Indian economic strategy in the new globalisation

by Vijay Kelkar and Ajay Shah.

A great global order has run astray. For over half a century, the world operated under an open system of movement of goods, services, capital and people, a system that was built by the post-war Western powers. India, for all its post-independence suspicions of the market and the world, was a big beneficiary of this order. From 1991 to 2011, India’s GDP growth quadrupled, not solely from an act of internal genius, but on the back of a global system that allowed Indian goods and services to find markets, that established the flow of capital, technology and business knowledge into India. Global companies brought new levels of productivity and knowledge into India, while foreign financial firms gave capital to India’s high-tech sector, and foreign buyers purchased Indian services exports that are at a run rate of $400 billion a year. Foreign companies provided the foundational technologies -- the CPUs, operating systems, the Internet and all the systems software -- on which India's knowledge economy was built. The champions for Indian openness, such as Jagdish Bhagwati and Ashok Desai, were proved right in abundance.

We must first confront a difficult truth: India's growth from 1991 to 2011 was partly built on a global system's benign neglect, a diplomatic dividend that has now been fully spent. In those years, India did not always play by the rules. We, as a nation, maintained a plethora of tariff and non-tariff barriers, all the while taking for granted the access granted to us by a world that was, for the most part, exceptionally indulgent. This indulgence stemmed from the West's perception of India as a decent, democratic country that would, in time, graduate to being a valuable successful country that would be a good citizen in the world economy. The West saw the idea of India; they felt India was a nation on a path to prosperity that was worth supporting, even if it did not always reciprocate with fair play when it came to economic nationalism. This benign neglect is an important element of India's growth story in the great years of 1991-2011, an element that is often neglected.

That era is now over.

The year 2016 was clear and sombre turning point. Donald Trump's rise to power and his subsequent policies of "America First" signalled the end of the post-war consensus on globalisation. At about the same time, China became estranged from the world due to its sustained use of unfair trade practices, going beyond tariffs to a dogged pursuit of economic nationalism where the ability of foreigners to operate in China is undermined. What we are witnessing is not a temporary hiccup, but a major change in the world economy. This is a new Globalisation, where the two poles of the old order (the US and China) are either hostile to the system or using it to their own unfair advantage.

So far, the US economy has endured the Trump shocks. We should not, however, be complacent about this good fortune. There are concerns about what will happen in the US economy on four fronts: local inflation which would then require tough monetary policy, loss of export competitiveness, adverse impact upon investment through increased uncertainty and punishment from the financial markets (Shah, 2025). Just as there are `gains from trade' with GDP growth induced by liberalisation, economic laws work in reverse also: Deglobalisation will harm growth, and the two epicentres of this problem are China and the US. All this paints a more sombre outlook for the world economy. A US with policy capabilities akin to those in an emerging market will be viewed with greater hesitation by global investors, inducing new stresses in financial markets. This is bad for the significantly outward-oriented economy that modern India has become: we need a successful prosperous world economy in order to sustain our rise.

For us in India, this is not a crisis moment on the scale of 1991. We are not facing an immediate balance of payments collapse. But it is an inflection point of equal, if not greater, long-term significance. The old strategies will no longer work. We cannot continue to rely on the indulgence of an open world that supports the rise of India. The path to India's ascent has just become considerably harder, and a commensurate, well-thought-out response is required.

The task of economic thinkers in India today is to strategise that response. Many good writings have emerged on this: Chinoy, 2025; Das, 2025; Ninan, 2025; Rao, 2025; Sengupta, 2025; Sharma, 2025. In this article we draw on all these and synthesise a full picture.

The New Core: Embracing the OECD (ex-US)

The first step in this new world is a pragmatic reassessment of our trade partnerships. If the US and China are now problematic partners, where does India’s future lie? The answer is to pivot aggressively and strategically towards a new core: the set of countries we can term the "OECD ex-US." This group includes the United Kingdom, the European Union, Japan, Canada, Australia, South Korea and many others. Adjacent to this are sophisticated countries such as Taiwan which are not members of the OECD. These are advanced, rules-based economies that remain committed, for the most part, to an open global system. While there are blemishes -- such as the agriculture policies of the EU -- by and large this remains the the sensible and stable core of globalisation today.

It is worth prioritising engagement with them as (a) They have a high level of GDP and (b) Their democratic and pro-globalisation policy frameworks are grounded in the Second Globalisation. Advanced mature democracies operate as institutions; policy movements are not personalised into the whim of a leader; when an agreement is made, it will stick for a long time, which is the time horizon required for private firms to commensurately respond.

We in India need to push on two approaches with these countries.

First, we should work with these countries to construct a new system of globalisation, where a variety of the unfair practices that were tolerated under the GATT or WTO are blocked [EiE Ep96 Is globalisation doomed?] That would be the best response. India has the opportunity to be in the founding group of such a new system. Once this is up and running between a core of important countries, such a system can be presented as an open system available to all countries, should they commit to deep globalisation on a defined set of conditions. The Trans Pacific Partnership ("TPP") -- which morphed into the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP) with the 11 countries going ahead without the US -- and the EU are examples of modern multilateral deep trade agreements.

Alongside this, we should make it a top priority to seek a new style of Free Trade Agreements (FTAs) or Comprehensive Economic Cooperation Agreements (CECAs) with every country in this bloc. The term `Deep Trade Agreements' (DTAs) vividly suggests the nature of bilateral trade agreement that is now desirable. The recent Indo-UK FTA is a step in the right direction. But it must be seen as the beginning, not the end. A DTA is not just about reducing tariffs; it is about harmonizing regulations, setting common standards, and creating a predictable legal and business environment that supports free movement of goods, services and capital. Such agreements would allow Indian firms to integrate into advanced global supply chains, gaining access to high-quality technology, capital, and markets.

This strategy demands an Indian retreat from the traditional protectionist approach. Our long-held reliance on high tariffs and a Byzantine web of non-trade barriers, a long list of redlines that subverted meaningful trade deals, is no longer viable. The benign indulgence we enjoyed in the past is gone. Our traditional ways, in a world of rising trade tensions, will be met with a reciprocal, and likely unpleasant, response. The United States is going through the throes of a great upsurge in populism; we cannot afford to provoke a turn towards aggressive economic nationalism, and a rejection of the global trading system, from the rest of the advanced economies. The message must be clear: India is no longer an aspiring economy seeking special treatment, but a serious global player willing to offer an equal, level playing field, and engage in deep globalisation.

This idea is not unique to us. Sensible policy thinkers the world over are looking at the wreckage of the post-Trump trade environment, and thinking on similar lines (Froman 2025, Hinz et. al. 2025).

Such deep engagement would make many new kinds of economic activity possible, which are presently not undertaken:

• Consider the German automotive industry under conditions of a DTA with the EU. Indian firms could then become part of the BMW or Mercedes-Benz supply chain, not just for low end parts, but for high tech components and software of the future automobile. This would require harmonising standards and IP protections.
• Consider the Japanese electronics or South Korean shipbuilding industries. A DTA with these countries could create conditions for them to see India as a China+1 partner (or really, OECD(ex-US)+1) for their advanced manufacturing.
• There are remarkable developments in defence R&D and manufacturing currently emerging, in the coalition of Poland and South Korea. Under conditions of deep integration with these countries, there is an opportunity for India to be a manufacturing platform for this joint work, harnessing Indian skills and geographical remoteness. This would simultaneously give India access to high technology and better defence equipment.

The Inward Turn: Removing the Domestic Shackles

Maximising our engagement with the OECD ex-US bloc is only half the battle. The other, and perhaps more difficult, half is to look inwards. To trade more intensely and successfully with a smaller, more discerning group of partners, Indian firms must be more globally competitive. This requires a sweeping agenda of domestic policy reforms that remove the shackles upon the domestic economy. Eight things loom large.

I. The indirect tax system

The current Goods and Services Tax (GST) regime, while a monumental step forward, is plagued by a major flaw: it fails to fully reimburse exporters for all indirect taxes paid. For the GST to actually be the promised "destination-based consumption tax", you do not tax non-residents. The existing system leaves many taxes (cesses, electricity, fuel, municipal taxes) embedded in the cost of production, which are not refunded to the exporter, thus making Indian exports artificially expensive. Input tax credit (ITC) has to flow fully, so as to generate the complete refund at the point of export. We advocate for a move to a single, low-rate GST, coupled with a simple carbon tax (Kelkar and Shah 2022, Kelkar, Modi and Shah 2025). Such a system would not only make Indian goods more competitive but would also align with evolving global standards, such as the European Union’s Carbon Border Adjustment Mechanism (CBAM), which taxes imports based on their carbon footprint (Jaitly & Shah, 2023).

