Regulatory Policy in India: Moving towards regulatory governance

by Lalita Som.

Regulatory policy, a comparatively young discipline, is evolving in different ways across the world, reflecting the diverse range of legal, political and cultural contexts on which countries have built their public governance. Regulation, one of the key levers of state power, is of critical importance in managing the economy, in sequencing business behaviour, implementing social policy and influencing behaviour. Regulatory policy thus helps to shape the relationship between the State, citizens and businesses.

In OECD countries, policies to increase competition in markets, and to "roll back the frontiers of the state" in the 1980s and 1990s, broadened to become regulatory reform. Regulatory reform became an essential adjunct to structural reforms, reaching out beyond the network sectors to encompass product market reforms and the liberalisation of professional services. Independent regulatory agencies were developed to manage key aspects of economies and society at an arm's length from the political process. This became known as the regulatory state. The regulatory state paved the way for the idea of regulatory governance (OECD, 2010a).

In OECD countries. regulatory policy has made a significant contribution to economic growth and societal well-being - through its contribution to structural reforms, liberalisation of product markets, international market openness, and a less-constricted business environment for innovation and entrepreneurship. Regulatory policy has supported the rule of law through initiatives to simplify the law and improve access to it, as well as improvements to appeal systems. Increasingly, it has supported quality of life and social cohesion, through enhanced transparency which seeks out the views of the regulated, and programmes to reduce red tape for citizens.

Many OECD countries are concerned about distributional equity – to maximise the welfare of the most disadvantaged, paying attention to distributional consequence of policy actions, albeit not beyond the point at which they would impede on overall prosperity. These insights have had a strong practical influence on approaches to the impact assessment of regulations and especially, analysis of costs and benefits, including distributional aspects and under conditions of uncertainty (OECD, 2010a).

Regulatory reform can be viewed strategically, in both developed as well as emerging markets, as one of the core instruments at the disposal of policy makers. The modern State will have to utilise its regulatory power wisely if it expects to be smarter in order to face challenges like the growing fiscal burden for providing key public services such as health, education and social insurance schemes, in establishing governance arrangements and rationalising complexities to manage the consequences of decentralisation, in supporting the investment climate and in reducing the state's role as an active investor in the economy.

In fulfilling these objectives in an effective way the overall framework of the formulation of laws and regulations requires an explicit whole-of-government approach for regulatory policy, including: responsibility for co-ordination and oversight of regulatory policy; a commitment to assess the cost-benefit of new regulatory proposals and existing regulations, and; the effective implementation of the principles of transparency and public consultation in regulatory decision making (OECD, 2010a).

In emerging markets, extensive state ownership and interference have led to regulatory uncertainty and a business climate that is not conducive to fair competition in open markets. The state's dual role as an active investor and referee has meant that the government is uniquely positioned to shape the applicable legal regime with its interests as shareholder in mind. In many cases, state ownership has created conflicts of interest for the authorities and distorted or suppressed competition. Regulatory institutions and processes are still young in emerging markets, and often regulatory authority is fragmented across a number of bodies, some of which have conflicting mandates. Inadequate co-ordination among government bodies at the national and sub-national levels is a widespread problem, leading to unclear, duplicative, and often conflicting efforts in a number of areas. The lack of sound regulatory governance has meant that popular perceptions of endemic patrimonial politics have persisted, with vested interests and collusion being assumed to operate at the expense of the national interest.

A recent OECD Regulatory Policy Working Paper, Regulatory Policy in India: Moving towards regulatory governance, looks at India’s existing regulatory regime and its evolution in the last two and half decades. The mechanisms of regulatory governance have weaknesses, and in some cases have fallen short of expectations. The paper looks at India's uneven regulatory environment and how its legacy features constrain the evolution of regulatory governance.

Foremost is the difficulty in designing and implementing regulatory policies given the government's inclination to maximize its revenue at the expense of social welfare. This trade-off has compromised effective regulation in the country because of a lack of understanding of what constitutes the objectives of regulatory governance. The paper highlights how the dichotomy between the interests of governments and businesses, as well as that of citizens, has manifested itself over the years in four distinct sectors i.e. mining, hydrocarbons, power and telecoms.

Basic regulation in India is implemented via the concerned line ministries, which may proceed to create industry-specific regulatory authorities that have varying degrees of autonomy, functions, and power. There are significant variations in the structure of the governing bodies, tenure of the members, sources of finances, and interface with the government. A noticeable feature of many of the regulators in India is that they are charged with the promotion and development as well as the regulation of a certain industry. That can result in the regulator thinking of the interests of the industry rather than the users of the industry.

In sectors like insurance, coal, petroleum, telecoms, banking, regulatory strategies are hampered by the presence of State owned firms. The inadequate institutional distance between regulators and state-owned firms, especially when there are no firewalls between them, has meant that the regulators have not promoted enough competition.

In these areas, the State is obliged to play a dual role: i.e. that of market regulator when it is also the owner of commercial SOEs, particularly in newly deregulated, often partially privatised industries. Whenever this happens, the State is inevitably conflicted in its opposing interests as: first, a major market player/firm owner in its own right, and second, as an arbitrator in the (supposedly) neutral, impartial, dispassionate role of regulator.

Regulators are expected to behave independently, and the challenge of independence is to avoid capture by interest groups who stand to benefit from regulation. It is equally significant to avoid regulatory capture by local politicians. Local politicians are attracted by the possibility of large economic rents in perpetuity. Too often, regulators have actively internalised political sentiments in their decision-making. In addition, the elite governmental bureaucracy has a ubiquitous presence in regulatory bodies. Regulatory independence from the executive is difficult to administer if regulators themselves come from a career backdrop of directing political decisions. This strain is exacerbated when regulators are appointed directly from senior governmental positions, requiring them to shift, from administering and defending government positions, to acting as an impartial referee (Dubash, 2008).

Many areas, such as agricultural markets, warehousing, or land, require coordinated approaches to regulation (both rule-making and enforcement) by the central government, and sub-national governments at the state and city levels. Economic liberalisation, coming on the heels of political federalisation, has transformed federal –state relations unleashing unintended and unplanned decentralisation (Sinha, 2004). Any regulatory reform agenda depends crucially on a close co-operation between different levels of government. Federal-state relations have been affected significantly with the rise of multi- party coalition governments and alliance politics in the 1990s. Coalition and alliance partners from states have become progressively more powerful at the national level and more capable of bargaining with the national government. That political reality has added considerable complexity to the environmental and social dimensions of economic decision-making which need the cooperation, and an explicit ethos for regulatory governance, of both national and state governments. The need for multi-level policy coordination has been felt making way for the creation of technical and regulatory agencies at various levels, at times adding to the complexity of policy processes, at others to the bypassing of traditional forms of accountability at all levels (Arora, 2014).

In addition to the legacy features of India’s regulatory environment, the country lacks a coherent policy on regulation. A whole of government policy towards "regulating" would provide the connectivity of different reform efforts and help the concerted effort towards regulatory governance instead of disconnected regulatory reforms. This may include a combination of creating or enabling institutions to embed good regulatory principles into their functioning, but also include the systemic implementation of good regulatory practices such as regulatory impact assessments, public consultation and administrative simplification in priority sectors.

