AN ECONOMIST IN THE REAL
WORLD
The art of policymaking in India
Book category- economics and policy
making
Author- Kaushik Basu
Book number- ISBN 978-0-670-08875-1
Summary writer- RAHUL.P
Reviewer -
Month and year of summary- April 2017
Kaushik Basu , who was the chief
economic adviser has written this book
which provides some insight to the
economic policymaking in India. Kaushik
Basus academic credentials are
impeccable. His first love is teaching and
researching. He has taught at several
universities in India and abroad. He has
published more than 160 articles in
scholarly journals and newspapers.
Currently, he is Senior Vice-President and
Chief Economist of World Bank. Basu
himself says that the book has drawn
heavily from contemporary research, his
experiences in the policymaking and his
ideological and moral predilections. But,
he start with a warning- the book is not a
diary and those readers who looks for
revelations will be disappointed.so, the
book can be considered as a treatise on
developmental economics with an intent to
help the readers of the discipline.
The main and constant theme of the book
is about the policy making in India. Basu
makes an analogy with economic policy
making and aircraft building where he says
that in both the cases the work may go
wrong if you go by popular opinion; but an
economist's job is more difficult than an
engineer. Being an academician Basu has
the advantage of being an outsider while
dealing with the government and hence the
book also has got it. With the benefit of
such an outsider's view he argues that
contrary to the popular belief in policy
making circles, it is not the dearth of
research that lacks in policy making but it
is the lack of theory and reasoning.
The book is structured neatly. The first
five chapters handle broad economic
issues. The sixth critiques food
storage/security policies and suggests
alternatives. The last four are non-
economic but impact economic policies
drawing on later-day research in
behavioural sciences. These chapters are
so well arranged that each chapter moves
on seamlessly to the next.
CHAPTER-1 -Arriving in Lutyens Delhi
The chapter is all about an introduction to
the authors arrival in Delhi to take the
office. Being invited by none other than
the then prime minister of India, Basu
discuss the initial difficulties that he faced
in the government offices. He contrasts the
work culture of the universities where he
worked previously and the atmosphere at
Delhi. The instances like his driver saying
to him that he need not wear a seatbelt he
can sit in the car without a seat belt etc. are
narrated in a funny way. Basu says that his
posting was an aberration in the
government as he was the first outsider
who became CEA.
Though there is a separate chapter given
on inflation in India, this chapter also deals
with it especially the food inflation
because it was the first policy discussion
the author was involved with. The FCI
which procures huge amount of grains
from farmers with an intent to release it to
the poor at a discounted rate does it by
auctioning off bundles 1000 metric tonnes
of grain. This prevents many players to
participate in the auction and what
eventually happens is creation of an
oligopoly. The author had a discussion
about this with the prime minister and was
able to persuade him to take decision for
releasing smaller bundles to the market
which will allow more players in the
auctioning and thereby induces
competition and lower prices.
Economics being a strange discipline with
one foot in the science and other being in
the common sense and intuition , it is very
difficult for the policy makers to take
decisions because everyone will have
some opinion regarding how the policy
should be carried out. This actually makes
it imperative for all the citizens to learn
some basic economics so that they can
participate in discussions more fruitfully.
Basu claims that one aim of the book is
exactly this.
CHAPTER 2- INDIAS GROWTH
STORY: STAGNATION, CRISIS AND
TAKEOFF
Like all other books on Indian economy,
the author also starts with history of Indian
economy after independence, but a brief
one. Basu traces of ideological moorings
of Indian economic thought and its
interactions with political thoughts of the
time, describes major shifts in economy
and its analysis and finally predicts the
future of Indian economy in this chapter.
Basu starts with intellectual roots of Indian
economy as he believes that ideas are more
important in shaping our lives than most of
us realize. Though India had many larger
than life legendary persons as far as
economic thought is considered Gandhi
and Nehru are the two towering figures
who influenced it more than anyone else.
There were inconsistencies in their
economic philosophies which was well
acknowledged by them. Nehru had great
respect for Gandhi but considered his
economic ideas of small self-sufficient
village republics as unrealistic in a modern
world and only if the whole world is like
that it could be implemented. But, Nehru
tried to incorporate Gandhian economic
thought in his famed Nehru-Mahalanobis
model of development where he tried to
protect and promote small scale industries
by regulations. This led to many
contradictions in the economy as the
policymakers tried to accommodate
contradicting policies at the same time
which later led to fissures and problems in
the system. A soviet styled planning was
introduced without full control by state,
capitalism was allowed but an
overpowering bureaucracy was nurtured,
rhetoric on socialism was conducted tough
base of Indian economy was capitalistic.
After Nehrus death in 1964 the period up
to 1984 can be broadly considered as
Indira years with brief interjections in
between. Unlike Nehru, Indira had deep
ideological convictions. Her period can be
divided into two - Indira Gandhi I up to
1977 when she had great commitment to
socialism (not in the sense of state control
of means of production but in the terms of
a redistributive system with reliance on
heavy industry) and Indira Gandhi II
from 1977-1984 where she was under
influence of her two sons especially Rajiv
Gandhi. During her first phase she did
things like nationalisation of banks and
during the second phase first steps to
liberalise India was taken.
