Monday, August 31, 2009

Questioning the SHG led micro-credit movement

Despite breaking into the arena of development public policy making atleast two decades back and assuming the role of being the premier anti-poverty instrument in countries like India, there have been very few detailed studies on the impact of Self Help Groups (SHGs) and micro-finance as a poverty eradication tool. All the while policy makers have been increasing their exposure to SHGs as the "magic pill" to deliver on the objective of poverty eradication. This does raise very valid questions about whether we are putting all our "development eggs" in the single "basket of SHGs"?

It is in this context that two recent studies raises interesting questions about the micro-finance driven model of poverty eradication that has become the touchstone for all such efforts in India. From a randomized trial in 104 slums of Hyderabad, Esther Duflo, Abhijit Banerjee and Co find mixed results on economic activity and no impact on social dimensions like measures of health, education, or women's decision-making. From a field experiment on credit expansion for microentrepreneurs in Manila, Dean Karlan and Jonathan Zinman find no evidence of improvements in the well-being of those accessing micro-loans, and also results that are diffuse, heterogeneous, and not directly on the targeted group.

Karlan and Zinman find several indirect effects or positive externalities from micro-loans. They find that targeted micro-entrepreneur households shrink by shedding un-productive workers form their businesses; use loan proceeds to invest in human capital of their children, rather than in capital specific to their businesses; and male entrepreneurs appeared to benefit more than female ones from mico-loans.

The study by Duflo, Banerjee and Co about the micro-finance to SHGs in Hyderabad flags off several interesting issues. They find that those households with high entrepreneurship propensity exhibit the most positive response to microloans, as they use the micro-loans to finance the fixed cost and revolving capital requirements of running a business. Micro-loans are found to increase their consumption/purchases of durables (or investments), either for their businesses or for their personal use. It is observed that micro-loans crowd-in investments in starting the business or expanding existing businesses and crowds-out spending on consumer non-durables and temptation goods (alcohol, betel leaves, tobacco, gambling, and food and tea outside home). Further, existing businesses report a large and significant increase in profits after the micro-laons were provided.

The study indicates limited or no effect of the opening of MFI branches on education, health or women's empowerment. This appears to overturn the conventional wisdom that self-help groups and microfinance activity has much greater utility as a tool of social than economic empowerment.

The purpose of this post is not so much to question the utility of SHGs and micro-finance as to examine the possible changes in approaches and methodologies required to make more effective use of these anti-poverty policy instruments. I will first list out some of the general issues relating to the role of SHGs and the present approach and policies surrounding their functioning and development.

1. What should be the most optimal size of groups? Why should it be 10, as is the case with the majority (if not all) SHGs in the country? Does not the otpimal size vary with the backgrounds of the groups - urban-rural, very poor-poor, literate-illiterate etc? What should be the size of federations? Vary the numbers of members in treatment groups to study this.

2. Are smaller groups more effective for economic empowerment through capital investments, while larger ones are better for social empowerment and consumption smoothing? Does this mean that groups should split as they gather capacity to ensure that the varying requirements of the different members of the group are more effectively addressed? In other words, after the second or third linkage, should the SHGs be split into smaller groups so as to enable the members to move forward at raising credit and expanding their businesses at their choice?

3. What should be the most optimal size of initial and subsequent loans? What should be the repayment tenor and schedule? How should loans be packaged? Should loans be use-directed or left to the discretion of the group? Should loans, especially for business investments, be supported with backward linkage support - business literacy, training, helping to source their capital equipments, marketing etc?

4. Women of which age group are more responsive for each category of loans? Does it not make greater sense to target business loans to women of a specific age group? What should be the most optimal age range of group members? Which age group is the most effective target group for SHG activity and bank linkages? Treatment groups to be divided along different ages and studied.

5. What is the impact of financial literacy, group capacity built, general adult literacy, business training etc on how the loans are utilized? How should different categories of loans be packaged, so as to optimize their cost and effectiveness for the group members? Is it more effective to package different categories of loans as loan plus one of these aforementioned linkages or support? In other words, should some categories of loans be disbursed only as a bundled product?

6. Would any other intervention involving increasing financial access, like opening of bank branches and starting of no-frills accounts have also produced the same impact as SHGs and microloans? What would be their respective impacts? Treatment-control studies on these would be instructive.

7. What is the impact of presence of MFIs on moneylenders? Do they lower their rates in view of the reduced demand for their funds? Do MFIs inculcate market discipline into moneylenders? What other positive externalities do the presence of MFIs exert? This assumes important given the fact that moneylenders perform (and will continue to do so for the foreseeable future) an important credit provisioning role in such societies and the challenge is not to eliminate or drive them out, but to discipline them into moderating their lending practices and terms.

8. What is the comparison of the loan-use break up on loans given by money lenders and MFIs? Did MFIs change the loan distribution profile by encouraging new business or business expansion loans?

9. Which economic, social, and religious groups are most and least responsive to loans? It is important to supplement with other anti-poverty measures for those groups of people who take to SHGs with the least effectiveness. In such cases, it would also be important to identify the deficiencies and the reasons for the relatively poor uptake by these people. What is the treatment impacts of loans for consumption, paying off debts, starting business, expanding old business, and purchasing consumer durables, on different categories (economic and social) of SHG members?

10. Should we not explore getting consumer durables retailers/financial institutions that sell their products in Equated Monthly Instalments (EMI) into lending directly to individual SHG members (who would other-wise take loan and purchase consumer goods)? If need be, the government can then directly transfer the interest subvention differential to the respective bank or financial institution. Is it not possible to nudge established financial institutions to provide individual loans for expanding established business by leveraging the credit worthiness provided by the individual's membership of a good SHG?

11. Should we not have a detailed database which tracks the uses to which different groups and its members have used their share of loans for and their impacts, so as to more efficiently tailor and direct the next round of loans? For example, if one member in a group was repeatedly using a large share of the loans for children's education, it may be useful to help the student linked up with a scholarship provider. The information on consumption loans can be used to provide assistance to access alternate smoothing strategies like insurance etc.

And here are a few questions on the aforementioned Hyderabad study involving the MFI Spandana

1. I cannot but help feel that Spandana, being a commercial MFI, showed selection-bias in identifying the areas it proposed to set up its branches. This is evident in the criteria it used to select the slums - "poor, but not the poorest of the poor", smaller habitations/bastis within the slums, home ownership by 80% of the groups members etc. Did these not provide an implicit guarantee and distort the selected group? SHGs in rural areas may not fit into this profile.

2. Did the comfort provided by home ownership, among 80% of group members, provide an implicit guarantee for Spandana? If this were the case, would the individual members have accessed institutional loans by mortgaging their title deeds (assuming they had title deeds, which they should have had in Hyderabad)?

3. Was the decision of new MFI entrants on where (which places) to enter influenced by the presence of Spandana groups? Did Spandana's presence have spill-over effects which may have created an upward bias on the outcomes of the other groups? What effect did these new entrants have on Spandana groups themselves? Since MFI activity was virtually absent, the impact of Sapndana's entry may have been different from if there was already strong MFI activity.

