Public policy's gatekeeping problem

This post will examine the rise of an important but less-discussed trend in public policy, the emergence of a category of entities as gatekeepers in the form of agents who accredit, certify, validate, or authorise the quality or efficacy of specific tasks or entities. In short, gatekeepers signal compliance of a third party with some benchmark. 

Such gatekeepers are pervasive in the market economy. Their examples include credit rating agencies, process and financial audit firms, product certification entities, third-party authorisers for insurance claims, asset valuation entities, etc. In the context of public policy, such gatekeepers include institutional certification agencies, standards certification firms, infrastructure works quality certification, licensed professionals (like architects, town planners, surveyors, etc.), rankings, and so on. Each performs the roles of assessment/evaluation and/or certification/validation.

I’ll skip the role of gatekeepers who operate in well-established markets and whose problems are widely known. Instead, this post will focus on the role of these firms in public services and development sectors. Some observations:

1. Gatekeeping is a specific form of outsourcing, since it involves the parcelling and contracting out of a distinct activity hitherto done in-house. It has its basis in the private sector, where activities can be neatly parcelled out, quantification of performance is possible, accountability can be fixed, and contractual incentives are aligned. The same cannot be said about the public sector.

A critical difference between the use of gatekeeping in the private sector and the public sector is the absence of any market test in the latter. Specifically, since users don’t pay for these services (or pay only a small part of the cost), there’s no competitive pressure to ensure good quality. 

In this context, it would be useful to keep in mind the example of the Ease of Doing Business (EoDB) rankings. While the rankings have doubtless triggered policy measures to simplify procedures and reduce hassles for businesses, the absence of a complementary attitudinal and cultural change management focus has reduced it to a performative exercise. Now that it has played out, I’m not sure about its signalling value for prospective investors. 

2. In keeping with the theory of scaling in the private sector, it’s a widely held view that state capability constraints to rapid expansion can be overcome by the likes of standardisation, outcome-based financing, and targeting. Accordingly, enlisting gatekeepers has become a prop to skirt around state capability deficiencies and rapidly scale activities. 

A good example is cleanliness programs like the Open Defecation Free (ODF) scheme. Another example is the certification of various kinds of educational, vocational training, skilling, and healthcare institutions. Similarly, with the certification of self-help groups, farmer producer organisations, and co-operatives. The Government of India enlisted the services of the Quality Council of India to undertake many of these activities. 

Poor service or institutional quality exists due to fundamental constraints arising from personnel capabilities and resource deficiencies. No gatekeeper or ranking can help systems leapfrog these deficiencies and overcome those fundamental constraints. They require sustained accumulation of capabilities and allocation of resources. 

For this reason, the ISO certification that had become a fad in the 2000s among government offices in many states has since fallen out of favour. The ISO 9001 certified offices had the form of quality without its substance. It was classic isomorphic mimicry. A tickbox exercise of cosmetic infrastructure upgrades, procedural changes, and role clarifications cannot be a substitute for state capability improvement and good governance. 

3. Ironically, the very state capability deficiency that necessitated the reliance on gatekeepers is generally also the reason for the failure of the gatekeeping solution. In the absence of monitoring, gatekeepers are vulnerable to being captured by the same interests they are supposed to evaluate or certify. 

4. Certifications can add layers of costs to the total price of the product or service. Certification comes with additional compliance requirements. A green certification often comes with the need for solar panels, water harvesting structures, new lighting fixtures, and so on, which add significant incremental costs compared to business as usual. The value of at least some of these requirements, especially their universal application, can be questionable. For example, the requirement of backup power sources like a diesel generator and solar panels to meet certain standards adds considerable incremental costs.

These cost layers can become a problem in an emerging market. The higher cost shrinks affordability, reducing the market size needed for these nascent markets to emerge and grow. This is best seen in the affordable housing market, where the restrictive zoning regulations, when supplemented with desirable features like sustainability, add several layers of cost that make the struggling market even less likely to emerge. It’s the classic everything bagel liberalism. 

5. On a related note, there’s a possibility that gatekeeping, by differentiating the certified/validated products, results in a distortionary market evolution. Let’s take the example of a star rating, where a product or a building is rated from 1 to 5 stars. Since people are less likely to buy the 1 or 2-star rated products, the sellers are more likely to invest in the higher-rated products. This results in perverse incentives like cutting corners on compliance and distorting the market with the lemon problem. Further, the higher cost of the higher-rated products also shrinks the addressable market. 

It’s, therefore, important to weigh the pros and cons before embracing gatekeepers. One strategy would be to confine gatekeeping to the higher market segments where signalling is valuable and where affordability is not a concern. 

6. Finally, in weak disciplining environments, like in the case with public sector institutions, gatekeepers are amenable to being captured and becoming handmaidens of vested interests. This distorts the gatekeeping signals and offers misleading information. 

There are several examples of this. Independent engineers and third-party quality audit firms becoming captured by the work contractors is not an uncommon feature in engineering works, especially in lower and mid-value works. Perhaps the most common are the several examples of rankings (of individuals in functional roles, institutions, administrative units, etc.) that are supposed to convey quality and performance. They have unfortunately become captives of unhealthy quid pro quos between the ranking agencies and those ranked. 

The Insolvency and Bankruptcy Code (IBC) in India triggered a new market for insolvency resolution professionals (IRPs), one that grew at a pace faster than the supply side could keep up with. The result is a system with a surfeit of poor-quality IRPs who have contributed to the lowering of the credibility of the process itself. The recent Supreme Court judgment in the case of the IBC-intermediated takeover of Bhushan Steel by JSW is a case in point (it’s perhaps more about the incompetence of the IRP than capture). 

For this reason, policymakers must be cautious and gradual in the adoption of gatekeeping in any sector.

Weekend reading links

1. From the early evidence, it appears that the New York City congestion charges are a success. 

Several indicators suggest a sustained decrease of traffic into, within and around the congestion zone. MTA data shows a 13 per cent drop in vehicles entering the central business district in March against a historical average, plus faster movement through the bridges and tunnels that are often snarled with traffic. This is supported by data from analytics firm INRIX that also shows minimal changes on Manhattan bridges outside the zone. On the funding side, the $500mn that the MTA anticipates raising this year from securities ahead of a big bond issue has provided investment for projects including signal upgrades, station elevators and a line extension.

This is corroborated by the findings of researchers in a new working paper who used Google Maps Traffic Trends data. They found speed increases for traffic into and inside the zone, without negative effects on local roads (spillover effects). 

This has also meant shorter response times for emergency service vehicles. 

2. Domestic value addition in exports has been declining in the US and India.

The share of domestic content in the output of US-based manufacturers dropped from 65 per cent in 1997 to 52 per cent in 2023. This decline was most pronounced during the period between 1997 and 2008, coinciding with the peak years of globalisation, when offshoring production to lower-cost economies became the dominant corporate strategy... India’s share of domestic value addition in its gross exports of manufactured goods (as a percentage of gross exports) has declined sharply from 88.2 per cent in 1995 to 63.3 per cent in 2012, before rising to 73 per cent in 2020.

