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, August 22, 2012

Towards a strategic foreign policy for India

In my last column, on India’s ‘global strategy’, I made several points. First, India should put economic growth at the centre of its foreign policy. Second, it should pursue knowledge and capital eclectically and vigorously from around the world, to support this goal. Third, attention to infrastructure in telecommunications, energy, roads, ports and airports is vital to national security, beyond the obvious economic benefits. Fourth, China’s rise is the main global strategic issue for India. In this column, I want to develop the implications of these points for foreign policy in practice.
I will begin with the last point, the implications of the rise of China. India has to deal with China in an accommodative way (there is no choice, given geography and history) but from a position of strength. Economic growth will not be sufficient to achieve this position of strength, especially in the short run. Therefore, to mitigate security risks, India has to engage in deeper strategic cooperation with other nations. Such cooperation goes beyond the conventional military dimension. On that front, the United States is almost the only game in town. A critical new front for strategic cooperation is information-sharing. Here, too, the US has enormous strengths, and a vital role to play, but there are other possible partners. Most such potentially valuable partners, however, have strategic ties to the US. The conclusion is inescapable that India has to deepen its strategic cooperation with the US. This is nothing like the Cold War world of treaties and alliances. It is about India assertively and systematically pursuing its interests in a framework of mutual benefit.

Is there a downside to closer strategic cooperation with the US? Will there be a cost because it offends China, or reduces India’s strategic autonomy? The answer must be ‘no’. Such cooperation strengthens India’s capabilities, especially if it focuses on learning (and it has more to learn than the US, in such cooperation). Will it provoke China? Not if it is done intelligently. And if the counter argument is that India should not seek to protect its security for fear of upsetting China, then that says that China is anyway reducing India’s strategic autonomy.

Given the necessity of strategic cooperation with the US, it becomes more important for India to seek economic ties more widely. Luckily, there are many alternatives here. In fact, barring higher education, information technology and some aspects of agriculture, US capabilities are not necessarily the best choices for India. To take a prominent example, US-style mass market retailing as it has evolved in the past decades may not be best suited to India’s geography and infrastructure. In renewable energy, mass transit, high-end engineering, consumer durables, mineral extraction and so on, Germany, Britain, Japan, South Korea, Australia and numerous other economies may have more to offer India in terms of knowledge bundled with investment. A diversity of economic ties acts as a counterweight to the narrowness of options for strategic cooperation.

To summarise, India has to integrate economic growth goals more clearly into foreign policy. Its diplomats should speak the language of commerce, and its business people should speak the language of the country they seek to do business in. (Wouldn’t it be wonderful if India invested heavily in foreign language training, not just for its superb diplomats, but also for its enterprising business people?) It has to pursue commercial engagement more actively across the globe. At the same time, India has to deepen strategic cooperation with the US, and existing strategic partners of the US. This is not about diplomatic treaties and grand alliances, but really about lower key information-sharing and security cooperation in all its modern forms.

Foreign policy is about pursuing national interests in the international arena. Sometimes, this means cooperating with other nations that have different political systems and values. Nixon famously went to China in pursuit of national interests, when China was still wedded to Maoism. But China wanted economic growth from that new engagement, and it succeeded. India has to deal with China, for many reasons, but not for reasons of strategic balance. India has little to offer China except resources, markets and acquiescence, and so is in a weak position. It has to strengthen that position.

Luckily, India has alternatives for strategic and economic cooperation with nations whose political values align well with India’s ideals. Even if shared values are not of importance in determining directions of international engagement, they are a useful bonus, as they enhance trust and cooperation. But ideals should not get in the way of national interests, and they should not be pushed on others. In any case, India has much to do on the domestic front before it can claim to be an international example of virtue. The bottom line remains that India’s government has to deliver greater material and non-material well-being for its citizens. Foreign policy is just one aspect of that larger challenge.

From Financial Express, August 14, 2012

India’s global strategy

A recent 70-page report by a distinguished group of Indian thinkers on the nation’s foreign and strategic policy in the 21st century has generated considerable debate. Provocatively titled “Nonalignment 2.0”, the document ranges over economics and politics, internal concerns as well as those of external relations. The breadth of scope is breathtaking and, despite the early disclaimer that it does not intend to prescribe specific policies, there are numerous specific prescriptions, as well as more general guidelines and exhortations. At the end of it, though, I was left feeling like I do after reading India’s five-year plan, national water policy, or similar documents. Ultimately, the clear strategic direction is missing. Indeed, the title itself hints at this problem. Here is my own take.

