May 18, 2018

The wage factor in NAFTA negotiations - a potential deal breaker


This is new and preposterous. It could be the dealbreaker. It might be better to face a non NAFTA trade barrier of 2.5% over complying with this provision. The median wages in USA for auto workers is almost 8 times that in Mexico on an average. In addition, there would be the burden of accounting and bookkeeping to comply with the provision. 

These types of requirements are usually designed for dealing with developing countries who prove too hot to handle for the domestic sector in developed countries. Recall the child labour free certifications, carbon footprint requirements, wood certification for legality and so on. These requirements are cloaked in the guise of humanitarian concerns, eco footprint, food safety etc to give it a semblance of respect while implementing. But the wage requirement is bare knuckle tactic that punches on the face of the idea of free trade. 

A wage requirement like the one proposed would take away the very key advantage that makes trade possible between developing and developed nations. Developing countries typically have wage advantage in terms of competitive labour costs. Take that away and the developing country is handicapped in cross border trade. There is still a possibility that Mexico might negotiate. But then, Mexico might as well walk away and face the tariff if the costs outweighs benefits. At the moment, it looks like it would be the dealbreaker.

It's interesting times to watch as NAFTA renegotiations are falling behind schedule. America is slowly and steadily undermining the very system it helped build in the last fifty and more years. Its amazing how one person's paranoia about free trade can grip an entire country and shake the very foundations on which lasting ideas are built. It's sad to see the very competent US trade officials twisting themselves into knots to propagate ideas that suit the president. 

Sooner or later, these ideas would trickle down to other forums including WTO. India needs to be on guard. 


Apr 25, 2018

The forgotten caveats

The headline in the business standard reads : "India must grow at 18% to ensure jobs to growing workforce: World Bank".  The article is based on the recent world bank report titled "Jobless Growth" under the south Asia economic focus series. 

One would agree that 18% growth for a country of our size is not attainable. That being so, the headline implies that World Bank is saying that India cannot secure jobs to its growing workforce. Gloomy picture indeed. There is an element of certainty about the nice round number 18 which misleads a lay reader. 

It is not so if one reads the actual report. The actual report has pushed in enough caveats to survive any close scrutiny about the number 18. The problem is, the report presents things in a way that make newspapers pick up such headlines. That's a danger that any report writer should be wary about, and should factor in while presenting data to a lay reader. To expand the debate, the assumptions behind the models and the assumed simplifications should be made amply clear to the uninitiated audience lest they take the models on face value and start drawing conclusions for real world. The simplified models work, under set of circumstances and assumptions, to enlighten about some particular causal phenomenon under study. And it stops at that. A brief look at the calculation of the number 18 would throw some light. 

The first assumption the model makes is the roughly U shaped relation between employment rates and economic growth. It runs thus. 

image of U curve GDP per capita versus employment in percentage
GDP per capital Vs Employment rate - The U curve

Data indicates that employment and per capita income appear to exist in a U shaped relationship as shown above. When per capita income is low, the country has high employment as people start working young and remain employed due to sheer pressure of survival. If they drop out, they go hungry. As per capita income grows, children enroll in schools and stay there longer, old  people may get pensions, women may not go to work, and the abject need to work for survival decreases. This leads to decrease in employment till a certain stage is reached where the per capita income increases enough to reverse the trend. This happens as people in countries with high per capita income have higher education, they are less likely to drop out of employment, including women who now have access to better daycare and health facilities and can afford to be in the labour force. Also, better healthcare and life indicators ensure that one remains in labour force longer with less drop outs. The first set of assumptions while deriving the 18% growth is that such a curve exists, and India exists at a point on the curve where it is downward sloping, that is, more prosperity would lead to less employment with people dropping out. 

The second set of assumptions is that the employment data the model relies upon is good enough. That might not be so, even in the own words of the report: 
Economists in South Asia agree that the quality of the available employment data makes it difficult to credibly assess the labor market situation in their countries...PP34
One may recall the recent debate in the newspapers about the EPFO based employment data being used to prove the growth in employment numbers. Everyone took sides, but agreed on the point that we are far from getting reliable data on employment. So the report cleans up some sets of employment data that it has and goes ahead with whatever best it could manage. 

The report outlines the below equation to represent the approximation of the U curve mentioned above

Where Et is the employment rate, Yt is the total output, Nt is the population, Beta is the approximate slope of the U shaped curve around Yt, and negative for countries like India as mentioned above. 
Delta captures the responsiveness of employment to economic growth and is expected to be positive for India. Alpha and Gamma are short and long term constants arising while linearising the equations respectively. 

