Friday, September 30, 2011

Coaching to improve performance

Atul Gawande has an excellent article in the New Yorker that examines the effectiveness of coaches in improving performance levels among professionals across sectors. He describes coaches,

"Coaches are not teachers, but they teach. They’re not your boss — in professional tennis, golf, and skating, the athlete hires and fires the coach — but they can be bossy. They don’t even have to be good at the sport... Mainly, they observe, they judge, and they guide."


How are coaches different from teachers?

"The coaching model is different from the traditional conception of pedagogy, where there’s a presumption that, after a certain point, the student no longer needs instruction... Coaching in pro sports proceeds from a starkly different premise: it considers the teaching model naïve about our human capacity for self-perfection. It holds that, no matter how well prepared people are in their formative years, few can achieve and maintain their best performance on their own."


How do coaches achieve success in improving the effectiveness or performance of their wards?

"You have to work at what you’re not good at. In theory, people can do this themselves. But most people do not know where to start or how to proceed. Expertise, as the formula goes, requires going from unconscious incompetence to conscious incompetence to conscious competence and finally to unconscious competence. The coach provides the outside eyes and ears, and makes you aware of where you’re falling short. This is tricky. Human beings resist exposure and critique; our brains are well defended. So coaches use a variety of approaches—showing what other, respected colleagues do, for instance, or reviewing videos of the subject’s performance. The most common, however, is just conversation."


Coaches also help improve learning outcomes in schools. He writes about coaches who sit and observe classroom instruction and provides information to the teachers about where they could improve or change, so as to optimize the learning outcomes in the class,

"California researchers in the early nineteen-eighties conducted a five-year study of teacher-skill development in eighty schools, and noticed something interesting. Workshops led teachers to use new skills in the classroom only ten per cent of the time. Even when a practice session with demonstrations and personal feedback was added, fewer than twenty per cent made the change. But when coaching was introduced—when a colleague watched them try the new skills in their own classroom and provided suggestions—adoption rates passed ninety per cent. A spate of small randomized trials confirmed the effect. Coached teachers were more effective, and their students did better on tests."


These specifics under observation in classroom coaching include - whether the teacher has an effective plan for instruction; how many students are engaged in the material; whether they interact respectfully; whether they engage in high-level conversations; whether they understand how they are progressing, or failing to progress.

In some sense, coaching is about feedback loops that indicate what improvements or changes are required. Even with all the modern technology, individuals cannot conveniently access information about where their professional deficiencies and failures lie. Even when they can observe, it is cognitively difficult for them to overcome all their biases and objectively accept their deficiencies and take steps to address them. It is in this context that a trained external observer, in the form of a coach, becomes valuable in providing the required feedback that can be used to improve their performance.

The challenge with coaching would be to get people who are trained to closely observe their objects in the least invasive manner, and who have a deep understanding of the processes that makes up the activity under observation. More than the content of the activity being observed, their focus should be on the subtle nuances of the many actions that are performed by their wards. Could they have done it any differently so that its impact would have been greater or less harmful? Gawande writes,

"Good coaches know how to break down performance into its critical individual components. In sports, coaches focus on mechanics, conditioning, and strategy, and have ways to break each of those down, in turn."


Gawande sees huge potential in using competent retirees in each profession as coaches to help professionals improve their efficiency and effectiveness. He however feels that professional's general reluctance to accept being coached (or observed in their act) is the biggest stumbling block to widespread use of coaches - "we may not be ready to accept—or pay for—a cadre of people who identify the flaws in the professionals upon whom we rely, and yet hold in confidence what they see".

How I wish there were coaches for bureaucrats!!

Thursday, September 29, 2011

The politics-policy disconnect

Just couldn't resist cut and paste this. It aptly sums up the state of affairs on both sides of the Atlantic and elsewhere.



In both Europe and the US, the need of the hour is much more aggressive monetary accommodation and fiscal stimulus. In Europe, national politics, especially in Germany, will not countenance such expansionary policies. Similarly, in the US, Republicans see debt and inflation as greater threats and oppose any further expansion.

In fact, it appears to be equally valid for India too. In the prevailing environment, there appears to be space only for "rights-based" policies - right to employment, education, food, and so on. The most important requirement, critical to sustaining the ambitious growth rates, is to ease supply-side bottlenecks - expediting investments in infrastructure, increasing the supply of quality manpower, labour market reforms etc. Unfortunately, none of this appears forthcoming in these times of policy paralysis.

Too Big To Fail fact of the day

Zero Hedge quotes the latest report from the US Office of the Currency Comptroller and writes about the extreme concentration of derivatives risk in the US financial markets,

"Of the $250 trillion in gross notional amount of derivative contracts outstanding (consisting of Interest Rate, FX, Equity Contracts, Commodity and CDS) among the Top 25 commercial banks (a number that swells to $333 trillion when looking at the Top 25 Bank Holding Companies), a mere 5 banks (and really 4) account for 95.9% of all derivative exposure... The top 4 banks: JPM with $78.1 trillion in exposure, Citi with $56 trillion, Bank of America with $53 trillion and Goldman with $48 trillion, account for 94.4% of total exposure."




And more worryingly, the TBTF problem keeps getting worse, posing even greater systemic risks,

"The biggest banks are not only getting bigger, but their risk exposure is now at a new all time high and up $5.3 trillion from Q1 as they have to risk ever more in the derivatives market to generate that incremental penny of return."

Obama's Jobs Plan in graphics



(HT: Washington Post)

Wednesday, September 28, 2011

On structuring lease concessions

The Hindu reports of a concession agreement signed between the Andhra Pradesh Tourism Development Corporation (APTDC) and a private hotel operator, Amogh Group of Hotels, for leasing out one of APTDC's centrally located Tourism complex in Hyderabad. Under the 15 year lease, terms of which have been arrived at through an open competitive bidding process, the private operator will be allowed to run the 84 room complex as a three-star hotel. The operator will pay Rs 23 lakh per month as rental fee and also provide 20 rooms to the state General Administration Department (GAD) for accommodating state guests.

This apparently simple lease agreement could be the setting for a simple thought experiment. The APTDC and state government's desired objectives are two-fold - accessing 20 rooms for the GAD, while maximizing the lease rental. There are two possible approaches to achieve this objective. One, as the APTDC has done, is to clearly state upfront the 20 room GAD requirement and then invite hotel operators to quote on the lease rental. Alternatively, treat the two as separate requirements and then let the private operator quote a lease rental for the entire hotel. Subsequently, the 20 rooms can be leased in either on mutually agreeable terms from the the same operator or a separate tender can be called for leasing in 20 rooms from any private hotel across the city.

Which of the two approaches is likely to be more beneficial - generate higher net returns - for the state government? An examination of the incentives and option values that bidders face would be illuminating.

In the first case, the operator factors in the costs and benefits of already having committed the 20 rooms. At a cognitive level, he has made two trade-offs - one on the lease rental amount for the 64 rooms and another on the lease amount that he sets-off against the 20 rooms. I am inclined to believe that he makes them as two separate decisions, under-weighting (or minimizing the rent pay-out) the first and over-weighting (maximizing the rent receipt) the second. There is also the option value he attaches to having foreclosed the option of retaining all the 84 rooms. In other words, there are atleast three factors that influences his decision, all of them having the effect of working towards keeping down the lease rental payout to the government. The multiplicity of incentive factors, all working separately, distorts the decision-making environment and each works towards bidding down the quotes.

In the second case, the operator is primed into bidding for the entire property and retains the option of whether to give or not give the 20 rooms. To that extent, the option value is discounted in the bid. There is considerable clarity in the bidding environment. The only factor working in the bidder's mind is to get the best possible deal on the lease rental. In this case, the competition between bidders will work towards keeping all the bidders honest.

