#90 "Politics is the Art of the Possible"

This newsletter is really a weekly public policy thought-letter. While excellent newsletters on specific themes within public policy already exist, this thought-letter is about frameworks, mental models, and key ideas that will hopefully help you think about any public policy problem in imaginative ways. It seeks to answer just one question: how do I think about a particular public policy problem/solution?

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PolicyWTF: One Nation, One Election

This section looks at egregious public policies. Policies that make you go: WTF, Did that really happen?

— Pranay Kotasthane

The series “One Nation, One X”, like another sitcom Tarak Mehta Ka Ooltah Chashmah, doesn’t seem to end. The latest season of the series is titled One nation, One election (ONOE).

PM Narendra Modi has batted for this idea on many occasions before. In his latest pitch, he said:

Elections are held at different places every few months, the impact it has on development works is known to all. Therefore, it is a must to have deep study and deliberation on ‘One Nation, One Election’.

This speech apart, the most robust defence of ONOE comes from a NITI Aayog discussion paper by Bibek Debroy and Kishore Desai. They cite four reasons. Let us investigate the top two.

Reason #1: Imposition of Model Code of Conduct by the Election Commission derails development programs and governance

According to this view, political parties, once in power, are brimming with development ideas but are not able to do so, that too for considerable periods, because of repeated elections. This view is shared by many people outside the government as well.

The discussion paper tries to estimate the development time lost because of elections. Based on a projection that at least two states go to elections in India every year the authors conclude:

“Assuming the average period of operation of Model Code of Conduct as 2 months during election to a State Assembly, development projects and programs (that of State Governments going to polls and of Union Government in those states) may potentially get hit every year and that too for about one-third (four months) of the entire time available for implementing such projects and programs. Such a situation is completely undesirable and needs serious deliberations and appropriate corrective measures.”

Sounds quite serious. But hang on. There are several problems with this assessment.

One, if the Model Code of Conduct is the problem, it can be changed either by shortening the length of the moratorium or by relaxing the kinds of developmental activities permitted during the election season. Even in its current form, the government can consult the Election Commission about the developmental works it plans to undertake and if they are deemed to not have electoral implications, they are allowed to continue. I’m in favour of removing these restrictions altogether. If a government wants to use developmental activities to lure its voters, it’s more than welcome to do so. If the government is promising freebies to distort voter choices, it can do so even today, just before the Model Code of Conduct comes into place.

Two, the claim that developmental activities get stalled for four months a year is misleading. That’s because the code of conduct applies only to the state where elections are to be held. There’s no reason why developmental activities need to stall in all other states. Moreover, it’s useful to see the development period lost over a five year period. Assuming that one Lok Sabha election gets held between two state assembly elections over five years, the total “developmental time lost” in the state is six months. That’s an average one-tenth of a year, not one-third.

Three, this “developmental time lost” argument sounds a lot like the dog ate my homework excuse. For one, governments know when the next elections are due and can reasonably plan their developmental works taking this ex-ante information into consideration. Secondly, and this is the bigger issue, this view relegates elections to a begrudgingly necessary event; a mere obstacle blocking the grand developmental vision of the party or the leader in power.

Reason #2: Frequent elections lead to massive expenditures by governments and other stakeholders

The NITI Aayog paper claims:

Elections lead to huge expenditures by various stakeholders. Every year, the Government of India and/or respective State Governments bear expenditures on account of conduct, control and supervision of elections. Besides the Government, candidates contesting elections and political parties also incur huge expenditures. The candidates normally incur expenditures on account of various necessary aspects such as travel to constituencies, general publicity, organizing outreach events for electorates etc. while the political parties incur expenditures to run the party’s electoral machinery during elections, campaigning by star leaders and so on.

While this is true, “massive” expenditures need to be unpacked. The first component is the government expenditure in conducting elections. The 2014 Lok Sabha elections cost 3870 crores i.e. an expense of 0.03 per cent of India’s 2014 GDP once every five years. State elections for a large state like Bihar cost a tenth of this amount i.e. 0.003 per cent of India’s 2014 GDP every five years. Even if we assume all states require the same amount as Bihar did, India would be spending 0.12 per cent of India’s 2014 GDP over a period of five years, all state assemblies and Lok Sabha elections combined. Clearly, this number is not unaffordable. It can’t be the primary motivation for undertaking a constitutional amendment exercise fraught with unintended consequences.

The other component of the cost is spending by political parties and candidates. While the latter is capped to laughably low numbers (Rs 70 lakh for Lok Sabha and Rs 28 lakhs for state assembly elections), there’s no cap on the former. The paper claims that taken together, this component amounted to Rs 30,000 crores for the 2014 Lok Sabha elections. This is indeed a worrying number, more so because the expenditure is often in the form of freebies and vote for cash exchanges. But, arguing that conducting simultaneous elections will fix this problem is an admission by political parties that they will not change their ways; it’s just that they will engage in this simultaneous corruption once every five years. Fixing election expenditure requires many urgent solutions but a simultaneous election is not one of them.

