By Ajay Shah, on January 2nd, 2013
Until recently, outsourcing by global financial firms to India conjured up an image of commoditised low end services outsourcing: call centres, peripheral systems programming, and testing and maintenance. However, in recent years, there is a new rise of more sophisticated work. This reflects supply and demand factors. Global financial firms are keen to cut costs. Capabilities of operations in India — both captives and independant firms — have grown for many reasons:
- The individuals involved in this field in India have gained experience (”learning-by-doing”) and credibility.
- New management practices and improved telecommunications technologies have improved the extent to which teams and projects are handled in a more non-local way.
- The Indian diaspora has been rising to senior management levels in global firms, and is better able to envision what can be done in India and to obtain execution.
A European investment bank was among the first to experiment by bringing in teams in India into critical projects. This was a landmark change as a lot of inertia about confidentiality was overcome. Other banks followed suit. New management practices, higher pay, greater meritocracy came in, which helped Indian teams make the transition from low-end work where the HR and management techniques used are quite different. Demand for high skill labour has helped induce greater supply, with a lag, as individuals were more inclined to tool up with advanced degrees and high-end knowledge.
Alongside the developments in finance, parallel developments were taking place in the field of offshoring which have driven up skill levels, and helped create a high skill ecosystem in India. Top tier consulting firms launched `centres of excellence’ in India, hiring grads from IITs, IIMs, IISc, statisticians, economists. While education in India has huge problems, the raw talent available in India was of good quality, particularly when we focus on individuals who were able to read on their own and reinvent themselves (”never let your school come in the way of your education”). This process has been helped by globally recognised certification exams such as the FRM and the PRM.
IT firms have have been evolving from core development and maintenance to an entire gamut of IT strategy and consulting for financial firms. Many smaller KPO firms with specialised domain knowledge in finance have emerged, who cater to smaller hedge funds, trading houses, not just outsourcing increasingly complex pieces of work, but also advising them on the entire outsourcing strategy. All this has helped create a pool of high skill labour which is moving between multiple employers in India and able to build knowledge through diverse kinds of experience.
The most impressive development of recent years has been the growth of offshore trading units of global brokerages and trading houses, where people sitting in India take independent trading decisions in international financial markets based on their own skills and judgement. In some ways, this is the highest level of transfer of decision functions to India, albeit at relatively low monetary stakes.
In this fashion, within a period of 15 years, India had graduated from doing repetitive low value tasks to Knowledge Process Outsourcing (KPO) for the global financial system. While these activities are primarily in Bombay, they are also taking place in Gurgaon and Bangalore. The number of high-end finance workers in Bombay has never been greater than it is today. It is estimated that there are now 50 individuals working in Bombay doing work for global financial firms who have Ph.D. degrees in quantitative fields. This is starting to become a big enough number for them to talk with each other and get network effects going. From an employer’s point of view, it is now possible to shop in the labour market in Bombay and recruit a 10-man team all with Ph.D. degrees so as to get a new group going. This is a sea change when compared with conditions just a few years ago.
To appreciate this change a little further, it was interesting to take a look at some of the capabilities of finance focussed KPOs, divided mainly into 4 broad categories, catering to Sales and Trading, Middle office and Back office:
- Quantitative Research and Analytics Support:
- Equity and FICC Analytics: Model Validation, Price Verification jointly with clients: these are pretty quant heavy functions which require in-depth understanding of products.
- Technical and Fundamental Analytics.
- Index and Portfolio Analytics: Index maintenance, design, construction, operations and after sales, Portfolio tracking, decomposition and correlation analysis, performance measurement and attribution support.
- Derivatives and Risk Analytics: Measurement of derivatives Greeks, Value at Risk, Tolerance checks.
- Research:
- Equity and FICC Research: Company research, Credit Research, Economics research etc. to augment senior analysts in money centres.
- Trade idea generation and back testing: Sales pitches for clients and internal trading desks.
- Country, Sector, Company profiling, trends, news and projections: Pitch book generation and support.
- 24×7 weather patterns tracking for global energy trading outfits
- Overnight trade and market tracking to feed in summary reports, Market Dashboards, news letters, morning meetings and agendas
- Market Research: Pre-entry market research and positioning survey for bank’s clients.
- Data Analysis and Modelling:
- Data sourcing from multiple heterogeneous sources, refining and maintenance: Static data, Live and Historical market data maintenance. Data research and statistical studies feeding into trading strategies.
- Data Mining solutions.
- Data modelling, smoothing: Providing data solutions for Algo trading desks.
- Operations and Control
- Derivatives trade processing and documentation: Trade review of structured trades and complex documentation. End to end life cycle management of trades e.g., matching, broker confirmations and fee calculations.
