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This material is taken from the Economic and Political Weekly which has adapted it from the text of the Seth Shantaram Mangesh hulkarni Lecture delivered in Mumbai 'on December 3,2005. I am not reproducing the article as there are chances that it will lose its essence. So it is the exact wordings of an insider who was involved in opening of NSE.DISCLAIMER: Article is very long but is worth reading.Indian capital markets have witnessed a radical transformation over just one decade. There is hardly any country in the world which has witnessed such massive changes in its capita market during such a short period. During the early part of the 1990s, the ranking of the Indian capital market with reference to the standard global indices relating to efficiency, safety, market integrity, etc, was not at all flattering. With reference to the risk indices, in particular, the Indian capital market was regarded a: one of the worst as it figured almost at the bottom of the league The same was the case in regard to its efficiency levels in trading and settlement systems. Strangely, not many people appeared to be bothered about the dismal state of our capital markets. As we are all accustomed to find India figuring in the bottom league in regard to so many other indicators of development such as per capita income, nutritional standards, health amenities to its citizens, literacy levels, etc, we did not seen worried that the capital market was also ranked at the bottom of the global ranking sheet.The same cannot be said about the current state of the Indian capital markets. From the viewpoint of both adoption of sophisticated information technology tools in trading and settlement mechanisms as also the efficiency of capital markets, not only is India ranked in the top league but it is also considered to be way ahead of many developed country capital markets. Even at the risk of being dubbed as personally biased I would affirm that the National Stock Exchange (NSE) has been largely responsible for significantly upgrading the Indian capital markets to the best global standards. I would be the last person not to agree with the proposition that the government and the Securities and Exchange Board of India (SEBI) have also played a very crucial role in this transformation process. But there is a limit to what can be achieved merely through official interventions or directives. It may be recalled that the government did seriously try to bring about several desirable reforms in the capital markets in response to the recommendations of the 1985 G S Patel Committee report. But it was not possible to make much progress in the desired direction as the stock exchange community was not receptive even to a marginal set of, reforms. What is even stranger, the powerful broker community started talking about their fundamental rights to do business as they thought fit, although that may not always have been in the interests of the markets and the investor community.But after the NSE was set up, the entire atmosphere changed. The broker-owned and managed exchanges started worrying more about the competitive threat that NSE posed to their business and how they should meet investors' minimum demands so that they did not lose out completely to NSE. All these exchanges became more receptive to what the government and SEBI were telling about adopting clean business practices. NSE, in that sense, strengthened the hands of the authorities in making the other exchanges conscious of their social responsibilities.How did the Indian capital market, which was considered to be one of the most inefficient and risky, get transformed into one of the best and the safest in such a short period of time? There appear to no parallels to this in any part of the world. In several countries, capital markets have improved in terms of quality and efficiency continually over several decades before they could be bracketed with the top league of the best capital markets of the world. To the best of my knowledge no other country, even in the developed part of the world, has been able to witness a quantum jump in the quality and efficiency of its capital markets in a short period, viz, a decade. Hence, a detailed study of transformation of the Indian capital markets during the last decade will certainly prove to be a fascinating story. All that I am planning to do here is to give a bird's eye view of the developments in the Indian capital markets as I have seen them from close quarters since I was fully involved with the setting up of NSE right from day one and was also its managing director and the chief executive officer for the first seven formative years. It is my humble claim that the NSE has been the most important catalyser of the radical transformation of the Indian capital market during the last decade. Hence, I consider myself to be one of those few fortunate people who could witness and participate in the unfolding of this fascinating story from where most of the catalytic activity took place.Let me begin my story by drawing your attention to the major disaster that struck the Indian financial system during 1991-92. It shook the stock market to its very foundations. During this scam several banks — both small and big, foreign and Indian, and public sector as well as private sector — lost huge amounts of money. Strangely, many stockbrokers prefer to refer to this disaster as a banking scam, as if the broker community did not have any role in perpetrating the scam. The real truth was that money was siphoned off from the banking system by the stock-brokers through many devious ways. Equity prices were manipulated by several prominent brokers with the help of money diverted form the banking system. Although brokers used to issue their contract notes, their concerned stock exchanges did not bother to conduct regulatory surveillance on these transactions. There is hardly any doubt or dispute about the proposition that the stockbrokers were the kingpins of the major fraud that shook the financial system and the capital markets. It was in this context that an urgency was felt to bring about necessary reforms in the capital markets so that such serious mishaps did not recur. This prompted the government of India to delegate powers to SEBI under the Securities Contracts (Regulations) Act, 1956 (SCRA) and later to enact a special legislation called the SEBI Act. But it was soon realised that merely empowering SEBI with more powers exchanges not enough. Since the governance of the stock exchanges was very poor something more in the nature of setting up a new model stock exchange was needed so that competitive pressure would force other stock exchanges to reform themselves. The government agreed to bless/support the lead taken by IDBI to set tip a modern stock exchange that would help introduce the best international practices, both in the areas of trading and settlement.It is worth noting in this context that in the initial stages, there was not much enthusiasm in favour of setting up exchange even among influential official circles. There was some scepticism as whether there was any need for such an exchange that would compete with the broker-owned-dominated stock exchanges. It was widely believed that the right course of action should be that SEBI should crack its regulatory whip. It was hoped that this would ensure good corporate governance among the stock exchanges, make markets function more efficiently and protect investors' interests. The then chairman of SEBI G V Ramakrishna did act tough to make stock exchanges fall in line. But the well-entrenched brokers were in no mood to listen to wise counsel. Prominent broker associations as also some of the stock exchanges were almost on a collision course with the market regulator. Soon it became abundantly clear that, in the absence of competitive pressure from a well functioning and professionally managed stock exchange, market standards could not be significantly improved.The second point that needs to be noted is that the NSE as has emerged was not the one to which we find reference in the Pherwani Committee. The concept of the stock exchange given in the Pherwani Committee was quite a timid one. The NSE, as proposed by the Pherwani Committee, was primarily meant for creating a corporate debt market as also creating liquidity in mid-range stocks that lacked liquidity on the main stock exchanges like the BSE. Foreseeing the opposition such a proposal would meet with from BSE and the powerful broker lobby the Pherwani Committee had suggested that such a stock exchange should be set up in New Bombay. Despite the fact that the NSE, as recommended by the Pherwani Committee, would have posed hardly any threat to the strongly entrenched BSE and other exchanges, there was tremendous opposition to the very idea of an exchange with different feathers. At that time the broker community a strongly believed that of stock exchanges were their exclusive preserve.It was certainly a difficult journey as we faced several difficulties, often from quarters, which should have, in the fitness with of things, supported us in our task. My intention is to share you an insider's story so as to dispel the wrong impression some people have, that it was cakewalk for us. It is also my desire to emphasise that the changes that the NSE has been able to bring about may appear to be irreversible; but it need not necessarily be so. If we are keen that our journey on the path of capital market reform is not slowed down or that the reform process does not get reversed, we should remain ever watchful of the games that the detractors play. We should try to see through the clever games which a number of powerful market operators repeatedly play to achieve their selfish objectives.NSE as a Trend SetterThe anonymous order matching system adopted by NSE is perhaps one of the best in the world, The New York Stock Exchange (NYSE), for example, would have remained free from the bad name that the floor specialists brought to the exchange, had it adopted NSE’s automated trading system. In terms of the geographical reach of real time trading facilities to the nooks and corners of the country, the Indian capital market is way ahead of most of the global capital markets. Investors can trade from close to 400 cities/towns across the length and breadth of the country on a real time basis. Today, investors in distant parts of the country feel happy that they enjoy parity with investors located in Mumbai as they also have the same type of access to the best prices as are available to investors in Mumbai. Before NSE came into existence the country was not even aware or the ironclad settlement guarantee for all the trades done on an exchange. NSE is the only exchange in the country which has set up a d clearing corporation which acts as the central counter party guaranteeing all settlements.NSE happens to be the first truly demutualised stock exchange of the world; it has almost fully resolved the conflict of interest issues that arise when brokers are in control of the boards of the stock exchanges. NSE represents a basic paradigm shift as the ownership and management of the exchange have been fully separated from the trading rights. NSE is owned by a set of premier financial institutions/banks and is managed by professionals who do not trade directly or indirectly on the exchange. NSE is the only stock exchange in the country which decided not to seek exemption from corporate tax, which all other stock exchanges in the country routinely enjoy. NSE has been paying sizeable corporate taxes every year, right from the first year of its operation.NSE believes in the philosophy of a fully competitive system insofar as its trading membership is concerned. There are no entry or exit barriers in regard to NSE membership. Since NSE does not limit arbitrarily as to how many members it will admit in any of its trading segments, any eligible corporate or non-corporate entity can aspire to become a trading member by paying the required security deposits and meeting other normal membership requirements. Similarly, its members are also to free to exit later if they find that they have other more profitable business opportunities; such exiting members can seek a refund of all the Membership deposits kept with NSE once they meet the dues of the exchange and their clients.Before we crystallised our architectural design for the proposed stock exchange we felt that we should have some idea as to how some of the best stock exchanges in the world functioned. We undertook a study tour of stock exchanges of Asia (Australia, Bangkok and Hong Kong), Europe (London, Paris), America (NYSE and NASDAQ, Vancouver). These visits convinced us that we should not copy the model of any particular stock exchange, Instead we felt that we should adopt an eclectic approach which implied incorporating in the conceptual design of NSE the best features that we found in different exchanges of the world. NSE thus incorporates today the features of(a) the big board of NYSE dealing mainly in very large stocks that are widely known across length and breadth of a vast country like ours,(b) a nationwide presence of trading terminals on the pattern of NASDAQ(c) a computerised order-driven trading system of the type found on the Paris bourse or in Vancougver, which is free from the manipulative behaviour of the market makers or specialists, and(d) a settlement guarantee system akin to the Chicago's future exchanges.We also needed a communication technology that would help us connect the trading terminals of our members to the exchange computers. In this area we borrowed the idea of the nationwide departmental stores of the US, many of which rely on their captive satellite communication network for executing instantaneous settlements. There was also another strong reason for choosing satellite-based communication technology (SBCT) in our context. When NSE was being set up, the terrestrial communication system provided by BSNL would not have provided a fault tolerant, time critical, and high bandwidth communication link between NSE, and its members. Even within Mumbai, broadband telecommunication links were not highly reliable, besides-the fact that they were relatively more expensive. For example, in Mumbai an end-to-end 64 kbps leased line from MTNL, used to cost NSE members almost `2 lakh per annum whereas NSE's highly reliable satellite link cost around half that amount. Secondly, quick availability of leased lines was also a problem in those days as there was no competition to the BSNL or MTNL. In retrospect, NSE's decision to go in for its own captive VSAT network proved to be a very wise decision. Such a highly reliable telecom link that enabled NSE to establish links with its rapidly expanding member community with a minimum time lag put NSE way