Holding their breath: Indian firms in an interruption of revenue

by Renuka Sane and Anjali Sharma

India is in a state of lockdown with only essential goods and services getting exemption. This has given a teachable moment on the role of liquid cash in corporate financial policy.

Most firms will see a varying degree of a revenue shock. Expenses such as salaries, rents and interest on debt will continue to be incurred in order to survive. In this article we ask: How many days of liquidity cover is there, in the large non-financial firms, to be able to meet a certain threshold of minimum expenses in the absence of any revenue?

Data

We extract data for all non-financial firms from the CMIE ProwessDX database, updated in December 2019, for three years: 2016-17, 2017-18 and 2018-19. Data on 2018-19 is not yet available for a large proportion of the firms. For most firms, therefore, we rely on the two older years of data.

We drop firms that report negative assets, negative income and negative sales. This yields a sample of 16,300 firms which are observed in the first two, and possibly in the third, year. For each of these firms we extract information from the database on: (1) identity variables such as age, industry, listing status and ownership, (2) income and expenses from the profit and loss statement, and (3) liquid assets i.e. cash and bank balance and marketable securities from the balance sheet.

We do not know the state of the firm in March 2020, when the lockdown came. We estimate the state of the firm using the mean of two or three years seen in the data (depending on data availability). The recent three years have been a period of stability of the nominal values, i.e. low growth, thus making these simple averages more useful.

Assumptions

We make four admittedly extreme assumptions:

1. A 100% sales shock for all non-financial firms. This is an extreme scenario. Most firms will face some degree of sales decline which may vary by the sector the firm is in. However, our assumption gives us a worst case picture for the hurdle that cash holdings will have to overcome.
   
   
2. Liquid assets only include cash and marketable securities. We do not include loans from the banking sector or receivables for the following reasons:
   
   
   • Indian firms are generally credit constrained. In the months prior to the lockdown, banks and non-bank finance companies (NBFCs), which are the mainstay of lending in the economy, were already under considerable stress. Their overall lending, and especially their lending to firms had stagnated, with negative consequences for liquidity in the credit markets. Looking forward, many firms will find it difficult to obtain debt capital, given the difficulties of the financial system. Hence, it's useful to analyse how liquid assets -- alone -- may carry some firms across the shock.
     
     
   • Our rationale for not including receivables is the suddenness of the lockdown. If firms had any notice that a lockdown was imminent, they would have made efforts to accelerate their receivables collection. But since the lockdown was announced and put in force with no notice, we assume that firms were not able to engage in this strategy.
     
     
3. A 50% realisation of the value of marketable securities in the book. Market conditions are also affected by the lockdown; the price and impact cost of marketable securities has deteriorated. The vast majority of liquid assets is cash, therefore the results are not very sensitive to this assumption.
   
   
4. The core expenses required to stay alive. We define the core expenses as: (1) salaries for employees and outsourced staff, (2) rentals, (3) utility costs, (4) other costs such as IT and communication expenses, insurance premiums and auditors fees, and (5) interest costs on debt.
   All firms are looking at ways to reduce the wage expenditure, by cutting wages and headcounts [example]. Our calculation deals with the outer extreme: a firm that makes no adjustment to its wage expenditure.
   Similarly, some firms may be able to contractually avoid paying rentals expenses using the force majeure clause, which also entails legal risk. We assume there are no gains on this score.
   For costs such as utilities and repair and maintenance we assume the expenditure will be 60% of the regular expenses, as these expenses will be lower in the absence of regular operations.
   On interest expenses, individual banks may choose to provide relief in terms of a moratorium on interest payment after the RBI circular on the same. But since this is still a decision that banks have to take, it is useful to understand the ability of firms to cover these expenses using their liquid assets. We do two cases: including and excluding interest costs.
   
   

Methodology

We compute the following variables:

• Liquid assets (LA) = Cash and bank balance + (Marketable securities)*0.5. Liquid assets are 5% of firms' total assets in India, and cash and bank balance accounts for 99.3% of total liquid assets.
  
• Minimum Costs 1 (MC1) = Employee salaries, PF and gratuity + Outsourced staff cost + (Power and water charges)*0.6 + (Repair and maintenance)*0.6 + Lease and rentals + IT and communication costs + Insurance premiums + Auditors fees + Rates and taxes + Financial services expenses including interest cost. In the dataset, the share of these elements is as follows:
  
  
  • Employee salaries: 43%
    
  • Outsourced staff: 12%
    
  • Interest cost: 20%
    
  • Financial service expenses: 4%
    
  • Rest of the expenses: 22%
    
  
  MC1 is 21% of firms' overall cash expenses excluding direct taxes (cash expenses exclude non-cash items such as depreciation and provisions).
• Minimum Costs 2 (MC2) = MC1 - Interest costs. MC2 is 80% of MC1.
• R1: days cover of liquid assets assuming the cost is MC1 = (LA*365)/MC1
  
• R2: days cover of liquid assets assuming the cost is MC2 = (LA*365)/MC2

Results

Figure 1: The fraction of firms that cannot hold their breath for a given number of days

Figure 1 shows the fraction of firms where the liquid assets are not able to pay for a given number of days of zero revenue, going by two definitions of minimum cost (i.e. including or excluding interest payments).

We see that 2.7% of the firms do not have liquid assets to meet MC1 for even 1 day. There are 29.8% (4,870 firms) that have 30 days or less of liquidity cover for MC1 and 54.8% (8,927 firms) that have 90 days or less of liquidity cover for MC1. These firms will be the ones most affected by the current lockdown and any future extension to it.

If we put interest expenses aside, thus assuming that all firms are able to obtain an interest payment moratorium, the results change slightly. Now, 2.3% of firms do not have liquid assets to meet MC2 even for 1 day. Now, 23.4% (3,799 firms) have 30 days or less of liquidity cover for MC2 and 47.5% (7,674 firms) have 90 days or less of liquidity cover for MC2.

Who are the firms who are vulnerable on account of low cash holdings?

Our sample of 16,300 firms has an asset base of around Rs. 164 trillion and annual sales of Rs. 107 trillion. The 8,927 firms which we identify as vulnerable (3 months or less of liquid assets for MC1) account for nearly 60% of the overall sales and total assets.

Around 19% of these are large firms (assets > Rs.5 billion), 27% are medium sized firms (assets between Rs.1 billion and Rs.5 billion) and 53% are small firms (assets less than Rs.1 billion). While the large firms may be able to solve their liquidity challenges by accessing credit, the medium and small sized firms will find it harder, given the weaknesses of the financial system.

Around 2,300 of these are listed firms, which is nearly half of all the listed firms in the country.

About 79% of these firms are old firms, that is they have been in existence for more than 10 years.

These firms are spread across many industries: manufacturing (43%), services (28%), trading (14%) and construction and infrastructure (8%).

Conclusion

Our calculation is admittedly based on extreme assumptions: Zero decline in wage expenditure, zero access to fresh credit, and zero revenues for a certain number of days. More than half of the Indian corporate non-financial balance sheet is unable to hold its breath for 90 days, under these assumptions. About a quarter of the firms will not be able to handle a 30 day interruption of revenues. This highlights the incompatibility of a zero decline in wage expenditure with a sustained period of zero revenue and no fresh borrowing.



The authors are with NIPFP and Finance Research Group respectively. Views are personal. We thank Josh Felman, Radhika Pandey, Ajay Shah, Pramod Sinha, and Harsh Vardhan for useful comments.

Elements of the low Indian labour force participation rate: The elderly

by Subhamoy Chakraborty, Renuka Sane and Ajay Shah.

India has a remarkably low rate of labour force participation. The Periodic Labour Force Survey (PLFS) carried out under the Ministry of Statistics and Programme Implementation estimated the labour force participation rate (LFPR), for individuals of age 15 and above, at 49.8% in 2017-18. The CMIE CPHS survey, which has more recent information, has shown a decline in the LFPR by 2019. These numbers suggest that a large part of India is not in the labour market. These magnitudes of non-participation are much larger than the rates seen with unemployment. The grand question of Indian labour economics is that of understanding the low LFPR. The grand question of Indian economic policy lies in obtaining a 50 per cent gain in GDP through a 50 per cent increase in the labour force.

One big element of this LFP problem is women's LFP. The women's LFPR has been falling. In 2011-12, India was already one of the countries with the lowest female labour force participation. This has gotten worse with time. In 2017-18, the female LFPR fell to a historic low of 23.3%. A remarkable feature of the Indian women's LFPR is the comparison against countries like Pakistan (24%) or Bangladesh (36%). For those of us who believe that women's agency in India is ahead of that in Pakistan, this is a bracing fact. The examination of women's LFP is an important crossroads between labour economics and gender studies. It also emphasises the importance of gender studies in thinking about India.

