India’s affordable housing policy problem

This post will raise a conceptual point about the size of India’s affordable housing market and the targeting of policy measures aimed at them. 

The vast majority of urban housing construction are apartment units that come not from the formal branded / organised developers in big plots with large numbers of units but from the informal small owner-builder segment in smaller plots with fewer units (typically 4-5 floors on about 500 sq yards). The vast majority of the latter belong to the affordable housing (AH) segment. However, state RERA rules, with their eligibility thresholds on the plot size and number of units, exclude the informal owner-builder segment. 

One implication is that the commonly reported numbers by real estate consultants are likely vastly overstating the deficit, which nevertheless is real and big, but also not reporting the quality, standards, and buyer protection problems that impacts affordable housing supply (by the latter). A bigger problem is that these owner-builder units are ineligible for all the policy benefits that the government provides on AH – GST, PMAY, PSL, etc. 

In other words, we have the perverse situation where all the policy benefits are cornered precisely by the formal / branded developers who hardly supply AH, whereas those informal owner-builders who supply almost all the AH are ineligible for these benefits. 

It is a challenge to get good data to assess the extent of the problem. 

The public debates on housing are anchored around the data supplied by real estate consultants. However, they are confined to the formal organized / branded developers in the top 7–8 cities, who develop RERA-registered gated-community projects with titled land and institutional finance. They contribute the vast majority of the units visible in the Credit Linked Subsidy Scheme (CLSS), 1% GST, 80-IBA, and Priority Sector Lending (PSL) developer construction finance. 

In contrast, it is a challenge to get good data on the builder-owner units. Three states — Telangana, Andhra Pradesh and Delhi — have built self-certification approval systems calibrated to exactly the owner-builder G+4 band. The approval volumes in those systems are the hardest evidence we have to assess the magnitude of supply of such units. The Telangana government’s TG-bPASS database informs that for the period from November 2020 to December 2023, the average number of owner-builder permits every year in Telangana urban for sub-500 sqm plots is about 35,000. 

Three independent estimations - extrapolation from the TG-bPASS, residual from housing stock accounting, and finance-implied - all point to about 0.6-1 million such units being constructed each year nation-wide. 

Based on the above, the graphic below captures a snapshot of the demand-supply landscape for housing. About four-fifths of urban housing demand is EWS and LIG. The formal / branded sector targets MIG and above. The owner-builder channel is the only channel at scale that reaches the middle of the LIG band and upper EWS.

Let us first look at the AH market served by organised / branded developers, who build large numbers of units in each project in big land plots. Their share of housing launches that are AH (<₹40 L) was down from ~40% of the pipeline of the top 7 builders in 2019 to about 16% in Q3 2025. Note that the share of even mid-level housing has been declining. In stark contrast, luxury housing has been climbing steeply. Difficult to miss the K-shape. It can be safely argued that organised developers are quietly exiting the AH segment, and this is the big problem. 

This is validated by the loans data from scheduled commercial banks, which are also drifting upmarket. Below ₹25 lakh, the SCB loan book share has fallen from 41% (Mar 2021) to 28% (Mar 2025). 

New AH launches too echo this trend. The developers have been drawing down the accumulated inventory, instead of starting new projects. 

The unit economics of a owner-builder house makes them much cheaper. These are mostly individual plot-owners partnering with a small local contractor to build typically G+4 on 300–500 sq yd (~250–420 m²) in tier-1 periphery and tier-2/3 towns, with 4-8 units and statutorily exempt from registration under the Real Estate Regulatory Act (RERA). They are sold directly, often before launch, and have minimal advertising, and is transacted in a large share of cash and with personal loans. 

While pricing and area ranges vary by city tier, the owner-builder model is remarkably consistent, consisting mainly of 800–1,100 sq ft carpet, independent floor on a residential plot. And the favourable unit economics allows it to come at a steep discount on the branded unit of same size. 

Now let’s look at the policy benefits available for AH. Interestingly, all policy benfits are gated through RERA registration. 

Under Section 3(2)(a) of the RERA Act, projects on land of 500 sqm or less, or with 8 or fewer apartments, do not require registration. Most states have adopted the central threshold. The G+4 structure on 500 sqyards sits almost exactly at the exemption line. 

The table below summarises the housing category-wise policy support provided.

The next table points to which among the different policy support measures are accessible to owner-builder projects. As mentioned, every single policy instrument designed for affordable housing uses RERA registration (directly or via tied eligibility conditions) as the gatekeeper, which ends up statutorily excluding the owner-builder segment. This is in keeping with the broader policy focus to formalise the informal. 

All this produces a perverse outcome. The branded / organised developer segment, which produces at most ~70,000 affordable units a year in the top 7 cities, captures the full stack of fiscal and regulatory benefits designed for "affordable housing", whereas the owner-builder segment, which likely produces 8–14× that volume of genuinely affordable apartments, captures effectively none of them! The graphic below tells a tale. 

