The British Government have decided to permit local councils impose a rubbish tax on households for the garbage thrown out by them. The "pay-as-you-throw" scheme, aimed at encouraging people to recycle waste, is part of the draft Climate Change Bill. The UK is faced with massive EU fines of upto $350 mn for failing to adhere to EU limits on the amount of garbage dumped on landfill sites. Such landfills, apart from polluting the soil and air, also the emission of powerful greenhouse gas methane from improper decomposition of biodegradable waste.
A few interesting things about the debate of relevance to us in India are
1. The difficulty in implementing the rubbish tax. It is acknowledged that local councils are going to find it politically difficult to impose such taxes. It is much the same in India, where the penal provisions for littering itself is very weak and inadequate. The transaction costs involved in the collection of fines for littering is prohibitively high.
2. The importance of awareness creation among general public. A Parliamentary Committee has found 57% of British citizens are "committed recyclers". Awareness creation should involve projecting a "save-as-you-throw" dimension, instead of the more penal "pay-as-you-throw" aspect. We have yet to make a meaningful start in India on this.
3. An organized market in recycled goods is virtually absent. Many items which can be easily recycled - bottles and packaging materials, damaged electrical equipments and materials, damaged vessels and utensils, rubber items, paper products, plastic materials etc - can be more easily collected through an organized retail network. The existing system of rag-pickers and other informal channels in developing countries, can at best be a second option. There is therefore an immediate need to create a market in recycled materials.
4. Waste to energy plants have practical problems. Waste energy plants across the world, more so in developing countries, face problems with local residents in terms of air pollution related public opposition. Apart from public opposition, there are other technolgy related problems, given the waste mix and calorific value of garbage generated from households in India. Both combustion and anaerobic digestion (bio-methanization) technologies have inherent limitations when applied to Indian and similar developing country contexts. Both technolgies require segregation of garbage (the most critical solid waste management challenge facing us) for economically viable operation of the plant. While there are successfully operating pilot plants (we have in Vijayawada both the types of plants), there are a very few or no fully operational large scale plants in the country. Compounding the problem is the low power tariffs offered by State Electricity Boards (In this context, we could have some certification like "Green Power", for power generated by such units, with some financial incentives structured so as to not distort the market)
Update 1
China is building large numbers of solid waste incinerators, whose harmful effects include toxic emissions, from dioxin to mercury, that can damage the body’s nervous. system
Tuesday, October 30, 2007
Saturday, October 27, 2007
Analysts then, credit rating agencies now, who next?
The two latest major bouts of irrational exuberance of our times, the dot com stocks and the real estate bubbles, owed their sustenance in no small measure to the failure of stock analysts and credit rating agencies respectively. Institutions which were suposed to provide objective assistance and advise in guiding investors, had failed collectively. The malaise was retrospectively traced back in both cases to moral hazard related market failures.
Hitherto it was thought that the major conflict of interest within a Bank was between equity analysts, who offered advise about stocks, and investment bankers, who were keen on selling those stocks. But, The Economist quotes a new study, "Sociopolitical Dynamics in Relations Between Top Managers and Security Analysts", by James Westphal and Micheal Clement, which focuses on conflicting interests in relationships between stock analysts and owners of the companies they cover.
The study covers thousands of analysts and executives of companies they cover, over two years. It finds that two-thirds of analysts admitted receiving favors from the firms they cover. Some of the questionable favors include - selectively sharing information to some analysts, putting an analyst in touch with executives at other firms, offering membership to private clubs etc. The study also found clear evidence of analysts responding bitterly to favors withheld by downgrading those stocks.
The sub-prime mortgage crisis has thrown light on another critical conflict of interest - that between credit rating agencies and the securities they rate. The rating agencies are paid by the same Financial Institutions (FI) that sell the rated securities. In fact, the rating agencies are not paid if the FI does not like the rating and even when they pay, the payment is made after the securities are sold.
What is the solution? How can we align the incentives of analysts and rating agencies with those of investors, instead of the company owners or investment bankers or securities issuers?
Following the dotcom bubble, the SEC intervened by separating the stock analysis function from the investment banking function. A solution along similar lines would involve having independent credit rating function, with securities issuing FI prohibited from paying the rating agencies. The investors, both individual and institutional, have to pay the rating agencies for accessing the ratings information.
The aforementioned two are not the only moral hazard generating activities. There is significant scope of moral hazard in the work of engineering consultants, given the interlocking and often direct relationship between them and construction contractors. Design and DPR preparation and Project execution are two independent processes, with separate bidding processes. There is the real danger of having Detailed Project Reports (DPRs) and even Master Plans, doctored to suit the requirements of specific engineering construction contractors.
This practice or trend is common in infrastructure sector projects. There are many infrastructure firms who openly flaunt their expertise in design and construction. There have also been numerous instances of the successful bidder for project development having a stake in the consultant who designed and prepared the DPR.
One way to avoid this moral hazard is by encouraging tendering processes like Engineering rocurement and Construction (EPC) in Project execution. But the more sustainable and effective manner is to strictly separate the functions of designing and execution. If some action is not taken to have more oversight on this, we will certainly have badly designed white elephants, designed not to meet infrastructure objectives but to boost the bottomlines of infrastructure companies!
Hitherto it was thought that the major conflict of interest within a Bank was between equity analysts, who offered advise about stocks, and investment bankers, who were keen on selling those stocks. But, The Economist quotes a new study, "Sociopolitical Dynamics in Relations Between Top Managers and Security Analysts", by James Westphal and Micheal Clement, which focuses on conflicting interests in relationships between stock analysts and owners of the companies they cover.
The study covers thousands of analysts and executives of companies they cover, over two years. It finds that two-thirds of analysts admitted receiving favors from the firms they cover. Some of the questionable favors include - selectively sharing information to some analysts, putting an analyst in touch with executives at other firms, offering membership to private clubs etc. The study also found clear evidence of analysts responding bitterly to favors withheld by downgrading those stocks.
The sub-prime mortgage crisis has thrown light on another critical conflict of interest - that between credit rating agencies and the securities they rate. The rating agencies are paid by the same Financial Institutions (FI) that sell the rated securities. In fact, the rating agencies are not paid if the FI does not like the rating and even when they pay, the payment is made after the securities are sold.
What is the solution? How can we align the incentives of analysts and rating agencies with those of investors, instead of the company owners or investment bankers or securities issuers?
Following the dotcom bubble, the SEC intervened by separating the stock analysis function from the investment banking function. A solution along similar lines would involve having independent credit rating function, with securities issuing FI prohibited from paying the rating agencies. The investors, both individual and institutional, have to pay the rating agencies for accessing the ratings information.
The aforementioned two are not the only moral hazard generating activities. There is significant scope of moral hazard in the work of engineering consultants, given the interlocking and often direct relationship between them and construction contractors. Design and DPR preparation and Project execution are two independent processes, with separate bidding processes. There is the real danger of having Detailed Project Reports (DPRs) and even Master Plans, doctored to suit the requirements of specific engineering construction contractors.
This practice or trend is common in infrastructure sector projects. There are many infrastructure firms who openly flaunt their expertise in design and construction. There have also been numerous instances of the successful bidder for project development having a stake in the consultant who designed and prepared the DPR.
One way to avoid this moral hazard is by encouraging tendering processes like Engineering rocurement and Construction (EPC) in Project execution. But the more sustainable and effective manner is to strictly separate the functions of designing and execution. If some action is not taken to have more oversight on this, we will certainly have badly designed white elephants, designed not to meet infrastructure objectives but to boost the bottomlines of infrastructure companies!
Thursday, October 25, 2007
Why are the richer areas cleaner than slums?
Sanitation and public health is one of the major concerns of any urban local body. In fact, it would not be incorrect to state that sanitation is the most immediate priority of any Municipal Corporation. Vijayawada, spread over 60 sqkm and a population of 1.1 m, has about 4000 public health workers involved in collection and transportation of Municipal Solid Waste (MSW). However, the Corporation is the target of repeated complaints and negative press coverage about how its sanitation staff neglects the slums and panders to the well off areas. At the risk of being politically incorrect, I have a different take on this issue.
Like any similar City, Vijayawada too has its own distinct upper-middle and upper class localities and slums. Apart from the size of houses and the wider road layouts, there are a few other distinguishing characteristics of the two areas. The one which is the subject of this post relates to cleanliness and why the posher areas look cleaner than slums. My contention is that well off areas look cleaner because of inherent personal dispositions of its residents, when compared to those of slum residents.
We need to control some parameters before we draw our conclusions. Let us assume that both localities have sewerage and water lines, roads and side drains. Let also assume that same number of workers are working in these areas. However in practice, the slum areas, due to their greater vulnerability to unhygenic conditions and epidemics, has more staff, higher materials consumption, and gets much more attention and supervision than the richer localities.
If more resources are spent on slums than the richer areas, why are the slums not proportionately cleaner? My contention is that the more well off people attach greater premium to cleanliness in their neighbourhood, than the less well off. A little bit of economics will help clarify it. The Marginal Social Benefit (MSB) to an individual or a community from any activity, is the benefit accrued to them due to an additional unit of that activity. Similarly, the Marginal Social Cost (MSC) to an individual or community from any activity, is the extra cost inflicted on them due to an additional unit of activity.
The MSC of keeping a locality clean increases, as the degree of cleanliness demanded increases. It is fairly easy, through the municipal sanitation workers, to keep an area reasonably clean. But the efforts of sanitation staff can only get you so far. Keeping an area very clean requires a much higher level of concerted effort from each resident, individually and collectively. In fact, the Marginal Cost of every additional unit of cleanliness keeps increasing, irrespective of the economic status of the residents of the area.
But the MSB of cleanliness is much higher for richer people when compared to slum residents. (Why the richer people attach greater premium to cleanliness shall be a subject for another post) Therefore, the residents of the richer areas have a greater incentive to maintaining their areas clean, and in the process even incur the additional opportunity cost for achieving the same. It follows that the richer people attach greater premium to keeping their neighbourhood clean, by both maintaining their personal surroundings clean and by being more demanding on the services of the Municipal sanitation staff.
This logic is similar to that underlying the concept of carbon trading under the Kyoto Protocol. Under the Protocol, lower cost polluters (those who can control their pollution at lower cost) can sell their carbon credits accumulated by adopting energy efficient technologies, to higher cost polluters (whose cost of reducing pollution is higher). More infamously Larry Summers, when he was with the World Bank, advocated shifting of polluting industries from developed countries to developing countries, where the marginal cost of every additional unit of pollution is lesser.
This logic can also be extended to explain as to why environmental and labour standards are immediate issues of public concern in the developed countries than in the developing countries. The MSB associated with progress in these issues are much higher in the former than the latter.
Like any similar City, Vijayawada too has its own distinct upper-middle and upper class localities and slums. Apart from the size of houses and the wider road layouts, there are a few other distinguishing characteristics of the two areas. The one which is the subject of this post relates to cleanliness and why the posher areas look cleaner than slums. My contention is that well off areas look cleaner because of inherent personal dispositions of its residents, when compared to those of slum residents.
We need to control some parameters before we draw our conclusions. Let us assume that both localities have sewerage and water lines, roads and side drains. Let also assume that same number of workers are working in these areas. However in practice, the slum areas, due to their greater vulnerability to unhygenic conditions and epidemics, has more staff, higher materials consumption, and gets much more attention and supervision than the richer localities.
If more resources are spent on slums than the richer areas, why are the slums not proportionately cleaner? My contention is that the more well off people attach greater premium to cleanliness in their neighbourhood, than the less well off. A little bit of economics will help clarify it. The Marginal Social Benefit (MSB) to an individual or a community from any activity, is the benefit accrued to them due to an additional unit of that activity. Similarly, the Marginal Social Cost (MSC) to an individual or community from any activity, is the extra cost inflicted on them due to an additional unit of activity.
The MSC of keeping a locality clean increases, as the degree of cleanliness demanded increases. It is fairly easy, through the municipal sanitation workers, to keep an area reasonably clean. But the efforts of sanitation staff can only get you so far. Keeping an area very clean requires a much higher level of concerted effort from each resident, individually and collectively. In fact, the Marginal Cost of every additional unit of cleanliness keeps increasing, irrespective of the economic status of the residents of the area.
But the MSB of cleanliness is much higher for richer people when compared to slum residents. (Why the richer people attach greater premium to cleanliness shall be a subject for another post) Therefore, the residents of the richer areas have a greater incentive to maintaining their areas clean, and in the process even incur the additional opportunity cost for achieving the same. It follows that the richer people attach greater premium to keeping their neighbourhood clean, by both maintaining their personal surroundings clean and by being more demanding on the services of the Municipal sanitation staff.
This logic is similar to that underlying the concept of carbon trading under the Kyoto Protocol. Under the Protocol, lower cost polluters (those who can control their pollution at lower cost) can sell their carbon credits accumulated by adopting energy efficient technologies, to higher cost polluters (whose cost of reducing pollution is higher). More infamously Larry Summers, when he was with the World Bank, advocated shifting of polluting industries from developed countries to developing countries, where the marginal cost of every additional unit of pollution is lesser.
This logic can also be extended to explain as to why environmental and labour standards are immediate issues of public concern in the developed countries than in the developing countries. The MSB associated with progress in these issues are much higher in the former than the latter.