ahead of all its competitors. This was perhaps one of the most important reasons which helped NSE's trading volumes grow almost exponentially. Secondly, given the state of the terrestrial telecom infrastructure of BSNL, and MTNL when NSE started its operations in 1994 it would have been practically impossible to establish NSE's nationwide trading network, connecting such far off places like Srinagar, Jorhat (Assam), Nagercoil (Tamil Nadu), Nainital (Uttaranchal) and Salasar (Rajasthan).Opposition to NSEThe proposal to set up NSE was met with tremendous hostility. The broker community was up in arms against any such idea for the simple reason that it was against their interests. They sincerely believed in the concept of mutuality of a stock exchange and firmly believed that only brokers should own and manage a stock exchange. They could sell such an idea to the lay people as the global history of the stock exchanges supported their contention. All over the world, almost all the stock exchanges are broker-owned and managed. Even in India history not only was in their favour but the spirit of SCRA was also in sympathy of their contention. The SCRA defines the stock exchange as follows: -Stock exchange means any body of individuals, whether incorporated or not, constituted for the purpose of assisting, regulating or controlling the business of buying, selling or dealing in securities".The second objection was that NSE, was given a mandate to spread to all the parts of the country, whereas the then existing stock exchanges were permitted to operate within a strictly defined narrow geographical territory. The area in which a stock exchange could operate, was most of the time coterminus with city limits where the particular exchange was set up. For example, the area of operation of BSE was confined to the municipal 'inn of Mumbai and that of DSE to Delhi. The design accepted by the authorities at that time was to divide the country into geographically non-competitive securities markets; in other words the then accepted policy frame was to create geographical monopolies for respective stock exchanges and to protect them from competition with other stock exchanges. With the arrival of NSE, with a mandate to operate in all parts of the country, the monopoly status of all the stock exchanges came to an end abruptly. The smaller stock exchanges were particularly worried that they would have to compete with the proposed exchange which was backed by powerful financial institutions of the country.They also took great objection to the proposition that NSE..., It would enter in a big way into the equity segment by setting up computerised trading facilities in equities all over the country. Most of those who were opposed to NSE were under the wrong et impression that we were implementing NSE as was conceived in the Pherwani Committee report. However, our design of NSE was radically different. All that we borrowed from the Pherwani Committee report was the attractive name of the NSE for the proposed stock exchange. The broker community therefore accused e us that we were going beyond our charter, which, according to them, was merely setting up of an exchange for trading in debt instruments.Misplaced FearsIt was then very widely believed that computerised trading would not succeed especially in a country like India where computer literacy was quite poor, especially among the stock market fraternity. When the NSE was being set up, most of the people that took up broking activity were not only not very well educated, most of them had not even touched a computer key board. In view of this, it would be very difficult to attract truly business savvy brokers into NSE's fold as they would detest computerised trading systems. It was widely believed that computerised trading requires highly complex computer skills and those who have such skills are unlikely to be good brokers. In a way, we were also worried about the difficulties of enticing the broker community into the fold of the NSE. Hence we planned to provide training in computerised trading to our members before we actually commenced our formal trading on the NSE. We set up trading floors in NSE's office premises by setting up a local area network (LAN) where members could be actually trained to do computer trading. We estimated that it would require at least three full days' training for each dealer. Our LAN could accommodate almost 100 dealers at any point of time. After the training started we were in for a major surprise. Most of the dealers at these training courses took just about two hours to learn all the tricks of the trade and they became quite proficient in computerised trading system. The main reason for dealers learning the skills fast was due to the high quality trading software that we had procured from a foreign software company and the subsequent improvements/modifications/ customisation done by Tata Consultancy Services (TCS), our main software vendor at NSE. The trading software had kept all the complexities at the host computers at NSE and the dealer terminal or front-end was kept as simple and user friendly as possible.NSE as Market ReformerConcept of a Demutualised ExchangeThe NSE brand of demutuality is perhaps unique in the world as it aims at a total separation of exchange ownership and management from the trading rights of members. In other parts of the world, demutualisation has meant converting the mutualised exchange into a corporate entity, with trading members having both ownership rights as also representation on the board of the company. Australia was the first country where a mutualised exchange got transformed into a demutualised corporate body in the latter half of the 1990s. In the Australian demutualisation case, brokers still have a strong voice in management as their shareholding in the exchange company continues to be sizeable. True demutualisation is one in which ownership and management of an exchange are totally separate from members' trading rights in the exchange. In a broker dominated exchange, all the office-bearers such as the president, vice-president/s, treasurer, and other board members are all elected by the general body of members who are trading members. It is also obvious that once you resort to election as a method for choosing office-bearers of the exchange, group politics is bound to emerge. As office-bearers of an exchange continue to remain active in their own day-to-day brokerage business, there is always a temptation to misuse their official position to have access to information about other members' market position in different stocks. It is not possible to prevent all such malpractices, unless all the office-bearers in control of the affairs of an exchange are not its trading members.This argument is sometimes countered by pointing out that a number of chief/senior executives of brokerage firms also sit on the board of NYSE. It is further argued that if that is considered to be reasonable in the case of NYSE — a premier stock exchange of the world — what is wrong in having brokers on boards of the Indian stock exchanges? The major point that should be noted in this context is that the senior member representatives on the board of NYSE are not only very far removed from the normal trading desks of their firms but that they scrupulously avoid having any contact even remotely with all those departments which are involved in the actual exchange activity. In spite of the self discipline observed by NYSE board members, there has been frequent criticism about the influence of powerful trading members on the management quality of functioning of NYSE. Recently, there has been intense criticism about the detrimental influence of the floor specialists on the price discovery process of NYSE and the role of powerful NYSE members firms in this.As of now there is hardly any disagreement in our country of the necessity of having demutualised stock exchanges. After the stock exchange crisis in 2001, the government announced that demutualisation will be made mandatory. However, the actual move in that direction has got considerably delayed. The main difficulty that arose in this area is about the beneficial ownership of the property that belonged to the exchanges after they got demutualised. Many people including me have argued that most oldie property that the exchanges had accumulated has been due to the favours by the government to the exchanges. They were exempt from all types taxes besides the fact that the land on which the buildings of most of the stock exchanges were constructed was given at almost throwaway prices to the exchanges. Since the exchange was considered to be a public utility it enjoyed so many other benefits including listing fees that are to be paid by the listed Companies. Recently, SEBI has come out with a broad demutualisation scheme for the exchanges where brokers will have 49 per cent of the share capital of the new exchange company and broker representation on the governing board will be to the extent of 25per cent of the total. It should be noted in this context that this scheme of demutualisation is materially different from that of NSE. Hence one is not fully sure as to what this will mean in reality for the quality of governance and resolution of the issues relating to conflicts of interests as noted above with broker members sitting on the boards of the stock exchanges. There is also one more puzzle that needs to be noted in this context. Before turn to NSE's attempt to, set up a nationwide exchange let me draw your attention to the tremendous pressure that was brought to bear on NSE from highly powerful quarters to have broker members on its board. Very ingenious arguments were being put forth in justification of having brokers on the board of NSE. It was said that just as we cannot have bar councils without lawyers on the bar or medical councils without doctors as its members how can we have stock exchanges without stock brokers on their boards? The major point that was missed all along was that bar councils or medical councils are like clubs of their own members and they are not on par with stock exchanges, which are granted recognition by the regulator so that they scrupulously follow a code discipline, protect integrity of the market and fully protect investors' interests. Common citizens do not deal with the bar councils or the medical councils in the same fashion that investors deal with the stock exchanges. Hence, it is meaningless to compare bar councils or medical councils with stock exchanges. Although NSE's trading members were fully aware that NSE's trading membership does not grant them any rights to its board membership, they also started an agitation to have board representation. However, NSE's board stood firm on this issue and refused to yield to pressures of the vested interest groups.Concept of Nationwide ExchangeWhen NSE, got its recognition as a stock exchange these powers were being exercised by the ministry of finance, government of India. When NSE was given a clear mandate that permitted it to extend its operations to all the parts oldie country it was not clear to the stock exchange community as to how we would be able implement such a difficult project. Hence most of them felt that this nationwide trading mandate would remain merely on paper, It is possible that most of the regional stock exchanges were not worried in th9 beginning that NSE would ever compete with them for business. With the resounding success of NSE's order driven anonymous computerised trading system, which rode a highly reliable satellite communication system, all the stock exchanges got very much worried about its competitive threat. BSE also got much more worried as we started eating in a big into its order flow that used to originate from the rest of the country. As NSE's trading volumes started spurting, all the stock exchanges started putting pressure on the regulator not to permit the spread of NSE to centres where the regional stock exchanges were located. We from the NSE took a stand that since NSE had been given a mandate to spread its trading network to provide real time and equal access to investors spread across the length and breadth of the country we cannot stop our drive of going to newer and newer places where investors existed.This became a highly contentious policy issue; hence it had to be finally referred to the government as the original mandate to NSE for nationwide trading was given by the government itself. The government was requested to review the policy in regard to NSE so that it is also obliged to seek appropriate approvals for all its future plans to expand its network to new geographical locations. The logic was that since other exchanges had to obtain approval before spreading their trading terminals to locations outside their licensed areas, NSE should also be subjected to the same rule. However, we from the NSE were vocal that the ban put on other exchanges from spreading to locations outside their pre-approved areas of operations should be removed so that all the recognised exchanges freely spread their operations to places of their choice. Since NSE was conceived from the beginning as a model exchange to significantly upgrade capital markets of the country and put competitive pressure on the existing exchanges to reform themselves, it was not necessary to set up different NSE type model exchanges in all places where the stock exchanges already existed. The technology adapted by NSE facilitates spreading its trading network to all the parts or the country therefore it is a cost-effective option to provide exchange infrastructure rather than duplicating the NSE model in cities and towns. The NSE model discards the archaic then prevailing capital market concept which identified a market with a particular geographical location. Prior to NSE, the capital market of the country was divided into isolated markets which were identified with the cities of their location, viz, BSE in Mumbai, DSE in Delhi, etc. When the policy about NSE's expansion was being reviewed, NSE had put on hold its expansion plans. However, it did not take much time for the government to reaffirm its earlier decision that NSE should be allowed to spread its trading network, without any hindrance, to all the parts of the country.Settlement GuaranteeThe concept of a settlement guarantee, which NSE currently operates, was almost unknown in India until 1995. Interestingly, the SCRA also does not talk much about settlement of trades done on the exchanges, except mentioning that the exchanges can set up their own clearing houses. We realised this was one area where a major reform was overdue. Our review of global practices indicated that even some of the major stock exchanges like NYSE, NASDAQ and LSE, did not have their own clearing and settlement infrastructure/entities. Even today, brokers