Friday, January 23, 2015

Revising India's rating depends on economic growth: S&P

Global rating agency Standard & Poor's (S&P) has said that it could raise India's sovereign rating if the economy reverts to real per capita gross domestic product (GDP) growth of 5.5 percent.
The rating agency in its report Asia Pacific Sovereign Rating Trends said: "We could raise the rating if the economy reverts to a real per capita GDP trend growth of 5.5 percent per year and fiscal, external, or inflation metrics improve."
"Conversely, we may lower the rating if the government's structural reform agenda stalls such that economic growth does not accelerate, or fiscal and debt ratios fail to improve," S&P said.
According to S&P, the stable outlook rating for the next 24 months reflects its views that the new BJP-led government has both the willingness and capacity to implement reforms necessary to restore some of India's lost growth potential.
The agency also said the new government should also have the willingness and capacity to consolidate its fiscal accounts and permit the Reserve Bank of India to carry out effective monetary policy.
The S&P expects that political developments in few Asia-Pacific sovereigns will be an important factor in shaping credit trends in the next few years.
"New leaders in India and Indonesia have made changes that are welcomed by investors after they came into office in 2014," S&P said.
Further reforms that improve the investment climate and strengthen fiscal health in India and Indonesia could brighten long-term growth prospects.
In both countries, under-investment in infrastructure has resulted in constraints on development.
Diverting funds from subsidies to public investment and reducing barriers faced by businesses could unlock growth potential and strengthen credit support for these sovereigns.

Monday, January 19, 2015

Interest rate cuts and lazy banking

Interest rate cuts and lazy banking

The RBI's surprise 25 basis points repo rate cut early this week has been greeted with widespread enthusiasm by India's corporates. With banks expected to lower the rates in response to the central bank's rate cuts, the  belief is that this marks the start of an easy credit cycle. I am not sure whether the rate cuts would readily translate into lower cost of capital for borrowers in the short-term, for atleast two reasons.

1. The more substantial economy-wide impact of the rate cut will be felt when the overwhelming majority of corporate borrowers, the small and medium enterprises, have access to cheaper credit. This is unlikely to happen anytime soon given the circumstances. Hobbled by distressed assets and declining capital adequacy ratios, banks are likely to be averse to assuming riskier loans, leave aside providing them at cheaper rates.

2. There is a strong likelihood that the banks may find the rate cuts as an opportunity to atleast partially ease the burdens from their distressed balance sheets. The temptation to only marginally lower lending rates while proportionately lowering deposit rates would be high given the proclivity for lazy banking among the country's banks. A recent Business Standard article gave an indication of the dominance of risk-free margin (spread between 10 year G-secs and deposit rate) on the banking sector's pre-tax profits.  

Make for India Vs Make in India

Make for India Vs Make in India

The debate triggered by the remarks of the Governor of Reserve Bank of India, Raghuram Rajan, on the central government's high-profile "Make in India" campaign missed an important insight about the strategy that should be adopted to encourage manufacturing. The Governor had cautioned about excessive focus of the campaign on both manufacturing and external markets and suggested "Make for India". So, how are 'Make in India' and 'Make for India' different?

Both are anchored around the East Asian manufacturing-led rapid economic growth strategy. The success of the East Asian model depended on both domestic and external demand. Proactive government policies encouraged manufacturers who produced export quality goods for both domestic consumption and exports. In all these cases, the domestic demand was supported by a wide enough consumer base for good quality products and the domestic market in turn provided the platform for manufacturers to develop and refine those products to world-class standards.

In contrast, manufacturers in India may struggle with domestic demand. The headline numbers that proclaim large declines in those living 'below the poverty line' (BPL) does not mean that the new entrants into the 'above the poverty line' (APL) are ready for middle-class consumption. In fact, as a MGI report from last year shows, atleast 56% of the country's population do not have the resources for their basic needs. Further, nearly 95% of the households make less than Rs 1.5 lakh a year.

It is fair to argue that these consumers are likely to be deeply price sensitive and less concerned about quality beyond some basic considerations and durability. Only a tiny sliver of the market is likely to be demanding on quality. A manufacturer making automobiles, clothing, or consumer durables is therefore encouraged to keep costs down, thereby discounting for quality. Margins are also minimal in this side of the market, thereby limiting their ability to expand or move up the quality escalator. Needless to say, none of these products can be exported. Export quality manufacturers are constrained by the limited domestic market base to refine their products through a "learning by doing" approach.
In the circumstances, India's manufacturers have two choices - 'Make for India' or 'Make in India' for export markets. As illustrated, they are qualitatively different choices. The former leaves them entrapped in a low-level equilibrium, exit from which is very difficult. Its market dynamics makes it difficult for these manufacturers to re-orient their production to also meet export markets. Further, manufacturers in this end of the market face stiff competition from cheap imports from competitors in China and elsewhere who have moved up the quality chain and can therefore produce the same quality at far competitive prices. Therefore any campaign to 'make in India' by 'making for India' is unlikely to achieve intended results, atleast in the medium-run.

The latter choice - 'make in India' for external markets - requires technological and professional expertise, which only a handful possess, and an enabling infrastructure and policy environment, which is sorely deficient. Here, India has sought to emulate the latest entrants into the "flying geese" model like China and Vietnam where public policy encouraged greater external-market focus through the establishment of export-only Special Economic Zones. But in order to make an impact, this strategy requires massive investments on infrastructure in these zones and its surrounding areas as well as equipping public systems there with much greater state capability. Further, it also assumes the presence of a receptive external market. The reliability of these assumptions are, at best, questionable. 

