Infrastructure dilemma

Few people have heard of K L Thapar because he likes to stay below the radar. But as far as infrastructure goes, he knows what he is talking about.

Most important, he is not a dilettante. That is why other countries ask him for advice — but not India because that’s how we are.

In 1992, he set up the Asian Institute of Transport Development on a mandate from the Planning Commission from which he had retired as transport advisor after a long career in the railways. He is currently the institute’s chairman. I got to know him in 1998 when he appointed me a consultant because, he said, he was impressed by my observation that “those who know English don’t know economics and those who know economics didn’t know English” and that I was one of those who knew a little of both.

I have worked closely with him since then, and I think that if Uday Kotak’s board at IL&FS needs some advice, it should talk to Mr Thapar. As problem solvers go, he is hard to beat.

In 2001, he asked me to think about the problems of infrastructure financing, which I duly did. Then after a few months, when he thought that I had thought enough, he asked me to write a monograph which also I duly did. His only instruction was to keep it simple, no technical mumbojumbo. “Thodi economics, thodi English,” he said.

Risk? No way

The key issue in infrastructure financing, we agreed, was the role of risk capital, and the extent to which it should be used. That involved, in the first instance, examining the history of infrastructure finance.

It turned out that even if the capital was called risk capital, the risk was so hugely mitigated by governments as to make it virtually risk-free. This was done via open and hidden government guarantees. Even the US has not been an exception to this practice.

The converse was also true: Wherever risk mitigation had been inadequate, as in Latin America in the late 1970s, the venture had gone bankrupt. Risk capital and infrastructure simply didn’t go well together.

Except when the capital was raised through long-term bonds, that is, when redemption would happen after such a long time that the risk was negligible. But what constituted such a ‘long’ term?

We found that there was no formal definition but by a process of tatonnement it had come to mean 30 years. But then the next question arose: How long did it take for this market consensus to emerge?

Well, folks, hold your breath: It took as long as a 100 years in the US and the UK, which between them constitute 95 per cent of the world capital and financial flows. A necessary condition for this was an abundance of capital, mostly flowing out of London to the colonies and the US.

Whence the next question: Why did it take so long? The answer was uncertainty caused by unsettled questions that led to wars and/or the gold standard that led to sudden and massive expansions in money supply that eventually led to inflation and/or market and bank collapses.

Moreover, there were no exception to this general phenomenon. In fact, it was the extreme instability of the financial system in the US that led J P Morgan to force the creation of the US Fed. Its job was to save the financial system from periodic collapses.

It was only after the Second World War that some sort of stability and predictability came about and the long-term bond market came into its own. But that has created problems of its own, mostly because of what economists call moral hazard, that is, when you know someone will help you out, you tend to take greater risks.

We are seeing some of those now in India even without a 30-year bond market.

Tax or guarantee?

What we found in 2002 only reinforced Mr Thapar’s longheld view that in India there was no alternative to tax-funded infrastructure. The only issue was how would the government pick the tax payer’s pocket: By higher taxes and/or cesses, or via explicit and implicit guarantees?

This we thought was a policy choice that would depend on several things. One of those was the need for political and election finance routed to the parties in power via gold plated, guaranteed projects awarded to private sector adventurers.

After 2004, we have seen a lot of this, all over India. Whether you call corruption of this order a negative or positive externality depends on how you view things.