From Financial Express, September 13, 2013

Getting India back on track

 In my last column (An Indian Spring? FE, August 22, http://goo.gl/hwW9cw), I raised the possibility of India descending into an Egypt-like situation. It probably will not get that bad, since India’s recent history and its societal makeup are sufficiently different. But there is one large commonality—a surplus of young people relative to decent jobs. That basic mismatch between demographics and economic opportunity can drive substantial waves of social unrest. One only has to think back to the early and mid-1970s to realise that India, for all its democratic resilience, is not immune to severe social and political instability. In an earlier column (Can India grow faster again? FE, August 19, http://goo.gl/8E9iwS) I listed some steps that India’s leaders need to take in the medium run: effective vocational training, removing constraints on electric power generation, and more devolution to the states and to cities. But before that, there is a short run crisis facing the country. Here are my thoughts on how to turn things around quickly and effectively. 

The immediate problem is a crisis of confidence. This is partly what has driven the plunge in the rupee, although the strength of the US and European economies has also contributed to the rupee depreciation. The erosion of confidence has been gradual, with multiple instances of government corruption and fiscal and monetary policy mistakes over the last couple of years. Fixing this will not be easy. The measures undertaken so far have smacked of panic: sudden promises of relaxing foreign direct investment caps, a grab bag of import controls, and derailing financial markets to curb “speculators”. All these measures, in my view, simply reaffirm the view that the government is adrift and that troubles will continue. The latter two types of measures also go against the basics of a coherent economic reform strategy, which should be built on promoting well-functioning markets in a global setting. 

With respect to the rupee, the Reserve Bank of India’s (RBI’s) initial response of trying to reduce speculation by making short-term borrowing harder simply sabotaged the working of short-term credit markets, and had no effect on offshore traders. Markets became thinner and more volatile. Instead, if RBI wants to prevent further overshooting downwards of the rupee’s value, it should follow an assertive and transparent (but feasible) intervention policy (something along the lines suggested by Kaushik Basu, announcing a schedule of intervention). Given what has happened, it may be mostly too late. One thing RBI should do is to raise its policy rate, as other emerging economies have been doing. Yes, this could further slow down growth, but the short run benefits of an interest rate hike, in terms of stabilising expectations about inflation and currency depreciation, seem to make this a worthwhile option. Reversing such rate hikes is easy and quick, and they do not have the deleterious impacts of unexpected changes in the rules governing the functioning of markets. 

With respect to the current account deficit, what the government needs to do is to use the opportunity of the rupee depreciation to push exports. The obvious areas are in information technology and related services, tourism, and possibly some kinds of consumer goods (including apparel, health and beauty items, and processed foods). Essentially, India’s products are suddenly a bargain, but some rapid and concerted marketing efforts are required to make sure that rich world consumers take advantage of these bargains. India’s embassies and missions abroad should be going into overtime, working with Indian businesses to seize the opportunity presented by the fallen rupee. Promoting exports, while more work and slower to take effect than restricting imports, will have a much larger medium term benefit. One of the easiest, most immediate opportunities is promoting foreign tourism, since the supply constraints are less problematic. 

On the domestic front, the politics of the looming national election make progress difficult, but if the government were to push harder to reach a grand bargain on the goods and services tax (GST), convincing the array of opposition parties that they will all benefit from a broader, more robust tax system, this would provide the prospect of a corrective on the fiscal front. My reading of some of the crisis of confidence is that it was driven by the government’s attempts to raise revenue through ad hoc, discretionary and retroactive measures, in turn driven by the need to reduce the fiscal deficit. But those policies hurt confidence, growth and government revenues, just the opposite of what was desired. 

The three examples I have suggested are policies that signal that the government is in charge, and is capable of providing leadership to the country. In contrast, most of the governmental responses to the crisis so far have seemed to signal desperation, weakness and lack of control. Much of the recent Indian policy debate has been reduced to finger pointing (evil speculators, heartless global capitalists, incompetent and venal politicians) and crying over spilt milk. It does not have to be so, and India’s leadership has to act as if it is worthy to lead in these challenging times.

