Prediction Time

—RSJ

In a year when countries as diverse as India, the United States, the United Kingdom, Russia, Taiwan, Pakistan and Palau go for their elections, it is tempting to go for an overarching theme for the year while looking ahead. Unfortunately, like these aforementioned elections and the many others that will see about 50 per cent of the human population exercise their democratic choice, there seems to be only a messy mix of political signals emerging from them. Illiberal forces are rising in some places, and autocrats are rubber-stamping their authority in others. Democracy is blooming afresh in a few, while the trends of deglobalisation and closed borders are resonating among others. Of course, there are the wars old and new and, maybe, a few more round the corner to complicate any attempt at a broad narrative for the world. To add to the woes of anyone trying to write a piece like this, the economic macros globally look volatile and inchoate. There is increasing talk of a soft landing of the US economy while the EU and the UK stare at another lost year. Depending on who you speak to, China has either put its economic issues behind it and is ready to charge back with its investment in future technologies like AI, EVs and hi-tech manufacturing, or it is at the “Japan moment” of the late 80s. Japan, on the other hand, is itself having a brief moment of revival, and no one knows if it will have legs or if it is yet another false dawn.

It is foolhardy to purvey macro forecasts in this environment. But then this newsletter won’t write itself. No? So, I guess the best course then is to make more specific predictions instead of taking big swings and hoping those come true while the macros swing wildly. This will also satisfy Pranay’s pet peeve about generic predictions that I mentioned in the last newsletter. So, let me get going with 10 somewhat specific predictions for next year.

* President Biden will decide sometime in early February that he cannot lead the Democratic Party to power in the 2024 elections. He will opt out of the race and give possibly the most well-backed Democrat, financially and otherwise, a really short window of four months to clinch the nomination. In a way, this will be the best option for his party. If he continued to run for the 2024 elections, it would have been apparent to many in the electorate that they are risking a President who won’t last the full term. If he had opted out earlier, the long-drawn primary process would have led to intense infighting among the many factions of the party, eventually leading to fratricide or a Trump-like populist to emerge perhaps. A narrow window will allow the Party to back an establishment figure and reduce the fraternal bloodletting. Who will emerge from this is anyone’s guess. But whoever it might be, if (and it is a big if) they have to come up against Trump, they will lose. To me, the only way Trump doesn’t become the next President is if he isn’t on the ballot. And the only way that looks possible is if he loses his legal battles. Otherwise, you will see a second Trump term which will be worse than the first one. 

* There’s way too much confidence about the Fed having piloted a ‘safe landing’ for the US economy despite the many odds that were stacked against it. I think this is fundamentally misplaced. The fiscal deficit is unsustainable, and much of the soft landing is thanks to it. The GDP growth has been supported by an almost doubling of the federal fiscal deficit. This won’t last. The higher rates that haven’t yet led to any real string of bankruptcies or asset bubble collapses will begin to make an impact. The geopolitical risks that have only been aggravated in the last 12 months and the increasing protectionism worldwide will make it difficult to sustain growth at 2023 levels. My view is that the real landing will be in 2024, and it won’t be soft.

* China will get more adventurous geopolitically as it weakens economically. Look, the property market crisis is real in China and given the influence it wields on its economy, it is difficult to see any return to the ‘normal’ 8 per cent growth anytime soon. The local government finances will worsen, and there is a real possibility of a few of them defaulting. There will be more fiscal support to prop up the numbers and more packages for sectors in stress. Foreign inflow will continue to be anaemic, though it won’t be negative, as it turned out late last year. The Chinese customers' long-awaited consumption spree isn’t coming in 2024. All in all, China will stutter while still wowing the world with its progress in tech.