- P&L and balance sheet control: Generation and reporting of P&L for vanilla products. Some banks have started moving exotics P&L functions to India. This is quite a significant milestone as such activities require high degree of confidentiality and direct user (e.g., traders) interaction who have zero tolerance for mistakes.
- Risk Stress testing, VaR back testing, Risk reporting to senior management.
- Auditing: external auditing of valuation marks of trading desks and control processes around it.
It should be noted here that since the funding crisis of 2008, these jobs have become quite complex as most banks have built more sophistication into their analytics. For example, most yield curves would now have multiple basis spreads (like tenor basis, xccy basis) and not just rates desks but even credit and equities desk have been using such advanced discounting curves.)
What’s next
The biggest push probably has been in quantitative middle-office functions with an ever increasing emphasis on valuations and counterparty risk management. Given the way markets have adopted collateral based pricing of derivatives, and the regulatory push on managing counterparty default risk, some captives have started building quantitative teams who will develop and manage CVA, DVA, etc. processes for all trading desks.
The new regulatory climate (Dodd Frank, Basel III etc) has lead to a substantial increase in costs due to additional checks and reporting requirements e.g., centrally cleared OTC trades, real time trade reporting to regulators, exhaustive risk reporting – all of which can are leading to fresh volumes of activity in offshoring.
All high quality banks have a team of techno-quants who work closely with the sales/trading desk, risk managers etc, on their day to day needs as well as on strategic projects. It is now feasible to move such high impact roles to India. It would be possible to have “extended front office teams” where dedicated staff support traders in money centres, doing real time risk analysis and client profiling, while the trade is being dealt overseas.
For a back-of-envelope calculation, if we think of internal billing rates of $100,000 per person per year, and if there are 10,000 persons at this average price, then this is services export of $1 billion a year, which is a sizeable amount. It appears that the early beach-head is in place, and this area will grow dramatically now.
This blog post reflects my experience, which is in investment banking and money management. A similar escalation of complexity of work in India is taking place in retail banking, insurance, etc., reflecting similar compulsions and opportunities.
Constraints
There is a certain tension between the push towards offshoring to India, and the activities that regulators consider `key in-house activities’ that cannot be outsourced.
There are serious constraints with education in India. The top institutions are producing some quantitative skills (e.g. fluency with matrix algebra, fluency in numerical computation). On one hand, there are weaknesses of broad intellectualisation that shapes cognition, creativity and malleability. On the other hand, there is essentially nothing in place by way of a finance education in India. A small amount of high-end finance research is taking place (example) but for the rest, there isn’t much capacity in the existing academic campuses. New approaches to learning and training need to be devised through which high quality individuals, with strong quantitative skills, can be converted into full fledged participation in high-end global finance work. A mix of public and private initiatives are required in order to jump to the next level.
There are strong synergies between the sophistication of the Indian financial system and the work that is done for global financial firms. There is a two-way feedback loop here: Better domestic capabilities will help do sophisticated offshore work, and the brainpower built for offshore work will strengthen domestic capabilities. The best example of this is found in the equity derivatives market, where India has a world-class market. The individuals with a domestic background here are ready for offshore jobs in fields like algorithmic trading, and individuals with capabilities built in offshore work are useful in the domestic setting. This is where India can set itself apart from Malaysia and the Philippines. To the extent that Indian financial reform makes progress, this will fuel the rise of high-end outsourcing to India.
Acknowledgements
I am grateful to Anand Pai, Paul Alapat and Gangadhar Darbha for useful discussions.
By Simon Grey, on December 7th, 2012
Paul Krugman demonstrates his irrelevance yet again:
What was Mr. Rubio’s complaint about science teaching? That it might undermine children’s faith in what their parents told them to believe. And right there you have the modern G.O.P.’s attitude, not just toward biology, but toward everything: If evidence seems to contradict faith, suppress the evidence.
No, Rubio apparently believes that parents—not the state—should determine what their children are to be taught. Now, the logical way to go about this is to homeschool your kids. However, I can’t think of a single good reason why state-run schools in a democracy educate citizens’ children according to the desires of the citizens.
Anyhow, Rubio’s complaint is not that science contradicts children’s faith; his complaint was that public education was teaching things contrary to the desires of the parents. Since parents are citizens in a representative democracy and also pay taxes, it is right for the government that claims to represent the parents to obey the wishes of the parents when educating their children. To put it in terms that hopefully even a statist clown like Krugman can understand, Rubio apparently believes that children belong to their parents and not the state.
The most obvious example other than evolution is man-made climate change. As the evidence for a warming planet becomes ever stronger — and ever scarier — the G.O.P. has buried deeper into denial, into assertions that the whole thing is a hoax concocted by a vast conspiracy of scientists. And this denial has been accompanied by frantic efforts to silence and punish anyone reporting the inconvenient facts.
