Policy making and accountability

Consider this. The national economy is liberalizing and individual states are competing with each other to attract private investments. They try to out-bid their competitors by offering attractive concessions - tax breaks, concessional utility services, land at lower rates or even free, and so on - to external investors.

It is that early phase of liberalization and economic growth when investors are uncertain of the area's economic potential and pro-active industrial policy is required to incentivize them. In these circumstances, any policy that seeks to attract investors through open-competitive bidding or auctions are not likely to have many takers.

In many states, the industrial or investment promotion policy itself explicitly provides policy makers the flexibility to offer concessions depending on the competition. The state governments (and its political leaders and officials) exercise discretion, on case-by-case basis, to attract investors. While there are broad guidelines, many of the decisions on concessions and preferential allotments are made based on estimates of what would be required to incentivize the investor prefer this state over its competitors. In the process, as is inevitable with such discretionary policies, especially when the stakes are massive, there are instances of excesses, corruption and nepotism in the concessions offered.

Now fast forward ten years. Large investments have flowed in, the state industrial sector has much greater depth and breadth, and its economy has taken off. The conditions that necessitated the promotional policies have changed and the state has established itself as an attractive investment destination. Many of the same promotional policies, while still in force, stand out as obvious anachronisms.

Concurrently, a few sordid tales of discretionary policy corruption emerge, wherein politicians, officials, and corporate groups colluded to cause loss to the state exchequer. The popular outrage leads to an acrimonious post-mortem and revisit of all the industrial policy decisions taken ten years back. Investigations begin and many of the discretionary policy decisions taken to attract investments, including those done in good faith, are called to question on the grounds that it caused loss to the public exchequer and therefore get attributed with malafide intent. So what gives?

Any post-facto assessment, especially given the passage of time and the dramatically changed economic environment, of such decisions are liable to be flawed unless carefully done. Most importantly, it needs to avoid getting entrapped into examining the policies and resultant decisions against the backdrop of the prevailing macroeconomic environment and the lens of regulatory governance. Such cognitive biases and investigation norms are most often difficult to side-step.

The investigations have to draw the clear distinction between the discretionary investment promotion policy decisions taken on behalf of democratically elected sovereign governments in good faith and those taken with malafide intent. Further, the malafide intent has to be established by deep scrutiny of the facts and circumstances surrounding the allotments, instead of the automatic presumption from the (now) apparent excessively generous nature of the concessions allotted.

I will go even further. If the due process has been followed and the democratically elected government has, in its wisdom (or lack of it), granted concessions to a corporate group, howsoever generous, then the investigations should be confined to examining the evidence of any malafide intent behind the decision or failure to adhere to the procedure established by law in its implementation. As to the magnitude or extent of concessions or the policy paradigm (say, auctions against the discretionary allotments) followed, I strongly believe that its adjudication should be left to an appropriate forum, say, the judiciary or the respective appellate tribunals. Atleast in democracies, any investigation by any subsequent governments, should adhere to the aforementioned principles.

In the absence of such protection, any exercise of judgement, on the part of an official or political leader, however well-intentioned, can be questioned subsequently on grounds of having caused loss to the public exchequer. All such decisions, by their very nature, incentivize and provide preferential treatment to one investor, so as to encourage them to invest in the state. Perforce they involve immediate loss to the exchequer. The trade-off is the expectation that it will set the platform for industrial growth and the recovery of the short-term loss through longer-term gains from economic growth.

If this subtle dimension to policy making is not appreciated in any post-mortem, the moral hazard generated by the apprehension of a possible future implication, will restrain policy makers from making judgement calls on such policies. An environment of decision paralysis will result.

Unfortunately, as this environment of suspicion and media trial gets entrenched into the psyche of civil society and defines the agenda of mainstream debates, policy making that involves any exercise of judgement will become a minefield. It will handcuff even those officials whose intentions are in the larger public interest.

This argument is not in anyway an approval or condonation of the obvious irregularities and corruption that have been a characteristic feature of investment promotional policies in many states and at the center in the past decade or so. Those responsible for the malafide actions and administrative irregularities that caused loss to the public exchequer should be punished and the deterrent against such actions strengthened.

However, this should not be at the cost of simplistic appraisals of complex decision-making environments that can only end up paralysing decision-making at all levels and turning the country into a banana republic. It is also pertinent to point out that the propensity for such excesses and corruption are an inevitable accompaniment to economic development in emerging markets.

