What can state governments do in the short-run to boost economic growth?

A friend recently asked me what can a state government in India do to boost GDP growth over a government’s five-year tenure. 

So I thought of a few areas where public policy can be useful for Chief Ministers and their governments who are seriously committed to this objective. 

These areas cover the typical economic growth drivers of government spending, private spending, and private investment. It excludes reforms on human resource development and capital formation that are more systemic and will play out over longer time frames. 

1. Completion of all ongoing infrastructure works will have the greatest impact. Since they are already ongoing, they involve immediate expenditure and, once completed, will generate at least some of the expected benefits. The government can appropriate political capital from the inauguration of these projects. This could be complemented with a few carefully identified highest value/impact infrastructure projects (critical connectivity roads, small and medium irrigation projects, water supply etc.). 

2. Improve the Ease of Doing Business (EoDB) and ensure their implementation in letter and spirit. It pays to build the state’s value proposition among investors in terms of its real EoDB. Real EoDB is about changing a culture and not merely tweaking rules, and it must be infused across the public system. This would entail going beyond EoDB for large industries (which is what EoDB has come to signify) to include micro and small businesses, including in the informal sector, and Ease of Living for citizens in accessing statutory and other government services. While changing culture in five years is hard, there are several ways in which leadership can signal its intent and reap transformational effects. 

3. Complement EoDB improvements with initiatives on the supply side of employment (labour market). This would include improving the quality of the ongoing skill development initiatives, focusing on effectively implementing the PM Internship Scheme, and reducing labour market frictions (facilitating labour market matching for both employees and employers). 

4. Focus efforts on the growth of existing industrial clusters by encouraging its current units to expand and also attract new manufacturing firms. This would involve addressing critical gaps in infrastructure and shared services, single-window facilitation for permissions and clearances, coordinating on labour supply and credit access etc. Given the prohibitive cost of land, facilitating access to land at reasonable rates alone can provide a big competitiveness boost for businesses. The aforesaid EoDB and labour market efforts should be implemented with greater intensity in these clusters. 

5. Prioritise the development of the major cities, which are the engines of economic growth. Complete all ongoing infrastructure works, take up some high-impact projects (road widenings, new infrastructure etc.) that are in long-standing demand and complete them in no more than 3 years, focus on affordable housing and generally lowering the cost of housing construction (see this proposal), and increase property tax collections (by improving collection efficiency and expanding the tax base) and other revenues (see this on adoption of land value capture methods).

Each of these must be developed as a package of a few interventions, and enabling government orders and guidelines must be issued. 

Their effective implementation would require focused four-level engagement - Chief Minister, Chief Secretary, Secretary/Head of Department, and District Collector. 

The initiatives on the five pillars should be identified and clear guidelines issued. The monitoring mechanism (parameters, periodicity, and follow-up) should be minimal and different for each level but decrease in granularity upwards. At the Chief Minister’s level, the monitoring should be monthly (to start with) and be such that it covers just 1-2 parameters proximate to outcomes for each initiative and ensures clear downward accountability. 

The Chief Secretary’s role would be to coordinate on emerging issues brought forth by the Departments and Collectors, as well as to follow up on issues emerging from the Chief Minister’s reviews. This monitoring system should establish clear performance accountability of the Secretary/HoD and Collector.

Weekend reading links

1. The new Labour government in UK wants to close down the "carried interest tax" loophole that Private Equity firms enjoy - it allows them to pay 28% instead of the regular 45% rate. Patrick Jenkins has a good article that examines the issue and proposes a compromise.

First, they make a principled point — that carried interest is not really income as reformers argue, but a genuine reward for executives, dubbed general partners in the industry, taking investment risk. If GPs invest alongside third-party investors — so-called limited partners (or LPs) — in a deal, any gain (or “carried interest”) they make should be treated as a capital gain because that is what it is. Second, the sector insists that implementing the policy as outlined would drive wealth creators and growth generators — key to Labour’s agenda of economic revival — out of the country... 

There are clear flaws in the industry’s arguments. Tax changes and differentials in this sector have not led to an exodus in the past. In 2017, Italy introduced a new regime, taxing carried interest at 26 per cent, instead of the 43 per cent of higher-rate income tax. Ireland taxes carried interest at barely half the UK rate. So far neither country has made huge inroads in attracting private equity executives... The more substantive point of principle is also moot. In many cases a private equity manager is not actually investing any of their own money, but is being gifted the “right to carry” by their employer, in much the same way as a banker might be gifted shares as part of a bonus (which is liable to income tax). There is no requirement to actually invest your own money in order to benefit from the carried interest tax break...

