Saturday, November 28, 2015

Weekend Reading Links

1. Carmen Reinhart estimates seven or eight non-oil commodity price booms since the late eighteenth century. The booms have typically lasted 7-8 years and busts about seven years and peak-to-trough declines of more than 30%.
The current bust is in its fourth year with prices having declined by about 25%.

2. The much-expected decline in bond markets after a sustained bond-cycle may be stemmed by the dynamics generated by demographic forces. Consider this,
The ageing population is transforming savers and risk-taking investors into rentiers — meaning an increasingly large proportion of the economy relies on a stable, regular and predictable income derived from past investments. As baby-boomers become pensioners, this class increasingly favours bond-like instruments and moves their portfolios away from stocks. According to Towers Watson, worldwide pension fund assets under management in the 16 major markets total $36tn — equivalent to nearly half of global gross domestic product. In the seven largest markets, pension asset allocation to bonds (30.6 per cent) was close to that of equities (42.3 per cent), and there is a discernible shift away from other investments towards bonds.
3. John Authers talks about the endowment effect among fund managers and how over-valuing assets contributes to losses,
The endowment effect is by far the most widespread psychological flaw in investors. Based on research of global equity portfolios worth more than $1tn in total, some 25 per cent suffer from the endowment effect... In investment, the endowment effect revolves around fear... and it afflicts successful stockpickers. In a typical example, the manager buys a stock at $20, expecting it to go to $50. It reaches $43 or $44 swiftly, and then stalls. But the manager cannot bear to sell until they have gained their full expected value... The fear of embarrassment, of not getting full value for a good investment, fools talented stock pickers into tying up too much capital in what has become “dead money”, when their skills would be far better put to work finding new stocks to buy... For portfolio managers... the average cost of the endowment effect at about 100 basis points. But for about 10 per cent of portfolio managers, the effect of overvaluing their winners can be far worse, at as high as 2.5 percentage points per year, a terrible disadvantage.
4. Livemint has a nice graphic summary of the evolution of India's human development - education, health, and income - since 1870 using an index constructed by Prof Leandro Prados-de-la-Escosura. The index finds that while the country has narrowed its income gap with the richer countries since the economic liberalization of the early 1990s, the health and education gap continues to widen. The comparison of the trajectories of India and China on the two sub-indices is instructive.
China's impressive health and education performance help laid the foundations for its subsequent economic achievements.

5. Two good data journalism stories in Livemint - in the run-up to Paris, a summary of the climate change problem, and commute patterns in the 53 million plus cities of India. The percentage of people traveling by foot or bicycle in many cities is very high, the single largest commute mode. Ironically, they get the least preference and investments (look at the lack of footpaths and road margin parking that obstructs bicycle users) and their voice rarely heard. This is hardly surprising since they are more likely to be the poorest and most disenfranchised.

6. On the even of the Paris COP, here is a summary of the emission reduction commitments made by the top 15 emitters.
Irrespective of whether a binding commitment emerges or not, and even apart from the fact that these commitments fall short of the two degrees celsius temperature increase target, it may be a prudent step for all concerned to agree to a five-year revision goal.

7. A reminder of the pervasiveness and scale of poverty in rural India comes from this graphic (based on the SECC) of the percentage of households with the monthly income of main bread-earner being less than Rs 5000.
Sustainable long-term growth given such elevated levels of poverty is simply impossible.

8. Container shipping is the latest market to suffer from a race to the bottom (in pricing) driven by excess capacity. So much so that it may be cheaper to rent containers than an equivalent amount of land space!

9. India leads in various measures of corporate fraud in an EIU study for Kroll. The share of companies affected by breaches of regulatory compliances, bribery and corruption, misappropriation of company funds, and theft of intellectual property was the highest in India.
10. Ananth has a very comprehensive list of weekend reading links here

Friday, November 27, 2015

More on empowered elected Mayors for Indian cities

I have made the case for empowered and directly elected Mayors for India's largest cities here and here. The graphic captures the priorities of even the most well-intentioned and smartest non-political Municipal Commissioners of Indian cities. The priorities are clearly skewed towards the short-term and very little thinking and effort goes into the city's long-term growth. 
Ironically, it is the politics surrounding an empowered Mayor (how powerful that individual would be against the local legislators and members of Parliament, even the Chief Minister in the case of the metropolitan cities) that comes in the way of such a reform. This may prove insurmountable.

A compromise would be to have directly elected Mayors to head metropolitan development authorities, with a few critical responsibilities which involve co-ordination among many local governments and departments. They could include affordable housing, economic growth and job creation, and transportation planning. 

Thursday, November 26, 2015

Quantitative easing, share buybacks, and secular stagnation

Martin Wolf lays out the reasons for the persistent low-interest rate environment. He attributes this to the "savings glut", arising not just from emerging market foreign exchange surpluses but also from the rising pile of retained surpluses of corporates from developed economies. These surpluses have been financing fiscal deficits in Japan and accumulation of foreign assets in the case of Germany. The first graphic points to the rising corporate gross savings.
However, the rising savings have been accompanied by declining corporate investment, a reminder of the secular stagnation argument.
These trends have led to accumulation of corporate retained earnings.
A significant portion of this is being used to buyback shares and return money to investors. In fact, corporates, especially in the US, have sought to leverage the ultra-low rate environment to finance the share buybacks. So much so that stock buybacks have overtaken aggregate dividends as the main form of corporate payout. These low rates and the resultant high equity risk premium make it prudent for businesses to replace costly equity financing with cheaper debt. The largest US corporates have been leading this market distorting trend. Apart from being an important contributor to fuelling the equity market boom, the resultant reduction in equity base has further inflated corporate surpluses. 

The BIS has documented that in the 2009-14 period, US non-financial corporates repurchased $2.1 trillion in shares and raised $1.8 trillion in net bond financing. 
Clearly, the extended period of quantitative easing and resultant ultra-low interest rates have served to amplify the effects of secular stagnation. 

Monday, November 23, 2015

An agenda for distribution sector reforms

I blogged earlier on my skepticism with power sector reforms. My concerns arise from deep-rooted fundamental problems that afflict the sector and not the details of the financial restructuring plan. 

On the face of it, the distribution side of power ought to be technically the simplest to manage. Power flows without any transactional engagement by the discom. The purely operational transactions done by the discom are secondary and just three - repair and restore supply when interrupted, replace non-working meters, and do periodic operation and maintenance (O&M). And then there are the management issues of releasing new services, spot-billing, and theft detection and disconnection. The discoms do none of these to any reasonable degree of satisfaction. State capability and political economy constraints bind big-time. And even if we get this right, we run into the twin challenges of free farm power and low tariffs. 

The limited technology adoption, archaic processes, low level of professional competence among field-level engineers (a reflection of our workforce employability crisis), limited large and credible enough local service providers (spot-billing, transformer and other equipment servicing, O&M contracting of services etc), unionization, corruption etc are first order problems. They are amplified many times over by weak state capability, sensitive electoral politics, and inherently complex nature of the problem, all of which make technology adoption, howsoever beneficial, a very difficult challenge.