Wednesday, October 24, 2007
India outsources outsourcing
Interesting article in the Guardian, India outsources outsourcing. Wage inflation and talent shortage, coupled with growing demand from non-English speaking markets, means that Indian software companies are opening up bases in newer locations.
The article mentions two interesting dimensions of the growth of Indian software firms,
The article mentions two interesting dimensions of the growth of Indian software firms,
"The ability of an industry in a developing country such as India to export "managerial and entrepreneurial capital" to wealthier nations is unprecedented, say economists. Arvind Subramanian, of Johns Hopkins University in Baltimore, says that India exports 1.2% of its GDP ($12bn) in foreign direct investment. Professor Subramanian says this is part of India's "anomalous pattern of development". Countries typically specialise in industries such as IT only when their income per head passes $15,000 and they do not export investment until per capita GDP touches $45,000. The comparable figure for India is only $900. "India finds comparative advantage in skills and managerial capital ... how precocious is that?" he wrote this year.
The other strange feature is that the Indian economy, booming at 9% a year, is not driving the growth of India's software firms. Barely 2% of Infosys's income comes from India. Instead Wall Street banks asking for "Spanish language support" or China's booming economy sway investment decisions. Mr Gopalakrishnan says Infosys's "non-English-speaking revenues contribute about a fifth of the total. It is growing fast and we have to build up expertise in languages.""
Religion and social benefits
There is a new NBER article by Rajeev Dehejia et al, which explores the influence of religious and social organizations in the lives of disadvantaged youth.
The authors consider a range of definitions of disadvantage in childhood (family income and poverty measures, family characteristics including parental education, and child characteristics including parental assessments of the child) and a range of outcome measures in adulthood (including education, income, and measures of health and psychological wellbeing), and concludes,
"Overall, we find strong evidence that youth with religiously active parents are less affected later in life by childhood disadvantage than youth whose parents did not frequently attend religious services. These buffering effects of religious organizations are most pronounced when outcomes are measured by high school graduation or non-smoking and when disadvantage is measured by family resources or maternal education, but we also find buffering effects for a number of other outcome-disadvantage pairs. We generally find much weaker buffering effects for other social organizations."
"Religion plays an important role in how households respond to the disadvantages they face. Our results are especially strong when disadvantage is measured by maternal education and outcomes are measured by the youth’s educational attainment."
The authors consider a range of definitions of disadvantage in childhood (family income and poverty measures, family characteristics including parental education, and child characteristics including parental assessments of the child) and a range of outcome measures in adulthood (including education, income, and measures of health and psychological wellbeing), and concludes,
"Overall, we find strong evidence that youth with religiously active parents are less affected later in life by childhood disadvantage than youth whose parents did not frequently attend religious services. These buffering effects of religious organizations are most pronounced when outcomes are measured by high school graduation or non-smoking and when disadvantage is measured by family resources or maternal education, but we also find buffering effects for a number of other outcome-disadvantage pairs. We generally find much weaker buffering effects for other social organizations."
"Religion plays an important role in how households respond to the disadvantages they face. Our results are especially strong when disadvantage is measured by maternal education and outcomes are measured by the youth’s educational attainment."
Tuesday, October 23, 2007
Green activists and environmental bogeys
It is remarkable that a surprisingly high level of utter ignorance masquerade as informed opinion in public debates on important issues of civic concern. As opinion makers and public servants, it is unpardonable, indeed an act of hypocrisy and duplicity, that we debate on public issues with assumptions that are a figment of our imagination and have no basis in fact and reality. Over the past few months, I have been a more than interested observer to a few similar public debates in Vijayawada on issues like water meters, Public Private Partnership (PPP), outsourcing civic services, and cost recovery/user charges. The latest addition to this impressive list is the issue of property tax increases.
In vigorous public debates on all these issues I have come across many instances of surprising lack of basic understanding of the issue, and more than a few instances of taking liberties with even facts. When confronted with the facts, the common refrain is that this was the information gleaned from newspapers and from other sources in the public domain (which by some definition cannot be incorrect). There have also been instances of dogmatic refusal to accept facts and persist with half truths and outright lies.
But such ignorance of facts is not the exclusive privilege of local debates. Even in national and international level debates, such misconceptions are common. Environmental issues are a fertile ground for such debates and the attendant misconceptions. After Bt Cotton, and GM Crops, biofuels is emerging as the new demon for environmental activists across the world. Given the growing importance of issues related to use of biofuels, I am convinced that the debate is about to reach its crescendo.
There is an interesting article by James Woudhysen, Why greens don’t want to ‘solve’ climate change, where the author seeks to explore the reasons for the environmental groups reluctance to accept technological fixes to problems that are a natural by-product of the process of development. Woudhysen's description of the Green's position on climate change is not very different from their position on other similar issues:
"For many today, both green activists and leading politicians, climate change is a moral and political issue rather than simply a practical problem. They see the ‘issue of climate change’ as a means to changing people’s behaviour and expectations, rather than simply as a byproduct of industrialisation that ought to be tackled by technological know-how."
Significant sections of the Green movement are consumed by a desire to achieve the ideal solutions to the many environmental problems thrown up by the process of development. They focus their energies on either trying to bring about wholesale attitudinal changes, an impractical task, or completely roll back the process responsible for generating the negative externality, an impossible task.
Such debates therefore most often emerges as a dialogue (or lack of it) between two extreme positions, with no effort whatsoever to find a modus vivendi. Each side rejects the other side wholesale, thereby boxing themselves to ideological corners from which there is limited space to manouvre. Thus Animal Rights activists like PETA categorizes all non-vegetarians as anti-environmentalists and sees vegetarianism as the only way to save the environment and the world from hunger. The "peak oil" theorists claim that the global oil resources are getting depleted fast and the time has come to seek out other alternatives. The Luddite anti-development extremists claim that if development as we define it today is allowed to continue apace, the day of environmental armageddon is not far in coming. The opponents of each of these positions reject it, and in turn go the other direction in completely denying the possibility of such disasters.
Take the case of the debate on bio-fuels. The environmental and human rights groups claim that the biofuels production would involve diversion of scarce land and other resources presently utilized in foodgrain production. They prophesize a doomsday of "massive world hunger" if biofuels are to replace conventional petroleum products. The biofuels debate has thrown up interesting alignment of interests - Greens and oil producers, Hugo Chavez and the Texan oil companies! In fact, if an international conference on biofuels were held today, we could have the remarkable sight of environmental activists and oil companies uniting in attacking biofuel producers. It has also divided opinions among the Green movement.
The Brazilian President Luis Inacio "Lula" De Silva, defended the Brazilian biofuels programme before the UN General Assembly in September. Responding to a UN report that calls for a five year moratorium on the production of ethanol fuel, Lula vehemently rejected the allegation that Brazilian sugarcane producers are diverting land from foodcrops and have also started deforesting the Amazon basin. He claimed that only a fifth of Brazil's arable land is currently under cultivation and of this less than 4% is used for ethanol.
Issues like global warming and its impact on sea level rise, bio-fuels and its impact on foodgrain production and its efficiency as a fuel, genetically modified crops and its impact on health and food security, etc have been well researched by academics from across the spectrum. But unfortunately the debate on these issues are rarely illuminated by incontrovertible facts. Facts and figures are distorted to serve ideological positions. Global warming sceptics quote dubious and obscure studies to deny the overwhelming evidence in favor of global warming and its consequences. How can any informed debate accommodate opinions that completely deny global warming?
Unfortunately the dogmatic all-or-nothing opposition of environmental campaigners to these problems, provides the ideal smokescreen for their opponents and deniers of any environmental damage, dominated by various corporate groups, to hijack the agenda and tailor policies to suit their interests. Given the impossibility of turning back the development clock, and the outright refusal of the Greens to accept technological fixes and market solutions, the decision making process is handed over to the environmental damage deniers in a platter.
The result of such blind ideological sloganeering and rhetoric is that essential debates on the efficacy of practical, real world solutions to various environmental and other issues get sidelined and often ignored. Thus the Green scepticism, and often outright rejection, of carbon trading has meant that even the genuine environmental concerns are not reflected or taken into account in adequate measure while policies are formulated.
There is no use clinging on to the ideal solution, when faced with the exigencies and problems of the real world, and in the process ending up achieving the worst of both worlds. The challenge for us is to engineer solutions that account for the reality, utilizing the latest technologies and processes, and the market, and mitigate the harmful effects of global environmental degradation thrown up by the rapidly moving dialectic of development.
Update
George Monbiot has written, The western appetite for biofuels is causing starvation in the poor world , on the topic.
In vigorous public debates on all these issues I have come across many instances of surprising lack of basic understanding of the issue, and more than a few instances of taking liberties with even facts. When confronted with the facts, the common refrain is that this was the information gleaned from newspapers and from other sources in the public domain (which by some definition cannot be incorrect). There have also been instances of dogmatic refusal to accept facts and persist with half truths and outright lies.
But such ignorance of facts is not the exclusive privilege of local debates. Even in national and international level debates, such misconceptions are common. Environmental issues are a fertile ground for such debates and the attendant misconceptions. After Bt Cotton, and GM Crops, biofuels is emerging as the new demon for environmental activists across the world. Given the growing importance of issues related to use of biofuels, I am convinced that the debate is about to reach its crescendo.
There is an interesting article by James Woudhysen, Why greens don’t want to ‘solve’ climate change, where the author seeks to explore the reasons for the environmental groups reluctance to accept technological fixes to problems that are a natural by-product of the process of development. Woudhysen's description of the Green's position on climate change is not very different from their position on other similar issues:
"For many today, both green activists and leading politicians, climate change is a moral and political issue rather than simply a practical problem. They see the ‘issue of climate change’ as a means to changing people’s behaviour and expectations, rather than simply as a byproduct of industrialisation that ought to be tackled by technological know-how."
Significant sections of the Green movement are consumed by a desire to achieve the ideal solutions to the many environmental problems thrown up by the process of development. They focus their energies on either trying to bring about wholesale attitudinal changes, an impractical task, or completely roll back the process responsible for generating the negative externality, an impossible task.
Such debates therefore most often emerges as a dialogue (or lack of it) between two extreme positions, with no effort whatsoever to find a modus vivendi. Each side rejects the other side wholesale, thereby boxing themselves to ideological corners from which there is limited space to manouvre. Thus Animal Rights activists like PETA categorizes all non-vegetarians as anti-environmentalists and sees vegetarianism as the only way to save the environment and the world from hunger. The "peak oil" theorists claim that the global oil resources are getting depleted fast and the time has come to seek out other alternatives. The Luddite anti-development extremists claim that if development as we define it today is allowed to continue apace, the day of environmental armageddon is not far in coming. The opponents of each of these positions reject it, and in turn go the other direction in completely denying the possibility of such disasters.
Take the case of the debate on bio-fuels. The environmental and human rights groups claim that the biofuels production would involve diversion of scarce land and other resources presently utilized in foodgrain production. They prophesize a doomsday of "massive world hunger" if biofuels are to replace conventional petroleum products. The biofuels debate has thrown up interesting alignment of interests - Greens and oil producers, Hugo Chavez and the Texan oil companies! In fact, if an international conference on biofuels were held today, we could have the remarkable sight of environmental activists and oil companies uniting in attacking biofuel producers. It has also divided opinions among the Green movement.
The Brazilian President Luis Inacio "Lula" De Silva, defended the Brazilian biofuels programme before the UN General Assembly in September. Responding to a UN report that calls for a five year moratorium on the production of ethanol fuel, Lula vehemently rejected the allegation that Brazilian sugarcane producers are diverting land from foodcrops and have also started deforesting the Amazon basin. He claimed that only a fifth of Brazil's arable land is currently under cultivation and of this less than 4% is used for ethanol.
Issues like global warming and its impact on sea level rise, bio-fuels and its impact on foodgrain production and its efficiency as a fuel, genetically modified crops and its impact on health and food security, etc have been well researched by academics from across the spectrum. But unfortunately the debate on these issues are rarely illuminated by incontrovertible facts. Facts and figures are distorted to serve ideological positions. Global warming sceptics quote dubious and obscure studies to deny the overwhelming evidence in favor of global warming and its consequences. How can any informed debate accommodate opinions that completely deny global warming?
Unfortunately the dogmatic all-or-nothing opposition of environmental campaigners to these problems, provides the ideal smokescreen for their opponents and deniers of any environmental damage, dominated by various corporate groups, to hijack the agenda and tailor policies to suit their interests. Given the impossibility of turning back the development clock, and the outright refusal of the Greens to accept technological fixes and market solutions, the decision making process is handed over to the environmental damage deniers in a platter.
The result of such blind ideological sloganeering and rhetoric is that essential debates on the efficacy of practical, real world solutions to various environmental and other issues get sidelined and often ignored. Thus the Green scepticism, and often outright rejection, of carbon trading has meant that even the genuine environmental concerns are not reflected or taken into account in adequate measure while policies are formulated.
There is no use clinging on to the ideal solution, when faced with the exigencies and problems of the real world, and in the process ending up achieving the worst of both worlds. The challenge for us is to engineer solutions that account for the reality, utilizing the latest technologies and processes, and the market, and mitigate the harmful effects of global environmental degradation thrown up by the rapidly moving dialectic of development.
Update
George Monbiot has written, The western appetite for biofuels is causing starvation in the poor world , on the topic.