Wednesday, January 7, 2015

The Difference Between Being Rich and Being Wealthy

Being rich and being wealthy seems to be synonymous as both involves having a lot of money. However, there’s a big difference between the two. If you notice, there are a lot of so-called ‘get-rich-quick’ schemes but there are no ‘get-wealthy-quick’ schemes.
The main difference between being rich and being wealthy is knowledge. Wealthy people know how to make money while rich people only have money. Rich people are motivated by money but wealthy people are motivated by their dreams, purpose and passion. Most rich people make a lot of money with their paychecks but the moment they stop working, they also stop making money.
Being wealthy is defined as that status of an individual’s existing financial resources that supports his or her way of living for a longer duration, even if he or she does not physically work to generate a recurring income.
For example, if a person’s monthly expenses amount to Rs. 25,000 and he only have Rs.100,000 in his savings, his wealth is approximately four months or 120 days. Wealth, therefore, is measured in time, and not in amount of money that you have. It suffices to say that wealth is dependent not only to the amount of income but also to amount of expenses one makes.
Wealthy people can build sustainable wealth that can last for years through asset investments producing multiple streams of income.
Rich people, on the other hand, may get money in an instant such as inheritance or winning a lottery. However, because of lack of proper mindset and poor money management skills, all of it can be lost in a short period of time. It makes sense that if you did not work hard to earn and build it, then it can just easily pass on your hands and splurge it on things which are not important. Some of these people are more commonly known as ‘one day millionaires’. Now they have it, the next time they don’t.
Wealthy and rich people both may experience downfalls and failures in their ventures. However, because wealthy people are knowledgeable when it comes to money matters, they can start all over again and build wealth over time. In contrast, rich people may find it hard to attain what he or she previously has. In essence, wealthy people are financially free while rich people are not.
Since wealth is not an overtime success, one must learn to distinguish an asset from a liability. Focus on creating and buying income-producing assets to generate a passive or a portfolio income.

How Strong is Your Wealth?

Now that you’re on your way in building your wealth, the next thing to do is to calculate and monitor your wealth ratio on a monthly basis to properly administer the financial and economic aspect of your life. The formula is:
The objective of calculating your wealth is to have your passive and portfolio income equal or greater than your monthly expenses. The moment you have a ratio of one is to one or more at any given month, then it indicates that you have increased your financial capacity to live a better life. On the other hand, if your wealth ratio is less than 1, it implies that you are still in a financial dilemma and your cashflow does not meet your basic life standard.
As I have discussed in the 3 types of income, passive income is the residual income that you get from compound interest or compound growth. They come in the form of rental income from real estate properties, residual income from network marketing or franchises, interest from savings and time deposits, income from a virtual assets, etc. Meanwhile, portfolio income comes mainly from paper investments such as stocks, bonds, trust funds, and other marketable securities.
The key in improving your wealth is to regularly monitor and increase your passive and portfolio income by increasing your means to earn more instead of acquiring more expenses. The moment you decide to make the passive and portfolio income a part of your financial habit and discipline yourself in building it, your are on your way to financial freedom. This is the path in maintaining a strong wealth foundation.

India's disappointing economic growth recovery

India's disappointing economic growth recovery

The latest IIP figures on the Indian economy makes dismal reading. It fell 4.2%, its worst performance in three years, on the back of weak manufacturing performance. This was despite the festival season and a favorable base-effect. So, despite all the "animal spirits" released in recent months, what's going on?

Madan Sabnavis of CARE Ratings captures symptoms of the malaise,
Growth in consumer durable goods for instance was 2.6% and 2.0% in 2011-12 and 2012-13 respectively, and then declined by 12.2% in 2013-14 and further by 12.6% in the first half of 2014-15. Clearly, households are not spending on non-food items. The reason is not hard to guess. Food inflation has eroded the spending power, as Consumer Price Index (CPI) inflation has been high averaging 10.2% in 2012-13, 9.5% in 2013-14 and 7.4% in 2014-15... industry has cut back on investment. This is mainly due to surplus capacity with the average capacity utilization rate coming down from 77.7% in first quarter if 2011-12 to 70.2% in the June quarter if 2014-15. Quite clearly, low consumer demand translates into lower demand for intermediate, basic and capital goods. Add to that the surplus capacity in a high interest rate environment and investment is bound to be curtailed.
For an economy where consumption makes up nearly 60% of the output and therefore critical to do the heavy lifting, this weakness is very damaging. As Mr Sabnavis identifies rightly, the prolonged period of inflation is the major culprit, having significantly eroded purchasing power among the workforce. To get a sense of the wealth erosion - the 9% average inflation over the 2008-14 period, exactly halved our purchasing power. It is reasonable to assume that incomes would have grown by far less to compensate for the loss. The steep negative impact on aggregate demand is understandable. The importance of RBI's stance on inflation has to be seen against this backdrop.

In the circumstances, as I have blogged earlier, there are two important parts to restoring economic growth - revival of credit growth and investment. Non-food credit growth, currently languishing at less than 10% has to return to atleast 15-20% levels. More importantly, infrastructure credit growth has fallen precipitously from its heady 35-40% growth rates in 2010-12 to less than 15% in 2013-14. Excluding power sector, itself weak, the infrastructure lending performance is poorer still. There are two important requirements to meet this target.

One, any rise in credit growth is contingent on the ability of banks to meet the demand. Here the weak balance sheets of the public sector banks, who supply over 80% of the bank credit, is a major constraint on lending, even if investment demand picks up. Large scale recapitalization is arguably the most urgent macroeconomic policy requirement and it is unlikely to materialize by merely divesting bank share holding.

Two, in the absence of investment demand - both due to the weak infrastructure investments and the anemic consumer demand - the government becomes the engine to trigger investment revival. Unfortunately, it does not have the fiscal space to finance infrastructure investments. This is reflected in the marginal budget allocations made for even flagship projects of the government, with unrealistic hopes being thrust on private sector and public private partnerships.

The additional fiscal space come from either increased tax revenues and squeezing expenditures elsewhere. But both direct and indirect tax collections have been disappointing - 5.8% growth in indirect taxes against the budget estimates of 25% and 7.09% growth in direct taxes against the budget estimates of 15.31% in the April-September half year. This is not surprising given weak demand, low corporate investment appetite, and anemic economy. Cutting welfare spending is politically contentious and better targeting through Aadhaar will take time. Thanks to the one-step forward, half-step backward reforms, the windfall from the more than 40% drop in oil price appears unlikely to be fully reaped. Most of the measures to improve revenues and optimize expenditures are diffuse and long-drawn and unlikely to yield similar windfall.