I have blogged earlier here, here, and here on this and am being deliberately provocative in arguing that technology solutions like GIS, SCADA (maybe DA, but surely not SC), DTR (transformer) metering etc are not going to happen in even our best discoms (power point presentations in conferences and seminars apart!) anytime for the foreseeable future. In a difficult and constraining environment, a strategy that focuses on these first-best solutions is certain to crowd-out the effective implementation of even feasible second-best solutions. It would detract from the effectiveness of supervision and make the best the enemy of the good!

So what is the way out? Understand the problem, acknowledge it, and then start work on it. As a first-order and non-negotiable requirement, discoms need to measure and audit its energy distribution and bill and collect from services, the equivalent of plain good governance in the distribution side. But this requires real-time metering of feeders, consumer mapping under each feeder (and keeping track of the dynamic downstream LV network), and then rigorous monitoring and enforcement. And the same with billing services, replacing non-working meters, and collecting dues. Simple as it appears, given the environment, this is a super-difficult challenge and unlikely to happen in quick time. Without arguing for a sequential approach to reform, this is an essential pre-requisite for any other reform. 

Technology can be useful here, but not as top-down GIS/SCADA/AMR solutions, as is currently being advocated. The best strategy is to make available the full spectrum of technology and re-engineering options available in the market and let discoms adopt what they can sustain and suit them best. Different categories of technology interventions in energy audits should be implemented across and within discoms and technology solutions should be allowed iterate and evolve. Given the size of the country, the three orders of the interventions (multiple discoms, multiple areas within a discom, and different technologies) should, if done in a focused manner, over a period of time, throw up technologies that emerge as successes and can diffuse into scale.

Sunday, November 22, 2015

Weekend Reading Links

1. David Evans in the World Bank blog has an awesome compilation of the papers presented at the Northeastern Universities Development Consortium Conference.

2. FT has a nice article which explores the valuation problem in mature start-ups arising from a new category of private shares with guaranteed returns. The insurance against downside distorts the valuation since the investors are now less concerned about the valuation and only interested in the pre-determined guaranteed returns,
Many of the investments in the more mature start-ups are structured: in effect giving investors guaranteed returns and a degree of protection against any losses.Financial experts refer to these headline valuations as “marketing numbers”, highlighting that they are a function of image as much as anything else: the greater the degree of guaranteed return a company is prepared to give, the higher the hypothetical value that investors place on the company... Even some of the best-regarded tech companies have used these methods. At Uber, a major investor received a guaranteed 25 per cent return during an early investment round. Investors also received significant protections during Airbnb’s $10bn round last year.
Square, the most prominent of the current generation of start-ups to have so far opted for a public listing, is typical of this trend. In its most recent private fundraising investors paid $15.46 per share, generating headlines about a $6bn valuation. Those who bought in were guaranteed a 20 per cent share price bump in an IPO. Their compensation, if Square fails to hit this: extra shares to make up the difference, potentially diluting the value for earlier investors and many employees.These new investors may have paid a higher price for their shares, giving them less upside if the company does well. But they also have a degree of insurance unavailable to other investors if the company falls short of expectations.
These multi-share class structures, along with the lack of a liquid market for private shares, have made it almost impossible to calculate an accurate valuation for many start-ups. Even investment professionals whose job it is to assess the value of private shares in their portfolios admit that they cannot do this with 100 per cent certainty. In a private company, unlike in public markets, each class of share commands a different price because of the protections that come with it. In Square’s case, the headline valuation figure of $6bn assumes wrongly that all shares could command the highest share price.
This trend to guarantee returns has been driven by founders desire to join the unicorn club, which enables them to raise more cash, recruit employees and raise their profile.

3. Much the same is happening in India, with late stage VCs putting in tough riders to guarantee their investments and startups accommodating those demands in order to attract the capital required to both sustain operations as well as expand their market shares. Such conditions, commonly described as 'liquidation preference' (LP), ensure that the investor takes back "its entire capital or the amount due to it in proportion of its shareholding in the firm, whichever is higher". As valuations froth, the LP multiples demanded has been rising. The immediate losers from such deals are the start-up founders, whose shares come only after the late and early stage investors recover their investments. 

4. John Reed, the former Chairman of Citigroup, comes out in favor of restoring Glass-Steagall and dispensing with the universal banking model. Apart from the questionable claims on financial benefits from a single entity, he also points to the unstable cultural balancing in bringing all activities under one roof,
As is now clear, traditional banking attracts one kind of talent, which is entirely different from the kinds drawn towards investment banking and trading. Traditional bankers tend to be extroverts, sociable people who are focused on longer term relationships. They are, in many important respects, risk averse. Investment bankers and their traders are more short termist. They are comfortable with, and many even seek out, risk and are more focused on immediate reward. In addition, investment banking organisations tend to organise and focus on products rather than customers. This creates fundamental differences in values.
In South Korea virtually all of your wants and needs can be met by Samsung, the most dominant conglomerate. You can be born in the renowned Samsung Medical Center, attend a prestigious Samsung-owned university, live in Samsung housing complexes — even buy life insurance from a Samsung subsidiary and go for vacation to the Samsung-owned Everland amusement park. It is possible to use virtually only Samsung electronic devices in daily life. And, if you ace the widely taken GSAT — Global Samsung Aptitude Test — you can land a prized job at one of its subsidiaries. No wonder that Samsung is so large that it is responsible for a fifth of South Korea’s exports and about 17 percent of the annual gross domestic product.
6. FT has this dismal assessment of the impact of QE exit on emerging markets,
By some estimates, $7tn of QE dollars have flowed into emerging markets since the Fed began buying bonds in 2008. Now, a year after the Fed brought QE to an end, companies in emerging markets from Brazil to China are finding it increasingly hard to repay their debts. The excess capacity these companies created became apparent just as China’s slowing economy triggered a collapse in global commodity prices, hurting companies across the emerging world and sending Brazil’s economy into deep recession. Some experts say QE policies by the Fed and other central banks have left a legacy of oversupply from which it will take years to recover.
The article also describes how the search for yields resulted in leveraged 'carry trade' from developed to EM economies. The BIS estimates an amount of $9 trillion flowed into the EM economies as bank loans and bonds in the 2009-14 period. As I have blogged earlier, it also found evidence of cash-rich EM firms using this route to speculate with 'carry trade' rather than for investment purposes.  
This has had the effect of driving up EM private sector debt, raising concerns about its repayment once the interest rates in developed economies start to rise.
The disturbing thing about this debt build-up is that it comes at a time when the EM economies are themselves slowing down sharply and consumer demand has been tanking. Apart from declining asset prices, the massive over-capacity in many of these economies mean that the ability of local borrowers to repay their debts once the capital flows tide reverses, as it can in very quick time, is seriously suspect. 

