Wednesday, April 29, 2015

Time over-runs and affordable housing

One of the biggest challenges with affordable housing is to bring down development costs. In this context, time and the resultant cost over-runs are an important factor. Livemint has a graphic which highlights the magnitude of this problem.
To put this in perspective, for a developer who expects to complete his project in 24 months, a two-year delay nearly doubles his cost of capital. In a business where developers leverage up heavily, the cost of capital is arguably the most important drivers of profitability. Since the margins are very narrow in affordable housing, developers have limited cushion for uncertainties. The risks associated with time over-runs, with its cascading effect on cost of capital, are simply too large for developers to bear.

While developers have to bear a large part of the blame themselves, with their aggressive estimations when the times were good, regulatory problems are atleast an equally important contributor to delays. Developers face harassment in land procurement, land-use conversion, building and other development permits, utility connections, occupation certificates etc, all of which take up inordinate time and layers of cost. This, in turn, erode their profitability and force them into cutting corners with construction quality and other amenities promised to their buyers, leaving them dis-satisfied.

One way to address this problem is to have a system where developers can register any new project and be able to track the status of various clearances. In fact, the entire process from land procurement to construction and occupation, for all housing projects, can be work-flow automated, incorporating all service departments, and its progress monitored on-line so as to minimize the harassment and delays in obtaining these permits. Since the vast majority of these projects are in municipal or urban development authority areas, the Urban Development Ministry in each state can be the nodal agency entrusted with the responsibility of monitoring and ensuring timely clearances. Developers can be encouraged to register by making such registration mandatory for loans, mortgage finance for their purchasers, availing various benefits under government housing programs, and so on. The Real Estate Development Regulatory Authority was expected to do precisely such enabling stuff.

Update 1 (28.06.2015)

Business Standard has two graphics which highlights the market failure with housing - while housing units absorption rate has declined sharply, prices have risen.
... prices have risen slowly.
Given the 2-3% rental yields, far lower than the cost of capital, and the marginal appreciation, buyers prefer to stay away.

Monday, April 27, 2015

The remarkable persistence of the idea of open capital account

It is remarkable that the idea of open capital account as a macroeconomic policy goal, a central pillar of the Washington Consensus and the policy recipe of any multilateral agency, still finds support among influential policy makers in countries like India when the orthodoxy has turned the full circle elsewhere. 
I have blogged extensively on this several occasions. This oped briefly makes the case against rapid capital account liberalization, arguing that markets over-react when countries respond to signs of trouble by reintroducing capital controls and other capital flows management measures, thereby making the original decision on liberalization all the more critical.  

There is nothing profound about this. The contagion from cross-border flows operates through multiple channels. Surging inflows cause exchange rate appreciation, which in turn lowers export competitiveness and generates current account imbalances, apart from unleashing inflationary pressures and adversely affecting local manufacturing and other tradeables. Simultaneously, in the financial markets, it engenders resource mis-allocation manifested in asset bubbles and reckless corporate leveraging. When the tide turns, the risks of over-leveraged corporate balance sheets and aggressive bank lending become evident, with devastating consequences. Sudden stop follows and capital rushes out. Interestingly, and this is important, the trigger for a reversal of capital flows, can happen due to exogenous events which have little to do with the host country. This is a reflection of the deep global financial linkages and necessitated by liquidity and portfolio rebalancing among global financial market participants. Unfortunately, by this time, the country's current account imbalances would have approached unsustainable levels, thereby amplifying the country risk perceptions and hastening the capital flight. De-leveraging and banking crisis invariably follow, accompanied by recession and prolonged slowdown. A decade or so is lost. And it is no different this time.    

In fact, in a landmark confession (the Economist said that "it was as if the Vatican had given its blessing to birth control!"), after rigorous examination of the evidence, the IMF, no less, argued that 'capital controls are part of the toolkit' and admitted to this,
Capital flows can have substantial benefits for countries. At the same time, they also carry risks, even for countries that have long been open and drawn benefits from them... They are volatile and can be large relative to the size of a country's financial markets or economy. This can lead to booms and busts in credit or asset prices, and makes countries more vulnerable to contagion from global instability... Global financial market volatility... has significant spillovers to emerging market economies... Countries with extensive and long-standing measures to limit capital flows are likely to benefit from further liberalization in an orderly manner. There is, however, no presumption that full liberalization is an appropriate goal for all countries at all times... For countries that have to manage the risks associated with inflow surges or disruptive outflows, a key role needs to be played by macroeconomic policies, as well as by sound financial supervision and regulation, and strong institutions. In certain circumstances, capital flow management measures can be useful. They should not, however, substitute for warranted macroeconomic adjustment. 
The IMF's latest country report on India, which examined the impact of global financial market volatility on India, has more to say,
A surge in global financial market volatility is transmitted very strongly to key macroeconomic and financial variables of emerging markets, and the extent of its pass-through increases with the depth of external balance-sheet linkages between advanced countries and emerging markets... We argue that strong fundamentals and sound policy frameworks per se are not enough to isolate countries from an increase in global financial market volatility. This is particularly the case where there is a sudden adjustment of expectations triggered by monetary policy normalization uncertainty in advanced economies... no country (neither advanced markets nor emerging markets) appears immune from the impact of a surge in global financial market volatility. 
In a speech in 2013 at the central banker's retreat at Jackson Hole, Helene Rey (pdf from here) of the London Business School went so far as to claim that "independent monetary policies are possible if and only if thee capital account is managed directly or indirectly". In fact, she describes monetary policy autonomy and free capital flows as an "irreconcilable duo". 

