Anticipating the Unintended (Pranay Kotasthane)

India Policy Watch: Our Week With Adani

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.

We turn 200 editions old today. It has been fun. Thank you for giving us your time. You can do without another self-congratulatory mail in your inbox. So, let’s get moving on with a nod to this classic line of Majrooh. 

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

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us. Listen in podcast app

- RSJ

The Trump administration is negotiating another stimulus package with Democrats that could be upwards of US$ 1.8 trillion. The Federal Reserve’s balance sheet continues to expand since the beginning of the pandemic. There’s a possibility it could touch US$ 10 trillion by the end of the year as it buys up treasuries, corporate bonds, mortgage-backed securities and muni bonds. With all this liquidity in the system and money in the hands of the average American, the macroeconomic puzzle is: where is the promised inflation? And if there’s no rise in inflation after such a dramatic increase in the deficit, why should the US bother about financial prudence? Why not just print money and spend your way to growth and prosperity?

The Indian Case

This has some resonance for India too. The loose monetary and fiscal policy regime we ran for longer than necessary after the global financial crisis (GFC) leading to high inflation in 2012-14 still casts a long shadow. That experience led to the flexible inflation target (FIT) that was set by the government for the Monetary Policy Committee (MPC) of the RBI. The results of the FIT regime have been mixed. It had become clear a couple of quarters before the pandemic began that this policy needed a relook. Growth had slowed down to a 4-5 per cent range while inflation remained at 4 per cent in the second half of last FY. But members of MPC-1 (whose term ended in September 2020) paused on rate cuts for the fear of inflation going beyond 6 per cent bound. Even at the peak of demand destruction in August, the MPC-1 had taken a hawkish stance on inflation that had the bond market worried.

The slew of measures announced by the RBI last week to keep the liquidity high in the system and to improve transmission from banks to borrowers to spur growth coupled with the commentary from the newly formed MPC-2, suggested it is willing to look past inflation running above 6 per cent. This came as a relief to the bond market as yields fell and spreads narrowed. The inflation question for India is relevant too. Will the quantitative easing done so far by RBI and its promise to continue to do more lead to higher inflation?

What To Make Of Inflation?

At the heart of these questions is whether the Friedman doctrine on inflation that has guided the actions of central banks for the better part of the last four decades still valid. He wrote:

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

The experience in the decade since the global financial crisis (GFC) doesn’t seem to bear Friedman out. Inflation has remained persistently low despite multiple rounds of quantitative easing by the Fed. There are structural reasons including a change in demographic composition, technological progress and innovation, productivity increases and global trade that account for this. This low inflation period in the developed world has meant there is a significant change in inflation expectations because of quantitative easing measures this time around. How do we know this?

Let’s look at the US 10-year yield movements over the past decade. In the aftermath of the GFC between 2009-13, on all occasions when the Fed pulled the QE lever (QE1, 2 and 3), the yields rose sharply on its announcement and fell when it ended. This showed there was a strong expectation of future inflation which led to people switching to short-term bonds from the longer ones. The pandemic related QE hasn’t seen this though. So far in 2020, the QE announcements by the Fed have hardly moved the needle on bond yields.

People no longer believe a loose monetary policy will lead to future inflation.

Central Banks’ Actions During The Pandemic

However, there is one significant difference in stimulus this time around. During the GFC, there was no significant fiscal stimulus provided by the US Treasury. It was a financial crisis, not a broader economic one. And it was solved by pumping more liquidity into the system. This time the quantum of fiscal stimulus to prevent destruction of demand has been enormous. Once the economy recovers and demand comes back organically, this extra money supply in the system will lead to future inflation. To what extent and when is still unknown. But the Fed is willing to have that kind of ‘heating’ up of the economy to support growth. And it doesn’t want to be forced to act when that happens. That’s the reason it moved to an average inflation targeting regime last month to give itself greater manoeuverability to take steps that could push inflation beyond the target of 2 per cent. It also signalled its intention of not raising the almost zero-bound interest rates anytime soon even if the inflation crosses 2 per cent.

In India too the message seems to be similar. We haven’t had a fiscal stimulus to match that of the US. But the RBI wants to signal it is willing to live with inflation running above ‘comfortable’ level in the coming days. The MPC report last week claimed almost 80 per cent of the increase in inflation beyond the 4 per cent target can be attributed to supply chain disruptions and increase in fuel prices. This it believes is a short-term phenomenon and inflation will be in the 5 per cent range next year. This is underlined to give comfort to bond investors to buy government securities without the fear of a near-term interest rate hike to contain inflation. Further, the other step announced by RBI in extending the HTM (hold-to-maturity) limits by another year to March 2022 is to protect any bondholder from the volatility of prices and booking losses on account of it. The overall RBI signal is it doesn’t want the worry of rising inflation and a consequent rate increase to come in the way of growth. It’s focus now is on improving the transmission of rate cuts to the borrowers to stimulate growth.

All of these point to two distinct shifts in thinking in monetary policymaking in both US and India. One, mere monetary expansion isn’t sufficient to trigger high inflation. Two, central banks are looking beyond price stability to include nominal GDP growth, currency management and employment as their objectives. This will be tough to manage but it is a more realistic set of goals to pursue in the current environment.    

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Why is Inflation so low? by Juan Sanchez and Hee Sung Kim published by the Federal Reserve Bank of St. Louis.

India Policy Watch #1: What Do Successive Defence Budgets Reveal?

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.

India Policy Watch: Passing the Burden

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.

India Policy Watch #1: Why We Don’t Care About Growth

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.

Global Policy Watch: Accident Ho Gaya

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.

Global Policy Watch: Bailout Pe Bailout Pe Bailout

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.

India Policy Watch: Those Mind Games

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.

India Policy Watch #1: Don’t Concentrate

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.

India Policy Watch #1: How Not to Let the Opportunity Slip Away

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

Global Policy Watch: Chronicle Of A Crisis Foretold

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.

Global Policy Watch: Much Ado About De-dollarisation

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.

India Policy Watch #1: Silly Season Is Upon Us

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.

India Watch #1: Of Protests and Perfect Tricks

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.

Being Pragmatic about ESG Norms, Lessons for India's Semiconductor Strategy, and Challenging Common Wisdom about India's Constitution-making.

Financial Regulation of Private Firms + Emigration of Indian Talent

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

Matsyanyaaya: Constraining the Pakistani Military-Jihadi Complex

Big fish eating small fish = Foreign Policy in action— Pranay Kotasthane

After a long time, India-Pakistan talks were back making the headlines last week. Moeed Yusuf, Special Assistant on National Security and Strategic Policy Planning to the Pakistani PM, hinted in an interview to The Wire that backchannel discussions about a political dialogue are in the works.

We don’t think political dialogues between India and Pakistan at the highest levels are useful. To the contrary, talks, especially at higher levels of the political spectrum, have a close correlation with terrorist attacks engineered by the Pakistani military-jihadi complex (MJC).

MJC is a framework we use to describe Pakistan’s seemingly duplicitous behaviour. That’s because Pakistan is not one geopolitical entity, but two. The first is a putative state which has all the paraphernalia that gives it a veneer of a normal state. However, this putative state competes with a multi-dimensional entity comprised of military, militant, radical Islamist and political-economic structures that pursues a set of domestic and foreign policies to ensure its own survival and relative dominance: something we refer to as the military-jihadi complex (MJC).

The status of the talks aside, I wrote a paper analysing the impact of some major recent political developments on the MJC and its India policy. I take stock of four developments, and analyse the risks and opportunities arising out of these developments for the MJC, and hence to India.

Development #1: The MJC’s External Benefactors Have Changed

Earlier, the MJC’s adventures were bankrolled indirectly by the US and directly by Saudi Arabia. Those days are long gone. The most important financier for the MJC now is China.

Risks and opportunities for India

The most prominent risk is that because the MJC is dependent on PRC like never before, and both are adversarial to India, it will continue to hurt Indian interests in order to prove its relevance to PRC.

The opportunity for India is that as PRC and MJC come closer, it will be easier to expose the structural flaws in their unequal relationship. As PRC increases its influence in Pakistan’s economy, nationalist forces (and even sections of the MJC) are likely to create fault lines between the two countries.

Countermeasures and Preparedness

India should prepare to face a diplomatic offensive of the MJC-PRC combine at various multilateral fora over Kashmir. Closer ties with the US, Japan, Australia and France are important to tackle this offensive. India also needs to be prepared for a rise in infiltration attempts and terrorist activity in Kashmir.

As a countermeasure, India’s messaging should aim to accentuate the underlying cultural, social, and economic differences between China and Pakistan in order to reduce the flow of capital from PRC to the MJC. The weaker the MJC’s external benefactor, the more constrained it will be.

Development #2: The US-Taliban Peace Agreement

The MJC has played a major role in steering and pressuring the Afghan Taliban to sign this agreement. In the process, it managed to partially repair flailing ties with the US. More importantly, it made major headway in its long-cherished aim of installing a pliant government in Kabul.

Risks and opportunities for India

The acceptance of the Taliban as a legitimate political force by the US is a moral and material victory for the MJC. The US-Taliban peace agreement is a tangible result for its policy of sustained terrorism in Afghanistan. Even a partial withdrawal of the US on the Taliban’s—and by extension, the MJC’s—terms will reaffirm the MJC’s faith in using terrorism as state policy. It might then apply this lesson to double down on terrorism against India as well.

India’s economic and diplomatic footprint will reduce in the short term. A case in point is the MJC’s attempt to designate four Indian nationals in Afghanistan under the UN 1267 Sanctions List accusing them of spreading terrorism in Pakistan.

Another risk is the MJC relocating its terror networks to Loya Paktika in eastern Afghanistan, a hotbed of anti-India activities in the past. This would allow the MJC to use terrorism against India while claiming that it has driven terrorists out of Pakistan.

The long-term opportunity for India is that as the US reduces its presence, Pakistan will be left with the unenviable task of managing the volatile situation in Afghanistan. It will be drawn into the seemingly irreconcilable differences in the Afghanistan polity. If a civil war-like situation erupts, the MJC will be left with more problems in its hands.

Countermeasures and Preparedness

India needs to be prepared for a scenario in which the MJC attempts to eliminate all Indian presence in Afghanistan. India must act to help its friends, not just in northern Afghanistan but also in the anti-Taliban forces in the south. At the same time, India would need to look at opening links, if not already done, with sections of the Taliban that do not want to be beholden to the MJC’s control. Finally, India’s focus in Afghanistan over the long-term should shift towards eliminating Pakistan-backed terrorist outfits’ relocation to eastern Afghanistan.

Development #3: India’s Revocation of the Special Status of Jammu and Kashmir

Given how invested the MJC has been in fomenting trouble in J&K, it is unlikely to take the abrogation of Article 370 lying down. Any action in Kashmir helps the MJC prove its relevance to the Pakistani society in the short-term. Hence, it would be eager to use this situation to further destabilise J&K and spread unrest elsewhere in India citing India’s move as the reason.

Risks and opportunities for India

The MJC is likely to continue with its policy of abetment of civil disobedience and violent protests. It will continue to support cross-border terrorism and might even resume a new insurgency against the Indian State by creating new outfits. The MJC would also want to revive insurgencies in other parts of India. Finally, India will face diplomatic offensive from PRC and Pakistan in the coming months over this move.

The opportunity for India arising out of this development is a chance to change the nature of the social contract of Kashmiris with the Indian state once and for all. Previous attempts at growth and prosperity in Kashmir were opposed by fundamentalists who saw these as attempts to change the demographic character of the Kashmir valley. The change in the special status of J&K allows India to ignore such calls and bring economic opportunities to Kashmir.

Preparedness and countermeasures

One, India needs to shift to a surgical and “smart” Armed Forces Special Powers Act (AFSPA) approach whose provisions can be limited in time and space. A change in the AFSPA will signal New Delhi’s bona fides and invite Kashmiri political leaders to reciprocate.

Second, the Government of India should opt for marginal, and not maximal response. It should reverse the damage done to the morale of the J&K police. It should lift the communications blockade and allow public protests and demonstrations to resume as these outlets are key to reducing the importance of the MJC as the prime influencer.

Third, India can consider deploying a Special Task Force of highly capable middle-level civil servants from across India for a period of three years to restore broken governance delivery systems.

With COVID-19, the tourism economy of Kashmir has been severely hit. This could make the young more vulnerable to the MJC’s machinations. Hence it is important for India to find livelihood alternatives. One way to do that is to create Priority Development Areas for the promotion of agro-processing, premium bottled water, and premium handicrafts. In the Jammu plains, the government could invite investors in contract farming. Bringing in international expertise in this space would also be a positive step.

Next, India needs to develop a strategic communication plan to defeat false and competing narratives generated by the MJC.

Finally, conducting local and assembly elections in the medium term to restart the political machinery and reverting J&K to a full state under the Republic of India after announcing elections will take off the edge from the MJC’s misinformation campaigns.

As a direct countermeasure, India should draw the world’s attention to the atrocities the MJC has unleashed in FATA. The Pashtun Tahafuz Movement (PTM) — a protest movement poses a unique challenge to the MJC because of its mass support base and a nonviolent character. This movement has the potential to seriously challenge the MJC and India’s efforts in Pakistan should be to align with the Pashtun cause. The Baloch insurgency by itself is too weak to change the power equations in Islamabad.

Development #4: Pakistan’s economic downturn

This weak domestic economy, coupled with the MJC’s diminished inability to extract from its external benefactors, also affects the MJC’s fortunes. It is now forced to look inwards and corner more resources for itself.

Risks and opportunities for India

A weakened economy reduces the range of options available to the MJC and makes some elements of it risk-averse. This means that the MJC will continue to rely on low-cost asymmetric options such as terrorism to hurt India. Abetting and sponsoring terrorism in areas with active insurgencies, both in Afghanistan and India are likely to continue.

The opportunity for India is that a weak economy puts the MJC squarely against forces opposed to it. For instance, the Pakistani Army has been opposing a reform for a fair division of financial resources between the federal and provincial governments. This offers an opportunity for India because this fight over economic resources has a powerful ethnic dimension. Sindh, Khyber Pakhtunkhwa, and Balochistan — all three provinces that stood to gain from the 18th constitutional amendment see this controversy as another attempt by the overwhelmingly Punjabi Pakistani Army to amass resources at their cost.

Preparedness and countermeasures

Whenever the MJC’s popularity declines in Pakistan, tensions with India allow it to regain lost ground. So, India should be prepared to face new asymmetric warfare attempts.

To further constrain the MJC, India should utilise the FATF mechanism and press upon the member countries that Pakistan still remains a hotbed of institutionalised terror activity. FATF grey-listing will make capital inflows difficult in an already investment-starved economy.

Finally, studies to expose how the MJC corners economic resources of the Pakistani state might also help manufacture a public opinion within Pakistan that questions the MJC. The lynchpin of the MJC, the Pakistani Army, is still the most trusted institution in Pakistan. To get the two Pakistans to lock horns with each other, a public narrative needs to be built exposing the extractive nature of the MJC.

After discussing these four developments, I end with the warning that the extent to which India can deploy these countermeasure options is limited by its own domestic situation. For one, a weak economy means that India will become cautious in exercising options that demand considerable resources. Secondly, the communally charged domestic narrative that the Citizenship Amendment Act has unleashed allows the MJC to reciprocally exploit fissures in Indian society. Conversely, a fast-growing economy and a stable, peaceful society will allow India to exploit a wider range of options to tackle the MJC.

The full paper can be read here.

India Policy Watch: That Tanishq Ad

Insights on burning policy issues in India— RSJ

Tanishq, a Tata company, withdrew its latest ad for its new collection titled ‘Ekatvam’ (“oneness”) after #boycottTanishq trended on Twitter. The ad featured a pregnant Hindu woman being surprised by her Muslim mother-in-law who had organised an elaborate traditional Hindu baby shower ceremony for her. This was a generic feel-good ad that’s a staple during the festive season. The Hindu-Muslim angle is one of the more tried and tested variants of this genre. No one was shown in any bad light and Suraj Barjatya would have been proud of its cloying storyline.

Yet, There Was Outrage

There were three reasons for the outrage depending on the sophistry of people being outraged.

First, the ad was seen as an attempt to normalise ‘love jihad’ – a belief that Muslim men are being trained and supported by forces inimical to India to woo Hindu girls and marry them in a ‘fresh’ attempt to colonise India. The government in parliament has denied its existence. It doesn’t require a lot of common sense to see through the lack of logic of this notion. That Muslim men will organise themselves to colonise India one Hindu girl at a time seems like a lot of effort with many low probability events to come through. Love in India doesn’t bloom easily even among the young of the same caste and community. ‘Love marriages’ still account for less than seven per cent all marriages. There’s no proof that Muslim men are being trained on some kind of finishing school that specialises in wooing techniques. Importantly, this assumes Hindu girls to be devoid of any agency of their own to decide who to fall in love with and marry.

Despite these obvious logical flaws, the narrative around ‘love jihad’ has built up over the years. The Muslim stars of Bollywood who have Hindu wives are often indirectly cited as role models for Muslim boys. As an aside, generations of Muslim female actors have married Hindu men over the years in Bollywood (from Nargis, Mumtaz, Zarina Wahab to Sonam). Any incident of a Hindu girl falling in love with a Muslim boy is used as an example of ‘love jihad’ and played up. The parents of girls in India live with multiple anxieties regarding their safety, well-being and marriage even in this day and age. This is unfortunate. To such paranoia, it isn’t too difficult to add ‘love jihad’.   

The second lot of outragers followed good, old whataboutery. Their contention: if the ad was serious about Hindu-Muslim amity, it should have reversed the roles. The girl should have been Muslim in a Hindu household. Apparently, this would have triggered massive Muslim protests, violence and liberal outrage about Hindus cornering the minorities and obliterating their identity and customs. This is all too easy to puncture. There have been films galore in the past two decades that have stereotyped Muslim jihadi villains without much of an outrage. In fact, Indian popular culture is replete with stereotypical Muslims – from a do-gooder neighbour, to a pir or, of late, a radical or a jihadi – without much of a reaction from the community. It is a bit specious to believe a reversal of roles would have meant trouble.

Lastly, there are those who have accused Tanishq of being too ‘woke’ for their own good. The argument is they should focus on selling jewellery and stay from ‘social causes’ that they don’t have an idea about. These aren’t compelling arguments. Consumer brands draw from the society to shape their communications. They research behaviour pattern, track changing social mores, and take stock of the attitudes and values prevalent in the society on an ongoing basis. No wonder advertisements often capture the zeitgeist earlier than other forms of popular culture – from yeh dil maange more to kitna deti hai. To accuse them of not understanding ground realities is rich. The point on being too ‘woke’ doesn’t merit any discussion. Any decent or noble thought can be dissed as one these days.

Despite the flimsy outrage, Tanishq withdrew the ad:

"This film has stimulated divergent and severe reactions, contrary to its very objective. We are deeply saddened with the inadvertent stirring of emotions and withdraw this film keeping in mind the hurt sentiments and well being of our employees, partners and store staff,"

That a group like Tata, a model corporate citizen with long years of service to the nation under its belt, could capitulate to online trolls and withdraw an ad that promoted harmony triggered another cycle of outrage.

Well, a day in the life of India on Twitter.  

This Is Different

The outrage, Tanishq’s reaction to it and its aftermath represent a distinct shift from the past. There’s something to learn from them about where we are as a polity now.

In this instance, we are in what can be termed the post-narrative phase engineered by the so-called cultural right-wing. Something nebulous like ‘love jihad’ has been crystallised over the past few years through multiple stories, myths and fake outrage. It even turned into a minor election issue in UP sometime back. Now this myth is so firmly established that its veracity isn’t in question. The reason for outrage instead is the ‘normalisation’ of it. That it is the ‘truth’ is already established. We are in the world beyond it. This will give a fillip to other such myths (multiple wives, high fertility rates to name two) that abound in this space. Sudarshan TV had recently run a programme titled UPSC jihad that alleged a conspiracy by the same elements who ran love jihad to now infiltrate the civil services in India. The Supreme Court had to intervene. But the seed has been sown. Now every time a Muslim candidate clears the UPSC test, expect UPSC jihad conspiracy theory to be revived. The trajectory for the future has been established.  

This apart, the outrage will deepen the ‘chilling effect’ in media and popular culture. The takedown of the Tanishq ad represents a win for a modus operandi that’s become common across the world – employ numerous bots to get the flywheel of outrage going, the flywheel then attracts others with imagined grievances or hate, it soon trends on social media that in turn creates fear of repercussions for the brand or the individual. Soon, they capitulate. From cancel culture on the left to right-wing conspiracy theories, this approach is a winner. It will take enormous courage for a brand or a film director to contemplate an inter-faith script in future.  

Lastly, there is something particularly odious about this outrage. There have been protests against ads, books or films in the past because of the alleged disrespect shown to a religion or a community. From banning The Satanic Verses, renaming a film Padmavat to not using Chattrapati Maharaj before Shivaji, the grievance is always about an insult – real or mostly imagined. This is the first case where the grievance is about harmony. It is about the alleged sinister machination underpinning this harmony. This is new and a significant step in the process of ‘othering’ where even coming together of communities cannot be countenanced.

Something to reflect on for every right-thinking Indian.

PolicyWTFs: The Tax Base Problem

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

— Pranay Kotasthane

Tax Revenue = Tax Base * Tax Rate

This simple equation implies that when revenues need to be raised, governments can do three things: raise the tax rate, increase the number of people paying the tax, or do both. However, in low state-capacity democracies like India, governments always seem to pick the first option. After all, it is always easier and faster for the governments to charge the same people more by increasing the tax rate than get more people to pay by increasing the tax base.

Following on, be prepared for calls to raise tax rates across the board. State and city government finances have gone for a toss due to COVID-19 and the union government’s chicanery on GST. They now have no other option but to raise their own revenues. Enter the dragon: tax rate hikes.

For instance, in Bengaluru, the local government is contemplating an increase of 15 to 30 per cent in property tax rates. On the surface, targeting property tax collections is prudent. The Economic Survey 2016-17 claimed that Bengaluru was collecting just a fifth of its property tax potential. Moreover, property taxes are paid by residents and hence this tax has a higher linkage compared to other taxes, between those who pay, those who benefit, and those who decide.

Where the government is getting it wrong is that instead of increasing the property tax base, tax rates are being hiked. Even if we ignore the ethical dimension given the pandemic, hiking rates is counterproductive. There is a negative correlation between tax rates and tax base i.e. high tax rates disincentivise people from paying taxes and create a parallel tax-avoidance economy in turn. The tax-avoidance economy is lucrative for the revenue collectors as well — higher the rates, higher the number of evaders willing to pay a lower amount bribe to them.

Whether it’s property tax rates or GST, the same policyWTF is repeated: first, a new tax gets levied with a low tax-base but a high tax rate. Next, the already high tax-rate is increased steadily because the tax base is low and finally, when increasing rates is no longer enough, raising the tax base is contemplated.

The approach should be the reverse. Every new tax should aim to cover the largest number of people first through extremely low tax rates. Once that’s done, technology should be used to prevent underpayment. Finally, tax rates can be revised incrementally. We are a long way off this ideal and we don’t seem to be learning even in this crisis.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] David French writing for the Persuasion on The Hate at the Heart of Conspiracy Theory. The lede sums it up: Liberty can survive intense disagreement. But it cannot survive pure hate.

* [Article] Govinda Rao on why the GST saga is terrible for the future of federalism in India.

* [Podcast] India’s armed forces still don’t operate under unified theatre commands. Why is ‘jointness’ beneficial and how should India’s theatre commands look? The latest episode of Puliyabaazi with Lt Gen Prakash Menon has the answers.

Read the edition here.

Read the edition here.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us. 

- RSJ

The Carnegie Endowment for International Peace in partnership with the research and analytics firm YouGov conducted the Indian American Attitudes Survey (IAAS) between September 1 and September 20, 2020. Sumitra Badrinathan, Devesh Kapur and Milan Vaishnav now have a paper titled ‘How Will Indian Americans Vote’ based on this survey that has a few interesting conclusions. 

The study is useful to test a few hypotheses that have emerged in India in the past few years. These include:

* Indian Americans have nudged closer to the Republicans on the back of Trump-Modi chemistry. The enthusiasm for PM Modi among NRIs and among BJP supporters in India for Trump has created a positive self-reinforcing cycle for both.

* Most Indian Americans have turned conservative over time going by their stand on domestic issues in India. This is drawn from the views of many vocal Indian Americans on social media platforms and the anecdotal evidence of friends and family on WhatsApp groups supporting the conservative or majoritarian stance of this regime. This has led many to assume a large defection of Indian Americans from the Democratic camp that leans liberal.

* There have been multiple instances of the Democratic leadership (Biden, Harris, Warren, Jaypal et al) being critical of India’s position on various core issues like revocation of Article 370, the clampdown in Kashmir and the handling of CAA protests. There’s been a feeling the Democrats will lose support among Indian Americans because of this.

* Lastly, Indian Americans are seen as a model minority that’s highly educated, law-abiding with twice the national average household income. Will the typical minority issues like immigration, race and identity politics animate them like they do for other minorities?

The key conclusions from the study are summarised below. It is quite an eye-opener when you consider the hypotheses outlined above.

* Indian Americans remain solidly with the Democratic Party. Recent anecdotal narratives notwithstanding, there is scant evidence that Democratic voters are defecting toward Trump and the Republican Party. Seventy-two percent of registered Indian American voters plan to vote for Biden and 22 percent intend to vote for Trump in the 2020 November election.

* Indian Americans do not consider U.S.-India relations to be one of the principal determinants of their vote choice in this election. The economy and healthcare are the two most important issues influencing the vote choice of Indian Americans, although supporters of the two parties differ on key priorities. “Kitchen table” issues dominate over foreign policy concerns.

* Indian Americans exhibit signs of significant political polarization. Just like the wider voting public, Republican and Democratic Indian American voters are politically polarized and hold markedly negative views of the opposing party and divergent positions on several contentious policy issues—from immigration to law enforcement.

* U.S.-born Indian American citizens tilt left compared to foreign-born citizens. While both U.S.-born and naturalized Indian Americans favor the Democratic Party, this tilt is more pronounced for U.S.-born Indian Americans. Political participation by naturalized citizens is more muted, however, manifesting in lower rates of voter turnout and weaker partisan identification.

* Harris has mobilized Indian Americans, especially Democrats. Harris’s vice presidential candidacy has galvanized a large section of the Indian American community to turn out to vote. On balance, while the Harris pick might not change large numbers of votes (given the community’s historic Democratic orientation), her candidacy is linked to greater enthusiasm for the Democratic ticket.

* A large section of Indian Americans view the Republican Party as unwelcoming. Indian Americans refrain from identifying with the Republican Party due, in part, to a perception that the party is intolerant of minorities and overly influenced by Christian evangelicalism. Those who identify as Republicans are primarily moved to do so because of economic policy differences with the Democrats—with particularly marked differences regarding healthcare.

* Political beliefs seep into perceptions of U.S.-India bilateral relations. Indian Americans believe Democrats do a better job of managing U.S.-India ties by a considerable margin while Republicans hold more favorable views of Modi.

Bottom line: That nationalist, majoritarian NRI friend on your WhatsApp group finds virtues in liberalism while making their electoral choice.    

Voter Apathy ≠ Political Apathy

— Pranay Kotasthane

Indian governments’ don’t do well on law and order, education, and public health. And yet there’s wide support whenever Indian governments and political parties promise new schemes to accomplish even grander things. What explains this paradox?

I have two hypotheses.

One, the political enthusiasm hypothesis. This is the reverse of the voter apathy idea. It means that the voters who have a disproportionate influence on setting the political agenda (read middle-income voters) were never apathetic to politics but only to government provision of public services.

They became apathetic towards government provision of public services because rising incomes meant that they could substitute the missing services with their own private solutions. Having done that, politics became a means to achieve other outcomes — those unrelated to market failures. Voting apathy never meant political apathy.

See this from the Exit, Voice, Loyalty thesis. Loyalty makes exit difficult. So the median Indian voter never really exited from Indian politics and instead chose to voice concerns unrelated to government provision of basic services.

My second hypothesis is more charitable to the Indian voter. I call it the expanding moral arc thesis. It is based on the book The Moral Arc by Michael Shermer. The book argues that the moral arc is continuously expanding because of science and reason.

The key insight for us is that Indian politics is being played out in the background of this increasing moral arc. This makes the Indian developmental challenge possibly more moral but definitely less fast. The inequality narrative in India is a reflection of this expanding moral arc. The government’s role in India is seen as a moral project, not a utilitarian one and hence we are okay to give its record on fixing market failures a free pass.

(Originally published at express.thinkpragati.com on April 2, 2019)

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Systematic Inequality and American Democracy by Danyelle Solomon, Connor Maxwell, and Abril Castro published by the Centre for American Progress

* [Article] David Brooks on social trust and moral convulsions in America

* [Video] This discussion on Raghuram Rajan’s The Third Pillar: How Markets and the State Leave the Community Behind is worth a watch. It will make you think harder about the distinct roles of the state, markets, and the community.

The full text is here.

The full text is here.

Full text here.

Read the full text here.

Course Advertisement: Admission to Takshashila’s Graduate Certificate in Public Policy (GCPP) programme is now open. Start your 2024 with a course that will equip you with the tools to understand the world of public policy. Check all details here.

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.

India Policy Watch #1: Like a Kid in a Candy Store

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.

Happy New Year

— 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.

Prediction Time

—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.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

Aap party hain, ya broker?

That line from Dibakar Banerjee’s sleeper hit Khosla Ka Ghosla (2006) sums up our attitude to middlemen. Indians have an instinctive distrust of business or ‘corporate’. But that’s small chhutta compared to our almost visceral antipathy to broker. We use dalal as a pejorative in polite conversations — it is someone who gets in the way of an honest transaction between two willing parties and takes a ‘cut’.

From the trader at the APMC mandis to the life insurance agent selling you a policy that you don’t need, the middleman is the easy policy target whose elimination is seen as necessary. Nobody can see what they produce or the labour they put in, yet they seem to corner most of the profits.

India might be an extreme case but elsewhere in the world too, the intermediary isn’t the most welcome of sights. For every business that has middlemen bringing the buyers and sellers together, there are scores of entrepreneurs building platforms to make them irrelevant. The billion-dollar start-up idea to disrupt any industry is to take out the intermediaries, drive the costs down, reduce ‘friction’ and offer customers a wider array of choices for free.

There are two questions that interest us here:

* Why did we have intermediaries in the first place if they add to friction, make a cut by buying low and selling high and, in general, viewed unfavourably by everyone?

* Is real disintermediation possible in any marketplace?

The Economic Case For Brokers

The usual arguments made for an intermediary are quite intuitive. There is the market-making role, to begin with. Take flowers for example.

There are customers looking to buy flowers but who don’t know flower-growing farmers. Even if they knew a few, those farmers might not be growing the variety of flowers the buyers need. In the same vein, the farmers won’t know their likely buyers beyond their immediate vicinity. The transaction costs of finding out each other for every individual farmer or buyer is just too high. The brokers step in to create a market. They understand the demand of the customers located in a specific area, search for farmers who grow those types of flowers, take the risk of buying them, then transport them to a market close to the buyers and provide an assortment of flowers as choices to the customers. There are various costs the broker incurs in this process – search, transportation, storage and risk capital. The broker makes the market ‘liquid’ – the transactions follow from there. Without these costs, there’s no market. Without a market, there’s no trade between the farmers and customers. No trade satisfying needs of two parties is a net negative for the society.

There’s more to this though. Once the broker repeats the transaction over time and attracts other brokers who compete for the same buyers and sellers, we have two additional benefits for the ecosystem. One, every broker looking to increase his business works to optimise the transaction costs which then translates to lower price for the customer. This dynamism of price discovery ensures there is a continuing relevance of the broker. Two, over a period of time, the broker is able to differentiate between the output of various farmers, rate them on quality and provide additional service of ‘certifying’ the product. This deepens the market with customers willing to choose their desired quality of product and paying a price for it.

However, even this example doesn’t quite capture the fundamental role of a broker in a society. Why? Because the above example is a win-win kind. Everyone benefits at the end of it. But what about instances where the size of the pie is fixed?

That brings me to R.A. Radford’s seminal paper, The Economic Organisation of a P.O.W. Camp written in 1945. This 11-page paper is a deep sociological study of life in a prison camp and from it emerges a truth that’s simple and profound.

The camp had over 2000 prisoners who received food parcels from the Red Cross. The parcels were exactly the same for everyone containing tinned milk, jam, butter, biscuits, beef, chocolate, sugar, etc., and cigarettes. The POWs in the camp were from various ethnicities and religions. It isn’t difficult to see what happened next. The prisoners had different preferences for the goods within the parcel. The non-smoker had no use of the cigarettes, many didn’t want the milk and the Sikhs didn’t want the beef. Soon trading started.

As Radford writes:

“At once exchanges, already established, multiplied in volume. Starting with simple direct barter, such as a non-smoker giving a smoker friend his cigarette issue in exchange for a chocolate ration, more complex exchanges soon became an accepted custom.

Stories circulated of a padre who started off round the camp with a tin of cheese and five cigarettes and returned to his bed with a complete parcel in addition to his original cheese and cigarettes; the market was not yet perfect.”

There are two fundamental truths here. First, the gift economy doesn’t stay that for too long. People like to trade. Second, a broker (like the padre mentioned) can go around enabling exchange among prisoners because he’s seen to be trustworthy and could end up with more than what he started. This is a very powerful point. Everyone who traded with the padre did so on their own volition. All transactions were voluntary. They traded because they thought they were better off with that transaction. Yet after all the trades were done, the broker (padre) made a tidy profit of a complete extra parcel. This was a classic case where the size of the pie was fixed. The total parcels remained the same. The padre merely rearranged them on the basis of individual preferences. The prisoners ended up with less than what they had yet everyone felt they benefitted.

Differential preferences and different perceptions of value drive trade among people and anyone facilitating that will make a profit even in a ‘zero-sum’ scenario. This was a remarkable insight.

Also, over time as the prices were ‘discovered’, preferences became more varied and barters got more complex, a full-fledged exchange developed in the camp:

“…there was a lively trade in all commodities and their relative values were well known, and expressed not in terms of one another - one didn't quote bully (beef) in terms of sugar - but in terms of cigarettes. The cigarette became the standard of value. In the permanent camp people started by wandering through the bungalows calling their offers - "cheese for seven" (cigarettes) and the hours after parcel issue were Bedlam.

The inconveniences of this system soon led to its replacement by an Exchange and Mart notice board in every bungalow, where under the headings "name," "room number," "wanted" and "offered" sales and wants were advertised. When a deal went through, it was crossed off the board. The public and semi permanent records of transactions led to cigarette prices being well known and thus tending to equality throughout the camp, although there were always opportunities for an astute trader to make a profit from arbitrage. With this development everyone, including non-smokers, was willing to sell for cigarettes, using them to buy at another time and place. Cigarettes became the normal currency, though, of course, barter was never extinguished.”

This isn’t easy to comprehend. Nothing was being produced by anyone in the camp. Yet a market developed and some middlemen made profits. As Radford writes:

“It is thus to be seen that a market came into existence without labor or production. …the articles of trade - food, clothing and cigarettes - as free gifts - land or manna. Despite this, and despite a roughly equal distribution of resources, a market came into spontaneous operation, and prices were fixed by the operation of supply and demand. It is difficult to reconcile this fact with the labour theory of value.”

Despite all of this, the middleman still got a bad rap:

“More interesting was opinion on middlemen and prices. Taken as a whole, opinion was hostile to the middleman. His function, and his hard work in bringing buyer and seller together, were ignored; profits were not regarded as a reward for labor, but as the result of sharp practices. Despite the fact that his very existence was proof to the contrary, the middleman was held to be redundant in view of the existence of an official Shop and the Exchange and Mart. Appreciation only came his way when he was willing to advance the price of a sugar ration, or to buy goods spot and carry them against a future sale. In these cases the element of risk was obvious to all, and the convenience of the service was felt to merit some reward.”

There is no getting away from this. The broker adds value, even in zero-sum scenarios, while being simultaneously despised. This is hard-wired into us. In some cultural contexts, like in India, this is deeply entrenched.

What makes it worse in India is the idea that state can play the role of the broker and eliminate the profits made by them for the betterment of the market. Multiple problems stem from this. One, the state is a monopoly. It doesn’t have the incentive like that of an individual broker to lower transaction costs and keep price dynamic. Over time the cost of this lethargy is borne by both the buyers and sellers. The agents of the state who wield the power of the broker without the attendant risks turn into rent-seekers. The buyers and the sellers are at the mercy of the broker who sets the terms of the trade.

Lastly, the market gets distorted. The price loses its value as a signal. Side deals are struck. Licenses are scarce and get auctioned in informal markets. Black markets emerge. And the liquidity is held to ransom by a few people. This is exactly what happened in India when the government played the role of intermediaries controlling the APMC mandis. The government didn’t eliminate middlemen. Quite the opposite, it metamorphosised middlemen into odious, profiteering rent-seekers. A free market of brokers with regulations that prevented cartelisation would have served the farmers and customers better.

Is Real Disintermediation Possible?

That brings us to the question of disintermediation. The internet has reduced the search and information costs down to zero. This gives the impression that real disintermediation is possible like that done by Uber, AirBnB or TripAdvisor. But there are three flaws in this argument:

* Many of these platforms have turned into intermediaries themselves with almost monopoly powers in certain markets. Come to think of it even Google and Facebook are intermediaries who turn in enormous profits every year in their roles as market-makers. The one disintermediating an industry eventually becomes an intermediary.

* These platforms disintermediated by offering more choices directly to the customers. Over time the choices available on them multiplied to an extent that it paralysed the users. Anyone looking to choose a restaurant in an unfamiliar city knows of this problem. Soon enough you will need an intermediary to sort through the many highly rated restaurants all around.

* There are intermediaries whose role is exact opposite of what traditional brokers do. They keep parties apart to enable a transaction. Investment bankers and sports agents are examples of this. The intermediary keeps things on balance and doesn’t let a deal fall through by keeping the parties from directly interacting with another. As search and information costs fall, this role of keeping parties away from one another continues to remain relevant.

So long as there is trade and there are differential preferences, the broker won’t go out of business. The poor image they suffer is on account of a deeply held Marxian belief that visible labour is the real thing of genuine value and anyone trading only in information or whose labour is invisible is a mere opportunist. This gets compounded when the state intervenes to intermediate themselves or allows for cartelisation of brokers.

A free market where broker competes on equal terms to drive transaction costs down, provide choices and keep the market liquid benefits all. Intermediaries came into play to reduce friction in transactions. Eliminating them won’t make things frictionless.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Tim Harford’s Undercover Economist piece on the Radford paper in the FT: Rules of trading in a POW camp.

* [Article] “It’s chiefly rent-seekers who oppose our farm reforms”: Shruti Rajagopalan writing for the Mint on how governments legislate to create rents for middlemen that distort the market.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch: Disinvestment — Aakhir Kyun?

Insights on burning policy issues in India— Pranay Kotasthane

On October 30th came the news that the government has modified bidding parameters to make the Air India disinvestment lucrative for buyers. Essentially, the government first made the sale difficult by inserting way too many conditions. Unsurprisingly, it found no buyers. Then hit COVID-19 and now the government is so desperate to raise resources that it is willing to finally remove the self-placed hurdles.

This got me thinking: what are the different narratives regarding the purpose of disinvestment? What stories do they tell and what policy actions do they imply?

I could think of three such narratives.

Narrative #1: Governments Should Sell Businesses it Can’t Run Well

The underlying story is simple: some PSUs incur consistent losses. Losses indicate that the government cannot run them well. Hence, these PSUs must be sold. The focus in this narrative is on numbers such as falling market caps to decide on companies to be sold. For example, the argument that Air India Makes a Loss of Over ₹ 20 Crore Per Day has repeatedly (and successfully) been used to rationalise Air India’s sale. The policy position implied (and unsaid) in this narrative is that it is okay for governments to run businesses as long as they are profitable. What’s also implicitly implied is that the sale of a government-run company first requires running it down into an incorrigible loss-making entity.

Narrative #2: Governments Can Raise Revenue by Selling Some Assets

The underlying story is one of urgency. Governments need money. One way they can make money is by selling the assets they own. Hence, divestment. Governments find this narrative quite useful. Every budget, the government sets a disinvestment target for itself with the aim of reducing its fiscal deficit.

The focus on a revenue target from disinvestment can lead to perverse incentives: when it can’t find genuine buyers, government coaxes government-run companies like LIC to purchase government-run companies on sale. This ‘sale’ shows up as revenue in the government accounts even though the government’s stake has not reduced in reality.

Narrative #3: Governments Should Sell What’s not-Strategic

In some sectors, markets might underproduce even though that sector is non-substitutable and vitally important to the nation-state. In such sectors, the government should continue to run businesses, regardless of the revenue a sale can generate or the losses made in running that business. Examples could be oil, rare-earth exploration or extremely critical defence equipment. Outside this reduced set, the government should sell all businesses. The focus in this narrative is on the reduction of overall government equity in non-strategic sectors, and not as much on the revenues raised by the sale of government assets.

A Battle of Narratives

Narratives 1 and 2 have enjoyed dominance in Indian policy discourse at various times. When the economy was chugging along, narrative #1 dominated: many PSUs were to be first put in a state of coma to enable an eventual sale in the distant future. Now, with almost a decade of poor economic growth, the revenue maximisation narrative has become more salient.

The third narrative is still on a weak footing. What's strategic and what’s not? What’s the marginal cost of public funds used for running a PSU? These questions rarely feature prominently in disinvestment discussions.

India Policy Watch: Growth, Liberty And Freedom

— RSJ

We have often argued for economic growth as a moral imperative for India. This opinion divides people. And we understand that. We get the usual questions thrown back to us. Should the pursuit of material wealth be such priority for any society? More so for one like ours where issues of equity, liberty and political rights aren’t yet settled; where there’s a chasm of everyday despair between the promise of our constitution and the reality that confronts us.

The pat response to this kind of argument is twofold. One, we (and others like us) make a point that growth is a precondition to solve these issues. Redistribution requires something tangible than mere lofty ideals to share with others. Putting it ahead of growth is putting the proverbial cart before the horse. Second, we can’t escape the trade-offs between growth and other social welfare objectives for our current stage of economic development. Of course, we must avoid the mistakes of other developed nations in our path to prosperity. But it will be futile to mimic policy actions they are taking now and apply them to our context while getting to where they are now. We have to bias our actions to achieve growth at the cost of other objectives. Else, we will achieve neither. This is the old Rostow (1960) ‘stage’ of development argument.

Sen’s Arguments

The philosophical challenge to this view comes from what we may term the Amartya Sen school of developmental economics. Sen has argued with passion about the need to invest in social infrastructure (education and health) that will build human capabilities across society. This is the only way to sustain growth. Like Sen once wrote:

“I know of no example of unhealthy, uneducated labour producing memorable growth rates.”

In other words, in Sen’s worldview people like us who prioritise growth are putting the cart before the horse. This debate can go on and on. As it has.

However, over the last few weeks, as I was reading Sen’s Development As Freedom (1999), I realised he has made more nuanced arguments on this than what my reductive reading of him has been so far. I haven’t read a lot of later day Sen and my views were informed by his interviews and columns in media since he started batting for an entitlement driven state-run programmes during the time of UPA-1. The book makes a strong case for freedom and views liberty from the perspective of a welfare state. I shook my head in disagreement often but far fewer times than I had anticipated. I nodded way more than I ever thought I would.

Freedom And Human Capability

As the name of the book suggests, Sen argues freedom is both the core objective and the primary means of development. Sen’s definition is wide and encompasses five types of freedoms that are distinct but related. These include political freedom, economic facilities, social opportunities, transparency guarantees and security. Like classical libertarians and enlightenment thinkers, Sen’s focus is the individual. He views individual freedom along the five vectors as the primary variable that determines their effectiveness and success. Compromising on any of these freedoms for economic growth cannot be considered a good outcome regardless of what the per capita income data might show. It will hurt in the long run.

Sen defines a ‘capability approach’ to freedom where he concerns himself with the individual’s ‘capability to lead the kind of lives we (they) have reason to value’. This freedom and this human capability when raised consistently is a net positive – it increases our choices, our wellbeing, our options to improve the society which should eventually lead to economic growth.

Sen supports markets, individual liberty and responsibility, and economic freedom as the factors that enable the increase in human capability. Social institutions and infrastructure should be built to support these especially in countries with low per capita income and a large workforce. The focus should be broader than enhancing mere human capital that views an individual as a means of production. Instead, a human capability frame sees the individual beyond being an agent for the production of goods and services. It takes a holistic view of what they could be.

The Need For Entitlement

This is where his focus on entitlement emerges. For him, an individual is poor when they are denied any of the five types of freedom he has outlined. This happens either because of path dependence or the nature of the state where they live. Either way, this has to be corrected and true freedom ‘to lead the lives they have reason to value’ should be an entitlement of every citizen.

The kind of thinkers Sen rounds up to make a case for freedom – Adam Smith, Montesquieu, Hayek – surprised me on one hand. After all, these aren’t the names you usually associate with him. On the other hand, it is difficult to make a case for individual and liberty without bringing these names into the discussion. Sen, as he came across to me through this book, is a believer in capitalism and the power of individual freedom to create value for the society. These attributes are important for what they produce but he also insists they are good even without being instrumental for growth.

Freedom is good. Period. That it also leads to growth, makes it better.

Benjamin Constant On Liberty Of Moderns

The book reminded me of the famous speech of Benjamin Constant, The Liberty of Ancients Compared with that of Moderns (1819). Constant used the word ‘commerce’ to broadly speak about economic growth. There were two insights in his speech about commerce and liberty that can be considered as precursors to Sen’s books.

First, he believed commerce is the perfect antidote to the arbitrary use of powers by the state. Essentially, economic growth leads to freedom which is one half of Sen’s argument. To use Constant’s words:

“But commerce also makes the action of arbitrary power easier to elude, because it changes the nature of property, which becomes, in virtue of this change, almost impossible to seize.

Commerce confers a new quality on property, circulation. Without circulation, property is merely a usufruct; political authority can always affect usufruct, because it can prevent its enjoyment; but circulation creates an invisible and invincible obstacle to the actions of social power.

The effects of commerce extend even further: not only does it emancipate individuals, but, by creating credit, it places authority itself in a position of dependence. Money, says a French writer, 'is the most dangerous weapon of despotism; yet it is at the same time its most powerful restraint; credit is subject to opinion; force is useless; money hides itself or flees; all the operations of the state are suspended'. Credit did not have the same influence amongst the ancients; their governments were stronger than individuals, while in our time individuals are stronger than the political powers. Wealth is a power which is more readily available in all circumstances, more readily applicable to all interests, and consequently more real and better obeyed. Power threatens; wealth rewards: one eludes power by deceiving it; to obtain the favors of wealth one must serve it: the latter is therefore bound to win.”

“… Commerce has brought nations closer, it has given them customs and habits which are almost identical; the heads of states may be enemies: the peoples are compatriots. Let power therefore resign itself: we must have liberty and we shall have it.”

The Danger of Trading Off Liberty For Growth

The other argument Constant makes is the danger of people getting immersed in individual pursuits and enjoyment that they easily cede their right to political power and transparency. This is what Sen would call sacrificing a few vectors of his definition of freedom for economic growth. The idea of a benevolent dictator who will curb some freedom but set things right that seduces many educated, well-off Indians. Constant warns:

“The danger of modern liberty is that, absorbed in the enjoyment of our private independence, and in the pursuit of our particular interests, we should surrender our right to share in political power too easily. The holders of authority are only too anxious to encourage us to do so. They are so ready to spare us all sort of troubles, except those of obeying and paying! They will say to us: what, in the end, is the aim of your efforts, the motive of your labors, the object of all your hopes? Is it not happiness? Well, leave this happiness to us and we shall give it to you. No, Sirs, we must not leave it to them. No matter how touching such a tender commitment may be, let us ask the authorities to keep within their limits. Let them confine themselves to being just. We shall assume the responsibility of being happy for ourselves.”

I will conclude with Constant’s final words on this which mirror those of Sen’s. And they are similar to what we have advocated when we have made a case for economic growth and liberty over the past year on these pages.

“The work of the legislator is not complete when he has simply brought peace to the people. Even when the people are satisfied, there is much left to do. Institutions must achieve the moral education of the citizens. By respecting their individual rights, securing their independence, refraining from troubling their work, they must nevertheless consecrate their influence over public affairs, call them to contribute by their votes to the exercise of power, grant them a right of control and supervision by expressing their opinions; and, by forming them through practice for these elevated functions, give them both the desire and the right to discharge these.”

Trivia: WLFPR in Bangladesh

Interesting facts and stats relevant to public policy

The Women Labour Force Participation Rate in neighbouring Bangladesh increased by nine percentage points in the last 15 years. India’s decreased by 11 percentage points in the same period.

Graph and Data: World Bank

HomeWork

Reading and listening recommendations on public policy matters

* [Article]: Bhagwati in the Mint on Why Amartya Sen Is Wrong

* [Article]: A summary by the Outlook on Sen and Bhagwati arguing on the pages of the Economist

* [Report]: On Bangladesh’s U-curve bending performance on Women Labour Force Participation.

* [Article]: An excellent data story on the five paths of disinvestment in India by Sudipto Banerjee, Renuka Sane and Srishti Sharma.

* [Podcast]: On Puliyabaazi, Pranay and Saurabh learn about the history of banking in India from Amol Agrawal.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us. Listen in podcast app

- RSJ

The Chairman of US Federal Reserve, Jerome Powell, in his speech at the annual Jackson Hole symposium signalled a significant shift in its approach to tackling inflation. He had his reasons:

“The persistent undershoot of inflation from our 2 percent longer-run objective is a cause for concern. Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy….

However, inflation that is persistently too low can pose serious risks to the economy. Inflation that runs below its desired level can lead to an unwelcome fall in longer-term inflation expectations, which, in turn, can pull actual inflation even lower, resulting in an adverse cycle of ever-lower inflation and inflation expectations.”

Fed’s Average Inflation Targeting Regime

This isn’t a surprise. An ‘ever-lower’ inflation expectation would lead to a lower interest rate. The perennial undershooting of inflation target in the US over the last quarter century has meant short-term interest rates approaching zero. Once you reach that there’s limited room for any rate cuts to boost investments, increase employment and stabilise the economy during a downturn. The experience of Japan and many EU countries that have negative interest rates is instructive here. Clearly, there is no appetite for negative rates among US lawmakers and public.

This led Powell and its policymaking body FOMC (Federal Open Market Committee) to draft the revised statement on Longer-Run Goals and Monetary Policy Strategy. The Fed will now follow the policy of ‘average inflation targeting’ with the goal set at 2 per cent. In an average targeting regime the Fed will allow inflation to run above 2 per cent for some time in order to ‘make up’ a period of inflation below 2 per cent. Powell explained:

“We have also made important changes with regard to the price-stability side of our mandate. Our longer-run goal continues to be an inflation rate of 2 percent. Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent.”

“…our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

Powers And Goals Of Central Banks

I was struck by a couple of different thoughts when I read his speech.

First is a political philosophy question. What is the basis for the absolute power that a central bank like the Federal Reserve has to set goals for the economy in a democracy? What are the checks and balances to this power? For instance, apart from the FOMC who else was involved in questioning or validating the change in regime? Or was it just an arbitrary consensus of some experts (elites?) who aren’t answerable to anyone?

Second, is a technical question. Isn’t the way the central banks set the inflation rate targets good old central planning at work? Instead of letting markets determine the price based on supply, demand, and labour (or factor) productivity, the central bank interferes to keep prices ‘stable’. Isn’t this a distortion of market mechanism? There are more specific questions. Where did it get the 2 per cent target from? Also, consider the scenario when actual inflation is different from 2 per cent. What’s the duration for which the Fed will wait till it acts? And how quickly will it want the average to be restored? At a theoretical level, what’s the basis for the Fed arriving at an average inflation targeting goal? What should be the goal of a central bank?

Is Central Banking A Liberal Concept?

These are compelling arguments and I thought it would be useful to use them to discuss two quite different concepts in a single edition of this newsletter. These are:

* The notion of separation of powers (or checks and balances) in a state that’s necessary to protect liberty of its citizens

* What goals should central banks pursue in a free market economy?

The separation or control of powers between various arms of the state first appeared in the works of the pioneers of political philosophy in England – Locke and Bolingbroke. However, the most compelling and specific argument for the division of powers was laid out by the French lawyer, Baron de Montesquieu, in Chapter 6 of his book De l’Esprit des Loix (The Spirit of the Laws, 1748) which is widely regarded as one of the greatest texts on political philosophy. He begins this chapter with:

“In every government there are three sorts of power, the legislative; the executive in respect to things dependent on the law of nations; and the executive in regard to matters that depend on the civil law.”  

Montesquieu has no illusions about human nature when it wields power. His view is that the only counter to power is power. This is a prerequisite for individual liberty. For him, liberty means the freedom from being harmed by others.

"Constant experience shows us that every man invested with power is apt to abuse it.

…it is necessary from the very nature of things that power should be a check to power"   

This danger of abuse of power can only be controlled through a separation of power between different institutions and people, and a system of checks and balances. That’s the only guarantee against tyranny. This was his profound insight. As he wrote:

“When the legislative and executive powers are united in the same person, or in the same body of magistrates, there can be no liberty. . . . There would be an end to everything, were the same man, or the same body, whether of the nobles or of the people, to exercise those three powers, that of enacting laws, that of executing the public resolutions, and of trying the causes of individuals.”

This wasn’t enough. Montesquieu went a step further. Apart from separating powers in hands of different bodies and people and setting them up ‘against’ one another, he also suggested each of these arms of the state should have some powers in their mandate to control other arms. That is, they have both negative and positive checks over others.

Checks And Balances

Montesquieu hadn’t contended with autonomous or regulatory institutions like central banks during his time. The notion of a central bank as a lender of last resort while being responsible for price stability and employment is only about 100-150 years old. What are the checks and balances on it?

There are two questions here? Who checks the actions of the central bank? And is there a feedback loop to its actions? The second question is easier to answer. The outcome of its actions is controlled by the market and the economy. This is what Powell meant when he mentioned the Fed has been ‘undershooting the inflation target’. The Fed aimed its actions to achieve an inflation target. The broader economy curbed its power in achieving it.

But what about the checks on its actions? Well, there are checks and balances internal to the central bank like a Board of Governors or FOMC (or its equivalent). However, these are nominated members with limited powers and there’s no external agency that has a positive check in controlling the actions of the central bank. Once the executive nominates the policy committee and the chairman (or governor) of the central bank, it hands over the keys of monetary policy to them. There’s merit to illiberal argument when it comes to actions of the central banks.  

Target Of Central Banks

We come to the question of what goals should the central bank be targeting? Over the years the central banks around the world have taken on responsibility for price stability, economic growth, and employment. But there is no shortage of people demanding more – from income equality to paying off college debts of students and ‘green new deal’. As the central banks around the world went for significant balance sheet expansion after the global financial crisis (GFC) with no corresponding rise in inflation, there has been greater clamour for monetary policy (therefore, central banks) to serve fiscal goals. This keenness to hand over more responsibility is a tad difficult to swallow when you consider the ‘illiberal’ argument.

So, how should we think of goals of a central bank? Let’s first take its role in price stability or inflation management. This is widely considered to be its primary goal. But we come back to the ‘central planning’ argument. How much sense does it make to control price when you want to manage the economy? George Selgin, currently at Cato Institute, in his book Less Than Zero: The Case for Falling Price in a Growing Economy(1998) framed this issue well:

“Using monetary policy to stabilise the price level is not at all like making the weather more predictable, as James Buchanan and Kevin Dowd have claimed. Stabilising the price level is more like making barometric readings predictable, while leaving the weather itself as uncertain as ever: price level movements allowed under a productivity norm are merely nominal indicators of underlying changes in productivity.”

Selgin instead bats for a ‘productivity norm’ which will achieve the same result as that of ‘zero inflation’ regime without interfering with the price mechanism. He writes:

“Instead, the price level should be allowed to vary to reflect changes in goods' unit costs of production. I call a pattern of general price level adjustments corresponding to such a rule for individual price changes a 'productivity norm'. Under a productivity norm, changes in velocity would be prevented (as under zero inflation) from influencing the price level through offsetting adjustments in the supply of money. But adverse 'supply shocks' like wars and harvest failures would be allowed to manifest themselves in higher output prices, while permanent improvements in productivity would be allowed to lower prices permanently.”

For Selgin rising prices during adverse supply shocks (like we are going through in a pandemic) would be better than zero inflation.

If it isn’t a target inflation rate, what should be the goal of central bank? This is a question that’s relevant for India as the term of the first monetary policy committee (MPC) ends. Should we follow the average inflation targeting regime like the Fed or should we continue with the flexible inflation target (FIT) regime (4 per cent with +/- 2 per cent range)? Or should we accept managing price isn’t feasible and look for other options?  

V. Ananta Nageswaran writing in the Mint makes two key points the goals central banks should set for themselves.

First, central banks through monetary policy have failed to raise inflation rates in developed economies by influencing short-term interest rates (a point Graeme Wheeler, the governor of Reserve Bank of NZ had argued for). Second, they don’t have the tools to influence nominal GDP growth. So, they should aim to control credit growth and through it the ‘overheating’ of the economy:

“Further, central banks’ failure to raise the inflation rate in the last ten to twelve years (US, UK and Europe) and in the last three decades (Japan) are powerful proofs against Wheeler’s claim with respect to the inflation rate. At the same time, they are powerless to influence economic growth too. So, the mitigation for the ill-effects and consequences of any inflation-targeting central bank is not to add economic growth as an objective but to hold them responsible for what they can actually control. That does not include inflation or economic growth. That is only credit growth—of both bank and non-bank varieties. They can control that through monetary and regulatory policies.”

I would tend to agree. Credit growth management isn’t distorting the signal that is price. It is also something that’s in control of the central bank through credit policy. As Nageswaran writes:

“The RBI should define overheating more broadly than only through inflation. Apart from the inflation rate, overheating manifests itself in trade deficit and in asset (financial and non-financial) price bubbles. Hence, managing credit growth through monetary policy and regulatory measures could not only rein in inflation but also other imbalances, of both real and financial variety. Thus, an ‘overheating’ mandate will also ensure financial stability.”

To conclude, the nature of the central bank as an institution gives it autonomy and powers that aren’t ‘liberal’. However, a better choice of goals for it than inflation rate targets and the feedback loop from the economy about its actions will nudge it towards a more ’liberal’ space.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] George Selgin on Average Inflation Targeting in Macro Musings with David Beckworth.

* [Podcast] Melvyn Bragg and his guests discuss Montesquieu in the legendary BBC programme In Our Time.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: Consumption And The Fable Of Bees

Insights on burning policy issues in India

— RSJ

‘The pandemic has shown us what is truly important in our lives.’

‘We learnt to go slow and consume only that we need during the lockdown. That’s one lesson we should follow beyond the pandemic.’

‘The earth is healing as the pandemic has forced us to slow down our lives and reduce our greed.’  

Every couple of weeks I come across a column that argues on similar lines as above since the pandemic began. I guess we have a great desire to search for a silver lining in the bleakest of scenarios. But this is exactly the kind of silver lining we should avoid. The idea we learn to reduce consumption so the earth can sustain our load doesn’t have any underlying logic. Worse, such reduction will harm the vulnerable and the poor the most. But, hey, good intentions are all that matter, right?

Any discussion on consumption as a vice takes me back to Mandeville and his work ‘The Fable of Bees’ which has a deserving claim of being among the most provocative and counter-intuitive texts of all time. Published in the early 18th century, it’s alternative title, Private Vices, Public(k) Benefits establishes its central thesis upfront. The book is in three parts. The first part is a poem, The Grumbling Hive, which is followed by an essay discussing the poem. The book concludes with an essay An Enquiry into the Origin of Moral Virtue that lays out his defence of vice. This essay, as we will soon see, is a proto-text for different schools of economic and moral philosophy that emerged during and after the age of enlightenment.

The Wages Of Virtue

The Grumbling Hive is a simple poem of uncertain literary merit. There’s a hive of bees that live in ‘luxury and ease’ while giving virtue, moderation and restraint a short shift. Instead of being happy with this prosperity, the bees question their lack of morality and wonder (or grumble) if there wasn’t a more honest way to lead their lives. Some kind of divine power grants them their wish and their hearts are filled with virtue now. This turn to an ethical hive however comes at the cost of prosperity.

Ease was a vice now, temperance a virtue and the industry that emerged from the bees competing with one another disappeared since the virtuous bees didn’t bother any further with competition. This lack of industry meant a fall in prosperity. Many thousand bees lost their lives, and society started collapsing. The bees weren’t deterred. They flew into a hollow tree that suited their new lifestyle of restraint. They were content being poor but honest.

Mandeville questions the social benefit of this trade-off.

What good is this virtuous life which keeps everyone poor?

This leads him to make the almost blasphemous claim that vice is good so long as it is within bounds of justice. Not just that he also bats for people as a resource. People are not a burden for society.

This was incendiary material then. And I guess, even now. He wrote:

So Vice is beneficial found, When it’s by Justice lopt and bound;

Nay, where the People would be great, As necessary to the State,

As Hunger is to make ’em eat.

And after having set the Thames on fire, he concludes the poem with these famous lines:

Bare Virtue can’t make Nations live In Splendor;

they, that would revive A Golden Age,

must be as free, For Acorns, as for Honesty.

With this, Mandeville earned his lifelong notoriety as a libertine of dubious morality. It didn’t bother him and his later defence of thievery and prostitution as public good suggests it possibly fuelled his desire to be more outrageous.

Private Vice, Public Benefit

In his essay ‘An Enquiry into the Origin of Moral Virtue’, Mandeville explains the paradox of private vice and public benefit further. Mandeville makes three key arguments:

* A virtuous act is one that’s unselfish and driven by reason. Acts that are selfish and involve raw passions were vices. Mandeville goes about looking for virtuous acts in society and draws a blank. However, he finds there are acts beneficial to the society that don’t qualify as virtues. He concludes individuals might pursue their self-interest (vice) but on an aggregated basis this might be creating a societal good. For example, members of a society might quarrel among each other pursuing their interest, but that quarrel generates employment for lawyers, clerks and judges. If they were to turn virtuous, this public benefit would disappear.

* The natural state of man (the term used in the text which we will use here) was to be selfish. The individual was a ‘fallen man’ who was selfish and sought pleasure only for himself. This vice was the foundation of the society and all social virtues emerged from self-interest. Vice is good. To Mandeville, virtue was a state of denial of this natural state.

* Even virtue that man displays is rooted in vice. A man acts with virtue for two reasons –either to satisfy his ego (vanity) of being seen as virtuous by the society or to not offend the ego of his peers. This is a facade to cover the underlying greed or selfish motives that give him private pleasure. These days we might call it virtue signalling.

This cynical take on man and society didn’t earn him friends. The act of calling virtue a facade was unacceptable in a society whose foundation was the Christian notion of virtue. The idea that a human couldn’t do a virtuous act without self-denial negated the concept of a religious man being a superior person who could rise above primal passions. There were multiple attacks on The Fable of Bees from moral and political philosophers of the time.

Yet the text survived for two reasons. One, in its belief that the society is held together by individual acts of self-interest of many and not by some kind of faith in the divine, it was the first attempt at separating social science from the clutches of theology. This was already achieved in natural sciences with scientists like Galileo, Copernicus and Newton challenging religious orthodoxies through the scientific method. The time was ripe for questioning the role of religion in social sciences too. Two, there was something liberating about a text that didn’t speak about how humans should be. Instead, it was a realist’s view of how humans behave in nature and that behaviour at an aggregated level produces social benefits. This was a powerful insight that advocated individual liberty.

The Long Shadow Of The Fable

The Fable of Bees served as inspiration for a wide range of philosophers over the course of the next two centuries. Hume agreed with the basic premise of Mandeville that the sense of morality or virtuousness in a man occurs only in a community or a society through aggregated acts. Hobbes drew from Mandeville on self-interest being the primary motivation for human action. Adam Smith was inspired by the notion of aggregated self-interest producing social good though he disagreed with Mandeville by bringing in the role of sympathy. He also thought vanity alone wasn’t the reason people acted with virtue. There was a desire for true glory too. As Smith wrote in The Theory of Moral Sentiments:

“It is the great fallacy of Dr. Mandeville's book to represent every passion as wholly vicious, which is so in any degree and in any direction. It is thus that he treats everything as vanity which has any reference, either to what are, or to what ought to be the sentiments of others: and it is by means of this sophistry, that he establishes his favourite conclusion, that private vices are public benefits.”

Yet Smith accepts there is a kernel of truth in Mandeville’s core assertion:

“But how destructive soever this system may appear, it could never have imposed upon so great a number of persons, nor have occasioned so general an alarm among those who are the friends of better principles, had it not in some respects bordered upon the truth.” (emphasis ours)

While the fable of bees influenced Smith and his methodological individualism, it also left a mark on Rousseau and the French collectivists who followed him. Rousseau agreed with Mandeville on the lack of social or public-spiritedness in man in the natural state. However, Rousseau introduced ‘pity’ or a “natural repugnance at seeing any other sensible being and particularly any of our own species, suffer pain or death” as natural sentiment within a man. This pity overrode self-interest and became the reason for other virtues.

It isn’t too difficult to see how Mandeville’s philosophy became the founding text for the economic theory based on the primacy of individual liberty and limited intervention of the state. If individual acts of self-interest could lead to social good, what was the need for any intervention by anyone? This was the argument of Friedrich von Hayek who took the fable of bees as the first text that advocated ‘spontaneous order’. He wrote:

“It was through asking how things would have developed if no deliberate actions of legislation had ever interfered that successively all the problems of social and particularly economic theory emerged. There can be little question that the author to whom more than any other this is due was Bernard Mandeville.”   

In a similar vein, Ludwig von Mises (Hayek’s peer from the Austrian school) explained, in Theory and History (1957):

“Only in the Age of Enlightenment did some eminent philosophers . . .inaugurate a new social philosophy . . . They looked upon human events from the point of view of the ends aimed at by acting men, instead of from the point of view of the plans ascribed to God or nature . . .

“Bernard Mandeville in his Fable of the Bees tried to discredit this doctrine. He pointed out that self-interest and the desire for material well-being, commonly stigmatized as vices, are in fact the incentives whose operation makes for welfare, prosperity, and civilization.”

While Hayek and Mises were crediting Mandeville for being the first to articulate spontaneous order, their great intellectual rival, Keynes, was finding merits in the fable of bees too. Keynes’ Paradox of Thrift is the intellectual progeny of the Private Vice, Public Virtue paradox:

“For although the amount of his own saving is unlikely to have any significant influence on his own income, the reactions of the amount of his consumption on the incomes of others makes it impossible for all individuals simultaneously to save any given sums. Every such attempt to save more by reducing consumption will so affect incomes that the attempt necessarily defeats itself. It is, of course, just as impossible for the community as a whole to save less than the amount of current investment, since the attempt to do so will necessarily raise incomes to a level at which the sums which individuals choose to save add up to a figure exactly equal to the amount of investment.”

The state could get itself out of a recession by stimulating demand and increasing consumption while it could dig itself into a bigger hole by reducing consumption. Keynes credits Mandeville’s work in his General Theory of Employment, Interest and Money for highlighting consumption (aggregate demand) as the principal engine for economic prosperity.

It is possible Mandeville wasn’t aware of the profound implications of his fable when he wrote it. He was possibly baiting the hypocrites of the society of his time who hectored others to live in virtue while committing vices themselves. It is also likely he was being ridiculous for the sake of infamy since he seemed to enjoy riling up people. But given his influence on the entire spectrum of philosophical and economic thought – from individualism to collectivism and from statism to laissez faire – I’m inclined to side with Adam Smith.

Mandeville’s fable borders on a fundamental truth – private vices may lead to public good.

A Framework a Week: A COVID-19 Vaccine Deployment Strategy for India

Tools for thinking public policy

— Pranay Kotasthane

What should India’s approach be to deploying a COVID-19 vaccine? Once a vaccine candidate passes all clinical trial stages, the sequencing problem is non-trivial for a country of India’s size and income levels.

Consider this: India’s rather successful and extensive Universal Immunisation Programme (UIP) vaccinates about 2.9 crore mothers (and 2.6 crore infants) annually whereas the COVID-19 vaccine has to reach nearly 100 crore people as soon as possible — a problem 30 times bigger than what the UIP manages.

Led by my colleague Shambhavi Naik, we have a reaseach document out that develops a framework for vaccine deployment. It breaks down the challenge into four parts:

(Source: Shambhavi Naik et al, A COVID-19 vaccine deployment strategy for India. Takshashila Discussion SlideDoc, September 2020)

* Estimate Need: Initially, prioritise a really small set of recipients initially based on how essential the service they provide is for managing the pandemic. Once that’s out of the way, randomisation works better than sequencing recipients based on age, comorbidity prevalence, or other such demographic indicators.

