Thoughts on international development VI

I blogged here highlighting the obsession in international development circles with new ideas and innovations and neglect of regular development interventions and examined the reasons; here questioning the belief that there are new ideas and innovations waiting to make a transformative impact; here that policies in most of the development matter very little and it's mostly about implementation; here questioning the conventional wisdom on impact evaluations and arguing that evaluations should focus on the use of administrative data (and surveys) coupled with qualitative information to help improve the effectiveness of implementation; and here that the combination of the grafting of externally generated ideas and innovations and the associated flow of easy money prevents developing countries from cultivating their ability to make good development decisions. 

In this post, I’ll argue that any significant scale implementation of a development program should necessarily be iterative if it’s to realise its objectives. There is virtually no program which can be taken off the shelf and implemented successfully across a region or country. Any human engagement-intensive program implementation will necessarily require continuous and grassroots iteration to succeed. It’s about the repetition of implementation, observation, iteration, and adaptation till you get to a reasonably good implementation. It’s the process of iterative adaptation. 

The exceptions to this strategy are those which involve pure logistics interventions (like cash transfers or subsidies) and execution of engineering works. 

This means it’s no good to have ideas. Instead, whatever the idea or innovation, the point is to execute it effectively. And such execution is generally about iterative adaptation. 

Let’s examine this with some examples. Take the implementation of an Edtech program in schools that gives tablets to students. For simplicity, let’s assume that the content is finalised. The delivery of the content raises several uncertainties - how and when should the student use the tablet, what’s the balance between the digital and physical content, how should the teacher tailor classroom instruction to facilitate effective use of the tablets, what kind of training to support the teacher, how do we monitor whether the student is using the tablet as intended, and how do we know that all this is creating the desired impact. 

Or take the uncertain elements of new a subsidised crop insurance scheme - what premium subsidy, what magnitude of coverage, what episodes trigger claims, who’s eligible farmer, what upper limit on eligibility, how damage assessed, how to manage quick payouts, how to prevent abuse of the scheme etc. These elements vary across crops and regions, and the getting them right is the difference between success and failure. 

Or an initiative where companies are given subsidies to hire apprentices - which types of companies to be targeted, what occupational/trade entry levels, what eligibility conditions for apprentices, how to transfer the subsidy, what stipend amount, how many years, how to limit misuse by companies and apprentices etc. In case the program is struggling to make an impact (as is the case in India now despite a strong commitment by the government), what’s going wrong and how to increase uptake? 

Or take the example of an initiative to encourage electric vehicle manufacturing. Here too there are too many uncertain elements - what part of the value chain to support to start with, which kinds of incentives, what magnitude for each incentive, what types of import restrictions, how much domestic content, how to move up the value chain, how to monitor compliance, how to phase down the incentives, what strategic considerations etc. 

As can be imagined, there’s no way ex-ante to get these uncertain elements right at the policy/program design stage itself. Issues will always emerge when the rubber hits the ground. How do we deal with them?

What makes all this even more challenging is that in all the cases, the emergent questions must be answered on an implementation done at scale across varying contexts.

Currently, governments tend to view these initiatives in largely static terms. They see the biggest challenge as getting the design of the policy or scheme right and then monitoring their implementation. At best there’ll be some tweaks at the margins, but triggered only when egregious failings surface. In the routine, the design is cast in stone and gets implemented for years. There’ll always be enough reasons to explain away any failures to meet outcomes, or most often outcomes are massaged to suit the administrative requirements. 

Instead, there’s a need to adopt a dynamic perspective on the design and implementation of policies and programs. In each case, the initial design could be seen as a minimum viable product (MVP) of a policy or program made based on theory, commonsense, and precedent. Once the MVP hits the ground running, its failings and weaknesses get exposed. There should be a process to capture feedback about what’s going wrong, analyse it for where and why, and how it can be rectified. There should be another process to incorporate the changes into the program design. There should be continuous surveillance of the implementation to watch for emerging challenges.

Finally, as mentioned earlier, given the varying contexts in countries like India, in many of these schemes and policies there might arise the need to have differential emerging designs (and their respective iterations). 

None of these iterations and process revisions are technical changes. The feedback and analysis are mostly observational and qualitative. Using this feedback, the decisions are made, essentially as exercises of judgment. The implementation of each program or policy is about a series of exercises of judgment. The effectiveness of the program/policy is critically dependent on the quality of the judgment and decision. This quality, in turn, depends on the strength of the state’s administrative and management capabilities. In other words, Hirschman’s description of development as the ability to make decisions boils down to the strength of state capability. 

It’s pertinent to note that this dynamic is just as true for the private sector as for public policies and programs. In fact, this approach is a feature of private startups in their growth trajectories. They release the MVP of their product or service and then continuously iterate to refine their offering. It’s to be however noted that given the far simpler nature of their markets and the more rigorous preparatory work possible, the quality of their MVP is superior to that in the public setting. Such iteration and adaptation is true not only of their products and services but the company itself. Companies keep pivoting and reinventing themselves in response to emerging market developments. 

It’s said that writers don’t start writing a book with all the chapters etched in their minds. As E L Doctrow said, “Writing is like driving at night in the fog. You can only see as far as your headlights, but you can make the whole trip that way.” The same applies to companies and public policy implementation in general. They are constantly iterating and adapting. 

Central government programs in federal systems

 The FT has three long reads assessing the programs initiated in 2019 in the name of “levelling up” to reduce regional inequalities. It included four central government regeneration programs for a five year period till 2025-26 with a total allocation of £10.4bn and covering mostly some form of construction.

The problems in the programs' design, implementation, and outcomes have strong resonance with similar central government programs in India like Smart Cities and AMRUT, for example. 

Data from nearly four years of implementation show that a disproportionately low share of the allocation has been released and a negligible share has been spent.

The programs have struggled with several problems.

Parliament’s public accounts committee concluded in a recent inquiry into the three main funds that it had seen “no compelling examples” of delivery to date. The committee’s Labour chair, Dame Meg Hillier, describes them as “a sticking plaster” over the huge reductions made to local government funding since 2010, with comparatively steady income streams from government grants and council taxes partly replaced with “a real top-down” approach. Local authorities complain of delays, moving goalposts, unachievable spending deadlines, costly bidding processes and opacity and unfairness in the way the cash was allocated. Higher inflation over the past two years has also pushed up construction costs, eroding the value of disbursements… half of the projects for which funds have been awarded have only just started being developed… 

The funds were mired in controversy from day one. The first such pot, the £3.6bn Towns Fund, was launched by Johnson shortly before the 2019 election. Ministers selected 101 towns across England for one-off regeneration cash.  A remarkably close correlation with Conservative electoral targets was quickly apparent, including some areas — such as Cheadle, a leafy marginal seat on the edge of Cheshire — with relatively low levels of deprivation. A public accounts committee report in 2020 found that the allocations had not been impartial…

(For the Levelling Up Fund) local authorities were required to draw up detailed bids for cash, including for transport, culture and regeneration projects.   One council official in a deprived northern area compares the core document for their first unsuccessful bid to a “dissertation”, noting that the submission ran to more than 30,000 words without appendices and related reports. Such analysis is often beyond the capability of councils whose economic development teams have been whittled away by years of centrally imposed budget cuts. As a result, they have tended to hire consultants to draw up bids at an average cost of up to £30,000, according to the Local Government Association…

The Department of Levelling Up, Housing and Communities (DLUHC) “had to assess multiple bids within a short timeframe”.  “It could not do so as quickly as planned, and subsequent delays in making decisions on successful bids meant that announcements about funding allocations were made later than planned,” concluded the NAO… A further problem emerged in 2022, as inflation began eating into projects that had been costed months earlier. In Bury, the council secured £20mn each for two regeneration projects with the intention of providing the remainder of the projects’ expected cost itself. “But then you get inflation and costs and all of a sudden your £40mn project becomes a £50mn project and you don’t necessarily have that [extra] £10mn,” says O’Brien…

Interestingly, the problems mentioned in the context of these UK programs are present in India too. 

