Friday, August 17, 2018

Rare industrial policy success in India

Manufacturing of mobile phones has got a boost from industrial policy pursued by Government of India,
Xiaomi, by far the top-selling Chinese smartphone brand in India, started having handsets assembled in the country by Taiwan’s Foxconn in 2015, and now says 95 per cent of those sold in India are put together there... In April Xiaomi said it had started local production of the printed circuit boards that are the heart of every smartphone. It made the announcement at a conference of dozens of international suppliers it had invited to India to discuss local investment opportunities. Xiaomi’s actions... reflect smart if belated policy moves by Narendra Modi’s government. Onshore phone assembly has boomed since the 2015 introduction of stiff tariffs on imported handsets. Crucially, the government has also taken steps to encourage domestic manufacturing of the parts inside phones. Xiaomi timed the start of printed circuit board production in India to coincide with the April introduction of an import duty on the item — part of a multiyear programme to gradually introduce tariffs on smartphone components, starting with basic accessories such as chargers in 2016 and working up to touch panels next year.
More importantly, great example of why free trade and lower duties are not always the best solutions. 

Wednesday, August 15, 2018

Inequality and the financial crisis - role of housing and equity prices

The latest research in inequality studies comes from the Minneapolis Fed which draws attention to the evolution of wealth among US households.

Moritz Kuhn, Moritz Schularick, and Ulrike Steins used the Historical Survey of Consumer Finances (HSCF) and examined the distribution of household income and wealth across population groups and asset categories for the 1949-2016 period and found,
Middle-class portfolios are dominated by housing, while rich households predominantly own equity. An important consequence is that the top and the middle of the distribution are affected differentially by changes in equity and house prices. Housing booms lead to substantial wealth gains for leveraged middle-class households and tend to decrease wealth inequality, all else equal. Stock market booms primarily boost the wealth of households at the top of the distribution. This race between the equity market and the housing market shaped wealth dynamics in postwar America and decoupled the income and wealth distribution over extended periods... We estimate that until 2007, middle-class capital gains on residential real estate slowed down wealth concentration in the hands of the top 10% by about two-thirds. The housing bust of 2007-2008 was a watershed event as it hit the middle class particularly hard.
More specifically,
The HSCF data show that incomes of the top 10% more than doubled since 1971, while the incomes of middle-class households (50th to 90th percentile) increased by less than 40%, and those of households in the bottom 50% stagnated in real terms... However, when it comes to wealth, the picture is different. For the bottom 50%, wealth doubled between 1971 and 2007 despite zero income growth. For the middle class (50%-90%) and for the top 10%, wealth grew at approximately the same rate, rising by a factor of 2.5. As a result, wealth-to-income ratios increased most strongly for the bottom 90% of the wealth distribution... Importantly, price effects account for a major part of the wealth gains of the middle class and the lower middle class. We estimate that between 1971 and 2007, the bottom 50% had wealth growth of 97% only because of price effects — essentially a doubling of wealth without any saving. Also, the upper half of the distribution registered wealth gains on an order of magnitude of 60% because of rising asset prices. For the bottom 50%, virtually all wealth growth over the 1971-2007 period came from higher asset prices...
From a political economy perspective, it is conceivable that the strong wealth gains for the middle and lower middle class helped to dispel discontent about stagnant incomes... When house prices collapsed in the 2008 crisis, the same leveraged portfolio position of the middle class brought about substantial wealth losses, while the quick rebound in stock markets boosted wealth at the top. Relative price changes between houses and equities after 2007 have produced the largest spike in wealth inequality in postwar American history. Surging post-crisis wealth inequality might in turn have contributed to the perception of sharply rising inequality in recent years. 
In simple terms, the relative price of the two assets - land and equity - is the driver of wealth distribution and thereby inequality.

For the period from 1971-2007, total wealth growth from houses and stock prices and their respective  shares for different population percentile of the wealth distribution.
But since 2007, following the bursting of the housing bubble and the subsequent equity market boom, there has been a significant shift in trends.
The inequality impact of financial crises is best captured by the graphic below. It shows that the average household in the top 10% of today's wealth distribution is three times as rich as the average household in the top 10% of 1971's distribution, whereas those in the bottom half are poorer. 
Notice the dramatic wealth destruction faced by the bottom half from the financial crisis. And the reason for that being the knock-on effect on housing prices.

