Saturday, April 30, 2011

Euro and Germany

Floyd Norris examines the widespread belief that the the big winner from the introduction of Euro has been Germany. He points to an ECB study which finds that since its introduction in 1999, Germany has gained competitiveness, not only against other major industrial nations but against all other members of the euro zone.



The study also finds that over the same period, Germany’s balance of payments has gone from a small deficit to a strong surplus, but in the euro zone as a whole the balance of payments position has deteriorated slightly. Norris writes,

"With the exception of Germany, each of the countries shown has lost competitiveness because unit labor costs have risen more rapidly in those countries. Absent the euro, many of the countries probably would have devalued their national currencies, but that is not possible as long as they remain in the euro zone."


I have already blogged about how decline in competitiveness has played an important contributor to the problems of countries like Portugal and Greece.

US health care costs in perspective

Medical Costs Infographic
Via: Medical Billing and Coding

Friday, April 29, 2011

Global shale gas reserves

Shale gas is fast emerging as the next big global energy source. Marginal Revolution points to this graphic of global shale gas reserves from an assessment of 48 shale gas basins in 32 countries made by the US Energy Information Agency. The EIA estimates that over 6,600 Tcf of shale gas resources are estimated to be technically recoverable.



To lend some perspective, 1,000 Tcf of natural gas contains the equivalent energy to 166 billion barrels of oil. Note that India does not have anything to cheer from this source too, atleast from this set of data. It is possible that exploration for shale gas is at its nascent stages in Asia and Africa.

The only real issue with shale gas is whether its costs - by way of hydraulic fracking causing pollution of aquifers and methane leakages from shale wells - exceed the benefits arising from lower carbon releases. However, the final verdict may not come anytime soon. Over the next few years, there will surely be significant improvements in technologies aimed at curbing pollution.

Update 1 (7/10/2011)

FT has this article on the potential of shale gas, especially in the north eastern rust belt in the US. Natural gas is much cheaper in the US at about $3.60 per million British thermal units compared with about $8 in the UK and $16 in Japan. More importantly, the US gas price works out at the equivalent of $22 a barrel, about one-fifth of the Brent crude price of more than $100.



Update 2 (7/12/2011)

WSJ has a story on concerns about water consumption associated with hydraulic fracturing, or fracking, in parched South Texas. Energy companies blast rocks far below the surface with enormous amounts of water-about six million gallons at a time-mixed with sand and chemicals at high pressure in order to release oil and natural gas, sometimes depleting local water supplies.





It takes 407 million gallons to irrigate 640 acres and grow about $200,000 worth of corn on the arid land. The same amount of water, he says, could be used to frack enough wells to generate $2.5 billion worth of oil.

To date, criticism of fracking has focused mainly on concerns that the chemicals energy companies are mixing with the water could contaminate underground aquifers. Oil industry officials regard that issue as manageable. The biggest challenge to future development, they say, is simply getting access to sufficient water.

Update 3 (24/2/2012)

A report by the US EIA of 48 shale gas basins in 32 countries estimates "technically recoverable" global shale gas resources at 6,600tn cubic feet, roughly equal to today’s proved reserves. Martin Wolf writes on the benefits of natural gas

Gas emits slightly more than half as much carbon dioxide as coal and 70 per cent as much as oil, per unit of energy output. Emissions from gas of carbon monoxide are a fifth as much as from coal. Emissions of sulphur dioxide and particulates are negligible. In any plausible scenario for managing emissions of greenhouse gases, natural gas will have to substitute for other fuels, though development of cheap carbon capture and storage would also strengthen the case for coal.


He argues that the wisdom of proceeding rapidly with this technology globally will depend on several considerations:

First, the local opportunity costs of water; second, the abilities and reliability of the operators; third, the capacity of the regulators; fourth, the benefits of any extra gas, compared with those of alternative fuels (or conservation), including for security; and, fifth, better knowledge of the impact of the technologies.
Update 4 (23/4/2012)

Good FT article on shale gas is available here. 



















Update 5 (8/5/2012)

A Cornell study finds that the carbon emissions footprint from shale gas is much higher than conventional fuels.
Natural gas is composed largely of methane, and 3.6% to 7.9% of the methane from shale-gas production escapes to the atmosphere in venting and leaks over the life-time of a well. These methane emissions are at least 30% more than and perhaps more than twice as great as those from conventional gas...


The footprint for shale gas is greater than that for conventional gas or oil when viewed on any time horizon, but particularly so over 20years. Compared to coal, the footprint of shale gas is at least 20% greater and perhaps more than twice as great on the 20-year horizon and is comparable when compared over 100 years.

China's high speed rail march stumbles?

China's spectacular $300 bn high-speed rail projects of the past decade has to rank as one of the most breathtaking infrastructure achievements of the last half century. It has been staggering not only in its sheer scale, but also in the pace at which it has been executed. As the graphic below shows, in a matter of five years China has destroyed all competition and has emerged as the unquestioned global leader in this cutting edge sector.



However, as a recent Washington Post article highlights, the success is fast tuning sour. For a start, the pay-back time on debts incurred to finance the projects has arrived and the Ministry of Railways is left with a whopping $271 billion in debt. Ticket sales and other revenue streams are hardly enough to cover the massive $27.7 bn in debt service for 2011 itself. Tickets priced at two to three times the regular rail ensures that ridership is poor.

However, of even bigger concern are question marks over safety and reliability. Contractors have been accused of colluding with officials and skimming off tax payer resources by using cheap, low-quality concrete and equipments. Tales of corruption abound, with even the Head of Ministry of Railways getting sacked.

As the Post article writes, Chinese high-speed rail will soon require government bailout. In this it is following the experience elsewhere, which conclusively shows that such projects are rarely fully viable commercially. Japan’s bullet trains needed a bailout in 1987. Taiwan’s line opened in 2007 and needed a government rescue in 2009. In France, only the Paris-Lyon high-speed line is in the black.

High-speed rail networks, with speeds of upto 350 km/hr, can deliver competitive advantage over airline for journeys of up to about 3 hours or 750 km, particularly between city pairs where airports are located far from city centres. Construction and rolling stock capital costs typically range from $35-70 million per km, depending on the complexity of the civil engineering work, rolling stock capacity etc. A World Bank report on high-speed rail writes,


"Governments contemplating the benefits of a new high-speed railway, whether procured by public or private or combined public-private project structures, should also contemplate the near-certainty of copious and continuing budget support for the debt. A developing country must reasonably expect atleast 20 million passengers/year with significant purchasing power, just to have the possibility of covering the working expenses and interest costs of providing that capacity with high-speed service; and probably double that number of passengers to have any possibility of recovering the capital cost.

In summary then, high-speed rail is now a tried and tested technology that delivers real transport benefits and can dominate market share against road and airline transport over the medium distances that many inter-city travelers confront. However, the demographic and economic conditions that can support the viability of high-speed rail are, in global terms, limited. The number of passenger transport corridors of the requisite length, that are already capacity constrained, and where there is sufficiently dense potential demand by people of adequate purchasing power, is limited; some may be in countries where the implementation capacity may be lacking."



