Sunday, November 30, 2008

The news channels wars

I am on a holiday. Without access to reliable internet connection, blogging was naturally intermittent. However, the rivetting events of the past few days kept me tuned on to the television channels. A few observations from the coverage.

Even as the NSG commando were fighting the terrorists holed up inside the Taj, Trident and Nariman House, another battle was being fought outside by the television news media channels to capture the media space. While the commandos acquitted themseleves with distinction, the same cannot be said of the ultra-competitive media channels. To put it bluntly, the actions of large sections of television channels were disgraceful, insensitive and indecent. Many of them came out as undignified and greedy vultures swooping down on hapless victims of the tragedy.

I had been under the impression that a reporter was meant to report events and even illustrate possibilities, which were then to be analyzed by editors and external analysts. But the events in Mumbai saw reporters throwing all such distinctions to the wind, elevating themselves as self-appointed analysts and media pundits, spraying "wisdom" in all directions. Some of them had even become self-appointed flag-bearers of nationalism and patriotism.

Ironically enough, the anchors and editors who were vituperative in criticising (rightly so) the politicians for using the tragedy to score brownie points, were culpable of falling prey to the same disease. Many of them, with a few honourable exceptions, saw this as an one-time opportunity to make and enhance reputations, and flagellate as popular opinion makers. What spouted out as informed analysis was the routine denuciations of the usual suspects - Politicians and Pakistan - and simplified band-aid solutions to a complex challenge.

Traumatized victims (especially foreigners) released from the clutches of terrorists were hounded for soundbites (despite polite refusals), and politicians (like spokespersons of political parties) were accused (even abused) of being responsible for the tragedy in a manner bereft of any dignity. The middle class sentiments were sought to be aroused by playing to the galleries through a brazenly artificial exposition of the courage and bravery of the soldiers and commandos and public catharsis of the released victims and their relatives.

If there was poignancy, it certainly was not evoked by most of these journalists, including the superstar ones (who even professed to conveying poignancy), reporting on it. The ruthless and insensitive nosing for news was disgraceful, to say the least. If this was an attempt to whip up national pride and stand up for our armed forces, please, don't ask us to be subtle about it!

I vividly recollect a bewildered Chinese looking chef of the Taj, who was hardly able to scramble through the fusillade of questions hurled at him by one of our superstar television journalists, apart from sticking to the safe, if monotonous, "no" to whether he had seen or heard anything. Questions on issues as weighty as who was responsible for the terrorist attacks and how many were killed and injured (something which even the intelligence agencies of the government were yet to figure out!) were thrust on the poor man who had just escaped the hotel. The poor lad was relegated to the backstage, even without as much as a sympathetic remark for the difficult ordeal he had been through, and obvious obscurity for even "not having heard a bomb explosion".

This particular "superstar" also "distinguished" himself in his other reports by constantly bombarding his "victims" with his non-stop barrage of questions which appeared to have the objective of eliciting a particular answer than the correct answer. Some of the antics of our popular television news anchors were clearly cheap attempts at imitating western media personalities like John Simpson and Christian Amanpour.

The most garish omission obviously was the near total lack of sympathy or coverage of hapless victims, who being lesser mortals" lost their lives in the oblivion of the not so "iconic" CST. So skewed was the coverage that a viewer could be excused for not knowing that the largest number of casualties and biggest "human tragedy" took place at the crowded railway station.

The last straw that broke the camel's back was undoubtedly the injured claim on the last day on how "the shocked victims would hardly speak to the journalists who had been patiently waiting for them outside".

Saturday, November 29, 2008

Ineffectiveness of Monetary Policy

The last few decades have been the high water mark of Monetarism. It had become a hallowed axiom of Central Banking and macro-economic policy making that by targetting inflation and maintaining price stability, economic growth could be controlled. When the inflationary pressures rose, raise interest rates, and conversely when it fell, cut the rates. The unprecedented long period of economic growth, with only minor blips, appeared to lend credence to this view. The business cycle appeared to have been tamed.

The Monetarists had long claimed that contrary to the Keynesian contention that monetary policy was impotent during depression-type conditions, the Fed could have, by loosening the monetary base prevented the Great Depression. Newer versions of the monetary theories have even claimed that the Fed caused the Depression. Paul Krugman lays evidence to prove that both the assumptions are wrong.

The original claim is disputed by the evidence that the monetary base rose steeply during the Great Depression. The aggressive monetary loosening by the Fed and bailout of the financial sector by the Treasury during the ongoing sub-prime crisis and its failure to stem the cascade of bad news seriously undermines the claim that monetary expansion can prevent Recessions.

Update 1
The most definitive proof that monetary policy can save the economy in times of economic slowdown comes from the present crisis. Unlike the Great Depression, nobody can accuse the Central Banks across the world, individually and collectively, of not doing enough and quickly at that. We have seen the Fed and others summon all the monetary policy levers - lower rates aggressively to the zero bound; capitalize banks and financial institutions with the most liberal terms; inject liquidity through their discount windows by relaxing all lending standards; act as a market maker of last resort by purchasing troubled assets and commercial papers; and provide blanket guarantees to deposits. The amounts involved have been mind boggling - more than $1.3 trillion in the US alone, and counting!

Apart from a few hours (in a few cases, a couple of days) of market rally, the financial markets and the economy appears to have hardly acknowledged these interventions. If anything, Central Banks, and not the Governments, have been the primary players in the drama so far.

However, despite the overwhelming proof, apologists of Monetarism, will surely claim that had the Central Banks not intervened so aggressively, the situation could have been much worse!

Friday, November 28, 2008

Dual economy parable!

Here is a parable about dual pricing. Assume a country, Economia, with economically integrated provinces, Subsidonia and Marketonia. The one difference between Economia and other countries is that its government is elected by an electorate consisting of all the children under the age of 15!

One fine day, as a 'children's day' gift to its electorate, the government of Subsidonia decides to give 20 kilos of chocolates to each child at Rs 2 per kg every month, through its numerous Choco outlets. Since the prevailing market price of chocolates is Rs 15 per kg, the announcement receives overwhelming support. However, apart from small differences in quality, perceptible only to the most discerning, the chocolates sold at Rs 2 and Rs 15 per kg are basically the same.

This decision sets off a chain of reactions. First, the shop keepers of Subsidonia now have no incentive in purchasing chocolates from their producers (and distributors) at the high rates of Rs 8-12 per kg. They can source it at far cheaper prices (say, Rs 4-8) from a set of middlemen, who have emerged overnight and who clandestinely procures chocolates directly from the Rs 2 market.

Second, the massive demand for the Rs 2 chocolate, crowds out the supply for the private market. The result is that a supply starved regular market experiences a spurt in chocolate prices from Rs 15 to Rs 25. Third, the increased differential makes the Rs 2 chocolate even more attractive, and its demand increases even further. Some children start making fake documents to claim more than their share, and adults masquerade as children to partake of the Rs 2 bargain.

Fourth, since government bulk procurement agencies are not too keen about the quality of the chocolates delivered and the producers are assured of their prices in an assured market, they have little or no incentive in maintaining quality. Further, chocolates being chocolates, children too do not mind the inferior quality.

Fifth, the children of Marketonia, angry with their government at being shortchanged in comparison to their colleagues in Subsidonia, find that they too can partake of a share in the chocolates originating in the Rs 2 chocolate market of Subsidonia. The chocolates from this market finds its way into Marketonia's chocolate market and gets sold for a price range of Rs 6-10.

Finally, in extreme cases, the producers and their wholesalers sell their chocolates to the government, and later repurchases it back from the middlemen at Rs 4-8 and then sells it back again to the government. And the circle continues!

Now replace Economia, Subsidonia and Marketonia with India and any of its states, chocolates with rice, Choco outlets with ration shops and children with adults, and we have an accurate description of the competitive populism induced Rs 2 rice scheme being implemented by different state governments in the country.

Standard economic theories and experience from across the world, conclusively proves that it is impossible to maintain a regulated dual market, especially one with steep price differential, in any commodity,leave alone something as essential as rice. Incentive distortions resulting in the emergence of parallel markets in the rice trade are inevitable.

A more effective way of ensuring subsidized food grains for the poor would be to give food stamps or vouchers, and then reimburse the shopkeepers who produce these vouchers. Another option would be to directly transfer the cash differential to the accounts of the beneficiaries. Such alternatives do not require a parallel market in the commodity. Therefore, it would not distort the incentives of the various stakeholders and will ensure more efficient targeting of the subsidy.

