Wednesday, July 31, 2013

The importance of state capability

I have an op-ed in Indian Express today that talks about the importance of state capability in development. I think this should be the most important structural reform that India requires. 

The mid-day meals tragedy

I have an oped in Mint today that draws attention to the how the mid-day meals tragedy is representative of a low level equilibrium in public systems. 

There are numerous similar examples of systems entrapped in such negative equilibriums. Similarly inadequate allocation of resources for food and maintenance, encourages hostel wardens in government welfare hostels and residential schools to manipulate attendance figures. The meagre budgetary allocation for public offices, from that of Tahsildar to the Station House Officer, makes them rely on local interests to manage logistics. These resource gaps provide a fig leaf for officials to make money and sustain a rent-seeking chain. Furthermore, since violation of rules and culpability varies only in shades of grey, enforcement becomes very tricky.

Update 1 (25/08/2013)

So the Parliamentary Committee on Empowerment of Women now finds the mid-day meal allocation unrealistic

Tuesday, July 30, 2013

Africa fact of the day

Africa hosts 30% of the world’s total hydrocarbons and mineral reserves. It holds 12% of the world’s crude oil reserves, 42% of the world’s bauxite, 38% of uranium, 42% gold, 88% of diamonds, 44% of chromite, 82% of manganese, 95% vanadium, 55% of cobalt and 73% platinum.
This and more, especially the trend towards development of "resource corridors" (instead of projects that are confined to mineral exploitation) that develop infrastructure as well as domestic and regional markets for Africa's oil and mineral resources on PPP basis, from Beyondbrics here.  

Saturday, July 27, 2013

Why an exclusive focus on economic growth is misplaced?

The biggest criticism of the current government in New Delhi has been that its excessive focus on redistribution programs has skewed governance priorities. It is argued that these programs have taken away from other more important growth creating and growth sustaining interventions like structural reforms (the second generation of reforms) and investments in infrastructure. Further, the large fiscal burden imposed by these subsidies has distorted incentives and engendered macroeconomic problems which have been a drag on the country's economic growth.

If we follow the mainstream critiques of the government, one cannot but not get the impression that it has taken the form of an aversion to all forms of growth redistribution. Accordingly, in this narrative a "subsidy" to a poor person is virtually a four letter word. An important argument of people like Jagdish Bhagwati is that India should initially focus just on raising growth, through structural reforms and liberalization, and then use the increased revenues to both expand its welfare state and re-distribute. If this ideology were to assume power, we would experience a drift to the other extreme with excessive focus on growth creation and a marginalization of growth redistribution policies. I believe that this would be as detrimental to long-term growth as the current skewed focus on growth redistribution.    

It is perplexing as to why this should be so difficult to understand. It has been widely accepted, and has also been borne out by India's experience over the last 15 years, that economic growth does not automatically create the conditions, capacity, and resources for sustained poverty reduction as well as further growth. This is because economic growth happens when markets expand - more people demanding goods and services attracts investments, raises production, creates jobs, increases purchasing power, creates demand for more and newer goods and services, and so on. 

The critical factor is "more people demanding goods". In other words, the base of the "demand pyramid" has to become as broad as possible, eventually encompassing all the citizens of the country. But more people can enter the market only if they are equipped with the human capital resources to access the opportunities that arise once economic growth picks up. In case of all successful growth stories, including East Asia, governments have laid this platform by making large and effective investments in human capital formation. They have generally been in the form of investments in education, health care, nutrition, and skill development.  

It is of course possible that in a continental economy like India, high growth rates can be sustained for some time by a much narrower pyramid, in relation to its potential size. Further, an initial spurt of pent-up demand, locked-up entrepreneurial energies, and readily available capital will help generate high growth rates and achieve some poverty reduction for some time. Furthermore, this initial phase of growth can be used to build up the capacity to provide a massive thrust on human capital formation. 

But neither does the access to opportunities for human capital formation nor the capacity of the state to provide the required thrust for improvements in human capital formation automatically follow from economic growth. It is here that Jagdish Bhagwati and Arvind Panagariya's argument about sequencing priorities fail. This assumes even greater significance in case of India since we carry a legacy of extremely poor performance on the human capital formation side. A weak state, misplaced policy priorities, and historical legacies, have come in the way of development of our human capital base. Despite the latest exultation on poverty reduction, an overwhelming majority of our citizens are even today not equipped with the basic skills and resources to access the opportunities in a competitive market place. 

In fact, it is possible that the dynamics of initial growth spurt created conditions that worked against the desired trends that economists like Bhagwati have taken for granted. There is growing evidence to argue that except for the small knowledge-based services sector, India's spectacular economic growth spurt of the past 15 years has been exclusionary and also been underpinned by a crony capitalism that may have even weakened the state's already feeble capacity to create the conditions for sustained economic growth. In any case, its sustainability is already in question.  

So the obvious answer is to acknowledge the importance of addressing the challenge of human capital improvements, without seeing it as a trade-off with economic growth. Economic growth is built on the size and quality of human capital. This does not of course mean that we should go the other way, as Amartya Sen and Co appear to suggest, and should spend time improving human capital before we focus on economic growth creating policies. But it should undoubtedly be a matter of great concern that this issue does not get anything remotely close to the attention that growth creation policies get in mainstream discussions in India. 

There is another argument for being cautious against an exclusively growth creating focus. In a large country like India structural transformations are most certain to be long-drawn, destabilizing, and politically difficult. A generous social safety, which seeks to provide a basic dignified human existence, is desirable not only on moral considerations, but even more importantly on economic and political grounds. Economically, it would be the necessary first step to equip these people with the requisite human capital to compete in the market place. It would provide the political space to push through the difficult structural reforms. 

