Monday, October 31, 2016

Why are cites in Europe denser than in America?

Fascinating video that explains why European cities are much denser than US cities.
The answer is one word - transportation. People congregate to minimise commute times. Urban planning facilitates this by allowing vertical growth, especially around transit corridors, and having excellent public transit services inter-connecting population nodes with the city centre and with each other. 

Unfortunately, urban planning in most developing countries fail badly on both counts. 

Saturday, October 29, 2016

Weekend reading links

1. Following pension funds and a growing list of institutional investors, the Carlyle Group, one of the four largest PE firms, is pulling back on its hedge fund investments. No wonder, given this,
Over all, hedge funds have underperformed the broader Standard & Poor’s 500-stock index for seven consecutive years. The average hedge fund returned 4.14 percent this year through September, according to the Hedge Fund Research Composite Index, the broadest gauge of hedge fund performance. The Standard & Poor’s 500-stock index gained 8 percent over that period, accounting for reinvested dividends... More than $50 billion has flowed out of the industry this year, according to Hedge Fund Research. In the latest financial quarter investors took $28 billion, the biggest quarterly outflow since the depths of the financial crisis in 2009.
2. Much of state and national industrial policy in developing countries like India are centred around fiscal and other concessions that benefit the largest firms. In fact, industrial and investment promotion itself is focused on the larger firms. As evidence, one only needs to verify how many small entrepreneurs or firms get called for consultations by governments or the high-profile business meets.

This flies against the fact that small enterprises form the major share of job creation and gross output creation. Not just in India, but even in the US. Consider this,
Out of 252,000 manufacturing companies in the United States, only 3,700 had more than 500 workers. The vast majority employ fewer than 20.
The difference with a developing country like India being that the vast majority of small enterprises are informal and grossly unproductive.

3. This high-profile working paper has created quite a stir and may have turned the tide in favour of Teaching at Right Level (TaRL) in primary school education. Here is from the paper,
The core element of all Pratham’s Programs discussed here is the pedagogy: it is called Combined Activities for Maximized Learning (CAMaL), but is also referred to as “Teaching at the Right Level” (TaRL). We call it TaRL below. This pedagogy has evolved over the years from Pratham’s own intensive experience, internal assessments, as well as external randomized evaluations...
It is interesting that Pratham chooses to call its model TaRL. This begs the question, what is Montessori, Activity Based Learning, adaptive learning etc, all of which focuses on instruction that is tailored to the student's learning level? At first look, the public policy challenge may be to get the right TaRL approach, one which is amenable to being scaled up in a business as usual public system. But I am not sure whether there is one right TaRL approach for every context. 

4. Olivier Blanchard and Julien Acalin have a study which questions the conventional wisdom about Foreign Direct Investment (FDI). They observe three stylised facts about FDI flows in the 1990-2015 period - a surprisingly high correlation between quarterly FDI inflows and outflows (why would domestic investors want to take out their money in a country which attracts high inflows, especially in the same quarter); increase in quarterly FDI inflows to EM economies in response to decreases in US monetary policy rate (why should FDI be so immediately elastic to quarterly changes, whereas portfolio flows would be); increase in quarterly FDI outflows from EM economies in response to decreases in US rates (why would outflows respond so immediately to US rate changes). They write,
These facts suggest two conclusions. The first is that, in many countries, a large proportion of measured FDI inflows are just flows going in and out of the country on their way to their final destination, with the stop due in part to favorable corporate tax conditions. This fact is not new, and, as discussed below, countries have tried to im- prove their measures of FDI to reflect it. But the magnitude of such flows came to us as a surprise. The second is that some of these measured FDI flows are much closer to portfolio debt flows, responding to short-run movements in US monetary policy conditions rather than to medium-run fundamentals of the country. Both have implications for how one should think about capital controls and the exclusion of measured FDI from such controls.
India had the sixth highest inflow-outflow correlation, exceeding 0.6. And of particular relevance,

A number of other statistical facts are also intriguing and suggest the need for a granular look at tax treaties, specific tax rates, treatment of FDI debt versus FDI equity flows, capital controls, and the details of tax optimization. For example, in a few countries (in particular, India), there is a high correlation between FDI equity inflows and debt outflows. This correlation is consistent with the hypothesis that some of the high correlations (between quarterly FDI inflows and outflows) reflect in part hedging of currency and country risks by foreign investors.
In the case of India, it has long been suspected that a significant share of its FDI inflows are round-tripping of domestic capital to take advantage of tax treaties. 

