Three new business concentration graphs

Market concentration and its harmful effects on the economy is well documented. But important decision makers (and opinion makers), especially in the US, remain unconvinced by the growing evidence. Or is it a matter of them being captured?

The latest comes in the form of the decision last week by a US Federal Court judge allowing the $85 bn merger of AT&T and Time Warner. The former provides phone, internet, video and data services (or distributes content), while the latter owns television channels across news, entertainment, and sports (produces content), and together they "can count as customers practically every household in America". The Judge ruled against a very weak challenge by the US Justice Department that the combination of a major producer and distributor of content could substantially lessen competition in media industry. The Steven Pearlstein in Washington Post has very nicely described the judgement as a "hatchet job" involving selective and biased evidence by a "judicial scoundrel"!

Be that as it may, here are three latest graphs that highlight the growing market concentration.

David Leonhardt has two graphs on economy-wide business concentration in the US from Business Bureau's Business Dynamics Statistics. The first captures the rising share of businesses with more than 10000 workers and the declining share of those with less than 20 workers.

And companies with more than 10000 workers employ more people than those with less than 50 workers. 

His documentation of the changes in the past quarter century are stunning,

In the late 1980s, small companies were still a lot bigger, combined, than big companies. In 1989, firms with fewer than 50 workers employed about one-third of American workers — accounting for millions more jobs than companies with at least 10,000 employees... The share of Americans working for small companies fell to 27.4 percent in 2014, the most recent year for which data exists, down from 32.4 in 1989. And big companies have grown by almost an identical amount. Today, companies with at least 10,000 workers employ more people than companies with fewer than 50 workers.

The third graphic covers a forthcoming IMF study on business concentration in developed and developing economies using data for publicly listed companies in 74 countries. It captures a measure of market concentration, average mark ups (or how much a company charges for its products compared with how much it costs to produce an additional unit of this product, expressed as a ratio).

The rise since the early nineties in the developed economies is capitalism gone berserk! Markups have increased by 43 percent since the eighties in those countries.

Ananth has a nice post on the irony of how the elites and decision-makers, even at places like the IMF, continue to pay lip-service to the evidence that their own research department comes up with.

The challenge with implementing public policy

You can have the best structured and incentive compatible policies and yet not have much impact on the ground in addressing the underlying problem. And this state of affairs can persist for years, even decades. Not for nothing is state capacity, in the opinion of this blogger, the biggest challenge facing India. 

Crop insurance and foodgrain procurement are two examples of where acute last mile gaps come in the way of realising desired outcomes. In both cases, it is easy enough to announce the best possible design of a crop insurance or crop procurement policy. But those announcements mean nothing when the rubber hits the road. In case of the former, the constraint is the insurance payout, while with the latter it is the actual physical procurement itself. There are no magic pill universally replicable innovations out of these problems.

Indian Express carries a story on the troubles faced by farmers selling off their produce at the public procurement centres at a mandi in Vidisha district of Madhya Pradesh.

Roop had received an SMS eight days ago from the cooperative society with which they are registered, asking him to come to the mandi on Wednesday, but the father and son chose to come a day earlier... Their token number, a chit issued the day they reached, is 234 — there are 233 farmers ahead of them in the queue. No more than 40 trolleys can be weighed in a day, which means the duo will have to spend at least five days before their turn comes... Until last year, trading at the mandi would happen between noon and 4 pm, when farmers would come, post-lunch, with their produce, which would be auctioned in the presence of mandi officials. This year, after chana prices started crashing due to a bumper crop and less demand, the government decided to buy directly from farmers — at Rs 4,500 per quintal — for the Central pool. Selling to the government offers farmers better returns than selling to private traders, which explains the rush... While the Singhs own their tractor-trolleys, many other farmers have hired vehicles to transport their produce to the mandi. “The rent for the first day is calculated according to the weight of the produce (anywhere between Rs 40 and Rs 80 per quintal of produce). From the second day onwards, we have to pay a daily rent for the trolley,” says Roop... The farmers wonder if a dharma-kanta (a weighbridge) would have eased their woes unlike the existing practice of unloading the produce on the floor of the mandi, packing it in bags, weighing each of them and sealing them, the entire process taking nearly 80 minutes for 40 quintals... Six days after they arrived at the mandi, the Singhs managed to sell chana from one of their trolleys. But they were told the chana in the second trolley had impurities. They will now get it cleaned and come back.

