Is skills gap a binding constraint on Indian economy?

Aashish Mehta makes an interesting intervention on skills gap in India. He questions the conventional wisdom that the country is facing a massive skills deficit. He points to two narratives, with the difference being that in one firms "cannot find skilled workers", whereas in the other firms "cannot find skilled workers at wages it can afford". From his joint work with others, he finds compelling evidence against the former and in favor of the latter.

He points to signatures that question the conventional wisdom on "skills gap" - stagnant or falling return on educational investment (or skill price), workers in labor-intensive manufacturing require barely secondary education and pick up skills in 4-6 weeks, textile firms with more than 10 workers pay 30% higher wages than those with less than 6 workers.

Further, the Employment and Unemployment Survey 2011-12 reports that workers in firms with less than 20 workers earned Rs 1581 a week, a third higher than the modest Tendulkar poverty line, whereas workers in firms which employ more than 20 earned more than twice the poverty line. The differential in wages between the two types of firms points to an affordability problem for smaller firms (the larger firms poach from the smaller firms) and a possible unwillingness problem for the larger firms (why should we pay 30% more for the same worker).

In simple terms, as long as the benefits (to workers and employers) from skilling exceed costs, the market (through "skill price" mechanism) and/or government (through skill development programs) can address the skills gap. But evidence, as aforementioned, appears contrary to this inference. However, if the wages are unaffordable for the majority of firms, neither markets nor governments can do much to alleviate the problem.

In India's case (even elsewhere), it is commonplace to hear firms, even in labor intensive sectors, complain of skills deficit. India's overwhelmingly small sized firm eco-system is a likely major contributor to this problem. Consider the scale - firms with less than 20 workers, constituting 73% of all manufacturing workers, produced 12% of manufacturing output in 2010-11. This is even more skewed in labor intensive sectors like textiles.

Small sized firms, being more likely informal, pay far less than larger firms, especially at the starting levels. In fact, the vast majority of these firms would, given the scale and nature of their operations, find it unviable to pay any more. These firms would struggle to retain their employees in the face of competition from medium and larger firms, and are therefore likely to complain of "skills deficit". The sheer numbers would add greater salience to their voices. Further, even among the larger firms, the exorbitant cost of labor related taxes, upto 45% of wages being deducted, limits their ability to pay high enough wages to attract and retain good workers.

A chorus of "skills deficit" is therefore not surprising, though it may be less a "deficit" problem and more an "affordability" one. If, as it appears, it is a matter of "affordability" than "shortage", then it points to other binding constraints facing those firms which need to be relaxed so as to enable them to pay higher salaries to attract workers.

Update 1 (3/12/2014)

A Times article that highlights shrinking educational wage premium in Chile. A combination of massive increase in skill acquisition and its decreasing quality appears to be responsible for this trend. Further, this has to be seen against the backdrop of Dutch disease - Chinese demand for copper boosting exports, causing currency appreciation, and reducing the demand for skilled workers. 

Dual price market in bad bank loans

A few days back I blogged about the distortions caused by the dual price market in labor wages. Another dual price market created by administrative fiat, in the aftermath of the global financial crisis, is on the classification of impaired assets by India's banks. Non-performing assets (NPAs) and loan restructuring have risen steadily since 2008. The RBI allowed a differential loan book classification of both types of assets in the aftermath of the crisis.

If an account becomes an NPA, it requires 15 per cent provisioning, while a restructured asset needs 5 per cent provisioning. 

The result has been bank managements scrambling to recast bad loans through debt restructuring and avoid NPA classification, thereby kick the can down the road, possibly to a successor CMD, on increased provisioning. It has also served to paper over the dregs of crony capitalist orgy over the past decade. The RBI Governor has been emphatic in denouncing such "risk-less capitalism".

Fortunately, unlike other dual-price markets, this has a sunset - the RBI mandates 1 April, 2015 as the end of this regulatory forbearance.