We need to seriously debate this social safety net. Who should be its beneficiaries? What should be its components? What should be the design of each component, so that incentives are aligned towards minimizing distortions and achieving the objective? What should be the exit protocol from this safety net? What should be the most effective channel for its delivery? How much resources are we able to spend on it? What should be the role of the private sector in this endeavor? 

One gets the impression that critics of the government suffer from representativeness bias. They appear to conflate the idea of a growth model that simultaneously focuses on human capital formation, establishment of a social safety net, and growth creating policies with those being pursued by the present government. This narrative sub-ordinates everything to economic growth and policies that are perceived as directly contributing to economic growth. Its occasional concern with distributional issues and sustainability of growth is confined to simplistic advocacy like replacing the PDS with cash transfers and increasing private participation in the delivery of health and education services.

The clearest proof of this comes from their diagnosis of the current weakness with the Indian economy. They blame the weakness on inadequate liberalization of foreign investment norms, lack of labor market reforms, still-born financial market liberalization, insufficient domestic tax reforms, deficient investments in physical infrastructure, and pervasive corruption. Investments in human capital formation and building state capacity to improve it are rarely discussed with anything like the passion associated with the former. Policies to establish a comprehensive social safety net has received even less attention.

In other words, a development model that focuses exclusively on economic growth creating policies, without much concern for enabling the availability of conditions for a broad-based and therefore sustainable economic growth, has come to dominate the mainstream media. If Amartya Sen's provocative push in the other direction, irrespective of its extremism, contributes towards re-balancing the agenda, he would have done more, albeit unwittingly, to the long-term future of Indian economy than any other intellectual.

Update 1 (27.07.2013)

This is a classic example of what I mean by mainstream discussion. One gets the impression that liberalization of FDI norms, infrastructure investments, and policies to make India more externally competitive are enough to overcome the "looming crisis". 

Friday, July 26, 2013

Thoughts on the Sen Vs Bhagwati debate

I have read neither of the two books that have been generating a very acrimonious ego battle among a few reputed economists. The mainstream media in India have given their own interpretations - right Vs left, state Vs free-markets, Modi Vs Gandhi, meritocracy Vs entitlements, Gujrat Vs Kerala, and so on. They also appear to have clearly come down on the side of Bhagwati and Panagariya, with some of the commentators accusing Amartya Sen of being responsible for India's current economic problems. Some of its has been plain pamphleteering. This is surprising since, stripped off all their respective ideological and political rhetoric, Sen and Dreze are drawing attention to a very important dimension of India's growth.

That economic growth is necessary to reduce poverty is a settled debate. There is nothing new about their argument that economic growth is important to directly reducing poverty and to raising the revenue required to make investments in public goods. Surely Bhagwati and Panagariya are not selling their book on this wisdom. So what has obviously caught the attention of the Indian media has been their personal preferences - an unambiguous excoriation of the "rights-based" approach to development embraced by the current government in Delhi and an endorsement of the "Gujarat model" of governance. Both have played that tune in their media pronouncements.

Sen and Dreze have questioned the quality of India's recent growth, arguing that it is not sufficiently broad-based and therefore not sustainable. More importantly, they have argued that this growth has not been accompanied by sufficient improvements in health and education, which are critical to the sustainability of future growth. They have sought to draw attention to the Indian state's poor record on delivery of essential public services, "a failing that depresses living standards and is a persistent drag on growth". These are important observations, though not completely new. However, like Bhagwati and Panagariya, Sen has voiced his preference for a "rights-based" approach, even claiming that a failure to pass the Food Security Bill will leave millions of children vulnerable.

Now on purely economic merits, and I suppose that should form the touchstone for judging the views of two sets of economists, Sen and Dreze clearly make the more relevant point. It surprise me that this should be a matter of debate. The uneven distribution of benefits and the failure to make much progress with health and educational standards threatens the sustainability of India's long-term economic growth, more than the excesses of a political economy fiscal cycle. Nobody, not event the extreme leftists, would dispute Bhagwati and Panagariya's argument on the importance of economic growth in reducing poverty.  

There is no disputing the fact that the gains from India's spectacular economic growth of the past two decades have been extremely unevenly shared. The distribution of gains have been far more skewed than with most other similar countries. India's human development indicators have doubtless improved with growth, faster than before the economy liberalized, but have improved slower than the progress made by poorer countries. So much so that India today stands out alone among Asian countries in social indicators, and does worse than even most sub-Saharan African countries. Worse still, this growth dynamics now threatens growth itself. So the argument that economic growth has reduced poverty and improved human development indicators, though at a slower pace than required, does not wash, since that slow pace is now self-destructing.

On political and ideological fronts, both sides stand on weak grounds. Sen has clearly allowed himself to be manipulated by an extremist view of governance priorities. Some of his pronouncements do no good to an economist of his repute. Bhagwati and Panagariya have waded, for reasons best known to them, into a heated ongoing election debate in India. Two competing political ideologies, with several shades of grey in their economic views, have been conflated into left and right by mainstream debates, and these two economists have clearly taken one side. And they are entitled to, but purely as a personal preference, just as is the case with Sen.

One can by no means argue that one side of the political divide is superior to another for India as a country, though they may be favorable to some group or the other. In fact, I would argue that, for the country as a whole, both sides to the political debate are deeply flawed. In any case, that is a matter which will be decided in mid-2014.

I would have thought that this was a great opportunity to elevate the debate into discussing the second-order issues of growth, those flagged off by Sen and Dreze and others. No, this does not mean that Sen and Dreze have got the prescriptions right. In fact, I believe that they have got it wrong, though in the opposite direction to Bhagwati and Panagariya.

