The paradox of a cashless society

To be successful, the push for cashless society must accommodate the anonymity of cash

There is no doubt that moving towards a cashless society has immense benefits: from making transactions convenient and highly efficient to bringing most of the economy under accountability. From where India stands at 2016, a concerted push towards reducing the use of cash makes a lot of sense.

In an editorial last week, Mint enumerated some important steps to ease the path towards a cashless society: availability of telecom connectivity, investment in technology that improves security and simplicity, and government incentives that favour cashless transactions. In an earlier interview with the same newspaper, Nandan Nilekani argues that since much of the necessary infrastructure — Aadhaar, IndiaStack and Unified Payments Interface — is already in place, the Modi governments currency reform (‘demonetisation’) will act as a shot in the arm for India’s move towards a cashless economy. [Disclosure: Mr Nilekani is a donor to the Takshashila Institution.]

The Mint editorial, however, misses one crucial aspect. Apart from cash being a wireless technology with near-infinite battery life, and one that needs no telecom connectivity, it is its inherent anonymity that makes it a very valuable instrument. Yet, most advocates of a cashless society advocate it precisely because it gets rid of anonymity. Ergo, the extent of cashlessness might well be defined by the extent that people value anonymity and privacy. What this means in practice is that unless the demand for anonymous transactions is satisfied, India might not cross what the editorial correctly describes as “the threshold level after which the network effect will take over.” The question is whether the desire for anonymity prevent a forming a critical mass of Indians that rely on electronic payments. This, more than technical considerations, might dictate the pace at which cash is displaced from its throne.

It is understandable, not least at times of moral panic, that ordinary people will fall in line with the arguments of moral puritans and self-righteous advocates and assert that law-abiding citizens need not fear lack of anonymity. Such views ignore the the reality that families and societies are often held together by harmless lies. For instance, one family member will to put away some money from the rest, without any illegal purpose in mind. Some people like to give anonymously to charity, without any malice or illegality involved. These kinds of innocuous, quotidian acts are a glue that binds society.

Then there are perfectly legal acts that people wish to hide from their families, society or government in order not to attract criticism or punishment. Many people have food habits they’d rather not admit to their family, others might want their alcohol and cigarette purchases to remain hidden. People might give money to NGOs and political parties that are heterodox, dissenting or championing unpopular causes. Such acts characterise and sustain liberal societies. Indeed, even some illegal activities — say prostitution or consumption of certain narcotics — that take place regardless of the letter of the law might have a stabilising influence on our societies. The fact that puritans are disgusted and outraged by this is beside the point. Indeed the story of post-Enlightenment social change around the world is one of legitimising a number of acts previously considered immoral, after weighing them in the court of Reason.

For this reason, some jurisprudence has equated anonymity of cash with free speech. I usually avoid turning policy arguments into a question of rights, as it forestalls further discussion. In this case, though, I think it is justified. It would be hard to sustain free speech if there is an audit trail exposed to the market, society or government. The chilling effect this would have would impinge on the foundations of a liberal society.

Therefore, there are good reasons, both practical and of principle, to retain anonymity in financial transactions. To succeed, initiatives to promote a cashless society must, er, account and accommodate them. Good policy ought to be able to balance many valid considerations and arrive at an optimum approach. Allowing cashless transactions to be anonymous below a certain limit might offer a reasonable compromise. For instance, a stored-value “cash” card, available without requiring proof of identity, limited to payments of Rs 10,000 per month, with an six-month expiry date is one type of solution. This will achieve the transactional benefits of electronic payments, the anonymity of cash and limit the risk of use in large-scale criminality. Of course, even these cards can be abused, but I’d argue that the social benefits outweigh the costs.

If the government takes such a route, it will create enough room for innovation that can, paradoxically hasten the march towards the cashless society. Otherwise, we might take a very long time to cross the threshold that will unleash those network effects.

Tailpiece: It’s not as if a cashless society will lead to greater honesty. Dan Ariely’s experiments suggest otherwise.

“From all the research I have done over the years, the idea that worries me the most is that the more cashless our society becomes, the more our moral compass slips. If being just one step removed from money can increase cheating to such a degree, just imagine what can happen as we become an increasingly cashless society. Could it be that stealing a credit card number is much less difficult from a moral perspective than stealing cash from someone’s wallet? Of course, digital money (such as a debit or credit card) has many advantages, but it might also separate us from the reality of our actions to some degree. If being one step removed from money liberates people from their moral shackles, what will happen as more and more banking is done online? What will happen to our personal and social morality as financial products become more obscure and less recognizably related to money (think, for example, about stock options, derivatives, and credit default swaps)?” [Dan Ariely, The (Honest) Truth About Dishonesty: How We Lie to Everyone – Especially Ourselves.]

New currency notes for old

A one-off reduction of unaccounted money must be followed by long-pending structural economic reforms.

Some of the most insightful arguments on the demonetising of high-value currency notes have come from Takshashila associates.

Ajit Ranade has long been a proponent of getting rid of the high-denomination bank notes, pointing out that this will make a big dent in holdings of unaccounted money.