How soon we forget East Anglia. Now, when even the head scientists at the East Anglia Institute itself admit that the data is faked, fraudulent, and highly massaged manipulated, then perhaps we can conclude that the data is not trustworthy. And since a goodly amount of working papers and policies are actually predicated on data released by the East Anglia Institute, then it is quite fair for most, if not all people to be somewhat skeptical or even highly skeptical of the case for man-made climate change.
Furthermore, since there has been little research on how the sun—you know, that big ball of fire in the sky that only heats the entire world every day—impact long-term global temperatures, then perhaps all of us would be justified in being a little more skeptical of anthropogenic global warming.
We are, after all, living in an era when science plays a crucial economic role. How are we going to search effectively for natural resources if schools trying to teach modern geology must give equal time to claims that the world is only 6.000 years old? How are we going to stay competitive in biotechnology if biology classes avoid any material that might offend creationists?
I don’t know, division of labor?
Both my parents are public school teachers. You know what they don’t teach to fourth-graders in public school? How to search effectively for natural resources. Know why? Because that subject is not something that most fourth-graders are able to grasp.
I attended public school for my last two years of high school. Know how many biotech classes my school offered? Zero. Know why? Most high school kids don’t have the intellectual chops for biotech. For crying out loud, most college kids don’t either. Come to think of it, a good number of adults probably can’t wrap their heads around it.
Now, maybe Krugman should retake Econ 101 and read up on the division of labor. This is a fairly well-established concept, having been around since at least 1776 (in Smith’s The Wealth of Nations), that states that production can become more efficient when labor is divided up into various roles and sectors. Not everyone is going to take a job searching for natural resources, nor is everyone going to take a job in biotech. Those who do go into those industries will likely require some training beyond mere public school. Thus, it makes little sense to complain how creationism will take away from future biotechnicians’ budding careers, since most kids won’t need those classes, and those that do won’t need them until college.
Frankly, Krugman has turned into a caricature of his former self. I don’t know what happened to him, but his critical thinking skills—not much to brag about in the first place—have just gone down the toilet. Does he have Alzheimer’s or something? If so, I think it’s pretty safe to say that his mind is about gone, so maybe the New York Times might to go ahead and let him go already.
By Ajay Shah, on December 6th, 2012
Ronald Coase has an interesting new piece titled Saving economics from the economics profession. You may like to see What is wrong with Economics on this blog.
Last week, in the US, I heard that the number of Ph.D. graduates coming out vastly exceeds the number of academic job openings. Most economics Ph.Ds. are going to end up in non-academic jobs. In fields like Physics, the basic arithmetic became clear early on. Each academic in a research university produces 12 Ph.D. students, on average, over his or her life. In steady state, 11 of them have to go into non-academic lives. For some time, in Economics, this phenomenon was masked by the rise of business schools and schools of government, which recruited a lot of economists. With that transition largely behind us, the simple logic of 1-in-12 comes back to hit us.
I feel the profession is not doing enough to prepare the 11-of-12 economics Ph.D. students for a life in the real world. I am a sunny optimist on the importance of economics in the real world. Whether it is Google or a hedge fund or a consulting firm: I think a good economist has a lot to say. But what we do to Ph.D. students is pretty bad. The skills required to succeed in academic economics seem to be precisely unlike the skills required to engage with the world. I feel that fairness to the students requires turning this upside down. We should be primarily training Ph.D. students to gear up to be useful in the real world, for only a tiny fraction of them will go back into academics.
Academic economics in India suffers from one additional layer of trouble: the legacy of development economics. India has moved on. Only 15% of Indian GDP is agriculture; the labour force is moving away from agriculture; only 20% of India is below the poverty line. This implies that development economics is of little use in thinking about India. Whether it is P. Chidambaram or Mukesh Ambani, the decision makers of India are not too interested in development economics.
The early days of physics shows us a nice three-step story. First, the datasets fell into place, with Tycho Brahe. Then came the empirical regularities, with Kepler. Once Kepler’s laws were firmly established as hard facts of the data, you could curiously ask: Why might this be the case? And this gave us theory, in the hands of Newton. In economics, and particularly with economics in India, we are struggling with the first phase. We barely observe the economy.
When the physicists did not observe the world, the frontier lay in observation (Tycho Brahe), and not in the guys doing angels on pinheads. But in economics, in the early years, in the absence of data, the field got dominated by mathematicians analysing artificial worlds, the bulk of which was angels on pinheads exercises. Instead of looking at the world, we looked at blackboards and made up assumptions. Research papers got written by looking at other research papers, rather than looking at the world.
