Saturday, August 23, 2014

Reviving India's Manufacturing Sector

Reviving India's Manufacturing Sector

The Prime Minister has declared his goal of "made in India" with "zero-defect" (quality) and "zero-effect" (on environment).

In this context, much of the discussion on reviving India's manufacturing sector revolves around the development of industrial clusters like special economic zones (SEZs) or national manufacturing zones (NMZs). This forms the centerpiece of the National Manufacturing Policy 2011 itself. There is nothing to suggest much has changed even with a change in government.

But, as Rahul Jacob wrote in an excellent recent op-ed, an SEZ-led manufacturing revival plan is not likely to lead us too far. A more prudent strategy, as this blog has consistently advocated, would be a concerted campaign to improve the country's business environment. The gains, especially to small and medium enterprises, from simplifying procedures and limiting regulatory discretion would be much more than those from government's fiscal and other incentives to firms in SEZs. Importantly, for fiscally strapped governments, this is as close to a free lunch as it can get.

The gains would come from both lowering the number of procedures and reducing the time (by simplifying and IT-enabling) for each of the activities defined in the chart below.
This is tough and long-drawn slog, un-sexy and diffuse, multi-dimensional and incremental. So, if the Prime Minister needs to walk the talk on making in India, he needs to get his bureaucrats to embrace the challenge of getting this right. 

Is labor market regulations a binding constraint on Indian economy?



Saturday, August 23, 2014


Is labor market regulations a binding constraint on Indian economy?

Even as the interest on reforming India's undoubtedly restrictive labor regulations mount,Pranab Bardhan has an excellent op-ed where he questions whether it is the "only or one of the main constraints" on the revival of India's manufacturing sector. All his arguments are compelling and I am inclined to agree that whether there are other even bigger constraints.

To the list of arguments posited by Prof Bardhan, there is more from the World Bank's Doing Business and Enterprise Surveys. The Enterprise Survey of business owners and top manager sin 4234 firms done in 2006 revealed the following snapshot of binding constraints faced by businesses (small, medium, and large) in both services and manufacturing.
As can be seen, labor regulations come way down in the worry list for businesses. Infrastructure, especially electricity, tax rates, corruption, and credit come much before. Only 5% of firms identified labor regulations as the binding constraint. 

Consider the following two graphics on the distribution of employees by firm size. The first graphic is on distribution of establishment sizes as a share of plants. It does not show a discontinuity anywhere. There is nothing to show that there is a sharp drop in the share of firms at the 100 employees mark, as would have been the case if the Industrial Disputes Act (IDA) were indeed a critical factor.  
The second graphic is a distribution of establishment sizes as a share of all workers employed. Here too, not only is there is no discontinuity but also the share of employees appear to increase monotonically on both sides of the 100 mark.  
Clearly, empirical evidence atleast does not appear to indicate any egregiously disruptive adverse contribution from the IDA or other legislations on the expansion of Indian manufacturing firms into medium and large firms with employment greater than 100. 

None of this is to deny the undoubted damaging influence of our restrictive labor regulations. Their reform would surely contribute to improving the country's business environment. But to claim that labor market reforms can dramatically improve economic prospects, as argued by the likes of Aravind Panagariya, is to basically elevate anecdotes as objective evidence. Such anecdotes gain prominence from high-profile labor disputes and factory lock-outs. 

There are two stories here. One, the overwhelming majority of Indian enterprises start small and informal, and remain like that. Since the typical firm starting operations is likely to start with far less than 100 employees, there is little reason to suggest that the IDA or the Contract Labor Act are important barriers to starting a business. This leads us to the second story of business expansion from small into medium enterprises. Here, the restrictions imposed by IDA surely adds a layer of regulatory cost and is a potential deterrent to growth of business, though far from a prohibitive one, leave alone being a binding constraint. 

Sunday, August 3, 2014

Calibrated push, not headlong rush on PPPs - A relationship that works

Public-private infrastructure projects should be restructured to enable better distribution of risk,more efficient and transparent price discovery.


