Solarisation in agriculture in Tamil Nadu

by Susan Das, Renuka Sane, Ajay Shah.

Highly subsidised electricity for farmers is an important problem faced in the working of the electricity sector. With falling prices of solar panels, there is the possibility of government subsidising solar panels established by farmers.

This could potentially induce welfare gains in several directions.

1. The fiscal burden imposed by the subsidy could decline.
2. The pricing distortion in electricity (where commercial / industrial / domestic buyers are overcharged) could decline.
3. Farmers could earn a revenue selling their surplus electricity to the grid.
4. Farmers could become more thoughtful in their extraction of ground water when they face an opportunity cost, in the sense that the electricity that is not used to pump water is a revenue generator for them. This would yield welfare gains by diminishing the `tragedy of the commons' in ground water.

These possibilities turn on careful calculations. Whether some or all of these gains are obtained depends on insolation, the magnitude of water required, the energy cost of extracting the water, the cost of solar panels and the price paid by the grid. There will not be one answer within a state, and therefore there will not be one optimal policy within a state. (Similarly, the economic possibilities from such pathways will vary greatly across the breadth of the country).

In a recent paper, Solarisation in agriculture in Tamil Nadu: A first principles evaluation, we try to engage in this careful calculation for one district (Erode) in Tamil Nadu. We analyse a corner solution: one where the government pays for the full cost of the solar panel. 

The results turn on the price at which the surplus energy, that comes from the farmer to the discom, is sold. If the discom is able to sell this energy at the (high) prices that are charged to the commercial and industrial ("C&I") customers, then the corner solution is financially efficient for the grid. At lower prices, the proposition is less attractive.

 One important parameter that influences the results -- the price of solar panels -- is likely to decline in the future. Hence, we simulate the scenario with lower costs. We find this expands the class of situations where solarisation in agriculture is useful.

This paper is about one district (Erode) in Tamil Nadu. The methods adopted are general and could be applied to other locations in India. The answers are likely to vary considerably depending on the precise setting. There is value in discovering how this varies across India.

This is a field with many intricacies in implementation. These include the mechanism of selling surplus electricity, the choice of the tariff paid to the farmer, the problems of (the lack of) metering of electricity connections to farmers, the trustworthiness of the government on timely payments to farmers, the financing mechanism for the capital cost the puzzles of operations and maintenance at the level of one farmer, and the path to a sound monitoring and evaluation of such programs. These are much studied areas where considerable research has taken place. These discussions will improve through using the carefully constructed numerical estimates, on a per-district basis, all across the country.

Competence in policing

David Montgomery, Sari Horwitz and Marc Fisher have a great story in the Washington Post about how the police tracked down the murderers in Boston. Also see Spencer Ackerman in Wired magazine. On a similar theme, look back at the attack at Times Square in New York.

We in India fare dismally on this. Lacking competence in the police, we repeatedly engage in faulty tradeoffs in security, where police either infringe on the freedom of citizens or resort to brutality against innocent `suspects'. Every time the police quickly solve a case, I worry that they merely tortured some plausible sounding suspect.

Law and order is the most important and most basic public good. Dense urban congregations, which are the essence of modern creative capitalism, are only possible with very high levels of safety. The US is priority #1 for the bad guys, and has had two attacks in 12 years, both of which were followed by outstanding investigations. We in India suffer from thousands of attacks, most of which are never solved. This shows the low capabilities of our law enforcement crew.

We in India go wrong at three levels:

• Elections have degenerated into competitive subsidy programs; both politicians and voters have stopped focusing on performance of the government on public goods. Left-oriented intellectuals are complicit in this, with an emphasis on inequality and subsidies rather than on public goods. When voters are not focused on public goods, the accountability through elections does not generate feedback loops in favour of better public goods.
• In this environment, inadequate resources go into public goods, the most important of which is the criminal justice system.
• Within the criminal justice system, there is little accountability, and we are not seeing feedback loops through which the system is constantly reshaped (within existing budget constraints) towards better performance.

The recent wave of outrage on law and order should ideally help set a new course. See Law and order: Going from outrage to action. Mistreating women is not encoded in our culture or our DNA: it is endogenous to the incentives provided by the criminal justice system. The same Indians behave very differently towards women when placed in alternative criminal justice systems in other countries. If enough voters demand performance from politicians for better law and order, we will get a greater focus on it, in terms of:

• More top management time. E.g. how many hours per year does the PM work on law and order in Delhi versus how many hours does he spend on NREGA?
• More money. E.g. how much money do we put into law and order in Delhi versus how much money do we put into NREGA? 
• More and better people. E.g. how do we get the best and brightest civil servants out of relatively unproductive tasks (subsidies) and into the things that matter (public goods)? How do we increase the staff strength of government in public goods, while cutting the size of government on subsidies? How do we make careers in police, courts and jails more attractive, and careers in education, health and welfare programs less interesting?
• More analysis. How do we get more research papers on the criminal justice system, and fewer research papers on development economics?

Law and order: How to go from outrage to action

There is fresh rage on the bad state of law and order in India today. That rage is entirely appropriate.

My father was born in 1926 and experienced British rule. One of the high points of his life was participation in the freedom movement. He used to say to me with great regret that under British rule, the Shiv Sena would have never arisen. What has happened in India is a disgrace.

The interesting and important question is: How can the problems be solved?

Moral outrage does not lend itself to good policy analysis. As with the problem of corruption, the problem of law and order requires sophisticated thinking. Just as the young people who got enamoured by Baba Ramdev and Baba Hazare got nothing done in terms of combating corruption, we should worry about what comes next on law and order. Anger and outrage, coupled with low knowledge of political science and public economics, is a sure path to poor policy analysis. What matters is shifting from anger to analysis to action.

As an example, if laws are modified to prescribe draconian penalties for rape, then rapists are more likely to kill the victim. What is required is better quality implementation of the existing law.

What would it take to make the police and courts work better? The three ingredients that are required are incentives for politicians, resources and feedback loops.

Incentives for politicans

The first issue is incentives for politicians. Politicians will deliver law and order if they think that this is what will get them re-elected. From Indira Gandhi's time onwards, politicians in India have felt that the way to win elections was to focus on welfare programs for the poor. As long as this is the case, the narrative that will dominate the Indian State is that of poverty, inequality, and welfare programs.

Economists distinguish between public goods and private goods. Public goods are defined to be those that are `non-rival' (your consumption of safety does not reduce my consumption of safety) and `non-excludable' (it is impossible to exclude a new born child from the environment of safety). The legitimate purpose of the State is to pursue public goods. All citizens gain from public goods, and all voters should respond to these benefits. The first and most important public good is safety, which requires building the army, the police and the courts.

The Indian State has, instead, gone off on the adventure of building welfare programs: of government giving private goods to marginal voters. The first priority of the Indian State is the themes of poverty, inequality and welfare programs. Politicians need to learn that this hurts. Sheila Dixit should realise that her top priority in Delhi is law and order.

There are undoubtedly problems in the leadership and management structure of the police. I believe that once politicians want law and order, this will drive them to recruit the leadership that is required, and undertake structural reforms, so as to get results. As an example, look at how the politicians broke with PWD and setup NHAI, or setup Delhi Metro. The question that matters is : Do politicians want law and order? From the 1960s onwards, the minds of politicians have been addled by welfare programs.

If Rs.X is spent as a gift on a few marginal voters, it makes a certain difference to winning elections. If that same money is spent on public goods -- e.g. better safety for all -- it should make a bigger difference to winning elections since more voters gain. The question is: Do politicans see this and act in response?

Resources

The second issue is resources. India needs much more staffing in the police and the courts. This includes both technical staff (e.g. constables and judges) and support staff (e.g. clerical staff, operators of computer systems, etc).

Courts and police stations need to be high quality workplaces with air conditioning, computer systems, modern office equipment, canteens, web interfaces to the citizenry, lighting, toilets, and such like.

Policemen need to live in high quality housing. If policemen live in high quality housing and work in high quality offices, they will be more civilised both in terms of the quality of intake and in terms of how their behaviour evolves on the job. This will cost a lot of money. The State in India has very little money. To improve the police and courts will require cutting back on welfare programs.

As Robert Kaplan says, underdevelopment is where the police are more dangerous than the criminals. One element of this is the biases in recruitment. As an example, the police in Bombay tends to be male Maharashtraian and relatively low skill. This needs to evolve into a more sophisticated workforce, with gender, ethnic and religious diversity that reflects the cosmopolitan structure of the populace.

