Saturday, June 23, 2018

Transformations within governments

New MGI report on achieving success with transformational programs within governments. The report studied 80 cases of transformation projects within governments across 50 countries and came up with five essential ingredients for any successful transformation.

1. Committed leadership 
2. Clear purpose and priorities
3. Cadence and co-ordination in delivery
4. Compelling communication
5. Capability for change

The report claims that embracing these five "disciplines" more than triples the likelihood of success with transformational implemenations. It advocates a combination of the five ingredients with three new age concepts - focusing on citizen experience, design thinking, and agile implementation.

While more or less all such case study examples are more likely an exaggerated illustration of the specific use cases and its channels of impact, and also an advertisement for McKinsey involved transformations (and therefore to be taken with a pinch of salt), the larger message is well taken. 

There is no substitute for passionately committed and decisive leaders who lead from the front, prioritise on a few objective, have a clear but flexible enough plan, have put in place a dedicated team with requisite capabilities, monitor implementation closely and intensely, co-ordinate among all government agencies, and engage deeply with all those affected by the change and communicate with them.

Monday, June 18, 2018

Three new business concentration graphs

Market concentration and its harmful effects on the economy is well documented. But important decision makers (and opinion makers), especially in the US, remain unconvinced by the growing evidence. Or is it a matter of them being captured?

The latest comes in the form of the decision last week by a US Federal Court judge allowing the $85 bn merger of AT&T and Time Warner. The former provides phone, internet, video and data services (or distributes content), while the latter owns television channels across news, entertainment, and sports (produces content), and together they "can count as customers practically every household in America". The Judge ruled against a very weak challenge by the US Justice Department that the combination of a major producer and distributor of content could substantially lessen competition in media industry. The Steven Pearlstein in Washington Post has very nicely described the judgement as a "hatchet job" involving selective and biased evidence by a "judicial scoundrel"!

Be that as it may, here are three latest graphs that highlight the growing market concentration.

David Leonhardt has two graphs on economy-wide business concentration in the US from Business Bureau's Business Dynamics Statistics. The first captures the rising share of businesses with more than 10000 workers and the declining share of those with less than 20 workers.
And companies with more than 10000 workers employ more people than those with less than 50 workers. 
His documentation of the changes in the past quarter century are stunning,
In the late 1980s, small companies were still a lot bigger, combined, than big companies. In 1989, firms with fewer than 50 workers employed about one-third of American workers — accounting for millions more jobs than companies with at least 10,000 employees... The share of Americans working for small companies fell to 27.4 percent in 2014, the most recent year for which data exists, down from 32.4 in 1989. And big companies have grown by almost an identical amount. Today, companies with at least 10,000 workers employ more people than companies with fewer than 50 workers.
The third graphic covers a forthcoming IMF study on business concentration in developed and developing economies using data for publicly listed companies in 74 countries. It captures a measure of market concentration, average mark ups (or how much a company charges for its products compared with how much it costs to produce an additional unit of this product, expressed as a ratio).
The rise since the early nineties in the developed economies is capitalism gone berserk! Markups have increased by 43 percent since the eighties in those countries.

Ananth has a nice post on the irony of how the elites and decision-makers, even at places like the IMF, continue to pay lip-service to the evidence that their own research department comes up with.

Tuesday, June 12, 2018

The challenge with implementing public policy

You can have the best structured and incentive compatible policies and yet not have much impact on the ground in addressing the underlying problem. And this state of affairs can persist for years, even decades. Not for nothing is state capacity, in the opinion of this blogger, the biggest challenge facing India. 

Crop insurance and foodgrain procurement are two examples of where acute last mile gaps come in the way of realising desired outcomes. In both cases, it is easy enough to announce the best possible design of a crop insurance or crop procurement policy. But those announcements mean nothing when the rubber hits the road. In case of the former, the constraint is the insurance payout, while with the latter it is the actual physical procurement itself. There are no magic pill universally replicable innovations out of these problems.

Indian Express carries a story on the troubles faced by farmers selling off their produce at the public procurement centres at a mandi in Vidisha district of Madhya Pradesh.
Roop had received an SMS eight days ago from the cooperative society with which they are registered, asking him to come to the mandi on Wednesday, but the father and son chose to come a day earlier... Their token number, a chit issued the day they reached, is 234 — there are 233 farmers ahead of them in the queue. No more than 40 trolleys can be weighed in a day, which means the duo will have to spend at least five days before their turn comes... Until last year, trading at the mandi would happen between noon and 4 pm, when farmers would come, post-lunch, with their produce, which would be auctioned in the presence of mandi officials. This year, after chana prices started crashing due to a bumper crop and less demand, the government decided to buy directly from farmers — at Rs 4,500 per quintal — for the Central pool. Selling to the government offers farmers better returns than selling to private traders, which explains the rush... While the Singhs own their tractor-trolleys, many other farmers have hired vehicles to transport their produce to the mandi. “The rent for the first day is calculated according to the weight of the produce (anywhere between Rs 40 and Rs 80 per quintal of produce). From the second day onwards, we have to pay a daily rent for the trolley,” says Roop... The farmers wonder if a dharma-kanta (a weighbridge) would have eased their woes unlike the existing practice of unloading the produce on the floor of the mandi, packing it in bags, weighing each of them and sealing them, the entire process taking nearly 80 minutes for 40 quintals... Six days after they arrived at the mandi, the Singhs managed to sell chana from one of their trolleys. But they were told the chana in the second trolley had impurities. They will now get it cleaned and come back.
Consider the problems. Immediately after harvest, with chana prices crashing following a bumper harvest, farmers rush to offload their produce at the procurement centres over a very short time window. The procurement centre, without any weigh bridge or other logistics, has to get the produce graded, packed into gunny bags, and weighed. All this takes up an inordinate time for a single farmer and farmers stand in line for hours days! This wait in turn inflicts heavy tractor rental charges and other opportunity cost on the farmers. And even after waiting for days to get their chance, farmers face the prospect of being turned away and being asked to come back after rectifying some defect or other!

Much the same (difficult last mile gaps) applies to the Soil Health Cards or electronic national agriculture market place (eNAM). Sample this series of actions suggested on eNAM,
The following steps should be taken in a concerted manner: (i) unyielding focus on agri-market reforms starting with basics of assaying, sorting, and grading facilities for primary produce as per nationally recognised and accepted standards; (ii) creating suitable infrastructure at mandi-level (like godowns, cold storages, and driers) to maintain those standards; (iii) bringing uniformity in commissions and fee structures that together do not go beyond, say 2%, of the value of produce; and (iv) evolving a national integrated dispute resolution mechanism to tackle cases where the quality of goods delivered varies from what is shown and bid for on the electronic platform.
Each of the four steps, after putting in place the enabling implementation frameworks, need to be materialised. And that is where state capacity, persistent action, and committed leadership becomes necessary. 

Programs like Fasal Bima Yojana, Bhavantar Bhugtan Yojana, Soil Health Cards (see this and this), and eNAM are examples of reforms where enacting the rules and regulations is the easier part. But when the rubber hits the road, state capacity and other systemic constraints start to bind. There is only so much (mostly tinkering at the margins) that can be done with technology and innovation.

