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    Anticipating the Unintended

    Frameworks, mental models, and fresh perspectives on Indian public policy and politics. This feed is an audio narration by Ad Auris based on the ‘Anticipating the Unintended’ newsletter, a free weekly publication with 8000+ subscribers.

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    Copyright: © Pranay Kotasthane & RSJ

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    Latest Episodes:
    #196 Roving Bandits Jan 15, 2023
    Show notes

    Predictions: 2023—RSJAs promised last week, let’s get going with some predictions for 2023. Pranay likes to keep them very specific (for a good reason), while I get away with broad bets.Global EconomyThe problem with predicting anything on how things will unfold globally is the random big event that upends all forecasts. This has happened in the last three years. The impact of the pandemic waves and the Ukraine war is yet to play out fully. By themselves, it makes for difficult terrain for forecasts. I’m hoping we don’t have another such event during the year. #1 The trend of securing your supply chain for critical products will get stronger.Look, it is difficult to disentangle from the globally integrated supply chains that have been a feature of the economic model since the end of the Cold War. But it is clear to most large economies that on issues that concern national security, it will be foolhardy to not plan for worst-case scenarios any longer. And national security could mean anything, really, but I can see on energy and key technology, nations will opt for more secure supply chains with watertight bilateral partnerships than be at the mercy of distributed, multilateral chains. I won’t go as far as calling it ‘de-globalisation’ yet, but this ‘gated globalisation’ is a trend that’s here to stay. What this will mean in concrete terms is there will be a gathering of pace on bilateral treaties among larger economies on these issues that reduces dependence on China or Russia. For India, there are a couple of issues here. How to continue to balance the purchase of oil from Russia for its energy security without inviting sanctions from the west? It has managed this well in the last year. The other issue is to find alternatives to Russian hardware for its defence machinery without rubbing it the wrong way. We have batted for free trades on these pages for a long time. So, it is concerning to see this retreat, but history has shown over time, geopolitics trumps geoeconomics. #2 The fears of elevated inflation and a recession in the US in 2023 are overblown. The recession is due, but it will come a bit laterI have made the point here earlier too. The Fed has gone overboard on inflation targeting with more rate cuts than necessary and not waiting for their impact to come through. The moderation of inflation in the past few months (though at 3.6 per cent, it is still higher than the target) suggests that the Fed has been partly successful and it should continue to remain hawkish. I am not so sure. It takes time for rate hikes to start impacting demand, and my suspicion is that the current moderation in inflation was due in any case. The impact on rate hikes on subduing demand and growth is yet to play out. My view is that as supply chain issues ease up with China opening up, energy demand going up and the US continuing to be at almost full employment, we might have a 2023 where for the most part, the US inflation will be higher than target, Fed will continue to remain hawkish, and the growth will hold up. This will mean the real risk of recession will be more toward the end of the year than now. #3 Big Tech will continue to be under the cosh Three problems look to exacerbate in the tech space in 2023. First, the valuation of ad-driven economic models and the insane optimism about the distributed ledger, crypto, DAO or independent sovereigns (yeah, remember that) will abate. A lot of value has been destroyed in the last year (esp in public markets), and I still think there’s more to go in the private market valuations. This correction will weigh on markets, fund raises and investments into startups. Second, global markets will shrink for Big Tech as more countries will place restrictions on how deep they will allow them to own commerce or payment infrastructure. I half expect India to gradually move all payment and eCommerce arms of Big Tech into a structure that’s domestically controlled and owned in 2023. Third, FTC, with Hina Khan at the helm, will accelerate antitrust and competition law changes to reduce the dominance of Big Tech. Some of these measures will be significant overreach in my opinion, but I see more executive orders in this space. Conversely, I see significant hype building up on AI platforms during the year. Like every hype cycle we will have people going overboard on AI, but I think this is one trend where in the classic sense, we might be overestimating the impact in the near term and underestimating it in the long term. AI will eventually get us a driverless car, but it will get to the mediocre creator economy faster. The jobs under immediate threat aren’t that of cab drivers and factory workers. The average copywriter, reporter and illustrator are in greater peril. It will be interesting to see how these groups who have a greater share of voice in the media will tackle the threat of AI in 2023. Indian Economy#1 Greater optimismI am a bit more optimistic about the broader numbers than most, and I will explain why. I think GDP growth will come in around 6.5 per cent for FY24, and inflation will be around 5 per cent. We might see a couple of rate hikes in the next few months, taking the repo rate to 6.75 per cent, but that will be it. I see even a small possibility of a rate hike cut in the later part of the year to spur growth with an eye on Lok Sabha elections in May ‘24. We have corporate balance sheets that are strong, banks across the board are well provided for, and inflation hasn’t gone out of control. I see domestic consumption to remain strong and exports, in the light of the shift away from China, to be good for manufacturers, and how much ever I might struggle to get behind the PLI scheme, it will yield some short-term benefits. IT exports might be a dampener, but on balance, I see more upside to these predictions. Of course, the risks are another global one-off event, oil prices going up and restrictions on accessing Russian oil and a bad monsoon. But those aside, I foresee India standing out as an outperformer thanks in no part to many cards falling into place for it often without its own efforts. But then why look the gift horse in the mouth?#2 Digitalisation: Wave 2 There will be a significant push on digitalisation in lending and eCommerce. The UPI infrastructure has revolutionised payments and, along with GST, has accelerated the formalisation of the economy. The benefits of these have so far been more skewed towards the government in terms of tax collections. I think we will see a focused push for the next round of benefits with platforms like OCEN (lending) and ONDC (eCommerce). The data that’s available because of the digital rails, the account aggregator framework that’s live now with banks and the groundwork done in getting small suppliers onboard on ONDC - these prerequisites are now available for the next order benefits of digitalisation for customers. Also, as I mentioned in an earlier point, doing this will also mean shifting the balance of power from Big Tech-owned entities to an open platform or domestically controlled entities. I sense a strong push in this direction in 2023.#3 The expected capex cycle push from the government will not come. There are a couple of reasons for it. First, this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency. The other reason for a muted capex spend is the likely belief that the private sector credit capex cycle seems to be picking up. These are early days for it, but the data for the past two quarters shows an uptick in corporate credit pickup and an increase in interest costs in the balance sheet. The benefits of the corporate tax cut in 2019 are now seen in strong corporate profits in FY23 for most sectors. That, plus the belief that the rate cycle has almost peaked, could mean the private capex cycle could strengthen during the year. I expect the MSME sector to gain from strength to strength on the back of China+1, PLI-like schemes and easier access to credit because banks are in better shape. MSME is the story of the next decade.India Political and Social#1 More of the sameThe expected consolidation of opposition forces to counter the BJP isn’t going to happen early enough for it to mount a credible challenge in 2024. There are eight state elections in 2023, and I suspect BJP will see reverses or very close fights in a couple of them where it is the incumbent (MP and Karnataka). But LS elections aren’t any longer an agglomeration of many smaller elections like they used to be pre-2014. So, I don’t see an upheaval in national politics in 2023 that will make a meaningful dent in 2024. This is a pity because we have reached a stage of single-party dominance of polity and media, which isn’t healthy for democracy in the medium term. But it is hard to see opposition consolidation or a credible case that they can make to counter the electoral juggernaut of the BJP at this time. Congress, the other national party, isn’t capable of moving the masses either with its agenda or its leadership. The vacuum in national politics looks set to stay.#2 More Exit, Less VoiceI have made the point in the past about social fault lines tripping us up while we magically have a growth window that’s opened up for us again. This holds true. The space for opposition or dissent has shrunk; more importantly, even the fight for protecting or broadening that space has gone out. As Hirshman (in Exit, Voice and Loyalty) asked in the context of the relationship between the state and its citizens: the citizen has the choice to either voice their disapproval when dissatisfied or exit from the state. The state would be dependent on citizens if they value their loyalty and would then pursue a policy that listens to their voice. However, if the state doesn’t value it and the citizens know their voice won’t matter, the only option is to exit. For certain sections of our citizenry, we are possibly at this stage of engagement with the state. This scenario might not hurt the majority today, but we would do well to remember it has never been a good idea for the state to not value the loyalty of its citizenry in the long run. An Excerpt from Missing in Action: Why Should You Care About Public Policy— A chapter from our upcoming book that releases on 23rd JanuaryChapter 11: When the State Owns What’s YoursA typical scene in those old Bollywood films with a rural setting was that of the zamindar standing with his ‘not-so- smart’ (naalayak) offspring on the terrace of their haveli and telling him:Yahan se jahaan tak tumhari nazar jaati hai, woh saari zameen hamari hai![All the land that you can see from here belongs to us.]In reality, the only zamindar who can make such a claim in modern India is the Indian State.A fundamental concept underlying economic reasoning and public policy is the property rights system. To an Indian, the phrase ‘right to property’ conjures up the image of a rapacious zamindar exploiting peasants. This narrative has fostered a zero-sum perception—owning property is assumed to have occurred in the context of the violation of someone else’s human rights. This perception has, in turn, meant that the enforcement of property rights has always been weak in India. Once a fundamental right, the right to property under the Indian Constitution was deprecated to a constitutional right by the 44th amendment. Now the State can go about violating an individual’s right over their property, as long as it can couch this takeover is being done under vaguely defined ‘public interest’.Why Is a Functional Property Rights System Necessary?A property right is an exclusive authority to determine how a resource is used. This applies not just to land but to any physical or intellectual property such as your phone, your water bottle, or your innovation. Such a right can be held by a person, a group of persons, or the State.When this exclusive authority over someone’s resources is protected—by the State or society—the owners can be confident of deploying and improving the quality of their owned resource instead of spending their energy in feverishly protecting the resource from being stolen by another entity. Moreover, giving an exclusive authority to someone to enjoy the use of a resource changes the nature of competition itself, bringing it into the realm of social acceptability. For example, without property rights, entities might compete over a common resource by resorting to means such as intimidation, denial, and distancing. But once it is demonstrated that the authority over a resource will be protected, competition shifts to owners improving their offering to win more buyers. Finally, a strong property rights system also enables the exchange and sharing of resources, as resource owners can be confident that their ultimate ownership is secure.Now this sounds quite theoretical and straight out of an economic reasoning textbook, which this book is not. So, to understand how pivotal the concept of a well-functioning property rights system is, we turn to an Indian story of violation of these rights. By understanding what happens when property rights are denied, we might better appreciate their importance.Daastaan-e-SandalwoodThe story of sandalwood production in India is as intriguing as it is frustrating. The wood is used for its timber. The oil extracted from its roots is used in perfumes, incense, soaps, and medicines. In India, sandalwood has a special religious significance as well.As hopeful consumers, many of you would have heard about the astronomical costs of this wood. Many of you would have also heard about brigands such as Veerappan who gained Robinhood status by smuggling sandalwood. Some of you might have been duped into buying ordinary scented wood being passed off as sandalwood. But few of us realize that the strand that connects these stories is misguided State action.Generally, the price of a commodity is indicative of its natural scarcity, but that’s not the case here. Nearly 90 per cent of the world’s sandalwood resources are available in the three Indian states of Karnataka, Tamil Nadu, and Kerala. And yet, the production of sandalwood in India has declined sharply. In 1965–70, annual production stood at 4000 tonnes. By 1999–2000, it had decreased by half. And by 2019, it had become just 200 tonnes. Other countries supplied a total of 400 tonnes in the same year, while the total global demand is estimated to be nearly 6000 tonnes a year. This massive demand–supply gap has made sandalwood so costly that it is often referred to as ‘red gold’.The drastic fall in sandalwood supply from India can be explained by a long history of denial of property rights. In fact, State interference in growing, producing, and selling sandalwood has a history of nearly 230 years in India. Here’s how the story goes.Sandalwood was in huge demand even during colonial times, especially in China. The East India Company— never one to miss a trading opportunity—aimed to exploit the resources in southern India and export them to China. The problem was that much of the sandalwood-growing area fell under the kingdom of Mysore, led by Tipu Sultan. Recognizing the commercial value of this resource, Tipu Sultan forbade his subjects from trading in the wood with the Britishers in 1786. To take this idea further, he decreed sandal as a ‘royal tree’, monopolizing sandalwood trade in 1792. Thus began, out of good intentions, the story of sandalwood’s decline.Eventually, this sandalwood trade blockade became one of the primary causes of the Anglo-Mysore Wars. Onc…

