#24 Free = Nothing

Judiciary's Panchayati Raj, New World Order, Bollywood on Rent Control, Corporate Distress 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: Muft, Muft, Muft

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

— Raghu Sanjaylal Jaitley

Suppose you wake up one morning and find the formula for the novel Coronavirus vaccine tucked under your pillow. You bring together the chemicals, reagents and whatever else is written on the paper and make a shot of the vaccine. Each shot of vaccine costs you Rs. 2000 to make including your time spent on administering it. You call up Arnab Goswami with the news. There are tests done on your vaccine and they prove successful. You are the superhero India was waiting for.

But superheroes also bow to the great Indian state. The SC takes suo moto cognisance of this news and asks you to provide the vaccine for free to everyone in India because ‘you have a role to play in containing the virus by extending philanthropic services in this hour of crisis’. There are millions lining up for your vaccine. But you will be bankrupt by the time you give vaccines to 5000 people.

What will you do? I guess you have two options. One is to give the 5000 vaccines to the neediest spread over a period of time. Then declare bankruptcy and retire to the forest (or to the Mallya home near London). The other option is to lock your home and disappear with whatever savings you have to start a new life as a social media influencer.

Umm, now read this - Make private Covid-19 tests free, says Supreme Court

One view on the long-term exit strategy from the lockdown is to do rapid testing like Germany or South Korea. This means the government should make sure every facility or lab that can do the test is enabled to the fullest extent. The private labs approved to do the tests in India aren’t huge enterprises. They are part of a hospital, diagnostic chain or a standalone lab. Each of them have been impacted because of the lockdown. The revenues have fallen, employee costs and other expenses aren’t easy to reduce and the cash situation is getting tighter. Most of them will struggle to stay afloat if the lockdown continues for another 4-6 weeks.

Now they have to do free COVID-19 tests each of which could cost them about Rs. 2000 (at a minimum) for the testing kits, sample collection materials and other equipment costs. With overheads and other expenses, it will be safe to assume a lab will lose Rs. 2500 for every test. For every 4000 tests, the clinic will lose Rs. 1 Cr. There’s no support so far from the government to share or reimburse this cost. You have to extend the philanthropic services at this hour of crisis. Period.  

If you run such a private lab, what will you do? You will probably do just the minimum number of tests that fulfils your contribution to the national effort without bankrupting you. Or, you will give any excuse to opt out of doing the tests at all. It is very difficult to see a scenario where you will go all out to do as many tests when you don’t have enough cash and you lose Rs. 2500 for every test. Unless, of course, Softbank is your investor but even that ship has sailed.

It is frustrating how when we need private clinics to be fully geared to do as many tests, we are doing our best to make sure they don’t do many. We first had the government putting a price cap of Rs. 4000 per test. That was bad enough. And, now this. Like we have mentioned here, the Indian state is reflexively socialist. We view anyone who runs a private enterprise as an Ambani (super rich who has money to lose) or a Pinchoo Kapoor from a 70s flick (devoid of any morals and intent on profiteering). Our collective imagination struggles with the notion of a hardworking entrepreneur serving his market and making a profit.

It’s sad how this has led to so many poor policy decisions over the years. It’s sadder we don’t learn our lessons from them.

It shouldn’t take an economics genius to figure this truth – at price zero, there will be zero supply.


A Framework a Week: Ingredients of a New World Order

Tools for thinking public policy

— Pranay Kotasthane

The phrase A New World Order is back in vogue due to Covid-19. You’re going to hear this over and over. So here’s a framework to help understand this phrase.

One of the better definitions of World Order comes from a book of the same name, written by Henry Kissinger in 2014. He defines it as

the concept held by a region or civilisation about the nature of just arrangements and the distribution of power thought to be applicable to the entire world.

The two words — ‘just’ and ‘power’ — are important in this definition. Kissinger further explains why legitimacy and power are the two components on which any order is based:

Any one of these systems of order bases itself on two components: a set of commonly accepted rules that define the limits of permissible action and a balance of power that enforces restraint where rules break down, preventing one political unit from subjugating all others. A consensus on the legitimacy of existing arrangements does not—now or in the past—foreclose competitions or confrontations, but it helps ensure that they will occur as adjustments within the existing order rather than as fundamental challenges to it. A balance of forces does not in itself secure peace, but if thoughtfully assembled and invoked, it can limit the scope and frequency of fundamental challenges and curtail their chance of succeeding when they do occur.