Basu then goes on to describe at length
about growth trajectory of India. Though
the economic growth of independent India
was more than 1%-1.5% during the British
rule at around 3.5% the country never
witnessed an escape from that trap which
the famous planner raj Krishna of DSE
called Hindu rate of growth. Assisted
green revolution Indira Gandhis career
reached a pinnacle with growth rate of 5%
in 1970-71 and her image grew with
Bangladesh liberation war. But then when
first oil crisis hit India in 1973 India's
growth slowdown and food inflation
reached more than 30% for the first and
last time till now. Due to multiple political
incidents both at home and outside Indira
declared emergency in 1975 .in 1975-76
India's growth was unprecedented 9% the
reasons for which are still debatable . Basu
mentions about trains running in time and
all but is not saying conclusively that an
increased growth rate is the result of
emergency. But this growth rate could not
be sustained and it plummeted to 1.2% and
to further -5% in 1979-80 which is the
lowest till date.
One interesting note I found here was
Basus theory on punctuality. He mentions
about the equilibrium phenomenon, i.e., if
others in your society are punctual it is
worth your effort to be punctual;
otherwise, not. (I found this observation
relevant even today with India being
notorious for lack of punctuality especially
in government sector).
Basu cautions the readers that the average
growth that India had was not bad when
compared with peers and makes a
comparison with China. The main
difference between the two was that
Chinas growth was more fluctuating. The
only time which India witnessed such wide
fluctuations during 77-80 which was
primarily a product of political
uncertainties. The author also gives some
insights into political developments of the
time like emergency. Emergency
according to him was the product of the
fear that Indira Gandhi felt about being
ousted by a CIA coup and other internal
developments. But, the author says that the
interaction he had with some of
bureaucrats made him realize that Indira
wanted people's support for declaration of
emergency and that's why she withdrew it.
The one good thing that happened to
economy during Morarji Desai was his
efforts to get closer with US the benefits of
which the nation reaped few decades later.
Then came Rajiv Gandhi with beginning
of liberalisation.
Basu consider the 1991 economic crisis as
an opportunity which the then PM and
Finance minister made good use of to lead
country to a path of faster economic
growth. Due to financial crisis triggered by
gulf war and wider economic structural
issues, India faced a balance of payment
crisis which compelled the government to
go to IMF. This resulted in many structural
reforms in the economy the important ones
being the elimination or reduction of ill
famed license raj in India this helped in
local manufacturing to kick in and
increased the production, the export and
import tariffs which were absurdly high
was brought down to 150% in 1991 and
later to 15% by 2005. This also eased the
inflow and outflow of foreign currency in
India making it the sixth highest holder of
hard currency now from a state where the
reserves always stood at 5 billion dollars.
The easing of imports like computer led to
boom of it sector and made the so called it
revolution possible in India. After
liberalisation Indian economy grew at a
fairly higher rate with possible exception
during the East Asian crisis of 97-98.
After 2005, the benefits of liberalisation
actually resulted in a growth surge with
investment rates and savings rates rising
dramatically high. Savings rate India was
just 10% till late 1960s but got increased
to more than 20% by late 1970s due to
policies like nationalisation of banks and
creation of UTI but it then got stagnated
and breached the 30% mark only in 2003.
This was mainly due to two reasons - one
is the non-verified argument that when a
nation grows rapidly the propensity of
people to save will also increase and the
second was the fiscal prudence taken by
government by rationalising the spending.
Basu says that like mysterious alignment
of stars India got into good terms with US
during that time and due to geopolitical
reality by growth of China US also wants
India. One interesting and novel
observation by Basu regarding 2004 US
presidential elections was about the free
advertisement that US election did to
Indian outsourcing companies. As both the
candidates campaigned about their jobs
being siphoned out by Indian BPOs many
small companies in US also came to know
about it . From 2005-08 economy grew at
the rate of 9%. This not only improved the
lives of the people but also improved the
perception about India globally.
The chapter closes with an account and
analysis about the global crisis that
gathered storm after 2008. US economy
being a major driver of global economy,
the crisis that started due to subprime
lending to non-creditworthy customers got
affected the whole world. Regarding India
the author observes that the phenomenon
of black money generation which results in
a house worth $100 to be registered for
$50 to evade tax helped banks to keep
healthy balance sheets as the banks
exposes themselves only to the registered
value of the property. Tus economics is not
a moral subject and the so called corrupt
act acted as a bulwark against the crisis.
Later with the help of stimulus the
economy grew more than 8% in 2009-10
and 2010-11.
But, again due to partial indigenous and
partial global issues the growth started
coming down. The indigenous issues were
the number of corruption scandals which
resulted in high degree of indecisiveness in
the government as many official feared to
take any measures. Along with that the
high inflation compelled the RBI to keep
the interest rates high which according to
the author was a bad strategy. Externally
the Eurozone crisis made the things worse
as Europe being the third largest consumer
for India. Eurozone is another example
like communism where the artificial
economic constructs fail. In addition to
this slowdown in China is also a concern.
The author ends the chapter with an
optimistic note about the Indias future.
Once the savings and investment rates
reach near to 40% it is less likely to go
down which will fuel the growth. The
most important reform that India should
ensure to make the faster growth happen is
the bureaucratic reforms which will help
the creativity and enterprise of ordinary
people. If we consider both politics and
economics one that is harder to change is
politics and India is lucky in this aspect as
the founding fathers have already invested
in the democracy.so for India it is very
much possible to return to a growth of
8.5%.
CHAPTER 3- INFLATION: THE
EMPEROR OF ECONOMIC MALADIES
Inflation is considered as the emperor of
all the economic maladies as it affects
everybody immediately, it is the most
important variable that influences the
mood of an electorate and it hurts the poor
the most. Thus, unlike other important
economic variables like fiscal deficit,
inflation is very much visible. Inflation has
nothing to do with the relative price rise.
