FT columnist roots for Modi

The Economist cast its vote against Modi about a month ago, saying that the Gujarat riots of 2002 in his time could not be overlooked. Several intellectuals abroad have signed letters saying pretty much the same thing.

FT's foreign affairs editor has a different view- he thinks Modi deserves a chance. Here's why:

His rise would send an invigorating message across a country where too many people’s chances are still blighted by poverty, class or caste. That anti-dynastic message deserves to resonate well beyond India. The upper echelon of China’s government is still dominated by “princelings” – men such as President Xi Jinping who are descended from Mao Zedong’s close comrades. The US could well witness another presidential election contested between the Bush and Clinton clans. South Korea and Japan are led by the daughter and the grandson of former heads of government. Politics is also strongly dynastic in India’s neighbours Pakistan, Sri Lanka, Bangladesh and Myanmar. It would be a welcome change for India to elect a self-made man.

......The ruling Indian National Congress has reason to be proud of the liberal economic reforms that it unleashed in the 1990s. But the party has now lapsed back into the rhetoric of redistribution and big government. By contrast, Mr Modi emphasises economic policies that are focused on encouraging growth, helping business and reducing the size of government. This kind of liberal agenda is no longer so fashionable in the west. But it has been crowned with economic and political success in Gujarat.

As readers of this blog would know, I am a little sceptical about the view that Mr Modi stands for Thatcherite reforms, which means small government and leaving things to the market. He will, of course, be business-friendly. But that does mean rolling back the state. If his record in Gujarat is anything to go by, the Modi approach is to combine pro-growth policies with effective state institutions. Gujarat's leading PSUs have effected a turnaround under Modi. The erstwhile Gujarat Electricity Board is an astonishing story of recovery. Public distribution in Gujarat is reasonably effective. So are public hospitals- Gujarat has a first-rate public kidney hospital in Nadiad and a cardiology hospital in Ahmedabad. 

My own view is that Mr Modi will bring his administrative skills to bear on strengthening public enterprises and institutions. I also reckon that he will not roll back the present welfare schemes, although he may refrain from expanding them. India's polity is such that it  forces people who want to rule at the centre towards the centrist position when it comes to political ideology; likewise, the basic economic ideology will have to be slightly left-of-centre if it is gain acceptance in a still poor country riven with inequalities.

More on this in a TV discussion on CNBC in which I participated recently.  Here are link1 and link2

Gujarat growth model: useful links

EPW has generated a lively debate on the Gujarat model. Here are the links:

1. Ravindra Dholakia: Relative growth performance of Gujarat

2. Ghatak and Roy

3. R Nagaraj

4. Sugata Marjit

5. Response to Marjit

Middle class' phoney angst over corruption

I have long argued that corruption cannot be a central issue in the Indian polity because corruption in one form or another exists everywhere. The best one can do is minimise petty corruption of the sort that the ordinary man faces in his daily life.

And yet from time to time one hears that corruption is a major issue. The people who say this are very often from the middle class- the very class that is part of the corruption that goes on and is a major beneficiary. Shankar Sharma has an interesting take on this theme in BS. dilates on this theme and says that the middle class had no problem with corruption in UPA- I when the benefits were trickling down to them- in the form of higher salaries, appreciation in stocks, etc. It is only when the economic slowdown began that corruption became an issue.

....since the big economic boom began in 2004, the Indian middle class has partied. Salaries increased at a compounded rate of 40 to 50 per cent across most professions. Packages of Rs 50 lakh and higher became commonplace. US salaries paled in comparison.
And which industries saw the biggest salary jumps? Largely, infrastructure, real estate, telecom, finance, mining, power and so on. Now, weren't these the very sectors in which some of the biggest scams (real or concocted) since 2004 have occurred? You bet. These sectors were the ones in which the same ultra-moralistic Indians fought each other to gain employment. Was middle-class India so innocent as to be unaware that bribes are an integral part of doing business to run any regulated business such as infrastructure, power or mining (anywhere in the world, actually)? That contracts in these businesses are almost never won honestly, or that bids won honestly have little if any profits embedded in them?

...Please note that the so-called anger against corruption started to gain momentum only in 2011 - almost precisely when our growth rates started to plummet. Truth be told: Indians were happy to make money off corruption, and happily turned a blind eye to what lay beneath the boom. It is only when our salary increases dwindled that we turned to the Kejriwals and the Modis on the rebound.

 Sharma goes on to argue that Indians are willing to wink at Modi's supposed lack of respect for democratic norms or secularism or even the prospect of crony capitalism under Modi because they expect the goodies to start flowing again. (This is an argument that is made for Singapore very often).

I have difficulty in going along with this proposition. People may believe that Modi will be an effective administrator but I doubt that they will be willing to let anybody trample over democracy or secularism. The very fact that the BJP and Modi have had to change their positions on these matters suggests that Indians will not compromise on basic tenets. Indira Gandhi found out this truth the hard way. So will anybody else who tries to take liberties with basic principles. 

