Weekend reading links

1. Nigeria oil production fact of the day.

Authorities estimate that Nigeria still loses as much as 300,000 barrels of crude per day to theft, pipeline sabotage and other criminal activities, despite a recent improvement in the security outlook. For comparison, Nigeria produced 1.3mn barrels per day of crude in September, according to Opec data.

Is Shell Foundation the best illustration of green-washing? Wonder why nobody asks Shell Foundation to focus all its doing-good energies to clean up the mess left behind by it in Nigeria?

2. Europe's diversification away from Russian gas should count as a remarkable success of western solidarity in the aftermath of the invasion of Ukraine. It's a truly impressive achievement. 

3. London bus service facts of the day

The most recent data show that 86 people died or were badly injured in bus collisions in London between 10 December 2023 and 31 March 2024... Compared with other world cities like New York and Paris the capital’s buses rank in the top quartile for financial efficiency but the bottom quartile for collisions per kilometre... Could this have anything to do with the way that bus contracts prioritise speed... Drivers described the pressure of long shifts, few breaks and having to drive in sometimes blistering heat, all while being shouted at over a monitor by controllers who want them to make up the time to the next stop, and keep the right amount of distance between their bus and next. It’s not surprising that a third of bus drivers, before the pandemic, reported having had a “close call” from fatigue... Michael Liebreich, a former McKinsey consultant who sat on the TfL board for six years, believes that TfL’s contracting out model is “institutionally unsafe”. Bus drivers are under such pressure, he thinks, that some may break the speed limit and overtake cyclists dangerously.

4. A measure of the Trump tariffs risk exposure of various countries.

5. FT long read writes that Germany is experiencing a serious downturn.

Over the past three years, Europe’s largest economy has slowly but steadily sunk into crisis. The country has seen no meaningful quarterly real GDP growth since late 2021, and annual GDP is poised to shrink for the second year in a row. Industrial production, excluding construction, peaked in 2017 and is down 16 per cent since then. According to the latest available data, corporate investment declined in 12 of the past 20 quarters and is now at a level last seen during the early shock of the pandemic. Foreign direct investment is also down sharply... In its latest forecast, the IMF says that German GDP will expand by just 0.8 per cent next year. Of the world’s largest and richest economies, only Italy is expected to grow as slowly. In manufacturing, where Germany is Europe’s traditional powerhouse, things look especially bleak. Volkswagen has warned of plant closures on home turf for the first time in its history. The 212-year-old Thyssenkrupp, once a symbol of German industrial might, is bogged down in a boardroom battle over the future of its steel unit, with thousands of jobs at risk. The tyremaker Continental is seeking to spin off its struggling €20bn automotive business. In September, the 225-year-old family-owned shipyard Meyer Werft narrowly avoided bankruptcy with a €400mn government bailout...

Economists and business leaders blame Germany’s economic woes on high energy costs, high corporate taxes and high labour costs, as well as what they describe as excessive bureaucracy. These issues have been compounded by a shortage of skilled workers and the dire state of the country’s infrastructure after decades of under-investment. Meanwhile, according to the country’s statistical agency, nervous German consumers are now saving 11.1 per cent of their income, twice as much as their US peers — thus slowing down the economy even further... According to the VDA, Germany’s automotive industry association, vehicle production in Germany peaked in 2016 at 5.7mn cars; last year the number was 4.1mn, down by more than a quarter. Since 2018, 64,000 jobs have been lost in the industry — nearly 8 per cent of the country’s automotive workforce — and tens of thousands more are at risk.

Industrial production has been on a downward trend since 2017. 

6. Hungary has absorbed more than a quarter of Chinese investments into Europe. This includes massive inflows into the EV industry, making Hungary the staging post for Chinese manufacturers push into the European EV market. This would avoid the 45% tariffs imposed on EV imported directly from China. 

BYD chose Szeged in South Hungary and CATL is building a €7.3bn plant in the east of the country. But as President Trump assumes office, Viktor Orban is faced with the challenge of balancing his two friends - Xi Jinping and Donald Trump.

7. Tesla is not the only Trump trade!

Private prison stocks are breaking out. Shares in Geo Group and CoreCivic, two of the largest for-profit operators of prisons and immigrant detention centres in the US, have shot up 74 per cent and 55 per cent since Donald Trump’s election victory this month. History suggests Make America Great Again trades do not always do so great. In theory, the two companies stand to benefit greatly if Trump delivers on his promise to crack down on border security and illegal immigration. For his second term, the president-elect pledges to oversee the largest deportation operation in American history.

8. Important point about Trump's legacy

Trump is the most important person of the century so far precisely because his dissent from the trade consensus, so shocking at the time, has spread.

9. The importance of Nvidia

When regular companies report quarterly earnings, investors peruse them, and the shares move up, down or sideways. When those earnings come from Nvidia, however, the financial world tilts on its axis... At $3.6tn, the company is the world’s biggest by market capitalisation, and makes up 7 per cent of the S&P 500 index. Back in 2000 when Cisco briefly became the planet’s most valuable company, its weighting was less than 4 per cent of the S&P. As of Wednesday, Nvidia’s stock accounts for 24 per cent of the index’s gains this year... Bank of America analysts had calculated this week that investors were expecting a 1 per cent index move in response to Nvidia’s earnings — greater than the shift they expect from US inflation data later this month. The interconnectedness is real: as Huang quipped on Wednesday, “almost every company in the world seems to be involved in our supply chain”... its valuation is far behind the 130 times earnings Cisco enjoyed in 2000... Cisco’s earnings were 20 per cent of its sales before the dotcom crash; Nvidia’s are nearly 60 per cent.