The other two big elements of the LFPR problem are the young and old. In this article, we delve into labour supply of the elderly and establish some basic facts of this field. The positive and normative economics of elderly LFP is an important element of labour economics, given the large and growing share of the elderly in the population. It is also a major issue in ageing studies. High labour force participation by the elderly is well known to contribute to emotional and physical well being. It is generally better for a person to work for a wage of Rs.50 a month rather than obtain a pension of Rs.50 a month. The puzzle of the field lies in devising labour market arrangements that will harness labour supply of the elderly, and avoid the abrupt event of retirement.

The elderly are defined as those above the age of 55. The 55-64 age group is also part of the conventionally defined working age group (age 15 to 64). The 65+ age group constitutes the old elderly.

Data

We study the Consumer Pyramids Household Survey (CPHS), a pan-India panel household survey of about 170,000 households carried out by the Centre for Monitoring Indian Economy. The survey asks about the present employment status of each member above 15 years of age. The response to the employment question is recorded as a 4 point status:

1. Employed
   
2. Unemployed, not willing and not looking for a job
   
3. Unemployed, willing and looking for a job
   
4. Unemployed, willing but not looking for a job
   

Individuals whose employment status is either Employed (1) or Unemployed, willing and looking for a job (3) are considered to be a part of the labour force. In this article, we examine the data for January - April, 2019.

Overall

Table 1 provides estimates of the labour force participation by age group. There are approximately 375 million workers in the 15-54 age group, giving a LFPR of 45%. The LFPR drops slightly to 44% for the 55-64 age group with 51 million workers. The LFPR drops dramatically to 12% for the 65+ age group with only 8.4 million workers.

Table 1: Labour Force Participation: Age Group

Age Group	Population (in millions)	LFP (in millions)	LFPR(%)
15-54	828.3	375.0	45.3
55-64	115.6	50.8	43.9
65 and above	69.1	8.4	12.1

Figure 1 presents the labour force participation rate (LFPR) of those above the age of 55. The labour force participation was a little over 55% at age 55, and fell to about 10% by age 70.

Figure 1: Labour Force Participation (55 and above)

Withdrawal by the elderly from the labour force generally happens for one of the following reasons: (a) people are required to leave their main job at a specific retirement age, (b) are unwilling to work because they value leisure more and access to pensions at a sharply defined age which makes it feasible to stop working (c) are unable to work because of health constraints or (d) the labour market is unfriendly to older workers. In the US, for example, sharp drops in participation are seen at the age of 62 and 65, when access to social security benefits becomes available.

In India, formal pension arrangements are only in place for a small part of the population. Hence, factors "(a)" and "(b)" above should not matter much in India. And yet, we see a sharp drop at age 60. This suggests that reasons such an unfriendly labour market might explain the large drops in labour force participation at older ages.

Changes over time

Figure 2 presents the labour force participation rate in 2016 and 2019. We see that there has been a small increase in the participation rate for the 55-59 age group between 2016 and 2019. However, for all other age categories, there has been a remarkable fall. For example, about 42% of the 60-61 age group participated in the labour market in 2016. This had fallen by about 10 percentage points in 2019. Similarly, in the 65 plus age group, labour force participation was at 28%. By 2019, this had fallen to 12%. This suggests that that stress in the economy has hurt the elderly more than prime-age working males. This may be part of a larger phenomenon, where prime age working males are protected in economic downturns, while all other parts of the labour force (women, the young, the old) seem to lose employment at higher rates.

Figure 2: Labour Force Participation: Over time

International comparison

It is useful to ask how these compare to the numbers in the OECD countries, where formal pension systems shape the decision to retire. Table 1 presents the elderly labour force participation rate (LFPR) in India, US and Japan.

Table 2: LFPR: Comparison with US and Japan

Age Group	India (%) (Jan-Apr 2019)	US (%) (2018)	Japan (%) (2018)
55-59	52.7	72.3	83.4
60-64	29.4	57.1	70.6
65 and above	12.1	19.6	24.7

In 2018 according to the Bureau of Labor Statistics in the US, 72.3% of those in the 55-59 age group were in the labour force. The participation rate fell to 57.1% for age group 60-64 and further declined to 19.6% for those above 65. Meanwhile the labour force participation rate in Japan, as reported by Statistics Bureau of Japan, was 83.4%, 70.6% and 24.7% for age groups 55-59, 60-64 and above 65 respectively. Japan has, in fact, seen a resurgence in elderly labour force participation in recent years owing to better health and education, as well as reduced generosity of social security programs.

Japan is considered one of the best countries in terms of integrating the elderly into the labour market. Suppose we treat Japan as a frontier: the outer limit of what is possible with labour market participation by the elderly. How much would we in India gain if we moved up to this frontier?

If the LFPR of the 55-64 age group in India (which is 43.9%) were to become the same as that of Japan's (77%), then the overall working-age LFPR would go up to 49.15%. This is a 4 percentage point increase in the LFPR owing to increases in the labour force participation of the "young old", and would mean that an additional 38 million individuals would be in the labour force.

An additional 9 million people, of age 65+, would also join the labour force, by matching the Japanese LFPR for the age group of 65+.

Totally, 47 million people would enter the Indian labour force if we moved up to Japanese levels of LFP from age 55 and above. This is an economically significant number. This magnitude of impact will go up in the future as India ages.

Conclusion

The Indian labour market has a remarkable feature: of low labour force participation. In this article, we examine one facet of this problem: the low LFP for the elderly. Despite the prevalence of a large informal sector, and the absence of a formal age of retirement, we find that the elderly labour force participation is low, and has actually fallen between 2016 and 2019.

Withdrawal from the labour market is bad for the elderly and bad for the economy. The examination of the LFP of the elderly is an important crossroads between labour economics and ageing studies. Further research is required in identifying the causes behind the low LFPR of the elderly.

 

The authors are researchers at the National Institute of Public Finance and Policy.

Human capital will fuel high Indian GDP growth for the coming 40 years

In a recent column in the Economic Times -- My generation -- I argue that the outlook on human capital in India is bountiful for the coming 40 years.

The changing role of women in India

The three modernisations

The trajectory of a country is about three modernisations: social, political and economic. Social modernisation is about establishing freedom and rights of individuals. Political modernisation is about achieving democracy, where there is rule of law, where State power is dispersed and restricted, where elections generate contestability. Economic modernisation is about achieving a high growth modern market economy, about a government that gets away from expropriation and central planning to a government that is focused on solving market failures.

All three modernisations interact in complex ways and fuel each other. As an example, Milton Friedman's `Capitalism and Freedom' hypothesis is the idea that political modernisation fuels economic modernisation and vice versa. This is a well established idea in the discourse. I find it also interesting to think about the other two legs of the stool: the interlinkages between social modernisation and the other two kinds of modernisation.

The role of women

When we think of social modernisation and economic modernisation, the big thing that leaps out is the role of women. A society that does not respect women is under-utilising half its labour force. We would expect to see a causal impact of greater equality of women upon growth.

We in India are sometimes complacent about the role of women in India. India is famous for having women in leadership roles. In a dinner meeting by Larry Summers, I once said that India was world #1 on one measure of the role of women: the fraction of the top 100 financial firms that are headed by women. I once met Andre Beteille, and asked him: When compared with 1947, in what aspect have things in India worked out much different from what you expected. He said: The role of women in the elite. He said that for upper class women in India today, it's better than even Japan, which is otherwise a very advanced country. The daughters of the elite in India have no glass ceiling, which is better than what we see in most places.

On a population scale, however, things are vastly worse. Paramita Ghosh reports, in the Hindustan Times, on a crime victimisation survey of women with scary results. The India Today survey (link, link) shows us that 79.3% of men believe that marital rape is okay. We don't know how many men in India act out on this belief, but the report Why do some men use violence against women and how can we prevent it? by the United Nations, shows us scary facts from some Asian countries that have men who think similarly to what the Indian data is showing. The Supreme Court ruling of yesterday is a reminder of the distance that we have to go on achieving social modernisation.

Things are changing dramatically with the young

With human capital measures like literacy or graduating high school, a person tends to achieve them when young. If a person has not become literate or graduated high school by age 20, things are unlikely to change later on. Hence, the analysis of the cross section in the population is tantamount to looking at the history: what we see for (say) 50 year olds today is a description of what things were like, 30 years ago, for 20-year olds. Age-specific rates are like rings of a tree.