In simple terms, successful implementation of these require committed and stable leadership at the Ministry/Department level for atleast five years, maybe as mission-mode projects, with the mandate being to fix the plumbing challenges and demonstrate success with at least a few models. And they need to be complemented with responsive systems both at the level of the District Collector and the Joint Directors (or equivalent) of Agriculture in the District, in at least some of the districts. And it needs to be done in a phased manner with diligence, practical compromises and improvisation where required. 

And also, a one speed nationwide roll-out of such things may not be possible (state capacity) nor desirable (since it may run into political economy challenges). We need to look at the possibility of doing such stuff as a multi-speed campaign (which would also not concentrate discontent) - get everyone to the starting line with all the enablers (both regulations and requisite documentation), make available a practical implementation plan with the likely constraints and possible solutions around it, let the districts/states run with it at different speeds, and foster healthy (but not high enough stakes) competition among them. 

Many things which can be done relatively easily at the district level may not be possible for the States or Government of India to prescribe. It demands more of a gradual and bottom-up diffusion approach than a top-down, one-speed, universal coverage approach. 

This applies as such to the IBC too. As we go ahead, some or all of the following are likely - the Resolution Professionals (RPs) will be captured, judiciary will intervene indiscriminately, NCLT will be compromised, promoters will create hurdles even after resolution, and so on. We need some concerted systemic effort to be at it for a reasonably long enough period of time to allow some hysteresis to set in. 

A practical agenda for a government is to identify no more than 10 schemes/priorities, structure them as Missions, appoint an appropriate Joint Secretary/Mission Director for each for five years, give them a clear (but practical) road map, equip them with sufficient resources, and let them run with it for 5 years. And monitor them closely for five years at different levels.

Monday, June 11, 2018

Social protection programs and impact on poverty

A recent article in the Economist pointed to success of Ethiopia's social safety net programs. It said that social safety net programs formed 1.5% of GDP in Sub-Saharan Africa. It writes,
Ethiopia’s rural scheme is widely regarded as a success. It has reduced rural poverty and helped the poor buy food during a severe drought in 2016 that might have led to famine.
Now this is deceptive. What do we mean reduced poverty? Does it mean that people's lives have undergone a significant change? I guess all this goes back to the artificial minimalistic thresholds that we have constructed around per capita incomes to define poverty levels. 

The World Bank defines Social Protection (SP) programs as consisting of social insurance (mainly public pension schemes covering old age and disability), social assistance (cash and in-kind transfers and workfare schemes, often targeted to the poor), and labor market programs (training, entrepreneurship support, unemployment benefits).

Martin Ravallion and Co explore the impact of social protection programs on the poorest, the floor level of incomes,
The bulk of the impact of SP in developing countries is due to public pensions, which lift the floor by $0.38 a day. This too is below the mean spending on such pensions, which is $0.67 per day. Social assistance on its own only raised the floor by $0.015 per day on average—merely 8% of the (already low) level of average spending on social assistance. The bulk of the impact of SP on the headcount index (5% points) is also due to contributory pensions. Social assistance on its own reduced the poverty rate by 2% points. Countries that spend more on social protection tend to have a higher floor. The correlation coefficient is 0.751. Mechanically, this relationship reflects both differing levels of SP spending and differing transfer efficiencies. Transfer efficiency in reaching the poorest varies greatly. We see that very few countries attain a value of FTE of unity or more. (Recall that this is the ratio of the gain in the floor due to SP to mean spending.) For the bulk of countries (87% of the sample), the gain to the poorest is less than mean SP spending. FTE tends to be better for social assistance on its own, for which the median value is 0.934, as compared to a median of 0.630 for all SP; 43% of countries have FTE for social assistance greater than unity. In addition to FTE, we measure the efficacy of SP in reaching the poorest 20%, giving our second measure of transfer efficiency, GTE. The two measures are correlated (r = 0.505), but certainly not perfectly; some countries are better than others at reaching the poorest people given their efficacy in reaching the poorest 20%. GTE is positively correlated with spending per capita (r = 0.656), but that is not true for FTE (r = -0.021). As countries spend more on social protection, a larger share of that spending tends to reach the poorest 20% but not the poorest.
Now the takeaways in English. We need to make the distinction between poverty alleviation (allows people to have three meals a day compared to two) and poverty eradication (allows people to have meat twice a week, or a more dignified human existence). SP programs in almost all the developing countries help address the former. It will keep people meaningfully above the biological poverty line. It does little, on their own, to help the poorest transition to any meaningfully higher income level. This is just stating the obvious - social safety nets are for poverty alleviation, and not elimination.

If this is the case, then how appropriate is to use indicators like increase in savings or increase in aggregate consumption to measure the impact of social assistance programs like cash transfers? A more relevant measure of impact would be just the change in food consumption - having enough to eat three meals against the typical one or two, or eating meat once a week, or something like those.

This is a bit like the debate about the role of women self-help group movement. It is often confused as an instrument of economic empowerment, when its more relevant utility may be as a tool of social empowerment

Sunday, June 10, 2018

Some PE myths busted

Fascinating article by Daniel Rasmussen that tests some of the claims made about the superior nature of private equity (PE) investments.

