Decision making on complex public policy challenges

The demonetisation and its aftermath has raised questions about the haste associated with it and the lack of adequate planning to meet the contingencies. A friend asked whether it was possible at all to carry out such decisions in a planned and pre-announced manner. 

I would believe that there are broadly two ways of bringing about deep-seated changes involving decisions which are politically sensitive and have complex operational details (like shrink the informal sector, reform critical regulatory institutions, reshape urban governance structures, change primary health care systems, administrative reforms, electoral finance etc). 

1. Carry out extensive stakeholder consultations, mobilise support among them, prepare a comprehensive plan covering all dimensions, elaborate operational issues to the last detail, and then roll-out the changes in a predictable environment.

2. Identify an important element of the reform process (based on political and administrative expediencies) and bite the bullet. Hope that it would generate the momentum for change (create conditions or ripen the moment for wholesale change). In due course of time, intervene strategically and opportunistically with all the other elements of the comprehensive plan. 

The first is a neat, linear and logical approach, whereas the second is by definition messy, ad-hoc, and iterative. I am increasingly inclined to the view that, especially on deep-seated changes, the former would most likely overwhelm the political and bureaucratic systems (albeit for different but very compelling reasons) and lead to decision paralysis. It's just that there are too many bells and whistles associated with such comprehensive plans that they are most likely to run into the constraints of political acceptability, financial and other resources, administrative capacity, and mobilisation of entrenched interests. 

In the circumstances, I feel that a more prudent approach may be to identify a totemic element of the implementation plan that can rally the troops, wait for an opportunistic political moment, intervene in a manner that it creates a momentum, have a very committed and nimble team in place to respond swiftly to the emergent problems, and then chip in with all the other elements of the plan. 

The risk with the latter approach is that we identify the wrong elements, intervene at an inappropriate time, and fail to follow up with other elements. The risk with the failure to follow-up is, in particular, very high. If the intervention fails, everyone becomes risk-averse and would anyway be reluctant to follow-up with other elements. If it succeeds, the supporters are likely to be carried away by the success and lose focus on the job ahead. 

The demonetisation may have complied with all the first three parts of this approach, and now awaits  the response team to act swiftly and unveiling of the other elements of the comprehensive plan. Given the rising discontent, it may be necessary to unveil all the other elements without waiting too long.

Forget growth to achieve growth

Our final column summaries the arguments in our book on India's growth prospects, including its policy prescriptions and process principles. Get over the fetish with growth and focus on the plumbing! 

Weekend reading links

1. Adam Minter has a nice article that points to the impossibility of relocating iPhone manufacturing jobs to US.

Low labor costs and minimal regulation were certainly part of China's appeal. But the most important factor was its huge and nimble workforce. The main iPhone facility in Zhengzhou now employs 110,000 workers, with other factories employing hundreds of thousands more. China's 270 million migrant laborers -- most of them ambitious and opportunistic -- have proven indispensable to a business that prizes flexibility. Last summer, Apple contractors reportedly hired 100,000 workers to ramp up production of the iPhone 6s in advance of its fall release. Nothing comparable could ever happen in the U.S., no matter what the president wants. A mass mobilization on that scale, and at that speed, likely hasn't been attempted since World War II. And there's little reason to think it would be successful or desirable today, even if Apple was willing to try. Finding enough skilled labor wouldn't be much easier. 

I would argue that these points apply to the possibility of manufacturers shifting from China to even other developing countries. While some shifts are inevitable, but large scale ones very unlikely for the foreseeable future. It would require cost advantages that are very large to off-set the significant benefits from being part of a large industrial eco-system, as manufacturing facilities in China are. It is no surprise that we find more stories of China leading the drive towards automation as these factories strive to remain competitive in the face of rising wages.

2. Stewart Wood tweets this remarkably prescient extract about a possible "strongman" emerging in the US from Richard Roarty's 1998 book, "Achieving our Country"

The last paragraph is stunning.