5. The WSJ has this graphic from the IMF's latest that highlights the indebtedness problem facing the world economy.  
The report is spot on in its assessment, 
Anemic global growth is "setting the stage for a vicious feedback loop in which lower growth hampers deleveraging and the debt overhang exacerbates the slowdown".
6. Finally, Fareed Zakaria has an excellent article on the rise of populism in developed economies. He highlights the point that while populism has been on the retreat in developing economies, even Latin America, it has been rising in developed economies. He attributes this to the slowing economic growth. Unfortunately, this has been accompanied by declining population growth rates, globalisation and off-shoring, automation and labor market displacement, and pervasive fiscal indebtedness, all of which leaves governments pretty ineffectual in singificantly ameliorating conditions. 

The result of all this, coupled with the convergence between the right and left spectrums of economic ideology (at least in practice, both have gravitated to the centre), has been the decline of economics and the emergence of other factors as driving force of politics. Zakaria points to the work of Ronald Inglehart and Pippa Norris who document the rise of right and left-wing populism in Europe since 1960s,
The most striking findings of the paper are about the decline of economics as the pivot of politics. The way politics are thought about today is still shaped by the basic twentieth-century left-right divide. Left-wing parties are associated with increased government spending, a larger welfare state, and regulations on business... Voting patterns traditionally reinforced this ideological divide, with the working class opting for the left and middle and upper classes for the right. Income was usually the best predictor of a person’s political choices. Inglehart and Norris point out that this old voting pattern has been waning for decades... Today, an American’s economic status is a bad predictor of his or her voting preferences. His or her views on social issues—say, same-sex marriage—are a much more accurate guide to whether he or she will support Republicans or Democrats... Noneconomic issues—such as those related to gender, race, the environment—have greatly increased in importance...
This convergence in economic policy has contributed to a situation in which the crucial difference between the left and the right today is cultural... The shift began, as Inglehart and Norris note, in the 1970s, when young people embraced a postmaterialist politics centered on self-expression and issues related to gender, race, and the environment. They challenged authority and established institutions and norms, and they were largely successful in introducing new ideas and recasting politics and society. But they also produced a counterreaction. The older generation, particularly men, was traumatized by what it saw as an assault on the civilization and values it cherished and had grown up with. These people began to vote for parties and candidates that they believed would, above all, hold at bay these forces of cultural and social change. In Europe, that led to the rise of new parties. In the United States, it meant that Republicans began to vote more on the basis of these cultural issues than on economic ones. The Republican Party had lived uneasily as a coalition of disparate groups for decades, finding a fusion between cultural and economic conservatives and foreign policy hawks. But then, the Democrats under Clinton moved to the center, bringing many professionals and white-collar workers into the party’s fold. Working-class whites, on the other hand, found themselves increasingly alienated by the cosmopolitan Democrats and more comfortable with a Republican Party that promised to reflect their values on “the three Gs”—guns, God, and gays.
Immigration, the "final frontier of globalisation", has become the rallying point for the latest spurt in the rising trend of non-economic populism.

Friday, October 28, 2016

More on judicial activism gone astray

The Allahabad High Court has abrogated the tolling contract awarded to the IL&FS owned Noida Toll Bridge Company Limited (NTBCL) on the 9.2 km eight-lane Delhi-Noida-Direct (DND) Expressway which became operational in 2001 as one the country's first PPP road projects. The court ruled the concession agreement as "unfair" and that NTBCL has "recovered all reasonable returns" from the bridge. The concessionaire has approached the Supreme Court.

This is all very sad and predictable. That the contract was deeply flawed, even fraudulent, is beyond doubt. The decision could therefore rightly be seen as divine (or democratic) retribution to crony capitalism. Populist grandstanding is therefore inevitable. 

The cavalier nature of the abrogation, with immediate effect, is increasingly becoming a feature of judicial rulings on large infrastructure contracts. The cancellation of the telecom spectrum licenses has been the most high-profile example. 

But such judicial actions impose prohibitive collateral damage on the country's institutional systems. Consider a very risky project, where the bidder bets on windfall gains, which are by definition more than "all reasonable returns", and where the risks subside significantly, for whatever reasons (and there could be many) after a couple of years of the project's commissioning. Given that most such judicial (and any investigative or audit) scrutiny is done with the benefit of hind-sight, without much appreciation of the context in which the decision was actually taken, even such fair bids run the risk of populist abrogation. 

I can understand the judicial revocation of a bad contract. But the grounds have to be legal inadequacies and established fraud in the contract. Both may never have been very difficult to establish with the instant concession, starting from 2001. But now, a fully fifteen years later, to revoke a contract on an interpretation of the gains made by the concessionaire, and that too by a judicial action and not by a technically competent entity, disturbs me. At the least, the matter could have been referred to the National Highways Authority of India or some other entity to identify the legal inadequacies and clearly quantify the cumulative construction cost and recoveries, and then adjudicate thereon.   