All this highlights the adverse headwinds that the Indian economy has to navigate before it can start growing at 6-7%, leave alone the heady 8-9% rates. And I am not even talking about these long-term trends. In the circumstances, the journey towards regaining a 6-7% growth rate looks likely to be painstaking and long-drawn. Talking up the economy can only take you so far, and there are no magic reform pills available in the government's armor. 

Will Narendra Modi 'Make It or Break It' in 2015?

Narendra Modi stood as the hero of the year 2014. Many promises came along the way which he certainly needs to keep for the following year as well. Now is the time for speculations and there is little doubt whether this man who dominated 2014 can dominate 2015 as well? The Firstpost has been reporting on the progress of Modi’s revolutionary initiatives and the results vary a little from the promises he made.

There is no doubt that the Prime Minister’s achievements so far are spectacular, he has been winning election after election for his party—the most recent one being Jharkhand.He succeeded in his efforts to give the prime importance to PMO’s office in policy matters. R. Jagannathan of Firstpost says that, “he is not just primus inter pares, but numero uno in all things that matter in this government,” which has been true so far. He has done things which the previous government was clearly unable to do. He not only changed waves but created his own waves in foreign policy, which is probably his most successful side so far. Manohar Parrikar and Suresh Prabhu were the highlights of his diplomacy; this move brought good changes in defense and railway leadership, which was the need of the hour.

India's new paradigm in financing infrastructure and attracting investments

India's new paradigm in financing infrastructure and attracting investments

India's Twelfth Five Year Plan estimates a trillion dollars investments in infrastructure. But atrifecta of problems threaten to pour cold water on these ambitions.

One, governments, both at the center and in states, are fiscally strapped and are likely to remain so even after recovery takes firm hold. Two, debt-laden infrastructure firms, especially in power and transport, have little or no space within their balance sheets to take on newer projects. In any case, despite all the hype around PPPs, many of these projects are hugely risky and are not amenable to such financing. Third, banks, especially the public sector ones who make up nearly 80% of the lending, are struggling with double-digit impaired assets and are touching their sectoral exposure limits. Even with the most aggressive reforms, the situation is unlikely to change in the foreseeable future. 

Faced with this perfect storm, governments appear to believe that the way out is by collaborating with foreign governments. More specifically, in partnerships with East Asian governments, whose large investible foreign exchange reserves are currently invested in low-yielding US Treasury bonds. In the face of global economic weakness and ultra-low interest rates in developed economies, these countries have limited investment options. In their search for yield, the sovereign wealth funds and external lending agencies of countries like China, Japan, and Singapore have been scouting higher-return long-term investment opportunities across the world. The size of India's economy and its relative strength makes the country an attractive investment destination. 

Realizing this, a few state governments and the central government have been aggressively wooing these governments. The successful summit meetings of the Indian Prime Minister with counterparts from Japan and China have provided a fillip to these explorations. Investments in infrastructure and manufacturing, both public and private, are being pursued on the back of bilateral agreements between governments. Such investments come essentially in two forms - long tenor concessional loans to finance infrastructure projects and financing of large industrial parks through joint ventures between public and private entities of the two countries. 

An MoU between the governments of India and Japan commits Japanese capital to the development of a 1500 km dedicated freight corridor between Delhi and Mumbai. Similar partnerships are being explored with Japan to finance a 534 km high-speed rail link between Ahmedabad and Mumbai at a cost of Rs 54000 Cr and with China for a 1700 km Chennai-Delhi link that would cut travel time from 28 hours to just six. MoUs have also been signed with the Chinese government to dovetail funding from China Development Bank for two large industrial Special Economic Zones (SEZs) in Maharashtra and Gujarat. The Indian and US Governments have signed an MoU to develop three smart cities at Ajmer, Allahabad, and Visakhapatnam. The government of Andhra Pradesh have signed an MoU with the Singapore government to develop the nucleus of the recently formed state's new capital city near Vijayawada. Similar MoU is being planned with Japanese government to develop the Vizag Chennai industrial corridor and facilitate Japanese companies to invest there.  

Such government-to-government partnerships have the potential to herald a new paradigm in attracting investments. However, they come with several cautions. 

1. Whatever the spin given, such investments in infrastructure are essentially public borrowings to be repaid over a long duration by government entities at different levels. Therefore, given the limited fiscal space, we need to be cautious not only about the scale of debts assumed but also about its public utility. In particular, instead of frittering away scarce money on grandiose aspirational projects with disproportionately low socio-economic utility, we need to channel it to financing projects which carry the greatest bang for the buck. This assumes greater significance since the counterpart governments are more likely to be interested in precisely such grandiose projects - like high-speed rail or metros - which offer the potential of highly attractive returns for their contractor and supplier firms. 

2. Another concern arises from the procurement conditions attached with such lending and investments. For example, lenders invariably insist that the contract be awarded to and procurements made from their firms. This raises concerns about whether public resources are being spent in the most cost-effective manner and on the most efficient technologies and appropriate systems. Even with the potential for joint ventures, Indian firms are likely to lose out to the larger and better endowed counterparts from these countries. Further, as experience of similar partnerships for real-estate based developments between state governments like Andhra Pradesh and Kerala with Middle Eastern governments have shown, the potential for cronyism and corruption are never far away.   

3. The Chinese, in particular, see development of SEZs in partnership with Indian agencies - MIDC in Maharashtra and DMIC in Gujarat - as excellent platforms for facilitating Chinese companies to invest in India without the general hassles associated with investing in the country. It could help orderly flow of production factors from China to India and an enabling regulatory framework that are required to support such investments. 

But given that Chinese imports are already out-competing Indian manufacturing, once these units become operational, the additional incentives that come with SEZs are unlikely to go down well with Indian manufacturers. In any case, there are enough doubts about the wisdom of encouraging manufacturing growth through the SEZ route. 