Besides these two reasons, there are other counterarguments that I haven’t considered at all. For example, there is a correlation between a higher percentage of electoral wins for national parties as against regional parties when Lok Sabha and state assembly elections are held together. There are also severe repercussions on India’s federal structures as state governments falling before completion of the five year period might have to be placed under the charge of caretaker governments or state governors.

Regardless, what this limited analysis shows is that even the two reasons given in favour of simultaneous elections don’t hold water. We don’t need One Nation, One Election.

India Policy Watch #1: RBI And Banking Licenses

— RSJ

The Internal Working Group (IWG) of the Reserve Bank of India (RBI) last week came out with draft report that recommended a calibrated entry of industrial houses into the banking sector and for conversion of large NBFCs into banks.

The usual brouhaha followed. But hidden in the brouhaha is an important lesson about the interplay between political and economic institutions. We will come to it later. First, the brouhaha.  

Always A Bad Idea

The camp against the idea of entry of corporates into Banking was led by the formidable duo of Raghuram Rajan and Viral Acharya. In a LinkedIn post titled – “Do we really need Indian corporations in banking?” – they laid out their reservations in no uncertain terms including an innuendo here and a wink there. It covered the usual grounds – risks of connected lending where a corporate house will raise cheap deposits from ordinary citizens and finance their businesses without due diligence; further concentration of economic power among few corporates in a country that’s fast turning oligopolistic and the need for the government to find more bidders when it begins privatisation of PSU banks that it can’t fund any longer.

“First, industrial houses need financing, and they can get it easily, with no questions asked, if they have an in-house bank. The history of such connected lending is invariably disastrous – how can the bank make good loans when it is owned by the borrower? Even an independent committed regulator, with all the information in the world, finds it difficult to be in every nook and corner of the financial system to stop poor lending.”

“The second reason to prohibit corporate entry into banking is that it will further exacerbate the concentration of economic (and political) power in certain business houses. Even if banking licenses are allotted fairly, it will give undue advantage to large business houses that already have the initial capital that has to be put up. Moreover, highly indebted and politically connected business houses will have the greatest incentive and ability to push for licenses.”

“One possibility is that the government wants to expand the set of bidders when it finally turns to privatizing some of our public sector banks. It would be a mistake, as we have said in an earlier paper, to sell a public sector bank to an untested industrial house.”

Do We Need More Banks?

The short answer is yes.

Look at India’s ambitions. A 5 trillion economy by 2025 that’s a global economic powerhouse. Keep your dose of realism aside for a moment. If India has to even make a fist of this ambition, it needs a robust, deep and competitive banking sector. What do we have today? A total of maybe six and a half large banks that have the capital, management strength and the ambition to support this vision.   

India is still severely underbanked. Credit to GDP is about 56 per cent which is woefully short of what a fast-growing economy needs. PSU banks that fanned out into the interiors hardly built a deposit base or managed to support enterprise at scale outside of urban centres. Despite such modest achievements, almost every PSU bank has drained taxpayers’ money with very little to show for. Turning PSUs around is nigh impossible. It is easy to recommend professionalising the management but there’s no easy way to achieve it. The government has mixed up its role of being a regulator, shareholder and the management. All sorts of conflicts of interest follow. The benefits of running PSU banks are concentrated among bureaucrats, employee unions and politicians who use them to pump prime the economy when it is politically expedient. The costs are diffused among millions of taxpayers. No wonder the market cap of all PSU banks put together is smaller than the biggest private sector bank.  

Is there really an alternative to big businesses or large NBFCs (many of whom have corporate houses as promoters) to support India’s ambitions? Who else has the ability to bring in patient capital and support a bank for a period of time in future?

Fait Accompli?

So, does this mean we will soon have corporate houses being issued bank licenses? In my opinion that’s unlikely unless government really nudges the RBI in that direction. I have my reasons:

* In the current dispensation itself, many NBFCs could have applied for banking license over the last five years. But they haven’t. Why? The capital requirements needed to run a bank are very different from that of an NBFC. That apart, the NBFCs face far relaxed regulatory oversight than banks. No wonder none of the NBFCs have touched it with a barge pole over the years.

* RBI will have to change the Banking Act, 1949 through a bill passed in the Parliament. Following that there will be a ‘fit and proper’ filter that will be with the RBI to decide on who to give the license. The IWG report suggests some of these will be made more onerous for the applicants.

* This is still a political hot potato. There are many voices within the government who might not be comfortable with this. The pressure group of unions, bureaucrats and opinion makers still wield significant power to block the entry of corporate houses.

* RBI will continue to make it very difficult for anyone applying the bank license

So, what’s happening here? Why is RBI coming out with a paper for allowing corporates in Banks while simultaneously making the criteria impossible to achieve.

A Balancing Act

RBI as an economic institution understands the need for more banks in India. But it does not believe the political institutions in India will be able to manage the conflict of interest inherent in having large corporates as banks. So on one hand it wants to show the political leadership it is supporting their aspirations in ambitions by re-looking at the guidelines for new licenses while making the conditions of the guidelines so onerous that it will make the license unattractive for an industrial house.

