Mar 6 • 25M

#161 No man is an island entire of itself; every man is a piece of the continent*

Update on Ukraine. Bad ideas never die - Import Substitution redux in India.

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Global Policy Watch: Possible End Game In Ukraine?

Indian perspectives on global events

— RSJ

Things have escalated a bit since I wrote last week about the economic sanctions on Russia by the West. Apart from cutting loose a few Russian banks from the SWIFT messaging system, we also had the unprecedented move to freeze the access of the Russian central bank to its forex reserves that are held with other banks in the West. Russia has been salting away about $640 billion worth of forex reserves over the past decade in anticipation of an event like this. They had reduced their exposure to the US dollar to about 15 per cent. But if it cannot now access about half of this, or maybe more, because of the freeze, it is a crippling blow. The central bank needs the forex to prevent the slide of the ruble by buying them and propping up its value. If it cannot, the ruble will continue to plunge and currency short-sellers will get into their game to drive it to dust. That apart, the Russian oligarchs and their assets are being targeted. This core group of Putin backers are being made to pay for his blunders. The idea is to drive a wedge between them and Putin.

Russian exports have been frozen because, without access to SWIFT, you only have barter as a trading mechanism. Russia is tightly coupled with the global economy unlike its predecessor USSR or other regimes that have faced big sanctions like North Korea, Syria or Cuba. Its economic model in the Putin era has been to focus on its comparative advantage in commodities while importing almost everything else. The sanctions will hurt ordinary Russians. Expect long queues at stores in Moscow. And long queues and Russia have an even longer history. It doesn’t end well for a regime when that happens. I could go on and on but you get the picture. This economic war unleashed by the west has turned more serious than Russia ever anticipated.

Review Of The Positions

But what I am interested in is what are the likely end-game scenarios here. For thinking through that let’s look at the two players, their objectives, likely actions and payoffs. Over the past decade, Putin had been building up to this moment. Testing the waters on the western response by annexing Crimea, sponsoring cyberattacks, meddling in elections of other countries and biting away chunks from its near neighbourhood. The western response to these has been tough words or economic sanctions of some kind. Based on these ‘games’ and their results, his expected scenario of what would unfold after Russia invaded Ukraine was clear.

The West would never put boots on the ground in Ukraine to fight Russia. The Russian tanks would roll into Kyiv in a few days. Putin would engineer a regime change, install a puppet and then wait for the West to react. That reaction, as he had seen in the past, would be another round of economic sanctions in familiar shape and form. He counted on western Europe’s dependence on Russian gas to manoeuvre through the sanctions. And he had built the forex war chest to navigate through a rough year or two after which things would be normal. On balance, he would have had Ukraine, a win to reconfirm his strong man status among his people, a warning like no other to his neighbours to accept Russia as their sovereign and to demolish whatever little credibility the US and NATO have as trustworthy allies who would come to your rescue. He also had China on his side who saw this as a test case for their ambitions on Taiwan and the One-China policy. When he weighed the pros and cons of the move, this was a no-brainer for him.

Let’s turn to the West now although there wasn’t much evidence prior to the invasion that it was a single bloc that coordinated its decisions. It lived in the hope that Putin would not invade Ukraine despite the clear signals emerging from Russia. It had already shown its hand by not sending troops and arms to Ukraine in anticipation of a war. It felt that it would be used by Putin to aggravate the situation and justify the war to his people. So, all it did was warn Russia of consequences without specifying them and left it at that. Putin saw through this. So, the invasion was inevitable.

Putin’s Wrong Choice

We move on to the next question now. What were the options Putin had on what form the invasion would take? Back in January, Jones and Wasielewski of CSIS had laid out the six military options that Putin had on Ukraine:

“Kremlin has at least six possible military options:

1. Redeploy some of its ground forces away from the Ukrainian border—at least temporarily—if negotiations are successful but continue to aid pro-Russian rebels in Eastern Ukraine.

2. Send conventional Russian troops into the breakaway regions of Donetsk and Luhansk as unilateral “peacekeepers” and refuse to withdraw them until peace talks end successfully and Kiev agrees to implement the Minsk Accords.

3. Seize Ukrainian territory as far west as the Dnepr River to use as a bargaining chip or incorporate this new territory fully into the Russian Federation. 

4. Seize Ukrainian territory up to the Dnepr River and seize an additional belt of land (to include Odessa) that connects Russian territory with the breakaway Transdniestria Republic and separates Ukraine from any access to the Black Sea. The Kremlin would incorporate these new lands into Russia and ensure that the rump Ukrainian statelet remains economically unviable.