Nonalignment was a useful way of navigating the cold war world, and provided, in some circumstances, a counterweight to both of the opposing cold war powers. Ultimately, though, it had limited usefulness, because it was a defensive strategy. It did not address the fundamental challenge of all governments that claim to serve their citizens, namely, to increase their well-being, both material and non-material. National security is a necessary component, but far from sufficient. What really mattered, it turned out, was domestic political capacity and national choices of economic systems. For countries that could manage internal conflict, global economic engagement and a sufficient degree of market friendliness paid off.

The world is no longer divided as it was 25 years ago, but asymmetries of power remain. The United States dominates in many respects, but China is flexing its muscles in numerous ways. The N2.0 report seems to view these two countries as the new Scylla and Charybdis that India’s global strategy must navigate. What is wrong with this perspective?

First, it is important to re-emphasise that what India primarily needs is rapid, sustained, inclusive economic growth. Foreign policy should put this goal first. Besides all the domestic problems that India needs to fix on the economic front, India needs deeper engagement with the global economy. But which parts of it? China is way ahead of India in almost every dimension of international economic integration. India needs capital and knowledge from the rest of the world. But China is not a trustworthy source of either of these things—deeper economic engagement with China will be asymmetric and risky, at least for now. Luckily, on this front, India has many options besides the United States, for investment and technology, including the stronger economies of Europe, and especially the miracle economies of Asia: Japan, South Korea, Singapore and, yes, Taiwan. India’s foreign policy should clearly serve its economic development, with clear strategic intent.

Why is China not trustworthy? Because of geography, it is in strategic competition with India in terms of conventional territorial and resource motives. Because of history, it has a point to prove to the West, and seeks to be a true global power, befitting its heritage and self-image. These strategic drivers for China make it a prickly partner and collaborator. This is true for India just as it is true for almost every East and Southeast Asian nation. This does not mean that India cannot manage accommodation and some engagement with China. Indeed, it must. Some of that necessity is a function of shared boundaries, and the classic needs of national security. India has to be nice to China, but has to be so from a position of strength, unlike the 1950s.

India has many other neighbours, none of them in the same category as China. India now has an opportunity to be good to all of these, no matter how problematic they are. A lynchpin of India’s global strategy should be economic generosity to its smaller neighbours, no matter what their problems or responses.

To make this work, India has to do better with domestic security. Besides economic growth, India needs better governance, valuable in itself, and not just for the economic benefits that it brings. More specifically, India needs to improve its physical infrastructure. Roads, airports, telecommunications and energy are such obvious aspects of internal security, beyond their economic benefits, that it is unbelievable that they have been so neglected. In this respect, global strategy starts at home.

So my take is that one should jettison labels, particularly ones that mislead in understanding the present world situation. The big story is the rise of China. India is a bit player in this story. Its strategy should be to avoid getting knocked down as China rises. This means pursuing its global economic interests, without the old moralising, in an eclectic manner, but with clear strategic intent. Building key parts of its infrastructure, and nourishing and educating its people effectively will serve its national security as well as its economic development. Seeking economic engagement with the many countries that have knowledge and capital to offer should drive foreign policy. This is a clear and simple global strategy for India.

From Financial Express, July 26, 2012

Demographic dividend or disaster?

India’s demographic trends could lead to a dividend of higher growth, as the working age population bulges. Two things have to happen for this dividend to be realised. If they don’t, the possible alternative is demographic disaster, and social unrest. First, India has to create more jobs across the board. In a previous column (Entrepreneurship and jobs, FE, November 28, 2011, http://goo.gl/ PYEdk), I discussed this side of the equation. Second, India has to give its people skills to work at jobs productively. In this column, I want to look at the basics of India’s education policy.

There are serious problems with Indian higher education. These include a shortage of high quality faculty, poor incentive structures, lack of good regulation (which would promote competition and transparency, rather than defending a dismal status quo), and artificial constraints on supply of educational services. I have often argued that allowing much more foreign entry in higher education would be a good solution to these problems.

As bad as Indian higher education is, the worst problems are in primary education. After all, without a good foundation, subsequent education cannot happen easily and effectively. This is true even for vocational training, not just elite education for the advantaged and talented. At the primary level, there are also serious problems with health and nutrition that impact the effectiveness of education and the capacity for learning, but let us set those aside and focus on the education sector, government-provided primary education in particular.