II. Regulatory reform

We need to build on the intellectual foundation of the Financial Sector Legislative Reforms Commission (FSLRC). The FSLRC’s core ideas -- checks and balances for regulators that wield legislative and executive and judicial power -- are not limited to the financial sector. They must be applied across all statutory regulatory authorities in India. When regulators are enveloped in checks and balances, their arbitrary power will be diminished and their behaviour will become more predictable. This predictability is the bedrock of business confidence, both for domestic firms and foreign investors. This agenda is the sensible interpretation of the fashionable word `deregulation' (Shah, 2025; Krishnan, 2025).

III. Improving the judiciary

None of this can succeed without fundamental improvements in the Indian judiciary and legal framework. The delays in Indian courts, and the risk of matters being decided incorrectly, are a major drag on economic activity. Businesses, both Indian and foreign, are hobbled by disputes that can last for decades. This unpredictability hinders modern business arrangements which are grounded in contracts that perform as promised, and help to create a significant "India risk" premium. There is now a body of knowledge and experience in building better courts which can be brought to play upon this problem (Shah, 2024).

IV. Cities are where production actually happens!

Whether it is services or manufacturing, export oriented production happens in cities. There is a direct connection between the Indian urban reforms agenda -- the economies of agglomeration of talented people into livable spaces -- and the ability of India to produce and export. Thus far, there is little to report on the agenda of decentralisation to city governments, and to better town planning. A great deal of knowledge has now been developed in the country and can be usefully deployed into these questions.

V. Solve the logjam in agriculture

We have long known that Indian agriculture is broken owing to the comprehensive array of state intervention. The Indian state is overseeing and subsidising a faulty system of intervention that is inducing a health crisis through bad nutrition and the burning of fields. Indian protectionism in this field is proving to be disproportionately costly for the overall Indian economy. This underlines the priority of obtaining progress in this area. The essential idea is to have a full play of the price system in agricultural inputs and outputs, with freedom for individuals to buy and sell land, to sell agricultural products, to trade in commodity futures markets in India and abroad, to store agricultural products, and to move agricultural products within India and across the border. Achieving these changes will need to be done with a comprehensive sense of all the margins of adjustment (partial liberalisation is harder for the people) and political wisdom. The metaphor of structural adjustment programs is required for solving the sites of the highest intervention in the past, i.e. Punjab and Haryana.

VI. Macroeconomic resilience

In this turbulent environment, it will be particularly important to maintain macroeconomic stability. The path to macroeconomic stability lies not in autarkic instincts, or stifling private sector innovation, but in creating institutions for resilience. India has made one big movement forward in the form of the inflation targeting system [EiE Ep68 Inflation targeting], which has now delivered better CPI inflation stability from 2015 onwards. We must keep a zealous watch on CPI inflation, and ensure it does not deviate from 4% as is specified in the inflation target. With that problem mostly under control, there are now four areas of work for establishing macroeconomic resilience:

1. There is a problem with fiscal prudence, with a debt/GDP ratio that has risen considerably, and a primary deficit which is well above zero in all years. New institutional designs such as a Fiscal Council can help in this journey.
2. There is a problem with exchange rate inflexibility: a floating exchange rate [EiE Ep67 Exchange rate flexibility] is a great shock absorber when faced with difficult times (Shah, 2024).
3. Much needs to be done to create robust and resilient financial markets, which can absorb shocks in times of need (Shah 2026).
4. The gradual dismantling of the financial repression system (Chitgupi et. al. 2024) will create a new kind of strategic depth for the Indian state in terms of its ability to borrow from voluntary lenders, both onshore and offshore.

VII. Finance as the brain, financing as the raw material

The financial sector itself needs a fundamental overhaul, again drawing on the FSLRC’s vision. Indian firms currently operate with a significant disadvantage: a higher cost of capital compared to their global peers. This is a direct consequence of the malfunctioning financial system and the partially closed capital account. The Indian system of financial repression -- where the state uses regulation to appropriate a portion of private savings -- must be dismantled. Financial reforms will increase the quality of thinking that finance, the brain of the economy, is able to put in when allocating scarce domestic savings. By liberalising the capital account in a careful, sequenced manner, we can allow Indian firms to access the cheapest possible capital from global markets, making them more competitive.

VIII. Improved engagement with the information space

Economic policy acts through the process of reshaping the optimisations of self-interested people, about the nature of government coercion and the strategy for future policy reforms and institution building (Shah, 2018). In this, the communication strategy of the government achieves importance. Central to the 1991-2011 macroeconomic boom was the trust and respect of the private sector, for a shared understanding of the strategy for reforms, carried across multiple elections and multiple teams. As the old adage runs, the policy maker must `say what you will do and then do what you just said'. The modern information environment has become more daunting, with the rise of social media. In such an environment, there is great value in a government that is known for truth telling. A strong orientation towards truth speech would be a powerful asset in improving the structure of expectations of the private sector.

All large global firms are looking to do less in the US and in China. If we play our cards right, India can be a OECD(ex-US)+1 centre of activity for many important firms. But this requires profound improvements in how the Indian state treats foreign firms. India needs to move towards a system of OECD-quality tax treaties and bilateral investment protection agreements. Most importantly, we need a clear Parliamentary law that establishes equal treatment for foreigners, moving away from a mindset of economic nationalism. This would send an unmistakable signal to the world that India is a safe and predictable place to do business.

Engaging the Giants from a Position of Strength

Once India has put its own house in order and established a new core of trade partners, it will be in a position of strength to deal with the two most difficult partners in the new world order: the United States and China.

The problems presented by these two countries are indeed knotty and cannot be solved with chest-thumping nationalism or bluster. Dealing with leaders who have an inward-looking political style requires deft handling and a deep understanding of their political economies. Public posturing or slighting them will not be consistent with Indian interests. The union government needs to create a sophisticated brains trust with a profound understanding of the US and China: their domestic politics, their economic vulnerabilities, and their negotiating styles—to do better in these complex engagements. Through border conflicts in Doklam and Galwan, the Chinese state has primed the Indian intellectual community with questions and concerns, and a significant depth of knowledge on the path forward is now understood (Bambawale et. al., 2021).

The problem of Chinese overproduction is real and immediate (Patnaik and Shah, 2024). The Chinese state's policy of subsidising its firms to maintain employment, which leads to a glut of cheap exports, is a form of economic warfare. It is not just unfair; it is destructive to the manufacturing bases of other nations, including India. A vigorous set of barriers against Chinese imports is not just justified, but necessary. However, this is not an argument for complete disengagement. There are many paths to engagement with China that can and should be pursued, particularly in areas where our interests align, such as in global institutions or in addressing global challenges. Collaboration between China and India is essential for global decarbonisation.

The United States presents a different, and perhaps more fundamental, challenge. The US, which built the old world order, is now in a period of self-doubt and retreat. There is no guarantee that a post-Trump environment will get the US back to its former normalcy as a champion of free trade. The protectionist genie is out of the bottle. Until the US finds its footing again, our primary strategy must be to embrace the OECD ex-US bloc. We should engage with China where it is rational, while recognising the sustained misbehaviour by China against India on numerous episodes before, and we should wait for the US to find its feet one day.

Conclusion

In summary:

1. India was a great beneficiary of globalisation
2. We must recognise that the nature of globalisation has changed, and that this is detrimental to India's interests
3. This is an important turning point in India's history; it is our duty to strategise a response.
4. India needs to be a prime mover of a new deep globalisation arrangement between the advanced economies -- excluding the US -- and India.
5. India needs deep trade agreements ("DTAs") with the advanced economies, excluding the US.
6. The competitiveness of producing in India needs to be addressed by domestic reforms: a globalisation-ready indirect tax system, regulatory reform, financial sector reform, legal system reforms, an environment of institutions for macroeconomic stability, making better cities, solving the policy stuck in agriculture, and shifting the communication strategy in favour of more truth.
7. We should engage with the highly flawed objectives of the US and China from such a vantage point of strength.

The era of India’s economic rise on the back of an indulgent, open global system is over. This is not a Balance of Payments crisis, where we have to mortgage RBI's gold in London, but it is an equally important moment. Our future depends on it. The leadership needs to take the opposition into confidence, as was done by A. B. Vajpayee in 1998 after the nuclear tests, and collaboratively lead this transformation. For all of us in India, for the people and the firms, this is a time to rise to our best and prove our mettle.

The authors are with the Pune International Centre and XDKR Forum.

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Economic stress in Russia

by Ajay Shah.

The Russian economy has faced a series of adverse shocks after the invasion of Ukraine:

• Many de facto restrictions have emerged upon international trade,
• Many foreign companies have chosen to pull out or restrict activities in Russia, spanning non-financial and financial firms,
• Many individuals living in Russia have chosen to emigrate; these are likely to be high skill people.