There has been an explosion of research and publications on this issue in recent years. Barry Eichengreen and Poonam Gupta used evidence from the Fed's 2013 tapering talk to show that capital flows volatility spares none,
Better fundamentals (the budget deficit, the public debt, the level of reserves, the rate of economic growth) did not provide insulation. A more important determinant of the differential impact was the size of the country’s financial market: countries with larger markets experienced more pressure on the exchange rate, foreign reserves and equity prices.
In this context, supporters of full convertibility point to the impossibility of effective enforcement of capital controls. This straw man is disingenuous since nobody disputes that capital controls are imperfect. In fact, several studies on the impact of capital controls in recent years while pointing to a mixed picture, also acknowledge the undoubted short-term benefits of capital flows management measures in limiting capital inflow surges. The best evidence that it has some intended effect comes from no less a person than Mohamed El-Erian, former CEO of world's largest bond trader PIMCO, as quoted in the Economist, who has this to say about capital controls,
They do exactly what they are intended to do : put sand in the market. We think twice, or three times.
From all these five things stand out. 
  1. Capital flows carry considerable risks.
  2. Even countries with credible institutional mechanisms are not immune to these risks.
  3. In fact, the vulnerability to global financial market volatility increases with increased economic integration with the world economy.
  4. There is nothing to suggest that full capital account liberalization should be the ultimate objective.
  5. Capital controls can be useful in certain circumstances.
This lends credence to the use of various capital flows management measures like capital controls and macro-prudential instruments. In fact, given their relatively greater effectiveness in comparison to capital controls, macro-prudential measures have become an increasingly common capital flows management instrument in the armory of central banks. They include counter-cyclically increasing capital reserve buffers on systemically important financial institutions, counter-cyclical leverage caps on trading positions and financial intermediaries, systemic liquidity surcharges, and regulatory restraints on asset markets (like loan-to-value and debt-to-income ratios in property markets) and external commercial borrowing (say, on short-term unhedged debts) to attenuate credit bubbles.  

Perceptions matter as much as reality, atleast in the short and medium term, in the financial markets. Credibility comes from consistency in public pronouncements. India's history of external account management is filled with some or other form of capital controls, the most egregious being the restrictions on gold imports, to mitigate the impact of worsening current account balance. The global consensus too is in that direction - all the major emerging economies have embraced capital controls in some form or other in recent years, albeit with varying levels of success. In the circumstances, it surely does little to enhance your credibility if we advocate the need for capital account convertibility.

Sunday, April 26, 2015

The power of marginal improvements

This blog has long argued that the cumulative effect of numerous small reforms and improvements can be dramatic. This assumes greater significance in systems where the low-hanging fruits have been plucked or decisional reforms implemented. Consider this,
UPS estimates that a savings of one minute per day per driver increases profit by $14.5 million over the course of a year.
All this and more from an excellent essay by Tyler Cowen and Alex Tabarrok on how technological advances have bridged information asymmetry and thereby lowered the resultant market failures.

Thursday, April 23, 2015

Institutional investors and widening inequality

Eric Posner and Glen Weyl points to a new paper by Jose Azar, Martin Schmalz, and Isabel Tecu who show how institutional investors like mutual funds reduce market competition and increase prices for consumers. They highlight the fact that a handful of institutional investors have large ownership stakes in the largest firms across industries, thereby raising the possibility of oligopolistic market power. In their paper they use the example of airline industry and write,
Many natural competitors are jointly held by a small set of large diversified institutional investors. In the US airline industry, taking common ownership into account implies increases in market concentration that are 10 times larger than what is “presumed likely to enhance market power” by antitrust authorities. We use within-route variation over time to identify a positive effect of common ownership on ticket prices. A panel-IV strategy that exploits BlackRock's acquisition of Barclays Global Investors confirms these results. We conclude that a hidden social cost - reduced product market competition - accompanies the private benefits of diversification and good governance... airline prices are 3 to 11 percent higher than they would be if common ownership did not exist. 
Posner and Weyl write,
Although we think of airlines as independent companies, they are actually mostly owned by a small group of institutional investors. For example, United's top five shareholders - all institutional investors - own 49.5% of the firm. Most of United's largest shareholders also are the largest shareholders of Southwest, Delta, and other airlines... If a mutual fund owns shares of United and Delta, and United and Delta are the only competitors on certain routes, then the mutual fund benefits if United and Delta refrain from price competition. The managers of United and Delta have no reason to resist such demands, as they, too, as shareholders of their own companies, benefit from the higher profits from price-squeezed passengers... The authors also point out that the investment management company BlackRock is the top shareholder of the three largest banks in the US; BlackRock is also the largest shareholder of Apple and Microsoft. The companies that are the top five shareholders of CVS are also the top five shareholders of Walgreens.  
Since the higher income people own a disproportionate share of the funds in institutional investors like mutual funds, the share of profits accruing to them is far higher. And this excess profits comes from the pocket of consumers, who cover a far wider income spectrum. In other words, these "institutional investors shrink the size of the market while giving the rich a larger share of what's left". The impact of these trends on inequality is unambiguous. 

