If only economists could be like dentists

Discussions about governance in India repeatedly turn into discussions about individuals. The Delhi Metro happened because of E Sreedharan; Sebi works well because of CB Bhave; education malfunctioned under UPA I owing to Arjun Singh. Why did urban governance in Surat or Nagpur work well? A few key individuals fixed the problems. If this is the core issue, it puts a huge burden on the appointments process.

Economists are trained to be unsatisfied with explanations based on individuals, and look for deeper sources of dysfunction. The story that an economist would tell is one where India has bad elementary education because Sarva Shiksha Abhiyan has basic design mistakes.

How would we make drinking water in Bombay work well? An emphasis on personalities would demand finding the right person to run it. How does this happen in advanced economies? The typical small town in an OECD country—and in many developing countries—has 24x7 supply of clean drinking water in the taps. This isn’t done by having a miraculously effective appointments process. There is a fairly humdrum process of recruiting fairly ordinary bureaucrats into water utilities, or contracting out to private utility companies, and the job gets done. In OECD countries, 24x7 clean drinking water in the taps is not exotic rocket science. It happens all the time, because the deeper institutions are structured correctly.

This is clearly the scalable path. A few good successes in the appointments process might achieve 24x7 drinking water in a few towns. But the real story is clearly deeper. It is about getting to an institutional mechanism that can be rolled out all across the country, which will deliver 24x7 clean drinking water in 5,000 towns.

Institutional change is hard, and all too often there is a temptation to paper over a dysfunctional institutional mechanism by demanding top quality leadership, which will produce good outcomes despite bad institutions. A good judge will overcome all problems in the legal system, work hard, process a large number of cases per month and deliver good judgments against the odds. A good doctor will rise above the terrible problems of a government hospital and heal patients all the same. These individuals are revered, and rightly so.

Each good judge and each good doctor deserves the gratitude of society for being useful against all odds. But these are drops in the ocean. Good governments are not built out of good individuals. They are built out of good laws and good incentive structures. The men who will heal health policy are more important than the men who will heal patients.

Keynes once wrote, “If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.” Mervyn King of the Bank of England famously said the purpose of monetary policy reform is to make it boring. This is all about removing the ‘mystique’ from central banking, depersonalising it so the identity of the governor does not matter. Instead, central banking should be based on transparency, predictability, accountability. A good central bank is one that delivers the same correct reaction function across changes in staffing.

An informal slogan at the ‘Water and Sanitation Program’ (WSP) was: “Don’t fix the pipes. Fix the institutions that fix the pipes.” What we need today is not a leader to properly run an organisation that repairs water pipes. What we need today is the leadership that will change laws and incentives so that we achieve good institutional arrangements on water supply.

A useful analogy is TN Seshan’s role in building the election commission, which is now one of India’s great institutions. We respect Seshan today not because he ran one or two elections well, but because he was an important actor in institution building. An equally great contribution was made in recent years with the implementation of electronic voting machines. This field has been successfully depersonalised: the performance in conducting elections has held up despite occasional dubious staffing choices at the election commission.

So do we hire great men or do we build great institutional arrangements? We hire the great men who will do institutional reform. As long as we are a third world country struggling to get ahead, we will remain vulnerable to the vicissitudes of the appointments process. But the recruiters should not look for the right person to man the system. His job should be to fix it. The interesting candidate is not someone who knows how to make decisions on raising or lowering interest rates. He is someone who knows how to set up a central bank that knows how to raise or lower interest rates.

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Economic slowdown: Is the end in sight?

