## Friday, February 24, 2012

### Doing better in our neighbourhood

A key intuition of modern thinking in international trade and international finance is that distance matters much more than we think.

We may like to believe that the world is becoming more flat. We may like to believe that for weightless things like services and financial flows, distance is irrelevant. But the research evidence is unambiguous: there is a gravity model' in the affairs of men. The interactions between two countries tend to go up in proportion to the product of their GDP, and vary inversely with the squared distance between them.

Traditional trade theory would encourage us to think that India and Sri Lanka (say) have similar factor endowments, so the gains from trade might not be so great. But this is not borne out by the evidence: some of the most intense trade relationships are found between countries in Europe and between the US and Canada: between countries with very similar endowments.

In this region, we need to be much more mindful of the importance of intra-regional finance and trade activities. For India, this means a strong emphasis upon East Africa, the Middle East, Pakistan, Central Asia (by plane today, but someday we should get to road connectivity from the Indian ocean), the land route to China through Tibet, Nepal, Bangladesh, Burma, Singapore and Sri Lanka. India stands out, in international comparisons, for having unusually low economic engagement with its neighbours. This implies that there are opportunities for very large gains. In recent years, some Indian firms have emphasised these countries in their internationalisation strategy (both trade & investment), reflecting a greater role for natural conditions dictated by geography.

Some of these places are hobbled by political problems and abysmally low GDP. The product of the two GDPs matters, and bad political systems like to interfere with globalisation. The wise thing for us to do is to have a consistent and welcoming engagement strategy, waiting for the time that the country finds its feet in terms of establishing a healthy political system, waiting for the country to engage. A good example of India doing something right is the positive approach towards MFN status for Pakistan. We have to wait for Pakistan to understand that this is in their self-interest - and I do believe that in time, they will - but there is no reason for us to get stuck on reciprocity.

Of particular interest in recent months is Burma. Hamish McDonald has a beautiful piece titled Tractors may have replaced horses, but country is still decades behind.  If Burma comes out of its deep freeze, then the opportunities for trade and financial links with India are huge. We would go closer to the arrangements which were prevalent in the early 20th century, which reflect the natural opportunities.

With increased trade & financial linkages will come greater macroeconomic correlations a.k.a. shared interests. I saw a fascinating new IMF working paper by Ding Ding and Iyabo Masha titled India's growth spillovers to South Asia. This finds that after 1995, Indian growth has a significant impact in the region. If this is a robust finding, it is new; the idea that Indian business cycle fluctuations reach out and influence the region is not part of our intuition, particularly given the onerous trade barriers in place. Perhaps there is a lot more trade going on than meets the eye.

## Tuesday, February 21, 2012

### CNBC Awaaz symposium on India's education crisis

India's education crisis is now high on our consciousness. In response to the recent developments, CNBC Awaaz did a four-hour symposium on national television (in Hindi/English) titled Kala Akshar: The Great Education Crisis. This brings together an interesting and diverse set of voices on the subject.

 10:00 - 11:00 AM 1 2 3 4 11:00 - 12:00 PM 5 6 7 8 12:00 - 1:00 PM 9 10 11 12 1:00 - 2:00 PM 13 14 15 16

## Thursday, February 16, 2012

Great insights into India's breakdown of governance, from N. Sundaresha Subramanian in the Business Standard.

Jeff Glekin and Hugo Dixon have a great three-part rumination about India. Also see Jeff Glekin and Shaji Vikraman on the ruckus at UTI.

Cullen Murphy has a great article about the Inquisition. His story is a troubling one for us in India, where we are at the point of transition from persecution by thugs to persecution by competent organisations.

At the crossroads, an article on education by me in the February issue of Pragati. Also see here.

Pratap Bhanu Mehta and Ila Patnaik, in the Indian Express, on the UID controversy.

Do away with surfeit of financial regulators to make the financial sector better, in the Economic Times. (This was by Shaji Vikraman.)