The one thing that strikes me is that the protest movements against the likes of widening inequality, stagnant wages, job losses from automation and trade and its concentration in geographical pockets, ballooning college and housing costs, lower capital gains taxation and corporate tax avoidance etc have been so subdued. Given the egregious manifestations of unfairness associated with these trends, it is surprising that these issues have not boiled over into the streets. The "occupy movement", for example, just fizzled out.  

Historically, the leadership for counter-movements against such excesses have originated within among the elites themselves. I do not see the green shoots of any such leadership emerging from within the elites and opinion makers. Even the academic activism against them have been, well, academic. The occasional bursts of protests in the form of books and articles have been staccato and one-off. Into this vacuum, it was inevitable that a demagogue stepped in.

Therefore, the more surprising thing for me is not so much the rise of Trump as the lack of the countervailing elite opinion that would have been the anti-thesis to the prevailing thesis. I think that those who claim to keep the conscience of the liberal order in the US failed badly. 

3. This article in the Economist on Trump's conflicts of interests is baffling in its benign assessment.  The conflicts are enormous, especially given the man's background and the signals of deep engagement of his children, who manage the business, with the US government activities. This article in the Times is an excellent investigation,

Even if Mr. Trump and his family seek no special advantages from foreign governments, officials overseas may feel compelled to help the Trump family by, say, accelerating building permits or pushing more business to one of the new president’s hotels or golf courses... there has been very little division, in the weeks since the election, between Mr. Trump’s business interests and his transition effort, with the president-elect or his family greeting real estate partners from India and the Philippines in his office and Mr. Trump raising concerns about his golf course in Scotland with a prominent British politician. Mr. Trump’s daughter Ivanka, who is in charge of planning and development of the Trump Organization’s global network of hotels, has joined in conversations with at least three world leaders — of Turkey, Argentina and Japan — having access that could help her expand the brand worldwide.

Trump's largest business interests out side the US are in India,

Several of Mr. Trump’s real estate ventures in India — where he has more projects underway than in any location outside North America — are being built through companies with family ties to India’s most important political party. This makes it more likely that Indian government officials will do special favors benefiting Mr. Trump’s projects, including pressuring state-owned banks to extend favorable loans.

Demonetisation and the informality debate

The end-game of demonetisation and less-cash economy is arguably about rolling back the informal sector. But this endeavour has to overcome an externalities play with a set of fundamentally conflicting objectives. 

Businesses and consumers optimise on costs and prices respectively. This is all the more so for the vast majority of enterprises, mostly micro and small, and consumers in a country like India. The net result is an equilibrium where businesses skimp on costs, especially which can be evaded (or avoided) and the resultant costs are affordable. On their side, consumers' very high elasticity (or marginal sensitivity) on prices encourage businesses to keep costs as low as possible. Nobody in this market bears any burden for the external costs of their actions. A weak or non-existent state and deficient formal markets helps maintain the equilibrium where a very significant proportion of transactions are informal. 

On the other hand, formal markets have a different set of dynamics. Here the rules of the game are strongly aligned towards internalising the external costs. The market equilibrium gets established subject to the rules of the game. The layers of external costs get added to the shares of the respective actors in the market. The net result is a higher cost for businesses and higher price for consumers. I have blogged earlier about the costs of formality in manufacturing, labor, housing, and land markets.

Consider the roadside barber shop or street-corner kirana store or small restaurant. They survive in a cash and informal economy, which pervades everything from shop rent, employee payments, purchases of intermediates, to final sales. In the process, they (and their transaction counter-parties) avoid making payments on their legal obligations - income and other taxes, social protections, safety and other standards etc. Everyone in the transaction chain agrees with this bargain with all its attendant compromises on quality.

There is nothing wrong with this. At a fundamental level, development is a process of seizing arbitrage opportunities. Across markets, capital and goods move from areas where they are cheaper to where they are more expensive. The formal and informal markets are no different. People earn incomes in the informal markets to access a progressively increasing share of consumption in the formal market, which expands in turn. Countries see an increasing share of their economic transactions move into formality as they develop. 

