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The reality of political opposition

A politician’s first goal is to stay in power and staying in power requires winning consecutive elections – Varun Ramachandra (_quale)

Policy analysis through models and frameworks is useful because it holds the potential to distill complex ideas in a simple manner without stripping the essentials. Therefore, it makes sense to analyse why governmental level reforms are hard to achieve through these very models.  Usually, we trivialise the process of reforms at the governmental level, but reforms are complex processes  involving multiple stakeholders (including politicians and policy makers). Political realities, parties’ own political future, and a multiverse of public opinions are considered before taking a decision.

“Overton window” is one such model that helps us achieve the said objective. This concept was first developed by Joe Overton of the Mackinac Center for Public Policy. The Overton Window describes the realm of political acceptability within which politicians and policymakers operate. This realm (window) is determined by what politicians believe will win them their next election. As described by this introductory essay in Mackinac Center, “Policies inside the window are politically acceptable, meaning officeholders believe they can support the policies and survive the next election. Policies outside the window, either higher or lower, are politically unacceptable at the moment”

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(Figure shows the Overton Window– more freedom refers to less government intervention, less freedom refers to higher government intervention)

A politician’s first goal is to stay in power and staying in power requires winning consecutive elections. Therefore, policy changes occur only within this window of reality. The window moves if and only if the move has the potential to lead towards another electoral victory. It is often thought that politicians with enough credentials can move the window either side, however that is very rarely the case. History has shown us very few leaders who have expanded this window, but these leaders are exceptions that validate the general rule (of course, the analysis holds true only in case of democracies and not in an authoritarian setup).

The word reform in the modern context refers to improving existing conditions or practices, and therefore it surprises many of us when we see opposition parties opposing reforms that an existing government tries to bring about. It is also true that depending on a person’s political ideology, certain reforms may not be thought of as reforms at all. This conundrum leads us to conclude that opposition to reforms might stem from 2 sources

  • From those who assess that the “proposed” change is outside their own Overton Window, thereby not opposing it might lead to electoral failure.
  • From those who assess that the proposed change is well within the “Overton window” of the ruling party, thereby ensuring the continuity of the existing ruling party.

It is not unusual to hear the term “opposition for the sake opposition sake”, while this is true in the larger context, from a political party’s viewpoint the quote transforms itself into “opposition for the sake of winning the next election”.

Varun Ramachandra is a policy analyst at the Takshashila Institution, he tweets @_quale 

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Challenges of Defence Economics

There are several operational difficulties that one faces while analysing the economics of defence in the Indian context – Varun Ramachandra(_quale)

Keith Hartley in his book “The Economics of Defence Policy” describes defence choices as complex because they have to be made in world of uncertainty and assumptions are on the basis of likely future threats(internal, external, and/or via non-state actors). Today’s choices may not be sufficient for tomorrow’s threats or worse still, today’s choices might be irrelevant tomorrow.

In such a scenario, the defence budget cannot be viewed as a stand alone entity. The larger question of how much of our national resources be directed to defence is an important one and deserves holistic treatment(pardon the cliche).  As AK Ghosh in his book “India’s Defence Budget and Expenditure Managament in a Wider Context” suggests “to say that it(defence budget) ought to be larger or smaller, without regard to its internal components or the external components that define it, is worse than useless”.

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There are several operational difficulties that one faces while analysing the economics of defence in the Indian context(or perhaps even in a global context) and this post explores the complexities one faces while studying this area.  The challenges can be classified as

  • Semantic
  • Accounting
  • Obfuscation

Semantic – Currently, there is no clarity on what constitutes as military expenditure and what constitutes as security expenditure. For constitutional and operational reasons internal security is the mandate of Ministry on Home Affairrs whereas the external defence is the mandate of Ministry of Defence. That said, there are several grey areas. Eg., Border Roads Organisation under the MoD has a peace time mission of “Contributing to the Socio-Economic Development of the Border States”. There are several strategic reasons for such assuming such roles, primarily being development and nation-building, but an analysis on whether this constitutes as military expenditure(and if it is being accounted for) is required.