Literacy of the cohort aged 22.5
(Time-series reconstructed from age-specific rates visible in the cross section)

The graph above shows the literacy of the cohort entering the labour force, which I approximate as being the cohort at age 22.5. The blue vertical line stands for today. This is constructed using the cross-section visible in March 2013 from CMIE Consumer Pyramids, a quarterly panel dataset with 150,000 households covering 700,000 individuals. With children, high literacy rates are found early on, and this yields projections for literacy of the age 22.5 cohort in the future.

We see that overall literacy of the cohort entering the workforce has gone up from roughly 70% in 1990, when India began opening the economy, to roughly 90% today and will go up to 100% in the coming 15 years. In addition, there was a big gender gap, which has been significantly reduced and will fully go away.

Let's turn to high school graduation.

High school graduates in the cohort aged 22.5
(Time-series reconstructed from age-specific rates in the cross section)

It seems shocking to think that in 1990, roughly 7% of the cohort starting off into the labour force, at age 22.5, had passed 12th standard. This has gone up dramatically to 20%. Sharp growth is visible into the future when today's 15 year olds become age 22.5, and there is no gender gap with today's 15 year olds.

The third thing that I want to show from household survey data is the ownership of mobile phones.

Age-specific rates of mobile phone ownership

All of us have been hearing about miraculous growth of mobile phones in India for a while, and have become a bit inured to the story. While a lot has happened, however, a lot remains to be done. The black line shows that with males, roughly 75% of the young and 80% of the old have mobile phones. The work is progress lies in taking this up to 100% for everyone. What's striking is the women. The upper red line, for March 2013, shows that 40% of girls have mobile phones, and this decays to 20% at age 45. On a related note, Avjit Ghosh, writing in the Times of India, talks about a paper by Yvonne MacPherson and Sara Chamberlain which finds that only 9% of adult women in Bihar have ever sent an SMS. There is a high rate of change with mobile telephony, in even the short timespan between the latest data (March 2013) and the first data from CMIE (June 2010) which is the lower red line.

Speculation

I feel that in the early decades after independence, we had a progressive elite, which was able to bring up daughters well and we made amazing strides at the top. But social modernisation took place only in the elite. For the bulk of the population, attitudes and indoctrination and levels of violence remained neanderthal.

M. N. Srinivas has emphasised the extent to which the rest of society aspires to catch up with the lifestyle and the values of the elite. In the early years, there was little catch up on the treatment of women: the elite and the proletariat coexisted like oil and water. Perhaps budget constraints came in the way of translating aspirations. Maybe poor households shortchanged daughters on nutrition and education and mobile phones and such like, thus encouraging subservience in daughters. In my opinion, the economic growth of the last 20 years is creating a new wave of households within which daughters are growing up differently. Daughters who have high school education and a mobile phone are going to engage with the world differently. As an example, they are less likely to accept sexual harassment and sexual assault. We may now be at the early stages of something very big.

Economic modernisation has created this phase of social modernisation. The rise of capable women who will not be pushed around will, in turn, fuel economic growth because we are then getting a superior labour force. There is an enormous distance to cover. In my opinion, it will be a story spread over two generations (50 years) starting from 2000, through which we will endup with something satisfactory on the role of women. Economic growth will create opportunities for women and for sensibly bringing up daughters, and the rise of capable women will fuel economic growth.

What platforms might work in Indian politics?

High GDP growth has led to structural transformation, with dramatic change in the composition of the labour force. The latest data from the CMIE Consumer Pyramids database pertains to December 2012, and shows the following occupation structure of the Indian workforce:

Occupation	Share (Per cent)
Small farmer	13.39
Organised farmer	8.69
Agricultural labourer	8.70
Industrial worker	7.92
White collar worker	8.44
Manager / supervisor	0.53
Support staff	6.93
Businessman	7.91
Small trader / Hawker	3.32
Self-employed professional	4.92
Home-based worker	1.50
Wage labourer	27.75

How might this influence political platforms?

The success and stagnation of the Left

The Left caters to the interests of tenured employees of manufacturing firms. They were very successful in influencing policies. To a great extent, the Congress stole the Left's thunder by pampering organised labour, and every political party in India treats them as holy cows.

This success undermined Left thinking as a political force. Left-influenced policies hobbled organised manufacturing, and we see only 7.92% of the workforce in `Industrial worker', which most closely fits the support base of the Left. It is ironic that the very success of the Left in shaping the Indian State has marginalised the Left as a political force. The price we pay for being a liberal democracy is the sacrifice of large-scale labour-intensive manufacturing.

The aristocracy of workers in organised manufacturing is grossly overpaid. What matters to their take now is not GDP growth or their marginal product, but their ability to use their privileged position to extract a rent out of the firms that have no choice but to deal with them. Hence, their interest in GDP growth is relatively low.

The role of agriculture

The farm lobby is not a monolithic bloc with unified interests. There are kulaks who seem to correspond to `Organised farmers' and are 8.69% of the workforce. And there are others (`Small farmers' at 13.39% and `Agricultural labourers' at 8.7%) who add up to 22.09% of the workforce. CMIE defines wage labourer as `Wage labourers are those who seek daily wages from non-agricultural sources. Typically, these are industrial workers who work in factories or companies but are not employed on a regular basis in these. Wage labourers also include construction site workers and those working in other non-agricultural activities. This includes a taxi driver who operates the owners' taxi' and hence this excludes agricultural labour. Policies that favour producers of agricultural products in broad terms would thus benefit 30.78% of the workforce (and hurt everyone else, who buys agricultural products). Policies that are more narrowly focused on the interests of kulaks, such as the old-school fertiliser subsidy, are good for 8.69% of voters and bad for everyone else.

India's structural transformation is giving a rapid decline in the share of the workforce in agriculture. While the CMIE data for December 2012 shows 30.78% of the workforce is in agriculture, the oldest available data, for December 2010, shows 32.68%. This is a decline of 1.9 percentage points in just two years. If we guess that on average, in each year, there is a decline of 0.75 to 1 percentage points, then in a decade, we will get to the range of 20.8 to 23.3 per cent of the workforce in agriculture.

Ordinarily, we would expect politics to favour the interests of buyers of food (69.22% of workers) trump the interests of producers (30.78%). Why is agriculture so prominent in Indian politics?  I can conjecture three explanations:

• As with Industrial workers, the priorities of Indian politics reflect the failure of imagination of the gerontocracy.
• The redistricting process is slow and for a long time had stalled. This has given an exaggerated emphasis to constituencies where agriculture is important. That Indian politics is a gerontocracy despite rapid economic and demographic change may partly be a consequence of slow redistricting.
• As with Industrial workers, once unequal policies create a focused beneficiary of distortions, these beneficiaries have a focused interest in lobbying in favour of the status quo. The costs of these policies are dispersed across society and the others don't have an incentive to mobilise politically.

In this context, it is interesting to see that in places like the US, Japan and Europe, there are strong agricultural lobbies that have achieved highly distorted policies even though their vote share has dwindled away to almost nothing. Brad Plumer in the Washington Post has some insights on how this comes about, and suggests that it is a combination of sharp interests of agriculturists in marginal constituencies.

How might competitive democracy construct an interest-based politics

Indian politics has come up with two ideas that transcend caste and religion : catering to agriculture and catering to industrial workers. Both these interest groups are not that salient in today's India. It is interesting to look at the table and puzzle over what might work.

Congress is pursuing the goal of setting up big welfare programs that target agricultural labour (8.7%) and wage labourers (27.75%), adding up to 36.45%. While this is a big chunk of votes, it isn't big enough to close the deal, particularly as in fast-growing India, many individuals within these two interest groups actually want to escape from poverty and welfare programs. Many of them would be interested in a platform that shows a roadmap out of poverty, instead of offering dole while perpetuating it. If even a small fraction comes to mistrust the strategy of dole, it undermines the extent to which this platform will win elections.

I think there is more possibility in a platform of public goods + growth when compared with the conventional wisdom. By definition, public goods (e.g. law and order or the infrastructure of transportation and communications) benefit all. There is no need to split up the vote and pursue narrow constituencies in this. A pro-growth stance is directly good for many sub-components: Organised farmers (8.69%), White collar workers (8.44%), Managers (0.53%), Businessmen (7.91%), self-employed professionals (4.92%), adding up to 30.49% which is similar to the size of the old-fashioned agriculture lobby (at 30.78%). Looking forward, this group will grow while those interested in either agriculture or dole will shrink.

In addition, a large chunk of the remainder of the workforce -- which may have only a weak interest in a pro-growth platform today -- aspires for a better life, particularly the young. The wage labourer of today wants to be a small trader tomorrow, and the small trader of today wants to be a businessman tomorrow.

