Technological Deflation and Structural Reform

I wrote a piece for Mint on how structural policy reforms have a similar effect to technology-driven deflation. The thesis for this article came from a tweetstorm:

This is the political challenge of structural reform. The disruptive transition caused by reform means not all incumbents make it into the “new world”, just like technological changes invalidate some of the incumbents with new entrants taking their place. Those affected adversely – whether they are business and asset owners who become uncompetitive, or workers who lose their jobs – will not take kindly to being sidelined.


India’s Economic Future

Harsh recently wrote an excellent piece on how India’s economy will grow from the current $2.5 trillion GDP to $12 trillion by 2030. His prediction rests on on two planks: increasing participation of women in the workforce, and technological change.

The Solow growth model – one of the few economics topics I actually remember something about from business school – takes three inputs, namely capital, labour and productivity growth, to project what the future output of an economy might be. Harsh has made a persuasive case from first principles, on how an increase in women’s participation in the workforce combined with the mobile internet revolution will propel India’s GDP to $12 trillion by 2030.

These media reports add a lot of colour to what can sound like a routine development – it is anything but that:

Rural Indian Girls Chase Big-City Dreams

Latest HRD survey shows girls going to college out number boys in seven states

Their Postcards For 2018: From 18 places, girls who turned 18 this year speak out

Harsh’s point on technology too is visible and obvious – Reliance Jio’s entry into telecom is making 4G mobile connectivity ubiquitous. Over the next 3-4 years, we should see 5G (with speeds on the order of hundreds of MB per second) rolled out across India. Consider what this will do for education, health care, media and entertainment. The possibilities are enormous.

Last year, I had co-authored two op-eds with investor Navroz Udwadia on how India can achieve sustained double-digit growth, by fixing the banking sector and building infrastructure for agriculture. The former addresses the capital piece of the Solow model, the latter helps increase productivity for agriculture through “technological” interventions. The introduction of GST too is a technological step change, the longer-term benefits of which monthly or quarterly economic data cannot capture.

There are real changes underway in how India allocates capital, in the composition of our labour force, and in technology. These will all mutually reinforce each other and the gains will compound. It can be difficult to see the bigger picture when we ourselves are inside the frame. I feel very positive about India’s economic future. It’s a great time to invest in India and to be an entrepreneur here.

Accelerating India’s Innovation Boom

Over the last three years, entrepreneurship has captured India’s imagination, and for good reasons. Never in our history has it been possible for first-generation entrepreneurs to start companies, raise seed capital and build a business in the way we have seen in recent times. The path available only to wealthy families and elite dynasties has been opened to every Indian today, thanks to the entrepreneurship boom.

Since taking office in May 2014, the Narendra Modi government has implemented a series of policy changes that have supported this unprecedented wave of entrepreneurship. The time taken for incorporation of companies has been brought down to a few days from several weeks. The Modi government has liberalised foreign direct investment across industries, and India is opening its doors to global capital even as the rest of the world becomes more protectionist.

In line with a commitment made in the 2015 Budget to gradually reduced the corporate tax rate, the government has cut the corporate tax rate to 25% for companies with revenues below Rs 50 crore, with the reduced rate now being considered for mid-size companies with revenues below Rs 500 crore. In a move to encourage startups to develop intellectual property-based businesses, the government implemented a concessional tax rate of 10% on income earned from licensing of patents, and India is now more aligned in this respect with global peers.

Small Industries Development Bank of India (SIDBI) has emerged as a significant domestic fund investor in India’s venture capital industry – with SIDBI’s support, several new early-stage funds have emerged to back Indian entrepreneurs, addressing a supply-side issue in the private capital market.

The public equity capital market, whose key function is to provide growth capital to businesses, has also seen substantive reforms. On the public markets side, the entry of Employees’ Provident Fund (EPF) is bringing depth and stability to the equity market while enabling organised sector workers to become beneficiaries of India’s long-term economic growth. The successful rollout of the Aadhaar program has reduced friction and identification costs associated with bank account and demat account opening by over 95% – it takes minutes rather than weeks now to open accounts with Aadhaar’s e-KYC facility. 

The stock market has played a critical role over the decades in supporting the growth of Indian business. When banks were not willing to provide capital to young companies in the 1970s and 1980s, intrepid entrepreneurs turned to the equity market. In the process, wealth creation was democratised and ordinary individuals were able to participate in the growth of companies like Reliance Industries and Infosys, which are today counted among India’s blue-chip corporates.

There are two ideas the government should consider to further streamline capital allocation in the economy and ensure that the wealth created by India’s entrepreneurs is shared widely across society. 

