#208 Go Shape the Molten Metal Now*

9 May 2023 · Anticipating the Unintended

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

Insights on issues relevant to India

— RSJ

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

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

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

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

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

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

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

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

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

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PolicWTF: Tariff ki Taareef Mein

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

— Pranay Kotasthane

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Global Policy Watch: What Fed Learnt From SVB Failure

Reflection on global policy issues

— RSJ

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

As the Economic Times reports:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

India Policy Watch #2: Devil and the Deep Sea

Insights on issues relevant to India

— Pranay Kotasthane

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

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

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

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

…

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

[The Indian Express, April 21]

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

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

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

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

HomeWork

Reading and listening recommendations on public policy matters

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

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

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

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

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

*From the poem Opportunity by Raymond Garfield Dandridge

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

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#240 Peering Into the Future
14 Jan· Anticipating the Unintended
Prediction Time
—RSJ
In a year when countries as diverse as India, the United States, the United Kingdom, Russia, Taiwan, Pakistan and Palau go for their elections, it is tempting to go for an overarching theme for the year while looking ahead. Unfortunately, like these aforementioned elections and the many others that will see about 50 per cent of the human population exercise their democratic choice, there seems to be only a messy mix of political signals emerging from them. Illiberal forces are rising in some places, and autocrats are rubber-stamping their authority in others. Democracy is blooming afresh in a few, while the trends of deglobalisation and closed borders are resonating among others. Of course, there are the wars old and new and, maybe, a few more round the corner to complicate any attempt at a broad narrative for the world. To add to the woes of anyone trying to write a piece like this, the economic macros globally look volatile and inchoate. There is increasing talk of a soft landing of the US economy while the EU and the UK stare at another lost year. Depending on who you speak to, China has either put its economic issues behind it and is ready to charge back with its investment in future technologies like AI, EVs and hi-tech manufacturing, or it is at the “Japan moment” of the late 80s. Japan, on the other hand, is itself having a brief moment of revival, and no one knows if it will have legs or if it is yet another false dawn.
It is foolhardy to purvey macro forecasts in this environment. But then this newsletter won’t write itself. No? So, I guess the best course then is to make more specific predictions instead of taking big swings and hoping those come true while the macros swing wildly. This will also satisfy Pranay’s pet peeve about generic predictions that I mentioned in the last newsletter. So, let me get going with 10 somewhat specific predictions for next year.
* President Biden will decide sometime in early February that he cannot lead the Democratic Party to power in the 2024 elections. He will opt out of the race and give possibly the most well-backed Democrat, financially and otherwise, a really short window of four months to clinch the nomination. In a way, this will be the best option for his party. If he continued to run for the 2024 elections, it would have been apparent to many in the electorate that they are risking a President who won’t last the full term. If he had opted out earlier, the long-drawn primary process would have led to intense infighting among the many factions of the party, eventually leading to fratricide or a Trump-like populist to emerge perhaps. A narrow window will allow the Party to back an establishment figure and reduce the fraternal bloodletting. Who will emerge from this is anyone’s guess. But whoever it might be, if (and it is a big if) they have to come up against Trump, they will lose. To me, the only way Trump doesn’t become the next President is if he isn’t on the ballot. And the only way that looks possible is if he loses his legal battles. Otherwise, you will see a second Trump term which will be worse than the first one.
* There’s way too much confidence about the Fed having piloted a ‘safe landing’ for the US economy despite the many odds that were stacked against it. I think this is fundamentally misplaced. The fiscal deficit is unsustainable, and much of the soft landing is thanks to it. The GDP growth has been supported by an almost doubling of the federal fiscal deficit. This won’t last. The higher rates that haven’t yet led to any real string of bankruptcies or asset bubble collapses will begin to make an impact. The geopolitical risks that have only been aggravated in the last 12 months and the increasing protectionism worldwide will make it difficult to sustain growth at 2023 levels. My view is that the real landing will be in 2024, and it won’t be soft.
* China will get more adventurous geopolitically as it weakens economically. Look, the property market crisis is real in China and given the influence it wields on its economy, it is difficult to see any return to the ‘normal’ 8 per cent growth anytime soon. The local government finances will worsen, and there is a real possibility of a few of them defaulting. There will be more fiscal support to prop up the numbers and more packages for sectors in stress. Foreign inflow will continue to be anaemic, though it won’t be negative, as it turned out late last year. The Chinese customers' long-awaited consumption spree isn’t coming in 2024. All in all, China will stutter while still wowing the world with its progress in tech.
* BJP will come back to power, but it will fall a bit short of 300 seats. This will surprise many, considering the continued electoral success of its machinery and all the Ram Mandir ballast it plans for itself from this month onwards. There are a couple of reasons for it, largely driven by electoral arithmetic across the states where it did very well in 2019 and where a repeat showing will be difficult. Also, the sense of complacency about winning it hands down will mean a letup in the door-to-door mobilisation model that it has perfected. All of this will mean a decline in 30-40 seats across the board. The new Modi cabinet will be a surprise with new Finance and Defence ministers and a whole host of new faces as it goes for a generational change in leadership.
* The somewhat surprising trend of record US deficit going hand-in-hand with the relatively strong showing of the dollar in the past two years will eventually come to a face-off. And my guess is 2024 is when the dollar will blink. As other emerging economies start to trade in currencies other than dollars - who wants to risk more exposure to the dollar? - and its economy doesn’t have a soft landing like I predict, US dollar will be hit. My guess is that 2024 will be the first year of a 3-4-year dollar down cycle. In the next year, I predict the dollar to fall by 10 per cent against most world currencies. This might not hold with India because we are a bit of a unique case. But a dollar slide looks inevitable to me.
* I had predicted a more aggressive anti-trust stance and significant moves against Big Tech by the FTC. It didn’t pan out. So, I will repeat the prediction. Lina Khan, the FTC Commissioner, has a nine-month window to go after them, after which it isn’t certain she will continue to be in her post. I predict a big scalp during this time, which will then be legally challenged. But expect a tough couple of quarters as she and her team do their best to leave a mark for the future.
* The Indian economy will continue its trend of surprising on the upside, though I think global headwinds will temper the overall growth. I expect a 6.5 per cent growth with the inflation at the 4.5 per cent mark through the year. The much-awaited capex cycle will not be broad-based and will show up in select sectors led by large Indian conglomerates or global platform players. I expect FII inflow to be among the lowest in many years in 2024, and much of the equity market will be buoyed by domestic fund inflow into the market. The Nifty will remain flat or be up 5 per cent because of global weakness and the relative overvaluation seen already.
* The Israel-Hamas war will end faster than people think. Maybe by April. Not because there will be some solution agreed between the parties. There’s nobody to fight any more in Giza. The Hezbollah won’t get involved, and the Houthi insurgency will be a mere storm in the teacup. On the other hand, the Ukraine war will continue with no real end in sight during the year. A Trump (or Republican government) in 2025 will likely stop funding the war, and that will pressure Ukraine to negotiate with Putin. But that’s for 2025.
* Two specific corporate predictions: One, AI will continue to impress us with its capabilities without making a dent on real business. So expect to be surprised by a best seller written by an unknown author that will later revealed to be an AI-trained algorithm. Or a music album, even. There will be many conferences and papers, but AI's wider impact will still be distant in 2025. Two, I think Novo Nordisk will be well on its way to becoming the most valued company in the world in 2024. It might become the most valued in Europe during the year itself as it will struggle to produce enough of its weight loss drugs to keep up with demand.
* I forecast one of two contentious pieces of legislation will come into play after the elections are over. We will see a real move on either the Uniform Civil Code or on one-nation one-election (ONOE) at the back end of the year. These are issues close to this government; they will get these going right after the elections.
That’s that, then. We will see how they go during the year.
India Policy Watch: The Services vs Manufacturing Debate
Insights on current policy issues in India
— Pranay Kotasthane
Breaking the Mould: Reimagining India's Economic Future, a book by economists Raghuram Rajan and Rohit Lamba, has started a much-needed discussion on India’s future growth trajectory.
The authors challenge the dominant narrative that India should imitate the manufacturing-led growth strategy followed by the East Asian countries. They instead point to India’s comparative advantage in low-end and high-end services, making a case for a policy reprioritisation to double down on these strengths. The book argues that replicating China's manufacturing success is neither possible nor desirable.
Not possible because manufacturing supply chains are shortening due to increased protectionism and higher rates of automation, making the conditions far more difficult than what China faced. Moreover, China hasn’t gone away; it remains a formidable competitor in manufacturing.
Replicating that success might not even be desirable, they contend, as the value added in a product’s manufacturing stage is dwarfed by the value captured in the upstream R&D stage and the downstream services (branding, marketing, content production, etc.) stage. And hence, they are against the kind of subsidies on offer for electronics and chip manufacturing assembly. The Micron chip assembly plant is a particular thorn in their eye because it will cost Indians $2 billion and produce a mere 5000 direct jobs with no R&D spillover.
They argue that services and Services for manufacturing are the sweet spot for India to focus on. The money splurged on manufacturing and assembly should be ploughed back into education and health, priming India’s human capital for global success.
In sharp contrast, international trade economist Devashish Mitra makes the case that low-end export-led manufacturing (such as in textile, apparel, and leather) is the only way out for India. In his book review for the Economic Times, Mitra writes:
“India is a labour-abundant economy. This abundance is in low-skilled labour, given that almost 80% of its working-age population does not have even a higher secondary education, with only an eighth of the working-age population having studied beyond high school. While India adds 8-10 million people to its labour force annually, roughly 2 million are college-educated or beyond. There is also a wide variation in the quality of degree programmes across India, most of which cannot impart marketable skills. Thus, high-skilled workers are scarce.Standard international trade theory tells us that an economy abundant in low-skilled labour, when open to international trade, will specialise in low-skilled labour-intensive production activities, which are the ones in which such a country has its inherent comparative advantage. Furthermore, India's technology-driven comparative advantage is also expected to be in low-end manufacturing activities, as those would be the ones in which India's productivity disadvantage relative to advanced economies would be the least, for example, textiles, apparel and footwear. Thus, high-skill specialisation for India, as envisioned by Rajan and Lamba, would have to defy standard international trade theory.”
Mitra also points out that the government should prioritise solving the unemployment problem, the only way around which is low-end manufacturing because IT and IT services have historically had comparatively low levels of employment growth.
Reading these two perspectives over the past few days has been rewarding. This is precisely the debate that needs the attention of our policymaking elite. At this stage, I have three initial observations.
One, the services vs manufacturing is a false binary. Both views are actually quite similar in their essence because they both advocate capitalising on India’s comparative advantages. That advantage lies in high-end services such as chip design and in low-end manufacturing such as textiles and footwear. There is no need to choose just one of them. Success in both areas needs the same ingredients—eliminate self-defeating policies, improve skilling, pass trade-friendly reforms, and invest in health and education.
Two, I feel the criticism of low-end chip and electronics assembly misses an important consideration. If chips are the building blocks of the Information Age, it makes sense for India to begin the journey at the lower end of the chip manufacturing supply chain and climb up that ladder over two decades or so.
Jobs generated per rupee of money spent is not the only criterion that should motivate economic decision-making. For example, India’s nuclear energy sector is not evaluated primarily on the number of jobs it creates. Similarly, the primary goal of building the intellectual and manufacturing capability for making chips is to reduce critical vulnerabilities in the future. India can pursue the twin goals of doubling down on comparative advantages and reducing vulnerabilities simultaneously. In any case, attracting a single 65-nanometre specialised fab (which would cost around ₹10,000 crores) doesn’t come at the expense of a better university education system. India can do both.
Third, the book brilliantly emphasises that the services sector needs a lot more policy focus. Trade economists propose that we are heading towards a future where manufacturing supply chains will become shorter (because of protectionism and China-related fears) while services supply chains will become longer (because of better technology). This implies that services as a percentage of global trade will only rise. When that happens, nation-states will start imposing trade barriers for services, too. So, the Indian government needs to champion trade frameworks that bring down services trade costs.
An analogous case is that of the Information Technology Agreement (ITA) of the WTO. Signed in the nineties, the ITA substantially brought down tariffs on information technology goods and their intermediate products. This move immensely benefited multinational companies and consumers worldwide, including in India. Similarly, it’s time for India to champion a Global Services Trade Agreement that lowers barriers that Indian service providers face in participating in global trade. It also becomes clear why data localisation policies that hamper services exports will have a disproportionately negative impact on India’s economic future.
Finally, do read both the book and Devashish Mitra’s paper linked in the HomeWork section. And yes, check out our Puliyabaazi with Rohit Lamba, which discusses some of these themes.
PolicyWTF: How Pro-Business Protectionism Hurts Indian Women
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
— Pranay Kotasthane
By now, it’s widely known that Bangladesh has eaten away at India’s share in textile and apparel exports. This industry is labour-intensive and employs a significant proportion of women in the formal labour force—46% of all Indian women in the manufacturing sector are employed by apparel and textile industries taken together. Hence, it’s important to diagnose the reason for India’s decline.
As with policy success, policy failure can also have multiple causes. Bangladeshi exports received preferential treatment in the West as part of the latter’s policy to help poorer countries. This is one important reason that helped Bangladesh. However, this reason alone doesn’t explain India's decline in fibre production.
It turns out that the reason is our favourite villain: pro-business protectionism. I learned about this causal linkage from an excellent 2022 paper, Reigniting the Manmade Clothing Sector in India, by Abhishek Anand and Naveen Joseph Thomas.
This is how I understood the story that Anand and Joseph narrate. India has been losing global market share in textiles and apparel since 2011 to Bangladesh and Vietnam. The global demand for artificial fabric-based cloth (such as polyester) is far higher than that for natural fabric-based cloth (such as cotton) for cost and durability reasons. Thus, India’s underperformance is largely due to a decline in its exports in the artificial fibre segment.
And why is that the case? The most important input for the polyester fabric is a chemical called Purified Terephthalic Acid (PTA). The villain enters the scene. In October 2013, the two major domestic producers of PTA (Reliance Industries Ltd. and Mitsubishi Chemical Corporation India Ltd.) petitioned the government to impose anti-dumping duties on imported PTA. The government agreed. The anti-dumping duties were supposed to remain in force for six months. But they were kept in force for over six years! To make matters worse, the government imposed additional import tariffs on PTA in 2018 as part of its atmanirbharta driveoverdrive.
This rise in PTA costs had a cascading effect on the downstream fibre-making and apparel industries, making their products costly even as Bangladesh continued enjoying preferential tariff treatment in the EU. Vietnam benefited from trade agreements with Australia, Canada, the EU, and also the RCEP. The productivity of India’s textile sector declined, and many potential jobs vanished in thin air, disproportionately impacting women.
There’s an even uglier face to this fiasco. While large sections of Indians lost out, the position of a select few protected businesses improved. Vertically integrated firms with a presence in the entire supply chain from PTA to polyester yarn, and finally, apparel, benefited immensely as their competitors had to pay higher rates for the imported PTA. Protected from the cost of imports due to their in-house PTA production capabilities, these companies cornered a bigger domestic market share. Notably, their lower productivity means that even these protected firms can’t compete in the global market.
This a canonical example of how pro-business policies hurt markets and people. Even though the government dropped the anti-dumping duties on PLA in 2020 and started a Production-linked Incentive (PLI) for textiles, it simultaneously increased import duties for the downstream polyester to now protect domestic yarn producers from foreign competition! Talk about learning from past mistakes. PolicyWTF indeed.
In any case, do read the entire paper. It’s written lucidly, without the jargon and the scary Greek alphabet.
HomeWork
Reading and listening recommendations on public policy matters
* [Article] Martin Wolf has an excellent column in the Financial Times on liberalism and its discontents. It cites the Inglehart-Welzel Cultural Map to argue that even if there is no ‘clash of civilisations’, there seems to be a ‘divergence of civilisations’ on freedom-related questions. As an aside, I observed that there is no data for India in the seventh round of the World Values Survey, which covers the period 2017-21. Does any reader know why? Is it a story similar to India pulling out of the PISA rankings?
* [Video] This is a good conversation on Devashish Mitra’s paper Manufacturing-fed, Export-led Growth for Gainful Employment and Skill Creation. The presentation has no scary equations, and the discussion is insightful.

