Progress and economic growth

I have blogged here pointing to the work of English philosopher John Gray who makes the distinction between progress in the scientific and social realms. While progress in the former is mostly continuous upward improvement, the latter is more complicated and could involve periodic reversions. 

Nowhere are such reversions more relevant than in the economic realm, where contrary to conventional wisdom not all trends over time constitutes progress. For example, the free-market economy’s remorseless pursuit of efficiency and profits maximisation poses a serious threat in so far as it can undermine all other arguably at least as much or even more important important factors - resilience, culture, history, community, equity, fairness etc. I have blogged on several occasions how the pursuit of efficiency maximisation has lowered resilience. The pandemic exposed us to the shortcomings of such relentless pursuit. 

In this context, I came across two articles about such trends in diverse parts of the economy. 

The first concerns how England’s Premier League clubs are trying to capture more of the consumption that happens on match day from the local economy of food trucks, pubs, and small restaurants. This NYT article informs how Aston Villa’s new fan zone is competing with the local entrepreneurs many of whom have been there for decades. 

Mr. Aujla has been a fixture outside Villa Park, in one place or another, for more than four decades, but Tony’s Burger Bar has been here, on this enviable and specific real estate, for three years — one of a handful of vans, all of them occupying much the same space, all of them offering roughly the same menu, all of them wreathed in the steam from their fryers. Recently, though, they have had to contend with the arrival of a rival on a slightly larger scale: an official fan area intended to lure customers, and some of the money in their pockets, away from the vans and straight to the club itself. 

In March 2022, Aston Villa repurposed Lions Square, a trapezoid of land in the shadow of Villa Park, into a “fan zone” — a sort of officially sanctioned tailgate — complete with a stage for live music, interviews with beloved former players, a couple of bars and a smattering of food trucks. It is not the first Premier League team to explore the idea, long a staple of major international soccer tournaments. Crystal Palace, Liverpool, Manchester City and a number of others have experimented with variations on the theme, and more intend to follow suit: Newcastle has announced plans to establish one outside its home stadium, St. James’s Park… Aston Villa, like most of its Premier League peers, is exploring a broad selection of options as it seeks to expand what it offers its visitors — its customers — in an attempt to monopolize what, and how, they spend…

Mr. Aujla knows the rhythm of game days instinctively. About 90 minutes before kickoff, it is relatively quiet. Fans are still boarding trains, or parking their cars, or thronging the pubs. Trade will pick up as the game approaches. Peak time will come in an hour or so. “Come back then,” he said. “We’ll all have queues.” There is competition among the food trucks, of course, but it does not bleed into rivalry. There has always been more than enough trade to go around, Mr. Aujla said. “You see a lot of the same faces,” he said. “People tend to have a favorite and stick with that one.” His van, and those nearby, are just a couple of the dozens of pubs, bars, restaurants and takeaway shops that dot the terraced streets around Villa Park, a shoal of remoras all reliant on the great whale at their center for their existence. Fan zones, on some level, threaten that tacit arrangement. The whale, in effect, has decided it wants to keep more.

The clubs have packaged this as part of efforts to improve fan experience, improve in-stadium offering, expand the period of fan engagement to the whole day, better manage fan movement if some come a little earlier etc. But the main motivation is obvious - “fan zones are another revenue stream to be tapped”! The clubs know that while the returns from this new revenue stream is relatively small, “it’s a margin nonetheless”. 

This revenue maximisation strategy is in its very early stages and therefore have not started to threaten the local entrepreneurs. But such strategies generally follow a process of continuous iteration and gradual expansion of the market share. It’s a fair bet that at some time, for whatever factors, the cannibalisation by the fan zones start to seriously hurt the local entrepreneurs and lead to many of them eventually going out of business. Apart from catering to match day consumption, these enterprises have been integral to the fabric of the local community besides also serving the local economy outside of football fans and match day. How do we characterise such a situation as progress?

Like maximising the value capture from fan consumption, the market dynamic ends up creating distortions in the form of resource misallocation of talent. A trend that has triggered much debate is whether the glamour and money associated with finance ends up sucking up a disproportionate share of human resource talent. The Times has a report on the latest example of how technology businesses are out-paying universities to lure away researchers from universities. Its illustration is Arena BioWorks, a pharmaceuticals startups financed by a few ultra-rich individuals. 

The group, bankrolled with $500 million from some of the wealthiest families in American business, has created a stir in the world of academia by dangling seven-figure paydays to lure highly credentialed university professors to a for-profit bounty hunt. Its self-described goal: to avoid the blockages and paperwork that slow down the traditional paths of scientific research at universities and pharmaceutical companies, and discover scores of new drugs (at first, for cancer and brain disease) that can be produced and sold quickly.

The model pursued by Arena BioWorks not only displaces talent from universities but also threatens to upend practices and norms with more profound consequences. 

The wrinkle is that for decades, many drug discoveries have not just originated at colleges and universities, but also produced profits that helped fill their endowment coffers. The University of Pennsylvania, for one, has said it earned hundreds of millions of dollars for research into mRNA vaccines used against Covid-19. Under this model, any such windfall would remain private… “It used to be that it was considered a failure to go from academia to industry,” said Dr. Joung, a pathologist who helped design the gene-editing tool CRISPR. “Now the model has flipped”… From 2010 to 2016, each of the 210 new drugs approved by the Food and Drug Administration was connected to research funded by the National Institutes of Health, according to the scientific journal PNAS. A 2019 studyfrom a former dean of Harvard Medical School, Jeffrey Flier, said a majority of “new insights” into biology and disease came from academia.

The motivations for these ultra-rich individuals and academic researchers to mobilise around this new model of drugs development.