* Secure Vaccine Supply: At our current production capacity, vaccinating 80% of the population will require 20 months. Which means India will need to source vaccines from other companies/countries and incentivise increased manufacturing in India. A transparent model contract specifying terms of technology transfer and manufacturing partnerships to build manufacturer and public confidence.

* Choose Delivery Channel: Use the Election Commission of India machinery to get the vaccine booths to the people in a mission mode operation. The state governments’ public health administration will coordinate the vaccine administration.

* Track Vaccine Distribution: A separate database, enabled by Aadhaar and/or election ink as an identifier, to track vaccine distribution and adverse events.

Do give the document a read and send in your suggestions. This problem needs all hands on deck.

Not a PolicyWTF: The Art of Letting Go

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

— Pranay Kotasthane

In this section, we are on the lookout for egregious policies. Such policies are not difficult to find. Very rarely though, the reverse happens. Governments spring up a surprise on us by bringing in pro-market reforms.

Here are two such cases from the recent past. Neither can be classified as a policy success. They are at best first steps in the right direction, requiring further work.

EV Minus Battery

On August 12, the Ministry of Road Transport and Highways notified that state governments allow registration of electric vehicles without pre-fitted batteries. Since batteries make up 30-40% of an EV’s cost, this move is intended to bring down up-front costs for consumers.

This is a positive move. Unbundling the battery from the vehicle creates new market opportunities. A consumer can potentially register an EV from a vehicle manufacturer but get the vehicle battery from an energy management company. Energy management companies can come up with new models for both battery swapping or for the charging infrastructure.

Of course, this move has made the incumbent vehicle makers unhappy as their own battery manufacturing plans now face a new challenge. Nevertheless, a pro-market policy is often an anti-incumbent one.

One bottleneck remains. Batteries are taxed at 18% GST while EVs are taxed at 5% GST. This creates an inverted duty structure (explained in edition#50) that will generate huge GST refund claims — some fraudulent, others genuine. This must be fixed by taxing both batteries and EVs at the same rate.

Governments prefer overregulation. But this move is an example of dismantling regulation and enabling markets. For governing technologies under low state capacity, stepping back instead of overdetermining rules is a better approach. Market conditions should inform regulation, not the other way around.

The Corporatisation of Ordnance Factory Board

If you thought defence PSUs such as HAL and BEL are underperforming, you haven’t met Ordnance Factories (OFs). These 41 factories form ‘the largest and oldest departmentally run industrial organisation in India’ (Indian Defence Industry: An Agenda for Making in India, page 20). Together they employ more than 80,000 people.

In 2013-14, OFs had sales of more than eleven thousand crores and yet being a departmentally run organisation, they do not have to follow commercial accounting practices, and do not have to maintain balance sheets and P&L statements. Even their barebones annual reports are classified and hence not open to public scrutiny. How convenient.

Not surprisingly, OFs have failed to deliver. The government has now constituted an Empowered Group of Ministers (EGoM) to begin corporatisation — a process that will make these OFs into one or more defence PSUs such HAL. Even though these DPSUs will remain a wholly-owned entity of the Ministry of Defence, corporatisation will make these factories quasi-independent of government and allow them to focus on business goals such as profits and return on investment. With their own budgets and balance sheets, their performance (or the lack of it) will be out in the open.

Corporatisation was first proposed by the Kelkar Committee in 2005. Fifteen years down the line, it seems to be gathering some steam. Nevertheless, as our DPSUs demonstrate, corporatisation is but a first step towards a modern defence industrial base. Going further, non-performing OFs should be shut down or the stake in them should be divested.

India Policy Watch #2: A Fog Of Information

— RSJ

We have made the point in an earlier edition about the perils of scanning sectoral data or select high-frequency indicators to arrive at any conclusion about economic recovery in India. The pandemic is still raging with daily case count on an upward trend, supply chains aren’t fully restored, and the consumers aren’t confident of stepping out of their homes and spending. The pandemic and the lockdown were idiosyncratic events and we should accept the uncertainty that comes with it. Yet we seem to be keen on highlighting narrow slivers of data and drawing conclusions from them.

Kidding Ourselves?

Take this news item that suggests “signs of a pickup that augurs well for manufacturing activity”. Our exports have gone up by 13 per cent and the railway freight loading is up by 10 per cent. That’s great news till you realise the period of comparison is a week! That is, we are comparing data for the week of Sep 1-8 this year to the previous year. It is difficult to draw any conclusion when you compare a random weekly data with the previous year in normal times. It makes no sense to do it in these times.

For instance, the railway freight loading could be up because the trucking and logistics companies might still be coming to terms with lockdown disruptions, working capital drying up and absence of drivers who might have gone back to their homes. Till you see a complete picture of the movement of goods across all modes of transport, it is difficult to conclude manufacturing activity is up. A similar case can be made for exports where a single week can’t suggest a trend. But you have the country’s #1 daily newspaper showcasing this as an instance of green shoots of recovery.

Or there’s this news item that talks up the auto sector. There’s been a 15-20 per cent growth in auto sales during the 15-day festive period of Ganesh Chaturthi and Onam in the two states of Maharashtra and Kerala. This data is then used to suggest a strong recovery could be on cards in the oncoming festive season. This despite an industry official making it clear these numbers aren’t comparable because of the floods in Kerala during the same time last year that had severely impacted sales.

Sobering Reality

Then we have this news which indicates we might have lost 21 million salaried jobs in the five months of the pandemic. As Mahesh Vyas, MD & CEO, CMIE, writes:

“An estimated 21 million salaried employees have lost their jobs by the end of August. There were 86 million salaried jobs in India during 2019-20. In August 2020, their count was down to 65 million. The deficit of 21 million jobs is the biggest among all types of employment. About 4.8 million salaried jobs were lost in July and then in August, another 3.3 million jobs were gone. These job losses cannot be confined to only of the support staff among salaried employees. The damage is likely to be deeper, among industrial workers and also white-collar workers.”    

Here we have a research agency that has a long track record of measuring employment data suggesting we might have lost almost a quarter of salaried jobs during the pandemic. Now even this is data for only five months, but you might agree with the long-term view of the author that salaried jobs once lost are more difficult to replace. So, this is a trend that should worry the policymakers.

In the same article, Vyas makes another important point about the stagnation of salaried jobs and the rise of ‘entrepreneurs’ who don’t employ anyone:

“In 2016-17, employment in entrepreneurship accounted for 13 per cent of total employment. This proportion rose to 15 per cent in 2017-18, then 17 per cent in 2018-19 and 19 per cent in 2019-20. This sustained increase in entrepreneurship in India has not led to a rise in salaried jobs. The count of entrepreneurs has risen from 54 million in 2016-17 to 78 million in 2019-20. During the same period the count of salaried employees has remained stable at 86 million. It is counterintuitive to see a rise in entrepreneurship but not a corresponding increase in salaried jobs.

Part of the reason for this is that most of these entrepreneurs are self-employed who do not employ others. Implicitly, they are mostly very small entrepreneurs. The government has propounded the idea that people should be job providers rather than job seekers. This objective seems to be succeeding but not entirely in ways that was intended.

Entrepreneurship is often a desperate escape from unemployment rather than an initiative to create jobs.”

Act With Confidence, Plan For The Worst

We understand all data is political in the best of times. It is used by partisans and critics of any government to build narratives that suit them. However, the normal expectation is that beyond the political rhetoric the policymakers know which data to use to draft a course of action. We fear this might not be true in these times.

First, the data from various sources isn’t indicating a definite trend about the economy. This inability to have any kind of predictive certainty about the extent of contraction, tax collections or the true picture of fiscal deficit makes decision making difficult. This is a difficult time to be a policymaker. This gets compounded by the government being keen to talk up a V-shaped recovery to an extent where there are fears it has started believing its own message about the economy is beginning to touch pre-COVID levels. There’s merit in highlighting feel-good news to build consumer confidence and spur consumption. We get that. We just hope the government is able to make out the difference between its own hype and reality. Often it is not easy to make this out.  

We have written in our earlier editions that a second ‘real’ stimulus has to be launched before the end of Q2. The extent of contraction in Q1, the impact on the informal economy that’s not fully measured yet, the fall in salaried jobs and the reluctance among consumers to spend make a fiscal stimulus necessary to get the economic engine going again. Also, a significant stimulus announcement in Q2 will be a good indicator of the government not drinking its own kool-aid about a V-shaped recovery.  

The government and the PM continue to enjoy very high approval ratings. The people are convinced about their intentions. There’s no taint of corruption or policy paralysis on it. These are ideal grounds for the government to take people into confidence about the challenges the economy faces and the sacrifices the people need to make in the short-term as we begin the long road to recovery. This clarity will be welcome. The current fog of information doesn’t help our cause.    

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Normany Barry on ‘The Tradition of Spontaneous Order’ where he traces the origin of this philosophical thought.

* [Article] A Business Standard editorial on why the government should listen to advice that it doesn’t consider politically ‘reliable’.

* [Paper] Elinor Ostrom’s integrative paper A General Framework for Analyzing Sustainability of Social-Ecological Systems continues to remain relevant.

* [Book] Indian Defence Industry by Laxman Kumar Behera gives a good overview of India’s defence industrial base.

That’s all for this weekend. Read and share.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch: The Indian State — Too Big or Too Small?

Insights on burning policy issues in India

— Pranay Kotasthane

In edition #23, we tried to answer this question: how to think about the Indian state? Closely related is another question: is the Indian State too big or too small? And as it holds true for many other phenomena in India, the answer is both.

I’m sure most readers of this newsletter feel that the Indian state is bloated, overbearing, and huge. Is that really the case? Let’s look at four important parameters.

Size Measured by Government Expenditure: Relatively Small

A government has three instruments at its disposal in any policy issue-area: produce, finance, and regulate. All three instruments require government expenditure. So, one way to judge government size is to measure public expenditure as a proportion of overall economic activity. The higher this parameter, the bigger the government.

In 2018, India’s overall public expenditure as a proportion of its GDP stood at 27%. The US was at ~38%; Russia was at ~36% GDP; Sweden was at ~49%, and Pakistan was at ~21%. Clearly, the Indian state is no outlier on this measure. Have a look at how some selected countries at disparate levels of economic strength stack up.

Essentially, this parameter has been steadily rising for most countries across the world, ever since the welfare state became mainstream. Moreover, there is a strong correlation between government spending and income levels — the richer a country, the higher the government’s expenditure as can be seen in the chart below. This is known as Wagner’s Law in public finance literature.

Note the US government expenditure. The common perception is that because it is a capitalist country, the government would have a smaller role to play in the economy. That’s clearly not the case when measured on this parameter. As the country got richer, there were even higher demands to fulfil on health, education, defence, and infrastructure. Coming back to India, as a low-middle income country, its public spending is relatively small as well. Clearly, the Indian state isn’t at the commanding heights of our economy.

Size Measured by Government Employees: Small

Another caricature of the Indian state is a bloated, overstaffed organisation with a large number of employees. But the Indian state is relatively small on this parameter too. Here are some stats making this point from Devesh Kapur’s must-read paper Why Does the Indian State Both Fail and Succeed?:

“In the early 1990s, the global average of government employment as a percent of population was 4.7 percent. In countries of Asia, it was 2.6 percent. In India, it was 2 percent .. Core elements of the Indian state—police, judges, and tax bureaucracy—are among the smallest of the G-20 countries. Indeed, while the absolute size of government employment peaked in the mid-1990s, in relative terms, the decline in size of central and local governments began much earlier.”

“A comparison between the size of the civilian workforce of the federal govern- ment in India with that of the United States is instructive. Remember, India has a large number of public enterprises and public sector banks that are under the central government. Even so, the size of the Indian federal government is half the size of its US counterpart when normalized by population: specifically, the US federal government had 8.07 civilian employees per 1,000 US population in 2014, down from 10.4 in 1995, while India’s central government had 4.51 civilian employees per 1,000 population, down from 8.47 in 1995.”

Even on this parameter, the Indian state is a relatively small one.

Size Measured by Competence: Too Small

Nothing counterintuitive here. The Indian state lacks competence in fixing the most basic market failures, from law and order to public health and education. The competence gap has only widened over the years as many bright Indians now have the option of taking up a job outside the government, even outside India, with changing times.

Size Measured by Ambition: Too Big

This is really where the Indian state is overbearing. The aspiration of the Indian state has no bounds. Right from the outset in 1947, the Indian state sought to transform colonial India economically, politically, and socially. This revolutionary DNA meant that the Indian state set itself ambitious goals regardless of the capacity to achieve them. Over the decades, new goals were appended to this lofty project.

What Does All This Mean?

So the Indian state is big as measured by its own ambitions. Unsurprisingly, it continues to own airlines and soap factories. As an ambitious democratic entity, it also seeks to frame regulations and laws to constrain virtually every private initiative in every issue-area. The paradox is that on all other parameters, the state is quite small, neither having the capacity to enforce rules nor the ability to anticipate the consequences of policies beforehand.

Devesh Kapur writes that this “precocious” nature of the Indian state has also skewed what Indians expect from their governments in three ways:

“One, precocious democracy tends to militate against the provision of public goods in favor of redistribution. Countries that experienced economic development prior to the transition to democracy also tend to adopt democratic institutions that constrain the confiscatory power of the ruling elite. However, when countries pursue democracy prior to economic development, the democratic institutions adopted enhance the redistributive powers of the state.”

“Second, a precocious democracy with electoral mobilization along social cleav- ages favors creation of narrow club goods. A central puzzle concerning the poor provision of basic public services in India is seemingly weak demand in an other- wise flourishing electoral democracy.”

“Third, an imperfect democracy with noncredible politicians will tend to emphasize the provision of goods that are visible and can be provided quickly, like infrastructure, over long-term investments, like human capital or environmental quality.”

Resolving this high ambition versus low capacity paradox is central to improving governance in India. It must choose to do fewer, more important things, and build capacity to do them well. Trade-offs are inevitable.

India Policy Watch: Factions and Liberal Democracy

Insights on burning policy issues in India

— RSJ

There’s much handwringing on how fractious the US society has become over the years. The next few months don’t look good. The dangerous speech Trump made at White House yesterday peppered with lies and conspiracy theories that undermined the engine that keeps democracy going – election – is only the beginning. Even if Trump fails to mount a legal challenge, he has convinced enough right-thinking Americans (and a lot of Indians going by social media) that elections can be rigged in America.

This isn’t a genie you can put back into the bottle.

Shifting Sands Of Factions

What’s worse in the US right now is that no one can be sure about the traditional definition of factions anymore. Fractiousness works when you know your faction is distinct and different from the other. But that’s not so easy to claim in the US. If Trump’s domestic policies could be loosely labelled racist, buoyed by white supremacists, what explains the higher votes he polled across all minority groups including Blacks and Muslims this election over last? If California is the home of Bernie bros, capital of wokeness and full of bleeding heart liberals, how do you square that with the population voting in favour of proposition 22? That vote will continue to keep drivers of Uber and Lyft and other gig workers classified as independent contractors with the freedom to set their own hours but not receiving protections like minimum wage, health insurance or overtime. What explains the Republicans gaining seats in the House and almost retaining the Senate with probably the most inept President at the helm. Or the race being so close despite Trump’s lack of any redeeming feature. Had it not been for the pandemic that revealed how shambolic his administration was, he would have won by a landslide.

Factions Can Be Good

So, the factions aren’t homogenous anymore based on traditional parameters on which they were defined – race, identity or common passions or interests whose origins could be religion, shared experiences or class. There’s some other realignment of factions happening here which will need a deeper study. Be that as it may, the idea of factions in a liberal democracy is actually a feature and not a bug. The notion of competing groups of passions or interests that counteract each other instead of coalescing into a majority that dominates the regime is good for democracy.

This is why there’s a view that coalition governments have better track records of reforms and governance in India. Or that the consolidation of Hindu vote with the BJP that obliterated the caste, region or language factionalism so dominant in the past three decades might actually be bad for India. In that sense, this dead heat of a presidential race might put the US in a better place as a democracy than the almost absence of factions that India’s polity is turning out to be in recent times. So long as there are institutions that can make the factions come together and get them to work, the US doesn’t have lots to worry.

Madison On Factions

Aristotle in Politics had a suggestion for how to manage the extremes of oligarchy and democracy in a society. He advocates a mixed regime that combines the elements of both. He writes:

“Where the middling element is great, factional conflict and splits over the nature of regimes occur least of all.”

So, the question is what’s the best way to have factions in a society and yet not be consumed by its internecine wars of passions and interests? How do we ‘manage’ the factions because it is clear we can’t stop it. This question brings me to the Federalist Papers (#10) written by James Madison (1787).

Madison writes:

“By a faction, I understand a number of citizens, whether amounting to a majority or a minority of the whole, who are united and actuated by some common impulse of passion, or of interest, adversed to the rights of other citizens, or to the permanent and aggregate interests of the community.

There are two methods of curing the mischiefs of faction: the one, by removing its causes; the other, by controlling its effects.”

Madison soon establishes that removing the causes that create factions will mean trampling on the liberty of people and is fraught with terrible unintended consequences. So, he soon focuses his efforts on managing the effects:

“The inference to which we are brought is, that the cause of faction cannot be removed, and that relief is only to be sought in the means of controlling its effects.”

“If a faction consists of less than a majority, relief is supplied by the republican principle, which enables the majority to defeat its sinister views by regular vote. It may clog the administration, it may convulse the society; but it will be unable to execute and mask its violence under the forms of the Constitution. When a majority is included in a faction, the form of popular government, on the other hand, enables it to sacrifice to its ruling passion or interest both the public good and the rights of other citizens. To secure the public good and private rights against the danger of such a faction, and at the same time to preserve the spirit and the form of popular government, is then the great object to which our inquiries are directed. Let me add that it is the great desideratum by which this form of government can be rescued from the opprobrium under which it has so long labored, and be recommended to the esteem and adoption of mankind.”

“By what means is this object attainable? Evidently by one of two only. Either the existence of the same passion or interest in a majority at the same time must be prevented, or the majority, having such coexistent passion or interest, must be rendered, by their number and local situation, unable to concert and carry into effect schemes of oppression. If the impulse and the opportunity be suffered to coincide, we well know that neither moral nor religious motives can be relied on as an adequate control. They are not found to be such on the injustice and violence of individuals, and lose their efficacy in proportion to the number combined together, that is, in proportion as their efficacy becomes needful.”

Madison is quite prescient about the need for a greater variety of parties to control the overzealous efforts of a single faction that seeks to flame passions. He writes:

“Hence, it clearly appears, that the same advantage which a republic has over a democracy, in controlling the effects of faction, is enjoyed by a large over a small republic,–is enjoyed by the Union over the States composing it. Does the advantage consist in the substitution of representatives whose enlightened views and virtuous sentiments render them superior to local prejudices and schemes of injustice? It will not be denied that the representation of the Union will be most likely to possess these requisite endowments. Does it consist in the greater security afforded by a greater variety of parties, against the event of any one party being able to outnumber and oppress the rest? In an equal degree does the increased variety of parties comprised within the Union, increase this security.

…The influence of factious leaders may kindle a flame within their particular States, but will be unable to spread a general conflagration through the other States. A religious sect may degenerate into a political faction in a part of the Confederacy; but the variety of sects dispersed over the entire face of it must secure the national councils against any danger from that source. A rage for paper money, for an abolition of debts, for an equal division of property, or for any other improper or wicked project, will be less apt to pervade the whole body of the Union than a particular member of it; in the same proportion as such a malady is more likely to taint a particular county or district, than an entire State.

In the extent and proper structure of the Union, therefore, we behold a republican remedy for the diseases most incident to republican government.”

In essence, factions are natural in a democracy and it is the republic that controls the effects of factions by restricting its spread to the Union. India hasn’t got credible political factions at the union but the factions in the states still offer hope of the state being taken over by a single party. The exit polls from Bihar (if they hold) continue to showcase this natural release valve of a liberal democracy.

A Framework a Week: Seven Stages of the Policy Pipeline

Tools for thinking public policy

— Pranay Kotasthane

This week’s framework comes from Vijay Kelkar and Ajay Shah’s In Service of the Republic. They argue that the ideal public policy process comprises these seven stages:

“Stage 1: the establishment of the statistical system. Facts need to be systematically captured. Without facts, the entire downstream process breaks down.

Stage 2: descriptive and causal research. This requires a research community which will study the data, establish broad facts and regularities, and explore causal connections.

Stage 3: the creative phase of inventing and proposing new policy solutions. A large menu of choices needs to be at hand, for possible policy pathways.

Stage 4: public debate where rival solutions compete with each other. This requires a vigorous process of debate and discussion, in writing and in seminars. A broad consensus needs to come about on what will work, within the analytical community. In the Indian context, this is often assisted by the expert committee process. The purpose of the expert committee process is to sift through an array of possible policy pathways that are in the fray at the end of stage 3, and filter down to a few which make sense.

Stage 5: the internal government process of decision making. This is where ministers and senior bureaucrats take stock of the range of possible policy pathways and make decisions. This is the zone of political economy, and the creative trade-offs that make progress possible.

Stage 6: the translation of the decisions into legal instruments. Most policy decisions must be implemented through law that is enacted by the legislature, or subordinate legislation in the form of rules or regulations. High technical quality, and subtle detail, of this drafting process is of great importance.

Stage 7: the construction of state capacity, in the form of administrative structures that enforce the law.”

— Kelkar, Vijay; Shah, Ajay. In Service of the Republic . Penguin Random House India Private Limited. Kindle Edition.

The most fascinating takeaway from this framework is that for better policy outcomes, capacity needs to be developed in all seven stages. For instance:

“A field is in poor shape on stages 1, 2 and 3 if we are not able to envision ten wise persons who can usefully be members of an important expert committee (at stage 4).”

This framework also explains why crises can produce terrible policies in the name of reforms. In difficult times, the willingness to do something is higher. But if there’s underinvestment in the early stages of the pipeline, crises can fast-track poor policies as well. A recent example of a poorly thought-out policy fructifying in the backdrop of a crisis is the Harayana government’s policy to reserve private-sector jobs for locals. As they further write:

“the possibilities in a crisis are the product of previous work that has been done in the early stages of the pipeline, and the human capabilities for stages 5, 6 and 7 that have been built ahead of time. The apparently high marginal product of crisis is partly grounded in misattribution; a lot of the credit has to go to the investments by the policy community of previous years. When we see the correlation between crisis and reforms, we are exaggerating the role of the runner who carries the baton across the finish line.”

This framework is a useful tool for thinking about effecting policy change in the Indian context.

HomeWork

Reading and listening recommendations on public policy matters

* [Video]: From Yale Open Courses, Prof Smith on Aristotle’s idea of polity to keep factions in check and how it presages Madison’s Paper 10.

* [Paper]: A useful guide to reading social science papers. Money quote: “Very few articles in a field are so important that every word needs to be read carefully. It's okay to skim and move on.

* [Article]: Marc Levinson’s latest on containers and mega-ships.

* [Report]: A detailed account of cesses & surcharges by Vidhi Centre for Legal Policy. Tip: both terms, though often used interchangeably, are quite different. The similarity is that both are evil.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

A topic we often like discussing in this newsletter is the role of unelected institutions like regulators in framing public policy. The usual defence of having a regulator is that not all laws can be legislated by elected members. There is not enough expertise available among them in the many areas of lawmaking nor do they have time to do so. The delegation of this role to regulators solves for this.

Perils Of Arbitrary Power

This delegation comes with its own risks. Both legislative and executive responsibilities are vested in these unelected regulators. In India, often, they have judicial powers too with limited freedom to appeal against their decisions. The benign view of a regulator is that of an enlightened referee who sets the rules of game and ensures an even playing field for all. But with almost unlimited powers at their disposal and with weak or absent feedback loops on their performance, it is no surprise the actions of regulators border on arbitrary in India.

Is there a better way to create regulators? Or, like many other features of democracy (indeed, democracy itself), is this the best among the worst options?

Two Examples

First, National Payments Corporation of India (NPCI), promoted by the Banking regulator, decided last week it will cap transaction volumes by a single third-party app (TPA) player to 30 per cent on its UPI platform. The reasons cited were to address the systemic risk of a single player dominating the payment ecosystem and to reduce likelihood of frauds. At the same time, NPCI approved WhatsApp to launch its payment service increasing the intensity of competition in this space. In parallel, the government at the start of the year had banned Merchant Discount Rate (MDR) for transactions on UPI which was the primary source of revenue for payment service providers.

Put together, we have a scenario where there’s a business with no revenue model because it is priced at zero for both the merchants and the customers. And there’s a market share cap beyond which players can’t grow. The unintended consequences of these aren’t difficult to anticipate. First, it will be a nightmare to implement because how do you cap someone at 30 per cent in a business where volumes and speed of transactions are key features. Will a payment service provider reject new service requests after they have reached the cap or will they temporarily deactivate their service to stay within the threshold? That will be a nightmare for customers. Second, with this, why will any player innovate on the UPI platform beyond a point? They will instead go back to the entrenched global payment networks and launch innovative products on them to gain market share or create revenues streams. Lastly, the players will be forced to use ‘sharp’ practices to monetise customer data that could be detrimental to the customers’ interests. Predictably, the two largest players have been up in arms against this ruling. But the die is already cast.

The second example is the that of CCI initiating a probe against Google for abusing its dominant position in the mobile operating system with Android and app store markets to force app makers to use its billing system and to include its payments app in every Android phone sold in the country. As the Mint reports:

The two issues, which the CCI is investigating, relate to “exclusivity regarding the mode of payment for the purchase of apps and in-app purchases" and “pre-installation and prominence of Google Pay on Android smartphones".

While the complaints centre around Google Pay, its outcome could have a broader impact on how the company enforces its Play Store rules in India.

If CCI concludes Google has indeed violated rules, it would be a shot in the arm for Indian startups, which have been protesting against Play Store’s decision to charge a 30% commission for in-app sales.

We have written about this in our editions #75 and #76.

In summary, it is very difficult to prove platforms like Google are monopolies in the traditional definition of the term. Banning them from bundling their services or building an India or government app store are worse ideas. There’s more thought needed on how to regulate these entities. It is to be seen how the regulator will view these in India. Our view has been that the problem of unelected regulators with limited checks has greater repercussions in India. Invariably, things tend to go from bad to worse.

The Right Way To Designing A Regulator

So, what’s the right way to delegate powers to an unelected entity like that of a regulator? This is an important question to ask in India where regulators have proliferated over the last 20 years across sectors. The search for this brought me to Paul Tucker’s book Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State.

Tucker who had a long career in Bank of England knows a thing or two in being in position of unelected power. He blends principles of political philosophy with public choice theory in answering key questions that form the four parts of the book:

A. When is the delegation of powers to the unelected the right thing to do?

In this part Tucker lays out the seven Delegation Criteria (DCs) which should guide the legislature on when to delegate its powers. The key point here is Tucker’s assertion that an independent agency should not make 'choices on distributional trade-offs or society’s values or that materially shift the distribution of political power’. That is, they must not be tipping the scales either way. Separately, he outlines the Design Precepts (DPs) on how to design an independent agency or a regulator. These include mandate with clear objectives and instruments (DP1), political procedures for deciding how to pursue the objectives (DP2), operating procedures for the use of instruments (DP3), procedures for communication to the wider society (DP4) and procedures for dealing with emergencies not covered by the mandate (DP5).

B. How should this delegation withstand democratic objections?

This is the crux of the book. The key question here is how to check for the legitimacy of a regulator or how to ensure that the democratic decision to delegate doesn’t itself turn undemocratic. Tucker uses this question to take the reader through the major political traditions of the world and establishes that so long as the principles of delegation as he laid out in the earlier part of the book hold, the regulator will be in the realm of democratic process.

C. How to ensure the right governance structure that manages the regulators so that the unelected officials running them have the right incentive to behave in democratic fashion?

This is the how-to part of the book where Tucker looks to shoehorn the regulators into the constitutional frameworks of liberal western democracies. These frameworks then provide the way to have checks and balances on the officials.

D. What should the role of a central banker be while pursuing multiple policy objectives and how should the delegation criteria apply to them?

This is a more specific segment relevant for the discussion on the role of the central banker as an unelected body with unlimited mandate to manage monetary policy. In the light of GFC, this is a useful section to think about the mandate and the management of a central bank within a democratic setup.

This is a great book to reconcile the role of unelected, powerful regulators with the need to have democratic accountability within them while ensuring they don’t turn slaves of an ever-changing legislative body.

In many ways, I found similar points raised by Kelkar & Shah in their book In Service of the Republic (the most quoted book over many editions of this newsletter). They write:

The first element of this is governance of the organization by a board which has a majority of independent directors. The officials who run the organization must be accountable to this board, where a majority of persons are external experts and stakeholders.

.. Once a regulation-making project is initiated, the staff must be required to build a documentation packet, articulating the problem that is sought to be solved, demonstrating that it is a market failure, and demonstrating that the proposed intervention is the least intrusive alternative available. This documentation packet must be put into public consultation, in order to solicit the views of affected persons and intellectuals. This packet, and the responses from the public, should lead up to a discussion, refinement and decision at the board of the agency. Only the board should be able to release a new regulation.

Public choice theory predicts that the staff of a regulator will favour arbitrary power in the legislative and executive functions. Hence, the parliamentary law which defines the regulator must write down the processes of regulation-making, licensing, investigation and prosecution in considerable detail. At an early stage of state capacity, the regulator must be given low powers of investigation and punishment, so as to protect the feedback loops of the push-back against regulatory actions from the economy.

Unfortunately, as we add to the burgeoning list of regulators in India, we aren’t giving enough thought and attention to this critical piece of public policy. How must we create an independent regulator without the danger of (what Kelkar & Shah call) the ‘democratic deficit’  that is inherent.

Unelected power of regulators is the reality of today’s governance around the world. A structured framework that channels this power and stays true to the principles of delegation will lend legitimacy to them.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Paul Tucker speaking on Unelected Power at the Watson Institute for International and Public Affairs.

* [Article] Building State capacity for regulation in India by Shubho Roy, Ajay Shah (NIPFP), B.N. Srikrishna (Retd. Judge, Supreme Court of India, Somasekhar Sundaresan (Independent legal counsel)

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: Production-Linked Incentives

Insights on burning policy issues in India

— Pranay Kotasthane

Production-Linked Incentives (PLI) — that’s the name the government’s recent, most-favourite industrial policy instrument goes by. It seems elegant on paper: the government will reward companies for incremental sales of manufactured goods with a subsidy. More the sales (either domestic or exports), more the subsidy amount.

The intent seems sound too: encourage companies to up their manufacturing game.

First introduced for the electronics sector earlier in the year, PLIs worth ₹2 lakh crore for ten disparate sectors over the next five years were announced by the Union Cabinet earlier this month. These sectors are automobiles and auto components, pharmaceutical drugs, advanced chemistry cells (ACC), capital goods, technology products, textile products, white goods, food products, telecom and specialty steel.

Let’s assume that the size of the incentive is big enough to change companies’ investment decisions at the margin (that’s a big if). What are the consequences likely to be in that case? Can we anticipate some unintended consequences beforehand?

Let’s parse this policy through the framework discussed in edition #48. Three unintended effects are possible:

* “Reasonable regulation drifts toward overregulation, especially if the costs of overregulation are not perceptible to those who bear them.”

The PLI scheme for the electronics sector has specific eligibility criteria both on incremental investment and incremental sales a company needs to commit over the next five years. This is supposed to be cross-checked by a Project Management Agency (PMA), a government-body formed under the Ministry of Electronics and Information Technology (MeitY).

The PMA will further submit its recommendations to an Empowered Committee (EC) composed of CEO NITI Aayog, Secretary Economic Affairs, Secretary Expenditure, Secretary MeitY, Secretary Revenue, Secretary DPIIT and DGFT which will make the final decision. The EC is also empowered to revise anything — subsidy rate, eligibility criteria, and target segments.

In short, more bureaucracy and predictably unpredictable delays. The speed of incremental investments might get decided by the speed of government decision-making. EC’s powers to make any changes to this policy in the future is also filled with possibilities of regulation becoming overregulation.

There’s one more gap. In order to increase innovation, the PLI scheme will not consider incremental investments towards land and buildings towards the eligibility criteria. Only investment towards plant, machinery, equipment, research, and development is allowed. This might incentivise companies to fudge their land dealings and for government officers verifying the real quantum of incremental investments to cut deals for themselves.

* “Moral hazard increases.” The ten sectors chosen by the government might see a crowding-in of investment at the cost of all other sectors. Are these ten industries strategic for India while others aren’t? I don’t quite know the basis of this selection.

Next, every policy move has an associated opportunity cost. It’s a bane of Indian policymaking that policy decisions are rationalised solely by looking at projected benefits; by ignoring opportunity costs. In the context of PLIs, the government needs to pay up ₹2 lakh crore over the next five years to a few companies in these ten sectors. The government will most likely rake in this revenue in the form of taxes. Using the Kelkar/Shah Marginal Cost of Public Funds (MCPF) estimate for India of 3, the total cost to India from this subsidy would be of the order of ₹6 lakh crore. The scheme would make sense if the benefits are projected to be higher than this number. Whether an analysis of these costs has been taken into account, we don’t know.

* “Rent-seekers distort the program to serve their own interests”. Companies that benefit will seek to modify the eligibility criteria to suppress competition thus leading to more market concentration. They might even try to extend the sunset clause of this scheme in order to keep benefiting from the discount.

These unintended consequences might substantially diminish the benefits that the PLI schemes are aiming at.

What are the alternatives?

Read this statement by the chairman of the India Cellular and Electronics Association (ICEA):

“The disability stack runs deep in the economy. For example, the taxes on fuel. Second, electricity is not subsumed under GST (goods and services tax). So how do you become competitive?

This is the key point. Perhaps PLIs are a much-needed band-aid solution for a wounded economy but it cannot transform manufacturing in India. Doing that would require consistent and simpler tax, policy, business, and trade environments. Improvements on these grounds will benefit all sectors and investments will follow sectors which show higher productivity. In other words, we’re still waiting for a reforms 2.0 agenda.

India Policy Watch #2: The Many Hues Of Charisma

Insights on burning policy issues in India

— RSJ

The recent Bihar election results confounded many. First, the consensus from multiple opinion and exit polls suggested a clear majority to the UPA. They got it wrong. Second, there was view the NDA coalition was going into the elections with a triple disadvantage – anti-incumbency, the particularly severe effect of lockdown on Bihari migrants and the disappointment among the youth about the economic progress in Bihar despite many years of promise. There was no regional face of the BJP to counter the rising popularity of Tejaswi Yadav. The pandemic also limited the ability of the NDA to field the PM and other star campaigners on the ground to mobilise the workers and make a case for their government. Despite such odds, the BJP had its best performance winning 74 seats out of the 121 it contested.   

What explains this?

Politics of Vishwaas

There are multiple theses here. The decision of AIMIM to field candidates across the state ‘cut’ the Muslim vote bloc is one. That women voted overwhelmingly in favour of the BJP is the other. These might have played a role in the electoral arithmetic but at a macro level the win reaffirms the strength of what Neelanjan Sircar has called the ‘politics of vishwaas’. As Sarkar writes:

“…is a form of personal politics in which voters prefer to centralize political power in a strong leader, and trust the leader to make good decisions for the polity – in contrast to the standard models of democratic accountability and issue-based politics.”

Sircar suggests two factors leading to this:

“First, like much of the world, there is an increasingly strong axis of conflict between those who believe in a unitary (Hindu) national identity for India and those who view India in ‘multicultural’ terms. This obliges supporters of Hindu nationalism to support political centralization to stymie federalism, which would require negotiation across regional, linguistic, caste, and religious identities. Second, the BJP’s control of media and communication with the voter, in tandem with a strong party machinery, give the party structural advantages in mobilizing voters around the messages of Narendra Modi.”

Vishwaas apart, the Bihar win suggests voters aren’t yet disappointed with the absence of achhe din the PM had promised in 2014. The charisma of the PM endures, and he’s still seen as an outsider upending the established order and the elites. This is a remarkable feat of narrative-building where even missteps like demonetisation or the severe lockdown are judged on their intent instead of their outcomes. The ‘politics of vishwaas’ is anchored on the personal charisma of the PM.

So, how should we think about this charisma? There are several ways.

Cometh The Hour

First, leaders build their charismatic appeal on the back of a deeply felt need in the society for change. In the run-up to 2014 general elections, two distinct needs coalesced. One, the simmering discomfort about how the constitution and its institutions had over the years infringed on the personal domain of Hindu lives while staying away from those of minorities (termed appeasement by many). Two, the shambolic performance of UPA 2 on economy driven by transactional corruption and policy paralysis.

All societies have inherent in them a set of core beliefs that in tandem with everyday issues of roti, kapda and makaan drive their choices and actions. Often, they are in opposition. Sometimes they coincide as they did in 2014.

Despite the liberal and secular constitution project that aimed at engineering a social revolution in post-independent India, the core belief, however suppressed, among the majority was always guided by their religion. This suppressed belief found a credible voice in the persona of PM Modi. They saw in him an agent of change who will restore personal belief and faith above the liberal ideas of the constitution. Those ideas were never in sync with our society anyway.

Therefore, so long as there are actions that suggest progress on this axis – CAA, revocation of Article 370 and building of the temple in Ayodhya – the relatively poor performance on roti, kapda, makaan issues will not matter. Even a raging pandemic and a 23% shrinking of the economy in Q1 hasn’t mattered. Charismatic leaders emerge in times of great need and so long as they deliver on their core promises (even those unstated but commonly understood), they will retain their hold on their followers.

Max Weber in his classic ‘On Charisma And Institution Building’ explained this eloquently:

“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.”   

Charisma Trumps Economic Structure

The somewhat forced reforms carried out by the PM in the last 18 months have challenged the status quo. The success of these reforms will depend on their implementation. The opposition has protested against a few of them especially the farm sector reforms. But barring pockets in Punjab and Haryana where the MSP economy looms large, there isn’t a groundswell of opinion against these reforms. Even the poorly thought-through reforms in labour and the swerve towards atmanirbhar Bharat have been difficult to counter. It is politically infeasible to defend the status quo while being in opposition. The ruling dispensation has taken on the mantle of change despite being in power for over 6 years.

On the economy, the track record of this government is weak; yet PM Modi’s charisma stays above it. Pratap Bhanu Mehta writing in The Indian Express captures this well:

“Despite economic headwinds, it has not been easy to use the economy as a point with which to attack the Modi government. It has still positioned itself as a breaker of the status quo. The opposition will have to think more intelligently about the political economy of protest to counter the new political economy of reform.”

This is the unique feature of charisma. India Gandhi had it when she went about destroying the Indian economy to consolidate political gains in the early 70s. The mission of the charismatic leader subsumes everything else, even their glaring flaws. More so on economic matters.

Weber had considered this in his ruminations on charisma and this is particularly applicable to the ‘fakir’ narrative that’s often associated with charismatic leaders in India:

 “In its economic sub-structure, as in everything else, charismatic domination is the very opposite of bureaucratic domination. If bureaucratic domination depends upon regular income, and hence at least a potiori on a money economy and money taxes, charisma lives in, thought not off, this world. This has to be properly understood. Frequently charisma quite deliberately shuns the possession of money and of pecuniary income per se… (charisma) always rejects as undignified any pecuniary gain that is methodical and rational. In general charisma rejects all rational economic conduct.

..In its purest form, charisma is never a source of private gains for its holders in the sense of economic exploitation by making of a deal. Nor is it a source of income in the form of pecuniary compensation, and just as little does it involve an orderly taxation for the material requirements of its mission. Pure charisma…. is the opposite of all ordered economy. It is the very force that disregards economy.”

The Transfer Of Charisma

The primary challenge to a structure that’s based on charisma is in the determination of transfer of that authority. The transfer comes about through various means – bloodline (Nehru-Gandhi family), search (Dalai Lama), revelation (prophets) or through a new need for a change (Obama or Trump, PM Modi etc). The core question for BJP is what after 2024? Clearly, it’s difficult to see the PM continue for a third term after he turns 75. How will it transfer the charisma to an anointed successor? The work on it will begin soon.

This won’t be easy.

Because PM Modi hasn’t used his charisma to build institutions that will sustain it beyond his time. In his introduction to Weber’s Charisma and Institution Building, S.N. Eisenstadt writes:

“… the test of any great charismatic leader lies not only in his ability to create a single event or great movement, but also in his ability to leave a continuous impact on an institutional structure – to transform any given institutional setting by infusing into it some of his charismatic vision, by investing the regular, orderly offices, or aspects of social organisations, with some of his charismatic qualities and aura.”

This is where Nehru was a genius. For the opposition, the fact that Modi hasn’t been an institution builder in Nehru’s mould offers them their only ray of hope. That this charisma won’t transfer in the post-Modi polity.

But till then the electorate will continue to confound pollsters.  

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Economists Ila Patnaik and Radhika Pandey on Production-Linked Incentives (PLI) scheme.

* [Article] India’s defence financing crunch can’t be solved by the Ministry of Defence alone. Lt Gen Prakash Menon and Pranay explain what needs to be done.

* [Podcast] If Business-State relations interest you, listen to this Puliyabaazi with Rohit Chandra.

* [Article]: ‘Can Democracy Handle Charisma?’ Review of David Bell’s Men on Horseback by Ian Beacock in the New Republic.

That’s all from us, folks.

In case Indian subcontinent geopolitics interests you, tune in for this event in context of the recently concluded elections in Myanmar.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

Democracies have periodic elections to ascertain the will of its people on who should govern them. Often the incumbents lose. This leads to a nebulous, yet perhaps the most precious of features of a democracy – the peaceful transfer of power between the vanquished and the winner. In most democracies, there isn’t a written down law on how this should happen. Instead there are norms of conduct and fair play that guide this. The idea that someone voluntarily steps aside and lets an opponent take over the reins of power is fraught with risk. There’s no guarantee if this gesture will be reciprocated or perpetuated in future. The ability to transcend this fear is what makes democracies tick around the world.

Cannot Be Taken For Granted

How precious this feature is can be gauged from this study done by Adam Przeworski of New York University that was cited by the Economist a few weeks back.

“Mr Przeworski’s database, which analyses elections in more than 200 countries between 1919 and 2015, shows that only a little more than half have had even one orderly electoral transfer of power—defined as government handovers free of coups, civil wars or constitutional crises after a vote.

Eleven such handovers from one party to another have occurred in America since the end of the first world war. This makes the country an exceptional success on this measure.”

Norms follow a logic unique to them. Once set it isn’t easy to dislodge them. Conversely, once challenged and then flouted, it’s difficult to restore them. The norm of peaceful transfer of power for the world was set in the US in the early 19th century. The elections of 1800 were fractious and fiercely contested between the Federalists led by the incumbent President John Adams and the Democratic-Republican Party led by Thomas Jefferson. This was a bitter battle. To quote www.history.com:

“During Adams’s presidency, Democratic-Republicans and Federalists clashed over everything from taxes to religion, but especially over the main policy dilemma facing the nation: how to deal with the ongoing French Revolution.

These bitter differences were front and center during the 1800 presidential campaign, which played out in the highly partisan press. Federalist newspapers and propaganda materials branded French sympathizers as dangerous radicals, while Democratic-Republicans accused the Federalists of wanting to re-establish a monarchy.

When the votes were counted, confusion reigned. Though Jefferson and his running mate, Aaron Burr, had defeated Adams and Pinckney, both had received the same number of electoral votes. The tie sent the decision to the House of Representatives, where Jefferson finally won the presidency on the 36th ballot.

In the early morning hours of March 4, 1801, John Adams, the second president of the United States, quietly left Washington, D.C. under cover of darkness. On the heels of his humiliating defeat in the previous year’s election, Adams was setting an important precedent. His departure from office marked the first peaceful transfer of power between political opponents in the United States, now viewed as a hallmark of the nation’s democracy. Since then, the loser of every presidential election in U.S. history has willingly and peacefully surrendered power to the winner, despite whatever personal animosity or political divisions might exist.”

In his inaugural address, Jefferson made his famous unifying declaration:

“But every difference of opinion is not a difference of principle. We have called by different names brethren of the same principle. We are all republicans. We are all federalists.”

Banking On The Usual American Exceptionalism?

Over the years, there have been laws drafted and passed to establish a mechanism for peaceful transfer of power. The Presidential Transition Act of 1963 and its numerous subsequent amendments have attempted to create more defined guidelines to achieve this.

Yet a few features remain unique to the transfer of power in the US electoral system:

* There’s an inordinately long 10-week transition period between the elections and the inauguration of the new President.

* During this period, the incumbent President continues to hold full executive powers till the President-elect is sworn-in.

* There’s no clarity about what happens if the incumbent refuses to transfer the power citing fraud or electoral irregularities.

Alexis de Tocqueville in his classic Democracy in America remarked on the period just preceding the presidential election and after it with acuity:

“Whatever the prerogatives of the executive power may be, the period which immediately precedes an election and the moment of its duration must always be considered as a national crisis, which is perilous in proportion to the internal embarrassments and the external dangers of the country. Few of the nations of Europe could escape the calamities of anarchy or of conquest every time they might have to elect a new sovereign.”

The ‘national crisis’ that he calls out isn’t a hyperbole.

This transition period where no one is really in control has seen some famous missteps by the U.S. political class. The transition from Buchanan (arguably, the second worst President after Trump) to Lincoln between November 1860 and March 1861 was when the states of the Confederate South prepared for the Civil War while the executive remained paralysed. Similarly, the protracted legal battle between Bush and Gore following the elections in 2000 is believed to have given Bin Laden and his associates the window to plan 9/11.   

These unique features and the dangers of protracted legal battle during the transition period have now come into focus as President Trump refuses to acknowledge he lost the elections. With the crisis of a second wave of Covid-19 striking many states and the urgent need for a national vaccination plan to be administered in the next six months, there couldn’t be a worse time to question the legitimacy of an election and rousing nearly half of the country to believe the voting was rigged.

But Trump has managed that. And more.

He is now striking at the foundational norm of democracy – the peaceful transfer of power – a gift that the US has given to the world. Such norms once questioned cease to be inviolable. All bets are then off for future transitions.

Tocqueville had cited three causes responsible for maintenance of democratic republic in the United States:

* The peculiar and accidental situation in which Providence has placed the Americans.

* The laws.

* The manners and customs of the people.

The Manners Of Americans

Of these, Tocqueville specifically cited the manners of American people as the most critical determinant of its success as a democratic polity. He wrote:

“The citizen of the United States does not acquire his practical science and his positive notions from books; the instruction he has acquired may have prepared him for receiving those ideas, but it did not furnish them. The American learns to know the laws by participating in the act of legislation; and he takes a lesson in the forms of government from governing. The great work of society is ever going on beneath his eyes, and, as it were, under his hands.”

“The laws and manners of the Anglo-Americans are therefore that efficient cause of their greatness which is the object of my inquiry.

The American laws are therefore good, and to them must be attributed a large portion of the success which attends the government of democracy in America: but I do not believe them to be the principal cause of that success; and if they seem to me to have more influence upon the social happiness of the Americans than the nature of the country, on the other hand there is reason to believe that their effect is still inferior to that produced by the manners of the people.

The manners of the Americans of the United States are, then, the real cause which renders that people the only one of the American nations that is able to support a democratic government; and it is the influence of manners which produces the different degrees of order and of prosperity that may be distinguished in the several Anglo-American democracies.”

As Trumpism and a deeply divided society contend with an unprecedented scenario of a raucous transfer of power that so far was the preserve of newly minted democracies of Africa and South America, one hopes the ‘manners’ of the American people that Tocqueville extolled, will save them from the blushes.

The American people will have to be at their best ‘manners’ in the coming days.  

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Timothy Naftali in the Foreign Policy: “The transition of power between presidents has long been a weakness of the U.S. political system. But never more so than now.”

* [Article] The Election That Could Break America, a long-form piece by Barton Gellman in The Atlantic about the various scenarios of transfer of power

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us. Listen in podcast app

Shinzō Abe, the longest-serving Japanese PM ever, stepped down from office last week. His second term that began in late 2012 was marked by his prescription for reviving 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, rise in entrepreneurship and 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 who 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 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 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 a 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 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, fall in bond yields and 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. A 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 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 the Abenomics in 2013. The three arrows were:

* A monetary policy based on 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 free trade (TTP), lower FDI barriers and global liberal order to counter China.

You couldn’t fault their prescription based on what they learnt from their past. Abenomics wasn’t a radically new construct but in 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 inflation in Japan remained persistently below 1 per cent. The primary objective of the 3 arrows was to ‘warm up’ the economy to an extent that spurs demand and gets the investment cycle going. On that count, it failed. It has seen limited success in increasing women 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 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 massive purchase of government securities and private assets work. 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, 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).

Our Lessons

These are important lessons for India as we consider the options to revive growth after the pandemic. The fears of an increase in fiscal deficit and a rise in debt, lack of coordination between fiscal and monetary actions and poor communication or guidance to the public about the road ahead should look familiar to all of us. We can avoid these pitfalls and yet bank on the demographic dividend that’s still available to us to have a version of Abenomics work for us.

The Abe playbook didn’t work for him, but it could work for his friend, PM Modi.

HomeWork

Reading and listening recommendations on public policy matters

* [Paper] Paul Krugman’s famous paper in six parts on Japan’s liquidity trap written in 1998 that explains the reasons for the lost decade.

* [Paper] Yoshino and Taghizadeh-Hesary in their ADB paper blame structural reasons of Japan for the lost decades. The paper counters the arguments of Paul Krugman that the Japanese economy is in a liquidity trap. For them Japan’s economic stagnation stems from a vertical IS curve rather than a liquidity trap.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch: Pro-market Vs Pro-business

Insights on burning policy issues in India

— Pranay Kotasthane

Indian governments have a rule-making obsession. These myriad rules, regulations, and laws are particularly onerous for running businesses. One anticipated unintended consequence is self-evident: over-regulation incentivises businesses away from the regulated activity into an activity that is far more harmful.

But that’s not all. The other unintended consequence is that overregulation increases rent-seeking opportunities i.e. some businesses cut side-deals with regulatory agents and thrive. Hallward-Driemeier and Pritchett explain this succinctly in their 2015 paper:

“when strict de jure regulations meet weak governmental capabilities for implementation and enforcement … researchers and policy makers should stop thinking about regulations as creating “rules” to be followed, but rather as creating a space in which “deals” of various kinds are possible”.

Kar, Pritchett et al in a 2019 paper find further evidence of the way these deals play out. They reach an interesting conclusion that as regulatory stringency increases, the proportion of firms obtaining clearances, permits, and licenses quicker also increases. In their words:

“..quick deals are often the result of weak implementation via regulatory capture and/or influence or evasion, rather than the result of better regulation or the more speedy completion of regulatory processes. In other words, firms are able to get permits and licences much faster, without due diligence being undertaken for their business activities, by influencing the regulatory bureaucracy and/or their political bosses. As a country’s state capability increases, there is greater ability to counter the pressure for regulatory capture and hence the proportion of such quick deals falls.”

This results in a low-level equilibrium where regulatory capture becomes the de facto norm.

Such deal-making reality is relevant in India today as sector after sector, market concentration is on the rise i.e. a few select firms are able to get clearances, permits, and licenses by cutting side-deals with governments. Unsurprisingly, a lot of media attention is on exposing these special high-level political connections or direct influencing mechanisms.

What’s lost in the din is that while such exposés can shed light on particular instances of government-business dealings, they don’t help reduce levels of corruption. One business tycoon gets replaced by another and the story repeats. As long as higher regulatory burden continues to coexist with low enforcement capacity, side-deals flourish.

The solution then is to decrease the regulatory burden in the short-term and increase enforcement capacity in the long-term. Simplifying rules are pro-market not just pro-business. They negate the advantage that some companies enjoy on account of their special connections with regulatory agents. That’s precisely why simpler tax, policy, and legal environments are pre-conditions for making India’s market more competitive.

Global PolicyWTF: Turkey For Thanksgiving

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

— RSJ

Bad policy ideas never go out of fashion. They spruce themselves a bit, don new clothes and return to wreak havoc all over again. They are remarkably resilient because the public falls for them every time they show up in a new garb. This is why strong institutions matter. Failing which an enlightened populace that appreciates economic reasoning can stand as the last line of defence. We talk a lot about PolicyWTFs here because our modest aim is to evangelise economic reasoning. The root causes of most PolicyWTFs that we target can be traced to two fundamental human failings – good intentions and hubris. In the past few months, we have seen this play out in Turkey in all its glory.

Killing The Messenger

On September 15, Moody’s Investor Service cut Turkey’s sovereign credit rating to B2, about five levels below investment grade. This put Turkey on par with countries like Rwanda and Jamaica.

“Turkey’s external vulnerabilities are increasingly likely to crystallize in a balance-of-payments crisis,” Moody’s wrote in their report.

"Turkey has been muddling through for some time now, but muddling through is not a strategy that can be used forever. At some point they will run out of road," Sarah Carlson, lead sovereign analyst at Moody's Investors Service, told Reuters in an interview.

President Tayyip Erodgan responded by attacking Moody’s and other rating agencies as he has done in the past. The usual bogey of interest rate lobby and currency manipulators was wheeled out to defend his position.

Turkey’s economy is on the rise and not dipping at the moment, but “they are downgrading our ratings again,” Erdogan said in Istanbul on Saturday after the Moody’s announcement. “Do what you want to do, your ratings are of no importance.”

The Certitude Of Erdogan

So, what’s gone wrong with policymaking in Turkey? Well, in a single word – hubris. Erdogan cannot imagine being wrong and worse, he thinks the economy can be managed centrally and bent to his will. He has fired central bankers, appointed his son-in-law as the Finance Minister and has made policy moves that would do a tin-pot dictator proud. Things were already bad for Turkey at the start of this year. Then came the pandemic. Alongside these Turkey has been flexing its political and military muscle all around the region. That has won it no friends. From the US, Russia to Saudi Arabia, it has been picking the choicest battles to dig itself further into a hole. The EU integration dream has been smashed beyond recognition.

But Erdogan fancies himself as the leader of the Muslim world and a strong man who will change the destiny of his people. He won’t change course. Admitting a mistake is the biggest sin in his worldview. So now you have a situation where foreign currency funding of over $50 billion has fled Turkey over the past couple of years while the local banks have been mopping up domestic savings in dollar-denominated deposits. These funds are being borrowed by the Turkish Central Bank (CBRT) and sold in the market to defend the Turkish Lira. The CBRT has negative net foreign currency reserves at this moment.

This means Turkish banks are sitting on huge exposure to CBRT which has nothing left in reserves while the government continues to borrow from the state-run banks to fund its ambitious infrastructure programmes. The Turkish Lira has fallen over 30 per cent this year, there’s double-digit inflation and the investors are voting with their feet. A balance of payments crisis is imminent and that’s what Moody’s and other rating agencies have flagged.   

Bonfire Of Economic Reasoning

The problem is you could see this coming for many years because the first casualty of political hubris is economic reasoning. And Turkey has shown a fine disregard to it under Erdogan. Turkey runs a large current account deficit (imports more than its exports) which requires external financing or a capital account surplus to fund. This is usual for an emerging economy with a strong and growing domestic market. Over the years the promise of deeper integration with EU and the relatively large size of its market has meant it has attracted strong foreign capital flow. This led to the expansion of credit that fuelled the consumption boom. The way to manage this is to continue reforms to retain the confidence of foreign capital, invest in infrastructure and human capital to improve the long-term competitiveness of Turkish industry and maintain internal and external harmony to keep the economic engine humming.

Instead, President Erdogan has put his own version of economics at the forefront to bring Turkey to the brink. The list of Erdogan PolicyWTFs is long:

* He loves low-interest rates that allow people to borrow and spend. That makes him popular. But he also has a warped notion that high-interest rates cause high inflation. This is a problem in a country like Turkey that has chronic high inflation and depends on foreign capital. A lower interest reduces the attractiveness of Turkish assets and foreign capital goes elsewhere. This weakens Turkish Lira. This is what has happened in the last two years where a domestic credit boom has been engineered by keeping interest rates artificially low. But the consumption upsurge has meant more imports because Turkish people love buying foreign goods. The weakened Lira means Turkey keeps importing inflation in the form of foreign goods. And the inflation keeps rising, hurting the poor the most.

* Demolishing the independence of central bank has been his singular achievement in the past few years. He has taken the powers to appoint members to CBRT’s rate setting board directly. He has installed a lackey as its Chairman who cut interest rates with little regard to the consequences over the last two years. There is no system of checks and balances left for Turkey to have an independent monetary policy anymore.

* As usual wrong root causes have been identified for the balance of payments crisis. That imports are a problem. One way to solve this is to find energy sources of its own so that fuel imports reduce. That explains its increased belligerence in the eastern Mediterranean region. Nothing good would come out of it except inviting more sanctions and a further flight of capital. Soon there will be a call for import substitution (there are already those calls) and to shun foreign goods. There will be another round of whipping nationalistic fervour to cover the economic mess.

* The three options that can help avert a balance of payments crisis are anathema to President Erdogan. He doesn’t like higher interest rates so that’s not an option. Buying Turkish Lira using domestic foreign exchange reserves is the other. This has been done to its fullest and the reserves are in negative now. The final option is to go to IMF who will dictate terms but that can’t be countenanced by a strong leader.

Turkey is a good lesson in believing intentions and political legitimacy trumps economic rationale. That a strong and popular leader who trusts his instincts can make bold calls for an economy. The economy bends to no one’s will. Except to reason.    

Money Quote: What Has Capitalism Done for the Poorest?

— Pranay Kotasthane

This month I’m reading the works of Deirdre McCloskey, one of the best living economists. These lines from her book Why Liberalism Works need to be reflected upon by everyone in the public policy space:

“..according to the scientific consensus in economic history, the much-maligned “capitalism” has raised the real income per person of the poorest since 1800 not by 10 percent or 100 percent, but by over 3,000 percent. Cheap food. Big apartments. Literacy. Antibiotics. Airplanes. The Pill. University education. The increase is a factor of thirty. That is, 30 minus the original, miserable, base of 1.0, all divided by the base is 29/1, to be multiplied by 100 to express it per hundred—or a 2,900 percent increase over the base, 3,000 near enough. I will keep saying it, and keep dazzling you with my prowess in arithmetic, until you feel it on your pulse. It is the greatest, yet regularly overlooked, fact about the modern world. Most people by actual questionnaire think that since olden days the real capacity of poor people to buy goods and services has increased maybe 100 percent, at the outside 200 percent, a doubling or a tripling. They’re quite wrong. The increase has been much, much greater. If we appreciate it, the appreciation will transform all our politics. For example, the fact of the Great Enrichment is a crucial element in showing that humane true liberalism of the modern sort I advocate here is good and enriching, in every sense.

The Great Enrichment doesn’t mean, of course, that there’s nothing more to do in helping the poor, especially by ending the numerous, monstrous, and yet politically popular policies that in fact damage them worldwide. But it does mean that it is mischievous to attack, as many political theories do, a “capitalism” that has done more than anything else to help the poor. The Great Enrichment doesn’t mean that little bits of other systems—a soupçon of socialism for worthy public projects, a cup of Christian charity for the poor, a tablespoon of encouragement to worker-owned cooperatives, such as law and accounting firms—are to be scorned. But it does mean that replacing “the system” as a whole would be disastrous for the poor, as it has been shown to be in the USSR after 1917, in Venezuela after 1999, and over and over again in between.”

McCloskey, Deirdre Nansen. Why Liberalism Works . Yale University Press. Kindle Edition.[Emphasis mine]

Matsyanyaaya: Assessing China’s Silicon Rush

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane and Rohan Seth

[An edited version of this article appeared first in South China Morning Post on 15th Nov under the headline China’s semiconductor gold rush: A reality check]

The semiconductor industry has become a major front of the US-China tech war. Given that this is a weak link in China’s otherwise impressive technology stack, the US has imposed export controls restricting Chinese semiconductor companies from accessing key equipment, software, and intellectual property.China has been aware of this weak link. Since 2014, the Chinese state has set up two 'Big Funds' to incentivise growth. These funds raise money primarily from government bodies — the finance ministry, state-owned enterprises, local governments — and invest it in upcoming semiconductor companies.The government-led investment has led to a 'crowding-in' of private enterprise. According to recent data, more than 13,000 Chinese enterprises registered as semiconductor companies in the first nine months of this year. That is a significant jump from the nearly 9,000 companies that registered last year. Such is the lure that several new entrants with no prior experience in semiconductors have thrown their hat into the ring. Many come from a range of disparate sectors such as automobiles and seafood.So, does this silicon rush mean that China will become self-sufficient in semiconductors soon? Not quite. China's state-backed funds might well spur private investment, even producing a few champions but such moves are unlikely to result in a self-sufficient Chinese semiconductor industry anytime soon. Here's why.The semiconductor supply chain is a complex one. It can be very roughly split into three main stages: integrated circuit (IC) design, semiconductor manufacturing, and assembly & testing. The returns of investment for China in each of these stages will be different due to their unique limiting constraints.

China's prospects in IC design

The first stage — IC design — is skill-heavy and asset-light. Coming up with newer chip architectures and integrating them requires a large number of high-skilled engineers familiar with specialised software. There were nearly 138,000 design startups in China as of September 2020, most of them getting registered after the first government-backed fund was announced in 2014. Though there are fears of talent shortage, government-backed massive investment means that such shortage can be tackled by poaching talent from Taiwan at higher wages. The fortune of design shops is on the rise.And yet, these design shops are not destined for success. One critical bottleneck remains in the US control: software. IC design is intricate and requires extensive use of automated design software collectively known as Electronic Design Automation (EDA). EDA requires massive R&D investment and in-depth knowledge of chip fabrication. As a result, this market has rapidly consolidated over the years. Currently, there are three dominant global players, two of which are US-owned while the third is based in the US. Exploiting this asymmetry, the US banned the sale of US-origin EDA software to HiSilicon, Huawei's IC design unit. With China having no EDA firm at the cutting edge and the US taking a hardline approach on IP piracy, developing self-sufficiency in EDA tools will require considerable time.The second bottleneck is processors for high-end mobile phones. ARM Holdings is the dominant firm here with over 90 per cent market share. ARM was recently bought by NVIDIA, making it directly subject to American export restriction laws that are being used to target Huawei. To overcome this dependence, Chinese companies such as Alibaba have thrown their weight behind a rival open-source architecture known as RISC-V. Though impressive development has taken place on this front, RISC-V still has many years of catching up to do before it can displace ARM’s core general purpose processors in mobile phones and tablets.

China's prospects in chip fabrication

Physically translating IC design onto silicon is a capital-intensive process requiring regular and massive capital infusion. For example, TSMC, the world's leading chip manufacturer estimates that its next-generation chip fabrication plant will cost $19.5 billion.China’s Big Chip Funds will help pool in the significant investment for building new fabrication plants. Despite this, two challenges will constrain China's hand in the catch-up game.One, China's starting point remains a handicap. Even Semiconductor Manufacturing International Corporation (SMIC), China's national champion in this space, can commercially produce 14-nanometer chips as of now. This is a couple of generations behind the industry leader's (TSMC) 5-nanometer capability. This number is indicative of the transistor size; the smaller this number, the more transistors can be packed in the same area leading to higher device performance. Even with enough capital investment, it might take the better part of a decade for China to catch up with TSMC. And by the time that happens, the cutting edge would likely have moved on to a more advanced process. Until then, companies such as Huawei have no local option for manufacturing their high-end chips.Two, a fast follower approach is challenging to execute with ongoing US sanctions. For instance, the US has been applying pressure on ASML, the world's only producer of a technology required to manufacture high-end chips. Applied Materials and Lam Research, two other US companies which supply critical manufacturing equipment to SMIC also face US export curbs. Without access to this equipment, SMIC will not be able to produce advanced chips.

China's prospects in assembly & testing

Finally, the back-end, commonly referred to as Outsourced Semiconductor Assembly & Test (OSAT), is a labour-intensive sector with lower profit margins.OSAT has already moved to countries that have a comparative advantage in the availability and cost of labour. The capital investment is still significant, but not as high as the manufacturing process. These characteristics make OSAT a low hanging fruit for China's Big Fund investments. Although Taiwan remains the leader in the space by a significant margin, China's market share has been growing steadily. Jiangsu Changjiang Electronics Technology Co. (JCET), backed by a Big Fund, now has over 15% market share in the global market. As the state lays out an increasing number of incentives, it is the OSAT segment that is most likely to benefit from them as compared to the other stages.China faces an additional geopolitical challenge in chip fabrication and assembly. Just a handful of Japanese companies dominate the global market in silicon wafers, photoresists, and essential packaging chemicals. These companies are well-regarded for their high-quality production capabilities and their products are not easily replaceable even by a manufacturing heavyweight such as China. In a changed world where strategic concerns are guiding technology flows, China’s chip ambitions can be foiled not just by the US but also by Japan and Taiwan.Based on this survey of China's strengths and weaknesses in different stages of the semiconductor supply chain, judging Big Funds' success by the number of registering companies doesn't provide an accurate picture. Throwing money at the problem is not a solution that can work for all sectors. The spectacular failures of Fujian Jianhua Integrated Circuit Company (a memory chip maker) and Wuhan based HSMC (a chip manufacturer) have amply demonstrated that China's push to be self-reliant will require a lot more than massive public investment. Crucially, China's own arrogant international conduct that has resulted in significant geopolitical barriers for its fledgeling semiconductor industry. To adapt William Gibson's oft-repeated quote, the future of semiconductors in China is here — it's just not very evenly distributed.

HomeWork

Reading and listening recommendations on public policy matters

* [Article]: ‘An imbalance of payments leaves Turkey with hard choices’: John Lubbock in the Ahval on where Turkey’s economy stands today

* [Paper]: Cooperative arrangements in the technology domain to balance China’s power seem to be gaining traction.

That’s all for the week from us.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

Are we done with the pandemic in India? While the case counts have seen a renewed surged in a few states and there’s been partial lockdowns and travel restrictions imposed, the markets are crowded, traffic is back on the roads and industry leaders are claiming everything is back to pre-Covid levels. Like most things in India, we follow rules while simultaneously not following them. So, we have found a way to pay our respect to the virus (wearing a mask) while getting on with life (pulling the mask over our chin while dealing with others).

This is the kind of contradiction we revel in. Unsurprisingly, our economy is following suit.  

Newspaper headlines would indicate we are seeing a robust recovery. Hardly a day passes when you don’t come across an interview of a business leader who announces their business volumes are back to pre-Covid levels. The message from the economic advisors to the government and from the officials of the Finance Ministry is upbeat. Apparently, the worst is behind us and the reforms initiated during the pandemic have set the stage for growth in future.

How real and sustainable is this? Our everyday experiences don’t sit well with this narrative. A lot of us still aren’t out and about to shop or to work. Our spends on discretionary items have been low because salary cuts are still operational. Services is still on the ropes as a sector as we aren’t travelling, eating out, watching films, or going to the salons as we did in the past.

So, how’s the economic recovery really going?

It’s best to look at macroeconomic indicators instead of cherry-picking data to make sense of things. There are three perspectives that emerge reading through the macro data.

#1 Data Is Good; But Who Is It Good For?

There are multiple areas where we are doing good:

* Stock markets are at an all-time high. Since the pandemic lows in late March, the market has rallied more than 50 per cent. Over 5 million demat accounts have opened since April ‘21. For comparison, 4.9 million accounts were opened in the whole of FY 20. Mutual Funds inflows in H1 has grown by 6 per cent over last year. If the index is a consensus estimate of future prospects of listed entities, we are at peak levels of optimism.

* Listed entities made record profits in H1 of FY21 which coincided with the pandemic and large-scale demand destruction. Net profits of listed entities grew in this period by 24 per cent. To put this in context, the median profit growth in the last 60 quarters was 9 per cent. The pandemic also accelerated the oligopolistic characteristics in most sectors of the economy. The top 3 players in most sectors accounted for more than 60 per cent of profits. The rich are getting richer.

* NPCI retail transactions have grown by over 30 per cent in volumes in H1 FY21 over the previous year while they are down 15 per cent by value. Value of UPI transactions in H1 has grown by over 50 per cent. Clearly, there’s more business transacted in the formal economy during the pandemic. More importantly, low value transactions have moved to formal economy as well going by the increase in volumes. Also, Bank deposits have grown by 10 per cent during the same time while household savings are at their peak.

Who is it good for? Two conclusions are easy to draw from the data above. One, the top 4-5 per cent of the populace that participates in capital markets seem to be doing well for themselves. This segment also accounts for a significant share of consumption of high-value goods. They haven’t held themselves back during the festive season. This is seen in the September data of various sectors. Two, the growth in retail transaction volume that’s captured by NPCI and UPI suggests a significant shift from informal to formal economy. The data about the informal economy or on those outside the 4-5 per cent isn’t exactly visible at this moment.     

#2 Data Is Good; But Is It?

