#22 A Light and Sound Affair
L1 tendering, Globalisation after COVID-19, Economic Revival, and more
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?
PolicyWTF: Trishul: Ek 'Tender' Prem Katha
This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?
While I’m a proud student of Whatsapp University, the solid foundation of my chequered academic career was built on Hindi films. Math, Chemistry or Physics; I could look them straight in the eyes because I had already been schooled in Do Aur Do Paanch, Tezaab and Mr India. Biology was a breeze – Hindi films literally showed me birds and bees to explain stuff. But the real deal was public policy. That’s where Bollywood went deep (and struggled to come out). For the intrepid researchers (not us), there’s a five-volume public policy tome waiting to be mined from them. We are just getting the ball rolling here for the brave ones…
For the rare capitalist-minded young boy growing up in the 80s, Hindi films presented two viable career options - a smuggler or an industrialist. I gave up on the smuggler option early. It involved a lot of unnecessary running (is there any other kind?), staying awake at nights and unloading sona at Madh Island (lucrative but with a side of insomnia) and having a pesky, upright, uniformed younger brother breathing down your neck (don’t ask).
But industrialist? Well, that looked swell. You wore safari suits, carried a briefcase that had lots of loose paper, drank an occasional Black Dog and went around a bit. The only work that looked real and kept you busy involved bidding for government contracts. A bit of bribe, some kindly threats or a minor kidnapping – the whole saam, daam, dand, bhed arsenal – was all you needed to get the civil servant (Manmohan Krishna, mostly) on your side to help you undercut your competition. This seemed all quite doable. What’s more, you had a palatial house with two spiral stairways running up (the same stairs came down too) and an agreeable name like Ahuja, Tarneja or R.K. Gupta. The only downside was in having a college-going progeny with dubious academic record who was prone to singing ‘gapuji gapuji gam gam’.
Well, into each life some rain must fall, as some (Long) fellow had said.
Anyway, let’s narrow our focus down to the government contract that exercised R.K. Gupta most often. The procurement of goods and services by the Government of India is still largely governed by the Contract Act 1872 and Sale of Goods Act, 1930 and General Financial Rules (GFR) that are amended periodically. The most prevalent mechanism of awarding a contract in government departments and PSUs over the last century has been the L1 system, also called the Least Cost Selection Method. There is a bit of history to this. The colonial government wasn’t too keen on spending a lot on projects in India. A minimal threshold of quality was all that was needed at the lowest cost. Though alternatives like the Quality and Cost Based System (QCBS) and Quality Based System (QBS) are being gradually adopted, the L1 system still holds sway after seven decades. Yes, we love our colonial past a lot that way. So, you could lie your way through the technical bid claiming excellent capabilities. Once you crossed that threshold, all you needed was some friendly insider who helped you price your bid lower than your rivals only marginally. Voila, you’re in business.
Three problems arose out of this. First, since technical bid didn’t have a weightage, the projects were often won by less competent firms who couldn’t either complete the project or did a shoddy job. Examples of this are visible all around us in government infrastructure projects. Second, it encouraged rent-seeking behaviour among public servants who had the information about rival bids. In that cult classic, Jaane Bhi Do Yaaro, municipal commissioner D’mello was playing two builders (Ahuja and Tarneja) to maximise his benefits till one of them bumps him off. Third, it led to crowding out of honest, competent players from the government tender market because they wouldn’t play ball.
In Yash Chopra’s Trishul, all of these issues come to a head. Vijay, who runs Shanti Construction, is an upstart who has no experience in large construction projects. In couple of pivotal points in the film, he either bribes the civil servant or uses inside information about his rival (Gupta Constructions) and outbids them marginally. When I say marginally, it is the very definition of the term - for one tender, he bids one Rupee lower than Gupta Construction. In no time, Shanti Construction drives Gupta Construction out of business.
Of course, I felt bad for R.K. Gupta. Not merely because he was a victim of poorly designed public policy. But he actually had a daughter in the film who sang ‘gapuji gapuji gam gam’.
