Sep 20, 2020 • 24M

#70 Concentrated Costs, Diffused Benefits 🎧

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Frameworks, mental models, and fresh perspectives on Indian public policy. Audio narrations by Ad Auris.
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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?

PS: If you enjoy listening instead of reading, we have this edition available as an audio narration courtesy the good folks at Ad-Auris. If you have any feedback, please send it to us.

India Policy Watch #1: 50 Years Of That Friedman NYT Article

Insights on burning policy issues in India


On September 13, 1970, Milton Friedman wrote his famous piece on the social responsibility of business in The New York Times. The clarity of Friedman’s thinking and his powerful articulation of the doctrine of shareholder value maximisation has made it, arguably, the most influential business article of all time.

Friedman scoffs at businesses talking of ‘social responsibility’ suggesting any attempt to do so will turn political that will force the individual to conform to the more general social interest. Who determines this social interest? In the hands of a dictator or a demagogue, this decision can be detrimental to society.

It is a compelling article. I would suggest you read it before you dismiss it as free-market fundamentalism. Friedman concludes:

“But the doctrine of “social responsibility” taken seriously would extend the scope of the political mechanism to every human activity. It does not differ in philosophy from the most explicitly collectivist doctrine. It differs only by professing to believe that collectivist ends can be attained without collectivist means. That is why, in my book “Capitalism and Freedom,” I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, there is one and only one social responsibility of business—to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception fraud.”   

Enduring Appeal

Over the years it has been attacked and its central message discredited in the light of the global financial crisis. Even businesses are reluctant these days to invoke shareholder value maximisation as their goal. There have been calls for societal value maximisation, stakeholder wealth creation and conscious capitalism to replace the Friedman doctrine. All good intentions aside, nothing has truly replaced it in how businesses operate. What explains its enduring appeal? Three reasons:

  1. A simple and measurable metric: The shareholder value maximisation goal is easy to set and monitor. It helps that there is a common understanding of the metric. The alternatives are amorphous. It is difficult to understand what does maximising societal value entail, for instance. Who will define what society wants? Are societal objectives of India and the US similar?

  2. Rewarding the risk takers: The shareholders invest risk capital in an enterprise. This willingness to take risk is what leads entrepreneurs to build new products, satisfy the consumers and create new jobs. The shareholders deserve the pursuit of maximum return by the firms for this risk they undertake. It is up to them what they do with these returns. They can invest it in newer enterprises or use it to improve the society as they deem fit. The management or anyone else should have no claim on how to invest the returns that belong to the shareholders.

  3. Shareholders are the residual claimants: Everyone who contributes to the value creation of an enterprise – the employees, the management team and the customers – get their fixed claim on the value through compensation for their efforts, stock options and the value derived from the products or services offered by the enterprise. Only when these fixed claimants are served well, the value for the residual claimant (the shareholder) is maximised. So, the pursuit of shareholder value will by itself serve the other stakeholders well.

Rajan’s Reassessment

Promarket, a publication of the Stigler Centre at Chicago Booth School of Business, is marking the 50-year anniversary of the Friedman article with a debate on the social responsibility of business on its pages. Eminent academists like Oliver Hart, Luigi Zingales and Lucian Bebchuk have written with depth and intellect on the relevance of the Friedman doctrine in today’s times. This week Raghuram Rajan weighed in on the debate with an article titled “50 Years Later, It’s Time to Reassess”. Rajan takes a clear-eyed view on what has worked for the Friedman doctrine and where it is fraying. He repeats the usual points that we have listed above in favour of the doctrine. Additionally, he emphasises the political argument of Friedman for shareholder value maximisation that seems relevant in the current times when we are debating the enormous clout of big tech in our lives.

Rajan writes:

“Finally, Milton Friedman thought that there was a political argument for shareholder value maximization, which keeps the role of the government and the role of the corporation separate. He thought that was important because he felt that corporate social responsibility was a backdoor way for special interests to push what they could not get through Parliament and therefore make rules for the firm which they could not make through legislation. In some sense, this is a very important argument because it says that sometimes, these pressures can be anti-democratic rather than pro-democratic—that because you’re frustrated in Congress or in Parliament, you might try to push that stuff through the backdoor by directly targeting corporations.”    