Shopping Guernica!

The incident involving the trampling to death of a Wal Mart employee in a New York store during the Thanksgiving shopping weekend captures the mood of the moment. As the economy weakens and the purses hollow out, American consumers, unable to shake off the long cultivated addiction to shopping, are finding solace in bargain shopping.

NYT has an excellent feature on the Wal Mart incident, comparing it to a "shopping Guernica"!

Assessment of new US Treasury Secretary

NYT carries an assessment of Timothy F Geithner, the Tresury Secretary designate in the Obama administration. It quotes Christopher Whalen of Institutional Risk Analytics,

"We have only two things to say about Tim Geithner, who we do not know: AIG and Lehman Brothers. Throw in the Bear Stearns/Maiden Lane fiasco for good measure. All of these ‘rescues’ are a disaster for the taxpayer, for the financial markets and also for the Federal Reserve System as an organization. Geithner, in our view, deserves retirement, not promotion."


As President of the Federal Reserve Bank of New York, Mr Geithner was closely involved with Henry Paulson and the Treasury in structuring the deals that form the bulk of the ongoing bailout of the financial markets. His role in creating and perpetuating the regulatory oversights and omissions that fuelled the mortgage bubble too has been the focus of criticism.

Update 1

Ben Stein is even more damning in his assessment, calling Geithner the "pre-eminent careerist of old-time finance".

Update 2
Frank Rich raises troubling questions about the "best and brightest" in the Obama administration.

Update 2
Michael Hirsh is right in asking why Joseph Stiglitz, the only man consistently on the mark in predicting the entire crisis and an earliest supporter of Obama, is not in the team which is now packed with a "center-right cabal". Stiglitz has been the leading voice opposed to the mindless liberalization of capital flows that brought us to where we are today.

Update 3
NYT has this chronicle of Tim Geithner's close ties with Wall Street. And Economix has the details, including his calendar.

Thursday, November 27, 2008

Fed as lender and insurer of last resort?

Initially, the Fed had radically relaxed its collateral requirements and permitted using even derivative securities as collateral in its term auction lending windows. But even this failed to have the desired impact, leaving the Government with no option but to make more direct interventions by pumping money directly to revive distressed markets, instruments, and institutions.

On November 25, 2008, the US Treasury and Fed unveiled a facility that will buy up to $200 billion of newly issued, top-rated asset-backed securities. Under this Term Asset Backed Securities Loan Facility (TALF), the Federal Reserve Bank of New York will make one year loans to institutions where the collateral is auto loans, student loans, credit card loans, or business loans guaranteed by the Small Business Administration (all triple AAA rated only). The first $20 billion of lending will come from the TARP, while the remaining will come from the New York Fed, "in effect leveraging each TARP dollar many times over via the Fed’s balance-sheet".

The Fed also promised to buy up to $500 billion-worth of mortgage-backed securities (MBSs) guaranteed by government-sponsored enterprises (GSEs), including the now nationalised mortgage agencies, Fannie Mae and Freddie Mac, and up to $100 billion-worth of their direct debt through auctions.



This marks the emergence of the Fed as a lender of last resort, even effectively lending directly to the homebuyers and taking over the role of the mortgage refinancing agencies itself. It is hoped that this would reduce the credit costs for the big underwriters of home mortgages, which should make it easier and cheaper for people to get mortgages.

There are many dangers associated with such guarantees and loans. At worst, the tax payers will have to pick up the tabs for any loans which get defaulted and any guarantees which have to be made good. The moral hazard concerns generated by it are enormous and we will have to live with it for years to come.

Tuesday, November 25, 2008

Financial inclusion and banking regulations

The Government of India has launched an ambitious program of Total Financial Inclusion (TFI) to provide access to formal credit mechanisms to those below the poverty line. The Government will do well to pay heed to a study by the World Bank on financial inclusion, which concludes that certain types of regulation and excessive document work is detrimental to increasing access. The graphic below clearly proves that fewer the number of documents required to open an account, the greater the number of accounts for every thousand population.



The report also finds that jobs in the organized sector increases access to formal credit streams. This poses formidable challenges for a country like India, where a recent report finds 96% of the jobs are in the unorganized sector. It also finds that stripped down or simplified banking products can contribute towards increasing access, something on which the TFI initiative has made considerable progress.

Irrational economic agents and the economic crisis!

Behavioural economists have debunked the rational economic agent hypothesis for some time now. The ongoing crisis appears to have made consumers in the US even more irrational in their consumption patterns. In what can be best termed as the "Wal Mart effect", large numbers of consumers are flocking to budget stores and stocking up materials in the belief that buying at Wal-Mart and Co. equals saving money. There appears to be a prevasive feeeling that you can save money by spending it, especially on cheap buys, whether you need them or not!

The downturn has had the obvious effect on people cutting down on certain spending like luxury goods, vacations, weekend holiday commutes etc. But the money saved on these appear to being spent with vengeance elsewhere, often on the not-so-essential items just because they appear cheap. People are signing up for discount stores that sell in bulk and over-purchasing ‘bargains’ that are so enormous they will not live long enough to use the item, and are whittling pennies from cable bills only to squander dollars on gas driving miles to discount stores, or on coupon-spurred splurges for nonessential items, like Cheez Whiz or organizing supplies.

Faced with declining conventional sales, businesses are adapting to the changing environment with innovative sales and marketing tactics that seek to play on the psychological insecurity of their consumers. Retailers have been cutting prices aggressively and offering interest free loans in an effort to lure in consumers. As one consumer said, "my phone bill still has charges like $4.99 per month for technical stunts I can’t even pronounce, much less access. No wonder Verizon is doing well"!

Post-modern cricketer

Andrew Miller is spot on in his analysis of the thrashing India has meted out to England in the ongoing one-day series. Even more appropriate is his description of Virender Sehwag as the first truly post-modern cricketer.

Sunday, November 23, 2008

Keynesian moment - time for Government to takeover?

Ben Stein and Paul Krugman, among others, feel that the US economy may be slipping into a Great Depression type high unemployment, long term Keynesian equilibrium. They feel that the tsunami of fear that first enveloped the financial markets, now threatens the economy. The result is that consumers and companies have cut back on spending, credit taps have gone dry and lending has come to a standstill, all of which raises the real possibility that economic activity will continue indefinitely at a level consistent with serious recession or even depression.

This fear psychosis and the possibility of getting trapped in its vortex, is being cited as a compelling enough reason for aggressive government intervention, both through large enough fiscal stimulus and bailouts of major firms and sectors. (Monetary policy has been driven to irrelevance as a stagflation beckons) Ben Stein writes that the costs of getting out of this turmoil are going to be high, "We cannot nickel-and-dime our way out of this".

How do we know we have reached the "Depression eve"? What are the ideal fiscal stimulus measures for the time and how large should they be? How should the fiscal measures be structured and scheduled? How do we select the firms and sectors to be bailed out? What should be the bailout help and how should it be structured? What should be the eligibility for bailout assistance?

These and other questions are going to be at the forefront of economic policy debates in the days and weeks ahead. None of these have clear answers, and decisions will be taken based on the individual and collective perceptions and judgements of the decision makers. One can only hope that decisions are taken as informed choices, untainted by ideological predilections and vested interests, perceptions of all stakeholders get appropriately aligned, and tons of luck follows.

Only time will tell whether these policies were good or bad. Such situations highlight the difficulty of economic policy making. There are no policy certainties in managing an economic situation.

Update 1
Greg Mankiw, of all economists, now sets the Keynesian context, which leaves only the Government with the leverage to boost aggregate demand, though he still finds greater role for the monetary policy. But as Paul Krugman points out, the Keynesian stimulus and the war spending laid the foundations for robust post-war economic growth, which combined with inflation, created an environment in which interest rates were high enough in the subsequent normal times that monetary policy was effective at fighting slumps. In other words, the post-war effectiveness of Monetarism was largely dependent on the success of Keynesian demand management policies earlier.

Update 2
Brad De Long finds virtue in old-fashioned Keynesianism, "the government must take a direct hand in boosting spending and deciding what goods and services will be in demand". He finds fault with the obsession of policy makers to prevent the princes of Wall Street from profiting from the crisis, which was reflected in the Fed-Treasury decision to let Lehman Brothers collapse in an uncontrolled bankruptcy without oversight, supervision, or guarantees. The Lehman Brothers bankruptcy created an extraordinary and immediate demand for additional bank capital, which the private sector could not supply.