China fact of the day

If you thought that the China story was all about manufacturing exports, here is a reminder about its consumption market

In 2010, Chinese consumers purchased 19 percent of all PCs sold throughout the world, 18 percent of the LCD TVs, 14 percent of the mobile phones, and 26 percent of the automobiles (all by unit volume).

Why Facebook is going public?

The Economist has an excellent graphical representation of Facebook's market reach and commercial prowess. The firm is seeking to raise $5 billion from its initial public offering, which would give it an estimated market capitalisation of $80-100 billion. It employs only around 3,000 staff, giving it an average revenue of $1.2m per person in 2011.



In this context, John Gapper has an interesting op-ed in FT where he questions the rationale behind Facebook's decision to go public. The company's free cash flow rose from $190m to $470m between 2010 and 2011, while its shareholders’ equity increased from $2.2bn to $4.9bn, leaving it with no immediate need for any additional capital.

It intends to put the cash into US government bonds and savings accounts, and perhaps use some to pay the tax due on converting into shares the "restricted stock units" it has given to its 3,200 staff... Its sole tangible purpose for the IPO proceeds is to meet a tax obligation that will be triggered by going public. Welcome to the Catch-22 world of the venture capital liquidity event...

Apart from meeting US regulations for a private company to go public when it gains more than 500 investors, Facebook’s motivation is clear: to gratify its venture capital investors and employees... a quote from Mr Zuckerberg’s letter to new shareholders, "We’re going public for our employees and our investors... We made a commitment to them when we gave them equity that we’d work hard to make it worth a lot and make it liquid, and this IPO is fulfilling our commitment".

In terms of Silicon Valley’s logic, it makes sense. The returns from occasional winners such as Facebook make up for venture capitalists’ losing bets on thousands of other start-ups – provided the winners are sold either to other companies or to the public markets.

The descent into a Banana Republic?

The quality of debate surrounding the Supreme Court's decision to cancel 122 2G spectrum licenses with the "stroke of a pen" is a reflection of the standards that prevail in public issue discourses in mainstream media in India.

Stripped off all its sensationalism, the 2G spectrum issue essentially boils down to this. The Government of the day, in its wisdom (or lack of it) and well within its rights, put in place (or inherited) a discretionary telecommunications spectrum allotment policy. However, in its implementation (during the 2008 allotments), there were clear discrepancies and irregularities, atleast in case of some of the bidders, that leave no doubts about malafide intent.

So the Supreme Court - three years after the allotments are made, operators have stabilized their full commercial operations, and a web of contractual obligations involving different market stakeholders have emerged - steps in and examines the evidence on corruption in the allotment process and puts a full-stop by cancelling all the spectrum allotments made during that period. What's more, it goes beyond the malafide intent and questions the government's use of a discretionary allotment policy and effectively seeks to "legislate" an "auction-based" allotment process. A nascent mobile telecommunications market-space, the equivalent of a mid-size European country, is decreed to be wiped out in four months.

Now consider this. A newly elected democratic government of Banana Republic, a war torn and military-ruled country in the continent of Timbuktu, decides to encourage foreign investments to boost its economy. It offers attractive concessions like free land, tax holidays, and so on in mineral exploration and manufacturing sector. Investors flock to Banana Republic, enter into sovereign contracts with its government, and start exploration and manufacuting activities. The economy booms, tax revenues increase, and the country starts its recovery from its war-era devastation. There are the inevitable tales of cronyism and corruption in some of the contracts awarded, all of which have aroused some national indignation. Then disaster strikes and the military takes power. Its first act is one of deep populism. It plays on the national resentment at the corruption in contracts signed with foreign investors and cancels all sovereign commitments of the previous government and expropriate the foreign investments. Banana Republic slips into its normal state of turmoil.

Apart from the different exterior trappings (the cancellation was at the "stroke of a pen" in the former, while it was at the "boom of a gun" in the latter), on substantive terms, is there any difference between the two scenarios? In both cases, sovereign policy commitments made by the respective democratically-elected governments of the day (whatever its flaws) and implemented deficiently (as is the case with any implementation in such societies) are, without any of the legal requirements of fairness and justice, cancelled over-night at the arbitrary discretion of a few individuals. In both cases, apart from moral hazard arising from defaulting on sovereign commitments and the long-term economic damage caused, the decision-makers have clearly over-looked the fact that much water has flowed under the bridge subsequent to the "original sin". The decisions extinguished the multiple economic transactions and contractual commitments - many of them without any malafide intent, based on legally valid legislative and executive decisions, and a consequence of the natural flow of economic activity - that have emerged after the original decisions/allotments.