Now consider the introduction of formality into these establishments. It immediately exposes two binding constraints. Most fundamentally, the vast majority of consumers will not be able to afford the incremental price. In other words, there are only so many people who can afford the beauty saloon instead of the roadside (or small shop) barber. The other constraint feeds in from the first - businesses will not have the market demand to service if they incur all the costs of formality.

The only way around this is to have standards (on environment, labor etc) that are not benchmarked to global best practices, but pegged to realistic levels and which tighten gradually and progressively. This would have to be complemented with a robust safety net that provides publicly financed social protections for those employed in the country's millions of small enterprises, so that the costs of going formal are not high. After all in the US, the largest beneficiaries of its social safety net are large firms like Walmart and McDonalds. But the argument in favour of a second-best set of standards goes against the grain of political correctness (the debate surrounding the real estate bill was instructive in this regard), while any attempt at building a deep enough social safety net runs into fiscal constraints.

There are no easy answers to such complex development challenges. I am less convinced that we can transition to a significantly less-cash (or less informality) economy over a five or ten year period. As we argue in our new book, the endeavour should be persistent economy-wide capital accumulation that grows national incomes to create a large enough consuming class, encourages firms to start formal and then grow, and builds up state capacity to regulate. That requires diligent action on multiple fronts. 

State capacity constraints and India's growth

Me and Ananth have our second column here based on our report on India's growth prospects. This is a more comprehensive view on the state capacity constraints. This also includes the focus on the veto often exercised by the Ministry of Finance, which has not been included in the oped but is available in our report. 

What is the most effective anti-poverty program?

Two graphs from Max Roser that convey why removing barriers to labor mobility is, by orders of magnitude, the most effective anti-poverty program.

The first graph compares the total net present value of all benefits from multi-faceted graduation programs and annual increase in wages of low-skilled labor migration to the US.

The second compares the relative gains from removal of barriers to trade, capital, and labor respectively. 

The case rests!

Weekend reading links

1. Interesting difference between what the Chinese and Indian students, the two largest category of foreign students in the US, choose to study,

Chinese students tend to choose undergraduate courses focused on business, while Indians opt for short graduate programs in more technical subjects like science and maths... The most Indian students were studying engineering–36%, followed by math or computer science–34.9%.

2.  Fascinating graphic in the Economist which captures the Brexit-Trump moments in the rich world. It shows that positive views of globalisation are today largely confined to the developing countries.

3. The Economist points to a new paper which calculates the challenge facing defined contribution (DC) savers as they grapple with the ultra-low interest rates in developed economies,

In recent history a fairly common savings rate of 8% each year over one’s career together with other common industry assumptions, would have allowed DC savers to reach a target retirement income replacement ratio (RR) of 75%. Unfortunately, current market yields indicate that both stocks and bonds may deliver lower returns in the coming years. This may impact savers significantly: we quantify that roughly 2% lower expected returns could potentially double the required savings rate over one’s working career in order to achieve this same 75% replacement ratio.

The historical real return of 7.5% from equities is expected to decline to 5%, and that from bonds from 2.5% to 1%, thereby generating a two percentage points lower annual return of 3.5% on a standard asset allocation of 60% US equities and 40% Treasury Bonds. This means that the worker now has to save 15% a year, not the current 9%, to reach the RR of 75%. On a 2.5% real return assumption, the contributions would have to rise to 19% overall!

This and the massive unfunded liabilities of defined benefits plans makes pensions a silent crisis lurking at the edge.

