Tuesday, July 31, 2012

More on the psychology of poverty

One of the most enduring and deeply controversial debates on poverty is about what causes poverty. Conservatives lay the blame for poverty on the poor themselves, specifically their apparent laziness. They point to the stereotyped image of poor people idling away, shirking work and indulging in self-destructive behaviour to validate their claim. However, this argument fails to resolve the causation-correlation problem - whether they are the cause or symptoms of poverty?

Bryan Kaplan writes,
If people are poor because they're behaving irresponsibly, they should be far down our queue of people to help - if they belong on the queue at all... I also happen to think that reducing the generosity of the welfare state and making assistance conditional on good behavior will (eventually) reduce bad behavior... the fact that poor people are often the authors of their own destitution is morally significant and sadly neglected.
I am not very convinced with this reasoning. In fact, I am inclined to agree with recent findings from behavioural sciences research that point to causal links running from poverty to bad behaviours. In particular, they highlight the self-control and commitment challenges imposed on people who are constantly exposed to an environment of scarcity in time and money. In fact, the "bone-headedly simple", "very very bad" choice trade-offs on "drinking" or "smoking" or "single-motherhood", are not as simple as it appears. Consider this parable that may resonate with many of us.

Mr Meritocrat is deeply satisfied man, completely at peace with himself, his world, and his work. He gets up in the morning, attends to his natural calls, drinks the hot coffee served by his servant, reads newspaper and browses the internet from the comfort of his air-conditioned room, switches on the morning television to do yoga, takes bath, has his breakfast, gets driven to office, and has his personal assistant arrange the daily schedule. He then dives deep into his hugely rewarding and enriching work, for which he pockets a fortune each month. And I could go on.
Now consider this counterfactual. He wakes up to find that there is no water in the toilet, no servant to boil tea, and no electricity to read newspaper or browse the internet or do yoga. Worse still, his cook has taken leave, forcing him to prepare his breakfast. After he gets ready, he finds that his vehicle has broken down and he needs to wait till a taxi is hired. Thanks to the delays, he arrives late for the morning meeting. There he finds that a critical functionary has taken leave for the day, rendering the meeting largely superfluous. The cascade of events leds to a build up stress that takes it toll on Mr Meritocrat, whose productivity declines precipitously for the day. The downsward spiral will take many forms and could go a long distance down.
Mr Meritocrats' travails, amplified many times over and in a qualitatively more depressing form, echoes with the plight of a poor slum resident of any Indian city. He wakes up every morning to a day of struggles. A daily routine characterized by a seemingly endless succession of such struggles, drains him/her emotionally and congnitively, and manifests in less than desirable behaviours.

This reasoning considerably complicates the search for explanations for poverty. In any country, even in tightly controlled command economies or despotic autocracies, merit and effort does get rewarded, though the extent varies. However, to draw the simplified linear inference that, therefore, all those not successful do not have the requisite merits is simply misleading. Those apparently "irrepsonsible lifestyles" on "bone-headedly simple" issues are therefore not necessarily a matter of choice.

A more nuanced search for explanations, one that accounts for the serious incentive and behavioural distortions caused by poverty itself, necessary for us to make any meaningful and sustainable dent in addressing the scourge of poverty.

Monday, July 30, 2012

Evolution of Olympic records

The Times has an excellent graphic that captures the changes in Olympic medal winning performances in swimming and track and field events over the forty year period till the last Games. The average improvements in medal-winning performances have been 10.3% for swimming events whereas the same was just 4.1% for track and field events.








































There was a veritable explosion of swimming records in the 2008 Olympics - 70 world and 66 Olympic records in the Beijing Olympics - sparking off a big debate on the role of technology in the sport in the form of sleeker, computer-designed Speedos to deeper (and, for the swimmer, less turbulent) pools. Here is an interactive graphic on the evolution of world records in Olympic events.

Thursday, July 26, 2012

More on India's urban housing challenge

FT points to this graphic from Bloomberg which highlights the exorbitantly high cost of housing in Mumbai. Though the absolute value of housing costs are smaller, in relation to its $3,700 per-capita purchasing power the average Indian would have to work 308 years to afford a 100 sq m luxury home at Mumbai.

The graphic would be representative of much of urban India and is one of the biggest development challenges confronting India. Further, a comparison of slum housing costs too would reveal much the same trends. In bigger cities, housing costs form an unsustainably large share of household income. Government housing programs under schemes like the JNNURM or the new RAY are enough to meet just a minuscule proportion of the demand. Compounding the problem is the very narrow market in lower income housing rentals.

In the circumstances, newer migrants find their way into non-notified squatter slums. They invariably develop all around the city suburbs. Alternatively, people encroach river and nala (storm water drains without boundaries) margins and hillocks, or wherever vacant government lands area available. Powerful land mafias, having nexus with local politicians and officials, are active in all Indian cities in promoting such illegal activities.

As I have blogged earlier, the only way out of this is to promote vertical growth, ease the stifling regulatory restrictions, and free up the massive extents of lands locked up with government agencies. In particular, defence, railways, and public sector entities, have large extents of vacant government lands in most large cities at central locations. Their locations, which were well outside the main city precincts when developed 40-50 years back, now form central parts of the vastly expanded city.

The cost of their relocation outside the city, including full reconstruction costs, would form a very small proportion of the potential value that can be unlocked from its redevelopment. Unfortunately, I am not aware of even a single case of such relocation anywhere in India. It would require commitment and co-ordination at the highest levels at both the state and central governments. The contrast with the plentiful such redevelopments in China could not be starker and is a reflection of the differences in development policy making in the two countries.

Even where such proposals have been discussed, they have revolved around simplified public private partnerships (PPPs). Such proposals, if they are pursued, are certain to fail and bring considerable disrepute to an already maligned concept. The uncertainties involved in such public real estate contracts - inter-departmental and state-central co-ordination, temporary resettlement issues, litigation, political opposition etc - are so huge that any private entity will simply hedge their risks and quote discounted values which in turn will invite populist criticisms of crony capitalism.

Governments, especially local governments, will therefore have to lead the redevelopment initiatives. Government owned Special Purpose Vehicles (SPVs) will have to be established and professional practices have to be adopted in managing such redevelopments. The financial structuring of these projects will have to be done with great care and detail. Private participation will have to be invited in carefully selected components and structured appropriately. It is only appropriate that in such projects the government assumes the construction risks (most of which are within their control) and allocate property rights to private entities only after those risks have been mitigated or eliminated. This will ensure the right risk allocation and enable fair price discovery in allotment of property rights within the redevelopment to private entities.

The initial funding for such projects will have to come mostly from the government, through equity and debt raised on the government's balance sheet. Once the construction and other government related risks are off-loaded, the SPV can be restructured and public ownership and debt swapped with private entities, wherever required, through transparent competitive bidding. This process increases the likelihood of ensuring the most optimal value capture by government, risk allocation among entities, and price discovery in allotment of property rights. The challenge will be with ensuring transparency and professionalism in this process and preventing its political capture.  

The magnitude of America's jobs market challenge in a graphic

The June 2012 American jobs market report is further confirmation that the US economy is stalling. The economy added a meager 80,000 jobs, and the unemployment rate remained at 8.2%. The rate of jobs addition is just about enough to keep up with population growth, but not enough to reduce the backlog of 13 million unemployed workers.

The graphic below captures the magnitude of the labour market challenge facing the US. In fact, if the US economy generates 208,000 jobs per month (well above the recent monthly job creation figures), the average monthly job creation for the best year in the 2000s, it will be well past 2020 when the labour market would have recovered to its pre-crisis lows.

