#52 Trade Surplus, Truth Deficit

Single-window clearances, hypocrisy in international relations, economic growth, and more

Jul 19, 2020

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

PolicyWTFs: "...But There Is Discipline and Moral Upbringing In Our Country”

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Raghu Sanjaylal Jaitley

Testing The Base

Of course, we will talk about these amazing tweets about India achieving monthly trade surplus for the first time in 18 years. It is always good to be optimistic in life. What have pessimists and naysayers achieved?

A lot has already been written about the misleading nature of this information. Some have questioned the competence of the ministry if it believes this is positive news.

What do we think about this? Well, there’s reverse Hanlon’s razor at work – “never attribute to stupidity what can be explained by malice.”

There’s more happening here than is seen:

The minister and the officials in the ministry know what trade surplus in the current environment indicate about the state of Indian economy. This isn’t rocket science. Instead, a simple hypothesis is being tested. Will the ‘base’ overlook truth and national interest as long as their party or leader is seen in a positive light? Knowing this truth can set the executive free. The narrative about no Chinese incursions despite evidence to the contrary is another instance of this hypothesis. The answer is clear. We have crossed a rubicon of some kind in the past few months.
Experts and objective commentators no longer matter in this world of information disorder. There’s a craven traditional media and a ‘captured’ social media to amplify the message before experts can even get a word in edgeways. This was known but there was some imaginary restraint on how far you could push the line with the truth. It’s gone.
There is a second-order problem. The government is the source of data, information and analysis that’s important for policy watchers. It is difficult to do this if the first step now is to verify anything released by the government. How should we view the government’s claim that green shoots are visible in the economy, for instance? The truth will get crowded out. And these bad habits persist across governments over the years.

We Are Speechless

Not content with the above, the minister was also at the valedictory session of FICCI Frames 2020. Three things from the speech stood out which we thought deserves discussion.

Single-window clearance

"I will talk to the states to see how we can shoot more films in India," he said. "FICCI and the film industry could help us devise a mechanism for single-window clearance for shooting films in India. If all stakeholders come together, we can surely make it easier to do business in India."

We have a single-window fetish when thinking of ease of doing business in India. It is one of our pet peeves and Kelkar and Shah in their superb book In Service Of The Republic have called this the single-window chimera:

“Every now and then, we hear proposals in India to hold state coercion intact and make life easier for private persons by setting up ‘single-window approval’. There are two problems with this approach.
First, we do not make the Gestapo nicer by setting up a pleasant front desk. Single-window systems do not solve the problem of state coercion, and the threat of raids and punishments including possibly criminal sanctions. Second, in the absence of deeper reform, it is hard to build single-window systems that overcome a maze of restrictions. Many or most enthusiastic announcements of single-window systems fail to work out in practice.”
“We must go deeper. We reform by whittling down and correcting state intervention, not putting a user interface on it.
…..Our problem in India is inappropriate state coercion that limits cross-border activities, and this is not solved by a single-window system governing approvals for cross-border activities.”

Trade reciprocity

The minister was on fire in this session:

“If any country is creating roadblocks for Indian films to be shown there, then India will reciprocate and not allow that country to display their entertainment products in our country. “India will work with reciprocity and we will engage with a position of strength and get a fair deal for all our industry.”

Why do we opt for free trade? One reason is we find markets in other countries in the same way as other countries find in ours. This is the thinking that drives reciprocity. But we must open our markets to others regardless of reciprocity. Because there are advantages to imports. Greater choice and global competition mean more value to the customer. Also, there might be one country or a few that might choose to close their markets to us but there is the rest of the world. Imports make domestic firms more competitive and that helps them win in other open markets.

Import is not a loss to the GDP of a country. This false notion is widespread.

GDP = Consumption + Investment + Government Spend + Net Exports (Exports-Imports) frames imports that way mathematically. Imports are subtracted in this equation because all the import spending is already accounted for either in Consumption, Investment or Government Spend. Since GDP is defined as the total of goods and services produced annually within the boundary of a country, the import has to be netted off to stick to the definition of domestic. Therefore, the subtraction of imports in the equation. It is a mere accounting exercise. More imports don’t mean lower GDP.