4. The distortions in the Chinese corporate debt market are scary. The system of dual rating of state owned enterprises (SOEs), a stand-alone rating based on the company's balance sheet and a state-backed rating that factors in government support, confounds the problems. Consider these,

Take, for instance, Beijing Infrastructure Investment Co Ltd, which operates the city’s urban rail system. With a hefty debt load, its initial credit rating would be BB-, a risky junk bond, according to S&P. But thanks to government support, S&P gives it a final rating of A+, eight notches higher, a solid investment-grade bond... In the onshore Chinese bond market, if the stand-alone ratings applied, SOEs would face annual interest rates of more than 10% instead of the roughly 5% they are used to. Even in the Hong Kong bond market, average annual borrowing rates for SOEs should be 3.5%, based on their stand-alone profiles; that, however, falls to roughly 2% after state support is included. That amounts to a two-fifths discount on interest costs—quite the subsidy.

This is all fine as long as the government can play along and provide the implicit guarantee. But a recent willingness to let a few fail shows that the possibility of massive turbulence cannot be ruled out.

5. India demonetisation snippet of the week,

Within a day of Mr Modi’s announcement, first-class tickets on India’s longest train route, between Dibrugarh and Kanyakumari, were sold out for the next four months: they could still be bought with old money, then later refunded for new.Within a day of Mr Modi’s announcement, first-class tickets on India’s longest train route, between Dibrugarh and Kanyakumari, were sold out for the next four months: they could still be bought with old money, then later refunded for new.

6. Livemint has a four part series on corporate debt in India. Given the scale of indebtedness, the process of deleveraging is slow, thereby prolonging the pain and postponing any revival of the investment cycle. An analysis of a sample of 305 companies shows that the smallest companies are the most leveraged. 

Compounding the problems, their ability to meet interest costs has dipped to the lowest in a decade.

In fact, even though India has one of the lowest corporate debt to GDP ratios, its corporate indebtedness is worsened by one of the lowest interest coverage ratios. This is caused by slower revenue growth and higher interest rates in India. 

As expected, the indebtedness has taken its toll on compensation, though executive compensation rose faster than those of regular employees. The counter-party in this are the banks, whose balance sheets have been bruised as the debt piles gradually turn sour. 

7. Livemint has a graphic of the share prices of 75 politically connected firms maintained by Ambit Research, compared to those of BSE 500.

This may well be the biggest achievement of this government in Delhi, controlling corruption and crony capitalism. The contrast with the previous government's tenure is stark.

8. Finally, fascinating article on what makes the All Blacks rugby union team tick. "Clean breaks" or slipping through defensive lines, was found to be the most robust predictor of scoring points, and New Zealand towers over everyone else.

State capacity and universal health coverage for India

This article proposes emulation of the Thailand's health care system as the model for India's own quest for universal health coverage (UHC). I am reminded of this post which attempts to explains why we systematically gloss over state capacity weaknesses when suggesting solutions to public policy failures. 

The authors outline all the ingredients of Thailand's success - purchaser-provider spilt, shift away from line-items based to outcomes based budgeting, strategic purchasing, regulation of standards and accreditation, and a robust information technology (IT) system that facilitates the development of electronic medical records. The presumption is that if these ingredients are super-imposed on the Indian health care system, then it would be possible to have a more efficient UHC system. 

While all these are necessary and should be gradually introduced, I am not sure whether they would help usher in meaningful universal health coverage, without more important complementary investments. While all these clear and distinct components of Thailand's path towards UHC are easily described, they were built on a painstakingly built up legacy of capacity building among public institutions. In fact, Thailand's journey did not start with the reforms at the turn of the century but nearly five decades earlier, with a massive campaign to build the capacity of its public health care facilities starting in early seventies. So much so that, by the late nineties Thailand could boast of an enviable network of publicly owned primary, secondary, and tertiary facilities, far superior to even the best facilities in India today. It was therefore easy to build these distinct reform blocks on this platform and embrace a capitation based model of UHC. 

In contrast, in India, we have a badly broken public health system in most states and an unregulated and informal private market. It is a stretch to imagine that such institutional atrophy can be rectified merely with the reforms suggested. In fact, the danger is that in the absence of deep-rooted refers, such measures can lead us to a worse equilibrium. Markets, especially on something like healthcare, do not just develop merely in response to incentive compatible regulations and nice IT systems. Nor does such measures alleviate deep institutional maladies. And we have not even talked about the political economy surrounding the introduction of reforms like those in budgeting. 

