Guns or Butter, Both Need Investments

Our common interest requires building a consensus on cash flows.

"Money, money, money… makes the world go 'round...." This line from a musical set in 1930s' Berlin is inescapable in the commercial, economic, and often the political aspects of reality. While the show emphasised escaping through make-believe, the real-world actually follows closely along.

Take India’s economy: Despite growth, without commensurate profits, employment, and wellbeing, we are marking time. Analysts point out that corporate profits languished since 2008, trending down as a percentage of GDP from 2010, excluding a  minor improvement in 2017. In fact, profits have not grown in real terms despite annual GDP growth of about 7 per cent for 10 years as shown in Chart 1.

In the boom from 2003 to 2008, profits to GDP doubled from 2.8 per cent to 5.5 per cent. Growth was driven by investment and exports as well as by consumption. After the subprime crisis of 2008 and the recession, profits in India slumped, partly because of excess capacity, and the rising costs of additional debt caused by inflation targeting (the components being wages, taxes, corporate profits, interest payments and rents).

Although profits recovered somewhat, they trended downward, and by 2018 were 3 per cent, the same as in 2003. By comparison, US figures (after a low of 4.95 per cent in Q4 2008) ranged from 9 to 11.7 per cent. Gross profit to GDP in the US was 20 per cent in 2015, while in China (2014) it was nearly 30 per cent (Chart 2). Surpluses are essential for investment and development, because neither can happen without them. Only thereafter is a higher wage-share affordable.

Source: https://www.schroders.com/it/sysglobalassets/digital/insights/2017/pdf/em-growth-mirage/gdp-and-earnings-growth-thought-leadership.pdf

Of the decline in India from 2008 to 2018, about nine-tenths happened in four sectors: PSU banks (36 per cent), oil and gas (19), metals (18) and telecom (15). During this period, consumption replaced investment as the driver, with growth in sectors such as automobiles, consumer durables and retail. Some commentators expect these trends to continue, with some optimism on the revival of investment.

The counterfactual is that we haven’t had any required reforms of structure and organisation for surpluses to grow in PSU banks, utilities or telecom. For instance:

• In banking, the NPA crisis remains, but the focus has moved away to elections.

• Reliable electricity supply needs financial sustainability and stable pricing, and neither is available. Coal mine auctions haven’t resolved resource costs and availability, while financial gambits in the form of race-to-the-bottom bids to start projects and sell out early, instead of staying for profits from operations, aggravate problems in pricing and delivery for renewable energy as for conventional fuels. The financial incapacity of state electricity boards has created another set of problems, compounded by continued populism (unsustainable prices).

• In telecom there has been only one major reform for 5 GHz spectrum for WiFi, despite the new National Digital Communications Policy.

Meanwhile, electoral wrangling threatens to further deplete the treasury, whereas the problem is the opposite: Lack of surpluses (profits, and ultimately, cash). Profits have been stagnant for a decade starting from UPA-II, partly because of the excess capacity of the boom. This has constrained development spending, because low surpluses have kept investments down. By contrast, investments and exports were strong from 2003-2008.

Several other social forces add to the downdraft.

• One is a political system that encourages splintering and divergence. As large parties have established hierarchies, it’s easier to start anew to get and control funding for splinter parties around divergent special interest groups.

• Another is incomplete or dysfunctional design, whereas expenditure must produce surpluses. For example, a new metro service in one part of the National Capital Region does not connect with the Delhi Metro. What’s more, the interchange is separated by several kilometres, and is reportedly designed to end ultimately with a gap of 350 metres at street level. A ‘rapid transit’ system that slows you down? If this were designed by enemy action to tie up resources and make people unproductive, they could not have done better. Similar problems assail the design of communications systems that often don’t ‘connect the pipes’ all the way through, such as spectrum regulations that hinder communications, hastily applied GST regulations, or expressways with bottlenecks.

• A third is behavioural acts of omission or commission that increase costs and reduce surpluses. Ignoring laws, rules and regulations, whether it’s driving down the wrong side, lane indiscipline, jumping traffic lights, breaking queues, littering, polluting, and such other lapses, including government agencies not paying bills.

