Monday, December 2, 2019

An slowdown caused by economic orthodoxy?

This is in continuation to earlier posts here, here, here, and here.

Harish Damodaran characterises the ongoing economic slowdown in India as a western style demand-side slowdown and blames it on commissions and omissions of policy. 

While we all agree that this is a demand-side slowdown, I think that is only a part of the picture. We may be missing the big picture necessary to address the underlying nature of the economic trends. Ashoka Mody got part of the remaining elements right, but not fully.

Here is my hypothesis. While we have an economic slow-down, from 8% to 4.5%, I feel that the 8-9% growth in the first place was itself built on shaky foundations. We therefore have a demand slow-down which has come on top of unsustainable booms. This makes the slow-down appear even more steep.

The capital foundations (human resource, physical infrastructure, financial capital, institutional strength, and market demand) required to sustain the high growth rates were never in place. This was outlined in Can India Grow. In the circumstances, the two spurts of growth – 2003-04 to 2007-08, and 2009-10 to 2010-11 – were built on two bubbles. The former was the capex and construction boom, especially driven by infrastructure companies, and the latter by the lagged effects of the transfers boom, especially driven by rises in MSP and NREGS spending and monetary accommodation. The former spawned a financial cycle, whose ruinous effects are seen in the banking and non-banking sector crises. The financial cycle was also associated with massive resource misallocation towards real-estate and construction (property prices went over the roof, and the pile up of massive real estate inventory has its origins in that cycle).

I am inclined to believe that in the absence of these two bubbles (excessive capex and construction investments, and excessive transfers), the economic growth would perhaps have been, in the range of 5-7%. 

While the signatures of decline in high-frequency indicators can be traced back to September-October 2018, it can be argued that the underlying drivers of growth had run out of steam much earlier. The euphoria surrounding the new government in 2014-15 provided tailwinds to sustain growth despite all the credit market and corporate balance sheet problems. This momentum was perhaps completely snuffed out by the triple shocks – demonetisation, GST, and regulatory over-kill and tight money policy by RBI – and the decline had started by early 2017. In other words, the triple-shocks were merely expediting and exposing the shaky foundations. 

Despite this ongoing economic weakness, the financial cycle appears to have remained buoyant and may be ebbing only now. This is borne out by the high FDI inflows, the vast majority of which went into finance, real-estate, renewables, and consumer technology services sectors. Less than 5% of FDI went into manufacturing. The solar investment bubble, where the chickens are now coming home to roost, was significantly inflated by private equity. Same with commercial real estate. In fact, PE has been consistently 40-60% of the total FDI, largely in the form of buyouts. QE and the global search for yields too were tailwinds sustaining this financial cycle, amidst the continuously weakening economy.

R Nagaraj has pointed to a financialisation dimension of FDI flows, highlighting the close correlation between inward and outward flows, and the possibility of tax arbitraging and treaty shopping. The IMF's latest Fiscal Monitor identifies almost 40% of global FDI as "phantom FDI" driven by tax avoidance.

The misleading economic data till recently gave the false impression to the government that everything was alright. It created a sense of complacency and came in the way of recognising the problems early on and taking measures to address them head-on. It also led to the Inflation Targeting regime and fiscal conservatism being pursued well beyond their limits.

Economists scorn at demonetisation. But ironically the remaining contributors to the mess were straight out of the orthodoxy - Inflation Targeting, Basel III adherence, fiscal conservatism, GST, RBI's slew of regulatory actions, IBC etc. For an economy struggling with the twin-balance sheet problem (corporates and banks), the combined squeeze due to all these, coming at more or less the same time, was understandably back-breaking. Complementing these was the enthusiastic embrace of cross-border capital flows and the crack-down on black money and shell companies. All these were best-in-class policies implemented at the behest of  technocrats with limited skin in the game. Why is no one discussing these? Where are the economists queuing up to study the effects of the sledgehammer shock from RBI?

Realising this structural dimension is important now as we pursue measures to revive the economy. The QE was pursued far beyond its relevance on the false assumption that economic growth (in the US etc) could be restored back to that of the Great Moderation era. Policy makers in the US were unwilling to accept the more realistic 2-3% growth rates. India’s policy makers too need to acknowledge the reality that a return to sustainable 8% growth rates is not possible without addressing fundamental capital accumulation deficiencies.