The second lapse was the obsession with keeping private sector private, which meant a reluctance to avoid partial or full nationalization of the components of the banking system deemed too big to fail.

Saturday, November 22, 2008

Punitive tax on criminals!

The Government of Andhra Pradesh is apparently considering imposing user charges on the most unusual of activities - policing faction hit areas! There is a proposal to revive a British time punitive tax on factionists, in the faction ridden Rayalaseema region of the state.

The tax would be collected from each factionist in a village and used to maintain a "punitive outpost" there. Factionists will presumably be identified by the formal cases registered against them in the local police stations. The tax proceeds will pay for the salaries of the police personnel employed there, and the other costs of maintaining the outpost. It is hoped that this tax will help overcome the resource scarcity that hampers effective maintenance of law and order in such areas. The factionists will now have to pay huge sums to those who are trying to contain their activities!

A logical extension to this would be to impose a similar tax on all the identified trouble makers within a police station area, called Known Depradors (KDs). Besides raising much needed revenue, this tax will also serve as a punitive tariff against these anti-social elements. Such a tax would be an economically efficient way of internalizing the negative externality imposed on the society by way of the anti-social activities of these individuals. The tax so raised can be used to deploy additional policemen and equip them better to contain the anti-social behaviour of the KDs.

Update 1
Inspired by the imprisonment of Bernard Madoff, a New York Republican has introduced a bill in the State Senate that would require rich inmates to pay for their involuntary stay in New York’s prisons. In this "pay-if-you-go" model, wealthy inmates pay for their own incarceration costs, thereby easing the burden on taxpayers. See also this.

Do big bonuses work?

Dan Ariely deploys research data to claim that by big bonuses (and also public scrutiny) may end up making employees, especially those involved in high cognitive skill works, stressed up thereby adversely affecting their performance and lowering outcomes. The experiments appear to suggest that for those works involving mechanical skills, higher bonuses does improve performance. Do these results make out a case for bonuses to incentivize workers as against executives? The limits on executive compensation in the bailout plans may not be that bad after all!

Update 1
Chris Dillow draws from the research of Luigi Bosco and Kathleen D Vohs to argue that competition for power and excess financial pay-offs can crowd out altruistic behaviour.

Update 2
Chris Dillow makes the case for bonuses.

Update 3
Chris Dillow writes that large bonus incentives are not only not justified by efficiency considerations, but can actually backfire, with the result that intelligent observers are demanding an end to them.

Update 4
See also Dan Ariely writing about studies which show how larger compensation does not necessarily increase output.

Ranking of Orchestras

Royal Concertgebouw Orchestra of Amsterdam has been ranked the world's top orchestra in a poll conducted by the Grampaphone magazine.

Friday, November 21, 2008

Global power trends

The US National Intelligence Council (NIC) (representing all the 16 US intelligence agencies) has released the latest edition of its five yearly report, Global Trends 2025, about the emerging and latent trends in the global balance of power and major challenges facing the world. The report seeks to "stimulate strategic thinking about the future by identifying key trends, the factors that drive them, where they seem to be headed, and how they might interact".

Among its predictions: the US will remain the most powerful country but will be less dominant; power will shift from West to East; transfer of global wealth and income from the West to East is without precedent; there will be intensified competition to control strategic resources, including energy, food and water; ideological conflicts akin to the Cold War are unlikely to take root in a world in which most states will be preoccupied with the pragmatic challenges of globalization and shifting global power alignments; the appeal of al-Qaeda will lessen; wane in the appeal of terrorism; end of the unipolar moment in the world balance of power and the emergence of a multipolar world with China, India and others playing greater roles; an "arc of instability" will stretch round the world among countries with young populations.

A brief of all the key trends is available here.

Thursday, November 20, 2008

Why US assets are in demand when the economy is doing badly?

One of the biggest surprises of the ongoing financial crisis has been the resilience of the US dollar and dollar denominated assets, especially in the face of a sharply deteriorating US economy. The "flight to safety" from the emerging markets in the form of unwinding of positions there by US financial institutions so as to shore up the credit strapped balance sheets of their parents back home, has had the effect of driving down both the domestic currencies and equity markets in these economies. This capital flight and attendant market declines have had a domino effect, hastening the scramble to the exit doors from the emerging markets.

The US enjoyed a capital inflow bonanza that funded its yawning current account deficits, and asset prices spiralled upward only to crash. As Carmen and Vince Reinhart explains, while the crash has constricted credit and is redrawing the financial landscape, the US has not been punished by investors pulling out the same way as the emerging markets. Instead of facing steep premiums on its debt, the US Treasury Bills have seen yields fall in absolute terms and markedly in relative terms to the yields on private instruments. What explains this "rush into a burning building at the first sign of smoke"?

Chastened by the 1997 East Asian economic crisis and in order to maintain their export competitiveness, these economies have been accumulating massive foreign exchange surpluses, which were invested mainly in dollar denominated assets. The twin booms in consumption in the US and global commodity and energy prices, swelled the forex surpluses. The IMF estimates that the international reserves of emerging market economies increased by $3.25 trillion in the last three years, with the bulk of the holdings in dollars. In fact, foreign governments, either directly or through entities like the Sovereign Wealth Funds (SWFs), now own almost a quarter of outstanding US government securities, and form about 10% of non-US nominal GDP. In the absence of adequate depth and breadth in their domestic financial markets, these forex surpluses were invested mainly in the US government securities, which despite their low returns offered the attraction of safety and liquidity.




With their forex investments intimately tied to the fortunes of the US economy, the emerging economy Central Banks are naturally wary of triggering off any alarms that would hurt them as much as anyone else. Many of these economies can only stay invested and watch in the hope that their investments survive the ongoing crisis without too much damage.

For an outsider, the unique position of the dollar confers on the US economy, in the words of Valerie Giscard d'Estaing, an "exorbitant privilege", whose costs are unfortunately borne by foreigners. This situation can be best summed up in the words of the former US Treasury Secretary, John Connolly, who once quipped, "the dollar is our currency, but your problem"!

This "privilege" partly explains why all previous and future US administrations have and will oppose any efforts that could lead to the emergence of Euro and the IMF's SDRs as alternatives to the dollar. However, in the aftermath of the bitter experiences of the sub-prime mortgage crisis, we could see a definitive shift in the investment strategies of investors, both private and government, away from dollar (and dollar denominated) into a more diversified basket in the coming months and years. To that extent, is the sub-prime crisis the beginning of the end for dollar?

Why US economy fell into crisis??

Here is a popular explanation circulating in the email circuit!!

An Israeli doctor says 'Medicine in my country is so advanced that we can take a kidney out of one man, put it in another, and have him looking for work in six weeks.'

A German doctor says 'That is nothing; we can take a lung out of one person, put it in another, and have him looking for work in four weeks.

The Russian doctor says 'In my country, medicine is so advanced that we can take half a heart out of one person, put it in another, and have them both looking for work in two weeks.'

An American Texas doctor, not to be outdone, says 'You guys are way behind, we recently took a man with no brains out of Texas, put him in the White House for eight years, and now half the country is looking for work.'

Wednesday, November 19, 2008

Potential for riots in US and France!

Sudhir Venkatesh has interesting explanations about impending riots in France and why the US may not experience collective protests. While many of the reasons appear to have a post-facto feel about them, some of them are genuinely interesting.

The refusal of the French government to allow either private or government bodies to gather statistics based on race or ethnicity on the grounds that it would come in the way of fostering the "French" national identity, has echoes in India too, where caste had long been kept out of the national decennial census. As Sudhir Venkatesh highlights, the North African minorities in France demand that they be treated as "French" citizens, while also being able to retain their distinct ethnic identities. This desire to retain both the national and sub-national (ethnic/caste/race) identity is a recurring theme of social debates in many countries. Experience from across the world shows that wherever communities face difficulty in maintaining these two separate identities, social and civil conflicts become inevitable.

Another issue that strikes me as interesting relates to the demographic configuration of France and much of Europe and elsewhere, with their suburban housing estates for the poor and lower middle class, which are the exact inverse of that in the US, with its inner cities housing minorities and suburbs the rich. I am not sure whether these contrasting divides are emergent demographic phenomenon or the result of conscious policy making. The presence of good public transport facilities which makes downtown commutes affordable in many of these European cities may be one explanation. The American love of the car and the cheap fuel (lowest taxes) may be another reason for the rich gravitating to the suburbs. There may be a few other reasons.