But Rajan believes this separation of business from politics that Friedman advocated has turned into its primary problem:

“And that leads to what I think is the deepest problem with Milton Friedman: shareholder value maximization means completely turning a tin ear to politics. It sounds sinister. It sounds pro-rich. It sounds evil, even if it may be the right thing to do for society under many circumstances.”

I’m not quite sure why something that sounds evil while it might be the “right thing to do for society” needs to change. There are many economic concepts that sound evil or counter-intuitive – efficient market mechanism, free trade, comparative advantage or Ricardian equivalence. They shouldn’t be discarded or changed because of it. Instead, they need to be explained better.

But Rajan goes ahead proposing an alternative:

“The alternative, in my view, is to maximize the value of long-term investors in the firm. This is different from the Business Roundtable statement, in that you can identify who these long-term stakeholders are. If you are a firm with a lot of impulse customers, they’re not your long-term investors—they come in and buy as they wish. If, however, you have long-term employees, they are long-term investors because their sweat equity is embedded in the firm. Similarly, shareholders, long-term debt holders, long-term suppliers, these are long-term stakeholders. A firm could say, when forced to choose between two stakeholders: I will choose the action that enhances the overall value of these stakeholders.”

There is a problem with this formulation – how will you know from the start who will be a long-term investor? For Rajan, the ‘impulse customers’ aren’t long-term investors. But won’t the impulse customer of today be a firm’s long-term customer over time? A similar argument can be made for long-term shareholders or long-term suppliers. They all will have to start somewhere in developing a relationship with a firm. Also, how do you define the length of time that will qualify a relationship as long-term? Not surprisingly, this alternative to shareholder value suggested by Rajan meets the same fate as others. It sounds good on paper but fails to be specific.

Rajan comes around to it by the end of his piece:

“Corporate boards should take pride in the investors they stand for. Being nice to everyone is, however, infeasible, meaningless, and simply deflection. That is what I take away from Milton Friedman.”

Friedman’s doctrine remains the most elegant and practical way for firms to pursue its objectives that deliver the most value to society. For Friedman, enterprises in a competitive market pursuing shareholder maximisation will do well for society. But a monopoly will have to do more. As he wrote:

“The participant in a competitive market has no appreciable power to alter the exchange, he is hardly visible as a separate entity, hence it is hard to argue he has any ‘social responsibility.”

“The monopolist is visible and has power. It is easy to argue that he should discharge his power not solely to further his own interest but to further socially desirable ends.”

So, a firm operating in a competitive market is free to pursue shareholder value maximisation. The shareholders can define the value differently in today’s world that goes beyond monetary rewards. This could include the environment, sustainable growth, or social equity. But for Friedman, this can’t be imposed by others on the shareholders. The decision has to be that of the shareholders alone.

A Framework a Week: What Made the US Enable China’s Rise?

Tools for thinking public policy

— Pranay Kotasthane

This question that has been bugging me over the last few months: what explains that the US — now single-mindedly focused on countering on PRC’s rise — aided and abetted the PRC’s rise in the first place? Despite its enormous intellectual horsepower, why wasn't the US able to anticipate and mount a response to the PRC challenge long before?

As it turns out, an incumbent great power enabling the rise of its own future rival is not an anomaly. In fact, that’s the default case. At least that’s the core argument of an excellent book Over the Horizon: Time, Uncertainty, and the Rise of Great Powers by David Edelstein (You can read a top-notch book review by my colleague Aditya Ramanathan here). The book presents a framework that manages to explain the US-China relationship quite well.

The core argument in Edelstein’s words is that:

… uncertainty about the future reinforces the pressures on state leaders to focus on the short term. Leaders of existing great powers are disinclined to expend considerable resources on an uncertain long-term threat. When existing powers focus on the short term, mutually beneficial cooperation with rising powers becomes more likely. Conversely, the more state leaders become alerted to the potentially threatening long-term intentions of a rising power, the less likely cooperation in the short term with a rising great power becomes.

