Cognitive Dissonance

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

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.

Pricing Management Education

This is a continuation of my previous post on HRD and management institutes. I had ended that post with the recommendation: Increase fees to be more aligned to the fees for comparable schools around the world and provide student loans to all students who require it to pay for their IIM education.
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India’s Biggest Blessing

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.

The Enemy Within

Anish Sankalia sent me an article where Andy Mukherjee warns that India’s Enemy Within Can Douse Explosive Growth. The enemy he identifies is government debt. Continue reading “The Enemy Within”

The HRD Madness about Management Schools

For India to emerge from being an impoverished country, some degree of sanity in policy makers must be an absolute precondition. The situation is so bad that one cannot read a paper without being hit in the gut with yet another insane policy being proposed. Take the matter of the Indian Institutes of Management (IIM) and what the Ministry of Human Resource Development (HRD) is proposing.
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Fundamental Change

Francois Gautier is one of my favorite journalists. In rediff.com he asks why the Indian government considers foreigners as cows to be milked. Blatant discrimination against foreign visitors cannot go unnoticed and cannot but have an effect on the volume of foreign tourism.

Who are these bureaucrats that make such brain-dead decisions? How can we bring about a change in their thinking? How can we persuade these cretins about the need to be somewhat intelligent in their policy making? Is there any hope for India if we continue to make idiotic policy choices at every level of our economy?
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The CAT and Transaction Costs

It is important to remind ourselves from time to time what poverty is all about. Poverty has something to do with production. Not exactly the most esoteric bit of knowledge but often it gets forgotten in the shuffle. To produce you need to have what we call factors of production which are usually broadly classified into land, labor, and capital.
Continue reading “The CAT and Transaction Costs”

The Rise of India

BusinessWeek online in its Dec 8th 2003 cover story The Rise of India says “Growth is only just starting, but the country’s brainpower is already reshaping Corporate America.” It is worth the read. Here is an excerpt:

If India can turn into a fast-growth economy, it will be the first developing nation that used its brainpower, not natural resources or the raw muscle of factory labor, as the catalyst. And this huge country desperately needs China-style growth. For all its R&D labs, India remains visibly Third World. IT service exports employ less than 1% of the workforce. Per-capita income is just $460, and 300 million Indians subsist on $1 a day or less. Lethargic courts can take 20 years to resolve contract disputes. And what pass for highways in Bombay are choked, crumbling roads lined with slums, garbage heaps, and homeless migrants sleeping on bare pavement. More than a third of India’s 1 billion citizens are illiterate, and just 60% of homes have electricity. Most bureaucracies are bloated, corrupt, and dysfunctional. The government’s 10% budget deficit is alarming. Tensions between Hindus and Muslims always seem poised to explode, and the risk of war with nuclear-armed Pakistan is ever-present.

I am glad that the article does not paper over the real problems. It goes on to report the confidence among some Indians.

Now, many talented Indians feel a sense of optimism India hasn’t experienced in decades. “IT is driving India’s boom, and we in the younger generation can really deliver the country from poverty,” says Rhythm Tyagi, 22, a master’s degree student at the new Indian Institute of Information Technology in Bangalore. The campus is completely wired for Wi-Fi and boasts classrooms with videoconferencing to beam sessions to 300 other colleges.

Boom, like beauty, evidently lies in the eye of the beholder. I like enthusiasm as much as the next guy. But let’s not get carried away by IT. It is not driving India’s boom because there is no boom to begin with. India’s economy is growing at a modest pace. Calling it a boom is silly. And it is worse than silly to believe that IT can deliver the country from poverty — it is dangerous.

Thinking that IT is the answer to India’s development is dangerous because it could divert limited resources into wasteful activities. Every now and then one hears of another large sum being allocated for e-this or e-that. Recently I was at a roundtable on e-governance. Speakers held forth on how e-governance would help. I could not for the life of me figure out what is the point in moving from bad-governance to e-bad-governance. I thought that the move should be from bad-governance to good-governance. But that was the minority view there because the consensus was that everything was as it should be and all that was needed to gild the lily was a bit of IT.