The importance of broad-basing economic growth and climate change transiti

Two fundamental issues on economic growth are often glossed over in public debates in India. One, sustained high economic growth rates require a broad consumption base that the country currently lacks. Two, adding layers of costs, whether in the name of formalisation or climate change or emulation of global standards, will further narrow the consumption base and slow down economic growth. 

In a recent interview, Mr RC Bhargava, Chairman of Maruti Suzuki, captured both these aspects nicely.

This year, we are seeing negative growth in the sub-Rs 10 lakh car segment, which represents two-thirds of the market. Only the over-Rs 10 lakh segment is growing, so overall growth is muted. Clearly, a 7 per cent growth rate cannot be sustained when one-third of the market is growing while two-thirds is shrinking… The country decided to upgrade its safety and environmental standards to be on a par with Europe. However, implementing these standards costs money, and it has led to a 60 per cent increase in production costs for lower-priced cars since 2019. The burden of this increase is proportionately much higher on small cars than on cars priced over Rs 10 lakh. So, a car priced at Rs 6 lakh now costs Rs 10 lakh, while salaries have not risen in similar proportions… I think growth will not exceed 3-4 per cent for a few years until economic growth helps bridge the affordability gap in the lower end of the market… It’s clear that the passenger car market in India won’t grow very fast, so we need to focus on exports.

Three things stand out. One, car sales are shrinking or stagnating in the larger lower-priced segment, pointing to a narrow base of the mass market. Two, the Indian car market is expected to grow slowly, only at 3-4%. Three, the costs of environmental and safety standards has fallen disproportionately on the lower-priced vehicles, thereby raising their prices and consequently lowering demand. 

While I don’t hold any brief for Mr Bhargava or Maruti, the points raised are critically important for India’s economic growth. Let’s discuss each point in turn, starting with the narrow consumption base. 

Consider a few data points on indicators that are proximate to consumption. India’s finished steel consumption rose from 66.4 mt in 2010-11 to 136.29 mt in 2023-24, an annual growth rate of 5.69%. Cement consumption rose from 230 mt in 2011-12 to 375.2 mt in 2022-23, an annual growth rate of 4.55%. Electricity consumption rose from 0.785 million GWh in 2012 to 1.403 million GWh in 2024, an annual growth rate of 5.42%. Two-wheeler sales rose from 11.79 million units in 2010-11 to 17.97 million units in 2023-24, an annual increase of just 3.3%, whereas over the same period, passenger car sales rose slightly faster at 4.11% from 2.5 million to 4.22 million units. 

In other words, the annual growth rates of the five most proximate indicators of consumption over more than a decade have trailed in the 3% to 5.7% range. All these growth rates were lower than the annual real growth rate of 5.73% in the 2011-23 period. These are not the indicators of broad-based economic growth for a country starting from a low baseline like that of India. Bhargava may just about be right in his assessment of the potential growth rate of the automobile market in India. 

For a massive economy like India, the binding constraint for the country sustaining high economic growth rates is the base of its consumption class. It needs a base of consumers whose assured and growing supply can support the kind of investments required to sustain those high growth rates. This base should span the spectrum from basic consumption to high-value consumption, with decreasing price sensitivity (and therefore higher margins). 

This broadening of the base must manifest across both consumers and geographies. The number of consumers in each segment must increase (intensive margin), and the geographical footprints of consumption must expand (extensive margin). 

On the spatial side, a market test for whether the economy is becoming more broad-based is to monitor the expansion of the popular markers of middle-class (as opposed to subsistence) consumption. The most definitive markers of such consumption are the popular (locally or nationally) brand retail chains of hotels, restaurants, clothing, consumer durables, grocery, and services (like hairdressing, hospitals, schools etc.). 

In this context, two questions are important for understanding the consumption base of the Indian economy and how it’s evolving. What’s the current distribution of these shops? How’s the distribution changing spatially?

The Ken has a graphic from a Sanford Bernstein report that mapped about 20,000 outlets run by India’s top 30 retail and restaurant chains to the country’s 19,300 plus PIN codes. It finds that just over a fifth of these pin codes are home to all these stores and only 5% have more than five stores. 

It’s a reflection of the narrow middle-class consumption base that the definitive markers of such consumption are confined to just a fifth of the population and in even smaller share of geographies. This must expand significantly if economic growth is to reach a sustained higher level. 

It’s in this backdrop that we are now introducing environmental standards and pursuing climate change mitigation policies. 

Before examining the costs of these standards, it’s worth pausing and taking a status check on what’s happening globally with climate change mitigation policies. 

As the Chief Economic Advisor, Ananthanageswaran has written, the current basket of policies considered globally will place a disproportionate burden on developing countries and are a major headwind on their primary objective of poverty elimination. Any meaningful and fair proposal should take into account both the stock and flows of carbon emissions and apportion commitments accordingly, with primacy for the former. This will necessarily entail atleast some modest de-growth in developed economies. If such policies are unacceptable to electorates in developed countries, it’s hypocritical to assume that the electorates in poorer countries will accept self-restraints and forego their opportunities to improve their lives from their current impoverished baseline. 

Like with any regulation, there are costs associated with such standards. The higher production costs translate to higher costs and lower affordability and reduced demand. 

