#244 Artificial Constructs

The Putin Interview, Macroeconomic Conditions, Indian Government as the First Buyers of Technology Products, and the Upcoming PLI Review

Global Policy Watch: Putin Together A Show

Global policy issues relevant to India

— RSJ

I spent over a couple of hours in the last few days listening to Putin speak in what appeared to be some interview with Tucker Carlson. A chubbier, ruddier version of Putin - war must be keeping him in good spirits - seemed quite pleased to share his perspectives about Ukraine, NATO, history and world peace. We got a first-hand look at the inner workings of a dictator’s mind.

All fascinating stuff.

Besides, I realised Putin and I are similar in two very distinct ways. Both of us love offering long, rambling preamble on any topic before coming to the crux, if at all. And, like me, Putin loves history. While I love going over and over pages of history to find how it rhymes in current times, Putin, being a man of action that he is, likes to rewrite history the way he wants the past to be. Why? Because he can. Plus, it makes it convenient for him to explain his actions today. I revise history to register events and their consequences in my mind. Putin revises history because that’s what good dictators do. In that sense, both of us are history revisionists in our own ways. 

The tl;dr version of the interview is that Putin believes Ukraine is an artificial construct. There’s no historical reason for it to exist. It was the folly of Lenin and Stalin to create a Ukrainian SSR with the boundaries of the state drawn up arbitrarily because they thought it was anyway going to all be part of the USSR or they were plain illiterates in history. Putin argued, marshalling facts from his own version of history, that the Russian state has existed since 862 CE with one faith, one language and one central state that controlled all the ‘Russian lands’. The definition of Russian lands in his mind seemed very flexible to me because he kept adding to it throughout the course of the interview. There was no historical entity called Ukraine till Poland started giving ideas to this gullible lot.

To quote Putin:

“But for decades, the Poles have been engaged in the Polonization of this part of the population: they introduced their language there, they began to introduce the idea that these are not entirely Russians, that since they live on the edge, they are Ukrainians. Initially, the word “Ukrainian” meant that a person lives on the outskirts of the state, “at the edge,” or is engaged in border service, in fact. It did not mean any particular ethnic group.

So the Poles did everything they could to polish and, in principle, treated this part of the Russian lands quite harshly, if not cruelly. All this led to the fact that this part of the Russian lands began to fight for their rights. And they wrote letters to Warsaw, demanding that their rights be respected, so that people would be sent here, including to Kyiv…”

And then, for good measure, he produces clinching evidence about this:

“So that you don't think that I am inventing things… I'll give you these documents…

But still, these are documents from the archives, copies. Here are letters from Bogdan Khmelnitsky, the man who then controlled the power in this part of the Russian lands that is now called Ukraine. He wrote to Warsaw demanding that their rights be upheld, and after being refused, he began to write letters to Moscow asking to take them under the strong hand of the Moscow Tsar. There are copies of these documents. I will leave them for your good memory.”

Carlson tries to steer the conversation back to NATO and its policies, which might have forced his hand on Ukraine, as Putin apologists often argue. But Putin doesn’t seem interested in that line. To him, what matters is history, or his version of it, where there could have been no Ukraine except for Polish knavery in the 14th century. And seven centuries later, he’s claiming what’s rightfully Russian. It doesn’t really matter if you think his history is all flawed. 

The one conclusion to draw from this is he’s not letting go of Ukraine anytime soon because it isn’t a legitimate nation for him. Like he says:

“After World War II, Ukraine received, in addition to the lands that had belonged to Poland before the war, part of the lands that had previously belonged to Hungary and Romania, - today  Western Ukraine. So Romania and Hungary had some of their lands taken away and given to the Ukraine and they still remain part of Ukraine. So in this sense, we have every reason to affirm that Ukraine is an artificial state that was shaped at Stalin’s will.”