At present, in India, spending on police and courts (which are core public goods) is classified as `non-plan expenditure' and is treated as a bad thing. Spending on private goods like welfare programs is classified as `plan expenditure' and grows lavishly year after year. In the UPA period, plan expenditure has gone up by four times in 10 years. These priorities need to be reversed.

The other critical resource, other than money, is top management time. The simple question that I would ask Sheila Dixit or Manmohan Singh is: What fraction of your time do you devote to public goods? My fear is that the bulk of their time is spent worrying about welfare programs. When the top management is not focused on law and order, safety will degrade.

The lack of safety is a regressive tax: it hits the poor more than the rich. The rich are able to insulate themselves at a lower cost. When a policeman faces me on the street, he immediately speaks to me in a certain way once he sees that I come from the elite. Poor people are mistreated by both criminals and the police. Through this, the number of votes that should be affected by improved law and order is large. The people who care deeply about the poor, and would like to focus the Indian State upon problems of inequality and poverty, should ponder the consequences of what they have wrought.

Feedback loops

In order to think about law and order, we need measurement. I used to think that the murder rate is high quality data. Over recent years, I have come to believe that in many parts of India, not all murder is reported to the police. In this case, we are at ground zero about the state of crime: we know nothing about how much crime is taking place out there.

What you measure is what you can manage. I had recently written a blog post about health, and the same issues apply here. Our first priority should be to setup crime victimisation surveys [link].

The most important outcome that I think matters is a question asked in a household survey of parents: Are you comfortable when your teenage daughter is out alone at 11 PM? That's it. That's the end goal. Civilisation is where parents are comfortable when their teenage daughters are out alone at 11 PM.

Once the CPI is measured, and measured well, RBI can be held accountable for delivering low and stable inflation. In similar fashion, the Bombay police can be held accountable once we get a graph updated every month about the crime rate in Bombay, supplemented by quarterly data from crime victimisation surveys. This would generate feedback loops whereby we can judge whether Sheila Dixit has improved law and order in Delhi on her watch.

When Sheila Dixit gets anxious about the lack of progress on publicly visible statistics about the state of law and order in Delhi, she will have the incentives to recruit high quality leadership for the Delhi police, and to resource them adequately, to get things done.

Why are these good things not getting done?

This is the hardest question. I have three opinions about what has been going wrong.

The first lies in the incentives of politicans. Why do politicians pursue private goods for a few when they can instead spend money on doing public goods that benefit all? Why does democracy not push Indian politicans towards the centre? I think one element of the answer lies in first-past-the-post elections.

Today in India, winning elections does not require pleasing all voters; it only requires a base of 30% of the voters. This gives politicans a greater incentive to dole out goodies for the 30% and not work on public goods that please all voters. This reduces the prioritisation for public goods.

The second issue is that of urban governance. The defining challenge for India today is to make the cities work. But our constitutional structure is confused on the location of cities versus states. The feedback loop from the voters in Bombay do not drive improvements in governance in Bombay.
Delhi is unique in this respect in that it's the first city of India where the basic structure is correct. Sheila Dixit is the Mayor of Delhi. She is held accountable for making voters in Delhi happy. Voters in Delhi bother to vote in the Delhi elections. Hence, I am far more optimistic about the future of Delhi than I am with Bombay.

The third issue lies in the intelligensia. Western NGOs, aid agencies and the World Bank are focused on inequality, poverty and welfare programs. This generates incentives for individuals to focus on inequality, poverty and welfare programs, owing to the funding stream and career paths associated with western NGOs, aid agencies and the World Bank. These large funding sources and career paths have generated a distorted perspective in the Indian intelligensia. We need more minds in India who think in terms of first principles economics and political science, without the distortions that come from the worldview of development economics.

We blame politicians in India for being focused on welfare programs. But to some extent, they are influenced by the intelligensia. It is the job of the intelligensia to hold their feet in the fire, and hold politicians accountable for public goods. The politicians were too happy when, from the 1960s, the intellecturals proposed welfare programs, poverty action, socialism, etc.

Acknowledgments

I am grateful to Pradnya and Nandu Saravade who helped me think about all this.

The IRR of UIDAI is over 50 per cent in real terms

We have released a cost-benefit analysis of the UID system. In one line, the result of the calculations, under fairly conservative assumptions, is that the IRR of building the system is 53% in real terms. Hence, building UIDAI is a pretty good use of public money.

Through this page, you can access a short and accessible explanation, a video presentation, and the full PDF paper. We have also released the spreadsheet used in our calculations, so that others can modify the assumptions or other numerical values, and obtain alternative answers.

This is true in the Indian case. Is it true in general? I feel the answer depends on (a) The scale of expenditure on subsidy programs and (b) The extent to which present implementation systems suffer from the kinds of leakages that UID readily addresses (multiple payments to one person, payments to ghosts). If a country has small welfare programs, that would undermine the case for UIDAI. If a country is doing a pretty good job of paying out subsidies through conventional procedures, that would undermine the case for UIDAI.

Transparency in the LPG subsidy

by Viral Shah.

Recently, the Petroleum Minister launched the LPG transparency portals for all three Oil Marketing Companies (OMCs):

The Oil Marketing Companies have been constantly leveraging technology to launch various initiatives for offering convenience to their consumers For example, some of them are offering the facility for booking refill cylinders 24x7online through their websites as well as through SMS and IVRS. In continuation of their endeavor to leverage technology to achieve more efficiency and improve business processes, Oil Companies have now put in place systems to capture the complete details of customers and track their LPG consumption pattern with an aim to increase transparency in LPG supply chain. With this information, each OMC has created a transparency portal which is hosted on their individual websites. These portals can also be accessed from MOPNG's website. These portals provide complete details of each customer with their consumer numbers, name, address, no. of cylinders supplied, dates of supply as well as the indicative subsidy amount for the cylinders supplied. The portals feature quick search options to find one's distributor,sort information based on consumer numberand consumer name, see thehighest off take consumer orput in a request to surrender one's connection. Logging a complaint is just as easy. Consumers can now even rate the performance of theirdistributors; and this is expected to help the services to improve further. These portals would truly empower the consumers and civil society to verify or seek information under one roof and bring about transparency in a government program where thousands of crores of subsidy is involved.

Links for the transparency portals are:

• Indane
• Bharat Gas
• HP Gas

LPG distribution

The production, supply, and distribution of Liquified Petroleum Gas (LPG) is governed by the Essential Commodities Act, 1955 and the LPG Control Order, 2000. The LPG Control Order specifies various aspects of LPG distribution in great detail: storage, transport, bottling, packaging, consumer connection, etc. Subsidized LPG is provided largely for domestic use, but institutional use is permitted for Government schools, hospitals, canteens, police stations, etc. Subsidized LPG cylinders are red in colour and contain 14.2kg of LPG, whereas commercial LPG cylinders are purple and contain 19kg of LPG. LPG is supplied to consumers through distributors, who are paid a commission for every cylinder they deliver. Distributors have very thin margins for subsidized LPG, and are given distribution rights by area by the OMC. Margins for commercial LPG are higher, with no restrictiction on distribution. Thus, by design, there is no competition between distributors for subsidized LPG, but commercial LPG is supplied competitively. Almost 90% of the usage in India is domestic, and hence subsidized.

LPG subsidy

A detailed price computation for an LPG cylinder shows that as of June 1, 2012, the consumer pays Rs.399 per cylinder in Delhi, and receives a subsidy of Rs.418 per cylinder. The true subsidy is only Rs.22 per cylinder, and the rest is termed under recovery to OMCs. The Government funds the full subsidy amount of Rs.22, but the under-recovery is funded out of profits of ONGC, OMCs, and partially by the Government. It is also worthwhile to note that LPG is exempt from Excise Duty from Central Government, and often also exempt from VAT.