Tuesday, July 24, 2012

Prospect theory and financial incentives for teachers

Daniel Kahneman and Amos Tversky formulated prospect theory to explain how real-world people evaluate losses and gains. In particular, they claimed that people show endowment effect - people value a thing more once it becomes their own - and loss aversion - people are more motivated by avoiding a loss than acquiring a similarly sized gain. These findings have been experimentally validated many times subsequently and is now widely accepted.

Roland G. Fryer, Steven D. Levitt, John List, and Sally Sadoff have a new working paper that seeks to leverage loss aversion among teachers to improve student learning outcomes. The challenge with the use of performance incentives have been that while there are experimental findings to prove that teacher quality matters for both student learning outcomes and long-term life outcomes, success with the use of financial incentives for teachers has been mixed (see this and this) for a variety of reasons. The use of financial incentives assume greater significance in view of the difficulty in using various observable screening techniques to ex-ante identify who is a good teacher. All these challenges are compounded in developing countries.

The study conducted by Fryer and Co were in nine schools of Illinois during the 2010-11 period. Teachers were tandomly selected for the experiment, and among those selected one again randomly selected group was given the standard incentives - bonuses at the end of the year linked to student achievement - while the other group teachers were given a lump sum payment (of same size as the bonus) at the beginning of the school year and informed that they would have to return some or all of it if their students did not meet performance targets. In this context, the authors write,
We demonstrate that exploiting the power of loss aversion - teachers are paid in advance and asked to give back the money if their students do not improve sufficiently - increases math test scores between 0.201 (0.076) and 0.398 (0.129) standard deviations. This is equivalent to increasing teacher quality by more than one standard deviation. A second treatment arm, identical to the loss aversion treatment but implemented in the standard fashion, yields smaller and statistically insignificant results. This suggests it is loss aversion, rather than other features of the design or population sampled, that leads to the stark differences between our findings and past research.
I have blogged here, here, and here about the use of financial incentives to teachers for improving classroom instruction quality and thereby student learning outcomes. I am inclined to believe that any teacher performance-based pay system, while unobjectionable at a theoretical level, may be very difficult to implement, both for political and administrative reasons, in the prevailing environment in countries like India. However, if financial incentives are implemented, its framing is a crucial small detail, which can dramatically improve the chances of its success in implementation. 

I see two big first level challenges with the deployment of financial incentives as suggested. The biggest evaluation problem with education is the challenges with getting reliable and cross-comparable data on learning outcomes. Given the stronger loss-aversion motivation, upfront rewards, to be taken back if the expected results do not come, are liable to nudge/force teachers into manipulating scores with much greater intensity. Further, the concept of taking back something given (even if done non-invasively by deducting it from the subsequent month's pay) is a relatively new strategy and may generate other unanticipated incentive and systemic distrotions and pushbacks.

Given the logical simplicity and attractiveness of this framing, it has uses beyond education and teachers. Further empirical studies may be required before we can draw more meaningful inferences.

Sunday, July 22, 2012

Lowering corruption in the delivery of statutory certificates

One of the commonest sources of corruption in India is in the delivery of statutory certificates by various government agencies. Every year, across the country, millions apply for caste, income, and nativity certificates, mainly to establish their eligibility to avail affirmative action and other benefits like concessional loans, self-employment schemes, subsidies, and even government jobs. How do we reduce the magnitude of corruption in the delivery of such services?

Under the prevailing arrangement, all applications have to come with certificates that establish eligibility (they can be either of the caste, income, residence, birth or another similar certificate). For example, for any government job opening, atleast ten people apply. Typically only a small percentage of applicants are finally selected. However, all the applicants, generally a large multiple of the required vaccancies, have to procure the eligibility certificate (generally the caste and residence certificates) from the local government officials. 

The publication of any such notification (for the job opening or the self-employment scheme) is invariably followed by a massive rush to procure the requisite eligibility certificate from the local Tahsildar (the Revenue Department) or Municipal offices. Since the applications have to be submitted within the prescribed time, the respective government offices face a sudden surge in the load of applications to be processed quickly. The over-burdened municipal or tehsil office staff inevitably dilute the quality of their mandatory field enquiries. The time constraint also increases the bribes associated with procuring the certificates.

This problem can be considerably mitigated with a small process re-engineering. Instead of applying with the requisite statutory certificate, the applications can be accepted with a self-certification about caste or income or residence. Once the process (for jobs, loans, or subsidies) is completed, the successful applicant can be directed to submit eligibility certificate within a month or so. This will decongest the certificates issue channel (by lowering both the load and time constraints), increase the rigour associated with its processing, and reduce the bribes expropriated.

It is possible that the magnitude of bribes will increase given the stakes involved - the successful candidate in a job interview has much more riding on the certificate than a mere applicant! In the circumstances, information asymmetry can be useful to mitigate incentive distortions. The certificates should be general in nature, not issued for any specific purpose (in some states, residence and income certificates are issued clearly indicating the purpose of its issue). This coupled with an applications processing system where the applicant does not come into contact with the official (applications submitted through an outsourced customer service center and the certificate to be mailed to the applicant's address within a specified time) will go a long way towards improving efficiency and reducing public harassment.

Alternatively, in cases of job employment and high value loans, the department itself can send the documents (collected along with the original applications) of the successful candidates to the respective certificates processing agencies and obtain the certificates without involving the candidates. 

Friday, July 20, 2012

Controlling institutionalized rent-seeking in engineering bureaucracies

One of the most pernicious forms of corruption is the institutionalized rent-seeking chain that pervades engineering bureaucracies in India. Robert Wade documented the flow of rent transactions among irrigation engineers in South India in decision-making on water discharge into irrigation canals and canal O&M contracts. In simple terms, bribes are transacted in a cascading manner between the contractor or water recipient and public functionaries at different levels. 

A recent op-ed in Times highlighted similar rent-seeking chains in China. I'll stick out my neck and claim that there are "no straight roads" in India too. A well-entrenched rent-seeking chain underpins all roads and other engineering works. Further, this chain, which covers functionaries from the work site inspector to the highest supervisory official, is extremely difficult to penetrate. Conventional approaches to tackling corruption are not likely to succeed much in breaking this chain.

There are two features of the environments in which these works are executed which add several layers of difficulty in their management.

1. The contractors and officials are involved in repeat games, played with high frequency. Engineering officials are likely to be in a post for 3-5 years, and the lower level supervisors are generally non-transferable. Contractors, especially the sub-contractors, have strong local roots, and are regular participants in government works in that area. In addition, both of them have strong links with the local political representatives. A three-way, mutually beneficial and therefore self-reinforcing, long-term chain gets established, both at the personal and also the institutional levels.

In the circumstances, the contractor finds it optimal to pay officials their standard rents, which gets proportionately distributed all along the official chain of command. They internalize this as the cost of doing business at their terms (read, poor quality and slow pace) without being inconvenienced. They also realize that they have to continuously do business with the same functionaries and get their help on expediting various issues related to the construction work. Given this, any major deviation from the standard norms (of rent-seeking) will immediate invite an institutionalized backlash.   

2. The engineers, especially those at the field level, exercise considerable leverage over the contractors. The contractor requires their help in securing the worksite, co-ordinating with other government departments for various services, obtaining permits and clearances for material procurements and transportation, supervising the quality and pace of construction, recording of work done, its sample check measurements, and payment of bills. And the level of engagement required from the officials is very high in certain types of works.

