governance, political economy, institutional development and economic regulation

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Barbarians in the temple of Dionysus

dionysus

For rational people, if this breed actually exists other than in the imagination of economists, the most logical way out of the Grexit logjam was for Greece to vote “yes, we can”. Just by agreeing to take the pain of austerity measures, they would have got the amount required for this year, estimated at around 80 billion euros.

Banks would have re-opened, ATMs would have started functioning and Greeks could have happily gone back to sipping their Ouzos in their favourite cafés. Meanwhile, negotiations could have carried on with Brussels and the International Monetary Fund on the minutiae of the minimum austerity measures required to access the 240 billion euros bailout package.

Negotiations and a hot head do not mix

If only the Syriza government had the foresight to seek technical assistance from the bureaucracy of any Latin American, African or Asian country on how to deal with agitated lenders, they would never have got into the mess they are in now. Developing countries, which went through the notorious IMF “structural adjustments” during the 1980s, have mastered the art of walking the thin line between throwing the bath water, but keeping the baby.

This is not an art the Greeks are skilled in. Greek theatre dating back to 500 BC has a tradition of keeping the two main genres — tragedy and comedy — strictly separate. Compare this with Indian theatre and Bollywood where the surefire mantra for success is to mix and match, masala. This is the underlying core of Indian flexibility and the omnipresent gene of jugaad.

But all is not lost. Greece and the rest of Europe are bonded by more than economics.

Greece is not alone

First, it’s not just Greece. Greece is beautiful, sunny and laid back. But it is not the only one. Italy, Portugal, Malta and even rainy Ireland, have all benefited from northern Europe’s largesse and subsidy. These partners in destitution are honour bound to press for softening the terms of the austerity measures. Whilst they don’t have much weight in decision-making, they can be the medium for an honourable back down, both for Greece and the lenders.

A group of southern Europeans (Spain, Italy, Portugal, Malta, Cyprus) pleading for mercy on behalf of Greece would allow Germany and the hard-working northern Europeans to back down without abandoning their harsh standards with respect to performance, keeping promises and fiscal discipline — the things prosperous countries care about.

Italy and Spain, the two big economies (together they account for 27 per cent of Eurozone GDP), are sunny, hot-blooded Mediterranean countries with an iffy record of fiscal rectitude. It would serve them well to make common cause with smaller economies in southern Europe just in case they need similar fiscal accommodations in future.

Sellers need buyers

Second, remember, the world faces a demand recession and growth is slowing. What could be better for Germany’s Northern Alliance than to show some noblesse oblige and allow Greece to continue to buy manufactured goods sourced from them, with borrowed money, in return for “progress on reforms” — making it easier to hire and fire workers and adjusting the liberal social security downwards?

After all, this dance of fiscal profligacy by borrowers and fiscal fundamentalism by lenders is not new. Developing countries have routinely needed and received such accommodation, paid for by taxpayers in the developed world. Generations of developing country citizens have suffered and endured precisely such privations brought about by the actions of their profligate, corrupt and inefficient governments. Why then should the developing country assistance code not apply to Greece?

Street fighters are rarely credible as administrators

Third, mind the credibility gap. History establishes that “Dutch courage” is difficult to sustain. The negotiating strategy of the Syriza government has been built around the assumption that Brussels would blink before they do.

This did not happen and Greece defaulted on its loan repayment to the IMF on June 30. Desperate to seek time, the Syriza government sought refuge in a referendum to support their hard talk. Many must have hoped that the people would betray them and vote “yes”, thereby enabling them to negotiate a surrender with the lenders, ostensibly out of deference to the will of the people.

They were thwarted in this plan by the campaigning of their charismatic, media-savvy finance minister, Yanis Varoufakis, who tapped into wounded Greek pride and induced the massive “no” vote. He subsequently resigned and left the people he incited to their own devices. This is a familiar ploy of street fighters who live on in public memory by seemingly heroic actions which burnish their esteem, never mind that people bear the consequences thereof.

But the civilizational glue still sticks

Fourth, the Syriza overestimated the value of the glue they provide to the Eurozone. Greece is less than two per cent of the Eurozone GDP. Turkey, now with an increasingly hard-line Islamic government, has been waiting to accede to the EU since 1987. Its GDP is double than that of Greece. But the problem is not economic; it is civilisational. An EU without Greece — the cradle of European civilisation — would be like Ramlila minus Ram or Bhairavi sung at midnight.

A new deal is needed to thwart the Russo-China combine

Whilst a departure by Greece does open a door for China or Russia to consolidate their influence in the Mediterranean, the burden of history is against this happening just yet. If the proud Greeks will not bend before the Germans, can one possibly imagine them in bondage to China?