Update 1 (23/6/2011)

Excellent Times story captures the benefits of light-rail network for China's economy,

"Around China, real estate prices and investment have surged in the more than 200 inland cities that have already been connected by high-speed rail in the last three years. Businesses are flocking to these cities, now just a few hours by bullet train from China’s busiest and most international metropolises.

Meanwhile, a shift in passenger traffic to the new high-speed rail routes has freed up congested older rail lines for freight. That has allowed coal mines and shippers to switch to cheaper rail transport from costly trucks for heavy cargos. Because of this shift, plus the construction of additional freight lines, the tonnage hauled by China’s rail system increased in 2010 by an amount equaling the entire freight carried last year by the combined rail systems of Britain, France, Germany and Poland, according to the World Bank.

The bullet train bonanza, and the competitive challenge it poses for the West, is only likely to increase with the opening of the 820-mile Beijing-to-Shanghai line, which will create a business corridor between China’s two most dynamic cities. The railway ministry plans 90 bullet trains a day in each direction."




The new, high-speed lines owned by joint ventures between the rail ministry and provincial governments, have also generated criticism for high costs and pricey fares, the quality of construction and corruption, and huge bank loan exposures. From Changsha to Guangzhou, the one-way fare in economy class for the two-hour journey, at speeds of up to 210 miles per hour, is 333 renminbi ($51). That is comparable to a deeply discounted airfare, but expensive for a migrant worker from Hunan who might earn only $160 to $400 a month in wages in Guangzhou. The same trip takes nine hours on an older, diesel train. But it costs only 99 renminbi ($15).

Thursday, April 28, 2011

Bernanke's priorities mapped!

The first ever formal press conference by a Fed Chairman was thought as an excellent opportunity to find out where the Fed's priorities lay. Which of the two - inflation or unemployment - did the Fed consider to be a greater evil?

Conservatives have been whipping up fears of an inflationary spiral, pointing to the dangers of the huge amounts of money from the two rounds of quantitative easing sloshing around. This coupled with the burgeoning public debt, they argue, is reason enough to indulge in austerity and fiscal contraction. In contrast, liberals point to the persistenly high unemployment rates, low inflation and the weak aggregate demand and have been advocating more expansionary policy, including a third round of quantitative easing. They point to the dismal latest economic growth figures and weak labour market conditions and claim that further austerity will contract the economy, increase the debt-to-GDP ratio, and drag the economy deeper into a recession.

So where does the Fed's sympathies lie? The Reuters have an excellent word cloud which conclusively highlights which direction the Fed is leaning towards.



For the record, Bernanke said that inflation must take precedence over employment because inflation would result in job losses,

"While it is very, very important to help the economy create jobs and help to support the recovery, I think every central banker understands that keeping inflation low is absolutely essential to a successful economy, and we will do what we can to make sure that happens... The trade-offs are getting harder at this point. Inflation is getting higher. It’s not clear that we can get substantial improvements in payrolls without creating a considerable risk of a dangerous rise in inflation."


This, as Mark Thoma and others have pointed out, is baffling given that unemployment rate rules high and inflation is running below the Fed’s preferred range of 1.5 to 2.0 percent. It is all the more surprising since the Fed, by Bernanke's own admission, believes the expected rise in inflation, due to rising commodity prices, is only transitory. Mark Thoma is spot on in his assessment,


"The potential benefit of further policy moves by the Fed is higher growth and lower employment. The potential cost of more quantitative easing is inflation. So the decision on whether to provide more help to labor markets comes down to a comparison of the expected employment benefits to the expected inflation cost... none of the Fed’s forecasts show any long-run concern about inflation at all."


Update 1 (30/4/2011)

Three excellent graphics - bond yields, inflation, and unemployment - from Paul Krugman, that lays to rest all speculation about bond-vigilantes, spiralling inflation etc.

Update 2 (2/5/2011)

Chad Stone has an excellent graphic that captures the across the board drop in US economic growth in the first quarter of 2011 compared to the previous quarter.



Update 3 (3/5/2011)

NYT editorial questions the real meaning of the modest reduction of unemployment rate in the US from 10.1% in late 2009 to 8.8% now. Over the last year, the number of new hires has been outstripped by the masses who have either given up looking for work or who have not undertaken a consistent job search, say, after graduating from high school or college. Those missing millions are not counted in the official jobless rate; if they were, unemployment today would be 9.8 percent.

Mohamed A. El-Erian points to a few other uncomfortable unemployment facts - much of the improvement in recent months (from 9.8% in November last year) is due to workers exiting the labor force, thus driving workforce participation to a multi-year low of 64.2%; if part-time workers eager to work full time are included, almost one in six workers in America are either under- or unemployed; more than six million workers have been unemployed for more than six months, and four million for over a year; unemployment among 16-19 year olds is at a staggering 24%.

Wednesday, April 27, 2011

Information over-load and health care

Standard explanations trace market failures in health care in general and health insurance in particular to information asymmetry (patients knowing more about their condition than the insurers and doctors knowing more about treatments and diagnostic procedures than patients) and its resultant adverse selection problems, and moral hazard (insured patients having no incentive to curb treatment and costs) concerns. Here are two less-discussed dimensions to this debate, both of which highlight the complexity involved in managing health care markets.

First, Tyler Cowen makes an important distinction between information asymmetry and information overload, and feels that adverse selection is less a problem. He writes,

"When it comes to the elderly, adverse selection as a problem is overstated. The real problem is usually a high degree of information about many conditions, so often insurance is difficult per se. It’s not the asymmetry of information that is the core issue, it is the existence of lots of information, and that is one of Arrow’s subtler points. That distinction matters a good deal for mechanism design.

An old person might know better his health care condition, but not know better his expected health care costs. That is a critical distinction. You can’t reach age 60 and credibly say: "I’ve been healthy so far, I guess my lifetime health care costs will be low." It’s not even clear whether the healthy or the unhealthy will have lower health care costs in their later years; the unhealthy might die rather quickly and decisively. Adverse selection on the grounds of health care costs need not be high and arguably actuaries can estimate those as well as the individual himself."


Another manifestation of information over-load involves the problem of patients being unable to effectively discriminate between multiple treatment options. For example, a patient exposed to two different sets of diagnosis, struggles to make a choice, leave alone the correct choice. Also, though the patient can avoid subjecting his/her body to all diagnostic tests if he/she can trust the doctor's clinical skills, such trust, for various reasons, is an increasingly rare commodity.

Further, most often, in their anxiety, patients end up following the herd and over-treating themselves. Unfortunately, the incentives of the doctors and the diagnostic service providers too are aligned towards leading patients down the path of the herd. In all these cases, it is not information asymmetry, but information over-load that either paralyses decision making or leads patients to make the wrong choices.

Co-payments and deductibles, while trying to incentivize patients to optimize on their treatment, does not always, atleast among those at the top half of the income ladder, curb over-treatment. Awareness campaigns and focussed information dissemination about medical conditions and treatment options can play an important role in helping patients make informed treatment choices.

In another post, Paul Krugman makes the point that health care recipients cannot be exact substitutes for "consumers" in the general marketplace. He writes,

"Medical care is an area in which crucial decisions — life and death decisions — must be made; yet making those decisions intelligently requires a vast amount of specialized knowledge; and often those decisions must also be made under conditions in which the patient is incapacitated, under severe stress, or needs action immediately, with no time for discussion, let alone comparison shopping.

