About "Make in India"

I have an oped in Indian Express today that does a differential diagnostic of the challenge of making in India. Infrastructure, labor taxes, and improving business environment appear as binding constraints.

Technology and disemployment fact of the day

Nouriel Roubini has an essay on the impact of automation and technology on the economy, in particular the labor market. He points to three "downside biases" associated with the technologies associated with the "third industrial revolution" - capital-intensive (favoring those with money and resources), skill-biased (favoring those already having a high degree of technical proficiency), and labor saving (reducing total number of skilled and unskilled workers in the economy). The example of e-books and e-publishing is illustrative,

Think of what e-books have already done: with a click, you can now download almost any book for about $10 on your iPad or Amazon Kindle. This is a great service and convenience for consumers. But most of the jobs in the printing and distribution of books—and soon in the newspaper and magazine industry—are already gone. And so are tons of jobs in the pulp paper industry... 

The next wave of Chinese investments and lessons for India

A Times article highlights Xinjiang region as the target of the Chinese government's hinterland development thrust. The Communist Party proposes to develop the north-western part of the province as the country's energy hub,

Xinjiang has an estimated 21 billion tons of oil reserves, a fifth of China’s total, and major new deposits are still being found... Xinjiang is expected to produce 35 million tons of crude oil by 2020, a 23 percent increase over 2012, according to the Ministry of Land Resources. Xinjiang also has the country’s largest coal reserves, an estimated 40 percent of the national total, and the largest natural gas reserves. Those three components form an energy hat trick that China is capitalizing on to power its cities and industries...  Xinjiang is where all the growth in oil, gas and coal is going to be coming from... all the imported resources from Central Asia, oil and gas, go through Xinjiang and then get distributed from there... Xinjiang will export electricity to more populated parts of China and perhaps to Central Asia... its economy will be further bolstered by President Xi Jinping’s vision of a “New Silk Road,” an ambitious plan to rebuild the ancient trade route into a 21st-century network of transportation and trade across Xinjiang, Central Asia and Europe.

Like with all its regional development interventions, massive public investments will drive this development,

In May, Beijing said that 53 state-owned enterprises — from energy to construction to technology companies — were investing $300 billion in 685 projects in Xinjiang. The State Council, China’s cabinet, announced in June that the Xinjiang government was investing $130 billion to build infrastructure such as roads, highways and railways.

The scale of the investments being planned is staggering. If the Chinese government can raise the resources to finance these investments, that would go a long way towards sustaining the country's spectacular growth rates for the foreseeable future.

This holds important lessons for India. As the mid-term economic analysis acknowledges, at a time of strained balance sheets - corporate and household - India's quest for a higher economic growth trajectory has to be driven by public investments. The new government has announced a slew of ambitious projects - one hundred smart cities, highways construction, housing for all by 2019, diamond quadrilateral of high-speed rail (the budget allocation is inadequate for even one feasibility study), inter-linking rivers, clean Ganga river, Digital India initiative, ten Coastal Economic Regions (CERs) under the Sagar Mala Project, National Investment and Manufacturing Zones (NIMZ) under the National Manufacturing Policy etc.

But none of these projects have a credible resource mobilization plan. In fact, the investment plans for all these projects outlined in their concept reports appear motivated more by wishful thinking than any reasonable assessment of commercial viability. Accordingly, public investments committed are minuscule and limited to technical grants for project development and viability gap funding. The major share of resources for these projects are proposed from the private sector, multilateral agencies, external commercial borrowings, and public private partnerships. However, given the public good nature of most of these investments and experience from across the world, private resources are unlikely to drive such projects, especially in their initial stages. Multilateral lending is marginal to be of any significance. It is amply clear that public resources have to bear the major share of the burden.

The financing problems are exacerbated by a triple whammy of fiscally squeezed governments, debt-laden corporates (especially those in the construction and infrastructure sectors), and bruised bank balance sheets. In the circumstances, the prospects of finding the resources to sustain such ambitions appear not very promising.

Update 1 (18/01/2015)

China has embarked on its latest investment splurge. The Times writes,

In November, for instance, the powerful National Development and Reform Commission approved plans to spend nearly $115 billion on 21 supersize infrastructure projects, including new airports and high-speed rail lines... Throughout China, equally ambitious projects with multibillion-dollar price tags are already underway. The world’s largest bridge. The biggest airport. The longest gas pipeline. An $80 billion effort to divert water from the south of the country, where it is abundant, to a parched section of the north, along a route that covers more than 1,500 miles.