Sr.	Elements (Delhi)	Unit	Effective 1st June'12
1	Free On Board Price at Arab Gulf of LPG	$/MT	852.78
2	Add: Ocean Freight from AG to Indian Ports	$/MT	43.39
3	Cost & Freight Price	Rs. / Cylinder	689.03
4	Import Charges (Insurance/Ocean Loss/ LC Charge/Port Dues)	Rs. / Cylinder	5.82
5	Basic Customs Duty	Rs. / Cylinder	0.00
6	Import Parity Price (Sum of 3 to 5)	Rs. / Cylinder	694.84
7	Refinery Transfer Price (RTP) for Domestic LPG	Rs. / Cylinder	694.84
8	Add : Inland Freight, Delivery Charges etc.	Rs. / Cylinder	39.46
9	Add : Marketing Cost of OMCs	Rs. / Cylinder	12.38
10	Add : Marketing Margin of OMCs	Rs. / Cylinder	6.68
11	Add : Bottling Charges (Filling and Cylinder Cost)	Rs. / Cylinder	38.68
12	Total Desired Price (Sum of 7 to 11) Before Excise Duty, VAT and Distributor Commission	Rs. / Cylinder	792.04
13	Less : Subsidy by Central Government	Rs. / Cylinder	22.58
14	Less: Under-recovery to Oil Marketing Companies	Rs. / Cylinder	396.03
15	Price Charged to Distributor (12-13-14) Excluding Excise Duty & VAT	Rs. / Cylinder	373.43
16	Add : Excise Duty (Including Education Cess)	Rs. / Cylinder	0.00
17	Add : Distributor Commission	Rs. / Cylinder	25.83
18	Add : VAT	Rs. / Cylinder	0.00
19	Retail Selling Price (Sum of 15 to 18)	Rs. / Cylinder	399.26
20	Retail Selling Price at Delhi (Rounded Off)	Rs. / Cylinder	399.00
21	Under Recovery due to Rounding Down	Rs. / Cylinder	0.26

The Report of the Task Force on Direct Transfer of Subsidies on Kerosene, LPG and Fertiliser provides some other interesting figures. There are 12.5 crore LPG connections, consuming 6 cylinders on average. The per-capita consumption of LPG is expected to be roughly 1.5 cylinders annually, leading to a family of four requiring 6 cylinders every year. The total subsidy to consumers in FY09-10 was Rs.16,071 crore, when the per cylinder subsidy was Rs.185. With the current international oil prices being much higher, the total subsidy to the consumers could add up to Rs.50,000 crore this year. The total subsidy to the consumer was Rs.76 per cylinder in FY02-03, and has steadily risen ever since to its current value of Rs.418 per cylinder.

Benefits from transparency

The Report of the Task Force on Direct Transfer of Subsidies on Kerosene, LPG and Fertiliser provides a number of suggestions to address the leakage of subsidies:

• Setting up a transparency portal
• Per-capita or per-connection cap on number of subsidized cylinders per year
• Sale of LPG at market price, with subsidy refunded to the consumer's bank account

The Ministry of Petroleum and Natural Gas, along with the OMCs, have launched transparency portals. Even though there is no restriction on the number of subsidized LPG cylinders that a consumer can order, checks have been put in so that there has to be a gap of at least 21 days between two bookings. The media has been quick to report on the heavy consumption of LPG by politicians and industrialists. The Government expects that the transparency portal will also curb the usage of domestic LPG for commercial purposes. Many are even asking whether LPG should be subsidized at all. Over the next few months, we will learn whether LPG diversion is checked due to transparency portals. However, the launch of other features such as rating of dealers, online complaints, and online booking are certainly going to be beneficial for consumers.

The Right to Information Act, 2005 has provisions that require Government to provide data electronically to citizens. Transparency portals are incredibly powerful accountability tools, and should be the first step towards e-Governance for any Ministry or Department. They take existing databases and make them available online for scrutiny, often without requiring major business process re-engineering. Rather than simply make these portals available for browsing online, care should be put in to produce high quality, anonymized, machine-readable datasets that researchers can use for various purposes. Such datasets can provide interesting insight into the microeconomics of households and also macroeconomic trends, when studied over time.

Welfare programs change behaviour

Many people like to envision worlds where the State will tax the rich and help "the needy" - this ranges from free health care to unemployment insurance to disability insurance, etc.

There are many problems with these schemes. One of them is the fact that people respond to incentives. We are not bricks, we are not stones, but men, and being men, we will optimise. When unemployment insurance is offered, people will try less hard to find a job, to acquire skills that will get them a job, to migrate to a place where jobs are more easily found, etc. When health care is free, people are more inclined to be fat or smoke or otherwise take less care of themselves. And so on.

Among economists, it's considered obvious that people drive in a more rash manner when wearing a seat belt, but in the wider discourse, this raises hackles. When researchers found that drivers pass closer when overtaking cyclists wearing helmets as compared with overtaking bare-headed cyclists, economists were among the few who were not surprised. Laypersons generally recoil from the idea that the presence of a government giving out free open heart surgery increases obesity.

The first element of the behavioural change is lying and misrepresentation by citizens. When a government says it will give out disability insurance, people have an incentive to go to a civil servant and claim that they are disabled. I remember hearing a story from Holland, when a certain set of rules were constructed to give an early pension to the disabled, and policy makers had estimated that 1% of workers would be eligible for those benefits. In a few years, 10% of workers tried to claim these benefits, and front-line civil servants were placed in the difficult situation of having to identify the few genuinely disabled within the large pool that was claiming to be disabled.

The second layer is genuine changes in behaviour. Ljungqvist/Sargent have emphasised the damage caused by European-style welfare programs, which encourage or support withdrawal from the labour market. Some of these problems are now coming about with NREG. Migration out of villages is central to India's future, but NREG is reducing the incentives of people to engage with the urban labour market and ultimately to leave.

I just came across an example of behaviour distorted by incentives that veers on the fantastical: An unemployed Austrian man sawed his foot off, to avoid being found fit enough to go back to work. We find it incredible that Aron Lee Ralson cut off his right arm (to avoid certain death). But sawing your foot off to avoid going back to work?

This is a colourful story and only an anecdote. The man is most likely a nutcase. It is nobody's case that such extreme responses will come about on a large scale. The claim of the microeconomics literature is more limited: that on average, fairly significant behavioural changes come about in response to changes in the rules of the game. Through this, welfare programs have unintentional consequences that go far beyond those visible at the surface.

Politicians and bureaucrats in India like to roll out out more welfare progarms. It would be useful to bring alternative perspectives on these questions, which are mainstream worldwide but are considered cutting edge in India: about the limited governance capacity of the State, about the fiscal crisis that the State faces, and about the behavioural changes induced by welfare programs. In this field, you may like to see a paper by Vijay Kelkar and me.

The resource curse of land ownership

by Ajay Shah.

 

Land ownership in pre-modern India

 

In India, 50 or 100 years ago, land was a defining feature of wealth. The stock of land generated a flow of income. The landless were low-paid agricultural labour. The landed gentry of rural India were the kings of their heap. They had power, prestige, position, prosperity.

In the eyes of many, the initial conditions of high inequality of land ownership were a key barrier that held India back. It was argued that a one-time bout of bloodshed was essential, to expropriate the rich, and to transfer land ownership into a more equitable distribution. In India, this capacity for State-inflicted bloodshed was present in some places only. In much of India, the unequal distribution of land ownership found in 1947 was left intact.

Fast forward into the present, and there has been a sea change in the fortunes of the owners of agricultural land.

Agriculture is less important

 

Particularly after we escaped from the Hindu rate of growth (3.5%) in 1979, the share of agriculture in GDP has dropped sharply. In relative terms, the wealth created through firms in industry and services has dwarfed the wealth of the landed gentry. The richest man in India today is born of one who started out with no land. Government interventions continued to stifle agriculture, but shifted to a greater laissez faire approach in industry and services; this helped accelerate the decline of agriculture.

The plight of those who stayed back

 

Rural to urban migration has unleashed new forces on the role and status of the landed lords. Within rich families, high IQ children may be going off to the city to a greater extent, e.g. based on the filtration by competitive examinations where outcomes are correlated with IQ. To the extent that such a process has been afoot, it has given a selection bias where the low IQ children were the ones more likely to stay back in the `idiocy of rural life' (as Marx characterised it). Over a couple of generations, the interplay of nature and nurture can add up to substantial effects.

That there was an easy option - to live off the land - was a `resource curse' which afflicted the households who had land. In contrast, for landless households, there was no conflict of interest in moving to cities (other than the recently introduced NREG, which tries to perpetuate poverty by hindering rural to urban migration).