Financial Express, December 28, 2012

Corporate virtue in India

In previous columns, I discussed the concept of virtuous growth, which encompasses inclusive growth. Virtuous growth includes promoting fairness, but it also means avoiding societal change that corrupts and degrades positive human values. I discussed how virtuous growth might be promoted in practical terms, in the realms of governance and civil society. Here I want to discuss the role of business, specifically large firms that are India’s leading institutions of capitalism. What can and should their role be? 

One idea of virtue is that of corporate social responsibility (CSR). This is fine as far as it goes, but it does not preclude a firm making large profits through unethical business behaviour and then allocating a small amount for superficial do-good efforts. Business tycoons also set up charitable foundations with their wealth, but, like CSR, these have no impact on the manner of doing business. The key desideratum is more ethical behaviour at the core of business practices.

One problem in effecting better business behaviour is that corruption is endemic in Indian society. The corruption scandals that are so common in government functioning also involve corruption by private sector firms. People in government demand bribes, and people in business supply them, in an unholy equilibrium. How can this equilibrium be changed? Kaushik Basu’s proposal to decriminalise bribe-giving (but not bribe-taking) focused on situations in which individuals are entitled to a government service but are forced to make illegal payments to receive it. At the Delhi Economics Conclave earlier this month, Avinash Dixit of Princeton offered a different focus and proposal for reducing corporate corruption.

If corporations need government approvals, or are competing for government as a client, they may pay bribes to avoid being at a competitive disadvantage if “everyone else is doing it.” Dixit proposes to address this problem through collective action mechanisms. In particular, he advocates self-regulation by the major industry associations, with clear codes of ethical conduct, explicit pledges, and mechanisms for punishing violations. The judicial system would have to create a framework for recognising such extra-judicial mechanisms, just as it does in the case of special arbitration. Existing examples of such institutions are university and military honour codes, and the workings of local associations to manage common pool resources (studying which earned Elinor Ostrom an Economics “Nobel”). Implementing such mechanisms is not easy, nor are they ever perfect, but they can work.

Dixit’s proposal is important as well as timely. Here I describe developments on the Indian institutional side, which complement his theoretical nuances. Interestingly, private sector bribery is not even a criminal offence in many cases. The government drafted a Bill in 2011, and it is circulating for comments. Major industry associations such as the Confederation of Indian Industry (CII) and the Federation of Indian Chambers of Commerce and Industry (FICCI) have come out in support of the Bill. Changing the legal playing field is an important start to institutional reform, and complements Dixit’s ideas. Ideally, some of the practical monitoring and enforcement tasks would be assigned to an independent regulator, as they are in the US or UK.

Closer to Dixit’s idea is last year’s proposal by CII, of a Code of Business Ethics for its members. While the draft code is too vague and broad in many places, it is categorically against corruption, including all bribe-giving. BS Raghavan, in the Hindu Business Line, has made specific suggestions for increasing the specificity of the requirements of the code, and raising levels of transparency with respect to lobbying and influence activities. Dixit’s proposal would strengthen this effort even further, with sanctions against violators. It is surprising that there has not been more public debate on this effort, and discussion of how to get it right. In fact, none of the other major industry associations appears to have followed CII’s lead.

Also just a few months ago, the Global Compact Network India (GCNI), an arm of the United Nations Global Compact, released a report ‘Raising the Bar Through Collective Action: Anti-Corruption Efforts in Action in India.’ The report release gained much attention, but there appears to have been no follow-up: the document is nowhere to be found on the Web. Press releases suggest that the report consists of a few case studies featuring transparency, monitoring and public standards of behaviour, together with advice for more collective action. Exactly!

In a sense, industry associations do not need GCNI’s report—they know what they have to do. But public debate has to push them into moving forward, to enshrine the ethical best practices that some of India’s iconic companies already have in place. In the short run, this will be difficult, as a critical mass of acceptance has to be reached. CII’s effort has broken the ice, and the other industry associations should follow its lead, or even leapfrog it, in creating and enforcing anti-corruption codes. In the long run, raising standards of corporate behaviour on this front will benefit those firms that can do well by being more efficient or innovative, not by bribing. This will enhance growth in the long run and make it politically more sustainable.