China's role in Latin America

Eduardo Porter has a story examining China's role in Latin America's recent economic prosperity. The benign side first,

In 2010, Chinese lending to Latin America roughly equaled that of the World Bank, the Inter-American Development Bank and the United States Ex-Im Bank combined. 

And the less benign side,

Not only did China’s cheap labor out-compete Latin American industry and draw the lion’s share of global manufacturing investment, but its appetite for Latin America’s minerals, oil and agricultural products also raised the value of currencies around the region, making their manufactured goods even less competitive. Manufacturing’s share in Latin America’s economic output has declined steadily for more than a decade, ever since China inserted itself aggressively into the global economy by entering the World Trade Organization. At the same time, the share of raw materials in Latin America’s exports, which had fallen to a low of 27 percent in the late 1990s, from about 52 percent in the early 1980s, surged back to more than 50 percent on the eve of the global financial crisis.

Value subtraction in India's public schools

In a new paper, Lant Pritchett and Yamini Aiyar finds that public schools in India subtract value when compared to private schools. Public schools cost more than twice private schools, and that too to deliver a far inferior learning outcomes output. Their estimate of what it would take public schools, at their existing efficacy in producing learning, to achieve the learning results of the private sector - 2.78% of GDP (or Rs 232,000 Cr or $ 50 bn)!

The graphic below captures this massive value subtraction.

Any serious effort at attaining and sustaining high economic growth rates should necessarily involve fixing the country's woeful school education system. 

India's disappointing economic growth recovery

The latest IIP figures on the Indian economy makes dismal reading. It fell 4.2%, its worst performance in three years, on the back of weak manufacturing performance. This was despite the festival season and a favorable base-effect. So, despite all the "animal spirits" released in recent months, what's going on?

Madan Sabnavis of CARE Ratings captures symptoms of the malaise,

Growth in consumer durable goods for instance was 2.6% and 2.0% in 2011-12 and 2012-13 respectively, and then declined by 12.2% in 2013-14 and further by 12.6% in the first half of 2014-15. Clearly, households are not spending on non-food items. The reason is not hard to guess. Food inflation has eroded the spending power, as Consumer Price Index (CPI) inflation has been high averaging 10.2% in 2012-13, 9.5% in 2013-14 and 7.4% in 2014-15... industry has cut back on investment. This is mainly due to surplus capacity with the average capacity utilization rate coming down from 77.7% in first quarter if 2011-12 to 70.2% in the June quarter if 2014-15. Quite clearly, low consumer demand translates into lower demand for intermediate, basic and capital goods. Add to that the surplus capacity in a high interest rate environment and investment is bound to be curtailed.

For an economy where consumption makes up nearly 60% of the output and therefore critical to do the heavy lifting, this weakness is very damaging. As Mr Sabnavis identifies rightly, the prolonged period of inflation is the major culprit, having significantly eroded purchasing power among the workforce. To get a sense of the wealth erosion - the 9% average inflation over the 2008-14 period, exactly halved our purchasing power. It is reasonable to assume that incomes would have grown by far less to compensate for the loss. The steep negative impact on aggregate demand is understandable. The importance of RBI's stance on inflation has to be seen against this backdrop.

In the circumstances, as I have blogged earlier, there are two important parts to restoring economic growth - revival of credit growth and investment. Non-food credit growth, currently languishing at less than 10% has to return to atleast 15-20% levels. More importantly, infrastructure credit growth has fallen precipitously from its heady 35-40% growth rates in 2010-12 to less than 15% in 2013-14. Excluding power sector, itself weak, the infrastructure lending performance is poorer still. There are two important requirements to meet this target.

One, any rise in credit growth is contingent on the ability of banks to meet the demand. Here the weak balance sheets of the public sector banks, who supply over 80% of the bank credit, is a major constraint on lending, even if investment demand picks up. Large scale recapitalization is arguably the most urgent macroeconomic policy requirement and it is unlikely to materialize by merely divesting bank share holding. In fact, even if most of the Rs 18 lakh Cr worth projects currently stuck up in various tangles are disentangled, a very small proportion of them are likely to find the capital to start work.

Two, in the absence of investment demand - due to debt-laden corporate balance sheets, weak infrastructure investments, and the anemic consumer demand - the government becomes the engine to trigger investment revival. Unfortunately, it does not have the fiscal space to finance infrastructure investments. This is reflected in the marginal budget allocations made for even flagship projects of the government, with unrealistic hopes being thrust on private sector and public private partnerships.

