## Wednesday, June 19, 2013

### The problem of State capacity

A defining theme of India's challenge today is capacity constraints. Even when an objective is sound (a public good is sought to be created), and when the resourcing is adequate, the Indian policy landscape is littered with failure. We are very bad at achieving the desired objective. To get to sensible outcomes, we need to push on three things: Focusing the government upon the small class of problems which are public goods (i.e. doing fewer things), ensuring adequate resources, and achieving better State capacity.

There is a palpable sense that State capacity in economic policy has declined in recent years. On one hand, this is about a relative and not absolute problem: Every doubling of GDP brings forth new challenges, and requires both new kinds of knowledge and new kinds of agencies and laws. In India, our stasis on the organisation chart of government, where we perpetuate laws and agencies designed for a very different India, has led to a gross mismatch between the requirements of the country and the existing capabilities of the government. As an example, there are big problems visible in RBI that is over 75 years old and in SEBI that is 25 years old which have been left unattended. In addition, the staff continuity at the Ministry of Finance from the early 1990s onwards was significantly disrupted when Pranab Mukherjee became FM in 2009. These two factors put together have created a serious gap in capacity.

### The role of think tanks

The mismatch between the capabilities of government and the requirements of the economy has led to a bigger role for organisations such as think tanks that are outside government. Four think tanks in Delhi matter -- NCAER, ICRIER, CPR and NIPFP. In the Economic Times today, I have a column about an interesting process of reinvention that is taking place at these four institutions, and its larger consequences for the economic reform process, and for the life of the mind in India.

### Hurdles in the next phase of financial reform

In the Economic Times, Shaji Vikraman has a fascinating piece where he takes us back to the successes of the last 20 years in financial reform, and reminds us of the role of leadership teams. The achivements of that period were critically about the MoF team including Dr. P. J. Nayak, the SEBI team including S. A. Dave, G. V. Ramakrishna, S. S. Nadkarni and C. B. Bhave, and the NSE team including R. H. Patil, Ravi Narain, Chitra Ramakrishna, and others. The capabilities of these three teams, and their ability to work together, was crucial to the success of the reforms of the equity market.

Shaji says that we are now on the cusp of the next wave of institution building, as the FSLRC architecture is implemented in coming months and years. This involves rebuilding RBI towards clarity of purpose and quality of work, and building six fairly new things: the Unified Financial Authority (UFA, the regulator of all finance other than banking and payments), the Financial Sector Appellate Tribunal (SAT on steroids), the Resolution Corporation (starts from scratch), the Financial Redress Agency (FRA, starts from scratch), the Public Debt Management Agency (PDMA, starts from scratch) and building out the Financial Stability and Development Council (FSDC, which has to go from tiny to substantial). Shaji says that this will require inspired leadership akin to that found at MoF, SEBI and NSE in the 1990s.

On this same subject, see the talk by Chitra Ramakrishna at the recent FSLRC meeting in Delhi organised by the Institute of Company Secretaries.

### In many respects, we are in better shape when compared with the early 1990s

There is no question that we will need all the implementation capacity that we can find in making this big transition work. It will require capabilities at MoF and the seven agencies that are quite different from the behaviour of these organisations in recent times. To some extent, Shaji and Chitra are right in stressing the importance of leadership at MoF and at the seven agencies in their formative years.

At the same time, there are four elements which make me see this differently:

The unique difficulties of a startup
When SEBI was founded by S. A. Dave, Ravi Narain and others, they were starting from a blank slate. The very concept of SEBI had to be invented from scratch. Political battles had to be fought against the Controller of Capital Issues at the Ministry of Finance who was not keen on ceding authority on merit-based clearance for raising capital, and against the BSE that was not keen on having regulation and supervision.
These issues are all now behind us. Other than one minor part of Indian finance that is hostile, the bulk of Indian finance will accept the expanded-and-restructured regulation and supervision of the draft Indian Financial Code without a whimper.
And, with the draft Code in hand, the journey does not start from scratch. The 450 sections of the draft Code constitute a clear blueprint for what each of the seven bodies has to do. It is more like building NSDL in 1995 -- where there was full clarity about the mission -- and less like building SEBI in 1988.
Insourcing vs. outsourcing
All the staff capacity does not have to be in the government. While government and regulatory agencies have weaknesses, numerous other organisations have capacity of various kinds, which can be pressed into service. This includes domestic and international consulting firms, think tanks, universities, industry associations, practitioners, etc. These choices were not available 20 years ago.
From 2007 to 2013, we got a paradigm shift in financial economic policy thinking in India, where the experiences of 1991--2007 were digested and turned into a program for action through the Mistry, Rajan, Sinha and Swarup reports, and then FSLRC. This showed capacity of a kind which was not present in the early 1990s. If an FSLRC-like project had been attempted in 1992, it would not have been possible to find the 146 persons required to man it.
Leapfrogging to IT-driven processes
In many situations, achieving the objective is synonymous with building and running a large IT system. By now in India, there is quite a bit of experience and achievement in building such government organisations. The Indian State does not have, and probably never had, the ability to run FRA in the pre-computer world [counter-example]. But if the FRA is an IT-driven process, then implementation is within reach. This implementation capacity is something that India did not have in the early 1990s.
Sound institutional design embedded in the law
Laws in India have been skimpy in their drafting. As ane example, the Payments and Settlement Systems Act of 2007 gives RBI power over the payments industry. It says little else. It does not state regulatory objectives, it does not establish checks and balances; there are no feedback loops of accountability mechanisms. Under these conditions, the individuals who lead regulatory bodies possess power without matching responsibilities. The behaviour and functioning of each regulatory agency then changes dramatically based on the individuals found within it. It is, hence, not surprising that Shaji sees such a profound impact of the individuals at the helm.
In contrast, the essence of the draft Code is a framework of institution building for these seven organisations. For each of these organisations, there is clarity of objective, there is specificity of powers and there are elaborate accountability mechanisms. While setting them up at first will be hard, it is likely that the Code will make them behave as genuine institutions that are bigger than the individuals that inhabit them.

### Conclusion

Shaji looks back at our glorious past, and bemoans the lack of heroes. But as Bertolt Brecht had Galileo say, sad is the land that needs heroes.

The essence of the draft Code is a system of checks and balances, and a framework for accountability, through which the seven bodies will deliver results when manned by ordinary public servants who are not heroes. This is the way regulation works all over the world, and this is what we should aspire for in India. Let us make financial economic policy an everyday and humdrum process. As Keynes wrote in Essays in Persuasion in 1931, If economists could manage to get themselves thought of as humble, competent people on a level with dentists, that would be splendid.

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