A Framework a Week: A 75% Solution to Normalcy
Tools for thinking public policy
This a follow up to previous lockdown post. A few things have changed since. The rate of spread has increased and we might be in the range of 8000-10,000 cases by April 15. Interestingly, since the last post (almost on cue), the narrative for a partial lifting of restrictions has gained strength across media platforms. The PM himself spoke about it in his video-conference with chief ministers. The alternatives that could work in a partial shutdown like contact tracing app, widespread usage of masks, cluster-wise lockdowns and more testing are being discussed or tried out. This is a more effective response to a fast-changing situation.
But what does partial lifting of restrictions mean? What framework should policymakers use to think about which economic or social activities should be allowed and to what extent? We have created a ‘rough’ framework to think through the answers. We believe about three-quarters of economic activities that are on pause currently could be started using this.
R0 and PPF
The restrictions are necessary because the virus is contagious. How contagious? The R0, that is the average number of people who will catch the disease from an infected person, for this virus is believed to be between 2-3. This means left unchecked, the infection will spread exponentially and turn into a pandemic. If R0 is below 1, the contagion wanes and dies out. Now, R0 is not a constant. It is an endogenous variable. It depends on the virulence and the norms of the society it strikes. The restrictions placed and the norms enforced like lockdowns, social distancing, compulsory usage of masks and gloves etc impact R0 downwards.
We can have two extreme cases available to us. Scenario 1 is a prolonged total lockdown that will bring R0 well below 1 (say, 0.5) with a significant slide in economic activity in the country (say, a fall by almost 75% of the usual). Scenario 2 is to continue ‘business as usual’ with no restrictions (R0 = 2.5) while we hope to develop ‘herd immunity’. These extreme cases aren’t really long-term policy options. These are merely used to bookend the analysis.
Economists use the Production Possibility Frontier (PPF) as a tool to illustrate a point where a country is most efficiently producing various goods and services. We will use a simple PPF chart where we assume the Indian economy only produces masala dosa or filter coffee. If you are at any point on the PPF curve, you are maximizing production efficiency. When you are inside the curve, you are being inefficient. Now have a look at the chart below:
We were on curve A before the lockdown (R0 = 2.5). We decided on March 25 on complete lockdown since the risk to a poor country with limited health infrastructure was immense. So, we shifted from curve A to curve C. Let’s say, that meant we shrunk economic activity by about 75%. Now, there’s curve B where R0 = 1 and which is the outer limit for the society being safe from the pandemic. Eric Budish has a paper that helped our understanding of this and explains this in greater detail.
Policymakers have two choices to exercise:
Choice 1: They have the room to move from C to B so long as they stay within B. This would maximize efficiency given the constraint of the pandemic.
Choice 2: Remember R0 is not a constant. The policymakers can shift curve B outwards by working on alternatives like those suggested in the previous post (more masks and gloves, social distancing app, rapid testing, cluster-wise lockdowns etc) and bring it as close to curve A.
Acting on the choices
Karthik Shashidhar has done some excellent and detailed analysis (thousands of MC simulations) to help us with Choice 1 here. He has used 4 archetypes of interactions that should cover all kinds of economic activities - a) Delivery: where there is one person who interacts with a number of people one at a time and for under 5 minutes; b) Shop: multiple people arrive in a queue and spend some time (about 10 mins) in an establishment with a few people permanently located there; c) Office: Many people are together in a place for a number of hours (say, 8 hours) and d) Conferences: Many people are together for many hours but randomly move around and meet others in groups. You can fit almost any other social or economic interactions, from airports to religious gatherings, into one of these categories.
The analysis suggests a lot than can be done while exercising Choice 1. Considering the society continues to follow all the COVID-19 precautions laid out by MoHFW and WHO, it is possible to open all ‘delivery’ archetypes (essential and non-essential goods) between businesses and consumers (B2B and B2C). This will ease the supply chain logjam while increasing the options of home delivery for consumers. Further, the ‘shop’ archetype can also be opened up for small store formats (typical kirana stores; less than 500 sqft with fewer than 3 people employed) without significant risk. Supermarkets, large store formats and malls need to remain closed. ‘Office’ is a riskier archetype that can wait a couple of weeks after April 15. Later, an option can be tried out with fewer than 30% of staff working on rotation with social distancing norms. No meetings or group brainstorming sessions should be allowed at offices. This could also include opening up of outdoor economic activities like construction and agriculture where meetings are fewer and the workforce has mostly ‘individual contributors’. ‘Conference’ is completely avoidable and strict norms should be put in place to restrict them.
