Welcome to the twenty-third issue of Ideas and Institutions – a fortnightly newsletter from Carnegie India’s political economy team.

This issue includes an essay reflecting on the implications of India's ranking on the Economic Complexity Outlook Index and a review of a World Bank study comparing urban governance institutions in India, United States, and South Africa.

Reflections on India’s Rank on an International Index

In recent years, the union government has revealed a fiscal strategy for growth that seems to comprise of three elements: protectionism through tariff hikes, production-linked incentives, and capital expenditure to create infrastructure. In this essay, I consider two elements of this strategy—protectionism and production-linked incentives. India’s pivot toward protectionism began in 2017, and the 2022-23 union budget moved the country further in that direction by phasing out of the concessional rates in most capital goods and projects imports and announcing that more than 350 exemption entries would be phased out. Since 2020, the government has also announced several production-linked financial incentive schemes. These began with pharmaceutical ingredients, electronics manufacturing, and medical devices and have expanded to include telecom and networking products, food products, certain household appliances, textile products, drones, and more.

As this year’s budget will be released a week from now, it is worth considering whether these two policy pivots are sensible given what we know about India’s economy. One way of doing this is to compare with other countries on the relevant metrics. International indices can be useful for understanding where a country stands, thereby informing policy choices. This is not to suggest that the organizations that prepare these indices are infallible. In a previous issue of this newsletter, we pointed out how India’s improved measurement of trade facilitation may have forced OECD to revise its scores retrospectively. So, experts from any country should, with evidence, challenge the validity, reliability, or objectivity of a measure. Such discussions should, however, proceed from a premise that there is value in well-prepared comparative indices.

Arguably, one such index is the Economic Complexity Outlook Index (COI) developed by Ricardo Hausmann, Cesar Hidalgo, and their colleagues. They study economic development in terms of productive capabilities (know-how) that go into making products. The more complex products usually require a wider combination of capabilities. These products also tend to be more valuable and provide better quality employment opportunities. In this respect, economic development can be seen as the transformation of a country’s economy towards the production and export of more complex products.

COI measures how well a country is positioned to grow through diversification into more complex products, by quantifying how close the products it makes are to the products that it does not make, weighted by how complex those products are. A high score on this index reflects that there are many nearby complex products that require capabilities similar to those reflected by a country’s existing production. Hausmann, Hidalgo, and their co-authors suggest that a higher ranked country on the index should be able to more easily sort out the problems associated with coordinating the development of new industries and the accumulation of required productive capabilities because the industries that are closer to a country’s existing capabilities tend to have fewer coordination failures to resolve and hence provide an easier path to the accumulation of capabilities.

If we look back at the COI rankings at three points in time—the years 2000, 2010, and 2020—India has ranked number one in each of these years. In contrast, China’s ranking on this index has gone through many changes—from the second rank in 2000 to the seventh in 2010 to rank forty-three in 2020. India not only ranks number one on this index, it also scores much higher (India’s score is 2.96) than the country that ranks second (Turkey with a score of 2.4). What are the implications of this for India’s growth?

First, while the index shows that Indian economy’s existing capabilities are well-suited to support rapid growth in the next decade or so, we cannot take it for granted that this potential will be realized. Back in 2015, it was projected on the basis of this work that India’s economy would grow at an average of 7.9 percent over the following eight years. In 2016-17, the economy grew at 8.3 percent, and it seemed that the actual growth would be consistent with the projection. However, India’s growth decelerated after that—to 6.8 percent in 2017-18, 6.5 percent in 2018-19, and 3.7 percent in 2019-20. The average for the four years before the pandemic—2016-17 to 2019-20—was 6.3 percent. Further, as noted in a recent issue of this newsletter, the economy is yet to properly recover from the impact of the pandemic. So, while the existing productive capabilities can support rapid growth, the political economy and the institutions would determine whether they are put to good use.