So what is the way forward in the UHC quest? We have outlined some of them in a just released co-authored report. We recommend a series of reforms, starting with strengthening of public institutions,  and a process of adoption that focuses on experimentation like the adoption of capitation model in a few districts, learning from it, and then gradually scale up. In the absence of such comprehensive and fundamental reforms, logically neat and distinct reforms may be just band-aid on gangrene. 

The limits to India's growth?

I have a report (pdf here) with V Ananthanageswaran that explores the constraints that face India's economic growth and suggests a set of policy prescriptions and process principles going forward. 

The short story is that India faces acute capital deficiencies on multiple fronts as well as much under-appreciated adverse global structural headwinds which pose serious constraints to the achievement of sustainable high growth rates. High growth can be achieved only as episodes of over-heating followed by years of pain and lower growth from cleaning up the excesses. In the circumstances, the most prudent strategy may be to target a long period of moderate growth by focusing on steady economy-wide physical, human, and institutional capital accumulation and opportunistically riding on emergent global tailwinds.

Please read the whole report. Comments would be much appreciated. 

Demonetisation and informality

I have an oped in Mint today with V Ananthanageswaran on the demonetisation and how it could be a good point to mobilise a campaign to shrink the informal economy. 

The demonetisation and central bank balance sheet

The debate surrounding the consequences of demonetisation in India, especially on the claims that it would lower RBI's liabilities or shrink its assets, create windfall profits for the RBI, cut fiscal deficit, reduce the base money, make the central swap money and non-monetary liabilities (commercial bank reserves, general reserves and capital) etc, are completely off kilter. It reflects a very basic ignorance of the central bank balance sheet, especially about how money is created and how it reflects on the central bank's liabilities side. 

This from the BoE primer about the central bank balance sheet nails it,

In most economies bank notes enter circulation through commercial banks. The process involves commercial banks drawing down banknotes in exchange for reserve balances held at the central bank. The wider population then obtains banknotes either through direct withdrawals from commercial banks or from other agents. Most central banks targeting price targets will supply banknotes on demand to commercial banks... While it is true that an individual commercial bank is free to choose between reserves and other assets, at the system-wide level the quantity of reserves is determined by accounting identities on the central bank’s balance sheet. 

In other words, once the money enters the market, it reflects on the individual balance sheet of commercial bank drawing it (and creating the proportionate reserves with the central bank, either from its own excess/free reserves or borrowing another's reserves). This claim can never be extinguished unless the underlying economic activity (or that part of the nominal GDP) is itself extinguished, and here too the process will be circuitous and play itself out through multiplier effects.

While as a step to address the challenge of black money, demonetisation is laudable and justified, these "killing 3-4 bids with one stone" arguments are just plain plain wrong. Market expectations are being formed on no foundations. 

Weekend reading links

1. From among the reams of coverage on Donald Trump's victory, this WSJ video story draws attention to the breakup of the two largest categories of the electorate.

And among each of these categories, those without college degrees, regular church goers, living in small towns and rural areas etc, may have swung the vote for Trump. It is unsurprising that these voters are among the worst affected by the consequences of the elite hegemony. 

2. Bibek Debroy has a very good article on the problems faced by the Indian judiciary. He zeroes in on the massive 33 million (March 2016) case backlog as the central challenge. Of the three dimensions of challenges - supply-side (more courts/judges); productivity (better procedures, work norms, shift systems); and demand-side (alternative dispute resolution, curb on government litigation) - he advocates focussing on the last. He digs up some very interesting statistics about the Indian Supreme Court's demand management, 

On appeals, the US Supreme Court receives 7,000 to 8,000 petitions a year and hears (for oral evidence) 80. This is around one per cent. There are serious data issues. However, a comprehensive paper by Nick Robinson found the Indian Supreme Court accepts between 15 per cent and 26 per cent of petitions(the exact figure depends on the year, let’s say an average of 20 per cent). This is too high and represents a hollowing out of the lower judiciary.