Some sub-national regulators in the power sector and the airports regulator have embedded stakeholder engagement with discernible positive outcomes. the more active use of Regulatory Impact Assessment (RIA) and stakeholder consultation, can inform the government on the cost of some of the trade-offs that India faces in the design of its regulatory policy. Although there exists a certain consensus on the importance of RIA and half-hearted efforts have been made so far to implement it, lack of political will, capacity constraints and limited awareness amongst other stakeholders are impeding its further application. Experience with regulatory governance in the last two decades has resulted in the Regulatory Reform Bill 2013 which intends to legislate an overarching regulatory law to introduce further regulatory reforms and standardise some basic institutional features and processes across all regulatory bodies. The OECD would welcome the opportunity to engage with the NITI Aayog during the redrafting process of this bill.

In addition, India could learn from the experience of both mature and young regulatory governance countries in implementing its regulatory policies. Malaysia which has undertaken large market reforms leading to initiatives for greater regulatory coherence. Australia and New Zealand’s Productivity Commissions, show, most importantly, that the regulatory environment needs to be constantly evaluated to make sure it is keeping pace with the changing technology, business environment, and consumer needs and demands (OECD 2010b). The United Kingdom’s Regulatory Policy Committee provides opinions and scrutiny over the quality of analysis by government departments and are engaged in setting "regulatory guidance" across the government. Korea's Regulatory Reform Committee drives forward the regulatory reform agenda (OECD, 2015).

Bibliography

OECD (2010a). 'Regulatory Policy and the Road to Sustainable Growth', OECD Publishing, Paris.

Dubash, Navroz (2008). 'Institutional Transplant as Political Opportunity: E-Practice and Politics of Indian Electricity Regulation', Comparative Research in Law & Political Economy Research Paper No. 31/2008.

Sinha, Aseema (2004). 'The Changing Political Economy of Federalism in India: A Historical Institutionalist Approach', India Review, Vol. 3, No.1.

Arora, Dolly (2014). 'Trends in Centre-State relations', Indian Institute of Public Administration, New Delhi.

OECD (2010b). 'Review of Regulatory Reform: Australia', OECD Publishing, Paris.

OECD (2015). 'Regulatory Policy Outlook', OECD Publishing, Paris.

 

Lalita Som has worked for the Organisation of Economic Cooperation and Development, Paris. She can be reached at lalita.som@gmail.com

TRAI's consultation towards a net neutrality framework in India

by Amba Kak, Mayank Mishra and Smriti Parsheera.

The context

The Telecom Regulatory Authority of India (TRAI) has issued a Consultation Paper (CP) on Net Neutrality seeking inputs for the formulation of final views on the subject. This comes almost a year after TRAI's regulation prohibiting discriminatory tariffs for data services based on content, framed using its power to determine the rates at which telecommunication services are to be provided. The present exercise covers a broader canvas of trying to identify the acceptable limits of interference in the provision of Internet access services. This includes practices like blocking, degradation or prioritisation of specific traffic, which often form the focus of the net neutrality debate. In TRAI's words, it is an attempt to "rethink the first principles of traffic management by telecom service providers (TSPs)".

While issuing the discriminatory tariff regulation, TRAI had highlighted the importance of "keeping the Internet open and non-discriminatory". This idea also flows through the CP and the pre-consultation paper that preceded it in May, 2016. In fact, TRAI acknowledges in the CP that the term "net neutrality" is being used in its commonly understood sense of equal or nondiscriminatory treatment of content while providing access to the Internet. The word "equal", however, does not appear in the ultimate question posed by TRAI on what should be the "principles for ensuring nondiscriminatory access to content". The CP does not clearly spell out the reason for this. It could be due to the difficulties of monitoring equality in a best efforts delivery system; or perhaps because the term non-discriminatory already captures the concept of equality.

Key issues raised by TRAI

The CP is reasonably comprehensive in its coverage of all major aspects that countries have considered while formulating their positions on net neutrality. Several of these, like reasonable traffic management, scope of prohibited activities and need for transparency were also discussed by TRAI at the pre-consultation stage. The difference, however, is that this CP takes a deeper dive into those issues, identifying the different approaches that could be considered and, in some cases, also weighing their pros and cons. On some issues, TRAI explores new areas, not covered in its earlier papers on the subject. The following are some key points discussed in the CP.

• First, TRAI notes that each country's approach on net neutrality is defined by its local context. Accordingly, it refers to some India-specific factors that may influence its approach. These include, the predominantly wireless character of access services -- 97 percent of Internet subscribers are on wireless networks. The CP later explains that traffic management on wireless networks may pose certain unique challenges due to spectrum constraints and variable usage patterns. It also refers to India's circle-wise licensing regime which often results in the usage of third party networks outside one's home service area. TRAI queries, who will be responsible for any neutrality violations in such situations?
  
• Second, the CP raises pertinent questions about the appropriate footprint of regulation, in terms of the services that are covered and the persons rendering them. In particular, it refers to the potential exclusion of "specialised services", which could be defined in several different ways. The manner in which India eventually chooses to answer this question will have far reaching effects on the adoption of future technologies in the country, particularly in the context of the Internet of Things revolution.
  
• Third, beyond trying to identify the reasonable limits of traffic management, this CP gets into more practical aspects of detection and monitoring of violations. It also suggests a collaborative approach for implementing the operational aspects of net neutrality, which, if adopted, would be a novel approach for the Indian telecom sector.
  
• Fourth, TRAI discusses the role of disclosures and transparency in guarding against discriminatory traffic management practices, an issue that was also raised in earlier consultation papers. However, in this case, it goes on to suggest two approaches on how this can be achieved -- a "direct approach" that would require a TSP to make specific disclosures only its own users; and an "indirect" one would also involve transparency towards third parties like content providers, consumers groups, research organisations and users of other TSPs.
  

Scope of acceptable traffic management

The chapter on "Traffic Management" in the CP sets out the crux of the net neutrality policy debate. First, it explains why traffic management is an integral function of access providers -- to address congestion, security and the integrity of the network. Next, it notes that while such motivations for traffic management practices (TMPs) could be considered "reasonable", others might be "non-reasonable" due to their potentially discriminatory and anti-competitive effects. As such, it explains why regulating traffic management is being considered as a policy option and then mulls over the varied regulatory approaches that could be adopted.

Congestion management, which is explained in terms of the variability of demand or "peak-load", particularly on wireless networks, is explained to be one of the reasons for which access providers might legitimately engage in TMPs. TRAI recognises that the real solution to such issues lies in enhancing the overall network capacity but goes on to note that "even in a situation of enhanced capacity, some degree of scarcity might persist", hence creating a role for traffic management. The key takeaway from this discussion is that "differences in network architecture and technology" will play a role in assessing the reasonableness of any TMPs.

Next, the CP highlights that the same commercial considerations that prompt the use of traffic management tools to improve network performance could also become the cause of exclusionary or discriminatory practices. It notes that there have been global examples of TSP interference in networks for patently anti-competitive purposes, namely "service blocking, prioritising affiliated content provider services or throttling competing ones". While this explains the calls for regulation, traffic interference driven by commercial arrangements is not the whole scope of TRAI's enquiry. Instead, the CP provides two conceptual frames that might be used for such regulation -- the "broad approach" and the "narrow approach".

The "broad approach" appears to be a principles-based approach to identifying which practices would be considered reasonable. Drawing from the European Union's regulations, it refers to guiding principles like proportionality, non-discrimination, transparency and absence of commercial considerations that can be used to define the bounds of reasonableness. Practices like application-specific discrimination, throttling encrypted content, deep packet inspections, etc. can then be tested against these standards.

