governance, political economy, institutional development and economic regulation

Archive for June, 2014

Why spend more on babus? 7th Pay Commission

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Babus are looking forward to another bonanza, courtesy the 7th Pay Commission, which the previous government constituted just before demitting office. The armed forces, always better organized, are first off-the-mark with an earmarked Pay Cell already created, headed by a two star General, to lobby for better terms and conditions. Other Unions and Associations will also gather themselves together, once PM Modi signals the go-ahead.

Here are five reasons why he should not do so.

First, the history of Pay Commissions (the first was in 1946 with the rest following almost every ten years) validates that they achieve very little beyond finding the lowest commonly agreeable formula, for farming out pay increases to babus and the armed forces.   Never has the pay increase been linked to higher productivity or even to aggregate measures of productivity, like economic growth. Growth, admittedly an overly-broad measure, is now on the downslide and expected to remain that way for at-least another two years. Aam admis find it difficult to swallow, that babus should get paid more, whilst they themselves are struggling to make ends meet.

Second, babus have been getting 100% inflation neutralization twice a year, since 1996. The dreaded inflation (often itself the outcome of loose fiscal control and inefficient expenditure policies) consequently, flows-off babu backs, like water-off a duck, but swooshes down onto aam admis and makes their life miserable. The biggest sufferers are the 700 million poor.

The urgency for another increase in the “real” pay of babus is difficult to justify, in a strained fiscal environment, where subsidies have to be gradually moderated and administered prices of petroleum products, electricity, fertilizers increased-all of which stoke inflation.

Government also has to increase the tax-GDP ratio in 2014-15 to provide the funds needed for stepping up long forgotten defence equipment; higher outlays for education, health, sanitation, water and infrastructure; all this within a fiscal envelope which does not further aggravate inflation. Increasing existing babu compensation, in real terms, will only stoke the flames of inflation.

Third, if the government feels that the existing pay structure does not promote efficient functioning, it has only to look at the reports of the past two commissions. Both Commissions recommended excellent measures for linking pay enhancement to productivity, which remain unimplemented. The Administrative Reforms Commission did similar stellar work in 2008. Throwing more money at the problem of inefficiency is a highly ineffective way of trying to deal with it, which is bound to fail. Better to brush the dust of previous research and get down to implementation.

Fourth, less than 4% of India’s working age population of 500 million (ILO) is employed by government. The total formal sector employment (including in government) is less than 10%. Unlike government, in the rest of this “labour aristocracy” there is no assured inflation indexing and individuals have to justify every year, why employers should even neutralize inflation let alone give them an additional increase in “real” pay.

The residual 90% of other workers live in a jungle, where they survive by their wits, with no help from law or regulation. The Minimum Wage Act is a non-functional piece of legislative gloss, which is regularly contravened in the unorganized sector. None of us, including babus and politicians, who employ household help or buy products made in the informal sector, where “sweat labour” is the norm, walk-the-talk, by being willing to pay the prescribed minimum wage rates.  Even the lowest level of compensation in government is way above the minimum wages.

Fifth, the process of babu pay determination has acquired a routine automaticity, which needs to be disrupted. Opponents of abandoning the business-as-usual stance, argue that the outcome of stagnating babu pay in real terms will be higher levels of corruption. This is difficult to buy. Despite the consistent increase in babu pay since 1952, corruption has also grown not decreased. Babus, even at the leadership level, including the previous PM, “passively accepted” corruption, even if they have not actively associated themselves with the loot. They have not endeared themselves to aam admis by such behavior.

PM Modi has already started the process of interacting directly with babu-level chains of command and demanding from them, measurable, targeted performance, aligned with the government’s priorities. Pay rewards should follow only in 2018 (one year prior to elections in 2019) if performance improves.

Between now and then, the government should start publishing Annual Service Delivery Report Cards for every urban ward and every rural village, listing the manner in services have improved. Pay rewards beyond 100% inflation indexing (which already exists) should come only if the citizen reports show improvements from 2015 to 2017.

Let’s apply the same “value for money” standards to public finance, which resonate so well with our personal lives, vividly captured in the “kitna daite hai” (how many miles does it go in a liter of fuel?) metric, popularized by MARUTI.      

