Sunday, August 2, 2015

Weekend reading links

1. Martin Ford, author of the Rise of Robots, has an oped in NYT where he says,
Midea, a leading manufacturer of home appliances in the heavily industrialized province of Guangdong, plans to replace 6,000 workers in its residential air-conditioning division, about a fifth of the work force, with automation by the end of the year. Foxconn, which makes consumer electronics for Apple and other companies, plans to automate about 70 percent of factory work within three years, and already has a fully robotic factory in Chengdu.
Even assuming some hype associated with the numbers, the pace of displacement is truly staggering. It assumes great significance for countries like India which have staked its economic growth and job creation fortunes behind manufacturing. While the initial trends in India are not alarming, the global experience does not lend much comfort.

2. Fascinating article on Phantom, the high-end audio speaker, developed by Devialet, the French acoustics engineering firm. This nugget about the Phantom was stunning,
There are only 10 separate parts inside the Phantom and not a single wire. 
3. Stephanie Flanders captures the dismal world trade scenario
The latest World Trade Monitor showed the volume of world trade falling in May by 1.2 per cent. It slid in four out of five months in 2015 and risen just 1.5 per cent in the past 12 months — less than the growth in global output and far below the long-term average of about 7 per cent a year... A recent study by the International Monetary Fund calculated that in the 1990s, every 1 per cent rise in global income generated a 2.5 per cent rise in global trade, much more than in the past... Since 2013, every 1 per cent of global growth has produced a trade bump of just 0.7 per cent.
This trend has to be the context to view India's new Foreign Trade Policy, 2015-20 which seeks to nearly double exports from $465.9 bn to $900 bn by 2019-20, an annual increase of about 12%!

4. At a time when the rapidly expanding share of Indigo Airlines, nearly 40% of the total domestic traffic, has raised concerns about monopoly in the Indian airline market, Economist points to an Associated Press study report that has some very interesting statistics about the US airline market,
At 40 of the 100 largest U.S. airports, a single airline controls a majority of the market, as measured by the number of seats for sale, up from 34 airports a decade earlier. At 93 of the top 100, one or two airlines control a majority of the seats, an increase from 78 airports... The four largest airlines control more than 80 percent of the U.S. market... 
In Indianapolis, the two leading airlines controlled just 37 percent of the seats a decade ago, and domestic fares were 9 percent below the national average. Then the city’s main airline, ATA, went bankrupt and was bought by Southwest, and its No. 2 carrier, Northwest, was absorbed by Delta. Now two airlines control 56 percent of the seats, and airfares are 6 percent above the national average. The Dayton, Ohio, airport was served by 10 airlines in 2005, and fares were 5 percent below average. Today, just four airlines fly there and prices are almost 10 percent above average. Big hub airports aren’t immune. In 2005, US Airways controlled nearly 66 percent of the seats in Philadelphia. Now that US Airways has merged with American, the combined airline has 77 percent of the seats. Airfare has gone from 4 percent below average to 10 percent above it. Delta’s hold on Atlanta, the world’s busiest airport, increased during that same period from 78 percent of seats to just over 80 percent. At the same time, low-cost AirTran merged into Southwest and reduced flights there. Domestic airfares at the airport went from nearly 6 percent below average to 11 percent above. Some cities are actually seeing lower fares than they did a decade ago. Prices in Denver were once 5.6 percent higher than the national average. Now that United’s market share there has dropped to 41 percent from 56 percent, fares are almost 15 percent lower than the rest of the country.
This market concentration is in some ways inherent in the conventional hub-and-spokes model of airline market. Even in the largest airports, it would not be competitive for more than an airline to operate hubs in one airport. Once a hub is established, the destinations in its vicinity are more likely to be competitively serviced by the hub airline.

