Why did Xi go to Davos?

I came across this piece in VoxEU thanks to a tweet by good friend Niranjan Rajadhyaksha. Very important conclusion with which many are in denial, simply because they cannot contemplate being on the same side of the fence as the American President:

The revival of nationalism in Western Europe, which began in the 1990s, has been associated with increasing support for radical right parties. This column uses trade and election data to show that the radical right gets its biggest electoral boost in regions most exposed to Chinese exports. Within these regions communities vote homogenously, whether individuals work in affected industries or not.

The same authors had done work on Brexit earlier and had reached a similar conclusion. The reference is available in the link above. [That is why this blogger took no cognisance of Mr. Tony Blair’s pathetic and self-serving recent intervention on Brexit.]

This very closely follows the work of Schott and Pierce with respect to U.S. manufacturing employment. No wonder Xi batted for globalisation in Davos!

Very interestingly and very unsurprisingly, I had read a summary of the book, ‘China: the gathering threat’ by Constantine Menges. He died in 2004. It is published by http://www.mustreadsummaries.com

He had written something there that echoes what Brad wrote and which I had blogged on, here, that China imported far less than was expected when China joined the WTO.

However, China usually ends up conceding far less than it receives in return for its normalized relationship with the United States.

What does this mean for India? India does not have the muscle to negotiate bilateral and regional trade deals with bigger powers. Even if it has, it does not know how to use them.

So, India has to bat for a global trading system. What I am not sure though is if it should do so with China or to counter China!

Philip Stephens imagines Orwell

FT’s Philip Stephens has a piece on what George Orwell would make of Donald Trump. Really? Have they all become so unimaginative that they cannot think of any other topic than President Trump?

This is what he wrote in the article:

An “America first” foreign policy is part of the same construct. Mr Bannon, the ideologue who informs Mr Trump’s impulses, anticipates a civilisational clash with Islam and a war with China. The flirtation with Mr Putin is about confessional and cultural solidarity against an imagined barbarian threat.

This is the comment I posted underneath the article:

Imagined barbarian threat? Probably, Mr. Stephens does not read real news stories of ISI attacks on Sufi worshippers in Pakistan and, in general, four attacks in five days, etc. Plus, a steady stream of research from Europe and the U.S., have documented the impact of imports from China on communities and not just on jobs.

Some references for him:

(1) http://voxeu.org/article/globalisation-and-economic-nationalism (ht: Niranjan Rajadhyaksha)

(2) http://voxeu.org/article/globalisation-and-brexit

(3) Dippel, C, R Gold and S Heblich (2015), “Globalization and Its (Dis-)Content: Trade Shocks and Voting Behavior,” NBER Working Paper 21812

(4) ‘The surprisingly swift decline in U.S. manufacturing employment’ (Peter Schott and Justin Pierce)

Is there any law that forbids ‘liberals’ from being intelligent and being able to face, accept and address reality? Don’t they know that denial does not solve problems and hardens positions, making problems difficult to solve and conflicts inevitable? May be, I am being too harsh on them. May be, that is what they are craving for – conflict.

Further on central bank independence

My friend shared with me an article by Shri. A.V. Rajwade on central bank independence. It is about a week old.

Some thoughts triggered by that article:

In recent times – post-1970 experience of stagflation – goverments decided  – inspired by academics – to cede more powers to a technocratic central bank for three reasons:

(1) It would be seen as a credible and large-hearted, long-term, visionary response to the problem of inflation: “We created inflation and we are now tying our own hands by transferring the power to another institution which does not carry our structural deficiencies.

(2) It was also convenient. Blame can be passed on to someone else. That situation did not arise because inflation was held back by a variety of factors.

(3) The economic paradigm changed in the Seventies. Fiscal policy and Keynesianism gave way to rules. Discretion was de-emphasised. Unfortunately, only the discretion of the elected representatives was de-emphasised but the discretion of unelected and largely unaccountable technocrats increased with the framework of central bank independence.