But that does not in any way take away from the importance of their central argument. An economy whose growth has not been built on broad-based human capital improvements and whose growth dynamics appears to do little to promote human capital improvements is surely in serious trouble. And Bhagwati and Panagariya have little of relevance to say about this.

It is not about economic growth stupid, but its quality! And that requires exploring issues like quality of school education, improving health care systems, making the vocational education system responsive to market signals, and improving the capability of the state itself. In fact, most serious economists would argue that significant improvements in the quality of human capital investments and a large (given the size of the country), but targeted, social safety net are essential for the sustainability of India's economic growth. The debate should be about its design, instead of battling the flawed personal preferences of two sets of economists.

Wednesday, July 24, 2013

Government Sachs and the art of price rigging

Excellent investigation by the Times on how Goldman Sachs, through its ownership of metal warehousing owner Metro International, rigs the Aluminium spot market prices. In brief,
Before Goldman bought Metro International three years ago, warehouse customers used to wait an average of six weeks for their purchases to be located, retrieved by forklift and delivered to factories. But now that Goldman owns the company, the wait has grown more than 20-fold — to more than 16 months, according to industry records. Longer waits might be written off as an aggravation, but they also make aluminum more expensive nearly everywhere in the country because of the arcane formula used to determine the cost of the metal on the spot market...
Metro International holds nearly 1.5 million tons of aluminum in its Detroit facilities, but industry rules require that all that metal cannot simply sit in a warehouse forever. At least 3,000 tons of that metal must be moved out each day. But nearly all of the metal that Metro moves is not delivered to customers, according to the interviews. Instead, it is shuttled from one warehouse to another.
Because Metro International charges rent each day for the stored metal, the long queues caused by shifting aluminum among its facilities means larger profits for Goldman. And because storage cost is a major component of the “premium” added to the price of all aluminum sold on the spot market, the delays mean higher prices for nearly everyone, even though most of the metal never passes through one of Goldman’s warehouses.
Aluminum industry analysts say that the lengthy delays at Metro International since Goldman took over are a major reason the premium on all aluminum sold in the spot market has doubled since 2010. The result is an additional cost of about $2 for the 35 pounds of aluminum used to manufacture 1,000 beverage cans, investment analysts say, and about $12 for the 200 pounds of aluminum in the average American-made car.
Here is a firm that advises its clients to buy securities, even as its analysts value them of doubtful quality, and its proprietary trading desk shorts the very same securities. It manages to convince gullible firms to hire it as an IPO advisor, prices the IPO cheap and gifts its preferred institutional investors and high value clients some easy money, and all this at the unsuspecting firm's expense and for a fee! At a global level it even offers its services to help a country hide the true extent of its indebtedness by constructing a web of shells and transactions. 

It is alleged to have influenced the decision-making process (and the decision-maker himself personally) at the peak of the sub-prime crisis, by extracting several suspiciously favorable decisions, which helped it survive the crisis. They include a costly bailout of insurance giant AIG, whose CDS insured Goldman's investments in risky CDO securities, which transferred $13 bn of tax payer cash to shore up a liquidity strapped Goldman, among others. Its CEO goes on to become arguably the most important actor in the global financial markets, apart from determining the financial policy of the world's largest economy. Now comes this blatant case of the simplest market manipulation, price rigging. And nobody has gone to jail for any of these "transgressions", and looks likely too!
Not only does it get away with all this, it also becomes one of the biggest beneficiary from the global financial crisis. Two of its biggest long-time rivals, Bear Stearns and Lehman Brothers, are eliminated, not to speak of hundreds of smaller ones, and many others weakened, including its leading competitors like Citibank, leaving Goldman with even greater concentration of market power. It was allowed to covert from an investment bank to a bank holding company, thereby giving it access to both the cheap liquidity window of the Fed if it was credit stressed as well as the FDIC deposit insurance guarantee. The half a decade of extra-ordinary monetary accommodation has enabled a handful of big banks like Goldman to access plentiful cheap capital to leverage up their trading strategies. Finally, these same banks have become systemically riskier and therefore even more too-big-to-fail, thereby enjoying an implicit subsidy that enables it to access capital at cheaper rates than otherwise.

Update 1 (11/9/2014)

Barry Ritholtz points to the failure of state and federal prosecutors in the US to press criminal charges and indict bankers accused of various financial market fraud - expediting foreclosures by fabricating documents, market manipulation through price rigging in commodities market and interest rate fixing, fraudulent mortgage origination/underwriting, manipulating derivatives market by blocking information flows and growth of exchange trading, money laundering, cooking books thereby committing accounting fraud, etc. In this context, he highlights the bankers ability to prevent indictment by entering into financial settlements with prosecutors. Since the fines, however large, gets paid out of the shareholders capital and does not pinch the managers, there is limited incentive to avoid such payments. In other words, shareholders bailout the bankers from being prosecuted for their criminal actions. 

Monday, July 22, 2013

China fact of the day

FT writes about the symbiosis between wealth and power in China,
A Bloomberg study showed that the 70 richest members of the National People's Congress, the national legislature, have a combined wealth of about $90 bn, compared with a combined wealth of about $7.5 bn for the 535 members of the US Congress, the President, his Cabinet, and the Supreme Court. Corruption scandals involving NPC officials erupt with regularity. 
Pranab Bardhan points to an even more staggering disparity in the wealth of Chinese and Indian politicians,
The Hurun Report, a Shanghai-based wealth monitor, estimated last year that the 83 richest delegates to the National People’s Congress and an advisory group, the Chinese People’s Political Consultative Conference, had a net worth of over $250 billion. By comparison, the declared assets of all of the roughly 545 members of the Lok Sabha, the lower house of India’s Parliament, amount to only about $2 billion. 
We really are looking at "epic corruption" in a "crony capitalist Gilded Age" for China!