3. Private equity distributions decline sharply

According to Bain & Company’s Global Private Equity Report, distributions as a percentage of net asset value have fallen from an average of 29 per cent in the period from 2014 to 2017 to only 11 per cent today. PitchBook estimates there are more than 12,000 US portfolio companies — around seven-to-eight years of inventory at the observed pace of exits. This is much higher than the five-and-a-half-year median exit time they’ve observed across the industry to date.

4. Nigel Farage's right-wing populist Reform Party has emerged as the biggest party in UK's local government elections even as Labour and Tories suffered their worst performance in decades. 

5. Cory Doctrow offers a negotiating strategy for other countries while negotiating with the Trump reciprocal tariffs. He points to the intellectual property law called "anticircumvention", which prohinit tampering with or bypassing software locks that control access to copyrighted works. 

The first of these laws was Section 1201 of America’s Digital Millennium Copyright Act, which Bill Clinton signed in 1998. Under DMCA 1201, it’s a felony (punishable by a five-year sentence or a $500,000 fine) to provide someone with a tool or information to get around a digital lock, even if no copyrights are violated. Anticircumvention laws are the reason no one can sell you a “jailbreaking” tool so your printer is able to recognise and use cheaper, generic ink cartridges. It’s why farmers couldn’t repair their own John Deere tractors until recently and why people who use powered wheelchairs can’t fix their vehicles, even down to minor adjustments like customising the steering handling. These laws were made in the US... The US trade representative has lobbied — overtly in treaty negotiations; covertly as foreign legislatures debated their IP laws — for America’s trading partners to enact their own versions. 

The quid pro quo: countries that passed such laws got tariff-free access to American markets. Canada enacted its anticircumvention law, Bill C-11, in 2012, after the ministers responsible dismissed 6,138 opposing comments on the grounds that they were the “babyish” views of “radical extremists”. Mexico enacted its version in the summer of 2020 in order to fulfil its obligations under the US-Mexico-Canada Agreement... Why should every peso that a Mexican iPhone owner pays to a Mexican app creator make a round trip through California and come home 30 centavos lighter? Why accept that for every 1,000 rupees someone pays in-app to India’s Dainik Bhaskar newspaper, the paper only gets 700 rupees? After all, if an Indian tech company makes its own app store, it could charge competitive fees that lure away all of Apple’s best Indian app maker customers. And why shouldn’t every mechanic in the world offer a one-price unlock of all the subscription features and software upgrades for every Tesla model... Monopolistic US companies have spent the first quarter of this century extracting trillions of dollars from consumers all over the world, insulated from competition by anticircumvention laws that they lobby to maintain. From printer ink to ventilator repairs, they have been able to pursue monopoly pricing, secure in the knowledge that no one would undercut them with cheaper and/or better add-ons, marketplaces, software, consumables and service offerings.  

6. Fascinating story about Disco Corp, a 87-year-old Japanese company with 7000 employees and $20.8 bn revenues that makes about three-fourths of all machinese used globally to cut, ground and dice semiconductors and has been run on pure free market pricinples. 

Disco is a business unlike any other. Since 2011, it has conducted a radical experiment to operate a blue-chip company on purely free-market principles. Nobody has a boss. Superiors cannot tell juniors what to do. Each day, employees choose whatever tasks they want. They can quit or join a different team at their own volition. Within this state of perfect freedom, most of their decisions will be guided by Will, as Disco’s internal currency is known. Employees earn Will by doing tasks. They barter and compete at auction with their colleagues for the right to do those tasks. They are fined Will for actions that might cost the company, or compromise their productivity. Their Will balance determines the size of their bonus paid every three months. The Will system, as it functions today, is the brainchild of Disco’s chief executive, 59-year-old Kazuma Sekiya, who sees his unorthodox management plan as fundamental to the company’s culture and success...

The Will system works like this. Sales of Disco’s machines generate Will. For each ¥1bn (£5.2mn) of revenue Disco accrues, approximately 400mn Will is typically generated for the sales staff to channel down through the company. They use that Will to reward or incentivise other employees to do tasks that support them. For example, they might pay Will to the manufacturing team to produce new machines for them to sell, pass on a stream of royalties in Will to the research team, or offer a tributary gift to their colleagues in HR for paying their salaries (in yen). Further down the food chain, the exchange of Will can be negotiated informally between employees in return for other tasks, paid for upfront, after completion or however the two parties agree is best. Disco also has an auction system for tasks, which works by dynamic pricing. The fewer people able or willing to do a task, the more Will has to be offered. If someone is desperate to do a certain job, or learn skills from a particular virtuoso, they might offer to pay Will for the privilege. Disco now has a team of eight employees who manage the Will system. They oversee a framework of 772 penalty and 337 reward items. About 187 of these payments and rewards are used regularly. 

The purchasing department fines people who write the wrong address on letters and packages, for example. The communications team has Will subtracted for negative articles that are published about the company. For Disco employees, Will dictates almost everything they do. Each member of staff starts the month with a negative Will balance, which they must strive to get above zero — an “existence cost”, so to speak. The system assumes employees are an inherent drag on the company until they prove otherwise. And the more senior you get at Disco, the greater your cost to the company is assumed to be.

7. Which developed country has had the most impressive economy since 1990?

This performance has helped the country maintain a AAA rating since 2003. The article is a good long read and examines the reasons for this economic perfornance. 

Mining grew to become one of the country’s largest exports, accounting for 12.2 per cent of GDP in 2024, according to Australia’s central bank. For the past three decades, Chinese demand for iron ore and copper, and Japan and South Korea’s hunger for natural gas and coal, have been the key drivers of economic growth... Australia’s lopsided economy, says Chris Bradley, director of the McKinsey Global Institute. The effects of what he calls a “productivity crisis” have been partly masked by the mining boom, high levels of immigration and increased state expenditure, according to a report he co-authored and published in December... “There is no greater beneficiary of the rise in China than Australia,” says Richardson... Whereas average productivity grew more than 1.5 per cent annually between 1993 and 2016, it has not grown since and has been falling since 2022. GDP per capita is down from 2.5 per cent between 1993 and 2007 to negative 1 per cent in the past two years.

8. Huawei has done several extraordinary things. But what it's attempting to do now is even more so and these efforts have accelerated since the US imposed sanctions in 2019. 

Huawei is involved in projects that aim to develop alternatives to technology from chip designer Nvidia, equipment maker ASML, memory-chip maker SK Hynix, and contract manufacturer Taiwan Semiconductor Manufacturing Company.

9. Fascinating description of the importance of the charkha by Mahatma Gandhi

“The spinning wheel represents to me the hope of the masses. The masses lost their freedom, such as it was, with the loss of the charkha. The charkha supplemented the agriculture of the villagers and gave it dignity. It was the friend and the solace of the widow. It kept the villagers from idleness. The charkha included all the anterior and posterior industries — ginning, carding, warping, sizing, dyeing, and weaving. These, in their turn, kept the village carpenter and the blacksmith busy. The charkha enabled the seven hundred thousand villages to become self-contained. With the exit of the charkha went the other village industries, such as the oil press. Nothing took the place of these industries. Therefore, the villagers were drained of their varied occupations, creative talent, and what little wealth they brought them.”

10. Akash Prakash makes an important point about how bringing back manufacturing to the US will be counterproductive for US companies.