Well said!

3. The just concluded Single's Day sales in China, considered to the largest online shopping day in the world, has amassed $18 bn in sales for Alibaba, 32% higher than last year's $14.3 bn. As a perspective, the last year's sale itself was more than double the combined sales clocked in the US during the Black Friday and Cyber Monday combined. 

Supporting these sales is the logistics management of delivering those orders, which numbered a staggering 540 million over the 24 hours last year. Accordingly, the country's express delivery, or courier, services market has been booming. Here too, like with everything else China, the numbers are staggering,

The average freight rate for two-day ground delivery between distant cities in America is roughly $15 per kg, whereas in China it is a measly 60 cents, according to research by Peter Fuhrman of China First Capital, an advisory firm.

4. How much impact will the demonetisation have on the fight against black money and corruption? Not much if this graphic is correct - cash is the least preferred source of storing unaccounted for money. 

The meaning of the Trump Triumph

So Donald Trump has become the President of the United States, plunging the US and the rest of the world into deep uncertainty. While his proposals to return the $2.5 trillion corporate reserves held abroad, invest in improving physical infrastructure etc are very progressive, those on trade tariffs and taxation are likely to cause irreparable long-term damage. His acceptance speech was surprisingly graceful, very "un-Trump", and bodes hope. One can only pray that power will chasten the bigot and will prove us wrong.

Much has been written about the surprise element in the outcomes, as has been about Brexit. The predominant explanation of the result has revolved around the disconnect between the elites, the upper middle-class, highly educated, and the intelligentsia and opinion makers on the one side and those belonging to the lower middle class and below on the other side. This divergence has been amplified and made to appear more egregiously unfair given the great convergence between the right and the left on many of the most important social and economic issues of our times.

I can think of a few areas where the divisions have been wide. For many years now, free-trade has reined unquestioned and any effort to question it would have invited sharp condemnation. Its undoubted adverse distributional effects, which inflicted considerable pain and suffering among very concentrated communities, were largely glossed over on ideological grounds. Now, over the past three or four years, the tide has turned and the same distributional consequences, which were always evident to any objective observer, have assumed significance with some vengeance. Much the same sentiments have dictated views on globalisation. 

A similar consensus of opinion currently rules on the debate surrounding automation. Automation is rightly seen as a sign of our progress as a modern society. But, in the mainstream debates, leave aside the rarefied scholarly ones, by corollary, any criticism of or scepticism about that is equivalent to a neo-Luddite response. For people who are the victims of automation and perceptive observers of the unfolding story, the damaging effects of automation are just so obvious. Even its aggregate impact is not as unambiguously positive as being made out. There is nothing different here from the conventional wisdom on free trade which travelled along similar lines to reach the present state of flux and consternation.

The same applies to the reluctance among mainstream opinion makers and intelligentsia to even restrain, leave aside oppose, the ongoing ultra-low monetary policy regime and call the continually inflating bond market bubble, both of which arguably benefit those at the highest end of the income ladder and work to the detriment of those at the lower-half of the ladder. Its consequences in terms of penalising savers, ravaging pensioners and their funds, and widening inequality cannot be overstated.

As to widening inequality, arguably the biggest socio-economic and political challenge of our times, its most disturbing consequence is not so much morality and ethics, important as they are, but its impact on the social and political bargaining. At such extremes of inequality, all the institutional checks and balances, howsoever strong, lose their sting and the political balance of power swings decisively towards those who pay the piper. The rules of the game get written to suit their interests, very often to the detriment of those less fortunate. This is reflected in the tax policies, public investment and expenditure decisions, changes to market regulation and property rights, and trade and external market related policies.