Putting everything together, it becomes clear that while the owner-builder G+4-on-500-sq-yard model probably supplies the majority of India’s urban affordable apartments, it sits outside RERA by statutory design, and therefore outside almost every fiscal and policy benefit the state offers for AH. Instead, all the benefits accrue to the formal / branded sector, which barely builds any affordable at all. Classic mis-targeting of scarce public policy resources. 

The big takeaway is that India has a serious affordable-housing policy problem, and less an affordable-housing supply problem. The channel that supplies most of the affordable apartment stock is not the one the policy architecture is currently designed to reach.

So what on the way forward? Four responses come to mind. 

On the measurement side, since the published AH supply numbers systematically overstate the shortage by excluding the owner-builder channel, it may be useful to build a supply tracker that captures RERA-exempt stock using municipal building-permit data (TG-bPASS, APDPMS, Delhi MCD, etc.), AHFC self-construction disbursals, and listing-site scraping. The state-level building permit systems should be standardised along the TG-bPASS model. 

On the regulatory side, instead of lowering RERA thresholds wholesale, thereby raising costs, it may be prudent to have a lighter-touch “RERA-lite” tier for sub-500 sqm / sub-8-unit projects, with structural safety certification, simple possession-timeline disclosures, and a public register.

On the fiscal side, AH fiscal benefits (GST 1%, 80EEA, stamp duty waivers) should be decoupled from from RERA registration, and eligibility should instead be based on unit characteristics (carpet area and price, differentiated across tier cities). It may also be appropriate to create a specific PSL category for owner-builder project finance (small plot, G+4), channeled through Affordable Housing Finance Companies (AHFCs) and Small Finance Banks (SFBs) with structural certification as the gate.

Finally, on the policy architecture, it may be useful to shift the policy frame from the excessive push to formalise the informal. I have blogged here and here about how forced formalisation adds layers of costs and can end up creating more perversions than good. 

AH is a teachable example of how a well-intentioned formalise the informal policy focus has ended up creating distortions without serving the purpose. Instead, here the policy focus should be to serve the channel that actually serves the demand, the owner-builder model.

Wekend reading links

1. Niall Fergusson points to some interesting divergence between the elites and the working class.

To see the extent of the gulf that now separates the American nomenklaturafrom the workers and peasants, consider the findings of a Rasmussen poll from last September, which sought to distinguish the attitudes of the Ivy Leaguers from ordinary Americans. The poll defined the former as “those having a postgraduate degree, a household income of more than $150,000 annually, living in a zip code with more than 10,000 people per square mile,” and having attended “Ivy League schools or other elite private schools, including Northwestern, Duke, Stanford, and the University of Chicago.” 

Asked if they would favor “rationing of gas, meat, and electricity” to fight climate change, 89 percent of Ivy Leaguers said yes, as against 28 percent of regular people. Asked if they would personally pay $500 more in taxes and higher costs to fight climate change, 75 percent of the Ivy Leaguers said yes, versus 25 percent of everyone else. “Teachers should decide what students are taught, as opposed to parents” was a statement with which 71 percent of the Ivy Leaguers agreed, nearly double the share of average citizens. “Does the U.S. provide too much individual freedom?” More than half of Ivy Leaguers said yes; just 15 percent of ordinary mortals did. The elite were roughly twice as fond as everyone else of members of Congress, journalists, union leaders, and lawyers. Perhaps unsurprisingly, 88 percent of the Ivy Leaguers said their personal finances were improving, as opposed to one in five of the general population.

2. Interest payments take up a staggering 57% of central government revenues in Pakistan.

India's 28% is a matter of concern. Compare with Indonesia's 15%. 

India's high public debt will appear fine as long as the economy grows by 7-8%. Once it slows down to 4-5%, the debt-to-GDP ratio will balloon, as also the interest payments as a share of revenue. Then we are set for the perfect storm.

3. The formal-informal sector wage gap in India is significant, in excess of 70%.

4. China has been the standout beneficiary from globalisation over the 1990-2018 period.

India's GDP per capital gain from globalisation has been less than one-third of that of China over the same period.

5. It's surprising how much of Blackstone's assets centre around real estate. The latest is data centres. 

After its $10 billion takeover of data center operator QTS in 2021, the world’s largest private equity firm is fueling rapid growth at one of the top landlords for tech giants. It’s bankrolling the development of massive structures that will handle crucial computing needs, while also reshaping communities across America. It’s part of the classic Blackstone playbook for real estate, the largest piece of its $1 trillion empire. The firm identifies where there’s a rising need for properties but too few to meet demand. It then directs billions of investor dollars to build giant landlords poised to capture big rents and market share, a move it has deployed in everything from warehouses to suburban homes...