I am optimistic about where we will go from here, for the computer revolution is finally giving us datasets where there is high quality observation of the economy. E.g. retail stores are capturing scanner code data, financial exchanges see every order, massive databases of census or tax authorities are being prised open, google trends data is available, satellites measure illumination at night and give us estimates for the GDP of each square kilometre of the country every night, etc. The future of economics lies in data science. Just as astronomers are drowning in the data coming out of telescopes, we in economics will shake our heads in wonder, as we find our way around immense treasures of large datasets of high quality.
Yet, at present, most economists and economics Ph.D. students are focused on theory, or the old perspective where economics is seen as a part of axiomatic mathematics and not as an observational science. For most people in economics, there is a certain willingness to accept bad data and bad econometrics since all this is (in any case) just an excuse to get on with the thing that really matters, the model. Matters are made worse, in India, by the typical Western referee who does not ask questions about data quality. This gives the economist in India zero incentive to be careful about measurement, and gives us an equilibrium replete with garbage-in-garbage-out.
I don’t want to overstate the problem. Things have changed enormously when compared with the 1970s and 1980s, when economics was almost entirely dominated by theory. Today, the most important work in the profession is applied. Applied papers get more citations. The ship is turning. But as Ronald Coase is saying, it’s still far from where it needs to be.
Academic economics is a self-sustaining system, on the strength of the tuition fees paid by a large number of undergraduates who register for these course. There is relatively little pressure to change. The impetus for change will come from four directions:
- While wages for a small number of the superstars of the profession are sky high, most academic economists are not paid that well and are not experiencing real wage growth. This gives an incentive for some to engage with the world through consulting. Their work will matter.
- As Larry Summers has emphasised, a strength of the business school and the school of government (and the think tank) is that they engage with reality. They have incentives to look at the field with new eyes. The work done in these places will matter.
- The 11 of 12 freshly minted Ph.D.s who show up in the real world and puzzle over it matter a great deal. For the vast majority of them, the Economics Ph.D. will recede in their minds like a bad dream. A small fraction of them will do stuff that matters.
- The people with skills in data science will do unexpectedly cool things with the new datasets where we observe the economy. This stuff will matter.
By Simon Grey, on November 1st, 2012
Maybe parents might want to consider the effects of pushing their children to get a college education:
Cyndee Marcoux already was stretched thin, thanks to the $80,000 in student loans she racked up after getting divorced and going back to school a decade ago. Her breaking point came in 2010, when her daughter defaulted on student-loan payments of her own.
That’s because Ms. Marcoux, a 53-year-old library administrator in Seekonk, Mass., co-signed for about $55,000 of her daughter’s loans. When the daughter was unable to keep making payments, Ms. Marcoux was on the hook—a burden that forced her to reshuffle her entire life. To scrape up the extra $550 a month she owed, she sold her house, then took a second job registering emergency-room patients on the weekend overnight shift. “You work your whole life and never pay a bill late,” says Ms. Marcoux. “You don’t ever think your kid isn’t going to pay.”
As certain internet writers have noted, this outcome wasn’t exactly unpredictable. When supply of college-educated labor outpaces demand, due in large part to federal subsidy and state propaganda, it should come as no surprise that the average income of college-educated individuals decline. And since demand for college has outstripped supply (though it should be noted that supply is radically increasing right now, almost like a bubble), two things began to happen at once: wages for college-educated workers declined while the cost of college education went up. The outcome? Lots of college grads are stuck with a lot of debt and no way to pay for it.
Making matters worse, the federal government—in conjunction with the major banks who lend out college loans, service the debt, and even act a collections agencies in the event of default—has conspired to basically make the recipients of student loans into debt slaves by preventing students loans from being discharged in bankruptcy. Furthermore, the federal government strongly encourages parents to co-sign for their children’s college loans by requiring their financial information when filling FAFSA.*
All this has started to bite a good number of parents in the rear. Deservedly so, I might add. Hopefully this will help other parents to wake up and start to actually consider whether a) their child should really go on to college and b) whether they will legally bind themselves to pay for their child’s worthless majors.
* Note: while this is only technically required to determine students’ grant status, it is assumed that parents are going to pay for their children’s education (hence the parents’ expected contribution) portion of the FAFSA calculation. Parents implicitly agree, since they are often expected and encouraged to sign for their children’s loans. Thus, the rarely-challenged assumption is that parents are good for their children’s education costs.