The additional fiscal space come from either increased tax revenues and squeezing expenditures elsewhere. But both direct and indirect tax collections have been disappointing - 5.8% growth in indirect taxes against the budget estimates of 25% and 7.09% growth in direct taxes against the budget estimates of 15.31% in the April-September half year. This is not surprising given weak demand, low corporate investment appetite, and anemic economy. Cutting welfare spending is politically contentious and better targeting through Aadhaar will take time. Thanks to the one-step forward, half-step backward reforms, the windfall from the more than 40% drop in oil price appears unlikely to be fully reaped. Most of the measures to improve revenues and optimize expenditures are diffuse and long-drawn and unlikely to yield similar windfall.

All this highlights the adverse headwinds that the Indian economy has to navigate before it can start growing at 6-7%, leave alone the heady 8-9% rates. And I am not even talking about these long-term trends. In the circumstances, the journey towards regaining a 6-7% growth rate looks likely to be painstaking and long-drawn. Talking up the economy can only take you so far, and there are no magic reform pills available in the government's armor.

Update 1 (20/12/2014)

In its mid-term economic policy review, the Finance Ministry too comes to the same conclusion - public spending has to do the heavy lifting for reviving the economy. It points to corporate's median debt-to-equity ratio of 70%, one of the highest in the world, and posits a "balance sheet syndrome with Indian characteristics". The report's argument that household balance sheets are alright overlooks the harm done by the "income erosion effect" from persistent high inflation.

It identifies fiscal space by highlighting that the country has a debt flow (high fiscal deficit) problem and not a debt stock (reasonable and declining public debt to GDP ratio) problem. Though it finds "growing ground for hope", I am not sure.

Update 2 (4/1/2015)

Business Standard reports that the power sector pipeline for the 13th Plan (2017-22) is barren as developers struggle with a host of problems, including strained balance sheets. Highlighting this, the order book of BHEL, the primary equipment supplier, is thin for the 13th Plan period. Half the 12th Plan commissioned capacity (48000 MW till date against 88537 MW for the entire plan) are in-operational because of fuel supply issues. A plant takes 4-5 years to become operational.

Further, recent bids called by the government for the 4000 MW UMPPs in Tamil Nadu (Cheyyur, using imported coal, Case II bid) and Odisha (Bedabahal, pithead plant, Case II bid) have met with lukewarm response. It is likely that no private developer will bid for these design-build-finance-operate-transfer (DBFOT) model projects, which do not have a power purchase agreement.   

China manufacturing facts of the day

From Forbes, on China's claim to be the factory of the world,

In 2011, for example, it manufactured 90% of all the personal computers produced globally that year, as well as 80% of the air conditioners, 74% of the solar cells, and 70% of the mobile phones.

From Nicholas Lardy, on the changing nature of Chinese economy and how private firms are its growth engines,

State firms now account for only one-fifth of manufacturing output, compared to four-fifths when reform began. They account for only one-tenth of investment in manufacturing. State firms in all sectors account for only one-tenth of urban employment and only one-tenth of China’s exports... According to data released by the People’s Bank of China, private firms received 52 per cent of all credit flowing to firms from 2010–2012, while the share of state firms was only 32 per cent.

Labor market reforms - deregulation or lower taxation?

I have briefly observed that instead of wading into the controversial hire-and-fire reforms, the next round of labor market reforms should involve addressing the dual price market in labor wages.

The fundamental problem is that Indian manufacturing firms start and remain small and informal. This engenders an inefficient equilibrium of low productivity, low wages, deficient social protections, limited investments, and stunted growth. What is required to break out of this equilibrium?

The likes of Arvind Panagariya argue that the restrictive hire and fire policies encourage firms to start small and informal and remain so. There is another possibility, as highlighted by Manish Sabharwal, that the high rate of labor taxation, payable by both employers and employees (upto 45% of wages are deducted for pensions and insurance for those with smaller incomes, whereas just over 5% of wages are deducted from those with higher wages), encourages much the same as above. It is certain that both - restrictive labor regulations and high rate of labor taxation - contribute to keeping firms small and informal. What is not certain is which is a greater constraint facing firms.