5. In the context of the demand by big US airlines that the US Department of Justice revoke the rights of the three big Gulf carriers (Emirates, Etihad, and Qatar) to fly to US destinations on the grounds that they have benefited from $42 bn worth of government subsidies in the past decade, Edward Luce had this to write about the benefits enjoyed by the US carriers,
US airlines have benefited from the huge advantage of the Chapter 11 bankruptcy law. Starting with United in 2002, most of the big US carriers have gone bankrupt at some stage. US law has enabled them to restructure debts, slough off legacy pension costs and survive to fly another day. The industry-wide crisis has also prompted consolidation. The market has shrunk to just three big legacy airlines plus Southwest. A fifth, Virgin America, is nibbling at the edges. Nor are they strangers to direct government subsidy. At today’s prices, US airlines have benefited from $155bn of government help in the past half century, according to a US government report.
6. Why has leisure time declined even at the top-end of the income ladder even as today's top one percent earn a few times more than their peers from a century or earlier? Tim Harford offers this explanation,
The best educated and the highest earners, both men and women, had less free time than ever. Starting in the mid 1980s, this elite began to drop everything and work ­furiously... By pulling the longest hours and taking the least leave, we climb the corporate ladder. It may be no coincidence that the collapse in leisure time began in the 1980s, at a time when inequality at the top of that ladder was surging. The rewards for working hardest are large.
7. Finally, FT has this richly informative graphic from Rystad Energy that maps the price points at which the different oil sources become commercially viable.
In fact, as oil prices have plunged, it has been estimated that the oil majors have cut about $200 bn in projected investments. FT points to consultant Wood Mackenzie's report that 46 big oil and gas projects with 20 bn barrels of oil equivalent in reserves have been deferred, of which 5.6 bn barrels are in the tar sands of Canada.

Thursday, July 30, 2015

London's 'Big Dig'

London's 'Big Dig' is about to start, with contracts to be awarded over the coming weeks. The £4.2 bn super-sewer, being build under the Thames river and one of the most complex infrastructure projects in the world, has several unique contracting features. The construction work on the project being built by Thames Water, London's privately owned water utility, through its special purpose vehicle, Thames Tideway Tunnel, is set to start in 2016 and will take seven years to complete. Apart from its sheer size (it is spread over 42 sites), the project has several technical risks including potential threat to Big Ben's foundations and flooding of the London metro network. 

Given the size and risks involved, a novel off-balance sheet financing arrangement has been worked out. Thames Water will finance a third of the cost, through the SPV's balance sheet, and the remaining two-third of £2.8 bn will come from a consortium of financiers, Bazalgette Consortium, which includes Allianz, Swiss Life Capital, and Dalmore Capital. The consortium will own, finance, and manage the project for 125 years. In order to pay for the project, Ofwat, the water regulator, and the Government have estimated that Thames Water's 15 mn consumers may need to pay a surcharge on their water bills, of upto £80 every year almost in perpetuity. Interestingly, the surcharge will become operational from the date construction begins, and the investors will therefore receive income from the beginning. This, coupled with the high tariffs and the long, almost a perpetuity, contract tenure provide the project's financial risk mitigation. Further, construction risks are mitigated by a few government guarantees, including accidents at project sites, meeting the insurance costs not covered by markets and also any "exceptionally large cost over-run". 

As critics have pointed out, the cost of capital for the consortium is certain to be much higher than would have been the case if it were constructed with public borrowing. Given that construction problems cause mega projects to become "over-budget, over-time, over and over again", whether done with public or private financing, the final cost of the project once construction is completed is most certain to be much higher than its current estimates. Would that result in an increase in the surcharge?

Further, the case for public financing followed by contracting out long-term once the construction risks are off-loaded becomes even stronger given that the government is already assuming constructions risks thereby limiting the project developer's incentives for on-time delivery. If the construction contract is given out as an Engineering Procurement Construction (EPC) contract and once constructed given out on a long-term operation and maintenance concession, the private sector efficiency gains could just as well have been captured, and at a lower cost of capital. 

Tuesday, July 28, 2015

The structural headwinds facing the Indian economy

Massive infrastructure requirements, alarming decline in private infrastructure investments, rapidly growing debt burden of infrastructure companies, rising debt-to-equity ratios for projects, and rising gross non-performing assets of banks. This, captured in the WSJ graphic below, constitutes the perfect storm that the Indian economy tries to weather in its attempt to regain the high economic growth trajectory.
Despite the optimism, the ingredients for the short to medium-term just do not look promising. In fact, even if growth recovers (forget the new series), it is unlikely to be sustained for beyond 2-3 years. Household savings are declining, widening the gap between supply and demand for investment resources. In the absence of massive recapitalization, and that may not be forthcoming, bank lending is unlikely to be anywhere near sufficient to finance high growth rates.  