The other classic dictator move Putin makes in the interview is the inversion of the notion of the aggressor and the victim. It is the idea that the victim (as the rest of the world sees it) actually overplayed their hand and forced the aggressor to act to protect their interests. So, the onus on stopping a conflict is not on the aggressor but on the victim. Putin inverts the history of WW2 by portraying Poland as the instigator to and abettor of Hitler’s plans. It is quite a remarkable feat of fact distortion when you consider the USSR had signed a non-aggression pact with Germany, the Molotov-Ribbentrop Pact just before the war started. But Putin sees it very differently:

“So before World War II, Poland collaborated with Hitler and although it did not yield to Hitler’s demands, it still participated in the partitioning of Czechoslovakia together with Hitler. As the Poles had not given the Danzig Corridor to Germany, and went too far, pushing Hitler to start World War II by attacking them. Why was it Poland against whom the war started on 1 September 1939? Poland turned out to be uncompromising, and Hitler had nothing to do but start implementing his plans with Poland.”

Ha ha. Poor Hitler. What else could he do but to start a world war attacking Poland. It is exactly how Putin sees himself. As being pushed too far by Ukraine and the West. This is the delusion he lives under and that the Russian state propagates to its citizens.

The one thing I often ask when people start using history to make assertions in current times is where in the past do you draw the line. Look at Putin here. He conveniently draws it at 862 CE and builds a narrative from there. But why stop there? Someone could argue that the Huns or the Khazars ruled those lands before 862 CE and therefore Mongolia or Turkey could make a claim on it. In fact, Mongolia could draw the line of history at mid-13th century and claim most of Europe and China as its original land. In India, it is convenient these days to talk about a thousand years of colonial rule with the line conveniently drawn at early 11th century to portray Muslims as foreigners. But you could go back another millennium and argue that the largest empire in north India then, the Kushana empire, was foreign to India. Or, you could go back another millennium and bring the Aryans into the fold if you believe in the Aryan invasion theory. The historians writing immediately after independence decided to draw the line at mid-18th century with the East India Company winning the Battle of Plassey. 

So, how long India was under colonial rule depends on what’s politically convenient to peddle in current times? The notion that rewriting or reclaiming history will lead to a civilisational revival or an awakening of a polity is flawed in that there’s no real starting point on which past should one go back to glorify. It is all a matter of convenience whether you choose the 8th-century Kailasa temple at Ellora or the 17th-century Taj Mahal as a matter of nationalistic pride. And it doesn’t matter what you choose to serve your political agenda of today, it rarely ever and alone, revives a nation and puts it on a path of progress. That requires real work and not symbolism. 

So, the image of Putin during this interview will remain with me. This late-stage dictator who’s got a bloody nose in this battle, trying his best to rewrite his own history and using nationalism as a crutch, hoodwinking his people. A quintessential WhatsApp uncle who rants every morning quoting from history. Eventually, nationalism runs dry of the good it has to offer fairly quickly. History has shown us that over and over again. All that remains thereafter is victimhood, animosity and a hollow sense of self-importance.

India will do well to remember this. 

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India Policy Watch #1: Good Luck, Good Policy

Policy issues relevant to India

— RSJ

The RBI MPC met this week, and as expected, it was status quo all around. It is now a year since the RBI last changed the repo rate. The CPI inflation for FY 25 is expected to be 4.5 percent, and RBI believes it will have to keep liquidity tight to rein it in further. So, no immediate rate cut in sight much to the disappointment of the market which expected some signal to emerge of a change in stance. Some of that market expectation was driven by the Fed Chairman making a specific comment that there could be at least three rate cuts in the offing in the U.S. 

But unlike in the past, there seems to be a greater decoupling between advanced economies and emerging economies during this cycle. For the central bank in India, the macros look good, growth is chugging along, corporate balance sheets are deleveraged, banks have clean books in a long time and inflation is largely in control. So, what’s the hurry to cut rates? 

Which brings me to the question - why have emerging economies stopped catching a cold when advanced economies sneeze? Well, a recent paper by Tobias Adrian, Fabio Natalucci, Jason Wu at the IMF points to some answers.

I have extracted two relevant portions below:

“While the lower sensitivity is in part due to the divergence in monetary policy between advanced economies’ and emerging markets’ central banks over the past two years, it nonetheless challenges findings in the economic literature that show large spillovers from advanced economies’ interest rates to emerging markets. In particular, major emerging markets have been more insulated from global interest rate volatility than would be expected based on historical experience, especially in Asia. There are other signs of resilience in major emerging markets during this period of volatility. Exchange rates, stock prices, and sovereign spreads fluctuated in a modest range. More remarkably, foreign investors did not leave their bond markets, in contrast to past episodes when large outflows ensued after surges in global interest rate volatility, including as recently as 2022.”

