Category: Ec101

Bob and Ronald Come to India, Part I

The Penny Drops

Imagine this:

Let’s say a young man calls you up. Could be your cousin, or your nephew.

I’ve got a problem, he says.

Temme, you say.

Well, it’s like this, he says. I work in an MNC in Bangalore, and make a lot of money.

Great, you say. What’s the problem?

Well, I stay with roommates, and it’s complicated. We were all together in college, and we’d sworn while in college that we’d be roommates. Problem is, all my friends earn nowhere near as much as I do. We’d sworn to live as one big happy family, so we’re all staying together, and that’s awesome. But…

Yeah, you say. But what?

Well, our motto was and is “All for one and one for all”. The problem is that what that ends up meaning is I contribute a lot to run our home, because I earn a lot more than the others. My contribution goes into a common “kitty”, proportionate to how much I earn. We all contribute half of our salary to run our home, but because I earn much more than the others, I contribute much more.

So what’s the problem, you yawn. If you contribute more, you should also get a bigger say in how that money is to be spent, no?

But that’s the problem!, comes the response from the other side. How the money is to be spent is not up to me. There, the principle is one person, one vote.

Wait a minute, you say. When it comes to pooling in the money, it is a function of what you earn. But when it comes to distributing the money, it is a function instead of how many of you are there?

Exactly, says the young, troubled whippersnapper. Now what?

If you contribute more, should you (or should you not) get a greater say in how your contribution is to be spent? And if not, should you be contributing more in the first place?

What is fair, what is just, what is desirable, and what is best? And for whom?

I don’t know if you’ve noticed, but there has been a bit of a kerfuffle recently about southern states saying it’s all very unfair. What exactly is unfair, you ask? Buckle up, because this is going to be a long ride.

The Background

Like I said, this is going to be a long story, but because this is one of the most important things we have to tackle as a country, let’s set about learning more about it. Let’s begin with the 42nd Amendment to the Indian Constitution:

Up until 1976, after every Indian Census the seats of Lok Sabha, Rajya Sabha and State legislative assemblies of India were re-distributed respectively throughout the country so as to have equal population representation from every seat. The apportionment was done thrice as per 1951, 1961 and 1971 population census. However, during The Emergency, through Forty-second Amendment the government froze the total Parliamentary and Assembly seats in each state till 2001 Census. This was done, mainly, due to wide discrepancies in family planning among the states. Thus, it gives time to states with higher fertility rates to implement family planning to bring the fertility rates down.

Even though the boundaries of constituencies were altered in 2001 to equate population among the parliamentary and assembly seats; the number of Lok Sabha seats that each state has and those of legislative assemblies has remained unaltered since 1971 census and may only be changed after 2026 as the constitution was again amended (84th amendment to Indian Constitution) in 2002 to continue the freeze on the total number of seats in each state till 2026. This was mainly done as states which had implemented family planning widely like Kerala, Tamil Nadu and Punjab would stand to lose many parliamentary seats representation and states with poor family planning programs and higher fertility rates like Uttar Pradesh, Bihar and Rajasthan would gain many of the seats transferred from better-performing states.

https://en.wikipedia.org/wiki/Delimitation_Commission_of_India

What does this mean, and why does it matter?

Let’s talk about a Lok Sabha constituency from Tamil Nadu, and a Lok Sabha constituency from Uttar Pradesh. If the Lok Sabha Member of Parliament (MP) from Tamil Nadu represents a 100 people (let’s assume this), how many people should the Member of Parliament from UP represent?

Should it be around the same number, 100? Is a little bit more OK? Is a lot more OK? At what stage do you say “whoa, this is too much!”? Let’s rephrase the question: should each state in our country send the same number of Members of Parliament to the Lok Sabha, or should larger states send a higher number of MPs? Larger defined in terms of total population, please note.

And one of the tenets of democracy is that each Member of Parliament should represent roughly the same number of people. We can’t have – or shouldn’t have, at any rate – a very large number of MPs representing very few people. Nor should we have a very small number of MPs representing very many people.

Malapportionment from 1971-2021 (based on census data till 2011 and author’s calculation thereafter) Source: Shruti Rajagopalan’s essay

This chart has been taken from Shruti Rajagopalan’s excellent essay, called Demography, Delimitation and Democracy. And what is shows us is one way to answer the question I have raised above. By her calculations, when the delimitation freeze ends*, Uttar Pradesh will have 12 to 13 seats short of what their population should merit. Or put another way, Tamil Nadu will likely have 11 seats more than what their population should merit.

Here’s another way of thinking about this: if a state has (say) x% of a country’s population, it should have (say) y seats in the Lok Sabha. If that be so, another state that has 2x% of a country’s population should have 2y seats in the Lok Sabha.

Why? Because otherwise, the second state will have a smaller number of MPs arguing for it in the Lok Sabha – smaller relative to the number of people in that state. And the first state, of course, will have a larger number of MPs representing that state in the Lok Sabha – a larger number relative to the number of people in that state.

As Shruti puts it in her essay:

One aspect of the “one person, one vote” concept, as envisioned by Ambedkar, was about granting every single Indian over 18 the right to vote in elections. India has adopted universal adult franchise since the birth of the republic in 1950. But to give the principle of “one person, one vote” any meaning, constituency sizes must be roughly equal. The random circumstance of being born in Bihar means that the constituency size is about 3.1 million, but if the same person is born in or moves to Kerala, the value of their vote increases because the constituency size is 1.75 million.

https://srajagopalan.substack.com/p/demography-delimitation-and-democracy

So in essence, each state should send a proportionate number of MPs to the Lok Sabha. And the number of these MPs should be proportionate to what? To the percentage share of the total population in each state. That way, we can make sure that each state gets proportionate representation in the Lok Sabha. Right now, there is an imbalance – the people of Tamil Nadu are over-represented, and the people of Uttar Pradesh are under-represented.

Of course, Tamil Nadu and Uttar Pradesh are used to represent, generally speaking, states in the less populous south and the more populous north respectively.

What is the scale of the problem?