This is more to the long list of market failures in financial markets. Roger Gordon, Daniel O' Brien and Steven Salop, and Julio Rotemberg have similar papers the role of financial interests and incentives of industrial firms. 

Wednesday, April 22, 2015

The flawed wisdom on microfinance

The conventional wisdom that underpins the micro-finance and self-help group movement is based on three assumptions about poor people
  1. They need money.
  2. They are willing to borrow if they have access to credit.
  3. They can use borrowed money to enhance their livelihoods. 
Now, a closer analysis would reveal that neither of these assumptions are as axiomatic as they would appear. Consider the first assumption. A recent J-PAL policy paper that summarizes findings from RCTs on micro-finance uptake among beneficiaries in Ethiopia, India, Mexico, and Morocco who were provided easier access to micro-credit, find modest demand for credit. A more plausible assumption is that poor people need money at certain times, when faced with certain unavoidable requirements.

As regards the second assumption, again the story may be complicated. Consider a society where debt comes attached with a stigma. If this were to hold, then families are unlikely to borrow even when plentiful credit is available. They would borrow to meet unavoidable consumption requirements - festival or marriage expenses, medical treatments etc. But they would not do so to meet avoidable consumption (eg. buy consumer durables) or investment (eg. expand business) requirements.  

Finally, the idea that poor people, in general, can work their way out of poverty through entrepreneurship is not only ahistorical (which society has escaped poverty by entrepreneurship?) but also simply an inversion of the conventional wisdom on risk allocation - risks should be assumed by those best able to bear it. Most business activities, however small, carries considerable commercial risks. Expecting poor people, who just about manage to make ends meet, to bear those risks appears a case of risk-burdening those with the least ability to assume commercial risks.

Incidentally, the J-PAL paper is a great read, with several interesting insights - micro-credit access did not lead to substantial increases in income; micro-credit driven business investments rarely resulted in profit increases;  none of the seven studies found a significant impact on average household income for borrowers; and there is little evidence that micro-credit access had substantial effects on women’s empowerment or investment in children’s schooling. 

Update 1 (01.10.2015)

Evidence that questions the utility of microfinance. David Roodman of CGDEV has a book where he writes, "The best estimate of the average impact of micro-credit on the poverty of clients is zero". A comprehensive DFID-funded review finds that the microfinance craze has been built on “foundations of sand” because “no clear evidence yet exists that microfinance programmes have positive impacts.”

Sunday, April 19, 2015

India and the AIIB

Last week the Chinese government announced that 57 countries, including India, have agreed to join the Asian Infrastructure Investment Bank (AIIB). The process of preparing the institution's shareholding pattern, governance framework and lending rules will soon start. So what should be India's strategy?

Foremost, India should realize that it is second only to China in all the parameters - GDP, population, actual infrastructure investments, financing needs and so on. But the politics and economics of joining AIIB pulls in different directions for India. 

Politically, it is undoubtedly in India's interest to not to be not part of the founding of an institution which now holds some global geo-political significance. India should aspire to a seat at the top of the table in an institution that has the potential to become one the leading multilateral financing institutions. But economically, India could well stay out of AIIB and not lose much. Its infrastructure investment needs are massive, nearly $ 1 trillion targeted for the 2012-17 period. The AIIB's contribution can, at best, be just a drop in the ocean. In fact, given its modest initial capital ($50 bn) and the perception discount (among investors and countries) associated with an institution that is clearly dominated by China, one could argue that economically the institution would benefit more from India's presence than India would. It is therefore safe to argue that the AIIB needs India atleast as much as India needs AIIB. India needs to leverage this to its advantage as it negotiates the Articles of Agreement (AoA) of the AIIB. It should not become just another invitee to a Chinese triumphal party.

Given the deep Chinese interest in displaying how the new institution will be fairer and more equitable than the Bretton Woods twins, India has the opportunity to play ball with China over negotiations on the AIIB's governance framework. Furthermore, given China's dominance in AIIB (its initiative, headquarters, leadership position etc), a framework which is fairer and more equitable than the Bretton Woods institutions would involve considerable sacrifices by China and gains for countries like India. 

Apart from the limited financing opportunities, what should be India's possible takeaways from an AIIB? 

1. India should push the AIIB away from multilateral sovereign lending and towards project finance lending. A country like India should have limited interest in sovereign loans and should be more concerned about using all potential sources to leverage international long-term capital to finance its, predominantly, privately financed infrastructure projects. For example, like with the case of World Bank and IFC, even a small AIB share in a project could serve as a credit enhancement and help crowd-in international capital at lower cost than otherwise. 

2. India should advocate issuance of bonds by the AIIB in not just dollar and renminbi (as is most likely, since China would not lose this opportunity to promote the renminbi as a reserve currency), but also rupees. This would help in the internationalization of the rupee as well as help Indian borrowers more cost-effectively hedge their losses and thereby lower the cost of their foreign capital. 