Modinomics: an American view

A former American bureaucrat, writing in the Hindu, compares Narendra Modi with Ronald Reagan. One common element, according to him, is that both have humble backgrounds. Modi is looked down upon by the nation's elites as Reagan was in the US  because he comes across as unsophisticated.

This is certainly true. It astonishes me that the elite in the media and elsewhere are unable to respect something as phenomenal as a chief minister of a state, with no experience at the centre, being able to generate a nationwide following, something that his party itself has never enjoyed!

The writer then suggests that Modi's economic vision is somewhat similar to Reagan's and that he has the capacity to unleash the nation's entrepreneurial energies:

As one who lived through Reaganomics, I believe that Modinomics can be the perfect antidote to the kleptocratic crony socialism that has kept India from realising her vast economic potential. If India’s natural entrepreneurial dynamism is ever fully unleashed, the sky will be the limit. I am persuaded by the evidence (hotly debated in an election season, of course) that shows that economic growth in Gujarat under Mr. Modi has been a boon to all segments of society, especially the poor. I am just sharing my view as an observer, and of course respect that it is for the people of India to decide what is best for them. 

One has to be careful not to overdo the comparison. Giving a boost to entrepreneurship is not the same as embracing Reaganomics. In India, no government can afford to move very away from welfarism. Modi's recent pronouncements seem to reflect this recognition. BS has caught this point well in a recent edit:

In the past, Mr Modi has said in speeches that his definition of reform does not include the changing of poorly framed policy, but merely building infrastructure. In his most recent statements, he has outlined a slightly different agenda. He has said, among other things, that "we will not reduce subsidies". As if to underline this point, he said that his economic agenda should be described as "pro-people", and added that "the poor will continue to control the coffers of India". This seems to suggest that Mr Modi's economic vision will maintain the United Progressive Alliance's (UPA's) welfarist policies .

....Mr Modi's attitude to privatisation of public sector undertakings (PSUs) was also disappointing. He said that the idea that PSUs were inefficient has "done much damage"......Most worrying, perhaps, is the one area where Mr Modi has promised a break with the UPA. He has said that a review of policies governing foreign direct investment was necessary: "We have to protect the manufacturing sector. If we are unable to protect the manufacturing sector and small-scale industries, our youth's future will be destroyed." 

This is a far cry from Reaganomics. Those who think that Mr Modi will make a clean break with past policies ignore the compulsion in the Indian context to walk on two legs: growth and welfarism. What we can expect of Mr Modi is that by improving governance, he will boost growth and he will make welfare schemes more efficient. As part of his effort to improve governance, he may tilt towards greater decentralisation. But it would be naive to suppose that Mr Modi will embrace free market economics a la Reagan. 

Gujarat growth model: is it for real?

There has been an enormous amount of talk about the Gujarat growth model. Modi's admirers say it has worked, meaning it has delivered growth and better living standards. His critics say that it has worked only for corporates. Where does the truth lie?

I have scanned the literature. Let me state my conclusions upfront:

•  Gujarat has been a leader when it comes to growth rate
• It has lagged behind in social indicators (meaning, its indicators are not as good as those another high-growth state such as Tamil Nadu)
• However, Gujarat has been catching up on social indicators too. Once Modi's attention was drawn to Gujarat's adverse indicators, he has been quick to address this issue.

Ok, now on to some key facts. How do we address the growth issue?

• Comparing Gujarat's growth rate in the 2000s with that in the nineties: Not correct, because it is not just Gujarat that has improved its growth rate but the rest of India
• Comparing Gujarat's growth rate with that of other states:Not correct because if Gujarat has always been ahead of other states, then the fact that it has done the same under Modi does not tell us whether Modi has made a difference
• Comparing the difference in growth rate between Gujarat and the rest of India in the 2000s (post-Modi) with that in the 1990s (pre-Modi): Correct. If the differential has changed, we can come to conclusions.

An article in EPW follows the last approach.  There are some important methodological issues. Do we look at growth in state domestic product (SDP) or growth in per capita SDP?  The authors use both methods and come to the following conclusions:

• Gujarat was at par with or ahead of the rest of India in the 1980s
• Gujarat was ahead of the rest of India in the 1990s
• Gujarat maintained its lead over the rest of India in the 2000s but the difference was not significantly greater than in the 1990s.
• Gujarat is not alone in the high-growth league: it must share honours with Maharashtra, Tamil Nadu and Haryana

The authors conclude that Modi not deserve special credit for his performance. It is possible to differ. Growth in the 2000s was on a higher base, so if Modi was still able to maintain the difference with respect to India, that constitutes an achievement.