There is a big gap between the long-term capital gains (LTCG) tax rate on unlisted private equity investment and the LTCG rate for listed public equity investment. For unlisted equities, the holding period for LTCG is more than 2 years and the applicable rate is over 20%. For listed equities, the holding period is 1 year and the gains are tax free. This wide discrepancy in treatment makes early-stage startup investment far less compelling when compared to investment in the stock market, even though the positive spillover effects for job creation and innovation are substantial in startup investment. 

This issue already seems to be on the Prime Minister’s radar – in a speech to the capital markets community in Mumbai earlier this year, Prime Minister Modi had said that stock market participants should make a “fair contribution to nation-building through taxes”. It is also worth looking at the taxation of dividends. The current regime of dividend distribution tax (DDT) is an indirect tax on all shareholders, even though it comes out of the company’s pocket. Shareholders, who are collectively the owners of a company, already pay corporate income tax on profits at the company level. DDT is effectively a double tax inimical to the interest of minority, non-controlling shareholders, who is typically a small retail investor. Introducing LTCG for listed equities, eliminating all taxation of dividends and bringing balance between taxation of unlisted private equity and listed public equity investment would go a long way towards improving capital allocation.

Finally, capital markets regulations on new listings and initial public offerings need to be relaxed and adapted to accommodate new-age technology and knowledge-based startups that aren’t able to comply with criteria that would apply more to industrial businesses. For example, companies wanting to list on Indian exchanges are required to have a minimum average pre-tax operating profit of Rs 15 crore in at least 3 years out of the last 5 years. In older times, when investor awareness and knowledge was low, a rule of this type served to protect inexperienced small investors. 

The landscape today stands transformed, where over a crore Indians are participating in the stock market through systematic investment plans, parking in excess of Rs 4000 crore every month into listed stocks. This is number that has doubled in the last few years. Crores of Indians are becoming indirect equity owners by virtue of being EPF beneficiaries. New media platforms and digital connectivity are helping educate the masses on the challenges and opportunities of stock market investing.

The effect of having the profit requirement for listing in India is high-tech businesses which have achieved significant progress and built an asset base but are still loss-making are forced to look abroad for raising capital through an initial public offering. Relaxing this requirement will help keep Indian companies in India, and will give an opportunity to India’s burgeoning retail investor base to build wealth by investing in tomorrow’s corporate champions.

The government’s war against black money has severely undermined the attraction of gold and land as investment alternatives. The taxation and regulatory policy ideas highlighted above would further help shift savings into productive, cash flow generating assets that spur the economy forward. India is well on its way to becoming an innovation-driven economy, and these policy reforms would accelerate our country on that path.

(Originally Published: Reflections, Prime Minister Narendra Modi’s website)

Rebalancing of Indian Equity Markets Will Smooth Volatility

Momentous changes in India’s equity market microstructure will improve market efficiency and smooth volatility over time.

Emerging markets are frequently stereotyped as being prone to wild swings and outsized volatility. In particular, India has historically been a market where foreign institutional investment has driven the direction of the market – bearishness by foreign investors has almost always pushed markets downwards, while optimism abroad about India’s prospects equally rockets equities to the stratosphere.

While sharp movements in either direction should not affect practiced value investors, the disproportionate impact of bipolar behaviour by international funds has both wreaked havoc in the Indian stock market, as well as created tremendous buying opportunities for the long-term value investor. For example, in 2014, when foreign investors pumped in over $40 billion into the Indian market after voters handed a single party with a majority in the general election for the first time in 30 years, the benchmark Nifty index rose over 30%.

Now, changes are afoot that will make India’s equity market more even-keeled over time. Employee Provident Fund Organisation (EPFO), an Indian government body, administers a pension fund drawing contributions from India’s formal sector labour force and controls about Rs 8 trillion (US$110 billion) in capital, In 2015, Prime Minister Narendra Modi’s Indian government decided that for the first time in India’s history, the corpus would be deployed in the equity market.

For its entire existence, EPFO had been investing heavily in debt securities. This was a system of indirect financial repression – the government would take workers’ pension and invest it primarily into government bonds. In line with how pension funds are managed globally, the Modi government decided that 5-15% of EPFO’s incremental corpus would annually be invested in exchange-traded funds tied to the major Indian market indices and a basket of government-owned enterprises. This is well below other large economies like Switzerland, where nearly 30% of pension money finds its way into the equity market, the United States (44%), and Australia (51%). EPFO’s equity allocation would translate to Rs 80-120 billion (US$ 1.2-1.5 billion) per year, and it invests in select ETFs that track India’s two benchmark indices, the Nifty and the Sensex.