I think it was also a very clever move to insulate from public scrutiny the influence of the interest of financial markets on public policy. An aloof, opaque, technocratic institution blessed with the perception of non-corruptibility is an ideal smokescreen for creating policies that favoured financial markets and financial interests. Democratic politicians would be subjected to harsher scrutiny. Ph.Ds with beards (or not) from elite universities would not be subjected to a similar treatment. They automatically got the benefit of doubt in the incestuous world of intellectuals-policymakers and the commentariat.

Journalists and commentators wanted to be seen as less in thrall to politicians but more to intellectuals. The latter is more respectable and acceptable. Hence, central bankers escaped tough scrutiny. That suited everyone, including the politicians!

These three factors explain how the idea of central bank independence took root in western economies in the 1970s.

To the extent that inflation is now welcomed and finance is being throttled back (let us see what President Trump does), automatically the case for an independent central bank is weakened.

Further, central banks have also invited the possibililty of losing their independence into their hallowed portals by conflating monetary policy with fiscal policy, with open contemplation of helicopter money – monetisation of fiscal stimuluses and with negative interest rates.

They overstepped and they have to be reined in. This is an outcome in accordance with the laws of nature.

But, economic frameworks, concepts, policies and prescriptions have a context. The context for developing economies is very diferent from the above discussion.

The dialogue of the deaf

The title of the blog post is the title of the book that TCA Srinivasa Raghavan had written. It is coming out soon. Anand Ranganathan of ‘Newslaundry’ had a conversation with TCA recently on the central bank independence, especially in the light of the needless heat and dust generated in recent weeks on RBI independence (or, the lack thereof).

I had read TCA’s pithily written short ebook, ‘A crown of thorns’.  That was a delightful monograph. I did not know that and I still do not know how one can pack so much information and insights in such a short work. Full of interesting anecdotes and nuggets of history.

The manner in which RBI got around to becoming responsible for fixing the daily exchange rate was interesting. That two ICS officers decided on the issuance of ad-hoc Treasury bills was amazing as was the information on R.N. Malhotra’s premature (said with the benefit of hindsight) liberalisation of deposit rates.

Regardless of whether the central bank has got operational, functional, managerial and decision-making independence, in the end, it still boils down to successfully managing the government. Conflict is inherent in the RBI Governor’s job.

Now, let us come back to this conversation that Anand Ranganathan (AR for short) had with TCA Srinivasa Raghavan (TCA for short).

My comments on the conversation in no particular order of importance:

(1) I liked the interview. There was much that I agreed with and a few I disagreed with, not just with TCA, of course.

(2) Good to hear TCA state forthright that the British colonial rulers were bandits and hence, ‘terrible fellows’.

(3) TCA is terrific with remembering dates and years. He also did a very good job of how central banks evolved from their origins as financiers to the Sovereign. There is an excellent paper  that traces the origins of central banks. Although the exposition of this paper was for a different intellectual purpose, it is very useful reading for the rest of us to get the historical perspective on central banks.

(4) TCA was also very right to dismiss the canard of credibility that only the financial market types are interested in. In their view, a central bank is credible if it did what they expect it to do or want it to do or what they judge as the correct thing to do. Otherwise, not. It is BS. TCA was very right to call it out. In fact, the interviewer should have also asked him about this so-called Central Bank Transparency: ‘basically, do not do anything that I don’t expect’

(5) The interview was an hour long. AR spent 50% of it on demonetisation (three-month vintage) while the interviewee had written a book on the 82-year history of RBI and Govt. of India relationship.

(6)  I would have to disagree with the interviewer and the interviewee on demonetisation. We simply do not know or would not know enough now to make an informed judgement on it. Most of us are under tremendous social (subtle and self-imposed in most cases) pressure to subscribe to the prevailing narrative which, in turn, was heavily influenced by the chaos of the distribution of the currency notes. As TCA himself noted later, that would be forgotten in a few months’ time. If it is indeed the case, then how can we let that influence our judgement on demonetisation?

