The need to reform ISDS and BITs

This post will question the wisdom of the provision of international arbitration granted to foreign investors from countries with which India has Bilateral Investment Treaties (BITs) or more generally the process of Inter-state Dispute Settlement (ISDS). I blogged on this here in the context of an essay by Columbia Professor Katharina Pistor that traced the legal origins of capital claims. 

It assumes significance in the backdrop of the ongoing India-UK trade deal negotiations where BIT is also on the table. Following a spate of high-profile arbitration reversals, India suspended BIT with 68 countries with a request to renegotiate based on the 2016 model BIT. The old BITs allowed for recourse to international arbitration. The argument is that local remedies are either weak or take too long, and therefore investors need international arbitration access to get them to invest in India. 

However, the newspaper report also mentioned that the Government of India may concede to the retention of international arbitration in its BIT with the UK. That would be a very bad idea. It's important that India stand its ground on the principle of BIT. Its quid-pro-quo concessions should not be on fundamental principles like BIT and instead focus on tariff lines.  

Rana Faroohar has an op-ed on the issue of ISDS and how it has become a feature of a global trade system that elevates the interests of multinational corporations over those of sovereign nations. She urges the US to take the lead and organise a multilateral exit from all ISDS arrangements. 

ISDS is a very common part of free trade agreements and bilateral investment treaties, in essence allowing foreign companies investing in particular nation states to sue governments for anything that stops them making profits — including climate regulations, financial stability measures, public health policy, and any number of other areas that are typically the purview of the state. The idea originated in the early 1990s, the era of nonstop globalisation, as a way to draw foreign investment into developing countries while also protecting rich country investors from the weak legal and governance systems in those nations. As of 2022, 1,257 ISDS cases had been launched, according to Unctad... 

The asymmetries of the system have always been stark. Only foreign investors have rights and only foreign investors can initiate claims. And claims can include not just actual losses but future ones, too. As a new white paper co-authored by academics from Georgetown and Columbia universities, as well as trade experts from the American Economic Liberties Project, points out, “corporations rarely invoke ISDS to protect against blatant expropriation or gross denial of justice”. Instead, they have been “consistently successful in exploiting the vaguely worded provisions within ISDS-enforced trade and investment agreements” to “initiate or threaten claims against democratic measures taken in the public interest that they believe have harmed their business interests.” 

Multinational airport operators have used ISDS to challenge Chile’s pandemic shutdown measures; a Canadian company has argued that mining rights should trump environmental protection measures in Colombia. Huawei has launched a case against Sweden over measures limiting its participation in 5G because of security concerns. In the US, the Keystone pipeline is the classic example. TransCanada sued the US during the Obama presidency because they weren’t allowed a permit to build, then revoked it under Trump (who allowed it) then sued again under Biden. So ISDS is also a pain for rich countries, but their companies usually benefit. For poorer countries, it can be devastating. Actions deemed to be in the public interest (such as raising health or labour standards) can lead to billions of dollars in claims that they can’t afford to pay. 

The big worry now is that such agreements could be used to prevent the clean energy transition. Fossil fuel companies and investors have filed numerous ISDS cases, totalling billions. Academics have estimated that global climate change efforts could result in $340bn of claims (the Keystone XL suit alone is for $15bn) Given all this, it’s little wonder that a lot of countries, including the US, Canada, Mexico, some EU member states, South Africa, India, Indonesia, and Ecuador are limiting or ending future ISDS agreements and even attempting to pull out of existing ones... According to Nobel laureate Joseph Stiglitz, there is little evidence that countries signing ISDS treaties saw more or better foreign direct investment than those that didn’t: “These deals just haven’t lived up to their promise.”

As an illustration of the egregiously bad nature of ISDS in BIT, consider this example. A foreign investor makes a commercial investment decision to take a stake in a project in India. The investor could be a private entity or a sovereign wealth fund. It subsequently transpires that the project is vitiated (by corruption or violation of local laws). The new development leads to a revision of the terms of the project, which is obviously less favourable to the investors. The investors respond by approaching the local courts. After exhausting the appellate process, the Supreme Court of India has upheld the revision. The domestic investors accept the verdict and move on. 

But the foreign investor now invokes the provisions of the BIT and takes the matter to international arbitration. The arbitration jury at London or Hague questions the revision and rules in favour of the investor and against the Government of India. It compensates the foreign investors for their commercial losses arising from the revision. 

Or consider the example of a taxation provision that's introduced afresh. Without getting into the merits of such an introduction, the fact remains that this is non-discriminatory and applies to all businesses operating in the country and it's a sovereign prerogative to tax. One can understand the Supreme Court of a country weighing in on the issue, but allowing an international arbitration jury to adjudicate on what's essentially a sovereign prerogative is deeply troubling. 

In the circumstances, we need to consider the following: 

1. International arbitration effectively becomes an appeal on the Indian judicial process. This is a direct and omnibus subordination of national law to international law. 

2. Any commercial investment decision is a contract. Such an omnibus international arbitration clause elevates contractual obligations above even sovereign law. 

3. The foreign investors enjoy a judicial recourse that domestic investors do not have. This forum shopping goes against fairness and equality. Foreign investors cannot have superior protections to what domestic investors enjoy. 

4. The BIT becomes an insurance against bad investment decisions and vitiated contracting. This generates moral hazard. It encourages businesses to invest without proper due diligence, and at worst nudges them to pursue dodgy deals to make quick and large profits. 

It’s time to seek revision of the boilerplate templates of BITs. There was a time when foreign investors needed the assurance of a BIT to invest in India. There are several reasons to argue that this insurance is no longer a requirement. 

Then there are the problems with the arbitration process itself. 

1. There’s an implicit bias among arbitration juries that developing countries tend to expropriate investors, and the default norm is to protect foreign investors. When the margins are thin, such cognitive biases invariably end up distorting jury decisions. 

2. International arbitration in places like London is dominated by a few global law firms that also compete for business from multinational corporations. This creates unavoidable conflicts of interests which all too often are apparent underneath the surface Developing country governments are constrained by having to rely on the same pool of law firms who also provide services to these private companies. 

3. Hamstrung by bureaucratic factors, governments cannot pursue these cases with the same intensity and focus as private investors can. Unlike private investors with the flexibility to undertake bilateral negotiations and settlements with various stakeholders, governments cannot cut corners in pursuing such informal pathways. 

4. Then there are the usual problems of nepotism, cronyism, and corruption within the worlds of law and finance, which further tilts the playing field against government interests. 

In light of all this, it's time to ease out the provision of BIT that allows foreign investors to do forum shopping and enjoy preferential treatment by way of access to international arbitration in their preferred locations that foreign (western) businesses enjoy while doing business in India. The BITs should be amended to this effect. India does not have a track record of expropriation of foreign assets to merit this undesirable layer of contract insurance against the Indian political, bureaucratic, and judicial system.

Update 1 (10.02.2024)

Times has a very good article illustrating the problems with international arbitration. In this case, two small-time Irish businessmen won $6.6 billion in damages from a London arbitration panel for the revocation of a corrupt contract won by them with the Nigerian Ministry of Petroleum Resources. Consider the contract.