The power and status of the landed lords was now twice undermined. Their quick-witted cousins who established themselves in the cities were connected into capitalism and getting ahead. Families of the landless have tended to move to cities, connect into capitalism, and get ahead. The erstwhile lords have started looking nervously at both groups of escapees, wondering whether land ownership was such a nice initial condition.

In a fascinating recent article, Devesh Kapur, Chandra Bhan Prasad, Lant Pritchett and D. Shyam Babu gave us some insights into these changing social structures. In their survey data, in 2007, 98.3 per cent of Harijans were contracting-out the work of tilling their fields to their erstwhile lords, the upper-caste men who owned and operated tractors. The upper tail of the Indian income distribution has, in a few generations, been reduced to operators of agricultural equipment.

The importance of engaging with the market

 

A defining issue of modern times, for an individual, is a continued and deep engagement with the market. For insights into this idea, see this interview with Tom Sargent. The Ljungqvist/Sargent story matters even more in India, when compared with what has happened in the West. At 7 per cent GDP growth, every few years, far-reaching change comes about in technology and processes. Each individual builds knowledge and human networks by continually engaging with the market. If a person is cut off from engagement with capitalism for even a few years, this generates a lot of human capital depreciation. At that reduced human capital, the person has to either accept an offer at a much reduced wage, or stay unemployed (which further undermines human capital).

The Ljungqvist/Sargent story helps us understand the plight of adivasis in India, who have been away from the market economy, and are unable to plunge into it. It helps us understand the plight of the unemployed of Europe: the welfare state pays them dole to stay warm and well fed for many years of unemployment, but after this they are unable to come back into the labour market.

In this setting, consider the plight of a land owner, who has been living off the land, and has never engaged with modern India. Particularly in the post-1979 period, when India has experienced relatively rapid growth, each year of being a country hick owning land meant being further away from the skills required to participate in the contemporary Indian economy. The landed gentry of India lacks the skills to participate in the market economy. Income from the land, their resource curse, dulls their incentive to overcome the barriers. They are often too proud to accept low wage assignments which are the starting point through which the unskilled connect to capitalism. These problems have come together to give a unique vicious cycle of dis-engagement with modern India.

Sale of land in the outskirts of cities

 

At the edges of all cities, urbanisation is proceeding through developers buying land from the local landed rich and transforming it into the endless suburbs. In the short term, this has generated immense windfalls of wealth for the landed rich. But in some ways, this is a bit of a disaster for many of them. Lacking in knowledge about the market economy, they are scammed by insurance salesmen and such like. Much of this newfound wealth tends to get dissipated in a few years.

Urbanisation and land development throws open vast opportunities for trade and industry. But the erstwhile landed rich tend to be uniquely ill equipped at harnessing these opportunities. They tend to be too proud to work for someone else, and inadequately equipped to stake out on their own. They experience a brief blaze of glory when paid fabulous prices for their land, and then fade away into insignificance.

Some politicians have been moved to advocate special legal protections for the hapless rural rich who sell land to the modern sector. It's quite a turnabout within a few generations: from landed elite that oppress the others, to witless folk who need to be protected by special laws that inhibit the sale of land.

The curse of land

 

A few decades ago, the left-of-centre view dominated the thinking in India. It was felt that inequality of land was a major bottleneck that held India back. Many argued that the failure of Indian democracy to engage in a one-time bout of class warfare through `land reform' was a major mistake that was holding India back. It was argued that the Chinese path was the right one: to expropriate the landowners and then start a capitalist economy under conditions where everyone is equal.

With the benefit of hindsight, things look different. I think this story reiterates the dangers of social engineering. We are dealing with enormously complex systems that we only dimly understand. As far as possible, it is wise on our part to use the force of the State as little as we can, and to always avoid treading on fundamental human rights such as property rights.

Acknowledgments

 

I am grateful to K. P. Krishnan, Suyash Rai and Mihir Thaker for insightful conversations.

Guide to the Eurozone crisis

by Percy Mistry.

How did it happen?

The worst financial crisis in the western world for nearly 80 years broke in September 2008.

It required banking/financial systems to be supported and recapitalised by governments across the EU and in the US.

In June 2009 it became apparent that the peripheral countries of the Eurozone (Greece, Portugal, Spain and Ireland) were grossly over-indebted.

Yet in some instances (Spain) their public debt to GDP ratios happened to be lower than those of the US, France, the UK and Germany.

The continued viability of their public finances depended entirely on markets being willing to refinance them with cheap money.

But, when markets scrutinised the sustainability of their fiscal positions, they baulked from refinancing except at punitive rates.

CDS spreads (against Germany as a benchmark) of peripheral Eurozone countries (PIGS or Club Med) debt began widening relentlessly.

Global financial markets began to price in an escalating risk of partial/full voluntary/involuntary default on PIGS bonds since December 2009.

Contrary to first impressions, except for Ireland, that was a result not just of the financial crisis and bank recapitalisation demands on the fiscus.

It became apparent instead that bank recapitalisation demands on public finance were only the last straws that broke the camel's back.

Greece, Portugal, Spain and Italy, as a direct consequence of joining the Eurozone, had been running up unsustainable fiscal deficits since 2000.

Ireland had not. It suffered because the bailout of its disproportionately large banking system caused its public debt to rise astronomically.

PIGS became over-indebted despite the supposed self-imposed discipline adopted by the Eurozone of prohibiting fiscal deficits >3% of GDP.

That discipline was violated by almost all Eurozone members, beginning with France and Germany, but more egregiously by the PIGS.

To make matters worse, however, the PIGS were also running increasingly large current account deficits (with Germany, France, China).

Though countries like France (and to a lesser extent) Germany were fiscal sinners, they were at least running current account surpluses.

PIGS had access to excessively cheap public and private money available on terms totally inappropriate to their economic circumstances.

Given their inherent risks, which markets mispriced completely, their borrowing costs should have been 300-500 bp higher than Germany's.

Instead, they were virtually the same for nearly a decade. That relieved market-induced pressure on PIGS' governments to behave responsibly.

Consequently, their public expenditures after 2000 ballooned out of all proportion to their intrinsic capacity to fund them from tax revenues.

Such expenditures became almost wholly dependent on access to increasing amounts of cheap public borrowing from capital markets.

In response to access to excessively cheap money, wages in the PIGS rose across the board as did growth in public sector employment.

With the financial crisis triggering bank recapitalisation needs, on top of this unsustainable structure, the edifice began to crumble.

The first early warning signals became apparent in December 2009 but the dam broke in mid-2010 with the first Greek bailout.

How has the Eurozone crisis been handled?

Extremely ineptly; indeed very foolishly, by sophisticated Eurozone authorities (political, fiscal and monetary) that should have known better.

Eurozone leaders learned nothing from the preceding debt crises in Latin America (1982-87, 1994-95) and Asia (1997-2000).

They went through avoidable phases of serial denial that there was a structural debt (solvency) crisis that could spread via contagion.

They treated it as a liquidity crisis that could be dealt with by temporary patch-ups of additional money combined with fiscal restraint.

They reiterated their commitment to ensuring there would be no default - partial or full, voluntary or involuntary - by any Eurozone member.

They believed that their remedial measures would stop the crisis from ballooning beyond the first bailout package for Greece.

They were totally wrong. That package did nothing to convince markets that Eurozone leaders understood the nature/severity of the problem.

In fact, the inadequacy of that first bailout package -- which did not provide enough money for sufficiently long - became quickly apparent.

Eurozone leaders were fixated on debt-affected PIGS being forced to live within their means through indefinite austerity without end.

Debt recovery/sustainability models did not provide sufficient new money, or permit debt restructuring, in ways that would restore stability.

Least of all were bailout packages designed to restore growth in a conscionable period of time that would be socially/politically acceptable.

Without financial system (and borrowing cost) stability, and absent growth, debt problems can never become better. They can only worsen.

Instead, as a result of poor design, all the bailouts did (except for Ireland) was to add new debt to bad debt and reduce growth prospects.

To exemplify: In mid-2009 the debt/GDP ratio for Greece was 115% of GDP and the debt service ratio about 11% of GDP.

But, by October 2011 the debt/GDP ratio for Greece was 161% of GDP and the debt service ratio nearly 20% of GDP.

It is projected with the third bailout to rise to 185% of GDP (although debt service will be lowered to 16%) before it comes down again.

