Category Archives: Economics

Should taxpayers subsidize philanthropists?

David Morris has an excellent piece in the Huffington Post decrying the increasing influence of private charitable players in public policy. In a system that is often bereft of any self-critique and usually celebrates the rise of philanthrocapitalism as an unequivocally good thing, the article raises two very important points.

First, it decrys the increasing influence of philanthropic institutions backed by private individuals in public policy. Two examples:

In 2008 Koch, or rather the Charles G. Koch Charitable Foundation, entered into an agreement with Florida State University to support the school’s economics department. The catch, according to the St. Petersburg Times was that Koch would have the authority to approve who ultimately filled the positions.

Gates (The Bill and Melinda Gates Foundation) financed the New Teacher Project to issue an influential report detailing the flaws in existing evaluation systems. The National Governors Association and Council of Chief State School Officers developed the standards and Achieve, Inc., a non-profit organization, coordinated the writing of tests aligned with the standards, each with millions of dollars from the Gates Foundation. The Alliance for Excellent Education received half a million dollars “to grow support for the common core standards initiative.

Concerns have been raised previously, including by the NYTimes and BMJ, that philanthropists may today have undue influence over public priorities and spending in ways not previously imaginable. A recent study found that giving by UK foundations for international development was just under half that of the DFID. Relying on philanthropy to solve public good challenges is simply a delegation of public responsibility but increasingly philanthropy is seeking to not just complement but change public financing, and this is not without consequence.

Morris, however, adds another critical argument. That such big ticket philanthropy is actually being subsidized by the state – and by extension the taxpayer.

We should bear in mind that what is reported as charitable giving by the 1% significantly overstates the actual private sacrifice, as economist Uwe E. Reinhardt points out. If the wealthy donate $10,000 and are in a combined 50% federal, state and local tax bracket their effective sacrifice is $5,000 and society as a whole, without its advice and consent, subsidizes the rest.

In the last few years a growing number of billionaires have established their own private foundations. They receive an immediate tax deduction for the full value of their contribution even though the foundation is only required to give away 5% of that endowment each year. Which means that for every $1 million contributed, which can mean a $500,000 loss to the public sector, the foundation must give away only $50,000.

This has long been the elephant in the room that no philanthropist will acknowledge. Most large foundations do not operate as charities – which spend all of their money each year. Rather, they operate as investment funds with large grantmaking teams, that spend only modest amounts on actually charitable causes. The rest goes to preserve the institution.

Charity enthusiasts also claim that philanthropy supports the public good and in many cases that is indeed the case – responding to humanitarian disaster, feeding the hungry, and supporting the local community. But the largest philanthropists are not content with those modest goals and are targeting more challenging issues – reforming public education, improving health systems, addressing the global AIDS epidemic, encouraging entrepreneurship.

These more ambitious objectives often tread on the public space. This would be good, if it led to a debate on how these challenges should be addressed. In reality, however, the wealth of these groups mean they not only advocate a particular viewpoint but also can finance its implementation. And the general popularity of philanthropy implies organizations, and viewpoints, not affiliated with them get short shrift in public opinion. The net result is not to increase, but decrease, debate.

This may well be unavoidable until philanthropists become more self-critical but does the taxpayer have to subsidize Bill Gates’ view on how education should be offered to people? Particularly when people are not even motivated by the tax incentive?

Is their a better dream than the American Dream?

On the NYTimes, David Carr provides Wall Street a lesson on failure. Speaking of “The Company Men,” he asks if we live in an age where the “game is rigged?” But that is a question that applies not just to Wall Street but to America in general. And it is one that holds much relevance for Asia, and India in particular as it seeks to balance an embrace of competitive capitalism with welfare.

Measuring the American Dream

Policy debate on economics has usually focused on economic inequality – which has been growing in America, together with many Asian countries, including India. The financial crisis has brought home this point in very simple ways, as reported in a Pew study:

Between 1979 and 2004, the real after-tax income of the poorest one-fifth of Americans rose by 9 percent, that of the richest one-fifth by 69 percent, and that of the top 1 percent by 176 percent.

