Vijay Kelkar

Financial Express recently did a special feature about 20 interesting people in India's economic reforms. In that, I wrote this profile of Vijay Kelkar.

Vijay Kelkar's is a fascinating story in Indian public policy. He started out as an economics Ph.D. and turned himself into a consummate policymaker. While he did many interesting things in the field of oil and gas, and as executive director of the IMF, I worked with him in his fiscal phase.

This involved carrying forward the tax reform agenda of the 1990s, translating the intent of the FRBM Act into a concrete workplan, leading the transformation of income tax administration through innovative institutional arrangements in the form of the Tax Information Network (where the implementation was contracted out to NSDL), analysing and championing the Goods and Services Tax (GST) and leading the 13th Finance Commission.

For most people, the idea of the fiscal reform is exhausting. Fiscal systems have many moving parts, and suffer from the political economy problem of entrenched beneficiaries. I used to get astonished at the way Kelkar, who is 20 years older than me, consistently found the energy and morale to go back into the fray again and again, chipping away at solving long-standing problems. This also taught me that while weary cynicism is a more fashionable pose, progress is only achieved through the dint of boundless optimism.

Practical people are often dismissive of the world of ideas, but that is not the Kelkar that I have known. For one thing, he made a point of reading the current global research in economics on an astonishing scale. I have been frequently humbled in finding that his knowledge of the current literature was better than mine. I suspect his years at the IMF were very useful in tooling him up in modern open economy macroeconomics, which is often a gap in the knowledge of those who experienced a closed India in their formative years. Kelkar has always encouraged me, saying that in an open society, ideas matter, so it was important to build good ideas, and to push important messages out in the public domain, even when this makes many people uncomfortable.

After decades of engagement, Kelkar is no longer active in the public policy work of the New Delhi community. However, he has begun a stint as chairman of the National Stock Exchange (NSE). Given the immense importance of the equity market in the Indian economy, and the immense complexity of ownership and governance of stock exchanges, it is indeed valuable that a person of his wisdom is performing this public service.

The US sells chopsticks to China

by James Hanson.

We generally think that the United States exports the operating systems that power the iphone, the ipad, the kindle, and Android; in return China exports mens underwear. This is roughly consistent with our notions of comparative advantage: the US has an abundant pool of the top end human capital of the world, while China has an abundant pool of low-skill labour. Each is better off from this trade.

It, then, comes as a surprise when the Economist reports that the US exports chopsticks to China:

Enter Georgia Chopsticks. Jae Lee, a former scrap-metal exporter, saw an opportunity and began turning out chopsticks for the Chinese market late last year. He and his co-owner, David Hughes, make their chopsticks from poplar and sweet-gum trees, which have the requisite flexibility and toughness, and are abundant throughout Georgia.

In May Georgia Chopsticks moved to larger premises in Americus, a location that offered room to grow, inexpensive facilities and a willing workforce. Sumter County, of which Americus is the seat, has an unemployment rate of more than 12%. Georgia Chopsticks now employs 81 people turning out 2m chopsticks a day. By year’s end Mr Lee and Mr Hughes hope to increase their workforce to 150, and dream of building a “manufacturing incubator” to help foreign firms take advantage of Georgia’s workforce and raw materials.

But that is some way off. For now Messrs Lee and Hughes, and their workers, keep busy shearing, steaming, shaving, cutting and drying huge logs into rough chopsticks. They still need to be finished—to eat with a pair of Georgia Chopsticks right off the Americus line you would need tweezers in your other hand and a high pain tolerance. For that they are shipped via the Port of Savannah to China (later this year they will start sending them to Korea and Japan) in boxes with a rare and prestigious stamp: Made in the USA.

This might be considered a paradox or another indicator of US manufacturing weakness, but in fact it probably reflects comparative advantage.

One basic theory of comparative advantage in exports is based on differences in the relative abundance of labor, capital, land, natural resources etc., leaving aside government interference with trade patterns and macroeconomic policy. Although this theory is hard to use to explain trade in a particular product between countries, US exports of chopsticks to China seem consistent with the theory.

US land abundance relative to growing use of land for non-agricultural uses in China probably means it makes economic and price sense for the US to grow lumber to produce chopsticks for China. This trade seems to be just another example of US net exports of agricultural products, which reflects the relative abundance of US land (and the land-intensive and capital-intensive agricultural techniques that are used in the US, as well as US Government policies).

The US exports semi-finished chopsticks, however: the final finishing is left to Chinese labor and capital. This characteristic of the US exports seems consistent with the theory and transport costs. Shipping just the wood would raise transport costs and fully finishing chopsticks is probably a labor intensive activity, especially if it must be done to satisfy the particular demands of Chinese consumers.