Standardizing the interfaces between officials and contractor is very difficult, even impossible in many of these works. For various practical real-world problems, the process of handing over the worksite, obtaining clearances from other departments, and so on, is a continuous process that is spread over the entire work duration. This is all the more so with road, irrigation, electricity distribution and transmission, urban infrastructure, and similar others with extended worksites.

I am inclined to the belief that the standard approaches to controlling corruption - increased transparency, expedited single-window clearances, standardized work plans and schedules, fixed timelines for work recording and bill payments etc - may not yield the desired results when dealing with such deeply institutionalized rent seeking. Strong enforcement through efforts to detect and punish the errant officials too is not likely to make much dent in this practice. Even innovative outcome-based contracting systems may not be able weaken the corruption chain significantly.

In the circumstances, a more relevant and effective strategy (based on anecdotal personal experiences) to controlling institutionalized rent-seeking corruption in the execution of these engineering works would be to work backwards by tightening quality control during execution. It works on the premise that once the estimates are prepared and work tendered out, if the quality of execution is maintained, there is very little margin for excessive rent seeking.

Currently, the rents come by way of compromises made with the quality of procurements and construction. Therefore, if the quality of execution is monitored rigorously, any rents will have to come at the cost of the contractor's standard profits. This will face strong pushback from the contractors, especially their sub-contractors, whose margins are smaller. It is certain to align incentives and generate enough internal forces to dampen tendencies for widespread rent-seeking and thereby minimize this corruption. 

It would be interesting if someone could study the dynamics behind such corruption and see whether the aforementioned anecdotal story squares up with the reality. 

Thursday, July 19, 2012

China chart of the day

Indications are that China's investment led economic growth is faltering. The precipitous boom in fixed asset investments, which touched 50%, is clearly unsustainable. The property prices are clearly on a massive bubble. This graphic from FT is illustrative










Domestic consumption is the only way out. Simultaneously, given the critical role played by land prices in sustaining investments, the government will have to manage the consequences of deflating property bubble on both the balance sheets of banks and the investment appetites of public sector entities and local governments.

Wednesday, July 18, 2012

Pricing transparency does not always pay!

Clothes retailer JC Penney is apparently doing very badly following the embrace of a massive, creative and aggressive new advertising and pricing campaign that promises simplified prices. Logically it would appear that, in a world where pricing information is "shrouded", a more transparent up-front full price revealing strategy would be much appreciated by consumers and increase revenues.

The practice of concealing the real price of a product or service by "shrouding" the prices of "add-on" components from the displayed price tag is rampant in many product markets. They include the high service or consumables cost for certain products which are priced cheap (like the cartridges and printers) and high cost complementary services that are attached with cheaper hotel rooms, stadium and theatre seats (pop corn in cinemas effect). Such shrouding helps the firm make money out of myopic consumers (who either do not have the knowledge or patience or inclination to sift through information) whereas the sophisticated consumers (who process all information and make the cheapest option) get greater value for their money. In simple terms, the former subsidizes the latter. 

In this context, a working paper by Xavier Gabaix and David Laibson found that in competitive markets where shrouding is rampant, it may not be possible for firms to make money by opting for transparency. They write about their study of products with add-ons, 
In competitive markets with costless communication, Bayesian consumers infer that hidden prices are likely to be high prices. Hence, firms choose not to shroud information. However, information shrouding may occur in an economy with some myopic consumers. Such shrouding creates an inefficiency. Sometimes firms have an incentive to eliminate this inefficiency by educating their competitors’ myopic consumers. However, if add-ons have close substitutes, a “curse of debiasing” arises, and firms will not be able to profitably debias consumers by unshrouding add-ons. In equilibrium, two kinds of exploitation coexist. Optimizing firms exploit myopic consumers through marketing schemes that shroud high-priced add-ons. In turn, sophisticated consumers exploit these marketing schemes. It is not profitable to lure either myopes or sophisticates to non-exploitative firms. We show that informational shrouding flourishes even in highly competitive markets, even in markets with costless advertising, and even when the shrouding generates allocational inefficiencies. 
In other words, advertising the real price upfront and disclosing low or no add-on or markups, and thereby educating consumers does not fetch revenues. In competitive markets, where "low-ball" pricing is rampant, such firms end up with the worst of all worlds. The sophisticated consumers anyways prefer the "shrouded" markets because they get good deals from them. The myopic consumers tend to be taken in the by the "low-ball" prices and other offers of competitors and also put off by the relatively higher prices of the transparent firm. Therefore a firm that unshrouds its add-on prices will lower its profits, implying a “curse of debiasing.”

There two important policy take-aways from the study.

1. Competitive markets will not necessarily debias markets and bridge information asymmetry. Certain categories of consumers, the sophisticates, will always prefer the"shrouded" markets. Myopic customers will be put off by the relatively higher prices of the transparent firm. There are others who would be indifferent to small price variations. All this will conspire to favor an equilibrium that involves "shrouding".

2. If it is in public interest to bring in greater pricing transparency to certain markets (like say financial products), this cannot be left to free-markets or voluntary unshrouding. Regulators may have to make unshrouding mandatory for all firms. This carries great relevance to the financial services sector, where finacial illiteracy will conspire with cognitive biases to generate undesirable outcomes.

Conventional wisdom has been that lower search costs and transparency in pricing in all markets will result in better outcomes. Accordingly, policy makers have preferred to adopt this strategy to increase efficiency in financial markets like that for insurance policies and savings instruments. However, if the aforementioned study is any indicator, a more effective strategy would be mandatory unshrouding with clear defintion of what constitutes such shrouding.    

Tuesday, July 17, 2012

The IS LM Model explained

The best way to revise a concept is to write about it! Paul Krugman has this description of the IS (investment-savings)-LM (liquidity preference-money supply) model that examines the interaction between the market for goods and services and the money market,
My favorite approach is to think of IS-LM as a way to reconcile two seemingly incompatible views about what determines interest rates. One view says that the interest rate is determined by the supply of and demand for savings – the “loanable funds” approach. The other says that the interest rate is determined by the tradeoff between bonds, which pay interest, and money, which doesn’t, but which you can use for transactions and therefore has special value due to its liquidity – the “liquidity preference” approach...
loanable funds or liquidity preference doesn’t determine the interest rate per se; they determine a set of possible combinations of the interest rate and GDP, with lower rates corresponding to higher GDP... the adjustment of GDP is what makes both loanable funds and liquidity preference hold at the same time.
Let us analayze both models. Consider the loanable funds first. As interest rates fall (for whatever reason), investment increases, economy expands, and income levels increase. Atleast some portion of increased income will be saved, thereby expanding the savings pool available. A new interest rate equilibrium develops at this lower rate level between investment demand and savings available. The IS curve "determines a set of possible combinations of the interest rate and GDP, with lower rates corresponding to higher GDP" (therefore downward slope for the IS curve).

Now for the liquidity preference model. People make trade-offs (assuming the same risk, between returns and liquidity) when they take decisions to allocate their wealth between different investment and savings options (specifically between money and bonds). For a particular instrument, if its returns rise, people become willing to settle for lower liquidity. If the central bank wants to increase the money supply (cash balances with people), it must lower interest rates so as to induce people to increase their preference for liquidity.  The liquidity preference curve is thererefore downward sloping.





















In the market for money supply (from central banks and passed on through commercial banks) and money demand (or liquidity preference), the former is vertical (in the short run, central banks can hold the money supply constant, even without changing the interest rate) while the latter is downward sloping. An increase in GDP, as indicated in the graphic above, will result in greater number of spending transactions, higher demand for money, and therefore a shift in the liquidity preference function outward. If the real money supply (supply adjusted for inflation) is held constant and the market has to equilibriate, the higher demand for money will have to be accompanied by an increase in interest rates. The LM curve, which is the set of all possible combinations of the interest rate and GDP where the money supply and demand matches, therefore slopes upward.