7. The FT has a graphic of the 10 most polluted cities in the world, with India contributing 6 and Pakistan 3.
In fact, the latest Global Burden of Disease report estimates that ambient air pollution was responsible for 586,788 premature deaths in India in 2013, up from 365,592 in 1990.

8. FT reports that peer-to-peer (P2P) lending platforms like Lending Club, Funding Circle, and Prosper have the potential to disrupt the banking sector in a Uber-style revolution. They offer higher yields to lenders, and faster, cheaper, and more convenient loans to borrowers of different categories - consumers, students, small businesses etc. Investors globally have raised more than $80 bn over the past two years for direct lending funds. Though, P2P lenders make up just 1.1% of all unsecured consumer loans in the US, PwC expects annual P2P lending in the country to soar from $5.5 bn in 2014 to $150 bn in 2025. As the article writes, their business model,
P2P lenders say their algorithmic credit scoring technology is as good as the banks. But because they do not need to hold regulatory capital or liquid assets, operate expensive physical branches or deal with costly legacy IT systems, they are more efficient than banks... the “frictional cost” for their companies in making a loan is equal to about 2 per cent, against about 5—7 per cent for a typical bank... As a result, P2P lenders can offer investors a higher yield than banks do to depositors. 
The P2P market has attracted insurers and asset managers who have launched direct lending arms, lending especially to small and mid-sized companies.

Four observations on this trend. One, as banking sector regulations tighten, such platforms could crowd-in the riskier categories of borrowers. Two, the very nature of such lending makes it difficult for the emergence of large lenders. Given that the major source of P2P financing are high-net worth individuals and also given the limits to how much you can lend through impersonal and algorithmic due-diligence, there may be an inherent self-limiting factor to the sizes of such enterprises. Three, this may be a welcome trend shift in the global banking sector in so far as it promotes greater systemic risk diversification. Four, however, the entry of financial institutions like insurers and asset managers makes greater regulation, atleast of their P2P lending arms, essential. Or this could end up being yet another of the "dark corners" of financial markets. 

9. This FT graphic is a very good illustration of the state of the Chinese economy. All the leading indicators of economic growth are falling.
10. In the recently concluded local government elections in Kerala, a corporate social responsibility initiative group won the Panchayat elections in Kizhakkambalam of Ernakulam district in Kerala state. Candidates of Twenty20 Kizhakkambalam, a CSR initiative of the local Anna-Kitex group, a Rs 15 bn garment and aluminium company, won 17 of the 19 wards and 2 out of 3 block panchayat seats. The village, with an area of 32 sq km, 8000 households and population of 23000 is predominantly agricultural and has a literacy rate of 94.74%. The 'party' campaigned on a platform of "improving facilities for drinking water, housing, food, toilet, electricity, healthcare, education and employment besides reviving agriculture in the village".

11. Finally, a reminder of the global downturn comes from this,
The price of iron ore in Qingdao, the widely accepted benchmark for Chinese metal consumption, is down 76 per cent from its 2011 peak... The Baltic Dry index, a measure of the cost of shipping commodities around the world, subsided this week to its lowest ever. It has now dropped 95.5 per cent from its peak set in 2008, shortly before the financial crisis.

Saturday, November 21, 2015

The digital platform opportunity

This report advocates digital platforms in fostering innovations. The example of Aadhaar is the most obvious and successful. It talks about other similar platforms. I think this is one idea that has great potential, far beyond what is outlined in the report.

Consider two examples - healthcare and schooling. In health care, the value chain of activities range from informational (where are the nearest hospital or diagnostic facility or specialist and their respective quality) to medical (outpatient consultations or immunization or treatment follow-up or disease surveillance) to logistical (ambulance or drugs supply chain management or fake drugs testing) services. Similarly, in school education, the activities include informational (nearest school and quality or student's report card), pedagogical (learning content and teaching support materials), and administrative (management of student records or on-line access to school transfer and conduct certificates, mark-sheets, degrees etc) services. 

In each of the specific interventions, while there are enormous opportunities, there are also critical regulatory and other challenges. While on the one hand hospitals, public and private, would find great value in having access to electronic health records, there are issues of data protection and portability. In all these cases, if data ownership and privacy concerns are satisfactorily addressed, then the possibilities from mobile and other software applications (apps) are enormous. Only governments, through enabling policy frameworks and proactive market opening interventions, can be impartial administrators in these areas. 

The most important enabling policy framework would be one on data protection protocols that would allow app developers to offer services - medical history tracking, drugs verification, antenatal and immunization interventions etc. Many of these services can be offered through a fee-for-service model, with data remaining protected and with the patient and the respective hospital, or leverage alternative revenue streams. The other critical enabler would be standardization of protocols. This would facilitate dual inter-operability - use of the same app by different service providers and different apps delivering the same service by the same client (hospital/school and patient/student/teacher). Market opening services would include some large government hospital taking the lead in commissioning an electronic health records management system for its patients and then letting the network expand to include the other public and private hospitals in its vicinity. 

A doctor in a private clinic treating a patient covered under a state government health insurance program, say Aarogyasri, could through a software application access the patient's primary care records from the PHC database, and see diagnostic reports retrieved from the diagnostic center's database. Instead of visiting the far-away hospital, the patient can then follow-up on whether the patient is adhering to the treatment protocol. Another app would help the patient find the nearest medical store where the drug is available and check whether the drugs purchased are fake or not by scanning the QR code. 

The state medical and health department could put out standardized maternal and child health treatment protocols for developers to create apps. PHCs could download and subscribe to such apps on a fee-for-use model, on a range of differentially priced services. While the basic services may be available for a very negligible fee, the more value-added ones could be priced higher and would be subscribed by PHCs and other clients only if they find significant value proposition in them. This would also foster competition among PHCs and different other health units. Much the same dynamics would be generated with education, where schools could choose from the menu of services that are catalyzed and those which they find valuable.  

In both these cases, the hospital records and school records can be the respective platforms to catalyze entrepreneurship and create an eco-system of services which significantly impact health and education sectors.

