Spare a thought for Nauru

Nauru is a strange country. It's a trivia nut's delight. It is the only country in the world without an official capital. It is the second smallest state in terms of population after the Vatican. Its 10,000 odd people are the fattest in the world. It is an island nation in the middle of the Pacific Ocean, thousands of miles from anywhere. But this post is not to extoll the Robinson Crusoeish place as some sort of a paradise - it is instead about the strangeness of its economy.

Nauru is , to put it mildly, plain broke. Bankrupt with a capital B. But in the 1970s and 1980s it was the richest country in the world in terms of per capita income ! How did the richest country in the world go bust in 30 years. It is a strange story indeed.

Nauru's prosperity came from the most unlikeliest of sources - bird poo.  Over millions of years, seabirds crapped all over the island. The poo accumulated and accumulated and became guam. When Nauru became independant in 1968, it found itself sitting on a valuable mineral - phosphate - that was easily extractable and a key ingredient for making phosphatic fertilisers.

Nauru became a major phosphate exporter. India was one of its chief markets - a joint venture company was even set up in Orissa, called Paradeep Phosphates between the governments of India and Nauru. Nauru made a killing with phosphate exports. And climbed to become the richest country in the world . Its 10,000 odd people lived a life of luxury - no taxes, no need to work hard. In the process they got fat. Very fat. Literally.

But Nauru is a small island. In 20 years or so, the phosphate deposits ran out. Now the islanders were left with nothing.

What they did next to raise income is a unique story that beggars belief. In the 1990s they tried to become an offshore finance centre. They, of course, were incapabale of managing this sensibly. Criminals made a beeline for the place and it became a major money laundering centre. The US promptly banned it and the dreams of becoming a financial haven quickly turned to dust. They tried selling citizenship for a fee, but once criminals found that they couldn't operate there, very few came.

Next it tried to play the diplomatic game to raise some money. In 2002, it  kicked Taiwan diplomatically and recognised the the mainland - The People's Republic. A grateful China gave it $130 million. In 2005, it kicked The People's Republic out and re recognised Taiwan. It is unclear how much money it made from it.  But you can do this sort of a thing only once ! It however remains ready to recognise any country in need of recognition. It did so with Abkhazia, a breakaway region of Georgia and a grateful Russia promptly gave it $ 50m.

In the last few years it has turned to yet another strange source of income. It takes in illegal immigrants - boat people landing up in Australia - in return for money. So some of the poor Vietnamese, Indonesians and Sri Lankans, find themselves in camps in Nauru instead of their presumed heaven of Australia. Australia pays Nauru for this "service".

The government of Nauru has been historically incompetent and useless. In that, of course, it is not alone. But it is now bankrupt and virtually shut down. It's bank accounts in Australia have been frozen. It's few assets , again in Australia, have been repossessed. It has defaulted on its bonds. Back home, it is not clear if the government can even function anymore. Australia has to save it.

The ordinary Nauruans deserve some sympathy. They have the highest incidence of Type 2 diabetes in the world, affecting 40% of the population Most people are unemployed.  If Australia does not send aid, they will be virtually in penury. The sad problem is that they are a speck in the ocean. Who cares ?

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How to sell all this to the electorate

Maybe I should amend the title to "Can all this be sold to the electorate" ?  Well, I am not sure whether this can or cannot be sold (admittedly a difficult task), but I strongly believe it SHOULD be. In a democracy, we elect the form of government we want. However imperfect, it is better , in the long run, than any other alternative. But a sensible democracy is only possible when presented with a choice of ideas - not a choice of personalities as Indian democracy tends to be.

Despite the Indian electorate being enamoured of freebies, open to bribery, largely illiterate, etc etc, it is not dumb. It is actually a highly intelligent electorate which maximises personal benefit ( why not ) and decides on the choices presented. It is the fault of the political class that they have not presented a different nature of choice.

I believe, its a complete misnomer that subsidies and freebies win elections. They do not. Consider the Congress party's last 5 years. Two major doles - the Rural Employment Guarantee and the Food Security Act are nothing but giveaways; totaling in excess of Rs 50,000 crores. Has it given them any electoral advantage ? None.  What about the state of Tamil Nadu - where parties competed with each other to dole out mixies and grinders. The DMK, which started this and faithfully implemented the promise, was thrown out at the last election. The Samajwadi party , which doled out free laptops in UP, is facing a fair defeat in this polls.  Many parties have written off loans, given free power to farmers etc etc - that hasn't always won them elections.

The Indian electorate has changed. Good governance wins elections now. The examples of Gujarat, Madhya Pradesh, Bihar and Orissa, and to a certain extent Assam are showing us the way forward. Spread across the political spectrum , they are indicative of a trend. Development and economics works and it can win elections. After all, the current frontrunner is running precisely on this plank.

The challenge for the political class is to explain economics in a simple way to the electorate. Almost nobody has cracked this (anywhere in the world). But that doesn't mean we should not try. Present the Indian budget in an even simpler form than what I outlined a few posts back. And then engage in a national debate  as to what the priorities should be. An honest, non corrupt leader, meaningfully engaging this issue will resonate with the voters. Indians understand debt and the need to live within our means very well - it is in our culture. Engage in a debate with them on priorities. I am willing to bet that a consensus amongst a vast majority will be reached, which would be sensible economically.