Bailout going astray!

The $700 bn "mother of all bailouts", engineered by Henry Paulson and his Government Sachs team, is increasingly resembling a case of good money being thrown after the bad! About $250 bn has already been committed with no perceptible improvement whatsoever. As Barry Ritholtz scathingly lists out, this appears to be the latest addition to an already susbtantial list of Paulson Blunders.

Naomi Klein even thinks that elements of the bailout are borderline criminal. About a third of this money has gone into dividends the banks are paying their shareholders, and the rest into severance pay, executive salaries and bonuses. Another portion has been spent in acquisitions designed to raise share values. All of these are of dubious legality. Another chunk has been poured into bailing out giant insurer, AIG.

Robert Reich and Federal Deposit Insurance Corporation (FDIC) Chairwoman Sheila Bair are among an increasing number of influential voices, who are now calling for using the remaining money to guarantee payment of mortgages whose terms are eased by lenders.

Ms. Bair is proposing that the Treasury use $24.4 billion from the bailout program to help refinance and reduce the mortgage obligations of people who are delinquent on their payments and in danger of losing their homes, so as to pre-empt a tidal wave of imminent foreclosures. Under her plan, lenders who modify troubled loans according to specific criteria would be insured against some of the losses they would incur if the modified loan were to default. That would give lenders an incentive to rework bad loans and in so doing, slow the pace of foreclosures and house-price declines.

Besides, it is also being suggested to use the money to restructure automobile companies whose creditors, executives, shareholders, and workers agree to put up money as well, to guarantee loans made to credit-worthy small businesses, college students, car buyers, and others who at this moment cannot get credit.

Even as the debate intensifies, the dismal news continues to mount (here, here and here) threatening to drag the economy into a long Japan style stag-deflation.

Tuesday, November 18, 2008

Match referees and racial discrimination

Allegations of racial discrimination among umpires and match referees in cricket has been a recurring theme in recent years. The perception that Asian players are at the receiving end of harsh and racially motivated decsions by both field umpires and match referees has been gaining strength. The high-profile incidents involving umpire Darrel Hair calling Sri Lankan off-spinner Muthiah Muralitharan for chucking, forfeiture of the Oval test in 2006 by Pakistan after being accused of ball tampering, and the decision of match referee Mike Proctor to slap "racism" charges on Indian spinner Harbhajan Singh during the Sydney test of 2007 (incidentally Darrel Hair was a party in the first two incidents, while Mike Proctor in the last two), have only added grist to the allegations. It is perceived by Asian cricketers that match referees adopt different yardsticks for punishing Asian and White cricketers for the same set of on-field offences.

It is in this context that an interersting NBER working paper by Justin Wolfers and Joseph Price on racial discrimination among NBA referees in the US assumes significance. They find that, even conditioning on player and referee fixed effects (and specific game fixed effects), that the more personal fouls are called against players when they are officiated by an opposite-race refereeing crew than when officiated by an own-race crew. These biases are sufficiently large that they find appreciable differences in whether predominantly black teams are more likely to win or lose, based on the racial composition of the refereeing crew.

This is surprising given the rigorous monitoring and feedback systems in place to monitor the performance of referees, so much so that it has been claimed that NBA referees "are the most ranked, rated, reviewed, statistically analyzed and mentored group of employees of any company in any place in the world". Further, the referees are arbitrarily assigned to basketball games, thereby minimizing chances of biased allocation.

It may be interesting if someone could do a Justin Wolfers and collect data and analyze disciplinary decisions by umpires and match referees in all types of matches over the past few years. Given the salience of racial discrimination in labour and other markets, as numerous studies have shown, I am inclined to believe that racial discrimination does exist in cricket too. Further, the growing bitterness surrounding recent cricket series between India and Australia and England, may only be a manifestation of the shift in global balance of power from Marylebone Cricket Club (MCC) to the Cricket Club of India (CCI), something which can have strong racial undertones!

(There is an interesting article by Robert Frank in the NYT about the difficulty in proclaiming the victory of Barack Obama as the triumph of racial equality over discrimination.)

Monday, November 17, 2008

Detroit Big Three and UAW come together!

Karl Marx will be turning in his grave if he were witnessing the drama surrounding the crisis that has engulfed the Big Three Detroit automaker - GM, Ford, and Chrysler. The exploiters and exploited, owners of capital and the labor have joined hands in an effort to save themselves. Faced with a battle for their very survival, United Auto Workers (UAW), the premier automobile workers union in the US, and the managements of the three firms are unitedly lobbying the Federal Government against any Chapter 11 bankruptcy and in favor of an additional $25 bn federal loan bailout of the auto industry.

A Chapter 11 bankruptcy will lead to removal of the existing management, cut executive payouts and dividends, abrogate workers’ contracts, and probably lead to sharply reduced wages and benefits for any jobs that remain. Saddled with high wage costs ($27 per hour) and burdensome health care benefits and pension liabilities, the Detroit automakers have been ceding ground to the Japanese automakers in recent years. If they obtained bankruptcy financing, the companies could then continue operating and slim down to a more manageable size, with cuts occurring over a period of months or years. But some of their operations could be taken over by other automakers or they could even be forced to liquidate.

The big Three companies employ about 240,000 workers, and their suppliers an additional 2.3 million, amounting to nearly 2% of the nation’s work force. Even in this year of plunging car sales (it fell 14.6% from 2007), the three automakers and their vast supplier network still accounted for 2.3% of the nation’s economic output, down from 3.1% in 2006 and as much as 5% in the 1990s.

The final decision on the fate of the automakers will be a test case of the American government's resolve to play by the game of free trade it regularly preaches to others. This assumes importance since many industry experts say the big foreign auto makers are established enough to take control of the industry and its vast supplier network more quickly than is widely understood, thereby minimizing the disruptions that are likely to be created if the Detroit Three go under. Like the Big Three, these foreign firms would together dominate manufacturing in the United States, becoming big customers for steel, aluminum, plastics, glass, machine tools, computer chips and rubber.

Update 1
David Leonhardt examines the wage costs of the Big Three.

Sunday, November 16, 2008

Liquidity crisis - failure of banking system!

It was a supreme irony to hear the head of one of the country's leading private sector bank, call on the government and the RBI to ease the liquidity crunch. The irony arose from the fact that the liquidity crunch facing the Indian financial markets, despite the unprecedented monetary easing by the RBI over the past few weeks, is due to the ostrich like reluctance of bankers to open their lending taps. The RBI can only facilitate the proverbial "bank" horse to lower rates, it is for the banks to in turn respond! The liquidity crunch is therefore more a psychological than a monetary phenomenon, atleast for now. And it is a testament to the inadequate maturity of the Indian banking and financial sector.

The banking sector has responded to the dramatic monetary easing, which released atleast Rs 2.8 lakh crore into the system, by parking them in the safety of Government securities, as evidenced by the sharp increase in G-sec holdings and downward pressures on the yields. The lending taps remained dry and the lending rates did not budge.

Standard economic theories tell us that monetary policy signals from the Central Banks gets automatically transmitted across the entire financial system resulting in either increase or decrease in the lending and deposit rates. The RBI has, through its dramatic monetary policy actions over the past few weeks, sent out clear enough signals that inflation concerns are secondary and it is committed to monetary easing. The only reason that could have justified the reluctance to lower rates was if, like in the US, there were uncertainty on counter party risks arising from a solvency crisis. However, the same bankers have been on all television channels claiming that they have no exposure to the toxic sub-prime mortgage like assets.

It was therefore natural to expect the banks to respond by lowering their commercial and retail lending and deposit (which was slashed immediately!) rates. If the banks did not do so and had to be arm-twisted by the Finance Ministry (and not the RBI) to fall in line, then it only indicates that the banks are not playing by the rules of the game. Further, by giving the Finance Ministry the chance to twist their arms, the banks may have to share the blame for setting unhealthy trends.

The RBI was right in tightening the monetary policy in the first half of the year in response to galloping inflation. The higher rates had the expected effect of raising the cost of capital for the corporate India and slowing down economic growth. The small and medium enterprises in India have long been excessively dependent on bank loans. The consumer durables and real estate sector too have become sensitive to interest rates, more so in recent years.