That may not, in and of itself, be unfair. But it does become so if only a few people ever have a chance to be in that top one-fifth or top 1 percent. That is where socio-economic mobility becomes important. Americans believe they live in a particularly meritocratic society that allows its people to move up the ladder – the quintissential American dream. Ben Bernanke called it thus:

Although we Americans strive to provide equality of economic opportunity, we do not guarantee equality of economic outcomes, nor should we. Indeed, without the possibility of unequal outcomes tied to differences in effort and skill, the economic incentive for productive behavior would be eliminated, and our market-based economy — which encourages productive activity primarily through the promise of financial reward — would function far less effectively.

Yet, it is increasingly clear that the twin assumptions therein – that a) there is equality of economic opportunity, and b) effort and skill are the only or even the most important variables to success – are wrong. It turns out that economic mobility depends much more on our birth and our upbringing than our own effort and skill. One measure – the extent to which individual and parental earnings are correlated – suggests that:

…about half of the advantages of having a parent with a high income are passed on to the next generation. This means that one of the biggest predictors of an American child’s future economic success — the identity and characteristics of his or her parents — is predetermined and outside that child’s control.

Malcolm Gladwell called this “accumulative advantage” in his book Outliers – the phenomenon of the rich getting rich and the poor getting poorer. Such accumulative advantage should not be a surprise – even if the extent of its influence is. Yet, if we are to strive for a meritocratic society that offers everyone a chance at success a critical question must be to what extent does a state manage to shield its population from the ravages of destiny?

On this point there is much evidence within the OECD showing that America falls far behind European and particularly Nordic countries. On the previous measure (earnings elasticity) the USA is just below Italy and the UK, with the least correlation in Denmark, Australia, Norway, Finland, and Canada.

Overcoming “accumulative advantage”

There are, then, two ways to measure a society – to what extent is it equal (more economic equality), and to what extent is it just (providing economic mobility). America hopes to be just, providing equal economic opportunity while accepting higher levels of economic inequality. Europe, meanwhile, believes that economic opportunity will never be truly equal and thus seeks to overcome or protect from hereditary disadvantages. Ironically, Europe’s model proves not only to be more just, but also more equal (with sufficient correlation between equality and mobility).

Ironically, though, as Europe’s model proves to be better, its very existence is threatened for being financially unsustainable. European governments, faced with massive debt, must choose which social programs to cut.

India is thus offered two models – one that fails to sustain itself, while the other that fails to deliver on the goal of an equal and just society. What do the policy choices of Indian politicians reveal about their preferred model?

India has since liberalization in 1991 been trying to seek high growth. Such growth ensures some form of economic mobility – incomes of successive generations increase along with overall growth. Put another way as the pie gets bigger everyone gets a bigger absolute part of the pie.

Yet, policy emphasis on growth itself resulted also in a more unequal society as those with a privileged birth – with at least well-educated parents – benefit disproportionately from the opportunities provided by liberalization. They do better than their parents. Meanwhile, the farmer in the hinterland – without the means to send his children to an English speaking school – must see his children continue to toil the land or seek opportunity in low-paid manual labor. Both equality and relative economic mobility thus go down.

In recent years, however, India has recalibrated its policies to be more welfare focused. In particular, a realization that the country cannot survive united nor compete unless everyone benefits, has brought forth some interesting compromises.

For one, government is starting to accept its welfare role in some areas – as illustrated by the rural employment guarantee scheme. Second, there has been some political pressure on competitive capitalism – this explains the edict of Andhra Pradesh’s politicians to the population not to pay back microfinance loans. And finally, companies and their wealthy seem to be taking some responsibility for good governance into their own hands – evident in the massive philanthropic efforts of individuals such as Azim Premji who focuses disproportionately on strengthening public schools, rather than creating a more efficient, but perhaps more expensive, private system.

Thus, India returns ever so often to the left, while seeking to convince the world it is the future of capitalism, with Ambani’s multi-million dollar mansion a clear reminder to those that may forget.

There is, therefore, hope that the disadvantaged in India will still see the benefits of growth. But a sustainable middle path requires combining two hard to reconcile social preferences – people must be highly motivated for the spoils of success (as in America and Asia), but hold a healthy regard for the welfare of others to allow for the redistribution of those spoils (as in Europe). To date no society has managed to do so, though the voluntary redistribution of wealth by the newly wealthy may provide some temporary relief.