of these exchanges trade on their respective exchanges but take their trades to an independent clearing corporation for the settlement. For example, NYSE brokers report all their trades to a clearing corporation which also clears and settles trades on other exchanges. But we realised this model was not suitable for the Indian conditions as there are even today no such independent clearing corporations that could take the responsibility of settlement by offering iron-clad settlement guarantee. NSE, therefore decided to set up a wholly owned subsidiary called the National Securities Clearing Corporation (NSCCL) for this purpose. The major advantage of NSE owning the NSCCL is that there is seamless integration of the two most important functions of trading and settlement with hill guarantee. Investors' interests can be thus be fully protected.Some argue that NSE itself could settle all the trades with a settlement guarantee by having an in-house clearing and settlement arrangement called a clearing house. But this is not a highly satisfactory solution for some important reasons. The major reason for setting up a separate legal entity for handling clearing and settlement is that an activity is a commercially risky proposition which the stock exchange itself should not undertake as an in-house activity. A clearing corporation may face the prospects of bankruptcy in extremely volatile market conditions, it the margin money and other funds on the basis of which settlement guarantee is extended to the clearing members is not adequate to cover the risks that may emanate when some of the clearing members become bankrupt and the guarantee fund is not enough to complete the settlement. From an overall point of view, an exchange is considered to be a public entity which should not ever face the prospects of bankruptcy. Hence there is justification to segregate the clearing and settlement activity by entrusting it to another corporate entity and not make it part of exchange activity.Given the speculative instincts that dominate market players in India, NSCCL introduced some of the most stringent regulations for its members. The mechanism of upfront or initial margins was introduced by NSCCL right from day one in a different garb. Each member was given trading exposure limits (net in each stock and gross across all the securities), based on the deposits that the member placed with NSE plus NSCCL. To begin with, the net exposure ratio was fixed at 10, meaning thereby that no member can have, at any point of time, an aggregate exposure of inure that, 10 times his deposits. If a member deposits say `2 crore he can trade within an exposure limit of `20 crore. To track member positions, NSCCL developed unique software which tracks each member's aggregate trading exposure on a real time basis. The software has the capability of not only informing the member of his exposure position on a real time basis, but can also disconnect all his trading terminals the moment he crosses the limit granted to him on the basis of the deposits made with NSE/NSCCL. The NSCCL has been making variations in the exposure ratio depending on the market conditions. Later NSE calculated security-wise margins, based on the volatility which different stocks are subject to. As of now, it would be no exaggeration to state that India has one of the most sophisticated systems that implements a scientific margining mechanism. It is also one of the few countries that has built strong capabilities to deny trading connectivity to members who exceed their exposure limits on a real time basis.When NSCCL introduced the concept of a settlement guarantee fund for smoothly managing the settlements, there was a lot of misunderstanding about the concept of settlement guarantee itself. In real life situations it is very rare that in each settlement all the pay-ins are made fully by the members. Temporary shortages of either funds :tor securities invariably happen for various genuine reasons, given the fact that members/investors trade on NSE from nearly 400 places across the country. For example, a member may find that his client has not been able to remit funds in time for the member to complete the pay-in before the predetermined time. In some cases, investors may not be able to give delivery of shares to the members in time if the members maintain their depository account with some other depository participant. It is also possible that the client of a broker or the broker himself has traded excessively and is not in a position to honour his obligations to the clearing corporation. In this context, it should be noted that just because all the pay-ins have not come forth the settlement should be aborted. In all such cases of shortages, the NSCCL which acts as the central counter-party for the whole settlement process steps in and completes the settlement. If there is a shortage of funds the settlement guarantee fund is used to complete settlement. If there are security shortages NSCCL procures the shares by buying them through an audio, or borrowing the securities as recently permitted by SEBI. Late the NSCCL recovers the dues from the members who are short in deliveries and also levies fines for not having made the required pay-in on time. It is only when the concerned member fails to pay up his dues to the NSCCL within the time frame stipulated by it that the procedure for declaring him a defaulter kicks in.In the beginning, when this system was introduced there was a great deal of misunderstanding about it. Some even unfairly and maliciously accused NSCCL as encouraging speculation by funding settlement shortages. They ignored the fact that before BSE put up its own form of a settlement guarantee arrangement, it had to shut down the exchange during the mid-1990s for three consecutive days to resolve the problems caused by settlement default by a member of a relatively small amount. A settlement guarantee fund helps to fund settlement shortages as a bridging mechanism so that the settlement goes though smoothly and there are no cascading defaults. During its existence so far, NSCCL has been able to manage all the settlements on time with the help of the settlement guarantee fund even when there were large pay-in shortfalls. In most of these cases, NSCCL has been able to recover later the pay-in shortfalls from the members. In all those cases where members failed to meet their obligations to the NSCCL, even after they were given reasonable time to make good their shortfalls, such members were declared as defaulters and the shortfalls were met out of the incomes NSCCL earns by way of interest on the settlement guarantee fund as also the small fees it collects from the members as settlement charges. By now the concept of the settlement guarantee fund and guaranteed settlements have become accepted folklore in our capital markets. But it should not be forgotten that when we introduced them for the first time in the country, we had to face a lot of malicious criticism from the market players and hostility from unexpected quarters. Some market players even went to the extent of spreading false-hood that IDBI was continually funding NSE's settlement short-ages as also losses incurred by NSCCL, just because IDBI was the main promoter of NSE.NSE: Third Largest ExchangeIn terms of the number of number of transactions, NSE is today the third largest exchange in the world, next only to NASDAQ and NYSE. How did NSE come to occupy this position within a decade. It has also been able to establish another major land-mark. It is the first stock exchange in the world to cross the turnover of an already well entrenched stock exchange in its own country, viz, BSE, in a very short period of one year. It is worth noting in this context that the initial run for the NSE was not at all that smooth. During the first few months of its existence, its trading turnover was quite modest, often less than `10 crore a day. It appears that the investors as also our members were testing our systems and our management capabilities. When they saw that all the settlements were being completed absolutely on time without any hitches they started developing confidence in us. As our rules and regulations were absolutely transparent and once investors started seeing prices and quantities in different stocks on a real time basis at all places where our terminals were located, they came to recognise a major difference between NSE and all other exchanges. As NSE volumes started growing, the Prices reflected on its screen became a benchmark for all other exchanges including BSE. It did not require much time for NSE to establish its leadership in the market. Another interesting thing that is worth noting is the composition of its investor class when it emerged as the largest stock exchange of the country. At that time more than 90 per cent of the value of trading was accounted for by non-institutional or retail investors. Strangely, even most of the promoters of NSE, were not trading on NSE. That is why I consider that institutional investors are less market savvy and laggards as compared to retail investors. Although the institutional investors' holdings have grown quite rapidly during the last decade the retail investors continue to be the backbone of our equity markets. Given the fact that NSE enjoys the maximum trust of the retail investor community, it will continue to grow both in terms of trading volumes as also in terms of market share.Depository with DematerialisationAs NSE spread across the country, it faced serious problems. related to the paper-based settlement system. The first set of problems related to transport of share certificates to the central clearing location in Mumbai. Since NSE decided to shorten the settlement period it introduced weekly settlement system as against BSE's fortnightly settlement. Shortening of the settlement period along with the responsibility of clearing settlement of the net obligations during the next week put an excessive burden on NSE. The pay-ins of securities from all over the country at Mumbai and the re-dispatch of pay-outs thereafter at all the relevant locations in a week's time created lot of difficulties for its members. NSE therefore decided to offer a helping hand to its members. It made arrangements to receive all the pay-ins at four major metros, viz, Mumbai, Delhi, Kolkata, and Chennai and also make pay-outs from these four metros. At its own expense NSE used to ship by air all the securities pay-ins from the other metros to the central location in Mumbai and reship by air the pay-outs to the other metros. On many occasions NSE had to airship share certificates weighing more than four tonnes a week each way at its own expense. The paper based system posed other more serious problems. Several anti-social elements tried to take advantage of the system by introducing fake and fraudulent securities and transfer forms that accompanied them. To deal with problem fake certificates, NSE, with the assistance of registrars and transfer agents of the companies, launched a system of scrutiny of the documents before they are accepted as pay-ins. Despite all this, NSCCI., as also several members, suffered loss due to the massive nature of the problem.NSE therefore took up in earnest, the task of setting up a depository where ownership records would be maintained in a dematerialised form. The speed with which this task was also implemented could be noted from the fact that the depository went live in November 1996, just two years after NSE went live in November 1994. It was a great encouragement and relief for us when C.B Bhave agreed to take up the responsibility as the first MD and CEO of the depository in the early part of 1996 He has done a wonderful job at the depository and taken great heights. NSDL therefore continues to be the preferred depository of the investor community. In this context, it is worth the remembering that despite the obvious advantages of a depository there were some people who were not in favour. These were the people who could benefit from badla trading environment. The true motives of some of these people got exposed during the 1998 stock market debacle when it was found that the physical share certificates were being misused in badla trading. If depository movement has become a resounding success in India in such a short period of time it is a tribute to both the -government and the SEBI for consciously pushing the capital market players in that direction. The Indian depository is unique in the world in one respect. It is perhaps, the only depository to have full data on investor holdings, which gets updated continually. The investors are therefore better protected from problems that may arise due to intentional or unintentional activities of the depository participants which are in the investors' interest. The success of a dematerialised depository has also helped to usher in an era of rolling settlement. In a period of less than four years the Indian capital markets could make a transition from a weekly account period settlement first to a T+5 settlement, then to T+3 settlement and finally to a T+2 settlement. It would have been simply impossible to think of rolling settlement if depository movement had not caught on in such a short period of time. India is one of the few countries where depository movement has become such a market-wide success.Futures and OptionsDespite the advice to the contrary even from many of our well-wishers we decided not to introduce badla trading system on the NSE. Some had favoured NSE introducing badla trading as they felt that we would be able to manage it more efficiently and in a transparent fashion. The main reason why we did not favour badla trading is that it is a hybrid product which muddies up the price discovery process as badla is a mix of the cash and the futures market. Badla grew rapidly in the Indian market after forward trading was banned in the 1960s because of the excessive speculation that it was leading to. Badla provided an escape route to the active market players; it gained in popularity with speculators as also many financiers who wanted to deploy their funds in a profitable way. The badla trading system also became a conduit for deployment of unaccounted money for traders in many areas. Right from day one of NSE, we were keen that India should graduate into the globally accepted most efficient form of futures trading, viz, futures and options. Hence our efforts were, at that time, concentrated on getting SEBI approval for futures and options. Being a totally new product it did take us quite some time to get the futures trading duly approved. A major part of the difficulty that we faced was on account of the powerful badla lobby which strongly opposed introduction of futures in the Indian markets. The main worry of the badla lobby was that, once futures were introduced