The motivation behind Arena has scientific, financial and even emotional components. Its earliest backers first mused about the idea at a late-2021 confab at a mansion in Austin, Texas, where Mr. Dell, along with the early Facebook investor James W. Breyer and an owner of the Celtics, Stephen Pagliuca, vented to one another about the seemingly endless requests for money from collegiate fund-raisers. Mr. Pagliuca had donated hundreds of millions of dollars to his alma maters, Duke University and Harvard, largely earmarked for science. That earned him seats on four advisory boards at the institutions, but it began to dawn on him that he didn’t have any concrete idea what all that money had produced, save for his name on a few plaques outside various university buildings. Over the subsequent months, those early backers teamed up with a Boston venture capitalist and trained medical doctor, Thomas Cahill, to devise a plan. Dr. Cahill said he would help find frustrated academics willing to give up their hard-fought university tenure, as well as scientists from companies like Pfizer, in exchange for a hefty cut of the profits from any drugs they discovered. Arena’s billionaire backers will keep 30 percent, with the remainder flowing to scientists and for overhead…

Universities, generally helped by their nonprofit status, have a nearly limitless, low-paid supply of research assistants to help scientists with early-stage research. Groundbreaking drugs, including penicillin, were born from this model. The problem, scientists and researchers say, is that there can be yearslong waits for university institutional approvals to move forward with promising research. The process, aimed at sifting out unrealistic proposals and protecting safety, can involve writing long essays that can consume more than half of some scientists’ time. When funding does come through, the initial research idea is often already stale, setting off a new cycle of grant applications for projects sure to be outdated in their own time… They say they are frustrated with the slow pace and administrative bogdowns at their former employers, as well as what one new hire, J. Keith Joung, said was “atrocious” pay at Massachusetts General Hospital, where he worked before Arena.

The motivations of the funders and researchers are clearly material, aimed at maximising value for their capital and their talents. Unlike others Mr Pagliuca is being candid in stating the reasons behind his donations to universities. Further unlike the past when the biggest donors made largely untied donations to establish the big universities and colleges, today’s philanthropy from new corporate wealth is less benign in its pursuit of specific agendas. It’s also about control over how those agendas will be pursued. How can we consider this as progress?

Should scientific research be dictated by the priorities of a few wealthy people? Should universities prioritise advancing the frontiers of basic science or applied science? What social and ethical norms should govern philanthropic donations to educational institutions? How much control should donors be allowed over the uses of their donations to these learning centres? 

In each case, the fundamental driving force was money. The EPL clubs were clearly motivated by the desire to maximise consumption value capture from the football fans. The academic researchers were largely motivated by the much higher riches from the new model, and the investors/donors were motivated by their interest in setting the agenda and controlling its pursuit. Unfortunately, the dynamics of the markets end up marginalising all other considerations. How do we say all this is progress?

Weekend reading links

1. The  yield curve represented by the gap between the two- and ten-year US Treasury yields has been inverted since July 2022. 

At the deepest point of inversion in July last year, 10-year notes offered 3.9 per cent, against almost 5 per cent for two-year debt. This week the gap shrank as low as 0.15 percentage points but still remains inverted. And regardless of the precise curve being measured, this current inversion over 19 months and counting is the longest since the early 1980s... An inversion has preceded every recession in the past 60 years and only sent a wrong signal through inverting once, in 1965, according to a 2018 paper by economists for the Chicago Federal Reserve.

2. Good summary of democracy's Greek beginnings. It's as relevant today as it was then.

Before Athens acquired the form of government that its founders called demokratia in 507BC, the main political faultline wasn’t tyranny vs the people; it was the ever-wealthier rich vs the vulnerable poor. Wealthy landowners leased property to the poor, who worked it for a living. Every so often, the owners would increase their rents. If tenants couldn’t afford to pay, the rich offered them loans at high rates of interest. The wealth gap widened. Tenants struggled, defaulted on their debts. Athens’s plutocracy-friendly laws allowed creditors to force debtors into slavery, until poorer Athenians revolted. In the early sixth century BC, terrified plutocrats asked a man called Solon to fix things before they got worse. He made it illegal to enslave debtors, created stimuli for a range of new trades and abolished hereditary political privileges. This wasn’t yet full democracy, and Solon’s new deal soon failed. The plutocrats went back to exploiting their compatriots, who did what the vulnerable always do: turned to a tyrant who promised to fight their corner. Though Peisistratos confiscated some of the nobility’s lands and gave them to the poor, this didn’t lead to democracy, since the tyrant monopolised political power for himself and his family.

When a group of well-born Athenians deposed Peisistratos’s son, they realised two things. First, that very unequal societies are less stable, productive and humane than those where inequalities are held in check. Second, that you can’t trust a single class or party to do the checking in a way that seems fair to all. The reformers put all free Athenian men on a more equal footing than ever before and redesigned government into units where rich, poor and middling citizens were forced to sit together in assemblies, arguing, compromising and rotating positions by lot... According to the Solon story, democracy was designed as a realistic solution to a concrete problem: how to stop the endless civil strife that came from gaps in personal and social security between richer and the rest. This was common democratic sense for centuries before the modern era introduced a sharp ideological divide — initially within a broad liberal tradition — between weakly and strongly regulated markets. Democratic freedom isn’t a condition where my private wishes can roam unchecked and acquire as much power or wealth as I can without considering how this affects others. It’s a key part of a power-sharing scheme called democracy. What makes democratic freedom democratic is precisely that it sets limits on my personal freedoms within this scheme, leaving opportunities and decent options for everyone else. 

3. The impact of Houthi attacks at the entrance to the Red Sea is staggering

Hundreds of ships are avoiding the Suez Canal and sailing an extra 4,000 miles around Africa, burning fuel, inflating costs and adding 10 days of travel or more in each direction... About 150 ships passed through the Suez Canal, which lies at the northwest end of the Red Sea, during the first two weeks of this January. That was down from over 400 at the same time last year, according to Marine Traffic, a maritime data platform... Shipping companies have tripled the prices they charge to take a container from Asia to Europe, partly to cover the extra cost of sailing around Africa. Shipowners that still use the Red Sea, mainly tanker owners, face rising insurance premiums.

4. The wisdom of owning the market

Despite that fierce bear market — and six others, including the pandemic bear market that began on Jan. 3, 2022 — these are the returns of the S&P 500 over the long haul from Aug. 31, 1976, through November, according to Bloomberg: Based on price alone, the S&P 500 rose 8.4 percent, annualized, or a cumulative 4,338.6 percent. Including dividends reinvested regularly in the index, the total return of the S&P 500 was 11.4 percent annualized, or a cumulative 16,145.4 percent.

5.  Infrastructure has been the hottest asset class in 2024. First came the purchases of Global Infrastructure Partners by BlackRock for $12.5 bn, making it the third biggest infrastructure asset manager after Macquarie and Brookfield. This was followed by the acquisition of UK infrastructure fund Actis by General Atlantic. And now Macquarie has announced that it had raised a record €8bn for its new European infrastructure fund. This is the firms seventh European infrastructure fund and the largest ever. 