This reality is unavoidable. And it’s true for any kind of exogenous intervention or economic transition, including the efforts to formalise the economy. We know this from free trade, where happy theory of labour market adjustment has consistently differed from the stark reality of labour market dislocation and pain. 

However, this does not mean that we should refrain from environmental standards or formalisation. Notwithstanding their costs, these reforms are not only essential for their own reasons but also in the long run increase productivity and usher economic progress. 

The critical point to consider for public policy is the balance and speed with which these reforms should be pursued. If pushed too quickly without any balance, they will hinder the economic adjustment process and hurt demand and economic growth. For sure policy can and must facilitate and expedite the adjustment process. But there’s only so much resource and capacity-constrained governments in countries like India can do to address complex challenges like these. 

It’s for these reasons, that economists’ argument that markets will adjust to accommodate those who lose jobs from trade liberalisation has not materialised in reality. Theory has consistently diverged from reality across countries. In fact, it can be stated with reasonable confidence that the economic and social costs associated with trade and immigration liberalisation policies pursued till date have been the two biggest contributors to electoral reverses in advanced countries in the last decade. 

In conclusion, as we have written here, if developing countries like India pursue their climate mitigation policies too aggressively to win brownie points among a hypocritical global audience, poverty and impoverishment will consume their populations before climate change will. The final word on this to the CEA, “It is always desirable and necessary to have the freedom and autonomy to determine the pace of such a transition ourselves. Countries must own the energy transition”. 

India's private sector and R&D investments

I have written several times on the Indian private sector. This post will try to summarise a few things. 

Naushad Forbes has several educative op-eds in Business Standard on the topic, including one where he helpfully outlines a benchmarking exercise for Indian firms.

I’ll draw on two sets of data from his opeds. 

One, the comparison of the R&D expenditures of the top ten profitable non-financial firms of the world’s five largest economies in 2021 shows that despite having the second highest profits as a percentage of sales, nearly double those of China, Japan, and Germany, the Indian companies spend an abysmally low share of profits and sales on R&D. 

Indian firms invest 0.3% of GDP in in-house R&D, compared to a world average of 1.5%.

This is the R&D spending in 2021 of India’s top 10 non-financial firms. It’s abysmally low, even for the IT firms. Despite a total sales of $276.9 bn and profits of $43.3 bn, their total R&D spending was not even a billion dollars (just $0.95 bn).

What does it tell about the country’s private sector when its top corporates don’t feel the need to invest in R&D despite enjoying very high profitability, much higher than counterparts in countries like even Japan or Germany?

Sample this from 2021 data

The most telling comparison is that each of the top seven (global) firms invests more than all of India (every firm, university and government laboratory put together).  And even firms #24 (Honda), #25 (Qualcomm) and #26 (Bosch) each invest more in R&D than all Indian industry combined at over $7 billion each.

Take the second exhibit, which compares the R&D spending of the top 2500 global firms. India has just 23 firms in the full list, with 10 in the pharmaceuticals and biotechnology sectors. 

We have no presence in six of the top 10 industries that invest in R&D: Technology hardware, electronics, construction, health care, general industrials, and industrial engineering. Where Indian firms are present, they invest less in R&D than the world average. In auto, the four Indian firms (Tata Motors, M&M, Bajaj, TVS) that figure in the top 2,500 R&D investors spend 3.8 per cent of their global turnover on R&D, which drops to just over 1 per cent without Tata Motors’ JLR subsidiary in the UK.  The world average for auto is 4.8 per cent.  In software, the top Indian firms (TCS, Infosys, HCL) invest 1 per cent of turnover in R&D, compared to a top 2,500 average of 14 per cent. In pharmaceuticals, the top five Indian firms invest 6 per cent of sales in R&D.  This is less than the world average of 17 per cent, but higher than any other industrial sector in India.  The problem is that our pharmaceutical firms are relatively small.  The average turnover of our five largest pharmaceutical companies (Sun, DRL, Aurobindo, Lupin, Cipla), at $3 billion, is a fraction of the $45 billion average of the top 20 pharmaceutical firms worldwide. Our top five firms invest an average of $200 million in R&D, compared to an international top 20 average of $7 billion.

There are several reasons offered for Indian companies’ failure to invest in R&D. They include cultural factors, smaller sizes, low margins (due to the price-sensitive market), lack of export focus, and so on. There’s perhaps a part of all in the explanation, and more. 

It’s surprising that even sectors like pharmaceuticals and software, where Indian firms enjoyed a head start, have struggled to invest in R&D. The pharma companies have failed to capitalise on their early start and expand to become at least global-scale contract manufacturers of APIs (or bulk drugs), besides having had limited success in moving up the value chain to formulations and nothing to show on drugs discovery. 

The case of India’s software firms is intriguing. As I blogged here, despite achieving global scale, Indian software firms have been unable to transition from being manpower services outsourcing firms to becoming software product companies. Besides, they have not been able to make breakthroughs in cutting-edge technology segments like cloud computing, robotics, data analytics, AI, IoT etc. The R&D spending as a share of sales of even the top Indian IT firms lags by orders of magnitude. 