Importance of racial diversity and persuasive power of graphs

Two interesting Upshot posts

1. The first article points to a new study that highlights the importance of racial diversity in trading rooms in preventing bubbles. They conducted trading simulations among groups of people with financial background and similar analytic capabilities to value imaginary stocks. Their finding,

We find that price bubbles are fueled by the ethnic homogeneity of traders. Homogeneity, we suggest, imbues people with false confidence in the judgment of co-ethnics, discouraging them from scrutinizing behavior. In contrast, traders in diverse markets reliably price assets closer to true values. They are less likely to accept offers inflated offers and more likely to accept offers that are closer to true value, thereby thwarting bubbles. This pattern is similar in Southeast Asia and North America, even if the two sites differ greatly in culture and ethnic composition, in what is implied by “ethnic diversity” and how it is operationalized...

we suggest that biases may stem not only from the limits of individual cognition, but also from the social context in which decisions are embedded. Homogeneity (or diversity) is not a feature of individuals, but of a collective: a team, a community, or a market... More broadly, homogeneity may play a critical role in herding—the convergence of people’s beliefs and behaviors through interaction—also known as (or related to) cascading, social contagion, peer effects, informational social influence, social proof, or institutionalization. If, as we find, markets populated by skilled traders possessing complete information are still so affected by homogeneity, it may have an even more pronounced role in other instances of herding, such as the spread of fashions, fads, false beliefs, and riots...

In our experiments, ethnic diversity leads all traders, whether of majority or minority ethnicity, to price more accurately and thwart bubbles. Ethnic diversity was valuable not necessarily because minority traders contributed unique information or skills, but their mere presence changed the tenor of decision making among all traders. Diversity benefited the market... Diversity facilitates friction. In markets, this friction can disrupt conformity, interrupt taken-for-granted routines, and prevent herding. The presence of more than one ethnicity fosters greater scrutiny and more deliberate thinking, which can lead to better outcomes.

In other words, diversity has an importance that goes beyond its moral imperative and is a positive contributor to improvement in collective performance. Just as an individual with a more diverse network of interactions and access to information is more likely to be successful, a more diverse group of people are likely to be more productive.

2. The second article points to a field experiment which highlights that graphical messages, by conveying the impression of scientific rigor, have a much greater persuasive power in conveying information than mere statements.

People who were given graphs or formulas along with claims regarding medication efficacy displayed greater belief in medication effectiveness. Such effects occurred for both graphs and chemical formulas, and for different populations: an online panel, a campus population, and a general population. The prestige of science appears to grant persuasive power even to such trivial science-related elements as graphs. Ostensibly, graphs signal a scientific basis for claims, which grants them greater credibility. This does not seem to be because graphs help cognitive processing. 

The effects of graphs hold even when no additional information is supplied or even implied by the graphs, and it is not moderated by increased understanding or retention of information. The effects of graphs are also not due to their visual nature—similar non-visual scientific signals also increase persuasion... It also appears that it is the general belief in science that is at least partly responsible for the persuasive power of graphs... Given that they signal scientific credibility, graphs have a greater effect for those who have faith in science. The effects of graphs on persuasion might exemplify a broader inferential process:

The information contains a graph (premise); Graphs signal a scientific basis (premise); Therefore, the information has a scientific basis (conclusion); A scientific basis indicates truth (premise); Therefore, the information is true (conclusion).

Furthermore, people who saw charts were found to be more likely to recall the results than those who read the text description. While this points to the power for graphs (and maps) in conveying information, it also highlights its potential of being abused to mislead people. 

Reforming the dual-price market in labor wages

Mainstream debates on labor market reforms in India focus on easing hiring and firing regulations. In an excellent column Manish Sabharwal points to another important labor market distortion - the massive difference between gross and net pay. He writes,

Current labour laws... require employers to confiscate 45 per cent of the salary of employees whose wages are under Rs 1.8 lakh per annum and hand it over to various programmes and agencies like the Employees’ Provident Fund Organisation (EPFO), Employees’ Pension Scheme, Employees’ Deposit-Linked Insurance Scheme, Employees’ State Insurance Corporation... government data is clear that employees with wages this low do not have any savings. It is impossible, or at least very difficult, for them to live on half their salary... divergence between what employees call chitthi-waali salary (gross pay) and haath-waali salary (net take-home pay)... - part of the difference is funnelled into schemes that offer poor value for money, bad service and are humiliating — breeds informal employment. In the case of informal jobs, gross salary is equal to net salary. 

