You will have to do ‘sabka saath, sabka vikaas’. No wonder ESG (Environment, Social and Governance) investing has been important for these large institutional investors. That ESG is now a critical agenda tracked by the board of every company because of these investors' efforts.

All good.

Now, let’s look at the incentives of political parties. It is to win elections. Everything else follows only after you have the keys to power. And elections in democracies are a permanent affair. There’s a key election of some kind happening every other year. Will a political party craft a policy that’s painful in the short run but good in the long run? They do, but it requires a combination of inspiring leadership or ideology, a looming crisis and a powerful communication strategy to walk on this difficult path. That’s rare. Instead, what you have is parties taking the easy, opportunistic way out while hoping it will somehow make sense in the long run. 

Two Roads Diverged

Here are two news items from last week for you.

#1: Democrats may be on the verge of passing historic climate legislation after all.

The $369 billion of climate spending in the Inflation Reduction Act that Sen. Joe Manchin (D-WV) announced on Wednesday includes funding for clean energy and electric vehicle tax breaks, domestic manufacturing of batteries and solar panels, and pollution reduction.

If the bill’s policies work as intended, it would push American consumers and industry away from reliance on fossil fuels, penalize fossil fuel companies for excess emissions of methane, and inject needed funds into pollution cleanup.

The bill would use tax credits to incentivize consumers to buy electric cars, electric HVAC systems, and other forms of cleaner technology that would lead to less emissions from cars and electricity generation, and includes incentives for companies to manufacture that technology in the United States. It also includes money for a host of other climate priorities, like investing in forest and coastal restoration and in resilient agriculture.

#2: Blackrock warns it will vote against more climate change resolutions

BlackRock (BLK.N) said on Tuesday it expected to support fewer shareholder resolutions on issues such as climate change in the current season of annual general meetings, as many proposals were too prescriptive.

While BlackRock said its view on the importance of managing climate risk remained unchanged and it continued to engage with companies over their efforts, a number of resolutions put forward at recent AGMs were too constraining on boards.

Among such resolutions that it said it could oppose were those requiring management to stop providing finance to traditional energy companies, or those requiring alignment of bank business models to a specific climate scenario.

Among votes that BlackRock has already opposed was an April 13 call for Canadian lender Bank of Montreal to adopt a policy to link financing with the International Energy Agency's Net Zero Emissions by 2050 Scenario.

While the US administration is going down the path of spending more on tackling climate change, Blackrock seems to be signalling a u-turn. 

What Led Them Here

So, back to the question with which we started. Who do you trust is taking a long-term view here?

Some context here will help. These moves have come on the back of an energy crisis facing the world today. Most of the commentary on this has attributed this to the Ukraine war and the sanction on Russia that followed. The general view is that this crisis will disappear once the war ends. How true is this? Not very if you look closely. Over the past many years, the energy inventory has been declining because the supply has held flat or gone down while the demand continues to be robust (except for the pandemic blip). The green sources of energy haven’t been able to fill the gap on the supply side. As we have come out of the pandemic, the global demand has gone up (though still below 2019 levels) while the supply isn’t keeping pace. This was even before the Russian invasion.

The reasons for this aren’t hard to locate. Conventional energy companies have found it hard to fund new projects because ESG investing norms have made the availability of capital difficult. The so-called ‘extractive industries’ are orphans in capital and debt markets. Most of the growth in energy supplies in the last decade has come from shales. A lot of money was put to work to increase the efficiency of pumping out oil from shales. The three big shale fields in the Permian, the Bakken and the Eagle Ford pumped out enough oil to not have anyone worry about supply shortages anytime in the last decade. But like all good things, we have depleted these fields at rates faster than predicted. There’s been hardly any capacity developed that has backfilled these fields elsewhere. And it is unlikely we will get a second-time lucky so soon in finding rich fields like them.

If the market were efficient, we would have seen capital find its way into funding newer sources. But the ESG overdrive led by the Big 3 index funds put up a barrier to that flow. And the energy companies that are making big profits now because of the high prices aren’t themselves putting money into conventional extraction. That would be seen as a negative in the market. So, even they are being constrained by the ESG norms. Into this decadal low in investment in production came the Ukraine war. Things have gone further south since. Europe needs Russian gas, and Putin is enjoying the gradual choking of the supply that will make things worse during the oncoming winter. Only last week, Russia’s Gazprom told its customers in Europe it cannot guarantee gas supplies because of ‘extraordinary’ circumstances. Heh!

Gazprom said stopping another turbine at the Nord Stream 1 pipeline would cut daily gas production to 20%, halving the current level of supply. It is likely to make it more difficult for EU countries to replenish their stores of gas before winter.

The Nord Stream 1 pipeline, which pumps gas from Russia to Germany, has been running well below capacity for weeks, and was completely shut down for a 10-day maintenance break earlier this month.

The European Commission has urged countries to cut gas use by 15% over the next seven months after Russia warned it could curb or halt supplies altogether. Under the proposals, the voluntary target could become mandatory in an emergency. On Tuesday energy ministers will meet in Brussels in an attempt to sign off the plans.

But numerous opt-outs are expected amid resistance from some member states.

To this, add that the US has been depleting its SPR (Special Petroleum Reserves) to boost supply and keep prices under control. Last week it announced another 20 million barrels were released from SPR. But this isn’t sustainable, and it is likely this is the last of it.

I don’t know about you, but I think the supply situation looks to worsen in the future. 

Evaluating the Responses

Now, look at the two news articles that we started with. After a decade of not adding real capacity to boost energy supply, starving investments in conventional energy, stupidly shutting down nuclear plants and going for investments in wind and solar that are by themselves energy and capital intensive to set up, we are here with two kinds of response.  

One is from the US government. Instead of finding ways to invest in the sector to solve this crisis is going the other way. Releasing special reserves, cutting taxes on gasoline, placing more restrictions on the conventional energy sector and planning to deficit fund more investments in green energy without a clear answer on how it will help with supply. These will only increase demand in the short term without any corresponding increase in supply to address it.

The other is from the face of greedy capitalism, Blackrock, who thinks we might have overdone the ESG investment thesis without fully appreciating the unintended consequences of starving the oil and gas sector of investments. Maybe the rhetoric against conventional energy has gone overboard without an immediate answer to the supply shortfall. So, some calibration is needed now. Else, there will be significant pain ahead with misallocation of investments and a deepening energy crisis. The poor and the developing nations are most affected by higher oil prices. And poverty is worse for climate change. More than fossil fuels.  

Those then are the two narratives. As London and NYC sweat in an unprecedented heat wave this summer, you know who will win the narrative battle.

The war will be lost though. 

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A Framework A Week: Building Models

Tools to help think about public policy

— RSJ

Last week I came across this piece on ‘Models as mediating instruments’ by Margaret Morrison and Mary S. Morgan. You should read the full chapter. The authors lay out the importance of model building in helping us learn about theories and how they might operate in the world:

Models are one of the critical instruments of modern science. We know that models function in a variety of different ways within the sciences to help us to learn not only about theories but also about the world. So far, however, there seems to be no systematic account of how they operate in both of these domains.

And then, they proceed to outline how we should think about developing models that function as autonomous agents and as instruments of investigation of the world. Here’s a short extract from their introduction to model building:

In order to make good our claim, we need to raise and answer a number of questions about models. We outline the important questions here before going on to provide detailed answers. These questions cover four basic elements in our account of models, namely how they are constructed, how they function, what they represent and how we learn from them.

Construction What gives models their autonomy? Part of the answer lies in their construction. It is common to think that models can be derived entirely from theory or from data. However, if we look closely at the way models are constructed we can begin to see the sources of their independence. It is because they are neither one thing nor the other, neither just theory nor data, but typically involve some of both (and often additional ‘outside’ elements), that they can mediate between theory and the world. In addressing these issues we need to isolate the nature of this partial independence and determine why it is more useful than full independence or full dependence.

Functioning What does it mean for a model to function autonomously? Here we explore the various tasks for which models can be used. We claim that what it means for a model to function autonomously is to function like a tool or instrument. Instruments come in a variety of forms and fulfil many different functions. By its nature, an instrument or tool is independent of the thing it operates on, but it connects with it in some way. Although a hammer is separate from both the nail and the wall, it is designed to fulfil the task of connecting the nail to the wall. So too with models. They function as tools or instruments and are independent of, but mediate between things; and like tools, can often be used for many different tasks.

Representing Why can we learn about the world and about theories from using models as instruments? To answer this we need to know what a model consists of. More specifically, we must distinguish between instruments which can be used in a purely instrumental way to effect something and instruments which can also be used as investigative devices for learning something. We do not learn much from the hammer. But other sorts of tools (perhaps just more sophisticated ones) can help us learn things. The thermometer is an instrument of investigation: it is physically independent of a saucepan of jam, but it can be placed into the boiling jam to tell us its temperature. Scientific models work like these kinds of investigative instruments – but how? The critical difference between a simple tool, and a tool of investigation is that the latter involves some form of representation: models typically represent either some aspect of the world, or some aspect of our theories about the world, or both at once. Hence the model’s representative power allows it to function not just instrumentally, but to teach us something about the thing it represents.

LearningAlthough we have isolated representation as the mechanism that enables us to learn from models we still need to know how this learning takes place and we need to know what else is involved in a model functioning as a mediating instrument. Part of the answer comes from seeing how models are used in scientific practice. We do not learn much from looking at a model – we learn more from building the model and from manipulating it. Just as one needs to use or observe the use of a hammer in order to really understand its function, similarly, models have to be used before they will give up their secrets. In this sense, they have the quality of a technology – the power of the model only becomes apparent in the context of its use. Models function not just as a means of intervention, but also as a means of representation. It is when we manipulate the model that these combined features enable us to learn how and why our interventions work.

The whole chapter and Mary Morgan’s book (The World in the Model: How Economists Work and Think) is a great tool for building models.  

India Policy Watch: Hoping Against Hope

Insights on burning policy issues in India

 - Pranay Kotasthane

Earlier this week, the union cabinet approved a revival package for the ever-embattled Bharat Sanchar Nigam Limited (BSNL) worth ₹1.64 lakh crores. Let’s analyse this decision ground-up

Let’s look at the two stated aims. The first argument is that the presence of BSNL in the telecom market acts as a market balancer; it plays a significant role in providing services to rural areas and during natural disasters. The second argument is that the telecom sector is strategic; hence, BSNL will become the vehicle for the government to “promote indigenous 4G technology development”. In other words, BSNL will have to commission an atmanirbhar 4G technology that Tata Consultancy Services and C-DOT are developing. A part of the bailout—₹22,471 crores—is allocated for capital expenditure on this deployment.

For a moment, assume that both objectives are desirable. The question is, are there alternative methods to achieve the two stated objectives?

Given the positive externalities of network infrastructure today, government intervention in rural connectivity makes sense. But the instrument required to achieve this objective doesn’t require the government to produce this service by itself through a public sector unit. The same objective could be achieved by a government procurement contract which finances private sector players for capital expenditure on network infrastructure in low-density areas. Think of a non-coercive version of the Regional Air Travel Connectivity Scheme - UDAN, but for mobile connectivity. This method would likely be far cheaper than attempting to revive a government-run company that incurs losses despite playing a game in which the umpire also belongs to the same team. This would be beneficial for the people living in far-flung areas too. Why condemn them to slow 3G services of BSNL when the government can finance private players to provide 4G services instead?

Next, consider the strategic necessity argument. 4G was introduced in India a full decade ago. When the world (and India) is commissioning 5G connectivity, an Indian consortium has now done trials for home-grown 4G technology. Granted, that 4G is not going away anytime soon, but why should it now be shoved down BSNL’s throat?

To me, it seems like a classic error—a violation of the Tinbergen Rule, which we had discussed in edition #135. The rule says: use one policy instrument for just one target (or as few as possible). Burdening one instrument with several objectives often results in a system that fulfils none. In the current case, it means that BSNL can either be an instrument to connect remote areas or it can be a testbed for indigenous technologies, but not both. To expect it to do both would make things tougher for an already troubled entity. More important, it would be a waste of taxpayers’ hard-earned money.

Since allowing adversaries to manage your core networks is a strategic vulnerability, a better alternative would be to give domestic players a target for eliminating Huawei from their 4G networks over time. If the indigenous solution is any good, some players will consider opting for it. The second option is to support the indigenous 4G’s go-to-market programmes in other countries. Either way, the objective can be achieved without hoping against the BSNL hope.

Finally, a reminder. The cost to society for one rupee raised by governments in India is ₹3 (Marginal Cost of Public Funds). So, Indians will be incurring nearly ₹5 lakh crores. For comparison, that is nearly 10 per cent of RBI’s foreign exchange reserves in equivalent rupees. Is protecting BSNL really worth this kind of expenditure?

Course Advertisement: Admissions for the Sept 2022 cohort of Takshashila’s Graduate Certificate in Public Policy programme are now open! Visit this link to apply.

PolicyWTF: Playing with Fire Again

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

A couple of weeks ago, a film poster depicting Kaali Maa began an outrage cycle. As it happens with frightening regularity nowadays, it culminated in a couple of FIRs being filed against the director. Forget the fact that the movie was released in Canada by an Indian citizen from Tamil Nadu; the FIRs were nevertheless registered in Delhi and UP.

It’s not worth spending time and energy on these Whack-A-Mole outrages. What concerns me more is the Indian High Commission in Ottawa’s press release. It read:

We have received complaints from leaders of the Hindu community in Canada about disrespectful depiction of Hindu Gods on the poster of a film showcased as part of the 'Under the Tent' project at the Aga Khan Museum, Toronto.

Our Consulate General in Toronto has conveyed these concerns to the organizers of the event.

We are also informed that several Hindu groups have approached authorities in Canada to take action.

We urge the Canadian authorities and the event organizers to withdraw all such provocative material.

In the past, the official Indian position would have been to play the matter down and leave the issue to the host country. It is unusual and disappointing for an Indian embassy to act as a messenger for religious groups in other countries. Canadian citizens of the Hindu faith aren’t Indians. This admonishment by an Indian government entity is out of place.

I say that the government is playing with fire here because acting on behalf of citizens of other countries—for whatever reason—is a slippery slope. There’s a reason that Indian immigrants are welcomed in many countries. Contrast that with China. The aggressive opposition by some Chinese immigrants against criticisms of the Chinese Communist Party in their host country ends up being detrimental to all Chinese immigrants. It’s in India’s interest that emigrants become trustworthy members of their host community. We shouldn’t go down the path China has.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] In the last edition, we had written about the Enforcement Directorate’s zeal to slap charges of money laundering. This week, the Supreme Court upheld its powers under the Prevention of Money Laundering Act (PMLA). In his latest column, Pratap Bhanu Mehta explains why this implies, “Rather than being the guardian of rights, the Supreme Court is now a significant threat to it”.

* [Podcast] In the latest Puliyabaazi, we take a long hard look at the consequences of emigration on India.

* [Article] How can the government intervene to reduce dependence on Chinese pharma APIs? Bambawale et al. explain.

* [Paper] Jonathan Haidt has helpfully combined all the latest research on social media’s impact on society in this one master document.

Insights on burning policy issues in India

— RSJ

The Indian rupee this week declined to an all-time low as it went beyond 80 per dollar. For reasons that aren’t always clear to me, this kind of thing makes a lot of news in India. I mean, it was 79.9 the week before. There isn’t a yawning gap between that and 80. Yet opinion pieces are written, cartoons sketched, and old tweets of macroeconomic theorists like Akshay Kumar, Juhi Chawla and Sri Sri (Sri?) Ravishankar are dug out to contrast their current reactions to this phenomenon with their past asides. The WhatsApp factory also rolls out their new models that suggest how a strong dollar is bad for the US economy and how this is some kind of a switch and bait move that we are making on them. Somewhere in many of our heads, the strength of the Indian rupee is no longer subject to the dynamics of the currency market. Like many things these days, it too is anchored to our self-respect. And since our national clarion call is desh nahin jhukne doonga (won’t let the country down), we then start working on the narrative that shows all of this in a warm, positive glow.

All in a day in the life of India.

Anyway, I thought it would be useful to take this moment to appreciate the winds that are buffeting it, the long-term view of what will actually strengthen the rupee and then zoom out a bit to appreciate what’s happening to the US economy and what it could mean for India.

The Safety Of Dollar

We will start with why has the rupee gone to 80 a dollar? The simple answer is the US dollar has been more in demand since the start of the Ukraine war than before. This is true for all currencies, not just the rupee, as the chart below shows.

There are reasons for this. The 40-year high inflation print that the US is witnessing month over month has turned the Fed hawkish. It is likely to raise rates by another 75 bps in its meeting next week, and the consensus suggests the benchmark rates will be around 3.4 per cent by the end of the year. These rate hikes make storing money in dollars more attractive. This potent cocktail of uncertainty around the Ukraine war, the high oil and commodity prices that make emerging markets more vulnerable and the prospect of a global recession is starting to give global fund managers a massive hangover. Their most obvious response: flight to the safety of the US dollar.

The dollar demand has gone up as foreign portfolio investors have checked out of domestic equities across the world. In India, we have had over ₹2.3 trillion of outflow from the equity market so far this year. Things would have been worse had it not been for the domestic investors (mutual funds and insurers) who invested about ₹1.4 trillion during this period. The price of oil—averaging over US$ 120 or so during this year—has made things worse because we import over 90 per cent of our requirements. The across-the-board rise in commodity prices has further increased our import bill.

Almost simultaneously, the high rate of inflation, the rise in interest rates and a prospect of a recession have meant our exports are beginning to soften. The commentary from our software services giants suggests the demand pipeline isn’t what it used to be. This might also show up in other export-dominated sectors as the steep rise in interest rates starts to kill off growth in developed markets. This has meant the consensus forecast among analysts for the current account deficit has inched up to 3 per cent for the year-end. We will need more dollars to support that kind of deficit.

That apart, our own inflation numbers have remained high, and we are running a negative real interest rate (the difference between interest rate and rate of inflation). This will continue to support riskier assets and reward consumption that will feed back into inflation. So, expect further interest rate hikes, and that will impact growth. All of this indicates the dollar strengthening against the rupee is here to stay.

Propping Up The Rupee

What can be done to address this? This is market dynamics at play. There are too many interlinked factors here. Beyond a point, there are only tweaks that you can do in the short term to support the currency. The RBI has tried to ensure that the depreciation is orderly and gradual, which is the best it can do now. It has increased dollar inflows by loosening norms in multiple areas, helping curb volatility. The raft of measures taken here shows how many short term levers are available with a central bank to manage currency volatility. These included removing the interest rate restrictions on banks for foreign currency and non-resident deposits. Such deposits have also been exempted from the statutory liquidity requirements that Banks need to carry for their deposits. This has allowed banks to hike their savings rates for such deposits by almost 75 bps. This will attract dollar deposits from non-resident Indians. The RBI has also relaxed foreign investments in debt instruments and allowed the use of overseas foreign currency borrowing for lending domestically in foreign currency. Even the amount of external commercial borrowing businesses can do through the automatic route has been doubled to US$ 1.5 billion. These immediate measures will smoothen the flow and increase the supply of dollars. The idea here is to weather through the Fed interest rate hike storm for the next two quarters and then take stock. 

The RBI also made an interesting move last week that was reported as the ‘internationalisation’ of the rupee. It allowed special accounts (rupee Vostro accounts) to pay and settle exports and imports in rupees. Further, the surplus in these accounts could be invested in government T-bills and securities. What does this mean? Simply put, if Indian firms can find counterparties who are willing to trade with them in rupees, they can do so more easily than before. On the face of it, this means very little. Because there aren’t many global firms who would want to settle their trade in a currency like the rupee that will depreciate in the long-term and which isn’t useful for trade with non-Indian partners. But it allows us to trade with Russia without getting the dollar involved.

In fact, it is both an economic move and a geopolitical one. We run a trade deficit with Russia. We can now pay for Russian oil in rupees. Russia can use those rupees to buy our exports. The surplus in these accounts can be used to buy government bonds. So we save on buying more dollars to settle this trade, and we create demand for government bonds because the surplus in this account will be invested there. Seems like a neat solution, and I guess the US and the west won’t mind because we have pointed out their hypocrisy on Russian gas and Saudi oil more than a few times now. Apart from this, the government has done its usual quota of excise duty tweaks to manage the situation. We have increased duties on the export of petroleum products and limited sugar and wheat exports. And we have cut import duties on key raw materials and on cooking oils to manage inflation. These won’t add to much, but it gives an impression that something’s been done to address inflation. When inflation stabilises, we will take ages to dismantle these duties. That is an old and different story. 

That takes care of the short term. In the long run, the rupee's strength depends on the fundamentals of our economy. We must run a current account shortfall below 2 per cent, bring down the fiscal deficit and debt to GDP ratio that have gone up significantly in the past two years and keep inflation in the four per cent range, which was the RBI mandate. All of this is hard work and will need the government to translate its words into action. Structural reforms in labour and capital have been pending for ages, the infrastructure push promised in the last budget is still in the works, and fiscal discipline is a tad out of fashion. If we continue to insist on pegging our self-respect to the rupee, then we must know what to demand from the government. 

Where Next?

Lastly, where does the global economy go from here? Well, it is clear that the Fed and other central banks were wrong in their assessment in 2021 that the inflation was transitory. They could have raised rates then, and we wouldn’t have seen the serious inflationary pressure we have now seen for the last six months. This isn’t hindsight. There were more than a handful of sceptics about the notion of transitory inflation. So, the question is, now that the Fed has gone into the territory of whatever it takes to control inflation, what kind of a landing will we have? Will it be a short and mildly painful recession, or are we going to be in for a hard landing? As some are saying, it is possible that we will see the peak of inflation in the next few months, and then the rate hike impact will start to bring it down quickly to more comfortable levels within a year. We could then have a rate reversion cycle begin as early as the end of 2023. That is what the optimists are seeing today.

However, it is possible that there’s a hard landing. That is not just inflation taking longer to tame, but the sustained high-interest environment kills growth and puts the financial system under enormous stress. There’s a possibility that a perfect storm of decline in investment, reduction in consumption and a recession could hurt incomes around the world. The pandemic saw a significant rise in debt levels for both firms and households. A scenario where interest rates stay high and incomes start coming under stress would spell bad news for the ability of these entities to service their debt. A cycle of default could then start and put the entire financial system under stress. We might not have a GFC (2008) like moment, but we could be in that vicinity in future. We have been so used to quantitative easing, low inflation and low-interest rate scenario in the last decade that it is difficult to envisage an alternative where things are radically different.

Yet, as history has shown, you ignore long-tail risks at your own peril.

As a parting shot, the then finance minister Manmohan Singh’s response in the Rajya Sabha addressing the fears of devaluation of the rupee needs a revisit:

Let me say that in this country there seems to be a strange conspiracy between the extreme left and extreme right that there is something immoral or dishonourable about changing the exchange rate. But that is not the tradition. If you look at the whole history of India’s independence struggle before 1947 all our national leaders were fighting against the British against keeping the exchange rate of the Rupee unduly high. Why did the British keep the exchange rate of the Rupee unduly high? It was because they wanted this country to remain backward and they did not want this country to industrialise. They wanted the country to be an exporter of primary products against which all Indian economists protested. If you look at Indian history right from 1900 onwards to 1947, this was a recurrent plea of all Indian economists—not to have an exchange rate which is so high that Indian cannot export, that India cannot industrialise. But I am really surprised that something which is meant to increase the country’s exports and encourage its industrialisation is now considered as something anti-national.

India Policy Watch #2: Q.E.D.

Insights on burning policy issues in India

— Pranay Kotasthane

Nowadays, it seems like just one government agency is burning the midnight oil: the Enforcement Directorate (ED). It’s never out of the headlines.

There’s data to back this claim too. Responding to a Lok Sabha question earlier this year, the Minister of State (Finance) revealed that while during 2004-14, 112 searches were carried out by the ED, this number stands at 2974 in the eight years since 2014, a twenty-six-fold increase! Forget for a moment that the conviction rate of ED in raids conducted under the Foreign Exchange Management Act is merely 0.5 per cent.

Whether it is political parties in the opposition, Chinese companies, fugitive economic offenders, or non-profits, the ED has become the de-facto brahmastra.

Structurally, ED is a law enforcement body deriving powers from a wide range of laws. It was constituted as the “Enforcement Unit” way back in 1956. And since foreign exchange control was a big obsession back then, it primarily investigated cases arising from the Foreign Exchange Regulation Act (FERA), 1947. Then came the Foreign Exchange Management Act in 1999, the Prevention of Money Laundering Act (PMLA) in 2005, and the Fugitive Economic Offenders Act in 2018. A wide remit backed by labyrinthine economic laws made it easily weaponisable.

Now, it is well-known that many law enforcement agencies in India are politicised. Neither is ED the first one nor the last. In the naughties, the “CBI raids” served the same purpose. Exploring the pervasive politicisation of the ED, Pratap Bhanu Mehta writes:

The use of the ED has three purposes. The first is intimidation. The second is to keep the narrative of the old corrupt regime boiling. This is not a difficult proposition to sell to the public. But the third is to reveal the sheer self-absorption of the Opposition.

“For my friends, everything; for my enemies, the law.” said a former Peruvian Field Marshal Óscar Benavides. That is precisely what seems to be happening here.

Domestic politics aside, two Chinese mobile phone companies have recently come under ED investigation. In response, China’s foreign ministry spokesperson had this to say:

The frequent investigations by the Indian side into Chinese enterprises not only disrupt the enterprises’ normal business activities and damage the goodwill of the enterprises, but also impedes the improvement of business environment in India and chills the confidence and willingness of market entities from other countries, including Chinese enterprises to invest and operate in India.

Keeping aside the hypocrisy of China’s moralising, the spokesperson makes an important point. If the narrative goes out that economic crime investigations are being used for political purposes, India will pay a big price. Retrospective taxation was the poster child for India’s economic mismanagement last decade. We don’t need another deterrent puncturing investment dreams this decade.

What could bring law enforcement agencies under control? Are there structural checks and balances that prevent political misuse? I don’t know. But an essential component of strengthening India’s Republic has to be to make investigative agencies truly autonomous from executive control.

Not(PolicyWTF): The Question of Choice

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

"Life is like a box of chocolates. You never know what you're gonna get." This Forrest Gump quote is equally applicable to the Indian judiciary. On most days, it comes out with verdicts that just follow the prevailing social trend. But, there are also those rare moments when the judiciary stands up to defend the Republic from the Democracy.

Take what happened last week. In 2019, the Central Consumer Protection Authority (CCPA) —a new regulatory body—was formed to protect consumer rights. Earlier this month, the CCPA, in its infinite wisdom, issued guidelines that prevent hotels and restaurants from levying service charges. The guidelines thundered:

No collection of service charge shall be done by any other name. No hotel or restaurant shall force a consumer to pay service charge and shall clearly inform the consumer that service charge is voluntary, optional and at consumer’s discretion… No restriction on entry or provision of services based on collection of service charge shall be imposed on consumers. Service charge shall not be collected by adding it along with the food bill and levying GST on the total amount.

Why would the Indian State want to invest resources and time in changing these small matters is an always-relevant confounding question. But this time, the courts came to a partial rescue. The Delhi High Court stayed the guidelines. The judge even had a libertarian statement to go with the ruling. He said:

If you don't want to pay, don't enter the restaurant. It is ultimately a question of choice.

Music to my ears. Information asymmetry is not a problem as long as the service charges are known to the consumer beforehand. There is no market failure. The State can move on.

How I wish the courts applied this new-found virtue of choice to other areas such as:

If you don't want to get offended, don't read the book. It is ultimately a question of choice. No need to ban the book.

If you don't want to pay, don't enter the movie theatre. It is ultimately a question of choice. No need to cap movie tickets.

If you don’t like what others say about you, don’t talk to them. It is ultimately a question of choice. No need for defamation laws.

You get the drift. Don’t make the State a tool to address your pet grievance. It has bigger fish to fry. (And let it apply service charges for the fried fish.)

Global Policy Watch: The Three Internets

Insights on policy issues making news around the world

— Pranay Kotasthane

Many editions ago, I linked to one of Yiqin Fu’s articles on the Chinese internet. There’s so much about it that’s different beyond the fact that the State tightly controls the information flow there. For instance, Fu explains that the Chinese internet is different from the Western internet in these respects:

One, search engines (and not just Google) are hardly used. People read primarily through social media feeds.

And two, the complete dominance of super-apps:

Take WeChat as an example. It is home to the vast majority of China’s original writing, and yet: 1. It doesn’t allow any external links; 2. Its posts are not indexed by search engines such as Google or Baidu, and its own search engine is practically useless; 3. You can’t check the author’s other posts if you open the page outside of the WeChat app. In other words, each WeChat article is an orphan, not linked to anything else on the Internet, not even the author’s previous work.

The result of a lack of rediscovery means that knowledge creation, reflection, and historical context-setting are disincentivised. This resembles some parts of the Indian internet but is not quite the same. This architecture also means that people are pushed towards tracking the latest social media trend, with little or no incentive to create and read time-invariant content, such as blogs, articles, and papers without news pegs.

So, there are three broad internet prototypes:

* The Western one: primary access is through desktop/laptop, not super-app based, search-engine driven, high discoverability of older articles, and email-based.

* The Chinese one: primary access is through the mobile phone, super-app driven, low discoverability, and instant-messaging based.

* The Indian one: The elites see an internet that’s a mix of the Western one and the Chinese one minus the censorship, while the non-elites are experiencing something much closer to the Chinese one.

Forget geopolitics for a moment. And consider the impact of these three internet prototypes on their respective users. Will their cognitive effects be different? If yes, in what way? This is a fascinating question to which I have no good answers yet. What do you think?

Another downside to skipping desktop is that weak ties built around emails are never formed. I don’t have data on Chinese employees’ modes of communication, but I wouldn’t be surprised if 90% of work communication is done over instant messaging. Multinational firms still use email, although when I asked on Chinese social media, my readers complained that emails often went unread. It seems like in the Chinese workplace, instant messaging still reigns supreme.

Fu argues that the result is that weak ties through cold emails are seldom formed. Again, not very different from the case in India where we need to have a phone number in order to form a weak link now. What is the social consequence of this phenomenon?

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] MacroVoices #333: Erik Townsend and Patrick Ceresna in conversation with Harley Bassman on Inflation, Bond Yields, VIX vs MOVE, Demographics & More.

* [Blog] Pakistan is in big trouble: Noah Smith covers the subcontinent for the second week in a row.

* [Article] The functioning of the Enforcement Directorate, by Sonam Saigal.

* [Paper] How to reform high-stakes exam systems? is an important question in the Indian context. A new NBER paper titled Pareto Improvements in the Contest for College Admissions has some clues.

Insights on policy issues making news around the world

— RSJ

What people do when they storm palaces is broadly instructive about what comes next.

In 1792, the French insurgents determined to end whatever remained of the ancien regime stormed the palace of Tuileries and confronted the Swiss Guards who were defending the palace on the orders of Louis XVI. Blood, gore and massacre followed, at the end of which about eleven hundred combatants were killed. These included, as J.M. Thomson wrote in his history of the French Revolution:

..common citizens from every branch of the trading and working classes of Paris, including hair-dressers, harness-makers, carpenters, joiners, house-painters, tailors, hatters, boot-makers, locksmiths, laundry-men, and domestic servants.

The Bolsheviks were not to be outdone on the night of October 25, 1917, when they assaulted the Winter Palace at St. Petersburg on the orders of Lenin. The insurrectionists barely met with any resistance from the yunkers, the Cossacks and the women’s battalion guarding the palace. To quote John Reed from Ten Days That Shook The World (1935):

On both sides of the main gateway the doors stood wide open, light streamed out and from the huge pile came not the slightest sound. Carried along by the eager wave of men, we were swept into the right hand entrance, opening into a great bare vaulted room, the cellar of the East wing, from which issued a maze of corridors and stair-cases. 

...One man went strutting around with a bronze clock perched on his shoulder; another found a plume of ostrich feathers, which he stuck in his hat. The looting was just beginning when somebody cried, ‘Comrades! Don't touch anything! Don't take anything! This is the property of the People!’ Immediately twenty voices were crying, ‘Stop! Put everything back! Don't take anything! Property of the People!’

Many hands dragged the spoilers down. Damask and tapestry were snatched from the arms of those who had them; two men took away the bronze clock. Roughly and hastily the things were crammed back in their cases, and self-appointed sentinels stood guard. It was all utterly spontaneous. Through corridors and up stair-cases the cry could be heard growing fainter and fainter in the distance, ‘Revolutionary discipline! Property of the People.’

The Filipinos did things a bit differently on Feb 24, 1986. As this news report suggests:

It started with a rock fight, then the gate was opened for a few photographers and the crowd pushed through into the palace the Marcos family occupied for 20 years, shouting and grabbing anything they could carry. They snatched clothes, shoes, perfume, monogrammed towels. Some wolfed food from the table at which Ferdinand E. Marcos and his family had dined before leaving in American helicopters for Clark Air Base and flight from the country.

Thousands of people were outside Malacanang Palace when the photographers arrived Tuesday night. Supporters of Corazon Aquino, who became president when Marcos fled, and Marcos loyalists started throwing rocks at each other.

They rushed through the gate, turning left to the administration building or right to the living quarters. Marcos loyalists followed them. The fights and looting started. Cheering, the rioters climbed on top of three tanks. One grabbed an ammunition belt. Others took guns.

Cut to present-day Sri Lanka. It has a foreign debt of over US$ 50 billion. Its foreign exchange reserves are about US$ 50 million. Inflation is running at over 50 per cent. The Sri Lankan Rupee has fallen by 80 per cent since the start of the year. What’s worse is that no one knows who is keeping score.

Former President Gotabaya Rajapaksa fled the country this week. Right now, he is in Singapore negotiating his asylum with friendly countries in the middle-east (why not China?). His brothers couldn’t get out of Sri Lanka in time. Gotabaya’s military plane didn’t possibly have space for two more passengers. Blood is thinner than aviation fuel. The other forty-odd members of the clan who hold various constitutional and government posts have gone into hiding. The time was ripe for an attack on the Presidential palace. And it happened, as they say, duly.

But this is how the Lankans did the storming (Photos: Arun Sankar/AFP)​

To misquote Tolstoy: happy citizens are all alike. Unhappy citizens are unhappy in different ways.

Though unhappy, Sri Lankans look suspiciously upbeat here. So, one thing can be said for sure. There won’t be a revolution in Sri Lanka. The Lankans are a resilient, patient and easygoing lot. They have endured tough times in the past four decades. Now that the Rajapaksas are out of the frame, a national government is likely to be formed; a deal might get worked out with the multilateral agencies involving restructuring of debt, fresh borrowings from friendly countries, and prolonged pain of austerity for the rest of the decade. They will probably muddle through as they have done for much of their independent history. That apart, it is useful to appreciate how Sri Lanka ended up here. There are public policy lessons there.  

There are two lenses to apply. The first is the structural weakness in the Sri Lankan economy that has persisted for a long time. Then there is the proximate cause of the recent past that led to sovereign debt default and bankruptcy. We will examine both here.

The Achilles' Heel

In 1948, the British left Sri Lanka (then Ceylon) with an economy that was quite similar to the many similar resource rich nations of the time. Manufacturing was non-existent, banking services were limited to a couple of cities and the mainstay of the economy was the exports of tea and rubber which were vulnerable to commodity cycles. However, it started with a good base of foreign reserve surplus that could cover imports for over a year. With this starting point, the obvious policy measures should have came into play. One, develop a manufacturing sector (public and private) that stimulates growth in the economy and reduces the dependency on imports of intermediates and finished products. Two, to develop the banking sector and create development finance institutions that could provide credit for this transition in the economy.

Neither happened. In fact, the focus on the plantation economy deepened in the decade after independence. The foreign reserve surplus soon turned to a deficit as Sri Lanka continued to import higher-value goods, and the government found it difficult to raise revenues to support its spends as its population increased.

By the mid-60s, Sri Lanka was contending with both a fiscal deficit and a current account deficit. The classic twin deficit pincer that low-income economies get caught in. Over the last six decades, it has struggled to come out of it. The reasons could be many - lack of domestic savings, absence of development finance institutions, inability to attract other sources of foreign capital like direct investment instead of debt and political instability and a long civil war that didn’t help the economy. Things didn’t go badly for Sri Lanka only in the last few years. Its economy was always fragile, as the seventeen different IMF bailout packages that started in 1965 indicate. See the table below for the history of IMF bailouts (SDR = Special Drawing Rights).

The comparison with India during the same period is useful. India chose the more inefficient state-led industrialisation and capital creation model and overdid it by the 70s with the nationalisation of the banks. But it led to the creation of a manufacturing sector and the availability of credit. India also created relatively strong institutions for a developing economy during that time. That meant we avoided a sovereign debt default scenario till 1991. The Indian state, after having generated the initial impetus, should have gotten out of most of these areas by the mid to late 70s. But that’s another story.

Sri Lanka never built that core capacity, nor did it follow the model of the ‘tiger’ economies of creating national champions in select sectors. In the early 80s it ‘opened’ its economy on the behest of the IMF that made these conditions collateral for further bailouts. The dismantling of duties and exchange controls made Sri Lanka even more dependent on imports as its nascent industries couldn’t compete with the foreign goods flooding in. The twin deficit continued to worsen and further de-industrialisation set in.

There are things Sri Lanka is commended for during this time. It has the best HDI metrics in the region, with good quality healthcare and education available to its citizens. These should lead to better economic outcomes, provided the structural issues are addressed. That these metrics themselves were built on foreign debt makes their sustainability suspect. Over-indexing on one measure while avoiding a comprehensive cost-benefit analysis and the unintended consequences is an old public policy error.  

Why did things go from bad to worse in the past few years?

Two things happened. One, the composition of Sri Lankan debt changed for the worse. Sri Lanka issued international sovereign bonds (ISBs) at attractive coupons that got in global fund houses into the mix with more dollar-denominated debt. China, too, got into the game with large infrastructure projects that have ended up as the proverbial white elephants. The chart below shows how its foreign debt stood in 2021.

The market borrowings now contributing to 47 per cent shot up in the last decade. This fresh source of funds further lulled the policymakers. The government continued to spend and feed domestic consumption without a plan to control the fiscal deficit while borrowing to build infrastructure and pay for imports.

In 2019, Gotabaya came into power, promising to reverse these policies. But the ‘strong man syndrome’ took over. There were bold initiatives announced with minimal debates and understanding of likely scenarios that could emerge. Corporate taxes and VAT were slashed in the hope of an economic boost. That didn’t come because there wasn’t an industrial base that could take advantage of this. The fall in tax revenues widened the fiscal deficit and increased the government’s borrowing from the central bank. The pandemic hit tourism, a significant contributor to the economy and a source of precious foreign exchange. The widening current account deficit had to be controlled, leading to another bold idea. The government announced an overnight transition to organic farming and banned the import of synthetic fertilisers and pesticides. There was no real conviction to organic farming here. It was just a means to reduce the import burden and bring the current account deficit under control. The consequences were disastrous. Paddy production fell over 20 per cent, and there was an immediate food shortage. Tea production suffered, and exports fell. Then the Ukraine war sent oil beyond US$ 100 a barrel, which was the last straw. The central bank supplied over US$ 2 billion in the past 12 months to import essential items. But eventually, they all ran out of runway. And we got here.

Of course, Sri Lanka's historical structural weakness is a factor to blame for its troubles. But you cannot take away the hubris of strong man decision-making that aggravated its situation in the last three years. Policy-making requires debates, scenario planning, anticipating the consequences and above all, strong institutions to take an independent, objective view of decisions. Bypassing them and going by instinct might seem like strong leadership, but the odds are stacked against good outcomes coming from them.

Matsyanyaaya: Ignorance Breeds Bias

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

When our level of understanding of another country is poor, we resort to cognitive shortcuts to make sense of the news coming from there. We interpret happenings in a way that reaffirms our current fears, hopes, and anxieties.

While parsing information about a stronger adversary, we start with a sense of awe. When a weaker adversary makes it to the headlines, we start from a position of derision. Similarly, when we interpret information from a stronger ally, we amplify news that shows us in good light with respect to the ally. As for a weaker ally, our starting point is self-aggrandisement.

Excessive reliance on these cognitive blinkers indicates that we don’t know enough about another country. And since we don’t know enough, we cannot differentiate between trash takes and informed opinions, rumours and facts, and between motivated actions and serendipity. It is easy to see these blinkers in action on social media discussions on Indian foreign policy issues.

Take, for instance, what happened in the US earlier this week. House Rep Ro Khanna proposed an amendment to the National Defense Authorization Act 2023. Amongst other things, the amendment had these lines:

While India faces immediate needs to maintain its heavily Russian-built weapons systems, a waiver to sanctions under the Countering America’s Adversaries Through Sanctions Act during this transition period is in the best interests of the United States and the United States-India defense partnership to deter aggressors in light of Russia and China’s close partnership.

The House passed the amendment. Immediately, Indian media and commentariat pronounced that the US had given India a CAATSA waiver. My first reaction was no different. I realised later that this amendment only urges the Biden administration to provide India with a CAATSA waiver since the authority to take this decision lies with the executive branch. Unsurprisingly, there’s not a single mention of this amendment in the top American newspapers (I checked WSJ, WaPo, and NYT). Still, we had already given ourselves a strategically autonomous pat-on-the-back here in India.

There are several other instances as well. In Feb 2018, a 26-member committee of the Pakistani Senate passed a resolution for the promotion of the Chinese language in Pakistan. Within minutes, Indian media was reporting that Pakistan has made Mandarin an official language of Pakistan! Someone just picked up a piece of bad news reporting from a Pakistani YouTube channel and assumed the worst. The sense of ridicule was almost instantaneous, and few stopped to consider how the official language of a State could be decided by a Senate Committee consisting of 20-odd members?

Of course, these cognitive shortcuts are the easiest to find in Indian discussions on China. Because we understand so little about its culture, language, and politics, we almost always solely rely on our preconceived notions. So, we are absolutely confident that the Sri Lankan economy faltered only because of China’s debt-trap diplomacy, that China’s already deployed AI for advanced decision-making in military systems, or that China’s social credit system is a real-life incarnation of the Black Mirror episode, Nosedive. The reality is quite different, but these narratives occupy prime positions in our discourse.

Can we train ourselves to not succumb to these cognitive shortcuts? Perhaps. Political Scientist Yiqin Fu has a really good solution set in the context of poor understanding of China in the US. She proposes four ways out:

* Tying more of one’s payoffs to what is happening in the target country as opposed to how news from the target country makes you feel would incentive you to form more accurate beliefs. Participating in online prediction markets or having some exposure to the target country’s financial markets would be a concrete example.

* The ultimate solution is to expand your knowledge.. as you can so that you are qualified to judge a wider pool of sellers (commentators).. A realistic approach could be talking to friends or following people with different skill profiles. Together you would be capable of evaluating commentary on a broader set of issues.

* Give more weight to commentary that uses systematic evidence… where applicable, the quality of commentary that cites systematic evidence is generally superior to those that do not.

* People on the knowledge frontier of any given issue bear special responsibility to amplify analyses they find reasonable, including those that reach conclusions they disagree with. On issues at the intersection of many niche areas, the average consumer has no way of distinguishing between analyses that are “reasonable but different from mine” and those that “rely on complete falsehoods.” So experts ought to share all commentary they find reasonable, regardless of how much they agree with the conclusion.

As a footnote, its useful to consider that the “CAATSA has been waived off” cognitive shortcut indicates one of two things:

* some of us are intuitively assuming that US domestic politics has a better appreciation of India’s worldview. And hence, we are ready to jump to the conclusion that the US has already waived off these sanctions. We are seeing what we want to see. Given the chequered past of the US-India relationship, even this mistaken assumption is a positive sign.

* However, I think most people are intuitively assuming that India is entitled to a waiver. A lot of Indians are convinced that the US cannot counter China without India on its side. And so, they interpreted the CAATSA amendment news as a reaffirmation of India’s global importance.

It is also interesting to consider if these mistaken assumptions will impact the Biden administration’s calculus on the waiver. Since many Indians are already convinced that India has got a CAATSA waiver, can it now afford to impose sanctions? The answer, of course, depends on a whole lot of other factors. Nevertheless, our cognitive shortcuts about another country reveal a lot about ourselves.

Course Advertisement: Admissions for the Sept 2022 cohort of Takshashila’s Graduate Certificate in Public Policy programme are now open! Apply by 23rd July for a 10% early bird scholarship. Visit this link to apply.

A Framework a Week: Things Governments Do

Tools for thinking public policy

— Pranay Kotasthane

(This post was first published in March 2018 on Indian National Interest)

A typology of government actions can be extremely helpful. Faced with a policy problem, such a typology can serve as a menu of actions that governments can respond with. Various policy solutions can then be seen in this comparative framework:

* might action X be the better way to solve this policy problem?

* why would the government employ action X over other actions?

* what are the disadvantages of using action X over other actions?

Surprisingly, I came across only a few typologies of government actions. One by Michael O’Hare and the other by Eugene Bardach.

O’Hare’s 1989 paper A Typology of Government Action says: all legitimate government behaviour can be classified in eight classes.

Note how this classification does not include things like laws, rules, and procedures — actions that we associate most commonly with a government. The reason is that these three are methods to implement the chosen government action. As such, a law can be a chosen method for many government actions: to prohibit (example: Prohibition of Child Marriage Act, 2006), to tax (example: Income Tax Act, 1961) and to subsidise (example: the Hajj Committee Act, 1959).

Eugene Bardach’s typology in A Practical Guide for Policy Analysis is the second one I came across. It classifies government actions into these categories:

1. Taxes (add, abolish, change rates, tax an externality)2. Regulation (entry, exit, output, price, and service levels)3. Subsidies and Grants (add, abolish, change formula)4. Service Provision (add, expand, organise outreach, reduce transaction costs)5. Agency budgets (add, cut, hold to last year’s level)6. Information (require disclosure, govt rating, standardise display)7. Structure of Private Rights (contract rights, liability duties, corporate law)8. Framework of Economic Activity (control/decontrol prices, wages, and profits) 9. Education and Consultation (Change values, upgrade skills, warn of hazards) 10. Financing and Contracting (leasing, redesigning bidding systems, dismantle PSU) 11. Bureaucratic and Political Reforms

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Ajay Shah on improving resilience against extreme surges in demand.

* [Blog] Noah Smith has an excellent post on the Sri Lankan economic crisis.

* [Book] Carrots, Sticks and Sermons — another useful classification of policy instruments

Insights on policy issues making news around the world

— Pranay Kotasthane

East Asian economic success is one of India’s favourite public policy discussion themes. Regardless of the facts, we have strengthened our own beliefs based on that transformation. For instance, many Indians are convinced that South Korea, Taiwan, and Japan became powerhouses through well-executed industrial policies in which governments threw their full weight behind specific domestic sectors and companies. East Asian examples are often used to justify India’s protectionist trade measures, a business environment that places higher compliance requirements on foreign companies, and generous pro-business subsidies.

In this debate, we forget the role of two other crucial factors. One, the role of geopolitics. As Arthur Kroeber’s notes in China’s Economy, Japan, South Korea, and Taiwan were part of the US alliance structure and benefited immensely from programs of technical assistance, educational exchanges, and access to the American market.

Two, what’s more significant is that South Korea’s transformation as an export powerhouse predates industrial policy measures. Like India, South Korea too had a scarce foreign exchange reserves problem. Like India, it too opted initially for trade and monetary policies ostensibly aimed at preserving these reserves. But starting 1964-65, South Korean leaders—nudged by the US—were able to reimagine a future in which their foreign exchange problem was to be ameliorated not by import controls but by increasing exports.

To explain the freakish similarities and differences between the paths India and South Korea chose, read these excerpts from an excellent NBER paper From Hermit Kingdom to Miracle on the Han: Policy Decisions that Transformed South Korea into an Export Powerhouse by Douglas A. Irwin.

The economic problems of the 1950s South Korea were uncannily similar to India:

Korea’s economic policy in the 1950s was built around “the three lows”—low grain prices, low interest rates, and a low price of foreign exchange—and the controls needed to maintain them. Although the controls led to perpetual shortages of grain, capital, and foreign currency, each had a rationale. The government sought low grain prices to keep the cost of living down, relying on grain imports from the United States made available through PL 480 (food assistance) grants. The government maintained interest rate ceilings, ostensibly to help borrowers and promote investment, but negative real interest rates meant there was little incentive to save, diminishing investment and financial development. The government kept the price of foreign exchange artificially low to make imported goods, particularly capital goods, cheaper than they otherwise would have been.

The shortage of foreign exchange led the government to introduce import controls to conserve foreign exchange reserves. Import licensing was introduced in 1946 to impede the purchase of nonessential foreign goods. In 1949, the Ministry of Finance began preparing a quarterly foreign exchange budget to determine how export earnings and aid inflows should be allocated in purchasing imports.

The overvalued currency had a devastating effect on the country’s merchandise exports, which declined from $40 million in 1953 to just $16 million in 1958, a year in which imports were $370 million.

South Korea too had an aborted devaluation attempt in the 1960s.

The government devalued the won in two steps… The February 1961 devaluation was made in conjunction with a major reform of the foreign exchange system. The government rationalized the complicated multiple exchange rate system and began to relax import controls, paving the way for a fully unified exchange rate in June of that year.

The devaluation increased exports significantly, but caused pain in the short term.

In the first two months of 1961, prices rose 15 percent, and industrial production, which depended on cheap imported intermediate goods, fell.21 The devaluation hurt the political fortunes of the deeply divided government, which went through several major cabinet reshuffles during its short period in power and never enjoyed strong public support. The government was widely seen as inept, and public dissatisfaction with the country’s situation led to protests. After renewed political unrest and street demonstrations by students, a military coup overthrew the nine-month-old government on May 16, 1961.

Changing tack, the incoming military rulers opted for atmanirbharta:

The government envisioned state investment to build up heavy and chemical industries to increase national security and end the country’s dependence on US aid and foreign sources of supply. Given Korea’s enormous trade deficit and tiny export base, the government thought it easier to replace imports by expanding domestic production of those goods rather than to try to make up the gap by exporting more. The plan was to make the country self-reliant in its ability to pay for its imports, but the plans were formulated “without due consideration of Korea’s short supply of capital and technology,”

This plan failed as each of these required more foreign exchange, which was the limiting condition. Then came a food crisis.

The US also withheld economic aid from Korea, including PL480 food assistance at a time when food was in desperately short supply. In April 1963, Korea agreed to a new stabilization program to reduce the budget deficit, in the hope of bringing inflation under control. The government also agreed to dismantle trade controls and eventually adopt a floating exchange rate. Aid was released, but by July it was clear the government was not living up to the agreement.

Things begin to change after elections in 1963. Eventually, the government went ahead with another devaluation, and a slew of decisive policy reforms in 1964-65.

In essence, Kim believed that the government would have to get rid of “the three lows”—the low exchange rate, the low-interest rate, and low grain prices—as well as reform the foreign exchange system. The devaluation had already raised the exchange rate; getting rid of low interest rates and low grain prices would be deeply unpopular. Said one leader: "“Eventually, the entire business world will protest the policies. Plus, the National Assemblymen will join them and intelligent media editorialists will criticize the policies . . . it will be very difficult.”

The government began promoting slogans such as “exports alone promise a way to economic self-reliance” and “exports as the yardstick to measure the sum of our national strength”

The economy started reaping the rewards even before the industrial policy kicked in:

“The export success of the 1960s and 1970s was basically due to the removal of impediments to trade, namely, the complicated foreign exchange system and the negative effects on export of the protectionist import policy,” “Once the impediments were removed, the economy began realizing its huge export potential, which had been left unexploited until then."

So next time someone sings paeans about South Korea’s industrial policy success, do tell them aap chronology samajhiye.

Thank you for reading Anticipating the Unintended. This post is public so feel free to share it.

The global outpouring of respect and admiration for Shinzō Abe is proof of his outsized impact on Japan and the world. To put his economic contributions in perspective, here’s an edited version of RSJ’s essay on Abenomics from edition #69.

Global Policy Watch #2: Abe Yaar! Lessons From 'Japanification' (From our Archives)

Insights on policy issues making news around the world

—RSJ

Shinzō Abe, the longest-serving Japanese PM ever, stepped down from office last week. His second term which began in late 2012 was marked by his prescription for reviving the Japanese economy. The world called it Abenomics.

Through a mix of unconventional monetary policy, robust fiscal stimulus, and structural reforms to boost growth, Abenomics was seen as a marked departure from the timid response that characterised the previous regimes. Abe was determined to jolt Japan out of the economic morass it had dug itself in for over a quarter-century since 1990. We will discuss Abenomics and what lessons it holds for us in more detail later. But let’s go back to the lost decades of Japan that gave us the pejorative term ‘Japanification’ and understand what happened during that time.

Bubble, Bust And No Recovery

Japan was the miracle economy following WW2, benefitting from U.S. largesse in infrastructure spending, government investments in technology and research, a rise in entrepreneurship and an increase in factor productivity for over three decades. Low-interest rates and all-round prosperity in the 80s led to an asset bubble. The stock market and real estate valuations went through the roof on the back of speculations and easy credit policy. There’s an urban legend (or truth?) of three sq. mts. of land near the royal palace being sold at US$ 60,000. That meant the appraisal value of the palace was more than the state of California then. In little over 25 years from 1960, the land value went up by 5000 per cent in Tokyo and other major cities. By the end of 1989, the Nikkei index was at its historic high of 39,000. This was a bubble and like all bubbles, it popped in 1990.

