#217 False Hopes and Weak Promises

Kremlin Intrigues, Liberal Democracies, China-India Comparisons, and Tax Policy Misconceptions

Global Policy Watch #1: Putin Survives

Insights on global issues relevant to India

— RSJ

Last week as I sat writing this newsletter, one of the great stories of our times was unfolding. Or, so I thought. A mercenary rebel leader was marching towards the capital of an imperial state led by an all-powerful dictator. There was the unmistakable smell of a coup in the air. It was an event that no one could see coming. And every expert was running short of theories on why it was happening. By the time I had published the piece, however, the other unthinkable in the history of coups had happened. Someone who appeared to have the upper hand in the coup decided to turn back. No one could explain this too. As we stand today, no one is sure of where he is or why did he act in the way he did or what happens to Putin next? Sometime in 1939, Winston Churchill described Russia as “a riddle wrapped in a mystery, inside an enigma.’ It turns out he was making an understatement. 

In a week after his misadventure, Prigozhin is getting the grand old Russian treatment of being scrubbed out of Russian history. This is a thing Russian bureaucrats know to do well for over a century now. Ask Trotsky or Stalin. Russia has now blocked the network of Prigozhin-controlled websites and media outlets that had turned churning out fake news into an art form. Ria Fan, Economic Today, Neva News, the list is endless, have all fallen silent. The army of trolls that his Internet Research Agency (IRA) employed to distort social media algorithms across the world to suit the agenda of the political masters in Moscow has left the building. IRA was the hub that controlled and ran systematic information warfare on behalf of the Russian state against its perceived enemies. No one is sure about what’s happened to the convicts that made up most of his mercenary Wagner group. Surely they haven’t gone back to their prison cells happy after the adventure they’ve had. Maybe they are the Russian army now, as are their colleagues who are spread across the many overseas locations where Wagner runs its operations. Prigozhin, meanwhile, is in Belarus as part of some kind of an agreement where he and his troops have been given a base to run their affairs. Putin is on a charm offensive on state media, talking up the morale of the armed forces by showing Prigozhin’s retreat as a grand success and making it clear to the ordinary Russian that only he is between them and some kind of a crazy civil war where the loonies take over. That the loonies are his own creation is a subtle point he’s hoping everyone will miss. 

Three possible scenarios will simultaneously unfold as we look into the future. All of which will impact the global economy in the next few quarters.

First, wild as it may sound now, it is possible Putin will consolidate more power centrally and emerge stronger after this. The elites have been scarred by the possibility of another Prigozhin-like character emerging again, spewing venom against the elites and threatening to overrun Rublyovka. The helicopters and private jets were on standby as Prigozhin got closer to Moscow that day. Their best bet is to continue backing Putin and hope for some peaceful transfer of power to a dictator beholden to them when the time is ripe. Putin can no longer be the strongman he once claimed he was, no matter how much he flexes his muscles now. But he, more than ever, is the best bet for everyone in control of political and economic power in Moscow to continue. As the last year has shown, Russia isn’t exactly a properly functioning state. Its army needs mercenary support to fight battles, it has global sanctions against it, and there’s a rule of law that’s subject to the whims of a dictator. And now that dictator has been shown up. It might sound like an exaggeration now, but he will soon turn into a toothless tiger. Good for a few growls and an occasional attack, but largely a ceremonial puppet. 

Two, the Ukrainian counteroffensive that had already started a month ago will gather additional steam after what happened last week. It is quite difficult to see how the Russian troops remain motivated to fight Ukraine. They have suffered large casualties and they cannot be fooled by the official numbers. They see a determined Ukrainian army that’s been fuelled by the anger at how the Russian army has treated civilians in the territories they have taken over. There is also the small matter of its NATO allies looking for some return in exchange for the increased hardware support they have been providing. So, expect Ukraine to continue this counteroffensive for the remaining part of the year. A weakened Putin wouldn’t like to step back and seek a compromise because then there’s a real danger he will get overthrown, regardless of whether such a compromise is a good idea. Putin cannot do that, given his position now. The war will continue to get bloodier, and I don’t foresee any end in sight unless Putin throws in the towel. 

Three, the global markets have so far shrugged off the impact of events in Russia. My guess is they will continue to do so. Everything Russia could do to impact global macros has already been done and priced in. There is nothing more in the downside scenario if Putin continues in whatever form or shape. If Putin is out and there’s a civil war kind of a scenario, then, of course, all bets are off. But that’s unlikely. For India, a weakened Putin isn’t great news because it has been taking advantage of him holding his own against the West. A continued counteroffensive from Ukraine could mean Putin will start asking for more than just support India has been showing by buying its oil. In any of the scenarios unfolding from here on, India will have to become better at its continued tightrope walk. It could still do quite well on that, but at a broader level, there’s only potential downside risk for India on the Russian front. 

This is how it looks today. But this could be entirely wrong because no one truly gets Russia or its political intrigue. It reminds me of another apt Churchill quote about Russia: “Kremlin political intrigues are comparable to a bulldog fight under a rug. An outsider only hears the growling, and when he sees the bones fly out from beneath it is obvious who won.” 

