Goldman Sachs’ 10-point Reform Package for India

Papers by the Scores

A recent report by Goldman Sachs, Ten Things for India to Achieve its 2050 Potential, makes for interesting reading. Part of a long series of papers, this is Global Economics Paper number 169, and their fourth paper dealing with India and its growth potential.

I found it hard to avoid reading it because more than a dozen people forwarded it to me, some with obvious approval of the content. Here I will briefly review the content of the paper and add some of my own thoughts on what reforms India needs. But first, a general word on these sorts of papers.

This paper is one more of the scores of papers dealing with the same subject that routinely get published by consulting firms, think tanks, academic institutions, financial institutions, the IMF, the World Bank, and government agencies. Professionally produced, the papers are slick, have nice charts and graphs, and are informative in an easy-to-digest sense. They are confident in their assertions, not betraying any doubt.

Their projections, though adorned with appropriate disclaimers, are sometimes right up there in the stratosphere but they don’t feel self-conscious about the matter. It’s those projections more than anything else that grabs the imagination of people and excites them (with the unfortunate side-effect that my mailbox gets flooded with more junk). I think that these airy projections are made precisely because it helps with the viral transmission of these reports.

There appears to be some sort of a cottage-industry feel to all those reports. Just like handicrafts produced in a small geographical area share basic design elements and reflect an underlying common artistic sensibility, these reports share something at the core. What they share, I believe, is primarily the data and secondarily the interpretation.

The Hall of Mirrors

There is naturally some hard data which reliably reflect some objective reality. But I think there are some data that are simply made up and these get quoted by others. Reinforced through repetition by others, these data take on a life of their own, running around in circles that spin the fact that they were invented. Perhaps even the inventor comes to believe that he did not make it up because he has recently seen a similar figure in another publication.

The interpretations are also often very similar. This need not arise out of simple herding behavior, although there may be some of that as well. After all it is safe to go along with what others are saying. Tommy says that the world is flat, others start echoing it, and soon enough it becomes fashionable to repeat that the world is flat because it seems daringly contradictory to say so. It’s oh so clever to claim that the world is flat and pretend to contradict the fact that the earth is a sphere.

But analysts are not all sheep and so herding cannot fully explain the similar interpretations. That the authors and/or the institutions face similar incentives perhaps explains the similarity of the interpretations. The reports serve to justify a particular overarching policy decision. Somehow that policy decision arises; let’s take that as a given. Now all that needs to be done is to get people to write reports that clearly indicate why it makes sense to follow a particular policy.

The incentive for writing a paper that supports a particular policy is that the policymakers then reward the report writers by quoting them in support of the policy, and thus provide mutually reinforcing support enhancing the credibility of both parties. It seems to me that the policy is the real object, and the reports appear as reflections in a hall of mirrors that the policy occupies.

Assuming for a moment that what I claim is somewhat true, is that a good thing? It could be, in a self-fulfilling sort of way. Suppose an interpretation says “that India could be 40 times bigger by 2050” (as the GS report says), and based on this and other similar reports, people start investing in India, it is possible that India would be bigger, although probably not 40 times bigger. Investor confidence is good and if a whole bunch of echo-chamber reports raises aggregate investor confidence, I say more power to them.

But there be other dangers. There be dragons lurking in the shadows.

On Accurate Predictions

One thing becomes amply clear when one surveys even perfunctorily the whole business of predictions. Fifty years ago the predictions generally centered around how the world of 2001 would involve space travel and flying cars. Nobody had the faintest clue about the revolution that actually occurred in information and communications technologies.

Predicting stuff is easy. Everyone can do it.[1]

Accurate predictions (especially predictions about the future, as a wit noted) are an entirely different kettle of fish because what happens is contingent on unforeseeable events. How the future unfolds depends on contingent–not necessary–factors.

The report says that India could be 40 times (I suppose its present economic size) by 2050. What I don’t quite follow is how anyone can foresee so far into the future with any degree of clarity. What I find amazing is not the reported vision but that one can claim to see that far at all.

Perhaps if everything was pretty much guaranteed to go along as they have been in the recent past, one could have a reasonable shot at guessing what the state of the world is likely to be say in 10 years’ time. But 50 years? Nobody, not even highly paid analysts, can have the type of foresight that is the domain of omniscient supernatural beings.

