McKinsey lessons for the NAC

Written by Sunil Jain | Updated: Feb 20 2014, 08:37am hrs
Sonia Gandhis Food Security Act, BJP prime ministerial hopeful Narendra Modi thunders in the script I have dreamt up for him, delivers each family a maximum of R500 of subsidies every monththats assuming a R20 per kilo subsidy on 25 kilos of wheat and rice. Why do you want to settle for just R500 per month when you can earn that much in one or two days from the jobs I will provide you When the NDA was in power, it created around 12 million jobs each year on average compared to just 2.4 million jobs created a year by the UPA in its 10-year tenure.

The BJPs prime ministerial candidate, it is clear, isnt going to take speech tips from a journalist, and one who doesnt even cover politics, but he may take a report just released by the McKinsey Global Institute a bit more seriously. And so he should, given the collective consulting experience, and across so many countries, of those involved in the study. Like any McKinsey report, this one too has a graph on every other page and complicated econometrics on many others. But if you dont get lost in this, there are some very clear takeaways, not just for a Modi, but more so for those in the UPA who are convinced most problems can be solved by throwing more money at them.

Its not as if the experts at McKinsey dont believe public spending needs to be stepped up. Indeed, one of the graphics in the report From Poverty to

Empowerment, talks of how while the number of services used by a household rises as income levels do, the same cannot always be said about community servicesits interesting that some of Indias richest cities (think Gurgaon) have the least access to community services like piped water and sewerage. Another graph talks of how it is expenditure on health that needs to be stepped up dramatically if Indias poor are to be brought out of povertythe share of social services expenditure on health/water/sanitation needs to rise from around 21% right now to nearly 50% over the next decade.

But the really big takeaway, and this is where Modis imaginary speech comes in, nearly three-fourths of the reduction in the number of people below the poverty line (McKinsey uses the term Empowerment Gap since it hikes up the poverty line expenditure by what households need to spend on, for instance, health services) has taken place due to incomes earned by people, only a fourth was due to more government spending. This is intuitively obvious to anyone who works on poverty, but is something that few in the UPA have ever bothered to stop and think about.

Actually that needs to be qualified. Enough people in the UPA have thought about it and thats why they often talk about how the countrys economic growth has been higher than that during the NDA yearsthe number of people India has lifted out of poverty each year has grown with each hike in GDP growth. But when the same persons are thinking about subsidies, this thinking goes for a toss. Indeed, as Financial Express columnist Surjit Bhalla has pointed out (Billionaires and crony socialism,, based on the difference in what the poor consume and what they need to be able to be classified as non-poor, while India needed just R48,000 crore in a year, it spent over R3,00,000 crore in anti-poverty subsidies. More public spending alone, McKinsey says, without addressing issues of waste and inefficiency, is likely to deliver at most 8 percent of total potential impact.

In the future too, over the next decade, if all goes according to McKinsey projections, non-farm job creation and a hike in farm productivity are what will drive almost 75% of poverty reduction.

But creating jobs is one thing, and creating good jobs quite another. After all, even the MGNREGA creates jobs of a sort, but the earnings from those jobs are nowhere near enough to eliminate povertyMGNREGA jobs, for instance, are available for just 100 days a year at the outside. In other words, there are no easy solutions, politicians just have to agree to the necessary reforms. The good news though, is that the solutions have all been tried out in different states, so the lessons are there for everyone to see.

Clean water and sanitation, for instance, will deliver a big kick to productivity, and therefore to poverty alleviation, since the biggest problem for the poor is ill-healthnot only does health expenditure take them into poverty, poor health means significant loss of salaries for each day not worked. Forget the UPA or the NAC, even the latest crusader Arvind Kejriwal hasnt spent much time looking at this, more concerned as he was about providing free water to his voters.

While Kejriwals focusgoing by his anti-big-business statementsis on small firms, it is interesting to note, as McKinsey does, that productivity levels are almost directly correlated to the size of business. So, while the annual wage (all numbers in 2005 $ terms) across countries was $587 for firms with 5-48 employees, this rose to $1,361 for firms with 50-199 employees and to $2,699 for firms with more than 200 employeesproductivity levels in these firms rose nearly 10 times between the smallest and largest firms. Not surprisingly, in the case of India, the states that have the highest proportion of organised sector jobsMaharashtra, Gujarat, Tamil Naduare the ones with the lowest levels of poverty.

McKinsey has some interesting statistics here. The productivity levels of Indias large firms are not too different from those of competing countries like Indonesia and Thailand, though China is really off the charts with a value-add of $31,000 per employee in large firms versus Indias $13,000(data in 2005 $ terms). Whats really worrying is that the value addition per worker, in 2005 $ terms, was $1,500 for Indian firms with 5-49 employees versus $5,700 for Thailand and $15,100 for Chinafixing this means taking care of all the factors in the World Banks Doing Business indicators.

Equally interesting is the data on states that have flexible labour laws versus states that dontbasically a take-off from the studies by Besley and Burgess which showed, a decade ago, that states with less flexible labour laws tended to have lower output, lower productivity, lower investment and lower employment in the organised sector. Flexible labour law states,

McKinsey points out, tended to have 30.8% of employment in the organised sector in 2005 versus 21.6% for those that didnt have flexible labour lawsby 2010, this had risen to 35.3% and 23.2% respectively. Though anecdotal evidence doesnt suggest having flexible labour laws, by Indian standards that is, has hurt the prospects of the ruling parties, it would be interesting to see how this has affected voting patterns over the years.

Lastly, given the number of Indians still living in rural areas, there can be no comprehensive solution without improving the levels of agriculture productivity. Like many others, the McKinsey experts also point to how India needs to improve the quality of R&D and its agricultural extension servicesthe government employees who teach illiterate farmers what crops to grow, and how. There is no doubt that this is true and wrong incentivessuch as cheap electricity and free waterhave meant India grows the wrong crops in the wrong areas, something most evocatively told by the destruction of Punjabs water table. But it is worth pointing out, as Commission for Agriculture Costs and Prices chairman Ashok Gulati argues (Financial Express, India's second Green Revolution',, productivity levels in Indian agriculture have shot up recentlythere has been a 51% hike in agri-GDP per worker in constant prices between FY05 and FY12. This was the result of a significant hike in farm investment and that, in turn, was driven by a big boost in agriculture incomes by hiking crop prices.

Clearly, Indias farm incentives are lopsidedtoo much incentive is given to growing wheat and riceand water/power/fertiliser prices need fixing, as does the strangulation of farmers by not allowing free exports or forcing them to sell in cartelised

mandis. But the important takeaway here, subject to all the caveats, is that if you get the pricing right, a lot of other things get fixed on their ownMonsanto, for instance, will ensure there are enough extension workers to explain to farmers how to sow Bt Cotton and it has an R&D budget for seeds several times that of the Indian government.

Having done so much hard work over the last year in preparing the report, McKinsey now needs to follow up with young MPs to showcase the examples it has collected from various states, and across countries, on how to improve service deliverythink SMSs for PDS in Chhattisgarh. But the most important lesson has to be on the importance of allowing markets to function.

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