4. Was there no government SHG activity in these sample areas at the baseline of 2005? I am inclined to believe that there was, more so given the fairly strong network of SHG activity in Andhra Pradesh. Has this effect been controlled for?

5. The quality of such household surveys are suspect, especially given the type of information solicited - asset ownership, decision making issues, expenditures, borrowings, savings etc. The households, especially in urban areas, have been socialized by government surveys to under-report their assets and savings, over-report their expenditures etc.

6. Is the increase in business openings in the aftermath of entry of Spandana due to the MFI loans or due to the fact that a few members who initially accessed these loans set off an emulation effect on their neighbours to start businesses? In other words, did Spandana's work exhibit spill-over effects on those who otherwise may not have taken micro-loans and if they did take it, would have used it to for other purposes? Did the new addition, due to this bring in an attrition bias into the sample, by adding newer memebers into the possible group of beneficiaries?

7. However,the selection-bias inherent in the choosing of Hyderabad, with its urban and relatively empowered socio-economic context, may have masked the cause-effect relationship between microfinance activity and social empowerment. One explanation for the limited assessed impact on the social empowerment dimension may be attributed to the fact that social changes take much more time than the two years of the study to have any noticeable impact. I am also inclined to believe that the effects would have been much more marked in the rural areas.

All these aforementioned issues can (and should) be examined extensively using randomized control studies, so as to re-design policies on SHGs and micro-finance to make them more effective and deliver greater bang for the buck.

Update 1 (20/6/2010)

Abhijit Banerjee argues that "there is now recognition that poor people and small firms have very limited access to capital and risk diversification"; they "do start a lot of firms, but these firms seem intended to remain tiny"; "the poor are not particularly well-suited to be entrepreneurs: They neither have the risk bearing capacity nor the human capital"; "nor will anyone give them enough capital to really grow the businesses". He therefore suggests that the main source of dynamism has to be growth of medium to large firms, though "there is evidence showing that these firms are too rare and too small in developing countries".

Sunday, August 30, 2009

Religious "nudges"!

A working paper by Angus Deaton (via Chris Dillow) which examined results from Gallup World Poll from across 140 countries appears to indicate that religion nudges people to good behaviour, which in turn results in positive social outcomes. He writes,

"Religious people report better health; they say they have more energy, that their health is better, and that they experience less pain. Their social lives and personal behaviors are also healthier; they are more likely to be married, to have supportive friends, they are more likely to report being treated with respect, they have greater confidence in the healthcare and medical system and they are less likely to smoke... these effects... tend to be stronger for men than for women...

... on average, over all countries, and over countries sorted into income groups, religious people do better on a number of health and health-related indicators. These protective effects appear to be stronger the poorer is the country... religion is a route to a better life in poor countries, but not in rich ones — and to protect men more than women."

Chris Dillow feels that this outcome is "because being religious is associated with things that are good for you... religious men are less likely to smoke, more likely to feel they are respected by others, and more likely to be married - and these things are good for one’s health."

Freakonomics points to more evidence that religious following can also nudge people to vote and help people overcome childhood disadvantages like poverty and difficult upbringing.

Saturday, August 29, 2009

Nudging on fertilizer use

Among all our subsidy challenges, the most demanding and complex involves that of fertilizer subsidies to farmers. Besides the massive and rapidly getting out-of-control fiscal burden, it has created numerous incentive distortions in fertilizer use and crop-patterns, considerable environmental negative externalities, and skewed national policies on power generation and gas pricing.

Encouragingly, in the Union Budget 2009-10, the government have decided to move away from the current product-based to a nutrient-based subsidy regime. It also announced the government's commitment to move towards payment of fertilizer subsidies directly to farmers, by dispensing off with the present arrangment where fertilizer companies are forced to sell their products at artificially low prices, in return for subsidy reimbursements. It is hoped that all this would ensure balanced application of fertilizers for increasing agricultural productivity and would enable coverage of a larger basket of fertilizers with innovative fertilizer products available in the market at reasonable prices.

In this context, Freakonomics points to an interesting working paper by Esther Duflo, Michael Kremer, and Jonathan Robinson that examined the fertilizer-buying patterns of farmers in Western Kenya for three years and offers policy recommendations based on behvioural economics to optimize on fertilizer use. Invoking the "paternalistic libertarian" arguements of Richard Thaler and Cass Sunstein, they claim that "small, time-limited discounts could yield higher welfare than either laissez faire policies or heavy subsidies, by helping stochastically hyperbolic farmers commit themselves to invest in fertilizer while avoiding large distortions in fertilizer use among time-consistent farmers, and the fiscal costs of heavy subsidies". Such discounts thereby helps present-biased farmers commit to fertilizer use without inducing those with standard preferences to substantially overuse fertilizer.

They base their claim on the fact that though even poor farmers have resources available at the time of harvest, being present-biased (farmers consume all they have) and not fully aware about this bias, they procrastinate and postpone fertilizer purchases until later in the season, when they are either not left with enough money to make the purchases or become too impatient to purchase fertilizer. They find that even those who are initially planning to use fertilizer often have no money to invest in fertilizer at the time it needs to be applied, for planting or top dressing, several months later. Empirically, they also find that such discounts in the cost of purchasing fertilizer at the time of harvest induce substantial increases in fertilizer use, comparable to those induced by much larger price reductions later in the season.

Such policies have another advantage in the context of developing economies like India where the targeted group fo farmers are those with small land-holdings, who ironically benefit disproportionately less than the larger farmers, who corner the lions share of fertilizer subsidies in their present form. The smaller farmers are much more likely to be responsive to these discounts and it is therefore more likely to increase fertilizer use by them, while the market prices at all other times will act as a deterrent to over-use by the larger farmers.

Note: The study assumes that instead of applying fertilizers during sowing, a more efficient and cost-effective strategy is to use fertilizers as top dressing during transplantation, when it is clear that seeds have germinated. It increases yields and eliminates much of the downside risk (if the seed does not germinate after sowing).

Update 1 (22/3/2010)
Esther Duflo and Micheal Kremer attribute two reasons for low adoption of fertilizers - lack of information and savings difficulties. They find that "offering farmers the option to buy fertilizer (at the full market price, but with free delivery) immediately after the harvest leads to an increase of at least 33% in the proportion of farmers using fertilizer, an effect comparable to that of a 50% reduction in the price of fertilizer (in contrast, there is no impact on fertilizer adoption of offering free delivery at the time fertilizer is actually needed for top dressing). This finding seems inconsistent with the idea that low adoption is due to low returns or credit constraints, and suggests there may be a role for non-fully rational behavior in explaining production decisions."

Comparing private domestic consumption

Among all major developing economies, India has the largest private domestic consumption as share of the GDP, at 57% in 2008.

This compares favorably with the developed economies, whereas China has an astonishingly low 37% share (though in absolute terms, private consumption there totaled $890 billion in 2007, making the country the world’s fifth-largest consumer market, behind the United States, Japan, the United Kingdom, and Germany).