Then quarterly changes in employment are correlated with quarterly GDP growth, the report mentions that Okun's law (which roughly states that employment increases in direct relation to GDP growth) doesn't hold for India. For each percentage point increase in GDP growth, India's growth seems to drop by 0.11%. Counterintuitive? Yes, but the models say so. And within south asia, the law holds in Pakistan and Sri Lanka and fails for India. Nevertheless, we plough ahead with acceptable p values. 
See images below. 

image of Jobless growth in India

image of jobless growth in India


Then the attention of report turns towards the question in hand. The one I have a problem with. How much growth is needed to create enough jobs? It takes three scenarios: 
a) Unambitious - let the Growth be whatever it is and lets see where employment would head
b) Constant - Growth needed to keep the level of employment constant
c) Catch-up or Ambitious - Growth needed to catch up in terms of employment levels and get pushed to the positive slope area of the U curve in a certain number of years. 

image of Okun's law in india

Based on T number of years to catch up, it models three equations by substituting above into the earlier two equations. Then the linear models look thus: 

image of Modeling employment unemployment GDP growth

Based on this, the model predicts the growth rates, and puts them on a neat bar chart. 

image of Unemployment and job creation problem in India
Now one may see that India needs a growth rate of around 18% to catch up with a time horizon T of 20 years. This chart doesn't contain any disclaimer. If one simply scrolls down the report and stops at it, it misleads. While the methodology is probably the best one could get in given circumstances of shaky data and inapplicable models, yet the chart doesn't mention any of those. It assumes a linear and deep reading of the text. 

If you observe, by the time you reach here in this post, you must have forgotten the first U curve assumptions I started with, unless you are econ types. Most policymakers in India are not Econ types. They are generalists who are more managers than policymakers. And that's why I have problems with data presented in this form. It has a ring of conclusiveness to it while the report embed the doubts about the U curve and Okun's law inside the text. To be fair, the report has been candid about employment data inaccuracies. 

If asked, I would present the following way. I would add up the uncertainties at each level in the modeling process as error terms. And when the final value is presented, and if forced to make a bar graph, I would include this cascaded final error term in the projection. It would be a range to reflect the uncertainties built into the model. 

Probably the headline then would read like this: 
India might need around between 7 to 25% growth rate for twenty years to ensure jobs for a growing workforce, depending on where we lie at the downward sloping U curve, and depending on the assumption that it's an U curve after all, with an inverse relation Okun's law holding tightly enough; which though counterintuitive, we shall somehow ignore, and depending on how much we believe on the employment data being generated, and given that other things remain constant in the time horizon considered. This after ignoring the inherent assumptions in data collection methods, which ignores pakora makers, and uncertainties in calculation of GDP growth. We are in bad shape. 

Probably that'll not be a click-bait headline. But then, who cares about the misleading headline too? 

Apr 17, 2018

Mainstreaming block chain technology in international commerce

This post was originally published at The Hindu Business Line newspaper here

Distributed Ledger Technology (DLT), a concept of recording and sharing data across multiple data stores, or ledgers as they are popularly called, is an idea whose time has come. The concept of DLT was introduced through block chains in the famous paper by the elusive author known only as Satoshi Nakamoto in 2008.
While the initial application was limited to crypto currencies, it didn’t take much time for the world to realise that the underlying technology of using distributed ledgers has multiple applications spanning various spheres. However, it is only lately that we are seeing actual implementation of the often discussed concepts.
To cite an example of block chain application in mainstream commerce in India, we may look at the Trade Receivable Discounting System (TReDS) guidelines of the RBI, which sought to set up a system to ease the liquidity crunch for MSMEs by way of bill/invoice factoring in the financial market for the supplies made to big corporates. The simplified process under TReDS may be explained with an example. Let’s assume Mismi enterprise, which is an MSME, supplies items to Bigcor, a corporate house. Usually Bigcor takes three months to settle the payments after the delivery of goods. This holds up Mismi's working capital for three months leading to a liquidity crunch for Mismi.
Mismi’s efforts to convince Bigcor to make payments earlier doesn’t work as Bigcor has market power to dictate terms to Mismi and other such suppliers. With the advent of TReDS, Mismi uploads the digitally signed invoice on one of the three platforms currently approved by the RBI. The upload is done after the supplies are made to Bigcor.
Bigcor gets a time window (say of two days) to approve the invoice online, thus verifying the authenticity of the supply and the commitment that it would pay the sum against the invoice raised within three months (or the agreed time frame).
The approved invoice can now be factored on the platform, through auction, by the financial intermediaries like banks/NBFCs. For example, BigBank may buy the invoice at a discount and pay the money to Mismi, thus providing it with immediate liquidity. The actual payment would be realised by the BigBank after three months from Bigcor.
In an ideal competitive market place the discount should equal the interest cost for three months plus nominal service charges. Registration on TReDS has been made mandatory for public sector enterprises by the government. As the public sector is a big ticket buyer for a large number of MSMEs, it is expected that a critical mass would be easily obtained by the system to start rolling. Three platforms (RXIL, M1xchange and A.TReDS) approved by the RBI are already active.
There are two clear advantages of using blockchain technology in such a situation. First, maintaining anonymity of invoice raiser is easier. Second, cross trading across multiple platforms is possible without the fear of double invoicing (double-spend problem). It makes the entire chain secure, anonymous, and verifiable at the same time. The credibility issue also gets sorted out.
As TReDS is one of the early examples of implementation of Blockchain in real commerce, we can look at it as torch-bearer of a future era of trade facilitation.
In fact, if the technology and infrastructure are set up correctly there is no reason as to why the entire paper based international trade transactions shouldn’t be moved onto something based on DLT.
However, when it comes to international trade, two further institutional arrangements need to be put in place. They are:
(a) International arrangement to give sanctity to DLT-based transactions through common agreement or laws and
(b) Physical infrastructure for DLT including the system architecture and configurations.
The first point can be integrated with the trade facilitation efforts in the next stage at the WTO. It could be augmented through efforts at making model laws and best practices at UNCITRAL/UNCTAD. The second part is where individual governments and private sector would have a greater role to play.
We have proved with TReDS that we have the ability to push it. India could become a leader if we take the initiative at blockchaining the entire gamut of international trade transactions. It might indeed be a 21st century issue that India might like to discuss at the WTO.