4. There are also concerns about the dynamics associated with Chinese investments which are certain to generate controversies and disputes. Howard French has written about thecontroversies surrounding Chinese investments in Africa on the displacement of local labor by Chinese migrants, racially clouded interactions with locals, and crowding out of local entrepreneurs and businesses. The visa problems faced by Chinese boiler-turbine-generator makers for Indian power plants and spying charges against Chinese telecoms equipment makers are cases in point.   

5. Finally, there are all the other risks and limitations associated with such capital inflows. Since these loans are foreign currency denominated and unhedged and the investments generate rupee cash flow, they leave the Indian government counter-parties exposed to foreign exchange risks. There is also a limit to such investments - a handful of iconic infrastructure projects and SEZs that are likely to materialize through this route can at best scratch the surface of requirements.

Friday, January 2, 2015

Economic Dangers for 2015 and Beyond

Investing isn’t done in a vacuum. Thanks to globalization, most economies in advanced as well as emerging economies are now intimately connected—and when one of them topples, it can cause a ripple effect around the entire globe, affecting investors worldwide.
That’s why it’s imperative for any smart investor to be aware of the macroeconomic and geopolitical forces that are in play right now.
The Roubini’s Edge team has put together an in-depth special report titled Five Serious Economic Dangers for 2015 and Beyond, which details the greatest risks we’re facing right now:
  • Euro-crash. With a very real risk of deflation looming, the euro zone might become a destabilizing force in the global economy.
  • Can Japan survive another lost decade? Abenomics may be backfiring, squeezing consumers, increasing economic hardship, and causing Japanese corporations to give up on their domestic market.
  • China slowdown. China’s financial system is exhibiting signs of significant stress. If its economic growth slows too much, it will severely affect commodities and trade-driven economies, like the US.
  • Geopolitical risks abound: Find out all about the seven biggest powder kegs in the world today.
  • Dollar shock. The recent strengthening in the US dollar is viewed as a positive by most Americans, but the dollar’s upside could be limited by the crushing effect it has on emerging markets.

Rise of the Machines: Downfall of the Economy?

Technology and disemployment fact of the day

Nouriel Roubini has an essay on the impact of automation and technology on the economy, in particular the labor market. He points to three "downside biases" associated with the technologies associated with the "third industrial revolution" - capital-intensive (favoring those with money and resources), skill-biased, and labor saving. The example of e-books and e-publishing is illustrative,
Think of what e-books have already done: with a click, you can now download almost any book for about $10 on your iPad or Amazon Kindle. This is a great service and convenience for consumers. But most of the jobs in the printing and distribution of books—and soon in the newspaper and magazine industry—are already gone. And so are tons of jobs in the pulp paper industry... 
Last Thursday night, I attended the Bloomberg BusinessWeek 85th Anniversary Dinner.
The party was held at the American Museum of Natural History, where Seth Meyers, the former Saturday Night Live star, hosted the evening beneath a massive, life-sized replica of a blue whale.
The party was packed with the usual collection of highly polished New York media and business types. (The entertainment highlight of the night for me was a charming duet by Lady Gaga and Tony Bennett.)
It was a great honor to be asked by Bloomberg and BusinessWeek to give an official toast during the event, along with my fellow toastmasters Henry Kissinger, Henry Kravis, and Mellody Hobson. For my toast, I was asked to select the innovation that I thought created the most disruptive change during the last 85 years.
I decided to speak about the microchip—because the microchip may well replace the human race.
Yes, I’m being intentionally provocative here: but it isn’t just because of my nickname (“Dr. Doom”) that I’ve chosen to find the dark shadow in the silver lining of technical progress.
A few weeks ago, Stephen Hawking, the greatest astrophysicist of our time, gave a provocative speech of his own: Hawking suggested that humans should start thinking about colonizing other planets, because eventually artificial intelligence and robots will replace the human race.
It may sound crazy now—but what seems crazy today may not sound so crazy 25, 50, or 100 years from now.
The Terminator: Source: Orion Pictures
This wave of technological innovation began in 1947 with the invention of the transistor. A little over 10 years later, the microchip appeared; and, soon after that, computers followed. From these basic roots, the rate of innovation simply exploded.
We now live in a digital age where personal computers, supercomputers, robotics, and artificial intelligence are everyday features of our world.
All of these new labor-saving technologies are cheap to deploy—and each will likely play a role in further automating and digitizing our economy.
Without further ado, let’s take a look ahead to what many are calling the Third Industrial Revolution.

The Third Industrial Revolution

Source: American Sociological Association
Looking back as 2014 winds to a close, I see that a lot has changed in the world economy this year. For example, there is a new perception of the role of technology. Innovators and tech CEOs both seem positively giddy with optimism. And while it is true that some wondrous opportunities may lie ahead, there are also dangers to be wary of as we look to the future.
Technologists claim that the world is on the cusp of a series of major technical breakthroughs. The excitement in this sector isn’t coming just from information technology. It’s also being generated in the fields of biotechnology, energy technology, nanotechnology, and especially from the manufacturing technologies of robotics and automation.
These new manufacturing technologies have spawned a feverish excitement for what some see as a coming revolution in industrial production.
This “Third Industrial Revolution” will provide many investment opportunities—such as green energy development and new kinds of direct investment in those nations most likely to benefit—as well as the potential for a steep rise in returns.
These are life-changing developments, and the consensus among experts is that we will all witness their impact very soon.