By Simon Grey, on October 18th, 2012
Richard Posner [Hat tip]:
Finally, I am not clear what we should think the problem of American education (below the college level) is. Most children of middle-class (say upper quartile of households, income starting at $80,000) Americans are white or Asian and attend good public or private schools, usually predominantly white. The average white IQ is of course 100 and the Asian (like the Jewish) almost one standard deviation higher, that is, 115. The average black IQ is 85, a full standard deviation below the white average, and the average Hispanic IQ has been estimated recently at 89. Black children in particular often come from disordered households, which has a negative effect on ability to learn and perhaps indeed on IQ (which is only partly hereditary) as well. Increasingly, black and Hispanic students find themselves in schools with few white or Asian students. The challenge to American education is to provide a useful education to the large number of Americans who are unlikely to benefit from a college education or from high school courses aimed at preparing students for college. The need is for a different curriculum and for a greater investment in these children’s preschool environment. We should recognize that we have different populations with different schooling needs and that curricula and teaching methods should be revised accordingly. This recognition and response should precede tinkering with compensations systems. [Emphasis added.]
As someone who has been in both home school and public school, my experience tells me that the quality of education in home school is considerably higher than in public school. The main difference between the two is that in home school, my teacher was not only extremely invested in my educational future, but was also able to invest a significant amount of time teaching me one-on-one. This is not to suggest that my public school teachers were uncaring robots; on the contrary, most of my teachers took a personal interest in me and my educational development. Some of them even gave some of their personal time to better explain various concepts to me when I had trouble getting them the first time around. The difference, though, is this: as much as my public school teachers cared, and as much time as they gave me, they never did care as much as my mom nor could they give me as much of their time.
I think the chief failing of the public education system is that of scalability. To put it simply, centralization quickly runs into diminishing marginal returns. The reason for this is what Posner noted: there is simply too much human variability in existence to allow for a one-size-fits-all approach to education. What works for one student may not work for another. What works for one teacher may not work for another. Human beings are complexly unique, and treating them all alike, as if they are interchangeable, is an incredible mistake because it is not a reality-based approach. Once you accept that humans are unique, and that there is a high degree of variability in children’s learning process, it should become clear that a single, universal approach to education is bound to fail.
One reason, then, why home-schooled students are often intellectually and academically superior to their public-school peers is because the parents of home-schooled children implicitly recognize scalability in education is not a feature but a bug. Those who homeschool their children are able to provide them with a highly personalized education, which is quite an advantage academically. Those in public school have no such luck, and thus suffer academically because the economies of scale afforded by mass education do not actually extend to academics, but rather to costs.
Quite simply, education is not all that scalable, which is why it becomes progressively worse when centralized, particularly in areas of cultural and ethnic diversity. The best option for education would be homeschooling, and the second best is whatever has the smallest scale.
By Christopher Briem, on September 13th, 2012
So there is an idea being put out there to raise the homestead exemption for local property taxes in the city of Pittsburgh and school district.
Now who suggested that might be a good idea broadly? I guess the only difference is I did not think of the idea of raising the exemption amount as “in lieu of” mandated anti-windfall millage changes. I guess the math works out the same. My point then and now is that you have to raise the homestead exemption proportional to the reassessment value change or else the impact is regressive by default. In other words.. the fixed amount exemption will be a lower proportion of total real estate value after the reassessment. Just to keep the tax incidence status quo you need to adjust the exemption amount.
By Ajay Shah, on August 23rd, 2012
The Economist runs a discussion forum titled The Economist By Invitation. In this, they recently setup a discussion about an opinion piece by Dani Rodrik about the future of manufacturing-led growth in emerging markets. I wrote a response there which is reproduced here.
The role of manufactures
I agree with a small element of Dani Rodrik’s argument, but mostly for different reasons. Rodrik says:
Except for a handful of small countries that benefited from natural-resource bonanzas, all of the successful economies of the last six decades owe their growth to rapid industrialization.
I have seen this kind of thinking among some policy makers in India also: that industrialisation is somehow special and good when compared with services. I would question this proposition, that I term `the widget illusion’. What matters to a country is having sophisticated firms that have a high marginal product of labour. We should not care whether this happens in services or in manufacturing. If anything, the opportunity to do it is perhaps better in services.
India is a good example of a country which embarked on its catchup by connecting into globalisation late: from 1991 onwards. It was probably the last country in the world to shed autarkic policies. This has given a remarkable growth acceleration. Sustained growth of 7 per cent is pretty good by world standards. These achievements have been significantly driven by services production in India within global supply chains (whether within production facilities owned by global MNCs who are operating in India, or contracted-out by global MNCs to Indian firms). If your null hypothesis was that industrialisation is essential to growth, then you would not have predicted what happened in India, where manufacturing was hobbled by an array of policy mistakes.
This illustrates the limitations of manufacturing-focused thinking, which seems a bit out of date in today’s world economy where most output is services. Agriculture and manufacturing have wilted away in the consumption of the global representative agent: to succeed in the world economy today requires prime attention upon services.