Cosying up to Russia would be far more acceptable. But low oil prices constrain the oil-dependent Russian economy from becoming even more profligate than it already is in foreign adventures.

No room for those who don’t tie their own bootstraps

Truth be told, the Syriza’s strategy was audacious and imprudent. Here is why. The world no longer suffers those who do not help themselves. For the multilateral and bilateral lenders and banks to depart significantly, just for Greece, from the fiscal rectitude economic mantra they espouse worldwide, would mean different strokes for different folks. This would be unconscionable and overtly iniquitous in these politically correct times.
Adapted from an article by the author in Asian Age July 7, 2015 http://www.asianage.com/columnists/barbarians-temple-dionysus-026

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FM Jaitley’s conundrum: Fat wallet but empty pockets

Jaitley fat wallet

(photo credit: http://www.firstpost.com)

Imagine if FM Jaitley had admitted in his budget speech of February 28 that of the Rs 17.77 lakh crores (US$ 287 billion) of expenditure he was tabling in Parliament, less than one third was really available for innovating on the past trends and the bulk of the funds relate to liabilities already contracted before the year begins.

Given the lack of fiscal space for new commitments one would think then that the budget would be transparently split between contractual liabilities of past decisions, which are “sunk cost”- loosely defined and new budget allocations to make instant and easy sense to citizens. After all it is the “new” allocations that everyone looks forwards to, assuming that they could perturb the status quo and kick start growth.

But you will not find the budget classified thus, even though the eleven budget documents, excluding the Finance Bill, runs into 949 pages! Instead it is split between Plan and Non Plan expenses – a practice that should thankfully end now with the demise of the Planning Commission– or Revenue and Capital, another archaic distinction, which was traditionally used to track investment expenditure due to the traditional direct linkage between investment and growth. But increasingly, the right kind of revenue expenditure is also critical. Funded by the “revenue black box” are catalysts for efficiency and innovation led growth- skilled employees; functioning institutions and well maintained public assets.

The cost of feeding the public beast

How much needs to be spent just to keep government systems alive even if they do nothing of value for citizens? This is a close proxy for “current liabilities”.

First, civilian employee pay and allowances account for around 8% of total expenditure, not high at all by international standards where high, double digit proportions are the norm.

Second,  expenditure on pension of government employees accounts for 5% of total expenditure but growing rapidly as ex-babu couples age and live longer.

Third, the administrative cost (providing workplaces, consumables and equipment) of managing 3.6 million civilian government employees has to be paid for. Assuming administrative cost to be one third of pay and allowances it amounts to around 3% (0.33 of 8%) of total expenditure.

Fourth, annual interest on government debt accounts for 26% of total expenditure.

Fifth, is expense on maintaining physical assets- the Achilles heel of the government. Chronic under provisioning results in axle-breaking pot holes; overflowing public toilets; broken x-ray machines and no doors or windows in classrooms. Two decades ago the PPP model for providing public services seemed like the way to go but those hopes faded.

Guess what? Maintenance expense is not transparently available as a separate line item in the budget documents. This is not surprising since the government has, inexplicably, not adopted a more complete economic classification of budget items, endorsed by the IMF and followed internationally.

Today we will have to make do with assumptions- albeit conservative ones. A God send is that ever since the promulgation of the FRBM Act the government is obliged to share an asset register of civilian assets (which excludes cabinet secretariat-a code word for India’s spooks; defence; police; atomic energy and space which together account for approximately 46% of the annual CAPEX).

The register of physical assets (excluding land) for 2013-14 values civilian assets at a measly Rs 1.87 lakh crores (US$ 30 billion) for a Rs 141.09 lakh crore (US$ 2 Trillion) economy. It seems designed, like the asset declarations of politicians, to hide more than it reveals.

Assuming a thumb rule asset value 20 times the annual capital expenditure yields a “notional” but more realistic value for government assets (other than land) of Rs 48.76 lakh crores (US$ 786 billion). Annual maintenance at 2% of “notional” asset value requires an additional 5% of total expenditure.

Just these five “tied” revenue expenses, all of which account for 47% of the total expenditure, reduce the “free play” money with the FM to 53% of total expenditure.

The drag of politics

But it doesn’t end here. Central assistance for states is what gives leverage to the PM to negotiate with state governments. In the new “cooperative federalism” framework envisaged by the PM, after the niceties are done, bargaining power will depend on the fiscal muscle the union government can flex in inter-state negotiations. How else could the PM, for example, influence the governments of Haryana and Delhi or the governments of Tamil Nadu and Karnataka to share water with the minimum of bloodletting as the searing heat of May pushes up water consumption? The 2015-16 allocation accounts for just 1% but is highly politically sensitive to change.