A corollary is this: while the survival of nation-states depends on power alone, achieving a world leader status requires both power and legitimacy.

Power simply refers to the ability to influence one’s will over the others, irrespective of the other’s will. In an international relations context, such power is attained through a combination of several factors: a strong military, a favourable geography, a big and growing economy, nuclear deterrence, and so on. However, even the most powerful nation-states require one more essential ingredient to transform themselves into world leaders: an exercise of power that is deemed legitimate by other actors in the system. In other words, great power status is the quest for authority —  an exercise of power which is not considered as being coercion but as legitimate.

An illustration: how power, authority, and legitimacy are related

Kissinger again explains the balance between legitimacy and power in a world ordering project elegantly:

To strike a balance between the two aspects of order—power and legitimacy—is the essence of statesmanship. Calculations of power without a moral dimension will turn every disagreement into a test of strength; ambition will know no resting place; countries will be propelled into unsustainable tours de force of elusive calculations regarding the shifting configuration of power. Moral proscriptions without concern for equilibrium, on the other hand, tend toward either crusades or an impotent policy tempting challenges; either extreme risks endangering the coherence of the international order itself.

Further, how nation-states become powerful is well-understood in international relations. But how world leaders come to exercise this power legitimately is much less understood. Essentially, legitimacy requires conformity to a set of rules. And because the international system is not governed by a single-set of rules, world leaders seek to gain legitimacy by projecting their own set of rules as being superior to others, and then as acting as credible upholders to these values.

This critical distinction between legitimacy, authority, and power, can help shed light into the most important world order shifts of the recent past.

The emergence of the US-led order

By the end of World War II, all European powers were exhausted. The US emerged as the most powerful nation-state. But accumulation of power was just the first step to a world leader status. To transform its power into authority, the US followed many more steps. First, liberty and democracy were identified as the values which the international order was supposed to encourage. Second, the US built multilateral institutions to reassure the other nation-states that the US was willing to limit its own authority. Third, the nation-states that adhered to this international order were provided with the benefits of security cover, economic assistance, and technology transfers. Done together, these three steps made US not just the most powerful, but the most authoritative nation-state in the modern world.

Why is a US-led order crumbling?

This framework also helps analyse why the US-led order is said to be crumbling even though there is no perceptive decline in virtually any of its power dimensions.

The reason is that while the US continues to be powerful, its international conduct over the last few years has led to a rapid decline in its legitimacy. This has happened in a few different ways. One, the nation-states that tethered themselves closely to a US-led order now have no assurance that they will benefit from such an arrangement. The emphasis of the Trump administration on  ‘fair and reciprocal trade’ and ‘shouldering more of the burden of our common defense’  illustrates that the benefits accruing from a US-led order have declined substantially for other players. Two, the US turning its back on the same multilateral arrangements it created has also been a severe jolt to its credibility. The withdrawal of the US from the Trans-Pacific Partnership (TPP), the volte-face on the Iran nuclear deal, and the decision to withdraw from the Paris Agreement on climate change are cases of this nature. All in all, the authority of the US has taken a severe hit even though it continues to add to its power.

What about China?

Even though China is nowhere near the US in terms of its power capabilities, the Communist Party leadership is hard at work to get there. Even if we take an extremely optimistic scenario where China’s power rivals that of the US, China has two structural limitations preventing it from exercising this power legitimately.

One, the Chinese vision for the world is at best a poor replica of the Westphalian principles of world ordering that preceded the assent of US as a world leader. Beyond the procedural aspects of “noninterference in domestic affairs of other states, inviolability of territorial integrity, and  sovereignty of states”, it provides no direction, making the generation of legitimacy difficult. Even the multilateral institutions that China has tried to build are alternates rather than substitutes for those created by a US-led order. Essentially, China has no set of norms to build its own legitimacy on. Two, legitimacy for the Chinese way of reordering the world is constrained by an essentially hierarchical Chinese worldview — one that divides the world between ‘civilisation’ and ‘non-civilisation’ depending on the extent of sinicisation a region has gone through. This makes the idea of a Pax Sinica a repulsive proposition to most states, let alone illegitimate. So, even if China were to become the most powerful state in the world, it is unlikely that it will become the most authoritative actor.

What does this framework say about India?