The original contract said that Nigeria had to give P.&I.D. wet gas not for a year or two, but for 20 years. Nigeria had failed to do this. Even though P.&I.D. hadn’t yet spent a penny on construction, Nigerian law — like British law — held that the party who breached a contract had to make the other party whole by paying them the amount they would have made had the contract been fulfilled. What this meant: When Nigeria paused on the wet gas, a legal wire was tripped. Nigeria owed P.&I.D. for two decades of hypothetical future profits from the sale of gas byproducts they had never processed, in a facility they had never built. But how much was that?

P.&I.D. had commissioned a report by a consulting firm, Berkeley Research Group, which laid out estimates of revenue and cash flow if the project had come to fruition. Financiers use something called a “discount rate” to calculate the value of future profits, taking into account all the risks that might be involved. The greater the risk of an investment, the higher the discount rate, and the lower the present-day value. Investments in Nigeria were considered risky because of political instability and corruption, so the standard discount rate at the time was more than 10 percent; the Berkeley report used 2.6 percent. On another page of the report, Berkeley predicted that oil — whose price historically correlates with that of natural-gas byproducts — would rise steadily, year after year, to $115 a barrel in 2024; but commodity prices fluctuate for all sorts of reasons, and today oil trades for $75 a barrel...

They weren’t paying bribes to lubricate an otherwise-solid project; they seemed to be paying bribes because they barely had a project at all. An early drawing of the wet-gas unit was a ripped-out piece of lined paper with hand-drawn pipelines on it, squiggles of blue marker representing water. A later drawing — the one they showed the Ministry — was a screenshot they took from designs for a different facility. By the end, the 34 bundles of evidence told a story that one lawyer for Nigeria categorized as “industrial scale” fraud. The former band managers, they argued, had shaken down a sovereign state for $6.6 billion, for failing to fulfill an illegally procured contract that relied on copied plans for a different project... The company was essentially a financial abstraction, a piece of paper that might or might not be worth a fortune (the award was now $11 billion with interest). It all depended on the outcome of the trial.

The case exposed the problems with secret arbitration proceedings. 

Born estimates that about 1,600 arbitration cases are filed every year in which one party is an investor and the other party is a state or state-owned enterprise, but the opacity of the system makes exact figures impossible to get. In some arbitrations, we know the parties, but the specific details of the proceedings remain private. In a majority, however, the existence of the arbitration itself is never disclosed... “If it was in court, it would be public,” Stephan Schill, a professor of international law at the University of Amsterdam, says of the P.&I.D. affair. “The press would monitor it, and would immediately pick out problems. The confidentiality is a big problem. It makes it easier to hide corruption.”

In one of the rarest examples, a Civil Court in London over-turned the arbitration judgement.  

Weekend reading links

1. Debashis Basu writes about the case of C&C Towers Ltd (CCTL), the latest example of the unholy nexus between bankers and businessmen that has resulted in socialised losses.

It had signed a 20-year concession agreement with the Greater Mohali Area Development Authority (GMADA) in April 2009 for an inter-state bus terminal (ISBT), three multi-storey towers with retail and office spaces, a multiplex, a five-star hotel, a banquet hall, hypermarkets, and a helipad on top of one of the towers. The project turned bankrupt and went into liquidation, and was admitted for debt resolution. On October 19, the Chandigarh Bench of the National Company Law Tribunal (NCLT) passed an order... against an admitted claim of over Rs 579 crore, the resolution plan could provide for only Rs 81.5 crore, or just 14.08 per cent... The moment CCTL bagged the large multiplex project, it immediately gave an advance of Rs 110.78 crore as pre-construction advance and Rs 63.30 crore as mobilisation advance to a group company, C&C Construction Ltd (a listed firm which is also bankrupt). As always, a bunch of public-sector banks sanctioned money in November 2010. CCTL also collected Rs 490 crore from 400 property buyers. Construction was inordinately delayed, leading to the GMADA issuing termination notice in April 2016 and invoking bank guarantees of Rs 11.90 crore. A corporate insolvency resolution process (CIRP) started on October 10, 2019...

Consider these details of related-party transactions. CCTL had extended an advance to the extent of 35 per cent of the contract price to C&C. The transaction auditor has pointed out that the general business/industry practice is to advance 15-20 per cent of the contract value. As much as Rs 25.93 crore of the advance is still unadjusted against construction. CCTL had also made an excess payment of Rs 40.87 crore to C&C over and above the bills and mobilisation advances allowed. No lender approval had been sought for this payment, said the NCLT order. According to the terms of the contract, CCTL had the right to impose and levy liquidated damages of 0.25 per cent of the contract value per week or part of a week, a maximum of up to 5 per cent of the total contract value, ie Rs 15.82 crore in the case of default by the contractor (C&C). The work was scheduled to be completed within 18-30 months from December 16, 2009, for the ISBT and the hotel & commercial complex. Despite inordinate delay, CCTL has not imposed liquidation damages on C&C.

Basu is spot on in his assessment,

The CCTL promoters crafted a contract to drain substantial amounts of money and got away with it. The bankers and “independent engineers” of the GMADA did not monitor the project and did nothing to prevent money from being drained off to group companies. They are primarily responsible for this fraud, but they too got away... What were the bankers doing? What were the engineers of the GMADA doing? The answer is crystal clear in all such bankruptcy cases (especially in real estate involving public-sector banks), but it is one that we don’t want to see: Rampant fraud and corruption by everybody involved... The source of humungous bad loans that are written off periodically has nothing to do with poor bankruptcy laws, as claimed by bankers, such as Arundhati Bhattacharya, former State Bank of India chairperson. Yet, there is widespread opposition (even articulated by former Reserve Bank of India governor Raghuram Rajan) to criminal action against bankers because they would like to label these normal “business failures”.

Solutions like IBC and privatisation of banks without addressing fundamental issues of governance and political economy are like band-aid policies. 

2. Interesting that the technology companies have laid off more people in India this year than all but the US! And layoffs among startups in India this year has already exceeded that for the full of last year.

This hiring winter comes even as Infosys and Wipro which together hired 208,000 graduates last three years have announced that they'll not be hiring this year. This is the first time since 2008 that any of the big Indian IT firms have not hired. 

3. China's Belt and Road Initiative (BRI) is at a crossroad.

The decline in investments has also been accompanied by rising criticism and domestic opposition in BRI countries, even as those countries struggle to repay the loans. 

The best example is Pakistan where projects worth $62 bn have been committed. But 40% of projects have run into problems of corruption, cost overruns, funding shortfalls or adverse environmental impacts, and 20% have been cancelled or delayed indefinitely.

The current problems should also not take away from the scale at which BRI was done and its unprecedented promise.

Recipient countries such as Pakistan find themselves able to finance projects they could never have dreamt of under old-style foreign bilateral or multilateral aid programmes, from power plants to high-speed data networks... “In some senses, it was an absolute game changer,” says Bilal Gilani, executive director of Gallup Pakistan, a consultancy. He added that China was bringing in almost as much foreign investment into energy alone than “what Pakistan received as FDI in total in various sectors in 25 years prior to CPEC”. Hussain, the Pakistani senator, goes further, saying infrastructure on this scale was inconceivable in the country prior to BRI. “The only two projects which we have successfully done with a certain sustainability, with a certain perseverance, with a certain determination — one was the nuclear bomb . . . and the second is CPEC.”