Saturday, October 20, 2007
No balls and incentives
An interesting piece of statistics from the recently concluded seven one day India-Australia series. India conceded just 3 no-balls (of which only one was for overstepping) in 317.2 overs bowled, and Australia 6 (of which 5 were from Brett Lee) in 284.3 overs bowled. To put this in its proper perspective, in the seven one-dayers played between India and England early this year, England bowled 20 no-balls and India 14. The ICC had started implementing the free-hit rule for no balls from this series. Under this, if a front foot no ball is bowled, then the batsman has a free hit for the next ball without any change in the fielding positions, and he cannot become out except by being run out. The dramatic fall in no balls is attributed to this new rule, which imposes unacceptably high costs on the bowler.
The lesson from this - with appropriate incentives and dis-incentives, it is possible to cut down on undesirable practices, that are within the control of the individual players (so it may not be possible to similarly control wides), even in a sports field. Incentives become effective if the deterring cost is prohibitively high enough for for the agent to change the behaviour. For example, I am not sure monetary fines would have deterred no balls. Another important area for similar intervention is for bowling all the overs within the specified time.
The lesson from this - with appropriate incentives and dis-incentives, it is possible to cut down on undesirable practices, that are within the control of the individual players (so it may not be possible to similarly control wides), even in a sports field. Incentives become effective if the deterring cost is prohibitively high enough for for the agent to change the behaviour. For example, I am not sure monetary fines would have deterred no balls. Another important area for similar intervention is for bowling all the overs within the specified time.
Thursday, October 18, 2007
'World is not Flat' hypothesis
Harvard Business School Professor Pankaj Ghemawat has written a new book, Redefining Global Strategy: Crossing Borders in a World Where Differences Still Matter, which counters the popularly held notion made famous by New York Times columnist, Thomas L Friedman, that the "World is Flat". He argues that the world is only partly globalized or "semi-globalized", in which "neither the bridges nor the barriers between countries can be ignored", and even questions whether the world is actually becoming flat.
The HBS website carries an interview of Prof Ghemawat. He marshals global economic statistics to argue that the world is not that integrated as is being made out to be,
"The most commonly cited figure concerns international trade, which represents more than 25 percent of most economies. But when I began to research a broader range of measures including investment, phone calls, tourism, and immigration, I found that, surprisingly, the average extent of globalization is only 10 percent. For example, for every dollar of capital investment globally, only a dime is accounted for by foreign direct investment."
Prof Ghemawat identifies four dimensions of globalisation - cultural, administrative/political, geographic, and economic. In the first three dimensions, there can be no doubt that the world is far from flat, and is at best moving towards some form of semi-globalization. In fact, the emerging trends strongly points towards strengthening sub-national and local cultures, growing national identities and entrenched national governments. Border controls and national boundaries continue to be sacrosanct, and free movement of labor remains a distant dream. Economically too, apart from a few functioning Free Trade Areas (FTAs), the national economy remains overwhelmingly dominant over the global economy. Even in terms of economic globalisation, many studies have shown up surprisingly small levels of economic integration.
A few recent phenomena lends further credence to the semi-globalized world hypothesis. The global financial markets were deeply influenced by the carry trades, wherein forex traders borrowed in low interest rate Japan (the policy of the Bank of Japan to hold yen low made the yen carry trade a relatively low risk activity) to invest in financial markets where interest rates were relatively higher. It is estimated that over $ 1 trillion was traded in yen carry trade this year alone. Theoretically, in a flat world, and global financial markets are today as flat as they can get, such arbitrage oppportunities cannot be sustained. Speculative shorting of yen to invest in high-yielding assets elsewhere, calmed down only when the yen started rising against the dollar. Arbitrage opportunities for various financial instruments across geographical boundaries, continues to provide the biggest margins for most participants in the global financial markets.
The law of one price, one of the most fundamental concepts in economics, is as distant as ever in the real world of commodities and manufactured goods. This is despite the increasing role of internet in sales of these goods. Thus, as Prof Ghemawat analyses, the prices of some of the global commodities like Coke varies across countries by much more than what theory would suggest. The prices of a Mac burger, that ubiquitous symbol of flatism according to Tom Friedman, is another example of such variation. (The The Economist's Mac Index captures the reality) Multinational companies have different marketing and pricing strategies for different markets. In fact, studies have shown a massive extent of product differentiation across national markets, and this is showing an increasing trend.
The overwhelming evidence would point towards the world being not just topographically uneven, but also economically and socially far from being flat!
The HBS website carries an interview of Prof Ghemawat. He marshals global economic statistics to argue that the world is not that integrated as is being made out to be,
"The most commonly cited figure concerns international trade, which represents more than 25 percent of most economies. But when I began to research a broader range of measures including investment, phone calls, tourism, and immigration, I found that, surprisingly, the average extent of globalization is only 10 percent. For example, for every dollar of capital investment globally, only a dime is accounted for by foreign direct investment."
Prof Ghemawat identifies four dimensions of globalisation - cultural, administrative/political, geographic, and economic. In the first three dimensions, there can be no doubt that the world is far from flat, and is at best moving towards some form of semi-globalization. In fact, the emerging trends strongly points towards strengthening sub-national and local cultures, growing national identities and entrenched national governments. Border controls and national boundaries continue to be sacrosanct, and free movement of labor remains a distant dream. Economically too, apart from a few functioning Free Trade Areas (FTAs), the national economy remains overwhelmingly dominant over the global economy. Even in terms of economic globalisation, many studies have shown up surprisingly small levels of economic integration.
A few recent phenomena lends further credence to the semi-globalized world hypothesis. The global financial markets were deeply influenced by the carry trades, wherein forex traders borrowed in low interest rate Japan (the policy of the Bank of Japan to hold yen low made the yen carry trade a relatively low risk activity) to invest in financial markets where interest rates were relatively higher. It is estimated that over $ 1 trillion was traded in yen carry trade this year alone. Theoretically, in a flat world, and global financial markets are today as flat as they can get, such arbitrage oppportunities cannot be sustained. Speculative shorting of yen to invest in high-yielding assets elsewhere, calmed down only when the yen started rising against the dollar. Arbitrage opportunities for various financial instruments across geographical boundaries, continues to provide the biggest margins for most participants in the global financial markets.
The law of one price, one of the most fundamental concepts in economics, is as distant as ever in the real world of commodities and manufactured goods. This is despite the increasing role of internet in sales of these goods. Thus, as Prof Ghemawat analyses, the prices of some of the global commodities like Coke varies across countries by much more than what theory would suggest. The prices of a Mac burger, that ubiquitous symbol of flatism according to Tom Friedman, is another example of such variation. (The The Economist's Mac Index captures the reality) Multinational companies have different marketing and pricing strategies for different markets. In fact, studies have shown a massive extent of product differentiation across national markets, and this is showing an increasing trend.
The overwhelming evidence would point towards the world being not just topographically uneven, but also economically and socially far from being flat!
Wednesday, October 17, 2007
Market solutions to Climate Change problem
The latest Nobel Peace Prize to Al Gore and the IPCC has pitchforked climate change debate into the forefront of the global environmental agenda. An article in the Guardian by Tim Watkin, Manufacturing the Green Revolution, captures the issues. As the example of Prius shows, it is less of ethical dilemmas instead of hard nosed material and economic incentives that drives the changes in the behaviour of human beings. (A recent survey in California found that a mere 2% of Prius users purchased it for environmental reasons, and an overwhelming majority did so for accessing the car pool lane and for establishing their green credentials!)
Though there have been numerous high profile celebrity campaigns espousing climate change, they have had minimal impact in making any substantive changes in people's behaviour. Cosmetic window dressing apart, such piecemeal efforts have limited utility value and cannot address the core issues in any meaningful manner. This requires bringing the market into the centre stage of the debate on climate change. This in turn necessitates appropriate Government intervention and regulation.
Unfortunately, Governments across the world have hitherto evinced only a marginal commitment in embracing policies that address climate change challenges. There are many immediately implementable regulatory solutions towards mitigating climate change. For a start, Governments could regulate on energy saving technologies and standards. Taxation policies can be tailored to incentivize people and firms to adopt energy saving technologies and processes. Therefore big vehicles, power guzzling electronic gizmos, etc could be discouraged with high taxes.
There is a need for Government policies that acts in two dimensions simultaneously. It has to turn away both the producers and consumers from energy intensive technologies and encourage them to adopt energy efficient systems and practices. This requires appropriate structuring of incentives, that seek to internalize the negative externalities imposed by climate change causing systems, while at the same time promoting cleaner and environment friendly technologies. This incentive structure and the resulting Government policies and regulations should aim to bring in a market in energy saving technologies and systems. Only a market driven solution that harnesses the incentives and dis-incentives, supplemented by appropriate regulations, can make a substantial and sustainable dent in the campaign against climate change.
I have tried to list out a recipe for a few immediately implementable policy solutions
1. Energy consumption standards and ratings for all electronic goods. Higher taxes on lower rating goods.
2. Energy saving technologies for consumer electronics like refrigerators, air conditioners etc. A one time retrofitting campaign for all old devices.
3. Higher taxes on gas guzzling vehicles. A graded system of Motor Vehicle Tax on energy intensive private vehicles can encourage a trend towards more environment friendly vehicles. Preferential tax treatment of vehicles like Prius can help.
4. Extensive promotion of Compact Fluorescent (CFL) bulbs. Mandatory use of CFLs in all offices. Incandescent bulbs should be phased out, while lowering the price of CFLs.
5. Standardization of energy consumption for different categories of electro-mechanical devices and capping energy consumption thereof. Any consumption over and above this should be heavily taxed.
6. Carbon emission to be capped and permits to be issued for trading. (Though important voices like Lawrence Summers favors Carbon taxes to such permits, Practical Steps to Climate Control)
7. Promoting research in solar and other renewable energy sources, and in technologies like LEDs and energy efficient motors/engines and lighting. Aggressive energy saving technology sharing protocols between nations.
8. Mandatory energy audit of all institutions, including Government run facilities. For example the Water and Sewerage facilities and streetlights of Urban Local Bodies can be audited and very easily massive energy savings achieved.
9 Reexamine all the over $250 bn worth energy subsidies, and permit only those which cannot be avoided. For the remaining, explore options to achieve the objectives through other interventions.
Though there have been numerous high profile celebrity campaigns espousing climate change, they have had minimal impact in making any substantive changes in people's behaviour. Cosmetic window dressing apart, such piecemeal efforts have limited utility value and cannot address the core issues in any meaningful manner. This requires bringing the market into the centre stage of the debate on climate change. This in turn necessitates appropriate Government intervention and regulation.
Unfortunately, Governments across the world have hitherto evinced only a marginal commitment in embracing policies that address climate change challenges. There are many immediately implementable regulatory solutions towards mitigating climate change. For a start, Governments could regulate on energy saving technologies and standards. Taxation policies can be tailored to incentivize people and firms to adopt energy saving technologies and processes. Therefore big vehicles, power guzzling electronic gizmos, etc could be discouraged with high taxes.
There is a need for Government policies that acts in two dimensions simultaneously. It has to turn away both the producers and consumers from energy intensive technologies and encourage them to adopt energy efficient systems and practices. This requires appropriate structuring of incentives, that seek to internalize the negative externalities imposed by climate change causing systems, while at the same time promoting cleaner and environment friendly technologies. This incentive structure and the resulting Government policies and regulations should aim to bring in a market in energy saving technologies and systems. Only a market driven solution that harnesses the incentives and dis-incentives, supplemented by appropriate regulations, can make a substantial and sustainable dent in the campaign against climate change.
I have tried to list out a recipe for a few immediately implementable policy solutions
1. Energy consumption standards and ratings for all electronic goods. Higher taxes on lower rating goods.
2. Energy saving technologies for consumer electronics like refrigerators, air conditioners etc. A one time retrofitting campaign for all old devices.
3. Higher taxes on gas guzzling vehicles. A graded system of Motor Vehicle Tax on energy intensive private vehicles can encourage a trend towards more environment friendly vehicles. Preferential tax treatment of vehicles like Prius can help.
4. Extensive promotion of Compact Fluorescent (CFL) bulbs. Mandatory use of CFLs in all offices. Incandescent bulbs should be phased out, while lowering the price of CFLs.
5. Standardization of energy consumption for different categories of electro-mechanical devices and capping energy consumption thereof. Any consumption over and above this should be heavily taxed.
6. Carbon emission to be capped and permits to be issued for trading. (Though important voices like Lawrence Summers favors Carbon taxes to such permits, Practical Steps to Climate Control)
7. Promoting research in solar and other renewable energy sources, and in technologies like LEDs and energy efficient motors/engines and lighting. Aggressive energy saving technology sharing protocols between nations.
8. Mandatory energy audit of all institutions, including Government run facilities. For example the Water and Sewerage facilities and streetlights of Urban Local Bodies can be audited and very easily massive energy savings achieved.
9 Reexamine all the over $250 bn worth energy subsidies, and permit only those which cannot be avoided. For the remaining, explore options to achieve the objectives through other interventions.
Tuesday, October 16, 2007
Spinning Dancer
Here is an amazing optical illusion making rounds in the blogosphere, about a spinning dancer and the direction of her rotation. I have observed it for a long time, at different times. I have even observed it with another person, and found me seeing it spin clockwise and my partner anti-clockwise. While most of the time it appears to be spinning clockwise, it sometimes appears anti-clockwise!
Update 1
Steve Levitt solicited responses from 219 people on relation between left/right brains and perception of spin direction. The results are posted in Freakonomics blog. The results are interestingly enough, exactly the opposite of what the spinning dancer blog suggests.