Then there are areas where the data suggests we are back to pre-Covid levels. All’s well now. This is tricky territory and needs to be understood better. Let’s look at a few high-frequency data indicators:

* In Sep 20, passenger vehicles volumes grew by 13 per cent while 2 wheelers volumes went up by 11 per cent over the same month last year. To put this in perspective, FY 19-20 was one of the worst years for the automotive sector. Tractors have sold really well; up by over 20 per cent in H1 over last year.

* E-way bills and railway freight traffic origination – the two metrics indicating the health of logistics sector – were up in September over last year after being down by more than 15 per cent till then.

* Net new EPF subscribers reached 1 million in August ’20. The pre-Covid levels in Jan and Feb was about 1 million. This suggests companies are back hiring.

The data above points to a robust recovery. But does it? Let’s take the data of net new EPF subscribers. Till the pandemic hit us in March, we were adding over a million new subscribers every month and growing at 15-20 per cent over previous year. Since the pandemic began, we have lost the opportunity to add about 3.5 million net new subscribers based on this run rate. How soon will we be able to make up this deficit? We will have to assume from September onwards we return to our usual growth trajectory plus we make up the lost ground with ‘real’ recovery, i.e. we have an incremental higher growth than the usual trajectory. Even if we assume this incremental growth to be about 10 per cent on y-o-y basis, it will take us between 30 – 36 months to recover the lost ground in areas where we claim to have hit pre-Covid volumes now.

The same principle will apply to any sector including passenger cars and two-wheelers that we have talked about above. Similarly, the logistics growth seems to be on the back of inventory being cleared that had piled up during the lockdown. To truly recover what we have lost will take us about 2.5 – 3 years on a best-case basis.

This is a sobering thought. The optimistic way to look at this is that we have recovered to pre-Covid levels in many of these areas sooner than we thought. That’s small solace.

#3 Data Simply Isn’t Good

There are multiple areas where the data isn’t good at all.

* Labour is under stress across the board barring the top 1-2 per cent of the working pool. The record profits seen by listed companies in H1 also come with the lowest wage increases (over the past 15 years) of less than 4 per cent y-o-y in the past two quarters. Companies have reduced their headcounts in this period and may have learnt they were carrying flab over the years.

* MGNREGA work demand has remained higher by over 50 per cent in H1 this year over last. Even in Sep ’20, the work demand was of over 24 million households was 71 per cent higher than last year. Employment provided by the scheme has also been at over 50 per cent higher. The 19 million households employed in Sep ’20 was 56 per cent higher over last year. The reverse migration of workers from the urban economy back to the agriculture sector that’s saddled with low productivity and low-income levels has undone years of movement away from it.

* CPI (retail inflation) has soared to over 7.3 per cent. This is already in the uncomfortable range. Liquidity in the system is still at all time high. The RBI will have its hands tied in cutting interest rates further to spur growth.

While the economic activity has picked up possibly faster that a lot of us expected, there’s hardly anything to be complacent about. The recovery is still fragile because we aren’t seeing the full picture yet. Sajjid Chinoy in the Business Standard made a pertinent observation:

“Operating profit growth of listed non-financial firms sizzled (+44 per cent in nominal terms) but largely on the back of firms rationalising expenditures. Recall, on the income side, GDP is simply the sum of economy-wide operating profits, pre-tax wage incomes and indirect taxes. If GDP is poised to contract in the July-September quarter, yet listed company profit growth is so strong and indirect taxes are recovering quickly, what does that tell us? That profits of smaller, unlisted firms and labour income (wages and employment) suffered sharp contractions last quarter. This, in turn, could have meaningful implications for future growth and income inequality.”

We still have a long way to go before we get back to the pre-pandemic output trajectory. A rough estimate suggests a minimum of three years on a conservative basis. Meanwhile, the informal economy and the labour are still bearing the brunt of the pandemic lockdowns. The stimulus injected by the government has been meagre so far. Most of what has been announced are relief measures or medium to long term reforms.

The annual budget is about 3 months away. It will be useful for the ministry to take a hard and realistic look at the economy and take measures that ensure we don’t lose more time. A well-timed stimulus will still go a long way.

There’s an invisible India that will continue to suffer for long otherwise.  

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] David Beckworth with Bilal Hafeez on his podcast Macro Musings. Bilal and David discuss the prospects for a K-shaped US recovery, COVID-19’s impact on the Eurozone and the UK, how the launch of the EU’s recovery fund has fared, and how the pandemic has impacted the outlook for the services sector, inflation, and the US dollar.

* [Article] Economist Ajay Shah peers into the economic recovery.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

PolicyWTF: One Nation, One Election

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

— Pranay Kotasthane

The series “One Nation, One X”, like another sitcom Tarak Mehta Ka Ooltah Chashmah, doesn’t seem to end. The latest season of the series is titled One nation, One election (ONOE).

PM Narendra Modi has batted for this idea on many occasions before. In his latest pitch, he said:

Elections are held at different places every few months, the impact it has on development works is known to all. Therefore, it is a must to have deep study and deliberation on ‘One Nation, One Election’.

This speech apart, the most robust defence of ONOE comes from a NITI Aayog discussion paper by Bibek Debroy and Kishore Desai. They cite four reasons. Let us investigate the top two.

Reason #1: Imposition of Model Code of Conduct by the Election Commission derails development programs and governance

According to this view, political parties, once in power, are brimming with development ideas but are not able to do so, that too for considerable periods, because of repeated elections. This view is shared by many people outside the government as well.

The discussion paper tries to estimate the development time lost because of elections. Based on a projection that at least two states go to elections in India every year the authors conclude:

“Assuming the average period of operation of Model Code of Conduct as 2 months during election to a State Assembly, development projects and programs (that of State Governments going to polls and of Union Government in those states) may potentially get hit every year and that too for about one-third (four months) of the entire time available for implementing such projects and programs. Such a situation is completely undesirable and needs serious deliberations and appropriate corrective measures.”

Sounds quite serious. But hang on. There are several problems with this assessment.

One, if the Model Code of Conduct is the problem, it can be changed either by shortening the length of the moratorium or by relaxing the kinds of developmental activities permitted during the election season. Even in its current form, the government can consult the Election Commission about the developmental works it plans to undertake and if they are deemed to not have electoral implications, they are allowed to continue. I’m in favour of removing these restrictions altogether. If a government wants to use developmental activities to lure its voters, it’s more than welcome to do so. If the government is promising freebies to distort voter choices, it can do so even today, just before the Model Code of Conduct comes into place.

Two, the claim that developmental activities get stalled for four months a year is misleading. That’s because the code of conduct applies only to the state where elections are to be held. There’s no reason why developmental activities need to stall in all other states. Moreover, it’s useful to see the development period lost over a five year period. Assuming that one Lok Sabha election gets held between two state assembly elections over five years, the total “developmental time lost” in the state is six months. That’s an average one-tenth of a year, not one-third.

Three, this “developmental time lost” argument sounds a lot like the dog ate my homework excuse. For one, governments know when the next elections are due and can reasonably plan their developmental works taking this ex-ante information into consideration. Secondly, and this is the bigger issue, this view relegates elections to a begrudgingly necessary event; a mere obstacle blocking the grand developmental vision of the party or the leader in power.

Reason #2: Frequent elections lead to massive expenditures by governments and other stakeholders

The NITI Aayog paper claims:

Elections lead to huge expenditures by various stakeholders. Every year, the Government of India and/or respective State Governments bear expenditures on account of conduct, control and supervision of elections. Besides the Government, candidates contesting elections and political parties also incur huge expenditures. The candidates normally incur expenditures on account of various necessary aspects such as travel to constituencies, general publicity, organizing outreach events for electorates etc. while the political parties incur expenditures to run the party’s electoral machinery during elections, campaigning by star leaders and so on.

While this is true, “massive” expenditures need to be unpacked. The first component is the government expenditure in conducting elections. The 2014 Lok Sabha elections cost 3870 crores i.e. an expense of 0.03 per cent of India’s 2014 GDP once every five years. State elections for a large state like Bihar cost a tenth of this amount i.e. 0.003 per cent of India’s 2014 GDP every five years. Even if we assume all states require the same amount as Bihar did, India would be spending 0.12 per cent of India’s 2014 GDP over a period of five years, all state assemblies and Lok Sabha elections combined. Clearly, this number is not unaffordable. It can’t be the primary motivation for undertaking a constitutional amendment exercise fraught with unintended consequences.

The other component of the cost is spending by political parties and candidates. While the latter is capped to laughably low numbers (Rs 70 lakh for Lok Sabha and Rs 28 lakhs for state assembly elections), there’s no cap on the former. The paper claims that taken together, this component amounted to Rs 30,000 crores for the 2014 Lok Sabha elections. This is indeed a worrying number, more so because the expenditure is often in the form of freebies and vote for cash exchanges. But, arguing that conducting simultaneous elections will fix this problem is an admission by political parties that they will not change their ways; it’s just that they will engage in this simultaneous corruption once every five years. Fixing election expenditure requires many urgent solutions but a simultaneous election is not one of them.

Besides these two reasons, there are other counterarguments that I haven’t considered at all. For example, there is a correlation between a higher percentage of electoral wins for national parties as against regional parties when Lok Sabha and state assembly elections are held together. There are also severe repercussions on India’s federal structures as state governments falling before completion of the five year period might have to be placed under the charge of caretaker governments or state governors.

Regardless, what this limited analysis shows is that even the two reasons given in favour of simultaneous elections don’t hold water. We don’t need One Nation, One Election.

India Policy Watch #1: RBI And Banking Licenses

— RSJ

The Internal Working Group (IWG) of the Reserve Bank of India (RBI) last week came out with draft report that recommended a calibrated entry of industrial houses into the banking sector and for conversion of large NBFCs into banks.

The usual brouhaha followed. But hidden in the brouhaha is an important lesson about the interplay between political and economic institutions. We will come to it later. First, the brouhaha.  

Always A Bad Idea

The camp against the idea of entry of corporates into Banking was led by the formidable duo of Raghuram Rajan and Viral Acharya. In a LinkedIn post titled – “Do we really need Indian corporations in banking?” – they laid out their reservations in no uncertain terms including an innuendo here and a wink there. It covered the usual grounds – risks of connected lending where a corporate house will raise cheap deposits from ordinary citizens and finance their businesses without due diligence; further concentration of economic power among few corporates in a country that’s fast turning oligopolistic and the need for the government to find more bidders when it begins privatisation of PSU banks that it can’t fund any longer.

“First, industrial houses need financing, and they can get it easily, with no questions asked, if they have an in-house bank. The history of such connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending.”

“The second reason to prohibit corporate entry into banking is that it will further exacerbate the concentration of economic (and political) power in certain business houses. Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses.”

“One possibility is that the government wants to expand the set of bidders when it finally turns to privatizing some of our public sector banks. It would be a mistake, as we have said in an earlier paper, to sell a public sector bank to an untested industrial house.”

Do We Need More Banks?

The short answer is yes.

Look at India’s ambitions. A 5 trillion economy by 2025 that’s a global economic powerhouse. Keep your dose of realism aside for a moment. If India has to even make a fist of this ambition, it needs a robust, deep and competitive banking sector. What do we have today? A total of maybe six and a half large banks that have the capital, management strength and the ambition to support this vision.   

India is still severely underbanked. Credit to GDP is about 56 per cent which is woefully short of what a fast-growing economy needs. PSU banks that fanned out into the interiors hardly built a deposit base or managed to support enterprise at scale outside of urban centres. Despite such modest achievements, almost every PSU bank has drained taxpayers’ money with very little to show for. Turning PSUs around is nigh impossible. It is easy to recommend professionalising the management but there’s no easy way to achieve it. The government has mixed up its role of being a regulator, shareholder and the management. All sorts of conflicts of interest follow. The benefits of running PSU banks are concentrated among bureaucrats, employee unions and politicians who use them to pump prime the economy when it is politically expedient. The costs are diffused among millions of taxpayers. No wonder the market cap of all PSU banks put together is smaller than the biggest private sector bank.  

Is there really an alternative to big businesses or large NBFCs (many of whom have corporate houses as promoters) to support India’s ambitions? Who else has the ability to bring in patient capital and support a bank for a period of time in future?

Fait Accompli?

So, does this mean we will soon have corporate houses being issued bank licenses? In my opinion that’s unlikely unless government really nudges the RBI in that direction. I have my reasons:

* In the current dispensation itself, many NBFCs could have applied for banking license over the last five years. But they haven’t. Why? The capital requirements needed to run a bank are very different from that of an NBFC. That apart, the NBFCs face far relaxed regulatory oversight than banks. No wonder none of the NBFCs have touched it with a barge pole over the years.

* RBI will have to change the Banking Act, 1949 through a bill passed in the Parliament. Following that there will be a ‘fit and proper’ filter that will be with the RBI to decide on who to give the license. The IWG report suggests some of these will be made more onerous for the applicants.

* This is still a political hot potato. There are many voices within the government who might not be comfortable with this. The pressure group of unions, bureaucrats and opinion makers still wield significant power to block the entry of corporate houses.

* RBI will continue to make it very difficult for anyone applying the bank license

So, what’s happening here? Why is RBI coming out with a paper for allowing corporates in Banks while simultaneously making the criteria impossible to achieve.

A Balancing Act

RBI as an economic institution understands the need for more banks in India. But it does not believe the political institutions in India will be able to manage the conflict of interest inherent in having large corporates as banks. So on one hand it wants to show the political leadership it is supporting their aspirations in ambitions by re-looking at the guidelines for new licenses while making the conditions of the guidelines so onerous that it will make the license unattractive for an industrial house.

For nations to succeed (like Acemoglu and Robinson have argued), its institutions have to be strong. In my view, a nation has to have its political and economic institutions in sync with another. It is difficult for it to have its political institutions extractive, exclusionary and rent-seeking while its economic institutions are liberal and inclusive; and yet succeed in the long run. Having an extractive and exclusionary political institution while continuing to work with economic institutions that are free and inclusive is an unstable equilibrium. Sooner or later, the extractive nature of one type of institutions casts its long shadow on everything. The post-independent history of India speaks to this phenomenon.

Following Independence, India chose a model where its political institutions were by design inclusive and liberal while its economic institutions came to be dominated by the state. In the late 60s, Indira Gandhi found it expedient to double down on the state control of economy in order to consolidate herself politically. This led to the nationalisation of various sectors including that of banks. As this domination and undermining of economic institutions turned complete, the political institutions couldn’t stay beyond it. The judiciary became subservient, roles like governors of state turned into rubber stamps, Article 356 was liberally used to dismiss state governments at slightest of pretexts and most independent institutions were packed with sycophants. No surprise then this culminated into the emergency of 1975.

The crisis of having both political and economic institutions that were extractive reached a point of no return by 1991. That’s when we decided to take a sharp turn away on how we’d like to manage our financial situation. The state reduced its control on factors of production, multiple independent regulators were born and a relativity free market came in to play. The feedback loop of the liberalisation of economic institutions soon started coming up against the extractive nature of political institutions. Through some fortunate circumstances of coalition politics, enlightened leadership and favourable global conditions, the political institutions began to change in the image of the liberal economic institutions. This was reflected in a more active election commission, laws like RTI being passed and the courts actively preserving the liberties of the citizenry.

However, over the last decade or so, the political institutions in India have turned the clock back on being extractive. Electoral victories on the back of a strong leader, a decimated opposition and the power of majoritarian politics have meant we have reversed the gains we made post-liberalisation on making our political institutions freer. As the feedback loops in, the economic institutions are starting to corrode.

This is where RBI finds itself today. It still is a free and liberal institution that’s walking the tightrope between a democratic mandate (that the government represents) and its own independent thinking. The draft IWG report in that sense is its stand. It will play ball yet not play it at the same time. It is anyone’s guess how long it can continue to do so.

The right solution of course is to go back to the path of strong, free and inclusive political AND economic institutions. But that doesn’t look likely anytime soon. It is a lost opportunity.   

India Policy Watch #2: Farmers’ Protests

Insights on burning policy issues in India

— Pranay Kotasthane

We warned in edition #70:

Any reform that is even remotely seen to impact the MSP gravy train is bound to face opposition from a host of incumbent beneficiaries. One, the farmers growing the 22 crops backed by the MSP. Two, the traders getting a percentage of the MSP. And three, the state governments making money by charging hefty commissions for the sale of produce at APMCs. None of this is surprising.

That apart, we mentioned two critiques merit serious attention: one, the timing of these reforms amidst the worst economic crisis in decades meant that the government needed to align the cognitive maps of those losing out. Two, the government fostered suspicions because the three farm laws said nothing about the impact on the existing procurement price mechanisms.

Unfortunately, the anticipated unintended consequences have played out according to the script above. Farmers in Punjab and Haryana are agitating while the government has not come out with a reconciliatory offer yet.

As usual, Pratap Bhanu Mehta’s article takes the long view. He writes:

“Given the far-reaching changes we need in agriculture in Punjab, it is important that the trust between the state and the farmer remains. A good faith dialogue that gives the farmers reasonable assurances and a face-saver is necessary. It is easy for the government to win. But how many times in Indian politics have we won short-term victories that create long-term political precariousness?”

Just like the GST compensation cess issue, the union government has pushed through a big change without getting other political parties or state governments onboard. These specific reforms might still go through but future negotiations will become even more difficult. Parties to the table will come with ossified positions. That’s a precursor to policy paralysis. We have seen this movie before.

In the crisis situation we find ourselves in, it is all the more important that the union government’s reform agenda should factor in distributional consequences of those losing out. The government needs to build bridges. Politics, after all, is the art of the possible, as Bismarck said.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast]: Acemoglu talks with Russ Roberts on why institutions matter.

* [Article]: Jagdeep Chokkar and Sanjay Kumar make a solid case against simultaneous polls.

* [Podcast]: In the second Puliyabaazi episode on Indian banking history, Amol Agrawal shares fascinating insights on princely state banking, the feud with the State Bank of Pakistan, priority sector lending, and lots more.

* [Article]: Mohammad Taqi in TheWire writes how “Pakistan’s Islamisation started almost a decade before its birth, and long before any army dictator or adventurist general came along.” Even Pakistan didn’t become Pakistan all of a sudden. Something for us to reflect on in India.

If you like the kind of things this newsletter talks about, consider taking up the Takshashila Institution’s Post Graduate Programme in Public Policy (PGP) course. It’s a 48-week in-depth online course meant for working professionals. Applications for the Jan 2021 cohort are now open. For more details, check here.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

If you haven’t been living under a rock, you would have come across this Andy Mukherjee column in Bloomberg over the last weekend. Titled ‘Why I’m Losing Hope In India’, it is a searing and despairing piece on how India is losing its window of opportunity for growth and prosperity. By Mukherjee’s own high standards of writing op-eds, it is a tour de force.

Predictably, the reactions to it have swung between extremes. There are those for whom Mukherjee has voiced, in limpid prose, their anxieties and disappointments with how things are turning out in India. For others, this is another elite, wringing his hands and pandering to his own discredited lot, as a new and different India takes shape. The few belonging to neither camps have praised the piece for raising pertinent issues but have taken exception to the deep pessimism pervading it.

Now, there are occasions when we too receive mails berating us for our pessimism about India. It is a criticism we fail to comprehend. You can contest the interpretation of facts or the logic underlying an argument. That’s understandable. It is difficult to argue on why someone shouldn’t feel a certain way. Also, like we have mentioned it a few times, the reason we write this newsletter is because of our optimism about the people of India. That by putting out our point of view regularly, we will have a public that will demand better policies from its representatives. We like to think Mukherjee feels the same way. There is no reason to question his pessimism so long as his arguments support it.

So, do his arguments merit his pessimism? Or is he projecting his biases and adding to the constant drumbeat of gloom that’s the par for the course among analysts living abroad who cover India?

Anantha Nageswaran in his blog – Why it may be the wrong time to give up hope on India? – has a factual riposte to many points that Mukherjee makes. He goes overboard a bit in defending the indefensible like demonetisation, handling of migrant issues during lockdown (quoting Bibek Debroy on some 1979 statute to absolve the Union government) and some unconvincing GDP comparisons with China by scaling them to non-financial sector debt. But these aside, he makes a good case for remaining hopeful about India. If you keep an open mind about these things, it is an interesting perspective on how many within this government might be looking at our economy in these times.

I have three problems with Mukherjee’s columns where his love for rhetorical flourish or a lack of economic understanding comes in the way of a reasoned argument.

* Mukherjee believes there’s a structural demand deficiency in India and the consumption led boom that sustained our economy has plateaued. For some reasons he believes all the recent reforms in farm or labour sector or the work that he praises this government for in areas like affordable health, formalisation of finances, providing for cooking gas, sanitation, and clean water, will only debottleneck the supply side. Not much will turn on the demand side. I don’t understand why he thinks so. It is true this government’s economic response to the pandemic has been largely supply-side focused. But that’s different from the demand generation potential of many of these ideas. You could argue with the economic merits of PLI (production linked incentives) or the atmanirbhar policies but in the short run it will boost employment and demand. The investment in public infrastructure in pre-covid era like on building national highway network or the work done under PM Grameen Sadak Yojana is good for solving structural demand issues. Like we have argued in the last edition, it is early days, but the speed at which demand has bounced back in many sectors after lockdown was lifted has surprised all of us. This isn’t a sign of structural demand deficiency.

* There have been many other columns of Mukherjee where he points to the problem of India’s stressed financial systems. This is widely understood as a problem. He mentions this here too. But what’s the solution? Is it a stringent bankruptcy code like that was put in place in February 2018? We have argued here that the IBC is a good reform that needs some runway before it can be made more stringent. Trying to be too harsh about insolvency guidelines will likely lead to that familiar policy issue in India – operation successful, patient dead. Besides, the root cause of many of these NPAs are in discretionary power of the state, the difficulty in getting projects off the ground in India and consistency in policy making. None of this is a financial sector reform. A lot of this precedes this government. My limited point here always has been to cheer every minor reform in these areas without being overly critical of it. It takes a lot to get reforms going in India. It is one of the reasons the farm bills need to be supported.

* Mukherjee also, surprisingly, goes for some convenient north-south divide narrative. The south, in his opinion, is better governed, faster growing and has therefore remained immune to the strongman charisma of the PM. The north, on the other hand, appears a bit of a basket case in the column. To quote Mukherjee:

“Sadly, I don’t see northern India’s economic pessimism — or its caste enmities, religious hatred and deep-seated misogyny — making way for a less toxic, more aspirational politics.”

Firstly, these have been features of north Indian politics for ages, aided and abetted by every large political party in these states. It isn’t a BJP created political environment. Secondly, you can argue the north isn’t as progressive on many metrics as the states of the south. But they aren’t regressing. On almost every parameter, social or economic, the northern states have continued to make progress. Of course, much needs to be done. But to ‘blame’ northern states to have been taken in by the PM and his brand of “chest-thumping nationalism and an atavistic yearning for a pre-Islamic past” isn’t exactly the most constructive way of taking this debate further.

These points aside, there’s a lot there in the Mukherjee article for us to reflect upon and debate with those who think all’s well with us. It isn’t whether we should be losing hope in India. The real question is what we can do to keep our hope about India alive. There are no full stops in history. Every phase, however interminable it might seem then, is transient in the long run. Public policy advocacy, like we never tire of repeating, is a marathon. We run on hope. 

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] The Diplomat’s Asia Geopolitics podcast host Ankit Panda (@nktpnd) speaks to Abhijnan Rej, The Diplomat’s security and defense editor, about how a Biden administration in the United States is likely to approach South Asia.

* [Article] Business Standard on India’s lost decade

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

New Book Out! — India’s Marathon: Reshaping the Post-Pandemic World Order

— Pranay Kotasthane

I’ve co-edited India’s Marathon — a collaborative effort that brings together bold ideas on India’s place in the changing world order from some of India’s finest young thinkers.

(India’s Marathon, book cover by Anirudh Kanisetti)

Don’t take my word for it. This is what Ambassador Shivshankar Menon writes in his foreword:

“This volume poses questions which everyone wants answered but few dare to reply: how will the world order evolve and how can India deal with it? The Takshashila Institution has brought together some of the best minds to answer this question, and to give an Indian perspective on world order issues. Just for this the book deserves to be welcomed. This volume consists of coherent contributions from these scholars covering how India should manage its external relationships and the reforms that India needs to undertake domestically.

… No reader would or should agree with everything in this book. I, for one, am not sure that India’s choice is between alignment and non-alignment any more, or that strategic autonomy is an unattainable goal for India. After all, strategic autonomy by one name or another is what all powers, even superpowers, seek. But this book would have served its purpose if it provokes thought and rational discussion about India’s place in the emerging world, whether it is ‘orderly’ or not. Despite the daunting world that seems likely, and the scale and scope of the necessary domestic reforms outlined in this book, I found it reassuring that so many contributors found it possible to rationally conceptualise these issues from an Indian perspective, and to map out a path through the dimly sensed future that awaits us.”

Pranay Kotasthane, Anirudh Kanisetti, Nitin Pai (editors). India's Marathon (Kindle Locations 144-150). The Takshashila Institution. Kindle Edition.

This Twitter thread lists all chapter ideas and contributors. It’s a stellar list, I tell you.

Get your copy from Amazon India. Do give it a read!

Global Policy Watch: Fukuyama (et al) And The ‘Middleware’ Solution To Social Media Monopolies

— RSJ

Twitter India did a first last week. It labelled a tweet by BJP IT cell head as ‘manipulated media’. It claimed the label was based on its Synthetic and Manipulated Media policy. This was a policy launched by it in February this year. The rule for its user states:

“You may not deceptively share synthetic or manipulated media that are likely to cause harm. In addition, we may label Tweets containing synthetic and manipulated media to help people understand their authenticity and to provide context.”

Curbing Digital Colonialism

It is unclear if Twitter found no such tweets in India since February that satisfied the criteria for manipulate media. Surely, this wasn’t the first instance of false information shared by a blue-tick user in India. In any case, a beginning has been made and it will be interesting to see where and how far it will go with this. These steps are part of similar efforts by other social medial platforms to self-regulate themselves as they come under increasing government and regulatory scrutiny. There is a greater urgency among regulators around the world to curb the abuse of the dominant positions of the big tech platforms.

EU pursued antitrust charges against Google for over a decade. In 2018, it fined it nearly $10 billion. But not much has come out of it. Google was left to devise its own measures to offer a level playing field to its rivals. Google continues to dominate the search-engine market in Europe with over 90 per cent market share. The U.S. Justice Department last month sued Google for violating federal antitrust laws in running its search and advertising business. Also, the US Congressional investigation into the power of Big Tech (Amazon, Apple, Facebook and Google) concluded in September this year with a voluminous 450-page report. The report indicts them in no uncertain terms:

"These firms have too much power, and that power must be reined in and subject to appropriate oversight and enforcement. Our economy and democracy are at stake.”

India hasn’t yet taken a concrete view about the dominance of Big Tech but there are rumblings. Last month, India’s antitrust regulator (CCI) opened an investigation against Google based on complaints from the start-up ecosystem. The practices of ‘forcing’ the app makers to exclusively use its billing system for in-app purchases and for bundling its payments app with Android smartphones sold in the country are under the regulatory lens. Last month, India brought all OTT platforms under the purview of its Information and Broadcasting ministry by changing the GoI (Allocation of Business) Roles, 1961. And it has been considering regulating the social media platforms and their content for a while now.

Not The Usual Lens

There are three key points that we have made about regulating Big Tech and social media platforms:

* Antitrust regulators take the old Chicago school view to monopolies. This looks at monopolies through the economic lens of consumers and checks if they are being harmed by the dominance of monopolies. This is difficult to prove in case of Big Tech monopolies who provide most of their services for free and have deep customer loyalty.

* The nature of these monopolies is quite different from those of the past. These players have appropriated huge amounts of data, run 2-sided platforms, have asymmetrical knowledge and power over their users, and can easily move into newer businesses based on these strengths. The traditional measures to curb the monopolies like breaking them up or stopping a line of business are difficult to implement.    

* Economic dominance is only one part of their power. It is the political dominance or the dominance of thought that can be more insidious. Like we wrote in edition #74,

“the data and attention appropriation done through these platforms constrain our choices: we live in echo chamber of our opinions, we buy things that are suggested to us and we see a version of reality that’s tailor-made for us and that no one else is seeing. Often the term ‘digital colonialism’ is bandied about when talking about Big Tech. This lack of freedom to be oneself, discover things on our own and not be dispossessed of our right to choose is what colonialism is about.”

* The current antitrust laws have nothing to manage this.

In short, our view was the minimum acceptable price of Big Tech businesses to exist wasn’t zero.

It was you. Your data and your liberty.

In the normal course of events, politics would be about contestation of ideas and narratives in the political marketplace. And the best or the most acceptable idea would surface from this that would guide the polity. But social media platforms engineer a failure in these markets. The ideas that get pushed to your timelines haven’t won their duels in the marketplace of ideas. They have been programmatically fed to you. That program can be gamed. And Big Tech isn’t willing to solve this problem on its own. It took a long time to even acknowledge it is a problem.

We had concluded edition #74 with these lines:

“These are early days of policymaking in this area. There’s a need for deeper philosophical and sociological work in this space that will enable our thinking in how to legislate this.”

A Novel But Half-formed Approach

As if on cue this week we had Francis Fukuyama, Barak Richman, and Ashish Goel publish an article in Foreign Affairs titled How to Save Democracy From Technology: Ending Big Tech’s Information Monopoly. The article picks up the core point made by us. The antitrust regulations are using old tools to solve the economic problem. They may or may not be enough. But they don’t even begin to address the political costs of the Big Tech monopolies. The solution offered is not exactly fleshed out in the article, but it is important because it goes beyond the conventional thinking that has dominated this space.

They write:

“The economic case for reining in Big Tech is complicated. But there is a much more convincing political case. Internet platforms cause political harms that are far more alarming than any economic damage they create. Their real danger is not that they distort markets; it is that they threaten democracy.”

It is remarkably similar to the points made by us in the past. The article then picks up the usual solution to break monopoly power – more regulations, breakup, data probability and privacy laws – and dismisses them all before proposing a solution:

“If regulation, breakup, data portability, and privacy law all fall short, then what remains to be done about concentrated platform power? One of the most promising solutions has received little attention: middleware. Middleware is generally defined as software that rides on top of an existing platform and can modify the presentation of underlying data. Added to current technology platforms’ services, middleware could allow users to choose how information is curated and filtered for them. Users would select middleware services that would determine the importance and veracity of political content, and the platforms would use those determinations to curate what those users saw. In other words, a competitive layer of new companies with transparent algorithms would step in and take over the editorial gateway functions currently filled by dominant technology platforms whose algorithms are opaque.”

The solution comes with its own set of problems. The authors acknowledge it and posit this as the start of a conversation to find a solution:

“Many details would have to be worked out. The first question is how much curation power to transfer to the new companies. At one extreme, middleware providers could completely transform the information presented by the underlying platform to the user, with the platform serving as little more than a neutral pipe. Under this model, middleware alone would determine the substance and priority of Amazon or Google searches, with those platforms merely offering access to their servers. At the other extreme, the platform could continue to curate and rank the content entirely with its own algorithms, and the middleware would serve only as a supplemental filter. Under this model, for example, a Facebook or Twitter interface would remain largely unchanged. Middleware would just fact-check or label content without assigning importance to content or providing more fine-tuned recommendations.

The best approach probably lies somewhere in between. Handing middleware companies too much power could mean the underlying technology platforms would lose their direct connection to the consumer. With their business models undermined, the technology companies would fight back. On the other hand, handing middleware companies too little control would fail to curb the platforms’ power to curate and disseminate content. But regardless of where exactly the line were drawn, government intervention would be necessary. Congress would likely have to pass a law requiring platforms to use open and uniform application programming interfaces, or APIs, which would allow middleware companies to work seamlessly with different technology platforms. Congress would also have to carefully regulate the middleware providers themselves, so that they met clear minimum standards of reliability, transparency, and consistency.”

As a new approach to deal with the problem of fake news and lies circulating on social media platforms and making it sit well with the notion of free speech, this is a useful starting point. The control of what kind of content we want to see should lie with us. Like it has always been in media, the content consumer has to be active while engaging with it and the provider passive. Not the other way around.

Matsyanyaaya: The Strategic Consequences of India’s Low Economic Growth

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Last week I came across a data story in The Business Standard and I haven’t been able to erase off my mind. Krishna Kant writes:

“Over the past 10 years, India’s per capita GDP is up 35 per cent cumulatively from $1,384 in 2010 to $1,877 now. In the same period, per capita GDP in China rose 141 per cent from $4,500 to $10,839, while it doubled in East Asian countries (excluding Japan, South Korea, Taiwan and Hong Kong) from $4,006 to $8,195.

Bangladesh saw the fastest growth with its per capita up nearly two-and-a-half times from $763 in 2010 to around $1,900 at the end of this year. And, Vietnam’s per capita rose 115 per cent from $1,628 to around $3,500.”

There’s a nice chart showing how the India growth story lost its way over the last full decade.

(Source: Krishna Kant, India's 10-year growth one of the biggest laggards in Asia, EM peers, The Business Standard)

The humanitarian consequences of low economic growth are obvious. I won’t bring them up here. The questions I have are concerned with India’s engagement with the world: what would be the strategic consequences of this poor economic performance? Does a decade of slow growth foreclose some options for India? Would India’s position on RCEP have been different had the last decade’s performance been at par with other peers? Would the PRC have been just as aggressive against a more prosperous India?

The search for answers took me back to Sanjaya Baru’s 2002 landmark paper titled Strategic Consequences of India’s Economic Performance. The paper captures what scholars were thinking nearly twenty years ago, just before the golden growth years between 2004 and 2009.

“For India, there is no doubt that the first and most important challenge is that of accelerating the rate of economic growth and development. Economic performance and capability certainly constitute the foundation of national security and power even more so for a developing nation like India. It will define the limits to military capability and alter the relationship between India and its neighbourhood, especially its two major adversaries, namely, China and Pakistan.

The paper’s observations on Pakistan have broadly stood the test of time. The Pakistani military-jihadi complex’s self-defeating policies have strangled the economy in ways that even a nuclear weapons status and use of terrorism as a state policy haven’t been able to offset. The dehyphenation between India and Pakistan in international affairs is now self-evident. However, the story of this last decade is humbling. The gap between the two has increased not because India has done well but because Pakistan has done far worse.

On China, the paper argued:

“The strategic consequences of the economic competition with China are, there- fore, fundamental to India’s future role within Asia and the global system. If India can sustain above average growth (over 7 per cent per annum in the next decade) and if China experiences a deceleration of growth, coupled with domestic political uncertainty, the widening gap between the two civilisational neighbours can be reversed to an extent. If not, China will emerge as the pre-eminent Asian power and force India into accepting its strategic leadership even within south Asia. The key to this strategic rivalry will be the relative economic performance of the two countries. The main strategic challenge for India in the medium term is, therefore, its relative economic performance vis-à-vis China.”

Remarkably prescient. Eighteen years on, the gap between the two countries has only widened. China has been able to forge strong economic ties with all countries in the Indian subcontinent.

Economic Reforms Needed

The paper identified these macroeconomic targets essential from a national security perspective:

* Elimination of the revenue deficit, a manageable fiscal deficit, elimination of wasteful subsidies not targeted to the poor;

* Low and manageable current account deficit;

* Low internal and external debt, low short-term debt in overall external debt;

* Profit-generation by public enterprises; privatisation of non-strategic public enterprises;

* Self-financing public utilities like power, irrigation water and public transport;

* An increase in the tax/GDP ratio to levels reached by rapidly industrialising developing countries of around 15 per cent of GDP from the current low of 9 per cent of GDP.

What struck me was that eighteen years since, many of these targets still remain aspirations.

Lessons for the Future

It is clear now that China’s rapid and sustained economic development over three decades played a fundamental role in transforming its international stature. The bad news for India is that not only did it start on the same path ten years later than China but it also seems to have fizzled out much earlier.

Going ahead as well, India’s economic development will underscore its international role. India’s economic trajectory will decide whether it can play the role of a swing power between the US and China or whether it gets relegated to a weak partner of the US, much like Pakistan is to China. The stakes have never been higher.

We put this rather simply in a flowchart to conceptualise India’s future options like this:

(Source: India in the Post COVID-19 World Order, Takshashila Discussion SlideDoc)

Money Quote: Why Care About Budget Deficits?

— Pranay Kotasthane

Dr M Govinda Rao pointed me to this quote by Martin Feldstein from his LK Jha Memorial Lecture at RBI. Feldstein warned about the adverse consequences of large budget deficits thus:

“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.”

Enough said.

HomeWork

Reading and listening recommendations on public policy matters

* [Interview] Promarket interviews Fukuyama. “A Loaded Weapon”: Francis Fukuyama on the Political Power of Digital Platforms

* [eBook] Friedman 50 Years Later series. A collection of 28 essays reflecting on Friedman’s essay on shareholder maximisation

* [Reports] US Thinktanks CNAS and CFR make the case for two different multilateral arrangements between powerful democracies to take on China in the technological domain

* [Article] Amit Cowshish and Rahul Bedi have a definitive take on India’s defence pensions system.

If you like the kind of things this newsletter talks about, consider taking up the Takshashila Institution’s Post Graduate Programme in Public Policy (PGP) course. It’s a 48-week in-depth online course meant for working professionals. Applications for the Jan 2021 cohort are now open. For more details, check here.

Note: Sorry for the delay in the mid-week edition. Life intervened

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

Readers are sending in all sorts of questions. So, our parampujya guru of economic and political reasoning, Prof. Arthananda Ilyich Smith-Hayek (AISH), is back. Prof AISH is a home-grown economist without a single videshi bone or cartilage in him. He is a veritable sangam of three key economic streams – Neoclassical, Marxist and Austrian – whose advice can be safely consumed in these low trust times.

Over to the burning question.

Dear Prof,

The CEO of Niti Aayog yesterday complained we have too much democracy in India. He later claimed he was misquoted. That, of course, dispelled any remaining doubt among us that he had indeed made that statement. All hell broke loose. Memes appeared, Immanuel Kant was quoted, and Twitter had a field day with the usual leftist malcontents suggesting fascism is nigh. I don’t understand this. All my life living in India I have felt we have too much democracy. Nothing moves in India because everyone has a say. You can’t get anything worthwhile done because no one is willing to pay any price. We elect goons and criminals because every fool has a vote. Anything that’s good for the majority can be hijacked by a minority that’s vocal and organised. We have all seen this. How can we outrage over the ‘too much democracy’ comment when we know it is true? What do you have to say? I hope you are wise enough to know what’s good for us.

Yours etc,

Prajatantra Mallik

Prof AISH:

Dear Prajatantra,

Thank you for writing in. There’s always a complaint of too much democracy when you are thwarted by the people. Never when you win elections by the slenderest of margins but earn the right to govern with full powers of the executive. That’s how things roll.

Anyway, there are three parts to my answer. The first part will clarify a few things about democracy and the state. The second part will be on the critique of democracy over the years. And at the end, I will talk about how despite everything blaming too much of democracy in the Indian context is meaningless.

Democracy, Republic, and The State

To start with democracy is a form of government - nothing more. There is an element of religious passion towards it by its adherents. This is particularly true in America and, possibly, stems from Walt Whitman, the poet of Democracy. Whitman elevated democracy to a mystical phenomenon. His poem For You O Democracy (from Leaves of Grass, 1892) is a hymn to it:

“I will plant companionship thick as trees along all the rivers of America, and along the shores of the great lakes, and all over the prairies,

I will make inseparable cities with their arms about each other’s necks,

                   By the love of comrades,

                    By the manly love of comrades.

For you these from me, O Democracy, to serve you ma femme!

For you, for you I am trilling these songs.”

It is difficult to top that. Democracy is an end to itself and it must be valued with passion. Whitman’s spirit pervades the US polity till date. The American exceptionalism over the last century has made democracy more than a mere form of government. It has come to be seen as an ideal for society. India too adopted not just a form of government following independence, but this belief about the virtues of democracy beyond it. This is one part of the problem.

But let’s start with its definition itself. Democracy may not even be an ideal form to choose who will govern the state. But like Churchill (never) said it is the worst form of government except for all the others. Broadly, it means everyone has a share of the government and the majority view prevails. This is understood to recognise every citizen has an equal opportunity in creating the legislature that will govern them. The state that has the monopoly of legitimate violence over its citizens has multiple arms to conduct its affairs. Not every arm of it is democratic in nature like the legislature. We don’t elect our judges or our bureaucrats through popular mandate. In most cases, the process is designed to find the most qualified or the most appropriate person for the role instead of the most popular. Through an elaborate mechanism of checks and balances, these non-democratic institutions are subject to the will of the people. There are hardly any pure democratic institutions in any democracy.  

Even the will of the people to determine the legislature isn’t democracy in its purest form. Most modern democracies are representative in their form. This is a recognition that the rule can never be directly of all people but of ‘typical members’ who represent them. It tacitly acknowledges those who represent the people are better suited than others to ‘rule’. In that sense, every democracy still retains an element of aristocracy or the rule of the elite. It is important to remember here, this representative form of government while being partly elitist still can’t be replicated in other spheres of the society. No firm or enterprise can run on democratic principles. Nor can any team, guild or community.

We shouldn’t seek more democracy in society; probably striving for more inclusiveness and openness makes more sense. Instead, we should be striving for a better republic that strengthens the process of choosing the best representatives among the people who then wield the power of the state and use it to enhance the welfare of individuals.

Criticising Democracy

There hasn’t been any shortage of criticism of democracy over the ages. And we aren’t including tyrants, despots, and dictators in this list. This is led by Plato and Aristotle who it could be argued lived in a society that was democratic (slavery notwithstanding). They viewed democracy as good in theory but difficult to put in practice. Aristotle clubbed democracy as a deviant constitutional form clubbing it with tyranny and oligarchy. To him, the ultimate end of a state was neither to maximize wealth as oligarchs would believe, nor was it to promote liberty and equality in every public sphere as the democrats aspire. Instead, he argued, it was ‘good life’ that’s the true end of the state. That requires a ‘middle constitution’ or a ‘mixed government’ of a numerous middle class that chooses a wise few to govern. If one were to be kind to Aristotle, the mixed constitution he bats for is the precursor to the modern Republic.

Following the French and American revolutions in the late 18th century, the ideas of liberty and democracy were debated widely. Political philosophers from Ruskin, Carlyle to Tocqueville were troubled by the exaggerated deference to the will of the majority. In their view, there was a qualitative difference among people and the idea to treat all of them equal in their right to rule the state was terrible. The majority will be swayed by demagogues who will pander to their worst instincts and the minority that’s qualitatively better will lose the will to fight. James Bryce in ‘Hindrances To Good Citizenship’ laid out the arguments of this school in detail. In a chapter titled, The True Faults of Democracy, he pointed out four flaws:  

“First, a certain commonness of mind and tone, a want of dignity and elevation in and about the conduct of public affairs, an insensibility to the nobler aspects and finer responsibilities of national life.

Secondly, a certain apathy among the luxurious classes and fastidious minds, who find themselves of no more specific account than the ordinary voter, and are disgusted by the superficial vulgarities of public life.

Thirdly, a want of knowledge, tact, and judgment in the details of legislation, as well as in administration, with an inadequate recognition of the difficulty of these kinds of work, and of the worth of special experience and skill in dealing with them. Because it is incompetent, the multitude will not feel its incompetence, and will not seek or defer to the counsels of those who possess the requisite capacity.

Fourthly; laxity in the management of public business. The persons entrusted with such business being only average men, thinking themselves and thought of by others as average men, and not rising to a due sense of their responsibilities, may succumb to the temptations which the control of legislation and the public funds present, in cases where persons of a more enlarged view and with more of a social reputation to support would remain incorruptible. To repress such derelictions of duty is every citizen's duty, but for that reason it is in large communities apt to be neglected. Thus the very causes which implant the mischief favour its growth.”

Fairly prescient there. The criticism of democracy remained muted through much of the great wars of 20th century and the cold war. However, the last 20 years have seen a revival of sorts. The question has been on new democracies that have sprung up without a fierce adherence to the notion of individual liberties. The earliest work on this was by Fareed Zakaria who in a piece titled The Rise of Illiberal Democracy (Foreign Affairs, Nov 1997) wrote about the perils of democracy without the concomitant pursuit of liberalism. In an interview in 2017, Zakaria updates his warning about democracy:

“The happy narrative we told ourselves was that there was an almost ineluctable path to liberal democracy, and the evidence suggests that this is not how it works. Liberal democracy seems to be one of the many exits on which the democratic experiment could end, but there are others, like illiberal democracy, that are equally likely.

It appears this is what's happening in Turkey right now and in parts of Central Europe and in Russia. It's important to remember that despite all the repression, Putin is very popular. What we're learning is that authoritarian politicians have figured out how to achieve a balance between liberalism and illiberalism that keeps people satisfied. If they can give enough bread and circus to the public, they can maintain a stable working majority buttressed by a certain degree of repression of the press and political opposition.

And we have to reckon with the possibility that this model might become the most stable alternative to liberal democracy.”  

The Indian Case

All of the above is not to suggest there’s a reason to applaud the lament of ‘too much democracy’ that springs among elite Indians. The reasons that have stymied India don’t have much to do with the perceived flaws of democracy. Like we have pointed out earlier, it has more to do with an overextended state that’s weak. Instead of being good in a few things, the state has chosen to be bad in a lot of things. The Niti Aayog and its earlier avatar, the Planning Commission, are great examples of this overreach. The check against ‘too much democracy’ is to become a better republic and to fix the ‘flailing state’.  

HomeWork

Reading and listening recommendations on public policy matters

* [Book] Bryce on American Democracy Selections from "The American Commonwealth" And "The Hindrances to Good Citizenship" and edited by Maurice Fulton.

* [Article] Caleb Crain in the New Yorker book review on The Case Against Democracy

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

PolicyWTF: What Broke the Constitution’s Seventh Schedule?

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

— Pranay Kotasthane

The Seventh Schedule of the Consitution has three lists scoping out the responsibilities of the parliament and the state legislatures. List I contains the subject-matters over which the parliament has exclusive power to make laws (defence, foreign affairs, banking etc.). List II does the same for state legislatures (health, public order, water, land, agriculture). List III contains subject-matters on which both the parliament and state legislatures can legislate (education, forests etc.).

Looks neat. Except that this assignment of powers hasn’t stopped union governments from designing and funding hundreds of schemes that squarely fall under List II — National Health Mission, Swachch Bharat Mission, Pradhan Mantri Awas Yojana, to name a few. You would imagine that these schemes, known as Centrally Sponsored Schemes (CSS), would be opposed tooth and nail by state governments, right?

Wrong. We’ve reached a low-level equilibrium where the state governments have grudgingly reconciled to the reality of CSS. They oppose it on paper or complain to Finance Commissions but are also happy to receive funds as part of these union government-sponsored schemes. And so, successive union governments have continued to misuse Article 282 of the Constitution — which permits union and states to make grants for any ‘public purpose’ regardless of where that purpose lies in the seventh schedule — to interfere with state subject-matters.

With no clear effective assignment of responsibilities, it is not surprising that people expect prime ministers to provide them with water supplies, public order, and clean streets, none of which are union government subjects. Without a clear assignment, there is no way to fix accountability. Without accountability, citizen preferences don’t matter. The State does what it can and citizens endure because they must.

In short, the Seventh Schedule is broken. As NK Singh, Chairman of the 15th Finance Commission argues: there’s a need to change the Seventh Schedule and Article 282, both. Absent that, we will keep CSS proliferating depending on how populist a union government wants to be. At present, there are approximately 211 schemes and sub-schemes under the 29 umbrella CSS!

For more, read:

* Ten Little Schemes, my article for Pragati

* Chapter 5, Review of Inter-Governmental Transfers and Consolidated Public Finance, Report of the Fourteenth Finance Commission, Volume 1.

* Rationalising Central Schemes, The Financial Express, M Govinda Rao

India Policy Watch #1: Missing Artists in Our Polity

Insights on burning policy issues in India

— RSJ

The farmers’ protests are now into their third week. The Union government seems to be in the mood for talks with farmer leaders now; after trying out the other alternatives, namely, barricading road, lathi-charging and using water cannons in cold Delhi winter. We aren’t sure about the kind of compromise that will be worked out. The track record of the government in arriving at a common ground isn’t great.

That we have fluffed our lines on reforms in a sector that needs them direly is quite incredible. It is starker when you consider the numerous expert committees in the past that have recommended exactly what the new agriculture laws aim to achieve. These recommendations have had broad-based support from most political parties and even made their way into their election manifestos. With such support and history, you’d expect we would have got these much-needed reforms off the ground. Yet we are struggling with it. It’s an object lesson in public policy implementation.

A Reform Whose Time Has Come

We have made our arguments in support of farm reforms before. No one can claim with conviction our agriculture policies have been a success since independence. The entire agriculture value chain – from pricing, storage, distribution and purchase – has been in a regulatory chokehold that was designed during the early 60s. Faced with successive failures of monsoon and with the memory of famines (Bengal, particularly) still fresh, we had to seek US support to import food grains under the PL 480 scheme. The scars of that event led to the Green Revolution that saw a dramatic increase in agriculture productivity.

Agriculture in India is a state subject. So, alongside the miracle of the Green Revolution, a majority of Indian states decided to enforce the Agricultural Produce and Market Regulation (APMR) to ensure food security. Soon, the purchase and the auction of food grains was restricted to the markets that were run by the state. The Agricultural Produce Market Committee (APMCs) and their mandis became the only legal buyer of the farmers’ produce. This was in keeping with the spirit of the times. The Indian state was in a massive expansion drive. It swallowed the whole of agriculture.

What has the past half-a-century of this state control given us? It is important to summarise the points again to appreciate how the status quo cannot be the answer.

* We achieved food surplus by the early 80s, but we didn’t stop the Food Corporation of India (FCI) continue the practice of buying wheat and rice at Minimum Support Price (MSP). The MSPs have continued an upward trajectory ever since. Where are we today with this policy? The FCI godowns today are bursting at seams with about 100 million tonnes (MTs) of food grains as against the buffer requirement of about 40 MTs. The burden of supporting FCI procurement is a huge drain on the exchequer. The 2020 budget had set aside Rs 1.36 lakh crores as FCI borrowings to support the MSP regime. The unintended consequences of this borrowing on our fiscal health are a separate story. This is the price we pay to sustain MSP.

* The farmers of Punjab and Haryana who constitute the bulk of protesters have a reason to feel aggrieved with the dismantling of the current system. Take rice for example. Only about 12 per cent of farmers benefit from MSP in India. That same number is north of 90 per cent in Punjab and in a similar range in Haryana. MSP support to rice has created a scenario where a primarily wheat eating region like Punjab is the biggest producer of rice in the country. This coupled with free electricity to farmers has meant a significant reduction in groundwater levels in these states. The narrow focus on these two food grains has meant we run a deficit in other crops including dals, oilseeds and other cash crops. We import these while continuing to produce surplus rice and wheat every year. The local variety of grains that are hardy and require less water (jowar, bajra and ragi) have all but disappeared from our plates over the years. Separately, the desire to raise two crops every year leads to farmers in Punjab burn their stubble. This adds to Delhi’s gas-chamber like pollution. Lesson: incentives matter and negative externalities are real.

* The Essential Commodities Act (ECA) that runs in parallel with the APMC makes things worse. The Union government periodically imposes stock holding limits for various grains and takes away the market flexibility to manage supply-demand swings. This has meant there are no organised sector entities in the agriculture supply chain to manage the storage. No wonder tur dal or onion prices skyrocket at various times in the year. Our retail inflation sways to these price movements.

* The upshot of it all? Agriculture with about 16 per cent contribution to our GDP supports about 60 per cent of our population. Less than 1 per cent of farmers own 10 hectares of land that can be considered optimal to pursue agriculture as an enterprise. The rest are in subsistence farming. Like we have asked before, how can anyone argue to continue with this system?

How Not To Reform

Despite this, we seem to be in a situation where we have to negotiate and may be dilute the three bills that sought to reform the farm sector. The bills allowed the sale of farm produce to players outside APMC, relaxed stocking restrictions under the ECA and enabled contract farming. The problem was correctly diagnosed, and the right solution offered. So, what could go wrong?

* Agriculture is a state subject. Any big reform needs consultations with state governments, farmers, and the opposition. Since a broad consensus on these reforms had emerged from the reports of various expert panels over the years, this could have been a process less fraught than what has been seen in the case of GST or other reforms that needed a federal consensus. Yet there were no deliberations. The manner of passing the bill especially in Rajya Sabha where a debate was avoided, and a voice vote was used to pass them through betrayed a lack of faith in parliamentary procedures.

* There is a strong desire for a big reveal that underlines the way the PM operates. This is how all key measures – from demonetisation, amending Article 370, CAA and labour reforms – have been announced and then pushed through. The desire to stun the nation with a bold move is seen to be the key to make a decision. This doesn’t help in managing change that big reforms entail. There is wider anxiety among the impacted stakeholders if things aren’t discussed and deliberated. This is further stoked by the minority that wants to stonewall these reforms. The opposition also latched on to this opportunistically. That’s how this has played out. Then the usual bogey of big corporates (Ambani and Adani) was raised. There’s always a currency for this in India.

* The desire and speed for a bold move have invariably meant poor anticipation of unintended consequences of these reforms. Clauses that can only be called illiberal have seen their way through these laws including those where the executive is given powers to adjudicate with no remedial mechanism to appeal against the decision in civil courts. This won’t stand in any court of law.

* Lastly, when confronted with the first signs of protests, the entire playbook of how not to manage protests was put into action. First, the police force was deployed to break the protests. Then the protesters were dismissed as rich farmers or middlemen protecting their turf. Finally, they were branded terrorists and anti-nationals before some mediation was attempted.

Missing Artists?

The unfortunate outcome of this might be the wrong lessons we will learn for future – that reforms are difficult to implement. Further, as Pratap Bhanu Mehta writes in the Indian Express there is a greater loss to the polity that’s likely:

“Chances are that, for the moment, given its overwhelming power, the government will ride out the protests. But the simmering discontent will remain. Cooperative federalism is in tatters, and the weakness of political parties means protests now take an amorphous form. Given the far-reaching changes we need in agriculture in Punjab, it is important that the trust between the state and the farmer remains. A good faith dialogue that gives the farmers reasonable assurances and a face-saver is necessary. It is easy for the government to win. But how many times in Indian politics have we won short-term victories that create long-term political precariousness?”

Over the years we have gotten used to the many reasons why we haven’t seen structural reforms gather pace in India. These have ranged from coalition compulsions, lack of majority in both houses, absence of political will, obstructionist opposition or ‘too much democracy’. As the farm reforms saga shows, these are mere ruses.

Politics is the art of possible. And we are missing those artists.

India Policy Watch #2: Lessons for Politics in Radically Networked Societies

Insights on burning policy issues in India

— Pranay Kotasthane

Beyond the specifics of India’s agriculture, some broader lessons come out of the ongoing logjam for politics and policymaking. Some quick intuitions here:

* Vocal Local is also the Global. The Canadian PM’s comments are an indication of a broader trend. No political issue is purely “internal” to a State anymore, at least as far as narrative-building is concerned. With networked communities, this trend will become stronger as outrage is the new form of entertainment. A corollary is that stakeholders with more narrative power but little interest in the issue can end up setting the narrative. Just like the ISI using this issue to fan Khalistani separatism again.

* Popular governments will try to bypass parliaments in crises citing the need for fast-tracking reforms in the backdrop of COVID-19.

* More of the same. No statement or action by the government and the opposition suggests a realisation that they aren’t willing to come together to tide over India’s first recession after 40 years. Unfortunate.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Sandip Das on “A fiscal crisis: Why FCI needs provisioning in food subsidy”

* [Podcast] On Puliyabaazi, Saurabh and Pranay speak to Gunwant Patil of the Shetkari Sangathana Farmers’ Movement on the three farm laws.

If you like the kind of things this newsletter talks about, consider taking up the Takshashila Institution’s Post Graduate Programme in Public Policy (PGP) course. It’s a 48-week in-depth online course meant for working professionals. Applications for the Jan 2021 cohort are now open. For more details, check here.

Note: Anticipating The Unintended will be on its annual break over the next two weeks. Normal service will resume from Jan 3, 2021

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

The focus of this newsletter is to make public policy accessible to the public. That’s a claim we often make around here. There are thinktanks and public policy specialists to advise those who are in power. We are at the other end of the pipe. Trying to influence the demand side of the market of democracy. The hope is that an aware and an enlightened public will demand better from their representatives. Once the pattern of demand changes, supply will adjust itself.

The reassuring bit about working at this end of the democratic pipe is the freedom to engage with and critique policies on their merits without tiptoeing our way around giant political or bureaucratic egos. Also, simplifying the language used in policy discourse is fun and enriching. Of course, the difficult part is getting people to listen to you. Not because it is difficult to reach them. Instead as we often realise, the public isn’t interested to know more. They interpret the world around them with limited information available to them and construct an imagined world in their heads. This constructed imagination is the lens through which they view all information they receive. This is what spurs them into political or social actions.

There’s no good answer on who should a public policy newsletter try and influence? The powers that be or the general public?

I realised last week while reading about the Lippman-Dewey debates, this is a century-old question. In the 1920s, the two were engaged in a fascinating duel of ideas and philosophy. While both believed in democracy, one saw it half-empty, the other half-full.  

Lippman’s Scepticism About The Ordinary Citizen

Democracy is founded on the belief that public opinion matters. But as the society becomes more advanced, knowledge more specialised and a wider range of issues impact lives, citizens find it difficult to inform themselves about all the issues impacting their lives. The ordinary public can’t be ‘omnicompetent’. This is the problem of knowledge that Lippman probed in his two seminal books – Public Opinion (1922) and The Phantom Public (1925). As Lippman wrote:

"The real environment is altogether too big, too complex, and too fleeting for direct acquaintance.”

The ordinary citizen “lives in a world he cannot see, does not understand and is unable to direct.” This leads to an inevitable discrepancy between “the world outside and the picture in our heads.” This “pseudo environment” in our heads is what we use to form political and public opinions. This is what political parties and media work on to create narratives. For Lippman this was the flaw with the democratic ideal of public participation in decision making. They are coming at it with the “most inadequate picture”.

Lippman though is empathetic to the ordinary citizen’s plight:

“My sympathies are with [the citizen], for I believe that he has been saddled with an impossible task and that he is asked to practice an unattainable ideal. I find it so myself for, although public business is my main interest and I give most of my time to watching it, I cannot find time to do what is expected of me in the theory of democracy.”

Democracy needs competent citizens. If the majority of voters aren’t able to make sense of the real world around them to make clear-headed judgments, what’s the point of it all?

Lippman’s response to this problem was in the role of experts. Representative politics “cannot be worked successfully…..unless there is an independent, expert organization for making the unseen facts intelligible”. An enlightened oligarchy of experts is the answer. In Lippman’s prescription, the expert is a disinterested participant with deep mastery of an area who advises those in power within the government or administration. As Lippman writes:

“The power of the expert depends upon separating himself from those who make the decisions, upon not caring, in his expert self, what decision is made.”

For Lippman this separation of responsibilities is critical for the functioning of the democracy. The role of the ordinary public is restricted in mobilising themselves to elect their representatives on the basis of their performance (real or promised) which in turn depends on how they have used the experts to frame laws and policies. Lippman has no illusions about the capabilities of a popular government that sways to the mood of the public. They need guidance from experts. The citizens neither possess the knowledge or the competence on the wide range of issues that concern their world nor can this be taught to them. Education is a bit overrated and only the optimists see it as a solution. The media and the political parties will continue to construct reality for the citizens that will drive their decision making. The best hope for democracy therefore is to have detached experts who have the ears of those at the helm.  

 Dewey’s Democratic Faith

The riposte to Lippman came from political philosopher and a champion of public voice in democracy, John Dewey. While Dewey agreed with Lippman’s thesis about an omnicompetent citizen being an illusion, he questioned the need for such special capability. Instead, he argued there are ways in which citizens can acquire sufficient knowledge to participate effectively in a democracy. This to him was a better option than the tyranny of the experts that Lippman favoured.

Dewey viewed knowledge as a kind of social capital that each individual possesses stemming from their participation in the society and from the long history of people gathering knowledge before them. To believe an individual has to know everything about the world around them is to ignore the accumulated knowledge that’s available and which people draw upon in their everyday lives. To him, as he wrote in The Public And Its Problems (1927), this knowledge is built-up through “association and communication; it depends upon tradition, upon tools and methods socially transmitted, developed and sanctioned.”

Dewey gives the example of scientific progress made by humankind as an example of this kind of knowledge. As he wrote:

“The development of tools into machines, the characteristic of the industrial age, was made possible only by taking advantage of science socially accumulated and transmitted.”

And he was convinced this accumulation of knowledge was possible for the political sphere too.

“Just as the specialized mind and knowledge of the past is embodied in implements, utensils, devices and technologies which those of a grade of intelligence which could not produce them can now intelligently use, so it will be when currents of public knowledge blow through social affairs.”

The build up of this social knowledge happens over the years through experts who study this area. So, there is still a role of experts in Dewey’s thesis. However, unlike Lippman, Dewey sees their role is to focus on informing the public, not the experts. The experts must continue to study the complex world around us and the forces that shape them. They must then interpret this for the average citizen who can then act with foresight within their social and political environment. Dewey wrote:

“…inquiry, indeed, is a work which devolves upon experts. But their expertness is not shown in framing and executing policies, but in discovering and making known the facts upon which the former depend.”

For Dewey, the experts must be guided by public spirit and owe their allegiance to the public. They must share their knowledge directly with the public and not restrict it to those in positions of power. The citizen doesn’t need to be omnicompetent; they must know enough through the stock of social knowledge and the guidance of experts to contribute meaningfully to public life.

We are no experts here. But as a public policy newsletter, we side with Dewey in these debates.  

HomeWork

Reading and listening recommendations on public policy matters

* [Article] A primer on Lippman-Dewey debates: Notes from Carl R. Bybee, 1997, Media, Public Opinion and Governance: Burning Down the Barn to Roast the Pig, Module 10, Unit 56 of the MA in Mass Communications, University of Leicester

* [Article] Sean Illing writing in the Vox: Walter Lippmann’s famous critique of democracy revisited.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: 50 Years Of That Friedman NYT Article

Insights on burning policy issues in India

— RSJ

On September 13, 1970, Milton Friedman wrote his famous piece on the social responsibility of business in The New York Times. The clarity of Friedman’s thinking and his powerful articulation of the doctrine of shareholder value maximisation has made it, arguably, the most influential business article of all time.

Friedman scoffs at businesses talking of ‘social responsibility’ suggesting any attempt to do so will turn political that will force the individual to conform to the more general social interest. Who determines this social interest? In the hands of a dictator or a demagogue, this decision can be detrimental to society.

It is a compelling article. I would suggest you read it before you dismiss it as free-market fundamentalism. Friedman concludes:

“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.”   

Enduring Appeal

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 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 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 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. 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.

Rajan’s Reassessment

Promarket, a publication of the Stigler Centre at Chicago Booth School of Business, is marking the 50-year anniversary of the Friedman article with a debate on the social responsibility of business on its pages. Eminent academists like Oliver Hart, Luigi Zingales and Lucian Bebchuk have written with depth and intellect on the relevance of the Friedman doctrine in today’s times. This week Raghuram Rajan weighed in on the debate with an article titled “50 Years Later, It’s Time to Reassess”. Rajan takes a clear-eyed view on what has worked for the Friedman doctrine and where it is fraying. He repeats the usual points that we have listed above in favour of the doctrine. Additionally, he emphasises the political argument of Friedman for shareholder value maximisation that seems relevant in the current times when we are debating the enormous clout of big tech in our lives.

Rajan writes:

“Finally, Milton Friedman thought that there was a political argument for shareholder value maximization, which keeps the role of the government and the role of the corporation separate. He thought that was important because he felt that corporate social responsibility was a backdoor way for special interests to push what they could not get through Parliament and therefore make rules for the firm which they could not make through legislation. In some sense, this is a very important argument because it says that sometimes, these pressures can be anti-democratic rather than pro-democratic—that because you’re frustrated in Congress or in Parliament, you might try to push that stuff through the backdoor by directly targeting corporations.”    

But Rajan believes this separation of business from politics that Friedman advocated has turned into its primary problem:

“And that leads to what I think is the deepest problem with Milton Friedman: shareholder value maximization means completely turning a tin ear to politics. It sounds sinister. It sounds pro-rich. It sounds evil, even if it may be the right thing to do for society under many circumstances.”

I’m not quite sure why something that sounds evil while it might be the “right thing to do for society” needs to change. There are many economic concepts that sound evil or counter-intuitive – efficient market mechanism, free trade, comparative advantage or Ricardian equivalence. They shouldn’t be discarded or changed because of it. Instead, they need to be explained better.

But Rajan goes ahead proposing an alternative:

“The alternative, in my view, is to maximize the value of long-term investors in the firm. This is different from the Business Roundtable statement, in that you can identify who these long-term stakeholders are. If you are a firm with a lot of impulse customers, they’re not your long-term investors—they come in and buy as they wish. If, however, you have long-term employees, they are long-term investors because their sweat equity is embedded in the firm. Similarly, shareholders, long-term debt holders, long-term suppliers, these are long-term stakeholders. A firm could say, when forced to choose between two stakeholders: I will choose the action that enhances the overall value of these stakeholders.”

There is a problem with this formulation – how will you know from the start who will be a long-term investor? For Rajan, the ‘impulse customers’ aren’t long-term investors. But won’t the impulse customer of today be a firm’s long-term customer over time? A similar argument can be made for long-term shareholders or long-term suppliers. They all will have to start somewhere in developing a relationship with a firm. Also, how do you define the length of time that will qualify a relationship as long-term? Not surprisingly, this alternative to shareholder value suggested by Rajan meets the same fate as others. It sounds good on paper but fails to be specific.

Rajan comes around to it by the end of his piece:

“Corporate boards should take pride in the investors they stand for. Being nice to everyone is, however, infeasible, meaningless, and simply deflection. That is what I take away from Milton Friedman.”

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. But a monopoly will have to do more. As he wrote:

“The participant in a competitive market has no appreciable power to alter the exchange, he is hardly visible as a separate entity, hence it is hard to argue he has any ‘social responsibility.”

“The monopolist is visible and has power. It is easy to argue that he should discharge his power not solely to further his own interest but to further socially desirable ends.”

So, a firm operating in a competitive market is free to pursue shareholder value maximisation. The shareholders can define the value differently in today’s world that goes beyond monetary rewards. This could include the environment, sustainable growth, or social equity. But for Friedman, this can’t be imposed by others on the shareholders. The decision has to be that of the shareholders alone.

A Framework a Week: What Made the US Enable China’s Rise?

Tools for thinking public policy

— Pranay Kotasthane

This question that has been bugging me over the last few months: what explains that the US — now single-mindedly focused on countering on PRC’s rise — aided and abetted the PRC’s rise in the first place? Despite its enormous intellectual horsepower, why wasn't the US able to anticipate and mount a response to the PRC challenge long before?

As it turns out, an incumbent great power enabling the rise of its own future rival is not an anomaly. In fact, that’s the default case. At least that’s the core argument of an excellent book Over the Horizon: Time, Uncertainty, and the Rise of Great Powers by David Edelstein (You can read a top-notch book review by my colleague Aditya Ramanathan here). The book presents a framework that manages to explain the US-China relationship quite well.

The core argument in Edelstein’s words is that:

… uncertainty about the future reinforces the pressures on state leaders to focus on the short term. Leaders of existing great powers are disinclined to expend considerable resources on an uncertain long-term threat. When existing powers focus on the short term, mutually beneficial cooperation with rising powers becomes more likely. Conversely, the more state leaders become alerted to the potentially threatening long-term intentions of a rising power, the less likely cooperation in the short term with a rising great power becomes.

This is a counter-intuitive proposition. Offensive realism theory argues that all that matters is relative power. Regardless of a rising power’s intentions, its rise is reason enough for an incumbent power to confront the contender as soon as possible. And yet, the empirical approach of declining powers has been quite the opposite. European powers cooperated with Bismarckian Germany, Britain capitulated to the American rise, European states, again, co-operated with Germany in the inter-war period, and finally, the US supported China’s entry to WTO and turned a blind eye to PRC’s aggressive actions and increasing capabilities for nearly fifteen years before executing a u-turn.

The author argues that this divergence from theory can be explained by taking into account two more variables. Not just relative power, but perceived intentions, and time horizons of states together explain if a declining power will confront, co-operate, or compete with a rising power. The framework that brings together all this is shown below.

When a rising power has a long-term focus and a declining power has a short-term focus, the two end up co-operating rather than contesting. This configuration occurs, for instance, when rising powers adopt a “hide our capacities and bide our time” approach. They focus on building long-term capabilities instead of attracting undue attention of the incumbent powers towards them. This is what PRC under Deng Xiaoping and Germany under Bismarck did. If successful, this strategy makes declining powers discount long-term threats and instead focus on short-term gains through co-operation. This is precisely what happened between the US and PRC after the Sino-Soviet split. PRC resisted overt provocation throughout the 80s and 90s, while the US companies and consumers benefited from PRC’s manufacturing prowess.