Ila Patnaik on the best contribution that RBI can make for high Indian GDP growth. And by her, see: capital controls are no way to try to block rupee depreciation [link].

Ila Patnaik on the subject of how the Eurozone crisis changes our thinking about achieving bank safety by stuffing banks with government bonds.

SEBI turns heat on USE, by Palak Shah in the Business Standard. Equity licence: MCX-SX faces fresh hurdle by Pramit Bhattacharya in the Mint, which was followed by The question of motive by the editor, R. Sukumar, of Mint.

Sino-Americana by Perry Anderson, in the London Review of Books. You might like to also read The undersupply of criticism by me.

How your cat is making you crazy by Kathleen Mcauliffe in the Atlantic, and a great video of an interview with Robert Sapolsky.

Wikipedia has serious problems, an article in the Chronicle Review by Timothy Messer-Kruse. My experiences have also been similar; I've given up on fixing errors in Wikipedia because people generally undo the work later on.

## Sunday, February 12, 2012

### An election rally in Amethi, Uttar Pradesh

by Naman Pugalia, Viral Shah and Ajay Shah.

We decided to experience the spectacle of Indian democracy, by going to an election rally in the Uttar Pradesh (UP) assembly elections. Elections in Uttar Pradesh are unbelievably big - in 2007 there were 110,654 polling stations, which gathered up 471 votes each (on average) into electronic voting machines (EVMs), adding up to 52 million votes. (For a comparison, the US presidential election in 2008 had 132 million votes). In UP, the 2012 elections are going to be much bigger than what was seen in 2007.

Deep inside the production function of the political campaign is the rally. From Gandhiji's public meetings to Nehru's memorable speeches, mass gatherings have been an integral element of political communication. Audiences pick up an array of subtle aspects of the voice, body language, and mannerisms of the speaker, through which a great deal is communicated other than the text of what is spoken.

On February 9th, we attended a rally organised by the Congress, where Priyanka Gandhi spoke. The meeting took place in Pari village in the Amethi district. This is a place so obscure that google maps does not know it.

 A small rally, with a special platform for the media to mount cameras.
Perhaps 500 to 1000 people from Pari and neighbouring villages had assembled to hear Priyanka, who urged them to vote for their (incumbent) MLA from the Salon constituency, Balak Pasi. A strong media contingent was there, with both local and national media being represented. In 2007, this constituency was reserved for a scheduled caste (SC) candidate. Balak Pasi had won handily, with 45,078 votes compared with his rivals Asha Kishor of SP who got 31,969 votes and Dalbahadur of the BSP who got 26,588 votes.

As with a music concert, you have to warm up the crowd before the main act. Two local politicians kept the audience entertained before Priyanka arrived:

 Local politicians, warming up the crowd before the main show.
Priyanka was fluent in Hindi, and was quite at ease. The well-rehearsed speech pitched Congress. There were two main planks of the speech: that UP had done badly with 22 years of non-Congress alternatives, and that Congress was doing good things for the people at the Centre but the failures of the BSP government had prevented these benefits from reaching them. It was a short, well-written speech: not a lengthy tiresome rant or ramble. The video you see ahead is from a different location, but the speech is essentially the same as what we heard.

The audience was not very engaged. We were told that audiences have not been too engaged with any political speaker after Gandhiji. After the speech, she stepped off the podium and walked towards the gathering to shake hands with a few awestruck attendees. In a few minutes, her convoy of SUVs, complete with SPG staff, sped off.

 Everyone was comfortable.

UP has a bad reputation for law and order, but we were struck by the civility of the entire process. Everyone was comfortable. It was a day out for the family, and aided by the beautiful winter morning, people were smiling. There was no hint of violence, intimidation or fear.

If mass politics evolves in this direction, a lot more people would be comfortable getting involved in it. It was one more reminder of the importance of law and order as the foundation of democracy and civilisation: when politics involves violence, only the goons will participate in it. As Fareed Zakaria says, the courts are even more important than the elections.