We have spoken of this in a previous edition here.

Unilateral free trade without any reciprocity from the other is better than protectionism. Any day. For more on this, listen in to this episode of All Things Policy.

Morality and society

Then the minister switched to morality, culture and society:

“I support creative expression (but) there is a lot of misinformation there and poor portrayal of India and Indian society. It can be a wake-up call, but one can’t glorify issues through such programmes. There have to be limits to allow global content to resonate,” Goyal said, and added that “high cultural and traditional ethos and moral values” need to be maintained in the country.
"Many countries have cultural depravity and children develop bad habits but there is discipline and moral upbringing in our country".

This is tricky territory. The point about cultural depravity of other countries and its contrast to the high cultural ethos and moral values of India is difficult to justify. Who can make an objective judgment about this? It is best to take the relativist position on this and leave it there.

What about censorship of content though? The remarks above were triggered by the unregulated content that’s available on OTT platforms that banks on erotica to attract viewers. While this is true, we also had a record viewership of the re-runs of Ramayana and Mahabharat during the lockdown. Which of them represents the morality of our society? If we accept one of them as a marker of the cultural values of our society, what explains the other? So, how should we regulate content?

The old question of law and morality comes in. Should law intrude into the moral sphere of citizens?

There are a few frames to think about this. The usual caveat of egregious unlawful content that shouldn’t be available applies to this discussion.

First, censorship is a blunt instrument to use. Setting a top-down list of objectionable activities and using them to police content by the state leads to rent-seeking behaviour among the guardians of morality and drives the market for such content underground. This makes things worse. Also, what constitutes moral content is difficult to define. We have had years of obscene bump-and-grind routine or gratuitous scenes of sexual violence in Hindi films passing through censors while a kiss between consenting adults onscreen was an anathema.

Second, there’s a distinction that should be made between public and private spheres. We use our intuition to guide our behaviour in public. This is different from our conduct in private space. The law should focus on maintaining this intuitive decorum that allows free individuals to conduct their business in public without the threat of private behaviour of others spilling onto public. This is the freedom that law should guarantee.

The private space of individuals has been guided by the doctrine John Stuart Mill put forth in On Liberty (pp 13):

“That the only purpose for which power can be rightfully exercised over any member of a civilised community, against his will, is to prevent harm to others. His own good, either physical or moral (emphasis ours), is not a sufficient warrant. He cannot rightfully be compelled to do or forbear because it will be better for him to do so, because it will make him happier, because, in the opinions of others, to do so would be wise, or even right.

It is, perhaps, hardly necessary to say that this doctrine is meant to apply only to human beings in the maturity of their faculties.”

In Mill’s view, the law shouldn’t be used to prohibit the rights of people who are acting on the basis of mutual consent. This principle has been central to liberalise the laws regarding sexuality and immorality over the past century.

So, the laws guiding morality or upholding cultural values should restrict themselves to the public sphere. The content on OTT platforms is for private consumption. It should be certified on the basis of its age appropriateness. Certifying is easier to regulate than censoring content. Identity and age proof along with a price mechanism can be set to ensure adherence to certification norms.

Anything beyond this is vacuous moralising that will have the unintended effects quite opposite of improving the moral standards of the society.

India Policy Watch: What Drives Rapid Economic Growth?

Insights on burning policy issues in India

— Raghu Sanjaylal Jaitley

In the edition #46 of this newsletter, we asked this.

Here’s a trivia for all of you from Vijay Joshi’s India's Long Road: The Search for Prosperity:
From 1950 to 2010, there have been only three countries that have had 6%+ growth for three decades or more on the run: X, Y, Z. Only Z has had a per capita growth rate of more than 8 per cent a year for thirty years. Another striking fact is that, apart from the above three countries, there has been no other country that has had per capita growth of 6 per cent a year for a continuous period of even two decades. Identify X, Y, Z.

The answer: China, South Korea and Taiwan.

An obvious question follows - what led to such rapid growth?

