Defence land: A key dimension of India's privatisation problem

As Vijay Kelkar has long emphasised, India's privatisation question should be viewed as a question about the portfolio of the State. For each Rs.10,000 crore of shares of Air India that the government owns, it is forgoing 2,000 kilometres of highways. The State needs to ask itself whether it is better to own 2,000 kilometres of highways as opposed to owning the same shares of Air India. On this subject, also see Section 4.3 of this paper.

The second key dimension that should shape the discussion on privatisation is that of improving GDP growth. When assets are moved from public control to private control, the translation of capital stock and labour into GDP growth generally becomes more effective. Through this, India would reap GDP growth by better utilisation of existing resources.

Both these issues have, so far, been largely seen questions about the control of public sector undertakings (PSUs). But both issues are broader: they are about asset ownership by the government more broadly. Given India's socialist background, government has frequently and wantonly grabbed assets, far beyond those required for the production of public goods. Hence, the problem of selling off assets is much bigger than just PSUs.

As an example, this article says:

The defence ministry is the largest state landowner, holding 80 percent of the 7,000 square kilometres of government land, much of it now prime real estate, according to the CAG report released Friday.

Here is the CAG report referenced there.

There are two interesting dimensions to the problems of defence land. First, while the Ministry of Defence undoubtedly needs large tracts of land on which it can run exercises, training, experiments, etc., it certainly does not require prime land in cities.

The heart and soul of a city is the dense interactions between top decile people. What makes a great city is greater interactions within a greater density of higher talent people. By definition, military installations are aloof from the general population; they do not interact with the main citizenry. Hence, large military installations are like black holes in a city: they increase distances for everyone else, and they stand aloof. The presence of big defence lands in cities is not just about wasting fiscal resources (you'd be better off selling that land and retiring public debt) but primarily about increasing the quality of the cities.

There is a case for placing defence research labs in other innovation hubs of India - e.g. Bangalore, Poona or Bombay. This is justified because they would serve to increase the density of scientists thus enhancing the quality of these cities, and because these defence labs would benefit from interactions with civilian scientists. Barring research labs, there is no case for placing defence facilities in cities.

There may be a role for one big HQ in New Delhi, but I don't see why dozens or other defence installations are required to be in Delhi. The governments stands to raise trillions of rupees by selling this land and shifting these organisations to locations in the boondocks, where land is roughly free. And there is a further kicker: When defence holdings in places like New Delhi or Poona are moved off into private ownership, India's GDP will go up. So this is a win-win at two levels: First, India's fiscal problem is eased by selling defence land and writing down debt, and India's GDP is increased because the land gets put to productive use.

Similarly, I don't see why anything connected with the Indian Navy needs to be in Bombay. It's perfectly feasible to create naval bases at boondocks locations on the coast and thus free up the space used in high marginal product land.

The second interesting dimension is that of the Ministry of Defence as a creator of new cities. If you start off with land in the boondocks, on day one, nobody wants to go there. The Ministry of Defence has the ability to solve the coordination problem. It can engineer the synchronised movement of a large number of distinct pieces that are required to create a new cantonment town. Once this has been put into motion, within 20 years or so after starting up, it would be wise for the government to sell this off and start over. For MoD, there is little difference between being in a mature cantonment town versus a brand-new one. But for the exchequer, enormous value is created through this process. And for India, this works well because new cities can be steadily created in this fashion.

Interesting readings

Sadly, India abstained.

In India, we're quite gloomy about the place that has been given to organised labour. But these questions are not closed elsewhere in the world. See Robert Barro on the appropriate place of trade unions, and Matt Bai in the New York Times magazine on a politician taking on public sector trade unions.

Manoj Mitta has written, in the Times of India, about the new world of a Supreme Court headed by S. H. Kapadia.

Censorship.

Maybe the time will soon come to close down this blog.

