Support for free markets and globalisation in India

On 5 October 2007, I had written a blog post Does urban India favour liberal economics?, where I had used survey data released by the Pew Institute, which measures attitudes of roughly 45,000 people worldwide with roughly 2,000 in India. Their sampling mechanism has an urban bias.

Today, I saw current information, and cross-country comparisons, on their website.

Support for the free market

 

The wording of the question was: Please tell me whether you completely agree, mostly agree, mostly disagree or completely disagree with the following statements: Most people are better off in a free market economy, even though some people are rich and some are poor. `Agree' combines "completely agree" and "mostly agree" responses. `Disagree' combines "mostly disagree" and "completely disagree."

The results, showing the proportion of those polled who `Agree':

In 2002, India was halfway in the list with 62% support. In 2009, India is at the top of the list, with 81% support.

Support for international economic integration

 

The wording of the question was: What do you think about the growing trade and business ties between (survey country) and other countries - do you think it is a very good thing, somewhat good, somewhat bad or a very bad thing for our country?. `Good Thing' combines "very good thing" and "somewhat good thing" responses. `Bad Thing' combines "somewhat bad thing" and "very bad thing."

The results:

Here also, India is now at the top of the list in terms of support for plugging into globalisation.

Why is this happening?

I think there are three factors at work.

First, everyone in India instinctively knows that when we tried our hand at socialism, GDP growth crashed, and vice versa:

1950s	3.59
1960s	3.96
1970s	2.94
1980s	5.58
1990s	5.68
2000s	7.22

The worst of India's years -- 2.94% average GDP growth with a fast growing population -- were in the peak of Indira Gandhi's socialism of the 1970s. As India stepped away from that, things got better. This process began with the Janata Party in 1977, was carried forward by following governments, and yielded results from the early 1980s onwards.

These changes were big enough and rapid enough that they are as persuasive as a natural experiment. Comparing socialist India vs. unsocialist India is almost as persuasive as comparing East Germany vs. West Germany. So the ordinary citizen, who does not know the GDP data, knows in his bones that getting away from a big State made sense.

The second factor is that a random sample of India has a lot of young people in it, who are less influenced by our socialist baggage. When you look at the political leadership, bureaucracy, academics or media, the views of old people have a lot more importance in shaping positions and the external perception. Old people in India seem to have more socialism, autarky, and unconfidence. Opinion polls show an unfiltered picture of India as it is.

Here is some data, from the CMIE household survey database, about the age distribution of Left supporters:

The CMIE data, with a tiny share of the population which supports the Left, is consistent with data from election vote shares and the Pew data. All three information sources thus increase our confidence in the basic message.

In your mind's eye, you need to think that India is a young population, with a lot of people below 30, and declining cohort sizes beyond. So the early years in the graph are disproportionately important.

In the overall population, Left support stands at 5.36%. India's future is young and urban -- but these two regions are where the Left support is the weakest.

However, another hypothesis can be cited: Maybe it is the experiences of young people which convert some of them from being un-Left when young to being Left supporters in middle age. Maybe political attitudes are not stable through time; maybe the young of today will turn left when they reach their late 30s and early 40s. In coming years, as the data of this survey builds up, we'll be able to evaluate this hypothesis.

The third dimension is about the welfare state. India does not have a welfare state and is unlikely to build one.

Voters do not seem to want a large welfare state. Political scientists say that a homogeneous population is more likely to support population-wide welfare programs: Each voter intuitively feels that the benefits of the program go to people-like-him. In countries with heterogeneity along the lines of ethnicity, class, religion, etc., voters are less inclined to favour population-wide welfare programs, because the picture in their mind of a recipient of welfare is not a person-like-them.

The intellectuals are not pushing a welfare state. In Western Europe, in the 1930-1960 period, the best intellectuals pushed the welfare state as an antidote to the brutality of the communist or Nazi ideologies. That sort of problem has not been an issue in India, where support for communism seems to be ebbing away.

The implementation capability is weak. When politicians have tried to setup large systems -- SSA or NRHM or NREG come to mind -- the limited administrative capacity has come in the way.

The bottom line is that India has a small expenditure/GDP ratio, and there is no welfare state that is under stress. Elsewhere in the world, there is a conflict between retaining the welfare state vs. plugging into globalisation. The gains from international economic integration are weighed against the perpetuation of the welfare state. In India, that conflict of interest is absent: people only see the gains from globalisation.

