Weekend reading links

1. The prioritisation of resilience over pure efficiency maximisation may end up boosting the demand for warehouses

The chastening experience of a pandemic during which stocks of everything from face masks to toilet paper ran short has shifted the way a range of businesses operate. Their priorities are now orientated towards building supply-chain resilience rather than pursuing maximum efficiency at all costs. That is creating demand for more local warehouse storage to guard against future shortages. “Every single person we talk to from an occupational perspective is talking about this: pharmaceutical companies, retailers, everyone,” says Preston. His company, Tritax EuroBox, has leased a vast warehouse in the southern Netherlands to food retailer Lidl. The shed is packed full of non-perishable goods that Lidl has no immediate intention of selling. “It’s a resilience package for them, full of pasta, tinned tomatoes, goods that won’t go off. Because when Covid came along, shelves were emptied, they learnt their lesson,” he says.

2. The private equity industry buys out Senator Krysten Sinema who blocked a bipartisan legislative effort to remove the so-called carried interest loophole that allows PE and hedge fund managers to have their investment gains taxed at a lower 20% compared to the marginal income tax rate of 37%. Sinema forced the dropping of the change in the tax provision in return for her support for the Inflation Reduction Act, a wide-ranging climate, health care, and tax bill. 

3. Despite the government's efforts to increase local manufacturing, the share of Indian companies in the smart phone market fell from 21% in 2017 to just 1% in 2021. Indian companies like Lava, Micromax etc have struggled to fight the Chinese competition. 

4. NYT article about the efforts in the US to regulate the container shipping industry 

The ocean carriers have multiplied their shipping rates and imposed a bewildering assortment of fees. The container shipping industry is on track to make $300 billion in profits before taxes and interest, according to Drewry, an industry research firm. The White House has seized on these two realities — soaring prices, and record profits for carriers... Three alliances of shipping companies control 95 percent of routes across the Pacific, according to the International Transport Forum, an intergovernmental body based in Paris. As shipping prices have soared, and as delays have besieged ocean transit, retailing giants like Amazon and Walmart have chartered their own vessels, prompting complaints from smaller importers that they are at an unfair disadvantage.

5. More on the strange recession this time around in the US,

Typically, in recessions, the problem is that businesses don’t want to hire and consumers don’t want to spend. Right now, businesses want to hire, but can’t find the workers to fill open jobs. Consumers want to spend, but can’t find cars to buy or flights to book. Recessions, in other words, are about too much supply and too little demand. What the U.S. economy is facing is the opposite... To most people, of course, this doesn’t feel like a boom. Measures of consumer confidence are at record lows, and Americans overwhelmingly say they are dissatisfied with the economy. That perception is grounded in reality: High inflation is eroding — and in some cases erasing — the benefits of a strong job market for many workers. Hourly earnings, adjusted for inflation, are falling at their fastest pace in decades... 

There is also a subtler consequence: uncertainty. No one knows how long the boom will last, or what the economy will look like on the other side of it, which makes it hard for workers, businesses and governments to adapt... Businesses have now spent two and a half years in a state of constant adjustment. In early 2020, practically overnight, Americans traded restaurant meals for home-baked bread, and gym memberships for socially distanced bike rides. Those shifts caused huge disruptions, in part because businesses were reluctant to make long-term investments to address short-term spikes in demand... Instead, the lingering disruptions of the pandemic, uncertainty over what the post-Covid economy will look like and fears of a recession have made businesses reluctant to make bets on the future. Business investment fell in the most recent quarter. Employers are hiring, but they are leaning heavily on one-time bonuses rather than permanent pay increases.

See also this.

6. FT long read on the changing face of private equity investing. From being small mercenary takeover specialists in the 1970s to early nineties, PE firms today manage nearly $10 trillion in assets. Their new area of focus is private debt,

Firms that once bludgeoned opponents now nurture complex business relationships with their competitors. Private equity has become just a fraction of their overall assets under management, with credit investing businesses now managing hundreds of billions of dollars, including providing loans for leveraged buyouts... With private equity deals now accounting for over 25 per cent of global M&A activity — a record market share — the collective power of the leading groups is starting to attract the attention of regulators... 