Reform is clearly needed, but with a spirit of pragmatic compromise. First, Reeves should follow through on her instinct that individuals must actually invest, say at a level equivalent to 1 per cent of the fund, as similar regimes in France and Italy already dictate. This would tighten the alignment between GPs and LPs, which is in everyone’s interest. Second, in order to qualify for carried interest taxation, the investment should genuinely be putting capital at risk. At present, CVC is one of very few firms where executives on a bad deal can actually forfeit money, even if the fund overall succeeds. Third, tax rates should be calibrated smartly. For cases where the threshold for real investment is met, a rate of, say, 33 per cent could be levied; if the threshold is not met, the rate would be 45 per cent. This would still be within the range of competitor jurisdictions, albeit towards the upper end. (France charges up to 34 per cent.)

2. The Skills Ministry appears to have bitten off more than it can chew with its target of having the country's top 500 companies providing internships to 10 million youth over the next five years. 

In the five years from 2019-20 to 2023-24, India added 4.47 million people to the salaried workforce, which stood at a little over 90 million in 2023-24, according to the Centre for Monitoring Indian Economy's consumer pyramids household survey. The salaried class includes managers, supervisors, white-collar professionals, clerks, industrial and non-industrial workers, and support staff. Offering internships to 10 million people in the next five years in India's top 500 companies will mean more than doubling the total employment generated across the salaried class in the past five years, or 11% of all the people employed under this category... According to Mint's study of annual reports of 94 companies on the BSE 100 index, there were 3.83 million employees at BSE 100 firms as of 31 March 2023. The data included both permanent and non-permanent employees, and excluded workers (in some cases, only permanent employees were considered due to unavailability of data)... 

As per the Union budget's announcement on Tuesday, the interns will be paid ₹5,000 per month along with a one-time assistance of ₹6,000. Companies will be expected to bear the training cost and 10% of the internship cost from their corporate social responsibility funds. The emphasis on skilling comes at a time when the Economic Survey for 2023-24 found that about one in two graduates straight out of college is not employable. “Estimates show that about 51.25% of the youth is deemed employable. In other words, about one in two are not yet readily employable, straight out of college," the Economic Survey, unveiled on 22 July, said. "However, it must be noted that the percentage has improved from around 34% to 51.3% in the last decade."

The scheme is part of five DBT schemes aimed at education, skilling and employment with an outlay of Rs 2 trillion over five years, to benefit 41 million youth. 

The difference of this scheme from the apprenticeship promotion efforts should be noted.

An apprenticeship is a structured system of training where individuals, known as apprentices, learn a trade or profession through a combination of on-the-job training and classroom instruction. Apprentices can be both graduates and non-graduates. Students who turn apprentices can also use the stipend to fund their education. The stipends depend on whether the candidate has been picked up under the NAPS (National Apprentice Promotion Scheme) or NATS (National Apprentice Training Scheme) programme. The former is meant for all trades and may take non-graduates, while the latter is largely for engineers and technical apprentices.

3. Nice snapshot of the budget numbers.  

This is the break-up of the capital expenditure proposals

I'm ambiguous on the Rs 1.5 trillion interest-free 50-year loans. State governments which had negligible or no liabilities to the central government over the years have become indebted to the central government through this scheme. It also means that the states are now ever more obliged under Article 293(3) of the constitution of India to the central government. 

And this on the important rural schemes

4. One area where India has trumped China is in its equity markets.

India formed just 6-7% of the MSCI ten years back. It has now risen to near 20%, whereas over the same time China has shrunk from over 40% to around 25%. But Indian stocks are clearly overvalued, trading at 24 times their expected earnings next year against 10 for China. 

5. Daron Acemoglu and James Robinson have an excellent article that articulates the need for the Democratic Party in the US to free itself from its current elite capture. 

When monarchies ruled... they had an elaborate justification for their legitimacy. In early modern England, it was the “divine right of kings.” In China, it was the “mandate of heaven.” It’s not just autocratic regimes that rely on such philosophies. The move toward greater popular participation also required legitimation and a new social contract. In England, that was articulated by philosophers such as John Locke, who provided the foundation of “popular sovereignty.”... That trust is largely lost. Center-left parties, which used to get a significant fraction of their votes from blue-collar workers and citizens without college degrees, now increasingly rely on votes (and money) from college graduates, professionals and managers.