Protectionism, recession, recovery: looking back and looking forward

In thinking of protectionism, the Great Depression, the Great Recession, and what might come next, here are two interesting angles.

Governments with their backs against the wall

 

Ideally, stabilisation using monetary and fiscal policy, alongside actions by the private sector, should restrain the decline in consumption, and yield conditions which are not too harsh for households. At the time of the Great Depression, much less was known of economics. Pegging the currency to gold meant giving up monetary policy autonomy; the US Fed succumbed to contractionary monetary policy once you take into account the closure of banks; the fiscal policy response at the time was miniscule.

It has been argued that the the Smoot-Hawley Tariff Act came about in the US in June 1930, at a point in time where the politicians were coming under enormous pressure to do something. After seven months of inaction by macro policy, with mounting difficulties in the economy, the politicians succumbed to protectionism. This appears to have been of decisive importance in sending the world down the destructive path of competitive trade barriers and cometitive devaluation. In the graph made famous by Barry Eichengreen and Kevin H. O'Rourke, at month 7 there was almost no decline in world trade. Douglas A. Irwin is worth reading on this.

Protectionism adversely impacts the recovery

 

Greg Mankiw and Scott Sumner point out one more channel through which Smoot-Hawley damaged prospects for the recovery was through the impact of protectionism on confidence.

The private sector saw protectionism as symbolising government backing away from responsible thinking in economics, and responded with a weakening of investment demand. This served to exacerbate the downturn.

Will this time be different?

 

The bulk of world GDP is now endowed with inflation targeting central banks. This ensures that monetary policy will be counter-cyclical: under bad business cycle conditions, inflation forecasts will drop below targets, and central banks will use every trick in their book to push inflation back up to target.

Fiscal policy has responded well this time around, thanks to better understanding of business cycles when compared with 1929. But there is little headroom to go further.

The world has as little ability to rein in some players engaging in competitive devaluation (e.g. China) today, as was the case in 1930. But with the bulk of world GDP being placed with inflation targeting central banks, the extent to which such tactics will be used will be relatively limited.

So far, we have had an upsurge of protectionism, but nothing on the scale of that seen from 1930 onwards. This could partly reflect the dramatic actions which governments have undertaken through monetary and fiscal policy, through which politicians have been able to reduce the domestic political difficulties that go along with business cycle downturns. But if, in coming months, the world economy remains mired in recession, then we could get fresh pressure to do something. In a recent voxEU post, Jeffrey Frieden points out that the path of adjustment of macroeconomic imbalances and currency distortions will involve political pain along the way, which could spillover into protectionism.

Some protectionist decisions could reflect bargaining tactics aimed at getting China to reduce or end their market manipulation of the currency market. But if there is an upsurge of protectionism beyond this, it will further damage the recovery by hurting investment, giving a spiral of bad economy -> protectionism -> reduced investment demand -> worse economy.

Five questions on asset prices and monetary policy

Howard Davies was a deputy governor of the Bank of England, and the first head of the UK FSA. He is one of the world's leading thinkers on financial regulation and monetary policy, and one of the people who combines skills in both finance and monetary economics. In a recent article, he focuses on the five interesting questions about central banks and asset prices. Everyone interested in monetary policy today needs to ask themselves these five questions.

Q1: Should central banks target asset prices?

 

Davies points out that the consensus view is that central banks should remain focused on inflation targeting and not target asset prices.

However, pretty much everyone would agree that information from the world around us, about asset prices, is useful for forecasting inflation and output, and should be used in figuring out what values for output and inflation we put into our Taylor rules (whatever they might be).

So it seems that on this question, there is consensus: Asset prices are (and have always been) useful inputs in monetary policy formulation, but monetary policy should continue to do inflation targeting and not asset price targeting.

 

Q2: Should the measure of inflation targeted include an element of asset price, and particularly house price inflation?

Any reasonable CPI must have house rent in it, and through this, a boom in house prices and thus rents will get reflected in the CPI. This would give one more channel through which asset prices would directly influence a traditional inflation-targeting central bank.

 

Q3: Is it possible to identify serious asset price misalignments, and are they of legitimate concern to monetary policy-makers?