India’s growth over the past several years has certainly raised wealth. But it has also led to a more unequal and a more unjust society. Of course, no society can be expected to completely shed its bias towards aristocratism. That would be against human nature. But the purpose of a state is not necessarily to change human nature, but rather to help those disadvantaged by some elements of it. In that, the American Dream has failed to become reality for too many people. India, looking for a dream of its own, can certainly promise – and ask – better to its citizens.

Economics and the Disregard of Reality

An editorial in the WSJ criticizes Tim Geithner for doubling aid to the IADB, calling him “the Obama administration’s first-string hurler, a man who never meets a problem that can’t be solved by throwing more money around.” Critics of the PPIP will probably agree to that categorization.

But the article points to a seminal Cato Journal article written in 1987, on the complete “disregard of reality” that economists sometimes show. Written by Peter Bauer, a leading development economist, it should be required reading for all economists – and indeed social scientists.

Before commenting on this article, it is worth noting that this article was written at a time when foreign aid was very much en vogue. At the time most developing countries had adopted centralized state planning and import substitition policies, often at the behest of economists from America and the UK. In the 1960s, India was a case in point. As noted in this 1992 Cato paper (Foreign Aid and India: Financing the Leviathan State), John P. Lewis – the head of USAID at the time argued:

that India’s planned development was the most feasible and desirable path for a country at an early juncture in the development process and that the decentralized market system was inappropriate, destined to fail, and had only led to the development of Great Britain and the United States because of “special circumstances.”

Bauer’s paper is a good early rebuttal of this view. Bauer argued against many of the popular views at the time, including “that there is by necessity a widening gap between rich and poor countries, and that central economic planning and large-scale capital investment are prerequisites for growth” (see this paper). Criticizing the concept of a vicious circle in development, he said “if the notion of a vicious circle were valid, mankind would still be in the Stone Age at best.”

The Causes of this Disregard

Bauer’s article is revealing in how despite his faith in economics he also held strong reservations on the subject, and particularly on its practice. While an economist himself, he was highly suspicious of the tendency of economists for groupthink and their ability to confuse economics with the natural sciences.

That second comment is particularly telling because economists today seem to fall into the same trap and think their ability to quantify social processes set them apart from other social scientists. Yet, Bauer argued that:

In the course of this shift of approach pertinent differences between the study of nature, especially physics, and economics have not been sufficiently recognized…the use of mathematics is particularly effective because of the language barrier it provides. What we see is an inversion of the Emperor’s New Clothes. Here there are new clothes…But all too often there is no Emporer within.

Implications for Today

Bauer’s observations have implications far beyond foreign aid because policy advocates tend to overlook the obvious, even today. There are two areas in particular where economists, have often neglected this basic test.

First, the current crises has led many economists to herald a new era. Those on the left declare this to be the end of capitalism. As Gordon Brown proclaimed at the G-20 summit, the “Washington Consensus is Over.” Those on the right, however, take it to mean that we have not had enough capitalism – and that we need to re-commit ourselves to free trade, liberalization, and the other tools at the disposal of free-market economists.

Both sides tend to ignore reality. On the left, they ignore that the world is inexorably moving towards greater, not lesser, capitalism simply because the hordes of Indians and Chinese are choosing to trade and consume? And those on the right ignore that countries that had embraced these free-market ideals have suffered the most.

The truth is simply that we have always had a mixed economy. This view, in the Indian context, was underlined most recently by the Indian PM Manmohan Singh (covered very well here). As Amartya Sen said in his article Capitalism Beyond the Crises (excellent recommended reading):

The market economy has depended for its own workings not only on maximizing profits but also on many other activities, such as maintaining public security and supplying public services.

So, if society has depended always on a mix of public and private institutions and players, what is needed is a healthy mix of the two – rather than a substantial reliance on any single one. This is a lesson Indian liberals should do well to remember.

The second area where economists have been particularly vocal these days, at the expense of the obvious, is in espousing the privatization of education in India. They moan regulation that prevents businesses from investing in and profiting from education providers. Implicit in their proposals is the claim that public education cannot work.

