Looking back at late 2008

by Ajay Shah.

P. Vaidyanathan Iyer has a great first draft of history, in the new Sunday magazine that goes with the Indian Express, telling the story of what happened in India in late 2008. This was a difficult period with 6 shocks hitting us in a short time period:

1. The Lehman failure,
   
2. The crisis on the money market,
   
3. Difficulties at some banks,
   
4. Difficulties in some mutual fund schemes,
   
5. The Bombay attacks, and finally
   
6. The Satyam crisis.

Things could have turned out much worse. The individuals at MoF, SEBI, and RBI really came together and delivered. As India becomes a more complex economy, it becomes more and more important to bring top quality skills into policy making. The Indian success of crisis management in late 2008 is tightly linked to India's success on the great conflicts over appointments in 2008. Reading Vaidy's article made me go back into September and October 2008 on this blog to see what I was thinking and writing at the time:

• On 25 September, I did a lunch talk on the crisis at DEA.
  
• On 29th September evening, murmurs about difficulties at ICICI Bank erupted after the Indian market closing time. I remember how, late in the night of the 29th, I watched the ICICI ADR trade in the US, saw nothing big happening, did some Merton model calculations, and thought we were okay. The next morning, I wrote this blog post on ICICI Bank.
  
• This was the first day of the 3rd Research Meeting of the NIPFP DEA Research Program. Those present will remember how the crisis made for a dramatic backdrop for the inaugural session and indeed the entire conference.
  
• On 6 October I started seeing the liquidity crisis coming together.
  
• On 10 October, I wrote about the remarkable collapse in the money market which had come about. From 13 October onwards, I started doing a series of Crisis Watch posts.
  
• On 10 October, Jahangir Aziz, Ila Patnaik and I started writing a paper on what was going wrong and what should be done. Our paper was emailed out on 14th, we did a meeting at NIPFP to discuss it on 18th, and finalised it on 20th.
  
• On 26th October, I wrote about the short selling question.
• We watched the Satyam crisis unfold with horror [Anticipation, Maytas, Worsens].
• Here is the 7 December 2008 picture of macro policy.

When I look back, I feel that (of all people) the NIPFP Macro/Finance Group should have quickly and clearly understood the linkages between multinationals and the money market, and how the collapse of the money market in London in late September would surely matter greatly to India. We had the building blocks: We truly get India's high de facto integration into global finance, and we truly get the rise of Indian multinationals as a game changer. But we weren't cool enough to connect these pieces and make the consequent inferences to a surprising conclusion. We only woke up when it was obvious that the Indian money market had collapsed. When I look back, the really hard thing at that time was the `fog of war' which envelops economic policy thinking. In the best of times, the Indian statistical system is weak, and at a time like that, the data was hopelessly out of date. We're being penny wise + pound foolish in ignoring the informational foundations of the economy, without which policy makers are forced to fly blind. We do this by tolerating an awful statistical system, and by preventing the financial markets which produce vital information.

There was a lot of drama and loud opinions, but it was very hard to figure out what was actually going on. I was quite concerned about Indian CEOs crying wolf in order to get money from the government, given the long history of Indian CEOs not standing on their own feet. So I was biased in favour of ignoring the cries at first.

SEBI order on MCX-SX

One more top quality order by SEBI. Bhave's SEBI has really set new standards for the quality of orders.

Interesting readings

South Asia's Geography of Conflict by Robert D. Kaplan.

A big black eye for India's attempt at being a democracy. Also see Devangshu Datta in the Business Standard on this.

Interesting survey evidence in the India Today about how voters are starting to see the UPA differently. Focus on the graph in there. And here is the main story by Ashok K. Damodaran.


Nitin P. Shrivasatava, writing in DNA, says that we may finally have cracked a working mechanism to borrow shares in India. If this is the real thing, it's a big step forward for the equity market: a good stock lending mechanism is the last piece of a well functioning stock market which was absent in India. Also see Mehul Shah in the Business Standard on co-location at NSE. Maybe we're finally breaking through some of these limits of arbitrage.

The two decade gap, by Ila Patnaik in the Indian Express.

Did you know that Saudi Arabia matches India's achievements on higher education.

Jayanth Varma says that a lot might be going on in terms of INR trading outside India.

I updated my India bookshelf page.

Eric Bellman in the Wall Street Journal about the growth of McDonald's in India. Apparently a new outlet in Bhopal has been getting 10,000 visitors a day.

T. N. Ninan, writing in the Business Standard says we should move to the metric system with million, billion and trillion. I agree! GDP is Rs.55 lakh crore or Rs.55 trillion.

The 9% question by Akash Prakash, and Somasekhar Sundaresan in the Business Standard, on India's middle income trap.

Shaji Vikraman in the Economic Times on the outlook for SEBI.

Amit Tripathi in the DNA has a story about Bharti Airtel starting a price war in Kenya. Once a telecom firm has learned how to sell at Indian-style prices, it is ready to compete with telecom firms anywhere. Also see.

William Neuman has an article in the New York Times, which made me think about the appropriate role of the State, and what are actually public goods, in the field of health. Translating $0.14 into rupees yields Rs.6.5 per hen, which is feasible in India, and I'm sure that Indian drug companies would be able to get to lower pricepoints.