Inflation refers to a sustained rise in
prices across the board, that is, a
phenomenon where the average price of all
goods is on the rise. The issue with
inflation is that it is very difficult to trace
its sources and according to Basu, even
experts have very limited understanding of
the phenomenon.
The bout of inflation in India started
during 2008 and the country faced an
unabating inflation for five years with rates
reaching as high as two digit inflation.
Prior to that India faced negligible
inflation for a dozen of years. Even during
the dozen years of price stability we had
more inflation than in virtually any
industrialized country in recent times, but
in comparison to most emerging market
economies and developing nations in the
world, Indias performance was creditable.
One reason why the recent run of inflation
seems so intolerable is the relative price
stability of the previous twelve years. This
is what led to talk of runaway inflation and
hyperinflation. According to author, such
kind of hyperinflations have happened in
Hungary, Germany and Zimbabwe etc. and
Brazil is one country which faced two digit
inflation for a long time. Brazils
experience gives us a bit of an insight into
what inflation does to growth. Eyeballing
of the data suggests that, when inflation is
below 10 percent, there is little correlation
between the rate of inflation and the
growth rate. But at higher levels, inflation
is usually associated with lower growth;
and especially when inflation starting at a
high level rises even further, growth slows
down.
The wide amount of research that has been
done in this field has made us realize a lot
about inflation but unknown is also a lot.
The existence of near monies make the
control of inflation complicated as the
inflation management includes not only
managing liquidity of money but also of
near money. This calls for unique research
for all nations to understand the
phenomenon. In India the matter is always
debated and a lot of research been done
regarding inflation on how to measure it
and all. Which indices are better (CPI or
WPI) if CPI which CPI (IW or AL). Basu
makes an interesting observation when he
says that if we compare the CPI and WPI,
CPI shows an upward trend (it is this
CPI_IW that is used to calculate
allowances of the same bureaucrats who
make the indices). As the indices are
following different indicators now way to
compare them would be to take the same
variables and to scale the weights equally
and then compare. Even then the CPI
shows an upward trend is something
doubtful.
Hoarding has been considered by many
especially layman as the main cause of
inflation and they believe that government
intervention can do everything to manage
the inflation. Basu criticizes the Essential
commodities Act as it can produce
opposite effect of what it is indented to do.
Keeping goods stored when there is
surplus can actually help in price
stabilisation. The author says that it is not
to say that deliberate black marketing
should be discouraged but to say that the
reactive hoarding as a response to price
cycles should not be penalised.
The chapter also discuss about the various
instruments to tackle inflation and consider
the interest rates as a key mechanism to do
it. As inflation is increase in the prices of
all the goods there is no way we can
increase the supply of all the goods in the
short run to reduce the prices and hence
the only way is demand management.
There should be a differentiation between
the relative price change and the inflation.
Relative price change should be left alone
and if governments tamper with it has
resulted in black marketing. What makes
the inflation a very complex problem is
that the overall demand comes from
multiple sources- corporations, farmers,
labourers, housewives, and government.
This can be found by an illustration of
what the policy of financial inclusion did
to inflation. The fact that more people
started putting money in the banks resulted
in having a higher money supply and
thereby higher inflation.
Since inflation is caused by aggregate
demand exceeding aggregate supply at a
certain point of time, one blunt instrument
is to redistribute some of the demand from
that time to the future. This can be done
by, for instance, confiscating from people
a certain amount of their income for a
certain duration of time. For example, levy
a 5 percent temporary income tax, which is
then held by the government without being
put to use (to use this would defeat the
very purpose of withholding buying
power) and eventually paid back to the
taxpayers over the next four or five years,
once the inflation eases out. This can have
the side effect of output declining in case
producers realize that demand will decline
as a consequence of this move. But
executed suddenly, it can curb the pressure
on prices, though it is unlikely to make the
government popular at the polls.
At an abstract, elemental level, inflation is
the product of our ability to make contracts
and deliver on promises. If we were a
totally untrustworthy people, who never
delivered on promises, we would not have
inflation. While we think of promises
mostly in bilateral terms, the most
important economic promise, one that
has made modern civilization possible, is
the mysterious promise represented by
money. So to control the inflation we have
to control the money supply. In India, the
major instruments for managing liquidity
are the repo, reverse repo, and cash reserve
ratio. In India, government does not
control interest rates, it is the RBI which
does it. When we analyse the correlation
between the repo, reverse repo and
inflation, it is not at all clear what drives
what. It is assumed in popular discourse
that if interest rates are raised, the demand
for credit will go down; and hence the total
amount of liquidity in the system will be
less.17 this is generally true. However, it
can be shown that in certain contexts the
opposite will occur.
There is no reason why we should assume
that the initial interest rate prevailing in the
economy will always be at or above where
the demand and supply curves intersect.
Credit markets are subject to interventions
by central banks and the government, and
they also have other external rigidities,
which can deflect the interest rate from the
neoclassical market equilibrium rate,
where demand always equals supply to a
rate where demand exceeds supply, that is,
to a zone where there is liquidity
deficiency. Supply being the binding
constraint (since there was an excess
demand for credit), in this case, this rise in
interest means that the total amount of
money lent in the economy will increase.
Hence, total credit in the economy goes
up. Since there was excess demand for
credit in the original equilibrium a small
decline in demand is of no consequence.