After the hotel, with all rooms, is bidded out, the government could negotiate and seek mutually agreeable lease terms. Alternatively, it could call tenders for leasing in 20 rooms from any existing hotel, within certain areas of the city. Either way, more so with the second approach, there would be more efficient price discovery with respect to the lease rental for the GAD rooms. It is possible that there are certain private hotel operators who would want to use the signal of government business to improve their hotel business itself and would therefore quote at a discount.

Tuesday, September 27, 2011

Public contracting Vs in-house service delivery?

Conventional wisdom would have it that private contracting is more cost-effective than government in-house activity in that they deliver services with greater quality aand at cheaper prices. I have sought to provide a more nuanced perspective on the issue here, here, and here.

In this context, a first of its kind comprehensive comparative study of the cost of in-house government delivery versus private contracting by the Project on Government Oversight (POGO) in the US reveals several interesting findings. It analyzed the total compensation paid to both federal and private sector employees, and annual billing rates for contractor employees across 35 occupational classifications covering over 550 service activities to assess the cost-effectiveness of federal service contracting. The study writes,

"The current debate over pay differentials largely relies on the theory that the government pays private sector compensation rates when it outsources services. This report proves otherwise: in fact, it shows that the government actually pays service contractors at rates far exceeding the cost of employing federal employees to perform comparable functions.

Our findings were shocking — POGO estimates the government pays billions more annually in taxpayer dollars to hire contractors than it would to hire federal employees to perform comparable services. Specifically, POGO’s study shows that the federal government approves service contract billing rates — deemed fair and reasonable — that pay contractors 1.83 times more than the government pays federal employees in total compensation, and more than 2 times the total compensation paid in the private sector for comparable services... Federal government employees were less expensive than contractors in 33 of the 35 occupational classifications POGO reviewed... Private sector compensation was lower than contractor billing rates in all 35 occupational classifications we reviewed...

We believe awarding government service contracts is nearly always more expensive than having such work performed by federal employees, even after accounting for the total cost to the government of federal employee fringe benefits and associated overhead costs."


In simple terms, this effectively negates the widespread perception that contracting out service delivery will result in considerable savings. The argument that outsourcing or contracting will automatically result in competition and resultant efficiency improvements and tax payer dollar savings is questionable, certainly the later. As the study finds out - using contractors to perform services may actually increase rather than decrease costs to the taxpayers.

And about the reasons for this failure of governments to wring out better deals from private contractors than even the private sector,

"POGO found several failures in government procurement, employment, and data systems that limit the government’s and the public’s abilities to assess and correct excessive costs resulting from insourcing or outsourcing federal services. Failures included the lack of standards for calculating cost estimates and justifying insourcing or outsourcing decisions; the lack of data related to negotiated service contract billing rates; not publishing government information about the number of actual contractor employees holding a specific occupational position under any given contract; and that there is no universal job classification system."


Cost-effectiveness consists of two parts - efficiency improvements and cost of service delivery. Though, as the study shows, contracting fails on the later, it does bring in efficiency improvements. This does mitigate the higher cost of service delivery to some extent. But even with this, the cost of contracting remains far higher, as seen from the comparative study, for similar service delivery in private sector (where the efficiency improvements are less substantial).

This cost of contracting becomes even greater in developing countries where the cost of transacting with the government is substantial and a premium gets priced into the contract cost. This apart, the inability or limitations inherent in public contracting systems comes in the way of governments getting the best possible deal. Finally, there is the issue of inherent problems of co-ordination and resultant transaction costs associated with scale that applies to contracting certain public services. All these three problems are greater in developing countries, and therefore the premiums are higher.

None of this is an endorsement of in-house serive delivery or a case against outsourcing or public contracting. My objective is two-fold. One, it is important that we rectify the skewed public perception that private service delivery is inherently more efficient and cheaper than in-house service delviery. Second, a proper recognition of these deficiencies is important to help us design and implement outsourcing contracts that are cost-effective.

Monday, September 26, 2011

Examining the failure of economic thinking

Mark Thoma is spot on in this passionate assessment of what ails the modern economic system,

"It's distribution, not production that has failed us over the last 30 or 40 years. We produce far more than we ever have, and we will continue to increase our ability to squeeze more and more out of the resources we have. We have the ability to produce enough stuff. But the distribution of the things we produce has been tilted toward the top. Instead of wages rising with productivity as our textbooks say they should, wages have stagnated and the rewards have gone elsewhere. Thus, while the pessimism of the past was about production not being able to keep up with population - many classical economists looked forward to a long-run outcome of a dismal, stationary state with most people struggling at subsistence wages - the pessimism of the present is driven largely by a failure of distribution. The haves get more and more, and the have nots get less and less even though overall output is rising... Pessimism about breaking through the wealth and power structures that stand in the way of change is understandable, as is the desire of the winners in our increasingly two-tiered society to keep the focus on growth rather than distribution."


The remarkable achievements of the past few decades - rapid advances in information and communication technology, spectacular economic growth in emerging Asia etc - is confirmation of the fact that markets have allocated scarce resources very efficiently. But the growing evidence of failures and sufferings across the world is ample proof that market systems have failed to ensure fairness in allocation of these resources.

Fortunately, many of these market failures are the inevitable consequence of the process of efficient allocation of scarce resources and they can be atleast partially mitigated by appropriate public policy interventions and through formal and informal social and political institutions. Progressive taxation, social safety nets, subsidies and concessions, and institutionalized regulatory restraints are some of the commonplace policy options used to address such failures in distribution or achieve fairness in allocation. Political parties in democracies, social interest groups, trade unions etc have played significant role in creating an environment that promotes fairness in allocation.

Traditionally, governments have intervened, often very aggressively, with such policies to address failures in the fair distribution of resources. The vibrancy of social and political institutions have also played a major role in containing the excesses emerging from the dynamics of untrammelled free market. However, the disruptive socio-economic changes of the past couple of decades have unleashed forces which have considerably undermined the tenuous balance between efficiency and fairness.

As the concentration of economic power and resultant widening of economic inequality has accelerated spectacularly in recent years, many of these traditional checks and balances have either been dismantled wholesale or their strength considerably eroded. Across the world, thanks to the spectacular growth of financial market incomes, the past few years have seen the emergence of a class of uber-rich elite, whose economic power has found reflection in the traditional political institutions. In other words, economic power has spawned political power.

This has had two fold impact. It has loosened the restraints put by social and political institutions. More worryingly, these changes have seriously undermined the resolve of governments at all levels to step in to rectify market failures. A false consciousness has been sought to be created that the big winners are the beneficiaries of a competitive merit race, and the outcome is a reflection of the natural order of things. Such explanations brush under the carpet the ovarian lottery that increasingly defines a major chunk of life's outcomes.

The strong opposition, not only in the West but also in many emerging economies, to increasing taxes on even the richest, withdrawing concessions to corporate groups, stronger regulation of financial markets, and expanding the role of government, even if only to provide basic social safety cushions to those most affected by economic shocks, is a reflection of this changing dynamics of social and political power.

Unfortunately, as a profession, economics has failed to either anticipate or do anything meaningful to highlight the implications of this failure. It has been too concerned with studying "efficient allocation of scarce resources" that it appears to have forgotten that the sustainability of this allocation depends on it being fair.

I am inclined to believe that this skewedness in focus among economists is attributable to two factors - limitations of mathematical models and ideological bias. Modern macroeconomic research is heavily dictated by mathematical formalism. However, unlike issues of efficiency (which is essentially a maximization problem, subject to certain constraints), those of fairness in distribution is not easily amenable to mathematical modelling. Fairness involves the exercise of human judgement, in some form or other, to bring about a desired final state of the system.