In this context, I have argued in detail that restrictive regulations may not be as binding a constraint as prohibitive taxation rates are. Consider this story. If you are the typical entrepreneur starting a textile unit, you are more likely  to start small and not be able to afford higher salaries. However, at such salaries, you are also unlikely to be able to attract workers, especially given the prohibitively high payroll deductions. So the firm prefers to either start informal or contract labor. Once it starts informal, it gets entrapped in a low-level equilibrium, exiting from which is constrained by several factors, including informality itself as well as restrictive labor regulations.

A more prudent strategy involving labor market reforms would revolve around lowering mandatory payroll deductions and replacing it with publicly funded social protection that is programmed for a gradual phase out. 

Observations on the declining oil price

Much of the current decline in oil price can be explained by recent demand-supply dynamics. Supply has risen sharply due to shale and tar sands oil production coming on line, return of Libyan and Iranian production, and new discoveries in Africa and elsewhere. On the other hand, demand has been constrained primarily by global economic weakness, and less so by increased fuel consumption efficiency.

Here are three less discussed observations on the decline in oil price.

1. There is little to doubt why this time is different with the oil price cycle. History teaches us that oil price spikes are associated with a sharp rise in investments in wells and refineries. These investments take time to come on line, by which time the business cycle reverses, causing a supply glut and declining prices. Since their investment option value is exercised, new producers keep producing so as to cover their variable costs. But falling price in turn boosts consumption and economic output, as well as discourage investments in production capacity (which any ways take time to become operational). The combined effect of increasing demand and stagnant production (and prospects) is a return to rising prices.

All the standard signatures of this dynamics are present in the current cycle. The China-led emerging market boom and pre-recession spike in oil price triggered an investment binge. It made shale and tar sands attractive sources. Businesses invested in sweet crude refining capacity in the US. The Great Recession struck and Chinese economy started showing weakness. Oil price falls by nearly 40% in less than six months. Consumers benefit and it is likely to be a net gain for the world economy as a whole. This sets the stage for increased demand and rising prices...

2. Much has been made out of the dramatic increase in shale oil production in the US and its salutary effect on US manufacturing and the economy. Now that the momentum has turned, the sustainability of the shale oil exploration induced economic growth has become questionable. Apart from the commercial viability of shale oil at these prices (which is highly contentious and very difficult to estimate), new drilling projects and other investments are being scaled back or cancelled. The cumulative impact on US economy could be substantial, even if off-set by the consumer wealth effect and decreased production cost for non-oil businesses. Recent stories about drillers cutting back on rigs is a pointer to a possible reversal.

3. Finally, the falling oil prices present opportunities for emerging economies like India and Indonesia in both lowering current account deficits (CAD) and rolling back their massive energy subsidies. However, in India's case, there are formidable challenges to seizing these opportunities.

Though India has already taken the first step by recently decontrolling diesel price, on top of the earlier decontrol of petrol price, there are doubts about its resolve to hold steady when prices recover. For example, the gains from the decontrol have been offset by the subsequent hike in excise duty on petrol and diesel and the decision to not pass it on to the consumers and let it be borne by the national oil companies. Further, instead of slowly lowering the subsidy by not reducing prices on the face of decline in global price, the government has preferred to pass on the down-side gains to the consumers.

Similarly, hopes of lower CAD may be misplaced. The decline in oil import bill could be more than offset by increased gold (consequent to easing of the import controls) and other imports (as the economic growth picks up). Indeed, the CAD is already showing signs of widening.

Update 1 (10/01/2015)

From Business Standard,

According to an analysis of Macquarie Research, lower oil and other global commodity prices bodes well for containing inflationary pressures. A 10% reduction in crude oil prices could reduce CPI inflation by around 20bps and a 30bps increase in GDP growth. A $10/bbl decrease in oil prices reduces India’s import bill and, hence, the current account deficit by $10bn or 0.48% of GDP. 

India's affordable housing challenge - a graphical summary

I have written earlier about the near impossibility of achieving the government's affordable housing mandate. The following graphics reinforce the point.

The country has one of the highest price-to-rent ratio among all its emerging Asian peers, thereby constraining demand. This points to over-valued property prices, a fact reflected here.

This is complemented by low rental yields, the gross annual rental income expressed as a share of property purchase price. Rental yields, a measure of the landlord's return on investment, have been stagnant at 2.5-3% for a long time.