The Coming Manufacturing Revolution

In the years ahead, technological improvements in robotics and automation will boost productivity and efficiency, which will translate into economic gains for manufacturers.
It will also benefit highly skilled workers—principally software developers, engineers, and those who work in material science and research. (If you’re a parent or a grandparent, you should encourage the younger generations to explore any talents they possess in these fields.)
Consumers and individuals should also benefit from lower retail prices caused by lower production costs to manufacturers. In short, things will be cheaper.
The quick growth of smart software over the past few decades has been perhaps the most important force shaping the coming manufacturing revolution. The extraordinary rise of the computer software industry has led many of the world’s best minds to focus on the challenges of developing better, smarter, more efficient computer code.
As software development becomes more “glamorous,” the number of bright youngsters studying software engineering increases, creating a virtuous cycle for the software industry.
In addition to software services, a number of new technologies driving the next manufacturing revolution are just now beginning to be felt. They’re like foreshocks, early tremors of the coming earthquake.
On the vanguard of this revolution we find 3D printing. Sometimes 3D printing is called “additive manufacture,” because the process involves computer-controlled robots adding layers of materials to create new things. (Traditional manufacturing usually removes layers from raw material, for example the way a lathe cuts away metal.)
3D printing and related technologies will open the door to advances in manufacturing that have never before been possible:
  • Mechanical engineers will be able to prototype new products more rapidly. New product designs can be created and tested in days rather than months.
  • Manufacturing can be distributed globally to create the greatest efficiencies in marketing and distribution.
  • Finally, customization of products for individual consumers can occur at a price point that was never possible in the past. Not only will things be cheaper, they’ll be your way, right away.
A 3D printer printing its own parts
On the plus side of the equation, these changes promise a great boom in productivity. Products will be created more cheaply than ever before. Early adopters of new technology will reap a windfall by perfecting the new techniques. Highly skilled jobs will be created for those educated enough to participate in the new tech-savvy manufacturing world. A few new high-tech manufacturing billionaires may be added to the ranks of the software barons of old.
However, for those workers not fortunate enough to participate in the gains of the new economy, it may feel as though the whole revolution is happening somewhere else. Entire economies risk being destabilized in countries that rely on advanced manufacturing and on service sector jobs. (If you’re reading this, chances are you live in one.)
But remember the dark shadows of those silver linings: with each new gain comes the potential loss of something else.
We know what we have to gain from this automated future. But what, specifically, do we stand to lose?

A Rather Shaky Foundation

In my view, from the economic perspective, the technological forces driving this revolution tend to have the following three downside biases. That is, advances in technology tend to be:
  • capital intensive (favors those who already have money and other resources);
  • skills biased (favors those who already have a high level of technical skill); and
  • labor saving (reduces the total number of jobs in the economy).
The risk is that workers in high-skilled, blue-collar manufacturing jobs will be displaced by machines before the dust settles at the end of the Third Industrial Revolution. We may be heading toward a future where factories consist of one highly skilled engineer running hundreds of machines—with one worker left sweeping the floor.
In fact, the person who sweeps the floor may soon lose that job to a faster, better, cheaper, industrial strength Roomba Robot!
For the last 30 years, emerging-market economies have increasingly displaced developed-market economies in the manufacturing sector as a base of production. This is a story we all know: the transition from the old industrial powers of Western Europe and North America to the new ones in Asia. But despite this shift, developed-market economies have somehow made up for those losses in their labor markets.
Over the last 20 years, the overall unemployment rate in the United States has hovered around 5% on average—except during periods of economic recession, when it has spiked upward for short periods of time.
In general, however, the loss of those manufacturing jobs has not caused catastrophic levels of unemployment.
How? Well, the short answer is the service economy.
(Of course, this replacement of manufacturing jobs with service jobs has not been equally distributed. Some regions have suffered more than others. For example, the so-called Rust Belt in the upper Midwestern section of the United States has experienced more economic pain than most other regions. But while the local suffering has been great in those regions hardest hit, the overall trend throughout most developed-market economies is that lost manufacturing jobs have been absorbed largely by new jobs created in the service sector.)
In my view, however, there’s no guarantee that this positive scenario—of service-sector jobs making up for lost manufacturing sector jobs—will continue.
In fact, some of the trends mentioned earlier imply that the Third Industrial Revolution will unleash forces that threaten the relatively benign status quo. In addition to the job losses in the manufacturing sector, these trends also threaten the very service-sector jobs that have so far helped us avoid an employment crisis.
To put the coming changes into context, think of what e-books have already done: with a click, you can now download almost any book for about $10 on your iPad or Amazon Kindle.
This is a great service and convenience for consumers. But most of the jobs in the printing and distribution of books—and soon in the newspaper and magazine industry—are already gone. (And so are tons of jobs in the pulp paper industry—though that may come as a relief to environmentalists).
Yet this is all just the tip of the iceberg. The powerful forces unleashed by technology that will radically slash jobs in the future are already upon us. Industries affected will range from health care to retail, education, finance, transportation, real estate, and even government.
One of the affected industries may even be your own.

It’s a Small Step from Offshoring to Automation

Think of the potential risks to service-sector jobs in the context of what I call the “Automated Checkout Economy.” Several decades ago, few people thought that low-paying jobs in the retail sector would be outsourced or eliminated. Technological progress may soon change their tune.
While grocery and checkout jobs cannot be entirely eliminated, at least not quite, technology can assist in drastically reducing the number of human beings needed to fill the remaining positions. A trip into a drug store in New York City, my home for the last several years, will often reveal a single pharmacy clerk watching over four automated checkout terminals, where customers scan and pay for their own purchases. I imagine that you’ve probably seen something similar in your own town.
Other low-wage and labor intensive jobs in retail, such as stocking the shelves of supermarkets with food, will soon be replaced by machines that can do those jobs better and faster than humans could.
This has already begun to happen in traditional brick-and-mortar stores, while automation at online “e-tailers” has gone even further. Giants like Amazon have already built massive robot-staffed warehouses to distribute their orders. One day soon, your friendly neighborhood UPS or FedEx driver delivering those Amazon packages may even be replaced by a drone. And it may be sooner than you think.
Amazon drone: Source: Amazon
In retail, the slashing of middle management jobs has already begun, as computers have become more efficient not just at crunching numbers but at providing managers with the right information at the right time.
Another trend that may result in a decrease in service-sector jobs is something we might call “The Offshoring Pathway to Automation.”
During the first phase of the transition to a truly globalized labor market, New York Times columnist Thomas Friedman and others popularized the narrative of high-skilled jobs being outsourced from developed markets to emerging markets. (Friedman’s book The World Is Flat is highly recommended reading on this topic.)
While this trend continues, it supports potential for a still greater transition.
Think, for example, about the process now in place for offshoring medical services. A patient in New York or London may have his MRI sent digitally to, say, Bangalore, where a highly skilled radiologist reads the scan. However, that highly skilled radiologist in Bangalore may only be paid a quarter of what a New York radiologist would earn for reading tests.
It raises the question: how long before a computer can read those images faster, better, and cheaper than that Bangalore radiologist can?
Such a transition is not far off. The offshoring process has already broken down reading an MRI into a series of simple steps resulting in digital output. That digital output can then easily be turned into an input in a fully automated process. This kind of transition, from offshoring to automation, may become a factor in reducing service-sector jobs in developed and emerging markets in the near future.