Thursday, November 19, 2015

Nudging with Amazon Prime

From Times on how Amazon uses its Amazon Prime ($99-a-year free two-day shipping and a host of free music, video, TV shows, and books) subscription service, which is estimated to grow by 10 m to 40 m by end of this year, to nudge shoppers,
Growth in Prime subscriptions matters because Prime alters the psychology of shopping. Once you’ve prepaid for shipping, you tend to start more of your shopping excursions at Amazon. According to some estimates, people spend three or four times as much with Amazon after they sign up to Prime...
But this “Prime effect” is key to Amazon’s long-term profitability. Analysts at Morgan Stanley reported recently that “retail gross profit dollars per customer” — a fancy way of measuring how much Amazon makes from each shopper — has accelerated in each of the last four quarters, in part because of Prime. Amazon keeps winning “a larger share of customers’ wallets,” the firm said, eventually “leading to a period of sustained, rising profitability.
The article lays out how Amazon has slowly built up a massive retail logistics infrastructure, apparently insurmountable for competitors, that appears to be now paying off and which positions the company comfortably to dominate the market for many years. It has built more than 100 (and growing) warehouses to store, package, and ship goods, which lowers logistics costs and allows the company to pass on benefits to customers by way of lower prices. And, Jeff Bezos has been patient,
What has been key to this rise, and missing from many of his competitors’ efforts, is patience. In a very old-fashioned manner, one that is far out of step with a corporate world in which milestones are measured every three months, Amazon has been willing to build its empire methodically and at great cost over almost two decades, despite skepticism from many sectors of the business world.
And Bezos has the deep pockets of its rollicking cloud computing service arm, Amazon Web Services (AWS), which has similarly built out massive computer storage infrastructure and rents out server space, to expand the Amazon's e-commerce business even more.

What could be a disruption? Amazon relies on stocking and selling its own products. But in many countries, including China and India, the e-commerce sites mainly connect buyers and sellers, taking a cut on each transaction. This model has proved successful because it enables the large numbers of legacy small retailers (and even small manufacturers) to directly sell to the end-users, thereby eliminating their transaction costs. But Amazon could as well do the same in these markets, as is happening, and use its other offerings to create a better shopping experience and induce a stickiness among them.

Wednesday, November 18, 2015

The search for the optimal PSC

In a departure from existing investment recovery model of production sharing contracts (PSCs) in oil and gas blocks allotted for exploration, India's Ministry of Petroleum and Natural Gas now proposes to adopt the revenue sharing model in all their future PSCs. The “bidders will bid the percentage of revenue that they will share with the government against two revenue scenarios—when revenue is less than or equal to lower revenue point or when revenue is more than or equal to the higher revenue point”. It also proposes to permit them to price and market gas as well as bid for areas/blocks of their choice (open acreage licensing).

In the former, the explorer recovers the entire capital investment before revenues or profits are shared, whereas in the latter, the revenue/profit sharing starts as soon as the production begins. Accordingly, while the investments risks are mitigated in the back-loaded sharing model, the latter transfers all the risks to the explorer and leaves the government as a rent seeker. The former runs into problems of valuation of investments made, with explorers incentivized to gold-plate their investments, while the latter is far simpler to monitor and suits a risk-averse bureaucracy.

I have blogged earlier on India's most famous gas pricing controversy, challenges of PSCs, and the dilemma for governments between maximizing auction revenues and allowing commercial viability. While the decision for the most appropriate type of PSCs is a difficult one to make, I have written in favor of a more nuanced approach, with a slight preference for a hybrid capital investment recovery model. The preference was also motivated by the fact that India does not have large oil reserves and is almost completely dependent on oil and gas imports, thereby making any new production a bonus.

My concern with the revenue sharing model is more fundamental. Given the risks involved with deepwater oil exploration, especially in an area not known for rich deposits, India needs to attract the major international oil exploration firms with the expertise and technology required to prospect efficiently. But a PSC where all the risks vests with explorers and the government is a passive rent-seeker may discourage the major firms, especially at a time of low international oil prices with not-so-promising medium term prospects. 

The major exploration firms will find the proposed structure attractive only if the technical and political risks are low enough and commercial attractions large enough. The PSC structure may be one militating factor too many.  

Tuesday, November 17, 2015

Power sector reforms - is this time different?

The markets have been largely appreciative of the latest round of power distribution companies debt restructuring. In this context, I am tempted to repost what I had written in the context of the 2012 debt restructuring. In particular, this graphic of the cumulative discom losses as a share of nominal GDP is very instructive - we are today at the same stage in terms of cumulative losses as in 2002.
So is this time any different? On the positive side, as this and this suggests, some of the originally anticipated biggest concerns in terms of the impact of the dilution of FRBM on the economy's credit ratings and perceptions may have been over-blown. The most realistic assessment would be that this is a necessary first-order macro-level intervention required to discipline the discoms. But in the absence of other more important field level initiatives like feeder mapping and rigorous energy audits followed by strict enforcement, we may well end up back to square one come the next electoral cycle. 

Saturday, November 14, 2015

Weekend reading links

1. Conventional wisdom would have it that the troubles of commodity producers are due to the slowdown in China. Merryn Webb in FT feels that there is another dynamic at play, the massive capital investment cycle since the turn of the millennium which has left commodity markets flush with excess capacity and supply,
When China started to go nuts for urbanisation and infrastructure, commodity prices rose alongside this frenzy and so did the profits of the big mining companies. Then the spending started: annual mine production rose by 20 per cent a year from 2000 to 2011. Banks doubled and then tripled the size of their commodity teams. New players poured in (small- and medium-sized miners were raising $30bn a year on the equity market by 2011). Mining capital expenditure rose from $30bn a year to $160bn. By 2014, a cumulative $1tn had been invested. Supplies soared — global iron production rose 125 per cent in a decade. And then commodity prices and mining share prices duly collapsed.
The natural end-game for such commodity boom and busts are mine closures, mothballing, and reduced CapEx. Over time, the excess capacity will shrink and prices will rise. The Minsky cycle repeats. 

2. Ashok Gulati draws attention to the very high levels of agriculture subsidies across countries in the form of high output prices, low input prices, direct income support, or crop insurance. Most countries have very high producer support estimates (PSE) which capture the levels of support to farmers as a share of gross farm revenues. He makes the case for sharp increase in agriculture support, mainly as direct income transfers to Indian farmers,
One of the reasons behind China’s spectacular achievement on the agri-front is the level of support given to farmers. China’s PSE level increased from 2 per cent in 1995-97 to 19 per cent in 2012-14. For Indonesia, the PSE has gone up from 4 per cent to 21 per cent over the same period. There are no PSEs available for India, but subsidies on major inputs like fertilisers, power, irrigation, and agri-credit — the main policy instruments through which the government supports farmers — hover between 6-8 per cent of the value of agri-output (2012-14)... The Chinese government has realised the limitations of using pricing policy to provide inputs at cheaper rates. It has begun making direct payments for input subsidies to farmers at a flat rate per unit of land. Overtime, aggregate amount of transfer has increased from 12 billion yuan in 2006 to 107.1 billion yuan in 2014 (about $17bn). The government has also increased the coverage under crop insurance to 73 million yuan per hectare (45 per cent of total planted area in 2013) by providing premium subsidy of 80 per cent.
I am not sure what should be the strategy on this. Unless there are wrinkles within the numbers, it does appear to contradict the arguments of those demanding pruning down of agriculture subsidies in India. Instead, we may need to increase, and sharply at that, the level of subsidies. But the types of subsidies may need to be revisited. Price support, farm power, fertilizer subsidies etc may not be the most efficient means to support farmers. Investment in irrigation infrastructure, massive expansion of extension services including leveraging technology, the creation of linkage infrastructure (godowns and cold storages), and direct income support may be a more effective strategy. 