But the unfortunate thing is that governments and, more surprisingly, developers never learn. We will continue to have such egregious excesses, as is still happening in many states with large tenders and land allotments. And all this will only encourage more judicial actions that strike at the sanctity of contracts. 

Saturday, October 15, 2016

Public policy in establishing markets

Samir Saran and Vivan Saran argue that Government of India's role in certain markets may be impeding its own Make in India initiative. The example of BSNL is instructive and I am inclined to agree. BSNL's greatest negative externality may well be that its presence crowds out other far more efficient private operators in public procurements of telecom services (by government entities), which forms a very significant share of the country's high value telecom services market.  

But I am not sure about whether the argument that government intervention to create the RuPay card through the National Payment Corporation of India (NPCI) belongs to the same category. In fact, the RuPay is already shaking up the market for payment transaction gateways which is currently under the vice-like oligopolist grip of "market" players like Master and Visa. A RuPay disruption may well be the difference between the widespread adoption of digital payments in a highly margin and price sensitive market like India. 

If the government can calibrate its arms-length role and gradually exit, then this should count as one of the great global examples of a public intervention to address a market failure. In any case, even with the heavy guidance by Reserve Bank of India, this is one of those market interventions that was long over-due. 

Amidst all this, one should not forget that the biggest disruption of them all, Aadhaar, was a government intervention. So is now the NPCI and its catalysing the roll out of the Unified Payment Interface (UPI) for mobile payments. The eco-system of digital payments is being created, maybe unwittingly, through direct government interventions. And, interestingly, this has involved not just enabling regulations but also the establishment of service providers and even products. 

Thursday, October 13, 2016

Italy represents the breakdown of bond market price discovery!

David Stockman highlights how quantitative easing has broken down the standard price discovery dynamics in the sovereign bond markets. 

The case of Italy is striking illustration. It has a clearly unsustainable sovereign debt of 133% ($2.4 trillion), the second largest in Europe after Greece. Its over-sized $4.4 trillion banking sector (double the GDP), with over $400 bn non performing loans, is technically insolvent. But the country's 10 year bond yields have been constantly declining. At 1.18%, it is lower than even comparable US Treasury Bond! 

Stockman is spot on,
The notion that today’s yield of 1.15% on the Italian 10-year bond even remotely compensates for the risk embedded in Italy’s fiscal and economic chamber of horrors is just plain laughable. And that’s to say nothing of the risk the Brexit is just stage one, and that the EU itself will ultimately succumb to a wave of populist insurgency, including a Five Star led move to take Italy out of the euro. Indeed, Italy is truly a case of the blind leading the blind... Needless to say, these (government bonds) securities are vastly over-valued owing to the Draghi bond-buying spree, and they would plummet in price were the speculators who have been front-running Draghi’s QE campaign ever to loose confidence in the ECB or the ability and willingness of an Italian government to continue the giant fiscal charade now in place... with public debt already at 133% of GDP, why would anyone except Mario Draghi’s printing press be buying 10-year bonds at a 1.15% yield? Once upon a time, price discovery by the bond vigilantes kept governments quasi-sober and functionally solvent. No more. The Italian Job now underway is just the opening round in a world of failed states and broken markets.

Tuesday, October 11, 2016

The scale validity challenge

Teaching at Right Level (TaRL) is the flavour of the season. I am favourably disposed. But, unlike this much discussed study, I am not sure about what should be the right design for remedial instruction - the grouping, duration of remediation, resource support necessary etc. I am not even sure whether there is any one "right model" that should be replicated across widely varying contexts. But this is for another post.

This post reiterates a constant puzzle for me about the scale validity dimension of the efficacy of evaluations like Randomized Control Trials (RCTs). This assumes significance in the context of drawing scalability conclusions from RCTs like the aforementioned. The discussion about efficacy of any RCT revolves around its internal (evaluation design) and external (generalizability across other environments) validity. But scale validity is critically important, especially if the results are to be replicated by a weak public system. I have written about the scale validity problem earlier,
One, there is a big difference between implementing a program on a pilot basis for an experimental study and implementing the same on scale. In the former, the concentrated effort and scrutiny of the research team, the unwitting greater over-sight by the official bureaucracy, and the assured expectation, among its audience, that it would be only a temporary diversion, contributes to increasing the effectiveness of implementation. Two, is the administrative system capable of implementing the program so designed, on scale? Finally, there is the strong possibility that we will end up implementing a program or intervention that is qualitatively different from that conceived experimentally.

