Monday 10 April 2017

Make in India, But How?

From the alarm clock that wakes us up in the morning to the zero-watt bulb that we glow at bedtime, there are innumerable manufactured goods we use every day.  Can we name a few among these which were originally developed and manufactured in India and the rest of the world copied them later?

If you experienced a long pause of silence, it is not surprising.  Of course, we make many products in India but we have mostly depended on others to develop these products first.  And, as long as products are invented, innovated, and/or first manufactured elsewhere, the make in India story will always be viewed as the story of catching-up with others.  The muslin cloth is perhaps the last of the popular goods originally developed and produced in India before industrial revolution moved manufacturing to England and Europe. There onward, the baton moved to the US in the first half of the 20th century, followed by Japan in the post World War II era and finally to the South East Asian countries.  And, this begs the question - Is it now India's turn in the 21st century?  India getting up to speed and firmly carrying this baton forward seems very challenging, for manufacturing does not account for even a seventh of India’s GDP today!  In fact, this lament is quite old and goes back to even pre-independence days.  The forerunner of the modern Indian economists, Justice M.G. Ranade of the then Bombay Presidency had warned in 1892 that the issue of political dominance by the British was receiving far more attention than the formidable though unfelt dominance of skill, pragmatic education, and capital.

At the time of independence, the dark memory etched on the Indian psyche was of foreign traders coming to India to buy muslin cloth but eventually turning masters of the land.  This East India Company phobia coupled with the Russian import of socialistic thinking resulted in Indian government cordoning-off the country from rest of the world.  Moreover, within the domestic economy, private sector was cordoned-off in favour of PSUs in a plethora of strategic sectors such as steel, power, petroleum, defence production, transportation, and telecom.  Furthermore, large and medium enterprises in the private sector were also cordoned-off in favour of SSI sector in about 800 reserved industrial items such as leather, textiles, and electrical goods.  Stringent labour laws, high corporate taxes, and multiplicity of indirect taxes made Indian products noncompetitive in the world market.  These policies provided little incentive for public sector to stay efficient, created unfair competition for the private sector, and blocked SSI sector from investing and growing out of its small scale mould.  The liberalization process that began with stealth in mid-1980s and then overtly in 1991 had some positive impact; however, compulsions of coalition governments, series of scams involving politicians, and, a general inertia in changing the 'licence raj' administrative structures halted policy reform, preventing Indian manufacturing to become internationally competitive.

And this begs the other question – What is it that we must do for Make in India story to unfold?  The answer lies in addressing four issues – removing policy inefficiencies that still continue to stifle manufacturing sector, creating skill and innovation enhancing environment in the country, promoting domestic savings and investments, and, providing macroeconomic stability to businesses.  Each of these measures requires an elaborate discussion.  You will find this discussion in my below referenced paper, “Make in India: Success Stories, Lesson Learnt.”  The paper is based on talks delivered by CXOs of four successful Indian multinationals that began as small scale units around the 1991 liberalization period and represent four very diverse manufacturing sectors.  What I have attempted is to galvanize their experiences with principles of economic theory:

Sunday 29 January 2017

CSR as Mandatory Trusteeship is an Oxymoron!

Corporate social responsibility or CSR as we know it today, has always been a part of Indian culture and history.  Traditionally, business communities have always supported construction of dharmashalas, panjrapols, ghats, and pathshalas.  In one of the earliest printed books in India published in 1863, the author Govid Madgaokar makes a mention of annachhatras patronized by the rich in the nineteenth century Mumbai.  In modern day equivalents, these can be termed as holiday inns, animal-health clinics, river-fronts, primary schools, and charity dining halls.  Today, of course, from food to fundamental research, the spectrum of CSR activities is very wide.  This includes provision of mid-day meals through Akshay Patra foundation to patronizing fundamental research since the early years of independence through institutions such as Tata Institute of Fundamental Research (TIFR).

Why would businesses undertake such CSR activities?  It turns out that society understands that free market fails to deliver right quantity and quality of merit goods such as education, health, and environmental sustainability.  For example, social benefit of educating poor young girls is much higher than the private benefit that accrues to those girls.  Economist and evangelical supporter of free enterprise, late Milton Friedman had said that a corporate executive’s responsibility is to make as much money as possible, provided he confirms to the basic rules of law and ethical system.  The qualification he makes about ethical system is important, for profits are inextricably linked to communities and environment without which a firm cannot operate effectively.  Though it is not obvious, CSR efforts help a firm improve the Triple Bottom Line (TBL) of profit, people and planet.  Two centuries prior to Friedman, father of modern economics, Adam Smith had also echoed this social responsibility aspect of business in his treatise, The Theory of Moral Sentiments.  And, in the Indian subcontinent, it was father of the nation, Mahatma Gandhi who invoked the notion of Voluntary Trusteeship through individual philanthropy.  Industrialist G.D. Birla, for example, was always very liberal in donating money to Gandhi if any of his projects were held back due to want of money.