At the equilibrium of IS-LM graph, the loanable funds (goods/services market) and liquidity preference (money market) are in balance. Now let us examine the effects of fiscal and monetary policy on the economy by using the IS-LM model. Fiscal Policy first. Anything which causes a change in consumption, government spending, or investments, will shift the IS curve. A rise in Government investment spending, by increasing the demand for goods at the same interest rate, has the effect of pushing the IS curve to the right. This in turn increases the aggregate demand and therefore the GDP. However, interest rates have to increase so as to equilibriate between the loanable funds and liquidity preferences.





















The classical economists refute this and argue that the resulting higher interest rates will eventually crowd-out private consumption and investment, thereby putting downward pressure on the growth of economic output. Further, the higher government spending will trigger inflationary pressures, which in turn will shift the LM curve inwards, thereby raising interest rates. These twin dangers, they contend, will invariably strangulate growth.   

Similarly with monetary policy, as the money supply is increased, the LM curve shifts outward or downward. This in turn will lower interest rates, spur investments and consumption, and raise national income.





















In both cases, exogenous shocks/events can lead to changes in liquidity preference and demand for savings, which in turn can shift the LM or IS curves respectively. However, in the long-run, prices/wages adjust to return the real money supply curve (and thereby the LM curve) backwards to its original position. It is therefore argued that the long-run impact of any change in monetary policy is minimal. But the fine print of the debate is about the magnitude of the adjustment in prices/wages and the time taken for this adjustment (or what constitutes long-term). Classicists claim that prices adjust quickly whereas Keynesians argue that prices are sticky. 

Similarly, when the economy faces conditions like the present situation - frozen credit markets, reduced investment and consumption apetite, very high unemployment rate, and zero interest rate bound - many of the standard assumptions of classical economics breaks down. In the circumstances, government is the only agent with the ability to pull the economy. Further, since the economy is operating way below its potential output frontier, large pool of labour unemployed, and aggregate demand heavily constrained by lack of purchasing power, an increase in money supply is not going to lead to inflationary pressures. Also, at the zero-bound, since cash and bonds become interchangeable, at the margins, money is just being held as a store of value, and changes in the money supply have no effect.





















See this excellent presentation of the IS-LM model and also this nice description.

Monday, July 16, 2012

The corporate corruption glass - half empty or half full?

Reminiscent of the robber baron days, crony capitalism and corporate corruption is front page news across the world. This naturally raises the question of what is responsible for this trend. Is the surge in  corporate corruption a result of the the extensive market deregulation of the last two decades or a reflection of the increased vigilance and enforcement by governments?

Eduardo Porter writes that corporate wrongdoing has today come to be seen as a routine occurrence,
The misconduct of the financial industry no longer surprises most Americans. Only about one in five has much trust in banks, according to Gallup polls, about half the level in 2007. And it’s not just banks that are frowned upon. Trust in big business overall is declining. Sixty-two percent of Americans believe corruption is widespread across corporate America. According to Transparency International, an anti corruption watchdog, nearly three in four Americans believe that corruption has increased over the last three years.
James Surowiecki takes the latter position,
Walmart allegedly covers up millions of dollars in bribes paid to local government officials in Mexico. A former Morgan Stanley executive is convicted of funnelling money to a Chinese official in connection with real-estate investments. The S.E.C. sends “letters of inquiry” to several Hollywood studios, looking into the possibility that they used bribes to crack the Chinese movie market. When you read the business pages these days, you can be forgiven for thinking that international commerce is a cesspool of graft. Yet, by historical standards, things have never been cleaner. What’s changed is how strenuously governments are cracking down on corruption.
The answer lies somewhere in between. While the intensity of regulatory crackdowns has risen, it cannot be denied that there has been a proliferation of corporate misdemeanours in recent years. Deregulation, especially in the financial markets, has distorted incentives and exposed egregious conflicts of interest among market participants.

Further, in the relentless pursuit to maximize short-term shareholder returns and profits, to the near total exclusion of all else, corporate environments are increasingly getting divorced from values and morals. Trust, one of the cornerstones of capitalism, is a casualty in this pursuit. In the context of recent scandals involving Goldman Sachs, Glaxo SmithKline, BP, and Barclays, John Kay recently wrote,
We need to be able to trust pharmaceutical companies. We expect banks to be run and populated by honest people, to keep our money safe, and to give us our money back when we need it. We want oil companies to have a strong culture of engineering professionalism and commitment to health and safety.
It is almost self-evident that capitalism has to be rescued from capitalists themselves!

Sunday, July 15, 2012

How Apple benefits from and promotes modern economic trends?

The spectacular concentration of wealth at the top of the income ladder and the sharply widening income inequality have been among the most intensely debated socio-economic issues of our times. While there have been many explanations offered for this trend, I am convinced that the dramatic growth of financial sector over the past two decades and the nature of distribution of gains in technology sectors have been among the biggest contributors. 

The best example of the latter comes from the latest in the New York Times investigation on the iEconomy, or the economy surrounding Apple products. Apple is widely acknowledged as the most remunerative wealth creation enterprise ever. However, while it has generated staggering returns to its shareholders, engineers, and executives, the same cannot be said about the returns to its remaining workforce. The executives and engineers, who are the high-profile and much-lauded public face of the company, form a small proportion of the company, whose majority workforce are the hourly wage earning sales staff in its retail showrooms. The Times writes,
About 30,000 of the 43,000 Apple employees in this country work in Apple Stores, as members of the service economy, and many of them earn about $25,000 a year. They work inside the world’s fastest growing industry, for the most valuable company, run by one of the country’s most richly compensated chief executives, Tim Cook. Last year, he received stock grants, which vest over a 10-year period, that at today’s share price would be worth more than $570 million. And though Apple is unparalleled as a retailer, when it comes to its lowliest workers, the company is a reflection of the technology industry as a whole... 

Divide revenue by total number of employees and you find that last year, each Apple store employee - that includes non-sales staff like technicians and people stocking shelves - brought in $473,000... The Internet and advances in computing have created untold millionaires, but most of the jobs created by technology giants are service sector positions - sales employees and customer service representatives, repairmen and delivery drivers - that offer little of Silicon Valley’s riches or glamour... Job growth has for decades been led by such service-related work. 
Its assessment of Apple's mystique and success with paying the majority of its employees the bare industry standard wages,
Apple’s success, it turns out, rests on a set of intangibles; foremost among them is a built-in fan base that ensures a steady supply of eager applicants and an employee culture that tries to turn every job into an exalted mission. This is why Apple can do something unique in the annals of retailing: pay a modest hourly wage, and no commission, to employees who typically have college degrees and who at the highest performing levels can move as much as $3 million in goods a year.
The sales and non-sales, non executive and non-engineering staff are typically fresh college graduates, attracted by the coolness associated with selling Apple products. They can be put to work in shop floors with little training and are willing to work for low wages. However, they have limited promotion avenues and very few of such recruits can make a long-term career in the firm. It is therefore no surprise that the turnover ratio is high in all such firms and average tenure is 3-6 years. These youngsters drop out after a few years and search for openings elsewhere.

This draws attention to how Apple benefits from squeezing value at every point in its value chain. As the Times has written earlier and I have blogged, it is now idealy documented that Apple benefits enormously from the low wages paid by firms like Foxconn to its local workforce. Further, Apple is also a very efficient tax optimizer, as its battery of trained tax consultants have managed to keep its tax payments well below that of its competitors.