EPFO draws over $12 billion a year in incremental funds from India’s salaried workers. Given that foreign investors pumped in $40 billion in 2014 and $9.5 billion in 2015, the share of the EPFO corpus invested in equities is relatively small today. Nevertheless, the entry of a significant domestic institutional investor into India’s equity market is a watershed moment. In its first year as an equity investor, the six decade-old EPFO parked 5% of the incremental corpus into ETFs. Late in 2016, it decided to increase the allocation from 5% to 10%, widening its mandate beyond large capitalization stocks to include mid-sized companies.

The Indian government is making a strong push to formalize the economy, and a burgeoning youth population means that EPFO’s incremental corpus from which a chunk is invested in equities should rise over time. The government also wants to increase the percentage allocated to equities over time, and the presence of a long-term domestic permanent capital will bring much needed balance and stability to the Indian market.

This is possibly the biggest structural change the Indian market has seen in the last 25 years, comparable to when the Indian market was opened up to foreign investors. Bringing this corpus into equities wasn’t an easy reform – powerful labour unions have resisted EPFO’s entry into equity investing for decades, but this time the Indian government prevailed.

Given this momentous change, investors would do well to move away from old notions and biases about the foreign investor-induced hyper-schizophrenia of India’s Mr Market. In practical terms, entry timing should matter less and volatility will be mitigated. The Indian market now has a new ballast. The permanent capital provided to equities by India’s largest pension fund means that foreign developments can’t whiplash Indian markets like they have in the past.

(Originally Published: Latticework)

Liberate Higher Education To Compete In The Knowledge Economy

In which industry does the US enjoy a globally dominant, almost unassailable position? No, it is not technology, pharmaceuticals, defence or aerospace. The one sector in which US dominance is near-absolute is higher education.

Every year, some 80% of the top 20 best ranked universities globally are US universities. No country comes even close when it comes to attracting the best students, retaining the best researchers and producing output that pushes the boundaries of knowledge in practically every field of human inquiry. America’s commanding strength in higher education powers its whole economy and endows the country with a formidable strategic edge over rivals and competitors.

Indian Institute of Management Ahmedabad’s Shailendra Raj Mehta published a comprehensive 47-page paper in 2012, studying what made US institutions so markedly better than others in the world.

Mehta cites Harvard’s Henry Rosovsky, who writes that “national wealth, large population, government support especially of science have to be significant explanatory factors” along with the migration of talent from Europe to the US because of World War II, and the “American habit of private philanthropy”.

Rosovsky also points to certain specific features in the governance structure, such as the fact that all senior and middle management for an institution “are appointed, not elected, and they can be dismissed”, and the “unitary governance” approach, with the university president being answerable only to the board of trustees and holding full executive responsibility.

Freedom and autonomy matter deeply to knowledge creation — academic research and scientific inquiry cannot co-exist with dogmatism, top-down control and doctrinaire thinking. Finally, inter-institution competition for talent and resources spurs universities to do better. Mehta cites the following standards, achieving which universities can be said to be autonomous and competitive:

1. do not need to seek government approval of their budget,

2. select their baccalaureate students in a manner independent of the government,

3. pay faculty flexibly rather than based on a centralized seniority / rank-based scale,

4. control their hiring internally,

5. have low endogamy,

6. own their own buildings,

7. set their own curriculum,

8. have a relatively low percentage of their budget form core government funds, and

9. have a relatively high percentage of their budget from competitive research grants.

It is easy to see how India’s higher education system would rate abysmally on almost every single count. Mehta says that though many countries have tried copying the US system, they haven’t succeeded. He also writes that all the success-inducing factors identified by Rosovsky weren’t available in the mid-19th century, when many of today’s great US universities were founded.

Mehta then identifies the “key innovation” that the US brought to higher education, which propelled its universities to the top ranks globally as “alumni control of the board of trustees” — not surprisingly pioneered by Harvard University, whose board was de facto controlled by alumni starting in 1710, with de jure control cemented in 1865. Harvard had been founded by the state of Massachusetts, and the Massachusetts legislature retained the right to appoint the board of trustees till 1865 (though it usually appointed only Harvard alumni) — thus, as Mehta writes, Harvard remained a public university or a “State School” for over 200 years after its founding.

Securing de jure alumni control over the board of trustees was anything but easy — in a nail-biting win, as Mehta records, the “Act in Relation to the Board of Overseers of Harvard College” was passed on April 29 1865 by a margin of just one vote in the Massachusetts State Senate, and two in the House. The legislation expressly barred government officials from becoming trustees of the institution and insulated the trustees from faculty influence by preventing faculty from voting in trustee elections. Harvard was already America’s preeminent university in 1865, and accelerated its rise after this critical — and hard-fought — change in its governance structure. Seeing its effectiveness, other US universities promptly emulated the Harvard model, and the rest, as they say, is history.