Then there are the ideological biases of economists, most of whom work in free-market democracies. Unlike the ideal systems of modern economic theories, the real world is full of imperfections, where the ideal world assumptions do not hold. In the circumstances, fairness demands interventions that seek to re-distribute resources and thereby correct the business as usual state of affairs in the system. But such remedial interventions, more often than not, go contrary to the ideological principles that underpin the theoretical foundations of these economists.

Update 1 (2/10/2011)

Mark Thoma argues that there is a need to revisit the socio-economic and political power balance, but is not sure how it will happen. He writes,

"Congress has no interest in doing so, things are quite lucrative as they are. Unions used to have a voice, but they have been all but eliminated as a political force. The press could serve as the gatekeeper, but too many outlets are controlled by the very interests that the press needs to take on and this gives them the ability to cloud most any issue. Presidential leadership could make a difference, and Obama’s election brought hope for change, but this president does not seem inclined to take a strong stand on behalf of the working class...

Another option is that the working class itself will say enough is enough and demand change. There was a time when I would have scoffed at the idea of a mass revolt against entrenched political interests and the incivility that comes with it. We aren’t there yet – there’s still time for change – but the signs of unrest are growing and if we continue along a two-tiered path that ignores the needs of such a large proportion of society, it can no longer be ruled out."

Saturday, September 24, 2011

The futility of monetary expansion

Given the strong opposition to any further expansion of its balance sheet, the US Fed has not gone ahead with a third round of quantitative easing but settled for the next best option of recalibrating its existing portfolio towards the longer end of the tenor spectrum.

The Fed's FOMC cited "significant downside risks" and announced that over the next nine months, it would sell $400 bn worth securities (treasuries and mortgage backed securities) with maturities below 3 years and purchase those with maturities longer than 6 years. With this, it hopes to twist the yield curve on longer term securities downwards without printing any more money and thereby further expanding its balance sheet.





While there is little doubt that it will have some impact in flattening the yield curve and lowering long-term rates, it is more or less certain that its impact is likely to be marginal. In fact, as witnessed by the steady flattening of the yield curve in the build up to the announcement, the markets may already have factored in its impact.

As an FT article suggested, though the lower long term rates will benefit home mortgage holders, their ability to take advantage of it remains questionable. It is estimated that about a quarter of borrowers have a mortgage worth more than their home and a half do not have the 20% of home equity needed to refinance at a lower rate. This effectively means that the two worst affected categories of mortgage holders will not be able to benefit from the flattening of the yield curve.

The lower long-term yields will also affect the profitability of banks, which traditionally borrow short-term and lend long. The flatter yield curves will dent their arbitrage margins. This will act as a further disincentive for them to lend in an uncertain economic environment.

Small businesses, the traditional engines of economic growth and job creation, especially in the aftermath of recessions, are badly credit constrained. Risk averse banks and financial institutions have been generally loath to lend to small businesses. As the plight of mortgage holders mentioned earlier shows, the battered household balance sheets have some distance to go before consumption can recover.

Most importantly, like the earlier quantitative easing programs, "operation twist" too will come up against the biggest problem facing monetary authorities and governments today - how to translate the dramatic expansion in monetary base and the resultant ultra-low long-term interest rates into increased credit ioff-take. In other words, monetary policies have not been able to make much headway with getting banks to lend, consumers to borrow, and businesses to invest. Except for a handful of the largest firms and financial institutions, credit remains squeezed.

This brings us to the fundamental issue which Paul Krugman and others have been higlighting, about the difficulty of squeezing much out of monetary policy when the economy is stuck in a liquidity trap and where aggregate demand is also in a deep slump. In a liquidity trap, since interest rates are touching the zero-bound (and therefore people do not have to sacrifice interest earnings to obtain liquidity), people are hoarding money not because of its liquidity value, but merely as a store of value. Worse still, since interest rates are close to zero, money and short-term treasuries become interchangeable and mere stores of value. This in turn means that conventional monetary policy actions that involve open market operations by swapping money for treasuries or expanding the money supply become ineffectual.

The graphic below highlights the near complete lack of responsiveness of monetary aggregates to the massive expansion in monetary base. Though the monetary base has exploded, the M2 money supply and its velocity have hardly budged, just as inflation has remained anchored to the bottom.



Clearly, as the graphic below shows, this massive infusion of money has found its way into the safety of bank's reserves.



It is amply clear that the present economic problems cannot be solved just by increasing the supply of money. Nineties Japan and Depression era US provides ample evidence of the futility of such expansion. In the circumstances, the solution lies in boosting aggregate demand. Monetary policy can only work at the margins in preventing the situation from getting worse.

Thursday, September 22, 2011

Some observations on the Great Stagnation

An interesting article in The Atlantic by Derek Thompson where he highlights a deep productivity decline in the US economy.

He draws attention to the increasing deprivation of middle class Americans despite food, clothing, and entertainment getting cheaper and forming a smaller share of household budgets. He attributes this to the rising prices of health care, education, housing, and energy,

"You could say that everything is getting cheaper except for almost everything you need. We need places to live, energy to move, education to move up, and insurance to stay healthy. The productivity revolution isn't doing much to make those things more affordable. Even after decades of building up and building out, homes and apartments are still prohibitively expensive in our most productive cities. Adjusted for inflation, home energy costs doubled between 1967 and 2003, and continued to rise in the last ten years. The cost of medical insurance is growing faster than wages. Tuition and higher education fees are growing even faster."


The graphic below highlights how the rise in the prices of these items have far exceeded the general wage increases.



Thompson points to a graphic from a McKinsey report which shows that more than half of total productivity growth comes from computers and information technology and practically zero have come from health care, education, and housing. It is therefore no surprise that health and education have to keep hiring people to do the same job, even as elsewhere the same job is being done by far fewer people than earlier. The resultant pressure to keep prices up is therefore unexceptionable.



Health care and education are susceptible to Baumol's cost disease, where the wages of workers rise even in jobs that have experienced no increase of labor productivity since the wages of workers in other jobs which did experience such labor productivity growth have risen. He attributes the productivity weakness with health care and education to their inherent nature - both are local services that are labor intensive - and are therefore not amenable to any external competition.

I have three observations from this

1. Interestingly, this brings us to the issue of increasing productivity in both these services. How do we get the same teachers and doctors to cover more students and patients? How do we leverage technology to reduce the cost of service delivery in both these services?

All available evidence and experience of other sectors indicates that this can be achieved only through competition, direct or indirect. One, atleast some of these services should be outsourced or off-shored and technology leveraged to deliver the same or higher level of service, so that the cost of service delivery comes down. Or else, there should be direct supply-side competition in these markets. This can be brought about by direct participation of foreign teachers and doctors in the US labour markets.

Either way, there appears to be a strong possibility for convergence of interests between the developed and developing economies. As I had blogged earlier, immigration offers the greatest poverty eradication potential. The same immigrants also offer the best chance for America (and many other developed economies) to ward off the Great Stagnation's impact on their middle class. In the circumstances, labour mobility, atleast in knowledge-based fields like education and health care has the potential to be win-win trade for all sides.

2. The changing dynamics of deprivation from that caused by food, clothing and basic consumer durables, to one that is caused by the prohibitive cost of education, health, housing, and energy, has implications for many developing countries. In fact, in countries like India, as a generation of people emerge out of the traditional consumption poverty, they are set to face the poverty wall erected by these newer requirements.

As economies and jobs become more knowledge and skill-based, the college education premium (and more specifically those related to certain elite colleges) would rise, and if supply fails to keep up with demand, as is most certain to be the case if the prevailing trends continue, then access to education will be a major source of middle-class deprivation. In health care, since technology will improve and expand its scope but with a rising cost, affordability will emerge as a major problem.

