#290 Deregulation FTW

DOGE in the US, Policies over Programmes in India

Global Policy Watch: Hacking The State?

Insights on global issues relevant to India

— RSJ

With Trump and Musk taking a chainsaw to the federal expenses and shutting down government departments in the past few weeks, I thought it would be useful to go back to one of our favourite subjects—the role of the state. Over the years, a lot of our writing has been about the state. We have discussed its origins, debated about its role, cautioned about its power and offered our views on making it more effective. We wrote a book on it—Missing In Action—whose byline went “in search of an Adarsh Indian State.” We believe that effective state capacity is an important determinant of nations' progress in the post-Industrial Revolution age. But very few get the ‘effective’ part right. In the quest for being effective or strong, most states mistake capacity for capability and start encroaching on areas that it has no business to be in (i.e., there’s no market failure to correct there).

Over the last three decades, there’s been a broad consensus on the state getting out of businesses in most democracies which has unleashed private entrepreneurship, growth and prosperity. The India experience bears this out. But as the state retreated from running businesses, it built up the capacity to regulate or direct businesses to protect and benefit the consumers, environment, and society. This morphed into a complex web of regulations that required more state capacity to manage, litigate and punish those who fell out of line. The process then takes precedence over outcome and state capacity is expended on compliance and slowing the system rather than protecting the interest of the society. Net result - the state capacity has only increased in the past three decades across the globe despite the overwhelming sentiment that the state is an inefficient user of capital and must retreat from its traditional domains to a set of small functions that only it can do.

Now, this shouldn’t be a surprise to anyone. The responsibility of shrinking the state to make it more effective goes back to the bureaucracy, which benefits from the power of a large, intrusive state. What incentive do they have to shrink it? Politicians may come and go, but bureaucracy lives on forever. And the cardinal principle of bureaucracy is to sustain itself. It reminds me of Yes, Minister and the chapter ‘The Economy Drive’ where Minister Jim Hacker wanted to slim down the bloated Department of Administrative Affairs that was running with 23,000 people, all administering the administrators of other departments. In the end, Sir Humphrey (the dye-in-the-wool civil servant) convinces the minister that the department will need another 400 people to work on the programme to slim down the department. Empirical data bears this out - even during the peak of small government drive during the Reagan-Thatcher era, government spending as a percentage of the GDP increased in both the US and the UK. So, for any effort to drive government efficiency to succeed, you will have to bypass the bureaucracy.

Trump and Musk believe they are doing just that through DOGE and the bunch of outsiders they have brought in to cut federal spending. They have borrowed the ‘chainsaw’ metaphor from what appears like the shining example of the success of this approach, Javier Milei of Argentina, who literally posed with chainsaws during his election rallies. In the first year of his anarcho-capitalist mode of governance, Milei eliminated half of the ministries in the government, fired more than 30,000 government employees, reduced pensions and public sector salaries, and scrapped a whole host of government projects. Government spending is down by a third within a year, and Argentina had a fiscal surplus every quarter last year, which is an unthinkable scenario in Argentine history. Monthly inflation is down to 2.4 per cent from almost 25 per cent about a year back, bringing him public support despite job losses and a recession. But Milei has been consistent in his communication about short-term pains and that there were no easy solutions for the basket case its economy had become. His expectation management has been exemplary, meaning his approval ratings were up at the end of the year from the time he was elected. How this will pan out in future is not clear. In my view, Argentina couldn’t get any worse. A Milei-like approach is its only way out of the decades-long debt trap and slow growth. A lot of Musk-led chaos in firing federal workers and shutting down departments seems to be coming from the Milei playbook.

Will it succeed in the US? There is a lot of scepticism about this. Much of it, to me, is unjustified.