There are however some pre requistes for a politician engaging in an economic debate

• He or she must be completely non corrupt personally. At the moment only Manmohan Singh, Mamta Banerjee,  and perhaps Narendra Modi qualify.
• He or she must be completely free of crony capitalism (both the gentlemen stand accused of this)
• He or she must have credibility (Manmohan Singh's has gone and the lady does her best to undermine her's) .

Such a leader must present the case for reform  to the Indian electorate.  It may not win him the election, but I strongly feel it won't lose him one. Building up some steam and buy in, makes the job of implementing them easier later on. Once the track record has been established, it will guarantee him future victories in elections far better than any populist measures will.

So here is a suggestion to the combatants in the elections

• Choose a personally non corrupt leader (most major parties have such individuals)
• Outline the boundaries of the economic plan. Of course, this is only aspect of a manifesto - others including social, political, cultural, and other issues are equally important
• Once in power, implement rigorously with zero tolerance for crony capitalism. State funding of elections, will help in this.
• When the time comes five years hence for re election, I submit you would win easily.

An alternate route to winning this election, I suggest,  will doom you to defeat in the next one. So what, you might ask ? After all five years of power and moneys are pretty good . Yes, maybe. But politicians will quickly discover that short term gains are not that attractive to them any more. They all aspire for a place in history.  That is certainly true of those who want to become the Prime Minister. A place in history comes with  the nation doing extraordinarily well - not by thuggery or maximising personal wealth.

With this post, I rest my case on the economic manifesto for India.

We enter a crucial next month when we as a nation will make a choice.  May we have the strength to chose wisely, and carefully. And May the Force be with the new leader, whoever that may be, and his government, to serve India well. May we be judged in times to come, as a generation which turned the corner for India. 

Amen.

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Get the poor to subsidise the poor

I am not sure what the Tamil Nadu government is. A bootlegger ? A bottomless pit ? A great implementer ? A humane  carer of the unfortunate ? A bunch of eunuchs in the court of a megalomaniac ? All of the above ? Read on.

I was tempted to take a one post detour from the economic manifesto for the country as a whole, to shine a spotlight on Tamil Nadu. This was prompted by a comment from myfloatingthoughts asking for an opinion on the freebies and other doles that bedevil this state. When I examined the financial situation of Tamil Nadu, it is a complex nuanced position. A mixture of the good, the bad and the awful. Judge for yourself.

                                                                                                      Rs Crores

REVENUES

State sales taxes                                                                                33,970

Profits and taxes from liquor sales                                                      23,400

State's share of central taxes                                                             14,520

Property Taxes                                                                                    8,338

Others                                                                                               21,549

Total Revenues                                         1,01,777

EXPENDITURE

Interest                                                                                              10,196

Freebies  (the awful kind like mixers, grinders)                                      8,350  

Pensions                                                                                            13,680

Unproductive expenditure                                                             32,226

Education                                                                                          16,293

Agriculture                                                                                           6,346

Health                                                                                                 5,365

Power                                                                                                 4,368

Urban Development                                                                            4,148

Other Revenue productive expenditure                                              10,108

Other Capital productive expenditure                                                 28,362

Productive expenditure                                                                 79,032

Grants to local bodies and Panchayats                                          9,233

Total Expenditure                                     1,20,491

Note : Classifications of" "unproductive" and "productive" are my own    

One thing immediately stands out from the revenues - the Tamil Nadu government is essentially a liquor company. It has commandeered a monopoly of the liquor distribution in the state. Liquor consumption is booming in Tamil Nadu, aggressively driven by TASMAC - so much so that the per capita liquor consumption in the state is the highest in the country. If you have seen a TASMAC outlet anywhere in the state, you would know it is one of the dingiest and most depressing of all places. Only the poor frequent TASMAC. If ever there was a case of the state robbing the poor ..........

The thing that stands out on the expenditure side is that pensions are a bigger problem than freebies. The freebie nonsense is a relatively small amount and can be turned off, for many of the freebies like mixers and grinders (the largest one is laptops)  are one time affairs. The real problem is pensions, to the 7 lakh retired employees of the state. It is a sobering thought that 1% of the population of the state (and relatively well to do at that) corners 14% of the state revenues. Wonderful.

The better side of the story is that a considerable portion of the expenditure actually goes to productive uses. The state has always been a leader in education. Its health sector is also one of the better managed ones in the country. Its roads are good. It has faced a chronic shortage of power and has stepped up investment in this sector by a huge amount. Irrespective of which political party is ruling, productive expenditure has always been high. Yes, a significant portion of this expenditure is siphoned away by the political operators - for this is one of the most corrupt states in the country. Yet, a fair amount does actually get spent. So the situation is not that bad.

There are no elections to the state due for a couple of years. When the state elections come, the chief issues , economically speaking,  for the state are

• Is it ethically right for the state to remain financially afloat purely by getting the poor to be fully drunk.
• What to do about pensions
• How can we get a greater proportion of well meaning productive expenditure to be actually spent instead of being siphoned away

I am willing to bet not one of these will be debated election time.              