The modern day private equity buyout traces to Michael Milken’s Drexel Burnham Lambert, the investment bank that popularised the “junk bond”. Drexel financed small teams of dealmakers targeting corporate giants such as Disney, Texaco and then RJR Nabisco, the signature LBO of the go-go 1980s. Milken, and many of Drexel’s clients, were considered aggressive outsiders, unafraid to gatecrash Wall Street... By the 2008 crisis, private equity had become part of the financial mainstream as it pulled off a string of ever-larger takeovers. These so-called “club deals” hinted at the willingness of some firms to co-operate out of self-interest...

Investment banks, hamstrung by new regulations like the 2010 Dodd Frank Act, were curtailed from holding risky assets such as low-rated debts, which has limited their ability to finance many deals. As a result, corporations and private equity buyers have had to seek new ways of issuing debt. Blackstone, Apollo, KKR and Carlyle stepped into the void. They bought billions of non-performing loans from banks in the US and Europe, betting that the portfolios would stabilise. As markets recovered, they shifted to originating new loans, underwriting midsized private equity takeovers that banks would not finance. It set off private equity’s march into new businesses such as lending, insurance-related investments, real estate and infrastructure, which were far from their original speciality in buyouts... These private financings have continued as interest rates rise — just as many investment banks have been refusing to make new lending commitments until loans from deals struck earlier in the year have been sold on.

Another trend is the rise of sales from one PE firm to another, or "GP-led secondary transactions",

The fastest way for buyout firms to deploy their nearly $2tn in “dry powder,” or funds they have raised that have yet to be invested, is to buy companies directly from other private equity firms. A record 442 of such deals worth $62bn were struck last year, according to Refinitiv. These deals can close in less than three months, say bankers, versus as long as nine months to acquire a public company. They can also be expedient: sellers sometimes look to quickly lock in gains and show strong returns as they raise their next fund, notes one private equity firm executive... There has also been a surge in so-called “GP-led secondary transactions,” where one private equity firm sells a large stake in an existing investment to another firm at a higher valuation. 

7. The pandemic induced surge in demand for goods is tapering off,

Consumer goods retailers and ecommerce companies who profited amid lockdowns and mistakenly expected the good times to continue rolling have been hard hit. Big box retailers Target and Walmart, which won last year by scooping up inventory and paying extra for air freight, are now having to slash prices and cancel orders to clear excess stock. Ecommerce companies such as UK fast fashion site Asos are similarly coming down to earth, as it becomes clear that pandemic-related online buying marked a one-time jump rather than a permanent shift to faster growth. Overall US online prices for goods fell in July for the first time since May 2020, with price drops recorded in 14 of 18 categories tracked by Adobe. Electronics, the largest ecommerce category, saw a 9.3 per cent year-on-year decline, as the bulge driven by home office upgrades begins to recede.

But the demand in services shows no signs of abating,

Now it is the service providers who are struggling to keep up. After two grim years marred by closures and limited demand, their sales are climbing. Walt Disney reported record revenue in its theme parks division, hotel chain Marriott bragged of “outstanding” results and both American and United Airlines returned to profit for the first time since the start of the pandemic.

8. Unintended consequences of private equity in housing

Right to Buy was a remarkable success in that it led to the sale of more than 2mn homes and resulted in an immediate transfer of wealth. But one of its direct, longer-term consequences has been that, rather than increasing home ownership, it contributed to the rapid growth of an under-regulated and precarious private rented sector. In 1979, more than a third of people in England lived in council housing built, owned and administered by local government. Now, more than 40 per cent of the council homes bought under Right to Buy have been sold on to private landlords, who rent them out at three or four times the price of an equivalent property in the social housing sector. The result is that, in many parts of the country, private renting is unaffordable for those on lower and even middle incomes, excluding people from the market and leading to a continuous cycle of eviction.

9. From FT about couple of graphics about the shipping industry. Interesting that the global LNG capacity has been more or less stagnant over the past five years.

Container freight rates have rocketed

10. Don't know the source of these numbers, Arun Maira quotes about India's labour market growth,

The gap between where our economy is and where it needs to be is increasing. Between 1980 and 1990, every one per cent of GDP growth generated roughly two lakh new jobs; between 1990 to 2000, it decreased to one lakh jobs for every per cent growth; and from 2000 to 2010, it fell to half a lakh only.