The larger corporates had been hurt more by the restrictions imposed on External Commercial Borrowings (ECBs) and the falling stock markets. Equity markets and external credit markets provided over 40% of the funds for Indian industry in 2007-08. The declining profits too added to the tight liquidity situation. All these developments have made the industry more reliant on bank credit. On the other hand, government borrowings, direct (loan waivers for farmers) and indirect (through borrowings by the oil companies against the oil bonds issued to cover the subsidies), have exerted substantial "crowding out" effect on private sector borrowing.

The reluctance of banks to lend is not completely psychological, and has partly to do with the strains faced by their balance sheets. The banks responded to the RBI's monetary tightening by outbidding each other in raising their rates to attract deposits. The rate increase reactions were excessive, and the result is that many banks are left holding high cost short and medium term liabilities without the means to finance them. The reluctance of the banks to lend may be partially explained as an effort to make up for some of their previous profligacy with deposit rates.

MSP as a futures contract!

One of the largest sources of food subsidy in India is the Minimum Support Price (MSP) assured to famers for various crops. The government periodically revises the MSP, especially for paddy and wheat, most often in response to political pressures, as a pork-barrel.



Stripped of all the welfare and political jargon, the MSP is a simple futures contract where the government contracts to buy the crop at a pre-determined price. However, unlike the conventional futures contract traded in commodities exchanges, MSP does not have any specified time duration and the buyers can exercise this contract free of cost. The MSP offered for paddy and wheat procurement by the Government of India, through the Food Corporation of India (FCI), can claim to being possibly the largest single futures contract in each of these commodities anywhere in the world.

So how about replacing the MSP with a specifically tailored futures contracts, in which individual farmers or their groups (co-operatives or farmers groups) enter into contract with market makers and traders (government through its canalizing agencies like FCI can also participate as a market maker) to sell their produce at pre-determined prices within a specified time? The market prices of many of these contracts may offer greater net benefits to the farmers than the fixed MSP support of the government.

If the number of participants in these exchange traded contracts increases, it adds to the depth and breadth of the commodities exchanges, thereby making prices more reflective signals of the market expectations and reality. If the government wants to assist the farmers by giving them an assured minimum price, it can subsidize the prices of the futures contracts by way of contract vouchers and through the provision of contract guarantees. An appropriately structured voucher pricing, can prevent market distortions, while providing assistance to the farmers.

The government should incentivize the setting up of trading terminals of the national commodities exchanges in each district head quarters. Agriculture co-operative societies (MACS, PACS etc) can enter into contracts on behalf of the individual farmers. Banks can leverage the business opportunities to act as clearing houses that stand guarantees to the futures contracts enterned into by the farmers. The State Warehousing Corporations can act as facilitators and initially as even market makers. Further, such initiatives will also enable greater access for farmers to formal credit mechanisms.

Saturday, November 15, 2008

Impact of falling oil prices

Oil prices continue their downward trend, touching $56 from its July peak of $147. In the US, gasoline prices have fallen by more than half to below $2 for a gallon in some states, from $4.11 a gallon in July. However, the lower prices may not have the desired impact on automobile sales and the wealth effect of American consumers. The cumulative adverse impact of the downturn, with its effect on almost all the sectors, more than offsets any consumer gains by way of declines in energy and commodity prices.

The high oil prices had set off a chain of reactions in the market in search of cleaner fuels and more fuel efficient engines and devices. The high prices had become an effective consumption tax on gasoline and incentivized many positive behavioural changes on consumers. The number of private vehicle miles travelled declined for the first time in decades and public transport systems across many American cities have experienced increased ridership. It was even being suggested that the high fuel prices could spell the doom to the suburban-based American residential culture. The high energy price was good for the environment too, in so far as it had achieved what government policies could not, by way of curbing oil consumption and helping contain global warming.

At the high gasoline prices, bio-fuels suddenly became commercially attractive, forcing American farmers into shifting from corn to soya and Brazilian farmers to clear off large tracts of the Amazon rain forest to cultivate sugarcane. The rise in foodgrain prices was linked to these bio-fuel bubble driven shifts in cultivation patterns.

Now, with oil prices on the way down, all these developments will face the inevitable countervailing pressures. Bio-fuels are surely commercially unviable at these oil prices. All the positive behavioral and lifestyle pattern changes now look unattractive.

Social welfare nets and recessions

Social safety cushions, besides being the first line of defense in a recession for workers and their families, also acts as automatic stabilizers in a weakening economy. The economic boom of the past two decades gave grist to the misleading impression that the good times would last forever and social safety nets could be pruned down and markets could takeover a part of that role. The result was a series of reforms across all countries, that restructured and even jettisoned conventional social welfare programs.

The far reaching welfare system reforms of the early Clinton years made it more difficult to qualify for, and keep receiving, unemployment insurance benefits. The results, as a recent report indicates, have been disastrous. Just 37% of unemployed Americans are receiving jobless benefits today, down from 42% during the 1981-82 recession and 50% during the 1974-75 downturn. Americans today receive a maximum of 39 weeks of unemployment benefits, down from 65 weeks in the 1970s. The average weekly benefit is $293. And low-income workers — a category that tends to include women and those in part-time employment — are one-third as likely to receive unemployment insurance as higher-income workers. Further, as states have imposed tougher restrictions on welfare, just 40% of very poor families who qualify for public assistance today actually end up receiving it, compared with 80% in the recessions of 1981-82 and 1990-91.

The recent events, including the steep rise in foodgrain prices and the unemployment in the US, highlight the continuing importance of social welfare measures. Incidentally, the increased globalization and integration of economies makes the poor and those at the margins more vulnerable and exposed to the vagaries of the business cycles.

Sub-prime mortgage bubble glossary

The sub-prime mortgage bubble and the ongoing financial crisis has spawned a whole new genre of vocabulary. First came the alphabet soup of mortgage and derivative products - ARM, ABS, CDS, CDOs, CMOs, CLOs, and many other permutations! Then when the bubble burst came the rationalization and blame game in the form of securitization, moral hazard, deleveraging, too big to fail etc. Here and here are two excellent elaborations of the "too big to fail" hypothesis. Forbes has an A-Z of the financial crisis. I am waiting for the next big book release - A Glossary of the sub-prime bubble!

Friday, November 14, 2008

Selling government lands

MR has an interesting graphic about land ownership in the US, which indicates a clear east-west divide. Surprisingly, the federal government owns more than half the high priced land in the west, and Alex Tabarrok proposes selling some of these lands to raise money.



Governments own large extents of land in most countries and these land bits are one of the largest sources of locked up income for governments. China is one of the best examples of how government ownership of land has been leveraged to raise massive investment resources. It has been estimated that proceeeds from such sales and partnerships in urban lands, has provided the largest source of government revenue for investments in infrastructure in the country.

In recent years, state governments in India have been selling large extents of lands to raise money. But unfortunately instead of leveraging this income for capital expenditure, governments have been using it to bridge their budgetary deficits. Further, most of these lands are disposed off through direct auction sales (instead of selling it for PPP developments or after developing layouts), which prevents the full capture of value in the chain.

There is a strong economic case that can be made in favour of facilitating the development of government lands, especially in urban areas. Apart from providing huge incomes, the development of such lands exerts significant multiplier effect on the local economy. Typically, governments have large tracts of highly priced real estate, which if released into the market can have the effect of generating a downward pressure on land prices. Lower land prices and rental values will make housing and commercial space more affordable, thereby sustaining the urban growth engine. In any case, government lands in urban centers are always vulnerable to being encroached or grabbed if left unattended for long!

Thursday, November 13, 2008

US bailout changes course again?

What started as a plan to bailout financial institutions in the US by purchasing their troubled assets like illiquid mortgage-backed securities in order to free up banks to resume normal lending, Troubled Assets Relief Program (TARP), is undergoing changes at breakneck pace. The purchase of troubled assets was soon abandoned in favor of a British style direct injection of cash into ailing financial institutions (bank capitalization) in return for equity stake and restraints on executive compensation and dividend payouts.

This change in strategy, coupled with the decision to guarantee bank deposits and inter-bank loans, have increased the willingness of banks to lend to each other. But it has had limited effect on de-clogging the commercial and retail lending markets. The uncertainty surrounding counter-party risk has ensured that the market for commercial debt backed by consumer and business loans has remained at a near standstill since Lehman Brothers collapsed in September. Borrowing costs for credit card issuers are at least five percentage points higher than they were before the credit crisis began. Financing costs for automobile lenders are even higher. Even student loans that are guaranteed by the federal government have been difficult to finance.