I would hazard the following guesses:

Occupation	Share (Per cent)	Dole	Public goods	Growth
Small farmer	13.39	Weak	Yes	Weak
Organised farmer	8.69	No	Yes	Yes
Agricultural labourer	8.70	Yes	Yes	Weak
Industrial worker	7.92	No	Yes	Weak
White collar worker	8.44	No	Yes	Yes
Manager / supervisor	0.53	No	Yes	Yes
Support staff	6.93	No	Yes	Weak
Businessman	7.91	No	Yes	Yes
Small trader / Hawker	3.32	Weak	Yes	Weak
Self-employed professional	4.92	No	Yes	Yes
Home-based worker	1.50	Weak	Yes	Weak
Wage labourer	27.75	Yes	Yes	Weak
Total	100.00	36.45	100.00	30.49

It seems to me that a public goods + growth platform would work better than most people in Indian politics think. Public goods are interesting to all, and the constituency that would strongly favour growth is 30.49% and growing. In contrast, a dole strategy is interesting to 36.45%, and is shrinking.


None of this is relevant if the question that is posed to the electorate is about religion, English, or social conservatism. It may well be the case that the 2014 elections will be fought purely on these questions. But in time, the competitive dynamics of democracy will favour platforms that reflect the interests of the populace, and then these kinds of considerations will matter more.

College and knowledge continued

In continuation to Let's not confuse college with knowledge :

1. See the comments on that post.
2. Is the labour market return to higher education finally dropping? by Tyler Cowen.
3. Rasheeda Bhagat in the Hindu Business Line (ht: K. Satyanarayan).
4. Dale and Krueger, QJE, 2002. (ht: Aditya Kuvalekar).

Some people wrote me email asking: What should I be doing in an undergraduate degree in economics to make sure I actually get the knowledge? I feel that an economics education in college should bring you to the point where you get the stuff on this blog.

Let's not confuse college with knowledge

The cost-benefit analysis of a college education in the US

I was fascinated by this interview in the New York Times with Laszlo Block, Senior VP of People Operations at Google. They seem to be doing instrumentation and analytics in the HR function, giving new insights into how things work (as opposed to preconceptions or conventional wisdom). In this, he says:

One of the things we’ve seen from all our data crunching is that G.P.A.’s are worthless as a criteria for hiring, and test scores are worthless — no correlation at all except for brand-new college grads, where there’s a slight correlation. Google famously used to ask everyone for a transcript and G.P.A.’s and test scores, but we don’t anymore, unless you’re just a few years out of school. We found that they don’t predict anything.

What’s interesting is the proportion of people without any college education at Google has increased over time as well. So we have teams where you have 14 percent of the team made up of people who’ve never gone to college.

If this is true of Stanford -- happy hunting ground for Google -- it is triply true about every other university in the world. I believe neither students nor recruiters should leave much to universities. I was particularly fascinated with the tidbit about Google staff that have never gone to college, and that this number has gone up over time. Some BPOs and KPOs in India are also recruiting high school graduates; the marginal value of college is not as obvious as it used to be.

Universities in the US have built up an imposing cost structure, where a child spends between $150k and $250k for a college education. It is going to be harder to justify these price points in the future, given the twin problems of skeptical employers (e.g. a Google that does not demand a college degree as a pre-requisite) and the new phenomenon of Internet-based learning. I have also encountered similar things in the UK, where many young people are not confident that the years and expense in college will be worth the trouble.

I suspect there will be less fat in higher education in the days to come. Perhaps we could go closer to the MIT and Caltech of old: lean structures with great scientists and less money spent on cafeterias, gyms, and administrative staff.

India's experience with GDP growth despite the lack of education

India got explosive GDP growth, once socialist policies started getting reversed, from $0.22 trillion in 1993 to $1.73 trillion in 2013. GDP per working person went up at a compound rate of 9.4% per year over these 20 years, from $374 in 1993 to $2637 in 2013. This is nominal GDP expressed in US dollars, without adjustment for US inflation, and without adjustment for PPP. On average inflation in the US is 2% so 9.4% growth in output per worker expressed in nominal dollars is roughly 7.4% in real terms.

Some of this output growth per worker came from capital deepening, the remainder came from productivity growth. The universities were bad and did not contribute much to this growth. We should reflect on how India managed to get such remarkable growth despite the lack of universities. It tells us something about the potency of learning by doing (along with substantial capital accumulation) over these two decades.

We have finished an important generation change in this period. The persons who were age 20 in 1993, who are now 40 years old, have experienced a full 20 years in the workforce while being connected to a competitive market economy, to globalisation, and to the Internet. This environment is one that is conducive to knowledge building. It is this learning by doing that gave the remarkable 9.4% per year compound growth in GDP per worker expressed in nominal US dollars, over the last 20 years.

While we have awful universities, I feel the outlook for the future is good for three reasons:

1. Having a brand name college is not that important. How a person builds herself is far more important than a brand-name that she carries. If individuals and recruiters shift away from looking at the brand-name, and focus more on the person, that will help.
2. The forces of competition, globalisation and the Internet are hitting India on a bigger scale today than they ever were. Twenty years ago, there was no choice of attending online courses.
3. The children of liberalisation are now coming into leadership roles [example]. When we recruit a 40 year old CEO today, we are getting someone who grew up with 20 years of the new world. This often implies better knowledge and instincts when compared with people who suffered from Indian socialism and deprivation in their formative years. The application of this human capital into important decisions will exert a positive impact. More than in other places, we need to propel this generation into leadership roles as soon as possible.

Should policy makers favour home ownership?

The argument in favour of home ownership

Many people believe that more home ownership is a good thing. It is felt that people who own homes have a greater incentive to get involved in local politics as they have a stake in higher house prices. In contrast, people who rent lack this commitment device. Indeed, in a short run sense, a person who is renting benefits when the neighbourhood goes bad : his rent goes down.

From the viewpoint of the individual, renting is always better as it preserves flexibility. Owning a house imposes limitations on the locations where one could live and work, as the frictions of moving home are substantial. This biases individuals in favour of renting.

In the four-part classification scheme of market failures (monopoly power, asymmetric information, externalities, errors by consumers), this falls under the heading of externalities. If home owners become better citizens and better voters and induce better urban governance, this induces positive externalities upon all residents of cities. To the extent that this is the case, some elements of State policy should favour home ownership, so as to counteract the market failure.

This argument has limited value in India today, given that urban governance is organised in a terrible way. We have just not established the feedback loops of accountability from voters to the city mayor. Even if a voter wanted to get involved in more political action, and wanted to nudge his city administration forward, he does not have the levers to do so. If one only looked at the India of the present, we would reject this externality argument and say that there should be a pure level playing field between owning and renting.

Or, one could be an optimist and think that in the future, as the political system is reformed, these feedback loops will fall into place. One could then argue that large scale home ownership sets up interest groups today that have a stake in cities doing well in the future, as their portfolio value is bound to the quality of the city. The presence of such interest groups may help increase the probability of political system reform, when households get worried about potential damage to their portfolios as a consequence of urban mis-governance.

Today we're highly distorted in favour of owning

If one started out at a undistorted market, one could have a reasonable discussion about whether there is something intrinsically good about owning as opposed to renting, and possibly envision whether levers of policy might be applied to favour home ownership, and the scale of intervention that is justified. In India today, unfortunately, the game is highly stacked against renting:

1. Tax policy favours owning in the divergent treatment of interest payments as deductible versus deductibility of rent.
2. Rent control laws inhibit renting.
3. High inflation disrupts rental contracts by forcing repeated renegotiation. 
4. House owners that are corporations have not yet emerged. It is, hence, hard to find professional contracting in this field. Search costs are high, and there are often restrictions such as owners that won't rent to single women or muslims out of social conservatism. Our failures on property as a fundamental right, and on achieving a capable judiciary, have led to the risk of expropriation when the renter is elderly, a journalist or a lawyer. This has the perverse effect of diminishing access to rented houses for such persons.
5. Contracts are frequently disrupted, which induces costs of moving and frictions such as fees to brokers.
6. Less than professional owners imply that many practical issues such as smoothly functioning utilities don't work out properly. Under home ownership, a person has the incentive to make sure that utilities work correctly. With renting, this falls between the cracks and the service level is often poor.

The game is thus highly stacked in favour of owning. We need to level the playing field in favour of more renting.

The problems of home ownership

From first principles, the ownership of an illiquid asset (a home) diminishes flexibility. A person who lives in a home is much less likely to move.

In India, we need to achieve massive migration flows. Large scale migration will generate better matching between the requirements of the labour market at various locations all over India, and the requirements of production. Large scale migration will break down tribal and ethnic loyalties.