But it's most likely in some similar range. 

11. Satyajit Das points to the private markets being the faultline for the next financial crisis. Investors have poured $9.8 trillion into unlisted equity, private debt, and seed and venture capital. The illiquidity, opacity, and diffusion of risks have led to valuation bubbles. Consider this recent example,

After being valued in 2021 at $46bn, a 2022 $800mn funding round valued Klarna at $6.7bn (an 85 per cent fall). As the disappointing initial public offerings of Uber and WeWork highlight, the case is not isolated.

Das points to the faultlines, 

First, as private investments are inherently illiquid, investors cannot cauterise losses easily. Monetisation, largely reliant on initial public offerings and trade sales, is now difficult, especially at previously anticipated prices... Second, the lack of market prices means opaque valuations, which frequently misstate investment or fund values... Third, private equity originally focused on long holding period investments purchased with substantial borrowings in traditional industries that offered undervalued shares, strong cash flows, low operating risk and the potential for business improvements. Today, many of these elements, other than leverage, are frequently absent... Fourth, for non-profitable or cash-flow-negative enterprises, availability of follow-on funding necessary for operations is presumed... Finally, private markets exhibit complicated layers of risk... Today, investments are frequently held through tiers of funds, some with borrowings from banks or private providers. Securitisation of private equity loans and non-bank credit display familiar opacity and exacerbate leverage in the system. Falls in asset value anywhere can create instability elsewhere within the financial system.

State Capability in India

My book, State Capability in India, co-authored with Dr T V Somanathan is finally published by Oxford University Press.It has a foreword by Robert Zoellick, former World Bank President and US Commerce Secretary.  

This and this are the publisher pages. It can be bought on Amazon here (India) and here (global).

This is the description

The deficiencies in the capability of the state to design and implement effective policies are arguably the biggest development challenge facing developing countries like India. This book seeks to assess state capability in India, identify weaknesses in policy design and programme implementation, and their causes, and propose some measures to remedy them. Importantly, it does so while recognizing political economy constraints and focusing predominantly on the administrative contributors. To this extent, the book's suggestions are practical enough for adoption by stakeholders at different levels.

It describes the institutional design, constitutional provisions, the organizational structure, and the personnel of the Indian state. It covers a wide spectrum of aspects impacting state capability, ranging from ideological narratives and systemic constraints to procedural and personnel management issues to the behaviours and attitudes of individual bureaucrats. It offers a new analytical framework to think about effectiveness of state on the policy-making process. It also offers a nuanced perspective and suggestions on many of the popular themes in public administration - size of the state, generalist and specialist debates, lateral entry, digital monitoring systems in governance, outsourcing and private participation, use of consultants, risk aversion in bureaucracies, performance-based incentives, programme evaluations, and so on.

Finally, being participants and observers in the bureaucratic system, the authors describe reality without always seeking to locate it in the framework of existing academic literature, thereby offering fresh insights and enriching the discourse on state capability.

I enjoyed writing the book and also learning from my co-author. Readers of this blog would know that state capability is a favourite topic and, in my opinion, its weakness is the most important long-term challenge to development. Hope the readers find something useful from it.

A graphical summary of market concentration and its consequences

Matt Stoller points to a striking graphic from Sparkline Capital about the progressive market concentration in defence contracting market in the US.

From the end of the Cold War to the early 2000s, the number of prime contractors shrank from over 100 to 5, from a diverse set of actors to Boeing, Raytheon, Lockheed Martin, General Dynamics, and Northrop Grumman.

This about the change in US contracting rules,

Policymakers in the Clinton administration also fostered contractor price gouging, especially on contracts where there was only one bidder, or ‘sole source’ contracts. A key way to do that was to eliminate contracting rules when buying things that were determined to be ‘commercial items.’ Originally meaning that contracting rules didn’t apply to things like pencils or off-the-shelf computers that are regularly sold to private citizens, Congress changed the meaning of ‘commercial items’ in the mid-1990s to mean anything, like military transports or sophisticated weapons system that are anything but commercial... For example, the C-130 transport - which has never been sold to a private commercial party - is considered a ‘commercial item.’ And its price, which should come down as technology and manufacturing know-how improves, has skyrocketed, from one model selling at $37.5 million in 1994 to a slightly bigger version going for $200 million apiece today...