In contrast, the "narrow approach" will confine itself to formulating a "negative list" of practices that will not be permitted, without going into the contours of reasonableness. TRAI leaves the content of the negative list open for discussion, but gives the specific example of practices motivated by commercial/strategic partnerships with content companies as a potentially proscribed activity.

The distinction between the two approaches does not appear to be one of mere semantics. The paper acknowledges that a negative list is, by nature, likely to be restricted to situations that we are aware of today -- "This may motivate providers to develop other types of business practices that are not explicitly covered in the narrow restrictions although they may have similar harmful effects". It also notes that there could be difficulties in establishing a commercial motive. One way to address this could be to treat the lack of any objective/ technical reasoning for a traffic shaping practice as being indicative of "commercial motive", even where this may not be explicit.

By weighing these different approaches, TRAI seems to acknowledge that regulating TMPs is a tricky exercise, with high likelihood of false positives and negatives. Narrowly defined ex-ante rules may therefore be an uneasy fit with the complex and technical nature of traffic management. The controversy over AT&T restricting Apple's FaceTime application, its high-quality video-calling service, on its cellular network, presents an interesting example. In 2012, when Apple first launched FaceTime for use on mobile networks, AT&T declared that the service would be available only on select pricing plans. On the face of it, this constitutes an application-specific discrimination that violates net neutrality principles, as pointed out by many neutrality advocates. The case, however, also throws up several complex issues, which were discussed in the case study prepared by a Working Group of FCC's Open Internet Advisory Committee.

First, pre-loaded applications, like Facetime, are likely to enjoy more large-scale adoption, thus more likelihood of creating pressure on the network -- only about 10 percent iPhone users voluntarily downloaded Skype, while all had Facetime preloaded on their phones. Second, high-bandwidth video calling applications put a particular strain on mobile data networks, in both the upstream and downstream direction. FaceTime, in particular, was found to consume "on average 2-4 times more bandwidth than a similar Skype video call" at that point of time. Third, limited trial deployment of a new application, for instance, by limiting it to particular pricing plans, could be useful for gathering measurement data to assist in developing better TMPs. Fourth, application management can take place on the device, as was happening in this case, or on the network -- "whether it matters where an application-management decision is enforced, and which organization decides on it". TRAI has also touched upon some of these aspects in the CP by raising questions on "application-specific discrimination", "duty-bearers" in a net neutrality regime and impact of traffic management at the level of the device or operating system being used by a person.

Conclusion

The public discourse that preceded the discriminatory tariff regulation took place in the shadow of Facebook's Free Basics offering. It led to heated debates and sharply polarised views, many of which were focused on the specifics of Free Basics. In contrast, this current consultation is taking place in a relatively less charged environment, with no poster child violation. This presents an opportunity for the regulator and stakeholders to proactively engage with one another for developing a suitable framework for India that can be tested against a range of potential practices. The real test will be to ensure that whatever principles India chooses to adopt at this stage convey a strong regulatory message on non-discrimination, but also have the flexibility to adapt to the dynamic environment of this industry.

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

Subsidies are the last refuge of a failed policy maker

by Ajay Shah.

The government wants to subsidise your use of energy efficient household appliances. RBI wants to subsidise merchants who accept cards. Many people want to increase Internet access by using subsidies, e.g. the money disbursed through the `USOF'. Are all these subsidies appropriate?

Market failures versus your pet peeve

My pet peeve about the world is that there isn't enough classical music. Does this justify State intervention? The careful answer of an economist is: No, the scope of interference must be limited to `market failures'. Market failures are situations where the free market gets the resource allocation wrong. These are also generally situations where the free market gets the price wrong.

A useful four-part classification of market failures helps us look for them. The four categories are: market power (e.g. a monopoly that jacks up the price and cuts the quantity produced), asymmetric information (e.g. you buy medicines at a shop but you don't know whether they're adulterated), public goods (e.g. law and order, where the private sector will always under-produce), and externalities (e.g. your smoking gives me cancer).

The absence of an opportunity to trade widget $x$ at time $t$ is not, in general, a market failure. It may be a perfectly rational outcome for the retailing industry to not sell woolens in the desert. It may be a perfectly rational financial market where limit orders of a certain kind are absent. We may want more prosperity, more development, through which these markets would be more active, but the absence of trading in widget $x$ at time $t$ is not, in general, a market failure. In India, often times, we find that abnormally low trading is caused by government failures where the government is banning or interfering with various kinds of economic activity.

Similarly, when we see person $p$, and we dearly wish that he could buy butter, but he is too poor to buy butter, this is not a market failure. It's poverty.

When we see something that is going wrong in the world, the first hygiene check should be: Is this just my value judgement, or is this actually a market failure? Just because I like classical music, this does not mean that the slow death of classical music is a market failure.

Addressing market failures

When faced with a market failure, we may try to come up with a State intervention which would address this market failure. This is a dark art which involves the following considerations:

1. The smallest use of force is the best. The best intervention that gets the job done is the one which uses the least coercive power of the State.  Spending money is grounded in taxation, which is a high use of the coercive power of the State. Each rupee of money spent by the government probably imposes a cost of Rs.3 upon society. We should be cautious before going there. In general, the engineering question -- the search for tools which address a market failure using the least force -- requires scientific knowledge in the form of a good understanding of the market failure. As an example, a careful analysis of the problems of energy efficiency leads to solutions very different from subsidising energy-efficient equipment.
2. Taking implementation constraints seriously. Some interventions are infeasible in the light of the constraints of State capacity. Sometimes, the incentives of politicians and officials are impossible to correct, and while we can conceive of a nice tool for addressing a market failure, this may prove to be administratively infeasible. When implementation constraints are unsurmountable, we should just walk away leaving the market failure untouched. The lower the State capacity in a country, the more we should push towards laissez faire. Addressing a large class of market failures through State intervention is the luxury of people who possess State capacity. There is libertarianism of necessity and there is libertarianism of choice; we in India have to often engage in the former.
3. Subsidies are the tool of choice when faced with one kind of market failure: externalities of the positive kind. Consider education. When person $p$ gets more educated, he captures certain gains, but there are also gains to society at large which are not captured by him. These positive externalities are not valued by person $p$, who would tend to under-invest in education. This under-investment is a market failure: the free market outcome is the wrong resource allocation. We can correct this market failure by having a subsidy. While this logic is true some of the time, not all positive externalities can be addressed using subsidies. Here's an example : of market failure in the undersupply of criticism.
4. How big should the subsidy be? This requires two pieces of measurement. We should measure the positive externalities. The magnitude of the subsidy should be set to the point where the marginal gains to society from the last unit of subsidy is equal to the marginal social cost of funds. At present, in India, we have little empirical economics ability on measuring either. When we don't measure these things, caution requires a bias in the downward direction: push towards low or zero subsidies.

Addressing the `digital divide' using subsidies? 

Consider recent debates about the `digital divide'. Facebook and others proposed net non-neutrality as a way to increase their profit rates, and claimed that this would address access problems to the Internet. Proponents of net neutrality said that if access was a concern, this could be achieved by issuing bandwidth vouchers through which the government pays for (say) the first Rs.50 of data consumption per month by each citizen of India. Yes, this can be done. But should it be done?

Suppose most consumers use data comm to watch cat videos. In this case, why should the violence of the State (taxation) be brought to bear on increasing the consumption of cat videos? Before we propose a subsidy that would increase consumption of data communications, we should have measures of the spillovers, the positive externalities.