Hence, we get a paradoxical response to
the interest rate tightening, whereby there
is no reduction in liquidity and, in fact, a
possible increase in liquidity, assuming
that the supply curve of credit is upward
sloping. Thus, in an economic context
where interest rates have no effect on
liquidity, or have a pathological reverse
effect on liquidity, then we may have to
desist from using this interest rate policy
and look to other kinds of interventions.
The case of Turkey is given as an example
to substantiate the above said possibility.
Tukey though faced high inflation during
2010 and 2011 went to reduce the interest
rates and this resulted in reduction in
inflation. Thus what the author tries to
convey is the importance of conducting
enough studies and research before taking
steps to control inflation as local
conditions can influence a lot in
effectiveness of policy. Thus, it is arguable
that India erred in following the traditional
policy of trying to control inflation by
keeping central bank interest rates high.
This reined in some of the growth, while
having minimal effect on inflation.
The relation between inflation and the poor
deserves special attention. He further
examines two theories of inflation India-
greater benefits given to the poor may
have caused some of the food price
inflation in 2009 and 2010 (benefits-
based inflation hypothesis) and a
common counterargument to this
hypothesis is the following: If it were
indeed true that it is the greater demand for
food on the part of the poor that caused the
inflation, then we would expect to see the
poor consuming more. But there is no
evidence for this. Hence, the benefits-
based inflation hypothesis is invalid. This
can be called as consumption-based
challenge. While examining the two
postulates the benefits based inflation
seems more plausible as the poor spends as
high as 67% of their income for food
expenditure and it is natural that if they get
more money it will lead to food inflation.
Regarding the other hypothesis if the
supply is limited the increase in money
among poor need not result in more
consumption but could only result in more
competition to buy fixed amount of food
and hence fuel inflation.
There was evidence of stagnation in
virtually all industrialized nations,
including the United States, the European
countries, and Japan; and there was
inflation in virtually all emerging market
economies, including India, Argentina,
Brazil, Vietnam, and China. In other
words, what we had was an unusual world
economy, with some parts caught in the
stag mode and some in flation, giving means. But the great depression and the
rise to a kind of salad bowl
stagflation. What the world is currently
caught in is best understood by imagining
an Indian economy in which we have high
interest rates in Gujarat and low interest
rates in Bihar. This would give rise to
perverse capital flows from one region to
another. Just as what happened during
quantitative easing following crisis where
the capital flowed to the developing
economies. The world economy being
more connected now it is a must to have
more coordinated responses by world
nation to control inflation. In the long run,
there is no escape from using multilateral
organizations to work collectively to
address problems such as those of inflation
in emerging economies and stagnation and
deflation in developed economies.
CHAPTER 4- FISCAL AND OTHER
MACROECONOMIC POLICIES FOR
AN EMERGING ECONOMY
As the author discussed about the
monetary policy in the preceding chapter
he discuss about the fiscal policy and
exchange range management in this
chapter. The main mistake that Indian
policymakers did was to micromanage
everything. Though the government should
try to deliver a wide range of policies, an
intelligent government recognizes that no
matter what kind of society it aims to
build, it is hopeless to try to deliver it all
by itself. But one of its central functions
has to be to create a stable macroeconomic
environment, where ordinary peoples
talent and enterprise can flourish. That is
what this chapter is concerned with.
Fiscal policy is concerned with the
management of the governments budget.
As most governments spend more than
what they earn, they end up having fiscal
deficits. Just like personal financial
management, the fundamental rule in
budgetary management for government
also is that don't spend beyond one's
Keynesian economics have taught us that
overspending is also sometimes good.
When the world faced with the repression
this time in 2008, the nations responded
with monetary expansion. As India had a
good record of fiscal prudence, it could
also go for that but, it faced a great chance
of inflation. So the first option for India is
to raise the tax-GDP ratio which is very
less compared to both peers and the
industrialised nations. This could be raised
to at least 15% from current 10%. This can
be done almost entirely through plugging
of loopholes and prevention of tax evasion,
and the implementation of a more rational
tax code, without having to raise tax
rates.3 such an increase can make a large
difference to the governments
engagement with society. It can have a
magical effect in terms of what the
government can deliver to its citizens in
terms of better infrastructure, energy,
water, and general social welfare. Though
increasing tax collection is one way to
improve the infrastructure, it is not the
only way, fiscal policy should also try to
lure the private sector to create
infrastructure as it is obvious that
government will not have all the
capabilities.
Recognizing that infrastructural
investment is more a matter of finance
than bricks and mortar, the Indian
government talked about a target of $1
trillion of infrastructural investment during
the twelfth Five-Year Plan, 20122017,
with about half of this being raised from
the private sector. It is clear however that
the success of raising this will depend a lot
on the governments policy. Experience
shows that when a government (with the
ability to print money) gives a guarantee,
investors are eager to put their money into
projects. Such guarantees, given
recklessly, can lead to unsustainable fiscal
deficits in the long run with all their
attendant problems such as inflation,
collapse in investment, and ultimately,
economic recession. This is not to negate
the fact that the government has to give the
assurances in certain cases especially
during the take-off stages of buoyant
economy. It has to check whether the
policy have lot of positive externalities and
then to do the analysis and then select a
careful cluster of complementary projects
and give well-designed guarantees. By
giving strategically designed guarantees to
investors, the government can actually
guarantee itself against any increases in the
total fiscal deficit.
