A fiscal compact for state governments in India

This post seeks to initiate a discussion for the formulation of a fiscal framework that could govern fiscal management by state governments in India. This would consist of a set of rules on fiscal rectitude and also outline a mechanism for its enforcement. 

The constitution of India defines India as a federal system. It has defined certain domains where the state and central governments respectively exercise sovereignty and certain others which are concurrently administered. The state governments are responsible for managing their respective finances.

The issue of fiscal prudence among governments has been a recurrent concern in public finance debates. There have been several efforts over the years to institutionalize the addressing of fiscal imbalances. The most important of which has been the Fiscal Responsibility and Budget Management (FRBM) Act 2003 which enshrined a fiscal deficit limit of 3% of economic output for both central and state governments. However, its performance has been mixed. 

The Covid 19 pandemic has had the effect of upending the fiscal balances of state and central governments. The fiscal consolidation requirement from the devastation caused by the once-in-a-century event presents an opportunity to examine the fiscal framework afresh and develop a compact that not only addresses fiscal stability but also the quality of expenditures. 

The compact should consist of budget balance rules, debt rules, expenditure rules, and revenue rules. The enforcement mechanism could range from softer approaches like moral suasion and market restraints to hard approaches like legislative constraints. But it's important that the hard approaches emerge through a consultative process and consensus, on the lines that marked the landmark Goods and Services Tax. 

What has been the global experience with fiscal rules? What parameters should be included in the fiscal compact? How might this compact be operationalized? 

There are several examples of fiscal rules that are followed by national economies. The focus here is on fiscal rules that govern sub-national governments. In this context, in terms of the nature of their operationalisation, there are two broad types of fiscal rules – top-down and bottom-up approaches. These fiscal rules have generally focused on the flow and stock of debts, as captured by the budget deficit and the public debt. 

A good example of a top-down fiscal compact is that enshrined in the European Union’s Stability and Growth Pact 1997 and Treaty on Stability, Coordination and Governance 2012. Broadly, this fiscal compact has the following Rules:

a. The fiscal deficit is to not exceed 3% of GDP.

b. The government debt to GDP ratio is benchmarked to be less than 60%.

c. A pathway for rapid convergence to a balanced budget with a structural deficit of 0.5-1% of GSP, an automatic correction mechanism, and a mechanism for enforcement

In fact, the EU Fiscal Compact has been encoded into the respective national laws, including provision for fines in case of deviations from its Rules. And adherence to the fiscal rules is a condition for accessing any assistance under the European Stability Mechanism (ESM).

The Switzerland cantons and US states are other commonly cited examples of federal and sub-federal fiscal rules, which however follow the bottom-up approach. In the US, the federal government exercises limited control over the fiscal policies of state governments. Most states have budgetary constraints, or ‘golden rules’ written into their constitutions prohibiting the government from running their budget at a deficit. Interestingly, in the US, the constraints in the state constitutions were not necessitated by any federal law but emerged from their independent realisation of having to ensure access to the financial markets. 

This also has a historical basis. Since the mid-nineteenth century, the federal governments in the US have refused to bail out states facing financial collapse and have laid the responsibility of debt service fully on the defaulting states. This has “set an enduring precedent and created a strong incentive for each state to ensure sustainable budgetary policies”.

In other words, the fiscal compact in the US federal system emerged bottom-up. Currently, 35 US states have constitutional balanced budget requirements, and fourteen have statutory or de facto obligations to ensure a balanced budget. 

The contrasting approaches towards a fiscal compact adopted by the EU and US are instructive. A monetary and political union (the US) has preferred the bottom-up approach, whereas the nascent monetary union adopted the top-down approach. 

So what are the contours of a fiscal compact proposal for India?

As mentioned earlier, a good fiscal compact should seek to target both fiscal stability and the quality of expenditures. Given this, a possible set of parameters could be as follows:

1. Fiscal stability parameters

   • Structural deficit (or average fiscal deficit over 5 years) or fiscal deficit 

   • Primary balance (or revenue balance)

   • Public debt to GSDP ratio (including all off-balance sheet liabilities)

2. Quality of expenditure parameters

   • Revenue expenditure as a share of the state's own revenues

   • Salaries and pension expenses as a share of revenue expenditure

   • Pensions as a share of total HR expenditure

   • Capital expenditure as a share of total expenditure

These are purely illustrative and aimed at starting a debate. A guidance value in the form of a threshold or a band for each parameter could be defined that provides the benchmark for state governments to target. 

We can choose other parameters too. The individual parameters should be supplemented with an index (even if imperfect) that allows for comparison across governments.

How to operationalise this fiscal compact?

Given its sensitive nature, especially considering the current circumstances, state governments would be wary of any efforts by the centre to constrain their fiscal freedom. Any efforts would be seen as attempts to squeeze the state government finances and thereby constrain their fiscal autonomy. 

It’s therefore essential that any attempt in this direction be done with the greatest sensitivity, without giving the impression that it’s being enforced top-down. Instead, it should emerge through a process of opinion consolidation from public debates and extensive consultations and consensus building by the central government with the state governments. 

The Indian fiscal compact should combine features of the bottom-up US system and the top-down EU Stability and Growth Pact. Besides, it should combine both the soft and hard approaches, with the latter being gradually phased in. The process is important. 

Accordingly, instead of directly hard coding the parameters of the fiscal compact into legislation, we could start with something which serves as a guidance framework. The Economic Survey, for example, could surface this issue for debate (not in terms of naming and shaming states, but pointing to possible benchmarks for important relevant parameters). The Ministry of Finance and the RBI could publish working papers on a fiscal framework for the state and center. The NITI Aayog could bring together officials concerned from all states to prepare a fiscal compact through a consultative process. In fact, these are not mutually exclusive and could all be done simultaneously. 

This should be complemented with a simple data reporting and disclosure system aimed at ushering in greater transparency about the state government’s finances. The RBI, as G-Sec market regulator, could mandate both state and central governments to disclose certain information with defined periodicity. We could start with the CAG audited accounts that come with a two-year lag. 

While these parameters are already in the public domain in some form or other, there are at least three problems. One, they should be standardised. So for example, pensions and salaries reported by many states do not include the wages of contract and outsourcing employees. Or public debt excludes the off-balance sheet figures and guarantees are not captured. Two, the information is not consolidated in one place and presented in a manner that allows for easy comparison across states. Say, a Fiscal Monitor of public finance. While there are various reports that occasionally compile them, they are both one-off and suffer from the first problem. Three, and most importantly, there is no guidance standard to evaluate the performance on each of these parameters. What's a desirable benchmark for capital expenditures as a share of total expenditure?

If we are able to address these three problems and make this information available, it would expose state government’s finances to greater public and market scrutiny. There would be some form of pressure on lagging state governments to reform. Over time the bond markets would start to price state government bonds more accurately based on their risk profiles. It would help differentiate among state government bonds and reflect in their G-Sec spreads. These parameters should also reflect in the lending decisions of development finance institutions like PFC, REC, and HUDCO. 

The disclosure should also include the actual outcomes against the commitments made in the three-year Medium-Term Fiscal Policy Frameworks (MTF) presented in state and central government budgets. The MTF covers a set of fiscal parameters and informs the stakeholders about the balance between revenue receipts and expenditures and how capital receipts are being deployed. The track record of adherence to its MTF commitments is a good indicator of the commitment to fiscal stability and the general credibility of a government. 

Once stakeholder consultations have been initiated and some information disclosures started, the fiscal compact could be discussed in a forum like the Inter-State Council. The central government could consider convening a Council meeting exclusively to discuss this issue. A sub-committee of the ISC could be entrusted with the responsibility of examining the outputs from various consultations, discussing with experts, and coming up with a set of recommendations. A mutually accepted fiscal compact could be formulated based on these recommendations.