That’s why we have medical ethics. That’s why doctors have traditionally both been viewed as something special and been expected to behave according to higher standards than the average professional. There’s a reason we have TV series about heroic doctors, while we don’t have TV series about heroic middle managers or heroic economists."


The term consumer-choice becomes meaningless in case of patients fighting to save their lives. The choice is mostly a fait accompli. As Krugman argues, it is indeed surprising that even forty years after Ken Arrow wrote this seminal paper distinguishing health care from other markets, the issue still evokes confused rhetoric. See also this post on the shockingly low levels of health care literacy even in the US.

Tuesday, April 26, 2011

Hospital infections - nudging on hand washing

Hospital infections are the fourth leading cause of death in America, with 2 million patients in America acquiring an infection in the hospital every year (about one in 20 patients) and 100,000 people dying of them. The ratios are certain to be much higher in developing countries.

The commonest source of such infections are unwashed hands of doctors and medical attendants. In fact, a recent study of several intensive care units in the US showed that hands were washed on only one quarter of the necessary occasions. The report claims that "hand hygiene (HH) is the single most important factor in the prevention of health care-acquired infections".

Though extremely trivial, hand washing by doctors and nurses before attending to each patient is one of the most vexatious of problems. Atul Gawande has documented the challenge posted by it and chronicled how some hospitals have tried to create a culture of hand-washing by using checklists and by redesigning hand hygiene systems to make hand-washing easier and automatic. However, the amount of efforts required makes such approaches difficult to replicate on scale. In this context, NYT Fixes points to a technological solution being piloted in a few hospitals in the US,

"Every health care worker wears an electronic badge. When she washes her hands or uses alcohol rub, a sensor at the sink or dispenser or her own badge smells the alcohol and registers that she has washed her hands. Another sensor near the patient detects when her badge enters a room or the perimeter around a patient that the hospital sets. If that badge shows that her hands were recently washed, it displays a green light or something else the patient can see. If she hasn’t washed, her hands, the badge says so and emits a signal to remind her to do so. The sensor also sends this information to a central data base. Information about the hand-washing practices of a particular unit, shift or individual is instantly available."


In other words, the sensors nudge hospital staff to wash their hands before they attend to their patients. They bridge the last mile gap by bringing in a point-of-care compliance monitoring system that nudges health care workers to follow hand hygiene standards.

Though these systems are largely in pilot phase, initial results are encouraging. Its prohibitive costs means that it will be some time before they become affordable for even the richer hospitals. However, the simplicity of the solution, RFID tags attached to sensors means that once its utility is established they could be quickly commercialized at affordable rates.

See Proventix's nGage, HyGreen's Hand Hygiene Recording and Reminding System, BioVigil's Health Care Badge and Alcohol Sensor, and Patient Care Technology System’s Amelior 360.

Update 1 (30/4/2011)

The second part of Fixes article by Tina Rosenberg is available here. Peter Pronovost's landmark paper in the NEJM (made famous by this New Yorker article of Atul Gawande) which chronicled the experiment of 103 ICUs in hospitals across Michigan that used a five-point checklist to prevent infections in central line catheters is available here.

The five-point checklist - wash hands; cover the patient with sterile drapes; clean the skin with chlorhexidine antiseptic; do not insert catheters into the groin area; remove catheters as soon as they are no longer needed - reduced the the median rate of infection to zero within 3 months and was sustained for the remaining 15 months of the follow-up.

Update 2 (2/9/2011)

A study of handwashing in the Journal of Psychological Science by David Hofmann and Adam Grant found that changing the messages posted in the hospital environment from "Wash Your Hands to Protect Yourself" to "Wash Your Hands to Protect Your Patients" could motivate some doctors and nurses to wash their hands more frequently.

They measured the change in soap use when they put up different signs by the dispensers. One sign read "Hand Hygiene Prevents You from Catching Diseases". Another read "Hand Hygiene Prevents Patients from Catching Diseases". And a third sign, which served as a control, had a generic message: "Gel In, Wash Out". The patient-focused sign produced a 33 percent increase in the amount of soap and disinfectant used per dispenser over a two-week period, compared with the other signs.

In a second phase of the study, trained observers recorded how often doctors and nurses physically washed or disinfected their hands. The sign urging doctors to think about patients produced a roughly 10 percent spike in hand washing compliance, a jump that was small but statistically significant.

Empowering consumers using behavioural insights

The Behavioural Insights Team located in the British Cabinet Office has released its latest strategy document (pdf here). It argues for the use of insights from behavioural psychology to empower consumers and help them make more informed and effective choices. It is hoped that this will in turn encourage competitive businesses, improve overall economic efficiency and thereby long term economic growth. As the report says, "A better deal for consumers and the economy means a better deal all round."

Its earlier report which advocated the use of insights from behavioural economics to address health care issues is discussed here. Its two-fold objectives are defined as

"1. To put consumers in charge so that they are better able to get the best deals for themselves individually and collectively as well as looking at ways to empower the most vulnerable who may not otherwise benefit from these exciting developments.
2. To contribute to our broader growth agenda, supporting a strong private sector recovery and helping to raise underlying long-term growth rates."


The strategies and initiatives proposed include,

"1. A radical new programme of work – 'mydata' – which will enable consumers to access, control and use data currently held about them by businesses;
2. A range of new ways of ensuring that consumers are given richer, more relevant information about the goods and services they buy (including clearer information on Credit Card Statements);
3. A drive to encourage collective purchasing and collaborative consumption, which enable people to come together to buy or use goods;
4. The development of a self-regulatory quality mark for web and comparison sites, and the publication by Government of complaints and performance data held about businesses"


The Better Choices : Better Deals program seeks to put power into the hands of consumers so that they can choose optimally between suppliers and in the process incentivize businesses to be more efficient and innovative. In order to achieve this, it seeks to leverage three recent trends,

"1. The increasing role of new technologies, in particular internet and mobile phone applications, that have opened up new channels for consumers to find, compare, and purchase goods and services.
2. The use of data, drawn from customers’ own transaction histories, that have allowed businesses to understand their customers better, allowing them to make more tailored recommendations.
3. The development of new ways for different consumers to collaborate across the economy – for example whether by sharing cars or bicycles, or giving feedback about a GP practice, a local tradesman or a multinational corporation."


The centerpiece of the campaign is the "mydata" program undertaken by the government in partnership with consumer groups and leading businesses to give consumers more control and access to their personal transactions data in a way that is portable and safe. This will enable them to "take advantage of the growing number of applications which can use this data to find them a better deal, or tell them interesting things about their spending habits".

The Better Choices : Better Deals campaign also proposes to go beyond the conventional regulations driven approach to protect and benefit consumers. This would include working in partnership with businesses and voluntary associations to build norms of social responsibility and consumer satisfaction. The program will appeal to businesses to reduce their carbon footprint, improve skills and create jobs, support the local community, and improve the quality and well-being of their consumers.

Sunday, April 24, 2011

Where are Dani Rodrik's shamans and councils of elders to regulate China's activities in Africa?