Skin by Mark Jacobson in the New York Magazine.

Patrick Chovanec speaks with Christina Larson in Foreign Policy, giving a glimpse into one of the last three communist countries in the world. He closes with: We look back now and it seems inevitable -- the fall of the Berlin Wall, China opening up -- but it wasn't inevitable. I'm grateful to be able to go home at the end of my trip, and I'm grateful for the people whose convictions and sacrifices made it so this kind of place is an anomaly in today's world, and not the rule.


The frontiers of computer warfare, by Fredric Paul in InformationWeek.


The great writers of the 21st century : Jonathan Franzen, David Foster Wallace.

Tim Harford in the Financial Times on the attacks on economics.

A rumination on creativity by Jonathan Lethem, in Harper's Magazine.

See this book review of Mao's Great Famine (Frank Dikotter) by Jonathan Mirsky, in the Literary Review.

Read this great interview with Tom Sargent. In particular, the chunk about how high microeconomic turbulence interacts with the welfare state to generate high and persistent unemployment.

Holman W. Jenkins in the Wall Street Journal on google.

Fred Brooks in the New York Times on how little we worry that we are wrong.

An interesting book: Better living through Economics, edited by John J. Siegfried.

Lawrence Lessig in the New Republic on the difficulties of using a government (through copyright law) to make information excludable.

David Pogue in the New York Times on the brilliant work at OpenDNS.

Patricia Cohen in the New York Times about the world of academic publishing that lies beyond peer review.

Geniuses and economic development

by Ajay Shah.

On VoxEU, there is a fascinating article titled China and India: Those two big outliers by Jesus Felipe, Utsav Kumar and Arnelyn Abdon.

The interesting fact that they highlight is that both India and China are wise beyond their per capita GDP when it comes to the sophistication and diversification of their exports.

The evidence that they show, on the change in export diversification, is quite striking:

	China	India
1962	105	71
2007	265	254
Change (times)	2.52x	3.58x

In India's case, in 1962, in the depth of India's autarky, there were 71 commodities exported with `revealed comparative advantage'. By 2007, this number had gone up by 3.58 times. Both China and India are outliers (with excessively high values seen for export diversification) when compared with other countries at the same level of per capita GDP on a PPP basis.

Explaining the unusual export diversification

One element of the explanation of diversification is sheer size. Continental India has a diverse array of locations. Coastal Gujarat is a good location for processing crude oil for export, and Bihar is a good place for growing Litchis for export. By aggregating both places into a single country, we get high levels of export diversification. A casual examination of their graph (Figure 2) makes me think there is some support for this conjecture - positive outliers in the graph are big countries like the US and Germany; negative outliers are small countries like Ireland and Finland.

Explaining the unusual export sophistication

Why does India do sophisticated export, well beyond what one would expect for its level of per capita GDP?

1. Sheer size matters. Consider the distribution of a certain specific kind of knowledge across individuals in the country. Suppose you set a high cutoff for the minimum knowledge required of that field in order to assemble a large sized firm. So if you want to build a large sized firm in that field, you need to recruit 1000 people who have this specialised knowledge in excess of this cutoff. In a country of 1.2 billion people, you have more draws from the same distribution. So even if the lay of the land is quite bad in the sense that most people have bad knowledge, the sheer size of the country enables the establishment of firms which require building groups with high end specialised knowledge.
   Consider the distribution of IQ. One in a thousand people have an IQ of above 146. To help fix your intution, it appears that GRE V+Q of 1450 is roughly IQ=146. In India, with a population of 1.2 billion, we have 1.2 million of them. These 1.2 million very smart people in the country can serve as a core around which extremely high quality firms can be built. These effects are accentuated by increasing returns to scale, and the operation of Metcalfe's Law, in the gains from interaction and competition between these people within a country.
2. There is an odd upper tail in Indian human capital. Looking back 100 years ago, there has been a bizarre upper tail of very highly skilled people in India. Think Ramanujan: by rights, you would have never expected that kind of incredible knowledge to be found in a place like India. But pre-independence India managed to have incredible geniuses like Ramanujan, C. V. Raman, S. N. Bose and C. R. Rao -- well before the post-independence push that created the IITs. Is this merely about size (a lot of draws) or was there actually a bizarre upper tail?
   On this subject, see India shining and Bharat drowning: comparing two Indian states to the worldwide distribution in mathematics achievement by Jishnu Das and Tristan Zajonc. Some fascinating estimates are shown in Producing superstars for the economic Mundial: The team in the tail by Lant Pritchett and Martina Viarengo, who estimate the number of 15 year olds in a country with a OECD PISA score of above 625. The US is estimated to have between 240,000 and 270,000 individuals in this rarefied zone. India has (a) A lot of people, (b) An abysmally poor mode, and (b) A strange upper tail. Putting these together, they estimate India has 100,000 and 190,000 individuals in this rarefied zone - which is incredibly impressive considering that the Indian per capita GDP is one-thirtieth of that seen in the US. This also tells me that we need to scale up the universities in India so that atleast 200,000 individuals each year: it's a shame underutilising these kids.