The breakdown of responses is given below, indicating the percentage of respondents who initially sees her spinning counter-clockwise. The higher this number, the more rational you are supposed to be (with the number of observations in parentheses):
Engineers/mathematicians/computer programmers: 21.8% (N=55)
Economists: 26.7% (N=60)
Scientists: 31.0% (N=29)
Social Scientists: 36.2% (N=47)
Humanities: 42.9% (N=28)
Either the "rational economic man" theory is wrong, or more probably, as Levitt suggests, the spinning dancer theory on left/right brains is wrong.
Update 1
Steve Levitt solicited responses from 219 people on relation between left/right brains and perception of spin direction. The results are posted in Freakonomics blog. The results are interestingly enough, exactly the opposite of what the spinning dancer blog suggests.
The breakdown of responses is given below, indicating the percentage of respondents who initially sees her spinning counter-clockwise. The higher this number, the more rational you are supposed to be (with the number of observations in parentheses):
Engineers/mathematicians/computer programmers: 21.8% (N=55)
Economists: 26.7% (N=60)
Scientists: 31.0% (N=29)
Social Scientists: 36.2% (N=47)
Humanities: 42.9% (N=28)
Either the "rational economic man" theory is wrong, or more probably, as Levitt suggests, the spinning dancer theory on left/right brains is wrong.
Monday, October 15, 2007
Why are our tourist sites not well developed?
One of the most commonly heard complaints about Government maintained establishments are that they are badly run and suffer from inadequate maintenance. No where is this more evident than in some of the tourist spots across the country. A recent visit to some of the country's premier historic sites left me wondering as to why we cannot develop and maintain them like even the many much less important and smaller tourist locations in the Europe and the US.
Very often, developing a tourist spot to international standards requires substantial investments that cannot be met from the regular budgetary allocations for capital expenditures. Given the compelling political need for striking a semblance of equity in the allocation of such funds, Government departments end up allocating shares which while satisfying the political compulsions, serves no substantive purpose. The minimal allocation is most often frittered away in small incremental additions and adhoc expenditures. The tourist site continues to partake of minimal allocations every year, without it making any dent on its total requirements.
Instead the Tourism Department ought to prioritize from among competing needs. It needs to identify those sites which are the priority for development, given its historic importance and popularity. It also needs to prepare Detailed Project Reports for the comprehensive development of such facilities, and channel the annual departmental capital expenditure allocations for completely covering these needs over a specified implementation period. Apart from being delivered as a full grant, a substantial part of this assistance can be funnelled as viability gap funding or bridge financing, to complement private investment. Any capital expenditure allocation should be provided only as part of a detailed development plan that comprehensively covers the full development needs of the tourist site.
The example of tourist sites and the Toursim Department can be extended to cover the workings of most other Government departments. This is another manifestation of the some-allocation-to-all complex that pervades all Government decsion making, and has been bought out in the case of our poverty alleviation programs in a previous post.
When faced with huge resource requirements and competing demands, Governments need to prioritize among those needs that generate the maximum marginal benefits, and not spread resources out too thinly. The maintenance expenditures, like the poverty mitigation efforts, should be spread out to cover all the establishments. However, like the poverty elimination programs, the capital expenditures should be more focussed and targetted in a prioritized manner, so as to maximize the marginal benefits. The plan should be to develop all our tourist sites in a phased manner to world class standards.
Very often, developing a tourist spot to international standards requires substantial investments that cannot be met from the regular budgetary allocations for capital expenditures. Given the compelling political need for striking a semblance of equity in the allocation of such funds, Government departments end up allocating shares which while satisfying the political compulsions, serves no substantive purpose. The minimal allocation is most often frittered away in small incremental additions and adhoc expenditures. The tourist site continues to partake of minimal allocations every year, without it making any dent on its total requirements.
Instead the Tourism Department ought to prioritize from among competing needs. It needs to identify those sites which are the priority for development, given its historic importance and popularity. It also needs to prepare Detailed Project Reports for the comprehensive development of such facilities, and channel the annual departmental capital expenditure allocations for completely covering these needs over a specified implementation period. Apart from being delivered as a full grant, a substantial part of this assistance can be funnelled as viability gap funding or bridge financing, to complement private investment. Any capital expenditure allocation should be provided only as part of a detailed development plan that comprehensively covers the full development needs of the tourist site.
The example of tourist sites and the Toursim Department can be extended to cover the workings of most other Government departments. This is another manifestation of the some-allocation-to-all complex that pervades all Government decsion making, and has been bought out in the case of our poverty alleviation programs in a previous post.
When faced with huge resource requirements and competing demands, Governments need to prioritize among those needs that generate the maximum marginal benefits, and not spread resources out too thinly. The maintenance expenditures, like the poverty mitigation efforts, should be spread out to cover all the establishments. However, like the poverty elimination programs, the capital expenditures should be more focussed and targetted in a prioritized manner, so as to maximize the marginal benefits. The plan should be to develop all our tourist sites in a phased manner to world class standards.
Sunday, October 14, 2007
Carbon Credits in Urban Local Bodies
It is by now universally acknowledged that there is an immediate need to internalize the external costs arising from negative externality producing activities like pollution. One of the ways of addressing this issue is by imposing a Pigouvian tax on the externality, thereby disincentivizing the polluting agent from indulging in more pollution. But this approach throws up many implementation problems. The more practical option is that of providing economic incentives for reducing the negative externality. One of the most popular form of this is the system of carbon trading for controlling greenhouse gas emissions.
Under the existing cap and trade, emissions trading arrangements, the Government sets a cap on the amount of pollutant that can be emitted by each agent. A credit gives the owner the right to emit one tonne of carbon dioxide (CO2). The agents are given credits that give them the right to emit a certain quantity of pollutants. Any emssion over and above this can be done only by buying unused credits from another agent, at a cost. The price of a carbon credit reflects the cost of polluting the environment. This incentivizes the polluters to reduce their emissions, so as to both meet their targets and also to generate enough credits to trade. It is an economically efficient solution, in so far as it enables those who can reduce their emissions at the lowest cost to do so and those facing higher reduction costs to buy credits to offset their excess emissions.
The Kyoto Protocol for limiting greehouse gas emssions, provides for a Clean Development Mechanism (CDM) under which developed countries with excess production of such gases can invest in projects in developing countries that can more cheaply reduce emissions. The Protocol also provides for converting any emission reductions into carbon credits, in the form of Certified Emission Reductions (CERs), which can be traded. The Executive Board (EB) of the CDM certifies and issues the CERs through an independent third party, Designated Operational Entity (DOE).
The largest international market on trading carbon credits is the European Union's Emission Trading Scheme ( EU ETS). It covers all the 27 EU nations, and the European Commission (EC) have put limits on the amount firms can pollute and have also issued an equivalent number of allowances. Those companies crossing the limit must either cut their emissions or buy spare allowances from others. Despite initial problems, the EU ETS carbon market is now well established, and has been found to have achieved its objective of reducing emissions. CERs have been found to be cheaper than EU ETS allowances. The global carbon trading market was about $30 bn in 2006 and has the potential to become the world's largest commodity market, with projected annual turn over crossing $1 trillion over the next few years.
The Kyoto Protocol and the carbon trading mechanism provide a huge window of opportunity for urban local bodies in developing countries, for both adopting newer technologies and profiting by trading carbon credits, and in the process improving urban environment. The civic infrastructure utilities in developing countries are ideally positioned to benefit from any emsissions trading schemes. Given the widespread obsolescence of existing techniques and the limited penetration of modern, environment friendly technologies and systems, there is enormous scope for reducing emissions at little cost. Hitherto, energy savings and environmental concerns were not major considerations in decision making in the Government. CERs and the emission trading markets provide an incentive for profitting from such emission reductions.
Solid Waste treatment and disposal facilities are a readymade source of CERs. Composting and waste to energy plants, and scientific landfills reduce methane emissions and are eligible for tradable CERs. Electro-mechanical devices and systems like water and sewerage motors and pumps, and streetlighting are easily amenable to substantial energy savings with appropriate technologies. Apart from claiming the CERs, energy saving technologies can generate atleast 30-50% savings on electricity expenditures. With appropriate technologies, the bio-gas produced in Sewerage Treatment Plants (STPs) can be converted to electricity. Modern public transport systems that promote public transport and thereby limits polluting private transport, are also eligible for CERs.
At the VMC, we have tried to adapt environment friendly technologies in some of the afore-mentioned systems. The VMC operates two waste to energy plants - an incineration plant and a bio-methanization plant. Apart from this, there are 25 vermi compost plants run on Public Private Partnership (PPP) with Resident's Welfare Associations (RWAs), which segregate and treat garbage in a decentralized manner at the community level. A scientific landfill is also under development. It is also proposed to instal gassifiers to generate electricity from biogas produced in STPs. A detailed energy audit has been undertaken for all the electrical installations. The entire 4.5 MW streetlighting systems have been outsourced to an Energy Saving Company (ESCO), generating an assured electricity savings of 42%. A project for retrofitting all sewerage and water pumps with energy saving devices is also on, and is expected to generate savings of atleast 30%.
On an average, 1 MW of power savings is equivalent to 4000-4500 mt of CO2 per annum. The price of CERs have fluctuated sharply between $1 - $60 per mt of CO2 in the EU ETS. (Though this is an area of concern, the volatility is likely to reduce as the market acquires more depth) The annual energy savings by the VMC due to these interventions is expected to be 25000-30000 mt of CO2 equivalent. At $10 per mt of CO2, the VMC could earn about Rs 1 - 1.2 Cr per annum. The earnings could be much higher for bigger cities, besides of course the attendant energy savings.
Under the existing cap and trade, emissions trading arrangements, the Government sets a cap on the amount of pollutant that can be emitted by each agent. A credit gives the owner the right to emit one tonne of carbon dioxide (CO2). The agents are given credits that give them the right to emit a certain quantity of pollutants. Any emssion over and above this can be done only by buying unused credits from another agent, at a cost. The price of a carbon credit reflects the cost of polluting the environment. This incentivizes the polluters to reduce their emissions, so as to both meet their targets and also to generate enough credits to trade. It is an economically efficient solution, in so far as it enables those who can reduce their emissions at the lowest cost to do so and those facing higher reduction costs to buy credits to offset their excess emissions.
The Kyoto Protocol for limiting greehouse gas emssions, provides for a Clean Development Mechanism (CDM) under which developed countries with excess production of such gases can invest in projects in developing countries that can more cheaply reduce emissions. The Protocol also provides for converting any emission reductions into carbon credits, in the form of Certified Emission Reductions (CERs), which can be traded. The Executive Board (EB) of the CDM certifies and issues the CERs through an independent third party, Designated Operational Entity (DOE).
The largest international market on trading carbon credits is the European Union's Emission Trading Scheme ( EU ETS). It covers all the 27 EU nations, and the European Commission (EC) have put limits on the amount firms can pollute and have also issued an equivalent number of allowances. Those companies crossing the limit must either cut their emissions or buy spare allowances from others. Despite initial problems, the EU ETS carbon market is now well established, and has been found to have achieved its objective of reducing emissions. CERs have been found to be cheaper than EU ETS allowances. The global carbon trading market was about $30 bn in 2006 and has the potential to become the world's largest commodity market, with projected annual turn over crossing $1 trillion over the next few years.
The Kyoto Protocol and the carbon trading mechanism provide a huge window of opportunity for urban local bodies in developing countries, for both adopting newer technologies and profiting by trading carbon credits, and in the process improving urban environment. The civic infrastructure utilities in developing countries are ideally positioned to benefit from any emsissions trading schemes. Given the widespread obsolescence of existing techniques and the limited penetration of modern, environment friendly technologies and systems, there is enormous scope for reducing emissions at little cost. Hitherto, energy savings and environmental concerns were not major considerations in decision making in the Government. CERs and the emission trading markets provide an incentive for profitting from such emission reductions.
Solid Waste treatment and disposal facilities are a readymade source of CERs. Composting and waste to energy plants, and scientific landfills reduce methane emissions and are eligible for tradable CERs. Electro-mechanical devices and systems like water and sewerage motors and pumps, and streetlighting are easily amenable to substantial energy savings with appropriate technologies. Apart from claiming the CERs, energy saving technologies can generate atleast 30-50% savings on electricity expenditures. With appropriate technologies, the bio-gas produced in Sewerage Treatment Plants (STPs) can be converted to electricity. Modern public transport systems that promote public transport and thereby limits polluting private transport, are also eligible for CERs.
At the VMC, we have tried to adapt environment friendly technologies in some of the afore-mentioned systems. The VMC operates two waste to energy plants - an incineration plant and a bio-methanization plant. Apart from this, there are 25 vermi compost plants run on Public Private Partnership (PPP) with Resident's Welfare Associations (RWAs), which segregate and treat garbage in a decentralized manner at the community level. A scientific landfill is also under development. It is also proposed to instal gassifiers to generate electricity from biogas produced in STPs. A detailed energy audit has been undertaken for all the electrical installations. The entire 4.5 MW streetlighting systems have been outsourced to an Energy Saving Company (ESCO), generating an assured electricity savings of 42%. A project for retrofitting all sewerage and water pumps with energy saving devices is also on, and is expected to generate savings of atleast 30%.