The exchange rate management was the
other topic discussed in the chapter. Basu
analyse the policy of China and says that
the Chinese policy of keeping the
exchange rates fixed and artificially
devalued is like a store selling its products
to others at a loss and cannot be continued
for long. That is as good as throwing the
products into sea. The only time we can do
such policy without any issue is in the case
of habit forming goods only. As buying
from nations can also be habit forming
china would have done it with this
objective and would soon start rising the
prices.
The question whether India should follow
this policy will have to be answered in
negative as we follow a totally different
regime. The current system in India is one
in which there are some capital controls
for foreign exchange sales and purchases,
and on rare occasions the Reserve Bank of
India has made market-based interventions
that take the form of buying and selling
dollars in order to keep the exchange rate
stable. Hence, if India is to use a deliberate
policy of trying to get nations habituated to
buying from India, this has to be through
strategic central bank interventions in the
exchange rate market. This is not a very
desirable option even though it may create
some benefits by increasing the exports.
One consequence of using standard market
intervention to try to hold the exchange
rate below what market forces result in is
that it leads to a build-up of foreign
exchange reserves. This happened in
China, which now has a staggering reserve
of around $4 trillion. The other issue is
that during times of depreciation also, the
power of central bank is not unlimited to
hold it especially during times of capital
flight like what happened during
downgrading of US treasury bonds.
It is, however, possible to argue that it is
not necessary to have an impact on the
reserves when trying to alter exchange
rates. By using a suitable strategic
techniquecalled schedule
interventionit is possible for the central
bank to game the private foreign exchange
dealers to influence the exchange rate
without running up costly foreign currency
reserves or running the risk of draining
limited reserves. Broadly, a schedule
intervention is one where the central bank
or its agent bank enters the foreign
exchange market not with a fixed quantity
demand but with a demand that is
conditional on price. In other words, it
makes it clear that if the exchange rate is at
a certain value it will buy (or sell) a certain
amount of foreign exchange, if the
exchange rate is at another level it will buy
(or sell) another amount, and so on.
Basically, a schedule intervention bends
the demand or supply curve of foreign
exchange (that private agents confront).
The claim is that exchange rate
management and reserve management can
be treated as two independent objectives.
The secret is to choose a suitable schedule
of intervention. If the currency market is
fully competitive, there is no advantage
from a schedule intervention; but if the
market has big, strategic dealers and
banks, then schedule interventions can be
vastly more effective. The central bank of
Mexico has already done this with success.
While closing the chapter the author
claims to do a analytical digression by
examining the balancing of the art of
managing the economy and making
predictions about it. It is impossible for the
policymaker-analyst to both manage the
macro economy and make forecastswhat
Ahamed refers to as economics
Heisenberg challenge. This is because of
the fact that the prediction itself will
influence human expectation and
behaviour and will in in turn shape the
actual inflation partly. So, the objective of
accurate forecasting and the objective of
inflation control pull in different
directions; and therein lies the dilemma.
Basu says that he doesn't know the
solution to this conundrum and leave to
others to solve it.
CHAPTER 5- GLOBALIZATION AND
THE CHALLENGE OF
DEVELOPMENT.
Globalization and the complexities that it
make to the policy makers is a dominant
theme that runs into many chapters of the
book. He demonstrates how well the world
is integrated with some examples that are
interlinked. He says that when US bonds
were degraded the global investors pulled
money and flew to US who was the only
state that could print the money and give to
them in case of a default. Had it been
before Eurozone crisis people would have
turned to Eurozone. But as Eurozone has
no central bank that would come to rescue
of individual nation during the time of
default. Likewise, when there was QE in
the US the developing economies like
India saw the influx of capital resulting in
inflation and stagnation at different parts
of the world which Basu calls as the salad
bowl stagflation. What the author wants to
stress is that policy matters like the end of
poverty and a better sharing of prosperity
etc., which are usually treated as matters
that are nation specific, however, with
globalization, even this area has become
one where interconnectivity of policies is
critical among nations.
In April 2013, the World Bank for the first
time veered beyond its usual commitment
to the mitigation of poverty to add the
sharing of prosperity and promotion of
greater equality among peoples as an
explicit goal. A certain amount of
inequality will always exist and, in many
ways, is welcome because it creates the
tensions and incentives needed to propel
society forward. But the kind of inequality
that we see in the world today, with
roughly a billion people living on less than
$1.25 a day and a handful of people with
incomes so high as to be difficult to
comprehend, is surely unacceptable. What
makes this issue complex is the
interconnectedness of nations which make
the effort to correct this within a country or
within a region usually leads to a flight of
capital and highly skilled people out of the
country or the region, which could actually
exacerbate the problem of poverty in the
region or the state.
Basu tries to establish that the targets
matters in establishing the domestic policy
and in laying out a global policy agenda.
He tries to explain it by trying to achieve
the goal of greater equity by a policy of
taxation. There are three ways of taxation
in a country to make the poor better off
where there are only two kinds of people -
skilled and unskilled who are rich and poor
respectively.
1. Utilitarian way where the only
concern is to increase the aggregate
income and overall growth where
the taxation will be zero
 2. Rawlsian tax rate- here the tax rate
to exactly that level where the total
tax collection is maximized.
3. Equality tax- the point where the
post-tax income of the rich is the
same as the income of the poor
after they receive their transfer.
Globalisation has made the taxation game
very complex as all nations are interested
in reducing poverty of its citizens which it
tries to achieve by luring a portion of
skilled people by reducing the tax rates
which actually hurts the others compelling
them also to reduce tax rates everyone to
finally have a tax rate that is negligible and
counterproductive to the goal of greater
equality. Unilateralism in terms of taxation
and other fiscal policies was fine until a
few decades ago when the global economy
was largely Balkanized, with respective
national boundaries marking out each
economy.