(HT: Paul Kedrosky, McKinsey Global Institute)

Friday, August 28, 2009

The need to expand health insurance in India

In the past few months, a number of state governments and the Central Government have floated health insurance schemes to cover various categories of poor people. This proliferation of a multiplicity of insurance schemes, aimed at specific categories of citizens, goes against the fundamental principles of designing cost-effective insurance policies and the spending becomes virtual give-aways to insurance providers (admittedly mostly government run ones, atleast till now). It surprises me at the virtual absence of any form of debate on this in any public platform nor any regulatory intervention or advisory by the Insurance Regulatory Development Authority (IRDA).

The Government of India, through the Health Ministry, had launched the Rashtriya Swasthya Bima Yojana (RSBY) in 2008 to cover all the BPL families, especially unorganized workers (self-employed, unskilled or migrants) in the country by 2013. The smart card-based scheme aims to provide benefits and cashless medical cover up to Rs 30,000 a year for a BPL family of five. The premium of the insurance cover is being shared by the Centre and the state governments in the ratio of 75:25 and in the ratio of 90:10 for North eastern states and Jammu and Kashmir. The Government is bidding out the right to provide these insurance contracts state-wise to the mainly government run insurance providers.

Simultaneously, State governments have been launching their own over-lapping and often parallel schemes. Early this year, the Andhra Pradesh Government launched its Abhaya Hastham co-contributory Pension Scheme for the women, above the age group of 18, belonging to the Self Help Groups. It also has another health insurance scheme, Arogya Sree, which offers free treatment for a little less than thousand for serious ailments and patients can claim expenses up to Rs 2 lakh. The Tamil Nadu Government launched the Chief Minister Kalaignar’s Insurance Scheme for Life Saving Drugs to reach out to the state’s 100 million poor people, and Rajasthan launched the Mukhyo Mantri BPL Raksha Kosh for insuring those below the poverty line.

There are numerous inefficiencies associated with such approach to selling insurance plans. For start, these schemes would incur considerable administration costs to screen out the ineligible and the inevitable leakages arising from those not eligible benefiting from it. It is being alleged by some state governments that only a small share of the entire spending on RSBY will be actually spent on patients' treatment.

The approach under the RSBY of selling the rights to provide insurance in a state to one insurer by competitive bidding, while ideal for other services, may not be the most cost-effective option. Insurance premiums are the lowest for the most diversified risk-profile and for the largest collection of buyers. Further, it is possible to negotiate the best terms with diagnostic and treatment service providers and pharamaceutical companies when the economies of scale are large enough, atleast for a plan with a basic package of benefits. Also, the larger health risks associated with the specific category being insured, the below poverty line (BPL) poor, will definitely skew up the insurance premiums. Finally, the presence of only a single insurer for the state, restricts choice by constraining buyers from choosing from the full bouquet of plans available in the market.

It therefore naturally follows that multiple insurance plans by the various state governments for specific categories of its population (especially the smaller ones) will be inefficient. Same is the problem with RSBY, being confined to a specific category of buyers and one insurer managing each state.

The most cost-effective and efficient solution is to make these plans part of a universal health insurance scheme like that offered in many developed countries. A basic package of health care benefits can be offered for a fixed rate premium by all insurers, both private and government-run. The Government can then subsidize, fully or partially, specific categories of the poor.

Round-trip of housing prices

Floyd Norris points to fascinating stats from the latest set of data from the S&P Case Shiller 20-city composite index (for single family homes). It reveals that during the period, from June 2001 through the June 2009, in real terms home prices have taken a round trip and got back to where they started out from. This period can be separated into two parts - the five-year boom (when home prices outpaced inflation by 10.7 percent a year) and the three-year bust (when they trailed inflation by 13.6 percent a year).

More graphics from Calculated Risk (via Paul Krugman) also appears to point towards much the same. The Case Shiller price-rent ratio is back to where it was in 1987. Almost similar is the story with the real home prices index which too appears to be back to where it started off eight years back.

However, despite all talk of home prices bottoming out (due to a small June upturn), as the graphic above indicates, CR feels that real house prices, in general, are still significantly above prices in the nineties and will decline another 10% to 20%.

Educational outcomes and incomes

I have blogged earlier about the significant positive co-relationship between parental care, peer effects, and societal environment on the one hand and educational outcomes on the other. Economix enriches this literature by comparing this year's SAT scores in the US with student family incomes and finding very strong positive co-relation between the two - higher family incomes co-relate with higher test scores. It finds that on every test section, moving up an income category was associated with an average score boost of over 12 points.

The conclusion is not that higher incomes causes higher test scores. But, that students from families with higher incomes stand a substantially greater chance of getting higher test scores, for a variety of reasons. In other words, their economic backgrounds confer a disproportionately high advantage on the children from well-off families.

Now, there is nothing profound about this conclusion. Its theoretical foundations have been superbly illuminated by the late John Rawls in his second principle of justice (the difference principle) - those with comparable talents and motivation should face roughly similar life chances, and that inequalities in society should always work to the benefit of the least advantaged. But it is unfortunate that this does not get reflected, in as unqualified a manner as it should, in public debates on social issues and when public policies are designed.

Update 1
Greg Mankiw points to an omitted variable bias and claims that the positive co-relation is due to the fact that "smart parents make more money and pass those good genes on to their offspring". Paul Krugman responds by pointing to this which shows that "students with low test scores from high-income families are slightly more likely to finish college than students with high test scores from low-income families".

Thursday, August 27, 2009

Update on CCT programs

Ever since first making their mark in the nineties, Conditional Cash Transfer (CCT) programs have become the most discussed idea in development policy making. Nancy Birdsall, of the Center for Global Development, calls CCTs "as close as you can come to a magic bullet in development". CCTs work on the twin ideas that inter-generational poverty is, at least in part, a "behavioral" problem that can be modified through free-market incentives and that providing direct cash to the recipients is the most efficient way of distributing welfare benefits.

Via Chris Blattman, the two latest developments on Conditional Cash Transfer (CCT) programs - analysis of a CCT trial in New York City and a World Bank study on the evidence from CCT programs across the world.

In September 2007, New York Mayor Mike Bloomberg launched the Opportunity NYC as a three year experimental CCT program, on the lines of the hugely successful Oportunidades Prgram of Mexico, for a broad range of health, education, and work-related activities. It is funded entirely by private philanthropies (including that of Mr Bloomberg), is being evaluated by a non-profit research firm, MDRC, using a random assignment research design and is administered by Seedco, a nonprofit community development organization. Families are rewarded with $200 per family member for annual doctor's visits and $50 per child every two months for good school attendance. Parents can receive from $40 to $100 a month if they keep up with their responsibilities with the education and health of their children.

A recent evaluation of the program reveals many positive things. Only 43 percent of families had a bank account when they enrolled in the program; now over 90 percent of the families have accounts, a requirement for receiving the payments. It has so far paid $10 million to 2,400 families living at or beneath 130% of the poverty line - about $22,000 for a family of three, and the typical participating family earned just under $3,000 during Opportunity NYC's first year.