Blackstone now says QTS could be one of the best investments in its history. The company has parlayed its land reserves to profit on a short supply of space and power in key markets. QTS has $15 billion of properties in development, up from $1 billion at the time of its acquisition. It’s become North America’s largest provider of leased data center capacity based on megawatts under contract, after ranking No. 4 just three years ago, according to research firm datacenterHawk... Blackstone President Jon Gray, the firm’s former real estate chief and now heir apparent as CEO, has corralled the company into the thematic bets where demand is running up against constraints. He now sees AI making a data center shortage all the more acute — and said those with land and capital will be at an advantage.

6. Long read on how the RN moved from the far-right fringes to the mainstream right in France. 

Long a fringe opposition party with little local presence, the RN has gradually stitched together a national network — initially helped by a dozen or so mayorships in small cities and towns like Hénin-Beaumont, Perpignan, and Fréjus... The effort was turbocharged in 2022 by an unprecedented election of 89 deputies to the National Assembly. With the MPs came money from the state funding system for political parties, a change for the usually cash-strapped RN, allowing them to hire more staffers. Le Pen then told her troops to fan out every weekend in their districts to attend local events to be what she called the “advocates of citizens” who often feel neglected amid the perceived retreat of public services, such as post offices or hospitals... Le Pen’s own election as the local constituency MP in 2017, her third attempt to enter the assembly. The following year, having lost the presidential election to Macron, she rebranded the Front National party to the Rassemblement National, aiming to make voters forget the racist and antisemitic excesses of her father and his contemporaries...

Such local presence has furthered Le Pen’s decade-long mission to “detoxify” the far-right movement co-founded in 1972 by her father, Jean-Marie Le Pen, and Pierre Bousquet, a journalist and former soldier in the French unit of the Waffen-SS during the second world war. Kévin Pfeffer, RN party treasurer, says... “Officials like the prefect, deputy prefect, police chief, and head of the unemployment office — they wanted to meet us,” ... whereas before the RN was largely shunned by local bigwigs. Slowly RN support evolved to cover a wider swath of the electorate allowing them to rack up more votes: women, white-collar workers and older people. The RN vote has evolved from one previously made out of protest or anger to one of confidence in the party’s agenda and its leaders Le Pen and her 28-year-old lieutenant Jordan Bardella... Studies have shown that people back the RN for multiple reasons, some ideological and rational, and others that are more subjective, such as a sense that the French “way of life” is in danger or that they do not “feel at home” in France anymore.  

7.  Graphic that shows how solar generation has continuously kept exceeding expectations.

8. Important point about the problem of slow deposit growth rate in banks.

Banks, influenced by societal hype about the primacy of digital outreach, halted the expansion of brick-and-mortar branches. Many bank chief executives, who had their bonuses linked to margin growth and market cap increases, also went slow on branch expansion to lower costs and boost bottomlines. There is now a belated realization that physical branches play a critical role in customer acquisition and deposit growth. Many leading banks are now making amends by setting aside capital expenditure to aggressively expand their physical footprint, to go hand-in-hand with increased investments in direct marketing and digital outreach... Within the banking system, the nature of the deposit mix is changing and moving towards high-cost deposits. Banks have traditionally relied on cheaper current-account-savings-account (CASA) deposits as a source of perennial low-cost funds. However, RBI data shows that CASA’s share has been shrinking in the overall mix, which has been compensated by some growth in costlier term deposits. The resulting pressure on margins may have also impelled bank management to revive CASA’s share by focusing on branch networks.

9. China does not have a KGB or Stasi but still maintains the most effective surveillance state in history.

A more significant secret-police agency lurks within the Ministry of Public Security, China’s regular police service, Mr Pei writes. This force-within-a-force is known as the political-security protection unit (zhengbao for short). The total number of Chinese police officers is not made public, but is thought to be over 2m. Drawing on provincial, municipal and county yearbooks and publications, Mr Pei estimates that 3-5% of all police work for the zhengbao at the national and local level. That equates to 60,000-100,000 zhengbao officers, or one for every 14,000-23,000 citizens. They are complemented by the wenbao, a police unit that watches cultural and educational establishments, especially universities. Another elite outfit is the Political and Legal Affairs Commission, a party body. It runs surveillance operations and “stability-maintenance offices" tasked with smothering strikes and protests before they start. A powerful agency, it oversees security policy generally, and vets police and legal officials for political reliability... 

its surveillance state rests on other pillars that offer part-time but invaluable help. The first is rank-and-file officers in neighbourhood police stations. In Chinese propaganda, there is nothing sinister about such police. They are hometown heroes who battle crime and keep the public safe. But tracking political dissent or public discontent is their job, too... Police stations also watch millions more “key individuals", a group that includes rights activists, religious believers and people petitioning the government for legal redress. All of that involves a second pillar of the surveillance state: informants.