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#239 Of Screws and Racquets
7 Jan· Anticipating the Unintended
Happy New Year
— RSJ
Happy 2024, dear readers!
We hope 2023 was good for all of you. If it wasn’t, we are glad that it’s behind you. We didn’t have too bad a 2023 ourselves. This newsletter went along swimmingly (or so we think) and we had our book ‘Missing in Action: Why You Should Care About Public Policy’ published on 23 January 2023.
Why haven’t you bought it yet?
Anyway, it seems to be doing well based on the modest expectations we had of it. I’m yet to see the pirated versions of it peddled at traffic signals. Heh, that will be the day. But then I see it on shelves of all decent bookstores and that’s quite reassuring. That apart, Pranay had another book (one productive chap, I tell you), When The Chips Are Down on semiconductor geopolitics which is an area that’s going to get more interesting and contentious in this decade. All in all, we ended up writing 44 editions during the year totaling up to over a hundred thousand words. A good year, I guess.
On to 2024 then. Like in the past, we will indulge ourselves a bit in the first edition of the year. First, looking back at our predictions for 2023 and seeing how badly off we were and then next week, I will be doing a bit of crystal ball gazing for 2024.
Before I bore you with that, let me share with you this wonderful excerpt from a paper I read recently. Titled ‘Enlightenment Ideals and Belief in Progress in the Run-up to the Industrial Revolution: A Textual Analysis’, it covers an area of eternal fascination for me - Enlightenment and its impact on Western Europe.
Interesting conclusions and a must-read:
“The role of cultural attitudes—specifically, of Enlightenment ideals that had a progress oriented view of scientific and industrial pursuits—in Britain’s economic takeoff and industrialization has been emphasized by leading economic historians. Foremost amongst them is Joel Mokyr (2016), who states that the progress-oriented view of science promoted by great Enlightenment thinkers, such as Francis Bacon and Isaac Newton, among many others, was central to what would become the “Industrial Enlightenment,” and ultimately Britain’s Industrial Revolution. In this paper, we test these claims using quantitative data from 173,031 works printed in England in English between 1500 and 1900.
A textual analysis resulted in three salient findings. First, there is little overlap in scientific and religious works in the period under study. This indicates that the “secularization” of science was entrenched from the beginning of the Enlightenment. Second, while scientific works did become more progress-oriented during the Enlightenment, this sentiment was mainly concentrated in the nexus of science and political economy. We interpret this to mean that it was the more pragmatic works of science—those that spoke to a broader political and economic audience, especially those literate artisans and craftsmen at the heart of Britain’s industrialization—that contained the cultural values cited as important for Britain’s economic rise. Third, while volumes at the science-political economy nexus were progress-oriented for the entire time period, this was especially true of volumes related to industrialization. Thus, we have unearthed some inaugural quantitative support for the idea that a cultural evolution in the attitudes towards the potential of science accounts in some part for the British Industrial Revolution and its economic takeoff.”
2023 Predictions Scorecard
I had 8 predictions across the global economy, Indian economy and Indian social and political order. So, this is how does the 2023 report card looks like.
Global Economy
This is what I had written:
#1 The trend of securing your supply chain for critical products will get stronger.
….but it is clear to most large economies that on issues that concern national security, it will be foolhardy to not plan for worst-case scenarios any longer. And national security could mean anything, really, but I can see on energy and key technology, nations will opt for more secure supply chains with watertight bilateral partnerships than be at the mercy of distributed, multilateral chains. I won’t go as far as calling it ‘de-globalisation’ yet, but this ‘gated globalisation’ is a trend that’s here to stay.
This is playing out but a bit slower than what I expected. Disentangling and building domestic capabilities isn’t easy. And it is costly. But through the year we had increasing curbs on what hi-tech (GPU chips, AI research) and defence companies domiciled in the West could export to China. At home, we continued the push on PLI on electronics and tech equipment with debates on how much value-added manufacturing is really coming through in these schemes. Also, interestingly, we are continuing down the path of decoupling from global ‘default platforms’ especially in financial services. The Rupay platform is continuing to get bigger with a specific push from the government to derisk payment infrastructure from global networks like Visa and Mastercard. Also, in a recent statement, the central bank has suggested building a homegrown Cloud Computing infrastructure that will be used on regulated entities in India so that they aren’t tied into global Cloud service providers.
#2 The fears of elevated inflation and a recession in the US in 2023 are overblown. The recession is due, but it will come a bit later
My view is that as supply chain issues ease up with China opening up, energy demand going up and the US continuing to be at almost full employment, we might have a 2023 where for the most part, the US inflation will be higher than target, Fed will continue to remain hawkish, and the growth will hold up. This will mean the real risk of recession will be more toward the end of the year than now.
Turns out I was accurate. In fact, the US economy has held up even better than I expected. And the Fed almost softened their tone by their last meeting of the year.
#3 Big Tech will continue to be under the cosh
I half expect India to gradually move all payment and eCommerce arms of Big Tech into a structure that’s domestically controlled and owned in 2023. Third, FTC, with Hina Khan at the helm, will accelerate antitrust and competition law changes to reduce the dominance of Big Tech.
I think I got this right in a big way. Through the year, fintechs have offloaded ‘troublesome’ shareholders (read Chinese investors) and there is a real trend of what’s called ‘reverse flipping’ where unicorns that were domiciled outside of India for tax and regulatory reasons are coming back home. Reason? Well, if you ask them they will tell you because they believe in the India story. That’s very convenient. The real reason is domestic regulators are making it difficult for a non-domiciled company to get a full bite of the Indian apple. From data security and storage requirements to tax and fund transfer regulations, the entities that are essentially Indian but are registered outside India to avoid ‘regulatory inconvenience’ are now facing business inconvenience in following that model. Here’s more on this.
Indian Economy
I think I wrote more about the Indian economy in 2023 than any previous year. Much of it was about my surprise, in a positive way, on how much better it was doing than my expectations. Now as I read what I had written at the start of 2023, I think I had somewhat forgotten during the year that I was quite optimistic about the economy at the start of the year. Here’s what I had written:
#1 Greater optimism
I am a bit more optimistic about the broader numbers than most, and I will explain why. I think GDP growth will come in around 6.5 per cent for FY24, and inflation will be around 5 per cent. We might see a couple of rate hikes in the next few months, taking the repo rate to 6.75 per cent, but that will be it. I see domestic consumption to remain strong and exports, in the light of the shift away from China, to be good for manufacturers, and how much ever I might struggle to get behind the PLI scheme, it will yield some short-term benefits. IT exports might be a dampener, but on balance, I see more upside to these predictions.
Couldn’t have gotten it more right. I think the growth for FY 24 might come in at 7 per cent. Repo ended up at 6.5 per cent and domestic consumption and manufacturing have stayed strong while IT exports have gone worse over the year.
#2 Digitalisation: Wave 2
There will be a significant push on digitalisation in lending and eCommerce. The UPI infrastructure has revolutionised payments and, along with GST, has accelerated the formalisation of the economy..... Also, as I mentioned in an earlier point, doing this will also mean shifting the balance of power from Big Tech-owned entities to an open platform or domestically controlled entities. I sense a strong push in this direction in 2023.
This was a no-brainer, really. I expected a bit more traction on platforms like OCEN and ONDC which haven’t taken off yet. The digitisation of the financial services sector has made low-value credit much easier for people to access. And UPI and digital KYC have enabled that to an extent that unsecured individual lending saw its biggest year ever in 2023. In fact, by the end of the year, we saw the central bank intervening to increase risk weights on these advances for banks and NBFCs and trying to bring down growth rates. The risk of an asset bubble because of faster and easier access to credit seems to become real based on the data they were reading.
#3 The expected capex cycle push from the government will not come.
There are a couple of reasons for it. First, this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency. The other reason for a muted capex spend is the likely belief that the private sector credit capex cycle seems to be picking up.
Got it mostly right except for the private sector capex cycle bit. That didn’t show up in 2023 as I was expecting. Government capex actually slowed as it kept its glide path to a 4 per cent union deficit by 2026. The efficiency improvement in tax collections and subsidy disbursement also helped in broadly sticking to the fiscal plan for the year. And as I expected, this government doesn’t need to loosen its purse strings in an election year. It has multiple other tools in its armoury to swing people’s opinion in favour of it.
India: Political and Social
I had generally anticipated a more-of-the-same year despite some of the noise surrounding opposition efforts at the start of 2023. BJP with PM Modi at the helm, is possibly the most formidable political force in the world and it can turn its missteps too into its advantage. We saw this during the pandemic when its response was poor and too late. But that’s all water under the bridge now. It is also helped by a coincidence of circumstances where China has gone off-track and India is able to play its ‘swing power’ role to its fullest advantage in global geopolitics. All of this has meant it has a compelling domestic narrative to offer to the people of India rising in global prominence. This has tremendous capital at least among the middle class and the Hindi heartland. Back to what I wrote at the start of the year:
#1 More of the same
The expected consolidation of opposition forces to counter the BJP isn’t going to happen early enough for it to mount a credible challenge in 2024. There are eight state elections in 2023, and I suspect BJP will see reverses or very close fights in a couple of them where it is the incumbent (MP and Karnataka)....But it is hard to see opposition consolidation or a credible case that they can make to counter the electoral juggernaut of the BJP at this time. Congress, the other national party, isn’t capable of moving the masses either with its agenda or its leadership. The vacuum in national politics looks set to stay.
Ho hum. BJP lost Karnataka like I thought they would. MP was a surprise and it only shows how poorly Congress has performed through the year. Everything else is, as they say, same same.
#2 More Exit, Less Voice
I have made the point in the past about social fault lines tripping us up while we magically have a growth window that’s opened up for us again. This holds true. The space for opposition or dissent has shrunk; more importantly, even the fight for protecting or broadening that space has gone out....The state would be dependent on citizens if they value their loyalty and would then pursue a policy that listens to their voice. However, if the state doesn’t value it and the citizens know their voice won’t matter, the only option is to exit. For certain sections of our citizenry, they are possibly at this stage of engagement with the state. This scenario might not hurt the majority today, but we would do well to remember it has never been a good idea for the state to not value the loyalty of its citizenry in the long run.
Nothing has changed on this. I guess this macro trend has only exacerbated in 2023.
So there I am with my report card. Not too bad, I guess though Pranay may again complain that these were quite generic and unless we make very specific predictions, it all seems to come true at the end of the year. Well, I will try to do that next week with my 2024 predictions. But don’t hold your breath on that, Pranay.
A Framework A Week: Four Components of an Economic Strategy
Tools for thinking about public policy
— Pranay Kotasthane
Montek Singh Ahluwalia writes that any economic strategy has four components: slogans, targets, programmes, and policies.
Slogans refer to rhetoric employed by the government. Ahluwalia calls it the “front end” of economic strategy. Rhetoric is necessary in a representative democracy for communicating the government's position on an issue in a simple, catchy form without going into the details of the accompanying policy measures. Think Garibi Hataao, Shining India, Inclusive Growth, Sabka Saath Sabkaa Vikaas, and Minimum Government and Maximum Governance.
Targets are specific, measurable goals of an economic strategy. An example is the articulation that India will become a developed country by 2047. The World Bank comes up with a GDP per capita threshold for classifying an economy as a high-income one. So the target becomes a guiding light for policies and programmes and also serves as a tool for holding the government accountable.
Programmes refer to government-led measures involving public expenditure. Policies are government directives that allow or disallow specific economic activities. The difference can be understood using another popular three-fold classification which says that all governments do only three things — produce, finance, and regulate. This means programmes are government actions that involve producing or financing, while policies are about regulating. For example, bank recapitalisation is a programme where the government is financing public sector banks. In contrast, the Foreign Trade Policy 2023 lays down the rules that govern all exports and imports.
This four-fold classification is useful for policy analysts for two reasons. One, it doesn’t look at slogans cynically. Economic narratives are important. Slogans are often launchpads for powerful narratives.
Secondly, differentiating policies from programmes is crucial. The default government tendency is often to bat for government-run programmes. Think Production-linked Incentives (PLI) and export subsidies. There are enough and more programmes from the past to tinker with and regurgitate them into a new programme to “solve” the economic problems of the day. However, chronic economic problems might need a fundamental change in policies that cannot be fixed by programmes alone. India’s manufacturing underperformance is one such example. Though there have been many a programme for overcoming this challenge, the solution lies in changing trade, tax, labour, and doing business policies. Another example comes from the 1991 economic reforms. At the time, many politicians thought that India only needed a debt restructuring programme. However, the reformers successfully argued that India needed a change in tax, business, and investment policies; a new programme alone wasn’t good enough.
For an illustration of this framework, check this article by Montek Singh Ahluwalia on the problem with India’s public sector banks.
PolicyWTF: Screws are Strategic
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
— Pranay Kotasthane
The Department to Ground Foreign Trade, or less accurately, the Directorate General of Foreign Trade (DGFT), is a gift that keeps giving. Their latest policy move is to restrict the import of cheap screws so that India can become a self-reliant vishwaguru of screws. A screwpower, maybe?
In a notification issued on 3rd Jan, the DGFT banned the imports of screws priced lower than ₹129/kg. Indian manufacturers used to import these from France, China, Australia, Bangladesh, Brazil, and Belgium.
So, the government wants to do an import substitution of a humble product that costs ₹129 per kg and already has a diversified supply chain. If this isn’t ridiculous enough, think about the impact on Indian manufacturers who relied on these imports. They are the ones getting screwed here because they will end up paying more for the same product.
Long-time readers might experience déjà vu as there was a similar policy restricting the imports of mosquito electronic racquets in 2020, to which RSJ had paid proper obeisance in edition #129.
In other news, one of the issues blocking the India-UK FTA is that Indian EV car manufacturers don’t want the high import duties to be dropped. Currently, electric cars priced above $40000 are slapped with a 100 per cent import duty, while those below $40000 are levied a 70 per cent duty. Domestic manufacturers argue that a reduction in import duty will stall the sunrise industry.
These two stories in recent months illustrate the slippery slope of industrial policy in low state capacity conditions. A domestic subsidy for manufacturers can still be justified because every other country is doing that. It’s become an entry pass of sorts to play the manufacturing game. But to couple domestic production subsidies with import restrictions makes these policies scarily close to the import substitution regime in the pre-1991 era.
Every government makes mistakes. However, low state capacity results in governments repeating the mistakes of the past as there is no institutional memory. We seem to be reaching that point with India’s industrial policies.
This observation also stands empirically. Check out the New Industrial Policy Observatory (NIPO) released by the IMF (hat-tip to Niranjan Rajadhyaksha for sharing the accompanying paper on X). The database classifies industrial policy actions over the last few years into eight categories: export barriers, import barriers, domestic subsidies, export incentives, FDI measures, Public procurement measures, Localisation content measures, and miscellaneous. This is by far the most detailed database of industrial policy measures I’ve seen—a fantastic tool for scholars working in economic policy.
Now here’s my initial analysis looking at the data for India in NIPO. Of the 195 industrial policy measures that India has taken, 55 are distortionary trade measures, illustrating that we are repeating import substitution ideas of the past. There’s more to this. In the database, one can also classify industrial policies sectorwise. Here again, we see that import tariffs feature across most sectors.
Such mindless import substitution will lead to export contraction, as Indian companies become uncompetitive and bow out of international competition. We have seen this movie before.
P.S.: Look at this chart of trade as a per cent of GDP for the world’s five largest economies. Trade is a higher proportion of India’s GDP than is the case for Japan and China. It’s been that way for the last ten years. Trade is far more important to India than we realise.
HomeWork
Reading and listening recommendations on public policy matters
* [Book] Vivekananda: The Philosopher of Freedom is a thoroughly enjoyable, myth-busting biography.
* [Blogpost] This post has a mind map of market failures and corresponding government interventions. A boon for anyone interested in public policy.
* [Podcast] Listen in to a Puliyabaazi with economist Rohit Lamba on India’s future economic trajectories. This is a fun episode.
* [Paper] A useful take on Foreign Trade Policy 2023 in Economic and Political Weekly.

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#238 Everything's Connected
18 Dec 2023· Anticipating the Unintended
India Policy Watch #1: Like a Kid in a Candy Store
Insights on current policy issues in India
— Pranay Kotasthane
In the previous edition, I asked you to name your favourite sports policy to date. I don’t have a great answer myself. Nevertheless, my candidate would be liberalising FDI in retail.
When posed with such questions, we often get anchored to the way governments are organised. The best sports policy can only be made by the sports ministry; the best education policy can only be made by the education ministry, and so on. These answers assume that the public policy system is a linear, deterministic system with a small number of variables and negligible overlap across ministries.
But as we discussed in edition #213, it is useful to characterise public policy as a complex system. Such a system is greater than the sum of its parts and these parts interact and share information with each other. Complex systems display non-linear behaviour as small actions can have large effects while large actions can have small effects. As a result, decomposing the system into its constituent parts, and analysing them separately often results in inaccurate analysis.
Deploying the complexity lens makes us think beyond narrow sectoral policies. In the case of sports, it means we can think beyond the obvious candidates such as Target Olympic Podium Scheme (TOPS), Fit India, or Khelo India. As an amateur sports enthusiast, I contend that liberalising FDI in retail had a disproportionately positive impact on sports in India because that policy led to the world’s largest sporting retailer setting up shop in India.
Until fifteen years ago, buying sports equipment was not very different from purchasing soap at a kirana store. The options were limited and the buying experience was consistently disappointing. Moreover, equipment of only the most popular sports found space in the retail storefront.
All that changed with the entry of the French sports retailer, Decathlon; first in the cash-and-carry segment starting in 2009 and as a single-brand retailer in 2013 after the FDI policy allowed 100% FDI in single-brand retail. Decathlon has given the Indian sports enthusiast a choice and a range of sporting equipment that my 20-year-old self would find unimaginable. Allowing FDI in e-commerce was the next step jump, making these sports equipment accessible to people outside Tier-I cities.
I wish we had a real study of the consumer surplus generated by FDI liberalisation. Nevertheless, this example shows how sector-agnostic liberalisation can have a major impact. Ten years after the entry of Decathlon, further liberalisation of multi-brand retail is needed to bring more competitors into the sector, benefiting Indians at large.
Of course, no one policy can solve all problems. All success is multi-causal, especially in a complex system like public policy. But my aim here was to make you think beyond ministry turfs when approaching questions of this nature.
India Policy Watch #2: Holiday Reading
Insights on current policy issues in India
— Pranay Kotasthane
The year-end holidays are approaching. So what’s the best way to spend the holidays? Reading, of course. This time around, I want to recommend some classic reports that tried to diagnose India’s condition. Initial conditions matter a lot in a complex system, hence I’ve picked out reports that give a fair account of the problems that India inherited in various domains around the time of independence.
* Economy: Milton Friedman visited India twice in the 1950s and wrote two stunning articles on “Indian Economic Planning” and “A Memorandum to the Government of India 1955”. His diagnosis rings true even today. Centre for Civil Society has compiled the essays into a book.
* Public Policy and Administration: Paul Appleby’s Public Administration in India-Report of a Survey was an important report where the American consultant tries to diagnose problems with India’s public administration. The report is available on the Internet Archive.
* Science Policy: AV Hill was called by the British government in 1943 to advise on the organisation of scientific and industrial research in India. Some of our over-centralised scientific establishment cut off from the university ecosystem can be traced back to this influential report.
* Politics: It’s amazing how Ambedkar’s diagnosis is accurate in so many areas simultaneously. In Thoughts on Linguistic States, he identifies “one language, one state” and “one state, one language” as the two different approaches for state creation. His election manifesto for the Scheduled Castes Federation from 1951 identifies problems with India’s economy, foreign policy, and society. On the emotional issue of partition, he displays an amazing clarity of thought and analysis. With the benefit of hindsight, we can say that his analysis foresaw events and phenomena other leaders of his generation couldn’t.
Enjoy reading! And share your thoughts on these reports with us.
HomeWork
Reading and listening recommendations on public policy matters
* [Paper] The 2023 RBI CD Deshmukh Memorial Lecture (there’s also an equally excellent NCAER CD Deshmukh Memorial Lecture Series) by Arvind Panagariya argues that India could become the second-largest economy, surpassing the US, 50 years from now. You might well disagree with the conclusion, as do I, but the paper’s worth a read.
* [Article] It takes earth-moving prowess to enjoy a monopoly and yet run into a loss. No surprise that only governments are capable of such feats. Shekhar Gupta masterfully narrates how the Delhi Development Authority has an unsold inventory exceeding ₹18000 crore in value, despite the monopoly power it has enjoyed since 1957.
* [Podcast] The always wonderful Rest is History podcast has a seven-part series on the JFK assassination that you mustn’t miss. I was hooked.
* [News] The union government has banned onion exports now. Controls on exports of non-basmati rice and wheat are already in place. Expect more controls until the 2024 elections. With interventions like these, there’s little hope for agriculture to become a normal area of economic activity.