CHAPTER 6- FOOD AND POVERTY
The chapter starts with a brief introduction
about anti-poverty programmes of the
Indian government and it is said that many
of the programmes were good on the paper
but deeply flawed on deeper analysis. Basu
analyses one major anti-poverty
programme of government- food sector.
This has led to prevention of famines and
great distress but in terms of tackling the
chronic poverty and malnutrition Indias
record is dismal.
India maintains a huge buffer stock over
and above the requirement to meet harsh
times. This was the case when the food
inflation was more than 20%. This was
when the global price of wheat was 30%
lower than the Indian price. Thus the very
system that was meant to help the people
ends up in hurting them. These facts
illustrate a pervasive weakness in Indias
policy - procurement, storage and
distribution. Our policy has not helped
both the farmers and the poor people. This
is what the chapter explains and tries to
find the solutions for it.
The popular perception in India about the
food inflation is that it is due to poor food
management. But inflation as it indicates is
a general price rise and mismanagement of
any few food grains should increase the
price of those items only. Ideally, food or
for that matter anything should be
purchased when there is a surplus and the
prices are less and should be released
when supply is less and prices are high.
But if we check the procurement data over
the years nothing like that has been done.
Another Flaw is in the release as of now
the food from FCI is released only to the
millers not to traders and the millers are
prohibited from selling the gains to others
and make a profit. If the target is to reduce
the price by reselling then there should not
be any reason to prevent the reselling by
millers. But if government tries to
micromanage what the buyer does it after
buying it is not a good thing. This will
reduce the zest to buy the food from FCI.
Though it is not governments objective to
make profit to the private player it is the
mechanism through which government can
direct the food to the poor.
The reason for having a MSP two fold -
one is to support the farmer and other is to
have a good reserve during the bad times.
While this is being done it results in the
problem of making MSP a price above the
equilibrium price in a free market. Then if
government tries to sell it above MSP it
will result in food inflation and if it sells
below it it will result in a fiscal deficit. It is
impossible to have three objectives of
providing high price to farmers above the
market price, to provide food to poor
below the market price and to make it
commercially viable.
A good food policy will ensure a buffer to
stabilise the price and would provide cheap
food to the poor. Because of geopolitical
reasons it is always advisable that all the
governments should keep their buffer even
though the trade is free across borders. But
for a buyer like government it is wrong to
buy all the times and it should ideally buy
more when there is a surplus. For this a
self-working switch can be created by
carefully designing the MSP which will
get automatically on and off according to
the production and market prices. This can
happen if we keep the MSP above the
lowest prices in bad time and below the
highest prices in good times. The process
of releasing is also as important as
procurement. If government does not
release the food it procures and becomes a
net hoarder then it will cause the inflation.
Thus though it is desirable to keep a buffer
it should also not be sacrosanct but s the
officials should be allowed to violate it
according to the needs of the economy.
(His argument that grain storage that is
not distributed is a waste (or as good as
not having) is a fallacy. Given the
psychology of traders, food storage is a
safeguard against profiteering and
exploiting shortages. Consider what
happened in the pulses trade last year in
the absence of buffer stocks. )
Food security for the vulnerable is an
important government function. Food
security for all does not entail the false
promise that there will be food for all at all
times, but simply that government will
ensure that everybody has access to a
certain minimal amount of food and, in
case there is an overall shortage of food in
the nation (which cannot be corrected
through imports), that everybody will
share in the shortage. Though the PDS
system through ration shops may be well
intentioned it has not worked well for
India. We have to design the policies by
taking into consideration the actors
involved in such a policy.
To solve the issues with the current policy
Basu suggest a good alternative in the
form of food coupons. He says that it can
be issued for the women of all the
households which will increase their
decision-making power and the researches
have proven that it is less likely to get
diverted for other use. These food coupons
can then be used to get food from any shop
not necessarily from ration shops. As the
shopkeeper will get full payment he will
not behave badly to the poor and as the
poor has more choices of shops it will
create competition among the shopkeepers
and their incentive to sell substandard food
will be less. The counter argument against
this idea is that people could use it for
something else. But in that way even now
we cannot ensure that the food supplied
through ration shops are eaten by people.
Too much micromanagement will be
counterproductive. It is also better than the
direct transfer of money as food coupon
distribution has more luring towards
buying the food than money.( i completely
agree with this idea especially when
considering the fact that it will be very
costly to have another layer of vigilance to
prevent the pilferage from existing
structure of PDS and it will also create the
question of who will police the policeman)
CHAPTER 7- NUTS AND BOLTS OF
ECONOMY
Basus application of behavioural sciences
to economic issues (O-rings, nuts and
bolts, as he terms it) is enlightening. By
nuts and bolts the author implies those
aspects of economy though seemingly
unnoticeable but are very vital for its
functioning, just like plumbing in a house
until and unless something goes wrong no
one will understand the importance.
Finance is such a nut and bolt of the
economy.
Discussion on finance is preceded by the
discussion on general theory of contract
which in simple terms says that if you give
me x today I will give you tomorrow. It is
the Pareto improvements that normally
govern the system of contract in a society.
It states that as long as a contract benefit
the contracting parties and do not
negatively affects the others in a society
then such contracts should be allowed. But
this has serious limitations when we check
for the cases like slavery or sexual
harassment at office place which are done
on the basis of consensus. In such cases
both parties are benefited and others are
not affected at all. But such cases when
increases in number negatively affects
others to say, one who is not willing to
make sexual compromises in the office.