(7) In theory, TCA is correct that, to do some of the things on chasing corruption or black money (he said that the GoI should address tax rates to handle black money and cited a figure of 52% as the effective tax we pay), one did not need demonetisation. But, nothing like a ‘crisis’ – induced or inflicted by others – to focus minds. That is what the Government’s action has done. That is what I mentioned in my Bloomberg Quint interview with Ira Dugal.

(8) I am glad that TCA mentioned that RBI had no choice but to comply with the government. Really, far too much has been made out of RBI ‘surrendering’ meekly to the government as though RBI had other options.

(9) The FSLRC report is an important development in the relationship of RBI-Government relationship. Although TCA said that he would not want to say something without evidence, AR should have asked him to share his perspectives on things that he was comfortable sharing. The sole raisio d’ etre of the report was to undermine RBI and in 2012-13, I had written extensively on it.

(10) TCA is right that it is the government that has to decide on the ‘length of the arm’ in its relationship with the central bank. An enlightened government would allow and even encourage some institutions to behave as intellectual ‘check and balance’ on it whereas the founding fathers had created other institutions that serve as watchdogs in terms of propriety, governance, etc. The government should allow RBI, the office of the CEA and the NITI Aayog to play that role – the intellectual counterweight and sounding board, occasional devil’s advocate, etc. I had written this in April 2016 when a controversy broke out over Raghuram Rajan’s ‘one-eyed king’ remark:

It is one thing to take offence when government policies are criticised publicly by officials who are part of the government but it is another thing to expect everyone to be a cheerleader for the government and the country. This government rightly took credit for strengthening the federal framework by devolving substantial resources as per the Fourteenth Finance Commission recommendations. It followed it up in this year’s budget with devolution to local governments. These things strengthen the institutional foundations of the democracy. Similarly, it should boldly announce that it would expect, encourage and empower (as the case may be) the Chief Economic Advisor, the Vice-Chairman of NITI Aayog and the RBI governor to act as ‘risk managers’ and ‘devil’s advocates’ for the government. Among other things, their roles should be to ask questions, explode myths and puncture halos. The government should be grateful for the respectable voices from within that warn about risks and caution against disproportionate euphoria. The great Tamil saint Thiruvalluvar has said that such a government cannot be defeated by any enemy.

In this regard, TCA was also very right to point out that RBI independence and autonomy do not have the same meaning as it has in western nations, when 75% of the banking system is in government hands.

Coincidentally, as I was writing this, a friend shared with me Wolfgang Muenchau’s article in FT two days ago on the independence of central banks. He reckons that it might be an idea whose time is past. Perhaps, in the Western context. This is one more proof, if it were needed, that most things in economics are a function of context. Thus, central bank indepedence can be considered a fad that is fading away with time, as fads do.

But, I think, in the Indian context, central bank independence is a goal that is worth pursuing, including for the government.

(11) I am glad that TCA was categorical about the Economic Survey and what he thought of it. There is nothing wrong in the Economic Survey having the imprint of the CEA’s personality. But, that cannot be at the cost of its usefulness as a policy document. Or, put differently, such personal imprint should be within the framework of its usefulness to the government and policymakers.

(12) The last question and TCA’s answer were both good. The question was whether one needed a central bank to set the price of money. After all, markets are supposedly better in setting the price – based on demand and supply.

One of my friends – Srinivas Thiruvadanthai – always said that central banking was central planning. TCA responded well. As long as there is a government that had certain responsibilities – including fighting wars – then one needed a central bank which is not in the control of private (market) hands.

If societies were organised as free-standing and self-governing communities, I doubt if a central bank would be needed.

Otherwise, markets can do that job better. Recommend reading George Cooper’s ‘The Origins of financial crises’ – a short book. Title is specific but the content is broader.