Now, in the latest course correction, Treasury Secretary Henry Paulson, has announced that that apart from banks and thrifts, companies that issue credit cards, make student loans and finance car purchases could expect equity injections. It is expected that such interventions would unlock the frozen consumer credit market and enable consumers to directly benefit from the bailout. This assumes importance in view of the increasing feeling that counterparty risk wary financial institutions have shut off their lending taps, despite the substantial infusions from Treasury.

Under the original plan, the Congress had approved a total amount of $700 bn, of which $350 bn was approved for immediate use and the remaining $350 bn to be cleared on fast track as and when required. The Treasury has already committed about $290 billion, with $125 billion allocated to the nation’s nine biggest banks and investment banks, another $125 billion for publicly traded regional banks, and $40 billion to expand the existing bailout of American International Group (AIG), the insurance conglomerate that collapsed in September.

There are a growing number of influential voices, including from the camp of President-elect, who are calling for expanding the scope of the bailout even further to include distressed automakers like GM and Ford, and refinance the mortgages of homeowners facing foreclosures. Though the Treasury has so far strongly resisted these suggestions, for fear of diluting the bailout and furthering moral hazard, it may be only a question of time before these too get included into the bailout.

The imminence of an expansion of the bailout to include corporate America raises serious questions about the role of tax payer bailouts as against bankruptcy filings. Robert Reich argues that such situations, where major private firms need to be bailed out, are best handled through Chapter 11 bankruptcy protection laws. Under it, creditors take some losses, shareholders even bigger ones, some managers' heads roll. Companies clean up their books and get to make a fresh start. And taxpayers don't pay a penny. He is correct in arguing that even if these firms are bailed out, their executives, shareholders and creditors should accept losses similar to that under Chapter 11, so that the burden on taxpayers are minimized.

Bankruptcy offers numerous other advantages over government equity injected bailouts. Government equity stake is likely to reduce the flexibility for the management in pushing through important decisions. Further, bankruptcy filing will keep a lid on unions and wage increase pressures. Further, as companies in industries like airlines, steel and retailing have shown, bankruptcy can offer a fresh start with a more competitive cost structure to preserve a future for the workers who remain. And it contains moral hazard concerns, besides reducing the cost for the tax payers.

Update 1
Joe Nocera outlines a plan by Jim Grosfeld to assist troubled home mortgage holders and prevent foreclosures, without modifying mortgages and without violating contractual obligations to bondholders. The proposal is to provide a 2 or 3% subsidy on the mortgage repayments to the distressed homeowners burdened by the most risky and unaffordable mortgages ever issued (FDIC chairwoman Sheila Bair estimates this number at about 3 million), so as to lower their monthly interest payments and incentivize them to stay on. If the subsidy were 2%, the total subsidy would be a small amount of $9 bn. Grosfeld proposes providing this subsidy for 5 years, which would cost a total of $45 bn.

Another proposal is that put forward by Daniel Alpert, outlined here.

Update 2
Some developers in the US are already offering a Rent Now, Buy Later plan, which is a version of the Daniel Alpert Plan.

Update 3
Glenn Hubbard and Christopher Mayer of the Columbia Business School, lend their weight to a plan to lower interest rate mortgages (to say 4.5%), indexed to the Treasury yield so as to prevent bubbles.

Wednesday, November 12, 2008

Gains of competition in hairdressing!

Daniel Hamermesh has this interesting explanation for the low haircut prices in Germany ($15-20, compared to $35 in the US).

The once regulated sector was liberalized with more easier licensing requirements, thereby lowering entry barriers, and leading to a proliferation of hairdressing salons. The the EU expansion drew in Polish barbers, thereby shifting the supply curve far to the right and lowering prices drastically.

All this has made German consumers and Polish hairdressers obviously better off. Young German hairdressers, who enter the market with the full knowledge of the lower prices, benefit from the increased business opportunities. It is conceivable that people cut their hair more frequently with lower prices, and the number of people who earn livelihood from haircutting also increases as the entry barriers get lowered. Only the older German hairdressers lose out by way of reduction in their incomes. But as Hamermesh concludes, this is a small price to be paid for the gains accruing to everyone else.

There cannot be a better illustration of the benefits of de-regulation which lowers entry barriers and liberalized labour mobility which fosters competition. Many of the regular services like plumbers, carpenters, mechanics, masons etc are similarly expensive in the US. The example of hairdressing in Germany gives a compelling enough reason for easing restrictions on immigration of these professionals to the US, especially from the developing countries where these professionals are available in large numbers. The net benefits from this will far outweigh the small price paid by a few.

Lehman failure and moral hazard

It is widely acknowledged that bailouts further moral hazard. They are supposed to make lenders and borrowers even more reckless in the firm belief that they are likely to be bailed out in case they run into problems. This line of reasoning partially explains why the investment banking major Lehman Brothers was allowed to fail.

But there are influential voices who now feel that instead of reducing moral hazard, the decision to not bailout Lehman may have, ironically enough, increased moral hazard. The decision to permit Lehman to go under and its role in triggering off the cascade of events that led to the collapse in confidence across global financial markets, sends strong signal across the spectrum. Government agencies would now be more inclined to feel that such large broker-dealers are too big to be allowed to fail, and therefore should intervene to bail them out. Similarly, the executives of large financial institutions facing such difficult times, are likely to be reassured (and therefore made even more reckless!) by the comfort of bailout insurance!

Therefore, as James Surowiecki says, the Lehman bankruptcy now makes it appear more important, to both policymakers and market participants, to save the troubled auto makers like General Motors!

Human frailty caused the crisis

Cass Sunstein and Richard Thaler argues that human bounded rationality and limited self-control played significant roles in fuelling and sustaining the ongoing financial crisis. So they suggest greater disclosure norms (eg. machine-readable files enabling third-party websites to translate hidden details of the terms), transparency, and financial awareness creation among lenders and borrowers. They also suggest nudges like minimum mandatory equity requirement in loans, loan repayments before retirement, greater benefits for faster repayments, and shortening the term of the loan if it is refinanced.

Tuesday, November 11, 2008

G-20 and global incomes

Technology diffusion and consumption shares



Notice how fast Technology 2.0 devices like Computers, Internet, Cell phone and microwaves have spread (among US households) compared to Technology 1.0 systems like radio, refrigerators, automobiles, telephones and electricity! Further, it is also true that the faster they spread, the faster their prices drop.

(HT: NYT and Visualizing Economics)

What makes humans nice?

The conservatives argue that religion and religious practices primes human consciousness to exhibit empathy and understanding of fellow beings. They contend that morality requires a belief in god. It is claimed that if you think about God, you believe someone is watching and therefore people tend to behave better. They invoke a few studies which appear to indicate that atheists are less charitable than god-fearing people in donating blood or money, or in helping homesless people. Further, the relatively larger philanthropic activity in a more god-fearing America, as against the other western countries, is claimed as confirmation of the "religion makes people nice" hypothesis.

The liberals argue that it is a strong sense of community that makes humans nice to each other. They cite the example of "god-less" societies of Scandinavia, with its expansive welfare and health care services, a strong social capital and sense of community feeling. The Danes and Swedes are religious without believing in God - they get married in church, have their babies baptized, give some of their income to the church, and feel attached to their religious community. In other words, their religion is secularized in belief and practice. And even without religion they have some of the lowest crime, suicide and anti-social activity rates, coupled with the highest human development indicators.

American atheists, in contrast, are often left out of community life. It has been found that scattered individuals who are excluded from communities do not receive the benefits of community, nor do they feel willing to contribute to the communities that exclude them.

It therefore appears fairly safe to assume that God or no-God, it is the "social being" dimension of humans that makes them nice towards each other. Humans are social beings, and we are happier, and better, when connected to others. This is also the moral of sociologist Robert Putnam's seminal work on American life, Bowling Alone, where he argues that voluntary association with other people is integral to a fulfilled and productive existence—it makes us "smarter, healthier, safer, richer, and better able to govern a just and stable democracy."

(HT: Slate)

Monday, November 10, 2008

From windfall profits to bailouts!

In six months of spectacular roller coaster ride, steel prices have fallen by nearly half, from over Rs 60,000 per tonne to slightly above Rs 30,000! When the prices were ruling high, the Government of India was requesting the steel producers to exercise some restraint in the price increases. Now that the wheel has come the full circle with steep declines in commodity prices, the CII and other representatives of Indian industry are at the doorsteps of the same Government with bailout requests. This has become part of a larger trend in Indian (businesses everywhere) corporate sector, where businesses scramble to seek Government help to tide out the bad times.