Wooing Pakistan; India’s “less friendly” neighbor

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(photo credit: post.jagran.com)

PM Modi’s external affairs team has hit the ground running; making friends and influencing people in the region. His visit to Bhutan and Sushma Swaraj, External Affairs Ministers’ forthcoming visit to Dhaka, build on links forged previously. These are relatively “low hanging fruit” to show that we want to be part of a friendly neighborhood. PM Modi said as much in Thimpu when, borrowing from  Acemoglou D. (2012), he stressed the criticality of “good neighbors” for gross happiness

But you can’t choose your neighbor and Pakistan is the biggest. It is a mixed blessing that Pakistan is defined politically by the province of Punjab and its heart beats in Lahore. Our blighted common history is most deeply etched in the minds of Punjabis. The upside is that PM Nawaz Sharief has a natural proclivity to develop his province; Punjab. In our Punjab, the BJP has an ally in the Akali Dal. Defence Minister Jaitley has laid claim to his Punjabi heritage and is likely to grow his links with Amritsar. Most importantly, our Punjab has been in relative decline since the 1990s; an outcome of poor fiscal management (Aiyer.S.2012 CATO) by both the Congress and the Akalis. Too many freebies and too little revenue wrecked Punjab, despite its robust agriculture; medium scale industry and vibrant entrepreneurship.

The immediate problem is jobs for unemployed youth. Economic prosperity allows a decent standard of life for even the unemployed young due to family wealth. But drugs and alcohol addiction are the downsides for directionless young people; too rich to work in the manual and semi-skilled jobs available. Rapid industrial growth is the answer for “quality jobs”.

Trade and investment normalization, between Pakistan and India, can immediately benefit the two Punjabs in volumes which could be significant for the two entities. When we expand the analysis to the national level, the welfare gains reduce and point to an imbalance in favor of India. The full potential for trade  is estimated at around USD 20 billion or ten times what it is today, by ICRIR (2013), FICCI (2012), CUTS (2012) and Hafeez Pasha, a previous Finance and Commerce Minister of Pakistan, now Dean of the School of Social Sciences, Beaconhouse National University, Lahore.

This would still be only 6% of India’s total trade but nearly one half of Pakistan’s total trade. It is unlikely that Pakistan would want to be in the precarious position of being dependent on India’s market to that extent. The realistic bound for trade level is consequently much lower. But this makes it of less interest nationally. Since the business opportunity comes with the considerable risks of insecurity and the adverse impact of an uneven keel in diplomatic ties, businessmen are justified in spending even less time on it.

To complicate matters, the central government in India is no longer in the drivers’ seat. Business opportunities are best defined outside the ambit of government sponsorship and regulation, not within it.  Shrinking fiscal space narrows the opportunities for “directed entrepreneurship” of the Chinese kind. Increasing levels of fiscal federalism and enhanced private investment has strengthened the role of state (provincial) governments in industrial development. Local labour and land regimes have become key to private investment.

Pratap Singh Kairon, Chief Minister of post-partition Punjab (including Haryana and Himachal Pradesh) was famous for micro managing economic development and inviting industrial investment to, what was then, a dusty, rural, unskilled hinterland, a mere adjunct to the urban marvel of Lahore, which still shines as a jewel. But successive governments in Indian Punjab have grown it into the granary of India by utilizing its comparative advantage. It is now time to pool the resources of the two Punjabs to mutual advantage.

Naysayers and conspiracy theorists will point to the downside of closer ties between the two Punjabs providing a basis for the break-away of an amalgamated Punjab from India. Either due to the allegedly “burning” desire of Pakistani elites to undo the shame of the break-away of East Pakistan, by amalgamating our Punjab into Pakistan. Alternatively, but less likely, the theory goes, this could happen due to the efforts of the Khalistani’s to become a separate nation.

Break-aways from India are a romantic’s fantasy, both in Kashmir and in Punjab. Both Kashmiri’s and Punjabis have much more to lose by breaking away from India, than there is to gain, by either carving a separate identity or amalgamating with Pakistan. “Landlocked” developing countries are more prone to fail, as separate nations, for a variety of reasons. Paul Collier (2007).  Punjab and Kashmir qualify on that count.