Outsourcing has been led by US corporations; they are the masters of moving the capital-intensive manufacturing piece overseas to China and white-collar services to India. The only reason to offshore is to lower costs. Given a choice, it is always easier to have your employees and manufacturing next to you. Offshoring brings complexity to supply chains and is only done if costs can be brought down by 15-20 per cent at a minimum. If the endgame of these tariffs is to bring more manufacturing back to the US, it will affect corporate margins, as it is more expensive to do the job in the US — the reason it was offshored in the first place. Every company cannot pass on the higher costs. US corporate margins are near all-time highs, with return on equity above 16 per cent; both will go lower in the coming years.

This reduction in corporate margins can be seen in two related perspectives. In the first place, these inflated margins were the result of externalisation of the costs of supply chain resilience and national security. The tariffs and trade war with China is now forcing an internalisation of these costs. And that's a good thing. 

11. DOGE may have failed, and Musk may be on his way out, but he may have clinched Starlink's biggest business opportunity.

Trump’s “Golden Dome”, which aims to replicate Israel’s “Iron Dome” for all of the US, could be one of the biggest taxpayer outlays since Ronald Reagan’s strategic defence initiative, better known as “Star Wars”. In dollar terms Trump’s dome may even rival Nasa’s Project Apollo, which cost $280bn in today’s money. Since the missile shield would need to rely on swarms of satellites, Musk’s SpaceX would be the largest beneficiary. The company has formed a Golden Dome consortium with Palantir and Anduril, which are run by his Big Tech friends. Musk’s lasting impact on Washington may thus be to divert a big chunk of US taxpayer money to his empire. As leaving gifts go, this one would be very nice. Whether it would enhance US national security is someone else’s problem. Ditto on whether Golden Dome contracts qualify as waste, fraud or abuse. When only one company can fulfil the project’s biggest functions, there is little prospect of an open bidding process.

12. The definitive graphic on China's continuously rising trade dominance.

This is staggering

“China has surpluses, not just with the US, not just with Europe, but with 172 economies in the world,” Bert Hofman, a former Beijing-based country director for China at the World Bank, told a meeting of the Foreign Correspondents’ Club of China. “And if you have surpluses with 172 economies in the world, that’s not a great soft power position.”

As also this

China was the subject of 198 trade investigations by WTO members over alleged dumping or illegal subsidies last year, double the tally of the previous year and accounting for nearly half of all measures reported to the global trade body, according to research by Peking University economics professor Lu Feng. More than half of the trade cases against China last year were initiated by developing countries, including India, Brazil and Turkey. Even close partner Russia has pushed back on China’s car exports.

13. One area where China is chronically dependent on US suppliers is in the aeroplane manufacturing industry.  

Beijing had been hoping that Comac C919, its domestic aeroplane, would challenge Airbus and Boeing.

With China’s three big state-owned airlines already flying 17 C919s and Comac expecting to build at least 30 more of the single-aisle aircraft this year, the tensions between Washington and Beijing are highlighting how Chinese companies can be heavily dependent on US companies in their supply chains. The C919, which made its maiden commercial flight in China in 2023, has 48 major suppliers from the US, 26 from Europe and 14 from China, according to Bank of America analyst Ron Epstein...

For most western aircraft components for the jet, there are no domestic alternatives readily available, analysts say, meaning the US “can [halt] Comac in its tracks anytime it wants”, said Richard Aboulafia, managing director of AeroDynamic Advisory. One of the most crucial parts of the C919, its LEAP-1C engine, is built by CFM International, a joint venture between the US group GE Aerospace and French manufacturer Safran. While China has been developing a domestic alternative, the CJ-1000A, it is still being tested and is “not ready yet”, said Dan Taylor, head of consulting at aviation consultancy IBA... But if the US, at some point, decides to restrict exports of key components to China and “if China stops buying aircraft components from the US, the C919 programme is halted or dead”, Epstein said.

14. In an important event, Foxconn has struck a deal to manufacture electric vehicles for Mitsubishi Motors of Japan. Foxtron, its EV subsidiary, will develop and produce a Mitsubishi vehicle for Australian and New Zealand markets. In an industry where in-house manufacturing has been the norm, this outsourcing model is a potential turning point for the industry. 

15. Alaska Sovereign Wealth Fund

In 1980, Alaskan leaders created the Alaska Permanent Fund to invest 25 per cent of the state’s revenue from North Slope oil. Each year the fund, which began with less than $1mn and now has around $80bn of assets, pays out a dividend to every Alaskan resident.

16. Agencies have sprung up offering "place-of-origin-washing" services to Chinese exporters by routing their exports to the US through third countries. 

17. Zara's remarakable supply chain integration that changed clothing retail.

In the old days, retailers released just two main collections a year, Spring/Summer and Autumn/Winter. For decades, most chains have outsourced manufacturing to lower-cost factories in the far east with the clothes arriving up to six months later. Zara went against conventional wisdom by sourcing a lot of its clothes closer to home and changing products much more frequently. That meant it could respond much faster to the latest trends and drop new items into stores every week. Just over half of its clothes are made in Spain, Portugal, Morocco and Turkey. There's a factory doing small production runs on site at HQ, with another seven nearby, which it also owns. As a result, it can turn around products in a matter of weeks. More basic fashion staples are produced with longer lead times in countries like Vietnam and Bangladesh... Every piece of clothing is packaged and despatched from its distribution centres in Spain, as well as one in the Netherlands...

CEO Mr Maceiras says, "It's something that allows us to make the right decision in the last possible minute, in order to assess properly the appetite from our customers, in order to adapt our fashion proposition to the profile of our customers in different locations." In other words, getting the right products to the right shops. At HQ, product managers then receive real-time data on how clothes are selling in stores worldwide, and – crucially – feedback from customers, which is then shared with designers and buyers, who can adjust the ranges along the season according to demand. Unlike some other High Street rivals, it only discounts when it stages its twice-yearly sales.

18. Amidst all the talk of the impact of the tariffs on the world economy, here's the impact of GFC and Covid 19 for perspective.

The GFC caused world economic growth to fall from 2.7 per cent in 2008 to minus 0.4 per cent in 2009, a decline of 3.1 percentage points. The Covid crisis saw global growth fall from 2.9 per cent in 2019 to minus 2.7 per cent in 2020, a drop of 5.6 percentage points... The International Monetary Fund (IMF) sees global economic growth slowing from 3.3 per cent last year to 2.8 per cent this year — a deceleration of 0.5 percentage points... The drop in global growth of 0.5 percentage points projected on account of the tariff shock seems piffling in comparison.

19. Muted salary and wage growth of India Inc's 457 listed companies that have declared their results for Q4  FY25

The combined salary & wage expenses of the country’s listed companies grew just 4.8 per cent in the January-March quarter of 2025 (Q4FY25) over a year earlier — in single digits for a fifth straight quarter, and the slowest rate in at least 17 quarters. For comparison, these companies’ combined salary & wage expenses had increased 6.1 per cent year-on-year in the same quarter of FY24 and 5.1 per cent in Q3FY25... The share of salary & wage expenses in Indian companies’ net sales declined to 12 per cent in Q4FY25 — against 12.14 per cent last year, and a five-year average of 12.6 per cent...