    Full show notes at the publisher

    #195 Missing In Action Is Here Jan 08, 2023
    Show notes

    Wishing You a Great 2023Others might begin the new year with resolutions, but we prefer excuses. Last year, we wrote only 42 editions. There was much to do in the remaining ten weeks. There was the Football World Cup, a few time-offs, a couple of vacations, and of course, a lapdog ate our laptops. If these honourable reasons weren’t enough, we add another: we wrote a book!Our bookMissing in Action: Why You Should Care About Public Policywill be published on 23 January 2023. Like this newsletter, it is a 'pop' public policy book in which we explain concepts through stories rooted in the Indian context. We couldn’t have asked for a more helpful and encouraging team than our friends at Penguin India, who got us over the line and in time for a Republic Day release. The book is ready for pre-order now. You will have to excuse us for a bit of promotion that we will do over the next month or so on these pages. So what’s the book about? At the heart of the book is our belief in the core objective of public policy. It should increase the welfare of the citizens. Like the verse from Bhagavad Gita goes:अनन्याश्चिन्तयन्तो मां ये जनाः पर्युपासते।तेषां नित्याभियुक्तानां योगक्षेमं वहाम्यहम्।।9.22।।That word - Yogakshema - to preserve the prosperity and welfare of citizens is what public policy should be about. We write this newsletter with the hope that it will, in its small way, move the needle on discourse. The book is a logical extension of this hope. Hope, as Andy Dufresne taught us, ‘is a good thing; maybe the best of things’. We are hopeful about the future of India, but not in a misguided nationalistic way. We believe we can make an impact, however small, on the demand side of the policy equation. That making people aware of policy choices and helping them anticipate the unintended will lead to a change in the supply side of politics. There are two preconditions for this to happen, which we assume hold true. One, people have time and mental space available for discussions that matter to their lives. Two, a belief we can arrive at what’s good for us through those debates and discussions.In the book, we have taken the citizens as the point of reference and elaborated on their interactions with the state, the market and the society. Think of the book as a primer to understanding the fundamentals that underpin these interactions. We cover why we need a state or the markets, what is the role of society and how the three interplay among them. We go back to the foundational texts on political philosophy and economy in the book to explain the core concepts of public policy but in what we hope is an accessible fashion. We have tried to avoid jargon and approached all topics using first principles. Like the 16th century Bhakti poet, Nabha Dasa, who compiled the life of every saint from time immemorial in Bhaktamala, wrote:"Jaat na puchhie saadhu ki, poochh leejie gyan, mol karo kirpan ka, padi rahne do mian" ("Do not ask for the antecedents of a learned saint. Only seek their wisdom. The true worth is what’s within us and not what you see from outside.")We have been ecumenical in our approach in this book.The other thing you might find interesting in the book is our focus on finding examples in the Indian context to illuminate a point or to make a case for our arguments. This will contextualise a lot of the discussions in the book to our immediate environment, and we hope it will make our reasoning clearer to our readers. Further, we have tried to keep ourselves free of dogma in the book. We have strong faith in markets, but we understand their limitations and the critical role of the state and society. We have been open to knowledge from all sources and have challenged our premises and priors before stating our point of view. Lastly, the tone of the book is conversational, and it is filled with some of our usual groan-inducing Bollywood references. Special thanks to all of you for reading us and engaging with us. Without your encouragement, we wouldn’t have attempted a book. And now that we have said such good things go buy the book! Truth be told, we are a tad nervous about how the book will be received. We hope you will enjoy reading it and recommending it to others. Show it some love, friends and order it now. ThanksPranay & RSJIndia Policy Watch: How Did I Do On My Predictions For 2022?— RSJ Each year I start with a prediction post. But before I get down to my predictions for 2023 (which I will in the next edition), there’s the unfinished business of how I fared on the predictions that I made in 2022. So, here’s a look back at the year through the lens of my predictions at the start of the year.Economy - Prediction #1 This is what I wrote:“we will be in the 5-5.5 per cent growth range (if you take the base of FY 21). Inflation (CPI) will be around 5 per cent with an occasional jump to 6 per cent during the year despite threatening to go out of control. Maybe three interest rate hikes (a total of 75 bps) during the year will keep a lid on it. Public markets will moderate a bit (around 10 percent upside).... China won’t attract it (foreign capital) as it will continue to go down the path of self-reliance and its notion of an equal society.”Result: No one could see the Ukraine war coming back when I made the predictions. Notwithstanding that, I think I got the growth and the inflation prediction in the ballpark. The war threw the interest hike prediction off totally. Instead of a 75 bps hike over the year, we got a 225 bps increase. I think, on balance, the Indian economy did quite well in 2022, given the headwinds. Domestic consumption was strong; we weathered the peaking of oil and commodity rates quite well, the twin balance sheet problem is now behind us, and by the end of the year, we saw private Capex growing. Not a bad state of affairs. I would have taken this happily at the start of the year. Overall, I’d give a 6/10 on this prediction.Economy - Prediction #2“There won’t be much to write about reforms. Some attempts at piecemeal MSP reforms will be attempted to make up for the repealed farm laws. The National Monetisation Pipeline will get going but the progress will be modest. A couple of more disinvestment proposals of PSUs (including banks) will be taken up. But this will be for raising revenues rather than a planned strategy to make PSUs market competitive. The LIC IPO will just go over the line and that will be the big event to showcase reforms.”Result: Got that pretty much spot on. Maybe an 8/10.Politics - Prediction #1 & 2Here’s what I wrote:“BJP election machine will continue its winning run barring the odd defeats in Punjab and Goa. The big prize, UP, will be fought hard but BJP will win a safe majority. The bahujan vote of the depleted BSP will shift to it more than to SP and that will make all the difference.”“There will be a split in the Congress. The party in its current form is untenable and beyond a point, there will be nothing to lose for those who split it. The key question is who will lead it - those who have a political base and think Congress leadership is a liability that cannot be carried along any further, or those without a political base but with strong ideological opposition to the BJP. My guess is it will be the latter. In any case, it won’t make much of a difference.”Result: Punjab went the way I had guessed. Goa was close. Congress didn’t split but it lost senior leaders like Capt. Amarinder Singh and Ghulam Nabi Azad among others. And despite the Bharat Jodo Yatra, which has only been in the news because people cannot believe Rahul Gandhi has sustained it for so long, I don’t think Congress improved its election prospects dramatically this year.Society - Prediction #1“Expect love jihad and anti-conversion laws in various states, some kind of population control bill, a revival of CAA and a push for a uniform civil code during the year. There’s that early 20th century Europe playbook of stoking demographic anxiety that plays on a threat to the survival of a civilisation or a way of living. The pitch will be queered on this. Indian society is a fertile ground for it. This land can be shown to its people as a palimpsest. But it can, perhaps more easily, be shown as a glorious, ancient civilisation that’s been asphyxiated for centuries by ‘outsiders’. A true revival of it requires setting the past records straight and the right demographic arithmetic.”Result: Well, there was the usual noise around a lot of these issues but, thankfully, we had a somewhat muted year on legislating these. This didn’t mean that the media mouthpieces and influential voices within and outside the government went slow on stirring the pot on these topics. We have reached a point where turning back on these issues will be difficult. It remains the one faultline that can derail our economic prospects that look surprisingly good at this moment. I will give myself a 7/10 as much as I want to score a zero here. Society - Prediction #2“Politics is driven by the idea of having an enemy; the other. For much of the last decade, this was the left-liberal cabal (Lutyens, Khan market, NYT, Soros, Amnesty etc). Even when much of news and propaganda came to be dominated by the right-wing, there was a strawman of this all-powerful cabal of anti-nationals that was kept alive because the notion of an enemy is critical. But once you have decimated it, what do you do? You look for the enemy within.”Result: I will be the first to admit that I am still amazed at how this prediction isn’t yet true. There are still imaginary left cabals to be fought against. It is a measure of both the enterprise of the propaganda machinery and the gullibility of ordinary voters that we are still drinking up all the kool-aid that we are being served on how anti-India interests are still the ‘establishment’ in India and globally. There's still a long way to go before finding the enemy within your camp to fight. I will give a 5/10 on this. Miscellaneous - Prediction #1“There will be serious big tech regulations that will come into play in America. Others will follow suit. India will have a version of this along with dollops of atmanirbharta. This will mean some tough days for big consumer tech giants in India.”Result: Some big tech regulations have come into play in the US, and the collapse of FTX will lead to further clamping down. India came down heavily on Chinese apps and made life difficult for consumer-facing tech giants like Amazon, Meta and Alphabet. I expect this to continue. I guess a 7/10 on here will be about right. Miscellaneous - Prediction #2“China will struggle for growth. Demographics, debt and delusion have come together in China in a way that will make it difficult for it to sustain growth. China-Russia relationship will get stronger with their support for each other and for other authoritarian regimes around the world.”Result: Even without the Ukraine war, I thought this was how it was going to play out. It only became stronger with the war. I think I got a 9/10 there. Miscellaneous - Prediction #3“Meta, Crypto, Decentralisation, NFT (and everything else pumped up by the Valley tech bros) will see their hype abate (about 25-30 percent drop in asset value). When John Terry starts buying Bored Ape NFTs, you know the whole thing has jumped the shark. About time too.”Result: I should have followed my gut more and doubled down on this last year. I could sense a big correction, and a large-ish collapse was in the offing in this space. But I stopped short of calling a mini meltdown in this space. But that’s how it turned out by the end of the year. An 8/10 here.So, there we are with how I fared on last year’s predictions. I will come back next week with a few specific and somewhat contrarian predictions for 2023. Not(PolicyWTF): Making Education ProfitableThis section looks at surprisingly sane policies- Pranay KotasthaneThe University Grants Commission (UGC) released draft regulations earlier this week, permitting foreign universities to set up Indian campuses. While the draft needs some much-needed improvements, this reform is in the right direction. For the moment, keep the programmatic part of the policy aside. It’s the politics of this move that caught my attention.Ritika Chopra in the Indian Express reminds us that the first such attempt was made in 1995. Another one in 2005-06 never made it past the cabinet. Then in 2010, the UPA government brought in another bill. The Foreign Educational Institutions (Regulation of Entry and Operations) Bill, 2010 was introduced in the Lok Sabha, a Standing Committee gave some suggestions, the government sat on it for three years, and it was tabled again in 2013. By 2014, the UPA was voted out, and the bill lapsed.It’s interesting to observe how the Overton Window has changed on this issue. The 2010 bill was far less radical than the draft UGC regulations being proposed now. That bill disallowed foreign universities from repatriating any money abroad, it mandated that interested entities have a corpus fund of at least Rs 50 crores, and it allowed only entities that had operated for at least 20 years. Despite these unreasonable restrictions, the Left and the BJP still found the bill too permissive and buried it. The Left had a far greater influence on the matter as it was a part of the ruling coalition. I went back to check the best form of arguments put forward by the Left. True to form, they argued that this bill would encourage “commercialisation” of education. The CPM said it would open the ‘floodgates for weakening and dismantling the public education system in higher education. And India could be atmanirbhar in developing a higher education system; we need no help from anyone. Shouldn’t we reflect on how much this ideological opposition cost us? What was the number of people who went ahead to get quality education in other countries, including in risky countries like Ukraine and Kazakhstan? Blocking foreign educational institutes for equity reasons is akin to banning people from eating Sushi just because India still has a large poor population. Forget the fact that a former General Secretary of the CPM is himself an alumnus of a British university. The BJP’s objection predictably was that the courses offered could ‘adversely affect the sovereignty and integrity of India’. That insecurity hasn’t subsided, and the new draft regulations have an explicit clause forbidding such courses. We can interpret the new draft regulations as an example of the Overton Window stretching on this issue. On some counts, it has extended the boundaries of freedom by allowing people to have more options within India while allowing foreign universities to repatriate money back home. It’s a hesitant acknowledgement that profit-making in education is not bad. On the other hand, the Window has also stretched toward “lesser freedom” with clauses banning certain types of courses, effectively implying that non-controversial “technology” universities might receive preference over liberal arts universities. Real-life policymaking is often a search for the second-best option. So I’ll take the door left ajar, rather than it remaining closed altogether.HomeWorkReading and listening recommendations on public policy matters* [Podcast] Some predictions for 2023 by the Puliyabaazi team* [Book] Optimally Irrational: Good Reasons Why We Behave The Way We Do is promising.* [Article] Many editions ago, we wrote about the EU ban on chargers, warning that it could come to India as well. That ban is here though, and we again reiterate why it is counterproductive. 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