An editorial on the questions that face U. K. Sinha as the new SEBI chief. And, Anirudh Laskar has an article in Mint about concerns about SEBI suffering a big upheaval.

Deepak Shenoy in Pragati on Paypal's problems in India.

A new opening act by Ila Patnaik, in the Indian Express on 2 March 2011, on the announcements in the budget speech on capital controls.

S. S. Tarapore in the Hindu Business Line, on the FSLRC.

Joel Rebello in Mint on the internationalisation of India's investment bankers.

Ashish Dhawan on his leaving the firm and what he will do next.

Good reporting in Mint by Sumeet Chatterjee about the potential for distress at Reliance Communications.

Ashish Khetan has a great story in Tehelka about the 2G scandal.

India is chipping away on removing visa restrictions.

Remya Nair and Surabhi Agarwal in Mint on post offices selling insurance products. Also see.

Why does China have a SOB-dominated financial system while India has a market-dominated financial system? Writing on Project Syndicate, Mark Roe has a clue.

A great lecture by Stan Fischer at the RBI.

Why I write, by George Orwell.

Felicity Barringer looks back at Chernobyl.

The revolutions of the Arab world are endlessly fascinating. Read Volcano of Rage by Max Rodenbeck and The revolution is not yet over by Yasmine El Rashidi on the New York Review of Books blog. On Libya: Omar Ashour on Project Syndicate.

Yuriko Koike on Project Syndicate, on the evolution of production chains in Asia. The end of China's cheap denim dream by Malcolm Moore in the Telegraph. Michael Pettis on the prospect of shorting a country that has $3 trillion in reserves.

Dubai on empty by A. A. Gill in Vanity Fair.

Football betting is a good place to measure the extent of wisdom of the crowd. In a paper titled Information and Efficiency: Goal Arrival in Soccer Betting, Karen Croxson and J. James Reade argue: In an efficient market, news is incorporated into prices rapidly and completely. Attempts to test for this in financial markets have been undermined by the possibility of information leakage unobserved by the econometrician.... sports betting markets offer a superior way forward: assets have terminal values and news can break remarkably cleanly, as when a goal is scored in soccer. We exploit this context to test for efficiency, applying a novel identication strategy to high-frequency data. On our evidence, prices update swiftly and fully.

When and where do great feats of architecture come about?

by Ajay Shah.

 

Why do some places achieve great feats of architecture, while others routinely opt for merely functional structures? The economist in me is instinctively unsatisfied at a claim that America lacks great architecture because they have poor taste. Taste-based explanations are a cop-out. Instead, how about the following five angles:

Surplus

To go beyond merely functional structures requires resources to spare. At low levels of income, people are likely to merely try to get some land and brick and stone together. In these things, we have nonlinear Engel curves. Pratapgarh looks picayune because Shivaji lacked surplus.

The desire to make a statement and to impress

Ozymandius wanted to make a point: He wanted ye Mighty to look at his works and despair. I have often felt this was one of the motivations for the structures on Raisina Hill or the Taj Mahal.

Arms races

There may also be an element of an arms race in these things. Perhaps the chaps who built the Qutub Minar (1193-1368) in Delhi set off an arms race, where each new potentate who came along was keen to outdo the achievement of the predecessor. I used to think that the Taj Mahal (1632-1648) was so perfect, that it could not be matched, and thus it put an end to this arms race. But then I saw the Badshahi Mosque in Lahore (1671-1673), and I had to revise my opinion. We are used to thinking of Aurangzeb as a bit of an ayatollah, but in the Badshahi Mosque, there is genuine beauty, and more than a hint of rivalry with the Taj Mahal. And that same arms race may have mattered all the way into the 20th century: perhaps if Delhi/Agra/Lahore had not been strewn with majestic structures, the British would have approached Raisina Hill (1912-1931) differently. In similar fashion, perhaps the great cathedral building of the European continent had an element of an arms race, where each team was keen to outdo all that had come before. As in biology, it is hard to predict where an arms race will erupt, but one can argue that if and when some quantum fluctuations set off an arms race, then it can lead to great flourishes of architecture.