And about the inefficient deployment of these hard earned savings,

There are 55 million dormant accounts, more than half the total number of accounts, in the EPFO. Hard-earned money is abandoned by employees because they are frustrated with the organisation’s incompetence, corruption and inefficiency. Additionally, the EPFO’s charge of 440 basis points makes it the world’s most expensive government securities mutual fund — other mutual funds charge 25 basis points for gilt funds. The Employees’ State Insurance Corporation has India’s worst health insurance claims ratio — it only pays 49 per cent of contributions as benefits — and offers rotten care, while sitting on Rs 28,000 crore of idle financial investments. 

I agree with Manish that instead of the controversial hire-and-fire reforms, the next round of labor reforms should involve addressing this dual-price market in labor wages, though the details may vary. This is one more in the long list of dual-price markets in India - market and registration value for property transactions, market and subsidized price for essential goods, MSP and market price for food-grain harvest, production cost and tariff for utility service, etc - that need to be urgently dismantled.

But there is a fundamental problem with the issue which is likely to surface when discussion starts on its reform. Employee social protection is typically financed either through a combination of employees and employers contribution. But at these low wage levels, it is difficult for the employees to contribute their share and any employer's share is generally a transfer involving a reduction in employee pay-check. Any reform that dispenses with the social protection is not only undesirable but also unlikely to pass muster.

The only option available may be some form of publicly funded social protections - pension and insurance. But such protections comes with fiscal burden. However, it can be mitigated by limiting them to salaries below a certain level or certain sectors or types of employment, with a gradual phase out of the same over a 10 year period. The Hartz reforms in Germany embraces these principles for low and mid-level jobs. In any case, instead of frittering public resources on unproductive indirect subsidies and incentives, this may be a more effective and less distortionary approach towards encouraging small enterprises into becoming formal. 

The role of management in schools

Fascinating new paper by Nick Bloom and three others which compares management practices in high schools in 8 countries across the world, including India. Their finding is that improving management could be an important way to raise school standards,

Autonomous government schools (i.e. government funded but with substantial independence like UK academies and US charters) have significantly higher management scores than regular government schools and private schools. Almost half of the difference between the management scores of autonomous government schools and regular government schools is accounted for by differences in leadership of the principal and better governance...

Having strong accountability of principals to an external governing body and exercising strong leadership through a coherent long-term strategy for the school appear to be two key features that account for a large fraction of the superior management performance of such schools... Autonomy by itself is unlikely to deliver better results, however, finding ways to improve governance and motivate principals are likely to be key to make sure decentralized power leads to better standards.

The differences in the quality of management in all types of schools among different countries is captured in the graphic below. The good management tail is virtually absent in India. This is in line with management practices elsewhere in India - fractions of manufacturing firms, hospitals, and schools, scoring above 3 is 22%, 10%, and 1.6% respectively.

Another graphic captures the difference in management scores across different types of schools - public, autonomous public, and private - in each country. Note that, unlike other countries, the aided schools do almost as bad as others while the private schools stand out as far better than others. Difficult to say whether the latter finding is a testament to the quality of private schools or its near-total absence in public schools.

A few observations.

1. The poor performance of aided schools in India is a testament to the deeply politicized and corrupt nature of allotment of these schools. Interestingly, Brazil runs its autonomous schools, which receive most of its funding from government, with such great success. In other words, there appears to be a massive "discount" associated with any activity that involves interface with government.

2. I see Prof Bloom's studies on management practices in business enterprises and now schools as important in highlighting the important role of guidance, monitoring, and supervision in the success of any enterprise, private or public. Given the poor quality of these attributes in public (and private) systems, a reflection of state capability deficiency, there is a terrific opportunity here. But I am not sure whether the conventional strategies to improve governance quality can be effective here.

3. There is a strong case (the high coefficient for India on Table II, Column 6 is reflective of this) that the quality of management is the foundation on which the various standard schooling inputs work their way. In other words, even if the students and teachers attend school regularly, the school has all physical infrastructure, and children are equipped with learning materials, the effectiveness in translation of teaching into learning is strongly dependent on the quality of management (leadership, governance, guidance, capacity building etc). In other words, the poor management of Indian schools may be having a value subtracting effect on the other interventions. 

Population density visualized

Two superb graphics which highlight how population density can affect the spatial dynamics of countries. The first shows the space, in term of area of US states, required to accommodate the total world population at the same density as in some global cities.