A big problem has been the absence of private sector linkages. The Chinese have avoided seeing BRI as an economic investment opportunity. Instead, they have followed the model of lending, contracting, and supplying, thereby multiplying the value capture from the loans and limiting local spillover benefits. 

“[We hoped] to get some Chinese companies to invest in Pakistan, in our special economic zones and then to export,” says a former Pakistani official, who declined to be identified. “That never took place. It’s OK to borrow money and build infrastructure, but it’s more difficult to bring investors into our zones to make stuff and sell it.” This lack of follow-through from Chinese private companies has arguably been CPEC’s biggest shortcoming. Analysts say that few Chinese businesses have shown an interest in setting up factories there, depriving the Pakistani government of the foreign currency earnings needed to service its non-rupee borrowings.

4. Livemint points to the annual survey of Indian cities by Janagraha and has some interesting graphics. This on the human resource deficiencies of Indian cities

This on the the low degree of devolution of powers to municipalities. 

This on how poorly paid municipal councillors are.

5. Tell-all memoirs by senior government officials like this do a lot of dis-service. Most often, as in this case, it's driven by personal agendas and egos. If that's not bad, it immediately increases risk-aversion in already risk-averse governments. 

Senior bureaucrats earlier too used to write their memoirs. But there are three differences. One, their memoirs used to be atleast some years after their retirement. Two, even when it came out, it avoided controversial topics and playing to the galleries. Three, these memoirs used to be dignified accounts. 

6. Some snippets on the emerging trends with the Indian economy.

Sample this about wages

Real wages of casual wage workers in agriculture shows a negligible growth of 0.1% per year compared to the wages in 2019. For non-agricultural wages, they are yet lower than the level in 2019, with a decline of 1.1% from a year earlier... The situation for regular workers is no better... The latest Periodic Labour Force Survey (PLFS) gives their earnings in 2022-23. Still, they fare worse, with real earnings remaining lower compared to the pre-pandemic levels. For the April-June quarter, real monthly earnings of regular workers have declined 0.5% per annum compared to their 2019 level. This is also true for the July-September quarter of last year, which shows real earnings decline at 1.6% per annum compared to their 2019 levels. But even compared to 2017-18, which is the year when the PLFS series begins, real earnings are lower for every quarter of 2022-23 compared to their levels in 2017-18. The decline is greater when compared to 2017-18, at an average 1.8% per annum.

This on a possible K-shape in the housing loans sector,

The housing loan interest rates before May 2022 had stood at 6.5-7%. Now they are at around 8.4% to 10%, with housing loan equated monthly instalments (EMIs) having jumped 20%. But this hasn’t slowed down their disbursal. Why? The answer lies in looking at the breakdown of housing loans between priority sector loans and the non-priority loans. Priority sector housing loans are defined as: “Loans to individuals up to ₹35 lakh in metropolitan centres (with a population of 10 lakh and above) and up to ₹25 lakh in other centres… provided the overall cost of the dwelling unit in the metropolitan centre and at other centres does not exceed ₹45 lakh and ₹30 lakh, respectively." The remaining loans are non-priority loans.

In the months leading up to May 2022, priority sector housing loans formed around 35-36% of the overall outstanding housing loans of banks. By June 2023, they had fallen to 31.5%, implying that banks are giving out more non-priority housing loans. Of course, these loans are largely taken on by the well-to-do, who do not get impacted much by the rise in EMIs. In fact, the outstanding priority sector housing loans of banks from January to June have been just 1-2% higher than during the same months in 2022. When it comes to non-priority housing loans of banks, they have been around 22% higher from January to June in comparison to the same months in 2022. Further, the percentages don’t explain this inequality well enough. The outstanding priority sector housing loans from June 2022 to June 2023 went up by ₹137.76 billion. In comparison, the non-priority sector housing loans went up by ₹2.47 trillion, nearly 17 times more.

And this about automobile sales in India. 

Vehicle sales have been declining since 2018-19 and car and passenger vehicle sales have been nearly stagnant since 2011-12. The real growth in all categories happened from 2003-04 to 2010-11.  

7.  One of the intriguing things has been the stock market's calm reaction to geopolitical events like in the Middle East. But Ruchir Sharma points to historical data which appears to inform that the reaction now is par for the course.

In the days after the terror attacks in the US on 9/11, much cited as an analogue to 10/7 in Israel, America was on red alert for a follow-up. The S&P 500 fell by 12 per cent, the fall magnified no doubt by the fact that the US was six months into an eight-month recession. But that phase passed quickly — the S&P 500 would recover all its losses by October 11. The same pattern can be traced back much earlier. Looking at the stock market reaction to 25 of the most significant geopolitical crises since the second world war, including cross-border conflicts from Korea in 1950 and acts of terror from the first World Trade Center bombing in 1993, the S&P 500 dropped on average by around 4 per cent, reaching bottom in 15 days, but recovering fully in 33 days. Sixteen of these events took place in the Middle East or stemmed from conflicts or terror groups there — such as the bombings on public transport that hit Madrid in March 2004 and London in July 2005. After an initial impulsive sell-off, the market usually recovered the losses quickly. And the market sell-off on the latest conflict in the Gaza Strip is so far less striking than it has generally been. The bigger worry is rising interest rates.

We tend to overreact to present crises

The collective mind of the market, in contrast, recognises geopolitical risk as a historical constant, and frames fraught moments in that context. Is it clear, for example, that the Middle East is more precarious now than during any of the major conflagrations there since the second world war? That Russia is a more dangerous power after the loss of half its combat capacity in Ukraine? That China is a greater threat today, despite the steady weakening of its economy? The sum total of these threats is highly uncertain and debatable; the market, an aggregation of millions of views, is inclined not to rush to judgment. I met the legendary investor Julian Robertson in the late 1990s, when the hopes for world peace that followed the collapse of the Soviet empire were erased by new risks, including India and Pakistan carrying out a series of nuclear tests. Robertson advised me, as a young rookie investor, not to overreact.

This is a very wise article. 

There's a natural propensity of humans to be more alarmed by their present and be blind to the long view. Are we really in a more fractured times? Is it worse than in 1972-73 or 1979, or earlier times of convulsions, especially during the peak of the Cold War? I'm being deliberately contrarian here.

8. On the implications of India's decision to ban on rice exports on the face of rising prices

By the end of July, India had banned exports of non-basmati white rice and followed this in August with a minimum sale price for basmati rice and a 20 per cent tariff on parboiled rice, extended until March. “It’s tough when a country that accounts for 40 per cent of global trade slaps a ban on half of what they export, and duties on the other half,” says Joseph Glauber, senior research fellow at food security think-tank International Food Policy Research Institute (IFPRI) and a former chief economist at the US Department of Agriculture... the benchmark rice prices in Thailand and Vietnam, the world’s second and third largest rice exporters, have risen 14 and 22 per cent since India imposed its ban. Arif Husain, chief economist at the UN World Food Programme, points out that the countries likely to be worst affected are already suffering from a litany of woes: sky-high food prices, soaring debt and depreciating currencies... 