We may think it is not hard for Russia to absorb these shocks. After all until 1991 it was the USSR, a land of central planning and autarky. We think they will just go back to those ways. However, the recent events are likely to impose substantial costs for the Russian economy.

Russia is no longer a centrally planned economy

It sounds funny, in today's world, to think of officials owning a target for exports, to think of officials making calculations about how much steel will be required in the light of what the five-year plan has envisaged for building railway lines. But that non-market mechanism for thinking and allocating resources did exist in the USSR (as it did in India).

That institutional capacity has been lost after 1991, and it cannot be quickly recreated. Now, Russia is a capitalist economy. The shocks will be dealt with by the price system in its usual ways.

Disruptions in the price system

Within the domain of the price system, trade and FDI have a deep influence upon the structure of production. Every modern economy involves millions of decisions about what to produce and how to produce. These decisions are made in a decentralised way, and millions of contracts are in place that govern the purchases and sales of each firm.

When 10% or 30% of these relationships are disrupted, it adds up to a storm in the economy. Yes, production can be reconfigured in a self-reliant way (and self-reliance will always induce greater poverty), but that takes time. There is a period of extremely volatile prices, of shortages, where every firm is cautiously waiting for the dust to settle before establishing a new set of self-reliant contracts. Millions of negotiations have to take place, to get a new set of production relationships going. There is a learning process where some contracts fall into place, and then prices change, and then once again some contracts are disrupted or renegotiated, and so on.

When the price system is humming, it is a marvel to behold, and when it is disrupted, getting back to normalcy (even the low level normalcy of self-reliance) is hard.

In the case of Russia, foreign goods and foreign technology are particularly important. They are an economy organised around selling natural resources and importing everything else. Hence, cutting off ties to the rest of the world will be particularly painful. Russia is more like Saudi Arabia and less like India in this regard.

Finance is the brain of the economy

Every real sector decision is shaped by finance. To get to the correct decisions in the real sector, we need finance to be operating correctly.

Russian finance is not operating correctly. The Moscow stock exchange was closed down on 25 February. For a month, the economy has not known stock prices. It is difficult for managers to make real sector decisions without the direction that stock prices provide. Conversely, the lack of observation of stock prices induces private decision makers to wait and see.

The credit market is also disrupted. Foreign banks have a position of about $120 billion (about 8 per cent of GDP) and are downgrading or exiting their role in the economy. Many borrower firms have a cashflow crisis owing to fluctuations in the economy, and would default on banks. A large scale banking crisis is likely. These fears, in turn, would hamper the ability of banks to fund real sector firms in rebuilding for a world of self-reliance.

The mind of the firm

In this thinking, it's important to go into the minds of the key persons of Russian firms. They are debating and thinking to themselves: Will I default on debt? What will happen when there is a default? What will input and output prices be a year from now? How can I put my skills to the best use in this environment, so as to buy locally and sell locally and make a profit? How do I address the departures of some of my employees? Should I leave? How much emotional and financial resource should I commit to overcoming this crisis? Do I just wait this out, and there will be a regime change, and we will go back to globalisation?

Many firms will choose to lie low and wait for the storm to end, as opposed to jumping to action in reconfiguring production for a new world of self-reliance. This inaction will increase the short term pain in the economy and increase the time required to get back to a humming economy.

The threat of emergency central planning

While Russia evolved into a market economy in the post-1991 period, in every society, when faced with a war and an economic crisis, there is a greater danger of central planning by the state. For an analogy, think of the behaviour of Indian officials when faced with Covid-19. In a crisis, there is a greater risk of abandoning the price system, of officials giving orders to firms. The lack of rule of law and constitutionalism in Russia implies that there is more of a free hand for officials to behave like this.

To the extent that central planning resurges in Russia, it will make things worse.

Conclusions

There are three levels of bad economic performance.

Economic performance is bad when there is self reliance.

It gets worse when we layer self reliance with central planning.

It is worst when the self reliance and central planning are brought in suddenly.

In steady state, Yes, it is possible to do self-reliance. We know that self-reliance will induce mis-allocation of resources and a low GDP, but it can be done. A sustained estrangement by Russia will taken them back to conditions reminiscent of the old USSR or the self-reliant India of old.

But getting to that (poor) state is itself a difficult task. In the short term, the Russian economy is in even worse shape than the mere self-reliance scenario.

The fact that the USSR was once the prime exponent of central planning and autarky does not mean that it is easy for today's Russia to readily go back to autarky and central planning. Russia now operates in the price system; the institutional capacity for central planning has atrophied and cannot be readily recreated. The sudden difficulties in trade, FDI, and finance, create a very difficult environment for every private firm. Self-reliant structures of production can indeed be created, and they will achieve a low level performance of the economy, but it will take years to get there, to reconstruct the complexity of the modern economy in a self-reliant way. In the short term, there will be a large scale economic collapse.

I have previously argued that freezing central bank assets is not that important. But the rest of the economic sanctions are an imposing barrier, that will likely induce an economic collapse, even without considering the direct cost of waging war.

I am grateful to Alex Etra and Josh Felman for useful discussions.

The lowest hanging fruit on the coconut tree: India's climate transition through the price system in the power sector

by Akshay Jaitly and Ajay Shah.

The world is projected to emit about 50GT of CO2 per year by 2055. Climate scientists say (net) emissions need to be ended by 2055, in order to avoid catastrophic events with reasonable probability. At present, India is emitting 2.5GT per year with a long term trend growth rate of about 5%. India is the 4th largest source of CO2 in the world, accounting for 7\% of emissions, with emissions that are roughly as large as those of the European Union. In a new paper, The lowest hanging fruit on the coconut tree: India’s climate transition through the price system in the power sector, we engage in strategic thinking about India's decarbonisation.

Decarbonising any economy is a large and complex problem. The electricity sector is a key site of the carbon transition, as it directly makes CO2 (e.g. by burning coal and gas), and because decarbonisation in other areas (e.g. cooking) involves switching away from fossil fuels to electricity. The sector is formally organised, which makes it more susceptible to policy intervention. Thus, in every country, decarbonisation calls for a large modification of the resource allocation in the electricity sector. Technical and business model decisions are required at each location in an economy about the optimal mix of renewables, storage and demand-side adjustment for the zero emissions world.

The Indian electricity sector is poorly placed to perform the required modification of this resource allocation. At present, it is a centrally planned system that is under growing financial stress. The process of private investment in electricity has lost momentum. Resource allocation is inefficient owing to multiple prices and a command-and-control system, rather than one based on producers and users that respond to prices. The command-and-control system works poorly in steady state, and particularly poorly when large changes in the resource allocation are required. By imposing enlarged costs upon the economy, a centrally planned decarbonisation runs the risk of greater political difficulties. The electricity sector is thus the critical choke point in India's climate transition.

Looking forward, the problems of the electricity sector are likely to deepen. Rising Indian emissions in coming years will sit uneasily alongside a decarbonising world. Regardless of the speed at which Indian policy makers might desire a change in course, there are forces reshaping the behaviour of Indian firms which are narrowing the options. Indian firms now operate under international asset pricing, and ESG investment has changed the incentives of Indian firms to favour buying and selling renewables. Some large economies could, in coming years, introduce trade taxes upon the carbon content of Indian exports. This would additionally induce Indian firms to desire reducing emissions in their supply chain. The cross-subsidy system within the electricity sector will come under increasing stress when buyers see renewables inducing some combination of a lower cost of capital, a lower operating cost and reduced trade barriers.

For 30 years now, political and fiscal resources have been expended in periodic incremental reforms of the electricity sector. These have not delivered the desired results. It is unlikely that similar efforts will work in coming years. In the meantime, 2021 is likely to be a turning point in the demands made upon the electricity sector owing to the carbon transition.

The climate transition is one of the most complex problems in Indian public policy and will now be subject to the new commitments made at COP26. A coherent strategy needs to be established and articulated, which can reshape the behaviour of a billion private persons across space and time.

This involves going with the grain of the price system, i.e. stepping away from the command-and-control system. All firms in the electricity sector need to be creatures of the market economy, which constantly reshape technology and business models in response to prices. Such firms have the incentive and the ability to look at the changing landscape of technology, financing and carbon taxation, and solve local maximisations that yield the correct engineering and business solutions all across the country. This distributed intelligence, this self-organising system, processes information better, values profit over conservatism and populism, engages in a process of search with risk-taking where some win and some lose, and avoids the state capacity constraints that hamper the central planning system. It will achieve the required Indian climate transition at a lower cost to the economy when compared with a centrally planned path.