For sustainable growth, India needs to get the ingredients right. It needs a broad enough platform of skilled labor, productive job creating industries, and consumption demand, none of which are easy to create, leave aside in a short duration. Consider each ingredient. Less than 5% of Indian workers receive some form of skill training, compared to 80% for Japan and 96% for S Korea. This compounded with the woeful school education standards means we have a 17 million strong semi-employable workforce entering the labour market each year. Less than 30% of women are employed, a distant last among any large economy. Supply of skilled labor is already a major constraint faced by businesses.  

Jobs get created and broad-based economic growth sustained by the growth of formal sector small firms into medium sized ones. But India's industrial landscape is characterized by the 'missing middle', a result of firms starting small and informal and remaining so. The ease of doing business should have as much to do with improving the business environment for domestic small and medium enterprises as with large and foreign manufacturers. The former requires that the mundane issues of getting land registered, building plans approved, utility services connected, and accessing credit should become hassle-free. Unfortunately, all these run into issues of state capability. 

Finally, India's consumption story too is characterized by yet another 'missing middle'. Contrary to the popular estimations of the 200-300 m strong middle class, recent domestic and foreign surveys points to a far smaller sized and not very rapidly growing middle-class. Further, rural demand, hitherto supported by the boost from various welfare programs, may no longer be able to provide the demand that supported the high growth rates of 2003-08.   

China's massive investments in infrastructure were complemented with policies that promoted hundreds of thousands of town and village enterprises, rising rural incomes, well educated and skilled workforce and strong female participation in labour markets. India has none of these in place and unfortunately, there are no quick-fixes for any of these deficiencies. They require long-drawn and relentless action at multiple dimensions, especially at the level of state governments. Acknowledging the same would be a good place to start. 

Sunday, July 26, 2015

Weekend visualization and links

1. The most popular example of capitalism with Chinese characteristics has been the crawling renminbi peg. Since 2005, the currency has appreciated 30%. As FT reported, while the direction of currency movement was clear, the pace and timing of changes not.
2. As Africa has weaned away in recent years from brutal dictators and internecine civil conflicts, a new scourge threatens to engulf large parts of the continent - extremist Islamism. As the graphic below shows, more than a dozen northern and sub-Saharan African countries are fighting the menace of Jihadism. Such Jihadism in turn forms the ideological breeding ground and recruitment centers for extremist groups like Al-Qaeda and ISIL.
And where do these groups draw their strength,
Although the extremist groups are backed by well-financed elites, they could not survive without popular support. Every one of them taps into well-known local grievances. From Mali and Nigeria to Kenya and Tanzania the story is the same: extremists emerge from and woo Muslim populations on the national periphery who are fed up with decades of neglect, discrimination and mistreatment by their rulers. Jihadists are able to exploit existing religious tensions and latch on to disgruntled Muslim communities. In addition, the conflicts they stir up have created ever bigger populations of refugees, who are either vulnerable to radicalization or likely to cause the sort of resentment that fuels it. Increasingly what drives African extremism is not just opportunity or firepower but ideology. No grand caliphate stretching from Mosul in norther Iraq to Maiduguri in north-eastern Nigeria is likely to emerge. Yet a distinct flavour of poisonous thinking has spread across thousands of miles. Islamism is the continent's new ideology of protest.
3. China has rapidly displaced the US and Europe as the largest investment partner across the developing world. As this NYT article and the interactive graphic shows, China has shown an amazing appetite to invest in some of the most difficult regions of the world, especially in Middle East, Africa, and parts of Latin America, which are largely avoided by western businesses and development finance institutions for both economic and political reasons.
For Beijing, these investments, mainly in the form of loans by state-owned banks, form part of its efforts to "win diplomatic allies, invest its vast wealth, promote its currency and secure much-needed natural resources". In countries which are starved of foreign funding, the Chinese readily offer financing, albeit at steep interest rates, most often in return for securing access to their natural resources and the expertise of their construction and mining companies. Consider this,
China has a lock on close to 90 percent of Ecuador’s oil exports, which mostly goes to paying off its loans... The Chinese money, though, comes with its own conditions. Along with steep interest payments, Ecuador is largely required to use Chinese companies and technologies on the projects... Energy projects and stakes have accounted for two-fifths of China’s $630 billion of overseas investments in the last decade, according to Derek Scissors, an analyst at the American Enterprise Institute... Chinese mining and manufacturing operations, like many American and European companies in previous decades, have been accused of abusing workers overseas. China’s coal-fired power plants and industrial factories are adding to pollution problems in developing nations...Chinese companies are at the center of a worldwide construction boom, mostly financed by Chinese banks. They are building power plants in Serbia, glass and cement factories in Ethiopia, low-income housing in Venezuela and natural gas pipelines in Uzbekistan.
The graphic below captures the $11 bn China has loaned Ecuador, mostly to finance hydro and wind power, transportation, mining, oil drilling, and river water linking. This is broadly representative of the country's investments elsewhere.
4. Stunning map that contrasts the daytime and night time population of New York City.
The daytime map reflects the population that commute to NYC for work, tourism, and other purposes, whereas the night time population captures the actual city residents. As this graphic shows, the hollowing out of the city center during night times is representative of other US cities and a reflection of the countries suburban growth. It drives home the importance of mixed-use urban planning in ensuring the vibrancy of cities. It also serves as a striking reminder to urban planners that estimations of work commuters and tourists are probably as much or more important than that of residents in planning infrastructure facilities for large cities.