The second (sent by a friend) shows the sizes of different cities and their population. Note the relatively similar populations of New York and New Delhi, and Tokyo and Dhaka, and the manifold difference in their sizes.  

This blog has several other interesting similar graphics. 

The rich and the super-rich

The real story in inequality is the explosive growth of income and wealth at the topmost tier of the income ladder, the top one-hundredth. While the incomes of the top 1% have surged, those of the top 0.01% have rocketed.

Times has this story of how this is reflecting in the market for luxury consumption in the US,

The wealthy now have a wealth gap of their own, as economic gains become more highly concentrated at the very top. As the top one-hundredth of the 1 percent pulls away from the rest of that group, the superrich are leaving the merely very rich behind. That has created two markets in the upper reaches of the economy: one for the haves and one for the have-mores. Whether the product is yachts, diamonds, art, wine or even handbags, the strongest growth and biggest profits are now coming from billionaires and nine-figure millionaires, rather than mere millionaires...

For decades, a rising tide lifted all yachts. Now, it is mainly lifting mega-yachts. Sales and orders of boats longer than 300 feet are at or near a record high, according to brokers and yacht builders. But prices for boats 100 to 150 feet long are down 30 to 50 percent from their peak... The private jet market is splitting in two. Sales of the largest, most expensive private jets — including private jumbo jets — are soaring, with higher prices and long waiting lists. Smaller, cheaper jets, however, are piling up on the nation’s private-jet tarmacs with big discounts and few buyers... According a jet market report from Citi Private Bank, deliveries of new so-called light jets — the smaller, cheaper models — were down 17 percent last year from 2012 and 67 percent from their 2008 peak. But deliveries of the biggest new private jets jumped 18 percent last year...

Update 1 (25/01/2015)

Oxfam's latest report on global inequality claims that by 2016, the top 1% of the global richest will own half the total global wealth. It also reports that the wealth of the 80 richest people is the same as that of the bottom 50% of population.

Scandinavian economy facts of the day

Times reports about Denmark's reliance on Moeller-Maersk,

Revenue at AP Moeller-Maersk, publicly traded but family controlled, equals more than 14 percent of Denmark’s gross domestic product.

And FT has this about the spectacular size of Norway's Oil Fund,

Every day for the past thirteen-and-half years, Norway's oil fund has grown by an average of $165 million... It has quintupled its assets in the past decade to $860bn and transformed itself into the world’s biggest sovereign wealth fund, with a 100-year plus horizon. Today, it owns the equivalent of 1.3 per cent of every listed company in the world.

Update 1 (12.07.2015)
FT reports that even as the industry has been losing money, Maersk Line has been an exception, thanks to aggressive cost-cutting and new investments,

In the first quarter, its operating profit margin was 11.8 per cent — an estimated 9.8 percentage points ahead of the average of its 12 biggest rivals. And in each of the past three years, Maersk Line has turned in a profit when its average competitor has been losing money. Maersk Line’s consistency could be seen as somewhat related to its size. It transports 15 per cent of the world’s seaborne container freight and is keen to stay the market leader.

India's Banking sector fact of the day

Ruchir Sharma has this stunning factoid about India's banks,

Since the end of 2010, when the Indian economy started to lose momentum, the value of shares in private banks has risen sharply, generating $33 billion in new wealth, while the state banks have destroyed $27 billion. This is the market’s way of pointing out which Indian banks work well, and which don’t.

In view of this and the need to raise alteast $50 bn required over the next five years to meet the Basel III provisioning requirements, he suggests outright immediate privatization. I am not sure for the following reasons

1. While the point about private sector efficiency is undoubtedly true and well-taken, its magnitude may be vastly over-stated by the appalling quality of corporate governance and rampant cronyism that bedeviled Indian banking sector in recent years. I have blogged earlier arguing that an examination of India's banking mess, especially as manifested in the massive portfolio of restructured loans, is certain to reveal scandals atleast as massive as anything uncovered so far. In fact, the shockingly high difference in levels of impaired asset stock between public and private sector banks, despite many of the latter themselves being no paragons of corporate virtues (less said the better of such banks elsewhere), is an even more damning indictment of India's public sector banks. The valuation difference pointed out by Ruchir Sharma is some proxy for the extent of malfeasance that went on in India's public sector banking boardrooms.