Sunday, July 21, 2013

Low level equilibrium in mid-day meals program

The tragedy at Chhapra in Bihar that claimed the lives of 27 children from consumption of poisoned mid-day meals, apart from being an example of administrative failure, is a great opportunity to focus attention on the low-level equilibrium that public systems are entrapped in. I have blogged earlier about other instances of public systems caught in low-level equilibrium.

Consider the facts. The Mid day meal (MDM) program covers 120 million children in nearly 1.3 million schools and early childhood centers across the country. The government provides rice from the PDS and cash to cover the cost of other materials, including fuel. The Government of India (GoI) allocates 100 gms and 150 gms of rice for each primary and upper primary school child respectively. In addition, Rs 3.11 and Rs 4.65 per child is provided (being shared in the 75:25 ratio between GoI and state) to cover the cost of pulses, vegetables, oils, salt, condiments, and fuel.It has recently been raised to Rs 4.25 and Rs 5 respectively. The rice is drawn from PDS and the other items purchased locally. Some states supply pulses, oil, and even fuel (LPG cylinders) through the PDS fair price shop, while vegetables and ingredients are purchased locally. Each school has a kitchen shed and a cook-cum-helper for a school with upto 25 children, who is paid Rs 1000 per month (raised to Rs 1500 recently). For every 100 students, an additional helper is provided.

The program mandates that children of upper primary schools be provided 30 gms of pulses, 75 gms of vegetables, and 7.5 gms of oil. Even with the cheapest wholesale purchase of materials, it is impossible to provide MDM to these standards, anywhere in the country, even when done in massive scale.  In addition the cost of transportation of materials, including for local purchases, is inadequate and rarely provided for. At a time when NREGS provides Rs 100-150 per day, it is very difficult to get people to work for even the increased amount of Rs 1500. The numerous other incidental expenses that come with managing such programs, especially in larger schools, have to be covered from the differential recovered by excess reporting. Not to speak of the problems associated with safe storage of provisions, water supply, and so on, all of which are sorely deficient in most schools across.

It is therefore obvious that it is not possible to deliver MDMs to the required standards with the prevailing allocation. The total unit cost of delivering mid-day meals of even barely acceptable quality is higher that that being allocated by the government. And it has been so for many years. The program though continues without much apparent discomfort, except for the occasional tragedies like the recent one. This equilibrium is underpinned by a rent-seeking chain which keeps all the major stakeholders satisfied.

Central to this is the manipulation of daily attendance reported from each school. Since the school claims MDM reimbursement based on the daily attendance, the incentives are aligned towards boosting attendance reports. It is therefore no surprise that school headmasters mis-report attendance figures extensively. They either show excess enrollment and/or report enrollment as attendance. It is common practice for schools to show the enrollment figure itself as the attendance for all the days of a school year.

The differential between the amount (and rice and other provisions) claimed (based on enrollment) and the actual attendance is used to cover the additional cost incurred as well as grease the palms of people all along the rent-seeking chain. The scale of evasion varies across schools. But, given the inadequate allocation, most schools indulge in some form of evasion. The governments, both at state and center, with limited fiscal space to provide additional resources, prefer to let things lie.

Permissive supervision maintains the equilibrium. It not only prevents school head masters and unions from revolting, but even keeps them happy. Such accounting manipulation inevitably attracts the interests of local political leaders and supervisory officials all along the state education bureaucracy.

Since more or less everyone indulges in some form of evasion, it becomes virtually impossible to effectively enforce the MDM rules. Occasionally when some enthusiastic supervisory official or district collector cracks the whip with effective enforcement, all these issues come out into the open. Unions and head masters will protest demanding reimbursement that covers the true cost of actually providing mid-day meals. But reimbursement to cover the true cost of providing MDM is a matter with nationwide implications. So after a few days things settle down back to business as usual. This gets repeated ad-nauseum across the country.

Even the honest and committed school administrators fall prey to this, left with no choice but to condone the practice of manipulating attendance figures so as to make ends meet. There are of course a handful of exceptional schools, where teachers have been resourceful and lucky enough to manage voluntary contributions from local people and elsewhere, and manage the program within the allocated budget. But that is no way to run a program for 120 million children.

Given the numbers of schools involved, their geographical spread, and the deficient (numerous vacancies) and over-burdened bureaucracy, effective monitoring of daily attendance is an extremely difficult task. Though there have been several initiatives to accurately capture attendance across the country, several last mile gaps have been deterrents to their effectiveness. Efforts to involve local Self Help Groups (SHGs) in managing the program and social audits of its implementation, while undoubtedly desirable, cannot gloss over fundamental inadequacies. Unless they are resolved, more children will continue to pay with their lives.

Saturday, July 20, 2013

The lack of indignation with "in-kind" bribes

Reuters reports that Chinese authorities have found evidence of GlaxoSmithKline channeling bribes to doctors and officials through travel agencies to boost sales illegally as well as raise the price of its medicines sold in China. Apparently, GSK created fake "conference services" as expenditure and funneled the bribes through travel agencies to officials and doctors.

This should not come as any surprise since I would imagine that such in-kind "bribes" are widespread across the world, in politics and corporate and public bureacuracies, especially at higher levels. What should be a matter of indignation is why such rent-seeking is treated with great indulgence. In fact, at the higher levels of the establishment, especially in many developing countries, the typical crude way of bribing directly by cash payments is increasingly giving way to more polished forms of "in-kind" bribes.