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#237 Looking Under the Hood
11 Dec 2023· Anticipating the Unintended
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India Policy Watch: In Search Of Growth
Current policy issues in India
— RSJ
A quick macro update. The RBI’s Monetary Policy Committee (MPC) met this week and, as was widely expected, kept the repo rate unchanged at 6.5 per cent for the fifth consecutive time. The Governor gave the usual explanation of global political risk, higher volatility in global financial markets, and continued inflationary expectations as the reason for keeping the policy stance unchanged as ‘withdrawal of accommodation’. And the Governor was quite clear that there is no ‘inadvertent’ signalling to the market that it has actually moved to a ‘neutral’ stance with its prolonged pause on rate hikes:
“Reaching 4 per cent (inflation target) should not just be a one-off event. It has to be durably 4 per cent and the MPC should have confidence that 4 per cent has now become durable.
We are very careful in our communication. There is no inadvertence in any of our communication. So, if somebody is assuming that it is a signal to move towards a neutral stance, I think it would be incorrect.”
Well, that takes care of any possibility of a rate cut before next year's elections. And what’s the need, really? Between now and the elections, there’s always an inflation risk on vegetable and food prices. Also, while crude oil price has been on a downward trend during this year which has helped on the inflation front, there’s no guarantee how that will trend given the global geopolitical situation remains uncertain. Most importantly, what’s the need to signal any rate cut when the GDP growth numbers are coming in significantly above even RBI’s somewhat optimistic forecasts at the start of the year? Q2 GDP grew at 7.6 percent, almost a full percentage point above estimates, leading the central bank to up its full-year forecast to 7 per cent. All good news so far. Further, the RBI note had this optimistic comment for the near term:
“The healthy twin balance sheets of banks and corporates, high capacity utilisation, continuing business optimism and the government’s thrust on infrastructure spending should propel private sector capex.”
Well, you can go back to the past six quarters, and you will find similar sentiments about an impending private sector capex boom from both the government and the private sector. But it is turning out to be a bit of a mirage. While both the corporate and bank balance sheets are the healthiest they have been in the past two decades, there is a continued ‘wait and watch’ approach on capex, which has mystified most observers. While the consumption growth remains robust, there are early signs that this lag in private capex is beginning to slow down corporate revenue growth. From the Business Standard:
“.... the slowdown in corporate revenue growth over the last one year has begun to reflect in India Inc’s capital expenditure as there is a close correlation between growth in net sales and investment in fixed assets. The net sales of 725 companies, excluding BFSI and state-run oil & gas firms, were up 4.2 per cent year-on-year (Y-o-Y) in H1FY24 – the lowest half-yearly increase in the last three years and down sharply from 12.2 per cent growth in the second half of FY23 and 31.3 per cent growth in the first half of FY23.”
As if on cue, the Chief Economic Advisor (CEA), picked the issue of sluggish private capex at a CII event this week. Instead of the expected anodyne address at events of this nature, he made some very insightful points. First, he correctly pointed out that to expect consumption to continue to drive GDP growth while private capex sits out for as long as it has defies logic. Consumption, as we have pointed out more than a few times here, is the residual factor. And that’s exactly the point the CEA made (again quoting the Business Standard):
“Waiting for demand to arise before they start investing will actually delay the onset of such demand conditions happening, because usually consumption has to be the residual. Investment leads to employment, which leads to income generation and which in turn creates consumption and then the savings are recycled back into the investment. So the more the corporate sector delays its investment, this virtuous cycle will not materialise.”
Then he mused on what might be holding the private sector back despite strong balance sheets, robust GDP growth and a general sense of global optimism about India’s prospects:
“So what is holding it (corporates) back? It is easy to say that there is general demand uncertainty. Post Covid, recovery has started. But one thing we have to remember is that this decade is going to be the decade of uncertainty, whether we like it or not. So for us to wait for the uncertainties to abate or recede, [its] like waiting for the waves to subside before taking a dip in the ocean. That is not going to happen.”
I won’t be surprised if there will be more plain-speaking to corporate India coming in the next few quarters on private capex from the government—three reasons for that.
First, the government has pushed its capex targets in the last two budgets and, somewhat surprisingly, kept pace with them. The public capex has grown at a CAGR of over 30 per cent in the last three years. It is now about 3.3 percent of GDP as opposed to the 1.5 per cent it used to be pre-pandemic. The government has found resources to fund this capex by trimming subsidies following the pandemic and by the continued growth in tax collections because of the efficiencies brought in with GST and the rapid digitalisation of the financial system. However, given the fiscal deficit constraints, this public capex growth will be difficult to sustain at this clip. Couple that with the recent data that shows household savings at a multi-decade low of 5.1 per cent of GDP, there is no other lever of growth to pull except private capex.
Second, given global uncertainty and the ‘higher for longer’ expectations in developed economies, the annual FDI flows have been the lowest in this fiscal year than at anytime in the past decade. The venture money in the form of investments by VCs and PEs has also dried up with a general ‘funding winter’ that has left all but a few startups untouched. While there’s stronger global demand for the MSME sector that’s visible across the board, it will start hitting the wall of lack of funds in the near term unless large capex projects take off and the general sentiment of investment picks up in the private sector, which then lifts all boats.
Third, this government is instinctively fiscally conservative and likes to stick to its targets. It has set a target to reduce the fiscal deficit by 1.5 per cent of GDP in the next two years. That apart, the imminent inclusion in global bond indices will also mean a greater level of scrutiny of public accounts. The government would like to project an image of fiscal prudence to boost confidence of investors. So, I don’t see a continued heavy lifting through public capex as has happened in the past couple of years.
Which then brings us back to private capex and that question of what’s stopping it from taking off. I think CEA has a point on the general aversion of the corporates to any kind of uncertainty which has continued for so long that it seems like despite all the talk, they are unable to take the final leap in making that investment. Will this go away in due course? I guess it is possible that the Lok Sabha elections may be the final trigger which may kickstart the process.
But that apart I think there are two other points that remain unaddressed. One, the promoters are yet to come to terms with the new regime of greater scrutiny by banks when they borrow, an insolvency process where they can lose control of their companies and the limited degrees of freedom to do the kind of ‘excesses’ they did in the past in the garb of capex. These ‘reforms’, while good for the economy as a whole, haven't been fully assimilated in the minds of Indian promoters. The better-governed promoters will start taking the leap, and others will reluctantly come along after appreciating this is the only way things are going to get done from here on. Two, while there have been good steps to improve the ease of business, there is a huge opportunity to push for more fundamental factor market reforms to improve risk-taking and bring in a new generation of entrepreneurs in sectors beyond services. Possibly, this should be the big agenda if the inevitable third term materialises in May 2024. Private capex is the big lever still waiting to be pulled.
Growth cannot come out of thin air, after all.
Numbers that Ought to Matter: In the ongoing Parliamentary session, the Ministry of Health and Family Welfare answered a question on the number of medical colleges and MBBS seats in India. There are 706 medical colleges in India, admitting 1,08,848 MBBS students annually. Over the last ten years, the number of MBBS seats in India has more than doubled (there were 51,348 seats on offer in 2014). However, the total number of seats on offer is quite low despite India now having the largest number of medical colleges in the world. On average, each medical college has just 154 seats. By 2020, China had 420 colleges offering 286,000 seats (i.e. 680 seats per college). Government policy should focus on helping existing colleges scale up. For more context, read edition #159.
Also, do check the new Rajya Sabha and Lok Sabha websites. They are useful data sources. Navigating the questions and government responses is much easier now. However, a lot of data remains locked in PDF files. That’s for another day.
A related project idea: Someone should parse the “Question Subject” field and classify it into meaningful categories. Maybe AI tools can help here. This data could be a proxy for the subjects that India cares most about. The next step would be to track if the subjects inviting the most questions successfully influence government policy. Any takers?
A Framework A Week: A Taxonomy of Defence Innovation
Tools for thinking about public policy
— Pranay Kotasthane
On November 30th, the Defence Ministry approved IAF’s capital acquisition proposal for 97 Tejas Mk1A aircraft. This move signals a major shift — India’s armed forces have accepted the Tejas platform as a replacement for their inventory of old and outdated, mostly Russian, aircraft.
This news item got me thinking about the process of defence innovation. What are the factors governing defence innovation? How are these factors related to each other? Why do some countries do better on this front than others? A search for answers to these questions led me to an excellent framework by Tai Ming Cheung in the Journal of Strategic Studies.
Instead of identifying a simplistic policy answer, Cheung looks at defence innovation as a system composed of several interrelated factors, as shown in the chart below.
In Cheung’s classification, there are seven types of factors:
* Catalytic factors are exogenous inputs that disrupt the defence innovation system. Examples include external threats, top-level leadership support, and revolutionary breakthrough opportunities.
* Contextual factors account for all path-dependent variables such as historical legacy, level of development, market size, etc.
* Input factors are the ingredients of defence innovation. Examples include Foreign Technology Transfers, budget allocations, human capital quality, and Civil–Military Integration.
* Organisational factors refer to the capabilities and mandates of organisations set up to deliver defence products.
* Institutional factors refer to shared norms, plans, strategies, intellectual property protection, and government-market relations.
* Networks and sub-systems include formal and informal networks linking various sub-systems.
* Output factors shape the final products coming out of the system. Examples include sales, marketing, commercialisation, and maintenance.
This approach allows the author to create a typology of defence innovation regimes, wherein specific pathways within the chart get amplified. Two such types relevant to India are incremental and rapidly catching-up regimes.
In incremental catch-up regimes, catalytic factors don’t play a significant role. Such countries produce incremental improvements by parsing input factors such as technology transfers through organisational factors (military and state agencies) and institutional factors (plans, strategies, and norms). The paper identifies India as a prominent example of this regime. Cheung illustrates the model as follows.
Rapidly Catching-up Regimes are underdeveloped defence innovation systems pushed by catalytic factors towards increased resource allocations and a strong research and development sub-system. Cheung classifies North Korea and China in this category. This model is illustrated in the chart below.
Readers should check the full paper and other regime types based on this framework. But the relevant question for us is this: has India transitioned from an incremental catch-up regime to a rapidly catching-up one?
There are some positive signs. Catalytic factors are playing a far bigger role now than in the past. This is mainly because China’s aggression and Pakistan’s relative decline have led to a new emphasis on the defence innovation system. The PM’s recent sortie in the Tejas illustrates that another catalytic factor—“top-level leadership support”—now has a more prominent role. There is also more focus on civil-military integration, diffusion networks, and technology development than in the past. And given that India enjoys a positive relationship with the US, the possibilities of “Foreign technology transfers” (a crucial input factor) are substantially higher than in the past.
The weakness is in the organisational realm. That part of the system is still governed largely by state-run entities with low technology absorption capabilities and fewer incentives for efficient production. The capabilities of universities and laboratories are also quite limited. The procurement system, classified as a network and sub-systems factor, is another weak link that discourages innovation while protecting inefficient government-run firms.
My subjective assessment using this framework is that India is catching up faster than before. It doesn’t seem to be “rapidly” catching up, though. Further, the more radical pathways, which lead to rapid breakthroughs in defence innovation systems, remain out of reach.
Whatever your assessment, Tai Ming Cheung’s framework is useful and helps clear many cobwebs of defence innovation.
HomeWork
Reading and listening recommendations on public policy matters
* [Question] What, according to you, is the Indian government’s best sports policy to date? Please drop a comment with your reasoning. We will put across your views and ours in an upcoming edition.
* [Podcast] The latest Puliyabaazi discusses the politics of polarisation. Gaurav Sood, a political scientist who has worked on this topic for over a decade, gives a detailed account of the psychological underpinnings of polarisation.
* [Article] This article on industrial policy challenges some of our Bayesian priors. More importantly, it links to many recent papers showcasing empirical research on industrial policy measures.
* [Article] A good article explaining how DARPA functions.

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#235 Right Diagnosis, Wrong Prescription
27 Nov 2023· Anticipating the Unintended
Read the full text here.

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#221 The Good, the Bad and the Ugly
24 Sep 2023· Anticipating the Unintended
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#220 (China+1) Or (1-China)?
24 Sep 2023· Anticipating the Unintended
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#219 Of Sins, Bets, and Bluffs
24 Sep 2023· Anticipating the Unintended
Full text here.

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#218 TechTalk
30 Jul 2023· Anticipating the Unintended
The full text is here.

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#217 False Hopes and Weak Promises
30 Jul 2023· Anticipating the Unintended
The full text is here.

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#216 Thick and Fast
2 Jul 2023· Anticipating the Unintended
Read the edition here.

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#215 Of Openings and Possibilities
2 Jul 2023· Anticipating the Unintended
Read the edition here.

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#214 The Stakes are High
13 Jun 2023· Anticipating the Unintended
Financial Regulation of Private Firms + Emigration of Indian Talent