Surjit Bhalla, writing in IE, follows a slightly different tack.  He looks at the pre-Modi Gujarat (years between 1992 and 2001) and Modi Gujarat (2002 to 2011/12) and compares indicators with seven states whose per capita incomes were at the same level as Gujarat in 2001. His conclusions are resoundingly in favour of Modi:

• Annual agricultural growth accelerated across India and in the similar seven states (SSS), agricultural growth accelerated by 1 per cent per annum (ppa) to 3.8 per cent; in Gujarat, the acceleration was more than three times as much
• Manufacturing in Gujarat accelerated by 5.6 ppa compared to an acceleration of 2.9 ppa for the SSS
• the service sector in Gujarat, from being 0.5 ppa behind the comparator states in the pre-Modi period, accelerated to 2 ppa higher with the arrival of Modi — 10.7 per cent per year versus 7.7 per cent before

What about the criticism that Gujarat's growth was not inclusive and that growth in Gujarat has been jobless? Well, Bhalla points out that when we look at growth in wages of the poor relative to those of the rich, Gujarat does better than other states; also, on unemployment.

What about social indicators? Bhalla has a piece on this aspect as well. He points out that on several indicators- inequality, education, access to sanitation and water, health and the sex ratio- the improvement in Gujarat's indicators is better than in the seven comparable states (except for female infant mortality).

Note, however, that only looks at the change from what you might call a low base for Gujarat. In absolute terms, Gujarat's indicators lag behind the best performers in the country, as Jean Dreze points out in his article in the Hindu:

Whether we look at poverty, nutrition, education, health or related indicators, the dominant pattern is one of indifferent outcomes. Gujarat is doing a little better than the all-India average in many respects, but there is nothing there that justifies it being called a “model.” Anyone who doubts this can download the latest National Family Health Survey report, or the Raghuram Rajan Committee report, and verify the facts.

Dreze makes a more interesting point. He questions the view that Gujarat's achievements are the result of private enterprise as distinct from state intervention (and,by implication, there are lessons for the rest of India). He writes:

When I visited Gujarat in the 1980s, I was quite impressed with many of the State’s social services and public facilities, certainly in comparison with the large north Indian states. For instance, Gujarat already had mid-day meals in primary schools at that time — decades later than Tamil Nadu, but decades earlier than the rest of India. It had a functional Public Distribution System — again not as effective as in Tamil Nadu, but much better than in north India. Gujarat also had the best system of drought relief works in the country, and, with Maharashtra, pioneered many of the provisions that were later included in the National Rural Employment Guarantee Act. Gujarat’s achievements today build as much on its ability to put in place functional public services as on private enterprise and growth.

Dreze asks: if Gujarat's high growth is not matched by a commensurate improvement in social indicators, does it has to do with a slackening in public services or with gender inequality? It is interesting that, in a recent interview, Modi has said that PSUs can do as well as private firms, if given adequate autonomy and has cited Gujarat's own PSUs as cases in point.

Sanjaya Baru's revelations

Sanjaya Baru's book, The Accidental Prime Minister, is making waves. I haven't read the book myself but I have read excerpts- and I can see that the book promises to be a racy read.

The media has focused on the bits about the relationship between PM Manmohan Singh and Sonia Gandhi. There are numerous other details that are eye-catching as well. Let me mention two:

• The post of principal secretary to the PM was first offered to a Tamilian. He declined saying that he had promised his father never to take up a government post after retirement. I would love to know the identity of this ex-bureaucrat. The man is a hero! A large number of bureaucrats do everything they can to get some position after retirement and they stoop to unbelievable levels to appease their political masters. Here is a man who said 'no' to a plum position that came to him on a platter!
• Baru quotes former NSA M K Narayanan as telling him that Narayanan kept tabs on the credit card spending habits of influential editors. If this is true, it means the intelligence agencies in India have carried snooping to heights not attained even by America's National Security Agency.The agency, one is given to understand, at least respected the privacy of US citizens. Baru's revelation is a serious one, especially given the way the UPA government has pounced on allegations of snooping done on Mr Modi's behalf- the so-called Snoopgate affair. One hopes the new government will look into what the intelligence agencies are up to when it comes on spying on citizens

Fixing the PPP model

Private public partnerships were to be the answer to our investment problem, especially in the infrastructure  sector. Nearly half the investment in the current five-year Plan is supposed to come through PPPs. Sadly, the model is broken and this explains the slump in investment in the last couple of years. One of the biggest challenges for the next government is fixing the PPP model so that growth can revive. (Where it can't be fixed, we have to find ways for government to fund investment).

EPW has a though-provoking article on the subject, with several interesting proposals for reform. The piece is written by an office in the ministry of finance, so it is not as if the government lacks ideas.

As the author points out, the government has been a on re-negotiating binge in several PPPs. In the power sector, for instance, the regulator has revised tariffs upwards. This sort of re-negotiation makes nonsense of the bidding process- those who lost out can always protest, saying that had the more favourable terms extended later been known, they would have bid differently. Secondly, any private operator who finds a project unviable can go running to the government and ask for re-negotiation, saying he cannot proceed otherwise. Effectively, project risk is transferred to government- this is conceptually no different from government bail-outs of banks.