A country where people easily up and move is one in which the labour market is more flexible. This is a blessing and has consequences such as milder business cycle fluctuations. That's a different kind of market failure. The State should favour renting as this gives a more flexible labour market which yields milder business cycle fluctuations, which induces gains for all. Every person who owns a house imposes a negative externality upon everyone else in the form of a more inflexible labour market.

On this theme, here is a fascinating new NBER WP by Blanchflower and Oswald. The abstract says: We explore the hypothesis that high home-ownership damages the labor market. Our results are relevant to, and may be worrying for, a range of policy-makers and researchers. We find that rises in the home- ownership rate in a U.S. state are a precursor to eventual sharp rises in unemployment in that state. The elasticity exceeds unity: a doubling of the rate of home-ownership in a U.S. state is followed in the long-run by more than a doubling of the later unemployment rate. What mechanism might explain this? We show that rises in home-ownership lead to three problems: (i) lower levels of labor mobility, (ii) greater commuting times, and (iii) fewer new businesses. Our argument is not that owners themselves are disproportionately unemployed. The evidence suggests, instead, that the housing market can produce negative ‘externalities’ upon the labor market. The time lags are long. That gradualness may explain why these important patterns are so little-known.

Turning to international finance, the objective of international risk sharing is to remove home bias. In the real estate context, what works best is for a person in Bombay to rent a flat owned by Japanese investors and for a person in Tokyo to rent a flat owned by Indian investors. This achieves risk sharing: each party avoids the risk of real estate fluctuations that are correlated with the main portfolio which includes human capital. Capital controls that interfere with such investments are an obvious mistake that need to be removed. But as in trade integration, once overt restrictions are removed, an array of institutional factors that impede cross-border interaction come to prominence.

For the risk-sharing outcome (homes in Tokyo owned by investors in Bombay and vice versa), we need real estate to be owned by professional companies that rent it out. The shares of these professional companies, or securitisation instruments that generate cashflows out of rental streams, can then be purchased by foreign investors. As long as real estate ownership is in the hands of individuals in India, we will suffer from home bias with too much of the portfolio of residents being invested in local instruments. This is another dimension of owning versus renting that we need to keep in mind; we are better off when there is less home ownership.

Conclusion

Most people assume that home ownership is a good thing, that a country is better off if more people own homes. Like most interesting questions in public policy, the story is more complex than meets the eye. There are two different externality-based market failures running in different directions.

At present, in India, the first externality (more home ownership makes people better citizens) is absent since urban governance is unresponsive to voters. The only externality at work is running in the opposite direction (more home ownership gives a less flexible labour market). In the short term, policy should work on pushing towards more renting.

In the long run, urban governance in India might improve, and then we would need to understand the magnitude of these two opposing effects, and then one could choose whether it's worth pushing in one or the other direction. If one can't quantitatively estimate these things, then a cost benefit analysis is not feasible. The best thing is then to do nothing.

In either event, the mainstream view -- that policy makers should push in favour of more home ownership -- needs to be questioned.

A sea change in the knowledge of the young in India

In 1887, roughly 14 million children were born in India, and we got one Ramanujan. It seems reasonable to think that there were 9 others who went undiscovered. We may guess that the Ramanujan rate is roughly one in a million. Applying this to the 28 million newborns per year that we have today, we may guess that there are 28 Ramanujans being born every year. Our challenge is to find them and nurture them.

So far, we are doing a terrible job of this. Pritchett & Viarengo suggest that while 18% of the 15-year olds in South Korea have a strong knowledge of mathematics, in India, this fraction is only 0.8%. Also see. We are doing roughly 20 times worse than we could, in achieving high quality mathematics knowledge among 15 year olds. Education in India is deeply broken and as long as the status quo remains in charge, improvements are unlikely.

India is experiencing a higher education revolution on quantity. Here is the age-specific probability of having graduated from college, drawn from the CMIE Consumer Pyramids database:

On the x axis are age groups such as age 20-25, 25-30 and so on. On the y axis is the fraction of persons who have graduated from college. The oldest available survey (December 2009) and the latest available survey (September 2012) are shown. We see a sharp surge in today's young, when compared with conditions one or two decades ago, when going to college was much more exotic: i.e. the 40 year olds of today are much less likely to have attended college (reflecting conditions 20 years ago) when compared with the 20 year olds of today. The age profile of educational attainment is a cross-sectional picture that expresses the time-series of historical experience, much like the rings in a tree.

What is remarkable is the increase seen from just 2.75 years ago (the oldest available survey) when compared with the latest data: in the overall population, the share of college graduates went up from 6.14% to 6.97% over this period. There is truly a revolution taking place in terms of the young going to college. The bottleneck is that almost all college education in India today is quite faulty.

Consider the software industry, which is believed to employ 3 million persons today. A wonderful story by Harichandan Arakali and Tony Munroe, from Reuters last week, tells us that the labour market is walking up the value chain; low-grade coding skills don't cut it any more. Most of the young people with freshly minted college degrees are not good enough for the firms. Entry level wages in computer technology have dropped; skill premia have gone up. On this subject, see my article Will BPO hit a staffing crisis? from 2005. I have long felt that it is dangerous for a young person to build job-oriented vocational skill: Broad intellectualisation is essential. What a person needs is the ability to think; the mere ability to code is no substitute.

Most young people in India today are not on a journey that gets them to think. As an example, IGIDR is arguably the best economics Ph.D. program in India today. Yet, I have been disappointed at how many students at IGIDR don't read books more broadly, don't read blogs, and don't read the Economist. While these problems afflict economics more broadly, we seem to face a greater danger of  narrowness of knowledge.

How is a young person to break free of mediocrity? For the first time, we now have a concrete set of answers: Plug into Internet-based education offerings, and read the great books of the world, across a diverse array of subjects. Plug into the blogs, and get connected to the great conversation about the world today.

The game changer is access to world class materials over the Internet. The Internet in general, and Internet-based education in particular, makes a significant difference to how we harness our human raw material. As a working approximation, an undergraduate education in Economics in India teaches little, but a student who will persevere and understand this blog will get somewhere. I recently wrote about the enormous gains that are possible for young people in India thanks to the new world of Internet-delivered education.

In this context, I found a fascinating fact about the nationality of the students at Coursera, which is one of the modern Internet-centric education offerings. Coursera has an enrolment of 2.9 million. The biggest single nationality is the US, at 27.7%. The second ranked country is India, at 8.8%. In other words, 255,200 persons in India are users of Coursera today. I would hazard a guess that across all the modern Internet-based education offerings, the enrolment from India might be 4x bigger than this, or a million. These are large numbers compared with the size of the knowledge workforce in India. And, this is only the beginning.

There is another angle through which the Indian labour market is getting connected up into the world, and thereby global skills, which is through Internet-based systems where the end-customer directly connects to the worker. These can be deployed for all problems where the task definition is unambiguous and payments can be done on a piece rate. While a lot of this is low end work, this is not necessarily the case. E.g. it is possible to pose pretty high skill challenges while retaining the idea of machine-driven verification that the work is done. I wrote a blog post about the fact that roughly a third of the persons working for Amazon's `mechanical turk' are in India. Ghani, Kerr and Stanton have a similar fact from a competitor to Amazon, oDesk. While the bulk of this work is low end, there is also high skill work here.

The overall picture that I see is one of enormous change in education and work in India, with four big themes:

1. There is a surge of young people studying for the IIT JEE (and thus getting up to world class knowledge at age 17), and attending college.
2. They are facing opportunities such as the mechanical turk and oDesk for low end work, and also some high skill work.
3. Indian firms that engage with globalisation are pushing in favour of higher skills; there is a substantial mismatch between what college/university is doing and what the firms want.
4. Internet-based offerings such as blogs and courses are giving access to the world of knowledge that go beyond what colleges and universities in India offer. 

In all four areas, the numbers are big. These are not fringe phenomena; they are of first order importance. World class knowledge is being demanded of the young, and for the first time, they have opportunities to build this knowledge on their own, without waiting for education policy makers to reboot the Indian education system. I feel that this phenomenon -- millions of young people bulking up with knowledge that is qualitatively superior to the knowledge of the old -- is the ultimate growth fundamental for India.

Important work by cobrapost that illuminates high-powered incentives

The investigative journalism by cobrapost, their videos, and Monika Halan in Mint add up to an important story.

Most of us have enormous respect for the achievements of Axis Bank, HDFC Bank and ICICI Bank. But as Monika emphasises, there are also genuine problems there. We saw it first with the hard-driving mis-selling in recent years, particularly with ULIPs, and now we see it here, with staffpersons supporting illegal activities.