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#213 The Mind Plays Tricks
13 Jun 2023· Anticipating the Unintended
India Watch #1: Of Protests and Perfect Tricks
Insights on issues relevant to India
— RSJ
For nearly a month now, some of India's top wrestlers, who between them have earned over 25 medals in various global competitions, have been protesting against the conduct of the Wrestling Federation of India (WFI) chief and BJP MP Brij Bhushan Singh. This is not an ordinary protest. The allegations in the FIR against Singh are quite serious, including a couple of instances of demanding sexual favours as a quid pro quo for professional assistance, about 15 incidents of sexual harassment and stories of inappropriate touching, and molestation of minor girls. You would imagine this would be some kind of an open-and-shut case.
I mean, here are a few women wrestlers who have everything to lose here by taking a stand against their own federation and the government. They aren’t superstar cricketers with financial security and access to media. They don’t have multi-million and multi-year sponsorship deals or lucrative post-retirement commentary gigs waiting for them. Their sport is everything to them, and they are willing to risk that one thing they have loved doing all their lives. These are girls who have come up the hard way in a society that doesn’t prize either women or sports and especially women in sports. They have persevered despite the odds against them because that’s what athletes do. So, the least you would have thought is that while the police investigations and the judicial process is going on, or, as we like to say in India, as the law takes its own course, the government should ask the WFI chief to step down temporarily. Surprisingly though, this doesn't seem to be a priority for the government. Instead, it appears they would rather suppress these voices than address their concerns. So, last week while you had saturation coverage on various channels about the inauguration of the new parliament building, these athletes were being roughed up and assaulted at the site of protest. There was barely any TV media there.
As they say, there are always two Indias at work.
It is tempting to zoom out a bit and say that this story, in many ways, reflects the current state of Indian politics and society. It is not there yet. But there is a pattern in how we are dealing with protests and dissent that merits a deeper look. Before I go there, let me count the number of ways we have got this thing wrong.
Firstly, for decades, we have managed sports and their governing bodies in India in the most unprofessional way possible. These positions have often been given to politicians as small consolation prizes to run their minor fiefdoms. Corruption, nepotism and high-handedness of officials have come along with this. Read any autobiography of an athlete in India and you will be struck by the remarkable apathy and neglect they had to overcome from their own sporting federation to succeed. As major sports events like the Olympics or Asian Games approach, there's often a question of why our sporting performance doesn't reflect our population size and recent prosperity. This story never gets old. While we have seen some improvement in the last decade, we remain an underperforming nation in sports. One fundamental issue to address is improving sports administration by involving experts with experience in either playing the sport, managing large organizations, or possessing a proven visionary track record. Indian tennis is a prime example where one family has presided over its administration for over half a century. We have only gotten worse in tennis, with almost no one ranked anywhere in the top 1000 in the world. Similar fiefdoms exist in other sports like boxing, shooting and even cricket.
Despite the efforts of some public-spirited lawyers and a few interventions by the Supreme Court to set things right, things have remained the same. There was some hope when this government came to power that there would be much-needed reforms in sports administration, especially in those early days. However, once you have the keys to the power of the state, it is difficult to resist its benefits. The result is a disheartening situation where politicians with limited understanding or passion for sports lead the federations. We are back to the bad old days now.
Secondly, we seem to be undoing all the progress we have made in addressing sexual harassment allegations in the workplace. There are POSH committees that are legally mandated in organisations and a framework that allows for a safe and secure environment for women at work. In India, the foundation for this framework was based on the Vishaka guidelines set nearly 25 years ago. In cases like this, the employer (in this case, the sports ministry) should form a committee with an independent chair who investigate these allegations and arrive at their conclusions. And it is usual that during such an investigation, it would be appropriate for the accused to step aside for a free and fair process. However, none of this process has been followed. Neither the WFI nor the Indian Olympic Association (IOA) have even acknowledged taking up these allegations. In fact, P.T. Usha, the current chief of IOA and a track legend initially dismissed them as false and an attempt to tarnish our nation's image. We are back in the territory of ghar ki izzat, and the patriarchal attitudes where raising such concerns are seen as bringing dishonour to one's family or damaging a country's reputation. It is concerning that even government officials are not adhering to their own established guidelines.
The response to the protests by both the sporting fraternity and the general public has been surprising. Despite the police manhandling of these athletes, very few voices have come out in support of them, with notable exceptions like Abhinav Bindra and Sania Mirza. Even their anodyne statements hoping that the athletes are given their due and that proper investigations take place seems like an act of courage. The 1983 cricket World Cup winning team, too, came out with a statement expressing anguish at the treatment of the athletes and hoping for a resolution. I’m not sure what resolution they are expecting in a case that should be picked up by the police and investigated with rigour. Quite disconcertingly, although to the surprise of no one, the usual set of partisans and news anchors have questioned the motives behind these protests. The usual whataboutery season is on in the TV debates, and the WhatsApp universities are busy generating content blaming the victims or distracting us with Rahul Gandhi’s US visit. It is a textbook case of a society losing its moral compass today while romanticising its glorious past and its superiority as a civilisation.
In a society where many underprivileged children pursue sports as a means to improve their lives, the exploitation by administrators and coaches within the system should be a matter of great concern. Despite this reality, political affiliations and a belief that our leader can do no wrong is now trumping reason. We now have a situation where there are people questioning the legal process put in place for sexual harassment complaints that apparently favour the woman victims’ rights to fight their case. This mindset risks undoing the progress made towards providing safe working environments for women. We are happy to go down the path of victim blaming and gaslighting than hold men in power accountable. This in a country where crime against women is still among the highest in the world and that has one of the lowest female participation rates in labor worldwide.
So, why is the government reluctant to act against Singh? Based on the track record of how it has handled previous protests, there are three possible explanations for this behaviour.
One, this administration perceives admitting a mistake as a sign of weakness. They would rather make incorrect decisions than appear weak in any way. We have made this point earlier. This is the basis of its electoral appeal. That it can do no wrong. Accepting that the protesters are right will dent its strong government image. Two, there is the electoral angle to this, given we are less than a year away from the Lok Sabha polls. Brij Bhushan Singh's influence in the Ayodhya-Gonda region cannot be ignored. He or his family members have won elections there for over three decades, regardless of their party affiliation. His ability to switch allegiances while maintaining electoral success suggests a ground network that doesn’t depend on a party for success. While the BJP is on a strong wicket for winning 2024, it doesn’t want to risk failure, especially in U.P. This calculus might still turn if the recent mobilisation of the local Jat communities and Khap panchayats to support the wrestlers becomes stronger. This shift may transform the protest into something more politically relevant, as it happened with the farmer protests. I don’t think I had imagined a day when the Khap panchayats would be seen as advocates of women’s rights. But we are there. The third explanation lies in the ruling party's deeper understanding of social undercurrents, which they believe represent the silent majority's views. This covers issues like women's liberation and how India has imitated Western liberal guidelines that aren’t compatible with our civilisational values. They would like to believe that a sizable portion of Indian society may support a pause on liberal issues especially relating to women’s freedom. I’m not very sure if this is an accurate assessment, but it doesn’t hurt to be politically ambiguous on this.
At a broader level, this is also about how we see protest or dissent in these times. It is intriguing how easily people trust the state despite the weight of history against it while distrusting the protesters who have a grouse against the powerful. This is an odd inversion that seems to have arisen because our collective sense of self-worth and pride are now closely intertwined with our perception of how well the state performs. So, questioning its actions or motives can be seen as an attack on the collective self-worth.
It is an almost perfect trick.
India Policy Watch #2: Beyond Isomorphic Mimicry
Insights on burning policy issues in India
— Pranay Kotasthane
“South Korea became a manufacturing and technological superpower riding on industrial policies that backed chaebols (large domestic business conglomerates), so why shouldn’t India do this too?”
“Technological upgradation of Chinese companies happened because of the Party-state’s policies of Forced Technological Transfer, also known as ‘trade-markets-for-tech (TMFT)’. India should adopt this approach as well.”
“France has banned short-haul flights to counter climate change. India should follow this lead and impose green taxes on air travel if not a full ban.”
“Amsterdam has bicycle tracks and Bogota has Bus Rapid Tranist (BRT); so should Bengaluru.”
I’m pretty sure you have come across similar arguments. Not just people outside the government, policymakers and career analysts can also be found making arguments of this nature. Now, it’s easy to ridicule these points of view as “isomorphic mimicry”, what Andrews, Pritchett, and Woolcock define as:
the tendency of governments to mimic other governments’ successes, replicating processes, systems, and even products of the ‘best practice’ examples… a key technique of successful failure that perpetuates capability traps in development.
My instinctive response to such arguments is similar. However, I now think that we need to go one step beyond and ask, “why are we prone to committing isomorphic mimicry? What makes us seek refuge in it?” This post is an attempt to answer these questions.
The fundamental reason behind such arguments is a mental model that imagines public policy as a deterministic process where heroic policies can quick-solution us out of trouble. It is this assumption that we must rethink in order to avoid isomorphic mimicry. Here’s why.
To begin with, we need dollops of humility. Forget quick-solutions, we don’t even know all the variables that impact major public policy processes.
Observe, for instance, the question of economic growth. In edition #52, RSJ explained how there’s no single answer as to why countries experience a period of rapid economic growth. At best, we can identify clusters of factors such as economic freedom, political freedom or institutions, geography, and investment in human and physical capital.
So is the case with innovation. Over the last few months, I tried to understand the reasons behind China’s strides in innovation and technology upgradation. The more I read about it, the more it became clear that forced technology transfer, IP theft, or industrial policy alone cannot explain the transformation. At best, I could come up with the explanation that China's innovation is a combination of fundamental factors and proximate factors. The fundamental factors were: a Capable Workforce, Technology Transfers, and State Focus on Innovation. The proximate factors such as Forced Technology Transfer, IP Theft, Specific Government Policies, and Selective Protectionism have, at best, played a cameo role.
So is the case with urbanisation. We have some good hypotheses about why certain sectors spatially organise into concentrated clusters, but we don’t know for sure what would it take to make a successful new city. We can identify some fundamentals, but it’s difficult to create a pathway.
These three examples illustrate the need to adopt a different mental model to think about public policy. One such frame is complexity theory. Over the last two decades, there have been several attempts to think about public policy as a complex system. Public Policy scholar Paul Cairney explains the attributes of complex systems in these words:
* A complex system is greater than the sum of its parts; those parts are interdependent – elements interact with each other, share information and combine to produce systemic behaviour.
* Some attempts to influence complex systems are dampened (negative feedback) while others are ampliﬁed (positive feedback). Small actions can have large effects and large actions can have small effects.
* Complex systems are particularly sensitive to initial conditions that produce a long-term momentum or ‘path dependence’.
* They exhibit ‘emergence’, or behaviour that results from the interaction between elements at a local level rather than central direction.
* They may contain ‘strange attractors’ or demonstrate extended regularities of behaviour which may be interrupted by short bursts of change. [From Paul Cairney’s post on his ever-excellent blog]
When applied to public policy, this complex system mental model gives us a few axioms.
Policy Ingredients, not Policy Recipes
The complex system lens shows us that it is futile to obsess about deriving policies using “best practices” from another country or city. It is far more important to think about preparing the initial conditions that could trigger emergent behaviour towards the desired policy goal. A government shouldn’t be designing a perfect quick solution to a chronic problem, but creating conditions in which different competing solutions can emerge. In a sense, governments need to put together all the essential ingredients that go into achieving a policy goal rather than create an award-winning policy recipe.
This line of thinking explains national innovation. There's no one blueprint to be found for innovation success. Countries have followed different pathways. But we know that ingredients such as reasonably high levels of human capabilities and infrastructure and strong connections with global science and technology ecosystems are common fundamental factors in innovation success.
Another example comes from economic policy. Pro-market policies are about putting together key ingredients for growth take-off, while pro-business policies are equivalents of step-by-step recipes handed down to you. I used to think that finance ministers claiming “the fundamentals of our economy are strong” was a cleverly-worded evasion. But the lens of complexity would suggest that fundamentals are exactly what the government should focus on.
The Idea of Probabilistic Success
The lens of complexity implies that governments are not as effective in achieving our goals. The best case is when governments have prepared all initial conditions for take off. But that’s no guarantee for success. In the Indian context, this thinking should give us a pause before we airdrop governments as a troubleshooter for all our problems.
The Merits of Decentralisation
In a complex system, it’s beneficial to give agency to organisations so that they can learn from their experience and change tack in response to on-ground conditions. In this sense, complexity theory is a reaffirmation of Hayek’s insight in The Use of Knowledge in Society. Individuals and, by extension, markets are in a better position to experiment and display different emergent behaviours than centrally engineered solutions from the top.
Hope, not Analysis-paralysis
Complexity can at once be liberating and shackling. The insight that there are no perfect policy recipes can drive us into an analysis-paralysis mode, leading to dejection and disillusionment. But the knowledge that given the right conditions, emergent behaviour can spring up unexpectedly gives a reason for hope and provides a new meaning to the shloka, “Karmanye Vadhikaraste ma phaleshu kadhachana” (perform your duty but do not expect the fruits of your labour).
P.S: The complexity theory mental model holds promise in public policy, but at present, there are far more questions than there are answers.
India Policy Watch #3: Why this Kolaveri with Assembly?
Insights on burning policy issues in India
— Pranay Kotasthane
I like the richness of the debate on the production-linked incentive scheme (PLI) for electronics manufacturing. Last week, economist and former RBI governor Raghuram Rajan questioned the government’s self-congratulatory messages on mobile exports using these words:
“.. it turns out that very little apart from assembly is done in India, though manufacturers claim that they intend to do so in the future. So, India imports much of what goes into the mobile phone, and when we correct for that, it is very hard to maintain that net exports have gone up.”
Some of you readers might recollect that we have regularly critiqued the electronics PLI since its inception. Our first post about it was written in November 2020. So, it shouldn’t surprise you that we agree with this recommendation:
The government should undertake a detailed assessment on how many PLI jobs have been created, the cost to the country per job, and why the PLI doesn’t appear to have worked so far before extending it to other sectors.
That said, I have several questions about the analysis.
First, I was surprised that one of the criticisms in the note is that “it is entirely possible that we have become more dependent on imports during the PLI scheme” on account of increased imports of mobile phone components for assembly in India.
It is well-known that imports of sub-components will keep increasing as we scale up assembly in India for a few years until local substitutes come up, as they did in China and Vietnam. Moreover, as we wrote in edition #185, China and Viet Nam witnessed a decrease in the domestic value added per unit of demand when they began assembling mobile phones. Companies preferred to import components, assemble, and then export them. Only after their electronics exports had achieved global scale did the two countries target local content addition.
And hence, we shouldn’t expect quick gains in the Indian case as well. Only after the assembly in India achieves some scale will local suppliers come up. In the Apple ecosystem, for instance, the Final Assembly Testing and Packaging (FATP) units run by the likes of Foxconn are the key nodes. Once they take root, it’s in their self-interest to develop a local supplier ecosystem to meet the unsparing demands of their product launch cycle.
Curiously, a terrible way for governments to reduce the import of components is to raise import tariffs further, a solution that the authors of the note would vehemently disapprove of.
Second, the note proposes that India should make its own chips. Manufacturing chips will help reduce the import bill, and that’s where the government’s semiconductor strategy comes in. However, the path to making a complicated leading-edge processor chip will perhaps take two decades. And to get there, the government would, in turn, need more PLIs and upfront capital investment in fabs. In fact, we should expect higher chip imports from China over the next decade until we have a semblance of chip manufacturing done here. Importing cheap chips from China is not a vulnerability.
In sum, I don’t see a rise in imports of components as an indication of the failure of the PLI, just as I don’t interpret the rise in mobile phone exports alone as an unqualified success.
HomeWork
Reading and listening recommendations on public policy matters
* [Chapter] Don’t miss this chapter on isomorphic mimicry. An old classic.
* [Podcast] On Puliyabaazi, MR Madhavan of PRS Legislative Research discusses all things Parliament. The part where we discuss the impending Lok Sabha constituency delimitation threw up a few interesting alternatives.
* [Blog] Paul Cairney’s long-running blog Politics & Public Policy is a must-subscribe.

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#212 Myths & Misconceptions
13 Jun 2023· Anticipating the Unintended
Being Pragmatic about ESG Norms, Lessons for India's Semiconductor Strategy, and Challenging Common Wisdom about India's Constitution-making.

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#211 Of Motives and Presumptions
28 May 2023· Anticipating the Unintended
India Policy Watch #1: Silly Season Is Upon Us
Insights on issues relevant to India
— RSJ
Late on Friday this week, the RBI issued a circular withdrawing the circulation of ₹2000 denomination banknotes. The RBI clarified that these notes would continue to serve as legal tender, so this isn’t another demonetisation. Here’s the Indian Express reporting:
THE RESERVE Bank of India (RBI) Friday announced the withdrawal of its highest value currency note, Rs 2,000, from circulation, adding that the notes will continue to be legal tender. It said the existing Rs 2,000 notes can be deposited or exchanged in banks until September 30, but set a limit of “Rs 20,000 at a time”.
“In order to ensure operational convenience and to avoid disruption of regular activities of bank branches, exchange of Rs 2,000 banknotes can be made up to a limit of Rs 20,000 at a time, at any bank starting from May 23,” it said.
“To complete the exercise in a time-bound manner and to provide adequate time to the members of the public, all banks shall provide deposit and/ or exchange facility for Rs 2,000 banknotes until September 30, 2023,” the RBI said.
The RBI circular and the press note also attempt to make a convincing, logical case for this decision. There appear to be three reasons for doing this.
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One, the ₹2000 denomination notes seem to have served their useful purpose. They were introduced in November 2016 when the legal tender status of existing ₹500 and ₹1000 banknotes in circulation were withdrawn. Looking back, it appears these were introduced to help re-monetise the economy really quickly, which was under the stress of not having adequate new legal tender banknotes. According to the RBI, after this task of re-monetising was completed, the printing of new ₹2000 banknotes was stopped in 2018-19. Therefore, after 5 years of not printing any new notes, this looks like the right time to take them out of circulation completely.
Two, since most of the ₹2000 denomination notes were issued prior to 2017, they have apparently completed the typical lifespan of a banknote which is between 4-5 years. In an ideal system, most of these old notes should have come back to the RBI by now. Further, these notes are not seen to be used for transactions anymore. They seem to be just sitting somewhere out there. So, in pursuance of the ‘clean note policy’, the best course of action is to withdraw them from circulation.
Lastly, there was also an allusion to the ₹2000 notes being often found by various investigative agencies in their haul of black money or frauds. So, somewhere there is a view that withdrawing these notes would smoke these fraudsters out, who are sitting on piles of this unaccounted-for cash.
Now, as students of public policy, we must assess this measure based on its intended objectives, the likely costs of doing it and the unintended consequences that are likely to arise. The first reason—that the ₹2000 banknotes have served their purpose, so it is time we take them out—can be scrutinised further.
I don’t think it was made clear when they were introduced back in November 2016 that the only reason for doing it was to re-monetise the economy quickly. There’s a bit of retrofitting of logic here. Also, the decision to stop printing new ₹2000 notes in 2018-19 has meant the total circulation of these notes has been on a decline. In the last four years, the total value of the ₹2000 notes in circulation has gone down from ₹6.5 trillion (over 30 per cent of notes in circulation by value) to about ₹3.6 trillion (about 10 per cent of total circulation by value). I guess, left to itself, we might have had this number slide to a smaller number, say below, ₹1 trillion in the next 3 years. The same point is relevant for the ‘clean note policy’ since these notes would have eventually come back if they were not being used for transactions and were already at the end of their lifetime. So, the question is, did we need to accelerate something that would have followed a natural path to the policy objective that’s desired? Would another three years of these notes in circulation have been detrimental to some policy objective? It is not clear. What’s clear is there will be another season of ordinary citizens queuing up in front of bank branches that will begin on Monday.
It might be argued that there won’t be any panic because the regulator has made it clear that these notes will continue to be legal tender. But who will receive these notes for any transactions starting today? These notes are as good as useless, and for anyone who uses them for transactions or has stored them for any legal purpose, the only way is to get them exchanged for those notes that are both legal and usable. There’s always a sense of schadenfreude among the middle class that it is the rich who will suffer. As was seen during the demonetisation exercise, the poor suffer equally, if not more. The cost of the logistics of sending all ₹2000 notes back from ATMs and branches to the RBI, replacing them with notes of other denominations, the extra hours spent by people exchanging their notes in batches of ₹20,000 and the additional measures to be taken to check for the provenance of the money that will come into the banking system and the risk of frauds during this process are all additional costs to the system. There should be a more compelling upside to these costs except to argue that these notes have served their purpose.
Lastly, on high denomination notes abetting corruption and fraud, there’s some data from experiences in other countries that suggest this. However, experience in India has shown after the initial ‘disruption’, the system finds a new equilibrium, and things continue as usual. The idea that demonetisation would aid the digital economy and will bring down cash in circulation was compelling at that time. But as seen, over time, cash in the economy continued to rise despite a significant ramp-up in digital transactions, which might have happened anyway because of UPI. There are more fundamental reasons for corruption that need to be addressed than making a case for smaller denomination notes. Anyway, the corruption argument never gets old in India, where everyone assumes that, barring them, everyone else around is corrupt. So, the usual arguments have started surfacing on social media that this will impact a small minority of people, and they anyway need to answer why they were hoarding these high denomination notes. And, there’s the political masterstroke argument which suggests this will derail the fundraising ability of the opposition in this election year. I’m not sure if that’s supported by data because we had the unusual scenario of almost 100 per cent of the invalidated denomination notes during demonetisation eventually returning to the RBI. Nobody was wiser when that happened. The only upside at the end of this exercise will possibly be with banks that will have a temporary increase in their deposits. The scramble for deposits that was on because of shrinking liquidity will abate for some time. That will possibly help them support loan growth that was dependent on deposit mobilisation. That might not be a bad outcome, but it is a torturous way to get there. But then we like convolutions.
In parallel, there was another interesting piece of policy-making going on. The TCS (tax collected at source) on international credit card spending outside of India. Earlier during the week, reports emerged that all such spends will now attract a TCS of 20 per cent which can then be recovered by individuals at the time of filing their annual return. The Indian Express on Tuesday reported:
THE CENTRAL Government, in consultation with the Reserve Bank of India, in a late night notification Tuesday amended rules under the Foreign Exchange Management Act, bringing in international credit card spends outside India under the Liberalised Remittance Scheme (LRS). As a consequence, the spending by international credit cards will also attract a higher rate of Tax Collected at Source (TCS) at 20 per cent effective July 1.
The notification brings transactions through credit cards outside India under the ambit of the LRS with immediate effect, which enables the higher levy of TCS, as announced in the Budget for 2022-23, from July 1. This is expected to help track high-value overseas transactions and will not apply on the payments for purchase of foreign goods/services from India.
Prior to this, the usage of an international credit card to make payments towards meeting expenses during a trip abroad was not covered under the LRS. The spendings through international credit cards were excluded from LRS by way of Rule 7 of the Foreign Exchange Management (Current Account Transaction) Rules, 2000. With the latest notification, Rule 7 has now been omitted, paving way for the inclusion of such spendings under LRS.
Now, what could be the reason for this? The Chief Economic Advisor in a column in the Indian Express gave an insight into the thinking:
It is a fact that remittances under LRS have increased multi-fold in the last few years, and as per data published by the Reserve Bank of India (RBI), LRS remittances which were Rs 0.9 trillion in FY2019, crossed Rs 2 trillion in FY2023. During FY2023, an interesting trend was noticed in the remittances for deposits, purchase of immovable property, investment in equity/debt, gifts/donations and travel. Remittances under these heads constituted almost 70 per cent of the total, representing a year-on-year growth of 74 per cent. Foreign travel alone was almost Rs 1.1 trillion in FY2023, a three-fold increase from the pre-Covid period. In all of these, payments made through credit cards are not reflected as such payments were not subject to the LRS limit. This is an anomaly that needed to be fixed anyway.
We are back to the old Indian argument. There are people who are spending money on their credit cards abroad that’s not captured in the LRS limit. We need to know who these people are and what is the amount they are spending. That’s fair. It is an information problem that needs to be solved. Find out who are the people spending this and add it back to their LRS eligibility. Better still, increase the LRS limit so that people can spend more freely. We aren’t in the 70s that we need to conserve foreign exchange through means that make the lives of ordinary citizens difficult. Why should a tax be applied to an information problem? And it is conceptually fine to say that this tax amount is only deposited with the government during the transaction and can be recovered at the time of filing the annual return. But there are way too many complications at an operational level, including upfront working capital costs.
The challenge of tracking international spending, separating corporate and individual purchases and optimising for the overall LRS limit, especially if people have kids studying abroad, will burden individuals. For card companies, it will mean helping customers track this, figuring out all sorts of exception scenarios when a customer cancels a foreign transaction on which a TCS has already been paid or where they default on payment but the card company has already deposited the TCS with the government. Instead of simplifying the tax structure and remittances, the attempt is to complicate things to catch hold of a few exceptions. And those who claim this impacts only 7 per cent of people who have a passport, I can only say why inconvenience even 1 per cent of citizens if there’s no compelling motive.
Thankfully, some sense seems to have prevailed, and we had a clarification from the finance ministry on Friday. The ministry clarified:
Concerns have been raised about the applicability of Tax Collection at Source (TCS) to small transactions under the Liberalized Remittance Scheme (LRS) from July 1, 2023. To avoid any procedural ambiguity, it has been decided that any payments by an individual using their international Debit or Credit cards up to Rs 7 lakh per financial year will be excluded from the LRS limits and hence, will not attract any TCS.
Small mercies. But it still doesn’t fully do away with an unnecessary measure.
India Policy Watch #2: Technological Learning is a Marathon, Not a Sprint
Insights on issues relevant to India
— Pranay Kotasthane
Electronics manufacturing is a hot topic nowadays, as it is being seen as a lead indicator of India’s improving manufacturing prowess. Not a week goes by without reports on this topic, ranging from the mobile exports clocked every quarter and the difficulties encountered by companies in localising production to the uptake of the Production-linked Incentives (PLI) scheme to encourage production.
Broadly speaking, the analyses can be classified into two simple categories: detractive (“hum se naa ho paayega” type) and presumptuous (“Hum jahan khade ho jaate hain line wahi se shuru hoti hain” type). I contend that both kinds of analyses make a common mistake: they don’t appreciate a concept of called technological learning. This leads them to reach similar conclusions, albeit through different perspectives.
Dodgson, a scholar of innovation, defines technological learning as “the ways firms build and supplement their knowledge-bases about technologies, products and processes, and develop and improve the use of the broad skills of their workforces”. The assumption is that firms build additional capabilities over time as and when they keep getting better at doing relatively simpler tasks, projects, and processes.
The detractors of India’s nascent electronics manufacturing are quick to point out that Indian manufacturers’ high failure rates are a clear indication that India cannot do large-scale manufacturing. For instance, the news report that iPhone casings produced at Tata’s Hosur plant had a 50 per cent failure rate, has become an oft-cited datapoint to downplay India’s manufacturing capabilities. While such critiques should not be dismissed lightly, it’s also important not to overreact. Electronics manufacturing in China faced pretty much the same challenges; in fact, Chinese manufacturers had far lower yields in the initial phases. Technological learning and upgradation happen over time; it is unrealistic to expect immediate success in this field.
On the other hand, fervent supporters believe that the Indian government can boost manufacturing output and export competitiveness merely by implementing industrial policies and import substitution measures. In this model, PLI schemes, higher import tariffs, and infant industry protection are necessary and sufficient conditions for building India’s electronics manufacturing sector. This line of thinking also ignores technological learning. Indian firms will have to begin with the assembly of imported components necessarily. In fact, we should be willing to digest a decrease in the domestic value added per unit of demand over the next few years, as was the case in China and Viet Nam. As Indian manufacturing achieves global scale, local content addition will increase by default, as firms seek to optimise costs, and employees go on to become local entrepreneurs. The hurry to localise domestic value addition runs at odds with exporting competitiveness, a point that the self-assured are ignoring.
And so, both viewpoints are misguided due to their disregard for the role of technological learning in manufacturing development. It is crucial to acknowledge that gaining proficiency in manufacturing takes time.
Naushad Forbes Business Standard article explains this process of learning took place in East Asia:
Firms like Samsung, Hyundai, LG, TSMC and Acer did not start as global brands. They began with outsourcing, as original equipment manufacturers or OEMs, building manufacturing operations of global scale. They used their demanding buyers as a source of technology that made them world-competitive. But they did not stop there. They invested in R&D, as process innovation, to make manufacturing more efficient. They then offered their buyers products with new and improved design, moving up the scale to own design and manufacture or ODM, claiming a piece of the innovation rents that came from better products. This required them to invest in substantial product design capabilities, which over time completely outclassed and replaced the design capabilities of their buyers. And, finally, with world-competitive manufacturing and leading-edge product design in place, they made the shift to own brand manufacture or OBM, launching their own brands, going beyond their home market, spreading step by step into the world. This is the story of Samsung in microwaves and semiconductors, LG in TV sets, Hyundai in cars and excavators, TSMC in microprocessors, and Acer in laptops. This OEM to ODM to OBM story is one of continuous learning.
It’s crucial to bring technological learning back in conversations on India’s manufacturing.
P.S.: Earlier this week, the government announced another PLI scheme for "laptops, tablets, all-in-one PCs, servers etc.", with a budgetary outlay of ₹17000 crores over six years. If the government appreciated technological learning, it would accompany this PLI with a reduction in customs duties. Competitive exports need competitive imports of intermediate components and equipment.
Matsyanyaaya: Launch India-US Trade into Another Orbit
Big fish eating small fish = Foreign Policy in action
— Pranay Kotasthane
Ahead of the Indian PM’s visit to the US next month, some of us at Takshashila propose an ambitious agenda on the trade front in this document—increase bilateral trade to $500 billion by 2030 and $1 Trillion by 2040.
Here’re the pathways to achieve this goal:
* Expand the existing US-India 2+28 ministerial dialogue: This dialogue currently comprises the Foreign and Defence ministers from both countries. However, to comprehensively address the intricacies of global trade relations, it would be beneficial to transition to a 3+3 format to include both nations' trade and commerce representatives.
* Capitalize on the role of states: The economic landscape in India is witnessing a shift towards the states. Various factors that significantly influence business operations, such as land acquisition and law and order, predominantly lie under the jurisdiction of individual states. Owing to India's vast size and diverse nature, different states have fostered their unique strengths and advantages. The trade relations between the two nations can be further enhanced through a partnership where groups of states engage in reciprocal visits each year, bolstering trade ties and fostering mutual growth.
* The Trade Policy Forum (TPF) must be held every year. It is the right cadence to ensure disciplined action and follow-through on ambitious goals. The institutional memory of the TPF will work to create continuity. The old adage "we overestimate what can be done in one year and underestimate what can be done in 5 or 10 years" is particularly applicable here.
* The organic growth in trade between companies on either side needs only the occasional enablement. Trade in technology services, pharmaceuticals, SaaS, industrial goods and many other sectors can continue. It will benefit from forums like the US-India Business Council (USIBC) that seek to remove frictions in the ordinary conduct of business and shine a light on some sticky areas.
* Create plurilateral trade partnerships. Until now, the US and India do not together find themselves in any regional trade partnership. The revived QUAD, with a heavy security focus, will be one such partnership with significant trade implications. The Indo-Pacific Economic Framework (IPEF) proposed this summer is a promising way to advance on a partnership, but the partnership details must be worked out. For the greater good, India and the US will have to work out sticking points in the data & privacy sections of the agreement. There appears to be significant mutual concurrence on tax, anti-corruption and clean energy, the other three pillars of the IPEF agreement.
* Trade in high-technology sectors would get a fillip from the two governments setting up specific framework agreements. The new US-India initiative on Critical and Emerging Technologies (iCET) is an example of a framework agreement that could kickstart interaction between government, industry and academia in areas such as artificial intelligence (AI), semiconductors, 5G/6G telecommunications, quantum computing, biotech, deep ocean and space technologies.
* In commercial and societal terms, the exchange of people will be the biggest binding factor between the two countries. In the short term, reciprocal visa access and availability should be addressed on a priority basis. In the longer term, both sides should work on Indians being separated from the general pool of "H1" applicants and in a category of their own. Additionally, the thresholds for each country employing citizens of the other should be brought down gradually.
[From Narayan Ramachandran et al., “Time to Launch the US-India Trade Relationship into Another Orbit,” Takshashila Policy Advisory 2023-02]
HomeWork
Reading and listening recommendations on public policy matters
* [Article] Anupam Manur on the ₹2,000 note withdrawal in Moneycontrol — “Like a nightmare resulting from a traumatic experience for a person suffering from PTSD, demonetisation came back to haunt the collective consciousness of this country when the Reserve Bank of India (RBI) decided to recall the 2000 rupee note.”
* [Podcast] In the next Puliyabaazi, Devashish Dhar talks about cities, urbanisation, working in government, etc. Strongly recommend it to people considering public policy as a career option.
* [Articles 1, 2, & 3] Naushad Forbes’ series on private R&D and national innovation in Business Standard is a must-read for those interested in technology geopolitics and tech policy.