In the meantime, over the last 32 months, the Greek economy has shrunk in size by almost 17% in nominal terms. It will be 1/5 th less in 2012.

Such inane 'remedies' do not solve debt problems. They only aggravate and exacerbate them.

While behaving in this absurd fashion Eurozone leaders repeatedly asserted for two years that they would do everything in their power to:

• Maintain the credibility of the Euro while ensuring that every member stayed in the Eurozone
• Not allow any default of publicly issued bonds to occur; and
• Do everything possible to avoid contagion spreading beyond PIGS (even as it became clear that markets were worried about Italy.

Instead they achieved the exact opposite of all three objectives through their inability to understand the implications of what they were doing.

Though now contrite and claiming to have learnt a few lessons from their serial bungling over 30 months Eurozone leaders have no solution.

The EFSF facility they created is woefully underfunded. It can barely deal with financing the third Greek bailout.

The idea of leveraging it or using it as a partial guarantee facility is absurd since it would add to risk and uncertainty not resolve them.

Yet over-indebted governments (including France and Germany) would have to issue more public debt in order to fund the EFSF properly.

That would simply mean requiring their fragile, near-bankrupt, banking systems (or the ECB) or global markets to buy more Eurozone debt.

Except for Germany (and even that will be in doubt soon) the market has no appetite for taking on more Eurozone debt given its risks.

Contagion has spread from the periphery and now lodges at the core of the Eurozone economy in which Italy is the third largest member.

What could have been resolved with about 300 billion euro in additional financing in mid-2010 is now a problem that may require 2 trillion euro.

Where are we now?

Over 35 EU/Eurozone summits in 30 months have resolved nothing. They have made matters worse; despite Herculean exertions!

Right now Greece is in 'effective' default; though markets are overlooking that because of the implications of CDS contracts being triggered.

Its borrowing costs for refinancing its debt would exceed 30% if it had any access to private markets; which it does not.

Any refinancing of, or addition to, Greek debt can now only be financed by the ECB; which the Germans will not permit the ECB to do.

Meanwhile the Greek banking system is bankrupt. Indeed the entire Eurozone banking system's credibility/stability/solvency is in doubt.

Today an outstanding portfolio of about 11-12 trillion euro in Eurozone debt - of which about 80% is held by EU firms - is souring relentlessly.

About 7 trillion euro of that portfolio is sufficiently affected by contagion to require provisioning (France and Belgium may soon be added).

About 5 trillion euro of Eurozone high-risk-debt is currently held by EU banks, insurance companies, pension funds and individuals.

That sovereign debt, which is supposed to constitute the 'safest' component of any asset portfolio, now constitutes perhaps the riskiest element.

That reality inverts the whole basis of banking/financial system soundness and stability across Europe (including the UK).

It compounds the problem of calculating capital adequacy requirements for these banking systems and puts regulators in a quandary.

Ireland's bailout programme is working but could be derailed by what is happening in the rest of Europe.

Portugal's programme is not working as intended. But nobody is talking about it because it pales in comparison with Italy and Greece.

Italy's outstanding public debt will soon cross 2 trillion euro (120% of GDP) and its debt service payments amount to around 300 billion euro per year.

That is made up of about 120 billion euro in interest payments and 180 billion euro in principal repayments. Average duration is 5 years.

Public debt service in Italy now amounts to around 17% of GDP and will rise to 20% unless Italy's debt is dramatically restructured.

Italy now needs to borrow about 40 billion a month euro (gross) and about 28 billion euro a month net in private markets to refinance its debt.

The world is holding its breath with every auction of Italian public debt (3-8 billion euro per week) any of which could trigger accidental default.

The cost of refinancing Italy's public debt has risen from around 4% a year ago to around 7% now. That adds 20 billion euro a year to its debt.

Meantime the Italian economy is flat-lining and its capacity to service additional debt is diminishing despite its running a primary balance.

Banks around the world are dumping their holdings of Italian public debt but there is no buyer other than the ECB because of the risk.

The ECB's capacity to refinance Greek, Italian and Portuguese debt is limited and constrained by Germany's unwillingness to consider that.

Contagion from Italy is now beginning to affect Spain and France which is supposed to be a bulwark for the EFSF's borrowing capacity.

The resulting gridlock is pushing the entire Eurozone system toward a catastrophic denouement with a binary outcome. Either:

1. Crisis-induced progress toward fiscal union with national sovereign bonds being replaced by a single Eurozone bond with a joint/several guarantee, or
2. Sudden disorderly collapse of the Eurozone with unimaginable fallout and consequences that would trigger a global double-dip recession.

Such a recession would last for a minimum of 2-3 years and would probably be quickly followed by a similar debt crisis in the US.

The resulting fallout of disorderly Eurozone break-up could trigger a break-up or restructuring of the larger EU as well.

So where do we go from here?

With the foregoing in mind it seems absurd that the world is waiting with bated breath to see what the new technocratic governments in Greece (Papademos) and Italy (Monti) will actually achieve by way of structural reform and increased debt servicing capability in coming months.

These technocratic governments inject new credibility but lack political and social legitimacy. They have been appointed not elected.

It remains to be seen how long their technocratic legitimacy holds out without the backing of gradually earned political/social legitimacy.

The risk is that if the ministrations of these technocratic governments (which their societies believe have been imposed on them from the EU above) do not work and bear fruit relatively soon (the probability is that they won't), public patience with them will melt.

Will they be able to convince electorates to accept the inevitability of austerity without growth for the indefinite future?

The next Greek crisis is perhaps 10-12 weeks away.

The next Italian crisis could be triggered by any one of the upcoming weekly auctions of Italian government debt.

Despite these rather obvious realities, global markets deem to be reacting in dream-like hope and optimism that all will be well.

There is of course a solution at hand; and the only one that will work because all the other options seem to have been exhausted.

That option requires Germany to reconsider its refusal to bear its large share of the fiscal burden that will come with Eurozone fiscal union.

It requires political/social willingness on the part of rich northern Eurozone members to finance fiscal transfers to poorer southern members through an exponential expansion of structural funds, currently applied to help develop more rapidly the poorer regions of the EU.

Reciprocally, it requires other Eurozone countries to relinquish fiscal, and a great deal of political, sovereignty immediately; in order to assure global markets of their commitment to structural reform, restoration of competitiveness, and relentless pursuit of fiscal/monetary discipline.

It requires all unwanted national sovereign bonds of Eurozone members to be replaced by a single Eurobond that is jointly and severally guaranteed and underpinned by the weight and ability of the ECB behind it to print money if necessary to ensure that such bonds are honoured.

This solution would resolve both the over-indebtness problem of the Eurozone and the problem of banking system collapse at a single stroke.

If it were adopted the need to provide for risky Eurozone debt and recapitalise (yet again) the EU banking system would disappear.

Yet, this is the one solution that keeps being discarded because of legitimate German constitutional, judicial and political constraints.

They inhibit movement in such a direction regardless of the consequences for the Eurozone, the EU, and mostly Germany itself.

It is like witnessing a repeat of 1939; not of conquest but of mindless destruction. But, this time with money rather than tanks being involved.

If that only workable solution continues to be discarded, the other possibility that will manifest itself is the disorderly break-up of the Eurozone; simply because its orderly break-up defies contemplation and imagination.

Talk of Greece being ejected from the Eurozone, or of Germany departing from it voluntarily, is fanciful simply because neither can afford to bear the costs of the consequences that will follow, regardless of what their populations and political leaders may believe or think (though 'thought' seems to be conspicuously absent from the process just now). Neither can their neighbours, regardless of what they may think.

Yet it is not unimaginable that a break-up will be forced on Eurozone members by global markets if the only workable solution continues to be ruled out as it seems to be repeatedly by the German Chancellor. But she has changed her mind so often the hope is she will yet again.

A disorderly break-up may result in a reversion to national currencies; which would be better than members trying to retain some semblance of the Euro through separate residual monetary unions of more compatible economies.

That would probably require four different Euros (for the super-efficient Northern economies a Baltic Euro, for the relatively efficient middling economies a Franco-Euro; for the newly acceding countries an Eastern-Euro and for the inefficient, uncompetitive Club-Med economies, a PIGS-Euro). Other than the first, none of the others would be credible for holding as reserves, or for trading significantly in global currency markets.

Finally, bear in mind that we have spoken of only the public debt problem in the Eurozone.