According to authors, this divergence is real and it is on the back of some good quality policy reforms done over the years in key emerging economies. As they write:

“This resilience was not just good luck. Many emerging markets have spent years improving policy frameworks to mitigate external pressures. They have built additional currency reserves over the last two decades. Many countries have refined exchange-rate arrangements and moved towards exchange-rate flexibility. Significant foreign exchange swings have contributed to macroeconomic stability in many cases. The structure of public debt has also become more resilient, and both domestic savers and domestic investors have become more confident investing in local-currency assets, reducing reliance on foreign capital.

Perhaps most importantly, and closely aligned with IMF advice, major emerging markets have enhanced central bank independence, improved policy frameworks, and gained progressively more credibility. We would also argue that central banks in these countries have gained additional credibility since the onset of the pandemic by tightening monetary policy in a timely manner and bringing inflation toward target as a result.

During the post-pandemic era, many central banks hiked interest rates earlier than counterparts in advanced economies—on average, emerging markets added 780 basis points to monetary policy rates compared to an increase of 400 basis points for advanced economies. The wider interest differentials for those emerging markets that hiked rates created buffers for emerging markets that kept external pressures at bay. In addition, the rise in prices of commodities during the pandemic also helped the external positions of commodity-producing emerging markets.”

India checks the boxes on a lot of these points. Which explains the divergence and the ease with which we have managed it this time. 

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India Policy Watch #2: The Indian Government as a “Venture Buyer”

Policy issues relevant to India

— Pranay Kotasthane

In the previous edition, I briefly discussed the budget announcement to incentivise private sector R&D investment through a corpus of Rs 1 lakh crore, which will provide long-term loans to companies at low interest rates.

At a foreign policy conference earlier this week, I was asked if there are any other measures that the government can take to accelerate applied R&D. Here’s my current answer.

Let’s begin with a basic framework. All governments essentially do just three things: produce, finance, or regulate. Now, producing innovation through Indian government labs has largely failed except in space and nuclear domains, where insecurity posed by external threats was instrumental in India performing a limited catch-up. In most other cases, government companies don’t face any real incentives to innovate, and that’s not true only in India. Government-run chip design projects in India, China, and the USSR spectacularly failed for similar reasons.

That leaves us with regulating and financing. When applied to private R&D, regulation means an intellectual property protection regime that makes companies reap the dividends of doing R&D through patents, copyrights, and trade secrets. We are far behind the curve in this domain, and it’s unlikely that we will catch up any time soon, given the status of our judicial capacity. Nevertheless, the government seems to have turned its attention towards this area. Increased human power in patent offices has reduced delays in granting patents, removing one major bottleneck that stymied innovation.

That leaves us with financing, which can happen in two ways. The obvious one is through subsidies, tax rebates, and interest-free loans. This option is less market-distorting because the government is not picking any particular technology or company. It is more pro-market and less pro-business.

But another form of financing is under-discussed. A mechanism for Advanced government purchases is key in areas where we need to do catch-up innovation to build well-understood core technological capabilities. This involves governments actively procuring products and solutions that don’t, as of yet, have a viable customer base.

Innovation scholars refer to this strategy as the “buyer of the first resort” or “venture buyer”. In a new Works in Progress article, Neil Hacker explains how NASA’s use of this strategy helped sustain Bell Labs and transistors in the 1960s while it also got the likes of SpaceX over the hump by procuring their commercial orbital transportation service program in the early stages. Hacker writes:

“What is less well understood is the power of bodies acting as ‘Buyers of First Resort’ – where some entity, public or private, helps to establish the first market for a good or service before it has reached the stage where it could support a customer base of its own.

..

Buyers of First Resort encourage risk taking by sharing some of the risk that the product does not work out, rather than placing it entirely on the firms developing it. NASA’s commercial orbital transportation service program (COTS), which ran from 2006–2013, illustrates this effect. The goal of COTS was to create options to resupply the International Space Station after the space shuttle was decommissioned.

What was different about COTS was that NASA did not want to just start a new program themselves; it wanted private industry to create the launch options in the hope that this would allow NASA to use the private sector’s competition, diversity, and experimentation to get the same output at a lower cost than if it developed transistors in-house. The hope was that this would also stimulate American space companies to build supplies of launch capabilities and eventually become global leaders that served customers all around the world, which would cement America as the leader in space.