All the while, the central government should strive to build confidence about its intentions and foster consensus among states about the compact. This process could borrow from the consensus-building approach followed by the remarkably successful GST Act. 

In due course, the GoI could gently introduce these parameters as entry-level conditions to access assistance like the 50-year loan or additional borrowings (some of it is already being done). There are precedents in so far as the central government has for long mandated sector-specific reform conditionalities to access assistance under CSS programs in the urban, power, etc sectors. Besides the Finance Commission transfers too include such conditionalities. However, there are very few examples of overall macroeconomic management conditionalities being part of any central government support. 

Formulating and institutionalising a fiscal compact is a very important long-term requirement. No government, anywhere in the world, likes to place fetters on itself, especially on its expenditures. Accordingly, fiscal rules have generally targeted one or two headline fiscal parameters and have had mixed success in realisation of their desired objectives.

In the aftermath of the pandemic, we have an opportunity to formulate a fiscal compact for India that targets both the sustainability and the quality of fiscal spending by the state and central governments. However, given the federal nature of the Indian polity, it's important that this process involve consultations with the state governments and the compact should be seen as emerging directly from this process. The process is critical, and the central government should go the extra length to build consensus, even if some states don't reciprocate. 

It may also be useful to adopt a multi-track and phased approach that starts with extensive stakeholder consultations, information disclosures, and surveillance systems. Moral suasion and market dynamics should become the primary means to enforce accountability among states on the fiscal compact. It may be prudent to introduce mandatory requirements and legislative constraints only after consensus starts to emerge.

Weekend reading links

1. On the politics of congestion pricing,

The state of New Jersey has sued to suspend the rollout of the first congestion charge in the US, planned for cars driving through central Manhattan, saying that such a scheme would divert pollution to neighbouring areas and impose an unfair cost on commuters crossing the Hudson river. In a complaint filed in federal court on Friday, New Jersey accused government agencies of turning “a blind eye” to the environmental effects of the charge on the Garden State when agreeing to approve the scheme last month, and administrators in New York of failing to distribute the proceeds of such a scheme fairly across the broader metropolitan region. The intervention by New Jersey comes just hours after Britain’s Conservative party narrowly hung on to a seat previously held by Boris Johnson on the outskirts of London, in a victory widely attributed to anger at the expansion of the city’s Ultra Low Emission Zone...

Last month, the Federal Highway Administration approved the proposed scheme, which aims to generate $15bn in revenue for the MTA, New York’s perennially cash-strapped public transport body, by charging drivers to enter Manhattan below 60th Street. The precise charge has not been established but is reported to be as high as $23 a day for some drivers. New Jersey’s governor Phil Murphy has long condemned the scheme as unfair to the 400,000 residents of the state who commute to Manhattan daily, and vowed to explore all legal options to frustrate its implementation. His state has passed legislation that gives tax incentives to businesses in a retaliatory attempt to lure them away from New York. This year, New Jersey also rolled out billboard advertisements across New York, with slogans such as “Paying a congestion tax to sit in NYC traffic? Get outta here” — and a call for passers-by to consider relocating to New Jersey. “We can’t fix a broken MTA in New York City on the back of New Jersey commuters,” Murphy said this month. “It’s a huge tax on them, and frankly, it challenges our environment because of all the rerouting of traffic.”

2. Scott Galloway points to how government actions were central to the post-war economic growth. Not only did these actions quickly shift the economy away from war production (in 1945, 40% of GDP went to the war effort, compared to 3% today, and jobs had to be found for 10 million youth leaving military service). 

Underlying this prosperity was robust state support. The G.I. Bill funded college for 2 million soldiers and home loans and small business loans for hundreds of thousands more. Truman’s housing legislation expanded the government’s role in building homes and financing home ownership. Eisenhower launched a 40-year project to build a national highway system, at a cost of over $500 billion in today’s dollars. Income taxes were progressive — the top rate was 91% — and the wealth of the biggest earners was redistributed through social programs and investments in infrastructure, education, and science. The greatest innovation in the history of the West, the American middle class, was the product of intentional and sustained public investment. Our retreat from that vision has led to decades of prosperity, but little progress. We’ve slid into a cascading pattern of failure — to rear, educate, and employ young men. Returning to our tradition of investment could rebuild the engine of capitalism and reverse the slide in their fortunes.

3. Excellent NYT visualisation story on how private developers who got additional floor-space and other building concessions in return for developing and maintaining public spaces in their properties have reneged on their commitments. Building regulation violations are universal, only their nature varies across countries.  

The plaza at 325 Fifth Avenue is just one example of a privately owned public space, commonly known as a POPS, that has not been maintained according to the developer’s agreement with the city. These agreements allow developers to build larger towers and earn more revenue in exchange for providing public spaces. In December, the Department of Buildings completed its three-year inspection cycle and found that about one in five of the properties violated the terms of their agreements. The lack of compliance with the law has been a problem for years. The city’s inspectors have issued violations to half of the 392 buildings with such spaces since 2011, according to a Department of Buildings dataset. The standard penalty for a violation is $5,000, which is a fraction of the value of the bonus space developers receive from the agreements. For example, the owners of 325 Fifth Avenue have been assessed a total of $54,000 in penalties since 2015. By contrast, the bonus floor area that the developers gained could be worth approximately $80 million if used for residential space, based on 2022 sales prices provided by Jonathan J. Miller, a New York City real estate appraiser.

4. On labour rights suppression at Starbucks,

The hectic, high-risk pandemic shifts had racked up record profits for Starbucks, but left many of the baristas exhausted and embittered. Workers at one cafe after the next were voting to unionize — more than 330 of its thousands of locations so far. Their demands include better pay ($20 an hour minimum for baristas, with annual raises), fair and consistent scheduling and easier access to the benefits that Starbucks executives were always touting... a sobering picture of employee rights casually crushed and labor laws too weak to help. Starbucks continues to fight and appeal the many labor complaints pending against it and maintains that the company has done nothing wrong.

But these professions of innocence are countered by piles of testimony from workers and National Labor Relations Board findings suggesting that Starbucks has indeed illegally repressed employees’ rights. The company has so far racked up a staggering number of complaints from the agency. In 100 cases, many of which consolidate a number of incidents, regional N.L.R.B. offices have decided there is sufficient evidence to pursue litigation against Starbucks. That includes a nationwide complaint, consolidating 32 charges across 28 states, alleging that Starbucks failed or refused to bargain with union representatives from 163 cafes... as strikes and union drives erupt across the economy, the coffee workers’ struggle illuminates the stark and sometimes insurmountable challenges confronted by ordinary American workers who try to exercise their right to organize.

That Starbucks is carrying on this campaign in plain sight may be the most damning aspect: Union busting is illegal, but consequences are inconsequential. The Starbucks case demonstrates that a large corporation can effectively bust a union with time, by dithering over details and exhausting legal appeals. According to national labor laws, an employer “must bargain in good faith.” But that is a squishy and essentially unenforceable rule. Starbucks may yet succeed in smothering one of the most energized labor movements of our time... The company has been accused of deploying familiar anti-labor tactics, such as the shuttering of some union stronghold cafes... Union activists reported being spied upon, harassed or fired on flimsy pretexts, complaints that Starbucks disputes. But Starbucks has also done a lot of nothing — time-buying, morale-eroding, innocent-seeming nothing.