Accounting – Currently, the services follow a cash accounting model which does not capture the market value of current asset and liabilities. A cash based process is a single entry accounting process which records cash transactions but does not capture non-cash transactions. This is a major challenge because large swathes of land and precious resources like spectrum and human resource are not captured while allocating newer resources. This results in unknown spending as opportunity costs are involved. (Some thoughts on accrual accounting by experts can be accessed here)

Obfuscation – As a strategic and a security measure there is definitely a need to obfuscate certain aspects of the defence budget. But care must be taken to ensure that the defence expenditure does not come under civilian heads (if however there is a case for it, it must certainly be justified and necessarily not concealed) . This adds an extra layer of complexity while analysing the economics of defence services.

Varun Ramachandra is a policy analyst at Takshashila Institution. He tweets @_quale

photo credit: Crossed wires via photopin (license)

 

 

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How does the Union Government earn money?

Amidst all the analysis about fiscal deficits, budget etc, the fundamental question about how the Union Government of India earns its revenues gets ignored. This post examines the revenue aspect of the budget.

All the revenue that the Union Government earns can be classified into three buckets

  • Tax Revenue
  • Non-Tax Revenue
  • Capital Receipts

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Tax Revenue:  Tax revenue is the largest source of revenue for the Union. The major heads under tax revenue include

  • Corporation Tax – This is the tax levied on the income of Companies under the Income-tax Act, 1961
  • Income Tax – This is a tax on the income of individuals, firms etc. other than Companies, under the Income-tax Act. This also includes Securities transaction Tax
  • Wealth Tax – This is a tax levied on the specified assets of certain persons including individuals and companies, under the Wealth-tax Ac
  • Customs – Revenues earned through taxes imposed on imported goods
  • Union Excise Duties
  • Service Tax – Taxes on service transactions(at hotels,
  • Taxes from Union Territories – comprises of taxes collected by UT Governments without Legislature and include items of taxes normally collected by States. These taxes collected by UTs accrue to Central Government.

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Non-Tax Revenue: The various forms of Non-Tax revenue includes

  • Interest receipt – This includes the interest earned by the Union from loans to states, loans to Union territories, interest payable by the Railways and several other smaller loans advanced by the Union
  • Dividends and profits – This comprises of dividends and profits from public sector enterprises and surplus of the Reserve Bank of India that is transferred to Union.
  • Fiscal Services
  • General Services – Fees and other revenues earned by the Union through various general services that it provides. Eg., Central police forces supplied by the Union to States etc.)
  • Social and Community Services – Fees and receipts earned through social and community services. Eg., entry fees collected at museums.
  • Economic Services(including Railway revenue) – Revenue earned through economic services delieverd by the government Eg., royalty on Oil and Gas produced from the Offshore fields
  • Grants-in-aid and Contribution – Grants received from external sources
  • Non-Tax revenue of Union Territories – The receipts of the Union Territories (without legislature) mainly relate to administrative services; sale of timber and forest produce mainly in Andaman and Nicobar Islands; receipts from Chandigarh Transport Undertaking and receipts from Shipping; Tourism and Power 

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Capital Receipts: Capital Receipts include

  • Non Debt Capital Receipts
  • Debt Receipts

Non Debt Capital Receipts include

  • Recoveries of Loans and Advances – Loans recovered from states and union territories
  • Miscellaneous Capital receipts – receipts on account of disinvestment of part of government equity in central Public sector Enterprises

Debt receipts are those receipts that the Union receives for the current year under the explicit assumption that it is a temporary receipt which acts as a liability on the part of the government.

  • Borrowings
  • Securities against Small Savings
  • State Provident Fund
  • Other Receipts
  • External Debt

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(All the information contained herein, including most of the definitions, is taken from the Union budget documents for 2015-16)

Author’s note: A big shout out to Karthik Dinne for pointing out a few errors in the graphs in the previous update

Varun Ramachandra is a policy analyst at Takshashila Institution He tweets @_quale

 

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Defence Offsets

My review of  ManMohan S Sodhi and Rajiv Bhargava’s edited volume “Perspectives on India’s Defence Offset Policy” appeared in The Business Standard.