Another aspect of such programs is the small amount each locality gets over a short period, which is inadequate to create anything transformative and with a long-term plan. 

“The theory of levelling up should be good,” says Hopgood. But the money has ended up sprinkled across the country, she adds. “They might as well have called it ‘spreading it out’.”… “At the moment you can’t engage in investment in longer-term capital projects, and projects that are more transformational, because you have to get all the money out the door in 24 months, so unless it’s ‘shovel ready’ it’s a non starter,” he says. “Sometimes the things that make the difference and have value for money are things that are planned and delivered on a longer fuse.” 

All this raises questions on the strategy of packaging all fiscal transfers from federal governments to sub-national entities in the form of national programs. Such transfers are appropriate in those cases where the objectives and means to achieve them are the same across the country. But it’s inappropriate for projects that require context-specific design or seek transformational area-wide impacts. 

The latter kind of projects generally entail a comprehensive plan with multiple components, significant resources, and long-drawn implementation. They will involve local consultations, plan preparation, dovetailing resources from multiple sources including debt, and coordination among several stakeholders. Most importantly they require local ownership. They are not amenable to traditional programmatic funding, even with flexibility.

A more appropriate strategy would be to make block transfers tied to the transformation plan for implementing some components. The entities should be allowed the freedom to leverage this money in whatever manner it deems fit to mobilise the additional funding required for the transformation plan. An even more effective approach would be to increase devolutions or enhance the local government’s powers to raise additional revenues. 

The UK levelling-up programs include devolution of funds. 

The “common sense” approach that has emerged more recently is reflected in the beefed-up devolution deals granted to Greater Manchester and the West Midlands last year, he adds, featuring longer-term and more flexible devolved pots. These provide a mixture of revenue and capital, avoiding the scenario in which funding is advanced for construction of a building or facility that the council cannot then afford to run, says Hawksbee… More recently, the government has also allowed some local areas to roll together separate bids from different funds into one more coherent programme, working particularly closely with councils such as Blackpool. 

Also this.

The government has struck devolution deals with a number of areas including North of Tyne, West Yorkshire, East Midlands and York & North Yorkshire. This means that nine out of 10 people in northern England are now covered by a devolution deal, while in the whole of England 64 per cent of the population lives under a devolved authority — up from 41 per cent two years ago — with powers over areas such as investment, transport and adult education. 

This also raises the issue of leveraging budget transfers to mobilise debt that can supplement the scarce fiscal resources to finance large investments. 

For example, the ongoing central or state government schemes in India in urban or rural areas can finance large projects in one city, village, or region. They require large financing upfront. 

The local or state government must find resources from somewhere to finance such investments. It’s highly unlikely that they can mobilise the kind of fiscal resources required from internal revenues alone. The only way out would be to use debt to mobilise the upfront resources required to make these investments and repay from future budget transfers or revenues. 

However, the prevailing budget accounting in India treats debts that are serviced partially or fully from budget transfers as direct liabilities of the government. These liabilities get deducted from the open market borrowings (OMBs) permitted to the state government under the Fiscal Responsibility and Budget Management (FRBM) Act. State governments are loath to give up their cheaper OMBs for the more expensive project borrowings from banks or through bonds. 

There’s therefore a compelling case to allow for such borrowings for certain kinds of projects without deducting them from the state’s FRBM limits. These borrowings can be mandated to be done through special purpose vehicles and shall effectively be off-balance sheet debts of the state government. There’s every risk of this provision being misused by some states. It’s therefore important to also place limits on the extent of such off-balance sheet borrowings permissible.

Weekend reading links

1. Deflation and currency depreciation may be another reason for the surge in Chinese exports. 

China’s real effective exchange rate, which adjusts for differences in inflation between China and its major trading partners, is back to where it was in 2014, unraveling a decade of steady appreciation... the currency’s inflation-adjusted slide means goods made in China are even cheaper than before, a trend reflected in weak import prices. That makes Chinese products keenly attractive for Americans, blunting U.S. officials’ goal of reducing reliance on Beijing... Compared with a basket of the currencies of its major trading partners, China’s yuan has fallen 6% from a recent peak in March 2022, according to data from the Bank for International Settlements, an international group of central banks...

China’s real effective exchange rate—which adjusts not just for whom China trades with, but also for differences in their inflation—has tumbled 14% in the same period. China is flirting with deflation, which most economists see as a bad thing because it weighs on spending and makes debts harder to bear. But it has a hidden benefit by making Chinese exports even more competitive on world markets, especially when inflation is high in the U.S. and elsewhere. The gap between China’s nominal and real exchange rates is the widest since the BIS data begin in 1994. The U.S.’s corresponding real exchange rate has risen 6% since early 2022... Chinese export volumes in February were around 10% higher than in March 2022. World export volumes were up only 1.4% in the same period, according to data from the CPB Netherlands Bureau for Economic Policy Analysis... Emerging Asian export volumes have fallen almost 2% over the two years that China’s have risen 10%, CPB data show.

2. Michael Pettis on China's steel production that's swamping global markets

China’s steel industry has become a stand-in for the overall economy, with growing supply facing declining domestic demand. According to the World Steel Association, China produces roughly 55% of all the steel produced in the world. It produces nearly 80% more than the next nine biggest producers, which are, in order, India, Japan, the US, Russia, South Korea, Turkey, Germany, Brazil and Iran... to achieve a dynamic balance between supply and demand... will require some combination of a decline in production, which is bad for growth and unemployment in China, and an expansion in exports, which won't be easy for other steel producers and exporters... So far exports have taken up much of the slack... an Oxford Economics report which measures China’s combined export volumes of iron and steel to be 80 per cent above pre-pandemic levels... Fitch says that China’s steel exports climbed by 36.2% in 2023, to 90.26 million metric tonnes, and by 30.7% in the first quarter of 2024, to 25.8 million metric tonnes. This accounted for only 5% of China's total output, suggesting it could grow a lot more.

3. Sri Lanka and its creditors agree to restructure its $13 bn debt which it defaulted in 2022 by issuing macro-linked bonds where bond payouts are linked to GDP growth rates.  