In simple terms, Apple is the company of our times par excellence, packing all the very best and the worst of current business practices. It is the lodestar for firms seeking to squeeze out all possible benefits from prevailing market trends. In its quest to maximize profits, it has managed to legally externalize all its costs wherever possible, at a global scale. It has been the biggest beneficiary of mega-trends like globalization, financial market deregulation and its global integration, lowering of trade barriers, decline in union power, and so on. Finally, by being a step ahead of regulators and law makers, it has exploited all the legally available opportunities to profit from its business operations.

Friday, July 13, 2012

Public perceptions on economic conditions in India

The latest Pew Research Center’s Global Attitudes Project's survey of public perceptions (pdf here) (via Economix) on various factors related to the economy and their well-being reveals certain interesting features. In particular, for India, there are some interesting findings. 

Indians are generally less optimistic across a range of indicators than are their emerging market counterparts.                                                                                  









In contrast, the Indian rich are far more gung-ho about their prospects and that of the economy across a range of indicators. In fact, the difference in economic attitudes between people with high incomes and people with low incomes is most notable in India. By a margin of 25 percentage points, high-income Indians are more satisfied than low-income Indians with their personal economic situation.
 









Predictably, 92% of Indians blamed the government for the current economic problems. But surprisingly, 64% of Indians blamed themeselves for their present state.


Thursday, July 12, 2012

Rational expectations, behavioural biases, and official transfers

Public corruption is the flavour of the season in India. A series of high profile corruption scandals across the country have ignited an intense debate about corruption in public offices. It has spotlighted attention on the pressures faced by public officials and about their frequent transfers if they fail to oblige their political masters. In this context, here is a Game Theory analysis of one way in which the brunt of such transfers are faced by upright officials. 

Consider the examples of Mr Honest Babu and Mr Corrupt Babu. As their names suggest, the former is scrupulously honest whereast the latter belongs to the opposite camp, and their respective reputations are accordingly well established. Both are Municipal Commissioners in two large neighbouring municipalities. As with all such jobs, they face a constant array of requests from political representatives on behalf of specific persons for individual favours.

They include requests for building permissions or layout approvals, property tax reductions, concessions on water or sewerage connections, transfer requests of officials, and so on. Some of these requests are genuine and deserve consideration, whereas, the majority are predictably without merits. Now both Commissioners face repeated such representations from Mr Percentage Mantri, the Municipal Minister. However, the nature of the requests going to the respective Commissioners through the Minister vary considerably based on expectations formed about these officers (based on their reputations) by applicants.

In case of Mr Honest Babu, applicants realize that he will personally follow-up and clear all genuine representations made to him, irrespective of whether it comes from the Minister or not. This message soon gets internalized and genuine applicants approach him directly. Others route their applications through the Minister and they invariably get rejected. Therefore, since only representations without any merit go through the Ministers office, all of them get rejected.

In case of Mr Corrupt Babu, applicants realize his willingness to indulge the requests, irrespective of merits, in return for bribes. But the bribes are often exorbitant if they approach him directly. Representations received through the office of Mr Percentage Mantri get favorable treatment. In such cases, the bribes are either waived off or are considerably reduced. Naturally, most representations, including the genuine ones, are routed through the Minister. And most of them get done.

Mr Percentage Mantri, prima facie percieves that while Mr Corrupt Babu indulges all his requests, Mr Honest Babu refuses everything. His office and those around him, who stand to benefit the most from the bribes collected from such representations, instigate the Minister against his honest Commissioner. He forms the impression that the latter is biased against him and therefore steps up efforts to get him transferred.

The example is a highly simplified illustration of a rational expectations and cognitive bias driven challenge faced by honest officials when discharging their responsibilities. There are two forces at work here.

1. In both cases, people quickly form expectations based on the respective administrative styles of officers and route their requests accordingly. The final outcome of this is that honest officer gets more requests directly, while the requests to the corrupt officer generally get routed through the minister. 

2. The Minister and his coterie - being unaware about this realignment of expectations and resultant changes in the pattern of routing requests (and the resultant changes in the conditional probability of positively actionable requests reaching each officer) - perceive one officer to be rejecting a disproportionately higher number of requests. In simple terms, the Minister's coterie develops an impression about Mr Honest Babu based on a representativeness bias.

I am not blind to the fact that the aforementioned analysis does not acknowledge for the blatantly illegal requests. Such requests are most likely to always originate or be routed from the Minister's office, irrespective of the nature of the officer. And the honest officer will invariably reject such requests whereas the corrupt man would oblige them. However, with such cases, Ministers too form rational expectations about officers (and the near certainty of them being rejected) and are therefore less likely to route such requests to them.

India and the world!

Two interesting maps that compare the Indian states with countries based on population and GDP. The population comparison is understandably flattering. If Uttar Pradesh were to declare independence, it would be the world’s fifth most populous country


















But the GDP comparison is dismal. India could easily be mistaken for Africa. In fact, UP with a population of nearly 200 million would only be the size of Qatar, a tiny oil-rich state of fewer than 2m people.


Wednesday, July 11, 2012

The Amazon Economy

Excellent feature in FT that explores Amazon's expanding sphere of influence in the e-commerce space. In recent years, Amazon has been transformed from being a mere online book retailer into a provider of the IT and even physical plumbing for e-commerce firms,
Mr Bezos is turning Amazon into a back office infrastructure provider that sells access to a digital market place with millions of customers, to petabytes of server space and to state-of-the-art warehouse facilities serving myriad forms of commerce... its shift into infrastructure is extending its power as a disruptive force to how business is structured. It is revolutionising the way entrepreneurs can create start ups, or revive staid companies, by letting them plug their ideas into pay-as-you-go systems that cost a fraction of the investment they would need to build such infrastructure alone...

Its services have already produced hybrid businesses where Amazon runs marketing, customer relationships, payments, computing, logistics and distribution, leaving executives to do nothing but find or make good products, both physical and digital... Amazon charges clients a pay-as-you-go fee for access to a flexible portion of cloud space where they can manage data and run their websites, making it easier to cope with demand spikes and reducing the need for in-house servers and technicians.
In simple terms, Amazon is leveraging its e-commerce expertise and physical infrastructure to position itself as an e-commerce meta-service provider. Amazon is tapping into the market for supply of outsourced services for e-commerce firms. Alternatively, as FT writes, Amazon's business model seeks to "unbundle" the corporation - let companies shed supposedly “core” processes that conventional wisdom says should be combined within a single entity. Instead of selling products, Amazon is seeking to sell services.

Interestingly, Amazon is also a competitor to many firms which use Amazon's e-commerce service platforms. For example, Amazon Web Services (AWS) is a cloud computing business, which is the engine behind digital content companies including Spotify, a digital music service, and Netflix, a video streaming service. But Spotify and Netflix also compete against Amazon’s Cloud Player and Instant Video services respectively.

Amazon's forays into providing back-end services has to be seen in the backdrop of its failure to make attractive profits from front-end retailing. It made a meagre $631m net profit on revenue of $48bn last year, and had an operating margin a mere 1.5% in the past quarter. It feels that it is more profitable to earn service fees than to buy and sell products itself. It feels a great opportunity to make money from its huge investments in warehouses and data centers.

Tuesday, July 10, 2012

India's power sector woes

Conventional wisdom would have it that expansion of generation capacity and lowering of transmission and distribution losses would effectively address India's power sector woes. But closer scrutiny reveals a need to go beyond these measures. In fact, India's power sector is a entrapped in a gridlock of self-reinforcing spirals, breaking out of which would require concerted action at multiple levels.