Staying with travel, there have been numerous exposures from across the world of public officials (both politicians and bureaucrats) rewarded with expensive foreign holiday expeditions in return for official favors. Other common place forms of compensating illegal favors include financing children's education abroad, gifting with expensive jewelries and paintings, or furnishing a house. A more sophisticated form, prevalent in many developed countries, is the practice of rewarding public officials with gold-plated speaking or consulting assignments when they leave office. This is just an illustration of the fact that such compensation can come in many forms.

In-kind bribes may also be less personally and socially stigmatizing, both for the bribe-giver and the bribe-taker. We all know that gifting a public official with a pen or a diary, however expensive, is considered acceptable, whereas paying him an equivalent amount in cheque is a social taboo. Much the same personal attitudes prevail in both cases. But this is a slippery slope. If pens today, why not paintings tomorrow, or even a holiday? And then, an expensive piece of real estate or a revolving-door appointment? And finally money itself? Once the psychological Chinese walls have fallen apart, there is nothing that comes in the way of slipping down the slope.  

It should be a matter of concern that even as rent-seeking activities take more sophisticated forms, we are stuck with fighting traditional cash bribery, leaving such corruption to proceed unrestrained, both at a social and personal level.

Thursday, July 18, 2013

More on the health care market failures

A number of stories in recent days about the distorted US health care market. Zero Hedge has a graphic that shows how the price of appendectomy varies within America and between countries. The most striking figure being the more than four times lower price across the border in Canada.

Last month, the NYT had a big story that explored the distortions in the market for routine cancer screening colonoscopy procedures. It varied widely, even within cities. In most, if not all, other developed countries, a basic colonoscopy cost just a few hundred dollars, certainly within $1000. It also finds that the emergence in 1980s of outpatient surgical centers, ostensibly intended to cut down on long hospital stays, has, on the contrary, ended up boosting prices further. 

Appendectomy and Colonoscopy are not isolated examples. Much the same trend is evident with Angiograms, hip-replacements, and other scans.

Further, as a new report by Commonwealth Fund explores health care costs in 13 developed countries, finds that though the US spends far more on health care than any other country, its outcomes are no better than far less expensive systems. In fact, in terms of outcomes, the performance of US has been falling relative to its OECD peers. It attributes the higher spending on higher prices, more readily accessible technology, and greater obesity. It also finds that Japan, which has the cheapest health care system, achieves similar outcomes through aggressive price regulation. 

In fact, a recent NBER working paper (pdf here) finds that productivity dispersion among hospitals in the US is lower than in manufacturing industries, thereby questioning the argument that price variations are determined by wide variations in the quality of care. Drug prices and physician fees also higher in the US, though not by the same magnitude. 
Drug Prices and Physician Fees in Select OECD Countries
A recent Times report has a nice graphic which shows that rising prices, and not greater use, is the driving force. Its report focuses attention on the market power exercised by service providers. Since health care markets are highly localized, it is vulnerable to excessive market concentration. You generally do not have too many providers in the same region offering similar quality services for the same medical condition. The report argues that the wave of hospital chain mergers since the mid-1990s has increased market concentration. It reports that market concentration raises hospital prices, lowers quality and innovation, and increases the number of uninsured in the vicinity. 

Health care in the US is a clear example of a market failure. Its reasons are not difficult to fathom. The incentives of all major stakeholders - patients, care providers, doctors, insurers, and employers - are not aligned towards containing prices. Insured patients have little incentive to bargain for lower costs. In any case, patients do not see prices till service is provided, if they see them at all, and they have limited choice in both the treatment options (you take the treatment the doctor prescribes) and the treatment location. Doctors seek to automate the process of diagnosis so as to minimize their clinical judgement and thereby limit the risk of being exposed to the ever present danger of patient litigation. The aggressive marketing of sophisticated latest tests and procedures, and the shadow of peer (and patient - Katie Couric effect) pressure, makes them prefer those tests and procedures, even when exorbitantly expensive and of limited known marginal value. Insurers can pass on the higher prices to consumers (or employers, in case of employer sponsored insurance) by way of increased premiums. Employers, in turn, pass on the higher premiums by muting the pay rises of employees. Faced with high cost of equipments used in the latest diagnostic tests and procedures, preferred by doctors, care providers are inclined to raise prices so as to recover their investments as quickly as possible. Those worst affected, the uninsured, are classic price takers - too voiceless to be of any influence in the price determination process. 

The only way to address this vicious loop of market failures is effective external regulation. And that is what the better performing health care systems in continental Europe, Japan, Taiwan, Thailand, and so on, have done, and have the results to show. In those countries too, the dynamics of market forces, arising from the aforementioned incentive incompatibilities, may result in higher prices unless the regulators stay one step ahead.

Update 1 (24/8/2013)

Excellent article by Ezra Klein making the case for why young people benefit from Obamacare. Essentially, as he writes, the ACA does not affect those currently covered by employer-sponsored insurance programs or those under Medicare and Medicaid. Its target is the 8% or so of Americans who are expected to benefit from the nongroup health insurance through Obamacare's new marketplaces.

Update 2 (10/6/2014)
Matt Yglesias points to four reforms that can transform US health care - liberalize immigrant doctors flows, curtail pharmaceutical monopolies (replace patents with tax-payer finance prizes), let non-doctors treat patients (nurse practitioners and dental hygienists can do many things in place of doctors), and move over to all-payer rate setting system (Maryland and many European countries a Government Commission negotiates with hospital groups and sets prices instead of each insurer doing separately).

Update 3(10/6/2014)
The NYT has a good interactive graphic of the price variations for 100 commonest treatments and procedures from 3300 hospitals across the US for 2012. It points to wide variations between the price charged by hospitals on uninsured patients for various medical conditions and the price paid by Medicare. The list price charged by the hospitals is a measure of the price paid by the uninsured, those with deductibles. It also gives a measure of how much private insurers will have to negotiate. 