Thus Basu develops an alternative to the
Pareto improvements which he call as
large numbers argument which
essentially seeks to ask a question -What
would lots of people signing such
contracts do to those who do not want to
give away these rights?
Despite being the least understood
segment of an economy, finance seems to
be the most important. This can be clearly
demonstrated by the fact that the decisions
that helped India to escape from clutches
of Hindu rate of growth were related to
finance
, viz, the nationalisation of banks,
and creation of UTI which helped the
investment rates and savings rates to rise
which in turn resulted in higher growth.
Thus despite being such an important
sector it has got enough attention it
deserved and India has more than 60 laws
in financial sector which are mostly
outdated and obsolete. What makes
financial policy very hard is the fact that
we need to protect the interests of weak
and poor as finance is an area where poor
gets trapped in contracts that they don't
understand.
Final section of the chapter deals about the
Ponzi schemes. Ponzi schemes acquired
their name and notoriety from Carlo Pietro
Giovanni Ponzi, later known as Charles
Ponzi. It is essentially a scheme which
relies on an ever increasing number of
people joining the scheme to sustain the
scheme and can take any form from being
selling an overpriced product to the famed
employee stock option scheme. The
difference in stock option with other Ponzi
is the possibility of company bringing
more innovative products which will then
help the company to go without launching
stock options further. The tragedy of the
Ponzi scheme is that it has to crash and
what compounds the challenge of
regulation is that there is no fixed point
where it crashes. What makes it further
complex is the intertwining of malignant
practices with perfectly legitimate and, in
themselves, benign practices that makes
the regulation of these operations and,
more generally, of financial markets so
hard.
The case of too big to fail companies is
also similar with people who heading it
realising that all the profits will be theirs
and the losses will be borne by the public
as any failure of the company will have
devastating consequence on the whole
economy. As a solution the author suggest
that while the government should save the
company it should not save the people who
head the company.
Finance is an essential part of the modern
world. Blanket prohibitions and excessive
regulation can do damage. But the obverse
of leaving it all to the market is no panacea
either. We have to live in a world of
continuous research and evolving
regulation.
CHAPTER 8- LAW AND ECONOMICS
This chapter puts forward one of the most
debated idea of Mr. Basu regarding
corruption and bribery. Unlike the
developed countries, the fact that law is
something that influence the economics is
not widely accepted in developing nations
like India.
Corruption is a widespread phenomenon in
India. Basu identifies a form of corruption
where a bribe giver has to give a bribe to
obtain a service he is legally entitled to get
which he calls as harassment bribes.
According to the section 12 of prevention
of corruption Act, both giver and taker will
be punished. This is mired not only with
the moral issue of not differentiating the
perpetrator and victim bit also with the
practical issue where the giver has no
incentive to disclose the action of bribery.
If we make only the bribe taker punishable
the trust element between the giver and
taker will be broken as the giver can now
report the bribe giving fearlessly. (I found
no reason to oppose this idea)
The importance of law and governance in
economy can be understood by the fast
growth of Bihar which had a better law
and order under new government. Basu
again stress that the most important legal
aspect for economy is the contract. One
major function of law is to facilitate such
contacts and exchanges. He then gives
how a faulty law on fixing the rent to be
paid by tenant actually hurts the economy.
It will hurt the tenant because the landlord
will quote a higher rent and the case is
worse for short time tenants who wants to
stay a few months as they will be deprived
of places with less rents. Moreover it
dampens the growth of construction sector.
Similarly, the Industrial Disputes Act also
hurts the same set of people it tries to
protect - the workers as it discourages
firms to employ more people temporarily
when time of need. This will form a classic
case of contract where both the contracting
parties are benefited and others are not
badly affected. But he criticizes the idea of
special economic zones where the contract
says that certain workers should waive
certain rights off which make the other
workers outside the zone worse off.
According to the standard paradigm of law
and economics, the law influences the
behaviour of individuals by allowing or
disallowing certain actions, or by altering
the returns individuals earn from certain
actions. If we assume while making a law
that people will follow it blindly then we
will be at fault. The law changes peoples
behaviour, to the extent that it does, by
altering their expectations of what others
will do. In the language of game theory,
when the law changes behaviour it does so
by creating a new focal point in the game.
Basu tries to explain the law abiding/
violating nature of people by concept of
focal point and Nash equilibrium. A
Nash equilibrium of a game is simply a
choice of action on the part of each person
(or player) such that, given other peoples
choices, no one wants to change his or her
own choice. Hence, it is also often called a
self-enforcing outcome. A focal point is
a Nash equilibrium that is salient and so
everybody knows it is the one each of
them is rooting for. Focal points arise
somewhat mysteriously from human
psychology and enable people to correctly
guess what others are planning to do.
Thus, if the law creates a focal point
people will abide by it. Thus the plethora
of laws in India like the child labour laws
are often violated because it fails to create
a focal point otherwise are not self-
enforcing which will in turn creates
incentives for people to deviate. This will
happen when the law is internally
inconsistent or too cluttered or unclear,
people learn to ignore it. Once this
happens with several laws, this damages
the focal point role of all laws. In this way
even a good law fails to be effective, since
people may have learned not to take law
itself as a signal. This is a focal point
problem. A focal point influences
behaviour only if all players treat it as
focal.
