#268 Wrong Theories of Change

Is ₹/Job a Helpful Metric for Industrial Policy?, The PM's Independence Day Speech, Subcontinental Geopolitics, and China's Economic Troubles

India Policy Watch #1: Independence Day Musings

Insights on current policy issues in India

— RSJ

We usually do an upbeat Independence Day edition. You know, the usual “We love India, warts and all”. It is still the most incredible post-colonial endeavour at nation-building that’s continued to remain largely steadfast to its idealistic founding principles. It’s not been easy, and this commitment has been tested to the brink many times over the past 77 years. Yet we survived and thrived. Some of this sentiment was echoed in the customary Independence Day speech of the PM, the first of the third term of this government and the longest among the eleven he has delivered on this occasion. Together with the budget speech last month, it showed where the priorities of the government lie at this moment as it sets out the agenda for this term. Clearly, there will be a sharper focus on the farm sector, employment, youth and women, if we go by the intent. 

These apart, the PM also signalled his intention to bring in a uniform civil code or, as he framed it, a secular civil code and one of his old favourites, one nation, one election. At different times, we have written about the risks of “One Nation, One X’ policies in a country as diverse as India and why we shouldn’t be expending any state capacity in implementing them. So, I will leave that for a moment.

The ‘secularisation’ of the uniform civil code agenda is an interesting turn of phrase. I see this becoming a talking point in the upcoming state elections and gathering steam until 2029. As I mentioned in a previous edition (#266), coalescing the Hindu vote base into a monolith that the BJP has done over the past decade has possibly reached its limit. The usual centrifugal forces of sub-caste, class and communities will fragment the monolith if left unchecked. The political problem for the BJP to solve is what will keep the base consolidated against the natural forces of fragmentation. I’m not surprised the thinktank has arrived at a ‘secular’ civil code as the answer. It fits multiple criteria needed to keep consolidation going. As an issue, it has been around for a long, and both the extreme secular and the extreme conservative sections among the Hindus support it for different reasons. This legacy of passion is important for raising emotional stakes on the issue. It also has the classic cause to rile up the majority, where any opposition to it will be seen as appeasement to the Muslim minority. And what’s nice for the government is it can be positioned as a progressive idea that will bring civil laws on par for every citizen of India. The risk, of course, is what benefit does it really bring to ordinary citizens? What if the opposition, instead of taking the bait and opposing it on emotional grounds like the government expects it to, chooses to stay focused on jobs, economic opportunities and inequity and brands such moves as the usual distraction tactic? There’s enough evidence to show people have gotten wiser to such moves, and anyone pointing it out to them will find support. So, it will be interesting to see how quickly things crystallise on this issue.

The other part of the speech that caught my attention was this:

"Around 25,000 youths every year go abroad for medical education and they go to such countries, I get surprised when I hear about them. So we have decided, 75,000 new seats will be created in the medical line in the next five years."

Yeah. Pranay raised this question in one of our editions when the Ukraine war started. What are thousands of Indian medical students doing in Ukraine? No global university rating metric suggested that Ukraine is blessed with world-class medical schools. Soon, we realised that Indian medical students stranded in strife-torn zones is news as old as the hills. Over the years, these students have been stranded in places like Kazakhstan, Turkmenistan, Antigua, Russia, Egypt and as late as last month in Bangladesh when Sheikh Haseena fled. I’m glad that the PM also is as surprised as us. 

But I’m afraid the solution to it cannot be a mega announcement of creating 75,000 seats in the next five years without a rigorous study of the current state of medical education, understanding the demand and the supply side constraints, the bottlenecks in capacity expansion around onerous regulations, faculty and infrastructure, creating simultaneous capacity in public health infrastructure and paramedical staff, the trade-offs between quality and quantity while rapidly increasing capacity, and the role of the state and private players in building this capacity. This isn’t a problem that has struck us out of the blue. It has built up over the years with deep roots that require clear-headed policymaking.

Just to put some of this in context, in the natural course of the expansion of capacity that’s happened in the last ten years, the total MBBS seats have gone from 52,000 in 2014 to about 113,000 in 2024. That’s about 7.5 per cent annualised growth in seats over a decade. The average cost of an MBBS education during this time has almost gone up 2.5 times. So, there is some kind of a functioning marketplace, and it isn’t as if the supply side isn’t receiving its signals. But as we can see, this hasn’t been sufficient. About 22 lakh students write NEET for the 1 lakh plus seats, and the stakes are so high that we have a massive coaching industry supporting this demand for seats. The paper ‘leaks’ and other modes of corruption are the natural by-products of this. So, the question we should be asking is, what has stopped the supply side from working and servicing this demand? It isn’t as if they were waiting for the PM to announce a 75,000 increase in seats to get themselves going. And neither will an announcement of this kind help address this conundrum's root causes.