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The virus of corruption

In the previous posts developing the economic manifesto, we had parked the issue of corruption to be discussed separately. We now address the tackling of corruption, arguably one of India's biggest problems and one which is indisputably linked with any economic road map.

My first submission is that corruption can never be totally eliminated - for it stems from one of the basic human  vices - greed. We can, and should, control it as much as possible. But elimination is impossible.  Nowhere on earth has corruption been made extinct.

The battle against corruption needs to be tackled on three fronts

• Minimise the chances of corruption by removing the need for government clearances, permits, licenses, etc except for where this is absolutely necessary

• Transparency and oversight over commercial transactions involving the government

• A powerful and vigilant independent body that monitors, checks and prosecutes cases of corruption

The problem with the Anna Hazare movement is that it exclusively focused on the third element and completely bypassed the first two. The reason why his political successor, the AAP, will not succeed in tackiling corruption is that it too exclusively focuses on Item No 3 and actually seeks to increase the first problem.

The first front of the battle has to be to eliminate the need for licenses, permits, and various clearances, that have long outlived their utility and which are exclusively designed to breed corruption. Every commercial activity in India is subject to a plethora of rules, procedures and licenses, three fourths of which are not required and are primarily the source of petty corruption. These can be eliminated easily by

• Trawling through such laws and repealing them
• Consolidating all others and making them single window procedures
• Making them  transparent, online and therefore not subject to the whims and fancies of the babus

There are many examples of this being successfully done in India. In 1991, we took the bold step of abolishing Industrial licensing , a previously unthinkable step. P Chidambaram, then a young turk full of energy simply abolished the Controller of Exports and Imports in one stroke - one of the most corrupt bodies then ( famous quip of his when he met the worthy was,  "I can understand somewhat your trying to control imports, but why on earth are you controlling exports !") . It has been done and can be done now.  It doesn't need a financial emergency to goad action. I am not advocating the Wild West at all - clearances such as pollution, fire safety, etc are paramount. But do you have to have laws saying the font size in which the name board of your company has to be in and the  need for first having Kannada and then only English in the name board. Or the need to inform the local babu everytime you have to open the office on Kannada Rajyotsava day ?  You would be amazed how many such requirements exist.

The second, and most important battle is to govern the processes of economic transactions with the government.  These are primarily in the areas of price fixation for assets owned by the government - spectrum, coal, etc,  and the execution of government projects such as roads, public events like the Commonwealth Games, etc. This can be achieved by 

• Clear and transparent, published rules governing each type of such transactions
• Oversight by independent regulators (already happens today when such transactions come under the purview of SEBI or TRAI or RBI, etc). As a corollary, make all these regulators independent, starting with the RBI.
• Create an ombudsman body, staffed by eminent independent Indians, who will pre approve all transactions above a certain limit (very high limit obviously)
• Government to get out of price fixation for products (like electricity, gas, coal, etc ) everywhere and leave it to markets. If it wishes to intervene, these will be in the form of open market interventions, very similar to how the RBI acts today
• Pricing of natural resources is to be through an open transparent auction (like what happened for 3G telecom)

A leader who is personally non corrupt, powerful and is prepared to leave government decisions in the hands of professionals will ensure that this is effective. Something like this is what has happened in Gujarat and is the reason for the halo around that leader. Copy the model elsewhere, although that will take some doing with two of the three gargantuan megalomaniac ladies that dot our political landscape.

The third (and only the third) step is to create a powerful, anti corruption oversight body. In the absence of the first two steps, this will never be effective. But in conjunction with the first two, this can be a solid weapon. Enough has been said on this subject. Simply enact the Lokpal Bill.

Is all this simplisitic. Yes, it is. I had no desire to write a thesis, but I will be happy to get into a detailed discussion on any aspect with any reader.

There is a missing ingredient in all this. It is the moral fabric and value system of the citizens of India - a factor rightfully emphasised repeatedly by The Million Miler, one of the regular commenters.  Unfortunately this is India's greatest weakness. The moral fabric of the nation and its citizenry, I am deeply saddened to say,  has been completely torn apart. It pains me to say this, but we are a corrupt nation intrinsically. It is a rare Indian who is not corrupt at heart. He expects everybody else to be clean, but doesn't think a fraction of a second before bribing anybody to get his job done.  That is the reason why corruption will always be a significant element in Indian life. A messiah is needed who will lift us from the sad levels to which our values have degraded to. Until then, we cannot eliminate corruption. But we can try to contain it.

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Lock the checkbook

After considering the revenue side in the previous post, let us turn our attention to expenditure. This is important, as the pattern of expenditure reflects our priorities and the debate really ought to be on whether the priorities are right or should there be a different set of priorities.

Even if you disagree on my classification of "productive" and "non productive" expenditure when I outlined the current state of India's finances, it is obvious to anybody that we should decrease non productive expenditure and increase the productive expenditure. However exactly the opposite has been taking place over the last 30-40 years. There is little doubt in my mind that a correction is required. But the correction should be gradual - any sudden reversal will trigger a revolution on the streets and is impractical.