Right, now that we have established this, let’s ask the next obvious question: how many people are there in each state in our country? Here’s one way to answer that question:

https://www.visualcapitalist.com/population-of-india-compared-with-countries/

Here’s another way of putting it – the Indian Prime Minister is in effect the Prime Minister of the populations of all of these countries put together.

You know how we keep saying that hey, we have one-sixth of the population of the world in our country, and it is therefore unfair that we don’t have a permanent seat on the UN Security Council?

Uttar Pradesh can say the same thing (kinda – you know what I mean), but at the national level.

So What Are We Waiting For?

Well, ok then, a layperson might say. All this is good to know, and er, carry on and all that – but why don’t we just go ahead and, you know, change the distribution of the seats in the current Lok Sabha? If UP gets to send 84 MPs to the Lok Sabha, up that number. And If Tamil Nadu gets to send 39 MPs, well, adjust that number downwards. What’s the problem?

Well, the endowment effect, for starters. But more importantly, it’s all well and good to talk about demography and all that, but this is, after all econforeverybody. Sooner or later, rokda must enter the building.

How does this country of ours function when it comes to finances? Well, back when we got independence, we decided that we would organize finance in the following way – states would get to levy some taxes, and they could spend that tax revenue on stuff they were responsible for, such as health, among other things. We call this Own Tax Revenue. The Union government would get to levy some taxes, and part of this revenue would be kept for the Union Government’s expenses (army related expenditure, for example, among other things). And there’s other complications, but we’ll skip that part for now.

But ah, there is a small part of one of the sentences in that last paragraph that hides a world of pain. Note that I said “part of this revenue would be kept for the Union government”. Now, the part that is not kept for the Union Government – how is it distributed to the states?

For example, let’s say the Union government collects 100 rupees in taxes.** How much should it keep with itself? Should it keep 40 with itself and give the rest to the states? Or should it keep 80 with itself and give 20 to the states? Or some other number? How do we decide? How should we decide?

Dr. Arvind Panagariya and his band of merry men and women shall answer this question for us in the months to come, as mandated by the law. They shall answer two questions (and do a whole lot of other things too, of course!)

  1. How much should the Union government keep with itself?
  2. Of what can be distributed to the states, which state should get how much, and why?

It is that second question that is tricky. Oh so very tricky. And figuring out how best to answer it is, as it turns out, what we’re all waiting for.

So How Do We Decide Which State Should Get How Much?

Of all of the taxes collected by the Union government, we first have to decide the split between what the Union Government keeps for itself and what is given to the states. This is called Vertical Devolution.

Then, of what is given to the states, we have to decide how much each state gets. This is called Horizontal Devolution.

The predecessors to Dr. Panagariya’s merry band came up with this formula:

https://fincomindia.nic.in/asset/pdf/commission-reports/XVFC_202021%20Report_English_Web.pdf, p. 29

The higher the population in a state, the more it should get when it comes to horizontal devolution. How important is this idea? It gets 15% weightage.

The larger the physical area of a state, the more it should get (15% weightage)

The greater the forest cover in a state, the more it should get (15%)

The poorer a state compared to average incomes in our country, the more it should get (45%)

The better a state at lowering it’s Total Fertility Ratio (demographic performance) the more it should get (12.5%).

The better it is at mopping up taxes, the more it should get (2.5%).

So while other factors apply, as they should, the primary consideration is this: the poorer a state, the more help it should get.

“Well, of course” you might say, channeling your inner Mahi.

And your inner Mahi would be right, of course. This is how it should be. Except, as our little story at the start of this blogpost helps us understand, it is a bit more complicated than that.

This is a multi-part series, to be continued! In later posts, we shall learn about how to think about this problem from an economic perspective, and how to think therefore about resolving the problem. But this point is worth emphasizing: if you are an Indian citizen, you should be thinking long and hard about this issue.

*Quite when the delimitation freeze will end is a matter of some conjecture. As Shruti says in her blogpost: “The Eighty-Fourth Amendment extended the 1971 census freeze on the total number of seats per state in the Lok Sabha/state legislatures until the publication of the census figures after 2026 (which is expected in 2031, unless the 2021 census is delayed so much that it is only published in 2026).”. I’ll go a step further and say that there is no guarantee, of course, that the 2031 census will be conducted as per schedule.

** How it collects these taxes is a story involving VAT, MODVAT, CENVAT, GST and other horrific acronyms. As with other inconvenient acronyms (such as, say, CRS) so with these acronyms in this blogpost. We shall simply assume that they don’t exist for now.

The Course of China’s Rural Reform

Consider this blog post your periodic reminder to read an essay called “The Course of China’s Rural Reform”, by Dun Runsheng.

Who was Du Runsheng?

Du Runsheng (Chinese: 杜润生; pinyin: Dù Rùnshēng; July 18, 1913 – October 9, 2015) was a Chinese military officer, revolutionary leader, politician, and economist. He has been hailed as “China’s father of rural reform”. From 1982 to 1986, he drew up the annual “Document No.1 of the Central Government” about rural reform, which promoted the development of rural areas.

https://en.wikipedia.org/wiki/Du_Runsheng

And what was he famous for?

Well, a lot of things, but this is relevant for us today:

Du Runsheng held the post of secretary general, Rural Work Department, in the Chinese Communist Party (CCP) Central Committee at the time the nation was founded. Concurrently he was deputy director of the Agriculture and Forestry Department of the State Council. After the Third Plenum of the 11th Central Committee of the CCP (1978), he held the post of director, Rural Policy of the CCP Central Committee, and director of the Rural Department, Research Center for Rural Development (RCRD), State Council, where he was mainly responsible for China’s rural economic reforms and development policy research. Du was often asked by the leadership to draft rural-related policy documents for the Central Committee of the CCP and the State Council. He worked in particular on the drafting of “No. 1 Documents,” which were issued continuously for five years by the CCP Central Committee, and which made outstanding theoretical and practical contributions, deepening rural economic reform and setting up the rural household contract responsibility system that advanced the market reform of the rural economy.

https://ebrary.ifpri.org/utils/getfile/collection/p15738coll2/id/125214/filename/125215.pdf

So how did China do it’s rural reforms? Please read the whole document to get a sense of how they went about it, but to me, the key words are “gradual”, “incremental” and “choice”.