Work in the Machine Age: Humans Need Not Apply?

The Third Industrial Revolution also coincides with other systemic changes taking place in the economy. Entire industries in the service sector will have to shrink massively for reasons initially unrelated to advances in technology.
Let’s take two of the most obvious examples: the financial-services sector and real estate.
In the years leading up to the economic collapse of 2008-‘09, market bubbles fueled huge run-ups in the prices of financial assets and real estate. With a bubble in asset prices came an explosion in compensation, causing new workers to flood into those sectors. As the last remnants of those bubbles deflate, job cuts in those industries may become inevitable.
But over time, technology may allow even the jobs in real estate and finance to be first outsourced and then totally eliminated.
Today, hundreds of thousands of back-office jobs in the financial sector are outsourced to India and other emerging markets. But tomorrow, a piece of computer code may be able to generate the same sophisticated analytics that some of Wall Street’s highly paid professionals now create.
Real estate—which is now highly labor intensive, with a plethora of agents and brokers—is experiencing a revolution. 12 years ago, in 2002, I was able to buy my first apartment in New York without a real estate agent by using the online New York Times listings. Today, even more sophisticated online tools reduce the need even further for expensive middlemen.
A revolution is also underway in education, which is also currently a very labor-intensive field.
With the growth of ever-more sophisticated online courses, will we still need hundreds of thousands of teachers in the decades to come? And what will all those former teachers do to earn a living instead?
It becomes possible to imagine a future where the top 100 economists in the world, for example, can provide high-quality and cheap online courses in their field. Those changes, however, would mean displacing the jobs of hundreds of thousands of other economics professors in the process.
Source: Cultus: e-Learning Portal
Indeed, in places like emerging-market Africa, where building brick-and-mortar schools is expensive and where training high-quality teachers is difficult, online courses and cheap tablet computers could gradually begin to replace traditional education, making it even more affordable. Ironically, this would lead to some unemployment, as the demand for highly educated people to fill teaching positions declines.
Governments are shedding labor too, particularly governments burdened by high deficits and debts.
The e-government trend can also lead to labor savings in the way in which government services are provided to the public. You can find tons of public services online and avoid spending hours standing in line in an overcrowded office just to request a few government forms.
Even transportation is being revolutionized by technology. Today a friendly Uber driver or a car-sharing service like Zip Car can replace the need to buy your own car or even rent one. But in a matter of years, driverless cars—courtesy of Google and others—may render the job of a driver or chauffer obsolete.
So, whether it’s retail or finance, education, health care, transportation, or even government, a massive technological revolution will sharply reduce jobs over time. Low-skilled jobs and medium-skilled white collar jobs will be the first to go, as they have always been.

Industrial Revolutions—Past and Future

In order to better understand the future, it’s helpful to take a look back at the past. During the First Industrial Revolution, which began around the same time as American independence from Great Britain, life began to shift away from agriculture toward increasing industrialization. Farmers moved to cities, and farms became industrialized.
Factories became widespread. A factory owner could take a farmer, perhaps a farmer who could not read or write, and give him a job. New methods—like the division of labor—and new machines allowed that farmer to become more productive. In fact, farmers were able to generate more “output” in a factory than on a farm.
But unlike modern automation, the machines needed to be run by a new generation of workers: Men and women needed to “man” those machines.
Productivity increased—and so did wages.
The Second Industrial Revolution, during the end of the 19th century and the beginning of the 20th, was an extension of the first. During those years, there was an explosion in technology and methods of communication. Thanks to the telegraph, the world became “wired” for the first time.
The new advances in technology, however, cut both ways.
Take the case of Frederick Winslow Taylor, a major figure in the Second Industrial Revolution. Taylor, known as the father of scientific management, once wrote that the brawn required for handling pig iron was proof in itself of the intellectual unfitness of ironworkers to manage their own work. This is hardly a democratic sentiment, and it was more or less the common one.
While new “scientific” methods of management increased the productivity of workers, improvements in working conditions lagged behind. (Taylor’s views didn't help matters.)
Perhaps the takeaway lesson is that it’s easier to improve technical methods of production than workers’ opportunities.
But despite these challenges, the Second Industrial Revolution created a higher demand for labor.
As we sit on the cusp of a Third Industrial Revolution, a revolution that is both industrial and digital in nature, it’s not certain that the demand for labor will continue to grow as technology marches forward—unless the proper policies to nurture job growth are put in place.
The world began to change during the first Digital Revolution—during the rise of the Internet in the late ‘90s. Then, the digital divide between those who knew how to use computers and those who didn’t led to an income gap between more-skilled workers and less-skilled workers.
At the extreme, as I mentioned in my introduction, some serious thinkers are even worried about technology not only replacing humans in jobs—but actually replacing humans entirely.
The implications of artificial intelligence, not just for jobs, but human life, are now being pondered by some of the best minds in technology.
There used to be a science fiction term for a state where human beings were no longer able to control technology: It was called “the Singularity.”
In the future, this Singularity may no longer be just science fiction.

Will There Be a Green Revolution?