On an average, 1 MW of power savings is equivalent to 4000-4500 mt of CO2 per annum. The price of CERs have fluctuated sharply between $1 - $60 per mt of CO2 in the EU ETS. (Though this is an area of concern, the volatility is likely to reduce as the market acquires more depth) The annual energy savings by the VMC due to these interventions is expected to be 25000-30000 mt of CO2 equivalent. At $10 per mt of CO2, the VMC could earn about Rs 1 - 1.2 Cr per annum. The earnings could be much higher for bigger cities, besides of course the attendant energy savings.
Saturday, October 13, 2007
Decoupling from the US economy
One of the most debated issues these days is about how the world economy will fare in case of a recession in the US economy. In other words, will the global economy successfully decouple from the US economy? The IMF in its World Economic Outlook 2008 expects demand in the rest of the world to be largely decoupled from the weakness in the US. In contrast, Morgan Stanley claims that 2008 will be the year of re-coupling.
For years, the massive US economy and its voracious consumers have provided the powerful engine for global economic growth. This consumption binge saw the American trade deficit reach $800 bn in 2006-07, as the Chinese and East Asian exporters competed with each other in exporting to the Americans. As James Suroweicki explains in Greenback Blues, despite the falling dollar and the resultant rising dollar costs, these exporters have refrained from increasing prices and have accepted reduced profit margins, so as to retain their market shares. The huge prospect and potential offered by the US economy encouraged them to adopt this policy. But now, with prospects of a weakening US economy and established market shares, they may feel constrained to keep the prices low, thereby further weakening the US consumers.
The low interest rates were the critical internal determinant in generating and then sustaining the consumer boom. It fuelled the stock market and then real estate booms, which in turn generated a "wealth effect", that saw "irrationally exuberant" consumers throw caution to the winds and indulge in a spending binge.
The decoupling may not be so evident in the financial markets as in the real economy. It will be more complex for the financial markets, given the ever growing integration of the $170 trillion global financial markets. Further, unlike the US economy, Wall Street is still firmly entrenched as the standard bearer of the health of the global financial markets. The massive losses suffered by the Wall Street Banks and the solvency problems facing many institutions over-exposed to the sub-prime mortgage and related asset backed securities, will tighten the credit available for new investments.
But there are other dimensions to the story, which claims that any recession in the US, in the short and even medium run, is likely to benefit the emerging markets. The weak dollar and falling interest rates, coupled with inflationary expectations and recessionary fears, makes the US equity and bond markets unattractive for Financial Institutions. In this context, the emerging economies are an excellent alternative, especially with very high profit opportunities. Another unpredictable element in the picture is the ever growing corpus of the Sovereign Wealth Funds (SWFs), who would look for diversifying their investments. All this will also provide an opportunity for the financial markets in the emerging economies to develop the requisite depth and breadth, besides the regulatory and other capacities, necessary to emerge as developed financial markets.
In contrast, any recession in the US will immediately hurt imports and thereby directly affect jobs and economic growth in the emerging economies.
Nouriel Roubini warns that decoupling may not be easy, "The rest of the world – including Europe – has so far deluded itself that it can decouple from a US slowdown. But decoupling would occur only if the US experienced a soft landing; if the US experiences a recessionary hard landing there will be no decoupling and global growth will sharply slowdown. And Europe could be one of the first victims of the US hard landing. Already the European financial system not only has not decoupled from the US one; it has been rather subject to a massive contagion since August. And since European firms depend on bank lending more than US ones the coming credit crunch will hit the European corporate sector and its ability to produce, hire and invest. Also boom and bubbles in housing were not limited to the US; similar bubbles were experienced by Spain, the UK, Ireland and, in smaller scale, by France, Portugal, Italy and Greece. Now such housing bubbles are starting to deflate in Europe adding to the downside growth risks.
Add to the problems of Europe the strength of the Euro that is sharply reducing the external competitiveness of the Eurozone; as well the forthcoming weakening demand for European goods from the US hard landing. Add to the mix high and rising oil prices. Then this combination of shocks implies serious risks of a sharp growth deceleration in Europe and even the possibility of a Eurozone hard landing. In the meanwhile while the Fed has already started to aggressively cut interest rates the ECB is deluding itself that it could raise its policy rate further once the perceived temporary financial crunch is past. What the ECB should instead to is to start cutting its policy rate now. Temporizing, like the ECB did in the 2001-2002 episode, will ensure that the negative growth contagion from the US to Europe will be more severe and protracted."
The story is no different with the Asian economies. The weakening US and European demand will adversely affect the export engine. The increasing share of internal trade among the Asian economies, will only slightly mitigate the impact of an American slowdown. The danger for Asian economies, except China, from a US recession is indirect. China is significantly dependent on exports to the US market, and any fall in that will be dterimental to Chinese growth prospects. This will in turn affect the East Asian exporters and commodity suppliers, who have been piggy riding on the Chinese growth.
The Chinese growth engines' dependence on trade is still substantial. Exports form 40% of GDP; investment is 50% of GDP and, leaving aside housing investment, most of such investment is directed towards the productions of more exportable goods; current account surplus has gone from $20b in 2002 (2% of GDP) to an expected $300 billion plus this year (12% of GDP).
A recent ADB report captures the essence of the new trade dynamics in East Asia, "But the rise of China has radically changed the Asian global production and supply chain: now East Asian countries tend more to produce inputs and intermediate goods and raw materials that are exported to China; in turn China, given its lower labor cost, processes these inputs and assembles them into final goods that are exported to the US. Thus, in spite of growing intra-Asian trade the dependence of Asia on US growth is now larger than any time before, both structurally and cyclically. So the argument that Asia can decouple from the US because of this greater intra-Asian trade is altogether flawed. Rather, once China slows down the Chinese demand for these Asian intermediate inputs and its demand for raw materials from Asia, Latin America and Africa will fall. Thus, you will observe both a slowdown in Asian growth and a sharp fall in commodity prices that will hurt all commodity exporters."
Ultimately the impact of the US recession will also depend, to a large extent on how the domestic economies are able to keep up consumption spending. In 2007, despite slowdown in exports, all the emerging Asian economies grew faster as domestic demand more than made up for the fall in exports. The health of the corporate sector in most of Asia is robust, with high capacity utilization, good profit growth, stronger balance sheets. The macroeconomic fundamentals are strong - balanced budgets, growing forex surpluses, managable inflation - giving these countries enough room to manouevre if the US problems start impacting economic growth. Though exports, especially to the US and Europe, still form a significant part of the economy, there are enough cushions in place to tide over a US recession, without as much adverse impact as in previous US downturns. Standard Chartered forecasts, emerging Asia to grow by 6.4% in 2008, as against 7.8% in 2007, a much smaller fall than the 3% slump to 4.2% following the 2001 US recession.
Among the Asian and other emerging economies, India seems best placed to tide over any US recession. Unlike the East Asian economies, it is not as closely integrated with the global economy by trade, nor is it dependent on any country for its exports. Its exports form just 23.5% of GDP, as against 36.6% for China, 36.7% for S Korea, 59% for Taiwan, and 72.7% for the ASEAN countries. It share of exports to the US is only 18.59%, to 21% for China, 22.5% for Japan, and 13.3% for S Korea. The exports to US is only 2% of GDP, compared to 8% of GDP for China and over 20% for Singapore, Hong Kong and Malaysia. Unlike the other East Asian economies whose major exports to the US are manufactured goods, employing large number of poeple, the major exports from India are software services, whose direct influence on jobs and the larger economy, is not very high.
Another consequence of a US recession and slowdown in Europe will be a downward pressure on commodity prices. This in turn will have different impacts on the commodity exporters and the commodity consumers like many Asian and East European economies. While the former wills ee a fall in export revenues, the later will benefit from cheaper import prices and thereby more competitive prices for their import heavy exports, besides encouraging domestic demand and keeping inflationary pressures under control.
The Central Banks of the world appears to have already de-coupled. Recession fighting has become the pre-dominant concern for the US Federal Reserve, while inflation remains the determining factor for most other Central Banks. This decoupling was highlighted by the fact that except for the Canadian Central Bank, no other major Bank cut rates in response to the two unprecedented 125 basis points cuts by the Fed in late January. The European Central Bank (ECB) Governor Jean-Claude Trichet even warned that he would not hesitate to raise rates. Our own RBI Governor YV Reddy declared that inflation concerns were pre-dominant in influencing rate decisions.
To conclude, the global financial markets will certainly remain coupled. If the conclusion is that the emerging economies will catch cold, now that US has sneezed, then it may not happen so. But their growth projections will have to be scaled down.
For years, the massive US economy and its voracious consumers have provided the powerful engine for global economic growth. This consumption binge saw the American trade deficit reach $800 bn in 2006-07, as the Chinese and East Asian exporters competed with each other in exporting to the Americans. As James Suroweicki explains in Greenback Blues, despite the falling dollar and the resultant rising dollar costs, these exporters have refrained from increasing prices and have accepted reduced profit margins, so as to retain their market shares. The huge prospect and potential offered by the US economy encouraged them to adopt this policy. But now, with prospects of a weakening US economy and established market shares, they may feel constrained to keep the prices low, thereby further weakening the US consumers.
The low interest rates were the critical internal determinant in generating and then sustaining the consumer boom. It fuelled the stock market and then real estate booms, which in turn generated a "wealth effect", that saw "irrationally exuberant" consumers throw caution to the winds and indulge in a spending binge.
The decoupling may not be so evident in the financial markets as in the real economy. It will be more complex for the financial markets, given the ever growing integration of the $170 trillion global financial markets. Further, unlike the US economy, Wall Street is still firmly entrenched as the standard bearer of the health of the global financial markets. The massive losses suffered by the Wall Street Banks and the solvency problems facing many institutions over-exposed to the sub-prime mortgage and related asset backed securities, will tighten the credit available for new investments.
But there are other dimensions to the story, which claims that any recession in the US, in the short and even medium run, is likely to benefit the emerging markets. The weak dollar and falling interest rates, coupled with inflationary expectations and recessionary fears, makes the US equity and bond markets unattractive for Financial Institutions. In this context, the emerging economies are an excellent alternative, especially with very high profit opportunities. Another unpredictable element in the picture is the ever growing corpus of the Sovereign Wealth Funds (SWFs), who would look for diversifying their investments. All this will also provide an opportunity for the financial markets in the emerging economies to develop the requisite depth and breadth, besides the regulatory and other capacities, necessary to emerge as developed financial markets.
In contrast, any recession in the US will immediately hurt imports and thereby directly affect jobs and economic growth in the emerging economies.
Nouriel Roubini warns that decoupling may not be easy, "The rest of the world – including Europe – has so far deluded itself that it can decouple from a US slowdown. But decoupling would occur only if the US experienced a soft landing; if the US experiences a recessionary hard landing there will be no decoupling and global growth will sharply slowdown. And Europe could be one of the first victims of the US hard landing. Already the European financial system not only has not decoupled from the US one; it has been rather subject to a massive contagion since August. And since European firms depend on bank lending more than US ones the coming credit crunch will hit the European corporate sector and its ability to produce, hire and invest. Also boom and bubbles in housing were not limited to the US; similar bubbles were experienced by Spain, the UK, Ireland and, in smaller scale, by France, Portugal, Italy and Greece. Now such housing bubbles are starting to deflate in Europe adding to the downside growth risks.
Add to the problems of Europe the strength of the Euro that is sharply reducing the external competitiveness of the Eurozone; as well the forthcoming weakening demand for European goods from the US hard landing. Add to the mix high and rising oil prices. Then this combination of shocks implies serious risks of a sharp growth deceleration in Europe and even the possibility of a Eurozone hard landing. In the meanwhile while the Fed has already started to aggressively cut interest rates the ECB is deluding itself that it could raise its policy rate further once the perceived temporary financial crunch is past. What the ECB should instead to is to start cutting its policy rate now. Temporizing, like the ECB did in the 2001-2002 episode, will ensure that the negative growth contagion from the US to Europe will be more severe and protracted."
The story is no different with the Asian economies. The weakening US and European demand will adversely affect the export engine. The increasing share of internal trade among the Asian economies, will only slightly mitigate the impact of an American slowdown. The danger for Asian economies, except China, from a US recession is indirect. China is significantly dependent on exports to the US market, and any fall in that will be dterimental to Chinese growth prospects. This will in turn affect the East Asian exporters and commodity suppliers, who have been piggy riding on the Chinese growth.
The Chinese growth engines' dependence on trade is still substantial. Exports form 40% of GDP; investment is 50% of GDP and, leaving aside housing investment, most of such investment is directed towards the productions of more exportable goods; current account surplus has gone from $20b in 2002 (2% of GDP) to an expected $300 billion plus this year (12% of GDP).
A recent ADB report captures the essence of the new trade dynamics in East Asia, "But the rise of China has radically changed the Asian global production and supply chain: now East Asian countries tend more to produce inputs and intermediate goods and raw materials that are exported to China; in turn China, given its lower labor cost, processes these inputs and assembles them into final goods that are exported to the US. Thus, in spite of growing intra-Asian trade the dependence of Asia on US growth is now larger than any time before, both structurally and cyclically. So the argument that Asia can decouple from the US because of this greater intra-Asian trade is altogether flawed. Rather, once China slows down the Chinese demand for these Asian intermediate inputs and its demand for raw materials from Asia, Latin America and Africa will fall. Thus, you will observe both a slowdown in Asian growth and a sharp fall in commodity prices that will hurt all commodity exporters."