 

From Financial Express, September 12, 2012

Virtuous growth for India

India’s ruling coalition has promoted the idea of inclusive growth. What this means operationally is something that can be debated. One idea is that a broad cross-section of society should enjoy the fruits of growth. For example, Kaushik Basu has suggested measuring the income gains of the bottom quintile of the population as a concrete, specific indicator of growth. One can also interpret inclusiveness to mean going beyond income. Amartya Sen has emphasised that there are other measures of development and well-being—literacy rates and life expectancy can also grow, for example. For others of Sen’s suggested dimensions of development, such as rights and capabilities, quantitative measures of growth may be difficult, but one can still speak of more inclusive development in a qualitative sense.

Material welfare and rights are reasonably well understood, though agreeing on how to measure gains, or manage tradeoffs between them, still can be a challenge. But there is a third dimension that has been stressed by philosopher Michael Sandel, who discusses the importance of virtue, in his books, Justice: What’s the Right Thing to Do? and What Money Can’t Buy: The Moral Limits of Markets. Sandel’s examples are mostly from the US, and are germane to the current political debate in that country’s presidential race. But they also have relevance for India.

Basically, Sandel argues that welfare and rights (especially freedom of choice) are insufficient to guide us to just social outcomes. There has to be a consideration of morality that goes beyond these. He favours “cultivating virtue and reasoning about the common good”. What this means in practice is hard to generalise, but he argues through examples, and he gets at the heart of some of the issues that trouble ordinary people when they consider the role of market forces. In particular, a key idea that he advances is that market exchange based on commoditisation can crowd out moral considerations and make us worse off as a society. For example, market exchange can destroy the good itself—friendship cannot be bought and sold. But even if the good is tradeable without being degraded (babies are an example he discusses), there is a loss to us individually and socially from such marketisation: the participants in the exchange are corrupted or degraded, rather than the object of exchange. A complementary possibility is that pure market-based allocation is undesirable because it is unfair, pricing all but the rich out of some goods (such as a visitor’s seat to watch Parliament in session)—this relates to more conventional notions of equity or egalitarianism, and the basic idea of inclusiveness.

Sandel uses his framework to discuss more concrete notions of citizenship, sacrifice, honour and responsibility. If markets intrude too much on social norms, then there is a loss of virtue. On the other hand, virtue is strengthened by its application—we learn to be good citizens through how we go about our civic duties. In particular, allowing the market to dominate the government will be problematic. Note that this does not constitute an argument against economic reform in India. In fact, the problem with the old system was precisely that it created opportunities for buying and selling government favours, in situations where open and transparent market allocation could have been more effective. My guess is that Sandel would have concerns about Kaushik Basu’s suggestion to decriminalise bribe-giving where the bribe is demanded for a service to which the recipient of the service is entitled. This can increase efficiency and material welfare, but can have a corrupting or degrading effect on individuals and society.

Sandel’s idea of virtue as important for individual and social good is not new. There are conceptual links to Gandhianism or even Nehruvian socialism. But like Nehru and unlike Gandhi, there is not a broad-based suspicion of material progress. And unlike Nehru, there is not a broad suspicion of markets. So I do not think that paying attention to virtue means neglecting traditional economic growth. Virtuous growth is not an oxymoron. If fairness is a virtue, then virtuous growth subsumes inclusive growth. But if inclusive growth means that rich and poor alike progress materially while becoming socially less engaged, or more corrupt, or materialistic in ways that are degrading, then even inclusive growth lacks something. It is possible that the sustainability of growth may require inclusion in the medium term, but virtue in the longer run. Virtuousness can align with intrinsic motivation, so that people do their jobs well, not only because they are paid for it, but because it is the right thing to do. It also focuses attention on how those jobs are experienced, so that dignity matters in itself, not just for the bottom line. There are implications for how the private sector chooses to conduct itself, aside from government regulation. The sharpest implications, however, are for the government itself, which in India, often fails to promote virtue or to practice it, while pretending otherwise.

From Financial Express, July 13, 2012

How not to defend the rupee

As India’s economy has soured, its currency has plummeted. The response of the Reserve Bank of India has been confused and counter-productive. Why do I make that claim? First, the fundamental value of the Indian rupee is determined by economic fundamentals. The rupee will recover when India does two things: put its macroeconomic house in order by controlling the fiscal deficit and inflation, and restoring its growth story through microeconomic and institutional reforms. These have little or nothing to do with RBI’s management of the exchange rate.