Here is what he says about overcoming resistance to the proposals (all three are direct quotes from the document, please note):

  1. First, the reform would not initially call for abandoning the people’s communes, but rather would implement a production responsibility system within them. This approach enabled many who would have opposed the change to accept it.
  2. Second, the responsibility system could take a number of forms, among which the populace could choose. One did not impose one’s own subjective preference on the populace but respected its choice.
  3. Third, the reform began in a limited region, where it received popular support, and then widened step by step.

We economists are very good at saying that Farm Reforms Must Be Implemented. And the political parties will be in complete agreement about the importance of these reforms depending on whether they are in power or otherwise. Learn to take both of these things as a given.

But as with any good idea, it is not its inherent quality alone that matters. It is also the manner of its implementation.

I am not for a moment suggesting that we copy what China did for its land reforms.

But I am very much suggesting that learning more about how China did it (and other nations besides) might help us.

Without a successful implementation of agricultural reforms, we don’t develop. Our problem is that we are all focussed on the phrase “agricultural reforms”. Not enough of us are focussed on the phrase “successful implementation”.

All About Industrial Policy, Part 2

Yesterday’s post covered what industrial policy is, a taxonomy of industrial policy, some details about South Korea’s industrial policy, and the importance of negative incentives.

So… well, then. We’re done, right? We know industrial policy is important (and why). We know what we did wrong, we know what South Korea got right. So let’s go ahead and er, make shit happen.

Industrial Policy From Here on In Won’t Be Easy

But hang on, let’s first make coffee.

What do we need to make coffee? Well, we need some coffee, we need some water, we need heating equipment of some kind, and we need a person to do all of this for us. In the language of the economist, we can combine raw materials, capital and labor in order to produce output.

But hang on for a second. Do we really need the last item on that list?

Now, you might notice that the cup was placed on the stand, the water was already in the machine, and about a thousand other “Well, actually” responses are possible. And depending on how we think about robotics and AI, our responses are likely to be biased towards either end of the “OhThat’sSoFreakingCool – WTF!” spectrum.

But like it or not, here’s the truth: the advent of AI and robotics is here, and it is only a matter of time before capital replaces many, many jobs in not just manufacturing…but also services.

Yeah, but that’s way out in the future, right?

The Ticking Time Bomb That is India’s Unemployment Problem

Um, not so much:

From 1990 to 2007, the study shows, adding one additional robot per 1,000 workers reduced the national employment-to-population ratio by about 0.2 percent, with some areas of the U.S. affected far more than others.

This means each additional robot added in manufacturing replaced about 3.3 workers nationally, on average.

That increased use of robots in the workplace also lowered wages by roughly 0.4 percent during the same time period.

“We find negative wage effects, that workers are losing in terms of real wages in more affected areas, because robots are pretty good at competing against them,” Acemoglu says.

The paper, “Robots and Jobs: Evidence from U.S. Labor Markets,” appears in advance online form in the Journal of Political Economy. The authors are Acemoglu and Pascual Restrepo PhD ’16, an assistant professor of economics at Boston University.

https://news.mit.edu/2020/how-many-jobs-robots-replace-0504

And the kicker is that this article was published in May 2020. Dunno if you’ve noticed, but there have been a couple of advancements in AI since then.

Long story short, there may just not be that much of demand in manufacturing for labor in the years to come. And that’s a problem for us, because the one thing we will have a lot of is, well, labor:

18 million people turn 18 each year in India and we have over a 100 million people surplus in agriculture. Unless we create 20 million new jobs each year, India’s dream of a demographic dividend could easily turn into a nightmare!

https://takshashila.org.in/20mj

And how are things going on the job creation front?

The number of fresh formal jobs created fell by 10 per cent in 2023 compared to the previous year, reflecting slowdown in the pace of formal job creation, a Business Standard analysis of the latest payroll data shows. This is crucial as only the formal workforce enjoys social security benefits and is protected by labour laws.

Released by the Employees’ Provident Fund Organisation (EPFO), the latest data available till October 2023 shows that 9.06 million new subscribers joined the Employees’ Provident Fund (EPF) between January and October. The figure was 10.1 million in the corresponding period of the previous year.
The data also shows that the number of new young subscribers belonging to the 18-28 age group declined by 11 per cent to 5.97 million this year from 6.71 million in the corresponding period last year. This is crucial because subscribers in this age group are usually first-timers in the labour market, thus reflecting its robustness.

https://www.business-standard.com/economy/news/fresh-formal-jobs-creation-falls-10-to-9-06-mn-in-2023-epfo-data-123122600612_1.html

Quality Over Quantity is Applicable to Debates Too, Y’Know

Now, if you like, you can yip about whether this is the correct way to calculate employment and go on a “actually, it is not all that bad” op-ed writing spree. If you like, you can yap about how this actually understates the problem, and go on a “actually, it is much worse” op-ed writing spree.

Me, I prefer to internalize the fact that we are simply not creating enough jobs, and haven’t been doing so for years.

Worse, the demand for labor is going to go down in manufacturing from here on in. Thinking through this problem is, I would argue, a better use of our time than generating forwardable content for WhatsApp.

This matters, by the way, because election season is upon us, and we will soon have hordes of people yelling at each other on every platform available to humanity, online and offline. Half of them will yell about how 2004-2014 was heaven, and 2014-2024 was hell. The other half will yell about exactly the same thing, but with a (-1) outside the bracket.

Is it half and half? Or is it 37% and 63%? Quick, somebody run an RDD on this so that we can talk about truly important stuff on Twitter!

I invite you, dear wise and discerning reader, to stick your tongue out at all those rabble rousers and look at this chart instead:

Manufacturing, value added (% of GDP) – India, China, Korea, Rep.

Fact: if we had an industrial policy across these twenty years, it has failed. Full stop. No proof required, one might say.

Manufacturing as a percentage of GDP has not only not gone up in this time, it has actually declined from 16% to 13%. I look forward to the world class econometric analysis that Extremely Angry Economists on both sides of the divide will come up with to show that “No, actually, most of the decline occurred in <U/N,P/D,A> era”…

…but again, my personal stance is why bother trying to figure out who couldn’t get a stalled car to start? It’s still sitting right where it was twenty years ago, and that’s the real problem.