The numbers for the Index of Industrial Production for January 2009, released Wednesday, are along broadly expected lines. The overall index dropped by 0.5 per cent from its level of January 2008, while the manufacturing component, accounting for about 80 per cent of the index, dropped by 0.8 per cent.
Along with the significant upward revision to the December numbers, which saw the estimated growth from December 2007 change from -2 per cent to -0.5 per cent, these relatively small negative numbers give the impression of a bottoming out of the decline. Indeed, they suggest that the stringent credit conditions that emerged in October, and contributed to the decline immediately afterwards, have begun to ease and producers are now using low input prices and interest rates to replenish depleted inventories. If this is the case, it is indeed good news for a beleaguered economy and its prospects for the year ahead.
However, the numbers need to be understood in greater detail, and must be interpreted with caution. In the first place, if these numbers were in fact a precursor to a bottoming out, they suggest that the transmission from policy action to economic response is lightning fast.
Monetary policy turned pro-growth in October. There was also a significant fiscal stimulus around the same time, as the government paid out a part of the arrears on account of the implementation of the Sixth Pay Commission recommendations. This, it appears, is having some impact.
The numbers for consumer durables production have shown an increase, though small, in contrast to the negative pattern seen for this category over the past few months. Perhaps government employees who received their arrears are doing the right thing by the economy and using them to buy new appliances. As the implementation spreads to state government and public enterprise employees, this suggests significant support to some sectors.
On the broader issue of transmission lags, though, the implied speed of the process raises some questions. Of particular interest is the surge in the industry segment machinery and equipment, which grew by 17.5 per cent over January 2008. This took the capital goods category to a growth rate of 15.4 per cent, completely against the grain of the past few months.
This number is, in fact, reminiscent of the investment boom of a couple of years ago. It would be greatly reassuring to policymakers and investors if machinery production were surging in the current environment. But, in the midst of all the news that is coming in from companies, banks and other players, it stretches credibility.
The aberration is even more striking when compared with the performance of other industry segments. Only five of the 17 showed positive growth. Metal products and transport equipment, both driven by the factors similar to machinery and equipment, declined by 4 per cent and 13.4 per cent, respectively, over January 2008. Cotton textiles declined by 8.5 per cent, as did sectors which have relatively high export content, like leather and leather products. Even food processing, typically seen as a relatively stable segment, declined by a huge 16.1 per cent.
In short, take away the machinery and equipment segment and the decline in the manufacturing sector would appear much more drastic. Quality and consistency issues apart, the conclusion that a bottom is being reached seems premature.

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Blame economists, not economics

Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks - at least those used in advanced courses - are fine.
As the world economy tumbles off the edge of a precipice, critics of the economics profession are raising questions about its complicity in the current crisis. Rightly so: economists have plenty to answer for.
It was economists who legitimised and popularised the view that unfettered finance was a boon to society. They spoke with near unanimity when it came to the 'dangers of government over-regulation.' Their technical expertise -- or what seemed like it at the time -- gave them a privileged position as opinion makers, as well as access to the corridors of power.
Very few among them (notable exceptions including Nouriel Roubini and Robert Shiller) raised alarm bells about the crisis to come. Perhaps worse still, the profession has failed to provide helpful guidance in steering the world economy out of its current mess. On Keynesian fiscal stimulus, economists' views range from 'absolutely essential' to 'ineffective and harmful.'
On re-regulating finance, there are plenty of good ideas, but little convergence. From the near-consensus on the virtues of a finance-centric model of the world, the economics profession has moved to a near-total absence of consensus on what ought to be done.
So is economics in need of a major shake-up? Should we burn our existing textbooks and rewrite them from scratch?
Actually, no. Without recourse to the economist's toolkit, we cannot even begin to make sense of the current crisis.
Why, for example, did China's decision to accumulate foreign reserves result in a mortgage lender in Ohio taking excessive risks? If your answer does not use elements from behavioural economics, agency theory, information economics, and international economics, among others, it is likely to remain seriously incomplete.
The fault lies not with economics, but with economists. The problem is that economists (and those who listen to them) became over-confident in their preferred models of the moment: markets are efficient, financial innovation transfers risk to those best able to bear it, self-regulation works best, and government intervention is ineffective and harmful.
They forgot that there were many other models that led in radically different directions. Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks -- at least those used in advanced courses -- are fine.
Non-economists tend to think of economics as a discipline that idolises markets and a narrow concept of (allocative) efficiency. If the only economics course you take is the typical introductory survey, or if you are a journalist asking an economist for a quick opinion on a policy issue, that is indeed what you will encounter.
But take a few more economics courses, or spend some time in advanced seminar rooms, and you will get a different picture.
Labour economists focus not only on how trade unions can distort markets, but also how, under certain conditions, they can enhance productivity. Trade economists study the implications of globalisation on inequality within and across countries. Finance theorists have written reams on the consequences of the failure of the 'efficient markets' hypothesis.
Open-economy macroeconomists examine the instabilities of international finance. Advanced training in economics requires learning about market failures in detail, and about the myriad ways in which governments can help markets work better.
Macroeconomics may be the only applied field within economics in which more training puts greater distance between the specialist and the real world, owing to its reliance on highly unrealistic models that sacrifice relevance to technical rigour.
Sadly, in view of today's needs, macroeconomists have made little progress on policy since John Maynard Keynes explained how economies could get stuck in unemployment due to deficient aggregate demand. Some, like Brad DeLong and Paul Krugman, would say that the field has actually regressed.
Economics is really a toolkit with multiple models -- each a different, stylised representation of some aspect of reality. One's skill as an economist depends on the ability to pick and choose the right model for the situation.
Economics' richness has not been reflected in public debate because economists have taken far too much license.
Instead of presenting menus of options and listing the relevant trade-offs -- which is what economics is about -- economists have too often conveyed their own social and political preferences. Instead of being analysts, they have been ideologues, favouring one set of social arrangements over others.
Furthermore, economists have been reluctant to share their intellectual doubts with the public, lest they 'empower the barbarians.'
No economist can be entirely sure that his preferred model is correct. But when he and others advocate it to the exclusion of alternatives, they end up communicating a vastly exaggerated degree of confidence about what course of action is required.
Paradoxically, then, the current disarray within the profession is perhaps a better reflection of the profession's true value added than its previous misleading consensus. Economics can at best clarify the choices for policymakers; it cannot make those choices for them.
When economists disagree, the world gets exposed to legitimate differences of views on how the economy operates. It is when they agree too much that the public should beware.
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It’s an emotional recession