Aside: PISA > 625 is a much weaker condition than IQ > 146.

Some people bemoan the inequality of human capital that is found in India, i.e. the huge gap between this upper tail and the modal value. But given that we have a low per capita GDP, would we rather have equality where everyone has low skills, or would we rather have an incredible upper tail in the distribution of knowledge, that is able to learn new technology, plug into globalisation, and power the country along?

This is also related to Albert Hirschmann's theme of unbalanced growth: he had argued that growth involves developing an `unbalanced' capability (e.g. India and the software industry led by a small core of high end capabilities), and then harnessing the benefits of the catchup by the rest of system (e.g. telecom reforms, mass scale computer programming education, broad business skills in running globalised firms out of India).

In a recent NBER working paper, Eric A. Hanushek and Ludger Woessmann offer interesting evidence about the tradeoff between `rocket scientists or basic education for all'. They say:

Both the basic-skill and the top-performing dimensions of educational performance appear separately important for growth. From the estimates in column 3, a ten percentage point increase in the share of students reaching basic literacy is associated with 0.3 percentage points higher annual growth, and a ten percentage point increase in the share of top-performing students is associated with 1.3 percentage points higher annual growth

....

the effect of the top-performing share is significantly larger in countries that have more scope to catch up to the initially most productive countries (col. 5). These results appear consistent with a mixture of the basic models of human capital and growth mentioned earlier. The accumulation of skills as a standard production factor, emphasized by augmented neoclassical growth models (e.g., Mankiw, Romer, and Weil (1992)), is probably best captured by the basic-literacy term, which has positive effects that are similar in size across all countries. But, the larger growth effect of high-level skills in countries farther from the technological frontier is most consistent with technological diffusion models (e.g., Nelson and Phelps (1966)). From this perspective, countries need high-skilled human capital for an imitation strategy, and the process of economic convergence is accelerated in countries with larger shares of high-performing students.

Many countries have focused on either basic skills or engineers and scientists. In terms of growth, our estimates suggest that developing basic skills and highly talented people reinforce each other. Moreover, achieving basic literacy for all may well be a precondition for identifying those who can reach “rocket scientist” status. In other words, tournaments among a large pool of students with basic skills may be an efficient way to obtain a large share of high-performers.

On a related note, it is very, very hard to create high end skills when starting from scratch. Witness the difficulties faced by China which had to start from scratch after destroying the elite in the Cultural Revolution. When the economy is ready with demand for a particular set of specialised skills, it may take decades to fill these gaps. As an example, by the late 1980s and early 1990s, it was obvious that there is a giant opportunity for India in software exports and in BPO. But it took 10 years for the education system to re-engineer itself to produce these skills in large quantities, and then make possible large numbers for IT/ITES exports. In similar fashion, the NDA got going on raising expenditure on infrastructure by 2003, but last month, Vikas Bajaj has an article in the New York Times about shortages of civil engineers. It is convenient, in economic development, to have a pre-existing base of high-end skills ahead of time, before the phase of high growth arrives.

Size and economic development

The argument in this blog post has emphasised size. There are many other good things about size, such as economies of scale in the domestic economy, and paying for the fixed costs of global firms in learning about a country in order to do business in it.

If size is such a good thing for economic development, why has it failed so far: as of 2010, why are India and China far behind OECD levels of per capita GDP?

One key story lies in globalisation. Big countries feel they can get away with autarkic policies. They feel self-sufficient and are prone to cut themselves off from the world. Policy makers in small countries don't think they have a choice in trying to create a domestic car industry, but their counterparts in places like Brazil or India or France feel they can experiment with industrial policy. Once this problem is solved -- as seems to be partly the case with India and China where trade liberalisation has arrived though capital account liberalisation has not -- big countries are no longer held back by autarkic policies. In addition, plugging into globalisation, by itself, yields world scale, and thus boosts certain dimensions of size.

Another story, emphasised by Lant Pritchett, lies in the extent to which India is not a single common market, and has thus squandered these potential gains from size. Conversely, as we strip away the legal and tax impediments against intra-India movement of goods, services, capital and labour, and as we bulk up on the infrastructure of transportation and communications, we will obtain returns to size which were not visible in the pre-2000 Indian GDP data.

Finally, on the role of size and sophisticated technological civilisation, see Insufficient data on Charlie's Diary.

I am grateful to Lant Pritchett, Jishnu Das, Pratap Bhanu Mehta, and Josh Felman for comments and improvements on this post.

Travails of the Indian B.Com.

Just heard that at the business school at the University of Essex in the UK, Indian applicants for the M.B.A. program are turned away if their undergraduate degree in India is a B.Com.

The gang that can't shoot straight

On the mistakes in the recent CSO data release, see P. Raghavan in the Indian Express.

By the time 3G telephony came about, India was well into the telecom revolution. By December 2007, there were 190 3G networks in 40 countries and 154 HSDPA networks in 71 countries, but none in India. We're now finally getting on with it, and will probably be the last place in the world with 3G telephony.

And there are the failures in organising the Commonwealth Games.

It is enough to make a man worried.