#40 From China But Not to Chandni Chowk

The Business of Banning Goods from China, India's Credit Culture, 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?

India Policy Watch: Cheeni Kum?

Insights on burning policy issues in India

— Raghu Sanjaylal Jaitley and Pranay Kotasthane

Ban Chinese goods; teach them a lesson.

There is a momentum to this idea in public discourse these days. There are two camps here. The first runs on emotions. China is a mortal threat to India. They are the aggressor at LAC now. They are duplicitous; they lied to the world about coronavirus and now they are profiting from it. In any case, ‘China ka maal’ is a shorthand for poor quality. We must teach them a lesson by boycotting their products. This is our national duty.

The other camp is more nuanced. We must develop our manufacturing base. China isn’t a free market paragon. Far from it. It is a centrally controlled economy with limited market price mechanism. They control their currency and they have used duties and tariffs to become the world’s factory. We have let Chinese products flood our markets for long. We are in the midst of a crisis now. There have been historic job losses. Why import now? This is the time to support our companies and our people. We must substitute Chinese imports for domestic goods. This is our moral duty.

Sonam Wangchuk’s now-viral video series straddles both these camps. Not buying Chinese goods is a moral duty that we owe to the Indian nation he claims.

Economics and Morality

Both are flawed economic arguments. When I say this, I’m often told there are things that go beyond economic reasoning. Virtue, nation, friendship and love; to name a few. Economics must not overstep its bounds. That free individuals pursuing their self-interest will lead to socially beneficial outcomes can only be true for the economic domain. Not for others. I get these counters, but I don’t agree with them.

First, sound economic reasoning is based on what’s good for the individual, the society and the nation. Good is subjective and, often, relative. Economics tackles this by identifying all choices and their trade-offs. The trade-offs (economic, social or political) are quantified and then compared to reach the most optimal decision. If all dimensions of trade-offs are included, the resultant is in fact, moral.

Second, economics, as Alfred Marshall wrote, is the study of people in the everyday business of life. You can try and keep economics out of other domains, but those domains will infringe into economics since they deal with people. Economics and morality aren’t engaged in mortal combat. They are the same.

In The Theory of Moral Sentiments, possibly, the greatest work of philosophy during the enlightenment, Adam Smith wrestled with this dichotomy and concluded with clarity:

“The respect which we feel to wisdom and virtue is no doubt different from that which we conceive for wealth and greatness. It requires no very nice discernment to distinguish the difference. But notwithstanding these differences, those sentiments bear a considerable resemblance to one another. In some particular features, they are no doubt different, but in the general air of the countenance, they seem to be so very nearly the same that inattentive observers are very apt to mistake the one for the other.”           

To wit, sound economics is moral.

More to Lose

How should we look at the India-China trade relationship? A simple way is to look at the share of each country in the exports and imports of the other. India imported $75 billion worth of goods from China in 2019. This is just 3 per cent of China’s total exports. But for India, this is 16 per cent of its imports. This share is higher if we exclude oil and defence imports where China isn’t a producer (oil) or we have a policy not to buy from them (defence). So boycotting Chinese goods to teach the CCP a lesson would be as effective as getting Virat Kohli to bowl out Steve Smith.

(Source: WITS)

Now on the other side, India exported about $18 billion worth of goods to China. This is 5.3 per cent of its exports. For China, this is only 0.9 per cent of its total imports.

You can see how the dependence is skewed. Also, what do we import from China? In popular imagination it is cheap toys, plastic goods, mobile phone knock-offs, firecrackers and diyas. In reality it is electrical machinery, nuclear plant equipment, chemicals, jewellery and plastic goods.

(Image and data source: OEC)

But gross trade is a crude measure in a world where the global value chains (GVCs) are inter-meshed. Open up a Chinese phone, you will find it barely Chinese. Conversely, the inside of a Japanese TV could be all from China. Almost anything we use in everyday life is likely to have a Chinese part within it regardless of its provenance. In this world, ‘what you make’ is more important than ‘what you sell’. The integration of a country with the GVCs and its position higher up the value chain are important measures of economic performance.

It is not gross trade in finished goods but trade in value-added (TIVA) that reveals the true nature of economic interdependence between countries. One metric of TIVA is the foreign value-added (FVA) content of gross exports. Simply put, the role of imports in export performance. Both India and China have about 17 per cent of FVA content in their gross exports.

There is an important detail within it. China is the single biggest contributor to FVA in India’s exports, at 34 per cent. What does this mean? About $16 billion out of the $75 billion we import from China, goes into our exports (* an earlier version had this at $27 billion. A sharp reader, Lakhan Dhingra, pointed out the error). India’s share in the FVA of China’s exports in contrast is a mere 2.4 per cent. So, China is important because we depend on its intermediate products to export our finished goods. (data source here)

So, who has the most to lose from cutting off trade ties with China? Don’t answer; it’s a rhetorical question.