Wednesday, July 17, 2013

Fundamentals or market expectations - the challenges facing the rupee

It's been sometime since I blogged on the Indian economy. But the current travails of the rupee is a teachable moment. Following the trends, one cannot but get the impression that the fundamentals of the Indian economy, while doubtless a matter of great concern and showing little signs of any sustained improvement, may not be the trigger or even the most important reason for the current decline in rupee. However, sustainably addressing the medium-term fortunes of rupee will depend on resolving the fundamental problems facing the economy.

On the immediate problem, Jahangir Aziz hits the nail on the head when he writes,
It has been ridiculously cheap over the last month to borrow rupees at the overnight rate, buy dollars and then wait for the exchange rate to crumble. In June, the monthly overnight interest rate was 0.5 per cent and the depreciation 10 per cent.
As he writes, nothing  new about the Indian economy's fundamentals and expectations about it, which was already not priced in, has emerged in the past two months for fundamentals to be the driving force behind the recent decline of the rupee. Further, the dollar has been steadily rising against all these currencies since mid-May, as expectations of an end to the US Fed's quantitative easing began to harden.

In fact, the best evidence of this being the driving force behind the recent emerging market currency depreciation was the relatively muted reaction of the foreign exchange markets in the immediate aftermath of the decision. They even appear to have settled down (in comparison to its lead up) in recent weeks.

About the mechanism of shock-transmission, in the aftermath of the Fed's announcement on tapering of QE, long-term rates in the US rose, Jahangir Aziz again writes,
It is true that the rupee depreciation was triggered by the global shock, but what has extended the bleeding is self-propagating expectations of rupee weakness. Key to this expectation formation has been the market's belief that the RBI won't step in to draw a line in the sand. Fulfilling the market's expectations, the RBI hasn't, letting rupee dynamics be taken over entirely by the market's fears and greed...
With the interest differential with the US narrowing and renewed fears of the rupee depreciating, foreigners first began selling bonds... With the authorities doing nothing in response, the debt outflows surged and the rupee depreciated further. Equity investors, who till recently had shown remarkable resilience, joined the exit once their fears of policy inaction were confirmed. The rupee went into free fall, with almost the entire market taking a one-sided bet against the currency. The key to the free fall was the absence of a line in the sand. 
In the words of Mr Aziz, the "choice of policy inaction" has become the "driver of rupee dynamics". This is not to refute the theoretical wisdom about rupee finding its true value. True, the persistence of high inflation and large current account deficits (the $25 bn gap, as JP Morgan's Sajjid Chinoy writes) had been continuously eroding the value of rupee for some time. Policy needs to pursue that objective, but at the appropriate time. But, as the aforementioned graphs show, the current downward drift appears driven not by fundamentals but by market expectations. Now, with market expectations about rupee not anchored, the more urgent priority is to reshape expectations and re-anchor rupee.

The RBI has been belatedly aggressive in its response - tightening money available (by capping  its window for banks' overnight borrowings at 1% of total deposit base of all banks, or Rs 75000 Cr), selling bonds worth Rs 12000 Cr in the secondary market to suck out liquidity, raising the Marginal Standing Facility (MSF) rate for emergency borrowings by banks from 8.25% to 10.25% (it is usually anchored at one percentage point above the repo rate, currently 7.25%) - all aimed at squeezing liquidity and making it expensive for banks to indulge in rupee-dollar carry trade (short the rupee by borrowing rupees cheap to buy dollars and close the position when the rupee falls as anticipated). This follows earlier measures by both RBI and the SEBI to cut the liquidity available for currency speculation. Taken together, they amount to a virtual rate hike. The good thing about this is that, instead of the usual baby steps, this is a very decisive signal of the central banks' intent.

Has the RBI done enough to catch up with the curve? Or does it need to go further and raise rates to satisfy the markets by more credibly signaling its commitment to defend the currency? This dilemma has no theoretical answers. The preference would be to avoid rate hike and a quick reversal of the liquidity tightening, so as restore growth conditions. The best course would be for the Central Bank to wait and see how things move in the build up to its credit policy review meeting later this month. In particular, how the markets will respond to the steps taken to backstop the rupee's slide will be of utmost importance. Similarly, if the other emerging economies will follow Brazil and Indonesia and raise rates, the pressure on RBI to follow suit will rise.

This reversal of monetary policy priority from loosening to tightening is a testament to the difficult situation faced by the Indian economy. The current tightening can reasonably be expected to be a temporary measure. So its impact on growth is not likely to be very adverse. However, there are stronger headwinds ahead, especially when the Fed actually starts tapering, sometime later this year, and the US economy too starts showing more promising recovery signals. Then if inflation and current account deficits are still not brought under control, the Indian economy will be even more vulnerable. Unfortunately, this period will coincide with the build-up to elections and a lame-duck government, and the strong possibility of a hung Parliament and resultant political instability. Navigating both domestic and global headwinds in the year ahead will be extremely challenging.

Sunday, July 14, 2013

The gas price debate - a problem of information asymmetry?

I can't get a proper handle on the controversy surrounding the government's recent decision to increase the regulated price of natural gas. In this I share Anantha Nageswaran's ambiguity.

For the record, the government has accepted the recommendations of the Rangarajan Committee, which has been variously estimated to virtually double the domestic price of natural gas to about $8.4 per million BTu by 1 April 2014. The Business Standard has a nice summary of its implications, especially on fertilizer and power prices. The Rangarajan Committee had proposed a pricing mechanism that took a simple average of US's Henry Hub, UK's National Balancing Point, Japan's JCC, and the 12-month average of imported LNG prices. It also suggested that the prices be revised every quarter and this arrangement itself be reviewed after five years.