Japan hasn’t recovered since. The obvious reasons were discerned immediately. The policy response to the bubble was to increase interest rates and quell speculation. But as the equity market and real estate prices crashed, borrowers who had overleveraged themselves were trapped. A debt crisis soon followed with widespread loan defaults. The contagion now engulfed Japanese banks which were staring at a huge pile of NPAs. The credit dried up, investments fell, and the growth slowed dramatically. The sentiment turned negative and the consumers cut down on spending. This began a deflationary cycle.

The Bank of Japan (BoJ) was slow to respond and the deflation spiral set in. Why would you spend today when you know the prices would be lower in future? BoJ began cutting interest rates and brought it below 1 per cent by the mid-90s to spur investment. But these actions weren’t coordinated with a fiscal response. The hike in consumption tax in 1996 meant the further dampening of consumption sentiments. The loan default crisis led to the collapse of three banks in the mid-90s. By 1997, as BoJ and the government were getting their act together, the Asian financial crisis dealt a crippling blow to the economy. This set it back for another three years.

What Went Wrong?

Krugman in 1998 argued the lost decade of the 90s was because of monetary policy failure. His view was the BoJ should have publicly taken a high inflation target that would have avoided deflation and prevented interest rates from going down to zero. Of course, this is supported by theory. A higher inflation target anchors inflation expectation at a higher number and this increased expectation, in turn, leads to higher inflation because of the forward-looking aspect of the aggregate supply equation. Further, the increase in inflation expectation would reduce the real interest rate because it takes time for the nominal interest rate to reach its long-term level. In the short term, this reduced real interest rate stimulates growth which in turn increases inflation. A kind of a virtuous cycle sets in.

Anyway, this wasn’t done by BoJ. The other option was to reduce the interest rate to zero quickly and provide substantial monetary stimulus quickly to check loss in output. A combination of a high inflation target (as suggested by Krugman) and monetary easing policy could have possibly worked.

Between 2001-06, the BoJ went on a quantitative easing overdrive purchasing long-term Japanese government bonds. After the global financial crisis of 2008-09, the BoJ extended this programme to purchase private-sector financial assets including corporate bonds, ETFs (therefore equity in private companies), CPs and invest in real estate investment trusts (REITs). This had an impact on financial markets with stock markets rising, a fall in bond yields and an increase in corporate bond issuances. But this expansionary policy came at a cost. The debt to GDP ratio which was around 60 per cent in the 90s went up to 240 per cent by 2012. However, all of these measures didn’t move the needle on inflation. It is possible a higher purchase of private risky assets like corporate bonds and commercial paper instead of government bond would have spurred growth and raised inflation expectations. But that was not to be.

Separately, the lack of coordination between monetary and fiscal policies hurt the economy. There were multiple increases in taxes to balance the budget while the monetary policy was working to increase consumption sentiments. Lastly, there was a lack of clear communication to manage expectations among the public about long-term inflation, interest rates or growth. Forward-looking guidance by the central bank on these parameters provides assurance to market participants more so when the financial system is weakened by high NPAs and general risk aversion. A recent example of this was seen when the US Fed indicated it will purchase corporate bonds as part of its stimulus during the pandemic. The planned purchase announcement itself did the trick in raising bond prices before the Fed actually bought a single one of them.

Abenomics In Play

Shinzo Abe and BoJ Chairman Haruhiko Kuroda assimilated the learnings from the lost quarter-century to formulate the ‘three arrows’ of Abenomics in 2013. The three arrows were:

* A monetary policy based on a qualitative and quantitative easing (QQE) framework with a 2 per cent inflation target, significant purchase of long-duration government securities and private risky assets, expansion of BoJ balance sheet and upfront guidance on these numbers. BoJ promised to double its monetary base to 54 per cent of the GDP by 2014.  

* A robust fiscal policy that increases absolute government spending on areas like public infrastructure, welfare for its ageing population and servicing the debt. This was to be done in close coordination with the monetary policy actions.

* Structural reforms to spur growth and private investment. This includes lower corporate tax, increase in participation of women in the labour force, more immigration and acceptance of high-skilled foreign workers, more inbound tourism to Japan and championing of free trade (TTP), lower FDI barriers and global liberal order to counter China.

You couldn’t fault their prescription based on what they learned from their past. Abenomics wasn’t a radically new construct but bringing the three arrows together, setting targets for them and then communicating it clearly, indicated Abe meant business. Japan needed to be jolted into a path of recovery and this was the way to do it. The salience of Abenomics grew as more economies, including US and EU, followed the path of QE to stimulate growth and manage financial stability.

Did It work?

Well, it is a mixed bag. The primary objective of the 3 arrows was to ‘warm up’ the economy to an extent that spurs demand and get the investment cycle going. On that count, it is a mixed bag. It has seen limited success in increasing women's labour force participation, more immigration and in keeping debt to GDP at a near-constant level of 240 per cent (pre-Covid) despite the increase in the monetary base. It’s not an unqualified success. The counterfactual, of course, can be asked. Could Japan be worse off today if not for Abenomics?

I think it would.

Lessons From Abenomics

So, what are the lessons learnt from 7 years of Abenomics in Japan? Robin Harding writing for the Financial Times has six lessons from Abenomics for the world struggling with ‘Japanification’. I am paraphrasing below:   

* Monetary policy through the massive purchase of government securities and private assets works. The ‘bazooka’ of 2013 had a positive impact on the Japanese economy – stock markets boomed, credit uptake went up and unemployment fell.

* Despite the promise of coordinated monetary and fiscal actions, Abe couldn’t keep fiscal hawks down. The rise in consumption tax from 5 to 8 per cent in 2014 worked counter to the efforts in increasing consumption. The economy went into a recession. Another increase last year to 10 per cent had the same impact.         

* Communication and future guidance on targets didn’t materialise. The promised inflation target of 2 per cent was never met and the consumption tax hikes meant the premise of raising expectations and letting it do the heavy lifting in raising inflation didn’t work.

* Expectations management works if you meet the expectations. Beyond a point, you need to intervene directly to meet your targets. The key commitments of Abenomics were never kept and soon the market stopped responding to the BoJ plans of further easing.

* Stimulus doesn’t cause an increase in public debt to GDP ratio going up. We have discussed this already. It remained range-bound at 240 per cent.

* Structural reforms didn’t cut to the key issues confronting Japanese society – an ageing population leading to a fall in total factor productivity, a disappointed younger generation carrying the burden through levies and taxes on income, a strong hierarchical working style stymieing innovation and a reluctance to embrace large scale immigration to get out of this rut (an advantage so far for the US).

Course Advertisement: Admissions for the Sept 2022 cohort of Takshashila’s Graduate Certificate in Public Policy programme are now open! Apply by 23rd July for a 10% early bird scholarship. Visit this link to apply.

Global Policy Watch #3: How Social Media Expands our Reference Networks

Global policy issues relevant to India

— Pranay Kotasthane

In edition #173, I argued there are three meta-mechanisms that make social media a powerful instrument: reference network expansion, Overton Window Expansion, and disproportional rewards for extreme content due to information overload.

This article generated an interesting conversation on social media (where else!). One of the discussion points was: what are the precise ways through which reference networks expand? Here’s an initial answer.

To rewind a bit, our reference network comprises “people whose beliefs and behaviour matter for our behaviour”. Social media expands our reference networks as people worldwide can now instantly and repeatedly influence our perceptions. It’s common to misinterpret reference network expansion as echo chamber-isation. However, there’s something much deeper going on.

A reference network expands when an individual associates herself with a new set of individuals. This association could be of two types: comparative and preferential. In the first type, we compare ourselves with others who we imagine to be similar to us. Social media expands the number of people who we can compare ourselves with.

In the second, the focal point is our preferences. Our behaviour is determined by the likes and dislikes of others we encounter on social media.

In the framework above, I have mapped these associations with likely impacts on our behaviours. It explains to a large extent how even domestic issues have global resonance, and why people are willing to support or hate people they’ve never met outside their social media apps.

From this perspective, echo chambers span two kinds of preferential associations (“others like what I like”, and “others hate what I hate”). There are four other mechanisms through which reference network expansion takes place.

Are there other ways you have seen reference network expansions happening on social media? Do leave a comment.

HomeWork

Reading and listening recommendations on public policy matters

* [Report] State of Discrimination Report by Bhuvana Anand and Sarvnipun Kaur analyses all the state-level legal barriers to women's employment in India.

* [Book] For those interested in community building, Peter Block’s Community: The Structure of Belonging has excellent insights. The portal abundantcommunity.com too has some handy resources.

Insights on policy issues making news around the World

- RSJ

On Friday, Justice Samuel Alito along with the conservative bloc of the US Supreme Court (SCOTUS) overturned the landmark Roe v Wade judgment that had granted women a federal right to terminate a pregnancy about half a century ago. The conservative raid into the SCOTUS that started with the efforts of Bush Jr and concluded with Trump appointing three judges during his term has delivered to the great woe of the progressives. The learned judges searched for the word abortion in the Constitution. And to their surprise, they figured it just wasn't there.

To quote:

We hold that Roe and Casey must be overruled. The Constitution makes no reference to abortion, and no such right is implicitly protected by any constitutional provision, including the one on which the defenders of Roe and Casey now chiefly rely—the Due Process Clause of the Fourteenth Amendment. That provision has been held to guarantee some rights that are not mentioned in the Constitution, but any such right must be “deeply rooted in this Nation’s history and tradition” and “implicit in the concept of ordered liberty.”  

The right to abortion does not fall within this category. Until the latter part of the 20th century, such a right was entirely unknown in American law. Indeed, when the Fourteenth Amendment was adopted, three quarters of the States made abortion a crime at all stages of pregnancy. The abortion right is also critically different from any other right that this Court has held to fall within the Fourteenth Amendment’s protection of “liberty.” Roe’s defenders characterize the abortion right as similar to the rights recognized in past decisions involving matters such as intimate sexual relations, contraception, and marriage, but abortion is fundamentally different, as both Roe and Casey acknowledged, because it destroys what those decisions called “fetal life” and what the law now before us describes as an “unborn human being.”

Roe was egregiously wrong from the start. Its reasoning was exceptionally weak, and the decision has had damaging consequences. And far from bringing about a national settlement of the abortion issue, Roe and Casey have enflamed debate and deepened division.

Strong stuff. But with a minor problem. I’m not sure SCOTUS has always stayed away from subjects that don’t have a reference to them in the Constitution like the learned judges have claimed. I mean I have gone through the US Constitution and the Declaration of Independence document a few times. I could have also told them they won’t find a reference to abortion there. But I didn’t find the word woman in them either. No idea how that section of the human species got all sorts of rights in the US then.

Also, missing from the Constitution are references to wild house parties involving strippers, or to tomatoes, home video recording, or swats to your bottom with a paddle to name just a few of my favourite things. But these are all things on whom the Court has delivered verdicts. Read them if your life is as boring as mine: Wild house parties involving strippers. Is the tomato a fruit or vegetable? The Betamax case of using a home recording device. And the case of the Principal who delivered 20 swats with a paddle to his pupil James. The SCOTUS has opined on them all.

So, you see the judges aren’t exactly being consistent with precedence here. And they are setting new dubious benchmarks. There have been numerous instances of the Court striking down past judgments to grant more rights. Not to take them away. This is a repudiation of a lot of truths that progressives take for granted. That the arc of history in the long term bends towards moral justice. Or, that gains on individual liberty that survive more than a generation become irreversible. 

Apparently not. 

So, we have the US now joining El Salvador, Poland and Nicaragua in the list of countries that have rolled back abortion rights in the last three decades. About 26 states will make abortion illegal or restrict it on the back of this judgment with immediate effect. It is all quite remarkable.

Some days you try and make sense of the pitched battles on the US cultural landscape: on how to use pronouns - he, she, they, it, them, their; or the definition of woman; or cancelling J.K. Rowling because she is a TERF. The terms of such debates are so rarefied that you need a primer first to understand the language being used before you can come to the substantive issues. And while they busy themselves in an ever-splintering contest of being ‘purer’ than the other, the rug gets pulled from under their feet with a judgment that rolls back years of hard-fought wins on women’s autonomy on their bodies, individual liberty and female reproductive health and safety. Now more than half the states are readying themselves to implement it tomorrow. It reinforces my view that any ideology or “-ism” isn’t threatened by its rival but by the absolute section of its own adherents. The desire to finish off the ‘near enemy” is stronger than fighting the real one. Some day the ‘trads’ and ‘raitas’ of Indian wrong wing will also get there. It is a point I have made a few times in explaining Schmitt’s notion of an enemy being essential for a political ideology to flourish.

It is not that progressive are alone in this kind of hypocrisy. The same conservatives who value the life of a foetus or of those who are ‘unborn’ don’t see any problem in defending the ‘gun culture’ that takes away more than fifty thousand lives every year. For some convoluted reasons, those lives are an acceptable cost to pay for the right to possess firearms. It is sad yet funny to an outsider looking in.  

This won’t stop here. The conservative majority in the SCOTUS took decades, and a lot of good fortune, to come to fruition. They will make the most of it.

Justice Clarence Thomas gave a sense of what is to come in his concurring note to this ruling:

“In future cases, we should reconsider all of this court’s substantive due process precedents, including Griswold, Lawrence, and Obergefell.”

Quick reminder. Griswold v Connecticut is about a married couple’s right to use contraception without state interference. Lawrence v Texas restricts the states from criminalising sodomy, and Obergefell v Hodges established the right for same-sex couples to marry in 2015. Justice Thomas might be alone now in raking these up. But something tells me that the genie is out now.

For all its pretensions, ideology reduces itself to three functional truths. Find something to hate viscerally, over-extend the shadow of your ideology to all realms of a citizen’s life and protect yourself by sanctifying a core principle within the ideology that cannot be made profane. You will enjoy the fruits of power while future generations will foot the bill. We are now on an overdrive of ideology on both sides of the partisan divide.  

Stepping back there are three points I want to make here about what this reversal could mean from the seemingly ineluctable path the American society was marching on since the civil rights movement of the 60s. 

First, the tyranny of the well-organised minority in a democracy is real. American society isn’t as divided on the issue of abortion as it was decades back. Roe v Wade didn’t ‘deepen division and enflamed debate’ as Justice Alito puts it. I went through Pew and Gallup surveys over the years on people’s attitudes towards abortion. It is safe to say anywhere between 60 - 80 per cent of Americans are against the idea of making abortion illegal. Most of the remaining too don’t hold extreme positions on this topic. Maybe there’s a 15 per cent minority of evangelicals and Catholics concentrated in certain states that hold views that have been upheld by the SC. Yet they have prevailed because single-issue voters like them matter in the Republican primaries and in winning the swing states. This is what explains Trump’s base among these groups despite his standing for everything they abhor on moral grounds. And once you establish this ‘tyranny of minority’, you can override the silent majority. Because the benefits are concentrated with them while the costs are diffused among the majority. It is not as if the founding framers of the US Constitution were unaware of this risk. Alexander Hamilton in Federalist Papers #22 (1788) had cautioned:

“To give a minority a negative upon the majority (which is always the case where more than a majority is requisite to a decision), is, in its tendency, to subject the sense of the greater number to that of the lesser.

If a pertinacious minority can control the opinion of a majority, respecting the best mode of conducting it, the majority, in order that something may be done, must conform to the views of the minority; and thus the sense of the smaller number will overrule that of the greater, and give a tone to the national proceedings. Hence, tedious delays; continual negotiation and intrigue; contemptible compromises of the public good.” 

This is the reality. The only way to deal with this is for the opponents to mobilise themselves into a single issue minority that counters this or to wait for this to splinter on its own. Neither seems possible at this time in the US. But the broader message on how a minority cause can overturn a majority consensus will not be lost on many who champion fringe causes. And this is also the reason one shouldn’t casually dismiss any voice even in India as fringe as we tend to do. Fringe swings votes and influences the social and cultural agenda of political parties. It is wise to remember that when considering the statements of Yati Narsinghanand or Nupur Sharma. 

Second, the concurrence note by Justice Thomas that refers to other hot-button conservative cultural causes will play out in a certain way. It is important to understand this. As he wrote:

“we have a duty to “correct the error” established in those precedents …. After overruling these demonstrably erroneous decisions, the question would remain whether other constitutional provisions guarantee the myriad rights that our substantive due process cases have generated.”

What Justice Thomas has done is in public policy called ‘shifting the Overton window’. What was earlier not in the realm of discussion or consideration now comes into play. The terms of reference for the cultural debate to be played out in courts have been widened with those lines. This will have an impact on the decisions made in numerous lower courts. Lives will be affected. 

Lastly, I come back to a point I have made before about the sanctity of Courts directing social norms in a top-down fashion as it was first done in Roe v Wade and the manner of overturning it on Friday. A bit of context will help here.

The conservative preference is for any social change to be gradual. Societal change is shaped through the many eddies of debates and protests that resist the flow of the mainstream. As they gain wider acceptance, they begin changing the course of flow of social norms. This could be painstakingly slow, but it makes change acceptable and sustainable. For the conservatives, the role of the judges is to apply laws, not to create them. Going beyond this brief becomes judicial activism. So, the original conservative view was that all issues of public or social policy should be discussed and debated by the legislative and executive branches of the state that represents the society. Courts resolve disputes following the written-down law while sending back any ambiguities to the legislative arm for approval.

The liberal position, as it has evolved over time, is marked with suspicion of the society reforming itself. The classical liberal approach to this problem was to accelerate the process of change in society. This was to be achieved through a combined political, social and cultural assault on the bastions of conservatism in the society. This led to the portrait of a liberal as a perpetual activist in a constant state of mobilisation to upend existing norms. The liberal belief that society must change from within was no different from the conservative stance. The difference was between the need to induce change through proactive measures and the speed of change. This need for speed eventually led the liberals to the courts.

Based on the evidence it can be argued the conservatives have lost the argument. The courts are at the front and centre of social policy-making today. The many historic judgments that cleave the US society are evidence of it. The legislative arms of the state representing the society aren’t drafting these laws.

But here’s the irony. The conservatives have co-opted the liberal model. With a few strokes of good fortune, the single-minded agenda of turning the US SC bench into a conservative majority has been fruitful. The peril of pushing social change into the cabins of a powerful, centralised and autonomous institution is clear to the liberals now when the shoe is on the other foot. A blunt instrument doesn’t look blunt till it is in the hands of your adversary. The path of wresting back control to society will be long and arduous.

Roe v Wade verdict in 1973 was ahead of its time. It was imposed on a society where the majority weren’t onboard. It bred resentment and a counter-movement. Justice Alito’s verdict on Friday takes us back in time. It too is imposed on a society where the majority isn’t with it. The Court is either ahead or behind the times in which they live.

And it is on this subject, I come to the only line that I agreed with in Justice Alito’s 213-paged judgment:

It is time to heed the Constitution and return the issue of abortion to the people’s elected representatives. “The permissibility of abortion, and the limitations, upon it, are to be resolved like most important questions in our democracy: by citizens trying to persuade one another and then voting.”

That’s the way it should always be. Back in 1973. In 2022. And in future.

Addendum

— Pranay Kotasthane

I don’t follow American politics. I’m also cognizant of my ignorance of the context of the abortion debate. And so I’ll stick to three broader points of comparison between the Indian and American political systems.

First, this case brings the Constitutional Immutability Dilemma into focus. The underlying reasoning of the judgment is that the American constitution makes no specific reference to a right to obtain an abortion. The cases Roe and Casey tried to link it with other rights, which the current Court did not find acceptable. As an Indian observer, one would think that the constitution should’ve been amended to insert this right expressly, but that’s where the Constitutional Immutability Dilemma kicks in — how amendable should a constitution be after all?

To resolve this dilemma, India and the US pick opposite ends. Amending the American constitution requires fulfilling extraordinary conditions, and hence just 27 amendments have been made in its nearly 250-year-old history. On the other hand, amending the Indian constitution is far easier. The latter’s mutability often attracts criticism on these lines—“a document that flexible is a periodical, not a constitution”. However, I’ve always been sceptical of that view. Constitutions are neither sacred books nor indisputable words of a supernatural force. Allowing subsequent generations to alter the constitution through their elected representatives is perhaps a better equilibrium than relying on future judges’ interpretations of an inflexible constitution. Ambedkar, in fact, cited Jefferson in defence of this choice:

“We may consider each generation as a distinct nation, with a right, by the will of the majority, to bind themselves, but none to bind the succeeding generation, more than the inhabitants of another country.”

As this case illustrates, having rigid conditions for amendments open the door for partisan court benches to interpret the constitution as per their ideological worldviews. At the very least, I submit that a periodical is not worse than an immutable book. The working of a constitution is dependent on many factors outside the nature of the constitution itself. These lines from Ambedkar’s Constituent Assembly speech reverberate today:

“..however good a Constitution may be, it is sure to turn out bad because those who are called to work it, happen to be a bad lot. However bad a Constitution may be, it may turn out to be good if those who are called to work it, happen to be a good lot. The working of a Constitution does not depend wholly upon the nature of the Constitution. The Constitution can provide only the organs of State such as the Legislature, the Executive and the Judiciary. The factors on which the working of those organs of the State depend are the people and the political parties they will set up as their instruments to carry out their wishes and their politics. Who can say how the people of India and their purposes or will they prefer revolutionary methods of achieving them?… It is, therefore, futile to pass any judgment upon the Constitution without reference to the part which the people and their parties are likely to pay.

Second, every polity has its unique set of ‘sacred cows’—issues involving such deference and passion that logical arguments stand no chance. For reasons of historical path dependence, these issues over time become wicked, insurmountable problems. Guns and pro-life are two such sacred cow issues of the American polity. To an external observer, the solutions might seem absurdly simple. But to someone in the midst of it all, the issue seems intractable. India too has many such sacred cow issues, one of which is the sacred cow itself.

Third, the judiciary often ends up confusing itself for the politician. These lines from the judgment are instructive: “And far from bringing about a national settlement of the abortion issue, Roe and Casey have enflamed debate and deepened division.” Why should it be a court’s problem if its judgment has led to more division? Is it a Panchayat that needs to come to a mandavali (negotiated settlement) or should it only be concerned with the Constitutional provisions? These questions keep making a frequent appearance in India. Looks like they aren’t settled yet in the US as well.

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India Policy Watch: Pension Tension

Insights on burning policy issues in India

— Pranay Kotasthane

The protests against the Agnipath scheme seem to have peaked. This gives us an opportunity to step back and look at the issue dispassionately. We have already looked at the Agnipath scheme in some detail last week. This time around, I’ll focus on the underlying motivation behind this scheme: India’s defence pension bill.

In the Hindustan Times, I present a short history of India’s pension bill.

"Before 1965, soldiers below officer ranks were recruited through a mechanism resembling Agnipath in the sense that they served seven years of compulsory service and didn’t receive a pension on retirement. This service period was first raised in 1965 to 10 years for bulking the armed forces after the 1962 defeat. Since a pension required a minimum service of 15 years, most soldiers still didn’t qualify.

In 1976, this ten-year service term increased to 17 years, meaning every soldier in normal circumstances qualified for a pension on retirement. With the welcome development of a rising life expectancy, there was also a steady increase in the number of pensioners. The combined effect of these factors was a rapid rise in the pension bill. From Rs 228 crores in FY81, the pension expenditure galloped to Rs 5923 crores by FY99.

The Kargil Review Committee (1999) set off the alarm bells over the pension issue, mooting the idea of reducing the service term to 7-10 years. As an alternative, the committee also proposed an inverse lateral induction mechanism, whereby a paramilitary force recruit would be deputed to the armed forces for seven years and repatriated back to the parent organisation after that. Through this mechanism, the experienced soldiers could be retained in the national security system longer while reducing the pension bill. None of these alternatives received the political nod. 

Meanwhile, in 2004, the union government was able to find a long-term solution for pensioners from the civil services cadre. While continuing to pay pensions of all current employees, the government moved its incoming employees recruited after 1 Jan 2004 to the National Pension System (NPS). NPS is a “defined contribution” scheme, where the pension is paid out of a corpus the employee and the government co-create over the employment period. Over time, this move will likely make the pension bill sustainable, as the liability is not being passed on exclusively to future taxpayers. However, armed forces personnel were kept out of this reform, mainly because non-officer rank soldiers retiring after a short 15-year service would not be able to build a robust corpus, unlike their civilian counterparts who were in service for twice that period. 

The lost opportunity in 2004 proved to be costly. By 2014, the public discourse had shifted in the opposite direction. Rather than customise the NPS to soldiers’ requirements—which would have been an ideal long-term solution—the NDA government implemented the One Rank One Pension (OROP) scheme. By agreeing to a “defined benefit” scheme that resets periodically based on current employee compensation, the union government unthinkingly committed itself to a perpetually fast-growing liability. 

While the government was happy to kick the can down the road, the COVID-19 pandemic was a wake-up call. On the one hand, government finances were thrown off balance. On the other, the border stand-off with China drove home the point that defence reforms are not just essential but also urgent. The creation of the Chief of Defence Staff (CDS) position was the first step. General Bipin Rawat repeatedly drew attention to the unsustainable defence pensions. During his tenure, a few alternatives were discussed. Each available option came with its own set of implementation challenges. Out of this imperfect set, the government chose to reduce the default service term to four years, labelling it as the Agnipath scheme.

In the Times of India, I try to estimate the defence pension savings arising from Agnipath:

Over the long term, it has the potential to reduce the pension burden substantially. At the same time, the scheme will not directly impact the allocations for modernisation in the short term. Here’s why.

Agniveers recruited today are replacing soldiers who would have retired approximately 15 years from now. The purported pension savings would start accruing only after a decade-and-half. 

As for the size of savings, we created a basic model from publicly available data. Our thumb rule suggests that the net present value of all future pension outflows per soldier is Rs 1 crore. The actual savings might be higher. Reports on the initial proposal by the Indian Army for a three-year Tour of Duty put the prospective lifetime savings per soldier at nearly ten times our estimate.

Arriving at an accurate figure is difficult as the government does not release the split-up of total pension expenditures between officers, soldiers, and defence civilians. To get around this data hole, we assumed that the average pension of a retiring officer is 3.5 times the average pension of a retiring soldier. To calculate the total pension outflow per soldier, we assumed that a soldier receives a pension for 29 years on average, i.e. the difference between average life expectancy (69) and the retiring age of a soldier (40). Further, since pension outflows happen over several years in the future, we use the Net Present Value (NPV) method to determine the current value of all future payments. For simplicity, we assume that the pension is indexed to the discount rate. Using even this extremely conservative model suggests significant long-term gains. Allowing 75% of the Agniveers recruited this year to let go after four years alone has a net present value of approximately Rs 34500 crores.

As highlighted earlier, these savings will accrue only after 15 years. But just as today’s deficits are tomorrow’s taxes, today’s reforms become tomorrow’s savings. Through Agnipath, the government can manage pension expenditures over the long term.

Finally, this entire defence pension debate has three important lessons in public policy.

First, secrecy is the enemy of public policy. Kelkar & Shah, in their book In Service of the Republic, identify secrecy levels as one of the barriers to building state capacity. They write that it is harder to achieve state capacity in areas closed to open feedback and criticism. The defence pension debate is a good illustration of their assessment.

As a policy analyst, the sad feature of this entire debate over defence pension is the complete absence of good data. Believe it or not, the government does not release defence pension data beyond the aggregate numbers listed in the budget documents. For example, we still don’t know how this Rs 1 Trillion amount is split up between officers, non-officers, and defence civilians.

In the absence of this foundational information, myths abound (We tried to tackle five common myths in ThePrint). Moreover, without good data, the policy pipeline is clean-bowled at the very first step. There are no good models or projections to inform a cost-benefit analysis.

Second, is the absolute need for ex-ante fiscal projections of government plans. Seemingly innocuous changes in pension policies can have hard-to-reverse adverse effects. An institution such as an Independent Fiscal Council can help the people and politicians understand the financial consequences of such plans even before they are implemented.

Finally, I liken pension reforms to six-day test matches. Reducing employees' pensions while they are in service would be an immoral breach of trust. And hence, all pension reform options can only tackle future employees. Reforms done today can at best contain the rise in spending a couple of decades later when these yet-to-be-hired employees retire. Hence, it is imperative to exercise caution on pension policies at the inception stage. 

HomeWork

Reading and listening recommendations on public policy matters

* [Articles] In #171, we discussed two missing meta-institutions in India. This week, a couple of excellent articles throw light on two other missing mechanisms. KP Krishnan in Business Standard writes about the need for an independent evaluation mechanism for statutory regulatory authorities. Rajya Sabha MP Sujeet Kumar, Vedant Monger, and Vikram Vennelakanti propose a method for formalised impact assessments before and after any law/scheme get a go-ahead.

* [Audiobook] The late Richard Baum’s The Fall and Rise of China lectures are terrific.

* [Podcast] Over at Puliyabaazi, we discuss Agnipath and related issues.

* Edmund Burke, Reflections on the Revolution in France, 1790

Insights on burning policy issues in India

- RSJ

The Union Defence Minister along with the chiefs of the three armed services on Tuesday announced the ‘Agnipath’ scheme for recruitment into the Indian military. You can read more about the scheme here. I have summarised the key features below:

* The soldiers under this scheme (referred to as ‘Agniveers’) will be enrolled for a duration of four years in a conscription or tour of duty (ToD) like model that’s prevalent in other countries. They will be paid between INR 30,000 - 40,000 per month during their tenure apart from risk or hardship allowance as applicable. 30 per cent of their salary will be deducted as a voluntary contribution into a corpus called ‘SevaNidhi’ with a matching contribution from the government. Roughly put, the soldiers will get this SevaNidhi package of about INR 11.7 Lacs plus the interest accumulated on this amount at the end of their four years of service. Few other post-retirement benefits are thrown in, including a life insurance cover and access to a bank loan of INR 18.2 Lacs against the SevaNidhi package.

* About 25 per cent of Agniveers will be absorbed into the regular cadre after four years. The rest will receive an Agniveer Skill certificate, the SevaNidhi corpus and some preferential treatment in getting into the Central Armed Police Force (CAPF) and maybe even state police forces. 

* The Agniveers who leave at the end of four years, however, will not get the usual entitlements of gratuity and pension. This is huge. Over a period of couple of decades, this could mean only about 25 per cent of the forces will have the pension benefits that are available to all today. 

* The enrollment under this scheme will be on an all-India and an all-class basis. This will be, by itself, a distinct rank in the armed forces with its own insignia. The likely implications of this are quite significant. The recruitment of soldiers today, especially in the army, is based on state-wise quotas and on the retirement of soldiers from various regiments that are class based. Class here should be read as an euphemism for caste or community. Drawing Agniveers on an all-class basis will mean withering away from the traditional structure of regiments. It could also mean a larger representation of states where unemployment rates are high because there might not be state-wise quotas anymore. This could further alter the composition mix of the armed forces.

The government also positioned this as a move that will infuse youth and vitality (or ‘josh’ and ‘jazba’ as mentioned in various media reports) into the armed forces. The whole thing including the names Agnipath and Agniveer sounds like a campaign for an early 1990s Nana Patekar film. You could soon shoehorn Agni Pariksha (for the recruitment tests), Krantiveer (best Agniveer cadet), Yugpurush (lifetime achievement award for Agniveers), Angaar, Tiranga, Prahaar and so on. You get the picture. We are in this territory now.

Anyway, the average age of the armed forces which is 32 now will come down by about five years. The younger workforce will be more technology-savvy that will be more attuned to the changing nature of modern warfare. Also, the 75 per cent of Agniveers who will go back into civil society will serve as a disciplined and nationalistic labour pool to draw from for organisations. There will be Agniveers in every village and taluk who will improve the moral fibre of our society. We will have no riots, no littering, no traffic violations and no crime. The retired Agniveers will change us. Because they will put the nation first. Always. Like Arnab.

Well, that’s the official line anyway. 

Backlash

Unfortunately, the response to the scheme hasn’t been what the government was expecting. There have been protests, arson and general lawlessness by unemployed youth that seems to be spreading across the country at the moment. A large section of retired armed forces officials too have questioned both the scale and speed of a change like this. The issues agitating them have some basis:

* There have been very few recruitment rallies during the two years of the pandemic. About 60,000 soldiers retire every year and this gap is filled up during the regular recruitment drives. It is safe to assume there's a 1.5 Lac gap that’s opened up since 2020. The expectation among aspirants was this will get filled up in the next year or so. That apart, there are those in the middle of their recruitment process who are unclear about their status now. Roughly put, there could be more than a crore of youngsters under the age of 21 who were waiting for these recruitment drives to restart. What they have now instead is about 46,000 open positions for the current year with a 25 per cent probability of a long-term career in armed services with full benefits. If you work the numbers, it also suggests a reduction in armed forces count by about 1.5 - 2 Lacs (about 10-15 per cent of the workforce) over the next four years. I’m not sure if that’s also a stated intent of this scheme but it will be a collateral result unless the Agniveer recruitment numbers are ramped up significantly in the following years.

* There is an inherent contradiction in acknowledging a modern military requires advanced warfare systems, technical know-how and expertise that takes years to build and having only 25 percent of personnel working on longer tenure commissions. Will the constant churn come in the way of managing these systems? Will there be institutionalised knowledge management that will be able to handle this scenario? Also, the eventual dismantling of the class-based system that this move seems to portend will need to be thought through. It is fundamental to how the army operates today.

* The other question is about the prospects of the 75 per cent who will be released every four years. This is a number that will keep rising over a period of time. All the romanticisation of the armed forces and its discipline aside, these will be youngsters without a college degree and with limited technical skills. How useful will they be to the wider world? Not much if you go by the current record of hiring of retired defence personnel. They will have to study further and acquire specific skills to be employable. To expect CAPF or the state police force to absorb them is a bit optimistic. Also, there are aspirants for those jobs too with their own patronage system who will scuttle these moves. 

* Lastly, for all the josh and jazba that are likely to come free because of this move, it will be useful to understand the repercussions of having a workforce that knows only one in four among them will qualify for the longer commission. What behaviour will this engender in them? How objective will the criteria for selection be? And if the 75 per cent who are released struggle to get jobs and earn their livelihoods, the feedback loop to the future cohorts will be immediate. The situation will turn more fraught at the end of every four-year cycle. The comparison with other countries that have a ToD model is useful but it is important to appreciate we are a US$ 2000 per capita economy with over 40 per cent of the employable labour pool either without a job or underemployed. In other countries, those who want to continue to be in the armed forces almost self-select themselves. 

These arguments, for and against aside, this is a good example to understand the complexities of policymaking, especially in defence, in India. 

A Difficult Problem

Let’s begin with the single most important policy objective for armed forces now in India. This is quite stark and apparent - it needs to modernise its defence infrastructure and increase its capacity in areas of modern warfare like the air force and navy. Given the threat perception on its borders, this is an already delayed exercise. You can read a detailed ORF report on India’s platform modernisation deficit here for more. TL;DR: yes, we do have a modernisation challenge on hand. And it is quite bad.

Now the key question is what’s coming in the way of modernisation? There are multiple answers to this but on the top of that list is a lack of funds. The defence budget has broadly remained around 2.2 per cent of the GDP over the last decade. India has struggled to contain its fiscal deficit and it has limited ability to allocate more to its defence budget. As we have written on umpteen occasions, the Indian state is spread wide and thin. It does way too many things badly. Therefore, it cannot find money to do things it must. More importantly, pension benefits (24 per cent) and wages (28 per cent) take up over half of its budget. These numbers, especially pension outlays, will continue to grow in the coming years as the full impact of OROP (one rank one pension) plays out.

The OROP that came into effect in late 2015 is a known and acknowledged policy mistake that is quite simply unsustainable. But it is almost impossible to walk back on that now. So, the search for circumventing that burden is one of the factors that has led to this scheme. A bad policy decision has a long-term downstream impact and this is a classic case of that playing out. Even if the Agnipath scheme is implemented as it stands today, the easing up of the pension burden will take decades to play out. The need for modernisation of the armed forces is as of yesterday. But the government is hoping through a combination of a 10-15 per cent reduction in the strength of the military and a long-term solution to control the burgeoning pension bill would have given it some room to ramp up on modernisation without increasing defence outlay. There are various estimates of the net present value of the expenditure on a single soldier who joins the armed forces today. At fairly conservative estimates of discount rates, wages and future pension benefits, Pranay estimates this to be about INR 1 crore. In my view, that is the absolute floor for that value and it might be around INR 2 crores if one were to take a bit more realistic assumptions. So, a 1.5 - 2 Lac workforce reduction could mean a significant availability of funds to modernise the defence platforms over time.  

Growth, Growth, Growth

That’s likely the thinking that’s gone behind the scheme. Everything else including the messaging on josh and jazba or having retired Agniveers in every village is to make it palatable to the public. It is difficult to acknowledge openly to people that the economy cannot support the defence requirements of India when you have made nationalism and nation-first important planks of your political strategy. This communication plan could have worked except it had to contend with the other real problem of the Indian economy at the moment.

Lack of jobs.

For reasons that could take up another post, the Indian economy isn’t generating enough jobs for its large youthful population. Roughly, India needs to create between 15-20 million non-farm jobs every year to keep pace with those entering the labour force. The labour participation rate has remained in the 40-45 per cent range for a long time. New job creation data can be contentious but it is difficult to argue that India is creating anything more than 3-4 million jobs every year. The quality of many of these new jobs isn’t great. The merry-go-round of employees switching jobs and getting big hikes in the IT/ITES sector shouldn’t blind us to the reality in the broader economy. There aren’t enough jobs.

The two prerequisites for job creation, an 8-9 per cent GDP growth and skew towards sectors like construction, infrastructure or labour-intensive exports aren’t being met. The reason the job crisis hasn’t snowballed into a larger political and social issue is the immense faith in the PM among the youth. There’s a strong belief among them that India is on its way to becoming a superpower. The regular dose of nationalism and jingoism that’s amplified by the media helps continue this narrative. A related issue here that accounts for the violent protests is the lure of government jobs. The public sector jobs at the junior levels have become more remunerative than similar roles in the private sector in the last decade. As much as people love quoting the salaries of the CMDs of PSU Banks or the senior IAS officers and comparing them to the compensation of private-sector CEOs, the reality is that at mid to junior levels the government jobs are better paying. You can dig deeper into the wage bills of listed PSUs and compare them with their private counterparts for evidence.

The other supposed benefits of a government job like job security, work-life balance and a possibility of rent-seeking (though low in defence jobs) make the package very attractive. This has meant a dramatic reversion in trend of people hankering for public sector jobs that had waned in the first couple of decades of liberalisation. So, a reduction in the number of such jobs or cutting down their benefits as the Agnipath scheme is likely to be isn't going to be accepted despite the great popularity of the PM and the ruling party among this segment. Their expectation, in contrast, is for the number of government jobs to go up.

Considering the constraints, it is difficult to see what else the government could have done here. The need to reduce wage and pension costs to fund modernisation is real. And given the fiscally conservative instinct of this government, it won’t deficit fund the modernisation programme. As is its wont, it has chosen to put a bold announcement with emphasis on other benefits while trying to solve its key problems under cover. There’s this myth that a big bang approach to reform is the only model that works in India. That’s wrong. A lot of what has looked like big reforms in India have actually had a long runway that’s often invisible to people. A more comprehensive reading of the history of ‘91 reforms makes this clear.

So, the usual template has been followed so far: minimal consultation, no plans to test it out at a smaller scale and instant big bang implementation. The results are unsurprising. I am guessing we will see a similar script play out for the next few months. There will be rollbacks (a few have been already announced), some concessions that will tinker around years of service or percentage releases, and a few sops thrown in, to temper the anger. If I were to give more credit than is due to this government’s planning chops, I might even say it possibly did this on purpose. Release a more extreme form of scheme, brace for impact and then roll back to the position that you always wanted in the first place. It is one way to game public opinion to your favoured outcome.

Of course, a more impactful solution to this is to acknowledge the mistake that OROP is and shift the pension of defence forces onto a voluntary, defined contribution scheme like the NPS which has been implemented since 2004 for all new recruits joining government services, except defence. That is the only sustainable solution to this problem. But dispassionate policy making in defence sector in India is difficult. All kinds of emotions about izzat, vardi, naam and nishaan get mixed up. Nana Patekar gets in the way of clear-headed thinking.

* (with apologies and acknowledgement to Harivansh Rai ‘Bachchan’)

Addendum

— Pranay Kotasthane

For a researcher working on the public finance of defence, the Agnipath scheme is an important milestone. Over the long term, it has the potential to substantially reduce the pension burden. And as RSJ writes, the scheme will have no impact on the allocations for modernisation in the short term.

Nevertheless, this scheme is important for the single reason that just as today’s deficits are tomorrow’s taxes, today’s reforms become tomorrow’s savings.

Many commentators suggest that India’s defence expenditure problem can be solved merely by increasing defence expenditure to 3 per cent of GDP, from the current allocation of 2.04 per cent. That’s hardly the case. Projecting current growth rates of defence spending components over the next ten years suggests that even if the government were to agree to a 3 per cent spending, pension spending will grow rapidly enough to allow only an incremental increase in the fiscal space for capital outlay.

Keeping the public finance angle aside, I took away two lessons in politics.

One, the political narrative that can be used to sell a policy solution sometimes matters more than the solution itself.

In an article for the Times of India in March, I listed four alternatives before the government to manage personnel costs. The three solutions that were dropped tried to address the pension problem directly. It wasn’t possible to project these solutions as achieving any other objective. In contrast, the solution that was picked up, i.e. Agnipath, was the only one that allowed the government to skirt the fiscal motivations for this reform. The government went in with this stated objective: “attracting young talent from the society who are more in tune with contemporary technological trends and plough back skilled, disciplined and motivated manpower into the society.”  No mention of the fiscal angle. At all.

This strategy itself had mixed results in the early days. Politically, it allowed the government to make statements such as these:

“We never see the Armed Forces through the perspectives of savings. Whatever we need to spend, the government is willing to spend. Our aim is to defend the country’s borders. Whatever needs to be spent, will be spent.” — Mr Rajnath Singh, Union Defence Minister

However, not acknowledging the real reason why these reforms were mooted, created an impression that the government has needlessly and suddenly foisted another disruptive scheme on unsuspecting masses.

Two, the government failed to align cognitive maps of important stakeholders, yet again. Pension reforms are wicked problems everywhere in the world because there are strong endowment effects of a large, organised collective at play. Some of you might recall that a couple of years ago, nearly 800,000 French people protested and disrupted key services across the country in opposition to the proposed pension reform. That reform merely aimed to consolidate 42 different pension schemes, with variations in retirement age and benefits, into a universal points-based system.

Even so, the government had an excellent, indigenous pension reform example at hand. As we’ve written many times before, the civil services pension reform of 2004 was a rare example of introducing a scheme to reduce the pension burden without protests. Despite this example, the government chose to opt for an Agnipath scheme that made some applicants suddenly ineligible for selection. The resulting protests and violence eventually made the government relax the age criteria this time.

The government mandarins would surely have anticipated these consequences. To smoothen the transition, the government could’ve done regular recruitment along with the Agnipath recruitment this year. Over the subsequent three-four years, it could have increased the intake for the latter and tapered down the intake in the regular induction in a phase-wise manner. But it chose a sledgehammer instead of a scalpel.

Global Policy Watch: Social Media’s Rule of Three

Global policy issues relevant to India

— Pranay Kotasthane

Social media continues to confound us all. By now, we all have read a number of hypotheses on how social media rewards “evil”. In the initial days, social media’s tendency to push us into echo chambers was oft-cited as the mechanism that made people more extreme in their views. Then came the view that the evil lay in the “likes”, “retweets”, and “share” features, which promoted an asymmetric virality. Thereafter came the notion that it was the economic models that were to blame. Advertisement-led services and Big Tech monopolies were the real problems, we were told. And over the last four years or so, it’s the algorithms and recommendation engines of social media companies that have been the target.

Despite these arguments, we still don’t have a conclusive answer. Several studies have refuted many of the assertions made above. And so, let’s take a step back from specific social media apps, and instead ask: what are the meta-mechanisms that make all forms of social media a powerful instrument?

I can think of three interrelated mechanisms. All three mechanisms are connected to sociological and cognitive behaviours in the Information Age.

One, Social Media expands our Reference Networks

Reference Networks is a term used by psychologists to mean “people whose beliefs and behaviour matter for our behaviour”. A really small part of our behaviour is independent of others’ actions and beliefs. Most of our behaviour is interdependent, i.e. it depends on what people in our reference network say or do.

For most of human history, geographic proximity largely determined our reference network. For instance, our on-road driving behaviour is shaped by people who are around us and whom we consider ‘like us’. TV, radio, books, and newspapers have played a major role in creating new horizontal comradeship (or what Benedict Anderson called ‘imagined communities’), but these media did not supplant the importance of geographically proximate reference networks.

Social media, by contrast, expands our reference networks like never before. People across the world can now influence our perceptions instantly and repeatedly. And by this reference network expansion, I do not imply the ‘echo chambers’ trope. Courtesy of social media, our reference network in fact now includes many more people who think unlike us. Sociologist Zeynep Tufecki explains this mechanism using a beautiful metaphor:

“While algorithms will often feed people some of what they already want to hear, research shows that we probably encounter a wider variety of opinions online than we do offline, or than we did before the advent of digital tools.

Rather, the problem is that when we encounter opposing views in the age and context of social media, it’s not like reading them in a newspaper while sitting alone. It’s like hearing them from the opposing team while sitting with our fellow fans in a football stadium. Online, we’re connected with our communities, and we seek approval from our like-minded peers. We bond with our team by yelling at the fans of the other one. In sociology terms, we strengthen our feeling of “in-group” belonging by increasing our distance from and tension with the “out-group”—us versus them. Our cognitive universe isn’t an echo chamber, but our social one is. This is why the various projects for fact-checking claims in the news, while valuable, don’t convince people. Belonging is stronger than facts.” [MIT Technology Review, August 2018]

Expressed another way, every issue becomes global by default because our reference networks are also global.

Two, Social Media expands the Overton Window

Repeating what I had written about this particular mechanism in edition #130.

The Overton Window framework suggests that for any political issue, there's a range of socially acceptable positions that's narrower than the range of all possible positions. These socially acceptable ideas are seen as being inside the Overton Window — they are mainstream and uncontroversial. On the other hand, policy positions outside it are viewed as shocking, upsetting, and electorally harmful. The key insight of this framework is that, with social pressure, the Overton Window can shift over time; today's radicals may become tomorrow's moderates. In the Information Age, something even more striking has happened. The Overton Window on practically every issue has been stretched such that nearly all possible positions on an issue have become socially acceptable. With that happening, the older institutions, which earlier exuded authority, are shredding legitimacy with every decision they make.

With the old gatekeepers no longer wielding the same power as earlier, the range of opinions on any issue can be extremely broad. And combined with the fact that each of those views attracts a new reference network, the Overton Window of social acceptability gets stretched.

Three, Disproportional Rewards for Extreme Content

Many analysts say that this mechanism is a result of skewed algorithms and the incentives arising out of an advertisement-based model. While that’s partly true, there’s a deeper reason: information overload.

Persuasion is a key power in the information age. Persuading someone requires attracting someone’s attention. And since attention is a scarce commodity in a crowded information environment, the only way to attract it is to come up with something surprising and shocking.

Consider this analogous example. If I were to write “Lng Yrs g, W Md Tryst WTh Dstny”, you would immediately identify that I’m talking about Nehru’s iconic 1947 speech, despite me dropping all vowels. From an information theory perspective, vowels carry “less” information content because they occur more frequently. In contrast, consonants contain “more” information because the probability of their occurrence is low.

In a similar manner, a news feed post which reads “There was a bomb blast in Kabul”, carries less information, because this has quite unfortunately become a regular occurrence over the last few years. In contrast, a shocking opinion or news like “Russian information ops influenced the 2016 election results” surprises us, and hence carries more information. Over time, not only does the Overton Window expand, it becomes broader at the two poles.

My proposition is that many real-life events attributed to social media (positive or negative) can be explained by a combination of these three mechanisms. Consider the work done by an online group DRASTIC (Decentralized Radical Autonomous Search Team Investigating COVID-19) in mid-2021. Their work alone changed the conversation on the Wuhan lab origin theory (RSJ wrote about it here).

In this case, the expanded reference network allowed a band of interested folks to build on each other’s work. The Overton Window expansion meant that the group could put forward an idea that seemed preposterous at that time. And a skew towards surprises meant that their idea didn’t just die away in a closed in-group, but instead sailed across the globe.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Janan Ganesh has a cracking column in FT, which discusses a favourite topic of ours: economic growth. Sample these lines from the column: “The looming recession will be painful. But it will also drive a certain kind of post-materialist humbug from polite discourse. Growth will be harder to dismiss as a bean counter’s tawdry obsession when there is so little of the stuff to go round.”

* [Article] Zeynep Tufekci’s analysis of “how social media took us from Tahrir Square to Donald Trump”.

* [Post] Gurwinder from The Prism has this terrific insight: ideologies are memetic superbugs. His words: “The most successful ideology in the West today, wokeism, has succeeded because it’s perfectly configured, not to establish social justice, but to establish more copies of itself. It’s a memetic superbug evolved for contagion rather than truth or compassion, and if contaminating others requires it to delude the senses, twist the truth, and darken the heart, then so be it.”

* [Tweet] The always-insightful Bryan Caplan’s take on intersecting echo chambers lights a bulb. He says: “If you want to combat error, critique your in-group. You speak their language and they trust you, so you might persuade someone. If you want to raise your status, critique your out-group. They won't listen, but your in-group will love it.” The latter tendency dominates the former by a big margin, I guess.

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Earlier this week, I stumbled on this headline in the Business Standard: "Remove price cap and channel bundling restrictions: Broadcasters tell TRAI”. For someone writing a weekly newsletter on Indian public policy, price controls are a gift that keeps on giving. Naturally, I went down this rabbit hole.

For context, read this consultation paper. Under the New Regulatory Framework 2017, there are price caps on channel bundles, individual channels that are part of bundles, and the overall package of standard-definition channels. Once this 2017 order came into force, broadcasters smartly kept the popular sports channels out of the channel bundles. The aim was to price them high, thereby cross-subsidising other channels. Further, some providers included these sports channels in bundles at a discounted rate so that they could be packaged with other trashy channels. Not surprising. And now, TRAI wants to reduce the price cap on individual channels that can be part of a bundle to ₹12 from ₹19 per month. Mind-boggling, no?

The consultation paper is quite well-written, to be honest. It makes me wonder the extent to which state capacity is applied to come up with price controls.

This instance got me thinking about how government restrictions have shaped today’s media environment in India. Let’s have a look at the three major types: video, radio, and written media.

How OTT (Over-the-top) became TOT (The-Only-Thing)

The same TRAI consultation paper highlights that OTT platforms (SonyLiv, HotStar, etc.) are displacing traditional TV. Anecdotally too, this shift is quite obvious. So why is it that there’s good Indian content on OTT platforms, while the old news channels seem to be stuck in a rut?

Government regulations are one big reason. There are no price caps on OTT platforms, allowing them to make investments, create niche content, and recover the investments at an appropriate price. In contrast, TV channel prices are controlled by the government since 2004.

News channels, in particular, have degraded the most. Writing in Hindustan Times in 2017, Ashok Malik traced the cause to (surprise! surprise!) price caps again:

“As per the TRAI tariff order of 2016, the price ceiling for a news channel is Rs 5 per month. In contrast the price ceiling for a general entertainment channel is Rs 12 per month.

Consider what this means. In theory, the general entertainment channel could be re-running old soaps (cost of content: zero). The news channel would be required to constantly generate fresh content. Even so, the former is allowed to charge more than double what the latter is able to. Besides a general entertainment channel is always likely to get more subscribers. So it is a double hit for anybody seeking to build a serious news channel.

Over time news channel owners have simply given up, and decided to take the route of reality TV. Today, with the sheer volume of free – occasionally dubious and sometimes outright fake – content available online, one wonders if the news business can ever be rescued in India.”

Not that general entertainment channels have fared much better. Broadband internet has now made subscription easier, and the people have voted with their feet, remotes, and phones. At present, TRAI no longer caps the prices of individual channels, on the condition that they are not included in any bundle. But that’s hardly a respite when enough damage has already been done.

Radio Silence

The case of another broadcast medium, the FM radio, is also instructive. The kiss of death here is a ban on FM channels broadcasting news or current affairs. Observe how the government justified pre-censorship in the Supreme Court in 2017:

“Broadcasting of news by these stations/channel may pose a possible security risk as there is no mechanism to monitor the contents of news bulletin of every such stations. As these stations/channels are run mainly by NGO/other small organisation and private operators, several anti-national/radical elements within the country can misuse it for propagating their own agenda.”

Need I say more? This is the reason why all our FM radio channels play mind-numbing songs, spoofs, and call pranks on loop. While some niche content has moved to podcasts, a lot of current affairs content is now sought after on non-English YouTube channels. As for “radical elements within the country can misuse it for propagating their own agenda”, that has been turbocharged by one-to-many communication on Twitter, WhatsApp, Facebook, etc.

The Pen is Mightier than its Subscribers

Now let’s come to the curious case of print and online media. There are no price caps on newspaper and magazine prices. Not that it wasn’t attempted. But in a 1961 Sakal Papers vs Union of India judgment, the Supreme Court, citing Article 19(1), declared unconstitutional a law that tried to connect prices to the number of pages published.

And so, India has an amazingly high number of newspapers and magazines— nearly a lakh registered ones, increasing year on year. But that’s where the party ends. Print media is disproportionately dependent on advertisement revenue and not reader subscriptions. Newspapers are primarily pamphlets, with a bit of news and opinion thrown in.