Consider the problems. Immediately after harvest, with chana prices crashing following a bumper harvest, farmers rush to offload their produce at the procurement centres over a very short time window. The procurement centre, without any weigh bridge or other logistics, has to get the produce graded, packed into gunny bags, and weighed. All this takes up an inordinate time for a single farmer and farmers stand in line for hours days! This wait in turn inflicts heavy tractor rental charges and other opportunity cost on the farmers. And even after waiting for days to get their chance, farmers face the prospect of being turned away and being asked to come back after rectifying some defect or other!

Much the same (difficult last mile gaps) applies to the Soil Health Cards or electronic national agriculture market place (eNAM). Sample this series of actions suggested on eNAM,

The following steps should be taken in a concerted manner: (i) unyielding focus on agri-market reforms starting with basics of assaying, sorting, and grading facilities for primary produce as per nationally recognised and accepted standards; (ii) creating suitable infrastructure at mandi-level (like godowns, cold storages, and driers) to maintain those standards; (iii) bringing uniformity in commissions and fee structures that together do not go beyond, say 2%, of the value of produce; and (iv) evolving a national integrated dispute resolution mechanism to tackle cases where the quality of goods delivered varies from what is shown and bid for on the electronic platform.

Each of the four steps, after putting in place the enabling implementation frameworks, need to be materialised. And that is where state capacity, persistent action, and committed leadership becomes necessary. 

Programs like Fasal Bima Yojana, Bhavantar Bhugtan Yojana, Soil Health Cards (see this and this), and eNAM are examples of reforms where enacting the rules and regulations is the easier part. But when the rubber hits the road, state capacity and other systemic constraints start to bind. There is only so much (mostly tinkering at the margins) that can be done with technology and innovation.

In simple terms, successful implementation of these require committed and stable leadership at the Ministry/Department level for atleast five years, maybe as mission-mode projects, with the mandate being to fix the plumbing challenges and demonstrate success with at least a few models. And they need to be complemented with responsive systems both at the level of the District Collector and the Joint Directors (or equivalent) of Agriculture in the District, in at least some of the districts. And it needs to be done in a phased manner with diligence, practical compromises and improvisation where required. 

And also, a one speed nationwide roll-out of such things may not be possible (state capacity) nor desirable (since it may run into political economy challenges). We need to look at the possibility of doing such stuff as a multi-speed campaign (which would also not concentrate discontent) - get everyone to the starting line with all the enablers (both regulations and requisite documentation), make available a practical implementation plan with the likely constraints and possible solutions around it, let the districts/states run with it at different speeds, and foster healthy (but not high enough stakes) competition among them. 

Many things which can be done relatively easily at the district level may not be possible for the States or Government of India to prescribe. It demands more of a gradual and bottom-up diffusion approach than a top-down, one-speed, universal coverage approach. 

This applies as such to the IBC too. As we go ahead, some or all of the following are likely - the Resolution Professionals (RPs) will be captured, judiciary will intervene indiscriminately, NCLT will be compromised, promoters will create hurdles even after resolution, and so on. We need some concerted systemic effort to be at it for a reasonably long enough period of time to allow some hysteresis to set in. 

A practical agenda for a government is to identify no more than 10 schemes/priorities, structure them as Missions, appoint an appropriate Joint Secretary/Mission Director for each for five years, give them a clear (but practical) road map, equip them with sufficient resources, and let them run with it for 5 years. And monitor them closely for five years at different levels.

