Trade distorting subsidies

I had written earlier (with Srikar) about China's extensive use of trade distorting producer subsidies, governed by the WTO's Subsidies and Countervailing Measures (SCM) framework, which disadvantaged exporters competing with China. We had written that the definition of "actionable" subsidies benefited Chinese companies,

The WTO agreement that governs the subsidies framework is SCM. It defines two basic categories of subsidies—“prohibited” and “actionable”. The former prohibits all local content subsidies which favour the use of domestic over imported goods. The latter, though not prohibited, can be challenged either through multilateral dispute settlement or through countervailing duties if the imports cause “serious prejudice to the interests of another member”.

A subsidy is “actionable” under the context of SCM only if it is “specific” to an enterprise or industry or group of enterprises or industries. Further, a subsidy is defined as a “financial contribution” that involves a “charge on the public account”. Alternatively, a subsidy which is “widely available within an economy” is excluded from SCM. 

This means that “subsidies” are restricted to grants, loans, equity infusions, loan guarantees, fiscal incentives, the provision of goods or services, and the purchase of goods. They do not include any indirect and trade-distorting structural subsidy by way of “revenues forgone”—lower (than cost recovery) utility tariffs, low land prices, repressed labour market, artificially cheap capital and so on—which are universal in nature.

Now an FT article by Alan Beattie has documented the increased use of such subsidies by many countries to protect their domestic producers. Concurrently there has been a sharp increase in the number of subsidy related litigation in WTO seeking the imposition of countervailing duties on such subsidized imports. Renewable energy sectors - biofuels, solar, and wind power - are the beneficiary sectors. He writes,

Since the global financial crisis struck in 2008, worldwide increases in import tariffs of the type seen during the Depression have been largely absent. But governments, richer with cash and regulatory power than in the 1930s, have found other ways to back their struggling producers at a time of deficient global demand. Disputes over state subsidies are spreading, the trade law to constrain them is not easy to use, and few governments can throw stones without worrying about the glass in their own houses. 

I am not too worried about such producer subsidies for atleast two reasons. One, given the weak fiscal position of most developed economies and their dismal short to medium term prospects, there is limited scope for such subsidies. They are therefore most certain to remain marginal. Second, in any case, sunrise sectors, especially those like renewables with important positive externalities, have traditionally received government subsidies in their nascent stages. In its absence, given the politics of oil, their emergence will be considerably delayed. I would be more concerned if the same subsidies were instead channeled into traditional sectors, similar to the subsidies given to airline industry on both sides of the Atlantic.

However, the particular case of Chinese subsidies are disturbing in both its breadth and depth. They are mostly subsidies "widely available within the economy" and therefore exempted under the SCM. This means that it benefits all the sectors. Further, the apparently deep pockets of the Chinese government means that it can sustain this support for a long time. Taken together, and given the fact that Chinese exports directly compete with those of emerging economies like India, this forms a serious concern for policy makers in these countries.

Rationing road capacity - Shanghai's success

This blog has consistently held the view that any meaningful effort to address traffic congestion has to revolve around policies that seek to explicitly ration road capacity, either through limiting vehicle ownership or restricting vehicle usage by owners. Given the lack of properly planned urban development and scarce land space available for road expansion, traffic conditions in our cities are certain to worsen in the future. In the circumstances, central to any attempt at effectively managing urban transport will be policies that can control the growth of private vehicles on these city roads and efficiently ration road carriageway among competing users.

In this context, the trends from Shanghai's license plate auctions (license plates have to be purchased in these monthly auctions before you can own a vehicle) are instructive. The graphic below shows how the city has managed to stabilize vehicle population growth. 

The rate of increase in auction prices is a reflection of how much the vehicle population would have grown in the absence of this restriction. The prices have continued to rise through 2012, recently touching 64000 yuan ($10000). 

India "brain drain" graphic of the day

A friend sends me this excellent graphic which highlights that more than a third of India's researchers emigrate, the highest among all major economies.

Would be interesting to have a graphic of what percentage of India's first generation entrepreneurs in knowledge based sectors are returning emigrants. What would be particularly interesting is exploring the dynamics of our "brain drain", especially by taking the more recent data.

I suspect that even as researchers have left, professionals from various knowledge based services may be increasingly coming back to India. This channel may be either by directly pursuing entrepreneurial initiatives or by relocating as part of their professional work with intentions of starting some enterprise once they have re-established themselves back here.

Lessons from India's "missing toilets" scam

The controversy surrounding the "missing toilets", claimed to have been constructed as part of the Government of India's Total Sanitation Campaign (TSC), should not have come as a surprise. It has all the features of bad policy design and equally bad implementation strategy. However, amidst the all the noise surrounding the corruption scandal, its substantive learnings have been glossed over.