Under an electricity sector that is grounded in the price system, there is a clear pathway to the climate transition: the single instrument of the carbon tax. Following a 5-10 year reform process of the electricity sector, the Indian state would announce levels of carbon taxation for the next 25 years, based on international commitments towards decarbonisation and net zero. Private persons would respond to these numerical values with business and technological strategies that are optimal at every location in the country. Every five years, policy makers would review the emissions, and modify the trajectory of taxes for the coming 20 years. Policy makers would control this one lever -- the carbon tax -- and the decarbonisation of the economy would be achieved through private decisions on the demand side, in generation and in storage.

Without a carbon tax, the union government lacks instruments for carbon policy, and intricate regulatory activities will induce enhanced costs upon the economy. Without an electricity sector that is organised around the price system, the resource allocation will be distorted thus enhancing the economic cost of decarbonisation. The optimal way forward is a combination of electricity regulation at state governments, a carbon tax led by the union government, and a private electricity sector organised around the price system.

While this appears to be an attractive vision, it is also a difficult policy project. Immense effort has been put into electricity reform in the past, by insightful policy makers. These leaders of Indian electricity reform, of the last 30 years, stayed within the strategy of a centrally planned electricity system. Why do we believe that things could work differently today?

There are six aspects in which the present situation is different, which creates a pathway to the fundamental reform that was elusive for the last 30 years: (1) There is greater understanding of the political economy landscape, and it is possible to design bargains where the losers from the reform are compensated. (2) State capacity in regulation is essential for the operation of an electricity sector organised around the price system, and there is now a greater understanding in India of how to establish the objectives and methods of regulation. (3) There is a path to electricity reform, one state at a time, which is more tractable and feasible when compared with grand schemes led by the union government which apply to the entire country. (4) The materiality of climate policy in the international discourse has shifted the political salience of domestic electricity reforms. Alongside this, the domestic policy envelope on establishing more market-led solutions has improved. (5) It is possible to fund the transition. (6) The fiscal cost of upholding the status quo in the electricity sector is likely to rise.

Analysing Bambawale, et. al., 2021 ("Strategic patience and flexible policies: How India can rise to the China challenge")

by Shubhashis Gangopadhyay.

This is the text of my discussant comments at LEPC 4.1 today, which is a session organised around a talk by Gautam Bambawale presenting the recent paper Bambawale et. al. 2021.

The paper makes a strong and convincing argument for the need to create an ecosystem that fosters growth that is fast and sustainable. It focuses strongly on what needs to be done to ensure Indian citizens a desirable future. This future is envisioned as one where we are in control of our own destiny, China notwithstanding. I am in complete agreement with the need for India to grow economic muscle. I also agree that this will play a large part or, could even be necessary, to thwart China’s adventurism in our neighbourhood. But what I like most about the paper is that the authors’ emphasis is not on diplomacy, or on battle preparedness, or on economics but on the realization that they all need to play their respective parts for India to reach a common goal.

The paper is a “must read” for all. The paper sets the tone for how public discourses need to be carried out --- state the problem, clearly articulate the solution and, explain why the solution will work. A public discourse is not simply the voicing of opinions but also explaining the reasons behind them. Reading it will not only inform, but also improve, the public discourse on this topic. Respecting the spirit in which this paper has been prepared, I will try and add to the discourse initiated by the authors.

The paper makes an excellent argument for reforming the ecosystem within which economic transactions are planned and executed. To borrow a term from game theory, building up India’s economic muscle is seen as the “dominant strategy” against the challenges posed by China. There is, or can be, very little dispute about the need for India to grow economically.

While agreeing completely with the recommendation in the paper, I would like to modify somewhat the problem statement. For that, I will distinguish between a goal, or an objective, and the strategy to achieve that goal. A winning strategy is determined by the desired objective of the player and the possible responses by her opponent. In other words, a player’s strategy cannot be independent of what the other player is doing or, of the different circumstance in which the game is being played out.

India’s strategy is not an action it should undertake but an enumeration of the set of all contingent actions that India must take. Contingent on what? Contingent on the response that China will undertake for each of the actions we take. The choice of actions could also be contingent on changing circumstances for which China may not be directly responsible. E.g., if we criticize Myanmar’s military government, China may move in and make the Myanmar government hostile to us; on the other hand, if we do not criticize, we may face problems in the Quad.

A player’s strategy is derived, among other things, from the player’s own objective and the threats to that objective posed by the responses of the other players (or competitors) and, the changes brought about in the environment by nature (uncertainty). Simply put, the strategy is derived from the objective and never the objective itself.

There are two reasons why I want to distinguish between a goal and the strategy to attain that goal. First, as stated before, formulating the problem determines the answer we get. The way the paper currently reads, China is the problem and growing economic muscle is necessary to thwart China. And, it is this that makes me nervous. Why? Our policymaking has been mostly in response to a crisis and we slip back to status quo ante as soon as the crisis blows over. As an example, consider the trade liberalization measures undertaken in the post-1991 period (when we faced a foreign exchange crisis), and the roll-backs in more recent years when we are not facing any foreign exchange shortage. Trade liberalization was never seen by our policymakers as necessary for economic growth; it was always seen as a step towards easing the foreign exchange shortage of 1991. Hence, I am afraid that if we do not clearly state that growing economic muscle is an end in itself (and not simply to thwart China’s adventurism), we will go back to our old economically inefficient ways as soon as the China threat is neutralised.

The second reason is a bit more nuanced and depends essentially on what one means by strategy. As the paper points out, correctly, the game will be played over many years giving enough time both, for China to push back on what India is doing and for circumstances to change as global uncertainties are resolved. For example, if we develop manufacturing and/or services to export into Africa, I do not think that China will simply watch us do so and not push back in various ways to defeat India’s purpose. The correct definition of strategy will enable us to consider the following options (say) --- grow through the African market, focus on the Western market, or ASEAN or, diversify in such a way that China has to push back in every market at great harm to itself (push back is always costly to the one doing it). In other words, we must plan our economic growth in such a way that China cannot, or will not, be able to force us to give up our growth plan in the way we have envisaged. Our growth path must be such that in case they want to affect it, it will be costly to them but with minimal repercussions on us.

This approach immediately alerts us to a careful formulation of our goal, along with a deep understanding of what (a) China is trying to achieve and (b) the national interests of our potential partners. This latter is very important and I get a whiff of romanticism in the paper’s suggestion of forming partnership with those who believe in individual freedom, market resourcefulness and the rule of law. The biggest supporters of the free world routinely justified their inactions against apartheid and continue to be in denial while condoning the atrocities of various “friendly” dictatorial regimes! In other words, they are going to partner with India, against China, only if it is in their interest to do so --- not because they have great regard for India’s righteousness. They will support us only when there is an alignment of our interest with theirs. Some years ago when I complained to a high level US official about how their policies in India’s neighbourhood are adversely affecting us, he was quick to point out that he was paid by US taxpayers not to meet India’s aspirations.

It could be dangerous to misread China’s objective. It may appear as an approach relevant to a zero-sum game (very “mercantilist”), when the economic world is uniquely, and definitely, a positive-sum game. So, why is China doing what it is doing? The paper seems to suggest that this is largely an attempt to raise nationalistic fervour within China to distract people from its domestic problems (of a growth slow-down amid growing disparities). If this indeed is the reason then once China gets back on its erstwhile growth path, Chinese adventurism along India’s borders will diminish. Contrast this with the possibility that irritating Indian border forces is a longer term plan. Should our responses in both cases be the same? To play the game properly, we must be able to anticipate China’s game plan. This will only happen through careful and deep investigation of the ground realities in China along with the interplay among its political actors. Not understanding fully China’s objective is where we begin to lose the game! The paper does point out that there are more people studying India in China than Indians studying China. Given our definition of strategy, the importance of correctly reading China’s objective is crucial to determine India’s optimal strategy.

I want to highlight a specific difference between our two systems that differentiates the manner in which we achieve our respective goals. China could get its banks, companies, policymakers and all other groups in their society to do exactly what the central authorities wanted them to do. In India, that is not feasible. This does not put us at a disadvantage as long as we are aware of it and, hence, stop borrowing “best practices” from China or, for that matter, any other country. We are going to rely on the resourcefulness of our people, operating through innovations and investments by the private sector, facilitated through the appropriate institutions implementing market rules. Historically, this approach has been found to be a more sustainable path to economic growth. As the paper correctly points out, this is a huge advantage for India especially if we see the fault lines now opening up in the Chinese system.