Of course, there are more optimistic sides of this story. Some of those perspectives show a much rosier picture. The green revolution in technology is a perfect example.
(Jeremy Rifkin is a believer in this view. In his 2011 book The Third Industrial Revolution, he makes a case for his bullish outlook. Rifkin is optimistic about a great many things: green renewable energy, urbanization of structural power plants, hydrogen cells, and an Internet grid for power transmission and distribution.)
These new technologies carry with them the promise of cleaner and more efficient energy.
This objective, of course, could not be more crucial. The search for green energy technology has become a global goal. The evidence of environmental damage, caused by pollution and the burning of fossil fuels, is now beyond question.
To cite just one sobering example of the size of the challenge, a study by the World Health Organization (WHO) recently concluded that one in eight deaths were caused by air pollution. This is especially true in the developing world, where environmental hazards tend to be significant.
As an example, air pollution in Beijing, where senior Chinese government officials live and work, has reached dangerous levels. The pollution in Beijing is now a practical threat to the Chinese economy and to China’s plans for future development.
The Chinese government has begun to come down hard on its domestic polluters by enhancing the power of the state to regulate pollution. In light of the growing pressure to restrict environmental pollution, it seems reasonable to expect that there will be intensified research of green technologies. Hopefully, this research will address the environmental challenges at their root, rather than just fixing the damage of their effects.

Automation and Rising Inequality

While the odds for a green technology breakthrough during the Third Industrial Revolution may be good, it seems very highly likely that serious challenges will follow in the wake of further developments in labor-reducing technologies.
As more and more workers are displaced, governments will need to search urgently for new solutions to the problems of automation.
During the First Industrial Revolution, some of the worst forms of winner-take-all capitalism festered in the newly industrialized cities of Europe and the United States. The rate of social and economic inequality increased rapidly. Despite the political opposition to change, a series of economic shocks ultimately convinced enlightened people in the US and Europe of the necessity of the social-welfare state.
The benefits that workers take for granted in developed markets—restrictions on child labor, pensions, retirement benefits, unemployment benefits—were all created out of necessity.
Enlightened social-welfare policies were ultimately vindicated, not just morally but practically. In places where social reform was not enacted, on the other hand, more destructive forms of change took place. (The most extreme case of this destruction was, obviously, the rise of Bolshevism in Russia.)
Now the concern is that technology, together with other factors, is leading to a sharp rise in income and wealth inequality. There is a further risk that inequality will also lead to social and political instability.
The redistribution of wealth—from labor to capital and from wages to profits—may even undermine growth. This makes perfect sense when we consider that the concentration of wealth in the hands of a few tends to reduce household consumption. In the United States, household consumption makes up more than two-thirds of our total GDP.
The rise in inequality was initially the result of trade and globalization, such as jobs being offshored to emerging markets. However, the technological innovation we’re witnessing now has the potential to seriously worsen that inequality—especially when those innovations are, as we discussed earlier, capital intensive, skills biased, and labor saving.
The view is even more pessimistic when you factor in the winner-take-all effects—also known as the so-called “superstar phenomenon.”
Thanks to these winner-take-all effects, the top earners in any field now get the lion’s share of the compensation. After making a windfall profit, the “winners” are then able to use those riches to influence politicians and write their own legislation, which creates even more inequality.
John Maynard Keynes: Time Magazine Cover: December 31, 1965
In the 1930s, John Maynard Keynes had a more optimistic view of the impact of technology: he argued that eventually we could all work 15 hours a week and spend the rest of our time in leisure—like creating art and writing poetry.
But in the Brave New World of labor-saving technology, it seems, 20% of the labor force will work 120 hours a week while the other 80% will have no jobs and no income.
So the ideal world of Keynes may turn out to become a nightmare.
Despite the rapid rate of change and the many uncertainties that lie ahead, the past can help to serve as a model for the future. Governments have a decided role to play in making that future livable—as they once understood. In that spirit, we must search for political and policy solutions to the coming challenges of the Third Industrial Revolution and promote them where we can.
This is not, after all, the first time we’ve faced such problems. At the end of the 19th and the beginning of the 20th centuries, world leaders stepped up to the plate and came face to face with the horrors of industrialization. Child labor was abolished throughout the developed world, work hours were made humane, and a social safety net was put in place to protect both vulnerable workers and the larger (often fragile) economy.

The Past as Prologue

Former Treasury Secretary Larry Summers observed not long ago that we don’t yet have an Otto von Bismarck or a Teddy Roosevelt or a William Gladstone to mediate the current revolution now underway in the technology sector. The Canadian writer and politician Michael Ignatieff picked up on a similar theme in a Financial Timesop-ed called “We need a new Bismarck to tame the machines.”
The references to these political giants of the 19th and 20th centuries are revealing. Otto von Bismarck, the father of the unified German state, is usually credited with the creation of the modern social-welfare state in the 1880s. (He’s also credited with militarizing Germany as he unified it—but let’s stick with his good works for now.)
At about the same time as Bismarck in Germany, British Prime Minister William Gladstone was reforming the most archaic aspects of the British electoral system. Ultimately, Gladstone’s work led to a great democratization and distribution of economic benefits in what was then the world’s leading industrial nation.
Here in the United States, Theodore Roosevelt is perhaps best remembered for breaking up the large industrial monopolies then known as trusts. And we could also add Franklin Roosevelt to the list who, in the tradition of his older cousin, sought to reform the worst excesses of capitalism during the Great Depression.
As we begin the search for enlightened solutions to the challenges that the Third Industrial Revolution presents, some of the overall themes begin to emerge. The first and most important characteristic is that the solution must channel the gains of technology to a broader base of the population than it has done so far.
To make that happen, the solution must have a major educational component. In order to create broad-based prosperity, workers need the skills to participate in the wealth that capitalism generates. That is a major challenge in a world where technology is changing the labor markets at a dizzying and increasing pace.
Workable solutions must address the world as it is, not as we wish it to be.
The way ahead cannot be a na├»ve “Great Leap Forward”: it must embrace the dynamics and creativity of free markets. On the other hand, while the solutions we must pursue can leverage the ideas of enlightened capitalists, those solutions must not rely solely on the generosity of capitalists to succeed.
That most fragile balance—between the freedom of markets and the prosperity of workers—must be sought and found.
Make no mistake: The machines are coming. The question for us is what kind of welcome to prepare for them. 