As all these examples illustrate, nowhere has the divergence been more stark than in economics. The lack of mainstream indignation (apart from those at the margins, and among populists) at the huge executive pay differentials, financial market excesses and the unbridled influence of that sector, the grossly unfair system of taxation where capital gains is taxed at less than half of what the middle-class earns and egregious tax evasion gets dignified as "tax avoidance", the on-your-face manifestations of widening inequality on every aspect of social life, and so on.

Similar elite consensus rules on areas like the demand for harmonisation of policies on labor, environment, cross-border financial flows, intellectual property, multinational investments, and so on. While these may not immediately and directly affect the developed countries and are more relevant to the residents of developing countries, its impact on the former, especially those less well-off in these countries, cannot be glossed over for too long. After all the troubling questions about the distributional consequences of free trade was for long considered "their" challenge and not "ours".

On cultural and social values, the genuine demand for individual liberty and empowerment has slowly slipped down the slope to take the shape of an entitlement, even license, to do anything. We forget Mill's caution that "my right to swing arms in any direction ends where your nose begins". At a very fundamental level, this has also had the effect of swinging the balance between individual rights and social responsibilities decisively towards the former. 

Social values have become entrenched around certain narrow conceptions of things like meritocracy and just desserts. This is manifested in our failure to acknowledge the numerous social and economic factors, apart from the sheer good luck of ovarian and other lotteries as well as happenstance events, that contribute to our successes. This narrow-minded conception of meritocracy makes us rationalise the unacceptable level of inequality across different aspects of our lives, even within those in the upper percentiles of the social and income ladders.

The lack of any strong countervailing movement, leave aside popular indignation, among those who hold the economic, social, and political balance of power at these very disturbing trends, despite their obvious adverse effects on those less fortunate, has been self-defeating. Trends like widening inequality and the untrammelled influence and power of the financial sector have reached alarming  enough proportions to demand at least some form of collective introspection and self-correction. In fact, it should have, by now, triggered a movement from among those holding the balance of power, similar to the anti-war movement of late-sixties. In its absence, it is only to be expected that the discontent simmers over and upends the economic and political order, most often with a lot of pain and suffering. That seems to have started and this may only be the beginning. 

India's "breakout-of-risk-aversion" moment

The decision by the Government of India to withdraw all currency notes with higher denominations from circulation with immediate effect has to be a landmark public policy decision. 

I can see two substantive dimensions to this - curtailing the circulation of black money and shrinking the informal economy. The former may be a subset of the latter. While this is an overwhelming positive on the former, there are several uncertainties on the latter. If this can significantly scale down the stock of black money, and with the measures that have been initiated to address the flow of black money (limiting cash transactions, mandatory PAN card requirements for certain purchases, more vigorous detection and enforcement etc), this move can be a masterstroke in addressing the black money problem. Importantly, more vigorous detection and enforcement will have to be put in place to detect and capture the black money stock that is currently locked up in real estate and gold and which are likely to return once these get unlocked after the new set of higher denomination currency is released. Also necessary would be more vigorous oversight on transactions in occupations like doctors and lawyers, especially at their higher end, where black money is today ubiquitous. 

At the least, with the stock diminished considerably and its future accumulation far attenuated, this is more than could have been possible with any other measure in addressing the limited issue of curtailing black money circulation. 

Maybe, follow-up with an immediate Voluntary Disclosure Scheme (VDS) over the next three weeks? One would think that, at least for a significant proportion, the benefits from such disclosures now far out-weigh the costs (losing a large share of their stock). 

On the challenge of shrinking the informal economy, the judgement may be more nuanced. And I'll address that in another post soon. All the talk about this being a move towards a cashless economy is just baloney, idle and lazy speculation that just sounds hifalutin and sexy to write about. 

Four other observations.

1. The surprise element to this has been stunning. It is a truly impressive achievement to have maintained the level of secrecy before striking. This is a genuine state capacity achievement which not too many countries, even mature democracies, could have pulled off. Teachable moment on one dimension of state capacity.

