Sunday, July 24, 2016

The costs of informality

Ananth has an excellent article that cautions the romanticism of small enterprises. He points to the Annual Survey of Industries 2013-14 report which shows that 72.68% of the 1,85,690 operating factories employ less than 50 workers, makes up 15.62% of all factory employment, utilize only 7.06% of fixed capital, produce 11.18% of gross output, and generates 7.71% of net manufacturing value added. And those with more than 200 employees forms a mere 9.06% of factories, utilize 78.61% of fixed capital, provide 61.44% of employment, produce 71.15% of gross output, and generate 75.78% of net manufacturing value added.

The figures would be even more disturbing if we take into account the respective shares among all economically active 58 million odd enterprises. It is very clear that Indian industry has a massive problem of "smallness". But its origins can be traced back the challenges posed by pervasive informality. The evidence is overwhelming that small enterprises in India start and remain informal, with limited productivity gains throughout its life. See the numerous graphics here and you'll realize that among developing or even the poorest countries, India's level of informality is simply extraordinary. Given this, encouraging more such small enterprises, howsoever much politically appealing, without addressing the root causes of informality may be a medication that worsens the disease.

The debate in India about job creation has become anchored around entrepreneurship. Incentivize innovation and entrepreneurs and jobs will follow. Unfortunately, that is unlikely to happen. Instead, for the vast majority of Indians, like those elsewhere in the world across history, the pathway to a good livelihood would most likely have to come through formal jobs in medium and large enterprises. In other words, we need more numbers of enterprises, which start formal and small, and grow into medium size or bigger, thereby creating large numbers of jobs.

A WTO study on informality quantifies the magnitude of certain costs,
Countries with larger informal economies experience lower export diversifi cation – an increase in the incidence of informality by 10 percentage points is equivalent to a reduction in export diversifi cation of 10 per cent... countries analysed in this study lose up to 2 percentage points of average economic growth due to their informal labour markets... countries with above-average sized informal economies are more than three times as likely to incur the adverse effects of a crisis as those with lower rates of informality... Countries with above average sized informal economies are almost twice as likely to experience extreme economic events, compared to countries with less informal employment.
In the specific area of trade, the paper makes the distinction between de jure and de facto trade openness. The former is a measure of implementation of trade reforms which immediately results in labor and other market readjustments, while the latter represents the actual flow of goods and services from and into the country. The paper says that "de jure trade reforms may be expected to require some time before they achieve de facto trade openness."
Empirical analysis carried out for the purpose of this study shows that more open economies tend to have a lower incidence of informal employment. By contrast, trade reforms, such as cuts in tariff rates, tend to be associated with higher informal employment. Likewise, larger inflows of FDI tends to be associated with higher informal employment. These findings may suggest that even if trade and investment reforms hold the promise of more and better jobs in the long run, such reforms tend to be associated with negative labour market developments in the short run. ƒDecent work policies can help to improve this trade-off between the short and long-term effects of trade reforms. Evidence in this chapter suggests that the incidence of informal employment is lower in countries that enjoy: a) better enforcement of the rule of law, including core labour standards, b) well-designed social protection and labour regulations, notably appropriately set minimum wages; and c) more transparent business regulations and a more supportive environment for sustainable enterprise creation.
The paper tries to quantify the effect of various policies and regulation on informality.
It is unsurprising that economic development is the biggest contributor to reducing informality. The surprises are that business regulation and subsidies and transfers (read, universal social safety net) do not appear to have the expected impact. Interestingly, decentralized wage bargaining is the second largest contributor to reduction of informality. 

Land title reform story of the day

Land title across large parts of developing world are a serious constraint on economic development. So, if this is indeed true, then it should count as one hell of an achievement,
Rwanda, for example, rolled out a programme over three years, whereby local surveyors worked with land owners and their neighbours to demarcate and register 10.3m parcels of land. By the time the scheme was completed in 2013, 81% of plots had been issued with titles, at relatively low cost; investment and women’s access to land have both improved.
This is bigger than anything that any Indian State has achieved with similar projects over a far longer period of time. 