The author spells out three elements needed in the reform of the PPP model: upholding the sanctity of the PPP contract, creating more regulatory certainty, and increasing the value for money (to government) from PPPs:

The answer to this opportunistic behaviour (of private parties) is not renegotiations, but to cancel bad projects and re-tender them to the private sector in a transparent manner. While this would be time consuming and could also reduce the inflated premia generated for the public sector, it would incentivise more realistic bidding....

One of the frequently cited reasons for seeking renegotiations is traffic overestimation. To ameliorate traffic risk incidence on the private concessionaires in the road sector, the government may consider introducing a new bidding parameter: least present value of revenues (LPVR). Under this bidding parameter, the user fees and discount rate are predetermined and the concession is awarded to the firm that bids the least present value of toll revenue. The concession ends when the present value of actual toll revenue is equal to the winning bid.

Then there should be a requirement of value for money calculation at three stages – at the appraisal stage (to decide whether it is worth going for the PPP option), at the operation stage (because the promised benefits may not materialise as in renegotiated contracts), and finally, at the end of the contract period (to compare the actual value for money with the projected). 

To further improve PPP project performance and VfM as also transparency, the concession agreements should be in public domain. This will enable all interested parties to monitor the project, which should improve performance and VfM. The direct liabilities created by PPP projects (as in annuity projects)⁴ should also be reported in the budget, which would provide a level playing field to all procurement options for provisioning public services.

Mor committee report on financial inclusion

The Mor committee report on financial inclusion has not received proper attention in the popular press. I dissect the report in an EPW article.

Very briefly, the Mor committee thinks the job can be better done through a new set of specialised players for whom a different regulatory dispensation is created. I have my doubts both about the viability of these players and the potential for systemic risk they can create. The committee also advocates a stiffening of priority sector targets. The scheme it proposes is rather complex and is likely to run into measurement issues. New institutions are welcome. But we need to get more out of the vast structure we have created for inclusion- regional rural banks and cooperative banks. I outline in my article how this can be done.

A retired banker, writing in EPW, has the same reservations about the new institutions proposed but he is rather more sanguine about the committee's priority sector recommendations. 

Was the 2G scam a scam at all?

One reason for the UPA's declining fortunes is the preponderance of 'scams' under UPA-II. One big 'scam' that has proved its undoing is the 2G 'scam'. Right from the time, the CAG report came out, I had argued that not opting for the auction route for spectrum rights and adopting a first-come-first-served policy, based on a low price, did not constitute a scam.

First, the policy had been practised by the NDA as well. Secondly, the low price ushered in competition and helped boost telecom density to great heights. So the policy itself was a success. Where things may have gone wrong- and this has to be established in a court of law- was in the manner in which first-come-first-served was implemented under the then minister, A Raja. PC Chacko, who headed the JPC enquiry into the subject, mounts a vigorous defence of the 2G policy in a recent interview:

The 2G scam is no scam. The media must have celebrated the 2G scam, but it is no scam.
There was some impropriety in giving licenses irrespective of the priority of the application and that mistake was done by (former telecom minister) A Raja. He was in jail for that failure, but the government did not defend him. He is still undergoing trial.
According to the CAG (Comptroller and Auditor General), the government's mistake was selling spectrum at a lower price and not by auction. This is totally unfounded. That is the basis of the allegation.So, I can repeatedly say that 2G is no scam at all.

Unfortunately, this defence and others put up by the UPA is likely to drowned in the general election din. Public perceptions are shaped by the media and the media loves a corruption scandal as much as the general public. Once the damage is done, it is hard to salvage a reputation. 

It doesn't happen only in India...

The nexus between crime and politics, which has been in the open in India in recent years, is by no means confined to India. It is a universal phenomenon. In Italy, a former senator and close business associate of ex-PM Berlusconi faces a seven-year jail term for his connection with the mafia, FT reports. He is now on the run from the law:

Mr Dell’Utri was long considered one of Mr Berlusconi’s closest advisors. Both men have accused the courts of leftwing bias and have consistently denied allegations by prosecutors and  mafia turncoats that Mr Dell’Utri had acted as a go-between for the mafia with Mr Berlusconi.

The Palermo-born businessman was placed under investigation in 1994, the year of the first of Mr Berlusconi’s three election victories, and was credited with mounting a campaign in 2001 when Forza Italia swept all 61 seats in Sicily.

Wherever there is big money, big crime is involved. Politics, business, major sports events all involve big money. So, they draw in criminal elements in a big way. Very often, big crime stays in the background and gets its job done by those in the limelight. However, it also happens that criminal elements decide that they should be running the show in politics themselves. This has happened in many democracies, including India. 

Top 10 emerging market risks

The prospect of an unexpected electoral outcome in India- that is, Modi not forming a government- is one of the 10 top emerging market risks listed by the FT. The stock market has surged on the back of such an expectation; if it is not met, there could be a steep reversal.

