Happy New Year

— RSJ

Happy 2024, dear readers! 

We hope 2023 was good for all of you. If it wasn’t, we are glad that it’s behind you. We didn’t have too bad a 2023 ourselves. This newsletter went along swimmingly (or so we think) and we had our book ‘Missing in Action: Why You Should Care About Public Policy’ published on 23 January 2023.

Why haven’t you bought it yet?

Anyway, it seems to be doing well based on the modest expectations we had of it. I’m yet to see the pirated versions of it peddled at traffic signals. Heh, that will be the day. But then I see it on shelves of all decent bookstores and that’s quite reassuring. That apart, Pranay had another book (one productive chap, I tell you), When The Chips Are Down on semiconductor geopolitics which is an area that’s going to get more interesting and contentious in this decade. All in all, we ended up writing 44 editions during the year totaling up to over a hundred thousand words. A good year, I guess.

On to 2024 then. Like in the past, we will indulge ourselves a bit in the first edition of the year. First, looking back at our predictions for 2023 and seeing how badly off we were and then next week, I will be doing a bit of crystal ball gazing for 2024.

Before I bore you with that, let me share with you this wonderful excerpt from a paper I read recently. Titled ‘Enlightenment Ideals and Belief in Progress in the Run-up to the Industrial Revolution: A Textual Analysis’, it covers an area of eternal fascination for me - Enlightenment and its impact on Western Europe. 

Interesting conclusions and a must-read:

“The role of cultural attitudes—specifically, of Enlightenment ideals that had a progress oriented view of scientific and industrial pursuits—in Britain’s economic takeoff and industrialization has been emphasized by leading economic historians. Foremost amongst them is Joel Mokyr (2016), who states that the progress-oriented view of science promoted by great Enlightenment thinkers, such as Francis Bacon and Isaac Newton, among many others, was central to what would become the “Industrial Enlightenment,” and ultimately Britain’s Industrial Revolution. In this paper, we test these claims using quantitative data from 173,031 works printed in England in English between 1500 and 1900. 

A textual analysis resulted in three salient findings. First, there is little overlap in scientific and religious works in the period under study. This indicates that the “secularization” of science was entrenched from the beginning of the Enlightenment. Second, while scientific works did become more progress-oriented during the Enlightenment, this sentiment was mainly concentrated in the nexus of science and political economy. We interpret this to mean that it was the more pragmatic works of science—those that spoke to a broader political and economic audience, especially those literate artisans and craftsmen at the heart of Britain’s industrialization—that contained the cultural values cited as important for Britain’s economic rise. Third, while volumes at the science-political economy nexus were progress-oriented for the entire time period, this was especially true of volumes related to industrialization. Thus, we have unearthed some inaugural quantitative support for the idea that a cultural evolution in the attitudes towards the potential of science accounts in some part for the British Industrial Revolution and its economic takeoff.”

2023 Predictions Scorecard

I had 8 predictions across the global economy, Indian economy and Indian social and political order. So, this is how does the 2023 report card looks like.

Global Economy

This is what I had written:

#1 The trend of securing your supply chain for critical products will get stronger.

….but it is clear to most large economies that on issues that concern national security, it will be foolhardy to not plan for worst-case scenarios any longer. And national security could mean anything, really, but I can see on energy and key technology, nations will opt for more secure supply chains with watertight bilateral partnerships than be at the mercy of distributed, multilateral chains. I won’t go as far as calling it ‘de-globalisation’ yet, but this ‘gated globalisation’ is a trend that’s here to stay.

This is playing out but a bit slower than what I expected. Disentangling and building domestic capabilities isn’t easy. And it is costly. But through the year we had increasing curbs on what hi-tech (GPU chips, AI research) and defence companies domiciled in the West could export to China. At home, we continued the push on PLI on electronics and tech equipment with debates on how much value-added manufacturing is really coming through in these schemes. Also, interestingly, we are continuing down the path of decoupling from global ‘default platforms’ especially in financial services. The Rupay platform is continuing to get bigger with a specific push from the government to derisk payment infrastructure from global networks like Visa and Mastercard. Also, in a recent statement, the central bank has suggested building a homegrown Cloud Computing infrastructure that will be used on regulated entities in India so that they aren’t tied into global Cloud service providers. 