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#210 Metastability
28 May 2023· Anticipating the Unintended
Global Policy Watch: Much Ado About De-dollarisation
Reflections on global policy issues
— RSJ
This week, Donald Trump urged Republican lawmakers to let the U.S. default on its debt if the Democrats don’t agree on massive budget cuts. Trump likened the people running the U.S. treasury to ‘drunken sailors’, an epithet I can get behind. Default is not something Janet Yellen, the U.S. Treasury Secretary, can even begin to imagine. As CNBC reported, Yellen chose strong words to express her views if the debt ceiling was not raised by the House:
“The notion of defaulting on our debt is something that would so badly undermine the U.S. and global economy that I think it should be regarded by everyone as unthinkable,” she told reporters. “America should never default.”
When asked about steps the Biden administration could take in the wake of a default, Yellen emphasized that lawmakers must raise the debt ceiling.
“There is no good alternative that will save us from catastrophe. I don’t want to get into ranking which bad alternative is better than others, but the only reasonable thing is to raise the debt ceiling and to avoid the dreadful consequences that will come,” she told reporters, noting that defaulting on debt can be prevented.
There is more than a grain of truth there in some of her apparent hyperbole. The U.S. hegemony in the global financial system runs on trust that they won’t default on their debt. Take that trust out of the equation, and what have you got left? This is somewhat more salient in these times when there’s a talk of de-dollarisation going around. Russia and China have been keen to trade in their own currencies between themselves and other partners who are amenable to this idea. And they have found some traction in this idea from other countries who aren’t exactly bit players in the global economy. In March this year, the yuan overtook the dollar in being the predominant currency used for cross-border transactions in China.
Here’s a quick run-through of what different countries have been doing to reduce their dollar dependence. Russia and Saudi Arabia are using yuan to settle payments for gas and oil trade. Russia offloaded a lot of US dollars in its foreign reserves before the start of the war and replaced it with gold and yuan. It will possibly continue building yuan reserves in future. Brazil is already doing trade settlements in yuan and is also using the CIPS (China’s response to US-dominated SWIFT) for international financial messaging services. Argentina and Thailand seem to be also doing more of their trade with China in yuan. And I’m not including the likes of Pakistan, Bangladesh and other smaller economies that have politically or economically tied themselves up with China and are following suit. And a few weeks back, the French President, Emmanuel Macron, also raised the issue of strategic autonomy of the EU after his visit to Beijing. As Politico reported:
Macron also argued that Europe had increased its dependency on the U.S. for weapons and energy and must now focus on boosting European defense industries. He also suggested Europe should reduce its dependence on the “extraterritoriality of the U.S. dollar,” a key policy objective of both Moscow and Beijing.
“If the tensions between the two superpowers heat up … we won’t have the time nor the resources to finance our strategic autonomy and we will become vassals,” he said.
You get the picture. This idea of de-dollarisation seems to be gaining traction. How real is this possibility? There are possibly three lenses to look at this issue, and we will cover them in this edition.
Why the recent hate for the dollar?
A useful area to start with is to understand where this desire to find alternatives to the dollar is emerging. I mean, it is obvious why Russia and China are doing it and the way the U.S. used its dominance over the financial system to shut out Russia. Companies were barred from trading with Russia, Russian banks couldn’t access SWIFT and networks like Visa and Mastercard stopped their operations. Russia got the message but so did other large economies that didn’t think of themselves firmly in the U.S. camp. ‘What if’ questions began circulating among policymakers there. What if, in future, a somewhat unpredictable U.S. president decides to do this to us? And once you start building these scenarios, you soon realise the extent of dependence the global financial system has on not just the dollar but, beyond it, to the infrastructure and rules of the game developed by the U.S. corporations. There’s been a measured retreat ever since.
In India, a visible example of this has been the push toward Rupay by the regulator and the government in lieu of Visa and Mastercard. But merely looking at the U.S. response to Russia as the reason would be missing the longer-term trend. In his book ‘Bucking the Buck’, Daniel McDowell shows data on the annual number of executive orders that instruct the US Treasury to enforce financial sanctions against specially designated nationals (SDNs). These were rarities in the 70s. By the early 2000s, such annual orders were in their low twenties and in the last few years, they have reached the three-figure mark. It is clear that the U.S. is using its enormous clout as the owner of the global reserve currency and financial infrastructure to punish those who fall out of line. This is war by other means. Interestingly, this ‘sanctions happy’ behaviour in the last decade coincided with a wave of populist leaders coming into power in many countries who would not like to be seen as weak or held to ransom by the U.S. This has meant these states have used strategic autonomy as a plank to pursue their interests to go around the U.S. built system. I don’t see this trend abating any time soon. The future U.S. administrations will continue to use financial coercion as a tool because it appears bloodless, and the larger economies will continue freeing themselves from this hegemony one system at a time.
The tough and fortuitous road to becoming a reserve currency
But does that mean we will eventually end up with de-dollarisation? Well, there are two things to appreciate here. How does a currency become a reserve currency? How did the dollar become one? And once it does, what keeps it there? If you go back a little over a hundred years, most countries in the world pegged their currencies to gold as a means of facilitating cross-border trade and stabilising currencies. But during World War 1, it became difficult for these countries to fund their war expenses without printing paper money and devaluing their currencies. Britain continued adhering to the gold standard, but it was difficult for it to sustain its war efforts too. It had to borrow to run its expenses during and after WWI. Between the two wars, the U.S. became a huge exporter of goods and armament to the rest of the world, and it took the payment in gold. By the time World War 2 was ending, the U.S. had hoarded most of the world’s gold, which made going back to the gold standard impossible because other countries just didn’t have any gold. When the allied nations met at Bretton Woods to discuss the new financial world order after the war, it became quite clear that the only real option of managing a foreign exchange system was one that would have all other currencies pegged to the dollar, which would then be linked to gold. It is important to understand that there was no specific effort made to replace Pound as the international reserve currency. It just became inevitable, given the mix of circumstances.
Around the same time and for a decade after, the U.S. led the post-war reconstruction efforts in Western Europe and Japan, which gave it a political clout that was unmatched. This political dominance, along with the remnants of the Bretton Woods agreement, is what runs the global currency system in our times, though, in the 70s, the U.S. delinked the dollar from gold as well. That led to the floating exchange rates system that exists today and the dollarisation of the global economy. Over time countries learnt to accumulate their foreign exchange reserves in dollars by buying U.S. treasury bills. Together with the IMF and WB and the associated ecosystem that got built around the U.S. dollar, it became the force that it is today. Now for any currency to replace the U.S. dollar, it has to have the happy coincidence of being a dominant political and economic force, a lack of alternatives for the countries and an alternative to Bretton Wood (or a modification of the same) which can replace the current system. It is very difficult to imagine how something like this can happen unless there is a global crisis of a magnitude where a rebaselining of everything becomes the only way ahead.
That brings us to the other point on what sustains the dollar as a reserve currency. There are multiple factors at play here. There are, of course, the network effects of the dollar being deeply embedded in so many commercial ecosystems that taking it out is rife with friction and pain. Also, the dollar is fully convertible, which makes it convenient for others to use it as a store of value. It has remained stable; its market is deep and liquid, enabling easy conversion of bonds to cash and vice versa; there exists a mature insurance market to cover currency risks and above all, we have an implicit guarantee that the U.S. will not default on its debt. This is a trust that has been built over the last eight decades because the world believes the U.S. will run a rule-based order with a strong legal framework to ensure no single person can override rules or conventions.
Yawn when you hear Yuan as the next reserve currency
So, how does one see the efforts of China or Russia to wean themselves away from this dollar-dominated system? Will the yuan be able to replace the dollar ever? Apart from the points mentioned above, which led to the dollar being in a unique place in the world in the post-war days and which won’t repeat itself any time soon, there are other fundamental issues with the idea of the yuan as a reserve currency. To begin with, it isn’t convertible, and China runs a ‘closed’ capital account system. It is difficult to move money in and out of the country freely. You will need approvals. The opaque legal system, the authoritarian one-party (one-man) rule and the lack of depth in the yuan market mean it is impossible to imagine any prudent central bank risking its entire foreign exchange reserve in yuan. China could turn into an economic giant by exploiting a global trade order without adhering to its associated political expectations. But to think it could do the same in currency exchange order is a pipe dream. Even the numbers of the recent past bear this out. For all the talk of de-dollarisation, there has been a net sell-off of Chinese government bonds by private players in the last year. No one wants to sit on Chinese bonds if things go south in the global political economy. The central banks around the world who have wanted to diversify away from the dollar in their foreign exchange reserve don’t seem to have walked their talk. Even they have been net sellers of Chinese government bonds barring the initial days of the Ukraine war. Lastly, China is still struggling to raise consumption in its economy because, with a closed capital account and surplus capacity, it doesn’t know what to do with the surplus yuan. Without consumption going up, it will make things worse if it starts becoming a reserved or a semi-reserve currency for the world.
The probability of de-dollarisation seems to be hugely exaggerated at this moment. The alternatives are worse, and for those who complain about the coercive nature of U.S. diplomacy because of their financial clout, wait till you have China with that power. You can check with Sri Lanka for how it feels to be under China’s thumb economically. Also, none of the hype around bitcoin, stablecoin or CBDC is ever going to materialise for them to replace the dollar. The recent events have shown the fairly flimsy ground on which the bitcoin exchanges (banks?) run. It is difficult to see the lack of trust to change in a hurry. But this also doesn’t mean the trend towards diversification of central banks’ reserves will buck soon. The gradual move towards reducing dependence on the dollar and its associated ecosystem will continue. Should the U.S. be worried about this? It shouldn’t, really. It draws enormous privilege for being the reserve currency of the world. It makes its job to borrow or access money very easy. And the fact that it is a safe haven means it benefits from every crisis. But it should also be clear that this privilege has hurt its ability to export because the dollar remains stronger than it should. This, in turn, has led to the financialisation of the U.S. economy, with the rich getting richer and an evisceration of the U.S. manufacturing capabilities. Reserve diversification won’t be such a bad thing for them. But that might mean a reduction of a few hundred basis points in what central banks hold globally in U.S. treasuries.
That won’t de-dollarise the world. For that to happen, something catastrophic will need to happen. Maybe that’s why Yellen used that word about the possibility of the U.S. defaulting on its debt. That’s the kind of self-goal they must avoid.
Matsyanyaaya: The Two Equilibria in India-US Relations
Big fish eating small fish = Foreign Policy in action
— Pranay Kotasthane
There has been a healthy debate over the last couple of weeks on the state of the India-US relationship. In a Foreign Affairs article, Ashley Tellis, a key figure in the 2005 civil nuclear deal, a well-known realist scholar, and a strong proponent of stronger India-US relations, cast some doubt on the burgeoning partnership. The article, provocatively titled ‘America’s bad bet on India’, concludes thus:
The United States should certainly help India to the degree compatible with American interests. But it should harbor no illusions that its support, no matter how generous, will entice India to join it in any military coalition against China. The relationship with India is fundamentally unlike those that the United States enjoys with its allies. The Biden administration should recognize this reality rather than try to alter it.
Tellis reasons that India wants a closer relationship with the US to increase its own national power, not to preserve the liberal international order or to collaborate on mutual defence against China. He further argues that the US ‘generosity’ towards India is unlikely to help achieve its strategic aim of securing meaningful military contributions from India to defeat any Chinese aggression in East Asia or the South China Sea.
As you would imagine, this article put the cat amongst the pigeons. However, I agree with the fundamental argument. Expectation setting is important, and it is true that India is unlikely to behave like a weaker ally; the US-India relationship will most certainly have some shades that the US-China relationship had between 1980 and 2005.
In what seems to be a rejoinder to this article, Ashok Malik—previously a policy advisor in the external affairs ministry—argues that fixating on India’s role in a hypothetical war on Taiwan is a wrong question to ask, an imagined roadblock that even the Biden administration isn’t overly concerned about. Instead, Malik lists the growing relationship in several domains to conclude that the two administrations are far more sanguine, having figured out an approach to work with each other despite key differences.
I agree with this view as well. There’s no doubt that the India-US relationship has grown across sectors despite fundamental differences during an ongoing war in Europe. It is easy to. observe the shift in India-US conversations at the policy execution levels. The talks are no longer about the whys but about the hows. Gone are the days when the India-US partnership conversations began with Pakistan and ended with Russia, with the two sides taking potshots at each other in between. The conversations are about debating realistic projects that India and the US could accomplish together in areas such as space, biotechnology, semiconductors, and defence.
How, then, can I agree with two seemingly opposing views? Because they aren’t mutually exclusive. The India-US relationship is so far behind the production possibility frontier on technology, trade and defence that there are enough low-hanging fruits to pick. And that’s exactly what we are seeing now. But if the US president were to change, or if there were to be an escalation around Taiwan, the India-US relationship would likely hit a ceiling that Tellis warns about.
In edition #165, I proposed a tri-axis framework to look at the India-US relationship: state-to-state relations, state-to-people relations, and people-to-people relations. There has never been a problem on the people-to-people axis. Like Mr Malik, I, too, think that state-to-state relations have turned a corner. However, it is the state-to-people axis which is the problematic axis. Many Indians still seem to harbour a deep frustration with the American State. On the other hand, many Americans also have doubts about the Indian State as a strategic actor.
Finally, it’s only the two administrations that can break this ceiling. The trade-offs aren’t easy, but they are real. Without the Indian government committing itself to do more to counter the Chinese military threat in the seas, the US is unlikely to transfer cutting-edge technologies. Likewise, unless the US quits its stubbornness to give more Indian products preferential access to its markets or delivers on the asymmetric promises under the technology and defence agreements, India is unlikely to revise its stance.
In other words, the stage is set for the Indian PM’s official state visit to the US next month.
India Policy Watch #1: Generalists vs General Equilibrium
Insights on issues relevant to India
— Pranay Kotasthane
Non-civil services folks who have worked in governments are almost always extremely insightful. Perhaps, their experience working with the bureaucracy gives them a filter to reject impractical ideas, while their breadth of knowledge allows them to take a long-term view of policy ideas. These "scholar-warriors" are often able to get to the root of issues.
One such person is Montek Singh Ahluwalia, who was a guest on this week's Ideas of India podcast. Among the many insights he delivers, one that switched a lightbulb on for me was the segment on "generalists vs specialists" in government. While this is an old debate, one that civil service "mains" exam takers would not so fondly recall, this conversation made me think somewhat differently.
Responding to a question on the HR problems in government, Ahluwalia says:
There’s big bias within the government against people wanting to specialize. The IAS’ view of itself is, it’s a generalist service. This I think is a bit of a colonial hangover. You come from England to rule the country; expertise is looked down upon. But in this day and age, we ought to be encouraging the people who are really into IT—there’s no point putting someone who’s really made up his mind that he wants to be in IT to have a stint in education and health and road transport and that sort of stuff.
At another point in the episode, he begins the journey of a policy reform as follows:
In the Indian system, and maybe it’s true in all systems, every area is assigned to a ministry, and changes of policy that belong (in a narrow sense) to that area are the responsibility of the ministry. There are two problems here. One is, the functioning of a system as a whole requires you to do more than just add up what needs to be done in each area, because you want to look at what the economist would call a general equilibrium approach. If you want to reach a particular result, you’ve got to do A over here, B over there, C over there.
I think there's a deeper insight at the intersection of these two dimensions. The “generalists vs specialists” debate masks another important dimension of effectiveness—whether the person approaches a problem with general equilibrium thinking or is limited to partial equilibrium analysis.
General equilibrium analysis takes into account the long-term interactions of a large number of economic agents. In mathematical terms, it is based on the assumption that several variables can change at once in response to a policy change. Partial equilibrium analysis, on the other hand, focuses narrowly on one sector and a handful of variables.
Ahluwalia explains that generalist civil service officers can default to partial equilibrium analysis because they are blinkered by their ministry mandates and interests. For example, few bureaucrats from the Ministry of Commerce will advocate that a unilateral lowering of tariffs will be beneficial to India, even though a general equilibrium analysis says so.
However, many specialists also fall into this same trap, albeit for different reasons. An urban planner is likely to hate mixed-use neighbourhoods, while an environmentalist might argue that all mining is evil. These partial equilibria arise from the failure to see the interlinkages across the economy, a crucial aspect of general equilibrium analysis.
So, irrespective of whether you are a generalist or a specialist, what matters is whether the bureaucrats are able to approach problems with a general equilibrium mindset. The current government mechanism to move career bureaucrats across ministries through deputations is probably a sub-optimal way to achieve competence in this dimension. The second mechanism is to have intra-ministerial committees or expert committees. Organisations such as the Planning Commission, Niti Aayog, or the PMO are supposed to bring in a general equilibrium mindset as well. The question is which of these bodies is best equipped to do this in this way. Probably, another way to push towards this equilibrium is to have economists and behavioural sociologists in many ministries so that their internal recommendations take a broader view beyond the self-protection of ministerial turfs.
PS: There’s a nice chapter on “Trace the general equilibrium effects” in In Service of the Republic by Shah & Kelkar.
HomeWork
Reading and listening recommendations on public policy matters
* A Twitter friend asked for book recommendations to understand post-independence Indian economic history. These are the ones that came to mind:
* India's Long Road: The Search for Prosperity by Vijay Joshi
* India: the Emerging Giant by Arvind Panagariya
* India's Tryst with Destiny by Arvind Panagariya and Jagdish Bhagwati
* Backstage: The Story Behind India’s High Growth Years by Montek Singh Ahluwalia &
* Changing India volume, this set is a compilation of Manmohan Singh’s papers (reading level: advanced)
* [Podcast] This Grand Tamasha episode is a great introduction to internal security in India, backed by the latest research and data on a crucial yet under-discussed topic.
* [Podcast] Should there be a caste census? Here’s a Puliyabaazi on this topic that’s sure to gain more traction as the national election draws near. We present two opposing perspectives, one by Yogendra Yadav and the other by Pratap Bhanu Mehta, before reaching our own divergent conclusions. Listen in and tell us what you think.