The combined net sales (gross interest income in case of lenders) of the 457 companies in our sample was up 6.4 per cent Y-o-Y in Q4FY25 — the slowest growth rate in six quarters. Their revenue is now set to grow at a single-digit rate for an eighth consecutive quarter —since the quarter ended June 2023. These companies’ combined net profit (adjusted for exceptional gains & losses) were up 6.7 per cent Y-o-Y at around ₹2.24 trillion in Q4FY25 — a decline from 7.1 per cent in Q3FY25, but an improvement from 6.4 per cent in Q4FY24... A slowdown in India Inc’s salary & wage expenses was led in the past by IT services companies like Tata Consultancy Services, Infosys and Wipro, the current round of rationalisation is led by BFSI, which has faced a slowdown in growth and margin pressures in recent quarters. Companies in the IT services and BFSI sectors are the biggest employers in the listed space, accounting for 48 per cent and around 30 per cent of the salary & wage expenses of all companies in our sample.

Weekend reading links

1. Harish Damodaran writes about the contrasting fortunes of two-wheeler and tractor sales in India. Given that 55-65% of two-wheeler sales are in rural areas, and given non-farm rural sector which has not been doing well compared to agriculture sector and they also form a significant share of the rural economy, is the distress in non-farm rural sector contributing to keeping down two-wheeler sales?

The article has an interesting point about how deferral of implementation of stricter emission standards may have contributed to higher tractor sales,

The government had originally planned to introduce new Bharat Stage TREM IV emission standards for tractors with above 50 horsepower engines from October 1, 2020. That would have entailed replacing mechanical pumps for fuel injection with semiconductor-based common rail direct injection (CRDI) engines. But following representations from tractor makers, the implementation of the revised emission norms was deferred and made effective from January 1, 2023. Companies were also given six months’ additional time to sell their existing stock of tractors based on TREM III A standards.

2. The rise of venture debt

Debt was around 30 per cent of all venture capital raised in European tech in 2022, according to figures from Dealroom, compared with around 16 per cent in the previous six years. Cleantech and fintech companies were among the biggest borrowers...

The Silicon Valley Bank was the pioneer and linchpin of a venture debt market that gave start-ups an alternative source of funding, without the need to sacrifice equity stakes or swallow a much lower valuation. Across the US, SVB was responsible for roughly a tenth of all venture debt issued in the year so far. But on its home turf in California, the bank was behind more than 60 per cent of all deals this year, according to data from Preqin.

3. It turns out that many popular Italian cuisine dishes are not after all Italian. In fact, the migration of South Italians in the late nineteenth and early twentieth centuries into the US led to the emergence of a fusion cuisine which has today come to dominate as Italian cuisine in popular imagination. From an FT article,

Panettone is a case in point. Before the 20th century, panettone was a thin, hard flatbread filled with a handful of raisins. It was only eaten by the poor and had no links to Christmas. Panettone as we know it today is an industrial invention. In the 1920s, Angelo Motta of the Motta food brand introduced a new dough recipe and started the “tradition” of a dome-shaped panettone. Then in the 1970s, faced with growing competition from supermarkets, independent bakeries began making dome-shaped panettone themselves... Tiramisu is another example. Its recent origins are disguised by various fanciful histories. It first appeared in cookbooks in the 1980s. Its star ingredient, mascarpone, was rarely found outside Milan before the 1960s, and the coffee-infused biscuits that divide the layers are Pavesini, a supermarket snack launched in 1948... 

Parmesan, he says, is remarkably ancient, around a millennium old. But before the 1960s, wheels of parmesan cheese weighed only about 10kg (as opposed to the hefty 40kg wheels we know today) and were encased in a thick black crust. Its texture was fatter and softer than it is nowadays. “Some even say that this cheese, as a sign of quality, had to squeeze out a drop of milk when pressed,” Grandi says. “Its exact modern-day match is Wisconsin parmesan.” He believes that early 20th-century Italian immigrants, probably from the Po’ region north of Parma, started producing it in Wisconsin and, unlike the cheesemakers back in Parma, their recipe never evolved. So while Parmigiano in Italy became over the years a fair-crusted, hard cheese produced in giant wheels, Wisconsin parmesan stayed true to the original. 

In the story of modern Italian food, many roads lead to America. Mass migration from Italy to the US produced such deeply intertwined gastronomic cultures that trying to discern one from the other is impossible. “Italian cuisine really is more American than it is Italian,” Grandi says squarely. Pizza is a prime example. “Discs of dough topped with ingredients,” as Grandi calls them, were pervasive all over the Mediterranean for centuries: piada, pida, pita, pitta, pizza. But in 1943, when Italian-American soldiers were sent to Sicily and travelled up the Italian peninsula, they wrote home in disbelief: there were no pizzerias. Before the war, Grandi tells me, pizza was only found in a few southern Italian cities, where it was made and eaten in the streets by the lower classes. His research suggests that the first fully fledged restaurant exclusively serving pizza opened not in Italy but in New York in 1911. “For my father in the 1970s, pizza was just as exotic as sushi is for us today,” he adds. 

Like pizza, mozzarella was fast-tracked to global fame through the funnel of mass migration to America from the Italian south. Comparing her recollections with those of my grandmother, it’s clear that Sicily’s elevated “Sunday” dishes (aubergine parmigiana, cannoli, pasta con le sarde) were the ones that went mainstream, thanks to the south’s contribution to the Little Italys of the US. My grandmother, on the other hand, grew up eating tordelli alla massese (large fresh tortelli with a meat filling, cooked in a ragú sauce) and cappelletti in brodo (fresh tortelli in chicken broth), dishes that are almost entirely unknown outside the region.

4. Martin Wolf has some suggestions on how to avoid the next banking crisis. This is an important and under-appreciated aspect,

The best protection against occasional huge banking crises is frequent smaller ones. Fear works. We have seen, for example, some unwise deregulation. That of smaller banks in the US in 2019, which contributed to the recent crisis, is a powerful example. Pressure for deregulation has also been growing in the UK. A shock like this should make mindless deregulation less appealing to politicians and mindless risk-taking less appealing to bankers. Both lessons might have been learnt in the US and elsewhere, for a while.

5. Charles Goodhart argues that bank managers must face personal financial liability

The main cause of moral hazard is limited liability, especially when this applies to bank managers’ large shareholdings, mostly from bonuses. We cannot go back to the pre-Victorian approach of unlimited liability for all, because it would mean that banks could never get equity capital from outsiders. But there is no reason why we could not require senior bank management to face multiple liability, and in the case of chief executives possibly to have unlimited liability. If senior management faced a really serious loss when their bank failed, there would be far less need for shed loads of restrictive regulations.