Post-WTO China

Brad Setser has a very good post on China in WTO – 15 years hence. Some key points from his post are:

Here is a point that I think should get a bit more emphasis. China’s imports of manufactures, net of its imports of imported components, peaked as a share of Chinese GDP in 2003—and have fallen steadily since then. There is no “WTO” effect on China’s imports of manufactures, properly measured (i.e. leaving out imports for re-export). Chinese imports of manufactures for China’s own use are now under 5 percent of China’s GDP—a low number compared to China’s peers. As a result, right now, China supplies roughly three times as many manufactures to the world as it buys for its own use (net of processing imports, manufactured exports around 12.5 percent of China’s GDP; net of processing imports, manufactured imports are around 4.5 percent of China’s GDP, for a manufacturing surplus of around 8 percent of China’s GDP).

He shows here that intervention in foreign exchange markets was almost as high as 15% of GDP.

China was hardly adding to its reserves at all when it joined the WTO. At the time, annual reserve growth, using my best estimates which attempt to count all hidden or shadow intervention, was 2-3 percent of China’s GDP. By 2006 it was ten percent of China’s GDP (counting hidden intervention through the banks); by 2007 it was 15 percent of China’s GDP (counting a new form of hidden intervention through the state banks). Based on the work of Joe Gagnon of Peterson Institute and his co-authors, I think that China’s intervention from 2003 to 2008 added between 3 and 6 percentage points to its current account surplus (I could argue for a higher number, actually—see the footnotes here). The market wasn’t allowed to work for a long time—China’s exchange rate didn’t really start to appreciate in a way that would push firms to reconsider their production structure until late 2007.

Other highlights of his excellent post:

Back in 2000 and 2001, China was expected to do well in the production of apparel and low-end consumer goods. But it was also expected to be a big market for a wide range of sophisticated U.S. and European capital goods. Broadly speaking that hasn’t been the case, setting aircraft aside.

The WTO rules aren’t all that constraining in a country like China—thanks to state control of commanding heights enterprises and banks, and institutions, such as the National Development and Reform Commission (NRDC), that assure party control of major state firms and large investment projects.

The U.S. for example, runs a significant trade deficit in capital goods with China (even after taking out computers). That wasn’t the expectation back in 2001.

The most interesting aspect of the blog post is how the WTO accession for China had some safeguards against dumping – the non-market economy status, the Special Safeguards provision. But, the Bush administration refused to invoke them even in situations there were four of them) where the case was clear cut.Whether the reluctance to invoke the Special Safeguards provision was ideological (non-interference with the so-called market mechanism) or something else, we would not know.

With the benefit of hindsight, I think it was a mistake not to make greater use of the 421 safeguard provision in the years following China’s WTO entry.** There were surges of imports left and right from 2002 to 2007 (and additional surges in imports of machinery in particular from 2010 to 2014). These surges had a material impact on many manufacturing dependent communities, especially in the American Midwest and Southeast (and in some smaller towns on the west coast that were part of the U.S. tech manufacturing sector). The threat of injury should not have been hard to show.

That is important. Who knows? Had they used them, some of the manufacturing communities in the U.S. would not have been badly damaged; Schott and Pierce had documented this very well; the anger over the loss of control over one’s lives would have been contained and, who knows, Donald  Trump might not have gotten elected! Talk of the law of unintended consequences!

He says that “fighting China’s intervention is in some ways fighting the last war.” The correct fight now has to be in these areas:

against the domestic policies that keep China’s savings so high;

against a surge in capital outflows that leads to a yuan depreciation that then becomes entrenched (if China’s currency goes down, I worry it won’t go back up) and

against Chinese import-substituting industrial policies that aim to displace major exports to China.

From a geo-political perspective, I am not sure if the fight has to be ‘against a surge in China capital outflows’. That is at least worth debating. If I were the American President, should I encourage it for it undermines China’s economic stability or should I ‘fight against it’ because it weakens the Chinese currency? Is the exchange rate as important now as it was then?