So, I hope this announcement will kick off a formal policy-making process where existing datasets will be collated and analysed, diverse stakeholders consulted, an expert committee set up and a set of recommendations will be finalised that will address the real issues and set us on the long-term course of medical education reforms. But I remain sceptical. The risk of such top-down announcements is that the number will be taken as a target that will be devolved to various government institutes as an annual mandate without taking into view the risks of such an increase in student intake. The private sector will remain passive because there’s no way one can set up a new, fully functional medical college in India in 5 years under the current regulatory regime. Any increase in capacity among private colleges is ruled out because of the commensurate increase they will need to do in infrastructure and medical beds in associated hospitals, which is mandated by various regulators like UGC and MCI. So much of the heavy lifting on numbers will have to be done by the government colleges. In different ways, this has played out in engineering and management education. Student intake will go up 75 per cent in the next five years with limited real capacity build-up. Class size will be increased, student-to-faculty ratios will be compromised because there is a shortage of good quality medical faculty to be hired, labs and practical learning will be compromised, and hostels will be packed to accommodate this increase. Worse, with no efforts to improve the quality of the student pipeline writing NEET, students with really poor scores will qualify to be doctors. This is a real problem even now.

In short the cure will be worse than the problem. I hope we don’t end up repeating history here. 

P.S.: Our editions on “One Nation, One Election”, a policy that has pride of place in our all-time PolicyWTF list: editions #249 and #226.

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India Policy Watch #2: Is ₹/Job a Helpful Metric for Industrial Policy?

Insights on current policy issues in India

— Pranay Kotasthane

There are many sensible ways to critique industrial policy. Arguing that such projects don’t employ “enough” people isn’t one of them.

In this newsletter, we have consistently argued that rising protectionism in pursuit of self-reliance might help substitute some imports, but it will also make Indian firms uncompetitive in the global market. Moreover, incentives given to firms for increasing local production circle back to the government as high-tariff collections without reducing the cost disabilities that stunt local production in the first place.

We have also argued that far too many PLIs are spread across disparate sectors. The policy’s “theory of change” is unclear, and it’s become a hammer in the hands of the government in search of nails, screws, and bolts.

However, in recent times, there are far too many critiques focusing on the number of jobs that each investment generates. The line of argument is somewhat like this: Certain sectors, such as semiconductors, that are receiving billions of dollars of investments will likely employ only a few thousand people. Thus, using a figure-of-merit obtained by dividing total investment by total jobs, the criticism is that a sector requiring crores of rupees per job is not worth government support.

Here’s why I think this is a false flag.

Direct employment in a sector is an important but not the only metric of success for government policy. There are other worthy goals as well. For example, government coordination and support can also target reducing strategic vulnerabilities, building on comparative strengths, and demonstrating national power. For these reasons, governments have supported sectors that perform quite badly on the Rs/job metric, such as space, nuclear weapons and nuclear energy, and green transition. The question we really need to ask the government is: what precise goal of the ones stated above is the industrial policy trying to attain?

Second, employees and investments are both inputs for a firm. To use a metric that divides one input from another doesn’t make sense. Surely, a better efficiency measure would be to assess whether an output measure, such as exports or total production, is worth the monetary and opportunity costs of the input investment.

Third, Goodhart’s Law applies. If this Rs/job measure becomes a target, governments will subsidise underemployment without regard for productivity. Soon, we will have a repeat of policies, such as items reserved for manufacture exclusively by the small-scale sector, which actively discouraged firms from using machines in the hope that they will employ more people instead. As it turned out, this policy neither led to more employment nor more firms. If Rs/job were the most important metric, India’s agriculture subsidies could be declared an outright success—it keeps over 40 per cent of India’s employed, isn’t it? And by the same logic, India’s success in IT/ITeS would be an abject failure.

Finally, it’s important to understand that government support has been crucial for the growth of certain industries, particularly during their initial development stages. For example, all major semiconductor industry players without exception, have needed an industrial policy push in the incipient stage, which tapers away as the industry finds its own feet. Using an Rs/job metric would mean that such sectors would never qualify for government support and hence will never come to life.