The prospects of increased investments in combating climate change, re-alignment of global supply chains, increased investments in chips, investments in data centres to power the AI revolution etc is driving the momentum on infrastructure. Macquarie has about €170 bn in real assets under management.   

The latest fund is targeting a low double-digit net internal rate of return. Investors are mainly pension funds and insurance companies but the group includes sovereign wealth funds and family offices. Macquarie is also working to bring on wealthy individuals as backers in its infrastructure funds. About half the fund’s investors are based in Europe, the Middle East and Africa, with about a third in the Asia-Pacific region and the remainder in the Americas. The target for the fund was €7bn- €8bn.

6. Interesting point about how food prices in India appears to have decoupled from the global price trends.

India has become self-sufficient and even an exporter in all food products other than edible oils and pulses. 

7. The protests by EU farmers this week is an illustration of the political economy challenges in fighting climate change. Despite its small share of the output, agriculture forms a major share of the EU's budget,

Agriculture contributed 1.4 per cent to the EU’s gross domestic product in 2022, according to the commission, but it employs some 8.7mn people, many of which are in eastern and southern Europe. The EU’s €387bn flagship Common Agricultural Policy, a framework of subsidies for farmers, accounts for around a third of the bloc’s 2021-27 joint budget.

The protest are being driven by discontent at EU regulations on agriculture

The protests are in large part driven by dissatisfaction with policymakers who prioritise cutting carbon emissions and preserving biodiversity over supplying consumers with homegrown food. Farmers are particularly angry with the bloc’s “farm-to-fork” strategy and other regulations they say damage their competitiveness against imports, even as they struggle with inflation and more extreme weather... The German government’s attempts to scrap an agricultural diesel subsidy, an edict to cull cattle herds in Ireland and an influx of Ukrainian grain into neighbouring EU countries has further infuriated the sector... 

Edwige Diaz, an MP from the RN in the French parliament from the Gironde region of south-west France, said their message of defending farmers from the excesses of Brussels regulation and unbridled globalisation was hitting home. “We want to cancel the EU’s farm-to-fork strategy, which would drastically cut farm yields in the name of preserving nature and the planet, yet make us more reliant on imports that do not respect any such rules,” she said. “Farmers will have little hope of things changing unless those in government are replaced.”

The discontent has provided fertile ground for far-right political parties to tap into. 

8. More signatures of "soft landing" for the US economy.

The US economy grew at a 3.3 per cent annualised rate during the final quarter of last year, capping off a strong 2023... For the year as a whole, the US economy expanded by 3.1 per cent, confirming it was the world’s fastest-growing advanced economy in 2023... Separate data released on Thursday showed consumer prices rose at an annual rate of 1.7 per cent in the fourth quarter, down from 2.6 per cent three months earlier... While the pace of growth in the fourth quarter cooled from the breakneck 4.9 per cent rate set in the previous three months, it was far higher than economists had expected. The 3.1 per cent expansion for the year as a whole also beat forecasts.

The US personal consumption expenditure index, the key measure of inflation that Fed uses in its rate setting decisions has been on continuous decline.

In the meantime more evidence that the ongoing decline in inflation has mostly been due to restoration of supply than actions of the Fed.

The CEA calculates, using research by Janet Yellen before she became Treasury secretary, that 80 per cent of recent disinflation was due to supply swings. Which, of course, lie outside the Fed’s control — and its models. 

See also this about how economists got it all wrong again about predicting the economy. 

9. Japan's labour force challenge in a graphic - 11 million workers short by 2040.

10. Fascinating contrast between the characteristics of two industries which are among India's largest exports - petroleum products and software.

India boasts of vast production capacity in one industry. The country is the world’s third largest exporter of its industrial products... Over 90% of the value generated in this sector accrues to capital owners. Thus, the positive wealth effect of these exports is limited. As it is one of the least labour-intensive industries, it employs only around 300,000 people. Almost all its raw material is imported, resulting in the highest foreign value-added content in Indian exports among all industries, and low employment generation via backward linkages... This is India’s refined petroleum industry, which contributes more than 20% to our merchandise exports in value terms. Contrast this with India’s leading services export: information technology (IT). Today, its exports in value terms are 1.5 times that of petroleum exports. Back in 2012-13, both were at nearly similar levels. The domestic value-added content of IT exports is among the highest. The labour share of value addition is only a bit less than 50%, compared to under 10% in refined petroleum. Close to 60% of employment in the sector is related to exports. Direct employment by IT services in India is estimated at 5.1 million, so about 3 million jobs are export-related. IT services have backward and forward linkages in sectors like transport, hospitality, security and housekeeping services, personal services, apart from the demand their employees generate for real estate, consumer durables, etc.

11. Finally, Andy Mukherjee points to the very poor returns from India's IPO market.

Analysts at Mumbai- and London-based YK2 considered all the 300-plus mainboard issuances since January 2004 with a 10-year trading history. The average IPO in this set has returned -3.5 per cent a year, according to their calculations, turning a Rs 100 ($1.2) investment into Rs 70 a decade later. It doesn’t matter whether they listed in 2004 or 2013, or any year in between. Indian IPOs have failed miserably at generating additional returns for investors over what they would have earned passively from just owning a broad benchmark. About 77 per cent have underperformed the NSE500 Index over a 10-year period, with average underperformance of more than 14 per cent annually. In other words, the Rs 100 not invested in debutants could have, with very little effort, become Rs 280.

Clearly investors are attracted to IPOs by the lure of the listing gains. One suggestion made is to have a mandatory one year lock-in period for all IPO investors.

Mobilising domestic risk capital in India

Small and medium enterprises (SMEs) are not only the largest contributor to job creation and economic output, but also to economic dynamism. Unlocking their potential is critical to India's sustainable growth prospects. But they are constrained on all the three factors of production. 

Land in any reasonably developed agglomeration has become so exorbitant that it's unaffordable to SMEs. There's an acute scarcity of skilled workers and good quality managers, and those available come at an exorbitant price. 