It is one thing to find considerable increases in teacher attendance due to the use of time-stamped photographs or rise in safe water consumption from the use of water chlorination ampules when both are implemented over a short time horizon, in microscopic scale, and under the careful guidance and monitoring of smart, dispassionate, and committed research assistants. I am inclined to believe that it may be an altogether different experience when the same is scaled up over an entire region or country over long periods of time and with the “business as usual” minimal administrative guidance and monitoring. And all this is leaving aside its unanticipated secondary effects. In fact, far from implementing an intervention which is tailored based on rigorous scientific evidence, we may actually end up implementing a mutilated version which may bear little resemblance to the original plan when rolled out at the last mile.
So, how do we discount for the fact that, for example, the TaRL study was done in a small number of schools under the watchful eyes of smart and committed RAs, which undeniably contributes to maintaining some rigour in the implementation. In its absence, as would be the case in business as usual scale up, how can we be confident about being able to replicate the results? This assumes even greater significance when the interpretation of most positive results are complicated by very low baseline and overall marginal (yet statistically significant) effects. 

Monday, October 10, 2016

India's first MPC meeting takeaways

India's newly minted Monetary Policy Committee (MPC) had its first meeting last week. The interest rate cut was surprising. I'll not delve into the technical merits of the decision. Instead I have three observations. 

1. The unanimity of the vote (6-0) at a time when the case for a cut is at least debatable and was definitely not unanimously expected is disturbing. Prima facie, it gives rise to the feeling that the MPC's objective function is skewed more towards growth, with attendant risks of being behind the curve. 

2. It may have been prudent tactically to refrain from a rate cut now, especially in the immediate aftermath of the exit of a hawkish Governor and the recent history of constant tussle with the Government on easing. In fact, just to stay the course would have been a good signal to reinforce perceptions about the central bank's autonomy, leave aside inflation fighting credentials.  

3. A rate cut now reduces the RBI's room to manoeuvre as the Budget quarter approaches. The pressure from the Government to oblige with another cut closer to the Budget will be intense. In response, another rate cut, following this one, will be viewed by the market participants as further proof of the ascendancy of North Block. 

In conclusion, as a statement of intent from a brand new institution to an audience who live on reading the tea leaves, this decision may have the potential of adversely unhinging a few expectations. 

Sunday, October 9, 2016

Weekend reading links

1. Richard Florida points to the work of Paul Jargowsky that documents the rise of concentrated poverty in the US,
Concentrated poverty is defined as neighborhoods or tracts where 40 percent or more of residents fall below the federal poverty threshold (currently $24,000 for a family of four). The study looks at this change across the nation as a whole and within its major metropolitan areas. The number of people living in concentrated poverty has grown staggeringly since 2000, nearly doubling from 7.2 million in 2000 to 13.8 million people by 2013—the highest figure ever recorded. This is a troubling reversal of previous trends, particularly of the previous decade of 1990 to 2000, where Jargowsky’s own research found that concentrated poverty declinedConcentrated poverty also overlaps with race in deeply distressing ways. One in four black Americans and one in six Hispanic Americans live in high-poverty neighborhoods, compared to just one in thirteen of their white counterparts.
There is nothing surprising about this. This may be the evolution of a Schelling sorting equilibrium which highlights the inexorable logic of segregation, even in systems marked by small differences in preferences. Even small increases in aggregate inequality, over time, leads to such segregated equilibriums. School education and housing are well known examples of such forces at work. 

Such concentration of poverty, apart from their socially corrosive effects, also makes it easy to aggregate political discontent. It is no surprise that populist demagogues like Donald Trump find fertile ground for their political ambitions. 