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#209 Of New Beginnings and Old Grouses
9 May 2023· Anticipating the Unintended
Global Policy Watch: Chronicle Of A Crisis Foretold
Reflections on global policy issues
— RSJ
A major state election (Karnataka) is coming up this week. But there’s hardly anything worth analysing. The Congress seemed to have a slight edge in the early opinion polls, but that’s wearing thin. The BJP, always with its ears to the ground, has cranked up its poll machinery in the last couple of weeks drawing upon the star power of the PM in the urban areas of the state. The friendly media houses have been mobilised to pick up ‘emotive’ issues that would tilt the scale in favour of the party in power. It is not too difficult to figure out what the average voter wants if you go by the opinion polls and surveys. But those substantive issues just don’t feature in the public discourse. If you read the papers or media reports on what’s being debated among parties in Karnataka, it is about who is a Hindu hater, who prostrates more often before deities and how going back to the OPS (old pension scheme) is such a wonderful idea. In the classical model of how representative democracy ought to work, the voters would have a limited view of how the world works, and it is the representative who owes the voters not only his labour but also his judgment on issues (to riff on Burke).
That seems to be inverted here. One set of representatives has, over the last few years, instituted all kinds of targeted laws - hijaab ban, anti-conversion laws, scrapping minority quotas and cow slaughter ban - in the hope that they will yield electoral gains. The other set is talking of another set of bans convenient to them and some really bad economic policies. We often say that this newsletter attempts to change the demand side of the political equation by making people more aware of public policies and demanding better from their representatives. What we have here is the public demanding the right kind of things (if opinion polls are to go by), but their representatives are keen on dragging them back to divisive emotive issues. The Karnataka election will be a good test of what prevails eventually. I can almost see the straight line from these polls to the general elections due almost exactly 12 months from now. We will all be debating similar trivial issues than what really should matter to India. For some reason, that doesn’t make for a good topic of debate. It makes any election analysis a waste of time, really.
Switching gears, as I finished writing my last week’s edition on what the US Fed refuses to learn from the SVB collapse, another mid-sized US bank, the First Republic Bank (FRB), went down and was sold to J.P. Morgan, the ultimate backstop in the US financial system. No amount of assurance from FDIC to the depositors of the bank nor the combined infusion of capital about a month back from a consortium of big banks into FRB was enough to stanch the outflow of deposits. Soon the bank was insolvent, the shareholders and bondholders lost everything, and J.P. Morgan was given enough of a sweet deal to pick up the pieces. I’m sure the Fed will come out with another report on the FRB collapse where it will blame the management for not hedging its treasury risks and being lax in its risk practices. There will be a light rap to the supervisors and staff from Fed who monitored FRB, and that will be that. I hope there’s some more introspection by the Fed than that. Because as the shares of PacWest and Western Alliance have sunk over the last two days, it is clear that a number of mid-sized banks are going to collapse in slow-motion and end up in the lap of J.P. Morgan or FDIC very soon. The feeble Fed response was a 25 bps hike in rates last week with a strong indication that it will hit the pause button on hikes now. The question is if that’s enough to structurally save many of these banks.
I have argued for the past couple of months (just after the SVB collapse) that there are three problems for the Fed to contend with, and there are no real answers for them. It is Hail Mary time. Choose the best among the worst options and brace for the impact. I will lay out the three problems it faces before suggesting what looks like the best of the worst option that the Fed has chosen.
First, the Fed continued raising interest rates to fight inflation without thinking through its impact on the banking system. This much is clear now. The surprises that have come up in the shape of SVB, Signature and FRB weren’t anticipated at all. As the interest rates rose, the value of the long-term assets held by banks has fallen while their liabilities, in the form of deposits, which tend to be shorter in term, haven’t fallen as much. The slowdown in the economy has meant there’s not enough demand for credit at elevated rates, which means banks continue to invest in long-term US treasury bills. Every time the rates go up, these held-to-maturity (HTM) assets take a notional mark-to-market loss. A recent report by the Hoover Institution suggests that at this moment, the US Banking system’s market value of assets is about $ 2 trillion below their book value. In an article on Yahoo Finance, Ambrose Evan-Pritchards writes:
The second and third biggest bank failures in US history have followed in quick succession. The US Treasury and Federal Reserve would like us to believe that they are “idiosyncratic”. That is a dangerous evasion.
Almost half of America’s 4,800 banks are already burning through their capital buffers. They may not have to mark all losses to market under US accounting rules but that does not make them solvent. Somebody will take those losses.
“It’s spooky. Thousands of banks are underwater,” said Professor Amit Seru, a banking expert at Stanford University. “Let’s not pretend that this is just about Silicon Valley Bank and First Republic. A lot of the US banking system is potentially insolvent.”
The second problem, which kind of starts giving this a contagion feel, is the state of the commercial property market in the US. Interest rates have moved up too fast, the slowdown is real with many large employers laying off people, so there’s no real need for commercial capacity, and the excess liquidity fuelled by the Fed during the pandemic meant additional capacity was built up cheaply, which now has no takers. What’s worse, the rapid increase in rates means that a lot of these loans that will come up for refinancing soon (at higher rates) will face defaults. The mid-sized regional banks have a sizable exposure to commercial real estate, with estimates that about two-thirds of all commercial property borrowing comes from them. From the same Yahoo Finance article:
Packages of commercial property loans (CMBS) are typically on short maturities and have to be refinanced every two to three years. Borrowing exploded during the pandemic when the Fed flooded the system with liquidity. That debt comes due in late 2023 and 2024.
Could the losses be as bad as the subprime crisis? Probably not. Capital Economics says the investment bubble in US residential property peaked at 6.5pc of GDP in 2007. The comparable figure for commercial property today is 2.6pc.
But the threat is not trivial either. US commercial property prices have so far fallen by just 4pc to 5pc. Capital Economics expects a peak to trough decline of 22pc. This will wreak further havoc on the loan portfolios of the regional banks that account for 70pc of all commercial property financing.
Estimates vary, but it is likely that even a 10-15 per cent increase in default rates on commercial property when the refinancing chickens come home to roost could mean about $ 100 billion in losses for banks. And these are real losses, not the notional variety sitting on the books. Will the regional banks be able to weather this? And what happens if 4-5 of them catch a cold together in this portfolio? The risk of contagion flowing up the banking food chain is real.
Lastly, the Fed, FDIC and the government took the extraordinary step of guaranteeing all deposits after the collapse of SVB to reassure depositors and not have further runs on mid-sized banks. But that didn’t stop the ever-increasing deposit erosion for FRB during April. People can do the math, and they realise there’s no way the government can fill a giant hole in case there’s a real deposit run. The FDIC, after all, has a little over $ 100 billion to act as insurance for such an eventuality. That’s loose change in the broader scheme of things. So, the depositors will flee the more you try and convince them all’s well. Plus, the blanket deposit backstop has meant there’s a moral hazard built right there for the management not to be too worried about the nature of deposits they bring or the risk of serious asset-liability mismatches.
At the time of SVB collapse, I wrote in edition # 205:
I guess one way to look at this is if you let fiscal dominance become the central canon of how you manage your economic policy, you will eventually reach the same place as other economies (mostly developing) that have indulged in the same for years. The monetary authorities in the U.S. have been accommodating the fiscal profligacy of the treasury for years. This was accentuated during the pandemic. Trillions of dollars were pumped in to save the economy. I’m not sure how much the economy needed saving then. But that bill has come now. First in the shape of inflation, followed by rapid, unprecedented rate hikes and the inevitable accidents that are showing up now. Almost certainly, a recession will follow. Isomorphic mimicry of Latin American monetary policy indeed.
Now, back to Evans-Pritchard and his article in Yahoo Finance:
The root cause of this bond and banking crisis lies in the erratic behaviour and perverse incentives created by the Fed and the US Treasury over many years, culminating in the violent lurch from ultra-easy money to ultra-tight money now underway. They first created “interest rate risk” on a galactic scale: now they are detonating the delayed timebomb of their own creation.
Chris Whalen from Institutional Risk Analyst said we should be wary of a false narrative that pins all blame on miscreant banks. “The Fed’s excessive open market intervention from 2019 through 2022 was the primary cause of the failure of First Republic as well as Silicon Valley Bank,” he said.
Mr Whalen said US banks and bond investors (i.e. pension funds and insurance companies) are “holding the bag” on $5 trillion of implicit losses left by the final blow-off phase of the Fed’s QE experiment. “Since US banks only have about $2 trillion in tangible equity capital, we have a problem,” he said.
Going back to the original question I posed - what will Fed do given these problems on hand? I guess it has decided to choose what it thinks is the least worst option. It cannot let go of its fight against inflation. It has to find a way to avoid recession. So, all it can afford is a controlled banking crisis. An oxymoron if ever there was one. But that’s where we are headed, where we will see things unfold in a slow but almost predictable manner. The Fed will try and boost the banks’ capital in the meantime and hope the best of them brave through this without any risk of contagion.
Anyway, in the worst case, there’s always Jamie Dimon and his chequebook.
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Numbers that Ought to Matter: In April 2023, the Union Health Minister reported that India has 108,000 MBBS seats in 660 colleges and 118,000 BSc nursing seats in approx 900 colleges. The total number of seats on offer is quite low, despite the large number of colleges. On average, each medical college has 163 seats, and each nursing college has just 131 seats. Government policy should focus on helping existing colleges increase their intake. For more context, read edition #159.
India Policy Watch #1: Coal is Out? Naah.
Insights on issues relevant to India
— Pranay Kotasthane
Earlier this week, I came across this Business Standard report:
“India plans to stop building new coal-fired power plants, apart from those already in the pipeline, by removing a key clause from the final draft of its National Electricity Policy (NEP), in a major boost to fight climate change, sources said.”
My prior assumption was that given coal-based power’s lower costs, India would construct many more coal-powered plants over the next two decades to meet a growing economy’s demand. Hence, this news item came as a bit of a surprise. So I went through the draft National Electricity Plan to understand the reasoning.
Before we dive in, some bureaucratic knots that need untangling. The cited “final draft” of the National Electricity Policy is nowhere to be found on the Ministry of Power website. But I could find an earlier draft on the IIT Kanpur’s Centre for Energy Regulation website! A Policy document such as this only lists the priorities and steers the sector. From it arises a Plan that’s to be released every five years by the Central Electricity Authority. The Plan document is the real deal as it does demand projections through an ‘Electric Power Survey’. It then presents the energy generation mix required to meet the projected demand scenarios. A part of this elusive plan document was released, after many delays, in September 2022. Some relevant insights from the plan:
* The current installed power capacity of ~400GW split looks as follows:
* By FY32, it is projected that India’s energy demand will be 2538 Billion Units, and peak power demand will be 363 GW, up from 1624 Billion Units and peak demand of 216 GW in FY23.
* Coal+Lignite accounted for 52.7% of total installed capacity in FY23.
* Using a planning tool that optimises for factors such as fuel availability, operational availability, and sustainability, the Plan throws up a required power generation capacity mix.
* After taking all these constraints into account, the Plan finds that by FY32, India would need an additional installed coal capacity of 42.6 GW in the base case scenario and 53.6 GW in the increased-demand scenario.
* Around 25.6 GW of capacity addition is already in various stages of execution.
Now, we come to the report claiming a ban on additional coal capacity addition beyond the current in-progress projects. It essentially means that to meet the projected demand, India will have to find other sources to compensate for coal. In the best case, an additional 17 GW capacity will have to be conjured up; and in the worst-case scenario, nearly 28 GW capacity will have to be compensated. This additional capacity goes beyond the planned additions in clean energy generation. That’s why I am sceptical about this news report. It’s unlikely that government will make a blanket commitment.
If we assume the report to be true, advancing the date of halting further coal power generation will require compensation by another reliable source to provide the base load. Only two options can be imagined with today’s technology — nuclear energy and Battery Energy Storage Systems (BESS).
Nuclear energy accounts for just 2 per cent of the total power generation mix today. The current plan already assumes a threefold increase in nuclear power capacity addition. For it to absorb the slack of stopping further coal addition, it has to reach six to eight times the current capacity.
Given that nuclear power generation faces the problem of high capital costs and invites protests, scaling it up is tough unless the Small Modular Reactor (SMR) technology breakthrough leads to mass adoption in India. Maybe for this reason, the government is “considering” overturning a ban on FDI in nuclear power. Expanding BESS capacity also depends on the ability to develop Lithium refining expertise and bring other options, such as Sodium-ion batteries, online.
So, stopping the building of new coal-fired power plants requires far too many other pieces of the puzzle to fall into place. Keep watching this space.
Tailpiece: check out this Puliyabaazi episode on the chemistry, geopolitics, and significance of Lithium-ion batteries.
India Policy Watch #2: Lessons from Apple’s India Journey Thus Far
Insights on issues relevant to India
— Pranay Kotasthane
Apple’s quarterly results are out. Its India revenue registered double-digit growth, prompting Tim Cook to make the now-commonplace “India is at a tipping point” statement. The last seven years have been stunning for Apple’s India business. From being shunned away by the government for their plan to import and sale of refurbished phones to becoming a poster child of electronics manufacturing in India, Apple’s India strategy has come a long way.
I’ve always wanted to know how Apple raised its India game and whether there are broader lessons for Indian public policy from this experience. So I was delighted to read Surajeet Das Gupta’s Business Standard article narrating Apple’s tryst with Indian public policy. Das Gupta identifies these milestones and speed-breakers:
* In 2016, after denying the import-refurbish-sell request, Apple was told to start manufacturing in India if it wanted to set up Apple-owned retail stores.
* In 2017, Apple put forward two pre-conditions for starting manufacturing in India:
* “15-year duty concessions (on capital equipment, components, consumables for smartphones).. and a reduction in customs duty on completely knocked down and semi-knocked down devices to be assembled in India.”
* relaxation of 30 per cent local sourcing directive for foreign direct investment (FDI) in single-brand retail stores.
* After both its asks were rejected, it set up an India team to work with the government and mobile phone industry associations.
* After three years of lobbying, the government relented by allowing the 30 per cent local norm to be met as an average for the first five-year period, not annually. Then the government agreed to qualify the value added by Apple’s contract manufacturers in India—regardless of the destination of these products—as “local sourcing”.
* The government allowed Apple to set up an online store before the physical store if it brought over $200 million FDI and extracted a commitment that the online store couldn’t get into heavy discounting.
* When PLI rules were modified to accommodate Samsung’s entry, Apple went along with the change.
* After the government made the entry of FDI from China in the Indian tech sector arduous due to the Galwan clash, Apple worked with the industry body to get 12 of its Chinese suppliers approved on the condition that they would enter into joint ventures with Indian partners who would have a majority stake. (We wrote about it in edition #199).
Take a breath. And it has only been seven years. There are three ways of interpreting this journey from a public policy perspective.
First, to the extent that the government has been able to capture Apple’s China manufacturing—even if in a really small way—its approach can be called a limited success. The government can rightfully claim that Apple’s supply chain has created over a lakh jobs in India. Grabbing some part of the manufacturing of the world’s biggest company has a signalling effect as well. It will also help Apple’s Indian partners upgrade technologically and raise their standards.
Second, Apple’s up-and-down journey also serves as a warning. If the world's most well-known company had to jump as many hoops, what chance does a smaller company have? How many other businesses will have the money and patience to set up India teams that negotiate with the government to remove roadblocks, one by one, calmly? And the approval of Apple’s Chinese suppliers shows that the government is comfortable making pro-business exemptions but is uncomfortable making pro-market relaxations. There’s a risk of going overboard with the “market access in return for manufacturing” approach.
A policy analyst must also pop the opportunity cost question. Could the government have spent precious state capacity elsewhere by following a general easing of these constraints? How many companies did India lose in the process of playing hardball with Apple? And what about the Indian consumers - what did they lose as a result of these overbearing conditions? These are tough questions to answer.
Third, this journey shows that technology policy is shaping up rather well in India. Industry associations and public advocacy departments of companies are now able to put forward their demands and grouses in front of governments in a far more transparent manner. Not just that, they are able to get governments to modify policies as well.
In my view, all three interpretations are simultaneously true. But this is just the beginning of India’s electronics manufacturing journey. The steps required to strengthen it might be drastically different from the approach required to start it.
HomeWork
Reading and listening recommendations on public policy matters
* [Article] Here’s a RestofWorld Q&A on the US-China chip war and its implications for India featuring one of us.
* [Story] FT has an excellent visual explainer on quantum computing this week.
* [Article] Niranjan Rajadhyaksha’s Mint column comparing Asian countries when their median age was 28 like India’s is today, is insightful.