By 2010, PRC’s time horizons changed. Its aggression towards its neighbours signalled that it was now focused on consolidating its position in the short-term. Meanwhile, the US was still focused on the short-term horizon. The aftereffects of 9/11 still loomed large, and the US strategic thinking was preoccupied with other issues — Iraq, Afghanistan, Russia, and Iran. The result was a mixture of skirmishes and pragmatic cooperation between the US and PRC.

By 2016, PRC’s continuing arrogance against its neighbours, the BRI ambition, attempts at influencing politics in countries such as Australia, and rapid buildup of technological power meant that the US was forced to extend its time horizon and look at PRC as a structural adversary. The result is that we are heading towards a preventive “war” — a scenario where the US is confronting PRC directly and provocatively not by force (yet) but in trade and technology domains.

This framework also explains that a preventive “war” scenario is not inevitable. If there is a rethink in PRC’s approach, a shift to either of the remaining three quadrants is possible. With Xi Jinping at the helm, it looks unlikely though. Despite the perception that PRC thinks long-term, Xi is operating with an extremely short-term time horizon and inviting pushbacks from a host of countries as a result.

India Policy Watch #2: No Looking Back On Agriculture Reforms

Insights on burning policy issues in India

—RSJ

The Lok Sabha passed three bills relating to agriculture this week. These bills replace the existing ordinances that came into effect in June. These bills are part of the agriculture reforms package that was unveiled by the FM in May this year. The bills will now be tabled in the Rajya Sabha on Sunday. These reforms were long due.

Despite the obvious failures of the state in the farming sector, successive governments balked at reforms. The entrenched ‘aristocracy’ of rich farmers, commission agents and farmer leaders thwarted all attempts. This time is different. For once the numerical advantage of this government and the political capital of the PM are being put to use for structural reforms that will serve us well in the long-term. The small and marginal farmers have suffered under the benevolent tyranny of the state. These reforms will liberate the sector.

Yet, there is a minor political storm brewing. Shiromani Akali Dal (SAD), a long-time ally of BJP in the state of Punjab, has opposed the legislations. On Thursday, its lone representative in the Union Cabinet, Harsimrat Kaur Badal, resigned. The SAD leader, Sukhbir Singh Badal, spoke against the bill in Lok Sabha:

“These bills have many provisions that go against farmers’ interests. We have repeatedly asked the government that please address the apprehensions of farmers, but the government had done nothing. Therefore, I oppose these bills.”

There are farmer protests in Punjab and Haryana against the bills. There is a possibility it could spread to other states. The usual bogey of capitalists and big businesses is being brought up. This is a government that’s especially sensitive to this kind of criticism. We hope it stays the course and uses its formidable skill in setting the narrative to sell these reforms to the farming community.

Farmers Aren’t Free

The reasons for the protests are instructive in understanding why critical reforms in any sector in India remain difficult to implement. A vocal minority that stands to lose the most has organized itself to protest while the majority for whom the benefits are diffused is silent. To understand the reforms, it is important to understand the ‘unconstitutionality’ of the current system:

* Farmers can only sell their produce at the state APMC registered mandis. There is no freedom to sell produce outside of the mandis. There’s no freedom to conduct inter-state trade for the farmers. There is only a single buyer – the state. There is no competition. The state sets the price of the produce.

* The state has its approved ‘middlemen’ to facilitate the process of buying from the farmers. Since the farmers are often small and poor, their ability to reach the mandi, to negotiate the byzantine paperwork of license fees and commission, and store their produce is limited. There’s a long chain of small and big traders and commission agents who fill in to provide these services. This is a deeply entrenched cartel that buys low from the farmers and bids up the price to the wholesaler. The farmers are at their mercy while the end consumers pay for the cartelisation. The evergreen anecdote of farmers making Rs. 2 for every kilo of onions they grow while the consumers shelling Rs. 80 a kilo is a result of this.

* There’s no freedom for the farmer to sell their labour for a price through a contract. This is a freedom guaranteed by the constitution to every citizen. Except the farmer. So, small and marginal farmers can’t enter into contracts with private buyers of farm produce to aggregate their produce and sell it a pre-determined price.

* There are restrictions on how much stock of ‘essential commodities’ can be held by farmer or a trader. The essential commodities include cereals, potatoes, onions, oilseeds and pulses. So, the market mechanism of stabilising price through supply management and storage isn’t available. There’s no incentive for players to set up modern warehouses and cold supply chains for these commodities. The result is frequent price fluctuations and criminal wastage of food.

The Sum Of All Good Intentions

The dismal state of Indian agriculture bears no repetition. The farm income growth has been stagnant for the last 6 years. The small and marginal farmers who constitute 86 per cent of India’s peasantry barely make a living out of farming with average per capita annual income below Rs. 100,000. About 45 farmers die by suicide on an average every day. The Food Corporation of India (FCI) buys the produce at the minimum support prices (MSP) from the mandis and distributes it at a subsidised rate through the public distribution system (PDS). This subsidy bill has grown to unmanageable level.

The FCI borrows from National Small Savings Funds (NSSF) to keep its operations going. It is estimated this loan will rise to Rs. 3.5 lakh crores in FY ‘21 from Rs. 2.5 lakh crores in FY ’20. Millions of ordinary Indians trust NSSF with their lifelong savings. It is anybody’s guess when FCI will be able to pay back NSSF. If this appears like a giant Ponzi scheme, that’s what it is. The food grains stocked at FCI are at an all-time high but there’s no market mechanism for its distribution when people needed it the most during the pandemic. They had to wait for the largesse of the state for the stored grains to reach them. This is a broken system. Even if you set out to create a dysfunctional system, you’d have struggled to reach here.

Who in their right minds would want this structure to continue? Who has it helped except entrenched cartels and a few dynasties of ‘farmer leaders’ who have built a system of patronage? It is the established rural structures that’s protesting. That doesn’t want to let go. They must be ignored.

How We Got Here?

The obvious question that comes up is why did we opt for such a system? The answer is that old Voldemort of all public policy choices in India – good intentions. The colonial powers had systematically exploited Indian farmers to the point of destitution. Nehru was taken in by Fabian socialism that was in fashion during that time. His first visit to USSR in 1927 and the subsequent success of Stalin’s first five-year plan in state-controlled agriculture strengthened his views.

Then there was the 1943 Bengal famine. The political and cultural impact of the famine still persists. A large part of our permanent suspicion of private capital and markets can be traced to the famine and the perception of how rich traders and merchants hoarded food grains and profiteered while millions died of starvation. The plays, songs and films of the Indian People’s Theatre Association (IPTA) left a deep imprint in our popular culture about the apathy of capitalism. This informed our public debate and politics in a manner where the economic right was forever tainted with the colonial anti-poor and anti-farmer philosophy. That’s why there was no trace of the market mechanism when laws for the farm sector were drafted after independence.

Sen On Famine

It is worth taking a short detour on famines here. Amartya Sen’s famous work on Bengal famine blamed the lack of accountability of the colonial government that didn’t have to face elections as the primary reason for the starvation deaths. His insight was simple and profound. Famines aren’t a food availability problem. They are ‘entitlement failures’ that can happen with even minor imbalances of production or some unintended effects of government policy. Sen defined entitlement as:

“The set of alternative commodity bundles that a person can command in a society using the totality of rights and opportunities that he or she faces.”

The entitlement set is the range of goods and services she can acquire by exchanging or converting her resources or labour. In famines, these entitlement sets fail to provide her food in exchange thus setting in starvation.

In case of Bengal famine, the proximate cause of entitlement failure was the inflation caused by the WW2 where the food prices rose by 300 per cent while farm wages rose by 30 per cent. This failure was exacerbated by the refusal on part of the colonial government to freely distribute food grains that were available in abundance. We haven’t moved too far away from that reality today despite the best intentions of the state to help farmers.

Stay The Course

Notwithstanding the obvious failures of our agriculture policies and the relative success of the market mechanism in other sectors, we raise the spectre of capitalists and big businesses harming our farmers whenever efforts at structural reforms are discussed. The farmers have been for long in the grip of the predatory state. These reforms will empower farmers. The government must ride over the resistance and set the farmers free.    

Addendum

— Pranay Kotasthane

Any reform that is even remotely seen to impact the MSP gravy train is bound to face opposition from a host of incumbent beneficiaries. One, the farmers growing the 22 crops backed by the MSP. Two, the traders getting a percentage of the MSP. And three, the state governments making money by charging hefty commissions for the sale of produce at APMCs. None of this is surprising.

That apart, there are at least two other critiques that merit serious attention.

* The timing critique. Agriculture in India is a sob story even in the best of times. And here we are, in the midst of an unprecedented supply and demand shock caused by COVID-19. So any reform that might remotely lead to lower incomes because of a dilution of the MSP promise is bound to face the question: why now? Can’t the cognitive maps of those losing out be aligned to absorb the short-term losses?

* The credibility critique. It’s tough to take a government seriously that claims it is liberating farmers even as it has no qualms in banning onion exports simultaneously. The fact that these legislations say nothing about the impact on the existing procurement price mechanisms has led to suspicions about government intentions. As Mekhala Krishnamurthy writes in The Print:

..instead of building up the confidence to develop a comprehensive framework for agricultural reform for these states, with a credible time horizon and coordinated support for farmers, the position on agricultural reforms has become further vitiated and volatile. Even if the three farm sector Bills do not directly legislate on MSP and procurement policy, it is simply not tenable to spearhead major national reforms in agricultural markets in India without making room for detailed deliberations on the future of where and how price support and procurement policies fit in.

Moreover, not having taken state governments into confidence calls into question the implementation credibility of these legislations.

So, what remains to be seen is how the government signals credibility amidst an economic crisis for a long-pending reform. This story is not over, not just yet.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Oliver Hart in Promarket on ‘How Shareholders Don’t Always Want To Maximize Shareholder Value’.

* [Article] Ashok Gulati in The Indian Express on why this is a 1991 moment for agriculture.

* [Podcast] We have an All Things Policy episode on Opportunity Cost neglect in Public Policy.

* [Paper] Dani Rodrik and Stephen Walt present their vision of the future world order.

That’s all for this weekend. Read and share.

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

— RSJ

Happy 2021 everyone!

There’s no logical reason to believe that turning over to a new year will make a difference in the fortunes of humankind. But we are an optimistic lot.

So, we hope the spectre of 2020 is behind us. It was what it was. If you are a believer, you’d think there was a cosmic message to us through the year.

Like Alexander Pope wrote in that great defence of the ways of God to men – An Essay On Man:

“Hope humbly then; with trembling pinions soar;

Wait the great teacher Death; and God adore!

What future bliss, he gives not thee to know,

But gives that hope to be thy blessing now.

Hope springs eternal in the human breast:

Man never is, but always to be blest:

The soul, uneasy and confin'd from home,

Rests and expatiates in a life to come.”

Pope concludes with:

“All nature is but art, unknown to thee;

All chance, direction, which thou canst not see;

All discord, harmony, not understood;

All partial evil, universal good:

And, spite of pride, in erring reason's spite,

One truth is clear, Whatever is, is right.”

We must accept whatever is, is right

We will continue to write to help us make sense of the world around in 2021. But a year like 2020 helps put things in perspective. The world works in mysterious ways. You can’t control it. Spontaneous order is ordained.

Ten (or Fifteen) Predictions For 2021

The laziest way to start a new year edition is to post predictions. Admittedly, I’m basking in my garden with the late winter morning Bangalore Sun warming my toes. So, let’s do the lazy thing here.

#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. There will be a plethora of books on the post-pandemic world (hey, Pranay has edited one too😊) and the lessons to be drawn from the pandemic. But my guess is barring the strange experience of the lockdown that will linger in our memories, the world at the end of 2021 will be quite similar to how it was at the end of 2019. There will be fewer business travels and more people will work from home, but this will be a mere acceleration of the long-term trend than a radical departure from the past. That apart there won’t be any great reset.  

#2

Global financial markets will be one area where the impact of the pandemic will be felt in the (really) long term. Don’t worry we will all be dead by then. 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. In some ways, we have subscribed to the modern monetary theory (MMT) without admitting to it. Deficits have come to mean nothing and any future slowdown in the economy or fall in markets will mean more stimulus. Someone in future will be left holding the can. We can’t see them nor can we feel deeply empathetic about them. ‘Deficit is all a myth’ line of argument will gather momentum.

#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. Others who were impacted by the lockdown will limp back to normalcy. With interest rates at historic lows and excess liquidity all around, the top 2-3 per cent who invest in equity will have no other options but to park surplus funds in the market. The millennials (who believe the markets only go up?) will enter the markets in large numbers on the back of zero-fee platforms like Robinhood and Zerodha. The divergence between the real economy and the street will continue to confound all of us.

#4

We spent a lot of time in 2020 thinking about economic recovery. What policy actions will aid it, what will be the shape of it and how quickly will we get back to the pre-pandemic levels on a sustained basis? 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. In India, this K-shaped recovery will have a second-order impact. We will measure recovery on the rising part of the ‘K’ since the data there is available at a greater frequency. Expect terms like ‘roars back’, ‘strikes back’ to be in vogue in the second quarter of the year while describing the economy. There will be limited economic rationale behind such commentary.  

#5

The Indian economy will trundle along. The twin balance sheet problem will persist. The impact of the moratorium on the financial services sector will show up in the latter part of the year. PSU banks will need more capital once they are done with their consolidation. The government will find it difficult to do that. Some kind of divestment will be attempted that will be stalled by the usual protests from the opposition, unions and public opinion. Banks and NBFCs will be extremely careful with lending, especially to new projects or new customers. 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. Government finances will continue to be under strain and its borrowings will crowd out others. Expect RBI to continue to bear the burden of holding up the economy.

#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. The anticipated move of global supply chains away from China will be insignificant in the larger scheme of things. China will continue with bullying its neighbours and those who don’t toe its line. India’s reluctance to be seen in the US camp and the new Biden administration will mean there won’t be any real Quad counterpoint to China in Indo Pacific. Most of US attention will be on domestic issues where race and identity politics will consume everything in the next year. There will be the usual handwringing about a democratic coalition of the willing to take on illiberal Chinese authoritarianism. But those will be words. There won’t be any real US response to China’s rise to the top.

#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. Some early efforts will be made to create common standards and shared investments in data protection, usage of AI, 5G protocol and cybersecurity in the western democracies. There will be greater regulation of Big Tech and social media platforms with some serious repercussions for Google and Facebook in 2021. The blunt instrument will be hiving off some of their businesses into separate companies. Or you could expect heavy fines for restrictive or anti-competitive practices and heavier hand of regulations on these companies.

#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. We know how to pull off large events of this kind. The state that’s all-pervasive and weak in getting things done is good in one thing. Mobilising people to stand in haphazard queues and getting them to do its bidding. Vaccination drive falls squarely in its sweet spot. Expect many ad hoc regulations, orders and trampling of individual liberties and common sense when this is being done. But we will surprise ourselves on this front. My bet is the PM uses the Republic Day platform this year to have the first person to be vaccinated in India. Expect it to be an old, female health worker from West Bengal.

#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. The weak economic performance will then be compensated by the unnecessary and illiberal social policies to keep the base enthralled. Expect more states to pass laws against love jihad and cow slaughter. Some kind of population control bill and revoking of the amendments made to the Constitution during the emergency might also be in news. Those worried that India is headed in the wrong direction will be driven to deeper despair.

#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. PM Modi will continue to remain above all of this as he cultivates his spiritual Mahatma image.

— Pranay Kotasthane

There are two kinds of 2021 predictions I have come across. The first kind says that the post-pandemic world will be the same as the pre-pandemic one. The second kind says that the post-pandemic world will have a far-reaching impact on that one phenomenon that the author is deeply invested in.

Both kinds of 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.

With that caveat out of the way, I have five predictions to add to RSJ’s ten.

#11 Petrol prices in Bangalore will hit ₹100 at least once before the end of 2021.

We have previously written about excise duties on petrol and diesel being the superhero of last resort for state and union governments. Given the resource crunch that’s set to continue in 2021, I expect the retail price of petrol to hit a swashbuckling century in my city.

#12 A maximum of 2 CPSUs will be privatised by the end of 2021.

There are many news reports indicating the union government plans to sell its stake in over 25 CPSUs. My prediction is that in only two of them (possibly, Air India and BPCL), the government will sell all its shares. In the remaining companies, the government will reduce its stake or the sale process might not complete.

#13 GST will continue to have the current five tax slabs.

The fiasco on GST compensation cess has meant that union-state relations are in the wrong place. Negotiations will be more challenging as both sides will harden their stands. They will guard the status quo and resist attempts to simplify the GST regime.

#14 The status quo at Ladakh in terms of territorial control will continue.

Even if there is a reduction in the numbers deployed, PRC is unlikely to back off. A negotiated settlement doesn’t suit the PRC.

#15 The number of US service personnel in Afghanistan will fall below 2500 by the end of 2021.

There seems to be a bipartisan consensus on Afghanistan in the US. Trump administration plans to reduce uniformed US troops from the current 4500 to 2500 by Jan 15. My prediction is that Biden will stay the course.

Finally, I disagree with RSJ’s prediction that there will be no real response from the US to China’s rise. There might be fewer tariff hikes but efforts to slow down China’s progress in advanced technology will gather steam. I did not include this in my list as I couldn’t come up with a specific, measurable prediction in relation to US-China relations. It’s hard to make good predictions!

What are your predictions for 2021?

HomeWork

* [Video] Fareed Zakaria interview on his new book - Ten Lessons For A Post-Pandemic World. Snark alert: a bit amazing that he already has a book about the post-pandemic world while we haven’t gotten over the pandemic yet! But he makes sensible points here. Watch it.

* [Article] What is Wrong with Econ 101. An excellent primer on common misconceptions about economics.

* [Article] Ajay Shah explains the critical difference between Inputs, Outputs, and Outcomes in relation to NFHS data.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

Welcome to the mid-week edition in which we write essays on a public policy theme. The usual public policy review comes out on weekends.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

The farmers protesting against the three new farm laws (“Farm Laws 2020”) have entered into the seventh round of negotiations with the Union government. We have discussed these laws a few times here, here and here. For a moment, leave the laws aside and focus on the protests. Not the conspiracy theories about who is funding them and what their ‘real’ agenda is. But on how protests work. I had a few questions as I thought about them.

Why do some issues generate protest over others?

Take the last couple of months in India. We have the new farm laws that seek to open up the markets for farmers to freely sell their produce. The economic conditions of our farmers under the APMC mandis and MSP regime need no retelling. The new laws are new only for India. In most parts of the world, this is normal. Yet we have protests that have built up quite a steam.

Now contrast this with the Prohibition of Unlawful Conversion of Religion Ordinance that the UP Assembly passed in November. This so-called love jihad law is being sought to be replicated in other states like Himachal Pradesh, MP, Haryana and Karnataka. The provisions under these laws (which are quite similar across the states) fly in the face of the fair, liberal and democratic order that India has enshrined in its constitution. There is a subversion of the individual right to freedom of religion, free will and of the fundamental legal principle on who bears the burden of proof. And it isn’t as if there weren’t existing laws to curb forced mass conversions in these states. These laws have only one purpose – to strengthen the strawman about a global Islamic conspiracy to turn India into a Muslim majority state. Demographics, arithmetic, or logic militate against this strawman. But the strawman has been created and now it is about demolishing it to prove the effectiveness of the regime.

So, what explains the absence of any mass protests against questionable love jihad laws while there are protests against farm laws that most political parties had in their manifestos in the past?

There are two possible reasons for this. First, for any protest to start there is a need for a core group that feels aggrieved by an issue and questions the fairness of the actions of the state or the society. Both the points are critical – a sense of hurt and a moral basis to question the action that has created it. Second, the core group has to have a long-held common identity that’s clearly defined. It isn’t an identity that has been formed only because of the issue on hand.

Now let’s use this to look at love jihad laws.

Is there a core group that’s aggrieved by this? Muslim youth? Not really. The idea that there’s an organised group of Muslims being trained to woo Hindu girls in some kind of love academy and then sent out to marry them and Islamise India is in the realm of fantasy. As a strategy, it’s plain stupid with high investment and low returns. There’s no ‘superhit formula’ for wooing girls and Hindu girls aren’t waiting to be picked while having no agency of their own. So, there won’t be any Muslim or Hindu protest against these laws. As an aside, this was different in case of the Citizenship Amendment Act. There you had a core group (of Muslims citizens) who had a reason to be aggrieved and a moral basis to protest. On love jihad laws, the only group aggrieved would be those who believe in liberal values of freedom and justice. They will question the fairness of it. But does this group of ‘liberals’ have a long-held common identity? Not exactly. Most liberals can’t agree on the definition of liberals itself, forget about forging a common identity. So, don’t expect mass protests against a genuinely bad law anytime soon. Also, expect more of such laws in future that play the dog-whistle to the base without any protests from any group.

Things are a bit different with farm laws.

There’s a core group of farmers in Punjab and Haryana (and possibly in western U.P.) that benefit from the MSP regime who are agitated by these laws. That they – farmers whose toil ensures food on our table – are being given short shrift gives them a moral basis to protest. Finally, as farmers, they have a common identity around which they have organised, politically or otherwise, on numerous occasions in the past. So, you will have protests from this group.

That brings us to the next question.

What creates momentum for a protest?

Protests are started by a small, core group of protesters. The economic rationale is simple. The costs of protesting – organising, the opportunity cost of time and the likely threat of state violence – is weighed by them against foregoing existing benefits or incurring new losses (tangible or intangible). The initial group of protesters tend to be those who stand to lose the most. This loss outweighs the costs especially the threat of state violence which could be high for a small band of initial protesters. As the protest gets going, a positive network effect comes into play. Every new member joining the protest has a lower marginal cost than the previous member since the costs of organising and of state violence is now spread over more people. But the benefits remain the same. Or increase because the probability of a protest being successful increases with more members joining it.

The positive network effect is relatively easier to create in the radically networked societies we inhabit now. Once the costs and benefits are articulated clearly, the dissemination costs through social media can be almost zero.

Two other factors influence the momentum.

One, the ability of protesters to broaden their support base without diluting the focus of their objectives. This is a delicate balance and often protests fail in treading this line. Not broadening the base runs the risk of the momentum of protest fizzling out eventually since the state can play the patience game for longer than protesters. But adding too many allies who might bring in their own issues into the mix and then speak in multiple voices can derail the original cause of the protest. The great mass protests of Indian independence (Non-cooperation or Quit India movements) are fine examples of getting this balance right. Two, the ability of the state to run a counter-narrative about the protest and undercut the support base. The democratic states aren’t usually great in doing this since their response time is significant when compared to the speed of a radically networked group. However, a more authoritarian state can compete with a counter-narrative through mainstream media and through its own radically networked base which is ready and can respond quickly.

The current farmers’ protest has two problems in creating momentum. The positive network effect hasn’t taken shape in states beyond Punjab and Haryana. A likely reason for this is the benefits of the APMC and MSP regime are restricted to those two states while farmers from other states don’t have any incentive to protest against the new laws. The other reason is possibly the poor articulation of the grievances of the farmers and its broadcast to the farmers across the country. This scenario is unlikely in current times of social networks.     

Finally, what does it take to make a protest successful?

The state responds when the continuation of the protest threatens its core interest of perpetuating itself. The size and the spread of the protest could reach a critical mass in the calculation of the state where it could threaten a regime change. Or the protest derails the lives of ordinary citizens who then turn against the state. Reasonable states will act in advance of such a scenario. In most cases, the state partly accepts the moral basis for protests and arrives at a reasoned compromise or it lets it counternarrative undercut the protest and let time take its own course. Only in rare cases does a state accept the moral basis of the protest and go back on its stand.

The protests we have seen in recent times (CAA, Article 370, farm laws) have seen this government use the counternarrative effectively. In fact, more than any other time in the past, this strength of the current regime will render most street protests ineffective. The protest on farm laws is a bit tricky since farmers account for 40-50 per cent of the voters in most states and have a history of mobilising themselves during elections. The narrative created in favour of the farm laws is strong and the limited appeal of the protests in other states has meant the government has stalled the protesters with multiple rounds of talks. Considering the limited geographic spread of the protests, the likely conclusion to these talks could be a few concessions made in the laws for these states. A full repeal of these laws is unlikely unless a groundswell of support for the protesters that’s so far missing emerges in the next few weeks.  

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Nathan Heller in The New Yorker: Is There Any Point To Protesting?

* [Article] Pratap Bhanu Mehta in The Indian Express on the farmers’ protests.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris.

Global Policy Watch — Storming Se Storming Tak: From 1642 To 2021

- RSJ

Here’s a short quiz to begin things.

What’s common to these dates (not an exhaustive list)?

4 January 1642: England

Feb 27, 1933: Germany 

Feb 23, 1981: Spain

April 27, 2017: Macedonia

Difficult?

Here’s a clue. The latest entrant to this list

Jan 6, 2021: USA

‘Workout-able’ now?

These are select instances of attacks on parliament buildings in democracies over the years. Of course, this is different from attacks that happen within the parliament building where lawmakers have a go at each other using microphone stands, paper-weights and files as projectiles. That’s a rich and glorious tradition where Taiwan, South Korea and India are global leaders.

The attacks on parliament from the outside is a different phenomenon. It points to a fracture in the common belief among citizens about the power or legitimacy of the sovereign. This is not mere symbolism. Often the attacks are real attempts to disrupt or change the outcomes of a parliamentary process to elect the head of the government.

That’s what happened, say, in Spain on Feb 23, 1981 when Lt. Col Tejero and his small band of army men burst into the lower house of the Spanish legislature during the vote to elect a new Prime Minister. The attempt to overthrow the democratic regime came unstuck when King Juan Carlos denounced it in a televised address. The storming of the Macedonian parliament in 2017 was done in somewhat similar circumstances though without any section of army backing it. That brings us to Germany. The fire at Reichstag in 1933 right after the Hitler had been sworn in as the Chancellor was blamed on a communist conspiracy. It is almost certain now that this was engineered by the Nazis to demonise their opponents. This incident of arson was then used by the Nazis to issue a nationwide emergency and pursue the communists with a vengeance. The Communists MPs were arrested and the Nazis won the elections to those vacant seats as was expected. Within a year the Nazis had complete control over the German state. You know how that story ends.

The Original Storming

My interest, however, is in the first instance of the storming of a Parliament: Jan 4, 1642.

This was no ordinary rebel laying siege over the lawmakers in Westminster. It was Charles I, the king of England. He entered the Parliament with armed soldiers to arrest five MPs who he accused of treason. What had they done? Well, to the king and his loyalists, they were anti-nationals. Sounds familiar. They were accused of encouraging Scotland to invade England and a conspiracy to defame the king. Charles went into the parliament and called out the name of the five MPs seeking their arrest. He asked the House speaker, William Lenthall, about their whereabouts. Lenthall responded:

“May it please your majesty, I have neither eyes to see nor tongue to speak in this place but as this House is pleased to direct me whose servant I am here; and I humbly beg your majesty's pardon that I cannot give any other answer than this to what your majesty is pleased to demand of me.”

In a historic first of sorts, the speaker had sided with the parliament over the divine will of the king.

“All my birds have flown,” Charles I said as he scanned the member benches for the five MPs.

The storming of the parliament by Charles I was a seminal moment in the history of democracy. The tussle for sovereignty between the parliament and monarchy that had been simmering for over three decades had reached its flashpoint.

The English parliament in those days was a collection of landed gentry who controlled the exchequer through their power of collecting taxes. The king needed its approval to raise taxes. By the time Charles I ascended the throne in 1625, the Crown was deep in debt no thanks to the expensive wars of the Tudor and Stuart periods and the lavish lifestyles of the royalty. This apart Charles had other problems too. There was a deep suspicion among the aristocrats about the strength of his Protestant affiliation after he married the Catholic Bourbon princess Maria of France. His subsequent religious acts did nothing to dispel this impression. The desire of Charles I to go to war with Scotland meant he wanted the parliament to increase taxes and do his bidding. The parliament continued to resist and Charles dissolved it in 1629.

The next 11 years when he ruled without a sitting parliament is termed his ‘personal rule’. He introduced new taxes arbitrarily, supported Catholic religious policies and hounded the aristocrats who opposed him. The tyranny was going well but for a small hitch. He still needed the parliament to convene for collecting the tax revenues. He called a new parliament in 1640 in the hope he will be able to control it. Not quite. The parliament passed an act that forbade its own dissolution and went about rolling back the policies that Charles had set in motion. The stage was set for him to storm the parliament looking for the errant MPs.

The Post-Metaphysical Age

The storming of the parliament led to what is collectively called the English Civil Wars (1642-1651) between the Royalists and the Parliamentarians. Charles I was tried and executed in 1649 (none of this namby-pamby impeachment business in those days). There were three key outcomes of the civil wars:

* The replacement of English monarch by the Commonwealth of England

* The consolidation of Protestant ascendancy and the defeat of Catholicism in England. The downstream impact of this was huge

* The precedent that the English monarch cannot rule without the Parliament’s approval. The seal of Parliamentary sovereignty and the establishment of individual rights, however, were legally established only after the Glorious Revolution of 1688.

There’s a subplot here.

A gifted English polymath who had fled England in 1640 to Paris watched all this unfold with interest and concern. A man of science who counted Galileo, Bacon and Mersenne among his friends, he was developing a theory of about people, nature and politics as he came to terms with the chaos in his country. He was also the tutor to Charles II, the young prince, who was in exile in Paris. By 1650, he was ready with his magnum opus that broke new ground on the relation between the state and its subjects. In 1651, he returned to England.

His name was Thomas Hobbes. The book was Leviathan.

The Genesis Of The Modern Liberal State

Hobbes is, arguably, the founder of modern political philosophy and Leviathan is a masterpiece of original thinking. Hobbes made three core arguments in it:

* The State of Nature: Human beings left to themselves will pursue their objectives of maximising their comforts. These pursuits will bring them in conflict with others. People are similar (within a range) in terms of their physical and mental prowess. So no one person can dominate others for long. This led him to conclude that humans in their state of nature would be in constant strife with one another. “A war of everyone against everyone” is how he called it. In this state, he famously said, human life would be “nasty, brutish and short.”

* The Laws of Nature: Hobbes argued that humans were rational beings who understood the futility of living in the state of nature. They would seek a practical solution to establish peace. To Hobbes, this solution was for people to establish mutual covenant (agreement) among themselves to submit to the authority of a sovereign. Simply put, people will be willing to forego some of their freedoms to a sovereign institution in return for peace and rule of law governed by that authority.

* Unlimited Sovereign Authority: For Hobbes, once the people had come together to hand over the power to the sovereign, its power was unlimited. There was no quid pro quo involved here. No real checks and balances. So long as the sovereign kept peace among its people and protected them from outside powers, it retained its political legitimacy. Nothing else mattered. Any attempt to split the powers of the sovereign would render it ineffective.

The impact of Leviathan on future political philosophers was profound. In many ways, it is the foundational text of the modern state. Everyone from Locke, Rousseau, Weber to Rawls have used it either as a springboard or as a counter to develop their social and political theories. The criticism of Hobbes over the centuries is also useful to shine a light on the originality of his thinking. The usual arguments offered against his political philosophy include:

* A bleak view of human nature: The short conclusion easily drawn from Leviathan is that Hobbes held no illusions about the nature of human beings. Left to themselves in a natural state, they would be in an endless series of internecine wars. This is Hunger Games territory. But Hobbes was a bit more nuanced than that. To him, it is not human nature to be in a war of everyone against everyone. Instead, in the absence of laws and its enforcer, human beings pursuing their rational interests will get in the way of each other. This will be the basis for strife and not the absence of better angels of their nature

* Social contract theorist: Some view Hobbes belonging to the line of social contract theorists who thought and wrote about the arrangement between the society and the state or the ruled and the rulers. This isn’t exactly accurate. Social contract theory assumes that society already exists with a contract among its members. The society then enters into a ‘second contract’ with the state by relinquishing some of its freedom in exchange for peace and stability from the sovereign. For Hobbes, there was no second contract. The society or the state don’t exist ab initio. There is only a single contract - the covenant between the members of the society to come together. The sovereign emerges from this. It is almost like the ‘Big Bang’ theory of political philosophy.

* Totalitarian: The other criticism of Hobbes is he justifies a totalitarian regime when he lets the sovereign off the hook for any kind of quid pro quo contract with the society. This is misreading of the term absolute. Hobbes considers the sovereign absolute in terms of its power which means they ‘can interfere’ in ‘any aspect’ of the lives of its citizens. This is different from a totalitarian regime which is based on the idea that the state ‘will permeate’ into ‘every aspect’ of the lives of its people. In fact, Hobbes was the first to free religion from the construct of the state. Once you are free from theology, you set the basis for a liberal state.

Bookended By Hobbes

The storming of the Capitol building by pro-Trump protesters marks a moment in the history of democracy in America. There’s always a temptation to over-read the current moment. But the irreversible slide of the discourse, the shrinking of the middle ground with a loony, conspiracy-theory fed right and an anarchist, self-righteous left and an almost cult-like adherence to prior beliefs that get accentuated in the echo chambers of social media have meant this moment was nigh. The strength of the social covenant (“we, the people) is under stress rarely experienced before. Once that covenant is broken, the political authority wanes or gets delegitimised as we see it happening in America for most of last year. Unless checked and reversed, we will be back to the state of nature. Chaos will follow.

Maybe there’s a polymath philosopher watching all of this unfold with unease while developing an original political thesis like Hobbes over four hundred years ago. The storming of the English parliament of 1642 and the siege of the Capitol in 2021 seem to bookend the political era whose foundation was laid by Hobbes.

There’s a need for a new social contract for these times.

A Framework a Week: OOO

Tools for thinking public policy

— Pranay Kotasthane

The union government’s first post-pandemic budget will be presented in the Parliament on Feb 1. The all-consuming buildup has already begun as if it were a Rajinikanth movie. As the budget date nears, you will come across many more number-based narratives — the need for higher public health expenditure, the imperative to reduce allocations for subsidies, and the necessity to adequately fund the requirements of our armed forces.

So let’s revisit a framework that helps put these numbers in perspective. The Outlays-Outputs-Outcomes (OOO) framework is a useful way to analyse the many schemes that the Finance Minister will announce on Feb 1.

Inputs/Outlays refer to the resources provided to a scheme or project that the government runs. Once the budget is presented, virtually all the public discussion will be on these outlays. This gives an idea of how the union government prioritises all its functions. But as we all know, 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.

Using this framework allows us to scrutinise government schemes better. As Ajay Shah writes:

This framework became famous around education, where the inputs are school buildings and recruitment of teachers, the outputs are kids who are enrolled and attend school, and the outcomes are what the kids actually know. From about 2004 onwards, we have understood that very large increases in public expenditure in the per-pupil expenses were associated with essentially no gains in the outcomes. The education bureaucracy has proclaimed its victories as counted by school buildings, teachers employed or kids enrolled. But at a fundamental level, state spending on elementary education has not delivered: vast increases in the input has not delivered gains in the outcome.

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? (all definitions are taken from Indicators of Inputs, Activities, Outputs, Outcomes and Impacts in Security and Justice Programming, DFID).

Ideally, any government programme should begin with a theory of change that connects the desired end state (outcomes) to the programme activities that need to be carried out (outputs) which further require a set of resources (inputs).

Seen from this frame, a policy that fails to achieve the desired outcomes can mean two things. One, that there was an implementation failure. Insufficient outlays or difficulty in converting outlays into outputs due to corruption are examples of implementation issues. Two, that there was a theory of change failure which means that the assumed causal linkage between outputs and outcomes was incorrect.

In the Indian context, a commonly held notion is that governments have good policies but poor implementation. What’s less appreciated is that policies often fail because the underlying theory of change itself is inaccurate.

Better data and feedback help uncover this theory of change failure. For example, ASER surveys have now shifted the conversation on education by disproving the theory that more schools and better-paid teachers alone can lead to better student learning outcomes. The National Family Health Survey data can similarly help question the assumed causal linkages between health outlays, outputs, and outcomes. It is indeed a positive sign that on both health and education, we are talking effectiveness and not just outlays. This reflects that governance in these areas is maturing.

PS: For the upcoming budget, skip the outlay PDFs and open this new document called the Output Outcome Framework. It maps each government scheme outlay to the desired outcomes and outputs over the next financial year. If the budget were also to map the performance of each scheme against the promised outcomes in the year gone by, it will go a long way in correcting both implementation and theory of change failures.

Matsyanyaaya: False Equivalences with Chinese Characteristics

Big fish eating small fish = Foreign Policy in action— Pranay Kotasthane

Political turmoil in the US has understandably shaken many of us here in India. Events of this magnitude lead to a general despondency about democracy itself. The hope is that this despondency would get displaced by introspection and positive alternatives.

At the same time, we need to guard against narratives that cite these events to equate the US and China. One strand of Indian strategic thought has long held the view that a world order shaped predominantly by the PRC might be just as good (or bad) for India as the current one underpinned by US power. China’s border incursions last year led to the deprecation of this narrative but the churn in the US can give it a new lease of life.

Aided by the PRC’s attempts at drawing false equivalences on one hand and spurred by the self-criticism that is bound to dominate American thinking, we might see arguments such as this make a comeback:

We do not know how Chinese hegemony will work in the future, but we know the exploitative and heinous character of the French and the British Empires. The question is, why are we not as afraid of the West as we are of the Chinese? [China is Not Alone in Adding to the Indian Ocean Woes, Economic & Political Weekly, Atul Bhardwaj, April 2018]

Nothing can be further from the truth.

For one, there is enough evidence to suggest that a Sinocentric world order will not align with India’s quest for yogakshema — peace and prosperity for all Indians. Look at the way China has alienated — simultaneously and purposively — a new generation of peoples in all of its neighbouring countries. Look at how the Chinese Communist Party has imposed one language on a diverse set of its own peoples. And finally, look at how it has transformed its all-weather friend into a mere tributary.

Second, it’s true that the US conduct on the liberal international order is not untainted. But the norm of a liberal international order is in India’s own self-interest. We must and we do question the US when it deviates from this norm. For example, the Indian PM’s condemnation of the Capitol violence is possible in the current order. In a Sinocentric world, this norm itself will cease to exist. If the Indian PM were to criticise something even remotely equivalent in China, the party-state will spring into concerted anti-India action in economic, political, and military dimensions.

These are two clear and important differences that we shouldn’t take our eyes off in the zeitgeist.

HomeWork

Reading and listening recommendations on public policy matters

* [Book] Leviathan by Thomas Hobbes with an essay by the late W. G. Pogson Smith (skip the religious bits)

* [Article] Tom Mctague in The Atlantic: Is This How Greatness Ends?

* [Article] Rathin Roy distinguishes between the better and worse forms of deficit financing.

* [Paper] Abel Schumann’s OECD paper Using Outcome Indicators to Improve Policies is a must-read for public policy enthusiasts.

* [Podcast] Indrani Bagchi discusses the geopolitics of the Quadrilateral Security Dialogue on Puliyabaazi.

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This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

The West German band Scorpions released their anthemic number Wind of Change sometime in early 1991. It is hard to find a better popular culture artefact that captures the mood in Europe during those times. The Berlin Wall had come down, democratic revolutions were sweeping across the countries of eastern Europe and it was clear the liberal democratic order running their economies on the ‘Washington consensus’ had won the Cold War.

The lyrics had both that triumph and a hope for future contained within:

“The world is closing in

Did you ever think

That we could be so close, like brothers

The future’s in the air

Can feel it everywhere

Blowing with the wind of change..

The wind of change

Blows straight into the face of time

Like a storm wind that will ring the freedom bell

For peace of mind”

To broaden things a bit beyond Europe, the 90s were also the time when China was entering the global economy and India was ‘reforming’. Things seemed to be all converging towards the same end. The ‘end of history’ as Fukuyama put it was nigh. Liberal democracy was the ultimate political system. Nothing could better it. We just needed to wait for every nation-state to realise this truth.

Not Quite The Expected Future

Exactly 30 years later, the obvious question is staring at our face. There’s the rise of populist, xenophobic and authoritarian leaders all across eastern and central Europe over the last decade. Russia is a kleptocratic oligarchy that bullies it neighbours who don’t toe its line. On various counts, India has regressed on liberal values and has slowed considerably on reforms. China, contrary to expectations, didn’t become more liberal or democratic as it integrated itself with the world. Instead, it now mocks the liberal western order for its weakness while exporting its brand of illiberal governance as it continues it inevitable rise to the top. Leave these aside for a moment. What’s worse, even the western democracies that were flagbearers of liberalism are caught in the pincer-like grip of populist political urges on both the right and the left.

So, what happened?

How did the spirit of liberalism that pervaded the world in the 90s dissipate so easily? Well, there’s a whole small-scale industry that’s developed over the years to answer this question. And I must add I’m a platinum-card carrying customer of this industry. Over the last year or so I have been reading up every book that elaborates either on the failure of the market economy or the shortcomings of liberalism.

The Light That Failed

A recent entrant to this list is the magnificent ‘The Light That Failed: Why The West Is Losing The Fight For Democracy’ by Ivan Krastev and Stephen Holmes. Krastev, a Bulgarian by birth, serves at the Institute for Human Science in Vienna while Holmes teaches at NYU School of Law. They bring a wide east-west perspective to their arguments on why liberalism failed. Among the books I have read in this genre (including Fukuyama’s Political Order And Political Decay), this is the most analytical in understanding the underlying psychosis of illiberal, populist movements sweeping the world.

At the start of the book, the authors talk about John Feffer, a young American, who in 1990 spends most of the year traversing across post-Communist Europe with an intent to record the transition of these countries into free, open and liberal societies. There’s something Naipaul-ian about this. Naipaul wrote Among The Believers based on his travels across non-Arabic Muslim world with a long pre-Islamic history (Iran, Pakistan, Malaysia and Indonesia) immediately after the Iranian Revolution. Naipaul wandered around without a definite plan, talked to a cross-section of people and ended up with deep insights about these societies. In a similar vein, Feffer spends most of his time speaking to local people to document their hopes and apprehensions in times of tumultuous change in their lives. And quite like Naipaul went back to the same countries two decades later and wrote Beyond Belief, Feffer goes back in 2015 to speak to the same people on how their lives have panned out in the intervening period. What he found was a warped kind of capitalism had taken root that had accentuated inequalities in the society. There was widespread resentment of western values that were transplanted there and a feeling of betrayal about the failed promise of 1990s. Feffer concludes: Communism was the god that failed for the post WW2 generation in eastern Europe. For the current generation, liberalism is the god that failed.

While Krastev and Holmes explain the reasons for the failing in eastern Europe in great detail, there are broader conclusions one can draw that could be used to explain the widespread disappointment about liberalism across the world. I drew three of them.

* Cheap Imitation: Liberal democracy adapted by these countries are a cheap imitation of the western model. There was limited attempt at locating it in the history and the culture of these nations. The national traditions were given a go by and there was no desire to transform the society from within to manage this transition. Foreign experts who barely understood the ground realities were flown in to set up democratic institutions. There was festering discontent among people who found the struggle to become a cheap imitation of a western democracy humiliating. The nativist backlash shouldn’t have surprised anyone. A spark was waiting to be lit. The populist leaders waded in. They questioned the superiority of this model, delegitimised the moral authority of political parties that followed the western liberal mores unquestioningly and spoke about a glorious past which should be the guiding light for the society. It worked. This is pretty much the playbook for all populist leaders around the world. Some of this has been followed in India too. The only thing remarkable about us is the backlash came some 70 years after independence. There was an undercurrent of resentment about western imitation in our society driven by a liberal constitution that seemed to have been thrust upon us. A combination of factors – heterogeneity in our society, charismatic leaders who were steeped in western ideals and an urban, educated elite who held the levers of power and media for long – seemed to have kept this resentment at bay for long. But this edifice is crumbling. Or maybe, it has already crumbled.

* Triumphalism of Liberals: The hard-won benefits of cold war were frittered away by a remarkable dropping of the guard by the liberals over the last two decades. As the authors write: “Liberalism fell in love with itself and lost its way”. The years of heady growth till 2008 where an interplay of forces of globalisation, technology advances and cheap credit kept the growth engine humming and led everyone to believe a rising tide was lifting all. The Global Financial Crisis (GFC, 2008) was a rude jolt. The faultlines of economic inequality, unaccountable financial institutions, a self-serving set of elites and a corrupt political class became stark and visible. The reckoning that was expected after the GFC never came. Instead the solutions to the GFC led most to believe the real culprits not only got away but also profited from it. The belief that losses are socialised while the gains are cornered by a few strengthened. GFC still casts a long shadow on the polity across the world. We have reached a stage where both the extreme right and left rile against liberalism to work up their base following the GFC.

* Demographic Anxieties: As the growth became more lopsided and inequality grew, the demographic anxieties strengthened. These anxieties take various shape in different democracies, but they have one similar feature – a sustained othering of the minority. The irrational fear that the more fecund minorities will gradually engineer a democratic and cultural ‘coup’ by turning themselves into a demographic majority and take over political and social power has gained strong currency. This takes shape differently across countries. In eastern Europe there is a steady degrowth of the native ethnic groups over the last 2 decades where the educated, liberal elites have voted with their feet and left their homes. In US and UK, income inequality, social fallout of globalisation and an ageing population has fed the paranoia about minorities. The story in India, of late, is well known to be repeated here. The common outcome of all of this is a lurch towards ethno-nationalism with a ‘nation-first’ doctrine. It is a far cry from the boundaryless global village that liberals thought they had achieved sometime back.

In the list of books I have read over the past 18 months, The Light That Failed scores over others in its rigorous analytical dissection of the reason for failure of liberalism. It is short on rhetoric. And unusually for the genre, it believes a diversity of ideologies is good while simultaneously holding out hope that liberalism will learn its lessons. That it will not again strive for homogeneity and ideological dominance around the world.

The authors end the book with a tip to Rudyard Kipling’s first book (from where the title is drawn) The Light That Failed. That novel had two different endings – one happy and one sad. The authors hope that a “chastised liberalism having recovered from its unrealistic and self-defeating aspirations to global hegemony, remains the political idea most at home in the 21st century. It is our choice to celebrate rather than moan.” That’s their expectation of a happy closure.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] Krastev and Holmes discuss the book at CEU (Vienna)

We have hit a century! Thank you for reading us.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris.

PolicyWTF: Prohibition and Morality

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

— Pranay Kotasthane

If one were to write a book chronicling bans on victimless crimes in India, the index entry for Morarji Desai would be a long one. After all, he holds the dubious distinction of turning lakhs of ordinary citizens into criminals by prohibiting two independent victimless crimes.

The first ban, on alcohol, is rather well-known. The notorious Bombay Prohibition Act of 1949 was passed when Desai was the state’s Home Minister. To enforce the ban, the government created elaborate compliance machinery, misdirecting the limited policing capacity towards apprehending tipplers instead of protecting victims of other crimes. By the time this act was watered down in 1964, more than four lakh people had been convicted under Prohibition! The draconian law is well-documented in Rohit De’s excellent book The People’s Constitution. Read this, for instance:

“The BPA granted vast powers to the police and Prohibition officers. It empowered Prohibition officers and all police officers to “enter at any time, by day or by night, any warehouse, shop, house, building, vessel, vehicle, or enclosed place in which [they have] reason to believe [that] intoxicants or utensils, apparatus or implements used for manufacturing intoxicants are kept.” They could also open packages and confiscate goods that they suspected of containing illicit liquor. Warrants were not required for arrests for any of these offenses or for searching premises. The BPA provided that people believed to have committed an offense under the act could be detained without trial and have their movements restricted. The Prohibition policy thus created a system that operated outside the penal code and the criminal procedure code that applied to most offenses.” [The People’s Constitution, Rohit De, page 45]

The direct consequences of this PolicyWTF aren’t hard to anticipate. People either switched to alternatives that bypassed the law or started consuming a far worse quality of alcohol in the black market. For instance, De writes:

By 1963 the Planning Commission was protesting the number of tinctures available in India. It pointed out that the British Pharmacopeia had reduced the number of tinctures from thirty-four in 1932 to fourteen in 1963, but the Indian Pharmacopeia of 1955 listed forty-two different tinctures. After interviewing leading medical representatives, the Planning Commission came to the conclusion that there was hardly any medical use of tinctures, which were outmoded and being replaced by modern drugs that were not alcohol-based. Spot checks revealed that several tinctures on the market were actually spurious, consisting solely of alcohol and a suitable coloring agent. Other manufacturers were producing eardrops and eyedrops with a large percentage of alcohol. The frustrated Planning Commission suggested that tinctures be abandoned for more modern medicine and that industrially produced eyedrops and eardrops be replaced by prescriptions that could be made by pharmacists. [The People’s Constitution, Rohit De, page 61]

Says a lot about central planning. When there’s demand, supply finds a way out in imaginative ways that governments can’t clamp down easily.

Desai’s second prohibition was on the sale and holding of gold, even in small quantities. It was this policyWTF that made smuggling of gold a lucrative profession. Here’s what the Directorate of Revenue Intelligence — a union government agency — observed in its Smuggling in India Report 2019-20:

The economic reforms of 1990s witnessed the repeal of the Gold (Control) Act, 1968 that had prohibited the import of gold except for jewellery. The erstwhile statute had led to the emergence of a notorious network of gold smugglers during 1970s and 1980s. The economic reforms and liberalisation led to the imposition of a modest specific duty of Rs 300 on 10 grams in 2011-12 (increased from Rs 200 in 2010-11) on the imported yellow metal, bringing gold smuggling almost to a grinding halt.

While both these policies had immediate adverse consequences, the general equilibrium effect was far worse: the successful and respected people in the society were the ones whose only competence was breaking the law.

PS: Nitin Pai, on his blog, succinctly captures the general equilibrium effects of banning victimless crimes in this figure.

Global Policy Watch: Student Loan Forgiveness and Friedman

- RSJ

The new Biden administration is expected to enact a student loan relief programme through legislation or an executive order when it assumes office later this month. There might even be a more comprehensive student loan reform on its agenda. The left-wing of the Democratic Party has made a case for a total student loan forgiveness for a long time now. Biden is a centrist, yet he might use the student loan relief proposal as a bargaining chip to rein in other more socialist ideas from them. It will be interesting to see if the administration merely forgives a part of the outstanding loan or it uses the student loan crisis to arrive at a more market-driven long-term solution to the problem of funding higher education and the role of government in education in general.

Quantum Of Crisis

There are about 45 million student loan borrowers who owed roughly USD 1.6 trillion in 2019. To put that in perspective, India’s total credit outstanding is in the same ballpark. On average, each borrower has over USD 34,000 outstanding credit. By some estimates, the Biden forgiveness proposal is to waive off USD 10,000 from this. That would mean a total waiver of about USD 500 billion. No small change even in the days where stimulus packages routinely run into trillions.

So, what explains these eye-popping numbers that are unique to the US education system?

Well, there are a few reasons.

* Because the colleges can: There has been no disruption in the higher education model over the past two hundred years. The system is an oligopoly. The same set of universities have remained at the top through a combination of brand building, (alumni) network benefits and bigger endowments (that are tax-free). The price set at the top is high and everyone below the chain benchmarks to that price. As income inequality has grown, the price has gotten unaffordable at every level except the very top.

* Student loans are expensive by design: There’s hardly any collateral to hold as security for a student who is getting started in life. These loans are largely unsecured, unlike a mortgage where the house is the underlying security for the banks. The possibility of a student getting a good job and paying back the loan is relatively lower than most other loan types. Added to this is the uncertainty about the final location of the student after he finishes off his education and the costs of tracking them down. It is no surprise the default rates of these loans are in excess of 10 per cent. These uncertainties are baked into the pricing of a student loan. They tend to be long-term and expensive.

* Universities have no incentive to innovate: Why should they? They control their supply and keep college seats ‘scarce’. The admission rates of Ivy league schools have been coming down over the years. They are at sub-five per cent these days. This scarcity gives them enormous pricing power. They offer lifelong tenures to the professors. There’s hardly anyone who holds a university to account for failed careers of its students. The student cops most of the blame. It is a great business model with limited accountability. Here’s a sample statistic. Students at public four-year institutions paid an average of $3,190 in tuition fee for the 1987-1988 school year, with prices adjusted to reflect 2017 dollars. Thirty years later, that average has risen to $9,970 for the 2017-2018 school year. That’s over 200 per cent increase after adjusting for inflation. The entry-level salaries haven’t kept pace with that. After adjusting for inflation, they are almost flat over this time.

This is what riles the ‘progressives’. The higher education system now perpetuates inequalities instead of reducing them. The system is rigged from the start - SAT scores track family income closely, private counsellors help kids from rich families to write their applications and expensive tuitions in drama, music or elite sports help in making the cut. The list of such privileges that are needed to get in is long. And the higher education system explains all of this away in the name of merit.

The Moral Burden Of Student Debt

Those who battle this entrenched system and take expensive loans to fund themselves can find the going tough. The job market remains choppy, the nature of jobs is changing and there’s increasing automation in every sector. To start your career with a debt that you can’t be sure of paying off is a burden that seems unjust. Worse, there are many others who can’t get a loan or don’t venture into higher education at all because the costs are high. It is a terrible loss of human potential.

This much is commonly understood. The problem is with the solution that the ‘progressives’ advocate - a kind of a universal free higher education model best captured by Bernie Sanders line “College For All and Cancel All Student Debt”:

Today, we say to our young people that we want you to get the best education that you can, regardless of the income of your family. Good jobs require a good education. That is why we are going to make public colleges and universities tuition free, and cancel all student debt.

The problems with such prescriptions are aplenty. We have devoted multiple newsletters to them. When the price is zero, supply tends to zero. The inherent moral hazard of cancelling debts. What about those who actually paid their debts? What about those who didn’t take up college because they didn’t want to take debt? What about other borrowers who took other types of loans? Why should their debts be not cancelled? This a terrain full of moral hazard landmines.

Government, Market and Education

So how should we think about solving this? To start with we need to understand the market failures in the education system. What are they?

* Primary and secondary education has positive externalities. There’s a benefit that accrues to the society in educating one person which can’t be captured by the supplier. This restricts the supply of such goods because they can’t be priced accurately. The government has a role in addressing this failure through subsidies or vouchers. Higher education or vocational training are tailored to provide employment to an individual. The positive externalities here are overshadowed by the private economic benefits to an individual. So higher education doesn’t have this type of market failure

* But it has other failures. One is the information asymmetry problem. You can never know how good a college is till after you finish college and enter the job market. The college and your goals aren’t exactly aligned. There’s no downside risk to the college if you don’t get the right kind of job after it. This asymmetry problem extends to the banks providing student loans. They don’t have enough information about either the student or the quality of college education to assess the risk of future payments. They err on the side of caution.

The interesting thing is there’s a 65-year old paper authored by Milton Friedman that captures the role of the government in education. The 1965 paper ‘The Role of Government in Education’ is a document of remarkable clarity and vision even by Friedman standards. It is not a dogmatic advancement of the market as a solution to the problem of funding education. It is nuanced and deeply insightful about what the government should be doing in education.

Friedman On Government In Education

I will end with two key excerpts from it. First, Friedman’s views on primary and secondary education and the role of the government in it. His solution was simple - public financing but private operations of education in this space:

“The arrangement that perhaps comes closest to being justified by these considerations--at least for primary and secondary education--is a mixed one under which governments would continue to administer some schools but parents who chose to send their children to other schools would be paid a sum equal to the estimated cost of educating a child in a government school, provided that at least this sum was spent on education in an approved school.

This arrangement would meet the valid features of the "natural monopoly" argument, while at the same time it would permit competition to develop where it could. It would meet the just complaints of parents that if they send their children to private nonsubsidized schools they are required to pay twice for education--once in the form of general taxes and once directly--and in this way stimulate the development and improvement of such schools. The interjection of competition would do much to promote a healthy variety of schools. It would do much, also, to introduce flexibility into school systems. Not least of its benefits would be to make the salaries of school teachers responsive to market forces. It would thereby give governmental educational authorities an independent standard against which to judge salary scales and promote a more rapid adjustment to changes in conditions of demand or supply. “

The second excerpt is about how to think of funding higher education or vocational programmes taken to improve employment prospects. Friedman suggests an Income Share Agreement (ISA) model all those years ago.

“For vocational education, the government, this time however the central government, might likewise deal directly with the individual seeking such education. If it did so, it would make funds available to him to finance his education, not as a subsidy but as "equity" capital.

In return, he would obligate himself to pay the state a specified fraction of his earnings above some minimum, the fraction and minimum being determined to make the program self-financing. Such a program would eliminate existing imperfections in the capital market and so widen the opportunity of individuals to make productive investments in themselves while at the same time assuring that the costs are borne by those who benefit most directly rather than by the population at large. An alternative, and a highly desirable one if it is feasible, is to stimulate private arrangements directed toward the same end.”

It is instructive to conclude here with Friedman’s conclusions from the paper:

“This re-examination of the role of government in education suggests that the growth of governmental responsibility in this area has been unbalanced. Government has appropriately financed general education for citizenship, but in the process it has been led also to administer most of the schools that provide such education. Yet, as we have seen, the administration of schools is neither required by the financing of education, nor justifiable in its own right in a predominantly free enterprise society. Government has appropriately been concerned with widening the opportunity of young men and women to get professional and technical training, but it has sought to further this objective by the inappropriate means of subsidizing such education, largely in the form of making it available free or at a low price at governmentally operated schools.

The lack of balance in governmental activity reflects primarily the failure to separate sharply the question what activities it is appropriate for government to finance from the question what activities it is appropriate for government to administer (emphasis ours)--a distinction that is important in other areas of government activity as well. Because the financing of general education by government is widely accepted, the provision of general education directly by govern mental bodies has also been accepted. But institutions that provide general education are especially well suited also to provide some kinds of vocational and professional education, so the acceptance of direct government provision of general education has led to the direct provision of vocational education. To complete the circle, the provision of vocational education has, in turn, meant that it too was financed by government, since financing has been predominantly of educational institutions not of particular kinds of educational services.”

A Framework a Week: A Taxing Month Ahead

Tools for thinking public policy

— Pranay Kotasthane

What’s a budget without new taxes, fees, cesses, or surcharges? As the budget date nears, let’s understand the categorical differences between these four seemingly interchangeable terms.

A tax is the purest economic manifestation of the state’s monopoly over the legitimate use of force within its territory. That’s because a tax is not accompanied by the promise of any specific service by the government in return. The money raised from taxes goes into the consolidated fund of the relevant level of government. Then on, it’s the government’s prerogative to decide what this money should be spent on. So if you were to file a case refusing to pay income and property taxes on the grounds that the road outside your house is broken, you would’ve no chances of winning the case.

A fee, in contrast, involves a quid pro quo. You pay for a service or good in return. When you pay a parking fee, you pay for the right to occupy a physical space for a specific period of time. The linkage between what you pay and what you get in return is much clearer than is the case with taxes. It is for this reason that collecting fees for private services is a less distortionary way of raising resources for local governments. We had covered this in more detail here.

A cess is tied to an earmarked purpose. The money raised through a tax is held separately to fund a project that the cess is meant for. A Swachch Bharat Cess, for example, is a levy on services, the proceeds of which are used to fund the Swachch Bharat Abhiyaan. If you filed your income tax returns, you would have also noticed a health and education cess of 4 per cent. A legitimate question is that if this cess is being used to finance something as core as health and education, what were the taxes you pay being used for in the first place.

Through some legal chicanery, the government has another advantage of raising money through the cess route. This money doesn’t fall in the divisible pool that needs to be shared with other levels of government. Unsurprisingly, the union government has been raising cesses to subvert the Finance Commission’s recommendation of devolving a larger chunk of the divisible pool of money to state governments.

Surcharges are eviler. They are merely taxes on taxes. They are not raised for an earmarked purpose. Neither are the proceeds shared with lower levels of government.

So that’s that. There are many ways in which governments can extract money from you, some better some worse.

For more, read:

* Why cesses are evil

* Cesses and Surcharges: Concept, Practice and Reform, A Fifteenth Finance Commission Study conducted by Vidhi Centre for Legal Policy

Matsyanyaaya: Decoupling Dynamics

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

A lot has been written about businesses moving away from China as a fallout of geopolitical tensions with the US. Fewer write-ups have tried to imagine what this decoupling would actually look like. A recently released report by the European Union Chamber of Commerce in China & MERICS does a good job of analysing this process.

The report breaks down decoupling into nine layers in four major categories:

* Macro decoupling – political and financial;

* Trade decoupling – supply chains and critical inputs;

* Innovation decoupling – research and development (R&D), and standards; and

* Digital decoupling – data governance, network equipment and telecommunications services

Of these, the authors identify three layers of high concern — decoupling of critical inputs such as semiconductors, software, and rare earths, decoupling of data governance regimes, and decoupling of standards. In contrast, financial decoupling is less likely because of China’s inability to internationalise renminbi and its continued dependence on the US dollar even for its Belt and Road projects.

In short, the US-China confrontation is likely to play out over critical and emerging technology and not over finance and industrial production.

Finally, there’s a useful framework visualising how decoupling across the nine layers might look in three scenarios.

HomeWork

Reading and listening recommendations on public policy matters

* [Book Excerpt] Toppling the myth of meritocracy: Excerpt from Michael Sandel’s “Tyranny of Merit: What’s Become of the Common Good?”

* [Article] Robert Farrington writing in the Forbes: “The Moral Hazard Of Student Loan Forgiveness”

* [Article] Prohibition’s ghosts continue to linger in Mumbai, writes Shoaib Daniyal.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

News reports suggest the vaccination drive among frontline workers is going slower than expected.

The issue isn’t the supply. It’s demand.

Frontline workers seem to have apprehensions about the safety of the vaccines.

An Old Story

I was reading up on the history of vaccines last week after I heard a good BBC history podcast on Edward Jenner who did pioneering work on smallpox vaccine. Four points stood out:

* The scourge that was smallpox. It was super infectious, and the fatality rates were over 30 per cent. It wiped out civilizations as European powers spread it through South America and Africa. There was no real cure except something called variolation where a small amount of material from smallpox scabs were given directly to healthy people. These healthy people then developed symptoms of smallpox but these were milder. Fewer of them died through this than the normal method of getting the pox.

* Jenner discovered vaccination somewhat serendipitously. He came across a milkmaid who told him she won’t get smallpox because she had already got cow pox (a milder disease). Jenner tested this theory by giving his gardener’s son a small dose of cow pox material. After a few months, he exposed the boy to the smallpox virus on multiple occasions. The boy never developed smallpox. Soon, Jenner wrote his treatise ‘On the Origin of the Vaccine Inoculation’. It wasn’t accepted by any reputed journal because it lacked adequate scientific rigour (even for those days). Jenner self-published the treatise.

* The vaccination method became hugely popular. There was no state drive to spread it. People tried it out and it spread through word of mouth. So widespread was Jenner’s fame that when France jailed a few doctors from England on some specious charge of espionage, he wrote to Napoleon to free them. Napoleon agreed because it was Jenner.

* The anti-vaxxer movement started right away. Since Jenner published his methodology for anyone to adopt, the doctors who earned their living through variolation and its side effects didn’t take to it. They did their bit by spreading misinformation. Also, injecting cow pox material meant other infections could get into a health person. This meant there were always cases of people contracting, or even dying, of other diseases after taking the vaccine. The vaccine scepticism took roots. And it hasn’t gone away since then.    

Why The Scepticism?

This got me thinking on why is it difficult for people to believe in the effectiveness of vaccines? Or, on climate change? Or, why do good policy proposals often lack popular support?

Three reasons seem likely:

* Our brains aren’t wired to believe non-intuitive concepts. These concepts aren’t often self-evident. Even if we understand them in theory, we end up doing the more intuitive wrong thing in practice. Behavioral economists have demonstrated this with multiple experiments. Vaccination is a non-intuitive concept. To inject oneself with a mild variant of a disease willingly in the hope that it will create long-term immunity goes against the intuitive idea of self-preservation. The notion of price in economics is similar for lay people. That price is a signal that adjusts itself to demand and supply instead of being centrally controlled is difficult to comprehend even if you are taught the theory. The first instance of surge pricing by Uber and the theory collapses. You believe it must be controlled. Pretty much the same way we react when people hear the news of deaths after vaccination.

* People don’t get probabilities. That more people will likely die without a vaccine than because of an unproven side effect of taking the vaccine can be proven with data. But the notion that we invite the side effects because we take a vaccine on our own while contracting a disease is outside of our control is quite strong. This obfuscates our understanding of probability. Even during the current pandemic, the probabilities weren’t clearly thought through by the policymakers. The Covid-19 vaccine was clinically ready almost a year back when we had the virus genome mapped. From then on it was about doing a sound cost-benefit analysis of what level of vaccine testing is acceptable given the costs of loss of human lives and the impact of lockdown on the economy. We might have been ready to use a vaccine much earlier had we done this right. In any case, that the vaccine is ready within a year when compared to almost a decade it took earlier is proof that we have taken a right probabilistic call, albeit a bit late. This should have been the norm earlier.

* News amplifies exceptions and this erodes the trust on experts. You will not hear of the millions who have taken the vaccines without any side effect. But every single death of someone who has taken a vaccine will be reported. That the cause of death is unrelated to the vaccine itself will struggle to find space in the news cycle. This is because we are looking for adverse news to confirm our intuitive bias about it. The more we come across this kind of news, the greater our scepticism of experts. Conspiracy theories take off from here.

The solution to this kind of scepticism about a sound public policy is available. Eugene Bardach in his seminal book A Practical Guide for Policy Analysis outlined the eightfold path to arriving at a policy decision. The eighth and the final step is ‘tell your story’ which is as important a step as any of the previous steps taken to arrive at the policy decision. This is often an area that’s given less thought by policymakers as they plan a rollout. I suspect we have done the same with the vaccination programme in India.

As Bardach writes:

If one of your goals is to engage a lay audience, keep in mind that ordinary folk are rarely moved by statistics alone. Indeed, relying on numbers to demonstrate the importance of addressing a problem can actually undermine the psychological processes needed to prompt a response; people may not only fail to grasp the statistics, they may be numbed into inaction. Data and statistics are obviously indispensable to analysis, but when it comes to telling your story to a general audience, be sure to put a human face on the problem. And show how your solution could make life better for real people.

If you are making a clear recommendation, make sure that you raise and rebut possible objections to it that might occur to various important audiences. Also, make sure that you compare it to what you or others might regard as the next best course of action, so as to be ready to show why yours is better.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Charlemagne in The Economist on ‘Why is Europe so riddled with vaccine scepticism?’

* [Article] A comprehensive view by The Guardian on vaccine scepticism

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

A Framework a Week: The Basis of Morality

Tools for thinking public policy

- RSJ

The other day at a dinner with a few friends (in our ‘bubble’) the topic of farm laws came up. The usual argument followed. Farmers need to be freed from the overbearing power of the state that has kept them poor for so long versus Ambani/Adani will take over and control food prices in future leaving nothing for the farmers or the consumers. Things were going according to the script till the issue of morality came up. Both sides were convinced they had the stronger moral argument to support them. Luckily, the dinner was served and good food quietened things down.

This set me thinking about how we think about morality. Regardless of how we define political axes in India (left vs right, liberal vs conservative, statist vs free marketer), each side arrives at their ideology based on what they believe is morally right for the society. What’s the basis for our inherent self-righteousness and why does it differ among people?

About Morality

Jonathan Haidt in his superb book The Righteous Mind: Why Good People are Divided by Politics and Religiongoes deep into this question. When he was at graduate school, Haidt learnt about Kohlberg’s six stages of moral reasoning. This model (Kohlberg’s) developed in the early 60s held that moral reasoning which forms the basis for ethical behaviour evolves over six developmental stages. These six stages were broken into three levels: pre-conventional, conventional and post-conventional. Each stage was more evolved and better at responding to moral dilemmas than the last. Kohlberg’s six stages were:

Level 1 (Pre-Conventional)

* Obedience and punishment orientation

* Self-interest orientation( What's in it for me?)

Level 2 (Conventional)

* Interpersonal accord and conformity( The good boy/good girl attitude)

* Authority and social-order maintaining orientation( Law and order morality)

Level 3 (Post-Conventional)

* Social contract orientation

* Universal ethical principles (Principled conscience)

Haidt found something amiss in this model. It seemed too cerebral with the rational mind driving moral decisions. In 2001, he wrote The emotional dog and its rational tail where he presented the social intuitionist model as an alternative to the rationalist model. Haidt’s point was simple: moral judgment was widely believed to be caused by moral reasoning. Instead, he argued, we reach a moral judgment based on our intuitions that are shaped by moral and cultural factors (link 1 in the model below). We construct a scaffolding of moral reasoning after that to support our judgment (link 2). Judgments based on reason (link 5) and change in intuitions after private reflection (link 6) are quite rare.