5. Seize only a belt of land between Russia and Transdniestria (including Mariupol, Kherson, and Odessa) to secure freshwater supplies for Crimea and block Ukraine’s access to the sea, while avoiding major combat over Kiev and Kharkiv. 

6. Seize all of Ukraine and, with Belarus, announce the formation of a new tripartite Slavic union of Great, Little, and White Russians (Russians, Ukrainians, and Belarusians).”

They had also outlined the likely payoffs and consequences of these options for Russia.

“Of these six options, the first two are the least likely to incur significant international sanctions but have limited chance of achieving a breakthrough on either NATO issues or the Minsk Accords due to their coercive nature. All other options bring major international sanctions and economic hardship and would be counterproductive to the goal of weakening NATO or decoupling the United States from its commitments to European security.”

It is clear that Putin has chosen some variation of option 4 or 5. These options needed groundwork. Lots of it.

First, it needed sustained domestic propaganda to show Ukraine as some kind of a Nazi state supported by NATO that’s a mortal threat to Russia. This has been in the works for many years now in Russia but its effectiveness is questionable. There were last-minute announcements by Putin where he rambled on about this but it is unlikely they sounded convincing within Russia.

Second, Putin seemed to have underestimated the complexity of urban warfare. The resistance from the cities has been the reason why Ukraine has held on for so long. This will eventually wilt because the armies are hugely mismatched. But the battles in the cities have given enough time for the world to coordinate its response. This was not in Putin’s calculus.

Lastly, there’s the question of the motivation of Russian troops to inflict casualties on Ukrainians. There is this romantic notion that Russian soldiers don’t see Ukrainians as enemies because of long-standing family and societal ties. I don’t subscribe to this. But it is clear in the past week there’s an undercurrent of that playing out in the war. It might soon disappear as the Russians suffer losses and we could be discussing the brutalities of the Russian army soon. But for now, there’s an element of holding back of the punches that’s evident.

The upshot of all of these is that Putin is in a hard place. He will eventually push through and have large chunks of Ukraine in some form regardless of when a ceasefire is declared. This is clear because NATO won’t get into a war. But this victory, whenever it comes, would have cost him a lot. The impact of economic sanctions in the short term will be severe on the Russian people. And it will take a long time to come out of it. Russians are strongly connected to the world outside. There will be visible changes in their lives if this continues. How they react beyond a point is the question. Also, there will be ongoing resistance to whatever parts of Ukraine Putin holds on to and this will mean a permanent low scale war. He will have the wrath of the oligarchs to deal with who already have their wealth outside of Russia wiped out. These are his domestic problems.

On the other hand, Putin has succeeded in strengthening his enemies outside. US-Europe unity is on display after a long time. There is unanimity in Europe that they need to diversify their energy sources away from Russia with urgency. Multinationals are voting with their feet getting out of Russia. Also, the apparent initial success of the economic sanctions has made Biden and other NATO leaders look good and decisive after a long time.

On The Negotiation Table

So, where do we go from here? Any negotiation, direct or indirect, between the West and Russia will be a difficult balancing act for the players. It will be useful again to bring Putnam’s two-level game theory to analyse this. A quick recap of Putnam’s model:

“The politics of many international negotiations can usefully be conceived as a two-level game. At the national level, domestic groups pursue their interests by pressuring the government to adopt favorable policies, and politicians seek power by constructing coalitions among those groups. At the international level, national governments seek to maximize their own ability to satisfy domestic pressures, while minimizing the adverse consequences of foreign developments. Neither of the two games can be ignored by central decision-makers, so long as their countries remain interdependent, yet sovereign. 

Each national political leader appears at both game boards. The unusual complexity of this two-level game is that moves that are rational for a player at one board (such as raising energy prices, conceding territory, or limiting auto imports) may be impolitic for that same player at the other board. Nevertheless, there are powerful incentives for consistency between the two games. Players will tolerate some differences in rhetoric between the two games, but in the end either energy prices rise or they don't. The political complexities for the players in this two-level game are staggering. Any key player at the international table who is dissatisfied with the outcome may upset the game board, and conversely, any leader who fails to satisfy his fellow players at the domestic table risks being evicted from his seat. On occasion, however, clever players will spot a move on one board that will trigger realignments on other boards, enabling them to achieve otherwise unattainable objectives.” 