#2 The fears of elevated inflation and a recession in the US in 2023 are overblown. The recession is due, but it will come a bit later

My view is that as supply chain issues ease up with China opening up, energy demand going up and the US continuing to be at almost full employment, we might have a 2023 where for the most part, the US inflation will be higher than target, Fed will continue to remain hawkish, and the growth will hold up. This will mean the real risk of recession will be more toward the end of the year than now.

Turns out I was accurate. In fact, the US economy has held up even better than I expected. And the Fed almost softened their tone by their last meeting of the year.

#3 Big Tech will continue to be under the cosh

I half expect India to gradually move all payment and eCommerce arms of Big Tech into a structure that’s domestically controlled and owned in 2023. Third, FTC, with Hina Khan at the helm, will accelerate antitrust and competition law changes to reduce the dominance of Big Tech.

I think I got this right in a big way. Through the year, fintechs have offloaded ‘troublesome’ shareholders (read Chinese investors) and there is a real trend of what’s called ‘reverse flipping’ where unicorns that were domiciled outside of India for tax and regulatory reasons are coming back home. Reason? Well, if you ask them they will tell you because they believe in the India story. That’s very convenient. The real reason is domestic regulators are making it difficult for a non-domiciled company to get a full bite of the Indian apple. From data security and storage requirements to tax and fund transfer regulations, the entities that are essentially Indian but are registered outside India to avoid ‘regulatory inconvenience’ are now facing business inconvenience in following that model. Here’s more on this. 

Indian Economy

I think I wrote more about the Indian economy in 2023 than any previous year. Much of it was about my surprise, in a positive way, on how much better it was doing than my expectations. Now as I read what I had written at the start of 2023, I think I had somewhat forgotten during the year that I was quite optimistic about the economy at the start of the year. Here’s what I had written:

#1 Greater optimism

I am a bit more optimistic about the broader numbers than most, and I will explain why. I think GDP growth will come in around 6.5 per cent for FY24, and inflation will be around 5 per cent. We might see a couple of rate hikes in the next few months, taking the repo rate to 6.75 per cent, but that will be it. I see domestic consumption to remain strong and exports, in the light of the shift away from China, to be good for manufacturers, and how much ever I might struggle to get behind the PLI scheme, it will yield some short-term benefits. IT exports might be a dampener, but on balance, I see more upside to these predictions.

Couldn’t have gotten it more right. I think the growth for FY 24 might come in at 7 per cent. Repo ended up at 6.5 per cent and domestic consumption and manufacturing have stayed strong while IT exports have gone worse over the year. 

#2 Digitalisation: Wave 2

There will be a significant push on digitalisation in lending and eCommerce. The UPI infrastructure has revolutionised payments and, along with GST, has accelerated the formalisation of the economy..... Also, as I mentioned in an earlier point, doing this will also mean shifting the balance of power from Big Tech-owned entities to an open platform or domestically controlled entities. I sense a strong push in this direction in 2023.

This was a no-brainer, really. I expected a bit more traction on platforms like OCEN and ONDC which haven’t taken off yet. The digitisation of the financial services sector has made low-value credit much easier for people to access. And UPI and digital KYC have enabled that to an extent that unsecured individual lending saw its biggest year ever in 2023. In fact, by the end of the year, we saw the central bank intervening to increase risk weights on these advances for banks and NBFCs and trying to bring down growth rates. The risk of an asset bubble because of faster and easier access to credit seems to become real based on the data they were reading. 

#3 The expected capex cycle push from the government will not come.

There are a couple of reasons for it. First, this government has always been careful about fiscal deficit, and it is particular about the risk of the fiscal space. The government has committed to a 4.5 per cent target for the union government deficit in the next 3 years from the current levels, that’s expected to be 6.4 per cent. I see a tightening in the fiscal stance during the year with a gradual reduction in some of the pandemic-related subsidies and better targeting of the benefits improving distribution efficiency. The other reason for a muted capex spend is the likely belief that the private sector credit capex cycle seems to be picking up. 