The more interesting part of the list is that three of the 10 risks relate to China- a failure to respond to stimulus, a property bubble burst and a collapse in the shadow banking sector.

On a macro-view, there has been a 180 degree turn in the economic outlook. Post the financial crisis, advanced economies were in trouble; emerging markets looked poised to continue rapid growth. Now, it appears advanced markets will recover while emerging markets face a slew of problems related to deep-seated structural factors. For an insight into this, see the IMF's latest WEO.

What difference can a Modi government make to economy?

People have been analysing the Congress and BJP manifestos to see what the key differences are. Broadly, both are for growth and equity. Writing in BS, economist Arvind Panagariya suggests that a Modi government would put growth first, with greater emphasis on the first:

Mr Modi firmly believes in building highways, railways, cities and universities to modernise India and to create jobs that would empower people to access housing, education and health. In assessing schools for recognition, he emphasises performance outcomes instead of inputs norms. In the provision of health, he gives wellness priority over illness and hence seeks enhanced public health measures.

The difficulty with the above formulation is that the manifesto does not spell out how these ambitious programmes are to be funded. Government does not have the funds and the PPP model is broken and needs serious rectification. In general, the institutional shortcomings are so acute that a recovery in growth, as I have argued earlier, is unlikely to emanate from any domestic initiatives. It's hard to believe that any new government has a magic wand with which it can accelerate growth.

The real difference with a Modi government, as Pangariya suggests, could lie elsewhere- in greater decentralisation of economic decison-making:

In the last decade, one-size-fits-all central schemes have proliferated in the health, education, agriculture, skill development, employment, urban development and rural infrastructure sectors. These schemes require states to contribute significant proportions of expenditures and have progressively shrunk their fiscal space while absorbing the states' scarce human resources.
Having been the victim of this "tyranny" of the central government during the last decade as the chief minister of Gujarat, Mr Modi will likely help the states recover some of this lost fiscal space. He will perhaps redesign the schemes in ways that give states greater flexibility and arrest their future proliferation. In contrast, under a Gandhi administration, the "rights" will expand and so will the central schemes, further shrinking the states' fiscal space.
A Modi administration is also likely to give greater legislative flexibility to states in subject areas included in the concurrent list such as criminal and civil procedure codes, labour, bankruptcy, legal and medical professions, education, acquisition of property, factories and boilers. Under Mr Gandhi, the legal grip of the Centre on the states will continue to tighten unabated.

If Mr Modi can do this, it will indeed be a significant change. What we have had under the UPA government is an attempt at economic centralisation as a means of countering the decentralisation brought about by democratic politics. Even as non-Congress governments have assumed power in many states, the Congress has sought to wield power and influence through centrally-sponsored schemes under the aegis of the Planning Commission.

Will Mr Modi be willing to reverse this trend? It's difficult for anybody holding the reins at the centre to let go. And Mr Modi's style in Gujarat has been concentrate power in his office. At the same time, he has declared time and again his opposition to the Congress way of running the country. It could well be that he will see a decisive shift towards decentralisation as one of the hallmarks of his regime. Let us hope he does.

UPA's economic performance: it's the world economy, stupid

I wrote yesterday that it is hard to argue that the current downturn is on account of serious policy errors committed by UPA-II. I said global factors and non-policy factors are more important.

Today, Ruchir Sharma, writing in TOI, points out that India's performance on growth and inflation has not changed between the NDA and UPA governments. Any change in growth is linked to the fortunes of the world economy. The boom in UPA-I and the downturn in UPA-I are both explained largely by the ups and downs of the world economy. He corroborates my view that the significant failure of UPA-II is in respect of inflation (which, I said, was parlty because correct economic data was not available to the government on time): 

The last BJP-led government took power in 1999 and presided over a five-year period of rather standard Indian performance. India posted average annual GDP growth of 5.8% — ranking 50th in the emerging world — with inflation of 3.9% — ranking 70th in the emerging world. This record represented little change from the previous 20 years, so it is hard to see why it should provoke much criticism, or bragging....
After 2003, with international trade booming and easy money pouring out of central banks in the West, growth started to accelerate sharply across the emerging nations, and India was no exception. Its GDP growth rate accelerated to 8% over the next five years, under the Congress government, but its place in the ranks did not improve much. From 2004 to 2008, India ranked 39th in the emerging world for average GDP growth and 73rd for inflation. ....  Over the past five years, India's average annual GDP growth rate has slowed to 6.5% on average but its global ranking is still basically unchanged at 45th as growth has faltered in many emerging nations...India's inflation rate has risen from 6.5% in its first term to 10.5% in the second, while its inflation ranking has fallen from 73 rd in the world to a near bottom decile rank of 130th  

Has UPA-II messed up the economy?