... countries in west Africa... are particularly exposed to India’s export ban, says the WFP’s Husain. In Togo, for example, almost 88 per cent of all rice imports came from India in 2022 and 61 per cent for Benin, the world’s largest importer of Indian broken rice. In Senegal, where 47 per cent of rice imports come from India... 

The rice export ban is also important since over 40% of the global rice exports come from India. 

The article points to concerns about global rice production going forward and its ability to meet the rising demand

Today’s predicament, analysts warn, is not so easily fixed. Fifteen years ago the world was not lacking in the grain, but that is no longer the case. The world population is set to reach close to 10bn by 2050 with the biggest growth in Africa and Asia. Researchers estimate this rise will increase demand for rice by almost a third, but yields are not keeping pace. After decades of rapid growth thanks to the development of new varieties, yields are stagnating in four big rice-producing countries in south-east Asia, according to a recent study in Nature Food, an academic journal. Globally, on average yields increased 0.9 per cent a year between 2011 and 2021, a slowdown from 1.2 per cent a year between 2001 and 2011, according to data from the UN. 

The chief reason for this setback is climate change. Because rice grows in hot climates — 90 per cent of the world’s rice is produced in Asia — it is often assumed that a few extra degrees will not matter... This is not the case. Above certain temperatures, rice yields drop, explains Sander, adding that the grain is particularly sensitive to night-time heat. A 2017 study found that a global increase in temperature of 1C was likely to reduce rice yield by an average of 3.3 per cent. Temperatures have already risen by at least 1.1C since pre-industrial times. Modelling by commodity data group Gro Intelligence forecasts that by 2100, Asia’s top rice exporters will all experience a sharp increase in the number of days above 35C, with Thailand potentially seeing an 188 additional days above this threshold in a worst-case scenario. For Asia’s rice-producing deltas, from the Mekong to Ganges, climate change could present other complications. As temperatures increase, sea levels rise and salty water flows into fresh water rivers, irrigation channels and the soil, reducing yields or making growing impossible.

9.  Parental income determines your SAT score in the US. Among SAT takers, the children of the richest 1% were 13 times and top 20% seven times more likely to score 1300 than children of the poorest quintile. 

Given the low proportion of SAT takers among poor students, the disparity becomes even greater when we compare the ratio for all students who score more than 1300.

And the picture of the distribution of SAT score by income is even worse.

10. Aswath Damodaran writes the obituary of ESG investing

Born in sanctimony, nurtured with hypocrisy and sold with sophistry, ESG grew unchallenged for a decade, but it is now facing a mountain of troubles, almost all of them of its own making... If an asset is less risky, it should have lower expected returns. Thus advocates who argue that improving ESG will make firms less risky are directly contradicting other claims that investors will earn higher returns if they invest in high ESG companies. Adding an ESG constraint to investing will lower expected returns, with the only question being how much, leaving fund managers who have fallen for its charms in a fiduciary bind.

And he points to an unintended perverse consequence of the ESG fetish,

ESG pressures have led publicly traded fossil fuel companies to reduce spending on exploration and to divest fossil fuel assets, but private equity has filled the investment void. Is it any surprise that after trillions of dollars invested in fighting climate change, we are just as dependent on fossil fuels now as we were a decade or two ago?

11. Rana Faroohar points to the latest UNCTAD report that highlights rising business concentration among exporters,

High levels of export concentration among the largest 2,000 firms globally increased during the pandemic. This was particularly true in developing countries, where data shows that the top 1 per cent of exporting businesses within each country received between 40 and 90 per cent of total export revenues for the nation as a whole. The median rate of corporate export concentration in a database of 30 developing countries is a whopping 40 per cent... The rise in corporate concentration has also mirrored the continued decline of labour share globally, which is down from 57 per cent in 2000 to 53 per cent today. As the authors put it: “The declining labour share and the rising profits of [multinationals] point to the key role of large corporations dominating international activities . . . [and] driving up global functional income inequality”.

12. Newspapers are reporting that Reliance is close to clinching a deal to buyout Walt Disney Co.'s India operations, Disney Star, at $7-10 bn. This would be a big coup for Reliance, coming on the back of pipping Disney Star to buy IPL rights for $2.7 bn and clinching a multi-year pact to broadcast Warner Bros Discovery Inc.'s HBO shows in India. 

This of course raises concerns about India's media landscape and the control that Reliance would exert on it, over advertisers, content producers, and audiences. 

13. India should refrain from pushing hard on IMF voting reform for now unless it has a good proposal with reasonable backing from others. As Alan Beattie has written here, any reform of IMF quotas in terms of voting rights proportionate to contributions or economic output is playing into China's hands and would leave India even worse off. He estimates that it would increase China'a voting rights from 6.4% to 14.1% and India's from 2.7% to 3.5%, a multiple of four compared to 2.25 now. 

For now, replenishing IMF and WB's finances without change in voting pattern would be in India's interest. This is an area where India and US align perfectly.

14. Akash Prakash explains the perspective of foreign portfolio investors to the Indian equity market

The primary concern regarding India is its valuations. India is now, along with the US, the most expensive market in the world. Most allocators are naturally hesitant to commit capital with such high expectations already priced in. The most common questions remain on what can go wrong and what are we missing? What are the flaws in the India story? Some mentioned that we have been here before only for India to disappoint in the past. Why is this time different? My sense is that on any correction, a wall of money is waiting to come in, as few doubt the long-term potential of India. Every allocator we met was clear that five years from now they will have a lot more capital in India than they have today. While new investors are hesitant to commit capital today, most of the existing India investors are happy to live with the current valuations and keep their allocations largely unchanged. I heard the comment that India has always been expensive many times from this set of investors. There seemed to be no desire to take profits off the table in any significant manner.

15. Seven US tech companies not only dominate the US S&P 500 but also the global markets.

Seven large US tech companies have driven all of the gains in global stocks this year, pushing the US dominance of equity markets to new heights. The so-called “magnificent seven” — Apple, Microsoft, Meta, Amazon, Alphabet, Nvidia and Tesla — have been propping up the S&P 500 index of blue-chip US companies for most of the year because of investor excitement about the growth of artificial intelligence. The trend has become so extreme that it is dominating markets abroad. But for the seven companies, MSCI’s benchmark All-Country World index of almost 3,000 large and midsized companies would have declined in the year to date, according to Bloomberg data. The seven have added almost $4tn in market capitalisation in 2023, compared with $3.4tn in gains for the MSCI index as a whole. They have added a combined 40 points to the index, which has risen 37 points overall. Unless there is a sharp turnaround by December, 2023 will mark the eighth year in the past decade that the US share of global market capitalisation has risen. US companies now account for 61 per cent of the $60tn index, compared with less than 50 per cent a decade ago. The largest 10 stocks make up almost 19 per cent of the index, up from 8 per cent in 2013.

This dominance has been accompanied by a rising concentration in valuations at the top in global equity markets. 

16. I have blogged on multiple occasions about the need for startup businesses to establish their value proposition to build long-lasting businesses and not focus on scaling/growth for its own sake. Here's what Nitin Kamath of internet stock brokerage firm Zerodha said while referring to his firm's valuation being "way higher than reality".