Choice 2 is going to be long drawn out effort to shift curve B outwards closer to A. This will need concerted efforts over the next 6-8 weeks that include:
Enforcing masks and gloves as societal norms while being outdoors. State capacity to produce the basic versions of these (not N95 kind) must be assessed and help sought from private players to provide for these at scale
Continuing the total lockdown for the vulnerable sections of the population - old, people with fever, and kids
Enabling mass and rapid testing to identify potential cases early
Ensuring widespread usage of contact tracing app with the ability to alert and quarantine people in contact with anyone who has tested positive
Using mass media to continue educating the society about personal hygiene and social distancing
Setting aside a healthcare stimulus package for hospitals and healthcare workers to fight the pandemic over the next year
The real endgame to this pandemic is a universal vaccine which is about 12 months away at this moment. The best-case scenario for India is to keep R0 below 1 for as long as possible through a combination of policy alternatives while pushing the PPF curve outwards. Policymakers should exercise Choice 1 immediately after April 15 to be on the PPF curve B and make good some of the economic losses. In parallel, all the steps needed for Choice 2 which shifts the PPF curve B closer to A must be implemented on a war footing. If done well, we could be looking at running at about 75-80 per cent of the normal economy by the end of May.
Matsyanyaaya: Globalisation Isn't the Contagion; it's the Cure
Big fish eating small fish = Foreign Policy in action
There’s no supply disruption of op-eds during a crisis. They keep flowing. There are two kinds that never go out of fashion. How did we get here and what will the future look like? In them the author casts a withering eye on the past policy missteps, of companies or countries alike, and how should they reset for the future. The stream of opinion pieces on how the current pandemic will lead policymakers to question and cast aside many shibboleths governing trade and globalisation fit into this. Apart from being too pat, there’s a fundamental flaw in these analyses.
So, is this a stress test for globalisation? We will use a different lens to look at this issue and explore how India should respond to the scenarios that emerge.
Globalisation on the ropes
The core argument bears repetition here. Companies and countries in their relentless pursuit to extract value have gone too far in integrating with global value chains and trading systems. The lean and hyper-connected nature of this network left them vulnerable to a global risk event. COVID-19 turned up and the taut loop tightened into a noose. There are four risks pointed out that policymakers should have monitored and mitigated.
a. Concentration risk: The globalised division of labour meant companies had significant concentration of their manufacturing or services bases in a single country that could deliver it at the lowest cost. The overwhelming dependence of electronics majors on China for manufacturing components or of global banks on India for their back-office operations are prime examples of this. A nationwide lock-down stops everything.
b. Overspecialisation risk: The single-minded pursuit of benefits of comparative advantage and global trade has led to countries specialising in a narrow range of products or parts. Countries lack a wider manufacturing base and a varied supplier ecosystem to make even the simplest of products outside their range of specialisation. The struggle of developed economies to produce masks or ventilators in the past months reflect this.
c. Inventory risk: The lean and agile value chain with its focus on just-in-time (JIT) production meant minimal buffer stock in the system to withstand any kind of shock. The immediate stockouts of a critical part or component and the cascading supply side shock that it led to can be traced back to this obsession with cutting down inventory.
d. Business continuity risk: The scenario planning done for business continuity were often restricted to Level 1 risks (site failure, city shutdown) and redundancy was built in to manage those risks. The scenarios for higher order risks and redundancies to cover for them were mostly on paper. They weren’t ever tested.