Apr 15, 2018

Strategic manufacturing growth - tariffs and policy nudges

(This post was originally published at Swarajya magazine https://swarajyamag.com/economy/building-a-manufacturing-ecosystem-screwdriver-technology-will-show-the-way) 
image for Strategy for Manufacturing sector growth in india

India has become world’s second largest mobile phone manufacturer in the world after china. While there are reasons to cheer, there is also a feeling that we are at the screwdriver level technology when it comes to electronics hardware manufacturing. We bring in most of the components and assemble them here using screwdrivers. The critiques use the term screwdriver technology to deride such activities. What many of them miss is the fact that usually such screwdriver technologies are the stepping-stones to upper levels of value chain. And while at it, the millions who turn the screwdrivers have a job.
During early 2000s I used to work in the engineering product development at an Indian firm. We designed the components in house, did all validation tests, and launched the products in the market. My skills got me a well paying job with a US multi-national corporation that had newly set up an engineering service centre in India. I was one of the first dozen employees there. Once I joined, I was placed in front of a computer and asked to do something called ‘engineering change note’ (ECN) work the whole day. The drawings arrived from US, through secure online mode, necessary minor changes were carried out at the center, and then the drawings were uploaded for checking and approval by the US parent. I never saw the actual product. It was frustrating and after a couple of months I barged into my manager’s cube to vent. The manager, a US-returned Ford motors veteran, told me coolly, “Son, keep at the ECN for some months, then I will get you 2D to 3D conversion work.” That 2D to 3D conversion work was just a miniscule step above in value chain than what I was doing. It was frustrating.
Recently, I visited the same facility after many years. The centre now employs more than a 1,000 engineers and carries out advanced engineering work including product conceptualisation and development. They have a full-fledged product-testing lab that carries out the product validations. The journey took less than 15 years for the centre. The ECN work was the screwdriver technology. The current work they do is cutting edge. There are thousands of such engineering centres in India today, falling somewhere along the spectrum that spans from ECNs to engineering system modelling. Most of them started with ECNs or 2D to 3D drawing conversions. The same story holds for IT services where we started out as Y2K bug operators, a screwdriver technology. When one spots a screwdriver, one should look at the direction it points to. Usually they point to the next level.
The same holds for manufacturing, but for two differences. First, goods face tariffs at borders and tariffs play a role in determining the technology that is developed in the country, which I shall discuss below. Second, manufacturing of goods, especially consumer goods, electronics hardware and advanced engineering products, has moved to global value chains (GVCs) in recent decades due to discretisation and specialisation of production steps, and containerisation of cargo, which led to ease of transportation.
The goods pass through tariff barriers whenever they cross borders. If the tariffs for parts as well as the finished item were to remain same, screwdriver plants would vanish, as completely assembled items would then be shipped in directly. Therefore, policymakers design tariffs in such a way that progressively higher value added products face steeper tariffs. This works in a tiered manner. The screwdriver assembly lines come up first. Then simple sub assembly lines would form. Then comes the component localisation. And finally we end up with the complete product being manufactured and assembled in the country. It might not always work the same way or in that order, but that’s the overall drift if things go as planned. The auto industry is a good example of how this worked. The sector was opened very gradually during the 90s. It still is one of the guarded industries, making US President rant against the high tariff walls on Harleys sent to India. But the calibrated move helped the sector.
On the other hand, WTO’s Information Technology Agreement (ITA1) ensured that tariffs on electronic hardware items covered through the agreement were brought to zero, and this stunted the growth of electronics hardware manufacturing in India. It made more sense to pick up the electronic hardware from ‘factory Asia’ (China, Japan, ASEAN) and ship them to India. There is a counter point that lower priced electronics helped the information technology (IT) service sector grow. However, this counterpoint does not factor in the loss to hardware manufacturing and associated jobs that never materialised, or the fact that IT services mostly operate out of zones such as software technology parks of India/special economic zones (SEZs), where duties anyway are zero for all imports. Add to it the loss in technology development, and we can easily see why it was a bad idea. The argument here is not that we should have high tariff walls everywhere; but that the policymakers need to pick and choose the way the tariffs are structured for each sector in order to help manufacturing. There is no point in dropping all tariffs to zero in the name of free trade.