in India badla would lose its attraction.After a great deal of efforts, futures were allowed to be introduced. However, BSE managed to score over NSE by launching futures one day prior to that of NSE. But that has not helped BSE in any way as could be noted from the fact that futures have not taken off at BSE. As of today more than 99 per cent of the futures trading in the country happens to be on the NSE. One need not put in great efforts to find out as to why BSE has lost to NSE in the futures game. The reason for this is simple. When NSE was concentrating its efforts on building its in-house expertise, developing the trading and settlement software, and the spread of the message of futures countrywide through large number of investor seminars, BSE was emotionally pleading the case of badla even in foreign countries. As a result, it lost a great deal in terms of getting seriously prepared for the introduction of a relatively more complex options and futures trading. Once having lost the lead in this area it has become more difficult for BSE to attract investors to its futures segment. During 2000-01 the market witnessed exceedingly high speculative activity on the exchanges, aided by badla with diluted standards and http://int.er-exchange position shifting. This led to a market crash forcing the government to ban badla and announce introduction of rolling settlements. My worst fears about the highly risky nature of badla trading were proved to be correct and our decision not to introduce it at any cost also proved to be the right one.Risks of Individual Stock FuturesThe original plan of bringing futures to the country in place of badla was to introduce index futures, index options and stock options. The SEBI committee that went into the whole issue of equity based futures was not in favour of futures in individual stocks which are, however, currently being traded on the NSE. In fact, all over the world the widely accepted futures products are the index futures, index options and stock options. In most of the countries, wherever equity futures are traded the individual stock futures either do not find any place or even if they are grudgingly allowed, not much trade takes place in them. Most of the market players either do not find individual stock futures to be useful products or they consider them... and very rightly so... as highly risky products.The basic purpose which the equity futures are supposed to serve is to provide a mechanism for investors to hedge their risks arising from unanticipated broad market movements. It is universally accepted that index futures serve this objective of protecting investors eminently from risks arising from broad market trends by incurring a small cost in the form of margins paid to the exchanges. Let me briefly explain what this means. The price of a stock at any point of time reflects the influence of two factors. The first set of factors relates essentially to the performance of the company itself. For example, if you have invested your money in a cement company, the price of its shares would depend on the profitability of cement, relative locational advantages/disadvantages of the production facility of the particular company, type of production technology, quality of its management, etc. The other set of factors that influence the share prices of the that cement company would depend on the state of the capital market itself. Even if there is no change in the factors that influence working of the particular cement company, prices of its share will go up or down depending on the bearish or bullish conditions in the market. When an investor invests in a company after making a detailed study he can be reasonably sure about the price he should pay as of today But it is not possible for the investor to predict as to what will happen to its price say alter three months if the overall market conditions change. To protect investors against such risks which are associated with the future market trends, index futures have been devised. If an investor is interested in only specific stocks he might as well buy options contracts in such stocks which the option writers provide. In fact, the stock options are safest for an individual since his upside risk of buying an option is limited to the extent of the margin money paid for buying stock options. In the case of stock futures, the risk can be very high if the market moves in the opposite direction by a large measure.The world over, Stock futures are not favoured in view of the risks they pose to the investors as also to the markets. Futures in individual stocks are considered to be highly risky primarily because they can be manipulated by unscrupulous speculators. A group of large speculators can come together and manipulate the futures prices of an individual stock by acting in a concerted fashion. Since a trader in futures has to shell out only margin amounts and not the full price of the value of the contract, leveraging becomes easy. In other words, the amounts required to manipulate futures prices of an individual stock would not be very large if a group of speculators can act in concert to manipulate its market price. The same cannot be said about index futures. For example, the NSE's main stock index, viz, Nifty has a huge market capitalisation of around `12 lakh crone. It is, therefore, not as easy to manipulate Nifty as individual stocks are included in Nifty. There has been some discussion in the newspapers about the manipulations of Nifty index by some unscrupulous speculators. The mechanism adopted by such manipulators is relatively simple. They pick up a share of a company like HLL which has a large weight in the index but a relatively smaller floating stock. After the introduction of individual stock futures it has become much easier to manipulate shares like HLL as one needs much less margin money to be deposited with the exchange for buying futures in HLL. If there were to be no futures in individual stocks, speculators would need much larger amounts to take delivery of stocks and hold them for manipulating share prices. Thus we have introduced a futures trading systems which makes it much easier for market players not only to manipulate prices of individual stocks but also of the indices on which futures contracts are written.Most of the countries that have introduced equity futures have preferred to introduce index futures, and options in index and individual stocks. Very few countries have taken the risk of introducing individual stock futures. Even in those countries where the individual stock futures have been introduced the relative trading colonies are quite modest. The Italian stock exchange which ranks next only to NSE in terms of value of traded contracts in individual stock futures, accounts for only 25 per cent of NSE's volume. But when it comes to the value of contracts in index futures the volume of the Italian exchange is nearly twice that of NSE. This is indicative of the fact that individual stock futures are not considered as safe as index futures even in the countries in which such futures products are traded. All the major futures exchanges of the world in the US or Europe consider that individual stock futures are not only highly unsafe but also that they do not serve any justifiable purpose. Despite the obvious risks that individual stock futures pose to the safety and integrity of the capital market of the country, they have been introduced in a hurry in our country.In my opinion it was not a wise thing for us to have introduced individual stock futures. I am fully conscious that I am in a hopeless minority to hold such a view. All those who had mourned the death of badla are very happy that a similar product is now available for them to play their games. Some prominent brokers also hold the opinion that the void created by the ban of badla has been filled up through an equally risky product like individual stock futures. I sincerely believe individual stock futures pose an avoidable risk to our capital markets because of the unbridled growth in their trading volume. Of the daily total trading volume of all the futures products, the individual stock futures alone account for over 60 per cent. Further, the daily trading volume of the individual stock futures is on an average more than twice the trading volume of the cash market.Shortening of Settlement PeriodMost of us remember that before setting up NSE, the settlement system followed by BSE — the exchange which accounted for nearly two-thirds of the trading volume of all the exchanges of the country until 1994 — was an account period cycle of trading for a fortnight and settling the net obligations after a period of 15 days. Thus, if somebody traded on the first day of the trading cycle he could get his funds or securities almost after a month. Often this period used to get extended to almost six to eight weeks if there was hectic activity in the market forcing the exchange authorities to club several trading cycles. After NSE started operating it reduced the cycle to one week of trading and settling the net obligations a week thereafter. But for more than four years we are all in a rolling settlement era. To begin with a T+5 cycle was introduced, meaning thereby that each day's trades are settled five days thereafter. Introduction of the rolling settlement meant India entering into the global league of more efficient markets. This prompted the authorities to push this reform to shorten the settlement cycle further to a T+3 settlement mode. Later, with a view to score over even the developed countries in shortening the settlement cycle it was reduced further to T+2 mode. In this context it should be noted that the major developed country markets in Europe and America have been toying For the last several years with the idea of shortening their settlement cycle from the current T+3 mode to T+2. But they have refrained from the temptation of reducing the cycle to less than T+3 mode for the simple reason that the disadvantages arising from shortening the settlement cycle far outweigh the gains. All that the shortening of the settlement cycle means funds or securities are obtained a day earlier. But the hassles of managing such a short settlement cycle are far too many, besides there is the risk of several players not being in a position to complete their pay-in of securities and settle funds in time to complete T+2 settlement.In India we face many problems due to differing levels of computerisation and risk management practices of several market players. It is simply not a question of availability or otherwise of RTGS at all places. Most of our banks do not have efficient electronic funds transfer (EFT) facilities which enable banks to move funds from one branch where a customer is located to the other branch which interacts with the exchange clearing corporation. Secondly, even though currently there is a depository mode of delivery, many investors find it too inconvenient to make their delivery in time for the settlement. Hence many investors either give the power of attorney (POA) to their broker or sign delivery slips well in advance and keep them with their brokers. . . Most of you might have read in the newspapers the horror stories that are coming to light where the brokers have cheated their investors. I do not want to dilate on this point too much as all of you are already aware of the risks that the investors are facing as a result or a shortening or the settlement cycle to T+2. One therefore often gets tempted to ask as what the investors have gained from shortening the settlement cycle except providing an opportunity to some people to claim that India is ahead of even the developed countries in terms of shorter settlement cycles.Problems of Participatory NotesWith our stock markets passing through an unprecedented boom, the problems posed by the so-called participatory notes (Ms) are being discussed in several responsible quarters. Some of the FIIs which are registered with SEBI and permitted to invest in our equity markets mobilise funds through PNs which are supposed to be subscribed by other eligible investors. When Flls invest funds mobilised through PNs for investing in the Indian equity markets, they have to give a written undertaking that they have not mobilised funds from non-eligible entities. Frankly, the current regulations governing the PNs are not satisfactory enough to ensure that absolutely the right type of funds are getting into our markets. Many people feel that the colour of money cannot be correctly known when it is flowing through the PNs. The worry about the PNs is that the current boom is largely fuelled by the FII money, bulk of which is flowing through the PNs. The vulnerability of the market to manipulations increases when it is difficult to know the source of money that fuels heavy trading activity in the market. Since a large amount of money has flowed into our equity markets through the PNs it is difficult to take any corrective action that may trigger a sudden outflow of money that has entered the market through the PNs. It is a big dilemma facing the policy-makers.Short Selling and Securities LendingCurrently, SEBI is seriously examining the desirability of allowing short selling by the institutions which cannot execute other than delivery-based trades. The idea is to provide a level playing field to the institutions so that they can also freely trade in the market as other market players. This policy is also expected to be accompanied by two other measures. When institutions are a allowed to sell short they will also be subjected to the same margining system as others who are permitted to do short selling. Secondly, to facilitate short selling, a scheme for lending and borrowing of securities would be introduced. Anybody who sells short can complete the settlement by borrowing the relevant securities from the willing lenders and delivering them at the pay-in time to the clearing corporation. The borrower of securities can then buy them from the market at an appropriate time to return the borrowed securities to the lender. The argument in favour of short selling is that it allows market players to take a view on security prices. lf a market player feels that the current price of a security is too high he can sell the borrowed securities and cover his position at a later day when the prices are expected to fall.In theory, the facility of short selling looks attractive since it may provide opportunities for intelligent players to introduce corrective market forces. But often the reality could be different as experienced by Hong Kong a couple of years ago. Several large players took advantage of the short selling facility together with the lending and borrowing facility to beat down prices. Large speculators can indulge in heavy short selling to push down prices steeply and cover