This was a risky proposition for private companies: their competitors might be able to copy some of their successful ideas and save the spend on the failed ideas. A private buyer would hardly be likely to indemnify them when things go wrong. Subsidies and tax credits could have helped by covering off much of the basic research, but they would not cover the risks in trying to develop these into successful products.

To overcome this problem, NASA agreed to be the cornerstone user of launch services provided by the companies it contracted with for a pre-agreed number of years after the shuttle was decommissioned, in order to provide reasonably stable market demand for the successful companies. This Buyer of First Resort mechanism was only part of the story – as well as this, the government spent around $800 million on direct funding, along with the private sector’s $1 billion – but it was a vital part of the process.

Because NASA was a Buyer of First Resort, and because it used milestone-based funding that reduced risk for the companies involved, the project was appealing to a wider variety of companies, including, unusually for a contract this size, many startups. One of those startups was SpaceX.” [Buyers of First Resort, Neil Hacker, Works in Progress]

This strategy seems to be an important element in accelerating innovation. However, lest we commit the folly of isomorphic mimicry, this strategy requires ecumenical state capacity in procurement and a willingness to let the private sector take the lead in producing innovation. Another important difference is that the US uses this strategy for procuring innovative products and solutions that don't yet exist on the commercial market. On the other hand, India’s requirement is often about creating domestic know-how for products that are already present in other countries. For instance, India would want to support private companies that process critical minerals, produce simple commercial chips or produce pharmaceutical APIs. The first products of these companies might not be great; for all we know, it might just be better to import these products from abroad as the higher production costs in India might have some deep structural reasons.

Thus, this strategy needs to be moulded for the Indian context. One idea to do this in a less market-distortionary way comes from this excellent Leap Journal article, India's supply chain vulnerability with Chinese APIs: Industrial policy vs. sophisticated policy design. Although the authors Bambawale et al. apply the “Buyer of the First Resort” strategy to pharmaceutical APIs in India, you will recognise that this approach can be used in other catch-up sectors that involve advanced manufacturing, such as drones or chips:

• A government agency would identify the top 50 APIs and the quantities q=(q1,q2,..q50) which are being imported from China.

• We establish the objective of domestic production that comes up to half of the imports from China over a five-year period. This suggests escalation of quantities as: 0.1q,0.2q,0.3q,0.4q,0.5q over a period of five years.

• We put out a binding commitment on the part of the state that the government will run procurement restricted to domestic producers only, where there will be purchases over the next five years of these quantities. The government will commit to placing orders with 3 lowest-cost firms that produce in India, in each year’s bidding. The requirement from a bidder should be that production is done in India. Foreign or Indian firms should be permissible, subject to a restriction against firms controlled by the Chinese state e.g. bar a firm where any one member of the board of directors is an employee of the Chinese state or the CCP.

• These commitments about a rising scale of GOI procurement will create incentives for Indian/foreign firms, located in India, to build knowledge and physical capacity to produce APIs at a large scale.

• The government agency has only one objective: to trigger off economies of scale and competition by producers in India. Once the goods are purchased by the Indian government agency, what is it to do with them? Indian firms might not like to buy these APIs at the purchase price, as the purchase price may well be higher than the world price of these APIs. Once the goods are purchased, this agency would run a global auction to sell the same goods off, at the highest possible price. Indian drug companies could potentially choose to buy these goods, but these purchases would be at an import-parity-pricing price. As a consequence, through this program, the Indian government would be drop shipping the goods, purchased in the make-in-India auction to buyers who came into the sell-from-India auction. [India’s Supply Chain Vulnerability..., The Leap Journal]

The last stage of this procurement supply chain is worth noting. The auction idea frees mission-critical government agencies from having to mandatorily incorporate substandard products just because they are made in India. This is just one flaw with the current atmanirbhar push in defence manufacturing.

What’s most important is to add advanced government purchases to India’s innovation policy toolkit.

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India Policy Watch #3: We Told You We Told You So

Policy issues relevant to India

— Pranay Kotasthane

This news report in Business Standard caught my attention:

“Concerned over “considerable delays” in issuing incentives to eligible companies under the flagship production-linked incentive (PLI) scheme for various sectors, the Cabinet secretary-led committee has advised the government’s think tank, NITI Aayog, to review the functioning of the nodal agencies involved with the scheme.”