Finally, there's capital, the subject of this post. Debt is both expensive and inaccessible to entrepreneurs and risk capital chronically scarce. Investors prefer to put their money in either fixed deposits, gold, land, and public markets (bonds, mutual funds and stocks). This means that the equity requirements for small businesses remain unmet. 

How do we unlock more risk capital to invest in local SMEs? This is arguably one of the biggest requirements for broad-basing economic growth and thereby making it sustainable. 

As a disclaimer, in the absence of hard data and any literature, this post is largely drawn from experiences and stories. To this extent, it’s only a hypothesis. But it’s a plausible hypothesis with several compelling examples and anecdotes, which therefore merit serious engagement by journalists, researchers, and commentators.

The year 2023 was spectacular for SME IPOs. Sample this

According to data from Trendlyne, 234 companies have raised funds from Indian markets so far in 2023, with a significant portion of 176 companies falling within the SME category. In comparison, CY22 witnessed 103 SMEs entering the market; the number was 52 in 2021, 31 in 2020, and 31 in 2019. Out of the 176 SME stocks listed this year, 62, or 35%, are trading with gains ranging between 100% and 1000%. Zooming out, 126 stocks are currently trading above their respective issue prices.

And this

The SME platform saw a record 168 offerings, with an average size of ₹25.6 crore, mopping up ₹4,305 crore. This is higher than the combined amount raised in the previous four years and nearly twice the previous record of ₹2,287 crore garnered in 2018. The amount collected by SMEs is roughly a tenth of the ₹44,882 crore collected by mainboard IPOs this year.The total market capitalisation of firms listed on BSE’s SME platform crossed ₹1-lakh crore this month. The total number of SME issuances since 2012 now stand at 887.

Apart from the sheer number of IPOs, the extent of their over-subscription has been staggering, pointing to the massive retail investor demand for these issuances. A sample is below:

SME segment saw 166 companies raising an aggregate of ₹4,472 crore by listing on both BSE SME and NSE Emerge. The most interesting aspect of SME IPOs was the subscription rates. Fifty one of the 166 companies witnessed subscription rates of more than 100 times, with 12 companies seeing over 300 times subscription, according to FYERS Research.

And this

Amidst the hype we should not overlook that the total amount mobilised in all this is slightly more than half a billion dollars, a tiny amount by any yardstick for an economy of India's size. The high IPO subscription rate is also deceptive since it's most likely that the same set of investors have been recycling their capital hoping to strike it rich by landing shares during the IPO and selling them immediately after listing to capture the easy gains from the possible listing premium. 

On similar lines, the hype about the tens of billions of private equity and venture capital inflows into India should not blind us to the reality that domestic equity capital raising in India remains very small. While there are no reliable estimates, the base and fund raising from domestic LPs appears too small to even merit a separate mention in annual reports of consultancies like Bain & Company. In fact, most of the fund raising by even the Indian PE funds have been from foreign LPs. Further, anecdotal evidence suggests that Indian high net worth individuals put their risk capital in the public markets and have limited exposure to the Indian private equity markets. It remains to be seen whether the current generation of start-up founders who have just struck rich will exhibit a greater risk appetite than their predecessors and choose to become LPs for domestically focused private equity funds. 

The availability of risk capital is one of the most important requirements for economic growth. The public debates and policy focus in this regard is confined to fund raising through public market IPOs and different forms of private capital like venture capital and private equity. But such fundraising which mainly covers large enterprises, the largest among medium enterprises, and technology entrepreneurs in the metropolitan cities form only a small part of the demand for risk capital.

There's a large unmet demand for risk capital from among new entrepreneurs and SMEs especially outside the largest cities and in non-tech sectors like agri-processing, metal works, engineering goods, textiles, mining and processing, pharma and chemicals, trading, dealerships, clinics and hospitals, diagnostics, schools and colleges, hotels and restaurants etc. They generally find the public markets and private capital providers out of bounds. Instead they are forced to rely on own savings and capital mobilised from close relatives for equity to start new businesses. In case of existing entrepreneurs, in addition to the above, equity for expansion comes from surpluses ploughed back. 

It would be interesting to study the profile of businesses in the SME loan book of our commercial banks and other sub-national lenders. An analysis of the equity sources of SMEs that access State Finance Corporations for working capital and other loans reveal that they have bootstrapped with their own money and at most from relatives. This is the case for even those entrepreneurs who have been in business for decades and have an excellent track record of performance. Another interesting aspect is that these businesses have very low debt:equity ratio. Besides they also remain small and show limited growth appetite. 

In a very large economy like India where SMEs form the major share of job creation, economic output, and economic dynamism, the businesses mentioned above outside of the largest cities are critical to the country's long-term economic growth prospects. If these entities are left with own sources as virtually the only means to mobilise risk capital, then it should be a matter of great concern. 

How would today’s developed economies met their risk capital requirements during their development trajectories? I'm inclined to believe that this risk capital scarcity for SMEs would have been the case with today's developed countries too in their own development stages. But their industrial base and capital base would have been much broader than what India faces today. This makes the constraint more binding on SMEs in India.   

But this scarcity for formal risk capital co-exists with a well-established practice of informal financial intermediation where businesses and brokers mobilise equity capital from local wealthy people for local investments. This is common in the real estate sector and also found in hospitals, colleges, retail malls, automobile and consumer durable dealerships etc., in Tier II and Tier III cities. Each of these cities have a few local well-heeled who have the money and the interest in making investments. But their investment horizons are often limited to the local area and prefer tangible assets. 

Local entrepreneurs sometimes mobilise equity informally for their projects from these local well-heeled. There are also local intermediaries who are good at spotting investment opportunities and mobilising capital from the local wealthy. The intermediary uses relationships and networks to raise money, typically in the range of a few crores (say, Rs 1-10 Cr), to invest in upcoming local real estate projects or hospital developments or a dealership. In the typical medium-sized Indian town/city there are perhaps 10-20 such individuals/households with the finances to invest in such projects. While there are no studies or estimates, anecdotal evidence suggests that such informal GP/LP relationship is common in at least some parts of the country outside of the largest cities. 

There are several well-known reasons why such investors, entrepreneurs, and intermediaries prefer such transactions to stay informal. It's interesting that one reason appears to be that these wealthy people in the smaller cities trust the informal non-legal personal relationship-based transactions more than the formal contract with a distant and institutional fund manager. 