It must however be noted that not all sectors are amenable to a mere structured tariff policy alone. For example, chip making or silicon wafer manufacturing technology operates at economies of scale and requires initial sunk research and development (R&D) costs, and this needs a massive initial push and support. Mere tiered tariffs will not convert the solar module makers of India, a simple assembly operation, into silicon ingot makers or wafer dicers even after decades. Further, handholding is required for that to happen. This is being done through efforts such as M-SIPS programme of MeitY, which is trying to boost electronics hardware manufacturing. Such dual effort of tariff structuring and handholding is required in multiple sectors to cajole the manufacturing into growth phase. Critics who lament every tariff hike or state led support as Nehruvian economics miss the point here. There is nothing wrong in thinking in that direction. It might appear to some as a return to licence-permit raj, but given the amount of efforts the government is putting towards automatic approvals and ease of doing business, it is wrong to compare this to the pre 90s era. The interfaces are fast moving online for all kinds of public citizen interfaces, right from customs clearances to industrial approvals. When China talks about ‘Made in China 2025’ and focuses on key sectors, they are actually talking about strategising such state support. It is a common developmental strategy.
The second often talked about matter in recent years is about how global value chains (GVC) has changed the way manufacturing is carried out. This is visible especially in sectors such as automobiles and electronics. The ‘designed in California assembled in China’ iDevices model is an example of GVC in operation. China adds less than 10 per cent of value to a typical iPhone, which is actually a product of multiple countries with each contributing various components and inputs.Being a part of GVC is important in order to bring in jobs in these sectors. If zero custom tariffs implied automatic participation in GVC, India should have become tightly integrated with ‘factory Asia’ long ago. We had cheap labour, zero or low tariffs on most electronic components and SEZ facilities where custom duties are zero for imports.
Therefore we should have automatically got integrated into the GVCs in a meaningful way. That didn’t happen to the extent we wanted. For sure, the trade in value add statistics for India makes us look good as long as we see the value added percentages alone. When we look at the quantum of trade, we are far below the expectations. Low tariffs is just one variable for GVC participation. In addition, we need infrastructure, skills, R&D investment, ease of doing business and supportive policies in order to gain the required competitiveness to be a significant GVC player. The government is moving in that direction.
That brings us to the point that the time in our hands is very limited given the twin factors of advancement of automation in manufacturing and what we call as peak trade phenomenon. The automation would soon disrupt the labour cost advantage. We need to strategise keeping this in mind. Only upskilling and increased productivity would keep us in the run for future. The appetite for old world way of discretisation of manufacturing is on the wane. The stalemate at WTO, threats of tariff wars, and the rise of anti trade sentiments is a testimony that probably the best of opening up days are behind us.
Developing a strong manufacturing sector is not an option but a necessity. We are in a different century, with unique challenges like automation, yet it would help us look at the experience of those who got the manufacturing right. A good example is China. They opened up with screwdriver level technology jobs, forced foreign companies to transfer technology through local partnerships, maintained cheap currency for decades, provided state subsidies and incentives, and used all tricks available in policymaker’s book to become a leader in manufacturing. South Korea followed neo-mercantilist trade policies up to early 80s to grow its exports machine. MITI played an important role in development of Japanese industry and exports. Had all these countries followed a universal low tariff theory during their stages of industrial infancy, they might probably not have ended up with the same results.
Here, one must caution that such state actions at times might generate unintended consequences and hence cannot be a blanket recommendation. However, one cannot deny that these examples demonstrate that a determined state which runs a systematic industrial and trade policy plays an important role in growth of manufacturing and exports. India is waking up to a synchronised industrial and trade policy where the government is looking at playing a facilitator’s role. There is nothing wrong if a tariff is hiked here or there for valid reasons. Or if some rudimentary assembly plants pop up in the interim leading to doubts whether ‘Make in India’ has ended up with just ‘assemble and sell in India’.
When I quit the private sector for a government career, I was working in area of system simulation of flight controls at Airbus, the biggest airplane maker in the world. That was as cutting edge as it got for me. The ECN job was a stepping-stone in my career. I am sure the screwdriver turning jobs of today would vanish sometime in a generation or two. We need to prepare for that future by moving up the value chain and preparing a solid manufacturing sector. The strategising and push must come from the state. I fail to see how it could be achieved otherwise.