Karthik Shashidhar, on the other hand, has calculated that the exercise will be very costly. In other conversations with some colleagues last night, we noted that the real costs will be even higher, given the higher transaction costs, friction and so on.

[Update] Anupam Manur has a thorough analysis of the demonetisation.

Deepak Shenoy, one of India’s shrewdest analysts of capital markets, has more recent analysis that argues that the Modi government’s move will have short-term negatives but long-term positives. You should read the articles I’ve linked to above.

The Modi government’s move (even if it rightfully ought to be the RBI governor’s move) to demonetize Rs 500 and Rs 1000 notes and replace them after some time with new Rs 500 and Rs 2000 notes will act as a move to massively reduce the existing stock of unaccounted money and counterfeit currency. [Update: There will be new Rs 1000 notes too!] This will generally hurt the people who are sitting on large amounts of cash holdings (mostly for evading tax) and also, temporarily, those who are holding on to some cash, but have no bank accounts. This is significant.

A senior colleague argued that this was an extremely courageous move by Prime Minister Modi, not least because it hurts business communities that have long supported him and the BJP. However, given that this is one of the few moves that makes honest citizens feel good, it is likely to strengthen Mr Modi’s personal popularity. Effects on electoral outcomes have probably been calculated by those whose business it is to do so, and are probably as good as the best (or the worst) guess. There are just too many factors at play when it comes to how people will vote.

Now, if the government (or the RBI) had merely demonetized the big notes, the effect would have been to put permanent brakes on tax evasion and a faster move towards ubiquitous electronic banking. However, since the big notes will be back, the effect will be one-time. In fact, as another colleague pointed out last night, the same mattress will hold twice as much cash if filled with Rs 2000 notes. Also, many cash holders will convert their current holdings into gold, foreign currency or some other assets until they can change it back to cash again. There are limits to how much money they can hide this way, but many middlemen will make healthy commissions by providing such “services”.

Bank accounts will see a lot more transactions as latent account holders begin to transact through banks. This effect too will not be complete, as some might just decide to wait until the new notes arrive, and then lapse back to old habits. Behaviour is very hard to change easily. Until mindsets towards banks, taxes and scruples change, people will continue in the old pattern. It’s a good time to refresh the case for structural reforms: deregulation, getting rid of the license raj (no, it didn’t go away in 1992), tax reform and liberalisation. This will require even more courage on the part of this government (or any government, for that matter).

Will the move hurt confidence in the Indian Rupee? A sober Anupam Manur, Takshashila’s macroeconomics analyst, noted that denominations don’t impact the value of the currency. He doesn’t think the rupee will be hurt. On the other hand, another colleague likened this to Mr Modi’s Tughlaq moment — more politically, perhaps than economically.

The war against corruption and unaccounted money can only be won when economic incentives change, and in turn, change behaviour patterns (and ‘culture’). Disclosure schemes and demonetization of high-denomination currency notes have a salutary, but temporary effect. There is, however, no alternative to Reforms 2.0.

What lies to the right of centre in India?

The cohabitation of traditionalists and market liberals

Ever since India’s 2009 general election, it has become fashionable for many politically-minded people in the country to style themselves as being “right of centre”, “centre-right” and other terms where “right” and something else is joined together with a hyphen.

It is clear what people who label themselves thus are against — the Congress party, and especially the family that constitutes its apex leadership. Mostly, they oppose its “appeasement” of minorities, especially Muslims. They oppose its propensity to create “entitlements” in the form of reservations, quotas, subsidies and special treatment. They oppose the cronyism in the economy and political corruption in governance. They oppose its pusillanimity in foreign policy. There are many more, but these strike me as the big ones.

It is less clear what they stand for. Many of our self-styled right-of-centrists are strident opponents of liberalism. Many have deep misgivings, if not outright opposition to markets and free trade. The most coherent “right” in India is the Hindu right, which is clear about its commitment to Hindu nationalism, broad or narrow. However, even the Hindu right does not have an economic agenda that is consistent with its political ideology: should the Hindu nation rely on individual liberty and free markets, or should it construct a strong state that draws lines on individual freedom and controls the levers of economic power? During and after the 2014 election campaign, market liberals and social illiberals found themselves in the same “right of centre” camp, often having to pretend to be each other in order to fit in.

This ideological confusion and political tension within the segment that calls itself right-of-centre in India comes because our political context and historical development is different from that of the West, where the Right and Left first came into existence. I’ve written about this in my Niti-Mandala post, constructing India’s political spectrum. I was reminded of it last week as I read Jonah Goldberg’s statement of the Conservative position in the United States: which connects tradition and markets and forms the basic worldview of the American Right that the Republicans used to champion before Donald Trump, er, shook things up.