Therefore, the conclusion: the benefits of globalisation have to be weighed afresh with these risks to decide on the future course. Manufacturing sites and supply chains will have to be brought back home, risks will have to be distributed and inventory stocks recalculated. Globalisation will need to reform and retreat. Prima facie, this is a compelling argument. Policies need to be tweaked or corrected in light of new evidence. Empiricism is a foundational basis for policymaking. However, a more faithful adherence to empiricism would question the higher weightage given to a recent event (the pandemic) over the history of evidence available to arrive at accurate trade-offs for future.
A thought experiment
A thought experiment could help here. The year is 2010. There’s a policymaker (for a corporate or a country; it’s immaterial) sitting at their desk with a magical crystal ball. They can clearly foresee every event over the next decade including the COVID-19 pandemic. They can see the economic boom across most markets, the rise and rise of China, the tremendous value globalisation brings to companies that embrace it, the secular bull run and the rise of valuations and, finally the pandemic that singes everyone and crashes everything.
Here’s the question. Will the policymaker do anything different with all the foresight than what they have done over the last decade? Assume it is a single turn game; the decisions can only be taken once at the start of 2010. There’s no provision to tweak it over time.
Would they, for instance, choose to not trade based on comparative advantage because they know one day when the pandemic strikes it might help them? Will it be sensible to lose out on the consumption boom during the decade by producing completely indigenous products that price them out of the market? Does it make sense to keep slack in the supply chain and let value erode when others won’t be doing it? Will they build extensive redundancy plans with spare, unused capacities spread across the world at prohibitive costs knowing it will help during the pandemic? Will they be willing to lose out as a country or a company when competitors use all of the above to rise to prosperity or higher market caps?
To state the obvious, the answer to most of the above is no. Well, if you can foresee the supply and demand-side shocks that are the result of the pandemic, you will just do whatever you can to maximise your gains till that event. You would have chosen globalisation in 2010 even if you knew what was coming. That’s the simple conclusion of this thought experiment.
Opportunity for India
The only question that might be answered in affirmative, partially, is about redundancy. The risk management matrix of organizations and countries will change post this crisis. There will be a re-categorization of goods that are of strategic importance to a nation. The governments will intervene to make sure there’s redundancy built-in domestically and across manufacturing bases in the world for these goods. This market distortion might be the one long-term impact of this pandemic on globalisation.
There is an opportunity here for India to fill in the redundancy needs of global manufacturers looking to de-risk their operations. India must do a detailed analysis of sectors, companies and countries which might be most amenable to doing this. This shortlist must then be pursued with vigour to help them set up manufacturing and supply chain bases in India with ease. Similarly, for goods that it categorizes as strategic but lacks the know-how to manufacture domestically, India should encourage OEMs to make in India. Some of the past policy missteps in these areas like ‘offset’ and meagre incentives for transfer of technology (ToT) must be avoided. There is going to be a narrow window of opportunity to exploit. It will be best to lay out the red carpet and take advantage of it than be caught up in looking for the most optimal long-term solution. That can wait.
The idea of a reset in globalisation because of the experience during this crisis is quite in vogue at the moment. This argument has limited merit. The benefits of globalisation are based on hard economic and empirical facts. If a few countries or companies retreat, others will step in and take advantage of it. It won’t take long then for the rest to fall in line again. Of course, there are certain lessons that will be learnt from this crisis. But these will be at the margins. Policymakers will need to pick through them carefully despite the weight of op-eds piling up on the other side. Like always, empiricism and scepticism should be their guides.
HomeWork
Reading and listening recommendations on public policy matters
[Book] Public Finance and Public Choice by James Buchanan and Richard Musgrave: This classic exchange on two contrasting visions of the state is quite relevant now as the big State is likely to make at least a temporary comeback.
[Article] Thomas Schelling’s classic article asks the tough question: why should we expect a world without nuclear weapons to be safer than one with (some) nuclear weapons?
[Article] Vivek Dehijia worries about the crisis of globalisation here.
[Article] Zachary Karabell isn’t counting on it yet
[Article] Robert Kaplan on the dangers of a new kind of globalisation
[Article] David Frum argues for the return of Washington Consensus and multilateralism to get China to behave better
[Article] Shannon K. O’Neil in argues for redundancy over reshoring in Foreign Affairs.
That’s all for the week. If you like this newsletter, please do read and share.