10. An Indian Express editorial makes the case for maintaining buffer stocks on important food grains.

Last year, in February-March, dairies were paying farmers Rs 37-38 per litre for cow milk. The same dairies have today slashed procurement prices to Rs 26-27 because of SMP realisations crashing to Rs 200-210 per kg, from their February-March 2023 peaks of Rs 315-320. These low prices, discouraging dairies from procuring and farmers from feeding their animals properly, could be a precursor to milk shortages and inflation next year.

But the editorial could not have been more wrong in its conclusion.

A buffer stocking policy in food items will also do away with the need for regressive anti-farmer measures such as banning exports or imposing stock limits on private traders and processors.

India sits on a rapidly growing pile of excess rice buffer stock that it's now desperately seeking to liquidate. This did not prevent the government from banning exports!

11. Interesting snippet about the thicket of regulations in India to get permission to sell fertiliser.

Registering a new fertiliser product takes an average of 804 days in India, according to the World Bank’s ‘Enabling the Business of Agriculture 2019’ report. This is against 570 days in Russia, 528 in Brazil, 356 in Pakistan, 270 in China, 225 in Canada, 210 in Argentina, 100 in Thailand, 90 in the US, 30 in Japan, and zero in the European Union countries. The sheer time taken — from the filing of application and field-testing at multiple locations for one or more cropping seasons, to the final notification under the Fertiliser Control Order as suitable for use by farmers and state-level approvals — hinders the introduction of new nutrient products into the country.

The article also suggests the liberalisation option

“The government should grant automatic registration for any new product meeting two requirements — a minimum content of total plant nutrients, and a maximum limit of heavy metals and other contaminants. This, along with mandatory label claims [open for testing by enforcement agencies], is what most advanced countries follow. They do not have agronomic or bio-efficacy trial requirements,” Sanjiv Kanwar, managing director, Yara Fertilisers India Pvt. Ltd, said. This procedure of automatic registration, subject to the product confirming to basic quality parameters and truthful labeling, is already being implemented in water-soluble fertilisers (WSF)... The specifications required WSFs to have a minimum 30% content of total nutrients — 25% primary (NPK), and the balance secondary (S, calcium, magnesium) and micro (zinc, boron, manganese, iron, copper, molybdenum) — and maximum prescribed limits for contaminants (lead, cadmium, arsenic, total chloride and sodium). Companies can market any WSF meeting these specifications (with legible labeling on bags/containers) after 30 days of intimating the relevant government authorities about “the details of the product and their intention to sell”.

12.  Judicial activism in the US triggered by their ideological preference for deregulation.

In the US... late last month, six conservatives on the Supreme Court handed corporate America a scythe. The high court majority shredded a 40-year-old precedent known as the “Chevron deference” that required judges to defer to government experts when laws were ambiguous. They also ruled in a separate case that even long-settled rules can be challenged by new industry players. But CEOs should be careful what they wish for. Those decisions, known as Loper Bright and Corner Post, are already reverberating across the country. The justices sent nine cases about wetlands, renewable energy and a range of other regulations back to lower courts to be reconsidered. A federal judge in Texas said last week that plaintiffs seeking to invalidate a Biden administration ban on non-compete agreements were likely to win now that judges rather than agencies have the final word on regulations. Then on Tuesday, a federal appeals court asked how the Loper decision should affect the future of a different Biden rule that allows pension plans to use environmental, social and governance factors when choosing among investments with similar financial profiles. Environmentalists, and investor and consumer groups are despairing, while lawyers predict that US regulators will have to become more cautious about imposing new rules on everything from money managers to social media platforms and pharmaceutical groups. That is just the start. Hospitals, utilities and even gun rights advocates are already lining up to use the decisions as a club to beat back new rules and challenge existing ones. Some corporate law firms are putting together kill lists of regulations they want to attack.

Some thoughts on India's economic challenges

Every country, at least the larger ones, faces its unique development challenges. India is striving to reach the upper middle-income status in the coming decade. But it has to realise this while also encumbered with a low capital base - human, physical, and financial - and poor quality of human resources. All this has created an economy with a very narrow productive base and not broad-based enough economic growth. 

This context appears to have created the conditions for an economy that will continue to grow at a fair pace but on two tracks - a small highly productive world-class economy that powers ahead at a rapid rate, creating its own relatively big consumption class; the vast majority of the economy, with a predominant informal sector, grows at a much slower pace and whose transition to the former will follow the trickle-down trajectory. The China or North-East Asia-type growth will require the latter to transition much faster to the former than what’s happening now. 

Against this backdrop, what are the possible drivers of high and rapid economic growth? 

I can point to some important factors that could drive rapid growth in India. One, its macroeconomic fundamentals are strong, much stronger compared to its peers. Two, when compared to all its peers and many higher-income countries, it has a very good track record of balanced macroeconomic management and fiscal prudence, and this looks most likely to continue. Three, it has largely pursued prudent growth-enabling policies, and those like Production-linked Incentives (PLIs), for all its critiques, may just have done enough to shift manufacturing to a productive and scale growth trajectory. 

