The missing supply side problem in development

The Business Standard reports about the problem of supply-side in national highways contracting in India,

As the Union government sets out to fix targets for the highways sector, there are few large players that can deliver as required... An official in the know said: “There are few players that can undertake build-operate-transfer (BOT) projects and 25-28 mid-sized firms to build hybrid-annuity projects. Together they may not able to achieve the targets set by the Central government. Therefore, we need global players for not just operation and maintenance but also execution.” The industry says maintaining a steady cash flow to do the job is tough... Over the past three years, 70 contractors and developers have bagged projects from the National Highways Authority of India and the Ministry of Road Transport and Highways, which includes all sizes of contractors. The sector, however, has been falling short of achieving the daily road construction target for the past few years, which may be attributed to unrealistic targets.

It's more than the working capital flows. Even execution will run into problems if expansion is very fast. There are hard limits to how quickly the supply side of BT paver machines, ready mix concrete, or skilled manpower can be mobilised. This example has resonance across other sectors. 

Development is about the combined action of state and markets. 

The former involves state capacity to design appropriate policies and implement them effectively. It is about making political choices regarding policies, but reasonable autonomy and capacity in ensuring their effective design and implementation. 

The latter involves three requirements - availability of market enabling regulations, and the emergence of demand and supply sides. 

There is copious literature on all these, except the last one, the availability of supply-side. I have blogged extensively on India's weak state capacity, deficient demand, and problems with carrying out business activities. 

However, the point about supply-side is often taken for granted. Even those who acknowledge the need for active policies to create demand (say, strategic purchasing by the government) and enabling requirements (say, ease of doing business reforms), stop short of overlook supply-side issues. There is a "build it and they'll come" assumption about the supply side. The strongly held beliefs about India's massive latent entrepreneurial talents and the vast globalised nature of markets reinforce this conviction.

For sure, supply-side will finally arrive. But there are two problems. One, the time taken may be inordinately long, often decades. Two, the system may have to go through multiple wasteful equilibriums before an adequate enough supply side emerges. 

Take a few examples. Private provisioning of water and sewerage or solid waste management or mass transit, or privatised electricity distribution, or public housing projects on PPP, or affordable private schools and hospitals, or various kinds of services ranging from cleaning to managing IT systems. 

As private participation in public services has deepened, an influential line of thinking has sought to shift the debate away from public production and provisioning of services toward private production and public provisioning of services, even private production and provisioning and public payment. Accordingly opinion makers and consultants have advocated that governments buy services instead of owning assets. 

So, for example, why own school or hospital buildings, or sewerage and water treatment facilities, or faecal sludge collection and treatment facilities, but buy the respective services through long-term concessions. 

There is no doubt that these are all thoughts in the right direction. So, for example, it has now become common for governments to outsource cleanliness of its facilities to sanitation contractors or hire vehicles instead of recruiting sweepers and drivers (and own vehicles) as full-time employees. Similarly, many facilities construction contracts are most often bundled with maintenance. These have all been undoubtedly beneficial fiscally and also improve service quality. But they have taken decades of experimentation and iteration to get de-risked and emerge as mature markets with deep enough supply-side. 

The same logic is now being applied to the newly emerging area of software as a service (SaaS) is attracting a lot of interest. So why not ask service providers to provide attendance monitoring as a service (and avoid owning biometric devices), location tracking on public vehicles as a service (and avoid owning GPS devices), or meter reading as a service (and avoid having to own household meters and their billing), or SCADA as a service (and avoid having to own the infrastructure). 

These too will emerge in due course. But now if you call a tender for any of these even in small volumes, you will be lucky to get competitive bids and luckier still to get service anywhere near the expected levels. And higher the volumes of supply solicited, greater the certainty of disappointment.  

There are multiple reasons for the slow pace of emergence of these markets. 

1. These innovations are less about technology and more about implementation. And there are several constraints to implementation - establishing field presence require hiring skilled personnel at affordable prices, being able to overcome entrenched vested interests. This requires getting execution right, a not so easy challenge given its environment. For example, a biometric or GPS implementation can be gamed or go wrong in so many different ways that it requires very tight and high intensity monitoring, for a long enough time for implementation to stabilise. 

As I have blogged here, this requires hunkered down execution by entrepreneurs, something not made easy by the prevailing incentive structures. 

2. Delivering these services at the required service levels often demand a much higher price than what the government offers. These services are often new or being done internally at far lower cost. For example, it would cost more to outsource maintenance of a water or sewerage treatment facility than to maintain them internally since the service level expectations with the former are much higher, which in turn demands higher costs.  

3. Unlike products, these services are generally delivered locally. Even SaaS requires local support teams. Building up such local teams and that too quickly and at reasonable scale is not easy. Managing these local  teams is a non-trivial management challenge. 

In fact, greater the degree of human engagement involved (and therefore quality consideration), the more difficult is it for private providers to deliver such service at scale. It's for this reason that third party quality audits for engineering works (outside the large projects) remains a very fragmented and localised market in India despite being in place for over two decades. 

4. Despite their logical appeal, some of these services are best done internally, at least until the country reaches a certain stage of economic progress and human development. Some, for their inherent nature, may never be done well by private providers or require much higher cost for private delivery.

5. Finally, human imagination and ideation runs far faster than reality can support. There is no cost to ideation and talk is cheap. Execution is costly.   

I have not dwelt on the bigger challenge of regulating these providers once markets mature. This, as developed countries are finding out today is leading to reversion to public production and provisioning in many areas.

So what can governments do to expedite supply side? Two, in particular, come to mind. 

In this context, industrial policy on development issues can be helpful in catalysing the supply side. The central and state governments could signal their policy intent so as to shape market expectations and investment. Announcement of long-term plans and adherence to them would be the best market signal. Even advisories encouraging specific trends, as far as possible, but without any mandatory requirements can be non-distortionary. 

We all know the impact of government purchases of smart meters and LED lights have had on the respective markets. But these are products. We need similar intent and action on the services side. 

Another area is for public policy is to standardise procurement processes and documents and disseminate them for use by interested officials at different levels of government across the country. And actively encourage these officials to apply them.