India is not a unitary system but a federal one. Indeed, whatever “ease of doing business” policies the central government rolls out, the ultimate hurdles can be taken down by state governments only. Why would various sops to foreign businesses bring in FDI when our own companies, even when they are flush with investible resources, not investing in India? So the first job of this exercise is to move out of Delhi and get the state governments aligned with the nation’s interest and coordinate their strategies. In this context, I must say that I am extremely sceptical of following a SEZ policy in India simply because China did it successfully. Its implementation invariably leads to corruption and crony capitalism, which will lead to umpteen consequential issues which are difficult to handle in a vibrant federal democracy where the rule of law should reign supreme. What China could do with its centralized economic approach and business activities through state-owned enterprises is simply not doable in India.

Our goal of sustained high growth has to be attained in a way that suits the Indian context. Japan, China, South Korea and the Far East, all followed their own paths to reach where they are now. The differences in the paths they followed are more pronounced than the similarities. And that is what we need to understand --- scholarship without thought will simply not do.

Shubhashis Gangopadhyay is a researcher on India and economics.

How will your armed forces perform?

by Ajay Shah.

Backdrop

In the world of public policy, there are two dimensions to thinking about performance.

How hard is a problem? "High load problems" are those where there is more discretion, a large number of transactions, and the stakes are high.

Are there easy mechanisms for accountability? Performance is greater when measurement of outcomes is more feasible. As an example, it's relatively easy to get performance from a central bank which is tasked with delivering a 4% inflation target and nothing else, as success/failure are highly visible. Performance is measured every month. If the central bank performs poorly, within a few years, this becomes visible, and that would kick off remedial actions.

Feedback into superficial change or deeper change? When institutions are weak, a government agency is personified into a few individuals at the top. When failure is visible, the response is to seek staffing changes. As an example, the 1962 war led to the sacking of V. K. Krishna Menon; the scandal of 1991/1992 led to the departure of S. Venkitaramanan. These were relatively superficial changes. For a display of better institutional capability, the Indian inflation crisis of 2006-2013 helped trigger off fundamental reform of RBI.

Rare events and feedback loops

The best feedback loops are those where measurement is frequent, and reports of low performance kick off small steps that address the problem. When measurement is infrequent, the feedback loop is much less effective.

A small number of actions, and thus a weak feedback loop, is something that we've seen in another domain: consumer finance.  In the field of consumer protection in finance, there has long been a sense about why consumers do badly when buying certain financial products like home loans or pensions: the transactions are so infrequent. When a consumer engages with toothpaste, there are many transactions through life, and a feedback loop is in place through which performance is improved. In contrast, many consumers buy only one or two home loans or pension products in their life. There isn't enough experience with small course corrections through which the feedback loops kick in. This leads to big mistakes by consumers. While this is an example about consumers and finance, the principle is general: infrequent actions hamper feedback loops.

The puzzle of building the armed forces

The armed forces pose a difficult challenge for public administration as it's hard to know whether they are working properly. Using vast public resources, an organisation is built for the purpose of waging war. In peace time, it's hard to know whether the organisation has the advertised capabilities. Wars often have a decisive win/lose outcome, but wars are infrequent, and there also, there are extraneous factors that limit accountability.

With the armed forces, we face the Principal-Agent problem where the Principal (the political and civilian authorities) want to get a target level of capability at the minimum cost, and the Agent wants to pursue self-interest. In this Principal-Agent problem:

1. Building the armed forces in peace, or using them in war, is a high load problem as it involves a lot of discretion, high stakes. It takes a lot of capability in the political and policy system to pull this off.
2. The checks-and-balances of democracy are weak given the opacity that envelops the armed forces.
3. The Principal (the civilian political leadership) knows little about the performance of the Agent (the armed forces). In peace time, years and years go by with no feedback loop about performance. For example, Germany knows little about the capabilities of their armed forces as they have been tested so little in recent decades. By this yardstick, the US fares best as there are frequent wars which generate data about performance.
4. For countries where nationalist feelings are prevalent, there is a greater risk of civilian authorities glorifying the armed forces and thus failing to employ public choice reasoning. By this yardstick, Germany fares better than the US.

In advanced countries, there is a considerable extent of the rule of law, and review of the armed forces, in times of peace and war. For example, see the 19 occurrences of the word `lawyer' in Ghost Wars by Steve Coll, and the long history of the political leadership sacking military leaders. But this is complex institutional machinery which is hard to build. A recurring feature of underdevelopment is that civilian authorities have limited power over the top leadership of the armed forces. When the generals claim excellence, it is hard for civilian authorities to be intrusive, impose management and staffing changes, etc. Weak oversight by the Principal is then the breeding ground for failure by the Agent. Claims of the greatness of the Agent increasingly diffuse through society, unchallenged.

Mistakes by the Principal

War is an expensive way to resolve a dispute; it seems like a shame that ordinary processes of bargaining are not able to avert more wars. Why do wars take place as much as they do?

Nobody would go to war if they did not expect to win. Yet, half the time, one party has gone to war with the mistaken notion that he was going to win. Why does the Principal make this mistake?

Some ingredients of this excessive willingness to mistakenly wage war may be as follows. In each country, the Agent claims I'm doing a great job of using your money, we're very capable, we're ready for a war, we will win it. Exaggerated respect for capabilities of the armed forces would arise when these claims are not challenged widely in society. There is a toxic interplay between places with high nationalism (which would tend to glorify the armed forces) and low institutional capability (which would tend to leave the Agent free to do as he likes). Under these conditions, the Principal may be prone to inefficiently continue politics by other means.

Conclusion

1. The armed forces are one of the hardest problems in public administration: high discretion, high stakes, high opacity. When wars are infrequent, the civilian authorities (the Principal) know little about the capabilities of their Agent. When a country suffers from nationalism, this further damages the ability of the Principal to coldly analyse and reshape the Agent.
2. Overconfidence bias would make the Principal over-estimate how well he is handling the Agent. Nationalism is likely to delude the Principal too. Hence, civilian leaderships may have a bias in favour of over-estimating the capabilities of their armed forces.
3. Fewer countries would go to war if they had a more accurate assessment about the incompetence of their armed forces.

I thank Shekhar Hari Kumar, Ila Patnaik, Kaushik Krishnan, Renuka Sane and Susan Thomas for useful discussions on this.

Iran may have developed offensive cyberwar capabilities

After Stuxnet, Iran seems to have developed offensive cyberwar capabilities, possibly with Russian help.

Catnip, organised by me in chronological order. First, the Stuxnet story:

• Israeli test on worm called crucial in Iran nuclear delay, by William J. Broad, John Markoff, David E. Sanger, in the New York Times, 15 January 2011.
• A declaration of cyber war, by Michael Joseph Gross in Vanity Fair, April 2011.
• Obama order sped up wave of cyberattacks against Iran, David E. Sanger, New York Times, 1 June 2012.
• Confront and conceal by David E. Sanger, 5 June 2012.
• Stuxnet: Leaks or lies, Steven Cherry interviewed Larry Constantine, IEEE Spectrum, 4 September 2012.

And then, the recent developments:

• Cyberattacks against US corporations are on the rise, by David E. Sanger and Nicole Perlroth in the New York Times, 12 May 2013.
• New computer attacks traced to Iran, officials say, by Nicole Perlroth and David E. Sanger, in the New York Times, 24 May 2013.
• Silent War, by Michael Joseph Gross in Vanity Fair, July 2013.

Faulty tradeoffs in security

The new world of security in India

Only in a police state is the job of a policeman easy.

-- Orson Welles

The policemen of India say: It is only by using onerous and intrusive tracking procedures that we will be able to block the terrorism, the tax evasion, the money laundering. But society should be designed for the convenience of the median citizen and not for the convenience of the policeman. Yes, when citizens have liberty, it imposes more work upon the policeman. That is a tradeoff we should favour.

In every place in the world, I walk into a coffee shop, open my laptop, and go into free open wifi networks. Except in India. Open wifi networks are banned in India, because they make life difficult for policemen. This is a bad tradeoff : we have sacrificed the immense gains from ubiquitous open wifi networks, in return for reducing the work of policemen.

Terrorists and criminals use roads. Does that mean that we will only permit people with photo IDs to embark on roads? Terrorists and criminals drink water. Does this mean that we will only permit people with photo IDs to buy water? And so on.

Global norms on financial distribution, which have been pushed hard into the direction of more monitoring by the US Treasury, do not require a know-your-customer on every transaction. They only require `customer due diligence' (CDD), which means that the due diligence applied on a transaction should be appropriate (a big principles-based word) for the transaction at hand. We in India have translated this into a mechanistic rule "demand KYC for everything". This is incorrect. A greater push-back is required, from citizens.