Theory Of Moral Intuition

It is a far-reaching paper that helps explain a lot of things around us.

What did Jefferson mean when he held certain truths as ‘self-evident’? Or, why do we now believe politics is downstream of culture? You can’t change politics unless you change culture. Why is this true? Or, why do you often end up in a political argument feeling frustrated that the other side doesn’t see your point of view which is moral or right?

To Haidt, this is because of our moral intuition. We don’t know why something is wrong but we just know it’s wrong. Haidt defined moral intuition as:

“..the sudden appearance in consciousness of a moral judgment, including an affective valence (good-bad, like-dislike), without any conscious awareness of having gone through steps of search, weighing evidence, or inferring a conclusion. Moral intuition is therefore the psychological process that the Scottish philosophers talked about, a process akin to aesthetic judgment: one sees or hears about a social event and one instantly feels approval or disapproval.”

Haidt gave the elephant-rider metaphor to explain this. This is a metaphor to explain how our unconscious mind guides our conscious rational faculty. The elephant is the total of our intuitions and our unconscious influences. It is large and chooses its own path. The rational conscious mind is like the rider on the elephant. She thinks she is controlling the elephant but that isn’t true.

“the mind is divided into parts that sometimes conflict. Like a rider on the back of an elephant, the conscious, reasoning part of the mind has only limited control of what the elephant does.”

Only a very skilled rider can sometimes change the course of the elephant. That’s the reason only the really sharp minds on either ends of the political spectrum can intellectually and morally justify the intuitions of the masses and direct them to a political or social goal. As Haidt concludes in his paper:

“The time may be right, therefore, to take another look at Hume’s perverse thesis: that moral emotions and intuitions drive moral reasoning, just as a surely as a dog wags its tail.”

But this wasn’t enough. Why do we have different moral reasoning among us? Why do two brothers who grew up together in the same household often hold diametrically opposite political views?

Our Moral Foundations

Haidt (with others) built the moral foundation theory to explain the differences in moral valence among people. They argued humans have six universal moral foundations that develop in them over time depending on culture, social interactions and their own understanding of the world around them. They proposed the five foundations of morality and later added a sixth:

1) Care/harm: This foundation is related to our long evolution as mammals with attachment systems and an ability to feel (and dislike) the pain of others. It underlies virtues of kindness, gentleness, and nurturance.

2) Fairness/cheating: This foundation is related to the evolutionary process of reciprocal altruism. It generates ideas of justice, rights, and autonomy. [Note: In our original conception, Fairness included concerns about equality, which are more strongly endorsed by political liberals. However, as we reformulated the theory in 2011 based on new data, we emphasize proportionality, which is endorsed by everyone, but is more strongly endorsed by conservatives]

3) Loyalty/betrayal: This foundation is related to our long history as tribal creatures able to form shifting coalitions. It underlies virtues of patriotism and self-sacrifice for the group. It is active anytime people feel that it’s “one for all, and all for one.”

4) Authority/subversion: This foundation was shaped by our long primate history of hierarchical social interactions. It underlies virtues of leadership and followership, including deference to legitimate authority and respect for traditions.

5) Sanctity/degradation: This foundation was shaped by the psychology of disgust and contamination. It underlies religious notions of striving to live in an elevated, less carnal, more noble way. It underlies the widespread idea that the body is a temple which can be desecrated by immoral activities and contaminants (an idea not unique to religious traditions).

6) Liberty/oppression: This foundation is about the feelings of reactance and resentment people feel toward those who dominate them and restrict their liberty. Its intuitions are often in tension with those of the authority foundation. The hatred of bullies and dominators motivates people to come together, in solidarity, to oppose or take down the oppressor.

As Haidt writes in the book:

“"the moral matrix of a culture is something like its cuisine: it’s a cultural construction, influenced by accidents of environment and history, but it’s not so flexible that anything goes. You can’t have a cuisine based on grass and tree bark, or even one based primarily on bitter tastes. Cuisines vary, but they all must please tongues equipped with the same five taste receptors. Moral matrices vary, but they all must please righteous minds equipped with the same six social receptors."

Why We Differ?

Over time Haidt developed a moral foundation questionnaire to understand how people from different political orientations (mostly from the US) valued the five moral foundations (the questionnaire dropped liberty). The results over thousands of surveys suggest the crux of the disagreement between liberals and conservatives (we are using the current American meaning of these terms here). Liberals value Care and Fairness deeply while Conservatives give almost equal weightage to all five foundations almost equally. As the abstract of the paper (the full paper is here) summarises:

“Across 4 studies using multiple methods, liberals consistently showed greater endorsement and use of the Harm/care and Fairness/reciprocity foundations compared to the other 3 foundations, whereas conservatives endorsed and used the 5 foundations more equally. This difference was observed in abstract assessments of the moral relevance of foundation-related concerns such as violence or loyalty (Study 1), moral judgments of statements and scenarios (Study 2), “sacredness” reactions to taboo trade-offs (Study 3), and use of foundation-related words in the moral texts of religious sermons (Study 4). These findings help to illuminate the nature and intractability of moral disagreements in the American culture war.”

Haidt (and Graham) argue that we need to use all five moral foundations to understand political or social issues. This suggests the onus is on the liberals to make the extra effort to go beyond their two values. This has earned the theory ire from the liberals. Haidt, who calls himself a liberal, has a more balanced view of this. He suggests we all need to step out of our moral matrix. We need to appreciate the diversity of our moral foundations. Once we do that it will be easier to step into others’ shoes.

That, like it is apparent to all of us these days, is easier said than done.

Matsyanyaaya: Vaccine Diplomacy

Big fish eating small fish = Foreign Policy in action— Pranay Kotasthane

India’s vaccine diplomacy was widely discussed this week. On one hand, a few heads of state and international media organisations lauded the Indian government’s decision to supply vaccine shots for free even as its own domestic vaccination campaign has only started. On the other hand, there were arguments suggesting that the government should’ve first vaccinated its priority population before letting a single vial out. That in the amoral context of international relations, giving away vaccines for free amidst a health emergency is unaffordable altruism.

So, how to make sense of this?

I would argue that it’s not altruism but national self-interest that guides international humanitarian assistance efforts by all states. The Indian government’s vaccine diplomacy can also be explained through this lens of self-interest.

Let’s consider the facts first. 3.2 million Covishield vaccines have been supplied under grant assistance to a handful of neighbouring states out of the 11 million procured by the Indian government. Moreover, of the 30 million priority-sector workers supposed to be vaccinated under phase 1 of India’s vaccine programme, only 1.5 million have been vaccinated by Jan 23th.

Now consider the options in front of the Indian government. One option would have been to wait for phase 1 to complete before gifting vaccines away. As such, this option doesn’t mean that the recipient countries would’ve been left high and dry. They would’ve had to wait for commercial exports of Covishield outside the GoI’s procurement like Brazil did. A second option would’ve been to block all commercial exports of vaccines manufactured in India until phase 1 is completed. A third option would’ve been to divert a part of the procured lot to select countries right at the outset to signal the positive role that India can play in the world order. The first two options can easily be argued as hard-nosed realism. But its the third option, the one that India chose, needs more reflection.

While it is true that this one act of benevolence is unlikely to change the future behaviour of nation-states towards India, it crucially reminds the smaller states in the subcontinent that India cannot be easily substituted by China, especially given how opaque the latter’s vaccine journey has been thus far. Extending help in a crisis situation also improves India’s credibility in international fora. Finally, the norms of international cooperation have evolved in a way that makes complete apathy more costly than non-reciprocal overtures. In 2015, Pavan Srinath and I had written this in the context of humanitarian assistance and relief efforts:

“Countries are expected to do a certain minimum amount of international disaster relief, be it unilaterally, or through contributions to charities. This minimal assistance has increasingly acquired characteristics of altruism. Many animals give out distress calls for the benefit of the herd and at possible cost to itself. Similarly, international disaster relief is a slowly becoming a norm that is obeyed without explicit rewards except that of building an atmosphere of cooperation.”

In short, India’s vaccine diplomacy is an act of self-interest but not selfishness.

As for the question of vaccinating Indians, it’s not the lack of doses that are holding things up. The government needs to enlist the help of private enterprises to increase the pace of vaccine deployment as soon as priority-sector workers have been reasonably covered.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] The Moral Roots of Liberals And Conservatives: Ted Talk by Jonathan Haidt

* [Article] Kohlberg’s Stages Of Moral Development

* [Blog post] This meta-post on Gulzar Natarajan’s Urbanomics blog is a must-read for anyone interested in public policy in India. Don’t miss the linked article: Overcoming behavioural failings: Insights for public administrators and policymakers.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- Pranay Kotasthane & RSJ

It’s the 72nd Republic Day today (as we write this). The Constitution of India is a revolutionary document. The past few years have seen some wonderful works of scholarship about our constitution. We’d like to call out a few here.

The Constitution will remain a distant and daunting document as long as we don’t develop a habit of referencing it directly. Thankfully, EBC has been publishing a coat pocketbook version since 2009. It works great as a reference book. And it doesn’t hurt that it looks elegant and makes for a wonderful gift. As an aside, a dream project of mine is to convert the constitution into a knowledge graph that visually connects the cross-referencing articles in the Constitution. If any AtU reader has the technical chops to make this happen, please ping us.

Madhav Khosla’s India’s Founding Moment: The Constitution of a Most Surprising Democracyis a brilliant and erudite work that is essential to understand the radical nature of our Constitution and the interplay of ideas and debates among people who cared deeply for this nation that led to its creation.

Rohit De’s A People’s Constitution: The Everyday Life of Law in the Indian Republic challenges the idea that our Constitution was the product of an elitist imagination whose impact in the lives of ordinary Indians was minimal. De uses four examples to make his case about the Constitution empowering the people of India to take on the state.

Tripurdaman Singh’s Sixteen Stormy Days: The Story of the First Amendment of Constitution of India shows how the idealism of the Constitution became a difficult burden to bear while running a government. No constitution can be eternally infallible. But we set a precedent of changing the architecture of our Constitution really early in the life of our Republic. We might never recover from that ‘original sin’.

Gautam Bhatia’s The Transformative Constitution: A Radical Biography in Nine Actsexplains in detail why the Constitution at its core aims to bring about a social revolution. Many a constitution aim to transform the polity and economy but few aim to change society itself. This is what sets the Indian Constitution apart. The classic work on this line of reasoning is Granville Austin’s The Indian Constitution: Cornerstone of a Nation.

This passage from Rohit De’s A People’s Constitution helps make sense of the remarkable achievement that the Indian Constitution is.

“The Indian Constitution was written over a period of four years by the Constituent Assembly. Dominated by the Congress Party, India’s leading nationalist political organization, the assembly sought to include a wide range of political opinions and represented diversity by sex, religion, caste, and tribe. This achievement is striking compared to other states that were decolonized. Indians wrote the Indian Constitution, unlike the people of most former British colonies, like Kenya, Malaysia, Ghana, and Sri Lanka, whose constitutions were written by British officials at Whitehall. Indian leaders were also able to agree upon a constitution, unlike Israeli and Pakistani leaders, both of whom elected constituent assemblies at a similar time but were unable to reach agreement on a document. The Indian Constitution is the longest surviving constitution in the post-colonial world, and it continues to dominate public life in India. Despite this, its endurance has received little attention from scholars. [Rohit De, A People’s Constitution, pg 2]

To explain the last point visually here’s a comparative chart plotting the number of constitutions against the year of independence for Asian states.

India, of course, falls in the heavily clustered zone labelled “independence era states” - political communities that overthrew European colonialism to establish new nation-states. Zooming in this era, we find that a handful of constitutions in Asia have survived. Only three amongst them had a constituent assembly that brought together people to make their own constitutions. And even amongst the ones where one constitution has survived this far, most have been beset by politically active militaries and dictatorships. The Indian constitution is without a doubt an exception to be proud of.

Among the many flaws that are often pointed out about our Constitution, the one we disagree most with is about how unmoored it was from India’s past. The accusation is we didn’t try and locate the great ideas and values of the Constitution in our past. This created a sense of distance of the ordinary Indian from the ideals of the people’s Constitution. We have two problems with this line of argument. First, this alienation from our tradition (if true) was to be bridged by later scholars and interpreters of the Constitution including legislators and administrators. The members of the Constituent Assembly shouldn’t have been expected to also write a commentary on it in parallel. Second, there are multiple references to how the principles enshrined in it are consistent with the best of our historical tradition.

Another common criticism is that the Constitution reproduced two-thirds of the GoI Act of 1935 and hence wasn’t transformative enough. What’s forgotten of course is that the 1935 Act itself was a result of a powerful Indian independence movement’s consistent political pressure on the British government. The charge of not being transformative enough” needs rethinking.

We will leave you with two excerpts of speeches made in the Assembly that support the assertion that the Constitution is consistent with the best of the Indian historical traditions while leaving out the undesirable elements.

On 17th October 1949, J.B. Kripalani made both the points we have stated above:

“Sir, I want, at this solemn hour to remind the House that what we have stated in this Preamble are not legal and political principles only. They are also great moral and spiritual principles and if I may say so, they are mystic principles. In fact these were not first legal and constitutional principles, but they were really spiritual and moral principles. If we look at history, we shall find that because the lawyers and politician made their principles into legal and constitutional form that their life and vitality was lost and is being lost even today.

Take democracy. What is it? It implies the equality of man, it implies fraternity. Above all it implies the great principle of non-violence. How can there be democracy where there is violence? Even the ordinary definition of democracy is that instead of breaking heads, we count heads. This non-violence then there is at the root of democracy. And I submit that the principle of non-violence, is a moral principle. It is a spiritual principle. It is a mystic principle. It is a principle which says that life is one, that you cannot divide it, that it is the same life pulsating through us all.

As the Bible puts it, "we are one of another," or as Vendanta puts it, that all this is One. If we want to use democracy as only a legal, constitutional and formal device, I submit, we shall fail. As we have put democracy at the basis of your Constitution, I wish Sir, that the whole country should understand the moral, the spiritual and the mystic implication of the word "democracy". If we have not done that, we shall fail as they have failed in other countries. Democracy will be made into autocracy and it will be made into imperialism, and it will be made into fascism. But as a moral principle, it must be lived in life. If it is not lived in life, and the whole of it in all its departments, it becomes only a formal and a legal principal. We have got to see that we live this democracy in our life.”

And more famously, Dr. B.R. Ambedkar in his last speech at the Constituent Assembly draws upon our past:

“It is not that India did not know what Democracy is. There was a time when India was studded with republics, and even where there were monarchies, they were either elected or limited. They were never absolute. It is not that India did not know Parliaments or Parliamentary Procedure. A study of the Buddhist Bhikshu Sanghas discloses that not only there were Parliaments-for the Sanghas were nothing but Parliaments – but the Sanghas knew and observed all the rules of Parliamentary Procedure known to modern times. They had rules regarding seating arrangements, rules regarding Motions, Resolutions, Quorum, Whip, Counting of Votes, Voting by Ballot, Censure Motion, Regularization, Res Judicata, etc.Although these rules of Parliamentary Procedure were applied by the Buddha to the meetings of the Sang has, he must have borrowed them from the rules of the Political Assemblies functioning in the country in his time.

This democratic system India lost. Will she lose it a second time? I do not know. But-it is quite possible in a country like India – where democracy from its long disuse must be regarded as something quite new – there is danger of democracy giving place to dictatorship. It is quite possible for this newborn democracy to retain its form but give place to dictatorship in fact. If there is a landslide, the danger of the second possibility of becoming actuality is much greater.”

The above lines are followed by his famous ‘Grammar of Anarchy’ passage. He knew what he was talking about.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] Ambedkar’s speech at the Constituent Assembly

* [Document] Judgment on Shankari Prasad vs Union of India: The First Constitution Amendment Act, 1951 was challenged in the Shankari Prasad vs. Union of India case. The Supreme Court held that the Parliament, under Article 368, has the power to amend any part of the constitution including fundamental rights.

* [Podcast] On Puliyabaazi, Rohit De joins Saurabh and Pranay to discuss India’s tryst with constitutionalism.

* [Article] Democracy and the Republic - the differences between these two concepts.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

Global Policy Watch: Capital Markets (Enter, Stage Right) - Radically Networked Societies

- RSJ

It is difficult to write a newsletter this weekend and not talk about GameStop. Even for a public policy newsletter. But I like to believe if you hold your gaze long enough at any news going around, you will find a public policy problem. This becomes especially true if you run a twice-a-week public policy newsletter. Everything starts looking like a public policy issue soon enough.

Anyway, a lot of what’s happened with the GameStop stock over the last couple of weeks is part of the broader gusts of change that’s buffeting society and culture since the global financial crisis (GFC). In that sense, it is useful to try and look beyond the story to understand the GameStop phenomenon. But let’s not get ahead of ourselves. Let’s do a quick recap of the story.

GameStop is a brick-and-mortar video game seller. A fairly routine presence across large malls across America, GameStop was meandering its way into irrelevance over the last many years. After all, who goes to the mall to buy video games anymore? And then the pandemic arrived to compound its woes. Its days seem numbered. Soon it would join the likes of Blockbuster, JC Penney and scores of other businesses that couldn’t reinvent themselves for the digital age. That was the consensus on Wall Street.

The Short Squeeze

But the Street is a strange place. A business with no prospects is also an opportunity to make money. By shorting its stock. You borrow a few shares of the company from someone (usually a broker) and you sell them in the market. Since you are borrowing the shares you pay a small charge for it. Plus the broker wants a bit of insurance in case things go bad. So you keep some money in an account that the lender can access in case things go south. Since you believe the stock price will go down, you wait for it to happen. When it does, you buy the same number of shares at the lower price and return them back to the broker. You pocket the difference. This is how it goes for any ordinary investor. If you happen to be a star fund manager of a hedge fund, you make it known to the world you are shorting the stock. You have a platform to voice your views and you send out a signal the stock will tank. Often this turns out to be a self-fulfilling prophesy. The stock does go down on your word and momentum does the rest. You make a tidy profit for your clients and a fat commission for yourself.

Of course, plans go awry too. The stock goes up contrary to your bet. You think this is temporary so you wait. But the broker is nervous and wants some assurance. So you top up the account where you had put some money in case things went bad. If the stock keeps rising, you have to keep topping this up. Since your loss can be unlimited (the stock can keep rising), you feel hemmed in as the stock rises. You feel squeezed. So you decide you want to call this bet off. The only way to do this is to buy the stock at an elevated price. You do that. But remember you are not the only one who had shorted this stock. As the likes of you buy the stock at the elevated price, the price goes up further. And other short sellers feel the squeeze. This is called short squeeze. It can wipe you out.

That’s that. Life is too short to know any more about short selling.

And The Gamma Squeeze

On the other hand, there are people who bet the stock price will go up. That’s usual. The riskier bet is buying a call option on a stock. Here you don’t buy the stock. Instead, you buy an option that the stock will go above a certain price. This is a small bet. You lose all money if the stock doesn’t reach there. But if it does, you make a lot of money on a small bet. Since this is a bet, there’s always the other party (market maker) that’s sold you the bet. They sell many such bets. And to hedge their bets they go out and buy a small number of the underlying stock. In case the stock price does go above the bet price, they will atleast recover some of their losses if they own that stock. For simplicity let’s call the rate of buying the stock to hedge the bet as ‘delta’. You can see where this is heading. If the stock keeps going up and more people buy call options, you will have the market makers buy more of that stock. This in turn drives the price further up. That is the delta keeps becoming faster. This rate of change of delta is called gamma. It is like acceleration. And this kind of squeeze in favour of stock going up is called the gamma squeeze.

Life is complicated enough already to know any more about Greek letters in stock markets.

Unstoppable GameStop

Events conspired in mysterious ways to bring both the short squeeze and the gamma squeeze to the GameStop stock overt the past few weeks.

* There’s a Reddit forum (r/WallStreetBets) that has a mix of investors - small-time investors with deep knowledge of the markets (very few), bored young men (mostly men) who trade in markets for a lark (few more), thrill-seekers and degenerates who trade by turning economic logic on its head (many more) and gullible new investors who are drawn into this in the hope of getting tips to make a quick buck (the largest number). The forum members see themselves as Davids taking on the Wall Street establishment (Goliath). Fun fact: only 14 per cent of Americans directly invest in individual stocks and 3 out of 4 of them belong to the top 20 per cent of American households by income. Calling themselves the ‘little guys’ is a bit rich.

* Sometime last summer a few members of the forum started making a case for GameStop as a stock that’s undervalued. The stock was trading at about $4 then. There was no rationale. It was pure optimism backed by hopes of a turnaround in the business. But that’s how even the best equity analysts often make a case for a stock. Or a VC fund values a start-up. The stock caught fancy of a few members in the forum and rallied a bit.

* In September, Ryan Cohen, an entrepreneur who sold his online pet store Chewey for $3.5 Bn a few years back, bought about 12 per cent of GameStop at $8.4 per share. Cohen believed he could turn GameStop into an online success. This was the validation the WallStreetBets members were looking for. The stock doubled in three months soon after.

* In January this year, things got weirder. GameStop was one of the most shorted stocks in the market (the total shorts were more than the available outstanding shares). As it rallied up, some of the prominent short sellers started talking down the stock. Particularly, two firms - Melvin Capital and Citron Research - called out the insanity around the stock. Now a word about short sellers, hedge funds and other established fund houses on Wall Street. For years since the GFC, there’s been a wave of simmering anger against them from the retail investors. Deservedly. These firms have done it all - cartelisation, manipulation of stocks leading to fake momentum and selling toxic products to ordinary investors. The calling out of GameStop rally by them triggered something extraordinary.

* The WallStreetBets forum decided to apply the short squeeze on the short-sellers. It was the mother of all squeezes. Meanwhile, GameStop brought Cohen and his two buddies on to their Board. Momentum was on. Gamma squeeze was in. The stock went berserk. From $20 to $320 over two weeks with wild fluctuations. Over 20 Bn shares were being traded daily making it the most traded stock in the world. Nothing had changed in its underlying business. In fact, the numbers were looking worse. But this wasn’t about GameStop anymore.

* In these two weeks, the whole thing has turned into a movement. It is no longer about making money. It is about making a statement. Socking it in the face of the establishment. There’s no logic anymore. It is a cult. Citron and Melvin have closed their positions and made extraordinary losses. These wins have given more life to the movement. Shorted stocks of companies that can hardly have a future have quadrupled. These include names like AMC, Blackberry (remember) and Nokia. The whole thing is nuts.

The bar for absurdity in Wall Street lore is high. Short squeezes have a long history. The original baron, Cornelius Vanderbilt, once short squeezed the life out of NYC Council members who were betting against him. The railroad empire he built was the result of that. George Soros took a $10 Bn short position on the British Pound and almost broke the Bank of England in 1992. And in the early days of the pandemic last year, the crude oil price went below zero. There’s something about the GameStop story that tops them all. There was a rational economic explanation to the earlier events however bizarre they appeared. This one goes beyond economics.

Markets In The Crosshairs

Four trends now deeply embedded in our culture and politics seem to have marked their arrival in the markets with this story.

* Radically Networked Societies (RNS) meet Capital Markets: Nitin Pai and Pranay define a radically networked society as a web of hyper-connected individuals, possessing an identity (imagined or real), and motivated by a common immediate cause. The emergence of RNS aided by cellphones, cheap data connectivity and social media platforms is a phenomenon for the hierarchical state to contend. The immediate cause that motivates an RNS could be irrational but before the state or the established institutions can even put their shoes on, the RNS might have gone around the world twice with their message. This is what fuelled the bizarre stories emerging from the suicide of a Bollywood star during the pandemic or with the rise of the QAnon movement in America. Well, RNS is now in the markets. The WallStreetBets is a classic case of RNS. A bunch of hyperconnected, mostly anonymous investors who view themselves as Wall Street outsiders and whose immediate cause is to take down short sellers and hedge fund managers. That their chosen targets are a greedy, egoistic bunch divorced from reality has made their job easier. The story sells itself - the long due revenge of the ordinary investor.

* Knocking the experts off their pedestal: The experts are all sold out. They have an agenda and they won’t tell you the truth. That’s the message that’s mainstream now in politics and culture. This is what drives the anti-vaxxers, climate science deniers, trade protectionists and other conspiracy theories going around. Now add the Wall Street experts to this list. If a research analyst says a stock has no future, bet against her. Do the irrational thing and if it pays off for even a day, you have been proved right.

* The crowd is right: What are people like you buying, watching, eating or wearing? So many people can’t be wrong. If I can watch and enjoy something based on what others are watching, I can buy a stock the same way. Zero brokerage platforms like Robinhood and Public have built their business models around this. Gamify the stock markets. Make it addictive. The millennials seeking thrill sitting at home during the pandemic have a new destination. Buy stocks, buy options and have fun. Let them buy high, sell low and take a selfie while doing so. You earn street cred doing this within your community. Who cares about the losses? YOLO.

* It is personal: Hyper-personalisation, the market of one, call it by any name. You are now invested deeply in your belief and your platform. It is your identity. The echo chamber you inhabit keeps reinforcing this belief. After a while, even the platform has no control over you as Twitter and Facebook have seen over the years. And Robinhood discovered to its dismay last week. They will take you down too. Because it is all personal. You can’t just let Citron Research or Melvin Capital have a view about GameStop that’s contrary to yours. They have to be taken down.

The GameStop phenomenon is just the beginning. It is like the Arab Spring of 2011 engineered on Twitter. Today it seems like a moment when the little guys took on the big, brutish establishment and won. This victory, like that of the Arab Spring, will be pyrrhic. The genie that escaped from that movement has been hard to put back into the bottle. The markets will now have to contend with the genie. It is out.

For those like us who battle to protect the fast receding middle ground everywhere, this is a new front. Anything that elicits support from both Alexandria Ocasio-Cortez and Ted Cruz must give the classical liberal a pause. That moment for Capital Markets is here.

A Framework a Week: Three Functions of the State

Tools for thinking public policy

- Pranay Kotasthane

Public Finance in Theory and Practice (1973) by Musgrave and Musgrave has an elegant classification of budgetary functions. Since you’ll be bombarded with the news about the union budget over the next few days, this classification would be of some use.

From a public finance perspective, the three main functions of the State are allocation, distribution, and stabilisation.

Allocation of social goods needs to be done primarily by the State because the market is likely to under provide such goods. Consider a private company willing to install street lights in your area for a fee that will be collected from all residents. Residents are likely to underpay because the benefits of good lighting will accrue to strangers beside themselves. Most people would prefer freeriding, the result being unlit streets. Here’s where the state comes in to allocate such social goods and imposing mandatory taxation, it tries to prevent freeriding.

Distribution of income or wealth is another important and perhaps the most controversial function of the State. If the income distribution is not in line with what the society perceives as being “fair”, the State tries to alter the distribution pattern. For example, it is now widely accepted that poverty and food insecurity are undesirable in the Indian society and hence there is broad support across the political spectrum for some subsidies to the poor.

Further, there are three fiscal instruments for redistribution:

* a tax-transfer scheme, combining progressive taxation of high-income with a subsidy to low-income households. example: tax money used for a direct benefit transfer for low-income families.

* progressive taxes used to finance public services, especially those such as public housing, which particularly benefit low-income households.

* a combination of taxes on goods purchased largely by high-income consumers with subsidies to other goods which are used chiefly by low-income consumers. example: GST rate of zero for grains and salt but tenwty-eight percent for cars.

All three instruments of distribution distort markets and hence need to be used in moderation. In a previous edition, we have written why a tax-transfer scheme is better than loading a tax-system with multiple objectives.

Finally, macroeconomic stabilisation seeks to achieve desirable levels of macroeconomic indicators such as inflation and unemployment since the market-determined values might not be optimal. Increase in the budget for the employment guarantee scheme (MGNREGS) due to COVID-19 is an example of budgetary policy being used to stabilise the unemployment situation.

Stabilisation can happen through these two instruments:

* Monetary instruments such as interest rates, discount rates, and open market operations, or

* Fiscal instruments such as raising public expenditures on infrastructure.

Often, a budgetary policy designed for one of these functions can cause problems in the other. For example, a government trying to stabilise inflation by banning exports of commodities can affect the distribution of incomes of producers. This is the precise predicament of export bans on onions. Hence the grand challenge is to design policies that minimise such conflicts.

Humour: Green shoots

The Union budget will be presented tomorrow and we bet you’ll hear the phrase ‘economy green shoots’ at least once. Many growth rate-based narratives around the economic recovery will compete with each other. So, here’s a pic in anticipation of all that — green shoots on a money plant.

HomeWork

Reading and listening recommendations on public policy matters

* [Audio] Amit Varma with Pranay on Radically Networked Societies in The Seen And The Unseen

* [Article] Kevin Roose’s The Shift column in The New York Times: The GameStop Reckoning Was a Long Time Coming

* [Article] Sarthak and Pranay have an article in Deccan Herald on an underrated budget document.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

The once in a century budget is now behind us. The reaction to it has been positive even among those who tend to be sceptical about the economic management of this government. What we are interested now is to understand if the budget portends a more fundamental shift in the economic policy or the outlook of this government.

Quick Take

As a newsletter, we like to avoid quick takes on events. But this time around a quick take is unavoidable. Here’s our take:

First, after a long time, we have had a budget that is transparent about the finances of the government. The expectations following a year like we have just had were low. The government has used it to present a tough but true picture of its finances. The fiscal deficit for FY21 (the current year) is pegged at 9.5 per cent of GDP. The deficit for FY22 is estimated to be 6.8 per cent and the glide path to a 4.5 per cent target in FY 26 has been laid out. This will mean a deviation from the FRBM Act. The government plans to submit a fiscal deviation statement and introduce an amendment to the Act.

Off-budget chicanery like the FCI borrowings from National Small Savings Funds (NSSF) that were done to keep the fiscal deficit optically low is being junked. There were no new (questionable) welfare schemes introduced and the tax regime was left untouched. These are good signs. Also, the long-drawn glide path suggests the government is being realistic about the recovery while shedding some of its fiscal conservatism. The broad message is it is willing to spend to support the recovery and initiate a capital investment cycle.

Second, the lack of private investment growth was a key problem in the economy over the last decade. There are multiple structural and governance reasons for the same - we have not had real reforms on resolution or liquidation of stressed assets, many key industries have turned oligopolies aided by arbitrary regulatory regimes and there’s an absence of a long-term economic plan that gives entrepreneurs the confidence to make long-term bets.

The budget shows some intent in tackling these issues. There is a significant government investment planned to develop infrastructure. The details of the plan will have to be seen because on the surface the contribution of infrastructure spending to the fiscal deficit (in percentage) doesn’t seem to be moving. But I think we should give the budget the benefit of doubt here. And this spend is required because, given the state of the economy, the government will have to be at the forefront of cranking the investment cycle. The private sector can come in later to buy these projects with good gains for the government and run them efficiently. There are multiplier benefits of investing in infrastructure and the private investor confidence will follow. The announcement about privatisation of two PSU banks and one general insurer is also welcome. It might not mean much in real terms but it signals a bolder approach to reforms. Private investments are the subject matter of confidence.

Third, like many budgets that have come and gone, this one promises divestments and privatisation of public sector units across industries. But there are a few points of difference. There’s no way the fiscal deficit math will work out over the next many years in normal course of events. Not even when you consider the gradual path suggested in the speech. Unless, of course, the government raises capital through strategic stake sale in PSUs. Other ideas like monetisation of government land are attractive but trickier. So, its hands are forced this time and there’s a sense that the Overton Window has shifted on divestment. Also, the speech was more specific in its intent. It named names. This will get done.

Fourth, there are a few areas where the government is either out of ideas or continues to peddle bad ideas. The atmanirbhar and nation-first ideology is now well and truly established as it marks its entry into the budget document. Random custom duty increases make no sense. We should focus on making ourselves competitive and we have written multiple editions of this newsletter arguing why this reversion to the economic thought of the 70s will be counterproductive. But what’s a bad idea worth if it doesn’t grow roots?

The other rehash is the proposals to set up an Asset Reconstruction Company (ARC) to house the bad loans (“bad bank” as it is known) and incubating another Development Finance Institution (DFI). Both these proposals don’t address the root causes of financial sector stress. At best these are band-aid fixes that will take a lot of time and effort to set up and they will go down the same path of irrelevance. The solutions to ‘twin balance’ sheet problem lie in more fundamental reform in regulation, resolution framework and in reducing the arbitrary role of the state in the industry. We will have to wait for that day.

In summary, it is a good budget as much as we find it futile to rate a stock-taking exercise. The problem on hand is two-fold. The government will have to balance a whole host of conflicting objectives.

The liquidity in the system is at an all-time high. RBI narrowed the reverse repo corridor and sucked some liquidity out of the system a couple of weeks back. Yields that were moving up gradually over the last few months accelerated upwards after the budget. The FX operations of RBI continues because it has to constrain Rupee from appreciating too much. We are in danger of being called a currency manipulator. The dollar purchase continues to add to the liquidity. With the express tasks of controlling capital flow and the exchange rate, the impossible trinity comes into play. We start to lose control of the domestic monetary policy. This is evident as the money market rates have become unmoored from the policy and gone below repo levels.

The RBI also has to manage inflation, spur growth and support Rs. 12 trillion of government borrowings next year. This is a non-trivial challenge. Inflation is moderating but there are fears it will go up. The increased cess on petrol and diesel, continuing high liquidity and existing concerns that we still haven’t got all supply chains running to pre-Covid levels mean we can’t be complacent on inflation in the near future. But growth will need an accommodative stance while liquidity will need to be high to support borrowing. It is a conundrum. It will require great sagacity and wisdom to thread this needle.

For macroeconomy watchers, the next few years will be wonderful. We are keeping the popcorn ready.

On the Defence Budget

— Pranay Kotasthane

The first five items of the Union List in the Constitution all deal with defence. As the foremost responsibility of the Union, no budget discussion is complete without understanding the government’s spending plans on defence.

To understand the defence allocations for FY22, we need to understand what happened in FY21.

The revised estimates of FY21 have increased by a marginal 2.3 per cent over what was proposed in the last budget. But there’s been a significant change in the composition of this expenditure. The revised pension expenditure went down by nearly ₹9000 crores while the capital outlay increased by nearly ₹20,000 crores in the same period. This implies that the government has defrayed pension expenses over multiple years while focusing on capital outlay.

Most of this increase in capital outlay is accounted for by committed liabilities for equipment already purchased by the navy and the air force.

The FY22 budget retains the same level of expenditure as the revised expenditure figures of FY21 except on pensions, which are budgeted to go down by a further ₹10,000 crores. 

On the revenue side, with the Fifteenth Finance Commission recommending a non-lapsable fund for funding modernisation, the government can earmark proceeds from the sale of surplus defence land and sale of defence public sector enterprises for modernisation. Over the long-term, this route holds some promise.  

The key lesson is that the government managed to just about maintain defence expenditures at pre-COVID levels in the pandemic year. To confront China’s aggression, India’s military planning needs a change in approach; hopes of a sudden increase in defence allocations should be laid to rest.

HomeWork

Reading and listening recommendations on public policy matters

* On the defence budget, here’s a quick take by Pranay

* Ajay Shah reminds that reversing the dip in private investment should be the parameter for evaluating budget performance.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: Rahne Do, Rihanna

Insights on burning policy issues in India

- RSJ

In one of the recent editions on GameStop, I wrote about the Gamma squeeze and I was particularly pleased with myself. After all, there might not be many newsletters who over the last year could have shoehorned Dr Shreeram Lagoo, Louise Glück and Gamma squeeze into their editions. Maybe there’s someone up there who is keeping an eye out for me. Because this edition has Rihanna and Mia Khalifa (careful now) in it!

What a time to be alive and, importantly, to be writing on public policy!

The Farm Laws Backstory

We have written quite a bit on the new farm laws in the past few months. I believe the laws are critical to transforming agriculture in India. Pranay agreed on the potential of the laws but questioned the timing and the lack of a narrative by the government to make them acceptable to all stakeholders. He felt this could get sticky.

Turns out he was prescient. A simple stakeholder mapping exercise would have revealed the key farmer groups in Punjab and Haryana would be the most impacted by these laws. They needed specific attention. Further, the years of paranoia built by the Indian state itself about corporates, profits and other capitalist bogeys in farming would not just go away by a stroke of the pen. It should have been expected that it will be used by those in opposition to create a counter-narrative. A government that encourages opinions and arguments within its cabinet and among its coalition partners would have figured a way to anticipate and resolve these issues. But the usual shock and awe playbook that this dispensation favours came into play. An announcement about the new farm laws was made at the peak of the pandemic as part of the COVID relief package. Then came the ordinance, and finally the farm bills went to parliament where they were passed with a voice vote in Rajya Sabha. That, remember, was the only place where there was a half-decent chance of a debate. It was not to be.

Now you can argue that almost every party has in the past had similar laws as part of their manifesto. Or there have been umpteen committees who have recommended opening up of agriculture and dismantling of MSP. But only a political novice would believe these would mean everyone opposed to the government today would lay out the red carpet for these laws. Nothing this sensitive and transformative will be accepted in our fractured polity without building a narrative for it. But there wasn’t any strong ‘sell your story’ efforts for a set of reforms that if pitched right might have actually been supported by Greta Thunberg. After all, the groundwater depletion and other ecological imbalances in many states are because of incentives and distortions the MSP provides to grow crops alien to the land.

In A No-Win Situation

So here we are. The farmer protests have gathered strength. The government has offered an eighteen-month delay in implementing them. The commitment to continue with MSP has been made. In short, the reforms are dead in water. But it has made zero difference to protests. Because while making these conciliatory moves on one hand, the government has gone into an overdrive painting the farmers as anti-nationals and terrorists. The protests now have morphed into a Shivji ki Baraat - all kinds of assorted species are in it. Then we have the unedifying spectacle of spikes being nailed and battlefield-like fortifications on roads leading up to national capital. This is to prevent the farmers from entering it. This has now gone beyond farm laws.

Into this mix walked in Rihanna. On Tuesday, she tweeted out “Why aren’t we talking about this?’ with a link to a CNN article about headlined, ‘India cuts internet around New Delhi as protesting farmers clash with police’ to her 101 million followers. Soon Greta Thunberg and Mia Khalifa tweeted their support to the farmers. That’s it.

The radically networked societies (RNS) of their supporters coalesced with the network of Indians who were protesting the laws. So in the red corner, we had the Radically Networked Society -1 (RNS1). The government got into the act. Soon we had Indian film stars and cricketers supporting the laws (and more). And in the blue corner, we had the RNS2. To top it, the Ministry of External Affairs (MEA) also came out with an officious sounding formal statement asking global celebrities to stay away from matters relating to India. We now have a triangular contest of sorts - the state, RNS1 and RNS2.

Going Deeper

There are a few issues involved that merit discussion and conceptual clarity. Let me attempt to tackle them. Your thoughts are welcome.

* Like Pranay says, every issue is global by default in the times of RNS. You don’t have to be universalist to take a position on an issue that doesn’t affect you directly. Social media allows you to take a position and broadcast it to your followers. And you will. A vocal stand on issues generates cohesion among the members of your RNS. Cohesion strengthens RNS and draws more members. This is the RNS flywheel (Jeff Bezos who secretly reads us would be so proud of me for this analogy).

* Celebrities have taken a stand on issues unrelated to their countries for decades now. They are private citizens and they are free to do so. And there will be more of this kind of activism seen in future. The challenge for the state is, in the times of RNS, they can inflict serious damage on the objectives of the state by supporting a counter-narrative. I’m staying away from whether the objectives of the state are right or wrong for now. The state is hierarchical and it cannot be agile enough to contend with the speed of RNS mobilisation. The state has two options - continue with its slothful response or mobilise its own RNS. The Rihanna tweet followed by the tweets of the ‘state celebrities’ is the Indian state’s recognition of the power RNS, its own limitation to counter it through official means and its signal to others that it can mobilise its own RNS. Should states be doing this? Probably some action was needed as self-preservation is the primary goal of the state. RNS is a threat and they must learn and deploy counters to it. Also, this was a way to pre-empt other celebs from jumping on to the bandwagon. The rest of the narrative built about these celebrities being paid or being on the payroll of George Soros (that’s one guy with all the time and money with him to support leftist causes, around the world, apparently) is meaningless drivel. That’s just the loony supporters and the IT cell discrediting the other RNS. It is stupid and it helps mobilise the opposing RNS.

* The other question is how should we view Indians who encourage global celebrities, organisations or governments to take a stand on government action. Do these acts constitute support for violation of our sovereignty?

Firstly, global organisations and foreign governments do take positions on acts of other governments all the time. These positions are conveyed through diplomatic channels as a matter of routine. In case this doesn’t work they use the media to make their position known. The most common of these issues are those where there is an established global order of going about things. For instance, just last month the US Treasury department put India on the list of currency manipulators. Now, is this a violation of our sovereign right to manage our currency? We live and trade in a global order. So we should abide by its rules. Else, others will act in a manner that will question our sovereign moves. On other occasions, the issue could be of the government action violating human rights or being undemocratic. This is a tricky area since it is not easy to define them. But that hasn’t stopped India to opine on others over the years or vice versa.

Secondly, there’s no such thing as internal matter as the Indian state likes saying. In the RNS world, issues are global. Also, the farmers’ protests haven’t emerged out of thin air. There’s a cause and an effect. So, it serves no purpose to ask others to keep off our lawns if there’s smoke coming out of our house. Fixing the smoke is our problem, of course. But others asking us to have a look at it isn’t a violation of any sort. They are only making statements.

Thirdly, and this is perhaps the most important point, private citizens of India raising their voice against certain actions of the government in domestic and international platforms is not the same as treason against the state. The state exists because the citizens have given it the legitimacy to use violence. The citizens can and should question if the state steps beyond it. There’s a line there that the citizens can’t cross where their acts, not words, can threaten the existence of the state. But that line is quite distant. It can’t be invoked on the smallest of pretences. Unfortunately, this has now turned into conspiracy theories about a deep state wanting to destabilise India or preventing its pre-destined rise to being a superpower. Superpower pre-requisite #1 is to be secure enough not to wallow in conspiracy theories against you. Read more about USSR on this.

* The other point I had was about the role of institutions in a democracy. Acemoglu, Johnson & Robinson have argued about the nature and the strength of institutions as the fundamental reason for the sustenance of a democracy and for its long-term economic growth. This explains why democracy has struggled to develop roots in countries like Myanmar or in many nations that won their independence following WW2. And also, why its sustains in India. All the revisionism about our history, our freedom struggle or about Gandhi, Nehru and Ambedkar won’t wear out a single unvarnished truth. The founding fathers of our Republic built institutions and served to strengthen them to sustain our fledgeling democracy. Why do I bring up the point on institutions here? Well, a question I have asked in the past week is what prompted a host of our celebrities to copy-paste the exact tweet to support the government? And did the irony of following a government diktat to the letter while taking a stand against propaganda was lost on them? Do they really believe in the benefits of the farm laws? Is this a show of patriotism? Or, are they toeing the line of the state because it is in their interest? Maybe it is the first two. But I’m sure there is an element of toeing the line here based on how coordinated the act was. And this toeing the line isn’t a new thing. Previous governments have done the same or worse. What do our celebs fear? Compare this with the stands taken by celebrities, sports personalities and many CEOs during the Trump era. The simple conclusion you reach is the US state can’t use its institutions to go after you. The police, the FBI and the tax authorities won’t find a hundred reasons to file charges. Their institutions are strong and they follow their own code. Plus, the state isn’t overbearing. Its laws don’t encompass every aspect of your life in a manner that you cannot ever claim you haven’t violated them. The question we must ask is what does the easy falling in line of celebrities or the fear of protesting against laws say about the state of our institutions and the nature of the state? And if our institutions are indeed weakening, what does it portend about the future of our democracy and our long-term growth prospects.

Among the great skills of the present government is how easily it can shift any discontent against its actions into the territory where it is the strongest. Nationalism. Over the years it has also built a strong media ecosystem that advances nationalism as a primary means to reach the objectives of the state - economic prosperity and protection of sovereignty. Unfortunately, history has shown nationalism is a blunt instrument to achieve sustainable prosperity. The Khalistan flags seen during protests or Rihanna’s tweets give the government ready props to fight the battle of ideas on farm laws on the grounds of nationalism. There, even if it loses the battle, it will win the war.

The question is if that holds true for India too.

Addendum

— Pranay Kotasthane

I have three short points to add to RSJ’s comprehensive take.

One, every protest should be assumed as being global by default. Gandhi’s political genius was to get the masses to participate in the freedom struggle at a low opportunity cost, by just spinning a charkha. Today, this job doesn’t require a Mahatma, it justgets done by the internet. Showing instantaneous support for any cause across the world is now almost frictionless. It can be done with low opportunity costs. Even when there’s no immediate cause, there’s work happening — latent identities get created or reinforced through social media tuned for rewarding polarisation. Come the next immediate political cause and this powder keg is ready for use. ‘Nolocus standi’ arguments are pointless.

Two, those with the lowest stakes in an issue might end up being the more powerful voices. Because the entry barrier is so low, you don’t need to have much at stake to show support. Such a scenario complicates dispute resolution as those with the highest stakes can get sidelined. Even worse, the state machinery will be hard at work to establish nefarious links between those with high stakes/low power and those with low stakes/high power, with the aim to discredit both.

And three, the more aggressive the State response, the more fodder it is for future RNSes. The State that responds, positions itself as the villain which brings together more people. It becomes the ‘other’ that creates the ‘us’. Once that happens, all that remains is the next political cause to emerge.

India Policy Watch #2: Politics and Visual Storytelling

Insights on burning policy issues in India

— Pranay Kotasthane

It irks me when someone forms a strong opinion on complex issues just by watching a Netflix series, movie, or documentary. Chernobyl and The Social Dilemma come to mind. Both these rather well-made series ended up confirming biases against nuclear power and social media respectively.

Visual storytelling is evocative. It can create powerful narratives that elicit instant responses from what Daniel Kahneman calls the fast brain. The more a visual story appeals to our emotions, the more the need to temper the fast brain response with reflection, education, and discussion.

And yet, our movies can reveal a lot about our politics. Not through what they show but through what they cannot show. For example, would it be possible today for a mainstream movie to have a plot in which a Muslim man elopes with a Hindu woman? Or would it be possible to recreate the iconic Mahabharat parody scene from Jaane Bhi Do Yaaro today?

What happened to Tandav and Munawar Faruqui indicate otherwise. This should worry us all. An insecure society abridges individual creativity and distracts the State from what it is supposed to do. It is this insecurity that paves the way for pakistanisation of a society.

PS: A French Netflix parody A Very Secret Servicecame as a refreshing change. The politically incorrect and satirical take on France’s national security apparatus spares none. I couldn’t help but rue the fact that something on these lines is unimaginable in present-day India.

India Policy Watch #3: The Constitution in a Knowledge Graph

Insights on burning policy issues in India

— Pranay Kotasthane

In #103, I had written how cool would it be to represent the Constitution as a knowledge graph. Well, one AtU reader, Rithwik, has now created one such knowledge graph and it looks stunning.

This image below is the Obsidian Knowledge Graph of the Indian Constitution. The backlinks are based on cross-referenced articles in the Constitution. One immediate thing you will notice is how disconnected the Directive Principles of State Policy section is. It’s like an afterthought.

Rithwik has helpfully put the code and all files on GitHub. We are now on the lookout for ideas to make the backlinking more intelligent and useful. If you have any such ideas, please do send a comment.

HomeWork

Reading and listening recommendations on public policy matters

* The unyielding demands of the protesters and the response of the government are both troubling, writes T.N. Ninan in the Business Standard

* [Report] The 15th Finance Commission report is out. It is a goldmine for people interested in Indian public finance. The studies commissioned by the Commission are equally useful.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

We have been writing about Radically Networked Societies (RNS) for the past couple of editions. Maybe you have had enough of it. But not the world around us. After the Rihanna/Greta tweet episode that led to the government mobilising its own RNS with film stars and cricketers in the van, we now have moved to the next stage of the battle of RNS.

New Front

The government this week asked Twitter to remove over 1000 accounts and posts which it believes spread misinformation about the new farm laws. Twitter responded by reducing the visibility of the hashtags that contain harmful content and suspending more than 500 accounts, some permanently, that violated its rules. But the government isn’t satisfied with the response. It has upped the ante now with not so subtle threats of arrests of Twitter officials if the company didn’t comply with the government orders under Section 69A of IT Act.

Into this mix jumped in Koo - Twitter’s Indian knockoff with the added feature of sending messages using eight Indian languages. The usual atmanirbhar noise was made by its founders and investors and soon we had ministers, MPs and ‘nationalist’ Twitter users advertising their migration to Koo. Of course, as the shift to Koo gathered momentum, the other camp started mock celebrating the ‘cleaning up’ of Twitter.

It is apparent there’s a level of government support to scale up Koo. The reasons are obvious. The government views the global social media giants with suspicion based on their broader liberal inclinations around the world. These companies follow their own free speech code and won’t always toe the government line on key issues. The impact of RNS in mobilising an opinion against a government plan was clear from the recent events. Why would the state want to be held to ransom by non-state actors with low stakes and a disproportionate voice? The solution to this for the state is either to curb the freedom of social media sites or to promote a homegrown site that can be controlled. My guess is we will try both.

Will it succeed?

Probably not. Why?

Well, let’s first get the most obvious reason out of the way. Network effect. Social media sites are addictive because of it. Koo might get a few users in the early days who are swept in with the momentum. But like we have seen in the past with Whatsapp users moving to Signal or left-wing Twitter users moving to Mastodon (remember), these things don’t really take off. People find the user interface clunky, miss features familiar to them or find a truncated version of their network that force them back to the old platforms. Network effect is a very strong moat. I will be surprised if Koo bucks this trend.

But network effect is not the lens that interests me here. If you were to apply a political philosophy lens to this migration to a like-minded social network, there are a few interesting points to consider here.

Firstly, your politics is defined more by what you specifically oppose rather than what you support. Your opposition is what defines you in specific terms; in fact, politics comes about because some people group together in opposition to others. This is a bit of a rehash of the Schmittian claim that the specific political distinction in society hinges on the friend-enemy distinction. Schmitt believed any difference that marks out a group from the other will take a political hue if it has the strength to align them into opposing and warring camps ready to inflict real damage onto others. Now I have no sympathy or time for Schmitt in general. The man was a fascist. But on this, he makes a compelling argument. You take away the friend-enemy distinction and the political engagement fades away. Leo Strauss writing to Schmitt in 1932 had summarised Schmitt’s view on political distinction:

"because man is by nature evil, he, therefore, needs dominion. But dominion can be established, that is, men can be unified only in a unity against—against other men.”

So, the right or the left-wing aiming for a social network that only has people like them and no enemies to unite against is a recipe for long-term disengagement with politics for its members. Confronting the enemy and beating them on any platform is necessary for the political existence of a group.

Secondly, a homogenous identity within a group invariably splinters the agglomeration. There is a simplistic assumption that once the friend-enemy distinction disappears because there is no longer an issue that separates members of a group, the political contest ends. This was the predominant assumption in the early 90s when the liberal democratic order felt it had vanquished the other. As later events have shown, political identity abhors a vacuum. People will find another identity to take on that will replicate the intensity of political conflict of the past. To repeat Straus: "because.. man needs dominion.” Any move to sequester your group from your enemies will lead to your group finding enemies within to fight.

Thirdly, it is ironical to find the right-wing or the conservatives (as loosely defined in India) moving to a platform that will encourage their common identity. The conservative critique of liberalism is that it aims for a vague universalism and a common bond among people across all markers of identity. The individual identity that’s built over centuries, that’s localised and which is linked to tradition and custom gets subsumed in this utopian ideal. This is an anathema to the conservatives who value individual identity and distinctiveness. To transition out of platforms that support diverse identities, however inimical to you, to single identity platforms will be going against the core belief of conservatism. It will diminish conservatism eventually.

To close, exclusive social media platforms based on ideologies might take off if they somehow create their own network effect fast enough to retain a critical mass of their members. However, it will also sow the seed for the future splintering of the group. A homogenous unit is the most fragile. Diversity is anti-fragile. And there are benefits of having enemies.

As Kabir said all those centuries ago:

“निंदक नियरे राखिए, ऑंगन कुटी छवाय,बिन पानी, साबुन बिना, निर्मल करे सुभाय।”

(Keep your critics close, they improve you)

HomeWork

Reading and listening recommendations on public policy matters

* The Wired on How to Break Out of Your Social Media Echo Chamber

* From the Hesiod’s Corner, Carl Schmitt: The Friend-Enemy Distinction

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris.

Not(PolicyWTF): Acknowledging State Failures

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

- RSJ

We rarely miss an opportunity when the political or the administrative class make an announcement or draft a policy that goes against our ideology of common sense. So, it is only fair we write about the rare occasion when someone gets things right. Even if it is only in a speech.

Something New

This was that week. Here’s our PM speaking in the Rajya Sabha about the state spreading itself too thin and the unfortunate demonisation of the private sector in our polity. The Print reports:

While doffing his hat to the private sector Wednesday for its contribution to the growth and development of the country, Modi questioned the “power centre we have created in the country by handing over everything to babus”. 

“Sab kuch babu hi karenge. IAS ban gaye matlab woh fertiliser ka kaarkhana bhi chalayega, chemical ka kaarkhana bhi chalayega, IAS ho gaya toh woh hawai jahaz bhi chalayega. Yeh kaunsi badi taakat bana kar rakh di hai humne? Babuon ke haath mein desh de karke hum kya karne waale hain? Humare babu bhi toh desh ke hain, toh desh ka naujawan bhi toh desh ka hai,” Modi said.

(Babus will do everything. By dint of becoming IAS officers, they’ll operate fertiliser warehouses and also chemical warehouses, even fly aeroplanes. What is this big power we have created? What are we going to achieve by handing the reins of the nation to babus. Our babus are also citizens, and so are the youth of India.) 

I don’t know when words of this nature were last spoken in the Parliament. Maybe Minoo Masani made a few speeches of this kind during the heyday of the Swatantra Party. But to have a hugely popular PM, one with the rare ability to make the public do his bidding, speak these words suggests a shift in direction that was long-awaited.

Anyway, that speech came on the back of weeks of protests against farm laws that had morphed into Ambani-Adani bashing. The names don’t matter. A few decades back it was Tata-Birla. We have also had the usual reports about how the pandemic has exacerbated inequality purely on the basis of notional wealth created by a rising stock market. And there have been bizarre articles devoid of any economic logic as well.

These are familiar grounds. We have framed it as growth or redistribution trade-off in a few of our past editions. Like many others, we have argued India needs growth before worrying about redistribution. We have also done our best to dispel a notion deep within our psyche. That we are in some kind of a giant zero-sum game and someone winning must mean someone is losing.

Is that it?

Or is there more that can be brought into this debate?

The state must aim to foster conditions in a society that advance the well being and prosperity of its members. No one argues with this goal. The fundamental question of public policy then is what are the means it must adopt to create this environment?

Should the state aim for equality among its member through redistribution of its resources? That there can be no harmony or stability in a society unless there’s fairness and equality among its members.

Or, should the state guarantee the fundamental rights of the citizens, provide for law and order that safeguards them against anarchy and then get out of their way. People don’t want the state to legislate for some notion of equality that’s in its mind. They want freedom and security. That would do. Thank you very much.

The old Rawls versus Nozick debate

Rawls’ seminal A Theory of Justice argued for justice as fairness (the title of a later book of his) with two key principles. First, the greatest equal liberty principle which proposed people’s equal basic liberties should be maximised. Rawls conceived of an artificial construct called the original position - a state where each one of us has to decide on the principles of justice behind a veil of ignorance. That is we are blind to any fact about ourselves; we are ignorant of our social position, wealth, class or any natural attribute. Behind this veil, Rawls asked how would we choose the principles of justice for the society?

For Rawls, the logical choice for all of us would be what he called the maximin strategy that would maximise the conditions of those with the minimum. This gave him his second principle - the social and economic inequalities should be arranged only to provide the greatest benefits to the least advantaged.

Nozick agreed on the liberty principle with Rawls. But he had a strong disagreement on the idea of maximin. For him, any distribution of wealth (or holdings as he termed it) is fair if it comes about by a just and legitimate distribution. He defined three legitimate means. First, where the acquisition of a property that is unowned is achieved through the enterprise of a person and this act doesn’t disadvantage anyone else. Second, a voluntary transfer of ownership between two consenting entities. And third, a redressal of a past injustice in acquiring or transferring the holdings. Anyone who has acquired wealth or holdings through these means is morally entitled to them. Any attempt by the state to redistribute it would be a serious intrusion on the liberty and, therefore, unjust.

So the goal to reach a patterned distribution of wealth had a problem at its core. Once you achieve such a delicate balance, how do you maintain it? Every random economic act from there on will disturb the balance. And such random acts will be too many for the state to control. The state will then have to constantly meddle in the lives of its citizens to redress the balance. This meddling will spiral out of control soon till the state takes over the lives of its citizens completely in a totalitarian future. For Nozick state can act to redistribute only with the consent of its citizens. If people voluntarily redistribute their wealth (means #2) to others and want to design a society on that principle, they are free to do so. But the state cannot impose it against their will.

To me, the first point of agreement between Rawls and Nozick is critical from an Indian context - the liberty principle or the basic freedoms that must be guaranteed to every citizen. These cannot be violated or the absence of such freedoms should not be tolerated even if doing so in some ways increase the aggregate prosperity of the society or help the poor. Before we argue about redistribution, we must ask if we have created a society that satisfies the greatest equal liberty principle. That must be our first goal.

Postscript:

I don’t remember when I lost my faith in the ability of the state to improve the lives of its people. Perhaps there wasn’t an exact moment. Growing up the state was all around me. I spent most of my childhood in what used to be called a ‘colony’. One of the many that dotted the semi-urban Indian landscape in the 80s. A small industrial township whose heart beat to the rhythm of the government-owned factory at the centre of it. My school, my playground, the hospital and even the temple were all run by the state.

The state then subsidised a world-class higher education programme for me. At the turn of the millennium, I entered the workforce. If you had cut me then I would have bled state.

Over the next two decades, I lost my faith. Gradually. Two factors led to it. One, I understood the privilege that allowed me to take advantage of the generosity of the state. The accident of my birth - a savarna Hindu male born in the mid-70s to educated parents - seemed to play a disproportionate role in my relative success. I noticed the state could barely enable others to do well who weren’t born to privilege like me. They didn’t have the freedom that I took for granted. The state was absent to those who needed it the most. Two, the state had tremendous confidence in its capabilities that, unfortunately, was inversely related to its actual performance. This led the state to have its finger in every pie with poor outcomes. The state cast its long shadow in everything I did. It was present everywhere.

The Indian state was simultaneously ‘omnipresent’ and ‘omniabsent’ depending on who you were. One thing was common though. The consequences of both were terrible.

Once I saw through the nature of the state, I couldn’t ‘unsee’ it. The sorry spectacle of the flailing state, as Pritchett called it, was all around me. I wondered how others couldn’t see it. Why despite the overwhelming evidence do we look for the state to solve problems where there was no apparent market failure? Why did the state not narrow its focus on things that really mattered and build capacity in them instead of spreading itself too thin? Whenever I read about the argument for state to get into further redistribution, I cannot help but ask how does the end result of this patterned distribution look like. Is there really any end to it? Why should we let it meddle even further into our lives trying to get the redistribution right? Why can’t the state focus on ensuring the privilege I was born with is made available to all its citizens? That would fulfil the first principle agreed upon by both Rawls and Nozick.

The rest is just criminal overreach.

PolicyWTF: Compulsory Philanthropy

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

— Pranay Kotasthane

We in India love our oxymorons. Back in college days, we had “compulsory elective” courses. Similarly, many government interventions are what my senior colleague Narayan Ramachandran calls “voluntary mandatory” — voluntary according to the law but mandatory in practice. The most common example is the requirement to submit the “voluntary mandatory” Aadhaar for accessing any government service.

To this venerable tradition, add one more - “compulsory philanthropy”. Philanthropy implies choice. It is an act of generosity, of empathy. But that’s not how the State sees it. Under the name of Corporate Social Responsibility (CSR), philanthropy was made mandatory starting in 2014.

That move didn’t go as well as the State desired (surprise surprise!). One, there wasn’t just enough CSR expenditure forthcoming. The highest total CSR expenditure, clocked in FY19, was just about ₹18,000 crores. For reference, the union government earned ₹20,000 crores in FY20 through the Education & Health Cess alone. Two, new frauds emerged, with some companies funding dubious CSR projects that clawed money back to their promoters (duh!). And three, and this is the most important one. Fearing the wrath of the State, many companies spent their CSR funds on the “safe” subjects such as primary education and health, precisely the areas where the State’s role is supremely important. In other words, this had the effect of allowing the State to outsource its core functions.

Given these problems, the union government notified changes to the CSR rules last month (you can read the gazette notification here). These changes are all too familiar — increase disclosure requirements, mandate impact assessments, and of course, generate more accounting work. To balance it out, there are some positives too — a regimented list of subjects that qualify for acceptance of CSR has been replaced with a negative list, while the CSR provision has been decriminalised (phew, small mercies!).

I will evaluate the impact of these new rules at a later point in time. For now, I want to return to the purpose of CSR and debunk three common arguments made in favour of mandating philanthropy.

The first argument is that CSR is just corporate tax by another name, so why bother.

I agree that once you make philanthropy mandatory and statutory — India is the only country in the world to do so — CSR becomes tax-like. And yet, it is only worse. Anyone doing business in India will attest that it’s impossible to do so without breaking one of the thousands of rules and laws that demand compliance. Now with new rules and additional compliance requirements, CSR becomes another tool in the hand of the State to corner businesses and worse still, create new corruption opportunities.

There are three costs associated with any tax-like mechanism: the cost of collection, the cost of compliance, and the cost of market distortion. Mandating CSR is a tax in which the cost of compliance is way too high for it to make any economic sense. If the objective is to mobilise resources for social welfare, there’s a much better tax-like mechanism — it goes by the name ‘tax’.

The second argument is that look, many great things have happened because of CSR — lakes are being maintained, schools have started functioning, and drinking water is being provided. So why not get companies to do even more?

I call this argument the cost-blind fallacy. Any expenditure worth ₹18,000 crores is, of course, going to do some good things. In a complex system, even the worst of public policies always have some positive benefits. That doesn’t imply that anything goes. Since every policy also has a cost attached to it, it’s benefits need to be compared with the costs incurred.

So, has anyone asked what were the explicit and implicit costs of mandating CSR? Does it make the State more complacent having outsourced its work? What are the compliance costs for companies? Does it make companies already involved in philanthropy of their choice scale back their efforts to satisfy government paperwork? Without an answer to these questions, recounting a few successful examples of CSR is poor reasoning.

The third argument is that companies spending money on social welfare will be more efficient at achieving the required outcomes than our already stretched-out State. A quote from this Business Standard report gives a good idea about this line of thinking:

“India has huge inequalities in society and there is much to do about our environment. It is not possible or fair for the government to tackle it alone. It would also take many, many years to see the results. The reason CSR law was brought in was to make industry an equal and responsible stakeholder in the development process.”

This argument falls flat on two counts.

One, development successes are not achieved by “equal” stakeholders trying to fix each other’s failures but by each stakeholder doing well at what it is supposed to do in the first place. It’s not about ‘everyone doing everything’ but about ‘everyone doing at least one thing well’.

Previously, I have argued how hyper multi-objective optimisation lead to poor institutions and policies. Let the objective of the market be to bring prosperity and create livelihoods. Burdening it with social welfare conditions will lead to a situation where it achieves neither of the outcomes.

Two, to think that companies can easily plug government failures is deluding ourselves. All of CSR expenditure in FY19 less than one-third of union government expenditure on MNREGS alone. It’s only the state that has the resources and stamina to provide public goods. It must be held accountable for that. No amount of philanthropy can be allowed to wash the State its hands of the results.

In sum, compulsory philanthropy is akin to the Indian State reprimanding Markets and Society by saying: I won't do what I'm supposed to but why the hell aren't you two doing what I'm supposed to do?

India Policy Watch: Resources for Budget Analysis

Insights on burning policy issues in India

— Pranay Kotasthane

The budget season is upon us. After the union government budget, states — which account for nearly sixty per cent of all government spending in India — are in the process of planning their next financial year.

I strongly believe that financial statements of governments require closer scrutiny. Without better analysis of incomes and spending, we cannot expect government accountability. Add to that, this is one activity that public policy enthusiasts can do from the comfort of their homes.

So in this edition, I want to share some publicly available resources that can help you understand government finances better. Apart from state and union budget documents, there are many other data sources scattered on websites of different government bodies in true Yes Minister fashion.

Hopefully, this non-exhaustive list will be of some help.

Primers

* If you want to understand the basics of a government budget, start with PRS Legislative Research’s Overseeing Public Funds - How to scrutinise budgets document. The portal OpenBudgetsIndia also has a good primer here.

* If you want to analyse the budgets of your state, we have a three-part YouTube tutorial here: 1, 2, and 3.

Public Finance Databases

* If you want to know the stated outputs and outcomes of union government schemes, read the output outcome framework document released with the other budget outlay documents.

* If you want detailed information on union government spending arranged by minor heads, the Controller General of Accounts releases finance accounts data every year.

* The Department of Economic Affairs releases an Economic and Functional classification of the union government budget.

* If you’re on the lookout for the combined expenditure of union and state governments on areas such as research, health, or education, look at the Indian Public Finance Statistics.

* If you are looking for information on disinvestment of union government-owned public sector units, the Bombay Stock Exchange maintains a database here.

* The RBI maintains a database of all state government finances in one place, that too in spreadsheet form(!), here.

* All supplementary grants made by the union government ministries can be found here.

If you know of more such documents that lie hidden in plain sight, send them to me. Let’s create an exhaustive public finance database index.

Quiz: An Election Manifesto Worth Reading

— Pranay Kotasthane

Election manifestos are boring laundry lists of promises and a litany of woes rolled into one. So let me present to you an exception.

Given below are excerpts from an election manifesto of a political party, written by a well-known Indian political leader. You need to name them. Send us your answers as comments to this post. If not, just enjoy this manifesto for its clarity and farsightedness. I’ve substituted XYZ for the name of the party in these excerpts.

On principles of the party

“The attitude of the Party in public affairs will be governed by the following principles:

* It will treat all Indians not only as being equal before the law but as being entitled to equality and will accordingly foster equality where it does not exist and uphold it where it is denied.

* It will regard every Indian as an end in himself with a right to his own development in his own way and the State as only a means to that end.

* It will sustain the right of every Indian to freedom- religious, economic and political– subject to such limitations as may arise out of the need for the protection of the interests of other Indians or the State.

* It will uphold the right of every Indian to equality of opportunity subject to the provision that those who have had none in the past shall have priority over those who had.

* It will keep the State ever aware of its obligation to make every Indian free from want and free from fear.

* It will insist on the maintenance of liberty, equality and fraternity and will strive for redemption from oppression and exploitation of man by man, of class by class and of nation by nation.

* It will stand for the Parliamentary System of Government as being the best form of Government both in the interest of public and in the interest of the individual.

….

There may not be anything new in the Principles of the XYZ. They will be found in the manifestoes of most political parties. But there are two considerations which distinguish the Z from other Political Parties. The first consideration is that the principles of the Z are not adopted by the Z merely to look politically respectable or merely to delude the voters. They are natural to the Z. They are borne out of the social condition of the XY. The XYZ cannot exist without adopting these principles and without holding up to those principles and living up to them. The principles of the XYZ are the life book of the XYZ. They are not the external marks of a political faith. They are the outward register of the inward feeling. They are not cloak worne for the purpose of winning the election. Many parties may adopt these principles. But no party can be so true to the principles as the XYZ.”

On what the party’s policy would be like

“The policy of the Party will be to try to give effect to the principles set out above. The policy of the Party is not tied to any particular dogma or ideology such as Communism, or Socialism, Gandhism, or any other ism. The Party will be ready to adopt any plan of social and economic betterment of the people irrespective of its origin and provided it is consistent with its principles. Its outlook on life will be purely rational and modern, emperistic and not academic.”

The Party’s approach to increasing productivity

“For the purpose of increasing production, the XYZ will not be bound by any dogma or any pattern. The Pattern of industrial enterprise will be a matter regulated by the needs of the time and circumstances. Where national undertaking of an industry is possible and essential, the XYZ will support national undertaking. Where private enterprise is possible and national undertaking not essential, private enterprise will be allowed. Looking at the intense poverty of the people of this country no other consideration except that of greater production and still greater production can be the primary and paramount condition. A pre-conceived pattern of industry cannot be the primary or paramount consideration. The remedy against poverty is more production and not the pattern of production.”