The government has also decided to do away with the earlier practice of revenue-sharing (with government) after cost of exploitation is fully recovered (by the field developer) in the production sharing contracts. Under the earlier arrangement, the government would get a share of the profits only after the developer recovers all its capital investments. In this case, there are strong reasons, as the CAG has pointed out, to believe that Reliance Industries (RIL) has gold-plated its capital investments, so as to defer the sharing of revenues with government.

The government's decision has apparently been motivated by two considerations. The first being that the gas price was, in any case, up for review on 1 April, 2014. The second, more substantive reason, being that it was thought necessary to encourage upstream investments, especially by foreign investors, which is necessary to raise oil and gas output and thereby ensure energy security as well as balance our current account.

It is clear that  RIL is going to be the biggest private beneficiary of this decision. It is also probable that RIL played hardball with the government, by "reducing" production from nearly 70 million metric standards cubic metres per day (mmscmpd) in 2010 to just 15 mmscmpd today. So the accusations of crony capitalism are inevitable.

But there are several areas where clarity is at a premium. In the circumstances, a more meaningful debate is possible only with more information. What is the realizable output from the field? What is the cost of realization? What is the capital investment made by the firm? What are the problems that hinder exploitation of the field? What are the additional investments required? A best estimate for each of these questions is necessary to clear the air and ensure fairness in pricing decisions.

In other words, oil and gas exploration sector suffers from the problems associated with information asymmetry. The exploration firm has the best answer to all the aforementioned questions. The regulator, whose responsibility is it to determine price based on the cost of exploitation, has access only to secondary information, which too comes mainly from the explorer firm. Fair price discovery is virtually impossible in these circumstances. It is also an invitation to cronyism and corruption. In the circumstances, any reform should push for an immediate institutionalization of a system of periodic technical performance audit of all oil and gas fields which have been leased out by the government.

There is also a need for greater debate on the best possible pricing model for gas producers. Is marginal cost pricing, at import prices, desirable? Given our scarce readily exploitable oil and gas reserves, what is the opportunity cost of inviting investments by foreign private developers? Does this, atleast partially, explain the reason why the large foreign firms have stayed out of Indian market? Needless to say, even this debate depends on answers to the questions raised earlier.

Unfortunately, a lot of the mainstream criticisms of the government's decision - here, here, here, and here - do not address any of these relevant issues. These critiques are focused on its impact on downstream fertilizer and power consumers, increased subsidy burden if government decides to absorb this impact, and most often, the inevitable availability bias that a corruption tainted government (and equally corruption-scarred RIL) engenders. In fact, it also highlights the difficulty of taking such decisions in an environment that has been vitiated by populist rhetoric of political parties and lazy analysis of mainstream opinion makers.

The most compelling critique of the government's decision comes from Surya Sethi. While his first two reasons are more rhetorical and speculative, the argument against raising prices for an "existing field" appears compelling,
What is the justification for raising the price of gas from existing fields? We can always pay a higher price for more difficult horizons provided the duly approved and audited costs of exploration and production warrant that. The current production was realized with no prospect of getting $8.4/MMBtu.
Here too it needs to be borne in mind that the agreement with RIL (and I am not fully aware of its details) does talk about periodic price revisions, as can be construed from the fact that the price was up for revision from April 2014. This article in Hindu does raise this issue and indicates that the production sharing agreements signed by the Government of India mandates arms-length market based pricing. So while an increase in prices may have been perfectly legal, though the magnitude of increase would be a matter of debate. But this too appears to have missed the radar of informed opinion makers.

In fact, even accepting Mr Sethi's very logical argument about revisions being applicable only for newer fields and cost-plus pricing of gas, we also appear to have missed an opportunity to debate the fundamental issue of pricing dry natural gas at the well-head. What are the different approaches to gas pricing across the world? Which of them, or their variants, is relevant for India and why? Is the Rangarajan Committee's recommendations the most appropriate pricing model for India? Should India adopt the marginal pricing (at well-head import prices) or pricing indexed to global petroleum prices or a cost-plus pricing model based on the cost of recovery from respective gas fields? Here too Mr Sethi has important points to make, none of which get carried forward into mainstream debates about reforming gas pricing.

What complicates matters is that natural gas markets are fragmented and prices vary widely and are volatile. In fact, current prices vary from 75 cents per thousand cubic feet in Saudi Arabia, $3-$4 in the US, around $12 in Europe, and as high as $16-$17 in Japan. The inherent difficulties associated with transporting natural gas has been a major contributor to the market fragmentation. In addition, the implicit US natural gas export curbs (by limiting the development of off-shore LNG terminals), have acted as a major deterrent to convergence in global prices.

I am inclined to agree with Mr Sethi that marginal pricing, based on import prices, may not be an appropriate price signal at a time when natural gas markets are extremely fragmented and prices vary widely across the world, being dictated by local factors than any objective market considerations. But this does not mean that cost-plus pricing is the natural alternative. We need to bear in mind that while this is the present state of global natural gas market, these arbitrage opportunities are too large and strategically sensitive to persist for too long. Therefore a pricing mechanism which overlooks global prices, while likely to be appropriate for now, may not be so in the future. Regulators and policy makers will need to respond dynamically to emergent scenarios.

In any case, three things, not substantively related to the particular issue, stand out from this. One, decision making on important issues with high stakes has become a treacherous activity, with politicians and opinion makers trying to outbid each other with populist rhetoric. Two, related to the first, with the media debates on important issues being disappointingly sub-standard, a critical forum to debate and contribute to the design of important reforms and build public support for them appears to have become superfluous. Three, one cannot but get the distinct feeling that the gas-price decision itself appears to be in keeping with the practice of re-negotiations that have become a feature of private participation in India's infrastructure sector.