Gurgaon is representative of the mess that is India's power sector. Its peak power deficit is 25%, amounting to 1200 MW. Supply to industries has been reduced from 18 hours a day to merely eight hours to meet the domestic and non-domestic demands. With demand rising at a staggering 25% every year, widespread powercuts have become a feature of life in Gurgaon in recent years.

Diesel generators or inverters are everywhere, even in middleclass households. Though the official electricity tariffs are far lower than global standards, the effective expenditure on electricity is well above that elsewhere. In other words, residents of Gurgaon end up paying much higher rates (than the formal tariffs) to access assured supply. But ironically, as with all other public utility services, any attempt to raise tariffs is inevitably accompanied by political protests. This collective unwillingness to pay higher tariffs obscures the individual's willingness to pay whatever its takes to access these services.

The system is therefore entrapped in a self-fulfilling downward spiral. The populist opposition to raising tariffs keeps utilities bleeding. Resource strapped and debt-laden utilities are unable to purchase enough power to provide adequate and reliable supply. Nor are they in a position to invest in network upgradation (to reduce losses) and expansion (to cover new areas). Consumers are forced to rely on alternate means, thereby increasing their effective cost of accessing power.  

However, even if adequate power is generated, there are formidable barriers to be surmounted before this power can be used. The deficient transmission capacity will hinder the evacuation of the generated power to load centers. This is all the more so with renewable sources, which are mostly located far outside the existing transmission corridors. In other words, if adequate power is available, then evacuation (from the generator) or transmission (to the buyers) corridors are not available.

Further, even if the transmission channels are available, the weak financial position of distribution utilities will surely restrict their freedom to purchase all the available power. In fact, it is an open secret that load sheddings are increasingly a reflection of the utilities' financial woes than caused by lack of power. The decreasing summer spot market prices in recent years, despite the increasing deficit, is a reflection of the unwillingness (borne out of their financial inability) to procure power even at relatively cheaper rates. 

Monday, July 9, 2012

Using libraries and reward incentives to improve learning outcomes

I've been a little late on these two recently published NBER working papers on education.

In the first paper Evan Borkum, Fang H, and Leigh L. Linden find that providing schools with library facilities (containing high quality reading material designed to support the existing language curriculum) does not have any impact on children's language skills (as measured by student scores on a language test administered 16 months later). The authors also find no impact on test scores in other subjects or on school attendance rates. In fact, their results are "remarkably consistent across individual language competencies (grammar, reading comprehension, punctuation, and vocabulary), mode of implementation, and also within individual subsets of the student population (gender, grade, baseline test score, demographic characteristics, and existing school resources)".

They speculate, from the intensity of treatment in other similar input side interventions which show considerable impact on student learning outcomes, that the intervention can be effective only if the librarians have significantly more contact with students (the study students interacted with the librarian only twice a month on average).

I am not sure whether even this conclusion is valid. Given the abysmal learning baseline student learning levels, library facilities, however intense the interaction between students and the library, may not have much impact, except maybe on the small top percentile of students. Further, government schools have no librarians and expecting a teacher to double up on that role would surely take away from his/her regular teaching duties. The finding therefore again raises the question of how scarce resources and effort should be prioritized in public schools environments.

I strongly feel that, conditional on the availability of a basic minimum on facilities/requirements, given the very low learning levels, scarce resources, and even scarce teacher mtoivation/energies, instead of spreading things too thin, education buraucracies should prioritize their efforts exclusively and directly on the issue of improving learning levels by focusing on classroom instruction.

In the second paper Steven D. Levitt, John A. List, Susanne Neckermann, and Sally Sadoff examine how behavioural insights can be deployed to incentivize students on their learning outcomes. In particular, they study the impact of reference dependent preferences, hyperbolic  preferences, and the value placed on non-financial rewards on educational outcomes.

They conducted field experiments involving thousands of primary and secondary school students by testing them and offering them financial and non-financial incentives (announced just before the tests), to be delivered immediately and one month afterwards. In the loss condition, both financial and non-financial, students received the reward at the start of the testing session and were informed that they would keep the reward if they improved (and that they would lose the reward if they did not improve). They write,
First, we find that incentives framed as losses have more robust effects than comparable incentives framed as gains. Second, we find that non-financial incentives are considerably more cost-effective than financial incentives for younger students, but were not effective with older students. Finally, and perhaps most importantly, consistent with hyperbolic discounting, all motivating power of the incentives vanishes when rewards are handed out with a delay.
At a theoretical level, I have no problems with the findings of the study. In fact, they have great relevance in the performance management toolkit in several fields and sectors. However, the issue of deploying rewards, especially financial ones, to incentivize students to improve learning levels, may, for a variety of reasons, be a near non-starter in developing countries like India. It not likely to work even with rewards for parents to ensure their wards' academic performance improves. I have blogged earlier about the hazards of financial incentives and their use to improve teacher performance.

Sunday, July 8, 2012

Behavioural scientists in government?

Richard Thaler makes the case for including behavioural science in the curriculum for training civil servants. He points to the initial success of the Behavioral Insights Team set up within the British government to introduce concepts from behavioral science to improving governance outcomes.

Prof Thaler points to two interesting reports brought out by the British Cabinet Office. The first one is a working plan for far-reaching and radical reforms to the British civil service.

1. The report seeks to "transfer power and control away from Whitehall, devolving power as far as possible to those actually using the services at local level".

2. Related to this is a call for the bureaucracy to "transform the delivery of services to its users" or to "become Digital by Default (by end-2012), in its skills, its style, how it communicates and how it enables service users to interact with it".

3. Leverage economies of scale and increase bureaucratic efficiency by the creation of five centres (with all physical infrastructure) for sharing transactional services (i.e. finance, payroll, HR, procurement) among different departments, to be made fully operational by 2014.

4. A prioritized thrust towards sharing of a wide-range of services and expertise - including legal services, internal audit, programme and project management resources and commercial contracting procurement skills - among government departments. It advocates that smaller departments should no longer expect to maintain full freestanding operations in all these functions. The logic for such sharing being that as departments shrink, they will "no longer be able to maintain high quality services in many expert and advisory services (such as policy making, analytical functions, and legal services)" without external support.

5. Encourage open, collaborative policy making and move away from the traditional centralized policy formulation models. Such approaches would include crowdsourcing questions to define the problem and solutions; set up "Policy Labs" to draw external expertise from a range of people and organizations and provide a unique environment to test new policies before they are implemented; creation of cross-departmental teams where Senior Responsible Officers (SROs) report jointly to departments; web-based tools, platforms, and new media to widen access to policy debates to individuals and organisations not normally involved; and making more data available freely so experts can test and challenge our approaches effectively.

6. Prioritizing work in a manner that ensures both administrative and financial resources are focussed on the critically important areas. Policy makers will therefore need to be equipped with skills to identify priorities and map its level of resources requirements. These skills would involve new age areas like behavioral sciences and digital technologies.

7. Designing policy by keeping implementation environments and its challenges in mind.

8. Focus on improving project delivery (in both quality and time) by closely involving the Major Projects Authority (MPA), set up recently to help assist in the design and monitoring of the highest risk and highest value projects. The MPA will analyze and share the progress of projects with departments. The turnover of Senior Responsible Officers (SROs) will be minimized during the project duration.

9. A slew of performance management measures that will seek to incentivize senior officials to constantly improve their skills. There will be accelerated development programs for the high-performers; training for high potential Senior Civil Servants to be sourced on the open market through Civil Service Learning, and conducted alongside high potential individuals in other sectors, especially the private sector.