An illiterate old man in Mumbai runs a brisk trade selling pakoras at a busy intersection. He never watches TV and cannot read, but is smart enough to push his sales with clever pricing options. As his profits increase, he branches out into other snacks, recruits support staff and even begins delivering to nearby homes. At some point of time, he manages to save enough money to open up a small shop.
One day, the old man’s welleducated son—thanks to his father’s hard work, he’s enrolled in a local management programme—asks his father, “Dad, aren’t you aware of this thing called the meltdown?” “No,” the father replies, “but tell me about it.” The son quickly runs through the recent chain of events: subprime fiasco, bank failures, global recession, slowdown in India, decline in exports, car sales and a whole host of other things that are too complicated for the old man to digest. But he gets the drift. Businesswise, things are getting bad. The father immediately cuts down on the variety of snacks and reduces staff. Fewer people stop by to eat. Sales drop rapidly. The father gradually looses enthusiasm for the business and closes shop.
Some of the details in this madeup story are perhaps improbable— who, for instance, doesn’t watch television in India?—but the basic premise gives a very coherent picture of the psychology of consumers and business owners today. Much like consumers who were caught in severe financial meltdowns such as the Great Depression of the 1930s in the US, or the Asian meltdown in the late ’90s—a serious crisis of confidence is now gripping Indian consumers who are spending less in the face of economic uncertainty. This is grim news for businesses that have had to contend with a steep drop in sales and are now forced to shut shops and fire employees. Problem is, when fewer goods are produced, less income is generated, further decreasing spending ability as well as consumer confidence, thereby worsening the situation in a deadly, never ending vortex.
Following swiftly on the heels of the US, India is going through a crisis of consumption. Though the rate of consumption growth had almost tripled through the past few decades—from only 3 per cent a year in 1970-71 to 8.5 per cent in 2007-08—a deceleration in this growth is almost certain in the current year .
Naturally, this cutback in consumption is putting people on edge. “I am suffering from Recession Depression,” complains a top investment banker who says that he can’t remember the last time he closed a deal. “Forget cabs, five-star hotels and lavish office lunches, I’m carrying tiffin,” he complains. The slowdown has meant fewer trips to his hair salon and a resolute avoidance of end-of-the-season discount purchases. Clearly, this banker has lost his sense of job security and his appetite for shopping.
Other professionals across the spectrum seem to echo these woes. “I have been dithering for a while now on my much-delayed car change,” says Shariff Khan, an auto engineer-manager in Pune. For the last five years, head hunters badgered Khan with offers, which he gave little time or attention to. Then came the slowdown, and in early February, Khan decided to spruce up his resume, the first time in a decade. He also activated his dormant IIM Ahmedabad and IIT Delhi alumni networks. “You never know,” says Khan. This sudden loss of job security seems to be sweeping the corporate landscape in India. “Unless you’re sure you won’t lose your job over the next 3-4 quarters, you’re not going to buy a new house or car,” says Siddhartha Roy, Chief Economist, Tata Group. Psychologist and author Judith M. Bardwick calls this a psychological recession, “an emotional state in which people feel extremely vulnerable and afraid for their future.”