PE firms claim that their investments "accelerate growth and more efficient operations due to superior capital structure and PE managers ability to make long-term investment decisions that public companies cannot make". On this, an examination of 390 deals in the US, accounting for over $700 bn in enterprise value representing the majority of the largest deals ever done, for the financials of the portfolio companies reveals,
In 54 percent of the transactions we examined, revenue growth slowed. In 45 percent, margins contracted. And in 55 percent, capex spending as a percentage of sales declined. Most private equity firms are cutting long-term investments, not increasing them, resulting in slower growth, not faster growth... In 70 percent of cases, PE firms are leveraging up the businesses they buy. PE firms typically double the amount of debt on the balance sheet, from 2.5x ebitda to 5x ebitda—the biggest financial change apparent from our study... As an industry, PE firms take control of businesses to increase debt and redirect spending from capital expenditures and other forms of investment toward paying down that debt. As a result, or in tandem, the growth of the business slows. That is a simple, structural change, not a grand shift in strategy or a change that really requires any expertise in management.
The addiction to debt is the Achilles Heel of PE,
There is a big difference—bigger than most realize—between what private equity used to do (buy companies at 6–8x ebitda with a reasonable 3–4x ebitda of debt) and what private equity does today (buy companies at 10–11x ebitda with a dangerous 6–7x unadjusted ebitda of debt). Debt is a double-edged sword. It can provide great benefits if used judiciously, but if regularly applied in large dollops, it can create massive problems... The real reason PE firms want control of the companies they buy is not because of superior strategic insight but because they want to significantly increase debt levels. And while debt magnifies positive returns and enhances the returns of good decision-making, it can also cut the other way, exacerbating negative returns and punishing bad decisions.
 On returns,
From 1990 to 2010, private equity returned 14.4 percent per year, compared to 8.1 percent per year for the S&P 500 index. This 6.3 percent outperformance was net of private equity’s “2 and 20” fee structure, meaning that the gross return of private equity over this period was more like 20 percent per year... since 2010, private equity has, on average, underperformed the public equity market. Cambridge Associates’ U.S. private equity index has lagged the Russell 2000 by 1 percent and the S&P 500 by 1.5 percent per year over the past five years...
The Canadian Pension Plan Investment Board (CPPIB) and the Abu Dhabi Investment Authority (ADIA) did a bottom-up analysis of 3,492 private equity transactions from 1993 to 2014 to understand these dynamics. They found that private equity deals are different on two key quantitative dimensions from public equity investments. First, PE firms buy companies that are significantly smaller than broader public benchmarks. The median market capitalization of a company in the S&P 500 is $41 billion. The median market capitalization of a small-cap company in the Russell 2000 is $2 billion. But the median enterprise value of PE deals is only $250 million. Only about fifteen private equity investments have ever been larger than the maximum market capitalization of the small-cap index. Second, PE deals are significantly more levered than the typical public equity. The CPPIB and ADIA found that the average ratio of net debt to enterprise value at inception has been approximately 65 percent. The typical Russell 2000 small-cap company is levered at about 16 percent while the median large-cap company in the S&P 500 is levered at about 18 percent.
These two factors have been basically constant since the early 1980s. Changes in deal size and deal leverage levels do not explain why performance relative to public equity markets dropped off after 2010. And differences in size and leverage explain only about 50 percent of private equity’s historical outperformance of public equity markets. The factor that has changed is valuation. Private equity firms have historically bought companies at much lower valuations than the broader public markets. Here we see a significant shift from before the financial crisis to after. Since the crisis, the flood of money into private equity has driven up purchase prices significantly, eliminating the formerly large gap between private and public market valuations... 
Private equity is price sensitive because of the use of debt. Higher prices require more debt, leading to higher interest costs and higher risk of bankruptcy... The first approach is to look at PE deals and compare returns to purchase price. One PE firm did just such an analysis and found that over 50 percent of deals done at valuations of more than 10x ebitda lost money and that the aggregate multiple of money was barely over 1.0x (i.e., for every dollar invested, only slightly more than one dollar was returned to investors). The second is to compare the average purchase multiple in a given year to the returns of the funds from that vintage year. There is a –69 percent correlation between purchase price and vintage year return, a strong inverse relationship... The third is to look at PE-backed companies that IPO. My firm, Verdad, looked at every company taken public in the United States and Canada by a top-100 PE firm since the financial crisis, a data set of 195 IPOs with an aggregate ebitda of $66 billion and an aggregate market capitalization of $728 billion... According to our research, the cheaper IPOs dramatically outperformed the Russell 2000, the moderately priced IPOs matched the Russell 2000’s return, and the expensive IPOs underperformed.
In the context of the criticism of short-termism associated with public equity markets and the resultant long-term flexibility that private equity provides, this punchline is delightful,
And it is of course ironic that the same PE firms making these arguments—Blackstone, KKR, Apollo—have themselves gone public.

Saturday, June 9, 2018

How much low can this get?

Two news stories over the week gave good illustrations of how far down the slope that the mainstream discourse and the establishment elites have slipped.

The first is an excellent story in FT about the latest in line from Wall Street's stable of financial market innovations. This one is manufactured default. In simple terms - buy default insurance on a company for a specific form of default, sell that company a loan which it "defaults", pocket the default insurance even as the loan keeps getting serviced in normal course. The graphic below nicely captures the transaction.
The description,
It is the debt equivalent of a controlled explosion: offering a company favourable financing, such as low interest loans, to convince it to intentionally default in a way that will trigger payouts on CDS contracts, but without bringing down the whole company. By doing this GSO pushed its trading edge on rivals to the limits of what many saw as legal.
The protagonist being Blackstone Group's GSO Hedge Fund, and the market being that for the very controversial Credit Default Swaps (CDS). And for once, Goldman Sachs was at the receiving end of chicanery that they have been used to dispensing, ending up owning the CDS which GSO had purchased. 

There are two observations. One, the surprising thing here was what a friend described as the break down of the "honour code" among the Wall Street majors. Goldman complained in public about manufactured defaults. Clearly, even by Goldman's standards this was a new low!

Two, this was not the work of a rogue trader. This was led by a Senior Managing Director, who apparently sat on  Blackstone's European Investment Committee. Clearly this was a part of Blackstone's (or GSO's) formal business plan. 

The second concerns this article on the happenings at London's Evening Standard tabloid whose editor is the former British Chancellor of Exchequer George Osborne (HT: Ananth). The ubiquitous London daily may be the first to almost formally breakdown the barrier between news and advertisements and package advertisements as news. Here is the summary,
London’s Evening Standard newspaper, edited by the former chancellor George Osborne, has agreed a £3 million deal with six leading commercial companies, including Google and Uber, promising them “money-can’t-buy” positive news and “favourable” comment coverage... The project, called London 2020, is being directed by Osborne. It effectively sweeps away the conventional ethical divide between news and advertising inside the Standard – and is set to include “favourable” news coverage of the firms involved, with readers unable to differentiate between "news" that is paid-for and other commercially-branded content... The London Evening Standard has a circulation of close to 900,000 and distributes more copies within a two-mile radius of Westminster than the Times does across the UK nationally. Many London commuters, who pick up their free copy of the Standard at underground and rail stations, will be unaware that they will be reading paid-for news coverage that is part of a wider commercial deal.
There is another important dimension to this story - the conflicts of interest associated with George Osborne. He also hold a £650,000 a year part time job (a day a week) with BlackRock, which holds a £500 m stake in Uber, one of the six groups.

Clearly, if these are true, Osborne is pioneering the standards for a new low in the formal news media industry. 

It also draws attention to the relevance of career politicians, as against those successful elites who foray into politics occasionally. Are we better served by corrupt career politicians who may have sufficient administrative capabilities? Or are we better off with fleeting professionals (and in the net maybe equally corrupt in a more sophisticated way) whose administrative capabilities are questionable (assuming that it does require some experience of government processes to be able to control government bureaucracies and get stuff done)? After all how can we reconcile President Obama who would have been confronted with very hard decisions on Wall Street firms and regulations governing them with Citizen Obama who is hobnobbing with them in the most egregious manner? Or Governor Ben Bernanke and Economist Ben Bernanke?

Now consider this. Both Blackstone and its executives, and George Osborne form part of the liberal elite establishment on both sides of the Atlantic. Their actions and the venality inherent in them are clear enough. Despite these they remain the most respectable icons of the establishment. 

I struggle to understand why Trump's actions are any more morally repugnant than these? I can understand the indignation that comes out when Trump uses public office to aggrandise himself. But I cannot understand when such egregious fraud and venality by the icons of the liberal establishment, which by the way is pervasive, gets nary a mention. FT has to be complimented for covering the GSO story. If this is the case, why should we at all be surprised by Trump or Brexit?

Friday, June 8, 2018

Predictive policing to deter crime

From the Economist Technology Quarterly,
Crime does not occur randomly across cities; it tends to cluster. In Seattle, for instance, police found that half of the city’s crime over a 14-year period occurred on less than 5% of the city’s streets. The red squares in Foothill district cluster around streets near junctions to main roads—the better to burgle and run while homeowners are at work—as well as around businesses with car parks (lots of inventory, empty at night) and railway stations. Burglars who hit one house on a quiet street often return the next day to hit another, hence the red squares.
The reference is to PredPol, a leading crime prediction software, which is used in Foothill and other districts across the LAPD, and each red square represents 2.3 hectare.  