Yet, this ignores reality because public education worked in many places, including the entire communist world. This is not to say that the communist system is better. Yet, anyone that suggests public education doesn’t work needs to first explain why, according to the latest UNDP statistics, Cuba has the highest literacy rate in the world (which at 99.8% is 17 ranks above the USA at 99%).


According to O’Grady, Tim Geithner disregarded reality by thinking that the solution to any problem is to “throw more money at it.” This is not true of foreign aid. Nor is it true of free-markets (the PPIP), or education, or healthcare. More money will not solve the problem. Nor will replacing one incomplete system with another.

However, the answers to our problems may not be that elusive. Rather than trying to rethink everything, or change the system we see as failing, we may wish to look at something more obvious but perhaps less sexy. As Amartya Sen says of the “new capitalism” what is needed is “a new understanding of older ideas, such as those of Smith and, nearer our time, of Pigou, many of which have been sadly neglected. What is also needed is a clearheaded perception of how different institutions actually work, and of how a variety of organizations can go beyond short-term solutions to contribute to producing a more decent economic world.”

And above all what is needed is, in Orwell’s words, “the restatement of the obvious.”

The Doha Round is Dead, Long Live Free Trade

It is now official. The “Doha Round” of  WTO trade talks has collapsed. Again. The supposed culprits are, to varying degrees, the USA, India, and China. It appears these three could not, for reasons best known to themselves, compromise on the fairly obscure clause of a “special safeguard mechanism,” designed to protect poor farmers from a sudden surge in cheap, subsidized farm imports from abroad.

Of course, the Doha Round has collapsed repeatedly in the past, only to be resurrected by countries eager for a multilateral agreement. However, that they have collapsed on a point so seemingly trivial suggests this must really be the endgame. The USA, China, and India may simply be positioning for a better outcome when they return to the negotiating table.

But this latest failure also puts into immediate perspective the choice most developing countries face when negotiating with “the West.” Immediately following the collapse of the talks, the EU reneged on a deal with Latin American exporters of bananas that, the EU says, was effectively tied to the Doha round. As this illustrates, most developing countries are better off negotiating as a group.

That said, some countries are more equal than others. India and China fall into that category, and must ask themselves two questions. First, if this failure is simply a negotiating tactic, will the rest of the developing world hold the line? Not likely. Instead, this failure is likely to give a fillip to bilateral trade agreements that have ballooned recently (see chart) with the US in the lead. Such a spaghetti bowl of agreements may be great for trade lawyers, but will do less to serve the people in the developing world.

More important, are farm subsidies or safeguards really the key issue that Indian and Chinese diplomats should be worried about? In a world where food prices are rising and expected to stay high, and where more and more European and American consumers are turning to locally grown organic food, India and China seem to be fighting yesterday’s battle. Are there not other issues on which the two can stake their negotiating position? Some obvious candidates spring to mind to tackle critical, and future, public good challenges: a food security fund; a technology transfer agreement for cheap renewable energy; a climate change adaptation fund; a medical research or procurement fund for tropical diseases?

No doubt India and China have earned the right to be bull-headed about the current round of trade talks. Previous rounds have come and gone and much has been given away by these countries. At the same time the American farm lobby is as important for American politicians, as the Indian farm lobby is for Indian politicians. Netherless this stalemate is unfortunate at best. There are more important issues out there that deserve at least as much attention.

High Food Prices: An Opportunity for the WFP

The FT reports that an upcoming OECD/FAO report predicts food prices “will not drop back to pre-crises levels for at least the next 10 years.” So why did India’s latest budget waive 600 billion rupees in agricultural loans to help indebted farmers? More curiously, why do farmers in India continue to commit suicide to escape crippling debt (between 2002 and 2005, 86,922 farmers committed suicide). Perhaps the oddest is America’s new farm subsidy bill, which will pay rich American farmers USD 40 billion more in taxpayers money.

How is one to reconcile these contradictions? And, to answer Natasha’s question – what can the World Food Programme do about it?