They appear to have become captives to their own successes in the lower-value manpower services segment and have not exhibited the courage and vision to breakout and aspire to move up the value chain. They have been unable to capitalise on their scale and invest in R&D. Their very low R&D spending (less than 1%, compared to the global average of around 10%) is a reflection of their lack of ambition and an important cause for their failure to innovate. 

I had written sometime back on India’s entrepreneurship deficit. While data is not available, it’s most likely that even the new-age technology sector firms like those in e-commerce and digital platforms’ spending on R&D is only a small proportion of their global peers. 

In this context, it’s also useful to look at the requirements for firm innovation. Mr Forbes also points to some microeconomic research on firm behaviour and when they innovate. In one paper, Philippe Aghion, Antonin Bergeaud, and John Van Reenen examined the impact of labour regulation on innovation and found:

We exploit the threshold in labor market regulations in France which means that when a firm reaches 50 employees, costs increase substantially. We show theoretically and empirically that the prospect of these regulatory costs discourages firms just below the threshold from innovating (as measured by patent counts). This relationship emerges when looking nonparametrically at patent density around the regulatory threshold and also in a parametric exercise where we examine the heterogeneous response of firms to exogenous market size shocks (from export market growth). On average, firms innovate more when they experience a positive market size shock, but this relationship significantly weakens when a firm is just below the regulatory threshold. Using information on citations we also show suggestive evidence (consistent with our model) that regulation deters radical innovation much less than incremental innovation. This suggests that with size-dependent regulation, companies innovate less, but if they do try to innovate, they “swing for the fence”.

Aghion and co-authors (also this) analysed the data of French firms’ exports for the 1995-2012 period and found that exports are associated with an increase in patent filings, but only from those firms with higher average quality patents and in the case of destination countries at intermediate stages of development. 

Another paper uses data from French manufactured goods exporters on their innovation responses (in terms of patent applications) to demand shocks in their destination markets.

Our first finding is that on average firms respond to a positive export demand shock by innovating more. In other words, we find a significant market size effect of export demand shocks on French firms’ innovation… Our second finding is that the innovation response to a positive export demand shock takes 2 to 5 years to materialize, highlighting the time required to innovate. In contrast, the demand shock raises contemporaneous sales and employment for all firms, without any notable differences between high and low-productivity firms... Our third finding is that the impact of a positive export demand shock on innovation is entirely driven by French firms with above-median productivity levels (in an initial period prior to the demand shocks). This heterogeneous response could simply reflect the fact that the demand shock only affects the most productive firms… We find that in contrast to what we observe for innovation, there is no heterogeneous response of sales or employment to a demand shock for low versus high-productivity firms. Thus, similar demand shocks only lead to future innovation responses by relatively more productive firms.

Some takeaways from all this microeconomic research are that only firms above a certain productivity level and size threshold might have the incentive to innovate to reach the technology frontier; only firms above a certain productivity level can benefit from exports; and export benefits accrue only when exporting to countries at intermediate stages of development. 

This assumes importance for the design of Make in India and the production-linked incentive (PLI) scheme. It highlights the importance of exports and that too to more advanced countries as an essential requirement for domestic firms to reap the productivity benefits. 

One of the things that public policy could promote in this regard is to incentivise Indian firms to operate at the technology frontier. One way to achieve this is to encourage making in India for the global markets. As Joe Studwell writes, the North East Asian economies and their companies became globally competitive market leaders by pursuing the policies of export competition coupled with the elimination of the uncompetitive. 

In conclusion, it may not be incorrect to argue that corporate India suffers from a culture where innovation and R&D investments are not valued appropriately. It appears to have become entrapped in a culture that prioritises cost-cutting over all else, including minimising innovation and R&D spending, to boost the bottom line. In this culture, companies do just enough to sell more and investments with long-term benefits like R&D get marginalised. Given this, whatever little R&D happens is in the form of jugaad, and not the industrial-scale research and development undertaken by globally competitive firms. 

It might be the case that the massive and deeply price-sensitive Indian market is a major factor in the emergence of this culture. The massive market means that by and large Indian corporates have realised that they can sustain themselves by merely serving the large domestic market. The low margins in the mass market segments discourage foreign firms, thereby shutting off foreign competition and the one big compulsion for domestic firms to innovate. This is perhaps a curse of the large and price-sensitive market. 

Unless it can break out of this culture, all other efforts will remain futile. Any effort by the government will only be tinkering at the margins. It’s time for India’s corporate leaders to seize the initiative and resolve to create 5-10 world-beating innovating companies over the next five years. As a start, they could begin to benchmark as proposed by Mr Forbes and own up the agenda.

Weekend reading links

1. FT reports on how Europe's automobile sector is struggling to stave off Chinese competition. The industry employs 14 million people and contributes 7% of EU GDP. Consider this

In its 87-year history, Volkswagen has never closed a factory in its German heartland. It is now considering shutting three and cutting workers’ pay by 10 per cent... Stellantis, owner of Opel, Fiat and Peugeot in Europe, is under intense pressure from Italian politicians and unions to keep its oldest Fiat factory in Turin running despite a slump in sales. Assembly lines in France are already being shifted to lower-cost locations such as Morocco and Turkey... Demand for cars is falling at home and abroad, while carmakers are navigating a risky and expensive multiyear transition from combustion engines to electric propulsion... Vehicle sales in Europe have not recovered to pre-pandemic levels and higher interest rates are hurting demand... The rise of homegrown brands has sharply reduced the sales of European, US and Japanese carmakers in China, which in recent years has been the biggest and most lucrative market for brands such as Volkswagen, Mercedes-Benz and BMW... Foreign brands’ market share of Chinese auto sales is trending at a record low of 37 per cent in the first eight months of 2024, down from 64 per cent in 2020...