The prescription by traditional law to have
more laws to prevent the violation of
existing laws are also flawed because it
will add to the layers of multiple laws
which will destroy the focal point. Also in
cases where the laws are inconsistent or
contradictory it will destroy the focal
point. The author advice against conferring
too many legal rights on the people,
without being clear that they can actually
be enforced. This does more damage than
simply having those rights unenforced. To
have a society where the law is effective,
we need to have simple, easy-to-follow,
non-contradictory laws; and we have to
also gradually nurture the norm of
following the law, through education and
through the leaders setting an example.
CHAPTER 9- THE SOCIAL AND
ORGANIZATIONAL FOUNDATIONS
OF ECONOMIC DEVELOPMENT.
Economic development depends critically
on the presence of appropriate social
norms, mind-sets, and institutions. Since
much of economic theory has been
developed in industrialized nations, there
has been a tendency to relegate social
norms to the background. This is why
many conventional policy prescriptions
given to developing economies, which
emanate from industrialized nations, such
as the Washington Consensus, had little
positive impact and often actually
backfired. This makes it imperative not
only to catalogue the human
irrationalities but the use of analytic
thinking to draw out the implications of
systematic human irrationalities for the
functioning of economies and the
construction of better policies.
However, utilizing our knowledge of
peoples norms is not the only way to go.
Norms can be changed. The best example
would be Japan which was notorious for
its tardiest nature in the beginning of the
20th century is now the most punctual
nation. This means that when we distribute
subsidized food or health benefits via
bureaucrats and government workers, we
will, in the short run, have to try to create a
system which does not provide scope for
cheating on the part of these bureaucrats.
But in the long run we can try to change
the norms whereby government workers
do not even try to cheat and take advantage
of the system. Not cheating should be part
of their instinctive behaviour.
If we examine the teacher absenteeism in
India also we can conclude that the norms
matters as the absenteeism is different in
different states. So the argument to have
stronger rewards and punishment system
will be of not much help. It is imperative
that we initiate the administrative reforms
for the nation to grow faster and for that
understanding the sociology and the
pathology of organisations is a must. If we
consider decision-making in India is at two
polarities- overlapping organisation
which allows everyone in government to
participate in decision making and
partitioned organisation where every
person has a say over a certain domain.
India inclines more towards the former as
can be seen where a file clearance requires
too many signatures. But it is imperative
that India needs to move towards the
partitioned organisation.(I feel that the
overlapping organisation despite having
the drawback of taking more time ensure
adequate checks and balances in the
public policy and could provide more
wisdom to a policy decision.)
CHAPTER 10- THE ROAD AHEAD
In the concluding chapter, Basu share his
vision and hope for India and makes a case
for easing of restrictions in the education
sector which he think could be another
success story like IT revolution.
India is at the verge of a take off stage
which is amplified by a plethora of
reasons. Firstly, the global economic
landscape can no longer ignore the cheap
labour by unfair trade practices. the march
of technology has created opportunities
not just for India but also for any emerging
economy that is able to keep its own house
in order by providing basic infrastructure,
law and order, an independent judicial
system to mediate in disputes, and an
enabling milieu for enterprise and
investment. Secondly, India has already
invested in a functioning and vibrant
democracy. Then, India and US are
witnessing alignment of their mutual
interests. Thirdly, Indian economy after
long years of stagnation has instituted a
series of economic reforms and finally
there is dramatic change of leadership
which indicates that people are ready to
accept changes in policy that comes with
the new leadership.
Basu believes that India has the potential
to join the ranks of industrialised countries
with per capita income more than $10,000
by 2040. But for that more scientific
policy making using statistics and data
should be instituted. There are sectors in
India like IT which grew not because of
government policy support but because the
government constraints were removed.
Another sector having such potential is the
higher education sector.
The long standing tradition of research and
English provides India advantage to
become a global hub for education. This
could in turn help in improving the
primary education and research for the
residents. Unfortunately India started to
lose it advantage but can be revived for
sure. For that firstly, UGC and AICTE
should be transformed from their present
status where they decide what to teach,
what fees colleges should charge and what
salary should they pay etc. to a new state
where they do just minimal regulatory
functions and ranking of universities.
Secondly, we should not try to make all
our 600 universities as equal which will
only result in the mediocrity of all the
universities. We should allow good ones to
flourish and the bad ones to suffer. The
universities should be allowed to fix the
salaries and all to the professors by
themselves. Finally, we should ensure
more private sector participation in higher
education and open the door for
collaboration with the foreign universities.
This will allow creation of top universities
in India which can attract students from
developed countries who can study the
same course with same quality for less
price in India. This will not only help the
country earn income but will also help the
government to focus more on other
pressing areas like primary education. To
aid this we need easy visa norms and laws
that will discourage misinformation to
students. (Though the idea is stimulating it
questions Basus own postulates that we
should form the policies suited for a
society based on its norms. India is
notorious for linkages between the
politicians and the private entrepreneurs
in education which has resulted in the
decrease in the quality of education)
As a closing note the author makes the
readers remember that thanks to the march
of technology, is rapidly shrinking, the
development project of any nation has to
be viewed as a development project of the
world. Ultimately, the nationalisms of the
day must make way for a global agenda
that all peoples, irrespective of their
narrow identities, can shape and
cherish. On the whole, this book is a
primer on economic development done by
a great theoretician who bends abstract
theories to suit real-world needs. If Basu
had amplified his book, drawing on the
debates he witnessed inside the
government as CEA, it would have added
more value. Perhaps, in his next book.
.