Such algorithmic applications have two use cases - one to monitor the policeman's performance by measuring arrests and other specific actions, and second to deter crime by increasing surveillance and patrolling in high-risk areas. 

It may be the second use case that carries greater relevance for police districts in developing countries. Instead of focusing on punitive actions and personnel performance management, supervisory officials could focus attention on whether resources are being deployed in line with the diagnosis generated by the algorithms so as to deter crime. While the counter-factual of crime prevented is not easy to comprehend or communicate, this is a more sustainable and appropriate approach to using such applications, especially in the early stages.

I am reminded of the story of the Municipal Commissioner who used a similar approach to get the public health staff to keep the city clean. Sanitation in cities is critically dependent on night-sweeping of main roads and early morning garbage lifting, and cleaning of roads and open drains. It is therefore a practice for good Municipal Commissioners to make early dawn surprise rounds of the city streets. Though the Commissioner rarely ventures out of his car during the couple of hours of morning rounds, the likelihood of a surprise round by the Commissioner (or his/her easily recognisable car) has a powerful effect in keeping the public health workers on their toes.

Some of the more enterprising Commissioners, instead of waking up early in the morning, would send out just their vehicles with instructions to the driver to randomly cover a few streets! The galvanising effect was just as same! The same could apply to Police Commissioners making surprise night patrols. Anecdotally at least, in weak capacity systems, one could argue that Commissioners (Municipal and Police) who make shirking and non-compliance costly are among the most effective officers.

Signalling and deterrence are powerful forces in disciplining weak capacity systems and keeping order.

Tuesday, June 5, 2018

Credit market access for low income countries, but at what cost?

One of the main objectives of international development agenda has been to enable greater access to private capital for low income countries. Though the headline objective has been achieved, the unintended consequences appear to be not very benign. The IMF's latest Fiscal Monitor has some very interesting snippets on this.

Diversifying away from multilateral and bilateral aid, low income countries have been able to increase their access to non-concessional private sources. Market access has been realised...
... and non-concessional lending takes up the dominant share of borrowings in some of the largest low-income countries.
But this trend has coincided with interest expenditures touching the highs prior to the debt-forgiveness initiatives of the early noughties...
... and indebtedness is slowly climbing back to the pre-debt relief times.
All this has squeezed public investment, thereby imperilling future growth.
This could not have been any different. These low-income countries struggle with weak state capacity, very low and stagnant domestic tax revenues, pervasive macroeconomic instability, and very corrupt governments. They have very limited capacity to absorb commercial capital and generate the necessary returns (in terms of economic output growth) to be able to service the high cost debt. The infamous $850 m Tuna Bonds issued by Mozambique ostensibly to promote fishing is only the most egregious example.

It is only a matter of time before we will have the need for another round of debt reduction initiative. The only difference being that this time it would involve private creditors and not governments, and why should the former play ball in the name of development? And unlike Argentina, these small and far less powerful countries would be at the mercy of distressed asset vultures like Elliot Capital Management. Heck, when even Greece could not get any meaningful debt reductions, how could we expect Congo or Zimbabwe to swing something better?

Talk about operation successful, but patient dead!

Monday, June 4, 2018

Anti-trust action in labour markets?

The case for anti-trust action is evident for most people except the American regulators and regulated entities.  

The latest evidence comes from Eric Posner, Glen Weyl, and Suresh Naidu, who demonstrate labour market concentration and monopsony power exercised by corporations over workers in several labour markets in the US. They argue that it lowers economic growth, raises prices, disadvantages workers, and widens inequality. Here is Cass Sunstein on their work,
Their central argument is that in the United States, many labor markets are not competitive. Employers have a ton of market power. They use it to suppress wages, often harming low-income workers in particular... Posner and his co-authors estimate that the economic power of employers is reducing overall output and employment by a whopping 13 percent — and labor’s share of national output by 22 percent. Their driving idea is “monopsony,” which arises when corporations have market power in their purchases of goods and services, including labor. As a result, employers may be able to drive down wages and benefits and to provide poor (and unsafe) working conditions.
Posner and colleagues show that anti-trust regulators generally ignore labour market power while evaluating mergers and confine themselves only to product market power, even though the latter invariably leads to the former. In fact they find that increased business concentration and attendant firm power leads to a compression of labour share of national income by upto a fifth. They write,
Employment, we calculate, is 5 to 18 percent less than it would be in a competitive market... Given the way our economy works historically, labor’s share of economic output should be about 74 percent if labor markets were perfectly competitive. Because of employers’ power to drive down wages, labor’s share of economic output falls to somewhere between 51 and 64 percent. This transfer significantly increases income inequality.
To put this into more concrete terms, consider the market for nurses. The median wage for a nurse is about $68,000. Given what we know about the labor market power of medical institutions, the true competitive wage for a nurse would be at least $90,000, possibly as much as $200,000. However, because most areas have few hospitals, they can suppress nurses’ wages without worrying that nurses will move to a rival hospital. Some nurses will drop out of the labor market entirely, but the hospital still earns a greater profit by shrinking its operation and cutting wages dramatically.

For the labor market as a whole, the median annual compensation is $30,500. If markets were competitive, we estimate that this amount could rise to $41,000, and possibly to as much as $92,000. If labor market power reduces employment and wages, then it must also reduce government’s revenue from taxes... Our calculations suggest that revenue declines by 20 to 58 percent as a result of labor market power.
In sum, growing labor market power may well be a significant explanation of the host of maladies that have beset wealthy countries, notably the United States, in the past few decades: declining growth rates, falling labor share of corporate earnings, rising inequality, falling employment of prime-age men, and persistent and growing government fiscal deficits... Many conservative economists blame high taxes for these problems. But inordinately high taxes cannot explain these trends, because tax rates have been cut several times during this period. Nor can globalization and automation. Globalization and automation can help explain why inequality has increased but not why economic growth rates have stagnated: On the contrary, globalization and automation should have increased economic growth (by expanding markets and by reducing the cost of production), not reduced it.
They argue that a labor market is confined to a few sq km area, in so far as people are reluctant to go beyond that in search of jobs. And in most localities business concentration means that some businesses have come to exercise significant labour market power. Non-compete clauses which prevent workers who leave a job from working for a competitor, cover nearly a quarter of all workers. 

Adding to their work, Jose Azar, Ioana Marinescu, and Marshall Steinbaum, write about labour market concentration,
Using data from the leading employment website, we calculate labor market concentration for over 8,000 geographic-occupational labor markets in the US. Based on the DOJ-FTC horizontal merger guidelines, the average market is highly concentrated. Using a panel IV regression, we show that going from the 25th percentile to the 75th percentile in concentration is associated with a 15-25% decline in posted wages, suggesting that concentration increases labor market power.
The problem is so evident that even the Economist has argued in favour of greater bargaining power to workers, or more and stronger unionisation!