Boycott or Learn?

Let’s pause here for a moment. One question that jumps looking at these figures is why have we become so dependent on China? Shouldn’t we decouple from it? The answer is no one forced us. China worked for over two decades to develop its manufacturing base. It did so not by boycotting products or raising import tariffs. Instead, it did the opposite. It integrated itself with global trade networks and value chains by making it easy for others to do business with China. It started from low-end products and over time, innovated and went up the value chain. It became an indispensable trade partner for most large economies. We don’t have to boycott China; we need to learn from its manufacturing success.

The Trade Deficit Problem

Another reason commonly used to justify the ban on Chinese goods is India’s trade deficit with respect to China. Now, despite the rap that the term gets, a trade deficit is not inherently bad. It just reflects macroeconomic factors such as trade competitiveness. For more on this, read this excellent short article on WEF.

Regardless, one can argue that India’s trade deficit with respect to China also has a geopolitical dimension because of the nature of the Chinese State and its arrogant displays of coercive power. This is a fair point. But here again, tariffs and bans won’t help. Niranjan Rajadhyaksha has tackled this problem here in Mint:

Bilateral tariff wars are not the solution because Indian consumers will merely buy from other countries, or China can channel its exports into India through third countries such as Hong Kong.

(Instead, India needs to) rein in its domestic macroeconomic imbalances on one hand and build competitive industrial capabilities on the other. 

(Also), large global investment projects will be the key. The larger lesson is that such industrial projects should help India plug into global supply chains, and use them as conveyer belts for exports of manufactured goods.

The Wrong Time

The other question is if we have to indeed decouple from China, is this the best time? China is the first major economy which is back to a degree of normalcy post-Covid. Over the last five years, it is transitioning from an export-led to a domestic consumption-driven economy. India has seen its demand collapse during the lockdown. The supply chains are still dislocated, and migrant labour will take time to come back. There is a real possibility of inflation over the next year. Boycotting Chinese goods in these times will increase prices and deepen the demand shock. It will also make our exports in many areas non-competitive exactly when we are looking for newer markets.

Also, a tit-for-tat response from China may see our exporters being shunted out of the growing domestic market in China. This will be a lost opportunity for industries like pharmaceuticals, chemicals, IT and agriculture produce where we have a comparative advantage.
We might face-off with the PLA at Ladakh but that shouldn’t mean an economic war with China. This is a complex, interconnected problem. It has no single, easy emotional solution. We can’t teach China a lesson using tariffs and bans without falling on our own sword (to mix metaphors a bit).

This Business of Boycotting Foreign Goods

India has a storied history of boycotting foreign products. Following the partition of Bengal in 1905, the swadeshi movement took off as a way to hurt Britain economically. Cheap clothes, sugar and other goods made in the factories of Manchester and Birmingham had begun flooding Indian markets. The Congress led public bonfires where people volunteered to burn their made-in-Britain goods. Gandhi drew inspiration from this and made swadeshi a national cause. The charkha (spinning wheel) became the symbol of self-reliance and of shunning foreign goods.

How did the swadeshi movement fare? It had limited political success but charkha and khadi found emotional resonance among people. Its impact on the economy of Britain doesn’t register at all in the records. And it certainly didn’t help the Indian industry because it wasn’t just British goods but the idea of industrialisation that India boycotted. In fact, you could argue the swadeshi movement set India back on its road to industrialisation. As Gandhi put it,

Machinery in the past has made us dependent on England, and the only way we can rid ourselves of the dependence is to boycott all goods made by machinery. This is why we have made it the patriotic duty of every Indian to spin his own cotton and weave his own cloth.

Tagore who led the protest against the partition of Bengal and supported the swadeshi brigade initially soon backed out of it. Tagore had seen first-hand in Bengal how the swadeshi movement hurt the poor and the marginalised. The British factory-made goods were cheaper, better and readily available. Many among the marginalised worked in factories or farms that exported raw or semi-finished material to Britain. There were hawkers and shopkeepers whose business depended on foreign goods. These people suffered. In his famous work, Ghare Baire (1916), Tagore explores multiple dichotomies – a woman’s place at home and in the world, tradition and modernity, western and oriental values and, interestingly, swadeshi and videshi goods. In it, he lays bare the moral duplicity and hollowness of the swadeshi leaders. The swadeshi movement, according to Tagore, had turned xenophobic and chauvinistic with no spiritual or moral centre. He wrote scathingly about this in his 1908 essay, Shodupaye (The Right Way):