2. Sharma talks about attracting long-term foreign capital into banks to broaden India's capital base. While again undoubtedly desirable, controversies, real and imagined, are certain to emerge about whether this is the right time to do that is most likely to vitiate the atmosphere and derail the process. This would limit the very confidence that is expected from such divestment. The gross mis-management and large build-up of impaired asset stock has severely dented market confidence and eroded valuations of public sector banks, as captured in the factoid. At a time when public sector banks command fire-sale valuations, it may neither be desirable nor prudent to privatize these banks.

So, what should be done to resolve arguably India's biggest immediate economic policy challenge? I would suggest a five step process.

1. Immediate administrative reforms, including separation of Chairman and CEO/MD posts and changes in the leadership recruitment process, that would increase operational accountability and freedom as well as reduce government interference. The government would have to step back and assume the role of an investor (rather than as sovereign) and stop meddling with operational activities and goals (only time will tell what is the damage done to bank balance sheets by a target-driven program like Jan Dhan Yojana) of the banks.

2. Aggressive pursuit of the restructured loans, complemented with policies to reform bankruptcy regulations and ease restrictions to encourage second-generation reforms in infrastructure financing markets.

3. Urgent recapitalization, by, say, diverting a major share of the subsidy savings from lower oil and commodity prices. This would help not only boost market confidence in the banks themselves but also improve economic prospects by boosting the anemic credit growth so essential to get the investment tap flowing freely.

4. Implement a medium-term (2-3 years) phased divestment plan, with major part, including strategic sales, back-loaded to a not-too-distant future when the aforementioned reforms restore market confidence, get credit flowing, and raise valuations.

5. A process of stakeholder consultations to prepare the ground for the changes, especially in personnel, that are inevitable with any type of privatization.

Update 1 (18/11/2014)

Good article by Subir Gokarn on how banking woes will constrain economic growth in the coming days. The lesson is simple - even if demand picks up and businesses start investment cycle, it will be held back by paucity of credit.

Update 2 (26/11/2014)

As on September 30, 2014, stressed assets in terms of gross advances for government banks was 12.5% compared to 5.5% for private banks. Of this, formal NPAs stood at 5.32% for PSBs. If an account becomes NPA, it requires a provisioning of 15% whereas a restructured asset requires only a 5% provisioning. From 1 April 2015, banks have to forego this forbearance and classify all recast loans as NPAs with 15% provisioning. 

Value capture from infrastructure projects

My latest Governance Agenda column in Pragati is on the different options for capturing increase in land valuation arising from infrastructure investments. 

Examining India's long-term economic growth prospects

As India's economic prospects improve, euphoric voices like this about the possibility of double-digit economic growth rates are bound to rise. But such speculation, anchored around the memories of China's spectacularly long period of double digit growth and our own brief interlude with similar growth last decade, overlook the presence of very strong headwinds.

In this context, the work of economists like Dani Rodrik and Arvind Subramanian cautions against such excessive hope and speculation. Three arguments are worth examining. 

1. Apart from favorable domestic conditions, the long period of East Asian economic growth, whose salience is amplified manifold by China's rise, benefited from a happy confluence of benign external conditions. This period of unconditional convergence coincided with favorable geo-political dynamics (the US provided geo-political stability, which also relieved E Asian economies from spending on defense), high-noon of globalization facilitated by sharp fall in tariffs and un-bundling of global manufacturing supply chains, rapid emergence of trade facilitating technologies like containerization and ICT, a receptive consumer market in US and Europe, availability of abundant cheap domestic and global capital, and so on. 

These trends are either considerably attenuated or have run its course. But all narratives of India's high growth prospects are significantly predicated on the continuation of these conditions. Furthermore, there is the strong likelihood of technological disruption of the labor market due to increasing automation and resultant disemployment. While these forces are not likely to immediately bind in any significant manner in countries like India, their potential to disrupt global manufacturing and thereby global labor market, is considerable and deeply uncertain. These are first order headwinds that the Indian economy will have to surmount in its quest for growth comparable to what the East Asian economies sustained for long periods.