The reasons for this low equilibrium are not very clear. Raju Narisetti contends in a recent book Media Capture: How Money, Digital Platforms, and Governments Control the News (edited by Anya Schiffrin) that the ‘invitation pricing’ model introduced by the Bennett Coleman & Company Ltd. (BCCL) in 1994 created a de-facto price cap for other players. However, that still doesn’t explain the absence of niche, small, and subscription-fuelled newspapers. Magazines do slightly better. I suspect the low purchasing power of Indians when newspapers were all the rage, can explain to an extent the inertia to pay more for reading news.

Whatever the reasons, it works well for India’s governments, for they are the biggest advertisers in newspapers. Mere threats of cancelling advertisement contracts become powerful means to exert influence on the content and tone of newspapers.

Nevertheless, online media has shown that new revenue models are possible. In the pandemic, most newspapers took their online portals behind paywalls. There’re also many subscriber-only portals catering to special audiences.

But how can you keep the government away? RBI’s new rules on auto-debit of recurring payments led to the cancellation of subscriptions and a decline in revenue. (Showing small mercies, the RBI this week decided to raise the e-mandate limit to ₹15,000 earlier this week.)

All in all, if you want to ask why our media environment is the way it is, tracking government regulations is a good place to begin the search. TV and Radio, and to a lesser extent print media, are all victims of seemingly well-intentioned yet counter-productive government regulations.

India Policy Watch: Inflation, Growth & Stability

Insights on burning policy issues in India

- RSJ

We are back to discussing macroeconomy here. This week, in its scheduled bi-monthly review, the Monetary Policy Committee (MPC) voted unanimously to increase the repo rate by 50 bps (100 bps = 1 percentage point) to 4.90 per cent. It also stayed firm on withdrawing its accommodative policy stance to tame inflation going forward. From the Governor’s press release:

“Let me now explain the MPC’s rationale for its decisions on the policy rate and the stance. The protracted war in Europe and the accompanying sanctions have kept global commodity prices elevated across the board. This is exerting sustained upward pressure on consumer price inflation, well beyond the targets in many economies. The ongoing war is also turning out to be a dampener for global trade and growth. The faster pace of monetary policy normalisation undertaken by systemic advanced economies (AEs) is leading to heightened volatility in global financial markets. This is reflected in sharp corrections in major equity markets, sizeable swings in sovereign bond yields, US dollar appreciation, capital outflows from EMEs and even from some AEs. The EMEs are also witnessing depreciation of their currencies. Globally, stagflation concerns are growing and are amplifying the volatility in global financial markets. This is feeding back into the real economy and further clouding the outlook.”

To put this in context, we have had an almost 100 bps increase in repo rate in about a month. Short-term rates in the market have already moved up by about 200 bps in the last six months. The impact of these will begin to pinch. And yet, inflation remains above 7 per cent and is likely to stay there for a while. There’s been a coordinated response between the government and the central bank in the recent past including a reduction in excise duties on fuel. Some external factors like the lifting of the palm oil exports by Indonesia and a likely good monsoon also might help moderate inflation during the year. But the 6 per cent upper limit of the inflation target range will be breached for most of the year. The Ukraine war and its repercussions on supply chains and commodities have kept prices elevated. The speed of monetary policy normalisation by the developed world has meant the dollar has appreciated sharply, equity markets have fallen across and capital has flown out of emerging markets.

The statement by the Governor acknowledged these issues and summarised its priorities (italicised by me below):

“Experience teaches us that preserving price stability is the best guarantee to ensure lasting growth and prosperity. Our actions today will impart further credibility to our medium-term inflation target, which is the central tenet of a flexible inflation targeting framework. India’s recovery is proceeding apace, offering us space for an orderly policy shift. While we will continuously assess the evolving situation to tailor our responses, our actions must demonstrate the commitment to keep inflation and inflationary expectations under check. Therefore, monitoring and assessing inflation pressures and balancing risks to growth will be crucial for judging the appropriate policy path as we move ahead. 

……Given the elevated uncertainties of the current period, we have remained dynamic and pragmatic rather than being bound by stereotypes and conventions. As the Reserve Bank works tirelessly in its pursuit of macro-financial stability, I am reminded of what Mahatma Gandhi said long ago: If we want to overtake the storm that is about to burst, we must make the boldest effort to sail full steam ahead.”

Nothing new there on priorities. For any central bank, they remain to manage the interplay between - price volatility, growth and macro-financial stability. This is an equilibrium hard to locate in normal, calmer weather. In uncertain times like today, it is a gigantic headache. We will dig a bit deeper to understand the variables that RBI will have to deal with in handling these three priorities during the year. 

First, let’s take inflation. As I mentioned above, the global risks to inflation will remain elevated with high crude oil and commodity prices and continuing supply bottlenecks for the next couple of quarters. The more interesting point here is that the input cost spikes haven’t yet been passed on to consumers in India. You can take a look at the declared results of the Jan-Apr quarter for listed companies to draw this conclusion. As this gets passed through eventually, inflation will keep pushing upwards. The opening up of the high contact services sector is almost complete now, notwithstanding the recent spike in Covid cases in parts of India. So, there is still the impact of services inflation to show up. Globally, central banks have made an about-turn on their earlier views of this inflation being transient. India is no different. The inflation expectations now show a secular upward trend and this is reflected in various surveys like PMI and BIES.

Like always, the lower-income bands are starting to voice their concern about prices because it materially affects their lives. Price rise in India is a politically sensitive topic and as much as this government is politically dominant with the opposition nowhere in sight, it is difficult to see how it will remain unfazed by it. An important point to also consider here is the unique K-shaped recovery that’s happened in India post-pandemic. We have spoken about it a few times earlier. This has meant there is further concentration of total consumption among the top 10-15 per cent of India. The problem with this is that it leads to stickiness in prices and wages. This creamy layer of consumers has a low marginal propensity to consume and that combined with the large cushion of savings with them means there isn’t a quick demand-side response to the rising prices in India.

Also, a useful question to ask is what is the impact on growth because of a change in real interest rate in India? Is there any historical evidence to find a relation between the two? A rough rule of thumb is that a 100 bps change in real interest rate could lead to a 20 bps drop in expected growth rate ( a summary of a 2013 paper by RBI that concludes this is at the end of this article). This suggests RBI won’t be worried about growth slowdown anytime soon as it raises rates. The government won’t be worried too. Why? Because there is a global slowdown and it can always point to China struggling with its own lockdowns. In any case, we have seen a 4 per cent growth rate just before the pandemic and that had no impact on the popularity of the government. The government will be willing to trade growth for lower inflation. So, the front-loading of interest rate hikes, as seen in the last month, will continue. My guess is, cumulatively, we will have another 100 bps rate hike by the end of this year.  

Second, let’s look at growth. The FY23 growth forecast has moderated from 9+ per cent about two quarters back to about 7-7.5 per cent range in most estimates. However, so far the high-frequency indicators of growth are holding up well suggesting robust economic activity. On almost every indicator - from fuel consumption, cement and sale production, exports, IIP, e-way bills or GST - we are up by a significant margin from the pre-pandemic levels (20-30 per cent in most cases). Credit offtake has also been strong in the retail loans segment so far. The recent rate hikes and the correction in the equity market will have an impact on this but we will have to wait and see how soon the slowdown in consumption will show up in numbers. My guess is it will take some time because of the nature of the consumption pyramid in India. 

There is also spillover effect of the US Fed's action on rate hikes on India. Will India be forced to mirror Fed’s moves? The inflation in the US is at a historic 40-year high and the economy is running at almost full employment. So supply disruptions apart, there are strong demand factors impacting inflation there. In India, there is some overheating in the labour market, especially in the technology space but we are far from any kind of tightening. It will be useful to bring in Taylor’s rule here to understand the likely monetary policy response. From Investopedia:

“Taylor's rule is essentially a forecasting model used to determine what interest rates should be in order to shift the economy toward stable prices and full employment. The Taylor rule was invented and published from 1992 to 1993 by John Taylor, a Stanford economist, who outlined the rule in his precedent-setting 1993 study "Discretion vs. Policy Rules in Practice."

Taylor's equation looks like:

r = p + 0.5y + 0.5(p - 2) + 2

Where:

r = nominal fed funds rate

p = the rate of inflation

y = the percent deviation between current real GDP and the long-term linear trend in GDP 

In simpler terms, this equation says that the Fed will adjust its fed funds rate target by an equally weighted average of the gap between actual inflation and the Fed's desired rate of inflation (assumed to be 2%) and the gap between observed real GDP and a hypothetical target GDP at a constant linear growth rate (calculated by Taylor at 2.2% from approximately 1984 to 1992). This means that the Fed will raise its target fed funds rate when inflation rises above 2% or real GDP growth rises above 2.2%, and lower the target rate when either of these falls below their respective targets.”

The current weights for India are 1.2 for inflation and 0.5 for growth while the growth weight for the US might be close to zero. Also, remember we didn’t use the fiscal tools as liberally as the US during the pandemic. The US treasury balance sheet expanded by more than a quarter on the back of the stimulus to prop up the economy in the last two years. We have a very different reality. Of course, there will be some defence of the Rupee that will be needed as the actions of the central banks of the developed markets strengthens the US Dollar. But beyond those temporary shocks of investors looking for a safe haven and creating currency volatility, there should be no real reasons why the MPC should follow the lead of the Fed's response to inflation in the US.

Lastly, how will this expedited, front-loaded rate hike actions impact the macroeconomic stability especially of the financial sector? As we have already seen, the transmission of interest rate hikes has happened with speed. Most banks have lost no time in resetting their rates. Also, remember the majority of small business loans to the MSME sector and mortgage loans in India are now linked to repo rates (or some external benchmarks like 30-day T-bills). If the global growth slows and exports weaken and if the large corporations pass on their input cost burden to the customers or their vendors, we might see stress building up in the system among smaller borrowers. This is a lead indicator to be watched although the repo rates after the latest round of hikes are still about 150 bps below where they were in 2018-19. This isn’t a scenario like in the US or UK where the interest rates are at multi-decadal highs. Some prudence on part of borrowers and a bit of flexibility in restructuring loans by Banks aided by the RBI should help the system see through this phase. 

On the balance, I see the CPI settling at about 5 per cent in four quarters from now. The “neutral” real interest rate should be about 1.5 per cent which would mean a repo rate of about 6.5 per cent. My estimate is that’s where we will end up from the current 4.9 per cent level in about 12 months. That’s when any option of moving back to an accommodative stance will start looking viable. The RBI will be walking on eggshells managing the multiple trade-offs between growth, inflation and macroeconomic stability during this time. Through a happy coming together of circumstances, India is placed relatively better than most economies at this moment. We should avoid any misadventures at this time, political or economic.

That’s not a lot to ask for, I hope. 

Postscript: Here’s the paper from the RBI website - “Real Interest Rate Impact on Investment and Growth – What the Empirical Evidence for India Suggests?”. It is a good empirical study about how much growth sacrifice should be needed to tame inflationary pressure. From its abstract: 

“Monetary policy is often expected to adopt a pro-growth stance in a phase of prolonged slowdown in growth and sluggish investment activities. Sacrificing inflation, i.e. lowering nominal policy rate even when inflation persists at a high level, is a convenient means to lower real interest rates, which in turn could be seen as a pro-growth stance of monetary policy. This paper, using both firm-level and macroeconomic data, and alternative methodologies - such as panel regression, VAR, Quantile regression and simple OLS – finds that for 100 bps increase in real interest rate, investment rate may decline by about 50 bps and GDP growth may moderate by about 20 bps. The empirically estimated sensitivity of investment and growth to changes in real interest rate suggests that if the RBI can lower real lending rates, it can also stimulate growth. Review of literature highlights that a central bank can lower real interest rates either through financial repression or by not responding aggressively to inflation while raising the nominal policy rates in response to inflation. 

Empirical estimates for India indicate that RBI’s monetary policy response to inflation has not been aggressive, and as a result the Fisher effect –i.e. one for one response of interest rate to inflation that could leave the real rate constant – does not hold. Thus, even when a high nominal interest rate may often signal that monetary policy stance is tight, because of higher inflation and absence of Fisher effect, lower real interest rate may actually be growth supportive. In India, real lending rates in recent years have been generally lower than the levels seen during the high growth phase before the global crisis. But lower real rates in the post-crisis period have coincided with sluggish investment and GDP growth. This is due to the fact that while real rates are lower, marginal productivity of capital, or expected return on new investment has also declined, which has dampened the expected positive impact of lower real rates on investment. In such a scenario, one policy option could be to lower real rates even more, by raising inflation tolerance, i.e. lowering nominal policy interest rate even when high inflation persists or inflation expectations remain high. This paper, however, provides robust empirical justification against any policy of lowering policy interest rates when inflation persists above a threshold level of 6 per cent. The beneficial impact of lower real rates on growth that may be achieved through higher inflation tolerance is more than offset by the harmful effect of high inflation, particularly when it exceeds a threshold level of 6 per cent.”

Matsyanyaaya: Dictatorship and Democracy in Israel and Pakistan

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

News reports suggest that Pakistan’s military dictator-turned-president-turned-politician Pervez Musharraf is in a critical medical condition. While I have no good things to say about the man, I was reminded of a post I’d written in 2017 which asked: despite their similarities, why has Pakistan had bouts of military dictatorship rule, while Israel has steadfastly retained electoral democracy?

The two religious States — Israel and Pakistan—were both created for the explicit purpose of securing a homeland for religious minorities. Given their preoccupation with security, the military-security establishment occupied a key position in the politics of the two States. Yet, what can explain this fundamental difference: while Pakistan has had long periods of rule by a military dictatorship, Israel has steadfastly retained electoral democracy?

The similarities between Israel and Pakistan are well documented. Faisal Devji’s 2013 book Muslim Zion argues that

Like Israel, Pakistan came into being through the migration of a minority population, inhabiting a vast subcontinent, who abandoned old lands in which they feared persecution to settle in a new homeland. Just as Israel is the world’s sole Jewish state, Pakistan is the only country to be established in the name of Islam.

In this regard, the military dictator Gen Zia-ul-Haq’s remarks made in an interview to The Economist in 1981 are also instructive:

Pakistan is like Israel, an ideological state. Take out the Judaism from Israel and it will fall like a house of cards. Take Islam out of Pakistan and make it a secular state; it would collapse.

So, what explains the difference?

My hypothesis to explain the difference is this: the mediating variable between democracy and dictatorship is the status of civil-military relations in the formative years.

The basis of this hypothesis is an argument developed in Steven Wilkinson’s excellent book Army and Nation. The book tries to explore why the armies in India and Pakistan—although cut from the same cloth—became such markedly different domestic political actors in their respective democracies. My case is that the arguments mentioned in the book apply equally to the Israel—Pakistan comparison. Here’s how.

Wilkinson lists three factors for the difference between the armies of independent India and Pakistan:

* India’s socio-economic, strategic and military inheritance in 1947 was much better than that of Pakistan. Among other things, Partition worsened the ethnic balance in the Pakistan army while improving it somewhat in the Indian army.

* The Congress party — unlike the Muslim League in Pakistan — was strongly institutionalised and had a political reach and presence that was difficult to replicate, let alone dislodge.

* During the first decade of independence, the Indian government took specific “coup proofing” measures: new command and control structures, careful attention to promotions, tenures, and balancing ethnic groups at the top of the military, and attention to top generals’ career pathways after retirement.

Now, if these exact factors related to civil-military relations in the formative years are applied to the Israel-Pakistan case, one can see that points (2) and (3) were exactly what David Ben-Gurion and his political forces managed to accomplish in Israel. And hence while Israel managed to retain civilian superiority over its military forces, Pakistan kept having episodic military dictatorships.

The follow-up question would then be: was Jinnah’s death immediately after Pakistan’s formation a big reason for the path it took, while India and Israel had the benefit of dominant, long-standing civilian leaders in the formative years?

I don’t think so. If Jinnah would have lived longer after Partition, it is likely that he would have put specific “coup proofing” measures in place [point (3) in Wilkinson’s schema]. However, the worsening ethnic balance of the army and a weakly institutionalised Muslim League [points (1) and (2)] would’ve still remained intractable. The paths that Israel and Pakistan are now on have a lot to do with what happened in the formative years of the two democracies.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] The EU has agreed to make “One Europe, One Charger” a reality in 2024. In October 2021, we had written why this move is a PolicyWTF. The decision is also a useful case study for policymaking. It demonstrates that we should be wary of intuitive solutions to policy problems.

* [Book] Media Capture: How Money, Digital Platforms, and Governments Control the News (edited by Anya Schiffrin).

* [Podcast] Ashok Malik speaking about TV price controls on The Seen and the Unseen

* [Podcast] Shruti Rajagopalan and Lant Pritchett have released another blockbuster Ideas of India episode. A must-listen for all public policy enthusiasts. If you are short on time, jump to Pritchett’s criticism of the poverty line. It’s superb.

Global policy issues relevant for India

- RSJ

Over the last couple of years, I have run through a list of books in what I call the ‘crisis in liberalism’ genre. There is a template that most of these books follow – begin with the fall of the Berlin wall, remind readers about Fukuyama’s ‘The End of History’ paper, run through the mistakes that a triumphal liberal order made through the next two decades, talk about capitalism running amok leading to the global financial crisis and then build a grand theory for the populist backlash we saw in the last few years.

I wrote about these books on these pages. The list is long – The Globalisation Paradox, Radical Uncertainty, Radical Markets, The Light That Failed, The Code of Capital and maybe you could add the various Piketty books in here too. There’s a cottage industry that’s built up here and you can say I’m a huge patron of their artisanal products. Well, the good news is there’s a new addition to this genre this week. “The Man Who Broke Capitalism: How Jack Welch Gutted the Heartland and Crushed the Soul of Corporate America--And How to Undo His Legacy” by David Gelles. The title is a mouthful, but it is also convenient. It says everything it has to say in its unwieldy length. There’s not a lot more in the book except trying to retrofit all kinds of ills of capitalism seen today by the author back to Jack Welch. Gelles is all over the media this week (here, here) talking up the book and making the same points over and over again. And it got me thinking on two counts. One, why business management research and literature is almost always garbage? And two, why do we get public policy on managing business and capital wrong so often?

On the book itself, I will try and summarise (in deliberate broad strokes) the three key arguments Gelles makes:

* There was some kind of a ‘golden age of capitalism’ in the thirty years after WW2. Companies took care of their people, distributed wealth equally, happily paid the taxes and employed people for life. Businesses saw themselves as more than profit maximising engines. There was a feeling of loyalty to the country, a fraternal sense of belonging to a community and a wider obligation to the supporting the government. All quite nice.

* Then in the early 70s, Friedman wrote that shareholder value maximisation paper (“The Social Responsibility Of Business Is to Increase Its Profits”) and the world was never the same again. Businesses focused more on their profits and soon lobbied for lower taxes and greater freedom in conducting their affairs. Reagan and the conservative revolution of small government followed. Into this mix came in Jack Welch as the CEO of GE, the iconic American institution. Welch singlehandedly destroyed capitalism as we knew it. He laid off people, shut factories, offshored jobs, built a shadow bank called GE Capital that reaped the benefits of financialisation, obsessed over meeting quarterly EPS numbers, stack ranked the employees in a bell curve, created the cult of CEO worship and initiated everything that you find wrong today in business. Quite an extraordinary feat in doing bad things at work. In Gelles’ words: “He's on the Mount Rushmore of men who screwed up this country.” The book then goes onto show how Welch’s long shadow still haunts corporate America despite obvious evidence that he got it all wrong. GE is among the worst-performing stock in the last two decades. It announced last year it plans to split itself into three different businesses to unlock shareholder value. GE Capital, the engine that Welch built, is defunct. Yet, business leaders worship at the altar of quarterly earnings, force ranking employees, financial engineering, building personal brands and negotiating ever increase compensation packages for themselves.  

* So, what’s the solution? I’m not sure if I understood it from the book. Gelles isn’t advocating for socialism surely. But he does throw around words like stakeholder capitalism and praises the current CEO of Unilever and the founder of WEF that holds an annual event at Davos for their efforts to build compassionate capitalism. Some kind of a future where we don’t measure companies on shareholder value but another set of metrics involving all stakeholders that rein in the single-minded pursuit of profits is his solution. All quite fuzzy because he seems to run out of steam by the end of the book. All that Welch bashing is tiring.

Let me digress a bit here.

When I started my career, the ‘GE way’ was a rage in corporate India. I remember picking up a pirated version of Welch’s autobiography from a streetside vendor at Kala Ghoda. Everyone I knew was reading it. Except for the parts about his growing up that were written with some honesty, the book was terrible. All the stories followed the same pattern. Welch gets a call and goes down to a factory floor or to a customer site. There he hears or notices something small that gets him thinking. Then he finds someone young who reminds him of his younger self – direct, analytical and abrasive. Welch decides either on shutting down or buying a new business based on his gut. He gives this young man (almost always a man) the mandate to do it. Young man does the magic and Welch basks in his foresightedness.

Interspersed between these familiar stories, I got Welch’s views on lifelong employability (not employment), how to be tough but fair, his views on the future of business and, of course, six sigma.

Ah, Six Sigma.

You couldn’t ignore Six Sigma in India during those days. Welch had elevated it into some kind of a religion at GE. Everyone had to follow it. There were weekly Yellow belt and Green belt training programmes in every company where employees would be taught some basic statistics, and something called the DMAIC model. If you did well, you would then go on to a rigorous Black belt certification programme. The ultimate big daddy of them all was the Master Black belt - a Shaolin master with scores of Black belts in his stable who could be unleashed on any problem. All Master Black Belts came from GE and for them, the answer to every single problem was a Six Sigma project. Complaints about canteen food in the office? Run a Six Sigma project. Spending too much on office stationery? Why, Six Sigma can help. People quitting because the work is drudgery? No problem, Six Sigma will solve it. I even remember a training programme where a Six Sigma expert told us he could solve the Israel-Palestine problem using Six Sigma if only they invited him. To me the whole thing, as it was run in India, was a charade. There was no new idea or insight that came out following it. It was just bureaucracy with some babus lording over us because they were certified in this nonsense. Japan was always shown as a shining example of the success of such techniques. I guess no one had heard about Japan’s lost decade.

Anyway, reading the book and seeing the success GE had then under Welch, I was convinced of two things. One, he foresaw the two trends of globalisation and financialisation way earlier than others. He figured both the threats and opportunities they presented and moulded GE to take advantage of them. He did this better than anyone else who was running a large business then. Two, he realised that running a diversified, globally distributed enterprise requires a certain ‘way’. So, he codified it - bell curve for ranking employees, global training centres for creating a kind of manager, Six Sigma as the common language to solve everyday problems and a common scorecard to rate business performance. In his scheme of things, process and order were more important than individual enterprise and innovation. GE probably didn’t produce a single world-beating product during his time but they did make truckloads of money for shareholders by being more efficient and faster to market than their competitors. And that didn’t happen by just mindless shutting down of plants or fudging the books as Gelles seems to allege.    

Coming back to the book, I have three problems with it.

First, there’s no pause to consider the counterfactual turn of events. Had Welch not done what he did at GE, what would have been the alternative history? It was clear by the early 80s that cheaper, and often better, consumer durables and industrial products were coming into America from Japan and the Tiger economies of the far east. American labour was getting more expensive, especially the retirement funds of workers that were run often on a defined benefit programme. Remember the great American motor companies had to be bailed out after the GFC in 2009 because they couldn’t fund the pension benefits of their ex-employees anymore. Welch was realistic enough to understand there wasn’t going to be any breakthrough technology that could change the businesses that were cash cows of GE. A refrigerator is a refrigerator. They had become commodities. Welch took a hard look at it and asked why couldn’t GE take the battle to the challengers? Why couldn’t GE outdo them in being more efficient, using the same sources of labour as them and getting into newer businesses? The breakup of the USSR and the opening up of economies around the world helped him to go overseas. So did the steep fall in telecom rates that powered the BPO revolution. He also figured he could use the large cash flows his core businesses generate to build a financial institution. And he created a behemoth in GE Capital.

These two decisions extended the lifespan of GE and, perhaps, saved a lot of jobs. GE might be thinking of splitting itself into three today but these are still reasonably profitable businesses employing thousands of workers. The graveyard of corporate America is packed with companies who once competed with GE in sectors as varied as electricals (Westinghouse, Whirlpool), packaging and plastics (Tyco), and household goods (Xerox, Kodak)…the list is long. They died because they didn’t do what GE did then. You can accuse Welch of being just a manager who got a couple of trends right and rode them but who didn’t innovate and build genre-defining products. That’s fine. Not being a gifted innovator isn’t really a moral failure. But Welch ran a management template that worked for its time. A lot that was good in that has helped other enterprises manage scale and complexity. He overdid things for sure and that toxic legacy of being obsessed over quarterly EPS targets, financial re-engineering to meet them and treating people as expenses is uniquely his too. But, on balance, he was responding to the incentives that he and GE had during that time.

The problem with a lot of business management books is that they use the hindsight of success or failure to go back and find reasons for it. This is a useful exercise in history. And it should be only read as history. As one version or interpretation of events. The trouble is many of these books start peddling these as some kind of deeply researched scientific material. It is not science because every single one of them will fail the falsification principle of Popper to demarcate science from non-science. Pick any book that teaches the Toyota way or the Netflix method of managing people and apply them in another context. The success rate of any such application, however generously you may use the term, is still quite low. In fact, the moment I see a book written on the unique way a company does something, I realise the company has jumped the shark. Gelles’ argument about Welch being the one man responsible for breaking capitalism is as flawed as the many books urging companies to follow the GE way a couple of decades back. There’s no science or verifiable truth here.

Second, the book has an America centric view of how Welch made things worse. Sure, Welch shut down plants and shipped jobs offshore. And you could argue that made lives of American workers worse. But that trend was already inevitable. I don’t know about you but I don’t think the pre-Welch era, say of the 70s, was some kind of golden age for capitalism. People were still protesting against inequality, wars and seeking global brotherhood. Inflation was high. Diversity in corporates was low. Politicians were being voted out of power because of how they fared on economy. Doesn’t sound like a golden age to me.

Gelles blames Welch for hollowing out the industrial belt and increasing inequality in the American society. Maybe it is true. But what about the countries where Welch set up new shops? Without Welch, there wouldn’t have been millions of jobs created in places like India, China, the Philippines and Eastern Europe. In the mid-90s, GE was the biggest customer of the then-fledgling Indian IT companies. The likes of TCS, Wipro and Infosys scaled on back of GE business that at various times accounted for about a third of their revenues. By the late 90s, GE began the BPO boom in India and other companies followed. Almost every company would visit the GECIS centre in Gurgaon to see what’s possible to outsource in India. You could claim with some confidence that he created the most jobs in the history of independent India. I witnessed this first hand. An entire generation made a good living and gained global experience because of the platform GE created in India. There is a good argument then that he might have actually reduced global inequality because of his actions. GE was a global enterprise. Why should only American workers and equality in American society matter in judging his legacy?

Lastly, it is easy to diss Friedman and his famous paper on maximising shareholder value without understanding him fully. Friedman didn’t advocate some kind of cut-throat capitalism where nothing else except profits mattered. He was a better thinker than that. I wrote about this a couple of years ago on the 50th anniversary of that Friedman paper and Raghuram Rajan’s assessment of it:

Over the years it has been attacked and its central message discredited in the light of the global financial crisis. Even businesses are reluctant these days to invoke shareholder value maximisation as their goal. There have been calls for societal value maximisation, stakeholder wealth creation and conscious capitalism to replace the Friedman doctrine. All good intentions aside, nothing has truly replaced it in how businesses operate. What explains its enduring appeal? Three reasons:

* A simple and measurable metric: The shareholder value maximisation goal is easy to set and monitor. It helps that there is a common understanding of the metric. The alternatives are amorphous. It is difficult to understand what does maximising societal value entail, for instance. Who will define what society wants? Are societal objectives of India and the US similar?

* Rewarding the risk-takers: The shareholders invest risk capital in an enterprise. This willingness to take risks is what leads entrepreneurs to build new products, satisfy the consumers and create new jobs. The shareholders deserve the pursuit of maximum return by the firms for this risk they undertake. It is up to them what they do with these returns. They can invest it in newer enterprises or use it to improve the society as they deem fit. The management or anyone else should have no claim on how to invest the returns that belong to the shareholders.

* Shareholders are the residual claimants: Everyone who contributes to the value creation of an enterprise – the employees, the management and the customers – get their fixed claim on the value through compensation for their efforts, stock options and the value derived from the products or services offered by the enterprise. Only when these fixed claimants are served well, the value for the residual claimant (the shareholder) is maximised. So, the pursuit of shareholder value will by itself serve the other stakeholders well.

Any kind of over-indexing on input metrics (like environment or society) instead of a residual metric like shareholder value runs the risk of the measure becoming a target and ceasing to be a good measure (Goodhart’s Law). The recent events around ESG investing and greenwashing are examples of this. See the Deutsche Bank story on this. More will follow.

And to quote Friedman from his original article:

“But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book “Capitalism and Freedom,” I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.”   

There is always a desire to ‘manage’ the economic system in a way that it allocates resources and rewards most efficiently. As we have seen over a few centuries now, this is a noble but flawed pursuit. It generates worse outcomes than a system that builds itself on fundamentals of human enterprise, behaviour and its response to incentives. There are many economic concepts that sound evil or counter-intuitive: efficient market mechanism, free trade, comparative advantage or Ricardian equivalence. But they work. There are reasons for market failures and there are extended periods of time when these failures are allowed to persist. But the beauty of spontaneous order is that the correction to its excesses is also built in. The correction is the time to learn from past mistakes and improve it. Not to call for discarding the system itself in favour of some kind of ‘planned design’. Welch was a remarkable manager – both a product of his times and someone who shaped his time. He pushed the boundaries in ways good and bad. That which was bad is already interred with his bones. The good must survive. 

India Policy Watch: Missing Pieces in the Jigsaw Puzzle

Insights on burning policy issues in India

— Pranay Kotasthane

A popular way to think about strengthening the Indian Republic is to ponder on improving its institutions. However, this route often ends up in mere despondence over our many underperforming institutions. While confronting these demons is an absolute necessity, here’s another way to think about this issue: what are the meta-institutions that the Indian Republic is missing altogether?

We aren’t talking here about institutions that don’t work, but institutions that don’t exist at all. And I’m not talking about the likes of a new sectoral regulator for cryptocurrencies, but about more important institutions, ones that could improve decision-making in governments across spheres.

I don’t have a comprehensive list yet. However, there are at least three that I’ve heard many experts talk about.

1. Parliament’s own think tank

Of all the roles parliamentarians end up donning, our current structure equips them the least for the very function they exist: making well-designed laws in their constituents' interests. India’s MPs are not assigned any research budget or research personnel. Combine this congenital defect with the curse of the anti-defection law, and you get a structure that’s subservient to political party interests. Of course, some MPs do stand out despite these constraints, but it does appear that the odds are heavily stacked against them.

Thankfully, a solution has emerged from civil society to fill this gaping hole: PRS Legislative Research — a 17-year old non-profit organisation that aims to provide independent and non-partisan research to the parliamentarians.

However, just one such institution is not sufficient for an India-scale entity. What we need, in addition, is another much bigger research think tank of the Parliament, that’s paid from the Consolidated Fund of India and has researchers who develop deep expertise in specific areas over the years. Consider, for instance, the Congressional Research Service in the US. This federally-funded agency has over 600 employees who are specialists in a variety of policy domains.

As the size of the Parliament increases after delimitation, and as policy issues keep getting more specialised, it’s imperative for India to invest in this missing institution.

2. An independent fiscal council

This institutional gap has been highlighted by the Thirteenth, Fourteenth, and Fifteenth Finance Commissions. While India has an institution (the Comptroller and Accountant General) to audit policies that are already in action, there is no institution that makes an independent financial evaluation of government policies before they receive the final approval.

The result is that tall promises of handouts in electoral manifestos of parties often become government policies swiftly, without any regard to the fiscal sustainability or opportunity cost assessments. A recent example is the One Rank One Pension (OROP) scheme which was implemented in 2015 after appearing in the 2014 election manifestos of both the major national parties.

An independent fiscal council then is an institution that is supposed to do three things. One, evaluate the quality of budget forecasts given how there is a wide gap between budgeted estimates and actual expenditures. Two, develop cost estimates of budgetary proposals ex-ante. Ang three, monitor if fiscal rules are being adhered to.

Dr Govinda Rao writes in The Hindu that the global experience with such institutions has been largely positive:

A study by the IMF (“The Functions and Impact of Fiscal Councils”, July 2013), documents that the existence of IFIs is associated with stronger primary balances; countries with IFIs tend to have more accurate macroeconomic and budgetary forecasts; IFIs are likely to raise public awareness and raise the level of public debate on fiscal policy. Case studies in Belgium, Chile and the United Kingdom show that IFIs have significantly contributed to improved fiscal performances.

In Belgium, the government is legally required to adopt the macroeconomic forecasts of the Federal Planning Bureau and this has significantly helped to reduce bias in these estimates. In Chile, the existence of two independent bodies on Trend GDP and Reference Copper Price has greatly helped to improve Budget forecasts. In the U.K., the Office for Budget Responsibility has been important in restoring fiscal sustainability. Cross-country evidence shows that fiscal councils exert a strong influence on fiscal performances, particularly when they have formal guarantees of independence.

Clearly a meta-institution we are missing.

3. An institution for vertical and horizontal bargaining

This idea again comes from Dr Govinda Rao. He writes in his recent book Studies of Indian Public Finance that India lacks an institution that can act as a credible umpire between various states, and between the states as a whole on one side and the union government on the other. The National Development Council created for this purpose is defunct, the Inter-State Council is a part of the union government, the Rajya Sabha is no longer the council of states in reality, and finance commissions are dissolved after making their recommendations. The result is that there is no institution that can truly champion cooperative federalism. The GST Council perhaps performs acts as a bargaining and negotiation platform in the limited area of indirect taxation. To manage India’s heterogeneity, a meta-institution that is dedicated to horizontal and vertical balance is imperative.

Another big lesson here is that the view that India’s government is oversized is inaccurate. The Indian State is quite anaemic when it comes to staffing for its core functions. We need more institutions, not fewer.

What are some more missing meta-institutions in the Indian Republic? Leave a comment.

India Policy Watch: The Paradiplomacy Opportunity

Insights on burning policy issues in India

— Pranay Kotasthane

Note these two developments over the last few weeks: Tamil Nadu was first off the blocks to send a relief consignment to the crisis-stricken Sri Lanka. And as many as three Chief Ministers—besides the sons of two other CMs—made their presence felt at the World Economic Forum in Davos.

Moreover, chief ministerial visits to business capitals of the world are now commonplace. Virtually every Indian state now has its own global investor summit. And yes, two states (Punjab and Kerala) already have departments for non-resident Indians.

Put all these developments together and it becomes clear that Indian states are also geopolitical and geoeconomic entities. In the past, I’ve written how Australia gets around its low diplomatic corps strength by allowing its states to have their own trade and investment offices in other countries. India too should take this path, and encourage state governments to have permanent trade and investment desks in important business centres of the world.

This view is not a popular one. The policy orthodoxy believes that since foreign affairs is under the Union List of the Seventh Schedule in the constitution, states have no role to play. Besides, state governments having their own foreign policy is at odds with the popular “one nation, one X” idea.

But in my view, economic diplomacy by Indian states can be beneficial to all relevant stakeholders. It is in the states’ interest because they understand their comparative advantages, needs and challenges far better than the union government. Thus, they can choose to invest in external economic relations that are suited to their conditions.

Economic paradiplomacy can also benefit the investors as they get to directly engage with the entity that controls crucial variables for running businesses, such as land, labour, electricity, and law and order.

And finally, this strategy can benefit the union government as well. It frees up the already strained capacity of the external affairs and commerce ministries for broader issues. The role of states in the India-Israel relationship demonstrates that there is also a political utility:

“Full diplomatic ties were established between India and Israel in 1992. Even after this move, collaboration with Israel was seen as a hot potato issue in India. The domestic implications of taking sides in what was essentially a religious conflict was a significant impediment to the ties taking off. A few Members of Parliament criticised this step on humanitarian grounds, arguing that New Delhi should have waited until an independent Palestinian state came into being. Some members of the ruling Indian National Congress feared that this step would be detrimental to their electoral appeal to the Indian Muslim community. The Babri Masjid riots further thickened the plot and the Indian government slowed down the pace of the partnership.

It was under these circumstances that the Indian states were allowed to expand Indian collaboration with Israel. Traditionally, Indian states were kept out of India’s foreign policy debates. Even the Constitution assigned all matters of legislation related to foreign policy exclusively to the Union government. Consequently, the proliferation of collaboration between Indian states with Israel was a bold and unique experiment by the PV Narasimha Rao government. While this allowed relations to prosper, it also avoided the politico-religious undertones that would have been hard to suppress had this engagement been anchored by the Union government alone.”

And so, economic diplomacy by the states is a win-win-win. For an India with global interests, its states have to come to the party. Should they be invited?

HomeWork

Reading and listening recommendations on public policy matters

* [Book] Dr Govinda Rao’s Studies in Indian Public Finance is a must-read for policy enthusiasts. I really hope OUP prices it such that the common Public can Finance the book purchase. Nevertheless, the book links to some classics in public finance. Here’s the compilation: Public Principles of Public Debt by James Buchanan, Public Finance and Public Choice: Two Contrasting Visions of the State by James Buchanan and Richard Musgrave, The Logic of Collective Action: Public Goods and the Theory of Groups by Mancur Olson, Public Finance in Theory and Practice by Richard and Peggy Musgrave, The Power to Tax: Analytic Foundations of a Fiscal Constitution by Brennan and Buchanan, The Calculus of Consent by James Buchanan, The Road to Serfdom by Hayek, and Democracy, Dictatorship, and Development by Mancur Olson.

* [Prediction Market] We’ve written previously about the utility of prediction markets in foreign policy. Check out this US-government project that is explicitly meant to ‘build a collective foresight capability that can provide U.S. Government policymakers with an accurate and nuanced rendering of the future’.

* [Report] Putting the Periphery at the Center by Happymon Jacob makes some excellent recommendations on Indian Paradiplomacy.

Insights on burning policy issues in India

- Pranay Kotasthane

The Universal Basic Income (UBI) proposal made it to last week's policy headlines. The occasion was the release of a report commissioned by the Economic Advisory Council to the Prime Minister. Written by the Institute for Competitiveness, the State of Inequality in India Report bats for “raising minimum income and introducing universal basic income” to reduce “the income gap and equal distribution of earnings in the labour market”.

There is no cost-benefit analysis or implementation details of the UBI in the report. Nevertheless, since this report has been commissioned by a government advisory body just a couple of years ahead of the next national election, the report has rekindled the conversation on UBI.

What Do We Know About the UBI in India?

UBI has been extensively discussed ever since the Economic Survey 2016-17. It is one of those rare ideas for which you will find liberal and progressive arguments both for and against it. So I’ll skip the usual arguments and get to the crux of the UBI in India.

What we know is that a “Universal. Basic. Income.” is an impossible trinity in the Indian context. The government can at best meet two but not all three of its elements—a basic income that won’t be universal; a universal income that will be way below what qualifies as “basic”; or something that is universal and basic but not in the form of an income.

This trilemma arises due to two reasons. One, India is just not rich enough for the government to fund a full UBI by taxing citizens at reasonable rates. The Economic Survey estimated that even a non-universal basic income for 75% of Indians would cost nearly 5% of the GDP. For context, the total expenditure incurred by the union government including all its portfolios was approximately 13% of GDP before the pandemic.

Two, some proponents of UBI argue that the government can stop existing implicit and explicit subsidies, and use the savings to fund a UBI. The UBI would eliminate leakages, obviate the need for complex delivery machinery, and reduce incentives for corruption, they explain. But in a democratic setup where every political party finds it imperative to give individual handouts before elections, this is a leap of faith. It’s more likely that taxpayers will foot the bill for all current subsidies in addition to the UBI.

Realising this trilemma, political proposals after the Economic Survey report have tended towards the first option— a targeted basic income scheme, which is non-universal by definition. One such formulation, the Minimum Income Guarantee Scheme for the Poor (MIGS), made it to the Indian National Congress’ 2019 manifesto.

What Explains the UBI’s Return to the Headlines?

This conversation on variants of UBI has picked up the pace again. Like any major crisis, the pandemic has impacted the poor more than the rich. And hence, various income support schemes are back in favour. The Overton Window seems to be shifting. Interestingly, this trajectory towards increased monetary transfers after a major crisis was anticipated in a book nearly 60 years ago.

In a 1961 book titled The Growth of Public Expenditure in the United Kingdom, economists Alan Peacock and Jack Wiseman observed the patterns of government spending in the UK between 1890-1955. The dominant view at that time was that government spending as a proportion of the overall economy keeps rising organically as citizen demands grow with rising incomes. In a poor country, most citizens make do with the State providing them with the bare basic public services. But as incomes and government revenues rise, citizens demand that the State also provide them with quality education, low-cost healthcare, and affordable housing, and so on.

Peacock and Wiseman challenged this view of the organic growth of government spending. They saw that government spending rise in the UK happened in the form of step-jumps due to major crises (and there were many in their study period).

Their explanation of this phenomenon was as follows. In normal times, the level of public spending is capped by the acceptable level of taxation. Even if citizens might find a higher level of government spending desirable, they won’t accept a higher rate of taxation in return. This equilibrium is shattered by a crisis such as a war, where government spending and rates of taxes increase to manage the immediate difficult situation at hand. However, once the crisis recedes, new ideas of tolerable taxation levels emerge, and government spending does not go back to its original position. This conjecture came to be known as the Peacock-Wiseman Hypothesis (PWH).

Are we seeing PWH in action in India, because of COVID-19? If one were to look at costly expenditure policies such as UBI, speculations about a GST rate of 8% replacing the 5% rate, and the high fuel taxes, it does seem that we are moving towards a new normal in government spending.

Another interesting element of this hypothesis is the “inspection” effect:

“social upheavals impose new and continuing obligations on governments both as the aftermath of functions assumed in wartime (e.g., payments of war pensions, debt interest, reparation payments) and as the result of changes in social ideas. Wars often force the attention of governments and peoples to problems of which they were formerly less conscious—there is an "inspection effect," which should not be underestimated.”

The optimist would say that the inspection effect might lead Indian governments to finally focus on key areas such as pro-market reforms, liberalisation of factor markets, defence, poverty reduction and public health.

But the realist would argue that the policy debate on public health hasn’t matured enough to present viable options, and hence it is more likely that the government might opt to spend on “quick-win” schemes such as the UBI or PLI, which are simpler and intuitive at face value. So, on the whole, we should keep a close eye on the government spending trajectory.

PS: Peacock and Wiseman hasten to remind us that their conjecture is not inevitable, the reality depends on the social and economic context of the crisis itself.

Speaking about PWH, we’re hosting a conversation with India’s foremost authority (and my public finance teacher), Dr Govinda Rao, this Friday. His latest book Studies in Indian Public Finance narrates India’s tryst with taxes, debt, expenditures and budgets. A must-read for any public policy enthusiast.

Global Policy Watch #1: Axel Leijonhufvud On His Tribe 

Global policy issues relevant to India

- RSJ

“The Econ tribe occupies a vast territory in the far North. Their land appears bleak and dismal to the outsider and travelling through it makes for rough sledding; but the Econ, through a long period of adaptation, have learned to wrest a living of sorts from it. They are not without some genuine and sometimes even fierce attachment to their ancestral grounds, and their young are brought up to feel contempt for the softer living in the warmer lands of their neighbours such as the Polscis (Political Scientists) and the Sociogs (Sociologists). Despite a common genetical heritage, relations with these tribes are strained-the distrust and contempt that the average Econ feels for these neighbours being heartily reciprocated by the latter-and social intercourse with them is inhibited by numerous taboos. The extreme clannishness, not to say xenophobia, of the Econ makes life among them difficult and perhaps even somewhat dangerous for the outsider. This probably accounts for the fact that the Econ have so far-not been systematically studied. Information about their social structure and ways of life is fragmentary and not well validated. More research on this interesting tribe is badly needed.”

That’s how the paper ‘Life Among The Econ’ began in the September 1973 edition of Western Economic Journal. Written by a young professor at UCLA, Axel Leijonhufvud, the paper was a humorous take on economists as a tribe written in the style of a field paper of an anthropologist. Reading it almost fifty years after it was written, it is hilariously accurate and relevant.

Axel Leijonhufvud died earlier this month. His defining work was his 1968 book ‘On Keynesian Economics and the Economics of Keynes’ where he questioned the validity of the IS-LM model that had become the foundation for applying Keynesian economics. The success of Keynesian economics and the subsequent research on it had made most believe that there was nothing left anymore to discover in macroeconomics. Leijonhufvud proposed a radical departure from this consensus. He called it the ‘cybernetic’ approach that begins with rejecting the notion that the system is in a state of equilibrium. Instead, he argued that the economy is always in a dynamic state which is continually evolving based on initial information available with transactors - their endowments, beliefs, expectations, existing relationships, assets etc. There are a set of possible actions given an initial state and the behavioural rules that will dictate what next step will be chosen. Economic systems, he claimed, operate at a tactical, transaction level with no planned long-term goal. You can study this over time and there will be patterns of behaviour and reference points that will emerge based on the initial set of assumptions but there’s no guarantee things will always converge to an equilibrium.

It was an intellectual challenge to Keynesian consensus and laid the ground for the takeover of the field by the adherents of the rational expectations theory. Famously, his book that theorised at length on macroeconomics didn’t have a single formula. He didn’t need them to make his point. Leijonhufvud believed then (1971) that economics was being taken over by top-down quant models without having an ear to the ground. 50 years later you could argue things have gotten worse.

Anyway, I will leave you with a sample of Leijonhufvud’s dry wit from his anthropological study of the econ tribe.

On status among economists:

“A comparison of status relationships in the different “fields” shows a definite common pattern. The dominant feature, which makes status relations among the Econ of unique interest to the serious student, is the way that status is tied to the manufacture of certain types of implements, called “modls.” The status of the adult male is determined by his skill at making the “modl” of his “field.” The facts (a) that the Econ are highly status-motivated, (b) that status is only to be achieved by making ”modls,” and (c) that most of these “modls” seem to be of little or no practical use, probably accounts for the backwardness and abject cultural poverty of the tribe. Both the tight linkage between status in the tribe and modlmaking and the trend toward making modls more for ceremonial than for practical purposes appear, moreover, to be fairly recent developments, something which has led many observers to express pessimism for the viability of the Econ culture.”

On the primacy of models over everything else:

“While in origin the word “modl” is simply a term for a concrete implement, looking at it only in these terms will blind the student to key aspects of Econ social structure. “Modl” has evolved into an abstract concept which dominates the Econ’s perception of virtually all social relationships-whether these be relations to other tribes, to other castes, or status relations within his caste. Thus, in explaining to a stranger, for example, why he holds the Sociogs or the Polscis in such low regard, the Econ will say that “they do not make modls” and leave it at that. The dominant role of “modl” is perhaps best illustrated by the (unfortunately very incomplete) accounts we have of relationships between the two largest of the Econ castes, the “Micro” and the “Macro.” Each caste has a basic modl of simple pattern and the modls made by individual members will be variations on the theme set by the basic modl of the caste. Again, one finds that the Econ define the social relationship, in this instance between two castes, in terms of the respective modl. Thus if a Micro-Econ is asked why the Micro do not intermarry with the Macro, he will answer: “They make a different modl,” or “They do not know the Micro modl.” (In this, moreover, he would be perfectly correct, but then neither, of course, would he know the Macro modl.)”

On the future of Economics:

It would be to fail in one’s responsibility to the Econ people to end this brief sketch of life in their society without a few words about their future. The prospect for the Econ is bleak. Their social structure and culture should be studied now before it is gone forever. Even a superficial account of their immediate and most pressing problems reads like a veritable catalogue of the woes of primitive peoples in the present day and age. They are poor-except for a tiny minority. miserably poor. Their population growth rate is among the highest in the world. Their land is fairly rich, but much of the natural resources that are their birth-right has been sold off to foreign interests for little more than a mess of pottage. Many of their young are turning to pot and message. In their poverty, they are not even saved from the problems of richer nations-travellers tell of villages half-buried in the refuse of unchecked modl-making and of the eye-sores left on the once pastoral landscape by the random strip-mining of the O’Metrs. It is said that even their famous Well Springs of Inspiration are now polluted. In the midst of their troubles, the Econ remain as of old a proud and warlike race. But they seem entirely incapable of “creative response” to their problems. It is plain to see what is in store for them if they do not receive outside aid.

Global Policy Watch #2: Let Musk Play 

Global policy issues relevant to India

- RSJ

Elon Musk couldn’t have existed at any other time in human history. Because at no other point in our history would it have been possible to simultaneously be the richest person in the world, run the most innovative and bold business enterprises, troll powerful politicians and colleagues, show a fine disregard for the law (esp SEC’s laws), smoke a joint on live web TV, create asset bubbles with just a single word and also be seen by millions as a messiah.

A thousand years from today just studying the life and times of Elon Musk would be enough to understand the 21st century. And this would have been true even a couple of months ago. However, that’s not enough for Musk. In the last few weeks, he has gone further. In April, he made a bid for buying out Twitter, the platform that is seen as the global public square of our times and taking it private. Of course, he bid for it at $54.20 per share because he cannot resist a ‘420 marijuana joke’ when he takes these important decisions. And since then, he’s been trolling Twitter. On Twitter. About its management, the likely bots it has as users, its policy on censoring content, its product features and on how its headquarters might be better used a shelter for the homeless. While it is tremendous entertainment for onlookers, there are those who are worried about the implications of a very rich man with strong libertarian and, often strange right-wing beliefs owning the most influential social media platform in the world.

Twitter is already chaotic with bad actors manipulating the platform to trend topics, troll people and create a fake news industry that has ruined lives, influencing elections and creating just about the worst kinds of influencers in countries around the world. The initial euphoria of it providing a voice to ordinary citizens, getting rid of the gatekeepers and the hope of many more Arab Springs have been replaced by a cynicism that it is a platform that can be abused by those with more resources for their political ends. And into this chaotic world, now we will have the king of chaos, Musk, himself holding the reins. This could get really bad.

Or will it?

At the heart of this issue is that old question that Plato tried to answer in ancient Greece. Who should hold power in a society and how should the use of that power be regulated?

There are three key concerns I read about Musk owning Twitter and it is useful to understand them a bit more.

First, there are problems with Twitter today. Bots, fake news, concerted abuse by mobs and somewhat random ways of censoring voices. These issues aren’t helped by its lack of transparency – the algorithm it uses to recommend and trend topics or how it decides on clamping down on certain accounts or tweets are all shrouded in mystery. People abuse the platform for their benefit while Twitter often ends up punishing the wrong guy. Musk has zeroed in on the source of this problem. To him, the platform is optimising for the attention of the user and its algorithms are built to reinforce your biases over and over again. And no one outside of Twitter knows how the algorithm decides which biases will it reinforce and which it won’t. Over time, he fears this lack of transparency will erode trust among users and reduce the effectiveness of the algorithm because of a lack of credible challenge from the outside. He views this as an engineering problem and to quote him – “open source is the way to go” – to solve this. That sounds vague but, hey, it is Musk talking. You can trust him to find the technical solution to this.

Those who oppose Musk buying Twitter are worried that this ‘engineering tech-bro’ mindset has gotten us into this mess in the first place. Musk might be good at putting rockets in space and, possibly, colonising Mars someday but solving a complex social problem is a different ball game. It requires a deeper understanding of people, their motivations and a mind that can think beyond rational expectations and incentives. Giving Musk the charge to make Twitter better is the equivalent of handing the keys of the asylum over to its inmates. That’s the argument.

I’m less than convinced about this. Twitter is a technology platform. Its engagement with its users, its feature of bringing the latest information to your feed and its ability to create a network for you based on how you use it are all products of its technology. The choices it has made on technology have created it in the shape it is today which is different from say, Facebook or Reddit. If the platform encourages click-baits, reinforces biases and tribal loyalties through the like button and optimises for your attention, the solution to it cannot be to solve for human nature. That is an unsolvable problem. This is an engineering problem. Sure, as history has shown once you think you have solved it, the problem will shift. This is an ongoing process in science and every technological innovation has evolved in this way over the centuries. The solution to human mobility has over time gone from horses to cycles to cars to aircraft with each solution bringing with it newer problems. Nobody has ever contended that the real solution is for humans to develop wings.

Two, there is a view that platforms like Twitter are a public good and it shouldn’t be owned by rich, powerful people like Musk. I can grudgingly admit that Twitter is like a public good. But that only means there’s a need for the state to intervene in framing guidelines on how it will be used. It doesn’t necessarily follow that it should be owned by the state. That would be a catastrophic mistake. There’s a long history of media being owned by the rich around the world. The state in most democracies has understood the criticality of media in the scheme of things and managed it well so far. Media moguls have influence but none has ever become a law unto themselves. On the other hand, the state has tried but it has not managed to stifle free speech. We have been worried about this equilibrium for a long time. As far back as 1941, Hollywood was making Citizen Kane about a powerful media owner and his outsized influence on politics and society. Media has only diversified and thrived since. Musk might suffer from a God complex. He might want to be the techno-feudal overlord of the universe. Even if he were to become one, he will still be less powerful than the state.  

Three, there is a belief that Musk is a canny operator and perhaps someone who understands the power of Twitter more than anyone else in this world. His reason for owning the platform is to have a free run to do things he likes to do in his spare time – troll the SEC, progressive left and other adversaries in business; pump up meme stocks or dodgy cryptocurrencies, make gains at the expense of his stupid followers and, who knows, probably build a base for some kind of a career in politics. So, Twitter is an expensive toy that he loves. He will play with it till he gets bored. At the end of it, the world will be poorer for his misadventure because Twitter is still an amazing platform for good.