Demand-side measures are urgently required to ensure that the economy does not get entrapped in a vicious downward spiral and ends-up like the Latin American economies and gripped by the problems of the middle-income trap. But it will have to be accompanied by deep structural reforms on all the four fronts of capital accumulation – human (fixing education), physical (infrastructure investments), financial (intermediation, savings), and institutional (state capacity, management of cities). This will have to be accompanied by policies that address problems in agriculture and manufacturing.

We cannot afford a sequential path, get immediate demand-side measures and then tackle the other structural issues. In fact, all these should have been solved yesterday!


KP said...

Can't agree more. We have been running a "sleazy" economy - and a large part of the inflated money bubble has only served to fatten the bureaucratic-political-nexus, a network of extractive agents, lacking both integrity and innovative capacity - but was / is being a black hole that sucked any fiscal or monetary intervention into private pockets at both levels - the upper echelons and the retail rent-seeking levels of government.

Somebody (can't recall) had characterized the attempts at reining in the institutional comedy that constitutes our banking / financial sector as a whack-a-mole problem - it surely is.

Take ILFS, it is paradigmatic of the bureaucratic farce that our Institutional arrangements represent – a closed group of rent manipulating agents who structured an organization to formalize rent extraction under the cover of a quasi-private sector fig-leaf. An organization mimicking a private sector firm, using state funds, off-loading contracts under “favourable” condition to a network of contractors – it is hard to believe that massive kickbacks were not built-in into the engagement, designed to be below the radar.

We have so entrenched the privileges of a few, that we have made it difficult to correct deep problems of integrity and competence - it possibly takes about 20 years to sack a chap who does'nt even appear at work or to sentence people who looted us wholesale.

We need to have bankers and bureaucrats sent to jail for creating and running the farce that our financial system was - and ensuring that we have a system that ensures that money (potential) spent into the economy delivers what it is supposed to. Not siphoned off into a politician or bureaucrat's private account, without doing anything for the economy.

We need transparency in infrastructure projects not as a response to some RTI query - but with public dashboards that identify who gets the contract and publicly account daily for the work done/money spent - OR fix responsibility when we pay top dollar/rupee to get trash as output. Otherwise we will continue to clean "bellandur lakes" forever and or white top roads at exaggerated cost or substandard quality that keeps on feeding the contractor- bureaucrat-state mafia that our politics and institutional arrangements have devolved to.

We need to stop treating education as a money spinner and a business that keeps giving to political families. Considering that all our netas and sundry middle-men are into education, we should believe that our politicians are all top of the line researchers / educators!!! These largely middling manipulators have cornered education licenses and run our mediocre teaching shops. About rural education – nothing to write – there is not even the pretence anymore – just a graveyard that pays a salary for life to “education bureaucrats” – analogous to our “agricultural bureaucracy” !!!

The private education system is largely a money-making tuition shop and government sector education is just a gaping black hole - a large cash for jobs scam, like many other government recruitment initiatives. Simply rambling about IIT's and IIM's or CBSE schools in cities (or its innovativeness?) ad nauseam only serves to reiterate the overall mediocrity of the ecosystem that make these appear to be shining examples of success.

We need to back talent to both create /own / run institutions, not cunning politicians who see a large almost-annuity business for the humbug that is dished out - be it schools / colleges or higher degrees.

Make grants and provide free infrastructure to teams of researchers and educators to run institutions in their area of expertise, not to another intellectual dullard or political clown using his/her clout to play a real estate game - cheap land / ostensible public purpose/ and running a money extracting farce in the name of education.

( on to 2)

regards, KP

KP said...

(contd from prev post 2)

We are a country where a million bureaucrats hold a billion to ransom - I have always maintained that our proximate institutional mechanisms are corrupt / hollow / compromised / slothful - and don't work. Added to that, incompetence is not even punished and wilful incompetence for a price is a way of life.

The fundamental need is to make our institutional frame more competent and transparent. Nothing can change as long as our legal / bureaucratic systems thrive and cash out on being dysfunctional, woefully out of date, incompetent and comatose.

We need to have better discussions - the kind your blog encourages - even if I am not entirely in agreement, many a time. The public discourse on policy always confuses the contingent with the institutional - effectively derailing any corrective for both.

We deflect from addressing even contingent concerns with intellectual puffery that expects institutional correctives - take the repeated instances of rape and murder - why are the police repeatedly allowed to get away with slothful responses. No speedy response from proximate mechanisms??? Why is the legal system so sluggish ??? Everything cannot be explained by having to reform an entire police force or judicial system before we get results ????