This is a public episode. If you would like to discuss this with other subscribers or get access to bonus episodes, visit publicpolicy.substack.com
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#208 Go Shape the Molten Metal Now*
9 May 2023· Anticipating the Unintended
India Policy Watch #1: How Not to Let the Opportunity Slip Away
Insights on issues relevant to India
— RSJ
A strange thing happens when you are away on a break. One week you are sitting and wondering how many different things you can write about because of the flurry of events around you. US banks getting into trouble, Rahul Gandhi being denied bail, more curbs on US companies doing business in China, frenetic moves in semiconductor politics - you get the picture. And then you take a break. And everything slows down. First Republic Bank doesn’t implode in a matter of hours like SVB. Instead, it drags its feet in a slow-motion death spiral. RBI pauses on its rate increases. Janet Yellen pulls back on US hostility towards China while cooing about how the two economies need one another. Things go to a standstill when you stop looking at the world with a weekly columnist’s gaze. It is like the vibe of a still summer day in India takes over everything. Nothing moves. Once back, what does one write about? Well, thematically, there isn’t any one thing that will do right now. So, I guess I will cover a few areas that could be of interest.
The big story out of India last week was that we might have overtaken China in the population sweepstakes. This was kind of inevitable, and a million people here or there doesn’t make a difference in the larger scheme of things. Yet, it is as good a moment as any to reflect on that elusive thing called the India opportunity. Now, we have devoted multiple editions to why having more people is a good thing. Somewhat to my relief, a lot of commentary in the last week has echoed this sentiment. There’s the usual comparison of the relatively younger demographics in India with that of China and the advantage of being more aligned geopolitically with the West. And, of course, the governments in India don’t do terribly arbitrary things like China did in the past couple of years to the tech sector. On this last point, I have my views, but we are using a really broad brush here, so I will let it pass. The general tone of these articles is that this is India’s opportunity to lose—a far cry from my school days when the population was seen as a problem. I have three points to make in this context which are a bit different from the usual view of what India should do not to let this opportunity slip.
First, there’s the usual prescription that India should industrialise faster to take advantage of this dividend and avoid the middle-income trap. My usual take on this is how well do we know why India couldn’t industrialise faster in the last 20 years when China took off. It is not like this is a fresh insight that wasn’t known to policymakers then. So, what gets in the way of India to industrialise? My short answer will always be the state. Despite all the hype around Make in India and the rising ease of doing business rankings, it is still quite difficult to start and run a business in India. The state is deeply entrenched in controlling capital in India, and it enjoys the arbitrary power that it has over them that it is impossible to change this with just better optics of ‘single window’, tax holidays or investment roadshows. In the last two decades, the state has retreated a bit in some areas, but paradoxically, with greater digitisation, it has more information and, therefore, greater power over industry.
My general contention is that the state can continue with its welfarism (or whatever else you may call it) on the social and political front, but for India to industrialise, the state has to retreat on the economic control it wields. This looks very difficult today because the state’s first goal is to perpetuate itself. It will require the PM to go back to some of his campaign promises of pre-2014 with real conviction. All Indian politicians of a certain vintage are instinctively socialist. And as the farm reforms saga showed, even a small vocal minority can derail a progressive reform. The other challenge has been the availability of capital for MSMEs to build their business and compete for global orders. For the most part, since 2009, we have had a twin balance sheet problem, and that has meant banks have been very choosy about whom to lend. Add to that the shallowness of the corporate bond market, and we end up having a manufacturing sector low on its ambitions. On this, we might be on a better footing now. Bank and corporate balance sheets are at their robust best, and the public digital infrastructure and GST network make it possible for better underwriting decisions using informational collateral. This is evident in the robust credit offtake reported in the MSME segment across the banking sector in the past year.
My view is we will industrialise a bit faster than in the past, but we are going to fall short of the expectations of the kind of industrialisation that’s expected for us to increase our per capita income from $2000 to $10,000 in the next 15 years. China traversed that exact journey between 2006-20, so it is possible. And it is possible to do it without making the same mistakes as China, where it went back on its decentralised model of growth that made regions and companies compete with one another to an overly centralised model now that will only hurt it further. We need a very specific retreat of the state from the economy with a regulatory framework that acts as an enabler rather than lording over it in a policing role. These seem to be difficult even for a PM and a party that’s hugely popular and has no immediate threat of losing power. We will therefore continue to do a respectable 7 per cent growth over the long run than a tearing 10+ per cent. It is what it is.
This growth is good but not good enough to take care of the employment aspirations of the people. So, we will have to contend with high unemployment or underemployment for the foreseeable future. What will compound this is automation and the speed of AI adoption in the industry. One of the things to watch out for is the increasing sophistication of AI tools that could automate the services sector. The short-term evidence of generative AI tools like ChatGPT or Dall-e shows how quickly lower-skilled white-collar jobs could be automated. Also, these tools are now getting ‘consumerised’; that is the AI use cases are no longer restricted to a business-to-business context. This will increase the ability of the end users to use them for their needs directly. And that will reduce opportunities in the services sector, which has been the growth engine of the Indian economy in the post-liberalisation decades.
Separately, we have talked about the increasing market concentration among 4-5 corporate groups in India. This trend is only getting stronger, and I have explained in the previous edition how this is different from the ‘national champions’ model of the Asian tigers. Simply put, unlike them, these national champions aren’t using their monopoly to win in global markets. Concentration is a classic market failure that will eventually lead to higher prices and poor allocation of capital. There’s a good argument on this that’s been made, of late, on this by Viral Acharya. But it has gotten drowned in the usual nationalistic noise that any criticism of this government brings these days. The usual caution that would have come up at this stage would be about the social risks of a young and aspirational population being unemployed. As I travel across India, I find this risk to be somewhat overblown. The availability of cheap smartphones, cheaper data and a general increase in prosperity mean the youth is forever busy staring at their screens engaged in low-quality entertainment. We will continue to generate low-end services jobs to take care of the top tier of Indian society like the ‘home delivery of everything’ model has already shown us. This ‘yajman’ system of one rich Indian supporting ten others will be a feature of our economy.
Lastly, we must realise that the surplus labour and surplus savings (we are already getting there) that we will have will need to find their use outside of India. We will be one of the few countries in the world to have these together and almost no one will have our scale of surplus labour and savings. Free trade and open borders will therefore play to our advantage. It will be counterproductive to champion protectionism or any kind of swadeshi brand of politics. It will just be bad economics and blunt our edge in the global economy.
There is no shortage of things to solve if we want to make use of the demographic dividend. I have read the usual lament on how we must improve the quality of our labour pool, upgrade our education system, improve infrastructure and bring women into the workforce - the list is long. I think these are downstream factors that will mostly get taken care of if the state makes it easier for the enterprises to do business. That retreat when the state has enjoyed having capital under its thumb for decades is mighty difficult. India will do well because there is an overlap of trends that favour it uniquely. The giant leap it so desires will need more than just this happy coincidence to come its way.
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PolicWTF: Tariff ki Taareef Mein
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
— Pranay Kotasthane
We’ve cried ourselves hoarse that India’s position on international trade in electronics is self-defeating. The consensus in India is that high tariffs, heavy customs duties, and other such barriers are a crucial pre-condition for creating world-beating Indian electronics companies. Another edition of this series titled “Tariff ki Tareef Mein” played out last week.
On April 17, the World Trade Organisation (WTO) dispute settlement panel ruled that India’s imposition of tariffs on mobile phones and electronic components violates its commitment under the Information Technology Act (ITA). The ITA is a plurilateral agreement of the WTO in which the signatories committed to reducing all tariffs and taxes on Information and Communication Technologies (ICT) products. Europe, Japan, and Taiwan raised these disputes separately against India.
No surprise, the Indian government plans to challenge the ruling. In fact, government officials are signalling that the ruling won’t have any impact because the appellate body of the WTO doesn’t have enough judges to hear India’s position.
India’s formal defence is based on two arguments: one is technical, and the other is ideological.
The technical argument is that India signed the ITA in 1997 when mobile phones, chargers, and many of the now ubiquitous digital wonders hadn’t emerged. So, the recent tariffs on new products that came to life after 1997 do not violate India’s ITA commitments.
However, a deeper ideological argument underlies the technical argument. The Indian government strongly believes that signing the ITA led to the decline of its domestic electronics industry. And as a result, import tariffs are critical for maintaining the current uptick in domestic electronics production. The commerce ministry website pulls no punches when it says:
“India’s experience with the ITA has been most discouraging, which almost wiped out the IT industry from India. The real gainer from that agreement has been China which raised its global market share from 2% to 14% between 2000-2011.
In light of recent measures taken by the Government to build a sound manufacturing environment in the field of Electronics and Information Technology, this is the time for us to incubate our industry rather than expose it to undue pressures of competition. Accordingly and also keeping in view opinion of domestic IT industry, it has been decided not to participate in the ITA expansion negotiations for the time being.”
As this official position indicates, the government seems to have internalised that the ITA was the reason that India’s past attempts failed. (That line about incubating the industry rather than exposing it to “undue” pressures of competition transported me to the 1950s.)
There are at least three problems with this line of thinking.
One, it mistakes correlation for causation. It is true that Chinese companies decimated the domestic Indian manufacturers of cheap mobile phones by 2017. Indian domestic players couldn’t match the “features per unit price” that Chinese companies were able to offer. The import of cheaper phones back then benefited millions of Indian consumers. The reason that domestic players couldn’t compete wasn’t the ITA but that they had no competitive advantage. Their business model relied on rebranding older phones sourced from China. Zero tariffs under ITA, in fact, made it possible for these companies to import components cheaply and climb up the assembly value chain. But without any significant investment in R&D or industrial innovation, these “domestic” players were easily wiped off the market. This story isn’t unique to electronic products. Even in segments to which the ITA doesn’t apply, such as machine tools, textiles, or toys, Indian companies couldn’t stand international competition. Surely, the problem then lies in India’s large-scale manufacturing troubles and not in signing the ITA. The much-lampooned ease-of-doing business factors, such as poor infrastructure, byzantine labour and land regulations, and a complicated tax system, can explain why production in India remained a challenge across sectors.
Two, protecting domestic players will not produce world-beating champions. This is particularly true for electronics production, which relies heavily on cross-border flows of materials, machines, and humans. To export one type of electronic product, you need to import another type; atmanirbharta is impossible. By disregarding the ITA, products manufactured in India will not be able to compete in the international market. An analysis by the industry body of phone manufacturers shows that higher import tariffs have meant that a large portion of the money companies receives under PLI gets re-routed to pay these tariffs, ultimately making production cost-prohibitive. This is the reason why companies such as Apple have been trying to seek duty exemptions for some electronic components. It is also a major sticking point in the India-Taiwan Free Trade Agreement. A unilateral reduction in tariffs by following ITA is thus in India’s interest.
Three, India’s vehement dismissal of the ITA places it at a disadvantage in future negotiations. India has opted out of the ITA-2 negotiations that sought to expand the list of ICT products on which tariffs were to be reduced. As a big manufacturer, China was able to get favourable exemptions in these negotiations. Instead of reducing tariffs to zero immediately, it was able to extract waivers that give it a gentle gliding path towards zero tariffs. India has a similar opportunity today, given that it is far more integrated into the global supply chain for electronics due to the manufacturing presence of players such as Samsung and Apple. The geopolitical situation, too, is far more favourable. But India’s obstinate stance on the ITA makes the question of negotiating waivers a moot one.
China signed the ITA in 2003. By then, it already had a strong electronics assembly and manufacturing setup. The ITA supercharged its powers and helped it become a global provider of ICT goods. Twenty years later, India, too, has been able to kickstart electronics assembly. It’s now time to approach ITA more confidently instead of falling back to the tested-and-failed tropes of import substitution and infant industry protection.
A basic rule of strategy is not to spread too thin on many fronts simultaneously. India's trade strategy seems to ignore this maxim. If our chief adversary is China, it's better to settle trade disputes with the EU, UK, Japan, Taiwan, and the US with minimal friction. Instead, we continue to treat every tariff reduction as a bargaining chip. Missing the woods for the trees shouldn’t become India’s guiding principle in international trade.
Global Policy Watch: What Fed Learnt From SVB Failure
Reflection on global policy issues
— RSJ
On the face of it, quite a lot. A 118-page report.
As the Economic Times reports:
“The Federal Reserve issued a detailed and scathing assessment on Friday of its failure to identify problems and push for fixes at Silicon Valley Bank before the U.S. lender's collapse, and promised tougher supervision and stricter rules for banks.
In what Fed Vice Chair for Supervision Michael Barr called an "unflinching" review of the U.S. central bank's supervision of SVB, the Fed said its oversight of the Santa Clara, California-based bank was inadequate and that regulatory standards were too low.”
It is useful to understand what policy lessons are learnt by a regulator from a setback. SVB was a small bank (16th largest) but a fairly important player in the valley. And it went down in a heap within hours because of a run engineered by the enlightened VCs who asked their investee companies to pull out their deposits. I have covered the saga in a previous edition.
In its report, the Fed has identified the reasons for the bank failure, which in hindsight, is clear to everyone now. It points to three broader issues:
“First, the combination of social media, a highly networked and concentrated depositor base, and technology may have fundamentally changed the speed of bank runs. Social media enabled depositors to instantly spread concerns about a bank run, and technology enabled immediate withdrawals of funding.
Second, as I have previously stated, a firm’s distress may have systemic consequences through contagion—where concerns about one firm spread to other firms—even if the firm is not extremely large, highly connected to other financial counterparties, or involved in critical financial services.
Third, this experience has emphasised why strong bank capital matters. While the proximate cause of SVB’s failure was a liquidity run, the underlying issue was concern about its solvency.”
All good, so far. And therefore, the question: So, what have they learnt from it? Well, the key “takeaways” summed up are here:
“1. Silicon Valley Bank’s board of directors and management failed to manage their risks.
2. Supervisors did not fully appreciate the extent of the vulnerabilities as Silicon Valley Bank grew in size and complexity.
3. When supervisors did identify vulnerabilities, they did not take sufficient steps to ensure that Silicon Valley Bank fixed those problems quickly enough.
4. The Board’s tailoring approach in response to the Economic Growth, Regulatory Relief, and Consumer Protection Act (EGRRCPA) and a shift in the stance of supervisory policy impeded effective supervision by reducing standards, increasing complexity, and promoting a less assertive supervisory approach.”
The Board and the management take a large portion of the blame. And then it appears like the Fed is holding itself accountable by calling out the weakness in supervisory standards. Till you read the fine print. It is largely throwing a small team of SVB-specific supervisors under the bus, thus making it sound like a specific instance of dereliction of duty. SVB failed because the Fed raised interest rates too quickly without asking what could be the possible risks of such a move. It didn’t do its homework for its actions on the banking system. And when it realised the likely vulnerabilities that it hadn’t anticipated, it went easy on the rate hikes than the hawkish stand it had taken only a week earlier. Had it been only an SVB-specific issue, what explains the slow unravelling of the First Republic Bank?
It is one thing not to anticipate the unintended. It is another not to acknowledge it and search for lessons which won’t help you the next time around. Or maybe it knows what went wrong, and it is too proud to admit it went wrong. Either way, it comes out of this poorly.
India Policy Watch #2: Devil and the Deep Sea
Insights on issues relevant to India
— Pranay Kotasthane
Over the last couple of weeks, the Congress’ new election slogan, “Jitni aabaadi, utna haq”, has caused quite a flutter. Bluntly speaking, it is a pre-election promise to expand reservations for Other Backward Classes (OBC).
We’ve seen this movie before. As was the case with the last election, it means that the grand narrative that’s been put forward to counter Hindutva majoritarianism is “backward” caste mobilisation. But this time around, the mobilisation comes with some clear demands: a caste census, an expansion of OBC reservation, and a dedicated ministry for the empowerment of OBCs.
In his characteristically edifying column, political scientist Pratap Bhanu Mehta explains why these three demands for caste mobilisation will not translate to social justice. Social justice needs good public institutions of education and inclusive economic growth, combined with strong affirmative action for the Dalits and some deeply marginalised sections of OBCs. Instead, political parties have reduced the logic of “social justice” to one and only one item: expansion of OBC reservation. In his words:
“The most important things that are required for social justice do not require caste data. Making quality education available to all, the creation of public goods in which all can participate, the design of welfare or other cash support schemes, the best mix of subsidies and income enhancing measures, and most importantly, an expanding economy that creates mobility do not require the framework of caste. The mistake of the social justice agenda was that it forgot Ambedkar’s lesson that to effectively attack caste you have to (for the most part) strongly but indirectly attack the range of material deprivations that make its logic so insidious. Second, we have to express the blunt truth on so much of what went under the name of social justice politics in North India.”
…
“In my years of dealing with higher education, it was rare to come across a social justice party that shed a single tear for the decimation of public education or the destruction of universities. But all their social justice outrage was focused on the one single point of reservations. So in Bihar you got the RJD that, for all its tapping into the politics of dignity, decimated the governance structures that could have empowered marginalised groups. In UP, under the garb of social justice agenda, we tolerated parties that had little interest in governing. What was called the deepening of democracy in North India did not lead to deepening of governance or inclusive growth.”
[The Indian Express, April 21]
As you would imagine, that article ruffled many a feather. Writing in the same newspaper, Manoj Kumar Jha (a Rajya Sabha member of RJD) and Ghazala Jamil mounted a defence with these words:
“The RJD and other opposition parties that he accuses of reducing social justice to distributing “government largesse based on officially reified caste identities” and “decimating public education and destructing universities” have, in fact, invested heavily in school education systems so that the marginalised sections can simply reach public universities. The quantum of ambition in Bihar’s youth for competitive exams for public jobs and their presence in all sectors of the private economy across India and abroad today is a testament to the massification of education, despite suffering from the effects of uneven development and the failure of cooperative federalism.” [The Indian Express, April 27]
To claim that RJD and opposition parties’ biggest success is increasing the “number of youth writing competitive exams for public jobs” proves Mehta’s point. With quotas as the primary instrument of action, government education institutions merely become vehicles to distribute positions along caste lines.
Of course, Mehta’s article is a lament that the opposition is using one form of majoritarianism to counter another form of majoritarianism. But those in favour are desperate to show that their project is morally superior. Both these views are somewhat orthogonal to how this issue will resonate with the electorate in 2024. As of now, we are stuck with the politics of religion versus the politics of caste.
HomeWork
Reading and listening recommendations on public policy matters
* [Article] Ajay Chibber’s take on fiscal decentralisation has useful comparisons:
“India’s share of sub-national (state plus local) spending at 60 per cent of total spend is quite high at its level of development. Other large federal states spend less. Brazil spends around 50 per cent at the sub-national level, Germany 46 per cent, the United States around 40 per cent, and Indonesia around 35 per cent. Only Canada and China spend more than 70 per cent at the sub-national level. …Going forward, where India must focus is the share of local government, which remains very small. India’s local government spend is less than 4 per cent of total government spending. This share is much smaller than in most advanced economies, but also much lower than in centralised authoritarian governments like China, where local government spending exceeds 50 per cent of total spending by government. China is an outlier in this, but in most advanced economies, the share is much higher than in India. The 28 countries in the EU spend 23.2 per cent at the local level, Canada 21 per cent, the US 29 per cent. In Latin America, local government spending is around 12.7 per cent and most analysts feel it should be much higher.” [Business Standard, April 20]
In this context, we earlier discussed a framework for decentralisation in edition #186.
* [Podcast] A Puliyabaazi on the population question. Is India really overpopulated?
* [Paper] The Information Technology Agreement, Manufacturing and Innovation – China’s and India’s Contrasting Experiences by Dieter Ernst is THE starting point to understand the debate on India’s protectionism in electronics.
*From the poem Opportunity by Raymond Garfield Dandridge