India is several notches down from where China is, on several dimensions of power. But it does better on the legitimacy front. Shyam Saran explains this well in his book How India Sees the World:

India possesses the civilizational attributes for contributing to a new international order attuned to contemporary realities. Its culture is innately cosmopolitan. India embraces vast diversity and inherent plurality, yet has a sense of being part of a common humanity. India should leverage these assets in shaping a new world order that is humanity-centric.

Beyond the civilisational attributes, the Indian Republic itself serves as a rare example of how continent-sized multi-ethnic, multi-religious, liberal democracies can be constructed. Essentially, the Indian story has many features attuned towards the generation of international legitimacy. The twin challenge for India is to preserve these values that make it a legitimate world power, while aggressively adding to its power capabilities.


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Lights, Camera, (Policy Precedes) Action: Rent Control

Public Policy via Bollywood

— Raghu Sanjaylal Jaitley

Bollywood has everything that’s worth knowing in public policy. For the intrepid researchers (not us), there’s a five-volume public policy tome waiting to be mined from Hindi films. We are just getting the ball rolling here for the brave ones…

The term middle-of-the-road cinema coined in the 70s is among the great lexicological contributions of India. There isn’t a specific definition of the term, but it’s widely used and misunderstood. Of course, it isn’t our greatest contribution to the English language. That spot, in line with our hallowed mystique tradition, is reserved for ‘mild lathicharge’. Anyway, what should interest you, dear reader, is that this genre of films mostly meditated on the public policy issues of the times. The director and the writer (the public policy enthusiasts of those times) didn’t do things in half measures. These robust men and women borrowed money, lived meagrely, mounted a film, threw the proverbial kitchen sink at the issues and retired from films to be later seen serving adrak chai at Prithvi Theatres’ canteen. In sharp contradistinction, today’s lily-livered public policy wonks do newsletters and podcasts. We have lost something important over the years. Not sure what but I guess there are half-a-dozen Pratap Bhanu Mehta or Santosh Desai pieces somewhere in there.

Today I will direct your attention to two films that will take you on an excursion of pet public policy peeves in India – rent controls, rent seeking, market distortions in real estate, the tragedy that is the Indian legal system and, of course, why did Zarina Wahab marry Aditya Pancholi?

The Bombay Rent Control Act of 1940 is a tourist attraction that you can’t miss when you go around the southern end of the maximum city. Almost every building is a living ruin. It is like Rome except people still live in those ruins. The Act froze the rental rates for about 60 years. All kinds of distortions followed. The supply of rental accommodation went down, landlords had no incentive to repair, paint or maintain their properties, tenants lived in fear of a building collapse during monsoons, sub-tenancy and black market flourished and, legal cases multiplied dragging on for years. The cascading impact of this led to supply shortages of housing in Mumbai and drove up the real estate rates over the years.

Saeed Mirza’s oeuvre is replete with films that can stand in for a Public Policy 101 course. The four films he made in the 80s – Arvind Desai Ki Ajeeb Dastan (ADKAD), Albert Pinto Ko Gussa Kyun Aata Hai (APKGKAH),  Mohan Joshi Hazir Ho (MMHH) and Salim Langde Pe Mat Ro (SLPMR) – apart from earning his films a place in future dumb charades hall of fame, had a simmering socialist tone that laid the blame for everything at the doors of capitalism. He got the story right but the diagnosis was totally wrong.

Nowhere was this more apparent in his 1984 film Mohan Joshi Haazir Ho (MJHH). Bhisham Sahni and Dina Pathak play an old Mumbai couple who sue their landlord (Amjad Khan) for letting their building fall into complete disrepair. The landlord wasn’t a great moral specimen of the human species. But he was also a victim of the Rent Control Act. He couldn’t care less for the upkeep of the building considering his rental income. The old couple hire a pair of chaalu lawyers (Naseeruddin Shah and Satish Shah chewing up the scenery) while the landlord brings on Kasturba Gandhi (Rohini Hattangadi). The lawyers quickly form a cartel and drag the case for years milking their clients dry. Finally, the court goes for a physical examination of the property that has been temporarily spruced up by the landlord. The court dismisses the case. In a memorable final act, Sahni bangs his head against the props that are holding up the building till they give away and the whole structure collapses on him.

You’d think the landlord and the lawyers were the villains of the piece. But like Amit Varma reminds us in every podcast, they were only playing to their incentives. The real culprit was the state. It had blood on its hands.    