Ultimately the impact of the US recession will also depend, to a large extent on how the domestic economies are able to keep up consumption spending. In 2007, despite slowdown in exports, all the emerging Asian economies grew faster as domestic demand more than made up for the fall in exports. The health of the corporate sector in most of Asia is robust, with high capacity utilization, good profit growth, stronger balance sheets. The macroeconomic fundamentals are strong - balanced budgets, growing forex surpluses, managable inflation - giving these countries enough room to manouevre if the US problems start impacting economic growth. Though exports, especially to the US and Europe, still form a significant part of the economy, there are enough cushions in place to tide over a US recession, without as much adverse impact as in previous US downturns. Standard Chartered forecasts, emerging Asia to grow by 6.4% in 2008, as against 7.8% in 2007, a much smaller fall than the 3% slump to 4.2% following the 2001 US recession.
Among the Asian and other emerging economies, India seems best placed to tide over any US recession. Unlike the East Asian economies, it is not as closely integrated with the global economy by trade, nor is it dependent on any country for its exports. Its exports form just 23.5% of GDP, as against 36.6% for China, 36.7% for S Korea, 59% for Taiwan, and 72.7% for the ASEAN countries. It share of exports to the US is only 18.59%, to 21% for China, 22.5% for Japan, and 13.3% for S Korea. The exports to US is only 2% of GDP, compared to 8% of GDP for China and over 20% for Singapore, Hong Kong and Malaysia. Unlike the other East Asian economies whose major exports to the US are manufactured goods, employing large number of poeple, the major exports from India are software services, whose direct influence on jobs and the larger economy, is not very high.
Another consequence of a US recession and slowdown in Europe will be a downward pressure on commodity prices. This in turn will have different impacts on the commodity exporters and the commodity consumers like many Asian and East European economies. While the former wills ee a fall in export revenues, the later will benefit from cheaper import prices and thereby more competitive prices for their import heavy exports, besides encouraging domestic demand and keeping inflationary pressures under control.
The Central Banks of the world appears to have already de-coupled. Recession fighting has become the pre-dominant concern for the US Federal Reserve, while inflation remains the determining factor for most other Central Banks. This decoupling was highlighted by the fact that except for the Canadian Central Bank, no other major Bank cut rates in response to the two unprecedented 125 basis points cuts by the Fed in late January. The European Central Bank (ECB) Governor Jean-Claude Trichet even warned that he would not hesitate to raise rates. Our own RBI Governor YV Reddy declared that inflation concerns were pre-dominant in influencing rate decisions.
To conclude, the global financial markets will certainly remain coupled. If the conclusion is that the emerging economies will catch cold, now that US has sneezed, then it may not happen so. But their growth projections will have to be scaled down.
Friday, October 12, 2007
Pareto improvements as touchstone for governance
It is evident that most Government decisions confer benefits on some citizens and cause losses to some others. The benefits are generally diffused over a large number of people, and hence its support base is much less focussed and distinct. However, it is natural for the losers to oppose those decisions, and most often oppose it vehemently. Further, numerous studies by psychologists have confirmed that human beings are much more averse to losses than they are appreciative of gains. Therefore the opposition to Government policies are often very deceptive, and need to be judged not merely based on the popular perception of this opposition, but should take into account the substance of the case.
There are large number of instances where the benefits of an existing policy is captured by a small interest group, who have lobbied hard to keep those benefits. Sociologists and political scientists, have studied the power of small, focussed interest groups, who wield disproportionately high influence in comparison to much larger groups who do not enjoy the benefits in a concentrated manner. Further, smaller the group, greater will be the group cohesion and the resolve to fight for the cause, whereas larger group encourages some members to shirk responsibility.
Pareto optimality is a useful tool in evaluating the impact of Government decisions. Pareto improvements are those changes in the status quo which makes atleast some people better off without making anybody else worse off. But perfect Pareto improvements are very rare in Government and such improvements are in any case easy to advocate and implement. This brings us to those changes in the status quo that causes both benefits and losses. Nobel laureate Joseph Stiglitz, refers to "near-Pareto improvements" that causes much more benefits than gains.
Stiglitz claims that if only a small interest group loses by a change, and everyone else benefits, then that change should be made. The touchstone for implementating a change could therefore be whether it maximizes the Pareto improvements. In other words, do the benefits outweigh the losses, and if so by how much?
There are large number of instances where the benefits of an existing policy is captured by a small interest group, who have lobbied hard to keep those benefits. Sociologists and political scientists, have studied the power of small, focussed interest groups, who wield disproportionately high influence in comparison to much larger groups who do not enjoy the benefits in a concentrated manner. Further, smaller the group, greater will be the group cohesion and the resolve to fight for the cause, whereas larger group encourages some members to shirk responsibility.
Pareto optimality is a useful tool in evaluating the impact of Government decisions. Pareto improvements are those changes in the status quo which makes atleast some people better off without making anybody else worse off. But perfect Pareto improvements are very rare in Government and such improvements are in any case easy to advocate and implement. This brings us to those changes in the status quo that causes both benefits and losses. Nobel laureate Joseph Stiglitz, refers to "near-Pareto improvements" that causes much more benefits than gains.
Stiglitz claims that if only a small interest group loses by a change, and everyone else benefits, then that change should be made. The touchstone for implementating a change could therefore be whether it maximizes the Pareto improvements. In other words, do the benefits outweigh the losses, and if so by how much?
Thursday, October 11, 2007
Road Widenings and Urban Renewal
Road widenings are always resisted by the land owners who lose their lands and supported by outsiders who benefit by way of wider roads. However, the story goes beyond such simple descriptions. Unfortunately there have been very few detailed studies, analyzing the consequences of such widenings across cities. Most often the debate on road widenings, confined as they are to traffic related issues, miss a whole gamut of other dimensions.
Wide roads are most often seen as a solution to the traffic problems of modern day cities. It is presumed that wider carriage ways accommodate more number of vehicles and hence reduce traffic congestion. But it is not as simple as this. Economists often refer to the Say's Law, which postulates that supply creates its own demand. Similarly, wider carriageways soon gets occupied by more and more vehicles and get congested, and we get back to square one! But the traffic dimension apart, road widenings have very important economic and social consequences.
The majority of road widenings are along the major roads in the city. They involve acquiring valuable lands and demolishing portions of very old structures, thereby effectively rendering the structures unfit for habitation. Instead of making financial compensation for the lands acquired, many Corporations have adopted policies transferring equivalent amounts of Floor Area Ratios (FAR) in lieu of the land surrendered for road widenings. This coupled with certain relaxations in setbacks, helps the land owner build up more floor space, despite the reduced land size. These FARs are therefore extremely valuable for big developers of commercial and institutional space.
Chennai and Hyderabad, are interesting cases for comparison. There have been massive road widenings in Hyderabad over the past few years, while Chennai roads have remained more or less the same. This can partly be explained by the fact that Hyderabad had narrower roads and hence there was a need to expand road widths, whereas Chennai already had reasonably wider roads. Interestingly, despite the massive road widenings, the traffic in Hyderabad has if anything worsened!
Most the major 100 ft and more roads in Hyderabad have been widened in the past decade. Subsequently, these road margins have witnessed unprecedented urban renewal, by way of large number of new developments. Old buildings have been pulled down, and massive new commercial and business spaces built up, utilizing the FAR bonds allotted. This re-development opportunity has spawned a huge boom in retailing and investment in institutional and office spaces, thereby attracting private companies to set up their corporate offices. The old shops and establishments have been replaced with shopping malls and commercial complexes with their glassy and gleaming facades. These complexes have multi-tier parking facilities, thereby providing for huge parking spaces. There have been numerous instances of fragmented land holdings been amalgamated, so as to make optimum use of the allocated FAR Bonds.
In contrast, the main roads in Chennai have not experienced this regeneration. The major roads continue to be inhabited by a large number of the old, small, family-owned businesses and traders. In many major roads, the same establishments have been running for decades, and re-development is minimal. Land continues to be fragmented, and carriage way encroachment for parking is common. In fact, most of the demand for new institutional and corporate office space in Chennai has been met in the Software Parks and other Institutional enclaves developed on the City margins. (It is of course debatable as to whether this relocation and concentration of such functional spaces in specific areas, instead of being located within the City alongside the main roads, is to be encouraged)
It makes for little economic sense to under-utilize valuable stretches of land alongside major roads for small and petty business activities. Most often businesses are run on single or two storied small buildings, thereby failing to make optimum use of the scarce and valuable land. This is not to decry the importance of such small and petty businesses, but a very convincing case can be made out for locating them in the smaller, internal roads. Such zoning would leave the main roads open for unrestricted flow of traffic.
A preliminary analysis of the statistics from one particular road-widening in Vijayawada City, throws up certain very interesting conclusions, validating most of the afore-mentioned arguments. The MG Road in Vijayawada is a 3.5 km long road, with 187 properties covering an extent of 1,49,024 sq yards, adjoining it. A massive road widening program was taken up on MG Road in January 2006 and completed in June 2007. The entire road stretch is a prime commercial district of the City, with thickly built-up area. But during and after the widening, there have been a large number of re-developments along this road. Existing structures have been pulled down and new high-rise structures are coming up. Significant number of smaller and fragmented properties have been purchased and consolidated into single plot by developers.
Of the 187 properties, 44 covering an extent of 60,169 sq yards have been razed down for re-development. To put in perspective, this covers 40% of the total land adjoining the road. In other words, a single road widening activity has sparked off urban renewal over 40% of an existing built up area. The figure of 40% is estimated to touch atleast 75% over the next two years. Land values in this road have surged, (also due to other factors) touching Rs 80000 to Rs 1 lakh range for a square yard, atleast a 50% increase in the past year.
Road widenings are therefore excellent examples of Governement catalysed, but not imposed urban renewal. The process of demolition of old buildings, sales transactions, amalgamation of land holdings, redevelopment of properties and opening of new businesses are all market driven, with the widening program and its associated policy instruments like FAR Bonds providing the external stimulus for these developments. Such widenings and the consequent renewals provide the large commercial developers opportunites to step in and redevelop existing, under-utilized lands. This process results in the maximization of the total economic surplus and draws out the full willingness to pay. Developers placing the highest value on such locations and therefore willing to pay the highest amounts move into these areas, while the sellers get the best value for their lands and retire to invest or live elsewhere.
Wide roads are most often seen as a solution to the traffic problems of modern day cities. It is presumed that wider carriage ways accommodate more number of vehicles and hence reduce traffic congestion. But it is not as simple as this. Economists often refer to the Say's Law, which postulates that supply creates its own demand. Similarly, wider carriageways soon gets occupied by more and more vehicles and get congested, and we get back to square one! But the traffic dimension apart, road widenings have very important economic and social consequences.
The majority of road widenings are along the major roads in the city. They involve acquiring valuable lands and demolishing portions of very old structures, thereby effectively rendering the structures unfit for habitation. Instead of making financial compensation for the lands acquired, many Corporations have adopted policies transferring equivalent amounts of Floor Area Ratios (FAR) in lieu of the land surrendered for road widenings. This coupled with certain relaxations in setbacks, helps the land owner build up more floor space, despite the reduced land size. These FARs are therefore extremely valuable for big developers of commercial and institutional space.
Chennai and Hyderabad, are interesting cases for comparison. There have been massive road widenings in Hyderabad over the past few years, while Chennai roads have remained more or less the same. This can partly be explained by the fact that Hyderabad had narrower roads and hence there was a need to expand road widths, whereas Chennai already had reasonably wider roads. Interestingly, despite the massive road widenings, the traffic in Hyderabad has if anything worsened!
Most the major 100 ft and more roads in Hyderabad have been widened in the past decade. Subsequently, these road margins have witnessed unprecedented urban renewal, by way of large number of new developments. Old buildings have been pulled down, and massive new commercial and business spaces built up, utilizing the FAR bonds allotted. This re-development opportunity has spawned a huge boom in retailing and investment in institutional and office spaces, thereby attracting private companies to set up their corporate offices. The old shops and establishments have been replaced with shopping malls and commercial complexes with their glassy and gleaming facades. These complexes have multi-tier parking facilities, thereby providing for huge parking spaces. There have been numerous instances of fragmented land holdings been amalgamated, so as to make optimum use of the allocated FAR Bonds.
In contrast, the main roads in Chennai have not experienced this regeneration. The major roads continue to be inhabited by a large number of the old, small, family-owned businesses and traders. In many major roads, the same establishments have been running for decades, and re-development is minimal. Land continues to be fragmented, and carriage way encroachment for parking is common. In fact, most of the demand for new institutional and corporate office space in Chennai has been met in the Software Parks and other Institutional enclaves developed on the City margins. (It is of course debatable as to whether this relocation and concentration of such functional spaces in specific areas, instead of being located within the City alongside the main roads, is to be encouraged)
It makes for little economic sense to under-utilize valuable stretches of land alongside major roads for small and petty business activities. Most often businesses are run on single or two storied small buildings, thereby failing to make optimum use of the scarce and valuable land. This is not to decry the importance of such small and petty businesses, but a very convincing case can be made out for locating them in the smaller, internal roads. Such zoning would leave the main roads open for unrestricted flow of traffic.