Should he be allowed to run a platform like Twitter to the ground because he has the money and the power? Well, maybe not. But the truth is that he has the power and the money because he has been proven right many times over. There is no divine reason for his magic. He commands trust among his millions of followers because he makes the seemingly impossible possible. Were he to take advantage of that trust to the detriment of his followers, he will begin to lose that power. Musk takes long-range bets – electric vehicles, space travel, EV batteries, hyperloop – and his credibility is the only reason why investors trust him to pull these off. He should know the perils of short-term gains at the expense of that credibility. He will not take a punt on that.

There are market failures that need attention in big tech and social media businesses. Elon Musk buying Twitter won’t make this worse. These failures need policy interventions that regulate the market dominance and the information advantage these companies have. Those are the guardrails that the state and the regulators need to build. The Musk Twitter drama is a sideshow.  

HomeWork

Recommended podcasts, papers, and articles on public policy matters

* [Paper] Mihir Mahajan and Shekhar Sathe estimate additional deaths in the pandemic years by using publicly available insurance data. TL;DR - the estimates are quite close to the WHO-reported numbers. If you prefer a podcast on this topic, listen to our Puliyabaazi.

* [Paper] This old paper asks: Did India’s public expenditure follow the Peacock-Wiseman Hypothesis as a result of the 1962 India-China War? TL;DR - yes, partially.

* [Article] Over at New Things Under the Sun, Matt Clancy summarises the literature that investigates the relationship between population and innovation. The evidence suggests that bigger populations are generally better for innovation.

* [Podcast] This BIC Talks episode with Faisal Devji on Gandhi is top-notch.

* [Paper] For a libertarian critique of the UBI, read Bryan Caplan. “The UBI is a triumph of simplicity over numeracy”, he says. Of course, he is speaking from the American socio-political context.

Insights on burning policy issues in India

- RSJ

Hello Readers! We are back after a nice, little break. 

Things have changed a bit in the past four weeks; haven’t they? Stock markets around the world are down by 10 per cent. Central banks have hiked interest rates by 40-50 bps. Inflation in the US is running at a 40-year high of over eight per cent. Retail inflation in India at 7.79 per cent is beyond the zone of comfort for RBI. The Rupee hit an all-time low last week. Technology stocks are down all over the world and the deal pipeline in the digital startup space has all but dried up. Musk is buying Twitter or maybe he isn’t. NFTs are dead and buried and crypto valuations are in a funk (or in a death spiral as Matt Levine puts it). And no one really knows anything about the Ukraine war. It drags on like a Putin-shaped monster waddling its way through the spring rasputitsa with no hope of getting anywhere.

Such then are the vagaries of the world.  

Thankfully, the Indian news channels were debating more important issues during these times. Like loudspeaker bans in religious institutions. Like a videographic survey of a Varanasi mosque by a 52-member team. Or if the Taj Mahal was indeed a Shiva temple called Tejo Mahalaya before Shah Jahan, that undisputed emperor of large tracts of Hindustan in the 17th century, figured he had run out of land to build a mausoleum in memory of his late wife. Or if Sri Lanka was more in the dumps than us in these times. These things matter. So they must be investigated by the intrepid reporters sitting in the studios. We must be forever thankful for the oasis of assurance that Indian news channels offer to us in this volatile and uncertain world.

Anyway, coming back to the point, things have turned for the worse since we last wrote on these pages. Yet, amidst all the talks of a recession or stagflation, I believe there’s some kind of silver lining for India if it plays this situation well. 

Sweet Are the Uses Of Inflation

First, let’s look at the inflation and the rising interest rate scenario. India didn’t go down the path of expanding the fisc by doling out cash incentives at the peak of Covid induced distress in the economy. Much of the “20-lakh crores package” that was announced in May 2020 was either repurposing of the existing schemes or putting a monetary value on loans, subsidies or free food that was offered to the people. So, while the RBI cut rates and increased liquidity, the supply of money in the system and the government balance sheet didn’t bloat like those in the US and other western economies. The upside of the US model was that the economy rebounded faster, it began running at almost full employment and people who got Covid relief checks started spending as the economy opened up. The downside is an overheated economy that now needs to be cooled down but that comes with its consequences. The war in Ukraine and the resultant rise in oil and commodity prices have queered the pitch. So, for the first time in a long, long time the Fed has had to raise rates while the markets are falling. In 2022, the global rich have lost over a trillion dollars already as markets have fallen while the poor have had their wage increases outpace inflation. There’s less K-shaped recovery discussions in the US happening today. Anyway, these are new scenarios for an entire generation raised on rising stocks, low inflation and low-interest rates. This will be a hard landing for them. 

In the model that India followed, on the other hand, there was real distress in the rural and informal economy because of the absence of a direct cash transfer scheme during the pandemic. As the economy opened up, there were supply chain disruptions that hurt multiple sectors. The rise in oil prices because of the war added to the inflation. But there is an important difference between our inflation and that of the West. It is more a supply-side issue for us. A few rate hikes, some stability in oil and commodity prices and our continued diplomatic balancing act that will help us with cheap oil from Russia should stabilise things. We could be looking at a transitory elevated inflation for a few quarters rather than something more structural. Also, we have a much greater headroom to control inflation by raising rates. The repo is at 4.4 per cent after the out-of-turn increase by RBI last week. It is useful to remember as late as mid-2018, the repo was at 6.5 per cent and that didn’t look like a very high rate at that time. So, the RBI has another 150-200 bps of flex to tame inflation without seriously hurting growth, unlike the West. And that is only if the inflation prints get into the teens. That looks unlikely. So, what’s in store for us? We will continue with the trends we have seen so far: a K-shaped recovery that will hurt the poor more, the formalisation of the economy will mean the published numbers of GST collections or income tax mop-up will be buoyant, the food subsidy and other schemes started during the pandemic will continue for foreseeable future and we might get away managing to keep inflation down without killing growth.

Second, the structural inflation in the western economies will mean they will have to take a couple of long-term calls. The discussion on the first of these calls is already on with an urgency markedly different from what it was six months back. How to reduce the dependence on oil and gas that support authoritarian regimes around the world? This shift away from the middle-east and Russia for energy is now an irreversible trend. Expect a rethink on nuclear energy and acceleration on the adoption of EVs. The other call is who should we back to replace China as the source of cheap goods and services to the west? The low inflation that the west has been used to over the past two decades is in large part on account of China’s integration into global trade. Now China wants to move up the value chain. Worse, it wants to replace the US as the dominant superpower. Continuing to strengthen China economically is no longer an option. China has done its cause no favour by being a bully around its neighbourhood (we know it first hand), being a terrible friend (ask Sri Lanka) and creating an axis with Russia and other authoritarian regimes around the world. There’s no going back to a working relationship with China of the kind that was prevailing before the pandemic. It is unreliable and it won’t turn into an open, democratic society with rising prosperity as was expected. It is difficult to see beyond India in filling that China-shaped void if the west were to search for continued low costs. Vietnam, Bangladesh and others could be alternatives but they lack the scale for the kind of shift that the west wants to make. The inflation pressure means the west doesn’t have time. India has an opportunity here. And I’m more sanguine about this because even if India shoots itself in foot like it is wont to, the way the die is cast it will still get the benefits of this shift. This is a window available for India even if it were to do its best (or worst) in distracting itself with useless, self-defeating issues. 

Lastly, there are some unintended consequences of a moderately high single-digit inflation for India. This is a government that likes to be fiscally prudent. It didn’t go down the path of ‘printing money’ during the pandemic because it cared about the debt to GDP ratio and the likely censure and downgrades from the global rating agencies. But it is also a government that likes welfarism. Welfarism + Hindutva + Nationalism is the trident it has used to power its electoral fortunes. A rate of inflation that’s higher than government bond yields will pare down the debt to GDP ratio and allow it to fund more welfare schemes. And that’s not a bad idea too considering there’s evidence that things might not be great in the informal economy. That apart, the inflation in food prices because of supply chain disruptions, increase in MSP and the war in Ukraine is good news for the rural economy. After a long time, the WPI food inflation is trending above CPI which means farmers are getting the upside of higher food prices. I guess no one will grudge them this phase however short-lived it might be. 

Well, I’m not often optimistic on these pages. But the way the stars have aligned themselves, India does have an opportunity to revive its economy in a manner that can sustain itself for long. The question is will it work hard and make the most of it? Or, is it happy being lulled into false glories and imaginary victimhood from the past that its news channels peddle every day?

A Framework a Week: Errors of omission and commission — how VLSI relates to subsidies

Tools for thinking public policy

— Pranay Kotasthane

(This article is an updated version of my 2014 essay on nationalinterest.in)

The fundamental idea of any testing is to prevent a faulty product from reaching the end consumer. A well-designed test is one that accurately identifies all types of defects in the product. Very often though, this is not possible as tests may not cover the exact range of defects that might actually exist. In that case, the suite of tests leads to errors of commission or omissions. The interesting question, then is — which of the two errors is acceptable?

An illustration

This second problem can be explained using a fairly simple scenario from “Design-for-Testability” theory used in all integrated chip (IC) manufacturing companies. Consider a firm that makes the processor chips going into your laptops. Every single processor chip goes through a set of tests to identify if the chip is good or bad. Four scenarios result from this exercise:

The two scenarios marked in green are the best-case scenarios. In the first of these, all the designed tests are unable to find any fault with the chip. At the same time, the chip itself does not show any defects after reaching the end consumers. When such awesomely functional chips reach your laptops, the chip-making companies make profits.

In the second “green” scenario, the tests indicate that there is a problem with the chip. Further debugging (which involves greater costs) concludes that this chip is actually manufactured erroneously. It is then the raison d’être of the tests to throw away these chips so that they do not reach the customers.

However, when tests are unable to identify any problem with the chip even though it is bad, we end up in the second choice problem 1 scenario or the “error of commission”. This is the scenario you encounter when your laptop crashes within a few days/weeks/years (within the guarantee period) after purchase. Obviously, this makes the consumer lose trust in the product and dents the manufacturing firm’s image.

On the other hand, there is the second choice problem 2, where tests are designed so thoroughly that they start eliminating chips which are actually not dysfunctional. This is the Error of Omission. The cost involved with this error is that it leads to a loss of revenue as many good chips are just thrown away based on faulty tests. It also lowers the confidence of the firm.

The above illustration shows the two errors that are commonly encountered in the chip manufacturing business. Which of them is tolerable is a function of the company’s image in the market, the end application of the product and the costs involved. For example, if the chip is being manufactured for use in mission-critical automobile systems like auto-braking or fuel injection, the preferable error is the error of omission as there’s a life and personal safety at stake. On the other hand, if the end application is a low-end mobile phone, the company might settle for a higher error of commission and avoid the extra costs of rejecting lots of chips.

Application — Subsidies

The above illustration can directly be applied to a subsidy case to explain the effect of identifying beneficiaries incorrectly. Using the framework above, we can visualise a subsidy program as shown in the figure below:

From the framework above, which would be your second choice? The first option would be to start with very few beneficiaries being fully aware that there will be a definite Error of Omission. The next step would be to work on reducing this error rate itself. The problem here will be that there might be some people who, even though needy are not attended to urgently.

Another option would be to start with a large number of beneficiaries being aware of the errors of commission. A subsequent step would be to try and reduce this error rate. The costs involved here are that the free-riders might sideline the really needy. Such schemes will also require huge sums of capital as they will start by serving a huge number of people. This is the path that most government subsidies follow in India. A digital identity project like Aadhaar plays a role right here — it can reduce the errors of commission.

If you were to design a subsidy scheme, which would be your second choice scenario? Thinking about second choices is generally useful in public policy as the first-choice option is often unavailable. The art of policymaking lies in picking a second-best option that makes most people better off.

India Policy Watch #2: Samaaj Ke Dushman

Insights on burning policy issues in India

- RSJ

Here is a quote for you to ponder over:

All these theoretical difficulties are avoided if one abandons the question “Who should rule?” and replaces it by the new and practical problem: how can we best avoid situations in which a bad ruler causes too much harm? When we say that the best solution known to us is a constitution that allows a majority vote to dismiss the government, then we do not say the majority vote will always be right. We do not even say that it will usually be right. We say only that this very imperfect procedure is the best so far invented. Winston Churchill once said, jokingly, that democracy is the worst form of government—with the exception of all other known forms of government.

Sounds relevant to our times?

Over the past month, I have been reading Karl Popper’s “Open Society and Its Enemies”. It is a wonderful book written during WW2 when open and democratic societies were facing their most difficult test yet. The key question Popper is interested in is how do we avoid democracies falling into the trap of turning themselves inwards and giving into a majoritarian system of governance. Seems like as relevant a question as it was during the time of his writing. 

While reading the book, I chanced upon a most amazing essay written by Popper himself about his book in The Economist in 1988. Reading it three decades later, it is remarkable how accurate he is in first framing the core question of a democracy right and then looking for solutions that can be tested with scientific rigour.

I have produced excerpts from that essay below:

In “The Open Society and its Enemies” I suggested that an entirely new problem should be recognised as the fundamental problem of a rational political theory. The new problem, as distinct from the old “Who should rule?”, can be formulated as follows: how is the state to be constituted so that bad rulers can be got rid of without bloodshed, without violence?

This, in contrast to the old question, is a thoroughly practical, almost technical, problem. And the modern so-called democracies are all good examples of practical solutions to this problem, even though they were not consciously designed with this problem in mind. For they all adopt what is the simplest solution to the new problem—that is, the principle that the government can be dismissed by a majority vote…

My theory easily avoids the paradoxes and difficulties of the old theory—for instance, such problems as “What has to be done if ever the people vote to establish a dictatorship?” Of course, this is not likely to happen if the vote is free. But it has happened. And what if it does happen? Most constitutions in fact require far more than a majority vote to amend or change constitutional provisions, and thus would demand perhaps a two-thirds or even a three-quarters (“qualified”) majority for a vote against democracy. But this demand shows that they provide for such a change; and at the same time they do not conform to the principle that the (“unqualified”) majority will is the ultimate source of power—that the people, through a majority vote, are entitled to rule.

Popper’s answer is the two-party system. The Congress is busy with its chintan shivir as we speak and I read Popper with bemusement when he wrote on the merits of a two-party system.

The two-party system

In order to make a majority government probable, we need something approaching a two-party system, as in Britain and in the United States. Since the existence of the practice of proportional representation makes such a possibility hard to attain, I suggest that, in the interest of parliamentary responsibility, we should resist the perhaps-tempting idea that democracy demands proportional representation. Instead, we should strive for a two-party system, or at least for an approximation to it, for such a system encourages a continual process of self-criticism by the two parties.

Such a view will, however, provoke frequently voiced objections to the two-party system that merit examination: “A two-party system represses the formation of other parties.” This is correct. But considerable changes are apparent within the two major parties in Britain as well as in the United States. So the repression need not be a denial of flexibility.

The point is that in a two-party system the defeated party is liable to take an electoral defeat seriously. So it may look for an internal reform of its aims, which is an ideological reform. If the party is defeated twice in succession, or even three times, the search for new ideas may become frantic, which obviously is a healthy development. This is likely to happen, even if the loss of votes was not very great.

Under a system with many parties, and with coalitions, this is not likely to happen. Especially when the loss of votes is small, both the party bosses and the electorate are inclined to take the change quietly. They regard it as part of the game—since none of the parties had clear responsibilities. A democracy needs parties that are more sensitive than that and, if possible, constantly on the alert. Only in this way can they be induced to be self-critical. As things stand, an inclination to self-criticism after an electoral defeat is far more pronounced in countries with a two-party system than in those where there are several parties. In practice, then, a two-party system is likely to be more flexible than a multi-party system, contrary to first impressions.  

PolicyWTF: The Wheat Ban Photo Op

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

The Directorate General of Foreign Trade (DGFT) has banned wheat exports from India with immediate effect. For an expert’s view on why this ban is a policyWTF, read Ashok Gulati and Sachit Gupta’s take in the Indian Express. The article lists three less-worse options that the government chose to ignore, and opted for this rather extreme step instead. From a broader public policy perspective, there are three points to learn from this PolicyWTF.

One, it reflects the perilously increasing scope of what’s classified as “strategic”. Once an item gets that tag, a fundamental concept behind international trade that “only individuals trade, countries don’t”, gets defenestrated.

Here’s why I think this “strategic” line of thinking is the real reason behind this policyWTF. Until 11th May, the message from the government was that it has procured sufficient stocks of wheat and that there is no plan for an outright ban on exports. The PM in his recent visit to Germany even proclaimed that Indian farmers have “stepped forward to feed the world" even as many countries grapple with wheat shortages. There were reports that the government might consider an export tax on wheat; a ban wasn’t on the cards. A May 14 Business Standard report cited an unnamed senior official thus:

“We have worked on four-five policy measures to curb this unabated flow of wheat from India. A final decision on this is yet to be taken. We are waiting for approval from the Prime Minister’s Office (PMO).”

So it seems that it was the PMO that opted for this extreme step. Why, you ask? The reason perhaps lies in the exceptions to the ban. The government plans to permit wheat exports bilaterally, on the request of specific countries. In one fell swoop, every bag of wheat being exported by an Indian farmer now becomes an economic diplomacy photo-op for the government. While this may seem like a masterstroke for the government, this ‘strategy-fication’ comes at the immense expense of farmers and traders. While they will not be able to cash in on the immediate opportunities, they might also receive smaller if not fewer international orders from international buyers in the future.

The second lesson from this PolicyWTF is for the farmers. While this particular ban will undoubtedly hurt the farmers and traders, its origins lie in the now-normalised intervention of governments in all aspects of agriculture. In that sense, Minimum Support Prices (MSP) and the wheat ban are two sides of the same coin. A government that giveth will also taketh at whim. The push for making MSP a law is likely to invite more such export bans from the government, in the name of consumer interest.

Observe the ease with which the State can take away economic freedoms in this statement by the Commerce Secretary:

"So, what is the purpose of this order. What it is doing is in the name of prohibition - we are directing the wheat trade in a certain direction. We do not want the wheat to go in an irregulated manner to places where it might get just hoarded or where it may not be used to the purpose which we are hoping it would be used for”.

The third policy lesson is the need to lift the bans on genetically edited crops. The ostensible reason for this ban was a decrease in production due to the heatwave in large parts of India. Assuming that climate change will lead to many more instances of crop failures, crops engineered to withstand higher temperatures are an important part of the solution.

In the wake of the ongoing wheat shortage, there are signs that the regulatory environment is changing in a few countries. Australia and New Zealand approved a drought-tolerant Argentinean wheat variety for human consumption last week. Many countries now classify gene edited crops that do not use DNA from a different organism, as non-GMO. Indian regulators hopefully too will move in the same direction.

HomeWork

Reading and listening recommendations on public policy matters

* [Post] The Indian ‘sedition’ law was in the news last week. We had a conceptual take on sedition in edition #115 that puts the current events in context.

* [Podcast] What’s it like to grow, operate, and sell a manufacturing firm in India? That’s the theme of the latest Puliyabaazi with Hema Hattangady.

* [Book] Lithium batteries are all the rage. For understanding the politics and the geopolitics of these batteries, read Lukacz Bednarski’s succinct Lithium: The Global Race for Battery Dominance and the New Energy Revolution. For a short introduction to battery failure accidents in India, here’s a nice primer by Saurabh Chandra on Puliyabaazi.

India Policy Watch #1: Hindi Hain Hum...

Insights on burning policy issues in India

- RSJ

There’s that oft-quoted line of sociolinguist Max Weinreich that goes ‘a language is a dialect with an army and navy’. Like many facetious remarks, it isn’t scientific, but it sounds great. Also, there’s a kernel of truth in it. The only reason a particular dialect races ahead of others and transcends a threshold to turn into a language is when it is backed by political patronage and the power of the state. Examples abound.

The version of Hindi that’s official in India today, for instance, wasn’t the kind that was spoken by anyone even two hundred years ago. Many in India find this hard to believe. But it isn’t too difficult to prove. Read any text or literature that was popular in north India before the 19th century, and you will find the language bears no similarity to the official Hindi of today. The great texts of 16th century India will help you with this. Ramacharitmanas by Tulsidas was written in Awadhi, Surdas used Brij bhasha and Guru Granth Sahib is an eclectic mix of languages ranging from Sindhi, Lahnda, Persian and Brij bhasha. The first works that bear a strong resemblance to the Hindi of today appeared in 1870-80s when Bharatendu sought to popularise a combination of Awadhi and Brij with a generous sprinkling of tatsam words from Sanskrit while stripping away the Urdu words. This project gained political support in the late 19th century when there was Hindu revivalism in the air. The decimation of the Mughal empire was complete and with it went the state patronage of Farsi and Urdu. There was desire then to find a purified version of the Hindustani language that preceded the Delhi Sultanate. Bharatendu filled this gap and his efforts were ably supported by the Raja of Benaras and the Kashi Dharma Sabha. Post-independence, this version of Hindi got its ‘army and navy’ with the might of the state behind it. And it turned into a language.

Quite appropriately, it was called the ‘rajbhasha’; the language of administration or the language of power. 

What’s the point of this bit of historicising? Well, here’s the press release from the 37th meeting of the Parliamentary Official Language Committee held last week that was presided over by the Union Home Minister (HM):

“Hindi should be accepted as an alternative to English and not to local languages.

Time has come to make the Official Language an important part of the unity of the country, when persons from States which speak other languages communicate with each other, it should be in the language of India.”

The usual furore followed. 

This isn’t the first time the HM has made this sort of an appeal. Every year on the occasion of Hindi Diwas there’s a similar pitch about Hindi. The usual benefits are stated. That we need a ‘link’ language for India and Hindi is best suited for it. Not English. That’s a foreign tongue and the language of our colonial humiliation. We will be somehow more united if we all speak in Hindi. It will foster a feeling of togetherness among Indians. Or that’s what I have understood as the benefits of this push. 

I’m sceptical of the unity argument because it makes limited sense. There are better ways of fostering unity than asking people to privilege a specific language in a country that has as many languages with long histories as India. In fact, it will likely lead to more divisions and strife. On the other hand, the ‘link’ language argument has some merit. What common language should people use to converse with each other when they are native speakers of languages as diverse as Punjabi, Bangla and Tamizh? It is a good question. But there’s no need to find a planned answer to this question. This is a question that was possibly as relevant during the times of Ashoka, Chandragupta, Akbar and Lord Canning, as it is today. The courts of those times used Pali, Persian or English as the official language of the state. But that didn’t mean these became the languages of the masses. People developed their own dialects and languages that worked for them to communicate with one another. A language can have its army and navy but those won’t make it the ‘link’ language. Because the adoption of a language and its usage in a society is the best example of spontaneous order at play. 

Spontaneous orders aren’t planned by anyone. There is no intentional coordination of actions by any external agent. Every participant acts in their individual best interest for their own objectives. However, these individual actions aggregate into a pattern of their own. It is the ‘unintended order of intentional action’ that emerges on its own and it adapts to the ongoing changes. Language is a classic example of this. No one individual could have designed it. There’s no central design of associating a sound with an object or an emotion. It evolves by the attempt of separate individuals trying to solve the problem of communicating with one another. The sounds that are easy to use and adopted by most individuals evolve into the lingua franca of the community. Language is ‘the result of human action, but not of human design’. As the language becomes more widely adopted, there are attempts to formalise its structure and syntax. As these structures become more rigid and people are forced to use a language in only a certain way, it begins losing its flexibility and its utility. People find a more flexible mode of communication and a new order emerges. A new language of the people is born. This is how Latin, Sanskrit, and Persian continued to be the languages of the church, court or the temples but the continuing rigidity of their grammar and their top-down imposition on people led to their decline. Spontaneous order killed them off. 

If the people feel the need for a link language, they will find one through the millions of everyday transactions that they undertake. In India, this could be Hindi, English or some motley mix of tongues that will work for people. That’s the direction we will head into as we find more reasons for domestic mobility and interactions. Any attempt to centrally plan for greater usage of an official language is therefore futile. It takes away time and attention of the state to focus on more real issues. And it leads to divisive politics over the imposition of Hindi over regional languages. World history is rife with examples of civil unrest and strife because of such impositions. These are unnecessary distractions that we can live without.

Or maybe that’s the point of all this.

India Policy Watch #2: …Watan Hai Hindustan Hamara

Insights on burning policy issues in India

- RSJ

I wrote a couple of weeks back about ‘Nehru: The Debates that Defined India’ by Adeel Hussain and Tripurdaman Singh. The book examines the key debates Nehru had with four of his peers, namely, Iqbal, Jinnah, Patel and S.P. Mookerjee, on questions of religion, foreign policy and civil liberties. The authors set up the historical context for each debate and why it was critical at that juncture and then reproduce the letters, columns, or speeches of the protagonists.

I have picked up the debate between Nehru and Iqbal this week. Iqbal and Nehru were temperamentally similar with both having studied at Cambridge and trained as barristers. They were steeped in enlightenment philosophy, had a taste for western literature and were socialists by instinct. Where they differed sharply was in their confidence in the transplanting of such values into Indian soil. They came at the idea of nationalism in a subcontinent as diverse as India with widely divergent first principles.

Nehru believed in a kind of inclusive nationalism where people would voluntarily shed those parts of their identity that separated them from others while retaining the core somehow. This was a difficult notion to explain, let alone implement. For Nehru, the state was to be secular with joint electorates, a reformed social code for Hindus and Muslims while simultaneously letting people practise their religions without any other interferences. Iqbal thought this was an impossible task. This utopian ideal of fusing the different communities into a single nation was fraught with disappointing everyone equally. The state would tread into areas of citizens’ lives that it had no business to be in. Democracy where numbers matter would make this risky for the minorities. There was a need to think of nationalism while protecting the identities of communities and giving them their space to breathe. Trying to hoist a unitary, majoritarian version of democracy without thinking about proportional or specific representation would lead to a situation where ‘the country will have to be redistributed on the basis of religious, historical and cultural affinities.’ Iqbal thought Nehru wasn’t thinking of the long term where those holding the power of the state would be different from them.

Needless to say, this idea itself was abhorrent to Nehru. He wrote a long response to Iqbal from the Almora district jail where he has housed in 1935. Titled ‘Orthodox of All Religions, Unite’, it gives us a window into Nehru’s thoughts on the consequences of the nationalism advocated by Iqbal. Reading it 87 years later is clarifying. It is a debate between an idealist who wants to ‘will’ a perfect society. Against whom is pitted a realist who knows this is futile and the best course is to set up a system that’s in sync with how the society works. This would then be supplemented by a code or set of guidelines that would provide the incentives for right behaviours by those in power than force a philosophy down their throats.

I have quoted parts of Nehru’s response below. It is a fascinating blend of idealism and naïveté which characterised the man:

“Other far-reaching consequences would follow the adoption and application of the joint views of Sir Mohamad Iqbal and the sanatanist Hindus. The ideals aimed at will largely be (subject to some inevitable adjustment with modern conditions) the reproduction of the social conditions prevailing in Arabia in the seventh century (in the case of the Muslims) or those of India two thousand or more years ago (in the case of Hindus). With all the goodwill in the world, a complete return to the golden ages of the past will not be possible, but at any rate all avoidable deviations will be prevented, and an attempt will be made to stereotype our social and economic structure and make it incapable of change. So-called reform movements will, of course, be frowned upon or suppressed. The long tentacles of the law of sedition may grow longer still and new crimes may be created. Thus to advocate the abolition of the purdah (veil) by women might (from the Muslim side) be made into an offence, to preach the loosening of caste restrictions or inter-dining might (from the sanatanist side) be also made criminal. Beards may become de rigueur for Muslims, caste-marks and top knots for Hindus. And, of course, all the orthodox of all shapes and hues would join in the worship and service of Property, especially the extensive and wealthy properties and endowments belonging to religious or semi-religious bodies.

Perhaps all this is a somewhat exaggerated picture of what might happen under the joint regime of the sanatanists and the ulemas, but it is by no means a fanciful picture as anyone who has followed their recent activities can demonstrate. Only two months ago (in June 1935) a Sanatan Dharma Conference was held in Bezwada [Vijayawada]. The holy and learned Swami who opened the Conference told us that ‘co-education, divorce and post-puberty marriages would mean the annihilation of Hinduism’. I had not realized till then that these three or rather the absence of them, were the main props of Hinduism – this is rather involved but I suppose my meaning is clear.

It is an astonishing thing to me that while our millions starve and live like beasts of the field, we ignore their lot and talk of vague metaphysical ideas and the good of their souls; that we shirk the problems of today in futile debate about yesterday and the day before yesterday; that when thoughtful men and women all over the world are considering problems of human welfare and how to lessen human misery and stupidity, we, who need betterment and raising most, should think complacently of what our ancestors did thousands of years ago and for ourselves should continue to grovel on the ground. It astonishes me that a poet like Sir Mohamad Iqbal should be insensitive to the suffering that surrounds him, that a scholar and thinker like Sir Mohamad should put forward fantastic schemes of states within states, and advocate a social structure which may have suited a past age but is a hopeless anachronism today. Does his reading of history not tell him that nations fell because they could not adapt themselves to changing conditions and because they stuck too long to that very structure which he wants to introduce in a measure in India today? We were not wise enough in India and the other countries of the East in the past, and we have suffered for our folly. Are we to be so singularly foolish as not even to profit by our and others’ experience?

Bertrand Russell says somewhere: ‘If existing knowledge were used and tested methods applied, we could in a generation produce a population almost wholly free from disease, malevolence and stupidity. In one generation, if we chose, we could bring in the millennium. It is the supreme tragedy of our lives that this millennium should be within our reach, so tantalizingly near us and yet so far as almost to seem unattainable. I do not know what the future has in store for India and her unhappy people, what further agonies, what greater humiliation and torture of the soul. But I am confident of this that whatever happens, we cannot go back inside the shell out of which we have emerged.”  

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Global Policy Watch: Why have Political Parties by Women and for Women Not been Successful Electorally?

Indian perspectives on global events

— Pranay Kotasthane

On International Women's Day last month, I went back to a question that has perplexed me for a long time: what explains the electoral insignificance of political parties by women and for women?

We see in India that political tribes—and parties—get created along many different identitarian dimensions. The proliferation of political parties backed by a small and reliable electoral base is quite common in India. And yet, we don’t see political parties created on the basis of gender. Most probably, there are structural reasons why this hasn’t happened yet in a society prejudiced against women.

However, India is not an exception in this case. Women’s political parties have been electorally insignificant even in Western Europe and Scandinavia. What gives? In this article, I am sharing a few notes from my ongoing search.

The Quillette asked this question in the UK context. Louise Perry's article has interesting insights. For instance, she writes that political tribes form when there is little interaction across tribes, which is not possible with gender as an identity variable. In her words,

Most political tribes live in close proximity to one another. We tend to live in neighbourhoods in which most people share our race, class, and regional identities, and therefore vote in the same way. One thing to emerge from the aftermath of the Brexit referendum is that many voters knew very few people—if any—who had voted differently from themselves. The Remainer and Leaver bubbles have significant influence and it’s easy to feel animosity towards other political tribes when they are imagined as faceless strangers.

None of this is true for women. The dream of a minority of Second Wave feminists that women would leave their husbands en masse and establish female-only communities never came to pass. Women are not an isolated group—they not only live among men, but also often love them as spouses, sons, fathers, and brothers. And that’s as it should be. But one effect of this is that true female solidarity is vanishingly rare. When asked to choose between identifying with other women, or identifying with “their” men, most women will choose the latter option. This means that women’s political parties will always struggle to gain a significant share of the vote.

Of course, Perry also highlights that feminist parties are not the only way to reduce gender discrimination.

We have witnessed within the last century the most remarkable progress in women’s political representation in the West. Decriminalized abortion, funding for rape crisis centres, reforms to the criminal justice system, anti-discrimination legislation, and many more landmark achievements—all this has taken place within a democratic system and without the existence of women’s political parties.

Further, Perry cites more studies to highlight that gender does not impact voting behaviour by much.

When it comes to electoral politics, however, women are not an identity bloc and they never have been. Gender has a small impact on voting behaviour, in that women tend to lean left and are also less politically engaged on average. But, on the whole, knowing a person’s sex gives you very little insight into how they are likely to vote. Although the gender gap is enough to influence an election result, sex has much less of an impact than other demographic factors. Simplistic references to “the women’s vote” overlook this fact.

In another article, Corwell-Meyers et al make an important distinction: not all women’s political parties are feminist parties.

In fact, surveying the platforms and manifestos of women’s parties reveals three types of parties: depending on the degree of transformation the party seeks, women’s parties can be feminist (challenging patriarchy), proactive (advancing women’s inclusion) or reactive (espousing conservative or traditional roles for women).

The authors conclude with a more considerate view of women's political parties and argue that there are some second-order benefits of such organisations, such as:

They tend to emerge in places where women perceive that the mainstream political parties neglect women or their issues, usually by not running female candidates or addressing women’s concerns. Because they typically emerge alongside or out of the grassroots politics of the women’s movement, they tend to do politics differently. As outsider organisations operating inside the system, they can recruit women to political activism, disrupt the perception that politics is a male-domain and connect women’s movement organisations to formal politics. And, even those that lack a large following have, in some cases, pressured the larger, more mainstream parties to run more female candidates or pay greater attention to women’s interests in their platforms and policies; because women’s parties have resources that civil society actors lack, they can impact both the descriptive and substantive representation of women and women’s interests. And, as both established and emerging democracies currently face reactionary pressure from populist and far right actors, women’s parties can challenge anti-woman and anti-minority group narratives.

That’s all I’ve managed to gather on this topic thus far. If you have any helpful links or articles on this topic, do leave a comment.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast playlist] Ambedkar Jayanti was celebrated earlier this past week. Check out our four episodes (1,2,3, and 4) on the great man’s writings at Puliyabaazi. We often like to say that the best way to understand Ambedkar is to read him rather than read about him.

* [Article] Arthur C Brooks’ three-step approach to changing people’s minds on contentious issues. To be read together with Ian Leslie’s Guardian article on the same issue.

Insights on burning policy issues in India

- RSJ

You must have noticed a distinct anti-west, pro-Putin tone in the media outlets that toe the government’s line in India. The intellectual right has been busy with columns equivocating on who has to shoulder the blame for the war. What could be the reasons for this? 

There’s of course the strategic autonomy argument. We are dependent on Russia for our defence and oil requirements. It has been a reliable friend of ours in the past. And we cannot trust the US anyway. There’s also the added hypocrisy of western Europe which continues to trade gas with Russia while lecturing us on our purchase of oil. Everyone is looking out for their interests and so should we. It is best to keep equidistant from any particular formation and act as a ‘swing power’. Pranay has written in the past few editions on why strategic autonomy as a policy isn’t suited for the likely emerging world order. But that aside, you can somewhat understand the anti-west stance if its origins lie in the traditional suspicion of the west and reflexive desire to be non-aligned in the policy circle in India. 

But there’s more here. The anti-west stance is also about fighting the favourite imaginary global nexus of liberals and wokes. So, you will notice almost every television debate on Ukraine will devolve into some kind of liberal and Biden bashing. If you are so concerned about Ukraine, why don’t you put your troops on the ground instead of hectoring India - is the usual line taken by anchors. Implicit in it is some kind of ‘Putin envy’ that I have noticed among the right-wing intellectuals in India. The idea that a strong man like Putin has revived national pride among Russians and brought it back into the superpower league from where it was languishing in the aftermath of the Soviet meltdown. This is obviously rubbish if you bother to look at the data. Russia is a small power whose economy has gone from bad to worse under Putin. It has a huge nuclear stockpile from its past that gives the rest of the world the only reason to pause before dismissing it as a nobody. But there’s a fascination among the right intellectuals to make the case for a Putin-like revival of India.

I remember just before the 2014 elections, Swapan Dasgupta made this argument in the Sunday Times of India (Mar 9, 2014):

“However, to a people exasperated with prolonged uncertainty and decline, Putin is the antidote to the unending sadness and deprivation that defined 20th century Russia. He has created the conditions for the average Russian to feel good, get rich and, for a change, indulge. This exuberance is unlikely to last indefinitely but, for the moment, the Russian context favours a Putin-like robustness......To the west, Putin’s reclamation of Crimea (and, earlier, a slice of Georgia) and his assertion of Russia’s stakes in Ukraine may seem ominous. For Russia, it is, however, symbolic of the bid to reverse the historic defeat in the Cold War. 

But Putin’s bid to reclaim Russia’s status as a Great Power was only possible because the economic and political foundations for an enhanced role have been firmed up over the past decade. In India, on the other hand, the fierce desire of the past 25 years to transcend mediocrity, shoddiness and look the world powers in the eye has floundered. It is not that the UPA government has no achievements to its credit. India has progressed but it has seriously under-performed in terms of its potential... 

Whether faith in Modi encapsulates the anger at a dismal present and a brighter future will be tested in a free election. If Modi prevails on May 16, we shouldn’t be surprised if his detractors paint him to the world as India’s Putin. If he lives up to the liberal demonology, those with a stake in India’s future should be elated. Just as Russia is with Putin.”

I remember this column distinctly for two reasons. It was already so wrong back then in thinking that Russia was becoming a Great Power under Putin. But, importantly, it gave me an early indicator of what kind of aspiration the right has from its political dominance in India. Some kind of muddled civilisational nationalism with akhand Bharat fantasies whose best example for them was an expansionist Russia of 2014. Putin was their best answer to western liberalism and the wokeism that accompanied it. It worried me then and it has only gotten worse.

The right intellectual ecosystem has continued in the same vein in the last two months. Here’s R. Jagannathan writing in the Swarajya on how NATO is past its sell-by date:

“The reality is that Europe is the most fractious of continents, and just as France and Germany decided after the two world wars that enemies must be part of the same economic union to avoid future wars, Russia needs to become a part of both the mutual defence pact and the European Union. This way Europe’s security needs will be buttressed with a mutual economic zone where Russia’s energy can power Europe, and Europe’s markets Russia’s economic revival.

America can at best be an observer in this alliance. The world cannot allow its over-grown military-industrial complex to decide who should go to war against who just so that this complex can protect its commercial interests.

India’s own security architecture would be better protected by aligning with this expanded Europe, and especially with France and Germany, with Russia and Japan being other big partners. A Franco-German-Russo-Indo-Japanese QUINT (rather than an America-led QUAD) could lead to a less threatening relationship with China.”

It is quite an intellectual leap to first contemplate some kind of QUINT with those powers coming together. What specific long-term interests bind them? None, except for the author’s fantasy to somehow shoehorn Russia as a legitimate and peaceful power under Putin. At its heart lies the same revivalist admiration and fantasy that Swapan Dasgupta spoke of in 2014. 

There’s, however, a different reason I can think of about the stance taken by these pro-government media channels on Russia and the war in Ukraine. And this credits the government with a lot more intelligence in managing its position on Ukraine. It is about the government playing the two-level game really well here. As we know, all negotiations in international relations are a two-level game as Putnam put it. At any time, a state is negotiating with other states (intergovernmental) while simultaneously managing its domestic constituency and its concerns on the issues. A clever negotiator will look to use his position on one ‘table’ to influence the outcome on the other in a way that gets him a ‘win’ that’s part of his ‘win-set’.

Maybe, just maybe, the government is playing a clever two-level game. It is using its phalanx of friendly editors and journalists to talk up India’s dependence on Russia, its historical special ties with it and how dumping Russia at this moment will be perceived negatively by the people of India. This seems like a good tactic to follow because it allows the ministry of external affairs to sit at the international table and show the constraints India has to give its unqualified support to the west. “See, this is the domestic mood on Russia. What do you want us to do beyond a point” - that’s what India might be telling the west. This seems like a good way to continue sitting on the fence on the issue and hoping for the war to end to have things sort themselves out. 

I would like to believe this is what the government has been doing to keep itself away from western sanctions while it continues to engage with Russia. Is it working? Well, it seemed to have worked for a while. However, the US patience seems to be wearing thin as this warning from Brian Deese, the White House National Economic Council Director, suggests:

"Our message to the Indian government is that the costs and consequences for them of moving into a more explicit strategic alignment with Russia will be significant and long-term. There are certainly areas where we have been disappointed by both China and India's decisions, in the context of the invasion."

Hmm. So, what changed?

One of the going-in assumptions in Putnam’s two-level game theory is about the credibility of the constraints and options each state might have in its hands. If you have to show you have a domestic compulsion because of which you will need some flexibility on the international table, it must appear credible to the other state at the table. India might be emphasising its domestic compulsions in supporting Russia by showing what’s appearing in the media as the mood of the nation. But for the US to consider it credible, it must be convinced that this domestic ‘view’ is emerging independently. Beyond a point that must be difficult to swallow for the US considering how a large section of our media has turned into government mouthpieces in the past few years. 

Of course, a fair and independent media is necessary for the domestic polity. But it is good for international negotiations too.

India Policy Watch #2: RBI’s Tough Act

Insights on burning policy issues in India

- RSJ

The Monetary Policy Committee (MPC) of RBI met earlier this week and based on its assessment decided to change its policy stance 

from 

remaining accommodative “as long as necessary to revive and sustain growth on a durable basis” 

to 

remaining accommodative “while focusing on withdrawal of accommodation to ensure that inflation remains within the target going forward, while supporting growth”.

I hope you were able to spot the change. Essentially, RBI has prepared the ground for an increase in policy rates in the second half of this year. One of my predictions for the year was that we will have a total of three policy rate hikes cumulating to 75 bps. The stage is set for that prediction to come true. 

Broadly, there were three messages from the MPC meeting:

* The input cost pressures will continue to impact the economy buffeted by global supply chain disruptions, commodity price increases and continuing uncertainty because of the war in Ukraine. RBI sharply revised its own estimate of inflation for FY 23 from 4.5 per cent to 5.7 per cent. This 120 bps increase was a belated recognition of the inflation risk in the economy with the likelihood of it breaching the 4 (+/- 2) per cent range. Once it goes beyond 6 per cent, the RBI has to explain it to the parliament. Though I don’t see why it should be such a concern if it is in lock-step with the Finance ministry and the government enjoys a brute majority in the house. But it seems like that 6 percent mark is some kind of Rubicon. That apart it made it clear that inflation control is now its chief priority over growth for the year. And that’s a big shift. My view is CPI inflation will go over 6 per cent during the year unless we see normalisation in Ukraine sooner.

* On growth, the RBI lowered its forecast from 7.8 per cent to 7.2 per cent for FY 23 citing a broad range of risks to it - a surge in commodity prices, hawkish policy stances in developed economies, supply-side disruptions, weakening global demand and geopolitical risks. The huge government capex cycle that was promised in the Budget isn’t going to happen in a hurry. The disinvestment proceeds have also been delayed because of the choppiness of the equity market and the big LIC IPO might happen at a more realistic and muted valuation than earlier projections. These are all weighing down the growth outlook. The good news on tax collection buoyancy, robust rural demand and a steady urban consumption trend have meant the RBI still expects the growth to come in above 7 per cent. That will be tested going forward.

* The liquidity in the banking system continues to be quite high (Rs. 8.5 lakh crores) and RBI was extremely careful about how it will suck this liquidity out in the future. RBI will follow a “gradual and calibrated withdrawal of this liquidity over a multi-year time frame in a non-disruptive manner”. In other words, they will stretch out this excess liquidity scenario as long as they can. RBI has been holding variable rate reverse repo (VRRR) auctions to absorb liquidity on a periodic basis while continuing with variable repo rate (VRR) auctions simultaneously to meet liquidity shortages. This ‘Operation Twist’ will continue. It has also increased the held to maturity (HTM) limit for banks from 22 per cent to 23 per cent and allowed them to have G-secs under this category. The RBI also introduced the standing deposit facility (SDF) as an uncollateralised form of reverse repo or liquidity absorption tool. What this means is that banks can now park overnight liquidity at RBI at the SDF rate of 3.75 per cent without RBI having to put G-secs as collateral into Bank accounts. In effect, the liquidity adjustment facility (LAF) corridor which is the difference of rates at which RBI takes in and infuses liquidity into the banking system, is back at the pre-pandemic level of 50 bps without RBI specifically increasing the reverse repo rates. Among the numerous RBI has already adopted, these are another set of ways to support the government borrowing programme for this fiscal. 

In summary, for the number of economic and global variables it has to juggle while keeping the government happy that it is doing everything to support growth, the RBI has the toughest job in the country.

And I will say it makes a fair fist of it.   

A Framework a Week: The Three Binding Constraints on Technological Progress

Tools for thinking public policy

— Pranay Kotasthane

In an excellent essay for Works in Progress, Brian Potter has an interesting insight on technology governance. He writes:

There’s a pattern that we frequently see in the development of a new technology. Initially, the practical functionality is limited by the technology itself – what’s built and used is close to the limit of what the technology is physically capable of doing. As the technology develops and its capabilities improve, there’s a divergence between what a technology can physically do and what it can economically do, and you begin to see commercialized versions that have lower performance but are more affordable. Then, as people begin to build within this envelope of economic possibility, capability tends to get further constrained by legal restrictions, especially if the new technology has any (real or perceived) negative externalities.

A framework from microeconomics can be used to visualise this insight rather well—production possibility frontiers (PPF).

A PPF curve results from trade-offs. Given finite resources, producing more goods of one kind leaves less resources on the table for another. Thus, given a fixed budget constraint, a PPF curve shows the production options available for a society. All points below a PPF curve are the available options (like points A,B, C & D in the figure), and the ones above it (like X) are unavailable due to resource constraints.

What Potter’s insight adds is that we can probably imagine three distinct production possibility frontiers in technological development—economic, policy, and technological, as shown in the chart below.

In the first stage of technology developlent, the technological PPF is itself a binding constraint as newly intriduced products have several bugs. In Stage 2, however, the technological PPF is no longer the binding constraint. At this point, it’s the economic PPF that sets the limits for what is producible. In the final stage, the limiting constraint is policy rather than economic or technological.

Development of cryptocurrency technology is a relevant example. In the first stage, the total currency that could be churned out was limited by the technology itself. Soon enough, those constraints were overcome and a number of different currencies proliferated. The binding constraint then became economic, as mining new currencies became tougher. With more energy-efficient mechanisms such as proof-of-stake on the horizon, the binding constraint is no longer economic. Instead, it’s the policy and legal constraints that limit production.

The closer the policy and economic PPFs move towards the technological PPF, the faster the technological development. At the same time, the policy PFF can be used to avoid production at the technological limits. Broadly, two approaches are available. Start with a tight policy PPF and then expand it slowly. Or start with a really loose PPF and reduce it depending on the observed negative effects. In low policy capacity situations, the latter approach offers more opportunities for growth. Easier said than done.

PolicyWTF: Bihar Prohibition Saga

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

Prohibition is a gift that keeps giving. Six years ago, the Bihar government criminalised the manufacturing, bottling, distribution, transportation, collection, storage, possession, purchase, sale, or consumption of alcohol. You very well know how that would’ve turned out. First, deaths due to consumption of spurious alochol became a regular occurence. Second, prohibition cases and ‘convicts’ overwhelmed the state’s already anaemic law and order machinery.

Eventually, the Supreme Court issued an order in February this year, stating that:

We find a number of cases coming to this Court arising from proceedings initiated under the Bihar Prohibition and Excise Amendment Act, 2018. The trial Court and the High Court are both being crowded by bail applications to an extent that at some stage 16 judges of the High Court are listening to bail matters and prosecutions under the Act concerned forms a large part of it. Denial of bail would also result in crowding of the prisons.

In response, the Bihar government now proposes to amend the Prohibition Act of 2016. Instead of getting rid of prohibition, the amendment focuses narrowly on the Supreme Court’s objections. For instance, being caught the first time for drinking now attracts a penalty of Rs 2000-5000 instead of imprisonment. And to reduce the burden of cases, the bill proposes that consumption offences will be heard by executive magistrates who will be appointed by the state government especially for such offences. It seems that the Bihar government is also recruiting ‘prohibition constables’ for better enforcement.

Anticipating the unintended consequences is easy. With different punishments for the first and subsequent offences, these rules will boost the Police’s rent-seeking powers. The Police will treat everyone as repeat offenders by default. On payment of an amount sufficiently greater than Rs 5000, the offence will be magically converted into a first offence, settled with a fine. Instead of focusing on Bihar’s terrible law and order situation, the Police and Executive Magistrates will take special interest in catching people for drinking alcohol.

The Supreme Court’s immediate problem might well reduce but the lives of Biharis will become worse. Bihar government would do well to heed to Ambedkar’s vehement rejection of prohibition:

“From the point of equity, there is no justification for prohibition. The cost of prohibition is borne by the general public. Why should the general public be made to pay the cost of reforming a lakh or two of habitual drunkards who could never be reformed ? Why should the general public be made to pay the cost of prohibition when the other wants of the public such as eduction, housing and health are crying for remedy? Why not use the money for development plans? Who has greater priority, the Drunkard or the Hungry? There are pertinent questions to which there is no answer except arrogance and obstinacy. Whatever happens, the policy of prohibition must be reversed and this colossal waste of public money should be put a stop to and the resources utilised for advancing general welfare.”

Advertisement: If you enjoy the themes we discuss in this newsletter, consider taking up the Graduate Certificate in Public Policy course. Intake for the next cohort is open. 12-weeks, fully online, designed with working professionals in mind, and most importantly, guaranteed fun and learning.

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Reading and listening recommendations on public policy matters

* [Magazine] Works in Progress is emerging as an exceptional storehouse of exceptional ideas. There are few other online spaces where the signal to noise ratio is as high.

* [Blog post] Yiqin Fu’s post on the unintended consequences of a mobile-first walled-garden internet on knowledge creation is an eye-opener.

* [Forecasting Tournament] We have written earlier about the educational value of making precise predictions. Check out the Metaculus forecasting tournament on the Ukraine conflict, and force yourself out of what Philip Tetlock calls “outcome-irrelevant learning”.

This section looks at policies that are surprisingly sane.

- RSJ

We signed a trade deal with Australia yesterday. For over a decade now, we have been trying to get this going. The deal falls just short of a free trade agreement (FTA) but that’s a minor quibble that should get sorted in future. Australia’s desire to reduce its dependence on China as the primary trading partner and India’s willingness to have a stronger link with the Quad on economic matters seem to have brought the deal to fruition. There is a small matter of upcoming national elections in Australia too where the economy will play a key role in setting the agenda. The deal is significant in what it signals about the Indian government’s view on global trade. For the past few years, we have gone on and on about atmanirbhar Bharat whose primary manifestation was an increase in import duties across a range of goods taking us back to the pre-liberalisation era. We have lamented about this wrong turn. As Pranay argues we must focus on atmashakti instead of atmanirbharta. So, reading the key terms of the deal warms my heart. As Reuters reports:

“The deal with India removes tariffs on more than 85% of Australian goods exports to India, worth A$12.6 billion, rising to almost 91% over 10 years. Tariffs will be scrapped on sheep meat, wool, copper, coal, alumina, fresh Australian rock lobster, and some critical minerals and non-ferrous metals to India.

It will see 96% of Indian goods imports enter Australia duty-free.”

That’s good. What’s better was the Comprehensive Economic Partnership Agreement (CEPA) that India signed last month with the UAE. There were the usual agreements on tariffs and duties which is in line with the agreement with Australia. From Mint:

“The CEPA between India and the UAE covers almost all the tariff lines dealt in by India (11,908 tariff lines) and the UAE (7581 tariff lines) respectively. India will benefit from preferential market access provided by the UAE on over 97% of its tariff lines which account for 99% of Indian exports to the UAE in value terms, especially for all labour-intensive sectors such as Gems and Jewellery, Textiles, leather, footwear, sports goods, plastics, furniture, agricultural and wood products, engineering products, medical devices, and Automobiles. India will also be offering preferential access to the UAE on over 90% of its tariff lines, including lines of export interest to the UAE.

As regards trade in services, India has offered market access to the UAE in around 100 sub-sectors, while Indian service providers will have access to around 111 sub-sectors from the 11 broad service sectors.”

But the eye-popping section in this agreement was on government procurement where the UAE based companies will be treated on par with domestic companies. This is a first and quite remarkable when you consider India hasn’t even signed the Government Procurement Agreement (GPA) as a member of WTO. UAE companies will now have the ability to bid for government contracts of value greater than Rs. 200 Crs while being seen as an equivalent to a domestic company. The unwillingness to agree on government procurement has stalled other FTAs between India and the EU, UK, and Japan. So, the UAE agreement appears like a watershed moment.

There has been the usual noise in some quarters about how this will impact the domestic producers, but that swadeshi lobby has been having it good for the last few years. So, maybe they will have to lump it this time. Having sat out of the RCEP much to my disappointment and raising the protectionist rhetoric in the past few years, these two agreements signal a shift in the government’s thinking. This is for the good. Indian manufacturers must see the world as their market. They must learn to compete with the best in domestic markets, improve the quality of their products and use the existing factor cost advantage to win in global markets. Also, opening up government procurement to suppliers from other countries will help improve the quality of government projects. The shoddiness we have come to associate with such projects owes its origins to colonial-era L1 (lowest cost) guidelines that are being dismantled, and to the jugaad mindset that’s prevalent among the suppliers to the government. Things can only get better if there is a global competition for such projects with best-in-class project management and governance practices. And like we have often argued here, voluntary trade doesn’t happen between countries. People transact with one another. And all voluntary trade is a win-win as has been demonstrated over and over again. The Indian consumer will eventually benefit.