their position at a later date at much lower prices. Such players can reap huge profits at the cost of other investors and market stability. One is really not sure whether it is desirable to introduce all such facilities which have the potential for destabilising the markets without any compensatory benefits.Is the Boom Going to Last?Most of those who have a large exposure to the equity markets are very anxious to know whether the current boom will last and how far the market will rise. Frankly, it is very difficult for anybody to make any reliable forecast on a subject like this. II anyone knew the right answer he could make a huge amount of money. It is for this reason that both astrologers and the chartists are so much popular these days. My simple suggestion to all those emotionally involved in the stock markets is that, do not believe anyone who is certain that the market is bound to move in a particular direction or that the stock index will be at a particular level by say June 2006 or some such date. If some "market experts" give such forecasts they are trying to play with sentiments. If, however, they are a part of one of the powerful manipulator groups they would perhaps be the people to know in which direction the market will move. But one can be certain that such manipulators will never tell the truth because their attempts would be to fool the market so that they can make money. If they want to buy particular stocks they would like to say that this is the best to time sell them so that they can buy them when the market goes down as a result of large sales.Like in most areas of our lives we should try to depend on native intelligence and not be misled by the quacks or scamsters. Investors should make their own careful study before jumping into the fray. The stock market is not meant for people who are governed by emotions and are likely to be carried away by the mad frenzy of bulls and bears. I would, therefore, like to provide some tools with the help of which investors should try to analyse market trends and the likely direction in which the market may move in the near future. The first question that comes to anyone's mind is how to judge as to what is the right or justifiable level of the market and when can it be said to be at an artificially high level or a depressed level? If one has the correct answer to such a question one can judge as to whether the market has the potential to go up or down in the not so distant future.There are two types of approaches to this problems. One set of people vouch by the technical analysis of the market and depend heavily on charts. The charts no doubt help us understand how the market moves. But that does not mean that an investor can make a huge amount of money with the help of charts. This approach is as good as what an astrologer can say. There is another set of people who can be said to be rationalists who believe that fundamentals of a company should be used for assessing whether the market price of a company's share is at a reasonably right level. A company with a high level of earnings and the prospect of future growth always commands the attention of investors who are willing to pay a good price to keep it in their portfolio. Even though a company is not currently earning a high level of profits, its share will also command a premium if there is a fair chance that its future earnings will be at high levels. Certain industries at particular points of time are considered growth industries and the companies belonging to these industries will be considered valuable. Companies belonging to stagnant industries will be valued cheaply even though they are profitable. My personal sympathies are with this group of rationalists who attach the maximum importance to a careful study about the current and future levels of profitability of companies before taking an investment decision. Since investors buy shares from return considerations, they should attach maximum importance to current as well as potential future growth in earnings. Company shares are not pieces art or culture, which are valued on totally different considerations. Hence investors should not be emotionally attached to particular companies and hold on to them even if there is clear evidence that many things are wrong with particular companies that are in the portfolio. All the same I would like to say a word of caution even about this rationalists' approach to investment decisions. It should be noted that fundamentals do not help much in deciding the right price of a share at any point of time. Equity markets are subject to cycles of boom and depression and the same company's shares even with unchanged earning conditions will be priced differently at different points of time. In a booming market even relatively dud shares command high prices. This phenomenon could be better noted from the fact that the levels of P/E ratios of individual shares as also of stock indexes are very high during a boom and are much lower under depressed market conditions. Boom conditions are often the results of irrational exuberance while prolonged depressed market conditions are many a time caused by irrational gloom. Thus fundamental analysis does not help to determine levels of prices of shares at all times and under all market conditions. All that the fundamental analysis tells us is whether relative price levels of different shares are rationally determined. If we accept this line of reasoning, we will have to agree that it is difficult to state if the market has priced itself correctly when the Sensex is around 10,000 or the Nifty around 3,000. Nobody can say correctly whether the market has some more potential left to go up further or whether the Sensex will cross 12,000 by the end of 2006. 1f somebody predicts that market has overpriced itself and the Sensex will fall below 8,000 over the next few months, there is valid justification to disbelieve it.My next proposition is that markets are deeply influenced by sentiments and herd mentality rather than logic. When a large number of players expect that the market is likely to fall, all or most of them will make attempts to exit as hastily as possible. Often, there is an attempt to exit hastily and the situation is similar to that of a stampede which often results in avoidable suffering and loss. Each market player plans to exit as early as possible so that he exits when the prices have not fallen too much. When a large number of market players hasten to exit, prices fall fast and steeply. Another interesting feature of market behaviour is that the responses of market players to certain developments are often disproportionate and excessive. In a relatively depressed market even a minor piece of bad news leads to a large fall in prices. Because of the herd instinct of the market players, price movements often tend to get exaggerated. My suggestion is not to treat market as a rational organism.One more aspect which most of the investors should keep in mind is as follows. Most of the time, markets are influenced, although in varying proportions, by market players who tend to profit from the mistakes of uninitiated and gullible investors. A large number of investors who buy/sell on the basis of half-baked reports/studies tend to be big losers. Every boom sooner or later flattens out and a large number of investors who hold on to their investments with a greed to profit from much higher prices end up as big losers. Most of such investors may not return to the market in the next boom. But like moths in every rainy season, a new generation of moths gets attracted to the markets. Hence the cycles of boom and burst recur. Investors who do not have the stomach to digest losses from market collapses or do not have the expertise to tread carefully to protect themselves from the furies of bulls and bears should not enter the wonderland of equity markets.

American companies are often forced to have a joint venture partner to sell products or services to Chinese people. That’s not really fair. Companies might prefer to have full control and reap the full economic benefits of people in China using their products or services.Chinese companies have a history of expropriating intellectual property. [1]“Just under one-third of CFOs of North America-based companies on the CNBC Global CFO Council say Chinese firms have stolen from them at some point during the past decade. … One in five North American-based corporations on the CNBC Global CFO Council says Chinese companies have stolen their intellectual property within the last year.”[2]The joint venture setup has allowed for intellectual property transfers, as it allows Chinese companies to see in detail how the American company operates.Patent laws can favor local companies who get patents that American companies have gotten all over the world in many other countries. To put it another way, China’s system of justice is arguably biased against Western companies, with respect to patents and copyrights.Sometimes Chinese companies license technologies and then just steal the intellectual property.An example there is American Superconductor, whose shares plummeted after a Chinese companies just decided to stop paying them royalties and allegedly just kept using the intellectual property.China has a history of allegedly trying to hack American companies to obtain their trade secrets as well as gaining military/security secrets about the U.S. To be clear, it’s not just American companies, as a recent article on China hacking “Norway's Visma to steal client secrets.”[3]China allegedly makes an effort to illegally gain access to proprietary technology.An example there was the effort to steal intellectual property from Dow and Monsanto. [4][5]Sometimes it plants spies in American who send stolen IP and technology to China. An effort to steal from Apple is one example.[6]A more recent example comes from the indictment of Huawei and all the technology that it has allegedly stolen. [7]Huawei has a long history of theft, and as the WSJ put it, “An early Huawei router design was shown to have been filched from Cisco, right down to copying the typos in the instruction manual.”[8] Huawei also allegedly tried to bribe Apple Watch suppliers into giving away trade secrets in exchange for large orders.[9]Another recent example comes from an attempt to see intellectual property from a Tennessee chemical company.[10]China allegedly stole Dupont’s “world-leading proprietary multi-stage process for producing titanium dioxide. “[11]There was an effort to steal Motorola’s cellular technology.[12]Huawei stole technology from T-mobile and was found guilty in court.[13]“In 2015, the federal government charged six Chinese citizens with stealing wireless communications technology from two Silicon Valley microchip makers, Avago and Skyworks, and launching their own company to sell that technology in China.”[14]“engineer Allen Ho was sentenced to two years in prison for providing nuclear energy technology information to China’s state-owned China General Nuclear Power Company (CGNPC)”[15]“Chinese spy Xu Jiaqiang stole data storage technology from a US storage technology company.”[16]“five members of the People’s Liberation Army (PLA) of China … hacked … aluminum producer Alcoa, nuclear power plant producer Westinghouse, solar cell manufacturer SolarWorld, Allegheny Technologies Inc., and labor union United Steel Workers. SolarWorld said that a key proprietary technology for making solar cells more efficient was stolen in this hack and turned over to a Chinese competitor.”[17]“ Solid Oak Software of California announced that parts of China’s Green Dam-Youth Escort software, which China required be loaded onto every PC sold in China to control access to pornography and other sites deemed unsuitable by the government was actually stolen directly from Solid Oak source code.”[18]Tesla alleged that one of its engineers stole source code that helped enable self-driving cars and delivered that stolen code directly to a Chinese company.[19]China tried for years to steal technology used by ASML for semiconductor manufacturing.[20]China allegedly tried to steal memory technology from Micron.[21]There may be many other examples where China was successful and just wasn’t caught.Some argue that this theft results in the loss of 100s of billions of dollars per year.[22]An FBI survey of 165 large companies found that half were regularly dealing with Chinese IP espionage efforts.[23]One recent example comes from a Phillips 66 where an Chinese insider there downloaded $1 billion worth of trade secrets with the intent to transfer them to a Chinese company.[24]China has large import tariffs on many products, including cars at 25%.China has soft non-tariff barriers that prevent other goods from being imported. For example, it can claim that there are safety issues or other issues that preclude something from being imported, even if those claims are false.After Canada detained a Huawei executive, China claimed that its Canola products were infested with pests and should not be imported. Canada denied these claims.[25]China works to build up its domestic companies and sometimes dump products or sell at very low prices in an effort to bankrupt foreign competitors outside of China.Their steel companies were found to be guilty of this and retaliatory tariffs were applied in 2016. Even before the retaliation, this approach from the Chinese had caused damage.China’s shipbuilders increased supply much more than the market demanded with negative consequences for shipbuilders.China actively works to boost local companies and undermine foreign competitors in China.One example is boosting Baidu at the expense of Google in China.Another is claiming that the Apple iPhone 6 was created using IP stolen from a Chinese firm, when that firm may have simply gotten patents in China that Apple already had internationally in other countries.China shut down iBooks and iTunes movies.[26]China regulatory concerns prevented Netflix from entering the Chinese market, saying “The regulatory environment for foreign digital content services in China has become challenging."[27]Chinese businesses are directly told or strongly encouraged to buy local — even if it is unfavorable in the short term. This helps local companies get stronger over time The Chinese government directly controls a number of businesses and strongly influences many others.China organized a boycott against Samsung to hurt that competitor after a dispute with Korea. Samsung has never recovered. Other such boycotts have been organized.Other examples include the blocking of Netflix, Facebook, Pinterest, Reddit, Alphabet’s Youtube, and many other American sites and firms. “Political reasons” are cited in these blocks but they are still blocks.China subsidizes many companies across many industries in China, giving Chinese companies an unfair advantage. “Subsidies include free to low-cost loans, subsidies to energy (coal, electricity, natural gas, heavy oil) and to key inputs, land and technology.”