This is more than a rhetorical question because the World Food Programme matters to a lot of people. It is the frontline agency feeding the world’s hungry and in 2004 delivered almost 50% of global food aid (7.2 million tons valued at USD 3.2 billion). With prices up to 40% higher, the WFP is reporting that it will be forced to cut back on the number of people it feeds. According to Josette Sheeran, Director of the WFP, this “silent tsunami” threatens up to 100 million people unless the agency receives an additional USD 700 million.

So, what is the WFP to do?

Greater funding of the WFP is not a solution. Though grain prices have fallen recently (wheat is 40% below its February peak), the spectre of sustained high prices suggests the WFP and national governments will have to seriously reconsider their long-term strategy for ensuring food security. But any strategy or solution will have to account for two factors.

Historical wheat volatility (CBOT)

First, that volatility is up. The sudden spikes and falls in food prices suggest we are far from an equilibrium. Data from the Chicago Board of Trade (CBOT) indicates that volatility in wheat prices, for instance, has risen (see chart). This suggests that long-term consumers of grains would do well to heed the call of Goldman Sachs’ oil analyst Murthi who suggests only buying long-term crude oil.

Second, the problem has many reasons. On the demand side greater demand and changing consumption patterns in China and India; on the supply side a shift of agricultural land towards biofuels and urban expansion and lack of research since the last green revolution. Agricultural commodities have also become an investment class contributing to higher volatility. There is no one culprit. Rather, the entire value chain of food markets is riddled with government intervention and inefficiency.

These problems will remain for the forseeable future therefore any solution will have to account for the fact that it cannot change the system. International grain prices will always be subject to domestic politics, such as the US farm subsidy bill; faced with high gas prices rich countries will still promote ethanol; urban expansion will continue; and climate change in the north will receive more funding than agricultural research in the south. The WFP cannot address the problem by throwing more money at it – even the entire USD 1.2 billion it was criticised for possessing.

Purchase for Progress

The good news is that, as one of the largest global consumers of food, the WFP is in a position to bypass the system. The Purchase for Progress program of the WFP does just that. It aims to increase farmer productivity in the developing world by creating market linkages, acting as a guaranteed buyer, and providing futures contracts to farmers to encourage long-term investments.

The concept is intriguing. Not because it is new but because it mirrors a similar move in India by retail giants such as Reliance and Walmart. As they execute plans to open hundreds of stores to serve millions of middle-class consumers in India, they are bypassing local agricultural markets, choosing instead to buy directly from the farmer.

Thinking Bigger: Building Markets

In the long-term, then, the WFP has a shot at putting in place long-term purchase contracts that help WFP as well as local farmers. And by buying locally, the WFP can reduce its dependence on national contracts – always a risk when governments can renege on export contracts as they did in this current crises.

But why stop there? Indeed, if the WFP can show that efficient markets are in the farmer’s and consumer’s best interests, it provides a strong incentive for local governments to dismantle the controls that hold back global grain trade (e.g. less than 8% of the global crop of rice is traded internationally). Done right, the Purchase for Progress concept could – and possibly should – be expanded into an Alternative Investment Market for agriculture – a global market for small-holder farmers.

With that in mind here is a more ambitious Purchase for Progress (P4P) 2.0.

  • Create an internal marketplace: The whole point of purchasing locally should be to turn food scare areas into food exporting areas. While the FAO and IFAD, amongst other agencies, try to increase productivity, the WFP is in the priveliged position of having the money to put where its mouth is. As local production increases beyond local needs, create an internal marketplace that trades the suplus to other parts of the world. Grow in Africa, send to Burma – and vice versa when disaster strikes Africa.
  • Become a clearing house: While I do not know the details, in its current avatar the P4P program partners with several organizations. However, it can go further offering for instance to be a local clearing house for retail giants such as Reliance. As the retail business in India is currently structured, farmers transact with multiple companies bilaterally. While this works for now, the scenario needs an intermediary market in the long term. The WFP can be that market, at least in some places. Not only would it offer its logistics experience, it could benefit by buying any surplus or at least having a better insight into supply and demand.
  • Use that investment fund: That USD 1.2 billion fund, for which the organization was criticized, can be put to good use. By all means, keep the reserve. In fact, create a long-term endowment because the world’s hungry are not going away anytime soon. But use part of the money to invest in agricultural SME funds such as Aventura or to provide loan guarantees to businesses that are needed to boost agricultural productivity. Why keep all that money in cash and cash reserves?