And this

Howard Schultz, a steely eyed, self-made former Starbucks chief executive, has told his story all over the country: the impoverished childhood in shoddy housing; the disabled and mistreated father; final vindication through the achievement of theAmerican dream, a phrase he likes to use. It’s a good story, and we bought it — we bought his coffee at a premium price, and we bought him, too. Hillary Clinton, by many accounts, planned to nominate Mr. Schultz for labor secretary if she’d won the presidential election in 2016. Mr. Schultz himself has toyed with the idea of running for president. Mr. Schultz frequently lectures people about having built a “different kind of company” that respects the rights of employees, whom he calls partners. An empty chair gapes at every board meeting in a symbolic nod to the partners, who may or may not feel gratified at being represented by a piece of furniture. 

When the recent wave of labor organizing first started to foment among Starbucks workers in Buffalo, Mr. Schultz was one of the corporate luminaries who jetted into town to discourage the union. It didn’t work, though — in 2021, a Buffalo Starbucks became the first company-owned cafe to unionize, and other stores quickly followed. Mr. Schultz greeted the union with an indignation that has yet to fade. He has flouted an N.L.R.B. order to apologize to his workers and to film and distribute a video explaining his employees’ rights.

This a teachable example about the problem with today's centre-left politics. A liberal newspaper like NYT highlights the cause of workers at Starbucks and liberal intellectuals and politicians passionately argue in favour of worker protections and rail against corporate high-handedness. Most of these liberals also wear their ideologies on their sleeves and embrace them in their personal lives (energy and water conservation, organic and local food, environmental protection etc).

The only problem is that this embrace is only when it's convenient. How many liberals are willing to boycott Starbucks and walk the talk on their pro-labour and pro-union professions? I would not be surprised if the article itself was written and edited while sipping Starbucks! But it's encouraging that the Times is exposing such practices among very high profile abusers. 

This hypocrisy is widespread. The liberals are deeply enmeshed with Big Tech and Wall Street firms whose activities engender some of the most damaging social problems and economic perversions. You can't be a honest protagonist against these problems (and the firms creating them) when you also benefit from the same companies. 

5. Simon Kuper asks whether we are at overtourism or peak tourism, given the sharp increase in tourist traffic, and points to governments now taking action to reverse tourism.

The official number of international tourist arrivals doubled from 1998 through 2019, to 2.4bn a year... In Barcelona, to cite an extreme case, the number of tourists staying in hotels jumped from 1.7mn in 1990 to 9.5mn in 2019 — a number that excludes the city’s Airbnbs, some of them entire buildings that have been removed from the local housing market and essentially offshored. Barcelona is one of several places that risk becoming a Venice: a former city that turned into a museum-cum-fun park. Venice now has around as many beds for visitors as for inhabitants: about 49,000 each. And the thinning ranks of residents tend to be older people who moved in decades ago when the city was still affordable. 

More ominously for cities, official tourist totals are probably understatements. In particular, they rarely capture visitors who stay with friends or family, or swap homes, or just drive in for the day and don’t stay overnight... A paper by Jacques Lévy of the École Polytechnique Fédérale de Lausanne and others, using phone data, finds a “big surprise”: on average, there were about 5mn customers of non-French phone operators in France in 2022-23, compared with just under 2mn foreign visitors measured by “official data”. In some neighbourhoods of Paris, the paper says, the number of foreign visitors per sq km exceeded 100,000. For comparison: Paris’s 20,000 inhabitants per sq km already make it Europe’s densest city. Here’s a painful paradox of urban tourism: the cities that attract most visitors are cramped, ancient places that lack space even for residents. You don’t get much tourism in the Houston exurbs.

6. Good FT long read on the challenge facing Leag, a coal mining and thermal power generation company headquartered at Cottbus in the Lusitz area of Eastern Germany and which is the second largest electricity producer behind RWE and employs 7000 workers in a town with a population of 100,000. With Germany mandating the closure of all coal-powered power plants to shut down by 2038, Leag is planning to shift away from coal and thermal power to solar and wind power generation.

The incremental capacity addition in Germany since the turn of the millennium has been completely renewables based. 

7. The Indian IT majors face a reckoning. Apart from the Y2K, they've failed to capitalise as would have been expected every opportunity that has come up in the last two decades - IoT, data analytics, cloud computing etc. Now the new big thing AI beckons. And the underlying trends don't look good this time too.  

8. Ishan Bakshi has some interesting statistics that point to relatively large high income pockets in India,

India’s per capita income is just under Rs 2 lakh or around $2,400. But this statistic conceals more than it illuminates. Delhi’s per capita income, for instance, is estimated at Rs 4.4 lakh ($5,475), Gautam Buddha Nagar at Rs 5.41 lakh ($7,261), Mumbai city and suburban at Rs 3.4 lakh ($4,390), Bengaluru urban at Rs 6.2 lakh ($8,006), Dakshina Kannada at Rs 4.43 lakh ($5,721), Hyderabadat Rs 3.5 lakh ($4,715) and Rangareddy at Rs 6.69 lakh ($8,980). There are also others like Gurugram, Ahmedabad, Chennai and Kolkata. (Years for the income estimates vary from 2020-21 to 2022-23)... The overall size of the market in these cities could well rival other geographies — the Philippines has a per capita income of $3,499, Vietnam $4,164...

For the assessment year 2018-19, around 1.5 crore individuals had gross total incomes of Rs 5-10 lakh ($7,100-$14,203, at the exchange rates). Another 52 lakh had incomes between Rs 10-50 lakh ($14,203- $71,013), while three lakh had an income of more than Rs 50 lakh (above $71,013). Five years later, in the filings for the ongoing assessment year 2023-24, the number of individuals in these categories is likely to be significantly more — they had doubled between 2014-15 and 2018-19... these numbers... are gross underestimates... they rival other markets — Croatia, with a population of 38.5 lakh, has an income of $18,413, while Lithuania has a population of 28.3 lakh and an income of $24,827.

This translates into a fairly big consumption base,

As per NFHS 2019-21, 7.5 per cent of households own a car. That roughly translates to 8 per cent of the population having some spending capacity. But, while sales of entry-level cars have slowed down, suggesting low upward mobility, there are also indications of growing spending ability in other cohorts. In 2021-22, 7.78 lakh cars sold were priced above Rs 10 lakh (more than $12,000) as per CRISIL Market Intelligence and Analytics. In 2022-23, that rose to 10.36 lakh. And this is when the tax incidence ranges from 30 to 50 per cent...

As per JLL, the houses sold in the Rs 1.5 crore plus category now account for roughly a fifth of all sales in the top seven cities. As per CBRE, projects with a quoted value of Rs 2 crore and above (more than $2,50,000) have increased by twice in comparison to pre-pandemic levels. Similarly, sales of high-end luxury cars (Mercedes, BMW, Jaguar, Porsche, Lamborghini, Bentley and Rolls Royce) rose to 27,910 in 2022-23, up from 22,166 the year before as per data from FADA. Add the others and sales surpass 35,000. The luxury watch market (Rs 1 lakh and above) is also seeing strong numbers. In 2019-20, the size of the market was estimated at Rs 3,240 crore ($450 million at the exchange rates). By the end of next year, it is likely to touch Rs 5,940 crore ($740 million) as per Ethos’s annual report. In the case of the art market, an even more rarified segment, sale of 3,833 artworks fetched Rs 1,145 crore ($144 million) in 2022-23 as per Indian Art Investor’s art market report.

This is a point that I've made in several posts on the Indian economy. It's growing high consumption class, while small compared to its own population is as big as some countries, and could contribute significantly to sustain high growth. This is the idea of a long-term K-shaped growth trajectory. 