Should the unthinkable (but increasingly likely) disorderly break-up happen, the public debt problem will be accompanied by an unresolved private debt problem throughout the Eurozone of equally monumental proportions! That really will break the system and the banks!

India: a nascent social democracy?

As India embarks on the early stages of middle income, there is interest in a more expansive outlay of expenditure for the government. This motivates the question: Can India now embark on constructing an array of welfare programs, which would ultimately add up to an approximation to a welfare state or a social democracy?

Vijay Kelkar and I wrote a paper Indian social democracy: The resource perspective on this question, for the 10th `Indira Gandhi Conference' which took place in New Delhi recently.

Fault Lines, by Raghuram Rajan

by Viral Acharya.

Raghuram Rajan's book Fault Lines (Princeton University Press for the international edition, and Harper Collins for an Indian edition with a special chapter on India) is possibly the most thought-provoking contribution in the aftermath of the economic and financial crisis that has engulfed the West after 2007 with significant global repercussions.

The epilogue of the book summarizes its punch line:

The crisis has resulted from a confusion about the appropriate roles of the government and the market. We need to find the right balance again, and I am hopeful we will.

The key idea of Fault Lines is to focus on slow-moving tectonic plates in the global economy: consumption by borrowing in countries with fiscal deficits, excess savings in exporting countries that are fiscally in surplus, and growing sophistication of the financial sector. None of these movements might seem dangerous in itself, but when these plates come together and collide, the global economy can get badly shaken. To most players focused narrowly on their own positions, leave alone the movements of the plate they stand on, the earthquake - like this crisis - may seem an unfortunate happenstance. In the analytical framework of Fault Lines, the crisis was not a pure accident and that more severe crises could arise in future unless the root causes are addressed sufficiently soon.

The book presents two important government distortions in the global economy and their underlying causes. These are (i) the push for universal home ownership in the United States, and (ii) export-led growth in countries such as Germany and China. Together, these policies have led to massive "global imbalances", with some countries such as the United States, the United Kingdom and Spain persistently being in deficit, and borrowing from the surplus, exporting nations. While pursuit for home ownership affordability and growth do not necessarily have to be distortionary, the book makes the sharp observation that these have been occurring at the expense of something more important but subtle.

In the United States, there has been growing income inequality, which combined with a relatively feeble safety net for the poor and unemployed, has created pressure on politicians to find quick ways to bridge the inequality. Instead of improving the long-run competitiveness of labor force for a global market with a changing mix of industries and required skills, governments have adopted the short-run option "let them eat credit" (the title of Chapter One). The presence of government-sponsored financial firms in the United States (Fannie Mae and Freddie Mac, in particular) enabled exercising such an option readily through a push for priority lending to the low-income households (sub-prime mortgages).

In case of surplus countries, it has been the problem of exporting to grow (the title of Chapter Two). Their single-minded focus on exports has led governments to ignore the domestic sector, preventing sufficient redeployment of surplus for internal development, and somewhat perversely, even boosted domestic savings rates significantly due to lack of adequate safety nets (at least in case of China, if not in case of Germany). As someone mentioned in a recent dinner conversation: Each child in China is saving to fund post-retirement expenses not just of two parents but also of four grandparents. These savings have thus had no place to go but outside, giving rise to massive capital inflows that fueled the housing sector expansion in the US, the UK and Spain.

What is fascinating is that Fault Lines explains how these lop-sided government policies of two separate sets of countries have interacted with each other - and with the financial sector - in fueling the expansion to levels of unsustainable housing bubbles. The idea here is that the invisible hand operating through the price when the price is distorted can also lead to massive distortions in the allocation of capital. The financial sector in developed world is so sophisticated and amoral (a great choice of word by the author) that its dispassionate pursuit of profits leads it to direct capital to wherever there is a relative mis-pricing.

So if governments are subsidizing home ownership, efforts will be made to deploy all free capital of the world to the housing sector. If some governments are finding it cheap to borrow because savings are seeking them out, the financial sector will grow at a sufficient rate to absorb and support expansion of housing credit through these capital inflows.

Clearly there have been incentive-based distortions in the financial sector, especially due the short-term nature of accounting-based compensation that ignores true long-term risks. The book explains, however, that the bigger issue was something else: that the imbalance of capital flows and the ease of pushing sub-prime home ownership - both due to government distortions - meant the financial sector was essentially a conduit to making happen what the rest of the world was seeking to achieve. In the process, banks made a ton of bad loans (but the governments were happy with that till it all really blew up). And some parts of the financial sector pursued this role even more aggressively than one could have imagined due to the steady entrenchment of too-big-to-fail expectations -- large banks being repeatedly bailed out through government forbearance and enjoying central-bank monetary stimulus each time markets turned south.

Some may question the basis of this argument by saying - why did we see credit expansion across board and not just in low-income households? Here, Fault Lines focuses on a rather fascinating phenomenon that recoveries from recent recessions, especially in the United States, have remained "jobless" for extended periods of time. Perhaps as a subconscious response to this (or due to ideologies in other cases), central banks have tended to provide massive monetary stimulus to get the financial sector to push the household consumption and real sector investment harder and harder through greater lending and intermediation. Such stimulus, unfortunately, again serves to transfer rents from households to the financial sector (by keeping interest rates low) and produces mispriced risk. Thus, the economy moved "from bubble to bubble" (the title of Chapter Five), until the most recent bubble could not be mopped up by anyone, not even the most innovative Central Bank of all, despite its own best efforts.

In essence, Fault Lines connects the dots visible to all of us in a rather ingenious manner to provide an explanation of what brought about the perfect storm we have recently weathered.

While the book is worth it even just for its explanation of why we had a crisis now rather than at some other points of time, it goes the extra mile and proposes valuable reforms, focusing on all three issues: building a better safety net in the United States (see in particular, the suggestions to improve education access to all and extend a greater level of unemployment insurance), reducing the global imbalances, and improving the regulation of the financial sector so that it (and its financiers) pay for mopping up of bubbles it fueled, rather than governments and Central Banks passing on these costs to taxpayers.

The book also helps understand why export-based Chinese and German growth, and their effective vendor financing of consumption in the US and Euro-zone countries, may ultimately face limits as consumption slows. These countries are now being forced to become the stimulators of growth and run the risk of planting seeds of bubbles in their own economies. This is how hidden fractures still threaten the world economy, as the book's subtitle goes. It also leads one to reconsider that India's slower growth rate than China, while not entirely faultless, might however be more balanced given its lack of extreme export reliance.

Raghuram Rajan's writings are always cogent and based in sound set of facts. But this book is special in the sense that here he paints on a much larger canvas, covering bases from distributional issues within income strata of society, to the persistent capital imbalances across large countries of the world, and the ruthless profit-maximizing incentives of modern market-based financial sector.

There is a lot going on in the book. But it is written with great examples and cases - almost lyrical at times (even has a fascinating poem recounted in the chapter "The Fable of the Bees Replayed"), and should be accessible to one and all. It will certainly question some long-held biases about current state of economic conditions in Western countries. But it is hard to not take a deep breath and ponder once you have read it all. In many ways, it shows that when economic conditions so demand or induce, the developed world behaves much the same way as the developing world: they are both after all driven by choices of human beings and the book lays out some common patterns of global economic behavior - in households, markets and governments.

Micro foundations of inclusive growth - from Economic Survey

Even if you don't usually read the Economic Survey, this year, the chapter titled Micro foundations of inclusive growth is well worth reading.

Fiscal crisis again

I have an article in Financial Express today about India's fiscal problem in the immediate context of the S&P rating downgrade.

Inequality

Michael Walton has a good opinion piece in Financial Express on the subject of inequality in India. He starts out with the eminent good sense on the subject:

Should we care about inequality? Many would see this as a dumb question. But there are two, opposing views on why it may be considered dumb. The first is that inequality is so obviously central an issue, so pervasive in Indian society that it is transparently the case that tackling inequality is central to the development process. Indeed, the long history of both rhetoric and action by the Indian state is, ostensibly, in line with this view.

A second view is that inequality is a big diversion. India is still a poor country. The first order question is sustaining growth, while ensuring the poor participate in that growth. (And, indeed, in most growth episodes, most of the time, the income of the poor grows more or less as fast as the average.)