Social protection programs and impact on poverty

A recent article in the Economist pointed to success of Ethiopia's social safety net programs. It said that social safety net programs formed 1.5% of GDP in Sub-Saharan Africa. It writes,

Ethiopia’s rural scheme is widely regarded as a success. It has reduced rural poverty and helped the poor buy food during a severe drought in 2016 that might have led to famine.

Now this is deceptive. What do we mean reduced poverty? Does it mean that people's lives have undergone a significant change? I guess all this goes back to the artificial minimalistic thresholds that we have constructed around per capita incomes to define poverty levels. 

The World Bank defines Social Protection (SP) programs as consisting of social insurance (mainly public pension schemes covering old age and disability), social assistance (cash and in-kind transfers and workfare schemes, often targeted to the poor), and labor market programs (training, entrepreneurship support, unemployment benefits).

Martin Ravallion and Co explore the impact of social protection programs on the poorest, the floor level of incomes,

The bulk of the impact of SP in developing countries is due to public pensions, which lift the floor by $0.38 a day. This too is below the mean spending on such pensions, which is $0.67 per day. Social assistance on its own only raised the floor by $0.015 per day on average—merely 8% of the (already low) level of average spending on social assistance. The bulk of the impact of SP on the headcount index (5% points) is also due to contributory pensions. Social assistance on its own reduced the poverty rate by 2% points. Countries that spend more on social protection tend to have a higher floor. The correlation coefficient is 0.751. Mechanically, this relationship reflects both differing levels of SP spending and differing transfer efficiencies. Transfer efficiency in reaching the poorest varies greatly. We see that very few countries attain a value of FTE of unity or more. (Recall that this is the ratio of the gain in the floor due to SP to mean spending.) For the bulk of countries (87% of the sample), the gain to the poorest is less than mean SP spending. FTE tends to be better for social assistance on its own, for which the median value is 0.934, as compared to a median of 0.630 for all SP; 43% of countries have FTE for social assistance greater than unity. In addition to FTE, we measure the efficacy of SP in reaching the poorest 20%, giving our second measure of transfer efficiency, GTE. The two measures are correlated (r = 0.505), but certainly not perfectly; some countries are better than others at reaching the poorest people given their efficacy in reaching the poorest 20%. GTE is positively correlated with spending per capita (r = 0.656), but that is not true for FTE (r = -0.021). As countries spend more on social protection, a larger share of that spending tends to reach the poorest 20% but not the poorest.

Now the takeaways in English. We need to make the distinction between poverty alleviation (allows people to have three meals a day compared to two) and poverty eradication (allows people to have meat twice a week, or a more dignified human existence). SP programs in almost all the developing countries help address the former. It will keep people meaningfully above the biological poverty line. It does little, on their own, to help the poorest transition to any meaningfully higher income level. This is just stating the obvious - social safety nets are for poverty alleviation, and not elimination.

If this is the case, then how appropriate is to use indicators like increase in savings or increase in aggregate consumption to measure the impact of social assistance programs like cash transfers? A more relevant measure of impact would be just the change in food consumption - having enough to eat three meals against the typical one or two, or eating meat once a week, or something like those.

This is a bit like the debate about the role of women self-help group movement. It is often confused as an instrument of economic empowerment, when its more relevant utility may be as a tool of social empowerment. 

Some PE myths busted

Fascinating article by Daniel Rasmussen that tests some of the claims made about the superior nature of private equity (PE) investments.

PE firms claim that their investments "accelerate growth and more efficient operations due to superior capital structure and PE managers ability to make long-term investment decisions that public companies cannot make". On this, an examination of 390 deals in the US, accounting for over $700 bn in enterprise value representing the majority of the largest deals ever done, for the financials of the portfolio companies reveals,

In 54 percent of the transactions we examined, revenue growth slowed. In 45 percent, margins contracted. And in 55 percent, capex spending as a percentage of sales declined. Most private equity firms are cutting long-term investments, not increasing them, resulting in slower growth, not faster growth... In 70 percent of cases, PE firms are leveraging up the businesses they buy. PE firms typically double the amount of debt on the balance sheet, from 2.5x ebitda to 5x ebitda—the biggest financial change apparent from our study... As an industry, PE firms take control of businesses to increase debt and redirect spending from capital expenditures and other forms of investment toward paying down that debt. As a result, or in tandem, the growth of the business slows. That is a simple, structural change, not a grand shift in strategy or a change that really requires any expertise in management.