[28]China had a history of currency manipulation. For a while many thought its currency was too weak, which boosted exports in the past and hurt foreign competitors. Now many believe that its currency will fall because government policies and economic conditions there will lead to capital flight. Of course if it does fall Chinese exporters would benefit. So first its currency was artificially weakened via a fixed exchange rate that was set by the government, and now it’s being weakened by economic conditions and government policies in China that are leading to capital flight.Some prominent Chinese companies have a history of using bribes to get business deals — and this hurts Western companies who would otherwise get the business. For example, “In the last 12 years, Huawei and its smaller Chinese rival ZTE have been ‘investigated or found guilty of corruption’ in as many as 21 countries, according to Andy Keiser, a former House Intelligence Committee professional staffer.”[29]China also uses import quotas in some industries. For example, China had “limited the annual number of foreign film exports to China to 34 and the share of revenue payable to foreign-rights holders to 25 percent of gross box office.”[30]China has exported unsafe products without caring about the consequences.China has allegedly not cracked down on production of fentanyl, a harmful drug which it exports to the U.S. because it allegedly cares about profits more than the health of Americans. The U.S. does its best to crack down on the production of illegal drugs.[31] Allegedly, China has no domestic fentanyl problem because it does crack down on domestic distribution. The fentanyl epidemic is killing Americans and is extremely costly to combat.China has attempted to illegally export pork amid their swine fever outbreak. If this pork infected U.S. pork, it would be horrible for the U.S.[32]China encourages U.S. citizens to invest in its companies, but because of capital controls Chinese citizens do not have the comparable freedom to invest in U.S. companies. Further there are widespread allegations of Chinese companies trying to defraud U.S. investors. In fact, a movie called The China Hustle was made partly because of this fraud.[33] [34] [35][36] Some allege that new fraudulent techniques are being used as well that are not yet widely understood.[37] Further China does not have the same audit and disclosure requirements that U.S. companies do, which provides investors less protection from fraud.“While the PCAOB regularly inspects audits of U.S.-listed firms, Beijing consistently challenges their efforts. Chinese law requires that financial records remain in China, and Beijing restricts access to accounting information, citing national security and state secrecy.”[38]China allegedly has fewer environmental protections than U.S. producers, which lowers the cost of its goods. For example, they allegedly emit large amounts of CFCs which hurt the ozone layer.[39]China does other things that normally would incur economic sanctions including tariffs.The U.S. has a track record of imposing economic sanctions on countries for human rights violations, and many such violations are alleged in China. For example, China allegedly detains ethnic populations in concentration camps and torture has been reported inside these camps.[40] Slave labor has also been reported in these camps. [41]Allegedly millions of people have been detained in these concentration camps. The camps allegedly are mostly Muslims, but there are allegations that some Christians have been detained as well. There are allegations that some dissidents in concentration camps have had their organs taken from them in a massive organ harvesting operation.[42]China hacked U.S. government servers[43] to spy on U.S. government employees.[44] Peacetime allies should not act this way towards each other.China has detained foreign nationals for indefinite periods of time to protest things it does not like, claiming they have “disappeared”. This is not OK. For example, China has allegedly detained Canadian businessmen to retaliate when a Chinese executive was accused of an actual crime.[45] [46]China is allegedly trying to influence political outcomes in multiple countries, including Australia[47], Canada[48], New Zealand[49] , Taiwan[50] , the Philippines[51] , and other countries. Beyond elections it tries to silence critics in other countries[52][53] [54] and promotes propaganda in social media as well[55].China plans to manipulate Taiwan’s politics to eventually elect leaders who will eventually cede Taiwan’s sovereignty and make Taiwan become part of China.‘“If China succeeds in returning the Beijing-sympathetic Nationalist Party (KMT) to power, that could be the tipping point after which Taiwan can never again exert its own sovereignty.” In other words, a Chinese military invasion is no longer the scenario Taiwanese fear most. China’s strategy to take over Taiwan is focused now on the hybrid warfare tactics authoritarian regimes increasingly deploy in free societies. Pro-Beijing interests have bought up a huge portion of Taiwanese media and coordinate with Beijing to spread propaganda and fake news and manipulate social media.’[56]China has loaned large amounts of money to companies that own ports, knowing that it will be able to take them over in the event of a default and use the ports for military purposes. One of these ports is in Sri Lanka. Another is in the Caribbean. [57] [58]Politicians in these countries are desperate enough for money that they will accept unfavorable terms that pushes financial pain into the future and ultimately makes things worse. There are additional allegations that a combination of bribes and influence operations have enabled China to take control of foreign assets at a reduced cost.[59]China is actively planning for Naval conflict with the U.S. in the South China sea.“China’s deployment of a large fleet of vessels to the Philippines-held Thitu Island in the South China Sea is aimed at blocking the country’s construction of military facilities on the disputed island in the Spratly chain because it is concerned that the United States will be able to use such facilities,”[60]China has threatened to invade Taiwan at some point and has conducted military exercises to support that threat.China is not doing enough to stop North Korea’s nuclear weapons program. North Korea has the potential to become a terrorist regime, and China may effectively act as a terrorist enabler there. Specifically, China enables the regime by allowing goods and services to flow to it[61], instead of shutting off North Korea entirely as the U.S. and much of the rest of the world would prefer.China helps enable Venezuela’s dictator to stay in power, thus hurting the people of that country.[62]China exports technologies that allow authoritarian governments to wall off portions of the internet and subvert freedom of speech by disallowing certain types of content to be posted online. [63]Because the U.S. has started to fight back against China, China has begun to lobby other countries to distance themselves from the U.S."It has encouraged the Philippines to distance itself from the United States, it has supported South Korea's efforts to take a softer line toward North Korea, and it has backed Japan's stance against American protectionism"[64] [65]If China is costing U.S. companies 100s of billions from some of the above efforts, then some sort of retaliatory tariff makes sense to compensate for that. The tariff could address both past actions and ongoing behavior. The tariff should be levied against goods made in China or against goods that contain contain components that were manufactured in China.Other countries have labor costs on par with China, and I’d be much happier for the U.S. to work with countries that compete fairly.To be clear, there is some flexibility with respect to this response. The U.S. may choose to target specific industries instead of all Chinese imports — a variety of responses are possible.When Russia was aggressive in Crimea, it was sanctioned by the international community. Therefore, another option would be to work together with other countries and apply economic sanctions on China. That may seem unrealistic and many other countries may prefer not to do that, but if I were President, I’d at least try to talk to other countries about this.As a result of increasing urban labor costs, China is no longer the low cost provider of labor and consequently many products can be manufactured more cheaply outside of China. The result is that for many products, tariffs simply shift manufacturing from China into other locations with minimal impact to the U.S. consumer. The result is that the U.S. helps build up countries that are good actors while avoiding funding many of China’s problematic activities. If the tariffs are targeted correctly the impact to the U.S. economy can be minimized.China has a history of promising that it will reform and then not following through. Tariffs could be put in place indefinitely and then if it becomes clear that China has made the necessary reforms and the tariffs have provided sufficient compensation for past actions, then they could be lifted.Footnotes[1] The Great Brain Robbery[2] 1 in 5 corporations say China has stolen their IP within the last year: CNBC CFO survey[3] China hacked Norway's Visma to steal client secrets: investigators[4] Chinese National Pleads Guilty to Conspiring to Steal Trade Secrets[5] Top Ten Cases of Chinese IP Theft[6] Second China-Bound Apple Car Worker Charged With Data Theft[7] The U.S. Case Against Huawei[8] Opinion | U.S. Can Destroy Huawei[9] Report claims Huawei tried to copy Apple Watch heart rate sensor by asking Apple supplier to share its secrets[10] Chinese-born U.S. Citizen Charged with Stealing Trade Secrets [11] Top Ten Cases of Chinese IP Theft[12] Top Ten Cases of Chinese IP Theft[13] Top Ten Cases of Chinese IP Theft[14] Top Ten Cases of Chinese IP Theft[15] Top Ten Cases of Chinese IP Theft[16] Top Ten Cases of Chinese IP Theft[17] Top Ten Cases of Chinese IP Theft[18] Top Ten Cases of Chinese IP Theft[19] Tesla sues former employees for allegedly stealing data, Autopilot source code[20] Why Might China Want to Steal These Silicon Secrets?[21] Inside a Heist of American Chip Designs, as China Bids for Tech Power[22] China Is Stealing American Property[23] FBI sees sharp rise in economic espionage cases[24] Insider Walks Trade Secrets Worth $1 Billion Out the Door on His Way to China - ClearanceJobs[25] 'We still haven't found any kind of pest': Canada presses China over contaminated canola claims | CBC News[26] How China doesn't play fair on trade[27] Netflix admits its plan for China has failed[28] Chinese Manufacturing Subsidies, Global Commerce and Trade[29] Huawei Global Business Model Relied on Bribes, Corruption[30] Here’s How the Trade War Is Affecting Hollywood[31] https://www.washingtonpost.com/opinions/2019/03/04/why-is-china-refusing-stop-flow-fentanyl/?utm_term=.820c8b2c380f[32] Feds seize 1 million lbs. of pork smuggled from China to N.J. port amid African swine fever outbreak[33] "The China Hustle" tells the story of a massive fraud you probably haven't heard about - Marketplace[34] When Chinese Stock Fraud Was Rampant[35] http:// https://www.thedailybeast.com/the-dirty-dollar50-billion-scam-wall-street-is-getting-away-with[36] https://www.washingtonpost.com/opinions/global-opinions/its-time-to-end-the-china-hustle-on-us-stock-exchanges/2018/08/30/50137c1a-ac8d-11e8-8a0c-70b618c98d3c_story.html?utm_term=.ed5605d92d11[37] BABA:...an "Earnings Call" without discussing "Earnings"[38] Opinion | You Can’t Trust a Chinese Audit[39] China confirmed as source of rise in CFCs[40] China says Xinjiang has 'boarding schools', not 'concentration camps'[41] Profiting From Persecution: China's Forced Labor Prisons[42] Organ Harvesting Tribunal 2019[43] China Using OPM Records for Spying[44] China Using OPM Records for Spying[45] The detained Canadians: Brace yourselves, China’s 'disappearances' are coming to the west | Hong Kong Free Press HKFP[46] Canada says 13 citizens detained in China since Huawei CFO arrest[47] 4corners on Twitter[48] Terry Glavin: It’s official – China is a threat to Canada’s national security[49] China's communists fund Jacinda Ardern's Labour Party: What the United States Congress was told[50] https://www.washingtonpost.com/opinions/global-opinions/the-united-states-must-help-taiwan-resist-chinese-dominance/2019/03/28/c6c07868-5188-11e9-8d28-f5149e5a2fda_story.html?noredirect=on&utm_term=.ddf6af0c2710[51] https://backroompolitics.net/2018/05/07/a-chinese-funded-philippine-president/[52] Chinese tactics to silence Uighur Muslims abroad revealed[53] Her Reporting Led To The Firing Of Canada’s Ambassador. That’s Made Her A Target For China’s State Media.[54] No longer safe: Researcher harassed by China in her own country[55] Redditors Say They’re Seeing Coordinated Chinese Propaganda On The Site[56] Page on washingtonpost.com[57] China Rising in the Caribbean[58] Has China made any loans that allowed it to take control of foreign ports and infrastructure? If so, what are some examples?[59] Kyle Bass on Twitter[60] China tried to stop Philippines building military facilities ‘to block US’[61] Understanding the China-North Korea Relationship[62] Venezuela's military, despite U.S. expectations, has not turned on Maduro[63] The U.S. Is Losing a Major Front to China in the New Cold War[64] Commentary: It's time for the US and Europe to ask what sort of world China wants to build[65] The Stealth Superpower