As a Chestertonian at heart, I like and respect old things. I like it when stuff beats the law of averages for reasons we cannot easily fathom. The Hayekian in me thinks old things that last often do so for good reasons we just don’t — and sometimes can’t — know. Unfortunately, we live in an age where we take the razor of reason to every little thing and strain to know the whys of it, as if knowing the why will empower the how. [National Review, emphasis added]

The same argument would be self-contradicting in India: where there are inhuman inequities embedded in caste discrimination and social practices. You can either defend the traditional Indian social order or individual liberty (and markets and so on). You can’t defend both, because the former is constructed without regard to, and often in suppression of the latter. This explains the confusion and tension among our “right of centre” compatriots, who are at best, — to turn a phrase from a best-selling novelist — Half Right. No pun intended.

They can either be traditionalists who seek to defend the old order from social revolution, and therefore come into tension with the Constitution that demands it. Or they can be liberals who pursue individual liberty and free markets, and thereby come into tension with everyone else who opposes either individualism or markets or both. They can’t be both.

Logical consistency apart, the practical question is to what extent can the two Half Right constituencies come together in politics. Is the tension between them bridgeable? Well, that’s hard to say, but the side with greater political clout will force the other into submission. Market liberals are not driving policy in the Modi government today.

The arrangement will hold to the extent that their dislike for the Left outweighs their dislike for each other. If the Congress party sheds its baggage — and that’s a big, big if — or another party takes up its Centrist space, it is likely that the the more liberal of the liberal Half Right will gravitate towards it. Until that time, the liberal Half Right will cohabit with the traditionalist Half Right, because most who seek the security of an ideological label are likely to lack the courage and commitment to stand apart, because that means standing alone.

Modi in the Valley

There are lessons and reflections for Narendra Modi in Silicon Valley

This is the original English version of an op-ed published in Hindi, in Nai Dunia, Indore, today.

If California were an independent country, it would be one of India’s important trading partners: last year we imported more than $5.3 billion worth of goods from that state. While IT services exports catch most of the limelight, India also exports items like cashew nuts, coffee, tea, engine parts, metal screws, rice and vegetable extracts. California hosts more than 4,75,000 Indian-Americans and is deeply connected to our technology industry. Silicon Valley companies have invested heavily in India over the last twenty years, and their presence contributes to the livelihoods of several lakhs of people in India — from IT & BPO employees to the taxi drivers who drive them to work. So much is Bangalore’s technology sector connected to America’s that we like to joke that the traffic in the city is lighter during public holidays in the United States.

So there are very good reasons for Prime Minister Narendra Modi to visit California, instead of limiting himself to the usual New York-Washington circuit that India’s political leaders usually do. Reaching out personally to top investors and business leaders helps promote India as a destination for investments, where we are in competition with China, East Asia and Eastern Europe. Whatever may be the domestic criticisms of the “Digital India” initiative, it is a good calling card for the Indian prime minister as he engages the some of the world’s most influential technology leaders. His personal charisma and public speaking skills make him a fantastic salesman and marketer of the India story.

Also, unlike our own businesspeople, it is likely that foreign business leaders will be more straightforward in telling him why they find it hard to do business in India. The country will benefit from such candid feedback, especially if Mr Modi diligently follows up on it once he is back in New Delhi.

That, essentially, is the real problem. Even without Mr Modi visiting Silicon Valley, it is a well-known fact that India has the talent, the resources and the market to make it a potentially exciting destination for investment. Yet, much of this potential cannot be realised because of the government gets in the way. Complicated tax laws, for instance, raise costs of doing business, increase corruption and invite political rent-seeking. Poor contract enforcement is merely the tip of the iceberg of a pervasive lack of trust in society, which deters investors. Lack of attention to basic public services, like water, electricity, education, health and transportation shifts the costs onto the private sector. This not only raises costs for investors (and makes India more expensive a place to operate from than it should be) but also creates social divisions, because others do not have them. We all know the problems with land acquisition and labour reform.

Mr Modi can’t be unaware of these issues. In his interactions with investors, he would probably have reassured them that his government will address these challenges. While he might get away with these responses as this is his first visit, he might not receive a patient hearing the next time. In other words, he has staked his personal credibility on addressing the challenges faced by investors and he will now have to deliver on them. This is not easy because it is unclear if his government realises that the entire Delhi Straitjacket has to be removed from our economic lives, not mere tweaking at the margins. We have not seen any sign of that since the Modi government came to power. Worse, even as Mr Modi promotes Digital India, his government scores such shocking self-goals like the recent one concerning a very poorly drafted National Encryption Policy that it was forced to withdraw after strong public criticism. The Modi government has done nothing to repeal the horrible IT Rules (including the infamous Section 66A) that were introduced by the UPA government.

After the success of the visit, Mr Modi will have to pay attention to the essential task of economic reform. Whether to satisfy the aspirations of the domestic population or demands of foreign investors, the answer is the same: economic liberalisation on a much bigger scale than Prime Minister Narasimha Rao’s in 1991.