The second is an excellent report on the role of randomized control trials (RCTs) in designing public policy. It advocates using RCTs to test (by introducing a draft policy intervention on randomly chosen groups), learn (by comparing its impact on the treatment group as opposed to the control group), and adapt (policy intervention to be modified to reflect the findings) policy initiatives before scaled up implementation.

India-China trade fact of the day

For every dollar’s worth of exports to China, India imports three, leading to a trade deficit of up to $40 billion in the year to March 2012, or about 2% of GDP. China accounts for a fifth of India’s overall trade deficit with the world, over half if oil is excluded.
(HT : The Economist)

Saturday, July 7, 2012

Shifting global economic center of gravity

The Economist points to a fascinating graphic from a new study by the McKinsey Global Institute that highlights the rapidly shifting global economic center of gravity. The graphic maps the movements in  this centre of gravity since AD 1 and how it is likely to move until 2025. It claims that the center is rapidly shifting east - at a speed of 140 kilometres a year and thus faster than ever before in human history.




Friday, July 6, 2012

Universal health care map of the world

Nice map in the Atlantic which maps countries with some form of universal health care system. Most of them are through compulsory, but government-subsidized, public insurance plans.












As it writes, the astonishing thing about the map "is how cleanly the green and grey separate the developed nations from the developing". The developed world exception is the United States.

Essentially, there are four models of health care systems. In the Beveridge model, as in the single-payer system of UK, health care is provided and financed by the government through tax payments. Many, but not all, hospitals and clinics are owned by the government; some doctors are government employees, but there are also private doctors who collect their fees from the government. The Bismarck model, adopted by Germany and other continental European countries, uses private service providers and several non-profit insurance funds, and is financed jointly by employers and employees, with means tested premium support for the poor. However, tight government control keeps premiums and service costs under control.

The National Health Insurance nodel of Canada, now embraced by South Korea and Taiwan, has private-sector providers, though payment comes from a government-run insurance program that every citizen pays into. Such single-payer, mandatory, community rated insurance system helps keep costs under control. Finally, there is the out-of-pocket model, where payments are made directly by the patients, based on the service delivered, without any intermediation by the government or insurer. Most developing countries have this model of health care delivery. 

Thursday, July 5, 2012

The changing nature of human deaths

Fascinating graphics from the NEJM (via Wonkblog) that documents the changes in the profile of disease related deaths in the United States since 1900. The first graphic (see the interactive graphic in the website) clearly shows that even as death rates have fallen, heart disease and cancer have come to become the dominant causes of deaths.



















Most impressively, all the most common sources of death, epidemic type diseases - pneumonia, tuberculosis, gastrointestinal infections, etc, have all been completely marginalized. However, this trend has been accompanied by an increase in the numbers of deaths due to lifestyle diseases like heart diseaes and, in particular, due to cancer.


Wednesday, July 4, 2012

Universal Health Insurance in Rwanda

This story of the dramatic transformation of the health care system of Rwanda, a mostly rural country of 8 million, though surely exaggerated, is truly impressive. It carries important lessons to countries like India where political initiative and administrative commitment to do something similar is sorely missing.

Since 2004 Rwanda has been running a community rated universal health insurance system, Mutuelle de Santé,
Mutuelle is a community system - premiums go into a local risk pool and are administered by communities. Until last year, Mutuelle’s premiums were about two dollars a year. This system turned out to be untenable - even two dollars a year was too much for a lot of people... Last year Mutuelle adopted a sliding scale. For the wealthiest, premiums essentially quadrupled, to about $8 a year. Each visit to a clinic has a co-pay of about 33 cents. If you need to go to the hospital, you pay a tenth of your hospital bill. But now the poorest - as judged by their communities - pay nothing. The Health Ministry says that the poorest 25 percent of Rwandans get free care... only 4 percent of Rwandans are uninsured.
This has been credited with dramatically improving Rwanda's health care standards,
AIDS has been cutting life expectancies in Africa and is widespread in Rwanda. Yet life expectancy at birth in Rwanda has increased from 48 to 58 - in the last 10 years. Deaths of children under 5 have dropped by half in five years; malaria deaths have dropped by roughly two-thirds. Of all countries in Africa Rwanda is probably getting the closest to having health for all, health access for all... 

A measure of Mutuelle’s success is a tremendous increase in the use of health care facilities... A clinic visit before was 5,000 francs - about $8.30... 80 percent of people in need of AIDS treatment are getting it - a figure in Africa rivaled only by Botswana, which is 20 times richer than Rwanda. Hospital utilization rates have tripled... Five years ago, when giving birth in a health center cost around $25, only 20 percent of women did so. Now that it is 33 cents, 70 percent do - a big reason that deaths of mothers and children have dropped so precipitously. Malaria - a major killer of children - is also now treated... Today, malaria is usually diagnosed by a community health worker. She can give the first dose of an effective medicine right away, then send the patient to a health clinic for a visit that will cost a maximum of 33 cents.
And it has had a salutary effect on the health care system itself,
Now there is a well-functioning national network of thousands of community health workers at the village level. There are hundreds of clinics, all with basic equipment and a full cupboard of essential medicines. Each of Rwanda’s 30 districts has a hospital, with at minimum 15 doctors, offering basic surgical services...
The increase in clients and the payments from Mutuelle they bring has transformed hospitals. Without income, hospitals couldn’t pay doctors or buy equipment. Now that hospitals can pay, doctors and nurses are moving from cities to the countryside. Before there was a marked concentration in cities... Now there’s equitable distribution across the nation...

It gives relief to people knowing that if you get sick, you don’t need to have a lot of money... It gives you psychological stability so you can concentrate on something else. The money can be used for other things - this is very important in trying to stimulate economic development.
The biggest challenge for Mutuelle is its financial sustainability since even with the cross-subsidy, premiums cover only about 45 percent of costs. The rest of the money is from the government and international donors. Given the low income levels, it is inevitable that a significant share of the cost of financing Muuelle will have to be borne by the government.

There are few important issues not raised in Tina Rosenberg's report that Rwanda will soo have to confront (or is already confronting). One, as access increases and offtake rises, public health care systems will become stretched out. There will come a stage when public systems will be unable to meet the requirements on its own, without being supplemented by the private sector. Once private sector enters the picture the current capitation based health insurance model will have to undergo radical changes. Managing this transition will be critical.

Two, as this system stabilizes and basic health care services are taken care of, there will be increasing demand for more advanced specialist services. But even with private sector support, the supply-side gaps for such care will not be easily bridged. Further, additions of more specialist services will also add to the financial burden on the government.

Three, even with all the user charges, hospitals will have adequate resources to incentivize only a handful of doctors to move to rural areas. In countries like India, which have much greater depth of medical personnel and governments offer relatively attractive terms of service, attracting even basic doctors, leave alone specialists, to work in rural areas has proven to be insurmountable. In fact, this rural-urban divide will widen with the growth of the private sector.

These, and a few others, are complex challenges, for which there are no easy answers. Rwanda will have to face them and innovate with local solutions to overcome them and sustain its universal health insurance system.  

Tuesday, July 3, 2012

A sustainable currency union has to embrace some form of political union

The debate surrounding the future of Eurozone, especially how it should redesign its institutions to prevent the recurrence of such crises, is essentially one about what are the pre-requisites for a currency union.

In the context of the ongoing crisis in Eurozone, I have blogged about optimal currency areas and how countries like India manage a single currency zone. In both cases, it is amply clear that some form of fiscal transfers are critical to manage asymmetric shocks faced by members. Such shocks are inevitable when members start out from different economic backgrounds and exhibit considerable heterogenity in their social and political systems. In simple terms, the loss of flexibility with monetary and exchange rate policies that accompanies any currency union will have to be traded off with a mixture of free labour market mobility and fiscal integration. See this brilliant description by Paul Krugman.