Here are my set of proposals for the expenditure priorities

• You can do absolutely nothing on the interest line as these are past commitments. However the one thing that you can do is stop it from going beyond control. My proposal is to decrease the rate of increase over the next five years so that it peaks in the fifth year and thereafter falls. We cannot do any better considering where we are starting

• In an ideal world, we can do away with defence expenditure, but humanity will never reach that state of idealism. Given the geopolitical situation we are in, it can be argued that we should be spending more. However given the state of finances I propose only modest half of inflation increase in the defence budget for the next five years. Once we reach somewhere near a balanced budget, our defence expenditure should increase gradually so that in 20 years it is at the same % of GDP as China

• We now come to the most vexing of areas - subsidies. I am not a votary of zero subsidies. Far from it. In a poor country like India, the unfortunate need  assistance. What I am absolutely opposed to is subsidy to the "rich". Here are my proposals

• Food subsidy should be retained and grown at a modest 3% per year. Subsidy to everybody but the real poor should be stopped (currently I am entitled to some rations). The Public Distribution System is very patchy in various states - the example of Tamil Nadu, where it is probably best done should be copied in other states. The combination of better implementation, a la Tamil Nadu and stoppage of subsidies to anybody above the poverty line means we can substantially cover and enhance the benefit to everybody below the poverty line.

• There is zero logic to Petroleum subsidies other than kerosene subsidy (which is the only subsidy that goes to the poor). The argument that raising the price of diesel will affect the common man is specious - the level of deficit financing is a bigger cause of inflation that a diesel price hike.  Reduce petroleum subsidy over 3 years gradually leaving only the kerosene subsidy as an expenditure item.

• There is also little justification for the fertiliser subsidy.  Phase it out over 5 years by drip feeding increase in price of fertilisers . More price increase when the monsoons are good, less or no price increase when the monsoons fail. We are a food surplus nation at the moment. Even if there is a temporary fall in foodgrain production, we can absorb it.

•  Retain all rural development subsidies other than the NREGA, which is surely one of the most awful schemes of the previous government. Phase this out over three years.

• Pensions to government staff is a monster - it is inflation indexed and most pensioners earn well above what their salaries were when they were working. There is little justification in cosseting this lot. Abolish inflation indexing and continue the pensions . However for current employees, make the pension scheme contributory - both employer and employee contribute every month and the corpus built up becomes the pension. Do this in stages. First abolish benefit scheme for new recruits, then for the under 30s, then for the under 40s, fiddle the inflation numbers to halt the runaway increase, then increase pensions by only half of inflation and so on. The power of creeping reforms is not to be underestimated.

• Keep all other "non productive expenditure", but grow them only at half the inflation rate and demand efficiencies to make up for the balance. There are examples in India today of states which are efficient in implementation. We have to copy the most efficient states model to the other states

•  Productive expenditure has to be increased substantially. Double the spend on Health and Roads over the next 5 years. Corporatise Railways (keep them in the public sector)  and let them raise their own borrowings in the market for investment. A  correction in passenger fares (amongst the lowest in the world) and freight rates (highest in the world) has to take place - drip feed the correction over  3 years.

• Education is being heavily invested upon - both by the Centre and the States. I propose a further 50% increase over 5 years. The regulatory bodies in education are amongst the most corrupt in India. Abolish them and reconstitute a professional body of experts - not bureaucrats.

•  Industry needs no substantial increase in investment (the private sector has to do this). Agriculture does. I am not an expert on agricultural policy, but there is a substantial need for reform. The level of investment needs to be doubled over 5 years. An expert committee with the likes of MS Swaminathan can draw up a comprehensive policy and the government must implement it in toto.

 Based on the above proposals the finances of the central government at the start of its term (now) , at  its mid point in 3 years time and the end of its term in five years is presented below.

 

	2013	2017	2019
	Rs cr	Rs cr	Rs cr
Revenues	1,056,381	1,406,043	1,701,312
Expenditure
Interest	380,066	447,811	471,727
Defence	203,672	222,558	236,112
Food Subsidy	92,000	100,531	106,653
Fertiliser Subsidy	67,971	27,188	0
Petroleum Subsidy	85,480	34,192	37,697
Rural Devp Subsidies	78,452	50,000	55,000
Pensions to Govt staff	74,076	63,511	57,319
North East Subsidies	24,262	28,086	30,965
Police	43,148	49,949	55,069
All Others	144,227	157,601	167,199
Non Productive Expenditure	1,193,354	1,181,427	1,217,740
Education	67,398	89,707	108,545
Health	30,145	45,847	60,632
Railways	30,223	12,089
Roads	21,399	32,545	43,041
Agriculture	17,557	26,702	35,313
Industry	22,393	25,923	28,580
All Others	88,926	118,361	143,216
Productive Expenditure	278,041	351,173	419,328
Grants to States for Plan Expenditure	119,039	149,955	174,907
Total Expenditure	1,590,434	1,682,555	1,811,975

As you can see we can come close to achieving a balanced budget despite increasing productive expenditure significantly and not eliminating every subsidy. With some luck and a higher growth rate, we can even hit a balanced budget. Once that happens, we enter a virtuous cycle - interest burden starts to diminish and we can substantially up the productive expenditure. Massive step up in education, health and infrastructure would then be possible. That would be basis to seek re election.