While no one might have told him this, but Mr Modi would do well to reflect on why Silicon Valley creates companies like Google, Tesla or Facebook that have a global mindset. Most startups there begin with a plan to capture the global market. Their dreams are big. Of course, the ecosystem enables them to fulfil those dreams, but the big dream is the starting point. Most of our entrepreneurs in contrast, limit their dreams to the borders of our own country. The Delhi Straitjacket is partially responsible for this, but there is also a mindset problem, in that we are content to think within our “narrow domestic walls”. Elon Musk wants to transform the way the whole world travels. He wants to even transform the way humans travel to space. If there is something Mr Modi should learn from Silicon Valley is the need to unshackle our richest, most capable and most talented people to open their minds and push the envelope of human achievement.

Those who criticise Mr Modi for going on too many foreign trips miss the point, for his trips help raise India’s profile abroad. What we should discuss is whether his government delivers on the reforms necessary to meet the additional expectations he has created at home and abroad.

On net neutrality and the national interest

Net neutrality might be an optimum compromise in the absence of full liberalisation of the telecom industry

This is a comment I wrote for the Hindi newspaper Naidunia (Indore). Given that Takshashila might submit an official response to the TRAI public consultation on the subject, it is important to state that this is my personal opinion.

The ongoing debate on net neutrality reveals clashes of several public goals and interest groups. Should service providers have the freedom to sell products of their choice to customers of their choice, or should they not have this freedom? Do consumers have the right to use internet services as they have always been used to? Should the open “ethos of the internet” continue to remain so even after it has passed out of the US government’s management and into the hands of the international community? Will an internet with different lanes for different traffic remain the internet as we know it? Should application and content providers like Facebook, Twitter and WhatsApp enjoy greater profits despite making much smaller investments than telecom service providers?

The issue is complex and entangled, and we should resist the temptation to see it as a fight between good guys and bad guys. There is nothing wrong in corporations trying to maximise their profits as long as they conduct business in a legal and ethical manner. It would be wrong to project telecom service providers who are seeking to improve their profitability as villains. Similarly, it is rather pointless for them to look at over-the-top (OTT) services like Facebook and begrudge them their profits. Different industries have different risks and different rewards. Consumers too cannot claim that things should be as they are and every change is a negative development.

So what should we make of this issue? I would like to answer this question by asking “what is India’s national interest with regard to IT in general and the internet in particular?”. There are three aspects to our national interest:

First, given that less than one in ten Indians has access to broadband, it should be a national priority to increase penetration. There is a correlation between broadband penetration and economic growth rate. India’s development needs our economy to leapfrog into the information age: for this we need reliable, affordable services. So when thinking about net neutrality at this stage, the government must give the highest priority to ensuring the maximum number of people take up broadband in the shortest duration possible.

This, however, should not come as a result of price regulation. Fixing prices and a government that worships at the altar of “low cost” will result in damage. Low prices should come as a result of market forces and competition.

Second, given that India’s IT industry is an engine for growth and development, we must ensure that it remains globally competitive. The industry is worth more than 100 billion dollars and employs more than 10 million people. There are thousands of startups in the country aiming to become the next Infosys and FlipKart. Our IT policy should not create more hurdles for entrepreneurs and ensure that they have the best possible start to build world-class companies. Without Net Neutrality, the risk that startups will face even greater “unfair disadvantages” against established firms is higher.

Third, it is in the public interest for the telecom and mobile service provider industry is healthy and competitive. In the past decade, the regulators pursued the goal of forcing the telecom providers to lower user tariffs. While India has one of the lowest costs of telecom services in the world, the service quality is patchy. Calls drop frequently. Broadband service often is of lower speed and suffers outages. Billing services are terrible. Anyone who has tried calling the customer service helpline of any telecom provider will attest to the fact that it is very difficult to get anything done. All this is because telcos are cutting costs in these areas. There are few lucrative or premium services left where they can increase their profitability. The only protection they enjoy is through licensing — the government limits the competition they face.

When deciding what to do about net neutrality, we must keep all three considerations in mind, and optimise them simultaneously. If the government opens up the telecom service market to greater competition, perhaps by issuing unlimited licenses, then there is a case to allow them the freedom to discriminate among customers. As the state-owned carrier, BSNL can provide a neutral internet. However, if the government does not open the sector to further competition, therefore shielding the telecom service providers from more competition, then mandating net neutrality provides a reasonable approach to promoting the public interest.

The current debate calls for the government to review the entire licensing regime and consider full liberalisation of the telecom industry.

Robbery is not right

The ‘rights-based approach to development’ is immoral and illiberal

Why was there ideological collusion in the passage of a bill that promises ‘food security’ but is certain to severely undermine India’s development path? Several reasons can be adduced—from the electoral to the conspiratorial—but what gave both the terrible bill and the even more terrible scheme it seeks to implement the impression of inevitability was the underlying narrative of a “rights-based approach”. And, as Narayan Ramachandran writes, “[the] apostle of the rights-based approach in India is the National Advisory Council (NAC).”

Over the last decade, the NAC’s narrative of a “rights-based approach” to development has acquired dominance. It has pervaded government policy because Sonia Gandhi, its chief and Congress party president, in all likelihood, genuinely believes in it. The power of narratives is such that even if you replace Mrs Gandhi and her NAC with another political leader and his or her own clique, they will be compelled to persist with the same policies as before, or undertake the Hanumanian task of countering the rights-based narrative before rolling back or changing tack on the massive entitlement schemes. (See my previous post on this).