10. SEBI cracks down on abuse of the SME trading platform by increasing the rigour of listing requirements.

Among those, the regulator has suggested increasing the application size from Rs 1 lakh to Rs 2 lakh. The shift is expected to bring relatively informed investors. It has also suggested increasing the minimum number of allottees to 200 from 50. This will help increase liquidity and also spread the risk. The issue size is proposed to be increased to Rs 10 crore. Further, the proportion of offers for sale is proposed to be restricted to 20 per cent of the issue size. Besides, it has been proposed that the utilisation of proceeds should be monitored for fresh issues above Rs 20 crore. Further, the regulator has suggested extending the disclosure requirements for related-party transactions under the Listing Obligations and Disclosure Requirements for companies above a certain threshold. An analysis by the regulator showed that 50 per cent of the top 50 listed SMEs have undertaken related-party transactions of over Rs 10 crore. Therefore, there is a greater need for scrutinising such transactions, which can be used to divert and misuse funds.

11. Demonetisation status update

The cash-to-GDP ratio fell from 11.9 per cent in FY16 to 8.5 per cent the following year, then rose to 14.2 per cent in FY 21 before falling to nearly 12 per cent in FY24... Digital payments have grown lightning fast, reaching Rs 36.59 trillion in FY24 from Rs 19.62 trillion in FY18, achieving a compound annual growth rate (CAGR) of about 44 per cent.

12. Power sector update

... cumulative debt of Rs 6.84 trillion and accumulated losses of Rs 6.46 trillion. These staggering numbers partly reflected the combined impact of a record demand in 2023-24, and a rising cost of expensive imported coal. The upshot was that 16 states —including large ones like Uttar Pradesh, Telangana, Maharashtra, and Punjab — saw financial losses jumping significantly.

13. Tatas inorganic growth into electronics contract manufacturing for Apple

Tata Electronics has agreed to buy a majority stake in Taiwanese contract manufacturer Pegatron's only iPhone plant in India... Tata will hold 60 per cent and run daily operations under the joint venture, while Pegatron will hold the rest and provide technical support... Tata already operates an iPhone assembly plant in the southern state of Karnataka, which it took over from Taiwan's Wistron last year. It is also building another in Hosur in Tamil Nadu, where it also has an iPhone component plant... The Tata-Pegatron plant, which has around 10,000 employees and makes 5 million iPhones annually, will be Tata's third iPhone factory in India.

14. Important insights about trends on private non-financial investments from Kavitha Rao of NIPFP by analysing the composition of income from income tax returns data of 408 non-financial corporates who make up the BSE 500 and form 94-95% of the net fixed assets of the index companies. She points to a reduced focus on capital formation in these companies.

The share of fixed assets has declined from 66 per cent to 59 per cent in the same period... the ratio of net fixed assets to financial assets... declined from 1.95 to 1.45 during the same period... the share of capital works in progress and intangibles as a percentage of net fixed assets has declined from 24 per cent to 14 per cent... Of the 408, considering 384 companies for which data is available for the entire period, 248 companies have reported an increase in the share of financial assets in total assets. These companies account for 62 per cent of the net fixed assets as of March 2024.

She proposes an explanation in terms of an emerging preference for long-term investments (or financial investments)

For non-financial companies, the share of long-term investments has increased from 61 per cent to 78 per cent, reflecting a reduced interest in long-term loans and advances. Apart from possible incentives provided by sharp increases in stock prices in the capital markets —an average growth of over 14 per cent in the index over the last 10 years and in more recent times, a growth of over 25 per cent — the above trends raise questions about the opportunities for gainful investment within the economy. A moderation in private investment in 2019, preceding Covid, suggests a medium-term moderation in demand in the economy — a simultaneous surge in stock markets would provide an attractive venue for investment of surpluses generated by profitable companies.

15. Nitin Desai writes that the most important economic liberalisation reform in India was the changes to the institutional arrangements in the financial markets that improved financial intermediation and boosted private investments.

A set of substantive changes were made that has transformed the financial market. The most impactful change was the opening of the banking and mutual funds sectors to private enterprises that has led to a substantial improvement in the quality of banking and investment services available to savers and investors. The simplification of share trading through dematerialisation greatly facilitated the widening of savers’ interest in shares. The shift of regulatory authority from the Controller of Capital Issues in the finance ministry to the Securities and Exchange Board of India (Sebi) is another important change. These, along with other changes in the government’s financial policies, have been major factors behind the average 6 per cent growth India has experienced over the past four decades. Private corporate growth was boosted by the liberalisation of the financial market, leading to a significant increase in new capital issues by private companies and a rise in the volume of assets in mutual funds. This opening of the finance market has continued with the emergence of non-banking finance companies that are more effective at reaching out to smaller borrowers, and lately, the emergence of fintech companies. The rapid expansion of digital infrastructure has also been critical to the broader liberalisation of the financial system. 

All this has led to a radical increase in private corporate investment relative to public sector investment, with the ratio between the two rising more than four-fold from 0.37 in 1990-91 to 1.63 in 2022-23. As for investment in manufacturing, in 2022-23, the private sector accounted for 71 per cent, small enterprises within the household sector for 22 per cent, and the public sector for only 7 per cent. One measure of the transformation because of the reform of the financial system is the sharp rise in the market valuation of shares as a percentage of gross domestic product (GDP), from an average of 37 per cent between 1991-92 and 2004-05 to an average of 85 per cent between 2005-06 and 2023-24. 

Some observations on WDR 2024 and increasing national incomes

The World Development Report (WDR) 2024 is out and it’s about avoiding the middle-income trap and presents a strategy for developing countries to reach high income status. The report has several useful insights and is a good documentation of the challenges associated with the middle-income trap. 

This post comments on the report and questions a few important assumptions and conclusions in the report. 

The report describes a three-stage path of transition to high-income status - investment, infusion, and innovation. Lower middle-income countries must transition from their predominantly investment-driven strategies to one where they “must also adopt modern technologies and successful business practices from abroad and infuse them across their economies”. This infusion is through the technology transfers embodied in the transfers of physical and financial capital. The upper-middle-income countries, in turn, should supplement infusion by adopting innovation and engaging at the global frontiers of technology. 