All of us on the core team have never thought of notional valuations right from the start because they can go up and down with market conditions. Focus on ever-changing valuations is a distraction... The focus has always been on building a resilient business, which means never having to rely on external capital.

17. Evoking memories of its crackdown on Jack Ma following his questioning of the government, China has cracked down on Foxconn

Two months ago, Terry Gou was talking big. Announcing his intention to run for president in his native Taiwan, Foxconn’s billionaire founder argued that China — home to most of the factories where the world’s largest contract electronics manufacturer churns out Apple’s iPhones — could not touch him or his company. “If the Chinese Communist party regime were to say, ‘If you don’t listen to me, I’ll confiscate your assets from Foxconn’, I would say: ‘Yes, please do it!’ I cannot follow their orders, I won’t be threatened,” Gou said, insisting his business interests would not make him beholden to China. Now, Beijing has called his bluff on that boast. Tax inspectors have descended on Foxconn subsidiaries in two Chinese provinces and are investigating land use by group companies in two others, in a co-ordinated large-scale probe that Taiwanese executives and government officials say smacks of a politically motivated crackdown... His presidential bid has irked the Chinese leadership because it further fragments votes for Taiwan’s opposition and makes a victory for the Democratic Progressive party — which refuses to define the island as part of China — more likely, said a person close to Foxconn.

This might perhaps be the crossing the Rubicon moment for China's relationships with foreign investors. For decades, Chinese provinces and the central government have courted foreign investors. Foxconn in particular was especially feted. But now that Chinese companies have acquired enough expertise across the value chain of manufacturing in many sectors, Beijing feels that it can afford to arm-twist foreign investors who refuse to follow the Party line.

GM Vs Apple - illustration of labour market challenge

Adam Tooze compares the output and labour force of GM and Apple to illustrate the labour market problem that faces modern manufacturing. 

In the 2010s a commonly quote set of numbers compared GM and Apple in their prime: In 1955 GM earned revenues of 105 billion in 2010 dollar terms well-nigh identical to Apple’s earnings in 2014. In 1955 GM generated this revenue with an American GM workforce of 470,000 as well as 70,000 staff working overseas in subsidiaries such as Vauxhall, Opel or Holden. It would go on to assemble a peak workforce of over 800,000 in the 1970s. In 2012 Apple, the iconic American firm of the decade, generated $ 108 billion in revenue, with a US staff numbering only 40,000. Overseas only 20,000 were employed directly by Apple. The vast majority of its workforce consisted of 700,000 foreign contract staff. GM was an American company with a clearly identifiable global footprint. Apple, by contrast, is a complex global network with a Californian brain.

In the context of secular stagnation, Larry Summers had written about the reduced cost of capital investments,

The internet revolution has allowed companies like WhatsApp—which had just 55 employees when it was acquired for $19 billion by Facebook in 2014—to reach a higher market valuation than Sony. Growing a multi-billion dollar company used to require hiring lots of workers, constructing offices and factories and so on. Nowadays, all you need is a loft and a couple of Macbooks. Summers also identifies a related problem: the types of capital companies actually do need to invest in—computers and software—have gotten drastically cheaper. The result is that as businesses open or expand, they no longer need to spread their wealth around by purchasing costly machinery.

The declining cost of capital equipment is driven by efficiency (and cost) maximising technological and process changes. While the former is well-known the latter is equally important. The emergence of process innovations like services outsourcing, shared services, Software as Service, and cloud computing has meant that companies can start with limited upfront capital investment. 

The rising capital intensity, decreasing cost of capital goods, and declining labour requirements of emerging technologies (especially compared to the ones they are replacing) coupled with the skill-biased nature of these technologies are the biggest political economy problems of our times. The first minimises labour requirement, and the latter bias it towards certain labour categories. 

In theory the reduced capital intensity, lower labour requirement, and process changes should have lowered entry barriers and increased competition. But this trend has been counteracted by network effects, consumer loyalty, and regulatory forbearance of abusive practices by large incumbents. The digital economy is only the most egregious example. The near-universal trend of business concentration shows that this trend is pervasive. 

So we have a confluence of three trends facing the economy - reduced labour requirement, preference for skilled labour, and increased entry barriers. Each of them run counter to one of arguably the most important economic priority of our time, the creation of lower-skilled jobs.

The challenges with forced formalisation of the economy

The informal economy has been an important topic of discussion in this blog. I have written here with my co-author about the problems with forced formalisation. History teaches us that informal to formal transitions happen not by way of informal sector firms becoming formal but in terms of expansion of the share of formal sector firms. Informal sector workers and firms face the binding constraints of deficient capabilities and resources to be able to transition to the formal sector. 

I have also blogged about how formality introduces layers of costs that the economy cannot support and thereby ends up dampening aggregate demand. Formalisation of all barbers does not take away from the stark fact that there are only so many Rs 100 haircuts that the economy can support. The vast majority of demand is for Rs 50 and below haircuts, which the informal economy cannot ever provide. 

Take the example of iron/metal scrap dealers. This economy involves hundreds of thousands of poor scrap pickers collecting scrap and selling it to local scrap dealers, who in turn sell it to upstream aggregators, who in turn sell it to re-rolling mills where the scrap is processed and converted into steel for construction and other lower end requirements. The chain from the scrap picker to the re-rolling mill often consists of several aggregators. Some of these aggregators are pure shell entities established to obfuscate and claim input tax credits (ITC) and evade the goods and services tax. 

Apart from these aggregators, there are also several other intermediaries - transportation companies, storage godowns, credit providers etc. But almost the entire network operates in the informal economy. Whilst it suffers from several inefficiencies, this informal sector provides livelihood for millions, including all the different kinds of intermediaries and their employees. This formal economy also exists because of the regulatory and legal arbitrage opportunities that help drive down aggregate costs for the upstream formal economy. 

Now consider the formalisation of this sector through Goods and Services Tax (GST). This would entail capturing transactions at different levels of aggregators and intermediaries and ending at the re-rolling mills. Further, a share of the value generated in this economy which was previously captured only by those in the informal sector now gets subtracted as tax revenues. 

Further, the re-rolling mill is now able to drive efficiencies by having greater visibility on its supply chain, being able to better monitor this supply chain, and contracting with fewer intermediaries. In the process, redundant layers and intermediaries are eliminated. All this increases the profit margins of the re-rollers and also the few large intermediaries (notwithstanding the loss suffered from difficulty to now indulge in fake ITC claims). 

The balance sheet of this transition is that the re-rollers and big intermediaries are likely to undoubtedly benefit. They'll expand and hire more people, and the more skilled and enterprising people in the informal sector will transition into formal sector employees. The government tax revenues from the sector will rise. However, a large portion of existing informal sector workers in the iron and metal scrap industry are likely to lose their livelihoods and be forced into penury and search for new livelihoods. 

In the partial equilibrium, the economic pie of the sector does not expand, but its distribution gets even more skewed towards the larger entities, and a share goes to the government. It's only natural that the pie going to the informal sector workers etc declines. In the general equilibrium, the pie will expand and the scrap sector will become more productive. But it'll both take time and the adjustment costs will be significant for a large share of those who were part of the informal economy. And in that time we're all dead or the costs are prohibitive enough to render the adjustment impossible!