There’s a view that such measures succeeded in Argentina because it had no choice where years of overspending and mismanagement used to bring it to the brink every few years. In contrast, the US federal spending is better managed and the state capacity is used more effectively than most parts of the world. This is true to a limited extent. The last surplus for the federal government was in 2001. The deficit has been in excess of $1.5 trillion since COVID-19 years, and there is a proposal in the House that could add at least $2.8 trillion to the deficit through FY 2034. Most previous such ceilings were breached and there’s no reason to believe they will be different over the next decade. Like that old Hemingway quote, you go bankrupt gradually and then suddenly. The only way to get out of this deficit spending economic model is to snap out of it with a focused set of initiatives as Milei has shown.

The other argument made is about the potential impact of Musk's shenanigans on public finances. The annual government spending was about $6.8 trillion last year, of which about $5.4 trillion (~80 per cent) is on defence, social security and related benefits, health and interest payments. These areas are considered out of bounds based on Trump’s campaign statements. So, all that Musk is left with is about $1.4 trillion to target his reduction while he has gone around promising a $2 trillion reduction. Also, employee compensation as a percentage of federal government spending is only about 7.5 per cent (about $530 billion). So, a lot of this chaotic slashing of federal jobs and shutting down departments will only bring in about $100 billion of savings. There are more prudent ways of getting there than what Musk is doing. Or, so this argument goes. My view on this is that I don’t believe Musk is taking a conventional departmental view of these numbers. His drive to understand the treasury and the government payment systems is to use first principles on how the federal funds flow and figure out leakages and inefficiencies in flows (optimising the float), and question the beneficiaries and the quantum of such flow. Also, I suspect he will use a zero-based approach to the budget spending on defence, health and social security rather than assume the current spends are a fait accompli. Some of the tough messages to NATO allies on paying for the U.S. military support is one way of defraying this cost. I expect Musk to take a more radical approach to these spending categories soon. There will be much hand-wringing and judicial challenge to such moves. Both Musk and Trump realise they have momentum and the Overton window for pushing these through in the first 12 months. They will use it.

The last argument against this, and for which I have a lot more sympathy, is about the danger of permanently weakening institutions of the state while increasing the discretionary power of the executive. There is always a risk, especially with a character like Trump, that there’s no real ideology at work here. No real motive of achieving a small state that’s driving his actions. That much of what he’s doing, using Musk as his attack dog, is to upend the institutions and a qualified bureaucracy (the alleged deep state) that stymied him in his first term and to replace them with people whose primary fealty will be to him, his family or a bunch of oligarchs. This will then ensure an army of Trump acolytes using the tools of the state to persecute political opponents, media and the intellectual elites to create an eventual permanent ’Trump’ state with or without Trump at the helm. I think this is giving too much credit to Trump and his ability to have a long-term game plan. Nothing in his career has shown such capability. A lot of legislation will need to be rewritten for the kind of state capture that’s being feared. I don’t think either Trump or Musk have the appetite or desire to go for it. For Musk, the $2 trillion target reduction in federal spending is like one of the many seemingly unattainable goals he has taken in his corporate career. People think he can’t do it. He sees this as a particularly difficult level of a video game. And he loves clearing it and going to the next level. I don’t see that script changing here. He’s paused his Mars colonisation plan to clear this level. Once he’s done here, he will go back to that. Trump, on the other hand, has no such illusions. All he wants is a pliant bureaucracy that will treat his word as the law. That’s how he has run his business empire. He will get that after Musk has run through his chainsaw on federal bureaucracy. But remember, he’s going to be around only till the end of 2028, and I have a feeling by then, the Republicans would have disgruntled enough Americans to lose the next elections. But they might have balanced the budget by then.

Trump doesn’t really care about either of them. And Musk would have got his $2 trillion and a small government. On the balance, it will be a win for the U.S.

---

India Policy Watch: Urban Challenges Need New Policies, Not Programmes

Insights on current policy issues in India

—Pranay Kotasthane

The differentiation between government programmes and policies is an underrated one. Programmes refer to government-led measures involving public expenditure. Policies are government directives that allow or disallow specific economic activities. The difference can be understood using another popular three-fold classification, which says that all governments do only three things — produce, finance, and regulate. This means programmes are government actions that involve producing or financing, while policies are about regulating. For example, bank recapitalisation is a programme where the government is financing public sector banks. In contrast, the Foreign Trade Policy 2023 lays down the rules that govern all exports and imports.