The addiction to debt is the Achilles Heel of PE,

There is a big difference—bigger than most realize—between what private equity used to do (buy companies at 6–8x ebitda with a reasonable 3–4x ebitda of debt) and what private equity does today (buy companies at 10–11x ebitda with a dangerous 6–7x unadjusted ebitda of debt). Debt is a double-edged sword. It can provide great benefits if used judiciously, but if regularly applied in large dollops, it can create massive problems... The real reason PE firms want control of the companies they buy is not because of superior strategic insight but because they want to significantly increase debt levels. And while debt magnifies positive returns and enhances the returns of good decision-making, it can also cut the other way, exacerbating negative returns and punishing bad decisions.

 On returns,

From 1990 to 2010, private equity returned 14.4 percent per year, compared to 8.1 percent per year for the S&P 500 index. This 6.3 percent outperformance was net of private equity’s “2 and 20” fee structure, meaning that the gross return of private equity over this period was more like 20 percent per year... since 2010, private equity has, on average, underperformed the public equity market. Cambridge Associates’ U.S. private equity index has lagged the Russell 2000 by 1 percent and the S&P 500 by 1.5 percent per year over the past five years...

The Canadian Pension Plan Investment Board (CPPIB) and the Abu Dhabi Investment Authority (ADIA) did a bottom-up analysis of 3,492 private equity transactions from 1993 to 2014 to understand these dynamics. They found that private equity deals are different on two key quantitative dimensions from public equity investments. First, PE firms buy companies that are significantly smaller than broader public benchmarks. The median market capitalization of a company in the S&P 500 is $41 billion. The median market capitalization of a small-cap company in the Russell 2000 is $2 billion. But the median enterprise value of PE deals is only $250 million. Only about fifteen private equity investments have ever been larger than the maximum market capitalization of the small-cap index. Second, PE deals are significantly more levered than the typical public equity. The CPPIB and ADIA found that the average ratio of net debt to enterprise value at inception has been approximately 65 percent. The typical Russell 2000 small-cap company is levered at about 16 percent while the median large-cap company in the S&P 500 is levered at about 18 percent.

These two factors have been basically constant since the early 1980s. Changes in deal size and deal leverage levels do not explain why performance relative to public equity markets dropped off after 2010. And differences in size and leverage explain only about 50 percent of private equity’s historical outperformance of public equity markets. The factor that has changed is valuation. Private equity firms have historically bought companies at much lower valuations than the broader public markets. Here we see a significant shift from before the financial crisis to after. Since the crisis, the flood of money into private equity has driven up purchase prices significantly, eliminating the formerly large gap between private and public market valuations... 

Private equity is price sensitive because of the use of debt. Higher prices require more debt, leading to higher interest costs and higher risk of bankruptcy... The first approach is to look at PE deals and compare returns to purchase price. One PE firm did just such an analysis and found that over 50 percent of deals done at valuations of more than 10x ebitda lost money and that the aggregate multiple of money was barely over 1.0x (i.e., for every dollar invested, only slightly more than one dollar was returned to investors). The second is to compare the average purchase multiple in a given year to the returns of the funds from that vintage year. There is a –69 percent correlation between purchase price and vintage year return, a strong inverse relationship... The third is to look at PE-backed companies that IPO. My firm, Verdad, looked at every company taken public in the United States and Canada by a top-100 PE firm since the financial crisis, a data set of 195 IPOs with an aggregate ebitda of $66 billion and an aggregate market capitalization of $728 billion... According to our research, the cheaper IPOs dramatically outperformed the Russell 2000, the moderately priced IPOs matched the Russell 2000’s return, and the expensive IPOs underperformed.