The high food prices have illustrated much about our inability to feed a substantial portion of the world’s population. However, this problem is not one of supply. Rather, it shows deep rooted problems in an international system of distribution. When such a system does not serve one’s ends, it is often easier to bypass it rather than fix it.

The WFP is in the ideal position to do just that. It has the purchasing power to be a market shaper with enough resources to push through changes further down the value chain (much like Nike does with its suppliers). It also has a special legal status that can allow it to bypass national laws – such as those banning independent agricultural markets or futures. And finally, it is not so big that anyone would actually notice a disruption in the overall market.

Indeed, that a substantial portion of WFP’s donations are tied is a good thing (Canada required 50% of wheat be bought from Canada, and the US generally provides in-kind donations). Not only is that food subsidized, but so long as the WFP meets those commitments both national governments and international commodity businesses (such as Cargill) will allow the WFP to build its own parallel system. Such a system can, one day, rival any national or international trading platform. It is in the benefit of WFP, but also in the interests of shifting agricultural trade in favor of poor developing countries.

A Dynamic Welfare State?

Is there a contradiction between a socialist welfare state and a dynamic, high-growth economy? Look at India and China and it would seem so. But is it possible to combine the benefits of a welfare state with those of competitive enterprise?

The current issue of the Harvard International Review looks closely at Sweden to offer some hints on how this may be possible. Sweden, along with Switzerland, Norway, and Finland, is amongst the most globally competitive, yet has an extensive welfware system for its citizens. To explain how this works the article compares Sweden with another welfare state – France:

The key difference between the leaking private sectors plaguing other European nations with the welfare model in Sweden is the way in which the government injects value into the economy. Because of the structure of Swedish welfare, the private sector doesn’t suffer. Swedish socialism is designed to protect the people, not just jobs themselves.

The reason for this apparent contradiction lies in the agent of action in Sweden’s social calculus. While French corporations are required by law to provide benefits, the Swedish government shoulders these costs. In addition, unions in Sweden have a different perspective than do their French counterparts. Much like the system as a whole, the goal of unions is not just to protect jobs, but to protect people by winning benefits for those who go off the employment rolls. In France, a worker represents costs to the company during and even after their employment, but in Sweden, the government takes over for the welfare of laid-off workers.

Clearly, by placing the burden of welfare and job protection on the government, the system retains companies’ focus on efficiency, hiring, and firing.

There is an additional consideration that allows this system to work – and explains why Swedes tolerate such high taxes. The country’s homogeniety makes such collective transfer payments acceptable – something that may not work in a more diverse country where group membership is restrictive (India), or where there is a traditional mistrust of the government (USA).

A final contrast between the Nordic country and its southern counterparts is national unity. With a largely homogenous population, Sweden’s view of community is unique. Unlike France, which is a nation historically marked by prejudice and racial conflict, Swedes are more willing to submit to the large tax rates that support the large government payroll and expenditures.

Of course, government is no paragon of efficiency, and Sweden is no exception. Indeed, the government’s overwhelming presence in society, together with the twisted incentives and changing social mores, are identified as threats to the system:

Because employee benefits are so generous, many abuse the system by faking illnesses and escaping work. Absenteeism is the largest unaccounted-for contributor to the discrepancy between government data and actual statistics.

A new issue altogether is increased apathy toward the Swedish government. Decreasing voter turnout reflects a populace that cares less for its government. There are two possible explanations for this drop. First, the Swedish people could be disillusioned with the government and its policies, possibly heralding a fledgling discontentment that has in the past resulted in troubles for other welfare states. Once a country’s citizens are unhappy with governmental policy, they are much less likely to be pleased with paying for it. This could prove to be a disrupting factor in the seemingly well-run model.

An alternative explanation lies in the changes and modernization taking place throughout the country. The Sweden of today features an increasingly diverse population. This results in less emotional and cultural investment in the nation as a whole, as well as less willingness to shoulder the burden of welfare for one’s fellow Swede. The homogeneity that differentiates this Nordic nation from other European welfare states is starting to dissipate, and with it possibly the security of the model’s success.