This is controversial territory. Some economists believe it is possible to ask central banks to make a call on when asset prices are misaligned.

I am personally skeptical about the extent to which this is possible. It is always easy to look back, ex-post, and say that it was obvious that US house prices were way off in 2006. But how many of the people who say this today were shorting US housing then?

Making a call about asset price fluctuations is hard even for a well motivated hedge fund manager. It is doubly hard in the public sector given the peculiar combination of skills and incentives that are found within central banks. The people with real skill in these things are unlikely to choose to work in a central bank; years spent in a central bank do not hone skills at market timing; the public will be very irritated if a central bank calls wrong.

So overall, I'm skeptical about the extent to which central banks (past or future) can usefully make calls about when asset prices are out of whack.

 

Q4: Even if we can identify misalignments, and believe that some price adjustment is bound to occur, is it right to use interest rates to try to moderate the expansion?

Even if you knew that asset prices were grossly wrong, interest rates seem to be a very blunt tool, which inflict collateral damage all around the economy. Davies quotes Mervyn King who said two months ago: Diverting monetary policy from its goal of price stability risks making the economy less stable and the financial system no more so.

 

Q5: Should we try to find and use mechanisms other than interest rates to moderate extravagant credit expansion and associated asset price bubbles?

I think there is a good case for building some kinds of counter-cyclicality into financial regulation. But operationalising this is hard.

It should be feasible for financial regulators to have three manuals which govern boom times, normal times, and recessions. Full public disclosure of these three manuals is, of course essential, to avoid the usual issues of transparency and consistency. The question is: When would you flip from one manual to another?

Doing this based on asset prices runs into the difficulties articulated above. How is a civil servant to know when asset prices are in a boom or a bust?

Doing it based on business cycle conditions is more objective and feasible. It should be possible to setup indicators like Eurocoin which give low latency information about a coincident indicator. This could be used to drive rules about when we go into each of the three manuals. I personally think this would be useful.

Such efforts can be rationalised on the narrow ground that we seek to reduce the extent to which finance is a source of pro-cyclicality in the economy. If this is done right, it would reduce the amount of heavy lifting that monetary and fiscal policy have to do by way of stabilisation.

You don't have to have a `financial markets are irrational' view to support this. All you have to believe is that the existing structures of financial regulation are a source of pro-cyclicality. If that much is agreed, then there is a case for changing the framework of financial regulation so as to reduce the extent to which this is the case.

Interesting readings

• Tim Harford in the Financial Times on the skepticism about the extent to which microfinance matters.
• London's attempts at turning away international finance: from the Economist, and Mint. Also see this piece from the Economist.
• M. R. Madhavan in Financial Express on the ineffectiveness of the UPA in translating Parliament time into economic reform.
• Michael Pomerleano on financial stability reform proposals.
• An idea from Ila Patnaik has popped up again.
• Sabrina Tavernise in the New York Times, on Syed Babar Ali, who started LUMS. Here's a comparison, of the footprint of the name of the institution upon google scholar, of LUMS as compared with India's ISB. LUMS was founded in 1986, and is well ahead of ISB in the extent to which they have evolved away from being a pure MBA program [undergraduate] [graduate].
• Ila Patnaik on the questions that RBI now faces on monetary policy.
• An eBook on financial reform, released by the Stern School of Business. A quick read of their chapter summaries gives you a sense of what they have done, and the questions faced in financial reform today on an international scale.
• In continuation of my recent article on the Bombay Club, do look at this view of Bajaj Auto by Swaminathan S. Anklesaria Aiyar.
• In Businessworld, Ashok Desai discusses a recent speech by Dr. Subbarao, and worries about competition amongst Indian banks.
• Ramachandra Guha in The Telegraph on India's nuclear energy program. Also see these two old pieces (from 2005) by Ila Patnaik: one, two.
• Protectionism alert.
• Deborah Solomon interviews Jeff Bezos, CEO of Amazon, in the New York Times. More CEOs in India should learn to speak like this.
• The meaning of open, a beautiful essay by Jonathan Rosenberg, Senior Vice President, Product Management, Google. More SVPs in India should learn to think like this.