In return for taking a roughly one-third haircut on their original debt, creditors have proposed a new $9bn bond with payments adjusted higher or lower in 2028 depending on the average US dollar GDP that Sri Lanka achieves. The country has put forward other ways of setting GDP-linked payments and is also assessing a creditor proposal for a separate governance-linked bond. This would cut coupon payments if the country raises tax revenue collection as a share of GDP and passes anti-corruption reforms. 

As they emerge from defaults, countries such as Ukraine and Uruguay have handed out equity-like warrants, which promise extra money based on factors like movements in the price of commodities that the country produces or GDP, as a way of getting creditors to swallow debt losses. But these instruments, which can be difficult to price and trade, have often ended up on the market scrapheap. Sri Lanka’s proposed bond could break new ground because “it is not a warrant — it is an adjustment to an existing bond that would take effect from 2028. That is the difference with earlier versions,” according to Thilina Panduwawala, senior macroeconomist at Frontier Research, a Sri Lankan advisory firm... Earlier this year, Argentina had to deposit hundreds of millions of dollars with a London court in order to appeal against a ruling that it must pay creditors €1.3bn for using the wrong GDP data for warrants it issued after its chaotic 2001 default.

4. Nice profile of Keir Starmer, the UK Labour Party leader and potential PM-in-waiting. Starmer is portrayed as an outsider who would roll-up his sleeves and focus on the execution of stuff. 

The article has this reference from an autobiography of Rory Stewart.

In his recent memoir Politics on the Edge, Stewart writes that “it was at the operational level that so many of the worst problems in British government lay. Not in the ‘what’ but the ‘how’.”

5. John Burn-Murdoch shows data on economic and social outcomes of migrants and points out that Anglosphere does better than Europe in attracting and integrating migrants. This graph is striking.

It's interesting that most of the migrants to Anglosphere are from China and South Asia, whereas those to France and Germany are from elsewhere. 

6. Steven Glinert points to an important blindspot in the US CHIPS Act, its focus on smaller size chips and neglect of the larger sized chips (mature nodes) that are commonly used across industries including military and where the Chinese are gradually establishing a stranglehold that has the potential to choke economies opposed to it. The majority of chips used in modern technologies are higher nodes. 

China's semiconductor strategy is driven by two main goals: the primary one being domestic self-sufficiency, viewing semiconductors as a critical national asset akin to strategic reserves of oil or food. The secondary goal is to establish a strategic leverage point in the global supply chain through mastery of mature node chips, effectively creating a potential chokepoint that enhances their geopolitical leverage... These chips are fundamental components of critical everyday objects including medical instruments, cars, planes, and most importantly, military hardware... 

The loss of control over higher node chips will not only compromise our consumer goods supply chain but poses a far more severe threat to our military supply chain. We already suffer from insufficient control over chip provenance within military applications, and the situation is worsening. A military Humvee, for example, requires thousands of chips, from GPS to sensors to CPUs. The most advanced processor in a military device might use 14nm technology—equivalent to what an iPhone used in 2015—with most being far less sophisticated. Losing control over our supply chain for these less advanced chips means losing control over our capability to produce essential military hardware. 

He points to how commercial interests and considerations may have captured the CHIPS Act.

We are funding companies that are investing heavily in profitable chips, yet our vulnerability concerning lower-tech, yet equally critical chips, persists... The most cutting edge machinery is designed for the most cutting edge, low node size, processes. Fabs always want to be ahead of the ball, so they devote resources to those cutting edge processes, while machines for older processes depreciates in value. TSMC is at such scale that they can keep depreciated equipment and facilities and continue using them, as they have some clever ways to squeeze cash out of these fully depreciated facilities. However, for companies like Intel and GlobalFoundries, mature nodes generally do not fit into the margin structures. For the most part, American companies sell their old facilities and old equipment (sometimes to the Chinese). One can see why. The economics of operating a modern fab are staggering. A reasonably sized fab might cost around $5 billion in capital expenditures, which requires generating $50-$70 in revenue per second to achieve a 20% return at the outset. Even after it depreciates, it still has to generate $30-$40. Producing a chip at 65nm might cost $5 per chip, necessitating the output of a large wafer every 30 to 60 seconds—a formidable challenge.

This is a good article about TSMC's struggles with labour supply and management culture clashes in establishing its chip facility in Arizona.  

7. The contrast between manufacturing and services in India is stark in several dimensions. One is the presence of foreign companies. While manufacturing is largely dominated by foreign companies and their brands, in finance Indian companies and brands have vanquished foreign brands. 

8. One area where Vietnam may be following in India's path, decision paralysis among bureaucrats induced by an anti-corruption campaign.

Vietnam’s anti-corruption drive, which the ruling Communist Party chief Nguyen Phu Trong likened to a “blazing furnace," is running hot. This year alone, two of the four pillars of power, including the chairman of the parliament and the country’s president, left their posts amid graft allegations. Last month, Truong My Lan, a real estate tycoon and Vietnam’s richest woman, was sentenced to death for her role in a $12 billion fraud case that involved Saigon Commercial Bank, one of its largest lenders. Eighty-five others were sentenced on charges ranging from bribery to abuse of power... 

At issue in Vietnam is infrastructure, which smartphone and electric vehicle manufacturers need for their mega factories. Vietnam, shaped as a long and curvy letter S, still relies on roads that can be narrow, congested and bumpy for most freight traffic... Trong’s anti-graft campaign has an unfortunate side effect—public procurements for infrastructure projects have stalled. Officials are too scared to make any decisions for fear of inciting scandal and punishment. In the first four months of this year, the government disbursed only 15% of what it had planned for public investments. To foreigners, the most glaring and disappointing example is Ho Chi Minh City’s much-anticipated first metro line, which began construction in 2012 and was originally scheduled for completion in 2018. It is still not open yet... With all the foreign manufacturers pouring in, power demand has been soaring. But almost no decisions on energy infrastructure have been taken since the anti-corruption campaign started in 2017, noted Gavekal Research.

10. It's reported that Blackstone is in the process of buying Omega Healthcare, an outsourcing services provider to the healthcare services sector globally and with 27,000 employees on its roll. The estimated valuation is $1.7 billion. Its current owners, Goldman Sachs Asset Management and Everstone Capital, are exiting. 

In India, Blackstone, with investments of $50 bn in India, has prioritised healthcare, technology, real estate and infrastructure. Globally, it focuses on health care, logistics, data centres, and hotels, apart from value-added exporters and consumer-centric businesses.

Accountability deficit in the corporate services industry

In this post, I’ll argue that the global corporate services sectors like management and technical consulting, accounting and auditing, credit rating, and other similar services suffer from a serious market failure, one of accountability deficit. 

A concern that critics highlight about these service providers is that they have managed to somehow or other insulate themselves from the consequences of their actions/advice. When confronted with the consequences of their advice, they have the standard cop-outs - the client did not listen to them, the information that formed the basis of the audit or rating was flawed, and so on. 

Consider the case of audit firms and their effectiveness in deterring fraud.