2. The second headwind comes from the changes taking place in manufacturing which raises questions about the traditional national economic development path. Manufacturing has traditionally provided the platform for rapid national economic development across history. Countries that have industrialized rapidly have done so by focusing on manufacturing and by moving up the manufacturing escalator - from less sophisticated to more technologically advanced products. Labor productivity in manufacturing has tended to "converge to the frontier"- the smaller the initial incomes, higher the growth in labor productivity (and therefore incomes). This convergence is significant in formal manufacturing, though absent in informal manufacturing. 

This feature of manufacturing sector helps absorb large number of less skilled labor, with prospects of moving up the skill chain on the escalator of industries. But, as Prof Rodrik and others argue, such manufacturing sector growth may be constrained by the weakening of the aforementioned favorable forces. They characterize it as "premature de-industrialization".   

Such de-industrialization, observed in the development trajectories of all advanced countries, appears to be happening much earlier among the emerging economies. In India, manufacturing's share of output has been stagnant at about 14-16% of GDP for nearly four decades and its share of employment peaked at 13% of labor force in 2002 and has since been trending downwards. As the graphic below shows, this feature has been true of even many East Asian economies, including China, who have started de-industrializing earlier than their western counterparts.

As can be seen, India started de-industrializing at a GDP per capita of $2000, in contrast to the $9000-11000 income levels at which manufacturing in western economies started decline. In fact, as the graphic from cross-national panel data below by Arvind Subramanian shows, at any stage in their development, not only are countries devoting less workforce to industries (the downward shift in the curves) but also the point of time at which industrial share of employment peaks is happening earlier (leftward shift in the curves). 

This potentially dampens the prospects for manufacturing led rapid growth for countries like India and Africa. 

3. In all the East Asian economies, the de-industrialization has been accompanied by proportionate growth in the services sector, "making them service economies at substantially lower levels of income". This has led to some commentators pointing to the potential for a new model of services led economic growth. The example of India's successful IT sector has often been cited in support of this, though an a cursory empirical analysis would reveal this as misleading, given its small size and limited relevance to India's overall economic growth. 

Prof Rodrik's argument, brought out also in this article, is that the inherent dynamics of services sector militates against generating similar growth and job creation trends as with manufacturing. The graphic below shows that there are very few examples of simultaneous growth of both productivity and employment.  

The high-productivity sectors, which are typically tradeable, being skill-intensive, cannot absorb much of the not so skilled workers who dominate the 12 million or so people entering India's workforce every year. In fact, as the graphic below from Arvind Subramanian shows, the more productive and therefore rapidly expanding (and mostly tradeable) services are also highly skill-intensive, far more than manufacturing. 

Further, unlike manufacturing, there is limited prospects for natural progression up the skill chain in services sector. While a textile or toy maker can with minimal training migrate into assembling electronic goods, the prospects of a barber or housekeeper moving into business services or banking, even at the lower end of that service, is remote or non-existent. 

India's woeful deficiencies in education and skill development would certainly come in the way of it being able to reap the benefits from tradeable services in any significant manner. It would require atleast more than a decade of intensive focus on education and skill development for the country to realize more substantial benefits from tradeable services. And even then, like with manufacturing, there are significant uncertainties over the possible disruption to parts of the services sector, especially at its labor-intensive lower end, from technological advances.    

The less productive non-tradeable services face self-limiting constraints - labor absorbing services are less productive and therefore slow growing, whereas the fast growing and more productive services experience higher relative wage growth with resultant limits on job creation. As Dani Rodrik writes, "services sectors that have the best productivity performance typically shed labor; labor absorbing sectors typically have worst productivity performance". It is therefore difficult to envision non-tradeable services as being the predominant channel for productive employment creation and rapid economic growth.

To conclude, global political, economic, and technological environment is undergoing important shifts. The traditional get-rich-quick route of escalator industries looks increasingly out of bound. And the prospect of services becoming the new rapid growth sustaining platform does not appear promising. In the circumstances, India and others will have to navigate against the combination of all three headwinds in their quest to attain high economic growth rates. 

In case of India, its preparedness - poor quality of human resources and pervasive weakness in state capability - constrain the country's ability to overcome these headwinds. The shackles imposed by restrictive regulations exacerbate our weaknesses, further limiting the ability to achieve high growth rates and sustain it for prolonged periods. With business as usual, given its massive size, even with all these internal weaknesses and headwinds, the country may grow rapidly in short bursts (as happened for a few years in last decade) interspersed with longer moderate growth periods. 