On Kashmir

“On the Kashmir issue, the policy adopted by the Congress Government is not acceptable to the XYZ. This policy if continued will lead to a perpetual enmity betwen India and Pakistan, and the possibility of war between the two countries. The XYZ believes that it is essential for the good of both countries that they should be good and friendly neighbours. For this purpose the proper policy to adopt towards Pakistan should be based upon two considerations. (1) There should be no talk about the annulment of the partition of India. Partition should be accepted as a settled fact not to be reopened and that the two countries to continue as two separate sovereign States. (2) That, Kashmir to be partitioned– the Muslim area to go to Pakistan (subject to the wishes of the Kashmiries living in the Valley) and the non-Muslim area consisting of Jammu and Ladhak to come to India.”

On Foreign Policy

“The other centre of our foreign policy which has made other nations our enemies is China. India is made to fight her battle for entry in the United Nations Organisation as a permanent member thereof. This is an extraordinary thing. Why should India fight the battle of China when China is quite capable of fighting her own battle? This championing of the cause of Communist China by India has been responsible for the prevailing antagonism between India and America with the result that it has become impossible for India to obtain financial and technical aid from America.

…. India’s first duty should be to herself. Instead of fighting to make Communist China a permanent member of the U. N. O. India should fight for getting herself recognised as the permanent member of the U. N. O. Instead of doing this, India is spending herself in fighting the battle of Mao as against Chaingkai Shek. This quixotic policy of saving the world is going to bring about the ruination of India and the sooner this suicidal foreign policy is reversed the better for India. Before championing the cause of Asiatic countries, India must strive every nerve, must seek every aid to make herself strong. Then only will her voice be effective. This will be the line of Foreign Policy that the XYZ will pursue.”

Finally, cheers to a strong 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.”

HomeWork

Reading and listening recommendations on public policy matters

* The Economist (Schools brief) on the three post-war liberals who strove to establish the meaning of freedom.

* [Article] Prof Govinda Rao has the authoritative take on the 15th Finance Commission recommendations.

* [Podcast] Pranay and Saurabh discuss GameStop, Rihanna, and the politics of radically networked societies on Puliyabaazi.

* [Article] Bharat Karnad has another contrarian take on Tejas and India’s search for fighter aircraft.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

Google and the Australian government are on a warpath. There is a proposed new law - the News Media Bargaining Code - that forces Google and Facebook to pay media publishers for links to the news on their sites. While other countries have tried to regulate and make Google and Facebook pay for the content they freely use from news sites, this law is a global first.

The Code

Here’s a brief summary of the Code from the Australian government press release:

The Code will support a diverse and sustainable Australian news media sector, including Australia’s public broadcasters, by:

* encouraging the parties to undertake commercial negotiations outside the Code;

* enabling digital platforms to publish standard offers, which provides smaller news media businesses with an efficient pathway to finalising agreements with digital platforms;

* establishing a negotiation framework under the Code that allows both parties to bargain in good faith and reach binding agreements;

* ensuring that an independent arbiter is able to determine the level of remuneration that should be paid under a fair and balanced final offer arbitration model should the parties be unable to reach agreement; and

* setting clear and workable minimum standards for digital platforms including requiring 14 days advance notice of deliberate algorithm changes that impact news media businesses.

The Code will initially apply to Facebook NewsFeed and Google Search. Other digital platform services can be added to the Code in future if there is sufficient evidence to establish that they give rise to a bargaining power imbalance. 

404 Error

Google’s reaction was swift. It went for broke in its open letter addressed to Australians:

The ability to link freely between websites is fundamental to Search. This code creates an unreasonable and unmanageable financial and operational risk to our business. If the Code were to become law in its current form, we would have no real choice but to stop making Google Search available in Australia. 

For Google, search is free and neutral. Its proprietary algorithm takes your search term, trawls the net, ranks the relevant sites and presents to you a million search results in order of what it thinks will be most useful to you. This is free because that’s Google’s mission - to organize the world's information and make it universally accessible and useful. Along with your search results, it throws up a few relevant ads that might be of interest to you based on your search. These are clearly identified and highlighted as ads. It makes money through them. Search and ads are different silos for it. There’s a separation (or so Google would have us believe) between the church and the state

For Google, paying news publishers to link people to their websites is a slippery slope. Other businesses will soon demand for the same. The search algorithm will no longer be pristine. Soon there will be bidding wars to appear higher on the search ranks. The whole principle of open internet will be vitiated.

The Australian government responded to Google’s open letter with PM Morrison indulging in some plain speaking:

“We don't respond to threats. Australia makes our rules for things you can do in Australia. That's done in our parliament. It's done by our government. And that's how things work here in Australia."

Meanwhile, Facebook decided yesterday it will block its users and news publishers from posting links to news sites because of the Code.

Best Of Both Worlds?

So, how should we think about this?

Well, first let’s get all the good that Google has done for the world out of the way. Google has been the among the most transformational tools ever made available to humankind. It deserves its extraordinary profits and market cap.

But there have been unintended effects of its dominance especially for news media. News publishers have lost customers as print has fallen out of favour. Their digital properties don’t draw in as much ad revenues and most traffic to them is routed through Google or Facebook. Classifieds which were the other source of their revenues have also gone online. The subscription model might be the way forward but no one has really seen it scale. It still looks like a niche game.

There’s hardly a viable business model to run a mainstream newspaper with extensive ground reporting, investigative pieces and deeply researched stories. What has replaced these are free websites with commoditised news from the wire, paid articles masquerading as news, listicles with clickbait-ey headlines and, of course, fake news or disinformation sites with specific political agenda. Poor quality news for free will drive away good quality reportage - that’s the Gresham’s Law for media.

The downstream impact of this in culture and politics has been huge. If this were to continue and the price for news nudges towards zero, the supply of news will also be eventually zero. All we will be left with is views, opinions, hearsay and manufactured disinformation.

The question therefore is this. Does the bargaining code like that’s being taken to the Australian parliament solve this problem? Sure, Google will be forced to come to the table and negotiate a deal with the publishers. This will mean some additional revenues for them to support journalism that matters to them. But let’s play this out a bit. Different media houses will have different bargaining power. The smaller ones who might be doing cutting edge work won’t have any power to cut a deal for themselves. Google will now have an incentive to push certain types of links over others. Maybe it will present the links from sites whom it doesn’t have to pay on top of its results. You might have the cheaper, low quality journalism being promoted. More Gresham’s Law in action. Will that be a good outcome? Or, will Google play arbiter in ranking the results based on what’s the best commercial deal for it? It will interfere in the search results. Remember it is a publicly listed company. It will do what’s in the best long-term interests of its shareholders.

Lastly, there’s a more fundamental shift in the business model of the traditional news publisher that’s needed for them to survive in the long run. An annual boost of income from Google is welcome but not enough. The ability to unbundle their core product, using digital tools to deliver news beyond the written form, flexible subscription options and continuing to invest in content are all steps many of them have taken to remain relevant. They will have to continue investing in them and thinking beyond to fight the good fight.

Google itself has worked on a solution to compensate publishers through its platform called Google News Showcase. As the Google open letter said:

“With News Showcase, we would pay for publishers’ editorial expertise and for beyond-the-paywall access to news content for users—not for links to news content.” 

But the hitch here is the News Showcase doesn’t exactly even the playing field between Google and media outlets. Google has unilaterally decided this is a model that works best for others and it’s now their way or the highway. It’s a bit odd that an organisation that wants to convince the world it isn’t a bully should use a one-size-fits-all model for all publishers or threaten exiting a country because it doesn’t like a proposed new law. It does the exact opposite. The natural question that comes up is if every other country follows the Australian model, will Google exit them all?

A more flexible and negotiable News Showcase model is possibly a better option than the News Media Bargaining Code approach that’s being thrust upon Google in Australia. The principles of open internet and free search are too critical to be compromised. It is in Google’s interest to continue to make its model more palatable to publishers than have governments interfere in a space where there’s no real market failure. It appears that’s the way it is going after the strong response it received from the Australian PM. The deal it struck with Nine Entertainment yesterday seems to suggest that. This wasn’t possible even two weeks back:

A fortnight ago Nine was dismissive about the Showcase product, insisting it would not negotiate with Google until the law was passed.

“This is what monopolies do, they put an offer, in the form of Google Showcase, but not offer to negotiate,” a Nine spokesperson said at the time.

“It has to be all on their terms and that is not an approach we will participate in. We support the legislation the government is proposing as the best way to secure a fair payment for our content.”

The impending law seems to have got Google back to the negotiating table. If that’s what the law intended to do, it is a good lesson for Google to be proactive about offering flexibility to media platforms world over. We need good quality journalism that’s financially viable and we need an open internet. There shouldn’t be a trade-off between them.

HomeWork

Reading and listening recommendations on public policy matters

* A quick primer by The Guardian on the proposed Australian law and its background

* Tim Berners-Lee in The Guardian: “Australia's proposed media code could break the world wide web”

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

Global Policy Watch: No Telefoon in Rangoon

- RSJ

Mere Piya Gaye Rangoon Wahan Se Kiya Hai Telefoon is how C. Ramchandra immortalised Rangoon (Yangon) in our collective memories all those years ago. Unfortunately, ‘wahan se kiya hai telefoon’ is a tad difficult these days for the people of Yangon.

Myanmar should be aware of the idea of eternal recurrence by now. That all events in the world recur in the same pattern over an eternal series of cycles. The coup earlier this month by the Tatmadaw (the armed forces) was a case of history repeating itself three times over in its short post-war history. The reason served by the military had a familiar ring to it. It alleged widespread voter fraud in the November 2020 elections that led to a landslide victory for Aung San Suu Kyi helmed National League For Democracy (NLD). The quasi-democracy that was in place in Myanmar since 2015 didn’t mean any loosening of the iron-fist of the Tatmadaw. It retained its control on the key levers of power. For it to allege voter fraud in elections is comical. It must follow then it is admitting its incompetence in being dictatorial. Anyway, leave that aside. History has shown logic isn’t a particular strength of military junta anywhere in the world.

But irony is

The senior-most military leader Gen. Min Aung Hlaing had this to say:

“I would seriously urge the entire nation to join hands with the Tatmadaw (Army) for the successful realisation of democracy.”

Then the junta went digital with its defence. In a country where Facebook is the internet, it posted this on its official site:

After many requests, this way was inevitable for the country and that's why we had to choose it.

And soon it blocked Facebook and disabled the internet for the sake of ‘stability’ in the country. The tanks were on the street and midnight knocks on the doors of NLD leaders began. Suu Kyi was taken into custody and the crackdown started. It was 1988 once again for Myanmar. The eternal cycle had recurred.

As Nietzsche wrote:

"Everything has returned. Sirius, and the spider, and thy thoughts at this moment, and this last thought of thine that all things will return". 

Myanmar has been living through a transition to a fledgling democracy over the last decade. A new constitution that allowed for representative democracy and elections took shape in 2008. In 2015, NLD won the general elections and Suu Kyi became the State Counsellor (the equivalent of PM) of Myanmar. She is constitutionally barred from becoming the President because she was married to a foreigner and her children aren’t citizens of Myanmar. There was an uneasy truce between her and the military over the last term as Myanmar saw an unprecedented period of opening up to the world, growth and freedom for its people. Anyone who visited it in the last five years would vouch for how ‘normal’ it felt.

So, why the coup now?

There’s never an easy answer to this. For all you know it could be General Hlaing having a bad hair day. But let’s look at it through the frames of political and social philosophy to arrive at few likely reasons.

Firstly, the old Weberian power and legitimacy lens. Power is the ability to impose your will over others despite their resistance. Legitimacy is when this power is considered fair, even appropriate, by those over whom it is exercised. As Weber wrote:

“The basis of every system of authority, and correspondingly of every kind of willingness to obey, is a belief, a belief by virtue of which persons exercising authority are lent prestige” 

Power needs prestige to be legitimate. Else, it is coercion. In Myanmar, the junta always had power but rarely legitimacy. In the quasi-democracy era, the junta ceded a thin sliver of power to the NLD. But legitimacy is a strange meal. It can feed that feeble power and bestow it with enormous strength. A second term for NLD would have done exactly that. Power is a zero-sum game. The army generals know it. People sense the winds of change fast. The military couldn’t take any further chances with this version of democracy. Self-preservation kicked in on Feb 1, 2021.

Secondly, a recurring self-delusion that most authoritarians suffer from is how popular they are among the masses. The Constitution of Myanmar was drafted in a manner that favours large, majoritarian parties. You get a disproportionate number of seats regardless of the margin of victory on vote count. This was, of course, deliberate. There were two reasons for this. One, Myanmar is a multi-ethnic country with a distinct minority presence in its southwestern and northeastern borders. But the polity (the military and the NLD) is dominated by the majority Burmese Buddhists. A majoritarian Constitution is quite convenient. Two, General Hliang probably harbours political ambitions. His term ends this year. He backed the opposition in this elections thinking a victory would see him transition to being a President soon. The results were a shocker. 83 per cent of seats to NLD. The way the election rules have been drafted (by him) would now suggest an almost permanent NLD majority for the next many elections. This wasn’t acceptable. His network of businesses and the many interests of his family and friends could not be left to the mercy of mere civilian politicians. The general didn’t see himself in his labyrinth.

This is the old authoritarian problem. You overestimate your popularity. No one tells you the truth. You call for the elections. Then you can’t handle the truth (no copyright issue here; Aaron Sorkin is a friend). Exhibit A of this behaviour is Indira Gandhi right after the emergency. Exhibits B, C, D.. are all dictators too many to name here. This is why good authoritarians go the other way. They change the constitution to reduce the freedoms of the opposition, they extend their terms or they take elections out from the political equation. General Hliang must speak more often to his friends who are on his speed dial - Xi, Putin or Erdogan.

Thirdly, this is as good a time to mount a coup with little or no fear of international repercussions. Political cosmopolitanism is in a state of irrelevance now. The idea that states should be subject to some kind of international morality and they must behave in a manner consistent with it is at its weakest. The pandemic has further raised the walls at the borders. Transnational economic or political ideas have to contend with them. It is no surprise that international condemnation of the Myanmar coup is muted. China has asked all parties to resolve their differences internally (ha!). ASEAN, the largest market for Myanmar, has responded in a similar vein. The Biden administration has imposed sanctions and this will be followed by a few other western democracies. They hardly matter. Myanmar has lived in isolation for long to be concerned with them.

So, what does the future hold for Myanmar? Will this emergency be a mere one-year interregnum and will we have democracy back after it? Freedom is addictive. Even in the smallest of doses. There’s a view that whatever passed off for democracy in the last decade will be too strong in public memory for the junta to erase altogether. Despite the internet ban, street protests are spreading and, importantly, the arms of the state like bureaucracy, police and public servants (bank or healthcare workers) are participating in a departure from the past. Will these be enough? As a realist, I understand the state can play the waiting game for long and with an increasing degree of coercion.

There’s little likelihood of a Yangon spring this season.

Global Policy Watch: I am Small, I contain Multitweets

— Pranay Kotasthane

Do I contradict myself? Very well then I contradict myself; (I am large, I contain multitudes.)

— From Walt Whitman's Song of Myself

That's too nuanced a point for social media warriors of all persuasions.

After all, it's now possible to judge and crucify someone — notwithstanding their unique life experiences and resulting perspectives — merely on the basis of what they tweet. Or what they don't.

Just imagine. Our social media profiles — filled with inane and often ill-thought System 1 garbage output — are our most important extrinsic manifestations. It's tragic.

Two recent instances drove home this point to me yet again. One, an Indian-origin Oxford University Student Union President-elect had to step down after someone dug up her old Instagram posts containing some pretty terrible (and not even funny) wordplay about a holocaust memorial. As if the label “insensitive” wasn’t sufficient, more posts were dug up to also label her "racist" and "anti-LGBTQ".

What the person is today in real life, I have no idea. But what seems pretty clear to me is that past Instagram mistakes don't deserve anything more than a sincere apology. That’s unfortunately not the case though. If the internet remembers everything, social media extracts a heavy penalty for everything remembered.

The second instance was a shoddy article in The Caravan titled Establishment Man: The Moral Timidity of Sachin Tendulkar. Among other things, the author was able to make gross generalisations such as "… Tendulkar also shares the worst traits of the Indian middle-class: its indifference to the general good, its lack of commitment to the values of human rights and democracy, and its intellectual vacuousness" merely on the basis of Tendulkar’s Twitter feed.

The specific accusation is that while Tendulkar joined the orchestrated chorus against Rihanna's tweet, his 'Twitter stayed silent' when Wasim Jaffer was removed as the coach of the Uttarakhand cricket team.

This is not a defence of Tendulkar. As much as I admire him as a cricketer, I understand that a great cricketer can also be a craven follower. But I do have a problem when this judgment gets made merely on what he didn’t tweet about.

For instance, the author is quick to conclude, on the basis of a Twitter feed that “..his personal decency has always been accompanied by a deeply ingrained timidity towards authority, a primal fear of upsetting any establishment, whether cricketing or otherwise.” Yet, Tendulkar’s 2009 statement “Mumbai belongs to all Indians”, going against the well-entrenched parochial ‘Marathi Manoos’ politics, doesn’t get even a cursory mention. Similarly, the author doesn’t even attempt to show if he investigated Tendulkar’s off-Twitter support for Jaffer’s shameful ouster. After all, there is a lot someone like Tendulkar can do — and we can expect him to do in this case — than merely signal virtue on Twitter.

The Wrong Path Chosen

These two instances illustrate that we give others’ social media feeds way too much importance.

The first instance follows a well-established practice of digging up old tweets to defame a present-day achiever. This tendency ignores the fact that the most important human preference is our ability to change our past preferences.

Moreover, the more we label people, the more we polarise our politics. Philip Tetlock claims that text analyses studies show that people already tweet more like politicians (signalling virtue) or as prosecutors (assigning blame) rather than as hypothesis testers. And so, disproportional attention to our social media past will only make more people don the role of politicians and prosecutors — ready to fight every battle across the world while burning bridges in our vicinity.

The Tendulkar case is a more recent trend — people are to be judged not only on the basis of what they tweet but also what they don't. This too has a similar effect of pushing us into becoming prosecutors who are obligated to jump from one burning issue to the next without solving any.

Finally, to pay disproportional attention to our social media selves is both foolish and dangerous. To rebuild broken bridges, we need to assume by default that people contain multitudes. It's going to be tough.

Answer to the Quiz in #108

Yes, the answer is BR Ambedkar, who else? Those were the excerpts from the election manifesto of the Scheduled Castes Federation from 1951. SCF was a precursor to the Republican Party of India.

The entire election manifesto is a fascinating read. As one can expect from Ambedkar’s writings, this manifesto is not just a vague litany of promises but a rare well-reasoned agenda. Sample this:

IV. Co-operation between Scheduled Castes Federation and other Political Parties

51. Mere Organization does not make a party. A party means a body of people who are bound by principles. Without principles a party cannot function as a party for in the absence of principles there is nothing to hold the members of it together. A party without principles is only a caravanserai. The Scheduled Castes Federation will not, therefore, ally itself with a Political Party which has not laid down its principles and whose constitution does not demand a pledge from its members to stand by those principles and whose principles are not in antogonism with these of the Federation.

52. It is not enough to have political ideals. What is necessary is the victory of ideals. But the victory of ideals can be ensured only by organized parties and not by individuals. For these reasons the Federation will not support independent candidates who belong to no party except in exceptional cases.

..

54. As regards other Political Parties, the Scheduled Castes Federation’s attitude can be easily defined. The Scheduled Castes Federation will not have any alliance with any reactionary Party such as the Hindu Mahasabha or the R. S. S.

55. The Scheduled Castes Federation will not have any alliance with a Party like the Communist Party the objects of which are to destroy individual freedom and Parliamentary Democracy and substitute in its place a dictatorship.

The manifesto can be read here (page 386). Don’t miss it. We found out about this document in a Puliyabaazi with prominent Dalit intellectual and entrepreneur Chandra Bhan Prasad.

HomeWork

Reading and listening recommendations on public policy matters

* Sabastian Strangio in the Foreign Affairs: “Myanmar’s Coup Was a Chronicle Foretold”

* Are coups good for democracy? A paper by George Derpanopoulos, Erica Frantz, Barbara Geddes and Joseph Wright. Answer: “We find that, though democracies are occasionally established in the wake of coups, more often new authoritarian regimes emerge, along with higher levels of state-sanctioned violence.”

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy of the good folks at Ad-Auris. If you have any feedback, please send it to us.

Global Policy Watch #1: A Bit About Bitcoin

Bringing an Indian perspective to burning global issues

— RSJ

What should we make of bitcoin? Should we think of it as the best performing asset class in the last decade? After all, it was priced at $1 in April 2011 and its current price is about $45,000. But was it designed to be an asset? Surely, no. Satoshi Nakamoto, who invented bitcoin, was driven more by angst than greed while writing the 31,000 lines of code that he put out to the world on Jan 3, 2009. Satoshi (a pseudonym) wrote a 500-word essay - Bitcoin: A Peer to Peer Electronic Cash System - to explain the working of the system he had created. The logic was simple - a software system that would spew out some 21 million bitcoins over two decades with people interested in the coins ‘mining’ for them using their computing prowess. 

Satoshi was clear about his aim. He had seen the global financial crisis and he could no longer trust the conventional currency (also called fiat currency) issued by the governments. All he could see around him was central bankers printing money mindlessly to prop up a system where the ordinary individual had no say. And the banks were willing to design more creative and more toxic products that only benefitted them. As he wrote:

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve. We have to trust them with our privacy, trust them not to let identity thieves drain our accounts.”

So he decided to take the governments and the banks out of the equation by his design of bitcoin. People could now transact with a currency that was purely digital, encrypted and anonymous with a distributed public ledger that kept track of the movement of the coin to ensure it isn’t used twice by the same owner to dupe someone. It was quite neat. More importantly, there was no bank or intermediary to get in the way of the transaction nor was there any central banker that could decide arbitrarily how many coins should be in circulation. This was a libertarian utopia. The last bastion of the state could fall now. Fiat currency, an imagined and a coercive construct of the state could now be challenged.

As the last decade has shown, bitcoin hasn’t exactly replaced fiat currency as a medium of exchange in any meaningful way. But that doesn’t mean it has slunk away into anonymity. It has seen a remarkable rise in the last six months with some of the smartest people in the world betting big on it. Bitcoin or cryptocurrency has never been a more mainstream part of discourse ever. 

There are multiple ways of looking at cryptocurrency and make sense of what’s happening here. I will take the most traditional one for this edition. And, maybe, over the next few months go a bit deeper into this area. 

Today, I will take the economic theory lens to evaluate cryptocurrency and its most valuable manifestation, bitcoin.

Let’s understand fiat currency a bit better. Why do all of us believe a Rs. 500 note has any value? Well, Econ 101 class would tell you that’s because the sovereign has decided it is a legal tender that’s worth Rs. 500. There’s a promise right there on the currency note signed by the RBI governor. That’s very reassuring. But does that explain why we don’t use any other commonly agreed medium of exchange? Back in the days when I stayed at a hostel, we used cigarettes or Old Monk as a medium of exchange. There were always more cigarettes and Old Monks in the hostels than currency notes (this was the pre-ATM era) and these had a stable range within which its value moved. If someone needed my help with an assignment, 2-3 cigarettes did the trick. Now the question is what if this was replicated at a larger scale? The demand for Rupee notes would fall and its value would fall notwithstanding the Governor‘s promise. 

So, why does this not happen more often? The answer is that old reason for most things in our society. Network effect. Since most people use Rupee as a medium of exchange, it is easier for the next person getting into a transaction to use it as well. Network effects create an exit barrier for people to adopt any other new medium of exchange and an entry barrier for that new medium wanting to usurp the position of the Rupee. You will need a lot of initial momentum going if you were to establish yourself as an alternative. And how will you generate that momentum? I mean why will people use you as an alternative? It isn’t like the Rupee is failing to meet your expectations as a medium of exchange.

But is that enough? Is Rupee valuable because we all collectively believe in the myth it is valuable? That sounds more Harari than real economics. So, let’s go back to the question of why do we think a Rs 500 note has a value. 

Some of the more original thinking in this area was done by the formidable Austrian school economist Ludwig Von Mises at the beginning of the last century. His view was that we use something as a medium of exchange today because at some point in the past it actually had a real intrinsic value. In his time most currencies traced their origin to a precious metal and overtime were backed by that real asset however nominally. 

That’s fine but what explains the value of Rs. 500 today. There is no real asset backing this except some vague notion of trust. Also, there’s no real reason why should we all believe that this myth of the Rupee having value will continue forever. What if we continue printing money endlessly leading to spiralling hyperinflation sometime in future? What if there’s a worse global pandemic in future that cripples the global economy? What if we know a meteor is on course to collide with Earth in the next 12 months? What happens then? Will we accept a medium of exchange that has no real value if we know our future is uncertain or doomed? Think of that last person willing to accept a fiat currency as a medium of exchange. Why would he take that risk? Doesn’t make any sense for him because there's no future person to whom he can give this currency for its value. We believe in fiat currency because someone in future believes in it too. No future means no such belief. Now work backwards. Why would the last but one person accept it if he knows the last person won’t? If you follow this backward induction logic to its end and if we all know the future is uncertain and (somewhat) doomed, you will conclude the value of fiat money will be zero in future and therefore it should be zero today. 

If you think about it this way, fiat money and this whole business of printing money to get over a crisis is a giant Ponzi scheme. Fiat money should have no value today. Whatever value it has now is a bubble. 

So why do people call bitcoin a bubble and not fiat money? 

Well, turns out there is one big use case of fiat money  - paying tax liabilities owed to the state. If you remember this was an argument used to explain modern monetary theory (MMT) too. If the only way to pay taxes to the government is through fiat money, then there is a periodic demand for it by the citizens. This goes up as the economy grows or as the government taxes more. Now we can avoid the backward induction logic problem that we discussed earlier. The fiat money has a value that’s non-monetary; it pays your taxes. This won’t allow its value to go to zero in future. Therefore it will have value today too.

On such arbitrary plank of state coercion the edifice of human progress rests.

So, what about bitcoin then? Like I said earlier it is as much a bubble as any fiat currency of today. There are three problems it has to solve. One, its unique architecture is both a feature and a bug. That there can only be that many bitcoins prevents anyone from flooding the market with them. This keeps its downside protected and makes it a stable store of value. But on the other hand, a limited stock of coins means the value of bitcoin will continue to rise to preclude its use as a medium of exchange. I mean why will you use bitcoin when you know it will be more valuable in future. You will store it. The ‘good money’ will go out of circulation. The old Gresham’s law will apply. Two, if people don’t use it as a medium of exchange, it won’t create network effects. Lack of network effects will mean it won’t create enough momentum to replace fiat currency. This is a chicken and egg problem. Three, there will be transactions where people will seek anonymity or privacy that will be good use cases for cryptocurrency. But will illicit goods and services on the dark web or those sought for by fringe libertarians be a market large enough to justify the crazy valuation that bitcoin has currently? 

Through a conventional economic prism, the whole bitcoin or cryptocurrency opportunity looks like an asset bubble. There’s a small probability that many Silicon Valley founders and mavericks will ‘bootstrap’ the network effect for a cryptocurrency by making their goods and services available only in that currency. This will bestow intrinsic value to them beyond being a medium of exchange. That’s the only chance it has. Unless the sovereign decides to start its own cryptocurrency that can be used to pay its tax liabilities. But that is for another edition.

Global Policy Watch #2: Disagreement in the Information Age

Bringing an Indian perspective to burning global issues

— Pranay Kotasthane

A democracy is as good as the discourse it fosters. And it needs no convincing that discourse has plunged many levels in many democracies across the world.

Redeeming our discourse requires two necessary but insufficient components: education in critical thinking, and praxis in disagreeing well.

Critical thinking is where we desperately need philosophers. Philosophy’s focus on argument as a topic of study has a lot to offer. Only when we have a methodological understanding of arguments can we train ourselves to reason well. Only when we reason well will we be able to reflect and reach independent conclusions.

If I were asked what is one course that should be added to high-school curricula, it would definitely be critical reasoning.

The other component, learning to disagree well, is a skill that needs a massive upgrade in the information age. We are not good at handling disagreements. We have a tendency to equate an attack on our opinion as an attack on us. This verb ‘attack’ itself illustrates how strongly we perceive disagreements.

All this was known yet manageable until we didn’t have social media. People disagreed but within their social circles, with people they shared some similarities they could always go back to when confrontations got ugly. But social media changed things dramatically. For one, it put us in contact with the opinions of people we otherwise know very little about. And two, it put our online selves in an endless status competition. The result: outrage without real disagreement, confrontation without camaraderie.

None of this is going away. And this is precisely why diagreeing well is a core skill in the information age. We are still only beginning to scratch the surface of what it means at an interpersonal level or a social media platform design level. Nevertheless, Ian Leslie’s Guardian Long Read article makes a good start.

His answer is two-fold. One, narrow the status gap. Leslie writes:

“People skilled in the art of disagreement don’t just think about their own face; they’re highly attuned to the other’s face. One of the most powerful social skills is the ability to give face; to confirm the public image that the other person wishes to project. In any conversation, when the other person feels their desired face is being accepted and confirmed, they’re going to be a lot easier to deal with, and more likely to listen to what you have to say.”

..

“When a debate becomes volatile and dysfunctional, it’s often because someone in the conversation feels they are not getting the face they deserve. This helps to explain the pervasiveness of bad temper on social media, which can sometimes feel like a status competition in which the currency is attention. On Twitter, Facebook or Instagram, anyone can get likes, retweets or new followers – in theory. But although there are exceptions, it is actually very hard for people who are not already celebrities to build a following. Gulled by the promise of high status, users then get angry when status is denied. Social media appears to give everyone an equal chance of being heard. In reality, it is geared to reward a tiny minority with massive amounts of attention, while the majority has very little. The system is rigged.”

Two, lower the identity stakes. Leslie writes:

“..what drags participants into destructive conflict is usually a struggle over who they are… That our opinions come tangled up with our sense of ourselves is not necessarily a bad thing, but it is something we need to be aware of when trying to get someone to do something they do not want to do, whether that’s stop smoking, adapt to a new working practice, or vote for our candidate. Our goal should be to prise the disputed opinion or action away from the person’s sense of self – to lower the identity stakes. The skilful disagreer finds a way of helping their adversary conclude that they can say or do something different, and still be themselves.”

More concretely, he identifies having a disagreement without an audience is one way of lowering the identity stakes. People feel more comfortable changing opinions beyond the performative glare. But this approach is suboptimal because it relies on reducing diversity of thought. The other approach is to “just be nice” at a personal level, to make an adversary feel that they can revise their opinion without losing face.

All this sounds quite difficult, of course. But the key takeaway for me was to think about disagreement as a necessary skill for the information age. I strongly recommend the entire article. It is an important theme of our times. and we need to pay a lot more attention to this line of inquiry.

PS: Two book recommendations for learning critical reasoning. Fundamentals of Critical Argumentation by Douglas Walton, and Critical Thinking Skills by Stella Cottrell. To get things started, there’s a good podcast by Oxford University as well.

PolicyWTF: Compulsory Philanthropy — I Told You So

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

— Pranay Kotasthane

In #108, we subjected the Corporate Social Responsibility (CSR) Law to an “anticipating the unintended” treatment. Turns out there’s evidence to back all those claims too!

Gautam John, one of the most steadfast supporters of this newsletter, sent us a paper that analysed the impact of government intervention on CSR funding since the mandatory CSR law came into effect in FY 2013-14. The authors Rajgopal & Tantri conclude:

* Overall, there is a marginal increase in the average CSR spending since the law came into effect in 2013-14. But ...

* “High CSR” firms — companies that used to spend 4% to 5% of their profits on CSR before the law came into effect — reduced their spending to the mandated 2% level. “Low CSR” firms — companies that used to spend less than 1% of their profits on CSR before the law came into effect — increased their spending to the mandated 2% level.

* CSR contributions became highly sensitive to negative shocks to profits. This meant that companies reduced their CSR spending during bad times but did not increase CSR spending by the same amount during good times.

In sum, “mandatory CSR crowded out voluntary spending”. It became a checkbox to be ticked, a tax to be complied with.

The effect is similar to what you see while booking flight tickets in India today due to COVID-19 price caps in force. Earlier, the ticket prices were distributed according to scarcity — the prices rose as the journey day got nearer and different airlines had different prices. That’s no longer the case. All airlines charge nearly the same amount, the one that just meets the price cap, regardless of how early you book the ticket.

Azim Premji has consistently highlighted the futility of mandatory CSR. Premji alone donated in excess of Rs 7000 crores last year in comparison to the ~Rs 18000 crores total CSR spending by ALL companies in FY 2018-19. On Feb 21, he spoke on this issue again:

"I do not think we should have a legal mandate for companies to do CSR. Philanthropy or charity or contribution to society must come from within, and it cannot be mandated from outside. But that's my personal view. As of now, this is the law and all companies must follow it.”

So, my conclusion remains unchanged. CSR is a tax but only worse.

HomeWork

Reading and listening recommendations on public policy matters

* [Paper] Events described historic at the time when they occur are rarely so in reality whereas the events that will be viewed as historic many years later attract little attention at the time. A really important finding that also explains why progress is so underrated.

* [Podcast] RSJ was on The Seen and The Unseen,

* [Article] Barun Mitra’s take on the way ahead for agricultural reforms is educational.

* [Article] Sarthak and Pranay have an article out on the latest attempt at making state finance commissions work.

* [Article] Devesh Kapur highlights the low-level equilibrium that our federalism has settled at with respect to agriculture.

- RSJ

Chaitanya Tamhane’s debut feature Court (2014) convinced me about two things. One, here was a global talent whose cinema will make us proud in future. He did that and more with his next feature - The Disciple (2020). I knew of the precocious Tamhane back from 2007-08 when his knowledge and analysis of global cinema of all stripes used to leave us awestruck. We were no mugs about cinema ourselves. But he was different. Next level as they say.

That aside, it is the second point that I was left with at the end of Court that has stayed with me for long.

Ruka Hua Faisla

But to back up a bit, here’s what Court is about.

It begins with a day in the life of an elderly Dalit activist, Narayan: a writer of protest songs and a teacher for poor kids living in the slums. A simple man of deep conviction he has devoted his life to causes that are dear to him. Soon, he is arrested because a manhole worker died by suicide after listening to one of his angst-ridden songs that seemingly abetted it.

The trial is a Kafkaesque nightmare. It is clear that the manhole worker died because of inhaling the poisonous sewage gases. This isn’t anything new. The plight of these workers who go into the manholes without any safety equipment has been documented many times over. Yet, the public prosecutor and the state produce fake witnesses who testify against Narayan and bring up bizarre new charges like possession of illegal books (there’s one on Yoga) to make it watertight case against him. The state can’t accept the man died because of the abominable work conditions.

Instead it must have been that old mass murderer over the ages - poetry.

The autopsy report and the testimony of the wife nail the lie. This was no suicide. Meanwhile Narayan’s health continues to deteriorate while he is in custody. The judge grants him a bail for a surety amount of Rs. 1 Lac. Good news? Wait. The next day Narayan is arrested again on another trumped up charge. This time it is about sedition and for waging a war against the state. The case is back to the same judge who tells them to appeal to the High Court.

The film ends with what appears like a complete non sequitur.

We see Narayan on bail going back to teaching the poor kids in the slums. And then there’s a surreal bit to end the film. The judge and his family go out for a day long picnic. They travel in a minibus singing songs and playing antakshari. We see members of the family seek the judge’s counsel on different issues. The judge is like that old uncle we all know. He dispenses vacuous, outdated advice. The last scene has the judge dozing off on a bench mid-afternoon while the children play cricket nearby. A ball hits the judge mildly. He wakes up and promptly slaps the boy who has come to pick it up.

The film ends.

A Reflection Of Our Society

There are multiple themes apparent in the Court: the vengeful state, an indifferent judicial system, the drudgery of bureaucratic work, the idealism of an aging activist and the tenacity of a young advocate who is representing him. However, I was struck by that last scene. What was that about?

Over the last few years, I have thought about that scene often. Why?

Well, let me offer you three recent newspaper pieces.

First, here’s Shekhar Gupta in The Print on “how our judiciary is murdering the principle of ‘bail, not jail’ routinely”:

“It is a challenge to decide which institution has declined over the recent decades, the police or the judiciary. But today, if you are someone the powers that be don’t like, they can easily find police officers to file a case with serious sections from the IPC, never mind if they don’t have a shred (or iota, which our judges prefer in their orders) of evidence.

You might still think, certainly, they still have to produce me before a magistrate who would easily see through the police case that’s thinner on evidence than Coronil, if even that. And once the magistrate sees that, the order will be determined by that immortal line from the legendary late Justice V.R. Krishna Iyer: Rule is bail, not jail.

Contrary to our belief, that Krishna Iyer line wasn’t immortal. If anything, it’s been murdered and cremated routinely, and at least three times in recent days. Check the cases of Munawar Faruqui, Nodeep Kaur and Disha Ravi. Our choice of three very young and vocal people is a conscious one.”

Or, read this from The Economic Times:

“Chief Justice of India triggered a controversy on Monday with his remarks in two cases. In one case, he asked a man accused of rape in a relationship with a 16-year-old, whether he was willing to marry the complainant. The man faces accusations of rape, cheating and criminal intimidation, besides charges under the stringent Pocso Act designed to prevent exploitation of children.

The CJI’s remark was panned on social media.In another case, the CJI asked if a man’s sexual conduct, however brutal, could attract rape charges if it was made by his partner.”

Or, how about this:

“Justice Pushpa Ganediwala recently acquitted a man accused of groping a 12-year old girl's breast because he did not make skin-to-skin contact, and days earlier, ruled that holding the hands of a five-year-old girl and unzipping pants do not amount to 'sexual assault' under the POCSO Act.

In two other judgments, she acquitted two persons accused of raping minor girls after noting that the testimony of the victims did not inspire confidence to fix criminal liability on the accused persons.

"No doubt, the testimony of the prosecutrix (victim) is sufficient for conviction of the accused. However, the same ought to inspire confidence of this Court. It ought to be of sterling quality, Justice Pushpa Ganediwala said in one of the judgments.”

I could go on and on but I think you get my drift.

A Good Citizen?

Why have things turned this way over the past few years?

I have 3 reasons to offer. Firstly, we draw our bureaucrats and our judges from our society. Our society has progressed on liberal axis over the past seventy years. But not enough. It is largely illiberal. Secondly, society was illiberal in the past too. But there was no incentive for those running it to be illiberal while interpreting the law or administering a rule. Going by the evidence above, this seems to have changed as the state has turned illiberal. When incentive changes, behaviour changes. Thirdly, we seem to be sorely missing virtue in public life. In the absence of it we have deified certain institutions where virtue is often visible. Like the armed forces or the judiciary. There’s always a price to pay for deification without adequate scrutiny.

That brings me back to that last scene of the Court. I seem to get it a tad better these days.

Apart from the many other themes apparent in the film, the one that was running in the subterranean was that old question of Aristotle - who is a good citizen?

Is an old activist fighting the good fight against the state, writing revolutionary poems and organising the downtrodden to demand for their rights, a good citizen? Or is a learned judge with the majesty of law by his side, lording it over a court where the witnesses are fabricated and charges are often false, a good citizen? The society and the state have an answer. But is that the truth?

Tamhane answers this in that brilliant coda to his film. The activist whom the state considers a threat is busy teaching kids despite his troubles while the judge with no care in the world wastes his time in a frivolous picnic and slaps a boy who disturbs his afternoon siesta.

Court was released in 2014. Like all good art it is timeless.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

Global Policy Watch #1: Deadly Advice

Bringing an Indian perspective to burning global issues

- RSJ

There are consultants and investment bankers who floor you with their presentations. And then there is Mckinsey & Co. When the ‘smartest guys in the room’ speak, you watch them transfixed. To use Coleridge’s immortal words:

“He holds him with his glittering eye—

The Wedding-Guest stood still,

And listens like a three years' child:

The Mariner hath his will.”

You are often the wedding-guest and you listen to them like a three-year-old.

I guess it didn’t exactly work out that way over the past few months when Mckinsey was answering questions about its role in abetting the opioid crisis.

Not Caring About the Consequences

On Feb. 4, McKinsey & Co., the management consulting firm, announced a $573 million settlement with 49 State Attorneys General for its past work for opioid manufacturers. In Nov. 2020, Purdue Pharma pleaded guilty to criminal charges of not doing enough to combat the opioid epidemic that has ravaged the American heartland largely on the back of aggressive marketing of its flagship product, OxyContin.

Purdue acknowledged it looked the other way when the prescription drug was diverted to the black market, it misled regulators to boost its manufacturing quotas and it paid doctors for random speaking gigs that were a way to reward them for writing more prescriptions for OxyContin. The costs to society were dramatic - over two million addicts and about half a million opioid-related deaths in the past two decades. There’s no other way to put it; Purdue Pharma was an evil enterprise that deliberately sold products that killed people while profiting enormously from it.

And Mckinsey advised Purdue from 2004-19 on how to do this well.

On Feb. 4, Kevin Sneader, global managing partner of Mckinsey, wrote a memo to all his colleagues on the settlement. It contained the oldest excuse in the book - we weren’t doing anything unlawful. That’s consulting-speak admitting we were unethical:

“Indeed, while our past work with opioid manufacturers was lawful and never intended to do harm, we have always held ourselves to a higher bar. We fell short of that bar. We did not adequately acknowledge the epidemic unfolding in our communities or the terrible impact of opioid misuse and addiction, and for that I am deeply sorry.”

And it contained this gem:

“It is also a key reason why we chose the course of action announced today since it allows funds to be deployed quickly and directly to victims of the opioid crisis while avoiding a long and protracted legal process.”

I’m not sure there is a consulting equivalent to that old Hindi proverb - “nau sau choohe maar, billi chali haj karne”.

But Mckinsey could use it next time.

The saga has followed a predictable course since. On Feb 24, the 650 global partners of Mckinsey voted to replace Kevin Sneader as its global managing partner. As far as Mckinsey goes, I guess, they have done all they could to put this behind them.

The Slippery Slope In Business

What makes a pharma company that set up its business to save lives go down the path of taking lives? Greed?

There’s always the usual punching bag brought up when something like this happens - the Friedman doctrine. The purpose of a business and its sole social responsibility are to maximise shareholders value. That, according to its critics, gives businesses a free run to do anything. It makes greed legitimate. But does it? We put up a passionate defence of the Friedman doctrine on the 50th anniversary of that paper in edition #70. Friedman, as we have argued before, wasn’t making a case of untrammelled capitalism. In fact, he makes following the rules of the game fundamental to how a business must operate. As he concludes in that paper:

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 or fraud.” (emphasis ours)

Business ethics is often half-jokingly cited as an example of an oxymoron. There are challenges inherent in the market system for a business to be virtuous or ethical on its own. There’s the principal-agent problem, to begin with. The people running the business often aren’t the owners of the business. They have an incentive to maximise their short-term gains at the expense of all others. Then there’s information asymmetry between the business and its consumers. It is not possible for consumers to know everything about the products of a company. They trust the company to make products that are good for them. The company then has the incentive to be economical with the truth. There’s also the collateral damage problem on the society or environment that a business often inflicts. Pollution, for instance. It is what the economists call a ‘negative externality’. How does a business pay for it? If markets were to be left free from any intervention, businesses will exploit these failures for their benefits. They might make inferior or harmful products, take short-term decisions that hurt their consumers, workers or shareholders, pollute their environment or harm society. You could say in the long-run the markets will figure this out and punish them appropriately. But the social costs incurred by then will be too high.

The Case for Regulations

This is where regulators come in. The only reason for the state to intervene in markets through laws and regulations is to address these market failures. But it is a cat-and-mouse game between the regulators and those who are regulated. Most companies follow the regulations and get on with their lives. Not all. There’s always a temptation to go around them. And it isn’t too difficult. If a company decides to hide or obfuscate the truth, it can hoodwink a regulator for long. We have seen this play out many times over across sectors.

But the case of Purdue Pharma is somewhat unique. It ran its racket of selling OxyContin as an opioid to addicts in plain daylight. Everyone who dealt with Purdue knew of it - patients, doctors, pharmacies, hospitals, auditors and consultants. The competitors knew of it. As did many reporters and writers who covered the opioid crisis over the past two decades in print and literature. Everyone except the regulator, which strictly followed the guidelines and only went by Purdue’s responses to their queries. So long as the responses and supporting evidence that went along with them were fine, the regulators considered their job done. And how did Purdue manage to do this?

Well, there’s Mckinsey & Co.

There’s no other way to put this. Purdue Pharma framed their problem this way - how to maximise the sales of OxyContin that included its abuse by addicts while keeping the regulators away with their smooth but inaccurate responses?

And Mckinsey, the smoothest of the mariner, hath their will (as Coleridge would say) with their presentations. Presentations that did some unique cost-benefit analysis ever in the history of consulting. Valuing human life. Presentations that suggested if Purdue paid $14,810 per “event”, and if 2,484 customers of the CVS pharmacy chain overdosed or became addicted in 2019, Purdue would pay CVS $36.8m that year. There’s more there in those presentations that will shake your faith in humanity.

As other cases and class action suits pile up, it is almost certain Purdue Pharma will cease to exist in its current form. The ‘philanthropic’ Sackler family that owns it will also have its day of reckoning. But what about Mckinsey? A $600 million fine and a change of its managing partner? That’s it? Seems like a fairly low cost to pay for some deadly advice.

The financial sector regulators have learnt from the many financial crises on how to regulate investment banking and advisory businesses. These included personal criminal liabilities, fines and clawback of bonuses paid if a wrongdoing is proven in future. There’s something to learn from them to ensure those in the business of advising corporates bear moral responsibility for their services. Not doing anything unlawful isn’t enough. Else, it is only a matter of time before another partner will be putting up similar slides to turbocharge another unethical business.

But can regulations ever be enough? Like we have seen over and over again, it won’t ever be watertight. Maybe a start needs to be made at business schools - the source of talent for these companies. Tom Peters, the bestselling author of many books on strategy and a Mckinsey alum, writing for FT makes this point:

In my opinion, this is not unrelated to the OxyContin affair. I have long argued that we should “shut down every damn business school”. This rant is hyperbolic, but my reasoning is that business schools typically emphasise marketing, finance, and quantitative rules. The “people stuff” and “culture stuff” gets short shrift in virtually all cases.

I agree. I’m not sure if there is equal importance given to the discipline of ethics as it is given to a course on Options and Futures in any MBA programme. You could structure a beautiful futures contract or devise a compelling strategy for enhancing sales force productivity using what you learnt in a business school. Those models could be terrible for society and your clients could be guilty of using human beings as means and not as an end in themselves. You could plead ignorance about these ideas. Or you could have read Aristotle and Kant at school and asked those questions before you began building your model.

Reading Friedman isn’t a problem. Reading only Friedman is.

A Framework a Week: The Domar Rule for Public Debt Sustainability

Tools for thinking public policy

— Pranay Kotasthane

This newsletter unabashedly bats for policies aimed at accelerating India’s GDP growth. We’ve reasoned out our position in myriad ways in previous editions. And yet, we realise that the sceptics aren’t fully convinced. The ideological challenges to GDP growth first — inequality, inclusive growth, and sustainability — continue to gain strength.

So let’s try another line of reasoning: even if you are in favour of big governments, you cannot escape the prior need for higher GDP growth. Here’s how.

Big governments need more money by way of higher taxation or higher borrowing. In the current economic situation when there are no profits to tax, governments across the world are competing to borrow money for restarting their pandemic-hit economies. In some economies like the UK, public debt has hit its highest level since 1945. Consequently, the interest rates these governments are promising their borrowers (bond yields) are rising.

This higher borrowing comes at the expense of the savings of future generations who will end up paying taxes in repayment of this mountain of debt. Is there a limit beyond which the fetish for big borrowing becomes unsustainable? A classic 1944 paper titled “Burden of Debt” and National Income by Evsey Domar gives an answer.

As the second world war was winding down, governments then faced a situation not different from today — the economic reconstruction needed massive borrowing. The policy orthodoxy at the time opposed wanton borrowing — today’s deficits would lead to tomorrow’s higher tax rates, they said.

Domar disagreed. Instead, he said that governments running deficits weren’t all that bad especially in times of crises when private investment would decline. Instead, the crucial variable one should be tracking was the national income. With a set of assumptions, he derived that as long as the national income grows at a rate faster than the interest rate, tax rates settle to manageable levels.

While it is true that higher deficits mean higher tax collections from subsequent generations, it doesn’t necessarily imply an increase in the rate of taxation. Provided that the economy grows at a robust rate, a smaller percentage of it hived away as tax can raise the same tax amount as would a higher tax rate raise on a slow-track economy. This is intuitive. For instance, a 12 per cent tax rate on an economy that is stuck at 100 units generates the same tax amount as a 10 per cent tax rate on a faster economy that has galloped to 120 units in the same period. In other words, compound growth counters compound interest.

Domar’s conclusion is simple but profound: the problem of debt burden is a problem of expanding national income.

The chart below illustrates this finding. At constant incomes (stagnant GDP), tax rates keep rising linearly. At the other extreme, when income rises at the same rate as the interest rate (2 per cent in this case), the tax rate remains constant. More interestingly, the sawtooth pattern below shows that even if there were recurrent wars every thirty years requiring recurrent massive government borrowing, tax rates would still be under control so long as the national income keeps growing handsomely.

So, higher levels of public debt are not all bad. The key is to understand how that additional borrowing is being utilised. If this money is invested in a way that accelerates economic growth, debt will be sustainable in the long run. In other words, spending on physical and human capital is desirable, spending on wasteful subsidies is not.

Now, armed with this framework, observe where India is. The interest rate on the government’s 10-year bonds is hovering at the 6.2 per cent mark while the GDP growth has barely turned positive last quarter after two consecutive quarters of negative GDP growth. Even before the pandemic hit, the situation wasn’t all hunky-dory. The slowdown of the last decade means that public debt sustainability has been worsening for almost a decade now.

A chart in Business Standard has a good illustration of this risk. Without returning to higher GDP growth rates soon, even government borrowing will become unsustainable. And if the government doesn’t have the spending power, all other worthy projects of tackling climate change and inequality have no chance of success.

Global Policy Watch #2: The Great Chip Squeeze

Bringing an Indian perspective to burning global issues

— Pranay Kotasthane

If you’re planning to buy a new car, don’t. Because you’re staring at indeterminate delays as the semiconductor IC chips that make your car infotainment and control systems work are just not available in the global market. No one’s quite sure when this shortage would be resolved. Some estimates suggest that nearly 1 million fewer vehicles will be produced the world over in the first quarter of 2021 because of the semiconductor shortage.

This peculiar market condition has been in the news for many weeks now. Two reasons are commonly cited. One, a massive advance purchase order from Huawei in anticipation of US sanctions last year gobbled up available manufacturing capacity. And two, as the demand for vehicles dropped during the lockdown period, contract semiconductor manufacturers shifted focus to meet the higher demand from a much more lucrative segment — phones, data centres, and routers. When the automobile demand eventually bounced back, the manufacturers had no spare capacity to offer them.

While these two are indeed the proximate reasons for the current shortage, the more fundamental cause is a uniquely bottlenecked semiconductor supply chain.

In the 1980s, the semiconductor industry was transformed by the arrival of companies specialising in manufacturing chips on contract. These companies in turn created a new generation of fabless semiconductor design companies which were unencumbered by the huge setup costs (setting up a manufacturing plant needs an investment in excess of $10 billion).

While thousands of fabless companies mushroomed around the globe, the contract manufacturing market kept consolidating with the end result that just one company, Taiwan-based TSMC, does nearly 50 per cent of the world’s contract chipmaking.

Not that anyone was complaining. This extreme form of comparative advantage-led diversification worked perfectly well. The labyrinthine supply chain worked so well in fact that TSMC was hardly known outside the tech world.

And then, the pandemic happened.

COVID-19 exposed the underlying fragility of this supply chain. The overdependence on a handful of contract chip manufacturers became a bottleneck and the supply chain unravelled. In most other markets, higher demand would have been met by new suppliers motivated by higher prices. But even this shock absorption is not possible the case of semiconductors. Setting up a new manufacturing plant costs three-four years, a lot of money, and top-notch talent.

The big takeaway from the current shortage is that the semiconductor industry is being seen in strategic terms. The US plans to get both Samsung and TSMC to set up new plants there while the CHIPS for America Act plans to pump in massive investment for local players. The Indian government too has floated an expression of interest to gauge interest for a semiconductor fab in the country. Europe for its part is also putting in place a plan to help its home-grown players. All this even as China has been pumping in billions of dollars since 2013 for its own version of semiconductor aatmanirbharta.

The moment is right for countries or industry bodies to form consortiums for financing the huge upfront costs of semiconductor manufacturing facilities. I have previously written why semiconductors should be the focus of technology cooperation in the Quad framework.

The lack of redundancy in the current supply chain coupled with the imperative to make supply chains of critical technologies China-free means that the semiconductor landscape is set to change this decade. Expect many policy flip-flops along the way.

HomeWork

Reading and listening recommendations on public policy matters

* [Paper] Political Economy of Government Finance in India by Govinda Rao gives a comprehensive overview of important features of India’s public finance story.

* [Article] How Covid-19 changes the geopolitics of semiconductor supply chains.

* [Article] Rathin Roy discusses why the quality of public debt is just as important as the quantity.

* [Article] The Economist asks - Should governments in emerging economies worry about their debt?

- RSJ

Two somewhat random thoughts triggered this edition.

One, we have been talking about Radically Networked Societies (RNS) a fair bit here. These are non-hierarchical networks of individuals who share a common identity and take up a cause they are passionate about through adroit use of social media platforms and cellphones. In an RNS, there are no clear roles, the decision making is amorphous and the leadership is diffused. But things move really fast. The state which has to contend with RNS is hierarchical, slow and regimented. It can’t keep up. We have seen this with the many protests world over that have been triggered by RNS. Forget the state, even nimble hedge fund managers have found it difficult to stay in step with an RNS-like Reddit forum, r/wallstreetbets. We have made the case RNS are here to stay and the state will have to find a solution to control them.

But over the weekend I was struck with a thought. What have these RNS movements truly achieved? Have they turned themselves into mass movements and brought dramatic change anywhere? The answer is no. Over the last decade (starting from Arab Spring), there have been innumerable RNS movements driven by Twitter, WhatsApp and other platforms that have created a stir and captured media imagination. But they have been transient. Their long-term impact is yet to be seen. Does anyone really believe that the most long-lasting among RNS instances like Black Lives Matter or Occupy Wall Street will ever morph into something like the Civil Rights movement of the 60s or, more impossibly, the Russian revolution?

No.

So, the question: why?

Two, the majoritarian problem that’s facing many democracies the world over today. This is the ‘tyranny of the majority’ that Burke and Tocqueville had warned about almost two centuries ago. So, the question is how do you trump majoritarian-ism in a democracy which is designed for it? Granted, it is not where a democracy should have reached, but having reached there how does it get out from it? A solution I have written about in previous editions is to do nothing. My argument has been it is impossible for a large agglomeration to remain stable over a period of time. It will splinter because the concept of political is about the existential distinction between friend and enemy like Schmitt wrote. So, you just wait for nature to take its own course. But that doesn’t seem a proactive solution to many. There must be a way to counter-mobilise the masses, they argue.

So, the question: is there a way?

Enter The Longshoreman Philosopher

Both these questions - why the many RNS movements haven’t turned into real mass movements and why is it difficult to counter-mobilise against majoritarian tendencies - bring me to the works of Eric Hoffer. More specifically, his first book - The True Believer: Thoughts on the Nature of Mass Movements (1951).

Eric Hoffer was an intellectual like no other. Consider this: he never finished even grammar school, he was blind between the age of 7 to 15, and he worked every day of his life as a longshoreman in the docks of San Francisco doing hard physical labour. Yet, or maybe because of these, Hoffer was a peerless social and moral philosopher with dazzling aphorisms and insights. At the age of 53, he wrote The True Believer, a slim book that packs in, to my mind, the most number of insights per page than any book I have read. It will be impossible to sum up the book in a few lines but let me try with a few helpful extracts from the book. Just to be clear, these do no justice to the richness of the text when read in full.

First, Hoffer establishes all mass movements, religious, political or social, are interchangeable. When the situation is right for a mass movement, it is right for any movement regardless of belief or dogma. So, for Hoffer, every mass movement from Christianity to Communism to Fascism have the same underlying features. As he wrote:

“Since all mass movements draw their adherents from the same types of humanity and appeal to the same types of mind, it follows: (a) all mass movements are competitive, and the gain of one in adherents is the loss of all the others; (b) all mass movements are interchangeable. One mass movement readily transforms itself into another. A religious movement may develop into a social revolution or a nationalist movement; a social revolution, into militant nationalism or a religious movement; a nationalist movement into a social revolution or a religious movement.”

Second, the movements get off the ground by what Hoffer called ‘Men of Words’. Most people don’t like change, no matter how dissatisfied they are with their present. They will seek change at the margins. They look upon a rabble-rousing change agent with suspicion. Men of Words, on the other hand, are different. Their core skill is their ability to articulate the need for change in a benign yet persistent manner. They find an audience with the restive masses with their farsighted prescriptions for change without an immediate sense of urgency.

“…. the man of words prepares the ground for the rise of a mass movement: 1) by discrediting prevailing creeds and institutions and detaching from them the allegiance of the people; 2) by indirectly creating a hunger for faith in the hearts of those who cannot live without it, so that when the new faith is preached it finds an eager response among the disillusioned masses; 3) by furnishing the doctrine and the slogans of the new faith; 4) by undermining the convictions of the “better people"— those who can get along without faith—so that when the new fanaticism makes its appearance they are without the capacity to resist it.”

Third, once the ground has been set by the Man of Words, the fanatics enter. They love chaos and they seek anarchy. The old order is rotten to its core and only a complete dismantling of it will satisfy a fanatic. They don’t want to waste time to reform it. It has to be overthrown. The fanatics get the mass movement rolling not with their convictions but something more primal. Hate. As Hoffer wrote:

“Mass movements can rise and spread without belief in a God, but never without belief in a devil. Usually the strength of a mass movement is proportionate to the vividness and tangibility of its devil.”

The fanatics are ready to sacrifice their lives to smash the old order. This passion is great when they are in a life and death struggle with their enemies during the movement. But it becomes a problem when victory is in sight.

“The danger of the fanatic to the development of a movement is that he cannot settle down. Once victory has been won and the new order begins to crystallize, the fanatic becomes an element of strain and disruption. The taste for strong feeling drives him on to search for mysteries yet to be revealed and secret doors yet to be opened. He keeps groping for extremes.”

Fourth, the revolution is then saved from the fanatics by the practical ‘Man of Action’. This marks the institutionalisation phase of the movement. The change that was so desired and is now at the doorsteps needs to be perpetuated through institutions and systems. This has to be done by the Man of Action. The practical man looking for order. As Hoffer wrote: “The genuine man of action is not a man of faith but a man of law.” He is seeking stability and he will go to the extent of coercing the masses to perpetuate the hard-won change.

“In the hands of a man of action the mass movement ceases to be a refuge from the agonies and burdens of an individual existence and becomes a means of self-realization for the ambitious. The irresistible attraction which the movement now exerts on those preoccupied with their individual careers is a clear-cut indication of the drastic change in its character and of its reconciliation with the present. It is also clear that the influx of these career men accelerates the transformation of the movement into an enterprise.”

Hoffer believed a successful revolution works when these 3 roles - Man of Words, Fanatic and Man of Actions - are split among different people who play their parts and move on. However, he was aware there was a rare breed of people who straddled these roles depending on where the movement was at any point in time.

“There are, of course, rare leaders such as Lincoln, Gandhi, even F.D.R., Churchill and Nehru. They do not hesitate to harness man’s hungers and fears to weld a following and make it zealous unto death in the service of a holy cause; but unlike a Hitler, a Stalin, or even a Luther and a Calvin,1 they are not tempted to use the slime of frustrated souls as mortar in the building of a new world. The self-confidence of these rare leaders is derived from and blended with their faith in humanity, for they know that no one can be honorable unless he honors mankind.”

Hoffer Today

Now back to the two questions I raised at the start of this edition - why the many RNS movements haven’t turned into real mass movements and why is it difficult to counter-mobilise against majoritarian tendencies?

Hoffer probably has some answers.

One, the men of words who can sustain a long campaign to “undermine institutions, discredit those in power, weaken prevailing beliefs and loyalties” are in short supply today. The modern men of words take on too many causes, speak on varied issues and often end up contradicting or discrediting themselves.

Two, fanaticism is cheap on social media. The cost of fanaticism is low. This creates a temporary mob of impassioned supporters of a cause who are high on noise and low on stakes. They are all fire and brimstone behind the cloak of anonymity on these platforms. They lack the fundamental Hoffer-ian feature that distinguishes fanatics from others: self-sacrifice.

As Hoffer wrote:

“One of the rules that emerges from a consideration of the factors that promote self-sacrifice is that we are less ready to die for what we have or are than for what we wish to have and to be.”

It follows that any counter-mobilisation against a majoritarian agglomeration must satisfy the requirements of a mass movement laid out by Hoffer. And what would that be? A real intellectual foundation that’s sustained over time by men of words followed by real activism and self-sacrifice by the fanatics to the cause. The men of action can then follow to institutionalise the change.

As I was reading Vinay Sitapati’s excellent Jugalbandi: The BJP Before Modi, I realised how Hoffer’s thesis on mass movements fits perfectly to the two seminal political events of India over the last century - the freedom movement leading to Congress hegemony till the mid-80s and the rise of the BJP and Hindu nationalism from then to the present. Both involved men of words creating the grounds for stoking dissatisfaction over years followed by hordes of self-sacrificing fanatics getting the movement off the ground. That then sets the stage for men of action to codify and institutionalise the change. What our history has shown is any mass counter-movement to the current order will take years to fructify with the right conditions. Of course, the current order will try and prevent the building up of the right conditions. That’s what we see around us now.

70 years since its first print, Hoffer’s ‘The True Believer’ has the best answers to the question that’s often asked in politics today - how will an alternative emerge? I can imagine a lot of people whom I can recommend it as an essential reading.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] An interview of Eric Hoffer (this is part 1. There are 4 more parts). The man was an original.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: Sedition, Blasphemy, Defamation

Insights on burning policy issues in India

- Pranay Kotasthane

A Delhi Court Session Judge’s admirable order granting bail to activist Disha Ravi in the #ToolKit case made me reflect on sedition as a concept. Here are a few initial thoughts emanating from that exercise. Fair warning: this is a conceptual discussion and not a legal one. If detailed legal critique interests you, head over to these two articles by Gautam Bhatia (1 & 2).

The “crimes” of sedition, blasphemy, and defamation lie along a continuum. They are categorically similar in that they punish the written or spoken word directed at some other entity. Where they differ is the targeted object. Defamation laws punish verbal or written attacks against a person or a group of people. Blasphemy laws punish utterances against something considered sacred by a group of people whereas sedition laws punish utterances that can threaten the State.

A Few Definitions

Before wading in any further, understanding three political science terms — nation, state, and government — is important.

State is a political construct, an abstract political institution. Max Weber’s instrumental definition of the State as “a human community that (successfully) claims the monopoly of the legitimate use of physical force within a given territory” is especially relevant here. To ensure that all its individuals’ liberties are protected, a State is invested with the powers to use violence or force to prevent other belligerent groups from terrorising individuals. It is for this reason that a State maintains armed institutions like the police and the army.

Going by this definition, an anti-State act would be the one that challenges the State's monopoly over the legitimate use of physical force. In other words, an act of violence or the use of force by anyone other than the State becomes anti-State.

Government is a temporary governing body of the State. If the State is like a corporation, the government is like its management. State is semi-permanent. It will live on until it is overthrown or replaced and a new social contract is established. Unlike the State, the government is composed of a set of people organised into a hierarchy. When the electorate vote, they choose their government and not the State.

By this definition, an anti-government act would be the one that criticises the policies, strategies, and directives of the governing body in power.

Nation, on the other hand, is a mental construct. Ernest Gellner defines this concept precisely yet comprehensively thus:

“Two men are of the same nation if and only if they recognize each other as belonging to the same nation. In other words, nations maketh man; nations are the artefacts of men's convictions and loyalties and solidarities. A mere category of persons (say, occupants of a given territory, or speakers of a given language, for example) becomes a nation if and when the members of the category firmly recognize certain mutual rights and duties to each other in virtue of their shared membership of it. It is their recognition of each other as fellows of this kind which turns them into a nation, and not the other shared attributes, whatever they might be, which separate that category from non-members.”

In other words, nations are imagined. People belong to the same nation only if they consider themselves to be so.

An anti-national act thus could be of two types. One that denies the existence of such an imagined community. For example, libertarians could argue that only individuals matter and not the groups these individuals are a part of. And the other view imagining a nation along lines different from the dominant belief. For example, communism sees workers across the world as one “nation”.

What is Sedition then?

With these key differences out of the way, we are now in a position to understand sedition and blasphemy laws.

Sedition laws can lie on a continuum. In dictatorships and party-states, sedition laws are applied wantonly to criticisms of the government. That is, being anti-government itself is being seditious. In most modern democracies, however, sedition laws punish only those anti-State actions which have the capability to directly challenge the State’s authority. Thus, criticism of the Republic of India would not count as sedition but inciting violence against the police would count as sedition. Crucially, being anti-national is not the same as being seditious.

On the other hand, blasphemy laws penalise a subset of anti-national actions, the ones that call into question something held sacred. As the idea of individual freedom has gained prominence, blasphemy laws have been repealed in many places. Not in India though.

The Indian Sedition Law

Now we are in a position to understand sedition in India. India’s sedition law i.e. Section 124A of the Indian Penal Code has colonial origins. Unsurprisingly then, being anti-government was reason enough to be labelled seditious. Tilak, Gandhi and scores of other leaders were tried for sedition.

After independence, the stated aim was to get rid of sedition laws altogether. That never happened. Sedition law continued in its colonial avatar. What did happen is that the application of such laws reverted to a stricter interpretation. Anti-State acts were penalised and not anti-government ones as a result of a right to freedom of speech and expression. In subsequent court rulings, the scope of sedition was further truncated. Only those anti-State acts that had the tendency to incite violence or disturb law and order were deemed to be seditious.

This dissonance between the original definition and application continues to this day. See for yourself. The sedition law says:

“Whoever,   by   words,   either   spoken   or written, or by signs, or by visible representation, or otherwise, brings or attempts to bring into hatred or contempt, or excites or attempts to excite disaffection towards, the Government established by law in India, shall be punished with imprisonment for life, to which fine may be added, or with imprisonment which may extend to three years, to which fine may be added, or with fine.

Explanation 1.-- The expression "disaffection" includes disloyalty and all feelings of enmity.Explanation 2.--Comments expressing disapprobation of the measures of the Government with a view to obtain their alteration by lawful means, without exciting or attempting to excite hatred, contempt or disaffection, do not constitute an offence under this section.Explanation 3.--Comments expressing disapprobation of the administrative or other action of the Government without exciting or attempting to excite hatred, contempt or disaffection, do not constitute an offence under this section.

Note how wide-ranging this law is. Even disloyalty and all feelings of enmity count as sedition. Now read the qualifier that the Supreme Court added in Kedar Nath vs State of Bihar 1962.

“..the sections aim at rendering penal only such activities as would be intended, or have a tendency, to create disorder or disturbance of public peace by resort to violence. As already pointed out, the explanations appended to the main body of the section make it clear that criticism of public measures or comment on Government action, however strongly worded, would be within reasonable limits and would be consistent with the fundamental right of freedom of speech and expression. It is only when the words, written or spoken, etc. which have the pernicious tendency or intention of creating public disorder or disturbance of law and order that the law steps in to prevent such activities in the interest of public order.”

In non-legalese, for an action to count as seditious, its connection with violence is necessary according to the Supreme Court but not so according to the original framing in the penal code.

This dissonance is a problem. To such an extent that the same judge presiding in two similar cases (Disha Ravi’s and Safoora Zargar’s), referring to the same 1962 judgment, reached two diametrically opposite conclusions! In Safoora Zargar’s case, bail was denied on the grounds that the connection of an act with violence is not necessary. In the Disha Ravi case, bail was granted on the grounds that the connection of an act with violence is necessary.

The other problem is the political economy of India’s sedition law. Because it is construed as a grave anti-State offence, it is cognisable i.e. investigation and arrest can happen based on just an FIR, and non-bailable i.e. bail is subject to the decision of a sessions judge. Such strict provisions mean that the police slap sedition charges indiscriminately and by the time charges are cleared, many years pass by. The process becomes the punishment.

Clearly, this needs fixing.

The Way Forward

Broadly, there are three ways out. The first method would be to revise the sedition law to end the dissonance between the text and its subsequent interpretation. Make the link with violence a necessary condition for the application of sedition.

A second way is to scrap the law altogether. If the tendency to cause violence is what triggers sedition, there are enough and more laws in place to address such actions. Even if this law were to be struck down, provisions to punish acts inciting violence against State, government, or other people will still be applicable.