First, there were our super star software companies calling out for concessions and support when the rupee appreciated (where are these voices now?). Then the captains of banking sector (some of the same voices were the loudest opponents against RBI's resistance to more comprehensive de-regulation of the equity and debt markets, and full convertibility on the capital account) of were calling for bailouts while at the same time claiming that Indian financial institutions were not exposed to the dubious sub-prime assets. Now the steel and commodity producers are calling for their share of the bailout pie - fiscal concessions, deferred payments, concessions in supply of electricity and other inputs etc.

It does not require any deep insight to realize that business cycles with good times and down turns are recurrent themes of the economic timescape. Though the extent and depth of the peaks and troughs vary, in general the industry and the economy show a sustained upward growth trend (otherwise firms would leave the industry and go elsewhere!). It is obvious to anybody that private firms in each industry need to manage the lean and bad times by drawing upon the profits made during the good times.

There is nothing exceptional about these responses by the corporate sector. They are an inevitable consequence of the moral hazard evoked by the regular and repeated precedents of corporate bailouts during downturns. It is therefore necessary for governments to respond firmly, atleast now, to such requests and send out the message loud and clear. The tax payers did not (rightly) partake a share of the windfall profits (which were reaped during the recent boom) enjoyed by the respective firms and industry, and it is therefore unjustifiable to expect them to take the tab for the losses sustained by the same firms during the downturn.

When the going is good, the captains of Indian corporate sector constantly (and again rightly) rail about excessive government regulations and claim that such interventions distort the market incentives. The same logic applies, with equal relevance, to the present situation too. As the cliched saying goes, you need to take the good with the bad!

Governments should intervene in the functioning of markets only under extra-ordinary circumstances. A slowdown that would lower the economic growth rate from 9% to 7% (or even 6% or 5%) cannot by any yardstick be called extra-ordinary (even as late as 2001, a 6% GDP growth would have been spectacular!). And given the domestic market dependency of Indian corporate manufacturing sector, the effects of the global downturn could be smaller and shorter than doomsday predictions would indicate. The present appears to be extra-ordinary also because we are living through them now!

It appears to be clearly a case of "what is sauce for the 'good-times' goose is not sauce for the 'bad-times' gander"! Indian corporate citizens need to grow up, for there are formidable global challenges they have to face up ahead, if they are to become world beating business leaders!

Sunday, November 9, 2008

Fiscal stimulus in India?

The Chinese State Council, its Cabinet, announced a massive fiscal stimulus of $586 billion (roughly 7% of GDP) over the next two years to construct new railways, subways and airports and to rebuild communities devastated by an earthquake in the southwest in May.

The global economic meltdown is weakening the Chinese economy as growth in exports and investment is slowing, consumer confidence is waning and stock and property markets are severely depressed. China needs to sustain the high growth rates to sustain the massive rural to urban migration that has under grid its double digit growth of recent years. It is also necessary to prevent mass lay offs that are inevitable due to the massive over capacity that has been built up across the manufacturing sector.

In China, much of the capital for infrastructure improvements comes not from central and local governments but from state banks and state-owned companies that are encouraged to expand more rapidly. Accordingly, the State Council said it was loosening credit and encouraging state-owned banks to lend as part of a more "proactive fiscal policy".

Further, unlike the Western economies, the Chinese government exercises considerable control over private sector investments too and can play a significant role in channelizing them to priority sectors. In fact, state-driven investment projects of this kind have been a major impetus to the impressive Chinese growth throughout the 30 years of market-oriented reforms. The biggest players in many major Chinese industries — like steel, automobiles and energy — are state-owned companies, and government officials locally and nationally have a hand in deciding how much bank lending is steered to those sectors.

The government said the stimulus would cover 10 areas, including low-income housing, electricity, water, rural infrastructure and projects aimed at environmental protection and technological innovation — all of which could incite consumer spending and bolster the economy.

Unlike China with its current account surplus, $2 trillion forex surplus, and balanced budgets, India suffers from soaring deficits in current account and on the fiscal front. The off-balance sheet items of oil and fertilizer bonds, farm loan waivers, etc stretches the fiscal deficit to unsustainable levels. The finances of the state governments are in even worse shape and with elections around the corner, they are likely to cut back on important long term infrastructure investment support in favor of populist individual welfare benefits.

In the circumstances, the federal government has very little cushion to indulge in significant fiscal pump priming or assisting the state governments. One of the options would be to take a leaf out of the Chinese book by incentivizing the banking sector, over which government continues to exert considerable influence, to lend to the infrastructure sector.

In any case, given the ongoing economic slowdown, banks too would have limited lending opportunities. Further, unlike the US, the financial markets in India are facing a liquidity as opposed to a solvency crisis, with apprehensions about counter party risks clearly coming in the way of regular commercial lending. Infrastructure presents one of the most attractive commercial lending opportunities, especially with its long gestation periods (this assumes significance since the slowdown is most certainly going to be a temporary one). With infrastructure providers dependent on bank lending for their massive portfolio of project proposals, and bankers sitting on an enhanced pile of cash, there is a reasonably good fit between the borrowers and lenders.

Another option would be to set up a form of Sovereign Wealth Fund (SWF) or a Special Investment Vehicle (SIV) that could channelize the $250 bn plus forex surplus into more productive investment avenues rather than in low return investments. For example, the SIV can finance infrastructure investors' import requirements of capital equipments.

Such alternatives will enable the government to keep the investment tap open and effectively pump prime the economy, without any adverse fiscal consequences.

Re-defining the role of Agriculture Department

The traditional functions of the agriculture departments in the different states have been confined to extension services that involve soil testing, crop selection and crop management advice, setting up of demonstration plots, supplying seeds, fertilizers and farm equipments at subsidized rates, and implementation of the various government schemes and missions. While many of these continue to be relevant and important, the time may have come for going beyond these activities and bringing about a paradigm shift in our agriculture policy framework.

Let me re-fresh the cliched story about the problems faced by farmers. For a start, the farmers make their crop choices without access to the latest market information. In the absence of formal credit sources, he has to borrow at usurious rates from the local moneylender. There is precious little by way of extension services, and he continues his traditional farming methods. Once the crop is harvested, since he has no access to latest price information and storage facilities, the farmer has to perforce sell off his produce to the local middlemen at the lowest price.

Under the re-defined policy paradigm, the four dimensions of agriculture policy will involve access to - adequate and timely credit, extension services and market information, forward linkages like storage facilities and markets, and risk mitigation mechanisms like commodities markets.

It is imperative that our agriculture policies make the issue of access to formal credit mechanisms a central concern. In recent years, while the nationalized banks have become more aggressive in their agriculture sector lending, it still retains the impression of being a target driven activity. The massive and growing market in informal money lending at usurious rate only underlines the fact that contrary to popular perception, farmers are credit worthy and willing to repay their loans. But the recurrent loan waivers have created a moral hazard, making banks wary of agriculture sector lending.

It is therefore important that government policies eschew such bad practices and incentivize the development of an active farm sector lending market. A quantum leap can be made in providing access to farm credit by issuing Kisan Credit Cards and expanding the network of ATM centers in rural areas. Taking a cue from the impressive strides made in bank linkage lending to women Self Help Groups (SHGs), a major campaign should be initiated to form farmers groups.

The entry of big box retailers into the food procurement chain has dramatically altered the scenario and opened up massive opportunities for farmers. One of the biggest challenges for our agriculture policy is to leverage these opportunities to benefit them. These big retailers and others in the fast food business incur huge transaction costs in accessing farm produce from the farmgate. Instead of dealing with individual farmers and middlemen, it is in their interest to assist farmers groups and co-operatives produce agriculture commodities of the specified standards and thereby have access to assured supply of good quality. By dealing directly with the end-user in the procurement chain, the farmers get a much higher price for their produce.

While Public Private Partnerships (PPPs) have become the flavour of sectors like infrastructure, it is rarely ever mentioned in the context of agriculture. But fortunately, the recent developments like nation-wide commodities exchanges and the entry of organized retailers presents numerous opportunities for PPPs.

The entry of organized retail should be utilized to incentivize the development of a formal market along the entire agriculture supply chain. There are big profit opportunities for the private sector in agriculture services like providing extension activities, market information, storage facilities and even commodities derivatives broking.

Agriculture policies should encourage the setting up of cold storages on PPP basis. For example, government can provide vacant land in villages through a formal and transparent tendering process to private developers, who will in turn develop cold storages and share the storage space with the Government or the local farmers co-operatives or farmers groups. These new storage facilities can be linked up with the existing government and private facilties to create a nationwide network of storage facilities that can service the commodities exchanges.