3. India should strive to use the AIIB as an instrument to promote the interests of its own infrastructure firms. It should not be a surprise if China uses the cover of AIIB lending to promote contracts for Chinese firms. There is a strong likelihood of this given the perception that China could use the AIIB to formalize the massive lending currently being undertaken by institutions like the China Development Bank, all of which are conditioned on awarding contracts to Chinese firms. In that case AIIB could become an extended arm of Chinese aid diplomacy. Instead, India should negotiate hard to ensure a level-playing field for Indian firms.

4. The bonds issued by the AIIB could be a potentially good source of risk diversification as well as earning higher returns for India's growing foreign exchange reserves, a large share of which are currently invested in low-yielding US Treasuries. In fact, India should use its reserves and unilaterally match any Chinese contribution either by subscribing to bonds or equity capital. 

China high-speed rail fact of the day

From Forbes,
An average kilometer of HSR track in China costs between $4.8 million USD (Jiaoji Line) to $32.7 million USD (Zhengxi Line), which is significantly less than the estimated $380 million USD to $ 625 million USD it will cost for laying down the British HSR2 project.
The cost variation is a truly stunning differential, which defies all conventional explanations. 

My guess is that the Chinese estimates do not cover many requirements ('right of way' procurement etc) and excludes the massive subsidies (cheaper land and other inputs, cost of capital, tax concessions etc) enjoyed by Chinese equipment makers. Even with these and assuming the highest efficiency standards among Chinese developers, there is still a lot of explaining to do. 

Saturday, April 18, 2015

The declining capital intensity and secular stagnation

Barry Eichengreen (via Mark Thoma) examines the various explanations for secular stagnation,
Four explanations for secular stagnation are distinguished: a rise in global saving, slow population growth that makes investment less attractive, averse trends in technology and productivity growth, and a decline in the relative price of investment goods. A long view from economic history is most supportive of these four views. 
The same investment projects can be pursued, it is hypothesized, by committing a smaller share of GDP, and any additional projects that might be rendered attractive by this lower cost of capital are not enough to offset the decline in the investment share. With less investment spending chasing the same savings, the result can be lower real interest rates and, potentially, a chronic excess of desired saving over desired investment.
He has this graphic which highlights the declining relative price of investment goods. 
While this may be true of many developed economies, where the services sector predominates, it may be less so with developing economies. In these countries, manufacturing still makes up a significant share of the GDP and services a less dominant one. This is one more reason for appreciating the international dimension of secular stagnation hypothesis. Once we assume an open economy, the potential for mutually beneficial outcomes from international trade and cross-border capital flows are immense. 

Friday, April 17, 2015

The case for universal social safety net for job creation

The Times points to a new study from the US which highlights how the tax-payers subsidize low-wage paying employers,
Poverty-Level Wages Cost U.S. Taxpayers $152.8 Billion Each Year in Public Support for Working Families... state and federal governments spend... on four key antipoverty programs used by working families: Medicaid, Temporary Assistance for Needy Families, food stamps and the earned-income tax credit, which is specifically aimed at working families... Taxpayers pick up the difference, he said, between what employers pay and what is required to cover what most Americans consider essential living costs... About 48 percent of home health care workers are on public assistance... So are 46 percent of child care workers and 52 percent of fast-food workers.
This carries important lessons for India, where nearly 90% of the employment is in the informal sector, with all its inefficiencies. These are predominantly low-paying jobs and covers all sectors - construction, services, manufacturing etc. An important reason for such pervasive informality is the high cost of going formal. Mandatory contributions to pensions, insurance, and so on make labor prohibitively expensive for most employers. 

The overwhelming majority of the recipients of the (informal) market determined compensation get just about subsistence wages. Since it does not cover the requirements of secondary and tertiary health care, children's education, old-age pensions, etc, they have to fall back on public systems. But our social safety nets are both too weak and inadequate to meet this demand. Mandatory contribution requirements are legislated to cover this deficiency.        

The government therefore faces a dilemma. Whereas not making contributions mandatory would be politically incorrect, especially when public systems cannot satisfactorily meet all social safety responsibilities, doing so would be the surest way of driving more employment underground. This can be resolved only with a basic universal social safety system that covers atleast all the essential requirements for a dignified life - assurance against catastrophic life illness, scholarships for children to pursue higher education, and old-age pensions. 

Apart from this, as I have blogged on several occasions, a universal safety net also provides the political cushion to push through several important labor, taxation, subsidy, and liberalization reforms. The biggest obstacle however is that the government is fiscally strapped to finance such a program. In the circumstances, the best strategy is to consolidate existing social safety interventions and gradually expand their scope and coverage. 