A third way out is to address the political economy question by making sedition a bailable and non-cognisable offence. With nothing to gain by slapping the additional charge of sedition, its usage is likely to decline. A solution with a similar effect is to make police personnel comply with additional requirements before arresting a person for sedition. The Bombay High Court tried to do this in the Asim Trivedi case by issuing guidelines to police personnel listing specific preconditions. A failure to adhere to these guidelines made the police officer liable to dereliction of duty. To what extent these guidelines been adopted since then, I do not know.

Given my biases, the second solution is the ideal one. But it’s also the most unlikely one in the current situation. We in fact run a real risk of going the other way — sedition laws might well revert to punishing anti-government utterances and blasphemy laws might be used more frequently. Given this reality, focusing on changing the incentives of police might be more practical.

For now, I’ll leave with these lines in Disha Ravi’s bail order that need to reach far and wide:

“Citizens are conscience keepers of government in any democratic Nation. They cannot be put behind the bars simply because they choose to disagreewith the State policies. The offence of sedition cannot be invoked tominister to the wounded vanity of the governments. Difference of opinion,disagreement, divergence, dissent, or for that matter, even disapprobation, are recognised legitimate tools to infuse objectivity in state policies. An aware and assertive citizenry, in contradistinction with an indifferent or docile citizenry, is indisputably a sign of a healthy and vibrant democracy.”

India Policy Watch #2: The Coming Inflation

Insights on burning policy issues in India

- RSJ

Last week Pranay wrote about the Domar rule and how to think about public debt sustainability. Pranay and I have long held economic growth is a moral imperative for India now. Domar’s paper, like Pranay wrote, makes it clear that growth is necessary even if you favour a big government. The argument is simple. Governments are free to borrow and spend on their favoured programmes. They can run deficits without worrying about today’s deficits turning into tomorrow’s higher taxes or higher inflation only if the national income (r) grows at a rate faster than the interest rate (i).

That is if “r” > “i”, we are fine with deficit spending.

The logic is simple. If you grow faster than the interest rate, you can keep your debt to GDP ratio at a constant level. So, please go ahead and spendbut choose wisely. Spend in areas that will yield higher growth rates in future. Growth will take care of your debt burden.

Since we are in the territory of public debt sustainability and role of government spends, I thought it would be useful to bring the Fiscal Theory of the Price Level (FTPL from here on) into this discussion. So, consider this an addendum to Pranay’s piece.

Price stability or inflation control is a key goal for all governments in a democracy. Why? Because they want to win elections and nothing irks public than price rise. So, there are two questions in public policy on this issue - a) how do we tame inflation and b) is there an optimal level of controlling it?

Now, the usual macroeconomic explanation offered to the first question was simple. Inflation is managed by the monetary policy of the central bank. An independent central bank focused on price stability will manage it by controlling the supply of money. If the total output grows at x per year and the money supply grows at y, then over a period of time the prices will grow at (y-x) per year. That’s your inflation rate. Simple.

There’s a problem though. It assumes the demand for money among people today is uniform across. This isn’t true. Because all of us have different beliefs about the future. If our view of future inflation is different, our need to hold money today will be different. This means there could be many paths to price stability other than just the monetary approach. These paths are varied depending on households’ views about the economy’s future state. And that’s influenced by fiscal policy. So, according to FTPL, a tough and independent central bank is good to have but it alone cannot guarantee price stability. Fiscal policy will have to work in tandem. Government’s choice of how it finances its debt has a key role in how inflation plays out in future. The central banker must continue to convince the government to adopt the right stance on fiscal policy.

On the second question - how much inflation control is optimal - FTPL suggests allowing price levels to swing to any wild variations to the government’s budget. This gets a bit complicated but a simple summary is that in times of economic shocks like a pandemic it is efficient to allow prices to go up.

That done, let me move to add my nuance to Pranay’s explanation of Domar’s rule. No one can argue about “r” > “i” logic. The key questions about the deficit, however, are for how long and how much? If you have a fiscal deficit of one per cent for one year and you take the next five to grow higher than the interest rate to offset it, you’re fine. But what if you keep adding a five or six per cent deficit every year for a decade and more? As a somewhat laidback, retiring fiscal hawk, this is what worries me when I see unlimited deficit spending all around. A trillion here in stimulus and another trillion there and soon we are talking about some real money here. My worry is we have reached a stage where “r” > “i” cannot support the deficit spending. So inflation will come in.

That’s my view. A high inflation future is inevitable.

Addendum squared

RSJ makes an important point. “r” > “i” is a necessary but insufficient condition. The reality is that “r” needs to be sufficiently greater than “i”. That’s because the “r” > “i” condition rests on the assumption that the primary deficit is zero i.e. the government is only borrowing to pay interest on debts accumulated in the past.

That’s not the case in India. The primary deficit in 2019-20 was 1.6 per cent of GDP while it is estimated to be 3.1 per cent in the next financial year. This means a lot of borrowing is being deployed not just for capital investment but also for the day to day running of the government.

With higher primary deficits comes higher responsibility to restart economic growth.

Not(PolicyWTF): Delhi Government’s Singapore Ambitions

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

— Pranay Kotasthane

Given how we keep going on and on about the urgency of economic growth, this line in the Delhi government’s budget came as a pleasant surprise:

“Our goal is that the per capita income of Delhi by the year 2047 is equal to the income of a Singapore citizen. To make this possible, we have to increase the income of our citizens by about 16 times which is a difficult target, but not impossible.”

It’s not new for Indian governments to aspire to be like someplace else. Isomorphic mimicry is in fact quite common. Vilas Rao Deshmukh wanted to transform Mumbai into Shanghai more than a decade ago.

What’s different this time is the Delhi government has set itself a measurable output target with a defined end date, something most governments refuse to commit to.

The Delhi Finance Minister even had a well-thought-out response to the question “Why Singapore?”. He said:

“Singapore has one of the most stable economies in the world, with high government revenue and a consistently positive surplus. As a result of its strategic geographical positioning in Asia, the socio-economic context of Singapore is relatable to that of India. In addition to this, Singapore is also a city state which has achieved substantial growth in the past 25 years. So, when we think of Delhi 25 years from now, we envision a Delhi which can stand at par with one of the fastest growing and developed economies in the world.”

Setting a clear, measurable income target against which performance can be measured is a welcome change. Hopefully, the other governments are watching.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] John Cochrane on fiscal roots of inflation. A great paper.

* [Article] ‘Disaffection’ and the Law: The Chilling Effect of Sedition Laws in India by Siddharth Narrain is a good overview of the history of sedition in India.

* [Podcast] Pranay and Saurabh discuss the impossibility theorem of affirmative action on Puliyabaazi.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: Choose Your Nationalism Wisely

Insights on burning policy issues in India

- RSJ

A short note on nationalism to think about for this edition.

There was the usual brouhaha in media last week over a few international agencies downgrading India on some kind of global ‘freedom index’. The usual reactions have followed.

For some, it is a validation of all they see happening around them. Our freedoms are being eroded and we watch silently, they claim. As Majrooh wrote (in that Guru Dutt romcom ‘Mr & Mrs 55’):

“मेरी दुनिया लुट रही थी, और मैं खामोश था”

On the other hand, the establishment and its supporters view this as another ‘left-liberal-woke’ attempt to malign a new, confident India. To them, there is freedom in India to freely express your dissent and criticise anyone. The old order of the privileged elite who feel left out in the present order is keen to paint India in poor light. They have been discredited and rejected by the masses, yet they persist. This is the argument made by the ‘nationalists’ (or atleast that’s what their Twitter handles claim).

The Counter

This was following the usual script on social media. We took interest, however, when the Minister of External Affairs (MEA) was asked about these ‘freedom’ reports. He dismissed the basis for their conclusions and questioned their intentions. More importantly, he gave two interesting counters to the usual ‘Hindu nationalist’ branding of the current dispensation in large sections of global media and among thinktanks.

The first was factual - they call us nationalists but we are leading the efforts in donating vaccines to countries around the world. We have already shipped over 40-50 million vaccine doses taking a humanitarian view instead of keeping them for ourselves. Tell us which western democracy is doing so? Then the second point - in these countries almost every elected official takes the oath of office with their hand on a holy religious book (America and the Bible were possibly what he meant). Do we do so in India?

Social media was abuzz with this clip. This is the ‘new, confident India’ was the usual comment among the partisans.

Well, maybe it is. Who knows?

To me, this incident is another useful lens to view nationalism. There are two things to parse here. One, is ‘vaccine diplomacy’ the antithesis of nationalism? Two, is the taking of an oath of office on a holy book blurring the lines between the church and the state?

A Masterstroke

Let’s tackle 'vaccine diplomacy’. We go on in these pages about international relations being guided by matsyanyaaya - big fish eating small fish. This is realism at play. All morality stops at the boundary of a nation-state. Beyond that is Hobbesian chaos. Going by this, donating millions of vaccines to other nations while you haven’t vaccinated your own would seem insane.

But that would be taking a narrow view of matsyanyaya. International relations is a long game with a clear understanding of your adversaries and their strengths. Vaccine diplomacy for India is a perfect counter to China in the post-pandemic world. China’s conduct in suppressing information during the initial phase of the pandemic and its bullying behaviour around the region later are open flanks for India to exploit. Donating vaccines at an early stage of their mass production checks all the boxes of being a reliable friend in international relations - it is relevant and timely, and it involves sacrificing self-interest to help others. That it provides a counter to the view in global media about this being a nationalistic dispensation is an added bonus. This act isn’t one of those false masterstrokes. This is the real thing.

What Kind Of Nationalism?

Now on to the oath and the holy book business. What’s the core issue here? If you peel the layers, there are two questions to be tackled.

* How important is the role of ethnocultural nationalism in the building of a modern nation-state?

* If it is important then what kind of ethnocultural nationalism should a state strive for to achieve its objectives of peace and prosperity for its citizens?

On the first question, it is hard to argue against the advantages of solidarity and a communitarian outlook that ethnonationalism engenders among the members of a nation. Universal brotherhood is great in the abstract but all kinship is real and very specific. The idea of a free individual owing allegiance to higher human ideals while being aloof from the emotions and instincts of his immediate surrounding is bizarre. It isn’t sustainable and it motivates no real action. It can never help in the project of nation-building. Nationalism might be seen as ‘false consciousness’ to the liberal but it is a tangible driver of change among its adherents. It can move mountains.

Ethno-cultural examples of nation-building abound in modern history. From the white Anglo-Saxon Protestants who built America, the ethnic chauvinism that welded modern Germany during the pre-WW1 period or the cultural renaissance that motivated imperial Japan between the wars. Even the rise of China in the past quarter-century is an ethnocultural project.

Now if that’s true, what about the second question? What kind of ethnocultural nationalism should the state strive for? There’s always the danger of an ethnocultural movement ascribing a core moral or cultural value to a nation that excludes a significant minority from it. This is almost certain if the ethnocultural value is derived from a glorious past (real or imagined) which is lost today because of reasons beyond the control of the majority that believes in the value. The notion of Aryan supremacy and its undermining by Jews in the past or the belief in the supremacy of the Japanese subjects of Sun God and its imperial project thereafter are examples of this.

The momentum of a nationalist movement is beyond the control of those who start it. History has shown it destroys a lot before it builds something. And what it builds is rarely sustainable. It is never easy to balance liberal-democratic values and nationalistic attitudes. A middle ground is often sought but rarely achieved. This was the project that faced the leaders of modern India at its founding moment in 1947. They chose a modern conception of the Indian nation - liberal, tolerant and statist - and promoted cultural and historical artefacts that supported this ethnocultural nationalism. That was the middle ground they chose to build a modern India.

This is what they thought worked for successful liberal, democratic nation-states they saw around the world. It was bold and it was a clear break from the past. And let’s be clear. It was also the only option that wouldn’t have plunged the nation into anarchy. This project of building ethnocultural nationalism caught the imagination of people in the early years. However, as recent years have shown, it didn’t grow deep roots. Why? It’s a whole different story and we have covered a few of the reasons on these pages.

In any case, India is back at that moment in its history. What kind of ethnocultural nationalism must it choose for the current project of nation-building? That’s at the heart of the debate these days. The democratic mandate seems to suggest upending the consensus of its founding moment.

There’s always the lure of learning the wrong lessons from history. Did India choose unwisely then or did it get the execution wrong over the last 70 years? It is hard to build and easy to destroy as Amit Varma says in his newsletter. There’s a lot to think over here. Choose your nationalism wisely.

Lastly, the American Presidents take the oath of office placing their palms on the Bible. Sure.

But they don’t open it to run the country.

There’s a balance.

Matsyanyaaya #1: Quad Not Being Square Anymore

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

It’s amazing how often and quickly a common, powerful, and abrasive adversary can make States bury their mutual differences. China as an adversary has reliably displayed all the three attributes, and in the process, created a new geopolitical formation — the Quad.

This formation, of course, is not new. It has hummed and hawed for nearly fifteen years. But it is China’s rapid growth and arrogant conduct that has breathed life into this idea. And finally, last week was the first time when the four heads of State met and proudly declared to the world that the Quad is here to stay and act. This reminded me of Edward Luttwak’s prescient analysis from his 2012 book The Rise of China vs The Logic of Strategy:

“Other things being equal, when a state of China’s magnitude pursues rapid military growth, unless the resulting shift in the power balance passes the culminating point of resistance inducing the acceptance of some form of subjection, it causes a general realignment of forces against it, as former allies retreat into a watchful neutrality, former neutrals become adversaries, and adversaries old and new coalesce in formal or informal alliances against the excessively risen power.”

In other words, for China, with great power came great adversaries.

This Quad summit meeting is significant at two levels: procedural and substantive.

By procedural significance, I mean that for the four States to meet and release a joint statement is itself a big deal. Usually, different countries have different readouts on major issues. The joint statement was followed up by a joint opinion piece under the names of the four heads of state. In diplomacy, where words are everything, the willingness to agree on terminologies, definitions, policy proposals, and actions with not one but three other differently placed partners, is major progress. Think of these joint statements as the diplomatic equivalents of conducting joint military exercises. Extrinsically, it is an exercise in signalling to the adversary. Intrinsically, it helps develop some comfort working in unison.

By substantive significance, I mean the creation of three working groups on vaccines, critical and emerging technologies, and climate change. While China is a glue that can hold these countries together, it can’t be a fuel that propels the Quad forward. That requires a positive agenda of action items, which these three working groups do.

Of the three areas, the vaccine partnership seems to be the most well-thought-out. In short, all four countries have agreed to expand the manufacturing of COVID-19 vaccines at facilities in India and give these vaccines to countries in the Indo-Pacific. Sanjaya Baru describes the geoeconomic significance of this move thus:

“What Quad has already achieved in geo-economic terms is to use the Asian demand for Covid-19 vaccines as an opportunity to create a four-way economic relationship that combines the benefits of American research, Japanese funding, Indian manufacturing capacity and Australian marketing network to supply vaccines to Asian developing countries. This is without doubt a smart idea and one that can ensure its equal ownership by all four partner countries.”

From the Indian perspective, Quad giving an impetus to vaccine investment in India pours cold water on the usual doubts that prevent collaboration with western countries.

The second working group on critical and emerging technologies seems to be the most undercooked. For starters, there isn’t an agreement on the definition of critical and emerging technologies. The Trump administration did label 20 technologies as critical and emerging but to expect multilateral cooperation on all twenty would be a high cost, low returns approach.

We have argued earlier that a better approach would be to secure semiconductor supply chains first for three reasons:

“one, the semiconductor industry underlies all critical technologies. Two, it is perhaps the most globalised high-value supply chain and no country can become entirely self-resilient. And three, all four countries have complementary strengths in the semiconductor supply chain.”

Better if the four countries can demonstrate measurable success on less controversial technologies such as semiconductors before dealing with the more vexing questions of cyber governance, data privacy, and AI governance.

Finally, this Quad meeting was initiated by the US president, putting all doubts to rest that the Biden administration might soften its stance against China. In fact, the US now seems to have a more concerted strategy to contain China. That they have a leader who is not abrasive is itself a big relief for the other partners.

Matsyanyaaya #2: Nayaa Pakistan Again?

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Pakistan is back in the headlines these days. Surprisingly though, for good reasons. First came the much-needed Line of Control ceasefire agreement earlier this month. Since then, no ceasefire violations have been reported. And last week came a couple of conciliatory statements by the Pakistani Chief of Army Staff and PM Imran Khan.

Gen Bajwa had this to say:

.. let me say profoundly that we are ready to improve our environment by resolving all our outstanding issues with our neighbours through dialogue in a dignified and peaceful manner.

However, it is important to state that, this choice is deliberate and based on rationality and not as a result of any pressure. It is our sincere desire to re-cast Pakistan's image as a peace-loving nation and a useful member of international community. Our leadership's vision is Alhamdullilah transformational in this regard. We have learned from the past to evolve and are willing to move ahead towards a new future, however, all this is contingent upon reciprocity.

Pakistani PM Imran Khan echoed:

“Pakistan could not fully exploit its geo-economic potential unless it improved its ties with neighbours by strengthening trading connection and establishing peace in the region.”

The ceasefire agreement and these two statements mean that the marginally hopeful types are again entertaining these two questions: has Pakistan turned a corner finally? Will we see a sustained improvement in India-Pakistan relations?

On the first question, it’s too early to conclude. However, there are a few signs. Pakistan did not ratchet up tensions on the western border all through 2020, at a time when India was busy dealing with the China threat. Two, from Pakistan’s standpoint, India’s changing of Jammu & Kashmir’s constitutional status provided it with a potential casus belli to escalate terrorism. It hasn’t yet done so.

What explains this change in strategy? Probably a mix of new drivers and constraints. The major drivers are a dawning realisation that deploying terrorism as state policy has done more harm than good and the need to impress the new US administration. The major constraint, and one that’s hurting them most, is a flagging economy with declining external benefactors.

To answer the second question, let’s revisit the theory of constructivism in international relations. Constructivism contests the realist worldview that anarchy in international relations immutably leads to a security dilemma. Constructivist theorists argue that while amassing power remains the most important priority in a state of anarchy, this competition doesn't imply permanent confrontation. In Alexander Wendt’s now-famous “construction”: Anarchy is what states make of it. In other words, while all states pursue power, their identities and interests are socially constructed — it is not impossible to reimagine enemies as adversaries, adversaries as neutrals, and neutrals as friends. Big fish do eat small fish but only when they’re hungry.

Seen from a constructivist lens, we can now ask if elites in India and Pakistan view each others’ states differently. If yes, we could well say that relations between the two countries are on the right path.

I doubt if that’s the case. Constructivism itself acknowledges that once state identities and interests get institutionalised over time, constructing new identities and interests becomes exceedingly difficult. This is precisely the case with Pakistan and India. Moreover, on the Pakistani side, there’s an irreconcilable actor — the military-jihadi complex (MJC) — whose dominance of the affairs in Pakistan rests on being anti-India. Constructivism hasn’t hit the MJC yet. Many attempts to redefine state interests and identities have been cut short by terrorist attacks engineered by the MJC.

On the Indian side, new state identities and interests are being constructed, but not in a direction that leads towards peace between the two countries. For example, the recurring rhetoric of taking back Gilgit Baltistan, and viewing partition as unfinished business prevent a reset in ties.

Finally, reconstructing interests and identities would require consistent positive actions. Pakistan allowing India-Afghanistan trade over its land and India making J&K a full state again might be two good starts.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Book review of Yael Tamir’s Why Nationalism by Nick Cohen in The Guardian: “The rise of nationalism – a product of the left’s embrace of globalism – can be a benevolent force, according to this ‘wine-bar’ polemic. Nick Cohen begs to differ”.

* [Podcast] A Puliyabaazi on the Quad with Times of India Diplomatic Editor, Indrani Bagchi.

* [Report] The University of Chicago’s Kalven Committee Report on the University’s Role in Political and Social Action is a must-read given what’s happening in India. Raghuram Rajan mentions this report in his note on Pratap Bhanu Mehta’s resignation.

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

A short mid-week note on some points that have emerged from the Pratap Bhanu Mehta resignation issue.

Let’s take the issue of ‘shrinking liberal space’ in the public discourse and how this is another example of it. All politics is a contestation of narratives. The primary motive is to have your narrative dominate while diminishing the rest. So, from a realist lens, this is what every political party aspires to while few achieve. Therefore to expect any different from any dominant political grouping is to live under a delusion. You might desire a secure and self-assured dispensation that lets a thousand different and often dissenting ideas bloom. But that ideal state of affairs is rare anywhere in the world and in history. India is no stranger to a narrative dominating its body politic for decades. Good or bad is beside the point here. There’s another narrative in town now and, naturally, it wants to dominate forever.

Questions

That brings us to a couple of questions. Isn’t good or bad that was conveniently brushed aside above, an important point in this context? If this narrative dominance is what is to be expected, should this be a worry for India?

Well, narrative dominance of any kind is an unstable equilibrium. For three reasons.

One, we aim for dominance but once we achieve it, boredom sets in. No one likes to watch games where their team is so dominant that there is no contest. Over time we lose interest or we create two versions of our team to play against each other. Soon it is “us” versus “them” again. Either way, the narrative dominance is broken. This is also the reason there can never be a successful conservative-only or liberal-only social media platform in the long term. People crave to argue. To go one up on others. They will invent enemies if they have to. We have written about Schmitt’s friend-enemy construct in politics before here.

Two, narrative dominance of any kind doesn’t emerge out of a vacuum. It is built on the vestige of a previously dominant narrative. Those who were dominated by the previous narrative, remember those times. The humiliation and the rage of being under it is the fuel that sustains the current narrative. Unfortunately, humans are mortal. They die and a whole new generation arrives who have no first-hand experience of the previous narrative. They only learn about it from the surviving members who tell them about the horrors of the past. Or, from books. That’s one of the reasons why changing history textbooks is always on the agenda of every dispensation in the world. You control the past, you control the future. But time wears down everything eventually. In the pre-internet era, this could take multiple generations to come to a pass. That has shrunk now. Alternative narratives sustain themselves online and the information velocity facilitates their spread.

Three, there’s always a tendency to overreach among those who are driving their narrative dominance. Nothing remains sacrosanct in their desire to dominate - university, media, courts, law enforcement agencies, regulators or independent bodies. In a democracy, with strong independent institutions, the checks and balances in-built in the system come into play to counter this. This is a battle of attrition between institutions and political formations. The institutions usually win because they are designed to be permanent. They are necessary for democracy to survive. If they are subverted, democracy withers away.

The Indian Problem

Between the three, the institutional response tends to be the fastest way to counter-narrative dominance. The other two could take time and a lot could be undone during that period. The challenge in India is the institutional mechanism has been systematically weakened over many decades. To begin with, we inherited colonial institutional and legal structures that weren’t exactly suited for liberal democracy. Whatever gains we made in building new institutions and strengthening them were lost starting from the 70s. The Emergency being a high watermark of that era. Since then it has been one step forward and two backward on this. The reasons why a state or the union government in India can make citizens or private entities (like a private university) fall in line are two-fold. One, there are just too many outdated laws often working at cross purposes that are impossible for anyone to manage. This gives the state the power to haul you up for breaking the law. Two, the willingness of the institutions to do the bidding of the political class because their independence has been compromised. This means a CBI or a Tax raid is always around the corner. Coercive institutions are a structural problem and there’s little incentive for political parties to change this.

This seems like an irreversible slide. The problem with this slide is clear. Overtime when this narrative loses steam and an alternative narrative emerges (as it will), expect its adherents to be keener to dominate every sphere. To eliminate space for any dissent. And they will do so using the same tools - political and ideological mobilisation that overwhelms the institutions.

Pratap Bhanu Mehta might have been countering the narrative of the current regime in his op-ed pieces. But the larger point he was making was probably beyond it. He was alerting us to the dangers of this inevitable slide.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] “The Spectre of Totalitarianism: The worst offenders in the new climate of intolerance are our universities” writes Edward Skidelsky in The Critic. Money quote: The “woke” left is currently pursuing this goal by way of a Gramscian “long march through the institutions” — a progressive co-option of the schools, universities, state bureaucracies and big corporations. 

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

- RSJ

We have been trying to make sense of the three key trends dominating the global financial markets over the past 12 months - the excess liquidity in the system driven by loose monetary policies and stimulus announced by central banks the world over, the persistence of the central banks to keep interest rates at historic lows without worrying about potential inflation, and the booming equity markets that seem to be completely divorced from the ground economic realities during the pandemic.

You can read some of our previous posts on these here and here.

How long can these trends sustain? Who knows?

The perpetual optimism on which the wheels of finance move shows no signs of abating. Now, history has shown these are trends that are neither sustainable nor safe for ordinary investors. But optimism is the opium of the masses. “This time it is different” is what you usually hear as a record new stimulus is passed or markets touch new highs. But like Scott Sagan wrote in his book, The Limits of Safety:

“Things that have never happened before happen all the time.”

Three Strikes And…

The world is full of surprises and three events in the past quarter should give regulators and investors a pause.

First, Melvin Capital lost half of its $13bn fund during the GameStop saga in January this year. Melvin had taken massive leveraged short positions against the GameStop stock convinced its business model has no future. Well, the Redditors on WallStreetBets organised themselves to do the world’s first RNS (radically networked society) driven short squeeze. Melvin couldn’t reverse out of the trade soon enough. Only an emergency line of $2.75bn from other hedge funds kept it afloat. We have covered the GameStop shenanigans here.

Second, the collapse of Greensill Capital, a ‘supply chain finance’ company doing Enron-like things in a decidedly dull corner of finance. The full impact of its fallout is yet to be ascertained. The collateral damage so far has been impressive: London-based steelmaker GFG alliance (run by India-born Sanjeev Gupta) is facing an existential crisis; a German retail bank that Greensill had bought has gone down; Credit Suisse that funded Greensill through securitisation of its invoice finance arrangement had to write down huge losses; Bluestone Resources, a US-based coal mining company that’s left high and dry without Greensill’s funding pipeline; and Tokio Marine Insurance that underwrote the risks Greensill’s clients and investors in Credit Suisse funds were taking is still counting its losses.

The Greensill story is a good example of how it is not different this time. Supply chain financing has been around for a long time. Company A buys goods from a smaller Supplier B and promises to pay it (say) in 90 days. Ideally, B would like to be paid immediately but it usually lacks the bargaining power. Company A would prefer to pay as late as possible since it improves its cash flow and use it to further its business. Enter C, the Supply Chain Financier. C promises to pay B faster but at a small discount as the cost of getting its money quickly. It then collects the full amount from A. In a way, C pays on behalf of A and then collects the money from A over a period of time. It is like a traditional short-term loan that’s backed by the security of the invoice. And how does C get the money to pay to the suppliers faster? Usually, C would issue commercial papers (unsecured promissory notes) to obtain funds from market participants looking to park their excess funds for a short-term to back their invoice arrangements. The spread it makes between the two is C’s business.

But in a world where the liquidity is high, interest rates low and stock markets at their peaks, there’s always money looking for avenues to make some ‘extra’ return. Greensill had a perfect plan for them. Instead of issuing commercial papers, it securitised the supplier invoices into short-term assets and offered them to the likes of Credit Suisse and other asset management firms. In other words, these invoices were turned into a different financial instrument which could now be positioned differently to investors. With this, the stage was set to get into riskier bets and shuffle the risk around in a way that made investors believe they were still investing in a safe supply chain financing instrument than something more complex.

These investment firms launched Greensill-linked funds and raised money from investors who were drawn to the promise of almost risk-free returns that were higher than money market funds. Greensill also got insurance companies to back the risks underlying these funds to make them appear safer and more attractive. This was mortgage-backed securities (MBS) that brought down Lehman Brothers in 2008 all over again. Not content with this, Greensill went a step further. It started advancing funds to its clients based on anticipated future invoices. That is, there was no supplier and no goods purchased. But it was giving money in anticipation of business being done with a supplier in future. In effect, it started offering long-term loans to its clients in the guise of short-term, low-risk loans with neither the insurer nor the funds like Credit Suisse being wiser to their tricks. It was only a matter of time before the house of cards would collapse.

Third, the implosion of hedge fund Archegos Capital late last week caused by extreme leverage. With GameStop and Melvin Capital, the leverage was on the short. With Archegos, it was on the long side. It borrowed money from the usual Wall Street names - Nomura, Credit Suisse (again!), Goldman Sachs and Morgan Stanley. But it used a derivative known as Total Return Swaps (TRS). The mechanics of this were simple. The hedge fund borrows money from the Bank to invest in stocks through a swap agreement. The hedge fund pays a small interest to the Bank, say, 2.5 per cent. The bank pays out any upside of investment made by the fund back to it. If there are losses, the hedge fund makes it up for the bank. This means the hedge fund makes investments without owning the asset. The bank has no real downside. The bank loves TRS because they make large fees from such arrangement without setting aside a lot of capital when compared to actual trading in securities. Being flush with liquidity in a low-interest environment makes such arrangements appear too good to resist for the banks.

Things were going well for Archegos as it went about building massive levered long positions in media stocks like ViacomCBS and Discovery and various Chinese internet stocks. Some of these were quite illiquid stocks where Archegos almost owned half of the total stocks available for trade. Till ViacomCBS, whose stock had gone up 3X over the past year, decided to do a $3bn share sale wanting to capitalise on its good fortune. This backfired and the stock nosedived. This triggered a margin call and we were back to 2008 again. Archegos couldn’t cough up funds to cover the losses and the brokers dumped the shares on their behalf. The forced liquidation led to a massive selloff late last week across markets. Nomura and Credit Suisse couldn’t get out fast enough and warned of significant impact to their earnings. The worries of a contagion started going around. No one is sure if the collateral damage has been contained.

Safety Valves Or Canaries?

One way to look at these three events is to consider them as the safety valves of capitalism. There are excesses that happen in each cycle and the market mechanism is subverted by a few players. But there is a reckoning soon enough and the markets are better off for it.

The other way is to view them as early signs of a looming crisis - the canaries in a coal mine. It is often said bubbles aren’t merely about skyrocketing valuations. The underlying truth to any bubble is the shortening of time horizons in the market. Everyone is out there to get rich and get out as quickly as possible. This snowballs very quickly attracting more short-term traders to make massive bets with levered money with ever-shrinking time horizons.

The markets might well take these events into their stride (as they seem to have done). The three firms collapse and everyone moves on.

That’s the end of it.

Or maybe not. This might just be a beginning.

HomeWork

* [Article] Apropos of nothing related to this post: Robin Hanson on “how best to explain UFOs if they are in fact aliens!”

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

📣📣📣 Announcement: Admissions are now open for the summer cohort of Takshashila Institution’s 12-week Graduate Certificate Programme in Public Policy. Visit takshashila.org.in/courses to find out more.  

Global Policy Watch: A Short History Of The Breitbart Doctrine

Bringing an Indian perspective to burning global issues

- RSJ

In edition #117 where we covered the resignation of Pratap Bhanu Mehta, we had a polemic by Edward Skidelsky as suggested reading in our homework section. We specifically quoted this line:

“The ‘woke’ left is currently pursuing this goal by way of a Gramscian “long march through the institutions” — a progressive co-option of the schools, universities, state bureaucracies and big corporations.” 

What’s this ‘Gramscian long march’ that’s mentioned here? That’s the first question for this post.

Separately, I was drawn to a U.S. national survey done by Cato Institute last year on freedom of expression. The results weren’t surprising to me (including the stupid graph that I have copied below from their site):

“Strong liberals stand out, however, as the only political group who feel they can express themselves. Nearly 6 in 10 (58%) of staunch liberals feel they can say what they believe. However, centrist liberals feel differently. A slim majority (52%) of liberals feel they have to self‐​censor, as do 64% of moderates, and 77% of conservatives. This demonstrates that political expression is an issue that divides the Democratic coalition between centrist Democrats and their left flank.”

I take the ‘strong liberal’ in the US to be the progressive wing of the Democratic party. They are the ‘woke’ Skidelsky was referring to in his article.

There’s no equivalent survey of this kind in India. But I would venture to suggest the “strong liberals” in India might not poll as well on speaking their minds nor would the Indian conservatives be as reticent as their American counterparts in today’s times. Based on incidents like P.B. Mehta’s resignation that seem to have become more frequent in recent years and the ‘chilling effect’ that follows, I would guess these percentages might just flip in India.

Anyway, the percentages aren’t of interest to me. My interest is in the phenomenon. This dominance of one side that makes the other side self-censor themselves.

What explains this? That’s the second question for this post.

That Old Chestnut: The Breitbart Doctrine

Both these questions - on Gramscian long march and on self-censorship - bring me to the oft-repeated Breitbart doctrine:

“Politics is downstream of culture.”

That is, change the culture and sooner, politics will change. Now you’d think this was an insight that galvanised the American conservative right following the Obama takeover of the establishment. It was what got Trump into the White House with Steve Bannon in tow. That this was part of the right-wing toolkit.

Nothing could be further from the truth. The left was likely the originator of the idea that culture influences politics. To understand this better, we will go through a short history of ‘manufacture of consent’ and ‘cultural hegemony’. Knowing it will help address the two questions raised at the start of this post as well.

Manufacture Of Consent

The term ‘manufacture of consent’ first appeared in Walter Lippman’s book ‘Public Opinion’ (1922). For Lippman, the world was too complex for an ordinary individual to comprehend. In order to make sense of it, people carried a mental image of the world inside their heads. These pictures were what drove groups or individuals to act in society in the name of Public Opinion. A strong democracy, therefore, needs institutions and media that help in creating the most accurate interpretations of the world in the minds of the people. But this isn’t easy. Lippman was worried democracy relied on something so irrational as a public opinion that takes shape in the minds of poorly informed and easily manipulated people. For Lippman, policymakers and experts should use narratives for ‘manufacture of consent’ among people which enables public opinion to be channelled in a manner that’s consistent with what’s good for society. Lippman believed persuasion and the knowledge of how to create consent through ‘propaganda’ will change politics in the age of mass media. As he wrote:

“A revolution is taking place, infinitely more significant than any shifting of economic power. Within the life of the generation now in control of affairs, persuasion has become a self-conscious art and a regular organ of popular government. None of us begins to understand the consequences, but it is no daring prophecy to say that the knowledge of how to create consent will alter every political calculation and modify every political premise. Under the impact of propaganda, not necessarily in the sinister meaning of the word alone, the old constants of our thinking have become variables.”

Noam Chomsky and Edward Herman in their book ‘Manufacturing Consent’ (1988) picked up this idea to argue media outlets are “are effective and powerful ideological institutions that carry out a system-supportive propaganda function.” Market forces and an entrenched establishment control the mass media which manipulates public opinion by revealing only half-truths and distorted facts that serve their interests. It manufactures consent through propaganda while keeping the ill-informed public in thrall with distractions and entertainment. Chomsky has since argued this control of mass culture through media and institutions and the ‘manufacture of consent’ is essential to the survival of capitalism.

Gramsci And Cultural Hegemony

While Lippman was writing about the need for the ‘manufacture of consent’ using culture in a capitalist democracy like America, Antonio Gramsci, an Italian neo-Marxist was thinking on similar lines in a prison in Mussolini’s Italy. Gramsci started with a simple question. Why didn’t the working class living in an oppressive regime (anything that’s non-Marxist was oppressive in his view) revolt more often when they could see clearly how badly the economic balance was tilted against them? Why didn’t the exploited rise in revolt more often?

Gramsci argued a capitalist state had two overlapping spheres that helped it to thrive. There was the ‘political society’ that ruled through coercion and control of means of production which was visible to all. But there was also the ‘civil society’ that ruled through consent and control of minds. The civil society was the public sphere of ideas and beliefs that were shaped through the church, media or universities. To him, the capitalist state was successful in ‘manufacturing consent’ among people through the ‘cultural hegemony’ it set up through its control of the public sphere. People living in such societies didn’t question their position or their exploitation because they thought this was the ‘natural state’ of existence. The cultural hegemony was so complete and overpowering that there could hardly be any mobilisation of people against the ‘political society’ which ruled through coercion. The minds of the people were brainwashed through propaganda.

Gramsci, therefore, concluded that for the struggle (or revolution) to take over means of production to even begin, the people will have to win the war over cultural hegemony. He used the WW1 terms that were in vogue then. For the war of manoeuvre (that is a direct attack over the enemy) to be successful, it has to be preceded by the war of position (digging trenches and cutting off enemy lines etc). The people will have to win the war of ideas and beliefs by creating their own cultural hegemony and taking over the public sphere through control of religious institutions, media and universities. This is the ‘Gramscian march’ that Skidelsky referred to in his article.

This was a far-reaching idea about how the nature of power had changed in a world where universities and mass media shaped people’s thinking. The power of engineering consent using culture is the first step to launch a successful attack over an existing power structure. While Garmsci used neo-Marxian terms to expound his ideas, the broader implications of his argument were clear. In short: establishing cultural hegemony is the first step to winning the minds and eventually, the votes of people (we are talking of democracy here). Over time, this hegemony in the public sphere will earn you the long-term consent of the people who will consider it their ‘natural state’. Self-censorship will follow as an outcome of this hegemony. That addresses the second question on why people self-censor themselves.

Over a hundred years since Lippman first wrote about ‘manufacture of consent’, the idea that politics is downstream of culture has only acquired greater currency in a saturated media space that all of us inhabit now. The left and the right have both acquired the toolkits to fight this ‘war of position’ in various democracies around the world. In the US, it is ‘woke left’ on a supposed Gramscian march today. In India, I suspect, the shoe is on the other foot.

But the march is definitely on.

India Policy Watch: Mandal Again

Insights on burning policy issues in India

- Pranay Kotasthane

A Constitution Bench of the Supreme Court is set to announce its judgment on the Maratha quota case. Amongst other issues, the court will decide on the question if state governments can breach the 50 per cent reservation ceiling. This 50 per cent limit comes from the Indra Sawhney judgment of 1993, which legally upheld the recommendations of the Mandal Committee Report.

Legal issues aside, today’s political reality makes this judgment even more riveting. Perhaps all political parties appear to be in favour of going beyond this 50 per cent limit, although in different ways. The NDA government has already increased reservations to ~60 per cent in central-government jobs, central-government educational institutions, and private educational institutions through the 103rd constitutional amendment in 2019. The additional 10 per cent seats are now meant to be reserved for economically weaker sections (EWS) of citizens not already benefiting from reservation. In other words, this quota is for persons from non-SC, non-ST, non-OBC classes, as long as their earning is below a defined income threshold. On the other hand, many caste-based and one-caste-dominated political parties are in favour of breaching the 50 per cent ceiling in order to extend or increase quotas for their caste base. The gap between the court-prescribed ceiling and the political reality has become unsustainable. To use a Ravi Shastri phrase, “something’s gotta give”.

Not to forget, that 50 per cent ceiling number itself is quite contrived. Read what the Indra Sawhney case judgment says:

Just as every power must be exercised reasonably and fairly, the power conferred by Clause (4) of Article 16 should also be exercised in a fair manner and within reasonably limits - and what is more reasonable than to say that reservation under Clause (4) shall not exceed 50% of the appointments or posts, barring certain extra-ordinary situations as explained hereinafter. From this point of view, the 27% reservation provided by the impugned Memorandums in favour of backward classes is well within the reasonable limits. Together with reservation in favour of Scheduled Castes and Scheduled Tribes, it comes to a total of 49.5%. 

Beneath the legalese, observe the narrative power of numbers at play. Any measured phenomenon creates implicit norms of what is “too high” or “too low”. The 50 per cent limit seems intuitively “just right” or “balanced” — half of the seats have quotas while the other half doesn’t. This powerful narrative largely survived for over 25 years but seems to be falling apart now.

And so it appears that reservations have ceased to be a means to correct for inadequate representation of certain disadvantaged sections. Instead, reservations have become springboards for all groups to demand proportional representation. The implicit norm now is that the State needs to enable representation of groups in educational institutions and government jobs according to their proportion in the population; the question of historical disadvantage has been relegated to an incidental criterion. Moreover, the general equilibrium effect of quotas is that group identities have become sharper and more powerful.

Is there another way out?

There is no doubt that a republic founded in a society with a long history of systematic discrimination will inevitably resort to some affirmative action. But is there a way out beyond caste-based reservations?

Nitin Pai and I had proposed one such alternative a couple of years ago in FirstPost:

Consider this thought experiment. There are no predetermined quotas for any posts. Positions are filled only based on a composite score of all applicants. The composite score is a combination of two measures. The first is an inequityscore — calculated to compensate for the relative disadvantage faced by an applicant.

The second measure strictly represents an applicant’s ability to be effective for the position they are applying for. Selection is on the basis of the composite score. No seats are reserved and yet the score allows for addressing multidimensional inequity much better than current methods.

The inequity score can be used to indicate relative disadvantage along several dimensions: individual, social and geographic. Different factors can be assigned different weightages. For instance, given the salience of caste in the Indian social context, the greater the disadvantage a community faces, the higher the weightage.

In addition, we can incorporate other parameters into the inequity score — parents’ level of education, income levels, rural upbringing, or even childhood nutritional deficiencies. Currently, our system of quota-based allocations does not account for non-caste disadvantages that have a disproportionate impact on life outcomes.

A national commission for equity can be formed to propose and review parameters and their weightages within a cooperative federal framework. It doesn’t have to be one-size-fits-all solution. States can assign their own factors and weightages according to the local conditions.

The second measure — an effectiveness score — can then be kept completely independent of equity considerations. It can take the form of a test, an interview or any other indicator to assess candidates’ ability to perform the job they have applied for. Information about the inequity scores can be masked from evaluators of the effectiveness score.

By filling positions based on a sum of the two scores, it becomes possible to be more comprehensive in addressing social inequities while also creating stronger incentives for an individual pursuit of excellence.

Satish Deshpande and Yogendra Yadav had proposed a similar model for higher education way back in 2006:

An evidenced-based model addressing multiple sources of group and individual disadvantages helps to de-essentialise identity markers such as caste or religion; that is, it provides a rational explanation why specific castes or communities are entitled to compensatory discrimination and undermines attitudes that treat such entitlements as a “birth right”.

In essence, this solution tries to solve for both “merit” and “disadvantage”. The opponents of reservation claim that quotas directly undermine efficiency and merit. The proponents of quotas on the other hand find the notion of merit completely odious. They argue on these lines:

Efficiency of administration in the affairs of the Union or of a State must be defined in an inclusive sense, where diverse segments of society find representation as a true aspiration of governance by and for the people.

In contrast to quotas, the composite score solution acknowledges that some assessment of “merit” is inescapable, even desirable. But it also doesn't ignore the problem that disadvantaged individuals face. Hence, we believe it is a better solution than quotas.

In edition#72, we discussed a framework on “nine competing visions of equality” only to reiterate Deborah Stone’s insightful conclusion:

“equality often means inequality, and equal treatment often means unequal treatment. The same distribution may look equal or unequal, depending on where you focus.”

Essentially, any distribution, however equalising it is in one respect, can be charged as being unequal on another parameter. What matters far more is whether a distribution is perceived as being fair or not. As Starmans et al write:

… humans naturally favour fair distributions, not equal ones, and that when fairness and equality clash, people prefer fair inequality over unfair equality

In the Indian context, quotas come with charges of unfairness. It is time to look beyond them.

PS: A commonplace assertion that “the constitution imagined reservations to last only for ten years at the outset” is a myth. This 10-year clause was meant to apply to reservations of seats for SC/ST groups in the Lok Sabha and Legislative Assemblies. There was no such 10-year limit on reservations in jobs and educational institutions under articles 15(4) and 16(4). I too believed in this urban myth having read it being regurgitated in countless opinion pieces. Hat-tip to an alert Puliyabaazi listener for updating my priors.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] "The Big Idea" - a half-hour interview between Noam Chomsky and British journalist Andrew Marr, first aired by the BBC in February 1996. A great interview where Andrew Marr is completely convinced he’s not taken in by the propaganda while Chomsky is sure he is!

* [Podcast] A Puliyabaazi episode discussing the nine competing visions of equality

* [Article] Alexander Lee on redesigning India’s reservation system

* [Article] Satish Deshpande traces the history of reservation policies

* [Article] Pratap Bhanu Mehta on how the open category is slowly becoming a reserved category through other means

This newsletter is really a public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration on all podcasting platforms courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

📣📣📣 Announcement: Admissions are now open for the summer cohort of Takshashila Institution’s 12-week Graduate Certificate Programme in Public Policy. Visit takshashila.org.in/courses to find out more.  

- RSJ

A couple of short takes for the mid-week edition.

An Obituary

Robert Mundell, the Noble Prize winning Canadian economist, died at his Italian home on Sunday. He was 88.

His obit in the New York Times read: Robert A. Mundell, a Father of the Euro and Reaganomics, Dies at 88.

I had mixed feelings when I read that line. Sure, you could argue Mundell’s works provided the intellectual foundation for the Euro and Reaganomics. But there are many other economists who might be ahead in the queue for claiming credit for those two phenomena. And then these aren’t exactly the greatest of times for either Reaganomics or the Euro.

Mundell’s greatest contribution to me was to set up a branch of economics singlehandedly. He theorised about international monetary policy when the idea itself was inconceivable. It might appear a bit odd today but notions of free cross-border movement of capital and a floating exchange rate weren’t anywhere near mainstream in the early 60s. Mundell almost presaged the future interconnected global economy and the monetary theory that would underpin it.

And to top it all, he summed it all up in a way that has set the bar for brevity for all future economists and policymakers. He proposed a trilemma, an intuitive interpretation of his theory, which made it the touchstone of the neo-Keynesian macroeconomic paradigm. The trilemma, also called the impossible trinity, is a beautiful representation of economic reasoning.

The policy trilemma says a country must choose between free capital mobility, exchange-rate management and monetary autonomy. Only two of the three are possible. A country that wants to fix the value of its currency and have an interest-rate policy that is free from outside influence cannot allow capital to flow freely across its borders. Think India during the 70s.

If a country chooses free capital mobility and monetary autonomy, it has to allow its currency to float. This is India now.

And if the exchange rate is fixed but the country is open to cross-border capital flows, it cannot have an independent monetary policy. Think countries now in the European Union.

Robert Mundell helped policymakers and central bankers think of the fiscal and monetary policies as two separate instruments to achieve varying objectives. His was a beautiful mind.

RIP.

An Interview

I also came across this interview of Jonathan Sumption over the weekend. Lord Sumption is a retired Justice of the Supreme Court of the United Kingdom and earned his reputation with his brilliant 4-volume history of the Hundred Years War.

The preface to the interview sets the stage for his responses thereafter:

“Over the past year, his unabashed criticism of lockdown policies has turned him into something of a renegade. It is a development that mystifies him; as he sees it, his views have always been mainstream liberal, and it is the world around that has changed.

In the course of our conversation, the retired judge doesn’t hold back. He asserts that it is becoming morally acceptable to ignore Covid regulations, and even warns that a campaign of “civil disobedience” has already begun.”

I will reproduce three of his answers below from the Unherd site that deeply resonated with me:

On the ethics of law-breaking:

“I feel sad that we have the kind of laws which public-spirited people may need to break. I have always taken a line on this, which is probably different from that of most of my former colleagues. I do not believe that there is a moral obligation to obey the law… You have to have a high degree of respect, both for the object that the law is trying to achieve, and for the way that it’s been achieved. Some laws invite breach. I think this is one of them.”

On the dangers of public fear:

“John Stuart Mill regarded public sentiment and public fear as the principal threat to a liberal democracy. The tendency would be for it to influence policies in a way that whittles away the island within which we are entitled to control our lives to next to nothing. That’s what he regarded as the big danger. It didn’t happen in his own lifetime; it has happened in many countries in the 20th century, and it’s happening in Britain now.”

On the fragility of democracy:

“Democracy is inherently fragile. We have an idea that it’s a very robust system. But democracies have existed for about 150 years. In this country, I think you could say that they existed from the second half of the of the 19th century — they are not the norm. Democracies were regarded in ancient times as inherently self-destructive ways of government. Because, said Aristotle, democracies naturally turn themselves into tyranny. Because the populace will always be a sucker for a demagogue who will turn himself into an absolute ruler…

Now, it is quite remarkable that Aristotle’s gloomy predictions about the fate of democracies have been falsified by the experience of the West ever since the beginning of democracy. And I think one needs to ask why that is. In my view, the reason is this: Aristotle was basically right about the tendencies, but we have managed to avoid it by a shared political culture of restraint. And this culture of restraint, which because it depends on the collective mentality of our societies, is extremely fragile, quite easy to destroy and extremely difficult to recreate.”

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast] On Persuasion, Yascha Mounk and Dr Leana Wen sit down to discuss the failures of expert opinions, the deadly consequences of inaction, and what the West needs to do to improve public health for the decades to come. 

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.

Global Policy Watch: A Mint With a Role

- RSJ

The People’s Bank of China (PBOC) has been trialling a form of digital Yuan for the past year. Last week the trials entered their second phase. (Umm, they seem to have more phases for this than for developing their Covid vaccines).

The Wall Street Journal woke up to the digital Yuan (paywalled) last week with this article that starts off like a Marquez novel:

“A thousand years ago, when money meant coins, China invented paper currency. Now the Chinese government is minting cash digitally, in a re-imagination of money that could shake a pillar of American power.”

What’s not to like an article that begins with hyperbole?

But there’s some grain of truth there. Before we go further we need to make sense of sovereign digital currencies or what’s now being called Central Bank Digital Currencies (CBDC).

What’s Money?

Like 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 holder of the note 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 it is able to 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 massive macroeconomic consequences including the loss of relevance of bank deposits that we have with our banks. A CBDC that offers interest would mean we will have a direct deposit account with the central bank. This will 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 will 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. In summary, central banks will become more powerful.

China’s Digital Yuan Play

For these reasons, I believe CBDC is inevitable in this decade. Central banks will have to contend with the competition of cryptocurrency and the needs of the digital economy. They will find a mechanism to create a ‘platform-based model’ where the central banks create CBDC using a Distributed Ledger Technology (DLT) or a centralised ledger model while allowing private players to provide interfaces for customers to deal with this ledger. They will have to provide some level of comfort on privacy to their citizens by separating the transaction layer of CBDC from the core ledger.

But for China, the benefits of a digital Yuan do not just stop there. Beyond these benefits, a CBDC is a boon for a surveillance state as it turns into an ‘eye in the sky’ for every transaction happening in the economy. For China where all banking is owned by the state, the secular shift from deposits of commercial banks to CBDC is also a lesser problem. And most importantly, China is looking at leadership in CBDC to replace the US Dollar in global trade. A digital Yuan is the most feasible option for it to challenge the entrenched ‘dollarisation’ of the physical currencies around the world. 88 per cent of global trade is done using the US Dollar and it is what sustains the Dollar as the global reserve currency. For China to replace the US as the future global superpower, it will have to find ways to make Yuan the reserve currency. An early lead in adopting CBDC for domestic and cross-border payments is a great option to make a real fist of it.

China’s early trials in this space will force a response from other large economies on CDBC. The interoperability of sovereign CBDCs and how quickly the US is able to put together a CBDC alliance that counters China will be interesting to watch. In the meantime, I expect the current Chines regime to overplay its hand here like it has been usual for it in the last few years. Expect China to play hardball with the digital Yuan in global trade. This will be an interesting space in geo-economics to watch.

PolicyWTF: Casually Banning Films Committee

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

— Pranay Kotasthane

Most film certification authorities in democratic republics categorise movie content according to age-appropriateness and nothing more. But India’s is an exception. The Central Board of Film Certification (CBFC) — commonly referred to as the “Censor Board” — also plays the role of a film editor. The CBFC is empowered to ask filmmakers to drop certain scenes. Not just that, the CBFC in its wisdom can just plainly refuse to certify a movie. In such cases, filmmakers have the option of appealing to the reviewing committee of the CBFC. If even that fails, they could hitherto appeal to a 5-member Delhi-based tribunal called the Film Certification Appellate Tribunal (FCAT). This tribunal has now been shut down through an ordinance along with eight other tribunals. The stated intent is that this move will streamline legal recourses. Filmmakers will now have to appeal to High Courts directly and wait for the law to take its own (long) course. In other words, “tareekh pe tareekh, tareekh pe tareekh, tareekh pe tareekh…”

You would have already guessed why this is a PolicyWTF. Higher transaction costs, the existing burden on our High Courts, lack of state capacity, yadda yadda yadda. You can read these arguments here, here, and here. I won’t go there.

Instead, let’s address the larger PolicyWTF - the CBFC itself. As long as it is a government-appointed body with the power to play the role of a film editor, absurdities will continue. It is for this reason that the Shyam Benegal Committee in 2016 recommended that the CBFC’s powers to modify and change movies should be taken away and it should purely function as a certification body. Exactly what was needed. But it was also exactly what the government wouldn’t allow. And so, five years after that report, we still have a CBFC which is rubbing its hands to also edit OTT content. Moreover, the percentage of films without any cuts fell to its lowest levels over the last 100 years in 2016-17. And now, even the FCAT has been shut down. Clearly, film censorship is going in a direction opposite to what previous committees have recommended. So, is there a solution to this meta policyWTF?

Yes, turns out markets can help here. 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.

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 need to adhere to certain minimum 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 choose to 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 a lot more detail in the paper about grievance redressal, certification guidelines, and appeals procedure. Read it here.

PS: A couple of days after the FCAT was shut down in India came the news that Italy on the other hand has abolished all film censorship and moved to a self-certification system instead. Saluti!

A Framework a Week:

Tools for thinking about public policy

— Pranay Kotasthane

Dr Yuen Yuen Ang is one of the most insightful writers on China’s economy. Her first book explained how China managed to escape poverty. Her second book, China’s Gilded Age: The Paradox of Economic Growth and Vast Corruption has a framework on corruption that’s relevant to us in India.

The framework classifies government corruption on two axes — “who in the government engages in corruption?” and “does the money giver get anything in return?”. Four types of corruption result from this categorisation as shown above.

Ang claims that in most East Asian economies, the dominant mode of corruption is “access money” — bribes given to political elites with an explicit quid pro quo arrangement. On the other hand, the dominant mode of corruption in India is “speed money” — bribes given to low-level bureaucrats for property registration, a driving license, and so on. Though it intuitively sounds right, I take this result with heaps of salt as it is based on a survey measuring perceived corruption from the eyes of just 15 experts from the countries discussed.

Nevertheless, I found the framework interesting. A typology of corruption is a great idea. The book claims that with rising income levels, corruption doesn’t vanish but just gets institutionalised in the ‘access money’ quadrant.

To drive the point home, Ang connects these four types of corruption to four kinds of drugs. In her words:

“all corruption is bad – they are all drugs – but petty theft and grand theft are like toxic drugs [or drinking bleach, a term suggested by Jordan Schneider]; speed money is like painkillers; access money is like anabolic steroids – they help you grow rapidly but come with serious side effects that accumulate over time.

Access money functions as an incentive system for politicians and capitalists to work together, especially when massive infrastructure, involving huge sunk costs, is required for an emerging economy to take off. Access money overpays capitalists to do this, through cheap loans, subsidies, state backing, and in return you get feverish growth that lifts 700 million people out of poverty.”

That’s neat storytelling!

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Stewart Paterson’s white paper on the Hinrich Foundation site: The digital Yuan and China’s potential financial revolution.

* [Article] Shyam Benegal on his tryst with CBFC. Money quote: ‘With Bhumika, there were no cuts, no obscenity. According to the censor guidelines, there was nothing that was transgressed, yet it was given an A certificate. I asked, why? They said, the subject of your film is adult.

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

- RSJ

By now many of you must have seen the pictures from the Kumbh at Haridwar. Till last evening, almost 3 million devotees had congregated at the Har ki Pauri for the shahi snaan (how long before we change the word ‘shahi’ there?). A lot has been made about the Covid protocols that were put in place for the Kumbh. It is safe to say it is almost impossible to maintain those protocols for such a crowd.

Like always this has drawn predictable responses.

The ‘liberals’ have compared the way media and many from the current dispensation demonised a markaz that was organised by the Tablighi Jamaat last March and how differently they are covering the Kumbh today. A lot of commentary in the early days of the pandemic last year was about the irresponsible members of the Jamaat who congregated at the time of a pandemic and then blamed them for the spread of the virus in the country. The ‘liberals’ contrast that with the cautious, almost benign, coverage of the Kumbh that has millions risking their lives in a likely ‘superspreader’ event.

The defenders of the Kumbh (right-wing, conservatives or any other label you might apply to them) have their arguments ready. The parallels with the Jamaat event are false. This is a planned event with the administration taking all precautions. Also, the devotees are out in the open which is safer than the enclosed markaz event. I will leave you to see the pictures and draw your own conclusions. Also, there’s the classic conservative defence that’s put up. This is a matter of an individual and their faith. Nobody is coercing them to go to the Kumbh. Our traditions and our culture are our inheritance. These are important for our well-being and they keep us going as a society. As Burke would have put it, some illusions and prejudices are socially necessary.

I’m not interested in the arguments of either side. These are mostly transient and change depending on the context. For instance, I’m almost certain there will be instances of Covid violations during the month of Ramzan which is upon us and during Eid. Then these arguments will flip. And yada yada yada.

What Explains Irrational Behaviour?

The question that interests me is what is the underlying impulse that prompts devotees, adherents of a cult or fanatics of any kind to put the interests or customs of that group over their personal safety and evolutionary instinct for survival? Why do we do stupid things in groups? For a moment leave aside the the sagacity of the government that allows for an event like Kumbh during a pandemic. Ask why have over three million people supposedly taken leave of their senses and gone there?

And that brings me to a topic that sets off evolutionary biologists, sociologists and philosophers on the warpath. The question of Group Selection or what’s has been updated to be called Multilevel Selection Theory.

The overwhelming consensus till the 90s was that natural selection acts on genes. Each gene, or ‘selfish gene’ as Richard Dawkins would put it, tries to perpetuate itself. An individual is the result of the selection of many such selfish genes. Natural selection, therefore, acts in the domain of an individual. Nature selects those genes that are adaptable and individuals with those genes carry them forward for future generations. Others fall by the wayside.

But there was always a separate strand of thinking that stayed in the shadows of evolutionary biology - Group Selection.

Darwin himself had hinted at it in The Descent Of Man:

“Now, if some one man in a tribe, more sagacious than the others, invented a new snare or weapon, or other means of attack or defence, the plainest self-interest, without the assistance of much reasoning power, would prompt the other members to imitate him; and all would thus profit. The habitual practice of each new art must likewise in some slight degree strengthen the intellect.

If the new invention were an important one, the tribe would increase in number, spread, and supplant other tribes (emphasis ours). In a tribe thus rendered more numerous there would always be a rather greater chance of the birth of other superior and inventive members. If such men left children to inherit their mental superiority, the chance of the birth of still more ingenious members would be somewhat better, and in a very small tribe decidedly better.”

The Wilsons And Their Russian Dolls

Anyway, as I said, group selection was not considered seriously by biologists for most of the last century. In the last two decades, however, there’s been a renewed interest no thanks to the works of E.O. Wilson (Harvard U.) and David Wilson (Binghampton U.). For them, evolution is as much a team sport as it is a battle for survival among individuals. An individual with favourable traits passes their genes to the next generations. But this could happen at more aggregated levels of biological hierarchy as well.

Simply put this means there could be certain group-level traits that enable a group to survive or thrive better than other groups. These groups adapt better and perpetuate over generations while others fall away.

The ‘Wilsons’ explained the multilevel selection using the Russian matryoshka dolls (extract below from the American Scientist Sep-Oct, 2008):

“To think clearly about group selection, it is important to compare the survival and reproduction of individuals in the right way. The problem with "for the good of the group" behaviors is that they are locally disadvantageous.

A prudent member of the herd might gain from conserving resources, but cheaters within the same group gain even more. Natural selection is based on relative fitness. If solid citizens are less fit than cheaters within their own group, then something more is required to explain how they can evolve in the total population. That something is a positive fitness difference at a larger scale. Groups of solid citizens are more fit than groups of cheaters.

These interacting layers of competition and evolution are like Russian matryoshka dolls nested one within another. At each level in the hierarchy natural selection favors a different set of adaptations. Selection between individuals within groups favors cheating behaviors, even at the expense of the group as a whole. Selection between groups within the total population favors behaviors that increase the relative fitness of the whole group—although these behaviors, too, can have negative effects at a still-larger scale. We can extend the hierarchy downward to study selection between genes within a single organism, or upward to study selection between even higher-level entities. The general rule is: Adaptation at level X requires a corresponding process of selection at level X and tends to be undermined by selection at lower levels.

This way of thinking about evolution is called multilevel selection (MLS) theory. Although the term "multilevel selection" is newer than the term "group selection," the Russian-doll logic has been present from the beginning, going back to the works of Darwin.”

Back To Kumbh

I have my scepticism about multilevel selection theory. Stephen Pinker wrote a terrific essay - ‘The False Allure Of Group Selection’ - refuting the theory in The Edge (June 2012). The essay and the comments that followed are quite simply the best debate you can read on this topic. It is also a good example of how good the internet can be.

I agree in large parts with Pinker but there are days when I see the events around me and I think this must be group selection at work. That we humans reached where we are today because of certain group traits that worked for us. Empathy, solidarity, the ability to forge a common belief, to work for a unitary purpose or have a shared slate of intentions - these are what made us unique and accelerated our evolution.

Maybe religion works that way for people. It is the most cohesive of groupings (atleast monotheistic religions are).

It is coded within us that coming together and sharing common, deeply held beliefs - about a supreme being, about how the world works or how to lead our lives - all help perpetuate our group. We thrive through these communitarian traditions and practices that are passed down to us over generations than staying apart, fending for oneself alone and letting selection play out at an individual level.

We are programmed to preserve our group traits because intuitively we know they have helped us come this far. They might or might not take us from here to wherever we want humanity to go. But our instincts won’t allow us to abandon what has worked for us so far.

As David Wilson famously put it:

“Selfishness beats altruism within groups. Altruistic groups beat selfish groups. Everything else is commentary.”

That alone can explain why people act in ways that go against their own survival instinct. There is a broader instinct to perpetuate at play. That’s what drives millions to the Kumbh. That is what will drive many to community Eid prayers later this month. That’s why your mom still wants to attend that family wedding in the middle of the pandemic. They aren’t being foolhardy.

They know their importance. They can’t explain it to you.

They just can feel it in their bones.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] Jonathan Haidt on The Groupish Gene: Hive psychology and the Origins of Morality and Religion. Haidt is simply a brilliant explainer of multilevel selection theory (as he is of other things).

Programming Note: We are taking a short break. Back on May 2. Stay safe.

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

PolicyWTF: Winging the Pandemic

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

- RSJ

One of the things we often say around here is how difficult it is to craft public policy. The process requires diligence in collating evidence, intellectual integrity in comparing the options and trade-offs, anticipating the unintended, planning for implementation, mapping the stakeholders and communicating to all of them. You know the drill.

Importantly, a lot of these decisions have to be taken when the future is unknown and there’s uncertainty all around. Your assumptions could be off the mark or unforeseen events could derail your plans. You cannot do much when you are dealing with ‘unknown-unknowns’. You have to opt for the best policy course while dealing with the ‘epistemological fog’.

This is one of the reasons why we don’t do a post-mortem of a policy decision with the benefit of hindsight. We call out a policyWTF the moment we think we have spotted one. And then go back to it as the future unfolds in line with what we had anticipated or differently.

But if I do have to analyse a policy response of the past, I follow what I refer to as the ‘retrospective case study’ method. It is a simple tool dealing with only the ‘knowns’ and I will use it to analyse India’s Covid-19 response. As India deals with a second wave with its healthcare infrastructure struggling to keep pace, the question that everyone is asking is how did we get here?

Maybe this tool will help us with few plausible answers.

Here’s the case study

Imagine you are in mid-March 2020. There are a handful of Covid-19 cases in the country. You have to put an emergency response plan. Like I mentioned before we will only deal with the ‘knowns’ at the time of response (March 2020) to avoid hindsight bias. So what are the knowns?

About the virus. You know the virus is infective (R0 is high) and the cases rise exponentially as already seen in Italy, Spain, USA, UK etc. The healthcare systems in these countries weren’t prepared for it. They buckled under the load. The ultimate cure is prevention. And the best tool for prevention is a vaccine. You know there are research efforts on in USA, UK and China. It is clear any vaccine will take atleast a year to be available for commercial use. This is a wildly optimistic scenario. You also know there’s a drug (Remdesivir) that has moved to phase 3 trials as a cure for Covid-19 infection. Lastly, almost every expert warns there could be more than one wave of infections as has happened with Coronavirus pandemics in the past. The virus mutates and not always to a less virulent version. So, it is likely this pandemic will see a few waves with mutants before vaccines or herd immunity brings it under control.

About India. You also know the challenges unique to India. The healthcare infrastructure is woefully inadequate. It ranks in the bottom quartile globally on hospital beds, doctors or paramedical staff on a per capita basis. The population is much larger with dense, cloistered urban clusters that are ideal for the spread of the virus. You also know its relative strengths. People comply with government orders. It is the vaccine factory of the world. And the elected government is strong and stable with an extremely popular PM.

For a moment keep the economic impact of decisions or the fiscal position of the government aside. Just focus on the health and well-being of the citizens. Based on the knowns that are available with you at that moment, what will you do?

I guess the simple policy response would have been:

* A lockdown to slow down the spread and to prepare the healthcare infrastructure to manage the eventual waves. This would mean creating additional capacity for hospitalisation, procuring testing kits, ventilators, oxygen cylinders and training people on paramedical activities during the lockdown.

* An ongoing effort at stockpiling the above once lockdown is lifted to manage the peak caseloads. A measurable set of metrics to assure the state and union governments about the inventory of these items on an ongoing basis. Continuing to be in this semi-permanent state of readiness till most Indians are vaccinated and herd immunity is achieved. Remember there are always subsequent waves as the past has shown.

* Advance Purchase Commitments for various vaccines candidates that are going to be in play. Maybe a similar arrangement for stocking up Remdesivir. This is critical given India’s population. Securing the supply of vaccines is the key. And then an initial plan for inoculating about a billion Indians in less than a year whenever the vaccine is ready. This is a non-trivial exercise.

I would say that’s probably it. This is the most you could have done a year back. Everything else was unknown. It is possible the whole thing could have blown over and all the preparations would have been in vain. Or things would have turned out worse than we imagined. Indians might have been careful and followed all protocols. Or not. The virus might have taken a toll on the seniors. Or not. Winters might have been worse. Or not. We would have a single wave. Or four. Or more. Who knew?

You could have only done so much then.

How have we done a year down the line on them as a second wave rampages its way through India?

What We Did

First, we locked down in a way that created another humanitarian crisis. That apart we used the lockdown to build some additional healthcare capacity to manage the rise in cases. After some policy missteps, we got our act together on temporary Covid care centres, PPE and testing kits, ventilators and masks. But that was about it. We didn’t have a measurable metric to track the inventory of the key items to assure us to manage any future peaks or waves. It was never enough but we managed this time. Soon we ran through the inventory and barely replenished them. No one knew because no one was tracking. We are world champions in winging it (or jugaad as we have mythologised it) and we thought we had gotten over the pandemic with it. Till the second wave arrived and we were back where we started. No testing kits, oxygen cylinders, ventilators and an overburdened healthcare workforce.

Second, like on many other occasions in the past, we declared premature victory. One of the abiding memories of my childhood is Javagal Srinath and Venkatapathy Raju dancing in celebrations mid-pitch instead of running the three runs that would have tied a World Cup (1992) game against Australia. They thought the ball had sailed over the ropes. What’s more, the fielder, the ever-reliable Steve Waugh, dropped the catch and gave us a fighting chance to run the three runs. Waugh rocketed a throw back to Boon and Raju, predictably, fell short of the crease while going for the third run. No providence wasn’t sufficient for our overconfidence.

We were hitting daily global peaks in August and September. We came through that period relatively unscathed. The mortality rates remained low for reasons unknown. It was providence much like Steve Waugh dropping the catch. But we started celebrating our victory like we had done something special to beat the virus. The case count went down as mysteriously as they had gone up. We declared we had herd immunity. We started hero-worshipping. And we were out and about. To complete the circle on cricket, we even had two T20 matches with over 60,000 in attendance in March played out at the Narendra Modi stadium. That bookended our premature celebrations.

Third, and this is a cliché that has held over time: other countries follow evidence-based policy making; in India we have policy-based evidence making. We have a phalanx of experts, op-ed writers and intellectuals who justify every policy decision with evidence collated after the fact. For the past few months, we have seen numerous articles that suggested we had done almost everything right in handling the pandemic based on retrospective evidence at that point in time. Unfortunately, the wheel turned and reading them today is a stark reminder of intellectual bankruptcy in India. There were no questions asked about our vaccine readiness. Did we secure them in advance? Are we making sure we have a supply of vaccines to inoculate most Indians as early as possible? Is the government really ‘donating’ vaccines in the numbers mentioned in media to other countries? Are we being careful about the virus mutants? The questions could have been many.

