Are firms in India credit constrained?

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Do Firms Want to Borrow More? Testing Credit Constraints Using a Directed Lending Program

Abstract

This article uses variation in access to a targeted lending program to estimate whether firms are credit constrained. While both constrained and unconstrained firms may be willing to absorb all the directed credit that they can get (because it may be cheaper than other sources of credit), constrained firms will use it to expand production, while unconstrained firms will primarily use it as a substitute for other borrowing. We apply these observations to firms in India that became eligible for directed credit as a result of a policy change in 1998, and lost eligibility as a result of the reversal of this reform in 2000, and to smaller firms that were already eligible for the preferential credit before 1998 and remained eligible in 2000. Comparing the trends in the sales and the profits of these two groups of firms, we show that there is no evidence that directed credit is being used as a substitute for other forms of credit. Instead, the credit was used to finance more production–there was a large acceleration in the rate of growth of sales and profits for these firms in 1998, and a corresponding decline in 2000. There was no change in trends around either date for the small firms. We conclude that many of the firms must have been severely credit constrained, and that the marginal rate of return to capital was very high for these firms.

Abhijit V. Banerjee and Esther Duflo, The Review of Economic Studies 2014 81: 572-607.

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Baba Ramdev and his unsound tax proposals!

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Bad ideas driving good ideas out- that is what is happening with Baba Ramdev’s tax proposals. Tax harmonization in general is good idea. So there is a good argument for abolishing interstate custom duties creating a unified market for commodities. There is also a good argument for streamlining the income tax code to reduce distortion of consumption choices and making tax calculation easy. But to scrap all the taxes and replace it by one single bank transaction tax- bad bad idea!

One for starters, as far as you cannot observe and tax people’s ability, economic theory suggests there is an optimal mix of direct and indirect taxes. Secondly, by taxing bank transactions, we change the relative price of cash versus transactions routed through banks. It only means that transactions would be done more with cash than through banks. It also might be regressive in the sense that people who do not have access to off the book cash will benefit at the cost of people who have to route their transactions through banks.

It looks like Baba Ramdev has been infected by Arthakranti‘s misguided ideas based on very poor understanding of economics. For those who are interested can find my critique of Arthakranti Proposals here. But let me demonstrate the absurdity of these ideas in a few lines.

For example, Ramdev wants de-monetisation of currency notes of Rs 500 and Rs 1,000 to help ease inflation, improve employment generation and also lower corruption. True that inflation in the long run is a purely monetary phenomenon but that does not mean if some denominations of currency notes become unavailable inflation is going to be eased. In order to reduce inflation, in this case, would need a sustained decrease in overall money supply.

Now this would work if in fact inflation is just a monetary phenomenon for India. There is plenty of literature debating on what actually causes inflation in India and the consensus seems to be that supply side bottlenecks and rising demand for protein foods is causing it. I am not sure how making some denominations of notes unavailable is going to change that. Moreover we actually want people to eat more protein based foods rather than less and as incomes improve we should expect this demand to increase further. Eventually, production will respond and the rise in protein prices will be arrested. What actually might help stem inflation right now is not to institute the next few pay commissions and may be use that money to fund more roads, electricity and schools!

Simplistic ideas are many times just that- they are simplistic but might end up causing more damage than good. We should all be wary of those and remember that there is no shortcut to better economic performance but to invest in infrastructure, education and health.

Equity Premium in India

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Asset Pricing and the closely related research agenda on equity premium puzzle is a fascinating research agenda and I am always looking for some pointers to what is happening in developing countries like in India in this context. Here is a very well written entry on the Equity Premium in India by Rajneesh Mehra the author of the original article on equity premium puzzle with Ed Prescott .

Is it time to give up on the Nehru-Gandhi Clan?

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I have often heard people complain about the dynastic nature of Congress and how many Indians fall for the Nehru-Gandhi clan’s charm. The question is does that mean that democracy has not truly deepened in India? While there are many other indicators of the shallowness of the Indian democracy, a vote for the Nehru-Gandhi dynasty may not be one of them!

In an interesting paper on dynastic choice, Tim Besley and Reynal-Querol address this choice of a leader from dynasty by looking at data across countries since late 1840s. Acknowledging that political leaders who are part of a dynasty have been an important feature of the political landscape throughout history, they argue that dynastic selection can play a role in improving economic performance when institutions for controlling politicians are weak and policy-making skills are persistent within a dynasty. Testing this idea empirically using a sample of leaders between 1848 and 2004, they show that economic growth is higher in polities with dynastic leaders but only when executive constraints are weak. They also find evidence that dynasties end when the economic performance of dynastic leaders is poor suggesting that citizens are tolerant of selection in dynasties when economic performance is good.