2. Margot Sanger-Katz has a fascinating article in Upshot about political ideology among medical practitioners. She points that while about two-thirds of politically affiliated surgeons, anaesthetists, and urologists are Republicans, a similar share of those from infectious disease medicine, psychiatry and paediatrics are Democrats. In general, higher paying specialties are dominated by Republicans, reflecting their preference to pay lower taxes. 
But such sorting goes beyond political preferences and influences treatment recommendations, as this study of over 20000 primary care physicians in 29 US states by Eitan Hersh and Mathew Goldenberg found out,
They asked the doctors to consider a group of hypothetical patients: one who smoked, one who drank, one who was overweight, and so on. They found that doctors viewed most of their patients’ health with similar seriousness and would advise similar responses. But for three of the hypothetical patients, they found differences. Those patients were devised to have health problems closely tied to hot-button political issues: One used marijuana, one owned guns, and one had a history of abortions. For those patients, Republican and Democratic doctors registered different levels of concern and said they would respond differently. When it came to the patient with a history of abortions, doctors who were Republican said they would be more likely to encourage the patient to seek counseling and express concern about mental health consequences; they also said they would be more likely to discourage the patient from seeking future abortions. For the patient who used marijuana, Republican doctors said they’d be more likely to ask the patient to cut back and to discuss legal risks of using the drug, which is banned under federal and most state laws. For the patient with guns, doctors who were Democrats indicated they’d be more likely to tell the patient not to keep guns at home. Republican doctors, on the other hand, would be more likely to discuss safe storage options.
3. Atul Gawande has more, this time with a brilliant essay on why certain medical practices spread rapidly whereas some others take an inordinate time. Take the example of hypothermia among new-borns,
Newborns have a high body-surface area and lose heat rapidly. Even in warm weather, hypothermia is common, and it makes newborns weak and less responsive, less able to breast-feed adequately and more prone to infection. I noticed that the boy was swaddled separately from his mother. Voluminous evidence shows that it is far better to place the child on the mother’s chest or belly, skin to skin, so that the mother’s body can regulate the baby’s until it is ready to take over. Among small or premature babies, kangaroo care (as it is known) cuts mortality rates by a third... But even in high-income countries we do not consistently use it. In the United States... more than half of newborns needing intensive care arrive hypothermic. Preventing hypothermia is a perfect example of an unsexy task: it demands painstaking effort without immediate reward.
In order to combat this, Gawande is involved with an initiative to provide mentoring support for nurses on precisely such "unsexy" tasks,
With the BetterBirth Project, we wondered, in particular, what would happen if we hired a cadre of childbirth-improvement workers to visit birth attendants and hospital leaders, show them why and how to follow a checklist of essential practices, understand their difficulties and objections, and help them practice doing things differently. In essence, we’d give them mentors... The project has recruited only the first few of a hundred or so workers whom we are sending out to hospitals across six regions of Uttar Pradesh in a trial that will involve almost two hundred thousand births over two years... 
If the intervention saves as many mothers and newborns as we’re hoping—about a thousand lives in the course of a year at the target hospitals—then all that need be done is to hire and develop similar cadres of childbirth-improvement workers for other places around the country and potentially the world. To many people, that doesn’t sound like much of a solution. It would require broad mobilization, substantial expense, and perhaps even the development of a new profession. But, to combat the many antisepsis-like problems in the world, that’s exactly what has worked. Think about the creation of anesthesiology: it meant doubling the number of doctors in every operation, and we went ahead and did so. To reduce illiteracy, countries, starting with our own, built schools, trained professional teachers, and made education free and compulsory for all children. To improve farming, governments have sent hundreds of thousands of agriculture extension agents to visit farmers across America and every corner of the world and teach them up-to-date methods for increasing their crop yields. Such programs have been extraordinarily effective. They have cut the global illiteracy rate from one in three adults in 1970 to one in six today, and helped give us a Green Revolution that saved more than a billion people from starvation.
This is very similar to the role of coaches, something on which Gawande himself has written earlier.

The essay draws parallels with BRAC's success in disseminating the use of oral rehydration therapy to address diarrhoea, largely through a massive door-to-door campaign involving women. Gawande and BetterBirth are trying to do a BRAC in India to address hypothermia and adoption of other post-natal practices. Good Luck to them!

4. As the extraordinary monetary accommodation across developed economies continues unabated, it threatens to upend the prevailing business models. Active managers, with their exorbitant fees, are facing the heat from passive funds,
According to Morningstar, a data provider, since December 2007 passive assets under management have tripled to $5.7 trillion, while assets in active funds have increased by only 54%, to $23.2 trillion. In the first eight months of this year, investors drew down $166.2 billion from actively managed funds specialising in American equities alone. In contrast, passive unds attracted almost $110 billion in new investment.
In the world of low yields, the prevailing model of fund managers is clearly untenable. It is no surprise that a number of the largest pension funds and endowments have been gradually in-sourcing more of their fund management responsibilities.

5. Finally, as the US Presidential election descends into a farce, watch Robert Di Niro here take on Donald Trump. He says he would like to punch Trump on his face!