5. As the US economic productivity has dipped to below 1% since 2010, Robert Solow's famous quip that "you can see the computer age everywhere but in the productivity statistics" has been much highlighted. WSJ has a nice article on this debate.

However, as a counter-point, Google's Chief Economist Hal Varian has claimed that US doesn't have a productivity problem, but it has a measurement problem. Pointing to the improvements in the quality of life brought about by the digital economy and time-saving apps, he argues that it is very difficult to capture the impact of quality improvements. Critics though claim that such measurement problems have always been there, understating the productivity measurements.

6. Fantastic visualization of the income levels along New York metro lines from this New Yorker project.
Similar maps of Washington and a few other cities by MIT Media Lab are here

Friday, July 24, 2015

Living with debt and what it means for countries like India

It is a sign of the times that the IMF has in the recent past departed from orthodoxy in many areas of macroeconomic management. After accommodating the possibility of capital controls, higher inflation target, and fiscal expansion even when faced with large and growing deficits, the latest mea culpa comes in the form of the possibility of "living with high debt".

At a time when many developed economies face high and growing public debt ratios, a highly contentious debate has been raging about addressing this problem. One side, represented by those advocating fiscal austerity, austerians, have been demanding policies for immediate reduction of debts. The other side, represented by Keynesians, oppose this and argue that growth recovery is the priority and the ultra-low interest rate environment demands more public spending, even if it increases the debt burden.

Now the IMF has waded into the debate, pointing to the possibility of "living with high debt". Its conclusion,
Countries facing imminent risk of a curtailment of market access, or that need to re-establish fiscal space against the risk of contingent liabilities or other shocks, naturally do not have the luxury of living with high debt. For others, the appropriate pace depends on the availability of non- (or less) distortionary sources of tax revenue. And for those countries in the fortunate position of enjoying asset price booms, the message must be that they should seize the opportunity to pay down public debt. In sum, the appropriate response to high levels of public debt depends very much on the extent of available fiscal space and other factors. There is no one-size-fits-all message: be it to pay down the debt to reduce the risk of a funding crisis or to live with the debt, letting the debt ratio decline organically through growth. Countries in the yellow and red zones in terms of fiscal space will not be in a position to “live with the debt.” But nor is it the case that countries with ample space— those firmly in the green zone—should rush to pay down their debt. 
Blessed with the IMF imprimatur, now consider the table below (numbers from here) which aggregates the debt to GDP ratios - dis-aggregated into component household, corporate, and government debts - of some of the larger Asian emerging economies from 2000...
... and from 2014.
It is evident that countries like India, Indonesia, and Philippines not only have low debt-to-GDP ratios, but also those ratios have been stable for more than a decade and even declining in recent years. In particular, household debt-to-GDP ratios for these three countries are among the lowest, and aggregate corporate debt (not that concentrated among the small proportion of the largest corporate groups) far lower than in their fast-growing peer group (during their fast-growing years). 