The combination of these two factors severely distorts the country's property markets. The former prices a large share of the population out of the market. The low rental yields, over and above acute land scarcity and high building costs, come as a disincentive to creation of housing stock other than for living in, and encourages land owners to hoard land rather than build on it. The combined effect of both is to severely constrain demand and supply respectively.

This effect is even more pernicious given the nature of demand and supply in India. The country's affordable urban housing demand stood at 25 million in 2010, of which 16.6 m was in slums. Nearly 90% of the demand comes from households with incomes below Rs 5,00,000.

The real estate consultancy Jones Lang LaSalle estimates that 60% of the demand would come from households with annual incomes below Rs 5,00,000, whereas units for them constitute just 10% of the total supply. Interestingly, those with incomes greater than Rs 7,00,000 form just 20% of the demand, whereas a whopping 70% of the units in the market caters to them. In other words, 90% of the housing units in the market cater to the demands of just 40% of the population, those with incomes above Rs 5,00,000.

A 2010 MGI report highlighted the housing unaffordability problem for those below the Rs 5,00,000 income barrier. The graphic below shows the affordability gap for Tier 2 cities in 2010. The affordability gap is massive among those at the bottom two categories...

... who make up the majority of the population. In 2005, they formed nearly 95% of the total population. Even in 2015, the share of population with household income below Rs 2,00,000 is estimated to be 78%.  

In the circumstances, meeting the affordable housing challenge appears a distant dream. 

Update 1 (27.02.2020)

A good graphical piece on India's real estate market here. This captures the unaffordability challenge. 

While Mumbai has among the lowest parking charges, its vehicles take up a disproportionate share of the space available.

A parked vehicle consumes the space of 8 people in Mumbai, while in New York Mid town, it occupies the space of .42 people.

The Great Depression - Greek Edition

The Global Financial Crisis and the subsequent Great Recession visited untold economic suffering on both sides of the Atlantic. But, as the graphic from Barry Rithotz below shows, nowhere was this as comparable to the Great Depression as in Greece.

The Greek economy contracted by more than a quarter and is even today at just three-fourths its 2008 baseline! The other PIIGS also have a fair bit to recover even to get back to the baseline levels of output. 

India drugs regulation capability fact of the day

The spate of punitive actions by the US FDA on drugs manufacturing facilities in India in recent months on grounds of impurities in samples and falsification of test results draws attention to the role of the Indian regulator, the Drugs Controller General of India (DCGI). In particular, this from a Business Standard report stands out,

While the Indian regulator has a total staff of 650, the USFDA has 20 times more at 13,000. 

For a sector with exports worth $14.6 bn in 2012-13, of which 26% went to the US, and with over 370 US FDA approved pharmaceuticals manufacturing facilities, the largest number outside the US, the level of regulatory over-sight leaves much to be desired. Apart from being a reflection of the doubtful corporate governance standards, the punitive actions are a reminder of the glaring deficiencies in India's state capability. If the "Make in India" campaign, and sustainable economic growth itself, is to stand any chance of success, the country needs to fix its sorely deficient state capability.

The grossly inadequate regulatory personnel is a first order deficiency and is representative of governance and regulatory failures across sectors. Early this year, the US FAA had downgraded the country's aviation safety ranking to Category II citing 31 inadequacies, including deficient technical expertise, lack of trained personnel (more than 500 vacancies), record-keeping, and inspection procedures being followed by the Director General of Civil Aviation (DGCA). 

Postscript : The Times carries an article on the government's efforts to ease environmental regulatory burdens by scrapping a layer of pollution inspections with voluntary disclosure and compliance by business owners. While streamlining the processes is welcome, it is unlikely to yield much benefits in the absence of its effective implementation.

It is here that India's state capability problems surface. Across states, the Pollution Control Boards (PCBs) are perceived as extremely corrupt and sorely lacking the professional competence and bandwidth to effectively discharge their implementation responsibilities. This is instructive of the capability deficit,

The newly appointed National Board for Wildlife, which must approve projects in and around protected areas, plowed through 140 pending projects during a two-day gathering in mid-August. One member said they worked at a rate of 15 to 30 minutes per file.

The point being made is that the weak state capability is as much a bandwidth problem as a professional competency problem. 

What to expect from mega construction projects

The Times carries an excellent story of yet another grandiose trophy project - the nearly $4 bn World Trade Center Transportation Hub - which is facing massive cost over-run and execution delay.