Lastly, we are a country that is easily deflected and consumed by an exaggerated reverence for our political icons and bureaucratic blowhards – but even better, nothing like coasting along in some department that is hardly visible – a lifetime of living on the tax-payers teats if you are a sluggish incompetent bureaucrat – not even the pinprick of having to respond blandly to queries.

There is no asking hard questions - everything seems to rest on the symbolism of some haloed political figure from the near or distant past, mostly peripheral to current day concerns.

Take a recent example, the management of the economy in the recent past - after a massive drain of money from the economy, we should have been asking hard questions about the competence of those giving us homilies on dosa economics or deflecting the problem away from the political dispensation that will bring into question the competence and integrity of those who had hollowed out an economy - that was already in a precarious state - dealing with legacy issues of Growth (or the lack of it in even basic HDI parameters of education/sanitation and health - toilets!, it can't get worse).

Government spending is about creating two distinct outputs - analogous to energy - Potential - long term - investment (education/ health/ sanitation/ infrastructure) and Kinetic - the producing economy - immediate (Goods and services).

Having run a bubble economy that thrived on skimming out money by asset inflation (fuelled by illegal asset acquisition where the source of money was never investigated) or capture of asset creation areas like education and infrastructure and depleting them of any quality - our large spends have only created political-contractor mafias /families ably assisted by compromised institutions.

The macroeconomic multiplier did not correspond to the reality (real asset creation) in the economy and credit offtake was largely fictitious and consumption led, with very little quality in capital formation. The problem is not about a macroeconomic tilt towards supply-side or demand-side policies - but something even more fundamental, that was exhibited by our pull-out from RCEP.

(onto part 3)

regards, KP.

KP said...

contd 3

We are precariously poised - forget about China and its manufacturing machine, we cannot even take on Vietnam and its agricultural prowess.

The inability to provide the right kind of transition (social mobility through quality education) to our largely agricultural population through the 60-70-80's – that was lost to silly sloganeering - is coming back to haunt us. The Lewis model is history,( and its operation was predicated on education that allowed a rural transition to the urban economy) our integration into the globalized economy can only get deeper, and we need a rapid transition to a more enabling economy to allow animal spirits to create capacities that match our needs. That cannot happen if we allow as we did in the past - a money-siphoning framework to keep us in a bubble, using worn out political slogans that have little relevance to issues at hand!!!

Right now we have an economy on a low-level equilibrium - making food - delivering food – Instagram-ing / discussing food while watching movies ??? or a flipkart kind of extraction framework aided by technology. This, while a semi-comatose bureaucracy enjoys its smug state of state sponsored decay – hardly qualified or having an incentive to handle a crisis that hardly affects them.

While there is a merry-go-round of money in the middle-class economy, what is missing is large innovative capacities. Research into materials / technologies- manufacturing hubs - electronic hubs with Fabs / electronic design hubs / production facilities etc etc are almost non-existent ... biotech hubs ... 3d manufacturing ... name it and there will be a minister aided by bureaucrats willing to spin a real estate / STP story about tax concessions and subsidized land .... the story starts and ends there - lot of money changing hands with little to show - another real-estate game to the hilt!

We have an even greater danger at the doorstep - the intangible knowledge economy, is poised to deliver a terrible blow, that is going to rapidly enhance the divide between the middle class and the permanent welfare class that our perverse socialism created.

While we have made some gains in the past few years in correcting the institutional perversion that has afflicted our democracy, the attitude of low tolerance to corruption and expectation/demand for functional / regulatory competence from our bureaucracy is hardly entrenched – and our political landscape seems to have very little talent or capacity to take forward the tough choices of the past few years.

Hopefully(?) … magically ??? ( just like your wish on a yesterday basis ... some magical thinking )…. the recent gains will allow a new leadership to emerge, otherwise we sink back into spending that fattens the fat-cat establishment, that lives off the teats of the tax-payer or plain loot by government spending carried home in sacks. The middle class tax-payer in India works for the establishment, rather than the reverse.

How long will it take to whip the permanent frame into some semblance of purpose, tame the political skimmers and moderate the rapacious bureaucratic infrastructure that fuels them (and itself) for a price ???

regards, KP.

ST said...

While it is a good dose of intellectual (and real) engagement that every post of yours bring along, KP's comments hit harder! Perhaps KP is venting his heart out, clearing out pent up frustrations, and I enjoy reading them. But they also hold the potential to make one feel dejected about the country, the economy and life in India. I just hope that something is going well for us, somewhere, at least.