For decades, investors have lamented how rarely external auditors uncover corporate fraud… The Association of Certified Fraud Examiners’ biennial report on how workplace fraud gets detected has typically shown auditors are the ones uncovering the wrongdoing only 4 per cent of the time… The latest report out a few weeks ago said the number is down to 3 per cent… A survey of investors by the Center for Audit Quality, a trade group for large accounting firms, found that 57 per cent thought the current system “frequently” failed to detect illegal acts… Regulators fear auditors are failing in their role as a last line of defence for investors against corporate shenanigans. 

A 3-4% fraud rate would imply global corporate governance standards that are almost of biblical purity. The rates are farcical. It's similar to the institutionalised small sample audits by superior authorities in government entities that rarely, if at all, uncover any lapses.  

Auditors have their reflexive responses.

Audit firms argue that company executives are responsible for the accuracy of financial statements and that the role of an auditor role is only to provide reasonable assurance — not a guarantee — that a financial statement is free from material misstatement. It is an argument that has prompted the US Securities and Exchange Commission’s chief accountant, Paul Munter, to exclaim to me on more than one occasion that he is fed up hearing from auditors what they do not do… PwC last year promised it would overhaul its fraud detection procedures and probe its clients’ whistleblower programmes more closely, among other reforms to boost audit quality. PwC boss Tim Ryan tried and failed to get all the Big Four firms to make a common pledge on these issues.

The responses get even more disngenuous

Audit industry leaders still talk of an “expectations gap” between what investors want an audit to be and what it really is, as if it is the investors that need to be educated instead of the profession that needs to change.

In response to the obvious problems in the audit industry, the regulators have started acting amidst stiff opposition from the industry. 

In the US, the Public Company Accounting Oversight Board is revamping rules on how auditors must look for and deal with evidence of a client’s non-compliance with laws and regulations (Noclar, in the jargon). The intent is to force auditors to cast a wider net for matters that could have a material effect on a company’s financials, even indirectly by leading to big fines or regulatory action that threatens the business. Audit firms have responded that they cannot be expected to make legal judgments, and that the huge amount of extra work implied by the Noclar proposal as currently drafted probably will not uncover anything significant that current procedures do not already… The latest move is by the International Auditing and Assurance Standards Board, which sets rules that are used as a template by scores of countries around the world. It has proposed strengthening standards on fraud detection to emphasise that auditors must look for financial misstatements that might not be “quantitatively material” but which might be “qualitatively material”, depending on who instigated the fraud and why it was perpetrated.

The FT article has the obvious logical suggestion on how the audit industry ought to have responded to these reforms. 

An alternative response to some of the current proposals would embrace them to strengthen the hand of auditors. They provide new justification to pry open clients’ businesses, push back on hostile finance chiefs and chief executives, and flag more matters of concern to directors, to investors or to the authorities — to follow through on the professional scepticism that is supposed to be at the heart of the auditors’ creed. There is room for agreement, even on the contentious Noclar proposal. Better still for auditors, there is evidence investors are willing to pay for a more robust service. The CAQ survey showed a majority would support auditors charging an additional 20 per cent or more to cover the extra work of rooting out non-compliance. 

We have an interesting problem. As the surveys indicate, investors strongly believe that audit standards are broken and need fixing. They are even willing to pay for any additional work necessary to fix it.When faced with such investor demand, the market should have responded appropriately. Instead, we have auditors pushing back strongly on efforts at any reform. 

In a quasi-cartelised industry like auditing where a handful of firms exercise tight control over the market and are entrenched in a comfortable self-serving equilibrium that also suits their clients, notwithstanding investor interest, reforms to change the equilibrium will naturally face resistance. This is a classic market failure, arising not due to any government intervention or regulation but purely due to the market's inherent inefficiencies and incentive distortions. It’s an example of a case where regulation has a constructive market-making role to play. 

I’m not sure that the auditors will embrace the reform proposals because it would increase their freedom to do more rigorous audits. There’s a trade-off between accountability and freedom. With reforms that confer more freedom (or strengthen their hands) to auditors comes greater accountability. And that’s a problem. 

On similar lines, organisations hire consultants to diagnose problems and offer recommendations. The organisations then decide to implement the recommendations. But when the outcomes don’t follow, the consultants are not held to account. Instead the consultants blame their clients for not executing them properly or for making changes to their recommendations or on confounding factors. Ironically, a consulting firm which advises an organisation on performance management does not hold itself to account for the non-delivery of its consulting objective. 

Here too there’s a market failure. An industry dominated globally by a handful of firms has collectively defined the standards and terms of their service, insulating them from any scrutiny of the consequences of their prescriptions. The incentives of the corporate executives and managers of these firms are most often aligned, for a variety of reasons, to adopt the prescriptions of the external service providers. Even if they want to enforce accountability, clients struggle to overcome the entrenched industry business model. The only way out is to break the stranglehold is through careful regulation that targets the accountability problem.

Given that the vast majority of these corporate services are procured by companies with diffused shareholders and hired executives and managers, market failure also creates a principal-agent problem. How do the investors know that their capital is being deployed and managed effectively when these ubiquitous and critical corporate services suffer from an accountability deficit? Therefore there’s a public goods case for regulation.

The case for industrial and trade policy

The case for free trade has been an article of faith in orthodox economics. It endures despite little evidence from the whole history of national economic growth. But notwithstanding orthodoxy, there has been renewed interest in industrial policy and trade restrictions in recent times. 

Gillian Tett points to a recent IMF report that describes no less than 2500 industrial policy actions globally in 2023 alone, and developing and developed countries racked up 7000 and 6000 industrial policy actions in the 2009-22 period. And industrial policies have spiked in developed countries, spurred by the threat from cheap Chinese imports. 

The IMF report says that “well-designed fiscal policies that support innovation and technology diffusion more broadly, with an emphasis on fundamental research that forms the basis of applied innovation, can lead to higher growth across countries and accelerate the transition to a greener and more digital economy.”

Tett also draws attention to a paper written by IMF economists Reda Cherif and Fuad Hasanov on the return of industrial policy

There is an important difference between policies that try to create growth by shielding domestic companies from foreign competition and those which help those companies compete more effectively on the world stage.  The former “import substitution” strategy was pursued by many developing countries in recent years, including India. It is also the variant favoured by Trump and the one being considered by some European politicians, for instance in the case of Chinese solar panels. But it is this latter approach that has given industrial policy a bad name. On the basis of copious data, Cherif and Hasanov argue that import substitution models undermine growth in the long term since they create excessively coddled, inefficient industries. By contrast, the second variant of industrial policy aims instead to make industries more competitive externally in an export-oriented model, while worrying less about imports. This approach is what drove the east Asian miracle, and is what creates sustained growth, the data suggests. The difference in approach is embodied by the contrasting fortunes of Malaysian automaker Proton car and South Korea’s Hyundai. The former was developed amid import substitution policies, and never soared; the latter flourished on the back of an export-oriented strategy. 

Cherif and Hasanov distinguish true industrial policy from a Technology and Innovation Policy (TIP) and argue that, unlike others, the East Asian economies pursued TIP.