Alternatively, one could say that the bottom half were kept in the wealth game for the quarter century till the crisis by the booming housing market. 

Noah Smith has the graph below from the work of Edward Wolff that indicates the shares of total wealth in housing and financial assets in 2013.
The Minneapolis Fed research authors also shine light on the broader racial distribution of wealth and income in the US and associated trends,
The historical data also reveal that no progress has been made in reducing income and wealth inequalities between black and white households over the past 70 years, and that close to half of all American households have less wealth today in real terms than the median household had in 1970... In 1950, the income of the median white household was about twice as high as the income of the median black household. In 2016, black household income is still only half of the income of white households. The racial wealth gap is even wider and is still as large as it was in the 1950s and 1960s. The median black household persistently has less than 15% of the wealth of the median white household... In terms of labor market outcomes, we document that over seven decades, next to no progress has been made in closing the black-white income gap. The racial wealth gap is equally persistent and a stark fact of postwar American history. The typical black household remains poorer than 80% of white households.

Monday, August 13, 2018

Story of growth - ideas and institutions?

Andrew Haldane has a nice speech where he draws attention to the work of economic historians Steve Broadberry and John Wallis, who offer an alternative explanation for long-term economic growth. 

The conventional wisdom is that since per capita incomes were largely stagnant till it started rising from the middle of 18th century, historically the "global economy stood still in growth terms" and that industrial revolution (and associated "ideas") was the game changer for economic growth. By this argument, the subsequent versions of general purpose technologies led industrial revolution - electricity, IC engines, and sanitation (late 19th century); digitisation, computers, and internet (later part of 20th century); and AI, Big Data, automation, robotics, nano-technologies (ongoing) - have been the growth drivers. In other words, "ideas" were the drivers of growth.

But closer scrutiny questions this line of reasoning. Broadberry and Wallis use moving ten year average annual GDP per capita growth data to show that there were as many, or more and higher, growth spurts in the 1300-1750 period as in the subsequent period. But, unlike during that period, there were as many similar contractionary episodes. As Haldane writes,
Between 1300 and 1700, GDP expanded slightly more than half the time. Over these expanding periods, growth averaged 5.3% per year. The reason average growth was far-lower over this earlier period – indeed, little more than zero – was because expanding periods were almost exactly offset by contracting periods. They accounted for slightly less than half the period, during which growth averaged minus 5.4% per year.
So what has changed in the period since the Industrial Revolution? Growth during expansion periods is relatively little changed. Since 1750, it has averaged 3.2% per year. That is in fact a bit less than growth during expansion periods prior to the Industrial Revolution. This strongly implies it is not the greater incidence of ideas-fuelled booms after 1750 that accounts for the growth inflexion. The explanation lies instead in the dramatic fall in both the probability and cost of GDP contractions. Recessions have occurred only 30% of the time since 1700 and only 17% of the time since 1900. During these periods, growth has averaged minus 2.2% per year since 1700 and minus 3.4% per year since 1900. Since 1750, recessions have become far less frequent and less painful. It is the avoidance of deep recessions that differentiates the Golden Era from its Malthusian predecessor. 
And the explanation, "institutions". So "ideas" and "institutions" were responsible for the remarkable growth since industrial revolution. Haldane writes,
I will argue that it was the emergence of institutions that explains the rise in the other capitals that were essential pre-conditions for growth (human, social, infrastructural, intellectual etc.) It was the emergence of these same institutions which also cushioned the damaging effects of recessions... a rather broader set of “capitals” – not just physical capital (plant and machines) but human (skills and expertise), intellectual (ideas and technologies), infrastructural (transport and legal systems), social (co-operation and trust) and institutional (national and civic, private and public) capital.
Political upheavals and technological disruptions are the common triggers for emergence and evolution of institutions. They trigger the formation of social infrastructure or "enabling" and "insuring" institutions. As to the latter, relevant today for developing countries, there was a wide-ranging shift in the role of State in society from 17th century,
State spending as a proportion of national income rose from around 1% in the 16th century to around 12% in the 18th, 14% in the 19th and 33% in the 20th.39 It financed social infrastructure of various kinds supporting those facing greatest hardship. This ranged from social housing to healthcare to income support. Its effect was to cap the downside, recessionary risk to individuals, economies and societies.
So the takeaway,
Well, the story that better fits the facts appears to be one in which the conveyor belt of ideas and innovation has been continuous over the centuries, causing lengthy if lumpy ideas-fuelled expansions. But whereas prior to the Industrial Revolution this conveyor belt was regularly halted by recessions, more recently these interruptions have been far fewer and less costly. Put differently, the real revolution in living standards after 1750 came about not exclusively, or perhaps even mainly, from the surge in ideas and technologies. Rather, it resulted from societies having found some means of avoiding the subsequent recessionary bullets. Prior to the Industrial Revolution, these killed expansions dead. After it, societies appear to have found some effective means of dodging them... 
Joseph Schumpeter spoke powerfully about the forces of “creative destruction”. The lesson of history seems to be that we need both to “cultivate the creative” and to “disarm the destructive” if innovation is to translate into rising levels of social, human and infrastructural capital and, then, higher living standards. It is only by establishing strong institutional roots that technological fruit can subsequently be harvested... But if history is any guide, the story of growth will hinge on the interplay between the two “i”s – the disruptive forces of innovation on the one hand, the stabilising role of institutions on the other.