There is also a geostrategic element to these trade deals. Closer integration with Australia on the eastern Quad and stronger relations with Israel and UAE on the so-called ‘western’ QUAD are good measures to build a counter to China on trade. They also provide these countries with access to India and the Indian subcontinent markets. Lastly, stronger trade integration is the best counterweight to bigotry in domestic politics. There is no credible domestic political force that’s left that can stem the tide on this. We need global markets and trade deals for growth. And closer economic cooperation with other nations will mean a responsibility to behave well on the domestic front. It may sound optimistic at this stage. But in the long run, global trade and the broader trend of decentralisation are the key countervailing forces to a fast-narrowing domestic polity.

But…

—Pranay Kotasthane

The trade agreements with the UAE and Australia deserve praise. However, my worry stems from inadequate state capacity.

A multilateral trade agreement is useful also because it can override points of bilateral contention. Moreover, multilateral agreements also make it easier for a government to convince its domestic stakeholders (recall Putnam’s paper Diplomacy and Domestic Politics).

India seems to have opted for a bilateral approach instead where it will fine-tune the deal specifics with countries. Such an approach will be protracted. It will face opposition from domestic lobbies, who will want to keep their products out of deals with states having competing suppliers. Finally, this approach would require immense and sustained political, intellectual, and administrative capacity. Without building this capacity, the Commerce and External Affairs ministries are likely to satisfice rather than maximise. So, I remain sceptical of the outcomes.

India Policy Watch: The Paradoxes of India’s Westernophobia

Insights on burning policy issues in India

- Pranay Kotasthane

Once again, the Russia-Ukraine war has brought India's geopolitical stance into focus. The last two weeks witnessed visits by delegations from the US, UK, European Union, Japan, Russia, and China. High profile visits by the Russian and Chinese foreign ministers, in particular, have led to heated debates about India's position. Some commentators in the West see these visits as further proof of India's Westernophobia. In contrast, some Indian commentators interpret that the Russia-India-China (RIC) grouping is not dead after all.

I think Westernophobia is self-defeating and RIC is good riddance. What K Subrahmanyam said with characteristic incisiveness in a Pragati interview fourteen years ago still remains a sound principle for guiding India’s foreign policy:

“India has to leverage this situation and change the US-EU-China triangle into a rectangle. Until then it is in our interest to help America to sustain its pre-eminence. After all, in a three-person game, If America is at Number One, China is at Number Two and we are lower down, it is in our best interest to ensure that it is America that remains Number One.”

With intense US-China contestation in play, the convergence of interests and values between the West and India is at an all-time high. A deeper collaboration with the West is critical for improving India’s economic, technological, and security futures. China and the East Asian countries benefited massively from a deeper relationship with the West over the last forty years. India now has the opportunity to play the same game.

Nevertheless, it does seem that a streak of Westernophobia, particularly its subset anti-Americanism, still exists in India. Why so? Let’s explore.

In my view, we should begin the analysis of India-US relationship using a tri-axis framework: state-to-state relations, state-to-people relations, and people-to-people relations.

As far as state-to-state relations are concerned, I’m less worried. India’s foreign policy establishment of India adroitly shifted its weight behind the Quad 2.0 as the China threat increased. With Pakistan having moved itself out of the equation, the job of the US and Indian officials has become far easier than it was in the past. The sensible statements made by the US spokespersons in response to India’s stance on Russia in the UN are indicative of the mutual understanding and trust between the two sides.

On the people-to-people relationship, there was never any doubt in the first place. On this front, ties between the West and India are absolutely no match for the ties between India and Russia or India and China. Indian elites’ reference network for everything from music to education is American. There is a robust movement of ideas, people, goods and services that has outpaced the state-to-state relationship for nearly three decades. This twitter thread by Brookings Senior Fellow Tanvi Madan gives a good idea of the deep connections.

It’s the state-to-people axis which is problematic. Many Indians still seem to harbour a deep frustration with the American state. Charges of unreliability (hint: the 1971 War) or hypocrisy (hint: Afghanistan) always make an appearance in casual discussions on India-US relations. The lesson people derive from such arguments is that if India were to throw its weight behind the US, it would get sucked into fighting America’s wars all over the world, only to be ditched by the US in one fell swoop soon after.

Here on, let’s focus on this third axis—the state-people relationship. Without going into the psychoanalytical reasons for why we think this way, there are three paradoxes implicit in this anti-American strand that I want to emphasise.

Paradox 1: Vishwaguru and Victim

The flurry of official diplomatic visits over the last two weeks has filled some Indians with pride. Notwithstanding India’s poor and declining economic potential over the last decade, many seriously believe that India’s concurrence is indispensable for any future global order. And that all sides desperately need the vishwaguru on their side.

The paradox is that the same people also hold the view that India is a victim of circumstances at the global stage. Hence, it should neither call out Russia’s invasion and revisionism for fear of losing cover in the UN or military supplies, nor should it ally with the US lest it becomes a mere pawn in the global machinations of an unreliable superpower.

Clearly, only one of these conceptions can be true. Either way, the conclusion remains the same: India need not stick to its old stance of non-alignment. If India truly is a swing power, it has enough leverage to go against its partners without necessarily facing the worst consequences. It can partner with the US without necessarily committing itself to all the global wars that America indulges itself in. It can also call out the Russian invasion for what it is, without the fear of a proportional retaliation from Russia.

On the other hand, if the dominant conception is that India is a victim of global machinations, gaining economic and military power in the shortest possible time remains the only way out. This approach again needs collaboration with richer and more powerful countries with which we have no major divergence on interests and values i.e. the West.

Paradox 2: Three is Better than Two

Many Indians seriously believe that a closer India-Russia partnership can wean Russia away from China. Hence, they argue that the answer to India’s current problems lies not in collaborating with the West, but by reinvigorating the Russia-India-China grouping. This argument is often couched under multipolarity mumbo-jumbo that I fail to grasp.

It is a paradox for two reasons. First, India’s ability to influence the Russia-China collaboration is exaggerated. India’s GDP per capita is a fifth of both Russia and China. The Russia-India partnership is a single-tracked one, relying on one way movement of defence goods. Contrast that with Russia’s China dependence, which is set to rise further due to the economic sanctions. There’s no scenario in which India would be able to drive a wedge between Russia and China on its own accord. Second, the notion that Russia and China would create a world order that is in India’s interests is truly fantastical. With RIC, the successor to the West’s unipolarity will not be multipolarity, but a Sinocentric world order.

Paradox 3: Silent Majority vs the Vocal Minority

The Westernophobia seen on India Twitter might not be a true representation of the state-to-people axis. I say this based on the first edition of the Global Outlook Survey conducted by my colleagues at Takshashila.

To a question ‘Which of these bilateral relationships is the most important for India to achieve its strategic objectives?’, 64 per cent of the non-expert survey takers answered India-US. Russia came a distant second at 10 per cent. Notably, the survey sample is skewed towards the young (63 per cent of recipients) and towards South and West India (57 per cent of recipients).

To another question ‘What sort of international order best serves India’s interests?’, 84 per cent of the non-expert respondents opted for ‘a multipolar order with an expanded UNSC’.

These two data points highlight an interesting dynamic. While many Indians consider the India-US partnership as supremely important, they also believe that the current world order is inimical to India’s interests. Therein lies an opportunity for the US. Backing India’s inclusion in UNSC, reducing barriers for technology transfer to India, and deeper technology alliance might make the vocal minority irrelevant.

In any case, resolving these three paradoxes on the state-to-people axis is a key policy challenge for India.

I want to end this essay with a question for all of you: what event, decision, or circumstance would make you reverse your current thinking on the India-Russia relationship?

India Policy Watch: Nehru-Jinnah Debates

Insights on burning policy issues in India

- RSJ

I was reading Nehru: The Debates That Defined India by Adeel Hussain and Tripurdaman Singh this week. The book has Nehru debating four of his contemporaries with whom he had differences about the fundamental question of the idea of India.

Two things struck me. One, the civility of exchanges that were otherwise marked by huge differences in views. Two, how the fundamental questions of that era (1930-50) remain relevant today. In many ways, they have come back to bite us. I will touch upon some of the debates in other editions.

The book is a must-read.

Today, I will reproduce extracts from the book on the Nehru-Jinnah debate about the question of Muslim representation in a democratic India. I have touched upon this in a previous edition. Quoting from the book:

“In Nehru’s view, the Hindu-Muslim problem or communalism was at its core a problem of ‘upper middle-class people’ who only made up a small fraction of the Indian population. If the ‘mass elements take part in the election of the constituent assembly’, communal issues would ‘recede into the background’. Broadly secular in his political outlook, Nehru never warmed to the idea that religion deserved a place in progressive politics. ‘The so-called Hindu-Muslim problem,’ Nehru disclosed his position in usual frankness, ‘is not a genuine problem concerning the masses, but it is the creation of self-seekers, job-hunters, and timid people, who believe in British rule in India till eternity.’

For Nehru, therefore, it was telling that Muslim politicians preferred to discuss the communal question from a numerical perspective and connect it to reserved seats in the legislature or the colonial administration. Nehru openly raged against the Communal Award of 1932, the chief institution that the British had established to ensure the retention of separate electorates for Indian Muslims. At its core, Nehru saw reservations opposed to the egalitarian principles of nationalism.

‘It is absurd to consider this question [of communalism] from the point of view of numbers,’ Nehru declared in the presence of Jinnah. ‘If there was a question of numbers we thirty five crores [350 million] of people would not have become a slave country being dominated by a small number of people in Britain.’

Against the Nehru Report (on Montagu-Chelmsford Reforms), Jinnah proposed his Fourteen Points, which sought, among other things, a federal constitutional make-up of India with residual power vested in the provinces, a fixed Muslim representation in the Central legislature and the upholding of separate electorates. However, Jinnah signalled that he was willing to consider joint electorates if the Congress met his other demands. Clothed into concrete modifications to the Nehru Report during an ‘All Parties Conference’ in Calcutta, Jinnah pressed the committee members who were deciding on the merits of the Nehru Report that at least ‘one-third of the elected representatives of both the Houses of the Central Legislature should be Musalamans’.

In a moving speech on the fifth day of the convention, Jinnah clarified that his desire was not to overwhelm the Congress with demands that would make it look soft on Muslims in front of the Hindu Mahasabha. Instead, Jinnah’s demands were guided solely by dry constitutional observations from other countries. According to Jinnah, by the 1920s, it had become conventional wisdom that ‘majorities are apt to be oppressive and tyrannical and minorities always dread and fear that their interests and rights, unless clearly and definitely safeguarded by statutory provisions, would suffer […].’

Jinnah reasoned that because the Nehru Report predicted that a third of the legislature would consist of Muslim delegates anyway, there would be no harm in implementing this figure as a formal constitutional safeguard. Such a written anchor would also allow Indian Muslims to distribute those seats more evenly and distribute the excess seats that they would receive in the Muslim-majority provinces of Bengal and Punjab to regions where Muslims were numerically weaker.

The delegates roundly rejected Jinnah’s proposal. Dissent to his suggestions even emerged from within the ranks of the Muslim League. Other parties rejoiced over the open split in the Muslim League. M.R. Jayakar of the Hindu Mahasabha, for instance, poked right into this wound. In his response to Jinnah’s speech, Jayakar cautioned the audience to ‘bear in mind that the demands, as set forth by Mr Jinnah, do not proceed on behalf of the entire Muslim Community, not even a large bulk of it’. With some justification, Jayakar reiterated that the position Jinnah voiced reflected the desires of ‘a small minority of Muhammadans’.

This speech left a mark on Jinnah. Responding to Jayakar, he moved away from his otherwise carefully measured statements that tended to evoke constitutional principles as an acid test for minority protections. Now Jinnah asserted that lasting harmony between communities could not be established in ‘a Court of Law’ or through a constitution ‘however perfect from a theoretical point of view it may seem’. Instead, it could only turn into a reality through ‘the highest order of statesmanship and political wisdom’ and the recognition that ‘there is no progress for India until the Musalmans and Hindus are united’. The alternative Jinnah presciently predicted was ‘a revolution and civil war’.

When Jinnah re-emerged on the political scene in 1934, after an extended hiatus to heal from the humiliation in the aftermath of the Nehru Report, he began to filter politics more squarely through the lens of war and peace….

Moving from contractual obligations to honour was reflective of Jinnah’s changed perspective. Earlier, he had viewed Indian Muslims primarily as a minority community, constantly vying to petition for rights from the British crown or the Congress party. Now he saw Indian Muslims as a distinct and separate nation capable of ensuring their rights through force. This view clashed severely with the secularist outlook of Jawaharlal Nehru, who could only interpret Jinnah’s religious posturing as a profound symptom of political alienation: a desperate attempt to plaster over existential anxieties that ranged from colonial oppression to unemployment and food scarcity. With constitutional reforms bringing more and more Indians into the realm of electoral politics, Jinnah and Nehru’s contradictory ideas of India clashed soon after their joint appearance in Lucknow.

In the 1937 provincial elections, the Indian National Congress secured a resounding victory. At the polls of India’s first large-scale election campaign that departed from the established system of dyarchy and increased the vote to thirty-six million Indians, including some women, the Indian National Congress secured more than 750 of some 1,500 seats. This sweeping success did more than underline the Congress’s claim of being a national party. It altogether transformed the Congress from a mass movement to a political party. Congress members now occupied ministries in five provinces outright and constituted coalition governments in another two.

Jinnah suffered a crushing defeat. His All-India Muslim League secured less than 5 per cent of the Muslim vote, although this slim vote share amounted to some 108 seats from 485 reserved for Muslims under the Communal Award….

In full awareness that the Congress did not require the League to rule, Nehru conducted this communication from a position of strength. Jinnah refused to acknowledge that the election result was an adequate measure of the political value of the Muslim League. To him, the communal question remained the most critical issue to determine India’s future. Jinnah’s cold responses were his way to shake Nehru out of this false sense of security that the Hindu-Muslim issue had receded into the background and given way to lofty ideas around socialism and constitutional democracy. Perhaps for this reason, Jinnah refused to lay the Muslim case to Nehru anew.”

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Reading and listening recommendations on public policy matters

* [Article] Check out our take on Hypocrisy in International Relations in edition #52.

* [Article] This post by Yiqin Fu has some cool insights on the consequences of a mobile-first internet with Chinese characteristics.

* [Podcast] On Puliyabaazi, we discussed organic farming troubles in Sri Lanka.

Insights on burning policy issues in India

— Pranay Kotasthane

Shruti Rajagopalan and Lant Pritchett's of India conversation is full of insights for all public policy students. From that conversation, there was one particular claim that I want to discuss this week: economic growth is not just necessary, but also a sufficient condition for reasonably high levels of human wellbeing.

Over the last few years, many people have grown sceptical about the very idea of economic growth. There is a whole cottage industry of experts and non-experts ready to diss economic growth in pursuit of other ‘worthier’ goals such as sustainability or inequality. This thinking is morally problematic given that economic growth is the only mechanism to reduce large-scale poverty in India.

Anecdotally, it is tougher to convince Indians born after 1991 in economically well-off families—and connected to the global conversation on development—about the centrality of economic growth.

Sometimes, the pushback against growth is not along the lines of "but, this is not the right way to achieve economic growth". Such pushback would've been desirable. Instead, some people firmly believe that India doesn't need economic growth anymore; it's had that enough. They argue that governments should now focus on redistribution to reduce inequality and directly tackle social progress indicators, moving beyond income progress indicators.

Even though we keep highlighting how every percentage of growth brings roughly two million Indians out of poverty, this policy narrative seems to have become stale. Instead, the counter-argument often is: if Bhutan is focusing on ‘providing’ happiness, why shouldn't we?

The confusion about the importance of economic growth is not just a non-academic one. Economists themselves have pushed this line that programmatic changes to specific schemes can bring significant changes to human wellbeing. Even those who advocate growth feel it necessary to qualify it as "inclusive" or "sustainable".

It is in this context that the paper National development delivers: And how! And how? by Lant Pritchett is an absolute must-read. Here's the abstract:

National development is empirically necessary and sufficient for high levels of human wellbeing. Measures of three elements of national development: productive economy, capable administration, and responsive state, explain (essentially) all of the cross-national variation in the Social Progress Index (SPI), an omnibus indicator built from 58 non-economic indicators of human wellbeing. How national development delivers on human wellbeing varies, in three ways. One, economic growth is much more important for achieving wellbeing at low versus high levels of income. Two, economic growth matters more for “basic needs” than for other dimensions of wellbeing (like social inclusiveness or environmental quality). Three, state capability matters more for wellbeing outcomes dependent on public production. These findings highlight the key role of national development—and particularly economic growth—as instrumental to increased human wellbeing, which is increasingly challenged in favor of “small” programmatic and project design which is, at best, of third order of importance.

Let's discuss these important meta-claims, which have a bearing on any field of public policy.

Claim #1: Redistribution isn't the answer; economic growth is.

Most of the world's inequality is between countries, not within countries. So inequality reduction is overwhelmingly a national task. And you cannot do redistribution if your income levels are low as the size of the economic pie is too small to create a difference meaningfully. Rich country governments spend up to 40% of GDP precisely because it is possible to collect higher revenues from a more affluent population, even at low tax rates.

Claim #2: Wellbeing is the outcome; national development is the output

The three indicators of National development —GDP per capita, state capability, and democracy- explain all the Social Progress Index (SPI) variations, a non-economic index comprising 58 indicators. There are no countries with high levels of national development and low levels of social progress. Similarly, no countries have managed high levels of social progress at low levels of national development. In other words, wellbeing is the outcome, and national development is the output.

Here’s the striking chart in the paper which explains this relationship.

Claim #3: Economic growth is much more important at low levels of income

There can be no one global pathway to social progress. Priorities of richer countries will be different from the priorities of the developing countries. The 58 indicators of SPI can be clubbed into three main categories —Basic Human Needs (e.g. water and sanitation, safety, nourishment), Foundations of Wellbeing (environmental quality), and Opportunity (personal freedom and choice). The paper empirically shows that economic growth matters immensely for fulfilling basic human needs. As long as we agree that basic human needs such as water and sanitation, safety, and nutrition are essential to social progress, economic growth is indispensable.

I think this paper deserves more attention, especially in the Indian context. We tried to discuss this idea on Puliyabaazi as well.

Global Policy Watch: Information Age Politics vs Full Spectrum Warfare

Indian perspectives on global events

— Pranay Kotasthane

The economic and technology sanctions have understandably generated much global debate ever since the Russia-Ukraine war began. These sanctions are intended to expressly hurt Russia’s financial and trade systems, and cut its access to cutting-edge technology. We have earlier discussed how to think about the direct sanctions imposed by the US and EU from an Indian perspective.

While these measures were expressly aimed at Russian political and economic elites, the effects have spilled over into the ordinary lives of ordinary Russians. That’s because several tech companies have also entered the fray. Google Pay and Apple Pay suspended billing, Amazon suspended shipping of all retail products, and Microsoft suspended all sales. As of March 26th, more than 450 companies had joined the bandwagon. Some have shut down their Russia operations completely, some have suspended operations temporarily, some others are scaling back operations, while others have put new investments on hold.

These seemingly synchronised actions by Western governments and companies have set the alarm bells ringing in India. For those who believe that the ultimate goal of economic policy is to reduce import dependence, these measures act as tailwinds. From their perspective, these instances prove that Western companies and governments are all joined at the hip. The separation between the state and markets is a lie. To them, all these withdrawals are coordinated to achieve a strategic objective—they are a part of a planned package to achieve control over Russia in all dimensions of the battlespace. In other words, they are a display of the West’s full spectrum dominance.

Framed in these prominently military terms, the logic of self-sufficiency becomes a logical response. All foreign companies start appearing like attack ‘weapons’ in the hands of an adversary, while national champions—however inefficient—in all sectors of the economy become a matter of self-defence. Imports become evil, exports go down in priority, and joint development between private actors start getting scrutinised by government officials.

As you can gather from my tone, this full-spectrum warfare is an inaccurate and counter-productive way to frame the ongoing events. Instead of being weapons in the hands of the West, I argue that these actions can be framed better as now ubiquitous instruments of Information Age politics.

Seen from this perspective, the spate of withdrawals by Western companies is not a part of a well-laid-out, coordinated plan by Western governments. Rather, it is a result of uncoordinated actions by companies which have willy-nilly become political actors in the Information Age. In that sense, these actions are not very different from some Indians breaking China-made TVs during the Ladakh standoff, or a NBA team manager showing support for pro-democracy protests in Hong Kong.

Even in the current case, there are several explanations apart from the ‘weaponised interdependence argument’ for why companies have withdrawn from Russia. One, it’ll just become too difficult to do business in Russia given the sharply falling rouble, and major financial uncertanties. Two, some companies have been booted out by Russian government on the grounds of ‘false propaganda’. Finally, there’s also a significant pressure from employees and customers, who are witnessing this war daily on their twitter feeds, and want to play their part in whatever way possible. This explains why even some open source software libraries have been modified to either cutoff Russian customers or delete files on Russian computers.

Seeing these actions not as full spectrum warfare but as a specific instance of a generalised phenomenon of Information Age politics is vital for India’s interests. The latter framing acknowledges that multi-national companies are geopolitical actors, but also leaves room for negotiations and bargaining, like all politics does. This lens permits taking the long view that technology collaboration with the West is necerssary for Indian companies to build their own complementary strengths. In an interdependent tech world that is here to stay much beyond the current war, this approach has a higher chance of success rather than national champions motivated by the outdated logic of reducing import dependence.

Advertisement: If you enjoy the themes we discuss in this newsletter, consider taking up the Graduate Certificate in Public Policy course. Intake for the next cohort is open. 12-weeks, fully online, designed with working professionals in mind, and most importantly, guaranteed fun and learning. Do not miss.

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Reading and listening recommendations on public policy matters

* [Article] This excellent Bloomberg article cautions that the second great age of globalisation might be coming to a close, unless the leaders act differently.

* [Article] In context of the International Women's Day, I went back to a question that has perplexed me for a long time: what explains the electoral insignificance of political parties by women and dedicated primarily to the issues that affect women? The linked article by Louise Perry is a good place to start the search for some answers.

* [Article] Another article on the tough road ahead for globalisation.

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

- RSJ

Many years ago, I went out for dinner with a client in Paris. It was a nice restaurant. Soon, the wines started flowing, escargots were polished off and I was educated on the mother sauces of French cuisine. The lark was on the wing, the snail was on the thorn plate, the client was footing the bill, God was in his heaven, and all was right with the world etc. You get the picture. Then late (very late) into the evening, desserts were served.

And I was served pain perdu. It looked like French toast. It tasted like French toast. But here it sat staring at me as a dessert. For a moment I thought we had dined for so long that we had crossed over to breakfast. But no. This was still dinner time. And here was pain perdu. It was then I added French toast to my list of food items that are difficult to categorise. The Bombay falooda tops the list. For good reasons. After all, what is a falooda? Sevai ki kheer? Icecream? Basil seeds or sago pudding? Jelly with milk and syrup? There’s no answer. There cannot be any.

Except, maybe it is 42.

However, things have changed in the past few years. I have gotten the answer to such existential food queries of mine from an unlikely source.

GST.

The GST appellate authority for advance ruling (AAR) of various states has been a steady source of insights on this topic. I have learnt the difference between barfi and chocolate barfi – one is a sweet, the other a chocolate; what’s the essence of falooda – it is icecream, everything else is incidental; is paratha different from parotta – yes, big time; is 100% wheat paratha different from roti and khakra – of course, it is; are basundi and badam milk sweets or are they beverages – they are beverages; is a biscuit with chocolate coating a biscuit; is a chocolate with wafer coating a chocolate – well, the jury is still out on this one.

I could go on. AAAR has always come to the rescue. See here and here (section 2).

Adding to this long list of nuggets of wisdom was the Haryana AAAR last week. Here’s the ET reporting on pizza and pizza toppings:

“A pizza topping is not a pizza and hence should be classified differently and levied a higher 18% goods and services tax (GST), the Haryana appellate authority for advance ruling (AAAR) has ruled. This could complicate taxation for several pizza brands, especially when the pizzas are sold within a hotel or restaurant, said tax experts.

GST rates on pizzas differ on the basis of how they are prepared and sold. A pizza sold and eaten within a restaurant attracts 5% GST, the pizza base bought separately attracts 12% while a pizza delivered at home attracts 18% GST.

The AAAR ruled on March 10 that pizza topping should face 18% GST as its preparation method is different from that of a pizza. It considered all the ingredients used in a topping and concluded that while a pizza topping is sold as a "cheese topping" it's not really cheese and hence should attract higher taxes.

The authority ruled that pizza topping contains "vegetable fat" as a substantial portion, being 22% of the ingredients, and hence, it does not qualify to be categorised as 'processed cheese' or a type of cheese. Pizza topping would merit classification as 'food preparation', it said.

Tax experts said GST rates could depend on three tests - common parlance test, end use test or ingredients test - and that often tax rates could differ how a product is categorised. Cheese, for example, is taxed at a lower rate if it is called "fat" or processed food preparation.”

This is the kind of clarity I always wanted in life.

The unintended benefits of GST through the AAAR clarifications on food items have been tremendous. Those who ask ‘show me an example of a good public policy’, should take note of this.

PS: Check out how the inverted duty structure of GST creates professional refund cheaters in edition #50.

India Policy Watch: The Kashmir Files

Insights on burning policy issues in India

- RSJ

There’s a new film in town. The Kashmir Files (TKF). It is so good that even the super busy PM has recommended it. Ministers have tweeted about it in glowing terms. State governments have given their staff a holiday to watch it. I have seen news anchors comparing it favourably with Schindler’s List. I guess a new wave of cinema is upon us. What a time to be alive. Let me admit I haven’t watched it yet, the philistine that I am. So, I cannot say much about the merits of the film. Not that it has made much of a difference to the prospects of the film. The film is a huge commercial success without my patronage. And that merits a discussion.

From what I have read about the film, it is a semi-fictional account of the exodus of the Kashmiri Pandits (KPs) from the valley in the early 90s. It traces the events leading to the exodus, the hardship faced by the community during those days and the tragedy of being uprooted from your homeland with the prospect of never going back. Like most displaced communities around the world, the KPs have shown remarkable resilience in building back their lives since. They have gone about doing it in a manner that reflects the ethos of a gentle and graceful community. The many KPs I have met (we all have had them in our colleges) always spoke of those days with a sense of loss and anguish. But never rancour. It is what always struck me about them.

The director, it appears, has taken this rich screenplay material and mounted a film that has drawn unqualified praise from the partisans of the BJP. The reaction from the opposite camp has been on expected lines too. That it is a propaganda film weaponising the tragedy of a community to sustain the ongoing campaign to vilify Muslims in India. Like many debates in contemporary India, I suspect this debate will be settled with the film earning billions at the box office in the shortest time. Or another vanity metric of this kind. The majority will have then spoken. Everybody will have to calm down.

The Right Reason To Make The Film

I have written in earlier editions about the value of encouraging contesting narratives about our history in the public domain. One of the mistakes in the early years of our independence was that we didn’t let this happen as much. An ‘establishment’ was created that dominated academics, culture and arts which swore by liberty and free speech but muzzled other voices than their own. The state often supported this overtly. There might have been compulsions of the moment then for the state to have propped up a narrative. But this continued far too long and over time turned into a cabal. This meant alternative narratives festered on the fringes with limited academic rigour or challenge. And when their moment came, as it always does, these loose and phantasmagoric versions have taken over social media. You can challenge a book that’s published based on some research. But how do you counter millions of fake WhatsApp messages that are sent out every day to create new history? The eventual outcome of suppressing alternative voices is always worse.

John Stuart Mill, while laying down his three arguments in favour of free speech in Chapter 2 of On Liberty, had warned about this. We now see the impact of this around us. This is the reason I believe we should welcome other voices. Our revulsion to them means nothing in the long run. For instance, I read the couple of well documented biographies of Savarkar that have come out of late. I’m no fan of the man. But there are many who are and it is worth having a full account of his life to understand the present moment. The books about him have been challenged both on their content and their message. There are debates about plagiarism of passages, poor research, and reproducing right-wing bile directly from his autobiography into the books. But they are out there for others to read and to criticise. You get a somewhat complete picture of a complex man like Savarkar; warts and all. The criticism of the books makes you more aware of the issues involved and hopefully, you will have fewer WhatsApp messages in family groups about the unproven myth of Savarkar. This should be seen as a net positive social outcome. Better than no books on him.

So, my starting position on a film like The Kashmir Files emerges from there. For long there’s the argument made that if you don’t like the left-wing slant in arts and cinema, why don’t you write your own books and make your own films? So, why should anyone complain if these books and films are being made? They may have dubious artistic merits and they may even be unvarnished propaganda but let that be debated in public. It is not that left-wing art didn’t have these faults. History has shown this works out better than suppressing them.

And The Wrong Reasons

With that point on principle out of the way, let’s move on. What interests me more is the question of the role of art in society and what does the phenomenon of TKF reveal about India today.

There’s the question of truth here. A lot of discussion about the film has been about its thinly fictionalised storyline that plays fast and loose with facts. Importantly, the partisans of the film have promoted it as a work that tells the ‘truth’ about what happened to the KPs of the valley. There are two problems here.

One, all art is a pursuit of a truth of some kind. But it is just that. A pursuit. TKF is a film, regardless of its merit, that pursues a version of truth its makers believe in. That cannot ever be absolute. Art must make what’s invisible, visible. In that limited way only, it serves the truth. So, this relentless campaign to posit this as the only truth about what happened in the valley is dangerous. The exodus of the KPs didn’t spontaneously emerge out of a vacuum. There was half-a-century history to it that’s riddled with wars, false promises and a sense of alienation. And there’s a timeline to Kashmir history after the exodus too that includes the highest military presence in any piece of land in the world, killing of the innocents and upending of lives. TKF will contribute to this composite truth. It cannot replace it. History is always ambiguous. What really happened and why are shape-shifting monsters. We all are in the Proustian search for lost time. Even personal memory gets addled over the years. So what will you make of collective memory? You can only have versions of it.

Two, I have an instinctive suspicion of the state promoting a work of art on an ideological basis. The state can be a patron as it has been for ages. It must create an environment for art to thrive. But when it weighs in on what’s good art and what’s not, understand that things have gone wrong. I’m not inclined to draw lazy parallels while writing here. But the experience of Soviet and Nazi attempts in using arts for the political end is too recent to be forgotten. Like Adorno wrote, “all art is an uncommitted crime.” It breathes because it challenges power and dominant narratives. Once it moves in lockstep with the state, it loses its vitality. Because soon works of art will be created to retrofit what pleases the state. Then there’s no pursuit of any truth. It all becomes in service of the state. What remains is propaganda.

As Camus wrote in his famous essay on art, Create Dangerously (1957):

“To create today is to create dangerously. Any publication is an act, and that act exposes one to the passions of an age that forgives nothing. Hence the question is not to find out if this is or is not prejudicial to art. The question, for all those who cannot live without art and what it signifies, is merely to find out how, among the police force of so many ideologies, the strange liberty of creation is possible. It is not enough to say in this regard that art is threatened by the powers of the State. If that were true, the problem would be simple: the artist fights or capitulates. The problem is more complex, more serious too as soon as it becomes apparent that the battle is waged within the artist himself.

…Of what could art speak, indeed? If it adapts itself to what the majority of our society wants, art will be a meaningless recreation. If it blindly rejects that society, if the artist makes up his mind to take refuge in his dream, art will express nothing but a negation. In this way we shall have the production of entertainers or of formal grammarians, and in both cases, this leads to an art cut off from living reality.

…Consequently, its (art’s) only aim is to give another form to a reality that it is nevertheless forced to preserve as the source of its emotion. In this regard, we are all realistic and no one is. Art is neither complete rejection nor complete acceptance of what is. It is simultaneously rejection and acceptance, and this why it must be a perpetually renewed wrenching apart.”

The question of TKF as a work of art therefore cannot be separated from what purpose is it serving in today’s India. Is it being used to learn lessons from the past? What does the story of the exodus of a minority community at midnight with a handful of valuables and a heart full of memories teach us? I think the only lesson Kant (Immanuel) would have asked us to take is that which can be applied universally. And that is a society must protect its minorities. The majority shouldn’t turn their heads away when something similar happens again.

The moral question then is simple. Is that the lesson that’s being learnt from TKF? Is that why it is a runaway hit? You know the answer as well as I do. Maybe these are big goals for a mere film. So, let’s narrow it. Is the film helping KPs in anyway? Or is it driving a wedge that makes a return to their homelands more distant? Some see the mere act of telling the story of KPs in the way it has been shown as a salve for their wounds. Maybe it is a salve. Maybe it is reopening of old wounds. Maybe it is both. That’s for the KPs to decide. What is the rest of India being asked to learn from it? There are only uncomfortable answers here. Its success tells us something about the times it has been made. Cinematically, I can bet TKF is no Schindler’s List. I don’t need to watch it to state that. We don’t need to declare holidays for people to watch it. If we want to watch a great film about India on a holiday, “uska prabandh kiya ja chuka hai.” It has been arranged. We show that great film every year across TV channels on October 2. Watch it. There’s always something new to learn for anyone who holds humanity dear.

The instrumental use of art for political ends is a frontier. When you cross that, you are in strange territory. The success of TKF at the box office points us only in one direction.

It is called an ‘andha kuan’ in Hindi.

PolicyWTF: Pension Troubles are Back

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

- Pranay Kotasthane

Long-time readers of this newsletter know that I have cited the civil services pension reform in 2004 as an example of a policy success because the government was able to align cognitive maps in a manner that generated little backlash and protests.

Until 2004, Indian governments promised to pay their employees’ pensions from the money collected from future taxpayers. Unlike in the private sector, where employees and the employer together contribute towards an employee’s pension fund, government employees bore no such responsibility.

As a result, the burgeoning pension bill led the government to change its stance in 2004. Through the reform, any employee joining the union government from April 1, 2004, contributed a part of their salary to their pension fund and the contribution was to be matched by the government. Over time, state governments (except West Bengal) implemented this reform.

To ensure that this doesn’t mean going back on past promises, this reform was applied only to new recruits, which immediately disarmed powerful unions of existing employees. Secondly, new employees effectively received a salary hike of 10 per cent, which was the government’s contribution to their pension fund. Finally, armed forces personnel were kept out of this reform given the short service term of non-officers.

Quite a fair proposition, one would think. Good economics intersects with good politics; all bases covered; cognitive maps aligned.

Well, not quite. Good economics needs a sustained cover of good politics throughout the policy life-cycle. Without the latter, the former has no chance. Having implemented the reform, governments forgot the need for good politics. The result is that in the last couple of weeks, two states—Rajasthan and Chattisgarh—have gone back to the old pension system. Some others are contemplating a similar move.

I don’t need to explain why this rollback is terrible. But just to drive the point home, Rajasthan today spends more than half of all the revenue it raises, on pensions and salaries of state government employees. As Mehrishi & Sane write, this implies six per cent of families in Rajasthan corner 56 per cent of all the state taxes and state fees paid by Rajasthan’s residents. By rolling back the reform, the Rajasthan government is going one step further in increasing this unfair redistribution. Future generations will be left holding the can of these ballooning pensions of today’s government employees.

The important question is: why the need for this rollback? The cynical reason is electoral politics. Both Rajasthan and Chattisgarh are due for elections next year and the state government is wooing the powerful lobby of government employees at the expense of faceless, dispersed citizens.

However, there is another structural reason emanating from poor politics, like in the case of the now-abandoned farm laws. The employees under the reformed pension scheme, who are starting to retire now, have received much smaller pensions than their older counterparts. This has led to protests to overturn the pension reform completely. State governments are responding to these protests. And hence, it’s important to take this concern seriously.

We can understand this phenomenon better using a framework from the 1970 book Why Men Rebel? by American political scientist Ted Gurr. Gurr claimed that one of the reasons why people rebel is relative deprivation. The greater the difference between their perception of “what we deserve” and “what we are getting”, the higher their propensity to protest or rebel.

In the case of pensions, the reference point for “what we deserve” is the inflation-linked and unsustainable pensions that the older retirees were getting. The perceived levels of “what we are getting” is already quite low because of implementation issues. Employee and government contributions to the funds have been delayed many times over, a concern the CAG has repeatedly raised. The gap between these two perceptions—the relative deprivation—is quite high, and hence the protests.

While this model is descriptive, it can also be extended to offer some lessons in politics. According to this framework, the government’s aim should be to reduce the sense of relative deprivation. This can be theoretically achieved in two ways.

One, by making it clear that “what the pensioners are getting” is not that bad a deal. This can be achieved by resolving the implementation issues and modifying the scheme to allow the pensioners to opt for higher market-linked exposure. The same effect can also be achieved by communicating how government employees are already much better placed in comparison to the people employed outside the government, in an economy marred by the COVID-19 shock.

Two, by adopting a realist strategy that lowers the pensioners’ perception of “what they deserve”. This is a difficult political strategy as it can backfire: who likes to hear that they don’t deserve the absolute best? But this narrative can be created by highlighting the unsustainable current pension burden and its impact on the economy and future generations.

In the current scheme of things, neither of these two strategies has been tried. Governments thought that the pension game-set-match had been done in 2004. 18 years later, they are realising that a lot still needs to be done. The Union government is masterful in creating and shaping narratives. That skill, for once, is much-desired here, lest a promising policy success turns into a grave policy error.

*The title of the edition is from L.P. Hartley’s 1953 novel “The Go-Between”

Advertisement: If you enjoy the themes we discuss in this newsletter, consider taking up the Graduate Certificate in Public Policy course. Intake for the next cohort is open. 12-weeks, fully online, designed with working professionals in mind, and most importantly, guaranteed fun and learning. Do not miss.

HomeWork

Reading and listening recommendations on public policy matters

* [Paper & Podcast] This Ideas of India conversation is not to be missed. The linked paper on why economic growth is a necessary and sufficient requirement for developing countries to meet their citizens’ basic needs is a must-read for all public policy students.

* [Podcast] The ‘One Nation, One Election’ idea is back in the public discourse. We discuss the problems with this idea in the latest Puliyabaazi.

* [Note] A work-in-progress compilation of opinions in Indian media about the India-Russia relationship.

Insights on burning policy issues in India

— RSJ

If there was more proof needed that Indian politics has changed forever, it came this week with the results of five state assembly elections. BJP won the big prize, UP, with a comfortable margin while AAP swept Punjab marking its presence beyond Delhi in a spectacular fashion. The question is what is this thing that has changed? Is this the usual hyperbolic overreading of events that we have come to associate with the media these days? Or have things changed in a more fundamental manner in Indian democracy? I read through much of the analysis that appeared in the print media to understand this. 

Something Has Ended

Three themes emerged. 

One that focused on some kind of an end of the ‘old republic’. Shekhar Gupta writes of this in the Business Standard:

“For 60 years since we became a republic in 1950, our politics was all structured around the Congress and its conception of a socialist, secular state. That epoch has faded fully. Now we are wading neck deep through a new, BJP/RSS/Hindu nationalism epoch. The preference of Hindu nationalism over Hindutva is consciously made. Religion has its oomph, but the pull of religiously defined new nationalism is enormously greater.

Today, if all of BJP’s rivals in Uttar Pradesh made a spectacle of walking to the Kashi Vishwanath temple across the new corridor—which I quite like—the secular republic has been redefined. Everybody has fallen in line. Today, we have a new nationalism, a new secularism and increasingly a new socialism redefined as efficient, non-leaky welfarism.”

The other theme was about some kind of an end to politics of identity, based on caste and other social formulations. As Pratap Bhanu Mehta writes in the Indian Express:

“The BJP has transformed the nature of politics in ways to which the Opposition has no answer. The first is a commitment to a generative conception of politics. The sense that the BJP has a deep social base, especially amongst women and lower castes, and a spectacular geographic reach as Manipur has demonstrated, completely belies the identity determinism that has for so long characterised Indian politics. The project of now opposing any national party on the basis of a coalition of fragmented identities is dead.”

Finally, there was the question of does economic performance matter in the face of ideology? Quoting Pratap Bhanu Mehta again:

“There will be another time to discuss how much of Yogi’s triumph in UP has to do with governance and delivery. This is empirically a complicated matter. This is in no small part because what a regime gets credit for is as much a matter of prior trust as it is of facts. Certainly Yogi’s new welfarism, or crackdown on certain kinds of corrupt intermediaries may contribute to the BJP’s popularity. But the idea that all of that was enough to wipe out the effects of the Covid-19 devastation, unprecedented inflation, a dip in consumer spending and a real jobs crisis requires more explanation. Perhaps the angriest and the most devastated no longer feel politics is the conduit for solving their problems. Your protest will be expressed more as social pathology, not as political revolt.”

At a macro level, these seem to be the conclusions to be drawn from BJP’s big win in UP - an epoch has ended with the dominance of a new nationalism as defined by the BJP; identity politics that emerged from the Mandal movement is dead; and, people care more for ideology plus welfarism than economic performance.

Are these valid conclusions or is this the usual overanalysis of a single election outcome? Is there a simpler explanation for the win in UP? Let me take you back to one of the predictions I made at the start of the year about UP elections:

“The BJP election machine will continue its winning run barring the odd defeats in Punjab and Goa. The big prize, UP, will be fought hard but BJP will win a safe majority. The bahujan vote of the depleted BSP will shift to it more than to SP and that will make all the difference.”

The vote share numbers that are emerging seem to suggest that’s what has happened. We didn’t have the usual triangular contests this time around. That worked for the BJP because the bahujan viewed it with less suspicion than in the past and the alternative of going to the Yadav-dominated SP wasn’t too alluring for them. Maybe, it is mere electoral arithmetic at play than some grand narrative. It is difficult to conclude. 

However, I won’t deny there are fundamental issues about our republic we must contend with as we look at the politics around us now. Electoral arithmetic doesn’t come out of a social or political vacuum. So, I will pick up three faultlines that deserve attention for where our polity stands today.

Representation And Nationalism

I will pick up the idea of representation in a democracy first. The democratic idea of sovereignty of people means there has to be a definition of what constitutes the ‘people’. And once you have defined the people, you then have to contend with the numerical advantage of various groups or identities within the people because democracy is a game of numbers. In India, the idea of a representational democracy took formal roots with the Morley-Minto Reforms of 1909 that introduced elections to legislative councils and allowed Indians to be elected to them. Muslims were granted separate electorates with seats reserved for them where only Muslims would be polled. This was to ensure a ‘fair share’ of representation of Muslims who would otherwise be underrepresented in elections where the Hindus would always be in a majority.

This is a central conundrum in any democracy that has a permanent group that’s seen to be a majority by a permanent minority. If you follow the principles of equality and one person - one vote, it is likely the majority will always win the elections. How do you then safeguard the interests of minorities? One answer was a separate electorate that was suggested by the Morley-Minto Act. The other could be by giving a veto on key issues to the minorities that would make them more secure. But both these formulations go against the fundamental nature of democracy and, more importantly, risk majoritarian backlash. The greater the backlash, the harder the minority demand for security in the form of special power or concessions in a democracy. You get into a vicious cycle then. This problem of representation played out fully in the two decades leading up to 1947. This was the unsolvable question that was the basis for partition.

However, partition might have solved this issue for Pakistan but the question remained open for India which still had about 20 per cent of the minority population. So our response was in the form of a Constitution that didn’t look back into the past for inspiration and stayed focused on the values of liberty, equality and fraternity. The hope was for a form of civic nationalism to emerge and for people to focus on their individual freedoms and mutual interdependence to power the nation into a new future. This was easier said than done. Because the minority can take solace in a liberal Constitution but then the question arises who will wield the power of administering it. If the majority administer it with the wrong intent, no amount of lofty ideals of the Constitution can assure the minority of their freedoms.

This is what led to a finely balanced model of administration by the Congress after independence that, in some sense, gave the minority a veto on various issues. That this veto was abused by the leaders of the minorities and by the Congress is a separate issue. It led to the minorities being seen as a vote bank and continued to fester a sense of anger among the majority at this pampered treatment. A dominant Congress with strong leaders could manage these contradictions without precipitating things. This balance was shattered in the mid-80s with the Rajiv Gandhi government, that instead of containing these issues as was the political custom, tried to take advantage of them by riding the twin horses of Hindu and Muslim appeasement. The Ayodhya movement, the bogey of Muslim appeasement using Shah Bano case as an example, the vocal assertion of Hindu victimhood of the past and its desire for revival emerged from there. The Mandal movement that encouraged fragmented identities among the majority delayed the inevitable for some time. That project is now dead largely because its leadership has no credibility anymore, it has no focal point to rally people and the BJP has melded those fragmented identities into a larger Hindu identity.

Muslim appeasement or the alleged veto of the past has been replaced by a complete shunting out from representative politics in most states where the BJP is in power. The UP win where the election was fought on the 80-20 plank and where less than 5 percent of minorities voted for the winning party bookends the cycle that began three decades back. This might appear to many like a defeat of appeasement politics and a win for equality as defined in the Constitution. It is decidedly not. A permanent minority stripped of representation will agitate and fight for it. History has shown this doesn’t go well for a nation. The horrors of our partition are but just one example of it.

Cultural Nationalism And Appropriating History

The other area of interest is culture and history that have always provided the fuel needed to drive nationalism. History is always contentious in a land as ancient and continuously inhabited as India. History isn’t only what’s written in the books by scholars. There is also a living memory of the past that gets passed down to generations. In the decades leading up to our independence, the question of how to integrate our history into the national movement was a tricky one. Our present as Indians under colonial rule then gave us a single identity but our past fragmented us on caste and religious lines in ways that were fundamental to our conception of self. This is what prompted the likes of Gandhi and Ambedkar to imagine the project of founding a modern India as an act of forgetting our past. To them, our past might have had glorious achievements but it was also violent, unequal and amoral. We could study to draw lessons from it but it had nothing to contribute to the imagination of a modern Indian state. So, let the past be. Let people figure out which past they want to read or imagine. Let there be competing narratives about it. But the state should be forward-looking and progressive. It should draw none of its legitimacy from the past.

This was a good model to adopt; possibly, the only moral one given our history. But it had two problems. One, it ignored the living memory of people about their past completely. This memory that was repressed then found its expression in a more radical and uninformed view of our past that was kept alive and propagated by the likes of Sangh parivaar. Two, the Marxist historians used state sponsorship to purvey a version of history that served the values of the modern Indian state but in the process whitewashed all truths of our past that were inconvenient to this narrative. In fact, many other voices that questioned these versions were shut out. This was an ethical academic folly.

But today that mistake seems worse. Instead of having a well researched and rigorous counter to the Marxist versions, we have competing views now that’s mere propaganda. That’s the price to pay for not letting legitimate contrarian views take roots. The versions of our history and culture that are spreading now through WhatsApp universities and other social media platforms not only counter the Marxian view, they also delegitimise the founding principles on which the modern Indian state was built. This is now an irreversible process. The UP election victory was preceded by elaborate ceremonies of laying the foundation of the Ram temple in Ayodhya and opening up of the new Kashi Vishwanath corridor. Alternative histories and versions now emerge every day with more dubious claims about our past that support the narrative of the current regime. The radical act of amnesia that marked our founding moment has been replaced by a vivid, technicolour Bollywood-ised version starring the likes of Akshay Kumar and Ajay Devgn. We have swung from one extreme to the other. Nothing good comes from reopening old wounds. As Ghalib once wrote:

“jalā hai jism jahāñ dil bhī jal gayā hogā 

kuredte ho jo ab raakh justujū kyā hai” 

(We persist in digging up the past. No idea why.)

Trading Off

Lastly, I agree with Pratap Bhanu Mehta that people no longer see politics as a conduit for solving their problems. I don’t know why he thinks this has happened. My view is this is the usual course of things in India. In the 75 years since our independence, we have always had a grand narrative that calls upon our people to make sacrifices for the greater good of our nation. In the Nehruvian years, it was about building a modern India unfettered by its past by letting the state become large and all-powerful. The people were supposed to kowtow to a prescriptive, omniscient state because we were building a new India. This was followed by the Indira era where the pretence of a new India was forgotten because there weren’t any resources left to build one. What was left was a hell where every citizen was asked to pay for the ineptitude of the state in the name of socialism.

The two decades post 1991 were a kind of an exception where economic freedom and growth were being promised and the sacrifice being asked from people was to look beyond their historical baggage of identity. It is no surprise that this period saw maximum social mobility and internal migration. We are now on to a different kind of compact. The proposition of this regime today is this - we are doing the difficult job of reclaiming the soul of India that was crushed for over a thousand years by invaders of various hues. This awakening might need sacrifices in the short-term on economic performance. You have lived through this for 75 years. What’s another 25? The UP victory is a confirmation of this. Economic outperformance is hard work with no clear linkage to electoral benefits. Reviving a glorious past that’s largely mythical and promoting welfarism is much easier with better payoffs.

Maybe I’m being overly pessimistic. It is possible that the broader Hindu identity project that’s on will meld all other castes and communities into a composite that’s more equal and less discriminating. Maybe the nationalism project will not be forever in need of an ‘other’ to fight and keep itself relevant. Instead of being a source of vicarious joy to the mediocre which it usually is, this brand of nationalism might inspire a generation to put itself in the service of the nation. Possible? Who knows? Maybe we will reconcile with our past once we have rewritten all our history in the way we think it happened. The permanent majority will then forever be rid of its sense of victimhood. It could happen. These are all in the realms of possibility. Maybe I should be hopeful.  

But then I look at history. And it tells me not to bet against it.

India Policy Watch #2: Irrational Fears and Homemade Potions

Insights on burning policy issues in India

— Pranay Kotasthane

Confirmation bias is a powerful cognitive bias. The tendency to search for information that confirms one’s own preconceptions is on full display in the technology and trade domains after the Russia-Ukraine war. For those who seek economic and technological self-sufficiency for India, this war has come at a right time to bolster their case for everything from data localisation, domestic social media platforms to SWIFT alternatives and de-dollarisation. The common refrain is: “see, this is what happens when you have trade and tech interdependence with the West. Imagine if the West were to use the same instruments against India in the future. Shouldn’t we decouple before they do this to us?”

Without doubt, this narrative will find resonance amongst many policymakers and Indian citizens. But before they convert aatmanirbharta into a full-on quest for autarky, I have three counter-points to offer.

First, the biggest lesson to draw from the Russia-Ukraine war is not that we need to become self-sufficient, but just that invading other countries comes at a humungous human cost to one’s own citizens. Nuclear-armed invaders might have immunity from conventional warfare by other nuclear-armed powers, but they will face a response in other domains—economic, technological, and sub-conventional.

I also suspect there’s the availability heuristic at play here. Many Indians recall the economic sanctions against India after the Pokhran tests. They fear that the information age variant of those sanctions could be similar to what Russia is facing. That conclusion completely ignores the history of the last twenty years. The days of India-Pakistan hyphenation are long behind us. The West too needs a powerful India to counter China. We forget that for this reason, the same post-Pokhran sanctions were replaced by a civil nuclear deal within a short period of seven years.

There’s also a category error in this comparison. Government-to-government sanctions against nuclear tests conducted on one’s soil are entirely different from the combined might of multi-State, market, and social sanctions that Russia’s invasions have invited. And so, since India has no designs to invade any other country (I sure hope so), we need not spend sleepless nights over similar sanctions.

Second, the pursuit of tech self-sufficiency is itself a near impossible goal. Whatever the level of domestic alternatives we build, there will still be some levers left in the hands of other technologically advanced countries to throttle India’s progress. I had earlier written that the idea of high-tech national industries is anachronistic.

That's because high-tech industries today rely on extensive cross-border movements of intermediate products, talent, and intellectual property. As R&D costs required to produce technological improvements have risen across sectors, erstwhile 'national' industries have been transformed into global supply chains. Instead of national champions making complete products independently, companies only specialise in specific parts of global supply chains.. Dependencies for intermediate goods and specialised equipment on other countries is inescapeable.

The impact of global ecosystems is exactly what China is discovering now as the West begins to cut its access to leading-edge semiconductor manufacturing and devotes resources to prevent industrial espionage by China in high-tech collaborations.

India shouldn’t be spending money, time, and resources on a delusionary goal.

Third, India needs strong collaborations with the West precisely for increasing its aatmashakti. Indians are deeply embedded in the West’s technology sector and that’s a source of immense national strength. These connections offer tremendous opportunities for India’s growth. Sure, one can crib about brain drain but reversing that requires better living conditions and opportunities back home, and not severing ties with the West. The trajectory that China followed has a few lessons for us. The sustained movement of ideas, capital, goods and services between China the West over forty years helped China build its own strengths.

Even on the strategic technologies front, there never has been a congruence of interests, values, and complementary strengths between the West and India, as it is now. The potential for joint development of key military technology has never been higher before.

These three reasons highlight, once again, the minefield that is the aatmanirbharta narrative.

PolicyWTF: I Failed my Unit Test

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

Thankfully, the misfired unarmed missile that landed in Pakistan only led to escalations of the Twitter-kind. How a missile (possibly one that’s capable of carrying nukes) could land in the territory of a nuclear-armed adversary despite all the checks and safety procedures in place, boggles the mind.

But the policyWTF I want to focus on is the press release by Ministry of Defence that was put out a full two days after the incident:

“On 9 March 2022, in the course of a routine maintenance, a technical malfunction led to the accidental firing of a missile.

The Government of India has taken a serious view and ordered a high-level Court of Enquiry.

It is learnt that the missile landed in an area of Pakistan. While the incident is deeply regrettable, it is also a matter of relief that there has been no loss of life due to the accident.”

That’s it. Not only did the message come after Pakistan had gone to town, it also has a “I failed my exam but It’s okay as it was just a unit test” feel to it. Unsurprisingly, Pakistan is now trying to internationalise the issue.