The Importance of Economic Growth

What does public policy optimise for? A simple answer would be welfare of the public. What constitutes public welfare is hard to define. But you can agree on its broad contours. The state is expected to create a society where people have access to their basic needs and lead a life of dignity with their rights and freedom protected. The state should pursue a policy that sustains this for a long time.

This newsletter has argued the sine qua non for this is rapid economic growth. For a country at the stage of development like India, this is a moral imperative. So, we spend a lot of time reading and discussing the conditions that support rapid economic growth. There’s an entire sub-genre of papers and books that try and answer this question using history to support their claims. This covers multiple disciplines – economics, sociology, political science and geography. The problem is when you read them, you are no closer to an answer. Maybe there’s no single truth. We will review the key arguments made so far in this area and ask what we could learn from them.

Four Reasons For Growth

We find there are four determinants (or clusters of factors) that have been used to argue why a country has seen rapid growth or, conversely, why they have failed.

Economic Freedom: In the post WW2 era, we find a strong correlation between economic freedom and economic growth. Economic freedom here is represented by open and free markets and limited government. The specific policy initiatives include trade liberalisation, labour market reforms, low tax rates, fiscal prudence (low debt to GDP ratio), open domestic financial markets and ease of doing business. The works of Wacziarg & Horn Welch on trade liberalisation, Ross Levine on domestic financial and banking reforms (abstract only) and Stephen Nickell on the downside of labour market rigidities provide cross-country evidence of their impact on economic growth.

The success of the Washington consensus, the collapse of the authoritarian, state-run eastern bloc nations and the emergence of the Asian tiger economies are used to support this argument. This became the standard prescription of the IMF to any developing economy looking for aid. While there are compelling arguments to support the economic freedom thesis, there have been two main criticisms of this.

First, the question of causality. Does economic freedom lead to economic growth or do countries that have seen economic growth tend to improve on economic freedom over time? In the 60s and 70s, South Korea and Taiwan used protectionist measures that restricted foreign players in their domestic market while promoting exports. The South Korean banking system was government-owned and they allowed national champions chaebols to emerge before they opened up their financial markets. Even Britain and the US rose in the periods they followed protectionist policies and then batted for free trade.

Second, the IMF prescription of fiscal tightening, structural reforms and economic freedom hasn’t worked in many countries across continents. A good example of this was following the Asian financial crisis of the late 1990s. Countries like Indonesia and South Korea that followed the IMF doctrine saw contraction and high unemployment. Malaysia that refused the offer and imposed capital controls and forex curbs fared better. The repeated bailouts of Argentina and Greece offer more examples of the failure of the prescription.

Political Freedom and Institutions: The role of individual liberty, property rights, limited regulations, and judicial effectiveness in enabling growth has been established through the works of Chicago school of neoclassical economists including Friedman, Becker and Stigler and their intellectual forebears like Hayek and Buchanan. Francis Fukuyama in his influential work Political Order and Political Decay makes a compelling case for a strong state (not same as a large state), democratic accountability and rule of law as the three necessary conditions for countries to be successful. He marshals facts from the industrial revolution to the present day to conclude liberal democracy is the eventual evolutionary end state for all successful political orders.

Acemoglu and Robinson in their book Why Nations Fail make a similar case for centralised power and inclusive institutions. States that create institutions that share power, focus on productivity and innovation and improve over time have fared better over those who have extractive institutions that steal resources and benefits from the society for private gains of a few. Again, Acemoglu and Robinson provide cross-country comparison with data, stories and history of institutions in different countries to highlight their role in economic performance.

However, these principles aren’t as universal as their authors would like us to believe. China’s rise is a strong counter to the notion of democratic accountability and inclusive institutions that privilege individual liberty and freedom. Taiwan, South Korea and Singapore were under authoritarian rules when their economies took off. Going back into history, it can be argued that the periods of strong growth in western colonial powers coincided with slavery, exploitation of women and huge income disparity which were supported by institutions and laws of that era. There’s a stronger case for reverse causality. That economic prosperity led to greater empowerment of the masses and forced changes in institutions making them more egalitarian.