And it gets worse:

Manufacturing, value added (% of GDP) – India

So let’s get one thing straight:

Not a single government has managed, over the last three decades, to set India on a sustained and sustainable path of increasing industrialization.

What Have We Learned, And What Do We Know?

Asking why no government could do this so far is a good use of our time. Asking what can be done from here on in is a good use of our time. Squealing and screaming about who is responsible for it not having happened so far may be cathartic, but that’s about it. Doesn’t help much beyond that.

So what can be done from here on in? Well, if the manufacturing chart is a depressing one, here is one imbued with some optimism:

Services, value added (% of GDP) – India

Can services absorb all those young folks looking for jobs in the years to come? Or will manufacturing have to come to the rescue? Can it, given robotics and AI?

How should a policymaker think about this in general? How should a policymaker think about this in an Indian context? What are the strengths and weaknesses of either approach? What does research say about all of these questions? That’s what we will talk about in tomorrow’s post.

But make no mistake: this is what really and truly matters. India managed a good start on the long road to development in 1991, but we haven’t traveled far enough on that route in the years since. And that long road is about to get a whole lot tougher, given AI and robotics.

So please, let’s get a move on.

Should we get started on this then, or should we continue to shirk our responsibilities and shout inanities online instead?

Now that’s the kind of s and sh pontification that I can truly get behind.

All About Industrial Policy, Part 1

In 1961, India’s income per person was $86, South Korea’s was $94 and China’s was $76. India was right in the middle of a very poor pack of countries. India’s income per person today is around $2300, China’s is around $12,500 and Korea’s is around $35,000.

Rajan, Raghuram; Lamba, Rohit. Breaking the Mould: Reimagining India’s Economic Future (p. 47). Penguin Random House India Private Limited. Kindle Edition.

Pictures are worth a thousand words, no?

And as I always say whenever this chart comes up in a class I’m teaching, I don’t think it is possible to look at this chart and not ask “Saala, what did they do that we didn’t?”. And because I like to play around with words, I say that some of the students might also wish to ask what we did that they didn’t.

So what did they do?

They enacted “government policies directed at affecting the economic structure of the economy”, in the words of Joseph E. Stiglitz and Justin Lin Yifu. Or if you prefer shorter, simpler phrases, they had better industrial policy.

So what are these government policies directed at affecting the economic structure of the economy? Why are they needed, what effects do they have, who came up with them, and is there anything special about industrial policy as regards India? Let’s deal with each of these questions in turn, one at a time:

What is industrial policy?

Rapid sustained economic development, Rodrik and Stiglitz tell us, requires an explicit strategy.

And almost always since we came up with the idea of rapid (it’s not always been sustainable in more than one sense of the term, alas, about which more later) economic development, the strategy has always had one goal: how can we industrialize better?

Why industrialize at all is a fair question to ask, of course. And the answer is that it is painfully clear to us that you cannot hope to be a developed nation without industrializing first. This becomes clear by doing lots and lots of complicated econometric studies, or by looking at a chart with a lovely title.

It’s a chart called What The Fuck Happened in 1750? And the answer is industrialization. Industrialization happened, starting 1750. Or there and thereabouts, at any rate:

And so what we would like to do is make sure that as many countries industrialize as quickly as possible, so that the citizens of all countries can live a longer, healthier and more productive life. Or that’s the plan hope, at any rate.

So what is industrial policy? It is a policy aimed at industrializing a country as quickly as possible. And if you go and take a look at the India, China and South Korea chart again, you can now look at it as three separate industrial policy experiments. One of them clearly worked when it was implemented, one figured it out a little while later, while the third is beginning to hit its straps only now.

So did these three countries differ in terms of their industrial policy, or did they have the same type of industrial policy, but different qualities of implementation?

Think diets, if that helps. If three of your friends are comparing their weight loss, were they on different diets, and therefore lost weight at different rates? Or was it the same diet, with some of your friends being better at sticking to it? And in the case of the the countries, it turns out they were implementing wildly different types of industrial policy.

Which begs the question: how many types of industrial policy are there anyway?

Types of Industrial Policy

Dani Rodrik and Mariana Mazzucato present a framework for evaluating the different types of industrial policies in their paper, Industrial Policy with Conditionalities: A Taxonomy and Sample Cases. On pp 8 and pp9 of their paper, they present a simple framework, based on which I have created that picture you see above.

Industrial policy depends, they say, on the answer to these four questions:

  1. What type of firm behavior are you targeting through your industrial policy?
    • Do you hope to ensure equitable access to the products and services that will result from your industrial policy?
    • Or do you hope to direct firms’ activities towards socially desirable goals?
    • Or do you hope to get the successful firms to share their returns with you, the government (via royalties, perhaps, although other options are also available)
    • Or do you plan to require that profits be mandatorily reinvested into productive activities?
  2. How do you plan to work out the conditionalities associated with the program? Are they up for negotiation, or are they cast in stone?
  3. Is the upside from the program split? Is the downside split? (When I say split, I mean between the firm in question and the government).
  4. Finally, what about measurement criteria?

Using this framework, Rodrik and Mazzucato say, you can figure out the type of industrial policy at play.

Here’s how their framework can be applied to the case study of the now famous Oxford/AstraZeneca vaccine program, for example:

https://drodrik.scholar.harvard.edu/sites/scholar.harvard.edu/files/dani-rodrik/files/conditionality_mazzucato_rodrik_0927202.pdf, Table 2

So all right, there’s industrial policy, which is about industrialization, and South Korea seems to have done a better job of it than China and India (so far), and that’s because they used a type of industrial policy that worked better. Speaking of types, there’s lots of different types possible. But it still begs the question: what was South Korea’s industrial policy, exactly?