Sunday, August 12, 2018

Black Death and Industrial Revolution

Peter Temin distils the literature that connects industrial revolution to the Great Plague,
Voitländer and Voth argue that the scarcity of labor after the Black Death led to a change in agricultural technology. Moving along the wage-rental isoproductivity line, farmers changed from growing crops to tending animals, from arable farming to husbandry... The result of this adaptation of agricultural technology changed the role of women in Medieval society. Switching from crops to husbandry reduced the demand for strength to push plows and expanded the scope of work that women could do. The result was a change in the status of women in society... The reduction in plowing reduced the demand for men’s labor and increased it for women’s labor. Women’s wages rose and their opportunity for work expanded. They delayed marriage, entered service and became more independent... It was a massive change in the structure of society...


The opportunities open to women delayed their marriage and reduced the rate of population growth. The result was the birth of the high-wage economies of England and a few neighboring countries. Voitländer and Voth... estimate that the share of pastoral production in English agricultural output rose dramatically from 47 to 70 percent between 1270 and 1450. And they show by regressions that... the extensive use of pastoral production increased the age of female marriage by more than four years... The adaptation to the initial shock led to a durable rise in people’s income. This in turn led to a demand for more meat in their diet, which of course was accommodated by more husbandry. The whole pattern fit together with the Black Death as a shock that shifted households and the economy from one equilibrium to another.

This all fits in with Allen’s view of the Industrial Revolution being the result of a high-wage economy... Allen argued that the initial innovations of the Industrial Revolution emerged from tinkering by producers to reduce the costs of expensive labor and reap the benefits of cheap power... Allen argues in more recent work that wages and energy prices in North America were close enough to the British pattern for policy initiatives like tariffs, education and infrastructure investments to create conditions hospitable to industrialization. This clearly was true of countries in Western Europe that also followed the British pattern once industrial productivity advanced from its initial level. These countries did not have the factor prices to make the initial innovations of the Industrial Revolution profitable, but further development of these innovations rendered them profitable at factor prices close to those in Britain. And, as Allen noted, policy changes helped industrialization along as it spread.

But this was all within the high-wage area described by Voitländer and Voth. They noted that the European Marriage Pattern extended only from the Atlantic to a line from St. Petersburg to Trieste. Other countries in Asia or Africa were low-wage economies subject to Malthusian pressure on wages, and their factor prices were not close to English prices. Small changes in economic policies were not sufficient to make industrialization profitable in India or Egypt. The story that links the Black Death to the Industrial Revolution therefore is also a story why Europe has industrialized most easily in the past two centuries.