The details first. The TSC was initiated in 1999 with the objective of providing low cost toilets for poor people. Successive governments have revised the targets, with the latest being the objective of completing 125 million toilets across the country by 2017 and thereby make India open defecation free. The Rural Development Ministry claims to have built 87.1 million toilets so far, whereas the census figures indicate that there are only 51.6 million toilets among the target households. Since many of the houses included in the census figures would certainly have had toilets before, the real magnitude of the "missing toilets" may be much higher than the 35.5 million estimated. So far Rs 196 bn has been spent on the program across 607 districts. Predictably, the violations appear to be most egregious in Uttar Pradesh, where the TSC reports indicate only 17.8% households without toilet to the census figure of 78%. 

There are multiple deficiencies with the TSC program. 

1. The most glaring failure with the program is the financing pattern. The initial estimated unit cost of Rs 2500 was low, even for rural areas. Though, the unit cost has been raised in stages from Rs 2200 to Rs 4500, it is extremely low and cannot finance any reasonably functional toilet. Even assuming this is a simple civil construction program, in the absence of the adequate unit cost funding, the best implementation strategy will fail to yield results. 

The low unit cost is a feature of programs and budgetary allocation across sectors. When forced to make the trade off between trying to cover as many beneficiaries as possible with scarce resources and providing adequate unit cost, governments invariably skimp on the latter. In this case, the actual cost of construction is rationalized downwards by promoting low cost materials and encouraging households to contribute labour costs. However, such arm-chair rationalizations, end up creating poor quality toilets, which fall into disrepair very quickly. 

2. The implementation strategy involves mobilizing beneficiaries to take up construction themselves. This is driven both by the ill-considered righteous opposition among opinion shapers and policy makers to the involvement of contractors and the need to dovetail beneficiary contribution into the construction. In most states local officials are given village level construction targets. Each of them have large numbers of widely spread out villages/habitations and given their other responsibilities, it becomes virtually impossible to supervise construction in any meaningful manner. Almost always, supervision is confined to taking figures from the village officials, and disbursing money. At best, the more motivated officials squeeze out some time to make a couple of inspections, mostly to the readily accessible and nearby areas. 

3. The inadequate funding acts as a disincentive to the beneficiaries. Given the actual cost of construction of a quality toilet being 3-5 times the allocation, and the resultant need to mobilize the major share of funding themselves, they find it not worthwhile to take up the construction. In fact, the unit cost may be enough to incentivize only those who had mobilized enough money and were anyways going to construct or repair their toilet or those people in very remote areas, where the construction costs may be lower and the marginal utility of the subsidy large enough. 

4. As indicated, given the widely scattered nature of the implementation, effective supervision is very difficult, especially for badly over-burdened and ineffective bureaucracies. It aligns incentives of all parties - officials, local political representatives, and beneficiaries - to fabricate document and share the spoils. This fraud is commonplace with rural households who already have toilets. 

5. In urban slums, there is the problem of finding space for constructing a toilet. Most houses have no space for toilets, and even when they do have, they find other uses with much higher immediate utility. In any case, the unit cost is too inadequate to provide any incentive. Community toilets should be the preferred strategy in such areas. Here too, the financing problems come to the fore. 

In most cities, the resource strapped local governments prefer to silence local criticism by providing token funds to construct a few community toilets each year. Here too, again in the desire to spread the butter thin and cover more locations, the unit cost is kept low and the quality of construction suffers. Further, there is also the problem of finding enough land space in congested slums to locate the toilet. Amidst all this, the arm-chair opinion makers worry about marginal issues like the failure to encourage private participation to run toilets.    

6. Finally, even if all the aforementioned problems are overcome and the toilet constructed, its usage poses another set of challenges. Most fundamentally, where is the water to run the closets? In villages, where even drinking water is scarce, free flowing water is mostly an exception. Maintenance costs too come in the way of households keeping such toilets functional. More than any of the first five problems, this has no readily available answers.   

The failures in the TSC has a counterpart in the program to construct toilets in schools. The Supreme Court and several High Courts have repeatedly issued deadlines to ensure that there are no schools without toilets. Several districts have even declared to have achieved this objective. However, despite this having featured as an important item in the agenda of the Sarva Siksha Abhiyan (SSA), the flagship national program to improve primary school infrastructure, the progress has been largely cosmetic. 