Apr 3, 2018

Commercial Blockchain application in mainstream commerce - An India Example

I have been a supporter of Blockchain technology (the keypin of crypto currencies) for long time now. I had blogged about the utility of secure open-ledger transactions here and here. Blockchain applications can be extended to virtually a lot of fields and international trade is one of them. India is at decent level of technology application when it comes to blockchains, as opposed to the shoddy levels we display when it comes to AI and machine learning applications in public policy sphere.

To cite a good example of blockchain application in mainstream commerce, we can look at the Trade Receivable Discounting System (TReDS) guidelines of RBI, which sought to set up a system to ease the liquidity crunch for MSMEs by way of bill/invoice factoring in the financial market for the supplies made to big corporates. 


image of blockchain factoring MSME India M1xchange
Blockchain technology behind MSME liquidity solution

I shall briefly explain the simplified process under TReDS with an example (or see image below). Let's assume Mismi enterprise, which is an MSME, supplies items to Bigcor, a corporate house. Usually Bigcor takes three months to settle the payments after the delivery of goods. This holds up Mismi's working capital for three months leading to liquidity cruch for Mismi. Mismi's efforts to convicne Bigcor to make earlier payments doesn't work as Bigcor has market power to dictate terms to Mismi and other such suppliers. With the advent of TReDS, Mismi uploads the digitally signed invoice on one of the three platforms currently approved by RBI. The upload is done after the supplies are made to Bigcor. Bigcor gets a time window (say of 2 days) to approve the invoice online, thus verifying the authenticity of the supply and the commitment that it would pay the sum against the invoice raised within three month (or agreed time frame). The approved invoice can now be factored on the platform, through auction,  by the financial intermediaries like Banks/NBFCs. For example, BigBank may buy the inovice at a discount and pay the money to Mismi, thus ending the liquidity crunch immediately. The actual payment would be realized by the BigBank after three months from Bigcor. In an ideal competitive marketplace the discount should equal the interest cost for three months + nominal service charges. Registration on TReDS has been made mandatory for the public sector enterprises by the government. As public sector is a big ticket buyer for a large number of MSMEs, it is expected that a critical mass would be easily obtained by the system to start rolling. The three platforms are already active. They are RXIL, M1xchange and A.TReDS

image of TReDS Process - blockchain invoicemart - From A.TReDS website
TReDS Process - Simple process flow - From A.TReDS website


When the system was initially set up, there were apprehensions that the big corporate bodies were uncomfortable with the identities of their suppliers being revealed online. Now the platforms have come up with the solution that includes the blockchain. I see two clear advantages of using blockchain technology in such a situation. First, maintaining anonymity of invoice raiser is possible.  Second, cross trading across multiple platforms is possible without the fear of double invoicing. It makes the entire chain secure, anonymous, and verifiable at the same time, in a way the simple digital key encryption cannot.

As TReDS is one of the early examples of implementation of Blockchain in real commerce, I see this as heralding an era of trade facilitation through e contracts, secure e waybills, secure letters of credit, bills of lading, international factoring and forfaiting services and so on. In fact, I don’t see a reason as to why the entire paper based international trade transactions including title of goods (currently the paper bill of lading) shouldn’t be moved onto something based on blockchains which are maintained through peer to peer open ledger platforms.

This would need two further institutional arrangements to be put in place:

A) International arrangement to give sanctity to these transactions through common agreement or laws
B) Infrastructure support to develop and maintain the basic structure of the transactions or the marketplaces - either through private parties or through a multinational consortium.

While A can be integrated with the trade facilitation efforts in the next stage at WTO, and through  efforts at making model laws and best practices at UNCITRAL/UNCTAD, part B has to be a joint or multilateral effort by the leaders in the field. Both are doable. The technology is there. We need to gather the will to push it. Probably India might be a leader if we take the initiative. It can indeed be a 21st century issue that India might like to discuss. 