Why is this story relevant for India today? A new government has taken charge in New Delhi, on the back of an unprecedented mandate. There is a surge in technology entrepreneurship across India — there are huge expectations India’s youth have for their country to emerge as a leader in education, research and innovation. The policies the Narendra Modi government implements will have far-reaching consequences for India’s global competitiveness in these areas.

India’s capacity for scientific research is linked inextricably to the quality of our higher education institutions. If America dominates the world in higher education, India would today win top honours for being a powerhouse exporter of outstanding human capital. Venture research firm PitchBook ranked universities based on the number of alumni who started US companies that were able to raise a first round of venture capital funding between 2010 to the end of the third quarter of 2013 — the Indian Institutes of Technology ranked number 10, the only non-US institution in the top 10, alongside Stanford University, Massachusetts Institute of Technology and three Ivy League institutions. The Pravasi Bharatiya Divas, an annual festival-conference organized by the Government of India, celebrates the export of such human capital.

Much of our human capital ends up in US institutions, sometimes never to return. A study by Brookings Institution shows that 71.5% of Indians studying in US universities in 2010 were enrolled in science, technology, engineering and mathematics (STEM) programmes. Indians constitute 65% of all international students pursuing masters degrees in STEM programmes.

But this is largely a self-inflicted problem. We have US-level economic aspirations with a North Korea-style higher education system. There is just one Indian university ranked in the top 500 in the world. Without world-class universities that are free to grow and compete with one another, tomorrow’s innovators and entrepreneurs who would strengthen India’s knowledge economy are often left with no choice but to move abroad.

The alumni of our institutions who have proven themselves running governments and global corporations are surely capable enough of helping govern their alma maters too. Urgent, decisive measures are needed to change the way universities and research institutions are regulated – thick, heavy cobwebs that are strangulating our institutions need to be cleared, such that both quantity and quality can be expanded to fulfill a wellspring of aspirations.

It would be a travesty if the new government repeats the errors of previous governments. Universities and institutions should not be treated as tools of political patronage. Knowledge creation cannot be substituted with indoctrination. It is puerile and self-defeating to replace one kind of dogma with another kind of dogma.

The choice is our’s to make – do we want to be known for exporting brilliant minds, or do we want to create opportunities for these minds here in India, so that they can drive growth, create jobs and help India compete in the global knowledge economy?

(Co-authored with Dr Shiladitya Sengupta.)

Originally Published: Mint

Four Ways To Liberate Indian Science

The economic liberalisation of 1991 was the second independence in Indian history. It represented a tectonic shift in policies, the start of the end of ‘licence raj’, and unshackled the growth of the country. Time has come for the third independence of India, the liberalisation of the academic, science and technology ecosystem in the country.

Historically, the growth of countries has been driven by continual advances in science and technology. According to Robert Solow, Nobel Prize winner in economics, capital and labour are not the only things that drive economic growth, half the economic growth in the US since World War II can be traced to advances in science and technology. Even China has realised this. At the current rates, China’s commitment to R&D is expected to surpass that of the US by 2022, when both countries are likely to reach about $600 billion in R&D. Unfortunately, successive governments in India have only provided lip service to the science and technology sector. Moreover, simply allocating money for science and technology is not in itself sufficient to drive economic growth. The new Government has the opportunity and the mandate to liberalise the Indian science and technology ecosystem, which is the transformative step required to take the Indian economy to the next level.

Academic and research institutions form the bedrock of the science and technology ecosystem, and are the fulcrum for creation of value. According to a 2011 report, sponsored by the venture capital firm Sequoia Capital, 39,900 active companies can trace their roots to Stanford University, creating an estimated 5.4 million jobs. If these companies collectively formed an independent nation, its estimated economy would be the world’s 10th largest. The reason that we do not have such institutions in our country is because our academic and research institutions are still stuck in the pre-1991 era. The new Government has the opportunity and the mandate to liberalise and transform this ecosystem so that our academic institutions move beyond producing skilled manpower to producing innovators and job creators for the nation.

Give autonomy to institutions

This will allow them to attract the best talents as researchers and faculty. This is critical as generation of new ideas require exceptional talent. New ideas can spawn industries that will generate employments for millions, creating a cascading effect on Indian economy. If institutions are given flexible grants rather than budgets under fixed heads, and allowed to compete for talent from all over the globe, we will see a resurgence of the sector.