Friday, August 10, 2018

Weekend reading links

1. Ananth points to the stunning shift in the market for leveraged loans,
Right now roughly 78% of the more than $1 trillion in outstanding U.S. leveraged loans are cov-lite, compared to just 29% in 2007, at the peak of last credit cycle (and just before the financial crisis). Cov-lite loans place fewer restrictions on a borrower than do traditionally structured credits... the average discounted recovery rate on cov-lite loans undertaken before 2010 is 78%. That figure drops to 56% for cov-lite loans originated in 2010 and after...
2. As the 5G telecommunications spectrum auctions beckon, Mobius Philippose raises the inevitable questions around winner's curse,
The recommended price for the 5G spectrum on offer is over seven times of what was discovered in a recently held auction in South Korea for 3,500 MHz spectrum. 
At the recommended reserve prices, the Telecom Regulatory Authority of India (TRAI) estimates the auctions would be worth over ₹5 trillion, or as much as $78 billion. Mobius feels that given their troubled balance sheets, the high reserve prices are likely to deter telecom providers from bidding for spectrum. 

I am inclined to agree with his view, but not the conclusion that keeping reserve prices high "shows that the regulator and the government don’t care much about the financial health of surviving telcos".

3. SEBI has a draft proposal to deepen capital markets in India by mandating corporates with outstanding long-term borrowing greater than Rs 100 Cr and with credit rating of AA and above to raise 25% of borrowings through corporate bond market. It is proposed for implementation from 1 April 2019, would be on a "comply or explain" mode for the first two years, and would have fines ranging from 0.2-0.3% of the shortfall.

Tamal Bandopadhyay has a nice article which highlights some of the concerns. 
According to a recent analysis by Care Ratings, as of March 2017, the credit limit of such borrowers was 1.5 times the amount of loans actually taken. The Care analysis finds that 106 large companies with over ₹ 10,000 crore credit limit in March 2017 sourced 47% of funds from banks and 16 of them have never entered the bond market. From a group of 42 companies with bank credit limit between ₹ 7,500 crore and ₹ 10,000 crore, 11 never raised money from the bond market...


In a rising interest rate scenario, companies prefer to borrow from banks where the cost is relatively lower than the bond market which reacts fast to rising rates. In the first quarter of current fiscal year, ₹ 66,997 crore has been raised from the market against little over ₹ 1.48 trillion in the year-ago quarter. The volume of gross issuance was ₹ 6.4 trillion in 2017 but dropped to ₹ 5.8 trillion in 2018 and will reduce further in the current year given the rising yields...
Currently, the bond market is dominated by AAA issuers and the issuances by A-rated entities are a measly 2%. The key reasons for the lack of appetite for the A and lower-rated companies’ papers (a bond is considered investment grade if its credit rating is BBB- or higher by Standard & Poor’s or Baa3 or higher by Moody’s) are that most of the investment regulations either do not permit investment in private corporate bonds with rating lower than AA and, even where it is permitted, discouraged through regulatory interventions.
4. Dani Rodrik makes the case to reform WTO to make it accommodate more diversity, 
Negotiated at a time of neoliberal triumphalism, WTO reached inside the border to constrain domestic policies in subsidies, health and safety and intellectual property. Any domestic regulation with an adverse impact on imports could now be treated as a trade restriction. Subsequent trade agreements went further, prioritising trade and foreign investment over domestic concerns. Western policymakers tend to think of today’s global trade rules as neutral and impartial, treating all participants fairly. But trade agreements are political documents, reflecting the interests of dominant coalitions. Multinational corporations, international banks and Big Pharma play a particularly important role in shaping them. It is no surprise that long-term concerns about development, or indeed labour rights and the environment, are given short shrift... When trade threatens to undermine domestic labour standards, fiscal systems, or investments in advanced technology, rich nations should be just as entitled to privilege these concerns over imports and foreign investment...  
If the WTO has become dysfunctional, it is because our trade rules have over-reached. A fair world trade regime would recognise the value of diversity in economic models. It should seek a modus vivendi among these models, rather than tighter rules.
The point being made is less about a justification of China as a case for flexibility within international  trade frameworks, but more about allowing the freedom for individual countries to respond to trends which are genuinely detrimental to their interests.