But this does not detract from the need to encourage institutional platforms that allow for mobilisation of funds from local high net worth individuals and their investment in promising local business opportunities. Such financial intermediaries could register as alternative investment funds (AIFs). But current regulations are too onerous and restrictive for these small intermediaries. Accordingly, if we are to attract such risk capital, perhaps the eligibility conditions and terms of AIF Category II funds will have to be relaxed along with simpler compliance and reporting requirements. 

Here, the SEBI could take a leaf out of its own experiment with the BSE and NSE's SME trading platform. The platform, functional since 2009, is a very good innovation and has allowed SMEs access the public markets. It allows for firms with even Rs 1 Cr paid up capital (compared to Rs 25 Cr paid up capital requirement for the regular exchange listing) and lower listing compliance requirements and post-listing reporting requirements.

This is the kind of private equity that India needs more of, atleast as much if not more than the kind of PE that public policy currently engages with. Unlike the big ticket PE capital which are mostly invested in brownfield assets and in technology intensive sectors with limited job creation, these investments are made locally and in local job creating assets. Apart from several other benefits, they are also an indirect means to capture black money that would otherwise have remained and rotated within the informal economy. 

In this context, if we dig deep we'll find that atleast some of the SMEs who issued IPOs in 2023 have their origins in such local informal financial intermediation.

Temporary recruitment in government

One of the proposals on the problem of job creation in India is the idea of using government employment as a combination of temporary employment and skill acquisition opportunity for youth at the start of their labour market journey.

On these lines here's one proposal about temporary employment in government.

One is, I think, the government could expand the number of people it employs if it didn’t offer them the kind of terms they’re offered. For example, in China — I haven’t checked the data — there are three people with a bachelor’s degree in every village working for the village government. That changes the world. These are people with certain skills and a certain amount of knowledge of the world. So one thought is that the government should start introducing maybe a transitional mechanism where you take a job, and then it’s only if you’re good at it, that you keep it otherwise you can work for some years, and then you don’t. It’s like a tenure system. That will still create more jobs. We need more people on the ground. I don’t think our government is big enough. There’s a lot of people who will say that we have a big government, but in fact, we have a small government that’s trying to keep control, which looks like a big government, a heavy government, but it’s not actually so. The size is small (but) the hands are heavy, as a result partly, because it can’t do anything new because it has so little bandwidth. So rethinking the shape of the government, having more young people in government, as a trial as a way to start your life, but then you can go out and do something else. And somehow getting the court systems to agree to not ex-post turn everybody into a government official. I think it needs a set of tough decisions. But I think without that, our employability issues are going to be fraught all the time.

There have been other ideas like recruiting local youth as apprentices, training them, giving performance-based marks, and offering exit payments if they do not get into regular recruitments. 

This is a logically good idea and has already been tried out in some form of other. The most salient example is that of the vidya volunteers in education, who were the local educated and who were recruited with a honorarium wage under the Sarva Sikhsha Abhiyan. The idea was that these local educated youth would meet local teacher shortages and also get some experience while also acquiring their BEd/DEd qualifications and preparing for their Teaching Eligibility Test (TET) examinations. If they qualified, they would get recruited as a regular teacher, and if not, they could move on to elsewhere. 

The only problem is that in general the movement to elsewhere rarely happen. The volunteers stay on, and then the political economy takes over to mount pressure to regularise them. And it's a matter of years (sometimes decades!) before they get regularised. Or be absorbed into something like the minimum time scale on the principle of equal pay for equal work enunciated by the Supreme Court. 

Once recruited on contract or any other temporary employment mode into the government, the political economy makes the retrenchment very difficult. And the strength of the political economy factors increase with the size of the group under consideration. 

Further, since the recruits internalise this expectation at the time of recruitment itself, very few of them end up leaving on their volition for better opportunities. After all why seek better opportunities, when you have a strong chance of being regularised, sometime or the other. 

Another example is contract faculty in higher education institutions. Thanks to the Supreme Court orders, all of them are now paid at the minimum time scale. When originally conceived, the idea was that these faculty would be only for a short time till the regular faculty got recruited. But for a variety of reasons, the contract faculty have continued. Very few among them leave after getting better opportunities. 

An emerging category of large non-regular recruitment that's happening in governments is that of data entry operators, who have largely replaced the Junior Clerks or Junior Assistants. Here too the logic of temporary recruitment was that these people will pick up some skills and experience and move on to the private sector. This rarely happens. And there are already pressures to regularise them in several states. 

As an empirical validation, it would be useful to look at examples of more than 100 people recruited by a government department or agency on some temporary mode across states and see how many of those recruitments got formally terminated. My guess is that there'll be just a few, if at all. We could start with examples of large scale temporary (or non-regular) recruitments in governments - vidya volunteers, contract teachers, work inspectors, anganwadi workers, ASHA or community health workers, municipal sanitation workers, and home guards. What proportion of those recruited got into regular government jobs, what proportion left for the private sector, what proportion got regularised, and what share are now left? This would be a great PhD thesis for a young scholar - the political economy of contract recruitments in Indian states! It would unpack several aspects of public recruitments hitherto unknown to outsiders. 

Similarly, all government recruitments come with a 1-2 year probation period. In fact, most states recruit teachers with a two year probation. And there have been numerous instances of clear irregularities and moral turpitude by probationers. But there'll be hardly any instance of terminations during probation in any state. 

I believe there are three very strong reasons why this logically appealing solution will struggle in the Indian context. One, there's a very large premium associated with local employment, even if it's on a contract mode and has limited career progression opportunities. Two, government employment, especially in the same district or region, is economically and for social status considered the best among all employment opportunities. And there is the strong moral hazard that the political economy will ensure regularisation of contract (and nowadays even outsourcing) recruitments even if it might take time. Finally, there are limited comparable opportunities available in the private sector. For a start, educated youth prefer white collar jobs. But in these kinds of jobs, till the middle-levels, private sector pays far less than their public sector counterparts. Also, unlike government jobs, good private sector jobs are found only in the larger cities, where costs of living too are much higher. Further, it also does not help that the vast majority of these youth would anyways be unemployable in the positions they aspire to work in the private sector. 

No idea or innovation can wish away these fundamental problems. All these ideas end up providing backdoor for virtual public recruitments without any of the eligibility qualification requirements of formal recruitments. Governments are left with poor quality employees.