Ordinarily, a subsidy is funded by general tax revenues. In this case, people often rush to proposing the use of the `Universal Services Obligation Fund' (USOF). This is a less efficient means of raising public resources as it is a tax on one sector. The marginal social cost of USOF money is higher than the marginal social cost of funds. Intuitively, if the marginal social cost of funds is 3, I suspect the marginal social cost of USOF funds is 6. A subsidy funded through USOF would thus have to be significantly lower than a subsidy funded through general tax revenues.

Aadhaar and the Indian debate on subsidies

Nandan Nilekani and his team were very controlled in their arguments. They said: We have no opinion on whether the purchase of LPG should be subsidised, but assuming you want to do this, here's a way to better implement this subsidy. The re-engineering of many subsidy programs using Aadhaar has occupied public attention and absorbed management capacity in government.

But this does not change the basic question: Why should we have the LPG subsidy in the first place? Now that the Aadhaar system is built, we should go back to asking deeper  questions. Do we really want to have a fertiliser subsidy?

The rampant use of subsidies

We can't get our policies on ATMs right, so let's just subsidise ATM placement in northeast states. This sort of policy reflex is found all over the Indian policy landscape.

We failed to get our policy framework on payments right. Now we see a point of pain: acceptance infrastructure is lacking. The solution: subsidies in the form of an `Acceptance Development Fund'.

We failed to get prices right and interest rates right. Hence, households have incentives to buy energy inefficient equipment. The solution: subsidies.

We failed to make the Bond-Currency-Derivatives Nexus work. The solution: create a specialised class of financial firms named `primary dealers' and subsidise credit to them.

We failed to make infrastructure financing and the Bond-Currency-Derivatives Nexus work. Infrastructure projects are unable to sell corporate bonds. The solution: subsidies in the form of tax exemption for these bonds.

A conjecture about the rampant use of subsidies

Why are subsidies rampantly used in India? Why are policy makers so quick to reach into their toolbox of diverse possible interventions and pick on the subsidy?

Perhaps there are many market failures out there. Perhaps there are pervasive failures of policy analysis, misbehaviour by politicians and officials, and a shortage of State capacity. Hence, many market failures are not addressed. Solving these problems at the root cause is hard. The easy way out is a subsidy.

From a political point of view, sound policy work on addressing market failures involves using the coercive power of the State in order to force certain persons to behave differently. This is always unpleasant and makes some people unhappy. Spending money, on the other hand, is always popular. The unhappiness is concentrated against the Ministry of Finance which has to use State violence in collecting taxes. Once taxes are collected, every department of government, and every government agency, is too happy spending money. This is the soft option, compared with actually addressing market failures.

Actually fixing policy institutions is hard work. The leadership of most policy institutions lacks the ability to achieve State capacity. Subsidies are a tempting alternative for an `action-oriented government'.  Samuel Johnson said `patriotism is the last refuge of a scoundrel'. In similar fashion, subsidies are the last refuge of a failed policy maker.

Inequality

If you believed that income inequality was a problem, the subsidy which addresses that is a transfer of Rs.1000 per person, every month, to the bottom decile of society. There is no need to interfere with the working of the market economy, for the purpose of reducing inequality.

Conclusion

Many times in India, subsidies are being used to express sheer value judgments; they are just the faddish thinking of one bunch of hausfraus running policy versus another. At other times, a market failure is indeed present. But instead of more subtle interventions and the minimum use of force -- based on a sound scientific understanding of the anatomy of the market failure -- we tend to rush to the excessive use of force that is a subsidy. Every subsidy is grounded in the monopoly of violence of the State that is required for tax collection. We should be far more circumspect before doling out subsidies. Subsidies are the last refuge of a failed policy maker.

TRAI's move on net neutrality

by Iravati Damle, Mayank Mishra, Smriti Parsheera, Sumant Prashant, Ajay Shah.

On Monday, the Telecom Regulatory Authority of India (TRAI) released a regulation and associated explanatory memorandum prohibiting discriminatory tariff for data services. This has elicited interest and responses from all over the world. We watched the Facebook stock price curiously over that period:

Facebook stock price vs. the Nasdaq index

On 4th and 5th (Thursday and Friday), there were rumours in the Indian press about what TRAI was about to do. After that, when the US market opened, they may have had some impact. On Monday, the US market opened after the TRAI regulation had been released. Overall, in this period, the Nasdaq index dropped by 6% while Facebook dropped by 12%. Perhaps some of this was caused by the TRAI action.

The TRAI regulation was preceded by an extensive consultation process initiated by TRAI in December 2015, where it posed the following question: Should telecommunication service providers (TSPs) be permitted to charge consumers for data based on the content that they access?

One group, led mainly by TSPs, favoured differential pricing on the grounds that it would increase Internet penetration, encourage investments in infrastructure and allow for the development of innovative products. The supporters of net neutrality disagreed. They argued that content-based discrimination would vitiate the basic principles of the Internet, lead to discriminatory practices and hamper competition and innovation among content providers. TRAI ultimately chose to answer its question in the negative, supporting its regulations with an explanatory note that shows the process and rationale for its decision.

Placing it in context

The topic of network neutrality has captured the Indian public discourse for the past several months. Network neutrality is the principle of equal treatment of data packets moving across the Internet. This touches on three core aspects of how TSPs should conduct their business:

Access: No authority to allow/block access to any content.

Speed: No throttling or increasing speeds to access particular content.

Pricing: No paid prioritisation. No content-based pricing.

The current regulations speak only to the third issue of price related discrimination, putting an effective end to the following types of practices:

• Zero rating - Access to specific content without counting it towards a user's data charges (e.g. Free Basics)
• Sponsored data - Content provider bears the cost of access (e.g. Airtel Zero)
• Content-specific packs - User pays for data but based on type of content (e.g. Special Facebook and WhatsApp packs)

The larger issue of how India will deal with the other core components of net neutrality still remains open.

A summary of the regulations

The regulation prohibits TSPs providing both wired and wireless services from (i) offering differential pricing to consumers, based on the type of content being accessed; and (ii) entering into agreements that have a similar effect. TRAI's rationale for moving in this direction rests on a detailed explanation of the basic architecture of the Internet, which is grounded in the idea of openness. Besides this, the explanatory memorandum also speaks about the market failures of information asymmetry and negative externalities, which created a need for regulatory intervention.

The prohibitions are subject to two sets of exclusions. First, TSPs are permitted to have differential pricing in closed communication networks - where the data is not transmitted over the Internet. This could include local intranet services and products like Internet Protocol Television (IPTV). The law however guards against potential misuse of this provision by saying that TRAI will keep a watch on practices that use the exception to evade the discriminatory pricing prohibition. Second, a reduced tariff can be charged in case of emergency services, subject to reporting to TRAI within seven days. For instance, the Chennai floods saw the instant mobilisation of applications targeted specifically for relief and rescue work. Such initiatives would not be hampered by the regulation.

The restrictions also do not cover differential pricing that may be charged independent of the content being accessed. To take an example, Aircel offers a limited period of free capped data on purchase of certain mobile devices. Within those limits, the user can access any available content on the Internet. This is not a violation of discriminatory pricing, as defined by TRAI.

Impact on the Internet and its stakeholders

The heart of the new regulations lies in what TRAI has labelled as "the need to preserve the unique architecture of the Internet". This is in line with TRAI's mandate to promote the orderly growth of the sector (i.e. Internet services). Our analysis of the impact on key stakeholders is as follows.

Internet users: The regulations uphold the user's right to choose from among multiple sources of information on the Internet, free from the white noise of discounted offerings. This means that users will have to continue paying for the data that they use while retaining the full freedom to choose the websites and applications that they access.