Thursday, July 21, 2016

Global energy market fact of the day

The most stunning anecdote about how the shale dynamics have upended the global energy market comes from this reversal of hydrocarbon trade,
Two cargoes of US liquefied natural gas from Cheniere Energy’s Sabine Pass plant in Louisiana have been delivered to Kuwait and Dubai in recent months to meet the rapidly growing demand for energy. 
And more on how the US shale exports have been transforming the global hydrocarbons market,
The Sabine Pass plant shipped its first cargo in February, and has already sent LNG to seven countries: Argentina, Chile, Brazil, India and Portugal, as well as Dubai and Kuwait... Those additional supplies are depressing prices, making LNG a more attractive fuel for power generation, and low-cost floating regasification plants have made it easier for countries to become importers. Kuwait’s LNG imports tripled from 1m tonnes in 2012 to 3.04m tonnes last year, according to the Middle East Economic Survey. Egypt and Jordan became LNG importers for the first time last year. Qatar is the world’s largest LNG exporter, but over the next few years it is set to be toppled by Australia and rivalled by the US. The International Energy Agency has forecast that by 2040 gas demand in the Middle East will almost double, so the region could become an increasingly important market for US LNG.
As regards oil, US continues to import about 1.6 million barrels a day from the Middle East, down from 2.4 mbd in 2003-04.

I think an even bigger transformation will be when more liquefaction terminals on the US east coast come on-line. It could lead to the emergence of a single global market in natural gas

Tuesday, July 19, 2016

The nuanced case for financial liberalization

Financial market development is most often conflated with financial liberalization in debates on economic development. Financial deregulation had therefore become a central pillar of the Washington Consensus world view. Capital account liberalization was advocated as an unqualified requirement for developing countries. 

Since the Global Financial Crisis, the IMF has been at the forefront of questioning several prevailing orthodoxies. The latest comes this working paper by Sami Ben Naceur and RuiXin Zhang which draws the distinction between various dimensions of financial development and points to certain less than benign effects of financial liberalization, especially its effect on income distribution. Specifically, going beyond the conventional focus on financial deepening, they focus on four other dimensions of financial sector development - access, efficiency, stability, and liberalization. They find, 
The results suggest that most financial development dimensions can help reduce income inequality and poverty. However, external financial liberalization tends to have the opposite effect on the global average. In addition, our evidence suggests that banking sector development has a stronger positive effect on income distribution than stock market development. 
They have interesting prescriptions for policy making, including giving priority to banking sector development over capital markets and caution with capital account liberalization,
Observing the benefits of financial development on both economic growth and income distribution, policymakers need to steer the development of the financial system in a progrowth and pro-poor direction. Financial reform policies aimed at expanding financial access and depth, as well as enhancing financial efficiency and stability, should all be encouraged. These policies may include relaxing credit and interest controls, and improving banking and securities market supervision. However, given that external financial liberalization aggravates poverty, capital account liberalization should proceed in a carefully designed and well-sequenced fashion in a stable macroeconomic environment to avoid offsetting the poverty-reducing gains with the development of other dimensions of the financial sector. It is also important to develop an effective regulatory system for financial institutions and to enhance financial infrastructure (credit information, and collateral and insolvency regimes) in order to limit risk taking of banks. Given that the development of financial institutions has a greater impact than the development of the stock market, policymakers may give priority to banking sector improvement when considering poverty and income inequality alleviation. 
This is very sound advice to countries like India which has very narrow traditional banking market and where commentators have tended to prioritize capital market development and external liberalization. Reflecting the very low financial market depth, compared to our even our peers leave aside more developed economies, banking sector assets as a share of GDP is among the lowest in India. Worse still, it has been stagnating for the past decade, including in the high-growth years in the middle of last decade. 
There is only so much you can intermediate with such a narrow traditional banking sector. This goes back to another structural deficiency in our savings balance sheet - over 70% of household savings are held in illiquid property and gold, far higher than elsewhere. These are plumbing issues that need to be addressed before we navigate into the deeper end of the financial development pool.