6. Rana Faroohar points to a potential fault line from the impact of higher rates on real estate holdings of private equity,

Consider, for example, the trouble brewing in commercial property loans, and private equity real estate funds. This is where the shadow bank and small bank stories meet. Small banks hold 70 per cent of all commercial real estate loans, the growth of which has more than tripled since 2021. Following the easing of Dodd-Frank rules for community banks, smaller financial institutions have also invested more in riskier assets owned by private equity and hedge funds (as have other institutions looking for better returns, including pension funds). Small bank funding to commercial real estate is now tightening. This, along with interest rate rises, is putting downward pressure on commercial property values, which are now below pre-pandemic levels. That will curtail capital flows, derail investments and put pressure in turn on private equity funds with loans that are maturing, or which need equity injections... This means asset managers may be forced to go to investors for more capital (which will be a tough negotiation at the moment) or sell property out of their portfolio to cover loans. This has the feel of a doom loop to me. Big real estate indices had already turned negative in 2022... Consider, for example, how rich non-bank asset managers such as Blackstone, Apollo, Carlyle and others became on both residential and commercial real estate in the wake of 2008. This was partly because they were able to make deals that more regulated banks couldn’t. Private equity players have also made new investments in utilities, farmland, transportation and energy.

7. Apple and Microsoft make up 7.1% and 6.2% of S&P 500, making them disproportionately influential drivers of the index. Tech sector itself has more than doubled to 29% of the index by 2021 since 2001.

8. India's interesting services exports growth story

The binding constraint to growth in IT services exports is the deficiency of quality manpower.

9. Tesla may be about to upend the global EV batteries market,

Most of the world’s electric car batteries are now made in China. Accounting for more than 70 per cent of market share by shipments... But Tesla’s new batteries are set to upend the hierarchy of the industry for good. Panasonic and LG Energy Solution have long been the leading suppliers. But in recent years, Chinese makers such as CATL and BYD have steadily won market share away from Korean and Japanese rivals and have grown to dominate the world’s supply. 

Electric car batteries have undergone rapid technological change in recent years. Until now, the priority has been on improving energy density — for longer driving range — by changing the composition of battery materials. The shape of the battery cells has been less of a focus. Currently, most electric car batteries are designed and moulded in the shape and form that ensures the most efficient use of space. That has meant batteries that are shaped like flat pouches or stackable rectangular boxes have been the leading standards for electric cars until now. Cylindrical battery cells, the third type on the market, have long been considered the less attractive option because empty gaps between the round cells when stacked together was seen as wasted space. These made up just a fifth of the global market last year. Yet Tesla is betting big that these will become the future industry standard. Its cylindrical 4680 battery cells, named after their size, with a diameter of 46mm and length of 80mm, have been developed to have energy density of up to five times that of the batteries currently used in most Tesla cars. For both electric car buyers and for Tesla, the cost advantage is clear. The new cells are cheaper to produce than previous versions. They use new material which includes aluminium, a relatively abundant and lower cost metal, and less raw materials overall. Upgraded technology means the batteries are made using fewer parts — also meaning less weight. They are easier to mass produce as they do not have to be customised to fit different car shapes and designs.

This vertical integration would be a shift for Tesla from its practice of relying on an ecosystem of suppliers. But it has its set of advantages. Further, Tesla is also expanding its Nevada plant to make 2 million 4680 cells a year, up from 1000 cells a week in December. And, this indigenisation will also help the company benefit from the incentives under the Inflation Reduction Act.

10. To the list of Martin Skhereli of Turing Pharmaceuticals, Elizabeth Holmes of Theranos, and Trevor Milton of Nikola, comes Charlie Javice, 31, a Wharton alumni, who falsified the number of subscribers of her student finance website, Frank, and sold it to JP Morgan to pocket $45 million in profits.

Javice represented to JP Morgan that Frank had 4.25 m customers when in fact it had only 300,000. This is a standard practice in the startup world where the headline number on users are a signal of growth potential. Founders are not forced to disclose whether these are mere free downloads or registrations, or one-off subscribers, or active subscribers, and several other categories in between. This can be described as subscriber-washing.

11. Martin Wolf has two graphics about global trade. The first points to the progressive downward recalibration of the trajectory of global trade.

The second points to the increasing rise in global trade restrictions.

12. Gillian Tett compares the current bank run with that in 2007-08 and 1997-98 in Japan. The big difference was the speed with which the information spread, depositors pulled out $42 billion, and the bank collapsed. And the contagion spread rapidly across others. As a metric, the share of US households using internet or mobile banking rose from 39% to 66% between 2013-21.

Until now, the models used in finance do not seem to have taken account of the fact that consumer behaviour online might be different from that in the old-fashioned, physical banking world. But one striking feature about American banks, even before the March panic, was that consumers were moving money out of low-paying deposit accounts into better-yielding money market funds at a dramatically faster pace than at similar points before in history.

That might imply that greater information transparency accelerates consumer reaction to news, even outside crises, increasing the risk of “herding”. Either way, we urgently need some behavioural finance analysis, since American banks will stay healthy only if they hang on to deposits — and digital herding could increase the risks of turmoil in other markets, such as Treasury bonds, if shocks emerge there too... The dangerous weakness of fractional banking is that if nobody has a reason to panic, banks are safe; but if everyone runs, a bank can collapse, even if it previously passed tests on issues such as capital adequacy — unless a government steps in. And while the government never used to worry about smaller banks collapsing, now they fear the digital domino effect.

This raises the issue of how fractional reserve banking can survive in the era of rapid and real-time information flows.

In the context of SVB, Morgan Housel writes,

Controlling your behavior amid uncertainty can be hard enough. Controlling your reactions to other people’s behavior is way harder. Fear is more contagious than any virus, and can instantly push people to react in ways that would have seemed unthinkable a moment prior... Bank runs have been happening for centuries. SVB was unique because it had the social web of a tiny town but the balance sheet of a big, disparate, bank. When one person yelled fire, every other deposit holder instantly heard it, and $50 billion rushed out the door.

When less is more in public policy

There are certain public policy interventions whose effectiveness is measured by the decline in its application with time or by the minimisation of its need or off-take. For example, lower its uptake, greater the success of any market intervention measure that stabilises prices. This post provides two examples.

Consider the example of the US Federal Reserve's liquidity operations to backstop the municipal bond market,

Economists at the Fed have given glowing reviews to the central bank’s emergency credit line to states and cities, called the Municipal Liquidity Facility. Despite its soporific name, it was an unprecedented extension of the Fed’s “lender of last resort” powers: It inserted the bank into the municipal bond market, which states and cities basically use to even out revenue streams and finance some large projects. And it was successful in its primary mission: The Fed’s very entry into this market prevented its collapse and kept private lending flowing. It kept borrowing levels relatively near the prepandemic status quo. Still, because the Fed itself didn’t offer very generous loan terms compared with private lenders, the M.L.F. directly lent to only two borrowers — the state of Illinois and New York’s Metropolitan Transportation Authority.

The success of MLF was due to its limited actual use. 

On similar lines, agriculture market interventions to stabilise prices obtained by farmers are most effective when they are calibrated in a manner that makes its use minimal. In other words, the objective should be the least intrusive manner of market intervention that stabilises market prices. As a corollary, the test for its effectiveness on a comparative basis is whether the intervention has declined or not. 