This is an article worth reading in its entirety for it offers two important lessons.

First, a welfare state is not necessarily contradictory to a free-market one. If the latter is necessary to lift people out of poverty, the former is necessary to keep them out of it. The hope offered by Sweden is that it may be possible, in certain conditions, to marry the two.

Second, just as a free-market system needs government regulation, a welfare state also needs regulation to minimize beauracracy. But who will regulate government? Some self-regulation occurs in times of economic distress, as demonstrated by economic restructuring during the Asian and Latin American financial crises and India’s own balance of payments crisis. But when no external triggers exist the only true regulator is a well-informed citizenry, vigilant and wary of excessive government.

Ironically, then, the countries best placed to establish sustainable but extensive welfare systems might be the countries most skeptical of them.

India and the Politics of Climate Change

The Bali Conference on climate change had been convened to achieve consensus on a post-Kyoto framework for addressing climate change. It concluded without any real agreement and with India continuing to maintain its principled stand of a “common but differentiated responsibility” for the developed and developing world. However, in its aftermath, and as pressure continues to mount on both India and China to take action on the issue, the question of what strategy is best for in these negotiations has becomes particularly pressing. Should India engage the world, or remain aloof?

Discussions on this issue generally take either an ethical or an economic perspective, with very few considering the politics of climate change negotiations. Yet, that perspective is particularly important for India, because the costs of climate change are so high for it.

By some measures India has the most to loose from climate change. This is not surprising given the country’s vast rural population, overwhelmingly dependent on natural weather patterns. Intuitively, India should therefore not only be acting forcefully to help its population adapt, it should be encouraging all developed economies to tackle climate change convincingly. Yet, India has resisted calls for binding emission cuts that would spur other countries to follow and has also avoided taking a lead role in negotiations on the issue.

Such resistance can perhaps be explained by the fact that western policymakers have seldom acknowledged the vulnerability of the developing world. Nor have their policy proposals, including Kyoto, included substantive provisions for helping vulnerable countries adapt. In the absence of assistance on adaptation, India has little incentive to participate in global mitigation efforts. Instead, India’s approach reflects the advice of economist Thomas Schelling that given their limited ability to adapt, “the best way for developing countries to mitigate global warming is through economic growth.”

We are presented, therefore, with a dilemma. In the long run, India would benefit from a collective response to global warming. But in the short term and with no agreement on a post-Kyoto framework, a unilateral strategy of high emissions growth would be more beneficial. Both parties in this situation would benefit from cooperating, but cooperation is hindered both by trust and the asymmetrical cost of cooperation.

The Case for Engagement

Such cooperation could be pursued for two reasons. The first is merely existential – anything that triggers a collective mitigation response from the developed world helps India. But a more compelling argument is political – by not participating in negotiations India risks the creation of a framework that does not reflect its concerns (see Why India Must Act).

There are unmistakable signs that this will happen, particularly with American business lobbying for a “global framework” that prevents balkanization of regulation, reduces operational uncertainty and prevents dilution of their competitive advantages. Last year the American Congress proposed legislation to tax imports from countries that do not restrict carbon emissions. Early this year, the European Commission too announced it was considering import taxes for carbon-heavy imports, triggering the prospects of a trade war with China and India.

There are useful parallels here to study from the incorporation in 1995, of the TRIPS agreement. The TRIPS Agreement came into being when the US, Europe, Japan, and Canada (known then as “the Quad”) decided to create a new international framework encompassing intellectual property. Rather than attempt to modify the GATT, they instead created the World Trade Organization, and forced developing countries to accept the TRIPS agreement, along with two others. Since developing countries did not participate in negotiations, their concerns were not reflected therein – a bias that has not been adequately corrected since despite the Doha Declaration on TRIPS and the currently stalled Doha “development” round. The lesson is simple – it is better to establish a favorable international policy, rather than try to change such a policy after the fact.

The Case for Disengagement

If the case for engagement is strong, the case for waiting for action by others is even stronger, though less obvious. Arguments for not participating in negotiations lie in the dynamics of bargaining power – and how participation in negotiations affects that power.