Not for a moment am I holding any brief for those who violated their constitutional responsibilities or who benefited fraudulently. All of them should be brought to book for their criminal liabilities. The political masters, bureaucrats, and the businessmen who colluded to defraud the exchequer should all be throughly investigated, their criminal intent established and punishment imposed. For example, the public servants who took part in the conspiracy should be punished under the prevailing rules, while the businessmen who benefited from it should be punished under the relevant rules and the amounts defrauded quantified and collected from them and their partners. This should be done in a manner that least disrupts the competitive marketplace (and even its critics would admit that the economic outcomes - technology, business models, consumer surplus etc - of India's telecommunications reforms has been one of its economic and policy success stories) that has emerged from the original decisions.

In any case, the sovereign policy commitments of democratically elected governments, however flawed, should always prevail and not be left at the mercy of flippant individual discretion, howsoever mighty, provided the allotment process is in conformity with the broad constitutional principles. This becomes all the more important if subsequent transactions, in good faith and based on the sanctity of a sovereign commitment, have been executed on the original decision. However, law should take its course and severely punish those who displayed any malafide intent, discrepancies, and wilful omissions in the implementation of the allotment process.

The term "banana republic" is characterized by two features - a country operated as a commercial enterprise for private profit and one where the sanctity of long-term policy commitments of any of its governments is of questionable value. On these grounds, does India qualify to be a "banana republic"?

Real American Unemployment Rate

Via MR, FT Alphaville points to the work of economists at Nomura who have constructed an excellent graphic that highlights the real US unemployment rate. It stands at 10.3% compared to the official rate of 8.5%.

Much is being made out of the fact that the US unemployment rate has been falling in recent months. However, this conceals the fact that the declining rate is a statistical illusion. It excludes the large numbers who have stopped actively looking for work and have theoretically "left the labour force and therefore count as unemployed".



The biggest concern is this

But what is striking about the broken line above isn’t where it now ends — at 10.3% — but rather the lack of any meaningful, sustained improvement for more than two years. This alternative measure has remained above 10% since September 2009, and aside from a bit of skittishness (some of which is down to uncaptured seasonality) has mostly just moved sideways.

Football transfers and corporate M&As go out of fashion?

In football signings there is a mathematical rule: three out of five fail... Like corporate takeovers, football transfers create turbulence and uncertainty. Often a player who succeeds in one setting fails in another. Economist Stefan Szymanski has shown that what clubs spend on transfers bears little relation to their performance in the league. Net outlay on transfers explained only 16 per cent of their total variation in league position. By contrast, the correlation between a club’s wages and its league position was about 90 per cent, averaged over about 15 years. Wages buy victories; transfers don’t.

(HT: Simon Kuper in FT)

Job creation in China - the role of cities and services sector

Felix Salmon has a superb post which highlights the critical role played by urban areas in sustaining economic growth and job creation in China. He points to two less-discussed facts about the Chinese economy.

1. Services sector employs more people than the manufacturing sector. The graphic shows that manufacturing sector, in terms of total jobs in the sector, actually declined for some part of the nineties but recovered slowly in the last decade.



Examining China's jobs growth over the past twenty years, Felix Salmon writes,

But it is surprising to see that if you take out the services sector, total Chinese employment has been going nowhere, and basically falling... Meanwhile, the services industry — tertiary industry — has been on fire: it now employs 263 million people, more than are employed in secondary industry (218.4 million), and has doubled since 1992... Of course it’s hard to find work in the services industry if you’re a rural peasant: tertiary industry is a fundamentally urban thing.

2. The growth in jobs has been coming mainly from the urban areas though rural China provides more employment than its cities. Apparently 13.7 million urban jobs were created in China in 2010 alone.



Felix Salmon makes the important point that unlike the US, where the construction boom was confined to the real estate sector, the Chinese construction boom "is building cities and roads and crucial infrastructure, which allows the service economy to keep on growing at a torrid place".

Both these graphics highlight the important role played by the services sector and cities in boosting China's labour market. Felix Salmon points to the closely inter-twined nature of cities and services sector job creation,

How do you create service-industry jobs? By investing in cities and inter-city infrastructure like smart grids and high-speed rail. Services flourish where people are close together and can interact easily with the maximum number of people. If we want to create jobs in America, we should look to services, rather than the manufacturing sector. And while it’s hard to create those jobs directly, you can definitely try to do it indirectly, by building the platforms on which those jobs are built. They’re called cities.

Will policy makers in India, obsessed with a rural-centric public policy paradigm, take notice and emulate China?