Livemint has a very good data article which points to the large variations in public procurements of wheat across states. In the 2020-21 Rabi season, wheat production soared to 109.2 mt in 2020-21 from 92.3 mt in 2015-16, wheat acreage rose to 34.6 m hectares, 14% more than the average of the last five years, and public procurement rose from 24.9% in 2015-16 to 39.6% in 2020-21. In 2020-21, 73.5% of wheat production in Punjab, the third largest producer, was procured, compared to just 17% in UP, the largest producer. 

Further, the number of farmers using public procurement facility to sell wheat too has been rising steadily. The number of farmers benefiting from public procurement in 2021-22 is up 2.5 times of that in 2016-17. 

So we have a trend where the share of production being procured is rising and the number of farmers using procurements is rising even faster, despite wheat prices in general being on the upward trend in the last six years (or at least not suffering a price collapse). The inference is clear - given the consistent trend over nearly six years, markets are not functioning well in providing adequate prices to the farmers and it appears to be getting worse. 

Is it the case that the main objective of procurement is being crowded-out by the activity of procurement itself? Is more proactive, targets-based public procurement distorting incentives and interfering with the market mechanism? 

Accordingly, in terms of evaluating such agriculture market interventions, there is a case that its success should be measured not in terms of the quantity of foodgrains procured but in terms of stabilising market prices. This makes the case for evaluating agriculture market interventions also in terms of some price stabilisation index as against only procurement targets. 

The challenge though is with developing a credible index, one which measures both price recovery and stability and is also benchmarked with global market prices. Further, the inherently volatile nature of agriculture commodity prices can leave with no option but to do large procurements.

The broader point of the post is that less of an intervention is often more required in certain areas of public policy.

Weekend reading links

1. Richard Thaler on measures to increase Covid 19 vaccination rates,

A focus on teamwork is also featured in the Cleveland-Cliffs steel company’s generous offer to its employees. Vaccinated employees get a bonus depending on how many others at their work site do likewise. The company will pay vaccinated workers $1,500 if 75 percent of employees get the vaccine, and $3,000 if the proportion reaches 85 percent. This focus on group vaccination rates reinforces the message that everybody benefits if more people get jabs.

2. Morgan Housel eternal wisdom of the week,

Incentives are almost like a drug in their ability to cloud your judgment in a way you would have found unthinkable beforehand. They can get good people to justify all kinds of things... it’s hard to know what you’d be willing to do until you’re exposed to an extreme incentive, and that blindness makes it easy to criticize other people’s mistakes when you yourself may have been just as tempted if you were in their shoes...

Everything worth pursuing has a less than 100% chance of working. And a lot of terrible ideas have at least some chance of working. So you can make good decisions that don’t work, bad ones that do, and everything in between. The hard thing is that when the probability isn’t easy to determine, the path of least resistance is to put your own failures in the “good bet that unfortunately didn’t work” category and other people’s failures in the “that was clearly a bad idea” one.

3. ReNew Power has won an SECI tender for delivering 1.3 GW of hybrid renewable energy to provide round-the-clock (RTC) renewable power by quoting a tariff of Rs 2.9 per unit. This, the first such tender in the country, will involve an investment of $1.2 bn and a plant load factor of 80%. 

The company would set up the cumulative capacity at three locations – Karnataka, Maharashtra and Rajasthan. The hybrid capacity would include 0.9 Gw wind power, 0.4 Gw solar power along with corresponding battery storage... The project will be designed to operate at an 80 per cent average annual PLF and will have a minimum capacity utilisation factor of 70 per cent monthly, despite being a renewable energy project... Power from this hybrid project is likely to be sold to northern and eastern states. SECI officials did not confirm the states. The tender provides for 3 per cent tariff escalation annually for 15 years. The company said ReNew Power will supply the electricity in the first year at Rs 2.90 per unit and this tariff will increase by 3 per cent annually for the first 15 years. After which it will stabilise for the remaining 10 years of the 25-year contract. Industry calculations indicate that the average tariff over the life of the life of the project would come to around Rs 3.5-3.6 per unit.

4. The multiple "truths" (HT: Collaborative Fund Blog)

Your truth and the truth are not always the same thing. The truth is a fact. Your truth is just an opinion. Nobody values somebody who is honest about their opinions if their opinions always suck. Knowing when to offer your truth and keep your mouth shut is a rare quality. The line between thoughtful dialogue and disrespectful disagreement is razor-thin.

5. Iceland has nearly three-quarters of its population vaccinated. Despite this, its third wave is clearly the worst. Also this about the resurgence of Covid in Israel, the first country to largely vaccinate its population. 

From a few dozen daily cases in early June — even zero on June 9 — new Covid infections twice hovered near 6,000 this week, the highest daily rate in six months... The Israeli ministry of health has twice revised downwards the long-term efficacy of the jabs — from the advertised 94 per cent protection from asymptomatic infections against the then-dominant Alpha variant, to as low as 64 per cent against the now-dominant Delta variant.

6. Fascinating NYT article about Liechtenstein. In terms of pace of casinoisation, the principality has few equals,

But only four years after opening its first casino, Liechtenstein — a tiny principality squeezed between Switzerland and Austria that is known mainly for its private banking and former status as a tax haven — now has more casinos per capita than Monaco, Macau or Clark County, Nev., which is home to Las Vegas. In the past few years, Liechtenstein has seen five casinos open — aimed mainly at attracting gamblers from neighboring countries — and there are plans for five more. The proliferation is causing alarm among some in a country where gambling had largely been illegal until 2010... The gambling boom in Liechtenstein dates to 2017, with the opening that year of two casinos. Three more followed soon after, and another two are scheduled to open by the end of this year.

This is predictably creating its backlash.

7. Business Standard report about the project for redevelopment of the Bombay Development Directorate's (BDD) chawls (large buildings divided into many separate tenements, offering cheap, basic accommodation) in central Mumbai. 

Spread over 92 acres in Central Mumbai's prime localities of Worli, Lower Parel, and Dadar and consisting of 195 four-storey houses, the BDD chawls were constructed in the 1920s... They were used as prisons to house freedom fighters. Later, they were used as accommodation for textile mill workers. Now, tenants live cheek by jowl in 160-square (sq.) feet (ft) cramped spaces. These chawls have remained trapped in time, even as swanky office buildings got constructed on textile mill lands next door... The Worli chawls will be redeveloped by the Tatas. Shapoorji Pallonji Group will redevelop the chawls on NM Joshi Road. Larsen & Toubro will redevelop the chawls in the Naigaon area. We have promised to hand over the keys within three and a half years to the present-day tenants, with only Rs 100 as registration fee... Meanwhile, the tenants have been given free housing in the government's transit camps till they are given the keys to their brand new 500-sq. ft home. As an additional incentive, the new highrises will not attract maintenance fees for the next 10 years after possession... smaller structures will be replaced by nearly 40-storey buildings, the entire landmass will significantly decongest these areas, bringing in elements of recreation, retail, and open spaces... Experts say over the next decade, 12-million sq. ft development will transform the micro markets of Worli and Lower Parel into a mid-market affordable housing settlement. Worli is currently a luxury destination, with prices ranging from upwards of Rs 50,000 per square feet on carpet area. With the BDD development, prices are likely to significantly come down to the Rs 30,000-40,000 per square feet on the carpet area... The possible addition to the housing stock, after settlement of all the project-affected people, may run into over 25,000 apartments of various sizes. 