That is all the more so in the United States, where the Democratic Party has gradually become associated with the preferences of the well-educated and urban voters. Democratic politicians often shy away from policies such as job guarantee programs, trade protection and stronger unions... Center-left parties need to lead the way in breaking this mold. This must start by the severing ties with tech billionaires, pharmaceutical giants and Wall Street tycoons. It is difficult to believe that a party that gets funding and ideas from the very wealthy will work hard for the well-being of the most disadvantaged. They must promote to leadership people with a background in manual work and from different educational paths. One visible and symbolic way of achieving this is to reserve a fraction of candidacies and leadership positions to individuals without a college degree. Similar strategies have been successfully used by Swedish social democrats and local governments in India... Campaign-finance reform would help, including public money for candidates that refuse support from big donors. There is also a case for introducing proportional representation voting, which can allow new parties to take up the mantle of working-class causes if the two major parties cannot get their act together. 

Note the point about severing ties with elite interests and promotion of people with a background in manual work and from different educational paths. In other words, return to truly representative governments.

6. The findings of a 3 year RCT study on unconditional income transfer among 3000 adults in Texas appears to pour cold water on UBI enthusiasts. 

The trial recruited 3,000 people in Texas and Illinois on the basis that they would be in a study receiving $50 a month or more for three years. Then a third of them were unexpectedly told they would instead receive $1,000 a month with no effect on any of their other income. The results definitively show that receiving more money provides a better life. Spending and saving rises... Time at work went down for both the recipients of the $1,000 and their partners, replaced by more leisure... The big question for the dynamic benefits of a universal income was what people would do with their additional time. Would they invest in their education, upskill, get better jobs or start businesses? The short answer was no. The findings ruled out “even small improvements” in the quality of employment and upskilling. The most that could be said was that the recipients spent some of their extra leisure time thinking about starting a business without actually doing it... Did universal support make recipients healthier than the control group? Again, the answer was no. Surveys and blood tests of recipients and the control group shows no improvement in physical health, and mental health improved only in the first year. There were more visits to medical facilities and more alcohol consumed, although also less problematic drinking.

7. Solar industry globally is facing a massive glut created by China that's driving down prices and destroying domestic solar industries in many countries, including in Europe. 

According to BloombergNEF, panel prices have plunged more than 60 per cent since July 2022. The scale of the damage inflicted has sparked calls for Brussels to protect European companies from what the industry says are state-subsidised Chinese products. Europe’s solar panel manufacturing capacity has collapsed by about half to 3 gigawatts since November as companies have failed, mothballed facilities or shifted production abroad, the European Solar Manufacturing Council estimates. In rough terms, a gigawatt can potentially supply electricity for 1mn homes. The hollowing out comes as the EU is banking on solar power playing a major role in the bloc meeting its target of generating 45 per cent of its energy from renewable sources by 2030.

The Chinese prices are so low that it requires very high tariff to level the playing field, besides constant surveillance to see whether the exports are being routed through third countries.

The Inflation Reduction Act.. has spurred almost $13bn of investment in solar manufacturing, more than six times the amount committed in the five years before the legislation... In May, it removed a tariff exemption for double-sided panels and lifted levies on Chinese imports of solar cells from 25 per cent to 50 per cent. Chinese companies now also face penalties if they are found to have dodged tariffs. US imports of Chinese polysilicon for solar panels had already been hit by a 2021 ban on products made or sourced from China’s Xinjiang because of concerns over the use of forced labour. Nevertheless, America’s solar power companies warn that the steps taken by the Biden administration this year will fail to provide enough protection... Chinese solar companies... dumping cells in south-east Asia, the source of the bulk of US imports. A solar panel manufactured in America using US-made cells costs 18.5 cents a watt, compared with 15.6 cents for a panel sourced in south-east Asia and just over 10 cents for one produced in China, according to estimates from BloombergNEF. 

Germany fact of the day

From a very good article by Edward Luce in FT which explores the attractions of German economic model as America grapples with stagnant or declining manufacturing and a crisis in its human skill development channels, 

Germany channels roughly half of all high-school students into the vocational education stream from the age of 16. In the US that would be seen as too divisive, even un-American. More than 40 per cent of Germans become apprentices.

As America suffers a big unemployment crisis, with no end in sight, structural issues like skills mismatches have been blamed as being responsible,

Almost half of Americans with a degree are in jobs that do not require one... Fifteen per cent of taxi drivers in the US have a degree, up from 1 per cent in 1970. Likewise, 25 per cent of sales clerks are graduates, against 5 per cent in 1970. An astonishing 5 per cent of janitors now have a bachelor’s degree. They must offer endless nocturnal moments to repent those student loans. 