• Yet another is accepting mediocrity, ignoring standards and protocols required for quality outcomes, products or services.

If we are to achieve surpluses, we will have to build a consensus focused on cash flows. The building blocks are ‘trainable’ virtues, with appropriate structures, processes, and behaviour. Social disciplines such as a sense of responsibility for and a desire to maintain good order, working logically, cooperatively, to plan — an ‘objective oriented, project management approach’ for individual and group gain — needs to be taught, ideally from the cradle, and reinforced in our activities, provided the connectivity and content are built to support this. These values can also be introduced at any level. Playing for group stakes and open, direct communication can be habituated through practice, by educational, economic and political systems treating them as worthy of inculcation and reward.

A necessary adjunct is to embrace long-horizon plans and group gains through multipartisan activity. For example, export initiatives are needed using digital technologies that feed into a digitally informed foreign trade policy (DIFTP). Such initiatives require diligent collective effort, recognising that short cuts are at the cost of larger gains. Until we practice such convergent, national-gain behaviour, we are unlikely to generate the surpluses we wish for.

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Shyam (no space) Ponappa at gmail dot com

1: “Corporate profit to GDP: Analyzing growth across cycles - 2018 mirroring 2003 bottom”: https://www.motilaloswal.com/site/rreports/636840041276772228.pdf

2: https://thewire.in/political-economy/what-explains-india-incs-corporate-earnings-conundrum

3: https://www.researchgate.net/profile/RASHMI_BANGA/publication/330824656_Is_India_Digitally
_Prepared_for_International_Trade

Hollowing Out India

Should India develop and sustain certain capacities, or allow them to be eroded?

Shyam Ponappa   |   April 5, 2018

A society’s functional capacity can “hollow out” in many ways. The following examples illustrate how self-imposed policies, regulations or practices subvert our capacity. To avoid this, our governments and polity need to adopt “rules of the game” based on constructive perspectives that maximise benefits. Our present approach is often restrictive and rationing, i.e., scarcity oriented.

A path-breaking article in the Economic and Political Weekly four years ago highlighted the fall of India’s share of manufacturing in total manufactured goods.¹ Although manufacturing exports were rising, imports grew faster than exports resulting in a hollowing out, with disproportionate gains to foreign suppliers. Manufacturing contribution to gross domestic product (GDP) remained at 14-16 per cent since the 1980s, compared with China’s growth of 34 per cent, Thailand’s 40 per cent, or Malaysia’s 24 per cent. Employment in manufacturing remained at 12 per cent from 2000 to 2009, while contribution to labour productivity growth was only 6 per cent, compared with China’s 32 per cent and Malaysia’s 68 per cent.

The World Economic Forum and A.T. Kearney's "Readiness for the Future of Production Report 2018" is more positive, although with a warning regarding the future. Countries are classified along two dimensions, “Drivers of production”, and “Complexity and scale of production structure”.

Source: http://www3.weforum.org/docs/FOP_Readiness_Report_2018.pdf
Note: Average performance of the top 75 countries (weighted average driver score, weighted average structure score) is at the intersection of the four quadrants to create the archetype borders.

On the drivers (vertical axis), India is a little below middling, while in scale and complexity (horizontal axis), India is somewhat better than middling.

India is in the “Legacy” quadrant (strong base, but at risk for the future) including Hungary, Mexico, the Philippines, Russia, Thailand, and Turkey among others, and is ranked ahead of Russia, Brazil, and South Africa.

Chart 2: Future of Productivity Readiness Some legacy Countries & Brazil - Rank Structure of Complexity Production  & Scale Hungary 17 42 India 30 44 Mexico 22 46 Philippines 28 66 Russian Federation 35 43 Thailand 12 35 Turkey 32 57 Nascent Countries Brazil 41 47

The commerce ministry is reportedly taking remedial action, applying recommendations by the same author who wrote about the hollowing out of manufacturing, Dr Banga, in her subsequent capacity as head of trade competitiveness at the Commonwealth Secretariat. Her recommendations are to link into specific Global Value Chains (GVCs).² India could benefit significantly if these initiatives are followed through, as with the  Automotive Mission Plan 2006-2016, now in its second 10-year cycle. Automobile assembly jobs grew from 10 million in FY06 to 32 million in FY16. This collaborative effort between the Ministry of Heavy Industries and Public Enterprises and the Society of Indian Automobile Manufacturers is a road map for sectors that need urgent attention, such as solar energy and wireless broadband. This is why politicians need to focus on working with government, industry and citizens on shared objectives, instead of destroying possibilities of working together through perpetual confrontation.