I believe the debates we have had on expenditure  in the past are every cursory.  Expenditure is all about priorities. Any individual expenditure or subsidy can always be justified. The problem comes when we are presented with the totality of the revenue and expenditure situation and then asked to defend if our favourite subsidy has to be continued then what alternate item should be cut. When we agitate on the streets for the cooking gas subsidy, we would do well to remember that.

Yes I know I haven't tackled the political saleability of all this. I promise not to duck this and do a full post of how we can sell this to the voters.

Waiting for all your comments. By all means tear me apart on any specific proposal. But remember, you have to present what would be the alternative !

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Grow baby, Grow

If you saw India's financial position in the previous post, you could be excused for opining that we must cut expenditure. For most other countries, that would be the answer. But not for India. For India, the mantra has to be grow baby, grow.

India is uniquely positioned. It has all the ingredients for rapid growth - a hitherto underdeveloped economy, a dynamic and large domestic market, a large and young population, an education ethic coupled with hard work (mostly), and all the institutions that can enable growth. The trouble is that it has been constrained all these years - first by socialist claptrap and second by the neta babu raj.

You can see why growth has to be the single most important mantra for the next 10 years

• The only way to provide economic upliftment for large sections of the population is through facilitating employment. The only way to facilitate employment is through economic growth - not by giving doles under the guise of the NRGEA.

• Economic growth will lead to explosion of tax revenues to the government - helping close the yawning gap between revenues and expenditure and enabling big rises in productive expenditure.

I submit we should target a 8% GDP growth year on year for the next 10 years. We should completely forget about equality of wealth  during that period (let a few people get rich; remember the immortal words of Deng Xiaoping when he set China on the growth trajectory). A decade later we can stimulate more equitable growth. For now, go full blast for growth. Let us have the enviable problem of the economy overheating through too much growth, a la China.

Growth can be achieved by the following strategy

• Reform the land acquisition policy - this is the most difficult reform of all.  Set up an independent body that will adjudicate on land acquisition issues. Set fair purchase price, insist on all families selling land to be provided employment, and establish the principle of 75% acceptance means the other 25% have to compulsorily give in.  The independent body shall be a quasi judicial body and the courts should refuse to intervene. Decision making by the body must be in short frames of time - say 3 months. Establish fair and transparent process and public acceptance would come. Ruling party , in its own self interest, should not instigate trouble in opposition ruled states.

• Single window clearance of industrial proposals by the government. Speed of clearance is essential - no more than 1 month, else clearance is deemed to have been made. No bureaucrat is to be made the subject of a CBI investigation for a decision that may later prove to be correct or incorrect - he should only be investigated if he has personally made money in the process.

• Trawl through all the laws relating to commercial enterprises - be it in agriculture, industry or services and repeal 75% of them, taking some risks in the process. Strict laws should only be in some limited areas such as consumer and worker health and safety, pollution, etc. In other areas, the government should stop its utopian meddling. There is a precedent for such action - when the 1991 reforms happened, this is exactly what Manmohan Singh and Chidambaram did in the field of exports . Some unintended consequences may happen, but that is a price to pay for growth and can be subsequently corrected.

• Enact the new Direct Taxes Code and the Goods and Services Tax, which has been in legislative limbo for a decade. This will make India one economic entity rather than each state erecting boundaries. If some states with opposition governments do not fall in line, they should be ignored and the rest should proceed. This will give stability in taxation.

•  Throw open every sector to domestic, foreign or extra terrestrial investment. Frankly it doesn't matter in today's world where the capital is coming from. If it comes from outside, all  the better - government's finances will be eased.

•  Big push to infrastructure for the next 5 years - power, ports, roads and railways. The government needs to do very little - simply allow private capital to do its job and not come in the way. Power sector reforms are essential - this is a specialist area by itself, but India has tied itself into knots. I won't get into the details of power reforms, but it just needs a strong leader to remove all the shackles, price power  economically (no freebies), buy / bully peace from the environmental lobby (no dilution of pollution standards however)  and let the problem solve by itself in 5 years.

• Access to capital is already good for economic enterprises - both equity and debt. The government needs to do nothing different and simply maintain status quo

• Make regulators independent, arm them and leave them alone to do their job. SEBI and RBI are two excellent examples that do this today. In every sector, simply clone this model.

• No subsidies, tax holidays, nothing,  for industries.  The sheer economic opportunity will spur investment. No sops needed.

• The industry and services sector do not need government intervention or help. Agriculture does. I am not an expert on policy measures required in agriculture, but entrust that task to experts like  M S Swaminathan and simply implement whatever they say.

• Above all, glorify speed. Introduce a law that specifies time limits for every governmental or regulatory action. No sitting on files. Making a wrong decision in haste is not a crime. Making no decision at all IS a crime. 

• Shift government's approach to economic activity to one of facilitation and not of investigation. Shamelessly court economic activity of any kind without making moral judgements on relative merits of one over the other. In that process a few (even many) rotten apples may slip through. I submit this is an acceptable price to pay for growth.