Overall, a great post by Brad Setser; of a very high quality and rigour that one normally associates with him; good to see him back to active blogging (well, he had resumed blogging in May 2016) after his days in the Obama administration.

Having Brad blog actively is one advantage of the Trump Presidency that not many would complain against!

Clarifying retrospective search and seizure

In my second column on the Indian budget in MINT, I had written the following:

Some interesting (or disturbing) aspects of the Finance Bill and the finance minister’s speech have caught the attention of journalists and interested parties. One is that the Finance Bill adds an explanation to Section 132 (1) of the Income-Tax Act to remove the obligation on the part of the department to provide reasons for their search and seizure operations to any authority, including the Appellate Tribunals. It has been backdated to 1962. Section 132 (1A) also has been strengthened with such an explanation dating back to 1975. The Telegraph has written a good story on it and points out that these explanations “could remove an impediment to the resolution of a large number of tax cases that have been stuck in courts across the country” (“Recipe For Unfettered Raid Raj”, 6 February 2017). [Link]

I think I understand the situation better now. I spoke to someone in the know. These (inserted in the Finance Bill) explanations would not have been necessary had the Supreme Court, in one of its recent judgements (how recent and what it is – I do not have the details) introduced some ambiguity into the status quo. It has always been the case that the source of the tip-off is never revealed to the assessee who is raided. It is to protect the integrity of the source and to prevent harassment and intimidation of the sources.

At the same time, the assessees always have the right of recourse to the appellate authorities and to higher courts in the land if the search procedure leads to confiscation of certain documents, materials, assets, etc. In fact, the Income-Tax Officers have to disclose  to the assessee what all they have seized and how they relate to their tax demand. The assessee will have a chance to explain the source of the assets and how they are not disproportionate. If the matter is not resolved, it can be appealed to higher authorities and/or higher courts. That remains intact.

The tip-off source and the information received is not revealed for reasons stated above. That is not new. That was the practice before some judicial pronouncement introduced some ambiguity and potential for litigation demanding revelation of the source of information and the information received, etc. In order to remove the ambiguity, the ‘explanation’ had been inserted into the budget. It is not a new ‘retrospective’ amendment on the part of the government.

One additional point: if it is alleged that there was absolutely no material for the search and it was purely vindictive, political etc. and was basically an abuse of power, then the affected person can use the constitutional remedy of a writ petition to the High Court or Supreme Court (but to no other court or tribunal); the HC /SC can require production of even the secret information leading to the search if it so wishes, but it would be in a sealed cover only seen by the Judges.  This remedy flows from the Constitution, not the Income Tax act and is not taken away and cannot be taken away by the explanations inserted.

Puzzle solved

A week or so ago I wrote about the ‘Small Savings Puzzle’ in India. Last week in Mumbai, Mr. Mohandas Pai told me to take a look at the Small Savings Shortfall. You can do so too. The accumulated shortfall (Expenditure over Income) is over Rupees 114,000 crores (1.14 trillion rupees). A rough rule of thumb is that Indian nominal GDP is 150 trillion rupees. Therefore, this accumulated shortfall is 0.7% of GDP.

May be, it is to bridge this deficit that the government is borrowing from the National Small Savings Fund by issuing securities and paying an interest rate of 9.5% per annum. The Fund, in turn, does not revise the interest rate paid to the savers in line with the government bond yield as promised. Therefore, banks face competition for deposits. Banks do not lower their deposit rates fast enough. Then, they cannot lower lending rates either too much. Then, we complain that credit growth is anaemic or non-existent. I am reminded of what Thor Heyerdahl said: “Progress is man’s ability to complicate simplicity.”

This is basically income  transfer by another name and an indirect one, of course. The public is given so many painkillers in so many different ways because providing them sustainable livelihoods – living wage that beats inflation – is such a tall order in India. I am not blaming the government. It is an impossible task, almost. Sometimes, that is what I feel about India.