Some may argue that the regulations potentially harm consumers by slowing down the process of digital inclusion and denying users access to free services. As highlighted above, the restrictions pertain specifically to the use of price discrimination to create "walled gardens" within the Internet. Other schemes that may provide free access to the Internet as a whole will continue to be allowed.

TSPs: TSPs will have to terminate existing arrangements that allow them or their content partners to subsidise access to specific content. They will also have to discontinue schemes that offer content-specific discounted rates. Another important impact will be felt in cases where a TSP is also a content provider - it will not be allowed to leverage its position as a TSP to promote its own content for free.

It is important to recognise that the value of the Internet will grow as more and more people become part of it, a process that is already taking place even without discriminatory pricing. This will continue to translate into economic benefits for TSPs. Their grouse may however be on the denial of the windfall profits that could result through discriminatory practices.

TSPs will have to then compete in the tough commoditised game of producing bandwidth at ever lower prices.

Content providers: The regulations ensure that the Internet will continue to offer a level playing field for all content providers. There will be no entry barriers for small content creators. This will foster greater innovation and competition.

Those that had already entered into private arrangements with TSPs will of course have to alter their plans to bring them in line with TRAI's regulations. Paying the TSP will not be an element of business strategy.

Conclusion

Many people from the world of business are used to unlimited complexity in business contracts. Hindustan Lever has all kinds of innovative contracts with distributors, retailers, etc. By analogy, it is felt that the world of telecom should be similarly unencumbered. However, the revolutionary achievements of Unix and the Internet, from the late 1960s onwards, are rooted in a particular philosophy and design strategy, of openness. We must recognise the value of this philosophy as a universal multilateral disarmament treaty, which ensures cooperation in some respects, and channels competition in others. Gentleman's agreements have given hygiene in the past. However, the commercial pressures of today's technology world do not give adequate guarantees about the future. Net neutrality law uses the coercive power of the State to protect this design philosophy.

TRAI's differential pricing regulations place India alongside countries like Chile, Netherlands and Slovenia that have also taken a clear stand against differential pricing (or zero-rating in particular). The interesting difference however is the fact that those countries did so within the framework of their net neutrality laws. Others like United States and the new regulations in the European Union have also taken a stand on net neutrality but have decided to consider zero-rating on a case-by-case basis. By ruling on the issue of differential pricing without waiting for a broader net neutrality law, TRAI has in effect won the last battle first, within powers under the TRAI Act, 1997.

The policy analysis will now turn to practices like blocking and throttling. It would make sense to think of deeper amendments to Parliamentary law which address net neutrality in a more complete way.

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.

Who is in charge of fiscal policy and tax policy?

In any country, various arms of government like to indulge in taxation of their own choice, and in setting up little treasuries that they control. However, it is quite clear that there must be only one treasury, and only one authority that determines taxation, through only one Finance Act.

In the Economic Times today, I have an article that applies this idea into analysing a recent proposal by DOT to impose an 8% tax on wireline broadband providers.

You may find some of the associated materials useful:

1. Consultation paper issued by DOT on this in December 2012.
2. National Telecom Policy, 2012.
3. TRAI recommendations on broadband.

Did the Indian GDP just jump up by a basis point?

Google made two important announcements:

• The database underlying google maps is now of the quality required to support turn-by-turn navigation. Every smart phone or tablet that can use google maps just became a GPS device that is capable of giving you turn-by-turn navigation including giving you instructions in audio.
• In six cities, they now have realtime traffic data available as an overlay on google maps. You can look at the map and it will show you what segments of what roads are congested.

This will, I assume, enable cool things within applications like Google Now to work: it knows your calendar, it analyses traffic conditions, and tells you at the right time "Now it's time for you to leave". Similarly, we can now use Google Places ("search for a coffee shop close to where I am right now"). It shows you the list of what's available, you touch one of them, and it's now ready to give you turn-by-turn directions to go there.

Industry sources say there are roughly 26 million smart phones out there that are able to use google maps. In other words, we have just had 26 million satnav devices added to the Indian capital stock. And, we've added realtime traffic data for the subset of these that are in 6 cities. Millions of people have just had a jump in productivity.

An interesting Fermi problem : Will this add one basis point to GDP? At first, I thought this was hard because it'd require making assumptions about how much time each satnav saves for the person, that person's output per minute, and so on. But a reverse calculation is illuminating: 1 basis point of GDP is Rs.1000 crore or Rs.10 billion. Divide by 26 million smart phones and you get : a flow of increased output of Rs.384 per satnav per year. In other words, if each satnav device adds Rs.384 of output to the owner's life per year, then Google's turn-by-turn navigation added 1 bps to GDP. And I'm not even counting the impact of realtime traffic data. This number (Rs.384 per satnav per year on average) seems plausible to me.

You may like to see this material on map databases in India.

White label ATMs

by Harsh Vardhan.

On 20 June, RBI issued guidelines that permitted White Label ATMs (WLA) to be operated in India. These guidelines could make a very significant change in the banking business - one that would go a long way in improving penetration of banking. This was a move that was long overdue. We can now look forward to very rapid expansion of the ATM networks along with many new services being offered at them.

ATMs arrived in the US in the late 1970s and in India somewhere in the 1990s, when some foreign banks set up a few in Mumbai and other metros. It was not until the late 1990's and early 2000's that ATMs became an important channel and there was a rapid growth. This growth can be attributed to the new generation private banks who used ATM's cleverly to expand the reach of their (then) limited branch networks to attract customers. These banks realized that it will take them a long time to match the branch reach of public sector banks, and hence adopted a model where a branch surrounded by a slew of ATM's became the means of attracting customer. The proposition to the customer was - "Open an account in the branch which may be far away from your home or place of work but transact on an ATM which is very close to you". A new generation of customers, more amenable to the use of this channel also helped. Slowly, most of the new generation banks managed to transfer a sizeable part (in some cases over 80%) of basic transactions -- cash withdrawal, balance enquiry, etc. -- to ATMs. The cost advantage was compelling. Doing transactions on ATM's can be 50% to 80% cheaper than using branches. We also saw some small "value added services" emerge at the ATM, such as bill payments.

Despite the rapid growth of the ATM network, their density is still low compared to other countries. India has ~ 77 ATMs per million population which is much lower than even countries like Thailand and Malaysia which have ~200 ATMs per million and significantly lower than the US which has over 1200 ATMs per million people. Clearly, ATM density will have to grow which means a large number of ATM's will have to be rolled out. For this to happen, appropriate incentives have to come into play in this field.

How do ATMs work?

It is important to first understand the mechanics of ATMs, to fully appreciate the roles played by different entities and how the new regulations change these roles and thus the incentives.