Four, its banks have recovered from their stresses and are well-capitalised and the corporate sector by and large is in very good health. Five, it has pockets of business dynamism which are large enough to contribute significantly to aggregate growth - a group of high productivity and high growth companies, a high-skills services sector exemplified by the Global Capability Centres, a large and growing IT sector, a vibrant start-up ecosystem, an emerging landscape of large contract manufacturing etc. Six, it has a small group of national champions with access to finances, risk appetite, and capabilities to rapidly scale up its infrastructure. Seven, it’s well placed to benefit from the geo-political tailwinds arising from US-China tensions and the trend of diversification away from China. Finally, it’s well positioned to reap the significant collateral benefits (like FDI and portfolio capital flows) from being a massive economy and also being the fastest-growing big economy for the foreseeable future.

In this context, this post will point to some issues that will be important factors for the country’s economic prospects and growth trajectory. 

1. Limits to formalisation. An important focus of India’s macroeconomic policy in recent years has been the aggressive push to formalise the economy. The demonetisation, the Goods and Services Tax, and digital payments have been high-profile policies in this direction. A feature of this focus has been its reliance on the supply side, i.e., creating the conditions to ensure supply is formalised. 

While this formalisation push is undoubtedly required, there are also limits to it. In theory, formalisation increases productivity, which in turn leads to efficiency improvements, technological upgradation, higher wages etc. But this supply-side focus overlooks the demand-side. A formal supply side requires the demand side that can absorb that supply. But formality ends up increasing prices, thereby making the product unaffordable for a very large segment. 

It’s for this reason that formalisation has historically been a slow process and closely linked to economic growth. Therefore, instead of forcing the informal firm/sector to become formal, the objective should be for new activities to start formal and thereby shrink the share of the informal over time. It also means there’s a need to ensure that economic growth is broad-based and productivity-enhancing so that there’s a proportionate increase in the consumption class.

In simple terms, the push to formalise supply should be complemented with demand-broadening economic growth. 

2. Green transition. A strategy similar to formalisation has been adopted for green transition. The belief is that India can leapfrog the green transition, shifting rapidly from internal combustion engines to electric vehicles, fossil fuels to renewables, and old energy to new sources like green hydrogen. 

But like with formalisation, there are several problems with this strategy. The green transition comes with costs and financing requirements. Who bears the costs of the transition - the phasing out of the current investments before their economic life-cycle, the adoption of more costlier and rapidly evolving technologies, taxes on climate change causing externalities etc? How can companies, banks, and governments absorb the losses and finance the new investments, and households afford the higher-priced green products and services? 

Again, like with any economic transition, the green transition too will have to take its time. For sure, it can and should be expedited. But only to the extent that the economy can support - the supply side can meet the requirements, and the demand side can absorb the supply. This means it’s required to be practical and opportunistic and phase the transition in all aspects, including the adoption of appropriate technologies (natural gas, plug-in hybrids and small battery vehicles, nuclear fuels etc).

3. Size of the productive economy. As I have blogged here, arguably the biggest concern about the Indian economy is whether it has the base to sustain high growth rates for long periods. But on the positive side, it can be argued that despite its narrow productive base, the continental size of the Indian economy might mean that this narrow base is large enough in absolute value to provide the momentum for attaining a high growth path. Once it attains this path, it can ride opportunistically on tailwinds to sustain the growth trajectory. 

However, this would depend on the absolute value of the productive slice of the economy - the number of people, the segmentation of their purchasing power, the types of economic activities they are engaged with, the geography of these people and their economic activities etc. Unfortunately, there are no reliable data on any of these. In its absence, we can only speculate based on anecdotal evidence. 

In any case, it’s hard to refute that the Indian economy has a skewed structure - a high-productivity small. segment co-existing with a predominantly low-productivity economy. This skew has widened since the liberalisation. It can be argued that while economic growth has largely improved all lives, its gains have been very disproportionately concentrated in a small segment (relative to the population). 

4. Anchor industries to trigger manufacturing scale. India’s efforts through Make in India and Production-linked Incentives (PLIs) at catalysing manufacturing have not yielded expected returns in terms of an increased share of manufacturing in economic output. But the PLI scheme may be a catalytic game-changer not because of the magnitude of the financial incentives it offers, but in terms of generating investor interest and bringing focus on a few prioritised sectors. PLI Scheme is the policy instrument to complement the marketing campaign of Make in India. Its most important success to date may be the platform it has provided for the intense courting of Apple and Foxconn in mobile phone manufacturing. Similar anchors in solar and wind power generation, electric vehicles and their batteries, and electronic equipment may just about be enough to push the economy into a higher trajectory in manufacturing. 