Mar 23, 2018

Rethinking Export promotion in the era of trade wars

(This article was first published few days ago on Swarajya Online Magazine with the heading "Export promotion in the era of trade wars" at this link)
The newspapers are awash with analysis of President Donald Trump’s tariff hikes and the subsequent threat by United States Trade Representative (USTR) to pull India to World Trade Organization (WTO) dispute panel for maintaining export subsidies to the tune of $7 billion. The current popular narrative revolves around how the US’s tariff move is bad for the world trade, and why India should stick to the stand of promoting multilateralism in international trade. The arguments are usually sound and include the fact that there is ultimately no winner in a long drawn trade-war. However, it is important to understand and analyse the matter in more depth, as the stand we take now would affect the direction of our industry and trade policies in future. In addition, it is also important that we understand and account for the emerging big picture in order to fine-tune our strategy for future.
The pundits and the papers have been almost unanimous in declaring Trump's tariffs economically harmful to the US. However, what they miss is that Trump is trying to do a Reagan of 80s who extracted so-called ‘voluntary export restraints’ (VER) from the exporters to the US. When Reagan went hard on trade and imposed tariffs on a wide range of goods including textiles, automobiles, electronics etc, people warned and recalled the horrors of Smoot-Hawley Act of 1930s, when tariffs destroyed trade and exacerbated the depression. That didn’t stop Reagan from going ahead. While it is debatable if VERs helped the US economy, it did make for a good PR, especially when the agreement with Japan was reached. It paved the way for low resistance towards further globalisation in the next decade when WTO was founded.
Today when Trump talks about reciprocal tariff measures and imposes duties on items ranging from washing machines to steel, one needs to factor in the need for Trump to do a good PR on this front. Renegotiating ‘bad’ trade deals has been one of the key planks on which Trump got elected. To that extent any discount that Trump extracts through the noise and actions would make for good PR. Only this time the world might not be ready to accommodate the US, and the US economy might indeed suffer more than it gains. Nevertheless, we should expect the noise to last the term at the least.
That brings us to India, as India has started figuring lately in Trump’s trade talks, after China. He has not taken kindly to high tariffs India maintains on some items. A favourite of Trump has been the tariffs India imposes on motorcycles (50 per cent) versus the tariff the US imposes (zero). Despite the recent reduction in duties by India, Trump was not happy. It doesn’t matter that US President’s favourite export product constitutes almost 25 per cent share of India’s motorcycle imports, whereas the US figures at 22nd place in the list of countries to whom India exports the item, with a share of 1 per cent in total (read more for details). Trump quoted the tariffs imposed, called it unfair, and warned about imposing reciprocal tariffs. A few days later USTR came down heavily on India’s alleged exports subsidies and sought consultations. Trump’s rants are less harmful than potential USTR actions.
To start with, one may safely ignore Trump’s threat of reciprocal tariffs on countries such as India as it is not easily implementable unless the US decides to violate the principle of most favoured nation (MFN) at WTO. If done, it would lead to unraveling of WTO and the rule-based trade ecosystem that the US has helped build over decades. While the US has undermined WTO in the recent years through measures such as blocking appointment of judges at dispute panels, it is safe to assume for the time being that the US is not willing to break the system completely. This is attested by the fact that when Trump imposed tariffs on steel and aluminum, he used the pretext of ‘national security’ in order to not fall foul with the WTO rules.
The USTR’s allegation that India provides export subsidies is partially true as acknowledged by Indian counterparts. Therefore, greater danger lies in the potential actions that USTR may propose if the consultations fail. India needs to be wary about it. The timing couldn’t have been worse given that India’s exports are slowly showing an uptick despite recent shocks to the economy. India has defended the move well so far. Under the agreement on subsidies and countervailing measures (ASCM) of WTO, certain exemptions and remissions are allowed. India would easily defend allegations on some of the schemes that she runs for export promotion; especially the ones where the indirect taxes are nullified. Other exemptions such as special economic zones and export-oriented units would take deft to defend by proving that they do not violate the spirit of ASCM. Some schemes such as merchandise export incentive scheme would be difficult to defend in the long run.
India was supposed to stop the subsidies once it reaches the GNP per capital level of $1,000 (ASCM Annex to Para 2(a) of Article 27), after 2015. There, India has taken the correct stand that a time of eight years to phase out the subsidies as mentioned under ASCM should be allowed, as allowed for other members at the time of agreement. In the end, it all boils down to the consultation process, and how well it is handled. There is a good likelihood that the consultations might go well and the countries reach an agreed middle ground. However, the allegations should act as a warning for the policymakers in future.
In a developing economy context, it is difficult to dictate that governments should stay away from all kinds of subsidies and assistance to industrial growth. The non-actionable subsidies allowed as per ASCM under Article 8 include research and development (R&D) support, generic support to disadvantaged geographical areas, and one-time assistance to comply with new environmental regulations. In addition, indirect tax nullification is allowed as per general rules. Apart from these any kind of direct or indirect support can be quantified under subsidies. Annexure I to ASCM maintains an illustrative list of export subsidies that covers almost everything that the government does in the name of export promotion/industry development, and effectively leaves little flexibility to the government to help the industries.
Therefore, the coming years should see industrial and trade policies aligning to these requirements. A good way to move forward would be to let the individual states formulate their export strategies. The individual state level solutions catering to local industries and trade would be more difficult to quantify and countervail. Assistance in the form of alleviating pain areas in industry development through process simplifications, easier documentation, support for integrated logistics infrastructure, R&D support for key sectors and special packages for backward districts would not fall foul with ASCM requirements. Government is already moving in that direction.
In addition, it is time India prepares its own team to counter bodies such as USTR. There is a severe manpower crunch when it comes to countering ASCM allegations from other countries. In addition, offense may be best form of defence in trade matters. The team should also research on potential subsidies provided by other countries and launch investigations aggressively. India may do well to groom and train a dedicated sizeable team of hundreds to man these positions. International trade has evolved from being a pastime for economists to being a part of strategic arsenal for a nation. One needs dedicated teams working full time on these matters.
Finally, India should continue with the principled stand of multilateralism in international trade. It is heartening to see that India is hosting informal talks for trade ministers and officials from WTO on 19-20 March. While bilateral and regional partnerships may have their charm, there is nothing that matches the WTO in terms of reach and potential. Many a times India has been singled out as being the deal breaker, yet the unwavering faith in multilateralism that India has shown at WTO is not easily matched.
WTO’s continued importance is underlined by the fact that despite efforts to dilute the effectiveness of dispute settlement mechanism in the recent years, the US still uses it to settle disputes with other members. WTO has shown the way to accommodate the less endowed members through the special and differential treatment clauses, and more often than not, has helped countries gain through trade. If we keep at it, probably in a decade or so, these years might appear like the Reagan era that ushered in hyper globalisation in the next decades, and today’s discontents.

Mar 20, 2018

GST long term positive for tax collection - More evidence

Image of GST effect on tax compliance
GST effect on tax compliance

Yesterday, Bibek Debroy commented that it might take around 10 years for the GST to settle down. That might be so, but some effects might start showing quite early. One of the effects I am very keen to see is the effect of computerised invoice matching between suppliers and recipients.  This matching should ideally eliminate mis/under invoicing over a period of time as the participants in the value chain realise that compliance is better than the efforts required to maintain informal accounts, and is not commensurate with the risks associated. This effect, I felt all these days, should not take more than two years. Two years should be the rough time period when a new system rolled out at a scale of our country emerges out of the teething troubles. Or so was my hunch. 