It uses the above framework to describe three processes essential for the Schupeterian creative destruction to play out - creation (where incumbents and entrants expand markets and technology frontiers), preservation (incumbents and elites tend to prefer the status quo and push back at change), and destruction (elimination of misallocated resources to free up the conditions that aid and resources required for creation). Middle-income countries currently face strong headwinds on all three processes. 

The report says that achieving a balance between the three processes requires a complement of policies that seek to discipline incumbent vested interests through competition regimes that encourage new entrants, reward merit by becoming better at accumulating and allocating talent across individuals and firms, and capitalise on crises by using the opportunities presented by the climate change to pursue greater energy efficiency and emissions intensity. The first weakens forces of preservation, the second strengthens forces of creation, and the third rides opportunistically to aid destruction. 

The table below captures the development strategy that the Report outlines. 

The report uses the case studies of three countries in particular to validate its case.

To the extent of the three case studies, the WDR 2024 is a ringing endorsement for industrial policy, albeit carefully calibrated and done in a very sophisticated and iterative manner. Sample this case study of South Korea

In the 1960s, a combination of measures to increase public investment and encourage private investment kick-started growth. In the 1970s and 1980s, Korea’s growth was powered by a potent mix of high investment rates and infusion, aided by an industrial policy that encouraged firms to adopt foreign technologies. Firms received tax credits for royalty payments, and family-owned conglomerates, or chaebols, took the lead in copying technologies from abroad—primarily Japan. As Korean conglomerates caught up with foreign firms and encountered resistance from their erstwhile benefactors, industrial policy shifted toward a 3i strategy supporting innovation. Then, as Korean firms became more sophisticated in what they produced, they needed workers with specialized engineering and management skills. The Ministry of Education, through public universities and the regulation of private institutions, did its part, setting targets, increasing budgets, and monitoring the development of these skills.

Or Poland

In the early 1990s, Poland underwent a transition from a planned economy to a market economy. It has since boosted its income per capita from 20 percent of the average for the European Union to 50 percent. What is Poland’s winning strategy? It began by disciplining the large state-owned enterprises (SOEs). It hardened their budget constraints by cutting subsidies, tightening bank loans, and liberalizing import competition—including at the iconic Stocznia Gdańsk shipyard, where the Solidarność (Solidarity) movement began. This discipline paved the way for comprehensive reform. In Polish SOEs, managers shifted their focus from production targets to profitability and market share, and they upgraded firms’ capabilities to prepare for privatization. Poland then built on this foundation to attract investment, focus on infusion next, and turn to innovation last. It followed this sequence largely by raising productivity with technologies infused from Western Europe—a process accelerated in the 2000s by its entry into the EU common market, which spurred foreign direct investment. Poland also increased tertiary education rates from 15 percent in 2000 to 42 percent in 2012. Educated Poles put their skills to work across the European Union, opening another channel to infusing global knowledge into the Polish economy.

All this is good theory and offers several useful insights. But the framework that the WDR 2024 hangs on struggles when examined with respect to empirical evidence. This post will use the example of India to highlight the point. 

First some interesting insights. It does a good work of listing the policy requirements for middle-income transitions - exposure to global competition, connect local firms with market leaders, reduce factor and product market regulation, avoid coddling small firms or vilifying large firms, let go of unproductive firms, strengthen competition agencies, deepen capital markets etc. 

The report has a Box item that describes incumbents in a comprehensive manner - firms, technologies, countries, elites, and men. This is an important insight, often forgotten in the analysis surrounding development and economic growth. These incumbents exert significant force of preservation that prevents everyone else from accessing opportunities and contributing to economic growth.

Preservation insulates members of social elites from the forces of destruction that, in a more open society with meritocratic institutions, might dissipate their advantages in wealth and privilege. The same forces ensure that, beyond elites, few children will get the chance to climb to a higher rung on a country’s income ladder than that occupied by their parents. So, income inequality remains high and social mobility remains low, transmitting inequality across generations, exacerbating the inequality of opportunity. 

Three kinds of preservation forces perpetuate social immobility in middle-income countries, shutting out talent from economic creation. The first force is norms—biases that foreclose or limit opportunity for women and other members of marginalized groups. Next are networks—above all, family connections. And the last force is neighborhoods—regional and local disparities in access to education and jobs.

This is a very important insight to be kept in mind. Developing countries, and more so large ones like India, have little chance of sustained growth without broadening the base of those participating productively in the economy. This goes beyond firms and individuals to include gender, regions, castes, and religions.

The report also points to the value of diaspora to a country’s growth prospects. An area where India appears well placed to capitalise is in the knowledge transfers from its vast diaspora. On this issue, it would be useful to cut through the clutter and get a sense of how much its large highly skilled and influential diaspora in the US, especially those in the highest echelons of finance and technology, have uniquely engaged with the Indian economy. What have been their contribution, over and above what would have happened anyways given the size of the Indian economy and its recent growth trajectory? What are the signatures of such engagement? How much of the high net-worth wealth and high-skill entrepreneurship have found their way back to investment and business creation in India?

While there are no studies that indicate so, despite its very large highly skilled and influential diaspora in the US, I cannot think of much by way of direct benefit to the Indian economy from the diaspora by itself. This contrasts with China, where many of the large manufacturing and industrial giants of today emerged from entrepreneurs who studied and worked in the US and elsewhere and returned to their homeland. As an illustration, while high levels of US corporate world is populated by a disproportionately high share of talented Indians, it’s striking that there are hardly any Chinese at those levels. Is it the case of the Chinese counterparts choosing to return to work in their country?

The report shows that sustained growth episodes are short. And India’s has so far been a lot shorter than that of others. 