ATMs are essentially electronic contact points between a bank and its customers. The jargon of the field involves three kinds of entities:

• Issuing banks - those that issue ATM cards (or debit and credit cards) to their customers
• Acquiring banks that operate ATMs and dispense cash (similar process also is followed in case of the so called Point of Sales (PoS) terminals that are used at merchant establishments for payments)
• Payment associations (also called Network Providers) - the intermediaries that facilitate the flow of information (payment instructions) and funds between issuing and acquiring banks

The process flow of cash dispensation by ATMs (which is 95% of what they do) works like this:

1. A customer approaches an ATM and inserts his card.
2. The ATM "reads" his card and passes the information to the bank which has set up the ATM. This bank is conventionally called the "acquiring" bank.
3. Computers of the acquiring bank read the information and determine if the customer is its own or of some other bank.
4. In case of its own customers the bank invokes his account, checks if there is enough money, and if the password is correct, sends instruction to the ATM to dispense cash. Such transactions, where the acquiring bank and the card issuing bank is the same, are called "On Us" transactions.
5. Sometimes the customer has a card issued by another bank ("the issuing bank"). The acquiring bank (i.e. the one which setup the ATM) sends a message to Visa, MasterCard or "NFS" the National Financial Switch (a system set up by National Payment Corporation of India) depending on the arrangements between the acquiring banks, the issuing bank and these entities. These entities are called "Payment Associations" and they perform the role of connecting card issuing banks with the acquiring banks
6. Upon receiving the information from the payment association, the issuing bank checks up the availability of a balance in the bank account, and sends the payment instruction to the ATM which dispenses cash. In this situation the acquiring bank is making the cash payment to the customer on behalf of the issuing bank. Such transactions are usually referred to as "Off Us" transactions
7. The payment associations keep records of all "Off Us" transactions. At the end of each day, they do clearing and settlement of funds whereby all banks pay or receive funds depending on the net Off Us transactions made through their customers and possibly their ATMs.
8. The issuing bank pays some fees to the acquiring bank and to the network providers for every transaction that their customers carry out on ATMs (i.e. for all "off us" transactions). These fees are a revenue for the acquiring banks which spends money in building and running the ATM network.

It is useful to think that there are 2 distinct flows in this process: a flow of information (or instructions), and a flow of money. Information flow takes place on communication lines between the entities involved and funds flow is mediated by the payment association through its own clearing and settlement processes. The two flows are linked but distinct.

The new guidelines

Historically, RBI regulations prevented non bank players from competing in this space. Regulations allowed only commercial banks to own and operate ATMs. This means that each ATM, in the view of the regulator, belonged to the acquiring bank. And no entity other than a commercial bank could do the acquiring part of this process.

Building and running ATMs is more of an IT/telecom business and many banks were not keen to create these capabilities. A significant amount of outsourcing was done by banks, whereby the maintenance and in many cases even the rollout of ATM's was done by independent companies for banks. But regulations dictated that all the crucial aspects of running the ATM network remained squarely with banks. Even the locations of ATMs - which banks needed to inform the RBI - were pegged to a bank. The new guidelines effectively open up most of the acquiring part of the process to non bank independent players. They clearly recognize that the information and the funds flow are distinct and while there may be some logic in keeping the funds flow within the ambit of commercial banks, the information flows can be performed by non banking entities. The new guidelines make some profound changes, including allowing:

• Independent white label ATM providers to set up and operate ATM networks (without being a bank); these companies can apply for and get approvals for the locations of ATMs - the locations will be assigned to these companies and not to banks
• Independent ATM networks to connect directly with network providers such as Visa Mastercard, and NFS - thus allowing them to pass on the payment instructions emanating from the ATM without having to go through the acquiring bank, While the cash settlement will continue to be via the acquiring banks (called sponsor banks under the new guidelines), an independent ATM operator can do such settlement through multiple sponsor banks
• Allowing companies to tie up with multiple banks as acquiring (sponsor) banks; this will meant that even if the arrangement between a particular bank and an ATM operator is discontinued, the operator can tie up with another bank and continue to operate ATMs
• ATM operators the freedom to offer value added services

Effectively, these changes imply that running the ATM network has now been recognized as an independent activity, but at the same time seeing that it is a business that needs the support by banks for activities such as managing cash and for settlement. Thus the RBI has taken significant part of running ATM networks out of the ambit of commercial banking.

Why is this a good idea? Building out the ATM network is not a core activity for banks. For banks, an ATM is a transaction point for customers. Setting up and running a large number of ATMs is an activity that adds little to the profitability and performance of banks but does add a significant amount of operational burden. This is the reason why many Indian banks started outsourcing ATM rollout and management once they reached a critical mass on ATMs. This is not the business of banking. At first blush, it is an IT or telecom business. But at a deeper level, it is closer to the retail business, with issues like location, branding, efficiency, multiple services, etc.

For independent white label operators, building out a large ATM network and squeezing operational efficiencies out of it would be the core business. They are expected to focus on much faster rollout of network, strategically thinking about locations, squeezing efficiencies in the management of the network, adding value added services, etc. An analog would be the case of money-changing business - what is popularly known as "Exchange Bureaus". For a long time only banks were allowed to run these and so we saw very few outlets even at airports and so on. This business was opened up for private independent players about a decade or so ago, which resulted in a dramatic increase in the number of outlets as well as the quality of their service. There are several classes of players that are likely to enter this business. Large established international players (eg Star, Pulse, NYCE from the US) should be interested as they would see India as a major growth market. Local players currently providing oursourcing services for ATM rollout and management would be another class of players that are likely to enter. ATM manufacturers (eg NCR, Diebold) also could look at this as an extension of their business. Other firms in related business such as telcos that provide the network connectivity could also consider entry. Each of these different classes of players have their own strengths and weaknesses. Time will tell which is the ideal business model. The competitive dynamics between these various kinds of players will give customers in India better ATM services in all respects: more locations, better locations, more services, and superior customer experience.

Many aspects of the white label ATM business will only become clear as the story unfolds. The most critical is the long term sustainable economics of the business which will determine the capital that is deployed into the business. While the RBI guidelines prescribe overall restrictions on the fees charged by the ATM operator to the bank, they stay away from prescribing the exact charges, which is the right approach. At first, there will be a bit of a competitive frenzy; some players will set some charges to very low or very high levels. It will be some time before stable pricing structures and levels emerge. The guidelines are not absolutely clear if these companies can develop independent brands for their networks (such as Most and Cirrus in the US). Such branding will be a crucial part of making white label ATM an independent business. My interpretation is that independent branding is not explicitly prohibited but it is not explicitly permitted either and clarity on this count would be very useful. Overall these guidelines are a move in the right direction. There is a lot in the payment space that is currently tied to commercial banking due to regulatory reasons. The evolution of technology and consumer behavior suggests that many aspects of payment business need not remain confined to banking and in fact taking them out could unleash innovation that would drive significant efficiency gain and consumer value. We can hope that the deregulation of ATMs is the first of several similar steps that the RBI takes to allow the emergence of a payments industry in India, distinct from the business of banking.

RBI vision document on payments: An evaluation

by Madhavi Pundit and Suyash Rai.

On June 27, RBI published its Payment System Vision Document (2012-15). The document shows RBI's vision and mission for the payment system, and specifies the objectives, approaches and courses of action emanating from the same. It is a laudable step taken by RBI to discuss its plans for payments in India. All regulatory activities, such as banking and capital account liberalisation should have vision documents to similarly show the road map. They bring clarity to market participants, and helps everyone plan better.

A vision document is an opportunity to think from first principles, and to dream about the payments landscape. The document does not do this sufficiently.

Going by the ideas of the vision document, it is difficult to hold RBI accountable to it or to evaluate its role as a regulator, because it is not clear what we should expect the payment system to achieve, say, five years from now. Though the vision itself may be a general, aspirational statement, it should be accompanied by quantifiable goals that can be achieved by Indian payments system (regulator + industry). For example, the regulator can set objectives that by 2015, cash will be x% of transactions, or that cheques will be phased out by 2020. RBI can then, as a regulator, take steps to facilitate the achievement of such goals, with the expectation that other participants will play their part. Such sharp statements are absent in the document.