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#207 The Rise and Rise of Conglomerates
3 Apr 2023· Anticipating the Unintended
India Policy Watch #1: Don’t Concentrate
Insights on issues relevant to India
— RSJ
In one of the recent editions on the Hindenburg short-selling saga, I had written about how easily the Adani group had spread itself into a diverse range of sectors. The group was highly leveraged because it was so keen on getting into newer sectors and then winning bids in them with metronomic efficiency. Generally speaking, it is difficult to run a conglomerate of different businesses. You might argue that each business can be handled by a competent management team who will use the brand name and deep pockets of the parent group to build a solid business. But it is easier said than done. Capital allocation decisions, which lie at the heart of executing a business strategy, are difficult within a single line of business. They become hugely complicated within a conglomerate of businesses. Misallocation of capital, lack of focus and inability to stay competitive against smaller, nimbler players eventually follow. Soon, the businesses need to be hived off, and you find companies convincing would-be investors on how they are doing fewer things and doing them well instead of spreading themselves too thin. This is the usual cycle.
Yet, you see conglomerates appearing on the business landscape across countries. In some cases, these are businesses integrating vertically or finding interesting adjacencies in their business. This kind of makes sense in the Coase-ian “Nature of Firm” way. I mean, if the transaction costs of finding someone to do a particular work are higher than you doing it yourself, sure, go ahead and do it yourself. But beyond that, there should be no economic reason for having conglomerates. Unless you have one of these conditions in the economy:
a) Cost of capital is high, and access to it is difficult. Newer players find it difficult to access capital to start new businesses while older, established players with free cash flow can muscle their way into unrelated but lucrative new sectors only because they have access to capital at a lower rate.
b) The playing field isn’t level for newer players to make a dent. Through a mix of friendly regulations, ‘working’ the networks and M&A activities, the bigger players continue to have an advantage going into a new sector over smaller players who might have expertise in cracking those sectors open.
c) There’s relatively little ease of doing business in those sectors or in the evening overall. The established conglomerates with an army of people, lawyers and consultants can get started relatively faster and capture the market than new entrants.
You don’t have to be a genius to see where the Indian policy-making framework is on the above conditions. There’s common and easy access to capital through a large number of PEs and VC funds but only for a particular kind of ‘flavour of the season’ variety. This also is getting difficult to access. The market for other forms of capital isn’t deep enough. In the same vein, long-term capital for greenfield projects where the credit risk has to be borne by the issuer isn’t available. There is always a whiff of regulatory capture especially in sectors where the government is closely involved bin decision making. Lastly, we might have moved up in the ‘ease of doing business’ rankings, but it isn’t clear yet how this has changed things on the ground. New businesses still find going tough for them.
All of the above means that in the past five years, we are reversing a trend seen since the ‘91 reforms. That of increasing salience of conglomerates in India. You don’t have to research too hard. Just take a look at any sector - already big or one that is emerging - you will have the same spectacle of a few large corporate groups getting themselves into all sorts of businesses, from defence to semiconductors or from airlines to carbonated soft drinks only because they believe they can take advantage of market distortions.
As if to illustrate this point further, here's news that’s only a day old. Here’s Moneycontrol reporting:
“The shares of Mukesh Ambani-led Reliance Industries Ltd (RIL) rallied 3.5 percent in the morning trade on March 31 after the company said secured creditors, unsecured creditors and shareholders would meet on May 2 to approve the proposed demerger of Reliance Strategic Ventures.
After the approval, the unit, which is the financial services subsidiary of the oil-to-telecom conglomerate, would be renamed Jio Financial Services.
Benefits that shall accrue on the demerger of the financial services business will be the creation of an independent company focusing exclusively on financial services and exploring opportunities in the sector, the independent company can attract different sets of investors, strategic partners, lenders and other stakeholders having a specific interest in the financial services business, a financial services company can have a higher leverage (as compared to the Demerged Company) for its growth and, unlocking the value of the demerged undertaking for the shareholders of the demerged company, the conglomerate said in an exchange filing.”
This isn’t out of the ordinary. If you search for similar news items from the last five years, you will notice the same pattern of large conglomerates (usually the big 5) muscling into other or newer sectors because they think they have the capital and they will be able to manage the sector well. While one cannot blame these conglomerates for their ambitions, this trend suggests we might have tipped over from being pro-markets to pro-business.
Coincidentally, as I was writing this, we had a paper authored by Viral Acharya (former Deputy Governor, RBI) on the opportunities and challenges for the Indian economy published by the Brookings Institution and being discussed in the media. Acharya has highlighted the concentration of power in Indian industry as a particularly worrying trend. He writes (I have paraphrased a bit):
“A striking feature of this rise in industrial concentration by private companies is that it is in part due to the growing footprint of “Big-5” industrial conglomerates, based on the overall share of assets in non-financial sectors in 2021. Data shows the following patterns.
First, until 2010, the Big-5 increased their footprint in more and more industrial sectors, broadening their reach to 40 NIC-2-digit non-financial sectors. After this breadth first strategy came the depth-next strategy. Starting in 2015, the Big-5 started acquiring larger and larger share within the sectors where they were present. In particular, their share in total assets of the non-financial sectors rose from 10% in 1991 to nearly 18% in 2021, whereas the share of the next big five (Big 6-10) business groups fell from 18% in 1992 to less than 9%. In other words, Big-5 grew not just at the expense of the smallest firms, but also of the next largest firms.
Next, this growth of Big-5 appears to be driven in part by their growing share of overall Mergers & Acquisitions (M&A) activity. Even though the aggregate number of M&A deals has dropped since 2011, the share of M&A deals by the Big-5 has doubled from under 3% in 2015 to 6% in 2021, without such an increase being seen in the next five biggest groups. Arguably, this growth has also been supported by a conscious industrial policy of creating “national champions” via preferential allocation of projects and in some cases regulatory agencies turning a blind eye to predatory pricing. Equally importantly, given the high tariffs, Big-5 groups do not have to compete with international peers in many sectors where they are present and derive most of their revenues domestically.”
Acharya then goes on to list the usual downstream problems of such an increase in market power concentration - inefficient allocation of capital, favouritism in project allocation, regulatory interference, related party transactions, over-leveraging while becoming too big to fail and crowding out new players.
But he also makes an important claim that this concentration of market power is one of the reasons for persistent core inflation. He concludes:
“In summary, creating national champions, which is considered by many as the industrial policy of “new India”, appears to be feeding directly into keeping prices at a high level, with the possibility that it is feeding “core” inflation’s persistent high level.”
I won’t go as far as Acharya yet on this thesis. As he admits, there’s more work that needs to be done here, but his conclusion on pricing remaining high because of industry concentration does pass the smell test. And it should concern policy makers. I know there are many who will ask what’s wrong in creating ‘national champions’ like the tiger economies did between the 70s-90s. But there are a few differences in our case.
Firstly, the focus on creating national champions elsewhere was to choose specific sectors where they might have a comparative advantage, invest in them, especially on technology and then win in global markets through an export-oriented strategy. It is a somewhat flawed approach, but it still makes sense for a low-income economy to do this. But we aren’t really doing this in India. Our so-called national champions are focused on domestic markets where there’s no particular need to have them. In fact, there is only a monopoly risk here with the attendant problems of price cartelisation and poor customer service. Also, the limited focus on exports that these big five domestic players have as of now is largely linked to natural resources and not large-scale, job-creating manufacturing setups. It is unclear how the broader economy is benefitting from this apparent design.
Secondly, the successful national champion model in other economies didn’t need high import tariffs to support their ambitions like it is now the case in India. We have written about this many times in the past. Higher tariffs will reduce the competitiveness of the domestic players in those sectors to compete globally. It is counterintuitive to have a high tariff regime if you want to build national champions. After all, global markets are much larger than the domestic market, and that’s where these conglomerates must be competing.
Thirdly, what’s the government getting out of the apparent tilting, if it is intentional, of the playing field in favour of these players? If the idea is to have national champions despite the obvious flaws in this intent, it makes sense to have stakes in these ventures to participate in the value being created.
Lastly, the overall economy will benefit if the process of creating such champions leads to factor market reforms and real ease of doing business for other participants in the process. Else, the larger players will continue to get ahead not because of better products or innovation but simply because they know how to manage the system. In other words, it is the 1970s all over again with a tadka of markets.
It is difficult to see how we can trace our way back from this path, given the apparent lack of opposition and the already dominant position of these conglomerates in industry and media. Also, any walking back will require some bold antitrust kind of measures (it is what Acharya suggests) which is quite impossible in India. Possibly, the only medium-term scenario is these conglomerates start stepping on each other's toes as they continue to diversify their businesses and that competition alleviates the problems of concentration. But that might be too late in coming, or they might have a tacit understanding of the rules of the game in competing with one another. It will distort markets further. Maybe this is a tad alarmist, but it is important to acknowledge there’s way too much diversification among the top conglomerates in India and that’s always a sign of market distortion.
India Policy Watch #2: We Need an Agnipath for India’s Diplomacy
Insights on issues relevant to India
— Pranay Kotasthane
In edition #198, I highlighted that at least three areas of the Indian executive need a quick state capacity boost. These were: the Ministry of External Affairs, Ministry of Electronics & Information Technology (MeitY), and economic regulatory bodies such as the Competition Commission of India (CCI).
Then I came across this tweet from the External Affairs Minister, which acted as a positive reinforcement for this line of thinking.
Managing these engagements in an unsettled world order needs an immediate boost in India’s foreign policy capacity. Solutions like incremental increases in the Indian Foreign Service (IFS), while required, will be too slow.
What we need today is a ‘surge hiring’ strategy. The external affairs ministry, in fact, was the first union ministry to experiment with a broader lateral entry for government officers in 2015. It also opened up positions in its policy planning and research division for people in academia and the private sector. However, these tentative trials seem to have lost steam. The underlying reason is the internal resistance from the foreign service officers, who see such attempts as a threat to their career progression.
The surge hiring strategy should try a different approach. It should attempt to hire a much larger number of people below ambassadorial positions. This way, the cadre protection impulse can be side-stepped. Instead of targeting joint secretary levels, two fellowships could be attempted: one for fresh graduates and another for young professionals working within and outside the government (thanks to Nitin Pai for this idea). Given the growing prominence of technology and economic issues as foreign policy domains, this approach would help build institutional knowledge within the ministry. More importantly, the surge should target staffing for the headquarter functions in Delhi for managing various engagements and new initiatives. Indian missions abroad can continue to be led by IFS officers.
Past attempts at lateral hiring were advertised as single posts in the unreserved category. By opening up a larger number of positions concurrently, the government could retain existing norms on reservations and quotas. Finally, the surge hiring strategy should have a sunset clause and a well-defined recruitment target. If it is conceptualised as a non-recurring measure keeping the current geopolitical situation in mind, it will resonate with the opposition and the parliament.
With the Agnipath experiment of the defence ministry, the idea of short-term employment within the government has gained some acceptability. It is no longer anathema to the government but an idea whose time has come. Without a surge in foreign policy capacity, we will only have great ideas but tardy implementation, resulting in a perennially underperforming foreign policy.
Matsyanyaaya: Reflections on the Quad
Big fish eating small fish = Foreign Policy in action
— Pranay Kotasthane
Last week, I attended a US State Department sponsored programme that aims to invigorate think tank research on Quad collaboration in the four countries. As part of the first segment of this programme, five representatives from each country’s think tanks were hosted in the US. What follows are my reflections on the Quad as a geopolitical formation, based on what I saw in this programme.
* Quad ranks higher on the US foreign policy agenda than I had expected. My prior assumption was that given the multiple alliances that the US leads, a new, amorphous grouping such as the Quad wouldn’t rank high on its priority list. However, the interactions with the officials suggested a conscious effort to infuse energy into the Quad.
* The Quad is being positioned visibly and intentionally as a positive force that would bring benefits to the Indo-Pacific at large, rather than as an anti-China “alliance”. This is the reason why the interactions as part of the grouping have spawned into six leader-level working groups—on COVID-19 Response and Global Health Security, Climate, Critical and Emerging Technologies, Cyber, Space, and Infrastructure, and at least three initiatives—Indo-Pacific Partnership for Maritime Domain Awareness, Semiconductor Supply Chain Initiative, and the Quad Fellowship. The strategy, if there is one, seems to be to throw several balls up in the air, knowing fully well that some of them will get dropped, while others might be caught on their way back by all four countries, or only a subset amongst them.
* As the Quad is not a traditional security alliance, its success metric will also be different. Not all cooperation will be Quad-labelled, and some of it might come in bilateral or trilateral formats. So, the increased cooperation between Japan and Australia on defence ties, and between India and Australia on economic ties, are also indicators that the Quad is moving in the right direction.
* While the rationale for Quad collaboration in many areas is often “common interests” or “shared values”, an underrated frame is “mutual complementarities”. In many spheres, especially in technology, the Quad is an attractive forum for cooperation precisely because each country has complementary strengths.
* Positioning Quad as a force for good in the Indo-Pacific—rather than a geopolitical grouping against China— in many areas runs the obvious risk of underperformance and loss of credibility. In international affairs, efforts at providing benefits to another country are usually known by their failures more than their successes. For instance, in May 2021, the Quad Vaccine Partnership targeted the provision of 1 billion COVID-19 vaccines. Even though the four countries individually delivered 670 million doses, including 265 million doses in the Indo-Pacific, the demand for vaccines waned by the end of 2022. The dominant narrative was that the Vaccine Partnership had failed, even though it had made a significant contribution.
HomeWork
Reading and listening recommendations on public policy matters
* [Podcast] We were on Shruti Rajagopalan’s excellent podcast Ideas of India to discuss our book and the Indian State’s many puzzles.
* [Podcast] A Puliyabaazi on citizencraft featuring Nitin Pai.
* [Paper] This paper by Isha Bhatnagar offers evidence that gender equitable preferences are rising in India. From the abstract:
Over more than a quarter-century period (1992–1993 to 2019–2021), I find a significant decline in son preference from 40 to 18 percent and an increase in gender-equitable preferences among most subpopulations. Multivariate analysis shows that for all survey years, education and frequent exposure to television significantly increased the odds of gender-equitable preferences. In the last decade, community norms supporting women's employment are also associated with gender-equitable preferences. In addition, decomposition analysis shows that compared to compositional change, social norm change accounts for two-thirds of the rise in gender-equitable preferences. These findings suggest that rising norms of gender equality have the potential to dismantle gender-biased preferences in India.

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#240 Peering Into the Future

#239 Of Screws and Racquets

#238 Everything's Connected

#237 Looking Under the Hood

#235 Right Diagnosis, Wrong Prescription

#221 The Good, the Bad and the Ugly

#220 (China+1) Or (1-China)?

#219 Of Sins, Bets, and Bluffs

#218 TechTalk

#217 False Hopes and Weak Promises

#216 Thick and Fast

#215 Of Openings and Possibilities

#214 The Stakes are High

#213 The Mind Plays Tricks

#212 Myths & Misconceptions

#211 Of Motives and Presumptions

#210 Metastability

#209 Of New Beginnings and Old Grouses

#208 Go Shape the Molten Metal Now*

#207 The Rise and Rise of Conglomerates