I address this issue in my post at a newly started current affairs website. I will lay out my main ideas:

• India's growth slowdown does not look bad compared to China's
• Domestic factors have contributed but these are not policy-related factors but non-policy related factors: court judgements, the CAG reports, the anti-corruption campaign, delays in environmental and land acquisition clearances etc, all of which have impacted on output and investment
• The key policy failure is in respect of inflation. Supply-side factors apart, aggregate demand in the form of the fiscal deficit is an important contributor. It appears the UPA government was slow to withdraw the post-fiscal stimulus. But this is strictly hindsight. The strength of the recovery in 2010 and 2011 could not have been foreseen when the budgets were presented. 
• The key global factor in the last two years has been the Eurozone crisis
• The UPA government deserves the fullest credit for getting on the top of the currency crisis that was brewing in late 2013. India's CAD position is amongst the best in emerging markets now. Add to that the fiscal deficit coming under control, a debt to GDP ratio of under 70% and a growth rate prospect of 5.5-6% in the coming year- and the Indian economy looks distinctly good in the international setting.

It should be evident that, except in respect of inflation, there was no significant "policy failure" in the sense of managing policy in the short-run. The failure is a larger one and it embraces successive governments, namely, the failure to put in place the necessary institutions for PPPs, land acquisition, environmental clearance etc. This is not something that can be remedied in a short span of time.

It is India's strong fundamentals that explain much of the rally in the stock market in recent weeks. The prospect of a stable government and strong leadership at the centre may be contributing but only at the margin. The notion that the UPA government has messed up the economy through welfarist policies thus has little basis.

An article in today's BS points out how good India looks in relation to other emerging markets. The authors give credit to the UPA government, although it is not necessary to share their fulsome praise.

Estimating the size of corruption in India

Everybody knows corruption is rife in India. Just how bad is the problem? The Economist attempts to quantify corruption in India using three methods:

The first is to tally the money made from scams, based on estimates from officials and investigators. (Our calculation uses realised profits, or the present value of anticipated profits. We use the low end of some official estimates.) The second approach, which is applied more widely in our new index of cronyism (see article), measures the relative performance of billionaires in industries, such as mining and property, that are prone to rent-seeking relative to those in other lines of business (see chart 1). A final method tracks the relative performance of an index of politically linked listed firms constructed by Saurabh Mukherjea of Ambit Capital, a broker (see chart 2). An average of the approaches suggests the gains from rent-seeking over the past decade peaked at about $80 billion. That is equivalent to 7% of the stockmarket’s value today. It is worth noting, though, that the share of GDP for the rent-seeking billionaires and the premium on politically connected firms are no longer what they were in the boom years.

Assuming bribes paid were 5-15% of money made by businessmen, the Economist estimates that total bribes paid would amount to $4-$12bn.  Presumably, this is over a decade. Translating into rupees, this amounts to Rs2400-7200 crore every year.

What ails democracy?

The Economist has an interesting essay on the subject. Democracy was widening until the turn of the last century. For the last eight years, it has declined, going by the number of people living in democracies. The declines have taken place outside the West. In the West itself, the effectiveness of democracy as a creator of prosperity is coming under a cloud. Why so? The Economist identifies what it believes are the two primary causes:

THE two main reasons are the financial crisis of 2007-08 and the rise of China. The damage the crisis did was psychological as well as financial. It revealed fundamental weaknesses in the West’s political systems, undermining the self-confidence that had been one of their great assets. Governments had steadily extended entitlements over decades, allowing dangerous levels of debt to develop, and politicians came to believe that they had abolished boom-bust cycles and tamed risk. Many people became disillusioned with the workings of their political systems—particularly when governments bailed out bankers with taxpayers’ money and then stood by impotently as financiers continued to pay themselves huge bonuses. The crisis turned the Washington consensus into a term of reproach across the emerging world.
Meanwhile, the Chinese Communist Party has broken the democratic world’s monopoly on economic progress. Larry Summers, of Harvard University, observes that when America was growing fastest, it doubled living standards roughly every 30 years. China has been doubling living standards roughly every decade for the past 30 years. The Chinese elite argue that their model—tight control by the Communist Party, coupled with a relentless effort to recruit talented people into its upper ranks—is more efficient than democracy and less susceptible to gridlock.

Setbacks to the cause of democracy include Russia under Putin, the Iraq war (which led many to believe that democracy was a fig-leaf for the spread of American imperialism) and the turn of events in Egypt where we are back to army rule. Political gridlock in the US and the stagnation in the Eurozone have done little good for the democratic ideal. Independent economic policy is becoming difficult to implement in a globalised world and this makes voters angry. In the West, voters are reluctant to stomach austerity in the medium-term as an answer to their current problems.