For such sectors, the right questions to ask are all on the outputs side: will government subsidies for low-end chips make India less vulnerable? Is the reduction in imports of foreign-made chips worth the investment? Can this pool of money be better utilised in segments of the semiconductor supply chain where we already have a comparative advantage? These are all questions we must hold governments accountable for. Focusing on the Rs/job metric is a distraction.

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Matsyanyaaya: Backyards and Conspiracies

Big fish eating small fish = Foreign Policy in action

—Pranay Kotasthane

It's been an interesting turn of events in our neighbourhood. Ms Sheikh Hasina’s ouster generated global interest when the news came out that she had allegedly told her supporters that her downfall was a direct result of her denying a military base to the US in Bangladesh. Though no one has seen a draft of this letter or a conversation recording, the conspiracy theory instantiated another module of the familiar West-is-Hypocritical-and-against-India game among some sections of India’s strategic community. Eventually, C Raja Mohan’s hard-hitting Indian Express column injected some much-needed sense into the debate:

“Conspiracy theories pander to political prejudices and discourage common sense. They avoid reckoning with the causes of a political catastrophe staring in your face. You don’t have to be a geopolitical genius to recognise that Sheikh Hasina was increasingly unpopular. She emaciated her party and turned it into a personal fief. Repeatedly rigged elections, a hardening monopoly over power, a shrinking bubble around the great leader, and growing authoritarianism combined with post-Covid economic challenges were building up anti-regime steam in Bangladesh for a while. The student movement against quotas provided the final trigger for the political blowout…

Hasina appears convinced that the US overthrew her because she refused to give America a military base. She is not the only South Asian leader who is blaming the US for losing power. Pakistan’s former prime minister, Imran Khan, has been at it since he was defenestrated in a successful no-confidence vote in the National Assembly in April 2022. Like Hasina, Imran Khan also thinks his refusal to give a base (“absolutely not” were his famous words) was what turned America against him.

To be sure, the US military is looking for bases and facilities as it responds to the Chinese military challenge in Asia. But to suggest that the US so desperately needs bases in Bangladesh and Pakistan that it is organising coups would be outlandish. But then paranoia does not need evidence to thrive. The coup theory also gives too much credit to the CIA. The South Asian lore about the CIA’s prowess outpaces the agency’s capacity. Consider the following: The CIA could not organise the ouster of much-reviled President Nicolas Maduro of Venezuela in the recent elections. The US failed to oust the communist regime in Cuba, in power for more than 60 years. Both are in America’s backyard.” [C Raja Mohan, Indian Express]

Even as the conspiracy theorists were busy blaming the “foreign agencies”, Maldives’ infamously anti-India President overtly signalled more than once that he was keen to improve ties with India. The Indian External Affairs Minister’s visit to the island country seems to have helped reset the somewhat strained relationship between the two countries.

Though these developments seem unconnected, they have the same inferences from an Indian perspective.

First, they tell us that we shouldn’t underestimate the agency of small-sized states as independent actors. Far too often, Indians are obsessed with outdated notions such as “India’s backyard” and “India’s Monroe Doctrine”. We might like to think we are important and consequential, but we aren’t as much. Just as it is in India, domestic issues are far bigger political forces than any foreign hand.

Second, we must tone down our worries about China’s economic presence in our neighbourhood. Most small states around India are behaving in archetypical ways—they are trying to play off India against China to bargain for partnership, resources, and protection. As long as these states are mindful of India’s security redlines, India shouldn’t be overly concerned with China’s presence. As the Maldives case shows, China’s abrasive approach often creates a rebound in India’s favour. In some cases, it benefits India if China gets involved in the subcontinent so that India does not have to bear the cross of the “domineering big brother”—a self-serving excuse deployed by small states. Given China’s unenviable performance in other small states, it will likely establish itself as a primary object of hate in these countries very soon.

Third, it is inevitable that one of the political forces in the small states will be perceived as being closer to India than another. Equidistance from all political formations will only translate to zero influence for India. What’s more important is to calibrate the rewards and threats so that the other side doesn’t take India for granted. In this regard, India’s outreach towards the interim government in Bangladesh, even as it continues to provide non-political help to its old ally, Ms Hasina, is a good move.