Hollowing Out Happens In Other Ways

One way is through equipment imports. Take solar equipment imports: The issue for India, with so much insolation together with other requisites such as technical skills and production capabilities, is how to formulate policies and regulations to support innovation in solar energy use, with incentives for R&D and manufacturing/marketing for such products and practices. The entire value chain has to be designed and set up comprehensively, instead of our typical piecemeal and/or episodic, or half-baked approach. Without this, such imports ensure that India, among the top five countries in terms of demand, remains a captive market for foreign producers. Similarly, domestic manufacturers of conventional energy equipment face foreign competition that has access to subsidised material and inputs, export incentives, low-cost funds, and better infrastructure. Imported equipment for solar or conventional fuels lasts for 25 years, blocking the best markets for developing local production capacity. This hamstrings local suppliers, who already lack comparable policy support, including government procurement and country-backed funding. In this situation, local production can rarely develop, if at all, to supply large but inaccessible local markets. We have to recognise all this, devise remedial ways, and follow through with implementation.

Competitive bids and auctions result in a race to the bottom focusing on the short run and hopes of cashing out, creating a mirage that prevents building sustainable capacity. A number of energy companies have done this, although several have stalled before they could sell out. Low bids below spot electricity prices obstruct genuine capacity building. For renewable energy, feed-in tariffs are unreasonably low, subverting their viability. One example is a Chinese-Japanese consortium bid in the United Arab Emirates at $0.0242/kWh (about Rs 1.61). Such bottom-fishing ensures that no projects succeed, whether for conventional or solar/renewable energy.

A variant is through controlling materials that go into batteries and electric vehicles, such as lithium, cobalt, nickel or manganese, or copper for charging equipment. For example, Chinese companies produce 77 per cent of refined cobalt.³ Therefore, decisions such as the promotion of electric vehicles over conventional vehicles need a life-cycle analysis, including the sourcing of raw materials.

Yet another example is how India’s policies hamper the design and production of wireless equipment for telecommunications and broadband. India has the chip-designing and production capability for Software-Defined Radios (SDRs) for wireless communications except for the fabrication of chips and chipsets (similar to Qualcomm), and is a huge market for such equipment. Yet, as evidenced by entrepreneurs designing SDRs and TV White Space devices, it is difficult even to get access to the spectrum required for testing devices. Innovators cannot begin to design commercial solutions and win without radical changes to our policies and practices, extending through funding at the intermediate stage, and access to domestic markets. Who will buy from unproven undertakings in an oligopolistic market dominated by a few international giants?

Many more areas — agriculture, finance, the Internet — have similarly obstructive rules and practices. As felicitous policies and regulations boost capacity, we need to adopt tariffs and local sourcing aligned with World Trade Organization norms, with the emphasis on permissible incentives, such as waiving excise for fuel and customs for exports, interest subvention, end-to-end financing, value chains, and access to markets. We need barriers and umbrellas, with heavy emphasis on the latter.

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Shyam (no space) Ponappa at gmail dot com

1. Rashmi Banga, “Trade Facilitation and ‘Hollowing Out’ of Indian Manufacturing, Economic & Political Weekly 49, no. 40 (2014). www.epw.in/journal/2014/40   |   http://www.epw.in/journal/2014/40/notes/trade-facilitation-and-hollowing-out-indian-manufacturing.html

2. Banga, “India’s Global Value Chains-Linking LDCs”, Commonwealth Secretariat (2016)

http://icsa.net.in/uploads/study/1493533092BoostingIndiaExports1.pdf

3. For details on control over sources, see Arunabha Ghosh, “A Wild West for minerals?”, Business Standard (March 26, 2018)

http://www.business-standard.com/article/opinion/a-wild-west-for-minerals-firms-are-rushing-to-buy-mines-overseas-118032601192_1.html