All these problems are being exacerbated by China — where competition for sales in the once-lucrative domestic market is ferocious, and whose high-quality, lower-cost EVs are now being exported to Europe in greater numbers... Electric cars are still expensive to produce in Europe, mostly because of the high cost of batteries, making them expensive to buy. Consumers want cheaper EVs and more charging stations, and many are holding off buying until they get them. As a result, sales are slowing just as tougher EU emissions rules from next year mandate a faster shift to cleaner vehicles... Chinese manufacturers such as BYD, Nio, MG-owner SAIC, Great Wall and Chery are building more advanced electric cars with costs 30 per cent lower than those of European carmakers.

Also this about the troubles of Volkswagen.  

2. BYD's EV success must count as one of the most impressive corporate successes of all time.

After increasing its annual sales in China 15 times over, to 3 million cars in only three years, BYD is now exporting to roughly 95 markets, including 20 new ones this year. The company is building, has recently opened or has announced plans for assembly plants outside China in 10 countries on three continents. The speed and scope of this expansion have caught the global auto industry off guard and triggered protectionist tariffs in the US and EU... BYD’s electric and hybrid vehicle car sales rocketed from just under 180,000 in 2020 to 1.86 million in 2022... 

BYD, which stands for “Build Your Dreams,” is the brainchild of Wang Chuanfu, a 58-year-old battery scientist who in the 1990s saw an opportunity to start a rechargeable battery company to challenge Japan’s hold on the industry. It began by focusing on batteries for mobile phones and power tools, but in 2003 it decided to pursue cars. Wang’s battery and manufacturing innovations, cushioned by China’s EV-friendly government policies and the scale of its domestic auto market, have helped BYD do what Tesla Inc., Ford Motor Co. and the rest of the auto industry haven’t: build an affordable electric car for the masses and make money doing it. Since introducing a new battery technology in 2020, BYD has gone from being an also-ran in China’s crowded car market to cracking the top 10 automakers in the world. It’s unseated Volkswagen AG from its decade-plus perch at the top in China and briefly—in late 2023—surpassed Tesla to become the biggest seller of pure electric vehicles globally... 

If the Motorola deal transformed BYD once, the Blade battery, unveiled in 2020—and now powering all of the company’s cars—would do it again. Most researchers outside China were trying to improve EV range by experimenting with nickel-based batteries. Wang chose lithium iron phosphate, or LFP, which was cheaper and less fire-prone but had been largely dismissed because it lacked energy density. Using LFP allowed Wang and his team to streamline the battery pack, do away with some of the clunkier fire-prevention components and fuse cells directly to the chassis. These improvements proved LFP could be harnessed for longer-range EVs, drastically reducing overall cost. It was so competitive that Toyota uses it in its cars in China, as do many Chinese carmakers... 

BYD’s Blade was introduced at a glitzy product debut in Shenzhen in March 2020... That summer, when BYD rolled out its new all-electric Han luxury sedan priced just above $32,000, it was clearly no knockoff; the company had hired expensive designers from Europe, led by former Alfa Romeo and Audi designer Wolfgang Egger. With its European style, 375 miles of range, leather seats and high-end driver assistance features, the Han comfortably undercut rivals on price and became a hit. Egger’s team of more than 1,000 designers would allow him to keep up with the frenetic product cadence of the Chinese car market, pumping out new vehicles or refreshes in as little as 18 months versus what is usually a three- to four-year cycle in the US and Europe.

This explains how the Chinese companies have come to dominate the EV market. This is a Kiel Institute study on the subsidies received by Chinese EV manufacturers. 

This on Volkawagen's struggles in the Chinese market.

For four decades, Volkswagen Group was the market leader in China, where drivers prized its wide range of cars, from frugal Volkswagen Santanas to potent Audis and Porsches. But VW has been replaced as China’s go-to carmaker by the Chinese electric vehicle powerhouse BYD. BYD rapidly expanded all-electric car sales over the past three years, forcing VW to make a big bet last year on that market. Then BYD caught VW off guard again early this year by ramping up sales of plug-in gasoline-electric hybrids that can go long distances on only battery power, with tiny gasoline engines as backups. VW has few offerings in that fast-growing category... Volkswagen’s troubles in China are affecting the company as a whole. Its 10.2 percent drop in the number of cars sold in China during the first nine months of this year more than erased all of its sales gain in the rest of the world. The entire group’s worldwide sales shrank slightly as a result, and the company announced on Tuesday that its profits plunged in the third quarter. The company may have to close factories in Germany for the first time in its 87-year history — as many as three plants, each employing thousands of workers — partly because of competition from China.