Urban housing is already showing signs of reaching breakdown point, as affordable housing in most of our major cities is already beyond the reach of a large majority of the middle class. As economy becomes more energy intensive and people start using more of it, it will become untenable for utilities to supply energy at its current cheap and subsidized rates. This energy requirement will go beyond household electricity use to include fuel used for private vehicles and cooking gas. The share of income that gets spent on energy will only increase.

In view of all this, public policy has an important role in promoting the development of these sectors. Fortunately, countries like India have just about time to put in place these policies, before the real middle-class deprivation problem will materialize. Education will have to be carefully deregulated to attract greater private investments and government will have to dramatically increase its investments in secondary and higher education. Most importantly, policy will have to catalyze the development of a vibrant market for financing education.

The only way to sustainably and meaningfully address the problem of rising health care costs is to put in place a nation-wide health insurance system. This has to be complemented by substantial investments in public secondary and tertiary care facilities, which will provide the critical "public option" that is necessary to improve competitiveness and keep prices under control.

Housing will be a much more difficult challenge to surmount. In simple terms, urban immigration is simply much faster than anything that can be done to increase supply. The only way to address the supply-side is to deregulate urban planning regulations and permit massive vertical growth, while simultaneously providing the infrastructure to support that growth. Urban slums will have to go vertical. Government policy will have to catalyze the development of an adequate stock of affordable urban housing. Instead of the prevailing paradigm of urban home ownership, a more appropriate strategy would be for governments to themselves build and encourage private developers to construct these housing stocks which could then form the platform for a liquid and vibrant market for rental housing.

The requirements of energy is tied to purchasing power since both consumption of all energy sources will increase and their prices too will rise as subsidies get withdrawn. Consumers' pockets will face the impact of this twin effect. This cannot be easily mitigated with any one policy. Public transport facilities will have to improve dramatically, so as to minimize the reliance on private transport which will become increasingly expensive. Further, even if governments want to susidize people's energy consumption, subsidizing public transport may be one of the least distortionary and most effective means to do so. Piped gas will reduce many of the overheads and reduce the cost of cooking gas.

3. Derek Thompson argues that the middle class have been able to manage with relatively less problems though from 1970 to 2010 despite real earnings of middle class men falling 28% even as the real GDP doubled. This has been facilitated by people working harder (typical two-parent family worked 26 percent more hours in 2010 than in 1975) and the sharp increase in women entering the workforce and thereby nearly doubling family incomes. However, both these trends have now run their course leaving the middle class with nothing to fall back. In the circumstances, without higher wage growth, the deprivation will only increase.

This requires a more balanced distribution of the gains from economic growth. Inequality and the forces that have been responsible by accelerating its widening, need to be reined in. Or else, the middle class will face a hollowing out of their incomes, and income and social mobility will be increasingly constrained.

Wednesday, September 21, 2011

Spin and Tennis Ground Strokes

The most amazing, some would say frightening, thing about modern tennis is the ferocity, wickedness and consistency of groundstrokes. This description is very appropriate,

"Again and again one player would hit a ball so hard and at such an effective angle and so deep into the court that it was obvious the other player couldn’t reach it. Then the other player would reach it–and hit another irretrievable shot that was retrieved and returned. The athleticism of these players is almost inconceivable... Their shots don’t merely dive hard onto the court. They often curve sideways as they dive and then explode from the bounce with sideways motion... When the ball bounced, it would skip not just up (flatly, because of the underspin) but jerk sideways toward the sideline — and away from the player who was, if you did this right and hit the ball deep enough, on the run and trying to hit the ball on the short hop."


The video below is an excellent illustration of this stunning combination of power and skill.



As David Dobbs writes, technology has played a significant role in this transformation in the nature of tennis groundstrokes.

"The co-poly strings in use today — which spread through the pro game only over the last decade or so — generate more spin than ever. They do so because they’re more slippery than prior string designs. Because the strings easily slide across one another, they can slip back and then snap back to position — all while they’re grabbing the ball — to create more spin... Thus Nadal, Djokovic, and their peers can hit the ball harder than ever and still generate enough topspin to bring it down into the court. Nadal in particular generates enormous topspin — an average of 3200 rpm, and as high as 4000... This is a huge jump over the spin rates of even his modern peers."


See this excellent Times video which illustrates how Nadal generates his topspin. Incredibly, Nadal's average topspin of 3200 rpm is much greater than Federer's 2700 rpm and double Samparas's 1700 rpm.

Tuesday, September 20, 2011

Visualizing Kiva flows

David Roodman has a superb graphical visualization of the cross-border flow patterns of over 4.3 million different types of microloans - education, health, food, agriculture, retailing etc - channeled through Kiva, the ostensibly person-to-person microlending site.

Intercontinental Ballistic Microfinance from Kiva on Vimeo.



The graphical illustration is stunning in its ability to convey the emergent dynamics of such activities. The flow patterns show how the numbers of lenders and borrowers build-up with time. Once a small trigger initiates the flow, (presumably) demonstration effects tap into latent demand among the massive pool of borrowers and generates confidence among lenders. It is also an excellent illustration of how social systems develop and the importance of initial patterns in consolidating the final outcomes.

The borrowers are concentrated in West Africa, Kenya, Latin America, Peru, Chile, Philippines, Indonesia, and parts of Eastern Europe whereas the lenders mainly come from US, West Europe, Australia and Japan.

On a more general note, I believe that a lot of complex public policy challenges can be more effectively communicated using vidualization graphics. For example, a time series trajectory of visuals of an area can highlight how specific infrastructure or other interventions there impacted the area's development in a cognitively striking manner. In fact, such visualization can beautifully capture the emergent dynamics of social and economic systems in response to specific triggers.

Monday, September 19, 2011

The Great Macroeconomic Policy Debate - How to restore growth?

The biggest macroeconomic challenge now is to manage a recovery from the stubbornly persistent economic slowdown. But a fierce ideological battle is on about what strategy is required to achieve economic recovery.

Everyone agrees that across both US and large parts of Europe, household, bank, and government balance sheets are suffering from huge debt over-hang. As households cut back on consumption and banks refuse to lend, businesses are postponing investments. The high unemployment rates show no signs of coming down and the economies remain stuck at the trough, far longer than the aftermath of previous recessions. Governments, the only other agency capable of engineering a turn-around, are faced with huge sovereign debts and battered fiscal positions. With interest rates at zero bound and even extraordinary quantitative easing measures already having been tried out, monetary policy appears to have limited traction. So what is the way out?

Conservatives are unambiguous in their advocacy of fiscal austerity and placing deficit reduction at the center of the macroeconomic agenda. They fear about the dangers of inflation taking hold and bond-market yields rising. They claim that the fiscal and monetary expansion of the last decade or so has produced several excesses that need to be wrung out before any meaningful economic recovery can begin. To this extent they advocate immediate re-balancing of public finances with policies to cut government expenditures, raise revenues (albeit without raising taxes), and carry out structural reforms.

They admit that while this will generate some short-term pain, it will be for the long-term good. They argue that this will generate "contractionary expansion", restoring market (business, investor, and consumer) confidence and shaping expectations and thereby encouraging business investments. See Robert Barro (academician), Stephen King (Business), and Wolfgang Schauble (politicians) advocating austerity and fiscal consolidation over expansion.

Liberals differ and propose further fiscal and monetary expansion as the only way out of this mess. The argue that the high persistent unemployment rates should be the central focus of policy makers. They point to historical evidence from US in 1930s and recently from Japan, to argue that unless governments undertake aggressive Keynesian stimulus spending and unconventional monetary expansion, the economy risks being stuck at the bottom for a long time.