But rent control isn’t all. Mumbai is among the costliest real estate markets in the world because we weren’t content with just one bad policy (the ek se mera kya hoga syndrome). The floor space index (FSI) that determines the vertical height of a building hasn’t changed for over 50 years. This has meant an artificial supply constraint in a city that is naturally short on inhabitable land. Also, about ten builders hold the rights to develop land in Mumbai. This kind of oligopoly has continued to keep supply scarce and prices high. The Ready Reckoner Rate (RRR) used to set the floor price at which a property can be sold is among the highest in the country and grows at a steady clip. This isn’t a surprise. RRR is the basis to calculate stamp duties and taxes that fund the state government. Then there are slums. The market distortions are such that there’s no supply of low-cost houses to serve millions of migrant workers who come into Mumbai every year. Inevitably, they encroach on parcels of free, available land that is usually owned by the government or trusts who don’t have the will to stop this or are driven by politicians who use it for political rent-seeking. Almost a quarter of available land is under slums. The slum rehabilitation programme typically involves bidding out the land to builder who has to provide for free houses to slum dwellers on one part of land and apartments for sale in the other. So, the regular buyers of houses have to subsidise the slum dwellers which drives the prices up. Plus, there’s moral hazard. The slum dwellers rent out the free houses and go out to encroach another piece of available land. And, the cycle continues. The Mumbai real estate market can be used as a textbook case for how bad policies hurt people.

How badly they hurt can be seen in the 1977 film Gharonda where Amol Palekar and Zarina Wahab are colleagues who fall in love at work. And, like every Mumbaikar since the Wadias shipped opium to Canton or had ‘the star-spangled banner composed’ on their ship, they want to own a house of their own. Big mistake. They pool together every single naya paisa to front up for a house in a building whose plans are still on paper. The price is exorbitant for the matchbox-sized house. The builder dupes them and disappears with the money. Palekar is left distraught. Enter Dr. Shreeram Lagoo, the owner of the firm where they work. Usually, Dr. Lagoo on screen means a paralytic stroke isn’t far away. Here (in an inspired twist) he’s got a dodgy ticker. He’s always been besotted with Zarina since she reminds him of his dead wife (yeah, right). Palekar encourages Zarina to marry the ailing Dr. Lagoo in the hope he will kick the bucket soon. They could then use his money to buy a house. Talk about single-minded focus! Zarina agrees to marry the old lech foreshadowing a lifetime of bad decision making in marriage market. Unfortunately, Dr. Lagoo gets a new life after he’s remarried and since this isn’t The Postman Always Rings Twice, Palekar is left without a house or a wife by the end. Zarina tells him it’s not me, it’s you and gets on the fast pativrata lane.

Palekar blames his fate. You watch and shake your head.

It is not fate; it is the state.  

The film ends with Palekar singing a dirge penned by Gulzar.

“Ek akela is shahar mein, raat mein aur dopahar mein,

sabudana dhoondta hai, aashiyana dhoondta hai”***.

What inspired lines from Gulzar capturing the eternal pursuit of a true Mumbaikar!

A home and some sabudana (vada?, khichri?).   

*** I know, I know


India Policy Watch: On Knife's Edge

Insights on burning policy issues in India

— Raghu Sanjaylal Jaitley

A great game of passing the parcel has begun in corporate India. It will run for a while giving a false sense of assurance. But the music will eventually stop.

Corporate India in the bardo

Imagine a mid-sized company in India today. It’s almost a month since business started slowing down. Revenue is about a tenth of what you usually do. Indirect fixed costs refuse to go down any further. You have done the usual – stopped IT projects, reduced capex, cut bonuses, deferred salaries. There’s no fiscal package that helps you directly. No paycheck protection programme. All regulatory and statutory payments have to be made. Banks haven’t opened up the floodgates to increasing existing credit lines despite the hype surrounding it. You foresee another couple of weeks of this. You might survive May but June is looking precarious on cash flow front. What do you do? You move up a gear. You call up vendors and suppliers and ask them for steep rate cuts (50% is fair game these days). You find any excuse. You blame them for supply chain disruptions. You decide on not paying any invoice in the current quarter. You start quoting force majeure in your communications. You buy time.