Dani Rodrik recently posted a nice parable that seeks to capture a simplified version of the development process facing developing countries. He describes the development tale of a poor little fishing village beside a lake, and cut-off from the mainland by a dense forest tract, whose residents lived off the fish they caught and the clothing they sewed and who are slowly faced with the challenges of globalization.

The tale traces the challenges the villagers faced when the fishing stock in their lake plummeted (they responded with co-operatives that imposed fishing quotas), started trading dried fish in return for sewed clothes with the villages on the other side of the forest (fishermen got rich, while those who sewed clothes were flooded with cheaper and better quality garments - resolved by forcing fishermen to make higher contributions to the village feast), and when transportation facilities opened the floodgates for fishermen from outside (which depleted fishing stocks and was remedied with toll collection on outside fishermen).

One could easily replace the fishing village with any African country or Suriname and the foreigners from beyond the forest with Chinese migrants to represent the problems generated by massive Chinese economic and political activity in many emerging countries of Africa and Latin America. In fact, we could also substitute the shaman with local advisors and opinion makers and the council of elders with the political establishment in Africa. In this context, the recent events and trends relating to China's economic activities in Africa and Latin America provides an excellent and immediate test to managing globalization effectively following second-best approaches.

China has emerged as Africa’s biggest trading partner (crossing $120 bn in 2010) and has replaced Europeans as the most important external economic and political influence in these countries. In the past two years China has given more loans to poor countries, mainly in Africa, than the World Bank. China has invested more than $40 bn in the 2005-10 period in sub-Saharan Africa. The physical Chinese presence itself in many African countries is substantial and migrants now run everything from small factories to health care clinics and trading companies.

As the NYT reported, "for many budding Chinese entrepreneurs, Africa’s emerging economies are inviting precisely because they seem small and accessible. Competition is often weak or nonexistent, and for African customers, the low price of many Chinese goods and services make them more affordable than their Western counterparts."

Politically, Beijing sees a great opportunity to exercise some form of control, even pick up stakes, in strategic mineral and oil assets, and that too on the cheap, in these resource rich African countries. The big-ticket infrastructure contracts that are in any case inevitable for economic development, apart from being critical for the exploitation of these natural resources, form a major economic attraction for Chinese companies. These state-owned firms have developed massive economies of scale in heavy infrastructure equipment manufacturing and expertise in execution of huge road, railroad, irrigation, electricity, and urban infrastructure projects.

Though, such investments and labor migration has its beneficial effects on the host country economy, there remain serious concern, especially given the scale of China's interventions and historical experiences, domestically or from elsewhere, of previous such activity,

"Africans view the influx of Chinese with a mix of anticipation and dread. Business leaders in Chad, a central African nation with deepening oil ties to China, are bracing for what they suspect will be an army of Chinese workers and investors... When they arrive, will they bring their own workers, stay in their own houses, send all their money home?

In Zambia, where anti-Chinese sentiment has been building for several years, merchants at the central market in Lusaka, the capital, said that if Chinese people wanted to come to Africa, they should come as investors, building factories, not as petty traders who compete for already scarce customers for bottom-dollar items like flip-flops and T-shirts...

Africans in many countries complain that Chinese workers occupy jobs that locals are either qualified for or could be easily trained to do... The problem with the Chinese companies is that they reserve all the good jobs for their own people. Africans are only hired in menial roles. Another frequent criticism is that the Chinese are clannish, sticking among themselves day and night."


Though Chinese development assistance and cheap labor helps build roads, low-cost housing, set up renewables based power plants, promotes shrimp farming, and so on, there are several concerns, especially with the influx of significant Chinese labor (estimated to be over 10% of the country's population) in countries like Suriname,

"In parts of Suriname, concerns over whether some Chinese laborers illegally stay past the end of their visas has led to debate over whether Chinese companies should be allowed to bring their own workers to the country, possibly depriving some Surinamese of jobs... many of the new arrivals are visibly involved in commerce, standing in contrast to Brazilians, Suriname’s other fast-growing immigrant group, who work largely at remote gold mines in the interior."


The Economist has an article that highlights how Chinese business practices are creating tensions in many African countries,

"Chinese expatriates in Africa come from a rough-and-tumble, anything-goes business culture that cares little about rules and regulations. Local sensitivities are routinely ignored at home, and so abroad. Sinopec, an oil firm, has explored in a Gabonese national park. Another state oil company has created lakes of spilled crude in Sudan...

At Chinese-run mines in Zambia’s copper belt they must work for two years before they get safety helmets. Ventilation below ground is poor and deadly accidents occur almost daily. To avoid censure, Chinese managers bribe union bosses and take them on 'study tours' to massage parlours in China. Obstructionist shop stewards are sacked and workers who assemble in groups are violently dispersed. When cases end up in court, witnesses are intimidated."


However, unlike Dani Rodrik's fictional fishing village, which had a benevolent and wise shaman and a far-sighted and disciplined council of elders, not many African countries or Suriname enjoy the guidance of such institutions to help chart the vicissitudes of the development process. Can African governments, with a notorious reputation of being willing participants in the loot of their own countries, and its civil society summon the necessary foresight, commitment, and spirit of co-operation to guide their nations through the uncertainties like that posed by the increased role of China in their economies and societies?

Happily, Prof Rodrik also tries to provide some answers to these countries to face upto these challenges,


"The parable suggests that internal debate and deliberation can produce a reasonable compromise. The compromise does not entail the blocking of trade or high barriers, as some groups want. But it does entail accepting some transaction costs on external trade and a departure from complete free trade."


And underlining the departure from first-best solutions and embrace of second-best ones, he writes,


"It would be little comfort to the villagers to be told that they should resort to lump sum taxation, non-linear income taxes, or allocating property rights over the fish stock – when the practical implementability of such potentially more efficient solutions remains unclear...

When openness to trade raises overall national income, a properly structured political process should not have an anti-trade bias to begin with. And allowing greater "policy space" to individual nations will in fact make it easier to uphold the social bargains that enable openness to trade. A (small) deviation from the ideal of complete free trade (hyperglobalization) is a small price to pay for this."


Even assuming a second-best approach, the challenge still remains of formulating inclusive and reasonable policies that accommodate the interests of all sides, and then mobilizing the political support and commitment to implement them. In the absence of policies that can manange a "reasonable compromise", the fishing stocks will decline, fishermen will refuse to pay up their share for the monthly feast, and xenophobic sentiment against outsiders "stealing our jobs" will grow and explode. Does Africa have wise shamans and enlightened political elders who can prevent such damaging outcomes?

Post script

MR points to Chinese interest - massive investments and labor migration - into Caribbean too. Diplomatic concerns, arising from the need to out manouvre Taiwan, and economic interests may be the primary motivators here.

Beijing's Transport Plans!

China has lined up ambitious plans to address Beijing's worsening traffic problems.

280,000 new parking spaces; 1,000 share-a-bike stations; 348 miles of new subway tracks; 125 miles of new downtown streets; 23 miles of tunnels; 9 new transportation hubs; 3 congestion zones; and 1 cure-all, "the use of modern technology".