They also point to the evident inability and reluctance of businesses to invest in such uncertain and weak environments, especially that of the job-creating but credit constrained small businesses. They see government spending as the only source of generating additional aggregate demand. They also argue that the ultra-low interest rates provide an excellent opportunity for governments to invest in infrastructure and other long-term spending so that the platform for longer-term growth is laid at the cheapest cost. They see little evidence of government spending crowding out private borrowing, inflation emerging as a concern anytime soon, or bond-markets catching cold. See Martin Wolf (Journalist), Mark Zandi (Business), Adam Posen (policy maker) and Dani Rodrik (academician) advocating expansionary policies.

There are also some others who have refrained from taking an explicit position, preferring to suggest specific measures. Some like Ken Rogoff have rightly argued in favor of policies that directly address the issue of cleaning up household and bank balance sheets. To this extent they advocate inflating away debts with a slightly higher inflation target, something which Olivier Blanchard, the IMF Chief Economist too had advocated earlier. However, the efficacy of higher inflation targeting has been questioned on credible enough grounds by Raghuram Rajan.

Interestingly, both sides invoke the magisterial historical examination of sovereign debt crisis, induced by various factors including banking collapses, by Carmen Reinhart and Kenneth Rogoff. Conservatives point to their finding that high-levels of growth dampen growth. Liberals point to their findings about the deep nature of recessions that follow banking collapses and argue that government support therefore is essential for expediting recovery.

All these views carry considerable ideological baggage and are evidently constrained by the need to accommodate their respective ideological predilections. Warts and all, the main issue is about which mixture of policies would be most effective in enabling a sustained recovery. An objective assessment reveals inconsistencies or practical difficulties with both sides.

The problem with the conservatives' position is that if all the actors - governments, businesses, financial institutions, and households - are badly constrained, then where would the thrust for recovery come from? Their argument is that debt restructuring and the dynamics that get generated could restore market confidence and thereby pull the economy up the recovery path. But, given the depth of the problems, will it carry the momentum required to pull the economy out? Even traditionally conservative institutions like the IMF have raised serious doubts about fiscal austerity arguing that it could hurt incomes and job prospects. Further, the experience in the current recession with such policies is hardly encouraging.

As several estimates of growth required to bring unemployment in the US to normal levels and also bridge the yawning output gap show, the scale - magnitude and time - of growth required to restore normalcy in the medium term is substantial. In the absence of a strong engine or anchor, what will be the source of this growth? The justifiable fear then is that the recovery process could go on for years.

The fundamental premise of the liberals' argument is that it is necessary to do everything possible to pull the economy out of recession. They fear, based on historical precedent, that in the absence of aggressive expansion, the unemployment problem will assume structural nature and become a socio-economic problem, and a lost decade will be inevitable. I am inclined to believe that this fear too has strong justifications. However, some of the liberals policy measures are not fully supported by fact and appear to based more on hope than objective considerations.

Their hope is that aggressive fiscal and monetary actions will buy enough time for the markets to repair battered balance sheets of all parties and set the stage for a sustainable recovery. But what if it does not? The trillions of dollars so far spent on fiscal and monetary stimulus in the US had not had the expected impact (there could be a counterfactual problem here). What is the certainty that more rounds of stimulus will work? More critically, it is possible that the amount of stimulus required to make any meaningful dent is so large as to make it fiscally and politically impossible. In the circumstances, expansionary policies would be merely throwing money down the drain.

So, if the fears of inaction appear well-justified, and the possible policy alternatives are fraught with deep uncertainty, then are the developed economies set to suffer a long and tortuous period of restructuring, high unemployment and low growth? Is this the inevitable cost of the excesses that got built-up over the past decade or so? Is it desirable to have a medium-term period of de-leveraging that is necessary to wring out the excesses and distortions, rebalance balance sheets, and achieve normalcy? In the meantime, is it appropriate if public policy refrains from anything proactive (either expansionary stimulus or austerity) and confines itself to the provision of a basic minimum social safety to those worst affected by the economic weakness?

Unfortunately this approach too appears untenable. It presupposes a longer period of high unemployment rates and economic weakness. However, there are widespread concerns about its long-term impact on the labour force itself. Longer the people stay unemployed, greater the difficulty to rejoin the workforce. Skills will atrophy and productivity will decline. The socio-economic impact of this will be pernicious. The long-term impact on America's labour force and the economy in general will be damaging. See also this excellent study by Alan Krueger and Andreas Mueller.

Then there is also the danger of Japan. That country ahs been stuck in the trough for nearly two decades now and no end appears in sight. Though there are considerable dis-similarities, there are exists striking similarities - similar asset crashes, huge public debts, aging work-force, and possibly a nominal zero-interest liquidity trap. The magnitude of the downside associated with these risks are so huge that not doing anything proactive appears unwise.

In view of all the aforementioned, and given the extremity risks, inactivity may not be desirable. But there is no clarity on which strategy is most effective in stimulating a recovery. In the circumstances, the only alternative may be to throw everything at the problem and hope that some mixture of policies does enough to put the economy in the recovery path.

Sunday, September 18, 2011

No lessons learnt - The UBS ETF scam

The $2 bn loss incurred by the rogue UBS trader Kweku Adoboli is surely another big blow to the confidence of the embattled European banking sector. It is also a reiteration of the fact that financial market regulators and governments have learnt little from the bitter lessons of the sub-prime mortgage meltdown.

Adoboli headed the Exchange Traded Funds (ETF) trading desk, which packaged ETF-based derivatives and transacted its trades for clients, and which are typically hedged to minimize risks. But Adoboli did not always hedge them, thereby exposing the bank to huge swings.

ETFs track financial indices and its value arises from either directly from an underlying index fund or a derivative with the index fund as the counterparty. It is the later which makes ETF's risky. If the counterparty suffers a huge loss, leaving it without the funds to service the derivative contract, then the ETF owner suffers huge losses.

Further, depending on the complexity of the packaging of the underlying index funds, the risk is dispersed far and widely across, making it difficult to accurately locate and price risk. In recent years, as ETFs have gained popularity, investment banks have even been packaging ETF derivatives to create "synthetic" ETFs (the counterparty is another set of derivatives). In this regard, it is similar to the complex and highly opaque Collateralized Debt Obligations (CDOs) and synthetic CDOs constructed by splicing and dicing and then packaging pools of mortgage loans.

The risks from activities of traders like Adoboli go beyond these. His 'Delta One' trading desk effectively conducted both client and proprietary trading. Investor clients were promised certain benchmark returns, with the excess returns going to the bank (and those in the trading desk), an incentive for the traders to take extra risk, often leveraging their employer's (bank's) balance sheet. Sometimes, even as banks sell ETF's to their clients, they themselves form the derivative counterparty (positions often taken with their proprietary capital), thereby creating the potential for deeply undesirable conflicts of interests.

Adoboli is only the latest in the long history of such rogue traders - Tomonori Tsurumaki of Sumitome, Nick Leeson of Barings, and Jérôme Kerviel of Société Générale - who caused huge losses to their employers and clients. Incidents such as these lend further weight to the argument that even the best monitoring cannot firewall a determined trader who tries to systematically mislead his employer, even over long periods of time. This naturally revives calls about separating commercial and investment banking operations in big financial institutions. An editorial in FT succinctly sums up the need of the hour,

"The narrow lesson is that derivatives can conceal risk as well as manage it. The broad lesson is that inherently risky investment banking must not be allowed to contaminate utility banking or the wider economy. It is a call to speed up efforts to increase investment banks’ capital buffers and the ease with which they can be resolved if the buffers are worn through. If this is done, the risks investment banks take on and the gains and losses that ensue are largely a matter between banks and their shareholders – provided that shareholders are not defrauded or misled."