    #194 The e₹ is in Town Dec 11, 2022
    Show notes

    Programming Note: A lighter edition this weekend because lifehappened of late-night football, missed flights, and several other things. Also, we will be away for a short year-end break. Normal service will resume on Jan 8, 2023. Happy holiday season, everyone! India Policy Watch: Digital Rupee (e₹-R) Is In TownInsights on current policy issues in India — RSJThe RBI launched the first pilot for the retail digital Rupee this week. It is now among the select list of central banks that’s got a CBDC pilot going. The RBI press release covers the plan for the pilot:* The pilot would cover select locations in closed user group (CUG) comprising participating customers and merchants. The e₹-R would be in the form of a digital token that represents legal tender. It would be issued in the same denominations that paper currency and coins are currently issued. It would be distributed through intermediaries, i.e., banks. Users will be able to transact with e₹-R through a digital wallet offered by the participating banks and stored on mobile phones / devices. Transactions can be both Person to Person (P2P) and Person to Merchant (P2M). Payments to merchants can be made using QR codes displayed at merchant locations. The e₹-R would offer features of physical cash like trust, safety and settlement finality. As in the case of cash, it will not earn any interest and can be converted to other forms of money, like deposits with banks.* The pilot will test the robustness of the entire process of digital rupee creation, distribution and retail usage in real time. Different features and applications of the e₹-R token and architecture will be tested in future pilots, based on the learnings from this pilot.The obvious question that comes up is how’s a digital currency different from a transaction on UPI. The RBI Governor got into the explanation mode on this at the press meet.Separately, in an earlier concept note, the RBI had outlined the two different types of CBDC it would pilot as part of this process:Based on the usage and the functions performed by the CBDC and considering the different levels of accessibility, CBDC can be demarcated into two broad types viz. general purpose (retail) (CBDC-R) and wholesale (CBDC-W).CBDC-R is potentially available for use by all private sector, non-financial consumers and businesses. In contrast, wholesale CBDCs are designed for restricted access by financial institutions. CBDC-W could be used for improving the efficiency of interbank payments or securities settlement, as seen in Project Jasper (Canada) and Ubin (Singapore). Central banks interested in addressing financial inclusion are expected to consider issuing CBDC-R.Further, CBDC–W has the potential to transform the settlement systems for financial transactions undertaken by banks in the G-Sec Segment, Inter-bank market and capital market more efficient and secure in terms of operational costs, use of collateral and liquiditymanagement. Further, this would also provide coincident benefits such as avoidance of settlement guarantee infrastructure or the need for collateral to mitigate settlement risk.About 18 months back, in edition #122, I wrote a fairly detailed piece about CBDC in the context of China running a pilot for digital Yuan. It will be useful to bring that piece up to contextualise the RBI CBDC pilot.What’s Money?As we have written in an earlier post, money performs three roles for us: it is a store of value, it is a medium of exchange, and it is a unit of measure. Through it, we save for the future, pay for goods and services and measure the value of very different things using a common unit. These roles mean anything that aspires to be a currency (the usable form of money) should have a relatively stable value over time and should be widely acknowledged as a store of value and unit of account among people. If it does so, the network effect takes over after a while, and it becomes a widely used currency.Throughout history, a key feature of a sovereign state was its control over the supply and circulation of money that’s used within its boundaries. The royal mints, after all, have been around for more than two thousand years. As modern nation-states emerged through the 19th and 20th centuries and as global trade increased, central banks emerged to manage the monetary system and provide financial stability.There are three forms of money in any modern economy:* Banknotes: These are physical paper currency notes issued by the central bank that we all use in our everyday lives. This is a direct promise by the central bank to pay the note holder a specified sum of money. This promise is printed on all currency notes.* Bank Deposits: Ordinary people and businesses don’t hoard banknotes to conduct their business. They deposit their money in commercial banks. These deposits are stored in electronic form by these banks. The banks offer two services to their customers. They convert these deposits to central bank money in the form of banknotes when you demand it at an ATM and they offer to transfer your money to someone else through a payment system that exists between banks. Unlike banknotes, your deposits aren’t risk-free. They aren’t backed by any sovereign guarantee. A bank will be able to convert your money into banknotes only if it is solvent and can honour its commitments. We have seen instances of a bank failing to do so in India (Yes Bank, PMC etc.).* Central Bank Reserves (“reserves”): Commercial banks have their own accounts with the central bank where they deposit their funds. These deposits are used by banks to pay each other to settle transactions between them. The reserves are the other form of central bank money apart from banknotes. These are risk-free and therefore used for settlements among commercial banks.Where does CBDC then fit in?Simply put, a CBDC is a digital form of a banknote issued by the central bank. Now you might think we already use a lot of digital money these days. Yes, there’s money we move electronically or digitally between banks, wallets or while using credit/debit cards in today’s world. But that’s only the digital transfer of money within the financial system. There’s no real money moving. The underlying asset is still the central bank money in the form of reserves that’s available in the accounts that commercial banks have with the central bank. This is what gets settled between the commercial banks after the transaction.This is an important distinction. We don’t move central bank money electronically. But CBDC would actually allow ordinary citizens to directly deal with central bank money. It will be an alternative to banknotes. And it will be digital.CBDC: The Time Is NowSo, why are central banks interested in CBDC now?There are multiple reasons.One, cryptocurrency that’s backed by some kind of a stable asset (also called ‘stablecoin’) can be a real threat as an alternative to a sovereign currency. Stablecoins are private money instruments that can be used for transactions like payments with greater efficiency and with better functionality. For instance, the current payment and settlement system for credit cards in most parts of the world has the merchant getting money in their bank accounts 2-3 days after the transaction is done at their shops. A digital currency can do it instantly. For a central bank, there could be no greater threat to its ability to manage the monetary system than a private currency that’s in circulation outside its control.Two, in most countries, there’s an overwhelming dependency on the electronic payment systems for all kinds of transactions. As more business shifts online and electronic payment becomes the default option, this is a serious vulnerability that’s open to hackers and the enemy states to exploit. A CBDC offers an alternative system that’s outside the payment and settlement network among commercial banks. It will improve the resilience of the payment system.Three, central banks need to offer a currency solution for the digital economy that matches any form of digital currency that could be offered by private players. Despite the digitisation of finance and the prevalence of digital wallets in the world today, there’s still significant ‘friction’ in financial transactions all around us. You pay your electricity bill electronically by receiving the bill, then opening an app and paying for it. Not directly from your electric meter in a programmed manner. That’s just an example of friction. There are many other innovations waiting to be unleashed with a digital currency. Central banks need to provide a platform for such innovations within an ecosystem that they control. CBDC offers that option.Lastly, digital money will reduce transmission loss both ways. Taxes can be deducted ‘at source’ because there will be traceability of all transactions done using CBDC. It will also allow central banks and the governments to bypass the commercial banks and deliver central bank money in a targeted fashion to citizens and households without any friction. The transmission of interest rates to citizens for which central banks depend on commercial banks could now be done directly.While these are the benefits of a digital currency, there are other macroeconomic consequences including the loss of relevance of bank deposits that we have with our banks. Some of these may seem speculative at the moment but these are factors to consider as things move forward. A CBDC that offers interest will mean we could have a direct deposit account with the central bank. This will also mean a move away from deposits in banks to CBDC with the central bank. Also, the nature of a bank ‘run’ will change. Today a bank ‘run’ means a rapid withdrawal of banknotes from a bank by its depositors who are unsure of the solvency of the bank. This takes time and is limited by the amount of money available in ATMs. In a CBDC world, the ‘runs’ will be really quick and only constrained by the amount of CBDC issued by the central banks. Depositors will replace their deposits with CBDC pronto.This secular move away from deposits could increase the cost of funds of commercial banks. They will have to depend on other sources of funds than the low-cost deposits that customers deposit every month in the form of salaries to them. A reduction in deposits will reduce the availability of credit in the system. This will have a repercussion on the wider economy. It will also mean greater demand for reserves from the central bank by the commercial banks to provide credit to their customers. Central banks will increase their reserves and their balance sheets will become bigger. These are among many potential scenarios that could unfold. These are early days and it will be interesting to track the iterations of the pilots that the RBI will do as it appreciates the use cases, the design features and the policy issues involved. This is an interesting space to watch. India’s track record on building national digital infrastructure in payments is second to none. It might be the one place where the promise of CBDC could turn into reality. A Framework a Week: China’s PredicamentTools for thinking public policy— Pranay KotasthaneA couple of weeks back, I had linked out to a CSEP paper by Amb. Shivshankar Menon. Titled Internal Drivers of China’s External Behaviour, he explains the domestic imperatives that are likely to modify China’s external behaviour. In that paper, one #lightbulb framework explains the novelty of the situation that China finds itself in. Here’s the text from the paper:Today, China faces an unprecedented situation at home and abroad and is therefore reacting in new ways. China is more powerful than ever before but is also more dependent on the world. This is an unprecedented combination, not known in Chinese history—not in the Han when she had to ‘buy’ off the Xiongnu by marrying Han princesses off to steppe leaders; nor in the Song when she was one and sometimes the weakest power in a world of equals; nor in the high Qing when she was powerful but independent of the external world, as the Qian Long emperor reminded George III in writing. [Internal Drivers of China’s External Behaviour, CSEP Working Paper, Shivshankar Menon ].We can interpret this insight visually in this 2x2 framework.The implication is that China finds itself in an unfamiliar position today and as a result, will act externally in new ways altogether. The high power-high dependence combination helps explain China’s belligerence in the Himalayas and the South China Sea. It also explains the drive towards self-reliance in technology domains. The high-dependence on adversaries acts as a motivation, and high domestic power gives China the confidence (over-confidence?) to do it all domestically. Observe China’s response to the US export controls on its semiconductor industry. I expected a definitive retaliation after the 20th Party Congress had reaffirmed Xi’s control. But that hasn’t happened. It only makes sense if China’s political establishment is confident of overcoming the dependence in due course while taking advantage of it to bolster present capabilities.Advertisement: Takshashila is now accepting applications for the next cohort of GCPP. Apply now. If you like reading this newsletter, you will find the course enriching.PolicyWTF: Emigration EmbargoesThis section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?— Pranay KotasthaneRina Agarwala has an excellent article in The Monkey Cage, highlighting the restrictions preventing the less-educated, poor Indians from emigrating easily. “Under India’s 1983 Emigration Act, poor emigrants have to hire a government-certified recruiter, fill out piles of government paperwork, pay huge fines and hope for government approval. Unlike Ramdas Sunak’s experience in the 1830s, they usually emigrate without family members on temporary visas, working under difficult conditions for little pay under the control of their foreign employer.Although these emigrants send home the largest share of India’s massive remittances — an estimated $100 billion in 2022, and which have saved India through multiple financial crises and cover 40 percent of the basic needs for millions of poor households — they receive little acknowledgment or support from the Indian government.Educated emigrants, by contrast, are free to leave India as they please. Since the 1980s, the Indian government has offered them awards and special financing options for savings accounts, investments and bonds within India. The government has also encouraged their temporary return to India with business partnerships and high-level positions within the Indian government. Receiving countries are also more likely to welcome educated Indians than poor immigrants. [Is the new U.K. prime minister a paragon of immigrant success?, Rina Agarwala, Washington Post]It is indeed quite disturbing how the emigration policy came to be this way. There are good intentions behind it, of course. The government’s rationale is that these entry barriers are meant to check human trafficking. That’s why the restrictions on less-educated women are even more stringent than those for men. Check this out:The Emigration Act (1983) states that persons of working age who have not completed schooling up to the tenth standard are issued an ECR (Emigration Clearance Required) passport. The remaining population is eligible for an ECNR (Emigration Clearance Not Required) passport. When men having ECR passports plan to emigrate for work, they need to obtain an “Emigration Clearance” from the office of the Protector of Emigrants (PoE) before travelling to certain countries (currently, 18 in total). What’s even more egregious is that a woman of age less than thirty with an ECR passport is completely banned from getting emigration clearance for all kind of employment in any ECR country.But the anticipated unintended result is that it blocks o…

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    #193 No Country For Young Men? Dec 04, 2022
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    India Policy Watch #1: Winning The Long GameInsights on current policy issues in India — RSJMany moons ago I sat down for lunch with someone who is often referred to in the media as a ‘doyen of the industry’. Among other things, I asked him the single most important advice he would give to anyone who is at the start of their career. I didn’t have any burning desire to succeed in the corporate rat race. So, I wasn’t looking for a life-changing insight. I asked it because custom demanded you ask such questions of doyens like him over a meal. Also, even back then I was aware that I should fill my pitaara with such stories because sometime in future I could use them to make myself appear interesting. Anyway, he squinted at me and with something that appeared close to conviction told me, “always defer gratification”. I nodded and pronged a moody forkful of Aglio e Olio. Instant gratification.Over the years I have come to appreciate that piece of advice. Running a successful business over the long term is all about how well you trade off short-term gains with doing what’s right for long-term sustainability. The odds are stacked against you because most of your shareholders, the analysts and the media are measuring you on quarterly performance. You can put out a convincing long-term story that will deliver a big, deferred outcome but how can anyone be sure you’re headed that way? Any short-term wobble can have people question you. It is tough to live a life of deferred gratification. I haven’t followed it to any meaningful extent in my life. Nor do I think even the doyen has done so since that meeting. But having understood how difficult deferring gratification could be, I appreciate how important it is for long-term success in any field of human endeavour. And, of course, that includes public policy in case you are wondering why am I channelling my inner Deepak Chopra and inflicting random truisms on you. OPS versus NPSThis problem of grasping short-term gains while jeopardising the long-term has been running on my mind for the past few months as I see the spectre of the Old Pension Scheme (OPS) returning as a key election promise in the manifestos of Congress and AAP in state elections. There are two issues that I have been thinking about. First, what drives a political party to make a bonfire of the future for a questionable short-term electoral gain? And I’m picking on the OPS issue and these two parties only to illustrate this point. Every party in India has done this in the past. The abandoning of the farm laws was an instance of this. So, the question is what prompts a political party to do this and, importantly, why does the average voter get seduced by this? The other question is what can be done to change the incentives of the parties to do this? In other words, how can we make sure political parties learn to defer gratification? But before I get into them, let me give you a short overview of what’s happening with the demand for OPS and the problem with states returning to it while abandoning the New pension Scheme (NPS). The Congress governments in Rajasthan and Chhattisgarh have already gone back to OPS and it has promised the same in its manifesto in Himachal and Gujarat. Not to be outdone, AAP plans to return to OPS in Punjab and might make it a plank in Gujarat. Nothing catches the imagination of our politicians like a bad economic idea, so we now have the Bharatiya Mazdoor Sangh, the RSS-affiliated trade union wing of the ruling BJP, demanding the same from the FM. As Business Standard reports:“National General Secretary of BMS, Ravindra Himte told IANS that during the meeting with Sitharaman, the organisation has urged the Finance Minister to restore the old pension system, increase the amount of minimum pension from Rs 1,000 to Rs 5,000 and to provide better health facilities to retired people under the Ayushman Bharat scheme.The BMS has also urged the Finance Minister to strengthen the social security scheme for workers and to take various other steps to protect the interests of the weaker section of the society.”For context, there are nine state elections scheduled for 2023. Pension of state government workers is a state subject. They can claim they have the mandate of the people to change this if they win using this as one of their key poll planks. Pension is a way to provide social security to workers following their retirement. A simple way to design a pension scheme is for an organisation to promise workers: upon retirement, we will continue paying, say 50 per cent, of your last drawn salary till you die. This is simple and intuitive. The worker has served the organisation for long and you reciprocate that loyalty by taking care of them after retirement. A few years of this scheme and you will soon have a reasonable request from the retired workers. The pension provided isn’t keeping up with the inflation. The last drawn wage about a decade back is hardly worth anything now and a pension indexed to that is unfair to the worker. What do you do as a welfare-minded employer? You offer to index the wage to the revised pay scale that’s prevalent now. So, the pension drawn by a worker is no longer 50 per cent of their wage when they were last working in the organisation. It is now 50 per cent of the wage of anyone doing the same job now to keep up with inflation. This is all good though a bit onerous. However, if you fast-forward this by a couple of decades, you will reach an uncomfortable scenario. The number of people who have retired from the organisation is now, say, equal to the number of people who are currently working. Those who have retired are drawing a pension that’s 50 per cent of the existing pay scale. Simply put, if the total wages paid to working employees is Rs. 100, the pension paid to retired employees is Rs. 50. A third of the total wage bill is allocated to pension. Another decade and you might have two-thirds of the wage bill being taken up by pension. This is a problem in many ways. First, the working employee is continuing to take additional burden to pay for the ever-increasing number of retired employees. The incentive to be productive for the current employee keeps going down when they know the lion’s share of any productivity gain will go to the retired pool. The organization continues to be weighed down by the pension bill. It finds it difficult to attract new talent because it cannot match market wage rates offered by newer companies that don’t have such a pension bill. It also cannot invest in new products and innovations because the pension bill keeps rising. Unless the employer is the State, in which case, it can print money, increase its debt and keep paying for pension, there’s really only one end state to this. The organization will go bankrupt because of its pension burden. This is not a hypothetical scenario. A whole generation of great American companies went down this path including the giant automakers of Detroit. The OPS that is being revived in many states in India is exactly this scheme. In 2004, the Union government introduced a New Pension Scheme (NPS) to avoid exactly this fate. The NPS model is quite simple. It is what is called a defined contribution model. The worker sets aside a small percentage of their salary every year towards a pension fund. The government matches that amount by making its own contribution from its coffers. This means there’s an additional wage burden for the government during that year. This amount goes into a pension fund which is managed by professional fund houses regulated by the PFRDA. The fund houses have fairly rigid investment rules that prohibit them from investing in speculative assets. This ‘accumulation phase’ continues till the employee retires. At the time of retirement, there’s a nice little corpus that’s built up. The employee can then take out, say 40 per cent of the corpus for their immediate need, the remaining amount moves into an annuity product where a fixed amount is paid out every year like a salary. Over the years the NPS scheme has been taken up by all Union government employees and gradually all state governments adopted it too. The professional fund houses that manage the NPS funds report annualised returns that have always been better than the Provident Fund (managed by the government) returns or even the best of mutual fund managers. And the first generation of retirees who use the NPS can vouch that the annuity they get has kept pace with inflation without having to wage-index their pension to the revised pay scale. This a beautiful solution that frees up the government from having a pension burden on its balance sheet after the retirement of the worker. No longer are current employees paying for the pension of the previous generation. In fact, we have often quoted the transition to NPS as one of the more successful public policy examples in India.Now, we want to undo it. There’s really never been a clamour for OPS. But if you go around telling retired or near-to-retirement employees that we will give you a higher-paying pension scheme by taking you back to OPS, you might find some traction. Even if the numbers don’t bear you out. Few voters will ask you how will you foot the bill. If the current and future employees don’t see that eventually, they will be paying for this largesse, you might be able to convince every working employee that this will work better for them. I don’t think we are there yet but I never bet against the popularity of a bad economic policy. They have tremendous seductive appeal. The Difficulty In Choosing Deferred GratificationThis is just another example where there are short-term pains in implementing a policy that will yield outsized long-term benefits. We could do that by implementing the NPS in 2004. Now, we are on the reverse. We want to implement a policy that might have short-term gains for a few but huge long-term costs for everyone. There are other similar policy questions in a democracy. How should we think about climate change? Should we take costly actions now by punishing polluting industries and impacting job creation while waiting for the benefits of these actions to pan out over decades? Or, how about increasing taxes today to rebuild roads and public infrastructure that will benefit society thirty years later? How should a political party think about these issues when their incentive is to win elections that happen every four or five years? Are democracies doomed to pick policies that are good in the short run but damaging in the long term because of this flaw?This intertemporal trade-off between maximizing societal welfare now and investing for the future is a vexing issue for political parties in a democracy. What I want to do is to understand the reasons for this trade-off being skewed in favour of short-term value maximisation and see if there’s a way to engineer a choice architecture for the public that redresses it. I can think of four reasons why the skew exists.Firstly, there’s the commitment problem among political parties. People are never convinced that a political party will stay the course on a particular policy. This is borne out of experience. Parties are less guided by economic ideology these days. The same set of politicians who might advocate a higher tax today and ask you to tighten your belts may change their tune tomorrow when they sense a change in the air. Also, politicians aren’t permanent. There is turnover among them within a party itself. And the newer set might renege on previous commitments. So, for the citizens, paying short-term costs because you believe in the political commitment of a party now is fraught with risks.Secondly, forecasting is difficult. There’s the fog of uncertainty and lack of adequate information to accurately predict these benefits. It is easier for a voter to use past performance as a guide to the future than predict it based on the impact of a new policy. The average voter anyway has only limited cognitive mind space for public policy. They might be able to think only about present outcomes with some clarity. This encourages politicians to think of policies that are typically myopic. Further, this information challenge means even if voters and the government say they care about the future, their actions will continue to be shortsighted. Separately, even those who are trained in public policy to think about the intertemporal trade-off can struggle to make accurate assumptions about the future. We live in a world that’s more volatile and ambiguous than before. To predict the future and the societal context that will emerge then is a risky proposition. For the policymaker, it is optimal to maximise a more certain near-term than go out on a limb for the distant future. Thirdly, we have the old problem of concentrated benefits and diffused costs. It is natural for a smaller group for whom the benefits of a policy are concentrated to organise themselves and demand its implementation. The converse of this is also true. Any policy action where the short-term costs are to be borne by a small but organised group while the benefits will emerge over time for the wider society will get scuttled by this group. The repeal of the farm laws was an example of this. Even if the short-term pain and the long-term gains both accrue to this small group, they will oppose it. Because a better alternative for them is to redistribute the short-term pain to everyone while securing the long-term benefits for themselves. Or, to continue with the status quo.Finally, we have the problem of political parties that have either run out of ideas or who want to make a dent in new electoral terrain. To them getting a foothold through the aid of a myopic policy is worth the price. After all, they have many other policies that are better for society, which they might rationalise. Or, it is a question of survival and how does long-term matter if you will cease to exist then. This is what explains the actions of AAP and Congress on OPS. Is There A Way Out?So how does a policymaker counter these? I have a few suggestions, some of which might seem Machiavellian.First, there are ways to take the sting out of short-term costs. A deft policymaker can obfuscate some of the costs by making their calculations more complex (say, in the design of an auction or a tax) that is difficult for the voter to understand. The idea is to reduce the overt display of the cost to be paid in the short-term. The other option is to impose the short-term costs in a phased manner or in specific cohorts (‘grandfathering’ certain beneficiaries for some time). There is a whole field of behavioural economics that can be used to nudge the voter towards a certain action like loss avoidance. The other way to do this is to diffuse the responsibility of who is imposing the short-term costs among many agents of the state including the government, independent regulators, corporates, local bodies or international treaties. This fragmentation of power and diffusion of the blame can make it easier to take difficult calls. They can take the sting out of the costs to be paid for future benefits. Second, there are ways in which the long-term gains can be crystallised into something more tangible in the present. There are ways in which some of the future payoffs can be advanced through well-choreographed pilots. This is particularly true for infrastructure investments where the example of a few recent successes can be talked up and few well-timed benefits early on in the investment process can convince the citizens of the long-term benefits. The other way to think about it is to play up the huge long-term consequences of not acting now with any small evidence in the present being used to project a terrible future. This is how climate change activists are playing the game today where any minor aberration in weather patterns anywhere in the world is used to proclaim ‘climat…