The sheer scale of that is staggering. To put it in perspective, it is more that what is planned in all Indian cities put together!

Friday, April 22, 2011

The 3G economies

Citi economists William Buiter and Ebrahim Rahbari investigated the likely future sources of global economic growth between 2010 and 2050 and have come up with 11 global growth generators. The 11 3Gs are Bangladesh, China, Egypt, India, Indonesia, Iraq, Mongolia, Nigeria, Philippines, Sri Lanka, and Vietnam.


Their analysis
(full report here) is based on country forecasts of macroeconomic data, historical data for the past 10 years, and research data on the drivers of long-term economic growth. They constructed a 3G index that aggregates some key growth drivers - gross fixed domestic capital formation (as a share of GDP), gross domestic saving (as a share of GDP), a measure of human capital, itself aggregating demographic, health and educational achievement indices, a measure of institutional quality, a measure of trade openness, and the initial level of per capita income.

Interestingly, three of the eleven are from South Asia and two are from Africa. Does this signal that the next half-century could belong to South Asia just as the previous half belonged to East Asia? It forecasts India to overtake China and become the world's largest economy by 2050, with India's economic growth to peak in the 2030-50 period. Further, the presence of two African countries lend credence to the growing belief that Africa is one the take-off path.

Developing Asia will contribute more than half the global economic growth over the next forty years, with Africa following behind. The combined shares of North America and Europe will be slightly more than 10%.



A reflection of Asia's pre-eminence as the engine of global economic growth is the eastward shift in the global economic center of gravity.



India is set to emerge as the largest economy by 2050



However, despite the spectacular and sustained growth, the per capita GDPs of most of these economies will remain less than half of the US per capita GDP even by 2050. This also means that the room available for convergence or catch-up growth with the technology frontier (say, the US) will be considerable, thereby boosting the economic prospects of these economies in the next half century.


Value of urban land space!

The Meaklong Market in Bangkok, which has a railroad passing right through the center of the market, must be one of the most extreme manifestations of the value attached to land space in urban areas. The videos show how the vendors manage their business without conceding any exclusive space for the trains which passes through eight times a day.





(HT: Marginal Revolution)

Thursday, April 21, 2011

On the progressivity of tax exemptions

More posting on taxation! Most often, public debates on the progressivity of taxes is restricted to only the actual tax incidence and overlooks the impact of exclusions (or tax expenditures, as in the US). Exclusions are exemptions from payment at the regular taxation rates, provided to a preferred category of consumers and for meeting certain public policy goals.

There is nothing surprising about tax exclusions being regressive and favoring the more well-off. Tax exclusions are, as aforementioned, by definition, promulgated to benefit specific interest groups. Only those lobbyists representing powerful interest groups command the political influence to push through such exclusions. Once put in place, these exemptions assume the character of entitlements and are difficult to eliminate.

Consider two of the most high-profile examples from the US - income tax exclusion for employer-provided health insurance and mortgage interest deduction, provided with the objective of expanding the quality and quantity of health insurance coverage and home ownership respectively. Both have been found to be far more beneficial to those at the higher end of the income ladder. In fact, many of the exemptions are positively regressive - the same rate of taxation for everyone. And when these deductions are applied for essential and substantial consumption items with wide variations in quality like health care and home mortgages, those with higher incomes naturally benefit disproportionately.

In the US, employer provided health insurance, covers three-fifths of the population under age 65. Under the existing law, workers who obtain health insurance through an employer need not pay any taxes on the 'employer contribution' to the premium (which is mostly more than 75% of the total premium). In fact, this tax exclusion is the largest of any tax expenditures, more than double the next highest expense. Its inefficiencies and incentive distortions are widely documented.



The mortgage interest deduction allows homeowners to pay their mortgage interest with their pre-tax income. Its biggest beneficiaries are the most affluent, as they are not only likely to own houses, but also have considerable mortgage interest outflow which can be deducted from the pre-tax incomes. Many people at the bottom half of the ladder do not even avail of this exemption.



In both cases, there is a concomitant tax penalty on those who do not follow the regular route and avail health care and housing services. Since the tax exclusion does not apply to privately purchased health insurance packages, people not availing employer-sponsored benefits have to pay a substantial tax on their premiums. Similarly, people who prefer to rent a house, instead of trying to own one, have no deduction on any part of their rental expenditure.

As David Leonhardt has pointed out, tax expenditures cost the US federal government about $1.2 trillion in lost revenues last year, whereas the budget deficit itself was just $1.3 trillion. In 2010-11, the central government in India lost potential tax revenues worth a staggering Rs 5.7 lakh crore due to the various exemptions, concessions and rebates it gave. These concessions, also formed about 80% of the total tax expected to be collected in the period.

At a time when increasing taxes is politically suicidal, removing tax exclusions are a more practical strategy to raise government revenues. In any case, this is the most economically efficient approach to increasing government revenues, at a time when governments in many countries face mounting public deficits.

Wednesday, April 20, 2011

Progressive taxation and user charges for government services

The Union Budget 2011-12 in India had left the marginal tax rates for both income and corporate taxes untouched, much to the applause of private sector and tax payers. This blog has repeatedly laid out the case for higher marginal tax rates on various grounds here, here, here and here.

Classical economics advocates that optimal taxation should be based on the principle of equalizing marginal utility of all members of the society - or taxing at the margins in such a manner that the marginal utility lost from each additional rupee of tax should be same. Translated into English, this meant higher tax rates on those up the income ladder. Opponents point to its perverse incentive effect on effort and the resultant efficiency costs of the tax.

In a very interesting paper early last year, Greg Mankiw had made the philosophical argument that any optimal taxation policy should be based on the premise that people should get the income they deserve - he who "contributes more to society deserves a higher income that reflects those greater contributions". He wrote,

"If we take public attitudes as a gauge of our innate moral intuitions, then in evaluating distributive justice, we should focus not on the marginal utility of different individuals but on the congruence between their contributions and their compensation... it is also a standard result that in a competitive equilibrium, the factors of production are paid the value of their marginal product. That is, each person’s income reflects the value of what he contributed to society’s production of goods and services."


In this world-view, if people are earning their "just deserts", there is no room for a progressive system of taxes and transfers, except in case of externalities (positive and negative) and public goods (national defense, police, the court system etc). This naturally leads to a tax system in which higher income individuals pay more in taxes and poor people are subsidized with transfers. He wrote,

"Surely, those with higher income and greater property benefit more from a governmental system that protects property rights. Moreover, the monetary value attached to other public goods (such as parks and playgrounds) and to positive-externality activities (such as basic research) very likely rises with income as well... What about transfer payments to the poor?... As long as people care about others to some degree, antipoverty programs are a type of public good... we would all like to alleviate poverty. But because we would prefer to have someone else pick up the tab, private charity can’t do the job. Government-run antipoverty programs solve the free-rider problem among the altruistic well-to-do."


This justification for higher taxes by the rich could be interpreted differently to arrive at much the same conclusions. It could be argued that the higher taxes paid by the rich are simply the cumulative user charges for the government services they draw upon to sustain their economic activities. Even a cursory analysis of government expenditures will show that the major share of the expenditures of modern day governments are not on subsidies and welfare. Instead, they are on capital intensive infrastructure investments (highways, ports, airports, power etc), whose marginal benefits are disproportionately higher for the rich than the poor.