Narayan argues that the rights-based approach is the wrong development model for India. In fact, “rights-based approach” is a misnomer. It is a clever way to refloat the failed policies of socialism under a new, fashionable but dubious political philosophy. In essence, this ‘development model’ identifies an ever-growing list of life’s needs and necessities, declares that they are ‘rights’ and suggests that these be provided by the state.

A lot of well-meaning people are fooled by this sophistry. Since few good people will dispute that people need food, education, healthcare and jobs to live in this world, they become susceptible to the argument that such necessities are rights. Moreover, since a lot of famous people, including Nobel laureates and rock stars, advocate this approach, the notion that such things are rights acquires wings.

Yet for all the celebrity endorsement, warm fuzzy feelings it creates, the so-called rights-based approach is immoral and illiberal. The only true rights are those that do not come at anyone else’s cost. Preetam’s right to life, equality, freedom and property do not come at Palani’s cost, and vice versa. The state might have to incur a cost to protect these rights, but not to provide them. [Meet Preetam and Palani, in Redistribution as Theft]

The entitlements that the NAC-types call ‘rights’ are different. It costs someone something to provide them. If Preetam and Palani are the only two citizens in a hypothetical state, the cost of providing Palani’s right to food, education, healthcare and jobs must be borne by the state. If the state, in this example, is financed by Preetam’s tax payments, Palani’s entitlements come at the cost of further infringing on Preetam’s rights (in this case, the right to use his money as he pleases).

It is sometimes reasonable to argue that Preetam must be made to pay for Palani’s necessities in order to have a equitable society. Or because Palani might be contributing to Preetam’s welfare in other ways. What is wholly wrong, though, is to contend that food, education, healthcare, internet connections, jobs and suchlike are ‘rights’, in the same way as life, freedom and property are rights.

However desirable, however necessary, if it costs (someone else) to provide, it is not a right. It is an entitlement. Liberal democracies can agree to make some entitlements obligations of the state. But it is important to keep these obligations distinct from rights. The framers of the Indian Constitution made this distinction when they separated Fundamental Rights from Directive Principles. Unfortunately, their successors in parliament lacked the same moral clarity, and proceeded to undermine Rights even as they attempted to rightify the obligations that fall under the Directive Principles.

Because it violates (someone else’s) rights, the rights-based approach is universally immoral. India cannot afford the luxury of this ‘international development’ fashion. The cost of providing an ever-growing list of entitlements is prohibitively large, and will severely undermine India’s future. Right-minded people and political parties (no pun intended) should reject the rights-based approach.

Tailpieces:
1. The Two-Person Test to determine what is a right (also known as the Preetam & Palani Test). If it costs Preetam to provide Palani something (and vice versa), then, however desirable it might be, it is not a right.

2. If we accept the rights-based approach, then we urgently need to legislate the “Right to Richer Spouse.” If every citizen has an enforceable right to marry a richer person, then poverty will disappear fairly quickly. Such a right will take away some freedom from the richer persons, but that’s no different from the rights to food, education, jobs and suchlike. If you find the Right to Richer Spouse absurd or repugnant, just remember that it is based on the same logic as the right to food, education, healthcare, jobs, internet connections and so on…

3. A storified series of tweets on the topic.

Redistribution as theft

Alleviating poverty requires economic growth alone.

It is not often that Indian public discourse seriously discusses big ideas. So it was nice to see, a few days ago, a debate in large sections of the mainstream and social media on economic growth vs redistribution. This debate received wider public attention because it was conflated with a personality clash between Jagdish Bhagwati and Amartya Sen, because it became entangled with the hottest political topic of our times and because it came at a time when the issue itself is important.

When faced with two sharply different points of view, it is common—not least in India—to insist that the truth lies somewhere in the middle. This is celebrated as being reasonable, as representing the compromise that is the hallmark of democratic practice and as being the mystic middle path. So when some economists insist that growth is the best way out of poverty while other champion redistribution of wealth, it is to be expected that there will be reasonable people who will say “we need both more growth and more redistribution”. This is a good way to end the debate amicably and drink to reasonability and democratic compromise.

Unfortunately, there’s a difference between appearing reasonable and being right. “We need more growth and more redistribution” is not a reasonable middle position. It is essentially an argument for redistribution but stated in a different form.

Without growth, redistribution is at best a transfer and at worst, theft. If a community earns the same amount of money (or produces goods of the same value) every year, then redistribution takes from Preetam to pay Palani. If Preetam consents to the arrangement, it is a transfer. If he doesn’t, it is theft. Over a period of time, it will make the community more equal, but it doesn’t necessarily make the community less poor, for even after achieving income equality, the average income can be below what is required to subsist.