Got it mostly right except for the private sector capex cycle bit. That didn’t show up in 2023 as I was expecting. Government capex actually slowed as it kept its glide path to a 4 per cent union deficit by 2026. The efficiency improvement in tax collections and subsidy disbursement also helped in broadly sticking to the fiscal plan for the year. And as I expected, this government doesn’t need to loosen its purse strings in an election year. It has multiple other tools in its armoury to swing people’s opinion in favour of it.  

India: Political and Social

I had generally anticipated a more-of-the-same year despite some of the noise surrounding opposition efforts at the start of 2023. BJP with PM Modi at the helm, is possibly the most formidable political force in the world and it can turn its missteps too into its advantage. We saw this during the pandemic when its response was poor and too late. But that’s all water under the bridge now. It is also helped by a coincidence of circumstances where China has gone off-track and India is able to play its ‘swing power’ role to its fullest advantage in global geopolitics. All of this has meant it has a compelling domestic narrative to offer to the people of India rising in global prominence. This has tremendous capital at least among the middle class and the Hindi heartland. Back to what I wrote at the start of the year:

#1 More of the same

The expected consolidation of opposition forces to counter the BJP isn’t going to happen early enough for it to mount a credible challenge in 2024. There are eight state elections in 2023, and I suspect BJP will see reverses or very close fights in a couple of them where it is the incumbent (MP and Karnataka)....But it is hard to see opposition consolidation or a credible case that they can make to counter the electoral juggernaut of the BJP at this time. Congress, the other national party, isn’t capable of moving the masses either with its agenda or its leadership. The vacuum in national politics looks set to stay.

Ho hum. BJP lost Karnataka like I thought they would. MP was a surprise and it only shows how poorly Congress has performed through the year. Everything else is, as they say, same same.

#2 More Exit, Less Voice

I have made the point in the past about social fault lines tripping us up while we magically have a growth window that’s opened up for us again. This holds true. The space for opposition or dissent has shrunk; more importantly, even the fight for protecting or broadening that space has gone out....The state would be dependent on citizens if they value their loyalty and would then pursue a policy that listens to their voice. However, if the state doesn’t value it and the citizens know their voice won’t matter, the only option is to exit. For certain sections of our citizenry, they are possibly at this stage of engagement with the state. This scenario might not hurt the majority today, but we would do well to remember it has never been a good idea for the state to not value the loyalty of its citizenry in the long run. 

Nothing has changed on this. I guess this macro trend has only exacerbated in 2023.

So there I am with my report card. Not too bad, I guess though Pranay may again complain that these were quite generic and unless we make very specific predictions, it all seems to come true at the end of the year. Well, I will try to do that next week with my 2024 predictions. But don’t hold your breath on that, Pranay.  

A Framework A Week: Four Components of an Economic Strategy

Tools for thinking about public policy

— Pranay Kotasthane

Montek Singh Ahluwalia writes that any economic strategy has four components: slogans, targets, programmes, and policies.

Slogans refer to rhetoric employed by the government. Ahluwalia calls it the “front end” of economic strategy. Rhetoric is necessary in a representative democracy for communicating the government's position on an issue in a simple, catchy form without going into the details of the accompanying policy measures. Think Garibi Hataao, Shining India, Inclusive Growth, Sabka Saath Sabkaa Vikaas, and Minimum Government and Maximum Governance.

Targets are specific, measurable goals of an economic strategy. An example is the articulation that India will become a developed country by 2047. The World Bank comes up with a GDP per capita threshold for classifying an economy as a high-income one. So the target becomes a guiding light for policies and programmes and also serves as a tool for holding the government accountable.

Programmes refer to government-led measures involving public expenditure. Policies are government directives that allow or disallow specific economic activities. The difference can be understood using another popular three-fold classification which says that all governments do only three things — produce, finance, and regulate. This means programmes are government actions that involve producing or financing, while policies are about regulating. For example, bank recapitalisation is a programme where the government is financing public sector banks. In contrast, the Foreign Trade Policy 2023 lays down the rules that govern all exports and imports.

This four-fold classification is useful for policy analysts for two reasons. One, it doesn’t look at slogans cynically. Economic narratives are important. Slogans are often launchpads for powerful narratives.