Nobel physics laureate C.V Raman also founded the Travancore Chemical Company in 1943
Nobel physics laureate C.V Raman also founded the Travancore Chemical Company in 1943

Capitalise assets and resources

Most academic science and technology institutions and universities are endowed with significant land. These institutions should be encouraged and given the flexibility to build Innovation Clusters on unused land in partnership with the industry; academic institutions will own new infrastructure from where they get rent that can go towards building a corpus, while the industry gets access to knowledge capital. Such clusters will create jobs for graduating students and prevent brain drain, generate research partnerships and funding for faculty, and foster an ecosystem that supports innovation and entrepreneurship. Silicon Valley for example was seeded by Stanford University, while Massachusetts Institute of Technology owns the buildings in Tech Square at Cambridge, which house hundreds of companies.

It is obvious that such bold steps will create a lot of anxiety in the current ecosystem, where ‘profit’ has been seen as a dirty word. Similar anxieties were expressed when the Indian economy was liberalised. However, few people realise that our finest scientists did not restrict their work to the laboratory alone-C.V. Raman, who won the Nobel Prize in Physics, started the Travancore Chemical Company in 1943. This model, where faculty commercialise research, was a pioneering move, far ahead of its time.

Make policy friendly to R&D investment

Start-ups form the backbone of translating scientific ideas and technological advances from academia into products that drive economic growth, and the process requires significant capital. However, the toughest stage in the life of a start-up is the first few rounds of investment that leads to a product. Early investments in this sector have been dismal. Between 2007-2012, India saw 11 private equity deals totalling $43 million, and eight VC deals worth a combined $55 million in the life sciences/biotech sector. In comparison, the city of Boston saw an early stage investment of $869 million in 2012 alone. The new Government can put science and technology R&D sector on steroids by granting special tax exemption status to investments in science and technology start-up and innovation clusters for the initial 7-10 years of their operation.

Jagadish Chandra Bose was the first Indian to get a US patent

Jagadish Chandra Bose was the first Indian to get a US patent

Respect ownership of intellectual property

Without this we cannot create a true knowledge economy, as we will never attract investments. Not many people know that the first Indian to get a US patent was Jagadish Chandra Bose, one of India’s finest scientists, for an invention that improved detection of electrical disturbances. Interestingly, Swami Vivekananda not only saw the importance of protecting intellectual property, but also influenced Tata group founder Jamsetji Tata to found the Indian Institute of Science in Bangalore. Time has come to emulate the visions of Vivekananda, and to liberalise our science and technology institutions such that they can truly reclaim their glory and transform the Indian economy.

(Co-authored with Dr Shiladitya Sengupta.)

Originally Published: India Today

Economic Development As Foreign Policy

In this piece, Harsh and I write about the importance of economic strength in the foreign policy arena:

Military strength, despite its great importance, offers diminishing marginal returns. Possibilities of asymmetric power projections preclude any simplistic linear comparison of military resources. This is especially true for those who have crossed the nuclear rubicon – notice how India and China have astutely said “No, thank you” to matching America or Russia when it comes to the size of their nuclear arsenals. When a weapon is so massively destructive, there is no real difference between having a hundred or having ten thousand. Moreover, economic strength and military prowess are inter-linked – the proceeds of economic growth when invested in creating military technology can generate a mutually reinforcing cycle of innovation, productivity gains and military strength.

More here.

Derivatives For Farmer Welfare

Harsh and I have co-authored a piece on using financial derivatives for replacing the minimum support price (MSP) system for farmer welfare:

With reduced risk thanks to commodity options, there will also be less of a need to keep crop inventories as buffer stocks. Farmers will be able to increase their incomes rather than forcefully smoothing production for consumption. Moreover, by not coercing farmers to sub-optimally diversify into different crops and different plots, agricultural productivity would increase and more land could be reforested, providing significant cumulative environmental benefits.

More here.

America’s Presidential Election

Harsh and I have co-authored a piece on America’s presidential election:

Early next month, Americans will decide whether to re-elect Democrat Barack Obama as President or vote in Republican Mitt Romney instead. Reports of America’s decline have been greatly exaggerated—it remains the world’s most powerful nation, although it does run the risk of being eclipsed by China in a couple of decades. With the global economy still struggling and tensions in the Middle East still high, a presidential election in the US is bound to have far-reaching consequences beyond American shores. A Romney victory will be better for economic growth in America and will weaken the renewed global allure of interventionist or authoritarian state capitalism that is more likely to end up in crony, rather than competitive, markets.

More here.

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