5. Global tourism has been growing at an explosive pace,
International tourism rose from fewer than 300 million trips in 1980 to some 500 million in 1995, before exploding to 1.3 billion trips in 2017—a number that’s expected to rise to 1.8 billion in 2030.
And China has been the main driver,
China also accounts for an estimated 80 percent of the growth in tourism spending over the past 10 or so years.
6. NYT chronicles Mawlynnong, the cleanest village in India.

7. One of the less discussed problem mounting up across the US and now UK (and elsewhere too) is the financial crunch faced by local governments and its impact on their ability to continue the delivery of regular civic and utility services. Sample this from UK,
Central government funding for local authorities has been reduced in real terms by 49 per cent between 2010-2011 and 2017-18, according to the National Audit Office, parliament’s spending watchdog. Nearly half of England’s 353 local authorities recorded real-terms falls in their reserves between March 2015 and March 2017, according to an FT analysis conducted earlier this year
With economic stagnation, declining or stagnant median incomes, widening inequality, rise of part-time jobs, and so on, cuts in important civic services and consequent pressure to pay for them could be adding fuel to the fire of discontent that feeds populist politics.

8. There is no bigger market failure than in the market for audit services. Talk about the illusion of competition and conflicts of interest in that market,
No fewer than 98 per cent of FTSE 350 constituents (the largest companies on the UK market) have their books vetted by one of KPMG, EY, Deloitte or PwC. In the US, the figure is 99 per cent for the S&P 500... Conflicts are often hidden discreetly beneath the surface. Accountancy firms are not required to be open about the consulting work they provide to companies, from pension and tax advice, to advising on pay policies or restructuring. These ancillary activities can often be much more lucrative than a plain audit contract (which, in addition to legal risk, also limits a firm’s ability to bid for non-audit business)... While situations where conflicts restrict large companies to considering at best two, or in some cases one, of the Big Four are rarely public knowledge, they are relatively routine.
And the conflicts can be egregious,
PwC was recently confirmed as the “delivery partner” to the regulator, Ofwat, for its next price review in 2019, This involves vetting industry business plans to determine appropriate prices. PwC undertook the previous price review in 2014, at a time when it audited or advised no fewer than nine of the UK’s 19 water companies. This time its role is more modest. But it remains statutory auditor to three firms, including the UK’s largest, Thames Water, and provides services to several more. Prem Sikka, professor of accounting at the University of Essex, said of the situation: “Such links will no doubt be exploited to attract clients and say that the firm will show you how to duck and dive and negotiate the regulatory environment. Firms can’t serve more than one master and must be banned from having their fingers in all pies.”
There are also more pernicious forces at work that deter smaller rivals from competing for audit contracts,
Across Britain’s largest listed companies, 61 of the 100 audit committee chair positions at the end of last year were held by Big Four alumni, according to Accountancy Daily. The ties that bind the Big Four to big business extend beyond the boardroom, to the worlds of politics and regulation. This creates a feedback loop that reinforces the giants’ dominance as their connections give them a powerful advantage when bidding for public or private work.
Wholesale break-up of the Big Four or separation of consulting and audit business or selection of the audit firm by a regulator, stock exchange or government are ideas under discussion to address the problem.

9. Finally, comparing China, India, and Vietnam,
“In China, the government can do everything; in India they can’t do anything,” says Huynh The Du, a lecturer at Saigon’s Fulbright University. “In Vietnam it’s somewhere in between: sometimes the government can’t do things because of the resistance of the people.”