3. L&T have announced the sale of Kattupalli Port near Chennai to Adani Port and Special Economic Zone Ltd (APSEZ). The deep-water, all-weather port, which started operations in January 2013, has the capacity to handle 1.2 million TEU of container traffic and dry-bulk and break-bulk cargo. This follows, the L&T's sale of Dhamra port in Odisha to APSEZ in May 2014. It appears to signal a trend of segmentation in the ports sector, with construction contractors like L&T building the port and then exiting by selling to port operators like APSEZ, which have greater expertise in attracting cargo and developing an eco-system for a port. Also, as I have blogged earlier, the creeping nature of such acquisitions by one developer raises concerns about monopoly and competition.

4. Vox has a map of countries scaled to the amount of aid received from the US, which underlines the importance of politics in aid financing.
5. Also in Vox a color-coded mapping of Africa's ethnic diversity. Uganda and Liberia are the most ethnically diverse. An interactive version of the map is here
6. China continues its investment-driven growth strategy. Despite a professed commitment to renewable energy sources and declining capacity utilization of thermal power plants, the country has been building coal powered plants unabated. The Times writes about
... a glut of coal-fired power plants — an astounding 155 planned projects received a permit this year alone, with total capacity equal to nearly 40 percent of operational coal power plants in the United States... In the first nine months of this year, state-owned companies received preliminary or full approval to build the 155 coal power plants that have a total capacity of 123 gigawatts, the report said. That capacity is equal to 15 percent of China’s coal-fired power capacity at the end of 2014. .. Greenpeace estimated that if the 155 plants operated at typical levels for new projects, they would emit 560 million metric tons of carbon dioxide annually, equal to Brazil’s total energy emissions.
This raises questions about the country's renewables commitment and the commercial viability of renewable energy sources,
The construction boom — with capital costs estimated by Greenpeace at $74 billion — is a clear sign that China remains entrenched in investment-driven growth, despite promises by leaders to transform the economic model to one based on consumer spending. It also raises questions about whether China is weaning itself from coal as quickly as it can and whether officials are sufficiently supporting nonfossil fuel sources over coal, which is championed by some state-owned enterprises... Renewable-energy interests — wind, solar and hydropower — are pushing back against coal-fired power plants, which have 40-year life spans. They say the rising number of coal plants prevents other energy sources from selling electricity on the grid and attracting more investment. They want the government to move faster with its promised “green dispatch,” giving priority to low-carbon electricity sources.

Thursday, November 12, 2015

India's productivity challenge

Sometime back this op-ed had argued in favor of a development strategy that combined economic growth with productivity for India. The latter assumes great significance for India, given that it lags woefully behind its aspirational peers.

A comparison of the country's capital investment productivity reflects the inefficiencies in utilization of capital. The small and fragmented nature of India's informal sector dominated manufacturing sector would be a major contributor to the very high ICORs.
Much the same can be said about labour productivity, which is orders of multiples below that of its peers. Interestingly, despite the sustained period of economic boom and higher GDP percapita in PPP terms than Indonesia, China has a lower labor productivity. It highlights the important role that capital investment has played in that country's growth.
It is therefore only natural that India enjoys very high catch-up growth potential. But while India's labor productivity growth has been second only to China, it has fallen sharply behind China.
It is not just growth that matters, the quality of growth is as much important. 

Monday, November 9, 2015

Solar power's mobile telephony moment?

Evangelists claim that we are at the cusp of a solar power boom, with the potential to disrupt and transform the power sector. Recent developments in India lend more credence to such claims. In India, in the latest round of solar auctions, US renewables major SunEdison bid a very low tariff of ₹4.63 a kWhr (or 7 cents) for 500 MW in an NTPC developed solar park in Kurnool, Andhra Pradesh. This tariff is way below Tamil Nadu's 15 year contract last year to purchase thermal power from four developers at ₹4.91 per kWhr.  Since the solar plant is in a fully developed park with transmission lines and involves PPA with NTPC, the promoter's risks are significantly hedged.

At the upstream side, the spectacular declines in the prices of solar panels (Swanson's law - everytime cumulative solar panel production doubles, its cost declines 20%) and the resultant 'grid-parity' with conventional sources mean that solar has the potential to radically alter the energy mix, though it comes with attendant grid management challenges. Downstream, solar's flexibility in scale allows for decentralized generation, raising the possibility of leapfrogging legacy networks and threatening the current distribution business models. 

The FT has this article about the solar power disruption, 
For decades the electricity industry has been a cautious and conservative business, but the plunging prices of solar panels, down by about two-thirds in the past six years, have woken it up with a bang. Dynamic rooftop solar power companies have entered the market, in the most radical change to electricity supplies since the industry was born in the 19th century. It has been described as the equivalent of the mobile revolution in telephony, or the PC in computing.
And about what drives the disruption, it writes,
The price of the panels has fallen so far that it is now less than a quarter of the cost of an installed system. It is the other costs, including sales and installation, that have become critical, and the companies have been working hard to make the process smoother and faster... Three years ago a typical installation would have taken two or three days; now it can generally be done in a day and, if straightforward, a crew can do one in the morning and another in the afternoon.
The other crucial innovation is in financing... The system is worth $31,000 fully installed, which would have been a prohibitive expense. Solar power works for households because they had to pay nothing up front. Promoters like SolarCity still owns the system, and the households pay a monthly bill for the solar power they generate, at a lower rate than they are paying for the remainder of their electricity, which still comes from the utility. The contract is for 20 years but after five they will have the option to buy the system for its depreciated value or just continue their contract. SolarCity, meanwhile, packages up the revenue streams from installed systems in structured finance funds, which companies including Google, Bank of America and Credit Suisse invest in...
And then China. China’s solar-cell production rocketed from just 50 megawatts of generation capacity in 2004 to 23,000 megawatts in 2012, by which time it was supplying more than 70 per cent of the world market... China’s soaring exports, helped by its lower labour and environmental costs, pushed many manufacturers in other countries out of business. Those who were left pressured their governments to launch anti-dumping investigations, and in 2012 the US imposed duties on Chinese solar imports, followed by the EU in 2013. 
Currently, the solar boom in US is underwritten by the federal Investment Tax Credit (ITC), which is 30% of the cost of a residential system, and the state rules on 'net metering', whereby the utility bills consumers based on their net consumption (usage minus the production by panels) without charging any grid management or capacity charges and by paying the same tariff for the power sold by the consumers. Both these run into problems when the scale increases. In a country like India, where recent solar additions have been coming without investment subsidy, it is the latter that poses concern.

