Month: December 2003

We are Made of Stuff

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… We are such stuff
As dreams are made on; and our little life
Is rounded with a sleep.

    Shakespeare’s The Tempest

Writing in the Dec 28th, 2003 edition of The Week, President Kalam says, “In the 21st century, knowledge is the primary production resource instead of capital or labour.”

I have been unable to fully comprehend that insight, fundamentally because it does not make any sense. Sounds profound but makes no sense. What is a ‘primary production resource‘? Did Kalam imply that once upon a time capital and labor were primary production resources but knowledge wasn’t? What changed so that labor and capital got displaced and now knowledge holds that position?
Continue reading →

Panchayat Raj

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The anniversary special of the newsmagazine The Week of Dec 28th, 2003 has lots of stories of the warm and fuzzy feeling variety. I went through the breathless prose of a large number of luminaries in it, including that of President Kalam’s. What especially caught my eye was an article in the section BestofTheWeek2003 section from their Jan 26th issue — the Republic Day issue — titled simply SOLD.

The story was about panchayats in rural India, specifically about women being ‘fined, humiliated, and sold to the highest bidder.’ It is chilling reading and here are some lines from that article.

… Devaki Bai, 30, had been sold to another man for Rs 5,000 … Women were auctioned during Panchganga, a panchayat held to hear matters of dispute … Women were asked to lower their saris and stand with stones on their heads. Continue reading →

Dutch Disease Disturbing the Universe

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Do I dare
Disturb the universe?

The Law of Unintended Consequences is pretty well known, I suppose. It is part of a more general law which I call the Zeroth Law of Ecology which says that you can never really do only one thing. That is, you want to do only A and instead you find that you have also done B and C, both of which you had no inclination to do. This is because the universe is complex and all its parts are interlinked and so when you do something to one bit of the universe, you end up disturbing the whole universe.

There must be many reasons why we cannot see all the connections. There may be ignorance, willful or otherwise, for instance. Or it could be that we are not omniscient. But, I believe, it is mostly due to what is called our bounded rationality, that is we are not clever enough to think through all the complexities of the universe.

I find paradoxical stuff fascinating. A paradox is puzzling only as long as you have not figured out the full story. Counter-intuitive stuff also give me thrills. Take, for instance, the observation that many people who win lotteries end up being not lucky after all. A good many of these lucky winners end up broke and sometimes worse off than they were before they got the windfall. It is like a winner’s curse with vengeance.

These unlucky lottery winners seem to be having a sort of their own personal DUTCH DISEASE. What is the Dutch disease and how can I avoid catching it? you ask. I will tell you. Here is what I found on the web (I have lost the link, unfortunately):

In 1959 a large reservoir of natural gas was discovered in the Netherlands, which by 1976 earned that country revenues of some $2 billion in addition to an estimated $3.5 billion of savings in imports. By the mid 1970s, gross corporate investment had fallen by 15% since the start of the decade, while employment in manufacturing had declined by 16%. The total level of unemployment had risen from a modest 1.1% to 5.1%, while the share of profits in national income which had averaged 16.8% in the 1960s had fallen to 3.5% in the first half of the 1970s. While the first oil crisis had a devastating effect on most of the western industrial base, why did The Netherlands, with its new-found fortune in natural gas, fare worse than most?

This process of de-industrialisation of the existing manufacturing base was attributed to the upward pressure that the energy discovery placed on the Guilder and the wage rate, and was dubbed the Dutch Disease. Since then, the term’s use has widened considerably to encompass any situation whereby a country’s apparent good economic fortune ultimately proves to have a net detrimental effect.

So where am I going with all this, you ask. Is there a Dutch disease lurking in India’s future? That question has been bothering me. Here is what I mean. I will present only the outlines of my concern and if there is sufficient interest, I will expand on the issue.

India is a two-sector economy: the urban educated sector and the rural uneducated sector. The latter forms the base of the huge pyramid and toils away at a subsistence existence. The urban sector is seeing a boom what with BPO and ITES and all sorts of stuff. Policy makers, politicians, journalists, management gurus, TV reporters, and everyone and his brother are totally wrapped up in this incredible phenomenon. India, they all scream, has arrived. Having convinced themselves of that, they focus entirely on that part of the urban sector that is involved in the boom. This leads to a shocking neglect of the larger rural sector. Then when the boom runs out of steam, the country is worse off than what it would have been without the boom at all.