TransDigm is a more blatant example. Transdigm is a company that bought up sole source providers of spare parts and raised prices; in one case they overcharged DoD as much as 4,451% on certain items. Indeed, according to the Pentagon’s inspector general, current regulations “enable sole-source providers and manufacturers of spare parts to avoid providing uncertified cost data, (which, if you want to get technical, is a much weaker and less reliable version of the certified cost data that contractors were routinely required to submit prior to the Clinton Administration’s embrace of defense contractors). Numerous government reports have repeatedly shown that the Pentagon pays too much for spare parts. For example, IGs found that companies charged DoD $71 for a pin that should have cost less than a nickel and $80 for a drainpipe segment that should have cost $1.41.

Sparkline Capital has a great read on the rise and consequences of monopoly capitalism. This from the airline industry, where by 2016 the big four airlines had an 80% market share.

This table captures the market shares of technology monopolies

This shows the market share in highly concentrated product markets

In general, David Autor and Co have shown that the market share in the US of the top four firms (superstar firms) in 676 industries increased by around 50% over the 1980-2012 period.

The spike in M&A activity since 1980s has been a major driver of this increasing market concentration.

The superstar firms can exercise market power and therefore are much more profitable 

... and rely less on labour

Given their heavy use of automation, the labor efficiency of Big Tech is even more extreme. Apple only has 0.37 employees per $1 million revenue. Using this logic, Scott Galloway estimates that Google and Facebook’s disruption of the advertising industry led to around 199,000 job losses.

Expectedly, US corporate profit margins have risen sharply since the nineties

Historically, profits were reliably mean-reverting around 6% of GDP (blue). However, starting in the late-1990s, they seemingly underwent a paradigm shift (red). While they still gyrate with the business cycle, itappears to be around a significantly higher mean.

And this has been also associated with a decline in the share of income going to labour - both have been mirror images since 1997 or so.

Explaining this trend, Jose Azar et al examined over 8000 geographic-occupational labour markets in the US and found,

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 17% decline in posted wages, suggesting that concentration increases labor market power.

And all through this period, anti-trust activity has been declining

Mergers are almost never blocked and companies are rarely fined for antitrust violations. The decline of antitrust enforcement has proceeded through both Democratic and Republican administrations.

On a theoretical note, this early finding by Larry Summers and Brad De Long is spot on,

“An industry with high fixed costs and near-zero variable costs has another important characteristic: it tends to monopoly. The rule of thumb in high technology has been that the market leader makes a fortune, the first runner-up breaks even, and everyone else goes bankrupt rapidly. … [C]ompetition in already established markets with high fixed and low variable costs is nearly impossible to sustain.”

This is in addition to the conventional network effects.

The most disturbing factor is the political capture that invariably follows such business concentration. This, more than the business concentration by itself, is the corrosive aspect.

Revising the paradigm on anti-trust in the United States

I have blogged here about the new era in anti-trust activity within the US government. The new paradigm calls on regulators to look beyond the test of just immediate consumer welfare to cover anti-competitive practices which creates the structural conditions for market concentration and consequent abuse. 

FT reports that the US Federal Trade Commission (FTC) has filed a lawsuit to stop Meta from buying Within, a small start-up which creates experiences for virtual reality (VR). Its biggest hit, Supernatural is a fitness app that's one of the most popular on Meta's VR marketplace. FTC's argument is that halting the deal was necessary to prevent Meta from quashing a competitive threat in a potentially large market. With this, FTC is testing for the first time its new theory of harm which deals with structural conditions. 

Part of Khan’s antitrust thesis argues that regulators have previously dropped the ball by waiting until companies became multibillion-dollar players before becoming concerned about takeovers or mergers. Technology companies have proven themselves to be adept at spotting cheap newcomers and making offers that almost cannot be refused... The FTC argued in its court filing that Within, while a minnow today, exists in a new market that may become a major new platform, following the same trajectory as the smartphone. Others note the potential for fitness games to be a “killer” app, the term given to breakthrough uses that spur widespread adoption of a new technology platform. The FTC argued a company that had found early success, such as Within, should remain independent, because doing so would force Meta to build its own fitness products, increasing competition in the marketplace. Instead, acquiring the company would remove Within as a competitor and discourage others from entering the VR fitness space, the FTC said, noting that Meta had already acquired seven similar companies in the metaverse industry.