Wednesday, August 8, 2018

The interesting case of employee promotions

Tim Harford points the work of Alan Benson, Danielle Li, and Kelly Shue which appears to establish Peter's principle ("every employee rises to his level of incompetence") at work in modern organisations. They use data from 214 firms, more than 53000 sales employees, and more than 1500 promotions into managerial positions. 
The authors of the paper discovered that the best salespeople were more likely to be promoted, and that they were then terrible managers. The better they had been in sales, the worse their teams performed once they arrived in a managerial role. What’s more, people were not promoted for behaviour that might seem correlated with managerial ability — in particular, those who collaborated with others were not rewarded for doing so. What mattered were sales, pure and simple. In short, Professor Peter was right. Brilliant people are promoted until they become awful managers.
If this is true, then Alessandro Pluchino, Andrea Rapisarda and Cesare Garofalo have another suggestion,   
If performance at one level of a hierarchy is uncorrelated with performance at the next level up, the best strategy is simply to promote the very worst people. Nobody knows whether they will make good managers, but at least they will no longer be dreadful staff — or as Dogbert in the cartoon strip Dilbert put it back in 1995: “Leadership is nature’s way of removing morons from the productive flow.” There are two difficulties with this approach: first, it may be too extreme to assume that no skills at all carry over from one job to the next; second, if the reward for failure is promotion, then the likely response is an organisation full of people bent on sabotage. So Profs Pluchino, Rapisarda and Garofalo suggest a compromise: promote people at random.
Managerial capacity, while often taken for granted, does not come by default or naturally. It needs to be cultivated just as an other skill. And even when cultivated, it is a scarce resource not easily imbibed by everyone. 

Tuesday, August 7, 2018

Are RCTs crowding out serious research on India?

Devesh Kapur writes on India focused scholarship emanating from the US. He has this assessment of the RCT research,
Suffice it to say the effects have been much more positive for the careers of US-based researchers than for India. Ironically, some of the very strengths, such as the stress on identification and causal inference, have been a source of weakness. The stress on these methods as “the gold standard” comes at the cost of relevance and timeliness. Only certain types of questions can be addressed by these methodologies. This is not to say there aren’t excellent studies that address important policy questions. But more often than not, even if they can address them, the costs and duration of these studies means they are more useful as citations than policy.
When asked how many of these expensive RCTs had moved the policy needle in India, Arvind Subramanian, Chief Economic Advisor, GOI, was hard pressed to find a single one that had been helpful to him in addressing the dozens of pressing policy questions that came across his table.
Kudos to him for having called this out!

This proliferation of RCTs in India may have also had the unintended effect of crowding out other more relevant research on issues concerning India. It should be a matter of great concern that even as many of the RCT papers have become popular, I cannot recall a single serious work by a reputed US-based researcher on India's ongoing banking crisis (say, a comparative study), the infrastructure boom and bust of the last decade, heterodox monetary policy success during the global financial crisis, financial market architecture and capital markets, economic growth trends and drivers over the past two decades, experience with PPPs, comparison of India's SEZs and industrial policy with China and others, public finance reforms, informal markets, fiscal federalism, urbanisation and so on. 

In all these areas, apart from some high quality work by local Indian researchers, serious exploration is confined to either reports by global Consultancies or one-off papers by researchers from IMF, WB, and ADB. It is a pity that even ethnic Indian researchers in these Universities prefer either to do the RCT stuff or focus on US and other countries.

The contrast with works on macroeconomy, infrastructure, financial markets, public finance and so on concerning China, Latin America, Italy, Spain etc coming out of places like Harvard is very stark. It may be no exaggeration to suggest that the only area of interest concerning India in top US Universities revolves around poverty studies of the kind involving randomised control trial (RCTs) and romanticised visions of entrepreneurship and social enterprises that serve the Bottom of Pyramid!

This is not the only negative externality. The RCT movement has also displaced good old ethnographies and other insightful qualitative studies. Consider this. Devesh Kapur again, has a very good paper which goes beyond the IAS bureaucracy and shines light on the dark underbelly of the Indian state - the "chronically under-resourced" frontline bureaucracy and the constraints they face. It is an indictment of the development research that this may be the only such ethnographic study of Indian bureaucracy by a foreign based academic. The vast majority of RCT researchers themselves would be enormously enriched by internalising the field conditions described by Devesh and his co-author.

In order to catalyse serious research on India, institutions like the RBI and NITI Aayog may have to take active interest. In co-ordination with the Ministry of Statistics and Program Implementation, they  could guide research on some of the aforementioned areas by making available with appropriate safeguards and conditions the country's very rich set of databases from Economic and ASI census, Companies Registration (MCA), labour related data (Labour Bureau, EPFO, NPS etc), taxation (CBDT, CBEC, GST, States etc), PPPs (MoRTH, DEA etc), stalled projects, and so on.