Now some critical observations about the findings in the report:

1. For a start, India’s current challenge is not so much escaping the middle-income trap as crossing even the upper middle-income threshold. The same is the case with most of the other large middle-income countries. By positing the middle-income trap, we are getting far ahead of the game. 

2. I’m not sure about this

It is unlikely that industrial policy will enable countries to leapfrog from an investment- and manufacturing export–driven model to an innovation-oriented model or services-led model of economic growth. The development literature is littered with reports recommending a leap from investment to innovation, skipping the stage of painful reforms to attract foreign investment and ideas.

I’m not sure whether this argument has any empirical basis. There’s a strong element of ideology here, one where the orthodoxy of openness to foreign investment must be qualified with foreign investment that’s contingent on technology transfers and significant value addition. 

This becomes especially important given the presence of China and its beggar-thy-neighbour industrial policy. In fact, I’ll venture out and argue that instead of accusing developing countries of not pursuing orthodox openness, the WDR should be accusing them of pursuing openness which does not place adequate safeguards against the decimation of local manufacturing bases by cheap Chinese imports. As I have blogged here, the problem of gradual destruction of the domestic manufacturing base arising from openness to cheap Chinese imports is a major problem facing developing countries today. 

To put the China issue in perspective and the near impossibility of competing with them in many areas, consider this.

Starting production of solar panels in India from raw materials, such as quartz minerals, would be at least 40 per cent more expensive than in China. This cost difference reduces to 25 per cent if he uses imported polysilicon wafers and decreases to 3 per cent if he uses solar cells imported from China… producing solar modules from raw materials is too costly… This is similar to India’s smartphone sector, which relies on imported subassemblies, and the electric vehicle (EV) battery industry, which depends on imported lithium cells. Most manufacturing happens abroad in both cases, and more than 85 per cent of the components are imported. The high-cost difference between India and China is partly due to India’s higher cost of production inputs and China’s subsidies for its firms. For example, in India, the capital cost for businesses is 9-10 per cent, compared to 4-5 per cent in China. Industrial electricity in India costs $0.08 to $0.10 per kWh, while in China, it’s $0.06 to $0.08.

3. A related point made in the report is that about contestability of markets 

Contestable markets—and the institutions that enable them—are vital for middle-income countries that aim to become global supplier and sustain rapid economic growth through sophistication and scale… A key part of contestability is openness to foreign investors and global value chains that give domestic firms access to larger markets, technology, and know-how and allows them to add value and grow. And they are encouraged to make use of that access, thereby exposing domestic firms to competition, but also inspiration, from international firms that operate at or near the global technology frontier. Firms at home can seize the opportunity to infuse technology, increase the sophistication of their operations, and scale up, or they can keep doing business as usual and be eased out.

Again, there’s a nuance missing. Yes, contestability and competition are essential. But it’s one thing to open the country to foreign investments but an altogether different thing to open up for imports. While contestability arising from trade liberalisation invariably follows the opening up, the same cannot be said about investments. Investment liberalisation takes time and effort to realise actual investments, if at all. FDI does not come merely by opening up the economy and requires efforts at multiple levels to relax entrenched economic and other constraints. Further, as developing countries are finding out, contestability arising from trade liberalisation is double-edged in so far as it ends up swamping the country with cheap Chinese products and destroying the local industry. 

The examples of how Chilean and European companies in the period from 2000-07 benefited from Chinese imports are deceptive. For one, the Chinese competition was in its early stages then and not distorted to the same extent as now by subsidies. Besides, the Chinese competition then was in the less sophisticated products. And the European companies engaged from a position of high competitiveness given their strong manufacturing base. The situation is very different today and in the context of countries like India. 

4. The report uses the Schumpeterian framework of creative destruction and the role that new entrants can play in triggering competition, creating value and displacing incumbents. 

There’s nothing inevitable or market-driven about this dynamic. Economies can get stuck in multiple equilibriums. Instead, this dynamic requires an active government role in co-ordination and relaxation of constraints.

Take the example of India’s textiles, footwear, food processing, consumer electronics and durables, capital equipment, automobile, and solar manufacturing sectors. While there are a few large domestic firms in some of these sectors, I cannot think of entrants over the last twenty years that have grown to become dominant firms in their sectors, leave aside become large exporters. How many entrants have emerged as competitors in India’s entire consumer durables or capital equipment or textiles or footwear market? How many entrants are there to validate the Aghion-Howitt thesis that they create value, displace incumbents, and become protagonists of economic growth?

The creation and innovation parts are very hard. In an acknowledgement of the problem, the report points to one of the most important problems with the landscape of manufacturing and industries, the low rates of productive business creation and deficient dynamism among incumbents. 

The forces of creation are weak in middle-income countries. In India, Mexico, and Peru, for example, if a firm operates for 40 years, it will roughly double in size. In the United States, the average firm that survives that long will grow sevenfold. For firms in middle-income countries, this implies a “flat and stay” dynamic: firms that fail to grow substantially can still survive for decades. By contrast, for US firms the dynamic is “up or out”: facing intense competitive pressure, a few entrepreneurs will expand their businesses rapidly, while most others will exit quickly. Among the majority who exit the market, many will become wage earners at the most flourishing firms. 

In keeping with the flat and stay dynamics, firms in India, Mexico, and Peru tend to remain microenterprises: nearly nine-tenths of firms have fewer than five employees, and only a tiny minority have 10 or more. The longevity of undersize firms—many of them informal—points to market distortions that keep enterprises small while keeping too many in business. For example, a high regulatory cost attached to formal business growth may inhibit an efficient firm from gaining market share and driving out inefficient competitors. Such policy-induced distortions in middle-income countries result in misallocated resources, hampering creation and infusion at scale.