Mexico's Oportunidades program, started in 2002 and covering 5 million households now, providing cash payments to families in exchange for regular school attendance, health clinic visits, and nutritional support, has become the touchstone for Conditional Cash Transfer (CCT) programs across the world.

The World Bank report (full report pdf), the first comprehensive evaluation of CCT programs across the globe, finds that these programs "can reduce poverty both in the short and long term, particularly when supported by better public services". The World Bank, whose lending support for CCT operations now covers 13 countries, expects to lend about $2.4 billion this year to start or expand CCT operations in Bangladesh, Colombia, Kenya, Macedonia, Pakistan, and the Philippines.

Unlike traditional anti-poverty and development programs, since their inception CCT programs have been followed by a vibrant culture of documentation, monitoring and evaluation that have contributed immensely towards course corrections, designing program components, and impact assessments.

Every Latin American country, Bangladesh, Indonesia, and Turkey, have large scale CCT programs while there are pilot programs in Cambodia, Malawi, Morocco, Pakistan, and South Africa. Bangladesh has programs for getting back out of school children, to incentivize unmarried girls who have completed primary schools attend secondary schools, and for primary school going poor children. India, stuck up with Self Help Groups (SHGs), micro-loans, and subsidies, remains alone among the major developing countries without even a pilot CCT program (apart from a small one in Haryana, and that too badly evaluated).

Update 1 (4/1/2010)

Tina Rosenberg assesses CCT programs in Brazil and Mexico.

Wednesday, August 26, 2009

Ratings inflation and moral hazard on investment banks

I blogged extensively about the conflicts of interest that bedevil credit rating agencies (CRAs), their role in the sub-prime mortgage crisis, and proposals to reform the ratings industry. Now here comes more evidence of the moral hazard created by ratings agencies on other financial market agents, this time investment banks.

In an exhaustive comparison study of sovereign debt issuance by emerging economy governments since 1820s, Marc Flandreau, Juan H. Flores, Norbert Gaillard, and Sebastián Nieto-Parra find that CRAs impose considerable costs on the financial markets. The find a sharp increase in the shares of speculative grade debt issuances, far out of proportion to the returns from these risks.

They claim that modern financial market regulation, by separating the processes of credit rating by CRAs and underwriting by investment banks, has encouraged more, not less, risk-taking. Further, this arrangement "insulates investment banks from reputational rewards" and the need to "win market share in such debt issuance by building a reputation for quality products".

Insulated and emboldened by the "liability insurance" provided by rating agencies, "underwriters have given up their former role as gatekeepers of liquidity and certification agencies to become aggressive competitors in a new Speculative Grade market".

Update 1 (25/4/2010
Gretchen Morgenson on how Wall Street was given access to the formulas behind those magic ratings and how they hired away some of the very people who had devised them.

Health care reform linkfest

1. Health Insurance Exchange combines the benefits of choice that are theoretically available on the individual market with the bargaining power and scale that's generally accessible only in large employers. It will have a wide array of competing providers offering different plans with varying benefit levels, emphases and price tags. And unlike the individual market, insurers won't be able to discriminate based on your health history or your future risk. Plans will have to be certified as meeting a minimum level of comprehensiveness. All this will engender greater competition and lead to lower prices and improved quality, besides preserving access.

2. The public option plan or public insurance has been mooted with the objective of lowering costs and keeping the inefficient and predatory private insurers on their toes. In the US it has been found that Medicare holds costs down better than private health insurance. In fact, as Simon Johnson and James Kwak writes, Medicare, which dominates the over 65 year market with its 40 million consumers, is the best example of a pulic option plan. Further, the substantially public systems employed by every other industrialized nation cost less and cover more than the private insurance led American model.

Though it wouldn't replace the private insurance individuals already rely on, it provides choice enables consumers make their own decisions. It thereby serves several purposes - act as a public insurer (use market share to bargain down the prices of services, and lowers administrative costs) and use competitive pressure to the rest of the insurance industry (private insurers need to offer premiums closer to their marginal cost, and they have to cut administrative costs, and they have to work on their reputation for cruelty and capriciousness).

Read also Jacob Hacker, here and here, making an excellent case for public plans.

3. The US has a massive employer-based health insurance market due to the employer tax exclusion provision that exempts all expenditure on health insurance from taxation. In other words, as Ezra Klein writes, "If you walk out, on your own, and attempt to give your friendly neighborhood health insurer a dollar, you're taxed on that dollar. If your employer gives the health insurer that dollar on your behalf, that dollar is not taxed." Most health insurance in the US comes in the form of taxes or employer deductions from paychecks, which means insurance can seem practically free. Such employer sponsored insurance insulates the employee (or the insured) form the insurance plans and the cost of health care. It has been estimated that the tax foregone due to the exclusion provision is more than $300 billion a year in the US.

4. Ezra Klein draws attention to an alternative to employer sponsored insurance that would permit employees to shop for alternative plans in the Insurance Exchanges and swap their employer sponsored plans for a better plan. According to one proposal (Wyden-Bennett Bill) put up in the US Congress during the debate on health care reforms, families would receive a voucher worth as much as their employer spends on their health insurance, and would then buy an insurance plan on an exchange where insurers would compete for their business. Insurers would be required to offer basic benefits, and insurers that attracted a sicker group of patients would be subsidized by those that attracted a healthier group. This would also make employer-sponsored plans portable.

See also here (Emmanuel Fuchs talks about health care vouchers) and here for versions of free choice plans. David Leonhardt gives a list of proposals that favor giving employees the freedom to opt for the plan of their choice.

5. While employers write the pay-checks for their employee insurance, the real costs are borne by the employees themselves. Most Americans believe that employers pay the bulk of workers' premiums and that governments pay for Medicare, Medicaid, the State Children'sHealth Insurance Program (SCHIP), and other programs. However, this is incorrect.

It has now been well documented that employers do not bear the cost of employment-based insurance; workers and households pay for health insurance through lower wages and higher prices. Moreover, government has no source of funds other than taxes (on other things and not health care) or borrowing to pay for health care. David Leonhardt sums up the issue, "The cost of insurance comes mostly out of employees’ paychecks. If insurance costs more, employees are generally paid less. If insurance costs less, employees are paid more. The cost of insurance does not have a big effect on employers’ overall compensation costs. That’s why no one should be surprised that employers don’t make for good consumers of insurance. And it’s why insurers are not operating in a very competitive marketplace."

6. See also this comparison (pdf here) of US health care with those elsewhere.

7. David Leonhardt links to a number of articles/posts which explains and gives examples of countries with private health insurance.

8. Simon Johnson and James Kwak argue that the fiscal costs are not a deterrent against health care reforms.

9. Nicholas Kristof makes the case for universal health insurance, drawing attention to the success of the best examples of "socialized medicine" - Medicare (despite public perceptions that it is not run by government) and Veterans Health Insurance scheme.