This is Dr. Atanu “Dooms” Dey signing off for now.

ADLI: A Lesson from the Age of Industrialization

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The transition from an agrarian to an industrial society was the great challenge that faced economies before. Much attention was paid on ways to make the transition. Of the various models of development (such as export-led growth, import-substitution industrialization, and others) used it is instructive to recall one called agricultural development led industrialization, or ADLI.


ADLI recognized that cost-reducing technological change increased agricultural productivity and therefore increased rural incomes. Increased rural incomes provided a demand boost for manufactured goods both for consumption as well as for use in agricultural production. The increased demand for domestically manufactured goods raised wages which in turn were spent on the consumption of agricultural output. On the labor side of the market, as agricultural productivity increased, labor shifted from the agricultural sector to the manufacturing sector. Thus the industrialization of the population was achieved at pace with the labor transition and was based on increased agricultural productivity attained through the use of appropriate technology.


The lesson from the ADLI model is directly relevant to the question of ICT production and use in the economic growth strategy of a large country such as India. The ICT sector in India is very small compared to the rest of the economy, as in any other developing country. While IT exports will only lead to direct gains only for the IT sector, far more gains can be realized through the use of IT in the non-ICT sector and through the production of IT for domestic consumption. The use of IT in the non-IT sector will increase productivity leading to higher incomes and greater demand for consumption goods which will increase employment, and so on.

India’s Development Experience

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India’s rate of economic development has not been very impressive by most standards. But compared to what it was prior to independence, there is cause for celebration. At independence in 1947, India was an extremely poor country with an annual per capita income of only $50 for its 350 million people. Life expectancy was 32 years and literacy rate was 17 percent. National savings rate was around 10 percent. Agriculture accounted for 60 percent of GDP and 80 percent of employment. Per capita food production and per capita income had been declining continuously for nearly the prior fifty years.

Liberalization

After independence, even under the growth-retarding effects of Nehruvian socialism and central planning, India’s performance improved. In a study of cross-country growth experience of 85 countries from 1960 to 1992, India’s performance is almost precisely average. This is poor in relation to the potential that India has given the degree of human, institutional, and natural capital at its command. Economists such as Jagdish Bhagwati have attributed that failure to the “nearly three decades of illiberal and autarkic policies” before the reforms of the early 1990s.

It is easy to see the effect of the mid 1980s change in the dominant ideology of economic development from state intervention to decentralized economic liberalization. Before 1990, the economy had a productivity doubling time of fifty years and the expected time to reach America’s current GDP per capita was 250 years. With the post 1990 growth rates, India’s doubling time is only 16 years and only 66 years for reaching the current US per capita GDP.

Indian Growth Miracle

Some observers have called the change from an inward-looking autarkic economy to an open, market-driven one since 1990 as the Indian Growth Miracle. The neo-liberal economic reforms propelled India to become one of the fastest-growing economies in the world. Yet India should have been one of the fastest growing economies in the decades before 1990, and not just in the post 1990 period. It did not because its planners chose to insulate the economy from the global economy. That conferred some benefits in terms of shielding India from external shocks, but it paid a very high price in terms of foregone growth.

A more serious concern is regarding the slowing down of India’s growth after reaching a peak of 7.8% in 1996-97. As T.N. Srinivasan points out, since 1997, the growth rate fluctuated between 4.8% and 6.6%. He writes that “the constraints on achieving a more rapid growth are mostly self-inflicted domestic ones, largely of political economy.” The Economist in an informative survey of the Indian economy referred to “India’s boundless potential” and compared India to a caged tiger. Amartya Sen believes that “the cage that keeps the Indian economy so well tamed is not only that of bureaucracy and governmental over-activity, but also that of illiteracy, undernourishment, ill health, and social inequalities, and their causal antecedents: governmental neglect and public apathy.”

The growth rates mentioned above are averages and conceal within them a more disturbing fact that must be addressed to better understand the causes of India’s poor performance and subsequently frame the correct response to the problem.

Cognitive Dissonance

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So here is something that does not surprise me in the least: Vajpayee has called for a common currency for the Indian subcontinent.