For nations to succeed (like Acemoglu and Robinson have argued), its institutions have to be strong. In my view, a nation has to have its political and economic institutions in sync with another. It is difficult for it to have its political institutions extractive, exclusionary and rent-seeking while its economic institutions are liberal and inclusive; and yet succeed in the long run. Having an extractive and exclusionary political institution while continuing to work with economic institutions that are free and inclusive is an unstable equilibrium. Sooner or later, the extractive nature of one type of institutions casts its long shadow on everything. The post-independent history of India speaks to this phenomenon.

Following Independence, India chose a model where its political institutions were by design inclusive and liberal while its economic institutions came to be dominated by the state. In the late 60s, Indira Gandhi found it expedient to double down on the state control of economy in order to consolidate herself politically. This led to the nationalisation of various sectors including that of banks. As this domination and undermining of economic institutions turned complete, the political institutions couldn’t stay beyond it. The judiciary became subservient, roles like governors of state turned into rubber stamps, Article 356 was liberally used to dismiss state governments at slightest of pretexts and most independent institutions were packed with sycophants. No surprise then this culminated into the emergency of 1975.

The crisis of having both political and economic institutions that were extractive reached a point of no return by 1991. That’s when we decided to take a sharp turn away on how we’d like to manage our financial situation. The state reduced its control on factors of production, multiple independent regulators were born and a relativity free market came in to play. The feedback loop of the liberalisation of economic institutions soon started coming up against the extractive nature of political institutions. Through some fortunate circumstances of coalition politics, enlightened leadership and favourable global conditions, the political institutions began to change in the image of the liberal economic institutions. This was reflected in a more active election commission, laws like RTI being passed and the courts actively preserving the liberties of the citizenry.

However, over the last decade or so, the political institutions in India have turned the clock back on being extractive. Electoral victories on the back of a strong leader, a decimated opposition and the power of majoritarian politics have meant we have reversed the gains we made post-liberalisation on making our political institutions freer. As the feedback loops in, the economic institutions are starting to corrode.

This is where RBI finds itself today. It still is a free and liberal institution that’s walking the tightrope between a democratic mandate (that the government represents) and its own independent thinking. The draft IWG report in that sense is its stand. It will play ball yet not play it at the same time. It is anyone’s guess how long it can continue to do so.

The right solution of course is to go back to the path of strong, free and inclusive political AND economic institutions. But that doesn’t look likely anytime soon. It is a lost opportunity.   

India Policy Watch #2: Farmers’ Protests

Insights on burning policy issues in India

— Pranay Kotasthane

We warned in edition #70:

Any reform that is even remotely seen to impact the MSP gravy train is bound to face opposition from a host of incumbent beneficiaries. One, the farmers growing the 22 crops backed by the MSP. Two, the traders getting a percentage of the MSP. And three, the state governments making money by charging hefty commissions for the sale of produce at APMCs. None of this is surprising.

That apart, we mentioned two critiques merit serious attention: one, the timing of these reforms amidst the worst economic crisis in decades meant that the government needed to align the cognitive maps of those losing out. Two, the government fostered suspicions because the three farm laws said nothing about the impact on the existing procurement price mechanisms.

Unfortunately, the anticipated unintended consequences have played out according to the script above. Farmers in Punjab and Haryana are agitating while the government has not come out with a reconciliatory offer yet.

As usual, Pratap Bhanu Mehta’s article takes the long view. He writes:

“Given the far-reaching changes we need in agriculture in Punjab, it is important that the trust between the state and the farmer remains. A good faith dialogue that gives the farmers reasonable assurances and a face-saver is necessary. It is easy for the government to win. But how many times in Indian politics have we won short-term victories that create long-term political precariousness?”

Just like the GST compensation cess issue, the union government has pushed through a big change without getting other political parties or state governments onboard. These specific reforms might still go through but future negotiations will become even more difficult. Parties to the table will come with ossified positions. That’s a precursor to policy paralysis. We have seen this movie before.

In the crisis situation we find ourselves in, it is all the more important that the union government’s reform agenda should factor in distributional consequences of those losing out. The government needs to build bridges. Politics, after all, is the art of the possible, as Bismarck said.

HomeWork

Reading and listening recommendations on public policy matters

* [Podcast]: Acemoglu talks with Russ Roberts on why institutions matter.

* [Article]: Jagdeep Chokkar and Sanjay Kumar make a solid case against simultaneous polls.

* [Podcast]: In the second Puliyabaazi episode on Indian banking history, Amol Agrawal shares fascinating insights on princely state banking, the feud with the State Bank of Pakistan, priority sector lending, and lots more.

* [Article]: Mohammad Taqi in TheWire writes how “Pakistan’s Islamisation started almost a decade before its birth, and long before any army dictator or adventurist general came along.” Even Pakistan didn’t become Pakistan all of a sudden. Something for us to reflect on in India.

If you like the kind of things this newsletter talks about, consider taking up the Takshashila Institution’s Post Graduate Programme in Public Policy (PGP) course. It’s a 48-week in-depth online course meant for working professionals. Applications for the Jan 2021 cohort are now open. For more details, check here.

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