• Create an overwhelming momentum for growth. When the momentum is overwhelming, opposition is difficult and might be restricted to a few areas. Backtrack there and let loose the rest of the push.

Growth will not be smooth - there will be some areas where things will turn out badly. Some (the 1%) will make huge money. Some will be left out. But a large and overwhelming majority will be uplifted. The example of China proves that this is indeed the case.  It is worth taking the risk, because inaction and not growing is sure to doom the majority of our brothers and sisters to perpetual poverty. That is a bigger crime.

What of corruption ? That is such an important topic in India that it will be the subject of  a full post that shall follow.

How can this be politically sold. Again a topic that deserves a full discussion in a separate post, also considering the implications of the proposals on the expenditure side.

Simultaneous with the growth push, the government should also remove income tax exemptions for agricultural income, for house property if reinvested, for long term capital gains etc. Very few (preferably nil) exemptions must exist in the tax code and the rates should remain at the current 33%. This has been the direction of tax laws anyway since 1991 - that's why income tax collections are such a success relatively speaking.

A GDP growth of 8% plus the removal of exemptions will result in tax revenues rising by at least 10% per annum. That will mean an additional Rs 1 lakh crores of revenues each year. Coupled with sensible policies on the expenditure side, the country can actually step up productive expenditure, and bridge the deficit, at the same time in 5-10 years.

Will such an approach work ? Yes it will. There are two examples in history. India itself in 1991, did something like this. The result is plain for all to see. And then there is China from 1980 to 2000. The Chinese example has one major difference - it was all government led with most of the investments coming from the government. I am recommending the opposite of this. The growth will be private led with governments only facilitating - for the Indian government today is not financially in a position to do any better.

For those interested internationally, this strategy can work only for India, and partly for Nigeria and Indonesia. It will not work for any other country. For those interested, happy to debate offline !

In the next post, we shall turn our attention to the expenditure side.

What do you think ?

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An economic manifesto for India

Indian elections are around the corner – easily the most complex democratic exercise on earth affecting one in seven people in the world directly, and more indirectly.

Democracy is all about choices. In order for that to succeed, the choices must be clear. The biggest issue facing India is economic – how to lift millions of Indians out of poverty and give the best possible economic advancement for as many Indians as possible. And yet, if you see the electioneering, there is total absence of economic policies or what the choices are. There are general myths , perceptions and blind loyalties on which the people are being asked to vote. No specifics at all. 

In the area of economic policy, the front runner is arguing that he would replicate the success of Gujarat nationally.  That is fine, but how would he do it ? India is not Gujarat.  It is far more complex and requires an entirely different set of policies.  So what specifically  would he do to ensure “development” (his favourite word) in India.  Complete silence.

The incumbent is maintaining complete silence as well. If the track record of the last ten years is anything to go by, he would be a disaster. If he is going to change tack, then he should say what is the new direction he would take. Nothing there

There is a motley crew who would all like to be the leader and who would like to constitute the third or fourth or fifth fronts. They are all, especially the three women amongst them, economically illiterate and their track records in their respective states is abysmal.  No announcement about what their policies would be, except the lady from the East mouthing some general platitudes.

Then there is the new kid on the block. We do not as yet know, whether any of his pronouncements are to be taken seriously, but the general feeling, economics wise, is that it would be the biggest disaster of them all. In any case his philosophy appears to be that noise is better than policy.

This is ill serving the people of India. If we are to make a choice, we need a specific manifesto. In the absence of any of them stating this, this blogger, in his hotheaded way is proposing to offer one. Not that anybody would take the slightest notice, but then blogging is all about airing one’s views. 

In the next post, I will outline India’s revenues and expenditure in a simplified way and ask you to make the choices. Then we will together, co create an economic manifesto. How about it. I will also plead with some of my usually silent readers to also articulate their view on the choices  - every Indian should think about the way forward.

By the way, the theory that economics does not matter with people and that they will not be influenced by what is economically the right thing to do is completely untrue. For evidence, you only have to look towards China. The entire legitimacy of a system of government that is unitary, non choice based, dictatorial , non representative, etc etc is the implicit economic contract with its people. Politicians in India might wish to ponder over the reality that if a free and fair election were to be held in China today, the Communist Party would romp home with a three fourths majority.

We will also cover the political side of the economic argument – how to sell it to the voters as well.   

Walk the next few days with me - I promise that the discussion will not be too technical. Let us create our own manifesto for India.

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China's debt problem

If you have seen, or heard about, China's wonderful infrastructure, have you wondered where the money is coming to finance all this ?  The laws of economics apply equally to China, as to the rest of the world. There is no free lunch. So where is the money really coming from ? This is a complicated question ; China's economic model is not easy to grasp for any outsider, but perhaps we can take a peek at it.