Although they were not hit with severe negative shocks or possessed some intrinsic characteristics for success, their high sustained growth was the outcome of the implementation of an ambitious technology and innovation policy over decades that kept adapting to changing conditions and moving to the next level of sophistication. The state set ambitious goals, managed to adapt fast, and imposed accountability for its support to industries and firms. We argue that first, TIP was based on the state intervention to facilitate the move of domestic firms into sophisticated sectors beyond the existing comparative advantage. Second, export orientation since the onset played a key role in sustaining competitive pressure and pushing firms to innovate. This strategy contrasts with import substitution industrialization strategies, prevalent until the late 1980s among developing economies, that led to inefficiencies, lack of innovation, and persistent dependence on key imported inputs. Finally, the discipline of the market and accountability were enforced in a strict manner… The more a country was willing to leap technologically beyond comparative advantage and the more this technology was produced by domestic firms, the higher the chances were to sustain high growth…

We argue that TIP offers broad concepts of a growth strategy, the modalities (e.g., tools) of which are yet to be defined… In terms of the role of state, TIP is the exact opposite of centralized planning, as it favors more competition and autonomy of the private sector, not less. The role of the state to intervene is to correct market failures where they exist and enforce a strict market discipline. As such, it is the exact opposite of indefinite support for under-performing, under-innovating and rent-seeking firms. We are not arguing that TIP is easy to pursue or that there is a cookbook recipe. For example, how to select sectors or enforce a strict market discipline is still an uncharted territory… TIP is not in opposition to the standard recipe of macro-stability, improving institutions and business environment, or investing in infrastructure and human capital. All these ingredients are necessary, but not necessarily sufficient for high sustained growth. Through the lens of TIP, policymakers can set clearer priorities for their growth strategies, and we argue that higher and more sustained growth is more probable. The Asian Miracles correspond to the most ambitious version of TIP, which led them from low-income to high-income status in a couple of generations. But there is a spectrum of possibilities depending on domestic and external conditions and how ambitious the authorities are and how willing they are to implement TIP.

Cherif and Hasanov have an updated version of their paper here. They argue that industrial policies failed in the past because the “true one was barely tried… among developing economies, very few pursued an export-oriented industrialization policy on a large scale as it was the case in the Asian miracles.” Cherif and Hasanov merely confirm what Joe Studwell has brilliantly illustrated here. 

The pursuit of TIP is hard. Consider the example of India’s automobile industry which is facing the transition from internal combustion engines to greener alternatives. I came across this article by Ajai Srivastava who uses the examples of India and Australia to highlight the points made by Cherif and Hasanov. 

The Indian auto sector took a leap in the early 1980s with a JV between the Indian Maruti Udyog Limited and the Japanese Suzuki Corporation. Japanese technology and India’s expertise in casting, forging, and fabrication enhanced the domestic auto sector’s productivity by 250 per cent over the next 20 years and set it on a high growth path. Subsequently, three government decisions shaped the industry: The imposition of high import tariffs ranging from 70-125 per cent on completely built cars and motorcycles, but a low 7.5-10 per cent tariff on parts and components to allow the import of inputs; not cutting tariffs under the free-trade agreements or FTAs; and allowing up to 100 per cent foreign direct investment through the automatic route. While high import tariffs sheltered firms operating in India from external competition, the presence of many top global firms making cars in India ensured intense internal competition… About 70 per cent of India’s passenger cars are made by companies controlled by foreign firms like Suzuki, Hyundai, Kia, Toyota, Honda, Ford, Skoda, Renault, Nissan, and Mercedes. Key Indian firms are Tata Motors and Mahindra & Mahindra…

Many experts question the rationale of high tariffs. The example of the Australian auto industry, however, suggests an unwelcome outcome of tariff cuts. In 1987, Australia produced 89 per cent of the cars it used, protected by a high 45 per cent import duty. However, as Australia gradually reduced these tariffs, the proportion of locally produced vehicles decreased. Today, with import tariffs at just 5 per cent, Australia imports nearly all of its cars. Major manufacturers like Nissan, Ford, General Motors, Toyota, and Mitsubishi, which once produced vehicles in Australia, have since closed their operations there.

While industrial and trade policy helped India create a strong automobile manufacturing base, it could not make it globally competitive or innovative. This meant an automobile ecosystem primarily serving the local market and that too by foreign manufacturers. There was limited incentive to innovate, expand the technology frontier, become globally competitive, develop domestic brands, and serve export markets. It’s striking that Indian corporates have failed to leverage their massive domestic market to develop globally competitive brands in any major consumption goods and services. 

As the article informs, there’s a danger that India might be committing the same mistake with its policies on electric vehicles. In particular, there’s a strong risk that the domestic EV industry will depend on Chinese components and be captured by foreign manufacturers. I blogged earlier on it here. 

The example of Australia’s auto industry mirrors manufacturing in general across many developed countries, especially the US. The emergence of business models that prioritised outsourcing and services over manufacturing and the attractiveness of cheap imports, coupled with an ideology that scorned industrial policy and trade restrictions, meant that these countries allowed heavily subsidised Chinese exports to destroy their local manufacturing base. 

In this context, here’s my summary of the case for a heterodox industrial and trade policy. 

Certain industries are critical in the evolution of any country’s manufacturing capabilities - textiles, footwear, steel, consumer electronics, automobiles, pharmaceuticals and chemicals, etc. They catalyse manufacturing ecosystems with productivity spillovers that generate good jobs in large numbers. These sectors have backward and forward linkages that allow economies to start with less skilled activities and move up the value chain of skill and productivity. The North East Asian and Chinese economic miracle have been built on these sectors. 

The standard macroeconomic toolkits of stable and predictable policies, enabling business environment, and investments in human capital and infrastructure are insufficient to develop dynamic and competitive manufacturing ecosystems. Instead, the realisation of these beneficial effects from manufacturing depends also on the industry structure and the nature of the demand. 

So for example, a textile or electronics industry dominated by small and medium firms and manufacturing for a lower middle-income country's domestic market is unlikely to harvest the full gains from manufacturing. They are unlikely to generate the market discipline, competition, and ecosystem required to increase productivity and move up the value chain. They are similarly unlikely to have the incentives to innovate and invest in new technologies and push the frontier by moving up the value chain. Scale and export competition are critical. 

Scale can be achieved either by a large multinational company or being a contract manufacturer for large global brands. The East Asian economies generally took the latter route in their initial years. It also meant that the firms had to maintain high competitiveness in productivity and quality. This created a solid foundation for the growth of the manufacturing sector in the region. They also benefited from favourable geopolitics, trade liberalisation, and globalisation. 

Trade liberalisation and globalisation led to global value chains (GVCs) that integrated businesses and industries across borders. These value chains expanded in breadth and depth, resulting in greater economic integration of whole economies into the GVC with all its beneficial effects. 