This book sets out with the objective of compiling different perspectives of the primary stakeholders in this space: the Indian government, global original equipment manufacturers (OEM), and Indian industrialists.

Through these perspectives, the book aims to understand the evolution, and trace the possible future trajectories, of defence procurement and offset policies in India. The volume opens with a bird’s-eye-view of these perspectives, followed by three sections containing chapters by individual stakeholders, and concludes with a section emphasising the importance of Indian manufacturing.

The entire piece can be read here

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More thoughts on accrual accounting

This is a part of a series on Defence Economics. Previous blogs on the same topic can be found here, here, and here.

In continuation with the last piece that dealt with democratic accountability and defence economics, this post provides some more sources that have analytically written about the importance of an accrual-based accounting system.

Gur Saroop Sood  in this excellent article refers to the cash-based accounting thus:

 “Under the cash-based system, the currency transactions, pertaining to a Financial Year, are available till the closing of accounts. Once the accounts are closed, past transactions do not become readily available. In this system, committed liabilities incurred do not get recorded in the accounts at the time of their occurrence. Therefore, for commitment control, such information has necessarily to be generated through additional reports. If the committed liabilities are not available, the possibility of over or under committing resources vis-à-vis available funds in a Financial Year cannot be ruled out. The accounting system also does not generate information for the decision-makers to know whether the money is being spent on core or peripheral activities. Due to the principle of lapse, the Executive tends to spend the earmarked funds during the month of March, sometimes also referred to as ‘March rush’, in order to avoid surrender of unspent funds spend the earmarked funds during the month of March, sometimes also referred to as ‘March rush’, in order to avoid surrender of unspent funds.”

Amaresh Bagchi in his Business Standard piece says

Such a system does not provide a full picture of the government’s liabilities, because accrued liabilities such as those from unfunded pensions and commitments are not taken into account; two, it keeps no track of the assets of the government, nor do they provide information on the costs of holding and operating them or of their consumption or use”

The 12th Finance Commission’s recommendations are as follows

“Compared to the cash based system, the system of accrual accounting recognizes financial flows at the time economic value is created, transformed, exchanged, transferred or extinguished, whether or not cash is exchanged at that time. It is different from cash based system in that it records flow of resources. Expenses are recorded when the resources (labour, goods and services and capital) are consumed, and income when it is earned, i.e. when the goods are sold or the services rendered. The associated cash flows generally follow the event after some time and may or may not take place during the same accounting period. Thus, in addition to cash flow, unpaid consumptions (payables) and unrealized income (receivables) are also recorded. Resources acquired but not fully consumed during an accounting period are treated as assets (inventory and fixed assets). Payments made for acquisition of inventory are included in the operating cost for the period in which it is consumed. Payments made for acquisition of physical assets, that have future service potential, are amortized over the entire useful life of the asset by charging depreciation

The system of accrual accounting thus, inter alia, allows better cost – price calculations, records capital use properly, distinguishes between current and capital expenditures, presents a complete picture of debt and other liabilities and focuses policy attention on financial position, as shown in the whole balance sheet not just cash flows or debts thereby providing a complete measure of cost of various services and provides net worth and their changes over time

The Controller General of Defence Accounts while talking about implementation of accrual accounting in Government says the following

Accrual accounting system enables system enables a more effective assessment of the performance and provides the necessary information for linking the input costs to outputs and outcomes that is required by services.

The challenge of moving to an accrual based accounting is the time that is required for the transition. Also, the switch will place considerable demands on the accounting personnel particularly at the lower and middle levels of the accounting hierarchy.

Amaresh Bagchi’s Business Standard piece has a solution to this problem as well where he suggests

 transitioning in a phased manner and in the interim both cash and accrual accounting can run in parallel to ensure a smooth transition.