For these countries, in their search for economic growth leg-room, this is encouraging news. There is large potential for credit absorption among the small and medium enterprises as well as for household consumption (especially in housing and consumer durables). But the challenge is to realize this opportunity by improving credit intermediation mechanisms and getting money across to these categories of borrowers. 

Wednesday, July 22, 2015

Urban development with Chinese characteristics

The latest plan from China, a megalopolis six-times New York, combining Beijing, Tianjin, and Hebei province, called Jing-Jin-Ji, with a population of 130 million,
The new region will link the research facilities and creative culture of Beijing with the economic muscle of the port city of Tianjin and the hinterlands of Hebei Province, forcing areas that have never cooperated to work together...  This month, the Beijing city government announced its part of the plan, vowing to move much of its bureaucracy, as well as factories and hospitals, to the hinterlands in an effort to offset the city’s strict residency limits, easing congestion, and to spread good-paying jobs into less-developed areas...
Jing-Jin-Ji, as the region is called, is meant to help the area catch up to China’s more prosperous economic belts: the Yangtze River Delta around Shanghai and Nanjing in central China, and the Pearl River Delta around Guangzhou and Shenzhen in southern China. But the new supercity is intended to be different in scope and conception. It would be spread over 82,000 square miles, about the size of Kansas, and hold a population larger than a third of the United States. And unlike metro areas that have grown up organically, Jing-Jin-Ji would be a very deliberate creation. Its centerpiece: a huge expansion of high-speed rail to bring the major cities within an hour’s commute of each other.
High-speed rail has a central role in this grand plan, 
Chinese planners used to follow a rule of thumb they learned from the West: All parts of an urban area should be within 60 miles of each other, or the average amount of highway that can be covered in an hour of driving. Beyond that, people cannot effectively commute. High-speed rail, Professor Zhang said, has changed that equation. Chinese trains now easily hit 150 to 185 miles an hour, allowing the urban area to expand. A new line between Beijing and Tianjin cut travel times from three hours to 37 minutes. That train has become so crowded that a second track is being laid. Now, high-speed rail is moving toward smaller cities. One line is opening this year between Beijing and Tangshan. Another is linking Beijing with Zhangjiakou, turning the mountain city into a recreational center for the new urban area... “Speed replaces distance,” Professor Zhang said. “It has radically expanded the scope of what an economic area can be.”
It is no surprise that the two central pillars of this strategy are relocating existing activity clusters (like the administrative center to the Beijing suburb of Tongzhou, and over 1200 polluting businesses outside city centers) to spread growth to newer areas and using high-speed rail to connect population centers within the large region. Both these are logistical interventions, in which Beijing has already demonstrated excellence. And with everything the Chinese do, the sheer scale is staggering. Amidst the recent gloom surrounding China, this may represent a reasonably sound potential economic opportunity for sustaining the country's investment driven growth model. 

Monday, July 20, 2015

Secular stagnation and prospects for a new growth compact

Overcoming secular stagnation (SS) is arguably one of the biggest challenge facing developed economies. The phrase, first propounded by Alvin Hansen in the context of the Great Depression and revived in 2013 by former US Treasury Secretary Lawrence Summers to describe the present times, essentially means “chronic excess of savings over investment” which serves to keep real interest rates low for a prolonged period.

It has been construed that these countries may have entered a phase of lower trend economic growth, a new normal, driven by "persistent shortfalls of demand". The most compelling argument in favor of its demand-side origins come from the fact that even a large asset bubble fuelled economic boom in the last decade was not accompanied by inflationary over-heating.