In stark contrast, India struggled to create globally competitive manufacturing ecosystems at scale in any of these sectors and failed to integrate with GVCs. For a long time neither could India produce multinational companies nor attract large contract manufacturing firms. The resultant lack of competitiveness and scale meant that India’s manufacturing base was largely aimed at making for India. The domestic companies could not compete with foreign competitors in wide swathes of the economy. The premium and higher segments were captured by foreign brands, leaving the low-margin lower market segments to the local manufacturers. 

Successive governments in India missed the opportunities to use industrial and trade policies like adjusting tariffs to move up the value chain, subsidies and concessions linked to export performance, joint ventures, technology transfers, local content requirements etc. Indian private sector failed to seize the opportunities to create world-class companies and brands and emulate their counterparts in East Asia. Their failure to invest in technology upgradation and innovation, manifest in their low R&D expenditures, must count as a singular failure of corporate India. 

It can perhaps also be argued that India may not have had the economic bargaining power in the early years of liberalisation to pursue such policies. Besides, unlike the East Asian economies, the global economic orthodoxy and institutions like the IMF have generally had greater influence on India’s macroeconomic policies. 

A marked shift in recent years has been the willingness to break out of the orthodoxy and exhibit greater commitment and diligence to pursue heterodox industrial and trade policies. It has certainly helped that the Indian economy is now larger and a major contributor to global economic growth, thereby dramatically increasing its bargaining power. Finally, the global concerns with excessive economic reliance on China and the escalating Cold War between the US and China have been tailwinds that favour the Indian economy.

This willingness to shun orthodoxy also owes to the economic and national security threat posed by Chinese imports and its dominance of sectors and critical manufacturing inputs. The tense border situation with China supplements the increasingly evident security risks posed by that country’s beggar-thy-neighbour economic policies. The refusal to join the Regional Comprehensive Economic Partnership (RCEP) and stiff restrictions on Chinese imports and capital inflows must be viewed from this perspective. 

However, given China’s current dominance in important industrial sectors, it would be foolish and impractical for any country to abruptly and significantly cut itself off from China in the short term. Any policy to reduce reliance on the Chinese economy can only be nuanced, gradual and calibrated. It’s like sailing on two boats or pursuing two conflicting goals. 

In the short term, it’s prudent to continue trade with China and benefit from the several advantages of such engagement. However, the evolution of such trade must be continually observed and policies tweaked to steer its course away. It would involve prohibitions on certain strategic sectors, imposing barriers on certain imports and continually adjusting them, encouraging the development of domestic capabilities, and diversifying away from China. Its success or failure cannot be evaluated based on short-term trends in imports from China. 

It will entail significant costs by hurting local firms and the economy. This must be seen as the cost of national security against China. Economic interest groups and commentators who wail at the so-called protectionist policies aimed primarily against China would do well to keep this perspective in mind. 

It’s undeniable that the cheap Chinese imports are great on a purely short-term cost-benefit assessment. In areas like renewables and new technologies, the Chinese subsidies have done more to mainstream innovation and technology and reduce costs. But they have come at the cost of the destruction of domestic industries across the world and created a very risky dependence on China across manufacturing sectors. This trend cannot be allowed to continue. 

But India’s biggest challenge will be its ability and discipline to pursue well-calibrated and dynamic industrial and trade policies of the export-promoting kind that the East Asian economies did. Can it ensure that these policies prioritise export competition over import substitution? How do we ensure that such policies do not get captured by private interest groups that prevent the changes and adaptation required to move up the value chain? Specifically, can it ensure that the protection of domestic producers does not become an end in itself? 

India’s private sector and mainstream commentators will by and large stoutly oppose such policies. Opinion makers will describe such policies as protectionist and retrograde. The central government ministries have disparate interests and would be far less committed to a national security narrative. More importantly, they will struggle to internalise that perspective required for the single-minded pursuit of such policies. Finally, there’s also the deficiency of the state capability needed to pursue such dynamic policies effectively.  

Weekend reading links

1. Less discussed achievements of Abenomics, on corporate governance and capital market reforms that are major contributors to the country's economic resilience and equity market rebound.

“Reforms, new policy ideas, and civil society participation arrived in a heady rush (with Abe),” says Jamie Allen, who recently stepped down as secretary general of the Asian Corporate Governance Association (ACGA), a non-profit membership organisation driving effective corporate governance practices throughout Asia. He lists the Japan Stewardship Code of February 2014 (it has undergone two revisions since, in 2017 and in 2020); the Ito Review, in August 2014, which put return on equity (RoE) and corporate competitiveness on the map; the Corporate Governance Code of June 2015; a new third system of board governance, the Audit and Supervisory Committee Company, in 2015; the growth of sustainability reporting, strongly encouraged by the Financial Services Agency and the Ministry of Economy, Trade and Industry (METI); the emergence of new director-training institutes; an official set of Guidelines for Investor and Company Engagement in June 2018; new METI guidelines on group governance in June 2019. “Part of (Abe’s) government’s genius was to link CG reform not to risk reduction — as in most markets where governance is a corrective to excessive corporate risk taking — but to the long-term growth of companies and the revitalization of the underperforming Japanese economy,” avers Jamie...

Japan Inc was cash-heavy and that the financial indicators for Japanese companies trailed their European and United States counterparts. Years of poor capital allocation led to low RoE and low price to book (P/B)... The challenge was to link governance and financial performance, which the Tokyo Stock Exchange did through its focus on capital allocation... In March 2023, the exchange asked companies with a P/B ratio below 1 to disclose specific policies and initiatives to lift their value above it. While there may have been other financial indicators for companies to focus on, like return on capital equity or return on capital employed, the exchange narrowed in on P/B, which is now the prominent indicator. Since then, companies have begun focusing on capital efficiency. They have begun buybacks, mergers, spinoffs, unwinding crossholdings, and disposal of treasury stocks. All these are standard tools for any well-managed company but were shunned by Japanese enterprises.

As can be seen,  these are not the kind of big bang ones that commentators harp on. Instead, they are the plumbing of corporate governance and equity market regulation. These less noticed reforms are the kinds of reforms that countries need.

2. India's trade story in numbers over the last two decades

The total merchandise exports figures went up from $63.84 billion in 2003-04 to $314.40 billion in 2013-14 (a rise of $250.62 billion), and now stand at $437.06 billion (a rise of $122.65 billion). So, while the merchandise exports grew almost four-fold during 2004-14, they grew by a little over a third during 2014-24. The services exports, however, grew from $46 billion in 2003-04 to $167 billion in 2013-14 (a rise of $123 billion) and to $340 billion in 2023-24 (a rise of $173 billion from 2013-14). Thus the rise in exports of services is more than the rise in the exports of merchandise in the past ten years... the share of petroleum products (Chapter 27) in our exports basket has stagnated around 20 per cent in the past ten years. The share of gem and jewellery (Chapter 71) exports (7.7 per cent) have halved during the past 20 years. The share of pharmaceuticals (Chapter 30) has doubled in 20 years but still is only around 5 per cent. The shares of chemicals (Chapters 28 and 29) at 5.2 per cent and farm, marine etc. products (Chapters 1 to 24) at 11.01 per cent have stagnated in 20 years. The share of cotton including yarn, fabrics etc. (Chapter 50) at 5.4 per cent has gone up from 3.9 per cent two decades back. The share of highly labour intensive readymade garments (Chapters 62 and 63) has gone down from 8 per cent to 3 per cent in 20 years. The success story is that of engineering products exports (Chapters 72 to 89) whose share in our total exports went up from 18.78 per cent in 2003-04 to 21.33 per cent in 2013-14, and now stands at 29.01 per cent. The share of other products has halved at 13.06 per cent in the past 20 years. From these figures, it is clear that engineering and petroleum products account for almost half of our exports.