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    #192 From Local to Global Nov 27, 2022
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    India Policy Watch: State Capacity, the Smart Parking EditionInsights on domestic policy issues— Pranay KotasthanePublic policy is all around us; observing the same public space over time can reveal much about public policy, implementation, and state capacity. So, I’ll try something different today. I will narrate the story of a parking policy reform, which I’ve observed closely over the last couple of years. In it are lessons for government contracting, deployment of technology, and public choice. Drop a reply if this story resonates with you or if you have other such anecdata in mind. The Pre-reform SituationMG Road is a busy thoroughfare in Bengaluru’s Central Business District. Well-known shops, pubs, restaurants, and offices line the road. As you can imagine, many office-goers and business owners commute to MG Road and park their vehicles next to the curb. On weekdays, finding a vacant parking space after 9 am is a sure-shot sign of divine intervention. Even though curbside parking is not chargeable nominally, scarcity causes Coasian transfers to originate. An informal cohort of unauthorised Parking Marshalls emerges. These marshalls help vehicle users negotiate parking in return for a fee. After multiple complaints about this “rent-seeking”, the city government puts up free parking boards and demarcates parking bays for two-wheelers and four-wheelers.A reduction in the real price of parking leads to increased demand. Office-goers rush towards the city centre earlier than usual. The threshold beyond which parking became an ordeal moves up to 8.30 am, after which people have to park about half a kilometre away in a designated paid parking. And since the Traffic Police have no capacity to enforce parking rules except once in a moon, you would usually encounter double-parked vehicles on MG Road, usually cabs. Some shops even employ valets to double-park customers’ cars, which are slid into vacant parking slots as soon as they become available. The motorable road width decreases because of these double-parked vehicles. It is quite a chaos. The Smart Parking ReformThe paid parking reform had been mooted on several occasions but wasn’t politically palatable. Finally, the city government bit the bullet after the first COVID-19 wave. BBMP —the city municipal corporation—realised that its tax revenue sources had thinned. And with an ongoing hoarding ban and a newly launched GST, revenue generation options had narrowed further. That’s when the Overton Window for paid parking opened up. Given the lack of state capacity, BBMP doesn’t usually do parking enforcement itself. So it enters into a public-private partnership in which one company Central Parking Services (CPS), is granted a contract for parking on ten major roads in the city’s Central Business District for ten years. Reports suggest that BBMP expected Rs 31.56 crore annually through this arrangement. To prevent corruption, BBMP employs technology. Curbside parking spots are clearly marked and numbered. Sensors are installed on each slot to identify the presence or absence of a vehicle. Customers can book a parking slot on arrival via an app and pay seamlessly through UPI/card/or wallet. Parking kiosks are also installed on footpaths for people who don’t have the phone app. To encourage digital payments, cash payments are made costlier by 16.6%, i.e., Rs 30 in cash grants parking permission for 50 minutes, while the same amount paid digitally allows you to book a parking slot for 60 minutes. For a detailed account, see this Deccan Herald report. To help people transition, parking charges are waived for the first week of operations. Thereafter, cars have to pay Rs 30 per hour.Now, guess what would have happened? Can you anticipate the unintended consequences?Post-reform observationsPricing a resource according to its scarcity leads to a more efficient resource allocation. We saw that scarcity principle play out here. Soon enough, you could find a parking slot at any time of the day. The contractor employed several uniformed parking marshalls to prevent double-parking and unauthorised use. The same road you saw above now started looking as below:The story doesn’t end here, though. It’s not as if parking requirements are this elastic in the central business district, and it’s not as if the city has reliable public transport options. What really happened was the displacement of parked vehicles from MG Road to a nearby residential road and a parallel thoroughfare. To avoid paying the parking fee, people started parking vehicles on other roads, sometimes right under “No Parking” signs. These infractions were uncommon earlier as these roads were patrolled by traffic police vehicles. But with the enforcement contracted out to a company in the surrounding area, perhaps the incentive for the Traffic Police to patrol the area decreased, as public choice theory would predict. And so, while the parking situation on MG Road improved, other neighbouring roads became free parking lots, causing congestion and unchecked traffic rule violations. As for MG Road, the “smart” parking didn’t remain smart for long. The sensors for most parking slots stopped working soon. The app and the kiosks showed a parking slot as" “empty” if you parked a vehicle there. At other times, it showed unpaid bills of previous customers. On one occasion, the app asked me to pay a parking fee of Rs 18,290!Despite repeated calls to the grievance contact number, the contractor didn’t seem to be interested in getting these fixed. The profit motive would have suggested that the company would aggressively keep all sensors active, but that’s not how it played out.As public choice theory would predict, corruption didn’t go away. The situation was much better than in the past. Nevertheless, since the sensors weren’t working, the Parking Marshalls sensed an opportunity. The system allowed them to reset or extend the parking time limits at the kiosks. Some of them started striking side deals with regular commuters. The parking marshalls also enjoyed discretion in enforcing steep fines for overparking. Since there was no robust check to track fines, they could strike a deal with the customer instead of registering an official fine. Zooming OutThe marginal benefits of the parking policy reform are greater than the marginal costs; hence, it should continue. But it is still a work in progress. Contracting out doesn’t obviate the need for enforcement entirely. My anecdata reiterates one important lesson in public policy: better contracting or procurement also requires state capacity. Without having built that muscle, contractors can easily take governments for a ride. As Chitgupi, Gorsi, and Thomas write in their LeapJournal article titled Learning by doing and public procurement in India:Procurement is an expertise. No government organisation can sporadically do this well. It is an expertise which can be built, albeit over many years. In any government organisation, people and processes can be organised to focus on this expertise, and to devote time and effort on the entire pipeline of government contracting. The process of developing this capability can be accelerated by bringing in people with this specialised expertise. Strengthening the entire life cycle is required to successfully spend budget amounts. But this is only the beginning of success in procurement where government can contract to deliver quality projects efficiently, on time and at low cost.Applications for the re-awesomed Post-Graduate Programme in Public Policy are now open. Check details here.Global Policy Watch: End GameInsights on global policy issues — RSJSome recent inflation prints from the US and other developed markets suggest the central banks are winning the fight. In India, too, the inflation expectations are getting less hawkish. Is this true, or is there more to this? A bit of a diversion here. A few editions ago, I pointed out how the ECLGS scheme launched during the pandemic to support the MSME sector had worked out well in India. The sovereign promised the banks they would guarantee the loans they disburse as part of this scheme. The banks could continue to use their underwriting norms without making them too stringent because of overthinking the negative impact of the pandemic on these businesses. The bank could, therefore, support these businesses, and as it has turned out, that’s all that was needed to keep this sector above water. The government didn’t have to dole out loans themselves, and the banks did what they do well, namely, underwrite, disburse and collect. Net result: the system NPAs for this scheme will end up in the 3-4 per cent range in line with this kind of portfolio in normal times. I bring this up because while writing about this last month, I thought it would be useful to check if other governments went down this path during COVID-19. It turns out yes, they did. Most of western Europe did the same. Over 60 per cent of new loans in France were guaranteed by the sovereign. In Germany, it was over 40 per cent, and now they have come up with a fresh scheme to stave off the energy crisis emerging from the Ukraine conflict. In Italy, not only were fresh loans state-backed, but they also rolled over older credit to these new schemes. This seems to be becoming a thing.Governments seem to have hit upon this nice little trick where they don’t have to raise debt or taxes to manage a crisis. They simply need to offer credit guarantee through banks. It will sit on their books as a contingent liability and won’t show up in debt ratios. Nobody gets hurt. Neat.So, why did I bring this up while talking about inflation? Since the global financial crisis (GFC) of 2009, the debt-to-GDP ratios in the developed economies have only moved one way. Up. Then we had the pandemic in 2020. Governments threw more money at the problem. The result is we have debt-to-GDP ratios upwards of 250 per cent in most OECD countries now. Two problems have arisen because of this. One, this indiscriminate money supply plus some supply chain constraints have meant inflation has hit multi-decade highs. Notwithstanding all modern monetary theory hypotheses that were in vogue a couple of years back, it turns out that more M4 money in the system will lead to higher inflation. And inflation hurts the poor most. Second, the system is vulnerable to collapsing at such debt-to-GDP ratios with the smallest of shocks going forward. I mean, how long can you keep kicking the can down the road?So, the inevitable has happened over the past six months. Central banks have raised interest rates in a dramatic manner to tame inflation. This seems to be working, as the slowing of headline inflation number suggests. But I am not sure about it. Most of the recent reduction comes from the fall in prices of the more volatile commodities. In fact, the ‘sticky’ part of the consumption basket seems to be still in inflationary mode. Also, the rising rates have killed growth in most developed economies. They are in a recession. And while the employment data suggests that jobs are being added, if you look closely, the worm is beginning to turn. The slowdown across sectors will mean layoffs, consolidation and a reduction in capital expenditure. The employment rate will soon start falling. With that backdrop, what are the choices available to a government? I see a likely scenario that brings these various tugs and pulls together for a short-term fix that might appeal to them. I will elaborate below.Now that inflation has touched multi-decade highs, and we are at that point in the rate hike cycle where we have pretty much killed growth in the short term, there isn’t more elbow room to increase rates. Inflation may subside a bit as supply constraints reduce, and maybe the war in Ukraine ends. But this is an opportune time for governments to reset inflation expectations upwards among its people. If you were running an inflation targeting model with a two per cent threshold (like in the US), it is somewhat easier now to raise it to 4-6 per cent without much furore. If you were running it at a 4-6 per cent range (like in India), you could reset it to 6-8 per cent. The Overton window is available for this. I think the governments will willingly take it. A slightly higher inflation expectation, without it becoming runaway, will allow central banks to pause raising the rate. It will also increase nominal GDP. This is important because a two per cent upward reset of the inflation target will lead to a corresponding increase in the nominal GDP. And increasing nominal GDP through higher inflation is the easiest way to reduce debt to GDP in the system for a government. Cutting costs and tightening the belt are all difficult ways of balancing the budget. Nobody wants to do that. In the past, letting inflation run high was unacceptable to any incumbent government. But the way the cards have fallen in the last six months, the governments can get away by citing forces beyond their control. I think no government will look this gift horse in the mouth. They will reset inflation targets. Now doing this means what’s called financial repression. That is, the savers will lose because their savings will be undercut by inflation in future. So, this will have to be done gradually. But I see this level of financial repression as inevitable. The success of credit guarantee schemes opens another front for governments. As I mentioned, the governments will do more of this because why not? So, in some sense, you will see a capture of private credit by government-directed guarantee schemes. It won’t be as much in India, but I see it quite likely in the developed economies. So, it is likely that while the economy will head to a recession, private banks will continue to supply credit because of these sovereign guarantees. There’s a likelihood that bond traders will take a dim view of this and push up yields significantly. But there are multiple tools with the government to force pension and insurance companies to buy government bonds. This will rise. Yield curve management isn’t a big deal anyway if central banks decide to do it. So, no fear on that front too. This will mean we could have continued credit expansion backed by the government in the near future without the fear of a rating downgrade. If you combine that with the developed economies bringing manufacturing back from China into their own countries, we could have a capex-led boom beginning soon after we have brought inflation into the new target limit. Of course, I’m not saying I support this kind of state intervention that pushes credit in the areas it wants to focus on instead of the market allocating capital in the most efficient way. In the long run, the state will make the wrong choices driven by its political objectives. But we will have to wait for the cycle of boom to first play out before that kind of bust unfolds. This might take a decade or maybe more. I am, therefore, sceptical of those who suggest a deep recession or stagflation is around the corner for the global economy. There will be a short recession, but other options are available for the state to manage this and push a real reckoning into the future. Stagflation might be the end game, but that end is not nigh. HomeWork* [Paper] Internal Drivers of China’s External Behaviour by Amb Shivshankar Menon is really helpful in understanding China’s recent actions. This line in the paper struck me (There’s a useful 2x2 matrix in it):“Today, China faces an unprecedented situation at home and abroad and is therefore reacting in new ways. China is more powerful than ever before but is also more dependent on the world. This is an unprecedented combination, not known in Chinese history—not in the Han when she had to ‘buy’ off the Xiongnu by marrying Han princesses off to steppe leaders; nor in the Song when she was one and sometimes the weakest power in a world of equals; nor in the h…