3. Which has been the most productive sector in the US economy over the last decade?

Productivity in the oil and gas extraction sector almost tripled in the 10 years ending in 2022, compared with a near-doubling in some tech-driven industries... America’s oil resurgence over the past decade was a different kind of technological breakthrough, the combination of drilling horizontally through layers of shale and then fracturing, or fracking, the rock with blasts of water, sand and chemicals to extract hydrocarbons. But shale drilling was initially thought to cost more and be geologically more limited over the long term than drilling the free-flowing reservoirs of the Middle East. Output from US basins like the Permian of West Texas and southeastern New Mexico was expected to run out of steam as producers exhausted well locations and faced rising costs... Chevron has doubled production in the Permian to nearly 1 million barrels a day just in the past five years, without making any significant acquisitions. These limits are being reevaluated. Oil and gas extraction is forecast by the US Bureau of Labor Statistics to see some of the fastest output growth among industries over the next decade...

Operators continue to improve the fracking process. That includes drilling longer wells and releasing the water at half the rate, reducing friction that can slow the process and waste horsepower. Explorers are now drilling 4-mile (6.4-kilometer) wells horizontally through layers of shale, up from 3 miles only a year or two ago. Industry consolidation is aiding the trend. Producers, by buying companies with neighboring acreage, are gaining access to larger swaths of land into which they can drill lengthier wells... Many drill bits, such as those offered by Baker Hughes Co., are now autonomous and can steer themselves. Using electronic sensors stuffed into a roughly 6-foot-long metal cylinder behind the steel-toothed bit, computers can chart the optimal course through layers of rock and self-correct in about a minute, rather than the more than 10 minutes it would take a human to change the trajectory. Workers at rig sites are also aided by improved software—a kind of three-dimensional, underground Google Maps—that advises them in real time where to direct the drill bit to stay in the biggest oil pocket...

Mergers and acquisitions are reducing the number of workers in US oil fields. Shale workers now need only a year to drill the same footage that, a decade ago, would have taken them three years to get through. As the number of crews is winnowed down, only the most experienced are left. Back in 2014, Permian operators needed crude prices above $70 a barrel to make a profit. But about a decade later, they can make money in the $40-a-barrel range, even as they expand to less favorable geologic formations, according to S&P Global Commodity Insights.

4. Good graphic that shows how news media in the US is completely divided into two distinct parts in terms of their political allegiances.

Does this mean that there's a market failure in the supply of balanced news? Or is there no demand for such news?

5. Tamal Bandopadhyaya makes an important point in the context of declining credit to deposit (CD) ratios of banks.

The cash management by the government – both at the central and state levels – has affected banks. Instead of keeping money with banks, the governments are now keeping money with the RBI. Particularly during the general elections, the government’s cash balance with the regulator was huge.

6. Brad Setser points to multinational croporations' tax avoidance. On "phantom" FDI, or large paper investments in corporate tax centres that shifted profits out of high-tax jurisdictions. 

On the same lines, the largest sources of US pharma imports by value are the tax havens and not the low-cost generics makers like China and India. In fact, $40 bn by value is imported from Peurto Rico, offshore for US tax purposes. Sample this

US pharmaceutical firms have announced several new greenfield investments in Ireland linked to the production of new patent-protected drugs... US pharmaceutical firms consistently report losing large sums on their US operations in their annual 10-K SEC disclosures even though US patent-protected drug prices are roughly three times higher than the global norm. Those same firms consistently report earning large profits outside the US even though said earnings are smaller than their US revenues... many pharmaceutical firms pay essentially zero in actual tax in the US, despite significant global profits... In 2022, the major pharmaceuticals paid about $3 billion in US tax on their $105 billion in global profit—an effective tax rate in the US of less than 3 percent. In 2023, the same set of companies, in aggregate, paid zero US tax on their $60 billion in combined global profits. In 2023, AbbVie, which generates almost all its profit in its zero-tax Bermuda subsidiary (that holds the intellectual property for its blockbuster drug Humira) and thus paid the GILTI tax, was the only one of the four largest US pharmaceutical companies to report paying any US tax. Johnson and Johnson, Pfizer, and Merck all did not pay any 2023 income tax to the federal government.

Much the same applies to Big Tech.

7. FT has a good primer on carried interest paid out by PE firms.

Carried interest... distributions to individual dealmakers can dwarf the salaries that firms pay using management fees — the steady income these receive on committed buyout funds, typically levied at a rate of 1.7 to 2 per cent. Globally, private capital firms have earned more than $1tn in carried interest since 2000, according to Oxford university research published earlier this year. Blackstone Group, the world’s largest private equity group, has earned $33.6bn in carried interest alone since then. In the UK, a Treasury analysis showed that 3,000 dealmakers shared £5bn in carried interest in the 2022 tax year — or £1.7mn each on average. Carry is typically treated as a capital gain, and taxed at a lower rate than income. Many buyout managers argue this is legitimate because they invest some of their own capital alongside their outside investors — the so-called limited partners in a fund. But critics — among them a few insiders and prominent financiers — say that carry, which is typically 20 per cent of a fund’s gains after a minimum return is met, is not proportionate to the capital that the firms and executives put at risk. That figure is on average just 4 per cent of total funds globally, with the median being just 2 per cent, according to Preqin. Because of that, these critics argue that carried interest is more akin to a performance fee and should be taxed as income...