Thursday, April 16, 2015

China graphics of the day

1. Max Roser tweets this stunning graphic that captures the change in night lights over Beijing area over the 1992-2009 period, reflecting the region's rapid pace of development.
2. Zero Hedge points to the potential headwinds faced in sustaining this pace of development. The country's latest trade data appears alarming. Trade surplus has nose-dived,already sluggish exports have fallen into the red, and imports continue to remain deeply in the red.
This graphic should ring alarm bells in India about a potential devaluation by China with its adverse consequences on India's exports, especially important given the country's ambitious 12% targeted annual exports growth till 2019-20. And it is not just a trade imperative that could drive the renminbi's devaluation. For a country exiting, and swiftly at that, massive credit and housing bubbles, and where deflation looms large, a prolonged duration of monetary accommodation, even multiple rounds of quantitative easing, looks inevitable. This too would add to the downward pressure on the renminbi. Given that Chinese exports compete with that of its larger emerging market peers, the prospects of currency wars are not far-fetched. 

Wednesday, April 15, 2015

The risks with courting Chinese investments

I had blogged earlier here and here urging caution with accessing loans from countries like China and Japan. In this context, Foreign Affairs has a nice cautionary tale about Chinese investments in Sri Lanka, totaling nearly $5 bn in loans since 2010, which describes them as 'predatory lending', 
Chinese investment loans are top-down. They are mostly designed to narrowly curry favor with the leadership, particularly with officials who served under the recently ousted President Mahinda Rajapaksa. These investments rarely generate downstream economic returns and thus breed tremendous resentment among the Sri Lankan public... most of the loans China offered were for “white elephants” masquerading as productive infrastructure investments. In other words, they are mostly vanity projects—a new cricket stadium, airport, and seaport (all built in Rajapaksa’s home district), as well as a new theater and a partially built communications tower in Colombo—that are considered frivolous, poorly planned, and debt generating... 
construction projects largely financed by China’s Export-Import Bank often come with a caveat: that contracts be awarded to Chinese state–owned companies, which then bring their own labor and raw materials... They force Sri Lankans to borrow at high rates for projects that economically benefit the lender, China... high (sometimes floating) interest rates of three to six percent; undisclosed conditions such as exclusive usage rights; and the absence of competitive bidding, transparency, or accountability, which sometimes results in low-quality products... China has also been blamed for saddling Sri Lanka with unnecessary debt, saturating it with tens of thousands of Chinese workers, and treating the country as a “colony” and Sri Lankans as “slaves.”
Though some of these concerns are not so much relevant to India, many are. Fundamentally any Chinese loans are sovereign debt of India. In a world awash with credit, and at a time when India stands apart as the most attractive emerging market investment destination, does it require such Chinese loans? Especially with the exchange rate, interest rate, and political risks associated with Chinese lending, not to speak of the procurement and contracting conditions? 

But turning away cheap creditors may not be the wisest thing for an investment starved economy like India. A more appropriate strategy may be to encourage the Chinese creditors to lend to Indian corporates or specific project entities. The Government of India would do well to create the enabling conditions for India's private sector and project developers to access financing from entities like the China Development Bank. The Chinese could potentially become one more credit channel for private entities. 

The Chinese creditors too are likely to find India's largest corporates and big commercially viable infrastructure projects more attractive lending targets than those elsewhere. But whether the Chinese are willing to play the ball on this remains to be seen. 

Monday, April 13, 2015

On lateral entry into civil service

I have an oped in Indian Express today advocating a nuanced approach to allow lateral entry into leadership positions in Government of India. 

Sunday, April 12, 2015

The cost of commute and other weekend visualizations

1. Fabulous graphic in Citylab which documents the social costs of different commute alternatives - walking, biking, public bus, private car etc - in Vancouver. Here is a graphic which shows the comparison of commute costs using different modes
This graphic shows how much does different modes of commute cost the society.
The calculation of the costs of different commutes is indicated here.

2. Striking interactive graphics from Commonwealth Fund comparing different parameters of health care costs and efficiency between the US and other countries.

3. The Urban Institute has a new data visualization site. This has nine graphics of inequality in the US.

4. Here is an interactive graphic that captures the changing trends in the origin country of migrants into the US.

5. The Economist has this graph which captures the ebbs and flows in the US technology sector since 1980, in terms of the trends in stock market valuations of technology firms.
6. The Times has this hugely informative interactive graphic on the changing nature of middle-class jobs in the United States over the 1980-2012 period. 

7. Finally, the Global Burden of Disease database has excellent visualization that captures time-series information on mortality and morbidity

Financial markets arbitrage fact of the day

From Sendhil Mullainathan's article in Upshot lamenting the human resource mis-allocation into finance in pursuit of careers that involve rent-seeking, transferring wealth from others to themselves, instead of wealth creation,
Arbitrage is valuable only to a point. It has a gold rush element with prospectors racing to get to the gold first. While finding gold has value, finding gold before someone else does is mainly rent-seeking. The economists Eric Budish at the Booth School of Business and Peter Cramton at the University of Maryland, and John J. Shim, a Ph.D. candidate at Booth, have shown in a study how extreme this financial gold rush has become in at least one corner of the financial world. From 2005 to 2011, they found that the duration of arbitrage opportunities in the Chicago Mercantile Exchange and the New York Stock Exchange declined from a median of 97 milliseconds to seven milliseconds. No doubt that’s an achievement, but correcting mispricing at this speed is unlikely to have any real social benefit: What serious investment is being guided by prices at the millisecond level? Short-term arbitrage, while lucrative, seems to be mainly rent-seeking.