 

The global youth unemployment crisis

The co-existence of large youth unemployment rates and labor market shortages, symptomatic of labor markets across the world, is a classic market failure. Econ 101 teaches us that job seekers and education service providers would respond to the market signals generated by employers and acquire the skills required to clear the labor market. But in the real world, there is apparently a massive co-ordination failure between employers, education providers, and job-seeking youth.

The McKinsey and Company have a timely report (pdf here) on this issue, where they examined more than 100 education-to-employment initiatives in 25 countries and surveyed employers, youth, and education providers from nine countries, including India. It points to a twin global crisis - "high levels of youth unemployment and a shortage of people with critical job skills". It writes,

In the OECD countries, more than one in eight of all 15- to 24-year-olds are not in employment, education, or training (NEET). Around the world, the ILO estimates that 75 million young people are unemployed. Including estimates of underemployed youth would potentially triple this number... Across the nine countries, 43% of employers surveyed agreed that they could find enough skilled entry-level workers... The McKinsey Global Institute estimates that by 2020 there will be a global shortfall of 85 million high- and middle-skilled workers.

As the report points out, the massive pool of unemployed youth represents not just a gigantic pool of untapped talent; it is also a source of social unrest and individual despair. It writes,

If young people who have worked hard to graduate from school and university cannot secure  decent jobs and the sense of respect that comes with them, society will have to be prepared for outbreaks of anger or even violence. The evidence is in the protests that have recently occurred in Chile, Egypt, Greece, Italy, South Africa, Spain, and the United States (to name but a few countries). The gap between the haves and the have-nots in the OECD is at a 30-year high, with income among the top 10 percent nine times higher than that of the bottom 10 percent.

The report argues that the biggest problem with bridging the labor market mismatch is the lack of data on "the skills required for employment or on the performance of specific education providers in delivering those skills". It writes,

Clearly, employers need to work with education providers so that students learn the skills they need to succeed at work, and governments also have a crucial role to play. But there is little clarity on which practices and interventions work and which can be scaled up. Most skills initiatives today serve a few hundred or perhaps a few thousand young people; we must be thinking in terms of millions. Why don’t we know what works (and what does not) in moving young people from school to employment? Because there is little hard data on the issue... This deficiency makes it difficult to even begin to understand which skills are required for employment, what practices are the most promising in training youth to become productive citizens and employees, and how to identify the programs that do this best.

Building a reliable and upto date database is easier said that done, especially given the dynamic nature of the job skills requirements. However, any meaningful effort to address this has to involve greater co-ordination between employers and post-secondary education service providers. The market mechanism may ultimately respond by forcing employers who face severe labor shortages to work more closely with education providers. However, a more promising approach will be for governments to play an important role in bridging this information gap and become the market facilitator.

The survey finds that the best education-to-employment programs across the world are characterized by close relationship between employers and education providers - the former helps design the curricula and students spend nearly half their training on a job site. Further, employers commit to hire youth before they are enrolled in a program to build their skills.

Though the report briefly touches on the issue of employers uninterested in investing in skills development, except specialized skills, for not being able to capture its full value. They realize that employees would benefit more and trained employees are more likely to move elsewhere in search of better opportunities. In other words, the social value of the skills training exceeds its private value for the employer. In fact, the social gains go beyond even the private gains to the individual employee. It contributes towards mitigating labor market frictions which constrains investment and keeps large numbers of people unemployed.

This does give skills training the nature of a public good, as much as education in general. It is therefore appropriate that governments finance, atleast partially, the cost of such post-secondary education-to-employment training. Some state governments in India have tried to address this through placement-linked jobs training programs, whereby government pays private institutions for short-term skills development trainings to unemployed youth in return for guaranteeing them employment. However, in the absence of close relationship between the training agencies and employers these programs, which are mostly short-term and academic inputs focused, have been largely failures. But they provide important pointers on the way forward.

Bridging our vocational skills gap

Ask any businessman in India about his biggest challenge, and more likely than not he will point to an acute shortage of skilled manpower. Even when they manage to recruit workers, they turn out deficient in the requisite workplace skills and thereby require further training. India needs to address this quickly if it is to sustain its ambitious high growth targets.

There are two fundamental issues here. One, the quality of students being churned out by the institutes and colleges are extremely poor. An overwhelming majority of students, apart those from a few premier institutions, are simply unemployable. Two, there is an acute under-supply of people with skills to work in manufacturing shop floors and in other semi-skilled professions. This is related to the dominant trend of students preferring the four-year professional courses over the shorter vocational skills training courses. So how do we break out of this?  