Monday, July 18, 2016

National cuisines and economic strength

Atlantic has an interesting article that charts the "hierarchy of tastes" or social acceptance trajectories of different national cuisines in the United States. In particular, why does the French and Japanese cuisine get admitted to high-ed, white-tablecloth establishments while the Chinese and Indian recipes are relegated to lower-status eateries as "ethnic" food?
Consider the cases of steak frites and carne asada. They both involve cooking a fairly high-quality cut of meat over high heat, and they’re both dishes whose origins are foreign to America. But they’re often listed on American menus at vastly different prices. Why? “The shortest answer would be cultural prestige, some notion of an evaluation of another culture's reputation,” says Krishnendu Ray, an associate professor of food studies at New York University. In a book published earlier this year, The Ethnic Restaurateur, Ray expands on this idea, sketching the tiers of what he calls a “global hierarchy of taste.” This hierarchy, which privileges paninis over tortas, is almost completely shaped by a simple rule: The more capital or military power a nation wields and the richer its emigrants are, the more likely its cuisine will command high menu prices.
Ray consolidated the average price of a meal at a Zagat-listed restaurant in New York and came up with this graphic, which appears to neatly tie up with the hypothesis about relative economic strength of the country. 
Interestingly, Indian cuisine has been falling down the "hierarchy of taste" since 1986!

More realpolitik for India's foreign policy

The US drone strike that killed Mullah Akhtar Muhammad Mansour, the Taliban leader, a few months back, while driving across Pakistan's Baluchistan Province, may have interesting consequences. A few observations.

1. The "violation" of Pakistan's airspace and the Pakistanis being unaware of the strikes may signal more strains in an already tenuous relationship. That Mullah Mansour was close to Pakistani military and intelligence establishment lends further credence to that view.

2. This victory for the Americans may be short-lived since Sirajuddin Haqqani, who is expected to succeed Mansour, is close to the Pakistani ISI and is a more hardline opponent of the peace process. 

3. For India, the US policy towards Pakistan is a teachable moment in realpolitik. The US are actively engaging with Pakistan, even willing to provide them military assistance, despite their soldiers suffering at the hands of terrorists supported by Pakistan. They see no problem with the apparent contradiction and neither do continuously complain about Pakistan's duplicity. They realize that the Pakistan army and intelligence apparatus are largely outside the control of the country's elected government. But engaging with the government at least leaves them with the best possible lever to influence the trajectory of developments in the country. Further, the weapons supply also helps them exercise some influence over the all-powerful Pak military establishment.

India needs to emulate the US foreign policy calculus in its dealings with both China and Pakistan, especially the latter. In contrast to the Americans' (public) nonchalance with the recurrent stream of Pakistani-supported Taliban attacks on its soldiers in Afghanistan, India makes a very public remonstration and suspends talks after every attack. I am not sure whether this even contributes to keeping Pakistan on the backfoot at international platforms. Playing to the domestic audience, maybe, but this trend has predated the rabble-rousing 24X7 media channels.

There is nothing inherently odd about juggling contradictions - deepening engagement even as we stave off the insurgents. The US foreign policy revolves around a marriage of Wilsonian idealism and George Keenan's realpolitik, although it sometimes throws up ugly contradictions. In dealing with nations, India's national interests dictates that we imbibe a dose of realpolitik. 

Sunday, July 17, 2016

China debt fact of the day

From a Bloomberg article on China's fascination with high speed rail, whose network has grown to nearly 12000 miles in just under a decade,
In May, state-owned China Railway Corporation, the operator of China's rail network, reported that its debt had grown 10.4 percent in the past year and now exceeded $600 billion; in 2014, roughly two-thirds of that debt was related to high-speed rail construction. That’s more than the total public debt of Greece. The company runs only one profitable line -- the massively traveled Beijing-Shanghai corridor.
That is a staggering number. The debt of just China Railway Corporation is 30% of India's GDP!