Saturday, June 2, 2018

Weekend reading links

1. Economist has a nice article that shines light on the rising entry barriers faced by start-ups in the digital economy from incumbent platform companies, especially Amazon, Facebook, and Google. He said,
Venture capitalists... now talk of a “kill-zone” around the giants. Once a young firm enters, it can be extremely difficult to survive. Tech giants try to squash startups by copying them, or they pay to scoop them up early to eliminate a threat... Venture capitalists are wary of backing startups in online search, social media, mobile and e-commerce. It has become harder for startups to secure a first financing round...
It has never been easy to make it as a startup. Now the army of fearsome technology giants is larger, and operates in a wider range of areas, including online search, social media, digital advertising, virtual reality, messaging and communications, smartphones and home speakers, cloud computing, smart software, e-commerce and more. This makes it challenging for startups to find space to break through and avoid being stamped on. Today’s giants are “much more ruthless and introspective. They will eat their own children to live another day,” according to Matt Ocko, a venture capitalist with Data Collective. And they are constantly scanning the horizon for incipient threats. Startups used to be able to have several years’ head start working on something novel without the giants noticing, says Aaron Levie of Box, a cloud and file-sharing service that has avoided the kill-zone (it has a market value of around $3.8bn). But today startups can only get a six- to 12-month lead before incumbents quickly catch up, he says.

As I have written on countless occasions, it is perplexing that these companies do not face anything close to the level of anti-trust focus they ought to.

3. Dani Rodrik places the China-US trade spat in perspective,
China plays the globalization game by... the strategy is to open the window but place a screen on it. They get the fresh air (foreign investment and technology) while keeping out the harmful elements (volatile capital flows and disruptive imports). In fact, China’s practices are not much different from what all advanced countries have done historically when they were catching up with others. One of the main US complaints against China is that the Chinese systematically violate intellectual property rights in order to steal technological secrets. But in the nineteenth century, the US was in the same position in relation to the technological leader of the time, Britain, as China is today vis-à-vis the US. And the US had as much regard for British industrialists’ trade secrets as China has today for American intellectual property rights. The fledgling textile mills of New England were desperate for technology and did their best to steal British designs and smuggle in skilled British craftsmen. The US did have patent laws, but they protected only US citizens. As one historian of US business has put it, the Americans “were pirates, too.”
3. Deepak Nayyar makes a compelling argument in favour of bringing back development banks, calling for the establishment of a National Development Bank for India,
Between 2000 and 2010, the outstanding loans of development banks as a percentage of gross domestic product dropped from 7.4% to 0.8% in India, but rose from 6.4% to 9.7% in Brazil and 6.2% to 11.2% in China, and declined from 8.6% to 6.8% in Korea, while this proportion rose from 8.5% to 15.9% in Germany and from 3% to 7.2% in Japan.
I agree.

4. A J-PAL analysis of ten evaluations of the use of weather index insurance (payouts based on rainfall) has this graphic on the insurance uptake and price.
Clearly large premium discounts are necessary to achieve significant uptake. In fact, an uptake of over 50% necessities discounts in the range of 70%. Given that the bottom half will consist predominantly of very poor farmers, the target for publicly subsidised crop insurance programs, it raises questions about the efficacy of index insurance. 

In the circumstances, an alternative proposal suggested by one of the NITI Aayog members, Ramesh Chand, is to avoid the transaction costs associated with an insurance and make pre-defined direct compensation payments to farmers who suffer crop damage from deficient rainfall. Sometimes we complicate public policy.

5. John Mauldin's weekly newsletter carries this graphic which highlights the financing challenge facing the burgeoning US government debt.
Foreign central banks stopped net purchases of US government debt five years back. In the circumstances, the only way for the US government to finance its rising deficits is higher interest rates to attract investors. And the consequences of that can be very painful.

6. NYT has a good story on the impact of fiscal austerity on public services in UK. The impact of such cuts are felt the most by local governments.
In the eight years since London began sharply curtailing support for local governments, the borough of Knowsley, a bedroom community of Liverpool, has seen its budget cut roughly in half. Liverpool itself has suffered a nearly two-thirds cut in funding from the national government — its largest source of discretionary revenue. Communities in much of Britain have seen similar losses.
The aggregate impact on welfare spending too has been very significant,
By 2020, reductions already set in motion will produce cuts to British social welfare programs exceeding $36 billion a year compared with a decade earlier, or more than $900 annually for every working-age person in the country, according to a report from the Center for Regional Economic and Social Research at Sheffield Hallam University. In Liverpool, the losses will reach $1,200 a year per working-age person, the study says... Local governments have suffered a roughly one-fifth plunge in revenue since 2010, after adding taxes they collect, according to the Institute for Fiscal Studies in London. Nationally, spending on police forces has dropped 17 percent since 2010, while the number of police officers has dropped 14 percent, according to an analysis by the Institute for Government. Spending on road maintenance has shrunk more than one-fourth, while support for libraries has fallen nearly a third. The national court system has eliminated nearly a third of its staff. Spending on prisons has plunged more than a fifth, with violent assaults on prison guards more than doubling. The number of elderly people receiving government-furnished care that enables them to remain in their homes has fallen by roughly a quarter... Virtually every public agency now struggles to do more with less while attending to additional problems once handled by some other outfit whose budget is also in tatters.
This is a fairly accurate description of how Britain got to this pass,
London bankers concocted a financial crisis, multiplying their wealth through reckless gambling; then London politicians used budget deficits as an excuse to cut spending on the poor while handing tax cuts to corporations. Robin Hood, reversed.
Conservative commentator Scott Sumner examines the aggregate UK government spending data and blames these problems not on austerity but on "progressivism" and its growing list of new "unmet needs". I think his focus on the aggregates is deceptive in so far as it glosses over the reality of local governments as offering the most basic services that citizens are concerned with and the fact that local government allocations have shrunk significantly in recent years.

Friday, June 1, 2018

Simplicity and effectiveness

Morgan Housel has this absolutely fascinating video on investing, one that is as much relevant to several other things in life itself. (HT: Ananth)
This slide may appear funny, but is profound.
People just instinctively prefer complexity. They have a problem with appreciating something which is simple. Patiently doing simple things is just not sexy enough!

In development, governments chase innovation even when there is no evidence of any innovation having made a significant dent on any of the persistent development challenges - poor learning outcomes, traffic congestion, poor property tax collection, poor primary care and public health conditions, malnourishment, social evils, leakages in government programs, poor attendance etc. Maybe self-help groups and micro-finance on small savings and women's empowerment. Nudges. What else? 

Instead simply doing basic stuff like good governance, or collecting and using routine data to monitor effectively, or ensuring compliance with procedures, or diligently monitoring performance and acting on them, or making inspections, or simple prioritisation of responsibilities, and so on, all of which are most likely to have effects which outstrip those of any innovation by orders of magnitude are considered unsexy.  

Maybe investing and development need a movement to go back to simplicity. A "Back too Basics" campaign?

Do watch the full presentation for it has several other very important insights. The transcript is here.

Wednesday, May 30, 2018

The Italian Crisis

Italy is in the throes of a crisis that has roiled the global financial markets and reignited the uncertainty about the EU project that appeared to have subsided after the twin victories of Emanuel Macron and Angela Merkel. 

President Sergio Mattarella rejected the nomination of avowed anti-European Paolo Savona as Finance Minister of the coalition government of Five Star Movement and Northern League. With the chances of Carlo Cottarelli, the former IMF official nominated by the President as caretaker Prime Minister, to form a government being slim in a Parliament where the Five Star movement and Northern League have the majority, snap polls appear inevitable. 