Geography: There are two ways to look at geography here. One is the natural resources available within a country. The other is the climate, lifestyles and culture that have an impact on the type of society (individualistic or collective) and attitude to change (open or closed). Jared Diamond in Guns, Germs and Steel proposed that the wide Eurasian landmass allowed humans to move along a latitude band over a huge area. This uniformity of climate and availability of land meant they could build large settlements, develop farmlands and domesticate animals. This early adoption of agrarian life and animal husbandry meant they were better organised as a society and more resistant to germs. The scientific revolution that started in north-western Europe consolidated these geographic gains and colonialism created a huge advantage whose benefits are still being reaped. Similar arguments have been made by people who have tried to explain why economic progress and distance from the equator are correlated for a number of countries and regions (farther you are from equator, greater the prosperity).

In a later book Collapse, Diamond overweighs the environmental problem and climate change as the reason why societies collapse. He makes the case for ‘carrying capacity’ of the land and how overpopulation pushes this to the brink. The rapid growth among the oil-rich states of West Asia in the last fifty years is another instance of geography trumping all other determinants.

The problem with geography as destiny approach is twofold. One, there’s not a lot of policy-making you can do to alter the geography of a country (except annexing other countries). Two, it is easily falsifiable because so many countries with similar geography have different growth trajectories (Russia with any western European country in the last century, for instance) and many great civilisations of the past thrived in geographies quite different from where prosperous countries of post-Industrial Revolution era are located.

Investment (Physical and Human Capital): We have discussed the Solow model in our edition #49. Solow showed given similar institutions and structural parameters, a country with a low base of capital investment can have rapid economic growth by increasing investment. Over time, countries will converge in terms of their per capita income as diminishing returns to reproducible capital plays out. Romer, who we also discussed in edition #49, showed this holds true for human capital too. But he added an additional variable of ideas through which he showed countries can go beyond the inevitable slowing down of the rate of economic growth.

So, investments in physical infrastructure, technology and human capital helped countries to catch-up with others over time while innovation and ideas helped them avoid diminishing returns and jump curves.

There are two challenges to this argument. First, it is difficult to control for the quality of institutions and structural capabilities to be same across countries. A country wanting to accelerate its growth cannot switch to similar institutions as a developed country overnight. A transition of this kind takes time and it is fraught with political and social risks. Two, there’s research done to show that not all kinds of investment have a positive correlation with economic growth. It is important to know the trade-offs involved. Also, developmental economists have shown a significant investment in the quality of human capital has to be done over a sustained period of time as a pre-requisite for growth to take-off. There is a lot of fog here and a lot of retrofitting of evidence done to prove a point on which investment should come first.

Cross The River By Feeling The Stones

It is clear there’s a no single answer to the question of why countries experience a period of rapid economic growth. Context matters and as does, I suspect, luck. This doesn’t mean there’s nothing to learn from others or from our own history. We are only suggesting the need to keep an open mind, follow sound reasoning and titrating policy recommendations to arrive at what suits us best based on evidence. However, what’s also clear is there are a set of negative variables that emerge from the above that we should learn to avoid. These are obvious – weak rule of law, poor accountability, lack of a performance-driven culture among institutions and entrenched corruption.

Lastly, there’s no permanent cycle of growth and rising prosperity. The Minsky Cycle holds true for countries and empires too. Within each boom, there’s a seed of bust already sown. Any rise is followed by a fall. It is inevitable. History stands witness to it.

Addendum

— Pranay Kotasthane

Let’s go back to the trivia question. Even these three countries that have achieved rapid per capita economic growth, though geographically and culturally closer to each other, followed very different paths. Arthur Kroeber’s book China’s Economy lists two ways in which the economic pathways of China and South Korea/Taiwan diverged.