This grave error deserved an unreserved apology to the people and government of Pakistan. It should have mentioned the steps the government has initiated to reassure not just Pakistan, but all important international stakeholders. Hopefully, this happens soon; it’s not too late.

Advertisement: At Takshashila Institution, there are quite a few positions open across policy research, education, programme management, and outreach functions. If you are interested, or know someone who might be interested, all requirements are posted here.

India Policy Watch #3: Mastering Diaspora Evacuation

Insights on burning policy issues in India

— Pranay Kotasthane

Indian officials and diplomats are doing a commendable job in extricating Indians from conflict areas inside Ukraine. An Indian Express report gives an indication of what it takes for evacuation from conflict areas such as Sumy:

* The PM's one-to-one calls to the presidents of Ukraine and Russia apparently gave a green signal for the evacuation, after both of them told the PM that they did not have a problem with safe passage.

* This led to instructions to Indian officials in Kyiv and Moscow for creating a humanitarian corridor.

* External Affairs Minister, the Defence Ministry, and the two Indian ambassadors were also involved in activating local contacts. Apparently, the Red Cross in Geneva also helped in making arrangements.

* In Sumy, Indian officials and local embassy staff were stationed. Their local contacts were critical in getting the buses to Sumy. Since drivers couldn’t be found, the vehicles were driven by Ukrainian army personnel. Apparently, some private cars were also used.

* Local contacts also helped in arranging fuel and other logistics.

* Finally, 12 buses reached a point in Sumy, picked up Indians from a nearby hostel. The buses took the students to central Ukraine. They took the train to reach the western border of Ukraine, from where they entered Poland. Thereafter, aircraft of IndiGo, Indian Air Force, and Air India were used to bring them home.

The Lesson

The events described above give an indication of the kinds of challenges and capacity required for evacuations. While the efforts of Indian officers is commendable, the above narration also indicates the absence of a well laid out protocol for evacuating Indian citizens. Given India's large and increasing diaspora, and the world disorder we find ourselves in, the need for an evacuation from conflict zones is likely to increase. India needs to be better prepared.

Recommendations

A Takshashila Institution 2016 Policy Brief Capacity Analysis for Evacuation of Indian Diaspora (written by my former colleague Guru Aiyar) had studied the capacity required for quick evacuation in detail. The study proposed a 'whole of government' approach to diaspora evacuation, which includes on-ground execution mechanisms such as:

* Creation of an Overseas Crisis Management Group(OCMG) under the NSA which will be responsible for synchronisation and control of evacuation operations at the apex level. It will coordinate with the military, bureaucracy, civil aviation, railways, and diplomatic missions.

* The Ministry of External Affairs (MEA) and the OCMG must have databases of logistics and transportation companies at foreign locations for ready use by Indian Missions abroad.

* Diplomatic push to set up overseas Overseas Coordination Points (OCPs) - airfields, ports, bus assembly areas, advanced landing grounds (ALGs) identified in advance.

* Maintain good diplomatic relations with countries where Overseas Coordination Points (OCPs) have been set up. For example, Djibouti becomes very important in West Asia for diaspora security.

* Wet lease of commercial ships & aircraft from friendly countries.

* For return to India, it is much cheaper to utilise civil carriers compared to Air Force or Air India.

* Include emergency clause in carrier licensing with commercial airlines and shipping companies to ensure: availability of aircraft with crew during emergencies, a compensation structure, and an Emergency Coordinator from all transport companies, airlines, shipping and railways with a lateral reporting channel to the OCMG.

Going Ahead

With Air India no longer a government company, it would be good for the government to include an emergency clause in carrier licensing now for all the private players. More importantly, India's diaspora evacuation must be better planned and executed instead of relying on the brilliance of individual officers in conflict situations where a lot of variables are not in control.

Read More

* Capacity Analysis for Evacuation of Indian Diaspora, Takshashila Policy Brief by Guru Aiyar, August 2016

* Challenges for Indian Diaspora Evacuation, Takshashila Discussion SlideDoc, Guru Aiyar and Nitin Pai

HomeWork

Reading and listening recommendations on public policy matters

* [Article] If there’s one article you want to read on the pension tension that prompted Rajasthan and Chattisgarh governments to announce a roll back of the pension reform, read Rajiv Mehrishi and Renuka Sane.

* [Note] A compilation of analyses on India-Russia relations.

* [Note] A compilation of studies and articles in search of answers to one question: Why have Feminist Political Parties not been electorally successful?

* [Podcast] In the next Puliyabaazi, Avani Kapur discusses public finance and fiscal decentralisation in India. Do listen.

Indian perspectives on global events

— RSJ

Things have escalated a bit since I wrote last week about the economic sanctions on Russia by the West. Apart from cutting loose a few Russian banks from the SWIFT messaging system, we also had the unprecedented move to freeze the access of the Russian central bank to its forex reserves that are held with other banks in the West. Russia has been salting away about $640 billion worth of forex reserves over the past decade in anticipation of an event like this. They had reduced their exposure to the US dollar to about 15 per cent. But if it cannot now access about half of this, or maybe more, because of the freeze, it is a crippling blow. The central bank needs the forex to prevent the slide of the ruble by buying them and propping up its value. If it cannot, the ruble will continue to plunge and currency short-sellers will get into their game to drive it to dust. That apart, the Russian oligarchs and their assets are being targeted. This core group of Putin backers are being made to pay for his blunders. The idea is to drive a wedge between them and Putin.

Russian exports have been frozen because, without access to SWIFT, you only have barter as a trading mechanism. Russia is tightly coupled with the global economy unlike its predecessor USSR or other regimes that have faced big sanctions like North Korea, Syria or Cuba. Its economic model in the Putin era has been to focus on its comparative advantage in commodities while importing almost everything else. The sanctions will hurt ordinary Russians. Expect long queues at stores in Moscow. And long queues and Russia have an even longer history. It doesn’t end well for a regime when that happens. I could go on and on but you get the picture. This economic war unleashed by the west has turned more serious than Russia ever anticipated.

Review Of The Positions

But what I am interested in is what are the likely end-game scenarios here. For thinking through that let’s look at the two players, their objectives, likely actions and payoffs. Over the past decade, Putin had been building up to this moment. Testing the waters on the western response by annexing Crimea, sponsoring cyberattacks, meddling in elections of other countries and biting away chunks from its near neighbourhood. The western response to these has been tough words or economic sanctions of some kind. Based on these ‘games’ and their results, his expected scenario of what would unfold after Russia invaded Ukraine was clear.

The West would never put boots on the ground in Ukraine to fight Russia. The Russian tanks would roll into Kyiv in a few days. Putin would engineer a regime change, install a puppet and then wait for the West to react. That reaction, as he had seen in the past, would be another round of economic sanctions in familiar shape and form. He counted on western Europe’s dependence on Russian gas to manoeuvre through the sanctions. And he had built the forex war chest to navigate through a rough year or two after which things would be normal. On balance, he would have had Ukraine, a win to reconfirm his strong man status among his people, a warning like no other to his neighbours to accept Russia as their sovereign and to demolish whatever little credibility the US and NATO have as trustworthy allies who would come to your rescue. He also had China on his side who saw this as a test case for their ambitions on Taiwan and the One-China policy. When he weighed the pros and cons of the move, this was a no-brainer for him.

Let’s turn to the West now although there wasn’t much evidence prior to the invasion that it was a single bloc that coordinated its decisions. It lived in the hope that Putin would not invade Ukraine despite the clear signals emerging from Russia. It had already shown its hand by not sending troops and arms to Ukraine in anticipation of a war. It felt that it would be used by Putin to aggravate the situation and justify the war to his people. So, all it did was warn Russia of consequences without specifying them and left it at that. Putin saw through this. So, the invasion was inevitable.

Putin’s Wrong Choice

We move on to the next question now. What were the options Putin had on what form the invasion would take? Back in January, Jones and Wasielewski of CSIS had laid out the six military options that Putin had on Ukraine:

“Kremlin has at least six possible military options:

1. Redeploy some of its ground forces away from the Ukrainian border—at least temporarily—if negotiations are successful but continue to aid pro-Russian rebels in Eastern Ukraine.

2. Send conventional Russian troops into the breakaway regions of Donetsk and Luhansk as unilateral “peacekeepers” and refuse to withdraw them until peace talks end successfully and Kiev agrees to implement the Minsk Accords.

3. Seize Ukrainian territory as far west as the Dnepr River to use as a bargaining chip or incorporate this new territory fully into the Russian Federation. 

4. Seize Ukrainian territory up to the Dnepr River and seize an additional belt of land (to include Odessa) that connects Russian territory with the breakaway Transdniestria Republic and separates Ukraine from any access to the Black Sea. The Kremlin would incorporate these new lands into Russia and ensure that the rump Ukrainian statelet remains economically unviable.

5. Seize only a belt of land between Russia and Transdniestria (including Mariupol, Kherson, and Odessa) to secure freshwater supplies for Crimea and block Ukraine’s access to the sea, while avoiding major combat over Kiev and Kharkiv. 

6. Seize all of Ukraine and, with Belarus, announce the formation of a new tripartite Slavic union of Great, Little, and White Russians (Russians, Ukrainians, and Belarusians).”

They had also outlined the likely payoffs and consequences of these options for Russia.

“Of these six options, the first two are the least likely to incur significant international sanctions but have limited chance of achieving a breakthrough on either NATO issues or the Minsk Accords due to their coercive nature. All other options bring major international sanctions and economic hardship and would be counterproductive to the goal of weakening NATO or decoupling the United States from its commitments to European security.”

It is clear that Putin has chosen some variation of option 4 or 5. These options needed groundwork. Lots of it.

First, it needed sustained domestic propaganda to show Ukraine as some kind of a Nazi state supported by NATO that’s a mortal threat to Russia. This has been in the works for many years now in Russia but its effectiveness is questionable. There were last-minute announcements by Putin where he rambled on about this but it is unlikely they sounded convincing within Russia.

Second, Putin seemed to have underestimated the complexity of urban warfare. The resistance from the cities has been the reason why Ukraine has held on for so long. This will eventually wilt because the armies are hugely mismatched. But the battles in the cities have given enough time for the world to coordinate its response. This was not in Putin’s calculus.

Lastly, there’s the question of the motivation of Russian troops to inflict casualties on Ukrainians. There is this romantic notion that Russian soldiers don’t see Ukrainians as enemies because of long-standing family and societal ties. I don’t subscribe to this. But it is clear in the past week there’s an undercurrent of that playing out in the war. It might soon disappear as the Russians suffer losses and we could be discussing the brutalities of the Russian army soon. But for now, there’s an element of holding back of the punches that’s evident.

The upshot of all of these is that Putin is in a hard place. He will eventually push through and have large chunks of Ukraine in some form regardless of when a ceasefire is declared. This is clear because NATO won’t get into a war. But this victory, whenever it comes, would have cost him a lot. The impact of economic sanctions in the short term will be severe on the Russian people. And it will take a long time to come out of it. Russians are strongly connected to the world outside. There will be visible changes in their lives if this continues. How they react beyond a point is the question. Also, there will be ongoing resistance to whatever parts of Ukraine Putin holds on to and this will mean a permanent low scale war. He will have the wrath of the oligarchs to deal with who already have their wealth outside of Russia wiped out. These are his domestic problems.

On the other hand, Putin has succeeded in strengthening his enemies outside. US-Europe unity is on display after a long time. There is unanimity in Europe that they need to diversify their energy sources away from Russia with urgency. Multinationals are voting with their feet getting out of Russia. Also, the apparent initial success of the economic sanctions has made Biden and other NATO leaders look good and decisive after a long time.

On The Negotiation Table

So, where do we go from here? Any negotiation, direct or indirect, between the West and Russia will be a difficult balancing act for the players. It will be useful again to bring Putnam’s two-level game theory to analyse this. A quick recap of Putnam’s model:

“The politics of many international negotiations can usefully be conceived as a two-level game. At the national level, domestic groups pursue their interests by pressuring the government to adopt favorable policies, and politicians seek power by constructing coalitions among those groups. At the international level, national governments seek to maximize their own ability to satisfy domestic pressures, while minimizing the adverse consequences of foreign developments. Neither of the two games can be ignored by central decision-makers, so long as their countries remain interdependent, yet sovereign. 

Each national political leader appears at both game boards. The unusual complexity of this two-level game is that moves that are rational for a player at one board (such as raising energy prices, conceding territory, or limiting auto imports) may be impolitic for that same player at the other board. Nevertheless, there are powerful incentives for consistency between the two games. Players will tolerate some differences in rhetoric between the two games, but in the end either energy prices rise or they don't. The political complexities for the players in this two-level game are staggering. Any key player at the international table who is dissatisfied with the outcome may upset the game board, and conversely, any leader who fails to satisfy his fellow players at the domestic table risks being evicted from his seat. On occasion, however, clever players will spot a move on one board that will trigger realignments on other boards, enabling them to achieve otherwise unattainable objectives.” 

For the West, the best outcome on the ‘international table’ will be for the sanctions to continue and to hurt the ordinary Russians just enough for them to show public dissatisfaction and not so much that they rally behind Putin against NATO. The hope then is that the cabal of generals, spies, oligarchs and bureaucrats will depose Putin in the name of Russians to protect their own interests. Of course, there’s no guarantee that a successor will be any better for the West. But you get Putin out of the picture in the short term. Ukraine holding out for long will be the key to this. However, between making Ukraine whole again and continuing with sanctions that can possibly lead to Putin’s exit, it is clear what the West will go for. On the ‘domestic table’, their position has to convince their allies (like Taiwan) that even if they don’t turn up militarily, they can cut their adversaries to size. For this also they have to ensure Putin must go. The other outcome to seek on this table will be to ensure an uninterrupted supply of cheap gas to Europe that will struggle without it. This will be the ‘goldilocks zone’ of sanctions that the West will seek.        

For Putin, the best war outcome will be to reach Kyiv and change the regime in the next few days and then sit down for negotiations. On the ‘international table’, he will seek a reduction in NATO forces around Russian borders and acceptance of Russian sovereignty in eastern Ukraine in return for a phased withdrawal. He might agree to some kind of peacekeeping force and a roadmap for free and fair elections. His objective will be to give enough away without restoring Ukraine to its previous form so that he has the sanctions reduced. He needs it to breathe easy at home. On the ‘domestic table’, he will try to delink the negotiations to Ukraine as much as possible and make it more a Russia versus NATO issue. Putin knows Russia’s integration with global trade works both ways. Cutting it off completely will hurt the rest of the world too. Russia is an important source of raw materials and commodities and the second-order trade effects will soon be playing out in various sectors. His focus will be to get a few wins on the reduction of sanctions that he can take back home. The rest he will manage. That would be his winning set on the domestic table. 

I suspect that’s the way any negotiation will play out. And it is likely Putin will manage to get those wins that will keep him in the safe zone. That’s how the default end state of this game is set. If the West wants Putin’s exit as the real outcome of this war, they will have to move away from this default. They must decide not to yield an inch on the sanctions and live with the collateral damage of this stand for some time. They won’t get an opportunity to corner Putin like this again. I’m not sure if the West will be as coordinated on this as they have been on the economic response to Putin. That’s where Putin will win.

In all of this, there’s only one real loser. Ukraine.   

India Policy Watch: Aatmanirbhar Bharat Approaching a Wrong Turn

Insights on burning policy issues in India

— Pranay Kotasthane

We wrote earlier (#56) that Aatmanirbhar Bharat has all the five characteristics of a powerful narrative. Another strength of this narrative is its breadth. This narrative is ambiguous enough to incorporate a vast range of policy objectives. But this strength is also its weakness. The same Aatmanirbhar Bharat cry can also throw up some tried, failed, and self-defeating policies of the past. Three events in the last couple of weeks suggest that we are heading towards this wrong turn. This post is to sound another note of warning.

First, the PM’s speech on 3rd March gave another glimpse of this government’s conceptualisation of Aatmanirbhar. Sample these statements:

We have to promote ‘Make in India’ for goods whose demand is increasing in the country today. Now there are two issues -- one to keep exports in mind and the second to meet India's requirements. Let's suppose, we are not able to become competitive in the world, but we can provide quality materials according to the requirements of India so that India does not have to look to foreign countries. We can do this.

Or this statement, with the same vibes as the Finance Minister’s “Can’t we make Ganesha idols of Clay” statement a few months ago:

“Indian manufacturers should see that the dependence of the country on foreign countries is minimized. Therefore, ‘Make in India’ is the need of the hour…We procure essential medical equipment from outside. Can't we make medical equipment? I don't think it is such a difficult task. Our people have the potential to do it. Can we put emphasis on it? We should not be satisfied that all the necessary products are available in the market according to our needs. Many products which are available in the market are imported. And when Made-in-India products should be available, there should be a feeling among people that these products are better than the imported ones and we have to purchase them. We should create this situation and this difference should be visible.”

These words indicate that the primary goal of Aatmanirbhar is quite clearly Import Substitution Industrialisation (ISI). The goal of becoming a major export power is now a distant second goal. ISI as a developmental strategy for India is as old as the Republic of India. After independence, as part of ISI, trade and economic policy measures were designed with the explicit aim of replacing foreign imports with domestic production. India went for one of the most extreme versions of ISI across the world. The results are for all to see. And yet, we seem to be going back to that path.

Moreover, this focus on reducing imports misses the point that imports are critical for exports. They allow a nation-state to build on its own strengths while leaving it to other countries to produce what can’t be done efficiently here. And so, it shouldn’t surprise us that as exports rise, imports will also rise concurrently. The world’s top two exporters are China and the US. And the world’s top two importers are also the US and China. There is no contradiction here. Hence, the government’s obsession with reducing foreign dependence is anachronistic and self-defeating.

The second statement on medical equipment was even more bizarre. How does one generate a feeling among people that Make-in-India products are better than imported ones? A better product is an objective fact, not a subjective feeling that can be implanted into a consumer’s mind, Inception style. For a detailed critique of this line of thinking, revisit Prof AISH’s sermon here in edition #46.

The second force pushing India towards the wrong turn is the Ukraine-Russia war. The breathtaking scope of the economic sanctions unleashed against Russia creates conditions for autarkic arguments to flourish. What if the West does something similar to us? Won’t it be better if we become Aatmanirbhar instead?

The harsh reality is that the West’s economic dominance is not going away anytime soon. TN Ninan in his Business Standard column explains it thus:

“That leaves the trigger response of self-reliance. This is a very partial solution as inward-looking economies don’t do well. Besides, there is no alternative to the dollar, supply chains are not about to disappear, the country will remain import-dependent for energy, and the West dominates all major international institutions. Breaking free is impossible unless one wants to be a North Korea. The push to indigenise every major weapons system may sound great, but could be overreach. If imports are stopped and domestic production does not happen, we could end up with neither. Besides, almost every indigenous weapons system has a significant import content — the Tejas’s engine is made by General Electric, the navy’s ships have engines from Ukraine, and so on.”

Instead of plotting a break-up with the West, India needs to dominate in other areas where the West is relatively disadvantaged. The IT industry is one such example. Not only did it massively benefit due to the connections and investments with the West, but it is also a lever that makes India’s economic relationship with the West more even-handed.

The right lesson to derive from the West’s weaponisation of its economy is not aatmanirbhar but aatmashakti. The richer that India becomes, the more difficult it is for any coalition to hurt India economically. And becoming rich quickly requires India to collaborate with the West. Free movement of goods, capital, and labour are crucial for building India’s aatmashakti.

Another reason for India to keep close ties with the West is the nature of the high tech sector. There are no national industries of semiconductors, AI, or advanced computing. What’s replaced them are complex global supply chains for products and interconnected global networks for cutting-edge research. While the usual critique of the West is its intransigence on providing India with advanced military technology, India’s deep connections with the West nevertheless foster a transfer of technology (through a flow of ideas and people) in critical and emerging technologies. Building tech aatmashakti requires deepening the connections, not plugging out from the West. That’s how, after all, China quickly shortened its own technology development cycles.

The third development that hints at another self-goal was the union government’s nonchalant ban on the import of all kinds of drones, starting last month. The stated intent: to encourage participation in the government-sponsored production-linked incentive (PLI) scheme for drones, through which the government aspires to make India a global drone hub, by 2030. But who will tell the government that banning the import of a good and becoming a global hub of the same good are contradictory outcomes? What incentive does a company shielded by protectionism have to compete with the best in the world?

More broadly, an uncharacteristically bold report by the mobile phone industrial body highlights the problem with using trade policy to ‘protect’ Indian companies. Its assessment found that high import tariffs were making Indian mobile manufacturers more uncompetitive on the global stage. Using a PLI scheme merely to generate domestic champions is effectively just a redistribution of money from the taxpayers to the manufacturers. India benefits from PLI schemes only when the economic pie grows through exports. And doing that requires friendly trade policies. This is an underrated factor in the success of east and south-east Asian economies.

We have sounded out many such warnings about Aatmanirbhar Bharat in the past. Industrial policies are incomplete solutions. Improving the business, trade, and tax environments in India is imperative for India to capitalise on a new geoeconomic environment that awaits us.

* From Donne’s ‘No Man Is An Island’

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Arjun and Pranay have a paper with a fee recommendations for India-Taiwan collaboration on semiconductors, in a first-of-its kind report that comiles the two countries’ relationship across multiple areas.

* [Paper] An interesting paper co-authored by well-known philosohper Cristina Biccieri which suggests that ‘informing people about the extent of inequality in a society will not effectively alter their support for redistributive policies. Political campaigns aiming at increasing awareness for the need for social welfare and taxation might want to thus consider to not focus too much on talking about, e.g. high incomes of top income earners since, while it is important that citizens are aware of such facts, it seems to have very limited effects on their policy support.’ This finding is congruent with an older Starmans, Sheskin, and Bloom paper which concludes “humans naturally favour fair distributions, not equal ones, and that when fairness and equality clash, people prefer fair inequality over unfair equality”.

Indian perspectives on global events

— RSJ

Among the rare joys of writing a weekly newsletter is the ability to pretend you’re an expert on everything under the sun. That way the last 2 years has been a gift that has kept on giving. Science of epidemiology, methods of lockdown, the efficacy of vaccines, how fiscal stimulus should be structured, what to do about China, the transitory nature of inflation or the long-term impact of working from home - there’s a wide swathe of subjects that I have claimed expertise on. The only thing missing was war.

This week God, Putin heard me.

And there was war.

Now we do talk about matsyanyaaya a lot around here. That is all international relations can be reduced to the maxim of ‘big fish eating small fish’. To many, it seems like a simplistic formulation. Surely it cannot be just about power, they say. What about things like global order, liberal values and democracy that we hear nations claim that govern their outlook? Didn’t we do just that during the cold war? Fought on principles and brought down an evil empire? I can sympathize with them. There’s so much talk about higher-order morals in international relations that you can easily be taken in by it. Well, my view is that most of that stuff is garbage. The naked truth about international relations is grotesque. It needs the garb of pious intentions. And this becomes clear as daylight when you have a war. As much as it is a humanitarian crisis that saddens you, war is also a moment when all pretenses fall away. And you see the truth.

So, what are the truths that emerge from the Russian invasion of Ukraine? The usual response to that question is about Putin, his ego and his frailties, his hegemonic ambitions and his desire for leaving behind a legacy that might appear dubious to us but important to him. Here’s a cross-section of views from experts in Brookings. Just to pick one of them (Pavel Baev, non-resident senior fellow):

“Now we know that Putin’s obsession with Ukraine — which constitutes a threat to his regime not because of hypothetical NATO missiles, but because of its choice for democracy and closer ties with Europe — prevailed over common political sense and strategic risk assessments. Wars rarely go according to plans, and this one is set to turn bad for Russia because it is based on serious miscalculations about Ukraine’s capacity to defend its statehood, the strength of NATO resolve, and quite possibly the readiness of Russians to partake in this aggression. Every setback will prompt Putin to raise the stakes yet further.”

In summary, Putin doesn’t like democracy in his neighbourhood, especially in countries with large Russian speaking populations. He fears any success there will have a risk of such ideas being transplanted and taking roots in Russia. So, he has to act. He will win the initial rounds but lose eventually though no one knows when. There are other views too but mostly in the same vein. I don’t have much to quarrel with these but I think there are other truths to consider in this clear moment of war. 

Firstly, there was a view gaining strength in the past decade that the interconnected nature of global trade and funds flow allows those who orchestrate them to wield tremendous power. An example of this was the way Iran was brought to the negotiating table by the US by freezing them out of SWIFT, a global financial messaging system that’s the spine that supports the money flow across the world. The term that’s often used to explain this ‘weaponized interdependence’. As Daniel Drezner of Tufts University in his introduction to the anthology, The Uses and Abuses of Weaponized Interdependence, puts it:

“Weaponized interdependence (WI) is defined as a condition under which an actor can exploit its position in an embedded network to gain a bargaining advantage over others in a contained system…

WI challenges long-standing ways that international relations experts think about globalization. States with political authority over central economic nodes can weaponize the networks to gather information or choke off economic and information flows, discover and exploit vulnerabilities, compel policy change, and deter unwanted actions.”

In the abstract of their original paper, Weaponized Interdependence: How Global Economic Networks Shape State Coercion, Farell and Newman, also explain this:

“Liberals claim that globalization has led to fragmentation and decentralized networks of power relations. This does not explain how states increasingly “weaponize interdependence” by leveraging global networks of informational and financial exchange for strategic advantage. The theoretical literature on network topography shows how standard models predict that many networks grow asymmetrically so that some nodes are far more connected than others. 

This model nicely describes several key global economic networks, centering on the United States and a few other states. Highly asymmetric networks allow states with (1) effective jurisdiction over the central economic nodes and (2) appropriate domestic institutions and norms to weaponize these structural advantages for coercive ends. 

In particular, two mechanisms can be identified. First, states can employ the “panopticon effect” to gather strategically valuable information. Second, they can employ the “chokepoint effect” to deny network access to adversaries. Tests of the plausibility of these arguments across two extended case studies that provide variation both in the extent of U.S. jurisdiction and in the presence of domestic institutions—the SWIFT financial messaging system and the internet—confirm the framework's expectations. A better understanding of the policy implications of the use and potential overuse of these tools, as well as the response strategies of targeted states, will recast scholarly debates on the relationship between economic globalization and state coercion.”

As we have seen in the past few days, this all-seeing, all-knowing panopticon (like the SWIFT) hasn’t worked as a deterrent against Russia. The Biden administration sanction order sounded like we will see a complete freeze on SWIFT for the biggest Russian banks and energy companies. But tucked under a subclause in that order was an exemption for energy companies. Hah. I mean what are you left with on sanctions if you exempt the Russian energy sector. So, the question is why was this carved out? There is only one answer.

All the networked interdependence by itself doesn’t create real, hard assets on the ground. It only facilitates their trade in a manner that reduces friction. Real world operates a step removed from this. Russia has cheap energy and the EU needs it. And the EU doesn’t love Ukraine more than the cheap, assured heating in their homes. That’s the reality. The other thing that we learned is any kind of freezing out of a node in a global interconnected network doesn’t put that node away for good. The network is so vast with so many strands crisscrossing them that quite soon a new equilibrium is reached. Order is restored and the freeze circumvented. The simple lesson here is that cyber warfare, paralyzing a network or cutting someone lose from the interdependence are legitimate and novel weapons in international conflicts. But when it comes down to the crunch, real assets trump everything. 

The other truth to appreciate is the hollowness of nuclear power as a deterrence to any potential escalation of conflict. The idea was somewhat simplistic. This is captured in the definition of the non-proliferation treaty (NPT):

“…the NPT non-nuclear-weapon states agree never to acquire nuclear weapons and the NPT nuclear-weapon states in exchange agree to share the benefits of peaceful nuclear technology and to pursue nuclear disarmament aimed at the ultimate elimination of their nuclear arsenals.”

Viewed from a perspective of deterrence, what was unwritten was the non-nuclear-weapon state would do good to ally with one or more nuclear-weapon states who would, in turn, help them in case they have to face off a nuclear state. I mean that’s the kind of thing Taiwan depends on. That the US will defend it in case China threatens to send over a few nuclear warheads their way. What’s the basis of this touching confidence in another nation? This is where things get nebulous. It is some kind of a commitment to values of friendship, liberty, human rights and, perhaps fresh air. Maybe this was true for a while in the post WW2 kind of polarised world. It is possible those who fought those wars and saw the iron curtain descend over eastern Europe believed in an exalted value that went beyond self-interest. Though it is difficult to believe how the crimes of Stalin in the 30s, especially in Ukraine, were too different from that of Hitler. Anyway, maybe WW2 was that moment of truth. And that generation realised some things were just too precious. That era and that generation have long gone. Those whom the Ukrainians trusted to come to their aid aren’t raring to get into their battle fatigues. There’s no urgency there while the Ukrainians huddle in their bomb shelters. It is an object lesson for the other smaller nations who are watching this.

Lastly, a global order needs a superpower that has the legitimacy that it will back its promises. The ability to do so is linked to multiple factors including the strength that superpower projects, its willingness to forge partnerships and lead them and its actions in following through on its words. For these to happen, the superpower needs a domestic polity that’s united on how they see their role as the enforcer of global order. If it is fractured on this point and on many others like the US domestic politics is now, it won’t be able to play its role. A default on that means loss of legitimacy. 

What’s happening in Ukraine is the crystallisation of the truths that were evident to all post 9/11 but difficult to prove. That truth is in front of us. You can talk forever about common interests and shared values. It means zilch.

A generation lived under the myth that the free world will take care of its members. That spell is broken.  

Matsyanyaaya: Where do we go Now?

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

As someone who didn’t know that Ukraine was the largest European country west of the Volga river, I don’t have anything to say on the specifics of the Ukraine-Russia conflict. Instead of looking up the operational and tactical aspects of the ongoing war, I’ll zoom out and try to ask: what do these events mean for the global order?

Over the last few days, there have been several articles attempting to answer this question. I have found them to be unhelpful because they focus excessively on the West-Russia divide in geopolitical terms.

What’s missing in these conversations is that the global order is a function of both geopolitics and geoeconomics. That’s why in our book India’s Marathon, we imagined 20 new world order scenarios, at the intersection of key geopolitical and geoeconomic trends. This framework serves as a useful anchor. Its intent is not to predict the future but to imagine the various possibilities.

Using this framework, what we can say is that the sharpening Russia-West conflict does not per se alter the world order situation on the map. We are still in the “Great Walls” scenario at the intersection of a stagnated global economy and an intensifying US-China conflict. If anything, the current war brings out more clearly where each state falls.

Whether Russia installs a puppet regime in Ukraine or not, the incoming sanctions of a united West are going to make it even more dependent on China. China for its own sake is hasn’t been overly appreciative of Russia’s warmongering, but the two states still remain close. China has much to gain from Russia’s presence in the Arctic, its energy supplies, and military equipment. Some scholars have suggested that the West’s refocus on Russia might allow China to achieve a modus vivendi with the US and settle on a “Co-opetitive G2” power distribution. However, it seems unlikely to me given how China has stood by Russia, and how it rebuffed US overtures to prevent Russia from attacking Ukraine.

What might the Great Walls scenario look like? Here’s what we wrote earlier:

US and China relations would break down, leading to a side-lining of global institutions and the world separating into alliances dominated by either power.

The superpowers would compete to expand their blocs while attempting to revive their economies and those of their allies, likely with investment packages or trade barriers as opposed to military intervention.

Both sides would see excessive tech disruption - such as automation - as a threat to stability, but military and software research would continue. Conventional conflict (between the US and China) would mostly be a last resort, and be low-intensity clashes over resources.

The relative lack of coordinated international effort would allow a very high degree of asymmetric warfare, both between states and between states and non-state actors. Owing to the increasing friction between the major powers, agreements on climate change are unlikely to bear fruit.

Updating this assessment after the pandemic hit, we had written that Great Walls will be characterised by three factors:

Stable geopolitics, dynamic geoeconomicsIn the post COVID-19 world, the US will likely see countering China as an overriding national priority. Reorienting supply chains to reduce dependence on China will be an important priority. As a result, the post COVID-19 global recession won’t be easily solved as global trade and investment flows are reoriented, leading to a period of secular stagnation for quite some time.

From One to Many Economic Webs In the post COVID-19 world, many ‘Great Walls of China’ may come up — a new version of the Iron Curtain, where the world is split into three economic webs - one dominated by US markets and investments, one by Chinese markets and investments, and a more diffused collection of middle powers who independently strike bargains with the US and China-led economic webs, and form their own networks of trade with friendly countries.

A New Age of Multilateralism Every facet of policy will be affected by the New Cold War. Like the global economy, the Internet may splinter into multiple interacting webs with unprecedented State oversight, especially outside the old Western liberal democracies. Global bodies would become far less important, and multilateral institutions organised around powerful nation-states become far more important for transnational cooperation.

As the west unites against Russia and China, these trends seem to be getting sharper.

Where does this leave India?

India’s task has gotten a lot tougher than before the war began. As long as the primary focus of the west remains countering China, India gains. As soon as the primary focus becomes Russia, India is on a weak footing.

India would come under significant pressure from both the US and Russia to show support for either side. Given its military overdependence on Russia (something we wrote about in the previous edition) on one hand and the overwhelming agreement with the west on countering China on the other, India’s choices have become more constrained. It will be a serious test of India’s diplomacy to keep both sides happy. It seems to be pushed to strategic autonomy by compulsion, not by choice.

PolicyWTF: Billboard Bans

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

As we like to say, public policy is all around us— the failures, the successes, the whole package. This week I came across an educational PolicyWTF courtesy that evergreen fount of knowledge: Bengaluru’s roads.

See this image below and identify the PolicyWTF.

My photography skills suck so I’ll try to explain in words. The yellow circles mark legal yet empty advertisement holdings. The red circles mark the illegal, haphazard but thriving advertisement hoardings. What gives?

Three years ago, the city government banned advertisement hoardings outright. The reasons: hoardings spoil the city’s aesthetics, cause visual pollution, and are a threat to drivers’ safety. After a number of contortions, this ban still stands.

And what does this ban do? First, it has pushed all advertisement hoardings just beyond the city government limits. Second, it has allowed illegal and more unsafe hoardings to come up. As you can see in the image, a legal, small ad-space high above the eye level of the driver of any vehicle is now replaced by ad boards of all shapes, sizes, and colours blocking a vehicle user’s eyesight. In pursuit of better aesthetics, we have made the roads more unsafe. Instead of using advertisement space fees to supplement the anaemic city finances, the city government now has to spend resources on policing illegal hoardings.

As for aesthetics and visual pollution? Seems like ‘isomorphic mimicry’ to me. With the GST taking away taxation powers of city governments, non-tax revenue through leasing land and advertisement space has become even more important. As long as the city government has to beg the state for half of its revenues, we can forget about improving aesthetics in any meaningful sense.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Ace international relations historian Lawrence Freedman’s take on Putin’s gamble is a must-read.

* [Report] The India Justice Report is a valuable input for the law & order, justice policy pipeline. This data collection exercise can spark off conversations on improving access to justice.

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - Pranay Kotasthane

The ongoing political crisis in Ukraine has a small sub-plot that links to India’s education policy self-goals. Before the current crisis unfolded, I had heard that Russia and Ukraine were popular destinations for aspiring medical students from India. What I didn’t know was how big this cohort is in Ukraine. Multiple news reports claim that there are nearly 18,000 of them in Ukraine alone. Apparently, Indian medical students are also opting to study in Bangladesh, the Philippines, and Kyrgyzstan besides Russia and Ukraine.

Of course, these students are merely responding to incentives. Commonly understood reasons for students taking up courses outside India are the limited number of seats in government medical colleges, and higher costs in private medical colleges. Ask anyone about MBBS education in India, and they will launch into a tirade about how the “commercialisation” of medical education has turned it unaffordable.

But as readers of this newsletter would know, price is just a signal of the underlying market conditions. And so, fixing prices cannot be done by price-fixing. In this particular case, higher prices are due to the low supply of undergraduate medical seats. Apparently, 88,120 seats are on offer every year. For reference, there were 2,86,000 undergraduate seats in China. A good 40 per cent of these seats are in government colleges where the fee is subsidised by the taxes Indian citizens pay, while the remaining 60 per cent are in private colleges where the fee can range from ₹18 lakhs to ₹30 lakhs a year. The demand outstrips the supply by quite a margin and hence the high prices.

Had the market for seats been liquid, many more colleges should have sprung up and brought the prices down. Since there are nearly 600 colleges in India now, collusion by all of them can be ruled out. But clearly, this hasn’t happened, for two reasons.

One, unreasonable restrictions for setting up medical colleges. Until 2019, the regulatory authority for this sector was the Medical Council of India (MCI), an organisation that regulated both medical education and practice. Run by doctors, increasing the supply of doctors wasn’t their highest priority. After all, which beneficiary wants to reduce the “elite-quality” of their professions? Setting up a college meant pleading with this regulator and complying with their conditions like owning 20 acres of land and running an attached hospital. Colleges had to justify their student intake and were evaluated on the basis of things like the size of the “auditorium-cum-examination” hall, classroom sizes, and of course the student fees. In short, all the perverse incentives dutifully put together to create a rent-seeking apparatus par excellence. Corruption rose. Only politicians who could stare down the regulator risked starting new colleges, and the rest stayed away.

Two, the existing medical colleges are dwarfs. In recent times, the number of medical colleges per se has increased handsomely, albeit from a low base. In a Lok Sabha reply, the union health ministry said that 132 medical colleges in the government sector and 77 medical colleges in the private sector have been approved by the NMC/MCI since 2014, an increase of 72 per cent since 2013.

However, the intakes of these colleges continue to remain low. While the number of undergraduate medical seats in China are nearly 3.5 times those in India, the former has far fewer medical colleges — 420 (2018 figure) as against India’s 596 (2021 figure). So, India now has the largest number of medical colleges in the world and yet isn’t producing nearly enough doctors.

The private colleges that pick up the gauntlet prefer to stay small rather than grow. The reason: regulations disincentivise scale. If you were to visit the webpage for starting a new college, you will find five different compliance categories. Depending on whether you admit 50, 100, 150, 200, or 250 students, the regulatory requirements keep scaling up. All the rules mentioned in the previous point — such as hospital seats, number of examination halls — need to increase correspondingly for the student intake to increase. Those who can, set up another college instead. Those who don’t, are conservative with the student intake.

And of course, what is regulation without a price cap! Fees for 50 per cent of the seats in private colleges are capped. There are only so many people in the other 50 per cent who will cross-subsidise the rest. Even 10 per cent of seats going vacant dents profits significantly. So, colleges prefer doing laghu-udyog.

And so, we continue to regret that India falls way below the WHO-recommended target for doctor density. Despite the miserable status quo, the policy community in this sector is unable to confront the trade-offs. Most people think the solution is simple — the union government must establish more medical colleges. They discount the fact that the size of the problem goes beyond the capacity of the government — fiscal and administrative. Enlisting the support of the market is necessary for India to have a shot at meeting the doctor deficit.

There are a few solutions that go against the grain. Dr Devi Shetty recommends introducing undergraduate medical education in private hospitals using a problem-based learning approach. The government has also suggested a two-year bridge course for AYUSH doctors. Whatever the merits or flaws with these solutions, it is difficult to budge the policy orthodoxy.

Like for farming and defence services, debates on healthcare professionals acquire moralising undertones quickly — “commercialisation” becomes evil and economic reasoning is deemed inapplicable. The fear of a poorly trained doctor misdiagnosing patients is used to dead bat any solution for liberalising medical education. Addressing this concern requires strengthening the regulation of medical practice, not smothering medical education.

And so, we continue to be stuck with the status quo. Second-order effects follow. The scarcity of seats generates a huge demand for coaching institutes that can help crack entrance exams, further increasing costs for students. Some states opt out of entrance exams unable to fix the underlying scarcity. The problem doesn’t go away.

If we are serious about changing the status quo, a radical liberalisation of medical education in India is the only option. The problem of ‘bad’ commercialisation can only be solved by more liberalisation. All other solutions are akin to putting a band-aid on a bullet wound.

(Thanks to three friends who understand the healthcare sector much better than me. Mistakes are all mine.)

India Policy Watch: Public Ka Paisa

Insights on burning policy issues in India

— RSJ

Public finance is complex to understand. How the government earns revenue, what principles it follows to allocate its funds among various constituents that are fair and productive, how it distributes its surpluses etc. The list is long. All sorts of frameworks are used to figure this out. Pranay has often written on this topic in previous editions.

A more fundamental question on public finance that doesn’t get covered is this. Who does the money belong to? I mean, of course, it belongs to the government. But where did it get this money from, to begin with? I guess the simplistic answer is it earned money from providing services to its citizens and taxing them for it. Then it built up the surplus, invested the money in creating assets that generate good returns, improved the productivity of the citizens that in turn helped in increasing revenues and this continues nicely so long as it keeps its expenses below its revenues. As we see all around this isn’t as easy for any government. Over time it spends more than it earns and creates a deficit. Then it goes into debt to bridge this gap. If that isn’t forthcoming, it prints more money. All of which is like taking a loan from future generations. And this sort of a giant Ponzi scheme of borrowing fresh money to pay past debt continues. Someone will be left holding the can in distant future. But who cares.

All this is quite intuitive. 

What’s the point of this preamble, you might ask? Well, the two topics I cover today are related to this. In one instance, there was quite surprisingly no “can” to hold for future generation for previous government’s excesses. Instead, there was a prize. So, if the future generations usually hold the can, do they also hold on to the prize in the rare event they get that? We’ll see how that goes. The other case is about where’s inflation in India? And how will the government meet its borrowing targets for the new fiscal?

Your Friendly Neighborhood LIC Agent

To begin, consider this.

You live in a nice, middle-class neighbourhood (the real middle class, not the gated variety). One of these days a nice, dependable sort of young man arrives. He’s a do-gooder sort. He helps with community issues, plays with the kids, tutors them in his spare time - you get the picture. A couple of years later he claims he can help manage your savings. He is open and transparent on how he will do this in a prudent and conservative manner. He will take money from people in the neighbourhood, pool all the funds together and he will invest it. He will earn a 5 per cent commission on whatever surplus he generates for you. You have seen such charlatans before so you’re careful. But you know this nice man. You have come to trust him so all of you decide to give part with some of your savings.

Turns out he is true to his word. He takes a small part of your savings and he keeps investing it every year. He is good at his job. He gives you a stable return. Not spectacular but you never lost any money. He’s a safe pair of hands who delivers.

Every year.

This goes on.

Not for one, two or three years. But say for 60 years. He is that one dependable presence in your lives. Though much older now. He now has a huge pooled fund that he manages. He keeps distributing modest and stable returns every year. But after giving all of you those returns, there’s a large surplus that’s sitting with him.

How did that happen? Well, there are reasons. He’s been conservative in how much return he gives you when the times are good because he thinks there might be tough times in future. Indeed, there were a few bad years in between. But they were never as bad as he had anticipated. So, over time that corpus gets built up. Also, many who invested at the beginning are no more. Their kids have left the country. They haven’t come back to claim the money. Others have left the neighbourhood and probably forgotten they made a small investment all those years ago. 

You get the picture. This old man is now sitting on a large amount that’s unclaimed by anyone. But he’s 85 now. He wants to sell this business to someone, hand over a tidy sum to his daughters and retire to the Himalayas. So, here’s the question: how should he treat that large unclaimed amount?

Should he:

a) distribute this unclaimed amount to all his current and past customers who have helped build his business over the years? After all, these customers took the risk of investing with him and the upside should be theirs. It is their money as a group.

Or,

b) add this unclaimed amount to the regular business that he’s selling to new owners. Why? Because this is the upside of him doing the hard work of running this business and giving steady returns over so many years. Nobody should grudge him this because he’s never defaulted on any of his promises. Whatever remains after that is his. So, he takes the sale proceeds for himself and retires.

Or,

c) keep the unclaimed amount as-is. Tell the new owner this is a separate amount and this has to be kept the same way for a rainy day in future. This is a conservative option but this doesn’t solve the problem of the unclaimed amount. It only kicks it down the road. 

Now, read this:

“State-owned insurance company LIC filed its Draft Red-Herring Prospectus (DRHP) on Sunday. Noteworthy among the risk factors mentioned by the corporation was the splitting of the single ‘Life Fund’ into participatory and non-participatory funds. This will, however, have a positive impact on LIC’s valuations as it approaches the primary market.

Let us start with participatory and non-participatory policies. Under a participatory policy, a policyholder can get a share of the profits of the company. This is received as a bonus. Examples of such products offered by LIC include Jeevan Labh and Bachat Plus. No such sharing of profits happens under non-participatory products, which under the LIC fold includes policies such as Saral Pension and  Nivesh Plus.

As all insurance companies do, LIC also reinvests premium monies that policyholders pay. The profits or surplus that comes about as a result was till September last year held in one single fund. This was the Life Fund. The surplus was divided in the 95:5 ratio between policyholders (in the form of bonuses) and shareholders (which is the Government, in the form of dividends).”

In summary, LIC is that dependable old man.

It is a state-owned company that’s over 60 years old. It has been selling investment products (with a small insurance component) to its customers and it has built up a surplus pool. In one surplus pool (participatory policies), the profit is shared between the policyholders (customers) and LIC’s owner (Government of India) in the ratio of 95:5. In another pool (non-participatory policies), the surplus need not be shared between the shareholders and policyholders. Why? Because here LIC promises some kind of guarantees to customers on their investment and so long as that is met, the surplus belongs to shareholders. And in the same way, if the guarantees were not to be met, the government would have had to pay from its pocket to meet the obligations. So, the risk and rewards are symmetric.

Through an amendment now the government (owner of LIC) has decided the entire accumulated surplus pool sitting with it can be transferred to this non-participatory pool. That’s one move. This move then enables the government as a shareholder of LIC to transfer that surplus to shareholders; current and future. And apart from this transfer, it appears LIC has valued the equity component of this surplus (that is the part that’s invested in shares of public companies) at the current market value. In finance speak, the equity component of the surplus has been marked-to-market.    

How much is this surplus pool and where has it come from?

Well, LIC has run for over 60 years. Customers have left without taking their money, some have died and no one has claimed the amount and LIC has been prudent in paying out annual returns to its customers and building a surplus for a rainy day ahead. How much is this amount that LIC has transferred to the book that’s now attributable to the shareholders? Around ₹4 trillion or ₹4 lakh crores. That’s what it looks like. Mind you, there’s nothing illegal here. There’s an amendment made and it is perfectly fine to then transfer the surplus to shareholders after that. And it is also fine to mark-to-market the equity component.

But then we go back to the original set of three questions I raised about the old man’s business. Now ask them for LIC.

Should it:

a) distribute this unclaimed amount to all their customers who have helped build LIC’s business over the years? After all, the customers have taken the risk of investing with them and the upside should be theirs.

b) claim this unclaimed amount to itself and its shareholders. It becomes a useful tool to sell its IPO as an attractive proposition. Nobody should grudge them this because they have never defaulted on any of their promises. This is the upside of them running the business and giving steady returns over so many years.

c) keep the unclaimed amount as-is. Tell the new shareholders this is a separate amount and this has to be kept the same way. This is a safe option but this doesn’t solve the problem of the unclaimed amount. It only kicks it down the road. 

The answer based on the LIC IPO is b).

I don’t know if there’s a right answer here.

But I have a feeling many policyholders may ask why not a)? 

It goes back to that question that’s not often asked in public finance. Whose money is it to start with?

That brings me to the other point I wanted to cover.

Where Is Inflation? 

We had the inflation prints of January come for India and the US last week. For the first time in over 30 years, we now have five consecutive months where US consumer inflation is higher than that of India. The US reported a consumer price inflation (CPI) of 7.5 per cent for January ‘22 while the corresponding number for India was 6 per cent. It looks like this trend will continue for the entire year.

So, what should we make of this? I mean leaving aside the usual chest-thumping in some quarters on how this shows the current government is managing the economy better than the Biden administration. There are five key points for us to consider.

One, the US inflation is being driven by three factors. The huge fiscal stimulus they gave their economy during the pandemic. Broad estimates suggest the total stimulus was about 25 per cent of the US economy. This has meant significant liquidity in the system. That coupled with supply chain bottlenecks that still afflict the global trade system and an almost full employment scenario means there’s more money chasing fewer goods in the US. Housing prices are high, petrol prices have gone up and consumption is up by 10 per cent last year. So, inflation. The Fed (US central bank) has no option but to raise interest rates to make money ‘costlier’ and reduce the liquidity in the system. Not taming inflation will hurt the Biden government politically. And like we have often said before, inflation is the worst kind of tax on the poor.

Two, the inflation outlook of the RBI in India is fairly benign. They expect it to be about 4.5 per cent next year. What explains this? Beyond all other rhetoric, the problem in India is demand. Private consumption which has been the primary driver of the Indian economy in the past decade is still at pre-pandemic levels. People aren’t spending enough. Maybe because their incomes aren’t growing and that’s because the economy isn’t really growing at a macro level. So, all the song and dance about stock markets, unicorns and wage inflation among techies aside, the aggregate numbers tell us we aren’t spending enough. And this despite the supply chain bottlenecks and higher liquidity environment that we are in which should lead to inflation in usual circumstances. 

Three, because of this the RBI doesn’t want to cut rates. The RBI came out with a very ‘dovish’ outlook in the MPC that concluded last week. Behind all the technical jargon, the message was this. We aren’t growing fast enough and we see the ‘recovery’ after the pandemic tapering off soon. The RBI spoke of the multiple indicators that suggest a slowing down of momentum in post-pandemic recovery - sale of automobiles, tractors, capital goods and fall in purchasing manager’s index (PMI) scores, all leading indicators of economic activity. So, RBI will continue to be as accommodating as possible to spur growth. RBI believes it is not behind the curve on this while most of the market thinks otherwise. The broader point about the recovery being weak and ‘k-shaped’ has been made in our past editions multiple times. There’s an underlying weakness in the economy that has to be addressed by first acknowledging and then working on it. 

Four, there’s a scenario in the next six months where the RBI will continue to hold interest rates in India while the US may have multiple rate hikes that could add up to between 75-100 bps (100 bps = 1 per cent). This means the gap between interest rates in India and the US will come down materially. Usually, this means spillover and volatility risks of the dollars flowing out of India and hurting the INR exchange rate. The RBI seems to be comfortable that it has healthy forex reserves, a narrow current account deficit and continued inbound investment flow that can cushion this risk. We will have to see how long this comfort lasts. 

Finally, the RBI has a task on its hand to manage this huge borrowing plan, remaining dovish to not scuttle even the weak recovery on hand while managing the risk of a narrower rate differential between India and the US. And the government has to find ways to service the ever-increasing interest burden of its debt while staying on course for the ambitious capex plan it has laid out. The borrowing programme based on the budget presented is to the tune of Rs. 15 lac crores in the coming year. Managing this requires a lot of skill. Whatever it does, there will be more debt in its books. 

That brings us back to that question again.

Who is footing the bill for this? Whose money is it?

Matsyanyaaya: Aap Hamaare Hain Kaun, Russia?

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

As Russia-Ukraine tensions threaten to reorder international arrangements, the question Aap Hamaare Hain Kaun, Russia? has gained renewed importance. “What does a worsening relationship between Russia and the West means for India’s strategic autonomy” has been a theme that’s dominated the mental bandwidth of India’s strategic community over the past month.

The choice for India should be obvious. If it has to pick between the US and Russia, the convergence with the US on all three parameters — interests, values, and capacities — far outweighs Russia’s importance to India.

Yet, three objections persist.

The first argument is that a strong relationship with Russia is necessary for India’s strategic autonomy. Without this partnership, the fear is that India will become a mere pawn in the hands of the US.

I vehemently disagree. Strategic autonomy is a function of power. And to gain more power, it's better to partner with a stronger partner who can build your capability. Even if it leads to a loss of tactical autonomy, it is better than betting on a weaker partner like Russia. To side with Russia just for the sake of proving one’s independent credentials is the precise opposite of ‘strategic’ thinking. Rajesh Rajagopalan puts it bluntly here.

“The argument that India’s strategic autonomy requires it to maintain high levels of political and defence relations with Russia is particularly thoughtless. Strategic autonomy is an objective of foreign policy, not a doctrine. As an objective, the question to ask is — which policy helps increase India’s strategic autonomy? In a complex international environment, for a relatively weak power, the answer requires picking among bad, unappetising choices.

A China-dominated Asian order, which will be the consequence of Moscow’s efforts to undermine the US, can hardly be conducive to India’s strategic autonomy. Refusing to deal with the deepening chasm in India-Russia relations will not make it go away, it will only make the fall that much harder.”

The second objection is even more ideological. The old guard in the strategic community of India has a soft spot for Russia. Soviet Union helped India in the 1971 war while the US backed Pakistan, and Russia has been a reliable partner through thick and thin for India, while the US hasn’t, are the arguments put forward in support of this line of thinking.

I again disagree. To explain why, consider this initial framework for assessing the reliability in international relations. This framework assigns reliability perceptions based on the impact of state X’s actions on India’s interests. Each quadrant assigns binary labels to the state based on its chosen strategy.

The strictest condition for reliability is when a state takes a self-harming action in India’s interest (lower-right quadrant). For many, the Soviet Union met this criterion by deploying destroyers and submarines in the Bay of Bengal to ward off the US Task Force 74 during the 1971 war. What’s forgotten is that four months before the war, India and the USSR had signed an Indo–Soviet Treaty of Peace, Friendship and Cooperation. India had effectively allied with the USSR. USSR’s actions were thus at best reliable in a much looser sense (upper-right and lower-left quadrants). We should get over this fiction of Russia being India’s super-reliable partner. Especially in today’s situation when it is a much weaker partner heavily dependent on India’s foremost adversary.