There are two counters to this claim. First, in the short run, the exchange rate can overshoot, and this can have harmful impacts on the economy during that period. Second, increased volatility of the exchange rate, which can accompany uncertainty about its level, is also harmful. The harm is that economic agents within India, particularly domestic firms, will suffer losses due to the fluctuations in the exchange rate or sharp movements in its level.

RBI has taken two types of actions to manage the rupee’s recent vulnerability. It has intervened in the foreign exchange market, and it has introduced new restrictions on trading in currency derivatives. Intervention is meant to directly counter private market participants’ views, buying when they are selling, or selling when they are buying. Restrictions on derivatives trading are meant to reduce speculation in movements of the currency. These restrictions can also support the first objective, by raising the cost for private market participants to trade, and give RBI more weight as a trader in the foreign exchange market.

The problem with foreign exchange intervention, as has been shown repeatedly across the globe in the past few decades, is that it has limited power in the face of global capital market sentiment. A large amount of trading of rupee derivatives takes place offshore, and the value of the rupee will be determined by large economic actors in global financial centres. Recently, Kaushik Basu has advanced an ingenious theoretical argument for effectiveness of intervention based on credible commitment by a central bank when other traders are a competitive fringe, but it has yet to be tested empirically. I think instead that RBI has very limited scope to do much beyond managing day-to-day liquidity and unusually sharp short-term falls or spikes in the currency. Even if the rupee is falling below its fundamental long-run value, RBI has to accept the limits of its power to influence the level of India’s currency.

Restrictions on trading in currency derivatives are more problematic. Restrictions include those on who can trade, what can be traded, when trades can take place, and what net positions currency traders may hold. RBI issued circulars in December 2011 and May of this year, substantially tightening existing restrictions. The ostensible goal is to reduce speculation, though a hidden objective may also be to thin out the market and give RBI more clout. But large amounts of trading take place offshore, beyond RBI’s reach. Many of the restrictions simply hurt Indian financial institutions at the expense of foreign players.

The nature of the restrictions also makes it harder for Indian firms to hedge their currency exposures. As India has globalised, the need for managing currency risks of all kinds has increased dramatically. RBI has taken retrograde steps that will make it more difficult for effective hedging opportunities to develop for India firms, especially smaller ones that do not have offshore liquid assets in their treasuries—larger firms with such resources can again operate globally to manage their risks.

The argument that currency derivatives caused problems for Indian firms in the past is like saying that a toddler fell because the parents did not clear the floor of obstacles, so now he should not be allowed out of the crib. RBI’s December 2011 restrictions on cancelling and rebooking forward contracts raise hedging costs for Indian firms, even for the simplest kinds of forward contracts. Such hedging has nothing to do with complex derivatives that were being peddled just before the financial crisis.

Indian firms, and India’s economy, would be better off with an approach to regulation that moves away from piecemeal, ad hoc measures that fragment markets, reduce liquidity and prevent learning. Transparent exchange trading of basic currency derivatives such as plain vanilla forward contracts, without arbitrary restrictions on contracting or net positions, would allow Indian firms to develop effective hedging strategies. The onus of risk management at the firm level would be on corporate boards, which would also learn how to do their job. None of this prevents RBI from regulating to avoid systemic risks, such as dangerously large aggregate currency exposures for the economy. Making sure that the playing field of currency markets is level and visible to all participants is also an important regulatory job. Good regulation is difficult—bad regulation is easy.

Breaking the spiral of despair

 

From Financial Express, June 23, 2012

Breaking the spiral of despair

Like it or not, India is on the world stage. Its achievements are being celebrated, but its shortcomings are also being dissected as never before. India has shown enough promise as a successful example of democracy and development that the chance of failure looms larger than it did a decade ago. The Economist magazine recently had an editorial lamenting India’s lack of leadership and the immense human costs of slower growth. Soon after, the magazine’s Asia column, “Banyan”, featured reflections from an unnamed senior government official, which seemed to boil down to the need to boost growth with a surge of infrastructure spending.