So, keeping in line with this finding, it looks like choice of a leader from Nehru-Gandhi clan may actually have been a rational one, since people did not trust the ability of Indian institutions to control other politicians. Also, it made sense if status-quo on economic growth was maintained. In the recent times, however, that confidence seems to be waning. It might be because the likelihood of having a viable candidate from the clan is perceived to be very low. Rahul Gandhi just does not seem to fit the bill!  Also, public activism through anti-corruption movements, judicial activism by the Supreme court, etc might have increased people’s confidence to control other politicians from non-Congress background.

This means that NaMo might stand a chance after all! Given the rise of AAP, NaMo better rise to the challenge though or else BJP might as well write off any future chances of forming a government at the center. The AAP, Congress, and people at large are going to watch for any slip-up very closely and it is not going to overlooked in future elections.

 

Weather shocks, railroads, and openness to trade

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It is quite interesting to see a bunch of papers written on one aspect of Indian economy from a variety of angles. Following are some such papers by Dave Donaldson of MIT. The first one was presented in the ASSA 2014 and that is what got me reading Dave’s work.

1. Can Openness to Trade Reduce Income Volatility? Evidence from Colonial India’s Famine Era

2. Weather and Death in India

3. Can Openness Mitigate the Effects of Weather Shocks? Evidence from India’s Famine Era

While we are on weather shocks, you might be interested in my earlier post on weather shocks and consumption smoothing in India and this one on general importance of rainfall shocks in post independence India.

NaMo or NoMo?

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Given the success of BJP in recent assembly elections, I think this note that I wrote on October 17 is even more relevant!

It is interesting time in India. The general elections are round the corner and there seems to be a really heated debate on which party and eventually which person is going to be given a chance for the next five years. It is actually heartening to see so many people sincerely expressing their views, concerns, opinions in the form of comments, status updates, links and news sharing, etc. This truly is the moment of different kinds of “Springs” all over the world in part fueled and sustained by social media. Being a college student in mid 1990s in India, I don’t think I had any inkling of how enormously effective and thoroughly transformative some of these technologically facilitated human interactions would be. I only hope it brings good in India as well.

The political choice that Indians face are truly enigmatic and dynamic. It is the choice between long-term social health and probable immediate economic gains. They have experimented with political solutions in form of coalition governments in the hope of delivery on economic front while not compromising on social front. But that has not been very successful and they are becoming impatient. Frequent exposure to distant greener pastures from foreign lands through actual visits or through popular media has made the realization of what the country lacks only extremely acute. People know that it is possible to do better and yet somehow politicians seem to be failing to facilitate the journey and at times even holding it back for their personal gains.

How would the electorate respond? Given the inefficiencies and delays of a coalition government, I think people are going to respond by electing a single party that shows the capacity to deliver. BJP was very clever to understand this and this shows in its choice of Narendra Modi as a prime-ministerial candidate. He had the success of Gujrat behind him though not all of it is his making. Gujrat has been a developed state for decades before Modi. But that does not matter. Perceptions have been shaped that Modi can deliver by repeatedly touting his success. His background also facilitates polarization of the society into two clear sections facilitating a majority vote. If you are a Hindu and stand for progress then you have to vote for BJP and Modi. Otherwise you are stuck with Congress with no strong leadership and allies that only drag it down. Some opinion polls already show that people would have a government that would act and not a juggernaut that does not move on any front.

True that the neo-liberal economic policies, as the Indian left calls the economic reforms, has left a lot to be desired. Markets have their limitations and there should be decisive government actions to keep them working efficiently and avoid being captured by few powerful interests. Traditionally the Left should have done this- worked asa watchdog. However, it has done a big disservice by neither providing an alternative economic framework nor making sure that reforms go ahead but they do not serve vested interests. The only thing they have achieved by constantly supporting Congress to avoid BJP from coming to power is forgone economic opportunities and a total lack of a meaningful debate on appropriate economic policies.

So looks like the results are clear even before election. Unless Congress manages to portray a strong non-Gandhi political leader, people are going to side with BJP. In this process, if society becomes more divisive or intolerant of diversity of people or opinions, that would be tolerated. The trade off between long term social health and immediate prosperity will be resolved in favor of prosperity. Who knows- at some point down the line when people become enough prosperous they might decide to give social health and true participatory democracy a chance.Till then we will have to wait and see. I only hope that by writing this I do not perpetuate a self-fulfilling prophecy. So as a caveat do remember what Keynes once said-

 “The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.”