Of course, CSR is not the main activity of corporates and there is no denying that one of the very raison d'ĂȘtre for the existence of a government is to provide merit goods.  After India’s independence, the statist model advocated by the first prime minister Jawaharlal Nehru, characterized social responsibility as an overarching state-driven endeavor.  However, following the Soviet model, state started dictating terms in each and every sphere of economic life.  This came at a heavy price – gross neglect of provision of merit goods.  Experience of seven decades since independence and the low levels of human development indices show a glaring state failure on this front.  Perhaps the abject failure on the part of government has now forced it to co-opt private sector in CSR activities through the new Companies Act of 2013.  In quite a few countries such as Australia, Denmark, France, Holland, Norway, and Sweden, while CSR reporting is mandatory, CSR spending remains a voluntary act.  India is the only country in the world, where both reporting and spending on CSR is mandatory for a certain section of the firms.  The Gandhian principle of voluntary trusteeship has been trapped in the legal net, reformulating it in what I call as the Mandatory Trusteeship!

It is true that government has the coercive power to impose mandatory trusteeship and corporates cannot wish it away.  However, the perception of various stakeholders in the economy can be gauged from a spectrum of opinions – Arguing from the left of the centre, the opinion would be that the government has abdicated its own responsibility.  Instead of asking firms to spend two per cent on CSR activities, government could have raised corporate tax by two per cent, prioritized the socially beneficial activities, and spent the tax collection in its own right.  On the other hand, arguing from the right of the centre, forcing a mandatory spending of two per cent of profits on CSR amounts to increasing corporate tax-rate by two per cent.  Already a 34.6 per cent corporate tax-rate in India is higher than the global average of just about 24 per cent.  Mandatory two per cent spending on CSR makes Indian corporates less competitive globally.  Moreover, arguing from a centrist perspective, it seems absurd to force CSR spending on corporates.  CSR is viewed as an inspirational activity which comes voluntarily from within.  Therefore, voluntary CSR mandated by law, a sort of mandatory trusteeship, is an oxymoron.

The new CSR norms apply to firms with a net profit of Rs. 5 crore and more, and/or a net worth of Rs. 500 crore and more, and/or a turnover of Rs. 1000 crore and more.  These firms must spend two per cent of their average net profits made during three immediately preceding financial years.  For this, firms have to form CSR Committees and their boards must mandatorily report the CSR activities.  Moreover, the spending has to be on about dozen eligible activities as per the law, which includes spending on items such as healthcare, education, poverty eradication, gender equity, as also contribution to Prime Minister's National Relief Fund.  The spending cannot be related to the firms’ own business activities.  These norms and processes are indicative of potentially inordinate administrative burden imposed by the act, both on the government and the firms.  In fact, studies have shown that the potential mandatory CSR spending was expected to be much more than Rs. 25,000 crore a year.  However, the actual spending has turned out to be only about Rs.5,000 crore.  Moreover, a survey conducted in December 2015 showed that among top 84 firms by market capitalization, only 38 per cent of them had spent two per cent of profits on CSR.   Furthermore, if we are to go by the experience of many decades of License Raj, the coercive policies of the government may create perverse and obfuscating reactions from stakeholders.  This may happen at all three stages – implementation, monitoring, and punitive actions.

The eligible list of CSR activities as laid down in CSR norms seems broad but not broader enough.  Almost all the eligible activities prescribed by the CSR norms come under the category of philanthropy through donations or running CSR foundations.  However, there are two other channels of CSR activities that do not get covered under the norms.  First,when firms improve their operational efficiency, say by developing smart-building solutions that contribute to reduced energy consumption, and/or they convert their food waste into biogas, and/or they ensure that mercury from the used CFL bulbs and tube-lights is recycled using a special crusher; these activities improve the triple bottom line of profits, people and planet.  Second, transformational business models by firms such as say drip irrigation initiative may also contribute to triple bottom line.  Selling drip irrigation system may increase firm’s profit, increase farmers’ land productivity and income, improve resource sustainability by lowering salinity ingress, and, importantly, conserve water for the society.  In its own interest firm may give loans to and buy-back produce from farmers for this initiative to succeed.  Such activities do not fall under the CSR activities specified under the companies act.  Now, to fulfill the straight-jacketed mandatory requirements, firms may anchor their CSR efforts away from such activities.  Clearly there will be a qualitative anchoring away from efforts, which in fact, improve the triple bottom line of profits, people, and planet.

The two per cent mandatory norm may create another kind of anchoring effect, this time a quantitative anchoring effect, which also may adversely affect CSR initiatives.  Experimental studies (including one at IIMA) suggest that quantitative anchoring effect may lower CSR spending by firms that are already voluntarily spending more than two per cent or were planning to spend more than two per cent.  Once a legal yardstick of two per cent is created, firms may reassess their CSR activities and anchor their spendings down to match the bare minimum new legal yardstick.