The extraordinary spike in Italian two year bond yield, to its highest ever recorded, puts the market panic in perspective.
Or does it? Is the situation worse than 2012 when Greece stood at the brink of default and exit, and contagion to the PIIGS, which included Italy, appeared only a matter of time?  Is it a case of the typical market over-reaction? I am inclined to think so!

It is very difficult to not expect Italy's membership of Eurozone to not be a major topic in the forthcoming polls. To that extent the high stakes brinkmanship over Paolo Savona may have had the effect of allowing Italian exit become a political topic. Should Mattarella have allowed the coalition to engage with EU and let matters play itself out rather than intervene pre-emptively against the formation of a coalition government? It is anybody's guess how this will impact the different parties and coalitions and which option would have been more appropriate.  

Further, as Bill Emmott has argued any exit is unlikely to help the country. Unlike Greece, Italy enjoys a 3% current account surplus and therefore does not suffer from any competitiveness problem to benefit from an exit and devaluation. And despite a massive 132 percent debt-to-GDP ratio, Italian borrowing costs remain low thanks to its membership of the Eurozone.

Wednesday, May 16, 2018

A Nudge carried too far?

I am a strong believer in the use of nudges in development. They are cute and simple. But the same cuteness and simplicity can blind us to the relevance of the specific nudge (in the specific context) as a serious enough development tool.

Martin Abel and Co have a paper which examines a nudge to increase the effectiveness of job search efforts by unemployed youth in S Africa. The youth are grouped with peers, encouraged to make daily job search plans, and are sent weekly SMS reminders. The youth in the treatment group (in the RCT evaluation) had 30% more job offers and were 27% more likely to get a job.

This is undoubtedly a really cute nudge, a useful addition to the body of knowledge on nudges in development. But is this something which would excites policy makers? Very very unlikely. Let me illustrate. 

The hypothesis is that nudging job seekers into being more effective with their job searches will increase their likelihood of getting jobs - more active searches, more offers, and greater likelihood of a placement. Given all these jobs will anyways be filled, the intervention will only add one more person (the one treated with this intervention) into the long line of active job seekers. We cannot claim any social return on investment (SROI) since for each person who is nudged ahead of his competitors to get the job, another equally deserving person (who ironically was enterprising on his own with the job search and did not need the nudge to be active with job search) is denied the job. 

In other words, the net partial equilibrium social impact of the intervention is virtually zero. 

In the general equilibrium, one can of course say it has contributed its tiny bit to improving the efficiency of labour market matching (for e.g., assuming the treated person was more capable than the one who would have otherwise got the job).

But should a deeply capacity constrained government get into such things, with the certainty of this activity displacing effort from something else more likely more important?

And we have not even talked about the state capacity challenge in implementing this with acceptable fidelity in these countries. Take this description of the treatment,
Study participants are randomly assigned to one of three treatment arms: Control (pure control), Workshop (workshop only), and Workshop Plus (workshop + plan making). A random subset of job seekers in the Workshop Plus group were additionally asked to identify a peer. Participants across the Workshop and Workshop Plus groups were further randomized to receive text-message reminders. 
This is not as simple as it appears. Making plans, weekly reminders, peer-support engagements etc in scale requires reasonably strong state capacity. It is inconceivable that this can be done in scale without being routinised by the implementing bureacracy to a degree that makes it ineffectual. Do we really think that the S African State (in any province) can do this in scale without significantly compromising the quality of implementation as to render it virtually ineffectual?

We are also talking about countries where for every decent job opening that becomes available, there are potentially thousands go job seekers. It is very unlikely that a job will remain unfilled because of lack of applicants or lack of awareness among job seekers (in any case with such cases the more appropriate intervention, by orders of magnitude, is to support placement agencies). For sure, some individual job seekers will be better off if they can be nudged into being more effective at jobs search (though at the cost of making some others, who would have got the job without this intervention, worse-off). 

The best that can be said about this is that, IF implemented in scale, it can very marginally (or more appropriately trivially, considering all the factors that constrain S African labour market and placing this intervention in perspective) increase the efficiency of S African labour market. And compare this with the competing areas for policy attention on the labour market side - education of kids, trainings to make the educated kids employable, facilitate job creation by businesses, enhancing productivity of those jobs, mechanism for efficient matching job seekers with jobs and so on.

Saturday, May 12, 2018

Weekend reading links

1. Barry Ritholtz argues that the restrictive policies favoured by taxi cab owners in New York created the likes of Uber,
Consider, the number of licensed cabs was about 16,900 in 1937, when the city's population was more than 1 million lower than it is today. Today, there are fewer medallions than 80 years ago. There have been only about 1,800 new medallions issued since 1996. It is an artificially created monopoly, and monopolies tend to lead to terrible economic behaviors. Just consider one aspect of the appalling level of service on offer. In New York, many taxi drivers change shifts between 5 p.m. and 6 p.m., abandoning the city in the midst of rush hour, returning to the outer boroughs or even New Jersey for driver changes. Let a single drop of rain fall and it is almost impossible -- no, it is impossible -- to find a cab. The cars are often in bad shape, devoid of shock absorbers, and back seats that make me want a shower afterward. Yellow Cabs also have been known to illegally refuse to pick up the hails of African-Americans. Unlike London, where drivers have an almost tour guide-like knowledge of their city, New York cab drivers are often utterly ignorant of the city where they work.
And on Uber's effect on medallion prices, 
Bloomberg Businessweek reported that medallion prices, which peaked at $1.3 million in 2013, were already sliding, falling below $900,000 in 2013. Just two years later 2015, prices had fallen another 40 percent. And it got worse: By 2016, the lowest reported price was $250,000. Last year, medallions sold for as little as $241,000. They are still falling. Axios noted a recent transaction that went for just 8 percent of the peak value, or about $100,000. Other cities, such as Chicago, have seen similar declines in medallion prices.
2. David Bell has a scathing critique of Steven Pinker's new book, Enlightenment Now, which is a celebration of the progress made by human civilisation in the post-Enlightenment era thanks, in the main, to the scientific and technological advances that arose from Enlightenment's reasoning and scientific enquiry. He writes,
Enlightenment Now... is a dogmatic book that offers an oversimplified, excessively optimistic vision of human history and a starkly technocratic prescription for the human future. It also gives readers the spectacle of a professor at one of the world’s great universities treating serious thinkers with populist contempt. The genre it most closely resembles, with its breezy style, bite-size chapters, and impressive visuals, is not 18th-century philosophie so much as a genre in which Pinker has had copious experience: the TED Talk... It makes use of selective data, dubious history, and, when all else fails, a contempt for “intellectuals” straight out of Breitbart. Pinker might not have intended the book to do so, but it will bolster the claims of populist politicians against intellectuals and movements for social justice while justifying misguided, coldhearted policy choices in the name of supposedly irrefutable scientific rationality... When it comes to issues like “democracy” and “equal rights,” Pinker seems to believe that progress has occurred almost by itself, as a result of whole populations spontaneously turning more enlightened and tolerant. “There really is a mysterious arc bending toward justice,” he writes. Almost entirely absent from the 576 pages of Enlightenment Now are the social movements that for centuries fought for equal rights, an end to slavery, improved working conditions, a minimum wage, the right to organize, basic social protections, a cleaner environment, and a host of other progressive causes. The arc bending toward justice is no mystery: It bends because people force it to bend.
In some ways, like Nassim Nicholas Taleb and Richard Dawkins, Steven Pinker may be respresenting the era of pop-intellectualism. 