In practice, such transitions are about the enrichment of some and the immiseration of others. Whether the former is a majority or not depends on the nature and pace of the transition. Are there sufficient interlinkages, capabilities, and restraints (on the mindless pursuit of efficiency and profits) to minimise the adjustment times and costs? What's the emerging structure of the formal sector in scrap collection, aggregation and trading? Are there adjoining or newly emerging sectors into which those forced out can be accommodated quickly? Is there enough time for these adjustments to happen? Forced formalisations, any change in general, more often than not end up failing and causing misery and suffering. 

Formality also introduces efficiency improvements which in turn eliminates redundant layers and intermediaries, technology that introduces transparency and leaves digital trails, and adds cost layers to the activities of intermediaries (they have to pay minimum wages, employment benefits, adhere to standards, pay taxes etc). This is the driving force behind the delayering and consolidation among aggregators. Over time, and it can sometimes be a long time, these trends have the effect of improving productivity and aggregate output. 

The example of iron or metal scrap trading applies to all informal sectors. They can be similarly disaggregated to identify the value chain and create a balance sheet of outcomes from formalisation. 

The point here is not an argument against formalisation, but to put the transition in perspective and draw attention to the complex nature of such transitions. As I wrote here with the example of climate change, economic transitions come with their costs.

I'll argue that any forced transitions to formality or higher labour or environmental standards is a supply shock induced demand compression, which invariably lowers the output. In general, any economic transition increases costs which if not supported by associated increases in demand, will necessarily lower output... formality introduces layers of production costs which increases the market prices, which in turn reduces market demand. At the higher price, only a smaller number of customers can afford the good or service. The cost structure of the formal market can be met by only a small proportion of the total demand. The market settles down to a lower equilibrium output. 

It's important to keep in mind these effects when we discuss and formulate policies on the issue of formalisation. 

Weekend reading links

1. In terms of annualised returns for several time periods, the Indian stock market tops, slightly superior to even the S&P 500.

While there's no doubt that for investors looking at the next decade and more, India stands at the pole position in terms of economic prospects. A large economy with relatively stable macroeconomic policies and domestic consumption being the predominant growth driver means that it's well placed to grow.  

But the big worry is the nature of its growth. In particular, the widening inequality and the relatively low growth in incomes for the vast majority is the problem. In other words, is the growth broad-based enough to sustain the high growth rates?

Whereas the share of GDP going to the top 1 per cent grew in China between the 1980s and the 2010s from 7 per cent to 13 per cent, in India it rose from 10 per cent to 22 per cent. India today is more unequal than post-apartheid South Africa and in the same ballpark as Putin’s Russia.

Yes, there is an Indian upper middle class that invests in the local stock market and that group is growing. But it accounts for 3 per cent of India’s population. By comparison, 13 per cent of Chinese hold some investment in the stock market, as do 55 per cent of Americans. And, as we know from the US, the vast majority of those retail investors have tiny holdings...

In 2020 on the World Bank’s Human Capital Index — which measures countries’ education and health outcomes on a scale of 0 to 1 — India achieved a score of 0.49, below Nepal and Kenya, both poorer countries. China scored 0.65, putting it on par with Chile and Slovakia, which have higher GDP per capita. Most dramatically disadvantaged are India’s women. Since 1990, Indian women’s labour market participation has fallen from 32 per cent to about 25 per cent. And behind them come hundreds of millions of underskilled youngsters. In 2019 less than half of India’s 10-year-olds could read a simple story, compared with more than 80 per cent of Chinese children and 96 per cent of Americans. In the coming decade, 200mn of these poorly educated young people will reach working age. A large share of them will probably end up eking out a living in the informal sector and getting by on handouts. Unemployment amongst the under-25s already runs at more than 45 per cent.

The article makes very good points, but it also makes some bloopers. 

Political connections may not give you the technological edge. But what they do deliver is easy credit. India’s growth has been heavily debt fuelled. Today it is Adani’s financial engineering that makes the headlines. But if you remember back to before the coronavirus pandemic, India was in the grips of a widespread bank crisis. Raghuram Rajan took on the job as governor of the Reserve Bank of India in the hope of cleaning house. By 2016 he was gone.

This is very bad analysis. For one, to extrapolate from the debt-fuelled rise of Adani to other corporate groups itself is wrong. In fact, the top Indian companies must be among the least leveraged and best performing in terms of return on equity etc globally. But to extend it to the Indian economy itself is ridiculous. The corporates have deleveraged and the banks have cleaned up their balance sheets. The household leverage is low, and sub-national government entities like municipalities are deeply under-leveraged. And Raghuram Rajan having initiated cleaning up the banking sector is more a lazy regurgitation of the popular social media narrative than any half-serious analysis. 

This is also the problem with commentators like Adam Tooze and Tyler Cowen who write on a very wide range of topics, based on secondary readings. It's one thing to write on Germany and European history, and point to good articles on the widest range of issues, but to start commenting about the fine details of Indian economy or African history is where they go terribly wrong and lose credibility.   

2. Times has a great story on Nepal's Pokhara International Airport which was built with Chinese debt and by Chinese companies, which is one more example of how the Belt and Road Initiative has thrust unnecessary infrastructure on low income countries and indebted them. 

The Pokhara airport highlights the pitfalls for countries that import China’s infrastructure-at-any-cost development model, which spins off money for Chinese firms, often at the expense of the developing country. In Nepal, China CAMC Engineering, the construction arm of a state-owned conglomerate, Sinomach, imported building materials and earth-moving machinery from China. The airport, built to a Chinese design, is packed with security and industrial technology made in China... an investigation by The New York Times, based on interviews with six people involved in the airport’s construction and an examination of thousands of pages of documents, found that China CAMC Engineering had repeatedly dictated business terms to maximize profits and protect its interests, while dismantling Nepali oversight of its work. This has left Nepal on the hook for an international airport, at a significantly inflated price, without the necessary passengers to repay loans to its Chinese lender...

CAMC’s winning bid of $305 million, almost twice what Nepal had estimated the airport would cost, raised the ire of some Nepali politicians, who called the price outrageous and the bidding process rigged. CAMC then lowered the price about 30 percent, to $216 million. China and Nepal signed a 20-year agreement in 2016; a quarter of the money would be an interest-free loan. Nepal would borrow the rest from the Export-Import Bank of China, a state-owned lender that finances Beijing’s overseas development work, at 2 percent interest. Nepal agreed to start repaying the loans in 2026.

The lack of local oversight is shocking

Nepal’s aviation agency was supposed to have teams of domestic and international experts as consultants, critical for a project of this magnitude, he said. But key roles were vacant, and the positions that were filled relied on recent college graduates with almost no experience. The initial construction budget had earmarked $2.8 million for Nepal to hire consultants to make sure CAMC was abiding by international construction standards, according to documents. As the project went on, the Chinese firm and Nepal lowered that allocation to $10,000, using the money elsewhere...