South Korea’s Industrial Policy

Understanding South Korea’s industrial policy requires a book length treatment, and there are more than a few that have tried to tackle the subject. As you might imagine, it is difficult to compress all of that material into a single blog post. But here’s what can be said:

  • South Korea’s industrial policy was inspired in part by the Meiji Reformation in Japan
  • The Meiji Reformation was in part based on the historical school of economics from Germany.
  • This historical school took part of its inspiration from… and this might surprise you a bit… Alexander Hamilton(!)
  • In particular, you might want to focus on a specific report:

One that has become especially well known was the ‘Report on the Subject of Manufactures’ submitted to Congress in 1791. In the report, he stressed that the United States needed to develop its manufacturing sector in order to grow its economy, bolster its military, secure its sovereignty, increase productivity, and absorb labour. He also stressed that industrialization was necessary to avoid being disadvantaged in trade with European nations, especially Great Britain, the industrial superpower at the time. The way to do this, according to Hamilton, was for the United States to protect and nurture its manufacturing sector through active use of industrial and trade policy. More specifically, industrialization was to be achieved by strategically applying tariffs and import bans on imported manufactured goods.

Hauge, Jostein. The Future of the Factory: How Megatrends are Changing Industrialization (p. 35). OUP Oxford. Kindle Edition.

And so the outline of South Korea’s industrial policy was to protect and nurture its manufacturing sector. Here are two questions worth asking:

  1. Protect it from whom?
  2. Nurture it for what purpose?

It is the answers to these questions that helps us understand where India and South Korea differ in terms of their industrial policy from the second half of the twentieth century.

The Carrot and The Stick

Both South Korea and India, you see, were clear about the answer to the first question. Both of their domestic industries needed to be protected from foreign competition.

But their answer to the second question could not have been more different. South Korea said that the protection and the nurturing was necessary so that South Korean firms could one day become world-beaters.

India, on the hand, ended up protecting its domestic manufacturers in perpetuity. Or least until 1991, at any rate.

We have names for both policies (of course we do). The South Korean policy was about export promotion – protect domestic firms until they learn to play with the big boys on their own turf. The Indian policy was about import substitution – if you’ve ever seen a mollycoddled spoilt Indian kid, that was India’s domestic firms until 1991. (As always, it’s a more complicated story than that, but hey, this post is long enough already. Some other day, maybe, we’ll dive deeper into this)

In other words the South Koreans got their incentives right – they held out the carrot, but didn’t hesitate to wield the stick when necessary. The carrot was pretty much whatever it was that the South Korean firms asked for – cheap labor, state supported finance, guaranteed power, great roads, you name it.

But Rodrik and Mazzucato’s framework comes into play here, because access (pillar 1) was given to export oriented firms, based on strict and non-negotiable conditionalities (pillar 2), with explicit and clear measurement standards (pillar 4):

The capacity to export told politicians in Japan, South Korea and Taiwan what worked and what didn’t and they responded accordingly. Since exports have to pass through customs, they were relatively easy to check up on. In Japan, the amount of depreciation firms were allowed to charge to their accounts – effectively, a tax break – was determined by their exports. In Korea, firms had to report export performance to the government on a monthly basis, and the numbers determined their access to bank credit. In Taiwan, everything from cash subsidies to preferential exchange rates was used to encourage exporters.

Studwell, Joe. How Asia Works: Success and Failure In the World’s Most Dynamic Region (pp. 76-77). Grove Atlantic. Kindle Edition.

And if the measurement in pillar 4 didn’t come up to the expected level, pillar 3 kicked nito play, and how:

North-east Asian politicians then improved their industrial policy returns through a second intervention – culling those firms which did not measure up. This might have meant a forced merger with a more successful firm, the withdrawal of capital by a state-directed financial system, withholding – or threatening to withhold – production licences, or even the ultimate capitalist sanction, bankruptcy. Since the 1970s, there has been much talk about state industrial policy in western countries being an attempt to ‘pick winners’ among firms, something that most people would agree is extremely difficult. But this term does not describe what happened in successful developing states in east Asia. In Japan, Korea, Taiwan and China, the state did not so much pick winners as weed out losers.

Studwell, Joe. How Asia Works: Success and Failure In the World’s Most Dynamic Region (p. 77). Grove Atlantic. Kindle Edition.

India? We have the Industrial Disputes Act, which makes it difficult for us to shut down loss making firms, let alone those firms that are not exporting.

The protection to labour in larger firms is extremely high in India and translates into excessively high effective labour costs. As an example, Chapter V.B of the Industrial Disputes Act of 1947 makes it nearly impossible for manufacturing firms with 100 or more employees to lay off workers under any circumstances. Such high protection makes large firms in labour-intensive sectors, in which labour accounts for 80 per cent or more of the costs, uncompetitive in the world markets. Small firms, on the other hand, are unable to export in large volumes.

Panagariya, Arvind; Bhagwati, Jagdish. India’s Tryst With Destiny . HarperCollins Publishers India. Kindle Edition.

So we’ve learnt:

1. What Industrial Policy is…

2. What types of industrial policy there are…

3. What South Korea’s Industrial Policy looked like back in the day…

4. The importance of negative incentives in designing effective industrial policy (and that India sucked at getting the negative incentives right)

OK, cool. So CTRL-C and CTRL-V the South Korean awesome sauce idea into India and we’re sorted. Right?

Right?

To be continued tomorrow!

Opportunity Costs and The Tragedy of Pluralism

Us economists, we are used to the concept of opportunity costs, and we love pointing out that opportunity costs are everywhere.

Part of my job when I teach principles of economics is to point this out relentlessly and throughout the semester – that no matter what you do in life, there are costs and consequences.

But there are those, we learn in today’s blog post, who may choose to not acknowledge the fact that there are trade-offs:

Consider the following moral clashes: Negative liberty v. positive liberty; liberty of the individual v. the safety and security of the community, group, or nation; deference to authority v. individual autonomy; sanctity and piety v. skepticism, curiosity, and irony.

Berlin maintained that every ideal listed above, on either side of each clash, is worthwhile. He then divided the human world into two broad human types—those who recognize these clashes and accept the need for trade-offs to negotiate them, and those who refuse either to recognize or accept the need for such choices. In an essay written a few years before “Two Concepts of Liberty,” Berlin adapted a saying by the Greek poet Archilochus—“The fox knows many things, but the hedgehog knows one big thing”—in order to flesh out the contrast

https://www.persuasion.community/p/isaiah-berlin-and-the-tragedy-of

Should one optimize for the liberty of the individual? What a stupid question, you might say. Of course one should. But ah, what if the liberty of the individual puts the safety and security of the community, the group or the nation at risk? Then, in that case, should one optimize for the liberty of the individual, or the safety of the community?