Our illustration of Putnam’s Two-level Games

For the West, the best outcome on the ‘international table’ will be for the sanctions to continue and to hurt the ordinary Russians just enough for them to show public dissatisfaction and not so much that they rally behind Putin against NATO. The hope then is that the cabal of generals, spies, oligarchs and bureaucrats will depose Putin in the name of Russians to protect their own interests. Of course, there’s no guarantee that a successor will be any better for the West. But you get Putin out of the picture in the short term. Ukraine holding out for long will be the key to this. However, between making Ukraine whole again and continuing with sanctions that can possibly lead to Putin’s exit, it is clear what the West will go for. On the ‘domestic table’, their position has to convince their allies (like Taiwan) that even if they don’t turn up militarily, they can cut their adversaries to size. For this also they have to ensure Putin must go. The other outcome to seek on this table will be to ensure an uninterrupted supply of cheap gas to Europe that will struggle without it. This will be the ‘goldilocks zone’ of sanctions that the West will seek.        

For Putin, the best war outcome will be to reach Kyiv and change the regime in the next few days and then sit down for negotiations. On the ‘international table’, he will seek a reduction in NATO forces around Russian borders and acceptance of Russian sovereignty in eastern Ukraine in return for a phased withdrawal. He might agree to some kind of peacekeeping force and a roadmap for free and fair elections. His objective will be to give enough away without restoring Ukraine to its previous form so that he has the sanctions reduced. He needs it to breathe easy at home. On the ‘domestic table’, he will try to delink the negotiations to Ukraine as much as possible and make it more a Russia versus NATO issue. Putin knows Russia’s integration with global trade works both ways. Cutting it off completely will hurt the rest of the world too. Russia is an important source of raw materials and commodities and the second-order trade effects will soon be playing out in various sectors. His focus will be to get a few wins on the reduction of sanctions that he can take back home. The rest he will manage. That would be his winning set on the domestic table. 

I suspect that’s the way any negotiation will play out. And it is likely Putin will manage to get those wins that will keep him in the safe zone. That’s how the default end state of this game is set. If the West wants Putin’s exit as the real outcome of this war, they will have to move away from this default. They must decide not to yield an inch on the sanctions and live with the collateral damage of this stand for some time. They won’t get an opportunity to corner Putin like this again. I’m not sure if the West will be as coordinated on this as they have been on the economic response to Putin. That’s where Putin will win.

In all of this, there’s only one real loser. Ukraine.   

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India Policy Watch: Aatmanirbhar Bharat Approaching a Wrong Turn

Insights on burning policy issues in India

— Pranay Kotasthane

We wrote earlier (#56) that Aatmanirbhar Bharat has all the five characteristics of a powerful narrative. Another strength of this narrative is its breadth. This narrative is ambiguous enough to incorporate a vast range of policy objectives. But this strength is also its weakness. The same Aatmanirbhar Bharat cry can also throw up some tried, failed, and self-defeating policies of the past. Three events in the last couple of weeks suggest that we are heading towards this wrong turn. This post is to sound another note of warning.

First, the PM’s speech on 3rd March gave another glimpse of this government’s conceptualisation of Aatmanirbhar. Sample these statements:

We have to promote ‘Make in India’ for goods whose demand is increasing in the country today. Now there are two issues -- one to keep exports in mind and the second to meet India's requirements. Let's suppose, we are not able to become competitive in the world, but we can provide quality materials according to the requirements of India so that India does not have to look to foreign countries. We can do this.

Or this statement, with the same vibes as the Finance Minister’s “Can’t we make Ganesha idols of Clay” statement a few months ago:

“Indian manufacturers should see that the dependence of the country on foreign countries is minimized. Therefore, ‘Make in India’ is the need of the hour…We procure essential medical equipment from outside. Can't we make medical equipment? I don't think it is such a difficult task. Our people have the potential to do it. Can we put emphasis on it? We should not be satisfied that all the necessary products are available in the market according to our needs. Many products which are available in the market are imported. And when Made-in-India products should be available, there should be a feeling among people that these products are better than the imported ones and we have to purchase them. We should create this situation and this difference should be visible.”

These words indicate that the primary goal of Aatmanirbhar is quite clearly Import Substitution Industrialisation (ISI). The goal of becoming a major export power is now a distant second goal. ISI as a developmental strategy for India is as old as the Republic of India. After independence, as part of ISI, trade and economic policy measures were designed with the explicit aim of replacing foreign imports with domestic production. India went for one of the most extreme versions of ISI across the world. The results are for all to see. And yet, we seem to be going back to that path.

Moreover, this focus on reducing imports misses the point that imports are critical for exports. They allow a nation-state to build on its own strengths while leaving it to other countries to produce what can’t be done efficiently here. And so, it shouldn’t surprise us that as exports rise, imports will also rise concurrently. The world’s top two exporters are China and the US. And the world’s top two importers are also the US and China. There is no contradiction here. Hence, the government’s obsession with reducing foreign dependence is anachronistic and self-defeating.