India’s Punjab, Haryana and Delhi have a combined GDP of around USD 190 billion; broadly similar to the GDP of Pakistan. 85% of Pakistan’s GDP is derived from Punjab and Sindh and 54% of the population is Punjabi.

Punjabiat” is consequently a significant force in forging closer links. But historian Zoya Hassan warns against falling into the trap of assuming that cultural history and identities on both sides of the border alone can drive the future. The political architecture; composition of the elites and aspirations have diverged considerably, since 1947. Notwithstanding the loss of close cultural similarities, economic cooperation provides a firm and sustainable basis for growth and positive welfare benefits on both sides of the border.

It may be wise to be practical rather than romantic or aggressive in identifying what is possible even with the bon-homie current prevailing between the two PMs. Three generic principals can help to make identification of the entry points.

First, trade and investment liberalization can never come at the expense of decreasing levels of security. Any adverse impact must be swiftly containable. This implies that normalization proposals must preclude the proliferation of generalized person-to-person contact.

Second, the proposal must be tightly monitorable. This implies its implementation in a defined and sanitized environment.

Third, it must provide real benefits-jobs and business to local populations along both sides of the border.

All three conditions are met if India proposes a jointly administered industrial hub along the Punjab border with a target of creating 1 million jobs and a turnover of USD 40 billion. This could be an EPZ linked both to Karachi and Mumbai or a combination of an SEZ and production for meeting domestic demand. Naturally 100% FDI would be available with attendant harmonized tax structures.

Since farmers on both sides complain of poor productivity, due to the insecurities of a border area, getting land should not pose difficulties. This would be made easier if displaced farmers are offered commercial incentives in real estate development. The facility could link into the proposed Amritsar to Calcutta and the Delhi to Mumbai industrial corridors on the India side.  

Like Pakistan, which faces growing fiscal pressure from dwindling external aid and has to meet the demands of its demographic dividend, the Akalis are under pressure in Punjab to shape up or ship out. The Defence Minister, Jaitley fell prey to this public disenchantment with the Akalis by failing to get elected from Amritsar. Time for Mr. Badal to act before he and Punjab miss the bus yet again.     

 

 

Spicing the Pak-India “Punjabi Tango” with Gujarati Dandia could yield results.

 

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(Photo credit: outlookindia.com)

The Pak-India affair is almost as tiresome as the Israeli-Palestine impasse.   Neither party can pull apart nor do they live together in peace. Successive governments on both sides start a peace initiative at the beginning of their terms, only to lapse into status-quo near the end-defeated by the inertia of babus and elite interest on both sides.

For most of India, south of the Vindhayas and East of the Yamuna, Pakistan remains a distant and intractable land. For the average Pakistani, India is a bully, growing muscular by the day, bent upon destabilizing Pakistan.

It doesn’t help that for all practical purposes, Pakistanis and North Indians are very alike.  They share the same values and prejudices. The daily “show” of faux aggression at the border post of Attari, near Amritsar, illustrates the brawny culture on both sides. Border guards on both sides face off in a peculiar, mirror image, “Punjabi Tango” of choreographed, muscle and moustache to the accompaniment of lusty words of encouragement of their country people. But the bravado ends tamely, with both sides trotting off to their own quarters, their duty done.

The similarities extend to the mirror, comparative advantages of the two countries; near similar human capital development levels, low income levels and low natural resource endowments. Also similar are the barriers to growth, vast inefficiencies in government and elite capture; by the agro-military-industrial complex in Pakistan and by the agro-industrial elite in India.

Both economies have benefited from adoption of the “open economy” model of growth since the mid 1980s. India more so than Pakistan, which has been constrained over the last two decades by its preoccupation with Afghanistan and its own war on terror-albeit some of it, of its own making. As Bhindrenwale was to Indira Gandhi, the Taliban has become for Pakistan; an out of control Tiger.