There is overwhelming evidence, and scholarly  agreement about moving towards an accrual based accounting system. It is a matter of wonder that the move has not yet happened. Perhaps, an analysis on why cash based accounting  system is still in vogue is an exercise worth undertaking.

Varun Ramachandra is a policy analyst at Takshashila Institution, he tweets @_quale

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Democratic accountability and defence economics

The previous post on defence economics described the need to study the subject. it was concluded that: development of defence economics is necessary from the perspectives of

  • democratic accountability
  • efficiency of resource allocation to ensure preparedness
  • military effectiveness to ensure the right mix of services are deployed to ensure peace
  • improvement of service conditions — that ensures state of the art quality of life for servicemen, ex-servicemen and their families

This post focusses on democratic accountability and the need to maintain it even while dealing with complex choices in defence.

Sound financial management of a country’s security sector is key to maintain an efficient and effective security force that is capable of responding to the population’s legitimate security needs. Avoiding excessive, wasteful, and corrupt military expenditures and procurement thus requires high levels of transparency and accountability in military budgeting and procurement processes.”Such processes should adhere to government-wide financial management and oversight practices, within a rigorously-observed defence policy and planning framework. This includes adherence to public expenditure management (PEM) principles of comprehensiveness, discipline, legitimacy, flexibility, predictability, contestability, honesty, information, transparency and accountability”[1].

In the Indian context, the government and citizens must know the full costs of national security and this can be achieved by making the asset value of services explicit without compromising the strategic secrecy that is the imperative of any defence service.  All the forces together own valuable land, spectrum, human resources, and equipment. Arriving at an explicit asset value creates incentives for increasing the efficiency of all these assets and creates a defence establishment that is effective, efficient, and fiscally prudent.

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The process is easier said than done. For example, a simple step that is tedious to implement is a shift towards accrual based accounting. Currently, the defence budgeting system is based on a cash accounting model which ignores all non-cash transactions. This has masked the exact net present value of all the resources that the services currently possess. Such a system “does not provide a full picture of the (government’s) liabilities, because accrued liabilities such as those from unfunded pensions and commitments are not taken into account; two, it keeps no track of the assets of the (government), nor do they provide information on the costs of holding and operating them or of their consumption or use”[2].  An accrual based accounting system enables more effective performance assessment and provides the necessary information to link the input costs to outputs, and outcomes that is required by services[3].

That said, the complexities of a process should not stifle measures that ensure democratic accountability.

Varun Ramachandra is a policy analyst at Takshashila Institution, he tweets @_quale

References:

[1] “Transparency and accountability in military spending and procurement” http://www.sipri.org/research/armaments/milex/transparency, accessed 15-July-2015

[2] Amaresh Bagchi, Accrual accounting in government, Business Standard, 5-April-2005, http://www.business-standard.com/article/opinion/amaresh-bagchi-accrual-accounting-in-government-105040501073_1.html, accessed on 15-July-2015

[3] Implementation of accrual accounting in Government, Controller General of Defence Accounts, http://cgda.nic.in/accounts/accrual.html, accessed on 15-July-2015

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Where India got it right

EU is trying to do what India did in 1947, but it has been trying to do so since 1958 – Varun Ramachandra(_quale)

It appears that the Eurozone leaders have decided to halt the crisis that they have been in recently. They have agreed to provide a third bailout to Greece, subject to certain conditions that the Greek government has to meet by 15th July 2015.

A lack of political union is being cited as a primary reason for the current crisis in Europe. In this context, some of my colleagues have attempted to compare the Indian Union and the European Union and contend that the EU is aspiring to do what India did in 1947.

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Although initially I did not agree, with time and more reading I partly agree with the hypothesis. EU is indeed trying to do what India did in 1947, but it has been trying to do so since 1958. At the time of independence, India faced a problem of political unity; a common currency across most of (today’s) India already existed. The Euro Zone, on the other hand, comprises of several states with independent governments that have agreed to be a part of a monetary union — ie., an adopted common currency.