Second, looking at existing productive capabilities can help us understand where we stand relative to other countries when it comes to attracting foreign investments. Let’s consider one aspect of the emerging geoeconomics of foreign direct investments: the attempt of some firms to diversify away from China. China is a leader in many sectors, but in 2020, its share in the trade of textiles (37 percent) and electronics (28 percent) was particularly high. For firms in these sectors looking to move away from China, the natural choice would be to look at countries with some demonstrated productive capabilities in these sectors. Moving production to such countries would be easier. If we consider, say, Vietnam between 2010 and 2020, its share in the world trade of electronics goods rose from 0.4 percent to 5.2 percent, and that in textiles rose from 2.4 percent to 5.8 percent. It is no surprise that Vietnam has attracted significant investments from those looking to diversify away from China. India’s share in electronics exports remained stagnant at around 0.5 percent all through the decade, and that in textiles fell from 3.4 percent in 2010 and 2.9 percent in 2020. This does not mean that India cannot attract investments in these sectors, but in the near future it may be harder than it is for Vietnam.

A journalist recently shared on twitter that India has taken over a large part of the Davos promenade at this year’s World Economic Forum. From the union government to certain state governments to private corporations, India has a large presence in this year’s forum. This is part of a broader effort to position India as a preferred destination for foreign investors. However, given the existing productive capabilities of India’s economy, if we do more to fix the political economy and institutional problems in Delhi and Dispur, we may not need to do so much at Davos.

Third, India’s standing on the COI can also guide the choice of a suitable strategic approach for creating growth opportunities. Countries that are at the technological frontier and are already producing existing highly complex products need to invest in developing new products and build capabilities for doing so. Germany and Japan are examples of such countries. Countries like Bangladesh and Nigeria, whose existing capabilities do not afford significant opportunities to diversify into more complex products, need to make leaps to build capabilities in strategically chosen areas that allow for diversification in the coming years, otherwise their economies may slow down. Bangladesh, for instance, relies heavily on textiles exports but has few demonstrated capabilities that can allow it to diversify into other more complex product categories. India is in neither of these categories. Its existing productive capabilities are quite close to those required to make a variety of more complex products. So, the suitable approach for India is a light-touch one, even though some states may choose to implement “parsimonious industrial policies” that identify and address specific bottlenecks to enable production of related products.

This takes us back to the question: why is India betting so much on fiscal incentives and tariff hikes to boost domestic production? In other words, why has India chosen more activist trade and industrial policies than seems necessary on the basis of its existing productive capabilities? One answer is that in some product categories, such as active pharmaceutical ingredients, India is keen to reduce dependence on countries that it does not trust. Another answer is that India may be looking to build capabilities in certain technologies that could yield diversification opportunities in the long run. Examples of this include semiconductors and related products. But such justifications can be offered only for a few sectors, and in those as well, questions can be raised about the methods through which these objectives are being pursued. They do not explain the proliferation of production-linked incentives schemes in sectors ranging from food products to textile products. They also do not explain why tariffs have been hiked on so many goods, including many intermediate goods. If the government believes that some market failures are preventing the productive capabilities from being used for producing more complex products, it is better to identify and address the same directly and precisely.

—By Suyash Rai

Understanding Institutions and Accountability Mechanisms in Urban Governance

How much does institutional design matter in urban governance? This question became a political one in the recently concluded municipal elections for India’s capital city of New Delhi. In the months leading up to the election, the central government merged three of Delhi’s municipalities into one—the Municipal Corporation of Delhi. The move was widely panned as a political one, with critics claiming this would benefit the incumbent councillors of the three municipalities and hence the BJP. While the BJP ended up losing the elections to the AAP, for students of urban governance, the move deserves to be studied on its own terms—will the redesign of urban governance institutions lead to better urban governance?

A World Bank report “Institutional Models for Governance of Urban Services” (2021) authored by Matthew Glasser addresses this and other questions in a comparative context. The report is based on a study of municipal bodies in four cities in India, and two each in South Africa and India. The study analyzes whether, and which facets of, the design of municipal services institutions impact outcomes the most. In the U.S., the report studies the water, sewerage, and road transport bodies in Chicago, Illinois, and Dayton, Ohio. In South Africa, the study covers the cities of Johannesburg and Mbombela. In India, the study covers the cities of Ahmedabad and Nadiad in Gujarat, and Amritsar and Patiala in Punjab.