Looks like the period indeed is around that much as per this NBER working paper by Fan, Liu et al.  It is a study of effect of computerisation of VAT in China during early 2000s. The study found that most of the good effects of tax increase due to computerised invoice matching are found in first three years before stabilising onwards. In terms of growth, this study of 7 years data post computerisation summarises thus: 
"In terms of magnitudes, the estimates imply that computerization caused the effective tax rate to increase by 4.7% in the short run, 14% in the medium run and 11.7% in the long run, from 4.95 to 5.19-5.65 percentage-points, and explains 14.38% of all VAT revenues during 2001-2007. Thus, the effect on government revenues is sizable."

The formalisation of economy is an important side outcome of invoice matching through computerisation. The paper uses a method similar to difference-in-difference (DnD approach was also used recently in our economic survey to isolate the effect of export incentives on textile sector). It appears to me that the study has done a good job at eliminating confounding factors such as economic growth post WTO and sectoral effects. It is a good read and the results seem directly transferable to Indian context. 

Another insight from the paper is that the compliance in indirect taxation had no spillover effect on other forms of taxation. So those expecting a corporate or income tax windfall might be disappointed: 

"An interesting question is whether strengthening the VAT information chain had positive spillover effects in the enforcement of other types of taxes. We examine corporate tax payments, which are also reported in our survey data. Table 8, column (1) shows that the interaction coefficients are positive but statistically insignificant. Thus, there is no evidence of positive spillovers.
The result on corporate tax is also interesting for another reason – it provides evi- dence against the concern that our main finding that computerization increased VAT is confounded by general improvements in tax enforcement."

Did the firms export more to avoid VAT as exports VAT paid is rebated? The papers says that no such effect was statistically present. So the domestic taxation didn't drive the participants to turn exporters. 

In the end, the simple effect of computerisation (or computerised invoice matching) seems to be that it increased the compliance and tax collection by bringing in more formalisation. That alone would be a significant achievement for GST. Three years are not that long. Mr Debroy should agree. 



Mar 17, 2018

Gigabattery factories - Engine of the renewables future

When we talk about electric vehicles, the battery technology that drives it cannot be left out. The success of Tesla stems from the ability to stack rows of Li ions batteries in dense modules that deliver sufficient power to run the car and system auxiliaries. The ability to pack rechargeable dense modules of Li ion will play out in the area of home energy too. The way we envision national grids and power distribution may undergo a paradigm shift with efficient solar modules generating and storing sufficient power in such batteries at individual home and even industrial units. This will accelerate as massive investments bring economies of scale in battery manufacturing consequently making them affordable, and viable alternative to fossil fuels as store of power. If that be so, any national policy that dreams of promotion of electric vehicle and renewables future cannot ignore battery manufacturing sector. 
image for Battery manufacturing capacity across the world - Bloomberg data
Battery manufacturing capacity across the world - Bloomberg data













The top Gigabattery factories under construction pan from Asia to Europe. It's not only Tesla which is investing heavily in such Gigafactories but all technology, hardware, energy and even mineral digging companies have now got interested. Even countries are waking up to this fact and are trying at policy levels to help attract such investments. 
Image of Economies of scale in battery manufacturing
Economies of scale in battery manufacturing














Today's news covered the item where British industrialist Sanjeev Gupta is building biggest battery at Australia. Such battery farms are the important linking chains between renewables and consumption points. 

Image of Manufacturing capacity and cost - the inverse relation - The Economist
Manufacturing capacity and cost - the inverse relation - The Economist


And that reminded me that I have not heard about any developments in the area of investments in India since the news item last year that Adani and Reliance are thinking on those lines. We don't have any gigafactory coming up as of now. The technology itself has not been mastered well here and we are dependent on imports. 

We need to seriously consider doing something about it in terms of policy push otherwise it would be sad for a country that is emerging as a leader in the area of renewables.  






Mar 11, 2018

The cooperative dairy sector of Gujarat - A case study in trade protectionism

This blog usually advocates free trade. However, a cautious approach is advised when it comes to sensitive sectors. Free trade doesn't mean zero tariffs everywhere. The costs and benefits needs to be balanced carefully. For example, when the dairy sector is protected, the milk and milk products might be sold costlier in domestic markets, leading to less consumption of an important source of nourishment in an otherwise poor low protein Indian diet. So it is important to understand the argument from both producers and consumers points of view. 

India sells milk at a price that is around 1.5 times the price in USA in absolute terms. So when we factor in the affordability (PPP) the figures become worse. Therefore the consumers are at a disadvantage in terms of price at which milk is sold in our country. India maintains steep import barriers to milk and the question is whether it is justifiable in light of the argument in previous paragraph. 

Gujarat and few other states in India run cooperative dairy model for collection of milk from farmers. This model depends on rural villages coming together to form village cooperatives, which then feed into district level cooperatives, and which uses an apex cooperative body for marketing purposes (GCMMF/AMUL, KMF/Nandini etc). The profits are shared back to the level of last farmer member of the cooperative after all operational expenses are accounted for. 