CAMC had started work before any consultants were in place, and that the work CAMC had done did not meet international standards. CAMC completed earth-filling work for the 8,200-foot runway, but it had no documentation that it had tested the soil density... no one on the Nepal side “knew how the foundation of the runway was built.” Without proper soil density, the runway could become bumpy or littered with cracks and potholes in the future... CAMC designed the airport drainage system without taking into account historical rainfall data in locations across Pokhara and the sloping topography near the site, forgoing a standard practice in international construction... There was also no paperwork ensuring the quality of Chinese-made building materials or information on the Chinese vendors providing the components... contrary to the stipulations in CAMC’s contract with Nepal... China’s Export-Import Bank, which had provided the loan, had appointed China IPPR International Engineering, a consulting firm, to track the quality, safety and timetable of the construction.

3. From an FT investigation on the hot-button topic of over-invoicing by the Adani Group

In January 2019, the DL Acacia, a 229m-long bulk carrier with a South Korean owner and Panamanian flag, departed the Indonesian port of Kaliorang in East Kalimantan carrying 74,820 tonnes of thermal coal destined for the fires of an Indian power station. During the voyage, something extraordinary occurred: the value of its cargo doubled. In export records the price was $1.9mn, plus $42,000 for local costs. On arrival at India’s largest commercial port, Mundra in Gujarat run by Adani, the declared import value was $4.3mn. The DL Acacia cargo was one of 30 shipments imported into India by Adani Enterprises that the FT examined in detail. In each case, the vessel’s customs records in India were matched with those filed in Indonesia. The records cover the period between January 2019 and August 2021, after which time Indonesian records ceased to be available...

According to the Indonesian declarations, these 30 representative sailings — totalling 3.1mn tonnes — cost $139mn, plus $3.1mn in shipping and insurance costs in Indonesia. The values declared to customs officers in India came to $215mn, suggesting the voyages made up to $73mn in profits, far in excess of plausible shipping costs. Coal trading is typically a high volume competitive business with profit margins in the low single digits. Priced in dollars per tonne, one expert in the Indonesian trade said “anything more than a couple of dollars above the market rate raises an eyebrow”. Adani Enterprises, the group’s oldest and most valuable company, generates the lion’s share of its sales and profits from its coal trading division called Integrated Resources Management...

Three “middlemen” companies that supplied the Adani group with coal appear to have made more substantial amounts: Hi Lingos in Taipei, Taurus Commodities General Trading in Dubai, and Pan Asia Tradelink in Singapore. Indian import data since July 2021 indicates Adani paid a total of $4.8bn to the three companies for coal sourced at substantial premiums to market prices... Senior industry traders questioned the use of little-known trading houses, as large buyers of coal generally prefer to partner with big trading houses that have strong credit ratings and a reliable record for commodity deals involving the exchange of hundreds of millions of dollars... Of the Indian import records reviewed, 311 shipments originating from Indonesia listed the calorific content of coal supplied to Adani by the middlemen. All but a few were priced at a premium to what the closest Argus benchmark price had been two to four weeks earlier, the typical shipping time from Indonesia to Gujarat. The median premium was 14 per cent.

Hard to refute these!

4. The protest democracy that South Korea is

Protest rallies have been a fixture of this capital city of Asia’s most vibrant democracy for decades, born during South Korea’s difficult march toward democracy in the 1980s when massive crowds, often armed with rocks, firebombs and even stolen rifles, clashed with riot police, tanks and paratroopers. Distrustful of their government, South Koreans have a penchant for taking all manner of grievances to the streets, so much so that it has turned demonstrating into a kind of national pastime.

As the coronavirus pandemic has receded, protest rallies have returned​ to Seoul with a vengeance. Barely a weekend passes without the city center ​turning into a raucous bazaar ringing with ​livestreamed protest songs, slogans and speeches that reveal a country increasingly polarized over its president. The vast majority of protests now are organized by rival political activists who use social media, especially YouTube, to mobilize supporters and livestream their gatherings. With churchgoers and other elderly citizens on the right, and mostly younger progressives on the left, they have become a public referendum on President Mr. Yoon Suk Yeol and his policies...

A typical demonstration features colorful banners and dance troupes romping on a temporary platform as concert speakers dangling from crane trucks blare protest songs. Organizers lead the crowd in chanting slogans, pumping their fists in unison or waving national flags. Peddlers weave through the throng hawking rain cover in summer and plastic cushions in winter. The hourslong rally usually ends with a march. Police officers walk alongside the demonstrations to keep order. Most of the rallies don’t make national news. But when they grow in size and intensity, they can herald a political storm ahead. Massive protests spearheaded by progressives in 2017 triggered the impeachment of Park Geun-hye, who was then the country’s conservative president. Monthslong protests led by Christian evangelicals galvanized a conservative pushback against Ms. Park’s progressive successor, Moon Jae-in, and helped Mr. Yoon win election as a conservative candidate in 2022...

Protest rallies in South Korea share elements of the populism sweeping much of the world. Both right- and left-wing activists accuse traditional news media of spreading fake news and political bias. They rely on social media platforms like YouTube for alternative news sources, using them to spread fears that South Korea is being dominated by a deep state (of corrupt conservatives or pro-North Korean progressives, depending on which YouTube channel one listens to). Livestreaming protest rallies has become a staple for partisan YouTube channels.

5. An article that explains how hard it's to diversify away from China for production of iPhones and how Chinese employees are assuming higher value added jobs in Apple's value chain,

Chinese companies with operations in India will still play a key role in Apple’s plan to make some iPhones in the country. In Chennai, India, the Taiwanese supplier Foxconn, which already manufactures iPhones in factories throughout China, will lead Indian workers’ assembly of the device with support from nearby Chinese suppliers including Lingyi iTech, which has subsidiaries to supply chargers and other components for iPhones, according to two people familiar with the plans. China’s BYD is setting operations to cut glass for displays, as well, these people said... The company is now increasingly tapping China to supply high-wage workers to do these jobs, these people said. This year, Apple has posted 50 percent more jobs in China than it did during all of 2020, according to GlobalData, which tracks hiring trends across tech. Many of those new hires are Western-educated Chinese citizens, these people said. 

The change in the way Apple works has coincided with an increase in the number of Chinese suppliers it uses. A little over a decade ago, China contributed little value to the production of an iPhone. It primarily provided the low-wage workers who assembled the device with components shipped in from the United States, Japan and South Korea. The work accounted for about $6 — or 3.6 percent — of the iPhone’s value, according to a study by Yuqing Xing, an economics professor at the National Graduate Institute for Policy Studies in Tokyo. Gradually, China nurtured homegrown suppliers that began to displace Apple’s suppliers from around the world. Chinese companies began making speakers, cutting glass, providing batteries and manufacturing camera modules. Its suppliers now account for more than 25 percent of the value of an iPhone, according to Mr. Xing.

6. FT long read on US Treasury basis trade by hedge funds, that involves paying two very similar debt prices against each other - selling futures and buying bonds - and extracting gains from the small gap using borrowed money.