Subsidies on items like food, fertilizer and petroleum and interest subsidy account for 14% of the total expenditure and also fall in this category. “We need to cut subsidy leakages not subsidies themselves” is what FM Jaitley remarked in his FY 16 Budget Speech on February 28, 2015.

The “Statement of Fiscal Responsibility” tabled under the requirements of the “Fiscal Responsibility and Budget Management  (FRBM) Act, 2003” unveils the FM’s hope that subsidies shall decline from 2% of GDP in 2014-15 to 1.6% of GDP in 2017-18. This could happen if annual GDP growth accelerates to the targeted 7.5% whilst the nominal amount of subsidy grows slower. But it sounds like an over optimistic assessment.

True, subsidies can be better targeted to eliminate waste and corruption. But there are also millions who are eligible for subsidy, but remain unable to access it today, because of complex administrative arrangements and poor documentation.  If the JAM (Jan Dhan, Aadhar, Mobiles) inclusion initiative succeeds it will likely swell the numbers accessing subsidy. Consequently, the jury is out on the net savings that better administration of subsidy can achieve.

Accounting for the amounts committed to assistance for states and subsidies, the “play” money available to the FM reduces from 53% to 38% of total expenditure.

Funding White Elephants

The remaining 38% or Rs 7.18 lakh crores (US$ 116 billion) sounds like a lot of money. But we still have not accounted for the FMs compulsion to fund the variable costs of programs managed by the mind boggling 72 (seventy two) departments of the union government-each a fiefdom in itself.

Not accounted either are allocations for ongoing projects which are unproductive “sunk cost” unless completed and operationalized. Budget 2015-16 proposes parceling out Rs 1.11 lakh crore (US$ 18 billion) of CAPEX  as grants to as many as 375 projects.

Oddly, the budget documents make no distinction between CAPEX allocations to ongoing projects and the CAPEX for new projects. Could this be because making such information public may reveal the absence of fiscal space for new projects or force government to abandon undeserving old projects?

Inefficient governments under-allocate to old projects thereby making space for announcing new ones. This makes sense politically, if sharing “pork” is the mantra of survival. But it happens at the expense of previous investment lying unutilized, worsening thereby the Incremental Capital Output Ratio- jargon for how much bang each buck buys and increases the interest burden every year as borrowed funds lie unproductively in incomplete projects.

To be sure none of this mess is of FM Jaitley’s making. But it is fair to expect him to clean it up since PM Modi’s is a government which works.

There are four initiatives the FM must launch to achieve this worthy objective.

First, he must walk the budget speech to aggressively resuscitate the PPP model and not solely because it pulls private capital into public projects. Partnering with the private sector forces the government to be efficient, effective and results oriented. Entering into explicit contracts with the private sector also makes information public, which can then be used to hold government accountable.

Second, the economic rationale behind civilian investment decisions must be made public. How are potential investments ranked? Hopefully, making the investment and economic analysis public knowledge can reduce the political noise and avoid wasteful decisions. We cannot just leave it to path breaking individual ministers like Suresh Prabhu to be punctiliously technocratic, as he was in the Railways Budget 2015-16. The weight of public opinion, via direct participation, must be institutionalized to assist the government in avoiding “bridges to nowhere”.

Third, at least ruling party MPs must commit time and effort to disseminate the logic of the budget to their constituents. It is for this purpose that Parliament takes a month’s recess during the Budget session- this year from March 24 to April 20. Have, at least, the BJP MPs fanned out to their constituencies to interact with citizens? Doing so would force MPs to understand the provisions better; come across as being well informed and initiate a more substantive dialogue at the local level. Delhi is a fish bowl in which MPs operate. Happenings here do not resonate with the rest of India automatically.

Finally, there is the appeal to save trees by reformatting the budget documents and making them shorter in length (500 pages for starters?) but more transparent in quality and to share both, the genuine constraints and the FM’s innovations to punch above his fiscal weight.

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Mega-cities are inhuman

Unlike monkeys, it is not in the nature of humans to huddle though we take to cuddling quite easily. The instinct to explore new frontiers and the excessive demands which we impose on natural resources; both push us to put space between each other. The ancestors of today’s Indians trekked all the way from Africa to the sub-continent around 500,000 years ago, possibly to put space between themselves and their African cousins. It is not for nothing that the self- sufficient, “Marlboro Man” was an icon for three decades starting from the 1960s albeit now discredited in a tobacco-less World.

monkeys huddling

There already are too many humans at 7 billion. Of these, 1.2 billion souls are concentrated in India, making us the most densely populated, large country in the World. Worse Indians are huddled in habitations in just 9% of the land available. The rest is forests (an implausible 23% in government data), private groves, pastures and agricultural land.