In fact, the immediate and direct benefits of all such investments are invariably confined to the rich. The poor and middle class benefit by its trickle-down, lagged and indirect effect. And we all know that such trickles are most often drips that hardly wet the parched populace at the bottom.

In India, the Union Budget allocated Rs 1.25 trillion for defence and Rs 1.21 trillion for the entire social sector. In many respects, national security is the price of an insurance against all forms of uncertainty. In modern societies, such uncertainty impacts the economy, especially its higher echelons, and the economic lives of people who inhabit there. In contrast, the impact of such uncertainty on the economic lives of the poor and even the middle class is marginal.

An episode of Chinese muscle flexing on the Bay of Bengal will impact the financial markets and the prospects of many businesses directly, immediately, and substantively. In contrast, its impact on the vast majority of India's poor and middle class would be indirect and marginal. Principles of efficiency and internalization of costs clearly indicate that the rich should pay more for national defence than the poor. The same logic could be extended to other capital intensive investment areas like most parts of infrastructure sector.

Tuesday, April 19, 2011

Cash transfers and negative income tax credits

Cash transfers are the flavour of the season in India. The two commonly discussed cash transfer strategies are direct cash transfers to replace subsidies (as in case of food grains, kerosene, fertilizers, cooking gas etc) and conditional cash transfers to incentivize social outcomes (immunizing, sending children to school, maintaining nutritional standards etc).

In both cases, it is proposed that the cash can be transferred using the Aadhaar identity number to the beneficiary's Aadhaar-linked savings bank account. Though this will not completely resolve the problem of beneficiary selection, the issues of pilferage (by ghost and duplicate beneficiaries) and administration of the transfers will be satisfactorily addressed.

Apart from the two aforementioned types of cash transfers, there is a view, still marginal, that advocates direct payment of cash to all those below the poverty line. Such a universal minimum income guarantee, it is argued, should replace all subsidies and, if delivered through biometrically validated Aadhaar-linked accounts, will simplify program administration, minimize leakages, and limit incentive distortions.

I am not interested in this post to get into the relative merits of the three approaches to cash transfer. Needless to say, there are some very formidable challenges with a universal minimum income guarantee cash transfer. However, if this is adopted, the most effective strategy to implement it would be to package it as a negative income tax (NIT) scheme.

An NIT is reimbursed to the income tax assessee whose income falls below the basic minimum income level for which no one pays income tax. Just as tax payers pay tax at a percentage of their positive taxable income, NIT assessees can be reimbursed, into their Aadhaar-linked accounts, at a percentage of their income deficit (or shortfall from the basic minimum level at which tax kicks-in, the negative taxable income).

Milton Friedman had first proposed the NIT in the late sixties to replace all other welfare programs for the poor. A variant of this, the earned income tax credit (EITC), was introduced in the US in the seventies for the working poor.

The NIT has several benefits in the Indian context. Apart from the numerous benefits arising from dispensing with all other subsidies, the NIT, by making every individual file his income tax returns, would be big step in legitimizing all income streams. Though there will be the risk of people under-reporting incomes, it will open up a large part of the massive parallel economy in India.

The formidable challenge, as mentioned, will be to get people to report their incomes with reasonable degree of accuracy. Rigorous analysis of the massive database so created would itself provide ample information that can further uncover the parallel economy.

In any case, this would be a definite improvement over a direct minimum income transfer where cash would be transferred without any pre-conditions to all the identified beneficiaries. But with NIT, the government would be benchmarking all transfers to the reported incomes of the individual.

Monday, April 18, 2011

Harassment bribes and corruption

Popular stereotypes of corruption can be classified into two broad categories - administrative and harassment corruption.

Those like the 2G spectrum and mining lease allotment, and CWG procurement scams are examples of administrative corruption. In such cases, either the administrative processes themselves are tweaked or its implementation is subverted to suit preferred parties. However, the more ubiquitous form of corruption involves the harassment of citizens by government officials through demands for bribes to access public services.

Though both forms of corruption are bad, harassment corruption is more debilitiating and generates widespread inefficiencies. It is the form of corruption that citizens are likely to encounter as part of their daily lives. Unlike administrative corruption, which exists in some form or the other in all countries (for example, the manner in which the TARP bailout was administered in the US smacks of administrative corruption), harassment corruption is very rare among the developed countries.

Here is a graphic of such harassment bribes from the latest Global Corruption Barometer about the bribes paid by ordinary members of the public to at least one of nine different service providers, including customs, education, medical services and the judiciary.



As the graphic indicates, India stands at the top in harassment corruption. More than half the citizens reported to have paid bribes to access atleast one of the nine most essential public services in the past 12 months. Addressing this corruption should form the major anti-corruption priority of governments across developing countries.

If the Anna Hazare led anti-corruption movement in India is to have any impact on the lives of ordinary Indians, it needs to go beyond top-down regulatory quick-fixes like Lok Pal Bill. It needs to adopt more systemic and incentives-based approaches to lowering corruption (see this, this, and this). But these are mostly un-glamorous and incremental administrative innovations whose implementation is highly context-specific, and are not amenable to being reduced into populist slogans.

Sunday, April 17, 2011

Macroeconomic challenge of the decade - economic growth in debt-laden economies

The sub-prime mortgage crisis and the resultant Great Recession has had a damaging effect on the fiscal balances of most developed economies. These economies have been squeezed on both the revenues and expenditure sides. On the one hand, they have had to face the cost of financial bailouts and fiscal stimulus spending, while on the other, the weak economy has affected the tax and other government revenues. From all available evidence, it is clear that the former (declining revenues) is the major contributory factor to the increased debt vulnerability.

The stagnation or weak recoveries in these economies have meant that the debt-to-GDP ratios and deficits have been on the rise. In other words, the same debt is now financed with smaller revenues. This forces governments to either cut back on investments (which in turn slows-down growth during recessions, and thereby reduces revenues still further) or borrow more (thereby increasing the debt-to-GDP ratios and also forcing up deficits). Either way, the GDP share of debts and deficits go north. All the major western economies and Japan face the prospect of a long period of grappling with rising deficits and debts.

Then there are the more damaging macroeconomic imbalances generated by this trend. Typically governments facing massive debts and deficits are vulnerable to both domestic and external pressures. On the home-front, debt financing eats into the resources available for productive purposes and also crowds out private investments. The result is a weak economy. Further, an excess supply of domestic debt can potentially generate inflationary pressures.

On the external front, economies like the US and peripheral European countries, which have considerable foreign debt exposure, rely on external financing to meet a considerable portion of their deficits. This in turn puts upward pressure on sovereign yields and domestic interest rates. Then there is the vulnerability to exchange rate fluctuations - if the domestic currency weakens in the face of these troubles (as is to be expected), the real burden of external debts rise.

Hitherto, the ultra-low interest rates prevailing in most western economies and the continuing global savings-glut, manifested in the surging foreign exchange surpluses of the emerging economies, have mitigated the real burden of the rising debts. However, with China already showing signs of paring down its dollar asset exposures, cheap and plentiful credit may soon become history.