Investments to establish a handful of mega global-scale manufacturing facilities including the creation of their supplier ecosystems may be the most practical strategy to give a significant boost to manufacturing. It creates the conditions for economy-wide productivity improvements and technology diffusion through learning by doing. Contrary to orthodoxy, it’s about picking winners at both the sectoral and firm levels. This has to be followed with highest-level courting, and long-drawn and credible facilitation of the preferred investors. Apple and Foxconn is the best example. 

However, this policy needs to be pursued with care, especially given the high tariff barriers erected against inputs to protect domestic manufacturers against cheap Chinese imports. In the case of mega-brands like Apple, quality and global competitiveness is not a problem. But in the case of others, industrial policy must incentivise export competition or risk ending up supporting mediocrity protected by high tariffs. The global competitiveness-reducing effects of high import tariffs on inputs can be offset by subsidies like the PLIs which are linked to exports. 

5. Services-led structural transformation. The spectacular success of India’s IT sector has created a belief that India’s structural transformation pathway lies through the services sector. There are several well-known reasons to doubt this strategy. I have blogged here. Services are mostly non-tradeable, therefore not amenable to benefit from technology diffusion and productivity improvements, and also constrained by limited demand. Manufacturing is an essential pathway for large-scale structural transformation, especially for a massive economy like India’s. Increasing manufacturing should be the primary pursuit of public policy. 

6. An industrial policy that supports jobs over capital-intensive manufacturing. It’s becoming increasingly evident that technological advancements have the potential to automate many, even a majority, manufacturing shop-floor jobs. The only reason for retaining shop-floor workers is the favourable unit economics in terms of the availability of cheap labour. This will change with time in favour of automation. 

Against this backdrop, in time it may become necessary to design an industrial policy to disincentivise automation and subsidise labour-intensive manufacturing. But its implementation will be challenging. For example, how to incentivise labour-intensive manufacturing without discouraging technological upgradation? Then there’s the challenge of its implementation.

7. Overcoming human capital constraint. There’s nothing more important than human capital quality in determining the economic growth trajectory of a country. But arguably the biggest constraint to India’s economic growth is the poor quality of its human capital and the acute deficiency of good-quality senior talent. Improving learning outcomes and creating a genuinely educated workforce is perhaps the most wicked of problems. While there’s a clear realisation of the importance of improving student learning outcomes in schools and colleges, I’m not sure we are doing anywhere enough to address the problem in any significant manner. 

This constraint binds across the economy. Large manufacturing firms struggle to access skilled and (at least nearly) employable labour at the scale they require. There’s an acute scarcity of good enough quality middle and senior managers, product managers, designers, scientists etc. Further, the large supply of new labour market entrants from technical institutions should not be conflated with good quality of supply. There are no easy answers to solve this constraint. And it can bind very quickly as the economy starts to grow at very high rates.

The challenges with forced formalisation of the economy

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

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

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

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

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

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

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

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

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

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

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

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

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

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

A model of economic transitions

I'll argue that any forced transitions to formality or higher labour or environmental standards is a supply shock induced demand compression, which invariably lowers the output. In general, any economic transition increases costs which if not supported by associated increases in demand, will necessarily lower output.  

I have blogged earlier in the context of formalisation of the economy that formality introduces layers of production costs which increases the market prices, which in turn reduces market demand. At the higher price, only a smaller number of customers can afford the good or service. The cost structure of the formal market can be met by only a small proportion of the total demand. The market settles down to a lower equilibrium output. 

In fact, it can create perverse incentives. In case of goods and services which are essential (or which have inelastic demand), the reduced affordable formal supply has to invariably result in substitution with lower cost informal supply. If formality is tightly enforced (as in case of certain goods and services), the informal market supply becomes an illegal (or harmful) market supply. 

Supporters will point out that increased formality will raise wages, productivity, profits, and quality which in turn will benefit workers, firms, and consumers in a virtuous loop. But this simplified belief assumes away the considerable adjustment requirements on all sides, which in the real world takes an inordinate time, and in many cases never materialises. It's for these reasons that such transitions have historically taken time, as with the developed countries of today. This ain't an area for leapfrogging. 

The supply will be constrained at both the intensive and extensive margins. At the intensive margin, the informal workers will not be able to acquire the skills required and the informal businesses will not be able to put up the capital for the increased production costs. At the extensive margin, supply of both new sets of workers and businesses will not expand as required. And, in any case, demand cannot expand enough in quick time to create a market which can absorb the higher production costs. 

This dynamic is just as true of labour or environmental or any other set of standards, which can all be seen as dimensions or aspects of formality. Each of these standards adds a layer of production and supply cost to the industry. And these costs must be passed through in the form of higher costs. 