The basis trade works by exploiting the gap in prices between Treasury futures, which commit users to buying at a certain price on a future date, and on cash bonds. Hedge funds sell the futures and buy the cash bonds, which they can deliver to the counterparty when the futures contract comes due. The difference between Treasury and futures prices is small, often just a few fractions of a percentage point, so the return is minuscule. But hedge funds can magnify their bets that the gap will close by using borrowed money to fund the trade.

Because Treasuries are considered the highest quality collateral, the prime brokerage divisions of major Wall Street banks are happy to lend against them, often at their full face value rather than a slight discount. In the repo market — short-term lending that facilitates a lot of Treasury trading — hedge funds need to post only small amounts of cash against their credit lines, sometimes levering up by more than 100 times. There is borrowing on the other side of the trade too; futures are inherently leveraged products and again, hedge funds need to put up only a small amount of collateral to satisfy the margin requirements of futures exchanges. Ten-year Treasury futures offered by US exchange group CME allow trades of up to 54 times the cash margin posted, for instance. By taking advantage of the ability to borrow on both sides of the trade, hedge funds can deploy huge leverage. The head of one fund that has engaged in this trade says traders have in the past been able to lever up to 500 times.

7. Is Xi Jinping China's latest Bad Emperor?

A Chinese reprint of a book about an emperor who ran his realm into the ground before committing suicide nearly 400 years ago has abruptly disappeared from book shelves in China and searches for it have been censored online. The Book Chongzhen: the Diligent Emperor of a Failed Dynasty, republished last month, recounts how the last emperor of the 1368-1644 Ming dynasty purged senior officials and mismanaged his kingdom before finally hanging himself on a tree outside the Forbidden City as rebels closed in on Beijing. The blurb on the book’s cover declares that the harder Chongzhen worked, the faster he brought about the collapse of the empire. “A series of foolish measures [and] every step a mistake, the more diligent [he was] the faster the downfall,” it says.

Thesis gone too far begets anti-thesis - explaining retreat of orthodoxy

The dominant trends for the last three decades like globalisation, liberalisation, trade integration, privatisation and so on are currently under attack. Mainstream commentary dismisses these critiques as regressive and detrimental to progress. It's assumed that these dominant trends are good for human development and economic growth and any deviation is undesirable and damaging. This narrative deserves to be questioned. 

I had blogged earlier here on the reversal of trends globally on important macroeconomic, trade, and policy issues. I argued that the orthodoxy on these issues is being overturned due to the challenges facing developed countries. 

There's another explanation for this reversal - a recalibration to correct for excesses. 

Take the example of the role of government. The FT is doing a series on the return of big government. I’m inclined to frame the return of big government as a reversion to the norm in the role of government. For nearly four decades, on the back of the neo-liberal ideology governments have been on the retreat. The dominant narrative has framed government actions as being detrimental to growth. 

Economic growth and development were best realized if governments stayed out of the way! The government’s role should be confined to the provision of certain public goods and the correction of a few market failures. This ideology sees no positive role for government in economic growth. The government has been retreating even from the provision of important public goods and social security (note the framing of the universal basic income idea).

Its manifestations include globalization, trade liberalization, outsourcing, financial integration, financialization, deregulation, technocracy, privatization, and technical solutions to development like cash transfers. It also meant that politicians and bureaucrats had marginal roles and important issues of economic concern were best managed by experts and technocrats.

These trends have now become momentum-driven and are not based on any evidence or logic. They have become ideological and are integral parts of the dominant narrative. They are also fuelled by the skill-biased technological advances of the times – digitization, telecommunication technologies, automation, artificial intelligence etc. 

The four decades have coincided with stagnant and even declining incomes among the poor, slow growth of middle-class incomes, persistence of poverty and deprivation, explosive growth in executive compensations, emergence of regressive individual and corporate taxation structures, hollowing out of manufacturing cores and loss of those jobs, loss of emergence of bad quality jobs, whittling down of labor market protections and loss of labor’s bargaining power etc. 

Amidst all these, for most people, the three biggest sources of household expenditure – housing, health care, and education – grew much faster than incomes could keep pace. This compounded the problems caused by income stagnation and widening inequality. 

Inequality widened to completely irrational and unhealthy extents. The ovarian lottery became ever more pronounced in determining life outcomes. Inter-generational social mobility stagnated, even reversed. Business concentration and political capture became characteristic features of the economic and political landscapes. The process of rule-making itself came to be captured by entrenched business interests. The social contract became corroded. 

Given the excesses that had accumulated across dimensions, the reversal was only to be expected. Each of the trends mentioned above had clearly gone too far, and now had to be reined in. The only thing to discuss was how this recalibration would happen. 

The political establishment was captured by entrenched interests. The left-wing parties and groups have become too weak, the centrists are too compromised to lead the recalibration. In the circumstances, a populist backlash is on, and populist ideologies are stepping into the political vacuum to assume leadership of the reversal process. 

Given this backdrop, the pushback and reversals were only to be expected and are even desirable. It's therefore wrong to tar everything with the same brush and oppose the entire reversal. As mentioned, the reversal is much needed. Perpetuating the existing system is tantamount to the protection of entrenched vested interests that have captured the economic and political system. 

The challenge is to calibrate the reversal and ensure that the anti-thesis does not swing to the other extreme. The problem is with the extremes. This is a big challenge, given that the dynamic of populism tends to move the pendulum to the other extreme.  

Even the latest global crisis playing out in Gaza can be viewed from this prism. Notwithstanding the barbarity of the Hamas attacks, we should not have been surprised by it. For seventy years, a population had been denied its rights, and in the last decade the issue had even dropped off the global radar, allowing Israel to undertake one of the biggest and longest collective punishments in history with blockades, air-strikes, and creeping encroachment through settlements. The Israeli government of recent years which was surviving on the support of two extreme right wing parties had thrown-aside any pretension of Palestinian rights. Any hope of a life without brutalisation, discrimination and humiliation was receding rapidly. The pendulum had swung to its extreme. Even the most oppressed and powerless will strike back when they can't take it any longer. 

As an aside, there's also something about the nature of such events. There's something universally repugnant about the concentrated massacre of 1300 people that is played out in social and mainstream media, as against a much more brutal occupation and dehumanising violation of the basic rights of over 5 million people in West Bank and Gaza that's long-drawn and played out silently off-camera, one that has led to the murder of several times more men, women, and children. 

The reversals on all important trends like globalization and trade liberalisation too should be viewed along the same lines. For three decades, globalization and trade liberalisation pressed ahead remorselessly. In the process, it engendered several distortions that conflicted with the interests of domestic political and economic systems. The discontent that had been brewing has now become powerful enough to turn the tide and recalibrate. This dynamic, popularly described as deglobalization and protectionism, should perhaps more appropriately be called balanced-globalisation.

There’s a natural dialectic associated with ideas. They trigger interest and get gradually adopted, with their degree of adoption increasing over time. This, in turn, creates distortions that cause a backlash against the idea. The backlash strengthens over time and results in a reversal of the excesses that had seeped into the idea. As Hegel wrote, thesis begets anti-thesis, both of which undergo a struggle to generate a synthesis. Another framework to view this is that of the cycles of history, one which people like John Bagot Glubb, Neil Howe, William Strauss, and Peter Turchin have popularised. It's useful to view the ongoing trends in the global economy and politics from this perspective.