There is also the issue of private and government debts. In many of these economies, apart from the governments, corporates and households too are heavily indebted. Many of the peripheral European corporates have significant external debt exposures. It is therefore natural that corporates and households use a greater share of their incomes to pay-off debts. This in turn means that investments and consumption spending take a back-seat.

In simple terms, the dismal economic prospects and stagnant aggregate demand means that there is no engine room available for the debt-laden private sector to drive any economic recovery. However, governments, the only other agency capable of providing some boost to the economy, too is facing steep debts and deficits. So what is the way ahead? How far is the light at the end of the tunnel?

As I have blogged earlier, economic growth, and earlier the better, is the only way out of such huge debt burdens. All other options - inflating away domestic debts, exchange rate depreciation (to lower the real cost of external debts), and sovereign defaults - are too costly and have very adverse long-term consequences for the economy. Exporting the way out of debt is not an option available for many of these economies, except maybe Germany.

Kenneth Rogoff argues that there is no short and easy way out of this mess. A long and painful period of tight-rope walking is inevitable. On the one hand, the balance sheets of all the three players - governments, corporates and households - have to be repaired and their debt burdens lowered. At the same time, the economy has to grow, so as to prevent the debt-burdens spiralling out of control.

In their latest paper examining debts in developed economies, especially in the aftermath of banking crises, Rogoff and Carmen Reinhart find that,

"A buildup in government debt has been a defining characteristic of the aftermath of banking crises for over a century, with government finances deteriorating to produce an average debt rise of 86 percent... Public debts in the advanced economies have surged in recent years to levels not recorded since the end of World War II, surpassing the heights reached during the First World War and the Great Depression. At the same time, private debt levels, particularly those of financial institutions and households, are in uncharted territory and are (in varying degrees) a contingent liability of the public sector in many countries. Historically, high leverage episodes have been associated with slower economic growth and a higher incidence of default or, more generally, restructuring of public and private debts."


Managing this twin challenge - maintaining economic growth while repaying the huge debts - will be the biggest macroeconomic question facing economists and policy-makers across many developed economies over this decade. What should be the government's policy responses to address this twin challenge? How much responsibility should governments shoulder in leading the depressed economies down the recovery path? What are the policy options that are likely to be effective? When should the government exit from their interventions?

Saturday, April 16, 2011

China Vs India on demographic dividend

The one area where India scores decisively over China - being on the right side of the long-term demographic profile. Its working population is estimated to keep growing well past 2050. This larger labour supply can be a major source of growth for India's economy.



In contrast, for China, the largest segment of population is in the 35-44 age group and the younger people form a much smaller share of the total population than India.



On the same issue, in a recent Vox post, Shekhar Aiyar and Ashoka Mody used state-level data from India, and found that its demographic dividend has "played a key role in India's accelerating growth since the 1980s and will add 2% to annual income growth for the next two decades".

Case-Shiller 1890-2011

Barry Ritholtz has an updated version of the 100 year Case-Shiller US property price index, which tracks the sales prices of standard existing houses after factoring out the effects of inflation.

Friday, April 15, 2011

The TBTF moral hazard gets even bigger

Excellent post by Simon Johnson highlighting the too-big-to-fail moral hazard that big financial institutions like Goldman Sachs enjoy. Far from being sensitized and forced into taking action to address this problem in the aftermath of the sub-prime crisis, public policy has regressed further. The TBTF moral hazard appears to be even more deeply institutionalized into the global financial markets.

In fact, while in 1999, the five largest US banking organizations had about 38 percent of total banking assets, the top five banks today have 52 percent of all bank assets. Prof Simon Johnson, writes about the TBTF hazard posed by the $900 bn giant, Goldman Sachs,

"If a bank like Goldman were in trouble, there remain the same unappealing options that existed for Lehman in September 2008 – either to let it fail outright or to provide some form of unsavory bailout. The market knows this and most people – including everyone I’ve spoken to in the last year or so – regards Goldman and other big banks as implicitly backed by the full faith and credit of the United States Treasury.

This lowers Goldman’s cost of funds, allows it to borrow more, and encourages Goldman executives – as well as the people running JPMorgan Chase, Citigroup and other large bank-holding companies – to become even larger."


Permitting TBTF institutions to fail, an orderly winding down through a resolution authority, while theoretically appealing, is not practical,

"But the resolution authority would not helpful in the case of Goldman Sachs, a global bank that operates on a vast scale across borders. Such a case would require a cross-border resolution authority, meaning some form of commitment among governments. As this does not exist and will not exist in the foreseeable future, Goldman is, as a practical matter, essentially exempt from resolution."


In this context, given the aforementioned, there are only two options - break up the TBTF institution or raise reserve capital requirements steeply. The former, while the most appropriate policy choice, stands no chance of success given the lobbying power of the banking industry. As Simon Johnson writes,

"Given that this is the case, the only reasonable way forward is to follow the lead of Prof. Anat Admati and her colleagues in pressing hard for much higher capital requirements for Goldman and all other big banks. If they have more capital, they are more able to absorb losses – this would make both their equity and their debt safer."


But the Basel III, which look likely to raise capital requirements to no more than 10 percent of Tier 1 capital, does not go far enough on this. This is despite the bankers arguement that equity is expensive (and possibly harmful to the banking industry's innovation and growth potential) being fairly comprehensively refuted by many leading finance academicians.

The final word on TBTF moral hazard should go to Neal Barofsky, the outgoing inspector general for the Troubled Asset Relief Program (TARP), who said in his final testimony before the Senate,


"For all its help in rescuing the financial system from the brink of collapse, TARP may have left a truly frightening legacy. It has increased the potential need for future government bailouts by encouraging the 'too big to fail' financial institutions to become even bigger and more interconnected that before, therefore increasing their ultimate danger to the financial system."

Thursday, April 14, 2011

Is the pendulum swinging on outsourcing civic services?

Conventional wisdom on the delivery of civic services holds that service quality can be improved only if urban local bodies (ULBs) outsource or contract out or even privatize their services. In-house service delivery is perceived as fundamentally inefficient and inherently poor in quality. Accordingly, in recent years, there has been a clearly pronounced trend towards outsourcing civic utility services - water, sewerage, solid waste management, IT operations, customer care centers, etc - in many Indian cities.

In this context, Stephen Goldsmith, the deputy mayor of New York, and an one-time Republican Party star for privatizing government services when he was mayor of Indianapolis, has triggered off a debate on the merits of privatization of civic services with this very interesting op-ed column,

"Usually, when government officials talk about spending less money, they talk about outsourcing services to the private sector. And in many cases, that can be very effective. But union leaders often argue that it would be more cost-effective to give the work to city employees - and sometimes, they are right...

Mayor Bloomberg requested that I review all information technology, or IT, contracting. After conducting a thorough review, I have concluded that much of the solution lies not in more outsourcing to the private sector, but rather in employing city workers to perform more of our IT work. So in the weeks and months ahead, we will decisively shift more work from consultants outside government to our talented public employees. This will save taxpayers millions of dollars a year."