If this gets completed in even five years, it'll be a great achievement. A rare example of large urban renewal in the Indian context. 

8. A bill in the California Legislature proposes deregulation of parking requirements to boost new housing construction, 

Known as AB 1401, the legislation would abolish local parking requirements for new residential and commercial developments near bus or train stops. It applies to counties with more than 600,000 residents and cities with more than 75,000 people. The bill does not prohibit or restrict parking. It merely deregulates it, allowing developers to decide what works best for a given project. It opens up the possibility, for example, of providing parking in an off-site garage or lot. It permits tandem parking to save space or subsidized shared ride services. It doesn’t prescribe a one-size-fits-all solution to how buildings can best serve the people who use them, and it allows flexibility as transportation options evolve.

This is an illustration of the distortions engendered by restrictive parking regulations,

Shoup’s book gives the real-life example of a standard-size L.A. parcel whose zoning allows eight apartments, with required parking of 2.25 spaces each, or 18 total. The lot is only big enough to accommodate 16 spaces on one level of underground parking, however. Going from seven to eight apartments means digging down another level, which is prohibitively expensive. So the builder settles for seven units. The parking requirement costs one more family a home. The biggest beneficiaries of abolishing parking requirements would probably be the sorts of projects both planners and ordinary city dwellers tend to like: smaller infill buildings, mixed-use projects with street-level retail that neighbors can walk to, repurposed historic buildings, and nonprofit low-income projects. Stringent parking requirements encourage large buildings that can spread garage costs over many units and charge luxury prices. Add in the parking minimums for commercial operations, and many mixed-use developments become impossible... A 2020 study of Low-Income Housing Tax Credit developments, conducted by the Terner Center for Housing Innovation at the University of California, Berkeley, found that a parking structure cost nearly $36,000 a unit. “For a 100-unit building required to include an on-site parking structure, this would mean that roughly $3.6 million of the project cost goes to parking,” write the Terner Center’s David Garcia and Julian Tucker in a report on AB 1401.

9. Berliners are campaigning for expropriating large residential landlords, 

... a radical campaign urging Berlin’s city government to expropriate 240,000 properties from Germany’s biggest publicly listed residential landlords, accusing them of squeezing out lower income, long-term residents through shoddy maintenance and jacked-up rents. After collecting more than 350,000 petition signatures, their proposal — which targets corporate landlords with more than 3,000 apartments each — will be voted on in a local referendum in September. Polling suggests nearly half of Berliners support expropriation, which would force the companies to sell their properties to the city government at a “fair” price.

Also this,

A referendum due in Berlin next month on expropriating big residential landlords should be a wake-up call. The ballot, prompted by a petition, would activate a never-before-used part of the German constitution that allows the state to take over “land, natural resources and means of production” in exchange for compensation. If it passes, the largest private landlords would be forced to sell their properties to the city government at a “fair” price. This would do little to solve Berliners’ grievances, but it demonstrates the extent of anger about seemingly broken housing markets across the developed world.

10. Last week saw the latest (and first since 2013) report of the UN's Intergovernmental Panel on Climate Change, signed off by 234 scientists from more than 60 countries, which estimated that even in a best case scenario of deep cuts in greenhouse gas emissions the world is likely to temporarily reach 1.5 C of warming within 20 years. Living in a world 1.5 C warmer than it was 200 years ago means that a heatwave that would previously have occurred once in 50 years is likely to occur nine times. 

CO2 will have the dominant contribution to global surface temperature increases from various kinds of emissions.

11. On a related note, India has been experiencing the effects of global warming - a 0.6 degree Celsius increase in temperature since 1950 has led to a three-fold increase in extreme rainfall and flooding. 

12. Chinese authorities have been clamping down on for-profit schools to promote public education,  

China has almost 190,000 private schools, educating more than 56m, or one-fifth of all students, according to official figures. There are more than 12,000 primary and middle schools. Beijing wants to reduce the proportion of non-high-school students attending for-profit schools from more than 10 per cent to less than 5 per cent as soon as the end of this year... Annual earnings for the tutoring industry have been forecast to fall from $100bn to less than $25bn. The problem for private sector owners of junior and middle schools has become more acute since May, when Beijing told local governments to “rectify” their runaway expansion. “We must make sure public schools are the main compulsory education provider,” said a circular sent by the central government to lower-level authorities, adding that Beijing would encourage the conversion of some for-profit schools into public ones... The education reforms marked a striking change after years of liberalisation. Over the past two decades, China’s private primary schools grew 10-fold, teaching about 9.5m students in 2019.

India faces the same problem of hugely expensive private schools creating an elite-only market and also a highly competitive coaching market. But the Chinese actions are not possible in the Indian context.

13. FT has an article on the rising trend of outsourcing of fund management by smaller investors. Globally, as on March 2020, there were about $2 trillion in assets managed with full or partial discretion by outsourced fund managers, a two-fold rise from 2013. Smaller funds and investors prefer not to incur the high fixed cost of putting in place an in-house investment team. This imperative is also amplified by the search for yields prevalent in the financial markets today. 

The article points to the latest seven year projection by Jeremy Grantham's GMO of returns from various asset classes.

14. Status report on piped drinking water supply to villages under the Jal Jeevan Mission.

This is very impressive,

New tap connections, which had ranged between 2,000 and 10,000 per day till FY20, zoomed to more than 88,000 taps per day in FY21... Government officials said one reason for this speed is the use of groundwater. Household tap water systems can be developed quickly in such villages with the next 30-40 years in mind... However, the speed has mellowed somewhat this year, despite a fivefold increase in central funding. In 2021-22 (FY22) till August, the daily rate has gone down to 18,000.

Even 18000 is impressive. The issue here is to ensure they are actually working and supply water.

15. Finally, an article that highlights how Sweden has emerged as the Silicon Valley of Europe. 

Sweden's home computer drive (government policy to put a computer in every home), and concurrent early investment in internet connectivity, help explain why its capital Stockholm has become such rich soil for startups, birthing and incubating the likes of Spotify, Skype and Klarna, even though it has some of the highest tax rates in the world... In the three years the scheme ran, 1998-2001, 850,000 home computers were purchased through it, reaching almost a quarter of the country's then-four million households, who didn't have to pay for the machines and thus included many people who were otherwise unable to afford them... Some executives and campaigners say the Scandinavian nation demonstrates that a deep social safety net, often viewed as counter to entrepreneurial spirit, can foster innovation... Childcare is, for the most part, free. A range of income insurance funds can protect you if your business fails or you lose your job, guaranteeing up to 80% of your previous salary for the first 300 days of unemployment...

It has the third highest startup rate in the world, behind Turkey and Spain, with 20 startups per 1000 employees and the highest three year survival rate for startups anywhere, at 74%, according to a 2018 study by OECD economists. Stockholm is second only to Silicon Valley in terms of unicorns - startups valued at above $1 billion - per capita, at around 0.8 per 100,000 inhabitants, according to Sarah Guemouri at venture capital firm Atomico. Silicon Valley - San Francisco and the Bay Area - boasts 1.4 unicorns per 100,000, said Guemouri, co-author of a 2020 report on European tech companies. No one can say for sure if the boom will last, though, in a country where capital gains are taxed at 30 percent and income tax can be as high as 60 percent.