The third objection is a realistic one. Since India is heavily dependent on Russia’s weapon systems, it cannot let the relationship worsen in the short term. I agree with this framing. While the short-term options are limited, the immediate implication is two-fold. One, diversify the trade relationship with Russia so that India can deter Russia’s denial of access to defence equipment by quid-pro-quo. Two, reduce dependence on Russia by buying from partners with whom India has a broader partnership. This is a point Nitin Pai has made for many years. In his words:

The fundamental challenge remains that our relations with Russia are massively concentrated on defence trade. It is best to purchase defence equipment from a country with whom we have broad and deep trade relations; failing which, to try and build such relations with the country we’re buying arms from. Russia falls into the latter category. Yet, bilateral trade has remained around $10 billion for years, with the balance being in Russia’s favour. India trades more with Venezuela, Belgium and South Africa.

In short, Russia is important to India for an instrumental purpose alone. No permanent friends, only permanent interests, and all that.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] Pavan Srinath on the need to liberalise medical education

* [Articles] Read these two opposing viewpoints in ThePrint on India-Russia relationship by Rajesh Rajagopalan and Andrew Korybko.

* [Article] How we fixed the Ozone Layer, by Hannah Ritchie for Works in Progress is fodder for a solutionist.

Insights on burning policy issues in India

— RSJ

The hijab row roiling colleges in the Udupi district of Karnataka reached the courts this week. A full bench of the Karnataka High Court ruled on Thursday that all students are restrained from wearing clothes with religious symbolism within classrooms in institutions that have a prescribed dress code or uniform. The bench adjourned the hearing to Monday while requesting the state government to reopen the educational institutions. The government meanwhile declared holidays till Feb 16 to avoid the burden of opening up the colleges in the interim. 

The order has some interesting passages including this:

“It hardly needs to be mentioned that ours is a country of plural cultures, religions, and languages. Being a secular State, it does not identify itself with any religion as its own. Every citizen has the right to profess and practice any faith of choice is true. However, such a right not being absolute is susceptible to reasonable restrictions as provided by the Constitution of India. Whether wearing of hijab in the classroom is part of the essential religious practice of Islam in the light of constitutional guarantees, needs a deeper examination.”

This is an old conflict from the time of enlightenment when reason, empiricism and individual liberty were placed on the pedestal by the leading thinkers of the time. Industrialisation, the weakening of traditional social structures because of population shifts to urban centres, and the loosening of the grip of religion in everyday lives meant the questions about the place of religion in civil society and the relation between church and state animated the political and social discourse. Over time though doubts emerged about the benefits of such progressivism. The anxiety over losing a sense of community, the guilt of turning away from one’s religion and a kind of longing for a past that was precious but now lost sowed the roots of cultural conservatism as we know it today. 

In less diverse societies than India, this battle is framed as that between individual freedom and choice versus the inner order and stability that a society draws from its legacy and culture collectively. This itself has been fraught as we have seen in the backlash against liberalism over the last decade. Things get more complicated in India. There’s the individual freedom to choose and the society that has to contend with that freedom and its impact on it way of life. And then there’s also the community, often in minority, to which the individual belongs which might privilege its desire to conserve its values over both the individual and the society.

This is a three-way problem. Should we see the girls wanting to wear hijab in educational institutions as exercising their freedom? Before we even get to whether this freedom has to be circumscribed in certain scenarios like the High Court has opined, should we ask whether we are convinced this choice of hijab is an individual choice? Some of you may ask does that matter. The girl students are themselves saying it is what they want to wear. Who are we to object? But is that choice so obviously individual? Or, is it the choice of another collective, the religious community, that’s imposing it covertly through its own code that’s coercive? Then, in the name of supporting the individual choice of wearing hijab, are we subjugating the choices of many other girls in future who might be coerced into wearing hijab were this battle won by these girls? Is the individual freedom a moral absolute in all circumstances? Or, does this kind of freedom that might mean absence of choice for other girls in choosing not to wear hijab in future that liberals should get behind in force?  

Our founders in their debates at the constituent assembly contended with these three forces - the primacy of the individual on the back of which the liberal constitution was being written, the communal identity of people that gave their lives meaning and structure over centuries and couldn’t be wished away, and the need for a centripetal force of legal and social system that drew the society closer together. Some kind of a balance was attempted and written into the constitution as fundamental rights. But a lot was left to the leaders and the people to find for themselves through practice, customs and traditions which would differ across regions and communities. It was acknowledged that people will have to be trusted to follow what’s acceptable and what has to be changed in their social realms without imposing a strict rule of law over it. This is why it is futile to argue over cultural issues through the lens of liberty enshrined in the constitution. There are enough exceptions all around us for every stripe of argument to be made for and against it. This is what we see in the hijab row. There are arguments about the individual choice of young Muslim girls and their rights over their bodies. There is a case made about how religious symbols of Sikhs are allowed within educational institutions or how easily we accept the Hindu festivals of Ganesh Puja or Saraswati Puja. And there’s the point made about keeping educational institutions free from overt religious symbolism else we set off on a slippery slope. There’s no easy or right answer.

The only answer to this is by asking what was the custom in these schools and colleges before the row started. And to revert to the status quo. Because things only get worse when trying to ‘solve’ such issues. Of course, any attempt to solve this must also be seen in conjunction with the politics that’s dominant in society now. It is difficult to argue on the principle of keeping religious symbolism away from the matters of the state when you have an almost daily spectacle of political leaders flaunting visible religious symbols of the majority denomination deliberately. That’s again a deviation from the status quo that threatens a fragile equilibrium we have maintained since independence. But maybe that’s the intent all along. To keep stirring the pot of communal disharmony to distract us. It isn’t so much about shaking things up and awakening the spirit that brings us together. That’s the ruse used to explain our relative underperformance. In essence, this is that old colonial game to use culture and religion to divide us in a new garb.    

In his famous essay, Culture and Anarchy (1869), cultural conservative, Matthew Arnold, made two key points about culture that I thought will be useful to bring here. It clarifies why culture is important to claim for social order and what kind of customs take us further in that pursuit of harmony and inner stability. It is a useful test to apply when we claim cultural practices as a manifestation of freedom of choice. Arnold writes:

“The whole scope of the essay is to recommend culture as the great help out of our present difficulties; culture being a pursuit of our total perfection by means of getting to know, on all the matters which most concern us, the best which has been thought and said in the world; and through this knowledge, turning a stream of fresh and free thought upon our stock notions and habits, which we now follow staunchly but mechanically, vainly imagining that there is a virtue in following them staunchly which makes up for the mischief of following them mechanically. This, and this alone, is the scope of the following essay. And the culture we recommend is, above all, an inward operation.”

Further, he writes:

“Thus, in our eyes, the very framework and exterior order of the State, whoever may administer the State, is sacred; and culture is the most resolute enemy of anarchy, because of the great hopes and designs for the State which culture teaches us to nourish. But as, believing in right reason, and having faith in the progress of humanity towards perfection, and ever labouring for this end, we grow to have clearer sight of the ideas of right reason, and of the elements and helps of perfection, and come gradually to fill the framework of the State with them, to fashion its internal composition and all its laws and institutions conformably to them, and to make the State more and more the expression, as we say, of our best self, which is not manifold, and vulgar, and unstable, and contentious, and ever−varying, but one, and noble, and secure, and peaceful, and the same for all mankind,−−with what aversion shall we not then regard anarchy, with what firmness shall we not check it, when there is so much that is so precious which it will endanger.

Nevertheless, though for resisting anarchy the lovers of culture may prize and employ fire and strength, yet they must, at the same time, bear constantly in mind that it is not at this moment true, what the majority of people tell us, that the world wants fire and strength more than sweetness and light, and that things are for the most part to be settled first and understood afterwards. We have seen how much of our present perplexities and confusion this untrue notion of the majority of people amongst us has caused, and tends to perpetuate. Therefore the true business of the friends of culture now is, to dissipate this false notion, to spread the belief in right reason and in a firm intelligible law of things, and to get men to try, in preference to staunchly acting with imperfect knowledge, to obtain some sounder basis of knowledge on which to act. This is what the friends and lovers of culture have to do, however the believers in action may grow impatient with us for saying so, and may insist on our lending a hand to their practical operations and showing a commendable interest in them.”

It is a point made over several editions in this newsletter. There’s value in custom and tradition of where we are today. It doesn’t need to be changed for an imaginary hoary past, nor do we need a ‘solution’ to a social problem of today that we think will unlock our glorious future. There’s very little to be achieved in stirring things up to assert an identity that might be more collective than individual. The values of liberalism or conservatism aren’t served here. There’s a status quo of culture that’s vital to be maintained so that true progress can be made that will lift the millions out of poverty in India. That’s the right kind of moral imperative to put our weight behind.  

India Policy Watch #2: What do Calls for Redistribution get Wrong?

Insights on burning policy issues in India

- Pranay Kotasthane

The last two weeks witnessed a familiar discussion on inequality. The NGO Oxfam International came out with another report Inequality Kills: India Supplement 2022. In response, some commentators questioned the report’s main recommendations (1,2). Regardless, it will continue to be cited and used in support of redistribution and higher rates of taxation.

Like many other reports of this genre, it gets the problem definition right but the proposed solutions are simplistic and betray the lack of public finance knowledge. What fascinates me is how calls for more taxes are written, discussed, and debated without an understanding of public finance and public policy fundamentals. So here’s an attempt to rectify this flaw in such reports.

To begin with the problem, the Oxfam report argues that "India’s governance structures promote the accumulation of wealth by a few while failing to provide safety nets to the rest of the population." Not much to contest here. The cited evidence — and one that makes for a good narrative — is that "The number of Indian billionaires grew from 102 in 2020 to 142 in 2021, the worst year yet for India during the pandemic. This was also the year when the share of the bottom 50 per cent of the population in national wealth was a mere 6 per cent."

Based on this problem statement, the proposed solution is "We call upon the government to redistribute India’s wealth from the super-rich to generate resources for the majority by reintroducing the wealth tax and to generate revenue to invest in the education and health of future generations by imposing a temporary one per cent surcharge on the rich for health and education."

Now, let me begin by stating what I agree with this report. It is true that COVID-19 has been unequal in its impact. RSJ has written about the K-shaped recovery here, here, and here in this newsletter. This pandemic has increased the monetary and non-monetary poverty headcount ratio, but we will know for sure only after the next round of the National Family Health Survey. For the next year or so, higher direct transfers to the poor, subsidised food, more credit, and higher employment guarantee scheme expenses are all desperately needed.

For the authors, the solution to this rise in poverty is simple: raise more taxes from the rich and distribute that money to the poor.

There are at least four problems with this line of thinking.

One: We’ve Been Here Before

“Taxation is also a major instrument in all modern societies to achieve greater equality of incomes and wealth. It is, therefore, proposed to make our direct tax system serve this purpose by increasing income taxation at higher levels as well as by substantially enhancing the present rates of taxation on wealth and gifts.”

The above lines seem to have been taken out straight from the Oxfam report. They aren’t. They are from Indira Gandhi’s 1970-71 budget speech. This line of thinking led to eleven brackets of “progressive” personal income tax, with rates varying from 10 per cent to 85 per cent. Further, a 15% surcharge on the super-rich meant that anyone with an annual income of Rs 2 lakh or more had to pay a marginal tax rate of 97.5 per cent. There was also a wealth tax of 5 per cent. Corporate taxes varied in the range of 45 - 65 per cent.

Surely, if the problem of poverty could be solved merely by taxing the rich, garibi would have been hataoed by the 1970s itself. Instead, these confiscatory rates of taxation went against the pursuit of equality in three ways.

Unsurprisingly, there was large-scale tax evasion. Who in their right minds will pay such high rates of taxes? I mean, people still fudge their income tax returns. Second, the rich took their businesses outside India, jobs were lost, and we learnt another important lesson: as capital is more mobile than labour, high taxes on capital end up being a tax on labour. Third, these high nominal rates of taxes didn’t translate into more revenue for the government because of various exemptions to companies. The tax policy was flogged in service of so many objectives —each requiring exemptions— that companies could offset much of their taxes against these allowances.

So, we have tried these measures before and failed. Not just in India, the highest marginal tax rates in UK and US were at the 90 per cent mark in the 1950s. Gradually, all these countries came to the realisation that redistribution should be one of the goals of the expenditure side of the budget. Raising revenues shouldn’t be tasked with this goal at all. Broadening the base, lowering the tax rates for all individuals and companies, and getting rid of tax exemptions is more progressive than highly progressive taxation. As we have written before, Robinhood Taxes don’t work.

Reports asking for higher and newer taxes must explain how their magic potion is going to have different results this time around.

Two: The High Costs of Raising New Taxes

I doubt whether the authors have tried to understand what it means to raise wealth taxes. Raising any tax is full of friction. Three costs are involved: administrative, compliance, and economic efficiency. The objective of any tax should be to increase revenue while minimising these costs. Wealth taxes fail on all three counts. Measuring wealth is not easy. For instance, estimating the cost of the artwork owned by a rich family requires the tax authority to have expertise in art, thus the administrative costs are significant. Next, people don’t have all their money in easily visible financial assets such as stocks. Some of the assets could be notional (such as equity in early-stage start-ups), some other assets could be outside India and still others in immovables such as real estate. Complying with wealth tax regulations on each of these assets isn’t easy. Finally, such a tax will have economic efficiency costs — people will transfer wealth (notionally) to relatives, take money out of India, and invest in assets that are difficult to value.

The burden of proof lies on the authors to show how the proposed taxes will generate more money than the costs required for their implementation.

Three: The Government Doesn’t Rely on Taxes Alone

Many people seem to think that the government is not spending on support for the poor because its tax revenues are less. Hence the calls for new taxes so that the urgent support to the poor may become viable. Check these lines from the Oxfam report:

“Instead, the burden of taxation in India currently rests on the shoulders of India’s middle class and the poor and not addressing the proposal for a one-time tax on the wealthy, for COVID-19 recovery, has resulted in the government using the only other available option i.e., raising funds through indirect tax revenue which penalises the poor.”

This again betrays a lack of understanding of government finances. The fuel sustaining the additional government expenditure in the last two years is not tax revenue but debt. In other words, nothing stops the government from spending more on urgent and immediate support for the poor adversely impacted by the pandemic. The additional borrowing will lead to higher taxes in the future, but it can be justifiable given the once-in-a-century situation we are facing now.

Four: Law of the Instrument

"I suppose it is tempting, if the only tool you have is a hammer, to treat everything as if it were a nail". These memorable words from Abraham Maslow indicate a cognitive bias that is at play in these calls for redistribution. What really hurts many people is to see a select few gain access to immense wealth and power. Redistribution becomes the “hammer” solution to prevent the concentration of money and power in a few hands. But if the core problem is to solve the phenomenon of the super-rich gaining more money and power, other better solutions exist.

In recent times, it is indeed the case that market concentration has increased across industries in India. So, if the super-rich are using anti-competitive means to eliminate competition and gain monopoly power, we need better competition laws, not more wealth taxes. Second, if the government wants more money from the super-rich, all it needs to do is to free the tax policy from the burden of several exemptions provided for other goals such as balancing regional development, increasing investment, generating employment, or promoting small-sector industries. A policy that tries to attain several objectives at once achieves none.

Growth, not Redistribution is the Answer

These four problems apart, inequality crusaders must realise that taking money from the billionaires through a new surcharge is not going to make any significant dent in poverty in India. The only solution is economic growth, as we have discussed many times before in this newsletter.

Much of the global inequality is between countries and not within countries. Across countries, variations in many important dimensions — literacy, life satisfaction, and health outcomes— can be explained by one single variable: incomes. Tackling inequality then essentially means increasing the incomes of poorer countries rapidly. Economic growth is a moral imperative.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Meanwhile, France has moved to ban hijab in competitive sports. "We must have the courage, wherever possible to do so, to preserve the unity and cohesion of the Republic," said Jaqueline Eustache-Brinio, a senator from the right-wing Les Républicains party.

* [Article] Do not miss this excellent article on global inequality and its implications for economic growth by Max Roser.

* [Paper] To understand and appreciate India’s experience with tax policies, read this India Policy Forum 2005-06 paper by Rao & Rao.

* [Article] Rajesh Rajagopalan has a characteristically clear-minded article on the implications of the Russia-Ukraine conflict on India. In this one article, he demolishes many myths governing India’s relationship with Russia.

India Policy Watch #1: The Indefensibility of India’s Defence Financing

Insights on burning policy issues in India

— Pranay Kotasthane

Government budgets should be seen in the context of on-ground realities and future targets. The immediate context of the latest defence budget is the continuing stand-off between Indian and Chinese troops in eastern Ladakh. Since it began in May 2020, this stand-off has underlined the need to urgently equip India's defence forces to manage the strategic challenge posed by China. More firepower than Pakistan can no longer be the end goal of defence planning. Instead, India needs a decadal plan to effectively block and deter China's salami-slicing strategy.  The other important element underlying the defence budget is the COVID-19 pandemic. Last year's economic downturn further reduced the fiscal space and precluded a substantial rise in defence expenditure. Given that the government expects the economy to cross the pre-pandemic level in the upcoming financial year, it is worth comparing this year's defence budget with the pre-pandemic and pre-Ladakh stand-off year FY20. The traditional approach of comparing expenditures with the last year's budget is not as helpful because the previous year was an anomaly on many counts.First, the overall trend in defence spending is not encouraging. One way to measure the importance of a sector is to analyse the percentage of overall government expenditure it occupies. The Ministry of Defence's (MoD) relative importance has declined on this count. MoD expenditure now comprises 2.02 % of GDP (down from 2.22% in FY20) and 13.3% of central government expenditure (down from 16.7% in FY20). The more worrying part is that this decline is not recent. Since FY10, the MoD's expenditure has been steadily falling as a proportion of government expenditure. The Parliamentary Standing Committee on Defence's 2017-18 exhortation that defence spending of 3% GDP is 'optimal and necessary for ensuring the operational preparedness of the Forces' hasn't had the desired effect.

Next, the change in the composition of MoD expenditure reveals a lot about government priorities. There are some positive signs on this count. The spending on defence pensions has relatively declined. It now comprises 22% of the MoD expenditure, down from 26% in FY20. One reason for this decline is that previous years' pension payments included some arrears. While this is welcome news, the respite is temporary. The five-yearly revision of One Rank One Pension (OROP) is due, and when it gets approved, pension expenditure will swell once again. Effective lateral entry mechanisms and a customised national pension scheme for the armed forces are the only long-term solutions for controlling pension spending.Another vital component of the defence budget is the pay and allowances for the armed forces personnel and defence civilians. Expenditure on this component has increased relative to other items. While salaries made up 29.9% of MoD's allocation in FY20, they are budgeted to be at 31.1% of MoD expense in FY23.The relative decline in pension expenditure has allowed some fiscal space for more capital expenditure on arms, ammunition, and platforms. Capital outlay now makes up 29% of MoD expenditure compared to 24.5% in FY20. For the third straight year, the capital expenditure exceeds the expenditure on pensions, reversing a worrying trend that continued until FY20.

However, this compositional improvement doesn’t translate much in absolute terms, despite the government congratulating itself for increasing the capital outlay. As defence analyst Ajai Shukla observes:

“the MoD announced that military modernisation and border infrastructure development was at the centre stage of the national security and defence planning process. To support this, the MoD pointed to the steady rise in the defence capital outlay from Rs 86,740 crore in 2013-14 to 1.52 lakh crore in 2022-23 – an enhancement of 76 per cent over a period of nine years. While that sounds like a healthy growth rate, it actually amounts to less than 5 per cent, compounded annually – barely enough to cater for inflation and foreign exchange rate variation.”

The Indian Navy's share of this capital expenditure has increased to 35%, up from the 27% range between FY16 and FY20. This increase is significant as the response to China's build-up in the mountains might well lie in building deterrence in the oceans. Budgetary allocations indicate that the government is trying to build up India's naval strength but at a slow pace. Ajai Shukla points out how the Navy plans to utilise this allocation:

This increment will be needed to support the acquisition of new platforms, such as six air-independent propulsion (AIP) submarines being acquired under Project 75-I, a second indigenous aircraft carrier (IAC-2), 57 twin-engine deck-based fighters (TEDBFs) and four more P-8I Poseidon long-range maritime patrol aircraft to keep a watch over the Indian Ocean. The navy is also creating operational and strategic infrastructure that will be needed when the tri-service maritime command is operationalised in Karwar, near Goa.

The other small bit of good news was a substantial increase in the capital expenditure budget got the Indian Coast Guard and the Border Roads Organisation. This will help accelerate the buildup of security infrastructure on India’s land and maritime borders in peacetime.

While the capital outlay has increased in monetary terms, it might not immediately translate into better hardware. That's because the government has earmarked 68% of the procurement budget for domestic players through negative import lists. It will take a few years for Indian players to build local manufacturing expertise and meet quality standards. Moreover, an umbrella of protectionism often disincentivises companies from making world-beating products. Aatmanirbharta has its costs; at least in the short term, the armed forces will be bearing a significant chunk of this cost.A disappointing miss is the dedicated non-lapsable fund for modernisation, recommended by the Fifteenth Finance Commission and accepted in principle by the government in FY22. This fund has been a long-standing demand of the MoD to make multi-year payments of defence equipment easier. This fund was to be seeded by transfers from the government, monetisation of defence land, and disinvestment proceeds of defence public sector units. However, there is no indication in the budget about the progress of this critical reform.

The Hour of Reckoning

These discussions on the defence budgets give us a rough idea about the priority that governments accord to defence. Beyond that purpose, these insights have limited value as they merely focus on the relative changes from past years.

The most important question — how much should India really spend on defence given its economic situation and threat perceptions? — is never asked, and hence never answered.

Year after year, the parliamentary standing committee on defence remarks that the MoD be allotted 3 per cent GDP. Although the basis of this 3 per cent anchor has never been explained, it has a debilitating effect on military reforms. Instead of confronting tough trade-offs, the military establishment finds it convenient to blame the government of the day for not raising the defence expenditure to 3 per cent GDP. The government for its part approves unsustainable personnel expenditures such as a One Rank One Pension (OROP) scheme without assessing its long term economic impact on defence preparedness. The net effect is that around the defence budget every year, a “passing the blame” game ensues. The armed forces personnel blame defence civilians for eating into the defence expenditure. The military establishment blames the bureaucracy for financial delays. The government responds to the parliament that “all is well”, not to worry.

In reality, India’s defence planning needs a strong dose of economic reasoning. The defence ministry needs economists and defence planners who can create expenditure plans based on domestic economic conditions, resource constraints, and future threat scenarios. A part of military modernisation has to be about building its financial planning and forecasting capability. Without building this capacity, we would be shooting in the dark against an adversary that’s richer and better equipped.

(A condensed version of this article was published in Hindustan Times, 3rd Feb edition)

India Policy Watch #2: Contextualising the FY23 Union Budget

Insights on burning policy issues in India

— Pranay Kotasthane

By now, you would have already read tens of fine-grained budget analyses. So, here’s something different. Earlier this week, I spoke with Narayan Ramachandran for the Bangalore International Centre’s Podcast. Instead of focusing on sectoral spending, we zoomed out to locate this budget in the context of India’s economic trajectory over the last decade. Here’s the conversation (also available on all podcast apps).

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] On All Things Policy, I spoke with Aarushi about why many policies end up being less effective than hoped?

* [Article] Pramit Bhattacharya has an excellent take on how to make sense of the big, confusing, and often misleading numbers in the budget. This article should be a mandatory reading before you go through any budget analysis.

* [Article] Resolving municipal distress in India, by Adam Feibelman and Bhargavi Zaveri-Shah on The Leap Blog explore a promising source of municipal finances.

India Policy Watch #1: Call Of Duty

Insights on burning policy issues in India

- RSJ

Many among you of a particular age might remember a familiar trope from old Hindi films. A key protagonist, grievously injured or sick, is wheeled into the operation theatre. There’s a small red bulb on top of the door that turns on. Grim music plays in the background. After a while, the surgeon steps out, take off his gloves and looks at the assorted mix of anxious relatives with resignation. Then he says, “ab inhe dawa ki nahin dua ki zaroorat hai” (he needs prayers now; not umm… paracetamol).

That’s how I feel when I hear public discourse in any democracy get tangled up between rights and duties. Not a lot of good has come out of exhorting people to do their duty in the history of this world. So pardon my anxiety when I find constitutional functionaries conflate rights and duties, or worse, seem to privilege duties over rights. But that’s exactly what I have been coming across in the past two months. Two examples will suffice. Last week the PM made these remarks in an event organised by Brahma Kumaris Sanstha:

At the same time, we also have to admit that in the 75 years after Independence, a malaise has afflicted our society, our nation and all of us. It is that we turned away from our duties and did not give them primacy. In the last 75 years, we only kept talking about rights, fighting for rights and wasting our time. The issue of rights may be right to some extent in certain circumstances, but neglecting one's duties completely has played a huge role in keeping India vulnerable.

India lost considerable time because duties were not accorded priority. We can make up for the gap which has been created due to primacy about rights while keeping duties at bay in these 75 years by discharging duties in the next 25 years.

A few days later, the President had this to say in his address to the nation on the eve of the Republic Day:

Rights and duties are two sides of the same coin. The observance of the Fundamental Duties mentioned in the Constitution by the citizens creates the proper environment for enjoyment of Fundamental Rights.

….Patriotism strengthens the sense of duty among citizens. Whether you are a doctor or a lawyer, a shopkeeper or office-worker, a sanitation employee or a labourer, doing one’s duty well and efficiently is the first and foremost contribution you make to the nation.

There are many, and their numbers are probably rising in India, who might wonder what’s remotely problematic with this kind of framing of rights and duties? Isn’t it true that we, Indians, don’t do enough for our country? Or, is this not what JFK meant when uttered those famous lines - “Ask not what your country can do for you – ask what you can do for your country.” Isn’t a call for public service and invoking a spirit of self-sacrifice for nation-building important? This is what leaders are supposed to do, they might say.

I won’t disagree so long as there’s clarity on the nature of rights and duties and where they are placed in relation to one another. This is often misunderstood in India where duty or its nearest equivalent Sanskrit term, dharma, has great civilisational and cultural significance. Rights are often seen as some kind of a western enlightenment imposition on our society which otherwise knew its dharma and its karma. Unfortunately, this as we will see, reflects both a shallow understanding of rights and of dharma.

Rights Aren’t Earned

The first notion to appreciate is that regardless of social, ethnic or temporal differences, an individual is born with certain rights. You could call them fundamental or inalienable. That she is endowed with these rights is prior to any other knowledge about her. This privilege of rights is what creates a corresponding set of duties among others. For instance, the right to life places the onus on others to not kill her. This can be of a legal nature which is enforceable by laws of the society. Or, in case of other rights, the onus on others could be a moral one which is then protected by a code of living together that’s understood by all. This onus then is the duty that an individual has towards rest of the community. It stems from accepting that others have rights. In other words, rights are ontologically prior to duties. This is the basis for the creation of any community. You respect individual rights, you create codes to protect them and living by that code becomes the duty of the members of the community. This is how societies are built.

Ronald Dworkin, the American philosopher, in his book Taking Rights Seriously, calls rights as ‘trumps’ that can be used to overturn any justification of collective imposition on an individual:

“Individual rights are political trumps held by individuals. Individuals have rights when, for some reason, a collective goal is not a sufficient justification for denying them what they wish, as individuals, to have or to do, or not a sufficient justification for imposing some loss or injury upon them.

We may therefore say that justice as fairness rests on the assumption of a natural right of all men and women to equality of concern and respect, a right they possess not by virtue of birth or characteristic or merit or excellence but simply as human beings with the capacity to make plans and give justice.”

Between Rights And Duties

But is being a rights absolutist enough to have a functioning and effective society? What’s the kind of interplay between rights and duties? Are there any grounds to limit the definition of a right to serve a larger public benefit? This is particularly tricky territory. A useful framework to think about this is to use what’s called “the Hohfeldian incidents” in jurisprudence. Named after the American legal theorist, Wesley Hohfeld, it explains the internal structure of any right to have four components or ‘elements’, namely, privilege, claim, power and immunity. Understanding this ‘molecular structure’ of a right is key to understanding its interplay with duty.

Privilege: You have the right to sleep on a weekend afternoon. This right is a privilege. You have no duty not to do it. No one can say it is your duty not to sleep on a weekend afternoon.

Claim: You have an employment contract with your employer and this gives you the right to be paid your salary. This right is a claim. That is you have a claim on your employer to pay you a salary. And your employer has the duty to pay you the wages. So, a claim-right always comes with a duty for someone who is the bearer of that duty (in this case the employer). The direction of the duty is often debated. For instance, you could argue that the employer has the claim-right that you do a certain amount of work based on the contract and you have the duty to do that work. Anyway, claim-right is critical to understand the relation between the citizen and the government as well. Take taxes as an example. The government has the claim-right to collect taxes from citizens to fund its work. The citizen bears the duty to pay taxes.

Privileges and Claims are often called the primary rules in Hohfeldian analysis. They define what activities can or cannot be performed by individuals. Power and Immunity are the secondary rules which explain how someone can change the primary rules.

Power: Power allows an individual to change his own or someone else’s primary rules (privilege or claim). So, the CEO of a firm may order someone to work on a weekend afternoon and take away the privilege of sleeping. Or, your friend may waive the claim that you do not drive away with his car by allowing you to borrow it during the weekend. This waiver endows you with a privilege that you otherwise didn’t have.

Immunity: When you don’t have the power to change someone else’s primary rules, then that person has immunity. For example, you have immunity from the Indian state forcing you to change your religion.

Opposites and Correlatives:

What Hohfeld did following this was to arrange these incidents in a logical structure of “opposites” and “correlatives”. He also added a few other terms: ‘no-claim’ which is the opposite of claim; and, ‘liability’ and ‘disability’ that correlate with someone having power or immunity respectively. In a simple form this can be shown as:

Opposites

If A has a Claim, then A lacks a No-claim

If A has a Privilege, then A lacks a Duty

If A has a Power, then A lacks a Disability

If A has an Immunity, then A lacks a Liability.

Correlatives

If A has a Claim, then some person B has a Duty

If A has a Privilege, then some person B has a No-claim

If A has a Power, then some person B has a Liability

If A has an Immunity, then some person B has a Disability.

As stated here:

A privilege is the opposite of a duty; a no-right is the opposite of a right. A disability is the opposite of a power; an immunity is the opposite of a liability.

‘Correlatives’ signifies that these interests exist on opposing sides of a pair of persons involved in a legal relationship. If someone has a right, it exists with respect to someone else who has a duty. If someone has a privilege, it exists with respect to someone else who has no-right. If someone has a power, it exists with respect to someone else who has a liability. If someone has an immunity, it exists with respect to someone else who has a disability.

A right can be enforced by a lawsuit against the person who has the correlative duty. A privilege negates that right and duty, and typically would be asserted as an affirmative defense in the lawsuit. A power is the capacity to create or change a legal relationship.

Simply put, there’s an interplay between rights and duties but in no circumstance are rights and duties ‘two sides of the same coin’ or ‘upholding of duties lead to a downstream privilege of enjoying rights’.

Our Civilisation Is No Exception

Lastly, there’s always a call to some kind of civilisational value among Indians where we apparently held our duty above everything else. The idea of maryada purushottam or various kinds of dharma - saadharan dharma, vishesh dharma and swadharma - are invoked to suggest we placed the adherence to our duties as the highest form of self-realisation and as the basis for organising our lives. Is this true? There’s, of course, the usual challenge of understanding the context of Indian scriptures. These concepts are variously described with a lack of coherence because what we are left with fragments of metatexts with no clear interpretation of why and how these ideas have come about. As commonly understood, dharma is about doing the right thing. A simple definition is that it is a code of doing the right things at a universal level that ‘holds all of us together’. It is a necessary condition for a functioning society but is it ontologically prior to individual rights? It is not clear. The fact that dharma is invoked to hold us together already presupposes we are together in some form. And it can be argued that coming together can only be on the basis of respecting the individual rights of one another in the first place. On that, we must have built an architecture of dharma to make sure public-spiritedness and working for the collective is codified in our way of life. In some ways, I can agree we might have figured out Hohfeldian logic in our scriptures much earlier than the West. But it is a far stretch to claim some kind of exceptionalism about being a society where duties came before rights.

The Emphasis On Duty

The reason I get anxious when I hear the discourse on duties is that it has a terrible past. Even in India, the founding fathers and mothers in all their wisdom didn’t include the idea of duties in our constitution. The bizarre idea of fundamental duties was included in the Constitution by Indira Gandhi during the Emergency through the 42nd amendment. There it has remained since. And it isn’t as if the post-enlightenment thinkers weren’t taken in by the idea of duties. Mazzini, whose thoughts and essays were instrumental in the creation of the Italian state, wrote about duties extensively. The exhortation to a people to think of themselves as different and better than that of the other and begetting proto-nationalism in the late 19th century Europe were his key contributions. Sample this:

…. Wherever you may be, into the midst of whatever people you have been driven by circumstances, fight for the liberty of that people if the moment calls for it; but fight as Italians, so that the blood which you shed may win honor and love, not for you only, but for your Country. And may the constant thought of your soul be for Italy, may all the acts of your life be worthy of her, and may the standard beneath which you range yourselves to work for Humanity be Italy's. Do not say I; say we. Be every one of you an incarnation of your Country, and feel himself and make himself responsible for his fellow-countrymen; let each one of you learn to act in such a way that in him men shall respect and love his Country.

Your Country is one and indivisible. As the members of a family cannot rejoice at the common table if one of their number is far away, snatched from the affection of his brothers, so you should have no joy or repose as long as a portion of the territory upon which your language is spoken is separated from the Nation.

As you will notice, while Mazzini begins his famous essay The Duties of Man (1844-58) by claiming the first duty of man is to humanity, he gradually sinks into ideas that had terrible consequences for humanity half a century later in the form of two world wars.

There’s a reason why there have been no recorded instance in history when people have agitated for their duties. All uprisings and rebellions are about the fights for rights. People understand their duties both intuitively and as part of the social compact. It is part of traditions in communities. Rights are often trampled in the name of duty by establishment and authoritarian figures to perpetuate power. There are temporary occasions when an overemphasis on duties is valid. During a war (like that Kennedy line on country during the peak of the cold war) or during an internal crisis (Gandhi often invoked it). But those exceptions aside, it is otherwise brought in by establishment to explain underperformance or to shift the blame on to citizens from the shoulders of the state.

It is equivalent to gaslighting the citizens in a democracy.

India Policy Watch #2: Buy Now Pay Later ft. Government

Insights on burning policy issues in India

- Pranay Kotasthane

The finance minister will present the union budget in Parliament next week. A related news item flagging the rising debt commitments caught my attention:

"Interest burden is likely to stay around Rs 9.30 lakh crore for FY23," a finance ministry official told ET.

This is an increase of 15 percent on the Rs 8.1 lakh crore which has been budgeted for interest payments in the current fiscal. The amount is also 16.9 percent higher than the revised estimate for FY21.”

If government finances don’t interest you, these numbers may sound meaninglessly large. Nevertheless, let me try and explain why you should care.

To the question “what is the single largest expenditure item of the union government?”, the two most common answers I get are defence or salaries. Both answers are wrong.

The biggest expenditure item is the interest paid by the union government to borrowers on past loans. The chart below from the previous year’s budget tells us that roughly a fifth of the government’s total expenditure is being spent on interest payments.

The news report from earlier this week suggests that this interest payment is set to increase further this year. The single most important reason we should care is because of intergenerational inequity — the more that governments live beyond their present means today, the less money they leave for future governments and citizens to decide their own spending priorities. That’s what a real debt-trap looks like.

Of course, many governments across the world run deficits and the Indian government is not an exception. Most often, governments take loans to finance physical and social infrastructure. If that is the case, intergenerational inequity is mitigated to the extent that the outputs continue to be used by future generations.

However, that is not the case in India. The union government still runs a sizable revenue deficit, meaning that a part of government borrowing is being used merely to keep the government running today. In other words, we are snatching money from future generations to meet the demands of the current generation’s citizens and government employees. This tells us why the rampant expansion of government expenditure is not just irresponsible but also unethical.

I’ll end this section with a quote by Martin Feldstein from his LK Jha Memorial Lecture at RBI:

“Unfortunately, it is easy to ignore budget deficits and postpone dealing with them because the adverse effects of budget deficits are rarely immediate. Fiscal deficits are like obesity. You can see your weight rising on the scale and notice that your clothing size is increasing, but there is no sense of urgency in dealing with the problem. That is so even though the long-term consequences of being overweight include an increased risk of a sudden heart attack as well as of various chronic conditions like diabetes. Like obesity, government deficits are the result of too much self-indulgent living as the government spends more than it collects in taxes. And, also like obesity, the more severe the problem, the harder it is to correct: the overweight man has a harder time doing the exercise that could reduce his weight and the economy with a large deficit and debt is trapped by increasing interest payments that cause the deficit and debt to rise more quickly. I emphasize the analogy to stress the point that budget deficits need attention now even when their adverse effects may not be obvious.”

India Policy Watch #3: The Great Indian Exit

Insights on burning policy issues in India

- Pranay Kotasthane

India has long been a leading outlier as a source for out-migration. Further, thanks to a Lok Sabha question in December 2021, we know that more than 1 lakh people have been renouncing their Indian citizenship every year over the last several years.

Emigration is an important consideration if not an important life goal for many Indians. At one end of the income spectrum, it is a ticket out of poverty. On the other end, it leads to a step-up in one’s quality of life.

But how should we see emigration from the lens of public policy? Beyond facile “brain drain vs brain gain” discussions, how do we understand the impact of emigration on India?

Let’s establish the boundary conditions first. Because emigration is a voluntary act by an individual, it is a force of immense good. As emigration is one of the partial answers for achieving yogakshemah, the Indian State must make it easier for Indians who want to leave India. There is no justification in a liberal democracy for moralising Indians on staying back just because, for instance, they received subsidised education in a government college.

Going beyond individual choices, what’s the aggregate effect of emigration on India? Turns out, there’s no good empirical answer. While states generally pay close attention to immigrants, the country of origin has little incentive to keep track of the lifecycle of emigration. Consequently, this area of research is not exactly a gold mine. And so, for the last comprehensive assessment of India’s emigration, we have to turn to a 2010 book Diaspora, Development, and Democracy: The Domestic Impact of International Migration from India by well-known political scientist Devesh Kapur. Given below is my annotated summary of the book.

Kapur remarks that:

“one cannot a priori posit whether international migration is “good” or “bad” for a country. The outcomes depend heavily on the policies of the country of origin—which of course can (and do) change over time.”

Coming to India’s case, he contends that the economic effects of emigration have been mixed while the political effects of emigration are largely positive.

The Economic Impact of Emigration

Let’s take the economic effects first. The migration of less-skilled labour to West Asia has had a positive effect not just for those who emigrated but also for those who were left behind as the decrease in labour supply has led to more domestic migration and rising wages. Further, incoming remittances have played a big role in stabilising India’s macroeconomic situation.

In contrast, the economic effects of the emigration of high-skilled labour to the West are more ambiguous. On the positive side, the success of these Indians has improved the reputation of India and Indians worldwide. Moreover, some of them have acted as bridges for the flow of ideas, technologies, and information back to India. On the negative side, the exit of professionals has contributed to making institutions that were globally competitive at the time of independence, mediocre organisations with low ambition and drive.

Kapur also suggests a reason as to why the famed Indian diaspora has not been able to make India a manufacturing hub:

“India’s economically successful diaspora has developed a comparative advantage in white-collar skilled services such as information technology (IT) and tertiary medical services. Consequently, the investments they have influenced into India have also been in these sectors, rather than blue-collar labor-intensive manufacturing sectors (the diamond industry is an exception).

The Indian example illustrates a broader point about how the sectoral expertise acquired by emigrants overseas diffuses back to the country of origin. Parallels can be draw with the Chinese example, where the economically successful Chinese diaspora (especially in Hong Kong, Southeast Asia, and Taiwan) made its wealth (and acquired relevant capabilities) in labor-intensive manufacturing, and therefore its investments into China were in related sectors as well.”

The Political Impact of Emigration

The political effects of emigration, Kapur argues, are positive in two ways.

One, returning emigres and international exposure have helped in strengthening the commitment to liberal democratic politics. Twelve years after the book was published, this claim appears weaker. Liberal democratic politics in the west itself has been battered. Moreover, the role of the Indian diaspora in furthering majoritarian anti-liberal politics has grown at a much faster rate than its antidote.

Two, Kapur suggests that the exit possibilities of emigration served an important social function. It acted as a pressure relief valve for the dominant upper-caste elites, making them less opposed to the political ascendancy of the marginalised social groups. In the absence of emigration opportunities, the contestation over job reservations and education quotas would’ve been much sharper. Here again, with the benefit of hindsight, we can say that the possibility of emigration hasn’t been an entirely effective pressure-releasing mechanism, as evidenced by the new legislation for reservations to economically backward but upper-caste sections.

The book’s conclusion resonated with me. Ultimately, where diasporas become sources of power or areas of weaknesses principally depends on domestic policy and politics.

First, forty years of socialist thinking, directly and indirectly, made emigrants distant. Illustrating this point, Kapur writes:

“In those years, when the Indian community was thrown out of East Africa, socialist India pressed the United Kingdom to admit them, seeing little benefit in attracting the community’s commercial skills and capital back to India. And when the British government finally gave in to pressure from India, it was seen as a major foreign policy achievement.”

Second, poor policy and business environments continue to make India less lucrative for emigrants:

“The well-known infrastructural and policy weaknesses in manufacturing have steered the diaspora’s role in IT more toward the software side, rather than developing the hardware sector. The decades of migration from Kerala have made it a remittance dependent economy, but one that has been unable to capitalize on this any further because of political and policy constraints in the state.”

And third, while India and Indians love to celebrate its emigrants who make it big in other countries, it does not allow the same opportunities for its immigrants.

In short, emigration from India does have a few negative political and economic effects. But mitigating these effects ultimately requires doing the tough job of improving the domestic social, economic, and business environment. There’s no shortcut.

Matsyanyaaya: Who’s Arm-twisting Whom?

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

(Cross-posted from Technopolitik — Takshashila Institution’s High Tech Geopolitics Newsletter)

This story has it all: geopolitics, anti-trust, national pride, future of technology, and capital markets.

The Prelude

ARM (mentioned as “Arm” from here on) licenses its CPU designs to customers such as Apple, Qualcomm, Nvidia, and MediaTek. For a long time, it has been trying to break into the data centre CPU market, dominated by Intel and AMD’s x86 designs. Despite an impressive list of customers, Arm’s financial fortunes haven’t been great — revenues through licensing fees and royalties have been on the decline since 2016.

Even though Arm is the sole supplier for mobile companies, why would this happen? Primarily due to four reasons. First, the mobile phone market is already saturating. Second, customers such as Broadcom, Qualcomm, Microsoft, Samsung, and Apple have an expansive Arm architecture license (as against implementation licenses), allowing them to design their customised Arm-compatible processors. So, Arm has little leverage over the sales from these companies. Third, Arm’s big bet on another market — datacentres — hasn’t worked out. And fourth, Arm cannot increase its license fee to compensate for sagging revenues because it faces a new challenge in the form of RISC-V technology.

The Players

In September 2020, Nvidia announced a deal to buy Arm. Since then, Nvidia’s shares have almost doubled. But after months of being blocked by four regulators — in China, the US, the EU, and the UK — reports suggest that Nvidia is planning to abandon the deal.

Let’s have a look at all the perspectives first.

In the US, the Federal Trade Commission (FTC) is opposing the deal because the deal would “distort Arm’s incentives in chip markets and allow the combined firm to unfairly undermine Nvidia’s rivals.” Unsurprisingly, many high-flying competitors of Nvidia such as Qualcomm and Intel are staunchly opposed to this deal as they feel Nvidia might partially delay or block their access to Arm CPU blueprints. The EU antitrust regulators also have similar objections to the deal.

In contrast, the dominant narrative in the UK is that the deal would hurt national pride. In ordinary times, such a narrative wouldn’t have carried far. But when the entire world looks at semiconductors from a strategic lens, this view has policy relevance. So, even though Arm is already owned and controlled by a Japanese investment firm, Softbank, the UK has renewed calls to list it back on the London Stock Exchange.

Next, Arm and Nvidia’s joint submission to the UK’s Competition & Markets Authority (CMA) comprehensively captures the two companies' viewpoints. Their main argument is that Arm faces an uncertain future without a takeover. The submission explicitly says:

Deal opponents romanticize Arm’s past and either ignore or disparage Arm’s most powerful competition. But if Arm had market power, it would have sizable revenue growth and would be enormously profitable.

The submission further claims why this deal would increase competition instead of reducing it.

For China, the concerns are entirely different. This deal would mean a more potent lever in the hands of the US to constrain China’s semiconductor sector. The US has already demonstrated that it could deploy wide-ranging export controls to block access to chips to geopolitical adversaries. With Nvidia controlling Arm, China fears that the US can easily prohibit Arm from selling to Chinese customers. As a result, China has been staunchly opposing this deal.

To be sure, the US can still pressurise Arm to not sell to customers in the absence of a deal. Just like it prevented the Dutch semiconductor manufacturing equipment star ASML from selling cutting-edge Extreme Ultra-Violet lithography machines to Chinese companies. Nevertheless, getting the UK — for whom this has become a national pride issue — to comply with such restrictions is far more complicated.

The Result

The deal opponents have their unique reasons. There’s no concrete evidence to suggest that the opponents are collaborating. Regardless, the net geopolitical effect is that China would be immensely relieved if the deal fails. At the same time, China would want to get RISC-V further up to speed with Arm so that this geopolitical weakness is taken out of the question over the long term.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] On Puliyabaazi, Pranay and Saurabh have an in-depth conversation on India’s newly announced semiconductor policies.

* [Speech] A speech on regulating capital markets by CB Bhave — one of the best takes you’ll find on the subject.

Insights on global issues of the day

- RSJ

Sometime in late 2019, Alan Jope, chief executive of Unilever, the global food and cosmetics giant, declared that brands without an evangelical purpose of contributing to society will soon face extinction. As the Guardian reported then:

Alan Jope, Unilever’s chief executive, said it was no longer enough for consumer goods companies to sell washing powders that make shirts whiter or shampoos that make hair shinier because consumers wanted to buy brands that have a “purpose” too.

“Can these brands figure out how to make society or the planet better in a way that lasts for decades?” said Jope, outlining the company’s thinking. Unilever is not working to a set timetable but Jope, who took over from Paul Polman in January, said it was possible that a brand or even whole product category “is not going to be able to find its purpose”.

His comments raised the possibility of the company selling off profitable brands, potentially hurting the bottom line, but Jope said: “Principles are only principles if they cost you something.”

This looked good. I mean we all want businesses to have more social responsibility. Here was a CEO willing to take a long view of what’s good for society and let go of short-term gains.

How are things going for Alan Jope now? Well, here’s Nils Prately writing in the Guardian last week:

Unilever is frustrating its shareholders. Last year’s stock market “rally in everything” bypassed the consumer goods giant entirely. The shares fell by a tenth and, at £39.42, stand roughly at their level of five years ago, soon after the group adopted a supposedly energising cost-cutting and deal-making overhaul in response to its close encounter with Kraft Heinz’s financial engineers.

Perhaps, the most entertaining rebuke came from fund manager Terry Smith:

“Unilever seems to be labouring under the weight of a management which is obsessed with publicly displaying sustainability credentials at the expense of focusing on the fundamentals of the business.

A company which feels it has to define the purpose of Hellmann’s mayonnaise has in our view clearly lost the plot. The Hellmann’s brand has existed since 1913 so we would guess that by now consumers have figured out its purpose (spoiler alert – salads and sandwiches).”

Heh!

But this isn’t an isolated instance of a corporation grandstanding on contribution to society as its purpose. And a lot of it is driven by other shareholders who value it more than, say, Terry Smith above. For instance, Blackrock, the world’s biggest investment manager, that owns like seven percent of every public company out there, has made ESG (environmental, social and governance) metrics a priority for their investment decisions. Over the last few years, Larry Fink, the chief executive of Blackrock, has emerged as the most influential voice on the role of business in driving the sustainability agenda. This has meant Blackrock cutting back its investments in enterprises that are seen to be bad for environment and sustainability. But this has not been without a backlash. The Republicans and their supporters see this another sign of ‘wokeism’ dominating business agenda. The more left leaning wing of Democratic party feel this is all lip service and Blackrock is not doing enough to push sustainability. There’s also the usual chorus about should it be elected lawmakers who must drive this or an unelected powerful businessman regardless of their good intentions? Plus, there’s been the usual unintended consequences. The throttling of investments into thousands of firms that have business models that still leech off environment while being hugely profitable has increased the spreads on their bonds giving an opportunity to other investors to profit. Also, with so much investments going into ESG, some sort of a ‘green asset bubble’ has been formed with businesses of all stripes positioning themselves as green and sustainable to free ride into billion-dollar valuations. These things usually end up badly for everyone.

So, in his latest annual letter to CEOs titled ‘The Power of Capitalism’, Larry Fink seems to suggest he’s moderating things a bit. He starts off in the usual fashion defending the focus on stakeholder capitalism (i.e., thinking beyond shareholder profits):

Stakeholder capitalism is not about politics. It is not a social or ideological agenda. It is not “woke.” It is capitalism, driven by mutually beneficial relationships between you and the employees, customers, suppliers, and communities your company relies on to prosper. This is the power of capitalism. 

He continues with his call for net-zero goals and finding a purpose beyond profits but there’s a subtle shift in tone:

In today’s globally interconnected world, a company must create value for and be valued by its full range of stakeholders in order to deliver long-term value for its shareholders. It is through effective stakeholder capitalism that capital is efficiently allocated, companies achieve durable profitability, and value is created and sustained over the long-term. Make no mistake, the fair pursuit of profit is still what animates markets; and long-term profitability is the measure by which markets will ultimately determine your company’s success.

Purpose Of Capital

We talk about the role of capital often here. What purpose must it serve in society? How should policies be drafted to channel it for all round, sustainable progress? These aren’t new questions. Adam Smith mulled over it. Marx wrote a whole book thinking about it in ways that were original and revolutionary. That they were fundamentally unsound is a different thing. Unpaid labour is not the source of surplus value in capitalism, like he thought. There was a pause in thinking about capital in a deeper way during the first half of the 20th century. The two world wars and the great depression created the field of macroeconomics that concerned itself with questions of managing the national economy. The early Austrian school economists went the other way in thinking about the micro - a rational individual, her utility from a product or a service and her actions to maximise it. While economic thought about the nature of a firm was around during that time, most notably in the works of Ronald Coase, it wasn’t mainstream. Only in the 60s when American capitalism produced a boom rarely seen before in history did economists turn their attention to the nature of wealth creation in society and its purpose. Of course, the most famous of the economists among them was Milton Friedman.

We have written about Friedman before. After a lot of soul searching, Friedman concluded:

“But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book “Capitalism and Freedom,” I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.”  

The role of any business is to maximize shareholder value in a legal way. That’s it. Everything else can be counted as good intentions but will have unanticipated consequences. Shareholder value maximisation, on the other hand, checks all the boxes of a good metric for three reasons.

* A simple and measurable metric: The shareholder value maximisation goal is easy to set and monitor. It helps that there is a common understanding of the metric. The alternatives are amorphous. It is difficult to understand what does maximising societal value entail, for instance. Who will define what society wants? Are societal objectives of India and the US similar?

* Rewarding the risk-takers: The shareholders invest risk capital in an enterprise. This willingness to take risk is what leads entrepreneurs to build new products, satisfy the consumers and create new jobs. The shareholders deserve the pursuit of maximum return by the firms for this risk they undertake. It is up to them what they do with these returns. They can invest it in newer enterprises or use it to improve society as they deem fit. The management or anyone else should have no claim on how to invest the returns that belong to the shareholders.

* Shareholders are the residual claimants: Everyone who contributes to the value creation of an enterprise – the employees, the management team and the customers – get their fixed claim on the value through compensation for their efforts, stock options and the value derived from the products or services offered by the enterprise. Whatever is left is for the shareholder. Only when these fixed claimants are served well, the value for the residual claimant (the shareholder) is maximised. So, the pursuit of shareholder value will by itself serve the other stakeholders well.

Doing One Thing Well

The Global Financial Crisis (GFC) wasn’t good for the Friedman doctrine. The massive ‘financialisation’ of business, the loosely regulated nature of financial markets which allowed for the excesses and the bailouts which saved those who had brought about the crisis were seen to be a product of Friedman’s profit maximisation philosophy. Since then controlling free markets and unbridled capitalism as ideas have found favour in most capitalistic societies. More so among the young. And in the last few years, we have had ESG added into the mix. Corporations are now supposed to do things that will serve the interest of the environment and sustainability in the long run. It sounds good and who can argue with it. But like all good intentions, it is hard to implement and runs the risk of doing just the opposite.

One, beyond profit maximisation, the shareholders will have heterogenous objectives and time horizons for their investment. The definition of what’s good for humanity will be amorphous among them. Should a company increase its costs of production by adopting ‘green’ practices and make losses in the next five years in the hope that it will eventually make more profits in the long run because of this shift? Will all shareholders reward the management for this? Seems quite unlikely. Some shareholders will have shorter time horizons. Others will disagree on what’s truly ‘green’ and a few might even ask if climate change is for real.