Moving from Latin America to India a year ago (as I did) casts this question into relief. At first glance the contrast seems to support the view that inequality is a second order question here. Latin America is the region of inequality par excellence. Measured inequality in India (from the National Sample Survey) is way below the Latin American average, and even below the most equal society theretiny Uruguay, famed for its extensive social insurance system. It is also lower than in China, Malaysia and Thailand. Sustaining rapid growth looks much more important than any feasible redistribution, not least for the poor.

On the scale of decades, the only thing that matters for poor people is GDP growth. Every percentage point of the growth rate that is given up in the quest of reduced inequality today does permanent damage of the trajectory of consumption of poor people in coming decades. As an example, suppose a family starts out in poverty in India today earning Rs.1000 a month. Here is what 30 years of growth does at a few alternative growth rates:

2.5%	2,097
6.0%	5,744
7.0%	7,612

6% growth over the coming 30 years gets a family making Rs.1000 a month in India today up to Rs.5,744 a month. But if the growth rate gets up to 7%, then this same family gets up to Rs.7,612 per month. These large differences are induced by small improvements in the growth rate. And, if we sink into socialist stasis of 3.5% GDP growth which would yield 2.5% per capita growth, then this family gets up to Rs.2,097 a month in 30 years.

I think 30 years is the right horizon to think about these issues, for it corresponds to the change that a person sees from age 0 to age 30, and then again from age 30 to age 60. It is very important for poor people in a country to see such massive changes in their well being coming about within such timescales.

Policymakers who care about the consumption of poor people have to have a very short-sighted discount rate (in addition to certain kinds of preferences) in order to espouse policies that emphasise equity at the price of growth.

Manish Sabherwal has a piece in Economic Times today, where he points out the logical fallacies of simplistic beliefs about inequality using a natural experiment that recently took place in India:

India has become substantially more equal since January 8, 2008. About two hundred billionaires have turned into millionaires. The drop in stock market and real estate values means that the top 5% richest people may have lost about 40% of their wealth and making the rich poor increases equality. But does this exponential increase in equality help India’s poor? Do they even care?

Michael Walton then runs through the criticisms of this perspective. First, inequality off NSSO data is underestimated. I feel that inequality using household survey data is underestimated everywhere. It's as hard for an investigator in Mexico City filling out forms to get into one of the haciendas of the rich, or an investigator in New York City filling out forms to get into a penthouse in Manhattan, as it is for him to get into a prosperous home in Bombay.

Second, the really important thing is inequality of opportunity. I fully agree. Here, it is possible to obtain first best with reduced inequality of opportunity and higher GDP growth, by undertaking fundamental reform of education and health in India. This is a rare situation where policy makers with an interest in one kind of inequality can actually assist growth. But so far, the gigantic spending programs in health and elementary education (e.g. Sarva Shiksha Abhiyaan) have been dominated by the interests of their respective civil servants, and not the interests of the users of these services. Higher education is another great opportunity to make a difference to equality of opportunity, but so far in India, the policy framework is systematically designed to disadvantage a person born in a family with weak financial and human capital.

Third, he says that inequality is likely to get worse, and that this will have implications for the political system and society. I agree with this outlook. Inequality in India will get a lot worse before it gets better, given that the top decile is in the process of plugging into globalisation, and generating tremendous wealth in the process. Over time, the remaining nine deciles will handsomely reap the fruits of this transformation, but in the short term, inequality will worsen.

Vijay Kelkar has always emphasised that inequality matters because it influences the political foundations of liberal economic policies. I see this as shaping up to be a big challenge for Indian politicians over the coming 25 years. So far, the early indicators are bleak.

In her article The first globalization: Lessons from the French, Suzanne Berger emphasises one of the `great surprises in history' : despite the inequalities created by capitalism, no electorate has ever voted in free national elections to overturn it. She argues that while anti-capitalist political parties have been strong, they have never won the day.

I'm not so sure. Democracy does contain the possibility of the demos coming together and expropriating private property and trampling on individual freedoms - as Indira Gandhi did and as a number of `idiotic' regimes in the world have shown. Berger emphasises one element of what holds such dangers in check:

...the constitutional engineering of Madison and the founders of other liberal democratic societies did work to protect the rights of individuals and the functioning of a market economy. Institutions like the Bill of Rights, the Supreme Court, and federalism did in fact build dikes that protected property and markets against democratic majorities

To the extent that the `constitutional engineering of Madison' is important in throwing up these dikes, we are in trouble in India, given the extent to which constitutional engineering (and re-engineering) have systematically damaged the rights of individuals and the functioning of the market economy.

Reforming PDS

Indian Express has a good editorial on the subject.

Waiver of Mass Debt (WMD)

This blog entry is by Vijay Mahajan of BASIX.

Iraq was attacked by the US and the UK on the basis of a fictional threat - WMD - weapons of mass destruction. We have seen the results of that lie, with shock and awe. India's WMD is less costly - Rs 60,000 crore, or only $15 billion - but is based on similar half-baked analysis of half-truths, and well designed to benefit those behind it - in our case Pawar-ful large commercial farmers.

As per the National Sample Survey, 59th Round, 2004-05, over half, or 51.4% of the farmer households in the country did not access credit, either from institutional or non-institutional sources. Further, despite the vast network of bank branches, only 27% of total farm households had any loans from formal sources (of which one-third also borrow from informal sources), while 73% did not. Among the marginal farmer category, as many as 80% did not have any borrowing from formal sources.

So the FM and the Agriculture Minister must have known in advance that their generosity will only cover the upper quartile of farmers. Yet, if we go by the details, only those whose bank loans were overdue on Dec 31, would get a waiver. So a big grape farmer in Nasik who had a bumper crop but was politically aware, so did not repay his loan, will get a waiver of Rs 1 lakh while a poor rainfed farmer in Vidarbha who has sold his less than normal yield cotton crop to the state monopoly cotton federation, at a lower than market price, will be deemed to have repaid his Rs 15000 loan from the proceeds that he has yet to receive, and will not get the waiver.

There is no fig leaf to this pro big farmer loan waiver, as can be seen by RBI's clarification that not only crop loans but also term loans for tractors, poultry farms etc will be covered by the waiver. To minimize backlash from those who did not get the waiver, in AP, the Chief Minister has additionally declared a 10% bonus payment to all farmers who sell their produce through regulated market yards - once again, the larger farmers.

Apart from the gross inequity in the name of small farmers, the loan waiver is particularly inept as it completely fails to address the underlying causes of the Indian agrarian crisis, including -

1. Dwindling size of land holdings;
2. Low percentage of irrigation, even protective irrigation; and where there was irrigation, tapering yields due to long years of mis-fertilisation and increasing level of pesticide resistance.
3. In rainfed areas, no measures for coping with recurrent drought, no significant varietal improvements, nor any agricultural guidance to farmers.
4. Increases in input costs, coupled with lower relative prices for produce, and price fluctuation, has meant that agriculture is not very profitable even for commercial farmers. For small farmers, with imputed wages for family labour, farming does not even break even.

The same Rs 60,000 crore could have been used to drought-proof 60 million ha of dryland @ Rs 10000 per ha, which would permanently secure the livelihoods of at least 3 crore of our poorer, farmers in rainfed areas. Dozens of successful examples exist, of the rehabilitation of natural watersheds and traditional water storage structures, by NGOs and government agencies. Part of the funds could also be used to rehabilitate the dilapidated canal irrigation systems, conditional on the states switching to participatory irrigation management (PIM).

Even if one were to accept that the loan waiver was aimed at gaining electoral advantage, it could have been done much more equitably and would have fetched more votes.

Recognising that the debt burden of small and marginal farmers is more from moneylenders and traders, a waiver should have been given for both bank and moneylender/trader loans. Given the difficulty of verifying these, the waiver could have been limited to Rs 5000 per ha for farmers with irrigation, and Rs 2500 per ha to rainfed farmers, with a cap of Rs 10,000 per farmer in both cases. Additional amounts from informal lenders could have been swapped for much lower cost bank loans, as has been tried in Andhra Pradesh by the "total financial inclusion" program of the Indira Kranti Patham project.

Further, to prevent leakage, the money could be credited to the bank accounts of farmers. This would also have incentivised banks to open "no-frills" accounts for 5 crore farmers who don't have bank accounts, as per the recently adopted national financial inclusion plan.

Rough calculations show that this alternate method would have benefited 10 crore farmers, about thrice the number likely to be covered at the moment.