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India Policy Watch: Martin Wolf on Liberal Democracy

Insights on issues relevant to India

— RSJ

I have been reading Martin Wolf’s wonderful new book ‘The Crisis of Democratic Capitalism’ (Penguin Random House, February 2023) for the past few days. Wolf is the long-time chief economics commentator at the Financial Times and, in my opinion, one of the few columnists who gets the big shifts in the global political economy and their underlying reasons. In this new book, he argues, as we have done in many editions here but with more persuasion and acuity, that democratic capitalism is still the best way for humankind to achieve ever-greater prosperity and happiness, but obviously, we have messed it up badly. It’s a well-written book, and what I have found very useful is how Wolf has tried to explain in fairly simple terms the definition of many concepts we take for granted. I have produced excerpts of two such definitions that will illustrate the point I’m making. It is a nice addition to this genre, and I recommend it. 

“The distinguished political scientist Larry Diamond, of the Hoover Institution, argues that liberal democracy has four individually necessary and collectively sufficient elements: free and fair elections; active participation of people, as citizens, in civic life; protection of the civil and human rights of all citizens equally; and a rule of law that binds all citizens equally. All these elements are necessary and, in combination, sufficient to make a democracy liberal. Note the emphasis above on “citizens.” A liberal democracy is exclusive: it includes citizens, but excludes noncitizens. This does not mean noncitizens—foreigners and immigrants—lack all rights; far from it. It means they lack the political rights of citizens. Crucially, liberal democracy is not just a way of deciding who runs the state, though it is that: the term also defines the sort of state it is. As John Stuart Mill insisted in his Considerations on Representative Government, democracy is, or should be, characterized by “liberty of discussion, whereby not merely a few individuals in succession, but the whole public, are made, to a certain extent, participants in the government, and sharers in the instruction and mental exercise derived from it.”

For a liberal democracy to work, then, citizens must be entitled to express their opinions, and fellow citizens must be prepared to tolerate opinions they disagree with and the people who hold them. In the terminology of Isaiah Berlin, as citizens, people enjoy negative liberty—the right to make up their own minds, free from coercion—and positive liberty—the right to participate in public life, including by voting. Such a political system is inherently pluralist. It cares about the political rights of minorities because it cares about the political rights of all citizens. In essence, a liberal democracy is a competition for power between parties that accept the legitimacy of defeat. It is a “civilized civil war.” Force is not permitted. But this means that winners do not seek to destroy the losers. A system in which gangsters seek to kill their opponents, trample on the rights of individuals, suppress the free press, and benefit financially from office, yet go through the motions of running rigged elections, is not liberal democracy. Nor is “illiberal democracy” democracy either. Such a system should be called what it is: at best, a dictatorship of the majority, and at worst, “plebiscitary dictatorship.” Putin’s rule over Russia is a plebiscitary dictatorship, as is Erdogan’s over Turkey and Orban’s over Hungary. Indeed, increasingly these are just dictatorships, without qualification.

By capitalism, I mean an economy in which markets, competition, private economic initiative, and private property play central roles. This system is “market capitalism.” The size, scope, and nature of government, with respect to regulatory intervention, taxation, and spending, vary across capitalist countries. Government intervention has also tended to intensify over time as societies became more democratic. This was inevitable, as the franchise widened to include people without significant assets. But it also reflected the growing complexity of economic life and the pervasiveness of what economists call “market imperfections”—situations in which market incentives may lead to socially or economically damaging results. Yet, as was the case with “liberal democracy,” the state, be it large and relatively intrusive or not, must be law-governed. Without the rule of law, there can be no market capitalism, just larceny. Moreover, capitalist economies, thus defined, are also (and have always been) open to global trade and capital flows, at least to some degree. Capitalism is never entirely national, because the wider world offers a host of opportunities for profitable exchange. More narrowly, by market capitalism I mean the form of market economy that has emerged over the past seventy years and particularly over the past forty, for which the word globalization provides a shorthand description. In their economic lives, just as in their political ones, people should possess freedom from arbitrary coercion, especially but not exclusively, from the state, and freedom to buy and sell their labor and anything else they may legitimately own. Again, as is also true in political life, such freedoms are not absolute, but must be bounded by regulatory, legislative, and constitutional limits.

The rule of law is an essential shared underpinning of democracy and capitalism because it protects the freedoms essential to both. This means that “all persons and authorities within the state, whether public or private, should be bound by and entitled to the benefit of laws publicly made, taking effect (generally) in the future and publicly administered in the courts.” If some individuals or institutions are above the law, nobody without such privileges can be secure in exercising their freedoms. The law must be universally binding and protecting if liberal democracy and market capitalism are to thrive. Both liberal democracy and market capitalism share a core value: a belief in the value and legitimacy of human agency, in political and economic life. In these respects, both systems rest on “liberal” ideas. But the workability of democratic capitalism also depends on the presence of certain virtues in the population at large and especially in elites. Neither politics nor the economy will function without a substantial degree of honesty, trustworthiness, self-restraint, truthfulness, and loyalty to shared political, legal, and other institutions. In the absence of these virtues, a cycle of mistrust will corrode social, political, and economic relations. In short, the political and economic systems depend for their success on the prevalence of fundamental norms of behavior or, as they are sometimes called, “social capital.” Today, however, liberal democracy and market capitalism are individually sick, and the balance between them has broken.”. 