For all the hype about PLIs, the actual disbursements under these schemes have been abysmally low. The total target for all PLIs over a five-year period is ₹1.97 lakh crore. Two years into the scheme, the total disbursement across all PLIs is only ₹4,415 crore, i.e. just 2 per cent of the target.

One of the causes for this dismal performance is that government agencies set up to manage PLIs, called project management agencies (PMAs), don’t have adequate capacity to process claims. As the above report confirms:

“There are considerable delays in the processing of incentive claims. Further, PMAs have not completed onboarding an adequate number of subject matter experts as directed in the earlier meeting,” the minutes of the EGoS meeting read.

…

Some of the PLI schemes have witnessed slower-than-expected progress. A major reason is the inability of beneficiary companies to claim incentives as they were unable to fulfil the obligations prescribed by the government. In some cases, the gestation period is expected to end this year, after which incentives can be claimed in the next financial year.”

None of this was unanticipated. We have been crying hoarse over this approach since 2020. Back in November that year, we wrote:

Three unintended effects are possible:

One, “Reasonable regulation drifts toward overregulation, especially if the costs of overregulation are not perceptible to those who bear them.”

The PLI scheme for the electronics sector has specific eligibility criteria both on incremental investment and incremental sales a company needs to commit over the next five years. This is supposed to be cross-checked by a Project Management Agency (PMA), a government-body formed under the Ministry of Electronics and Information Technology (MeitY). The PMA will further submit its recommendations to an Empowered Committee (EC) composed of CEO NITI Aayog, Secretary Economic Affairs, Secretary Expenditure, Secretary MeitY, Secretary Revenue, Secretary DPIIT and DGFT which will make the final decision. The EC can also revise anything — subsidy rate, eligibility criteria, and target segments. In short, more bureaucracy and predictably unpredictable delays. The speed of incremental investments might be decided by the speed of government decision-making. EC’s powers to make any changes to this policy in the future is also filled with possibilities of regulation becoming overregulation.

There’s one more gap. In order to increase innovation, the PLI scheme will not consider incremental investments towards land and buildings towards the eligibility criteria. Only investment towards plant, machinery, equipment, research, and development is allowed. This might incentivise companies to fudge their land dealings and for government officers verifying the real quantum of incremental investments to cut deals for themselves.

Two, “Moral hazard increases.”

The ten sectors chosen by the government might see a crowding-in of investment at the cost of all other sectors. Are these ten industries strategic for India while others aren’t? I don’t quite know the basis of this selection.

Next, every policy move has an associated opportunity cost. It’s a bane of Indian policymaking that policy decisions are rationalised solely by looking at projected benefits; by ignoring opportunity costs. In the context of PLIs, the government needs to pay up ₹2 lakh crore over the next five years to a few companies in these ten sectors. The government will most likely rake in this revenue in the form of taxes. Using the Kelkar/Shah Marginal Cost of Public Funds (MCPF) estimate for India of 3, the total cost to India from this subsidy would be of the order of ₹6 lakh crore. The scheme would make sense if the benefits are projected to be higher than this number. Whether an analysis of these costs has been taken into account, we don’t know.

Three, “Rent-seekers distort the program to serve their own interests”. Companies that benefit will seek to modify the eligibility criteria to suppress competition, thus leading to more market concentration. They might even try to extend the sunset clause of this scheme in order to keep benefiting from the discount.

And each of these anticipated-unintended consequences is playing out. Nevertheless, it is good that the government is finally rethinking these PLI schemes. Instead of spreading itself too thin across 14 sectors, it may be time to double down on just a handful of sectors where there is existing government capacity to manage PLIs. Better to acknowledge mistakes and self-correct than lose all-around credibility.

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HomeWork

1. [Paper] This paper confirms that friend-shoring is indeed happening. On the surface, it should be good for India. Except, it is not for two reasons. The first is our own self-defeating model Bilateral Investment Treaty. The other reason is that India is not sufficiently aligned geopolitically with the US yet to exploit the investment opportunity.

2. [Podcast] Check out our Puliyabaazi on starting, running, and quitting start-ups.

3. [Event] Readers in Bengaluru: come over to the Bangalore International Centre on 15th Feb for a discussion on the Geopolitics of Semiconductors.

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