An excess of incentives and institutions in development

One of the problems with modern development discourse is its dissonance with both history and reality. One example of this is the idea of using incentives to generate development outcomes. So, if people don't vaccinate, then incentivise them with payment (or lentils). If you want children to do homework, incentivise them with payment. If people don't quit smoking, pay them to quit. And so on. In general, if you want to get people to do something, incentivise them with conditional cash transfers. 

The body of work on getting people to do stuff which advances development causes revolves almost completely around rewards/incentives and nudges. There is an asymmetricity in policy response to such problems in so far as in contrast to incentives, there is little by way of plain vanilla stuff like just making people abide by rules and enforcing those rules.

In this context, in a recent paper, Edward Glaeser points to how nineteenth century New York got people to connect to water and sewerage networks. He writes on the role of mandates and their enforcement in utilisation of infrastructure,

In 1842, New York City opened its Croton Aqueduct, which brought clean water into the city. This engineering achievement did not, however, end New York City’s Cholera problem. Somewhat surprisingly, the city would continue to suffer from cholera outbreaks for another 24 years. The persistence of cholera was not a puzzle to Dr. Stephen Smith, who led a team of doctors during the 1860s that trooped through the city and produced the 1865 “Report of the Council of Hygiene and Public Health of the Citizen's Association of New York Upon the Sanitary Conditions of the City.”

New York City had piped water, but water connections were expensive and tenement owners avoided the expense. Poorer renters lacked both resources and the incentive to internalize the wider health benefits of sanitation. New York City even had about 2,300 hydrants that dispensed free water, but using hydrants requires carrying water significant distances. Consequently, poorer New Yorkers continued to use shallow wells and pit latrines and they continued to die from cholera.

Smith’s report then produced the legislation that created New York City’s Board of Health, and Smith became its first leader. He began a system of inspections and fines that pushed tenement owners to connect to the water system. The Board’s inspection service was independent of the corrupt police force controlled by the Tammany Hall Machine. The doctors who set atop the Board’s leadership seemed to have been reputable men, like Smith, whose preferences (and reputations) kept them from striking corrupt bargains with those property owners who preferred not to pay for clean water.

This has resonance with all cities across developing countries. Even when water lines or underground sewerage systems are laid, very few households take the connections. The incentive-compatible approach that development economics advocates revolves around finance (and now nudges) - pay people to take connections, lotteries, lower connection charges, amortise connection charges with bills (pay-as-you-go) etc. 

I am inclined to argue that these are logically neat and theoretically robust. Besides they are amenable to guilt-free and elegant field experiments and research publications. In short, this is all fine for armchair theorising. Nothing beyond that. 

Let me layout a conceptual framework on thinking about this issue. 

Social contracts are two-sided. Citizens and governments agree to a contract. Citizens demand certain public goods and services and pay taxes for it. Governments use the taxpayer money to produce/provision those public goods and services. There is often a gap, for whatever reasons (including poverty and access), between delivery of those goods/services and their utilisation or uptake. Even when access has been provided, utilisation often remains elusive. In such cases, citizens have to be made to utilise the good/service offered. 

This process of making citizens utilise what is offered is a combination of rules/regulations/mandates (or exercise of state capability) and incentives. As the example of water and sewerage in New York shows, on most development issues and from historical examples of developed countries, ensuring utilisation has been largely about rules/regulations/mandates and their enforcement. Incentives have mostly been marginal contributors, relevant mainly in mopping up the few holdouts. This holds just as much to vaccination or school enrolment, as it does to taking water/sewerage connections. 

In the case of most public goods/services, history points to rules/regulations (in the form of exercising state capability) as the preferred choice to ensure utilisation. Development economics, on the other hand, is blind to rules/regulations and is focused on rewards/incentives, and in recent times on overcoming human psychological biases (the nudge factor).  

In simple terms, on the issue of utilisation of public goods/services (and more) development economics skirts around the difficult to grasp and even more difficult to implement issue of state capability and settles down on the comforting and logically neat ideas of measurable and testable incentives and nudges. 

In many developing country cities, utility connections have less than 20% households coverage in streets with water and sewerage connections, especially with latter, even in the middle class colonies. In low income areas with public taps, water connections uptake is similarly very low (even when connection charges are low). Unlike a case where just 10-20% of households are holdouts, and would perhaps need some incentives or subsidies, a case where just 10-20% have taken connections demands enforcement of rules. 

This World Bank working paper is a good example of a study that lists out as reasons (see the table in page 12) for low coverage of water and sewerage connections everything except the simple fact that many people just don't want to change the status quo and take a connection. And they don't face significant cost in maintaining the status quo. It's a teachable exhibit - it uses the word 'incentives' 36 times and the words 'enforcement' and 'rules' just six times each! Its 128 pages is also a classic example of over analysis in the context of development problems. Incidentally, it's also replete with several examples from developing countries on successful experiments with increasing utilisation through the likes of incentives, but none from developed countries about how they achieved the same. 

Incidentally, this is a very rare experimental study on the effectiveness of disconnections in ensuring utility bill payments. 

This is an unfortunate distortion, a deep negative externality imposed by excessively theoretical and deeply disconnected discourse that dominates international development and aid agencies. It has crowded-out serious engagement with hard issues of state capability improvements and crowded-in massive aid spending into mostly marginal and even silly ideas tailored around financial incentives and nudges. 

None of the above is an advocacy for strict penalties and hard enforcement, and avoiding incentives. But the reality is that when the baseline of compliance is so low, even among those who can afford to comply, then the first line of engagement should be enforcement. We can get to incentives and subsidies when we come to those who clearly cannot afford.

The anecdote about New York is also important for another aspect. It highlights the importance of individual agency. The personal initiative and role of Dr Stephen Smith in bringing forth the legislation and also working to enforce its implementation was critical in New York's success in delivering clean water. 

In the 18th Brumaire, Marx pointed to the limitations of individual human beings and the importance of circumstances and legacies. Extending that logic, development theories focus excessively on institutions - organisations and systems - and somewhat less on contexts/circumstances and historical paths (path dependencies). But it more or less marginalises the role of individuals. 

There is very little systematic research on the importance of individual (mostly non-political) bureaucratic or technocratic leaders in transformational development. This is surprising. History is replete with names like Stephen Smith, Robert Moses, Joseph Bazalgette, Baron Haussmann etc whose contributions were immense. Or the numerous Latin American mayors in cities like Mexico City, Sao Paulo, Curitiba, Medellin, Bogota etc who left indelible marks on their cities. Each country has their heroes among bureaucrats and technocrats.

Closer home, India has its names - KL Rao, E Sreedharan etc. There are several IAS officers who have played remarkable roles in transforming their terrains. It's common place for institutions and districts/corporations to be meandering along for years, only to be galvanised by the arrival of a dynamic officer who undertakes far reaching reforms and implements them with militant discipline and commitment, and for the system to revert back to its initial somnolence once the same officer departs. There cannot be anymore definitive evidence of human agency. And India's development history is full of such instances across geographical jurisdictions, Departments of state and centre, and state and central public sector entities.