9. Some very interesting data on the flight of white students away from schools with greater number of Asian students, the "white flight". Gillian Tett points to a new paper by Leah Platt Boustan, Christine Cai and Tammy Tseng that use population, economic and school enrolment data in high socio-economic status Californian suburbs between 2000 and 2016

They argue that the arrival of each new Asian student was correlated with the departure of 0.6 white students. And when adjusted for demographic factors, “on average, the arrival of one Asian student in a suburban school district leads to the departure of 1.5 white students”. They note that this “rate of white flight that is somewhat lower but not too dissimilar from flight from black/Hispanic populations documented in different settings”... But the factors that sparked “white flight” from African-American and Hispanic incomers — namely racism, crime and house prices — do not seem to be to blame. 

High socio-economic status (SES) areas have low crime and high house prices. And while separate research by experimental psychologists suggests that white families do sometimes see Asian-Americans as “a foreign cultural threat” in other US locations, the economists see little evidence of overt hostility in Cupertino. Instead, they point to education as a possible reason for the flight: white parents wanted to use public schools in other districts, where their children could come top of the class, and thus have more chance of entering California universities, which emphasise class order in admissions. “Asian arrivals lead to test score gains for the full student body in these high-SES districts, but do not boost most measures of test scores for white students,” the authors note. “The learning of white students appears unaffected [by immigration] but the relative performance in the class for the average white student would fall with Asian entry . . . raising parental concerns about competition.”

Thoughts on the return of industrial policy

Off-shoring and outsourcing, Chinese imports, and technology-biased changes have depleted the manufacturing base in many developed countries. Besides, the Chinese dominance of the manufacturing supply chain poses serious risks. Industrial policy is therefore becoming the new norm across developed countries. This post will examine some aspects of this change. 

Manufacturing's share of the economic output has been declining across the world.

In order to reverse this trend, in the span of less than a year, the US has passed three legislations - Infrastructure Investment and Jobs Act in late 2021, Inflation Reduction Act and Chips and Science Act in August 2022. These policies are being considered critical to incentivise investments

“The IRA really underpinned the business case to stay here,” adds Jorg Heinemann, chief executive of EnerVenue, a US battery company building a $264mn factory in Kentucky. “Take away the IRA, now it becomes a much more difficult equation . . . the pull of Asia would have been difficult to resist.”

History may well remember this speech by President Biden in Chicago that unveiled a new economic policy making paradigm, Bidenomics, as formally announcing the return of industrial policy.

The economic vision for this country: the economy that grows the economy from the middle out and the bottom up instead of just the top down. When that happens, everybody does well. The wealthy still do — (applause) — everybody does well. The poor have a ladder up, and the wealthy still do well. We all do well. 

This vision is a fundamental break from the economic theory that has failed America’s middle class for decades now. It’s called trickle-down economics — fundamental economics, trickle-down. The idea was — it’s the belief that we should cut taxes for the wealthy and big corporations... I’m tired of waiting for the trickle-down. It doesn’t come very quickly. Not much trickled down on my dad’s kitchen table growing up. And it’s a belief that we should shrink public investment in infrastructure and public education — shrink it; that we should let good jobs get shipped overseas. And we actually have a tax policy that encourages them to go overseas to save money. We should let big corporations amass more power while making it harder to join a union... Under trickle-down economics, it didn’t matter where you made things, as long as you helped the company’s bottom line, even if that meant seeing jobs and industries go overseas for cheaper labor... Trickle-down also meant slashing public investment on things that helped drive long-term growth and helped America lead the world in innovation...

Bidenomics is about building an economy from the middle out and the bottom up, not the top down. And there are three fundamental changes that we decided to make with the help of Congress and been able to do it: first, making smart investments in America; second, educating and empowering American workers to grow the middle class; and third, promoting competition to lower costs to help small businesses... We’re supporting targeted investments. We’re strengthening America’s economic security, our national security, our energy security, and our climate security... We’re now investing in key industries of the future, making targeted investments to promote domestic production of semiconductors, batteries, electric cars, clean energy... Biden economics means the industries of the future are going to grow right here at home... addressing the 40-year decline in unionization by supporting project labor agreements, collective bargaining, prevailing wage laws, that’s the reason today Americans’ support of unions is higher than it’s been in 60 years.

Initial signs appear to show a revival. Manufacturing investments have taken off, almost doubling in the last two years.

But the scale of these policies from the US has generated severe backlash (and emulation) among its competitors, 

Ever since the Biden administration passed the Inflation Reduction Act and the Chips and Science Act for clean energy and tech last year, there has been a mutinous mood among some American allies in both Europe and Asia at the scale of the new US subsidies. What the US sees as a strategy to reverse deindustrialisation in deprived areas, allies have interpreted as a thinly veiled exercise in protectionism because it encourages companies to shift plants and customers to Buy American...

After several decades when the US has used its influence at institutions such as the World Bank and the IMF to pressure governments to cut back subsidies, many have been quick to call hypocrisy over Washington’s new embrace of industrial policy. Europeans, in particular, are anxious about the competitive threat and the risk of seeing some of their industrial base migrate to the US. Yet as the dust has settled in recent months, the reaction has shifted from anger to a search for ways to catch up. The EU, Japan and South Korea have all introduced subsidies for their tech and clean energy sectors, in order to attract new investment or prevent more companies from shifting to the US...

Many of the incentives are focused on businesses that assemble products in the US, which encourages companies to move production there. And not only do they qualify for the massive subsidies on offer from the Biden administration — they can also benefit from lower energy costs and taxes. Meyer Burger, a Swiss-based solar technology company that has three plants in eastern Germany, warned last month that it would build its new solar cell factory in the US rather than Germany unless Berlin provided more financial support... The IRA has prompted an investment spree by Japanese manufacturers with Panasonic, Toyota, Honda, Bridgestone and others announcing additional spending plans in the US... South Korean companies have also been among the largest investors in green technologies in the US since the IRA was passed last year... by 2026 Korean battery makers will stand to collect an annual collective subsidy from the US taxpayer of upwards of $8bn from the IRA’s “advanced manufacturing production credit” alone.

And others too are following the US in adopting the green transition industrial policy

Analysts stress that European countries have already developed a green agenda that incorporates tens of billions of euros of subsidies. While the US regime offers subsidies worth $7,500 an electric car, for example, the average in the EU was already €6,000 per vehicle in 2022. Under the €800bn NextGenerationEU Covid-19 recovery programme, member states are required to commit at least 37 per cent of spending to the green transition. This comes on top of a regulatory framework that uses a carbon price, via the EU Emissions Trading System, to drive up investments in renewables and greener technologies... The European Commission last year relaxed its strict state-aid rules, giving member states more leeway to help their companies get through the turbulence triggered by Russia’s invasion of Ukraine... 

The new “temporary crisis and transition framework” (TCTF) allows EU countries to provide subsidies to companies making things like solar panels, wind turbines, heat-pumps and the electrolysers needed to produce green hydrogen, as well as carbon capture and storage projects... The TCTF framework is now being used to help solar companies, too... South Korea has responded to the US subsidies with a semiconductor package of its own, the so-called “K-Chips Act”. Passed in March, the legislation boosted tax credits for companies investing in manufacturing of “national strategic goods”, including semiconductors.

This is an interesting point about the contrasting nature of their policies,

Businesses praise the relative simplicity of the US offer, which focuses on uncapped tax incentives targeted at manufacturers. By contrast, EU attempts to forge a convincing green industrial policy have been undermined by a patchy regulatory framework and complex processes for accessing multiple pots of money... “The risk is that the EU’s response to the IRA will in the end be too little, too late,” says Südekum, the German academic. “The programmes are too complicated and are getting bogged down in details.”