Saturday, July 13, 2013

The social "trade-offs" are no longer trade-offs?

Greg Mankiw has a nice description of the three trade-offs faced by society and how differing views about them are shaped by our ideological predilections. He writes,
Arthur M. Okun... wrote that the big trade-off faced by society is between equality and efficiency. We can redistribute income to give everyone a more equal slice of the economic pie, but as we do so we blunt work incentives and the economic pie shrinks... From this perspective, the Democrats are the party of more equality, and the Republicans are the party of more efficiency.  
Another view is that the important trade-off is between community and liberty. As members of society, we have goals we want to achieve with others. But as we reach those shared goals, we are asked to sacrifice some personal freedoms. From this perspective, the Democrats are the party that emphasizes communal values, and the Republicans are the party that emphasizes individual liberty.
Finally, there is the issue of how much one trusts centralized governmental power. Democrats tend to want to expand the scope of the federal government to improve the lives of the citizenry, while Republicans are more fearful that centralized power leads to abuse and lack of accountability.
There is nothing wrong with these trade-offs by themselves. What makes it disconcerting is how the interests of the economic and political establishment, cutting across party divisions, converges towards one side of the trade-off, thereby perpetuating the status quo.

Consider this. The economically and politically entrenched, and their supporting intelligentsia, have an obvious interest in favoring efficiency over equality. The debate about any form of increase in taxation is a reflection of this trend. The other two trade-offs relate to a cognitive bias that has become socially internalized about the role of the government.

The traditional free market view has been that government's role should be confined to the issue of currency, national defense, protection of property rights, enforcement of contracts, maintenance of law and order, and provision of certain basic public goods. In the post-war consensus, a welfare state consisting of a basic social safety net has become added to government's responsibilities. The dispute about the role of government has mostly revolved around the extent/boundaries of the provision of public goods and social safety nets.

As the economic and political system has become more self-perpetuating (for example, social mobility has declined), the practical and psychological imperatives for its beneficiaries to support public provision of public goods and social safety net has eroded. They are both able and could afford to access most public goods from private providers or pay for their use. Assured of their entrenched socio-political and economic positions, the normative underpinnings of social safety nets is of limited concern for them. A two-tier system - where one group is privileged to access the best schools and health care, benefit from establishment networks, and enjoy even better quality of public goods - which works against equality of opportunity appears to have emerged.

Therefore, the decision makers in all three trade-offs, are more likely (and this likelihood may be increasing) to be pre-disposed in one direction. These are no longer real-world trade-offs, and are confined to ideological debates. Unfortunately, this trend is not confined to the US alone. Marx, it appears, was atleast partially right.

Wednesday, July 10, 2013

The "red herring" with uniform labor standards

The horrific disaster at Savar in Bangladesh which claimed more than 1100 lives has re-ignited the debate on whether there should be mandatory stricter safety and working condition standards in factories and sweatshops in developing countries. While everyone agrees that there should indeed be stricter standards, the means to its realization is a matter of dispute.

In the context of demand for stricter standards for Bangladesh, Paul Krugman writes,
If we do this for Bangladesh, and only for Bangladesh, it could backfire: the business could move to China or Cambodia. But if we demand higher standards for all countries — modestly higher standards, so that we’re not talking about driving the business back to advanced countries — we can achieve an improvement in workers’ lives (and fewer horrible workers’ deaths), without undermining the export industries these countries so desperately need.
While logically unexceptionable, this could prove to be the thin end of the wedge. Who determines what is "modestly higher standards"? At a time when developed economies are struggling and protectionist sentiments are widespread, any effort at harmonization of labor standards would invariably become highly politicized. Industry lobbies in the US and Europe will try to push through higher standards, so as to reduce their competitiveness gap. The larger countries like China and India may even agree for some higher standards - both because they already have better labor standards and also it is likely to find domestic support - in return for concessions elsewhere that suit their interests.

But Bangladesh and smaller nations, especially from Africa, with aspirations to emulate the East Asian labor-intensive exports-led growth model, are certain to be adversely affected. With firms trying to engineer labor out of the production chain using technology and innovation, there is already a not insignificant possibility that the East Asian model may not be replicable. The labor cost differential is critical to sustaining this model for exports like textiles and toys. In the circumstances, a well-intentioned movement to harmonize labor standards is likely to play into the hands of vested interests in developed countries and be detrimental to the interests of smaller developing countries.

Textile exports from these sweatshops have been instrumental to the rapid progress made by Bangladesh in recent years. From its beginning from scratch in the eighties, the sector today employs 4 million workers, 80% being women, forms three-quarters of export earnings, and is over a sixth of the GDP itself. By any yardstick, it has been one of the true successes from outside East Asia. To paraphrase Krugman, these 4 million "bad" jobs are better than "no" jobs.

The movement towards better standards have to come from within each of these countries and from among the western clothing retailers who buy these products. For sure external pressure and support can contribute towards this. But a WTO-style move towards a harmonized minimum global labor standards is most certain to do more bad than good.

Friday, July 5, 2013

Tuesday, July 2, 2013

China's Africa policy fact of the day

China is relentlessly courting Africa...
According to the UN Conference on Trade and Development, Chinese investment in African manufacturing almost equals its investments in commodities. China-Africa trade has shot up more than tenfold since 2000 to just under $170bn in 2012 – twice the level of US-Africa trade. It has more than 150 commercial attaches in sub-Saharan Africa, against just six for the US. During Mr Obama’s first term, Hu Jintao, then China’s president, visited Africa seven times. Within weeks of taking over from Mr Hu in March, Xi Xingping went on a three-nation tour of Africa.
(HT: FT)