The Economist's solutions are not particularly inspiring. It wants to curb the growth of the state, which may be the right answer in the West but not necessarily the right one in developing countries. In the latter, the problem is not that the state is too large but that it has not got the mix of activities right. A more efficient state, not a smaller one, is what a country like India needs. Another solution is to insulate policies from short-term populist pressures by handing over decisions to technocrats and independent commissions. This assumes that technocrats will work for the larger good and can be held accountable if they fail to do so. In a country like India with weak institutions, it is better to have incompetent politicians who are accountable that very competent technocrats who are not.

The Economist glosses over the subversion of democracy by money power or crony capitalism, which has done a great deal to discredit democracy. To succeed in politics, you need big money and the providers of big money have to be taken care of by successful politicians. No democracy has been able to tackle this scourge. Another big problem is the lack of accountability of politicians in the interregnum between elections. We can kick out the party in power once in five years but how do voters express their ire towards politicians or policies during that period? These issues, to my mind, are most important than the ones the Economist raises- and so is the need to find answers to them.

Urjit Patel report on monetary policy

There has been a fair bit of controversy over the Urjit Patel committee report on monetary policy. The idea of inflation targeting, in particular, has drawn flat. DM Nachane, member PM's council of economic advisors, has a very good critique in EPW.

First, Nachane questions the assumption that there is no long-run trade-off between inflation and output, which is another way of saying that the Phillips curve holds only for the short-run. This, he says, has been "empirically rejected" in recent research.

More importantly, he believes that inflation targeting won't work for the following reasons:

i. It means letting go the nominal exchange rate- and that's hard to do, given the havoc that can be wrought by sharp movements in the exchange rate. (eg if the exchange rate is appreciating, you may need to lower the interest rate but you can't do that if inflation is above your target).

ii. It's hard to practise as long as the fisc is out of control.

iii. Inflation targeting does not mean asset price stability and hence financial stability- this is the great lesson from the sub-prime crisis.

One might add a point that has been made by others in the debate: when inflation is largely supply-driven and, that too, food-driven, targeting it through demand side policies will cripple growth without making a dent on inflation. The really solid case for inflation to be kept within a limit would be that otherwise we could have prolonged currency depreciation and this would undermine confidence of foreign investors. But it is not necessary that the currency should depreciate if there is an improvement in productivity. 

Nachane also makes weighty arguments against the use of the CPI instead of the WPI for measuring inflation. One is that the CPI is more representative of the consumption of the better off because consumption is weighted by each household's expenditure- what he calls a 'plutocratic bias'.

Incidentally, the problems with inflation targeting don't go away if parliament sets the inflation target, a solution that has been mentioned in the debate. Inflation targeting is not desirable in the present Indian context. Period.

Maruti's Gujarat plant: a test case for corporate governance

The controversy at Maruti seems to be hotting up with news that independent directors on the board- or at least some of them- have raised the flag of revolt. The issue is the decision on the part of Maruti's parent, Suzuki, that it will invest in a car factory on land provided in Gujarat and not Maruti, which will be used more a sales arm for the products of the Gujarat plant.

Institutional shareholders- mutual funds and insurance companies- have protested, saying that the decision on the part of Suzuki is against the interests of minority shareholders. One critical issue is of transfer pricing of cars between the proposed Suzuki plant in Gujarat and Maruti. There are apprehensions that the transfer price can be managed in ways that suit the parent and work to the detriment of Maruti shareholders.

Now, independent directors have been stirred to protest. If they do take an uncompromising stand- and if some of them resign if Maruti and Suzuki stick to the decision on the Gujarat plant- we can say that we have finally a fundamental shift in corporate governance in India. Maruti is thus an important test case- and its resolution will be worth watching now that Sebi has reportedly taken up the matter suo moto.

ET reports:

Highly-placed sources said that the majority of independent directors on Maruti's board have opposed the decision. The independent directors are corporate lawyer Pallavi Shroff, former Ranbaxy chief executive D S Brar, NHAI chairman R P Singh and ex-PwC head Amal Ganguli. Suzuki chairman Osamu Suzuki, instrumental in pushing the deal, is also a member of the Maruti board.

The sources said the minutes of the last board meeting, where the surprise decision on the Gujarat plant was taken, will be discussed when the directors meet on March 15. The protests by shareholders and directors is bound to crop up given that the issue has now reached the market regulator Sebi.

While describing the latest event as "a repeat of 2004" when Suzuki Powertrain (majority owned by Suzuki) was formed for making diesel engines, some of the independent directors want Suzuki to clearly state that Maruti will not be asked to fund the Gujarat project later. In any case, there are fears that Maruti, which commands nearly 50% market share, will turn from a leading carmaker into a "trading concern".

Maruti management, however, insists that the deal remains profitable for the company and investors. "It is a win-win proposition and we are not re-considering it," Ayukawa told TOI, in perhaps the first reaction from the Japanese MD after the investors went public with their dissent. 