It cannot be denied that the scale of the intervention is staggering and poses dangers of distortions, inefficiencies, and wastages,

Nowhere have the risks of such a contest been more obvious than in the case of Intel’s big new German investment. The chipmaker had announced plans last year to invest €17bn in two new fabrication plants or fab in the eastern German city of Magdeburg. The German government had promised to subsidise the project to the tune of €6.8bn. But then Intel said it wanted more, citing higher energy and construction costs. In the end, the government agreed to raise the level of subsidy to €9.9bn, though Intel also announced it was increasing the investment volume from €17bn to €30bn. “There’s a lot of subsidy shopping going on at the moment,” says Moritz Schularick, head of the Kiel Institute for the World Economy in Germany. “Companies can say to politicians here: ‘we get more funding in the US’, and that can convince them to shell out even more money.” 

Many orthodox economists in Germany have expressed horror at the level of subsidies being offered to companies like Intel. Such support — and the mere suggestion of “industrial policy” — is an affront to German “ordoliberalism”, with its rejection of state intervention in the economy and its abhorrence of subsidies or tax privileges. Habeck admits that subsidies go against the grain of “pure economic theory”. But the Europeans had no choice but to match the huge incentives on offer in the US and China, which are attracting billions of dollars in investment. “We have to decide: do we continue to act according to what’s in our textbooks?” he told the Süddeutsche Zeitung at the end of June. “If we do, we won’t have any of the key industries of the future.”

The Economist has questioned the wisdom of such large scale industrial policy-based push into manufacturing, and described it as manufacturing delusion. It's perhaps right about the scale and speed of the shift and for sure a significant share of these subsidies are likely to be inefficiently deployed. 

But such wholesale condemnation of industrial policy is misleading. For example, it scorns at US government efforts to support the semiconductor industry citing the unsuccessful Japanese attempts in 1980s to subsidise the memory chip manufacturing industry. This is plain wrong since the Japanese semiconductor industry was dominant in the seventies and eighties thanks to its industrial policy of the seventies. Further, the current dominance of TSMC and Samsung are in no small measure due to industrial policy in Taiwan and South Korea. 

Yes, it'll be inefficient and more expensive (the US chips are expected to be 30% costlier than Taiwanese) to manufacture in the US. But without it, there's no chance of de-risking and diversifying arguably the most strategically important industry. And it's fanciful and foolish to believe that China will not weaponise any control it manages to achieve with its own industrial policy on semiconductors over this industry. This becomes a real threat also given the excessive industry concentration in Taiwan and TSMC. And given its capital intensive nature, industrial policy support is essential for semiconductor manufacturing to stand any chance of flowering in the US. Even with such support, its success would be long-drawn and a host of other complementary factors. 

In the aggregate objective function of the semiconductor industry (one that takes into account the interests of all stakeholders and not just sellers and buyers), efficiency and price are not the only considerations. Others like resilience, restoring local manufacturing capabilities, strategic diversification, and having control over strategically important industries ought to be equal or even more important existential parameters. Foremost, national interests often dictate a control over certain industries. 

Critics of the manufacturing push are also making the mistake of underestimating the importance of making things to the economy as a whole. In the guise of moving up the value chain and specialising in knowledge based industries, academics and experts have provided the ideological cover for shifting away from activities involving human labour and making things. Such excessive shift in one direction has negative implications for general economic resilience and strategic autonomy (the pandemic and now the reliance on China for critical minerals and technologies for green transition are examples), ability to create the good jobs necessary to accommodate a large portion of the population unable to do these knowledge-based jobs, and for economic productivity growth and technology diffusion in general. 

Then there's the point of being able to specialise in cutting-edge manufacturing-associated services when there's no experience of manufacturing itself available to learn and internalise the nuances and details that are critical for high-quality design. It's not surprising that Tesla, the most successful EV company, one that seeks to be primarily an EV platform company, has, unlike others, vertically integrated the entire supply chain including battery manufacturing. Germany's technological superiority, for example, is built on the foundations of its mittlestands that make equipment and devices. An IT industrial ecosystem that's detached from the underlying physical processes that it seeks to manage is unlikely to be able to maintain its dominance for long. Manufacturing and associated services have to co-exist to be able to innovate on a sustainable basis. 

The scepticism and criticism about industrial policy are based on anecdotal examples (read Solyndra) and narrow project-specific costs-benefit assessments (for example, Economist quotes the example of a $1 billion New York State-built solar-panel factory rented out to Tesla for $1 per year, which has returned only 54 cents in benefits per dollar spent). Both suffer from serious limitations. The former is a case of what's newsworthy is what captures the mood of the times and gets reported. The latter makes the mistake of overlooking the general equilibrium benefits of such efforts. 

In this context, we should bear in mind that India's efforts at boosting mobile phones and semiconductor manufacturing will certainly have inefficiencies and wastage. But the alternative of not doing anything and allowing foreign competitors to move in and make outside (or assemble inside) and sell in India is not good for the country's economic prospects. It robs the country of opportunities to expand its capital base. Given all the available trends, the magazine's dismissal of India's PLI scheme as having generated only a low-value assembly of mobile phones looks certain to bite back. 

Delusions about industrial policy in terms of just picking winners and throwing money being enough to reshore manufacturing investments are certain to end up in tears. On the same lines, leaving market forces to play out and maintaining the globally integrated supply chains are just as likely to leave everyone with deep regrets. The need of the hour is an embrace of calibrated industrial policy - where critical industries are identified and targeted with industry-wide support, tariff and other barriers are complemented with export competition, and generally, tax concessions and subsidies that target outcomes. 

Adam Posen of the Peterson Institute is disturbed by the scale of industrial policy and its combination with protectionist trade and investment policies. I think there's some cause for concern. He prefers that government confine itself to funding R&D, worker training, infrastructure provision, and regulation of innovation, and refrain from directly engaging to subsidise sectors and companies. And the industrial policy in the US might be a case of too much being pumped in too quickly with the near certainty of leakages and wastage. And the protectionist push might be used by the domestic industry to perpetuate inefficiencies. 

Some of his concerns are baffling,

The real damage from decoupling and conflict between the US, China and other economic blocs is reduced productivity growth. We would see less diversification both financially and in inputs, including of ideas and business practices, along with less competition, which directly diminishes productivity. We would also see further restrictions of migration, foreign direct investment, flows of information and technology once economic nationalism is entrenched. So, if we continue down this path, we’re looking at a meaningfully bleaker outlook for average growth in the world. It’s going to be harder for the developing world to break through except through political pandering to China, EU or US, which they cannot depend on. There’ll be the occasional country that has a temporarily critical mineral supply or whatever which will try to play off the three in a bidding war, but that never lasts as an advantage. The lasting large magnitude decline in average global productivity growth will hamper our response to climate change.

Do we even have an alternative to decoupling? Can a good faith economic integration continue with Xi Jinping's China? Does he even realise the consequences of Chinese hegemony and control over strategic industries? What's the basis for the confidence that the current trends on Chinese dominance in every imaginable emerging and critical industry will be a force for global good? Is there any practical basis for assuming that global economic growth prospects will be better in an integrated world economy? This is pure ivory-tower opinion-making. 

Then there are some purely self-serving arguments,

For all the talk about how ashamed so-called neoliberal economists should be about trade and inequality, the fact is, the people pushing for manufacturing jobs in specific places in the UK or the US are immorally slighting just how important trade, cross-border investment, migration, and technology transfer has been to billions of people in the developing world. This isn’t just about China. This is hundreds of millions of people in India. This is people in Poland, Turkey, Indonesia and Vietnam, and southern Africa and large parts of South America.

Really? These same developing countries are and have been among the loudest proponents of calibrated globalisation and trade liberalisation, and have always been active users of industrial policy. In short, the West is now embracing what these countries have all along preached and practised. It's plain disingenuous to now use them to justify the orthodoxy. 