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Global Policy Watch: China Troubles

Global policy issues relevant to India

— RSJ

Some China economy news. This week, the central bank released data for July, and there was bad news all around. Here’s Reuters on the numbers:

After a dismal second quarter, the world's second-largest economy lost momentum further in July: new home prices fell at the fastest pace in nine years, industrial output slowed, export and investment growth dipped and unemployment rose. Other data beat forecasts, but not for positive reasons. Rising inflation was attributed to bad weather rather than stronger domestic demand, a jump in imports reflected frontloaded chip purchases before expected U.S. technology curbs, and a pickup in retail sales was flattered by low comparisons in 2023.

In all, the data paints a worrying picture for policymakers, who look increasingly likely to ramp up stimulus unless they accept slower growth and the prospect of a downward spiral in consumer and business confidence.

The usual playbook of infrastructure spending is bringing dwindling returns after decades of investment in bridges, roads and rail. Meanwhile, China's preferred driver of growth, advanced manufacturing, is fanning trade tensions and concerns over industrial overcapacity and factory gate deflation.

"The Chinese economy, given its size, cannot run on manufacturing and exports alone," Societe Generale analysts wrote in a note on the latest data.

"To hit the 5% growth target - if that's still the target - policymakers need to step up support for domestic demand."

This is a point I have made in multiple previous editions. Instead of rebalancing the balance sheet and spurring consumption-led growth (hard work), China has gone back to its old playbook. As I wrote in #265:

“It has built humongous overcapacity in the green energy sector and is now looking to export it worldwide to fuel its growth in the same model that worked for it in the first decade of this millennium. The problem is that the developed economies have learnt their lesson this time. China is struggling and will continue to find it difficult to export this overcapacity so easily this time around. The second-best option for it is to set up production facilities in the markets it wants to access. This reduces the risks of a ballooning trade deficit with China and creates employment opportunities in the domestic market. The US and much of the Western world are possibly closed to this option because they have their own manufacturers to protect and revive.”

Unsurprisingly, the latest issue of Foreign Affairs has a comprehensive piece titled ‘China’s Real Economic Crisis (Why Beijing Won’t Give Up On A Failed Model)’ on exactly this. I have a small extract below, but I will suggest you read the whole article:

After years of pandemic lockdowns that brought some economic sectors to a virtual halt, reopening the country was supposed to spark a major comeback. Instead, the recovery has faltered, with sluggish GDP performance, sagging consumer confidence, growing clashes with the West, and a collapse in property prices that has caused some of China’s largest companies to default. In July 2024, Chinese official data revealed that GDP growth was falling behind the government’s target of about five percent. The government has finally let the Chinese people leave their homes, but it cannot command the economy to return to its former strength.

To account for this bleak picture, Western observers have put forward a variety of explanations. Among them are China’s sustained real estate crisis, its rapidly aging population, and Chinese leader Xi Jinping’s tightening grip on the economy and extreme response to the pandemic. But there is a more enduring driver of the present stasis, one that runs deeper than Xi’s growing authoritarianism or the effects of a crashing property market: a decades-old economic strategy that privileges industrial production over all else, an approach that, over time, has resulted in enormous structural overcapacity. For years, Beijing’s industrial policies have led to overinvestment in production facilities in sectors from raw materials to emerging technologies such as batteries and robots, often saddling Chinese cities and firms with huge debt burdens in the process.

Simply put, in many crucial economic sectors, China is producing far more output than it, or foreign markets, can sustainably absorb. As a result, the Chinese economy runs the risk of getting caught in a doom loop of falling prices, insolvency, factory closures, and, ultimately, job losses. Shrinking profits have forced producers to further increase output and more heavily discount their wares in order to generate cash to service their debts. Moreover, as factories are forced to close and industries consolidate, the firms left standing are not necessarily the most efficient or most profitable. Rather, the survivors tend to be those with the best access to government subsidies and cheap financing.

P.S.: Check out our previous edition for a framework to manage the negative fallout of China’s overcapacity.

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HomeWork

Reading and listening recommendations on public policy matters

1. [Podcast] In the Independence Day Puliyabaazi, Achyut Chetan delivers a masterclass on the decision-making mechanics in India’s Constituent Assembly.

2. [Video] This India Policy Forum panel conversation is perhaps the best discussion on India’s unemployment/wages problem

3. [Paper] Who’s been lending to the Indian governments over the last decade, and why? This fantastic xKDR paper has the answers.

4. A throwback to our 2022 Independence Day post, which scans through every year since 1947 and asks: What happened in the year that had long-term repercussions for our nation?

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