If this sounds too abstract, consider the problem of gun control in the United States of America.

What about individual autonomy? Should one optimize for it, even when it goes up against showing deference to authority? Consider the right to protest, for example. Should one optimize for it, even when it goes up against showing deference to authority?

What about sanctity and piety versus skepticism, curiousity and irony?

The point that Isaiah Berlin was making in this, his most famous essay, was the fact that even something as worthwhile as liberty comes at a cost. The negative and positive dimensions of liberty are “in deep tension with each other”, and optimizing for one often means giving up on the other:

The ordinary resources of empirical observation and ordinary human knowledge … give us no warrant for supposing that all good things, or all bad things for that matter, are reconcilable with each other. The world that we encounter in ordinary experience is one in which we are faced with choices between ends equally ultimate, and claims equally absolute, the realization of some of which must inevitably involve the sacrifice of others. … If, as I believe, the ends of men are many, and not all of them are in principle compatible with each other, then the possibility of conflict—and of tragedy—can never wholly be eliminated from human life, either personal or social.

Berlin, Isaiah. “Two concepts of liberty.” In Liberty Reader, pp. 33-57. Routledge, 2017.

The optimization of one’s particular “monism” is ultimately both a failed as well as dangerous pursuit. There are other truths in the world, and other people have other ideals. When one’s ideals and one’s goals go up against someone else’s, there is a “clash of values”.

Resolving these clashes isn’t easy or exciting. But not resolving them, or worse, defeating to the point of subjugation those who dare oppose your own one true way hasn’t ended well:

“But you must believe me, one cannot have everything one wants—not only in practice, but even in theory. The denial of this, the search for a single, overarching ideal because it is the one and only true one for humanity, invariably leads to coercion. And then to destruction [and] blood….”

https://www.persuasion.community/p/isaiah-berlin-and-the-tragedy-of

Or, in the language of this blog, yes, sure, be clear about what you’re optimizing for. But also ask if that is the only worthwhile goal in life, and ask if it’s absolute and total attainment is worth it. Even if you say it is worth it, relative to what?

And hey, remember: the truth lies somewhere in the middle!

Selection > Incentives

I blame old age, so there.

See, the thing is, I cannot for the life of me remember where and in what context I heard this line today: selection matters more than incentives.

It sounds like the kind of thing Tyler Cowen would say (and indeed, he’s written an entire book about it), but I cannot say for sure. So my apologies for not being able to attribute it properly, but whatay idea, no?

We’re big on the line “incentives matter” in these parts. In fact, if you click on that link in the previous sentence, you could spend a couple of hours, easy, going through my earlier posts on the topic. And don’t get me wrong – not for a moment am I suggesting that incentives do not matter. Of course they do!

But in the context of getting folks to do what you’d like them to, selection often matters more than incentives.

And as with so many other things in the world, it comes down to just two words: demand, and supply.

Example : You, as a college professor, would like students to do a really god job on their theses in their final year.

Example : You, as a manager of a team in an organization, would like your team members to execute a particular project really well, and on time.

Example : You, as a citizen of your nation, would like your elected leaders to do a good job.

In each case, you could (and should) ask about how to go about designing the best set of incentives in order to achieve your objectives. That’s supply.

But that being said, it sure would help if the folks you were designing these incentives for were good at execution in the first place! What is the demand like for these awesome incentives you’ve got lined up?

You could have the best incentives in the world, but if you don’t have the best students/team members/politicians to begin with, the incentives don’t matter much, now do they?

And so the story begins with a good selection mechanism: how do we get “the best” students into a college? How do we hire the best employees for an organization? How do we go about electing the best possible leaders?

Once we figure out the answers to these questions, we can (and once again, we absolutely should) figure out how to best incentivize them. But incentivizing good, talented and motivated folks is much easier than it is to incentivize average folks.

The primary constraint is getting the right people in place. Once you do that, getting the incentives right is the relatively easy part.

Or, as the title of this post puts it:

Selection > Incentives

Now Do Cricket!

As you might know, Tyler Cowen wrote a book about the Greatest of All Time in economics. It is a free to read book, and can be read “through” ChatGPT. Here’s the book, if you haven’t read it yet.

The book was written mostly during the pandemic, and the idea for writing the book in the way that it has been written came via Bill Simmons. Who is Bill Simmons is an entirely fair question to ask if you are not a fan of basketball:

In July 2008, Simmons announced that he would be taking 10 weeks off from writing columns for ESPN.com’s Page 2 to concentrate on finishing his second book, The Book of Basketball: The NBA According to the Sports Guy, which was released on October 27, 2009. The book tries to find out who really are the best players and teams of all time and the answers to some of the greatest “What ifs?” in NBA history. It debuted at the top of The New York Times Best Seller list for non-fiction books.

https://en.wikipedia.org/wiki/Bill_Simmons

Long story short, Tyler Cowen wrote a book explaining who his favorite economist was by writing it the way a basketball fan would have written the definitive book about who his favorite basketball player was.

Such a good idea, no?

But wait, it gets better.

Cardiff Garcia interviewed Tyler recently, about just this book. But with a twist: the second half of the interview is about asking who the basketball equivalent of a truly great economist would be.

So, for example:

So if Adam Smith could be compared to one great basketball player, who would it be for you?

https://www.bazaaraudio.com/the-new-bazaar/if-econs-could-hoop

Tyler’s answer, and Cardiff Garcia agrees, is Bill Russell. Now, I know next to nothing about basketball, so I have no clue how to evaluate this answer. He and his team won 11 out of the 13 (!) seasons that he played in the NBA, though, so I’m happy to go along with their pick.

But I have the obvious question, as a fan of cricket: who is the cricketing equivalent of Adam Smith?

To my mind, there are only two possible answers: WG Grace, and The Don. But based on what little I know of both of them, and this little nugget from Tyler and Cardiff’s conversation, I’d probably go with Sir Donald Bradman:

CARDIFF: With all that as a windup, I’m gonna first start by asking you about the three GOATS that you listed in your book. So these again would be Adam Smith, John Stuart Mill, and Milton Friedman, and ask if there are any analogs from the history of basketball. So if Adam Smith could be compared to one great basketball player, who would it be for you?