In a civilised society, employees of government will have to work hard and work smart in blocking terrorism, obtaining tax revenues, etc. This is okay. We should not set out to make the life of these employees easy. Obtaining a high tax/GDP ratio requires careful, detailed hard work, and a lot of brainpower. In the absence of this, there is a temptation to resort to quick fixes, which should be avoided.

A civil liberties perspective

They who can give up essential liberty

 to obtain a little temporary safety,

deserve neither liberty nor safety

-- Benjamin Franklin

We get asked to prove identity to enter an airport, to do financial transactions, to get a mobile phone, etc. We have become used to the idea that this is essential in this world inhabited by too many terrorists.

I think anonymity and privacy are precious and valuable. We in India seem to have given up on protecting civil liberties from an encroaching State that wants to know a lot about us. Particularly given that we are a fragile democracy that works imperfectly, it is important for us to have less information in the hands of the State. One element of the imperfection of our democracy is the undersupply of criticism. We need to cherish and protect the critic, which will be assisted by having a government that knows less about us.

The best we're able to muster today, in the Indian discourse, is the hope that UIDAI will reduce our transactions costs of complying with the surveillance state. I think it's important to go deeper, to question this array of rules that monitor us. How much security do they buy us, in return for what costs to society?

What bang for the buck?

We should be more intelligent in weighing these tradeoffs between imposing costs upon society at large, and the extent to which they help us catch criminals. A great deal of what passes for security procedures today is quite silly when you pause to think about it.

We are obsessed with monitoring electronic payments. The bad guys will just use cash. The amount of money required for pulling off the WTC attacks is believed to be roughly \$100,000, which was wired to Mohammad Atta. It is not hard to move \$100,000 through non-electronic channels: this is the value of 11 bars of gold, each the size of a pack of cigarettes.

In fact, it is very convenient for the authorities when the bad guys use electronic channels, since greater tracing becomes feasible. We have a fair clue that this money came to Mohammad Atta from Pakistan's ISI because the money was wired; if the bad guys had moved money through cash or gold or diamonds or platinum, we would have not known this crucial fact. It is better for us if more bad guys ride on the electronic highways of the financial system. As long as cash is around in large quantities in India, it makes little sense to block people from coming into electronic payments on the grounds of KYC.

We are obsessed with physical IDs as a tool for security. But the bad guys will easily forge any physical IDs that you can propose. It is not clear what safety we're buying, in return for the enormous human resource and cost in time that is being expended today in checking IDs.

We in India are surprised to discover that in the US, you can buy a temporary one-month GSM SIM card at a storefront, without any know-your-customer or proof of identity. They do not even want to know your name. This is not to say that the security agencies in the US are not watching everyone keenly. The point is that they are doing this in ways that impose lower costs upon society; the security procedures are less of an eyesore.

A need to rethink where we're going

Many elements of the information before us, today, suggest things aren't going well:

• In the US, despite a fairly open and liberal system (e.g. freely selling GSM SIMs to anyone, without requiring even a name), law enforcement has been pretty effective: They haven't had a single successful terrorist attack after 2001, despite being the #1 target of myriad nutcases like OBL. In India, thousands of people have died in terrorist attacks, even though we have embarked on a barrage of security procedures.
• Every terrorist caught dead or alive in India has a cell phone. This suggests that our attempts at requiring a KYC for every mobile phone aren't so useful.

Failure should have consequences. We should rethink the way we work today, drawing on these blocks of evidence.

We need to ask three questions:

1. Tradeoffs between freedom and safety. How much of a violation of personal freedom are we willing to accept, in return for better enforcement of laws. We should be willing to sacrifice some safety in return for more freedom. E.g. Saudi Arabia has low crime, but do we want to be Saudi Arabia?
2. Tradeoffs between prosperity and safety. How much inferior GDP are we getting, as a consequence of the security procedures which are being put into place? We are willing to sacrifice some safety in return for more GDP. E.g. there would be fewer road accidents if the speed limit were 25 kph (and road accidents kill vastly more people than terrorists), but we're willing to live with the carnage on the roads in return for higher prosperity.
3. Does the claimed security procedure even work?? What is the bang for the buck, the effectiveness of these procedures? As many examples above have suggested, many of the security procedures used in India seem to be poorly thought out.

Drawing on my experiences in Indian public policy process, I can venture a guess about how the prevailing tools of security came about. A meeting was organised. Everybody in the room was an experienced security practitioner. The only viewpoint present was about how the world can be redesigned to make life easier for the employees of government. Everyone was indignant. We have to do something. A few security as theatre proposals came up. Everyone agreed. It felt like we were making progress; we certainly got plenty of showy security procedures to impress Parliamentarians and the media. Nobody asked second order questions; nobody analysed the data. This combination of factors (indignation, decision making dominated by the status quo, theatre to satisfy journalists and politicians, lack of a feedback loop through data capture and data analysis) is not conducive to problem solving.

We in India repeatedly find ourselves in a situation where law enforcement is placed under pressure to deliver. Whether it is a crime wave, or a terrorist attack, or a low tax/GDP ratio: officials are asked to do better. Such demands for performance are entirely appropriate. However, at such times, we should be careful to not accede to bargains where the enforcers promise results in exchange for arrangements that make life convenient for the enforcers, at the expense of the open society.

Why Ngozi Okonjo-Iweala should be the next head of the World Bank

by Lant Pritchett.

The US had a chance to lead. It abdicated that chance, to play domestic politics and put forward a US nominee who is manifestly less qualified to be head of the World Bank, than the alternative candidate nominated by African countries: Ngozi Okonjo-Iweala.

The World Bank is a full-service development institution that provides loans, grants and development advice to promote development, which is the transformation of countries towards prosperous economies that support broad based improvements in material well-being, democratic polities that respect citizen rights and respond to citizen demands, and capable administrations that allow governments to carry out their core functions: law and order, education, macro-economic management, health, infrastructure, regulation, security.

Therefore an ideal candidate should have:

• Some experience in government and the process of policy-making (as the World Bank's clients are all governments);
• Some acquaintance with economic policy and policy making: including the tough choices like allocation of resources across uses;
• Some knowledge of finance (it is, after all, a bank that makes income from lending money);
• Perhaps some management experience in a multilateral organization;
• Exposure to the breadth of development issues.

Experience in Government.

Ngozi has been the Minister of Finance of Nigeria, twice. If one had to name a tough job in the world, I think that would be it. She did it first from 2003 to 2006 and by all accounts handled a very tough situation -- including tackling entrenched corruption -- in an admirable way. Jim (to be fair we'll use first names for both) has no experience in government. He has been engaged in development as an academic and through NGOs.
Advantage Ngozi.

Acquaintance with Economic Policy.

Ngozi has had training in economic development from MIT. Jim has been trained as doctor and anthropologist. Ngozi has been a Minister of Finance making budget allocations and dealt with the entire array of economic policies to promote growth and prosperity. Jim has worked exclusively on health issues (rightly, as he is a physician) and never been in position of responsibility about economic policy. Health was just one of many sectors for which Ngozi had to allocate budgets and promote performance.
Advantage Ngozi.

Knowledge of Finance.

Ngozi has been a Minister of Finance as such, among other things, she led the Paris Club negotiations that led to billions of dollars debt relief for Nigeria. Jim has no demonstrable experience in finance, banking, the private sector.
Advantage Ngozi.

Management Experience.

From 2007 to 2011 Ngozi was a Managing Director of the World Bank. She therefore has in-depth experience running a large and complex multi-lateral organization. Jim was director of WHO's HIV/AIDS department, from 2004 to 2006, and so has some experience in a multilateral organization. Jim has also, for two years, been president of an American university. But while Ngozi was near the top of a large organization dealing with all development issues Jim was responsible for one disease in an organization that does only health.
Advantage Ngozi.

Breadth of exposure.

There is a massive difference between doing development policy, and doing charity work to mitigate the consequences of the lack of development. Ngozi has done development policy in many settings and in many positions both in Nigeria and within the World Bank. Jim deserves praise for having devoted his time, attention and expertise in medicine to improve the health care for people in the developing world -- which is certainly one component of development -- but his development experience is limited.
Advantage Ngozi.

Passport.

Jim holds an American passport. Ngozi is a Nigerian woman.
Advantage Jim.
In this day and age, is that still really all it takes?

Guide to the Eurozone crisis

by Percy Mistry.

How did it happen?

The worst financial crisis in the western world for nearly 80 years broke in September 2008.

It required banking/financial systems to be supported and recapitalised by governments across the EU and in the US.

In June 2009 it became apparent that the peripheral countries of the Eurozone (Greece, Portugal, Spain and Ireland) were grossly over-indebted.

Yet in some instances (Spain) their public debt to GDP ratios happened to be lower than those of the US, France, the UK and Germany.