So, how exactly are people saving to get them through these bleak times? The BT Demand Survey shows that out-of-town travel and outside-of-home food is what people are cutting back the most on. An increasing number of puband-bar goers have downtraded to cafes. Spending on clothes, footwear and celebrations have shrunk, too. Footfalls—which is not the same as buyers—for Shoppers Stop during April-September 2008 were up just 1 per cent. Thirty-year-old Parul Ahluwalia, a private bank executive, is restricting her wedding celebrations to two days instead of three. One of the ceremonies is now to be held at a temple. “Though I may be able to keep my job, there surely won’t be a bonus,” says Ahluwalia.
This hesitation to spend is causing serious pain for businesses. A BT-CII producers’ survey shows just how bad the news is. Demand has shrunk for 90 cent of the respondents in the survey. Nearly 70 per cent rated lack of consumer confidence as the biggest economic problem today—several notches above credit unavailability. “Less than half the inquiries are converting into sales,” rues Rajiv Mitra, official spokesperson for the second-largest car maker Hyundai, although he says that the company has fared better than its peers. Sales are down at all price points for the car maker. “The big real estate developers used to be big buyers but we aren’t seeing them any more,” says Manishi Sanwal, GM, Louis Vuitton Moët Hennessy Watch & Jewellery India. The luxury product maker isn’t too alarmed yet, but admits that the small and medium entrepreneurs aren’t flocking to its outlets any more.
Consequently, companies are making some painful decisions. Ramesh Srinivasan, Executive Director, KPMG, says that companies are cancelling new product launches and cutting back on expansion plans. Retail chains, for instance, are shutting down stores. “It’s no longer wait-and-watch, but cancel,” he says. “An economy that was expanding at 10 per cent growth now has to adjust to 5 per cent growth,” says Subir Gokarn, Chief Economist, S&P, India. Latest available data on capital expenditures from the CMIE indicate that for June-September ’08, as many as 45 investment projects worth Rs 42,700 crore were abandoned or shelved, 20 more than the same period last year.
Cutbacks in production and consumption mean that offices have become stingier. The handset allowance for all of B.K Modi Group’s mid-level officers is down from Rs 10,000 a year to Rs 3,000. “Foreign magazines were disconbt tinued about the same time toilet paper was withdrawn and the joke was that the office didn’t want them misused,” says Ramanathan Bhat, a mid-level employee at a Bangalorebased CA firm. An unforeseen consequence of all of this is a rise in office politics; bosses are getting bossier. “Would you believe, I bumped into my arch rival at the shrink’s last weekend,” says a senior manager of an export house. Turns out, acute insecurity and sleep loss are the common diagnoses for both since only one will keep his job.
So, who looks like they’re doing okay? Rural and semiurban India seem to be immune to the “won’t-spend” virus. Sales of electronics, especially colour TV sets and soaps and shampoos, continue to remain healthy. “Newer markets beyond the top 35 cities are booming for us,” says Ruchika Batra, official spokesperson for Samsung Electronics.
The urban poor, however, are just as vulnerable as the upwardly mobile classes. 23-year-old Ravi Yadav, a flower-garland seller in Old Delhi, took home unsold flowers every single day in January. Gulabi, a 28-year-old sex worker in Mumbai’s red-light area of Kamtipura, where hourly rates go up to Rs 3,000 says: “The amount of work has doubled but rates have halved.”
Ultimately, this dangerous whirlpool effect of a consumption drop leading to a supply slide—and therefore more layoffs and more economic pain—can become a crippling, vicious spin cycle. This is where the government’s stimulus package can become vital bridges between short-term economic uncertainties and longer-term prosperity . Still, stimulus packages can only do so much. For a quick recovery, consumers need to put aside apocalyptic visions of the future, and go out and do what they’ve been best at so far—spend money.