In the olden days, politicians did a small number of speeches for big audiences. Meetings were announced many days in advance, and a large crowd took the trouble of going to the meeting venue. The world has changed. Small rallies are a much more intimate experience. They are also a security nightmare, owing to the very intimacy of the experience. At the same time, we felt that the security arrangements were non-intrusive.

With these small rallies, the politician comes to the audience. The speaker probably does 10 rallies a day, and thus touches perhaps 5000 people a day. Another feature of the new production function of political campaigns is television: A politician may do a speech for a small rally, but the omnipresent television cameras beam it all across Uttar Pradesh, to a vastly larger audience.

The rally was pretty nice, but at the same time, political parties in India are not professional organisations. There were numerous small issues where a relentless process engineering perspective could have added value. Politics in India is a bit like the way big companies used to be twenty years ago (and small companies are today). Big Indian firms have figured out how to graduate from mom and pop operations to professional organisations, how to write process manuals, setup instrumentation of the process in motion, and how to bring in high end brainpower to improve processes. That transformation of Indian politics -- from cottage industry to professional organisations -- has mostly not begun.

 After the speech, the crowd peacefully dispersed.

## Saturday, February 11, 2012

### The blog as a platform for conversation

There are three ways in which a person can speak in today's Internet into the public domain: to write on twitter (140 bytes), to write a comment on a blog (~ 1000 bytes) or to write a blog post (~ 5000 bytes). The appetite of each person varies, reflecting a combination of having something to say and having the discipline of carefully constructing sentences and paragraphs. Each of these three choices comes with a different set of human factors which shapes who participates and how much.

This blog started out in end-2005, and quickly built up thousands of readers. It branched out from a single-author blog to having many people writing. There is a certain kind of person who reads this blog, where 20% of the words have three or more syllables, and hence there is a natural opportunity for intra-group conversation between us. But for a long time, there was relatively little going on by way of discussion on the blog through comments.

At first, comments were unmoderated, which is nice in that writing a comment gives instant gratification to the author of the comment. Google Blogger does not block spam in blog comments on the scale that Gmail does, and I was forced to shifted to moderated comments. This introduced an inevitable delay between writing a comment and seeing it come up on the page. The threshold readership required for significant discussion was further pushed up once comments were moderated. So one had to sit back and wait for readership to further build up before interaction-through-the-blog took off.

On the other side, Blogger recently released a nice new feature: the ability to pointedly respond to a comment with a comment. I think this has helped increase the attraction of comments.

In recent days, I've seen a significant increase in comment traffic. Here are a few recent posts, with the number of comments in brackets: Diluting the role of the IIT JEE (17), Girish Sant (10), The first PISA results for India: The end of the beginning (16), Uncomfortable times in real estate in store? (16), The rupee: Frequently asked questions (21), Taxing investors to pay NGOs (12), Residential water heating and the rise of the gas-fired economy (15), Envisioning future scenarios for India and China (13), Can we get back to track on corruption now? (12). Prior to 2011, there was seldom a post with over 10 comments. So it looks like we have crossed some threshold on participation which is leading to liquidity in comments.

Some interactions have been particularly noteworthy. At Diluting the role of the IIT JEE, AVI said "please give some references to support your assertion". I replied about my (lack of) verifiable evidence, and then Murli responded with verifiable evidence. This was blog-based interaction at its best.

Similarly, it was a comment by Anonymous (on an unrelated post) which got me going on the recent OECD PISA results. This led to posts by Lant Pritchett, Jeff Hammer, and me (link, link). This was blog-based interaction at its best (though it did start with an awkwardness, a comment on an unrelated post).

## Thursday, February 09, 2012

by Thomas Laubach and Ajay Shah.