It is widely recognised that at some groups, individuals are not required to co-invest their own money to be eligible for a share of the eventual profits as carried interest. Authorities in countries such as the UK, US, Spain and Germany also do not currently require a co-investment by individuals to levy carry at a lower rate than the ordinary income tax rate. In the UK, the firm or its executives might pay token amounts into the carry vehicle for tax purposes. On a £100mn fund, for example, it might be £2,500 between 30 people, according to one leading funds lawyer.  

Buyout funds often pool their fund manager capital in a partnership (the co-invest vehicle) that invests in or alongside the fund, and they also often establish a carry vehicle to receive the carried interest. 

This explains the carried interest distribution.

In a simplified example, if a $100mn fund bought three companies on day one and the first exit returned $140mn after five years all of those returns would be allocated to investors to give back their capital and meet the annual 8% preferred return. If the next company was sold for $10mn, all of that would be returned to the carried interest recipients to allow them to ‘catch up’ on 20% of all profits distributed so far. The proceeds from the exit of the third company would be shared 80:20 between investors and the carried interest recipients. This example shows what is known as a typical “European waterfall”, which only allows carry to be distributed after the original cost of all investments and the preferred return on such investments has been paid to investors. US firms tend to follow a different structure, known as the “American waterfall” — though some European firms adopt a version of it. Rather than wait until the cost of all investments has been paid back and the preferred return paid out, American waterfall funds distribute carried interest on a deal-by-deal basis. This structure means a fund could pay out carried interest after selling its first portfolio company — provided that it makes enough from the sale to cover the original cost and preferred return on that investment.

This about who's entitled to receive carried interest

While it differs between firms, carry is often concentrated on a small number of top dealmakers. Sometimes the way carry is divided up between executives will have been fixed at the start of a fund. But the split is sometimes determined based on how they have performed — or a mix of the two. People who leave the firm sometimes have to forfeit their right to carry, but other firms allow them to remain invested and receive their share. One executive at a large European firm said every employee, even in the IT and HR departments, was able to invest to receive carry, while their counterpart at another group said only partners participated. One said around 30 people shared carry; a partner at another firm said their total tended to be closer to 100. At EQT, the Swedish listed buyout group, carried interest is usually split 35:65 between the firm and its professionals based on their investments.

8. Startup statistics

Statistics from the United States and from India show that nine out of 10 startups don’t make it; ie only 10 per cent survive and prosper. A further analysis shows that 20 per cent of startups fall apart after a year, another 30 per cent close down within two years, 20 per cent shut their door within five years, and the remaining 20 per cent dissolve within 10 years, meaning only one out of 10 startups ever makes it to any economic worth.

9. Useful data points about the Indian economy

Net services exports of $161 billion last year and, two, the deluge of foreign remittances from non-resident Indians (NRIs) — about $125 billion last year. Without these two contributions, the rupee would have been much weaker and inflation and interest rates higher, leading to very poor growth rates.

10. Livemint points to a study that shows household biomass cooking is the biggest contributor to the Delhi air pollution crisis.

This finding is supplemented by further data.

A 2021 CEEW study showed that between 62-65% of Delhi’s PM 2.5 load comes from outside of the city. During the peak winter phase (15 December to 15 January), household cooking and heating contributed most to PM 2.5 pollution (32%). This is a reason why measures limited to city limits—like taking cars off the road, a ban on diesel generators, a stop to construction activities, vacuum cleaning and water sprinkling of roads—often fail to clean the air. Since the use of biomass as a heat source in and around Delhi goes up as winter progresses, the residential sector becomes the single-largest contributor by 15 December, the CEEW study stated. It suggested encouraging households to shift to cleaner fuels for cooking and space heating.

The geo-climatic causes for the concentration of smog in the NCR area.

Meteorological conditions prevailing during winter lead to a sharp plunge in air quality. For instance, last year, Delhi’s PM 2.5 load in November was seven times that of August when monsoon rains cleaned the air by washing away pollutants. In winter, the air near the soil surface is dense and cold. The warm air above blocks the cooler air, trapping it by forming an atmospheric lid. This is known as winter inversion, which coupled with low wind speed prevents the dispersion of pollutants in the wider atmosphere, turning Delhi into a gas chamber... In addition to these sources and meteorological conditions, Delhi’s air quality is also impacted by the so-called ‘valley effect.’ Delhi lies in the Indo-Gangetic plains surrounded by hills and mountains such as the Himalayas and the Aravalli, a topography which traps polluted air in the valley... The National Capital Region is the most polluted part of India due to the high density of polluting sources and reduced ventilation trapping pollutants.

11. Important finding from the latest ASI report.

Between 2001-02 and 2022-23, the absolute number of workers in India’s formal manufacturing sector more than doubled, increasing from 5.96 million to 14.61 million. However, during the same period, the share of workers directly employed by factories went down, while contract workers’ share increased from 21.8 per cent to 40.7 per cent. Contractual workers are not directly employed by firms but are hired on a contractual basis, often through third-party agencies. The ASI data also exhibits large inter-state variations. In Bihar, 68.6 per cent of its industrial workforce is employed as contract labour, while the corresponding share for Kerala is only 23.8 per cent... A sectoral analysis of contractual workers by various researchers reveals that capital-intensive industries have seen a greater increase in contract-worker intensity over time, although such industries need more skilled workers than labour-intensive ones do...