Corporate India has reached this stage at the moment. Liquidity is low and companies aren’t willing to part with it anymore. The problem is the supply chain isn’t linear. It’s a loopy, multi-nodal network with infinite interconnections. So, as you start telling your suppliers about your plans to defer payments to them this quarter, they, in turn, tell their partners. So on, the parcel gets passed. Don’t be surprised if in no time you get a call from your customers with their plans to defer payments to you. This isn’t karma. It’s the network. Soon you won’t pay anything, but you won’t receive your payments too. Companies will be in the bardo – a state of existence between death and rebirth, varying in length depending on your conduct in life and the impact of the pandemic.

A long road to recovery?

Of course, all conversations about these deferrals or cuts make it appear like things will just sort themselves out magically after this quarter. How will we make a quick, sharp rebound in Q2 is anybody’s guess? Since everyone’s playing the game, no one is interested in this question at the moment. But it is important to look beyond and understand the likely systemic challenges we face for the foreseeable future.

Banks have been asked to come to the rescue and let credit flow in this quarter. Since there’s no backstop provided by RBI or the government yet to these loans, banks will bear the burden of them going bad. It is no surprise despite the Rs. 3.74 lac crores of easing done by RBI, the banks aren’t flooding the market with liquidity. Eventually, Banks (particularly the PSUs) will have to let credit flow with timely nudges from the RBI and government. The triaging of the credit won’t be scientific because there isn’t enough time to understand business models or work out their prospects in post-Corona world. With limited information, a hazy outlook and the clock running out, poor decisions will be made. The whole banking and NBFC system was under stress even before the pandemic. This will add to it further. NBFCs are already struggling in the face of redemptions worth Rs. 2.5 lac crores coming up at the end of this quarter. The TLTRO (Targeted Long Term Repo Ops) programme is limited to Rs. 1 lac crores and will help only the top rated NBFCs. Mid and small sized NBFCs are on a wing and a prayer at this moment. The giant passing game will eventually end with the Banks holding the parcel. This is the chronicle of a financial crisis foretold.

The passing game will have an impact on the aggregate demand across sectors. The entire consumption class from daily wagers to salaried employees (about 12-15 crores households) will either lose a few months of earnings or be impacted by salary deferrals or cuts. The one thing this shock will teach them is to save more and consume less in future. Then there are companies that have already been dealt a body blow – those that depend on summer months for a huge part of their annual sales, sectors like airlines, travel, retailers, restaurants etc who won’t ever recover lost revenues. The impact on their employees is going to be long lasting.

The commercial real estate sector will be hurt badly. Early signs suggest companies will probably let go of about a third of their rented real estate since work-from-home is here to stay. There is going to be a glut of commercial space available and companies will renegotiate rentals (if they aren’t already doing so). A sharp 20-25 per cent correction in rates isn’t beyond the realm of possibility. Similarly, discretionary IT spends in India and the rest of the world is going to be cut dramatically. The complete destruction of demand for about three months in the developed world will mean cancellation of IT projects, reduction in BPO headcount and renegotiation of rates till companies get a semblance of normalcy back in their business. This could take 12-18 months. IT services sector was cutting the flab at its middle for the past two years as the nature of work changed. This process will be accelerated.

It is likely the virus won’t be eliminated forever in a couple of months. There is a real possibility of sporadic cases breaking out in different cities through the year. This could mean recurring short-term shutdowns limited to a city or state through the year. This won’t do consumer confidence index any good. Also, this would mean a general suspicion of crowded places like malls, airports and restaurants which will further dampen demand.

Consumption is material. It is also a sentiment. The recovery will be long drawn out. The sentiment won’t turn around so quickly. Never before has the need for a fiscal relief plan been more urgent.

Things are on the edge at this moment.


HomeWork

Reading and listening recommendations on public policy matters

  1. [Article] Pratap Bhanu Mehta on History after Covid-19

  2. [Paper] The flypaper effect: a public finance intuition which says that a rupee of exogenous grants-in-aid leads to significantly greater public spending than an equivalent rupee of citizen income i.e. Money sticks where it hits.

  3. [Course] Christina Bicchieri’s landmark work on Social Norms is available as an online course now.

  4. [Articles 1 & 2] Devesh Kapur and Arvind Subramanian have a two-piece series on creating the fiscal space to manage the crisis.


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If you like the kinds of things this newsletter talks about, consider taking up the Takshashila Institution’s Graduate Certificate in Public Policy (GCPP) course. It’s fully online and meant for working professionals and has three specialisations: Technology Policy, Public Policy, and Defence & Foreign Affairs. Applications for the May 2020 cohort are now open. For more details, check here.