The Hub, with its winged "Oculus" pavilion, designed by the famed architect Santiago Calatrava, is being developed by the Port Authority of New York and New Jersey. It is estimated to cost about $3.7 bn when it is likely to open in 2015, many years delayed and at more than twice the original estimate when the project was unveiled in 2004. After all this spending, it turns out that instead of being a predominantly transportation hub, the project would in all likelihood end up being a "high-priced mall, attracting more shoppers than commuters".

The experience from this and numerous other similar projects points to a few important lessons that appear universal for such projects

1. Cost over-runs and time delays are unavoidable, unless you are doing it in China. It is therefore appropriate to factor in this at the beginning using some form of "optimism bias" to accommodate the inevitability of delays and cost over-runs. This would help all parties - government agencies, developers, financiers, and citizens - appreciate the real challenge, instead of being misled by the highly deceptive initial estimations.

2. Star planners, designers, and architects are more likely than not to disappoint. However, this cannot be a reason for not considering them. They are essential to meet the client's (a political leader or a wealthy promoter) aspirational hubris, atleast when the project is initiated. It is just that the hype surrounding any sales pitch has a dynamic of its own which camouflages reality and most often fuels excessive expectations. Even other wise, plans submitted by them are likely to run into technical (it is rarely possible to literally translate the design into physical structure - any change to the design, which is mostly inevitable, to get it to suit field conditions is most likely to disrupt/compromise the original promised effect) and financial (it is too expensive to translate the design literally) challenges. Either ways, when the promised effect does not materialize and disappointment sets in, the architect/planner would blame it on the developer/government failing to keep its side of the contractual bargain.

A rigorous enough analysis of the design/plan (so as to test its aforementioned technical and financial dimensions) that can anticipate all possible technical/financial contingencies is almost impossible at the initial stages of a project. The emergent dynamics of these large projects are difficult to anticipate. So being disappointed with the work of star architects/designers is par for the course.

3. Much the same fate is likely with other important external service providers like project managers, owner's engineers, master planners, and construction contractors. This assumes significance since almost $655 million of the $3.7 bn for this project will be spent on such administrative costs. Disputes, like with the Hub's construction contractor Phoenix, are commonplace. It is difficult to write complete contracts that define the scope to last detail and capture all contingencies. The scope of work undergoes continuous changes at the different stages of execution for a variety of unforeseeable reasons. The best that can be done to mitigate this is too have in place enough flexibility within the contract to deal with such contingencies and attendance disputes, given the inevitability of it surfacing.

4. The emergent dynamics of such projects necessitate several decisions which are not easily justified on terms of objectivity. For example, from hindsight one gets the (mistaken) impression that in the Hub project, given the exorbitant increases in cost, there were occasions when the design could have been junked for a more prudent and financially viable one. But the reality is that the option value of shifting to a new design is most often zero, even negative, given the different types of sunk-costs associated with the original design. Or the decisions to agree for expensive sub-contracts to expedite the work, or the

This raises the question of how do public managers, especially in countries where post-construction audits are done with the apparent wisdom of hindsight, take decisions that do not fall foul with such auditors. This assumes great significance for India where audits-induced decision paralysis has become an important problem in recent years. In fact, a business as usual audit of this project in India could have incrimated all the concerned, including Mayor Bloomberg, of causing loss to public exchequer and even left many in jail. 

The Chinese and Japanese investment rush

In the past two months, the Chinese President Mr Xi Jinping and the Japanese PM Mr Shinzo Abe have promised investments worth $20 bn and $35 bn respectively over the next five years. In the aftermath, Chinese and Japanese investors have been swarming across the country, scouting investment opportunities. States like Andhra Pradesh have been aggressively courting these investors. A few observations.

1. The Chinese investment push is led by provincial governments, who have secured lending commitments aimed at India from the China Development Bank. In typical Chinese style, they are ready to deploy funds immediately and get started with investments. The Japanese investment push is led by its large trading houses, zaibatsus, who too have secured commitments from the country's overseas assistance and lending agencies JICA and JBIC respectively.

2. Investments come either in the form of government-to-government loans to help build infrastructure assets - high-speed rail is at the top of list for both countries - or by businesses to establish manufacturing and other facilities. Both countries, especially the Chinese, prefer loans. In fact, the Chinese provincial delegations have been expressing their intent to lend at the "most concessional rates" to governments, though there is considerable opacity about the terms of such lending.