As part of this review, the Bloomberg administration has sought to consolidate the city's 40 separate data server rooms into a handful of centralized data centers. This project, expected to yield taxpayer savings of atleast $100 mn over the next five years, is being executed using public employees,

"To build our new data center, instead of hiring an outside vendor for project management and quality assurance as we would have done in the past, we insourced the work to the Department of Information Technology and Telecommunications' project management team... Using the know-how of city staff to oversee these projects will save an additional $25 million over and above the $100 million we will save from having fewer server rooms and other efficiencies. That center where the mayor stood was built in record time, from start to finish in only six months."


He also wrote about other successes with in-sourcing,

"Our Business Express tool - which helps businesses get permits faster - and our expanded 311 online program are both now led by insourced city employees, not consultants. The Finance Department is hiring 45 city employees to replace outside consultants, almost entirely in its technology department. That will save millions more."


And about the way forward,

"At the same time as we intelligently insource, we need to tighten our oversight over outside contractors. Competent and honest vendors respond best when they are well-managed by able city officials. We are proposing, therefore, to expand a high-level city vendor management office - and in the process, reduce the cost of outside projects and test whether certain projects are even necessary.

And we are going to start challenging all components of technology contracts, and ensure that the city does not pay a markup to a consultant for work we could just as well do internally. We must also focus on subcontractors - companies hired by our own vendors to help them complete their assignments... Insourcing the management of projects and important decisions about scope and cost will allow us to save taxpayer dollars, enhance service delivery and ensure that IT vendor resources throughout the city are delivering on time and on-budget for New Yorkers."



Predictably, this has re-ignited the debate about the merits of in-house service delivery and outsourcing of municipal services. Here are a few observations

1. As Mildred Warner writes, "Contracting out only saves money if there are technological innovations or economies of scale that come from moving functions out." It therefore becomes critical to objectively and accurately assess the costs and benefits of any such initiative. However, as we have seen with the numerous examples of high-profile failures with mergers and acquisitions with big private firms, such decisions are difficult to make.

It is no surprise that in recent years there have been a large number of cases of reverse contracting - bringing previously privatized services back in house - from cities across the world. A study for the International City Managers Association (ICMA) by Mildred Warner and Amir Hefetz finds that the reasons for reverse contracting are problems with service quality (61%), lack of cost savings (52%), improvements in public delivery (34%), problems with monitoring (17%) and political support to bring the work back in house (17%). As can be seen, the "reversals reflect problems with service quality and lack of cost savings in contracted services" instead of the usual suspect of political opposition.

2. There is a fundamental incentive challenge - private firms have incentives to reduce quality to enhance profits and governments have the incentive to reduce costs. This means that the city managers have to effectively police and re-align the incentives of the contractors. At the same time, they have to bear in mind the need to ensure that life-cycle costs of delivering the service is optimized.

However, this requires that the city managers have the requisite professional competence and integrity to effectively carry out this responsibility. Unfortunately, there are very few cities which have the required numbers of professionally competent (upto speed with the latest technologies and processes) and honest managers.

3. It is no surprise that there are massive delays in all types of projects being executed in our cities. Monitoring and supervision, even of internally executed projects, have never been a strength of public systems. It is therefore unreasonable to expect municipal governments to do an effective job of external contract management, especially those involving complex and difficult to quantify outcomes.

Monitoring the adherence with service levels involves rigorous data collection and supervisory over-sight which is often beyond the competence of public officials and their bureaucratic systems. As can be expected, project management is one of the weakest areas of urban governance.

4. The most critical determinant of the success of any contracting agreement is the ability to monitor with reasonable degree of accuracy the achievement of outcomes. However, it is difficult to quantify the outcomes, leave alone the quality, of many civic services. Sometimes, it is difficult to even define and monitor certain outcomes. Performance-based contracts, which are successfully implemented across the private sector, is therefore difficult to structure for civic service delivery.

Further, even when it is possible to quantify outcomes and their quality, the process of data collection is a source of concern. It is either gamed by the contractor, in collusion with the supervising public officials, or its reliability suspect due to the sheer inefficiencies within public bureaucracies.

5. Compounding the problem is the absence of adequate competition and depth in the market for service providers. In the US itself, for most local government services the average number of alternative providers is less than two. Only one third of the 67 most common local government services have two or more alternative providers in the market. Reflecting the virtual absence of choice, fully 75% of contracts are given to the incumbent without re-bidding. The situation is far worse in developing countries like India. In other words, "all privatization does is substitute a private monopoly for a public one".

6. Cronyism and corruption is rampant in all our urban local governments. However it is not the exclusive preserve of our local bodies. Chicago's parking meter privatization is the most high-profile example of incompetence, short-sightedness, and corruption that characterises contracting of civic services.

Contracting out civic services, especially in the larger cities, require a highly professional bid process management. It should be free from external interference and decisions should be taken on purely professional and objective considerations. It is difficult to replicate such environments in most Indian cities.

The net result is a completely compromised bid process, in which extraneous considerations prevail over professional qualifications. The willingness of most service providers to play this game only makes the process even murkier. The result is a badly designed/structured contract (often done to favor certain parties) awarded to a contractor with neither the expertise nor the intent to execute the project effectively. Failure, criticism and controversy is therefore inevitable.

None of this is to oppose outsourcing and privatization and advocate in-house civic service delivery. As Nicole Gelinas writes, "Privatization of government services can be a tool for competent governments but it's not a cure for incompetence... privatization doesn't obviate the need for government competence and honesty, as well as for the democratic checks and balances that encourage these traits". Governments should decide to use outsourcing and privatization based on the specific project and the local market conditions and not on ideological considerations. Elliott Scalar has this standard for making privatization decisions,

"Three factors drive the decision: the number of interactions required between the service supplier and the purchasing organization; the ability of the purchasing organization to judge the quality of the product; and the nature of control over the physical assets and people involved in delivering the goods. The general rule of thumb is that when the number of interactions is high, quality is not easily determined and control over assets is required, you should keep the function in-house. If the reverse is true, you can outsource."


John Donahue prescribes this standard,


"Tasks that are well-defined, easy to monitor and available from competitive suppliers — call them 'commodity tasks' — are prime candidates for privatization. Tasks that are complex and mutable, lack clear benchmarks or are immune from competition — 'custom tasks' — should be kept in-house."


All this ultimately boils down to the original Coasean theory about firms and transaction costs - firms exist because the transaction costs associated with doing ancillary activities externally are simply too large. In this case, certain services, instead of being outsourced, are more effective if done internally within the civic utility.

The final word should go to an excellent meta-study of privatization across the world of water distribution and garbage collection by Germà Bel, Xavier Fageda, and Mildred E. Warner, which finds,

"Privatization of local government services is assumed to deliver cost savings but empirical evidence for this from around the world is mixed. We conduct a meta-regression analysis of all econometric studies examining privatization for water distribution and solid waste collection services and find no systematic support for lower costs with private production. Differences in study results are explained by differences in time-period of the analyses, service characteristics, and policy environment. We do not find a genuine empirical effect of cost savings resulting from private production. The results suggest that to ensure cost savings, more attention be given to the cost characteristics of the service, the transaction costs involved, and the policy environment stimulating competition, rather than to the debate over public versus private delivery of these services."