Humans huddle in cities more out of necessity than choice. Group living does not come naturally to humans, unlike lions, elephants, antelopes and penguins. The Swedish alternative lifestyle experiments in the 1960s, demonstrated that whilst cuddling was definitely in, huddling was out. Commune members tended to pair off, even if temporarily. More evidence on human choice is available from the preferences of the rich, who sprawl in gardens, whilst the poor are crammed into tiny, multiple stories precariously piled on houses.

Babus, in India, are willing to serve the government, even without pay, for the privilege of living in Lutyen’s green, heritage, garden city. The nouveau rich meanwhile are busy buying up unauthorized, “farm houses” in Delhi suburbia. Part of the fascination of “going West”, particularly to the US, is the affordability of sprawling houses as compared to the tight, modular, frightfully expensive “paper” abodes of the Japanese.

Neither time not technology, augur well for huddling or cuddling. Thanks to digitization of information; the internet and social media, human relationships are now virtual and often best conducted remotely. Many a face to face encounter has spelled disaster. Business is also increasingly digital and even government is going that way. All of this reduces the need for huddling in cities. The modern “Morlboro Man” is a woman with her Iphone.

Gandhiji’s vision of “self-sufficient” villages and Julius Nyrere’s vision of “Ujama villages”, on which the Washington Consensus smart set poured scorn, now increasingly seems not only a reality but a potential option for preserving the best of humanism. Consider that with the revolution in printing technology, it is already possible to print out a plastic tumbler or bowl in one’s home. Consumer durables are most likely to follow suit. This will completely change the “scale economy” for manufactured goods. The most scalable part of the new technology would be the software, which in all probability may have been conceived in a garage! Of course we would still need some “old industry” type factories to make the chips, the computer accessories and most importantly the printer, which makes all this possible.

Old age technology and industrial habits have fueled the international trend in urbanization towards mega cities (population of 10 million and above) whose number increased from 2 (Tokyo and Rome) in 1970 to 28 in 2013 and will likely go to 37 by 2025. India today has 3 mega cities and Mumbai is the second most densely populated megacity after Dhaka. The demise of the mega huddle of a mega city is not immediately imminent because the available “industrial age” technology still makes them scale efficient. But in India recent data indicates that growth in the mega cities is slower than in second rung cities which shows that they have reached the economic limits of their efficiency.

Mega cities are bad news for the following four reasons.

First, humans are bad huddlers because with the existing technology, cities with a density in excess of 4000 persons per sq km, end up severely polluting the air, land and water. Our mega cities have a density of around 12,000 persons per sq km and are unsustainable, as are China’s.

Second, as population density increases, the pressure on land drives up the price of realty, making “land intensive” business like “international scale multi-brand retail” uneconomic. Contrary to popular criticism, the AAP knows that no international multi brander would want to locate in Delhi because land is too expensive and hence had no downside in siding with the populist naysayers.

Third, increasing population density requires a higher spend on environmental mitigation of local pollution further driving up the cost of doing business.

Fourth urban led growth is inherently iniquitous. It creates pockets of luxury amidst vast swathes of wretchedness. The IMF (the bastion of the erstwhile Washington Consensus) estimates that in the US, 90% of the incremental wealth from growth benefits just 1% of the population.  Inequality is a growing concern and a key driver of political and social instability and crime and a major threat for poorly governed countries.

The term SMART city is the current buzzword to make cities efficient. This is a misnomer since cities by definition are not SMART. SMART is to digitize; connect electronically; disperse population; integrate rural and urban areas seamlessly and not to huddle.

Our cities should be self-financing and not draw on central or state funds. Public spending on infrastructure should focus on making rural areas more productive. It should improve the quality of life for rural residents since dispersed habitations make market based solutions for basic services unviable. At the best of times, making sensible public investment is tough. It becomes unconscionable when public funds are used to artificially drive up the demand for realty through public expenditure on creating cities. This growth pattern has also been a key source of corruption with elite capture of the land just prior to its development into an urban area using State finance.

The US is the best example of publicly funded investment in highways since the 1950s. However, even they found it difficult to do so efficiently. They also have bridges to nowhere. The recent publicly financed programs of demand creation since 2008 have been downright wasteful. California, for example, is persistently broke because it is wedded to “big government”. Publicly funded research and infrastructure can only be attempted by very efficient governments and India is not one of them.

We should go back to our roots in communities. Public finance should be used primarily to subsidize connectivity (ports, airports, rail, roads, airwaves and electricity)in segments where market solutions are not available and private investment unviable. Building and maintaining stuff is best left to the private sector.

The urban-rural divide is an artificial cleavage. Gandhi’s village need not be devoid of modern facilities. Migration should be a choice enabling people to vote with their feet but it is demeaning as a necessity. Spending public money on urban areas is like giving a hungry woman a fish to eat. But investing seamlessly across the country is like teaching people how to fish. Only the latter is sustainable.

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