This is a counter-intuitive proposition. Offensive realism theory argues that all that matters is relative power. Regardless of a rising power’s intentions, its rise is reason enough for an incumbent power to confront the contender as soon as possible. And yet, the empirical approach of declining powers has been quite the opposite. European powers cooperated with Bismarckian Germany, Britain capitulated to the American rise, European states, again, co-operated with Germany in the inter-war period, and finally, the US supported China’s entry to WTO and turned a blind eye to PRC’s aggressive actions and increasing capabilities for nearly fifteen years before executing a u-turn.

The author argues that this divergence from theory can be explained by taking into account two more variables. Not just relative power, but perceived intentions, and time horizons of states together explain if a declining power will confront, co-operate, or compete with a rising power. The framework that brings together all this is shown below.

When a rising power has a long-term focus and a declining power has a short-term focus, the two end up co-operating rather than contesting. This configuration occurs, for instance, when rising powers adopt a “hide our capacities and bide our time” approach. They focus on building long-term capabilities instead of attracting undue attention of the incumbent powers towards them. This is what PRC under Deng Xiaoping and Germany under Bismarck did. If successful, this strategy makes declining powers discount long-term threats and instead focus on short-term gains through co-operation. This is precisely what happened between the US and PRC after the Sino-Soviet split. PRC resisted overt provocation throughout the 80s and 90s, while the US companies and consumers benefited from PRC’s manufacturing prowess.

By 2010, PRC’s time horizons changed. Its aggression towards its neighbours signalled that it was now focused on consolidating its position in the short-term. Meanwhile, the US was still focused on the short-term horizon. The aftereffects of 9/11 still loomed large, and the US strategic thinking was preoccupied with other issues — Iraq, Afghanistan, Russia, and Iran. The result was a mixture of skirmishes and pragmatic cooperation between the US and PRC.

By 2016, PRC’s continuing arrogance against its neighbours, the BRI ambition, attempts at influencing politics in countries such as Australia, and rapid buildup of technological power meant that the US was forced to extend its time horizon and look at PRC as a structural adversary. The result is that we are heading towards a preventive “war” — a scenario where the US is confronting PRC directly and provocatively not by force (yet) but in trade and technology domains.

This framework also explains that a preventive “war” scenario is not inevitable. If there is a rethink in PRC’s approach, a shift to either of the remaining three quadrants is possible. With Xi Jinping at the helm, it looks unlikely though. Despite the perception that PRC thinks long-term, Xi is operating with an extremely short-term time horizon and inviting pushbacks from a host of countries as a result.

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India Policy Watch #2: No Looking Back On Agriculture Reforms

Insights on burning policy issues in India


The Lok Sabha passed three bills relating to agriculture this week. These bills replace the existing ordinances that came into effect in June. These bills are part of the agriculture reforms package that was unveiled by the FM in May this year. The bills will now be tabled in the Rajya Sabha on Sunday. These reforms were long due.

Despite the obvious failures of the state in the farming sector, successive governments balked at reforms. The entrenched ‘aristocracy’ of rich farmers, commission agents and farmer leaders thwarted all attempts. This time is different. For once the numerical advantage of this government and the political capital of the PM are being put to use for structural reforms that will serve us well in the long-term. The small and marginal farmers have suffered under the benevolent tyranny of the state. These reforms will liberate the sector.

Yet, there is a minor political storm brewing. Shiromani Akali Dal (SAD), a long-time ally of BJP in the state of Punjab, has opposed the legislations. On Thursday, its lone representative in the Union Cabinet, Harsimrat Kaur Badal, resigned. The SAD leader, Sukhbir Singh Badal, spoke against the bill in Lok Sabha:

“These bills have many provisions that go against farmers’ interests. We have repeatedly asked the government that please address the apprehensions of farmers, but the government had done nothing. Therefore, I oppose these bills.”