Transparency

You only need to impress someone when there is asymmetric information, where that someone does not know how great you are. Shah Jahan needed to build big because the targets of his attention did not know the GDP of his dominion and his tax/GDP ratio. In this age of Forbes league tables, Mukesh Ambani does not need to build a fabulous structure for you to know he's the richest guy in India. A merely functional house suffices; a great feat of architecture is not undertaken.

Accountability

The incremental expense of going from a merely functional structure to a great feat of architecture is generally hard to justify. Hence, one might expect to see more interesting architecture from autocratic places+periods, where decision makers wield discretionary power with weak checks and balances. As an example, I think that Britain had the greatest empire, but the architecture of the European continent is superior: this may have to do with the early flowering of democracy in the UK.

From this point of view, let's think about architecture in India and China and the outlook for this in the coming decade. China is undertaking great feats of architecture today. What explains this, and how might things shape up?

Surplus.

China's GDP has grown fabulously and has generated this surplus. Perhaps India's new buildings will match up to China's within 10-15 years, when India's GDP matches the present Chinese GDP. But the other four elements of the reasoning go against such a prognosis.

The desire to make a statement and to impress.

The lack of legitimacy of the Chinese State implies that there is a greater desire to impress.

Arms races.

Has there been a competitive element in China's construction, where each person running a project is out to prove he's better than those that came before? And in India, perhaps one or more powerful people could set off an arms race. Gujarat's GIFT project could represent a first salvo of that.

Transparency.

The greater transparency in India reduces the urge for architecture.

Accountability.

The greater accountability in India reduces the outlook for great feats.

Trading on Japan

If you are in India, and hear news about the earthquake, tsunami and nuclear reactors in Japan, you might want to trade on this. Either because you are hedging Japan exposure that's embedded in your Indian equity holdings, or because you think you are an informed speculator who has a better and faster judgment about what these events mean for Japan.

Sadly, the Indian capital controls don't let you trade on the Nikkei 225, which is the Nifty of Japan. But there is something you can do: Trade on the JPY/INR futures trading on NSE.

Quite a few people seem to have thought like this. Here's a graph of the turnover:

Now let's pause to think about the story playing out on this market. On one hand, it's the purely domestic speculators or hedgers, who are buying and selling from each other. This is fine, but where are the linkages to the global financial system?

The most important arbitrage which should be at work is in the currency triplet INR/USD, USD/JPY and JPY/INR. But unfortunately, currency futures trading in India does not include the USD/JPY contract, so one crucial leg of the arbitrage is not readily available. With turnover like $100 million in a day, I'm sure some people are doing such arbitrage in some painful ways.

Rule of law: A pair of stories

by Shubho Roy.

One essential feature of the rule of law is transparency. When a government says something, it must say why it said so. This is important from three points of view:

1. A government that does not need to explain itself is one that has arbitrary power. When a policeman can tell you that you're prohibited from driving because he does not like your face, it is rule of men and not rule of law.
2. The fundamental idea of common law is that the laws enshrine principles that are unvarying for decades or centuries. But institutional and technological details of the economy change rapidly. Well reasoned orders tell the households and firms of the economy how timeless principles are to be interpreted in the present milieu.
3. The aggrieved party can appeal against the order, on the grounds that there are factual errors or errors of reasoning in the order.

A success story: A recent SEBI order

I picked up a recent SEBI order banning a brokerage services agency from operating for two weeks. The punishment is not all that bad: the firm is out of business for two weeks. Yet, before inflicting such a penalty, SEBI had to do the following hard work in the order:

1. Point out when the investigation was ordered.
2. Clearly state which rules were violated. A vague reference to a governing Act does not suffice.
3. Informs the reader about when the affected company was asked to respond. It also mentions that the copy of the investigation report was given to the company.
4. The order then mentions the advocates who appeared for the accused.
5. The findings of the enquiry officer are summarised.
6. The observations of the enquiry officer are recorded.
7. The arguments that the broker made in defense of its actions are presented.
8. The exact transactions which were found to be illegal are described.
9. The reasoning of the officer making the order is clearly laid out.
10. The amount of penalty (suspension of certificate to trade for two weeks) is clearly mentioned.