3.  Tamal Bandopadhyay has a very good column taking stock of the Insolvency and Bankruptcy Code.

A November 2023 report of rater Crisil Ltd pointed out that the recovery rates (as a percentage of admitted claims) have fallen from 43 per cent to 32 per cent between March 2019 and September 2023 even as the average resolution time has more than doubled, from 324 to 653 days. Realisation by financial creditors, as a percentage of liquidation value, has also dropped from 194 per cent to 168.5 per cent during this period... Since the IBC’s inception, 6,815 cases have been admitted to the NCLT, and 2,827 of these cases, that’s 41 per cent, are still undergoing the resolution process. The average resolution time has been rising and is now at a three-year high. Till December 2023, of the 6,815 cases, 891 had been resolved (against financial creditors’ claims of Rs 9.09 trillion, the realisation is Rs 3.1 trillion); 2,376 ended in liquidation (1,789 received no resolution plans and 587 got at best a couple of plans); and 721 in voluntary liquidation.

There are two problems that are not easily addressed. One, corporate India's innate instincts of using vexatious litigation to delay and subvert the process. Two, more importantly, the judiciary's willingness to foist themselves on these cases and leave them unheard for months (as the Videocon-Vedanta case pending in Supreme Court for more than two years shows). 

4. Have long run neutral interest rates in the US gone higher?

The neutral rate, sometimes called “r*" or “r-star," can’t be directly observed, only inferred... Every quarter, Fed officials project the longer-run interest rate, which is, in effect, their estimate of neutral. Their median estimate declined from 4.25% in 2012 to 2.5% in 2019. After subtracting inflation of 2%, that yielded a real neutral rate of 0.5%... if inflation resumes its decline, questions about neutral would drive how much the Fed ultimately cuts rates. The Fed wants to “normalize policy, but ‘normalize’ to where?" said David Mericle, chief U.S. economist at Goldman Sachs. “They are not going to stay in the 5s, but normalization is not going to take them all the way to 2.5%. Where in the 3s or 4s they feel comfortable stopping is still up in the air." There are several factors cited for why neutral may be rising: soaring government deficits and strong investment driven by the green-energy transition and an artificial-intelligence-fueled frenzy for electricity-intensive data centers. Higher productivity from AI could also lift long-run growth and the neutral rate. Dallas Fed President Lorie Logan warned in a recent speech that interest rates may not be as restrictive as believed because of a higher neutral rate. “Failing to recognize a sustained move up in the neutral rate could lead to over-accommodative monetary policy," she said... Interest-rate futures suggest the fed-funds rate will stabilize around 4% in coming years.

5. Interesting that the growth of GST collections have lagged behind the growth rates of nominal GDP and Income Tax.

The corporate tax cuts have not only not revived private investments but has also led to a reduction in corporate tax revenues as a share of GDP.

The tax cut failed to achieve its goals, as private investments have not taken off and the government has been forced to pump in massive amounts through capital expenditure to support the economy. At the same time, the immediate result of the tax cut is visible in collections, which is expected to be 3.2% of GDP in 2024-25, significantly less than the average mop-up a decade before the decision. As such, the government’s coffers are being filled more by personal tax collections than by corporate tax, raising questions about whether it is indeed pro-corporate.

6. FT has an article that points to the steep decline in water desalination costs on the back of cheap solar power.

Older, thermal plants, which used heat to turn salt water into steam, delivered potable water at more than $3 per cubic metre. Since then, reverse osmosis technology — in which water is pushed through a membrane to remove salt, minerals and impurities — has taken over. Plants cost less to build — perhaps $400mn to purify 500,000 cubic metres per day, says Christopher Gasson of GWI. Including installation, a return on capital and operating costs, that translates to $0.30 per cubic metre of water. Newer plants also need less energy — 2.6KWh per cubic metre — and are increasingly powered by cheap solar plants. The cheapest plant in the world gets energy at $0.025/KWh, or $0.07 per cubic metre. Put that together and it explains how the Hassyan project in Dubai has promised desalinated water at just $0.37 per cubic metre. For reference, drinking water in London is priced at £1 per cubic metre. At this sort of level, desalination becomes more affordable for dry, coastal areas, not just in the Middle East but also in Egypt, Algeria and Morocco, which are all building new plants... the market for new plants is expected to grow by perhaps 8 per cent a year from now to 2030... early movers in the desalination sphere, including Saudi Arabia’s ACWA power, Spain’s Acciona and France’s Veolia, have a clear advantage in a competitive race.

7. Rana Farrohar points to the dysfunctional nature of the US home insurance market.

A couple of months ago, my insurance company decided to raise the price of the yearly insurance premiums on our Brooklyn home by 51 per cent over three years, after more than doubling the estimated cost to rebuild should it burn to the ground or be washed away in a hurricane. While neither outcome seems likely for a limestone townhouse that sits on a hill more than a mile and a half away from the nearest flood zone, our insurer came up with an estimate that was more than double what the house would go for on the open market, making coverage both excessive and unaffordable... No one was willing to sell us a premium for the market value of our home and simultaneously prepared to write us a cheque for that value in case of total loss. We had two choices. Take out a policy with a handful of luxury insurers that would only sell us far greater coverage than we wanted for much more than we could afford. Or go with a budget policy offering roughly a third of what it would cost to buy a similar home in the case of a total loss — with the money only paid out if we chose to rebuild on site... we have any number of friends with similar homes who are paying wildly different prices for insurance. When I asked our broker how it was possible, or even legal, for a neighbour with the same insurer and the exact same house three doors away to pay a bit more than half our new quote, she told us that their premiums would very likely be raised next... 

How could there be so few options, so little transparency and such tolerance of inflation and inefficiency in a market as big as New York? Why was my home, which has never been seriously damaged by weather, being risk-assessed like something in a hurricane flood zone that is more than a mile and a half away? Why is the insurance industry so bad at pricing risk in a more precise way around the city, and indeed, much of the rest of the country?

Talk about free markets and their magic! This is a great example of how markets on their own fail to work, thereby necessitating regulation and government intervention to make them work effectively.  

8. China economy imbalance facts of the week.

China’s investment to gross domestic product ratio, at more than 40 per cent last year, is one of the highest in the world, according to the IMF, while private consumption to GDP was about 39 per cent in 2023 compared to about 68 per cent in the US. With the property slowdown, more of this investment is pouring into manufacturing rather than household consumption, stimulating oversupply, western critics say. “China is responsible for one-third of global production but one-tenth of global demand, so there’s a clear mismatch,” US secretary of state Antony Blinken said in Beijing last week... China’s high national savings rates, which, at more than 47 per cent of GDP in 2022, are double the world average.