There are farmer protests in Punjab and Haryana against the bills. There is a possibility it could spread to other states. The usual bogey of capitalists and big businesses is being brought up. This is a government that’s especially sensitive to this kind of criticism. We hope it stays the course and uses its formidable skill in setting the narrative to sell these reforms to the farming community.

Farmers Aren’t Free

The reasons for the protests are instructive in understanding why critical reforms in any sector in India remain difficult to implement. A vocal minority that stands to lose the most has organized itself to protest while the majority for whom the benefits are diffused is silent. To understand the reforms, it is important to understand the ‘unconstitutionality’ of the current system:

  1. Farmers can only sell their produce at the state APMC registered mandis. There is no freedom to sell produce outside of the mandis. There’s no freedom to conduct inter-state trade for the farmers. There is only a single buyer – the state. There is no competition. The state sets the price of the produce.

  2. The state has its approved ‘middlemen’ to facilitate the process of buying from the farmers. Since the farmers are often small and poor, their ability to reach the mandi, to negotiate the byzantine paperwork of license fees and commission, and store their produce is limited. There’s a long chain of small and big traders and commission agents who fill in to provide these services. This is a deeply entrenched cartel that buys low from the farmers and bids up the price to the wholesaler. The farmers are at their mercy while the end consumers pay for the cartelisation. The evergreen anecdote of farmers making Rs. 2 for every kilo of onions they grow while the consumers shelling Rs. 80 a kilo is a result of this.

  3. There’s no freedom for the farmer to sell their labour for a price through a contract. This is a freedom guaranteed by the constitution to every citizen. Except the farmer. So, small and marginal farmers can’t enter into contracts with private buyers of farm produce to aggregate their produce and sell it a pre-determined price.

  4. There are restrictions on how much stock of ‘essential commodities’ can be held by farmer or a trader. The essential commodities include cereals, potatoes, onions, oilseeds and pulses. So, the market mechanism of stabilising price through supply management and storage isn’t available. There’s no incentive for players to set up modern warehouses and cold supply chains for these commodities. The result is frequent price fluctuations and criminal wastage of food.

The Sum Of All Good Intentions

The dismal state of Indian agriculture bears no repetition. The farm income growth has been stagnant for the last 6 years. The small and marginal farmers who constitute 86 per cent of India’s peasantry barely make a living out of farming with average per capita annual income below Rs. 100,000. About 45 farmers die by suicide on an average every day. The Food Corporation of India (FCI) buys the produce at the minimum support prices (MSP) from the mandis and distributes it at a subsidised rate through the public distribution system (PDS). This subsidy bill has grown to unmanageable level.

The FCI borrows from National Small Savings Funds (NSSF) to keep its operations going. It is estimated this loan will rise to Rs. 3.5 lakh crores in FY ‘21 from Rs. 2.5 lakh crores in FY ’20. Millions of ordinary Indians trust NSSF with their lifelong savings. It is anybody’s guess when FCI will be able to pay back NSSF. If this appears like a giant Ponzi scheme, that’s what it is. The food grains stocked at FCI are at an all-time high but there’s no market mechanism for its distribution when people needed it the most during the pandemic. They had to wait for the largesse of the state for the stored grains to reach them. This is a broken system. Even if you set out to create a dysfunctional system, you’d have struggled to reach here.

Who in their right minds would want this structure to continue? Who has it helped except entrenched cartels and a few dynasties of ‘farmer leaders’ who have built a system of patronage? It is the established rural structures that’s protesting. That doesn’t want to let go. They must be ignored.

How We Got Here?

The obvious question that comes up is why did we opt for such a system? The answer is that old Voldemort of all public policy choices in India – good intentions. The colonial powers had systematically exploited Indian farmers to the point of destitution. Nehru was taken in by Fabian socialism that was in fashion during that time. His first visit to USSR in 1927 and the subsequent success of Stalin’s first five-year plan in state-controlled agriculture strengthened his views.