3. Ricardo Hausmann makes the point that has been a constant theme of this blog for more than a decade - private participation in infrastructure is best done by way of public finance of construction followed by private concession of operation and maintenance. 

But he glosses over the challenge with even the latter. As I blogged here in case of India's roads monetisation, private participation in O&M too is fraught with several risks.

4. I liked this Amartya Sen assessment of Karl Marx's legacy. Sample this,
I would place among the relatively neglected ideas Marx’s highly original concept of “objective illusion,” and related to that, his discussion of “false consciousness”. An objective illusion may arise from what we can see from our particular position — how things look from there (no matter how misleading). Consider the relative sizes of the sun and the moon, and the fact that from the earth they look to be about the same size. But to conclude from this observation that the sun and the moon are in fact of the same size in terms of mass or volume would be mistaken, and yet to deny that they do look to be about the same size from the earth would be a mistake too... The phenomenon of objective illusion helps to explain the widespread tendency of workers in an exploitative society to fail to see that there is any exploitation going on — an example that Marx did much to investigate, in the form of “false consciousness”...

In one of Eric Hobsbawm’s lesser known essays, called “Where Are British Historians Going?”, published in the Marxist Quarterly in 1955, he discussed how the Marxist pointer to the two-way relationship between ideas and material conditions offers very different lessons in the contemporary world than it had in the intellectual world that Marx himself saw around him, where the prevailing focus — for example by Hegel and Hegelians — was very much on highlighting the influence of ideas on material conditions. In contrast, the tendency of dominant schools of history in the mid-twentieth century... had come to embrace a type of materialism that saw human action as being almost entirely motivated by a simple kind of material interest, in particular narrowly defined self-interest. Given this completely different kind of bias (very far removed from the idealist traditions of Hegel and other influential thinkers in Marx’s own time), Hobsbawm argued that a balanced two-way view must demand that analysis in Marxian lines today must particularly emphasise the importance of ideas and their influence on material conditions... To Hobsbawm’s critique, it could be added that the so-called “rational choice theory” (so dominant in recent years in large parts of mainstream economics and political analysis) thrives on a single-minded focus on self-interest as the sole human motivation, thereby missing comprehensively the balance that Marx had argued for. 
5.  The Economist has a briefing on the global logistics market. This is interesting,
The industry’s backwardness can be seen in its thrall to paperwork. Systems based on e-tickets that say who is entitled to go where, and how, have been mandatory in air-passenger transport for ten years. But half of air cargo still travels with paper “bills of lading” rather than e-tickets. In the world of containerised shipping things are even worse: freight forwarders deal with shipping firms, airlines and hauliers mainly by fax. The cargo on each voyage of the Munich Maersk generates a library of documents—many of which then need to be sent to the ship’s destination by some other means. That secondary shipping is not foolproof, either: vessels and aircraft are often delayed in port because the paperwork has not caught up with the goods that they carry. The cost of all this is enormous. Removing administrative blockages and outdated practices would, by some accounts, do more to boost international trade than eliminating tariffs. The UN reckons that putting all the Asia-Pacific region’s trade-related paperwork online could slash the time it takes to export goods by up to 44%, cut the cost of doing so by up to 31%, and boost exports by as much as $257bn a year.
6. Putting Chinese foreign lending in perspective,
By the end of 2014, just two Chinese policy banks — the China Development Bank and Export-Import Bank of China had outstanding loans to foreign borrowers of nearly $700bn, much the same as the total outstanding lending of the World Bank and six regional development institutions... As a study from the Center for Global Development notes, 23 of the 68 countries potentially eligible for lending under the Belt and Road Initiative are vulnerable to debt distress. In eight of these countries — Pakistan, Djibouti, Maldives, Laos, Mongolia, Montenegro, Tajikistan and Kyrgyzstan — the lending associated with the Belt and Road Initiative will add substantially to the risks.
7. Fiscal incentives to attract businesses is arguably one of the largest examples of wasteful public policy. Eduardo Porter from the example of state and local governments in the US,
Research on a program of corporate tax breaks in Texas found that 85 to 90 percent of the projects benefiting from such incentives would have gone forward without them. Even when tax breaks work and spawn new jobs, local residents gain little if anything... State and local government spending on tax incentives like those offered by Wisconsin and New Jersey has increased sharply since 1990, to about $45 billion in 2015... It amounts to roughly all the money that state governments collect from corporate income taxes. Is this just about opportunistic politicians dipping into state coffers so they can be photographed cutting the ribbon at a spanking new factory? I wouldn’t doubt it. But I would also suggest another, more troublesome motivation: desperation. Fiscal incentives are one of few tools for cities like Racine and Newark to create jobs.
Much the same most likely applies to state governments in India competing with each other to attract investors.

8. International development's mindless obsession with RCTs has crowded out much more valuable ethnographic studies like this by Aditya Dasgupta and Devesh Kapur on the challenges faced by the frontline development bureaucracy in India. Nice documentation of a reality which is deeply internalised by those working within these systems but not amenable to any randomisable study. It also highlights the challenge of implementation validity that I blogged about here.

9. Vietnam may only be the latest example in the well established fact that many countries have achieved US levels of student learning outcomes in Math and Science at very low levels of income. 

10. An assessment of the progress made by China's One Belt One Road (OBOR) initiative in the Nikkei Asian Review. In particular, it finds that projects sometimes experience serious delays and resultant cost-escalation, ballooning debts in Pakistan, Sri Lank, Maldives, and Laos, sovereignty concerns, and lack of participation by local workers and local banks.
11. CityLab has a series of articles on the problems being faced by public buses in US cities. It writes,
Numbers released last month from the Federal Transit Administration’s National Transit Database show a 2.5 percent decline in total transit ridership from 2016 to 2017, with bus ridership leading the way with a 5 percent drop... Going back to 2014, ridership is down 7 percent, and bus ridership in 2017 was down almost 20 percent from its peak in 2008. During the same nine-year period, the Chicago Transit Authority alone lost more bus riders than all U.S. agencies with growing ridership gained.
And on the role of ride sharing services in this state of affairs,
2018 will be the first year that for-hire vehicle trips (including taxis, Uber, Lyft, and their peers) will outnumber bus trips in the U.S., transportation consultant Bruce Schaller forecasts. Research in New York, San Francisco, Boston, and nationally show that the rapid growth of ride-hailing is adding new vehicles to congested city streets. These services offer shared rides via “pooling” services, but they have seen limited uptake and cannot physically match the people-moving efficiency of city buses.
12. Keith Gessen has a fascinating exploration that rips off the veil shrouding what actually determines the US view of Russia and how its drives American policy towards that country. The essay explores the relationships through the lens of the worldview and prejudices of Russia hands in the Military and State Department who run the bilateral relationship.
The abiding mystery of American policy toward Russia over the past 25 years can be put this way: Each administration has come into office with a stated commitment to improving relations with its former Cold War adversary, and each has failed in remarkably similar ways. The Bill Clinton years ended with a near-catastrophic standoff over Kosovo, the George W. Bush years with the Russian bombing of Georgia and the Obama years with the Russian annexation of Crimea and the hacking operation to influence the American election. Some Russia observers argue that this pattern of failure is a result of Russian intransigence and revisionism. But others believe that the intransigent and unchanging one in the relationship is the United States — that the country has never gotten past the idea that it “won” the Cold War and therefore needs to spread, at all costs, the American way of life.
Sample this about the different world-views of American officials,
The longtime Russia hand Stephen Sestanovich, a veteran of the Reagan and Clinton administrations, says there are two kinds of Russia hands — those who came to Russia through political science and those who came to it through literature. The literature hands, he suggests, sometimes let their emotions get the best of them, while the political-science hands, like Sestanovich, are more cool and collected. Fried, who served in every administration from Carter to Obama, also thinks there are two kinds of Russia hands, though he draws a different dividing line: There are those, like himself, who “put Russia in context, held up against the light of outside standards and consequences.” These people tend to be tough on Russia. And then there are those “who take Russia on its own terms, attractive and wonderful but subject to romanticization.” These people tend to give Russia what Fried would consider a pass.