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    #191 #TwitterMustDie? Nov 20, 2022
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    Global Policy Watch: Tu Cheez Badi Hai Musk, Musk (umm, sorry)Insights on global policy issues — RSJOne of the great problems of policy, or even philosophy, is who should own things that are or that behave like public utilities. For instance, who should own news broadcasting services? Suppose you prepare a case study explaining what’s news broadcasting, the perils that someone abuses such a service to spread fake news and propaganda, and the damage they do to society. Now hand over this case to a bunch of well-meaning people and ask them: how would they frame a policy on ownership of such a service? What do you think the answer will be? I don’t have any empirical evidence to back this, but I think in most scenarios, you will find a group of well-meaning people supporting some kind of ownership by the state or a distributed set of individuals. They might suggest a set of tightly regulated norms on what should be broadcast, and they could also throw in a stringent penalty regime for violations. It is unlikely that any group will come up with the answer that it should be owned by a megalomaniac rich man who believes in free speech, flips the bird to regulators on most occasions and has a penchant for poop emojis. A public utility cannot be left to such unstable people regardless of their genius, is what most would say. Twitter is the equivalent of a global public square where news stories are broken, and opinions and trends are generated. Should it be owned widely by the public with a governing board that regulates the platform, its content and its algorithm? Or should it be owned by the state, which can run it like a public utility without a profit motive? Or should Elon Musk own it? What do you think?Twitter Is DifferentBefore I venture to write about the options, it will be useful to lay out the unique character of Twitter as a platform. During the week, I reached out to Amit Varma(doesn’t need an introduction to readers here), who always has a clear-eyed view of things, to understand what he makes of the happenings at Twitter. His views helped me articulate my thoughts better. Read his insightful piece on Twitter here. First, unlike broadcasting services of the past, Twitter is exceptionally quick because it is a hyperconnected network of people. Events unfold in real-time on it, and trends catch on fast. Mobilisation on Twitter is faster than the speed of response of any state. It plays an outsized role in shaping the discourse because speed is a feature in today’s age. Two, the incentive architecture of Twitter is designed to reward extreme positions. The ‘retweet’ or ‘quote’ button, the notion of having ‘followers’ and the constraint of the 280 characters all mean there’s more purchase for broad generalisations, provocative positions and performative behaviour to pander to your own tribe. Three, Twitter is a monopoly in a very unique sense. Granted, there are other platforms that take a share of our attention, but there’s only one platform that richly rewards us for our attention with the dopamine hit in the manner Twitter does. Social media platforms tend to be ‘winner takes all’ plays because, as a user, once you build a certain kind of network and reach that’s unique to that platform, there’s little incentive to start building it all over again for the same benefits in another. The switching costs are just too high. #OwningTwitterThink of these features of a broadcasting service together - hyperconnected and quick, rewarding fringe behaviour and a natural monopoly. How should we think about its ownership? Now look at the three options of its ownership - a) the state (or a group of states), b) a widely-held listed public company or c) a Musk-like figure. One way to think through this is to understand the natural incentives of these respective owners, how they will use the platform to achieve those and what will be the net societal outcomes of those actions. Take the state first. All good intentions aside, as we have demonstrated over and over again on these pages, the primary incentive of the state is to perpetuate itself. Or, the party that runs the state to continue being in power forever. While to many in India who are brought up to think of the state as the mai-baap, it seems like a fair arbiter of how a public utility should be managed, the evidence all around us should go against that intuition. A public utility like Twitter controlled by a state that’s benign and fair can be a tremendous aid for the welfare of the community. But in public policy, you must consider the ‘corner cases’. You must ask, what if a utility like Twitter is in the hands of the politician you dislike the most? Will they be fair and benign? And then think about ownership and governance of such a utility and its consequences. So, the argument that a global public square like Twitter should be owned by a state or a group of states and managed like a global public good appears pious and workable on paper but is fraught with the risk of a bad faith actor with sovereign power taking it over. That will mean only one kind of fringe taking over. Bad things will follow. Next, let’s consider the ownership by a publicly held company which is how Twitter used to be till Musk bought it out. The management of such a company is the shareholders' agent, and its incentives are aligned with what’s best for the shareholders. The management, therefore, works to maximise shareholder returns which get tracked every quarter based on the company's performance. Regardless of how visionary the management team is, they are toast if they do not deliver every quarter. There’s no avoiding short-termism here. What’s the incentive for any manager to fundamentally retool this company, take short-term hits for many quarters and live in the hope that the strategy will pay off in the long term? Nada. Shunya. Nobody has seen the long-term, and the shareholders have other places to invest than to wait for so long. Twitter has dug itself into a hole where outrage and fringe positions bring in engagement, and that engagement is monetised for advertisers. Even if you had an enlightened management team that knew the damage this ad-dependent business model was doing to society, it would find it impossible to junk the model and change the engines mid-air, so to speak. Because any change in course will need to be dramatic, meaning significant short-term pain. That would understandably test the time and patience of the shareholders. You would need a Steve Jobs-like reality-distortion capability to convince them otherwise. There aren’t many Steve Jobs around to run a public company as professional CEOs. The best that Twitter, in its public company avatar, could do is to be managed efficiently. That’s it. That efficiency on its current model however would mean it would only get better in coarsening our discourse and widening cultural chasms. I think this is what is called irony. Lastly, let’s consider the option of a Musk-like figure buying out Twitter and doing what he pleases with it. What happens here? While it was somewhat easier to appreciate the incentives that drive the state or the shareholders of a public company, we can only speculate on Musk’s incentives. There’s no academic research done (yet) on Musk’s behaviour and actions. So, we can only think in terms of scenarios here. Scenario 1 is what I call the ‘Matt Levine view of Musk’. Levine is a modern-day Plato. The most lucid interpreter of capital and economy in the world today. His newsletter is quite simply the best chronicle of our times. And it’s free. What a legend! He has built a theory of Musk’s purchase of Twitter in many delightful editions. In this theory, to Musk, Twitter is a video game he loves. Ordinary people, like you and me, play a game, get addicted to it and then, over a period of time, get bored with it. We start hating a feature, or a new upgrade isn’t to our liking, or we see too many people playing it. Whatever. We move on. But Musk is not any of us. He’s the world’s richest man. He is also the world’s most addicted user of Twitter. He loves to troll people there, responds with poop emojis to the tweets of others and originates many meme cycles. He’s the shahenshah of all Twitter super users. So he buys up the video game company. Now he can play around with features as he fancies so that he can continue to enjoy the game. He placed a bid for it that was high. Then as the tech stocks and the markets crashed, that bid looked worse. Like any rational actor, he tried to get a better deal by threatening to pull out of the deal. Eventually, he bought it because a) he always wanted to buy it or b) maybe, because legally, he couldn’t opt out of it. Whatever. It is his now. Is there a reason to believe this theory of Levine? The answer is yes. Musk is rich enough to throw $44 billion for his favourite toy. In any case, he’s not paying everything from his own pocket. Maybe about half of the $44 billion. Nothing in how Musk has used Twitter so far suggests he has any great vision for the platform. In fact, he enjoys and leverages all the toxic features of the platform. Musk will play with this for some more time, and during that time, he will keep it running with some mix of charisma and his unique gift to meme-ify things. He will then hand it over to a sucker and walk out with a tidy profit. Twitter will then collapse in a heap. Or maybe it will collapse under his watch itself. An expensive way to amuse himself? Sure. But does he care? Either way, he’d have had his fun. That was his only incentive. Scenario 2 is the alternative that I want you to consider. I don’t necessarily believe in it, but it has equal merit to exist as the Levine scenario. Think of it as the RSJ scenario. For a moment, consider that Musk is an incredibly rich man because he makes things that people pay a nice premium to own. In short, he’s not a Sam Bankman-Fried. His businesses that are live offer genuine products with real software running within. People die if he gets them wrong. He has often mentioned in his interviews (listen to him speaking to Lex Fridman or Seth Rogen) that his primary concern is the survival of the human race. Therefore his preoccupation with autonomous cars, clean energy and finding an alternative to Earth as a home for our species. He doesn’t think about them like a scientist. He isn’t interested in the theory beyond a point. He wants to build products that will use science to solve these problems. He’s an innovator. In this scenario, he views Twitter in its current form as a net negative for the race. He sees it going only from bad to worse. It is worth his time and money to intervene. To innovate. This is hard work. Remember, he doesn’t need to work for a single day in his life. He can donate a tiny fraction of his wealth to build museums and libraries and earn all the praise and fame for posterity. His problem is there won’t be any posterity. He isn’t interested in delaying the inevitable. He wants to build an alternative for the inevitable. He doesn’t want to tweak Twitter for it to be a net positive. He is certain it won’t help. The old Twitter has to be changed at its foundation. That’s why he is at the Twitter HQ working long hours (and occasionally tweeting). This is a different frame to look through. If you consider this scenario, Musk’s incentives are to build a platform for good that doesn’t have to cater to extreme positions for engagement and ad revenues. He has no short-term pressure to show better numbers, no shareholders to answer to, and no sword hanging over his head to show instant results. He is his own man. He will change Twitter for it to be a force of good at his own pace and time. $44 Billion is important even for as rich a man as he is. He could have put it anywhere to make more wealth. He’s sinking it into a platform he thinks can do enormous good for humanity if it is changed. That’s the only incentive that matters to him. Now consider how things will play out if you take the Levine and RSJ scenarios together. In both, Musk will behave based on his incentives. One of the two results is only possible then. Twitter will die in short order or turn itself around and be a force of good. In either case, we will be better off from where we are now with Twitter. Stacking It All UpSo, let me summarise this ownership and consequences thing here. a) The state(s) could own Twitter, and their incentive will mean they will weaponise it further to perpetuate themselves. This will be bad for everyone. It will be worse than where we are today. b) Or Twitter could continue being a widely-held public limited company with incentives that will dig a deeper hole for itself. It will mean ever-spiralling toxicity forever. Again a worse outcome. c) Or, Twitter could be owned by someone like Musk. Here, it will either die quickly or become a force for good. Either scenario will be an improvement on Twitter in its current form. Which ownership option from among the three would you choose? Applications for the re-awesomed Post-Graduate Programme in Public Policy are now open. Check details here.Matsyanyaaya: Managing China the Aussie WayBig fish eating small fish = Foreign Policy in action— Pranay KotasthaneAnthony Albanese, the new Australian PM, had a tough couple of days this week. Asked about Taiwan’s candidature for the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) — a regional trade pact of 11 countries — he said, “The CPTPP is a relationship between nation-states which are recognised”. Since the statement came just three days after Albanese met Xi Jinping, it ruffled quite a few feathers. Did the statement mean Australia was trying to build bridges with China again? Was Australia changing its position concerning Taiwan as a result? In any case, the Australian government swung into action, clarifying that Canberra remains open to Taiwan joining the CPTPP. Albanese, too issued an explanation:“Our position has not changed. We will deal with applications that are dealt with by consensus for economies applying to join the CPTPP. At the moment, they’re dealt with one at a time.”So, it’s pretty likely that the Australian PM misspoke. There doesn’t seem to be any change in the Australian position on Taiwan or China. However, this incident provides a window into the debate in Australia on its China policy.Australia, in recent years, has been the most vocal opponent of Chinese expansionism and authoritarianism. The surfacing of a case of Chinese interference in Australian domestic polity in 2017 was an inflexion point in Australia’s China policy. Since then, it has actively tried to counter China’s aggression unilaterally and balance China’s power multilaterally. It is also the most enthusiastic participant of Quad 2.0. There is a bipartisan consensus that Australia needs to partner with the US and other powers to counter China, even if it means significant economic setbacks. And yet, there are some in Australia who oppose this consensus. Hugh White is one of them. In a recent Quarterly Essay, White opposes Australia’s current China policy. He locates his opposition in realism and not idealism or liberalism. Some of his arguments echo the voices in India who are opposed to a closer collaboration with the West. For this reason, it’s worth studying it in some detail. Here’s my summary of the essay.BackgroundHugh White is a well-known Australian professor of strategic studies. He wrote Australia’s Defence White Paper 2000. A constant theme in his writings has been that Australia should not overly rely on the US. It should instead learn to co-exist with a powerful China by drawing a few red lines. Essentially, he makes what we know in India as the “strategic autonomy” argument.TL;DRWhite argues that the US will “abandon” Australia as the costs to the US for meaningfully challenging China in East Asia are far higher than the benefits. The stakes f…