Saturday, October 8, 2016

The return of micro-lending

The Economist has a feature on the return of micro lending,
In 2015, after examining the results of randomised controlled trials in Bosnia, Ethiopia, India, Mexico, Morocco and Mongolia, American researchers questioned whether microlending worked at all. As expected, offering small loans increased business investment. But it had a negligible effect on poor people’s fortunes. Borrowers seemed to cut back on wage work in order to spend more time bent over their sewing machines or running their small, not terribly profitable shops. These days international donors and charities are much more excited about other approaches, including mobile money and “graduation” programmes, which give livestock to indigent people and teach them how to take care of them. As the development caravan rolls away, though, microlending is booming. MIX, which collects data on the industry, estimates that the number of borrowers worldwide grew by 16% between 2014 and 2015, to 130m. The total loan portfolio is now worth about $96 billion. In India, which has more microborrowers than any other country, lending was 64% higher in the second quarter of this year than a year earlier, according to MFIN, a national industry body.
This is worth pausing,
If capturing new clients is essential to success in microlending, creating new loan products is not. “There is zero innovation,” says Ratna Vishwanathan, the head of MFIN. “It’s a vanilla product”. That is a shame because, although small loans are plainly popular and do no economic harm to the average borrower, they could equally plainly do a much better job of helping people become less poor. Like many tiny businesses, Mr Iqbal’s shop swings up and down. He can be extremely busy around Hindu festivals, when people like to shop, but is idle at other times (when your correspondent arrives at his shop, he is napping). In the slowest months, he cuts back spending on himself and his family until he can scrape together enough for the monthly payment. And he knows to take on only as much debt as he can service in the lean season. At this rate, he is no more likely to prosper than he is to default on his loan.
This applies not just for micro-finance, but regular banking itself. As I have blogged earlier, the focus of financial inclusion has so far been confined to enabling access to institutional finance. But, as India's Jan Dhan Yojana program shows, access still leaves us with critical last mile gaps. It may be that poor people, farmers, and small businesses need products that cater to their unique requirements

Unfortunately, we are busy tinkering at the margins,
An experiment in Kolkata by two American researchers, Erica Field and Rohini Pande, found that offering borrowers a grace period of just two months at the beginning of a microloan doubled the rate at which new businesses were created. Borrowers were able to take bigger risks, which brought bigger rewards on average. After three years business profits were 41% higher and household incomes were up by 19.5%. If microlending could routinely deliver results like that, it would still be the height of fashion. IFMR Lead, a research organisation based in India, is now testing an even more flexible loan. In conjunction with Sonata, it is offering a few hundred people microloans with two three-month “holidays”. Borrowers will still have to pay something each month, but much less than usual.
This is unlikely to get us far. In fact, it is more likely with such products that they fall prey to scale dynamics. As (or, If) such types of loans increase, the rigour of screening will necessarily (to keep transaction costs low and arising from the dynamics of a growing business line) come down so as to be commercially viable. Moral hazard can get baked in very quickly. The cost of capital for lenders can rocket upwards. It is one thing to do such loans in small pilots under the watchful eyes of high bandwidth research assistants, but an altogether different thing when scaled up. 

Thursday, October 6, 2016

Internalizing externalities in Solar Power

As the share of solar and renewable power, especially roof-top and other forms of captive generation, rises, one of the less discussed concerns revolves around its impact on the existing distribution utilities. Consider this story about the impact on the electricity distribution companies from the massive investments in solar and bargain hunting in power procurements by the large Las Vegas casinos,
While corporations are motivated to “go green,” their push to be more energy efficient leaves the utility with less revenue to maintain the grid and can lead to rate increases. This can cause what energy market observers call the “death spiral.” “If people are consuming less electricity, revenue for the company is going down, so they raise rates on others. That forces more of them to defect.” says Bill Ellard, an energy consultant and chair of economics for the American Solar Energy Society. “Soon, they won’t have enough money to keep gear, power lines, transmission stations working,” Ellard adds. “We have an old, ancient grid. A lot of power companies are just duct-taping and band-aiding things. Now monopolies like NV Energy are competing with free market innovation, and innovation is not their mantra. You don’t have to innovate when you’re a monopoly.” Meanwhile, corporations that have the wherewithal to move forward without the utility are doing so. This year, MGM expanded the solar array at Mandalay Bay Resort and Casino, making it one of the largest rooftop systems in the country. The 8.3 megawatt array can power the equivalent of 1,340 single-family homes, and can handle up to 25 percent of Mandalay Bay’s energy needs when fully active during the day... 
While MGM and Wynn will buy their electricity from a brokerage, they still need to use NV Energy’s transmission lines and other equipment, and will remain customers of the utility in that regard... NV Energy, the state-regulated energy monopoly, has to serve a diverse group of energy users and makes plans on how to meet demand years in advance. Confronted with increased use of solar power as the systems become more affordable, the company has moved to stabilize revenue. Earlier this year, NV Energy decreased the amount it pays residential owners of solar arrays for excess electricity they send into the grid, causing a public outcry. Eventually existing solar users were grandfathered into the original rate.
There are three problems here. One, consumers who use renewables during sometime of the day and rely on grid power during peak hours pose grid management problems for the utility. Furthermore, they also sell power back to the grid. Two, there is an investment management problem that distribution companies face with planning their future investments in distribution and transmission networks. Then there are also the investments required to support the unknown amounts of potential sales into the grid. Three, the power tariffs, both consumption and sales back to the grid, do not reflect these externalities imposed in grid and investment management. 