TYLER: There are analogs for all three. Adam Smith, to me, is the Bill Russell of economics. Or Bill Russell is the Adam Smith of basketball. The first player to get it right, do very well, play the game seriously, bring to it quality, intelligence, work ethic, win a lot of championships, build a great team.

https://www.bazaaraudio.com/the-new-bazaar/if-econs-could-hoop

Perhaps you agree, perhaps you don’t. Perhaps you have another contender, which is awesome, for we can then have a passionate argument about economics and cricket, and what could possibly be better?

(But, uh, you’d be wrong. The only correct answer is Don Bradman.)

But ah, Cardiff’s next question is an even bigger lightning rod for controversy. Which basketball player, Tyler is asked, is the right analog for John Stuart Mill. The reason this matters is because John Stuart Mill is Tyler’s pick for Econ Goat. So who, Tyler is being asked, is the basketball Goat?

Tyler’s pick is LeBron James.

Who, then, is the cricketing equivalent?

I’m forty-two years old, and an Indian. Do you even need to ask?

Read the rest of their conversation to learn more about Goat economists, Goat basketball players, and in order to frame (hopefully) endless debates about Goat cricket players.

But also read the rest of the conversation for some truly delightful nuggets about economics. Of which, this is by far my favorite:

TYLER: The one time I spent time with Robert Solow was the retirement event for Thomas Schelling at Harvard. Solow was so rude to Tom. On the date of his retirement. Tom didn’t want to retire, there was mandatory retirement at 70. They got everyone together to pay tribute to Tom. Everyone else was warm and glowing.

Bob Solow totally cut the legs out from underneath Tom, insulted him, told him he didn’t know enough math, didn’t use enough technique.

CARDIFF: On the day of his retirement?

TYLER: On the day of his retirement, in front of a lot of other people! I couldn’t believe it.

CARDIFF: That’s a little strange. I’ve never heard that story, by the way.

TYLER: Not many people were there. It was organized by Dick Zeckhauser. And Tom even afterwards kind of shrugged and looked at me like, well, I guess this is how it’s going to be, and he took it in good enough humor. But I was appalled.

https://www.bazaaraudio.com/the-new-bazaar/if-econs-could-hoop

Huh.

And finally, wouldn’t it be fun if Indian economists replicated the entire exercise for cricket, and made a podcast or YouTube video out of it?

And I know just the person too…!

In Praise of Random Questions

I’ve written about this before: I am in the habit of asking my students to ask me five random questions at the end of each class. The questions can be about absolutely anything, the only condition being that they cannot be about the topic we have discussed in class.

The reason I bring this up is because Tim Harford’s column in the Financial Times serves up it’s own share of delightfully random questions:

Last year, inspired by Randall Munroe’s delightful books What If? and What If? 2, I invited the good folk of Twitter to ask me absurd hypothetical questions about the economy, to which I would attempt some serious answers. This year, we’re going to do it all again.

https://timharford.com/2024/01/more-of-your-crazy-economics-questions-answered/

Tim Harford covers five questions in this column, and while I encourage you to go read his answers in his original blogpost, I’ll list out the questions here:

  1. How big would an asteroid made of precious metal have to be for it to be worth doing a space mission to bring it back?
  2. Could a universal currency ever be based on electricity, or currents?
  3. What if your tax bill was discounted by the distance you lived from the centre of London (eg if you lived in Kingsway, you paid the full amount; if you lived in Shetland, you would pay no tax)?
  4. What if inflation was made illegal? Could we legislate that no prices could ever rise?
  5. In the UK, we used to print banknotes on paper, now it’s a horrible slippery plastic. Could we use a more environmentally friendly material, like leaves? Or perhaps something edible — printed on some sort of simple flour and water biscuit? No waste!

Magnificent – just magnificent questions. In answering them, Tim Harford covers (without always naming them explicitly) scarcity, relative prices, optimization, the functions of money, volatility, Jane Jacobs, relative prices, price as a signal (not to mention an incentive!), Douglas Adams (!) and the supply of money.

One needn’t stop there, of course. You could introduce many other topics into the discussion, in addition to those already covered by Tim Harford. But the point here is that all of these topics could be introduced in response to the questions asked by the students. These topics aren’t being introduced “because they are a part of the syllabus”, but because these are helpful concepts that help in formulating sensible responses to delightfully random questions.

Sensible responses to delightfully random questions is exactly what “What If” and “What If 2” are all about, as Tim Harford points out in his column. And that, of course, is the guiding spirit behind such questions – students should tap into their natural curiosity about the world, and ask mind-bending and patently ridiculous questions.

This forces the person answering the question to build up their response from first principles, in order to show why and how the answer to the question cannot help but be ridiculous. What a remarkably powerful way to teach, no?

Why is it remarkably powerful? It is remarkably powerful because we ask the students to imagine a better world, if only we could do x. Look at the fifth question in the list, for example.

And then the question becomes, well, why can we not do x? Well, here’s why: reason 1, reason 2 and reason 3. In order to explain our reasoning, we introduce concepts. We don’t introduce concepts Because That Is What We Do So That The Syllabus Is Completed – we introduce concepts in order to answer questions that students came up with.

And I don’t know about you, but both my theory of how the world work and my experience for having taught introductory economics for many years tell me that students are much more likely to be attentive when it is weird questions being answered sensibly.

Or here is another way of putting it: memorizing a textbook, and occasionally asking if it is applicable to the world can get pretty boring. But looking at the world, asking questions about how we can make it better, and then learning about concepts that either validate or invalidate the premise of the question – that’s not boring at all.

Would you rather memorize the functions of money, for example, or would you rather wonder about why we cannot use electricity as a currency? Or time, for that matter! Now, if you were to ask me why we couldn’t use electricity or time as money, I may have to end up explaining the functions of money to you, and also explain why these functions can’t be carried out by time or electricity.

Ah, you might say, that makes sense. Now you know why time can’t be money (hehehe), plus you’ve ended up learning about the functions of money. Fun discussion, plus learning. What’s not to like, I ask you.