A large amount of empirical research has been done on this subject in the last decade. We now know much more than we did a few years ago. Karthik Muralidharan, a major contributor to this research programme, has recently summarised what we know, and drawn out the policy implications. There is a large gap between what we know and what policymakers are saying and doing. If policymaking and implementation do not respond quickly to the latest lessons, India’s youth will be poorly prepared for productive participation in the economy.

What does Muralidharan’s survey (presented at the recent India Policy Forum) teach us? The following is my own interpretation. First, many kinds of school inputs do not translate into improved learning outcomes. This includes toilets, electricity, computers, mid-day meals, student grants, more teachers and better-trained teachers. This does not imply that these measures are bad, just that they are not enough. On the other hand, certain kinds of incentives linking teachers’ rewards to performance do work. These incentives may be monetary or non-monetary, small or large, positive or negative. The best mix can be context-dependent and subtle. One important example of incentives is that contract teachers do better than those who are tenured government bureaucrats, even when paid much less. But even regular teachers do better when their rewards are linked to performance, which can include showing up to teach as well as having their students do better on tests.
The implication of all the studies is that education policymakers are focusing on the wrong things. Muralidharan notes that the ministry of human resource development’s central policy document, while discussing access, equity, quality and departmental processes, has “no mention of learning outcomes.” Quality is just about improved inputs, not outcomes. Certainly, just changing this mindset would be a start towards reform of educational policy. Muralidharan acknowledges the political and institutional difficulties, even as he discusses possible reforms of curricula, organisations and governance.

My own take on the current situation is that change from within will come too slowly for India. A disruptive, radical solution is needed. A clue to where to look comes from the reported research which shows that remedial instruction actually does improve learning. My guess is that the key feature is that this instruction is targeted, individualised, and has a quick and clear feedback loop. Apparently, computer remedial programmes do better than teachers, but cost more. This differs from research that computers alone are useless. I think the problem is with the way digital technology is used. Computers are not needed to teach basic reading and mathematics skills. Very cheap specialised devices for playing educational games, with preloaded software that allows students to move up levels by answering problems or recognising words, and to compete with each other, can combine low cost with strong learning incentives.

This is a far cry from elaborate textbooks and curricula, and will outrage most professional educators as debasing education. But it will work, and will not need to wait for massive institutional reform. Children have to get hooked on learning. They have to get quick rewards for achieving small learning outcomes, with continual progress. They have to be able to measure themselves against their peers. This can all be done with simple software and cheap dedicated devices. Once a start is made, more sophisticated tools can be developed for older children and higher learning, even ones for teachers. Educational computer games can be the first step towards reaping the demographic dividend.

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.

Economics and the Economic Crisis: Who is to blame?

At my university, a generous alumnus, Stephen Bruce, has funded an initiative on “Rethinking Capitalism.” As the fallout of the financial crash of 2008 drags on, now with the banking crisis in Spain, the topic seems inordinately relevant. Even in India, the crisis has given critics of economic reform ammunition against that direction of policy, aside from the direct impacts on India of the weakening global economy.

In April, the Bruce Initiative took its efforts from the redwoods of Santa Cruz to the closest academic precincts of the centre of capitalism, with a conference at New York University, a stone’s throw from Wall Street. And the opening remarks were delivered by NYU’s Goddard Professor of Media, Culture and Communication, who happens to be a very famous expatriate Indian, Arjun Appadurai. Professor Appadurai began as follows, “Why does there appear to be no one to blame for the ongoing destruction of the economy, society and environment? The government, banks, experts, and regulators have all claimed innocence, while taxpayers have had to speculate on their futures. It is time to point the finger: it is the discipline of economics that has brought about this state of affairs. From business to the media to academia, economists now run the world.” I have heard this sentiment in different forms from several colleagues across the other social sciences and the humanities, along with complaints that economists should now show more humility, since we got things so wrong.

Are economists to blame for where we are now? My first thoughts on reading Appadurai’s remarks were that he was tarring the whole profession with the misguided optimism of a part of it—Alan Greenspan musing on the taming of the business cycle, for example—and that he was confusing economists with business people and politicians, who indeed did much to bring about the current mess. Towards the end of his brief talk, however, Appadurai states, “We can move toward a new form of social inquiry that looks at the relationship between quantity, quality and personhood. This is a different theory of social action that moves away from rational choice.” So clearly he has a problem with the core methodology of economics.

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