Tuesday, May 8, 2018

The false dawn of micro-pensions

There is a disturbing irony in encouraging poor people, who barely manage to make ends meet just for physical survival, to save for old-age and insure themselves against diseases. Self-financed micro-pensions and micro-insurance, aided by the allure of modern technologies, are a fad in international development and impact investing. It is flawed on both philosophical and financial considerations.

The fundamental assumption with micro-pensions is that it is both desirable and possible for informal workers (or poor and lower middle-class) to save money from their current income to finance their pensions. 

The desirability condition is, at best, a benign paternalistic concern of outsiders for the welfare of the poor and informal workers during their retirement. I will leave this at that. The possibility condition is contingent on another assumption. These people have the incomes to save long-term for their pensions, and it is human behavioural and cognitive failings that prevent them from doing so. 

This assumption flies against the near universal evidence on the difficulty impossibility of long-term financial savings (pensions or insurance) among the poor. Forget the poorest, even the typical rural and urban informal worker in a low income country lives a virtual hand-to-mouth existence, barely surviving from month to month on their meagre wages. 

India, for example, has a pension and health insurance scheme for all formal sector workers which requires mandatory deductions from worker’s salaries. The mandatory deductions amount to slightly above 30% of the worker’s salaries, including the employer contributions. This is actually counter-productive because it deprives the badly stretched worker off money he badly needs today to meet daily needs and forces him to borrow at much higher cost from local money lenders for those needs, thereby likely making him more indebted. While the logic of making this voluntary at least for workers with monthly wages below Rs 15000-20000 is clearly understood, its politics very challenging.  

It is also for this reason that almost all developed countries have either lower mandatory deductions or higher government contributions for low income workers. In fact, this was a major component of the acclaimed 2004 Hartz IV reforms of Germany, often claimed as the cornerstone of Germany’s recent economic success. In case of the poor, it is almost always completely public funded social safety nets that provide pensions and health insurance. 

It is ironical that international development entities promote self-financed pensions and insurance for the informal workers even though it is an idea that is not even considered for their arguably far better off (both in relative and absolute terms compared to others in their respective countries) counterparts in developed countries. 

How many countries have self-financed pension schemes for informal workers? Is there any country at all that has this creature of innovation? In fact, how many examples of micro-pension business is there in any developing country? Is there any self-financing (or non-subsidised by governments) micro-pension company which has say, 100,000 regularly paying informal worker subscribers? Is there any micro-pension company in any country which has been in existence for even 10 years? Do we have entrepreneurs offering micro-pensions to the legions of part-time or contractually (hourly-wages) employed workers (say, McDonalds and Walmart workers), who form a very big share of the labour force in the US? Do we have impact investors offering financing for such entrepreneurs? If not, why?

This is a bit like Lant Pritchett’s example of women in rural India asking him how the women Self Help Groups were in the US! 

Even if we set aside the philosophical objection, there is the question of its financial viability. In order to be sustainable, a micro-pensions entity has to overcome the following constraints.

1. The country should have deep enough long-term investment opportunities. Pension funds will have very strict and low regulatory limits on equity exposure and that too to highly rated ones too. But in low income countries the supply of such instruments which are not very risky and which can generate a significant return (to cover inflation, costs and returns) is likely to be limited.  

2. These micro-instrument agencies are unlikely to have the expertise to manage these funds internally in a manner as to generate the required returns, thereby necessitating outsourcing of funds management responsibilities to asset managers, with the attendant high management cost. This is a problem for even established microfinance NBFCs in mature markets like India. 

3. Since poor people are unlikely to be able to make certain in-payments for long periods (and in case of micro-pensions are also likely to withdraw money at the earliest opportunity), the entity offering such instruments may have to offer the product with flexible terms. This would seriously limit the flexibility of its investment options.

4. Minimise customer acquisition and retention costs, as well as ensure reasonable average savings inflows for each customer, and that too among the most financially vulnerable groups of people

5. Overcome the business longevity risk and remain a going concern for a long time, in the range of decades, a critical determinant for a business like insurance/pensions. It is also not for no reason that large legacy institutions are, for good or bad, the ones who have been successful with penetrating the insurance and pensions market in developing countries. Successful pension and insurance companies don’t suddenly emerge overnight and grow big. The entry barriers are very high. They have to piggyback on existing credible platforms. 

6. Finally, as discussed earlier, success of these instruments will have to overcome the large body of evidence on poor people being unable to accumulate large amounts in cash (as against physical assets like house, livestock, gold etc), even through small periodic cash savings, required to sustain a pension or insurance scheme. 

There are the following costs associated with these constraints and the final investment returns have to offset them

1. Cost of routine operations (acquiring, retaining pensioners etc)

2. Outsourced asset manager cost (even if done in-house, the costs can be prohibitive, in terms of attracting and retaining talent etc)

3. Costs due to uncertain inflows and outflows associated with the nature of customers 

4. Reasonable profits for the entity

5. Inflation – typically high in all low income countries

In a typical case, the first four alone will aggregate to 10-15% returns, if not more. Add in a 10% inflation rate, and we are looking upwards of 20-25% rate of return over a very long-term for this to be commercially viable as a micro-pension entity. Can we imagine the enormity of this challenge? How many such asset managers (or any kind, much less those dealing with low risk instruments/asset categories) are there in any developing country who can generate such returns? And all this out into the future? 

As an illustration of a micro-pension program, MicroSave has this nice illustration of the Abhaya Hastham program of the Government of Andhra Pradesh for women self-help group members, which pays out Rs 500-Rs 2200 per month (depending on the age of enrolment, and in today's nominal rupee) by saving Rs 1 per day (or Rs 365 per year). As the graphic below shows, when the program reached 4 million clients, it required very significant top-up by government required to make it sustainable. 
Whatever the wonders of technologies like digital money and blockchains, we cannot escape the bitter reality that poor people have hardly anything to save. It is a constraint which cannot be relaxed. I cannot imagine that we are helping the poor by making them cut back on their basic human necessities to save penurious amounts for their old age. And that too by asking them to trust a financial model which does not stand the test of even a cursory scrutiny. 

The micro-pensions fad is yet another example of the unfortunate digression away from serious  debates on important development challenges like, in this case, fiscally sustainable and incentive compatible social safety nets.