In this answer, I will attempt to explain the kind of theoretical and political contexts in which the development strategy of India was framed. Be warned that this will be a rather long answer, and I don't like writing Tl;Dr's.1. Early growth theoryLet's start with the man who started it all - Adam Smith. His book, Wealth of Nations, proposed a theory of wealth creation, public policy, and economic growth. He placed great emphasis on trade, and argued that savings and investments are by-products and precursors of domestic and foreign trade. Savings and investments, along with the size of the market, division of labor, and efficiency of production determine, according to him, the rate of growth of the economy. Let's study this a little more closely, since almost every single later economist conceptualized the economy in Smithian terms.Savings and investments stimulate growth directly through the accumulation of capital, indirectly through increases in labor productivity, and with further indirect effects through interaction with exchange and trade through foreign investment, although domestic markets could take the place of foreign markets if they were large enough (or had the potential to be large enough). Smith strongly argued that increasing the efficiency and quality of labor, capital and land would positively affect economic growth. Thus, he advocated "the erection and maintenance of the public works which facilitate the commerce of any country, such as good roads, bridges, navigable canals, harbours, etc." He also feared the social, political, and economic consequences of inferior education among the masses, and called for public investment in education.Smith was followed by Thomas Malthus and David Ricardo. The former came up with the population trap model, and argued that increased population growth (especially due to the poor) would lead to impoverishment, famines, and wide-spread suffering, and that there was nothing society could do to restrict it (except by starving the poor). The latter worked on the theory of comparative advantage with respect to international trade, and theorized the importance of land and rents.John Stuart Mill, however, criticized the Malthusian prediction that population would outgrow productive capacity. He argued that better education of the masses could, in fact, restrain population growth. He also separated the processes of production and distribution. He argued that the laws of production may be natural laws, but the laws of distribution are created and enacted by human beings. In other words, wealth is the natural end product of labor, but the distribution of wealth is determined by the decisions and the will of actual people (the elite) and is not simply part of the order of nature. Mill carries this view quite far, maintaining that human laws and institutions can and should determine how wealth is distributed. Thus, for Mill, economics is closely tied to social philosophy and politics.Karl Marx, however, while belonging squarely in the Smithian school of thought, came to different conclusions. He argued that production and distribution cannot be segregated, and that those who own the means of production gain the profits. Distribution, is thus, closely allied to production, and wealth will always go to the capitalist owners of the means of production unless the workers revolt and take control of the means. Thus, not just distribution, but production is also determined by laws and institutions of society, and can thus be changed through political action. Marx also argued that the limits to economic growth observed by Malthus are inescapable. However, they were not due to excessive population growth but due to technological unemployment, where workers are constantly thrown out of work due to labor-displacing technology.Alfred Marshall was a great economist with massive contributions to the field. It was he who brought in organization as the fourth factor of production. Marshall made an explicit connection between education and growth. He also argued that the distribution of wealth and income matters for the economic efficiency and growth (but he fails to emphasize this). For Marshall, the most powerful engine of production was knowledge.Joseph Schumpeter was a very interesting thinker whose sole aim was to destroy Marxism, even though he was influenced by Marx. Marxism argued that capitalism is inherently unstable, and that its instability would lead to communism. Schumpeter turns that argument around its head by arguing that this instability occurs because of technological innovation that leads to creative destruction. In other words, this instability is what gives capitalism its dynamism and leads to economic growth. He argues that invention, innovation and entrepreneurship drives technology-led economic growth. This is because a new technology allows the firm to access monopoly profits through rents. Schumpeter believed, rightly, that perfectly competitive markets would not be conducive to economic growth since no rents can be captured under perfect competition. His dynamic, change-oriented, and innovation-based economic ideas were derived from the Historical School of Economics, which we shall see in a while.The final (in this section), and probably one of the most important economists of the 20th century, was John Maynard Keynes. Keynes reiterated the fact that economic growth was an outcome of the accumulation of capital, a view held by almost everyone in this list. He too emphasized the importance of science and technological inventions. But his fundamental contribution was to challenge the neoclassical notion that free markets would automatically lead to full employment and economic growth. Instead, he argued that aggregate demand (in other words, Smith's concept of the size of the market) determined the overall level of economic activity, and that inadequate aggregate demand can lead to prolonged periods of high unemployment. His solution was that the state should intervene using fiscal and monetary policies to increase the level of demand in the economy by increasing the purchasing power of individuals. The success of his policy suggestions led to the adoption of Keynesian policies in almost all capitalist countries during the 1950s and 1960s.2. Early theories of development economicsDevelopment economics started with the rise of mercantilism in the 17th century in Europe. Mercantilists believed that the resources of the nation must be harnessed by the state in order to build a powerful economy that can support a robust state and a mighty army. They emphasized production and an export-led economy in order to accumulate bullion, which they saw as crucial to the economy. Philipp Wilhelm von Hornick was a German civil servant who provided the most comprehensive treatise on mercantilism in 1684. At around the same time, Jean-Baptiste Colbert, the French finance minister from 1661-1683, implemented mercantilist policies that not only developed France into a manufacturing power of its time, but also provided the template for later policy makers.While mercantilism was severely criticized by Smith and others, it still found great favor among a lot of economists and policy makers. By the late 18th and early 19th century, it had morphed into a form of economic nationalism that was later called the historical school of economics. The two countries closely associated with this school were the USA and Germany. Alexander Hamilton of the USA was deeply influenced by the policies of Queen Elizabeth I of England and Colbert in France, and his thoughts were collected in his magnum opus, Report on Manufactures. Other important Americans associated with this school were the politicians Henry Clay and Abraham Lincoln, and the economist Henry Charles Carey. Meanwhile, Friedrich List, a German who had been exiled from his country, came across the American Historical school during his stay in the USA. He was impressed by Hamilton's ideas, and he wrote the book National System of Political Economy, where he differentiated between Smith's theory of values with his own theory of productive power. He argued that nations shouldn't engage in free trade at the cost of their own manufacturing power. Rather, it is the duty of the state to do all that it can to increase its manufacturing power, and switch to free trade only when its 'infant industries' have become strong enough to compete with foreign firms.List's influence was great, and he was considered to be the most important political economist of the 19th century along with Marx. His ideas inspired the development of Germany, which in turn inspired Japan, and consequently the other East Asian economies, including China. Even today, there are development economists, such as Erik Reinert and Ha-Joon Chang, who work within this school of economics.The 1950s saw the rise of two new theories of development. One was the linear-stages-of-growth introduced by W.W. Rostow in 1956. This theory modifies Marx's stages theory of development and focuses on the accelerated accumulation of capital, through the utilization of both domestic and international savings as a means of spurring investment, as the primary means of promoting economic growth and, thus, development. He outlined five stages of development, starting with the traditional society, which is wholly focused on the primary sector with barely any social mobility. As external demand for raw materials increases, the society starts to shift towards a more commercial economy that produces cash crops and invests in canals and ports. Soon, with increasing commercialization, the economy "takes off" and the secondary sector expands, beginning with the textile industry. As the industrialization process matures, the industrial base diversifies, with multiple industries taking root and expanding. There would also be a large-scale investment in social infrastructure like schools, universities, and hospitals. The final stage is that of a mass-consumption society, where the industrial sector dominates the economy, and high-value consumer goods are consumed. While it's based on history, Rostow had a fundamental disagreement with List. The latter argued that a country which relies on exports of raw materials would get "locked in", and would not be able to diversify. Rostow, however, brushes those concerns aside (foolishly, in my opinion) - raw material exports would finance the development of the industrial sector.The second theory of development was the structural-change theory proposed by Arthur Lewis in 1954. Structural-change theory deals with policies focused on changing the economic structures of developing countries from being composed primarily of subsistence agricultural practices to being a "more modern, more urbanized, and more industrially diverse manufacturing and service economy." Lewis' model views agrarian societies as consisting of large amounts of surplus labor which can be utilized to spur the development of an urbanized industrial sector.By the 1960s, however, development economics faced severe internal criticisms. One of the radical perspectives that emerged was the structuralists. Some of the key economists were Raul Prebisch, who focused on import-substitution; Celso Furtado, who studied the agrarian sector; Gunnar Myrdal, who argued that the re-organization of production relations can transform the economy; and Hans Singer, who posited that developing economies always have negative terms of trade, which is why they are not able to grow. Some of their key observations were that technology was the motor of development, developing countries cannot grow on their own, and that foreign demand cannot drive development. They were export-pessimists, and looked inward at domestic production through import-substitution. The Prebisch-Singer hypothesis, which argues that the price of primary commodities declines relative to the price of manufacture goods over the long term, thereby causing the terms of trade of primary-product-based economies to deteriorate, was an excellent theoretical foundation to import-substituting industrialization, and a clear refutation of Rostow’s argument.3. Mathematical Models of Economic Growth and DevelopmentThe basic Keynesian idea that the government should intervene to increase aggregate demand in the economy was taken up in the Harrod-Domar model. The model had two major variables - the savings rate in the economy, and the efficiency (or productivity) of capital. The model shows that if savings can be effectively converted to investment, then increased savings in the economy could lead to increased investment, thereby leading to the augmenting of the capital stock. Increased capital stock leads to increased production and increased employment in the industrial sector, thereby leading to increased growth and development. Another way to grow the economy was to increase the efficiency of capital, thereby amplifying the effects of investment. The Harrod-Domar model was almost revolutionary, since it not only provided a mathematical model to study growth, but also provided policy-makers an entry point in the economy. The state could now increase the savings rate in the economy, and also invest in better technology. This model is also known as the endogenous growth model because growth in the economy depends on economic variables that are, by definition, endogenous to the economy. Thus, any changes in these economic variables could have an effect on growth.There were, however, severe problems with this model. The first is that increasing the savings rate in the economy means a decrease in the consumption levels in the economy. This would not only lead to a fall in aggregate demand in the economy, but would also depress the standards of living. This means that new wealth would have to go mainly to those individuals who have a higher marginal propensity to save (that is, the rich). Income inequality, however, can harm the development process and lead to social and political upheavals. Another problem was that the variable that the model used to measure capital efficiency, the Incremental Capital-Output Ratio, did not have much basis in reality, and was not a very useful marker of technology. A third criticism was that the model assumed that the financial sector was an efficient transformer of savings into investments. That need not be the case, however. A related point was the extent to which the government could increase savings rates. A fourth criticism that was leveled at this model was that it was a macro-economic model, and lacked proper micro-economic foundations. A fifth criticism was that it ignored the role of labor, and only focused on capital.In 1956, Robert Solow created what is known as the Solow-Swan model of economic growth as a response to the perceived failures of the Harrod-Domar model. Solow argued that underdevelopment was due to government intervention and dirigiste (or neo-mercantilist) policies. The path to economic development was to embrace free markets and to get the prices right. Solow made two very significant contributions in his model. First, he provided a solid micro-economic foundation by basing his growth model on a production function that could be given an explicit form (Cobb-Douglas production function, for example). Second, he factored in the role of growth in labor and technology. But Solow also introduced a very clever sleight of hand. He argued that economic growth depends on two major factors - population growth and the technological progress. By definition, these two variables are exogenous to an economy. Thus, according to Solow, economic growth is also an exogenous variable, which means that the government cannot embark on any economic policy in order to accelerate growth - the market alone can do that. Thus, Solow's model is also known as the exogenous growth model. While I'm cutting out a lot of things, it suffices to know that there was a sense of dissatisfaction with this model, since it