Ordinarily, a media outlet in India bringing such information out has to worry about brazen strong-arm tactics being deployed against them, such as filing of criminal cases. In this case, luckily, there is a certain decency about these three organisations which precludes such concerns. It is ironic that the Indian media vigorously reports on the misdeeds of civilised people, and tends to be silent about uncivilised people.

In India, most of us are reverential about the power of incentives. To make people work, we think, you have to have high powered incentives. We revere incentive packages, stock options, stock grants, which whip the staffperson into a frenzy of hard work.

Economists led this charge, starting with Jensen and Murphy, 1990. The notion that high powered incentives are a good thing came out of academia and went into the real world. But increasingly, it has become clear that there are problems. By 2004, Jensen and Murphy themselves were saying that we should be more circumspect about using high powered incentives.

A person facing high powered incentives tends to focus on one thing. There is an excessive pursuit of that one thing, and all other considerations tend to evaporate. Similarly, when there are quantitative goals alongside qualitative goals, high-powered incentives will generate a focus on quantitative goals and tend to crowd out qualitative goals. Employees of a bank that are given powerful incentives to hit targets for deposit growth (sacked if you don't, given a 100% bonus if you do) are more likely to try to pull in that deposit growth by hook or by crook. If the internal controls of an organisation are weak, then employees are likely to achieve their targets by dubious means.

For all of us in India, coming from a backdrop of socialism and State, it is natural to have extreme hostility to the absence of incentive for a civil servant to do his job. We have seen how private organisations have triumphed by giving employees more incentive. But it's easy for us to overdo this message. In many situations, I feel it's better to go from no incentive to low-powered incentives, but not all the way to high powered incentives.

These issues are widely discussed in the global debate. When we transplant these ideas into India, a big difference lies in the weak governance environment. Super-charged employees in private firms seem to be willing to break laws in their pursuit of profit. Since CEOs weigh the costs and benefits of unethical behaviour, we may argue that when, in a weak governance environment, the expected punishment is small, an increase in the gains from unethical behaviour (through high-powered incentives) results in reduced fairplay. 

This suggests two things. First, HR managers needs to be more sophisticated in how the objectives of an employee are defined. If we could be more nuanced in clarifying what the employee is to maximise, this could yield better results. The second issue is about internal controls. When internal controls are strong, they become a non-negotiable constraint within which growing sales or profit has to be done. Unfortunately, once the top managers of an organisation are really hard-driving, chasing growth and profitability, these kinds of niceties (of both kinds) tend to fall by the wayside.

One of the most important mechanisms through which we get high powered incentives is : an entrepreneur who manages a company with family members, and who has dominant shareholding. The one area where this gets us into the most trouble is: Finance. A series of papers that have analysed the Great Recession have found that financial firms where CEOs had more high powered incentives got into more trouble. I am a great advocate of less public sector and more private sector in finance, but we have to be cautious about high powered incentives e.g. those that go with dominant entrepreneurs in a family business.

A prominent example of this debate has been `financial market infrastructure institutions' (FMIIs), a category that comprises organisations like exchanges, depositories, clearing corporations, all of which produce public goods for the financial system. In all these areas, the organisation is unique in that, alongside the goal of maximising profit, there is a regulatory function. This tiny handful of firms is unique, when compared with essentially any other part of capitalism, in that some government functions of regulation and supervision are placed in private, profit-maximising hands. High powered incentives to produce profit or valuation will lead to a dilution or worse of regulatory and supervisory functions. If profit-seeking owners/managers of these organisations under-emphasise or abuse the regulatory and supervisory functions in the quest for profit, this has far-ranging externalities. Failures of regulation and supervision at exchanges have given macroeconomic crises in India in 1992 and 2001. Hence, even though the revenues and profits of these firms is truly tiny on the scale of the economy, this conflict of interest is an important issue for policy makers.

Similarly, there has been a vigorous debate about entry by private banks. As a working approximation, we have to assume that RBI supervision is less than perfect. In this case, I feel that we should be quite circumspect about banks led by entrepreneurs.

The Internet changes everything: Indian higher education edition

The old triusm `never let school interfere with your education' is particularly relevant in India, where most schools, colleges and universities are pretty bad. For almost every young person in India, the option of being institutionalised and on auto-pilot, of letting the curriculum and examinations define you, is a bad one.

The contours of a better world are increasingly clear. Over the web, the person can plug into the likes of Udacity, edUx, Coursera, and M.I.T. Open Courseware, and get a world class education. The trouble is, there are no examinations and no degrees.

I get a lot of resumes of people who ask me for a job. In most cases, a glance at the resume shows me that the person is underskilled. A viable path for young people and for employers lies in the following steps:

• The student must envision what life he wants to lead and construct a set of classes and books that take him in this direction. This requires analysing websites of courses in top 10 universities to get a sense of what would happen there. 
• It would help greatly if the student is able to find persons around her or him who can play a mentoring role in this stage. What are the available lifestyle choices? What knowledge is important? E.g. I would always encourage the construction of broad intellectual capabilities and not narrow job-specific knowledge. E.g. an economics undergraduate should learn enough to understand this blog.
• The student should then turn to the web course offerings and construct a program for self-study. Every few months, this program needs to be re-evaluated because the life plan can change and because the offerings available on the web are changing quite rapidly. Here also, mentoring would help greatly in constructing these plans.
• This process should be continued until the person has done courses and mastered books that yield rough parity with a person who graduates from one of the global top 10 universities.
• The resume of the student should show a specific checklist of courses with URLs which have been done, and books that have been mastered. This is just a claim by the student, because there is no diploma.
• The student would say to the employer: I am willing to face an interview where you test my knowledge of these things.
• Employers should welcome students who have resumes which exhibit this approach of choosing a way of life, and of connecting into the best educational resources in the world.
• Employers should run video interviews through which they test the capabilities of the student.

From the viewpoint of students, this is a great thing because it is an opportunity to escape the low quality of colleges and universities immediately available. For employers, this is a great thing because it is an opportunity to do better than the low quality of students that can be recruited through conventional channels.

This approach requires more work for students and more work for employers. It was easy for a student to say "I have started a Bachelor's in English Literature and now I'm on autopilot". It was easy for an employer to say "I only take in IIT grads; apart from that I am on autopilot". The new world is absolutely wonderful, but it requires that both students and employers need to think more about what they're doing. Read Meeta Sengupta on this.

The rise of high-end finance work in India

by Shashank Bansal.

Until recently, outsourcing by global financial firms to India conjured up an image of commoditised low end services outsourcing: call centres, peripheral systems programming, and testing and maintenance. However, in recent years, there is a new rise of more sophisticated work. This reflects supply and demand factors. Global financial firms are keen to cut costs. Capabilities of operations in India -- both captives and independant firms -- have grown for many reasons:

• The individuals involved in this field in India have gained experience ("learning-by-doing") and credibility.
• New management practices and improved telecommunications technologies have improved the extent to which teams and projects are handled in a more non-local way.
• The Indian diaspora has been rising to senior management levels in global firms, and is better able to envision what can be done in India and to obtain execution.

A European investment bank was among the first to experiment by bringing in teams in India into critical projects. This was a landmark change as a lot of inertia about confidentiality was overcome. Other banks followed suit. New management practices, higher pay, greater meritocracy came in, which helped Indian teams make the transition from low-end work where the HR and management techniques used are quite different. Demand for high skill labour has helped induce greater supply, with a lag, as individuals were more inclined to tool up with advanced degrees and high-end knowledge.

Alongside the developments in finance, parallel developments were taking place in the field of offshoring which have driven up skill levels, and helped create a high skill ecosystem in India. Top tier consulting firms launched `centres of excellence' in India, hiring grads from IITs, IIMs, IISc, statisticians, economists. While education in India has huge problems, the raw talent available in India was of good quality, particularly when we focus on individuals who were able to read on their own and reinvent themselves ("never let your school come in the way of your education"). This process has been helped by globally recognised certification exams such as the FRM and the PRM.

IT firms have have been evolving from core development and maintenance to an entire gamut of IT strategy and consulting for financial firms. Many smaller KPO firms with specialised domain knowledge in finance have emerged, who cater to smaller hedge funds, trading houses, not just outsourcing increasingly complex pieces of work, but also advising them on the entire outsourcing strategy. All this has helped create a pool of high skill labour which is moving between multiple employers in India and able to build knowledge through diverse kinds of experience.

The most impressive development of recent years has been the growth of offshore trading units of global brokerages and trading houses, where people sitting in India take independent trading decisions in international financial markets based on their own skills and judgement. In some ways, this is the highest level of transfer of decision functions to India, albeit at relatively low monetary stakes.