The one mystery is - why did not the Left argue in favour of a more equitable waiver? Have they lost interest in the agrarian vote bank after Nandigram? Or is it a deal which we will understand many years later?

Progressivity of taxation

Greg Mankiw shows this remarkable graph, about the tax payments made by households in five quintiles of income categories in the US:

Unfortunately, information systems in India are so weak, one just doesn't know what a comparable picture in India might look like.

A lot of people believe that income tax rates should be `progressive' - i.e. that richer people should pay higher tax rates. A belief that progressivity of income tax is a `good' thing is one of the instinctive reflexes from the decades of socialism. However, the logic in favour of this from first principles is not apparent, as David Friedman recently reminded us.

Two interesting documents from the IMF

The IMF released two documents on 4 February: India: 2007 Article IV Consultation, and India: Selected Issues.

Selected Issues

While a quick search on the IMF website shows many `Selected Issues' documents, I had not noticed this product type earlier. It turns out to be a small edited book containing seven papers about India:

1. Competitiveness and Exchange Rate Policy by Hiroko Oura, Petia Topalova, Andrea Richter-Hume, and Charles Kramer;
2. Challenges to Monetary Policy from Financial Globalization: The Case of India by Charles F. Kramer, Helene K. Poirson and A. Prasad;
3. Monetary Policy Communication and Transparency by Helene K. Poirson;
4. Financial Development and Growth in India: A Growing Tiger in a Cage? by Hiroko Oura and Renu Kohli;
5. Developing the Foreign Exchange Derivatives Market by Andreas Jobst;
6. Inclusive Growth by Petia Topalova;
7. India's Social Protection Framework by Andrea Richter Hume.

Of these, three stood out for me.

It has been previously noted that the RBI fares very badly in international comparisons of central bank transparency. Further, while central banks worldwide have improved over the last decade, RBI has stagnated. The paper by Helene K. Poirson is an outstanding how-to manual on how RBI's transparency can be improved. It is sensible, well written and immediately actionable. It reviews the recent difficulties of monetary policy from the viewpoint of communication strategy, and draws on these episodes to propose solutions. I hope RBI is able to implement all this right away. Everyone interested in Indian monetary economics should read this article.

The paper by Hiroko Oura and Renu Kohli was also most interesting to me. There is a vast literature based on the CMIE firm-level database; this one stands out as obtaining interesting answers to interesting questions. Specifically, it sheds light on the areas where the Indian financial sector does or does not deliver the goods in terms of financing of firms.

The paper by Jobst on currency derivatives is an excellent policy paper, one that is particularly timely given that RBI is presently engaged in trying to ensure that a currency futures market does not succeed.

Article IV Consultation document

I am generally cynical about Article IV documents. Too often, they are suffused with bureaucratic triumphalism, with sentences of the form ``Under the steady guidance of the great leader, the peasants and workers reaped a glorious harvest''. The IMF is forced to praise India's deft handling of macroeconomic policy in every alternate paragraph. If your tastes run to `ruthless truth-telling', the result of the Article IV process is often not interesting.

However, this time, the document is well worth reading, particularly if you're able to ignore the platitudes. It gives the reader a good grip of the overall macroeconomic situation, and a sound perspective on the difficulties of both fiscal and monetary policy. It struck me that there isn't an Indian effort of this genre out there.

Reservations as cancer

Business World has an editorial titled Reservations as cancer where they say that reservations were always unjust -- now they create only misery and jealousy all round without political advantage to any party:

It is an historical accident that Meenas were included amongst scheduled tribes and Gujjars were not. There was a time when Meenas were like any other Rajput clan. They built Amber fort, which commands the approaches to Jaipur. In the 16th century, Baharmull Kuchhwaha, a Rajput king, transferred his allegiance to Akbar, and with his help, destroyed the Meena kingdom of Naed. The feud continued for four centuries. When the British came, Rajput kings allied themselves with them to defeat Meenas, who lost their kingdoms and turned to robbery. That is how they ended up in the list of criminal tribes. Later, when the British ceded power to nationalists, the label, “tribe”, proved a godsend. It brought Meenas reservations in the civil service and education, and proved to be their entry ticket to the lucky Indian middle class. Today, Meenas are well represented in the civil service, and are turning to business.

Gujjars have a less distinguished history. They were originally nomads spread across the dry tracts of western India and Pakistan from Kashmir to Karnataka; it is possible that they came from Central Asia, perhaps Georgia. There are two subcastes of Gujjars: dodhi and bakarwal, or buffalo-keepers and goat-herds. When India was sparsely populated, they used to take their animals up to the Himalayan foothills in summer and descend back into the plains of Punjab and Uttar Pradesh in winter. Now that settled population has grown and grazing grounds have shrunk, they are being forced to take to more sedentary occupations. But not being a landed community like the Meenas, they do not have steady incomes or family support and have not invested as much in education. As a result, they have found it difficult to climb up the social ladder.

When the mutiny broke out in 1857, Gujjars were amongst the most energetic rebels; as a result, they had their share of hangings and dispossession, and earned their place in the 1871 list of criminal tribes. But somehow the curse of the British did not turn into a blessing of the Congress on the advent of independence; Gujjars were not included amongst scheduled tribes.

It is thus an accident of history that Meenas are a scheduled tribe and Gujjars are not. Meenas did the right crimes in the 19th century to earn their place in the fortunate category of tribes; Gujjars somehow fell through the cracks of history. This is no justice; it is sheer chance.

This government does not believe in justice; it is prepared to take a chance. Its resolve to shower favours upon Other Backward Castes (OBCs) is a perfect example. OBCs are so close in their social parameters to the main population that if they deserve reservations, so does almost everyone. They are backward only in name; if they are backward, there are no forward castes, except politicians. But they are a big vote bank; reservations are the way the Congress hopes to get their votes. Hence, the government’s opportunistic move. Mayawati came to power by giving sops to the most forward caste; the Congress does not want to be left behind in opportunism.

But here too, Gujjars are unlucky. They are not numerous enough for the government to bother. There are many groups and castes related to Gujjars — after all, Gujarat calls itself the land of Gurjars — but they would rather hide their kinship to the poor Gujjars.

The looming civil wars of India are not over class as the Prime Minister claims. The working class may have fought bloodthirsty capitalists in the textbooks he once read; but in the India he rules, it is castes that are fighting over the right to undeserved jobs and places in educational institutions. The way to douse their wars is to leave caste behind, and to abolish reservations. Reservations were originally introduced for an opportunistic reason: the Congress wanted to wean away Untouchables from Ambedkar, and to persuade them not to convert themselves to Islam and Buddhism. So it gave them reservations — but only if they were Hindus. There are Muslim Meenas, called Meos; they were excluded from the reservations.

For reasons of political advantage, the Congress divided the people by caste and religion. But now those divisions it created are causing bloodshed and havoc. There is no more political mileage in them; instead, there is only trouble. Even sectarian political parties must see that the time for favouring vote banks has passed.

No politician likes to take a radical decision, least of all the Prime Minister. It may be beyond him to abolish reservations. But he should at least begin to reduce the reservation percentages. If he wants to profit politically, he can replace them at the margin by reservation for the meritorious poor. Let him practise inclusive growth.

Update: Arvind Subramanian wrote in Wall Street Journal Asia suggesting that the State shift from quotas to targeted education vouchers.

Understanding inequality

There is a lot of concern that high GDP growth in recent years has been associated with higher inequality. Gary Becker and Kevin Murphy have a fascinating and different take on understanding higher income inequality. They say that the bulk of the phenomenon of recent increases in inequality are caused by bigger skill premia in the labour market. Also see this New York Times article by Tyler Cowen.

I'm faintly reminded of the argument by Montek Ahluwalia in the late 1990s on the subject of rising inequality between states of India. He pointed out that it was only after liberalisation that the opportunities became available for some better governed states to do better than the rest, so it's natural that in the early period of market-oriented policies, inequality should have gone up. The forces which reduce inequality - the `equalising differences' of the price system (see the comments on this post for more on `equalising differences'), and the feedback loop influencing governance through the political system - impact with a lag.

The return of the idiot

Alvaro Vargas Llosa has a fascinating article in Foreign Policy, about Latin America, titled The Return of the Idiot. I know, Latin America is fundamentally different from India in culture and political dynamics. But one can't help feel uncomfortable at the echoes of this article which ring true, here.