Economics is a rich and fascinating subject. But all too often, the teaching process forces young people in the field to look at the tail of the elephant, to think about macroeconomics as the game of solving dynamic models. There is actually much more going on. (On a related note, you might like to see Books that should be read before starting a Ph.D. in economics on this blog, 18 May 2011).

In this blog post, we walk through the evolution of the key ideas in historical order, and offer suggestions to interesting readings, which will help you see the fuller picture. Many of them are on your reading list, but some are not.

Nobody tells it better than The age of uncertainty by John Kenneth Galbraith.

The old paradigm is now in the dustbin of history. But in order to comprehend the revolution in macroeconomics, it is rather useful to start from there. One encounters these arguments from time to time, so it's worth knowing about the furniture of that mind.

### The revolution of modern macroeconomics

The starting point is a speech : The role of monetary policy by Milton Friedman, American Economic Review, 1968, which had enormous influence in arguing that the mainstream Keynesian paradigm was fatally flawed, and that it was not going to work as a guide to policy on a sustained basis. By the early 1970s, the empirical evidence was showing that Friedman was on the right track, which led to everything that followed. This speech is arguably the beginning of modern macroeconomics. At the same time, this was only an argument conducted in English, and not a model.

The next big milestone was the Lucas critique: Econometric policy evaluation: A critique by Robert Lucas, Carnegie-Rochester Conference Series on Public Policy, 1976. This devastated traditional macroeconomics. In addition, it's a remarkably elegant idea.

Lucas, Sargent and others mapped out a work program in a series of non-technical pieces, which were enormously influential. They set a generation of economists going to build a class of models that were rooted in the intuition of Friedman, 1968, and were invulnerable to the Lucas critique. You should read: Understanding business cycles by Robert Lucas, Carnegie-Rochester Conference Series on Public Policy, 1977; After Keynesian Macroeconomics by Lucas and Sargent, Federal Reserve Bank of Minneapolis Quarterly Review, 1978; Methods and problems in business cycle theory by Robert Lucas, Journal of Money, Credit and Banking, 1980.

As important as the Lucas Critique was Rules rather than discretion: The inconsistency of optimal plans by Kydland and Prescott. An accessible set of materials on this work is found in their 2004 Nobel Prize page.

This work came to fruition in the early 1990s in the form of the NK-DSGE model with a policy rule. Important tools got developed in a classical setting (the RBC model), and then Keynesian frictions were put in, to give the NK-DSGE model. It has many problems, but with this, the Lucas program did work out. Nice readings on the NK-DSGE model are The science of monetary policy: A new Keynesian perspective in the JEL by Clarida, Gali, Gertler (1999), and their Monetary policy rules and macroeconomic stability: Evidence and some theory in the QJE in 2000.

The new macroeconomics is nicely showcased in Technology, employment, and the business cycle: Do technology shocks explain aggregate fluctuations? by Jordi Gali in AER, 1999. This is a wonderful example of confronting empirics with theory, plus a fundamental (if highly controversial) contribution in the eternal quest for the sources of business fluctuations.

On the other side, there is a powerful critique of the micro-founded approach to macroeconomics: The scientific illusion of empirical macroeconomics by Larry Summers, Scandinavian Journal of Economics, 1992.

By the late 1990s, there was a lot of progress to report. There is a nice article: Thirty-Five Years of Model Building for Monetary Policy Evaluation: Breakthroughs, Dark Ages, and a Renaissance by John B. Taylor, Journal of Money, Credit and Banking, 2007. There is the best single book on monetary policy: Monetary Policy Strategy by Frederic S. Mishkin, 2007. And, there are two other nice articles: A stable international monetary system emerges: Inflation targeting is Bretton Woods, reversed by Andrew K. Rose, Journal of International Money and Finance, 2007, and How the World Achieved Consensus on Monetary Policy, by Marvin Goodfriend, Journal of Economic Perspectives, 2007.