In this context, the FT has an excellent article that draws attention to the "ability of the German system to match young people’s skills to those required by the labour market" through an apprentice system. It writes,

It emphasises a combination of theoretical training in the classroom and hands-on technical experience on the factory floor... In Germany, apprentice schemes such as this are the norm. About 60 per cent of the country’s school leavers begin an apprenticeship, which lasts up to three and a half years. About 570,000 trainees – or Azubis as they are known in Germany – started a dual programme in 2011.

The roots of Germany’s vocational training stretch back to the Middle Ages and foreigners have often viewed the system as complex, rigid and antiquated. Children are streamed for technical education earlier than in the UK or US, for example, and join one of about 350 prescribed trades that range from baking to floristry and industrial mechanics... German companies also seek to involve local partners, especially local colleges, both to help train the apprentices and to develop the curriculum.

Training is provided on the job and in vocational training schools, combining theory and practice. This model requires close co-operation between companies, vocational schools, local governments, employer associations and trade unions, which develop the curriculum together. Government even subsidize a share of the training costs. The trainee gets paid whilst learning and there is a very high likelihood of obtaining a job at the end of the process. The company benefits by way of cheaper access to the labour market and customizing the trainees for the specific skill-set.

Given the highly skilled nature of workers in many Germany equipment manufacturing firms and the deficiency of people with such skills, German firms have been adopting the dual programme approach even outside the country. Are there lessons for countries like India which are struggling with labour market shortages? Given the large network of industrial and vocational training schools across the country, there is a great opportunity to establish partnerships with local firms to train their prospective employees.

Update 1 (25/1/2013)

NYT has this nice report about the shortage of factory workers in China. It talks about jobs and positions for which skilled workers cannot be found, whereas on the other hand there are talented people with academic degrees, but no skills, who cannot find jobs. It writes,

China’s vocational secondary schools and training programs are unpopular because they are seen as dead-ends, with virtually no chance of moving on to a four-year university. They also suffer from a stigma: they are seen as schools for people from peasant backgrounds, and are seldom chosen by more affluent and better-educated students from towns and cities. Many youths from rural areas who graduate from college... are also hostile to factory jobs... The more educated people are, the less they want to work in a factory.

The market for vocational skills

Sample this from Louis Uchitelle in NYT about the professions that have bucked the trend druing the recession,

"Welder is one... critical care nurse is another. Electrical lineman is yet another, particularly those skilled in stringing high-voltage wires across the landscape. Special education teachers are in demand. So are geotechnical engineers, trained in geology as well as engineering, a combination sought for oil field work. Respiratory therapists, who help the ill breathe, are not easily found... And with infrastructure spending now on the rise, civil engineers are in demand to supervise the work."

The recession may have taken its toll with many well paying, high-skilled, knowledge-based jobs being lost over the past few months. However, as the NYT report indicates, demand for skilled labour with experience appears to be immune from the vagaries of the business cycle. The market evidently puts a premium on specialized technical (or vocational) skills honed to near-perfection through years of experience.

The cycle-proof nature of such vocational skills stems from the inelastic nature of the demand for these jobs. Plumbers, carpenters, electricians, and those offering specialized engineering (environmental, transport, hydraulics, structural, marine etc) and para-professional services have a well established and more or less invariant market in any economy, irrespective of the conditions. Add in experience to the basic set of occupational skills, and their market demand increases considerably.

And in economies like India, where infrastructure driven construction activities will play a dominant role in the economy for the foreseeable future, the demand for such occupational skills will be insatiable. And among them too, those with experience will command a very high premium, far out of proportion to their basic educational qualifications.

Since these jobs do not require long duration and expensive college degrees, and can be attained by attending specialized vocational tranining institutes (it is an altogether different matter that there is dire shortage of such institutions in the country) for shorter duration courses, there is a clear case in favor of more students embracing careers involving such occupational skills. The market forces, manifested in the ever increasing demand for such professionals and their wages, will in due course of time incentivize more and more people to venture into such careers. The demand for experienced professionals will continue to remain uncleared for such time till large enough numbers of those joining such careers gathers adequate experience over the next decade or so.

Free Exchange points to a "rigidity premium" associated with such professions, since workers who entrench themselves in these specialized skills find it difficult to find alternative employment opportunities in the unforeseen event of a disruptive change that undermines their professions. It writes that this is "a strong disincentive to attempt to develop the experience that is now so valued... employers of experienced workers... have to compensate their employees for the fact that their skills do not readily translate into alternative employment options".