Rodrik says:
Consider India, which demonstrates the limitations of relying on services rather than industry in the early stages of development. The country has developed remarkable strengths in IT services, such as software and call centers. But the bulk of the Indian labor force lacks the skills and education to be absorbed into such sectors. In East Asia, unskilled workers were put to work in urban factories, making several times what they earned in the countryside. In India, they remain on the land or move to petty services where their productivity is not much higher.
As Rodrik points out, there are important gaps between the skills of the great unwashed masses in India versus China, where elementary technical training reached a larger mass of humans. In addition, China did better on core economic policy choices about (a) Removing protectionism; (b) Removing barriers to FDI; (c) Building hard infrastructure; (d) Labour law and (e) Rationalising taxation.
What policy advice would flow from this? India should not have have made these six mistakes in economic policy (low training for the masses, protectionism, barriers to FDI, weak investments into infrastructure, labour law and mistakes in tax policy). At the same time, this does not recommend a bias in favour of manufacturing. It is hard to discern a meaningful choice about emphasising services versus manufacturing in Indian economic policy. Participation in all global production is good. Governments should remove all barriers that inhibit global integration whether in goods or in services – e.g. the six mistakes in Indian policy sketched above.
A paragraph earlier, Rodrik says:
To be sure, some modern service activities are capable of productivity convergence as well. But most high-productivity services require a wide array of skills and institutional capabilities that developing economies accumulate only gradually. A poor country can easily compete with Sweden in a wide range of manufactures; but it takes many decades, if not centuries, to catch up with Sweden’s institutions.
I would point out the contradiction: “A poor country can easily compete with Sweden in .. manufactures” but earlier it was asserted that the gaps in Indian skills inhibited India’s ability to compete with Sweden in manufactures.
Doing things that push skills and institutional capabilities
I would go further to say that it is good to go after fields which require a wide array of skills and institutional capabilities.
I am reminded of Ricardo Hausmann’s `Good Cholesterol’ argument about financial globalisation as opposed to mere FDI. When a poor country operates in an institutional vacuum, foreign investors are uncomfortable, and the only thing that can happen is FDI. To obtain financial flows, the country has to build institutions: laws, regulators, property rights, and so on. This is a good thing! A country that gets to FDI and gets stuck there should ponder what is going wrong. In similar fashion, no country aspires to have low-wage production; every country wants to understand the secret sauce through which a part of the labour force can earn high wages by world standards.
As a country rises out of poverty, it is essential to build up skills and institutional capabilities. If policy makers hinder services and/or favour manufacturing, there is a greater chance of being stuck in low skills and low institutional capabilities. I am not proposing industrial policy in favour of services. I am only proposing the absence of industrial policy; we should avoid a `widget illusion’ and foster more global integration without trying to push towards one industry or another.
In India, with 7 per cent growth, GDP doubles every decade. As a thumb-rule, I feel that a comprehensive transformation of skills and institutions is required across each doubling of GDP, which is roughly each decade for India. A country that is stuck in low-skill manufacturing will find it difficult to achieve the reinvention of this `soft infrastructure’ of the mind. If policy makers tried to push a country towards doing low end grunge work, it would be harder to obtain these repeated transformations of institutions and the furniture of the mind, which would lead to growth decelerations.
As an example, in the article New wave of deft robots is changing global industry, John Markoff says:
Foxconn has not disclosed how many workers will be displaced or when. But its chairman, Terry Gou, has publicly endorsed a growing use of robots. Speaking of his more than one million employees worldwide, he said in January, according to the official Xinhua news agency: “As human beings are also animals, to manage one million animals gives me a headache.”
The project of economic development requires sophisticated interactions between firms and workers. The laws, human rights and management practices that are required when dealing with humans are different from those required when running a firm with `one million animals’. I would hence argue that it is limiting for a country to focus on the political, legal and institutional requirements to produce a la Foxconn. It is better to confront the complexities of high skill, high wage production, and to build the environment for this to happen: in the political and legal system, in management practices of firms, and in the power structure embedded in a conversation between two citizens who are co-workers within a firm. Services production is a valuable learning ground where the complex management practices that involve high skill humans can be learned.
The new world of manufacturing
Rodrik correctly points out that manufacturing has become more sophisticated in recent years. This has some fascinating dimensions:
- The rapid improvements in capabilities and declining costs of robots.
- The rise of open source design coupled with 3-d printers. If a 3-d printer in the US fabricates a part close to its usage in an assembly line, while the labour-intensive design work (”services”) that controls the 3-d printer is done in India, does this entail manufacturing or services work in India?
- The world economy is likely to be in a low interest rate environment for a long time, which will encourage capital intensity worldwide (robots, 3-d printers), thus blunting the value of low wages.
Momentous changes are afoot, which challenge our traditional notions of manufacturing versus services. To some extent, we are even seeing some manufacturing go back to the US.