### The second stage

Once the basic plan was laid, important work emerged in connected fields. A critical issue that came to fore was the role of finance in macroeconomics. Agency costs, net worth, and business fluctuations by Bernanke and Gertler, AER 1989, is the most elegant illustration that financial structure matters for macroeconomics.

We close this off with a canonical reference about fiscal policy from a macro perspective. A good recent treatemnt is Activist fiscal policy to stabilise economic activity by Auerbach and Gale, from the 2009 Jackson Hole symposium.

### Post-crisis revisionism?

On this, see Monetary policy and financial stability: Is inflation targeting passe? by Takatoshi Ito, July 2010.

## Sunday, February 05, 2012

### The JEE used to serve India well

Many years ago, high school education in India worked in a twin track system: There were those who studied for the IIT JEE and there was everyone else who didn't. The former studied good books like Resnick/Halliday, which is a college level book elsewhere in the world, solved physics problems from Irodov, etc.

In contrast, studying for the 12th standard ("board examination") tended to emphasise rote memorisation, focusing on trivial questions where you had to plug numbers into a formula, emphasised accuracy of calculation and good handwriting. I vividly remember a textbook for 11th class physics used in Maharashtra, which said that Newton's second law did not apply for living things and powered vehicles. The thoughtful author must have wondered how a stationary cat started walking without the action of an external unbalanced force, and resolved the problem by limiting the footprint of Newton's second law. The less time that kids spend in studying for board examinations, the better.

I used to be optimistic that the footprint of the enhanced curriculum, and complexity of examination questions, lay far beyond the tiny number of people who entered IIT. Even if only 2,000 kids entered IIT, if 40,000 of them studied for the JEE, it gave them world class capabilities at high school. In each cohort, we got 40,000 people who were very good by world standards. In a country with pervasively low capabilities, it was very useful having this slice of high inequality of knowledge, for it gave a group of people who were able to learn modern technology, connect to globalisation, and create firms which generate a lot of high-paying jobs. It is fashionable to complain about inequality of knowledge, but given that you are in a LDC with a very low mean, would you really rather have very low variance??

With this old configuration, we also got a nice tool for inter-generational class mobility. The middle class got their kids into IIT, and almost all these graduated into upper class by the time they were 30.

More generally, a lot of countries have found that high stakes examinations are a good thing. High stakes examinations push the work ethic, grow the ability of young people to work hard in a sustained manner with high concentration, ensure foundations of mathematics and science, and encourage a meritocracy. They create a self-selected elite of young people who are not immersed in and defined by mass culture. All these are good things.

### Problems of the JEE

I used to think like this for a long time. I have reluctantly been persuaded, over recent years, that the JEE isn't working so well.

Too many young people are studying for the examination and not the subject. The obsessive focus upon coaching classes is producing a one-dimensional personality which isn't so well suited to entering college. In the 1980s, the most interesting students in IIT were thinking people who read books, knew a lot about the world, and could also solve monkeys on pulleys. With brutal competition, and the coaching classes phenomenon, too often, all that's left today is the monkeys on pulleys. There is a certain kind of parent who is willing to have a child go live in Kota at age 15. This screened out many families from the race.

Economists know about this phenomenon in agency theory. High-powered incentives are a problem because the agent only focuses on the incentive and tends to cut corners (or worse) on everything that's not mentioned in the incentive contract. Andrade and Castro bring this generic idea in agency theory into the question of examinations, and find similar effects.

In the 1980s, there was substantial diversity of background, experiences and class amongst the students. This was a good thing, since students would then pick up the culture of people unlike them. In recent years, it appears that there is much greater homogeneity of background, experiences and class. The extent to which the person gets transformed in the four years has, as a consequence, gone down. When very few children of the elite go to IIT, this reduces access to the knowledge and networks of the elite for everyone who goes to IIT. This has reduced the ability of IIT to generate inter-generational class mobility.