Public-private infrastructure projects should be restructured to enable better distribution of risk,more efficient and transparent price discovery
The Planning Commission estimates investments worth $1 trillion to flow into the infrastructure sector over the 12th Five Year Plan. At least half the investments are expected from private sources. Accordingly,governments have been aggressively pursuing public-private partnerships (PPPs). However,experience from across the world suggests a need for caution.
A comprehensive study of more than 1,300 infrastructure concessions and PPPs in Latin America and the Caribbean by World Bank economist J. Luis Guasch finds that renegotiations are the norm,even when awarded through competitive bids. The same could be said about India. In recent months,a number of large road and power projects have either been terminated or gone for renegotiation. In all these contracts,the developer either badly overshot the construction period or miscalculated heavily on revenue streams. Similarly,bank balance sheets have come under strain in the face of unsustainably high exposure to infrastructure projects and a rise in the restructuring of debt advanced to the sector.
In these circumstances,a more effective way to finance these projects may be through a two-stage process. In the first stage,a professionally managed special purpose vehicle (SPV) could be established to construct the project using short-term bank loans or through takeout financing by a consortium of banks. This may require the government to provide some form of guarantee or credit enhancement. Once the construction risk is offloaded,short-term loans can be swapped for long-tenor debt. Private participation can be introduced either through long-term concession grants to operate the entire project or parts or it,or by outsourcing certain services. Another strategy would be to capitalise the assets by taking the SPV public.
This arrangement is likely to be effective in sectors like water and sewerage,solid waste,power transmission and distribution,and public transport,where the project construction and stabilisation risks are substantial and most often outside the control of the private developer. Historically,such projects suffer inordinate delays due to problems in acquiring possession of site and right of way,protracted litigation and regulatory uncertainty.
This approach has many benefits. First,the fundamental principle of any project structuring is the allocation of risks among those most capable of bearing it. The typical construction risks are beyond the control of the private participant and can be mitigated only by the government. The inordinate delays due to problems with site handing-over and environmental clearances that are commonplace with road and power projects in India are a reminder of this.
Second,it would help bridge the information asymmetry that characterises such long-term projects. Once the project is commissioned and stabilises,it minimises,or even eliminates,many uncertain elements,and enables all sides to more reliably assess commercial prospects and thereby facilitate efficient price discovery.
Third,it is certain to reduce the need to renegotiate contracts. Post-construction concessions or service contracts have much less uncertainty and risk,and are,therefore,likely to result in more complete contracts.
Fourth,it is well established that public systems are less effective at efficiently managing and expanding large infrastructure projects,whereas the private sector is more efficient in these activities. The security of tenure and service conditions of the public sector are based on the civil service,and not well tailored to the very different needs of efficient operation of an infrastructure facility. It is therefore appropriate that the project be structured in a manner that leverages the private sector’s comparative advantage.
Fifth,it would help catalyse the development of the much-needed long-term debt market in India. Once the construction and other related risks are offloaded,the developer is left with the more predictable market risks. This,coupled with the long-term nature of a less uncertain project revenue stream,makes such debt attractive for bond market investors.
Sixth,related to the earlier point,the development of a long-term debt market will ease the current unsustainable burden on banks. With long-term debt being raised through bond offerings,banks would only need to finance the shorter-term construction loans. It will reduce the asset-liability mismatches in bank balance sheets.
Finally,all these advantages would work to ensuring the most cost-effective financial structuring. The government would be able to raise construction capital at a much lower cost than any private contractor. The swap would help access the cheapest long-term funding option for the project.
Critics would argue that this model is a throwback to a bygone era of public development of infrastructure works. But they overlook the fact that when faced with risks that cannot be effectively mitigated and in conditions of considerable information asymmetry,inefficient contracts are inevitable. Careful structuring of the project — in a manner that bridges information asymmetry,effectively allocates risk and enables transparent and efficient price discovery — therefore becomes critical to its sustainability and cost-effectiveness.
The success of this model will depend critically on the project design. A deficient project design would render it unattractive to private participants,thereby increasing the risk of creating further “white elephants”. This highlights the importance of professional project conceptualisation and construction management processes. Fortunately,since all major projects are today designed with external professional expertise,it is easier to structure them in a manner that facilitates post-construction private participation. The Indian Infrastructure Finance Company Ltd and similar market facilitators could accordingly help arrange for construction financing.
Experience from across the world shows that PPP projects generally run into problems either because the private partners make excessive profits,thereby provoking political opposition to revoke the contract,or make large losses,forcing them to seek renegotiations. The complex nature of underlying risks,especially those related to construction and project stabilisation,are not readily deciphered at project conceptualisation. In these circumstances,the PPPs structured after project construction or commissioning are more likely to succeed with the partnership.
The writers are members of the IAS. Views expressed are personal