One way to frame the protectionist push is to formulate it as an adjustment towards a more prudent and fair real-world balance between domestic and foreign competitors, a levelling of the playing field that had become lop-sided in favour of foreign competitors (especially the deeply subsidised Chinese imports). The push towards industrial policy too should be viewed as a corrective to the market-knows-best paradigm that has dominated policy-making in the developed world (and among international institutions) for a few decades. It's flawed to blindly believe that comparative advantage will promote mutually beneficial outcomes without local content requirements, levelling the playing field with subsidies and concessions, incentivising local job creation etc. 

On the same lines, the current focus on anti-trust activity should be seen as a recalibration of the prevailing policy of overlooking corporate size and anti-competitive actions on the grounds that consumer welfare is all that matters. Or the blind faith in the private sector's willingness and ability to support important public objectives like the green transition should be corrected with one where the public sector is complemented by the private sector. 

There's a subtle and important difference between the recalibration proposed above and a wholesale shift towards protectionism or regulation or government-knows-best industrial policy approaches. The worry is that those advocating the former come to be used as the Baptist by the latter bootleggers! But when faced with choices involving strategic national interests, these risks may be worth taking. 

Update 1 (20.08.2023)

Indonesia's decision to ban nickel ore exports should count as an industrial policy success

In refusing to sell its raw nickel to the world, Indonesia has drawn more than $14 billion in investment, primarily from Chinese companies, into smelters that process it into products used to make stainless steel and E.V. batteries. Since the ban was introduced in 2014, Indonesia’s exports of nickel products have multiplied more than tenfold, exceeding $30 billion last year, according to government data. The European Union asserts that its companies are being deprived of a fair chance to import nickel ore. It brought and won a case at the World Trade Organization, gaining the power to apply punitive tariffs on Indonesia’s exports even as the country appeals. 

Luhut Binsar Pandjaitan, Indonesia’s coordinating minister for maritime affairs and investment, likens that position to a perpetuation of the colonial era, when the Dutch, Portuguese and British hauled spices, sugar and other lucrative commodities back to European entrepôts. The nickel export ban is a corrective, he said, the means of securing the value of extraction for Indonesians... Government officials say they welcome investment from any place that brings capital and know-how. Chinese firms arrived early, recognizing the importance of nickel in the emerging realm of electric vehicles.

Indonesia is now lobbying with the US to include Indonesia among the list of friendly countries so as to enable US manufacturers using nickel from Indonesia access the tens of billions of dollars in tax credits that are being offered by the Biden administration to spur electric vehicle manufacturing. 

Thoughts on affordable housing IV

I have blogged on multiple occasions pointing to affordable housing as being one of the biggest threats to urban growth. In fact, it's a binding constraint on urban productivity and growth. This is the last one with links to the previous ones. 

James Gleeson has an awesome awesome blog post (from 2018) on how Tokyo has managed to continuously keep adding to its stock of housing (HT: Noah Smith). Even as the rest of the country is depopulating, Tokyo prefecture has continued to grow, adding 940,000 people between 2005 and 2015 to reach 13.5 million.

Starts hit a peak of 192,000 in 2003 and a trough of 108,000 in 2009 but averaged 155,000 new homes over the two decades... In just a fifty year period Tokyo’s housing stock nearly tripled in size, from 2.51 million homes in 1963 to 7.36 million in 2013... Tokyo does demolish a lot of housing – between 2002 and 2011 there were 1.58 million starts but between 2003 and 2013 the stock grew by 1.17 million, so if we assume that it takes an average of two years from start to completion then it looks like 0.41 million homes were demolished in a decade, or about 7% of the 2003 stock. Put another way, roughly one home is demolished for every four new ones built. But the scale of construction still means that Tokyo’s housing stock is growing very fast – roughly 2% a year, about twice as fast as that of Paris, London or New York.

In general East Asian cities appear to have done far better than western cities in expanding housing supply. 

In an FT article, Robin Harding puts Japan's housing achievement in greater perspective

In 2014 there were 142,417 housing starts in the city of Tokyo (population 13.3m, no empty land), more than the 83,657 housing permits issued in the state of California (population 38.7m), or the 137,010 houses started in the entire country of England (population 54.3m). Tokyo’s steady construction is linked to a still more startling fact. In contrast to the enormous house price booms that have distorted western cities — setting young against old, redistributing wealth to the already wealthy, and denying others the chance to move to where the good jobs are — the cost of property in Japan’s capital has hardly budged. This is not the result of a falling population. Japan has experienced the same “return to the city” wave as other nations. In Minato ward — a desirable 20 sq km slice of central Tokyo — the population is up 66 per cent over the past 20 years, from 145,000 to 241,000, an increase of about 100,000 residents. In the 121 sq km of San Francisco, the population grew by about the same number over 20 years, from 746,000 to 865,000 — a rise of 16 per cent. Yet whereas the price of a home in San Francisco and London has increased 231 per cent and 441 per cent respectively, Minato ward has absorbed its population boom with price rises of just 45 per cent, much of which came after the Bank of Japan launched its big monetary stimulus in 2013. In Tokyo there are no boring conversations about house prices because they have not changed much. Whether to buy or rent is not a life-changing decision.

The city's stock increase has been faster than its population growth, thereby resulting in a surplus of housing. This stock addition has been aided by demolition of older housing and replacement with high-rise apartments.

In 1963 there were 2.69 million households in Tokyo, and by 2013 this had grown to 6.51 million. So while the number of households grew quickly, the number of homes grew faster, and Tokyo went from having a crude ‘housing deficit’ in 1963 to a ‘surplus’ in 1973, and an even bigger surplus every year after that. By 2013 there were 849,000 more homes than households...

Tokyo illustrates... strategy: keep building more and more housing, far past the point of mere sufficiency and into the realm of abundance... The fastest growth has been in apartments, particularly the tallest ones (six storeys or more). In 1978 there were 823,000 homes in Tokyo in apartment buildings of 3 or more storeys. 25 years later there were 3.6 million. Over the same period the number of houses grew slightly while the number of low-rise apartments fell. All of this is consistent with a pattern of housing growth achieved primarily through densification rather than sprawl. That’s backed up by data on land use, which indicates that the acreage devoted to housing in Tokyo grew by around 1.5% between 2006 and 2011, whereas the number of homes grew by 9.2%. On average there are around 110 dwellings per hectare of residential land in Tokyo, compared to roughly 60 in London as of 2005.

It has also resulted in a sharp increase in per capita floor space availability despite the high density and population growth, 

When you combine the average floorspace per home and the average number of people per household you get the below trend in average floorspace per person (this shows the space in occupied homes only – if you took vacant homes into account it would be much higher). The amount of space per person saw a remarkable increase from 15m2 in 1963 to 32m2 in 2013... in stark contrast to Tokyo there has been little or no increase in London in around 20 years.

Foremost, the housing stock increases have been aided by simple zoning regulations and central government involvement to address any problems of NIMBYism,

Japan has a relatively simple and unambiguous zoning code, one which the national government has repeatedly adjusted in order to allow for more housing growth in Tokyo. That has been done in the face of opposition at neighbourhood and even city level, opposition that in countries which have devolved land use decisions to a local level would be enough to stop densification or at least divert it to poorer areas. 