More generally, the empirical patterns of international trade are quite complex and defy simple theory. There is a lot of rich-rich trade than the simple theory would predict. Many poor countries are exporting remarkably sophisticated things (e.g. India exporting motorcycles or software). Many rich countries are exporting low-skill things (as above). Explaining the observed patterns in the data, about international trade, is hard. But there is more good sense in the classical theory than meets the eye.

Interesting readings

The Anna Hazare silliness is depressing. Writing in the Indian Express, Shekhar Gupta has an interesting angle on why there is so much interest in this snake oil.

India's $2 trillion economy means we have to reform faster by R. Jagannathan on FirstPost.

Meera Subramanian has a beautiful story about how Diclofenac, fed to cows, is killing off India's vultures. We're down from 50M vultures to 60k. The consequences are bigger than we think.

Former Sebi member Abraham?s claims under CVC lens by Appu Esthose Suresh in Mint.

China's port in Pakistan?, by Robert D. Kaplan, in Foreign Policy.

The 10 most corrupt Indian politicians.

A promising band: Menwhopause. Listen.

The decline of Asian marriage, in the Economist.

Vinayak Chatterjee on ten projects that matter in India today.

The new draft Microfinance Bill. Back story.

Nirvikar Singh in the Financial Express on the CCI order about NSE.

Think again: War by Joshua S. Goldstein in Foreign Policy.

Hegemony with Chinese characteristics by Aaron L. Friedberg, in the National Interest. Arab Spring, Chinese Winter by James Fallows, in the Atlantic. The South China Sea is the future of conflict by Robert D. Kaplan, in Foreign Policy.

The problems of dogs in Iran.

Household financial choice of the hapless households of India

by Ajay Shah.

In February 2010, I had the opportunity to visit Pudhuaaru KGFS in Thanjavur. This is a remarkable project which helps us see the interface between households and the financial system in a wholly new light.

What a difference 17 months makes! On that visit, I had found a little tenuous Reliance CDMA cover at one place in Thanjavur city. On this visit, I found 3g or Edge cover in many remote places. On that visit, the ride from the airport at Tiruchirapalli to Thanjavur took two hours. This time, it got done in 30 minutes on the new NHAI road, with a peak velocity of 110 kph. While there are many reasons to be gloomy about the problems that India faces, some things are moving along merrily.

The KGFS approach to households and finance

KGFS emphasises the very important idea that for households to correctly engage with the financial system, this relationship must be (a) rooted in high quality advice, (b) which is grounded in a state of strong information about the household. The first is achieved by focusing on the incentives of the front line staff, by pushing them to think about household financial choice in its entirety instead of thinking about one product at a time, and by having no sales commission.

The removal of asymmetric information matters in many ways. On one dimension, if credit is extended to the household, a state of high information helps ensure better credit decisions. But more generally, across an array of financial products, when the advisor knows a lot about the household, the advisor would be able to synthesise an appropriate mix of sophisticated financial products which add up to an improvement in household welfare. In time, the advisor will increasingly lean on an expert system to help him do this better: it's a good approach today and it will get better in coming years.

I think there is enormous value in this approach. I believe that KGFS is doing a great job of building this kind of information about households in their present rollout (which involves going into really small villages at three locations, in Thanjavur, in Uttarakhand and in Orissa).

The typical KGFS front-end is a three-man branch in a village, where the three employees live in that very village. Remote villages in India are an environment of radical transparency. The households are relatively trusting. The three people in the outlet know an incredible amount about the households that surround them. Households and dwellings in small villages are rather stable: there is relatively little action through migration / change in financial conditions, etc. If there was ever an environment where asymmetric information is being removed, it is this.

The line between household finance and small business finance cannot be drawn. An adaptation of the KGFS approach can be quite effective with small business also: the KGFS branch would obtain a full picture of the firm, and deliver a portfolio of financial services to it.

A nice feature of the places where KGFS branches are being rolled out is the lack of alternatives. At a time when Indian financial regulation does not do much to check the behaviour of conventional financial distribution, a few high pressure sales agents can queer the pitch for the KGFS staff. By being in remote places that are being ignored by distributors, the KGFS staffpeople have the luxury of dealing with households without the households being tugged by various high pressure sales tactics of rival sales agents.

Urban households are being mistreated by finance

I also realised some limitations of this approach. Looking forward, India is urbanising. At first blush, it may appear that there is a big problem with the utilisation of finance in rural India. But there are big problems with the utilisation of finance in urban India.