10. This article by Robert Reich explains the raucousness associated with health care debates in the US, "Universal health care has bedeviled, eluded or defeated every president for the last 75 years. Franklin Roosevelt left it out of Social Security because he was afraid it would be too complicated and attract fierce resistance. Harry Truman fought like hell for it but ultimately lost. Dwight Eisenhower reshaped the public debate over it. John Kennedy was passionate about it. Lyndon Johnson scored the first and last major victory on the road toward achieving it. Richard Nixon devised the essential elements of all future designs for it. Jimmy Carter tried in vain to re-engineer it. The first George Bush toyed with it. Bill Clinton lost it and then never mentioned it again. George W. expanded it significantly, but only for retirees."

11. Superb post by Edward Glaeser that links to many resources that illustrate the inefficiency in American health care system. It has been found that "areas with a high concentration of specialists also show higher spending and less use of high-quality, effective care", and "the incremental Medicare dollar in high cost areas tends to be for medical specialist visits, diagnostic tests and use of intensive care and hospitalizations for medical visits". See also this testimony by CBO Director Peter Orszag on "The Overuse, Underuse, and Misuse of Health Care".

12. Times has this article on the Swiss model, with its universal and private run health insurance system. Swiss private insurers are required to offer coverage to all citizens, regardless of age or medical history. And those people, in turn, are obligated to buy health insurance. Ezra Klein however feels that the Swiss system which has the highest out-of-pocket payments of any OECD country, including the United States, is another example of the fact that substantially public systems hold down costs much better than substantially private systems.

13. Times has nice explanations of the Public Plan, Single Payer systems, and Medicare.

14. In most countries, governments set the rates that will be paid for different treatments and drugs, even when private insurers are doing the actual purchasing. In the US, the government doesn't set those rates for private insurers, which is why the prices paid by Medicare are much lower than those paid by private insurers. Ezra Klein has this excellent post, with the series of graphs that compare the prices for procedures, treatments, drugs etc in different countries. See also this (McKinsey) and this explanations for the high cost of health care in the US. See also this and this interviews with George Halvorson, CEO of Kaiser Permanente, the largest managed-care organization in the United States, about the high health care costs in the US.

15. Ezra Klein also has this article which says that Americans overpay to the tone of $477 billion per year, or $1,645 per capita due to "higher doctor salaries, higher drug costs, higher operation costs, more per day in the hospital, etc, etc." On drugs alone Americans overpay $66 bn, on doctors compensation $58 bn, $147 billion due to the fee-for-service system (wherein doctors are paid based on how many procedures they recommend and carry out), and $98 bn in additional costs of administration.

16. Excellent explanation of all the key issues in the US health care reforms debate is available here.

17. David Leonhardt on evidence based health care.

18. Moneywatch guide to health care reforms. See this nice explanation of the public option. How to make health care cheaper.

19. Fee-for-service medicine, or payment based on procedures carried out, has been identified as one of the most important reasons for over-treatment and the large health care costs in the US. See this on CT scan and MRI usage among OECD countries.

20. Prof Jonathan Gruber makes an excellent case for financing the deficit in health care plan with a "cadillac tax", a 40 percent assessment on insurance plans with premiums of more than $8,500 for singles and $23,000 for families. He writes, "Under current law, if workers are paid in wages, they are taxed on those wages. But if they receive the same amount of compensation in the form of health insurance, they are not taxed. As a result, the tax code has for years provided a large subsidy to the most expensive health plans - at a cost to the U.S. taxpayer of more than $250 billion a year."

21. Community Rating 101 from Uwe Reinhardt. Also this on the widespread use of community rating. See also this summary from Prof Reinhardt.

22. Daniel Gross calls the bluff that the Obamacare reform proposals are not a "government take-over" of health care. It does not contain either the public option or the single-payer attributes that are the characteristics of government run health insurance systems. The only big government intervention is by way of subsidies to those who cannot afford the high premiums. He also shows how successive Republican administrations had increased the share of government expenditures in health care. See also this report on health care in the US.

Maxine Udall makes this passionate plea for a comprehensive, affordable health insurance for the US. See Mark Thoma here.

23. The excellent Dartmouth Atlas of Health Care, a compendium of research on Medicare spending, (methodology here and map here) has found that the hospitals and geographic regions with the highest medical spending are often the ones delivering the worst medical care. However, this Times article has questioned the study findings and the authors respond here.

24. What makes the US health care system so expensive? Links to the full series by Aaron Carroll here and slides here.

25. American families spend almost twice as much on health care — through premiums, paycheck deductions and out-of-pocket expenses — as families in any other country. But Americans don’t live as long as people in Canada, Japan, most of Western Europe or even relatively poor Jordan. Misdiagnosis is common. Medical errors occur more often than in some other countries. Unique to the developed world, millions of people have no health insurance, and millions more, like many fast-food workers, are underinsured.

Reforming executive compensation - France takes lead

It is now well acknowledged that incentive arrangements skewed towards short-term returns that faced bankers, fund managers and traders played a critical role in inflating the sub-prime bubble and causing the deepest economic recession since the Great Depression. Accordingly, all recent efforts at regulatory reforms to impose greater oversight on the financial markets have sought to place curbs on executive compensation.

However, nothing substantial has till date been legislated or decreed into action. In the circumstances, the French government has taken the lead by concluding an agreement with the leading banks to limit executive compensation. It was agreed that up to two-thirds of bonus payments should be deferred for three years, while a third should be paid in shares of the bank. It was also agreed that the bonuses would be paid out based on the performances of the bank as a whole and not that of particular trading desks.

However, the French decision will not be sustainable without similar strong action in other countries, especially across the Atlantic. In the absence of co-ordinated action of similar kind across the major economies, the holdout economies will benefit as they will end up attracting more financial activity and the better bankers. This assumes even greater significance, in view of the disturbing signals on "business as usual" emanating from the US.

Economists like Lucien Bebchuk have called on governments to take on the role of monitoring and regulating pay in financial firms, failing which the perverse incentives that contributed to the current crisis could easily recur. In a recent article he argued that compensation-induced incentive distortions will apart from going against shareholder interests, also produce incentives for excessive risk-taking that imposes unacceptable costs on the society and economy at large. However, instead of micro-managing by imposing quantitative limits on payments, he prefers "regulatory standards that could require equity-based plans to preclude managers from cashing out awarded shares and options during a certain minimum period after vesting".

Update 1
Eric Dash lists out the possible reasons for the mis-alignment between Wall Street pay and risks taken.

Update 2
Switzerland joins France with its own, albeit watered down version of limits on executive compensation. While there were no caps on bonuses, high-level executives are to have a significant part of their pay deferred for a minimum of three years to insure it is better linked to risk. It also requires that the bonuses "actually have been earned by the company over the long term". It also excludes all but the country’s biggest financial services companies from mandatory compliance.

Update 3 (23/3/2010)
Times reports that of the 104 senior executives whose pay was set by the federal pay regulator in the last two years, 88 executives, or nearly 85 percent, are still with the companies even though their pay was drastically cut back. This flies in the face of fears that lower executive compensation would lead to top executives fleeing firms in droves.