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Matsyanyaaya: China-India Comparisons v2023

Big fish eating small fish = Foreign Policy in action

— Pranay Kotasthane

Graham Allison, a former US assistant defence secretary and a well-regarded professor of government at the Harvard Kennedy School, initiated a fresh round of India-China comparisons last week. In a Foreign Policy article, he contended that India is unlikely to surpass China as the next superpower.

He gives four reasons to support his claim. One, India’s “been there, not done that” before. The impressive growth between 2004 and 2008 petered out while China grew robustly. Two, India’s economic size is still too small (about one-sixth) compared to China. Three, India performs poorly in science and technology development, which is critical for powering economic growth. Four, China’s workforce is far more productive, while poverty and malnutrition still persist in India.

It’s not difficult to contest Allison’s reasons and inferences. Economic size is an important but not the sole determinant of national power. As Lt General Prakash Menon has written on many occasions, national power is a contextual and relational factor. Aggregate measures of economic components of power don’t tell the full story. For instance, China’s GDP is three-fourths of America’s, and its per capita GDP is one-sixth that of the US. If it can be classified as a superpower with a much smaller economy, there’s no reason to believe that India’s superpower status will get unlocked only after it ranks higher on economic parameters than China. What matters is the relative power India and China can exert on specific military, economic, and political issues of global importance.

Seen from this lens, one could also argue that India is already a power of significance. Today, all other past and present superpowers want India on their side. Pakistan is no longer a major restraint on India’s ambitions. Moreover, it is able to chart its own path on contentious issues, such as the Russia-Ukraine war, while both sides have chosen to accommodate its stance.

Despite these refutations, Allison’s article serves an important purpose. If you observe closely, all four reasons he cites are in India’s own domain of control and influence. This article is essentially another call for India to reform its economy, education, health, and research sectors.

India is indeed in a geopolitical sweet spot. It is now able to wield a much greater global influence at this moment. However, it is also true that its new ability to influence global politics is both limited and transitory. It is only by building power along the dimensions that Allison suggests can India hope to extend this geopolitical opportunity into a long-term advantage.

For this reason, we should welcome Allison’s article. These regular reminders are important for highlighting the urgency of reform. Without reforms, India might remain stuck in a low-income trap. Whether India is already a global power or not might be up for debate, but the undeniable fact is that India’s economy and income are both one-sixth that of China. A new set of reforms is crucial for attaining yogakshema—peace and prosperity—for all Indians.

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Global Policy Watch #2: Don’t Flog Tax Policy

Reflections on global policy issues

— Pranay Kotasthane

I think this might come as a surprise to many readers. The US tax system is more progressive than in Europe. In other words, rich Americans face higher tax rates than their European counterparts, while low-income Americans shell out a much smaller portion of income as taxes compared to their European counterparts.

Fed on a diet of half-truths, we intuitively think that Europe performs better than America on income equality because of its tax structure. The rich cough up a lot more for their privilege in Europe; that money is redistributed to the poor, and that is how Europe has been able to reduce income inequality.

But a 2021 paper Why is Europe More Equal Than the United States, by Blanchet, Chancel, and Gethin, will make you rethink these assumptions. The reason is that indirect taxes (taxes on consumption) are far lower in the US than in Europe, while taxes on income aren’t that different in both regions. The overall result is that the US system is more progressive than Europe.

Despite performing better on taxation, the authors find that Europe has less income equality because it does “predistribution”—not redistribution—better.

Redistribution here refers to government interventions on the revenue side, i.e. meddling with tax rates, while predistribution refers to government interventions on the expenditure side, i.e. education, health, labour unions etc.

While my personal belief is that income inequality isn’t India’s problem to solve today (poverty is), this paper delivers an important insight for those who are concerned about income inequality.

There are way too many folk theories suggesting that higher tax rates and wealth taxes are a solution to income inequality. But public finance suggests otherwise. Robin Hood Taxes don’t work. Often, they increase income inequality as a tax on capital ends up becoming a tax on labour.

So, stop focusing on increasing tax rates even if you care about inequality. Maybe, focus on better methods for “predistribution” instead? India should reduce tax rates at all income levels to attract global businesses and generate employment. Broaden the base, and lower the rates. BBLR, as the public finance economists say.

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HomeWork

Reading and listening recommendations on public policy matters

1. [Article] The Economist has a bold article in support of the US Supreme Court’s decision to terminate race-based affirmative action. There’s a case to be made in India for looking beyond reservations for affirmative action. A 2021 article by Nitin Pai and Pranay proposes an alternative.

2. [Podcast] Don’t miss this Puliyabaazi with Achyut Chetan, author of an excellent book Founding Mothers of the Indian Republic: Gender Politics of the Framing of the Constitution.

3. [Book] Jinnah: His Succeses, Failures, and Role in History by Ishtiaq Ahmed smashes some shibboleths.

4. [Article] Why sound trade policy matters for electronics manufacturing success.

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