Once a suitably ambitious, but quantifiable, vision for payments has been stated, achieving it requires looking beyond incremental modifications. This brings us to the kind of steps RBI has proposed in the document; the things that it will do to achieve the vision over the next three years. For a vision document, the proposed steps are rather tactical and operational. From this document, it seems RBI is running all payment systems, with incidental cooperation from the private sector. It is difficult to imagine how industry participants should work towards the vision. For an example of how this can be done, contrast the RBI document with the Strategic Review of Innovation in the Payments System, recently released by the Reserve Bank of Australia. Unlike RBI's document, the focus of this document is purely strategic, and on removing barriers that prevent market participants from innovating.

The document should clearly state what RBI sees as its role in payment systems - which is above all, that of a regulator - and what it sees as the role of market participants. While the document focuses on the development of certain types of electronic payment systems, certain standards, authorisation methods etc., there are a host of other ways the market could innovate. The document's approach precludes other means by which the same goal of higher electronic payments can be achieved.

All regulation must be rooted in market failures that damage the interests of consumers or threaten systemic crises. A specific regulation must address a specific market failure and thus tangibly further consumer protection or systemic stability:

1. In payment systems, consumer protection would entail measures that ensure transparency and disclosure by payment providers, so that consumers receive what they are promised.
2. In addition, providers must be subjected to micro-prudential regulations, such as capital requirements, risk management and investment restrictions that ensure their safety and soundness, based on the risks they take. The risk based approach means that small value systems with real-time payments need less regulation than large value systems that hold clients' funds for a certain amount of time.
3. For systemic stability, enhanced regulation and supervision of systemically important payment systems, especially back-end infrastructure, such as RTGS, is required.

RBI ought to focus on these regulatory objectives, where it would deliver public goods, rather than take on `private goods' functions that can be handled ably by the market. Systems such as NEFT and ECS, which essentially require capabilities that go beyond a regulator's core competence, can be run well by the private sector, under RBI's regulations. In such systems, competition is of essence.

From this perspective, the vision document starts looking less impressive. It is tied to the existing ways of doing things, and intent on incrementally improving them, rather than questioning the existing paradigm. This is unsatisfactory, for a paradigm shift is what India most requires.

Perhaps that is why there seems to be a lack of clarity of purpose. For example, RBI talks about investing in cheque systems and electronic systems at the same time. Developing a grid system to replace clearing houses as suggested is expensive. If the objective is to phase out cheques and promote electronic payments, the revamp of the cheque clearing system has no place in the vision document for electronic payments.

The emphasis on electronic payments is welcome. It is time for India to become a less-cash society, and ultimately a cash-less society. Myriad inexpensive, safe and useful electronic technologies are available, and more are being developed as we write. Hence the extensive use of cash and other paper-based instruments is not acceptable. They are expensive and inconvenient, and cost the most to those with the least - who pay for using these instruments and also face value erosion due to inflation. More needs to be done to move to electronic payments, and soon.

Competition and innovation are both important for this goal. The document talks about the dilemma the regulator faces with regard to pricing. To us, there is no such dilemma. To a large extent, the regulator should not intervene in business decisions such as pricing. In terms of market structure, there are two types of charges in payments - by retail payment providers and by infrastructure providers in the system. At the front end, innovative and cost effective payments products and gateways can develop if there is competition and there is no case for regulatory intervention here. It is a serious issue, and as experience from credit markets would suggest, a cap on pricing usually leads to more exclusion than inclusion.

Anti-competitive actions by players can be taken up to the Competition Commission. At the same time, it is important to note that in industries that are network based, there may be a need for monopolies or duopolies in infrastructure provision which require modification of the standard approaches of competition law (example).

Under these circumstances, if there is evidence of supernormal profits, there may be role for regulating prices. But even here, price determination should be done transparently, based on a full analysis of costs and reasonable returns, and in consultation with industry participants. For example, in the recent announcement of a cap on merchant discount rate on debit cards, there is no explanation from the regulator for how the amount 0.75 per cent was decided, and what are its costs and benefits to the system.

The role for non-banks is conspicuous by its absence in the vision statement. Currently, regulations tie the hands of non-bank payment providers. Take the example of Airtel money, which is a semi-closed mobile wallet. This means money can be transferred to other Airtel customers and transactions can take place with certain merchants, but there is no possibility for cashing out. Vodafone has partnered with a bank, and hence allows cash out from retail points; but these registered points have to be within 30 km of the bank partner.

A key insight that should guide the way forward is that payments is a separate business from banking, and should have its own regulation. Decoupling them could help achieve the twin goals of innovation and inclusion. An electronic payments revolution can take place when small value transactions are done electronically, i.e., customers in every nook and corner of the country can access secure, efficient and low cost retail payments services that can be considered cash substitutes. E-money in many countries has exploded on the backs of non-bank led payments systems such as telecom companies and retail chains, and their reach has been impressive. Easing restrictions on non-bank payments systems in India is required to really take advantage of their vast networks that have already penetrated unbanked areas. There are risks, but nothing that a forward thinking regulator who recognises the immense potential cannot creatively address. (See How to achieve safety in payments for an example.)

Finally, for large value electronic payments systems, RBI's vision should be to bring them up to world standards and integrated with global systems. Cross-border payments are an important facet of international trade and integration, and this can lead to settlement/ Herstatt risks. RBI should address operational and regulatory issues to minimise these risks. For example, RTGS should be brought as close as possible to a 24 by 7 settlement system to ensure overlaps with corresponding systems in other countries and time zones.

Additionally, in light of recent data that shows that the INR is the third most traded emerging market currency, these and other steps should be taken so that the INR becomes an eligible currency for settlement in the Continuous Linked Settlement (CLS) system, alongside the other international currencies already on CLS. In conclusion, it is commendable that RBI has released a payments vision document. Such a document gives an opportunity for us to understand the mind of a government agency, and discuss and debate its priorities and actions. But writing a vision statement is a chance to step away from the familiarity of set ways and ask the big questions. RBI should not squander this opportunity.

Uptake of systems like Amazon's `Mechanical Turk' in India

I have long been aware of Amazon's `Mechanical Turk', a mechanism through which tasks are farmed out to a large bank of humans. Each human worker has full flexibility on how many hours are worked and when. From the customer's point of view, Amazon supplies an API and access to a very large pool of humans who can perform small tasks. The median wage is $1.4 or Rs.80 per hour. In effect, Amazon has created a large market through which workers can find work, and firms can find workers to perform well defined tasks.

In a recent issue of The Economist, I was surprised to discover (a) that Amazon's Mechanical Turk has 0.5 million workers and (b) that roughly a third are from India. That's roughly 150,000 persons in India who are plugged into Amazon's Mechanical Turk. We don't know how many hours/week are spent in doing labour supply, but it's still a lot.

There are a few other such systems also. Here are links for exploration: oDesk, CrowdFlower, Elance, Amazon's Mechanical Turk.

These mechanisms add up to a whole new world for the functioning of the labour market. For first world customers who would like to connect up to cheap labour in India, our traditional view was that there had to be a man in the middle - a Datamatics or a TCS or an IBM. What these new systems seem to suggest is that for a certain class of tasks, it is possible to disintermediate the Datamatics or TCS or IBM.

For many individuals in India, the flexibility of working from home without rigidity about how many hours are supplied, and when, these systems could be a big win. At present, many households do not have computers and broadband connections, which is an important impediment. But this is also a constraint that is being rapidly eased through 3G, LTE, etc. These developments, put together, could become a whole new chapter in the story of India's connecting up to globalisation.