The final report of the Independent Commission on Banking, appointed by the British Government to improve stability and competition in the British banking system, and headed by John Vickers, which was released a few days before, has much the same to say. It calls for ring-fencing investment and deposit taking retail banking and alos higher capital buffers for investment banks to limit systemic risks.

Ring-fencing will limit the taxpayer guarantees to individual and business depositers and will not cover the risks taken by traders within the investment bank. Today, the deposit insurance guarantee within the large universal banks (that combines all activities, not spearated from each other), acts as an effective public subsidy for their private investment banking activity. As Martin Wolf has argued, ring-fencing, and not outright separation (as was the case during the Glass-Steagall era in the US, which was replaced with the Gramm-Leach-Bliley Act in 1998), will retain the benefits of a single management - like an investment bank bailing out its failing retail banking division.

In this context, Matt Taibi raises an important point about inherently risk-taking investment banking traders and the apparent incompatibility of their activities with the need to protect the interests of retail depositers and tax payers. He argues that there is little distinction between rogue traders and most investment bankers, in so far as both have the freedom to take excessive risks with their client's money and bear limited direct and immediate responsibility to their clients' interests. He writes scathingly about the adverse consequences of the legal end to separation of retail and investment banking and the inherent risk-taking nature of investment bankers,

"the brains of investment bankers by nature are not wired for "client-based" thinking... it just defies common sense to have professional gamblers in charge of stewarding commercial bank accounts... Investment bankers do not see it as their jobs to tend to the dreary business of making sure Ma and Pa Main Street get their $8.03 in savings account interest every month... investment bankers by nature have huge appetites for risk...

The influx of i-banking types into the once-boring worlds of commercial bank accounts, home mortgages, and consumer credit has helped turn every part of the financial universe into a casino... They’re not "rogue" for the simple reason that making insanely irresponsible decisions with other peoples’ money is exactly the job description of a lot of people on Wall Street... they don’t call these guys "rogue traders" when they make a billion dollars gambling.

The only thing that differentiates a "rogue" trader like Barings villain Nick Leeson from a Lloyd Blankfein, Dick Fuld, John Thain, or someone like AIG’s Joe Cassano, is that those other guys are more senior and their lunatic, catastrophic decisions were authorized... if you're a well-groomed 60 year-old CEO who uses his authority to ignore quality control and internal audits in order to make disastrous trades that could sink the company, you get a bailout, a bonus, and heroic treatment in an Andrew Ross Sorkin book... rogue companies are protected at every level of the regulatory structure and continually empowered by dergulatory legislation giving them access to our bank accounts."


Felix Salmon's makes this excellent case for separating or atleast ring-fencing retail/commercial and investment banking activities,

"When you’re hiring people for the UBS trading floor, you’re hiring men who love to win, congenital risk-takers. And then you surround them with risk-management protocols designed to keep them under some semblance of control. There’s a natural tension there. And if you take the hundreds of thousands of risk-takers working on trading floors in London and Hong Kong and New York and Paris, it’s a statistical inevitability that one or two of them will go rogue every year or so.

Risk-managment protocols are important, but they can never be foolproof, because they’re run by humans. So we really shouldn’t let investment bankers — by which I mean risk-hungry traders with access to billions of dollars of balance sheet — anywhere near the systemically-important balance sheets of our largest commercial banks. Losses like the $2 billion at UBS are manageable. But they’re small beer compared to the entirely legitimate losses made by the likes of Morgan Stanley’s Howie Hubler during the financial crisis. He managed to lose $9 billion, and get paid millions for doing so."

The impact of declining manufacturing in the US

Even as America is debating whether austerity or stimulus should take precedence, a quiet transformation has been taking place in the country's manufacturing sector. The Times reports,

"Manufacturing’s contribution to GDP... has declined to just 11.7 percent last year from as much as 28 percent in the 1950s, according to the Bureau of Economic Analysis... It isn’t that fewer autos or plastics or steel products or electronics are coming out of American factories. Quite the contrary: output continues to rise, reaching $1.95 trillion last year. But other sectors of the economy have grown faster in recent decades, and that dynamic has reduced manufacturing’s share.

In particular, the finance, insurance and real estate sectors — driven especially by investment banking and home sales — rose from less than 12 percent of GDP in the mid-1950s to more than 20 percent before the onset of the financial crisis, and even now remain nearly that high. In China, in sharp contrast, manufacturing’s share of national output is more than 25 percent. While the United States has a far larger economy — $14 trillion in GDP versus China’s $6 trillion — it has less factory production."


The graphic below nicely captures this story.



However, as the aftermath of the sub-prime crisis has shown, financial sector cannot be the basis for a nation's economic growth. It can at best support and lubricate economic growth, but cannot be a substitute for manufacturing. As the Times writes,

"Recovery from the recession, they say, would not be so sluggish if there were still enough manufacturers to jump-start an upturn by revving up production and rehiring en masse at the first signs of better times. What’s more, each new manufacturing job generates five others in the economy. Shrinking the relative size of manufacturing has undermined that multiplier effect."


The long-term consequences goes beyond this. The report writes,

"The intractable trade deficit is attributable in part to manufacturing’s shaken status. And in many areas, craftsmanship in America has been eroding. Forty percent of the nation’s engineers work in manufacturing, for example, and that profession’s numbers have been declining. That is a particular problem because innovation often originates in manufacturing, frequently in research centers near factories, which aid in the creation of products and the tweaking of them on assembly lines...

As American multinationals become ever more global, they are placing sophisticated research centers near their overseas factories, partly to keep R&D close to assembly lines and partly because of enticing government incentives... At the very least, this trend challenges the view that the United States has the best scientists and research centers and is thus the research-and-development pacesetter."

Friday, September 16, 2011

The meaning of the gold price surge

Conventional wisdom on the surging gold prices has been that it is in indicator of inflation wary investors fleeing to a traditional safe asset. Accordingly, conservatives have invoked the recent spike in gold price in support of their advocacy for fiscal consolidation.

Paul Krugman has an interesting post, where he argues that contrary to conventional wisdom, deflationary fears may be driving gold prices. He points to the famous Hotelling Rule which says that people have an incentive to hold onto an exhaustible resource (by storing it or keeping it unextracted) because of rising prices. Economically this means that "a mineral deposit in the ground has the same significance as a bond, and is in some sense interchangeable with such a financial instrument".

A consequence of this Rule is that, assuming negligible storage costs and the major part of the stock has already been extracted (so the choice is between storing it for the future or selling it now), the "real price must rise at a rate equal to the real rate of interest". If the real rate of interest is lower, as is the case now, people have an incentive to "hoard gold now and push its actual use further into the future" because the lower rates reduces the return on investment of the sale proceeds. This translates to higher prices in the short run and the near future. Krugman writes about its implications,

"(T)his... 'real' story about gold, in which the price has risen because expected returns on other investments have fallen; it is not, repeat not, a story about inflation expectations. Not only are surging gold prices not a sign of severe inflation just around the corner, they’re actually the result of a persistently depressed economy stuck in a liquidity trap — an economy that basically faces the threat of Japanese-style deflation, not Weimar-style inflation... And if you view the gold story as being basically about real interest rates, something else follows — namely, that having a gold standard right now would be deeply deflationary. The real price of gold 'wants' to rise; if you try to peg the nominal price level to gold, that can only happen through severe deflation."




In other words, since interest rates are low and rational expectations are for an extended period of low rates (and therefore low inflation), people prefer to hoard or store gold, thereby boosting gold prices in the short-run. This analysis would see the increase in gold price as a signature of deflation.