The NYT writes about how this suit seeks to upend the prevailing anti-trust paradigm,

At the heart of the F.T.C.’s lawsuit is the idea that regulators can apply antitrust law without waiting for a market to mature to the point where it is clear which companies hold the most power. The F.T.C. said such early action was justified because Meta’s deal would probably eliminate competition in the young virtual-reality market. Since the late 1970s, most federal challenges to mergers have been in large, well-established markets and aim to prevent already clear monopolies. Regulators have mostly rubber-stamped the purchases of start-ups by tech giants, such as Google’s 2006 deal to buy YouTube and Facebook’s 2012 acquisition of Instagram, because those markets were still emerging. As a result, Ms. Khan faces an uphill climb. Regulators have been reluctant to try to stop corporate mergers by relying on the theory that competition and consumers will be harmed in the future.

As the FT article reports, the industry and its lobbyists have sought to paint this as regulatory over-reach and have warned that this could have a chilling effect. 

Should it become more difficult for big companies to acquire promising start-ups, they argue, it would deprive early-stage investors of one of their primary means of cashing in on their support.

This is an important moment in the new-found anti-trust activism. It could set precedents. 

However, it may be very difficult to establish the likelihood of harm before a court of law. It's required to convince the judge on the promise of VR and in particular Supernatural, and that Meta's acquisition would, in the net, be damaging to market development.

What makes Khan’s move groundbreaking, said one antitrust academic, was the degree to which the decision may well hinge on a judge’s assessment of VR. Its prospects of commercial success are by no means certain, with adoption still lagging far behind that of traditional video games.

Then there is the risk that any policy maker faces while making decisions - is this the right time to take the decision?

But leading experts in antitrust law said the FTC’s lawsuit was “high risk”, and questioned whether Within will genuinely provide a huge boost to Meta’s dominance at the expense of consumers... A loss might undermine the FTC’s newly zealous approach, and give credence to claims that Khan’s impartiality on tech is compromised because of her prior academic work about the monopoly power of Big Tech.

But Ms Khan's response may be in terms of how the suit could shift the reference frame and the set of possibilities on anti-trust debates,

For Ms. Khan, winning the lawsuit may be less of a priority than showing it’s possible to file against a tech deal while it is still early. She has said regulators were too cautious in the past about intervening in mergers for fear of harming innovation, allowing a wave of deals between tech giants and start-ups that eventually cemented their dominance.

The paradigm set by the originalist interpretation of the US Constitution by conservatives like Robert Bork is now under serious attack for the first time in over forty years. Given the massive stakes involved and the enormously powerful interests behind them, it's unlikely to give way quickly. The struggle between the Borkian thesis and its emerging anti-thesis led by the triumvirate of trust-busters in the Biden administration is most likely to be long-drawn. 

Weekend reading links

1. Global semiconductor industry facts of the day,

What makes the U.S. effort unique is the enormous one-time sum—roughly $77 billion in subsidies and tax credits—earmarked to boost American manufacturing of the ubiquitous tech component... China has prepared investments of more than $150 billion through 2030, according to one estimate. South Korea, with an aggressive array of incentives, aims to encourage roughly $260 billion in chip investments over the next five years. The European Union is pursuing more than $40 billion in public and private semiconductor investments. Japan is spending about $6 billion to double its domestic chip revenue by the end of the decade. Taiwan has around 150 government-sponsored projects for chip production over the past decade, with its leader pushing for more localized manufacturing of semiconductor equipment. Singapore landed a $5 billion chip factory earlier this year from United Microelectronics Corp...

Annual chip-industry revenues are expected to hit $1.35 trillion by 2030, more than doubling from $553 billion in 2021, according to International Business Strategies Inc., a chip consulting firm... About three-quarters of chip-making capacity is located in China, Taiwan, South Korea and Japan, according to the Semiconductor Industry Association, an industry trade group. The U.S. represents 13%... The semiconductor industry is already on a historic spending spree. It approved some $153 billion in capital expenditures in 2021—about 50% more than before the pandemic started and double the levels from five years earlier... The U.S. was expected to capture about 13% of global semiconductor capital investments through 2026, according to Gartner projections from July, with Asia forecast to account for more than three-quarters of the total spending.