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    #190 Hubris Leads to Downfall Nov 13, 2022
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    Global Policy Watch #1: FinTech ManoeuvresInsights on global issues relevant to India— RSJOne of our favourite topics to talk about around here is regulations. We aren’t dogmatic about things. But the one principle that comes close to being a dogma for us is our belief in spontaneous order. The world is a complex interplay of many economic and social networks. Don’t try to force an order on it. Let the spontaneous, uncoordinated actions of the millions run their course. Some order will emerge from it. There might be occasional ‘disorder’ but inbuilt into such systems is an autocorrecting mechanism which will kick in. This is better than some powerful entity (like the State) trying to force order because it thinks it knows best. No one really can be a Laplace’s demon. The top-down forcing of an order will make things worse. That said, we aren’t libertarians by any stretch. The State must intervene when there’s a market failure. And more than any other sector, I believe financial services need regulation because of two obvious market failures endemic to them. One, there’s a serious information asymmetry between the supplier of these products and services, and their customers. The products get more complex over time as suppliers look for additional arbitrage to make higher income, and customers can only understand so much of what’s often non-intuitive. I mean, compounding as a concept is a leap for most people; figuring out more complex instruments ain’t going to be easy. Two, the market power and dominance gets built up really fast in this sector. With it comes the risk of a contagion or the spectre of ‘too big to fail’. All of these leads to misallocating of capital that’s worse than most state interventions. So, I tend to look at financial regulations somewhat more benignly than, say, regulating cattle transportation. Having got that preamble out of the way, here’s a news item that many of you might have seen last week:“The founder of the world’s second-largest cryptocurrency exchange, FTX, has apologised for his company’s near-collapse this week, saying he “fucked up” in his calculations and in his communications during the crisis.Due to “poor internal labelling of bank-related accounts”, he said he “was substantially off” in his calculations of the sums that the exchange had lent out to users to let them make leveraged bets – borrowing money to trade with, magnifying potential gains and losses…The sudden collapse in value was prompted by leaked documents which implied that Alameda Research, a hedge fund tightly intertwined with FTX through its common owner, Bankman-Fried, was, in effect, insolvent….The leaks about Alameda turned into a crisis for FTX when Binance, the largest cryptocurrency exchange, announced it would sell its own major stake in FTX. The fire sale that followed crashed the token's value far below the $22 floor that FTX had committed to support and prompted the equivalent of a bank run at FTX itself as customers raced to withdraw their deposits faster than the exchange could process them.”It wouldn’t be out of place to say there’s a lot to unpack there. But is there really? I have held a general theory about fintechs for a while. There are three sources of value in fintechs as I have seen them. One, they build slick, frictionless journeys that make buying financial products easier and more intuitive. Traditional players either don’t think this way or their legacy systems just don’t allow them to create such convenience. This focus on customer journey is good and somewhat sustainable in sectors where customers value speed and efficiency over risk management. Now ‘friction’ isn’t great in most cases but it has a few benefits. It slows things for you to pause and reconsider. In financial services, some friction is necessary to protect the customer. Not all of them have the ability to manage speed and the attendant risks that come with such lack of fiction. Anyway, frictionless works in sectors that have savvy customers. The best examples of such disruption have been new-age retail brokers like Robinhood, or closer home, Zerodha. There isn’t a lot more there in terms of product innovation or better management of risk that are traditional sources of value. It is all about convenience. Of course, such simplification and gamification - like, animated confetti floating all around when you make an options trade - runs the risk of drawing customers who don’t have the financial nous or the appetite for such risky products. And those accidents happen. But you could still argue there’s some tangible value fintechs have created in forcing everyone to rethink customer journeys in the industry. Is that sustainable, and does it warrant a huge valuation? Not quite. But at least you’ve got a real reason for customers coming to you. The second source of value - risk arbitrage - is of a more dubious kind. Traditional finance is built like it wants to reject customers. You must know your customers well, assess their risk profile, check for the suitability of the product and then offer them your product. At least, that’s what is expected. And for the risk appetite you decide on, the regulator will ask you to maintain capital so that you don’t ever have to turn your pockets inside out, tilt your head to the side and tell your customers you have no money. If you slack off on this, you might get away for a short while, but the chickens come home to roost fairly quickly. You have stringent disclosure norms, so there’s nowhere to hide when things go wrong. This means traditional finance does the equivalent of an airport strip search for every customer while taking them on. Sure it inconveniences 99.99999% of the customers but there’s no point taking that infinitesimally small risk by going around and trying to avoid it. Now, this isn’t exactly how most fintech models operate. There’s greater value in getting truckloads of customers in really fast, offering them discounts because no one is asking you to make profits and creating a Bezos-like ‘flywheel’. This model militates against prudent risk management practices. The many lending apps that promise loans in seconds, the entire Buy Now Pay Later (BNPL) craze that swept through in the last few years and the many variants of such models are good examples of this mindless model. The only good news is that such models are up against fundamental economic sense. The risk starts to bite soon, and there’s nowhere to hide. The dismal performance of such fintechs once they’ve gone public should surprise no one. The only way out is by going back to the harsh reality of doing business in finance - manage your risk. And that brings us to the third, perhaps the rarest, source of value among fintechs - product innovation. This is rare because of two reasons. Firstly, traditional finance is innovative enough. This might seem surprising, but I guess a charge that’s laid on banks is that in the last thirty years they’ve innovated too much. It led to what’s often called the financialisation of the economy. In fact, one of the lessons from the global financial crisis (GFC) for the regulators was to clamp down on innovation to reduce the possibility of toxic products. So, there’s not been any dearth of innovative thinking in traditional finance. Secondly, real product innovation is hard work. It requires deep knowledge of the domain and an understanding of the customer to arrive at one. Now, there aren’t more than a handful of fintech models that truly qualify as innovative, or to apply that much-abused term, disruptive. And if we have true product disruption, then there will be an information asymmetry-driven market failure deeper than usual. I mean if people don’t understand the run-of-the-mill financial products well now, what are the odds they will appreciate a real disruption? What this means is that ‘disruptive’ regulations will have to be applied to address the disruptive model in play. Importantly, the timing has to be right. Apply them too early, and you won’t have the disruption that’s useful in the long run. Go too easy on them, and you might create a beast that will be difficult to tame when things go wrong. Crypto(currency) is a real product disruption by this definition. We have covered it in a few previous editions (here, here, and here). The promise of a decentralised monetary system that isn’t ‘repressed’ by central banks worldwide has its own appeal. Not to me, but there are all kinds of people in this world. And FTX was (as I write this I hear it has filed for bankruptcy) a fine example of the possibilities of this disruption. It was the second-largest crypto exchange in the world. You could open an account with it and transfer some money to it to buy any bitcoin. And they would hold it for you. When you want to liquidate the bitcoin for money, they will do so. They will charge you a small transaction fee for their troubles. That’s it. Not much of a business model till you start complicating things. Bitcoin isn’t exactly a stable asset. Its price fluctuates quite wildly. Now to some, this is a problem, but to people in financial services, this is an opportunity. So FTX started offering other services. You could borrow money from them to buy more bitcoins, or they could offer you bitcoins for money if that’s what you wanted (maybe you wanted to short bitcoins). Soon, it was no longer just an exchange or securities brokerage business. It was doing (margin) lending and taking risks on its books. It also started issuing tokens (think of it as its own kind of currency) that it offered to people to lend against. One of the things about finance is that there’s no real product that’s shipped from factories. People can make up products on the fly if they spot an opportunity to arbitrage time or risk appetites. So things get out of hand in terms of complexity soon. With FTX that’s what happened. You are lending and borrowing across time and risk horizons and you don’t know whether you can have your assets and liabilities match over the medium term in all likely scenarios. This can get messy in a traditional bank with all the bells and whistles of risk management and treasury teams monitoring this daily. In a fintech start-up that has some opaque tech platform with limited supervision and scenarios planned, it can be quite catastrophic. In FTX’s case, they had the added complexity of having their own tokens, which they were accepting as collaterals against loans. So FTX had loaned a load of its customer assets to another of its company (Alameda) in return for its own tokens. The value of the tokens was based on FTX’s value. But FTX was also sitting on a load of them as collaterals. If the value of the tokens fell, FTX would be impacted because it held a lot of them. If FTX got impacted, the tokens would fall further because that’s what the intrinsic value of the token was. If you are a token owner worried about the token crashing, you would take out your money asap. And if everyone thought like you, as they will, you will have a run on the bank (or the exchange). It was tailor-made for a death spiral. All it needed was a spark which was provided by its friendly rival Binance who tweeted one fine day about what it thought of FTX’s tokens. FTX, which was valued at $ 32 billion about a month back has filed for bankruptcy. Its investors (like PE giant Sequoia) have marked their investment value down to zero. Some customers will almost lose all their money here. There are counterparties involved, so we will know the full extent of its collapse after a while. The details that have emerged since about how FTX was governed are hilarious. There’s no other way to put it. There were only three members on its board. Two executives, including the founder and a lawyer based in a tax haven. No equity investor had a presence there. There was hardly an Asset-Liability Management (ALM) committee or a model. The founder’s partner ran the finance function. The whole thing ran on the back of an engineering team that built the platform with hardly any supervision on what was coded. The founder tweeted that there may have been a ‘labelling’ error in one of its fields and that could’ve led people to believe it had a liquidity problem. I used to make such excuses for MS Excel errors at the turn of the millennium when I was wet behind the ears analyst working for peanuts. For all the talk of software eating the world and decentralised platforms disrupting governments, it would be good to begin by acknowledging that the generations that have gone before us building what they built were no fools. In financial services, regulations are often a feature, not a bug. Thinking people don’t get it because they don’t understand disruption has no basis. It is hubris, and that leads to a fall. That’s the only lesson of history. India Policy Watch: Don’t Choke Cheap Chips from ChinaInsights on domestic policy issues— Pranay KotasthaneA lot has been said about India’s dependence on chip imports. Especially on chips coming from our long-term strategic adversary, China. And yet, I haven’t come across an analysis to understand the composition, size, and trends in this particular item of trade. So, I decided to investigate it further using the Department of Commerce’s Trade Statistics portal. Chips (or Integrated Circuits) are India’s eighth-biggest import item by value. Energy imports — petroleum, petroleum gas, and coal rank above it. So do gold and diamond. The other items we import more than chips are products made using them — computers (including laptops, desktops, printers. etc.) and telephones (including mobiles, modems, etc.). Now, let’s look at the chip imports from China. Considering PRC and Hong Kong as one political unit, India imports 64% of its ICs by value from China. Over the last five years, imports from PRC have increased seven-fold. Check this chart below to see the various kinds of ICs that come to India from China.While this chart may look alarming, it can be misleading in many ways. One, the absolute increase in chip imports from China follows the overall trend of increasing chip imports to India. Total chip imports to India have also increased sevenfold over the last five years. India is importing many more chips from all countries, including China. And this is a good thing. It’s positive because it indicates that a lot more electronic device assembly is happening in India. A country will import chips — not finished electronic goods — in large quantities, only if it has a downstream domestic equipment manufacturing ecosystem. As even more Samsung, Apple, or Redmi devices get assembled in India, we should expect chip imports to India to rise for at least another decade in the best-case scenario, by which time we could have a semblance of chip manufacturing done here. Two, chips imported from China are not necessarily Chinese chips. For one, it is likely that they are just assembled in China. Chip assembly is a labour-intensive process that is outsourced to other companies. China is a much bigger player in outsourced assembly and packaging of chips, than in fabrication. So, it’s quite likely that a die (an unpackaged chip) travels from Taiwan or Japan to China, gets packaged and finds its way into India. Secondly, even when chips are fabricated and packaged within China, a portion of it is done by foreign companies with facilities in China (such as Samsung, UMC, SK Hynix, etc.).And three, its a fool’s errand to think we will ever be in a situation when no chips are imported. If India’s own chip assembly and packaging takes off, import of unpackaged chips will rise substantially. ICs are in fact the biggest import category by value even for Taiwan, the semiconductor superpower. It’s a folly to look at the entire semiconductor supply chain through a “national security first” lens. Cross-border movements of chips are desirable and inevitable. To mitigate risks, what can be done is t…

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    #189 Strange Are The Ways Of Democracy Nov 06, 2022
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    India Policy Watch #1: Ganesh Ji & Lakshmi Ji To The Rescue Insights on domestic policy issues — RSJSometime last week, this newsletter marked three years of its existence. A blink of an eye in the larger scheme of things. Yet, it feels nice to have reached this milestone. Consistency might be the virtue of an ass, but it is a virtue nevertheless. In these three years, we have stayed somewhat true to our purpose in every edition we have sent out. We have analysed policies intending to anticipate their unintended consequences. We have debated about what’s good in the long term for India since we care for it. And we have tried to influence or perhaps shape the demand side of the political equation by increasing awareness about public policy among our readers. This is a marathon, and we are in it for the long run. No effort is too small. We cannot thank you enough for the generosity of your time in reading us. Anyway, returning to one of the things we care for deeply. India’s future prospects. No amount of thinking about it could have brought us to the conclusion that Arvind Kejriwal reached last week about this vexing issue. The leader of AAP addressed a press conference where he asked the PM for a critical policy intervention:"I appeal to PM Modi that the Indian currency has the picture of Gandhi ji on one side, it should remain like that. But on the other side, there should be a picture of Ganesh ji and Laxmi ji. We need efforts to make the Indian economy stronger, but we also need the blessings of gods and goddesses," he said.While Laxmi is the goddess of prosperity, Lord Ganesh is believed to solve all our 'vighnas' (problems), Kejriwal said."We are not asking for printing fresh currency, but all the new currency that gets printed, this should be implemented. Eventually, the circulation of these notes will increase," he said.As the yesteryear villain Ajit (“the loin”) would say: smart boy.Soon another AAP leader, Atishi, took the battle to the BJP camp:“BJP leaders can hate Mr. Kejriwal but why hate Hindu deities Lakshmi and Ganesh? Do you not want the blessings of our gods to be with the people of the country? I humbly request leaders of the BJP not to oppose this noble proposal. It is not just a proposal from Arvind Kejriwal, but is the proposal of 130-crore citizens of this country.”I don’t remember when I (among them aforementioned 130-crore citizenry) signed up for this proposal, as Atishi suggested. There’s something to be said about how times change people. A person whose last name ‘Marlena’ was derived from her family’s belief in the Marxist-Leninist strand of godless communism is now asking for deities to be put on currency notes as a policy measure. I guess this is how things roll in politics. Keeping an open mind, I looked around for evidence correlating having Lakshmi Ji and Ganesh Ji on currency notes with economic growth anywhere in the world. I didn’t make much headway. No developed nation has ever had them on its notes. Indonesia did issue 20,000 Rupiah notes from 1998-2005 with Ganesh Ji on them, but it was discontinued in 2008. The Indonesian economic growth during those intervening years was nothing to write about. I also came across a few Devdutt Pattnaik videos on Lakshmi Ji and yajman and how the yajman must make sure she doesn’t leave them. Very compelling stuff. Considering he was with the Future group during those days and it has since gone into bankruptcy, I’m not sure it helped much there too. The bottom line, there isn’t a lot of academic literature out there to help with the Kejriwal thesis.The AAP move has spawned numerous opinion pieces, of course. Some have accused them of soft Hindutva (a unique Indian term like ‘mild lathicharge’) and being a ‘B team’ of the BJP. Others have lamented the loss of idealism in politics. And then some think it is the pragmatic way for Kejriwal to turn the tables on the BJP and nothing more should be read into it. Well, who knows? I think it is helpful to examine this in the context of public choice theory. There are three conclusions one can draw from this, which I will elaborate here.Firstly, we must acknowledge that any political system, particularly a democracy, rewards a politician who appears to be doing the right things. Now, what’s the ‘right thing’ is defined by the moral standards prevailing at a particular time in that society. Most politicians will try to do what is considered good by the people. But moral standards aren’t constant. They change with time. An astute politician, therefore, needs to be morally flexible to change according to what’s considered good at a point in time in society. Moral rigidity might be good for philosophers and idealists but not for politicians. There’s no incentive for a politician to question the prevailing moral standards. A rare politician who does that is playing a high stake game. They often lose. And a politician who loses is worthless. The conventional moral standard prevailing now in India allows Kejriwal to make a statement like this. Anyone in India can now position their bad-faith actions or beliefs in a way that they fit this conventional standard. Politicians are power-hungry. Their incentives are aligned that way. A singular pursuit of these incentives separates a good politician from the bad one. It makes them sociopaths, but that’s an unfortunate side effect they learn to live with over time. The question in India today shouldn’t be why Kejriwal is making such bizarre demands. The real question is what does it say about our society that politicians can make such demands in the garb of what is good or right for the society. Secondly, there’s this belief that democracy, with its periodic elections, changes in the mood of the people and a system of checks and balances can temper this power lust of the politicians and channel it for the good of society. In this view, Kejriwal (or any another politician, really) is making these statements to do well in some elections (Gujarat?), but once he’s in power, his true moral self will be back, and that will be good for the society. He’s got to play the game, you see. There are two problems I see with this thesis. One, it assumes that the conventional moral standards of society are permanent and any number of such statements don’t change them. Once the gains from such a statement are realised, society, like some kind of a memory foam, will remember its original shape and go back to demanding what’s right for it. This is optimistic and isn’t borne out by history. Two, it also assumes that a politician who gets positive returns from this approach will not continue doing so in an ever-spiraling escalation down this path. That will be an illogical option for any power-hungry politician who doesn’t like to lose. He would like to keep doing more of the same if the returns don’t diminish. This isn’t about what’s right. It is about ensuring he gets the power to do what he thinks is right in the larger scheme of things. Politicians are plain old opportunists. This is why I don’t understand how any logical mind can have ‘tribal loyalty’ to a particular political party.Thirdly, some of you may ask this. On the one hand, we advocate free markets, where we believe that individual incentives come together spontaneously for everyone to benefit. On the other, I’m making a case that in the political marketplace, individual incentives don’t work for the overall good. How do I square this? Well, for one, there is a fundamental difference between a businessman (to use a gendered term) and a politician. The businessman has the belief and the incentives (long and short term) to maximise profit. He might couch it with good intentions in his public statements because of his bias for social desirability. This bias won’t change his actions, though, because he’s a rational actor. He might say something against his conviction but he will do exactly what will maximise his incentives. In the case of a politician, this might play out differently. The social desirability bias can, and often does, change their immediate actions in a manner that’s different from their long-term incentives. Not only will he speak against his conviction to be more accepted, he might also act in the same manner. The Kejriwal statement is a good example of this. Also, history has shown that voters are different from consumers. Voters get swayed by emotions, tribal loyalties, affiliations and demagoguery. Consumers might be swayed temporarily, but soon rationality takes over. A good example of this distinction is evident in the film business in India. Over the past few years, the incentive to make films that portray some glorious Hindu heritage without historical basis was quite high. This led to a steady pipeline of films with ever-increasing religious jingoism and ramping up of Hindu ethno-nationalist pride. Yet, within a relatively short period, the consumers have seen through this ‘formula’, and the recent box office rejection of these films bears testimony to this. Free markets have corrections built in because the assumption of rational actors largely holds. That doesn’t work for the political marketplace.At a broader political level, Kejriwal’s statement is an interesting reflection of how the political class is reading society now. Conceptually, there are two possible approaches to contend with the formidable politics of Hindutva. One option is to counter it with the diversity of thoughts and iconographies within Hinduism to deny a monolithic, Abrahamic version of the religion that Hindutva desires to apply to all its adherents. This diversity or internal divisions that often cancelled each other out in electoral politics was considered a societal default position. There wasn’t much to do to change it, except to get the electoral arithmetic right and capture power. That default is changed now and you could try to bring that back. That’s one play in the current political landscape. The other option is to join the Hindutva politics bandwagon, raise new issues, however bizarre and peddle those optics to the public. The goal isn’t to outdo the original Hindutva masters. Pursuing that would be folly. The idea is to make the Hindutva plank par for the electoral course in a manner that voters no longer find it necessary enough to make it a part of their voting calculus. If everyone is on to it, it no longer is a differentiator. It is clear now that the political class is giving up on the first option. There will be greater convergence on the second option. The underlying belief among them seems to be that one can retrace the steps back after having used the second option opportunistically. That’s what those supporting Kejriwal believe. I’m not so sanguine. Postscript: Pratap Bhanu Mehta articulates the fundamental fallacy of an either/or formulation in making these choices in his excellent column in the Indian Express: ‘Why it’s wrong to say that Hinduism is a product of colonialism’. He writes:If the Hindutva project is to homogenise and centralise Hinduism, the answer to that cannot be the historically ill-founded and philosophically inept strategy of denying the historical existence of Hinduism altogether. Or worse, to imagine that pre-modern Hinduism is simply an endless proliferation of sects, walled up, with few interconnections and not dependent on a shared cosmology, social system, or even intellectual concerns. It is to reduce Hinduism to simply an aesthetic heteroglossia, and not take seriously any of its imaginative constructions, intellectual endeavours or practices. If Hindutva uses identity to erase diversity, it is also important to avoid the opposite fallacy: To use diversity to deny the fact that the diverse parts may also be parasitic on referencing a larger whole, and common canons of contestation. India Policy Watch #2: The Tyranny of Context in Electoral SystemsInsights on domestic policy issues — Pranay KotasthaneIsrael voted for the fifth time in four years earlier this week. The former PM Benjamin Netanyahu is set to come back once the arduous coalition-building talks reach another precarious consensus. Opinion pieces routinely refer to this process of coalition stitching in Israel as “horse-trading”. Meanwhile, the vote share of the extreme right-wing party Religious Zionists has more than doubled, and they will now demand their pound of flesh in the government formation talks. One aspect of the Israeli political system should interest many Indians. Unlike India, Israel follows the List Proportional Representation (PR) system. This system optimises for the proportional conversion of vote share into equivalent seat share. People vote for a party, not a candidate. All parties with a vote count above a minimum threshold (3.25% currently) are sure to have their representatives in the Knesset. India follows the First Past the Post (FPTP) system. Voters vote for a candidate. The one who polls the most votes wins. The parties fielding the losing candidates get zero seats, even if they poll just one vote lesser than the winning candidate’s party in every constituency. The disproportionality between the vote share and seat share is a feature of this system, not a bug. So a party with a 30 per cent vote share might be able to win a majority of seats and form a government. Now, one is sure to come across this statement in casual conversations about elections in India: “the root cause of unfair electoral representation is that India follows the primitive FPTP. We should instead move on to a ‘fairer’ Proportional Representation (PR) system, one in which the legislature represents the true vote shares.” But the lived experiences of Israel’s (and earlier, Italy’s) PR system show it’s riddled with problems too. In this article, I explain why PR is an overrated solution to India’s problems with electoral representation.Issue 1: The Purpose of an Electoral SystemA PR system can be perfectly representative and yet utterly dysfunctional. The proponents of the PR system are right when they say that it is fairer than FPTP in translating vote shares into seat shares. By design, it will have another positive effect of having representation of many more political parties in the legislature. At the same time, another inescapable feature of the PR system is post-election coalition-building, in which many fringe parties hold all the aces. Israel’s recent electoral struggles are a case in point. Many smaller extremist parties are openly demanding specific ministerial posts as a precondition for their support to Netanyahu. In a democracy that is 120 times bigger than Israel, this problem of unstable and unworkable coalitions could get amplified. A government would be formed by a coalition of 20-30 parties, and the smaller partners will have disproportional leverage. Fewer governments will complete their full term. Israel has had 25 elections to the Knesset thus far, and only on nine occasions has the government completed or come closer to completing the four-year term. Confronting the trade-off between fairness in translating vote shares to seat shares and effectiveness in creating governments that can perform is inevitable. And I’m not sure if the PR system in India can strike the right balance. I spoke with a friend who understands India’s polity much better than me. In his view, the fundamental goal of an electoral system is not necessarily proportional representation but to render a government legitimate. And on that count, Indian governments elected using the FPTP system have been broadly accepted by the Indian electorate after the elections. The current government is testing the limits of this acceptance, but its legitimacy to govern is not under serious question yet.Issue 2: The Party vs the LegislatorIn a PR system, the legislator is virtually a rubber stamp, as candidates vote for parties, not specific candidates. The political party is at the front…