Agreement in international negotiations occurs not because there is an economic or ethical case for it. Rather, it is based on quid pro quo. Countries that loose from the agreement join a treaty when they are appropriately compensated by those that gain.

So, who looses and who gains from climate change?

The economic models of Nordhaus & Boyer estimate the economic cost of global warming will be highest for India, Africa, and Europe. In comparison, Russia will receive a mild boost to its GDP, while the impact on America and China is expected to be relatively low. This explains why Europe and Africa are enthusiastic for a collective response. It also explains why America did not join Kyoto – because the treaty did not compensate it sufficiently for the economic costs of carbon mitigation.

This suggests it may be smart for India not to participate in ongoing negotiations just yet. As a country that looses from climate change and benefits directly from a collective response to it, India’s case for any compensation is weak. India’s bargaining power derives not from its ability for give-and-take, but rather from the world’s desire to include it in a future treaty. The moment India indicates a desire to participate in those negotiations it weakens its own bargaining power.

A Middle Path: Free Riding on China

How then is India to proceed? One option, perhaps, may be to free ride on China’s negotiations with the US. China is the counter-point to the US within the developing world – it looses little from climate change, yet its involvement is essential to the success of any future treaty. Therefore, China is much better positioned to bargain for compensation (e.g. technology transfer, R&D financing, or adaptation assistance), and should therefore be at the vanguard of negotiating a climate treaty with the US and EU.

There is still much India can do, as it reiterates the principle of “common but differentiated responsibility.” For instance, India needs to lead efforts to reframe the issue of climate change as one of adaptation, not mitigation (which is a Euro-centric view). It also should work closely with major emerging economies to define a collective bargaining position for the developing world in return for participation in a climate change treaty. Not only would such bargaining improve the potential outcome in favor of the developing world, it would also support and reflect India’s political rise and ability to convene.


A climate change treaty that binds India to mitigating action is no longer an option but a virtual certainty. Such a treaty will become fact either through negotiation or through unilateral measures by the developed world. To avoid lockout, India must have a strategy for addressing such negotiations.

Current disagreement between India on the one hand and Europe and the US on the other is unlikely to be resolved till a new treaty addresses the dilemma faced by India. That will essentially involve payments from winners of the agreement, to the loosers. Some of the elements of such a payment system are already in place, such as Kyoto’s Adaptation Fund, but they must be substantially expanded. Domestically, India should continue to cherry-pick and implement initiatives that are domestically economically viable to reduce emissions growth. But at the international level, India’s best strategy for negotiations may simply to promote China as a collective bargainer and signal its own resistance to bargaining – a signal which up to a point will strengthen India’s position.

Subprime Loans and Race Inequality

The NYTimes has an interesting article on the relation of subprime lending and race in America. The article looks at the distribution of subprime lending, to discover that the majority of such loans were concentrated in black and hispanic neighborhoods, and that these communities were much more likely to take on subprime, but high interest rate loans even after controlling for income.

There has been less attention paid to the concentration of these loans in neighborhoods that are largely black, Hispanic, or both. This pattern, documented in federal loan records, holds true even when comparing white middle-income or upper-income neighborhoods with similar minority ones.

Last year, about 70 percent of the loans made in the Detroit neighborhood (97% black) carried a high interest rate — defined as 3 percentage points more than the yield on a comparable Treasury note — while in Plymouth (97% white) just 17 percent did.

Last year, blacks were 2.3 times more likely, and Hispanics twice as likely, to get high-cost loans as whites after adjusting for loan amounts and the income of the borrowers, according to an analysis of loans reported under the federal Home Mortgage Disclosure Act. (Asians are somewhat less likely than whites to take out high-cost loans.)

One can draw several interesting inferences from this. First, it would appear that banks in America have been unable and unwilling to move down the “pyramid” to cater to people with bad or unknown credit histories. This stands in start contrast to the success microfinance in the developing world.

Second, credit is not a good thing by itself. In this case, it was overzealous and highly competitive lenders that “actively sold subprime loans” (see also). The corollary for microfinance is that if the aim is development (as opposed to building a new business model), one needs more than credit.