The Gujarat plant is not the only contentious issue involving Suzuki and Maruti's minority shareholders. The royalty that Maruti pays to Suzuki is also an issue. On this TN Ninan of BS has some scathing observations to make:

Consider the royalty question. Suzuki charges 5.7 per cent of Maruti sales as royalties (nearly double the level that prevailed before the government abolished caps on such payments in 2009). This is an astonishing 40 per cent of pre-royalty profits, and the company is far and away the top remitter of such royalty payments. What makes the payment particularly egregious is that cars are not like pharmaceuticals - between a half and two-thirds of the final product value comprises bought-out items like tyres, ball bearings, wheels, batteries, seats, headlights and gear assemblies. To claim royalty payments on their value, to which Suzuki has contributed nothing by way of technology, is rich. The royalty outgo, if calculated on the car value that is not bought-out, works out to 15 per cent or more. This is extortionate; the company's defence, that Maruti nevertheless offers good profits, is not an answer. Ambit Capital, which has looked at international companies in India, ranks Maruti as the worst for how it treats its Indian shareholders. 

There are conflicts of interest between the majority and minority shareholders at PSUs and Indian industrial houses. The revelation in recent years is that MNCs are not exactly exemplars of governance when it comes to treatment of minority shareholders.

Job creation should focus on rural sector, not manufacturing

Most economists writing about India have a standard prescription for job creation: unleash private manufacturing by changing labour laws, reducing approvals and getting rid of inspector raj. The comparison made is with China, which was able to generate a large number of jobs in light manufacturing. As long as manufacturing's potential is suppressed, the argument goes, there isn't much hope on the employment front.

Rajiv Lall, writing in BS, has a refreshingly different point of view. India's planners want to raise the share of manufacturing employment in the labour force from 11 to 22 per cent over the next 15 years. Lall thinks this is a trifle too ambitious because the corresponding share in China today is just 12 per cent, and even at its peak was only 15 per cent. India missed the light manufacturing bus over the past couple of decades and is unlikely to catch it because technology is changing the future of light manufacturing:

However, technological developments in the field of digitisation, robotics and 3-D printing are going to have profound implications for the future of low-cost manufacturing around the world. Such technologies are replacing low-skill labour and making it possible, to cite just one example, for toy makers in California to profitably relocate their manufacturing operations from Asia back to the US. The same is likely to happen to consumer electronics. So if we are imagining that we will be able to replicate the experience of the Asian Tigers in generating jobs and raising incomes by focusing on low-cost manufacturing, we need to think again.

So, solutions to boost employment through manufacturing are unlikely to yield much. What should we do? Lall sees useful pointers in where jobs have come from in recent years. The share of agriculture in employment dropped by eight percentage points in 2000-2010. Of this eight per cent, nearly two thirds were absorbed in the rural, not urban, sector. Where did they go? Into construction and services in the rural areas. "So, in fact, it is the rural non-farm, non-manufacturing sector that has emerged as the largest job creator in India - it has added as many as 35 million jobs since 2000."


The rural, non-farm, non-manufacturing sector, is, therefore, where the focus on job creation must be in the coming years:

Employment opportunities are, therefore, likely to grow fastest in the rural non-farm sector, which has undoubtedly contributed to the impressive fall in rural poverty that we have seen over the past decade. This poorly understood segment of our economy needs to be empowered to allow millions of self-employed and casual workers to take advantage of the spillover effects of rising urban and farm incomes in order to find more stable and gainful employment opportunities in the future. 

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What is the best way to give food subsidies?

There are three ways in which subsidies can be given: food handouts, cash, vouchers. Which is most effective is an important policy issue. The Economist summarises the results of a recent paper on the subject, which analysed an experiment carried out by the World Food Program in Ecuador in 2011:

The study found that direct handouts—Iran’s new policy—were the least effective option. They cost three times as much as vouchers to boost calorie intake by 15%, and were four times as costly as a way of increasing dietary diversity and quality (see chart). Distribution costs were high, and wastage was also a problem. Only 63% of the food given away was actually eaten, whereas 83% of the cash was spent on food and 99% of the vouchers were exchanged as intended. Food transfers have also been the costliest option in similar projects in Yemen, Uganda and Niger, according to John Hoddinott at IFPRI.

In Ecuador there was little difference in cost between handing out cash and food vouchers, the other two options. But vouchers were better at encouraging people to buy healthier foods because of restrictions on what items could be exchanged for them. It was 25% cheaper to boost the quality of household nutrition using food vouchers than it was by handing out cash. A switch from universal subsidies to vouchers could be the most efficient way of boosting health as well as relieving poverty.

So, the order of preference, according to the study, should be: vouchers, cash, handouts. However, it would be unwise to generalise from the results of an experiment in a small country such as Ecuador. It is easier to hand out vouchers to a small population. Moreover, access to food can be ensured. In a large country, such as India, how do we ensure that, in the absence of public distribution outlets, there are places where people with vouchers or cash can go to in order to exchange these for food? Moreover, we need a certain stability in food prices. Vouchers or cash may not fetch enough food if they have been issued on the basis of food prices that were lower than the prices at a given point in time.