2. Central Banks have acted in unison to slay inflation.

3. Thomas Edsall points to some stunning facts about the economic composition of the two political parties in the US

In 2018, according to ProximityOne, a website that analyzes the demographics of congressional districts, Democratic members of Congress represented 74 of the 100 most affluent districts, including 24 of the top 25. Conversely, Republican members of Congress represented 54 of the 100 districts with the lowest household income. The median household income in districts represented by Democrats was $66,829, which is $10,324 more than the median for districts represented by Republicans, at $56,505. The 2018 data stands in contrast to the income pattern a half-century ago. In 1973, Republicans held 63 of the 100 highest-income districts and Democrats held 73 of the 100 lowest-income districts.

He also points to this observation by Princeton political scientist Nolan McCarty,

Democrats are mostly the party of the master’s degree — modestly advantaged economically but not exactly elite. On the flip side, the Republicans are the party of the associate degree (a two-year college degree), less educated than the Democrats but not exactly the proletariat.

This from NYU Law Professor Richard Pildes

Since the New Deal in the United States and WWII in Western Europe, the base of the dominant parties of the left was less affluent, less highly educated voters; the dominant parties of the right drew their primary support from higher income, more highly educated voters... Democratic candidates received twenty-two points less support from voters in the top ten percent of the income bracket than from those in the bottom ninety percent. By 2012, that gap had dropped to only an eight-point difference and in 2016, voters in the top ten percent had become eight points more likely to vote for Democratic candidates. Similarly, in the 1940s, those with university degrees in the United States were twenty points less likely to vote for Democrats, while in 2000 there was no difference and by 2016, they were thirteen points more likely to vote for Democrats.

4. More on the problems at Byju's here. More one sees it (several articles in The Ken), Byjus appears similar to the infrastructure contractor who specialises in striking deals, cutting-corners, and massaging accounts, masquerading as a tech startup. It's also pertinent that nearly two-thirds of its revenues come from hardware, and looks likely to increase given its recent focus on physical tuition centres.   

5. Rahul Jacob writes that the US Stimulus programs were also a large Marshall Plan for Indian exporters. He argues that the country's spectacular export performance in 2021-22 was driven by US demand.

India’s strong export performance in 2021 benefitted from a once-in-a-century surge in US demand, a black swan outlier of the happy kind... merchandise exports to the US from India grew 43% in fiscal 2021-22. Our nominal exports of jewellery and leather products to the rest of the world actually declined in 2021, compared with the mostly pre-pandemic yea r of 2019. Exports of these products to the US, by contrast, surged by 50% and 20% respectively. In other words, the huge US stimulus packages in 2020 and 2021 turned out to be a Marshall Plan to revive Indian labour-intensive exporters, albeit unintentionally.

It'll be hard to replicate 2021-22, as we are already finding out. A reversion to the mean is most likely. 

6. Interesting graphic in an FT article shows the disproportionately high share of fuel imports in the India's import basket

The country's inflation is the second highest, after Thailand, among major Asian economies. More worrying is the similar position in terms of external balance.

7. FT has a report on immigration trends in UK which has a graphic highlighting the positive role played by immigration in keeping its population younger than most of Europe.

8. The year 2021 may well have been "peak-VC". From an FT report

Sample this stunning statistic,

According to Coatue, one of a new band of “crossover” investors that moved from the public markets into the VC world, $1.4tn found its way into promising growth companies globally last year, half of it in the form of venture capital and half through IPOs. That single-year surge, it calculated, was nearly $1tn more than the average of $425bn a year raised over the previous decade.

The age of FOMO is on the rearview mirror.