“A few days ago, a letter arrived from the provinces saying that in a large market, traders had received a notice stating if they do not comply with the Boycott of foreign goods, their stalls will be set on fire. In some places such notices have been followed by arson. …. It is indeed sad that for some of our educated men this kind of oppression is not wrong. They have decided that such terror tactics are necessary for the good of the country. It is useless to talk of justice to such men. They claim that what is done for the sake of the country cannot ever be unjust, an ‘adharma.’ But even to a perverse mind we should repeatedly reiterate that injustice cannot be good for a land and for its people…” (contd)

“This is the reason why I say that the greatest curse upon the country is not foreign cloth but this quarrel within it. Nothing is worse than one section of the populace enslaving the opinions of another through force and against their will…”  

Tagore was no economist. He saw the boycott as a moral issue and he opposed it. He reached the same conclusion as Adam Smith – economics and morality are the same.

There’s a moral and economic lesson for us today as we seek to boycott Chinese goods.

PolicyWTF: Culture Vulture

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

— Raghu Sanjaylal Jaitley

What’s culture in the economic domain? One definition is there are norms of behaviour and you get rewarded to stick to them. You repeat this over time and you build a culture. The norms are easy to arrive at. For instance, you take a loan and agree to pay it back with interest over a period of time. Keeping this promise is the norm. Everyone understands this intuitively. The reward (or punishment) is however what builds the culture. You keep your promise, you get a good credit score (and karma); if you don’t, you face terrible consequences. This requires law and its enforcement.

In India, the state just doesn’t get this. It finds it expedient not to enforce norms when it has to choose between politics and economics. In doing this, you end up building no culture. For instance, farm loan waivers have killed credit culture among farmers over the years. Free or subsidised water and electricity have led to a poor resource conservation culture. The list goes on. Now, there’s a danger we will add poor credit culture among retail and corporate customers to this list.

Retail Credit Culture at Risk…

The Supreme Court (SC) this week granted time to RBI and the finance ministry till June 12 to file a response on a petition that seeks interest waiver during the moratorium period. The RBI had extended the moratorium period to six months (till Aug 31) only last week. As the Business Standard reports,

The bench was hearing a plea, filed by Gajendra Sharma, in which he has sought a direction to declare the portion of RBI's March 27 notification "as ultra vires to the extent it charges interest on the loan amount during the moratorium period, which creates a hardship to the petitioner being a borrower and creates hindrance and obstruction in 'right to life' guaranteed by Article 21 of the Constitution of India".

There are some interesting observations and comments made during this hearing in the SC. As the Mint reports:

The three-judge bench, comprising Justices Ashok Bhushan, MR Shah and SK Kaul, said, “We know, economic aspect should not be higher than health of people."

Justice Bhushan identified two main issues in the matter -- first whether interest should be charged during the moratorium period and second whether interest should be charged on the accrued interest. "There are two issues in this: no interest during moratorium period, and no interest on interest", said Bhushan…...

Senior advocate Rajiv Dutta, appearing for the petitioner, while referring to the [RBI{ reply said, “cat is out of bag…They’re saying profitability of bank is prime". “So only the banks should earn and rest of the country goes down under?" he added.

Here are a few points to consider:

  1. RBI and the finance ministry had announced the moratorium to help individuals and companies who might have short-term liquidity problems during the lockdown. Had they not announced it, would there have been a plea of this kind filed? The answer is no. What you have here is the classic slippery slope. The government decides to intervene with good intent and then gets dragged in because now it has to answer on the nature and strength of the intervention.

  2. It is incredible that ‘only banks will earn profit’ kind of argument is getting time and attention. Firstly, how do we know banks will earn profits in future? The economic distress all around only suggests a terrible year ahead on NPAs and provisioning. A loan waiver of six months, like the RBI argued in its counter affidavit, will cost the banking system about Rs. 2 lakh crores. There’s no way the system can absorb such a hit without reducing deposit rates correspondingly or taking losses. Also, what’s wrong with banks trying to earn profits or avoid losses? The man who has filed the plea is doing the same.

  3. What does ‘the economic aspect should not be higher than the health of the people’ mean? Haven’t we learnt through the lockdown experience this is a false dichotomy? Both health and economy matter. The health of the banks is important. Else, customers will earn low returns on their deposits and borrowers will find it difficult to get loans. A stressed financial system will derail any recovery.

  4. Finally, what about all those who continued to repay their loans with interest during the lockdown? What lesson will they take if a waiver is announced now? That they were suckers to have repaid diligently. If there’s any moratorium announced next time, 100 per cent of all borrowers will not pay anticipating an interest waiver. The moratorium meant those who had the ability to pay should continue to do so. A waiver would mean even those who can pay, won’t pay. This will hurt banks. And this will hurt credit culture in retail loans.