The continued viability of their public finances depended entirely on markets being willing to refinance them with cheap money.

But, when markets scrutinised the sustainability of their fiscal positions, they baulked from refinancing except at punitive rates.

CDS spreads (against Germany as a benchmark) of peripheral Eurozone countries (PIGS or Club Med) debt began widening relentlessly.

Global financial markets began to price in an escalating risk of partial/full voluntary/involuntary default on PIGS bonds since December 2009.

Contrary to first impressions, except for Ireland, that was a result not just of the financial crisis and bank recapitalisation demands on the fiscus.

It became apparent instead that bank recapitalisation demands on public finance were only the last straws that broke the camel's back.

Greece, Portugal, Spain and Italy, as a direct consequence of joining the Eurozone, had been running up unsustainable fiscal deficits since 2000.

Ireland had not. It suffered because the bailout of its disproportionately large banking system caused its public debt to rise astronomically.

PIGS became over-indebted despite the supposed self-imposed discipline adopted by the Eurozone of prohibiting fiscal deficits >3% of GDP.

That discipline was violated by almost all Eurozone members, beginning with France and Germany, but more egregiously by the PIGS.

To make matters worse, however, the PIGS were also running increasingly large current account deficits (with Germany, France, China).

Though countries like France (and to a lesser extent) Germany were fiscal sinners, they were at least running current account surpluses.

PIGS had access to excessively cheap public and private money available on terms totally inappropriate to their economic circumstances.

Given their inherent risks, which markets mispriced completely, their borrowing costs should have been 300-500 bp higher than Germany's.

Instead, they were virtually the same for nearly a decade. That relieved market-induced pressure on PIGS' governments to behave responsibly.

Consequently, their public expenditures after 2000 ballooned out of all proportion to their intrinsic capacity to fund them from tax revenues.

Such expenditures became almost wholly dependent on access to increasing amounts of cheap public borrowing from capital markets.

In response to access to excessively cheap money, wages in the PIGS rose across the board as did growth in public sector employment.

With the financial crisis triggering bank recapitalisation needs, on top of this unsustainable structure, the edifice began to crumble.

The first early warning signals became apparent in December 2009 but the dam broke in mid-2010 with the first Greek bailout.

How has the Eurozone crisis been handled?

Extremely ineptly; indeed very foolishly, by sophisticated Eurozone authorities (political, fiscal and monetary) that should have known better.

Eurozone leaders learned nothing from the preceding debt crises in Latin America (1982-87, 1994-95) and Asia (1997-2000).

They went through avoidable phases of serial denial that there was a structural debt (solvency) crisis that could spread via contagion.

They treated it as a liquidity crisis that could be dealt with by temporary patch-ups of additional money combined with fiscal restraint.

They reiterated their commitment to ensuring there would be no default - partial or full, voluntary or involuntary - by any Eurozone member.

They believed that their remedial measures would stop the crisis from ballooning beyond the first bailout package for Greece.

They were totally wrong. That package did nothing to convince markets that Eurozone leaders understood the nature/severity of the problem.

In fact, the inadequacy of that first bailout package -- which did not provide enough money for sufficiently long - became quickly apparent.

Eurozone leaders were fixated on debt-affected PIGS being forced to live within their means through indefinite austerity without end.

Debt recovery/sustainability models did not provide sufficient new money, or permit debt restructuring, in ways that would restore stability.

Least of all were bailout packages designed to restore growth in a conscionable period of time that would be socially/politically acceptable.

Without financial system (and borrowing cost) stability, and absent growth, debt problems can never become better. They can only worsen.

Instead, as a result of poor design, all the bailouts did (except for Ireland) was to add new debt to bad debt and reduce growth prospects.

To exemplify: In mid-2009 the debt/GDP ratio for Greece was 115% of GDP and the debt service ratio about 11% of GDP.

But, by October 2011 the debt/GDP ratio for Greece was 161% of GDP and the debt service ratio nearly 20% of GDP.

It is projected with the third bailout to rise to 185% of GDP (although debt service will be lowered to 16%) before it comes down again.

In the meantime, over the last 32 months, the Greek economy has shrunk in size by almost 17% in nominal terms. It will be 1/5 th less in 2012.

Such inane 'remedies' do not solve debt problems. They only aggravate and exacerbate them.

While behaving in this absurd fashion Eurozone leaders repeatedly asserted for two years that they would do everything in their power to:

• Maintain the credibility of the Euro while ensuring that every member stayed in the Eurozone
• Not allow any default of publicly issued bonds to occur; and
• Do everything possible to avoid contagion spreading beyond PIGS (even as it became clear that markets were worried about Italy.

Instead they achieved the exact opposite of all three objectives through their inability to understand the implications of what they were doing.

Though now contrite and claiming to have learnt a few lessons from their serial bungling over 30 months Eurozone leaders have no solution.

The EFSF facility they created is woefully underfunded. It can barely deal with financing the third Greek bailout.

The idea of leveraging it or using it as a partial guarantee facility is absurd since it would add to risk and uncertainty not resolve them.

Yet over-indebted governments (including France and Germany) would have to issue more public debt in order to fund the EFSF properly.

That would simply mean requiring their fragile, near-bankrupt, banking systems (or the ECB) or global markets to buy more Eurozone debt.

Except for Germany (and even that will be in doubt soon) the market has no appetite for taking on more Eurozone debt given its risks.

Contagion has spread from the periphery and now lodges at the core of the Eurozone economy in which Italy is the third largest member.

What could have been resolved with about 300 billion euro in additional financing in mid-2010 is now a problem that may require 2 trillion euro.

Where are we now?

Over 35 EU/Eurozone summits in 30 months have resolved nothing. They have made matters worse; despite Herculean exertions!

Right now Greece is in 'effective' default; though markets are overlooking that because of the implications of CDS contracts being triggered.

Its borrowing costs for refinancing its debt would exceed 30% if it had any access to private markets; which it does not.

Any refinancing of, or addition to, Greek debt can now only be financed by the ECB; which the Germans will not permit the ECB to do.

Meanwhile the Greek banking system is bankrupt. Indeed the entire Eurozone banking system's credibility/stability/solvency is in doubt.

Today an outstanding portfolio of about 11-12 trillion euro in Eurozone debt - of which about 80% is held by EU firms - is souring relentlessly.

About 7 trillion euro of that portfolio is sufficiently affected by contagion to require provisioning (France and Belgium may soon be added).

About 5 trillion euro of Eurozone high-risk-debt is currently held by EU banks, insurance companies, pension funds and individuals.

That sovereign debt, which is supposed to constitute the 'safest' component of any asset portfolio, now constitutes perhaps the riskiest element.

That reality inverts the whole basis of banking/financial system soundness and stability across Europe (including the UK).

It compounds the problem of calculating capital adequacy requirements for these banking systems and puts regulators in a quandary.

Ireland's bailout programme is working but could be derailed by what is happening in the rest of Europe.

Portugal's programme is not working as intended. But nobody is talking about it because it pales in comparison with Italy and Greece.

Italy's outstanding public debt will soon cross 2 trillion euro (120% of GDP) and its debt service payments amount to around 300 billion euro per year.

That is made up of about 120 billion euro in interest payments and 180 billion euro in principal repayments. Average duration is 5 years.

Public debt service in Italy now amounts to around 17% of GDP and will rise to 20% unless Italy's debt is dramatically restructured.

Italy now needs to borrow about 40 billion a month euro (gross) and about 28 billion euro a month net in private markets to refinance its debt.

The world is holding its breath with every auction of Italian public debt (3-8 billion euro per week) any of which could trigger accidental default.

The cost of refinancing Italy's public debt has risen from around 4% a year ago to around 7% now. That adds 20 billion euro a year to its debt.

Meantime the Italian economy is flat-lining and its capacity to service additional debt is diminishing despite its running a primary balance.

Banks around the world are dumping their holdings of Italian public debt but there is no buyer other than the ECB because of the risk.

The ECB's capacity to refinance Greek, Italian and Portuguese debt is limited and constrained by Germany's unwillingness to consider that.

Contagion from Italy is now beginning to affect Spain and France which is supposed to be a bulwark for the EFSF's borrowing capacity.

The resulting gridlock is pushing the entire Eurozone system toward a catastrophic denouement with a binary outcome. Either:

1. Crisis-induced progress toward fiscal union with national sovereign bonds being replaced by a single Eurozone bond with a joint/several guarantee, or
2. Sudden disorderly collapse of the Eurozone with unimaginable fallout and consequences that would trigger a global double-dip recession.

Such a recession would last for a minimum of 2-3 years and would probably be quickly followed by a similar debt crisis in the US.

The resulting fallout of disorderly Eurozone break-up could trigger a break-up or restructuring of the larger EU as well.