Three things stand out, all of which revolve around finances. One, despite recent increases, the Rs 35000 currently being sanctioned, is inadequate in many parts of the country. Second, though most schools have toilets, they are invariably inadequate and badly maintained. Even when toilets are sanctioned, they are spread out to cover as many schools as possible, while adequacy considerations take a backseat. Finally, the most frustrating deficiency is the failure to provide for adequate operation and maintenance. The total maintenance allocation for schools under the SSA, including cleanliness, consumables, and small repairs is a pitifully small amount of Rs 5000 each year. 

Raising finances at such fiscally strained times is not easy. However, we need to be aware of these issues before we pass judgements on programs and pour more money down the drain by scaling them up with even more ambitious targets. 

Spanish infrastructure investment fact of the day

There is the Opera House, a cross between the one in Sydney and something you would imagine only in your more disturbed dreams - 400 million euros to build, 40 million a year to run - 15 performances a year.

The BBC has a nice story of how the legacy of massive and wasteful investments during the boom years, financed by debt and buoyant property taxes, by Spanish provinces, in this case Valencia,now haunts them. See also this. 

State capability deficit

I have an op-ed in Mint today highlighting India's state capability deficit. 

The importance of decentralization - Lessons from Camden

Times has this (HT: Andrew Fraker) story of the county of Camden in New Jersey which has decided to disband its ineffective and unionized police force. 

The police acknowledge that they have all but ceded these streets to crime, with murders on track to break records this year. And now, in a desperate move to regain control, city officials are planning to disband the Police Department. The reason is that generous union contracts have made it financially impossible to keep enough officers on the street. So in November, Camden, which has already had substantial police layoffs, will begin terminating the remaining 273 officers and give control to a new county force. The move, officials say, will free up millions to hire a larger, nonunionized force of 400 officers to safeguard the city, which is also the nation’s poorest...Camden’s decision to remake perhaps the most essential public service for a city riven by crime underscores how communities are taking previously unimaginable steps to get out from under union obligations that built up over generations... the plan to put the Police Department out of business has not prompted the wide public outcry seen in the union battles in Chicago, Ohio or Wisconsin, in part because many residents have come to resent a police force they see as incompetent, corrupt and doing little to make their streets safe.

And what was the trigger for this reorganization? Budgetary problems arising from the Great Recession.

Camden’s budget was $167 million last year, and of that, the budget for the police was $55 million. Yet the city collected only $21 million in property taxes. It has relied on state aid to make up the difference, but the state is turning off the spigot. The city has imposed furloughs, reduced salaries and trash collection, and increased fees. But the businesses the city desperately needs to attract to generate more revenue are scared off by the crime.  

Camden's police force is characterized by features that are commonplace among police and other public systems in countries like India - unionization, generous salaries and benefits, erosion of professional standards, and indiscipline manifesting in rampant absenteeism (30% at anytime!). And worst of all, they are ineffective. But the difference is that the people of Camden have decided that enough is enough and disbanded the entire system. This post is not to debate the merits and demerits of the correct contracting model of a police force for Camden, but about the popular indignation that led the residents of Camden into exercising their rights.

Why is it that Camden can take such decisions to enforce accountability, while small towns and villages in India, faced with even more apathy and neglect from the public officials appointed to serve them, can't? I will argue that the difference is decentralization. The police department of Camden are a distinct police force, appointed by the Camden county, paid for by them, and therefore accountable only to them. The accountability relationship of any Camden policeman is directly to the residents of Camden. The firing of one policeman or disbanding of the entire force itself is therefore a matter of concern only to the people of Camden and their police force. It has no regional or national consequences.

In contrast, most public functionaries in India are appointed by the state government. They form part of a large statewide labour force. They are transferred and posted by the state government officials and even receive their salaries from there. Their service conditions are part of a statewide set of standards and their powerful unions will do whatever it takes to ensure that no attempt is made to dilute its generosity. In other words, their fortunes are almost completely linked to their masters in the distant state capital. Their only link with the local community they are supposed to serve is that they just happen to have been posted there, and that too temporarily. Given this massive incentive incompatibility, is it any surprise that we have things as they are?

The teacher or the policeman could care less what the local residents think about them and their work ethic, however bad or perverse. In simple legal terms, the local residents have no role in deciding who should serve as their local school teacher or doctor, and can do nothing to punish errant officials. They cannot even stop their salaries, leave alone suspension and dismissal. Any action to change their service conditions to suit local requirements, leave alone disband them, will have statewide ramifications and is therefore not a possibility. Local residents have to accept whoever are foisted on them. And they do so with resignation because they have come to realize that it makes no difference and they don't anyway pay for these services.

In the prevailing regime, no Indian panchayat or municipality will face the budgetary nightmare that Camden faces, foreclosing that "forced" reform option.