Two, the management which is the agent of the shareholders running the business has an incentive to have shareholders with ambiguous objectives. The classic management defence for short-term underperformance is we are building things for the long run. Nothing is more long-run than saving the earth seen from the perspective of the management annual performance cycle. The more ESG pressure that shareholders bring about on the management, the easier it is for them to include the long-term indeterminate objective of saving the earth in explaining their decisions and performance. There is already a danger that a lot of management teams have embraced this notion of purpose (like for mayonnaise) for performative reasons. They know talking ESG is good for the stock in the short term. Or, there is an incentive to explain away their lack of near-term performance to the pivot of being ESG friendly. Neither is good for society.

Three, the core management problem in an enterprise is how to allocate capital among the many competing priorities in an enterprise. This is a prioritisation problem that takes a lot of skills to get right - understanding the financial returns of different products and markets, anticipation trends in consumer behaviour, figuring out competitors and regulatory environment. Managers spend their careers learning to get this right. Most fail in the long run which is why corporate mortality is so high - maybe 10 companies or fewer have survived among the top 100 U.S. enterprises from about 50 years ago. Now to burden them with a variable that’s not just difficult to quantify or predict but also is freighted with political and personal beliefs will only make decision making more difficult. More likely than not they will get it wrong.

It is for these reasons Friedman’s doctrine remains the most elegant and practical way for firms to pursue its objectives that deliver the most value to society. For Friedman, enterprises in a competitive market pursuing shareholder maximisation will do well for society. The policymakers should work on frameworks that create the right incentives for shareholders and the management to do so while serving the long-term interests of the society. The management then works within it. It isn’t for the management or for the shareholders to optimise for objectives beyond that. The shareholders can take those returns and do what they believe is best for the society based on their beliefs. Somewhere in that Fink annual letter is a muted acceptance of this idea.

PolicyWTF: One Person, One Hand Bag

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

 - RSJ

This caught my attention yesterday (from the Business Standard). Yes, there’s a guideline to enforce one handbag rule as cabin baggage in flights.

In a memo, BCAS (Bureau of Civil Airport Security - who knew there was this too?) said:

“It has been seen that an average passenger carries 2-3 hand bags to the screening point. This has led to increased clearance time as well as delays, congestion and inconvenience to passengers. It is, therefore, felt that enforcement of the aforesaid circulars must be ensured by all stakeholders,” it added.

Like those hold-all bags my family used to carry during rail travel in three-tier compartments, there’s a lot to unpack here.

Congestion has been a problem for long in Indian airports. In fact, the pandemic has meant lower congestion than usual. So, how did this problem and this solution present itself to the Bureau? Here’s the answer from the same report:

People aware of the development said a few parliamentarians had complained to Civil Aviation Minister Jyotiraditya Scindia regarding congestion at security checks. Following that, the regulator was asked to implement steps to ease congestion.

“We had a meeting with the representatives of airlines and have told them to impose the rule. It takes more time to clear multiple bags,” the security agency said.

Ah! Few parliamentarians complained. I’m unsure if they were held up because of congestion because there’s usually a separate VIP channel in all Indian airports. Maybe the number of VIPs have proliferated to such an extent now that there’s congestion in that queue too. It ain’t easy to be a VIP these days. Anyway, the solution that we have come up is two-fold. Quoting the report again:

“All airlines and airport operators may be instructed to take steps to implement ‘One Hand Bag rule’ meticulously on ground to ease out the congestion and other security concerns. Airlines may be made responsible and depute staff to guide passengers and check and verify their hand bag status before allowing the passenger for pre-embarkation security checks, “ the memo added.

And the second solution:

Besides, airlines were also asked to change flight timings so that too many flights don’t arrive or depart around the same time to prevent overcrowding at airports. However, the idea was dropped after airlines opposed this saying changing flight timings in between an ongoing schedule will not leave flexibility and force them to cancel flights, leading to chaos.

Thankfully, the second solution was dropped. On to the first solution about enforcing the one-bag rule strictly. So, what will people do? They will be forced to check in their luggage to comply with this. And that will mean the baggage check-in queues will be congested which takes even more time than the security check queue. This is the Indian flyover solution. Build a flyover to solve for congestion and soon realise the congestion hasn’t eased. It has only moved to another location.

What about the real solutions? Like thinking about better queue management processes, figuring out queuing patterns during different hours of the day and week based on data and planning capacity to manage the peaks or increasing the capacity for security checks - there’s not a word on these.

It is a chhota story. But it has everything that you need to know about public policy in India.

India Policy Watch: The Problem with Protectionism

Insights on burning policy issues in India

— Pranay Kotasthane

Policy success, like beauty, lies in the eyes of the beholder. One such policy success that’s been talked about a lot of late is the increase in mobile phone production in India. The narrative underlying the success is that through a prudent mix of protectionism and industrial policy instruments, India has been able to reduce its mobile phone dependence on other countries, particularly China.

This deemed policy success is now being seen as the playbook for many other manufacturing sectors such as electric vehicles and pharmaceuticals. For instance, see this excerpt from Nilesh Shah and Pankaj Tibrewal’s article titled The mobile phone sector has lessons for India’s economy:

“We were one of the largest consumers of mobile phones in 2014. In 2014-15, our mobile phone imports exceeded $8 billion. Our electronics imports were threatening to exceed our oil imports. The government took many steps like 100 per cent automatic FDI, levy of import duties to protect local manufacturers, the Phased Manufacturing Plan (PMP), manufacturing clusters (EMC 2.0) and the Production Linked Incentive (PLI) scheme. Despite some execution challenges on the ground, these steps have developed our mobile phone manufacturing base. They have attracted investments, created lakhs of jobs, and have moved us from being a net importer to a net exporter.

Our mobile phone manufacturing value has jumped more than eight times from Rs 0.27 trillion in 2013-14 to Rs 2.2 trillion in 2020-21. Samsung runs the world’s single-largest location mobile handset manufacturing plant in Uttar Pradesh. We have surpassed the US and South Korea to become the second-largest manufacturer globally.” [Indian Express, Jan 20]

Impressive, isn’t it?

By now, you already know there’s going to be a “but” somewhere. So here it is.

Judging a policy based only on the benefits it brings is possibly the most common mistake in policy discussions. To understand the complete picture, we also need to analyse the costs.

What about the Costs?

Of the policy instruments used, allowing 100 per cent FDI through the automatic route is an unequivocally positive step. And we have dealt at length with the promise and perils of the mushrooming PLI schemes in editions 86, 118, and 153.

In this edition, we will limit the discussion to the third instrument in the armour: increasing import tariffs.

The modus operandi seems to be somewhat like this. Through the Phased Manufacturing Program (PMP), the government increases import duties on final consumer products such as mobiles, chargers etc. This leads to import substitution because products assembled in India (even with imported parts) start to become cost-comparable to the duty-levied imports. Every year, the government keeps adding new products to this PMP list, with the objective of increasing the number of final goods that are assembled in India. The final aim and hope is that these assembly units will become the nuclei for a complete manufacturing ecosystem over time.

No, the costs of this strategy are being borne by two sets of Indians.

The first losers are all consumers. Higher import duties mean that mobile phone prices have been increasing. The absolute increase isn’t alarming at first sight, to be frank. But electronics prices commonly fall sharply with improving technology, and that has certainly not happened for phones over the last five years. Vivek Kaul has explained the cascading effect of this price rise here:

When an individual spends more on something, she cuts down on expenditure in some other area. Given this, if one business benefits due to protectionism, another business or other businesses, lose out in the process. It’s just that this is not so obvious in the first place and hence, is the unseen effect of protectionism.

Second, the Indian manufacturers themselves have been under the pump because of rising tariffs for mobile phone parts. The lure of protectionism is such that it quickly spreads from final products to intermediate inputs. Soon, it was felt that not just mobile phone makers but domestic manufacturers of camera modules and connectors should also be ‘protected’. The result — not surprisingly — the import duties are now negating all the benefits provided under the PLI schemes. Manufacturers are still unable to compete in export markets because the parts they import have become costlier. A recent comparative study analysing import tariff regimes of India, Thailand, Vietnam, China, and Mexico puts this well.

The main difference in their policy approach is the tariff policy of India compared to others. India has relied heavily on higher tariffs whereas other countries have not done so. Higher tariffs orient the approach of investors and domestic producers away from global markets and towards the domestic market. Notably the exports for India compared with others have remained low as has been examined in this report.

This is a crucial point. While the various incentives and protectionism has been successful to the extent that imports of phones have reduced, we are still far away from becoming a competitive exporter. Have a look at this chart I made from government data on mobile exports.

As you can see, India’s mobile phone exports fell sharply from FY15 to FY18 with increasing tariffs. Though exports in absolute terms have picked up in the last three years, mobile phones as a share of India’s total exports is still below what was achieved way back in FY09!

Going ahead, India’s domestic market alone (projected to be 8.8% of the global market in FY26) is insufficient to attract more manufacturing here. The ability to competitively export will be a key determinant of policy success going ahead. And for exports to rise, imports tariffs must be brought down.

In sum, before copying the mobile phone policy success playbook in other sectors, we must remember that the burden of protectionist policies is borne by the consumers and eventually the manufacturers, both. Protectionism can play spoilsport in India’s hopes of exporting its electric vehicles and mobile phones to the world.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] An insightful episode of All Things Policy with MR Sharan on his new book Last Among Equals: Power, Caste & Politics in Bihar’s Villages

* [Report] An excellent comparative study on tariffs in electronics by ICEA.

Insights on global issues of the day

- RSJ

I want to write about the Andhra Pradesh cinema ticket price cap kerfuffle this week (read here for context). A regular reader, Prem Sagar, wrote to us last week giving us a picture of what was happening in Tollywood. All the great ingredients of a timeless PolicyWTF have come together there - good intentions, political games, conspiracy theories, a government order on price controls that Indira Gandhi would have been proud of and the inevitable unintended consequences. I wept with joy going through them all. 

But before that Joan Didion.

The great chronicler of American life passed away a couple of weeks back. Why Joan Didion in a public policy newsletter, you may ask? Public policy is an interdisciplinary science. At the heart of it is understanding the public - the basis for its motives, its fears and insecurities and its wants. There was no one better than Joan Didion to show a mirror to a society in prose that was unsparing, sparse and crystalline. Didion didn’t go looking for grand narratives. There was no conscious painting of a big picture. She was intimate in her approach and got busy with the minutiae. But from that appeared something that made you rethink your priors. She wrote as she saw it. And she saw a lot. From the underlying vacuity of the unrest in colleges in the late 60s, the hollowness of the counterculture movement in California, the depravity hiding under Kennedy’s Camelot, the absence of any ideological truth bar nihilism among Black Panthers, the mendacity of Nixon and the arriviste pretensions of the Reagans. She covered them all with insight and acuity.

Not many realise today that Didion grew up as a Goldwater conservative who wrote quite often in that conservative bible, the National Review during the late 50s and 60s where she reviewed films, eviscerated other authors and their books (her takedown of Salinger’s Catcher In The Rye is one for the ages), championed individual liberty and cautioned against the inevitable disorder that stems from collective self-righteous passions. No one was spared. Later in her life, she would turn that flint-edged gaze onto herself in her collection of essays ‘Where I Was From’ where she reflects on the myths and beliefs of the old California way that shaped her person. And on how wrong she could have been. 

Didion On Morality

Among her essays, a particular favourite of mine is On Morality (in the anthology Slouching Towards Bethlehem) where she holds the word morality in her finger and turns it over and over again against the cold light of the day to make sense of it. I often think of it as a short cultural companion piece to Adam Smith’s The Theory of Moral Sentiments in its dissection of morality. She writes:

“What does it (morality) mean? It means nothing manageable. There is some sinister hysteria in the air out here tonight, some hint of the monstrous perversion to which any human idea can come. “I followed my own conscience.” “I did what I thought was right.” 

How many madmen have said it and meant it? How many murderers? Klaus Fuchs said it, and the men who committed the Mountain Meadows Massacre said it, and Alfred Rosenberg said it. And, as we are rotely and rather presumptuously reminded by those who would say it now, Jesus said it. Maybe we have all said it, and maybe we have been wrong. Except on that most primitive level—our loyalties to those we love—what could be more arrogant than to claim the primacy of personal conscience?

At least some of the time, the world appears to me as a painting by Hieronymous Bosch; were I to follow my conscience then, it would lead me out onto the desert with Marion Faye, out to where he stood in The Deer Park looking east to Los Alamos and praying, as if for rain, that it would happen: “...let it come and clear the rot and the stench and the stink, let it come for all of everywhere, just so it comes and the world stands clear in the white dead dawn.”

She then agonises over the frequency of the word ‘morality’ appearing in politics, media and everyday lives. Like most timeless pieces, there’s both prescience and a definite universality in her analysis of morality. She puts her finger on the performative nature of those sermonising others in society:

“You see, I want to be quite obstinate about insisting that we have no way of knowing—beyond that fundamental loyalty to the social code—what is “right” and what is “wrong,” what is “good” and what is “evil.” I dwell so upon this because the most disturbing aspect of “morality” seems to me to be the frequency with which the word now appears; in the press, on television, in the most perfunctory kinds of conversation. Questions of straightforward power (or survival) politics, questions of quite indifferent public policy, questions of almost anything: they are all assigned these factitious moral burdens. There is something facile going on, some self-indulgence at work. Of course we would all like to “believe” in something, like to assuage our private guilts in public causes, like to lose our tiresome selves; like, perhaps, to transform the white flag of defeat at home into the brave white banner of battle away from home. And of course it is all right to do that; that is how, immemorially, things have gotten done

You don’t have to look too closely at that passage to find its echo in today’s India. She warns as she concludes the essay:

“Because when we start deceiving ourselves into thinking not that we want something or need something, not that it is a pragmatic necessity for us to have it, but that it is a moral imperative that we have it, then is when we join the fashionable madmen, and then is when the thin whine of hysteria is heard in the land, and then is when we are in bad trouble. And we suspect we are already there.”

The only thing constant about Joan Didion’s work over half a century was her honesty. She didn’t lie. She told us no stories to make us feel better or righteous. She changed her views of people and she changed herself. She didn’t belong to camps. She was fiercely her own person. She could not be appropriated. She was an original. RIP.

PolicyWTF: The Disuse of Knowledge in Society

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

- RSJ & Pranay Kotasthane

Okay. Back to the A.P. Government’s decision to cap the price of film tickets in the state. Here’s the order. How many different ways can you say WTF while reading a government order? Let me count the ways.

* There’s a maximum ceiling rate of film tickets that’s set by a committee that was constituted vide G.O.Ms No.42, Home (Gen.A) Department, dt.09.03.2020 under the Chairmanship of Special Chief Secretary to Govt., Revenue Department. Whenever I read the word ‘vide’, I feel a surge of power flowing through me. Nothing says sarkaari power more than ‘vide’. Mere reading it makes you picture a Turkish towel on the backrest of your chair and a glass of water with a coaster on top of it. Now, this committee has divined the fixed rates for admission into cinema theatres based on geography (municipal corporation area, nagar panchayat area et al), on theatre type (Multiplex, Ac/Air Cool, non-AC) and on ticket class (economy, deluxe and premium). The prices range between Rs. 5 (gram panchayat, non-AC, Economy) to Rs. 250 (municipal corporation, multiplex, premium). The management is at liberty to charge lesser rates but before doing that they should inform the Licensing Authority and take an acknowledgement.

* Any violation of the maximum rates can lead to penal action. Of course!

* The theatre management must make provision for online ticketing. It gets better. The AP government is now planning to launch an online portal (like IRCTC) which will be the only portal that will sell cinema tickets in the state. Yes, there’s so much state capacity lying idle that we can now afford to have the government run the business of selling cinema tickets.

* The number of shows in a day is restricted to 4. Why? Because 4 is perhaps the lucky number of someone in administration. 

* The maximum retail price of any item should not be exceeded while selling refreshments to the customers. Free drinking water and clean restrooms must be provided. Yeah. 75 years of independence and many governments later, the state hasn’t provided clean drinking water to homes of people but now it can demand private establishments to do so.

* A.P. Government short films must be screened for 120 seconds before the start of the show and for 30 seconds during the interval of the show. Good. Hopefully, the propaganda short films would be about how price caps on cinema tickets are helping Telugu biddas. 

* The maximum retail price of any item should not be exceeded while selling refreshments to the customers. Free drinking water and clean restrooms must be provided. I know this is the same as #5 above. But this isn’t a typo on my part. The official government order has this point repeated twice at sections 2 (iv) and 2 (vi). I am assuming there’s a deeper meaning hidden here because I start with the assumption that the state can do no wrong. 

* The entry and exit into the theatres should be such that traffic around the theatre does not stop or slow down. Sure. Because there are no traffic jams elsewhere in AP. Autobahns all over the state.

* Sufficient parking must be provided and the parking charges should be reasonable. Why not? Why leave parking out of all this?

All The Wrong Reasons

I grew up with more than a handful of Telugu speaking friends around me (the late 80s and early 90s). Films were a bit more than entertainment to them than any other community in our small town. This meant they were often the ones who would rent a video player for 24 hours (fixed cost) and a movie marathon would ensue with whatever videotapes we could get our hands on. This led to the happy circumstance of me watching the greatest hits of Chiranjeevi and the entire canon of ‘Rowdy’ films (Rodwy Alludu, Rowdy Gari Pellam, State Rowdy, Assembly Rowdy et al). Those were the days.

I digress. Anyway, so films are big in A.P. There are thousands of cinema theatres in the state with millions directly or indirectly employed. There’s a material impact on livelihoods because of a bad policy decision. But here we are.

There are three reasons given for this move by the state government. One, the pandemic has been tough on people and the prices of tickets are prohibitively high. So, the government is doing this to make cinemas affordable for people. Two, there’s huge tax evasion by theatre owners and the state barely gets the tax revenues it should. Three, the YSRC government feels the film industry leans towards the opposition parties (TDP, Pavan Kalyan) and this is its attempt to bring it under their thumb. These are specious and plain stupid. Like we have written umpteen times here, the price isn’t set by someone who knows better. No one knows better. It is a signal that sends information to buyers and sellers. When supply or demand changes, market prices adjust to reflect the new reality affecting the incentives of buyers and sellers. Nobody needs to set this. It happens on its own in a market system. But this is an idea that never finds acceptance in India. The public often expects the government to set price caps and governments feel it is their duty to make sure ‘corporates’ aren’t gouging customers and making huge profits.

Price Is Not For You To Set

We have written about this in edition #140 with an extract from Hayek’s landmark essay ‘The Use of Knowledge in Society’. The essay explains that the price system is a decentralised coordinating mechanism for society. As he wrote in the essay:

“Assume that somewhere in the world a new opportunity for the use of some raw material, say, tin, has arisen, or that one of the sources of supply of tin has been eliminated. It does not matter for our purpose—and it is very significant that it does not matter—which of these two causes has made tin more scarce. All that the users of tin need to know is that some of the tin they used to consume is now more profitably employed elsewhere and that, in consequence, they must economize tin. There is no need for the great majority of them even to know where the more urgent need has arisen, or in favor of what other needs they ought to husband the supply. If only some of them know directly of the new demand, and switch resources over to it, and if the people who are aware of the new gap thus created in turn fill it from still other sources, the effect will rapidly spread throughout the whole economic system and influence not only all the uses of tin but also those of its substitutes and the substitutes of these substitutes, the supply of all the things made of tin, and their substitutes, and so on; and all his without the great majority of those instrumental in bringing about these substitutions knowing anything at all about the original cause of these changes. The whole acts as one market, not because any of its members survey the whole field, but because their limited individual fields of vision sufficiently overlap so that through many intermediaries the relevant information is communicated to all.”

Every time the government interferes with the price system, the information residing in the price gets diminished. The real-world implications of this loss are all too familiar — price caps lead to shortages and poor quality, price floors lead to wasteful expenditure. Distorting prices costs lives.

And it is funny but sad when the government complains of large scale tax evasion as the reason for doing this. The solution to tax evasion is simpler taxes, an efficient mechanism to collect them and a clean administrative machinery. To give more power to a corrupt and overbearing administration to lord over license distribution, do surprise raids and be all-powerful is to invite inspector raj all over again. 

The unintended consequences are already showing up. Cinema halls are shutting down because the prices are unviable. Distributors and exhibitors who are still reeling from the impact of pandemic and lockdowns on their business are exiting. Raids and fines have become common. Soon there will be an artificial scarcity of tickets created and a black market will emerge. The quality of production will go down because who will invest in a high-quality product when the profits are capped. Good content will go to OTT or its supply will go down. The state government will neither get more taxes and the people will lose out on quality entertainment. Everyone loses.

We have seen this movie before. But governments never tire of showing this to us again and again. There’s never any cap on that.

Addendum:

— Pranay Kotasthane

The creator of the idiom “We’ve seen this movie before” obviously lived in a place where movie price tickets weren’t capped.

Hat-tip to two readers of this newsletter for alerting us about this issue, which has been simmering over the last eight months. RSJ has already covered the important points of the saga. Nevertheless, this policyWTF was too inviting a rabbit-hole. So here are some more points to consider.

Some personal context first. Like RSJ, I too have Telugu friends who love cinema dearly. Back in my college days, every hostel block had a “TV Room”. Except on cricket match days, only one other item ran on that TV: Telugu movies. So powerful was the pull of the movies that any person trying to locate a batchmate from Andhra Pradesh would begin their search from the TV Room.

So I don’t find it surprising one bit to see journal papers with titles like Box-Office Revenue Estimation For Telugu Movie Industry Using Predictive Analytic Techniques. Or that both Telangana and AP have a ministerial portfolio for cinematography. Or that capping movie tickets would make for a popular policy.

What should surprise us is how bad ideas regurgitate from state to state. AP is but just one of the many states that impose price caps for cinema tickets. Karnataka, Telangana, Tamil Nadu, all have their own versions of movie ticket price regulations. Based on news reports, I was able to compile this table.

Not only do some states impose price caps, but they also impose price floors i.e. no theatre can show a movie for prices below the government-mandated price, even if they wished! Also, note that Kerala — a state one would expect to administer prices enthusiastically — doesn’t. Instead, that state prefers to collect higher entertainment tax and use the collections for other policy purposes.

My colleague Anupam Manur had anticipated the unintended consequences of such policies way back in 2017 when the Karnataka government joined the bandwagon. Let me summarise the main points below.

* Since they can’t change ticket prices, theatre owners will be incentivised to showcase movies that are guaranteed to run full houses. Movies with time-tested stories and superstars win. Consumers lose as their choices shrink. (Someone should create a Herfindahl–Hirschman index to track how such price caps help incumbent production houses).

* Tickets will be sold in “black” to people who are willing to pay higher than the price cap.

* The price of complementary goods — popcorn, cola, parking — will increase.

* It will have the Bombay Rent Control Act effect — theatres will spend less on maintenance and safety. Some of them might close down due to low profitability, further reducing consumer choice.

* Increasing price caps in the future will become a centralised political question rather than a decentralised economic question. This is the case in TN where — much like the Central Pay Commission revision — price caps were hiked after a full 10 years in 2017.

Reflecting on the Causes

There are three larger points to ponder why despite these obviously anticipable effects, controlling movie ticket prices remain popular.

First, the inequality argument. “If actors can become billionaires due to astronomical signing amounts, why are they opposed to lowering down prices for the average cinema-goers?” This is a classic moralising stance completely devoid of economic logic. The causation actually flows the other way. It’s because there are enough and more people willing to buy tickets that producers are confident to remunerate actors better. Nevertheless, “protecting the interests of the common man” is an evergreen justification for terrible policies.

Second, “protecting the culture” argument. While the linguistic organisation of states perhaps helped India stay together, state governments consider themselves not just as administrators of federal units but as custodians of local culture, language, and cinema. Besides capping prices, governments don’t bat an eyelid before making it mandatory to screen movies in the state language.

Third, the fascination with low movie ticket prices. That one could see a movie in Tamil Nadu at ₹120, was seen as a matter of the state’s pride and neighbours’ envy for a long time. The question we really need to ask is — why should it be the government’s responsibility to equalise everyone’s chances for watching the “first-day, first-show” of a movie? Until we, the citizens don’t appreciate what we lose when prices are kept artificially low, governments will gleefully administer prices.

Thus it’s not the first time that we’ve seen the fracas over movie ticket prices. In fact, it’s probably the first time that this policyWTF is facing spirited and united opposition from a cinema community. Hopefully, the movie stars will be able to impart some Economics101 gyaan to us all. My best wishes are with them.

Announcement: Puliyabaazi with Jairam Ramesh on the 1991 Reforms

— Pranay Kotasthane

Over at Puliyabaazi, Saurabh and I hosted member of parliament and historian Jairam Ramesh for a chat on the politics of 1991 economic reforms. Having served as an officer-on-special-duty in Prime Minister Narasimha Rao’s office at the time, he closely witnessed — and shaped — several conversations around the reforms.

I have quoted from his 2015 book To the Brink and Back: India’s 1991 Story on many occasions in this newsletter. So it was an absolute delight to discuss these topics with him. In particular, his story about getting his ideas on industrial delicensing approved by the cabinet tells a lot about the importance of narratives in public policy.

Do not miss this episode and yes, do subscribe to the Puliyabaazi YouTube channel.

India Policy Watch: Upgrading the Reform Narrative

Insights on burning policy issues in India

— Pranay Kotasthane

Marketcraft is a brilliant new term I came across recently, courtesy of fellow traveller Rohit Chandra’s newsletter for The Morning Context. Rohit’s description of the term covers the main idea quite well:

“Markets are not birthed spontaneously in the absence of the state; as political scientist Stephen Vogel has argued, most countries have actively constructed, governed and shaped markets in underdeveloped sectors rather than just blindly deregulating them, a process he calls marketcraft. While discarding the legacies of state ownership and Plan-based micromanagement may be part of marketcraft, so is creating an efficient legal system to resolve disputes, changing bureaucratic mindsets that tend to regard the private sector with suspicion, and creating a level playing field to prevent large corporations gaining excessive market power. Marketcraft is as much about building institutions as it is about doing away with previously interventionist regulation.”

Caricatures of capitalism in India suggest that it is a system where matsyanyaaya reigns — rapacious businessmen run amok while the government is happy to sit out. Marketcraft instead emphasises that even the US — the poster child for free-market economies — is in fact, heavily governed.

Not everything that Vogel writes applies to the Indian context but there’s one idea that resonated with me — the need to change the narratives we use for talking about reforms.

Decades of dissing markets have resulted in a deep distrust for markets in India. The 1991 economic reforms have had limited success in changing this narrative. There is still more-than-enthusiastic support for price-fixing, bans, and government-run enterprises. Nothing scares people more than typeset phrases of the capitalist canon; “leave it to the market”, “trust markets”, “privatisation” are terms that evoke fear rather than hope. They conjure the image of being abandoned by one’s parents in a mela (the government is maai-baap after all). In response, policy analysts sing in the praise of markets using the same vocabulary that most Indians either find foreign or deeply distrust. Hence, it’s not surprising that reforms are episodic and often done through stealth rather than conviction.

Since using standard free-market vocabulary is not quite effective, what we direly need are new narratives that make the case for reforms in a language India can understand. This table from Marketcraft gives an idea of how it could be done.

There is merit in finding similar phrases that would make the language of reforms less alienating. Aatmanirbhar, Make in India are some good examples that could’ve been deployed for this purpose. Alas, they morphed into protectionism and industrial policy measures instead of building the case for markets.

Another way to make reforms more palatable is to lay stress on the improvements in regulatory capacity when reforms are articulated. Take the case of the now-abandoned farm laws. The government spoke about the need to reduce intervention but failed to assuage farmers on dispute resolution. Moreover, replacing the jurisdiction of civil courts with a complex method under the full control of a bureaucrat fanned fear among the farmers.

Crafting the right narratives is a much more difficult task than coming up with catchy slogans or spiffy abbreviations. It’s time we rise to that challenge.

HomeWork

Reading and listening recommendations on public policy matters

* [Paper] An economic guide to ticket pricing in the entertainment industry

* [Article] Anupam Manur’s article on why fixing movie ticket prices is a terrible policy.

* [Podcast] We’ve started a new 15-minute episode series on Puliyabaazi, where we discuss one public policy question every week.

Insights on burning policy issues in India

— RSJ

Happy New Year!

This is a time of hope, optimism and new beginnings. But 2022 has signalled it has no time for such niceties. It is already hitting high notes on all kinds of wrong metrics - peak COVID-19 positivity rates, deeper social polarisation and dangerous levels of toxicity on social media. And it is only the first week. Maybe 2022 intends to get all the bad news out early and then coast on calm waters. That’s the hope. 

Hope, like Andy Dufresne taught us, is a good thing; maybe the best of things. We write this newsletter because we are hopeful about the future. We believe we can make an impact, however small, on the demand side of the policy equation. That making people aware of policy choices and helping them anticipate the unintended will lead to a change in the supply side of politics. There are two preconditions for this to happen which we have assumed to hold true. One, people have time and mental space available for discussions that matter to their lives. Two, a belief we can arrive at what’s good for us through those debates and discussions.

But there are days when you wonder if these hold. The cacophonous noise on issues of identity, validity and nationalism drowns all other conversations. There’s no conceding of ground regardless of the merits of an issue. Any factoid that questions your existing hypothesis isn’t seen as worthy of contemplation. The more perceptive might register a mild dissonance. Instead, you wait for your side to dig out a counter that reconfirms your bias and negates the dissonance. Politics is often considered to be performative for the audience that’s the electorate. Now, the audience has donned the makeup and is declaiming on stage. The possibility of consensus on what’s good is increasingly remote. And once you are in this territory, the public part of public policy goes out of the window. Whatever remains then is no different from a fiat. 

But then hope is a good thing. And so we begin the new year with hope. 

Like those last lines from The Great Gatsby:

“...tomorrow we will run faster, stretch out our arms farther…And one fine morning-

So we beat on, boats against the current, borne back ceaselessly into the past.”

Like last year, we start with that timeless lazy way to fill pages during this time of the year.

Here is my random list of predictions for 2022.

Economy

#1: It will be more of the same for India on growth, inflation and fiscal deficit. Factoring in the Covid base effect, we will be in the 5-5.5 per cent growth range (if you take the base of FY 21). Inflation (CPI) will be around 5 per cent with an occasional jump to 6 per cent during the year despite threatening to go out of control. Maybe three interest rate hikes (a total of 75 bps) during the year will keep a lid on it. Public markets will moderate a bit (around 10 percent upside). Private market valuations will continue to be in bubble territory. There’s a lot of liquidity that’s already raised and ready to be deployed for start-ups. China won’t attract it as it will continue to go down the path of self-reliance and its notion of an equal society. So, expect even more than the $36 billion that flowed into startups in 2021. There will be more gushing commentary on the Indian entrepreneurial energy. That will be appropriated to show how well the economy is doing. The money flowing for Indian startups is good news, of course. But it cannot be the only metric to determine the health of the economy. The divergence between the formal and informal economy and the K-shaped recovery that we have written about (“Two Indias”) will continue.

#2: There won’t be much to write about reforms. Some attempts at piecemeal MSP reforms will be attempted to make up for the repealed farm laws. The National Monetisation Pipeline will get going but the progress will be modest. A couple of more disinvestment proposals of PSUs (including banks) will be taken up. But this will be for raising revenues rather than a planned strategy to make PSUs market competitive. The LIC IPO will just go over the line and that will be the big event to showcase reforms. All of this doesn't mean we will be short of big announcements about reforms or intention to reform.

Politics

#1: BJP election machine will continue its winning run barring the odd defeats in Punjab and Goa. The big prize, UP, will be fought hard but BJP will win a safe majority. The bahujan vote of the depleted BSP will shift to it more than to SP and that will make all the difference. By the end of the year, there will be a more formal coming together of regional parties as opposition. Some sort of a “front” will be formalised.

#2: There will be a split in the Congress. The party in its current form is untenable and beyond a point, there will be nothing to lose for those who split it. The key question is who will lead it - those who have a political base and think Congress leadership is a liability that cannot be carried along any further, or those without a political base but with strong ideological opposition to the BJP. My guess is it will be the latter. In any case, it won’t make much of a difference.

Society 

#1: Demographic anxiety is now a thing in Indian society. The desire to address it or to be seen to address it will animate much of our social discourse. Expect love jihad and anti-conversion laws in various states, some kind of population control bill, a revival of CAA and a push for a uniform civil code during the year. There’s that early 20th century Europe playbook of stoking demographic anxiety that plays on a threat to the survival of a civilisation or a way of living. The pitch will be queered on this. Indian society is a fertile ground for it. This land can be shown to its people as a palimpsest. But it can, perhaps more easily, be shown as a glorious, ancient civilisation that’s been asphyxiated for centuries by ‘outsiders’. A true revival of it requires setting the past records straight and the right demographic arithmetic. That’s the view and it is open season for this. There will be more performative gestures that will be broadcast as reclaiming of that civilisation. 

#2: The last week saw the mainstreaming of the ‘trads’ and ‘raitas’ nomenclature. If you don’t know about this sharp distinction that’s emerging within the right-wing, here’s a short introduction to it. We have written in the past Schmitt’s ‘friend-enemy’ distinction in politics. Politics is driven by the idea of having an enemy; the other. For much of the last decade, this was the left-liberal cabal (Lutyens, Khan market, NYT, Soros, Amnesty etc). Even when much of news and propaganda came to be dominated by the right-wing, there was a strawman of this all-powerful cabal of anti-nationals that was kept alive because the notion of an enemy is critical. But once you have decimated it, what do you do? You look for the enemy within. That’s what trads versus raitas is all about. It isn’t a surprise really. This is something I discussed in Amit Varma’s podcast last February.  

Miscellaneous

#1: There will be serious big tech regulations that will come into play in America. Others will follow suit. India will have a version of this along with dollops of atmanirbharta. This will mean some tough days for big consumer tech giants in India.

#2: China will struggle for growth. Demographics, debt and delusion have come together in China in a way that will make it difficult for it to sustain growth. China-Russia relationship will get stronger with their support for each other and for other authoritarian regimes around the world. 

#3: Meta, Crypto, Decentralisation, NFT (and everything else pumped up by the Valley tech bros) will see their hype abate (about 25-30 percent drop in asset value). When John Terry starts buying Bored Ape NFTs, you know the whole thing has jumped the shark. About time too. 

Global Policy Watch: A Season of Industrial Policies

Bringing an Indian perspective to burning global issues

— Pranay Kotasthane

On December 29, the union government issued guidelines for another production-linked incentive (PLI) scheme, this time for textiles. In all, there are thirteen sectors — from electronics to steel — where PLI schemes are under various stages of execution. We had given such schemes the full Anticipating the Unintended treatment in edition #86. In this edition, I want to step back and review the merits and demerits of industrial policies, of which PLI is a specific variant.

What’s an Industrial Policy?

Scott Lincicome of the Cato Institute has a neat definition. Industrial policies are

“targeted and directed government interventions intended to achieve specific, market‐​beating industrial and commercial outcomes within national borders. The specificity of these targeted interventions is what makes them different from other kinds of broader, more general interventions.”

In contrast, broader pro-market policies that are not sector-specific such as reducing corporate tax rates, reducing import duties, simplifying labour laws and making land acquisition easier are not categorised as industrial policies.

Why Should You Care?

Industrial policies are all the rage today and not just in India. Industrial policies never went in demand really. The theory of change behind industrial policies is enticingly simple: “to get an uncompetitive business sector of yours to grow, subsidise investment in that sector over the next few years out of taxpayer money.” And as you can imagine, industrial policies are quick-fix solutions that any policymaker would love. So, one or the other industrial policy solution is always cooking in government departments regardless of the sector and the country.

The reason why such policies are now getting concurrent attention worldwide is because of one reason: China. With all the talk of reducing dependence on Chinese technology and manufacturing firms, entire sectors are being deemed as “strategic” across countries. And once a sector gets termed as strategic, a “strategic” industrial policy is never far away. And so, the US, EU, India, and China itself, are all launching a spate of new incentive schemes to reshore manufacturing and technology firms.

Do Industrial Policies Work?

They are popular, alright. But are industrial policies effective? In this section, I’ll review some arguments for and against them.

Batting for industrial policy, albeit in the American context, Steven K Vogel declares in a Niskanen Center paper that industrial policy is both imperative and inevitable going ahead. His argument is that all critical goals of the future — reducing carbon emissions, mitigating climate change, and strengthening supply chain resilience — would be unachievable without targeted government support. And that achieving these goals cannot be left to private firms because of three reasons. One, only the government can formulate national missions. Two, the private sector is bound to underinvest in R&D due to positive externalities. And three, only government can resolve coordination or network failures.

Batting against industrial policies are people at the Cato Institute (of course). Their paper Industrial Policy: A Bad Idea Is Back is a searing critique of industrial policies due to four reasons that block success.

One, centralised attempts to pick winning critical technologies are more likely to fail as the government does not know it all. Even when the government picks up the right industries for support, it often ends up picking up the wrong products and companies.

Two, as you can guess, targeted support enables rent-seeking. Companies that get government backing block competition and seek to mould the scheme for their own benefits rather than policy objectives. Costs balloon, performance falters, bailouts get demanded, and political considerations become paramount.

Three, industrial policies come at an immense cost to society. Besides the “seen” cost overruns, there are “unseen” opportunity costs, misallocation of resources, and deadweight losses due to higher tariffs.

Finally, industrial policies don’t pick winners but it’s winners that pick industrial policies. This means even in sectors where such policies created a few successful companies, “government support mostly went to companies that could have obtained private funding or produced outcomes that the market could have provided (and did previously without government assistance)”.

Where Does That Leave Us?

From an Indian perspective, I want to amplify two concerns about industrial policies.

First, as the previous section suggests, the real problem with industrial policies is in their design and implementation. Vogel argues that one can get industrial policy ‘right’ by doing three things: set clear priorities, deploy the appropriate policy tools; and structure government institutions to limit political capture and maximize policy effectiveness. Each of them requires high state capacity. While the first two can be still resolved as they are not transaction-intensive, a lack of adequate regulatory capacity to prevent companies from gaming the system is a big challenge in India.

Second, the opportunity cost argument is especially important for a 2000$ per capita income economy. Given that every rupee of revenue raised by the government costs three rupees to the Indian society, industrial policies are by default expensive instruments.

Reflecting on both sides of the argument, my current position is that industrial policies should be deployed very selectively, in sectors that are uber-strategic or where Indian companies enjoy a comparative advantage globally. For example, I would support an industrial policy for building a speciality semiconductor fab in India but I would oppose one that attempts to make display panels in India. Reducing import dependence from China cannot be the driving reason to shower billions of dollars for as many as thirteen sectors.

We shouldn’t forget that incentive schemes are finally band-aid solutions. They might create a few national champions but to eliminate the cost disabilities lakhs of Indian companies face, there is no alternative to improving tax, business, intellectual property, and trade regimes.

Post Script: Industrial Policies for Semiconductors

The union government launched four schemes worth a total of $10billion to build a semiconductor and display ecosystem in India. I’ve given these policies the Anticipating the Unintended treatment here and here.

To understand the European Union’s perspective on industrial policies in this sector, I spoke with Mathieu Duchâtel in an episode for the All Things Policy Podcast.

* from Emily Dickinson’s “Hope” is the thing with feathers

HomeWork

Reading and listening recommendations on public policy matters

* [Book] Diana L. Eck’s 2012 masterpiece India - A Sacred Geography challenges the notion that the Indian “nation” was a project born in response to colonial occupation.

* [Paper] Questioning Industrial Policy: Why Government Manufacturing Plans Are Ineffective and Unnecessary is an insightful read.

* [Article] Noah Smith on “Six reasons 2021 was a better year than people think”

If you find the content here useful, consider taking a deep dive into the world of public policy. Takshashila’s PGP — a 48-week certificate course will allow you to learn public policy analysis from the best practitioners, academics, and teachers. And that too, while you continue to work. In other words, the opportunity costs are low and the benefits are life-changing. Do check out.

Happy Holidays.

This is the last edition for 2021. There’s always a temptation to look back at the year gone and arrive at some kind of things-we-learnt-this-year list. As much as we’d like to do that, we really have nothing insightful to offer. It wasn’t a great year for most part because of the pandemic and it is ending on a foreboding note. Anyway, so what do we have in this year-end edition? 

We start with talking about the one overriding emotion that the two of us had through the year. What’s that one constant feeling that summed up our view of most events during the year? We then move on to the predictions we had made at the start of 2021 and see how each of us fared. And we close out with books, newsletters, podcasts or videos that we enjoyed greatly. That’s what is on the menu today.

The 2021 State Of Mind

RSJ:

Through the year my mind went back to the lines from one of my favourite poems, The Second Coming by W.B. Yeats. It is somewhat apposite too. Yeats wrote the poem just after WW-1 had ended and during the Spanish flu pandemic. His pregnant wife contracted the flu and survived after a harrowing time. Yeats paints a bleak landscape of disorder and anarchy with warring factions and a divided world order. The voices of reason lack moral strength because the false convictions of the passionate have taken over. To quote Yeats:

“The best lack all conviction, while the worst

Are full of passionate intensity.”

That’s how I felt most of 2021. 

Funnily enough, I started noticing many variations of these lines over the past months. I guess I lived through the Baader-Meinhof phenomenon on this one. I have collated them here. 

Back in 1871, in the introduction to his book, Descent of Man, Charles Darwin wrote:

“Ignorance more frequently begets confidence than does knowledge: it is those who know little, and not those who know much, who so positively assert that this or that problem will never be solved by science.”

In his 1931 essay, The Triumph of Stupidity, Bertrand Russell wrote:

“The fundamental cause of the trouble is that in the modern world the stupid are cocksure while the intelligent are full of doubt. 

Even those of the intelligent who believe that they have a nostrum are too individualistic to combine with other intelligent men from whom they differ on minor points. This was not always the case. A hundred years ago the philosophical radicals formed a school of intelligent men who were just as sure of themselves as the Hitlerites are; the result was that they dominated politics and that the world advanced rapidly both in intelligence and in material well-being.

It is quite true that the intelligence of the philosophical radicals was very limited. It is, I think, undeniable that the best men of the present day have a wider and truer outlook, but the best men of that day had influence, while the best men of this are impotent spectators. Perhaps we shall have to realise that scepticism and intellectual individualism are luxuries which in our tragic age must be forgone, and if intelligence is to be effective, it will have to be combined with a moral fervour which it usually possessed in the past but now usually lacks.”

In his essay, A Cult of Ignorance, published in the Newsweek (1980), Isaac Asimov wrote:

“Anti- intellectualism has been a constant thread winding its way through our political and cultural life, nurtured by the false notion that democracy means that my ignorance is just as good as your knowledge.

Now we have slogans on the part of obscurantists: "Don't trust the experts!"... We have a new buzzword too, for anyone who admires competence, knowledge, learning and skill, and who wishes to spread it around. People like that are called 'elitists'.

...What shall we do about it? We might begin by asking ourselves whether ignorance is so wonderful after all, and whether it makes sense to denounce 'elitism'. I believe that every human being with a physically normal brain can learn a great deal and can be surprisingly intellectual. I believe what we badly need is social approval of learning and social rewards for learning.”

Of course, all of this culminated into a wonderful paper by David Dunning and Justin Kruger titled, “Unskilled and unaware of it: How difficulties in recognizing one’s own incompetence lead to inflated self-assessments”. Published in the Journal of Personality and Social Psychology, Dec 1999, the abstract of the paper asserted:

“People tend to hold overly favorable views of their abilities in many social and intellectual domains. The authors suggest that this overestimation occurs, in part, because people who are unskilled in these domains suffer a dual burden: Not only do these people reach erroneous conclusions and make unfortunate choices, but their incompetence robs them of the metacognitive ability to realize it.”

Thus was born the Dunning-Kruger effect.

It owned 2021.

Pranay:

As for many of you, 2021 was my first year, in many many years, spent entirely at home. Until 2021, there were two neat compartments in my head: a ‘professional’ one and a ‘personal’ one. I associated terms such as ambition, learning, and planning only to the ‘professional’ compartment. On most issues outside that sphere, I thought I could just wing it. To use RSJ’s framing, it was the Dunning-Kruger effect at play in one compartment of life. So, 2021 has been about trying to unlearn many erroneous conclusions I had reached about wellbeing (physical and mental), parenting, relationships, and self-worth. There’s a lot to learn. But just the dissolution of the false assumption that two very different approaches apply to the two spheres of life is liberating.

Our Predictions Report Card

At the start of this year, we were foolhardy enough to make a few predictions. We will see how we fared on them.

RSJ:

Pranay had made an important point about predictions then:

“... predictions are susceptible to what Philip Tetlock calls ‘outcome-irrelevant learning’ — a situation wherein no matter the reality, people are in an excellent position to explain that what happened was consistent with their view.

One way to check outcome-irrelevant learning is first to make specific, measurable predictions and then reflect on real-world outcomes at the end of the prediction horizon. Which, for this newsletter, means we will do another post at the end of 2021 reflecting on our hits and misses.”

I must admit my 10 predictions didn’t exactly fit Pranay’s definition of being specific and measurable. So, as I look back, you can accuse me of conveniently retrofitting the actual outcomes to them. FWIW, let’s see how I fared.

Prediction 1: By the end of 2021, we will all realise we overrated the long-term impact of the pandemic on everything. There won’t be any ‘new normal’ to write home about. Things will be more of the same.

Outcome: Largely true, I would think. Maybe 6/10 on accuracy. No dramatic shift seen on anything yet. 

Prediction 2:  The size of the stimulus in most developed economies and the amount of liquidity pumped into the system will mean two things – eventual inflation and a repeat of the taper tantrum in future. Deficits have come to mean nothing and any future slowdown in the economy or fall in markets will mean more stimulus.

Outcome: Not bad. I guess 7/10 on this.

Prediction 3: The stock markets are in bubble territory now. But there won’t be any reckoning in 2021. The stocks doing well during the pandemic will continue to do well. The divergence between the real economy and the street will continue to confound all of us.

Outcome: Cannot complain. 7.5/10

Prediction 4: The early signs are of a K-shaped recovery around the world. This will be strengthened in 2021. A small set of companies and people will see a rising graph of growth and prosperity. The long-term impact of the pandemic will be to worsen inequality. The early but definite signs of this will show up in 2021.

Outcome: Again 7.5/10

Prediction 5: Credit offtake will be weak and the revival of consumption story will be dampened because of this. Private investments were trending downwards anyway before the pandemic. Its revival seems unlikely in 2021.

Outcome: Maybe 7/10

Prediction 6: The Chinese economy will lead the global growth engine. Despite its misadventures during the pandemic, China will continue its rise to the top. The Biden administration will take a more accommodative stance towards China. The trade war will subside and the EU will continue to strengthen its relationship with China. 

Outcome: Mostly wrong. China has continued to do well but it has its problems. 3/10

Prediction 7: Technology sovereignty will be a key theme in 2021. Countries across the western world will assert their technology independence. The most common form this will take is in keeping Chinese technology companies out of strategic sectors like telecom and finance infrastructure services. Or you could expect heavy fines for restrictive or anti-competitive practices and heavier hand of regulations on these (big tech) companies.

Outcome: Largely right. China itself came down heavily on its tech giants while Lina Khan, the chair of FTC, continued her tirade against Big Tech. 6/10

Prediction 8: How to vaccinate India will be a policy question that will keep everyone busy in the first half of 2021. Everything about vaccines – procurement, pricing, storage, administration and safety – will test our policymakers. My guess is we will do quite well in this entire exercise. 

Outcome: I guess we did better than what we expected at the start of 2021. We are still behind on booster doses and vaccines for kids though. 7/10

Prediction 9: It won’t be a great year for reforms. The wrong lessons will be learnt from the protests against farm law reforms. Plus, the usual set of assembly elections and the weak economy post the pandemic will continue to weigh on the government. So good, bold and much-needed reforms across sectors will again go into the backburner. 

Outcome: Cannot disagree. Barring Air India sale and some boost to manufacturing, not much happened here. The start-up story isn’t really a government story to own. Then there was the farm law repeal. Enough said. 7/10

Prediction 10: The BJP election machine will have a mixed year. Barring Assam where it should keep its majority and some gains in West Bengal, it won’t see much success. The campaign and the narrative building leading up to elections in Assam and West Bengal will not be for the faint-hearted. There will be a plethora of fake news, violence and no-holds-barred Muslim bashing. The signs are already there on the news channels. The opposition will remain largely ineffective with some kind of split happening in the Congress during the year. But there will also be the earliest sign of some kind of coming together of regional parties to counter BJP in 2024. This seems inevitable.

Outcome: Well, that looks fairly accurate. So 8/10.

Overall, not bad but I will try to be more specific about next year’s predictions.

Pranay:

This is the report card of the five predictions I made at the start of 2021.

Prediction 11: Petrol prices in Bangalore will hit ₹100 at least once before the end of 2021.

Outcome: Petrol prices were at ₹86.47 in Bengaluru on 1st Jan 2021. The prediction was based on the reasoning that excise duties on petrol and diesel are the superhero of last resort for state and union governments. As public spending rose in the backdrop of the second wave of COVID-19, both union and state governments took the easy route of increasing taxes on petrol and diesel. Petrol prices hit the hundred mark in June and galloped to ₹113 by November. Since then, they have settled to just above ₹100. Of course, there were no nationwide protests over the issue. No electoral results were attributed to this price hike, even though the rising inflation would have hit many people hard.

Prediction 12: A maximum of 2 CPSUs will be privatised by the end of 2021.

Outcome: The backdrop of this prediction was the buzz surrounding the union government’s grand scheme to sell its stake in over 25 CPSUs. The Ministry of Finance’s reply in the Lok Sabha has the details. And from what I can gather, just two CPSUs have found a buyer this year — Air India and Central Electronics Limited.

Prediction 13: GST will continue to have the current five tax slabs.

Outcome: My reasoning behind this prediction was that the fiasco on the GST compensation cess has broken the trust between union and state governments, and the latter will not welcome any further changes in the GST regime this year.

Prediction 14: The status quo at Ladakh in terms of territorial control will continue.

Outcome: Just yesterday, the Indian Air Force Chief had this to say:

“the standoff does continue. Disengagement has taken place in certain areas in Eastern Ladakh. But, the complete disengagement has not yet been done I would not like to go into the details, but suffice to say we are deployed, we are prepared to take on any challenge that may face us in that area with the shortest of notice.”

Prediction 15: The number of US service personnel in Afghanistan will fall below 2500 by the end of 2021.

Outcome: The prediction turned out to be true of course. But little did I expect that the withdrawal would put the Taliban in full control of Afghanistan.

Finally, I also had a note related to RSJ’s prediction on US and China. The Biden administration has, indeed, continued key elements of the previous administration’s trade policies on China. In the high tech domain, the restrictions are likely to tighten further.

These were my five predictions. In retrospect, it looks like I made some safe (and obvious?) bets.

Read, Saw Or Heard

We will close with our top recommendations of books, podcasts, newsletters et al, that we came across in 2021. 

RSJ:

In no particular order, here are mine

* This Is How They Tell Me The World Ends: The Cyberweapons Arms Race. A riveting take on global cyber warfare by Nicole Perloth that reads like a thriller. Deservingly won the 2021 Financial Times Business Book of the Year award.

* The Code Breaker: Jennifer Doudna, Gene Editing, and the Future of the Human Race. Walter Issacson’s book couldn’t have been more timely. The history of gene editing, development of CRISPR and how all of it came together to create vaccines for Covid-19 are all part of this absorbing and informative book. 

* The Light that Failed: A Reckoning. Krastev and Holmes on why liberal democracy faltered in eastern Europe. There are lessons for everyone there. 

* India’s Founding Moment: The Constitution of a Most Surprising Democracy. Madhav Khosla’s wonderful narration of the people, the ideas and the debates that went into the creation of our Constitution. 

* Wanderers, Kings, Merchants: The Story of India through Its Languages by Peggy Mohan. A forensic on Indian languages and what they tell us about our history and the evolution of our culture. Civilisation and reclaiming of it is often thrown about loosely in India these days. Our languages hold the secrets of our civilisation. Understanding them may be a useful precondition to whatever it is we are trying to reclaim. 

* Klara and the Sun by Kazuo Ishiguro. A peek into our future where kids are kept company by artificial friends but love still makes the world go round. 

* The Plot by Jean Hanff Korelitz. A ‘howdunit’ that keeps you engrossed till the end though you figure out the climax two-thirds of the way. Surprising that way.

* The Reith Lectures: Pranay introduced them to me and I have been hooked since.

* The Lex Fridman Podcast: The ‘Amit Varma, Sam Harris and Russ Roberts rolled into one’ of science and tech podcasting. Long episodes (many over 5 hours) about deep tech, AI, string theory, ultramarathons, truck driving and whatever else that catches Lex’s fancy.

* Ideas of India by Shruti Rajagopalan: Great conversations and a much needed platform to hear from young scholars about their work on India.

* Newsletters: Noahopinion by Noah Smith (original and insightful) and Chartbook by Adam Tooze (the best place to find out about new books and interesting ideas). Also, Strange Loop Canon by Rohit (no idea about his last name) and SneakyArt Post by Nishant Jain - two newsletters from Indians based abroad that I found interesting. Read them.

* There were other books (esp fiction) and interesting podcast episodes to share but maybe some other time

Pranay:

* Humankind: A Hopeful History challenged my Bayesian priors like no other book this year.

* The Quillette online magazine usually has pieces that go against the prevailing dominant narratives.

* Womaning in India newsletter taught me a lot.

* Anirban Mahapatra’s Gyandemic newsletter is full of TILs on new science findings.

* Your Undivided Attention Podcast convinced me that our information environment is polluted and we need to take charge of our consumption choices.

Take care. Stay safe. See you in 2022.

Insights on burning policy issues in India