2. This would count as a true breakout-of-risk-aversion moment for the Prime Minister himself. I cannot remember anything else comparable for this government. Given the numerous uncertainties associated, and there are several of very great significance and be certain would have been repeatedly harped on by the bureaucracy, it was an amazingly bold decision. Very very rare in Indian or democratic politics anywhere in the world in recent years. 

3. Politically very astute move in re-capturing the anti-corruption agenda, whose sheen was fading and which was also moving back from the limelight. This, unlike the VDS and repatriating black money, will be perceived by most Indians, even those in rural areas. Ironically, this may precisely have been the risk mitigation source! The result could be a few electoral gains and the political space for more reforms.

4. Finally, isn't it surprising that we have had two landmark events (admittedly, in different scales) in India and US on the same day. But roles reversed, from the general trend, in terms of aspirational value. So compliments well worth it!

China fact of the day

WSJ points to the trend of decreasing Chinese reliance on imported components for their exports, especially for high-end products,

Exports to China, which had risen nearly every year since 1990, fell 14% last year, the largest annual drop since the 1960s. They are down another 8.2% this year, through September. The decline helped shave 0.3 percentage point off world trade growth last year, and is a big reason that growth is expected to slow to 1.7% this year from the 5% a year it has averaged over the last two decades... The value of components and materials imported by China for use in other products fell 15% last year from the prior year, the largest annual decline since the global financial crisis, and it dropped another 14% in the first nine months of this year... Part of that decline is because Chinese exporters have been using less of those imports in their goods... The proportion of foreign-made inputs in Chinese exports has been shrinking by an average 1.6 percentage points a year over the past decade, and last year fell to 19.6%, from more than 40% in the mid-1990s...

Rising business concentration and labor market failures

I have blogged earlier about the trend of decreasing returns to labor. To the growing list of possible contributors - globalisation, skill-biased technologies, automation, stagnant minimum wages, reduced power of unions etc - comes the latest, reduction in competition among firms. 

There is a growing body of evidence, especially from the US about the increased concentration of market power - loan market share of top ten banks rose from 30% to 50% in 1980-2010 period; share of revenues held by top four firms increased in 1972-2002 in eight of nine agricultural industries; hospital market concentration increased by about 50% since early 1990s to 2006 etc. 

In particular, a briefing paper by the US White House economists points to the disturbing trend of labor market monopsony arising from decreased competition across industries. It shifts the bargaining power towards employers, leaving employees as effectively price takers in the labor market. It points to certain trends that highlights rising employer discretion over wages - rising market concentration accompanied by declining "business dynamism" (or entry of new firms); declining "labor market dynamism" (or frequency of job changes by employees) due to rising regulatory barriers and lower geographic mobility; and decline in union membership; and decreasing real federal minimum wage. 

Its suggestions go far beyond antri-tust enforcement and are reminiscent of a clearly centre-left agenda,

Additional important policies include those that facilitate job search, increase worker options, and directly counter the wage-setting power of employers... Promote Equal Pay... Policies that support minimum benefits are therefore an important complement to minimum wage and overtime laws to counter the market power of employers... Reform Unnecessary Occupational Licensing Requirements and Increase Portability across States... reform land use regulations to make housing affordable... Support Workers’ Right to Collective Bargaining and Concerted Activity... modernise overtime regulations to protect workers who are not eligible for overtime but who have relatively low salaries... raise the minimum wage.

In a recent speech, Jason Furman the Chairman of Council of Economic Advisors, pointed to seven macroeconomic trends, largely similar to those outlined above, related to this environment of decreased competition. He suggests four policy areas for addressing this - patent and intellectual property rights reforms that strike a balance between the need to promote innovation and the dangers of granting excessive monopoly rights; policies that increase the bargaining power of workers; reforms to occupational licensing which has grown from covering under 5% of US workers in 1950s to over 25% in 2008; and reforms to land-use regulations to increase housing supply.