The first casualty of insecurity is investment-both public and private-especially in infrastructure. Long payback periods are unsuitably risky if revenue streams become uncertain. More importantly, with the world increasingly in the “open economy’ mode, there are easier business pickings elsewhere. The 21st century belongs to growth in Africa and that is where business is rushing to be, both Indian and Pakistani.

It is not surprising therefore, that trade between Indian and Pakistan is minimal and stagnant, relative to the total trade of both countries. Pakistan exports only 1% of its total goods to India and only 4% of its imported goods are Indian. Of course, the official data underestimates the actual trade through third countries and destinations. Both could benefit by cutting out the intermediaries margin and higher transportation cost of acceptable third party destinations. Non-tariff barriers on both sides; poor trade infrastructure and low financial integration make even the best cross border trade intentions die. Cross border investment is yet to be a reality.

Why then bother at all to disrupt the convoluted stalemate of the past five decades? Here are three good reasons:

First, Pakistan estimates (Economic Survey 2013-14) that it loses up to 3% of its GDP due to insecurity, bleeding it of nearly one half of its potential GDP growth. For India, an insecure Western border is expensive. The geo-politics of Pan-Islamic militancy unsettles its domestic, plural aspirations.

More generally, “including the poor” is a common challenge for both countries. The last thing, either could possibly want, is to add the cost of managing terror to that long list of unproductive, resource draining preoccupations.

Second, India and Pakistan both gain by operationalizing the Turkmenistan-Afghanistan-Pakistan-India gas pipeline. This has been on the agenda for the last two decades and 2018 is the new aggressive target. Both economies are deficient in gas, a clean and versatile fuel for power generation, domestic use and industrial purposes. India loses 0.5% of its GDP every year due to shortage of peaking power capacity. Perversely, domestic coal supply shortages and the high cost of imported coal and LNG keeps installed capacity idle. The TAPI pipeline, would meet around 20% of our gas demand till 2030.

Third, the lack of Pak-India economic integration provides a ready opportunity to China; the “big Panda in the room”, to deepen the economic “silos” with each integrated independently to China, but not to each other. This is already happening. Whilst trade between India and Pakistan stagnates, trade between China and Pakistan is booming, as is trade between China and India.

Of course China is the world’s factory. It aggressively supplies price competitive goods, well suited to the limited pockets of developing countries. Chinese trade comes with generous financial outlays to develop and manage strategic infrastructure; Gwadar Port in Baluchistan (linking the Middle East to China in a trade and energy corridor) and the offer to build high speed railways and highways in India.

Both Pakistan and India will accept much needed foreign capital and investment from anyone who offers it. That is the wise thing to do commercially. But it makes strategic sense to also develop alternative trade and investment opportunities in their “near abroad”. Infrastructure development is a great facilitator for growth. But it also has enduring legacy value. It determines the future spatial spread of growth and jobs along economic corridors. It is sobering to remember that Karachi Port is nearer to Delhi and Amritsar than is Mumbai.

Democracy is great for transparency but is a killer for negotiations, strategic deals and moving on, which are best done in privacy. This is a limitation for PakIndia normalization. The history of distrust and animosity extends far beyond the cricket field. Babu led governments become hostage to the “agency problem”. The narrow self-interest of the managers drowns the real interests of those they represent.

Progress can only come from “disruptive innovation” by leaders. It’s PM Modi’s call. A dash of Gujarati Dandia could spice up the frozen-in-time “Punjabi Tango” to produce results.  

 

DGCA kills innovative, consumer friendly pricing by Air Asia

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Air Asia,the newest aviation kid on the block, got a taste of the heavy hand of Indian regulators even before it starts service on June 12. The Director General of Civil Aviation directed them not to implement their innovative initiative to charge only those passengers with check-in luggage for the service. The normal practice is to build-in the average cost of a 15 kg free luggage allowance whether one needs it or not.

Why DGCA was compelled to do so remains in the secret annals of the regulator which, being a government agency, hoards information on why decisions are made. There could be three possible reasons why this happened.

First, this unbundling of the checked in luggage charge was a departure from the norm. Babus hate such departures. The absence of the all-important “precedent” complicates life for them. A possible stint at Tihar, looms large in their minds, if their decision is perceived as favouring the licensee. This particular decision predated the assurance from PM Modi that babus need not be scared of retribution, unless it is deserved.