Update 4 (13/7/2010)
The European Parliament approves tough limits on bankers’ bonuses. Under the new rules, bankers will receive only 20-30% of their bonus in upfront cash. Banks must defer payment of 40-60% of bonuses for 3 to 5 years. And half of a banker’s upfront bonus must be paid in shares or 'contingent capital' — bonds that convert into equity if the bank gets in trouble. The rules allow for banks to claw back bonuses paid to executives whose investments are initially profitable but go awry a few years down the road.

Alex Edmans points to AIG's recently announced proposal that 80% of their executives’ bonuses will depend on the price of their firm’s bonds and only 20% will depend on the price of their equity, and argues that "such moves will better align CEO fortunes with those of all investors – both shareholders and bondholders – and help prevent future financial crises".

Tuesday, August 25, 2009

Taxes must rise

"In nearly all countries, the costs of the crisis have added to the fiscal burden, and higher taxation is inevitable".

writes IMF's Chief Economist Olivier Blanchard, on sustaining a global recovery.

Among all developing countries, the fiscal burden is nowhere more intense than in India. It is therefore only appropriate that corporate tax concessions made during the slowdown be rolled back, marginal tax rates be raised, and direct taxes rationalized.

Across the world too, the momentum in favor of raising taxes has been gathering. The Economix even started the Club Wagner (named after Adolf Wagner, a 19th-century German economist, who predicted that taxes would rise as societies became wealthier) of economists who acknowledge the basic economic reality that taxes in the US must rise! And its membership has been growing at an impressive pace.

Blanchard has more, and of relevance to India,

"Large deficits lead to rapid increases in debt, and, because debt levels were already high in many countries, such increases cannot go on for long. As large deficits continue debt sustainability comes increasingly into question. And with this comes the risk of higher long-term interest rates, both because of anticipated crowding out of private borrowers by government borrowers and because of a higher risk of default."

And true to this prediction, as the graphic below indicates, the yields on the benchmark 2019 G-Secs have been on a clear rising trend (it has risen by 206 basis points since start of this fiscal year) on the back of concerns about the massive government borrowings.

Monday, August 24, 2009

Wanted - Indian whistleblowers in Swiss banks!

In a decision fraught with far reaching implications and a break from the tradition of banking secrecy that have been the hall-mark of Swiss banks, UBS has agreed to release to the United States the names of 4,450 American citizens suspected of using secret Swiss accounts with it for tax evasion.

This decision was made possible by evidence from an American-born whistleblower — code name Tarantula — a disgruntled former UBS employee from the Boston area who was working in Switzerland. He was part of a UBS team that made frequent trips across the Atlantic to aggressively market investment strategies to rich Americans to elude the scrutiny of the US Internal Revenue Service (IRS). While admittedly, the decision is one-off and applies to only a particular category of customers under a specific circumstance, it is believed that the momentum of anger against financial institutions in the aftermath of the global financial crisis could force the Swiss authorities to relax their banking secrecy rules.

In India too, there have been a growing chorus of opinion asking the Government to bring pressure on the Swiss Government to reveal details of the alleged $500 bn to $1.4 trillion of slush money stashed away in secret Swiss bank accounts and in other tax havens. Notwithstanding the deal between US IRS and UBS, the Indian government will find cracking the Swiss code very tough, if not impossible. The US Justice Department and the IRS have been in a long drawn out campaign to prevent these banks from selling offshore banking services that enabled tax evasion to American citizens, with limited success till date.

The Indian Government could do with some help from an Indian version of Tarantula! Any potential Indian whistleblower working at UBS or Credit Suisse listening?

Comparing prices, wages and purchasing power across cities

The Economist points to the latest version of UBS's Prices and Earnings Comparison Report, which offers a fascinating array of information about prices, wages and purchasing power for 14 professions in 73 cities across the world.

The report finds that Oslo, Copenhagen, Zurich, Geneva, New York and Tokyo are the world's priciest cities; Kuala Lumpur, Manila, Delhi and Mumbai are the cheapest cities to live in; employees in Zurich and Geneva have the highest net wages in the world; and people in Cairo and Seoul work the longest – roughly 600 hours more per year than their peers in Western Europe. It also finds that it takes a mere 12 minutes at work to afford a Big Mac in Chicago, Toronto and Tokyo, whereas employees must toil for over two hours to earn enough for the same fix in Mexico City, Jakarta and Nairobi.

Interestingly, the price comparison based on the weighted cost of a shopping basket geared to west Eureopean consumer hanits and containing 122 goods and services (without rents), shows that Delhi and Mumbai have the cheapest living costs among the sample of 73 cities. The wage levels arrived at from a weighted index based on wage figures and working hours of 14 professions shows Delhi at the 70th spot and Mumbai at the last with the lowest wages. It required 61 minutes of working time in Mumbai and 49 in Delhi to earn enough to buy a Big Mac, 37 and 58 minutes respectively to buy a kilogram of rice, and 177 and 122.5 hours respectively to buy an iPod Nano. Employees have to work a global average of 37 minutes to earn enough to pay for a Big Mac, 22 minutes for a kilo of rice and 25 minutes for a kilo of bread.

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A comparison of the prices of train (200km in 2nd class), taxi (5km within city), and bus/tram/metro (10 km) reveals that public transport is most expensive in Western Europe and North America. Local public transport is the cheapest in Delhi, with Mumbai being the third cheapest and Taxis are cheapest in Mumbai followed by Delhi.

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Interestingly, the prices of expensive furnished and unfurnished apartment units in Delhi are comparable with the more expensive cities. The normal rents paid by average households while cheap, are larger than the rents in many major East Asian, Latin American and African cities. This may be a reflection of the relatively limited stock of dwelling units available in our cities compared to their compatriots elsewhere.

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Sunday, August 23, 2009

Why the world economy should remain coupled?

The OECD's latest forecast for the world economy in 2009 and 2010 predicts a return to robust growth in emerging economies, even as the developed economies labour back to some form of recovery. This has naturally re-ignited the debate about decoupling of the emerging economies from the rest of the world economy.

The OECD estimates China to grow at 7.7% this year and 9.3% in 2010, India at 5.9% and 7.2% respectively, and Brazil’s economy, after slowing down, to reverse this year and expand 4% next year. In contrast, it predicts the US economy to shrink by 2.8% this year and grow by 0.9% next year, Japan to shrink 6.8% and Europe 4.8% this year.

I have atleast three important reasons why the re-decoupling phenomenon could be bad for the world economy as a whole and would only end up reinforcing some of the macro-economic imbalances that played a major role in blowing the sub-prime bubble.

1. It could unleash another round of capital flight into the emerging economies and creating an equity market bubble there. There are already indications, based on the performance of emerging economy stock markets this year (already up more than 50%), that this may be on the way. The faster than expected return to economic normalcy in these countries, the persisting low interest rates in the developed economies, the declining strength of the US economy and the weakening dollar, and the demand for foreign capital by private businesses in the emerging economies (for investments in infrastructure etc) have all contributed to this trend. The effect of this could be disastrous.