The urban middle class and upper class is deluged with sales pitches by a variety of sales agents of financial firms. But these agents are almost always mis-selling, given their drive to push a product (through commissions) and given their lack of knowledge about the household's overall financial problem. Almost all financial products that are pushed in India (i.e. sold and not bought) seem to be mis-sold. I also feel that when the conversation between a sales guy and the household is about a product and not the overall household financial choice, it is almost always leading to the wrong answers. It's tantamount to a salesman who sells a drug without knowing anything about the patient.

What is out there, in urban finance, is a scandal, and I am embarassed to be an accessory to the crime (in however peripheral fashion). While in Thanjavur, I got the odd sense that at its best, a rural household that's well connected to a local KGFS outlet is doing better on utilising the power of finance, when compared with most urban households who are victims of the sales practices that are mainstream in Indian finance.

In this sense, the real problem for India is not the tawdry state of financial inclusion of the very poor in remote places. The real problem for India -- one that influences the bulk of Indian GDP and the households that matter greatly for India's growth -- is the tawdry state of financial planning of the typical urban household.

The KGFS approach is valuable and important to the places where it's being rolled out. But the burning challenge is that of fixing the mainstream. The mode of India is not brutally poor and isolated; it is middle class urban. Improving the interface between middle class and urban households, and the financial system, matters on a GDP scale.

An unrelated rumination: How important is rural deprivation in thinking about India?

The discussion above is a recurring theme in Indian economics. A variety of incentives (development journals, first world aid agencies, government rhetoric) make it fashionable to emphasise rural deprivation. But India is changing and the sweet spot has shifted. The emphasis on poverty and rural is increasingly off-centre. To stay relevant, and do the most important things in today's India, we have to keep our eye on the ball.

To fix intuition, it's useful to look at the distribution of annual household income, over April 2010 to March 2011, from the CMIE household survey of 143,000 households:

Percentile	Household income
10	45,700
20	59,900
30	72,800
40	90,000
50	112,200
60	142,500
70	180,000
80	240,000
90	348,500

As an aside, I think it's useful for anyone who thinks about India to memorise these nine numbers. Or atleast memorise these three numbers: the 25th percentile is Rs.66,000; the median is Rs.112,200 and the 75th percentile is Rs.208,500.

Middle India today has a household income from Rs.66,000 a year (at the 25th percentile) to Rs.208,500 a year (at the 75th percentile). The old-style Indian story of rural deprivation is (roughly speaking) about the 20% of households who are below Rs.59,900 a year (and the size of that group is shrinking). The main story of India is about the remainder.

An emphasis upon exotic poverty is as misplaced, in thinking about today's India, as an emphasis on designer clothes. Perhaps a bit worse, looking forward, since the extremeties of deprivation are being extinguished by growth, while designer clothes are a superior good.

Urban households are a much harder problem

So it's natural to ask: How can the KGFS approach be applied to urban India? When dealing with the urban poor and middle class, it seems that things are much harder.

Rural households tend to be more trusting, particularly in an environment of ethnic homogeneity and the repeated game that prevails in the village setting. But in urban India, households are more skeptical given the lack of ethnic ties and given the greater experience with people who have finked in prisoner's dilemmas.

Rural households tend to be a stable household in a stable dwelling place. Urban households tend to be physically mobile with greater fluctuations in the household composition.

Until deeper reforms on consumer protection take place in Indian financial regulation, urban households will be constantly tugged by unscrupulous sales agents of financial firms pushing products based on high pressure tactics Even if a KGFS tried to be patient and thorough, the very presence of such high pressure sales tactics would contaminate what a KGFS and its ilk can do.

It is relatively easy to construct information about the economic environment of a farming household (though seasonality and revenue volatility is a serious concern). I feel it may be relatively hard to even put together a picture of an urban household, particular when there is informality of labour supply coupled with entrepreneurship. This makes it difficult to do financial planning for such households.

On the other hand, in urban India, the revenue per household would be higher, and perhaps households could be persuaded to pay for advice qua advice. Or, the government could move on giving out advice vouchers to households, thus spurring the rise of an unconflicted advice industry.

Summary

I think KGFS is a great approach and it will be fascinating to watch them execute their agenda in the really remote places of India. What they are doing is path-breaking and important. This should help us set our sights higher on the problems of urban India. I have traditionally felt gloomy, in the knowledge that most households in India are being scammed by the agents selling financial products. As I look at KGFS, I find myself thinking: Can't we do something like this in mainstream India? I think this is an important question to ask. At the same time, there are some visible hurdles which suggest that this will be hard.

Credits

I am grateful to Bindu Ananth, Ramesh Ramanathan, S. G. Anil Kumar, Kshama Fernandes and K. P. Krishnan for many conversations which helped in improving this post.