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Irrelevance of interim budgets

Economic reforms have been extensively debated in this country for quite a few decades. Much before Manmohan Singh ushered in economic reforms in 1991, policymakers and economists within the government and outside began examining the appropriateness of opening up the economy and substituting discretionary policies with a transparent and rule-based policy regime.
It was from the 1980s that licensing controls began to be relaxed and a low-to-moderate tariff-based system began replacing quantitative curbs. This journey may have been slow because of the intense nature of the debate. On many occasions, therefore, policymakers have had to go back a step after having taken two steps forward. But never has there been any doubt on the trajectory of the direction of economic liberalisation.
The unprecedented balance of payments crisis and fiscal indiscipline in 1990 hastened the pace of reforms as it was felt that without those measures the country’s economy could have collapsed. Since then, it could be argued, economic reforms have gone beyond the purview of debates. Economic reforms have remained an article of faith for all the governments at the Centre in the last 18 years, irrespective of the political parties that formed them.
Legal reforms, too have gone through a similar phase. There have been debates on how comprehensively the country’s legal system could be made more efficient to deliver justice without delay. Our courts are clogged with cases and cannot deliver justice within a reasonable period of time. While a lot has been achieved by simplifying procedures in civil cases, by specifying rigid time frames to complete formalities before the cases can be argued, the use of information technology in the functioning of courts has begun to make a difference to litigants and lawyers alike.
Undoubtedly, the use of information technology can be even more widespread. But a small beginning has been made in the courts at least in some states. There are many states where nothing has changed and, hopefully, the current debate will result in some action there as well. But the fact that a debate on the need for legal reforms has started is a positive sign. As veteran policymakers will argue, starting a debate for a change is the first concrete step towards achieving the final goal of reforms.
As another session of Parliament is slated to start from tomorrow, questions are bound to surface also over the slow pace of reforms in our parliamentary procedures and convention. Till 1999, for instance, the Union Budget was always presented at 5 pm in the evening. There was no apparent logic except that this was the convention. It was a practice that dated back to the days of the British Raj. But the practice of presenting the budget at 5 pm was continued for 52 years even after independence and no finance minister or parliamentary affairs minister during those years thought of switching over to a different time that is logical from the Indian government’s point of view. It was left to Yashwant Sinha to take that decision and at around noon on February 27, 1999, he presented the budget for the following financial year.
What about the convention of interim budgets? Why should the finance minister of a government that is going to polls in a few weeks be allowed to wax eloquent on what the achievements were in the previous five years? Worse, why should he be given the opportunity to present some indirect tax changes to make some populist gestures? The legislative requirement of an interim budget is to let the government seek Parliament’s approval of its expenditure for a period of three to four months by when elections would be completed and a new government in place to present a regular budget. So, why not restrict the interim budget to only seeking Parliament’s approval for those expenditure allocations for different ministries? Why should the aura of an interim budget ornament an exercise that is mostly an attempt to woo the electorate to vote the ruling party back to power?
Even more unjustifiable is the presentation of interim railway budgets. On February 13, Lalu Prasad will present the interim budget for the railways. While doing so, he will beat his own drum on how well he has managed the Indian Railways and what more he wants to do in the coming financial year. But why should he be allowed to talk about his plans for the next year if a general election is to be held in a few weeks? Why can’t Lalu Prasad simply seek Parliament’s approval for the Indian Railways’ expenditure in the first four months of the coming financial year and let the new railway minister after the elections, whoever he or she may be, outline the grand plans for 2009-10?
Unfortunately, no debate questioning the relevance of interim budgets has begun in this country. Interim budgets are treated more as a parliamentary spectacle and an opportunity for ruling party politicians to take credit for their government’s achievements and announce some populist schemes. Till a debate starts, there is no hope of saving this country from the political gimmickry of interim budgets in the near future.

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