2. This capital flight could lead to substantial appreciation of emerging economy currencies, which in turn would reduce the competitiveness of their exports. This would force the Central Banks into intervening and and purchasing dollars to prop up their domestic currency. The result would be an increase in the pace of accumulation of foreign exchange reserves, which would invariably find its way into the US Treasuries, thereby making available an increased pool of cheap debt which would, in all likelihood, fuel financial market bubbles.

3. The adverse impact of the slowdown in exports to US and Europe on the emerging economies, especially those of East Asia, is by now well acknowledged. It is imperative for the green shoots of recovery taking hold in these emerging economies that their export markets in the developed world gets back to normalcy at the earliest or atleast shadow their own recovery.

Inflation targeting scorecard

Interesting graphic from Rebecca Wilder, which compares the relative performances of the US Federal Reserve, Bank of England (BoE), Bank of Canada (BoC), and European Central Bank (ECB) in keeping actual inflation within their respective target rates or bands.

In the period 1992-2008, the BoC and the BoE were the most successful at targeting inflation, with average annual inflation equal to 1.86% and 1.96%, against their targets of 1-3% and 2% respectively. The ECB over-shot its target rate of 2% by 0.2 percentage points, whereas the US Fed was the least effective - the annual inflation rate averaged 2.5%, against a central tendency of 1.7-2% (there is no specific taraget rate, and the mandate is to promote high employment, stable prices, and moderate long-term interest rates).

Update 1
See this chronicle of the evolution of inflation targetting from being pre-emptive (based on money supply growth) to reactive (based on economic indicators).

Discrimination against girl child and public policy making

NYT Magazine has an excellent article by Tina Rosenberg, highlighting the problem of discrimination against the girl child and the "daughter deficit" (or "missing girls"), widespread in many poor societies where having a son is seen as a financial and social necessity. The article is an excellent example of how conventional and easier to implement best-practice prescriptions of arm-chair policy makers under-estimates the complex challenge of addressing social issues and thereby fails to achieve the desired results.

I am inclined to believe that such complex socio-economic problems provide fertile ground for micro-economists and behavioural scientists to design public policies that would "incentivize" or "nudge" parents towards girl children (or away from a son preference). Such attempts have to be rooted in the specific local social and economic context and may need to go against the grain of political correctness and unsettle some of the entrenched traditional conventions, customs and institutions. Conventional regulatory and trickle-down development approaches may need to be reinforced with these subtle and context-specific nudges (like nudges to stigmatize dowry taking) and incentives (say, tax-breaks for inter-caste marriages) if we are to expedite the process of desired change on these issues.

Conventional wisdom has it that a four-pronged strategy of enforcement of strong regulations (banning foetal sex identification, dowries etc), awareness creation, economic development ("the wealthier the home, the more educated the parents, the more plugged in to the modern economy, the more a family will invest in its girls"), and aid to women ("a mother who has more money, knowledge and authority in the family will direct her resources toward all her children’s health and education") will bring about an end to the selective discrimination against girl children. But, as the article points out, there is ample evidence to suggest that such optimism glosses over the sheer complexity of the challenge.

Researchers have found that "girls are actually more likely to be missing in richer areas than in poorer ones, and in cities than in rural areas", "having more money, a better education and (in India) belonging to a higher caste all raise the probability that a family will discriminate against its daughters", and "while increasing women’s decision-making power reduced discrimination against girls in some parts of South Asia, it made things worse in the north and west of India". Fascinatingly, it has been found that the level of discrimination varies between the first and subsequent girl child, with the first daughter treated like her brothers. However, "a subsequent daughter born to an educated mother was 2.36 times as likely to die before her fifth birthday as her siblings were to die before theirs — mainly because she was less likely to see a doctor".

Fundamentally, the sociological "son preference" has perceived economic underpinnings - male children earn, they look after parents, they require dowries etc - which can be addressed only by increasing the "economic returns to girls". The "deeply embedded son preference associated with highly patriarchal social systems" means that all conventional policies have to be supplemented with civic mobilization and social movements to "change customs regarding marriage and inheritance associated with patriarchal kinship systems, which favor males".

Difficult to define policy actions for these and even more difficult to implement and achieve the desired outcomes.

See also very good articles on discrimination against women here and here.

Saturday, August 22, 2009

Hal Varian on how Internet is reshaping the economy

Very interesting interview of Google's chief economist, Hal Varian.

About the age of "combinatorial innovations"...

"If you look historically, you’ll find periods in history where there would be the availability of a different component parts that innovators could combine or recombine to create new inventions. In the 1800s, it was interchangeable parts. In 1920, it was electronics. In the 1970s, it was integrated circuits. Now what we see is a period where you have Internet components, where you have software, protocols, languages, and capabilities to combine these component parts in ways that create totally new innovations. The great thing about the current period is that component parts are all bits. That means you never run out of them... There are no inventory delays."

On advertising revenue sources and its psychology,

"We have to look at today’s economy and say, 'What is it that’s really scarce in the Internet economy?' And the answer is attention. [Psychologist] Herb Simon recognized this many years ago. He said, 'A wealth of information creates a poverty of attention'. So being able to capture someone’s attention at the right time is a very valuable asset... we’re (google) capturing your attention when you’re doing a search for something you’re interested in. That’s the ideal time to show you an advertisement for a product that may be related or complimentary to what your search is all about."

On statisticians being the "sexiest job of the future"...

"The ability to take data — to be able to understand it, to process it, to extract value from it, to visualize it, to communicate it — that’s going to be a hugely important skill in the next decades, not only at the professional level but even at the educational level for elementary school kids, for high school kids, for college kids. Because now we really do have essentially free and ubiquitous data. So the complimentary scarce factor is the ability to understand that data and extract value from it."

On "computer-mediated transactions" - the utility of computers in lowering transaction costs and thereby making several hitherto impossible transactions and activities possible...

"Now, in the middle of almost every transaction from person to person or organization to organization, there’s a computer. And the computer can monitor that transaction, record the information, collect the data, and assure that the transaction is carried out the way it was intended to be carried out. So one of the subtle implications of this is you can now write contracts and make contracts enforceable that simply weren’t enforceable before."

Friday, August 21, 2009

End of corporate R&D?

The age of wikipedia, open-source platforms, and crowd-sourcing appears to be catching up with corporate Research and Development (R&D). And the squeeze on corporate profits, and by implication the resources available for exclusive pursuit of R&D, is only adding to the challenge. Are we witnessing a paradigm shift from "proprietary innovation to populist innovation"?

An interesting article in the NYT points to a trend towards a "federated" model of corporate R&D that "leverages all the innovative work by outsiders in universities, start-ups, business partners and government labs". The corporate lab becomes "more of a coordinator and integrator of innovation, from both outside and inside the company walls".

Open-innovation leaders like HP and IBM have been placing larger bets on fewer projects, besides expanding their nets wider to seek ideas on specific reserach projects/subjects from outside through yearly online contests, soliciting grant proposals from universities worldwide, and so on. The objective is to tap "the collective intelligence, selectively, of leading academics around the world".