Harding supplements,

Cities are zoned into commercial, industrial and residential land of various types. In commercial areas you can build what you want: part of Tokyo’s trick is a blossoming of apartment towers in former industrial zones around the bay... As bad loans to developers brought Japan’s financial system to the brink of collapse in the 1990s, the government relaxed development rules, culminating in the Urban Renaissance Law of 2002, which made it easier to rezone land. Office sites were repurposed for new housing. “To help the economy recover from the bubble, the country eased regulation on urban development,” says Ichikawa. “If it hadn’t been for the bubble, Tokyo would be in the same situation as London or San Francisco.”... All of this law flows from the national government, and freedom to demolish and rebuild means landowners can quickly take advantage. “The city planning law and the building law are set nationally — even small details are written in national law,” says Okata. “Local government has almost no power over development.”... Constant rebuilding helps to explain why housing starts in the city are so high: the net increase in homes is lower. Like our next-door neighbours, however, a rebuild often allows an increase in density... “The Japanese system is extremely laissez-faire. It really is the minimum. And it’s extremely centralised and standardised. That means it is highly flexible in responding to social and economic change,” says Okata.

Some observations: 

1. The answer to affordable housing is simply to increase the stock. Build, build, and build. Create the conditions that allow for sharp increases in supply. And that means simple and flexible regulations, and institutional restraints on NIMBYism. The negative externalities imposed by NIMBYism should be countered with centralised mandates. 

2. The extent of land in any city is fixed. Unlike other forms of capital, land is a natural resource. And the extent of land is a constraint on urban growth. There's therefore a case to regulate land use in a manner that maximises the housing supply. Aesthetics and conservation, while important, has to be balanced with the primary requirement of an expanded affordable housing supply.

3. Since land is more or less fixed, the only way to increase supply in any meaningful manner is to go vertical. So the need for policies that encourage vertical development and densification. Conversely, we may need to start thinking of policies that penalise low-rise and independent units. 

So, for example, low-rise developments should be seen as imposing negative externalities and costs on society. Consider the carrying cost on the local infrastructure imposed by any land. A low-rise unit imposes a much higher per capita land area carrying cost, whereas an apartment unit has a lower per capita carrying cost. A stand-alone or low-rise development takes away from the market the full realisable potential of housing stock supply, thereby adding a premium to the average housing market price. This makes the case for higher property taxes and building permission fees for independent units and low-rise developments, and vice-versa for vertical developments. 

4. Ease of redevelopment is critical to the success of any affordable housing policy. In fact, there's a strong case for incentivising the redevelopment of older properties that expands the supply of housing units. Come to think of it, any redevelopment of an older structure is most likely to result in an increased number of units. So, the greater the redevelopment, the more incremental supply. Such redevelopment policies should also make it easier to repurpose existing commercial and industrial land-use facilities into residential units. 

In all these cases, policy should take care to ensure that the objective is affordable housing. As I wrote here earlier, left to itself (without policy guidance in that direction), easier building rules will only lead to gentrification and increased stock of large dwelling units. 

5. Finally, it's important to shift the paradigm from focusing on land ownership to building rights. In most countries, while land belongs to the landowner, natural resources found in private lands belong to the sovereign and their extraction is tightly regulated. Extending this logic, it can be argued that the land owner's property right should be restricted to the specified building right that comes with the ownership of the land. 

This idea is also legally enshrined in some countries like France where the land title confers only a basic building right, beyond which the owner has to purchase from the municipality. The French urban reform and land policy of 1975, Plafond Légal de Densité, was one of the first efforts to separate both these rights. It set building right at a FAR of 1 as part of property right for most of France except Paris where it was set at 1.5. 

None of this should be taken to paint the picture of a city being a place filled with high-rises. For one, there should be enough community areas and green spaces. Instead of allowing the development of large sprawls, urban planners and policy makers should decongest cities by encouraging the emergence of satellite townships and newer cities interconnected to each other through good public transport facilities. The last, incidentally, is another important factor in Tokyo's success.

Weekend reading links

1. Automation fact of the day

Ford’s revamped electric-vehicle (EV) plant in Cologne, located on the banks of the Rhine in Germany’s industrial heartland, is one such example. The chassis and bodies of vehicles are coated in chemicals to prepare for painting and to prevent corrosion. This happens across multiple storeys; the number of workers involved in the work on site is precisely zero (two keep tabs remotely). Shiny yellow assembly robots further down the production line are sufficiently advanced as to be able to mostly monitor themselves. Although workers are required for assembly—about as many as for traditional petrol-powered vehicles—the activity requires a lot more training. This matches the national picture: according to a study by Wolfgang Dauth of the Institute for Employment Research and co-authors, industrial robots have made available work more complex.

2. For those scorning at industrial policy and government role in market making, look no further than the work of Indian Space Research Organisation (ISRO). 

India has become home to at least 140 registered space-tech start-ups, comprising a local research field that stands to transform the planet’s connection to the final frontier. It’s one of India’s most sought-after sectors for venture capital investors. The start-ups’ growth has been explosive, leaping from five when the pandemic started. And they see a big market to serve... anticipates a global need for 30,000 satellites to be launched this decade... Driven more by private enterprise than by gigantic government budgets, space technology is fulfilling smaller-scale, commercial purposes. Imaging systems feed information about the planet back to Earth, helping India’s farmers insure their crops or commercial fishing fleets track their catch. Satellites bring phone signals to the country’s remotest corners and help operate solar farms far from India’s megacities. Since June 2020, when Mr. Modi announced a push for the space sector, opening it up to all kinds of private enterprise, India has launched a network of businesses, each driven by original research and homegrown talent. Last year, the space start-ups raked in $120 million in new investment, at a rate that is doubling or tripling annually...

As ISRO, pronounced ISS-ro, makes room for new private players, it shares with them a profitable legacy. Its spaceport, on the coastal island of Sriharikota, is near the Equator and suitable for launches into different orbital levels. The government agency’s “workhorse” rocket is one of the world’s most reliable for heavy loads. With a success rate of almost 95 percent, it has halved the cost of insurance for a satellite — making India one of the most competitive launch sites in the world... there is money to be made launching equipment into space: That market is worth about $6 billion this year and could triple in value by 2025... India’s vendor ecosystem is staggering in size. Decades of doing business with ISRO created about 400 private companies in clusters around Bengaluru, Hyderabad, Pune and elsewhere, each devoted to building special screws, sealants and other products fit for space. One hundred may collaborate on a single launch.

In recent times, Elon Musk's Space X has dramatically altered the economics of space launch. 

His company, SpaceX, and its relaunchable rockets brought down the cost of sending heavy objects into orbit so much that India could not compete. Even today, from American spaceports at $6,500 per kilogram, SpaceX’s launches are the cheapest anywhere.

This is a great opportunity for Indian startups to break the mould (of being mere copycats) and leverage the strong ecosystem and foundations for satellite launches and dominate the global market. 

3. Pointing to the enormous potential for growth in mutual funds in India, it emerges that they are just a fifth of the total bank deposits.

4. Russia responds to the sanctions by expropriating the assets of western companies based in the country that have closed down operations. The long-term damage of these actions to Russia's credibility among international investors is serious. 

It's ironical that the two strongmen leaders of China and Russia have arguably done more long-term damage to their countries interests than any enemy could ever have achieved. 

5. Shyam Saran points to a possible Japanification of China

Inflation in China is remarkably low and it is an outlier in this respect. This is the result of weak demand and a fall in producer prices. This could be the start of a deflationary phase of the kind Japan experienced in the early 1990s, brought on by a combination of a property bubble bursting, bad debts multiplying and a rapidly ageing population. Japan went from constituting 18 per cent of the global economy in 1990 to only 8 per cent in 20 years.

Despite repeated policy announcements that the Chinese economy must shift from being investment-driven to one that is driven by rising consumption, this has not happened so far. Consumption is still at a relatively low level of 40 per cent compared to over 60 per cent in most mature economies. The Covid pandemic, spanning three years, has dampened consumer demand, and stagnant or falling incomes have made the situation worse. An article in the Nikkei reports that retail sales in China are still 10 per cent below the level reached pre-Covid. Chinese are saving more and these are mainly precautionary savings because the overall economic outlook has worsened. The household saving rate currently is 3 per cent above pre-Covid level, which suggests a continuing reluctance to spend.