“The solution has always been a massive increase in investment,” Pettis says. But, he adds, with signs of over-investment now “everywhere”, from the property sector to overbuilt infrastructure, and debt to GDP at about 300 per cent, “you can see that investment can no longer be the solution”... Greater consumption would also necessarily mean reducing the role of manufacturing or investment in the economy. This could be done by unwinding China’s intricate system of subsidies to producers, which includes government infrastructure investment, access to cheap labour, land and other credit, says Pettis. But if that was done in a big bang fashion, the share of household consumption to GDP would increase while overall GDP would contract as manufacturers suffered. This was obviously not a politically preferable option for Xi. “They are locked into this system,” Pettis says.

9. Michael Pettis has a nice summary of the economic imbalance problem.

China’s structurally-high domestic saving rate is the result of a decades-long development strategy in which income is effectively transferred from households to subsidise the supply side of the economy — the production of goods and services. As a result of these transfers, growth in household income has long lagged behind productivity growth, leaving Chinese households unable to consume much of what they produce. Some of these subsidies are explicit but most are in the form of implicit and hidden transfers. These include directed credit, an undervalued currency, labour restrictions, weak social safety nets, and overinvestment in transportation infrastructure. These various policies automatically force up Chinese savings. By effectively exporting excess savings through the subsidy of the production of goods and services, China is able to externalise the resulting demand deficiency...

China’s structurally-high domestic saving rate is the result of a decades-long development strategy in which income is effectively transferred from households to subsidise the supply side of the economy — the production of goods and services. As a result of these transfers, growth in household income has long lagged behind productivity growth, leaving Chinese households unable to consume much of what they produce. Some of these subsidies are explicit but most are in the form of implicit and hidden transfers. These include directed credit, an undervalued currency, labour restrictions, weak social safety nets, and overinvestment in transportation infrastructure. These various policies automatically force up Chinese savings. By effectively exporting excess savings through the subsidy of the production of goods and services, China is able to externalise the resulting demand deficiency.

10. The economic imbalance is also creating foreign policy tensions, and increasingly with other developing countries over cheap Chinese imports flooding their markets and destroying local industries. 

Brazil’s industry ministry has launched a number of investigations into the alleged dumping of industrial products by China as Latin America’s largest economy reels from a wave of cheap imported goods. At the request of industry bodies, the ministry has in the past six months opened at least half a dozen probes on products ranging from metal sheets and pre-painted steel to chemicals and tyres... In addition to Brazil, China’s steel exports to Vietnam, Thailand, Malaysia and Indonesia have risen sharply in recent months... In Thailand, the government has accused Chinese companies of evading anti-dumping duties, while industry groups have warned of big losses from cheaper steel in the market. Vietnam’s government has launched investigations into dumping of wind towers and some steel products from China after complaints from the local industries. In August last year Mexico imposed tariffs of 5-25 per cent on imports of hundreds of goods from countries with which it does not have a free trade agreement, with China being one of the countries most affected.

11. A less discussed but one of the most remarkable achievements of energy policy, foreign policy (and the European Project), and infrastructure mobilisation was the success of Germany and Europe in replacing Russian natural gas imports in the aftermath of the Ukraine invasion. Germany took the lead in establishing LNG import terminals, Floating Storage Regasification Units (FSRU). 

Wilhelmshaven was the first floating storage regasification unit (FSRU) to come online during the crisis but many more are in the works. Since Russia started cutting pipeline supplies to Europe in 2021, at least 17 liquefied natural gas (LNG) terminals have been planned or are under construction. LNG received by these FSRUs have helped replace all but 10 per cent of the gas supplies that previously came to the EU from Russia via pipelines, helping to reduce gas prices from record highs of over €300 per megawatt hour in August 2022 to near pre-crisis levels of around €30 per megawatt hour today. The energy crisis that Europeans feared two winters ago has not come to pass, thanks to a combination of unprecedented energy policy interventions, cuts in demand and good luck... The bloc is reliant on imports, either through pipelines or LNG shipments, for nearly 90 per cent of its supplies. Before the war, flows through four main pipelines from Russia accounted for around 40 per cent of the EU’s total supplies.

The higher prices being paid in Europe led LNG traders to prioritise deliveries to customers there over those in Asia, says Tom Marzec-Manser, head of gas analytics at ICIS. “Market signals were fundamental in allocating resources where it was needed.”

12. Hybrids cars are growing faster than EVs, whose growth has declined globally.

According to S&P Global, the penetration of all categories of hybrids has gone up from 9 per cent globally to 11 per cent in 2023 and is neck-and-neck with electric cars, though the latter are marginally ahead at 12 per cent, compared to 10 per cent in 2022. In the United States, hybrid sales in 2023 were 1.4 million and overtook electric cars, which sold 1.2 million. Globally, sales of plug-in hybrids grew faster, going up by 43 per cent in 2023, compared to a 28 per cent increase for electric cars.

Plug-in hybrids have two engines and the electric part has a much larger battery than in the regular hybrids. As the name suggests, plug-in hybrids require to be plugged into an electric socket to charge their battery. A regular hybrid gets its battery (smaller than in plug-ins) charged by the gasoline engine – the two complement each other -- and regenerative braking. Plug-in hybrids in China grew by 85 per cent in 2023, while electric vehicles grew by 70 per cent. In India, the popular hybrids, such as Toyota Hyryder and Maruti Suzuki’s Grand Vitara, do not require to be plugged in. The global trend towards hybrids is now visible in India, where they are being seen as an essential bridge to EV land... Electric cars attract a goods and services tax (GST) rate of 5 per cent. Hybrid cars attract 28 per cent GST, but the cess takes the total tax incidence to 43 per cent, unless it is a small car. ICE cars attract the same GST, but the cess takes the total to up to 50 per cent, varying according to the size of the body and engine.

This is an interesting cautionary tale from Norway about the promised emission benefits from EVs.

A study by Goehring & Rozencwajg, a natural resource investor, says despite the noise on Norway’s successful model for electrification of cars, the country forks out $4 billion on electric vehicle subsidies annually, as much as it does for building highways and maintaining public infrastructure, which has a big financial impact. Goehring & Rozencwajg also points out that despite all the action on the electric front in Norway — 20 per cent of all vehicles on the country’s roads and 80 per cent of new vehicles are electric — gasoline demand has gone down by only 4 per cent. That is because Norwegians are reluctant to give up their ICE cars even after they have bought an electric. Two-thirds of car owners in Norway have at least one ICE vehicle, and they continue to use it.

This effect is likely to be more pronounced in India.

13. Shyam Saran has a good oped on the ongoing situation in Gaza, which is clearly a genocide and a humanitarian disaster happening with the full knowledge of the UN and the international community and with so limited restraints on Israel. As Saran writes, the political survival of Netanyahu depends on the continuation and escalation of the situation in the region.