In another post Krugman also makes the distinction between gold and other commodities, in so far as their applicability to this hypothesis. Unlike gold, most other natural resources, including oil, does no conform to atleast one or both of the assumptions - negligible storage costs and most stock has been extracted out.

Thursday, September 15, 2011

"Twisting" on debt maturities as QE3?

The latest dimension to the US Federal Reserve's attempts to lower long-term interest rates through its quantitative easing (QE) program is "Operation Twist". It involves selling short-dated Treasuries (1-3 years) and buying longer-term securities (mostly 7-10 years) in an attempt to push down longer-term yields. These yields affect corporate borrowing and mortgage rates far more than short-term rates.

Hitherto, in the two rounds of QE (QE1 in 2009 was for $750bn, measured in 10-year Treasury equivalents, and QE2 in 2010 was for $412bn), lowering of long-term rates was sought to be achieved through massive purchases of long-term securities. This has involved a huge expansion of the Fed's balance sheet, though the resultant increased monetary base has been mostly confined to banks' reserves. This expansion of monetary base has generated criticism about stoking inflationary fears, weakening the dollar, and spawning other systemic distortions. It has also come in the way of another round of QE.

The new strategy avoids expanding the Fed's balance sheet and seeks to lower long-term rates by swapping short-term debt for longer-term ones. This would not involve any additional balance sheet expansion and would only cause maturity transformation of existing debt portfolio towards the longer-term. In simple terms, it would be merely re-balancing the Fed's portfolio.

It is estimated that by merely "recycling maturing bonds into longer-dated ones", $110bn would be added, and by "actively selling its portfolio of 1-3-year bonds and buying as much long paper as permitted", the Fed could achieve another $390bn. The former involving about $20 bn a month may not enthuse the markets as much as the later which could involve more than $65 bn a month. The Fed at present owns $632bn in Treasuries with a maturity of less than four years. See this Goldman estimate of Fed's possible Operation Twist strategy.



Twisting of the yield curve is not without precedents, though its impact has not been encouraging. It was first used, unsuccessfully, by the US in 1961 and then by Japan, again unsuccessfully, in the nineties. It carries with it certain clear risks. As the FT writes, it "could disrupt trading flows in the bond market, while reducing earnings for banks that borrow cheaply and invest in long-term Treasury debt". It would adversely affect the returns of institutions like insurance companies and pension funds that have large exposure to long-term debt instruments and also the net-interest margins of banks (who invest in long-term bonds).

Finally, it also increases the long-term interest rate risk in the Fed's portfolio, which could, at certain point, constrain the Fed's policy making freedom. Fed would then effectively become a player in the bond markets. And there also exists the probability of making considerable losses when the Fed exits from its current accommodatary stance. It is also being argued that speculation of Operation Twist has already been priced into long-term yields and not much will be achieved with the actual operations.

Update 1 (22/9/2011)

The Fed announces that it would invest $400 billion in long-term Treasury securities over the next nine months, using money raised by selling its holdings of short-term federal debt, in an attempt to drive down interest rates on mortgage loans, corporate bonds and other forms of credit. With this, the Fed hopes to drive down rates not by expanding its portfolio, as it has done twice in recent years, but by shifting its money into riskier long-term investments.

The Fed has amassed more than $1.6 trillion of federal debt. It said that by June 2012 it would sell $400 billion in securities with remaining maturities of less than three years and buy roughly the same amount in securities with maturities longer than six years. It said the result would shift the average maturity of its holdings to 100 months, or more than eight years, from the current average of 75 months, or just over six years.

Lower interest rates so far had not produced the full measure of predicted benefits because lending standards remained unusually strict. Most outstanding mortgages still carry interest rates above 5 percent, despite the availability of lower rates, because it remains difficult to refinance. Tough lending standards are likely to limit the benefits from lowering interest rates. Loans already are cheap, but they are also hard to get.

Update 2 (20/6/2012)

The Fed announces extending its Operation Twist till the end of 2012 in response to weakening labour market and economic prospects. The FOMC said that it "intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less". This continuation of the maturity extension program should put downward pressure on longer-term interest rates and help to make broader financial conditions more accommodative. This does not add to the Fed’s balance sheet but is intended to lower long-term interest rates, therefore offering some relief to the economy.

In other words, the Fed said that it would buy about $267 billion in longer-term Treasury securities over the next six months, with money raised by selling some of its current holdings of short-term Treasuries, maintaining its portfolio at roughly the same size.

Wednesday, September 14, 2011

Land Acquisition Bill - a backlash against corporate greed and government corruption?

After years of debate, the Union Cabinet finally approved the new Land Acquisition Bill, which is to replace the 117-year-old Land Acquisition Bill, 1894, and which for the first time integrates both land acquisition and relief and rehabilitation (R&R).

It mandates that compensation be paid at the rate of four times the land value in rural areas and twice in urban areas. It also requires the consent of a minimum of 80% of landowners if the land is being acquired for private companies for public purposes. It also mandates that for the next ten years, 20% of the appreciated value of the land be shared with the landowners every time the land is sold or transferred.

On the whole the Bill provides ample safeguards for both landowners and livelihood losers. Its generous R&R provisions even extend to lands purchased privately. It makes R&R mandatory if private companies buy 50 acres or more in urban areas, or 100 acres or more in rural areas. It also reserves 20% of the developed land for landowners as part of rehabilitation entitlement, and subsistence allowance for 12 months and annuity for 20 years.

Industry representatives have criticized these provisions as being too generous and claim that it would sharply increase the cost for developers. They argue that it will inflate the business costs for housing, mining, metal and infrastructure sectors.

The Bill seeks to strike a delicate balance between the need to protect the interests of landowners and livelihood losers and the imperatives of industrial development and urbanization. However, on the balance, it clearly errs on the side of caution and goes considerable distance to protect the interests of land and livelihood losers. Without going into the merits of either view, it needs to be acknowledged that the events of recent past had left the government with no option.

The egregious unfairness of some of the high-profile cases of land acquisition for commercial real estate development had made it impossible for any government to be seen to be favoring corporate groups over the land losers. In fact, the provisions of any proposed Land Acquisition Bill had to be openly favorable to those losing their lands for it to stand any chance of passing the Parliamentary process. Development or not, the interests of the "victims" had to over-ride those of the "beneficiaries". The prevailing anti-corruption environment made the balancing act even more difficult.

An important point that needs to be internalized from this whole process is the damage to incentives caused in recent years by the short-sighted and greedy demands of industrial groups and their complicit governments. As the skeletons from the closet of scams have shown, corporate India is as much, if not more, culpable for escalating corruption to its new levels.

In the first flush of liberalization, over the last two decades, the country has witnessed a massive spurt in private investments. The Union and State governments have rolled out the red-carpet, provided extraordinary concessions, and welcomed these investors claiming them as harbingers of economic growth and new jobs. Businesses played up the importance of these concessions, even locking state and local governments to compete with each other to attract them.

In the process, governments threw aside all semblance of propriety and principles of natural justice to favour private interests at public cost. The notification for acquiring lands under the Land Acquisition Bill, 1894, had become the most visible symbol of this degeneration. The booming property prices across the country and examples of re-sale at many times the acquisition value added to the real and percieved sense of injustice among the "victims".

All the stakeholders, except the land losers, benefited - corporates got land at throw-away prices (which in turn inflated their profitability), governments could claim credit for bringing development, and politicians and officials expropriated massive rents for these favours. Everyone, including all the first-level names in corporate India, knew about these nefarious and blatantly unfair dealings. It is plain hypocritical to now turn around and profess surprise at the spectacular rise of crony capitalism in India over the last decade. Having sown the wind, the industry is now reaping the whirlwind.