Then there was the 1943 Bengal famine. The political and cultural impact of the famine still persists. A large part of our permanent suspicion of private capital and markets can be traced to the famine and the perception of how rich traders and merchants hoarded food grains and profiteered while millions died of starvation. The plays, songs and films of the Indian People’s Theatre Association (IPTA) left a deep imprint in our popular culture about the apathy of capitalism. This informed our public debate and politics in a manner where the economic right was forever tainted with the colonial anti-poor and anti-farmer philosophy. That’s why there was no trace of the market mechanism when laws for the farm sector were drafted after independence.

Sen On Famine

It is worth taking a short detour on famines here. Amartya Sen’s famous work on Bengal famine blamed the lack of accountability of the colonial government that didn’t have to face elections as the primary reason for the starvation deaths. His insight was simple and profound. Famines aren’t a food availability problem. They are ‘entitlement failures’ that can happen with even minor imbalances of production or some unintended effects of government policy. Sen defined entitlement as:

“The set of alternative commodity bundles that a person can command in a society using the totality of rights and opportunities that he or she faces.”

The entitlement set is the range of goods and services she can acquire by exchanging or converting her resources or labour. In famines, these entitlement sets fail to provide her food in exchange thus setting in starvation.

In case of Bengal famine, the proximate cause of entitlement failure was the inflation caused by the WW2 where the food prices rose by 300 per cent while farm wages rose by 30 per cent. This failure was exacerbated by the refusal on part of the colonial government to freely distribute food grains that were available in abundance. We haven’t moved too far away from that reality today despite the best intentions of the state to help farmers.

Stay The Course

Notwithstanding the obvious failures of our agriculture policies and the relative success of the market mechanism in other sectors, we raise the spectre of capitalists and big businesses harming our farmers whenever efforts at structural reforms are discussed. The farmers have been for long in the grip of the predatory state. These reforms will empower farmers. The government must ride over the resistance and set the farmers free.    


— Pranay Kotasthane

Any reform that is even remotely seen to impact the MSP gravy train is bound to face opposition from a host of incumbent beneficiaries. One, the farmers growing the 22 crops backed by the MSP. Two, the traders getting a percentage of the MSP. And three, the state governments making money by charging hefty commissions for the sale of produce at APMCs. None of this is surprising.

That apart, there are at least two other critiques that merit serious attention.

  1. The timing critique. Agriculture in India is a sob story even in the best of times. And here we are, in the midst of an unprecedented supply and demand shock caused by COVID-19. So any reform that might remotely lead to lower incomes because of a dilution of the MSP promise is bound to face the question: why now? Can’t the cognitive maps of those losing out be aligned to absorb the short-term losses?

  2. The credibility critique. It’s tough to take a government seriously that claims it is liberating farmers even as it has no qualms in banning onion exports simultaneously. The fact that these legislations say nothing about the impact on the existing procurement price mechanisms has led to suspicions about government intentions. As Mekhala Krishnamurthy writes in The Print:

    ..instead of building up the confidence to develop a comprehensive framework for agricultural reform for these states, with a credible time horizon and coordinated support for farmers, the position on agricultural reforms has become further vitiated and volatile. Even if the three farm sector Bills do not directly legislate on MSP and procurement policy, it is simply not tenable to spearhead major national reforms in agricultural markets in India without making room for detailed deliberations on the future of where and how price support and procurement policies fit in.

    Moreover, not having taken state governments into confidence calls into question the implementation credibility of these legislations.

So, what remains to be seen is how the government signals credibility amidst an economic crisis for a long-pending reform. This story is not over, not just yet.

Share Anticipating The Unintended


Reading and listening recommendations on public policy matters

  1. [Article] Oliver Hart in Promarket on ‘How Shareholders Don’t Always Want To Maximize Shareholder Value’.

  2. [Article] Ashok Gulati in The Indian Express on why this is a 1991 moment for agriculture.

  3. [Podcast] We have an All Things Policy episode on Opportunity Cost neglect in Public Policy.

  4. [Paper] Dani Rodrik and Stephen Walt present their vision of the future world order.

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

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