In fact, we can extend this logic to economic growth itself. Economic output can grow sustainably only if the demand side can grow at the same pace as the expansion in supply. While it's possible for the supply to expand rapidly (say, with foreign capital), it cannot do much in the short-run to increase demand. In other words, sustained high economic growth requires the growth to be broad-based enough as to support growth in demand. 

The exception, which China and East Asian economies benefited from, is if the increased demand can come from an external market. In this case, the local economy can benefit with more investments and jobs, and greater productivity and higher incomes, without the proportionate expansion in demand. This positive supply shock will, in course of time, create the foundations for sustained broad-based economic growth. But this opportunity appears to have shrunk considerably. 

In the circumstances, any action plans for economic transitions, like that involving informality or renewables, should acknowledge its limitations and financial costs.

Weekend reading links

1. In the context of the new Production Linked Incentive (PLI) scheme of the government, the Business Standard examines the air conditioners market in India. 

This is a good summary of India's manufacturing challenge, the much smaller size of local market than expected,

Currently, in the Rs 18,000-crore local AC market, 70 per cent of the cost material used in assembly are imported. Key parts like compressors, variable speed motors in indoor units, and high quality copper pipes, among others, are imported. But with no incentive for incremental assembly, manufacturers are now hoping that large global component makers set up shop here. Since key components that are being imported require huge investments to manufacture locally, setting up such facilities will not be a viable business proposition for entities in India, clarified companies. To turn such investments profitable, the kind of scale that is required does not exist in the local market. At 6 million units a year, India’s AC market is much smaller, compared to leading global markets like China (50 million units), the US (17 million), and Japan (12 million).

2. On the importance of manufacturing to developed economies, Rana Faroohar writes,

In the US, for example, although manufacturing represents just 11 per cent of gross domestic product and 8 per cent of direct employment, it drives 20 per cent of the country’s capital investment, 30 per cent of productivity growth, 60 per cent of exports and 70 per cent of business R&D, according to figures from the McKinsey Global Institute... A fascinating study by MGI, to be released on April 15, examines 30 main manufacturing sectors in the US. It finds that 16 of them stand out for their economic and strategic value, as measured by their contribution to national productivity and economic growth, job and income creation, innovation and national resilience. Apparel is not on the list. But semiconductors, medical devices, communications equipment, electronics, autos and auto parts, and precision tools are.

And this very interesting snippet about China

Chinese producers exported 71 per cent of finished apparel goods in 2005. By 2018, it was just 29 per cent.

3. I've never understood the case for lowering corporate tax rates in India. This is a good set of graphics.

4. Larry Summers makes a very persuasive critique of the post-Covid fiscal policy in the US,

If you look at the economy at the beginning of this year, prevailing forecasts were that Covid would reduce wages and salaries to American households by $20bn-$30bn a month, with that figure declining over the year. So, that would be a $250bn-$300bn hole in wages and salaries over the course of the year. So, I look at this hole and then I see $900bn of stimulus in the December package, $1.9tn of stimulus in the recently passed package and $2tn in the savings overhang, which is also likely to be spent. I see the Fed with its foot on the accelerator as hard as any Fed has ever done... That could manifest itself, as a much smaller period of excess did during the Vietnam war, in rising inflation and a ratcheting-up of inflation expectations. It could, as has often happened, manifest itself in the Federal Reserve feeling a need for a sharp and surprising increase in interest rates, and the subsequent deceleration of the economy into recession. It could manifest itself in a period of euphoric boom and optimism that leads to unsustainable bubbles, or it could all work out well... 

There’s not much argument that the 2009 stimulus, in retrospect, was too small. It was 4 to 5 per cent of GDP over a couple of years, so it was 2.5 per cent of GDP in the first year, against a gap that was 6 or 7 per cent of GDP and growing, so it was perhaps a third or half of that gap. Today’s stimulus is above 10 per cent of GDP in the face of a gap that is 3 or 4 per cent of GDP. Relative to the gap, this stimulus is already of the order of five or six times as large as in 2009... I could have been comfortable with a headline figure well in excess of $1.9tn if it had been a large-scale, multiyear programme of public investment responding to our deepest societal concerns. But that’s not what this is. It transfers to state and local governments that don’t have any new budget problem, according to the latest figures. It’s paying people, who have been unemployed, more in unemployment insurance than they earned when they were working. It’s giving cheques to families in the 90th percentile of income distribution. It doesn’t seem prudent on resource allocation grounds, as well as being problematic on macroeconomic grounds.