9. Jared Dillian on the strange nature of the current "recession"

Activity has contracted, as measured by the official gross domestic product calculations put out by the Commerce Department, but it doesn’t feel like a recession. The economy has added 2.74 million jobs this year through June. This earnings season has shown that many consumer-facing companies such as Starbucks Corp. and Uber Technologies Inc. are enjoying pricing power, and travel companies are experiencing booming demand, with Marriott International Inc. saying hotel occupancy has nearly returned to pre-pandemic levels. If you have taken a flight within the US recently, you have probably noticed that the plane is completely full and the airports are mobbed. Overall, members of the benchmark S&P 500 Index are on track to post record profits for the second quarter.

10. Shuli Ren has a very informative essay on the Chinese conglomerates, jituan, and their convoluted holding structures to raise capital. This opacity is becoming the Achilles heel as corporate defaults mount. 

The article points to the Korean chaebols which the Chinese are trying to imitate. The likes of Samsung have perfected the art of controlling massive businesses with small shareholding through multi-layered shareholding structures. 

The difference in case of China being the role of public finance, government ownership of some of these conglomerates, and their role as instruments of Chinese geo-political ambitions. Ren points to the example of Tsinghua Unigroup, "a Samsung wanna-be" and leading the Chinese semiconductor ambitions.

This seven layered structure which allowed Unigroup to both exercise control over the flash-memory chip maker YMTC and also mobilise large volumes of debt, has also proved its failing by reducing accountability and transparency. 

Some thoughts on the public sector consulting work of big consulting firms

I've blogged about the dangers with the creeping influence capture of important public policy decision-making processes by management consulting organisations. This is a universal trend across countries and across consulting firms, varying only in the degree and brazenness of their actions across contexts. 

South Africa during the regime of Jacob Zuma has witnessed some of the most egregious examples of corrupt practices by these organisations, with established cases of misconduct. 

Early this year, Bain and Co was found guilty by a South African judicial commission of being an enabler of graft. Specifically, it helped the Zuma regime systematically weaken the South African Revenue Service (SARS) by crippling its ability to carry out investigations of tax evaders and allowing "state capture" by vested interests. The Judge wrote in the report that Bain's work on weakening of SARS was "a clear example of how the private sector colluded" on state capture. 

Over the past decade, Bain has worked closely with state companies and the private sector in South Africa. Vittorio Massone, the firm’s former South African managing partner, forged a close relationship with Zuma, meeting him on average every six weeks between 2012 and 2014, according to the report. An event management company owned by a soap-opera producer close to Zuma became Bain’s second-highest paid local adviser around the world, the report said... Between 2012 and 2015, Bain laid plans “to restructure entire sectors of the South African economy” and centralise state procurement, the report said. “Central procurement agency: he loves it, wants an implementation plan,” Massone said in one email that the inquiry said referred to Zuma... Bain’s quest for influence even extended to Massone attending meetings to discuss the manifesto of the ruling African National Congress, according to the report.

Now the British government has come down hard on Bain, banning it from tendering for government contracts for three years for its "grave professional misconduct". The government felt that Bain's role in the scandal had rendered its integrity "questionable". This is one of the first major actions by a western government against corrupt practices by western consulting organisations.  

In fact, Bain is only the latest in the series of misconduct by western firms in Jacob Zuma's South Africa

McKinsey agreed in 2020 to repay about R650mn ($39mn) over irregularities in contracts it had entered into with a local partner at government-owned companies. Auditor KPMG apologised in 2017 for “mistakes” in work for businesses linked to the Gupta family, accused of serious corruption through ties to Zuma. UK public relations company Bell Pottinger was brought down by its work for the Guptas, which led to accusations that it had stoked racial tensions in South Africa.

The UK government's barring of Bain from its public procurement process raises the question about why McKinsey and others with similar, if not worse, charges should not be similarly punished. 

Consider the infamous case of McKinsey's work with Purdue Pharma, where they advised both drug makers and the government regulators is an egregious example of practices which are becoming all too common in many developing countries too. See also this about McKinsey's work in South Africa and elsewhere. I've blogged here about questionable practices by McKinsey.

Consultants play an important role in shaping and reinforcing narratives on issues involving the intersection of public and private sectors. Most often, like with all profit driven incentives, their interests coincide with those of their private sector interlocutors. 

The problem with the work of consulting organisations advising governments is that it's largely opaque and secretive, commands disproportionately large influence, involves high stakes, and the incentives are clearly distorted. 