Actions recommended and taken on the basis of pious hopes are par for the course. Let’s be nice and in turn they too will be nice, that is the pious hope. Let’s take a bus yatra and shake hands and recite some neighborly poetry and they too will respond in kind. Yeah, really. Never mind the fact that a thousand of our miserably equipped soldiers had to die at Kargil.

Let’s have a rail link for people to people contact. Never mind that it also gets terrorists in by the trainloads. And not just terrorists, it also makes it easier to transport the truckloads of fake Indian currency from there.

Common currency? Surely, it already exists: Pakistan prints them already and ships them to India without any prompting.

Pious hopes. Deja vu all over again. Panchasheel and Chacha Nehru and the Chini-Hindi Bhai Bhai. Next thing you know scores of thousands of poorly equipped Indian soldiers are being slaughtered by the Chinese.

The problem is that the leaders don’t have to pay for their folly: only the poor soldiers die in the frozen wastes of the Himalayas.

Forward he cried from the rear
And the front rank died
The generals sat and the lines on the map
Moved from side to side

So sang Pink Floyd. The politicians and netas make the decisions that doom the foot soldiers. And not just them, the costly weapons that the country has to constantly buy condemns millions to a miserable existence.

Cognitive dissonance.

That is what I believe is the primary cause of all this craziness. Disconnect with reality. Not being totally clued in to the real nature of the world, interventions are suggested based on some idealized rosy view of the world.

It is a second best world out there. There are multipledistortions and divides. In such a world, attempting partial solutions can often transfer one from the frying pan into the fire.

Let me save you from drowning, said the monkey to the fish, as he put the fish up on a tree. Good intentions are not sufficient for achieving any utopian vision. More often than not, good intentions without a correspondence with reality, pave a path to hell.

Time for a reality check. Pakistan is precariously close to lobbing nukes at India. At the drop of a hat, there is talk of 1000-year jehads against infidel India. And in this salubrious enviroment, common currencies are being proposed.

Deva! Deva!

BPO and Kuznet’s Curves

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These days one of the dangers of reading newspapers is that one is faced with yet another article on business process outsourcing (BPO) and how there is a backlash from specific sectors in the developed countries. It makes for breathless copy and many of these articles are mere regurgitation of rehashed articles on the same subject. What is the broader context in which to locate all this talk of BPO?

Let’s step back a bit and look at an economy from a macro viewpoint. Economies are usually subdivided into three sectors: agricultural, manufacturing, and services. At the earliest stages of an economy’s development, agriculture is the dominant sector. It is low productivity initially and therefore low wages prevail. Since most of the population is engaged in low wage agriculture, income inequality is low.

Then manufacturing starts to grow, which is high productivity relative to agriculture. Manufacturing wages are therefore high relative to agricultural wages. Income inequality grows in the economy. The mechanism for this income inequality was first explained by Kuznets in 1955 in his paper Economic growth and income inequality. Here is an introduction to the paper from a World Bank site:

The process of industrialization engenders increasing income inequality as the labor force shifts from low-income agriculture to the high income sectors. On more advanced levels of development inequality starts decreasing and industrialized countries are again characterized by low inequality due to the smaller weight of agriculture in production (and income generation).

In other words, there is an “inverted-U” relationship between income inequality and per capita income. At the two extremes of very low and very high per capita incomes, income inequality is low; at intermediate per capita incomes, income inequality peaks.

There is a fractal nature to this “inverted-U” phenomenon in that this relationship holds at different scales of organization. It is definitely true for the rural and urban regions of an economy. The income inequality exists not just at level of an economy, it exists at the global level as well. Early on in the history of the world economy, various parts of the globe had similar income levels, since all were pretty much in subsistence agriculture. Then, as some regions industrialized before others, income inequality grew. In some future time, all regions will become industrialized and once again income inequality will fall. So also, urban regions of a country will initially have higher incomes relative to rural regions. But in time, rural areas will become urbanized and income inequality will fall.

In the long run, income inequality will eventually decrease to zero. But, as John Maynard Keynes observed, in the long run we are all dead. What I understand from that is that the ‘long run’ is really very uninteresting. Interesting things happen in the short- and medium-run time frames. And that’s where we are today — in the intermediate stages where income inequality is high in the global arena.