* BJP will come back to power, but it will fall a bit short of 300 seats. This will surprise many, considering the continued electoral success of its machinery and all the Ram Mandir ballast it plans for itself from this month onwards. There are a couple of reasons for it, largely driven by electoral arithmetic across the states where it did very well in 2019 and where a repeat showing will be difficult. Also, the sense of complacency about winning it hands down will mean a letup in the door-to-door mobilisation model that it has perfected. All of this will mean a decline in 30-40 seats across the board. The new Modi cabinet will be a surprise with new Finance and Defence ministers and a whole host of new faces as it goes for a generational change in leadership.

* The somewhat surprising trend of record US deficit going hand-in-hand with the relatively strong showing of the dollar in the past two years will eventually come to a face-off. And my guess is 2024 is when the dollar will blink. As other emerging economies start to trade in currencies other than dollars - who wants to risk more exposure to the dollar? - and its economy doesn’t have a soft landing like I predict, US dollar will be hit. My guess is that 2024 will be the first year of a 3-4-year dollar down cycle. In the next year, I predict the dollar to fall by 10 per cent against most world currencies. This might not hold with India because we are a bit of a unique case. But a dollar slide looks inevitable to me.

* I had predicted a more aggressive anti-trust stance and significant moves against Big Tech by the FTC. It didn’t pan out. So, I will repeat the prediction. Lina Khan, the FTC Commissioner, has a nine-month window to go after them, after which it isn’t certain she will continue to be in her post. I predict a big scalp during this time, which will then be legally challenged. But expect a tough couple of quarters as she and her team do their best to leave a mark for the future.

* The Indian economy will continue its trend of surprising on the upside, though I think global headwinds will temper the overall growth. I expect a 6.5 per cent growth with the inflation at the 4.5 per cent mark through the year. The much-awaited capex cycle will not be broad-based and will show up in select sectors led by large Indian conglomerates or global platform players. I expect FII inflow to be among the lowest in many years in 2024, and much of the equity market will be buoyed by domestic fund inflow into the market. The Nifty will remain flat or be up 5 per cent because of global weakness and the relative overvaluation seen already.

* The Israel-Hamas war will end faster than people think. Maybe by April. Not because there will be some solution agreed between the parties. There’s nobody to fight any more in Giza. The Hezbollah won’t get involved, and the Houthi insurgency will be a mere storm in the teacup. On the other hand, the Ukraine war will continue with no real end in sight during the year. A Trump (or Republican government) in 2025 will likely stop funding the war, and that will pressure Ukraine to negotiate with Putin. But that’s for 2025.

* Two specific corporate predictions: One, AI will continue to impress us with its capabilities without making a dent on real business. So expect to be surprised by a best seller written by an unknown author that will later revealed to be an AI-trained algorithm. Or a music album, even. There will be many conferences and papers, but AI's wider impact will still be distant in 2025. Two, I think Novo Nordisk will be well on its way to becoming the most valued company in the world in 2024. It might become the most valued in Europe during the year itself as it will struggle to produce enough of its weight loss drugs to keep up with demand.

* I forecast one of two contentious pieces of legislation will come into play after the elections are over. We will see a real move on either the Uniform Civil Code or on one-nation one-election (ONOE) at the back end of the year. These are issues close to this government; they will get these going right after the elections.

That’s that, then. We will see how they go during the year.

India Policy Watch: The Services vs Manufacturing Debate

Insights on current policy issues in India

— Pranay Kotasthane

Breaking the Mould: Reimagining India's Economic Future, a book by economists Raghuram Rajan and Rohit Lamba, has started a much-needed discussion on India’s future growth trajectory.

The authors challenge the dominant narrative that India should imitate the manufacturing-led growth strategy followed by the East Asian countries. They instead point to India’s comparative advantage in low-end and high-end services, making a case for a policy reprioritisation to double down on these strengths. The book argues that replicating China's manufacturing success is neither possible nor desirable.

Not possible because manufacturing supply chains are shortening due to increased protectionism and higher rates of automation, making the conditions far more difficult than what China faced. Moreover, China hasn’t gone away; it remains a formidable competitor in manufacturing.