Secondly, differentiating policies from programmes is crucial. The default government tendency is often to bat for government-run programmes. Think Production-linked Incentives (PLI) and export subsidies. There are enough and more programmes from the past to tinker with and regurgitate them into a new programme to “solve” the economic problems of the day. However, chronic economic problems might need a fundamental change in policies that cannot be fixed by programmes alone. India’s manufacturing underperformance is one such example. Though there have been many a programme for overcoming this challenge, the solution lies in changing trade, tax, labour, and doing business policies. Another example comes from the 1991 economic reforms. At the time, many politicians thought that India only needed a debt restructuring programme. However, the reformers successfully argued that India needed a change in tax, business, and investment policies; a new programme alone wasn’t good enough.

For an illustration of this framework, check this article by Montek Singh Ahluwalia on the problem with India’s public sector banks.

PolicyWTF: Screws are Strategic

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

The Department to Ground Foreign Trade, or less accurately, the Directorate General of Foreign Trade (DGFT), is a gift that keeps giving. Their latest policy move is to restrict the import of cheap screws so that India can become a self-reliant vishwaguru of screws. A screwpower, maybe?

In a notification issued on 3rd Jan, the DGFT banned the imports of screws priced lower than ₹129/kg. Indian manufacturers used to import these from France, China, Australia, Bangladesh, Brazil, and Belgium.

So, the government wants to do an import substitution of a humble product that costs ₹129 per kg and already has a diversified supply chain. If this isn’t ridiculous enough, think about the impact on Indian manufacturers who relied on these imports. They are the ones getting screwed here because they will end up paying more for the same product.

Long-time readers might experience déjà vu as there was a similar policy restricting the imports of mosquito electronic racquets in 2020, to which RSJ had paid proper obeisance in edition #129.

In other news, one of the issues blocking the India-UK FTA is that Indian EV car manufacturers don’t want the high import duties to be dropped. Currently, electric cars priced above $40000 are slapped with a 100 per cent import duty, while those below $40000 are levied a 70 per cent duty. Domestic manufacturers argue that a reduction in import duty will stall the sunrise industry.

These two stories in recent months illustrate the slippery slope of industrial policy in low state capacity conditions. A domestic subsidy for manufacturers can still be justified because every other country is doing that. It’s become an entry pass of sorts to play the manufacturing game. But to couple domestic production subsidies with import restrictions makes these policies scarily close to the import substitution regime in the pre-1991 era.

Every government makes mistakes. However, low state capacity results in governments repeating the mistakes of the past as there is no institutional memory. We seem to be reaching that point with India’s industrial policies.

This observation also stands empirically. Check out the New Industrial Policy Observatory (NIPO) released by the IMF (hat-tip to Niranjan Rajadhyaksha for sharing the accompanying paper on X). The database classifies industrial policy actions over the last few years into eight categories: export barriers, import barriers, domestic subsidies, export incentives, FDI measures, Public procurement measures, Localisation content measures, and miscellaneous. This is by far the most detailed database of industrial policy measures I’ve seen—a fantastic tool for scholars working in economic policy.

Now here’s my initial analysis looking at the data for India in NIPO. Of the 195 industrial policy measures that India has taken, 55 are distortionary trade measures, illustrating that we are repeating import substitution ideas of the past. There’s more to this. In the database, one can also classify industrial policies sectorwise. Here again, we see that import tariffs feature across most sectors.

Such mindless import substitution will lead to export contraction, as Indian companies become uncompetitive and bow out of international competition. We have seen this movie before.

P.S.: Look at this chart of trade as a per cent of GDP for the world’s five largest economies. Trade is a higher proportion of India’s GDP than is the case for Japan and China. It’s been that way for the last ten years. Trade is far more important to India than we realise.

HomeWork

Reading and listening recommendations on public policy matters

* [Book] Vivekananda: The Philosopher of Freedom is a thoroughly enjoyable, myth-busting biography.

* [Blogpost] This post has a mind map of market failures and corresponding government interventions. A boon for anyone interested in public policy.

* [Podcast] Listen in to a Puliyabaazi with economist Rohit Lamba on India’s future economic trajectories. This is a fun episode.

* [Paper] A useful take on Foreign Trade Policy 2023 in Economic and Political Weekly.

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