Given this, I’m not sure also about the third-generation Schumpeterian Akcigit-Kerr view of incumbents being spurred by competition from new entrants and foreigners, and increasing their productivity and innovating to the technology frontier. This view sees incumbent market leaders as bringing scale and advancing domestic industry towards the technology frontier. 

As I have blogged here, India’s private sector incumbents (and startups) have been remarkably slow and deficient in operating at the technology frontier across sectors. This lag is reflected in their very low R&D spending compared to peers even among the larger middle-income countries. In fact, scale manufacturing (this and this) has been an enduring deficiency of India’s business landscape, and remains so. 

For example, despite the head start enjoyed in pharmaceuticals, the Indian drugs industry has not managed to move up to pharmaceuticals value chain to formulations and drug discovery, much less emerge as large contract manufacturers of APIs of the kind their Chinese counterparts have become. The behemoth IT firms have struggled to come up with any major software products and are virtually absent in cutting-edge areas like cloud computing, artificial intelligence, the Internet of Things, and data analytics. The established domestic manufacturing firms in areas like capital equipment, automobiles, and consumer durables operate distant from the global technology frontier. Finally, even the much-hyped startup ecosystem struggles to innovate at the technology frontier. 

In areas like consumer electronics manufacturing, it has taken active industrial policy and nudging by the government through the likes of Make in India and Production Linked Incentives (PLI) scheme for even the limited breakthroughs that have been made. 

Similarly, there’s nothing inevitable about the movement up the value chain. So, for example, the dynamics of market forces will not gradually push India up the manufacturing value chain of mobile phones or solar panels in terms of increasing domestic value addition. The Indian mobile phone and solar panel manufacturing industries can remain stuck in the low-value assembly part of the value chain for a long time. As the experience of the North East Asian economies shows, there’s a need for active industrial policy to guide and push industries and businesses up the value chain. 

Orthodox economists will blame entry barriers and other constraints that prevent competition for the above problems and failures. But in a reasonably well-managed, macroeconomically stable, continental-sized economy, as India is, even with all constraints, there should have been at least a few Schupeterian examples. So what gives?

One explanation is that ideas and their adoption will be contingent on real-world challenges and constraints, many of which will remain no matter what. In these circumstances, active government engagement will be an essential requirement even with the Schumpeterian framework. 

5. An area of ideological faith among opinion makers and commentators everywhere is the belief that there are large amounts of foreign and domestic private capital willing to invest in developing countries. The argument goes that it’s not so much the capital availability per se, but the absence of good projects and investment opportunities. 

Instead, a more appropriate framing would be that private capital, debt and equity, and especially foreign capital, demand a rate of return that’s too high to be borne by the vast majority of investment opportunities available in any economy. There’s a circularity here - private investments are constrained by a lack of investment opportunities, and investment opportunities are limited by the prohibitive cost of capital and return expectations. 

It can therefore be said that one of the biggest impediments to accelerated investment in developing countries like India is their cost of capital and high return expectations of investors. As the graphic below shows, the cost of capital in low-income and lower-middle-income countries is more than double that in high-income countries. This will be higher once you add the layers of country and currency risks that foreign capital must bear. This 8-10 percentage points differential is huge and renders many investments unviable. 

Unfortunately, there are very few straightforward measures to bridge this gap. And, as I blogged here and here, the few that can bridge the gap somewhat require deep-rooted plumbing reforms. 

Projects and ideas/opportunities that routinely attract investments in developed countries struggle to find investors in developing countries. And that will remain a reality until those countries reach similar stages of development and incomes.

6. The report sees the climate change crises as an opportunity for developing countries. Yes, in theory, there’s an opportunity in so far as it provides these countries new investment opportunities and that too which can operate at the technology frontier. But in practice, this opportunity can be misleading. 

Consider the example of India’s solar industry. While the country has expanded its renewables generation capacity, it has struggled to gain even a toe-hold on solar and wind power manufacturing. And this is despite the leverage provided by the country’s massive capacity expansion potential. Econ 101 tells us that this context is ripe for the creation of domestic manufacturing facilities. Clearly, contrary to what’s being suggested in the report, openness and markets by themselves will not result in foreign investment and technology transfers. This example holds for several industries.

Then, there’s the issue of the costs associated with the green transition. I have written here in detail highlighting the serious limits to developing countries being able to use the green transition as an opportunity to boost their economic growth. 

In conclusion, developing countries face a Hobson’s choice. On the one hand, trade openness threatens to swamp the country with cheap Chinese imports, and destroy the local industry. The idea of import competition to improve the competitiveness of the domestic industry falls apart when faced with cheap Chinese imports. On the other hand, investment openness is a long route to change with several capabilities requirements and the national security vulnerabilities of relying on Chinese FDI, whose coming itself is questionable. 

I’ll argue that developing countries should pursue a three-pronged strategy, one shorn of any ideology or orthodoxy and which is grounded on strict prudence and realism. It’s also the one that Joe Studwell has very nicely articulated as the ingredients of the successful North East Asian economies. 

One, internally they should pursue an industrial policy that promotes domestic industries and businesses and disciplines them with subsidies and concessions that are linked to export competition. This would necessarily involve picking specific sectors and less so, firms, and supporting them and calibrating policy continuously to ensure that they keep moving up the value chain. This industrial policy should be cautious of being captured by domestic vested interests. 

Two, externally they should encourage foreign investment, but at terms that come with value addition and technology transfer. This would require policies that explicitly encourage joint ventures with big domestic companies, mandate domestic content requirements in the manufacturing investments and technology transfer conditions, and provide incentives that are linked to exports. 

Three, trade policy should be responsive to the threat posed by cheap Chinese imports and erect tariff and non-tariff barriers against them. While there’s a thin line here between protectionism and capture by domestic vested interests, this risk cannot allow the domestic industry to be invariably destroyed by cheap Chinese imports. 