If you aren’t asking weird questions, you aren’t learning.

Ask weird questions!

Home, Expensive Home

The chart of the day comes from the excellent Vivek Kaul:

https://www.livemint.com/industry/buying-homes-why-tax-policies-need-a-tweak-11705234900028.html

What this shows us is that over the last sixteen years or so, there has been a steady increase in the percentage of home loans that have been given to the non-priority sector – that’s the blue line. These were at about 30% in 2007, and are at about 70% today. Obviously, the red line shows us that priority home loans have taken the journey in the opposite direction, falling from about 70% of all loans disbursed in 2007, to about 30% today.

What is a priority home loan, and what is a non-priority home loan?

Priority home loans are loans amounting up to Rs 35 lakhs in metropolitan centers, and up to Rs 25 lakhs in other parts of the country. There’s fine print, but for our purposes, this is a simple and good enough definition. Non-priority home loans, of course, are loans above these amounts.

Long story short, rich people are taking loans to buy homes, while poor folks, not quite as much. But why should this be so? Part of the reason, Vivek Kaul says, is incentives:

Tax policy in India incentivizes buying homes as an investment. Income earned from the salary or business income of an individual is taxed at the marginal rate of tax. The highest marginal rate of tax, even without taking the different kinds of surcharges for higher income into account, is 30%. At the same time, long-term capital gains made from selling residential real estate is taxed at 20% with indexation benefits being available. Indexation allows the consideration of inflation while calculating the price of buying a house as well as improvements made on it over the years, in order to calculate capital gains. Long-term capital gains on selling a home come into the picture if the period of holding between the buy date and the sell date is more than 24 months. This effectively means that the tax on capital gains (a form of income) made from buying and selling of homes, is significantly less than even 20% (it can be even lower than 10%). Plus, the holding period of two years is way too low

https://www.livemint.com/industry/buying-homes-why-tax-policies-need-a-tweak-11705234900028.html

When you buy a house and sell it, say ten years down the line, the gains you make on selling the house at a higher price are taxed at 20%, not 30%, as your highest income would be. Second, your gains aren’t taxed – your gains net of inflation are taxed. And so buying a house and selling it can be plenty darn profitable – a house isn’t necessarily a place to stay. It is, instead, an investment. Take away this incentive, Vivek Kaul says, and you might see the “demand” for housing come down.

Speaking of incentives, he also has an idea for increasing the supply of homes available in cities for renting:

At the same time, the government needs to encourage those who own homes, to not keep them locked and rent them out. On the tax front, this can be achieved by taxing rental income from homes at a lower tax rate. This will also discourage those landlords who insist that tenants pay them in cash (at least in part).

Of course, this will only be a very small step in making residential real estate in cities across India a little more affordable, given that the sector is too complicated and too convoluted to be set right only through incentives and tax policy.

https://www.livemint.com/industry/buying-homes-why-tax-policies-need-a-tweak-11705234900028.html

Incentives matter, and our current policy mix incentivizes the construction of, and the purchase of, unnecessarily expensive homes, but not for the purpose of staying in them. Vivek Kaul says that taking away the incentive of capital gains tax on housing, and introducing a lower tax rate on rental income could go a long way in terms of maki housing for affordable in India’s cities.

Now, homework:

Is this a good idea or a bad idea? Who will benefit by this, and who will be harmed by this? Who will support this idea, and who will protest such an idea? Which group is likely to be politically more active? What are the risks of implementing Vivek Kaul’s ideas? Try adding at least a couple more questions to this list, and then answering them. Some of these questions (and their answers) are already there in Vivek Kaul’s column, see if you can spot them!

How Might I Be Wrong?

Nobody does it better than Tyler Cowen, and it’s not even close.

What am I talking about? I’m talking about the extremely difficult art of asking the question that is the title of this blog post, and then answering it by writing about it.

There was a post over on MR recently titled “Will Milei Succeed in Argentina?”. In the very first paragraph, Tyler points out that he (Tyler Cowen) wants Milei to succeed.

I give him a 30-40% chance, which is perhaps generous because I am rooting for him.  Bryan Caplan, who is more optimistic, offers some analysis and estimates that Milei needs to close a fiscal gap of about five percent of gdp.

https://marginalrevolution.com/marginalrevolution/2024/01/will-milei-succeed-in-argentina.html

But the rest of the post doesn’t lay out reasons for why Tyler is right to root for him, or why Milei might succeed. It is, instead, the exact opposite. Tyler asks the much more difficult question: why might Milei fail?

You may or may not agree with the rest of Tyler’s post, and about his take on whether Milei will succeed or not. The real lesson to take away from here is the point that Tyler is forcing himself to ask, and answer, the most difficult question of them all for a writer: “What is the best possible argument for how I might be wrong?”

And this is a really, really difficult thing to do. Say, for example, that you are opposed to PM Modi. Your task is to write about ways in which his policies have been good for India, and will be good for India in the years to come. On the other hand, if you are a supporter of PM Modi, your task is to write about the ways in which his policies have been bad for India, and will be bad for India in the years to come.

You could take the easy way out and do a round-up of what other people (on the other side of the fence) are saying. But that’s not the point – that simply shows what other people are saying. Worse, supporters and detractors have a way of confidently expressing hopeful assertions. The causal pathways are often missing from their analyses – it isn’t so much an expression of ways in which they might be wrong. Rather, it is a statement to the effect that “if x materializes, I will have been proven to be wrong.”

What we’re looking for is this instead: “Here’s why I don’t think x will materialize. Here are my reasons for thinking what I do, and here are the ways in which I could be wrong, and for the following reasons.”

This is really, really hard to do (trust me). But the more you force yourself to do it, the better a thinker you are likely to become. I try and do these exercises every now and then, and the reason I don’t post the results of such exercises very often is because a) I avoid doing this as much as possible b) I’m not very good at it when I do get around to doing it (if you’re itching to point out the causal link between these two, I’m way ahead of you. Go away.)

So hypocrisy alert aside – I don’t practice what I’m about to preach, you see – do give it a try. Ask yourself how you might be wrong about your model(s) of how the world works.

Good luck, because you will need it.