In this fashion, within a period of 15 years, India had graduated from doing repetitive low value tasks to Knowledge Process Outsourcing (KPO) for the global financial system. While these activities are primarily in Bombay, they are also taking place in Gurgaon and Bangalore. The number of high-end finance workers in Bombay has never been greater than it is today. It is estimated that there are now 50 individuals working in Bombay doing work for global financial firms who have Ph.D. degrees in quantitative fields. This is starting to become a big enough number for them to talk with each other and get network effects going. From an employer's point of view, it is now possible to shop in the labour market in Bombay and recruit a 10-man team all with Ph.D. degrees so as to get a new group going. This is a sea change when compared with conditions just a few years ago.

To appreciate this change a little further, it was interesting to take a look at some of the capabilities of finance focussed KPOs, divided mainly into 4 broad categories, catering to Sales and Trading, Middle office and Back office:

1. Quantitative Research and Analytics Support:
   1. Equity and FICC Analytics: Model Validation, Price Verification jointly with clients: these are pretty quant heavy functions which require in-depth understanding of products.
   2. Technical and Fundamental Analytics.
   3. Index and Portfolio Analytics: Index maintenance, design, construction, operations and after sales, Portfolio tracking, decomposition and correlation analysis, performance measurement and attribution support.
   4. Derivatives and Risk Analytics: Measurement of derivatives Greeks, Value at Risk, Tolerance checks.
2. Research:
   1. Equity and FICC Research: Company research, Credit Research, Economics research etc. to augment senior analysts in money centres.
   2. Trade idea generation and back testing: Sales pitches for clients and internal trading desks.
   3. Country, Sector, Company profiling, trends, news and projections: Pitch book generation and support.
   4. 24x7 weather patterns tracking for global energy trading outfits
   5. Overnight trade and market tracking to feed in summary reports, Market Dashboards, news letters, morning meetings and agendas
   6. Market Research: Pre-entry market research and positioning survey for bank's clients.
3. Data Analysis and Modelling:
   1. Data sourcing from multiple heterogeneous sources, refining and maintenance: Static data, Live and Historical market data maintenance. Data research and statistical studies feeding into trading strategies.
   2. Data Mining solutions.
   3. Data modelling, smoothing: Providing data solutions for Algo trading desks.
4. Operations and Control
   1. Derivatives trade processing and documentation: Trade review of structured trades and complex documentation. End to end life cycle management of trades e.g., matching, broker confirmations and fee calculations.
   2. P&L and balance sheet control: Generation and reporting of P&L for vanilla products. Some banks have started moving exotics P&L functions to India. This is quite a significant milestone as such activities require high degree of confidentiality and direct user (e.g., traders) interaction who have zero tolerance for mistakes.
   3. Risk Stress testing, VaR back testing, Risk reporting to senior management.
   4. Auditing: external auditing of valuation marks of trading desks and control processes around it.
   It should be noted here that since the funding crisis of 2008, these jobs have become quite complex as most banks have built more sophistication into their analytics. For example, most yield curves would now have multiple basis spreads (like tenor basis, xccy basis) and not just rates desks but even credit and equities desk have been using such advanced discounting curves.)

What's next

The biggest push probably has been in quantitative middle-office functions with an ever increasing emphasis on valuations and counterparty risk management. Given the way markets have adopted collateral based pricing of derivatives, and the regulatory push on managing counterparty default risk, some captives have started building quantitative teams who will develop and manage CVA, DVA, etc. processes for all trading desks.

The new regulatory climate (Dodd Frank, Basel III etc) has lead to a substantial increase in costs due to additional checks and reporting requirements e.g., centrally cleared OTC trades, real time trade reporting to regulators, exhaustive risk reporting - all of which can are leading to fresh volumes of activity in offshoring.

All high quality banks have a team of techno-quants who work closely with the sales/trading desk, risk managers etc, on their day to day needs as well as on strategic projects. It is now feasible to move such high impact roles to India. It would be possible to have "extended front office teams" where dedicated staff support traders in money centres, doing real time risk analysis and client profiling, while the trade is being dealt overseas.

For a back-of-envelope calculation, if we think of internal billing rates of $100,000 per person per year, and if there are 10,000 persons at this average price, then this is services export of $1 billion a year, which is a sizeable amount. It appears that the early beach-head is in place, and this area will grow dramatically now.

This blog post reflects my experience, which is in investment banking and money management. A similar escalation of complexity of work in India is taking place in retail banking, insurance, etc., reflecting similar compulsions and opportunities.

Constraints

There is a certain tension between the push towards offshoring to India, and the activities that regulators consider `key in-house activities' that cannot be outsourced.

There are serious constraints with education in India. The top institutions are producing some quantitative skills (e.g. fluency with matrix algebra, fluency in numerical computation). On one hand, there are weaknesses of broad intellectualisation that shapes cognition, creativity and malleability. On the other hand, there is essentially nothing in place by way of a finance education in India. A small amount of high-end finance research is taking place (example) but for the rest, there isn't much capacity in the existing academic campuses. New approaches to learning and training need to be devised through which high quality individuals, with strong quantitative skills, can be converted into full fledged participation in high-end global finance work. A mix of public and private initiatives are required in order to jump to the next level.

There are strong synergies between the sophistication of the Indian financial system and the work that is done for global financial firms. There is a two-way feedback loop here: Better domestic capabilities will help do sophisticated offshore work, and the brainpower built for offshore work will strengthen domestic capabilities. The best example of this is found in the equity derivatives market, where India has a world-class market. The individuals with a domestic background here are ready for offshore jobs in fields like algorithmic trading, and individuals with capabilities built in offshore work are useful in the domestic setting. This is where India can set itself apart from Malaysia and the Philippines. To the extent that Indian financial reform makes progress, this will fuel the rise of high-end outsourcing to India.

Acknowledgements

I am grateful to Anand Pai, Paul Alapat and Gangadhar Darbha for useful discussions.

The young are getting away from agriculture

Who does agriculture in India? Here's some fascinating evidence, from the CMIE Household Survey for the quarter Apr-May-June 2012. This is a survey of 700,000 individuals in 150,000 households all across India, both urban and rural. Let's look at the share of the working population, in each age group, that's engaged in agriculture:

Age 15-20	19.69
Age 20-25	21.22
Age 25-30	24.70
Age 30-35	28.22
Age 35-40	30.91
Age 40-45	32.76
Age 45-50	34.75
Age 50-55	36.96
Age 55-60	40.02
Overall	31.31

As we see, in the overall dataset, 31.31 per cent of the working population is in agriculture. CMIE shows three categories of this -- `Small farmer', `Organised farmer' and `Agricultural labourer'. I have added up these three categories to make the table above.

That 31.31 per cent of the Indian workforce is in agriculture is fairly well known. What I had not thought about, previously, is the age structure. Will agriculture have a bigger share of young or old workers? We can envisage two competing effects. On one hand, if a family has underemployed young ones who are engaged in agriculture by default, then we'd see a lot of young people in agriculture. On the other hand, if families try hard to get their kids off the farm, and the growth in industry and services in India is successfully absorbing this workforce, then we should see a smaller share with the young.

The evidence above favours the latter story. The share of the overall workforce which is engaged in agriculture is 31.31%. But amongst the old (age 55-60), the share is higher at 40.02%. This share steadily drops as you get to the young. In the class of the working young (i.e. age 15-20 but a part of the working population), just 19.69% are in agriculture.

Perhaps there is greater malleability of human capital with the young: the old may not be able to easily pick up the skills required to participate in the modern world of services and industry. When the shift of a worker into services or industry is accompanied by migration, it adds up to a powerful engine of social and economic modernisation. It is a powerful mega-trend that is reshaping India today.

The agricultural workforce is greying. There are many divides between the old India and the new one. This evidence suggests one more: the old world of agriculture is disproportionately one of the old, while the new worlds of industry and services are disproportionately manned by the young.

This data helps us understand India's demographic dividend. Many people worry that services and manufacturing in India will not absorb the great surge of young people in India. If that was the case, there would be a lot more people in agriculture. Instead, we see only 20% of the young depending on agriculture.

The application of sound economic principles in the field of agriculture will give us a situation where no more than 5% of the workforce is required there. At present, agriculture is using up 31% of the workforce. This gives us a headroom of an additional 25% of the workforce which can move out. This movement would give a one-time improvement in GDP because the per-worker output in industry or services is greater than that seen in agriculture. But these effects are diminished with the young, where the alteration that's feasible is smaller: from 20% to 5%.