Further, in both cases, loans are conditional on procuring their respective national firms, mostly through nomination. This means a go by to the conventional global competitive bidding that is the norm for awarding large public projects in India. In any case, only a small proportion of the massive investments that have been committed by the leadership of both countries can be realized through nominated public procurement.

3. The traditional and sustainable route of private capital investing in manufacturing and other facilities is a distant secondary prong for both countries. However, investors from both countries express willingness to invest in large development/economic zones if the state governments allot land to them. The JBIC financed Delhi-Mumbai Industrial Corridor (DMIC) is a case in point. But there are limits to such investments and may not be desirable, especially if these investment zones come with large and prolonged fiscal concessions.

4. All the hype around these investment commitments should have opened up several large private-to-private investment partnership opportunities for Indian firms with those from China and Japan. However, such partnership announcements have been conspicuously missing in action. What is holding back Indian businesses from reaching out and establishing partnerships? For example, since Japanese investors have announced investment commitments in power generation, where are the JVs in local manufacturing of power generation equipments (BTG)?

5. Given their massive foreign exchange surpluses, currently invested in low yielding US Treasuries, both countries naturally view India as a large destination to invest their swelling surpluses at far more attractive returns. In turn, India has massive infrastructure and industrial investment demand which can be whetted only through large foreign capital inflows. There appears a great potential for mutually beneficial partnerships, though the fiscal space available with central and, especially, state governments for absorbing large volumes of loans may be limited.

All this raises several questions. Are central and state governments willing to preferentially nominate Chinese or Japanese firms for large public projects? Is it desirable to compromise on quality just to access the less demanding capital that accompanies Chinese and Japanese firms? Do state governments have the fiscal space to take loans to finance such large projects? Assuming a relatively stronger renminbi in the years ahead, do state governments have the ability to bear the forex risks associated with large exposures in projects (like HSR) where revenues are in rupees? Given the likely upward trajectory of interest rates globally and in both countries in the years ahead, how affordable are such loans? What is the likely cumulative cost of capital, when accounting for these risks?

What can be done to make it attractive for both investors to assume risks and invest in manufacturing and other industrial facilities in India? What can be done to promote private-to-private investment partnerships between business entities in both countries? What can be done to encourage investors from both countries to establish manufacturing facilities where Indian governments procure directly from Chinese and Japanese firms? What can be done to leverage Chinese and Japanese investment loans towards their JVs with Indian firms?  More ideally, can Indian firms, in some partnership with their firms, access this capital to establish industrial facilities here? Are the Chinese investors willing to set aside their propensity to in-source their labor for their projects? What is Indian state's economic diplomacy doing to facilitate partnerships and address concerns?

Answers to some or all of these questions, and its mutual appreciation, will give a more sustainable push to such investment partnerships. In its absence, such hype is likely to remain just that. 

The case for immigration, and social protections

Noah Smith makes the case for liberalized immigration which is as simple as anything I've read on the issue,

Tech companies want cheap labor. Tech workers -- or prospective tech workers -- want expensive labor. So they fight over whether to let in more skilled immigrants. Letting in more skilled immigrants will expand the industry (and the overall economy) a bit faster, but more of the revenue will flow to the owners and top-level managers of the companies. Letting in fewer immigrants will slow growth a bit for the industry and the economy, but will give a bigger piece of the pie to native-born skilled workers.  

Ignored in this argument are the rest of the people in the economy, the grocery clerks, cab drivers and landscapers who don’t have tech skills... The skilled immigrants will shop at the grocery stores, take cab rides and get their lawns landscaped, thus putting money into the pockets of the low-skilled American workers. 

Meanwhile, some native-born tech workers will be put out of a job, but since the number of jobs in the world isn’t fixed, they will find new jobs at new companies -- possibly for a bit less money than they earned before, but they will be OK. And with the creation of those new companies, the economy will grow... Some Americans might lose out, but more will gain, and the people who gain will be working-class laborers, not highly trained engineer types.

I agree with him completely. But the argument is incomplete without invoking the second welfare theorem and compensating the losers, atleast those badly affected, with lump-sum redistributions. In other words, liberalization of immigration rules (and similarly of trade itself) has to be complemented with social protections that cushion those worst affected and most vulnerable against the adverse consequences of the liberalization policy.

It is for this reason that the next round of reforms in India, essential for moving up a sustainable high growth trajectory, and invariably involving further liberalization of trade, has to be preceded by steps that lead to the creation of a basic social safety net that at the least cushions those worst affected by the reforms.  

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.