Things that might `go wrong’
Finally, Rodrik talks about reduced willingness in the West to tolerate unfair tactics like the Chinese exchange rate regime. I would generally consider this to be a good thing, both for developing countries and for the world. In any case, the Asian `Bretton Woods II’ episode seems to be subsiding. As an example of the disenchantment with exchange rate distortions: From 2004 to 2007, India debated exchange rate rigidity, and walked away from it. The links between undistorted exchange rates and growth have not been adequately emphasised in the discourse. A developing country builds up inferior skills and institutional capabilities by exporting under a subsidised exchange rate: it is better to force firms to confront the market price and achieve the productivity required to participate in globalisation when facing an undistorted price vector.
He worries about a rise in protectionism in the West, but we have to admit that the 2008-2012 experience has been pretty good in this regard: by and large the West has not succumbed into protectionism. In 2008, all of us worried about Smoot-Hawley. Today, things seem to be be going well.
Conclusion
In summary, I would argue that we should avoid a `widget illusion’. There is nothing special about manufacturing or industrialisation: as long as people in India get high wage jobs, this is good. Getting there requries deep integration into the world economy, which includes policy battlefronts such as:
- Openness to the Internet
- Use of English
- Inbound and outbound FDI
- The array of cross-border financial services that are the enablers of complex globalised production of both goods and services
- Globalisation-compatible tax policy on both trade and finance
- The absence of either protectionism or mercantalism
- Fostering high quality human skills, and
- Infrastructure.
To the extent that globalised production of goods and services happens in areas which involve high skills and complex institutional development, this is a bonus, since any high growth country needs a rapid pace of reinvention of laws and institutions.
Most of this is the old orthodoxy. Policy makers worldwide are generally focused on these issues, as they should be. From the 1960s onwards, dirigisme has generally subsided, with the twilight of policies like fixed exchange rates, industrial policy, capital controls, protectionism, etc. These key lessons remain intact in the 21st century.
By Simon Grey, on June 29th, 2012
Here’s some sad commentary about the current set of grads:
Seven in 10 of these recent graduates said they would need more education if they were to have a successful career. Despite their belief in the value of post-secondary education, though, only 38 percent definitely planned to attend college to get more education in the next five years. Barriers included skyrocketing tuitions and family obligations.
These grads are, of course, entirely correct in believing that college credentials are generally necessary to having, if not a good career, at least a decent one. What’s sad, though, is how many of these grad think they need a higher education in order to succeed. In essence, 70% of current grads are not willing to make their own success; they are relying on others to do it for them.
I know that not everyone can self-employed entrepreneurs that go about making new businesses and products, but it is pathetic that so many won’t even consider such an option. People can’t work at Microsoft or Apple without their first being a Bill Gates or Steve Jobs. Unfortunately, not many seem to want to be Gates or Jobs.
Of course, given the current economic climate, this isn’t altogether unexpected. The current regulatory regime very much favors established big businesses, and generally hamstrings small businesses (assuming they operate within the bounds of regulation). The taxes accompanying success aren’t encouraging, either. Really, it is easier to rely on others to provide some small measure of success for you than to fight for it yourself.
And really, there is no better sign of a declining society than its youth’s lack of desire to take risk. Quite simply, young people in the United States have bought into the notion that they need to have a higher level of education to succeed in their career. That they are so concerned with conforming to the desires of economically privileged in order to have a tolerable life is saddening. That the current state of affairs actively encourages this mindset of dependency is simply sick.
By Ajay Shah, on June 12th, 2012
What should government do?
In the question “What should government do?”, economists have one big answer “do the public goods”. A public good is something that is non-rival (the consumption by one does not come at the cost of consumption by another) and non-excludable (it is not possible to exclude someone from benefiting from the public good).
The regulation of air pollution is the favourite example which illustrates a public good. Clean air is non-rival (if you breathe clean air, it does not diminish my supply of clean air) and non-excludable (if the air is cleaned up, nobody can prevent me from breathing it in). Indeed, nothing that one person can do can make a difference to air pollution. Only the government can regulate pollution and this deliver clean air.
Similar issues arise with defence, police, judiciary, monetary policy, financial regulation, public health (though not the health of the public), biodiversity, etc., all of which add up to the economists’ vision of what government should be doing.
What should government do in the field of education?
Education is substantially a private good. I study, I benefit. There are spillovers (”externalities”) to others, and so there is a case for a government subsidy. But barring that, this is a field where the incentives are well aligned for each person to be the main one in charge of his own education.
Public funding solves the problem of externalities. At the level of elementary education, vouchers are a nice way to deliver public funding that is large enough to pay for the externalities. At the level of higher education, public policy can focus on economies of agglomeration alongside some public funding, nudging the outcome in India so that there are 100 high quality broad-based universities.