Contractualisation is increasing in other non-farm sectors as well, including trade, transport, health, and education. Results from the Quarterly Employment Survey, released by the Labour Bureau, showed the share of contractual employees in the nine major non-farm sectors of the economy more than doubled to 18.44 per cent in the second quarter of 2022-23 from 8.3 per cent in the second quarter of 2021-22. Contractualisation has become pervasive not just in the private sector but is also increasing in public-sector establishments.

12. Some snippets from the commentary around the US Presidential elections. This must count as among the biggest political comebacks of all time, besides going against the grain of what has been considered the basic requirements to aspire for high political office. 

He overcame seemingly fatal political vulnerabilities — four criminal indictments, three expensive lawsuits, conviction on 34 felony counts, endless reckless tangents in his speeches — and transformed at least some of them into distinct advantages. How he won in 2024 came down to one essential bet: that his grievances could meld with those of the MAGA movement, and then with the Republican Party, and then with more than half the country. His mug shot became a best-selling shirt. His criminal conviction inspired $100 million in donations in one day. The images of him bleeding after a failed assassination attempt became the symbol of what supporters saw as a campaign of destiny... For almost any other politician, Mr. Trump’s conviction on 34 felony counts related to hush-money payments to a porn star would have been the worst day of his candidacy. Instead, it gave him financial rocket fuel. Small donors poured $50 million into his coffers in 24 hours.

Brett Stephens writes about what liberals are likely to think

How, indeed, did Democrats lose so badly, considering how they saw Donald Trump — a twice-impeached former president, a felon, a fascist, a bigot, a buffoon, a demented old man, an object of nonstop late-night mockery and incessant moral condemnation? The theory that many Democrats will be tempted to adopt is that a nation prone to racism, sexism, xenophobia and rank stupidity fell prey to the type of demagoguery that once beguiled Germany into electing Adolf Hitler.

David Brooks

Many on the left focused on racial inequality, gender inequality and L.G.B.T.Q. inequality. I guess it’s hard to focus on class inequality when you went to a college with a multibillion-dollar endowment and do environmental greenwashing and diversity seminars for a major corporation... Maybe the Democrats have to embrace a Bernie Sanders-style disruption — something that will make people like me feel uncomfortable.

Elon Musk and the influence of big money in politics

Mr. Musk’s new super PAC effectively led Mr. Trump’s get-out-the-vote operation in battleground states... An ultrawealthy donor took advantage of America’s evolving campaign finance system to put his thumb on the scale like never before. Mr. Musk almost single-handedly funded an effort that cost more than $175 million. His canvassers knocked on close to 11 million doors in presidential battleground states since August, including about 1.8 million in Michigan and 2.3 million in Pennsylvania, according to people with knowledge of the matter. Another $30 million was spent on a large direct-mail program, and about $22 million on digital advertising, including on Trump-friendly mediums like Barstool Sports... The super PAC’s apparent success could inspire similar efforts, helping to transform modern campaigns.

And this

Even before Donald J. Trump was re-elected, his best-known backer, Elon Musk, had come to him with a request for his presidential transition. He wanted Mr. Trump to hire some employees from Mr. Musk’s rocket company, SpaceX, as top government officials — including at the Defense Department, according to two people briefed on the calls. That request, which would seed SpaceX employees into an agency that is one of its biggest customers... The six companies that Mr. Musk oversees are deeply entangled with federal agencies. They make billions off contracts to launch rockets, build satellites and provide space-based communications services. Tesla makes hundreds of millions more from emissions-trading credits created by federal law. And Mr. Musk’s companies are facing at least 20 recent investigations, including one targeting a self-driving car technology that Tesla considers key to its future... Mr. Musk could even gain the power to oversee them himself, if Mr. Trump follows through on a promise to appoint him as head of a government efficiency commission... The effect could be to remove, or weaken, one of the biggest checks on Mr. Musk’s power: the federal government...

Tesla benefits from a $7,500 tax credit for electric-vehicle purchases, which helps bring down the cost of buying one of its cars... Changes to the tax credit given to new car buyers and to the federal emission standards on new cars could impact the benefits Tesla receives... The biggest ties to the federal government among Mr. Musk’s operations are with SpaceX, which just last year secured $3 billion in new federal government commitments and a total of about $11 billion in contracts over the five years. But Mr. Musk is seeking more... SpaceX also holds huge contracts with the Defense Department, so many that Pentagon officials have grown concerned that they are over-reliant on Mr. Musk’s company for rocket launches.

This discusses how Musk stands to benefit in his various business ventures from a Trump administration.

It's important to distinguish between candidate Trump and the issues he espouses

“I think the reason that Trump is so Teflon is because this isn’t about him — it’s about the issues,” says Palantir adviser Jacob Helberg. “People want solutions on inflation. They want solutions on national security. They want solutions on crime — and Trump is offering the better solutions.”

This is echoed by this FT editorial

In voting Donald Trump back into the White House the electorate appears to have concluded that his record as a convicted felon, his unpredictability and his reputation for disdaining the norms of democracy matter less to them than his crisp “America First” prescriptions on the economy, national security and the world.