A preliminary analysis of the statistics from one particular road-widening in Vijayawada City, throws up certain very interesting conclusions, validating most of the afore-mentioned arguments. The MG Road in Vijayawada is a 3.5 km long road, with 187 properties covering an extent of 1,49,024 sq yards, adjoining it. A massive road widening program was taken up on MG Road in January 2006 and completed in June 2007. The entire road stretch is a prime commercial district of the City, with thickly built-up area. But during and after the widening, there have been a large number of re-developments along this road. Existing structures have been pulled down and new high-rise structures are coming up. Significant number of smaller and fragmented properties have been purchased and consolidated into single plot by developers.
Of the 187 properties, 44 covering an extent of 60,169 sq yards have been razed down for re-development. To put in perspective, this covers 40% of the total land adjoining the road. In other words, a single road widening activity has sparked off urban renewal over 40% of an existing built up area. The figure of 40% is estimated to touch atleast 75% over the next two years. Land values in this road have surged, (also due to other factors) touching Rs 80000 to Rs 1 lakh range for a square yard, atleast a 50% increase in the past year.
Road widenings are therefore excellent examples of Governement catalysed, but not imposed urban renewal. The process of demolition of old buildings, sales transactions, amalgamation of land holdings, redevelopment of properties and opening of new businesses are all market driven, with the widening program and its associated policy instruments like FAR Bonds providing the external stimulus for these developments. Such widenings and the consequent renewals provide the large commercial developers opportunites to step in and redevelop existing, under-utilized lands. This process results in the maximization of the total economic surplus and draws out the full willingness to pay. Developers placing the highest value on such locations and therefore willing to pay the highest amounts move into these areas, while the sellers get the best value for their lands and retire to invest or live elsewhere.
Wednesday, October 10, 2007
Mint article on Slum Economy
The Slum Economy Revisited argues that urban shanties need more than a mere physical makeover for growth and regeneration
Friday, October 5, 2007
Political Correctness
It is unarguably true that diversity of ideas and opinions makes everybody wiser. If the objective is to make informed decisions or choices, then we ought to be aware of the full spectrum of opinion. Therefore, by shutting off alternative views and exposure to all shades of opinions, political correctness makes the society poorer. It is generally a recipe for making uninformed and wrong decisions and choices, thereby inflicting greater costs on the society than what it is supposed to prevent. It creates an atmosphere of distrust and even hatred which reduces the tolerance for any alternate view, which goes against the grain of political correctness.
Assume Mr Liberal and his ideological friends are living in Subsidyland, where the overwhelming majority considers subsidies as their birth right. Subsidyland is staggering under a huge budget and current account deficit, and the economy is in shambles. But the policy makers, led by Mr Parochial, and the electorate of Subsidyland are pumping for further subsidies. They claim that subsidies are necessary to support the overwhelmingly poor population of the country, and allege that anybody opposing subsidies is anti-poor.
As can be seen from the above example, the atmosphere of political correctness, prevented Mr Liberal from expressing his very pertinent and extremely important dissenting views on subsidies. Subsidyland was the poorer due to cutting off Mr Liberal's views. Now substitute, Subsidyland with India till the seventies or any of the erstwhile Communist countries, and you have real world examples. There was little ideological counterweight to the command economy norm in these countries, just as we have limited space today to alternate economic thoughts in Capitalist America.
Not only does political correctness makes the society poorer by limiting exposure to contrarian views, it also reinforces biased and parochial opinions. Therefore while Mr Liberal got sidelined, Mr Parochial is implicitly favored. A vicious cycle of resistance against change gets strengthened.
An economist would say that political correctness distorts the market incentive structure. The honest and unbiased are forced to lie or hold back their socially useful and important views. The dishonest and the biased are rewarded for lying and reinforcing existing stereotypes. Political correctness therefore favors the dis-honest at the expense of the honest. The result is a poorer, less innovative and conformist society.
Assume Mr Liberal and his ideological friends are living in Subsidyland, where the overwhelming majority considers subsidies as their birth right. Subsidyland is staggering under a huge budget and current account deficit, and the economy is in shambles. But the policy makers, led by Mr Parochial, and the electorate of Subsidyland are pumping for further subsidies. They claim that subsidies are necessary to support the overwhelmingly poor population of the country, and allege that anybody opposing subsidies is anti-poor.
As can be seen from the above example, the atmosphere of political correctness, prevented Mr Liberal from expressing his very pertinent and extremely important dissenting views on subsidies. Subsidyland was the poorer due to cutting off Mr Liberal's views. Now substitute, Subsidyland with India till the seventies or any of the erstwhile Communist countries, and you have real world examples. There was little ideological counterweight to the command economy norm in these countries, just as we have limited space today to alternate economic thoughts in Capitalist America.
Not only does political correctness makes the society poorer by limiting exposure to contrarian views, it also reinforces biased and parochial opinions. Therefore while Mr Liberal got sidelined, Mr Parochial is implicitly favored. A vicious cycle of resistance against change gets strengthened.
An economist would say that political correctness distorts the market incentive structure. The honest and unbiased are forced to lie or hold back their socially useful and important views. The dishonest and the biased are rewarded for lying and reinforcing existing stereotypes. Political correctness therefore favors the dis-honest at the expense of the honest. The result is a poorer, less innovative and conformist society.
Wednesday, October 3, 2007
Moral Hazard and market failures
In all the debate surrounding moral hazard, Lawrence Summers has presented an interesting view in his FT article, Beware moral hazard fundamentalists
While drawing the distinction between moral hazard in insurance from that in other sectors of the financial market, he argues for active intervention to enhance confidence and stability in the financial markets. Prof Summers defines three pre-requisites for Central Bank interventions
1. Possibility of contagion effects
2. A liquidity and not solvency problem
3. No cost imposed on the tax payer
Assessing each of the three pre-requisites, while appearing simple at first glance, presents considerable challenges. As I have outlined in my previous posts, the major challenge for Central Banks and policy makers is in recognizing the arrival of the tipping point at which the progress of events makes a contagion effect on the entire system inevitable. The recent Northern Rock fiasco threw up divided opinions on whether the crisis was confined to the Bank in question or threatened the entire financial system. In any case, it may not be reasonable to assume that independent Central Banks have some form of divine wisdom, inaccessible to others, in objectively deciding when a crisis threatens to spread across the system. In order to ensure greater transparency and objectivity, it may be desirable to identify certain parameters that are broad indicators of the contagion red-lights starting to flicker.
Recognizing whether the problem arose from a liquidity crisis or from solvency related issues, is easier, but would still throw up interesting dilemmas. The critical question here is who decides as to which firm or Fund is solvent and which not, and for what reasons? Credit Rating agencies were supposed to do precisely this, and have been shown up repeatedly when crisis struck. Surely Governments and the Finance Ministries cannot be expected to be objective and dis-interested judges in such suituations. So do we leave it to the Central Banks to decide it? If so, based on what economic parameters or financial indicators? Or do we strengthen the Credit rating agencies?
The third point is not so much a pre-requisite as a procedural concern. This point drives home is the distinction between free bailouts and those which impose the due economic cost. In other words, there cannot be any free lunches. Any bailout has to be at a cost, a prohibitive one at that, be it in terms of the cost of capital or the other terms of servicing or re-scheduling a loan. As Prof. Summers says, quoting Walter Bagehot, when acting as a lender of last resort, the Central Bank should "lend freely at a penalty rate against good collateral". A solvent firm or institution or even a Fund, facing a run in, is surely only facing a liquidity problem and its assets are a credible and good collateral. And this can happen to the best of financial institutions. If the firm is solvent, and is only facing a run in, for whatever reasons, then it makes sense for the Central Banks to intervene and arrange for loans, but at a high enough cost. In fact, the market should determine the cost of capital for re-scheduling the loan. If on the other hand, the firm or Fund is insolvent, then it should also be the sole yardstick for allowing it to default or collapse.
Prof. Summers' arguement against the oversimplifcation of moral hazard and using it to justify non-intervention in the financial markets, is an acknowledgement of the possibility of market failure in the financial markets. It is also a clear message to all those proponents of full capital account convertibility, free capital mobility, and extensive deregulation of the financial markets. Market failures are common in the financial markets and moral hazard is a major contributing factor, and such failures demand external intervention, by Government or its agencies!
While drawing the distinction between moral hazard in insurance from that in other sectors of the financial market, he argues for active intervention to enhance confidence and stability in the financial markets. Prof Summers defines three pre-requisites for Central Bank interventions
1. Possibility of contagion effects
2. A liquidity and not solvency problem
3. No cost imposed on the tax payer
Assessing each of the three pre-requisites, while appearing simple at first glance, presents considerable challenges. As I have outlined in my previous posts, the major challenge for Central Banks and policy makers is in recognizing the arrival of the tipping point at which the progress of events makes a contagion effect on the entire system inevitable. The recent Northern Rock fiasco threw up divided opinions on whether the crisis was confined to the Bank in question or threatened the entire financial system. In any case, it may not be reasonable to assume that independent Central Banks have some form of divine wisdom, inaccessible to others, in objectively deciding when a crisis threatens to spread across the system. In order to ensure greater transparency and objectivity, it may be desirable to identify certain parameters that are broad indicators of the contagion red-lights starting to flicker.
Recognizing whether the problem arose from a liquidity crisis or from solvency related issues, is easier, but would still throw up interesting dilemmas. The critical question here is who decides as to which firm or Fund is solvent and which not, and for what reasons? Credit Rating agencies were supposed to do precisely this, and have been shown up repeatedly when crisis struck. Surely Governments and the Finance Ministries cannot be expected to be objective and dis-interested judges in such suituations. So do we leave it to the Central Banks to decide it? If so, based on what economic parameters or financial indicators? Or do we strengthen the Credit rating agencies?
The third point is not so much a pre-requisite as a procedural concern. This point drives home is the distinction between free bailouts and those which impose the due economic cost. In other words, there cannot be any free lunches. Any bailout has to be at a cost, a prohibitive one at that, be it in terms of the cost of capital or the other terms of servicing or re-scheduling a loan. As Prof. Summers says, quoting Walter Bagehot, when acting as a lender of last resort, the Central Bank should "lend freely at a penalty rate against good collateral". A solvent firm or institution or even a Fund, facing a run in, is surely only facing a liquidity problem and its assets are a credible and good collateral. And this can happen to the best of financial institutions. If the firm is solvent, and is only facing a run in, for whatever reasons, then it makes sense for the Central Banks to intervene and arrange for loans, but at a high enough cost. In fact, the market should determine the cost of capital for re-scheduling the loan. If on the other hand, the firm or Fund is insolvent, then it should also be the sole yardstick for allowing it to default or collapse.
Prof. Summers' arguement against the oversimplifcation of moral hazard and using it to justify non-intervention in the financial markets, is an acknowledgement of the possibility of market failure in the financial markets. It is also a clear message to all those proponents of full capital account convertibility, free capital mobility, and extensive deregulation of the financial markets. Market failures are common in the financial markets and moral hazard is a major contributing factor, and such failures demand external intervention, by Government or its agencies!
Tuesday, October 2, 2007
Interest Rate hikes
The recent, higher than expected, 50 basis points hike in the benchmark federal funds rate, by the US Federal Reserve, has been the focus of endless analysis and discussion. This rate is what the banks charge each other for overnight loans. This cut in interest rates will reduce the cost of borrowing, and is thereby expected to ease the credit squeeze and sustain consumer spending.
A brief history of the recent US interest rate changes is instructive. The latest rate cut is the first interest rate cut for more than four years. Alan Greenspan's Fed had cut the interest rates to a 40 year low of 1% in June 2003, in efforts to stave off recessionary trends and stoke investment and consumption growth. The rate remained at this low of 1% for a year, till June 2004, when the Fed started hiking rates to put the brakes on a booming economy. There were 17 consecutive 25 basis points hikes till mid-2006, as the Fed grappled with trying to keep a lid on inflationary pressures thrown up by the rapidly overheating economy, spurred on by a borrowings driven housing and consumption boom. However, since the last rate hike in mid-2006, the rates have been kept unchanged at 5.25%.
In January 2001, the Fed started a series of 11 consecutive rate cuts, bringing the rates down precipitously from 6.5% to 1.75% over a period of 11 months, as the US economy stared at imminent recession. By November, 2001, the recessionary fears eased and the Fed eased off its foot from the monetary policy pedal.
Alan Greenspan spoke many times of "measured" changes in the interest rates, so as to influence economic growth without simultaneously creating inflationary expectations. This can be seen in the 11 consecutive rate cuts of 2001, and the 17 consecutive 25 basis points hikes of 2004-06, in response to recessionary and inflationary trends. In both cases, Greenspan argued that the small rate changes, helped the Fed respond to the situation as the economy moved forward. It was felt that forecasting the medium term outlook in such unpredictable times was impossible, and hence the more wiser course of action was to adjust monetary policy in response to the immediate future.
It has been normal practice for Central Banks to adopt the wait-and-watch attitude and then respond with regular and small rate changes. The US Federal Reserve has been adopting this strategy in recent years, and Central Banks elsewhere have been imitating this strategy. While giving the Central Bank an apparent freedom and ability to control the immediate financial environment, such small and recurrent rate changes, tend to be adhoc and reactive, thereby missing the big picture. While bringing short-term relief and calm, such tinkering does little to reduce the medium-term uncertainty nor mitigate risks. There is one school of thought which in contrast, argues for fewer, and larger rate changes, which tend to give a clear indication of the policy being pursued by the Central Bank. This clarity feeds more certain and assured expectations among investors, thereby reducing uncertainty and risks. It tries to reduce the information assymmetry and thereby channelize expectations and mitigate risks.