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    #187 Seek Not To Alter Me Sep 25, 2022
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    Programming Note: We will be on a short ‘writing’ break. Normal service will resume from Oct 29.Global Policy Watch: When Traditional Institutions Work Insights on topical policy issues in India — RSJKing Charles III was coronated last week. I saw the pictures of the event, and if you did not know the history of the British monarchy, the whole thing looked like a Monty Python sketch on a Nolan-esque budget. The King wore a costume that might have appeared outdated even in the 12th century when the Westminster Hall was built. The political class in their finery bowed, the aristocracy in splendid robes kept a stiff upper lip, the media continually upped the circus quotient for public consumption, and the Yeomen of the Guard marched in precise steps while some grand music (Handel?) played on. It was all pomp and circumstance (Elgar would have approved).I watched this with mild bemusement. I mean, here’s King Charles III, a man who is reputed to speak to his plants, iron his shoelaces, show strange interest in red squirrels and, who often, rails against scientific revolution and the modern economy. What a strange man to ascend the throne of a nation vastly different from him. He must have found the quaintness of the pageantry to his taste. On the other hand, I’m sure he would have some time during the ceremony contemplated the history of the other Charles (Charlies?), who might have ascended the throne with similar accompanying pageantry.Charles I was beheaded for treason by the parliament led by Oliver Cromwell at Whitehall, not too far away from where Charles III was seated. The second King Charles led a charmed life with childhood exile, a triumphant return to the restoration of monarchy, and finally, a long suspension of parliament in the last years of his rule marking his legacy. Uneasy may not lie the head that wears the crown these days (there’s really no day job here), but Charles III cannot be too careful about the institution that he represents. The institution is in a perilous state, and he’s seen by many as an oddity unfit for the role. The commonwealth states don’t have any time for the monarchy. The link to the colonial past is no longer about nostalgia. That’s been erased and replaced with an indifference bordering on disdain for monarchy and its role during the excesses of colonialism. Among the young in Britain, the support for the monarchy is on the wane. Only 33 per cent in the age group of 18-24 support monarchy today compared to the 59 per cent who did a decade back. Some feel with the passing of Queen Elizabeth II, the institution of the monarchy will struggle to remain relevant or to serve its vital role of being the ceremonial head of the state. An elected president could do it better. I mean, what’s the point of monarchy barring providing grist to the paparazzi mill, occasional photo shoots with visiting heads of state and announcing a few royal honours every year? Why spend enormous money and effort propping up an archaic and undemocratic institution? Why have a democratic constitution and then have a hereditary basis for choosing the head of the state? Isn’t that a traditional and conservative imposition on the people?I have more than one reason to support such traditionalism in a democratic polity.Firstly, people need symbols and customs that represent continuity with their past. This assurance that you are part of an unbroken chain that holds all that’s good and great about your culture gives meaning to many people's lives. That it extends beyond the personal (faith and family) to the political in how you organise your community and run your nation makes it both an anchor to hold a society steady and an escape valve that lets off any built-up steam of anger. Old institutions build up their influence over the ages. This is how they become easier to follow at any given time. This is a vital capability to preserve in any democracy.Writing in the mid-1860s, Walter Bagehot, the editor of the Economist then, made an insightful observation of how to create and nurture a good Constitution that will clarify this capability further:In ..constitutions there are two parts (not indeed separable with microscopic accuracy, for the genius of great affairs abhors nicety of division) first, those which excite and preserve the reverence of the population — the dignified parts, if I may so call them; and next, the efficient parts — those by which it, in fact, works and rules. There are two great objects which every constitution must attain to be successful, which every old and celebrated one must have wonderfully achieved every constitution must first gain authority, and then use authority, it must first win the loyalty and confidence of mankind, and there employ that homage in the work of government.There are indeed practical men who reject the dignified parts of government. They say, we want only to attain results, to do business: a constitution is a collection of political means for political ends, and if you admit that any part of a constitution does no business, or that a simpler machine would do equally well what it does, you admit that this part of the constitution, however dignified or awful it may be, is nevertheless in truth useless. And other reasoners, who distrust this bare philosophy, have propounded subtle arguments to prove that these dignified parts of old governments are cardinal components of the essential apparatus, great pivots of substantial utility; and so they manufactured fallacies which the plainer school have well exposed. But both schools are in error. The dignified parts of government are those which bring it force which attract its motive power. The efficient parts only employ that power. The comely parts of a government have need, for they are those upon which its vital strength depends. They may not do any thing definite that a simpler polity would not do better; but they are the preliminaries, the needful prerequisites of all work. They raise the army, though they do not win the battle.Secondly, in this age of polarisation and tribal loyalties trumping reason, the idea of an apolitical sovereign reigning as the head of state is appealing. There’s a hope there that such a sovereign might not help rally people toward a populist cause but could perhaps hold them back from falling prey to raw emotions and passions. This moral authority, however undeserved, can constrain any political movement that threatens to derail democracy in the name of populism or majoritarianism. There’s an additional element to the exercise of undemocratic sovereign power. When things are going good, the checks and balances of power between the legislature, executive and judiciary work effectively. There are debates and consultations before a consensus on the way ahead is arrived. But in times of crisis and exigencies, there’s a need for an additional reserve of power or authority that can supersede or expedite the usual decision-making process of a democracy by imposing its will. A constitutional monarchy run on a parliamentary system has that reserve. A presidential style of government lacks this and runs the risk of not being agile enough to counter such exigencies. Like Bagehot put it:“at a quick crisis, the time when a sovereign power is most needed, you cannot find the supreme people. There is no elastic element, every thing is rigid, specified, dated. Come what may, you can quicken nothing and retard nothing. You have bespoken your government in advance, and whether it suits you or not, whether it works well or works ill, whether it is what you want or not, by law you must keep it.”Lastly, a functioning and aware monarchy helps assuage the deeply embedded anxieties about identity in society while gradually accepting the inevitable change that times bring with it. One of the things that the British monarchy, with Queen Elizabeth II at the helm, did well was to stand for what was to be British in times of tremendous upheaval. She was resolutely Christian, proud of the empire, rarely apologetic about its excesses, devoted to her duty as the unelected sovereign and funny in a very British way. Each of these was (and is) a fault line in a society wanting to modernise and cast away the sins of its past. She carried them along because maybe she understood the importance of being a gradualist. Or it is likely the legacy of the institution guided her to be one. It is strange, but the monarchy, the most top-down of the institutions, perhaps has been the bulwark against any hastily concocted plans of a top-down imposed change in societies. I went back to some of the early speeches of Queen Elizabeth II to see if she always knew this was what she had to contend with being a modern constitutional monarch. It could be her speech writers who saw this, or it could be her imprint on them, but her early speeches give a sense of her awareness about this. In her coronation day address, she said:The ceremonies you have seen today are ancient, and some of their origins are veiled in the mists of the past. But their spirit and their meaning shine through the ages never, perhaps, more brightly than now. I have in sincerity pledged myself to your service, as so many of you are pledged to mine.Therefore I am sure that this, my Coronation, is not the symbol of a power and a splendour that are gone but a declaration of our hopes for the future, and for the years I may, by God's Grace and Mercy, be given to reign and serve you as your Queen.Parliamentary institutions, with their free speech and respect for the rights of minorities, and the inspiration of a broad tolerance in thought and expression - all this we conceive to be a precious part of our way of life and outlook.During recent centuries, this message has been sustained and invigorated by the immense contribution, in language, literature, and action, of the nations of our Commonwealth overseas. It gives expression, as I pray it always will, to living principles, as sacred to the Crown and Monarchy as to its many Parliaments and Peoples. I ask you now to cherish them - and practise them too; then we can go forward together in peace, seeking justice and freedom for all men.Listen, much of this can seem like pompous drivel to the more cynical among us. But it is uplifting and meaningful to a lot more. There’s a lot worse that was being said—then and now—to people from positions of authority. I’d rather have thousand-year-old institutions rooted in modern or outdated traditions speak uplifting drivel like this. People should get more of this.It applies to India too.Matsyanyaaya: The Chips are Down for Russia's Defence CompaniesBig fish eating small fish = Foreign Policy in action— Abhiram Manchi & Pranay Kotasthane(An edited version of this post first appeared in the Times of India’s September 23 edition)Russia is considered a dependable defence partner to India, and rightly so. An underlying assumption is that Russia will continue to be a reliable supplier even in the future. But this assumption fails to consider that Russia’s defence production capabilities will continue to decline well after the ongoing war in Ukraine ends. Here’s why.Consider these telltale signs first. Russia has delayed the delivery of two Talwar-class stealth frigates for up to six months. There are also short-term delays in the supply of S-400 Triumf missile systems and spares for Kilo-class submarines, MiG-29 fighters and Kamov Mi-17 military transport helicopters. These setbacks shouldn’t be dismissed as routine. They indicate a deeper problem: Russia’s inability to access semiconductor chips for defence platforms going ahead.Ukraine put out an alleged shopping list of semiconductors, connectors, transformers, etc., that Russia is desperate to purchase. Politico, a US-based media company, divided this list into three parts Critical, Important, and Not-so-important. The Critical list has some chips of basic complexity, such as connectors, and memory chips, besides digital signal processors and Field Programmable Gate Arrays (FPGAs), which fall slightly higher in the complexity grade. There are no cutting-edge chips on the list. These items are pretty standard and can be manufactured on a large scale in most cases. This surprising lack of complexity in Russian equipment has also surprised the US. There have been claims that college students majoring in electrical engineering could reverse engineer and build most of the electronics used. Also, there have been instances of Russian-guided missiles missing their mark purely due to the old versions of navigation systems.When Russia invaded Ukraine in late February, the US quickly banned selling semiconductors used in defence systems to Russia. The new controls target chips, encryption software, lasers and sensors, etc., for Russia’s defence industry. The other three pillars of the semiconductor industry, i.e. Taiwan, South Korea and Japan, also banned the export of items through the export control list provided by the US. These controls essentially mean that none of the high-end chips will be available for use by Russia. Russia also does not have the infrastructure to manufacture these chips domestically. Only two Russian companies, Angstrem-T and Mikron Group, are reported to have elementary production-grade chip manufacturing capabilities.As a result, Russia is feeling the pinch. It is running low on hypersonic weapons because of the unavailability of microchips. Examination of the remnants of the missiles Russia launched on Ukraine showed the usage of older technology parts with elementary GPS systems. Sometimes Russia even used chips taken out of dishwashers and refrigerators.This puts India in a precarious position. India is the largest importer of Russian weaponry in the world. Even after the ongoing war ends, it is unlikely that the West will remove these high-tech sanctions. With these constraints to negotiate, Russia could proceed in two ways, neither of which augurs well for India.As seen in most weapons in Ukraine, Russia could use chips from western manufacturers by indirectly sourcing them. It is tough to track chips once they leave the foundry, as there may be multiple unregulated second-hand markets for them. There are also third-party firms sourcing chips and then directly selling them to Russia. While Russia has been a reliable defence partner of India, it would prefer to replenish its declining stocks of chips before considering India’s requirements. From the Indian perspective, even if Russia does continue the supplies, India has to think twice before using chips obtained from these dark markets.The other option for Russia’s defence industry is to approach China and obtain the chips from them. While this may work for Russia and be advantageous for China to have Russia in their debt, India has to be wary of these Chinese chips entering into the defence equipment being sent to India. Do we want Chinese chips in our missiles and submarines?Whatever the option Russia opts for, India must prepare for a sharp drop in Russia’s ability to deliver on defence purchase orders. Their technology is dated, and the chips would come from the black market or China. There will also be delays and cost overruns, with supply chains disrupted, financial systems in tatters and Russian manufacturers closing shop. India will now also face issues with its exports to other countries, a case being the partnership with Russia to work on assault rifle export.Given the reality of Russia’s defence sector, India must diversify its weaponry in the short term and focus on local manufacturing over the long term. Regardless of Russia’s intentions, its capability to meet India’s defence needs has taken a big hit. India must utilise partnerships with the US, Japan, Australia, France, and Israel to secure defence equipment and chip supplies. India Policy Watch #1: India’s Semiconductor Policies v2.0Insights on burning policy issues i…