Building the perfect GST

The 13th finance commission has released the report of the task force on the GST. Here are some responses:

• Let's design a good GST, an editorial in the Economic Times.
• The Economist.
• M. K. Venu in Indian Express.
• Satya Poddar and Sukumar Mukhopadhyay in Business Standard.
• Anil Padmanabhan and S. Narayan in Mint.
• Editorial in Financial Express.
• Tina Edwin and Gautam Ray in the Economic Times.

There are three huge and complex projects which are afoot in India today, each of which is of critical importance in transforming the landscape. They are: the Goods and Services Tax (GST), the New Pension System (NPS) and the Unique Identification (UID).

A lot of what I know about pension economics comes from David Lindeman, and he often quoted Larry Thompson in saying that such reforms involve three dimensions of effort : policy, politics and administration. Each of the three has to work out right in order to obtain success. If any one of the three goes wrong, then the overall outcome is attenuated.

With the NPS, we have made enormous progress on the politics and policy, but are weak on implementation. The GST faces political difficulties and it is not clear that the policy thinking will be done right. But the moment these early stages are crossed, the brunt of the problem will become administration. With the UID, there seems to be political support (so far), and the challenges are of making the right moves on policy and administration.

Bringing Nandan Nilekani to run UIDAI is an important step forward because it shows a recognition that the administrative challenges of these systems are unlike business-as-usual in government. These are complex IT systems, and require a new kind of execution punch in terms of rolling out complex nationwide IT systems. Similar thinking needs to be brought to bear for NPS and GST also.

Till date, the best success of a large complex system of this nature is the TIN. That was a problem which was all administration - it did not involve complex problems of politics and policy. However, it has proved a certain model of how to get this done (by contracting-out to NSDL using a certain kind of contract structure).

On large complex IT systems and their impact on India, you might like to see: Improving governance using IT systems, page 122-148 in Documenting reforms: Case studies from India, edited by S. Narayan, Macmillan India, 2006.

How bad was industrial production in October?

by Radhika Pandey and Rudrani Bhattacharya.

This appeared in Financial Express today.

In India, many people look at year-on-year changes to track the state of the economy. This indicator has important weaknesses. It is the moving average of the change seen in the latest twelve months and is hence a sluggish indicator of the changes in the economy. In order to monitor current developments in the economy, it is preferable to look at month-on-month changes.

However, month on month changes are distorted by seasonal fluctuation. The solution lies in seasonal adjustment. The seasonally adjusted month on month changes provide more timely information about the state of the economy. Internationally, the standard procedure for examining and monitoring economic series uses seasonal adjustment.

The figure shows the familiar time-series of year-on-year growth of IIP. This shows that output in October 2009 was 10.3% bigger than the level of October 2008. This seems reassuring.

Far more informative is the time-series of month-on-month changes. Each of these values is the annualised month-on-month change in the seasonally adjusted IIP. The term applied is `SAAR change' which stands for the Seasonally Adjusted Annualised Rate of change. This shows an unhappy value of -5.12% for October 2009 (when compared with September 2009). The key strength of this approach is that we are discussing the change from September 2009 to October 2009, instead of the 12 changes from October 2008 till October 2009.

Is the picture so dismal? To answer this, we need to look into the non-economic factors which might influence this number. October 2009 was a month of festivities with fewer working day but enhanced purchases prior to Diwali. At the same time, Diwali does not occur in a fixed month every year. Hence, the simplest seasonal adjustment procedures will not remove these effects.

In the jargon of seasonal adjustment, Diwali is a `moving holiday'. It requires special care in seasonal adjustment. Hence, in our work on seasonal adjustment, we test for the impact of moving holidays such as Diwali and Id, and when these effects are statistically significant, we adjust for them. Through this procedure, we find that SAAR for IIP for October 2009 works out to +0.12%. In other words, correcting for Diwali yields a change from an estimate of -5.12% SAAR for October 2009 to an estimate of +0.12% SAAR.

The figure superposes the two time-series of SAAR IIP (without adjusting for Diwali) and SAAR IIP (with adjustment for Diwali). In most months, the two series are obviously identical. But in some months, the interpretation of the IIP data strongly requires care in treatment of Diwali as a moving holiday.