The key to effective governance is innovation. This “can-do” approach is foreign to the average babu DNA, across the world. But it is only innovation, which can reduce transaction cost and improve efficiency- both sorely needed in India.

The international experience in economic regulation indictates that intrusive regulation retards innovation. Nor does it help consumer interest, because the supplier is left with no incentive to increase profits by optimizing costs and maximizing revenue. Secondly, the entrepreneurial energy, which is unleashed by competition in the market, gets blunted if market forces are unduly restrained.

The Indian aviation market has more choice than two decades ago. But competition is still stifled by the “cartel” of five scheduled operators: Air India, Jet, Indigo, Go and Spice jet. To be fair, since their injection into the market, they have led on price discovery. Air India has been unable to compete and is accumulating massive loss, despite the advantage of preferential allotment of prime travel slots and destinations.

Cartels, like babus, hate “disruptive innovation” since it shakes up a stable financial equilibrium they have adjusted to over time. Consumers on the other hand look for such innovations in pricing which adapt to their specific capacity to pay. Think Hindustan Lever’s shampoo sachets.

Air Asia did just that. It slashed its inaugural tickets to negligible amounts. But it proposes to charge if you want to check-in luggage. This is welcome news for those on short trips, who carry nothing more than a briefcase. But it is terrible news for those who travel with a “colonial style” “bistra bund”. Air Asia proposes to allocate cost only to those on whose behalf they are incurred. Today the “bistra bund” lot free rides on the price paid by the “briefcase” lot. This is also bad news for passengers who consume their 15 kg free allowance but hang around, trying to pool their surplus luggage with other obliging passengers. Many obliged becuase their unused free luggage allowance was a sunk cost, till Air Asia came around.

Tariffs drive behavior. Airlines have already unbundled preferential seat allotment and food service with salutary effect on customer and staff behavior. Customers no longer jostle, pull rank or use influence to get the seat of their choice for free. Now its pay and get. Cabin staff, which previously used to throw free food and drinks at customers, like relief workers do at refugees, is now responsive to customer needs. Paisa bolta hai (money talks)

Possibly DGCA had concerns about Air-Asia duping customers into buying cheap tickets and then loading charges on them at the last minute, whilst checking in. This could have been dealt with by requiring the airline to (1) get a declaration signed from the customer that they are aware of the “no free luggage” clause and (2) ensured that in all advertisements of the cheap fares, the “no free luggage” clause is prominently displayed. After all airline customers have already got used to paying for their food and drinks on board and paying for specific seats. How is luggage so different?

A third concern, DGCA may have had, is of predatory pricing. This is what the existing “cartel” charged Air-Asia to be indulging in. At the very least the charge is odd. Predatory pricing is a strategy usually adopted by an existing dominant supplier, with huge sunk costs, to keep competition at bay. The fledgling Air Asia is hardly a likely candidate to invite the charge of predatory pricing.

Civil Aviation is a vital sector of the domestic economy. Viewed holistically, with railways, road and waterways; it is integral to an efficient multi-modal transportation system, each of which has a comparative advantage for a particular profile of passenger and cargo.

Unfortunately aviation continues to be viewed as a service for the rich. Aviation fuel is taxed punitively. The sector is ruled with a heavy hand by the DGCA-the government managed regulator. A report authored by Nathan Consulting in 2008 concludes that aviation needs to transition to more light handed and market oriented regulatory options, in the interests of enhanced competition and protection of customer interest.

The DGCA has erred in knocking down the very worthwhile innovation by Air Asia, which is perfectly in line with sound economics for the determination of fair and efficient user charges. At the very least, this reeks of an unsuitable, heavy handed, danda  wielding style of regulation. At its very worst, this action can be construed as undesirable collaboration with the “cartel” to “discipline” the kid in town- Air-Asia. In either case it has not brought glory to DGCA, which is more familiar with engineering safety concerns rather than the nuances of economic regulation.

One hopes, that the new chief babu in Civil Aviation and the new Minister will show the way and reward rather than retard dynamic and innovative pricing.

 

 

 

    

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