Friday, April 10, 2015

Illustrating the obvious - RCTs and pollution control

Before the reforms, firms chose and paid their auditors directly. There was also no mechanism to scrutinize the quality of auditors' reports. As a result, auditors that reported the truth were unlikely to be hired, especially by highly polluting firms that did not wish to be noticed. The experiment increased auditor independence. In a pilot group of nearly 500 plants, the researchers randomly assigned some firms to maintain the status quo audit system and others to come under a new scheme where auditors were randomly assigned to plants, paid from a common pool, and had some of their field work independently double-checked. The double-checking enabled the researchers to compare audit reports to the true underlying pollution levels at industrial plants... Under the new system, auditors were 80 percent less likely to submit a false pollution reading. 
The results
Auditors systematically reported plant emissions just below the government standard, although true emissions were typically higher. For example, for particulate matter—a harmful air pollutant—auditors reported that only 7 percent of industrial plants violated the government standard when in reality 59 percent were emitting more than the standard. The new audit system led auditors to report pollution more truthfully and substantially lowered the number of plants that were falsely reported as compliant with pollution standards. In the restructured auditor market, the accuracy of auditor reports increased significantly: the auditors were 23 percentage points (80 percent) less likely to falsely report a pollution reading as in compliance with the relevant regulatory standard. Additionally, their reported pollution readings were 50–70 percent higher than those of auditors working in the status quo system. Industrial plants reduced pollution in response to more accurate audits. Plants facing the new audit system reduced pollution by 0.21 standard deviations on average. 
Three observations

1. I am not sure whether it required a long and expensive RCT to find out that audits done by randomly-assigned, independent (in selection and payment) auditors are far more effective than those by auditors selected and paid by the very firms they are auditing. It is only surprising that such audits were even being allowed to happen. The straw-man (business as usual in the Pollution Control Board, PCB) is therefore a very bad, even disingenuous, baseline. In fact, independent and randomly assigned audits are commonplace in some states for smaller engineering works, like the school buildings under SSA or Panchayat works. 

2. It is certain that this strategy would have cropped up in audit process reform discussions within the PCB many times over. The J-PAL study played the role of credibly and objectively illustrating the advantages from the reform, thereby creating the momentum required to overcome the internal resistance. It goes back to the argument that managements most often hire reputed consultants to provide internal credibility to reforms they want to implement. The PCB found the study a convenient handle to push through the reform. But this begs the question as to whether the same could have been done more quickly and cheaply through a deep-dive problem-solving by hiring, say, IIM Ahmedabad. 

3. Finally, even assuming one gets the audit implementation design right, there is the question of scale-dynamics. Here we run into questions about effectiveness of supervision and state-capability. This long series of events - communicating the right inspection formats, transparently selecting auditors, randomly-assigning them, ensuring their effective inspections, managing the secondary-checks, consolidating all reports, scrutinizing them, reporting for action on violators, initiating action, and persisting with proceedings till punishment is imposed - are most often beyond the scope of the enfeebled state machinery.

Accordingly, officials turn a blind-eye to even egregious transgressions. In fact, it is not uncommon for such reports to pile up, without anyone even reporting on them, leave aside initiating action. Further, once scaled up, the supply-side constraint too kicks in - only a handful of auditors have the capacity to credibly transact their inspections. Furthermore, it is only a reflection of the weakness of state capability, evident in the quality of monitoring, that such egregious violations were happening. It may be a stretch to expect the same state to now act dutifully on the inspection reports. 

Wednesday, April 8, 2015

Dis-incentivizing corruption by targeting assets

I have blogged earlier about how the incentives are stacked in favor of being corrupt. As the graphic below shows, it just pays, and pays big-time, to be corrupt.
Clearly, the probability of a corrupt person being identified, charged, found guilty, penalized, and his ill-gotten wealth appropriated is about as much as him being fatally hit by fragment from a falling meteor! Even assuming the officer is found guilty and penalized, thereby inflicting some shame and minor pecuniary cost (in relation to the rents), in all likelihood he retains his rents. The massive stakes (in terms of the magnitude of rents) and declining social stigma associated with being perceived as corrupt further distorts incentives. 

In the circumstances, one possible strategy to deter rent-seeking, especially at higher levels, is to target the wealth amassed by officials. Once the preliminary investigations reveal some form of rent-seeking, the investigations should simultaneously target the assets of the official and his family. This strategy has atleast two advantages. One, in so far as it is outcomes focussed, targeting the real gains from rent-seeking, it appears more incentive compatible as a deterrent. Two, it may be legally less difficult to establish disproportionate wealth (even with benamis etc) than establish procedural irregularities. 

Interestingly, the Chinese government's ongoing anti-corruption drive targets the wealth accumulated by the "tigers". And it appears pretty successful. 

Monday, April 6, 2015

India monetary policy transmission fact of the day

This blog had urged caution against the belief that the RBI's rate cuts will translate into lower lending rates. Business Standard has this evidence from the last cycle of rate cuts,
In the last easing cycle (April 2012-June 2013), a 125 bps cut in the repo rate, along with a 200 bps cut in the CRR (Jan 2012-June 2013) led to a bank-base rate reduction of just 50 bps.
As long as financial repression, by way of fiscal dominance (the high Statutory Liquidity Ratios) and the presence of administered savings alternatives  (NSS, PPF etc), prevails, the transmission of even large repo rate cuts will be muted. The battered bank balance sheets is more sand on the wheels of monetary transmission. In this context, nudging and directing banks to lower lending rates is barking up the wrong tree.