There are serious limits to how smaller and even medium-sized countries can pursue such a strategy. But for large economies like India, there’s ample space to pursue the three-pronged approach indicated above. The danger though is its capture by vested interest and the lack of adequate state capabilities to implement them effectively.

25 economic orthodoxies that should be discarded

Angus Deaton has set the cat amongst the pigeons by writing a book lamenting the state of economics in America. He has written that economists have been unmoored from realities with their dogmatic attachment to theories that are based on markets and efficiency maximisation. He has a chapter that goes to the heart of the issue titled, "Is economic failure a failure of economics?". I look forward to reading it. 

In this backdrop, this post will point to twenty-five insights from the real world that demand a break from theoretical orthodoxy. This blog has covered all of them in different posts (though I've not linked to them here). 

1. Just as there are no frictionless surfaces, there are no free markets in this world, ones that have perfect competition. Nor can there ever be any such markets. All markets, embedded as they are in the real world with people having widely varying and idiosyncratic preferences, suffer from imperfections and failures. The markets cannot self-correct these. Policy interventions are essential in those markets where failures impose significant social costs. 

2. The untrammeled pursuit of efficiency should not be valorised. Efficiency trades off against other important factors like resilience, fairness, democracy, community, etc. It invariably results in the marginalisation of these factors. The desirable objective function on any public issue is dependent on all these factors. The pursuit of efficiency maximisation is the driving force of capitalism, and manifests mainly as profits maximisation for a handful while inflicting large social costs. These social costs generate political consequences that cannot be ignored. 

3. Trade produces powerful winners and powerless losers. The losers are also often diffused across the population. The adjustment costs are both prohibitive and long-drawn, if at all. And the winners are powerful enough to prevent any meaningful redistribution. This limits the case for theoretical trade liberalisation. 

4. There's no level playing field in international trade and trade liberalisation has gone too far that its aggregate costs have become prohibitive. A rebalancing is not only politically inevitable but also desirable. Instead of describing it as protectionism, a more appropriate framing would be the reversal of a trend that had gone too far for the public good. There's enough evidence from economic research by the likes of Dani Rodrik that tariff levels are well into the state of diminishing economic returns. As David Autor and others have shown, there's indeed a China effect that causes local suffering and discontent. 

5. Like with trade liberalisation, the pendulum on globalisation too has swung to an extreme. Business trends like outsourcing, off-shoring, and unbundling of value chains in pursuit of efficiency have reached a stage where their private transaction costs exceed their benefits, and where their social costs far exceed their private benefits. Besides, they pose resilience risks and create disturbing strategic concerns. There has to be a recalibration of globalisation.

6. As Dani Rodrik has described, global citizens are national shirkers. Immigration is not an unalloyed good. At a time when good jobs are getting scarcer, let's acknowledge that immigrants compete with locals for jobs. In this context, beyond a certain level of immigration, its aggregate benefits start to be outweighed by its localised (or concentrated among certain geographies or population groups) costs. At a social level, it has to be recognised that immigration beyond a certain level strains communities. Opinion makers and academic scholars cannot wish away the real-world pressures faced by politicians due to immigration. 

7. The agenda of capital account convertibility must be replaced with capital flow management (aka capital controls), especially for developing countries. Financial market deregulation has gone so far that private benefits far exceed its social costs. Global financial markets suffer from the problem of recurrent cycles of capital flows and sudden stops that destabilise and devastate whole economies. Finance loses its disciplining powers in good times and engenders irrational exuberance which in turn inflates bubbles. 

8. Marginal tax rates should be increased to account for the extraordinary growth in wealth and incomes at the top percentile or so. High marginal taxes have been the norm for much of the last century and during the entire period in the fifties and sixties of the longest-ever post-war economic expansion and broad-based prosperity. Besides, there's nothing to suggest that people will reduce effort and investment if marginal tax rates are raised. 

9. The preferential treatment given to capital gains should be eliminated. It has distorted financial intermediation and created a world where capital gains are the major source of wealth creation globally. It also amplifies the pre-existing biases towards capital (and against labour) and ends up creating a self-reinforcing spiral of ever-widening inequality. 

10. The tax deduction on interest expenses should be restricted to a certain upper limit, beyond which it should be taxed. There's a market failure in the provisioning of capital when firms with the largest cash reserves leverage up and undertake share buybacks. The largest firms and those too big to fail enjoy an implicit market subsidy in their cost of capital. Besides, it distorts the capital allocation process by encouraging firms to leverage up excessively. 

11. Governments should not shy away from imposing windfall taxes when it's clear that the companies did nothing to earn their out-sized profits. Mining and oil companies at times of geo-political tensions, financial institutions in times of extraordinary monetary accommodation, and shipping companies during the recent pandemic lockdowns are examples. Windfall profits are an unearned increment. They are acts of God. Just as companies rush to governments seeking bailouts when faced with negative shocks, it's only natural that windfall profits be socialised.

12. It's a reality that tax arbitrage and avoidance are pervasive among multinational corporations. They incorporate entities in tax havens and transfer profits to them. They also create shell companies and exploit tax arbitrage opportunities like Double Irish with a Dutch Sandwich to minimise their tax outgo. In the globalised world Corporate tax arbitrage Tax havens, off-shore and on-shore, are a negative externality on the world economy. They are a good example of beggar-thy-neighbor policy. Such tax base erosion by profit shifting should be curtailed if not eliminated. 

13. Financial markets have come to assume a disproportionate share of the economy and corporate profits. It's already a magnet that crowds out talent from other important economic sectors like manufacturing. Businesses tend to find financial market opportunities and revenue streams more attractive than their core businesses. Financial structures and instruments that raise capital by converting private risks into systemic risks whose costs have to be borne by taxpayers should be strictly regulated. These are all market failures. How much financialisation is too much?

14. There should be deep reform of the institutional plumbing of global financial markets. These should include credit rating agencies, auditing and accounting firms, and international arbitration systems. Instead of being gatekeepers and intermediaries to ensure the effective functioning of the financial markets, they have been captured by vested interests.