Banyan also reported on a speech by Kaushik Basu, the Indian government’s chief economic advisor, which boldly stood up for economic reform, openness to the world economy, and economic growth as a path to raised living standards. Dr Basu acknowledged that India’s current problems are of its own making, and that a “spiral of despair” must be broken for India to “come out on top” in a few years.

How can that happen?

A few years ago, I suggested that India’s Prime Minister displayed “Level 5 leadership”, a paradoxical blend of personal humility and intense professional will. One saw this in the nuclear deal. One sees it in the dealings with Pakistan. Domestically, one can only guess as to the constraints that prevent such leadership being exercised for economic policymaking. Perhaps India’s new president will display the same traits once elected. On the whole, though, this kind of leadership has been sorely lacking in India, despite the amount of talent near the top. Professional will is often present, but distorted by an over certainty of views, leading to a failure to incorporate all ideas and information that may be useful or relevant. In other cases, both will and humility are absent, in politicians who are mainly concerned with personal gain. India needs level 5 leadership, right away.

Even the best leaders cannot make all decisions unaided. India has been suffering from not having the right people on board, in the right positions. If the PM has to manage the finance ministry as well, or one person has to deal simultaneously with two immensely important ministries such as telecom and education, one cannot expect that each job will receive the attention it deserves. If senior bureaucrats do not have years of specialised expertise pertaining to their positions, decisions will not be made optimally. On the other hand, fresh ideas can come in if the expertise was developed outside the “government hot-house”. India needs more of the right people in the right positions, right away.

Banyan commends Dr Basu for supporting openness, globalisation and economic reform, but suggests that India’s politicians shy away from doing so. This is not quite true. The PM and all the senior economic team have repeatedly stood up for these principles. The problems have been in implementation, in doing the deals that will move things forward. Many reforms have been creeping along in the background. But what is needed is a prioritisation and focused push. Perhaps reforms like FDI in retail, cutting fuel subsidies, and overhauling land acquisition laws are politically too challenging for the moment. But there is one single reform that can strike at the root of several problems besting India. The central government has been desperate to raise revenue, and reverted to old-style discretionary, if not extortionary, taxation methods. It should focus on the tax overhaul that would do the most good, the rapid introduction of a simple, comprehensive Goods and Services Tax. If the states need to be brought on board politically, this is an opportunity to give them a higher tax share, and the greater spending autonomy that comes with revenue authority. The states are where effective government spending decisions can be made for many things that matter, like health and education. India’s central government should focus on a few things, get them done right, and get them done quickly.

Top leadership, the right team below that leadership, and focus on one or two really major structural reforms. These are obvious ideas for India, as it battles a spiral of despair. Meanwhile, the country of over a billion will keep lurching along, with day-to-day decisions to be made, as well as long-term plans, across a wide range of economic and social issues. Whatever happens with India’s leadership and governance, it will benefit from a more concentrated, focused and interactive attention to this entire range of issues, by the top minds working on India’s economy. Under Dr Basu, the Economic Survey of India has begun to give a sense of how to bridge the gap between rigorous economic theory and empirical analysis on the one hand, and policy prescriptions on the other. This is something that needs to happen in a more general and continuous way. Ultimately, this bridge of ideas will be crucial to breaking the spiral of despair.

The Great Indian Growth Debate

Here are two columns about the Sen-Bhagwati contretemps on India's growth

"It's Growth, Stupid -- Or Is Growth Stupid?"

The debate between two of India’s greatest economists, Jagdish Bhagwati and Amartya Sen, is important for India’s policymakers. Are growth targets diverting policy attention from other important development goals? Chief Economic Advisor Kaushik Basu has said the differences are less substantive than they are made out to be, but what is the common ground? Here is my take on the great growth debate.

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Fighting Malnutrition in India

Growth is good. So are health and education. Malnutrition is bad. As I noted in my last column, everyone, including those involved in India’s growth debate, agrees on these things. But differences emerge in recommendations for how to improve India’s human development status. Malnutrition is a good example. One view is that focusing on growth alone diverts attention from tackling problems like malnutrition. Another view is that accelerating growth is crucial to generate the resources for addressing such problems.

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