Update 1 (02.10.2015)

From the FT on India's monetary policy transmission problem,
India’s transmission mechanism problem is particularly acute, say analysts, because of banks’ heavy reliance on deposits for funding, a correspondingly low level of interbank borrowing, and a banking system frozen by high rates of bad loans. Deposits make up 78 per cent of the total liabilities of India’s commercial banks, according to ratings group Crisil, compared with a figure close to 50 per cent in the US... Only 1 per cent of SBI’s borrowing came from the open market, meaning policy rate changes reduce the bank’s cost of funds slowly and it would take more than the RBI’s cuts so far for the bank to reduce lending rates further... Credit Suisse reckons about 11 per cent of loans are bad or being restructured, with smaller public sector banks worst affected. That is prompting banks to sit on their hands and margins, afraid to take on new risks ahead of a sustained economic recovery.
And on the 50 basis points cut, FT Alphaville quotes Credit Suisse,
There are three effective rates: the cost of borrowing for banks (repo rate), that for the government (10-yr G-Sec yield), and for the corporates (SBI’s base rate). While the policy rate at 6.75% is now the lowest since 2011 (Fig 2), corporate borrowing rate is nearly 1 pp higher than it was then. Even after SBI’s 40 bp cut, the base rate-repo rate gap is 255 bp now vs 150 bp in 2011. For consumers, particularly in mortgages, where NBFCs gain from lower bond yields and also lower risk weights, rates are already at 2011 levels and may fall further.

Sunday, April 5, 2015

The last mile challenge with public service delivery

The latest edition of IMF's Finance and Development monthly has an article by Jorge Coarasa, Jishnu Das, and Jeff Hammer which urges caution against expansion of public health care and advocates focussing on improving existing systems, public and private. This assumes great significance in view of private, formal and the less-than-fully-qualified informal, care providers forming the majority of point of contact in developing countries.

In particular, it points to recent studies involving vignettes and survey which highlight the quality problem - less time spent with patients, non-adherence to treatment protocols, wrong treatment prescriptions, over-treatment etc - being faced by health care systems in developing countries. They write,
Consultation time varies from as little as 1.5 minutes (public sector, urban India) to 8 minutes (private sector, urban Kenya). Providers ask on average between three and five questions and perform between one and three routine examinations, such as checking temperature, pulse, and blood pressure. In rural and urban India, important conditions are treated correctly less than 40 percent of the time; when patients receive a diagnosis, it is correct less than 15 percent of the time. Unnecessary and even harmful treatments are widely used by all providers and in all sectors, and potentially lifesaving treatments, such as oral rehydration therapy in children with diarrhea, are used in less than a third of interactions with highly qualified providers. Less than 5 percent of patients receive only the correct treatment when they visit a provider... Public doctors in primary health clinics prescribed antibiotics for diarrhea 75.9 percent of the time, spending 1.5 minutes to reach a treatment decision.­
However, while the quality of care is poor in both private and public sectors, it is far less inferior in the former. Interestingly, they also find that "patient-centered interactions and treatment accuracy were highest in private sector clinics with public doctors", underlining the higher median quality of doctors in public systems.
All this highlights the challenge associated with achievement of desired outcomes in sectors where the quality of human interface is the critical determinant. Like with poor quality of learning outcomes in school education, this is an example of the frustrating last-mile deficiencies with some public service delivery challenges that are not amenable to readily available, off-the-shelf solutions.

Such activities, what Lant Prtichett has described as "thick" activities, are more transactional, requiring continuous engagement by human agents, and difficult to script into monitorable actions which can be supervised with information. They stand in contrast to "thin" activities that are informational and involve some form of logistics which can be readily monitored using information.

This assumes great significance as the government in India grapples with the scaling up of transactional activities like Clean India, Skill India, Open-defecation Free India, and so on. 

Saturday, April 4, 2015

Zoning regulations and the next generation of urban reforms

It is now well-known that restrictive zoning regulations - building height and land-use restrictions - constrain urban land supply, boost housing prices, and widen urban inequality. In fact, it is arguable that they are the most prohibitive of taxes faced by urban residents, especially migrants searching for affordable housing, and the most egregious of unearned rents, accruing to existing land-owners. Given that cities live and die by the quality of their migrants and widening inequality threatens to unravel its social contract, it is surprising that such policies do not get the level of attention they deserve.  