Sustaining very high growth rates for long periods like East Asia would require large-scale and long-drawn reforms in numerous areas coupled with concerted efforts to improve human resource capacity and state capability. Even if the reforms are initiated with vigour, it is unlikely to result in any dramatic gains in the short or medium-term. This, rather than cognitive biases, should form the basis for any examination or speculation on the country's long-term growth prospects.  

India transportation fact of the day

From FT

Indian truckers, it turns out, spend a quarter of their journey times waiting at checkpoints, state frontiers (there are 650 border posts) and city entrances, and another 15 per cent at toll plazas. In all, they spend only 40 per cent of the time driving, often in herds to comply with urban time restrictions. For the rest, the truck is not moving. They cover just 250km-300km a day on average, compared with 800km in the US.

And more,

At present the cost of logistics for Indian manufacturers is often more than the entire wage bill – more than double, in the case of textiles – and far higher as a percentage of sales than for international competitors. Halving the delays caused by roadblocks and other stoppages would cut freight times by 20-30 per cent and logistics costs 30-40 per cent, says the World Bank.

The transformation of public policies

Subir Gokarn draws attention to the violation of Tinbergen's "one instrument for one objective" rule in public policy issues in India. Specifically, he points to the transformation of Minimum Support Price (MSP) from being an instrument to encourage foodgrain procurement to being also an instrument to sustain farm incomes. The other example presented is that of labor-friendly labor regulations, which while seeking to both job creation and unemployment insurance, have imposed prohibitive costs on businesses.

There are several other examples. The NREGA which began as an employment insurance program, got transformed into being also a job creation cum job entitlement program. Housing programs intended at providing shelter (rental or otherwise) for poor people, changes into home ownership program. More generally, the recruitment of teachers and other public workers, aimed at delivering specific public services, gradually become an end in itself, with attendant distortions, due to the creation of a constituency of voters who captures the bureaucracy.

Gokarn's point is well taken. But the challenge here is not so much the issue of violating the Tinbergen rule as one of managing the political economy. These examples are illustrative of the complex political economy that surrounds public policy decisions. While any policy generally begins as an instrument to address one objective, it difficult to keep it that way. As implementation proceeds, the emergent dynamics pushes policy makers to embrace other objectives, even when they conflict with the original objective. Further, most often, the new objective crowds-out the original one, thereby distorting the program's focus and making it dysfunctional. This is one of the biggest challenges in the management of public policy.  

Japan's remarkable resilience

In lamenting Japan's struggles with deflationary stagnation, we overlook the dramatic demographic shifts the country has undergone in the past two decades.

Its working age (15-64 ages) population dropped sharply from about 87 million in 1998 to about 77 million in 2013. This 12% drop in its primary factor of production over just 15 years is remarkable, considering its strong downward pressure on economic output.

This was accompanied by a 35% appreciation of the currency, with attendant consequences on a heavily export-dependent economy. If we take both this into account, instead of being concerned, we ought to be surprised at the economy's resilience.

Clearly, the Japanese have been successful in squeezing more out of its remaining factors of production. Further, successive Japanese governments should be complimented for having avoided the public suffering that accompanies such prolonged slowdowns. In fact, as Krugman has written, Japan's real GDP per working age adult has risen faster than others since the Great Recession.  

One possible way out of this is to liberalize immigration rules and nudge the country into being more open to migrants. This could be the fourth arrow of Abenomics. But that looks some time away since we are still awaiting the third.

Update 1 (23/03/2015)

Adair Turner argues that Japan's quantitative easing program is effectively monetizing away the country's massive public debt burden, apart from sustaining the country's debt financed public spending programs,

Japanese government debt now stands at more than 230% of GDP, and at about 140% even after deducting holdings by various government-related entities, such as the social-security fund...  For Japan to pay down its net debt even to 80% of GDP by 2030, it would have to turn a 6%-of-GDP primary budget deficit (before interest payments on existing debt) in 2014 into a 5.6%-of-GDP surplus by 2020, and maintain that surplus throughout the 2020s. If this was attempted, Japan would be condemned to sustained deflation and recession... 