In the context of the criticism of short-termism associated with public equity markets and the resultant long-term flexibility that private equity provides, this punchline is delightful,

And it is of course ironic that the same PE firms making these arguments—Blackstone, KKR, Apollo—have themselves gone public.

How much low can this get?

Two news stories over the week gave good illustrations of how far down the slope that the mainstream discourse and the establishment elites have slipped.

The first is an excellent story in FT about the latest in line from Wall Street's stable of financial market innovations. This one is manufactured default. In simple terms - buy default insurance on a company for a specific form of default, sell that company a loan which it "defaults", pocket the default insurance even as the loan keeps getting serviced in normal course. The graphic below nicely captures the transaction.

The description,

It is the debt equivalent of a controlled explosion: offering a company favourable financing, such as low interest loans, to convince it to intentionally default in a way that will trigger payouts on CDS contracts, but without bringing down the whole company. By doing this GSO pushed its trading edge on rivals to the limits of what many saw as legal.

The protagonist being Blackstone Group's GSO Hedge Fund, and the market being that for the very controversial Credit Default Swaps (CDS). And for once, Goldman Sachs was at the receiving end of chicanery that they have been used to dispensing, ending up owning the CDS which GSO had purchased. 

There are two observations. One, the surprising thing here was what a friend described as the break down of the "honour code" among the Wall Street majors. Goldman complained in public about manufactured defaults. Clearly, even by Goldman's standards this was a new low!

Two, this was not the work of a rogue trader. This was led by a Senior Managing Director, who apparently sat on  Blackstone's European Investment Committee. Clearly this was a part of Blackstone's (or GSO's) formal business plan. 

The second concerns this article on the happenings at London's Evening Standard tabloid whose editor is the former British Chancellor of Exchequer George Osborne (HT: Ananth). The ubiquitous London daily may be the first to almost formally breakdown the barrier between news and advertisements and package advertisements as news. Here is the summary,

London’s Evening Standard newspaper, edited by the former chancellor George Osborne, has agreed a £3 million deal with six leading commercial companies, including Google and Uber, promising them “money-can’t-buy” positive news and “favourable” comment coverage... The project, called London 2020, is being directed by Osborne. It effectively sweeps away the conventional ethical divide between news and advertising inside the Standard – and is set to include “favourable” news coverage of the firms involved, with readers unable to differentiate between "news" that is paid-for and other commercially-branded content... The London Evening Standard has a circulation of close to 900,000 and distributes more copies within a two-mile radius of Westminster than the Times does across the UK nationally. Many London commuters, who pick up their free copy of the Standard at underground and rail stations, will be unaware that they will be reading paid-for news coverage that is part of a wider commercial deal.

There is another important dimension to this story - the conflicts of interest associated with George Osborne. He also hold a £650,000 a year part time job (a day a week) with BlackRock, which holds a £500 m stake in Uber, one of the six groups.

Clearly, if these are true, Osborne is pioneering the standards for a new low in the formal news media industry. 

It also draws attention to the relevance of career politicians, as against those successful elites who foray into politics occasionally. Are we better served by corrupt career politicians who may have sufficient administrative capabilities? Or are we better off with fleeting professionals (and in the net maybe equally corrupt in a more sophisticated way) whose administrative capabilities are questionable (assuming that it does require some experience of government processes to be able to control government bureaucracies and get stuff done)? After all how can we reconcile President Obama who would have been confronted with very hard decisions on Wall Street firms and regulations governing them with Citizen Obama who is hobnobbing with them in the most egregious manner? Or Governor Ben Bernanke and Economist Ben Bernanke?

Now consider this. Both Blackstone and its executives, and George Osborne form part of the liberal elite establishment on both sides of the Atlantic. Their actions and the venality inherent in them are clear enough. Despite these they remain the most respectable icons of the establishment. 