Growth is the only way to increase the overall income of a community. It can raise the respective incomes of both Preetam and Palani, although Preetam’s income might rise faster than Palani’s. Inequality will rise in such a community—perhaps because Preetam was born into a better endowed family, perhaps because Preetam works harder or perhaps because Palani faces greater social hurdles—but because both Preetam’s and Palani’s incomes rise, the whole community can climb out of poverty. There is vast empirical evidence for this, and growth is the best antidote to poverty. It’s the most effective anti-poverty scheme known to humankind.

Here’s the best thing: in such a society, there is no inherent need to take from Preetam to pay Palani on the grounds of poverty alleviation. There might be other issues—for instance, progressive taxation to finance public goods based on the ability to pay, but not to help a poor Palani out of poverty.

Hey, wait a minute! Isn’t inequality rising? Isn’t that a bad thing? Aren’t Palani’s prospects not handicapped by historical social hurdles? Aren’t Preetam’s disproportionate gains coming from exploiting Palani? The reasonable people who argue that “we need both more growth and more distribution” usually raise these questions to argue for more redistribution. (There are unreasonable people who raise these questions for other reasons, but let’s stick with responding to the reasonable).

Yes, inequality will rise, especially during periods of high growth. But inequality is a social problem only if it is permanent and ossified. However, growth is the best way to ensure that it is not—with growth comes mobility, and the expectation that one can improve one’s life allows societies to thrive despite the inequalities. Ask migrants to New York or Mumbai. Many also see a moral problem with inequality, but why expect the state to solve moral problems? Let the moral conscience of society address its moral problems.

Shouldn’t we account for historical social hurdles that hobble some citizens? Yes, but these are addressed by creating equality of opportunity, not by insisting on equality of outcomes (where Preetam and Palani end up earning the same income). You can achieve equality of opportunity without redistribution—affirmative action and reservations (without subsidies) are ways to address this challenge.

Isn’t Preetam exploiting Palani? This blog post will not attempt a comprehensive critique of Marxist thought. However, the ideas of economic freedom, property rights, voluntary exchange and comparative advantage together prove that Preetam’s gain is not at Palani’s cost. Although the sort of people who argue that Preetam exploits Palani will seldom acknowledge that redistribution, by definition, means that Palani’s gains come at Preetam’s cost. Unlike redistribution, growth creates non-zero-sum or win-win situations. Only growth creates such situations.

From this alone, we should conclude that “we need growth, not redistribution”. But reasonable people will go to great extents to be reasonable. It’s about sequencing, they’ll say, and contend that some redistribution is necessary for growth. It’s unclear why this is called a reasonable argument—if we accept that both Preetam and Palani will be better off with growth, then the decision to take some from one and give it to the other is unnecessary, whimsical and entirely arbitrary. Instead, why not spend extra effort to ensure that there are no constraints to growth in areas that benefit Palani?

Ergo, what appears reasonable is not quite reasonable: we need growth, not redistribution. The state can ensure growth by getting out of the way of private enterprise, ensuring public goods are provided, acting as an impartial referee, ensuring equality of opportunity and a level playing field. Governments are not good at redistribution: it involves taking money from people who don’t want to give it up and passing it through a system where everyone wants to grab as much as they can get. That is why redistribution is attractive to politicians who are keen to listen to intellectuals who say it is necessary.

Why sports betting must be legalised

An industry that operates above ground is less likely to engage in fixing

The ongoing spot-fixing controversy in Indian Premier League cricket has evoked the usual response. We need a new law—to criminalise cheating in sports—, with harsh punishments, strict enforcement and so on. Given statements made by politicians who are also cricket administrators, it is possible that such a law will indeed be enacted. But if you think the problem of fixing will come down substantially because of this, you will be mistaken.

First, let’s be clear—no matter what you do, it is impossible to completely eliminate illegal activity. There will always be some people who will cheat. What you can do, however, is to reduce the incentives for cheating to such a level that very few people cheat and tighten enforcement enough to catch some of those who do. If this is done, there is a possibility that eventually a culture of integrity will emerge and you’ll have few errant cases to deal with.

In other words, you need to drain the swamps. In the world of Indian cricket, the swamp consists of the illegal economy of betting. Because betting is considered illegal, it is mostly under the control of underground international syndicates that are usually mixed up with other, more dangerous types of illegal activity—like arms trafficking and terrorism. These syndicates operate outside the law and often with key operatives located outside the country, beyond the reach of Indian authorities. The criminal syndicates bribe policemen, bureaucrats and politicians in order to be able to carry out their activities. They also employ thugs and other unsavoury characters to enforce ‘contracts’. And yes, it also creates a lot of unaccounted money that then goes into other underground activities.

There is an economic rationale for this entire criminal economy to exist—there is a lot of money in betting. According to FICCI, illegal betting in sports is worth Rs 12000 crore to Rs 20000 crore per annum. If betting is legalised, this rationale begins to weaken. If people have a choice to place their bets at licensed betting counters—like they do for many sports in many countries—the likelihood that they will prefer to deal with unlicensed bookies will be lower. How much lower depends on the regulatory framework—competition among operators, taxation and anonymity, for instance—but to the extent that it does, the illegal operators will suffer.