Infrastructure spending is not necessarily a profitable business - returns to investors are meagre from roads, railways, etc etc. In China, as in most countries, the government is the one that invests in, and builds infrastructure.  Since 1980, China has been growing at double digit rates. That growth resulted in big increases in tax revenues to the government. Chinese are also a nation of big savers. With growing incomes, came growing savings which were all vacuumed into the state banking system. The government spent a lot of it on infrastructure - banks are all under government control anyway and they were told to lend to industry and infrastructure. Since all land is owned by the government and since land prices rocketed, governments made huge money leasing land to the private sector. All in all a massive party, if you'll pardon the pun.

Came 2008 and the global financial crisis. China being an economy that relied heavily on exports, the effect was instantaneous. However, China could not afford to slow down; the political legitimacy of the Communist Party is predicated on continuing high growth and economic prosperity. So it turned the tap on investment - banks were told to lend, no matter what and growth rates continued to be high. Cities built shiny buildings, huge metros, big highways, added manufacturing capacity etc etc much of which is underutilised and certainly not providing decent economic returns. If you invest with little or no return, some day or the other you have to pay the bill.

Now the chickens are coming home to roost. China suffers from the same problem as India - the central government is largely fiscally prudent, but state and local governments indulge in the worst form of profligacy. Out came the data a few days ago that China's local public debt has exploded from very little to US$ 3 trillion - 58% of China's GDP. Since 2008, 80% of bank lending has been to local governments. And much of this money has gone into spending that will generate no return. While 58% of GDP is itself not a very high figure and much lower than say US or Japan, the rate of growth in debt is staggering (70% in 3 years) and if it continues like this, it will reach unsustainable levels.

China has a debt problem. The Chinese government knows this very well and a year or so ago forced banks to contract lending.  The impact on growth was immediate - it alarmed the government and they turned the tap on again.  A few weeks ago, China faced a short term liquidity crisis and the central bank was forced to pump cash into the economy.

The world will watch China's actions carefully. They will fiddle with the tap turning it on and off and adjusting the flow to check the growth in public debt and at the same time not let economic growth go down too much. This is an inexact science and to manage this at a national level, and that too for the second largest economy in the world, is extremely tough to do. If they get it wrong, the consequences will not be just economic - given China's system,  it will be political as well.

Longer term, the cliche of an investment led economy turning to a consumption led economy is the medicine economists prescribe for China. Easy to prescribe, not easy to administer. Unlike in say India, where political legitimacy is not dependant on macroeconomics, in China it is. If the economy wobbles, so will China's Communist Party. Any political turbulence in China will be painful, not just for China, but for the whole world.

I know economics is a dull and boring subject, but watching what China does and what the outcome is, will be fascinating if you are interested in such things. China is not a gold mine anymore. There are significant risks to the global economy from China. The party may not be coming to an end, but the music is sounding a bit off key and not so loud at the moment. Funny, you could also say that about the Communist Party.

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The US Treasury should be ashamed of itself

There is nothing more irritating than somebody who pontificates. Even more irritating is if the guy has absolutely no credentials to pontificate on the subject in question. Imagine the Pontiff (if you'll pardon the pun)  lecturing on the merits of Viagra. Or Sarah Palin extolling the merits of Shakespeare. Or even this blogger blogging about Kollywood !!

That is how I can best describe the American Treasury's criticism of Germany's economic policy. The criticism is that Germany's current account surplus as a danger to the eurozone and the world economy. Germany runs a current account surplus - that is, it exports far more than it imports. This is , according to the American Treasury, a big danger to the world economy. This blog is not meant to be a technical paper - so I will desist from explaining this , which will make it too technical. Suffice to say some "leading economists" also share this view.

First let us play the man rather than the ball - after all this blog is refreshingly free of any responsibility and therefore can attack any which way ! Of all the people, America should not be lecturing on fiscal responsibility. If there is a prize for the most fiscally irresponsible nation on earth, surely the US of A would be a prime candidate. The land of the free has many redeeming virtues, but fiscal responsibility is not one of them. The US Congress hasn't even passed a budget for the last 3 years. The last time they balanced their budget was 1998-2001 and before that  1969. They have had a President who cut taxes massively and then started two wars. They are now flirting with a sovereign default every 6 months. They have promised Medicare and Social Security to their citizens, then inadequately funded it and have no plan to defuse the time bomb.  Because the dollar is the world's reserve currency, they take on levels of debt that most other nations would shrink in horror at the very thought. And collectively as a nation, they foisted the global economic crisis of the last few years. Even India, another prime candidate for the ultimate fiscal irresponsibility award would be hard pressed to match that.

And the country they are taunting is Germany. Post reunification, they were termed the "basket case of Europe". They lifted themselves out of that by their bootstraps. Their prudence is legendary - they are so scared of inflation that they follow the most conservative  monetary policies of all. They struck a deal with the unions when they were in a mess, to hold wages and little by little built up German competitiveness back again.  When the Eurozone crisis hit, they have been the chief (only ?) lenders bailing out every nation that is in trouble.  They don't manipulate currencies (unlike another country we know which also runs a big current account surplus). Can you imagine America bailing out other nations in today's world (to their eternal credit they did that after the Second World War, but that is 70 years ago - the America of today is a pale shadow of the America of those years).

What is the prescription. The Germans must stimulate their economy. They should take more debt. They should consume more and save less. Great.