Many analysts warned about reading too much into the weak October 2009 IIP performance, on the grounds of a Diwali effect. We go from this broad but unspecific caution to a precise estimate of what happened to overall IIP and IIP-consumer goods in October 2009 when compared with September 2009, after adjusting for seasonality and Diwali. The result is a gloomy value of 0.12% SAAR for IIP in October 2009.

The biggest impact is visible on the IIP-consumer goods (figure above) which shows a pleasant value of 7.01% SAAR after the Diwali adjustment, while without this adjustment, there is a worrisome SAAR value of -25.07%.

The calculations reported here are updated every Monday at http://www.mayin.org/cycle.in on the world wide web. For all series, Diwali effect testing is done, and wherever the impact is statistically significant, it is adjusted for. It proves to be significant for IIP, IIP (Manufacturing) and IIP (Consumer goods).

The trading hours controversy

Shifting away from central planning

 

Traditionally, Indian socialism has involved government control of all aspects of financial products or processes. As an example, government specified the time of day at which trading starts and the time of day where it stops. The RBI committee process on currency futures and interest rate futures specified that trading must start at 9 AM and stop at 5 PM.

In most areas of the Indian economy, goverment no longer controls the economy in such fashion. The government does not specify what time a shop opens or closes. There was a time when the Indian government did not permit the use of aluminium for making cans of soft drinks. A large fraction of such meddling in the economy has been dismantled (though not in finance).

A few weeks ago, SEBI came out with a liberalised policy: Exchanges could open anytime afer 9 AM and stop trading anytime before 5 PM. If NSE or BSE opt for longer hours, securities firms will face the decision about the time at which the shop opens for business and the time at which it closes. Staying open longer will involve somewhat higher costs and in return will yield somewhat higher revenues. Each shop will make its own decision about choosing a starting and a closing time.

 

What do we gain?

 

If Indian markets to be open from 9 AM to 9 PM, there are two benefits. First, consumers should have maximal choice on when they can achieve their trading needs. Recall that internationally, many grocery stores choose to stay open for 24 hours a day.

Second, in the late evening in India, the ADR market opens in the US, and it is important to link up the closing Indian prices to the opening US prices.

 

How will exchanges and their members cope?

 

If securities firms have to stay open for 12 hours a day, this will require process modification, including multiple shifts for certain employees.

These changes might seem burdensome. But similar changes have taken place before. With floor trading at the BSE, trading only lasted for two hours a day; but when NSE came along, trading moved up to 5.5 hours a day. Members doing commodity trading are already running to almost midnight.

Securities firms and exchanges will need to change their process design to achieve longer hours. If a securities firm has to trade from 9 to 9, this will require two shifts. The first shift will probably come to work at 8 AM, and stay till 3 PM, while a second shift will probably come to work at 3 PM and stay till 10 PM. Some firms will find that this does not make sense for them and they will choose to only keep their shop open for shorter hours.

The operation of securities markets in India is held back by infirmities of the payment system. A shift to longer trading hours will encounter frictions owing to problems with payments.

At first, clumsy solutions will be found because of problems of the payments system. But at the same time, when the industry demands more from the payments system, we set ourselves on the course for deeper surgery of the payments system. In this 21st century, we can and should have a payments system which processes 100,000 messages per second and runs for 24 hours a day. When the industry complains enough about the infirmities of what is in place, the existing payments system will be questioned, which could ultimately lead to improvements in the payments infrastructure.

 

A messy situation?

NSE and BSE have gone through a series of announcements. First, BSE said they would start at 9:45. Then NSE said they would start at 9 AM. Then both said they would think about this after the holidays.

These activities seem messy and confusing in the public eye. These tactical details are an inherent part of the market economy. When government control is withdrawn, and a license-permit raj is scaled down, we go from a tranquil and stable environment -- the silence of a graveyard -- to a dynamic environment where firms are thinking and reacting. This should be welcome.

 

Doing more on moving away from central planning

 

SEBI needs to move forward on many fronts in terms of getting away from government control of product features. There is no reason to restrict exchanges to the zone from 9 to 5. Similarly, many other product features on the derivatives market need to be decontrolled: what underlyings to use, whether cash settlement or physical settlement, the expiry dates, the contract sizes, etc. Government control of these product features is as legitimate as government control over the design of a bicycle.

There is a difference between regulation and control. The role of government is to specify pollution standards for cars and to require seat belts or airbags. It is not to design cars.