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    #186 Of Magnitude and Littleness* Sep 18, 2022
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    India Policy Watch #1: The Anatomy of DecentralisationInsights on topical policy issues in India— Pranay KotasthaneThe human-made floods in some parts of Bengaluru generated much furore. Writing about it in our previous edition, RSJ remarked:The way the political economy is structured right now, it is difficult to see how there will be enough devolution of power and finances to a city. A big city most often is a bankrupt political orphan in India. It doesn’t look like changing any time soon.I share his anguish. However, I remain hopeful because there are many global examples of cities first committing themselves to and then rescuing themselves from the tyranny of half-hearted decentralisation. Decentralisation: Take 1The term decentralisation is a catch-all term in public policy. There was a time when it was touted as the solution to all ills. But many PhD dissertations, journal papers, and World Bank projects later, we understand it better now. Throwing some light on this concept can help us put a finger on what’s exactly wrong with Indian cities. Let’s begin by understanding the three forms of decentralisation — deconcentration, delegation, and devolution. Deconcentration is the simplest form of decentralisation. As the name suggests, it means decentralising functions and responsibilities. For example, if you can submit a passport application in Mysuru instead of having to come to the state capital, this function can be said to have been deconcentrated. The various government branch offices and grievance centre kiosks are examples of deconcentration. Delegation means that specific functions are carried out by another organisation or the government nearest to the citizen on behalf of the more distant government. In the Indian case, the plethora of state public sector enterprises (SPSEs) for public transport, power distribution, and water distribution are examples of delegation. For example, BESCOM is a Government of Karnataka company tasked with the responsibility of supplying electricity to the state capital.Devolution is the most comprehensive form of decentralisation. Devolved units hold defined spheres of autonomous action. Policy implementation and authority shift to the government nearer to the citizen. This typically means having elections at the subnational level. For example, Indian states are devolved units with clearly defined responsibilities, and tax revenue handles in the Constitution.With these definitions at hand, we have one way to diagnose the dismal performance of our city governments: the Union-State government relationship is characterised by devolution, while the State-local government relation is characterised by delegation and deconcentration. Elections do take place at local government levels. After the 74th Amendment in 1992, some more functions were devolved to urban local bodies. And yet, they hardly enjoy autonomy and authority in any defined sphere. State governments tightly control resources, personnel and plans, treating local governments as deconcentrated implementing agencies. Decentralisation: Take 2There’s another way to see the Indian experience in light of decentralisation theories. Decentralisation can happen along three dimensions — political, administrative, and fiscal. These dimensions are further characterised by four factors: authority, autonomy, accountability, and capacity. The USAID Democratic Decentralisation Programming Handbook has a helpful framework that combines these three dimensions and four characteristics. In the chart below, here’s how I think India’s urban governments fare on the twelve parameters at their intersection. My crude classification into three categories is subjective and based on my understanding of local government public finances. Even so, this framework can offer valuable insights into India’s urban governments. First, they are characterised by poor capacity across all three dimensions of decentralisation. Hardly surprising. But here’s something more interesting: urban governments in India do pretty okay on administrative decentralisation, not so well along the political dimension, but score a big zero on the fiscal dimension. Devesh Kapur writes, “At the heart of state-building is a fiscal story”. And so, it’s not unexpected that the sorry state of fiscal decentralisation is a powerful reason behind the abject failure of our urban governments. The Way AheadAnd so, to fix our cities, we need energy and focus on improving along the fiscal decentralisation dimension. And how exactly do we get there? In this talk below, organised by the Bengaluru Navanirmana Party, I propose a few ideas for the Bengaluru government:* “Wherever possible, charge”: underpricing leads to overconsumption. Cities ought to get better at generating non-tax revenues.* Strengthen the State Finance Commissions. It’s amazing how bad they are, despite the example of the stellar performance of Union Finance Commissions. Untied grants through the state finance commissions are imperative for devolving critical political and administrative functions to urban local governments. * Rent out property owned by city governments. * Simplify laws for regulating businesses in the city so that trade license fees can go up. * Capitalise on the property tax potential.India Policy Watch #2: This Moment is Precious Insights on topical policy issues in India — RSJThe more perceptive among you, dear readers, might have espied a certain pattern in my posts over the past six months. On the one hand, my tone has been steadily bullish on the medium-term prospects of the Indian economy. Almost four months back, in edition #168, I concluded that the then-nascent Ukraine war and the inflation roiling the developed world have put India in a sweet spot among global economies. I wrote:“I’m not often optimistic on these pages. But the way the stars have aligned themselves, India does have an opportunity to revive its economy in a manner that can sustain itself for long.”Then in edition #182 (Aisa Mauka Phir Kahan Milega?), I sort of doubled down on this:“For India, all of this is a golden opportunity. China will remain busy with these transitions that it has wrought upon itself. The jury is still out on whether it will have a soft landing on them. Global businesses that started seeking more resilient and cost-effective alternatives to China during COVID-19, are now convinced that they must employ a ‘China + 1’ model to safeguard their long-term interests. There are only that many economies that have the labour pool, capital and a business environment that can take advantage of this shift away from China, however gradual.There is a high likelihood of a golden decade ahead for MSMEs in India if it plays its cards right.”In the past couple of weeks, there has been a flurry of reports from global research firms echoing the same sentiments. IMF, usually the last to know what’s happening around the world, also seems to have cottoned on to this trend. This week its chief Kristalina Georgieva said that “despite global uncertainty and headwinds, India continues to be a bright spot in the global economy.” The proximate reasons are evident all around. Domestic demand is strong, inflation isn’t the runaway kind, the bank balance sheets are stronger and cleaner than ever, and we seem to be seeing off the peak of the commodity cycle. The other large emerging markets have their own troubles. South America is in the throes of one of its ‘how to shoot yourselves in the foot’ scenarios. Brazil is going through its most fractious election campaign ever, with the hard-left rhetoric of Lula seemingly ahead of Bolsonaro. That’s been enough for Bolsonaro to again take a leaf out of Trump’s playbook and raise doubts about the integrity of the electoral process. Venezuela has a Hugo Chavez bhakt running against a populist ‘outsider’ who wants to upend the system and start fresh. Turkey has an autocrat who turns macroeconomic theory on its head in running its economy. South Africa is muddling through, and Russia is mostly an international pariah at the moment. Indonesia and smaller economies like Vietnam and Laos are possibly the only emerging markets that can claim to be in a similar zone as India. There’s no competition, really.On the other hand, I have called out India’s remarkable ability to lose its way because of either overconfidence or distracting itself with a ‘zero return’ nationalist agenda of aatmanirbharta or some random ‘One Country - One X’ ideology. Like I wrote in edition #182:“…not overdoing aatmanirbhar Bharat beyond the rhetoric and remaining an open and liberal democracy that convinces others that it will have sufficient checks and balances to not lose its way. These are the basic block and tackle moves to capitalise on the opportunity.Because the only lesson to learn from a possible China misstep is that overdetermined leadership and top-down economic thinking eventually fail.”It becomes challenging to plan for India's long-term prospects because of this dichotomy of being bullish on its economy while being worried about social harmony. I mean, one day, you applaud the entrepreneurial spirit taking root in small-town India and the other day, you hear another state enacting some love jihad law.It is like that E. B. White quote:“I arise in the morning torn between a desire to improve the world and a desire to savour the world. This makes it hard to plan the day.” Anyway, for the sceptics on either side, I will try to go beyond the evidence that people are good at avoiding. There are structural reasons why both these arguments about India hold.Let’s tackle the issue of why India is in this sweet spot.Firstly, in the past few years, there’s been a retreat from globalisation, or hyper globalisation , as Dani Rodrik would put it. This was somewhat inevitable if you go by Rodrik’s trilemma: it is impossible to enjoy the fruits of integrating with a hyper-globalised economy, national sovereignty and being a democracy simultaneously, because only two of these things can be achieved at any one time. Rodrik believes that eventually, most large economies will choose national sovereignty and democracy and retreat from globalisation. This has come to a pass all over the world now. India, which has always been somewhat ambivalent about globalisation, now finds it doesn’t stick out because of this stance. This retreat has meant that any economy with a large domestic market is at a relative advantage. Through a fortuitous mix of demographic dividend and periodic fiscal stimulation, domestic demand in India is going strong. This will attract capital flow into the economy.Secondly, the widespread adoption of digital means for production and distribution has meant the traditional constraints of infrastructure and labour laws aren’t as binding as before. The national digital infrastructure in India (JAM, FASTag, UPI, etc.) is among the best in the world, and there’s evidence now that they are improving domestic efficiencies across multiple sectors. Even surface transport, railways and ports have improved substantially in the last few years. These are nowhere near world-class, but the improvement is sufficient to reduce service costs across industries. Also, while ‘retail’ corruption remains an issue in India, even the most prominent critic of the current government will admit that large-scale institutional corruption is a thing of the past. There are allegations of crony capitalism which might come back to bite in future, but for now, India provides as good a level playing field as any other emerging market.Thirdly, the aftermath of the pandemic has been surprisingly benign for India. The extended credit scheme for small businesses, free food distributed through PDS for BPL families and the restrain shown in keeping the fiscal deficit in check appear to have paid off. The national-level vaccination drive has all but erased the memory of those traumatic days of the second wave. Contrast that with China’s botched vaccination policy that is still hurting its economy. I will confess I didn’t see this scenario unfolding. Even the Ukraine war and the rise in oil price has been managed well. In continuing to buy oil from Russia (now in INR) and allying with the US on Quad, India seems to have manoeuvred the geopolitical storm well. Despite strong misgivings in some quarters (with good reasons), the key institutions (central bank, market regulators) have stayed objective and independent in their policy thinking. The bar on strong and independent institutions in emerging markets is set really low, and India seems to be scaling it easily. Finally, the freedom to raise or issue debt in its own currency, the inflating away of debt that’s happening now and the flexibility of the labour market, all mean India isn’t in any near-term danger of stagflation that’s spooking the west.Many of the above factors can be credited to the sound policy measures taken over the past two decades. And, there’s, of course, the good fortune of being in the right time at the right place.All good. So, why do I harp on the risks of social harmony and overdetermined leadership? Well, the history of many emerging countries is replete with such moments of opportunity in their history. Barring a few exceptions, most have failed to capitalise on them. They didn’t get their economics wrong. Most often, they failed on political and social fronts.It turns out that being a functional, liberal democracy does improve your odds of getting this right. However, in most cases of failure, countries turned more illiberal, assuming it won’t hurt them. Curbing freedom of expression, compromising judicial integrity, restricting voting rights of minorities and abusing coercive power of the State are classic moves here. This is abetted by creating an ‘us’ versus ‘them’ construct that takes over everything. The blame for any shortcoming can be laid at the doors of ‘them’, who typically include the old elites, intellectuals and some hapless minorities. Once this template is set, the divisiveness in the society between ‘them’ and ‘us’ is played up at every opportunity. The pitch is queered further by the revisionist history project to redress past wrongs, the mindless glorification of the nation, a continuous search for enemies among the ‘them’ and escalating levels of punishment for any deviation from the norm. The middle continues to shrink, and debates and compromises become rare. Everything is maximal. Many people think these moves won’t hurt the economy because in markets, as the Indian aphorism goes, ‘paisa bolta hai (money talks)’. This is both a flawed understanding of economics and a complete disregard for history. A society that loses its middle ground makes terrible choices. And that shows up in the economy.We have a tremendous economic opportunity because of the way cards have fallen in our favour. And we are making the classic mistakes in potentially fomenting social trouble and losing the opportunity again. I don’t understand why it is difficult to hold these two ideas together in our brains and find a way forward.There’s a possibility that this dichotomy could be solved if there were public discussions on these issues together. But it is rare to find that kind of a platform where a dispassionate and constructive discussion about India’s future is possible. Those who believe in the ‘sweet spot’ thesis have very little inclination or a sense of historical perspective to appreciate the existential risks of social disharmony. They are happy nodding off to ‘this is India’s time’ lullaby. While the others who bemoan the loss of what’s often called the idea of India cannot believe India could be, by design or happenstance, sitting on a golden opportunity under this regime. There must be a catch somewhere and they spend inordinate amount of time looking for it. It reflects the barren intellectual landscape prevalent in India that we cannot acknowledge an…

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