The spread of information communication technologies like Internet and the mobile phones should be leveraged to benefit the farmers. There have been numerous successful examples of private companies like ITC, through its famous e-choupals, and now Reuters, selling extension services and market information to farmers. The agriculture department should work towards scaling up these experiments and put in place policies that incentivize private participation in the agriculture services market.

The utility of the new commodities futures market in India has so far been limited to being another source of financial investment and speculation, rather than being a platform for farmers to hedge their risks. The overwhelmingly large portion of contracts are speculative in nature and conclude in cash settlement, rather than any physical delivery settlement.

The Agriculture department should encourage farmers to access the futures market, either individually or more realistically through farmers groups and other existing co-operative societies. Market makers like broking houses can be encouraged to set up shop, initially in some districts, and help the farmers access the futures markets. Just as the eighties and nineties saw off a revolution in equity ownership among the Indian middle class, we now need a similar revolution in farmers participation in commodities derivatives.

The government should encourage the expansion of trading centers and terminals of the major commodities exchanges in districts across the country. A large-scale and intensive Information Education Campaign (IEC) should be launched to accquaint farmers with futures trading contracts, and trading processes and agents like brokers and margin requirements. Farmers need to be made aware of maintaining commodity standards and specifications and adhering to their contractual obligations.

It is also important that the farmers have access to clearing houses that stand guarantee for their futures contracts. The exchanges can be encouraged to set up their local centers in a few high volume districts and local banks can be encouraged to perform the clearing house functions in other places. Government agencies like the State Warehousing Corporation or even vibrant co-operative societies too can act as clearing houses.

In a different way, the commodities futures and options markets perform the role of the Minimum Support Price (MSP) by providing the farmers a platform and instruments to hedge for an assured high market price for their produce. These markets help in fixing a market determined MSP, which while hedging farmers against losses also signals priceless market information well in advance thereby enabling farmers make more informed choices about their crop selection.

This MSP will take the form of a series of futures contracts spread out across the country, and based on the needs and requirements of individual or groups of farmers. It will also open up the possibility of farmers getting prices in excess of the government assured MSP. In the initial stages, the Agriculture department should intensively focus on advising farmers in enetering into beneficial futures contracts.

How NYT covers the world

Here is a map of the world in which the size of all the 192 countries (of the UN) are adjusted to the number of articles about them appeared in the New York Times from 2000 till the present. Interestingly Iraq and not China is the second most discussed subject country! In many ways the size of the respective countries is an approximate indicator of its importance in American foreign policy!



(HT: Marginal Revolution)

Why India cannot do big?

Can you think of any $1 billion plus construction project completed in India this decade? I trawled the Internet and could not come across anything. Apart from a few roads and bridges under the Golden Quadrilateral project, the Delhi Metro, Hyderabad Airport and a couple of oil refineries, there have been very few intergrated projects with investments of even Rs 1000 Cr, in both the private and government sectors. For all talk of massive real estate activity, I could not find a single billion dollar plus real estate development project, nothing to even remotely compare with the construction activity in Shanghai, New Songdo City or the Dubai Palms. India it appears has a major problem with doing big projects!

Though numerous Special Economic Zones (SEZs), Ultra Mega Power Plants (UMPPs), Irrigation Projects, airports, ports etc, with investments of over Rs 1000 Cr have been sanctioned, most of them are caught in the usual problems and are getting inordinately delayed. The contrast with the Chinese economy could not have been starker.

One of the most remarkable dimensions of the Chinese economic miracle has been their ability to concieve and execute in record time, massive construction projects with frightening regularity. Massive irrigation structures, power plants, ports, airports, railway lines, expressways, signature buildings, and so on have been springing up at breakneck pace. And most of them get completed well within the stipulated time, with no cost over-run.

In the context of the spectacular infrastructure investments made by China for the recent Olympics, Harvard Business School Professor Tarun Khanna reasons that China can build, or revitalize cities overnight, while Indians can't even build roads, because India is a "land of million vetoes". He writes, "Whenever there is a conflict between public interest and private rights, China tends to adjudicate in favour of public interest at the expense of private rights, while India opts to protect private rights even if public interest is compromised. Unlike In India, no small group of individuals can veto physical asset creation in China once the Party apparatud has decreed a course of action".

Citing the example of the massive success of China in the Olympic games, he also attributes Chinese success vis-a-vis India to the disciplined focus of the Chinese state in pursuing specific goals. Here are a few other more specific reasons why India fails this test:

1. Severe constraints on the supply side. This is the single biggest problem standing in the way of India moving into the big league in infrastructure and construction. Any large scale construction project would require massive amounts of cement, steel, sand, metal chips, and other materials. We face supply constraints on each of these materials. The depth of the market is so limited that a Rs 1000 Cr construction project would be enough to squeeze out most, if not all the supply from that area.

Consider these statistics. China produced 489 mt of steel in 2007, 9.5 times more than India's meager 53.1 mt. Chinese steel production has doubled over the last five years, whereas India's has grown by a mere 15 mt in the same period. In cement, China's production in 2007 was about 1.4 bn mt, more than 9 times India's production of 160 mt. Chinese cement production doubled from 704 mt in 2002, while India's grew by just 60 mt over the same period. In many ways, the annual increase in Chinese cement and steel production has been much more than India's total production.

A more detailed compaprison of the two countries is available here.

2. Scarcity in skilled personnel. There is an acute scarcity in skilled people at every level, from engineers to workers. Despite all talk of the largest pool of engineers and scientists, we suffer an acute shortage of skilled and experienced structural, environmental, and other engineering personnel. More distressingly, there have been a number of recent studies highlighting the poor quality of our professionally trained manpower, most of whom have been classified un-employable based on objective standards.

Similar problems affect the supply of skilled workers - rod benders, masons, plumbers, electricians, carpenters etc. While nurturing professional training in engineering and medicine has been a priority since independence, development of vocational and direct employment related skills has been badly neglected. In many respects, deficiency in basic skills like the aforementioned may be a much more immediate and greater cause for concern. The recently launched National Skill Development Mission may be a few decades too late.

3. Lack of professional project management practices. Though such practices have become increasingly common in recent years in the private sector, they are still to make their mark in the public sector. The market for supplying such services is still in its infancy and populated by very few players, and with limited capacity and reach.

4. Problems associated with land acquisition and R&R, and environmental clearances. This is a result of our democracy and its institutions, something which Prof Tarun Khanna highlighted. It is commonplace to have major project works running into stiff opposition and getting stuck up in court litigation over land acquisition, difficulty in removing encroachments on project lands, controversy over relief and rehabilitation packages etc. The small, but very visible and vocal group of environmental activists, using judicial and other civil society platforms have most often come in the way of major projects.

Ironically, most often the multiple levers of democracy end up helping entrenched vested interests than being of help to the really poor and exploited. More on this in a separate post.

5. Infrastructure deficit. The poor state of physical infrastructure by itself sets in motion a negative feedback loop, that besides strangulating economic growth also hinders further infrastructure development. Many analysts claim that infrastructure bottlenecks could end up severely squeezing India's economic growth. The inadequate internal transport logistics, poor quality of power supply, and heavily clogged ports are a virtual tax on our exporters and importers, seriously eroding their global competitiveness. Massive infrastructure projects most often involve significant import components. Despite some recent improvements, importing machinery and other inputs for mega projects remains a major challenge. Here is a comparison of where we stand in terms of infrastructure against our competitors.



6. Bureaucracy. I have outlined the problems in great detail in earlier posts here and here. The obsession with bureaucratic form and procedures imposes constraints that come in the way of expediting project execution. This lack of flexibility becomes even more of a handicap since many of the contracting procedures and concession models are being implemented for the first time and have no bureaucratic precedent. For these reasons, bureaucratic limitations and constraints are one of the major reasons why we find it difficult to push major projects off the ground.

7. Absence of adequate numbers of contractors. The supply side of the contracting market is very thin. There are only a handful of qualified major contractors in each sector, and all of them have overflowing project portfolios under execution. While the market is fast developing depth, there are significant entry barriers attached to infrastructure contracting.

Finally, there is also the cyclical arguement that the failure to achieve a few successes is the biggest handicap facing Indian construction/infrastructure sector. Once a few major projects get completed and become operational, the market will develop the required breadth and depth.