Jishnu Das and Tristan Zajonc have found a nice bump in the upper tail of the distribution of skills in India. The pessimist sees this as being about class or caste: certain families bring up kids who know more. The optimist in me used to think this was the bunch studying for the IIT entrance. Also see Geniuses and economic development on the importance of the upper tail of the skills distribution.

It is increasingly difficult to be optimistic about how this is going. Narendra Karmarkar graduated from IITB in 1978, and went on to do truly important work in 1984. My optimism about the IITs peaked in 1984. Phenomena like Narendra Karmarkar should have scaled up manifold in the following years. This has not happened. In the 1980s, I used to think that by 2010, we'd have atleast one Nobel laureate from the IITs. That has not happened. This tells us that the IITs are not delivering on their early promise; things haven't worked out well in the following years. While the IITs suffer from many problems, I think the JEE is also a part of the problem.

One of the most disappointing features of the recent OECD PISA evidence was the absence of this bump in the upper tail. This new evidence shows a scary world of low inequality of skill, of a country with a terrible mean and no upper tail of an elite that can power the country out of mass poverty. I would conjecture two potential explanations for what has been found. One, it could be the case that this testing was done at age 15, at which time not much of the IIT JEE studying has as yet taken place; we're only picking up the victims of board examinations. Alternatively, it could be the case that studying for the IIT JEE is distorted by the coaching class phenomenon, and is not producing good knowledge.

### But the solution being offered doesn't seem to be the right one

There are two views on how these problems can be solved. The first alternative is to shift away from admissions based on a high stakes examination. Universities in the US screen applicants on many parameters, so this is generally thought to be better. But when we look back in history, universities in the US used to focus primarily on academic performance only, until a glut of Jews showed up in Harvard. The shift to asking for well rounded personalities' was a tool by the dominant anti-semetic elite to screen out Jewish kids who did not play football. So we should be cautious in respecting the undergraduate admissions process in the US. It is also important to remember that the quality of kids starting college in the US is quite weak by world standards. There are other countries (e.g. Japan) where large scale high-stakes examinations are used for university admissions, with much success.

I feel that the core problem that we have in India is just too few seats, which has generated a ridiculous extent of competition and distorted behaviour on the part of the kids. The solution lies in solving the policy problems in higher education, so that a large number of kids are taken into world class institutions every year. E.g. adding undergraduate programs at I I Sc, with recruitment through the JEE, was a move in the right direction. We need to grow the size of the entrant class in universities in India, that figure in the Times Higher Education Supplement ranking, by 25-fold. At present, we have only one university in that list - IIT Bombay.

Kapil Sibal is offering neither of the two solutions above: we are not being offered a modified admissions process based on looking at a fuller picture of the child, and we are not being offered a Japanese scale world of high stakes examinations with a lot of seats in world class universities. What we're being offered is a scaling down of the role of the IIT JEE. A greater role for the 12th standard examination is just a recipe to emphasise rote memorisation, focusing on trivial questions where you had to plug numbers into a formula, emphasising accuracy of calculation and good handwriting. This seems wrong to me.

You may like to also see: Education in India: A compact reading kit.

## Friday, February 03, 2012

### Girish Sant

 Girish Sant, at New Rajendra Nagar in New Delhi, 10 January 2002

Girish Sant died of a heart attack in a hotel in Delhi yesterday.

`Bandya', as he was known to friends, could have chosen any career when he stepped out of IIT in 1986. He chose the less travelled path of taking interest in the public policy, and applying himself to a combination of technical mastery and the dogged persistence that is essential to making a difference. He founded a think tank, Prayas, which has come together as a pretty unique organisation in the Indian landscape. The Indian development project desperately requires more people who combine his intellect with his commitment to fixing up the world.

I always thought of Bandya as a gentle giant. He combined a soft and understated personality with depth of knowledge. When I spoke with him, I was always running at 100% CPU utilisation.

On a more personal note, Bandya was a lead climber in the first ascent of Konkan Kada, and I was part of that team. That was a peak experience. We will miss him.