It makes ample sense, therefore, to legalise betting and regulate it with the purpose of prevent the industry from falling into the hands of criminal syndicates. As the swamp is drained, the likelihood that it will breed disease-causing mosquitos will go down. There will always be unscrupulous individuals who will attempt fixing, but they will be a lot more isolated from the underground criminal networks than they are today. It is riskier to be an individual crook than to be a member of a big criminal syndicate; so fewer people will be tempted. Law enforcement authorities will be able to do a better job apprehending them because they are fewer in number and operate as individuals or small gangs.

Is it necessary to legalise betting? Won’t law enforcement alone suffice? Well, merely tightening laws and enforcement is likely to have the effect of raising the price of fixing. Spot fixing, like match fixing, will continue, but players and bookies will demand higher prices.

From my archives: On legalising prostitution and two thoughts from Amsterdam

In defence of lobbying

The lobbying industry must be allowed to function transparently within the ambit of the law.

This is an unedited draft of today’s column in Business Standard.

A famous Indian politician was searching for an issue that could energise his party cadre and move the masses. An group of businessmen produced a report on “making India self-contained in her supply” of a particular commodity. It had arguments on the rationale on consumption of the commodity, why it was necessary and why the poor needed it more than the rich. One of the politician’s close associates forwarded the report to the party leadership across the country while his personal secretary echoed the report’s arguments in an op-ed article the subsequent week.

The politician embraced the cause and triggered off a historic agitation, the basis of which, partly at least, was the output of corporate lobbying. The politician was Mohandas Karamchand Gandhi, the industry group was FICCI and the commodity common salt. The historic event in question, of course, is the Salt Satyagraha (see this post for details). It would be hazardous to suggest that a FICCI monograph singularly triggered off Gandhi’s famous march to Dandi. It would, however, be equally hazardous to discount the importance of lobbying on national politics then, as indeed in contemporary times.

The current debate over corporate lobbying conflates two separate issues: one, the legitimate persuasion of politicians on the merits of a certain policy measures and two, the illegal activity of bribing them in pursuit of this goal. The latter is wrong. The former is necessary. We might be in the throes of moral panic, but we should not mix up the two.

Lobbying is inevitable in a modern representative democracy: the more rules you make, the more complex the economy, the more the need for ‘specialists’ to intermediate between citizen, corporation and the state. That’s why we have lawyers, who help individuals and firms navigate the legal system. That’s why we have chartered accountants, who interpret the arcana of tax laws. These intermediaries play an important economic role by specialising in such matters and saving you and I the trouble of mastering law and the tax code when all we want is to go about our business.

Lobbying serves a similar function. It is far more efficient for businesses to hire public affairs specialists and lobbyists rather than involve the management in the byzantine world of Indian politics. If we consider lawyers and chartered accountants as legitimate professionals, why not lobbyists?

One argument against mainstreaming lobbying is that lobbyists risk making democracy a plaything of the rich. Those with deeper pockets will get to unduly influence government policies. This is reasonable in and of itself. However, isn’t it true that richer people can afford better lawyers and bend justice in their favour? Isn’t it true that richer people have smarter accountants who can find ingenious ways to pay less tax? More importantly, isn’t it the case that richer people already influence government policies, but in opaque, shady, dubious or wholly illegal ways? Those who doubt this can contact Mr Kejriwal for details.

Hey wait! What about the Niira Radia controversy? Doesn’t that connect shady corporate lobbying to high corruption? Yes, it does. However, that controversy arose in a country where lobbying is not only unregulated by perceived by many as a dubious activity. Had lobbying been a recognised as a legitimate profession, bound by its own norms and governed by a set of rules—like law and accountancy—we might have been spared some of the scandal.

This is, in fact, a good time to have a public debate over lobbying. Before 1991, most corporates would line up outside government offices as supplicants pleading for licenses, quotas and permits. After 1991 and until the exposure of big corruption scandals of 2010, canny businessmen sought to create legislative loopholes that would allow them to squeeze through, but keep their competitors out. This approach is becoming untenable.

Economic growth, globalisation, the Right to Information (RTI), urbanisation and the penetration of social media have changed the nature of how India’s corporations and governments engage each other. Businesses that try to create and exploit loopholes have a greater chance of being exposed, with the attendant loss to reputation and valuation. Like their counterparts in mature democracies, Indian businesses will have to engage in public affairs in cleaner, more professional, and transparent ways.

This can only happen if we allow the lobbying industry to function within the law. It is far better to regulate it rather than drive it underground. Indian democracy will be better served by placing the lobbying industry in a regulatory environment that requires companies to declare their lobbying activities and expenses, lobbying firms to disclose their activities and lobbyists to adhere to professional codes of practice. This is what the United States does. It’s not a silver bullet, but certainly an improvement over hypocritically persisting with a sanctimonious moral blindfold and pretending to be surprised that odious things happen in our country.

Copyright © 2012. Business Standard. All rights reserved.

The dogmas that undermine our defence

Reforming defence procurement, mindset first

This the unedited version of my op-ed in today’s Business Standard.