The Economist has an excellent graphic of federal fiscal transfers among the 50 American states that puts this in perspective. Would be interesting to have a similar graphic for India!


















Derek Thompson in The Atlantic contrasts the difference between US and the Eurozone,
The poorest states like Mississippi, New Mexico, and West Virginia rely on enormous transfers of federal taxes in the form of unemployment benefits and Medicaid. Like the United States, the euro zone is all on one currency. Unlike the United States, the euro zone collects a teensy share of total taxes at the EU level and has no legacy of permanent fiscal transfers from the richer countries, like Germany, to the poorer countries, like Greece.
As Krugman writes, in addition to fiscal transfers and labor mobility, a currency union should also embrace banking union (a single banking regulator and area-wide deposit insurance) and monetary union (mitigate liquidity risk by the creation of a single currency-zone wide lender of last resort). His assessment of Eurozone as a currency union is spot on,
Members of a currency area, it turns out, should have high integration of bank guarantees and a system of lender of last resort provisions for governments as well as the traditional Mundell criterion of high labor mobility and the Kenen criterion of fiscal integration. The euro area has none of these.
Whatever its denouement, as the Eurozone lurches from one crisis to another, there is increasing realization that some form of banking, monetary and fiscal union is inevitable. The latest Eurozone leaders summit saw the first step in a banking union with agreement to replace the 17 national banking regulators with a Eurozone-wide single banking supervisor under the control of the ECB.

This first step to a banking union will be followed by the EU bailout funds being injected directly into Spanish banks (to recapitalize them) instead of the current practice of being routed through the Spanish government's balance sheet. This means Spain can remove the burden of bailouts off its sovereign books. Further, instead of being subjected to Greek-style austerity programmes, these countries will have to maintain their EU debt and deficit commitments, though EU authorities could mandate tighter deadlines and timetables. The bailout funds will also be able to directly buy sovereign bonds in the market and loans from rescue funds would not be senior to existing loans. All this is likely to be followed by the slow introduction of the other elements of a banking union like a Eurozone wide deposit insurance.

If the Eurozone comes out of the current crisis in one piece, or at worst minus Greece, then we can say with some certainty that it would have advanced more down the path of a political union than would have been possible through negotiations and deal-making during the normal times. Historians of European integration will then take the name of Angela Merkel in the same breath as that of Robert Schuman and Jean Monnet. But that's going far ahead in time!

Monday, July 2, 2012

The end of commodities super-cycle?

The sharp decline in oil prices in recent weeks - amidst talk of slowdown in emerging economies, including China, to add to the Eurozone crisis and America's economic weakness - has triggered a debate as to whether the sustained rally in oil prices is nearing its end. More importantly, given the similar downward trend with other commodity prices, is this the end of the commodities supercycle?

The commodities supercycle is premised on the belief that "the rise of emerging markets led by China would continue to drive up prices for oil and other commodities, from copper to corn". It has, over the past decade, spectacularly boosted the fortunes of many commodities producing economies. This quote from the Governor of Reserve Bank of Australia, Glenn Stevens nicely illustrates the magnitude of the supercycle,
Five years ago, a ship load of iron ore was worth about the same as about 2,200 flatscreen television sets. Today it is worth roughly 22,000 flatscreen television sets.
Ruchir Sharma feels that the latest round of commodities supercycle is merely following the 200 year long trend in commodity prices - one decade up, followed by two decades down. Now with the decade of rise over, the long period of decline is round the corner. This, he argues, is likely to boost the mainly western commodity importing economies, and result in capital allocation to more productive industries. He points to certain interesting features of this supercycle,   
At the height of the dotcom bubble, tech stocks comprised 25 per cent of global markets. After the bust, commodity stocks – energy and materials – rose to replace tech stocks and, by the end of the last decade, accounted for 25 per cent of global markets too... The total invested in commodity funds has more than doubled over the past five years to more than $400bn in 2011. The daily volume of trades in energy futures is now a staggering 25 times higher than daily global demand for energy...

The dotcom billionaires were truly creative people, many of whom are still advancing the tech revolution. Today’s billionaires make money by digging stuff out of the ground. In 2001, the world had 29 billionaires in the energy industry, 75 in tech; by 2011, the numbers had reversed, with 36 in tech and 91 in energy, mostly in oil. These tycoons contribute only in so far as they inspire competitors to devise alternatives to oil.
The spectacular rise of Australian iron ore mining heiress, Gina Rinehart, to the position of the richest woman in the world mirrors the fortunes of Australia in particular and the commodities supercycle in general.

A recently released study of commodity prices changes since 1865 by Bilge Erten and José Antonio Ocampo (via FT) claims that the remarkable strength and length of this upswing in commodity prices reflect the extraordinary resilience of growth performance of major developing countries, particularly China.

The graphic below puts the current supercycle in perspective. In the top section, the figure displays the natural logarithm of the real total non-oil commodity price and the long-term trend superimposed on it. The real commodity prices trended very slightly upwards from 1865 to the mid 1910s, trended downward until late 1990s, and then trended upward through the end of the sample.






















The authors analyse their graphic,
The non-trend component representing the difference between the actual series and the long-run trend is shown in the bottom half. The left scaling in logarithms shows that a value of 0.40 indicates a 40 percent deviation from the long-term trend. The cyclical fluctuations illustrated by the non-trend component... contain shorter-term as well as the super-cycles, which are not always symmetrical. The latter are estimated to be in the 30-40 year range. The super-cycle component... reveals three and a half long-term cycles in real commodity prices since the late nineteenth century. 

The first long cycle begins in late 1890s, peaks around World War I, and ends around 1930s, and shows strong upward and downward phases. The second takes off in 1930s, peaks during the post-war reconstruction of Europe, and fades away in mid 1960s. It shows a strong upward phase but a weak downward one. The early 1970s marks the beginning of third cycle, which peaks around early 1970s and turns downward during mid 1970s and ends in late 1990s. This cycle shows a weak upward phase and a strong downward one. The post-2000 episode is the beginning of the latest cycle, which has shown a strong upward phase which does not seem to have been exhausted so far.

The degree to which the total non-trend component deviates from the super-cycle component shows the significance of other shorter cycles induced by business cycle conditions and medium-term factors. These shorter fluctuations appear to be strikingly large, particularly in the interwar period of the twentieth century. This implies that periods of high volatility resulting from business cycles often accompany the long-term trend and super-cycle in real commodity prices. The presence of shorter-term high volatility further brings large price risks for those involved in the investment decisions that may be long-term in nature.
A cursory analysis of the graphic appears to indicate that the non-oil commodities supercycle is now primed to start winding down. Incidentally, its amplitude in the latest cycle, since the nineties, has been bigger than in earlier periods. A comparison with the supercycles in crude oil prices reveals that its supercycles have gotten far bigger in the recent cycle compared to those in earlier cycles. Further, in sharp contrast to the non-oil prices, the real oil prices have been rising sharply since the seventies.





















Given these trends, it may not be unwise to argue that the supercycle in both crude and non-oil commodities are set to wind down in the years ahead. Slower growth in China - which formed almost three-fourth of the consumption growth in iron ore, coal and copper - adds credence to this arguement. In fact, as the FT recently reported, the FTSE All-World mining index has already dropped 31.8 per cent from its peak in April 2011. It will be interesting to see the pace and trends associated with this easing of the supercycle.