15. Fraudulent practices, especially in financial, legal, and consulting services should attract criminal liabilities. No senior Wall Street executive went to jail in the US for having brought the economy to its knees with their financial engineering. Executives and employees of firms in these industries currently pursue such practices, having internalised the belief that if detected they'll get away with a slap on the wrist and (relatively) small financial penalties. They have internalised these penalties as the cost of doing business. 

16. There should be limits to executive compensation, one that's benchmarked to the median salary of the corporation's employees. There's no evidence to suggest that the spectacular salaries that many chief executives pay themselves generate anything close to value for money, nor is there anything to suggest that these executives will stop working and putting in their best efforts if all their salaries come down by a few orders of magnitude.

17. The regulatory arbitrage enjoyed by technology platform companies over their brick-and-mortar counterparts should be eliminated. Now that these platforms have grown into dominant and well-established companies, and the social costs from their arbitrage are prohibitive, it's time to level the playing field. It's time to end the delusion of being contractors and not employers, content providers and not publishers, private carriers and not common carriers, and being marketplaces without any responsibilities.

18. Data is today's oil, and there's a deep failure in the market for data. Consumer data (specifically the digital trails left behind by consumers on their platforms) is a free feast for large Tech companies. In a perversion of property rights, the rightful owners of those digital trails are not only deprived of their property rights but also do not get any compensation for their commercial exploitation by Big Tech. Entire lucrative business models and massive revenue lines have emerged from these digital trails that have enriched corporations while its generators are, at best, left with deeply discounted crumbs in the form of conveniences and addictive pleasures.

19. Technological choices have to be collective socio-political choices and cannot be left to the whims and fancies of a few large corporations and individuals. Left to the incentives of commercial interests, technological evolution will be determined purely by considerations of revenue expansion and profit maximisation. The examples of Social Media and Artificial Intelligence (AI) illustrate that a purely commercially driven direction may pose existential challenges to human society. As Daron Acemoglu and Simon Johnson have shown in their book Power and Progress, historically there's nothing automatic about the trajectory of technologies. Those trajectories are conscious social and political choices. 

20. Automation is already looming as an existential threat to humanity. Where will the jobs to absorb the expanding global population come from? How much automation is too much? In these circumstances, the adoption of technologies like driverless cars should not be left to the commercial considerations of the market. Similarly, in developing countries with an abundance of cheap labour, industrial promotion policies should step back from supporting capital-intensive industries towards labour-intensive ones. 

21. The practice of contracting labour and outsourcing services has gone too far. Businesses now see contract hiring and outsourced labour services as a cost minimisation strategy. But such labour market practices impose externalities by forcing society to bear the costs like the provision of social security. It's the exact opposite of what Henry Ford did in the early part of the twentieth century in creating good jobs that support mutually beneficial self-reinforcing economic growth. At a time when technology and the dynamics of capitalism threaten to shrink the pool of good jobs, it's important that firms be prevented from exploiting regulations to exacerbate the problem. 

22. The scope of anti-trust actions should expand beyond mere consumer welfare to include anti-competitive practices, technology, and business models that are likely to cause future harm and business concentration. There are now too many examples from the business practices of Big Tech companies to incontrovertibly demonstrate their intentions to do whatever it takes to kill off any emerging competition and retain their now deeply entrenched market power. The world of network effects and high entry barriers demands a revision of the prevailing narrowly conceived anti-trust paradigm. 

23. In the world of too big to fail (TBTF), there's a compelling case for putting limits on how large a company can become in any industry. It'll be very hard in practice to determine what's a threshold for TBTF. However, market regulators and policymakers should keep this in mind while designing and implementing policies. Apart from the market power exercised by dominant corporations, they also end up capturing the political process that formulates the rules of the game. It destroys the social compact and corrodes democracy itself. Very early Adam Smith recognised this potential for market abuse and political capture.

24. The patent protection regime should undergo change to prevent abusive and restrictive practices. Patents, especially in the pharmaceutical industry, have become a high-stakes rent-extraction system. There's little to suggest that this degree of protection is required to sustain innovation nor that without it the incentives for innovation would be significantly blunted. 

25. Lack of affordable housing is already perhaps the biggest threat to urban growth, especially in developing country cities. Affordable housing requires a combination of orthodox policies like easing zoning restrictions and also policies like public housing construction and, in some cities, appropriately calibrated rent controls even if for short periods of time. It's also required to disincentivize the practice of buying residential property purely as an investment by increasing its cost (of such purchases and holding them) with tax and other policies. 

I'll also list three general principles that should inform public discourses on issues of public interest.

1. We live in the real world with its social constraints, messy politics, scarce resources, and weak institutional capabilities. These means that reality deviates considerably from theory and logic, and this cannot be wished away. Policy prescriptions and ideas should therefore take into account these realities. Advocating policies that deviate from realities is at best ignorance, and at worst, misleading. 

2. Related to this is the insight that the solutions to complex and intractable public policy problems are rarely technocratic in nature. They require combining the smartness of technical expertise with more importantly the wisdom of experience. The former without the latter is most often misleading or plain wrong. But experience is gained through an immersive and accretive process and its acquisition cannot be short-circuited or learned in a classroom setting. 

Effective solutions emerge from the exercise of good judgment that combines technical expertise with experiential knowledge. The ancient Greeks had a word for this, phronesis, the wisdom relevant to practical action. Technical experts rarely have the experiential knowledge to be able to exercise good judgment on complex issues. In order to bring accountability, the credibility of technical experts should be determined based on how their career prophecies held up when faced with realities. 