Until they plug-off completely from the grid, households are critically reliant on the grid for stabilizing the unstable solar supply and meet their remaining requirement. But if they are allowed to sell power to the grid at the same price as their purchase price, it would not include the cost of both establishing and maintaining the grid as well as stabilizing it with base-load and peaking plants. The battle between utilities and residential solar companies is already making news in places like Nevada, offering a portend of things to come,
NV Energy (a residential solar company) points out that although they may be using less power from the utility’s grid, solar homes are still connected to it. It argues that under the present system, customers with net metering are not paying their fair share of the costs of the grid, including all the wires and transformers and gas and coal-fired power plants that lie behind them, ready to be called on if needed... There will be a great future for rooftop solar but it has to be done in such a way that makes sure the company and the investors investing in that fixed grid are rewarded appropriately... As their market share grows, however, so will the pain for the traditional utilities, and the battles are likely to become more intense.
Another disruptive force in the sector will come from storage sources, which in turn is most likely to be driven by the ambitions of many electric car companies like Tesla. Though currently constrained by technology and cost factors, it may not be prudent to discount the possibility that storage market may be about to enter a very fast growth trajectory
Lux Research estimates the installed base of grid storage in October 2015 to include 841 projects worldwide, with a total of 1,788MW in power — equivalent to a large nuclear station — and 3,460MWh in stored energy. Annual growth rates since 2011 have been 33 per cent in power and 20 per cent in energy... Complementary research by Frost & Sullivan values the global market for utility-scale, grid-connected storage at $460m in 2014 and estimates that it will reach $8.3bn in 2024... The home storage market is growing particularly fast, says Lux Research, with nearly 14,000 battery units installed in the first nine months of 2015 — more than double the annual number of residential units deployed in 2014. Tesla will begin to ship its Powerwall before the end of this year, and Lux expects Tesla to overtake all other residential storage suppliers, with 29,000 home units to be installed during 2016.
This is all the more so given the state of research in newer technologies like flow-batteries which store energy in chemical fluids contained in external tanks (instead of the battery as in case of solid-electrode batteries) and thereby decouple the two main components - the electrochemical conversion hardware through which the fluids are flowed (which sets the peak power capacity) and the chemical storage tanks (which set the energy capacity). This in turn means that the amount of energy storable is limited only by the size of the tanks, which can be large and kept in the basement or roof of a house. 

So what does this mean for India's ambitious solar power targets? It is critically dependent on catalyzing an eco-system of solar providers (already present), storage suppliers (currently absent), aggregators like SolarCity (absent), and financiers (absent). While the last two will emerge in response to market signals, currently the storage market is the constraint, and may well continue to be so for the foreseeable future. This also means that solar becoming a disrupter by leap-frogging like mobile telephony will have to wait.

An even bigger immediate obstacle in the solar ambitions will be the grid management challenges. The intermittent nature of renewables necessitates the availability of adequate variable capacity, which will keep rising as the renewables capacity itself increases. Such variable capacity is typically provided by hydel, gas, and nuclear plants, all of which form just a quarter of the country's capacity and widely scattered across a country beset with transmission capacity bottlenecks. In the circumstances, the country's nearly 60% thermal plants have to be retrofitted to serve as peaking plants. This will have to be complemented with upstream investments in strengthening and expanding the transmission capacity. 

Finally, even without storage, the extremely poor quality of existing supply coupled with the declining solar prices will encourage some of the high-value consumers (malls, hospitals, gated communities etc) to install solar panels. This could very adversely affect the distribution companies, who are dependent on precisely the same consumers for their fiscal balancing. In fact, this may even have the potential to set in motion dynamics that can discipline distribution companies and force cost-recovery based tariffs. But it also raises regulatory concerns, where discoms will start demanding higher fixed capacity charges for providing the balancing load to consumers who rely on off-grid solar. 

Saturday, November 7, 2015

Weekend reading Links

1. Business Standard reports a series of incentives offered by the Government of Maharashtra to attract Foxconn to establish manufacturing facilities in the state at an investment of $5 bn. They include 100% and unlimited subsidy on fixed capital investment, 20% capital subsidy over and above central government subsidies, 100% exemption on stamp duty during investment period, 100% exemption from local body taxes (property tax, land conversion tax, and entry tax), 100% VAT exemption on local purchases, 100% retention from VAT and CST payable, electricity at Rs 2 per unit, and exemption from payment of energy and water duties for 15 years.

These are staggering commitments made with little public debate and most likely, limited understanding. There has been little discussion of its magnitude, in terms of transfers and revenues foregone, or its costs and benefits. This is sure to rekindle another round of race to the bottom among states in attracting trophy investors. It also raises questions about the central thrust of the 'Make in India' campaign. 

In the context of special investment zones like Charter Cities, NYU economist Paul Romer has the following smell test, which carries relevance to this debate,
This smell test is in sync with the 'Make in India' campaign, whose objective is to boost the country's manufacturing sector by competing on improved ease of doing business environment and not by a race to the bottom with irresponsible and unsustainable fiscal transfers. 

2. Indian states are not the only ones in the race to the bottom with fiscal incentives. Ireland, which already has one of the lowest corporate tax rates, has opened a new front in the global race to the bottom with taxation rates. It recently announced a new 6.25% rate category, a "knowledge development box", on revenues and royalties derived from patents and other forms of intellectual property. Countries like Britain, Luxembourg, and Netherlands have created similar tax categories for intellectual property, but with far higher rates. It has been argued that the royalties and other payments on IP no not reliably reflect where the inventions were made or where the innovations generate the most revenue.

The move comes on the face of a ruling by the European Union Competition Commissioner Margaret Vesteger last month that the sweet-heart tax deals given by Luxembourg to Fiat and Netherlands to Starbucks were illegal. Both the firms have been asked to pay €30m on the grounds that the payments constitute illegal state aid. Both firms, and many others, are alleged to have received "selective" tax benefits, comfort letters, unavailable to their competitors, which allowed them to transfer large slices of their profits calculated at non-market prices (even as market pricing comparables exist) from one part of the firm (located in the host country) to another (located in another country) and classify them as royalty to avoid payment of taxes. In case of Starbucks, its Dutch subsidiary under-reported its profits and transferred them to a subsidiary in UK, a low IP tax country, for coffee-roasting services.
The OECD, which conservatively estimates global tax avoidance to be about $240 bn or 10% of global corporate tax revenues, too has initiated moves to crack down on tax avoidance strategies by multinationals. America's largest 500 firms hold more than $2 trillion in profits overseas, and this has been growing rapidly.
Unless the "independent entity" principle which underpins corporate taxation policies, whereby subsidiaries are treated as separate legal entities, is changed and the entire corporation is taken as a single firm, transfer pricing strategies can never be satisfactorily resolved.