In this context the words of the  English Economist Nicholas Kaldor sound prophetic

… Some day the nations of Europe may be ready to merge their national identities and create a new European Union – the United States of Europe. If and when they do, a European Government will take over all the functions which the Federal government now provides in the U.S., or in Canada or Australia. This will involve the creation of a “full economic and monetary union”. But it is a dangerous error to believe that monetary and economic union can precede a political union or that it will act (in the words of the Werner report) “as a leaven for the evolvement of a political union which in the long run it will in any case be unable to do without”. For if the creation of a monetary union and Community control over national budgets generates pressures which lead to a breakdown of the whole system it will prevent the development of a political union, not promote it.

Another important difference between the EU and India is that the individual Indian state derive its legitimacy from the Union. This is sorely lacking in Europe, where the Union draws its legitimacy from the individual members.

It is therefore safe to contend that the Indian experiment is actually a success, at least when compared to the ongoing European experiment, whose results are not yet out.

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Opportunity cost of delays

Recent news reports suggest that the final operational clearance for  India’s homegrown Light Combat Vehicle might be delayed. If this is indeed true, this is not good news.  There is also news about handing over the entire project to the private sector. Irrespective of whether the LCA will be delayed or not, most newspapers and reports suggest that the Indian government has spent enormous amounts of money on this project.

Although the losses are significant,merely looking at a huge rupee number does not complete the story. The concept of opportunity costs has to be factored in while analysing such delays in projects. Opportunity cost in simple terms can be defined as the loss of the next best opportunity. In case of the LCA or any other delayed projects the question that must be raised is “What is the next best thing we could have done with the money”?

In an area like defence, the opportunity costs are exacerbated because delays inevitably reduce combat preparedness. A logical question to raise therefore is to track how many such delays have affected India in the numerous conflicts that it has had to face in the past.

As this ET report suggests

Sources said discussions have taken place in the top echelons of the government on the best ways to inject urgency into the Tejas programme, possibly even with the involvement of a private sector player that would be clearly incentivised to deliver a new aircraft on time and within budget

One wonders why the government has decided to bring in private players so late in the game(Depending on how the timelines are viewed, there has been a delay of more than 10 years in the LCA project).  The idea about only state-run firms handling  strategic programmes has not been a success. It is time the defence ministry and the defence establishment views efficiency, as opposed to ownership, as the metric while choosing vendors/partners.

Better late than never. Hopefully.

Varun Ramachandra is a policy analyst at Takshashila Institution and tweets @_quale

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Need for a systematic study of defence economics

Ensuring security from external aggression is a basic public good that the governments have to provide and given that it is not possible to reveal individual preferences, this has to be financed from taxes.   The important issue confronted by the policymakers, however, is the basic economic dilemma of scarcity and choice.  The funds allocated for defence are not available for spending on physical infrastructure or human development which are necessary to improve the living conditions of people.

As stated by David Greenwood[1], “What the budgeting system should ideally do is to ensure that the ‘right’ amount is spent on defence in the light of pattern of national priorities, and the ‘right’ military capabilities developed in the light of the structure of security priorities” The answers to what the “right” amount is depends on the economic choices the government has to exercise in providing various public goods, merit goods and services, given the overall resource envelope.

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As the world’s largest democracy, with an annual gross domestic product (GDP) of almost $2 trillion it is imperative to understand what the ‘right’ amount is and to evaluate whether what we are currently spending is high, low, or indeed the ‘right’ amount. While understanding the numbers are important, it is also important to explore the following

  1. various priorities in which defence spending can happen
  2. assessing existing resources
  3. investigating the possibility of developing  normative frameworks to understand security priorities & threat perception
  4. how the defence forces can be effective and yet be fiscally prudent

The national security of a country depends on defence installations and facilities being in the right place, at the right time, with the right qualities and capacities. Spending on defence, therefore, is a resource allocation problem and the budgeting for defence has two broad functions[2]

  1. Management Function — to enable concerned personnel to spend money for various activities in an efficient and economical manner.
  2. Planning Function — Budgetary resources are to be allocated such that it enables achievements regarding operational preparedness and defence capability-building.