Supporters of SS hypothesis point to multiple reasons for excessive savings - rising share of incomes going to those with "high savings propensities"; increased uncertainty, greater indebtedness, and expectations of lower returns encourage people to save more; and the burgeoning surpluses of emerging economies and oil exporters which find their way to the safety and liquidity of US Treasuries. On the investment side, they point to the substantial reductions in the relative price of capital goods as well as capital intensity, reflected in the declining share of investment goods in the GDP. This is most evocatively captured in Larry Summers’ example of "WhatsApp, worth $19 bn, with 55 people in a big room with Sony, worth $18 bn, and owning lots of factories and office buildings and the like".

Then there is the challenge posed by demographics. Demographic trends affect both investment and savings. A lower population growth reduces potential output, and limits the scope for investments. An aging population means people save more to fund their retirements. A combination of excess savings, amplified by the accumulating surpluses in emerging economies, and limited investment opportunities keeps interest rates low, even negative in real terms.

Finally, there is the productivity explanation, best captured by Tyler Cowen's best-selling book, The Average is Over - all the low hanging fruits from technological and process innovations have been plucked and large productivity enhancing innovations are very difficult to come by. The combination of all these factors point to the difficulty of operating at full employment and potential output without inflating destabilizing asset bubbles. Critics though dispute the SS hypothesis pointing to the remarkable ongoing economic recovery in the US.

The conventional wisdom on responding to SS has been either monetary accommodation, using unconventional approaches like quantitative easing, or fiscal spending on infrastructure. But the former engenders resource misallocation and ruinous asset bubbles, whereas the latter is constrained by fiscally strapped governments. It is in this context that the international dimension assumes significance.

A striking feature of the SS hypothesis is its "closed economy" assumption. Since the low hanging fruits from technological innovations have been plucked, developed countries, and their firms, face a future of declining gains in productivity. Their companies, exemplified by the cash hordes at two iconic firms Apple and Google, have limited investment opportunities. The income stagnation at all but the highest income levels boosts savings and limits consumption demand. All these trends are confined to developed economies and tend to assume them living in isolation from the rest of the world.

Faced with declining investment opportunities and lower returns to capital, Econ 101 teaches us that the natural response would be to expand trade and other economic linkages. The developed economies have the technologies, businesses, and even capital, all searching for opportunities. It also faces an aging population and therefore diminished supply of labor. In contrast, emerging economies have rising productivity, remunerative investment opportunities, growing consumer demand, and a large pool of labor. The complementarity could not have been any more mutually beneficial. The scope for a new growth compact between the two economic groups could not have been more opportune.

So far, the operations of multi-national corporations has been focused on selling products produced in developed to consumers in developing countries. Imagine the potential of a market for goods and services that are essentially needed for the developing countries. What if the firms from developed countries are able to realize increasing gains in productivity by making products for developing countries? What if there are remunerative investment opportunities in developing countries? As capital flows out from developed economies, their depreciating currencies would boost exports.

Such innovation opportunities and incentives abound – massive savings in infrastructure investments from efficient construction technologies, low cost medical technologies could dampen rising health care costs, on-line instruction technologies can transform education and health care markets, and so on. The "jugaad" innovations that characterize many breakthroughs by Indian firms are an example of such opportunities. 

Developing countries are estimated to invest trillions of dollars in their physical infrastructure over the coming decade. They include investments in electricity, mass-transit, telecommunications, and urban utility systems. The potential for technological innovations to optimize cost-effectiveness in their construction, reduce various forms of operational inefficiencies, and enhance environmental sustainability is enormous.

Consider the potential for transformational change from the recent advances in data science on governance itself. Arguably the most critical governance challenge in developing countries is with translating policies and programs into their desired outcomes during implementation. An important contribution to bridging this implementation deficit can be a right combination of analytics and visualization delivered through a variety of hand-held devices. The cash hordes of the likes of Google could transform governance in developing countries in a mutually beneficial partnership.

Finally, there is the channel of migration. It is no coincidence that Japan, with the most restrictive immigration rules, is the worst affected by secular stagnation, and US, with the least restrictive immigration rules, looks the least affected by secular stagnation. Liberalizing immigration rules could be another important contributor to alleviation of SS, especially in countries facing adverse demographic shifts like Japan and Germany.

We should therefore strive to see the current problems in the developed world as a great opportunity to construct a new paradigm of economic and social co-operation between the developed and developing countries driven by mutually beneficial imperatives.