I struggle to understand why Trump's actions are any more morally repugnant than these? I can understand the indignation that comes out when Trump uses public office to aggrandise himself. But I cannot understand when such egregious fraud and venality by the icons of the liberal establishment, which by the way is pervasive, gets nary a mention. FT has to be complimented for covering the GSO story. If this is the case, why should we at all be surprised by Trump or Brexit?

Predictive policing to deter crime

From the Economist Technology Quarterly,

Crime does not occur randomly across cities; it tends to cluster. In Seattle, for instance, police found that half of the city’s crime over a 14-year period occurred on less than 5% of the city’s streets. The red squares in Foothill district cluster around streets near junctions to main roads—the better to burgle and run while homeowners are at work—as well as around businesses with car parks (lots of inventory, empty at night) and railway stations. Burglars who hit one house on a quiet street often return the next day to hit another, hence the red squares.

The reference is to PredPol, a leading crime prediction software, which is used in Foothill and other districts across the LAPD, and each red square represents 2.3 hectare.  

Such algorithmic applications have two use cases - one to monitor the policeman's performance by measuring arrests and other specific actions, and second to deter crime by increasing surveillance and patrolling in high-risk areas. 

It may be the second use case that carries greater relevance for police districts in developing countries. Instead of focusing on punitive actions and personnel performance management, supervisory officials could focus attention on whether resources are being deployed in line with the diagnosis generated by the algorithms so as to deter crime. While the counter-factual of crime prevented is not easy to comprehend or communicate, this is a more sustainable and appropriate approach to using such applications, especially in the early stages.

I am reminded of the story of the Municipal Commissioner who used a similar approach to get the public health staff to keep the city clean. Sanitation in cities is critically dependent on night-sweeping of main roads and early morning garbage lifting, and cleaning of roads and open drains. It is therefore a practice for good Municipal Commissioners to make early dawn surprise rounds of the city streets. Though the Commissioner rarely ventures out of his car during the couple of hours of morning rounds, the likelihood of a surprise round by the Commissioner (or his/her easily recognisable car) has a powerful effect in keeping the public health workers on their toes.

Some of the more enterprising Commissioners, instead of waking up early in the morning, would send out just their vehicles with instructions to the driver to randomly cover a few streets! The galvanising effect was just as same! The same could apply to Police Commissioners making surprise night patrols. Anecdotally at least, in weak capacity systems, one could argue that Commissioners (Municipal and Police) who make shirking and non-compliance costly are among the most effective officers.

Signalling and deterrence are powerful forces in disciplining weak capacity systems and keeping order.

Credit market access for low income countries, but at what cost?

One of the main objectives of international development agenda has been to enable greater access to private capital for low income countries. Though the headline objective has been achieved, the unintended consequences appear to be not very benign. The IMF's latest Fiscal Monitor has some very interesting snippets on this.

Diversifying away from multilateral and bilateral aid, low income countries have been able to increase their access to non-concessional private sources. Market access has been realised...

... and non-concessional lending takes up the dominant share of borrowings in some of the largest low-income countries.

But this trend has coincided with interest expenditures touching the highs prior to the debt-forgiveness initiatives of the early noughties...

... and indebtedness is slowly climbing back to the pre-debt relief times.

All this has squeezed public investment, thereby imperilling future growth.

This could not have been any different. These low-income countries struggle with weak state capacity, very low and stagnant domestic tax revenues, pervasive macroeconomic instability, and very corrupt governments. They have very limited capacity to absorb commercial capital and generate the necessary returns (in terms of economic output growth) to be able to service the high cost debt. The infamous $850 m Tuna Bonds issued by Mozambique ostensibly to promote fishing is only the most egregious example.

It is only a matter of time before we will have the need for another round of debt reduction initiative. The only difference being that this time it would involve private creditors and not governments, and why should the former play ball in the name of development? And unlike Argentina, these small and far less powerful countries would be at the mercy of distressed asset vultures like Elliot Capital Management. Heck, when even Greece could not get any meaningful debt reductions, how could we expect Congo or Zimbabwe to swing something better?

Talk about operation successful, but patient dead!