Why is it that on the one hand India is the world’s biggest arms buyer, and on the other, the outgoing army chief has complained that we are short of basic war-fighting equipment like tank ammunition and field guns? Why is it that our defence procurement takes years to complete and can be halted or reversed by allegations of corruption? Is corruption so rampant within the top echelons of our armed forces that the both the army chief and defence minister could shrug off a brazen attempt to bribe the general in his office? How come the defence ministry has spurned and blacklisted vendors from countries whose geopolitical interests are aligned to ours?

It is easy to treat these issues as merely the failings of individuals and the shortcomings of the latest procurement rules. It is easy to park the unholy affair under the general head of how corruption is undermining our nation. To do so would be to ignore the underlying causes of why things have some to such a pass.

The first is the dogmatic pursuit of indigenisation, a mindset that pervades the defence establishment. It has resulted both in policy capture by public sector unit (PSU) network and introduced layers of complexity in procurement rules. Ordinarily, as end users, the armed forces would want the best possible equipment for the rupee, but they too are prisoners of a narrative that involves the pursuit of a chimerical indigenisation. For in New Delhi, it is still nearly heretical to suggest that an enemy killed by a foreign-made bullet is as dead as an enemy killed by a partly-indigenous bullet.

This is not say indigenisation is an unworthy goal. Rather, it is to suggest that the longstanding approach to indigenisation has not only met with limited success but also that the same goal can be achieved using different means. Back in the 1970s and 1980s the government couldn’t produce an indigenous passenger car no matter how many it purchased from Hindustan Motors and Premier Automobiles. It was only after the liberalisation of the economy and the entry of foreign competitors that Tata Motors, Mahindra and others could produce automobiles that are not only indigenous but also in the same league as their foreign competitors. The route to effective indigenisation, therefore, is counter-intuitive. We must open our defence sector to foreign investors so that Indian industry can acquire the capabilities to produce the equipment our armed forces need.

This cannot be achieved by offsets that require foreign suppliers to spend part of the contract price in India. Offsets might re-inject part of the defence expenditure into the domestic economy but will not result in the transfer of knowledge, skills and human capital that are essential for India to build a modern defence industry. The most effective way to get there is to open doors for foreign direct investment in defence manufacturing. Capping the foreign equity at 26% has attracted few investors. Instead of arguing over another arbitrary level at which to set the cap, we should do away with it altogether.

The second is the equally dogmatic anti-middleman mindset. Going by the statements of the defence minister, it would appear that middlemen—like their lobbyist cousins—are uniformly evil and therefore ought to be banned outright. Yet middlemen are not the cause of corruption. Rather, both middlemen and corruption are the twin offspring of the same parent—complex procurement rules.

The more complex a set of rules, the more the need for ‘specialists’ to help navigate through them. The reason lawyers and chartered accountants exist is because the law and the tax code are complex. Middlemen exist because they perform a useful economic role. There’s nothing intrinsically wrong or immoral about them. It is our rules that make them so, driving underground a genuine economic activity.

Why do we have complex procurement rules? Because we have overcrowded them with multiple, sometimes conflicting objectives. Changing our approach to indigenisation as argued earlier can simplify them to some extent. Even so, it is unlikely that they can be simplified enough to eliminate the need for agents. That is why instead of prohibiting middlemen in defence procurement, a far better policy would be to create a regulatory framework under which they can operate legitimately.

Agents could be required to declare their past and current affiliations, and disclose relevant family connections. Former defence officers and their civilian counterparts could be required to serve out a cooling off period before getting into the business. The policy objective ought to be to align—to the extent possible—the economic incentives of the middlemen to the organisational interests of the armed forces. We don’t have to like lawyers and chartered accountants in order for us to let them discharge their economic roles. Why should it be any different with middlemen?

The final cause of the mess in our defence procurement is that we often ignore the geopolitical consequences of our purchases. Awarding the tender to the lowest bidder might be the best method to resurface parade grounds but not for billion dollar purchases of equipment. To treat both purchases the same way would be to lose strategic leverage that comes from being able favour a country which can give us something else that we need. Blacklisting companies from friendly powers exposes us to purchases from less friendly ones.

The biggest argument for indigenisation is that reliance on foreign suppliers is risky because supplies can be withheld in order to coerce us. That risk can be mitigated if we procure military equipment from countries with which we have extensive economic ties, and vice versa. Reducing the incongruence between our top trading partners and our top arms suppliers ought to be an important policy goal.

The ghost of Bofors continues to haunt our defence procurement. Avoiding stepping on the dung on the road is now more important than getting to the destination. As the defence minister admitted in parliament, the pace of modernisation is slow because every allegation of corruption is investigated. This leaves us with the unfortunate implication that that anyone, from an inimical foreign power to a disgruntled equipment vendor, can apply brakes on the modernisation process. The ghost must be exorcised by liberalising the defence manufacturing sector and getting rid of the superstition that passes off as strategy.

Copyright © 2012. Business Standard. All rights reserved.