3. As the graphic below shows, debt raising by frontier markets, a group of 18 EM economies, have surged in the last couple of years, touching a record $23 bn in 2014. 
Driven by a world awash with cheap credit from quantitative easing and search for yield by asset managers, many of these debt issuances have been at attractively low rates. But early this year, in a sign that the reversal of the commodity super-cycle and slowdown in China was taking its toll on these economies, Ghana had to pay 10.75 per cent to borrow over 15 years, one of the highest borrowing rates for any country in the past two decades. Underlining the perils of foreign currency borrowing, the FT writes,
Countries rarely borrow for the first time with the intention of repaying their debt at maturity. They borrow under the assumption that they will refinance the debt and keep on borrowing... A little over a year ago, Ivory Coast was able to borrow for 10 years at a rate of 5.63 per cent while Vietnam secured a rate of just 4.8 per cent, illustrating the abrupt shift in sentiment towards frontier debt.
The problem now is that having already borrowed, most of these countries have no choice but to borrow again to refinance their loans as it matures. And that comes at an ever higher cost, thereby pushing them down the slippery slope. 

4. A Coasean bargain appears to be playing itself out in the global asset management industry. FT writes
Global asset managers are facing a double hit to their fees, as sovereign wealth funds withdraw billions to support their oil-dependent economies — and switch to a cheaper in-house investment approach... Azerbaijan’s oil fund, which oversees $37bn of assets, has said in its annual report that it intends to bring the management of all of its assets in-house... Similarly, the Abu Dhabi Investment Authority — the second-largest sovereign fund globally with $773bn of assets — has also grown its in-house teams. It reduced its allocations to investment managers from 75 per cent to 65 per cent last year — in effect, a $77bn outflow from external fund houses... According to a new report from Moody’s, the rating agency... sovereign wealth funds taking money in-house represents a long-term trend — and, those that still use external managers are “being more aggressive about negotiating prices”.
This was to be expected given the persistently high fees on these services despite the low returns on these investments. It is also following the pattern of large endowments like those of universities which already are primarily managed by in-house teams. 

5. Italy is the latest to join the negative interest rate club. It joined Germany, Switzerland, and France in being able to sell €1.75bn of two-year debt at a yield of minus 0.023%. That "investors are paying to lend to a country which has one of the highest debt-to-GDP ratios in the world and has long been a byword for fiscal profligacy" and whose short-dated borrowing rate had it 8.12% at the height of the eurozone debt crisis, turns conventional wisdom on its head. 

This follows the recent announcement by the European Central Bank president Mario Draghi that it is not averse expanding on its current €1.1 trillion monetary easing involving monthly purchases of €60 bn worth of mostly government bonds. Andrew Milligan, head of global strategy at Standard Life Investments reflects the underlying sentiments,
This is an Alice in Wonderland situation. Negative rates are highly strange. What is underpinning them is not so much a desire to own a particular country’s debt but the broader issue of slow global growth and what central banks are going to do to address it.
6. The remarkable story of blood-testing start-up Theranos, its rise and disgrace, is emblematic of this age of instant celebrity-dom. The firm says its technology can run a wide range of lab tests from a tiny sample of blood from a finger prick, collected on nanotainers, thereby eliminating the need for intravenous blood draws and making blood-testing more accessible. 

As the Times writes, Ms Elizabeth Holmes, who dropped out of Stanford and started Theranos at the age of 19, raised $400 m in venture capital, got prominent people like Henry Kissinger, Larry Ellison, and Cleveland Clinic to embrace the firm, and reached a valuation of $9 bn, fitted in the classic mould of the start-up entrepreneur with a great story,  
It all fit together perfectly: the college dropout, the fear of needles, the humanitarian mission. She checked all the boxes. Indeed, Ms. Holmes seems to have perfectly executed the current Silicon Valley playbook: Drop out of a prestigious college to pursue an entrepreneurial vision (like Bill Gates, Steve Jobs, and Mark Zuckerberg); adopt an iconic uniform (black turtlenecks like Steve Jobs); embrace an extreme diet; and champion a humanitarian mission, preferably one that can be summed up in one catchy phrase... Ms. Holmes envisions “a world in which no one ever has to say goodbye too soon,” brought about through improved health care. Theranos also has a slogan: “One tiny drop changes everything.” She stays relentlessly on message, as a review of her numerous conference and TV appearances make clear, while at the same time saying little of scientific substance.
All went well till WSJ ran this investigative story which questioned the company's technology and its processes, showing that it does not even use the technology that it promotes and doubting the intent behind its refusal to subject its technology to peer review. 

7. Global steel industry looks set for a long period of turmoil on the back of massive over-capacity and falling demand which has rendered producers in many parts of the world uncompetitive.

As the FT writes, this has left the door open for Chinese producers to aggressively export away their excess capacity,
Since 2000, China's annual production has expanded nearly sevenfold, reaching 858m tonnes in 2014 — around half of the worldwide total... However, while China’s output used to be for domestic consumption, its appetite for steel shrank for the first time last year — resulting in its producers pushing their output into other markets. Exports are expected to surpass 100m tonnes this year, after jumping by more than 50 per cent to 93m tonnes in 2014... By undercutting European costs, Chinese imports are finding buyers around the world... 
For steelmakers, the level of capacity being utilised becomes important, as high fixed costs mean that if they are running at less than 80 per cent capacity, plants use raw materials less efficiently and producers lose pricing power.High quality global journalism requires investment. This requires the permanent shutdown of excess global capacity, which is expected to widen to around 645m tonnes above demand this year and was identified by the OECD as one of the main challenges facing the sector.
8. Gavyn Davies points to this stunning productivity trend graphic of advanced economies since 1960.

The persistence of the secular downward trend echoes the 'average is over' hypothesis that economists like Tyler Cowen have been making.

9. Times points to the latest in customized political campaigning, neuropolitics. It involves capturing facial coding, biofeedback, and brain imaging, which reveal the true nature of voter's feelings and preferences,
In the lobby of a Mexico City office building, people scurrying to and fro gazed briefly at the digital billboard backing a candidate for Congress in June. They probably did not know that the sign was reading them, too. Inside the ad, a camera captured their facial expressions and fed them through an algorithm, reading emotional reactions like happiness, surprise, anger, disgust, fear and sadness. With all the unwitting feedback, the campaign could then tweak the message — the images, sounds or words — to come up with a version that voters might like better.
10. Times has an excellent investigation, here and here, of more than 25000 arbitrations in the 2010-14 period across the US,
From birth to death, the use of arbitration has crept into nearly every corner of Americans’ lives, encompassing moments like having a baby, going to school, getting a job, buying a car, building a house and placing a parent in a nursing home... But arbitration often bears little resemblance to court. Over the last 10 years, thousands of businesses across the country — from big corporations to storefront shops — have used arbitration to create an alternate system of justice. There, rules tend to favor businesses, and judges and juries have been replaced by arbitrators who commonly consider the companies their clients... This amounts to the whole-scale privatization of the justice system... All it took was adding simple arbitration clauses to contracts that most employees and consumers do not even read. Yet at stake are claims of medical malpractice, sexual harassment, hate crimes, discrimination, theft, fraud, elder abuse and wrongful death, records and interviews show....
Little is known about arbitration because the proceedings are confidential and the federal government does not require cases to be reported. The secretive nature of the process makes it difficult to ascertain how fairly the proceedings are conducted... And unlike the outcomes in civil court, arbitrators’ rulings are nearly impossible to appeal. When plaintiffs have asked the courts to intervene, court records show, they have almost always lost... Unfettered by strict judicial rules against conflicts of interest, companies can steer cases to friendly arbitrators. In turn, interviews and records show, some arbitrators cultivate close ties with companies to get business...
Arbitration records obtained by The Times showed that 41 arbitrators each handled 10 or more cases for one company between 2010 and 2014. Anthony Kline, a California appeals court judge, said, "Private judging is an oxymoron. This is a business and arbitrators have an economic reason to decide in favor of the repeat players"... Victoria Pynchon, an arbitrator in Los Angeles, said plaintiffs had an inherent disadvantage. “Why would an arbitrator cater to a person they will never again see again?”.
This should be seen as the latest example of how private delivery of essential public services can end up seriously distorting the markets and failing to deliver on its objectives. It also, at a very broad level, reflects the concerns about widening inequality and how it enables political capture that leads to the disenfranchisement of citizens and the evolution of political and public institutions.  