The world does not stand still. Things change. Revolutions happen, some good like the internet in the US, and some bad like the cultural one in China. Discoveries are made, booms and busts rush in and out, technologies are invented, new business models come into being. Nataraja’s dance of creative destruction continues unbroken.

And the Report

But enough of the preamble. Let’s jump into the Goldman Sachs 24-page June 16th report authored by Jim O’Neill and Tushar Poddar and start with page 1.

* As we have shown before, India could be 40 times bigger by 2050.

* To achieve this, India needs to implement many changes.

* India needs to improve its governance, control inflation, introduce credible fiscal policy, liberalise financial markets and increase trade with its neighbors.

* It also needs both to significantly raise its basic educational standards, and increase the quality and quantity of its universities.

* India needs to boost agricultural productivity, improve its infrastructure and environmental quality.

* Delivery of all these would ensure strong, persistent, medium to long-term growth, allowing India to reach its amazing potential.

That’s about the gist of the report and I would strongly recommend reading the report. It is hard to argue with any of those things. They are all reasonable recommendations. They are reasonable in an a priori sense and that is what makes the problem so intractable.

Old Hat

Suppose the recommendations were truly amazingly novel. One could have then said, “Yes, now we know what is to be done. We had no idea 50 years ago that that was what we should be doing. But now, because of such-and-such reasons, wisdom has finally dawned and now we can get busy with doing these things.”

Sadly, that is not so. Every one of those recommendations would have applied to the India of 50 years ago and people knew it. That it was known is clear from seeing that other economies did precisely those things. This brings up a number of troubling questions.

Why is it that these were neglected in the past? There must have been reasons why India did not do them. Is there any reason to believe that the conditions have changed and so now we will be able to do them? And if the conditions have not changed, what makes us believe that going ahead we will be able to change our tack?

Change the Conditions

In this essay my aim is not to criticize the Goldman Sachs report but rather to use it as an exhibit to argue a larger point. My thesis is that most of the recommendations are secondary to what primarily needs to be done. I claim that what is secondary should not occupy our attention until we get the primary done. The secondary bits will automatically happen because the primary bits will create the conditions for the secondary to arise naturally. Conversely, I claim that if one neglects the primary changes, all efforts at implementing the secondary bits will be in vain because they will be an unnatural intervention in a system that is not ready for the change.

I believe that trying to implement the recommendations without changing the factors that have prevented their implementation in the past is like attempting to address the symptoms without doing anything about the causes. It could be worse: a report like that could actually be misused with disastrous consequence.

The Education Recommendations

Let’s take the recommendations dealing with education. It says that India needs more schools and colleges as one of the factors that will help India reach its potential in 2050. That is reasonable and good. But what could happen is this: the government immediately sets about the task of increasing the spending on education. But wait, you cannot spend without earning. Fine, the government does not have to earn — it just has to tax more.

Suddenly, another x percent “additional super education cess” is added to the already y percent “education cess”. Additional revenues come rolling in. Now the ministry of education (and therefore the minister for education) has an additional Z thousand crores a year on top of the existing W thousand crores rupees it already has. So now instead of only W thousand crores being handled with sticky fingers and most of it lost through corruption and ineptitude, the economy is now going to lose even more money. Yet another “{Indira, Rajiv, Sanjay} Gandhi or {Jawahar, Nehru} Shiksha Yojna” will get launched.

Will that suddenly raise “basic educational achievement” and “increase quality and quantity of universities”, as the GS report recommends? No, it will not. Because after spending hundreds of thousands of crores of rupees over decades if half the school age children are still illiterate and the majority of the graduates are unemployable, giving more money to the government to squander is insanity. It is insane to persist in doing the same thing and expect different results.

What needs to be done is to rethink and re-engineer the whole scheme. First, examine dispassionately why is it that the Indian education system is an unspeakable disaster. Then, second, fix it so that the same mistakes are not made. Then stand back and watch the system take off.[2]

My conjecture is that it is the government involvement in education that is at the root of the problem. Get the government out of education first. Then in a new government-free environment figure out an alternative educational system.

The report states:

The National Knowledge Commission has proposed an increase in the number of universities from 350 today to 1,500 by 2016. It has also proposed an increase in the 18-24 age group—to be educated to university level from 7% to 15%.

While they were at it, why didn’t the NKC also propose a pony for every child and an pretty rubber ducky for every bathtub in every house?