The last Fed rate cut took the markets by surprise, in the extent of the reduction. The 50 basis points was a clear expression of the Federal Reserve's commitment to try everything possible to stave off any financial crisis, arising due to the sub-prime mortgage defaults. It was a firm and unambiguous step towards easing any liquidity crunch. The markets got the message, and responded accordingly. The stock markets, both in the developed and the emerging economies, have been soaring ever since. It would be instructive as to what would have been the market response to a smaller rate cut, of say, 25 basis points. On the flip side, the higher than expected rate cut bonanza may have encouraged further "irrational exuberance" in the financial markets! The supposed cure may have inadvertantly worsened the disease.
There is another less discussed dimension to this debate about interest rates. It is widely perceived that lowering interest rates would help spur investment and prevent the US economy from slipping into recession, and also stabilize the sub-prime panic hit financial markets. While the latter may be true, the former reason is not as simple as is being made out.
Interest rates were consistently above 5%, touching even 7%, in the high growth Clinton years of 1993-2000, when the real economy enjoyed its best years. In fact the performance of manufacturing and services was much better during this period than in the first half of this decade, which was marked by historically low interest rates. The investment rates rose from a low of 17.8% of GDP in 1993 to a high of 20.80% of GDP in 2000, during the period of high interest rates. So it would appear that all the talk of high rates affecting investment and the real economy would appear not borne out by facts.
Monday, October 1, 2007
Targets and poverty eradication programs
In the sixty years since independence, our governments, both central and the state, have undertaken a large number of poverty alleviation programmes of different kinds. Like the proverbial curate's egg we have been successful partially in our endeavours. The great challenge facing us is to focus on alleviating or even eliminating poverty using the scarce resources at our disposal. In other words, an economist would call it a challenge of efficiently allocating scarce resources.
Any government assistance for the poor can be divided into two broad categories. One category consists of the basic social welfare functions like primary and secondary education, primary health care, minimum social safety nets, civic services and facilities like sanitation and drinking water etc, that are intended towards providing the basic minimum civic infrastructure and services for every citizen. The other category consists of more specific poverty eradication assistance like self employment and wage schemes, many categories of subsidies, soft loans etc. This assistance is aimed at specifically assisting the Below Poverty Line (BPL) households in increasing their incomes and emerging out of their present poverty trap.
My interest is with this second category of government poverty programs. Nobody will dispute that economic development is a continuous process of movement up the income ladder. But my contention is that in the real world, for this movement to have any substantive effect, it has to be a discrete jump and not a continuum crawl. In fact, an individual is meaningfully benefitted by a government poverty elimination program only if the assistance helps him move up from a lower to a higher trajectory of growth.
I am therefore convinced that for any assistance at poverty alleviation to be effective, it should aim towards catapulting the assisted towards a higher trajectory of livelihood or growth. In other words, the poor person should be able to leverage this assistance to move into atleast the next higher income group. The anti-poverty programs should therefore trigger off a cascading movement up the economic ladder.
Any assistance which would increase the income of an individual from say Rs 20000 to Rs 25000, would surely fail to achieve this objective. It would only provide a slight repreive for the poor person. Unfortunately most of our poverty eradication programs are afflicted by this problem. In our anxiety to cover as many people as possible with our poverty elimination programs, we end up losing focus and converting these programs into poverty mitigation efforts, which is precisely what our first category of government programs are supposed to deliver.
Instead imagine, a poor person being able to leverage a specific government program assistance to move up from Rs 20000 per annum to Rs 50000 per annum. This assistance could be anythig from a soft loan to buy a tractor to scholarship for his son to be admitted for a professional course. Now we have a genuine climb up the ladder and the first victory in the battle against poverty. This jump to the next income level would invariably be accompanied by a movement up the occupational ladder too. Thus a landless farmer would move up to either own some land or preferably migrate to some more remunerative non-farm employment; a non-farm employed poor could increase his income by entering the manufacturing or the tertiary sector.
There are numerous examples. One of the ways in which we can most certainly, but only slowly, help move people up thet economic ladder is by assisting their children get admitted into a proffessional course. We need to spend our poverty elimination resources in training the more promising students among the poor to clear the entrance examinations for these professional courses, and then support them with scholarship assistance during the course period. This investment would go a long way in poverty elimination than any piecemeal division of huge resources among a large number of people.
Many of our self-employment assistance programs consist of giving small amounts of assistance to buy a sewing machine or set up a kirana shop. Having seen and interacted with thousands of such beneficiaries, I am yet to see even a single case of a sewing machine or a kirana shop propelling a poor person into a higher growth trajectory! In fact, I am convinced that most such people who benefit minimally by the sewing machine, would have purchased it even without the government assistance! Maybe, it would make sense to assist someone already running a sewing shop with one machine, to be assisted with say two or three more machines. This will atleast help him move from a being worker to being an entrepreneur. With adequate training and some linkages, we will have the ingredients in place to push him up to a higher trajectory of growth. Instead of helping 100 people in the village this year, we may be able to assist only 50. But atleast we can be assured that this 50 will not approach us again next year for assistance.
Similarly instead of giving subsidy cum soft loan assistance for purchasing a cow or a goat or a buffallo, to every farmer in a village, we may as well spend the resources more efficiently by providing the same assistance to those farmers who are already having two or three animals and can move up the income chain substantially with this additional unit of cattle.
The guidelines of these programs and the bureaucratic and political imperatives results in this distortion of objectives and dissipation of scarce resources. Typically, all these poverty alleviation programs like self-employment and wage employment assistance schemes are target oriented, with the objective of covering as many beneficiaries as possible. The implementing bureaucrats scramble to cover as many beneficiaries as possible, so as to meet their targets. The importance of numbers in a democracy, and the attendant political compulsions only exacerbates the problem. Further, most often, they adopt an one-size-fits-all approach, with the same program components and guidelines for the entire country and for all sections of poor.
It is therefore important that our poverty alleviation priorities move away from simple target-oriented output based to a more outcome-based approach. This would involve focussing on identifying the specific local needs and remunerative local economic opportunities, and the target beneficiary groups, and then delivering the critical mass of assistance required for them to move into a higher trajectory of economic growth. Instead of mindlessly covering as many poor people as possible with no concern for the quality of assistance, the objective should be to ensure that the beneficiary should not come back seeking more next year. However, to cover as many people as possible, it may be more appropriate to target all those at the margins of the poverty ladder, and lift them up to the higher growth trajectory.
The economic case for such analysis is simple. Any efficient allocation of scarce resources would demand that the total marginal utility be maximized. We should focus on helping those at the margins of each income or occupation level, who have the maximum marginal utility to be gained by any incremental unit of assitance, since they would move up to a higher growth trajectory. By helping those at the margins, we can maximize the utility gained by allocating the scarce available resources. In contrast, the most poor and the more poorer require much higher quantum of unit assistance for it to make any meaningful difference to their lives.
This way we can maximize the marginal utility gained by the spending and thereby optimize the allocation of scarce resources. It would mean that we allocate every incremental money spent on poverty elimination among those whose marginal utility with that resource is maximum.
The argument is simple, albeit politically incorrect. In any case, by spreading ourselves thin by trying to cover as many people as possible, we are giving too little help for anybody, to actually achieve our objective. The beneficiary will continue to keep coming back to us the next year demanding more assistance. We will continue to take one step forward and two steps backwards! In contrast, if we focus our resources on those at the margins we are utilizing our resources more efficiently. It helps achieve our desired outcomes, and lift the beneficiaries to a higher level of economic opportunity and growth. That will be two definitive steps forward!
Any government assistance for the poor can be divided into two broad categories. One category consists of the basic social welfare functions like primary and secondary education, primary health care, minimum social safety nets, civic services and facilities like sanitation and drinking water etc, that are intended towards providing the basic minimum civic infrastructure and services for every citizen. The other category consists of more specific poverty eradication assistance like self employment and wage schemes, many categories of subsidies, soft loans etc. This assistance is aimed at specifically assisting the Below Poverty Line (BPL) households in increasing their incomes and emerging out of their present poverty trap.
My interest is with this second category of government poverty programs. Nobody will dispute that economic development is a continuous process of movement up the income ladder. But my contention is that in the real world, for this movement to have any substantive effect, it has to be a discrete jump and not a continuum crawl. In fact, an individual is meaningfully benefitted by a government poverty elimination program only if the assistance helps him move up from a lower to a higher trajectory of growth.
I am therefore convinced that for any assistance at poverty alleviation to be effective, it should aim towards catapulting the assisted towards a higher trajectory of livelihood or growth. In other words, the poor person should be able to leverage this assistance to move into atleast the next higher income group. The anti-poverty programs should therefore trigger off a cascading movement up the economic ladder.
Any assistance which would increase the income of an individual from say Rs 20000 to Rs 25000, would surely fail to achieve this objective. It would only provide a slight repreive for the poor person. Unfortunately most of our poverty eradication programs are afflicted by this problem. In our anxiety to cover as many people as possible with our poverty elimination programs, we end up losing focus and converting these programs into poverty mitigation efforts, which is precisely what our first category of government programs are supposed to deliver.
Instead imagine, a poor person being able to leverage a specific government program assistance to move up from Rs 20000 per annum to Rs 50000 per annum. This assistance could be anythig from a soft loan to buy a tractor to scholarship for his son to be admitted for a professional course. Now we have a genuine climb up the ladder and the first victory in the battle against poverty. This jump to the next income level would invariably be accompanied by a movement up the occupational ladder too. Thus a landless farmer would move up to either own some land or preferably migrate to some more remunerative non-farm employment; a non-farm employed poor could increase his income by entering the manufacturing or the tertiary sector.
There are numerous examples. One of the ways in which we can most certainly, but only slowly, help move people up thet economic ladder is by assisting their children get admitted into a proffessional course. We need to spend our poverty elimination resources in training the more promising students among the poor to clear the entrance examinations for these professional courses, and then support them with scholarship assistance during the course period. This investment would go a long way in poverty elimination than any piecemeal division of huge resources among a large number of people.
Many of our self-employment assistance programs consist of giving small amounts of assistance to buy a sewing machine or set up a kirana shop. Having seen and interacted with thousands of such beneficiaries, I am yet to see even a single case of a sewing machine or a kirana shop propelling a poor person into a higher growth trajectory! In fact, I am convinced that most such people who benefit minimally by the sewing machine, would have purchased it even without the government assistance! Maybe, it would make sense to assist someone already running a sewing shop with one machine, to be assisted with say two or three more machines. This will atleast help him move from a being worker to being an entrepreneur. With adequate training and some linkages, we will have the ingredients in place to push him up to a higher trajectory of growth. Instead of helping 100 people in the village this year, we may be able to assist only 50. But atleast we can be assured that this 50 will not approach us again next year for assistance.
Similarly instead of giving subsidy cum soft loan assistance for purchasing a cow or a goat or a buffallo, to every farmer in a village, we may as well spend the resources more efficiently by providing the same assistance to those farmers who are already having two or three animals and can move up the income chain substantially with this additional unit of cattle.
The guidelines of these programs and the bureaucratic and political imperatives results in this distortion of objectives and dissipation of scarce resources. Typically, all these poverty alleviation programs like self-employment and wage employment assistance schemes are target oriented, with the objective of covering as many beneficiaries as possible. The implementing bureaucrats scramble to cover as many beneficiaries as possible, so as to meet their targets. The importance of numbers in a democracy, and the attendant political compulsions only exacerbates the problem. Further, most often, they adopt an one-size-fits-all approach, with the same program components and guidelines for the entire country and for all sections of poor.
It is therefore important that our poverty alleviation priorities move away from simple target-oriented output based to a more outcome-based approach. This would involve focussing on identifying the specific local needs and remunerative local economic opportunities, and the target beneficiary groups, and then delivering the critical mass of assistance required for them to move into a higher trajectory of economic growth. Instead of mindlessly covering as many poor people as possible with no concern for the quality of assistance, the objective should be to ensure that the beneficiary should not come back seeking more next year. However, to cover as many people as possible, it may be more appropriate to target all those at the margins of the poverty ladder, and lift them up to the higher growth trajectory.
The economic case for such analysis is simple. Any efficient allocation of scarce resources would demand that the total marginal utility be maximized. We should focus on helping those at the margins of each income or occupation level, who have the maximum marginal utility to be gained by any incremental unit of assitance, since they would move up to a higher growth trajectory. By helping those at the margins, we can maximize the utility gained by allocating the scarce available resources. In contrast, the most poor and the more poorer require much higher quantum of unit assistance for it to make any meaningful difference to their lives.
This way we can maximize the marginal utility gained by the spending and thereby optimize the allocation of scarce resources. It would mean that we allocate every incremental money spent on poverty elimination among those whose marginal utility with that resource is maximum.
The argument is simple, albeit politically incorrect. In any case, by spreading ourselves thin by trying to cover as many people as possible, we are giving too little help for anybody, to actually achieve our objective. The beneficiary will continue to keep coming back to us the next year demanding more assistance. We will continue to take one step forward and two steps backwards! In contrast, if we focus our resources on those at the margins we are utilizing our resources more efficiently. It helps achieve our desired outcomes, and lift the beneficiaries to a higher level of economic opportunity and growth. That will be two definitive steps forward!
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