Defence budgeting literature indicates that budget is a three-tiered exercise in choice. First, it involves choosing how much to spend on defence, given the resource constrtaint, keeping in view other competing demands. Second, it involves choosing the basis for allocating resources among the services (army, navy and airforce). Third, it involves allocation among various programmes for capability-building, which entails what capabilities to acquire & maintain and the degree of military preparedness to aspire for[3]. Therefore, development of defence economics is necessary from the perspectives of

  • democratic accountability
  • efficiency of resource allocation to ensure preparedness
  • military effectiveness to ensure the right mix of services are deployed to ensure peace
  • improvement of service conditions — that ensures state of the art quality of life of servicemen, ex-servicemen and their families.

Varun Ramachandra is a policy analyst at Takshashila Institution and tweets @_quale

[1] David Greenwood, “Budgeting for Defence”, RUSI, 1972, p8.

[2] AK Ghosh, “ Defence budgeting and planning in India”, p.25

[3] Ibid 27

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PS- My thanks to Nitin Pai and Dr. M. Govinda Rao for their inputs and help.

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Linguistic States in India

In an otherwise uneventful journey, recently, I had the pleasure of talking to a bus driver who was plying between Indian states A and  B. He was ruing about how commercial and other state transport vehicles(from the ‘other’ states) do not let you overtake based on the letter code on your number plate.

Anecdotes are the lowest forms of data, that is if it can be considered data at all. That said, the story about overtaking(or the lack of it) is an excellent example of how linguistic sub-nationalism surfaces in India.

The movement for linguistic states in India existed much before Independence, but became a reality due to the unfortunate death of Potti Sriramulu who fast unto death for the creation of a separate Andhra Pradesh. Linguistic states are a now reality and have, depending upon the situation, been a matter of great elation and/or chaos.

Language cloud

Creation of linguistic states has had many advantages but it has also had several negative effects. First, boundary tensions exist between several states. Second, water-sharing agreements between higher and lower riparian regions are still not sorted. Third, multilingual scholarship has been a serious casualty  —  it has become the job of another state to promote their own language.

It is undeniable that strong sentiments are attached to languages. The sub-continent itself has witnessed civil wars and creation of an independent nation on the basis of a language. Therefore, it is important to be cognisant about this sentiment, but it is also important to ensure that sentiments do not get the better of us.

In his excellent essay titled State Name and Linguism in  Public Affairs in 1972, the Kannada poet and intellectual D.V Gundappa, says the following

 Emphasising the linguistic element in the nomenclature of the Provincial states in India is a way of promoting separatism and disharmony. (…) The names of the Provincial States should not be such that they could be used as a handle by a fanatic of any kind. Language is emphatically such, as much as Religion. The name could no harm if it is based upon locality or town or upon a  historic dynasty now extinct and incapable of separatist or offensive sentiment — like Kadamba or Chola. If unprovocative is not found , the best course would be to assign a number to the State. The names of States given in Schedule I to the constitution may be rearranged in alphabetical order and numbered consecutively so that they will be known as State the Eighth, State the Fifteenth, State the Twentieth and so on. This may not be the most convenient nomenclature. It may put great strain on memory. But at whatever cost, our provincialism must be subordinated to our nationalism.

Although DVG’s suggestion about numbering the states is not too practical, it raised extremely valid points, especially at a time when the fervour for linguistic states was at its peak.  It is therefore important for us to now ask similarly important questions: Are linguistic states a ticking countdown for something bad? Will linguistic states continue to strengthen the Indian state with a sub-nationalist layer? Is the linguistic organisation of states truly successful both economically and culturally?

This topic deserves holistic analysis and should not be pushed into the realm of taboo.

Varun Ramachandra is a policy analyst at Takshashila Institution and tweets@_quale

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