Programmes are easy to begin—there’s little opposition to additional government spending. However, steering new policies is complex and requires politicians to undertake the real political work of convincing, persuading, cajoling, and punishing. As a result, every policy domain is littered with multiple programmatic ideas but has fewer policy ideas. You can often judge the maturity of policy thinking in a domain by observing this ratio of policy ideas to programme ideas.

Urban governance as a field does abysmally on this count. The conversation here almost entirely revolves around programmes. Consider urban transport, for instance. The focus is on programmatic questions: why is the government financing a metro system instead of a rapid bus transit system? Why isn’t it putting money on suburban rail? Some ask about tunnel roads, while others want the government to finance bicycle tracks. Given the opportunity costs involved, it’s great that we are having these debates. However, all sides of the argument also know they don’t have the complete answer. In any case, I think we need all of the above. Thus, investing in whatever the government can is a practical approach to these programmes instead of public transport flame wars that pit one mode against another.

The more significant point, though, is the absence of policy options in this debate. For instance, one urban transport policy option is to eliminate the license raj that prevents private bus operations in many big Indian cities. This policy change will likely create a significantly higher number of buses on the streets than any programme which relies on repeated government procurement and operations. Government-run programmes inevitably face funding constraints because they are often loss-making and, in turn, depend on constant capital infusion from the government. Thus, if the government could even procure thousands of buses today, these would soon fall into disrepair in a few years without subsequent rounds of government support for upgradation. This situation is similar to what happened with the Indian government’s semiconductor fabrication facility in Chandigarh. The government programme began okay but kept falling behind under funding constraints.

It’s here that a policy change would be useful. Allowing private buses would eliminate the need for recurrent government capital procurement and financing. For under-serviced areas, government-run buses could continue. Or better still, private buses could be made to run a fixed number of under-serviced routes for every trunk route slot allotted to them. Call it the UDAN scheme but for buses. If we are okay with privately run airlines, we should surely attempt to formalise and incentivise privately run bus networks. These policy options aren’t fully formed, but the fights over programmes crowd out all conversations on such questions.

Another such sub-domain is urban housing. Here, the dominant conversation is about programmes such as the Pradhan Mantri Awas Yojana (PMAY). This programme has seen multiple reincarnations and is nowhere near solving India’s urban housing challenge. And yet, our blinkered view doesn’t allow us to think beyond this programme and tackle policy issues that depress urban housing supply. Senseless restrictions prevent the creation of more houses, resulting in exorbitant prices and subsequent calls for government programmes to subsidise housing.

These two cases illustrate that our urban challenges require a strong dose of deregulation. We need to shift our thinking from band-aid programmes to transformational policies.

---

Continuing the conversation on deregulation, the PM’s announcement to establish a Deregulation Commission is a welcome move. This year’s Economic Survey made a strong case for deregulation as a source of economic growth. Setting up a commission to take this work forward is a good way to shift the conversation towards policies and away from programmes. With the government having burnt its fingers with the 2020 Farm Acts, a commission could also depoliticise much-needed policy changes in several contentious domains simultaneously. I am not hoping for any miracles given the limited successes of other commissions of this nature—National Knowledge Commission, National Manufacturing Competitiveness Council, Capacity Building Commission, and so on. Nevertheless, focusing on regulatory issues will hopefully pin down the root causes of our economic problems.

---

HomeWork

Reading and listening recommendations on public policy matters

1. [Podcast] Check the Puliyabaazi on components of a deep tech ecosystem, and how India fares in each of them.

   All About Deep Tech Ecosystem in India

2. [Article] A Policymaker’s Guide to China’s Technology Security Strategy by Emily Jin has a helpful categorisation of technological developments.

3. [Post] Paul Triolo has an excellent readout of the Paria AI Action Summit.

---