 

PISA Scores and Human Capital in India

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I came across this interesting paper by Gustavo Ventura and his coauthors titled “Talent, Labor Quality, and Economic Development” in which they use PISA scores as a measure of quality of labor. They show that there are huge differences between labor quality between rich and poor countries based on these scores and they could explain some of the income differences across the world. Developed countries like the US, Canada and Western Europe have been investing in education for the past 200-300 years. The dividends that are being reaped now are because of this huge investment. Unfortunately, India does not figure into the analysis because we have shied away from taking the test. Only two states, Tamil Nadu and Himachal Pradesh, volunteered and the results are not at all encouraging. You can find some analysis here, here and here.

Employers in India have been lamenting about quality of human capital for a while now. There is an urgent need of reform starting from schooling to address such concerns effectively. Of course there are Indian kids who could surpass the rich country kids in these tests- all the ones who would eventually go to IIMs, IITs, and other elite educational institutions in India for example could do that. Students who come from educated families in general will be also in this list. But all said and done this is still a tiny winy percentage of the population. To reap the demographic dividend for economic growth, skill improvement needs to happen at much broader level than that. One could also argue that PISA tests does not really measure skills. Pratham has been conducting its own tests and the results are not very different!

How are we going to do this? Poor infrastructure, Teacher absenteeism,  and quality are some of the major problems at all levels of education in India. Some of it would need more investment but a lot could be achieved if incentive structures are changed to motivate the stakeholders to improve outcomes. For example, curriculum and school calendars may have to be revised to meet the local constraints and maximize attendance and learning. Research shows that poor quality of schooling reflects on performance in higher education and eventually the job market outcomes. This provides additional rationale for improvement of schooling across the board.

As we are on the topic of unused capacity and perverse incentives it has to be noted that this problem is not only limited to schooling. I know colleges in Pune, India where the classrooms are empty while students pay through their nose for coaching classes. The quality of education provided is overall abysmal. In order to get as many students through the college system as possible, there has been significant dilution of syllabus for almost all the courses through out. Centralized and standardized examination system has only made matters worse. It has taken away the agency from college teachers- no wonder there is huge apathy towards increased effort.

Moral of the story: education in India needs reform! This is one area where government spending and investment could really make a difference. The story about India’s PISA scores only underscores the dangers of continued neglect of such impetus to education.

Why do some bikers wear helmets?

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Why do some bikers wear helmets?

Abstract

In many domains risky health behavior is still only poorly understood. Analysis is often plagued by incomplete data and a general lack of information. In this study; we try to understand the determinants of helmet use among motorcyclists in Delhi; a context in which road safety is very low. We use a very detailed data set collected especially for the purpose of the study. To guide our empirical analysis; we rely on a simple model in which drivers decide on their speed and helmet use. The empirical findings suggest that risk averse individuals are more likely to wear a helmet. We do not find any systematic effect of risk aversion on speed. Both findings are coherent with our theoretical model. Helmet use also increases with education. Drivers who show a higher awareness of road risks; because for instance; they are better informed about Delhi’s actual road traffc accident fatality and injury rates; are both more likely to wear a helmet and to speed less. In turn; those drivers who show a high level of unawareness take the highest risks. Controlling for risk awareness; we observe that drivers tend to compensate between speed and helmet use. The most obvious solution to India’s road safety problem and the related high social costs that result from it is to enforce the helmet law and speed limits. An alternative strategy; and probably more feasible in the current context; is to design interventions which raise awareness of road risks. Improvements to the road infrastructure are also a possible solution but these measures bear the risk that drivers will react to the improved road safety by either increasing speed or lowering helmet use.

 

 

 

 

 

 

Convergence across Castes

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Abstract:

Over the past 25 years there has been a remarkable economic catch-up by scheduled castes and tribes (SC/STs) towards non-SC/ST levels in the terms of their education attainment levels, their occupation choices as well as wage and consumption levels. This is remarkable given the centuries of socio-economic deprivation faced by these backward castes. In this paper we Örst document these facts and then examine the relative contributions of di§erent factors, in particular, aggregate and sectoral shocks, toward this catch-up. We then develop a multi-sector model with the two types of agents to show that aggregate TFP shocks can induce a convergence between the two groups without any other concurrent redistributive policy changes as long as there exists an initial policy of education subsidies for the relatively disadvantaged group.

link: http://econ.la.psu.edu/papers/Lahiri102611.pdf