For an interesting comparison against China, in 2007, roughly 10% of the workforce was in agriculture in the age group from 16 till 35. By the time you got to the age group of 41-50 (in 2007), roughly 45% were in agriculture.  By 2012, China has reached a point where there is relatively little upside for GDP growth by getting workers out of agriculture. The Indian evidence for 2012 looks similar to China of 2004, so India is perhaps 10 years away from this loss of upside in GDP growth.

The widget illusion

The Economist runs a discussion forum titled The Economist By Invitation. In this, they recently setup a discussion about an opinion piece by Dani Rodrik about the future of manufacturing-led growth in emerging markets. I wrote a response there which is reproduced here.

The role of manufactures

I agree with a small element of Dani Rodrik's argument, but mostly for different reasons. Rodrik says:

Except for a handful of small countries that benefited from natural-resource bonanzas, all of the successful economies of the last six decades owe their growth to rapid industrialization.

I have seen this kind of thinking among some policy makers in India also: that industrialisation is somehow special and good when compared with services. I would question this proposition, that I term `the widget illusion'. What matters to a country is having sophisticated firms that have a high marginal product of labour. We should not care whether this happens in services or in manufacturing. If anything, the opportunity to do it is perhaps better in services.

India is a good example of a country which embarked on its catchup by connecting into globalisation late: from 1991 onwards. It was probably the last country in the world to shed autarkic policies. This has given a remarkable growth acceleration. Sustained growth of 7 per cent is pretty good by world standards. These achievements have been significantly driven by services production in India within global supply chains (whether within production facilities owned by global MNCs who are operating in India, or contracted-out by global MNCs to Indian firms). If your null hypothesis was that industrialisation is essential to growth, then you would not have predicted what happened in India, where manufacturing was hobbled by an array of policy mistakes.

This illustrates the limitations of manufacturing-focused thinking, which seems a bit out of date in today's world economy where most output is services. Agriculture and manufacturing have wilted away in the consumption of the global representative agent: to succeed in the world economy today requires prime attention upon services.

Rodrik says:

Consider India, which demonstrates the limitations of relying on services rather than industry in the early stages of development. The country has developed remarkable strengths in IT services, such as software and call centers. But the bulk of the Indian labor force lacks the skills and education to be absorbed into such sectors. In East Asia, unskilled workers were put to work in urban factories, making several times what they earned in the countryside. In India, they remain on the land or move to petty services where their productivity is not much higher.

As Rodrik points out, there are important gaps between the skills of the great unwashed masses in India versus China, where elementary technical training reached a larger mass of humans. In addition, China did better on core economic policy choices about (a) Removing protectionism; (b) Removing barriers to FDI; (c) Building hard infrastructure; (d) Labour law and (e) Rationalising taxation.

What policy advice would flow from this? India should not have have made these six mistakes in economic policy (low training for the masses, protectionism, barriers to FDI, weak investments into infrastructure, labour law and mistakes in tax policy). At the same time, this does not recommend a bias in favour of manufacturing. It is hard to discern a meaningful choice about emphasising services versus manufacturing in Indian economic policy. Participation in all global production is good. Governments should remove all barriers that inhibit global integration whether in goods or in services - e.g. the six mistakes in Indian policy sketched above.

A paragraph earlier, Rodrik says:

To be sure, some modern service activities are capable of productivity convergence as well. But most high-productivity services require a wide array of skills and institutional capabilities that developing economies accumulate only gradually. A poor country can easily compete with Sweden in a wide range of manufactures; but it takes many decades, if not centuries, to catch up with Sweden's institutions.

I would point out the contradiction: "A poor country can easily compete with Sweden in .. manufactures" but earlier it was asserted that the gaps in Indian skills inhibited India's ability to compete with Sweden in manufactures.

Doing things that push skills and institutional capabilities

I would go further to say that it is good to go after fields which require a wide array of skills and institutional capabilities.

I am reminded of Ricardo Hausmann's `Good Cholesterol' argument about financial globalisation as opposed to mere FDI. When a poor country operates in an institutional vacuum, foreign investors are uncomfortable, and the only thing that can happen is FDI. To obtain financial flows, the country has to build institutions: laws, regulators, property rights, and so on. This is a good thing! A country that gets to FDI and gets stuck there should ponder what is going wrong. In similar fashion, no country aspires to have low-wage production; every country wants to understand the secret sauce through which a part of the labour force can earn high wages by world standards.

As a country rises out of poverty, it is essential to build up skills and institutional capabilities. If policy makers hinder services and/or favour manufacturing, there is a greater chance of being stuck in low skills and low institutional capabilities. I am not proposing industrial policy in favour of services. I am only proposing the absence of industrial policy; we should avoid a `widget illusion' and foster more global integration without trying to push towards one industry or another.

In India, with 7 per cent growth, GDP doubles every decade. As a thumb-rule, I feel that a comprehensive transformation of skills and institutions is required across each doubling of GDP, which is roughly each decade for India. A country that is stuck in low-skill manufacturing will find it difficult to achieve the reinvention of this `soft infrastructure' of the mind. If policy makers tried to push a country towards doing low end grunge work, it would be harder to obtain these repeated transformations of institutions and the furniture of the mind, which would lead to growth decelerations.

As an example, in the article New wave of deft robots is changing global industry, John Markoff says:

Foxconn has not disclosed how many workers will be displaced or when. But its chairman, Terry Gou, has publicly endorsed a growing use of robots. Speaking of his more than one million employees worldwide, he said in January, according to the official Xinhua news agency: ``As human beings are also animals, to manage one million animals gives me a headache.''

The project of economic development requires sophisticated interactions between firms and workers. The laws, human rights and management practices that are required when dealing with humans are different from those required when running a firm with `one million animals'. I would hence argue that it is limiting for a country to focus on the political, legal and institutional requirements to produce a la Foxconn. It is better to confront the complexities of high skill, high wage production, and to build the environment for this to happen: in the political and legal system, in management practices of firms, and in the power structure embedded in a conversation between two citizens who are co-workers within a firm. Services production is a valuable learning ground where the complex management practices that involve high skill humans can be learned.

The new world of manufacturing

Rodrik correctly points out that manufacturing has become more sophisticated in recent years. This has some fascinating dimensions:

• The rapid improvements in capabilities and declining costs of robots.
• The rise of open source design coupled with 3-d printers. If a 3-d printer in the US fabricates a part close to its usage in an assembly line, while the labour-intensive design work ("services") that controls the 3-d printer is done in India, does this entail manufacturing or services work in India?
• The world economy is likely to be in a low interest rate environment for a long time, which will encourage capital intensity worldwide (robots, 3-d printers), thus blunting the value of low wages.

Momentous changes are afoot, which challenge our traditional notions of manufacturing versus services. To some extent, we are even seeing some manufacturing go back to the US.

Things that might `go wrong'

Finally, Rodrik talks about reduced willingness in the West to tolerate unfair tactics like the Chinese exchange rate regime. I would generally consider this to be a good thing, both for developing countries and for the world. In any case, the Asian `Bretton Woods II' episode seems to be subsiding. As an example of the disenchantment with exchange rate distortions: From 2004 to 2007, India debated exchange rate rigidity, and walked away from it. The links between undistorted exchange rates and growth have not been adequately emphasised in the discourse. A developing country builds up inferior skills and institutional capabilities by exporting under a subsidised exchange rate: it is better to force firms to confront the market price and achieve the productivity required to participate in globalisation when facing an undistorted price vector.

He worries about a rise in protectionism in the West, but we have to admit that the 2008-2012 experience has been pretty good in this regard: by and large the West has not succumbed into protectionism. In 2008, all of us worried about Smoot-Hawley. Today, things seem to be be going well.

Conclusion

In summary, I would argue that we should avoid a `widget illusion'. There is nothing special about manufacturing or industrialisation: as long as people in India get high wage jobs, this is good. Getting there requries deep integration into the world economy, which includes policy battlefronts such as:

• Openness to the Internet
• Use of English
• Inbound and outbound FDI
• The array of cross-border financial services that are the enablers of complex globalised production of both goods and services
• Globalisation-compatible tax policy on both trade and finance
• The absence of either protectionism or mercantalism
• Fostering high quality human skills, and
• Infrastructure.

To the extent that globalised production of goods and services happens in areas which involve high skills and complex institutional development, this is a bonus, since any high growth country needs a rapid pace of reinvention of laws and institutions.

Most of this is the old orthodoxy. Policy makers worldwide are generally focused on these issues, as they should be. From the 1960s onwards, dirigisme has generally subsided, with the twilight of policies like fixed exchange rates, industrial policy, capital controls, protectionism, etc. These key lessons remain intact in the 21st century.