Replicating that success might not even be desirable, they contend, as the value added in a product’s manufacturing stage is dwarfed by the value captured in the upstream R&D stage and the downstream services (branding, marketing, content production, etc.) stage. And hence, they are against the kind of subsidies on offer for electronics and chip manufacturing assembly. The Micron chip assembly plant is a particular thorn in their eye because it will cost Indians $2 billion and produce a mere 5000 direct jobs with no R&D spillover.

They argue that services and Services for manufacturing are the sweet spot for India to focus on. The money splurged on manufacturing and assembly should be ploughed back into education and health, priming India’s human capital for global success.

In sharp contrast, international trade economist Devashish Mitra makes the case that low-end export-led manufacturing (such as in textile, apparel, and leather) is the only way out for India. In his book review for the Economic Times, Mitra writes:

“India is a labour-abundant economy. This abundance is in low-skilled labour, given that almost 80% of its working-age population does not have even a higher secondary education, with only an eighth of the working-age population having studied beyond high school. While India adds 8-10 million people to its labour force annually, roughly 2 million are college-educated or beyond. There is also a wide variation in the quality of degree programmes across India, most of which cannot impart marketable skills. Thus, high-skilled workers are scarce.Standard international trade theory tells us that an economy abundant in low-skilled labour, when open to international trade, will specialise in low-skilled labour-intensive production activities, which are the ones in which such a country has its inherent comparative advantage. Furthermore, India's technology-driven comparative advantage is also expected to be in low-end manufacturing activities, as those would be the ones in which India's productivity disadvantage relative to advanced economies would be the least, for example, textiles, apparel and footwear. Thus, high-skill specialisation for India, as envisioned by Rajan and Lamba, would have to defy standard international trade theory.”

Mitra also points out that the government should prioritise solving the unemployment problem, the only way around which is low-end manufacturing because IT and IT services have historically had comparatively low levels of employment growth.

Reading these two perspectives over the past few days has been rewarding. This is precisely the debate that needs the attention of our policymaking elite. At this stage, I have three initial observations.

One, the services vs manufacturing is a false binary. Both views are actually quite similar in their essence because they both advocate capitalising on India’s comparative advantages. That advantage lies in high-end services such as chip design and in low-end manufacturing such as textiles and footwear. There is no need to choose just one of them. Success in both areas needs the same ingredients—eliminate self-defeating policies, improve skilling, pass trade-friendly reforms, and invest in health and education.

Two, I feel the criticism of low-end chip and electronics assembly misses an important consideration. If chips are the building blocks of the Information Age, it makes sense for India to begin the journey at the lower end of the chip manufacturing supply chain and climb up that ladder over two decades or so.

Jobs generated per rupee of money spent is not the only criterion that should motivate economic decision-making. For example, India’s nuclear energy sector is not evaluated primarily on the number of jobs it creates. Similarly, the primary goal of building the intellectual and manufacturing capability for making chips is to reduce critical vulnerabilities in the future. India can pursue the twin goals of doubling down on comparative advantages and reducing vulnerabilities simultaneously. In any case, attracting a single 65-nanometre specialised fab (which would cost around ₹10,000 crores) doesn’t come at the expense of a better university education system. India can do both.

Third, the book brilliantly emphasises that the services sector needs a lot more policy focus. Trade economists propose that we are heading towards a future where manufacturing supply chains will become shorter (because of protectionism and China-related fears) while services supply chains will become longer (because of better technology). This implies that services as a percentage of global trade will only rise. When that happens, nation-states will start imposing trade barriers for services, too. So, the Indian government needs to champion trade frameworks that bring down services trade costs.

An analogous case is that of the Information Technology Agreement (ITA) of the WTO. Signed in the nineties, the ITA substantially brought down tariffs on information technology goods and their intermediate products. This move immensely benefited multinational companies and consumers worldwide, including in India. Similarly, it’s time for India to champion a Global Services Trade Agreement that lowers barriers that Indian service providers face in participating in global trade. It also becomes clear why data localisation policies that hamper services exports will have a disproportionately negative impact on India’s economic future.