This has serious consequences in public procurements and institutional reforms. Weak checks and balances and institutional maturity within public systems encourages the Chinese walls within consulting organisations to become porous and allow commercial considerations to over-ride client interests and public interest at large. 

Appropriate safeguards by way of disclosures therefore become extremely important. For example, in case of consultancies advising governments on activities that involve private sector engagement, it's important that all the sector-related commercial engagements of the consultant be disclosed in the procurement documents. Consultants who advise on the sell-side of a private service/product should be barred from advising the buy-side government agencies. 

Similarly, public officials engaged with consulting organisations should be mandated to make public their or family connections with consultants. This should be done both before and for at least two years after the officials leave the post or the engagement has ended.  

It's also time that philanthropic foundations and civil society organisations, as well as multilateral organisations, support work that looks closely at the activities of consulting organisations working with governments. I have not come across even one comprehensive study scrutinising the business practices of consulting organisations advising governments. A part of the reason is that these organisations themselves are advised by the same consultants. 

Finally, taking a cue from the UK government's action on Bain & Co, western governments should redefine the scope of bribery and corruption to clearly include such practices. Firms engaging in such activities and held guilty in the host countries should be banned from public procurements in western countries too. 

A thought on the political economy of monetary policy

The Fed has raised interest rates by 75 basis points for the second month in a row, taking the target range to 2.25-2.5%. Faced with the highest inflation in more than four decades, this is the Fed's most aggressive monetary tightening since 1981, with the first 75 basis points rise being the first since 1994. 

In his remarks, the Fed Chairman Jerome Powell hinted at the need for a period of slower growth and weaker jobs market to bring down high inflation. 

This belief draws its theoretical basis mainly from one of the most important and contentious concepts in Economics, the Philips Curve which emerged in the 1950s. It describes the inverse relationship between inflation and labour market strength. As unemployment rises, demand declines, driving down inflation. So, the theory goes, to kill inflation, unemployment has to rise. It's a different matter that this relationship has not held in recent decades.

Apart from this, there is another important conceptual framework which sees rising inflation as a process of reshaping of expectations towards a period of higher inflation which makes workers demand higher wages. A wage-price spiral emerges, with the trigger being wage demands. With average labour wages having risen 15% since the onset of the pandemic, this wage-price spiral framework resonates loudly in inflation debates. 

Taken together, it's assumed that killing inflation requires cooling down the labour market, both at the intensive (limiting wage increase demands among existing workers) and extensive (limiting further tightening of the labour market) margins. The underlying theoretical framework is of aggregate demand increase driving up inflation.

This demand-driven-inflation assumption has been questioned in view of the obvious impact of supply shocks on the current episode of inflation. The disruptions to the global supply chains and manufacturing facilities due to the Covid pandemic was just starting to normalise when the Russians invaded Ukraine and Covid made a comeback to China. As Claudia Sahm writes,

There is no increase in the unemployment rate that would produce microchips for new cars, end China’s lockdowns, defeat Vladimir Putin, drill oil and build apartments. The Fed raises interest rates and lowers demand, cooling off the labour market. Whether it inadvertently causes a recession or not, higher interest rates would not fix the supply problems and would probably make some worse by discouraging investments.

In other words, fighting the current episode of supply-shock based inflation by raising interest rates may be barking up the wrong tree. This cure may turn out to be worse than the problem. 

On an emprical note, the report points to a study by Adam Shapiro which decomposes inflation contributors and shows that less than a third of monthly core inflation is due to demand.

In addition, I see a political economy dimension to the Fed's response. In the collective consciousness of important opinion makers and decision makers, the old theoretical framework of wage-price spiral exerts an overpowering influence. This theory also fits neatly with the ideological narrative which posits capital and labour as the all-time antagonists. The establishment at all levels therefore have a strong collective resolve in keeping the bargaining power of labour constrained. 

So, even at the cost of increasing their borrowing cost and also triggering a recession, I'm inclined to argue that the establishment (Wall Street, opinion shapers, and decision makers) would prefer to nip in the bud any revival of labour's bargaining power and the attendant possible wage-price spiral. Even if there is no overt conspiracy to do the same, this motive is baked into the collective consciousness of the establishment as to be a reflex response.