This is a classic case of public policy and corporate greed elevating short-term private benefit over issues of longer-term sustainability. Corporate India failed, or conveniently refused, to acknowledge that their plunge to make a quick buck through crony capitalism was unsustainable in any democracy that lives on multi-party electoral politics. Once the backlash began, the incentives of the same political class, who were their earlier partners, now tilted south. Faced with uncertainty at the hustings, they have gone the other extreme and embraced populism.

This phenomenon cannot be confined to land acquisition, but would cover all examples of blatant misuse of power and private profiteering at public cost. Let us leave aside all talk about corporate India assuming leadership in development, since we are far away from that. But speaking a language they better understand, it is in their own interests that their actions do not dramatically unsettle the incentives of any stakeholder to their transactions. If that happens, then the inevitable dynamics of India's populist electoral democracy will surely strike back and push development even further back.

Monday, September 12, 2011

Sunday, September 11, 2011

The rising risk correlations

"The correlation between the biggest 250 stocks in the S&P 500 over the past month has reached its highest since 1987 this week, at 81 per cent, according to JPMorgan figures. This means those stocks move in the same direction 81 per cent of the time. The historical average is 30 per cent. The measure peaked at 88 per cent during the October 1987 US crash, when the Dow Jones Industrial Average fell 22 per cent in one session. Other spikes in correlation, including the collapse of Lehman and the Japanese earthquake, peaked at about 70 per cent but quickly fell away."


The FT article is a strong pointer to a repeat of the 1987 crash. The high correlations provide a circular ring to volatility. Higher volatility puts pressure on VaR limits, forcing traders to pare back their positions, which in turn drives the correlations further up. In these conditions, a small trigger can set off a cascade, bringing down the markets.

The other barometers of market uncertainty too are on the rise. The CBOE Volatility Index, VIX, which measures the prices of S&P 500 index options 30 days ahead, is at nearly three times its historical average and has remained there for more than a month now.

Saturday, September 10, 2011

The global sovereign debt crisis story so far...

From the excellent Kevin Kallaugher, the story of the global sovereign debt crisis.



Wonder when and how the story will climax.

Economic History of the past 40 years of US in a graphic

The Times has this superb graphic that captures the contrasting tales of the US economy in the two halves of the post-war era.



(Click on the graphic to expand)

Robert Reich has an excellent assessment of this period, and his conclusion that sustainable economic growth is impossible with this type of concentration of wealth (and thereby political power) could not have been more accurate. The productivity boom of the past thirty years have resulted in disporportionately shared income gains, thereby concentrating wealth at the top in an unprecedented manner. Middle class consumption over the past forty years was sustained initially by the sharp increase in women working and later, more damagingly, by different forms of debt.

He laments that the Great Moderation and the economic opportunities presented during this period of stability was not used to shore up America's human resources development infrastructure and broaden and increase the quality of its social safety net. Instead, tax cuts and other enabling policies helped businesses retain and appropriate the overwhleming share of the windfall incomes.

Any visitor from outerspace, examining America's economic history of the past 40 years will readily agree with Robert Reich's assessment and conclude that American economic history of the period is a classic example of a market failure. As economic power gets concentrated, checks and balances get dismantled, and policy distortions are an inevitable concommitant.

Thursday, September 8, 2011

The Economics of Migration

Removal of cross-country barriers to labour mobility has often been described as the largest single policy intervention to address global poverty and the last remaining prominent distortion in the global economy.

Micheal Clemens, one of the leading researchers on labor migration and who has described it as the "world's greatest arbitrage opportunity", has an excellent summary of the literature on migration in the current issue of JEP. His conclusion about the benefits of labor migration is unambiguous,
"The available evidence suggests that the gains to lowering barriers to emigration appear much larger than gains from further reductions in barriers to goods trade or capital flows — and may be much larger than those available through any other shift in a single class of global economic policy... For the elimination of trade policy barriers and capital flow barriers, the estimated gains amount to less than a few percent of world GDP. For labor mobility barriers, the estimated gains are often in the range of 50–150 percent of world GDP. In fact, existing estimates suggest that even small reductions in the barriers to labor mobility bring enormous gains."
He finds "trillion dollar bills on the sidewalk" from liberalizing restrictions on emigration. The paper has a nice summary of the estimated benefits from emigration.



He argues that research on migration has hitherto focussed on remittances and "brain drain", and paid limited attention to the considerable direct and indirect human capital externalities that arise when people migrate from poorer countries to richer in search of livelihood opportunities. More fundamentally, migration research has focussed on the effects of immigration but little on emigration. He therefore sets out the agenda for work on this field,
"It should be a priority of economic research to seek a better characterization of the gains to global labor mobility and to investigate policy instruments to realize a portion of those gains. The four questions in this paper suggest one structure for that agenda. We clearly need a better theoretical and empirical understanding of human capital externalities; the dynamics of labor demand under large-scale migration flows; the magnitude and mechanisms of the effect of workers’ location on their productivity, relative to the effect of workers’ inherent traits on their productivity; and the policy instruments that might make greater labor mobility possible."
As Prof Clemens writes, the reason why "migration packs such an economic punch" is that a worker's productivity depends much more on location than any other factor, including skill. An earlier study (see also here), profiled the wage gaps of Peruvian workers with different profiles working in Peru and as immigrants in the US, and found massive differentials. The same would apply to workers from any other developing country migrating to developed economies and doing the same occupation. Differences in work environments, regulatory environments, legal systems, technology spill-overs, proximity to other high-productivity workers, etc explain this difference. The graphic below captures the differential for Peruvian domestic workers and immigrants.



The biggest challenge in achieving success with reduction of barriers to emigration will be political. In particular, it immediately raises the regular bogeys - loss of jobs for the destination country labour, downward pressure on wages there, impact on national security, and so on. Surmounting these very formidable and entrenched fears will be a big challenge before the issue of barriers to emigration can be addressed to some level of satisfaction.

The current weakness in developed economies is a dampener to immigration. The political opposition to immigration can be blunted only when the economy is flourishing and when the domestic workers in these developed economies are themselves not constrained by unemployment. At a time when protectionism is slowly creeping into international trade, policies that favor relaxation of restrictions on labour mobility may generate intense opposition in these economies.

However, the silver-lining could be the demographic trends in many developed economies. As the demographic profiles of these economies shift upwards, they will experience labour shortages across many areas. Once this starts affecting their economies, like what is already happening in Japan and parts of Western Europe, policies that favor immigration will find greater acceptance. This shortage is more likely to manifest itself in less knowledge-based and lower skilled professions, especially in services, which the older-aged workers will not be able to perform. Fortunately, these are also precisely the same labour categories where the marginal gains from immigration are the largest.

There are possibly two other reasons why this differential will be predominant among lower skilled than high-skilled knowledge workers. In case of the later, as part of globalization and demand in advanced economies, restrictions on labour mobility have been eased considerably over the past two decades. This has also had the effect of lowering arbitrage opportunities in their wages. Further, many of these activities are not location based and could be easily off-shored. In contrast, many semi- and lower-skilled professions in the services sector cannot be off-shored, and their persistent high wage differentials coupled with the impending labour shortage (in developed economies) will offer attractive opportunities for migrants.

Update 1 (9.11.2014)

Tyler Cowen makes the case of liberalization of immigration controls for developed economies facing adverse demographic headwinds.

Eric Posner and Glen Weyl makes the case that the Arab countries, despite their extremely high inequality (between locals and migrants), and through their liberal immigration policies, have been the biggest contributors to the reduction of global inequality. The graphic below shows that the developed economies, despite their low internal inequality, contribute little to reduction of global inequality, whereas Arab contribute, especially those like Qatar, contribute massively to the reduction of global inequality.