If in 60-odd years, India has been able to run only about 350 universities, what has changed that will suddenly enable India to create an additional 1,150 universities in a span of 8 years? Can we overnight magically make enlightened foresighted beings out of our current crop of venal politicians and bureaucrats? Did I miss the memo which said that the gods have altered the basics of human nature?

Policies and Institutions Matter

The primary lesson of development economics has to be that policies matter. Economic policies determine the destinies of economies. Economic policy is made by policymakers. Policymakers are human beings just like you and me. They are motivated by self-interest and operate within the confines dictated by the institutions that exist. Institutions are endogenous. Which is, they arise from within the system and co-evolve with the evolution of the aggregate consciousness of the society.

Institutions are all around us and we are immersed in them. They include the constitution, the market, the judicial system, the financial system, the government. The will of the people gets transmitted to the policymakers through the institution of a representative democracy. For the policymakers to do something different from what they have been doing, the will of the people has to change. And therein lies the rub. I will take only one dimension of the expressed will, and that is the planning horizon.

Planning Horizons

A long planning horizon indicated that one is concerned with maximizing or optimizing some variable over a long time frame, not just for the immediate or short term. If the representative citizen has a long planning horizon, policymakers will necessarily plan for the long haul.

There is often a tension between short-term and long-term planning: what is optimal for the short term may not be optimal in the long term, and vice versa. We are not always free to choose long planning horizon. Circumstances may confine us to a short planning horizon. One could be too poor to consider the long term. When one is at the edge of starvation, one could be compelled to eat one’s seed corn: it would jeopardize the future crop but if one is going to die without food, saving the seed corn for the future is pointless.

Aside from dire necessity, one’s short-term planning horizon could simply arise out of ignorance and shortsightedness. One could just not realize that saving for the future is a good idea and that a little short-term pain could lead to long-term gain. This is a common human failing and one is generally saved from oneself if one has the good fortune of having well-meaning wise counsel. The representative citizen may be shortsighted but if wise leaders perceive the big picture and enact appropriately wise policies, the economy could overcome the citizen’s shortsightedness.

Not Everybody Votes

Voting is a way of expressing one’s opinion on what should be done on issues that matter to them. If you cannot vote, you don’t have control over something that is of interest to you, material or otherwise. I certainly have an interest in policies that will affect my material well-being. For instance, I care whether next year there will be sufficient food for me and others around me. That is of material value to me. But I also have an interest in the well-being of those who will be alive in 2070, a date by which I will be most certainly deceased. Their well-being enters into my calculations as present psychic satisfaction.

How long my planning horizon is dictates how I will vote on certain matters. But here’s the kicker: my vote today will have an impact on the world of 2070, and there will be people living in 2070 who have not yet been born. So an issue which will have an impact on those alive in the year 2070 can never be fully voted upon. If the current generation’s planning horizon is short, it disenfranchises future generations on matters that is of interest to future generations.

Now it is trivially true that everything we do today will have an impact on the future — both the near-term and long-term future. But those who vote today are overwhelmingly more interested in the near-term. So most policy decisions that are dependent on voting by the current generation will be necessarily shortsighted. The leaders are forced by their self-interest to give all their attention to the current voters and disregard the interests of the future. This is the ultimate in vote-bank politics and in the manner that all vote-bank politics is bad, it is the ultimate bad thing.

If we seriously consider this matter in some detail, we will recognize that the India of 2008 is suffering because of the shortsightedness of the policymakers of India of 1950s, and by extension the ignorance and shortsightedness of the voters of 1950s. The majority of us were not even born in the 1950s. If our non-embodied selves could have voted, we would have made different choices than those that were made only by the voters of the past.

Independent Authorities

So is there a way out of this? Can we somehow put a mechanism in place that will be able to take the long view? Most certainly there is. Let’s consider that for a bit. What we want is a mechanism which will insulate the decision makers from the current set of voters. It is called an independent authority or institution — one which is independent of any elected government.

Let’s go back to the education sector for concreteness. Imagine a “Education Regulatory Authority of India” which is independent of government influence. The ERAI decides how the educational sector is organized, how it is funded, how it is regulated, and so on. If it determines that the private sector should be allowed free entry into the sector, it can do so. Unlike the government, it does not have an interest in vote-bank politics and therefore will be immune to special pleadings. Unlike the present government, it will not trash the educational system just so as to win the next election. It can take the long view and include the interests of not just the current generation but also the interests of the unborn generation when it makes policy.