This is a nice example of legal process in operation. It is a reasoned legal order. Anyone can read and understand it. The order adds to the body of law of securities in the country. It gives an example of the transactions which are considered illegal by SEBI: everyone can learn from the order and not make the same mistake. An appellate court can read the order and decide whether the action of SEBI was fair or not. More generally, SEBI is accountable to the public at large and Parliament in particular, to behave in such controlled fashion.

The right to operate is a very valuable thing. Interfering with the life and liberty of an individual or firm must not be taken lightly. By providing a detailed order, SEBI clearly shows why this right was withdrawn from a person.

A failure story: A recent RBI order

A recent update from the Reserve Bank is a study in contrast. The order prohibits a company from providing money transfer services to India. The text just states that the company is barred from operating in India under the Payments and Settlement Systems Act, 2007. It seems that the company had applied for a licence for operating in India and that application has been rejected.

The order is not reasoned. It does not inform the reader as to why the company was banned. Did the company not comply with rules? If so, which rules did it not comply with? Were there any other reasons, such as inadequate capital, or lax oversight, or failure to enforce KYC rules, which led to RBI denying them the permission? Was there any other required disclosure that the company did not make? Was any hearing given to the affected party? The order/press release also does not state the procedure that RBI used to come to its conclusion.

This is not how common law should function. The order does not add to the body of law in the country. Prospective businesses do not learn what led to the rejection of the application and may continue to make the same mistake when they apply.

Conclusion

The agenda for legal reform in India consists of (a) writing laws rooted in the common law framework, (b) of building agencies such as SEBI which are fully imbued in this ethos, and then (c) of building top quality courts like SAT which exert checks and balances upon regulatory agencies.

Related reading

1. Rule of law and foreign venture capital
   
2. C B Bhave's 3 years at SEBI
   
3. Corporations and OTC derivatives
   
4. Chapter 4 of the Report of the Working Group on Foreign Investment discusses the importance of rule of law in financial regulation in detail.

Buying respectability

The Economist has an article titled Glitzkrieg, where the blurb reads: "Respectability is for sale. Here is a buyer's guide."

As I read it, I thought: A lot of these tricks are used within India by some businessmen rocketing up to respectability! But there are a few unique dimensions of this racket in India. E.g. big hoardings on the street in Bombay; Gaddafi doesn't do that in London.

But it's interesting to think of three shades of gray:

1. Goods with objective attributes: An ogre can make a commodity like steel, and the customer does not care. The quality of the steel is objectively visible in the steel.
2. Goods where reputation helps: A second tier of products & services are those where there are some intangible attributes.
3. Goods where reputation is essential: In finance, regulators require producers of certain products & services to be fit and proper. Here, it's a matter of life and death. A wannabe has to buy the reputation, to be considered fit and proper, else he will be thrown out of that business. It is similar with ponzi schemes: The emergence and survival of ponzi schemes requires constructing a reputation. There is also an intersection: of ponzi schemes which require fit and proper approvals.

So an ogre who makes steel can choose to spend money on buying a private jet or he can choose to spend money on buying a reputation: that's just a matter of taste. But as you go into the 2nd and 3rd categories, the purchase of reputation increasingly becomes a cost of business.

On these issues, you might like to see: Section 8.1, The intrinsic value of regulation for IFS production, in the Percy Mistry report; and Ethics and entry barriers.

8th conference of NIPFP-DEA Research Program

The Program is up on the website. The full set of papers and slideshows will trickle in within a day or three.