Overall, the dairy exports from India has been decreasing for the last few years, with a slight uptick during 2017. The below graph is self explanatory (UN Comtrade data: Reporter: India, Partner: World)


Image for Dairy milk product exports from India
Dairy exports from India




However, the above is not the complete picture. While India produces one of the largest amounts of milk, our share in world trade is quite low and we appear at 36th position in the list of exporters (2016 Comtrade data). In terms of imports, we appear at 94th position (with an imports of around 42 million USD per year), after countries like Latvia and Fiji. This is explained by the fact that dairy products (under ITC HS chapter 04) are heavily tariffed and the total duty on imports on these products range from 40 to 75%. So it's not easy to penetrate Indian dairy produce market from abroad. Apart from tariffs we have various restrictions and quality requirements which might be construed as non tariff barriers. 

I shall take the example of Gujarat now. As the Gujarat milk cooperative model is well studied, I shall leave the readers at the mercy of Google for further details. I shall focus on one such district cooperative (the 2nd biggest) in Gujarat and explain the operational model. Then I shall zoom out to bigger picture to make the argument. 


Sabar dairy is the second biggest dairy factory in Asia with a peak processing of around 30 lakh litres of milk per day, after Banaskantha Dairy in neighborhood dist which stands at no. 1 in Asia with a capacity of 60 lakh litres per day. Sabar dairy is one of the 19 district cooperatives dairies in Gujarat under the umbrella marketing brand of AMUL (GCMMF). The Sabarkantha Dist Cooperative Milk Producers Union consists of around 2500 village level societies (11000 such societies across Gujarat) which feed the milk into it. Sabar union owns 20% share in GCMMF. The sabar dairy plant employs around 1300 people on regular basis (including their Ice-cream plant at Rohtak Haryana) and around 4000 on contract basis. They have around 400 milk tankers on hire basis for ferrying milk from collection and chilling stations to dairy plant. The plant works all 3 shifts with varying load. A significant part of the plant is automated, with imported machinaries working along with manual packaging lines. There are around 10 lakh cattle (Buffalos + Cows) in Sabarkantha district as per 2016 census out of which two thirds are usually in milking stage. 8 lakh cattle are RFID tagged and insured. The jurisdiction of Sabar dairy extends to entire district. 80% of the farmers are small farmers owning less than 3 cattle per family. All contributing farmers are members of cooperative society. This way the majority of the rural population is covered by the cooperative.

The milk is procured at a price of around 40 Rupees/litre (Buffalo full 6% and above fat) and around Rs 35/litre (Cow, 4-5% fat). The total production and value additon costs make the price of milk go upto Rupees 72/litre on an average. The milk and various derived products are sold at around Rs 90/litre leading to a gain of around Rs 18 per litre of milk bought. The profits generated through the operations are used to support various rural initiatives and support services such as cattle feed plant, veterneriary services (Sabar union employs 120 veterinary doctors across the district), maintenance of chilling units etc. Whatever profits remain are redistributed to village cooperatives, retaining only enough for modernization purposes. Last financial year, Sabar union retained around Rs 18 crore and distributed the rest. The money is being used for procuring machinery and construction of new plant in the nearby premises.

Image for Leading Dairy Exporting States of India
Leading Dairy Exporting States of India - DGCIS data


The state of Gujarat has more than 11000 village cooperative societies. In a way, a major part of the entire gujarat rural farming sector relies upon this model for alternative source of income. While it is difficult to confirm officially, it is said that this source of income has help avoid rural distress in Gujarat to a great extent. But for this income, the situation of rural Gujarat could have been worse. 

Coming to consumer side of it, India is second largest milk producer in the world as per World Atlas

Image for Leading milk producing nations
Leading milk producers - World Atlas Data

However, when it comes to per capital consumption (FAO 2013) we appear at 72nd place in the list of countries in terms of whole milk availability and 97th in terms of skimmed milk. That's poverty among plenty especially in a country where sources of nourishment in normal meal is limited. Now, the good thing is that it has improved over last couple of decades (FAO stats) and appears to be stagnating (unfortunately) now. We need more data for later years to derive more insights. 
Image for Per Capital Milk Availability in India - FAOSTAT as on March 11 2018
Per Capital Milk Availability in India - FAOSTAT as on March 11 2018
Given that our children certainly need more milk (more proteins and more of everything) to get healthier, is it right to maintain such high tariffs on milk imports? Let's say we decrease the tariffs to zero. This might inundate world milk into India. In the process, it would depreciate the prices of milk in India and might dent rural incomes. But then, the amount of depression in milk prices may of the order equal to tariff decrease, that is around 50%. So the milk producing farmer would now get around 25 to 30 Rupees per Kilo of fat milk in place of 40 to 45 earlier. Would this lead to mass rural distress? I doubt. But then, it might just make the cooperative model unworkable. It might be the last pound that breaks the squatters back. 

I can go on making yada yada blah blah arguments for both sides...but you get the drift. It is a public policy nightmare. The policymaker is stuck between a rock and a hard place. Rural employment vs milk nourishment for children and citizens. 

The above are the facts. 

What would you do sir? Would you still advocate free trade with zero tariffs or keep Trumping this sector? And how do you defend it?