5. Mahesh Vyas points to the informal market distress,

As people lost jobs and jobs became scarce in 2020-21, labour that lost jobs moved from one kind of occupation to another. Large numbers eventually migrated to agriculture, apparently, when all other possible occupations failed. As a result, employment in agriculture in March 2021 was nearly 9 million higher than it was in 2019-20. This implies an eight per cent increase in labour in agriculture. Agricultural output is estimated to have increased by 2-3 per cent in almost each of the four quarters of 2020-21. The 8 per cent increase in labour implies a sharp fall in labour productivity. We believe that this huge influx of labour into agriculture is largely disguised unemployment. It hides the greater employment challenge in March 2021 than the 5.4 million net jobs lost. The biggest loss of employment in 2020-21 was among the salaried employees. As of March 2021, there were 76.2 million salaried employees. This was 9.8 million less than the 85.9 million salaried jobs observed in 2019-20.

Salaried jobs are mostly in urban India. Urban India accounted for 58 per cent of all salaried jobs in 2019-20. But it accounted for only 38 per cent of the 9.8 million salaried jobs lost. Over 6 million salaried jobs were lost in rural India. Most of these are likely to have migrated to farming. Rural India also saw nearly 3 million business persons being rendered unemployed. These could also have migrated to farming. Farming saw an increase of 9 million jobs in rural India. So, the churn in rural India seems to have been people losing salaried jobs and losing their business and these unemployed people moving into agriculture for unproductive employment. The increase in agricultural jobs in March 2021 was essentially a migration of people who lost non-farm jobs in rural India into farming. This was not an urban to rural migration.

6. More disturbing news, which points to outright fraud, about Sanjeev Gupta's business activities,

Last week the FT reported that several loans to Liberty Commodities, part of GFG, were based on suspect invoices and that Credit Suisse executives were becoming increasingly concerned that their clients were victims of fraud. Several European metals businesses told the FT last week that they had not carried out any business with Gupta’s groups, despite invoices linked to them being repackaged as notes by Greensill and sold to Credit Suisse investors.

7. The Government of India has approved the Russian vaccine Sputnik V for use in India. It has also accepted a recommendation by the National Expert Group that vaccines approved by health regulators in the EU, US, Japan, and the UK and by WHO should be granted emergency-use approval in India. Till now India had insisted that these vaccines had to still conduct additional 'bridging' trials in India before use.

This decision, which ought to have been taken much earlier and is now precipitated by the acute shortage of vaccine stocks, is a precedent for several other areas. Regulators in other sectors could explore the possibility of using the regulatory approvals in other countries to allow use in India. 

8. Interesting contrast between the employee attrition rates of TCS and Infosys. The rates for the last quarter of 2020-21 was 7.2% and 15.2% respectively for the two companies, both being all-time lows and highs. Is there something about their respective business models which explains this big differential? Or does it tell us something about work cultures in the two companies?

9. Noushad Forbes points to an interesting fact,

In January 2021, India approved its first vaccines for use. The Ken Nutgraf tells us that between July 2020 (before any vaccines had passed testing) and January 2021, the US ordered (and paid for) over 600 million doses. That’s for a total population of 300 million. In the same period, India ordered 11 million doses, for a country of 1,300 million.

Indian Express has an article which points to how India did not put forward at-risk capital (or advance market commitment to purchase vaccines) to promote vaccine manufacturing. 

From all available accounts, India did not invest “at-risk” in SII and its first commercial agreement on vaccine offtake only came in mid-January 2021. And the pricing of Covishield is a factor in SII’s struggles to keep up with demand as the private, unlisted firm has committed to deliveries under AZ’s deals and through multilateral arrangements such as COVAX. SII has now sought “roughly” Rs 3,000 crore from the government to expand its “very stressed” capacity, SII CEO Adar Poonawalla told NDTV. “The globe needs this vaccine and we are prioritizing the needs of India…we’re still short of being able to supply to every Indian that needs it,” he said. “At the moment, the price (Rs 150 per dose) that is set is profitable. However, it is not profitable enough to re-invest substantially in building capacity, innovating new vaccines — including the new variants that we may need to develop and make and go into clinical trials and other things,” he added.

10. Ed Luce on tax avoidance by US companies,

Last year, 55 of America’s largest companies, including Nike and FedEx, paid nothing in corporate taxes in spite of collectively making about $40bn in profits. The headline US corporate income tax rate is 21 per cent, which Biden wants to lift to 28 per cent. However, the official rate is not the point. The effective US corporate tax rate is just 11.2 per cent, which is below that of Ireland. The US Chamber of Commerce and the Business Round Table complain that the nation’s corporate taxes are higher than the western average. In practice, they end up close to the lowest. US tax collections amount to 1 per cent of gross domestic product, compared with a 3.1 per cent OECD average. All such avoidance is entirely legal.

11. As Covid relapses and schools start to shut down, a good report on where India stands with respect to schooling.

Learning and future prospects of a cohort of children may be the biggest long-term casualty from Covid 19 lockdowns.

12. Interesting change in the IBC, for MSMEs, which now allows promoters to remain in control during the restructuring negotiations with creditors.It may be an appropriate response for the Covid 19 induced business stress, but given India's business environment, it remains to be seen how this will work out. 

13. Progress in a graphic