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#91 Hope And Despair In India🎧 Dec 02, 2020

Show notes

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 is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

#90 "Politics is the Art of the Possible" Nov 29, 2020

Show notes

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 ElectionThis section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?— Pranay KotasthaneThe 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 governanceAccording 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 stakeholdersThe 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— RSJThe 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 IdeaThe 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 licenseSo, 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 ActRBI 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…

Full show notes at the publisher

#89 Uncovering The Recovery🎧 Nov 25, 2020

Show notes

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.

- 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 is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

#88 Economics Matters, Capitalism Works Nov 22, 2020

Show notes

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-businessInsights on burning policy issues in India— Pranay KotasthaneIndian 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 ThanksgivingThis section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?— RSJBad 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 MessengerOn 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 ErdoganSo, 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 ReasoningThe 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 KotasthaneThis 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 RushBig 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 designThe 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 t…

Full show notes at the publisher

#87 A Not-So-Peaceful Transfer Of Power🎧 Nov 18, 2020

Show notes

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.

- 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 is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

#86 Production-Linked Subsidies & Decoding Charisma Nov 16, 2020

Show notes

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 KotasthaneProduction-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 CharismaInsights on burning policy issues in India— RSJThe 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 VishwaasThere 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 HourFirst, 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 StructureThe 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 CharismaThe 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. HomeWorkReading 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 is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

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#85 Legitimacy Of Unelected Powers🎧 Nov 11, 2020

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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.

- 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 Indiaby Shubho Roy, Ajay Shah (NIPFP), B.N. Srikrishna (Retd. Judge, Supreme Court of India, Somasekhar Sundaresan (Independent legal counsel)

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

#84 Factions Are Natural Nov 08, 2020

Show notes

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 KotasthaneIn 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 SmallA 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: SmallAnother 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 SmallNothing 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 BigThis 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 DemocracyInsights on burning policy issues in India— RSJThere’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 FactionsWhat’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 GoodSo, 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 FactionsAristotle 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 PipelineTools for thinking public policy— Pranay KotasthaneThis 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…

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#82 What Does it Mean to be Free? Nov 01, 2020

Show notes

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 KotasthaneOn 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 WellThe 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 AssetsThe 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-StrategicIn 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— RSJWe 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 ArgumentsThe 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 CapabilityAs 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 EntitlementThis 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 BangladeshInteresting facts and stats relevant to public policyThe 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 BankHomeWorkReading 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 is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

Full show notes at the publisher

#81 Aap Party Hain, Ya Broker?🎧 Oct 28, 2020

Show notes

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.

- 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 is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com

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