Friday, November 6, 2015

The latest social experiment in China - social and moral credit scores!

I have blogged earlier that the bigger concern from China is that its social and political liberalization may not keep pace with its economic liberalization, thereby constraining those channels which have to drive its next stage of growth. 

In fact, as this New Yorker article points out, the Chinese government seems to be going in the reverse direction. The country is apparently planning a social credit system (SCS) by 2020, which seeks to capture the social, moral, and financial history of its citizens, and "encourage keeping trust and punish breaking trust",
It aims to compile a comprehensive national database out of citizens’ fiscal, government, and possibly personal information. First publicized, last year, in a planning document published by the State Council, S.C.S. was billed as “an important component part of the Socialist market-economy system,” underwriting a “harmonious Socialist society.” Its intended goals are “establishing the idea of a sincerity culture, and carrying forward sincerity and traditional virtues,” and its primary objectives are to raise “the honest mentality and credit levels of the entire society” as well as “the over-all competitiveness of the country,” and “stimulating the development of society and the progress of civilization.”
And the manner in which the government proposes to do this, while reflective of its "crossing the river by feeling the stones" approach, is appalling its invasion of privacy and quest for social engineering, 
The Chinese government... maintains a Web site that allows any citizen to check what serve as proxies for other people’s credit ratings, including court judgments and other interactions with the state. The site uses data from thirty-seven central government departments and is run with help from Baidu, China’s main search engine, which is privately owned but submits to the rules of the state. Similarly, S.C.S. will likely elicit help from major private enterprises to manage various segments of its operation. Prior to its rollout, now planned for 2020, the government will observe how eight private companies come up with their own “social credit” scores under state-approved pilot projects...

Alibaba, the world’s biggest online shopping platform, creates an incentive for customers to use its own payment service (also part of Alipay) by raising the Sesame Credit scores of those who do. The company makes no secret of its interest in accessing the payment history of its four hundred million users, to make judgments about their creditworthiness and character. “Someone who plays video games for ten hours a day, for example, would be considered an idle person, and someone who frequently buys diapers would be considered as probably a parent, who on balance is more likely to have a sense of responsibility,” Li Yingyun, Sesame’s technology director, told Caixin, a Chinese magazine. In some ways, Tencent’s credit system goes further, tapping into users’ social networks and mining data about their contacts, for example, in order to determine their social-credit score.

The information-harvesting tactics of Alibaba and Tencent play to their advantages and exploit the companies’ unique points of access to their users. For the Chinese government, this is exactly the sort of competitive strategizing that might ultimately prove instructive to the construction of its own omniscient system. Indeed, part of what has kept the Party in command over the decades is its pairing of authoritarian imperative with adaptability—a willingness to evolve its mechanisms of control with the technology of the times. To maintain the regime’s political power, the state has already leveraged the market and, for example, erected the Great Firewall. Engineering the lives of its citizens by way of a comprehensive database seems almost like the logical next step.
It is a testament to India's democratic vibrancy and political maturity that there is such pre-emptive hostility and abhorrence to such ideas, despite the country being technologically and systemically ahead of China in being able to do precisely the same. This is surely one area where China has a lot to learn from its southern neighbor. Score India 1, China 0 on this!

Thursday, November 5, 2015

More on the secular stagnation debate

The main argument in favor of the extended period of extraordinary monetary accommodation has been that it would provide the space for balance sheets to heal and the economy to get back to pre-crisis growth trajectory. Now, what if a return to the pre-crisis growth path may no longer be possible, for whatever reasons?

Economists like Robert Gordon have for some time now been cautioning about a productivity growth slow-down. Tyler Cowen had popularized this trend in his book "Average is Over", claiming that all the low-hanging fruits of recent technology revolutions have been plucked and actual productivity enhancing innovation has reached a plateau. Larry Summers has sought to provide a theoretical framework to the underlying trends by resuscitating Hyman Minsky's 'secular stagnation' hypothesis. Essentially, declining investment demand, induced by a variety of long-term structural factors, have forced down the Wicksellian natural interest rate to historic low levels, with limited prospects of a recovery for the foreseeable future. 

The supporters of unconventional monetary policy responses, led by Paul Krugman, have argued that such policies will not only help repair distressed household and corporate balance sheets, but also stoke the inflationary expectations required to restore consumption and an exit from the liquidity trap. They have claimed that central bankers could "credibly promise to be irresponsible" and unhinge inflationary expectations. While they also support fiscal policy measures, all those are made conditional on the persistence of monetary accommodation.

In this context, a recent dialogue between Larry Summers and Paul Krugman is instructive. Krugman, one of cheer-leaders of ever more monetary accommodation, assumes a return to pre-crisis growth path. But Summers describes the belief in pre-crisis recovery taking hold as a 'deus ex machina' event, and writes,
The essence of the secular stagnation and hysteresis ideas that I have been pushing is that there is no assurance that capitalist economies, when plunged into downturn, will, over any interval, revert to what had been normal. Understanding this phenomenon and responding to it seems the central challenge for macroeconomics in this era... I suspect it will lead to more emphasis on fiscal rather than monetary actions in depressed economies.
Krugman has grudgingly accepted the possibility that a return to pre-crisis normalcy may not be possible, thereby making policy response that much harder. If we agree to Summers' point that pre-crisis growth may not be a possibility, then low interest rates are here to stay, thereby making government borrowings, especially to finance much-needed investments in infrastructure in the US less of a problem. But the flip side of this argument is that this too may have limited traction as a growth driver and may end up down a slippery slope, as Japan is today. While the US does not face as bad a demographic headwind, Japan's struggles with the use of fiscal expansion in triggering growth draws attention to the limitations of fiscal policy itself in such circumstances. 

In any case, all this would also mean that the US has followed Japan and, possibly, Europe, into a long period of low growth rates, with attendant drag on the emerging markets and the world economy itself.