The Germans have been more peeved at the newsy bugging of Angela Merkel's phone. They haven't reacted with fury  at the American Treasury. They should tell them to piss off and take their pontification elsewhere.  Perhaps the best way to do it is for "Mutti" to whisper on the phone that the US Treasury is a greater danger to the world than Al Qaeda (probably true) and leave it to the NSA spooks to relay that upwards.

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T I N A

If there was, the dollar would be kaput. But there is really no alternative. So it has to be the dollar as the world's reserve currency.

It would be useful to go back to basics and understand what a currency really is.  A currency is really nothing more than a piece of paper backed by the promise of  a government. If you believe in the promise of the government , you hold that currency. If not, it is worthless. Remember the promise is only an act of faith - there is no backing of gold or a real asset behind the currency. Take out an Indian rupee note - any rupee note. It will say "I promise to pay the bearer the sum of xxx rupees" under the seal of the government of India. That's what it is - a promise.

Governments have the licence to print money. But if they simply keep printing on, it will lose its value. Beyond a point, the population will simply lose faith in that currency and resort to barter or to some other currency. That is precisely what happened in Zimbabwe sometime back - the Zim $ lost all value and the US $ became the de facto currency.

When it come to international trade and countries holding reserves, the only real currency of faith is the US dollar. Because the world had, and still has, the maximum faith in the US government above all. But that faith has been seriously eroded in the last two years thanks to antics in the US Congress. If there was an alternative, many would have fled the dollar. But there isn't. The Euro is on an even worse footing than the dollar - which country is the backer of the Euro ? Germany ? France ?  for there is no country called Europe. The Japanese Yen inspires very little confidence. The Chinese Yuan ?? - well the world has to go a long way before that happens - is everybody prepared to trust the Chinese government more than any other ?

China has called for a new global reserve currency. It has to, for after all, it is the largest lender to the world. Easy to say. But what will that reserve currency be ? And which government, or governments, will back it . And how can we trust that any more than the US dollar.

So there really is no alternative. But that should give those in the governance of the United States food for thought. The dollar retains its pre eminence only because the others are worse. Trust is hard to earn, but easy to lose. Those doing the antics  in the US for the last few weeks ( actually for the last four years) have done much to erode that trust. But the problem lies deeper. The US has been printing money like there was no tomorrow, for quite some time. It has come to the brink of default once before, and is now engaged in the same brinksmanship again. There is increasing evidence that sound economics is becoming a rare feature of the management of the US economy.

I am no economist and learned academicians ( are you there J !) have to design the future global reserve currency. But whatever that might be, it all boils down to trust. Alas, there is little to trust in today's world. Whose word can you trust when the only economy that is practiced is that with the truth.

The US dollar note says "In God we trust". I'm not sure if the irony strikes the governing class in that country.

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One small step for Shanghai ......

........  Will it be one big leap for China ? This is the Shanghai Pilot Free Trade Zone, which is opening in Shanghai this weekend. Already it is being compared to the launch of the famous Shenzhen Special Economic Zone in the eighties that heralded the economic revolution in China. Is it economic reform 2.0 in China ? Only time will tell.

China is a strange country when it comes to economic freedom. At one level, it resembles the Wild West economically. Anything goes. You can open a business, do whatever you wish , and make tons of money (and hush hush, ignore most laws regulating business). At another level it is more akin to the Soviet Union. In industries like telecommunications or insurance or banking, you can do virtually nothing. Foreign firms are not welcome, Even Chinese firms are regulated with an iron hand. 

Conventional wisdom says China is at a major fork in its economic journey. Growth rates are slowing down. Relative to the past, that is - even though every other country in the world will give an arm and a leg to be where China is presently. The  investment and export led boom seem to be coming to  a "difficult to sustain" phase. Consumption led growth is the prescription from the economists. A second wave of reforms is prescribed - always difficult in China where politically there is always opposition to economic reforms (even Deng Xiaoping faced bitter opposition when he launched the first wave of reforms). There is also the mortal fear that more economic reforms will inevitably lead to political reforms and nothing terrifies the Communist Party of China more than that.

So a low key testing of the next phase of reform is a sensible move. And that's what the Shanghai Free Trade Zone is rumoured to be. Although there is precious little detail in the government announcement, it is widely expected that inside the zone, the financial sector will be deregulated, the yuan will be convertible and industries such as telecom will be open to foreign investment.  If that indeed proves to be the case, then this is really a big move with potentially global ramifications.

Even more tantalising is the rumour that there will be other types of freedom too inside the zone , not available in the rest of China. The Great Firewall of China will be lifted it is speculated. Currently inside China, Facebook, Twitter, You Tube, Blogger, Word Press and a host of sites we take for granted in our everyday life are all blocked. The Great Firewall also censors every social website inside China. If you post something that the censors don't like, it will be taken down. If you do it repeatedly, there will be a midnight knock on your door. The wilder speculation is that inside the Zone , censorship would be lifted. If this does come true, it would be an earth shattering development in China.

The world is watching. It could prove to be nothing more than a false hope. Or it could be epoch making. I suspect even the bosses in the Party don't know what it will be.  We shall see.

At least China is attempting something. What can I say about India ? Alas.

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