In general, it's observed that such approaches work best for higher skilled contract posts like individual consultants or technical personnel, and where the recruitments are done in small numbers. In these categories, the pressure groups will be too small to mount pressures to demand regularisation.

Weekend reading links

1. FT writes about Vienna's co-housing model,

Vienna has several innovative affordable housing schemes aimed at different social groups. The co-housing model is popular with middle-class families who have some capital but can’t afford to buy and want to bring up their kids in the city. To make sure the property is never sold on the private market, residents of Gleis 21 do not own their flats. Instead, they own shares in the building company they formed. Their monthly “rent” is their share of the mortgage repayment. At the start, each member of the co-housing group must pay €580 per sq m as a deposit (some flats are bigger than others). If they sell, they get that money back plus a bit more depending on how long they have lived there and how much money they have put in to pay off the loan... 

Denmark was the first European country to adopt this co-housing model in the late 1960s and early 1970s. Most of the communities were formed by families with young children who wanted to share the burden of childcare. Since then, it has evolved to include single parents, empty nesters and older people. From the 1980s onwards, the Danish government has supported co-housing groups with low-interest government loans... Most co-housing groups draw up their own rules on how to live together and how to share responsibility but this does mean being prepared to sit through long meetings with your fellow residents as you talk through difficult issues.

It highlights the example of Gleis 21

Gleis 21 is an award-winning, intergenerational co-housing project in Vienna that the residents own, operate and manage collectively. Plant-filled terraces encircle the four-storey building, built almost entirely from wood apart from four central concrete pillars. Unlike a 1970s commune, residents have their own separate apartments as well as access to the communal spaces on the 700 sq m rooftop. There are 38 units in all, including a two-bedroom guest apartment that can be booked for visiting friends and family. The residents, who range in age from 27 to 72, came up with the concept, raised the money and oversaw the construction of the building. The core group was formed in 2015. By 2017, they had the architect’s plans and the funding in place. The building was completed in 2019 and they all moved in shortly before lockdown. The total cost of the project was almost €10mn. The group found €2mn themselves, the rest came from the bank in the form of a 30-year mortgage and they also received subsidies and a loan from City Hall... All the residents have their own flat in the building and for this they pay an average of €600 a month.

2. The Economist has a long read on the state of scientific research in India.

At 31%, a larger proportion of its graduates studied stem subjects than in America (20%) or even Israel (27%). But many students graduate with a poor education because of inadequate facilities, mediocre teaching and outdated curriculums, and many of the most talented go abroad... Last year India became the largest source of overseas graduate students in America, ahead of China. Including undergraduates, Indians now make up a quarter of all foreign university students in America. Of the roughly 2.5m immigrant stem workers in that country, 29% are Indian. In AI, India is the source of 8% of the world’s top researchers; the proportion who work in India itself rounds to zero.

India's R&D problem is predominantly a problem of corporate India's failure.  

3. Manufacturing's share of Indian GDP has continued to decline, even with all the efforts to support it. 

Faced with headwinds in manufacturing, some countries are falling back on their natural resources to drive growth by attracting industries that use those resources. 

Governments in Latin America are keen. So are the Democratic Republic of Congo and Zimbabwe. But it is Indonesia that is leading the way, and doing so with striking heavy-handedness. Since 2020 the country has banned exports of bauxite and nickel, of which it produces 7% and 22% of global supply. Officials hope that by keeping a tight grip they can get refiners to move to the country. They then want to repeat the trick, persuading each stage of the supply chain to follow, until Indonesian workers are making everything from battery components to wind turbines.

Officials are also offering carrots, in the form of both cash and facilities. Indonesia is in the midst of an infrastructure boom: spending between 2020 to 2024 ought to reach $400bn, over 50% more a year than in 2014. This includes funding for at least 27 multibillion-dollar industrial parks, including the Kalimantan Park, constructed on 13,000 hectares of former Bornean rainforest at a cost of $129bn. Other countries are also offering sweeteners. Firms that want to install solar panels in Brazil will receive subsidies to also build them there. Bolivia nationalised its lithium industry, but its new state-owned conglomerates will be permitted to enter into joint ventures with Chinese companies.

4. Section 144 of the Companies Act in India bans accountancy firms from offering non-audit services to their audit clients. To skirt around this the big Four firms have created their Indian audit entities - BSR& Company (KPMG), Deloitte Haskins & Sells, SRBC & Company (EY), Price Waterhouse Chartered Accountants. 

But a recent report by the National Financial Reporting Agency who's in charge of regulating accounting and audit firms found that these firms were still closely tied to their non-audit parent and there were other serious conflicts of interest.

The NFRA, when examining these big accountancy firms, their portfolio of businesses, and their relations with a larger group of businesses, noted this principle of independence might have been violated. The regulator’s concern is that if an accounting firm or a company in the accountant’s network earns income from consulting with a firm in other capacities, then its incentives for independence as an auditor are misaligned... The grey area is what happens immediately before and after an accountancy firm becomes an official auditor to some client, and whether other companies in their network group can offer such non-audit services instead... In the case of BSR, for example, the NFRA has specifically said that its claims to being an entity separate from those parts of the KPMG India network do not stand up to scrutiny. The regulator’s observations and some of the auditors’ reactions suggest there is scope for improving regulatory and legal clarity.

5. New Infrastructure Investment Trust (InvIT) transaction in the highways sector

KKR-backed Highways Infrastructure Trust (HIT) will acquire 12 road projects from PNC Infratech and PNC Infra Holdings at an enterprise value of Rs 9,005.7 crore. This will be one of the biggest acquisitions in the road and highways sector... The road portfolio comprises 11 hybrid annuity concessions from the National Highways Authority of India (NHAI) and one toll road concession from the Uttar Pradesh State Highways Authority (UPSHA)... The total projects represent about 3,800 lane kilometres in Rajasthan, Uttar Pradesh, Madhya Pradesh, and Karnataka... Of the 12 projects, 10 are currently operational and rest are under-construction, and will be acquired after operations begin.

6. The Bain & Company's annual report on private equity sees India emerging as the leader in Asia Pacific. The main investment areas were provider and related services, contract research organisations (CROs), contract development and manufacturing organisations (CDMOs), biopharma, and healthcare information technology. Biopharma and related services make up the largest share. Some graphics.