The new world of computers

I read a beautiful article, Why software is eating the world by Marc Andreessen. It made me reflect on how the world of computers and networks has evolved over the last 20 years. It is comfortable for us to think that the world has only evolved in incremental ways. But as I look around me, it seems that the hard-driving pace of change on many fronts has added up to fundamental change, to places far away from the comfort zone of people of my vintage.

All the way till the 1980s, business computing was dominated by databases. The basic story was one of capturing data, storing it, and summoning it forth with queries.

At first, databases were the exclusive preserve of mainframes and minicomputer. The PC revolution made it possible for small databases to be held on the desktop. It's interesting to note that at first, we got PCs without networks. We evolved from databases stored on remote mainframes or minicomputers to databases stored on PCs. All the way into the late 1980s, it was quite a cool thing to have a standalone PC holding a database where certain queries could be executed.

The first wave of change, of the early 1990s, was networks in the form of TCP/IP (the universal communication protocol) and the Internet (the universal network). Now, suddenly, the data centre became more interesting. Instead of storing and manipulating data at the desktop, we could do so many better things by storing and manipulating data at a big central computer. The desktop diminished from being the location of data and computation to being the location of the user interaction.

Then came a series of surprises which have added up to a qualitative shift.

1. The network got ubiquitous

First, the Internet went everywhere for the road warrior armed with the laptop computer. Crashing prices of laptop computers and then netbooks meant that essentially everyone had one. So workers started spending much more time outside the office (with 100% connectivity).

Software had to adapt itself to reach out on an Internet scale. This killed off applications which worked on the scale of the LAN. The software that the busy road warrier used was the software that worked effortlessly on his laptop.

Today, 1 Mb/s wireless networks are common and 50 to 100 Mb/s offerings are on the anvil. This is relentlessly shifting the balance of convenience to mobility.

In a place like India, the low-end staff might not have netbooks and/or Internet on the go. So for certain very low-end applications, it might make sense to hug the desktop at the workplace. For any modestly well paid person, laptops / netbooks coupled with 3g or CDMA networks are the norm, and hence being tethered to the office network is quite limiting.

2. The user interfaces got better

In the 1980s, software came with fat manuals. Users actually sat down in training classes. A remarkable feature of the new world is how the manuals and training are gone. Software is incredibly capable but there are no manuals. Google maps or Amazon or Apple Mail are very powerful programs, but the fundamental assumption is that a reasonable person can just start tinkering with them and learn more as he goes.

The modern office worker gets no formal training in software all his life. The modern knowledge worker learns major tools (e.g. a programming language) and often puts in enormous effort for these. But for the rest, the ordinary flow of day to day life, where new software systems come up all the time, is done without formal training.

Once the modern office worker faces high quality UI design from google and such like, where there is zero training and zero marketing, it became much harder to accept training. Standards have changed; in the olden days, people would actually try to learn. Today, knowledge workers are willing to get training in programming languages (e.g. R or Stata) but not in applications. The MBAs are generally training-proof.

3. All of us got busy

There was a time when one purposedly went about the work day systematically doing certain things with certain software tools. Knowledge workers have become deluged with information and with stimuli. We have gone from being an information scarce economy to being an attention scarce economy.

Software and information systems are now competing for the attention of the user. The scarce resource is now the mind share of the user. This is linked to the problem of user interfaces. If something has a complicated user interface, and there are a hundred other tasks that need to be done, the user ignores the complicated thing. Software systems that don't fly immediately just die.

4. Peers determine where attention is directed

In a world where the knowledge worker is bombarded with hundreds of things every day, what does he do? He tends to direct his scarce time into the things that come well recommended. The recommendations of respected peers are supremely important in determining what a person does.

High powered sales compaigns have lost power. The person just asks his friends what they do. The impulses through the day coming into each person - over email, IM, twitter, social networks, etc. - are the de facto controllers of the persons' time.

Peers are thus the gatekeepers to the user. The stuff that is striking and remarkable gets noticed and pointed to friends. What gets pointed tends to get a high google pagerank.

The importance of high pressure sales dropped. Some of the most successful firms got by with negligible sales departments. Their stuff was intuitive and good, and got immediately picked up.

5. Network effects leading to user generated content

The old model was one of corporations producing information and users consuming information. In that power structure, the user was only a source of revenue.

In the new world, the critical story is about kicking off network effects. The systems that win are those that get better because of one more user interaction.

At the simplest, user interactions kick off impulses to peers which brings in more customers (viral marketing). But very soon, user interactions generate relevant data. Google watches what users click and uses that to improve search. Amazon tells you that the people who liked this book also liked that book. Amazon has user-generated content in terms of reviews.

Good systems create a warm and supportive environment in which users contribute bug fixes, feature suggestions. These systems ride the power of user eyeballs and brains to get better. The power structure has changed. IBM DB2 used to be designed in a temple and then went out to the helpess masses. Google's world is critically linked to the users at so many levels (a receptive environment for bug reports, feature requests, user generated content, and usage data being turned back into strengthening the system).

The bottom line: Successful designers found ways to harness every single user and user interaction to build the quality, the content and the footprint of the system. Stalinist structures, which disempowered the user and treated him only as a source of revenue, stand isolated and stagnant.

6. Loss of power of enterprise IT

In the old world, enterprise IT mattered more. Grave decisions were made by enterprise IT managers and then thousands of users fell in line. In the new world, users forge ahead with their laptops and tablets and mobile phones, exercising enormous autonomous choice about how they spend their time. Consumer considerations, and the loyalty of each individual user, are far more important than they used to be. The enterprise IT department is much less of a gatekeeper. In the olden days, hardware and software was sold to enterprise IT, which made decisions for everyone inside the organisation. In the new world, usage is won one user at a time, and it is contestable every day.

7. CPUs became too cheap to meter

In the old world, computation was something scarce. The money that went into building data centres was carefully weighed. System designers carefully did things that were parsimonious in the use of CPU.

With the rise of parallel computation, bringing 1000 CPUs into a problem became cheap. Successful designers were those that found ways to deploy incredibly large amounts of computer power to do things that delight users. Google and amazon are spending millions of clock cycles in the back end, thinking about how to handle the next move, as the mouse cursor moves! When faced with a choice between doing something nice that users will like, versus doing something that saves compute power, the former always won.

8. Unexpected revenue sources

Who would have imagined that an ad agency would become the most powerful author of operating systems for mobile phones in the world? When hardware got dramatically cheap, and the Internet generated access to eyeballs on an unimaginable scale, new revenue models came about which were surprisingly different from the way we used to think earlier.

Watching markets work: Bad move, Nokia

I have long marvelled about how quickly the world of mobile phones has rapidly moved through four paradigms. My first mobile phone was a Nokia and they seemed to rule. But then Blackberry won because Nokia did not get the importance of email. And then Apple won because Blackberry did not look beyond email. And then Google Android seems to have won because Apple did not understand the problems of a closed system. At each stage, it looked like there was a dominant solution, but the pace of change was brutal and the king of the heap was rapidly unseated. What an amazing pace of creative destruction.

So when I heard that Nokia was now going to be quite wedded to operating system from Microsoft [press release], I thought to myself ``That can't be so bright''. Then I looked at the stock price and it said:

So the market seems to have knocked Nokia down by 18% for wanting to run with a loser like Microsoft. And what's more funny, the market seems to have knocked Microsoft down 4% for this contract too (which I don't understand - compared with being wasteland, it seems that it is good news for Microsoft to have the support of Nokia).