As property markets are on their longest ever losing streak, there's pressure mounting on the government to undertake some form of pump priming. The government has so far resisted such measures, preferring to let the markets decline and thereby gradually lower the excessive dependence of the economy and local governments on property prices.

6. Ruchir Sharma has some statistics on the burgeoning US deficits and public debt stock,

During the pandemic, the US budget deficit tripled to more than 10 per cent of gross domestic product, more than double the peak in other developed economies. In coming years, the US deficit is expected to average close to 6 per cent of GDP — well above its historic norm, and a full six times the average in other developed economies... all the $6.7tn in new spending from the Biden administration came after 2020 was over. Most of it had nothing to do with pandemic relief. Instead, Joe Biden used the sense of crisis to launch a latter-day New Deal, building infrastructure and industry ostensibly to compete with China and combat climate change... The US has been running deficits almost every year since the 1960s without triggering a serious financial crisis. So the conventional wisdom is that deficits don’t matter. Many economists argue that they pay for themselves if the economic growth generated by new public spending exceeds the government’s interest payments. That feat was easier to achieve when interest rates were near zero, however. Now that rates are rising, it’s almost impossible...

Through 2025, the trillions unleashed by this administration will push government spending up to 39 per cent of GDP, most of it not covered by new revenue... the US deficit is still projected to hover near 6 per cent of GDP throughout the next decade... While inflation did spike worldwide, it did so most sharply in nations that spent the most during the pandemic. Few spent more than the US. A recent study from the Federal Reserve attributed two-thirds of America’s recent inflation surge to excess demand, and half that increase in demand to deficit spending... it is now one of the most fiscally irresponsible nations. Its deficit has climbed the ranks to worst in the developed world, its public debt is already the third highest after Japan and Italy.

7. Scott Galloway has a great post that touches on many aspects, including Silicon Valley billionaire vanity, 

The Dunning-Kruger effect is a cognitive human bias that causes us to overestimate our abilities in domains where we have low competence. This acutely affects some in the venture capital and tech communities. Enabled by their public profiles, wealth, and tech bro enablers, these folks shapeshift from one week to the next into geopolitical experts and constitutional law scholars and computer scientists. The less they know about a topic, the more confident their tone. We’re all enablers re Elon. If Zuckerberg announced he was building an EV or multistage rocket, wouldn’t we question the industrial logic?

This point about Musk's dramatic retrenchments at Twitter is instructive,

The business strategy that marked 2023 is not leveraging AI or adopting hybrid work, but focusing on bloat. Specifically how to reduce it. Whether you’re a critic or a stan, Elon’s 80% reduction in the bird’s workforce is the most impactful business decision of the year... The result is the Nasdaq’s best first half in four decades, fueled by the nitro and glycerin of AI hype and profits increasing thanks (mostly) to cost cutting. A new generation of business leaders discovered that a firm with a 20% operating margin can see as big an increase in value by cutting costs $1 billion as it can by increasing revenue by $5 billion. For all the complaints from Musk critics about a buggy site “on the precipice of crashing,” he’s maintained a minimum viable product while shedding 4 in 5 employees in six months... Elon didn’t fire 6,000 employees at Twitter, he (effectively) terminated over 300,000 workers across tech. Because every other tech CEO felt they could have the great taste of reduced expenses while avoiding the calories of collapsing revenue. Elon fired people for arbitrary reasons or no reason at all.

This on the spectacular implosion at Twitter

Twitter’s implosion is historic. There has never been a firm in the modern economy that’s fallen this far, this fast that has not been accused of fraud... The erosion of Musk’s guardrails as money and sycophants melt whatever better judgment or grace he had has resulted in a reputation experiencing the same trajectory as Twitter’s revenue. If Elon had never downloaded the micro-blogging app he’d be much wealthier and universally revered for his formidable accomplishments. Instead, he’s set a land speed record for hero to villain.

8. Very interesting set of graphics on Indian oil purchases from Russia over the last year. Since April 2022, India's oil imports from Russia have grown more than ten-fold, with its market share surging from 2% to 24.2%, touching 40.4% in May 2023. OPEC's share of Indian imports fell from 75.3% in May 2022 to 40.3% in May 2023.

The Russian oil has come at a discount, though risk pricing on freight, insurance etc has lowered the discount. 

Interesting that Gulf (Saudi and UAE) oil was the most expensive, compared to even the US and Iraqi oil.

9. Naushad Forbes makes his recommendations for increasing R&D spending in India. 

Indian industry invests around 0.25 per cent of GDP in in-house R&D, to a world average of 1.4 per cent. Indian government spending on R&D, at 0.3 per cent of GDP, is reasonable by world standards. The problem is that unlike the rest of the world, research is not done in universities but in autonomous government institutes. Consequently, India allocates a mere 0.04 per cent of GDP for research done within the higher education system. So what we need to fix is clear: Indian industry must scale its investment in in-house R&D by at least a factor of five. And investment in publicly-funded research within the higher education system must grow eight times.

He points to the promise of the new National Research Foundation (NRF) that gets Rs 50,000 Cr over five years, or Rs 10,000 Cr a year, for research in higher education (in academic research institutions and not autonomous national laboratories), in both public and private institutions. This would double the research done in higher education system. This is interesting

Stanford, a private university, which in 2022-23 spent $2 billion (Rs 17,000 crore, more than every higher education institution in India put together) on research.

There's a bit of populist rhetoric, laced with hypocrisy, in the recommendation for governance of the NRF

Instead, getting a fully professional board (read: No bureaucrats!), headed by an illustrious professional willing to devote the time and energy this needs, would be a far more effective solution.

Such rhetoric does more harm than good. These are the same "illustrious professionals" who have headed Indian corporates and had great opportunities to themselves contribute to the identified failure of abysmal corporate R&D spending! Post-retirement sinecures for corporate executives are just as corrosive as that for bureaucrats.

10. Finally, interesting review of a book on Macquarie, the Australian investment bank firm famous for its infrastructure funds. Its origin can be traced to Hill Samuel, a venerable old British merchant bank and famous for creating the oil company Shell. 

The authors show Macquarie’s culture was far more important than any particular business deal, strategy or innovation, with several of its peculiarities going back to the bank’s early days. The philosophy of David Clarke and Mark Johnson, who built Hill Samuel Australia in the 1970s, “was to give employees as much latitude as possible, while remaining consistent with safety and controls”. Throughout Macquarie’s history there has been little top-down strategy or capital allocation. Instead, the company empowers entrepreneurial individuals to evolve new business lines, from 24-hour foreign exchange dealing in Sydney, to gold bullion arbitrage with London, cash management trusts, cross-border leasing and later ideas in infrastructure and commodities. 

Macquarie loved to explore “adjacencies”. If it was doing well in gold bullion, it could push into other metals. Once it had pioneered infrastructure finance in Australia, it could take the same model abroad, making small bets, each with the potential to grow into a large business. Those that failed, Macquarie quickly shut down; those that succeeded got capital to grow, and the individuals behind them became exceedingly wealthy. Central management was there to support and monitor, while enforcing strict risk controls — another early part of the culture — to make sure nobody blew up the bank. Described like this, Macquarie does not sound so magical, but it is a rare management that truly backs its staff. Macquarie’s approach also differs notably from the strategies that European banks deployed on Wall Street: no transformational acquisitions, no mass hirings of mercenaries from larger companies, no attempts to buy market share by deploying a large balance sheet, and no promises to offer a full range of services — all approaches that led to bloated cost structures and unwise risk-taking.