Global PE activity in healthcare is largely a US and Europe phenomenon, with Asia-Pacific being a small share. And health care itself is a tiny share of the overall PE market. 

India is emerging a major destination for PE deals in health care.

The reports attributes this rise to three factors - greater expenditure on private and public healthcare, booming pharma manufacturing and services, and an evolving healthcare technology ecosystem. 

In 2023 India is expected to host 22 deals, a slight decline from 26 in 2022, and the deal value is expected to be $4.6 bn below $4.7 bn in 2022. 

7. MS Sahoo has an excellent educative oped that provides a different perspective to look at the performance of the IBC. He argues that traditional assessments inflate claims and liabilities and overlook realisations. 

For such appraisers, recovery tends to overlook realisations from equity holdings post-resolution, the reversal of avoidance transactions, and the insolvency resolution of guarantors. Additionally, the claims include written-off non-performing assets (NPAs) and penal interest on such NPA, encompassing both loans and guarantees against those loans. This results in a distorted recovery rate of 32 per cent against claims, a figure at odds with the World Bank’s estimate of recovery of 72 per cent from the IBC process... It makes sense to link realisation of creditors to the tangible assets on the ground rather than their claims, as the market offers a value for the assets a company has, and not what it owes to creditors. The IBC process is realising a remarkable 169 per cent of the value of the assets of companies. Any alternative option would at best realise 100 per cent minus the cost of such realisation. The excess realisation of 69 per cent is a bonus from the IBC for creditors while rescuing viable companies for the economy...

The metric and methodology for appraising the IBC should align with its objective, which is the resolution of stress. The primary parameter for assessment should be whether the IBC is resolving stress irrespective of the mode of resolution. On this critical parameter, the answer is an unequivocal “yes”. Out of the 7,000 stressed companies that entered the IBC process, 5,000 have successfully exited, while the remaining 2,000 are in different stages. The secondary parameters are the efficiency and efficacy of such resolution. The IBC envisages two efficiency parameters, namely, resolutions to be time-bound and to maximise the value of stressed assets. The performance on these efficiency parameters is less encouraging. During April-September 2023, 127 resolution processes concluded, taking an average of 867 days for completion, compared to the intended 180 days. Similarly, the resolution plans are realising only 86 per cent of the fair value of the companies, suggesting a gap in achieving the desired value maximisation. An efficacy parameter is the quality of resolution. A recent Indian Institute of Management (Ahmedabad) study finds it to be good. Post-resolution, the companies have witnessed significant improvements: Turnover increased by 76 per cent, profitability ratios converged with benchmarks, and market capitalisation tripled.

8. This is quite a stunning graphic which shows that the share of affordable housing loans  in the total number of housing loans given out by banks has fallen spectacularly from 71.5% in April 2007 to 28.5% in November 2023!

The affordable housing loans are the priority sector loans - upto Rs 35 lakh in million plus cities and Rs 25 lakh elsewhere, with overall cost not exceeding Rs 45 lakh and Rs 30 lakh respectively. Banks make up 80% of all home loans, and housing finance companies the rest. The report also informs that over a period of five years, close to four-fifths of incremental outstanding homes loans are non-priority. 

9. Very good interview of Joseph S Nye. At 86 years, he's old enough and seen enough to take the longer-view, and his views should come as a reminder to be worried, even alarmed, at global developments without being excessively so. He gives examples of threats to democracy in the US in the 1930s and to Harvard in late 1960s. On US and China, he says,

Nye gives five reasons why the US will not necessarily be eclipsed by China: geography and friendly neighbours; domestic energy supplies; the dollar-based financial system; demographics; and tech leadership... he argues that China, despite 20 years of investing in Confucius Institutes to promote its perspectives, lags behind on soft power too... “Why is China unpopular in its own region? Because it is seen as a threat. It’s very difficult to develop soft power in New Delhi by establishing a Confucius Institute if your troops are killing Indian troops on the Himalayan border. “From a strategic point, it’s equally mistaken to underestimate and overestimate your opponent. And right now what’s popular in Washington is overestimation [of China].” He identifies not with the hawks (who, he argues, overestimate the Chinese threat), or the doves (who underestimate it), but as an “owl”. War between China and the US is not probable, he argues.

This is actually so true of high table decision making. Wish more people said this. 

Under Clinton, he chaired the National Intelligence Council, and was “surprised to find how much of [the president’s daily brief] I could have learnt by reading The Economist, the Financial Times, or the Washington Post”.

10. Climate change or not, economics and politics will out. FT writes about the surge of LNG terminal construction in the US Gulf Coast

The US became the world’s largest LNG exporter in 2023. Its seven existing terminals can produce as much as 86mn tonnes a year, according to the Energy Information Administration — enough to satisfy the combined gas needs of Germany and France. Five more projects under development will add another 73mn tonnes a year and the energy department is reviewing proposals for at least another 16.

The US should understand that developing countries far stronger, even existential considerations, in their fight to scale up climate change investments. 

Reinforcing this point, it emerged this week that Hertz will sell 20000 Tesla EVs, or a third of all EVs in its fleet, and replace it with petrol vehicles since damage costs for EVs were much greater. 

11. Simon Kuper has a counter-intuitive take that electric cars are not likely the future but e-bikes, e-mopeds, and e-scooters. 

Addressing poverty and human development in India

I’m a strong believer in the argument that there are no grand narratives or explanations for most intractable social, political, and economic problems in the world. Neither are there similarly all-encompassing solutions for these problems. Almost always, the explanations and solutions are mani-fold and often vary widely across contexts for the same problem. 

Importantly, most often the solutions are about persistent and long-drawn efforts, more like hundred small steps than two or three big bang measures. These small steps create the conditions for change in culture, norms, attitudes, behaviours and practices. The challenge is to bring these steps together in a Big Push, with collective commitment and execution diligence. 

On the same lines, I think that the answer to India’s economic development lies in a carefully tailored heterogeneous and varied basket of measures. There are no universal and time invariant one-size-fits-all big bang measures. Instead there should be different bouquets of measures for different localities and regions, depending on history, culture, remoteness, backwardness, caste and (even) religion. These bouquets would vary in their prioritisations and thrust on some specific set of measures aimed at the specific context. 