I will not go into the reason for the differential emergence of industrialization in some regions of the globe. For now, I will take that as a given and thus also take as given the income inequality. It is interesting to ask what accounts for the maintenance of that inequality. Primarily it is the cost of population migration from low income regions to high income regions. By ‘cost’ we mean barriers both natural such as distance, and man-made such as laws against migration. The natural barriers can be lumped together as ‘transportation costs.’ With technological advances, transportation costs come down. However, man-made barriers continue to exist and therefore labor migration is still not possible.

However, since transportation costs have come down, it makes possible what I would call virtual labor migration which is achieved through trade between the various regions. Virtual migration takes place because labor is embodied in the goods that are traded. A Chinese laborer virtually migrates when the goods produced in China are sold in the US. This virtual migration of labor is a factor that puts pressure on wages so as to equalize them across the two regions. To use a mechanical analogy, if the income levels in the two regions were seen as two containers with different levels of liquid in them, then the lowering of transportation costs can be seen as a pipe connecting the two containers: the pipe allows equalization of the fluid levels.

The trade in goods is just a way for labor in the manufacturing and agricultural sectors of low income countries to be available to high income countries. What about the services sector? Services are categorised as tradeable and non-tradeables. In the latter category is included services such as haircuts and house-cleaning and transportation: the production and consumption of which is local. For these, transportation costs are so high that they can almost never be ‘traded’: the cost of haircut in NY is $20 but the cost of a trip to Mumbai is $1000 where a haircut is only $1. Unless transportation costs (and times) come down to $5 (and half hour), haircuts will continue to retain their price differentials.

For those services whose transportation costs have dramatically reduced, trade becomes possible. With the advances in information and communications technologies (ICT), certain services have become tradeable and thus the phenomenon of business process outsourcing. Income inequality between regions is what drives the BPO phenomenon and one can no more wish away the BPO phenomenon than wish away the income inequality underlying it.

Just like the trade in goods, trade in services will tend to equilibrate wage levels across the trading regions. Programmers in the US are paid multiples of wages earned by Indian programmers. With fewer H1-B visas and lower costs of transporting bits, instead of physical movement of Indian programmers to the US, you will have Indian programmers doing work for US firms off-site for lower wages. With perfect substitutability between American and Indian programming skills, the wages will tend to “equalize” after adjusting for average wage levels in the two countries. This adjustment will always keep Indian programming wages lower than American wages and therefore at least in the medium run, programming will continue to get done in India, just as manufacturing will be done in China.

Time to conclude this one. BPO is a consequence of income inequality just as much as off-shore manufacturing is. Both are here to stay until the other end of the Kuznet’s curve is reached.

India’s Biggest Blessing

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This one is in the context of an entry on HP’s Thin Client at Rajesh Jain’s weblog. In response to a bunch of comments on that entry, Rajesh wrote to me:

I think we will need to create the large domestic markets for the affordable computing solutions.

I totally agree. And I am thankful for one positive factor in India’s favor.

The most significant positive factor in India’s favor is its size. It is what we economists call a “large economy”. Large economies have the luxury of changing parameters which define the market itself. In comparison to that, “small” economies have to take those parameters as given (or ‘exogenous’) or external to them or outside their control. In a way, you can consider a large economy to be have some sort of ‘monopoly power’. Monopolies have the power to change one parameter (price) at will which firms in competitive (or oligopolistic) markets don’t have — the latter are ‘price takers’ in that they cannot dictate prices and take whatever price they can get.

So India is large enough to be able to change ‘world prices’. Suppose you were to create a widget which is suited to Indian conditions. Assume that the cost of production of these widgets exhibit economies of scale — that is, fixed costs are extremely high and marginal costs are very low, and hence average costs continue to decline as the volume produced increases. In such a case, given India’s enormous population, the number of widgets required would be high, and thus the average cost will be appropriately low, and therefore the market clearing price for widgets will be low and quantities will be high.

Now replace ‘widgets’ in the above with whatever — “COMPUTING SOLUTION” for instance. Get the hardware that is appropriate for the Indian market developed and get the software developed for the same. Concentrate on the needs of India alone to begin with. Note that hardware and software meet the criteria of high fixed cost and low marginal cost. Marry the hardware and software to create the computing solution, price it just above average cost, and voila! YOU HAVE LIFT-OFF!!

Do we need to create the large domestic market? If by creating you mean bringing the solution to the market, then yes. However, all the ingredients exist. We just have to judiciously put them in them together using the right recipe. I suspect that we are more than up to that job.