Janan Ganesh writes

In retrospect, the US election of 2024 was settled on August 12 2020. It was on that day that Joe Biden chose Kamala Harris as his presidential running mate. Given his age, this put her in a strong position to lead the Democrats in the medium term... The most important controllable variable in politics is the candidate. When Harris essentially finished last in the 2020 primaries, history was telling the Democrats to look elsewhere for a future leader. Their failure to do so has amounted to forfeiting a winnable election.

This about what to expect in Trump 2.0

But if he follows through on his campaign trail talk, he would restructure the government to make it more partisan, further cut taxes while imposing punishing tariffs on foreign goods, expand energy production, pull the United States back from overseas alliances, reverse longstanding health rules, prosecute his adversaries and round up theoretically millions of people living in the country illegally.

Finally, the main contributor to the victory of President Trump might be the persistently high inflation whose effects on the living standards of ordinary Americans were palpable.  

13. India's higher education loans fact of the day

The market for education loans in India has evolved significantly over the years, with the outstanding portfolio under education loans growing by 17 per cent to Rs 96,847 crore in 2022-23. However, over 90 per cent of education loans in the country are used for pursuing studies abroad. Additionally, in 2022-23, about 8 per cent of all education loans disbursed by public-sector banks turned into non-performing assets (NPAs), higher than the overall NPAs in the banking system.

Female labour force participation and marriage penalty

Arguably one of the biggest constraints to sustained high economic growth rates in India is the low female labour force participation rate. Much has been written on the topic, analysing the possible causes and proposing solutions.

A new World Bank working paper by Maurizio Bussolo, Jonah Rexer, and Margaret Triyana points to a marriage penalty. This penalty forces women to drop out of the labour force post-marriage. They used statistical techniques on data from multiple rounds of the nationally representative Demographic and Health Surveys (DHS) from Bangladesh, India, Maldives, and Nepal and isolated the marriage and child penalties for women. They find that the penalty is highest in India. 

These two events are correlated in time for a given individual. As such, estimates of the marriage penalty are obscured by the presence of children, and estimates of the child penalty are likewise capturing at least in part a marriage penalty… We find that South Asian women reduce their labor force participation by 12 percentage points (p.p.) following marriage, even before childbearing. Among women with children, this rises just 4 p.p to 16 p.p. As such, 75 percent of the combined family formation penalty is driven by marriage itself, rather than the burden of childbearing, at least in the first five years of marriage. 

The largest effects are observed in India, while more muted effects are observed in Nepal, where the majority of the combined penalty is driven by children. Dynamic event-study estimates reveal flat trends in employment status leading up to the marriage date, and sharp drops in employment in the first year of marriage. These trends lend additional support to the notion that these estimates represent the causal effect of marriage. Men, in contrast, enjoy a marriage premium. This premium does not depend on the presence of children, consistent with the existing literature showing no child penalties for men… We find that educated women have much smaller marriage penalties, with post-secondary education erasing nearly half the baseline marriage penalty. 

They examine the possible causes

The marriage penalty may represent an optimal solution to a joint household maximization problem. If women have limited outside options in the labor market relative to their husbands, then specialization in home-based tasks might be economically efficient, even without children. However, the value of women’s home production is greatly diminished without children, suggesting a role for social norms in driving the marriage penalty, particularly those that constrain women’s mobility outside the home… Despite the fact that gender norms are more progressive in urban areas in South Asia, we find no significant difference between urban and rural marriage penalties… we argue that a woman’s education affects both household gender norms and her outside employment options. In contrast, her husband’s education affects household norms, but does not directly affect her employment prospects. This suggests that outside options at least in part play a role in determining the marriage penalty… We find strong evidence that women in households with more liberal gender norms experience smaller marriage penalties. The effects of education and social norms appear to be independent, suggesting that both opportunity costs and social norms play a role in driving the marriage penalty.

As a framework, the net penalty on female labour force participation can be considered as a cumulative result of three effects, as captured below.

The marriage penalty is clearly higher in India compared to even its South Asian counterparts like Nepal and Bangladesh, pointing to historical and cultural factors. When faced with such entrenched legacies, public policy might be able to only do so much. Measures like establishing creches at workplaces or providing free bus passes might at best be tinkering at the margins. 

Even a significant increase in access to girl children’s school education might not be sufficient to overcome these penalties. This possibly explains the lack of meaningful improvements in the female labour force participation rate in India despite the considerable improvements in girl’s school enrollment and retention rates. 

Meaningful change in the status quo will require changes in cultural (within the family) and social (in society) norms and sharply increasing access to higher education for girls and good jobs. 

Higher education can enable women to get higher-paying and higher-status jobs and, over time, increase their now negligible proportion in senior management levels in public and private sectors. This kind of economic mobility/status, with several examples of aspirational models across small communities, might be required to have a significant impact on cultural and social norms. The factory-floor jobs in manufacturing, while very important, are more likely to take the long route to change in revising cultural and social norms. 

Public policy should pursue ways to increase access to higher education for female students - scholarships, preferential policies in admissions etc. Simultaneously, the private sector needs to become sensitive to increasing the share of women in senior management positions.