For each city, the report details the institutional design of the relevant service delivery institutions—municipal corporations, departments, spin-off municipal enterprises, and special districts—and provides stylized information and analysis about their place in the larger urban governance ecosystem, autonomy, and their accountability mechanisms and financial performance.

The report raises and answers important questions, starting with the one posed at the beginning of this review. It asks whether institutional design has any bearing on outcomes. As per the report, institutional “coherence” itself does not seem to have much of an impact: “Institutional coherence is no guarantee of success. . . . South African cities are significantly more integrated than Indian cities, both horizontally and vertically, and yet the range of outcomes is similar.” The report instead speculates that differences in outcomes could also have other explanatory factors, like differences in GDP and per capita income - “Given the dramatic differences in terms of GDP per capita, one obvious hypothesis is that cities in a rich country can afford to provide better services than cities in poor countries. Although the Indian cities may be burdened with fragmented institutions, it is wise to remember that the per capita GDP in the US is thirty times that in India.”

Does this mean that governance improvements will happen automatically as India grows? Following this line of thinking would imply that institutional fixes are unnecessary and that growth will solve all problems. The report points to institutional differences and their consequences that deserve remedial attention—fixing accountability mechanisms. It notes that accountability chains in India are both long and often disrupted because of the way our urban governance institutions are structured.

By way of comparison, the report states that in Chicago, “the long-route of accountability for Chicago’s water service is direct, relatively short, and effective. The citizens of Chicago elect a Mayor, who acts as the Chief Executive of the city – all department heads report directly to the Mayor.”

In India, the Municipal Commissioner’s accountability is often misaligned with city residents: “The Commissioner’s accountability leads back to state citizens, rather than ULB citizens specifically. In Ahmedabad, for example, the Commissioner is accountable to Gujarat’s Principal Secretary for Urban Housing and Urban Development. . . . Ahmedabad’s particular needs do not determine state priorities.”

There are contrasting examples that highlight better accountability mechanisms within Ahmedabad itself. The governing board of the bus rapid transit system (AJL) includes “…Mayor, the Chair of the Standing Committee of the AMC [Ahemdabad Municipal Corporation], the opposition party leader of the AMC…”, all of whom are responsible to local residents. Given that the same cities contain institutions with better local accountability mechanisms, it is curious why these practices are not replicated within other institutions in the same city. This is a question the report does not address.

The report concludes that institutional coherence is necessary but not sufficient for improving outcomes, but improvements in accountability and participatory mechanisms do tend to lead to better governance outcomes. This finding is relevant to the ongoing Indian discussions on the institutional designs of urban governance bodies, and whether a particular institutional form is appropriate for certain kinds of urban service delivery bodies.

It also provides food for thought for the other important question relating to urban governance—if state governments are unwilling to devolve power to municipal governance bodies, how are the improvements proposed in the report supposed to take place? All the changes proposed in the report, from fundamental changes to incremental ones, depend on the willingness of the central and state governments to devolve power. However, city governments seem more reliant on them than ever before.

For example, a recent RBI report on municipal governance highlights how Indian municipal bodies, on average, are more fiscally dependent on external sources (rather than their own revenues) than they were in the 1960s. While the World Bank report underscores the importance of city governments being financially autonomous and accountable to local residents, it is unclear how this will take place given the increasing financial dependence of these bodies on external financing. The report therefore lays out a pragmatic approach to improvements in urban governance, but even modest reforms will require the other tiers of government to act in enlightened self-interest, or for cities to somehow negotiate powers away from states.

The answer to Delhi’s local governance problems does not necessarily lie in the number of municipal bodies but in whether these bodies derive their resources and their legitimacy from local sources. At their core, as the report implies repeatedly, institutional problems are necessary but not sufficient for solving political problems.

—By Anirudh Burman