All in all, therefore, government may want to do a rethink on the mandatory trusteeship.  A reconsideration of Friedman, Smith, and Gandhi’s ideas of rules of ethics, moral sentiments, and voluntary trusteeship could be a step towards saving the firms’ CSR from getting trapped in the legal net.

Views are personal.  Read original journal article here.

Friday 30 December 2016

Newton to Namo: Debasement of Money & Demonetization

Isaac Newton was the Warden of the Royal Mint in England around the end of the seventeenth century, a time when every fourth coin was a forged one. Newton went after William Chaloner, a key mastermind of the forgery racket. He designed new minting machines which made forgery harder and started letting off an arrested forger if he or she informed on two other forgers. Very soon, Newton was able to get Chaloner hanged.  Now, let us move to a more contemporary experience.

The latest RBI Annual Report indicates that 6.33million high-denomination forged notes were detected last year, an increase of about 46 percent since 2011.  The forged currency is reportedly being pumped into India by Pakistan.  While high denomination Indian notes were readily accepted in Nepal for decades, they are not accepted there anymore!  One is reminded of Keynes who wrote in his book titled The Economic Consequences of the Peace – “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”   Forging notes is only one aspect of “debauching” or debasing a currency. There are three other forms that get christened ‘black money.’

One is the market for illegal goods such as narcotics, liquors, weapons, and human trafficking.  These markets also get financed by counterfeit Indian rupees.  The second is the markets for goods that are legal but the transactions are either unreported or under-reported.  The consequent tax evasion leads to lower government revenues and poorer levels of public goods delivered to the destitute.  It also leads to underestimation of GDP.  Yet another form is corruption.  This involves bribery to curry favours in business deals and to skirt administrative rules.  Corruption results in allocation of contracts to inefficient firms, violation of safety and sustainability rules, and distribution of income in favour of politicians/bureaucrats.  Income generated through any of the above routes can get invested in gold, benami properties, or sent abroad through hawala and often brought back in the form of FDI, a process known as round-tripping.  In all these forms, the overwhelming mode of payment is cash. 

We have witnessed such forms of financial debasement for long, but nothing worth mentioning was done about it.  Morarji Desai did scrap Rs. 1000 and higher denomination notes in 1978.  Of course, its effectiveness was not high, for very few used large denomination notes and the element of surprise and secrecy was missing. The demonetization drive that began on 8 November may appear to be madness to some, but there seemed to be some method in it.  It is now clear that secrecy had to be, and was, maintained at the highest levels. There was bound to be some inconvenience to the population when exchanging the old notes.  Despite the 50-day window, people were anxious resulting in long queues.  Issuance of new Rs. 2000 notes also seemed to have been done with a view to prevent persons from recycling old Rs. 1000 notes into new Rs. 1000 notes through ATM withdrawals and subsequent deposits.  Yes, reaching the last branch and the last ATM was a gargantuan task and may have had its own challenges.  However, alerting on such possibilities prior to the demonetization announcement would have led to an abortive demonetization effort!  The failure of the bandh called by political parties and the tolerance shown by people so far indicates that society has adjudged the transition as a regrettable necessity for the larger good in the long run.  Daily news regarding police/IT officials stumbling upon large caches of old high-denomination notes are indicative of the fact that a credible threat seems to have been created for avoiding purposive or inadvertent unreported transactions.

Of course, demonetization is only one of the pieces of the jigsaw puzzle of eradicating black money.  Hopefully, more and more citizens will opt for use of debit/credit cards and internet banking.  There has been a surge in the use of ‘cash wallets’ as well.  The importance of financial transactions through Post Office Correspondents in rural areas gets highlighted in such situations.  A few more measures need to be followed through.  Demonetization restricts current flow of black money and deters its future flow.  However, the stock of black money invested in benami properties will have to be addressed as well.  It is no coincidence that two important laws were amended and passed just before November 8, 2016.  Provisions of the amended Benami Act had come into force on November 1, 2016 and Black Money Act had come into force only a year earlier in July 2015.  These recent provisions give the required fillip to the administration to follow up on demonetization efforts.  GST implementation in the near future would also provide an incentive for businesses to get into formal sector.  Similarly, the time is opportune to bring all donations to political parties within the gambit of formal banking.

Some criticize the demonetization decision as dictatorial. Perhaps we had become used to justifying indecisiveness on grounds of the compulsions of coalition governments; and are not used to transformational decisions attributed to a seemingly dictatorial electoral majority.  Such perceptions are intriguing when some Indians hold charitable opinions on dictators like the late Fidel Castro who thrust many sacrifices on to Cubans for long periods.  India is a democracy.  Assembly elections are round the corner.  The Taste of the Policy is in the Polls!

Views are personal