About "Make in India"

About "Make in India"

I have an oped in Indian Express today that does a differential diagnostic of the challenge of making in India. Infrastructure, labor taxes, and improving business environment appear as binding constraints.

Make in India essentials

The prime minister has declared his goal of “Make in India” with “zero defect” (quality) and “zero effect” (on the environment). As a vision statement, there could not be anything more appropriate. But walking the talk is, arguably, the challenge.
India’s manufacturing has been a puzzle. Since the late 1970s, even as its peers in East Asia have greatly diversified into manufacturing, the sector’s share has stagnated at around 15 per cent of the GDP. It is not that past governments have not tried to revive manufacturing. For decades now, not just the Centre, the states too have had an industrial policy. At some time or the other, many states have even pursued it vigorously. Some of these policies have also been well designed. But the results have been universally disappointing.
This alone should be adequate to chasten us about the task at hand. The revival of our stagnant manufacturing sector is arguably the biggest economic challenge India is facing. Unfortunately, the problem is complex and intractable, demanding several, often diffuse, sets of solutions.
So what is holding back India’s manufacturing? The potential candidates are obvious, though their relative importance is contentious. Sorely deficient infrastructure, inhospitable business environment, corruption, poor quality of human resources, problems with access to timely and adequate credit, difficulty of getting land, high burden of taxation and restrictive labour regulations would figure prominently on any list.
In an ideal world, public policy would be tailored to address all these problems. But in the real world, governments have limited resources and face serious administrative and political limitations. Further, many of these are intimately linked to the country’s stage of development.
One way to prioritise among them is to do a differential diagnostic of the various constraints facing the sector to identify those primarily responsible for holding back manufacturing growth. In other words, such binding constraints are those factors whose relaxation generates the greatest bang for buck. This approach was popularised by economists Dani Rodrik, Andres Velasco and Ricardo Hausmann in the early 2000s and has since been embraced by many countries across the world in designing their industrial policies. In their own words, growth diagnostics is simply “a strategy for figuring out the policy priorities”. Simple as it sounds, in the context of India’s manufacturing sector, it is a formidable exercise. Here is a simplified diagnostic analysis of the sector.
Infrastructure tops the list of most surveys on doing business in India. In particular, chronic deficiencies in transportation and power impose prohibitive costs and lower business competitiveness. Multiple enterprise surveys have identified electricity as the biggest constraint. Further, India lags behind on every measure of transport connectivity. Though there have been considerable recent successes spurred by private participation, much needs to be done.
Credit access for small and medium enterprises (SMEs) is a concern even in developed economies. Interestingly, among the ten parameters in the World Bank’s Doing Business Survey (DBS), India scores best on access to credit, better than its emerging market peers. Other surveys also confirm this. The more important concern would be the undoubted difficulties faced by informal firms in accessing credit. But then, this is more a matter of informality than access to credit.
Scarcity of land and skilled labour have already started troubling businesses, though it is difficult to describe them as binding constraints. Consider land: Over the last decade, several states have generously allocated massive amounts of land, virtually free of cost, for the establishment of manufacturing facilities. But, pointing to constraints that go beyond land, only a minuscule proportion of these investments have materialised.
Our poor human resource quality — 70 per cent of the workforce is educated up to the primary level or lower, though only 10 per cent has received some skill training — is likely to emerge as a constraint in the days ahead. However, work of economists like Aashish Mehta and Rana Hasan finds little evidence that the skills gap is a binding constraint. It is more likely that businesses are unable to hire skilled workers at affordable wages. A more sustainable strategy to bridge the “employability deficit” is to fix the quality of school education.
The regulatory hurdles are equally onerous. India has some of the most restrictive labour regulations. But evidence on growth in the manufacturing sector from states that have eased hiring and firing regulations is, at best, mixed. In any case, a gradual reform process on this is afoot and given its politically contentious nature, this could be the best strategy forward. A bigger constraint may be labour-related taxes, as pointed out by Manish Sabharwal in these pages (‘Pains of the pay cheque’, IE, November 25). They not only impose prohibitive costs on employers but also an unbearable burden on employees, thereby forcing both sides into informal contracting.
High taxes erode business competitiveness. The 2015 DBS reveals that Indian firms’ total tax obligations are among the highest. A multiplicity of indirect taxes raises both the tax burden as well as administration costs. Fortunately, the rationalisation of indirect taxes through the proposed goods and services tax should significantly address this. In any case, our less-than-encouraging experience with tax concessions, the core of numerous Central and state industrial policies over the years, does not lend credence to the view that taxation costs are a binding constraint.
Finally, we have the business environment. Here, I am referring to the interface with various organs of the government in accessing transactional services — procuring land, starting a business, getting utility services, enforcing contracts, resolving insolvency and recurrent routine contact. As numerous studies and surveys show, corruption and harassment plague these transactions. It has an even more pernicious effect on incentives.
Such hostility encourages businesses to start and remain informal, thereby perpetuating India’s overwhelmingly dominant informal sector. All the aforementioned constraints bind with much greater force on informal firms. It also discourages expansion of small business, a major source of job creation, reflected in the “missing middle” of India’s firm-size distribution. While many of these transactions can be eased by simplifying the regulations concerned, their implementation would run into state capability and related governance problems.
Apart from all these, sound macroeconomic policies are necessary to create a low-inflation, low-interest rate and high-growth environment that is essential for the country’s global manufacturing competitiveness.
In conclusion, labour taxes, infrastructure, and the business environment appear to be binding constraints on the revival of India’s manufacturing sector. However, given the huge size and vast diversity of the country, a diagnostic for each state may be a more prudent strategy. In any case, instead of big-bang reforms, sustained efforts in multiple directions, which cumulatively generate large effects, are required to relax these constraints so that we can realise the goal of making in India.
Natarajan is an IAS officer, batch of 1999. Views are personal
Written by Gulzar Natarajan |Posted: December 29, 2014 1:13 am