left the state with no role to play. The state was supposed to just let the market work its magic on its own, and wait for growth to happen. There were several other important criticisms, and this led to the new growth theory, which rejected exogenous growth and went back to the endogenous growth model, where several other complications cropped up. All in all, this is a very exciting field for research.4. Development StrategiesGiven these different schools of thought and different models, what could be some possible development strategies?Let's start with what's known as the two-gap model. It posits that developing economies face two gaps in their economy which they have to fill. The first gap is that between savings and investments in the economy. A developing country starts off with very low savings, but it has to engage in a big push by investing heavily. In what ways would countries fill that gap? Economists were sharply divided on this issue. Some argued that developing countries require aid from developed countries. Others argued that these countries need to trade in order to gain trade surpluses, which could then be used to fill the gap. This leads us to the second gap which is that between exports and imports. A developing country by definition produces only primary goods, whereas it would require large imports of consumer and capital goods. There is obviously a cost differential here, because of which developing countries would necessarily face current-account deficits. How can a country fill that gap between exports and imports?Except for a very few economists, almost everyone agreed that there has to be some role for the state in kickstarting the process of development. Leaving a developing country to the free market would only mean that it would get "locked in" to the agricultural sector, as List argued, and its manufacturing sector would never grow, thereby ruling out a structural transformation in the nature of the economy. Thus, the consensus was that the state had to kickstart the industrialization process. But in what manner? There were multiple views, but they could all be encapsulated into two major strategies: inward-orientation and outward-orientation. Let's look at them in more detail.Inward-oriented economies emphasize domestic markets. They are generally countries with relatively large populations that can create an internal demand for goods. Investments in these economies arise from using domestic savings. Technical progress is based on domestic innovations and the purchase of foreign technology. These economies rely on import-substitution, where domestic production substitutes imports. This is achieved through trade barriers, subsidies, and exchange controls, and the state controls the prices through an administered-price mechanism. These economies have the benefit of adopting a short-cut method to develop - in other words, they aim to crash-industrialize. There is also much greater coordination in the economy, and great synergies are formed between different sectors that then further boost development. But the downsides are that the markets face low competition, and administrative costs start to rise. Inappropriate factor inputs tend to become a problem. However, the most serious concerns are those of the current account deficit and the rise of powerful interest groups.Outward-oriented economies emphasize external markets, for which trade policy is crucial. Growth, which is export-led, would provide the funds to purchase foreign-made capital goods and 'embodied' technology and other needed inputs. This development strategy exploits the comparative advantage that the country may have in some sector, and the gains made in this sector would gradually diffuse to other sectors. These economies have the benefit of a large foreign exchange surplus that can be used for domestic investment. Their exporting firms are also highly competitive in the world market, and there is greater technology transfer. However, there are problems in this strategy as well. These economies face incomplete or lack of information, and also face incomplete markets, especially since production is geared for exports and not for consumption. A third problem is that of diffusion of benefits. It's not necessary that the gains made by the exporting sector would actually spread to other sectors.A common feature in both these strategies is that there is a presence of a very strong state that actively intervenes and "governs the markets". The administrative strength of the state, its penetration into society, greater legitimacy, ability to effectively wield its authority, and the creativity to build good institutions are all important factors that can impact the development process.5. East Asian DynamismEast Asian countries provide one of the best examples of rapid development and economic growth. In fact, the term "developmental state", which refers to a powerful state that is characterized by heavy state intervention in and extensive regulation and planning of the economy, was coined with reference to the Japanese state. There have been many debates that study the 'miracle' that is East Asia, especially with respect to the level of state intervention. But a close study of their development process helps us glean some fascinating insights.The first is that the East Asian economies are the heirs of mercantilism and the Historical school of economics. They did not follow a purely inward-oriented nor a purely outward-oriented policy. Instead, they created a clear order and structure of industrialization characterized by successive stages of specialization of comparative advantage. The process can be described as follows:1. These economies started with primary import-substitution in order to replace labor-intensive manufacturing imports with domestic production.2. They then shifted to a primary "export-substitution", where agricultural exports were replaced by labor-intensive manufacturing exports.3. At the same time, they entered the phase of secondary import-substitution in order to start the production of intermediate and capital goods for the domestic market.4. Finally, they shifted to secondary export-substitution of labor-intensive to capital- and knowledge-intensive exports.The second insight is that the East Asian development process very obviously displays Schumpeterian characteristics, where technological growth takes place in a 'distorted' markets so that monopoly rents could be captured. The state actively distorted the market by "getting prices wrong", in clear opposition to the neoclassical school which emphasizes getting prices right in perfectly competitive markets in equilibrium. The state provided all kinds of incentives, financial and otherwise, in the favored industrial sectors that pushed the firms to reach economies of scale quickly, and once the firms were competitive enough to export in the global market, the subsidies and other incentives were withdrawn.The third, and the most distinctive, insight that can be gained is geographic diffusion of industrialization. This is referred to in the literature as the "flying geese model". Japan, which kickstarted the entire development process in the region, helped buoy up all the other economies nearby through its FDI. As each wave of development took place in Japan, it displaced exports of the prior wave to the neighboring countries, which would then displace the previous wave in the next group of neighboring countries, and so on, compelling restructuring of the economy in all these countries. The broad outline of the restructuring was from a labor-intensive industry to a capital-intensive one, and finally to knowledge-intensive sectors. The fact that all these countries managed to grow through exports meant that there is a dynamic notion of comparative advantage - the state can not just exploit existing comparative advantages, but actually create new ones.A fourth observation that has to be made is that these countries are mostly small, in terms of both territory and population. They are also composed of mostly homogeneous populations, thereby reducing the potential for conflicts. Most of these states were also heavily authoritarian, or in some cases, quasi-authoritarian, which allowed for quicker decision-making and greater flexibility in pursuing different strategies.6. What could India have done?One of the immediate problems that India faced soon after independence was the Partition. Nobody in the West seemed to think that the country could stay united for more than ten years. Besides, the rather large territory and massive population meant that the state would have relatively greater difficulty in having its authority established (this is still true of the North-East and the Red Corridor). The penetration of the state into society wasn't quite as deep as what was found in Japan and South Korea. The interface between the state and the population was still mediated by many local leaders who wielded enormous influence at that level. On top of that, the country was established as a democratic republic, which meant that all sorts of conflicts between different linguistic, regional, religious, caste, and cultural groups could take place that would shift the focus of the state away from development. Democratic politics also meant that parties could use development as a populist tool and a political weapon. And the icing on the cake was the India's geopolitical situation, where it faced a hostile Pakistan (and China), and had to commit a large amount of resources to defense. It also had to chalk out a very independent foreign policy that would stay clear of the Cold War politics, unlike Japan, South Korea, Taiwan, and Hong Kong, which had to toe the American line. A non-aligned policy meant that India could receive food aid from the USA while receiving technological and industrial support from the USSR.Given all these hurdles, one thing is certain - India could not have become a developmental state. Development had to be slow, and had to give way at times to social, political, and military considerations.But India's development goals, at least at the outset, were based on classic development models. The First Five Year Plan was based on the Harrod-Domar model, where the state aimed to increase the savings rate of the economy and convert it into investment. The goal was to increased the productivity of the agricultural sector so as to free up labor for industrialization. The state built large dams and irrigation projects, addressed health issues such as infant mortality rate, started five IITs, and signed contracts to build five steel plants. The increased investments did actually lead to growth. The Second Five Year Plan was based on the Feldman-Mahalanobis model, which argued that a shift to a domestic consumption goods sector meant that the state should invest in building a capacity in the production of capital goods. A high enough capacity in the capital goods sector in the long-run expands the capacity in the production of consumer goods. These two plans were probably the only reasonably successful ones (in the short run).The overall thrust of the Indian economy was clear - we had adopted an inward-oriented strategy that could work very well because of the potentially large size of our domestic markets. We adopted a mixed economy, where the state would play a large role in determining regulating and planning the production process. Due to lack of domestic technical skills, we opened up institutes of technical excellence, so as to increase domestic innovations. We opened up steel plans, increased coal production, and invested heavily in the capital-goods sector. But at the end of the day, nothing worked out well. The inward-oriented strategy meant that we faced high administrative costs while the firms faced low competition. The infant industries which had to be protected refused to grow up. Interest groups arose which brought in a lot of friction in the implementation of plans. The state could not manage too many things at the same time - defense, healthcare, education, industrial development, road and rail infrastructure, irrigation, social reform, etc. Political parties found it easier to engage in demagoguery along linguistic, regional, casteist, religious, and cultural lines. The IITs produced a lot of top-class engineers, of whom many left India, and domestic innovation floundered. The capital goods industry barely provided much employment, and it required a lot of heavy capital investment which had to purchased through a current account deficit. This was highly unsustainable. By the 1960s, the problems of this approach were highly visible.But then, as the saying goes, hindsight is 20/20. Given the kind of theories propounded at that time, and given the constraints that India as a country faced, our leaders had to take very risky decisions. Definitely, we could have done much better. Personally, I'm biased towards List and the Historical School of Economics. I would say that we could have started with labor-intensive industries, like textiles, that could have pulled more people out of agriculture and pushed them into relatively better paying manufacturing jobs. That would have not only increased the productivity of agriculture, but would have also led to more diffused model of development, rather than the concentrated factories of the capital goods industry. Once the first round of restructuring was completed, we could have shifted into a more capital-intensive industrialization. But this is empty speculation. There are no perfect solutions - they simply do not exist. There are thousands of variables that need to be controlled for, and it is difficult to coordinate easily given the size and social constraints. Also, remember that India was embarking on a massive experiment to weld development and democracy in multicultural, post-colonial society. Comparing ourselves with East Asia is fraught with problems, and given the fact that we are the pioneers in this realm, we must be kind of proud that we've managed to survive this far, despite all our difficulties and setbacks.ConclusionMy rather long answer tried to situate India's development strategy in a historical, theoretical, and political context, and show that searching for a "perfect" strategy is fool's project, and that while we know today that we could have done much, much better, it is still a point of contention as to what alternative strategies could have been chosen. I do hope that I've managed to do what I had hoped. If any clarifications are required, do not hesitate to comment.Further ReadingList, Friedrich - National System of Political EconomyChang, Ha-Joon - Kicking Away the LadderReinert, Erik - How Rich Countries Got Rich And Why Poor Countries Stay PoorAmsden, Alice - Asia’s Next GiantWade, Robert - Governing the MarketJohnson, Chalmers - MITI and the Japanese Miracle