This is an institutional innovation, not a technical innovation. What it primarily does is to take away some power from the government. It removes from the hands of a mean-minded short-sighted government an instrument of control that the government uses so ruthlessly to divide the present generation and impoverish the future generations.

What we need are institutional innovations that will remove from the government all those areas that can be safely entrusted to independent institutions that can determine policy without interference from electoral politics. Which of course implies that a different constitution has to be adopted. That is the first and the most fundamental reform that is needed in India.

Reduce the Power of the Government

Consider the implications of reducing the power of the government. Suppose the government is divested of the responsibility (oh, what a burden!) of collecting thousands of crores in taxes for running (ruining?) educational institutions. The money disappears and with it the lure that government office holds for the dregs of society. There is no ministry of education and there is no minister of education. The money is gone and so is the corruption that money ultimately engenders.

Remove from the government the responsibility for power, for transportation, for telecommunications (oh yes, we do have a Telecom Regulatory Authority of India but let’s get rid of the Department of Telecom), and so on. Reduce the government to the point that it does not handle much money at all. And you will find that one does not have to worry about corruption in the public sector — there will be no public sector. Na rahegi baans, na bajegi baansuri., as the Hindi saying goes.

My 5-Point Reform Package

I am partial to one way of thinking. I think that if the conditions are right, good things happen. We have to create the conditions, however. If the infrastructure is there, people will figure out how to create wealth. That was the central idea behind RISC — Rural Infrastructure and Services Commons — the model I believe that can help accelerate the development of the rural populations.

There is a larger set of “infrastructural elements” that I consider critical for India’s development. I don’t know and will not hazard a guess as to how large the Indian economy will get by the year 2050 if these elements are put in place. It really does not matter. What matters is that if we don’t get these done, there’s no need to pack our bags because we aren’t going anywhere.

1. Constitutional reform to reduce the size of the government by removing all functions of the economy except a few from government control. A small government will be an efficient government. And extraordinarily severe punishment for any government official — elected or appointed — who is convicted of corruption and misbehavior.

2. Funding for R&D in the energy sector. Create a mechanism for R&D in India by providing massive incentives to firms. Announce the equivalent of the Nobel Prize or whatever for researchers who get breakthroughs. Give tax incentives for firms to invest in renewable energy.

3. Dismantle the government education system and liberalize the sector. Allow private sector firms to enter all levels of education. Allow them full freedom to price tertiary education at full cost. Create mechanisms for loans for all who qualify for higher education. Provide financial support for all for primary education.

4. Create an independent authority that will create a private-sector long-distance transportation network based on steel-wheels on steel-rails. This is a coordination problem and there has to be body that will do the coordination. The money is there. The vision and the will has to be articulated.

5. Last and not the least: fix the legal system. This is a government function. The judiciary is of course an independent authority from before. What we have to do is to make it so efficient that “the rule of law” is not just a phrase that easily rolls off the tongue but actually means something to the average person. Without an efficient legal system, you cannot have an efficient economy.

That’s all.

NOTES:

1. This recalls to mind a Polish folktake, “The Wonder Rabbi”, quoted in “Adam Smith Goes to Moscow” by Walter Adams and James Brock:

It is said that a wonder-rabbi of Chelm once saw, in a vision, the destruction by fire of the study house in Lublin, fifty miles away. This remarkable event greatly enhanced his fame as a wonder-worker.

Several days later a traveler from Lublin, arriving in Chelm, was greeted with expressions of sorrow and concern, not unmixed with a certain pride, by the disciples of the wonder-rabbi. “What are you talking about?” asked the traveler. “I left Lublin three days ago and the study house was standing as it always has. What kind of wonder-rabbi is that?” “Well, well,” one of the rabbi’s disciples answered, “burned or not burned, it’s only a detail. The wonder is he could see so far.”

2. The analogy that I imagine goes like this. There’s a huge sailing ship with its sails unfurled sitting in the harbor. The wind is strong and favorable. But for some reason the people on the shore will not let the anchor go. The wind picks up even more the ship is listing and is in danger of capsizing due to the strong wind. But those on the shore don’t care if the ship sinks — as long as they have a hold on it. The wind is strong and is threatening to break the masts. If only, lord, if only they let the anchor go, the ship will sail swiftly across the ocean.