The role of FDI: FDI was central to China’s growth story while it played virtually no role in the growth stories of Japan, South Korea, or Taiwan. The difference, Kroeber argues, is geopolitics. Japan, South Korea, and Taiwan were part of the US alliance structure and benefited from programs of technical assistance, educational exchanges, and access to the American market. This access to the US allowed them to develop technological expertise without needing foreign companies to set up bases there. In contrast, this route wasn’t open to China and hence the need for a liberal FDI policy.
Timing and luck: Japan, South Korea, and Taiwan began their ascendence at a time when supply chains were national. China began its growth phase when logistics and transport advances had enabled global supply chains. That, coupled with its huge labour supply and access to the Hong Kong port, allowed China to use outsourced manufacturing as the lynchpin of its growth.
The role of State-Owned Enterprises: As a communist country, the Chinese party-state found it convenient to produce than to regulate. The post-war Japanese economy was largely privately owned. South Korea had state banks plus chaebol conglomerates. Taiwan had state-owned banks along with a large number of private enterprises that paved the path for growth.

Matsyanyaaya: Hypocrisy in International Relations

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

All of us have at some point labelled some of our friends, relatives, or colleagues as hypocrites. Some even pin this label to nation-states. The US’ foreign policy often gets labelled so on the issue of human rights. Even Indian foreign policy has been accused of being hypocritical on many occasions. Indeed, nation-states are often hypocritical in their foreign policy conduct.

This charge of hypocrisy carries with it a moral implication. The difference between a person’s stated preferences and revealed actions irks us when the stated preferences carry some moral weight. For instance, the Indian Constitution is a moral reference point for Indian governments. When a government pledges to abide by the Constitution and yet its actions are to the contrary, its hypocrisy also becomes immoral.

That’s exactly why hypocrisy in international relations is not a problem. There is no moral reference point in international relations. In a Matsyanyaaya world, only power matters. In fact, power also determines whether other nation-states even choose to call out another nation-state’s hypocrisy. Here’s a framework to explain this:

If a state is low on power and high on non-hypocrisy, it is at best a sincere irritant. You can cry hoarse about other states’ hypocrisy in the UN and it would change nothing.

If a state’s low on power but does act hypocritically, it easily gets labelled so. India lies in this quadrant perhaps and hence has to bear the cross of hypocrisy.

In contrast, if a state has high power, even its hypocritical acts aren’t labelled. Other states prefer not to get into the bad books of the authoritative pretender. This is the reason why the PRC doesn’t get called out for its treatment of Uighurs while deviating from its professed goal of ‘maintaining peace and promoting common development’.

Great powers aren’t just content with not being labelled as hypocrites. They go one step further and aim to make their own moral claims universal so that their hypocritical acts get masked. The US did this for a while. It could attack Iraq under the pretext of protecting democracy, a value it tried to universalise.

This WaPo article by Farell & Finnemore further explains the value of hypocrisy:

“Hypocrisy has a bad connotation, but it offers a useful middle course in the world of geopolitics; it once lubricated the engine of U.S. power. A world where the United States abandoned all ideals and values would be cowardly and vicious. On the other hand, a world where words and deeds always and transparently matched each other — one where the United States refused to work with foreign leaders whose countries did bad things — would be unworkable and probably dangerous..
Hypocrisy has traditionally allowed American presidents to skillfully manipulate the ambiguity between pious rhetoric and sordid power relations, pretending they are unaware of the bad behavior of key allies.
Artful hypocrisy requires the long-term cultivation of a reputation as a principled player on the world stage… The United States frequently failed to live up to the grand ideals it proclaimed. It selfishly bent or broke the rules it had helped create, and it made common cause with unsavory authoritarian regimes and human rights abusers. Such acts of hypocrisy helped cement U.S. dominance, even when no one believed them.”

In essence, nation-states are often hypocritical in their international conduct. It’s only their power which determines whether that label sticks. Even if so, this hypocrisy has no moral implication in matsyanyaaya. There are no rewards for being a non-hypocrite.

HomeWork

Reading and listening recommendations on public policy matters

[Article] Chapter 1 of the book The Power of Productivity written by William Lewis, founding director of the McKinsey Global Institute, which has sharply drawn insights on economic growth based on global productivity data across countries.
[Article] Frederic Bastiat on Must Free Trade Be Reciprocal
[Paper] Robert Barro’s classic paper, Economic Growth in a Cross-Section of Countries (1991)

That’s all for this weekend. Read and share.