With corporate profits under tremendous pressure, the economic case for in-house R&D may appear to be clear. However, closer scrutiny reveals that more collaborative approaches may conflict with many of the fundamental tenets and ethos of capitalism itself. The transactions costs associated with such R&D work, in terms of searching partners, concluding agreements, enforcing contractual provisions, maintaining confidentiality requirements, avoiding collaboration by the same partners with competing firms, and co-ordinating between various departments or teams etc, may be too large to be ignored. Further, as the article itself points out, tight-knit teams inside corporate labs, can outshine the open model when working on multi-disciplinary challenges in projects soon heading to market.

The good and bad of narrowing inequality in the US

Excellent graphic in the NYT about how the financial meltdown and the resultant economic recession has pulled down the incomes and wealth of the richest Americans, thereby slowing down the pace of increase in inequality.

While highlighting the sharp declines in the financial assets held by the rich Americans and their consequent loss of wealth and income, the article does not shed much light on whether the incomes of the non-rich have increased or remained stagnant. In light of the economic recession that followed the bursting of the asset bubbles, it may not be incorrect to claim that the incomes of the remaining Americans too have either declined or at best remained stagnant. In the present crisis, the economic crisis that followed has badly affected all others too, with the severest impact, in relative terms, being felt by the poor.

After all, it is one thing for your income to drop from $10 million to $ 1 million, and an altogether different thing for it to drop from $10,000 to $8000. In substantive terms, the rich have been forced to cut on their luxury purchases, while the poor have been squeezed on their basic needs. Being forced to auction off your summer retreat or luxury yatch is qualitatively different from being forced out into the streets.

However, in any recession, especially that induced by a crash in asset values, the rich, being the most exposed to such markets, will be more adversely affected than the poor. Jonathan Parkerand Annette Vissing-Jorgensen have found in a recent NBER working paper, the incomes of the affluent tend to fall more, in percentage terms, in recessions than the incomes of the middle class, and those of the very affluent — the top one ten-thousandth — fall the most.

Though the falling incomes of the rich may have narrowed inequality, the stagnant incomes of the rest of the population may have left the economy with the worst of both worlds. On the one hand, the falling incomes of the rich will quickly translate into lower tax revenues, fall in consumption spending and decreased philanthropic activity, all of which will act to further depress aggregate demand and the economy. On the other hand, the poor do not benefit by any increase in their incomes and bear the brunt of the depressed economic activity. Of course, there is a strong and well-established case that narrowing inequality is good by itself, in so far as it slows down the entrenched and institutionalized discrimination that comes with the concentration of economic and political power among a relatively small group.

The Times article points to Mohamed A. El-Erian, chief executive of Pimco, one of the largest bond traders in the US, who describes the spectacular asset bubble of the last twenty years since 1987 thus, "We are coming from an abnormal period where a tremendous amount of wealth was created largely by selling assets back and forth... You had wealth creation that could not be tied to the underlying economy and the benefits were very skewed: they went to the assets of the rich. It was financial engineering."


Emmanuel Saez and Thomas Piketty have used the IRS income data from the late seventies to 2007 and found that the cutoff to qualify for the highest-earning one ten-thousandth of households jumped from roughly $2 million, in inflation-adjusted, pretax terms to $11.5 million and the cutoff to be in the top 1 percent doubled to roughly $400,000. In contrast, pay at the median — which was about $50,000 in 2007 — rose less than 20 percent, and at the bottom of the income distribution, the increase was a mere 12 percent.

In 2007, the top one ten-thousandth of households took home 6 percent of the nation’s income, up from 0.9 percent in 1977, and the highest such level since at least 1913, the first year for which the IRS has data, and the top 1 percent of earners took home 23.5 percent of income, up from 9 percent three decades earlier. Further, since 1980, tax rates on the affluent have fallen more than rates on any other group, as the graphic below shows.

Update 1
The census data for 2008 shows that poverty increased, median household income fell, and the percentage of Americans with employer-based health coverage continued to decline in 2008. The poverty rate rose to 13.2 percent, its highest level since 1997. The number of people in poverty hit 39.8 million, the highest level since 1960. It also finds that the $787 bn ARRA has helped keep atleast 6 million Americnas out of poverty. The official poverty rate rose in 2008 to 13.2 percent, from 12.5 percent in 2007.

Analysing the IRS data, Thomas Piketty and Emmanuel Saez find that two-thirds of America's total income gains from 2002 to 2007 flowed to the top 1 percent of U.S. households, and that top 1 percent held a larger share of income in 2007 than at any time since 1928.

Economix finds two distrubing trends - economic growth in the current decade has been slower than in any decade since before World War II; and inequality has risen sharply that so much of the bounty from our growth has gone to a relatively small slice of the population. The result has been a decade with no real income gains for the median household for the decade ending 2008.

And here are a series of excellent graphics from the census report.

Update 2

From Economist and Emmanuel Saez.

Update 3 (14/4/2010)
David Leonhardt debunks the conservative arguement that rich Americans pay a disproportionately high tax rate and that American tax system is highly progressive here, here and here. Taking all taxes (and not just federal income taxes) - other federal taxes like payroll taxes and capital gains taxes, state and local government taxes (which are mostly indirect taxes and lot less progressive) - into account, it becomes clear that American tax system is not as progressive as being claimed and that the rich are those most benefitted by the taxation system. He writes

"Add it all up, and you can see why the wealthy are paying a greater share of federal taxes even though they are paying less tax on each dollar they earn. They’re simply making many more dollars than they used to."

Thursday, August 20, 2009

Health care - positive externalities

That basic health care is a public good and provides considerable positive externalities, and will therefore have to be supplied by the government is widely accepted. Now here comes more examples of its positive externalities.

A CEPR study which finds that small business activity to be marginal in the US, considered the home of entrepreneurial capitalism, has provoked various explanations for the surprising finding, prominent being the role of high health care costs in the US.

About the reasons for the low self-employment rates in the US, the study writes,

"One plausible explanation for the consistently higher shares of self-employment and small-business employment in the rest of the world’s rich economies is that all have some form of universal access to health care. The high cost to self-employed workers and small businesses of the private, employer-based health-care system in place in the United States may act as a significant deterrent to small start-up companies,12 an experience not shared by entrepreneurs in countries with universal access to health care."

Paul Krugman makes this interesting punchline, "We’re not independent free spirits; on the contrary, we’re more likely than Europeans to be cubicle rats working for big employers." NYT has this op-ed which makes the case for universal health care and its importance in lowering costs for small businesses. The reforms proposed by the Obama administration like the setting up of health insurance exchanges would enable smaller firms to buy helth insurance plans for their employees at the same cost as larger firms.

Contrast this low level of small business activity in the US with India, whose cities have been found to be teeming with entrepreneurial spirit. Interestingly, here too the absence of additional health care costs for their employees may also be an important contributing factor to the proliferation of small businesses. However, in this case, the government is not bearing the health care burden and there is no clear and enforceable mandate on the employees to do so. In the circumstances, the workers are left to fend for themselves, with profoundly adverse implications for the society and economy as a whole.

Update 1
The US Secretary of Commerce makes his case in support of universal health insurance as beneficial to both small employers and their employees.