3. The essence of equilibrium in any system is balance. The Greeks had a word for this, meson, or the middle. Unfortunately, the innate dynamic of most phenomena generates a gravitation or swing to the extreme. This is just as true of social systems as it is of physical systems. Any trend - capitalism, socialism, statism, globalisation, liberalisation, privatisation, deregulation, financialisation, automation, etc - if left to itself follows a self-reinforcing feedback loop that ends up destroying countervailing forces and creates its excesses. There's therefore the need to consciously create or encourage countervailing forces to achieve a dialectical balance.

Thesis gone too far begets anti-thesis - explaining retreat of orthodoxy

The dominant trends for the last three decades like globalisation, liberalisation, trade integration, privatisation and so on are currently under attack. Mainstream commentary dismisses these critiques as regressive and detrimental to progress. It's assumed that these dominant trends are good for human development and economic growth and any deviation is undesirable and damaging. This narrative deserves to be questioned. 

I had blogged earlier here on the reversal of trends globally on important macroeconomic, trade, and policy issues. I argued that the orthodoxy on these issues is being overturned due to the challenges facing developed countries. 

There's another explanation for this reversal - a recalibration to correct for excesses. 

Take the example of the role of government. The FT is doing a series on the return of big government. I’m inclined to frame the return of big government as a reversion to the norm in the role of government. For nearly four decades, on the back of the neo-liberal ideology governments have been on the retreat. The dominant narrative has framed government actions as being detrimental to growth. 

Economic growth and development were best realized if governments stayed out of the way! The government’s role should be confined to the provision of certain public goods and the correction of a few market failures. This ideology sees no positive role for government in economic growth. The government has been retreating even from the provision of important public goods and social security (note the framing of the universal basic income idea).

Its manifestations include globalization, trade liberalization, outsourcing, financial integration, financialization, deregulation, technocracy, privatization, and technical solutions to development like cash transfers. It also meant that politicians and bureaucrats had marginal roles and important issues of economic concern were best managed by experts and technocrats.

These trends have now become momentum-driven and are not based on any evidence or logic. They have become ideological and are integral parts of the dominant narrative. They are also fuelled by the skill-biased technological advances of the times – digitization, telecommunication technologies, automation, artificial intelligence etc. 

The four decades have coincided with stagnant and even declining incomes among the poor, slow growth of middle-class incomes, persistence of poverty and deprivation, explosive growth in executive compensations, emergence of regressive individual and corporate taxation structures, hollowing out of manufacturing cores and loss of those jobs, loss of emergence of bad quality jobs, whittling down of labor market protections and loss of labor’s bargaining power etc. 

Amidst all these, for most people, the three biggest sources of household expenditure – housing, health care, and education – grew much faster than incomes could keep pace. This compounded the problems caused by income stagnation and widening inequality. 

Inequality widened to completely irrational and unhealthy extents. The ovarian lottery became ever more pronounced in determining life outcomes. Inter-generational social mobility stagnated, even reversed. Business concentration and political capture became characteristic features of the economic and political landscapes. The process of rule-making itself came to be captured by entrenched business interests. The social contract became corroded. 

Given the excesses that had accumulated across dimensions, the reversal was only to be expected. Each of the trends mentioned above had clearly gone too far, and now had to be reined in. The only thing to discuss was how this recalibration would happen. 

The political establishment was captured by entrenched interests. The left-wing parties and groups have become too weak, the centrists are too compromised to lead the recalibration. In the circumstances, a populist backlash is on, and populist ideologies are stepping into the political vacuum to assume leadership of the reversal process. 

Given this backdrop, the pushback and reversals were only to be expected and are even desirable. It's therefore wrong to tar everything with the same brush and oppose the entire reversal. As mentioned, the reversal is much needed. Perpetuating the existing system is tantamount to the protection of entrenched vested interests that have captured the economic and political system. 

The challenge is to calibrate the reversal and ensure that the anti-thesis does not swing to the other extreme. The problem is with the extremes. This is a big challenge, given that the dynamic of populism tends to move the pendulum to the other extreme.  

Even the latest global crisis playing out in Gaza can be viewed from this prism. Notwithstanding the barbarity of the Hamas attacks, we should not have been surprised by it. For seventy years, a population had been denied its rights, and in the last decade the issue had even dropped off the global radar, allowing Israel to undertake one of the biggest and longest collective punishments in history with blockades, air-strikes, and creeping encroachment through settlements. The Israeli government of recent years which was surviving on the support of two extreme right wing parties had thrown-aside any pretension of Palestinian rights. Any hope of a life without brutalisation, discrimination and humiliation was receding rapidly. The pendulum had swung to its extreme. Even the most oppressed and powerless will strike back when they can't take it any longer. 

As an aside, there's also something about the nature of such events. There's something universally repugnant about the concentrated massacre of 1300 people that is played out in social and mainstream media, as against a much more brutal occupation and dehumanising violation of the basic rights of over 5 million people in West Bank and Gaza that's long-drawn and played out silently off-camera, one that has led to the murder of several times more men, women, and children. 

The reversals on all important trends like globalization and trade liberalisation too should be viewed along the same lines. For three decades, globalization and trade liberalisation pressed ahead remorselessly. In the process, it engendered several distortions that conflicted with the interests of domestic political and economic systems. The discontent that had been brewing has now become powerful enough to turn the tide and recalibrate. This dynamic, popularly described as deglobalization and protectionism, should perhaps more appropriately be called balanced-globalisation.

There’s a natural dialectic associated with ideas. They trigger interest and get gradually adopted, with their degree of adoption increasing over time. This, in turn, creates distortions that cause a backlash against the idea. The backlash strengthens over time and results in a reversal of the excesses that had seeped into the idea. As Hegel wrote, thesis begets anti-thesis, both of which undergo a struggle to generate a synthesis. Another framework to view this is that of the cycles of history, one which people like John Bagot Glubb, Neil Howe, William Strauss, and Peter Turchin have popularised. It's useful to view the ongoing trends in the global economy and politics from this perspective.