…Also, The Corporate Credit Culture

The Cabinet also approved the proposal to suspend the Insolvency and Bankruptcy Code (IBC) for six months which can be extended to a year. IBC is a mechanism for time-bound resolution of insolvency of a company. The IBC bill was passed in 2016. It was a much-needed reform since the insolvency process dragged on for years in courts and the banks were saddled with NPAs on their books. There are fears a year-long suspension could bring back the bad habits of the past. As the government puts the ordinance together to bring this suspension into effect, it must anticipate the unintended outcomes of this:

  1. The economy was slowing down before COVID-19 hit India. How will the government ensure those businesses who would have defaulted regardless of the pandemic won’t benefit from this suspension? Insolvency resolution helps in reallocating capital from weaker to stronger businesses and improves market efficiency. A total suspension of this allows inefficiencies to remain in the market. The government must keep the option of those who volunteer to the IBC process to be allowed to do so.

  2. Banks have been demanding a one-time loan recasting exercise. The suspension of IBC will also, possibly, stop the insolvency resolutions that were currently underway. This will mean banks won’t receive funds from the resolutions that were expected this year. The government and RBI should facilitate this instead of a blanket suspension

  3. Banks will have an increase in NPAs because of the moratorium and the wider economic distress. The IBC suspension will close the door for any recovery this year. There’s also a possibility of legal wrangles next year when borrowers will argue the Covid impact on their business continues. This can quickly degenerate into a banking crisis whose flames will envelope the wider economy. The stress on the banking system must be anticipated and managed

  4. There are other mechanisms under the Companies Act, 2013 that allows for debt restructuring using ‘schemes’ between a company and its creditors. This is a viable alternative and with a few tweaks can be used to restructure the debt obligations of a company. L Viswanathan and Gaurav Gupte in the Business Standard have details on how Companies Act can be used to achieve this. The only caveat is the dependence on an already overloaded NCLT in the process.

… And The Stimulus Culture

During the 2009 GFC, the Obama administration passed the Recovery Act which signed into law a stimulus package of $800 billion. Many predicted a runaway inflation soon. However, over the next decade the CPI in the US barely went above 2% annually which was no different from the two decades preceding it. So, what happened?

The Dow Jones index during the same time went up by about 250 per cent. There wasn’t an inflation in goods and services, instead, the prices of stocks, bonds and real estate shot up. You got asset price inflation. Looking back, based on evidence, it is clear the stimulus design helped corporate America and Wall Street instead of the main street. The life of an average American didn’t change a lot but the rich got richer. The income inequality got worse and you could argue a Trump-like phenomenon is the political result of that stimulus.

As the Nasdaq hit a record high on Friday, it is clear what the stock market is signalling. The $3.5 trillion stimulus package announced so far has flooded the system with excess liquidity. The companies and the market know the Fed and the Treasury have got their backs. No wonder the markets have rallied to record highs. The divide between the market and the real economy couldn’t have been wider. We will wait and watch which way the evidence goes for the stimulus in India.

It is funny how participants rationalise this by arguing markets look at the long-term and have gone beyond the Covid crisis. The same people used to lament until recently how public markets force companies to have a short-term focus. This is just convenient post facto analysis. Nobody will admit to the truth.

The economic culture has changed from being market-friendly to business-friendly.

There’s a difference there. Its price is being paid politically on the streets of America today.


Meanwhile, fake Whatsapp messages had a good week. They reached the Supreme Court courtesy the Solicitor General (SG) of India who apparently read out a fake Whatsapp message verbatim. He compared journalists who reported on migrants’ crisis with vultures (with the latter coming off favourably). He later clarified it wasn’t the journalists but ‘speech warriors’ who were in his crosshairs. That’s good to know but it is difficult to imagine what constitutional crime ‘speech warriors’ have committed in a democratic India. We should have more ‘speech warriors’.

What’s not in doubt any more is Whatsapp gyaan is now a part of our ‘argumentative’ culture. Right up to the highest level.

Leave a comment


Reading and listening recommendations on public policy matters

  1. [Article] The Stanford Encyclopedia of Philosophy has a detailed overview of Adam Smith’s Moral and Political Philosophy. It is the next best thing to reading The Theory of Moral Sentiments.

  2. [Article] Kimberly Clausing makes a case against protectionism in the light of US-China trade wars long, long time ago in Dec 2019

  3. [Article] Tagore on the Cult of Charkha where he makes this still relevant point - “There are many who assert and some who believe that swaraj can be attained by the charkha, but I have yet to meet a person who has a clear idea of the process.”

That’s all for this weekend. Read and share.

Share Anticipating The Unintended