It is only a matter of time, as the scale of such transacted power rises, that the commercials of the current business models on roof-top solar and large-scale captive power become questionable. Give-aways like net metering will have to end and replaced with more tariffs that internalise the costs of fixed investments and grid management requirements. 

But distribution utilities cannot afford to relax. This could change with another disruption, that in storage. If it becomes possible to store power at commercially viable price points, as looks likely to happen in the medium-term, then the bargaining power of the utility's consumers increase enormously. 

Leaving aside all these details for a moment, an underlying subtle message that I draw from the churn that is happening in this market is that cost recovery in utility services essentially rests on cross-subsidy. The larger and richer consumers provide both the economies of scale and higher tariff increments that can support commercially viable network-wide distribution. In other words, cross-subsidy in inherent to universal supply of such services. So how will governments respond to this emerging scenario where the richer and larger consumers move away from utilities? 

Tuesday, October 4, 2016

This time is no different

Livemint reports that the EPC bids for the National highway projects have been following the same script of aggressive and over-optimistic bidding,
A total of 52 EPC road projects worth about Rs.26,700 crore have been awarded between January and June, according to data compiled by brokerage Equirus Securities Pvt. Ltd. Of these, close to 40 projects were won below the National Highways Authority of India’s estimated cost and each of the projects attracted three to 14 bidders. The government’s push for a new low-risk hybrid-annuity model (HAM), in which the state commits up to 40% of the project’s total cost to kick-start private sector investments, and the emergence of a number of smaller, regional companies have added to the competitive intensity, according to road developers and analysts.
And to get a sense of the scale of froth,
Larsen and Toubro Ltd (L&T) has... won five awards in the six months ended 30 June, all of them below estimated costs. It won two EPC projects in Tamil Nadu in February by bidding 27% and 13% lower than the project cost... In March, L&T won a road project in Kerala at a bid that was 38% below the estimated project cost. Similarly, Bhopal-based Dilip Buildcon Ltd has won six contracts, which were between 13% and 31% below the estimated cost.
It is inconceivable that these projects can be completed at such optimistic cost estimations. Given the transaction costs and inevitable delays (even with full site acquired), it would be a near miracle to make reasonable returns at such cost estimates. The public agency which is allocating the bids and the bankers who are lending to such developers are clearly living in a world with a different set of economic rules. 

Clearly developers are bidding aggressively to bag the contract, with the expectation that they can renegotiate. Further, for cash strapped infrastructure contractors, the 40% upfront cash payment holds great attraction. Cash flow considerations, therefore, trumps commercial viability. 

In the real world of infrastructure financing, there is nothing unusual about such reckless bidding. In fact, it is a truism that finance loses its disciplining powers and developers their prudence, when the market is on the upswing, as is the case with roads EPC projects. The only surprise is that the latest cycle has been initiated even as the damages from the previous bout still remains large on the balance sheets of both developers and lenders.  

Monday, October 3, 2016

Developing world needs jobs and entrepreneurship, but much more of the former

More on the globalisation theme. Does free trade and globalisation, with its accompanying sweatshops, increase incomes and welfare? Is globalisation good or bad for the poor? One would have thought that the rise of China was proof enough to settle the debate.

Chris Blattman and Stephan Dercon may have re-ginited the debate with their results from a randomised control trial (RCT) from Ethiopia. Their six year study presents inconclusive evidence on the beneficial effects of trade and investments on host developing country populations, 
As low-income countries industrialize, workers choose between informal self-employment and low-skill manufacturing. What do workers trade off, and what are the long run impacts of this occupational choice? Self-employment is thought to be volatile and risky, but to provide autonomy and flexibility. Industrial firms are criticized for poor wages and working conditions, but they could offer steady hours among other advantages. We worked with five Ethiopian industrial firms to randomize entry-level applicants to one of three treatment arms: an industrial job offer; a control group; or an “entrepreneurship” program of $300 plus business training. We followed the sample over a year. Industrial jobs offered more hours than the control group’s informal opportunities, but had little impact on incomes due to lower wages. Most applicants quit the sector quickly, finding industrial jobs unpleasant and risky. Indeed, serious health problems rose one percentage point for every month of industrial work. Applicants seem to understand the risks, but took the industrial work temporarily while searching for better work. Meanwhile, the entrepreneurship program stimulated self-employment, raised earnings by 33%, provided steady work hours, and halved the likelihood of taking an industrial job in future. Overall, when the barriers to self-employment were relieved, applicants appear to have preferred entrepreneurial to industrial labor.
There are three observations

1. This should not be mistaken to posit the debate on development as a choice between "productive wage employment" and "entrepreneurship". We need both, though more of the former than the latter. After all, there are only so many entrepreneurs that an economy can support. 