But these measures have to be supported with a set of uniform interventions - infrastructure (mainly irrigation, roads, electricity, and drinking water), public goods (public health, schools and hospitals), human resources development (nutrition, learning proficiency etc.,), livelihoods (skilling, industrial clusters, parks etc.,), policy enablers (simplify regulations on land and labour, facilitate access to credit, ease of doing business), and good governance.

Hitherto the focus has been on a few uniformly applicable set of interventions that are mostly in the nature of brick-and-mortar infrastructure and logistics development and ease of doing business. We need to go beyond this. These measures by themselves are unlikely to address the chronic and entrenched constraints that entrap localities and regions in backwardness and under-development. 

In this context, I recently came across an eye-opening presentation by Dr Sekhar Bonu, previously Director General of the Directorate of Monitoring and Evaluation, NITI Aayog. He has graciously allowed me to blog on it. In the unpublished work, he uses the existing survey data from NFHS, PLFS, and other sources to document the wide geographical variations across a host of economic and human development parameters. He uses GIS maps involving districts to illustrate the wide variations across geographies (even adjacent districts) to show why it’s futile to think of one India when we design policies to address development deficiencies. In fact, for sustainable and meaningful efforts, aside from the aforementioned common interventions, we should be thinking in terms of districts as the unit of iteration. 

In another recent paper published in the EPW, Anirudh Krishna and Sekhar Bonu mapped out similar significant inter-district variations and clustering of lagging districts by intergenerational changes in education. 

I’ll sample a few from the as-yet unpublished work, with his permission. He uses wealth, consumption, and human development data to highlight the differences across districts. 

Household wealth index shows that poorer households reside largely in the Eastern part of North India, North East India, and East India. But per capita household wealth, a more accurate representation of wealth, show the desert districts of Rajasthan with higher backwardness, while North East districts show less backwardness. 

Percapita consumption map shows North East and Rajasthan have relatively higher household monthly expenditure compared to household wealth standing, whereas pockets of low expenditures can be seen in Telangana, Karnataka, Maharashtra, TN, and Gujarat. 

On nutrition while there is significant overlap with wealth and consumption expenditure, districts in AP, Gujarat, Maharashtra, and Karnataka are unique to Nutritional backwardness

On child mortality, while there’s significant overlap with wealth and consumption, some districts in Karnataka and Gujarat are unique to child mortality

On years of schooling (where not even one member of the household aged 10 years or older has completed six years of schooling), Andhra and Telangana in particular are uniquely backward. 

Bringing all together, he does a composite scoring of all districts based on the three kinds of parameters. Almost all districts in Bihar, large parts of UP, tribal belts of Orissa, Chhattisgarh, and Jharkhand, tribal cluster covering Gujarat/Rajasthan/MP and Maharashtra, a pocket in Karnataka emerge as the areas requiring support. 

While the maps show several instances of districts as islands of underdevelopment, it also finds that backward districts are contiguous and clustered. It therefore advocates cluster and state-based approach over and above district-based approach to deal with extreme backwardness. It points to geographical factors of vulnerability - floods, forest, dry lands, remoteness - and historical/cultural factors among tribes, scheduled castes, and minorities. 

Some general observations:

1. The maps convey a world of wide variations across districts within the same state, underlining the point that there’s no one India nor even one state when it comes to human development and economic growth. At best, there are geographical clusters. 

2. If we take all these maps together, it’s clear that in terms of states, Bihar, Uttar Pradesh, Jharkhand, Madhya Pradesh, and Chhattisgarh are where India’s biggest human development and economic growth challenges lie. Kerala, Tamil Nadu, Andhra Pradesh, and South Karnataka stand out, followed some distance behind by west India including North Karnataka. Maharashtra and Karnataka pose a problem given the co-existence of prosperity and development with backwardness and underdevelopment. 

3. This also means that reconciling these variations with practical administrative convenience, we can perhaps have four or five broad categories of national programs on education, health, nutrition, skilling, drinking water, irrigation, housing, rural electrification, social welfare etc. One for the core southern states; another for Punjab, Haryana, HP, J&K, and Delhi; one for the west; another for the northern states; and a fifth for North East. Perhaps the first and second could be merged. Maybe we start with just three. This could be a prudent first step in reforming the current one-size-fits-all approach of central share and central sector programs. 

4. The clusters and contiguous districts can perhaps be significantly be addressed through Big Push measures, primarily focused on irrigation, connectivity, and electricity. But this alone will not be sufficient. It’ll also require some economic growth catalysis. This part is difficult. For example, these clusters could benefit from some growth anchor or igniter - a town/city within the region, an industrial cluster/corridor, a large new investment, a large government institution etc. 

The isolated district (or 2-3 districts) are a much bigger problem. They are entrapped in bad historical equilibriums and would require more concerted district-wise efforts to relax cultural, historical, caste/religious constraints. 

5. I’m not sure about the mechanics of implementation of the second layer of context-specific interventions. For simplicity, I can only say that these interventions will need to be carefully thought out by involving stakeholders, prioritised, and a 20 year plan made with clear outcome objectives and intermediate milestones and timelines. This will include prioritisation of infrastructure investments, economic growth interventions, and measures to relax the social-cultural constraints. As a note of caution, the danger here is that this exercise will get outsourced to some management consultant, thereby signifying a kiss-of-death even before the implementation has started. This effort will be blunt without an explicit acknowledgement of state capability weakness and poor governance, and efforts to address them. 

6. I can think of two areas to build on this work. One, change in these economic and human development parameters over time based on investments in roads (PMGSY), irrigation (PMKSY and projects coverage) and electricity, and programs like NREGS, Poshan Abhiyan etc. Apart from being an evaluation of these flagship programs, it would also throw up insights on whether these alone are creating any impact and whether there’s the need for complementary interventions. 

The second is to introduce elements of state capability and governance. I’m inclined to believe that whatever one does with hard infrastructure and public goods, and enablers, without good governance it’ll be hard, if not impossible, to break out of entrenched backwardness and poverty. What are good indicators of governance? I can think of comparisons on vacancy of teachers, nurses, and doctors in primary schools and primary health facilities; average expenditure percentages of certain important programs (or program components); some measure of institutional penetration (Police Station, Post Office etc per unit of population or area). For sure, there’ll be endogeneity in many of these with backwardness.