The second statement on medical equipment was even more bizarre. How does one generate a feeling among people that Make-in-India products are better than imported ones? A better product is an objective fact, not a subjective feeling that can be implanted into a consumer’s mind, Inception style. For a detailed critique of this line of thinking, revisit Prof AISH’s sermon here in edition #46.

The second force pushing India towards the wrong turn is the Ukraine-Russia war. The breathtaking scope of the economic sanctions unleashed against Russia creates conditions for autarkic arguments to flourish. What if the West does something similar to us? Won’t it be better if we become Aatmanirbhar instead?

The harsh reality is that the West’s economic dominance is not going away anytime soon. TN Ninan in his Business Standard column explains it thus:

“That leaves the trigger response of self-reliance. This is a very partial solution as inward-looking economies don’t do well. Besides, there is no alternative to the dollar, supply chains are not about to disappear, the country will remain import-dependent for energy, and the West dominates all major international institutions. Breaking free is impossible unless one wants to be a North Korea. The push to indigenise every major weapons system may sound great, but could be overreach. If imports are stopped and domestic production does not happen, we could end up with neither. Besides, almost every indigenous weapons system has a significant import content — the Tejas’s engine is made by General Electric, the navy’s ships have engines from Ukraine, and so on.”

Instead of plotting a break-up with the West, India needs to dominate in other areas where the West is relatively disadvantaged. The IT industry is one such example. Not only did it massively benefit due to the connections and investments with the West, but it is also a lever that makes India’s economic relationship with the West more even-handed.

The right lesson to derive from the West’s weaponisation of its economy is not aatmanirbhar but aatmashakti. The richer that India becomes, the more difficult it is for any coalition to hurt India economically. And becoming rich quickly requires India to collaborate with the West. Free movement of goods, capital, and labour are crucial for building India’s aatmashakti.

Another reason for India to keep close ties with the West is the nature of the high tech sector. There are no national industries of semiconductors, AI, or advanced computing. What’s replaced them are complex global supply chains for products and interconnected global networks for cutting-edge research. While the usual critique of the West is its intransigence on providing India with advanced military technology, India’s deep connections with the West nevertheless foster a transfer of technology (through a flow of ideas and people) in critical and emerging technologies. Building tech aatmashakti requires deepening the connections, not plugging out from the West. That’s how, after all, China quickly shortened its own technology development cycles.

The third development that hints at another self-goal was the union government’s nonchalant ban on the import of all kinds of drones, starting last month. The stated intent: to encourage participation in the government-sponsored production-linked incentive (PLI) scheme for drones, through which the government aspires to make India a global drone hub, by 2030. But who will tell the government that banning the import of a good and becoming a global hub of the same good are contradictory outcomes? What incentive does a company shielded by protectionism have to compete with the best in the world?

More broadly, an uncharacteristically bold report by the mobile phone industrial body highlights the problem with using trade policy to ‘protect’ Indian companies. Its assessment found that high import tariffs were making Indian mobile manufacturers more uncompetitive on the global stage. Using a PLI scheme merely to generate domestic champions is effectively just a redistribution of money from the taxpayers to the manufacturers. India benefits from PLI schemes only when the economic pie grows through exports. And doing that requires friendly trade policies. This is an underrated factor in the success of east and south-east Asian economies.

We have sounded out many such warnings about Aatmanirbhar Bharat in the past. Industrial policies are incomplete solutions. Improving the business, trade, and tax environments in India is imperative for India to capitalise on a new geoeconomic environment that awaits us.


* From Donne’s ‘No Man Is An Island’

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Reading and listening recommendations on public policy matters
  1. [Article] Arjun and Pranay have a paper with a fee recommendations for India-Taiwan collaboration on semiconductors, in a first-of-its kind report that comiles the two countries’ relationship across multiple areas.

  2. [Paper] An interesting paper co-authored by well-known philosohper Cristina Biccieri which suggests that ‘informing people about the extent of inequality in a society will not effectively alter their support for redistributive policies. Political campaigns aiming at increasing awareness for the need for social welfare and taxation might want to thus consider to not focus too much on talking about, e.g. high incomes of top income earners since, while it is important that citizens are aware of such facts, it seems to have very limited effects on their policy support.’ This finding is congruent with an older Starmans, Sheskin, and Bloom paper which concludes “humans naturally favour fair distributions, not equal ones, and that when fairness and equality clash, people prefer fair inequality over unfair equality”.