2. This is a very partial equilibrium finding. More specifically, it only tells that in the initial stages of industrialisation, as Ethiopia undoubtedly is at, labor markets can be very exploitative. Further, in such conditions, the private returns on investment may be higher from entrepreneurship than wage employment. 

3. However, with time, based on historical experiences of development trajectories in recent decades, a different dynamic emerges. On the one hand, competition, broadening of industrial base, better regulations, and so on contribute to making sweatshops far less exploitative and raises the general income levels. On the other, small entrepreneurship tends to spawn a large and unproductive informal sector. 

Sunday, October 2, 2016

Skill-biased labor market graph of the day

It is now well known that offshoring and automation, in that sequence, have dramatically affected the labor markets in developed economies. Routine, repetitive, and outsourceable jobs, which form the vast majority of the labor market, have fallen prey to these trends. Only those requiring high skills and cognitive resources, and less skilled manual jobs in caring and assisting occupations have escaped the trend. 

The St Louis Fed has a graphic that capture these trends. It shows how routine cognitive (sales and office occupations) and routine manual (construction, transportation, and manufacturing) occupations have been declining since the eighties.
Here too, migration has the effect of increasing the supply of labor available for the manual jobs, thereby depressing wage growth and crowding-out local labor. Those with non-routine cognitive skills are the only real winners in the economy. The attendant widening of inequality is only to be expected.

Saturday, October 1, 2016

The backlash against globalisation

Interesting points from a nice article in the Times on the challenge facing globalisation. The concerns from the distributional consequences of free trade could be papered over in the initial years of the current phase of globalisation because of fortuitous global factors,
The North American Free Trade Agreement, or Nafta, exposed workers in the United States to competition with Mexico, but its passage came in the mid-1990s, just as investment was pouring into the web, creating demand for a range of manufactured goods — office furniture for Silicon Valley coders, trucks for the couriers delivering e-commerce wares. China’s entry into the World Trade Organization in 2001 unleashed a far larger shock, but a construction boom absorbed many laid-off workers... But the pervasive stagnation (today) has left little cover for those set back by globalization.
The effect of China's entry has been the tipping point, both in terms of its scale and its exposure of concentrated fault lines,
In the first 13 years after China entered the W.T.O., its exports of goods swelled to nearly $2.3 trillion in 2014 from $266 billion, according to the World Bank. The beneficiaries of this surge include anyone who has bought practically anything touched by human hands — an iPhone, a car, a Christmas ornament. Corporations that used China to cut costs raised their value, enriching executives and ordinary investors. The casualties of China’s exports are far fewer, but they are concentrated. The rugged country of western North Carolina suffered mass unemployment as Chinese-made wooden furniture put local plants out of business. So did glassmakers in Toledo, Ohio, and auto parts manufacturers across the Midwest. A paper published last year by a trio of economists — David H. Autor at the Massachusetts Institute of Technology, David Dorn at the University of Zurich and Gordon H. Hanson at the University of California, San Diego — concludes that Chinese imports eliminated nearly one million American manufacturing jobs from 1999 to 2011. Add in suppliers and other related industries, and the total job losses reach 2.4 million.
It is for this reason that social safety nets become a critical ingredient of any public policy that promotes free trade. Unfortunately, here too orthodoxy comes in the way by limiting such social safety nets on grounds of incentive compatibility. Interestingly, the comparison between the US and Europe is instructive,
In the five years after a job loss, an American family of four that is eligible for housing assistance receives average benefits equal to 25 percent of the unemployed person’s previous wages, according to datafrom the Organization for Economic Cooperation and Development. For a similar family in the Netherlands, benefits reach 70 percent.
The Economist makes a spirited defence of globalisation. It writes,
The worst-off benefit far more from trade than the rich. A study of 40 countries found that the richest consumers would lose 28% of their purchasing power if cross-border trade ended; but those in the bottom tenth would lose 63%. The annual cost to American consumers of switching to non-Chinese tyres after Barack Obama slapped on anti-dumping tariffs in 2009 was around $1.1 billion, according to the Peterson Institute for International Economics. That amounts to over $900,000 for each of the 1,200 jobs that were “saved”.
And more
A study by Pablo Fajgelbaum of the University of California, Los Angeles, and Amit Khandelwal, of Columbia University, suggests that in an average country, people on high incomes would lose 28% of their purchasing power if borders were closed to trade. But the poorest 10% of consumers would lose 63% of their spending power, because they buy relatively more imported goods.
There is no denying the obvious benefits of trade. But, as I have blogged here, the central challenge of globalization is in managing the political economy of its negative externalities. While its benefits are diffuse and less appreciated, its costs are concentrated and intense. Democracies, especially in times when economic growth is weak, cannot afford to gloss over the sufferings of the losers, howsoever big the net social benefits.