Instead of being repaid, the government's debt is being bought by the BOJ, whose purchases of ¥80 trillion per year now exceed the government's new debt issues of about ¥50 trillion. Total debt, net of BOJ holdings, is therefore falling slowly. Indeed, if current trends persist, the debt held neither by the BOJ nor other government-related entities could be down to 65% of GDP by 2017. And because the government owns the BOJ, which returns the interest it receives on government bonds to the government, it is only the declining net figure that represents a real liability for future Japanese taxpayers...

That reality is not yet openly admitted. The official doctrine is that the BOJ eventually will sell back all of the government bonds that it has acquired. But it need not do so. Indeed, the BOJ could maintain its current level of government-debt holdings indefinitely, making new purchases as existing bonds mature. And if the money created – in the form of commercial bank reserves at the BOJ – ever threatened to support excessive credit growth and inflation, the BOJ could offset that danger by imposing reserve requirements on the banks.

The undesirable and hypocritical quest for harmonization

I am generally always in agreement with Simon Johnson. But his argument in a recent article urging the US to use its trade policy to fight foreign exchange market interventions deserves to be refuted.

He advocates that the US should insist on making participation in the ongoing Trans-Pacific Partnership (TPP) contingent on refraining from currency market intervention. He claims that such intervention is "an unfair way to gain a trading advantage, with excessive negative effects on trading partners" and that "some Asian countries have overstepped the boundaries of reasonable behaviour", with "associated adverse effects on sectors and communities in the US". In simple terms, currency market intervention imposes adverse negative externalities on other countries.

I do not contradict this allegation. Currency market manipulation undoubtedly has a beggar-thy-neighbour dimension. But so do most other macroeconomic policies. Almost any industrial policy, including those supporting defense industries, where the US is the undisputed leader, would unfairly disadvantage similar industries elsewhere. Similarly, national trade policy interventions, even those  not infringing WTO regulations, invariably involve decisions that favor one group over another, whose effects are felt within and across countries.

Further, it is not as though the "currency manipulators" are trying to weaken their currencies. It can be safely argued that in today's world no country can have the fire-power required to "manipulate" their currencies downward in any significant manner, leave alone consistently. At best, they can only try to prevent their currencies appreciating further, so as to arrest the erosion of their existing competitive advantage. And here too, there are significant limitations. The BoJ's attempt to hold down the rising yen in recent months is a case in point.

In fact, there are more pernicious forms of economic policy manipulations, which attract much less attention. The recent debate on tax avoidance highlights how differential taxation policies can harm other countries. The extraordinary quantitative easing policies followed by US, Japan, and European countries have generated massive capital flows, and has been the biggest contributor to global macroeconomic instability.

If the East Asian economies are being accused of "manipulating" their currencies to retain trade competitiveness, then by the same yardstick the central banks in US, Europe, and Japan would have to be accused on "manipulating" their monetary policy to restore economic growth. What is sauce for goose is also sauce for gander.  

Or how about the negative externalities imposed by America's high fiscal deficit in a world where the US dollar enjoys the exorbitant privilege? It encourages (or atleast contributes to) other countries (say, China) to consume less and run up large surpluses; make them to park their savings in low yield US assets; amplify the risks arising from cross-border capital flows, and so on. More disconcertingly, irrespective of its economic fundamentals, it privileges America to print money and borrow very cheap, more than any other country, and at the cost of the savers in other countries.

One could go on about other such perceived "policy manipulations". After all, as we have seen, the negative externalities arising from many policies naturally lead to accusations of "manipulation". But the response to such policies in the form of a selective quest for harmonization betrays both naivety and hypocrisy.

In a world of such vast social and economic disparities, economies move forward in widely varying trajectories. It is therefore inevitable that they follow different, often conflicting, policies on the same issue. Most often, especially with external market policies, these policies generate undesirable negative externalities. This has been case all along the modern era of the nation state. In fact, these policies have underpinned the successful growth trajectory of all of today's developed economies.

In the circumstances, a selective quest for harmonization of policies in a manner that suits the requirements of a few is not only undesirable but also hypocritical. The adverse consequences of the European monetary union, which deprived peripheral economies the traditional option of restoring competitiveness by devaluing their currencies, is fresh in memory. Heterodoxy in policies and not harmonization has been the norm in all of history. Therefore, instead of seeking harmonization, economies should try to adjust their policies to mitigate the negative externalities arising from policies of others, as was being done for centuries.