Finally, do read both the book and Devashish Mitra’s paper linked in the HomeWork section. And yes, check out our Puliyabaazi with Rohit Lamba, which discusses some of these themes.

PolicyWTF: How Pro-Business Protectionism Hurts Indian Women

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

— Pranay Kotasthane

By now, it’s widely known that Bangladesh has eaten away at India’s share in textile and apparel exports. This industry is labour-intensive and employs a significant proportion of women in the formal labour force—46% of all Indian women in the manufacturing sector are employed by apparel and textile industries taken together. Hence, it’s important to diagnose the reason for India’s decline.

As with policy success, policy failure can also have multiple causes. Bangladeshi exports received preferential treatment in the West as part of the latter’s policy to help poorer countries. This is one important reason that helped Bangladesh. However, this reason alone doesn’t explain India's decline in fibre production.

It turns out that the reason is our favourite villain: pro-business protectionism. I learned about this causal linkage from an excellent 2022 paper, Reigniting the Manmade Clothing Sector in India, by Abhishek Anand and Naveen Joseph Thomas.

This is how I understood the story that Anand and Joseph narrate. India has been losing global market share in textiles and apparel since 2011 to Bangladesh and Vietnam. The global demand for artificial fabric-based cloth (such as polyester) is far higher than that for natural fabric-based cloth (such as cotton) for cost and durability reasons. Thus, India’s underperformance is largely due to a decline in its exports in the artificial fibre segment.

And why is that the case? The most important input for the polyester fabric is a chemical called Purified Terephthalic Acid (PTA). The villain enters the scene. In October 2013, the two major domestic producers of PTA (Reliance Industries Ltd. and Mitsubishi Chemical Corporation India Ltd.) petitioned the government to impose anti-dumping duties on imported PTA. The government agreed. The anti-dumping duties were supposed to remain in force for six months. But they were kept in force for over six years! To make matters worse, the government imposed additional import tariffs on PTA in 2018 as part of its atmanirbharta driveoverdrive.

This rise in PTA costs had a cascading effect on the downstream fibre-making and apparel industries, making their products costly even as Bangladesh continued enjoying preferential tariff treatment in the EU. Vietnam benefited from trade agreements with Australia, Canada, the EU, and also the RCEP. The productivity of India’s textile sector declined, and many potential jobs vanished in thin air, disproportionately impacting women.

There’s an even uglier face to this fiasco. While large sections of Indians lost out, the position of a select few protected businesses improved. Vertically integrated firms with a presence in the entire supply chain from PTA to polyester yarn, and finally, apparel, benefited immensely as their competitors had to pay higher rates for the imported PTA. Protected from the cost of imports due to their in-house PTA production capabilities, these companies cornered a bigger domestic market share. Notably, their lower productivity means that even these protected firms can’t compete in the global market.

This a canonical example of how pro-business policies hurt markets and people. Even though the government dropped the anti-dumping duties on PLA in 2020 and started a Production-linked Incentive (PLI) for textiles, it simultaneously increased import duties for the downstream polyester to now protect domestic yarn producers from foreign competition! Talk about learning from past mistakes. PolicyWTF indeed.

In any case, do read the entire paper. It’s written lucidly, without the jargon and the scary Greek alphabet.

HomeWork

Reading and listening recommendations on public policy matters

* [Article] Martin Wolf has an excellent column in the Financial Times on liberalism and its discontents. It cites the Inglehart-Welzel Cultural Map to argue that even if there is no ‘clash of civilisations’, there seems to be a ‘divergence of civilisations’ on freedom-related questions. As an aside, I observed that there is no data for India in the seventh round of the World Values Survey, which covers the period 2017-21. Does any reader know why? Is it a story similar to India pulling out of the PISA rankings?

* [Video] This is a good conversation on Devashish Mitra’s paper Manufacturing-fed, Export-led Growth for Gainful Employment and Skill Creation. The presentation has no scary equations, and the discussion is insightful.

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