None of this was discussed in depth. Instead, we were preening about how ‘Indian vaccines’ and the PM were saving the world from Corona. We appropriated Covishield as ‘Indian vaccine’ and it almost seemed like India had run Operation Warp Speed to fast-track vaccine development for the world. Last weekend the Ken covered India’s vaccine policy with depth and insight. The contrast between the US and the Indian policy response couldn’t have been starker.

So, here we are today. In the middle of a second wave for which we seem to be worse prepared than the first. We can blame people for being irresponsible and letting their guards down. Or we can wheel out data to blame the state governments we don’t favour for this wave. Or we can say nobody could have seen this coming. None of this is going to change the reality on the ground. You know the truth.

But then the truth is the first casualty during a crisis in India.

PS: Even as we write this edition, the government gifts us another policyWTF: a price cap on Remdesivir — a drug that’s in high demand and short supply. You all already know what to anticipate next.

PPS: This is the birth centenary year of Sahir Ludhianvi, one of our greatest poets and lyricists. In Guru Dutt’s Pyaasa (1957) he wrote these immortal words which seem apt for the current times:

यहाँ इक खिलौना है इसां की हस्ती

ये बस्ती हैं मुर्दा परस्तों  की बस्ती

यहाँ पर तो जीवन से है मौत सस्ती

ये दुनिया अगर मिल भी जाए तो क्या है? 

India Policy Watch: Three Levels of Discussing Ambedkar

Insights on burning policy issues in India

— Pranay Kotasthane

14th April every year is celebrated as Ambedkar Jayanti. I happened to be on a Hindi TV panel discussing Ambedkar’s economics. That experience made me reflect on the three levels at which discussions on Ambedkar take place in India.

Level 0: Hero-Worship

I call this the zeroth level because discussions at this level aren’t even about Ambedkar’s ideas. They are about raising him to demi-god status, statue included. It is indeed ironic that a person who warned India and Indians of the dangers of hero-worship has been put on pedestals across the country. To the hero-worshippers, these lines from his Grammar of Anarchy speech are a perfect answer:

“The second thing we must do is to observe the caution which John Stuart Mill has given to all who are interested in the maintenance of democracy, namely, not "to lay their liberties at the feet of even a great man, or to trust him with power which enable him to subvert their institutions". There is nothing wrong in being grateful to great men who have rendered life-long services to the country. But there are limits to gratefulness. As has been well said by the Irish Patriot Daniel O'Connel, no man can be grateful at the cost of his honour, no woman can be grateful at the cost of her chastity and no nation can be grateful at the cost of its liberty. This caution is far more necessary in the case of India than in the case of any other country. For in India, Bhakti or what may be called the path of devotion or hero-worship, plays a part in its politics unequalled in magnitude by the part it plays in the politics of any other country in the world. Bhakti in religion may be a road to the salvation of the soul. But in politics, Bhakti or hero-worship is a sure road to degradation and to eventual dictatorship.”

Level 1: Political Ideology

The first level of discussion on Ambedkar the intellectual is about trying to place him into an ideological category. Was he a Socialist? Was he a left-liberal? Was he a nationalist who opposed Pakistan? Or was he a capitalist because he argued for industrialisation? — these are some common questions that characterise this level.

Such an exercise is disingenuous because he was none of the above. If anything, he was foremost a pragmatist. But because he has left behind such a rich body of work, it is always possible to pick one quote from him in order to slot him in your favourite ideological category. In the process, what’s forgotten is what he wrote in the only election manifesto he ever wrote, for a party he founded:

“The policy of the Party will be to try to give effect to the principles set out above. The policy of the Party is not tied to any particular dogma or ideology such as Communism, or Socialism, Gandhism, or any other ism. The Party will be ready to adopt any plan of social and economic betterment of the people irrespective of its origin and provided it is consistent with its principles. Its outlook on life will be purely rational and modern, emperistic and not academic.”

Surely, what he wrote in the manifesto of a party he founded needs to be given more weight than his advocacy for insurance nationalisation, cooperative farming, or even rapid industrialisation.

Moreover, Ambedkar wrote widely and often changed his views. Hence, to pull out a quote by him to prove he was on ‘your side’ is rendered moot by another Ambedkar speech that seems to be saying exactly the opposite. If there’s one quote of his that needs to be internalised before falling into this trap, it’s this:

“To a critic who is a hostile and malicious person and who wants to make capital out of my inconsistencies my reply is straight. Emerson has said that consistency is the virtue of an ass and I don’t wish to make an ass of myself. No thinking human being can be tied down to a view once expressed in the name of consistency. More important than consistency is responsibility. A responsible person must learn to unlearn what he has learned. A responsible person must have the courage to rethink and change his thoughts. Of course there must be good and sufficient reasons for unlearning what he has learned and for recasting his thoughts. There can be no finality in thinking.”

Level 2: The Thinker

This is the level where we engage with Ambedkar’s ideas, specifically his reasoning. It’s not always possible to engage at this level with all thinkers’ ideas. As you explore their arguments, you hit a dogma they hold dear pretty soon. It is in this respect that Ambedkar’s writing sets itself apart.

His argumentation style often follows a purva paksha approach i.e. he starts by articulating the best-case arguments made by his opponents. He then proceeds to dismantle them one after the other. While doing so, he builds his own case logically and explicitly. This means that you can trace the causal chain of his ideas and clearly locate your point of disagreement without having to paint him in any one ideological hue.

Take his ideas on the cause for poverty in India, for example. He clearly writes that poverty in India is a double-edged problem of low productivity and high population. He then identifies rapid industrialisation (private and public) and state-led mechanisation of agriculture plus cooperative farming as a solution for increasing labour productivity. To control the population, he argues for birth control and even ‘more drastic measures’ if need be.

As someone reading Ambedkar today, I can argue that population is no longer a problem for India today. The birth rates are steadily converging towards replacement rates, and hence any drastic measures would be counterproductive. The problem of today’s poverty solely becomes a problem of increasing productivity. Here again, I could disagree with his state-led mechanisation approach through reason and evidence.

More than any specific ideas of his, India would benefit a lot if we could learn from his commitment to reason. The true tribute to a scholar like him would be to engage with his ideas and critique them. Indeed, there can be no finality in thinking.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] The NY Times on Europe’s vaccine rollout. It is a joke. No advance purchase agreements, overcautious about vaccine approvals and their side-effects and lack of coordination among members.

* [Article] Sarthak and Pranay write in thequint on how the union government has OD’d on cesses and surcharges.

* [Podcast (Hindi)] Listen to this Puliyabaazi with Vishwanath S for practical ideas and fresh perspectives on water governance in India.

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

PolicyWTF: Our Democracy In Wave 2 

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

- RSJ

It is difficult to write anything with clarity when almost every second message you read is a cry for Oxygen, ICU beds, Remdesivir or plasma. This isn’t an exaggeration. This is the reality of every urban Indian today. Yet they are lucky. The ability to amplify is itself a privilege. There are many others going silently into the night; mourned by their voiceless kin but unnoticed, uncounted and unmourned by the state. Because it is inconvenient to even acknowledge them.

This is a difficult moment for India. It is not easy to write with perspective and acuity about our criminal neglect of lives while retaining empathy for those on the frontlines of this battle. So, excuse me if I ramble a bit in this edition.

No Information, No Democracy

There’s a lot made about democracy in India. If we were to believe our own hype that is. We have a rambunctious multi-party system. Our elections are festivals celebrating people’s choices. The janata is the janardhan, apparently. For years, the more cynical among us have seen through this charade. Today, the despairing shallowness of these claims are laid bare for all us to see.

At its heart, democracy is about availability of information. As information became more accessible and moved with greater speed in the industrial age, societies had to adopt democratic norms. Other choices could only be coercive. Because information is power. It helps you compare, to make informed choices and to hold those in power accountable. It is no surprise then among the first thing any authoritarian regime does is to control information. Information makes democracy tick. Without it, democracy is just a periodic voting exercise.

The remarkable thing about India’s pandemic response is the sheer absence of information available to the public. Even the Supreme Court cannot get direct answers out of the government. The number of vaccines we have purchased in advance, the current stockpile we have, the monthly rollout plan we have in mind or the price of the vaccines. Nothing is known. The anticipated number of infections we might have for every district in the country, the future need for Oxygen, ventilators, doctors, healthcare workers or technicians in each district, the real mortality rates, the data on genome testing, the amount of foreign aid or where it is going - the list is endless. There are no past datasets, there’s barely any data being collated now and there’s no forecast for us to plan a better response future even as we see the pandemic spreading to rural areas in India. We don’t have a daily dashboard or targets against which we monitor our response to a virus that’s knocked us over. Administrative incompetence and deliberate official suppression have brought us to this parched information landscape.

This lack of information in the midst of a catastrophe renders democracy void. Only a chimera remains. Every living moment is filled with anxiety because you are a step away from being drawn into the Covid apocalypse. You cannot plan even for the week ahead. You cannot judge the actions of the government because there’s hardly any information. You read a news report about foreign aid gathering dust at the airports and the next day the partisans of the government point to another report on how things are moving quickly. In this see-saw battle between information and disinformation, in the midst of this epistemological fog, we have to find the right direction.

Democracy is about choice in the hands of people. Choices are made by weighing the arguments put up by either side. Arguments need information. Cut the information supply and democracy gasps for breath. It is not just patients that are running out of Oxygen in today’s India.

There Won’t Be Any Reckoning

This also makes the next point that I want to discuss almost irrelevant. Is the handling of the second wave a moment of reckoning for PM Modi and his government? In any normal, functional democracy with rational voters and a modicum of opposition, it should have been. But I’m not sure about it happening in India.

First, the lack of transparency or information makes it easy for the government to spin narratives that take away the heat from it. We have already seen some remarkable feats of narrative building in the past month. Merely listing them down inspires awe within me in for the narrative entrepreneurs building them. But it also boggles my mind on how these logically weak or inconsistent narratives aren’t countered with vigour. I have made a simple table below to reflect this.

Any reasonable person with an open mind will come to a similar conclusion as I have reached in the table above. But people lose their sense of perspective while thinking about politics.

This is an old problem. Why do people find it so difficult to let go of their political beliefs?

I don’t want to go into either the philosophy or the neuroscience of this issue in this edition. Some day I will. The short answer is this. People who have agency (in India those that are educated, employed and with means) have a disproportionate belief in the soundness of their judgment. They consider they have arrived at their political beliefs using reason and on their conviction of what’s wrong with the world. This process is deeply personal. It becomes a part of their identity. This causes them to invest emotionally into any politician or a political party that furthers this view. This is different from familial or religious ties that are accidents of birth. This is a product of your own logical mind. A mind that, all things considered, is superior to others. This is the reason why families or old friendships cleave on political beliefs. Even blood is thinner than political faith because the political is personal and vice versa.

In India of today, there is a large coalition of people who have invested deeply in PM Modi and his vision of India. This coalition is useful to study to understand why there won’t be a reckoning despite the abject failure of this government to provide the basic right of life to its citizens.

First, there are those in the coalition who believe we wasted the first 67 years of our independence pursuing wrong economic and social policies. Merit was stymied, enterprise was killed and a rigid bureaucracy along with a venal state held us back. Among this lot, there are those who are disappointed already with PM Modi today and sit on the fence. The other side of the fence doesn’t make for great company either. The great hope there is in the form of Mamata Banerjee whose only virtue is that she defeated the BJP. Governance isn’t exactly her forte. This is the kind of political thinking that’s got us here. Anyway, the greater number in this section of the coalition are the ones who respond to the ‘system’ is all flawed message. So, PM Modi needs more time to smash this ‘system’ to smithereens. He is forever the outsider for them.

Then we have the garden variety bigots of various hues who believe India is held back because the minorities in tandem with global forces are undermining it. They hark back to India’s glorious past and its abiding civilisational values. These are the consumers and distributors of the millions of fake messages churned out by the WhatsApp factories. The general consensus here is a thousand years of ‘foreign’ rule set a superior but somewhat naïve race back. Our path to salvation lies in showing these ‘foreigners’ their place while going back to those civilisational values. In PM Modi they find a man who will set us on the path to deliverance.

And the final section includes those who have a nuanced view that our civilisational values can be blended with modernity to arrive at a modern conception of Indian state that’s different from the Nehruvian one. Indeed, I think this can be a worthwhile project. But it needs a philosophical and cultural articulation of our values that is in sync with the current reality of a diverse India and a modern world. And it has to be compelling enough to rewrite the constitution in a way that won’t fracture society. To draw an analogy, it needs clear thinking of the likes of Paine, Burke or Montesquieu with the civilisational understanding of Vivekananda or Aurobindo. That’s a tall order. Instead they have the likes of Sadhguru and Rajiv Malhotra to aid their efforts. In any case, in PM Modi, they have the anti-Nehru at the helm. And that’s good enough for now.

The despair about the future of India that’s often written by a section of commentariat these days might be overblown. We have lived through terrible political and economic choices for many centuries. We will survive. Not thrive. And that’s tough to swallow. We had a window of opportunity to realise our potential as a nation and to improve the lives of our people. We could have been a contender. It is all in the past now.

But to most Indians today it doesn’t matter. A tendentious reading of the past and a majoritarian fantasy of the future has clouded our judgment. Form takes precedence over substance. Appearances matter more than truth.

No surprise then to discover the final counter to any political argument in India today is - aayega to Modi hi.

India Policy Watch: What Matters and What Doesn’t

Insights on burning policy issues in India

— Pranay Kotasthane

The Union government has received a lot of flak over its criminal negligence in managing the pandemic response. It deserves nearly all of it, and more. We have written about this over several editions.

Today however, I want to look at three incorrect — or at least problematic — frames being used to blame the government’s pandemic response, shoddy as it is. The intention is to ask the right questions. Only then can we hope for the right answers.

Incorrect Frame #1: Blame Vaccine Diplomacy

As the cases have skyrocketed and vaccine supplies have plummeted, India’s vaccine diplomacy has come under the scanner once again. The question doing the rounds is that did India commit a grave mistake in gifting vaccines to other nation-states? With the benefit of hindsight, the dominant narrative today is yes, by prioritising vaccine exports over domestic inoculation, India did a disservice to its own people.

I disagree.

In edition #102, I made a realist case for India’s vaccine diplomacy. I stand by that view. The original sin of the Union government, of course, was that it didn’t place enough vaccine orders and hasn’t done so even until now.

Rewind to February and you’ll notice how complacent the government was of having conquered the virus had peaked. It seemed that the government would sail through a dying pandemic with a snail paced vaccination campaign. It is with this line of thinking that vaccine diplomacy began.

Another way of thinking about vaccine diplomacy is to think of its opportunity cost. At the current vaccination rate, India would’ve had five additional days of supplies had it not given any of the nearly 10.7 million doses as gifts to other countries. In fact, a majority of the deliveries (nearly 35 million) have been under commercial terms between manufacturers and other countries. It’s likely that countries would’ve not helped India in the current crisis the way they did had India blocked exports of vaccines earlier.

Holding the Union government accountable for its mistakes is important. Equally important is identifying what the exact mistake was. By internalising that India was wrong in extending its help to other countries in its own time of help, we would be learning the wrong lesson. Such heuristics tend to stick around for long in the Indian strategic affairs community. Try arguing for developing overseas operations military capability of any kind and the idea will be shot down citing the IPFK failure in Sri Lanka more than three decades ago. It’s important that vaccine diplomacy isn’t perceived as another IPKF moment. This pandemic is as much about learning the right lessons as it is about not learning the wrong ones.

Incorrect Frame #2: “ದುಡ್ಡಿಲ್ಲ” Government Has No Money

Nero fiddled while Rome burned. How we love this story. Every ineffectual leader in the times of crises gets equated to Nero. This time around, the charge of callousness rests on the government’s plan of redeveloping India’s central administrative area at a reported cost of nearly ₹20,000 crores. The critiques argue: can’t the government redirect some of this money for increasing the number of hospital beds, oxygen plants, and vaccine procurements? — problems that are dire and important today.

From a political perspective, this line of attack probably makes for a powerful narrative. I wouldn’t know. But wearing a policy analyst’s hat, this logic makes little sense. That’s because the government has enough monetary resources at its command for fighting the pandemic and building a new parliament, both.

Facts of the matter first. The ₹20,000 crores amount is to be spent over multiple years, of which less than ₹2,000 crores is being spent this financial year. For perspective, this is 0.05% of the Union government’s FY21-22 budget.

Moreover, such arguments asking for diverting money from one purpose to another play in the hands of the government by inadvertently giving it safe passage as long as it can show monetary constraints. The truth of course is that the Union government has enough options at hand to beg, borrow, and steal money for fighting the pandemic.

The State as an institution is unparalleled. It doesn’t easily run out of money like households do. If it does, it always has the option of monetising deficit (albeit at the risk of future inflation). And if there ever was a case to be made for monetising deficit, a raging pandemic would definitely make the cut. After all, what is the use of a democratic republican State that cannot spend to protect the life of its citizens dying by the thousands every day?

In fact, after a lot of hullabaloo about how asking the states to procure vaccines from manufacturers might lead them to fiscal troubles, most states, — including low-income ones such as Bihar and Odisha — have promised free vaccines to all adults in the 18-45 age group. As an example, we estimated that Karnataka would require approximately ₹3900 crores to vaccinate all its residents in the 18-45 age group for free. Of which, ₹3176 crores can be borrowed immediately by using RBI’s Way and Means Advance facility.

Don’t listen to government excuses over money in these times.

PS: As far as the Central Vista Redevelopment Project is concerned, India would indeed need a new parliament a few years down the line once the delimitation of constituencies takes place in accordance with the 2031 census (thanks to a helpful reader, Kamil, for dispelling my belief that delimitation would happen in 2026). This is not a new demand and India is capable enough of funding the redevelopment of a small pocket in Delhi even as it fights a pandemic.

PPS: It beats me why the government could not postpone the Central Vista Redevelopment Project until the second wave peaked. That would’ve been prudent.

Incorrect Frame #3: The Liberalised and Accelerated Phase 3 Strategy is to be blamed

The move to allow state governments, private hospitals, and industrial establishments to procure vaccine doses directly from the manufacturers has been under fire ever since it was announced. The criticism is on two counts.

One, this approach would lead to confrontation between state governments seeking better deals from manufacturers. Two, the Union government can use its scale to strike better deals with both domestic and foreign manufacturers.

The solution suggested is that the Union government must incentivise vaccine production, procure all these vaccines from manufacturers, distribute them using a transparent formula to the states, and provide all vaccines for free. Moreover, do all this in mission mode.

The problem with this criticism is that it heavily overestimates the Union government’s capacity. To expect a government that couldn’t strike advance contracts with a handful of manufacturers to do all the above is to ignore the constraint that inadequate state capacity imposes.

From a citizen’s perspective, to expect a different result while repeating the same failed strategy doesn’t make sense. I suppose most people think that the real cause of the government’s ineffectiveness is either the lack of money, intent or both. In reality, the problem is a deeper one, of capacity — bureaucratic, intellectual, and implementation.

Another deeply ingrained narrative today is that if Indian governments can organise Kumbh Mela (spot the irony) and nationwide elections, it should also be able to organise a mission mode vaccination campaign. Unfortunately, it is more likely that vaccinations will continue in the slow burn mode over multiple years and will need to deftly change track as the virus mutates and better vaccine variants get discovered. I doubt a centrally planned system will be able to solve for all this.

State capacity should change public policy alternatives we choose and hence, it’s better to get state governments and private players to get involved. As the number of vaccine candidates increases, more options will become available to these entities, far quicker than a centrally planned system run by a low-capacity union government.

As Ajay Shah and Amrita Agarwal write:

“These changes will unlock the energy from varied Indian buyers — states, firms, communities, and individuals — and increase their accessibility to global supply.

Indian buyers need to explore the global vaccine market and be comfortable paying market prices. As an example, the Israeli government paid $28 per dose (i.e. ~2,000 per dose) to Pfizer and Moderna in late 2020, which was 43 per cent higher than the price paid by the US and the EU. This got them rapid vaccine deliveries. They have vaccinated most of their population and now do not force people to wear masks.

If Indian persons (private and public) put down ~2 trillion, i.e. a billion doses at ~2,000 per dose, this would yield transformative impact. This is a price worth paying to control the economic and human cost.”

Of course, this doesn’t mean the Union government can wash its hands off entirely. It still has an indispensable role to play. One, only it can accelerate domestic production by getting all vaccine manufacturers to share knowhow and ramp up capacity. Two, while the global supply squeeze eases, it must create a transparent prioritisation mechanism for distributing the scarce supply within states.

In sum, to get the right answers, we need to ask the right questions, again and again.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Pratap Bhanu Mehta writing for the Indian Express: “If our politics continues as usual over the next few months, the devastation to our lives will be immeasurable.”

* [Report] Samanth Subramanian asks Why is India, the world’s largest vaccine producer, running short of vaccines?

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

India Policy Watch: Radically Networked Succour

Insights on burning policy issues in India

— Pranay Kotasthane

When the going gets tough, we become desperate for signs of hope. Unfortunately, the union government has inspired no such thing. It has instead opted for image management over accepting responsibility, complacency over taking charge, and whataboutery over offering succour.

Hope, then, springs from the stories of ordinary people pitching in to plug government failures in their own unique ways. A big portion of this effort is invisible to us from our immobile locked-in existences. The part that’s visible is what is happening over digital media. Over the past few weeks, all of us have seen relief efforts of various types, sizes, and success rates unfolding over the internet. Arranging for oxygen cylinders and hospital beds, verifying these requirements, administering advice, and contributing money — all this and more are happening at high speeds in a society densely connected with each other. In other words, radically networked succour.

Often, the term radically networked societies (RNS) conjures up the image of a mob. Admittedly, most examples we’ve cited earlier have depicted the darker side of RNS. However, the term itself is value-neutral and applies to any group meeting these three conditions:

a web of densely connected individuals, possessing an identity (imagined or real) and motivated by a common immediate cause.

Visualising the online relief efforts through a RNS framework, we see that:

* The complete inadequacy of the Indian State became the immediate cause that mobilised community action. As the second wave started hitting near-and-dear ones while our governments continued to be in a parallel reality, people felt that the government’s effectively saying “Apna Apna dekh lo (Fend for yourselves)”. Then came the realisation that the problem has grown too big for our governments to solve.

* The speed and scale was provided by the internet, specifically digital media platforms. The hierarchical nature of the State is an impediment in emergencies. That’s where flattened networks excel, spreading information to various nodes at a speed States cannot match. Our social media feeds transformed into emergency response management systems.

* The identity dimension is not so clear in the sense that people providing radically networked succour do not define themselves as being a part of any one imagined identity. In some cases, pre-existing identities such as religion have inspired a community response. In others, the sinking feeling that we are all in this together has produced new bridging social capital.

One identity that’s been conspicuous by its absence is the electoral and social media apparatus of the governing political party. Being one of the largest political organisations in the world that understands how to harness the power of digital media like few others do, it’s surprising to see it missing in action. One can only guess what came in the way —the arrogance of power, a refusal to acknowledge the problem, or a pre-programmed plan to focus on attacking the opposition?

The Impact

The past few weeks have also made clear the strengths and limits of relying on civil society action alone.

The most encouraging lesson is to see that in difficult times, people have contributed in their own little, unique ways that governments can’t. Whether it’s by delivering food to a patient in the neighbourhood, by helping those in need of financial assistance, or by delivering critical medical supplies, the RNS has saved many lives.

At the same time, it has also exposed the limits of what a civil society can do. People actively involved in such efforts themselves couldn’t shake off the feeling that they were boiling the ocean — regardless of the growing monetary contributions or the number of hands on deck, the problem seemed to be growing at a much faster rate. The scarcity of life-saving equipment meant that for every one person you could help, another equally — or perhaps more — needy patient was dying.

The tragedy has also made it clear that a civil society cannot, by itself, summon newer hospital beds, healthcare staff, and life-saving medical supplies. For increasing capacity on these counts, the role of the State and markets is indispensable. We need the State to do what it should and get out of the way where it must for markets to play their magic. Whichever political ideology we may hold dear, the pandemic should make us realise the need of all three — State, Society, and Markets. Of which, it’s the omniabsent State that should worry us most. The Indian State is small where it really matters and simultaneously, overbearing in areas where it shouldn’t have a role.

Until we get the balance between the State, Society, and Markets right, my deep gratitude to everyone who has been providing succour to India and Indians.

Global Policy Watch: Three Truths Of Ideology

Bringing an Indian perspective to burning global issues 

- RSJ

It must be a sign of times when the apparently honorable and normal act of someone taking a stand for her ideology and paying the price for it becomes global news. It happened last week. The Republicans in the US House of Representatives voted to remove Liz Cheney as the chair of House Republican Conference for her persistent criticism of Donald Trump and his persistent claims of a stolen election.

Liz Cheney is no ordinary Republican. She comes from a dynasty that’s long been a pillar of the Republican establishment. Her father, Dick, a former VP, needs no introduction to the Republican base. That she is no longer considered ideologically pure by the GOP is quite remarkable.

Now the cynic in me doesn’t for a moment believe what Liz Cheney did was all about her principles. Political ambitions aren’t realised by playing it safe. You must roll the dice when the time is right. She did just that. She staked her future knowing well what the short-term repercussions could be. It is how political careers are made.

Truth #1: The Mortal Enemy

What interests me about the episode is the use of ideology by both sides in justifying their decisions. There’s something to learn about ideology here. This is what Liz Cheney wrote in her op-ed in the Washington Post:

“Finally, we Republicans need to stand for genuinely conservative principles, and steer away from the dangerous and anti-democratic Trump cult of personality. In our hearts, we are devoted to the American miracle. We believe in the rule of law, in limited government, in a strong national defense, and in prosperity and opportunity brought by low taxes and fiscally conservative policies.”

That last line sums up the Reagan conservative ideology that’s been the guiding light of the party till it was upended it by what can only be called Trumpism in 2015.

The reactions against Cheney weren’t about the principles. It involved the first truth about ideology. An ideology needs a mortal enemy, an anti-Christ, to survive.

As a prominent Republican, Mike Gallagher, responded:

“House Democrats under Speaker Pelosi have been ruthless in advancing their radical progressive agenda, and Representative Cheney can no longer unify the House Republican conference in opposition to that agenda.”

It doesn’t matter what we stand for so long as we know what we stand against. Ideological cohesion is easier to achieve in knowing your enemy than knowing your friends.

In a famous speech delivered in January, 1962, Barry Goldwater laid down the seven principles of American conservatism. There’s no better articulation of a political philosophy in modern times. It is clear, concise and it helps translate these principles into specific policy proposals. Yet, Goldwater lost in a landslide in the 1964 presidential race. About 16 years later, Reagan used the Goldwater template but with one big difference. He located the enemy in his election campaign.

Big government.

Reagan would govern based on Goldwater’s principles but he never forgot what builds cohesion in his base. Late in his second term with no further elections to fight and his ideological dominance complete, he continued to fight the enemy with this famous quote (Aug, 1986):

I think you all know that I've always felt the nine most terrifying words in the English language are: "I'm from the government, and I'm here to help."

Truth #2: The Seed Of Destruction Within

Ideology is the prism through which we view politics. And conversely, it is a collection of values that guide politics to achieve the social or economic ends it believes are right for us. A clear articulation of ideology eases decision making for citizens and lawmakers alike. This is good. But running a state on ideology isn’t easy. The modern state extends itself far and deep into the lives of its citizens. And the demands on ideology to provide answers in every human realm imaginable continues unabated.

This stretches any ideology thin. It is impossible to have an ideology that can be consistent and convincing across every aspect of governance - economics, social, legal, foreign policy, science, religion et al. This over-extension is the seed for future destruction of the ideology. And this is the second truth about it. This is the opposite of what Marxists refer to as ‘false consciousness’. Here the extension of ideology across social institutions and over the masses is overt and in a direct sense, the reality.

It creates two problems. One, it splinters the ideologically cohesive unit. You could be against gay marriage but you believe in climate change. Since the conservative ideology in the US has extended itself to both these domains with clear views, you cannot hold your positions without a strong sense of dissonance. These faultlines increase in count and deepen over time as ideology permeates the lives of people. Two, as the ideology extends itself too thin, it loses the strength of its core that made it popular. Others then move in to appropriate the core identity. This is what Clinton or Blair did in the 90s by sidling their communitarian-minded parties into the free market positions that Reagan and Thatcher had made mainstream.

Truth #3: Finding The Sacred

The skill in maintaining ideological dominance over long time therefore lies in understanding the two great threats. First, your adversary is able to paint your core principle as its big enemy by using the changing patterns in the society or the environment. This is what has happened in the US after the global financial crisis (2009) where institutions representing the dominance of free markets and globalisation came under attack first from extreme left and as the notion became mainstream, from the extreme right too. Second, the inevitable loosening of the compact that brought your side together as your ideology stretches itself thin over a wide array of issues.

The way to hold off these threats is by finding that one core principle that can be made so sacred that it cannot be desecrated. And then envelope or extend every argument against your ideology into that sacred domain. This is the third truth about ideology. This is what Make America Great Again was about. The ‘American way of life’ exalted to a status so sacred that you can use it to argue against wearing masks, owning guns, pulling out of Paris agreement or proposing to build a mythical wall on the Mexican border.

This has been done successfully elsewhere too. In the erstwhile USSR or today’s China, the sacred maxim is that the Party is supreme and the only truth. In countries too numerous to name here, it was nationalism or ‘nation first’. You can draw your own conclusions about India in recent years. Nothing can make the sacred profane. Anything can be justified in its name. Once you have sanctified a principle among the majority of the masses, all you need to do is to manoeuvre any ideological battle to those grounds and you win. This is never permanent as history has shown. But it lasts way longer than any real ideology.

Liz Cheney might be fighting for conservative principles of the Republican Party. But the party knows those principles are stretched thin and only the empty yet hallowed slogan of the ‘American way of life’ that Trump has come to represent to its base gives them a fighting chance in elections against the woke progressive agenda they so hate.

For all its pretensions, ideology reduces itself to these 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.

Enjoy the fruits of power.

PolicyWTF: Price Controlling the Pandemic

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

— Pranay Kotasthane

The term PolicyWTF is too frivolous to apply to the horrendous events of this week such as over 2000 bodies being found along the banks of Ganga or the undercounting of nearly 60,000 COVID-19 deaths in Gujarat.

So, this week’s policyWTF award goes to the Kerala government for price capping everything from triple layer masks to surgical gowns.

Please note the precision. Inspection gloves are to be priced at ₹5.75, not ₹6 and triple layer masks are decreed to be priced ₹3.9 and not ₹4. While you are at it, have a look at the replies to the tweet as well. Nearly everyone is lauding the Kerala CM and tagging their own CMs to implement similar price controls.

It’s easy to anticipate the unintended:

* The better quality masks, gloves, and PPE kits will disappear from the shops in Kerala.

* Given the continuing high demand for these items, producers from Kerala will try to sell these items in neighbouring states that don’t have such price controls.

* Producers from other states will not sell these items in Kerala.

* An underground market will develop for these goods. The government will catch a few people and blame rapacious profiteers but where demand exists, supply will find a way.

A basic lesson in public policy is that good intentions don’t imply good policies. But we reward activity rather than consequences.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] Slavoj Žižek in conversation with Barbara Bleisch on Ideology. English subtitles available. Žižek is his usual maverick and brilliant self and Bleisch is an outstanding interviewer. Must watch.

* [Article] A constitution bench of the Supreme Court turned down the Maharashtra government’s move for Maratha reservation. In a convoluted judgment, it upheld the union government’s law of reserving seats for economically weaker sections, even if the total reservation exceeds 50%. Gautam Bhatia has a clear-eyed take on the issue. For our views, check edition #120.

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

India Policy Watch #1: Jabki Dimaag Khaali Hai (While The Mind Is Empty) 

Insights on burning policy issues in India

- RSJ

The sound and the fury surrounding all that’s happening in India now is quite maddening. Any kind of meaningful analysis risks drowning in it. In any case, there’s no analysis possible any more in India. There are only positions. We have fallen in love with the culture of intellectual nihilism. All arguments start with a bad faith assumption. And before you end it, you are tagged with toxic monikers and a litany of half-truths in the garb of whatboutery. And they bookend any discussion between two ‘argumentative’ Indians these days.

We cannot say we didn’t see it coming. It is easy to cast democracy into a vessel that channels the passions of the majority. You can ride those passions to the levers of power. But it is another thing to govern and meet the aspirations of the demos. The easy way then to cover for failures is to continue fighting some mythical ancient regime or entrenched enemies who are undermining your efforts. This is imagined victimhood. When this becomes a political, social and cultural defence to any challenge, intellectual nihilism follows.

Facts don’t matter then. Only faith does.

We are in a tight spot today. To come out of it requires leadership, farsighted policymaking capabilities and a consensus on the path to nation building almost at par with the task we had on hands right after independence. This isn’t easy even with the best of intentions and capabilities at your disposal. Instead, I fear we have real constraints in thinking our way clearly through this.

Acknowledging The Problem

The economy wasn’t in a great shape going into the pandemic in April 2020. The twin balance sheet problem and the shock of demonetisation meant a modest 4-5 percent growth was beginning to look the best we could do. The national lockdown and the impact of the first wave has meant we will end up with about an eight percent decline in GDP in FY20-21. The general consensus within the government early this year was India had seen off the pandemic and a V-shaped recovery is well on its way. This second wave has set us back again. So, where does that leave us on the economy? There are a few factors to consider here:

* Unlike wave 1, this time the impact has been felt more directly by the consuming class. This is evident from conversations with friends and colleagues, social media posts and the case counts. People have been scarred and sentiments have taken a hit. More importantly, people will wait to get vaccinated before lowering their guards. The lessons of complacency seem to have been learnt. The talk of wave 3 and its likely impact on kids have only queered the pitch. Vaccination to about 50 percent of people looks unlikely before the end of 2021. This would mean when the wave 2 subsides, there won’t be a quick bounce back in terms of increased mobility and consumption spends. There will only be a gradual return to any kind of normalcy.

* Unlike last wave, this wave has impacted the hinterland. The extent of the impact is difficult to ascertain but the ground reporting from rural UP and Bihar has been heartbreaking. Rural supply chains have been disrupted and the expectation that rural economy will hold out like last year are misplaced.

* Much of the heavy lifting last year to support the economy was done by the RBI through monetary policy. There’s a limit to that and it seems we have reached the end of it. The fiscal room available to the government is quite limited. It is worse than last year. The fiscal deficit is the highest it has been in a long time. Yet, the government will have to come out with some kind of a stimulus soon. People are hurting. But where will the money for stimulus come from? Expect more headline management like the Rs. 20 lac crores Aatmanirbhar Bharat package announced last year.

* Exports could be a silver lining considering most of the developed world will be back on growth path by next quarter. The challenge is how well are our businesses (especially SMEs) positioned right now to take advantage of it. It is difficult to be an export powerhouse while simultaneously dealing with an unprecedented health crisis impacting the workforce.

* The consensus growth projections for FY21-22 have already been lowered from 11.5 percent to 9-9.5 percent. My fear is this will slide down to 7-7.5 percent range by the time we have seen through wave 2. Since this wave is unique to India in terms of spread and impact, our economic performance, deficit and the future prospects will be an outlier compared to most of the world in FY22. We will have to keep an eye on the sovereign rating given our circumstances. There’s a danger lurking there.

Given these, it is evident we will need to bring together our best minds across government, administration and industry to navigate these waters. But that will require to acknowledge we got things wrong to reach here. This isn’t likely going by precedence. It will also be interesting to see how Indian industry and capital responds to this. Of course, the public stance, like always, will be cheerleading the dispensation. But it is no secret that private capital investment has been stagnant for most of last decade. Indian capital doesn’t put its money where its mouth is. It is far too clever for that. As 4-6 percent growth (if that) becomes the accepted norm for this decade, it is likely that Indian industry and the wealthy will try and conserve what they have instead of taking risks. There are other second order social implications that might arise out of another ‘lost decade’ of tepid growth that Indian capital will be worried about. They might continue to prefer a ‘strong leader’ given these concerns.

It is also clear now that any recovery will be K-shaped to begin with. The formal, organised and larger players will consolidate their gains and grow at the expense of the informal and smaller players. This trend has been seen over the past 12 months. The stock market, divorced from the real economy, already knows it and it is reflected in the performance of the benchmark indices that represent 30-50 top companies. This structural shift to an oligopoly in most sectors is evident. This will allow the state to control capital more easily as markets turn less free. In any case, the benefits of aligning to the political dispensation are already evident in the list of richest Asians. So, the industry will be more than willing to be subservient. These aren’t the best of conditions for releasing the animal spirits of enterprise.

The Absent Media And Opposition

It isn’t difficult to foresee the challenges outlined here and to set up a policy framework to address it. There are two problems here. First, the centralised nature of governance in the current establishment precludes any acknowledgement of missteps or an honest assessment of the problems on hand. Second, the conventional outlets of holding the government to account, the opposition and the media, are mostly absent. Large sections of mainstream media are owned directly by the industry who would rather cheerlead than ask tough questions. Many in the industry and the media may even be ideologically aligned to the establishment. The opposition is fragmented with regional leaders often holding their own in the assembly elections. But any kind of national mobilisation to politically counter the party in power is not in sight. The PM continues to be popular despite the wave 2 failings. The political genius of the PM has been to dissolve the natural fragments of region, caste, or even, language, that precluded over-centralisation of power in the past. The Lok Sabha elections will continue to be presidential in nature for the foreseeable future. So, any real political opposition will need to contend with this.

The other source of opposition, class, has disappeared from Indian politics for long. Students’ unions are politicised along party lines and have no independent line of thinking, trade unions have no teeth and farmers movement is splintered despite the protests we see against farm laws.

The near absence of media and opposition has meant policy debates and discussions have suffered. There’s complacency and lack of rigour in policy making as has been evident in the past many years. There is no price to be paid for policy failure. And any failure is quickly papered over with some kind of narrative.

The Surrender Of Elites

Lastly, let’s turn to the elites. The section that often tends to have a disproportionate share of voice in the polity. The institutional elite have either been co-opted or they have thrown in the towel in the face of an overwhelmingly popular establishment. Universities, courts, bureaucracy, police and what’s referred to as civil society can no longer be counted on to be independent voices that will uphold the tradition of the institutions they serve. This isn’t a first in our history. But, remember, the last time it happened the consequences were terrible. That should, therefore, give us no solace.

The other set of elites are those who have provided intellectual scaffolding to this dispensation over the years. Loosely put, this group would identify themselves ideologically as either conservatives or belonging to the right. I have articulated their grouses in earlier editions. It runs the spectrum - the resentment with a liberal constitution that was not rooted in our civilisational values, the anger at the radical act of forgetting our history that the Nehruvian elites thrust upon us in their wisdom, the overbearing state and the failures of leftist economic policies during the 60s-80s that held us back and the deracinated deep state (“Lutyens Delhi”) that apparently controlled the levers of power regardless of who was in power.

In the past seven years it should have been clear to them these grouses aren’t easy to set right nor will their elimination lead to any kind of great reawakening in the masses. The intellectual articulation of a political philosophy that’s suited to the modern world while addressing these grouses isn’t clear yet. Instead, what we have on our hands are thuggish attempts at settling imaginary scores and continuing degradation of scientific temper in the hope it will usher in a modern version of our glorious past. If these intellectuals want the supposed UP model of today to be what India of tomorrow should look like, good luck with that ending well.

I have been reading the great Hindi essayist, historian and scholar, Hazari Prasad Dwivedi over the past few months. Dwivedi was an intellectual powerhouse who was deeply rooted in the Indic tradition and philosophy. A great Sanskrit linguist who spent a lifetime studying the Sastras and writing beautiful expositions on them, Dwivedi should be more widely read today. His essays, their themes and his arguments, betray no trace of western enlightenment influence. He had a clear-eyed view of the richness of our heritage and its relevance in the modern age.

In his anthology, Vichar Aur Vitark (Thoughts And Debates), there’s an essay titled ‘Jabki Dimaag Khaali Hai’ (“While The Mind Is Empty”) published by Sachitra Bharti in 1939, which is often quoted by Pratap Bhanu Mehta to make a specific point about our current obsession with our glorious past and the identity crisis among Hindus. As Mehta writes:

This identity is constituted by a paradoxical mixture of sentiments: a sense of lack, Hinduism is not sure what makes it the identity that it is; a sense of injury, the idea that Hindus have been victims of history; a sense of superiority, Hinduism as the highest achievement of spirituality and uniquely tolerant; a sense of weakness, Hindus are unable to respond to those who attack them; a sense of uncertainty, how will this tradition make its transition to modernity without denigrating its own past; and finally, a yearning for belonging, a quest for a community that can do justice to them as Hindus. This psychic baggage can express itself in many ways, sometimes benign and creative, sometimes, malign and close minded. But these burdens cast their unmistakable shadow upon modern Hindu self-reflection, often leading to a discourse on identity that Dwivedi memorably described as one, where the ‘‘heart is full and the mind empty (dil bhara hai aur dimag khali hai).’’

The passions that have been fanned to animate the majority cannot lead to nation building in the absence of intellectual rigour and clear reasoning. The problem is once that genie of passions is out, it is impossible to put it back in the bottle. Its demand will never be sated.

I will leave you with an extract from Dwivedi’s essay (my mediocre English translation follows):

My translation:

But when the mind is empty while the heart is brimming over, there cannot be any possibility of an engaging exposition of the Sastras. 

Otherwise, there isn't any reason to be anxious about a race whose writ once ran from the shores of River Vaksh in Central Asia to the end of South Asia, the imprint of whose culture transcended the Himalayas and the great oceans and whose mighty fleet once controlled the waters of the eastern seas. It is true that this mighty race is a pale shadow of itself today. The sons of Panini (the great Sanskrit grammarian from Gandhara) sell dry fruits and heeng on streets today while the descendants of Kumarjiva are involved in the basest of trades. Yet, there's a hope that there must be a semblance of that glory still running in the veins of this race. And it will show its true colour some day. But then I wonder. After all, a tree is known by the fruits it bears. The state of disrepair that the Hindu society is in today must trace its cause to that once glorious civilisation of the past. How can that tree be so glorious when its fruits we see all around today are so terrible?There was indeed an age of prosperity for this race. That is true. Those verdant streets of Ujjain, the gurgling sounds of river Shipra and the celestial music of the kinnaras still echo in the Himalayan valleys - these memories remain fresh in our minds. And amidst these riches, our eyes can clearly see the attack of the Huns and the defiant stand of the Aryans, the numerous rise and fall of empires, the thunderous roar of Vikramaditya. The glories of Magadh and Avanti were unparalleled. Its elite could wield the sword and the brush with equal felicity. They could fight fire with fire and let their hair down when they wanted. But things changed. The elite suppressed the masses; they paralysed the polity. The chasm within the society began to open up. The elites immersed themselves in the pleasures of the material world while the masses were tied down to scriptures and their orthodoxy. One took refuge in merriment while the other was often lampooned for their outdated beliefs. And the fissure in the Hindu society widened further. Over the centuries every invader used this to their advantage - Huns, Sakas, Tartars, Muslims and the British. They divided us further and they ruled. Today that Pathan dry fruit seller asked me if that beautiful house belonged to a Muslim or a Christian and could scarcely believe it could be that of a Hindu. And I wondered if the chasm continues widening everyday. But then the Sastras don't bother about such identity issues of the Hindus and I lack the courage to intellectually confront this issue any further. When the mind is empty and the heart full of passion, isn't it enough to have even mentally contended with the existential conundrum of our race.            

Matsyanyaaya: A Cautionary Tale on the ‘Israel Model’

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Full diplomatic ties between India and Israel were established quite late in 1992. Even so, this bilateral relationship has quickly grown into a robust and multi-dimensional partnership over the last three decades. This is a welcome development.

Israel’s technological prowess finds many admirers in India. In casual conversations, this admiration often escalates into a desire for emulation — "see how they tackled terrorism, we should learn from it", or "we should also have mandatory military service, like Israel does", or "why can't India kill terrorists in Pakistan the way Israel assassinates Iranian nuclear scientists?"

The latest round of Israel-Palestine conflict should, however, force uncritical admirers of the Israel model to update their Bayesian priors.

A side note before I begin: what model Israel adopts is its own problem and I have neither the competence nor the inclination to challenge its approach. Every conflict today has its own set of initial conditions and a long and bloody path-dependent history. I am only interested cautioning people who seek to transpose Israel’s strategy to an Indian context.

Here are my four strategic insights from the Indian perspective for those in awe of the 'Israel Model'.

#1 Force alone cannot end insurgencies

Even an overwhelming superiority in force structure is insufficient for ending insurgencies. The US experience in Afghanistan and the ongoing Israel-Palestine conflict both demonstrate that insurgencies are not easy to dislodge. Neither the Iron Dome nor the ‘Mother of all Bombs’ can fully deter an insurgent force from retaliating in the future.

Force can, at best, modulate terrorism but it can't end insurgencies. Ending insurgencies also requires co-opting rival elites and making compromises with insurgent factions. More the disproportional use of force, more elusive such dealmaking becomes.

#2 Assassinating terrorists can be both ineffective and high-cost

Fed on a diet of Hollywood movies, the assassination programmes of Mossad and Shin Bet are admired by many people in India. Every terrorist attack in India raises one question: if Israel can kill Iranian nuclear scientists, why can’t India kill the likes of Hafiz Saeed?

This romanticisation of an extensive assassination programme misses the fact that such operations have often been strategically ineffective. Praveen Swami’s take in MoneyControl on Israel’s assassination programme highlights this point well:

“From 1971, when a new Palestinian resistance emerged in the West Bank and Gaza, both targeted assassination and sometimes-indiscriminate civilian killing were deployed on a growing scale. Forty-man covert assassination squads, code-named Rimon, or Pomegranate received target lists from Israel’s internal intelligence service, Shin Bet for execution.

The killings formed the backdrop to the rise of terrorism, culminating in the savage massacre of Israeli Olympic athletes in Munich in 1972. Mossad responded by unleashing Operation Wrath of God—arguably the best known of all its efforts—which, over the course of twenty years, used covert teams to target their alleged killers across Europe and the Middle-East.

Leaving ethics aside, the gains from Israel’s tactics are controversial: Rimon’s killings didn’t deter the outbreak of the First Intifada in 1987; indeed, it could be argued to have radicalised an entire generation. Even leadership-decapitation operations, like the 1988 assassination of Palestine Liberation Organisation second-in-command Khalil al-Wazir, did little to change the course of history. Arguably, Israel’s anti-PLO operations only served to open the way for more dangerous Islamist groups.”

Another unintended and yet anticipated consequence of such an approach is the potential of domestic spillover. If a State repeatedly uses assassination against State enemies, how long before it becomes an acceptable method against domestic anti-national ‘enemies’ ?

A key cognitive dissonance is at the centre of democratic statecraft — in the amoral world of international relations, the grammar of power applies while in a liberal domestic realm, rule of law explicitly restrains the primacy of power. This delicate balance is tougher to achieve in a State with an extensive assassination programme. A secondary consequence is that conflicting parties become incapable of compromise and dialogue and resort to acts that further aggravate the situation.

#3 People matter more than territory

The Israel-Palestine conflict is a visceral conflict over a piece of land. Such is its history and deep-seated animosity that today, even localised fights over pieces of neighbourhood land have the potential to trigger a full-scale arms exchange. The lesson for India is that the desire for territorial integrity should not override the primary goal of peace and prosperity for all Indians. Take the instance of India’s land border with Bangladesh. In the 2015 Land Boundary Agreement, India gave away more land than it got back from Bangladesh. In a strict sense, India’s territorial integrity was violated. And yet, it was a prudent decision because, among other things, it put an end to the abomination called a third-order enclave — a piece of India within a piece of Bangladesh within a piece of India within Bangladesh. The hitherto uncertainty over the border had led to a denial of basic services to Indians in such enclaves.

#4 Excessive use of force is counterproductive in the Information Age

Despite its clout, the international narrative has gone against Israel over the past month. International coverage has portrayed Israel as the aggressor. The armed attacks by Israel were broadcasted widely and the bloodied faces of Palestinians led many countries to pressurise Israel for a ceasefire.

The key lesson here for India is that information age conflicts will be global by default. In the Industrial Age, state suppression could be covered up; that’s no longer the case in radically networked communities. State use of force against non-combatants is almost certain to receive instant condemnation from other countries. This further calls for prudence in using force.

In sum, there’s a lot to be gained for both sides from a stronger India-Israel partnership. But a blindfolded emulation of the Israel Model will do far more harm than good.

India Policy Watch #2: Vaccine Inequity 

Insights on burning policy issues in India

- Pranay Kotasthane

Vaccine inequity — you are going to be hearing a lot of over the next few months. It is a hydra-headed term being used in a variety of contexts — some make sense and others don’t. Let’s explore all its facets.

#1 Vaccine inequity in the international relations context

Canada, UK, EU and other rich countries are hoarding vaccines for its citizens. Citing inequity, repeated calls have been made by concerned citizens, groups, and WHO for releasing these hoarded doses.

However, equity is orthogonal to the amoral world of international relations. Equity presupposes morality but when the international relations operates on the principle of matsysnaaya, every country is on its own. Calls for vaccine equity then may well make some countries donate a few token doses from their hoarded stock to ward off future criticism but it is unlikely to cause a significant shift in national stances.

Instead of asking for vaccine equity, appealing to national interest will work better. At present, India is perhaps not in a position to cause pain to a state that doesn’t offload its excess supply. But it can definitely promise to deliver benefits to countries that do. A lowering of tariffs on some goods or conceding on a less-important point in a trade negotiation in exchange of vaccine donations, has higher chances of securing vaccines from abroad.

#2 Inter-state vaccine inequity

State-wise allocations have also come under fire on the grounds of vaccine inequity. This is not surprising. Neither is it solvable to everyone’s satisfaction. The paradox of distribution, in Deborah Stone’s words, is that “equality often means inequality, and equal treatment often means unequal treatment. The same distribution may look equal or unequal, depending on where you focus.”

Till there’s supply scarcity, equalising distribution across states is impossible. Regardless of the formula used, it will be contested on the ground of being unequal by states that don’t fare well on a particular formula.

In such a case, the goal should be distribute fairly and not equally. In the current circumstances, the fairest way out is to transparently declare a formula for distribution of vaccines from the union government quota and simultaneously allow states to procure additional doses on their own.

#3 Digitally inflicted vaccine inequity

Getting a vaccine appointment requires you to have a phone, an internet connection, and the ability to read English, and that this is unfair to people who have access to none of them. This is the vaccine equity dimension I sympathise with most.

The CEO of the National Health Authority dismissed these concerns in an Indian Express article thus:

“Imagine the chaos if online appointments had not been compulsory. Vaccination centres would have been swamped by people, creating not only law-and-order issues but also risk of infections. Invoking the digital divide, as the authors do, is premature and misplaced, for the vaccination drive is evolving as it unfolds, and data is the torchlight for correcting the anomalies.”

“CoWin provides for on-site registration of people without access to the internet, smartphones or even a feature phone. Out of the 18.22 crore doses administered as on May 16, only 43 per cent have been administered through online appointments, the rest availed of on-site registration. Self-registration is just one component of CoWin. On-the-spot registration, walk-ins, registration of four citizens on one mobile number and use of common service centres for assisted registration underline the inclusive nature of CoWin.”

Of course, what he hasn’t mentioned is that walk-in registration and appointment is not available for 18-44 age group. It would be fair if a predetermined percentage of vaccine slots are opened up for walk-in registrations. Even cinema halls allows on-spot movie ticket bookings in addition to the online-booked ones; surely our COVID-19 vaccination drive can accommodate for this requirement. Further, some centres can be dedicated for walk-in registrations.

As the supply constraint eases, this problem should become less serious.

#4 Income inflicted vaccine inequity

The argument here is that since the rich, formally employed citizens can get themselves vaccinated through their employers, the employers must in turn vaccinate low-income earners for equity reasons.

This is a flawed argument. A government-run channel providing free vaccines is a better alternative. Mandating the private sector to cover up whenever the government fails is morally repugnant. It is precisely the kind of thinking that has allowed us to give our omni-absent state a free pass.

A reminder to end this section. Given that vaccines have positive externalities, the primary goal of the vaccination drive should be to give jabs to as many people as soon as possible. Doing so in a fair and transparent way is the best that can be done for equity. To prioritise equity over speed would be counterproductive. The option is to choose between two suboptimal outcomes. After all, confronting trade-offs is the what separates better policymaking from the worse one.

HomeWork

Reading and listening recommendations on public policy matters

* [Audio] Dr. Rajendra Prasad Memorial Lectures series, 1969: Acharya Hazari Prasad Dwivedi on Guru Nanak: Personality, Concerns and Objective. Wonderful speech combining history and philosophy.

* [Article] An excerpt from a promising new book on ending counterinsurgencies.

While excellent newsletters on specific themes within public policy already exist, this thought letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways.

Audio narration by Ad-Auris.  

Global Policy Watch: Global Order - Where Will It Come From? 

Bringing an Indian perspective to burning global issues

- RSJ

A couple of recent events made me wonder about the state of global affairs these days and an excuse to write about Hedley Bull and his famous book, The Anarchical Society – A Study of Order in World Politics (1977).

Take the incredible story of Belarus forcing down a Ryanair flight while it was in its airspace to arrest Roman Protasevich, a dissident who runs a popular Telegram channel widely used to protest against the regime of the dictator Alexander Lukashenko. A MiG 29 fighter jet was used to force the flight carrying 170 passengers to make a u-turn and land at the Minsk airport. This was a state sponsored hijacking with overt support from President Putin of Russia.

The EU condemned the incident and banned any carriers from flying over the Belarusian airspace. But barring strong press statements and warnings there wasn’t much teeth in the response from the West. Meanwhile, Russia and Belarus upped the ante. On Thursday, Russia refused to let planes land in Moscow that were planning to bypass Belarus. The EU plans to apply sanctions on Belarus who is a signatory to the 1944 Chicago convention that established common rules of aviation safety. But Belarus could hardly be bothered. It was their airspace, their perception of threat to their sovereignty and they are going to apply their laws. And they have Russia backing them. Who are you to ask questions?

That’s their dare to the NATO and EU.

The other story that broke in the middle of last week is of Whatsapp suing the government of India over the Information Technology (Guidelines for Intermediaries and Digital Media Ethics Code) Rules, 2021 which came into effect in May 26.

Now there are reasons why the Government wants to regulate social media platforms. We have often spoken about radically networked societies (RNS) here and how difficult it is for a hierarchical setup to counter the speed with which RNS mobilise themselves. This speed or the virality of the social media platform can pose real danger to society when used to spread rumours, hate speech and abusive content. So, regulations are welcome if they address this problem.

There are two points of contention in the Intermediary rules though for Whatsaspp.

The first is the demand for the traceability as written in Rule 4(2) of the guidelines. It requires a messaging platform to enable the identification of the first originator of information when demanded through a judicial order or an order passed by a competent authority as per IT Rules, 2009. This is a problem for Whatsapp (or any end-to-end encryption messaging service). They can only know the first originator if they start tagging each message with a unique identifier and create a metadata for tracking and marking every message on its platform. This is non-trivial technical problem to solve but more pertinently this will mean the ability of the platform to trace every message and know its details. This violation of privacy of every user of the platform to know the details of a select few doesn’t pass the test of proportionality. So, this should be unacceptable to any end-to-end encrypted messaging platform.

The second issue here is the very broad nature of what can constitute grounds for seeking this information. Like most laws this involves messages that are specifically criminal in nature like child pornography, sexual abuse etc. But like the definition of free speech in the Indian Constitution, they also include subjective grounds like threatening sovereignty and security of India or creating law and order problems. These subjective interpretation could be abused to seek information about anyone. Any rule should be drafted with a view on how it could be used for wrong ends by anyone in the future. The current reassurance given in the law that there will be no requirement of disclosure of the message or the sender has no meaning when the demand for the originator is made based on the message itself.

There are three arguments being made against Whatsapp on this case that merits discussion.

One, Facebook (that owns Whatsapp) has built a business model by collating all kinds of data about its users (with or without consent). So, irony kills itself when Facebook claims to be a champion of privacy. This is true except for one important point. Facebook isn’t a state. It abuses data for its commercials gains. You can call it an exemplar of the surveillance economy. But a state having access to that kind of data is different. The state has the monopoly of violence over its subjects. No company has that. A surveillance state is a completely different ball game than a surveillance driven business model.

Two, Whatsapp cannot wash its hands off any responsibility for the messages that flow through its platform. This is correct and Whatsapp should be asked to provide mechanisms through which messages that are flagged by its users, a judicial or a competent authority as abusive or illegal can be restricted from being passed along any further. This must be asked of all social media platforms. Asking for the originator of a message, however, opens up a Pandora’s box that directly impinges on individual liberty.

Three, there’s an interesting argument made that Whatsapp cannot go against the law of the land. This is a bit troubling. Whatsapp has been in India for many years following the law of the land. It disagrees with a particular clause in a new set of rules and it is contesting that in the court of law. This is usual judicial procedure. This isn’t an MNC challenging the sovereignty of India as it is being made out. Those making these arguments either want to use the easiest crutch of nationalism to obfuscate the principle of privacy on which Whatsapp is making the argument or have their own vested interests in ‘digital nationalism’. In any case, there isn’t a final privacy law that has been debated and passed by the parliament. So, the point of challenging the law of the land on this topic is itself moot.

Enforcing Global Order

There is a broader point I want to discuss based on these incidents. Is there any legitimate global authority left that can enforce any kind of global order any more? Who will stand up for basic human rights like the freedom to dissent, to question the powerful or the right to privacy? Is there a need for a global policeman, a competent and empowered multilateral institution or a rules based order, that will question a nation-state about its actions? Or, will nations justify all their acts under the cover of sovereignty?

We talk about international relations quite often here. Pranay uses Matsyanyaya (big fish eating small fish) as the principle that guides relations between nation-states. This is what’s termed as the realist view. Nations act in their self-interest and they form alliances or take positions that furthers it in the long term. A cynical view of this would be to think of nation-states in a Hobbesian ‘state of nature’.

Of course, the reality isn’t exactly this. Nations help other nations, agree mutually on a common set of rules to guide their behaviour and set up multilateral organisations to follow a code of conduct in global affairs. Yet the realist will say these sound great on paper but cannot be enforced unless there is a real possibility of a more powerful nation or nations threatening real harm to another nation which isn’t toeing the line. Stripped of all niceties, multilateral organisations depend on a global power to maintain world order. It is matsyanyaya after all.

After the fall of USSR, the overwhelming consensus was the liberal, democratic global order will have a long, uninterrupted reign. Nations will recognise this to be the ultimate political and social end and they will strive to be co-opted into this order. History, in that sense, had ended. But that was not to be.

There were two reasons for that. One was philosophical: an ideology without a counter loses it raison d'etre. The nature of the political rests on the Schmittian ‘friend’ versus ‘enemy’ divide like we often say here. It will splinter from within over time and find its own enemies. That’s what happened eventually to the liberal, democratic hegemony as the extremes on both left and right pared it away. The second reason or a set of reasons was rooted in specific events and it was more substantive. The Iraq War based on fake reports of weapons of mass destruction possessed by the regime, the global financial crisis (GFC) and the policy response that led to delegitimisation of globalisation among the masses, and the spectacular rise of China that benefitted from global trade but didn’t turn into a liberal, democracy as was expected - all of these events fanned populist movements across democracies and turned them insular. The liberal democratic world order lost its bearings. It was the light that failed.

So, here we are.

Notwithstanding the recent moves of the Biden administration to undo the Trumpean ‘America First’ stand, it is evident the US remains reluctant to lead a world order to promote liberal democratic values in the way it did during the Cold War. Then we have Xi Jinping advocating a ‘community of common destiny’ that conveniently sidesteps any values that are inconvenient to China. And global MNCs and tech giants with user base larger than most countries aren’t interested in taking a stand on liberal internationalism. That has dissolved any hopes many had on globalisation countering great power rivalries, trumping rules of non-intervention in matters of sovereign states and promoting an order based on commercial interests. That old Friedman chestnut about no two nations that both had McDonald’s will ever fight a war against each other is well and truly buried.

So, what kind of a world order should we hope for in a future?

Bull And Neo-Medievalism

Strangely, that’s what brings me to Hedley Bull’s The Anarchical Society. Bull accepts the idea of Matsyanyaaya but argues for an international society that’s built on anarchy with some kinds of overlapping natural checks and balances. Bull argued any kind of hegemonic world order like what the liberal democratic order aspired for post Cold War or the dreams of some kind of universal government are bound to end in disappointment. Instead, he suggested the society could move towards what he termed ‘neo-medievalism’, a system that would:

“avoid the classic dangers of the system of sovereign states by a structure of overlapping structures and cross-cutting loyalties that hold all peoples together in a universal society while at the same time avoiding the concentration inherent in a world government"

He used neo-medievalism from the order that was prevalent in western Christendom in the middle ages:

“It is also conceivable that sovereign states might disappear and be replaced not by a world government but by a modern and secular equivalent of the kind of universal political organisation that existed in Western Christendom in the Middle Ages. In that system no ruler or state was sovereign in the sense of being supreme over a given territory and a given segment of the Christian population; each had to share authority with vassals beneath, and with the Pope and (in Germany and Italy) the Holy Roman Emperor above. The universal political order of Western Christendom represents an alternative to the system of states which does not yet embody universal government.”

It appears to me we are in this kind of a nether space today. In the foreword to the 2012 edition of Bull’s book, Andrew Hurrell wrote perceptively about why Bull remains relevant in this age:

“And yet, it remains plausible to argue that alternative global frameworks for order are either pluralistic and contested (for example transnational civil society) or efficient but highly unstable (as in case of markets and the global economy). Yes, the past 35 years have seen an intensification of economic and social globalisation , but the inequalities and discontent of globalisation have generated increased political strains both internationally and within many states, and have undermined the notion that globalisation will lead easily or unproblematically to shared values, resilient institutions, or to a meaningful global moral community. Yes, the density of the norms, rules and institutions of international society has increased tremendously, often pushing in liberal direction. And yet Bull’s scepticism may still be merited: whose solidarist or liberal order? What kind of liberal and liberalising order is it that seeks to promote democracy but ignores distributive justice and brushes aside calls for the democratisation of global decision making? How stable and how legitimate can a liberal order be when it depends so heavily on the hegemony of the single superpower whose history is so exceptionalist and whose attitude to international law and institutions has been so ambivalent?

How will international society confront its current triple challenge - a power transition driven by rise of new emerging powers; a structural transition in the scope of cooperation as governments have to face a series of complex and often inter-connected global challenges; and a cultural transition as both state power and the dynamics of the global economy move beyond the West.”

In a world still fighting a pandemic where the absence of global order was felt in our uncoordinated response and our inability still to inoculate the world together, Bull’s warning about premature celebration of global solidarity rings true.

A reimagining of the world order is necessary. But no one knows where it will come from.

PolicyWTF: Ek Machchar…

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

- RSJ

There’s that old joke about Roger Federer (RF) and his Indian Fan (IF).

IF: Do you know Indians buy the maximum number of tennis balls and racquets in the world?

RF: Oh! Must mean a lot of Indian kids playing tennis then.

IF: No. We play cricket with tennis balls.

RF: Then what do you do with the racquets?

IF: We use them to kill mosquitoes.

The mosquito killing electronic racquets are ubiquitous in India. You will find them at homes, at shops and with anyone who works outdoors in the evenings (watchmen especially).

There are reasons, of course. First, the excessive use of DDT and then liquid mosquito repellents have meant mosquitoes that have mutated to resist them. Two, liquid mosquito repellents are expensive with a refill costing Rs. 50-70 that are needed almost every two weeks. Three, liquid repellents need constant supply of electricity and are useless outdoors.

I don’t want to go into the familiar lament of the state not being able to provide safe air and a mosquito-free environment to its citizens in 70 years. In fact, things have gotten worse. Almost no one who grew up in 70s-90s remembers dengue or chikungunya being the kind of epidemic they have turned out to be in the last two decades.

The electronic mosquito-killing racquet was therefore a lovely little contraption. Priced between Rs 200-300, these could last a few months and once charged could be used for a few days uninterrupted. Importantly, they could be used outdoors which made it popular among those who worked outdoors in the evenings. Indian traders mostly imported these racquets (at likely import price below Rs 120) and incurred the import duties, costs of storing and distributing these racquets far and wide.

Now read this.

The Directorate General of Foreign Trade (DGFT) in a notification dated April 26 has prohibited the import of “mosquito killer racquet” (their words) if the C.I.F. (cost, insurance and freight) value is below Rs. 121 per racquet.

Of course, the process that led to the threshold being precisely Rs. 121 is something I want to study when I grow up.

Anyway, the general idea appears to be to become Aatmanirbhar in making these racquets and not allow cheap imports dumped in India.

We have elaborated on the unintended consequences of such steps in umpteen editions. But we are never tired of repeating them. Here’s what will happen:

* Jugaad will set in quickly. Traders will ask importers to increase the prices of their racquets above Rs. 120 and overinvoice them. The same racquets will now cost more.

* Once this jugaad is noticed, we might prohibit any import. There will then be a short term shortage in supply of racquets as we won’t be able to up our domestic production capacity to meet demand. The price of racquets will go up.

* In the absence of imports, there won’t be an incentive for domestic manufacturers to compete with the best. This could lead to poor quality of racquets and a permanent higher prices for them in future. In any case, there is a price floor set now of Rs. 121. We have seen this film play out all through the 60s-80s across sectors.

* Unfortunately, the poor will suffer the most. The short term supply shortage will hurt and then the elevated prices will bite (apart from the mosquitoes whose karma is to bite)

There’s a lot that ‘mosquito killer racquets’ and their import prohibition tells about our public policy over the past seven decades.

But I will let Nana Patekar do the talking.

India Policy Watch: The Wicked Problem of the Shrinking Women’s Workforce

Insights on burning policy issues in India

— Pranay Kotasthane

India’s continually declining female labour force participation rate from 30 per cent in 1990 to nearly 20 per cent in 2019 is a cause of much concern. Despite a rise in education levels and a drop in fertility rates, a greater proportion of women are unable to secure paid jobs.

Thanks to a robust research community that has developed over the last decade or so, we know a lot more about this worrying trend. To crudely summarise their work, it seems that this wicked problem is not just a government failure but also an enduring social failure.

Take the social failure. Ambedkar had written that the caste system is not merely a division of labour but an unnatural division of labourers into watertight compartments. This description partly applies to social norms regarding female employment as well. A false notion that women are better suited for domestic work — both household chores and child care — while men are suited only for outside work has created an unnatural division of workers. This is not merely a division of work as there is no evidence to show that men have an innate comparative advantage over women in doing outside work or that women have an edge over men in doing domestic work.

Solutions for addressing this social problem by the government include familiar ideas such as reducing income tax for women, family leave policies and mandating childcare facilities at workplaces. But such solutions are likely to make no dents on female unemployment in an overwhelmingly informal economy. Instead, there is still one underrated measure where governments can help. By enabling economic growth. The last decade has been one of missed opportunities, regulations that make it difficult for companies to hire people, and falling economic pace. Consequently, the economy has not been able to absorb India’s growing working age cohort, both male and female. Unless the overall supply of non-agricultural jobs increases, the problem of falling women’s labour force participation cannot be addressed in any meaningful way.

As far as the social failure is concerned, it requires solutions far beyond the government. In my view, the fantastic research and storytelling in this area is our best bet at creating what Cass Sunstein calls ‘norm entrepreneurs’. Social norms are more fragile than they are thought to be. Entrepreneurs who challenge existing norms can create fast-paced norm cascades. On that note, I want to plug a Puliyabaazi conversation with Mahima Vashisht, creator of the Womaning in India newsletter. I increasingly feel that this is perhaps the most important topic that we have ever discussed on the podcast. Do listen.

A Framework a Week: 8 Things to Unlearn before Learning Public Policy

Tools for thinking public policy

— Pranay Kotasthane

Last week, we made a short video on things to unlearn before learning public policy. It’s based on edition #6 of this newsletter. The aim is to clear some cobwebs in our heads before thinking about public policy.

HomeWork

Reading and listening recommendations on public policy matters

* [Video] "World on the Edge": the crisis of the western liberal order: An LSE discussion between Professor G. John Ikenberry, Professor Beate Jahn and Professor John J. Mearsheimer with Professor Michael Cox in the Chair.

* [Book] ‘Why Loiter?’, by Shilpa Phadke, Sameera Khan, and Shilpa Ranade, on the absence of women from public spaces in Mumbai.

* [Podcast] Alice Evans and Shruti Rajagopalan on the Great Gender Divergence, Ideas of India Podcast.

* [Article] How Did East Asia Overtake South Asia?, by Alice Evans.

* [Report] ‘Working or Not: What Determines Women’s Labour Force Participation in India?’ gives a good overview of the literature on female workforce participation in India.