In this context, The Economist has a nice essay illustrating the costs imposed by zoning regulations,
A 2005 study by Mr Glaeser and Raven Saks, of America’s Federal Reserve, and Joseph Gyourko, of the University of Pennsylvania, attempted to derive the share of property costs attributable to regulatory limits on supply. In 1998 this “shadow tax”, as they call it, was about 20% in Washington, DC, and Boston and about 50% in San Francisco and Manhattan. Matters have almost certainly got worse since then. Similar work by Paul Cheshire and Christian Hilber, of the London School of Economics, estimated that in the early 2000s this regulatory shadow tax was roughly 300% in Milan and Paris, 450% in the City of London, and 800% in its West End. The lion’s share of the value of commercial real estate in Europe’s most economically important cities is thus attributable to rules that make building difficult... the net effect of these costs is felt more by the poor than by the rich.
And its macroeconomic effects, in terms of higher rents discouraging migrants and displacing economic activity, are equally damaging,
Chang-Tai Hsieh, of the University of Chicago Booth School of Business, and Enrico Moretti, of the University of California, Berkeley, have made a tentative stab at calculating the size of such effects. But for the tight limits on construction in California’s Bay Area, they reckon, employment there would be about five times larger than it is. In work that has yet to be published they tot up similar distortions across the whole economy from 1964 on and find that American GDP in 2009 was as much as 13.5% lower than it otherwise could have been. At current levels of output that is a cost of more than $2 trillion a year, or nearly $10,000 per person.
As to its contribution to widening inequality,
In a recent paper Matthew Rognlie, a doctoral student at MIT, noted that the rising share of national income flowing to owners of capital, rather than workers, is largely attributable to increased payments to owners of housing. Capital income from housing accounted for just 3% of the total in 1950 but is responsible for about 10% today.
These regulations are impediments to India's urban growth, something that the country can ill-afford at this stage of its growth. In fact, given the population pressures and acute scarcity of vacant land, land has already become a binding constraint on the growth of cities. Cities are therefore left with no option but to go vertical or expand outwards. The former runs into the country's stringent height restrictions, leaving suburban growth, with all its damaging consequences, as the default option.  

Instead of imitating older western models of expansive urban planning, India needs to embrace more utilitarian strategies that combine vertical growth with mixed use settlements and prudent deployment of green spaces. Permitting higher Floor Area Ratios (FAR) along important transit corridors, near transit stations, larger plots, and greenfield locations; encouraging vertical and mixed-use developments in blighted areas, complemented with affordable housing mandates; and incentivizing urban renewal by higher FAR and property tax concessions are possible strategies to manage sustainable urban growth. They should form the centerpiece of the next generation of urban reforms. The Government of India would do well to nudge and incentivize states and cities to embrace these reforms. 

Friday, April 3, 2015

Private participation in infrastructure

The World Bank's Private Participation in Infrastructure database has data on over 5000 projects in 139 low and middle-income countries in the 1990-2014 period and covering an investment of $2.3 trillion. Here are three graphics covering six countries who make up nearly 60% of the investments.

1. Brazil and India are the biggest destinations for private investment in infrastructure. Clearly, the Chinese infrastructure investment driven growth has been largely under-written by the Government, with private participation being just about $130 bn, a small proportion of the massive investments made in infrastructure.
2. Telecoms and power sector predominate in attracting investments. This is understandable given that both sectors are the most amenable to cost-recovery through tariffs. The share of private participation in water and sewerage is universally low, being the lowest in India. China has been successful in attracting private participation in transport sector, which formed 44% of all their private investments.
3. Greenfield projects take the lion's share of private investments across all countries. In India, telecoms and power takes up almost all the greenfield projects and transport that of concession projects. But the country's performance with dis-investments has been dismal.  
Interestingly, Brazil, the leader in attracting private investments, has a more balanced distribution of investments across sectors and type of contracts. 

Thursday, April 2, 2015

The "secular stagnation" opportunity

I am surprised that it took such a long time for an eminent economist to advocate the international dimension of secular stagnation. I had blogged about it here and here.

Now, Ben Bernanke no less, has kicked off his new blog with a reference to how opportunities elsewhere (see also this) can stoke sustainable, demand-supported, economic growth in developed economies,
My greatest concern about Larry’s formulation, however, is the lack of attention to the international dimension. He focuses on factors affecting domestic capital investment and household spending. All else equal, however, the availability of profitable capital investments anywhere in the world should help defeat secular stagnation at home. The foreign exchange value of the dollar is one channel through which this could work: If US households and firms invest abroad, the resulting outflows of financial capital would be expected to weaken the dollar, which in turn would promote US exports. (For intuition about the link between foreign investment and exports, think of the simple case in which the foreign investment takes the form of exporting, piece by piece, a domestically produced factory for assembly abroad. In that simple case, the foreign investment and the exports are equal and simultaneous.) Increased exports would raise production and employment at home, helping the economy reach full employment. In short, in an open economy, secular stagnation requires that the returns to capital investment be permanently low everywhere, not just in the home economy. 
More specifically, as I had illustrated with a parable involving stagnating and emerging economies, the choices and demands could not have been more complementary,
Stagnation Land has the technologies, businesses, and even capital, all searching for opportunities. It also faces an aging population and resultant demand for different kinds of labor. Emerging Land has rising productivity, remunerative investment opportunities, growing consumer demand, and a large pool of labor. The complementarity could not have been any more mutually beneficial. The scope for a new growth compact between the two countries could not have been more opportune.
Is it possible that the gloom of secular stagnation could also provide the gleam of hope for more sustainable and mutually beneficial economic integration between developed and emerging economies, which alleviates stagnation in the former and promotes rapid economic growth in the latter?