So where do we go from here?

With the foregoing in mind it seems absurd that the world is waiting with bated breath to see what the new technocratic governments in Greece (Papademos) and Italy (Monti) will actually achieve by way of structural reform and increased debt servicing capability in coming months.

These technocratic governments inject new credibility but lack political and social legitimacy. They have been appointed not elected.

It remains to be seen how long their technocratic legitimacy holds out without the backing of gradually earned political/social legitimacy.

The risk is that if the ministrations of these technocratic governments (which their societies believe have been imposed on them from the EU above) do not work and bear fruit relatively soon (the probability is that they won't), public patience with them will melt.

Will they be able to convince electorates to accept the inevitability of austerity without growth for the indefinite future?

The next Greek crisis is perhaps 10-12 weeks away.

The next Italian crisis could be triggered by any one of the upcoming weekly auctions of Italian government debt.

Despite these rather obvious realities, global markets deem to be reacting in dream-like hope and optimism that all will be well.

There is of course a solution at hand; and the only one that will work because all the other options seem to have been exhausted.

That option requires Germany to reconsider its refusal to bear its large share of the fiscal burden that will come with Eurozone fiscal union.

It requires political/social willingness on the part of rich northern Eurozone members to finance fiscal transfers to poorer southern members through an exponential expansion of structural funds, currently applied to help develop more rapidly the poorer regions of the EU.

Reciprocally, it requires other Eurozone countries to relinquish fiscal, and a great deal of political, sovereignty immediately; in order to assure global markets of their commitment to structural reform, restoration of competitiveness, and relentless pursuit of fiscal/monetary discipline.

It requires all unwanted national sovereign bonds of Eurozone members to be replaced by a single Eurobond that is jointly and severally guaranteed and underpinned by the weight and ability of the ECB behind it to print money if necessary to ensure that such bonds are honoured.

This solution would resolve both the over-indebtness problem of the Eurozone and the problem of banking system collapse at a single stroke.

If it were adopted the need to provide for risky Eurozone debt and recapitalise (yet again) the EU banking system would disappear.

Yet, this is the one solution that keeps being discarded because of legitimate German constitutional, judicial and political constraints.

They inhibit movement in such a direction regardless of the consequences for the Eurozone, the EU, and mostly Germany itself.

It is like witnessing a repeat of 1939; not of conquest but of mindless destruction. But, this time with money rather than tanks being involved.

If that only workable solution continues to be discarded, the other possibility that will manifest itself is the disorderly break-up of the Eurozone; simply because its orderly break-up defies contemplation and imagination.

Talk of Greece being ejected from the Eurozone, or of Germany departing from it voluntarily, is fanciful simply because neither can afford to bear the costs of the consequences that will follow, regardless of what their populations and political leaders may believe or think (though 'thought' seems to be conspicuously absent from the process just now). Neither can their neighbours, regardless of what they may think.

Yet it is not unimaginable that a break-up will be forced on Eurozone members by global markets if the only workable solution continues to be ruled out as it seems to be repeatedly by the German Chancellor. But she has changed her mind so often the hope is she will yet again.

A disorderly break-up may result in a reversion to national currencies; which would be better than members trying to retain some semblance of the Euro through separate residual monetary unions of more compatible economies.

That would probably require four different Euros (for the super-efficient Northern economies a Baltic Euro, for the relatively efficient middling economies a Franco-Euro; for the newly acceding countries an Eastern-Euro and for the inefficient, uncompetitive Club-Med economies, a PIGS-Euro). Other than the first, none of the others would be credible for holding as reserves, or for trading significantly in global currency markets.

Finally, bear in mind that we have spoken of only the public debt problem in the Eurozone.

Should the unthinkable (but increasingly likely) disorderly break-up happen, the public debt problem will be accompanied by an unresolved private debt problem throughout the Eurozone of equally monumental proportions! That really will break the system and the banks!

Pakistan, India, MFN: What are the implications?

For once, I am pleased at how India played it: India gave Pakistan MFN status way back, in 1996, without getting into the silliness of reciprocity. A hallmark of professional competence in international trade is the idea of unilateral liberalisation: Even if another country is silly enough to have barriers against us, we should not have trade barriers against them. Removing barriers against India's globalisation is a favour to us, regardless of what it does to anyone else. India often gets into cul de sacs by obsessing on reciprocity - e.g. we won't open up to imports of agricultural products because the Europeans won't. We won't allow foreign banks to operate in India because some other countries have barriers against the operations of Indian banks. And so on. But for once, in this case, our guys seem to have played it right (and way back in 1996, too!).

And now, we have a nice next step: Pakistan will give India MFN status. What might happen next? Here are some conjectures:

1. At present, there is significant Indo-Pak trade; it merely gets routed through Dubai. Once Pakistan gives India MFN status, the entrepot trade that was going Bombay -> Dubai -> Karachi will go Bombay -> Karachi. This is bad news for Dubai and for individuals and firms which are invested in the future of Dubai as an entrepot centre. Trade data should show a fairly sharp decline in India's exports to UAE and a fairly sharp rise in India's exports to Pakistan.
2. There will be a boom in shipping, communication and trade serving the direct Bombay -> Karachi route. Similarly, the ports of Gujarat will do a lot of business directly to Karachi.
3. At first blush, little changes: the goods that used to go via Dubai would now go directly to Karachi. Another dimension is the cost of the middleman in Dubai, which would be eliminated. To a reasonable man, these changes add up to small numbers. But a recurring theme in economics is the extent to which apparently small frictions loom large. The removal of fairly modest frictions matters a lot for business activity. So when the cost of shipping goes down by roughly 3x, even though the cost of shipping may be small in absolute terms, this would have a big impact on trade. 
4. Important dynamics will now set in amidst firms in Pakistan. Firms that compete with exports from India will suffer. Firms that consume imported inputs from India will thrive. Creative destruction will take place; resources will shift from one group of firms to another. Exporters will be better able to export to India, both because of access to cheaper labour and capital that's freed up by firms that die owing to import competition, and because of improved competitiveness that comes from cheaper raw materials. Exports from Pakistan to India will go up significantly through this movement on import liberalisation.
5. Large Indian and Pakistani corporations will look much more seriously at the opportunities that lie just beyond the national border. Over time, human capacities and human networks will build up on both sides, supporting cross-border operations. This will take time to ripen, but when it does, the effects will be large. A good fraction of global trade is intra-firm trade, so it's very important to have large firms of both countries having operations in both countries, in order to get growth of trade. But for this, both sides have to do more on capital account liberalisation through which firms will expand operations across the border.
6. The biggest gains in India will be in Gujarat, given the myriad ports in Gujarat which are a short distance away from Pakistan. But in the future, if road and rail links open up, then there are big opportunities in Punjab also. Wouldn't it be nice to have a NHAI style road running from Ahmedabad to Karachi, and from Amritsar to Lahore?

To the extent that we're merely rerouting trade, bypassing Dubai, this will impose no new stress on ports and airports in Pakistan. But to the extent that new trade is created - as I expect it will (and as argued above) - then new work will be required in Pakistan on enhancing the capacity of ports and airports. I would personally be surprised if the effects are not large. In other words, this initiative will need to be followed through by new work on infrastructure in Pakistan.

In the intuition of economists, there is a gravity model in the affairs of men. Proximity and low transactions costs are incredibly important. The natural opportunity for India to grow international integration on all dimensions (goods, services, people, ideas, capital) lies in our immediate neighbourhood. India's connections into the region are shockingly below those seen for all other large countries. Doing better on connections with Pakistan would be a nice step forward.

Consider a product like cement, which is ordinarily considered a non-tradeable. Transportation of cement is so hard, there isn't a unified national market even within India. There are a series of regional markets. But even in this, modifications of transportation have mattered greatly. E.g. when Gujarat Ambuja came up with the innovation (back in the mid 1990s) of sending cement from Saurashtra to Bombay, by sea, this was a very big deal. By that same logic, cement from the coast of Saurashtra can go to Pakistan (or vice versa, depending on who produces at a lower price).

We should not see trade in goods in isolation. All dimensions of globalisation are intimately connected to each other. It is not possible to have mode of internationalisation (trade in goods) without having the others. To do more trade in goods and services, we need more movement of people. Ergo, the silly visa restrictions that both countries impose on each other need to be eased. Finance follows trade: So where trade in goods and services leads the way, bigger financial integration will follow with trade financing, cross-border banking, payments, purchases of information, operations of multinationals and FDI, INR/PKR currency risk management, and investment flows. More will need to be done on investment guarantees, export/import trade financing, etc. Conversely, if all those elements are blockaded, then trade in goods and services will not blossom.