As I read The delicate technology of creating excellence by Pradip Ghosh in the Telegraph, I was reminded of the public goods character of testing and curriculum development. As he says:
in this very large country with a multitude of school boards and their non-uniform curricula and examination standards, it would be inappropriate to go by board grades because that would yield unreliable, undesirable results — we would not get the best students. And, such a course, therefore, would be unfair both to the aspiring students and to the institutions they would be entering. A single post-high school examination with a well-defined syllabus and a centrally administered paper-setting and grading system was thought to be the best alternative
The production of education services is a private good problem, to be sorted out between one student and one education provider. However, the problems of curriculum and testing have a public goods character. Let’s run the tests of a public good, for a nationwide system for standardisation of curriculum and testing.
Is it non-rival? Does the consumption of the services of this system by one person diminish the amount of this system available for another? With computerised testing, there should be full scalability (though Pradip Ghosh argues, in the article above, that there are problems with this).
Is it non-excludable? High quality curriculum is non-excludable in that once curriculum documents are on a website, everyone can download them. Testing is excludable if you want to be cussed about it, but for the rest it should not be possible to exclude anyone from taking a nationwide test.
This argument guides us in thinking about what government should be doing in the field of education:
1. Funding (calibrated to overcome the externalities)
2. Curriculum development
3. Testing
4. Information infrastructure about education service providers (i.e. schools but also all sorts of new ways of organising education service delivery) so as to assist choice by parents and students.
The entire focus of management time, and the entire resources available for the task, should be devoted to these 4 problems.
Central government or local government?
Once we know that testing and curriculum are public goods, we have to ask who should do it.
If an important outcome (getting into the IITs) was linked to regional board examinations, that is a recipe for grade inflation. This is a reason for doing this at the central government.
There are economies of scale. A curriculum only needs to be developed once. This is a reason for doing this at the central government.
In conclusion, the IIT JEE has many problems, but the building and running of high quality examinations is an important task of the central government and should not be diluted or abandoned. The fraction of management time, and resources, that are devoted to curriculum and testing need to go up.
By Simon Grey, on May 29th, 2012
The number of PhD recipients on food stamps and other forms of welfare more than tripled between 2007 and 2010 to 33,655, according to an Urban Institute analysis cited by the Chronicle of Higher Education. The number of master’s degree holders on food stamps and other forms of welfare nearly tripled during that same time period to 293,029, according to the same analysis. [Hat tip.]
There have been some that have proposed that the current surge in college costs is not proof of a bubble, but rather the natural byproduct of college’s sorting function. (I think I first heard this proposal at Foseti’s.) If that were the case, it doesn’t make sense that holders of advanced degrees are having difficulties getting good jobs, since the natural purpose of sorting is to take the best and brightest and put them in the best positions.
The theory of sorting makes its case on the grounds that colleges are largely meritocratic—a dubious claim at best, though true relative to colleges of, say, fifty years ago—and that they can be trusted to determine the best, brightest, and most dedicated. Naturally, employers cannot perform direct testing for this, mostly because those sort of tests are racist, and so they need other proxies. The meritocratic elite just so happen to provide those proxies.
Unfortunately, the sorting theory of higher education is untrue because the reality does not follow the model: namely, those who have earned high educational honors and degrees aren’t more employable or working the better jobs. Thus, if college is supposed to sort people, it has obviously failed, as evidenced by the fact that holders of advanced degrees are 300% more likely to receive food stamps now than three years ago, while US citizens in general are only 43% more likely (see linked article above.)
Funnily enough, there is a model that would generally predict this occurrence, and it is the bubble model, which posits that wages for holders of college degrees will decline as the supply of holders of college degrees increase, which is a direct result of government intervention into the market, particularly through the expansion of cheap credit and direct subsidy. Low and behold, this has come to pass, mostly because the bubble model has better predictive power than the sorting model, and is thus more correct.
Since we’re on the subject of college degree holders, I’d like to point out as an aside that the idea that degrees aren’t real property because they aren’t transferrable is partially false. It is true that one student can’t sell his credentials to another student, but it should also be noted that students aren’t the only ones who use the credentials they earn. Employers also use student credentials by hiring employees who have certain credentials. While they don’t “transfer” credentials per se, it is observably true that when someone switches jobs, the people employing their credentials also changes as well. Given that there are signaling elements to college credentials (as evidenced by every guidance counselor that ever repeats the trope that college grads do better on the job market because they’re college grads), it should be plausible that there is a type of transference that exists with college credentials, except that is at the employer level, not the possessor level. Incidentally, this conceptual model reinforces the idea of a college bubble since it suggests that there can be diminishing marginal returns to adding one more college educated participant to the labor market, thus driving down wages.
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